What will Dr. Ben Bernanke announce tomorrow? By a slim margin, let me suggest the odds favor Ben doing The Full Draghi i.e., threatens to ‘do whatever it takes’ to help the economy and job market. But no QE3. Not until after November 6th at the earliest, and potentially not ever. (let me reference my letter from summer 2011 regarding the perils in QE3 –and why it should not be launched. click here to read that page.)
Tomorrow, Dr. Bernanke will either :
1) Do The Full Draghi.
2) Announce a small round of QE (say $400-600B) that will begin in December or January. (Half a trillion dollars is now considered a small amount of money?) Also note that this could be marketed as a $1T Fed program by including the $50B/month being spent to maintain the current size of the Fed’s balance sheet via Operation Twist (if the program were to be extended to June next year).
3) Announce a very big round of QE (say $2-3T –or don’t set a limit!) that will begin in December or January. A coordinated central bank effort would raise the total printing to the $6-8T range. This sort of drastic and desperate option might be (ill) considered when it has become obvious short term QE programs are ineffective, thus encouraging an ‘all-in’ move.
I’m going to take option #3 (a $2-3T QE3) off the table first. The Dow at 13300 is not where Ben is going to want to use-up his last monetary nuke. This move -when/if it happens- will be a game changer. The program would probably last two years or so, and it would cause a massive spike in inflation. The ramifications for this on global economic stability are dire. Food & fuel inflation would rise in dramatic fashion. Social stability in developing countries would be tenuous. For that matter, it would also be tenuous in Europe and eventually even here in the US. From a PR point of view, a monetary policy action of this size would have been integrated with last week’s ECB announcement. For an event as epic as this, the ECB and Fed could figure out a way to align their schedules and press conferences. So no, I doubt we’ll see a major QE effort announced on Thursday. For the sake of handicapping, let’s call it a 10% chance.
Let’s address option #2. The US stock market is priced for Bernanke to announce option #2 i.e., a smallish $400-600B QE program that would focus on mortgage backed bonds but might also extend operation twist more heavily into longer maturity US Tbonds. I give this a 40% chance, yet Wall St is probably closer to 70%. A small QE3 announcement is not a slam dunk on Thursday for several reasons:
- More QE will not solve the problem, and Ben knows it. He therefore knows that since we’re into the diminishing returns of QE, it is clear that both he as well as the Fed as an institution would lose more credibility by the time next summer comes around sporting an economy and jobs market that are no better, but with higher inflation. At all costs, Ben must maintain the illusion that the Fed can solve any economic problem it is given. Were it to become common knowledge that the Fed’s bag of tricks has reached the point where there are no goodies remaining with an ability to keep the party going, we’d face a loss of confidence in the economy and the financial system. In effect, we’d have to ride without training wheels. That’s not something the US economy has had to do for a quarter century — since before the perpetual ‘Greenspan put’ began to distort the economy in 1987.
- Ben must know that more QE means he’ll be feeding our QE addiction, and will continue to let our politicians off the hook.
- Worst of all, it will raise the pressure on the Fed to launch a much larger QE when the effects of a latest dose wear off in 2Q next year. Surely he does not want that problem.
Having Ben announce a smallish QE3 program would likely propel the S&P500 to 1500 by October, and flirt with an all-time high (1560) in January. Then it is “once more unto the breach, dear friends.” (from King Henry V by William Shakespeare). I would expect any significant amount of QE to induce the Greedometers to blow-out to all-time highs i.e., indicate we are on the doorstep of the largest stock market collapse ever.
So we’re left with option #1 : Ben does The Full Draghi and disappoints by not launching more QE. I give this the remaining 50% chance. Consider what happens if this unfolds. The risk-on bet will come to a screeching halt. A drop in the S&P500 from the 1430s to the 1000-1050 range by year-end would be entirely probable. And unless a large QE3 program is launched in Q1 2013, I’d look for the S&P500 to drop to 500 (or so) by March. Given how Ben apparently pays so much attention to the US stock market, he’s not going to like this reaction. But even this is preferable to the collapse that would happen after a QE3 program that fails to do appreciably more than induce inflation and another sugar-rush-inspired stock market rally. An announcement devoid of QE3 would cause a rush to US currency. By the end of this year, the yield on the 10yr Tnote would flirt with 1.1-1.2%, and the long bond would probably touch 2.5% as fear would drive investors to perceived safety. Note I write perceived safety on purpose. Panicked investors flocking to US Treasuries will drive the price up (and therefore the yield down). But when inflation eventually takes hold, those investors will get crushed (buy high, sell low). In the short term (by year end), mortgage rates would drop to all-time lows, helping to put a floor under what will be a fairly rapidly falling housing market this winter. That’s right. By not directly supporting the mortgage bond market, mortgage rates would probably drop.
The Fed has taken actions to forestall economic collapse because monetary policy steroids have been the only game in town. The failure of politicians to design and implement responsible but unpopular fiscal policy (cut spending / raise taxes) created this situation. The past two weeks have provided an opportunity to hear more half-truths and a complete lack of a credible plan to address our debt and spending problem. So I can understand why the Fed may feel it is going to be the only game in town for a long while to come. But this view is flawed. There is another player in the mix called the bond market. This player has a powerful truth serum with an ability to bring politicians to their knees, forcing them to take actions that are responsible. Per Moody’s comments earlier this week — next year the bond market will begin to apply its truth serum on whomever wins in November, in search of a plan to ensure we do not end up with a Greek-like 150% debt:GDP by 2020 (because that’s the path we’re on).
Fear not, Ben. Help is on the way. In the meantime, keep improving your Full Draghi impersonation.