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Gold and "risk" assets
rally whenever traders get the faintest scent that more QE (a central bank
program designed to increase the money supply) is coming. Our view is that
while more QE will eventually happen, buying in anticipation of such a policy
move is fraught with danger.
Things are
bad enough in the euro-zone (EZ) to justify* more QE at any time. Also, the
rate of monetary inflation is low in the EZ, which lends support to the
assertion that the ECB could do more good than harm by pumping money into the
economy. However, the Fed is not in a position to implement another QE
program in the near future, for the following reasons.
First, QE2 is
widely (and correctly) perceived as a failure. In particular, a critical mass
of people is aware that QE2 elevated the stock market and the cost of living,
but did nothing to improve economic conditions for the average person.
Second, with
the election less than 5 months away there would be a huge political backlash
against the Fed if it initiated a new round of QE without an airtight excuse.
To be politically feasible, the QE would have to be in response to a US (not
EZ) economic emergency. To put it more clearly, things would have to get much
worse for the US economy, the US stock market and/or the US banking system
before more Fed QE would become a politically viable option.
Third, given
the current grotesque size of its balance sheet the Fed would rather reduce
than increase monetary accommodation. That's why the actions it has taken
over the past 11 months have changed the mix of items on its balance sheet
but haven't increased the balance sheet's overall size. More QE would result
in a large increase in the Fed's balance sheet, which the Fed would prefer to
avoid if at all possible.
Here is
another point worth contemplating. Even if we make the dubious assumption
that the Fed is prepared to adjust monetary policy to improve Obama's chances
of being re-elected, there is no guarantee that more QE over the months ahead
would help achieve such an objective. It could actually achieve the opposite.
This is because beyond knee-jerk reactions in all markets, there's a
realistic possibility that a new QE program would do nothing other than raise
the prices of oil and gold (and silver -- when we say gold we mean gold and
silver) while the economy continued to weaken. In fact, the only price that would
be sure to make a large and sustainable gain on the back of more QE is the
price of gold. There was a preview of what we are talking about on 1st June,
when much weaker-than-expected US employment data sparked the idea that more
QE was on the way. Gold quickly rose $60 while the
prices of most other assets fell.
As an aside,
the Fed could take a backdoor approach to increased monetary accommodation by
encouraging the commercial banks to lend more money into existence. This is
something we discussed last year and could be done by cutting the interest
rate paid by the Fed on excess reserves or, if that failed to provide
sufficient incentive for the banks to put the reserves to work, charging the
banks to hold excess reserves. This course of action could boost the money
supply without drawing unwanted political attention to the Fed.
Summing up,
the prices of many assets will probably move a lot lower between now and when
the Fed announces a new monetary inflation program. Furthermore, if
speculators 'jump the gun' and bid up asset prices in anticipation of future
Fed-sponsored inflation they will eliminate the justification for the
inflation. In other words, the more that prices rise
in anticipation of a new round of QE the less reason there will be for central
banks to implement a new round of QE.
The upshot is
that there is a lot more to be lost than gained by making large purchases of
anything in anticipation of QE. A more prudent approach would entail waiting
for the formal announcement before establishing QE-related trading positions.
The right positioning could then be determined based on market prices at the
time.
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