Is QE 3 Any Good?

On 13th September 2012, the Federal Reserve’s Open Market Committee (FOMC) announced Quantitative Easing 3 (QE3). This round of quantitative easing will see additional purchases of agency mortgage-backed securities (MBS), at a pace of $40 billion per month. The FOMC also announced that it will extend the average maturity of its existing holdings of securities/Treasuries through to the end of the year; reinvest principal payments from agency debt and mortgage-backed securities back into mortgage-backed securities; and maintain near zero fed funds rate (0-0.25%) through mid-2015.

These actions will increase holdings of longer term securities by $85 billion a month through the end of the year. The Federal Reserve Bank of New York’s statement confirmed that the additional purchases of agency MBS will start on 14th September 2012, and will likely total $23 billion by the end of September.

 

The goal of the FOMC’s actions is to (flatten the yield curve) “put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodating”.  Its move to maintain the target federal funds rate at 0 to 0.25%, aims to “support continued progress towards maximum employment and price stability” and “anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.” The FOMC was also concerned that “without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labour market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.” What is significant is that the Fed left the policy open-ended, which means they are willing to commit for a longer term.

Following the announcement of QE3, we saw the markets rising across the board; however this may be purely based on investor sentiments following the Fed’s action. The effect of a fiscal policy may only be seen in a longer term. On 26th July, the S&P fell for a fifth straight day – the longest since July and erased its gain since QE3 was announced.

How we see it is – Equities will continue to rise as long as job numbers, manufacturing data and housing numbers continue to improve, and with the QE3 taking place we expect this number to improve! As mentioned above, this may not happen overnight, we expect to see this in the next 3 months.

However, like QE1 and QE2, such stimulus measures are not meant to be programs that should be sustained for long periods as it doesn’t solve problems but just buys time for a proper solution to be in place.  The FOMC’s measures can only help to create a supportive economic environment. A real plan needs to be in place to create and sustain long term job growth.  Such a plan must come from the president himself, and it’s likely that we won’t see anything until after the presidential elections. How effective any plan will be, is going to be dependent on the details itself.  But it must create enough jobs to replace the ones that were lost during the financial crisis (automaker and financial sectors).

According to the U.S. Bureau of Labour Statistics, US unemployment in August 2012 was 8.1% (which is still a very high level).  The only way that jobs will be created and sustained is if companies grow and expand which results in them hiring more employees.  Manufacturing and housing data will follow only if long term employment can be created.  As such, similar to QE1 and QE2 we do not believe QE3 measures are meant to fix the economy permanently.

 

To take advantage of the temporary rally we may see from the improving economical data from the effects of QE3, we have increased exposure to US equities.

Risks are increasing globally. If Europe’s problems are not solved, the Euro and the EU will face a further probability of collapse.  Growth creators are desperately needed in Europe, and there are no signs of that on the horizon. China’s credit crisis is bursting, and the situation is continuing to spiral out of control as the repercussions of shadow banking problems and bad loans come to the forefront. Even China’s official economic data can’t hide the ugly situation there. Huge stimulus packages are being put into place, but the country also needs to worry about controlling inflation and rapidly declining revenues from the country’s largest industries.  There is still a long way to go until we see the full impact of the economic crisis from the world’s second largest economy. This may eventually drag equity markets down on a global basis, which would be a buying opportunity for our defensively allocated portfolios.

We are still pessimistic towards European equities, as such we have little or no exposure to the European region. As for China, we have exposure towards the Chinese market through our Asean investment. Though the Chinese economy seems to have stagnated, we believe there is still room for growth for the Chinese companies and believe effective fiscal policies by the leaders may see an improvement in the second largest economy in world.

As a result of QE3, we have seen gold nearing USD 1,800 due to the anticipation of inflation. The large amount of money printing from the largest economies of the world make massive inflation more likely, however inflation does not seem to be the matter of concern at this period, though it is certain. With this in mind, our portfolios do have exposure to gold.

Commodities will also see price rise in the short term – the next three months – due to the depreciation of the US dollar which is the main currency it trades in. However in the mid-term as demand continues to decline mainly from Europe and China, commodity prices are most likely to fall. In the longer term, we expect to see China and the developed economies getting back into growth mode which will then cause commodity prices to increase due to demand. We have started taking small positions on the sector and aim to have a significant holding in the commodity sector by the end of the first quarter of 2013.

With markets reacting the way they are, we believe in firstly protecting capital and achieving growth by taking advantage of short term rallies, and our mixed asset investments are performing just the way we want.

 

For more interesting articles, please visit our CEO's blog: www.stuartyeomans.com

 

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