What was that about QE3? | FT Alphaville

What was that about QE3?

US stocks ended their bear run on Wednesday but it was tin hat time again on Thursday morning.

Idle QE3 chit chat between three former Fed directors and the Wall Street Journal was cited by many as the reason for Wednesday’s about-turn. With central bankers meeting at Jackson Hole, scene of Ben Bernanke’s QE2 announcement last year, on August 26, there was hope of a repeat performance.

Fundamentals, both American and European, appear to be back ahead of Friday’s non-farm payrolls but Stephen Lewis of Monument Securities makes the additional point that recent declines may be as much to do with the end of QE2 as a lack of QE3. The Fed view is that QE3 works via a stock — not a flow — effect but Lewis thinks this could well be bunkum.

Still, there are strong grounds for arguing that the latest slide in US equities reflects, more than any other factor, the termination of the Fed’s QE2 Treasuries purchases on 30 June. The equity market is behaving much as it did following the end of the QE1 asset purchasing programme in March 2010. Then, equity prices went on rising through much of April 2010 before peaking on 26 April, seventeen trading sessions after the end of QE. This time, the market’s advance extended to 21 July, fourteen trading sessions from the end of the Fed’s asset-buying. It presumably takes a little time for the recipients of Fed liquidity to commit those funds to the capital markets, hence the short lag between the end of QE and the market peak. Some observers might contend that, on both occasions, market confidence in the economy turned down and this was the primary factor undermining equity prices.

However, disentangling causes from effects is far from straightforward. It may be that the weakening in market confidence reflected the fact that the Fed was no longer injecting liquidity. Supporting this view is the observation that, in the latest episode, the equity market kept on rising even after the June non-farm payrolls report had provided objective evidence of weak economic activity. If investors were really responding to views on the economy, equities would surely have turned down when the payrolls figures were released and not waited for a further two weeks to begin their decline. The Fed’s argument has been that it is the stock, not the flow, of QE that matters most. The past month’s experience points in the opposite direction. Dr Bernanke is probably beginning to realise that he has a junkie under treatment.

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