This is becoming something of a trend.
An ever-increasing number of strategists - George Magnus excepted – are taking the view that another dose of QE won’t work. In fact — it could make things worse.
Here’s a couple of notes that have landed in FT Alphaville’s inbox in the past day. The first comes from JPMorgan’s European Credit Team (emphasis ours):
The risk market reaction to a further expansion in the size of the Fed’s and other central banks’ balance sheets is a key issue, in our view. The current wisdom appears to be that more quantitative easing (QE) would be a good thing. If you believe more QE would stymie the upward pressure on market volatility from lower growth then, yes, more QE would probably be a good thing as far as credit markets are concerned. If, however, you believe markets take a more sceptical line – that this is a trick we’ve seen before, that it didn’t really do what it said on the proverbial tin first time round, so why should it the second - then there are likely to be diminishing marginal benefits from more QE. If this were the line risk markets were to take, you might additionally argue that there are increasing marginal risks from a further expansion of the Fed’s and other central banks’ balance sheets.
Meanwhile, over at Unicredit, strategist Tammo Greetfeld has been investigating what would happen if the Fed purchases a further trillion dollars worth of Treasuries — a move that would swell its current holding of $780bn by 130 per cent!
Based on work by the New York Fed, Greetfeld says it would shave just 25 basis points off 10-year Treasuries, because of among other things the law of diminishing returns:
The more Treasury securities the US central bank already holds, the lower the effect of further purchases becomes. Net for net, we therefore assume that even a massive additional program for the purchase of Treasury securities totaling one trillion USD would lower the yield level by only approximately 25 basis points.
And in any case the transmission channels are now so clogged, it’s doubtful that lower interest rates would reach through to the real economy:
After the first securities purchase program of the US central bank, mortgage rates fell approximately 150 basis points. However, a recent study published by the San Francisco Fed shows that the number of refinancings has fallen far short of the value that would have been expected at these attractive rates.4 That means that many home owners are not benefiting from the lower interest rates. As reasons for this, the study cites various factors related to the bursting of the housing bubble: stricter lending standards, lower demand for real estate (normally, refinancing happens on the sale of a home), and a high number of foreclosures (even lower rates do not benefit households whose mortgage is “under water”). All these factors would not be changed by even lower yields and mortgage rates. Accordingly, the impact of additional quantitative easing on household finances and, therefore, private consumption will be limited.
But the impact on the dollar might not be. As Greetfeld goes on to add:
The reason for the current strength of the US dollar is that investors consider the greenback a safe haven investment in times of crisis. But exactly that could change because an even more expansive monetary policy. If the US central bank were to decide to purchase even more Treasury securities, this could easily undermine confidence in the Federal Reserve and the US currency. With such a move, the US central bank would after all be entering unchartered monetary policy territory
At the end of July, the Congressional Budget Office (CBO) outlined in graphic terms the risks of a debt crisis and, in the process, even cited the USA in the same breath as Argentina, Ireland and Greece (see chart on the right).6 In such an environment, further purchases of Treasury securities by the US central bank would inevitably rekindle the debate over the monetization of the federal debt. That would fuel inflation concerns, trigger a loss of confidence in the US central bank and, ultimately, result in a weaker US dollar. In this way, the more expansive monetary policy would stimulate exports – albeit at a high price. If foreign investors would lose confidence in the US dollar, interest rates rise and investment falls.
Ben Bernanke, are you listening?
Related link:
Uncooperative QE – FT Alphaville