Is QE3 Coming?

Bloomberg.com – Pimco’s Gross Says Fed May ‘Hint’ at QE3 at April Meeting
Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said the Federal Reserve will probably signal it plans to arrange a third round of debt purchases when policy makers meet in April. The end of tax breaks enacted by President George W. Bush and $1 trillion of mandatory federal budget cuts are raising concern that declining unemployment will give way to slower economic growth that requires support from the central bank. Policy makers under Chairman Ben S. Bernanke have purchased $2.3 trillion of Treasuries and mortgage debt in two rounds of so- called quantitative easing, known as QE1 and QE2, as they try to sustain the expansion. The Fed is “likely to hint” at QE3 at its April 25 gathering, Gross wrote on Twitter.

Comment

Gross is so plugged in to the FOMC it is as if he is the de facto Federal Reserve chairman. His comments on Federal Reserve policy hold the same weight as the WSJ’s Jon Hilsenrath (aka “the Federal Reserve’s mouthpiece”).

Recall that the first tweet Gross ever sent told everyone to expect Operation Twist by fall, which is largely what happened.

In the last week, many members of the FOMC argued in favor of ending any form of QE, citing rising inflation expectations. See the story below.

Gross is telling us to ignore this sentiment. The printing presses are still on and another edition of QE is coming.

How will the market take this? Will it embrace risk assets (stocks) because more money printing is coming or will it worry that the Federal Reserve is going too far and inflation is coming back?

We fear the latter. As we have pointed out before, traders now have a better grasp on the effect of QE on the markets.

Stocks peaked seven weeks after QE1 ended (the market was slow to understand QE)
Stocks wised up and peaked three weeks before QE2 ended

Following this pattern, we have argued that this time stocks will peak on the announcement of QE3. Is the hope of QE3 one of the supporting reasons the S&P is up 11% YTD? In other words, has the market already experienced the QE3 rally (buy the rumor) and will its announcement mark a peak in risk assets (sell the news)?

If we are correct that stocks (risk assets) fail to advance on more QE, inflation fears will be cited as the reason.

Bloomberg.com – Fed Purchases of More Bonds Opposed by Two Regional Presidents
Two Federal Reserve district bank presidents said the strengthening U.S. economy is reducing the need for additional monetary easing. “As the U.S. economy continues to rebound and repair,” additional steps “may create an overcommitment to ultra-easy monetary policy,” St. Louis Fed President James Bullard said in a speech yesterday in Hong Kong. Atlanta Fed President Dennis Lockhart said in Washington that “we should hold the balance sheet where it is for the time being and watch how the economy evolves.” The remarks from Lockhart and Bullard, who have never dissented from a decision by the Federal Open Market Committee, reflect broadening sentiment on the panel against further steps to spur growth. The Fed has held interest rates near zero since 2008 and purchased $2.3 trillion in bonds to spur growth after unemployment rose to as high as 10 percent in 2009. The jobless rate is now 8.3 percent, and the economy has been expanding for more than two years.

Click to enlarge:

Source: Bianco Research