In the past three years, the U.S. Federal Reserve Board has ridden to the market’s rescue – twice – with unconventional measures to stimulate growth. Economists and strategists aren’t convinced that a third time would be a charm.
As investors contemplate the possibility of so-called “QE3” – a market-buoying third round of quantitative easing by the Fed – experts caution that the timing isn’t right. And, they say, another round of monetary stimulus may not improve the conditions that have been undermining the markets in the first place.
“We worry that the feel-good factor from QE3 will be more muted than it was ... last year, largely because many believe that QE2 was a failure in terms of stimulating growth,” said Mark McClellan, managing editor of U.S. Investment Strategy at Montreal-based financial research firm BCA Research Inc., in a special report published Monday.
“Monetary policy cannot cure all that ails the economy,” he said.
The markets turned upward Monday amid growing hopes that Fed chairman Ben Bernanke will hint at further stimulus measures at a major speech at the end of this week at the Kansas City Federal Reserve's annual symposium in Jackson Hole, Wyo.
A variety of moves are thought to be under consideration, ranging from QE2-style purchases of bonds to reducing the interest rate paid on excess bank reserves held at the Fed, which would encourage banks to increase their lending.
But many Fed watchers think investors may be disappointed in what Mr. Bernanke has to say.
“I’m not convinced that we’re going to get QE3 in the very near future; I think inflation will get in the way,” said Paul Dales, senior U.S. economist at Capital Economics. With U.S. consumer price inflation running at a steep 3.6 per cent annual rate, the Fed is unlikely to make a major policy move that would add to the inflationary pressure, he said.
He predicted that the Fed would have to be convinced that inflation is peaking before it would consider QE3. “The markets have gotten ahead of themselves,” Mr. Dales said.
Given that the goal of quantitative easing is to drive down long-term interest rates to stimulate lending and spending, experts aren’t sure QE3 can do much more than has already been achieved. And the Fed has helped do that in recent weeks without resorting to expensive and politically controversial stimulus tools – just words.
Since the Fed came out of its monetary policy meeting two weeks ago pledging to keep its benchmark rate at near-zero through mid-2013, the yield on the 10-year U.S. government bond has fallen nearly half a percentage point, to about 2.08 per cent.
Meanwhile, QE2 has shown that low rates haven’t sparked the desired borrowing and consumption that are needed to kick-start the U.S. economy – raising questions about the value of a QE3.
“Borrowing rates are already extremely low and are not at a level that would curtail spending, so lowering them further is unlikely to spark much more spending,” Mr. McClellan wrote. He said the credit marketplace “remains largely blocked, because banks are still fixing up their balance sheets and the private sector is reluctant to borrow.”
Many economists believe the Fed will feel compelled to introduce some form of additional stimulus if U.S. economic and job growth continue to stagnate. If nothing else, any move by the Fed would improve confidence that policy makers are tackling the problem. “I think confidence management is a big part of the Fed’s job now,” Mr. Dales said.
But they noted that market confidence got a boost when QE2 was introduced – and the effects didn’t last, as ultimately the stimulus efforts were no match for a waning economy. Investors won’t be so easily impressed this time around, experts cautioned.
“The positive reaction in risk assets might be more muted this time, and could even be subsequently unwound,” said Mr. McClellan. “If investors do not see an immediate positive impact on the economy of the policy stimulus, a sense of hopelessness could set in that sends risk assets lower.”