As QE2 ends, market debates Fed’s next move


The Federal Reserve ends its $600 billion bond-buying program, known as QE2, on Thursday and has yet to offer any hints of more monetary easing to come. That hasn’t stopped investors from wondering what new tricks the central bank may have in its repertoire if the economic crisis continues in the second half of 2011.
Bill Gross, manager of PIMCO, the world’s largest bond fund, said last week the Fed may signal as soon as August that it stands ready to print more money if the economy worsens and recession starts looking like a real possibility.
“I’m surprised at how quickly talk has turned to QE3. It began even before QE2 had ended,” said Gregory Whiteley, who manages the government debt portfolio at DoubleLine Capital, a Los Angeles-based fund with some $12 billion in assets. “But it’s a bit like automakers who offer incentives to buy. People get hooked on them, and before one program ends, they’re thinking about when the next one will come along.” Not everyone thinks the Fed will act quite so quickly. Including QE2, the central bank’s unprecedented policies in recent years have pumped $2.3 trillion into the financial system.
After a recent run of weak economic data, Fed chief Ben Bernanke said last week that “a little bit of time to see what happens would be useful” before taking more policy decisions. In a Reuters poll of 24 fixed income strategists this month, the median probability of QE3 was 20 percent.
A poll of 46 economists in May had even longer odds of 15 percent.
But timing for the Fed has not been ideal. The end of QE2 comes just as the U.S. economy is losing steam. Growth slowed sharply in the first quarter and data has yet to signal a quick recovery. The jobless rate remains above 9 percent.
“Part of the Fed’s mandate is to support full employment, so they will have to stay involved,” said Quincy Krosby, investment strategist at Prudential Financial, with $859 billion in assets.
“They will have to get more imaginative.”
How the Fed would do that depends largely on whether one thinks QE2 and all its side effects were worth the trouble. The policy was launched late last year to keep a fragile U.S. economy that had just endured the worst recession since World War II from falling back into recession. The risks at the time were real. Recovery had stalled, prices were falling, the jobless rate was rising and stocks had gone into a multi-month swoon.
“QE2 was an extraordinary policy tool designed to stave off deflation and it has clearly worked,” said Alan Wilde, who helps manage $50 billion at Baring Asset Management in London. “I’m surprised central bankers have not tried to take more credit for getting some inflation back into the system. They should be shouting this from the rooftops.”
But while all that cheap money sparked a stock market rally – the benchmark S&P 500 is up some 25 percent since August 26, 2010, the day before Bernanke hinted QE2 was coming – it also helped boost oil prices, which hurt consumers and did little to encourage job growth or revive a moribund housing market.
It weakened the dollar, which makes U.S. exports cheaper and theoretically helps growth. But that has stoked inflation abroad and, some say, threatens to raise U.S. prices as well. Greg Michalowski, chief currency analyst at FXDD, said the mixed results may make the Fed think twice about another round. “I think maybe one of the reasons why they’re not doing QE3 is because, well, you know, (QE2) didn’t work.” he said. “Oil prices went up. Money went into speculative things. It (hasn’t) gone to lending. It’s going to speculation.”
Wilde said he thinks “QE3 is still a long shot,” but added that persistent below-trend growth or rising unemployment mean “a further round (of easing) cannot be ruled out completely.”