Markets seem to be undertaking a form of "hyperbolic discounting" in their reaction to the moves by the Fed to the next stage of Quantitative easing. We really have a jaundice view of this and feel that equities are way ahead of themselves on this front because we just can't see the outcome that will satisfy the expectation.
The Economist magazine has an article titled "it's all up to the Fed - The Fed will try to force the economy into orbit with more bond purchases" which highlights what markets seem to be expecting in its title. The article looks at the challenge ahead for the Fed and the US economy. It's worth a read if you get the time but the intro is our favourite bit:
"ROCKET science may be out of fashion on Wall Street, but it still has a following at the Federal Reserve. All year long officials there have looked for signs that the economy has reached “escape velocity”: growth that is strong enough to bring down unemployment once the propellants of government stimulus and inventory replenishment are spent....Such signs remain maddeningly elusive." Our Bolding
http://www.economist.com/node/17258945?story_id=17258945&fsrc=scn/tw/te/rss/pe
To our mind the point of quantitative easing is to get money sloshing around the economy and get a little bit of inflation working through the economy. In this way, so the theory goes, people’s, or should we say consumers, behaviours will be returned to their thriftless ways of spending not saving what they earn and have. It’s the role that mortgage equity redraw played in the recovery from the post September 2001 lows and the early decade economic weakness. Indeed we remember Chairman Greenspan in a speech in 2002 or maybe 2003 lauding the fact that US home owners had buttressed the economy from the worst of the possible economic decline by using mortgage equity redraw as a tool for consumption. Gary Shilling, the doyen of US Economists, has often shown that were it not for Mortgage Equity Redraw the US growth rate for 2001 and the subsequent 3 years would have been negative. That is people used their homes (fixed asset) as a line of credit to finance in what large part appears to have consumption (recurrent expenditure).
To our mind the point of quantitative easing is to get money sloshing around the economy and get a little bit of inflation working through the economy. In this way, so the theory goes, people’s, or should we say consumers, behaviours will be returned to their thriftless ways of spending not saving what they earn and have. It’s the role that mortgage equity redraw played in the recovery from the post September 2001 lows and the early decade economic weakness. Indeed we remember Chairman Greenspan in a speech in 2002 or maybe 2003 lauding the fact that US home owners had buttressed the economy from the worst of the possible economic decline by using mortgage equity redraw as a tool for consumption. Gary Shilling, the doyen of US Economists, has often shown that were it not for Mortgage Equity Redraw the US growth rate for 2001 and the subsequent 3 years would have been negative. That is people used their homes (fixed asset) as a line of credit to finance in what large part appears to have consumption (recurrent expenditure).
Now we know where that has got them now and as stretched as the analogy might be with quantitative easing that’s what the Fed and policy makers seem aimed at trying to do. They want to get a bit of inflation into the system to get people spending again. But we know that the net equity position of many US households has been eroded and we know that with almost 10% unemployment and another 7 or 8% underemployment getting consumers spending in such a manner so as to give the recovery self sustaining momentum will be difficult. Which brings us back to our sceptical position on the impact of QE and its efficacy.
One of the things in finance that irks us is just this point – we are about to see another theory rolled out and tested in real time on the world’s biggest economy with no surety of its efficacy and the only live experiment in Japan having shown that it has limited benefit. Thankfully drug companies can not unleash cures on us like this. So as David Blanchflower said overnight QE does not work quickly (perhaps at all) and we are going to need to see a very large program of buying.
No wonder currencies are being pursued as the easy fix.
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