EXPECTATIONS about quantitative easing (QE) have now been driven so high – with the market anticipating between $500bn and $1 trillion of extra liquidity – that someone was soon bound to call a halt to the party. That killjoy has arrived, in the form of US broker BTIG’s Mike O’Rourke.
“There are many who have QE trades on and we believe there is high risk that they will be disappointed if the Federal Open Markets Committee (FOMC) walks the way it has been talking the talk,” he wrote in a note to investors last week.
O’Rourke suggests that Ben Bernanke has completely lost control of the QE narrative, leading to expectations massively out of line with his original intentions. The Fed is therefore in a bind: disappoint and cause a correction or pander to the markets. Either way, O’Rourke points to the influence of St Louis Fed chairman Jim Bullard as evidence that Bernanke will let the extra cash dribble out of the Fed only gradually and in response to economic data. If he is correct, the FOMC’s next meeting on 2-3 November will be a nasty shock for markets that have grown increasingly reliant on a tidal wave of QE.
As GFT’s David Morrison says: “The market has priced in QE; the question is how much is priced in.” Morrison estimates $1 trillion. BNP Paribas’ forex strategist Mary Nicola puts it at $500bn over five months, followed by an additional $1 trillion if necessary. As a result, she forecast that “a weaker dollar looks like it might have more to go” and is predicting parity with the Aussie and loonie by the end of the year.
But the truth is that the Fed’s lack of clarity has kept everybody guessing. The realisation that huge QE inflows are not a given seems to have knocked the dollar upwards in the last few days, as CMC Markets’ Michael Hewson notes: “The Fed chairman’s comments about the difficulties in determining the pace, size and costs of any purchases has given the markets pause for thought.”
A pause is well-advised. If the Fed is not sending clear signals, after all, neither is the US economy. A reasonably strong earnings season and good retail figures on Friday are matched by persistently high unemployment and a struggling housing market weighed down further by the foreclosures mess.
As Charles Schwab’s Kully Samra says: “Adding more cash into the system isn’t necessarily going to change things. The problem is not the amount of money. It’s the velocity of money – the amount of money left on the sidelines (see chart).”
The truth is that for the US economy in the long-term, it might not matter what the Fed does. In the meantime, dollar traders are left guessing how much QE the market has banked on and how much Bernanke will deliver.