Is QE4 coming? Of course that was just a headline to catch your attention. The Labor Report certainly was a bust and came in far lower than my expectations. However, it has certainly justified and offered an excuse for our “Data Dependent” Fed NOT to raise rates. Of course if you have been following the Market Preview, I have yet to get on board with any rate hikes. My reasoning’s have little to do with the Labor Report, which I believe is a combination of window dressings and a distraction that can be used for justification.
First we need to come to terms that QE3 ended in name only. What do I mean by that? QE is defined by the Federal Reserve printing money to purchase US Treasuries (bonds) and mortgage back securities (MBS) and other assets. The Fed has been running QE for several years (QE1, QE2, and QE3) which have expanded the Fed’s balance sheet to over $4 trillion.
Courtesy of FRED
At some point the bonds that the Fed had purchased started maturing and they started receiving their principal back. This allowed the Fed to use money from matured expired bonds to purchase more bonds. When enough bonds began maturing that allowed the Fed to stop printing money to continue their purchase program, they announced QE3 ended. When in fact it didn’t, by their own admission in the FOMC statement, they continue to purchase bonds, MBS, and assets. The only thing that changed was where the money was coming from. So QE3 ending was really semantics.
FOMC SEPTEMBER STATEMENT:
“The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.”
The facts are seen easily in their balance sheet and actions. They have not reduced their balance sheet, they continue to buy bonds and MBS, and interest rates remain at zero. Additionally, while they are not printing new money to purchase assets, they are printing new money to increase the money supply.
Courtesy of FRED
So why would QE4 be coming if QE3 never really ended? As bonds rally and yields fall, the demand for government bonds at lower yields wain and the Fed are the buyer (lender) of last resort. Additionally, if we look at their “rolling” strategy (described above, using mature bond money to purchase more bonds), the math shows that to maintain that strategy across the yield curve, they are slowly running out of short-term bond maturities to continue to fund their bond buying efforts.
To avoid QE4 the only mathematical options are:
1. Government tax revenue increases to reduce deficit spending and thus reduces bond auctions.
2. Government cuts spending and reduces deficit spending and thus reduces bond auctions.
3. Fed raise rates considerably to make bonds attractive to generate enough buyers that they no longer have to participate.
4. Fed starts printing money to continue their asset purchase program. QE4
I think we can all agree that 1-3 are not very probable outcomes, which puts the pressure on the Fed again to ramp up the printing presses to maintain their asset purchase program as the maturing bonds are not enough to fund their program.
Of course there are other creative options as well. Remember “Operation Twist”? The Fed could sell other assets to fund short-term purchases. The Fed could back via the “discount window”, a third party buyer of bonds. There are also currency swaps and the Fed could fund another “Belgium” back-door bond buying program. Of course the “Belgium” bond buying program is based merely on conjecture that the Fed was behind it or some other nation, but it is interesting and one has to wonder where Belgium received 100′s of billions to become one of the largest bond purchasers. There is also the IMF and SDR funding, which would be another back-door bond buying program. The point is someone – if not the Fed and QE4 – will need to step in to maintain the asset purchases. Whether it is QE4 is really a matter of marketing and whether the Fed can sell it for a 4th time, they have other options.
Labor Report Justification
The reason I bring up the QE4 comes about from this morning’s Labor Report. Yesterday I wrote at length the problems with the Labor Report and why I think the Fed doesn’t give it much weight as to setting monetary policy. So why would I assume it would impact QE4 option, simple – it is used for Justification of monetary policy.
Think about it – you have this very highly watched government economic data point. Everyone believes it is the most important data point in which the Fed decides monetary policy. Yesterday, I explained in detail why the Fed no longer really uses it, had removed it from their FOMC statement, and even has admitted there are significant problems with relying on it. Yet – it remains this very influential data point and the assumption remains that it IS a deciding factor.
So if the Fed wanted to change monetary policy, raise rates, lower rates, launch QE, or anything – they would need to point to something to give them justification to do so. There MUST be a reason for their action. Of course I have previously argued the real reason is the bond auctions to continue to fund government deficit spending, interest on existing government debt (currently over $400b per year), and also the massive leverage ratios that could not afford to carry to name a few of the real reasons. However, those reasons are NOT part of their “Dual Mandate” nor are they good enough reasons for politicians, citizens, or the market to understand. Therefore, they need to point to their “Dual Mandate” and the corresponding government data as the reason for their monetary policy changes.
Courtesy of FRED
With a super low Labor Report and Job Creation, it is the perfect reason NOT to raise rates, but it can also fuel the talk of another round of QE. While everyone is focused on whether the Fed will raise rates, the real shift in talk in the coming days will be about another round of QE.
The Labor Report showed a dismal 142,000 jobs created when 206,000 were expected. Last month was revised lower from 173,000 to 136,000. The U3 rate remained unchanged at 5.1%.
The market will certainly sell off, but I think it will quickly find support and when the Fed changes tune and there is NO Rate hike and none expected for this year – combined with an increase level of expectations of QE – we could see a strong rally again. I think we could be finding support very soon – coming into the October FOMC meeting. It really will be based on whether the Fed can sell and convince the market that more easing (QE) and low rates are here to stay.
This morning the 10-year bonds are rallying, sending the 10-year yield below 2%. The dollar is coming off and gold is starting to rally. Bonds, Dollar, and Gold are all pricing in NO rate hike and I think we can start seeing the pricing expectations of another round of QE.
Support & Resistance
We could crack below 16,000 but watch the close to see if we can close above it. The low support area is 15,600 – 15,800 range. I believe we will find a support area and then when talk shifts to no rate hikes and even QE – we could see a rally later on.
We could be in for a rough and sloppy support area – as we see this market jerk around. I would look at 4000 as a lower support. Watch the close for support.
The S&P 500 should see support in the 1880 range and we need to close above it into the close.
While we can see some big volatility and low moves in the Dow Jones, it is the Russell that we need to pay closer attention to. If we see the RUT stronger and holding firm compared to the other indices, it will be a good sign that we are in a support range. I would look for a strong close around the 1080 level to confirm this. If we break and close on the low – look towards 1060 area. The Russell should be the best indicator if we are seeing a race for the exits or finding support.
The Fed is certainly not going to raise rates in October or even December. The real question is whether they start up QE4 or some other stimulative efforts to boost this market. I think the talk around QE or similar program will start very soon – as these dismal Labor Report numbers will fuel that talk and consideration.
How many times the Fed can go back to the QE well and continue to keep the borrowing/spending game going is uncertain. I am not looking for any huge crashes just yet, only because the Fed hasn’t played their QE card to try to supercharge the spending again. I believe another round of QE can certainly buy some more time – perhaps another year.