Mixed picture emerges as QE2 ends

The Star Online > Business
Saturday June 11, 2011

Mixed picture emerges as QE2 ends

By FINTAN NG
fintan@thestar.com.my

June 30 is a date that investors will be looking to with trepidation as it's the day the US Federal Reserve's second round of quantitative easing (also known as QE2), ends.

In fact, pundits have been pondering the future beyond QE2 since end-March.

With recent macroeconomic data indicating a slowdown, the question being asked now is how will the end of the latest round of bond-buybacks by the Fed impact the markets?

What will the impact be across asset classes such as the US dollar, equities, bonds, oil, gold and other commodity futures in light of the slowdown?

Most strategists will already have told their clients to review their positions across asset classes as June 30 nears if they have not done so. They also see a potential market correction.

Some like Oversea-Chinese Banking Corp Ltd analyst Barnabas Gan believe that gold prices may be supported by inflationary pressures and political risks.

He said in an April 14 report that while the end of QE2 would see inflation easing due to there being no further increase in liquidity, higher food and energy prices would still outweigh the effects from QE2.

For Asian equity markets, the end of QE1 in March last year saw the benchmark MSCI Asia ex-Japan index fall 16% as investors fled to gold and short-term US Treasuries.

This may well happen again when QE2 ends although analysts feel that any pull-back this time will be moderate despite the worse-than-expected macroeconomic numbers because compared with a year ago, economies are in a better footing.

On the bond markets, a number of analysts agree that 10-year US Treasuries (the focus of QE2 purchases) will likely see yields rise as demand recedes.

Others see corporate bonds as still a buy despite the slowdown because profits are still being made and banks have stronger balance sheets.

Broadly speaking, quantitative easing involves the increase of the money supply which is then used to buy government bonds and other financial assets such as mortgage-backed securities and corporate bonds.

This is done in order to inject liquidity into the banking system and reflate asset classes so that confidence will be restored which then hopefully will stimulate spending and investments.

In the context of the United States, QE1 was implemented between early 2009 and early last year to provide greater support to mortgage-lending and the housing market.

QE2 was unveiled last Nov 3 following hints from Fed chairman Ben Bernanke late last August that another round of stimulus will be needed to support growth and in particular to lure investors back to riskier assets such as equities.

The Fed implemented QE2 at a time when there was a threat of deflation, that is, in economic-speak, a decrease in the prices of goods and services due to a lack of demand as consumers wait for prices to fall further.

By the time QE2 ends, the Fed will have purchased US$600bil worth of US government bonds in addition to the US$1.75 trillion acquired in the first round.


Slowing growth hurting

Investors' lack of confidence is already being reflected in the US markets, which have been falling since the beginning of the month. When Bernanke did not hint on Tuesday at whether there would be any more stimulus such as a QE3, markets again reacted by dropping.

While US markets closed in positive territory on Thursday after data showed the trade deficit narrowed (due to a weaker greenback), this will be a temporary reprieve since unemployment remains high and the housing market weak.

The slower US growth will also impede global economic growth as demand for goods and services drop. This will impact emerging Asia's export-driven economies the most.

Global indicators are showing this slowdown with the US Institute for Supply Management manufacturing gauge contracting to 53.5 last month from 60.4 in April, the third straight month of decline and the lowest in 13 months.

Similarly, Malaysia's industrial production index, which measures manufacturing activity, fell 2.2% in April from a year ago with regional peers also seeing declines.

China's official purchasing managers' index (PMI) for May showed a slight decline to 52 from 52.9 in April and the PMI reading provided by London-based Markit showed eurozone PMI for May fell to 54.6 from April's 58.

The US Conference Board Consumer Confidence Index decreased to 60.8 in May from 66 in April while the eurozone's consumer confidence index unexpectedly improved in May to minus 9.7 from April's minus 11.6.

Furthermore, the International Monetary Fund has cut Japan's gross domestic product (GDP) forecast to minus 0.7% for the year from 1.4% and the Bank of England left benchmark lending rates unchanged due to sluggish growth even though Brits face 4.5% inflation.


Is there a silver lining?

For some observers, the objectives of QE2 have been met when measured by the easing of lending conditions, the lower yields on long-term US Treasuries and a rise in inflation expectations.

The rise in inflation expectations (via the reflation of assets) is important as this will signal that QE2 is working while lower yields on long-term US Treasuries have induced investors to move into riskier assets, in particular equities.

The question is how will US equity markets fare in the face of higher unemployment and a weak housing market, which economists say may last for a few more years?

Participants at the Reuters 2011 Investment Summit said a QE3 was unlikely because the US economy was showing signs of growth despite a slew of weaker economic numbers, a Reuters report from Thursday showed.

They felt that the weaker numbers might just be temporary as US GDP grew 1.8% in the first quarter and is forecast to grow by about 2.5% in the second.

“I kind of think this is transitory. The (economic) numbers are already starting to reverse,” Richard Bernstein, chief executive of Richard Bernstein Capital Management LLC said.

Charles Schwab Corp chief investment strategist Liz Ann Sonders pointed out that stimulus measures should cease after QE2 so that the US economy could stand on its own.

“It's high time we just chill for a little bit and see if the economy can stand on its own. Stop with this excess stimulus. We are not a fan of any suggestion of QE3,” he said.

Source/转贴/Extract/: The Star Online
Publish date:11/06/11