The talented people at Zero Hedge makes a hard hitting analysis of the next phase of quantitative easing by the Federal Reserve. Their estimate for the whole so-called QE2 is stunningly 3 trillion dollar – almost the double of QE1 with a price tag of 1,7 trillion. Here’s some highlights, and link to the full report.
Perhaps at this point it is prudent to recall what the first definition of credit is:
1. Belief or confidence in the truth of something.
By that definition, America‘s “credit” has ran out.
Recently the debate over when QE2 will occur has taken a back seat over the question of what the implications of the FED’s latest intervention in monetary policy will be, as it is now certain that Bernanke will attempt a fresh round of monetary stimulus to prevent the recent deceleration in the economy from transforming into outright deflation.
Whether or not the FED will decide to engage in QE2 on its November 3 meeting, or as others have suggested December 14, and maybe even as far out as January 25, the actual event is now a certainty.
And while many have discussed this topic in big picture terms, most notably David Tepper, who on Friday stated that no matter what, stocks will benefit from QE2, few if any have actually considered what the impact of QE2 will be on the FED’s balance sheet, and how the change in composition in FED assets will impact all marketable asset classes.
We have conducted a rough analysis on how QE2 will reshape the FED’s balance sheet:
We were stunned to realize that over the next 6 months the FED may be the net buyer of nearly $3 trillion in Treasures, an action which will likely set off a chain of events which could result in rates dropping all the way to zero, stocks surging, and gold (and other precious metals) going from current price levels to well in the 5 digit range.
A Question of Size
One of the main open questions on QE2, is how large the FED’s next monetization episode will be.
This year’s most prescient economist, Jan Hatzius, has predicted that the minimum floor of Bernanke’s next intervention will be around $1 trillion, which of course means that he likely expects a materially greater final outcome from a FED that is known for “forceful” action.
Others, such as Bank of America‘s Priya Misra, have loftier expectations:
“We expect the size of QE2 to be at least as much as QE1 in terms of duration demand.”
As a reminder, QE1, when completed, resulted in the repurchase of roughly $1.7 trillion in Treasury and MBS/Agency securities.
It is thus safe to assume that the FED’s QE2 will likely amount to roughly $1.5 trillion in outright security purchases.
However, as we will demonstrate, this is far from the whole story, and the actual marginal purchasing impact will be substantially greater.
A Question of Composition
Probably the most important fact that economists and investors are ignoring is that QE2 will be accompanied by the prerogatives of QE Lite, namely the constant re-balancing the FED’s balance sheet for ongoing and accelerating prepayments of the MBS/Agency portfolio.
This is a critical fact, because once it becomes clear that the FED is indeed commencing on another round of monetization, rates will collapse even more beyond recent all time records (and if we are correct, could plunge all the way to zero).
What is very important to note, is that as Bank of America’s Jeffrey Rosenberg highlights, a material drop in rates, which is now practically inevitable, is certain to cause a surge in mortgage prepayments of agency securities:
“Our mortgage team highlights a 100 basis point decline in rates would raise the agency universe of mortgages refinanciability from currently about half to over 90%.”
Full report link.
Additional: BofA Securitization Weekly 9.17.pdf
Related by the Econotwist:
- The Fed Is Pushing On A String (businessinsider.com)
- “How To Reverse A Deflation: Helicopter Ben Needs To Drop Some Money On Main Street” and related posts (atlanticfreepress.com)
- Why David Tepper Is Wrong To Bet That The Fed Can Drive Up Asset Prices (businessinsider.com)
- Gonzalo Lira: Keep Buying Treasuries And You’re Living In A Termite-Riddle House (businessinsider.com)