Markets hopeful the US Fed will launch QE3

LONDON: “We're saved!” cry Vladimir and Estragon in Samuel Beckett's allegorical play Waiting for Godot, whenever they think Godot may be approaching.
Sound
familiar? For Godot, just substitute the Fed and QE3 and there you have
markets' joyous reaction to the slightest hint the US Federal Reserve
may be about to embark on its third money-printing, quantitative easing
(QE) round.
But Godot represents not only Fed/QE3 an attempt to stimulate the economy by pumping money into it but also the European Central Bank (ECB) and the People's Bank of China (PBOC), both of which are expected to act to support growth.
Almost two-thirds of investors believe QE3 is on its way, a Reuters
poll finds. Another poll reveals markets are confident the ECB will buy
Italian and Spanish bonds from September and will cut interest rates to
record lows.
And in China, investors expect the PBOC to loosen
banks' required reserve ratio by at least one percentage point by the
end of 2012, freeing up more cash for lending.
Such is
investors' faith in Godot's ultimate appearance that they have driven
up world shares 3.5% since the end of June, shrugging off fairly
lacklustre company earnings as well as dire growth and manufacturing
data almost everywhere.
Betting that the ECB will do the right
thing, markets have pushed Europe's top stock index 7% higher in August
and brought Spanish yields 120 basis points (bps) down from July highs.
Next week they may get an inkling of when, if at all, the Fed might turn on its printing presses.
Fed
boss Ben Bernanke speaks on Aug 31 at a central bankers' get-together
at Jackson Hole in Wyoming. Given Bernanke announced a previous QE
round at the same shindig a couple of years ago, expectations are high
he will do the same this time.
To see whether the ECB fulfils its pledge to “do whatever it takes”, investors must wait until its Sept. 6 meeting.
But market players such as Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets are confident.
He sees QE3 from the Fed overshadowing all risks over the next couple of months.
“QE3 for September seems to be in the bag,” Gijsels says.
“We
continue to give the market the benefit of the doubt, despite the clear
and present dangers like Greece, Spain and the U.S. fiscal cliff,” he
added, referring to looming deadline for the expiry of crisisera US tax
breaks.
A host of trades, from short-dollar to long-bonds, emerging markets to oil futures, hang on the bet for central bank action.
It has driven a jump in stock market positioning a Bank of America/Merrill Lynch poll showed funds had a net 12% equity overweight in August, from 3% in July.
Underweight positions in Europe fell to net 13%, halving from July.
Other
central banks such as Brazil and Colombia are expected to cut rates
next week and there is a chance of a rate cut in Hungary too.
But investors' eyes are on the Big Three.
Now, here's the rub. What if central banks, starting with Bernanke next week, don't deliver what markets want?
Volatility levels are near five-year lows, implying that markets are not priced for nasty surprises.
In
Europe, not everyone on the ECB board sides with Draghi on buying
periphery bonds. And Germany cannot ratify the European Stability
Mechanism, the bloc's permanent rescue fund, unless its constitutional
court approves it on Sept 12. - Reuters
For QE3, the minutes of
the last Fed meeting said “fairly soon”. But as James Bullard of the St
Louis Fed has noted, data since then has shown signs of an uptick in
the U.S. recovery.
“There is always risk of disappointment when
everyone believes it's going to be oneway,” said Peter Wilson, who
helps run a $6 billion bond portfolio at First International Advisors,
a subsidiary of Wells Fargo.
Creeping doubts pushed 10year
Treasury yields to threemonth highs for a while, an implicit policy
tightening effect, Wilson notes. That leaves the Fed with no option but
to print money, he reckons, with question marks only over the timing.
But
overstretched bond markets could still be disappointed, for instance if
the Fed goes down the route of purchasing other assets such as mortgage
securities, Wilson said, adding: “If that happens you would still see
Treasuries underperform”.
The U.S. housing market has regained
its footing, consumer sentiment is rising and bank deleveraging has
progressed, argues Rob Drijkoningen, a fund manager at ING Investment
Management. He is among those who expect no fireworks at Jackson Hole.
“I'm in the camp of no QE3 for now so that may lead to some disappointment,” he said. “Bernanke won't be too worried.”
What
of China, where the PBOC's silence has driven stocks to 3year lows and
weakened the yuan. Defying investors' hopes, the bank has steered clear
of rate or RRR cuts, resorting instead to a temporary arrangement of
cash injections to interbank markets.
Possibly the fear of
reflating a housing bubble created by its own massive post2008
stimulus, will making the PBOC wary of drastically easing policy even
though data this week showed China's factories contracting sharply.
Back
to Beckett. Those familiar with his play will recall Godot doesn't show
up. Vladimir and Estragon are instead told to expect him another day,
leading them to contemplate suicide.
(Additional reporting by Atul Prakash. Editing by Jeremy Gaunt.)