This coming Friday, August 26th, Fed Chairman Bernanke will speak after he wraps up the annual Jackson Hole Conference. The question for most traders and proactive investors is, will there be another round of Quantitative Easing-QE3.
The way the 10 and 30 year treasury futures along with the TLT (for the equity players) have been rallying the past month, it seems that it is already pricing this in. In fact, I would argue that the rally in the longer end of the curve of the treasury market is already QE3.
One can argue that the demand for US treasuries can be partly attributed to weaker than expected growth in GDP as well as investors seeking the safety and liquidity of US the bond market versus the riskier equities market. Afterall, it came straight from the Fed–” The Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting and anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, downside risks to the economic outlook have increased.”
So what does this mean for us? Well for starters, those who have mortgages north of 5.25% who are eligible and still haven’t, it’s time to refinance. A decrease of to 4.25% on a $300,000 mortgage adds about $185/month to the budget. Assuming there are 28 years left on the mortgage, this comes out to about $62,000 in savings. Two things are accomplished: 1) realized savings and 2) the idea of having more money to spend elsewhere. The latter is what I believe what the Fed is gunning for here.
Why? Well, the chart below will show you. It’s an M2 velocity chart. I don’t want to complicate it with long winded economic explanations but basically it shows how much money is changing hands….meaning how much money is not being hoarded to pay off debt or being kept in savings accounts. Low readings show that money is not being transferred from one party to another eg no economic transaction is taking place. Without this, economic growth derived from the private sector will be sluggish and thus no sustainable job growth can occur. Look at how this indicator dropped in 2008-people thought the end of the world was coming, hoarded cash and velocity of money collapsed. The indicator came up slightly from 2009 to mid 2010 but has since been trending down. What does this imply? Households are either hoarding cash or further deleveraging (paying down debt).
The rumors for QE3 is that it will take the form of the Fed buying long dated treasuries. If this is the case, it will push yields further down. Investors who got scared away from the equity markets might have no choice but to get back in after a big sell off especially if the reward of parking one’s money into long dated treasuries isn’t as appealing.
The questions now become
1) Will more money for households translate to actual spending money or will it find its way into people’s savings accounts and/or credit card payments to reduce debt. While one can argue that a good indicator for this are retail sales numbers, I would say consumer sentiment index as a better indicator because retail sales is backward looking while consumer sentiment is forward looking.
2) With yields on long term treasuries further decreasing, will investors continue to find parking their money in safer US bonds more appealing versus the riskier equities market. Basically, this boils down to whether investors are more concerned about capital preservation or capital appreciation.
Last year, with the announcement of QE2, the stock market across rose. Will QE3 happen? My guess is some type of QE will happen. General elections are coming up AND the administration’s hands are tied when it comes to providing more stimulus. There is enormous pressure to give the economy a boost and looks like it won’t be coming in the form of fiscal stimulus.
If QE3 is announced on Friday, we at the stockguy22.com chatroom will be discussing trade ideas off of it.
Questions or comments? You can find me in the chatroom username jgwilson929 or @jdub929 on twitter.
The opinions expressed above are my own and do not reflect the opinions of stockguy22.com or its affiliates.