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Musings on Jackson Hole and What the Fed Could Do to Save QE3

Musings on Jackson Hole and What the Fed Could Do to Save QE3

Christopher Vecchio, CFA, Senior Strategist

Global central bankers will descend on Jackson Hole, Wyoming today, for the Federal Reserve’s annual Economic Policy Symposium. The event has garnered a great deal of attention over the past few years, and especially since 2010, when Federal Reserve Chairman Ben Bernanke hinted at a major bond-buying program aimed at the middle portion of the yield curve. This program was quantitative easing round two (QE2) and was implemented in November 2010. Ultimately, the program’s effect has done little to help the real economy, although the S&P 500 hovered near four-year highs at the program’s completion in June 2011 while US Treasury note yields fell to (then) all-time lows.

Now, expectations for further accommodative actions are riding high – again. Federal Reserve Chairman Ben Bernanke will make his much awaited speech at the Jackson Hole Economic Policy Symposium tomorrow, with the fate of the US Dollar very-much in the balance as it appears that further easing is just around the corner.

The Federal Reserve’s Minutes from the July 31 to August 1 meeting suggested that new QE was on the way, and that if the US’ economic recovery continued to move at stall speed, the Federal Reserve would pull the trigger on more accommodative measures. However, we don’t believe that the “New QE” necessarily means “QE3,” or a bond-buying program aimed at lower yields. Similarly, we don’t believe that the “New QE” necessarily means a large-scale asset purchase program (LSAP) aimed at mortgage-backed securities (MBS), like QE1.

Instead, we think it is possible that the New QE means a program aimed to help consumers in a more tangible sense to help the recovery further; it is clear that despite all-time low mortgage rates, the housing market still can’t catch a break. Any form of housing assistance would make sense for a number of reasons. This would satisfy the innovative stimulus idea that many have searched for, and would restore credibility to the Federal Reserve, as it would show that there are a number of policies that could be deployed to help the US economy, not just LSAP or debt monetization.

The idea is simple: free up income for consumers to dispose of, and growth will strengthen (consumption represents nearly 75% of the headline growth figure in the US now). If the Federal Reserve doesn’t resort to QE3 a la QE1 or QE2, then it saves that bullet for a more crucial time, when yields start to spike, for example. This fits in very neatly with the approaching “fiscal cliff,” which could very-well push yields up. In that sense, then, if yields do climb in the beginning of the year, which would hamper the recovery, QE3 could be implemented to help cushion the economy.

If QE3 is announced, we should expect the US Dollar to take a severe beating, especially against the Euro and the Japanese Yen, over the next several weeks and months (withstanding a tail-risk event out of Europe). However, if any form of New QE is announced which doesn’t suppress the yield curve, the US Dollar could appreciate quickly over the coming weeks. In any scenario – a major announcement, a minor announcement, or no announcement at all – investors will be focused squarely on the September 13 Federal Open Market Committee meeting once Federal Reserve Chairman Bernanke steps away from the podium tomorrow.

--- Written by Christopher Vecchio, Currency Analyst

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