In spite of QE and not because of it

This article was posted to CNBC yesterday, and brings up a number of salient points. 

Fed Easing Has Little Impact So Far: Out of Bullets?

Posted By: Jeff Cox | CNBC.com Senior Writer

CNBC.com 

 

The Federal Reserve's latest easing program may be nicknamed "QE Infinity" on Wall Street, but it's having a very limited effect on the markets and economy so far.

Stocks have been flat to slightly lower since the central bank announced the third round of its quantitative easing program — QE3 — while economists remain pessimistic that it will achieve its stated goal of bringing down the unemployment rate.

Consequently, sentiment is beginning to build that the Fed may be running out of bullets.

"We've been range-bound as everyone digests the information," said Robert Laura, president of Synergos Financial Group in Brighton, Mich. "There's nothing that's going to take us any higher. The headwinds out there are too large for QE to overcome."

Previous easing rounds have helped push up stock and commodity prices, but only after rounds of volatility that Laura expects to occur again this time but without the QE-inspired bounce at the end.

Laura pointed out that the first QE, which came at the depths of the financial crisis in November 2008, pushed the Dow industrials up 400 points in a day and spurred a month-long rally. But the market then began its death plunge until stocks cratered in March 2009.

In the November 2010 launch of QE2, the stock market moved higher initially but then tumbled 400 points over the next week. Investors then had an entry point to a rally that lasted until February 2011, but the market slid again and has had a volatile climb since.

This time around, Laura thinks the Dow will retreat to the 12,600 range, giving investors another opportunity to buy on a dip.

But he thinks that will come "in spite of" QE and not because of it.

"The only time you start at the top is when you’re digging a hole, and that’s where we see the markets," Laura said. "You can’t come in at this point and expect things to move higher. There’s no major catalyst waiting in the wings and a number of economic headwinds remain. It’s all flash with no substance right now."

To be sure the market has had its share of up days since the Sept. 13 QE3 announcement.

But even then, rallies have been sold through the day, with the final hour of trading showing a net decline of 0.13 percent, according to Bespoke Investment Group.

"If it feels like gains have been washed away in the final hour on up days, and losses have intensified in the final hour on down days, it’s because they have," Bespoke said in an note in which it suggested that institutional investors probably have been selling into strength at the market close.

QE3, though, is not specifically designed to drive up the stock market in the way that its predecessors did.

Instead, the program is targeting $40 billion a month of mortgage-backed securities in an effort to drive down home loan rates beyond their present record-low levels. In turn, the Fed hopes, homeowners will refinance, giving them more disposable income to buy goods that in turn will generating hiring.

In the near term, QE3 has helped bank profits but not bank stocks, which have fallen about 2.5 percent.

Indeed, the theory has many critics, with economists continuing to doubt that central banks are better at price stability than creating jobs.

That is troublesome considering that the Fed is tying QE3 to the unemployment rate, with some Open Markets Committee members suggesting that 7 percent will be the key level for ending easing. (Read More: Fed to Ease Until Jobless Rate Falls Below 7%: Evans)

"The indicators that provide some steer of where the unemployment rate is heading over the next few months supply little evidence that it will dip below 8 percent," Capital Economics said in a note. "What’s more, we doubt that (gross domestic product) growth will be strong enough next year to drive the unemployment rate as low as the Fed hopes." 

Capital cites lagging domestic capital expenditures as proof that the economy remains mired, and said that indicates "QE3 would then last longer and be larger than most expect." 

The interminable nature of QE3 has some in the market spooked.

Kevin Ferry, head of Cronus Futures Management in Chicago, believes that the Fed's exit strategy — or how it will unwind what ultimately will be more than $3 trillion of debt it holds on its balance sheet — could be "hold to duration." The belief comes on the notion that rising rates will make it difficult to sell the notes the Fed holds to fixed income  traders.

If that's the case, the balance sheet will continue to bloat through more rounds of QE and stoke inflation fears as the Fed creates more money to buy more debt.

"The Fed basically is tilting in a direction that is new but not admitting that the old direction was wrong," Ferry said. "They can't say we will sell securities into the market every month. It's not an option."

The ultimate impact of QE3, then, may be some modest impact  on the stock market while falling short of the economic stimulation that the Fed seeks.

"The effect of QE3 is nothing more than pushing up the stock market," Sam Zell, CEO of Equity Group Investments in Chicago, said in a CNBC interview on Wednesday. "The market is being pushed up to record levels with limited trading. We have a very low volume and the market goes up, which is manipulation."