The stimulative efforts of QE3 are not what they appear to be. We all know that the FOMC is prepared to buy about $85 billion worth of U.S. Treasuries (TLT) and mortgaged-backed securities, but when the left hand is shuffling the cups one way we need to pay attention to what the right hand is doing -- or else this shell game could get the best of us. In this case, at the same time the FOMC is buying bonds the U.S. Treasury is selling them, and when the government sells bonds it actually drains liquidity from the system.
Looking back to QE2, I wrote a report titled "Pulling Back the Curtain on the Wizard," which described the true stimulative nature of QE2. That program sought to buy about $100 billion of bonds per month, but after the offsets by the U.S. Treasury (including maturing bonds) the net stimulus was only about $30 billion per month. This is much lower than the face value of the program, $100 billion, but it still worked to induce the wealth effect and stimulate equity markets.
Arguably, that has caused a "valuation bubble" in our equity markets, but we'll leave that analysis for another time. Today's discussion is on the real net stimulus of QE3, but this time there is more than just one other hand at play in this shell game. Not only does the U.S. Treasury act as a drain on liquidity this time, but fiscal policy is now poised to do the same.
Breakdown of QE3
Without the inclusion of the U.S. Treasury, the stimulus would be the face value of the program, $85 billion. But when we include the offsets by the U.S. Treasury, the net stimulus changes to $11.5 billion/month. This reduced stimulus estimate is no surprise because QE3 is lower than QE2 by $15 billion/month anyway, but another important factor is at play. Fiscal policy will now also drain money from the system, and although no one knows what that will look like yet, we can deduce a best-case scenario now.
Assuming a best-case scenario of a $200 billion headwind this year, which would have been negotiated down from about $600 billion as we know, the monthly headwind of fiscal policy would be about $16.66 billion. This further offsets the $11.5 billion that came after the U.S. Treasury was included in the equation, and changes the net real stimulus of QE3 to a negative number. The true net stimulus of QE3 is -$5.1 billion per month with a best-case scenario in mind.
The table below offers tangible estimates and comparisons:
After U.S. Treasury
After Fiscal Headwinds
If you think this shell game has fooled some investors into thinking the reaction to QE3 may be the same as the reaction for QE2, you may want to fade the market's recent strength. For details and more information, please visit Stock Traders Daily.