Expect More Quantitative Easing When Bonds Falter

Here’s some food for thought from Nandu Narayanan, one of the few hedge-fund managers to have lived up to his industry’s promise to deliver positive returns regardless of market conditions (see table below for his investment performance). He argues that U.S. policymakers are going to need to administer much more quantitative easing and fiscal stimulus — and as the realization dawns on financial markets, they won’t like it.

I have said before that eventually things will get back to normal. Maybe it’s just incurable optimism on my part. But that doesn’t rule out some volatility in the meantime. Narayanan writes:

Unfortunately for the Fed, were a recovery to materialize, the bond markets should suffer forcing the Fed to more quantitative easing. And were the economy to weaken, the fiscal deficits are going to increase further demanding even more quantitative easing. This makes the Fed largely powerless in the current situation – its policies of dollar printing are here to stay in most reasonable scenarios for the economy. When the markets realize this, we should enter the next leg of this unfinished crisis.

What he means by “the bond markets would suffer,” is that if the economic recovery shows more signs of taking root, government bond yields will ratchet up. Since the rising yields will endanger the recovery — as I discussed in a previous post – the Fed will have to print more money to buy up Treasuries and hammer their yields back down.

Where Narayanan extends the analysis for me is that even if the economy doesn’t pull out of recession, fiscal deficits will get even wider and require the Fed to buy up more government bonds than presently expected. This, of course, will require more money to be printed.

So, regardless of the economy’s direction, the Fed may be driven into more quantitative easing — and this could be unsettling to the market when it catches on. As he outlines in his latest commentary, Narayanan seems to think the most likely scenario is that the economic recovery will falter: “A slowdown in the U.S. will trigger even more government expenditure and more quantitative easing by the Fed – actions that will increase the risks of a dollar and/or a bond market crisis.”

Narayanan’s investment performance:

Comments

[doubleguns:]

Humpty Dumpty has fallen and all the feds bonds and and the states bonds cant put him back together again.

Pension plans, SSN, medicare, unemployment, HUGE deficit, and the list goes on and on.

Iceberg hit...we know whats coming.

Salvaging from these depths is not possible.

May 19 09:19 AM

[yellowhoard:]

Question is, how long can this game of musical chairs continue?

May 19 09:26 AM

[Whippet:]

So at this rate, what is the logical end? The Fed's balance sheet contains all Treasury obligations (~$15 trillion?) on one side and $15 trillion in FRNs on the other. The worthless dollar is traded in at 1000:1, and we've "cut" the national debt by 99%.

This is absurd, but really, where else does it go??

May 19 10:52 AM

[Vuke:]

Add the startling news that Chinese companies will soon be issuing their own dollar denominated bonds.
www.moneymorning.com/2.../

The article states this will likely lead to a massive investment in commodity development as the Chinese rush to secure long term supplies. He thinks it bad for gold but maybe not. A new flood of USD can only lift gold in the end.

May 19 11:01 AM