To QE Or Not To QE: That Is The Question

 |  Includes: AGQ, GDX, GDXJ, GLD
by: Dave Kranzler

A lot of "noise" has surrounded a report by Jon Hilsenrath published by the Wall Street Journal in its Saturday edition in which Hilsenrath interviewed one of the Fed's monetary "hawks," who suggested that the Fed was working on mapping out a strategy to systematically remove its Treasury and mortgage bond purchase program, otherwise known as QE. Here's the article: Fed Maps Exit From Stimulus.

For all of the criticism the Fed is getting over its easy monetary policies and the associated enormous amount of money supply being created as this monetary policy is implemented, I believe that if the Fed were to remove, or even reduce, its monthly Treasury and mortgage bond purchases that the effect of this on interest rates and the housing market would throw our economic system into a serious depression.

Ironically, and in direct contrast to the comments from the Dallas Fed's Richard Fisher - the person I referenced above as a monetary policy "hawk" - the latest FOMC policy decision statement specifically said:

The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. FOMC Statement

What this direct statement tells me - as opposed to an interview with a policy hawk who is not even part of the FOMC - is that the Fed is just as likely to increase QE or maintain its current level as it is to reduce the monthly level of QE. The fact that 11 of members vote for this decision versus one voting against reaffirms my view.

In order to assess what the next likely move is going to be, let's examine the fundamental data, something the Hilsenrath article fails to address.

First, currently the Treasury is issuing roughly $100 billion of new Treasuries each month. Of this amount, the Fed has been buying $45 billion of this new supply each month. Think about the effect on Treasury yields if the Fed were to stop buying close to half of all new Treasuries issued. Interest rates would have to rise to a level which would induce $45 billion worth of new buyers in to replace the Fed. A higher rate of interest would risk killing the Fed's carefully induced housing market bounce.

Speaking of the housing market, since the end of September 2008, the Fed has injected $1.28 trillion into the housing market via its purchase of mortgage securities. $441.6 billion - or 34.4% - has occurred since September 2012: Fed Mortgage Backed Security Activity. With this kind of massive injection of printed money, it's no wonder the housing market has bounced a bit. But what would happen if the Fed reduced or stopped buying mortgages? I would suggest that, if the Fed backs off on its mortgage purchase activity, mortgage rates would spike up to a level which would choke off most of the home buying activity, which requires low down-payment, low interest rate Government-backed mortgage financing. In other words, the housing market recovery would turn into a housing market decline.

Finally, let's look at employment. Despite the headline-reported 7.5% unemployment rate reported on May 3, the Bureau of Labor Statistics issues a more comprehensive calculation of the labor force, which shows a 13.9% rate of unemployment: BLS alternative measure of unemployment. That number is not even close to the Fed's stated objective of getting the unemployment rate down to 6.5% using QE. What this data shows me is that there are a lot of people who are working part-time but would prefer to work full-time and there's a lot of people who have been discouraged from looking for a job altogether.

Interestingly, FOMC board member Sarah Bloom Raskin gave a speech on March 22, in which she argues that most of the jobs created since the last recession have been low-wage and low-quality types of jobs, which have failed to replace the massive loss of higher-pay manufacturing and corporate "white collar" jobs:

About two-thirds of all job losses resulting from the recession were in moderate-wage occupations, such as manufacturing, skilled construction, and office administration jobs. However, these occupations have accounted for less than one-quarter of subsequent job gains. The declines in lower-wage occupations--such as retail sales and food service--accounted for about one-fifth of job loss, but a bit more than one-half of subsequent job gains. Indeed, recent job gains have been largely concentrated in lower-wage occupations such as retail sales, food preparation, manual labor, home health care, and customer service

Here's the link to her speech: FOMC's Sarah Bloom Raskin If you read through her remarks, it's clear that as a voting member of the FOMC she is not going to vote on a policy that reduces QE any time soon because, up to this point, the Fed's QE implementation has not adequately fulfilled the Fed's explicit mandate of using monetary policy to promote maximum employment and price stability. Moreover, there's no question in my mind that if the Fed were to remove QE, a lot of the jobs that have been created since the Great Financial Crisis would be lost.

Thus, based on what I believe would be the extraordinarily negative consequences for the economy if the Fed were to actually reduce or remove QE bond purchases, the Fed will not be pulling away from QE anytime soon. In fact, I would argue that it is more likely that we will see QE4 rolled out before the end of the year. We've heard the QE-removal noise many times since QE was first rolled out, usually from regional Fed bank Presidents who are not members of the policy-voting FOMC. But every time the latest QE stage is ready to expire, the Fed actually takes QE up a notch. This time will be no different because there's not a policy-maker or politician alive who is willing to live with the consequences of removing QE.

Gold and silver have held up well ever since the initial hit the metals took when rumors of the Hilsenrath article were leaked out on Thursday late in the trading day. Clearly the precious metals market is not taking the Hilsenrath article very seriously. Neither is the Dow/S&P 500, as the Dow closed down a small .18% and the SPX actually finished slightly green. If you think, like I do, that Fed is more likely to increase QE than it is to reduce QE, a good way to play the theme is to start accumulating precious metals and mining stocks, which are significantly oversold at this point and will stage a huge move higher if I'm right. I like GLD, AGQ (2x silver ETF), GDX and GDXJ (junior miners) for this purpose.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long, and the fund I co-manage is long, precious metals, mining stocks and AGQ