Perry Puts Another Nail in the QE3 Coffin

Includes: DIA, QQQ, SPY
by: Eric Parnell, CFA

“If this guy prints more money between now and the election, I don’t know what you all would do to him in Iowa, but we – we would treat him pretty ugly down in Texas. Printing more money to play politics at this particular time in American history is almost treacherous, or treasonous in my opinion.”

--Rick Perry, Governor of Texas and Republican Presidential Candidate

These are strong words from the campaign trail. If there was any doubt that Ben Bernanke and the actions of the U.S. Federal Reserve were a hot button campaign issue, they were answered by Rick Perry on Monday. He didn’t mince words either. It’s not as though the Texas Governor was calling into question the subtle nuances of any potential monetary policy actions by the Fed. Instead, he likened it to a crime of betrayal against the United States by purposely acting to undermine our country. Whether you agree with him or not, these are strong words indeed that reinforce the idea that the Fed will stay on the sidelines and not enact QE3 at Jackson Hole or anytime soon. And this may come as disappointing news to a still hopeful stock market.

Of course, this statement must be taken with a grain of salt as campaign rhetoric. After all, Mr. Perry just entered the race and is looking to make a splash. And I don’t think anyone would expect him to actually charge Ben Bernanke with treason if he were elected President. But it does highlight where the national mood is about the economy and the Federal Reserve’s role in bringing us to where we are right now. After all, Rick Perry is not some fringe candidate with low single-digit poll numbers. Instead, he is considered a potential frontrunner for the Republican nomination. And Mr. Perry does not stand alone with his views, as the two winners of this weekend’s Iowa straw poll in Michelle Bachmann and Ron Paul are clearly not big fans of the Federal Reserve and its recent actions either. Whether you agree with the views of these politicians or not, it is without a doubt that long gone are the days of the “Maestro”, when previous Fed Chairman Alan Greenspan would wax both prophetic and incoherent to swooning politicians basking in a strong economy. And this shift in sentiment is not unique to Ben Bernanke, as many of Mr. Greenspan’s policy moves are now reflected on with a good deal of scorn in many circles.

This mood change about the Federal Reserve has important implications on its policy decisions going forward. While the theoretical design of the Fed is to be impervious to political influence, it’s members are human beings that are responsive to what people are saying and thinking just like everyone else. Ben Bernanke had some swagger last summer after QE1 had helped pull the global economy back from the brink, but his monetary policy sequel in QE2 has received mixed reviews at best and has been sharply panned by many critics. With $600 billion added to the Fed’s balance sheet since late 2010 and the sense of little to show for it economically, the Federal Reserve is likely to be much more cautious with policy actions going forward. This is particularly true when the independence of the Fed has been increasingly called into question and revelations of policy actions details such as major support for non-U.S. banks. And having a top tier Presidential candidate using words like “treasonous” in relation to potential future policy decisions will only add to the Fed's caution in taking any additional aggressive policy steps like QE3 at this point.

This may come as a great disappointment to the stock market. With the economy deteriorating toward recession and stock markets cascading lower in recent weeks, many investors that had hoped for more than a two-year ZIRP commitment from the Fed on August 9 quickly turned their sights to the Fed’s Jackson Hole conference on August 26 for the potential QE3 announcement. After all, it was in Jackson Hole in August 2010 when Bernanke made the clear announcement that QE2 was on its way, which sent stocks off and running higher for almost a year. But a lot has changed since last year. First, the Fed had swagger last summer post QE1, but now they feel muzzled post QE2. Second, the Fed had been telegraphing QE2 for months before Bernanke finally confirmed it at Jackson Hole. It was this telegraphing that actually helped put a floor under the market starting in early July 2010. But the Fed has said little to nothing this time around. Third, the Fed is far from unified on any policy action at this point, with three dissents on the latest policy statement that reinforced a zero interest rate policy that many in the market already assumed would remain in place anyway. So getting everyone on the Fed unified to take the QE3 leap will likely be much more challenging this time around.

Stocks may not respond all that well to further QE anyway. While much of the rally from the March 2009 bottom had been driven by aggressive monetary stimulus, evidence was building in the final months of QE2 that the associated positive impact on stocks might have finally been reaching its limit. Furthermore, if the situation in Europe continues to deteriorate, this would likely be a negative for risk assets such as stocks that would more than overwhelm any additional stimulus that the Fed was able to pump into the markets at this point. So while we might see an initially strong positive response in stocks to any QE3 announcement, it may not be as long lasting this time around.

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The challenge for the Fed in the months ahead will be figured out how to act without triggering the alarms of politicians and the public. As a result, any future policy decisions are likely to be subtle and on the margins. And these are not likely to be the types of moves that create another dramatic updraft in stocks like we’ve seen over the last two years.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.