The signs are adding up and the market is not going to like it -- broad-based QE is not coming next week. More specifically, the Fed will not be engaging in large scale asset purchases next week. That is not to say that the Fed will not announce some other form of easing (particularly a program to stimulate lending), or to say that they will not engage in large scale asset purchases later this year, but indications are that they are not ready to act on QE just yet.
Despite all of the prognostication about impending asset purchases by the Fed, the currency markets are telling a different story. Specifically, the Euro-Dollar market is telling a different story.
As news mounted that the ECB intended to act (not just talk) at the September 6 meeting, the euro climbed from $1.2289 on August 15 to $1.2596 by the beginning of September. Given that most commentators keep claiming QE is on the way and it will drive down the value of the dollar, the fact that the September 6 intra-day euro high was only $1.2652 on news of a plan to shore up Europe's weakest bond markets signals two things:
- The forex market does not believe that QE is coming, or if it is coming, they believe it will somehow not diminish the value of the dollar.
- The forex market does not believe that the plan announced by Mario Draghi is the end to the euro crisis.
Both of these facts lead to the same conclusion: equity markets will correct in the very near future.
ECB, Markets and Employment
In addition to indications from the forex market, the confluence of data coming from the ECB, equity markets and employment data does not warrant further asset purchases by the Fed at this time. In particular, the plan announced by the ECB on Thursday, September 6 involves a firm policy of "unlimited" bond buying. While I have pointed out the plan's myriad shortcomings, this strong language sent a huge signal to markets. Investors now believe (rightly or wrongly) that Mario Draghi has the tools to do what is needed to save the eurozone. Markets rallied around the news, pushing the Dow and S&P near four-year highs.
Adding to the mix of data is a poll by ADP Employer Services indicating that the U.S. private sector added 201,000 new jobs in August. While this is not enough jobs to cause a precipitous drop in the unemployment rate, it is enough to lend further credence to the story that the spring slowdown in job growth was a result of a warm winter, not underlying weakness in the labor market. Although Fed officials are undoubtedly taking these numbers as part of a much larger package of data, I expect that they will see signs of improvement -- albeit slow improvement -- in the labor market as a reason to wait and see what happens next rather than act impulsively.
Forex speculators don't seem to be expecting the dollar to decline in value, thus indicating that they see major weakness in Europe unresolved by the ECB's bond buying plan and/or they see no signs of further easing coming from the Fed. Adding in the labor market data and the fact that the stock market is at multi-year highs, and it is clear that the conditions don't warrant a massive capital injection into the U.S. economy by the Federal Reserve. Throw in the fact that it is the politically safest move right now for the Fed to wait and see, then act after the November election if necessary, and the likelihood of LSAP being announced next week declines even further.
None of this is to say that the Fed will not announce any policy change next week, just that I doubt it will be major, broad based asset purchases. If anything, it will likely be a targeted purchase program or another means of stimulating lending to bolster the mortgage backed securities market. Regardless, those investors banking on a huge QE program next week should take a close look at the economic data and seriously consider repositioning.