The September unemployment report, which showed the employment rate remained above 8%, forced Fed Chairman Ben Bernanke to employ QE3 to help keep the economy afloat. In addition to the $2.3 trillion in purchases of treasuries and MBS pursuant to QE1 and QE2, Bernanke pledged $40 billion in monthly MBS purchases. During his September 13 press conference, Bernanke asserted his goal under Q3 was a sustained improvement in the labor market, though he had no specific number in mind. Bernanke's rationale drew the ire of Richmond Fed President Lacker, who had the following dissenting comments:
Further monetary stimulus now is unlikely to result in a discernible improvement in growth, but if it does, it's also likely to cause an unwanted increase in inflation. Economic activity has been growing, on average, at a modest pace, and inflation has been fluctuating around 2 percent, which the Committee has identified as its inflation goal. Unemployment does remain high by historical standards, but improvement in labor market conditions appears to have been held back by real impediments that are beyond the capacity of monetary policy to offset. In such circumstances, further monetary stimulus runs the risk of raising inflation in a way that threatens the stability of inflation expectations.
Bernanke's goal in driving down long-term rates was to lower consumers' mortgage payments, generating billions in excess cash flow and hopefully, additional consumer spending. Yet the vital signs of the economy have remained anemic, despite Bernanke's efforts. According to "Long-Term Unemployment and 'The Pain Ahead,'"
Big ticket items like housing and autos drive the economy. The Fed initiated its Quantitative Easing program in the fourth quarter of 2008. Yet housing starts have been flat since that period; starts were 906 thousand in 2008 and ranged from 554 thousand to 609 thousand from 2009 to 2011. Auto sales were 13.5 million in 2008, reached a trough of 10.6 million in 2009 and rebounded to 13 million in 2011. But they still pale in comparison to the roughly 17 million just prior to the financial crisis.
The economy's dismal vital signs, and no improvements from Bernanke's stimulus efforts, do not bode well for long-term unemployment, homebuilders like PulteGroup (PHM), Toll Brothers (TOL), DR Horton (DHI), KB Home (KBH), and Lennar (LEN), or auto companies like Ford (F) and General Motors (GM). Furthermore, until two of the largest components of GDP - housing and autos - improve, inflationary expectations will remain in check.
Another major development that is keeping a lid on inflationary expectations is that corporations have reacted to the stagnant economy by laying off more people. Bank of America (BAC), recently announced mass layoffs of 16,000 people - the equivalent of a small town. The reductions "are part of a larger effort to retool Bank of America into a leaner and more focused enterprise." The plan is designed to make the company take less risk, and generate more revenue out of existing customers. Meanwhile, in response to a reduction in demand for its bikes, Harley Davidson (Harley (HOG)), has cut its staff in half at its York, PA plant, introduced flexible work schedules and is in the process of restructuring additional plants. According to the article, "Harley Davidson Pulls A 'Jedi Mindtrick',"
It has cut half the staff (over 1,000 hourly workers) at its York, PA plant and more job cuts are expected at other facilities. Where previously Harley was built for strong profits when operating at maximum capacity, it now has the flexibility to increase operating margins below peak levels of demand. According to the company's 10-K report, in 2007 it achieved an operating margin of 15.2% on revenue of $6.1 billion. By 2011 Harley's revenue had declined approximately 13.5% to $5.3 billion. However, its operating margin improved to 15.6% ... That said, the company expects to restructure its plants in Kansas City, Mo. and Milwaukee, Wis., resulting in cost reductions of approximately $275 million.
There always exists the possibility for global price shocks in commodities in high demand in China (corn and apples) or oil, whose price can fluctuate based upon U.S. relations with producers in the Middle East. However, until there is a sustainable improvement in the economy's vital signs, do not expect inflation to increase on a large scale. In my opinion, the biggest threat caused by QE3 will be the continued deterioration in U.S. credit quality. With debt-to-GDP approaching 100%, we run the risk of another downgrade of U.S. debt or a decline in foreigners' willingness buy our bonds.