Did The Fed Just Announce Plans For QE4?

by: Robert Kientz

Recently, Morgan Stanley's Chief US Equities Strategist Adam Parker made a case that the Fed would probably initiate the equivalent of QE4 because of weaker economic data.

Data has been softer for several weeks now. People have been ignoring it.

Because of weakness in economic data and furthering decline in European fiscal conditions, Parker believes the Fed will have to do more than the previously announced $40 billion per month MBS purchases to offset the flagging economy.

Parker describes QE as "creating money on a computer to buy their own securities" and doesn't believe this activity will spur hiring until fiscal policy direction has settled, which may be January at the earliest.

It was an interesting take and one that may have proved prescient. On Monday, President of Chicago Federal Bank Charles Evans declared that the Fed should purchased $85 billion worth of MBS and securities through the end of 2013 in an extension of the Operation Twist program ending this year. That is more than double the amount of QE3 money announced by the Fed.

While only an opinion of what the Fed should do, Evans is also the person who publicly predicted the QE3 program announced by the Federal Reserve. Whether intentional or not, Evans may be acting as a mouthpiece for the Federal Reserve to the market of coming easing announcements.

And this view of continuing Operation Twist is certainly line with Morgan Stanley's prediction that QE3 by itself won't work.

QE3 will likely be insufficient to significantly boost equity markets and we wouldn't be at all surprised to see the Fed dramatically augment this program (i.e., QE4) before year-end, particularly if economic and corporate news continue to deteriorate as they have over the past few weeks.

The law of diminishing returns suggests that each new issuance of money needs to be larger than the last, a point to which Morgan Stanley agrees.

Although QE3 is open-ended, the currently announced pace and program of purchases is much smaller than previous QE programs…QE3-related gains could cumulate to 3-4% return by year-end, but we see headwinds - negative earnings revisions, especially for 2013, and reappearance of tail risks - that could dominate and more than offset these potential gains.

As I noted in a previous commentary, Goldman Sachs has already shown that unless the Fed continues the printing scheme indefinitely, the market immediately pulls back and this may cause a panic. Morgan Stanley has also noticed this pattern.

In addition, there is evidence that gains from QE2 saturated as it continued, i.e., evidence of diminishing returns to the program as some investors speculate.

The Federal Reserve surely has the same data as Goldman and Morgan and knows what is has to do to prop up the markets. Print and don't stop.

Rising yields are quickly becoming reality. Given the enormous current debt load, any rise in financing additional could affect the solvency of those debts to investors. The Fed is already purchasing most of the new debt issued because other countries have stopped their large purchases.

What happens next is that as the market has apparently begun losing faith in the ability of the US to make good on her debts, yields must rise to entice any interest from the markets.

Deutsche Bank predicts:

We think yields are gravitating higher and have raised our year-end target for 10s to 2 percent. QEF ('F' for forever) raises some interesting issues in terms of how to frame the outlook for yields if the Fed is apparently willing to commit to unlimited purchases subject to (economic) conditions. The ability to influence yields comes down to the play off between depressing real yields directly versus the risk of elevating inflation expectations.

So what does Deutsche Bank predict will happen if the Fed does not extend $45 billion worth of Operation Twist monthly purchases into QE4?

We have a revised nominal yield model for the post crisis period. If the Fed doesn't deliver on QE4, yields could easily rise towards 2.5%.

US dollar devaluation has led to investors dumping US debt. The first quantitative easings flooded the market with dollars and served as a warning to investors the central bank wasn't against using their bazooka. Counties like China and Japan, the largest holders of US Debt, began shedding securities in favor of other assets such as commodities, land, valuable companies, and precious metals.

The continued outcome of endless money printing seems pretty clear. The Federal Reserve is going to have to monetize 100% of all debt issuance in the future because the market is clearly losing confidence in ever getting their principal back.

This loads the Fed with too much debt and make the bank insolvent. Yields will rise faster with each new money printing. The US debt system is now bordering on collapse.

The good news is you can own assets to protect your wealth against this monetary debasement and the potential debt collapse in the US and Europe.

Purchase hard assets such as energy and productive farmland. Also purchase precious metals, which are the only asset that is not simultaneously someone else's counter party risk and also have a history of retaining their value over time.

It is a good idea to protect your wealth while you still have time.

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. I have no business relationship with any company whose stock is mentioned in this article.

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