To QE or Not to QE? – David Brady (19/09/2019)


by David Brady, Sprott Money:

Yesterday, the Fed cut rates by 25 basis points and forecast no further rate cuts this year with perhaps one more depending on incoming data and future developments. They also continued to be upbeat on economic growth and employment with no sign of recession in the next few years. In addition, they downplayed the liquidity issues in the overnight repo facility recently. Markets were rightly disappointed with stocks down, bonds down, nominal and real yields higher, DXY up, Gold and Silver down.

Then came these comments from Fed Chair Powell:

“We’re going to be assessing the question of when it will be appropriate to resume the organic growth of our balance sheet.”

“It is certainly possible that we will need to resume the organic growth of the balance sheet earlier than we thought. That has always been a possibility and it certainly is now. We’ll be looking at this carefully in the coming days and taking it up at our next meeting.”

He added:

“It’s better to be proactive in adjusting policy if you can.”

“It can be a mistake to try to hold on to your firepower until a downturn gains momentum… What we believe we’re facing here, what we think we’re facing here, is a situation that can be addressed and should be addressed with moderate adjustments to the Federal Funds rate. As I mentioned, we are watching carefully to see whether that is the case. If in fact the economy weakens more, then we’re prepared to be aggressive, and we will do so if it turns out to be appropriate.”

Markets responded as follow: Stocks rebounded, yields fell, the DXY too, and Gold and Silver bounced. Why? The markets, algos in particular, interpreted Powell’s comments to mean that the so-called “Fed Put” is alive and well; that the Fed has their back in the event of a downturn in the economy and/or markets; and that the Fed will not wait for a crisis to play out before acting, the Fed will be proactive rather than reactive should financial conditions worsen significantly. But is this an accurate interpretation?

Powell also said:

“If the economy does turn down, then a more extensive sequence of rate cuts could be appropriate. We don’t see that, it’s not what we expect. But we would certainly follow that path if it became appropriate.”

This means that if we get a downturn in the economy, the Fed will first respond with further rate cuts before they even consider expanding their balance sheet. Furthermore, repeating what he said in a speech in Zurich two weeks ago, Powell said, “We’re not forecasting or expecting a recession.” Of course, the Fed never has nor will ever forecast a recession, but he basically said that if it occurs, they will resort to rate cuts first, but they don’t expect it to occur. QE is not on the table any time soon.

He also said:

“We made one decision today and that decision was to lower the Fed Funds rate by a quarter of a percentage point… We’re going to be highly data dependent as always.”

The Fed did not decide to resort to QE, they have no plans to do so, and despite saying that they will be proactive, they will wait for the data to tell them if they need to act, which is reactive by nature. Simply put, there needs to be a significant downturn before they pull the trigger on QE. This is nothing new.

Lastly and perhaps most importantly, when he referred to renewed balance sheet expansion, he did not say a return to QE. Instead, he repeatedly stated that the Fed could “resume the organic growth of the balance sheet.” The Fed’s balance sheet organically grows in line with GDP. This, too, does not refer to QE, which he was clearly stating when he referred to “organic growth” of the balance sheet.

In summary, my interpretation of Powell’s comments yesterday is that it’s just more of the same strategy they’ve used for years: talking up the stock market with references to balance sheet expansion without actually having to expand it. This is the contradiction that the market continues to ignore: The higher stocks go, the LESS LIKELY the Fed is to revert to QE.

In reality, like the Bank of International Settlements, the Fed will want to keep its powder dry for the next crisis. They have so little left as it is. The only caveat to this is that they believe that there is no coming back from the next crash, that their policies won’t be effective, that they don’t have enough ammo, so they’re trying to avoid it at all costs. If this is the case, then QE won’t matter anyway when the next crisis hits.

What does this mean for bonds and precious metals? As long as stocks continue to rise, there is next to zero chance of a return to QE and yields will continue to rise and gold and silver will continue to fall, imho.

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