It’s all about the Fed and QE

By Jeremy Gaunt, European Investment Correspondent

LONDON (BestGrowthStock) – The event putting investors’ positions most at risk in the coming week is the very opposite of what they feared back in January.

Then it was the “exit strategy” central bankers would employ to unwind the liquidity they had pumped into the world’s economy to get it running again after the financial crisis.

Now it is the prospect of a “re-entry strategy” — the Federal Reserve embarking after its meeting on Wednesday on renewed asset-buying to stimulate the moribund U.S. economy with a new quantitative easing (QE) program.

The risk is that what the Fed ends up doing will not justify the huge investment plays that have already been put in place in the run up to the Federal Open Market Committee meeting.

“There is scope for disappointment,” said David Shairp, global strategist for JPMorgan Asset Management. “There is always the danger it will be seen as too timid.”

Financial markets are not totally fixated on the Fed’s QE — there are, for example, earnings seasons under way and signs of good growth in China, Germany and even Britain, plus Bank of England, European Central Bank and Bank of Japan meetings in the week ahead.

But as macro, top-down events go, there is little to compete with it.

Since the prospect of further QE was accepted by markets around the time of the Jackson Hole central bankers’ retreat in late August, what was already a solid investment flow into emerging markets has turned into a torrent.

It is based on the notion that a) that is where the growth is; b) QE will mean a weaker dollar with next to no yields, pushing up emerging market currencies; and c) the financial system is about to get a new boost of liquidity.

Fund trackers EPFR Global say that nearly $70 billion net has flowed into the emerging market stock funds they monitor over this year, close to half of it since August. Year-to-date flows into emerging market bonds funds, meanwhile, stand at a net $46.4 billion compared with $9.48 billion for the whole of 2009.

Developed economy stock markets have also been buoyed by the prospect of new liquidity. In all, it took the MSCI all-country world stock index (.MIWD00000PUS: ) to two-year highs during the past week.

The dollar, meanwhile, has been clobbered, falling as much as 9.7 percent against a basket of major currencies (.DXY: ) since late August before bouncing back a bit this week.

These huge moves would be at risk if the Fed does something unexpected or markets have a rethink about what it all means.

For that reason alone, JPMorgan Asset Management’s Shairp said he has called for his fund firm to take some risk off the table.


So what could go wrong? The most obvious risk is that the Fed will not meet minimum expectations.

William Dudley, president of the Federal Reserve Bank of New York, has said that $500 billion of bond purchases would likely have the same impact as a 0.5 or 0.75 percentage point decline in the Fed’s benchmark federal funds rate.

But other, higher figures have been floated. Consider the following from hedge fund Bullman Investment Management:

“Our view is that the $500 billion-$750 billion figure is likely to be released by the FOMC and this may well not be enough to appease markets.”

Bullman added that the Fed may need to let loose $1 trillion as a minimum for equity markets to avoid a correction.

Markets in the past week have pulled back a bit, however, after various comments from Fed officials were seen as dampeners.

Among them was Dudley saying the U.S. economic context would determine whether an incremental or big bang approach to asset purchases was better.

This means that as well as the amount of QE, investors will also have to digest any announcement about the length of the period over which it will be delivered.

And at the other end of the scale there is the question of whether any of the amounts being floated will be enough to lift the U.S. economy out of its difficulties.

In that sense, markets could look at a QE release they have priced in and reflect that it is actually a reflection of weakness in what is still the world’s largest economy.

All in all, it points to one of the most tense weeks in ages for investors.

And if that is not enough, there is always the U.S. mid-term elections on Tuesday.

(Editing by Ruth Pitchford)

It’s all about the Fed and QE