Sterilized QE? Bernanke真係當人係傻仔

真係話口未完。“消毒”過的QE, 考立名目，要不就推立即推QE3, 又Operation Twist, 又買MBS, 都是一樣，已病入膏肓，食咩藥，打咩針都冇用，隨時certify. 

Forbes. March 7, 2012

Who Cares About Sterilization? The Fed Pretty Much Just Announced QE3

A report that the Fed is considering “sterilized” QE sparked a risk rally that shouldn’t really make sense.  On the one hand, the breakdown of the how the Fed would actually execute the operation provided nothing new, on the other, “sterilized” QE would amount to a capital injection that puts enough restrictions on that capital to make it unusable, making the injection neutral at the end of the day, at least in terms of speculative capital. 

What’s really happening?  The Fed, via WSJ’s Jon Hilsenrath (dubbed “mouthpiece” by ZeroHedge and “Fedwire” by FT Alphaville), is testing the waters.  Bernanke & Co. are telling markets QE is definitely on the table while acknowledging they recognize the inflationary threat carried by another round of quantitative easing.

Risk assets rallied on Wednesday just as Hilsenrath piece came live, around 11:06 AM in New York.  All three major U.S. equity indices made a 30 minute climb.  By 3:10 PM, the Nasdaq led the way, up 0.8% to 2,932 points, followed by the S&P 500 (up 0.7% to 1,353) and the Dow (up 0.6% to 12,841).

Gold, oil, the euro-U.S. dollar exchange rate, 10-year Treasury rates, even Apple shares moved up around that time.  All because of sterilized buying; it seems like a typical “buy the news” risk-rally.

Sterilized bond buying is nothing new, despite Hilsenrath’s characterization as “novel.”  Under its first two quantitative easing (QE) programs, the Fed injected capital into the system by virtually printing money and buying assets (Treasuries and agency mortgage backed securities, MBS).  Paradoxically enough, most of that capital was then parked back in the Fed by major banks, using it to bolster their capital ratios instead of lending, as Dallas Fed’s Fisher made clear this week.

Under the sterilized version of the bond buying program, the Fed would print virtual money and once again buy assets (probably longer-termed Treasuries and maybe MBS), injecting capital into the system.  But this time, the Fed would restrict primary dealers like JPMorgan Chase and Citi, along with other institutions, from using that capital via “new market tools they designed to better manage cash sloshing around the financial system”.  They will use “reverse repos” to tie up capital by borrowing from these institutions for very short-terms, say 28 days, at low rates, effectively locking up the capital and “sterilizing” it.

What’s the point, you may ask?  If you’re injecting capital but restricting market players from putting it into play, then are you actually stimulating the economy?  Depends on your definition.  If the Fed buys up longer-term Treasuries, it’s still flattening the yield curve (by lowering long-term rates), while forcing market players out of supposedly safe, longer-term instruments.  If you’re buying MBS, you’re taking distressed assets off banks’ balance sheets and freeing up usable capital.

In both cases, the Fed would be trying to spark the so-called “wealth effect,” forcing market players out of the comfort of “safe” assets and into risk.  This should spur investment in equities, help homeowners refinance their mortgages, and lead to a virtuous cycle of investment and economic growth.  Sterilization should lower the inflationary risks inherent with this strategy (QE forces the Fed to expand the monetary base).

Will it work?  It seems to me the more appropriate question is “does it matter?”  The Fed’s two programs of quantitative easing have definitely fueled risk-asset rallies.  During QE2, equities surged, but so did equities markets across emerging markets (which didn’t really help the U.S. economy).  QE also fueled non-productive asset rallies as capital massively went into gold and other commodities (effectively helping crude oil prices surge).

At the end of the day, monetary policy works by affecting market perceptions.  Fed Chairman Ben Bernanke was masterful in leading markets ahead of his announcement of “Operation Twist.”  In Congressional testimony, Bernanke sort of screwed up, failing to mention QE and causing a massive risk-off sell-off, with gold and equities plummeting after a very successful start to 2012.

Thus, market participants are asking themselves if Bernanke will engage in a third round of QE.  The reaction to Wednesday’s news seemed to be indifferent regarding sterilization, but the general trend in risk assets has shown that the market responds to the expectation that the Fed will buy assets and expand its balance sheet.  Bernanke has been very clear that despite improved economic indicators, the U.S. recovery remains fragile; he also said interest rates are expected to remain in the zero-range until late-2014, indicating the Fed believes the economy needs monetary support at least until then.

While there is assurance of the future, global risks abound.  Europe is still teetering on the edge and has entered a mild recession, China has downgraded its growth prospects for 2012, and oil prices have surged. If the U.S. economy doesn’t manage to accelerate, the stage is set for another round of QE, for which the Fed now seems to be testing the waters.