By Barbara Cohen
Chief Information Officer, ShadowTraders
This last week we saw the coming and going of Quantitative Easing 3.
The age old Hamlet soliloquy, circa 2012, "To be or not to be -- that is the question," became the daily mantra. Shakespeare would have been pleased to watch the play unfold as it was ripe with drama.
First, a bit of background so you will understand the play called "Quantitative Easing."
Quantitative Easing, otherwise known as QE, is the Central Bank's unconventional "monetary policy" that is used to stimulate an otherwise flagging economy when normal monetary policy is ineffective.
The role of the Central Bank is to regulate the national economy by establishing official interest rates. The higher the interest rate, the less attractive borrowing becomes. Companies expand less, fewer household mortgages and construction loans are taken out, and all of this equates to fewer employment opportunities.
In a flagging economy, the Central Bank's first thought is to stimulate borrowing by lowering interest rates for the short-term. The problem is that when interest rates are kept at ridiculously low rates (namely, close to zero) for a long duration, they provide little to no stimulus. Where is the incentive to invest bonds or other interest driven securities known as the Capital Markets?
Enter unconventional Quantitative Easing, also known as "printing money." With the hocus pocus of computer accounting, the Central Bank creates new money, increasing the credit line of its own bank account. It then uses this "created money" to purchase assets: government bonds, corporate bonds, and as of late, "toxic" assets from other banks, (left-over sub-prime mortgages that are still sitting on the books of many of the banks). The idea is that, buy the mortgages, put more money into the banks' hands, and they are then free to lend more to business. Any time the Market hears the words "QE" from the Central Bank it skyrockets.
Now, the background stage is set. The lights dim. The play begins. Monday morning, 8:00am EDT, March 26th.Bernanke takes center stage. Delivering a speech to the National Association for Business Economists 2012 Policy Conference Bernanke says, "Further significant improvements in the unemployment rate will likely require a more rapid expansion of production and demand from consumers and businesses, a process that can be supported by continued accommodative policies." The Dow runs up 161 points. The S&P 500 gained 19 points. The Market interprets Bernanke to be saying that he is preparing for QE 3. He goes on to say, "Further significant improvements in the unemployment rate will likely require a more-rapid expansion of production and demand from consumers and businesses, a process that can be supported by continued accommodative policies." The Market runs up even higher.
Tuesday morning, March 27th..CNBC Interview with Federal Reserve President James Bullard, He states that, "I think QE3 would require the economy to deteriorate somewhat from where it is right now." "The basic story on the U.S. economy is that we've had good news over the last six months or so, especially compared to the recession scenario that was being painted in the August-September time period of last year." The Market hears that there may not be a QE 3.
Tuesday morning, 10:00am EDT, March 27th..Federal Reserve Bank of New York President William Dudley takes center stage. Delivering a speech at the Domestic Monetary Policy and Technology Subcommittee Hearing, in Washington DC, he said, "I do not anticipate further efforts by the Federal Reserve to address the potential spillover effects of Europe on the United States." The Market continue to believe that there will be no QE3. The Dow falls 42 points.
Wednesday, 12:15pm EDT, March 28th..Federal Reserve Bank of Atlanta President Dennis Lockhart takes center stage. Delivering a speech at the Commerce Club, in Atlanta, he said, "The financial risk has been reduced recently, quite literally in the last two or three weeks." "I don’t see too much danger coming from Europe through real-economy channels." The Market is now sure that there will be no QE3. The Dow plummets 77 points.
Thursday morning, March 29th, in an interview with CNBC..Richmond Federal Reserve Bank Jeffrey Lacker says, ""If we get growth about what I am expecting, about what a lot of people are expecting... if we can get growth around those lines, I don't see where the rationale for further easing is going to come from." That's it...there is no QE 3. The Market drops another 74 to a low of 13048 before recovering at the very end of day.
The play ends for the week. The players take their bows. The soliloquy delivered. To be or not to be -- the question remains...for the next week where the play will resume.
Register Now to Attend a FREE Live Trading Event with Barbara Cohen on Tuesday, April 10, 2012 at 8 pm EDT.