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Jackson Hole: We Need QE2, Not QE3

08/22/2011
Federal Reserve Chairman Ben Bernanke will deliver a highly anticipated speech from Jackson Hole, Wyoming at 10 a.m. on Friday, August 26. The domestic economy and capital markets find themselves in a challenging environment eerily similar as before his August 27, 2010 Jackson Hole speech.
 
My expectation for Friday’s speech is Chairman Bernanke will acknowledge with great concern the deterioration in financial markets’ stability, rising recessionary risks, and persistently high unemployment.  He most certainly will strike an extremely dovish tone attempting to comfort financial markets that he stands ready to implement both conventional and unconventional easing measures. In fact, his language on Friday will be his ultimate mechanism to comfort markets.  
 
I do not expect Chairman Bernanke to telegraph or commit to actual implementation of QE3. Fortunately for the United States, the value of our currency remains in a structural downtrend, in essence, monetizing our debt which many European sovereigns wish they had the ability to emulate. Many of the problems Europe is now challenged by are a direct result of its hesitancy to adopt a similar Bernanke method of quantitative easing this time last year.
 
Quite candidly, I expect QE3 is not necessarily what would stabilize financial markets and reduce recessionary pressures. There is significant credibility risk with QE3. It would diminish the value of prior and future easing measures. As an analogy, think back to the blockbuster films, Godfather 1 and Godfather 2, followed by Godfather 3, the dud.
 
The teetering global economy and unstable financial markets need further QE; however, not QE3 in the United States, rather QE2 in Europe.    

  • Contrary to the aggressive efforts by U.S. policy makers in 2008, European financial institutions remain undercapitalized and vulnerable to further capital needs if sovereign debt concerns spread further in the European Union.
  • Contrary to the summer of 2010, Germany is not a source of economic strength supporting the entire euro region:
    • Therefore, Germany may lack the ability to fund any bailout.
    • Q2 GDP in Germany was .1% versus 1.9% in Q2 2010.
    • June exports fell 1.2% versus a June 2010 gain of 2.3%.
  • In late 2008, the ECB enacted QE1, expanding its balance sheet from $1.5 trillion to $2 trillion. Today, the balance sheet is slightly south of $2 trillion, and the ECB has actually raised interest rates twice in 2011 in order to tighten monetary policy.

Plain and simple, European policy makers have played their monetary policy cards wrong over the past 15 months. We often talk of a “Bernanke Put” under the falling equities market. This time around, we need an “ECB Put” under the market. We need QE2 from Europe more than we need QE3 from Chairman Bernanke. My fear is that the ECB will only be motivated to enact QE2 with further riotous behavior in the capital markets and a confirmed recession.
 
The markets are in a vulnerable place. Market stability was not certified this week. As I said on CNBC’s Fast Money Thursday evening, August 18, I remain more concerned about the market’s next three weeks than the next three months. My reasoning? Flawed European monetary policy and a disgraceful exhibit of partisan politics in the United States. Until one of those headwinds dissipates, the tailwinds of attractive market valuations and continued excellent corporate earnings are diminished.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.