Stage set for Helicopter Ben

As the continuing turmoil in Europe is casting an ever-gloomier shadow over global markets, markets are hoping that US central bank boss Ben Bernanke will provide some relief by launching a fresh round of monetary stimulus.
Their hopes have been bolstered by recent dismal US economic data pointing to continuing troubles in the jobs market and falling factory orders, which has fanned fears that the US economy is now sliding back into recession. At the same time, the US economy is being dragged down by tighter financial conditions due to the ongoing European crisis, with equity prices falling, while credit spreads are widening and the US dollar is rising.

Investors know that Bernanke is no longer worried that a third round of quantitative easing – dubbed QE3 by the markets – will fuel inflationary pressures. The sharp drop in commodity prices in recent months – including a $US25 a barrel drop in crude oil prices – has resulted in falling input costs. At the same time, wages growth has been feeble because of high unemployment rates.

In a recent note, Goldman Sachs chief economist Jan Hatzius argues that the US central bank will be well aware that financial conditions should be accommodative, given that both economic activity and inflation are weak. Instead, both are moving in the wrong direction, with financial conditions tightening, while the economy is losing momentum.

As a result, he expects Bernanke to unveil a new program of buying long-term US treasury bonds, or mortgages, or both, after the US central bank's next board meeting on June 19 and 20. He also considers it likely that the US central bank will push back the timeframe for the next hike in interest rates until 2015.

But although markets are keeping their fingers crossed that Hatzius is correct, many economists argue that the US central bank's previous bond-buying programs – QE1 and QE2 – have failed to provide lasting benefit to either the US economy, or financial markets.

As Dr John Hussman from Hussman Funds points out, the S&P has delivered a cumulative total return of less than 10 per cent since April 2010. Still, investors continue to pin their hopes on the "Bernanke Put” because "even though it's fairly obvious that QE has done nothing durable for the economy or the financial markets over the last couple of years, a hit of QE might at least be good for a few months of 'risk on' delirium. If the American public can't get thoughtful economic leadership, at least Wall Street's speculative junkies can hope for a little taste of Q from Sugar Daddy".

Hussman argues, with the yield on 10-year US bonds now less than 1.5 per cent, a fresh round of QE basically represents a transfer of wealth from taxpayers to speculators. He notes that a very small increase in the 10-year bond yield will leave the US central bank nursing losses.

He points out that if the US Federal Reserve buys treasury bonds at this point, it will lose money – after interest – unless interest rates rise less than 20 basis points a year during the entire period that the bank holds the bond. And, he notes, it will be near impossible for the US central bank to sell the bonds without taking a loss, because the price of bonds would tumble (which would push yields higher) at the first suggestion that the US central bank wanted to offload its bonds.

As a result, he argues, the US central bank will almost certainly face capital losses, at taxpayer expense, if it starts buying US treasury bonds now. These capital losses, he says, represent "an implicit subsidy to speculators who sold those bonds to the Fed at elevated prices".

Still, Hussman complains that even though QE3 effectively subsidises banks and bond speculators at taxpayer expense "that doesn't mean the Fed will refrain from more of its recklessness".

But, he asks, "does anyone actually believe by now that QE would improve the economy, durably elevate risky assets beyond a few months, or materially relieve global debt strains?”