Download PDF - Marquette Associates

Investment Stewardship Guidance
InvestmentPerspectives
December 2012
Fed’s QE3 Expected to Total Nearly $1T - Marquette Associates Survey
Institutional Fixed Income Managers Share QE3 Endgame Expectations
Eric Przybylinski, CFA, CAIA, SENIOR RESEARCH ANALYST
On September 14, the Federal Reserve announced that it would begin another round of quantitative
easing by purchasing $40 billion dollars of mortgaged backed securities (MBS) a month. The
plan, referred to as QE3 by analysts, is intended to boost a U.S. economy suffering from high
unemployment. Investors have closely followed the Fed’s Quantitative Easing (“QE”) programs due to the unconventional monetary policies’
effects on broader asset markets, as well as the possibility that Fed actions may stoke inflation down the line. Given the open-ended nature
of QE3, market expectations of the size, duration, and effectiveness of the plan may be both especially relevant and diverse.
To gauge market perceptions of the plan, Reuters surveyed and reported on the forecasts from bank economists, as reported on October 6.
While banks, especially primary dealers, are important members of the U.S. fixed income markets, so too are asset managers. To that end,
Marquette Associates, Inc. conducted a similar survey of large institutional fixed income money managers regarding their opinions on QE3.
The 35 respondents to Marquette’s survey broadly agreed with economists surveyed by Reuters about the goals of QE3. Both economists and
asset managers think the Fed is targeting
Exhibit 1: At What Unemployment Rate Would the Fed Halt QE3?
about 7% unemployment on average before
45%
terminating the program. While the asset
managers surveyed had a variety of opinions
regarding other aspects of QE3, there was
35%
relatively strong agreement on this number.
30%
Nearly half of all responding managers
25%
unemployment rate falls to 6.75-7.00%. The
believe the Fed will halt additional QE if the
20%
majority of economists and asset managers
15%
purchase Treasuries after Operation Twist
10%
ends at the close of the year. Previously,
5%
Treasuries as it purchased longer duration
the Fed had been selling short duration
Unemployment Rate
<5.75%
5.75-6.0%
6.0-6.25%
6.25-6.5%
6.5-6.75%
6.75-7.0%
7.0-7.25%
Treasuries.
72.5-7.5%
0%
also agreed that the Fed will continue to
7.5-7.75%
PERCENT OF MANAGERS
40%
Interestingly,
asset
managers
generally
believe that the ultimate size of QE3 will
be significantly larger than the economists
180 North Lasalle Street, Suite 3500, Chicago, Illinois 60601
PHONE
312-527-5500
WEB
marquetteassociates.com
in the Reuters survey. The median economist
Exhibit 2: Size of QE3
predicts the ultimate size of QE3 will be $600
billion, while the median asset manager
16%
believes the size of QE3 will amount to $975
14%
responses, there was a wide array of opinions
billion.
responses are summarized by Exhibit 2.
10%
In addition to these questions, asset managers
8%
also shared their opinions on the duration
6%
of QE3, as well as what inflation rate would
cause the Fed to halt QE purchases. The
4%
median manager thinks QE3 will extend to
2%
continued trend of gradual improvements
>$1650B
$1501-1650B
$1351-1500B
$1201-1350B
$1051-1200B
$901-1050B
$751-900B
$601-750B
the 1st or 2nd quarter of 2014. Assuming a
$451-600B
0%
In contrast to the unemployment
regarding the ultimate size of QE3. Survey
12%
$300-450B
PERCENT OF MANAGERS
18%
to unemployment, this is consistent with an
unemployment rate of about 6.75-7.00% in
the first half of 2014.
The goal of the Fed’s asset purchases is
to boost growth, primarily by increasing
Exhibit 3: Duration of QE3
inflation expectations, the “wealth effect”
12.0
of rising stock prices, and aiding the housing
recovery. Somewhat higher inflation would
10.0
lead to higher nominal GDP growth and
decreased debt burdens in real dollars
would speed the deleveraging process.
8.0
UNEMPLOYMENT RATE
This coupled with lower bond yields could
boost the returns of risk assets. Of course, if
6.0
inflation runs too high it would be a negative
for most asset classes’ returns. Based on
4.0
breakeven inflation rates, the Fed so far
may have been more effective at increasing
long-term inflation expectations than in the
2.0
0.0
Nov-04
short-term. Five year inflation expectations
five years out have steadily been rising, while
Nov-06
Nov-08
Nov-10
Nov-12
Nov-14
inflation expectations over the next five years
have been falling.
Uncertainty about the Fed’s commitment to its strategy, as well as the unknown inflationary impact of unconventional monetary policy,
may hinder the effectiveness of QE3. On one hand, if the Fed has little tolerance for even slightly higher inflation, it may halt stimulus just
as it becomes effective. On the other hand, if stimulus is too effective, rapidly rising inflation may force the Fed to reverse course quickly
and potentially raise interest rates.
While most asset managers are roughly in agreement about the Fed’s employment goals, there is
disagreement on how much inflation the Fed will tolerate to get there. The median manager believes the Fed will continue QE3 purchases
until inflation rises to 3.3-3.5% as measured by core CPI. As a point of reference, the October reading of core CPI was 2.0%. Core CPI tends
to run 0.35% higher than the core personal consumption expenditures index (PCE), the Fed’s preferred inflation measure; this implies that the
median manager expects the Fed to tolerate moderate - but not significantly higher - inflation to reach its goals.
Fed’s QE3 Expected to Total Nearly $1T
December 2012
2
However, the dispersion of responses is
Exhibit 4: At What Level of Core CPI Would the Fed Halt QE3?
25%
telling, and points to the dilemma the Fed
faces when influencing expectations. Though
the median response was 3.4% inflation, a
relatively large number of managers believe
20%
that the Fed would tolerate either much
higher or lower levels of inflation.
15%
Low
expectations could indicate a belief that
either the Fed’s stimulus will prove ineffective,
or a belief that the Fed is not committed
10%
to further stimulus in the face of even mild
inflation. Higher expectations could indicate
either a belief in the commitment of the Fed,
5%
or a belief that QE could cause much higher
inflation down the road. The Fed’s ability to
>4.3%
4.1-4.3%
3.9-4.1%
3.7-3.9%
3.5-3.7%
3.3-3.5%
3.1-3.3%
2.9-3.1%
2.7-2.9%
get the mix just right will continue to play an
2.5-2.7%
0%
important role in the gradual U.S. economic
recovery and asset class returns.
While growth has been tepid, the U.S. has enjoyed stronger than expected GDP growth in the wake of a financial crisis, and one of the best
performing equity markets in the developed world. This is at least partly due to more accommodative policy from the Fed compared to other
developed central banks. In the short-term, if the Fed succeeds, interest rates may stay lower for longer. In the medium-term, however, if the
Fed is effective in its goals the level of rates should normalize sooner than it would have otherwise. A return to normalized growth following
continued deleveraging should be a boost to growth sensitive assets, such as equities. If the Fed fails in its goal to stimulate growth and
external shocks push the U.S. towards recession, Treasuries should be strong relative performers, despite already low rates. Finally, if stimulus
does stoke inflation, financial assets could suffer, while commodities outperform.
Fed’s QE3 Expected to Total Nearly $1T
December 2012
3
PREPARED BY MARQUETTE ASSOCIATES
180 North LaSalle St, Ste 3500, Chicago, Illinois 60601
PHONE
312-527-5500
WEB
marquetteassociates.com
The sources of information used in this report are believed to be reliable.
Marquette Associates, Inc. has
not independently verified all of the information and its accuracy cannot be guaranteed. Opinions, estimates,
projections and comments on financial market trends constitute our judgment and are subject to change without
notice. References to specific securities are for illustrative purposes only and do not constitute recommendations.
Past performance does not guarantee future results.
About Marquette Associates
Marquette Associates is an independent investment consulting firm that guides institutional investment programs
with a focused three-point approach and careful research. For over 26 years Marquette has served this mission
in close collaboration with clients – enabling institutions to be more effective investment stewards. Marquette is
a completely independent and 100% employee-owned consultancy founded with the sole purpose of advising
institutions. For more information, please visit www.marquetteassociates.com.
Fed’s QE3 Expected to Total Nearly $1T
December 2012
4