Goldman Wants QE3, Will They Get It?

When Goldman Sachs called for QE3 to be announced, many expected it would be hinted at, or perhaps even announced at Jackson Hole. Obviously that was not the case, with Federal Reserve Chairman Ben Bernanke not announcing any plans. Bernanke did leave the door open at Jackson Hole, but nothing concrete. Chicago Federal Reserve President Charles Evans basically came out this morning and said he wants QE3 to happen. Back in July, Goldman Sachs' chief economist Jan Hatzius said, "We have lowered our forecast for US real GDP growth further and now expect real GDP to grow just 2%-2½% through the end of 2012. Our forecast for annual average GDP growth has fallen to 1.7% in 2011 (from 1.8%) and to 2.1% in 2012 (from 3.0%). Since this pace is slightly below the US economy's potential, we now expect the unemployment rate to be at 9¼% by the end of 2012, slightly above the current level." Hatzius went on to say, "Even our new forecast is subject to meaningful downside risk. We now see a one-in-three risk of renewed recession, mostly concentrated in the next 6-9 months. There are three specific issues that concern us. First, a worsening of the European financial crisis, and a failure of European policymakers to respond adequately, could lead to a further tightening of financial conditions and credit availability, which would worsen the economic outlook globally. Second, our forecast assumes that the payroll tax cut—currently scheduled to expire at the end of 2011—is extended for another year, but if that failed to happen the fiscal drag in early 2012 would increase significantly. Third, increases in the US unemployment rate have historically had a tendency to feed on themselves, and this could happen again." With the Federal Reserve expanding its September meeting to two days from one, the markets seem to have taken that as a sign that another round of quantitative easing is under heavy consideration, especially at the top levels of the Fed. Some have said that "QE3" could be a second version of Operation Twist, or perhaps include other securities, as Goldman suggests. Thanks to ZeroHedge, we have Goldman's report from this morning about what the Fed needs to see to enact QE3. It's not just a drop in the S&P 500, although many have now deemed the stock market as the Fed's third mandate. "There are three main ways in which the Fed could be more radical: (1) an extension of the QE program into markets other than Treasuries and agency MBS, e.g., private sector securities, (2) a much bigger QE program, up to the extreme version of a promise to buy as many securities as needed to hit a specific yield target (i.e. a "rate cap" further out on the yield curve as then-Governor Bernanke suggested back in 2002), and (3) an explicit or implicit change in the Fed's policy targets," wrote Goldman in its note this morning. After Evans made those comments this morning and Goldman released its note, you saw gold and silver shoot up. Inflation is one negative side affect of additional quantitative easing, and gold could soar to numbers never before seen if the Fed enacts a third round of QE. In the note, Goldman has a self-asked and answered question and answer session, with regard to what could bring about QE3. The most important piece of information is that the Federal Reserve could buy alternative securities, not just U.S. Treasuries this time. In the first round of quantitative easing, the Fed bought mortgage-backed securities as well, but this time, the range could be expanded even further. From the note: Q: What assets would they buy? A: Probably mostly longer-duration Treasuries. To be sure, the recent widening in agency MBS spreads has somewhat raised the probability that Fed officials might go back into that market, and a further widening could raise it further. It is also possible that MBS would be incorporated into a possible "twist" via sales of high-coupon securities (which have relatively short duration because of a higher probability of refinancing/prepayments) and purchases of low-coupon securities (which have relatively long duration). However, we think the hurdle against duration extension in the MBS market is relatively high because Fed officials remain determined to return to an all-Treasury balance sheet in the longer term. An increase in the stock of low-coupon securities that may not roll off the balance sheet for up to 30 years would make this process even more challenging. Q: Does the Fed have more extreme options up its sleeve? A: Yes, but the hurdles are very high, and a more radical approach is unlikely unless the economy and/or the financial markets perform substantially worse than we are forecasting. There are three main ways in which the Fed could be more radical: (1) an extension of the QE program into markets other than Treasuries and agency MBS, e.g., private sector securities, (2) a much bigger QE program, up to the extreme version of a promise to buy as many securities as needed to hit a specific yield target (i.e. a "rate cap" further out on the yield curve as then-Governor Bernanke suggested back in 2002), and (3) an explicit or implicit change in the Fed's policy targets. If the Fed were to buy alternative securities such as corporate bonds, or ETFs, as Goldman suggests it potentially could, there is no telling how big or how long this program could be. The major caveat to all of this is that it is not likely to be enacted unless the situation becomes incredibly dire. Japan has already enacted this, by buying real estate investment trusts (REITs) and ETFs. Jan Hatzius and the rest of his team at Goldman are essentially demanding that QE3 be enacted, and with comments from Evans this morning, it looks as if the Fed is listening. Whatever Goldman wants, Goldman usually gets. There's a reason they are known as "Government Sachs." ITEMS:

Bullish:
Traders who believe that QE3 will come, and Goldman gets what it wants might want to consider the following trades:

• Go long precious metals. Gold jumped $40 an ounce on the comments this morning from Evans, and there is no reason to think it will change should a program be enacted. Consider ETFs such as SPDR Gold Trust ETF GLD, ProShares Ultra Silver ETF AGQ and PowerShares DB Gold Double Long ETN DGP.

Bearish:
Traders who believe that QE3 is coming may also want to consider currency trades:

• This is ultimately bearish for the health of the U.S. dollar. Traders can short PowerShares DB US Dollar Index Bullish UUP or go long PowerShares DB US Dollar Index Bearish UDN if they think the U.S. dollar will go down.
  
  

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