Goldman: QE3 Optimism is Excessive

on June 09 2011 3:58 PM
Goldman Sachs
A Goldman Sachs sign is seen above their booth on the floor of the New York Stock Exchange Reuters

The hot debate these days seems to be about QE3. 

Will the FED print more money? 

One thing is for sure that QE2 will end at the end of June.  With unemployment still above 9%, many believe that its only a matter of time before the FED continues its path of quantitative easing. 

Before we hear what Goldman has to say, let's take a look at who thinks there will be or won't be QE3.

QE3 Will Happen:

Jim Rogers - Jim Rogers: US Dollar Total Disaster, Own Chinese Yuan  Shouldn't happen but there most likely will be QE3 since thats all Bernanke knows, maybe with a different name

David Blanchflower/ Marc Faber/ Fred Hickey/ Stephen Roach/ David Rosenberg/ Nouriel Roubini/ Gary Shilling - Top Economic and Market Forecasters Predict: QE3 Is Coming

QE3 Will NOT Happen:

Richard Fisher - Fed's Fisher: No need for QE3, US Dollar Implications

John Taylor - John Taylor: Buy US Dollars in the next 3 or 4 days, Global equities on the brink of downtrend

Mohamed El-Erian - El-Erian of Pimco says FED Unlikely To Have Third Round of Easing - QE3

Goldman Sachs, Dominic Wilson, came out with a note aptly titled QE3 optimism is excessive, here is an excerpt:

Part of the reason for speculating that QE3 optimism is excessive is that many investors believe that equity markets have been strangely resilient. We have ourselves pointed out that US equity indices have been vulnerable to the growth downgrade that their own rotations out of cyclical sectors imply, and some of that gap has recently closed. But it is also true that the current pattern of asset markets is broadly consistent with the way mid-cycle slowdowns are often priced. Cyclical assets underperform broad equity indices, bonds rally as the market adjusts its views of policy and that dynamic in turn partially cushions the hit to risk assets overall. As Themos Fiotakis described in a recent Daily, a weakening dollar is not uncommon in an environment where the global cycle is showing positive but declining growth. So the critical question again comes back to how persistent and how significant the underlying growth slowdown turns out to be. Amid all this is a reminder that the simplest US slowdown trade - mid-cycle or otherwise - is generally to be long US fixed income.

While the market has been quick to price easier policy in the US in response to the growth slowdown, it has been slower to relax about EM tightening risk. At one level, that makes sense given tighter capacity and more intense inflation pressures in many of the large EM markets. But we think a US slowdown - up to a point at least - is probably more helpful to EM than to DM markets. This is simply the reverse of our argument in late 2010 that an accelerating US recovery would add to EM policy dilemmas by pushing commodity prices higher and providing a tailwind to local demand. While persistently slower US growth would be more troubling for the large developed economies that are still trying to make inroads into spare capacity, it would also create more room for EM economies to grow without hitting global constraints so hard. That was the rationale for our long EM Top Trade recommendation in April. The timing of our shift has clearly been premature. But we are less puzzled that EM equities have been outperforming again recently in this environment than we were by their underperformance in the first half of May. Our latest tactical FX trade recommendation to be short MXN/CLP, based on Robin Brooks' and Alberto Ramos's recent work on cyclical momentum in Latam, has a similar flavour.

One potential lesson of the last few months is that the global economy finds itself in uncomfortable places when US growth accelerates alongside robust growth in other parts of the world. Our latest round of forecast revisions in May were to a large extent about acknowledging that the energy constraint is more binding than we expected going into the year. The silver lining of a US slowdown could thus be that it takes the sharpest edge off some of the commodity-related inflation worries. Our own new forecasts look for higher commodity prices over the coming 18 months, but not for the kind of rapid acceleration that we started to see in the first quarter of this year in energy markets. Those forecast revisions do reinforce our preference for commodity exposures - having taken a break in April and early May - and Jeff Currie and team added fresh long recommendations in oil, copper and zinc two weeks ago. With that shift and an expectation of more USD weakness, we added a short $/NOK Top Trade recommendation (our eighth) at the same time, which is off to a good start.







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