Will the Fed launch QE4? It’s a simple question, a five word, seven syllable sentence. In my experience, the answer to this question depends on which camp you belong to. If you believe the US is in no danger of a recession, of course your answer is no and you look at the person asking the question with a tilted grin.
The problem is that there exists a very real probability of a US recession this year. If the Fed continues to tighten, a 2016 recession is all but guaranteed. At the very least the Fed has been forced to change its tune as China threatens to push the world into a global recession. China’s turmoil last august delayed the Fed rate hike by 3 months. So there is precedent of Chinese disruptions forcing looser monetary policy from this Fed. As China’s conditions deteriorate so to will the resource rich countries. With low oil prices on the verge of sparking financial crises in major oil producing countries around the world, it looks like QE4 is a matter of when not if. In short, the “fundamentals” supporting a future QE have arguably never been stronger.
However, there is that one small caveat, QE doesn’t work. With commodity prices at multi decade lows, QE has failed on an absolutely massive scale. The EU which is in the midst of its own failed QE program is going to hell in a handbag. EU equities are negative since the ECB launched its QE program a year ago. Now that’s not to say that QE doesn’t work in the short run but the diminishing returns have fallen so much that members of the FOMC are now forced to grapple with the idea that QE4 may not be worth it or if they do launch a QE program, the size of said program will have to be absolutely enormous to have any positive short term effect.
I think they will blink. I think that as the Fed stares down the bottomless asymmetric pit that is the global economy they will cave to pressure both internal and external. Imagine the public outrage at the Fed if they sat by and let the American economy collapse in on itself when everyone shares this belief that the Fed has the power to turn the economy around.
So if you are hoping that the Fed won’t allow your 401k to fall 20% before bouncing it back to all time highs you could be sadly mistaken. The Fed has been quite silent during this recent sell off which may show their frustration with the markets as well as their resistance to use looser policy.
I think some of this resistance lies in the belief that commodity prices can’t fall forever. And it’s true, they can’t go to zero, but as we have seen, they can go lower and can stay low for a very long time. Remember the Fed viewed oil’s drop as “transitory”. Of course everything that ever existed is transitory and this drop in oil is no different. The point is, the Fed has held this belief that commodity prices will eventually revert to their long term averages and rise which will put huge upward pressures on inflation. Starting from an incredibly low base, inflation could get out of control and the Fed would fall behind the curve. After all, “price stability” is the Fed’s most important objective.
But in a world where an inevitable Yuan devaluation leads to ABSOLUTELY MASSIVE SKULL CRUSHING AMOUNTS OF DEFLATION, the Fed will no longer be afraid of QE stoking a dramatic rebound in commodity prices. Without fears of higher inflation, the Fed will have the go ahead to launch QE4.