Weighing the benefits of quantitative easing

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ON September  12 this year, the volatility index popularly known as the VIX tumbled 6% as an increased appetite for risk assets resurfaced in the global  market. The VIX is a measure of the implied volatility of S&P 500 index options. It is often referred to as the fear index or the fear gauge and represents one measure of the market’s expectation of stock market volatility over the next 30 day period. The VIX is presently trading at 14,57, the lowest level in more than 24 months. This was after the US Federal Reserve announced that it would be buying mortgage-backed securities to the tune of US$40 billion every month for an indefinite period. The FED also announced that the low interest rate regime would continue till 2015 and that it would extend Operation Twist for the remainder of the year.  The rationale behind punters piling into equities was the prospect of strong returns. History has it that each time easing measures are implemented, equity markets respond positively. The S&P 500 rallied 33% over the course of QE1  in 2009.

Report by Kumbirai Makwembere
A similar trend was also evident when the announcement to commence QE3 was made. The trio of Dow Jones, S& P 500 and the Nasdaq have all gained approximately 1% since Thursday last week.

 

Commodities also rallied, with gold prices in particular breaking above the US$1 700 barrier. Currently, the precious metal is trading at US$1 756 per ounce. Platinum and Silver also followed, registering gains of 1,2% and 1,8%, respectively.

 
Whilst equity and commodity markets rallied, other market players were frowning at the Fed decision to go ahead with QE 3. The main objective of implementing easing measures is to resuscitate the ailing housing and job markets. Republicans in particular argued that even if it does achieve the intended objective of stimulating the economy, it is likely to be inflationary and comes at a time when food prices are soaring. The Fed chairman Ben Bernanke also admitted back in 2011 that indeed the inflationary impact of quantitative easing outweighed its intended benefits. Furthermore, QE 1 and QE 2 have failed to achieve the attendant objectives of lowering the unemployment rate from the current level of 8,2%. The US government spent US$2,8 trillion under the two versions and this created only two million jobs.

 
However, one thing that should not be ignored is the fact the bailout packages the Fed rolled out since 2009 helped save General Motors and Chrysler, in the process saving millions of jobs.

 

 

Republicans again view the action of pumping money into the economy less than 100 days before presidential elections as literally throwing a second term to President Barack Obama.

 
It would however appear that pumping money into the economy was the only way to encourage consumption and to create employment. The jobless rate in America, which peaked at 10% in October 2009, is currently at 8,1% and has consistently remained above 7% since December 2008 when the subprime mortgage crisis intensified. Whilst the US economy managed to create 2 million jobs since the commencement of QE 1, the decline in the jobless rate is largely a result of Americans giving up looking for employment. The housing market, on the other hand, remains in the doldrums. Sales for new homes for instance, are currently hovering near record lows.

 
Whether or not easing was the right approach is something that punters on the market are not worried about. Activity on the financial markets is expected to be buoyed by the additional liquidity that will be injected into the market. Risky assets like commodities and equities will continue to benefit from increased demand. Gold will now regain its inflation hedge status as the US dollar is likely to remain weak. Already the dollar index, which measures the strength of the US dollar against a basket of currencies, is trading below the psychological mark of 79.

 
It is encouraging to note that the US government is prepared to do whatever it takes to save the economy. However, they still have one more hurdle to jump at the end of 2012. This is known as the Fiscal Cliff.

 
This is a term being used to describe the conundrum that the US government will face at the end of 2012. US lawmakers have a choice: they can either let current policy go into effect at the beginning of 2013 — which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession — or cancel some or all of the scheduled tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a crisis similar to that which is occurring in Europe.

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