In a note out today on rates and the end of QE2, BofA/ML’s Priya Misra takes the sanguine view: There’s no particular reason to think that the end of bond buying will lead to a spike in rates (as Bill Gross claims he thinks). As it is, professional investors are already short-biased, and if the economy slows or inflation expectations tamp down, bond fund flows should pick back up, cancelling out any impact of the Fed’s deseration from the market.
Meanwhile, Misra lays out three reasons that QE2 will be the last QE you see for a while:
Inflation expectations are much higher today versus the fall of last year. In Q3 2010, one of the major concerns for the Fed was avoiding deflation. As noted by Chairman Bernanke in October 2010, “the risk of deflation was higher than desirable” which was one of the reasons that encouraged the
FOMC to launch QE2. We no longer see a risk of deflation and FOMC officials have acknowledged that core CPI may be close to bottoming. Further, higher commodity prices have also turned attention towards inflation expectations which are close to all time highs. In our view, it would be very
difficult for the Fed to justify further expansion of its balance sheet given elevated inflation expectations.
The FOMC faced unprecedented domestic and international backlash post the announcement of QE2. Top Republican lawmakers sent a letter to the Fed criticising the central bank’s actions fearing its potential to lower the dollar and to stoke inflation while China, Brazil, Germany and South Africa all
criticised the Fed’s actions saying the move would create asset bubbles in
Most economists do not forecast growth slowdown in 2H – which wouldcreate the need for QE3 – even though 1Q growth forecasts have been revised down drastically. And most economists believe there is a high hurdle for QE3 as reflected in Fed speeches and the last few FOMC minutes.
So there you have it.