The FOMC has conditioned the market to expect an announcement of further treasury security purchases after this week’s FOMC meeting, writes David Einhorn’s Greenlight in its latest letter to investors, which is available in full on Dealbreaker.
This is a mistake, according to Einhorn, who lays out five reasons that QE2 will most likely fail.
He ends his argument with the chilling statement:
We can’t say whether the Federal Reserve will succeed in creating another asset bubble, but we wouldn’t bet against it.
Here’s why Einhorn thinks a successful QE2 is doubtful, and it might lead to another asset bubble:
- QE2 won’t lower unemployment much. “It is hard to see how it will lower unemployment materially.”
- Sentiment indicates people will continue to act conservatively. “Corporations and consumers are acting conservatively because they fear an eventual relapse. The prior round of QE has led to a build-up of excess bank reserves, indicating that bank lending activity is not constrained by a lack of low cost funding. Few people we speak with believe that QE2 will significantly lower unemployment or that 10 years from now we will look back and say that QE2 was a good idea.”
- QE2 will probably create inflation, which might create another asset bubble. “QE2 is much more likely to be successful in creating inflation and speculation in financial instruments. It is perverse that on the heels of suffering the after-effects of the collapse of the internet bubble and then the real estate bubble (both of which the Fed disclaims responsibility for creating or supporting), the Fed would like to encourage the formation of yet another asset bubble.”
- QE2 won’t be big enough, so it will create inflation in unintended markets. “It is going to take a lot of QE to make [the CPI, owner’s equivalent rent] rise far enough to achieve a higher rate of official inflation. [So] it is quite likely that QE2 will slow the economy by raising food and energy prices [because it is easier to generate these price increases]. [These price hikes] would act as a tax on consumers and businesses.”
- The market is reacting early to QE2, but the reaction will likely reverse quickly because investors are just front-running. “It seems there are very few holders of long-dated treasuries who actually plan to hold them for their duration. With the Fed potentially purchasing trillions of dollars of long-dated bonds, speculators are willing to buy government bonds in an effort to front run the Fed’s future purchases.”
His advice at the end of all this is that “owning too many equities could eventually prove hazardous.”
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