A NEW ROUND OF MONETARY EASING AHEAD ? / BARRON´S MAGAZINE ( A MUST READ )

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Up and Down Wall Street
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FRIDAY, APRIL 20, 2012
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A New Round of Monetary Easing Ahead?
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By RANDALL W. FORSYTH
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The bulls assume central bankers have their back. But the impact of stimulus may be waning.

Is the world on the cusp of a new round of monetary easing? Not yet, but if the global economies, debt crises or risk markets deteriorate, investors are expecting central banks to pump up their liquidity provisions, again.


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Two of the BRIC nations -- India and Brazil -- cut official interest rates more than expected while China is expected to lower required reserve ratios for banks, which frees up liquidity. Meanwhile, the last member of the quartet, Russia, also could ease policy down the road if its economy cools.



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Elsewhere, Australia could resume lowering rates next month. And Japan has pledged to keep the monetary pedal to the metal in order to weaken the yen and bolster trade. All of which reflect signs of slowing in global trade, which affects these largely export-dependent economies.



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The real focus will be on the two most important central banks, the European Central Bank and the Federal Reserve. While the official line at the ECB and the Fed is that no further stimulus is in prospect beyond what's already been provided, markets are looking for clues for that to change.



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But the salutary effects of the ECB's Long-Term Refinancing Operations appear to be wearing off. While the €1 trillion ($1.31 trillion) of cheap (1% for three years) funding provided to European banks in the first tranches of the operation helped quell the euro zone sovereign-debt crisis -- which was an important element in boosting global risk assets, including U.S. stocks -- the impact of the LTRO has been short-lived.



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The focus has moved to Spain, where 10-year bond yields this week hit 6%, a psychologically important level that led to bailouts for Greece, Ireland and Portugal, according to the just-published May issue of the Bank Credit Analyst. Meantime, losses at Spanish banks have mounted and the stock market has fallen back to financial crisis lows of March 2009.



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Indeed, the LTRO may have worsened the financial situation by inducing peripheral banks to use the cheap loans from the ECB in a carry trade in Spanish securities, a losing position since the rise in yields and consequent fall in bond prices, BCA adds.



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"Spanish Prime Minister Mariano Rajoy has, of course, dismissed the idea that Spain needs a bailout, confirming Otto von Bismarck's observation that one should never believe anything in politics until it is officially denied," according to the highly regarded research publication.



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An ECB official briefly calmed the markets last week by suggesting the ECB could resume buying sovereign bonds, but BCA sees a problem. After the precedent of the Greek bailout -- in which the ECB's holdings were senior to those of the private sector, which was forced to take a hefty haircut in the bond swap -- private holders of securities that the ECB buys to support the markets would find themselves similarly subordinated. The unintended consequence could be higher financing costs for European governments, BCA concludes.



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In the event of a new crisis, however, the ECB can be expected to throw money at it, along with the other members of the "troika," the European Union and the International Monetary Fund. Ahead of the weekend meeting of the latter, IMF head Christine Lagarde said Europe has sufficient resources to deal with the problem. Left unsaid is that these monetary moves don't address the basic fiscal problem, that the austerity forced on deficit nations exacerbates the debt problem by crushing economic growth.



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As for the U.S. central bank, no action is expected at next week's two-day meeting of the Federal Open Market Committee that concludes Wednesday. But there is apt to be plenty of talk with the release of updated economic projections and a follow-up press conference by Ben Bernanke, the Fed head. Key will be comments about what to do when its maturity-extension program -- the swapping of shorter paper for longer issues -- ends in June.



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Poor employment numbers will revive talk of a third round of outright purchases, or quantitative easing, according to Owen Fitzpatrick, chief equities strategist and head of the U.S. large-cap equity team at DWS Investments unit of Deutsche Bank.



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The potential for QE3 puts "a floor under the U.S. equity market," Fitzpatrick says. It's "an escape clause" for equity investors, who last year got hit by a summer swoon as the economic numbers turned weak and the debt-ceiling fiasco roiled sentiment.



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For better or worse, the bulls assume the central bankers have their back. Perhaps, but the half-life of any effects of any treatment seems to be getting progressively shorter.