The Multi-Dimensional Impact of QE3

There. The Federal Reserve implemented an open-ended quantitative easing policy (QE3) last Thursday with a promise to: 1) extend ZIRP to at least mid-2015; and 2) purchase a monthly average of $40 billion worth of agency MBS for the foreseeable future.

By the end of the week, the U.S. stock market sat at a post-financial crisis high, while gold prices flirted with $1,800 an ounce. WTI spot hit $99 a barrel, and copper prices rose to a five-month high of $3.80 a pound. The Euro also rose to $1.31, its highest level since late April.

QE3 will directly benefit the U.S. housing market through lower mortgage rates–all the more so given the recent tailwind in U.S. housing prices. Those with negative housing equity–at least those still making their mortgage payments–will eventually be made whole. The spending habits of a household with a positive balance sheet are considerably more generous than those of a household with a balance sheet in the red. From the end of WWII to 2008, U.S. housing activity has been one of the best U.S. economic leading indicators. With U.S. housing sales and prices normalizing, the U.S. economy should perform relatively well in 2013, as we have previously mentioned.

As evident on Thursday, QE3 will also benefit stock prices and prices of other risky assets, such as junk bonds. This is not surprising. As the Federal Reserve’s MBS purchases squeeze out more investors through lower MBS yields, these same investors will purchase more risky assets (e.g. junk bonds, emerging market bonds, and even stocks) to garner the necessary returns. At the same time, such money-printing should also result in higher gold prices, inflation expectations, and a lower US$.

As stock ownership is skewed towards wealthy households, the majority of U.S. households don’t benefit much from QE3. Worse yet, the U.S. poor and lower middle class will suffer from higher gasoline and food prices–as gasoline and food spending represent a higher portion of their budgets. Unless there is some kind of “trickle down effect” (higher housing prices leading to increased retail spending and hiring), QE3 does not benefit the U.S. from a social standpoint.

As mentioned in prior commentaries, we like U.S. housing, gold, commodities, and U.S. economic prospects in 2013. We now add to that the commodity currencies, such as the Australian Dollar and the Canadian Dollar. The Euro is still structurally flawed. However, we like the Swiss Franc. We understand that the Swiss National Bank stands by its 1.20 per Euro cap–and to that end, has accumulated foreign reserves equal to 71% of its GDP. As such, the Swiss Franc remains a solid currency, especially with Bernanke’s promise to create $40 billion worth of U.S. currency every month on an indefinite basis.

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