11/22/2010 04:38 pm ET | Updated May 25, 2011

Markets Say Phew to QE2

Doris Day sang it best -- Que sera, sera (Whatever will be, will be).

Wall Street might well want to join in, applying the words of that catchy tune to Ben Bernanke's ambitious $600 billion QE2 quantitative easing package because of all the uncertainty surrounding it.

As Washington has told us, this sizable liquidity injection -- reflecting the Federal Reserve's planned purchase of Treasuries from a group of 19 dealers (such as JP Morgan Chase, Citigroup, Goldman Sachs and Morgan Stanley) -- is supposed to be an economic panacea, designed to further lower interest rates, increase asset prices and invigorate the economy.

But here again, it's another case of whatever will be, will be, because nobody knows whether QE2, with its inflationary connotations, will be a flop or a success.

Since the official kickoff of QE2 on November 12, the Fed has bought $35.9 billion worth of Treasuries maturing in 1212 through 1216.

But oddly enough, the reaction in the financial markets has been kind of strange, decidedly contrary to expectations. For example, 10-year Treasury yields, mortgage rates and the U.S. dollar should have all gone down. Instead, they all went up, with mortgage rates hitting a three-month high. Likewise, the stock market, which should have risen on the economic stimulus, went down.

In the Old Testament, it says dream no small dreams. In the case of QE2, it may be that Bernanke is dreaming too big of a dream.

That view was clearly intimated in a commentary that David Rosenberg, the chief economist and strategist of Gluskin Sheff, a leading Canadian wealth management firm, sent to clients late last week.

His message, in brief: QE2 may not be all that exciting a panacea as it's supposedly cracked up to be.

Bernanke's $600 billion experiment may get investors in a prolonged frenzy, observes Rosenberg, but in the end all it does is add 0.25 percent to real GDP growth and trim the unemployment rate two tenths of a percentage point as a standalone static event.

As for those peculiar market reactions, Rosenberg speculates that QE2 may have suddenly lost its allure. Or perhaps, he points out, all of it and then some was already priced in with all the Fed chatter that occurred in September and October to reignite investors' "animal spirits."

Meanwhile, it's noteworthy that Robert Fisher, president of the Federal Reserve Bank of Dallas, also voices some reservations about QE2. In a recent speech, he questioned whether the latest Fed accommodation might not be working in the wrong places.

Fisher feels far too many large companies he surveys that are committed to fixed investments report that the most effective way to deploy cheap money raised in the current bond markets or in the form of loans from banks is to invest it abroad where taxes are lower and governments are more eager to please.

(In other words, instead of using government funds to lend money and create jobs, the tendency instead is to invest abroad, especially in the Asian markets.)

Economist Madeline Schnapp of West Coast liquidity tracker TrimTabs Research described QE2 a few weeks ago as a Hail Mary. "There's no certainty it will work" she told me the other day. "What happens if there's no demand for money? Granted, you're lowering borrowing costs, but how much lower can already low interest rates go?"

The hope, of course, is that banks will use part of the government money to help strengthen business balance sheets, notably smaller businesses, the kind that have accounted for 65 percent of net new hires over the past 17 years.

Schnapp is dubious. What happens, she asks, if the money does not get into circulation and banks need more capital as reserves to offset increasing levels of defaulting mortgages and choose not to lend the money?

As for the argument that QE2 will help offset the renewed housing market decline, Schnapp has her doubts, noting demand is too low, there's too much inventory and the sector is expected to experience no growth over the next three to five years.

She also sees QE2 creating some potential damage. For starters, she notes it may set the stage for a highly inflationary environment that would hurt savers on fixed income. Likewise, the Fed's balance sheet will expand by $600 billion to $3 trillion. And how, she asks, will the Fed unwind that $3 trillion and approach its historic pre-2008 norm of $800 billion.

For a perspective on such stimulus, it's worth looking at how QE1 fared last year. In that case, it involved the purchase of $300 billion in U.S. Treasuries and $1.25 trillion in mortgage-backed securities.

That, in turn, helped stabilize the MBS market, knocked down 30-year mortgages from 6.5 percent in September 2008 to 4.23 percent today, sent the S&P 500 soaring 50 percent between March 2009 and March 2010, and dramatically narrowed the spread between the yields on corporate bonds and comparable U.S. Treasuries.

Unfortunately, though, economic growth remained sluggish and unemployment jumped to nearly 10 percent, which were the justification for launching QE2.

Schnapp's bottom line: "QE2 will fail and the U.S. economy will have to face the music of runaway deficits, high unemployment and an aging population that is intent on deleveraging so they have something for retirement."

And as far as the stock market goes, her message is equally emphatic: "Don't bet the ranch on QE2!"

What do you think? E-mail me at