If you’re like me, the announcement today of QE3 got you wondering. Wondering specifically about how long could the indefinite nature of QE3 really go on at $40B of mortgage-backed paper being taken down by the Fed month after month after month after month…….
According to this website http://www.sifma.org/research/statistics.aspx there was at the end of Q1 2012 $8.4T of mortgage-related debt outstanding. Assuming all of that mortgage-related debt could be securitized there, my friends, is the theoretical upper limit of QE3. Now, according to this other website http://www.federalreserve.gov/releases/h41/current/ the Fed already owns $844B of mortgage-backed paper as of yesterday. So, it’s $844B down and only about $7.6T to go. At $40B per month, QE3 could go on for another 189 months or 15.7 years if one makes the simplifying assumption that the amount of mortgage-backed debt stays flat over the next 15+years. And really, unless banks start lending again (to anyone, let alone subprime borrowers [ie, people who shouldn't ever be able to get a mortgage in the first place]) it’s probably not a bad assumption to make.
That appears to be the key takeaway right there. It’s not QE to infinity. It’s QE for the next 15 years. Although I don’t think QE3 will last even a tenth that long. During QE2 the Fed injected $600B into the capital markets (you’re kidding yourself if you think it went any place other than the capital markets or bank balance sheets). During the duration of QE2 $WTIC went from $71.63 (closing price on 8/24/10) to $113.93 (closing price on 4/29/11). That was a gain of 59%. In other words, for every $10B of QE $WTIC gained 1%. At $40B of QE each month $WTIC should go up 4% each month. After a year of QE3 expect that $WTIC should be around $155 per barrel. That means that after a year of QE3 expect that gasoline should be between $7 and $8 per gallon. That’s the effect of just QE3. Now imagine how high the prices of $WTIC and gasoline would be if Israel were to bomb Iran sometime within the next 12 months.
The Fed itself is on record as saying that one of the key pre-requisites of a recession is a spike in oil prices greater than the inflation-adjusted high over the preceding 3 years. The unadjusted high in $WTIC over the preceding 3 years is $109.95 (intra-day high on 2/24/12). With $WTIC closing today over $98, at 4% per month expect the inflation-adjusted high in $WTIC to be taken out around the time the calendar turns to 2013. Should the Fed insist on carrying on with QE3 after $WTIC has crossed $110 per barrel and gasonline prices have cross $5 per gallon, the recession that will result will make 2008 look like a day at the beach.