QE3 and its impact on financial markets

With this round of quantitative easing QE3, the Federal Reserve will look at providing extended assistance and stimulus for economic activity in the US by keeping the interest yields on bonds low, and thereby forcing investors to spend money . The idea is that these investments in the economy will in turn create a wealth effect and result in more consumers spends. This will increase the wheel speed of the US economy

Fed can consider QE3 for following reasons.

·  The high rate of unemployment:

·   Low inflation rate

·  The U.S. debt ceiling raise: following the House of Representative’s decision to raise the U.S Debt ceiling by $2.1 trillion earlier this month, the deal between Obama and Republicans included budget cuts, which may eventually further slowdown the economic progress (this budget cuts will try to slowdown the growth in deficit, which will reach nearly $1.2 trillion in 2011 fiscal year. But in any case, by launching a stimulus plan to purchase treasury bills, it could help finance some of the growing debt of US government.

·   U.S. housing market: the recent reports show that the current real estate market is slightly better than last year, but isn’t doing well or growing. In order to jumpstart the economy it needs to build and sell housing. This stimulus plan might push more funds towards housing, even though many commercial banks are still reluctant to provide credit for obvious reasons;

·  The current stock market and Treasury bills: following the downgrade of US credit rating from AAA to AA+ by S&P, the US stock markets sharply declined; on the other hand, the US Treasury bills yields sharply declined as well due to higher demand for US Treasury bills; e.g. the 10 year T-bills yield fell by 0.72 percent point during August – the sharpest monthly fall in 2011. The QE3 program could bring back some stability to the US stock market and the US Treasury bills market.

On the other hand Fed can avoid another stimulus plan for following reasons

• The previous two QE programs didn’t work
• Low interest rates:
• Weaker US dollar: even though the US dollar held its grounds against the Euro, it did fall against the “safe currencies” such as CAD and AUD. This QE3 might further weaken the US dollar, QE3 could push inflation in emerging markets

Impact on dollar

The dollar is expected to weaken against major world currencies. The Fed will expect a weaker dollar to have a positive impact on the current trade imbalances. However, the cross currency movements will depend on several other global factors too such as developments around the sovereign debt crisis in Europe.

Impact on global inflation

The QE3 is expected to increase liquidity in the markets. It can, hence, aggravate the inflation rate further. The inflation rate is manageable in the developed countries due to slow the economic activity. However, it will hurt emerging markets like India which are already facing a high rate of inflation.

Impact on commodities

The prices of global commodities went up quite a bit during the last QE phases. The main reasons for the are weakness in the US dollar and sharp cross currency movements.

The commodity prices have corrected over the last couple of months as the QE2 effect faded off. Analysts believe another round of quantitative easing will trigger another cycle of high commodity prices in the global markets. In fact, there have already been some in global commodities over the last few days over speculations on the QE3 package announcement.

Impact on domestic markets

Because of dollar weakening QE3 is good for importers and bad exporters especially IT industry.The QE will increase inflow of funds to emerging markets from foreign institutional investors. The fund inflows here have slowed down considerably since the beginning of this year due to signs of economic recovery in the developed countries.