Amid ugliness, there's always hope for QE3

The S&P 500 has declined all of 5 per cent from its high in April amid uncertainty in Europe and weak U.S. economic news – but it doesn’t take much these days to get everyone talking about the salvation of QE3.

The Federal Reserve has twice before resorted to the experimental policy of quantitative easing, or buying U.S. government bonds with printed money in an effort to drive down borrowing costs. And while no one is really sure how effective the policy is in economic terms (after all, U.S. economic growth remains weak, unemployment is still high and the housing market is still a disaster), investors love it.

According to recent figures from Ed Yardeni, the first round of quantitative easing between November 2008 and March 2010, sent the S&P 500 up 36 per cent. The second round, begun with mere thinking-out-loud by Fed chairman Ben Bernanke well before the policy was implemented, boosted the index by 24 per cent.

Admittedly, there were other things going on here apart from Fed meddling – but investors can spot a pattern. And with a couple of high-profile observers arguing that QE3 is getting closer, some of the worries hanging over the stock market seemed to dissipate on Wednesday.

Both PIMCO’s Bill Gross and Goldman Sachs’ Jan Hatzius believe that economic conditions point the way toward a reaction from the Fed – even as the central bank has remained uncommitted in recent policy statements. In April, the Fed did not mention quantitative easing in its statement, although statements from Fed officials have made it clear that the policy remains on the table.

Now, with the European sovereign-debt crisis flaring up again and the U.S. economy producing dismal payroll gains, it’s not surprising that the stock market might be looking for a little assistance.

According to Bloomberg News, Mr. Gross – who heads the world’s largest bond fund – said on Twitter that a Fed decision to buy more bonds is “getting closer.”

Mr. Hatzius, chief economist at Goldman Sachs, appeared to have similar thoughts (also via Bloomberg): “In such an uncertain environment, taking out a bit more insurance still looks like the sensible choice for U.S. monetary policy makers,” he said in a note. “We have stuck with our forecast of some additional monetary easing,” though not until the Fed’s next policy meeting in June.

The S&P 500, down more than 20 points in earlier trading on Wednesday, pared its losses toward midday trading. At around noon, the benchmark index was down just 6 points or 0.4 per cent, to 1358.

Will another round of quantitative easing do anything for the economy? “Who cares?” the markets seem to be saying: “Just bring it on.”

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