What would QE3 mean for the markets?

With QE2 ending next month there is an expectation that the Fed’s balance sheet will come to a standstill at approximately $2.75 Trillion. Given the rise in the money supply and banks increasing their lending throughout QE2 the rapid expansion experienced during those months could place pressure on continue lending by banks and generate expansionary economic activity because of the decrease in the money supply. Some economists are torn between a continued QE program on the face of inflationary pressure or unemployment prospectus. The first argument has the CPI (Consumer Price Index) heading towards the lower levels of 5%, while the second item of unemployment is expected to remain 8.7% for 2011 according to the latest (May 13^th) Bloomberg survey. Whichever item provides the strongest pressure if QE3 were to be implemented (And I personally think it will) the unveiling would occur before the January 2012 presidential election kickoff season. The pressure on the Treasury market after June could fold either way but there is enough buyers both institutional and foreigners to drive the market up and keep yields low. But many factors could come into play such as China’s growth, the IMF’s (International Monetary Fund) leadership change, and the Eurozone debt crisis plus that the number 3 has been notoriously famous in government such as the 3 branches of powers (Legislative, Executive, and Judicial).

Charts from: http://mises.org/daily/5299/The-Effects-of-Freezing-the-Balance-Sheet

Are we on the Brink of Rising Rates

At the Commerce Street Capital LLC annual bank conference in Las Colinas, Texas on April 8^th the take away message was that banks need to evaluate their potential interest rate risk on their balance sheets. The bank’s CEO, Dory Wiley stated that since the sustained period of low interest rates many banks have become more liability sensitive thus squeezing deposit margins and shifting banks to shorten their durations of their portfolios. This type of activity if overdone can expose banks to income losses if rates rise.

As one solution presented were for banks to consider setting caps on loans to avoid borrowers becoming distressed when rates rise, as borrowers’ nature is to be liability sensitive. In Fact approximately 6.80%, or 445, of the 6,540 commercial banks in the U.S. were asset sensitive at Dec. 31, 2010, compared to 13.13%, or 820, of the 6,245 commercial banks in the U.S. at Dec. 31, 2006 as presented by Mr. Wiley. Although the hope for many institutions is that loan demand returns especially when the rates begin to rise but not as fast the 350 bps increased which this occurred after the last credit cycle in 1994.

http://www.snl.com/InteractiveX/article.aspx?ID=12605506