More Fed Easing Could Hurt Obama

If it happens soon, any boost to the economy could completely wear off by Election Day.


Everything that happens in Washington these days is politicized, so it's reasonable for investors to wonder if a third round of quantitative easing by the Federal Reserve, if it comes, might be timed to help President Obama win reelection in November.

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But that might be backward logic. If the Fed eases again, as seems increasingly likely, the stimulative effect could be so short-lived that it has completely worn off by the time voters head for the polls in November. If easing happens soon, it could even leave markets in a downward swoon by Election Day.

Most analysts agree that the Fed's medicine has become decidedly less potent over time, which means a third dose of quantitative easing—"QE3"—could have an underwhelming effect on markets. There's another powerful force that could undercut the Fed's efforts: Congressional bickering over $600 billion worth of tax hikes and spending cuts due to go into effect at the end of the year. "We think the market's resulting euphoria following the announcement of QE3 will likely fade if it is not accompanied by clarity on the fate of our tax and regulatory policies," writes Sam Stovall, chief equity strategist for S&P Capital IQ.

Quantitative easing is designed to do two related things: Push investors out of safe assets like bonds and into riskier assets like stocks, and force down long-term interest rates. So far, it has generally worked, with prior rounds of easing clearly helping boost stock values while pushing rates down to record-low levels. But there's also a pattern of diminishing returns, which is why expectations for QE3 are modest at best.

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The first round of easing lasted from November 2008 through March 2010. Stocks over that time rose by 37 percent, even though markets were in a free fall for the first four months of that time frame. If you measure the bounce fromm March 2009, when the Fed announced an aggressive expansion of its first easing program, the run-up in stocks was 46 percent.

The second round of easing ran from November 2010 through June 2011. Stocks gained about 11 percent during those seven months. Not nearly as impressive as QE1.

"Operation Twist," which is kind of like QE-lite, began last September, with the Fed extending it in June. Over that 10-month period, stocks have risen by about 12 percent. Since Operation Twist covers a longer period of time, that performance is even weaker than the gain correlated with QE2.

So each subsequent easing announcement has coincided with lower gains in the stock market. In each case, the biggest gains came in the first few months immediately following a Fed announcement, with stocks flattening out afterward. And stocks started to fall a couple of months before each of the first two easing programs ended, as investors worried about the disappearance of central-bank support.

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As for record-low interest rates, the Fed itself acknowledges that they've had only a limited effect, because so many people can't qualify for a mortgage or other type of loan. Since more easing won't change people's ability to qualify, there's no reason to expect a fresh pop in home sales from any additional easing.

There are many other things that affect stocks and the housing market, of course, but that's all the more reason to be worried about the need for quantitative easing now. Three years into a supposed recovery, there should be no need whatsoever for more help from the Fed to stimulate the economy. Yet investors are clamoring for more QE, and the mere expectation of it may already be providing an artificial lift to stock prices.

If the Fed announced QE3 just a couple of weeks before the November elections, that could indeed trigger a pleasant stock market rally that lasts through Election Day and boosts Obama's re-election odds.

But most economists think that if the Fed pulls the trigger once more—as Fed officials have been hinting they will—it will happen sometime between now and the Fed's meeting on September 12-13. That means QE3 would officially be in effect for eight to 15 weeks or so before the November elections.

If the pattern of diminishing returns holds, stocks could enjoy a modest runup in early fall but be out of steam by November. At that point, tax and spending uncertainties will loom much larger, with investors watching their portfolios shrink and wondering, what now? If President Obama has to answer that question on the eve of the election, he may be the one questioning the timing of the Fed's moves.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.