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Why Markets Should Cheer QE3 Is Not Coming Soon

Global equity markets are taking a hit from fading expectations that the U.S. Federal Reserve will act again in coming months to boost growth – but maybe investors should be cheering at this prospect, say some analysts.

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They argue that another round of monetary stimulus, widely expected in the form of quantitative easing (QE) by the Fed, would signal dire straits for the U.S. economy and so, the absence of such a move should be taken as a positive sign by investors.

“Any form of QE is a last resort: an admission that other monetary tools are not working. No QE suggests there is no panic,” said Peter Esho, Chief Market Analyst at City Index in Sydney. “So the fact that they (the Fed policymakers) are not pushing ahead with QE is positive and the market tends to forget that.”

Quantitative easing, the buying of government securities to inject capital into financial markets, is seen by economists as an unconventional monetary policy tool used by central banks to boost growth when conventional monetary policy has become ineffective.

This has been the case for a number of major economies since the global financial crisis began about five years ago. The Federal Reserve has kept interest rates near zero since 2008. It has also conducted two rounds of quantitative easing to lower long-term borrowing costs and promote investment and growth.

Wall Street shares retreated on Thursday, giving up some of their recent stellar gains, while Asian share markets were broadly weaker on Friday as investors scaled back expectations for quick stimulus from the Fed.

Hopes for further monetary stimuluswere boosted after the minutes from the Fed’s latest meeting, published on Wednesday, indicated the central bank may be ready to act again. But those expectations were knocked back on Thursday after St Louis Fed President James Bullard said that economic data since the Fed’s July 31-Aug 1 meeting have come out better and that the minutes were “a bit stale.”

The World MSCI Index fell to its lowest in a week on Friday. Still the index is up about 12 percent from almost six-month lows hit in early June.

“Markets have been resilient and we’re just seeing a pull-back right now,” said Esho.

Global stocks markets have been on a broad upswing since early June, lifted by some signs of a recovery in the U.S. economy and expectations that European policy makers will take decisive action to end the euro zone debt crisis.

Analysts said some positive signs in the jobs markets were one reason to expect the Fed to hold off on further monetary easing for now – the latest key jobs report for instance, showed that U.S. employers hired the most workers in five months in July with non-farm payrolls rising by 163,000.

“If payrolls stay above 100,000 that does not give me a lot of confidence that the Fed will act before the election,” Boris Schlossberg at BK Asset Management told CNBC Asia’s “Squawk Box” on Friday, referring to the U.S. presidential election due to take place in November.

“Unless we have really horrible numbers I think QE3 is unlikely at this point,” he added.

Not everyone shares this view. Chicago Fed President Charles Evans for instance on Friday reiterated calls for further easing, arguing that there’s “a lot of reason to do more.”

According to Schlossberg, markets are underestimating the pressure on the U.S. central bank not to take action before the November presidential elections.

“The market went off thinking QE3 was in the bag and I’m skeptical of that. The market is underestimating the amount of political pressure the Fed feels not to act ahead of the elections – Especially when the economic data in the U.S. has not been that horrid,” said Schlossberg.

- By CNBC's Dhara Ranasinghe

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