Asia Economy

Further Easing 'Lethal Cocktail' for Bonds: Expert

The worse-than-expected U.S. jobs reportfor May has increased speculation that the Federal Reserve may be forced to embark on a third round of quantitative easing once the second round winds down at the end of this month.

No Double Dip, No QE3
No Double Dip, No QE3

Thierry Apoteker, CEO, Founder and Chief Economist at TAC Financial thinks that would be the wrong medicine for the U.S. economy and would create a "lethal cocktail" in the bond markets, which many already see as heavily mispriced.

"If you have fiscal policy that is loose and monetary policy that is loose, commodity prices rising, then you have a recipe for a very lethal cocktail on the bond market," he said.

Apoteker says long-term U.S. treasury yields should be at the same level as nominal gross domestic product (GDP) growth, which would be around 4.5 percent. Compare that to the current yield of just under 3 percent for the 10-year Treasury, which Apoteker attributes to the large amount of liquidity available and few attractive assets to buy.

If Apoteker is right about long-term yields, U.S. Treasury prices could be set for a significant correction, since yields and prices move in opposite directions.

Other experts also think the economic data doesn't yet justify further monetary easing.

"I think things will have to get considerably worse or at least stay as bad as they currently are for an extended period before QE3 really comes back on the policy agenda," Russell Jones, Global Head of Fixed Income Strategy at Westpac Institutional Bank told CNBC on Monday. He says there’s enough political opposition against the move for now, unless there’s a drastic deterioration in the economy to warrant it.

It's a view echoed by Michael McCarthy, Chief Market Strategist at CMC markets.

"At this stage, it's far too early to say we have established a trend in weakness. It's certainly a concern to see these weak readings, but until we see that established as a trend, until we've got a couple more months where that is the case, I don’t think we've derailed the U.S. recovery story as yet," said McCarthy.

QE3 in Another Form

Experts suggest that if QE3 does happen, it would have to surface in a different form.

"I think there is a sense of quantitative easing having diminishing returns,” said Jones. “I think if they [fed policy makers] are forced into this kind of policy again, they will probably do something like target long-term interest rates and allow the balance sheet to expand to whatever level is necessary to achieve that target," he said.

Paul Gambles, Managing Partner of MBMG International, agrees.

“We don't think they can put their hands up and say lets have another go at doing this thing that hasn't worked twice,” he said, adding that effects of QE2 already started to fizzle out mid-way in recent months. "But we think they will find a backdoor way.”

Gambles says there are many options for the Fed to financially engineer and pump money into the system without resorting to overt quantitative easing, like the TARP (Troubled Asset Relief Program) scheme in 2008 when the Treasury bought up equity stakes in troubled U.S. financial institutions; and when the Fed took on the liabilities of Fannie Mae and Freddie Mac onto its balance sheets.

"They got to do something now if they want to try and give this impression of creating jobs and of supporting asset prices," he said.