The Federal Reserve's second round of quantitative easing was working until a major jump in oil prices hit growth in the US, according to Charles Robertson, the chief global economist at Renaissance Capital.
Like many in the market, Robertson is calling for a third round of QE from the Fed as he believes the US, unlike Japan, is a society that is geared towards inflating away its debt.
“The market is unlikely to rally as much as it did from QE2, as the markets will perceive QE2 to have been a disappointment for growth,” said Robertson in a research note on Tuesday.
“We continue to believe that QE2 was working, but that high oil prices ruined US consumer confidence, as oil jumped in February and confidence began collapsing after February.”
For QE3 to work, Robertson believes Brent oil prices, currently hovering around $108, need to decline to $90 a barrel.
“This would boost global confidence, and despite being painful on a one - to two-month horizon for markets like Russia and other energy exporters, it would be helpful in the longer term,” he wrote.
A fall in energy prices could also do a lot to boost consumer confidence even if Fed Chairman Ben Bernanke does not unveil another round of unconventional measures on Friday at a meeting in Jackson Hole.
It could be argued that a big reason that oil prices went so high was the impact of QE2 on asset prices. While the second round of QE did little to boost growth, it did help sentiment by helping drive a number of riskier assets, like oil, higher.
Predicting the US economy will grow by between 1.5 and 2.0 percent this year and by 2.5 percent in 2012 on the assumption that the Fed will act, Robertson believes the Fed and president Obama will do one of four things over the coming days and weeks.
The first option is that Bernanke promises QE3 at Jackson Hole on Friday and, when added to a speech by Obama on boosting jobs, the market rallies by 10 percent.
Outcome two in Robertson's view is that Bernanke waits for Obama's speech and promises QE3 at the next meeting of the Fed on September 20th, delaying the 10 percent market rally until the fourth quarter.
The third option is no QE3 but a big jump in fiscal stimulus in the short term and a promise to cut spending over the long-term. Robertson believes the political environment in Washington makes this scenario very unlikely.
The final option is the Fed does nothing, Obama's ambitions remain limited and markets continue to decline.