The Shell Game: Net QE3 Stimulus is -$5.1B

December 26, 2012, 08:40 am ET, BY Thomas H. Kee Jr- Editor, Stock Traders Daily| Editor: Thomas H. Kee Jr. (Follow on LinkedIn)

The Stimulative efforts of QE3 are not what they appear to be.  The FOMC is prepared to buy about $85 Billion worth of US Treasuries (NYSE: TLT) and Mortgaged backed securities, we all know that, but when the left hand is shuffling the cups one way we need to pay attention to what the right hand is doing or this shell game could get the best of us.  In this case, at the same time the FOMC is buying bonds, the US Treasury is selling them, and when the government sells bonds it actually drains liquidity from the system.

Looking back to QE2, I wrote a special report titled “Pulling Back the Curtain on the Wizard,” which described the true stimulative nature of QE2.  That program sought to buy about $100B of bonds per month, but after the offsets by the US Treasury (including maturing bonds) the net stimulus was only about $30B per month.  This is much lower than the face value of the program, $100B, but it still worked to induce the wealth effect and stimulate equity markets. 

 Arguably that has caused a ‘Valuation Bubble’ in our equity markets, but that is left for another of our analysis.  Today’s discussion is on the real net stimulus of QE3, but this time there is more than just one other hand at play in this shell game.  Not only does the US Treasury act as a drain on liquidity this time, but Fiscal Policy is now poised to do the same. 

Breakdown of QE3:

Without the inclusion of the US Treasury the stimulus would be the face value of the program, $85, but when we include the offsets by the US Treasury the net stimulus changes to $11.5B/month.  This reduced stimulus estimate is no surprise because QE3 is lower than QE2 by $15B/month anyway, but again another important factor is at play.  Fiscal Policy will now also drain money from the system, and although no one knows what that will look like yet we can deduce a best case scenario now. 

Assuming a best-case scenario of a $200B headwind this year, which would have been negotiated down from about $600B as we know, the monthly headwind of Fiscal policy would be about $16.66B.  This further offsets the $11.5B that came after the US Treasury was included in the equation, and changes the net real stimulus of QE3 to a negative number.  The true net stimulus of QE3 is -5.1B per month with a best-case scenario in mind.

The table below offers tangible estimates and comparisons:

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