The case for QE3

Following a week of disappointing economic data, QE3 is no longer a matter of if, but when. Higher input costs, stagnant employment conditions, and an approaching fiscal cliff are all factors that increase the pressure on the Fed to act. Despite some upticks in manufacturing activity (especially with Q2 productivity coming out better than expected at 2.2%, with lower labor costs), we should expect the Fed to be unfazed by "slight improvements" in the economy. The fact of the matter is that the economy is performing below expectations, and as history shows, the Fed is not one to miss a prime opportunity to deliver.

It seems as though QE is implemented right at the inflection point of employment. When employment increases and nears a peak, the Fed delivers. Right after, there seems to be a decline in employment. This could be that the Fed anticipates a decline, or that QE is not working to boost employment. The former point should be used by outsiders to anticipate Fed action at the peak areas of employment. The graph below shows the timing of the strategy.

Judging from the Fed Minutes last month, and Bernanke's Jackson Hole speech, it is clear that the economy has failed to deliver signs of growth by Fed standards. There seems to be a big concern on employment - specifically the long term unemployed. The latest jobs report showing a decrease in the labor force could indicate that many people have stopped searching for work.

Certainly, with Draghi finally laying out some details of unlimited bond buying, the pressure is now on the US Fed to come up with a strategic plan of its own.



Update on Canada

It became very clear this week that the Canadian dollar is very sensitive to US economic conditions. Leading up to the big US non-farm payroll report, the Canadian dollar rallied as the market anticipated better jobs numbers for our neighbors up north. There seemed to be some reliance on the positive ADP jobs number, which came out earlier in the week. A good ADP number provided hope for a strong non-farm payroll number. ADP is a private measurement of payroll change which comes out one day before the non-farm payrolls report. Canada was also scheduled to release employment numbers at the same time last Friday with the US. With disappointing US jobs numbers and relatively strong Canadian jobs numbers, the Canadian dollar rallied, triggering new one year lows in the USD/CAD pair.

As the Bank of Canada Governor Carney stated in his press conference: employment conditions in Canada are slowing down. He went even further to state that we can't just look at one month's worth of data; the underlying fundamentals deserve greater attention to get a better picture of economic performance. The fact is that the good employment data in Canada was driven by an increase in the labor market, mainly occupied by temporary workers. As we know, temps are here today and gone tomorrow.

Furthermore, we received more proof of a cool-down in the Canadian housing market with a decrease in August building permits. There is pressure on the Bank of Canada to raise rates, mainly to reign in the housing market, but economists project rates to increase gradually throughout 2013. The graph below shows a clear downwards slide in building permits which supports my call of a soft landing.

Update on SLV

Note that Silver (SLV) is still in positive territory, and will likely continue it's rally as risk-on sentiment persists leading up to the Fed's QE decision and continued economic disappointment as the year closes. Keep an eye on treasuries, net long/short positions in USD, and equity price action to measure market reaction.