Prices Stand in the Way of QE3

Last week we said a major reason for no QE3 in September was the avoidance of further oil price hikes. Today’s Prices Paid index further confirms this obstacle. But a sub-50 reading in services ISM and a sub-100K reading in NFP will complicate matters for the Fed.

The 14.5 point jump in the August Prices Paid component to 54 was the biggest monthly increase since September 2005. Such a surge was mostly due to rising energy and grains prices, thereby dampening expectations of any immediate QE this month. (See Reason #2 below)

August manufacturing ISM eased down to 49.6 from 49.8, producing the third monthly consecutive figure below 50. New Orders deepened into contraction at 47.1 from 48, while Employment fell to 1.6 from 52.0.

With US equity markets at only 2% below four-year highs and US data lacking the negative consistency of late spring, QE3’s data-dependent role means the Fed could afford to wait until October. Here are is a reiteration of those reasons:

Three reasons September QE3 is unlikely

1) The latest US data on jobs, retail sales, services ISM and Philly Fed presented no real urgency for the Fed to force out QE3 in this month’s Jackson Hole conference. If, on the other hand, the data were poor and the Fed showed reluctance to QE3, then this would prove negative for equities. But the facts cannot be ignored and the data reduces the urgency for the Fed to act in September.

2) Announcing QE3 now would further boost already rallying oil prices (and grains) at a time when the G7 is pressing the International Energy Agency to ask countries to release oil reserves to offset rising prices. And with US consumer confidence having dipped to nine-month lows in August, US average gasoline prices are up 15% from their July lows, hitting a four-month high of $3.80 per gallon.  The combination of rising fuel prices and eroding consumer confidence is never a good idea, especially ahead of Presidential Elections.

3) Conserving firepower. The Fed may prefer to act at its October meeting, when pre-election market volatility is expected to escalate, especially in the event of a close race presenting the argument that ‘uncertainty equals volatility. And not to mention, volatility emerging from the Eurozone.

Onus is on Draghi this Week

Yesterday’s Draghi comments making the case for the ECB purchasing up to three-year bonds created a new “expectations function”, into Thursday’s Council meeting. This should likely keep EURUSD cemented above the 1.24, while remaining confined between its 100-DMA and 55-DMA of 1.2595 and 1.2395 respectively.  Fresh interest is expected to re-emerge near 1.2450s for a retest of the July top near 1.2660s