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Bob Janjuah: Hard Landing in 2nd Half of 2011 Makes QE3 Unavoidable

6 – Why are we so bearish under the hard landing outcome? The key is that the policy tools needed to respond to a hard landing now are very limited, in our view, perhaps even non-existent in DM (EM/stronger BS nations, e.g. Brazil, Australia, still have plenty of policy flexibility/tools). In the UK and euro zone, we see virtually zero credible policy options from here on in. We think the only “hope” for the West is another policy mistake – in the form of QE3 in the US. But as mentioned above, the “hurdle” over which Mr Bernanke would have to jump to get agreement for QE3 is now much higher because of both domestic and international concerns. So, almost by definition (for us) more QE3 is likely, but only once the situation has become really bad in markets (1000/sub 1000 S&P 500; the UR starts rising again; the hard landing). In our view, the Fed has already put at significant risk its independence and its credibility, which in turn risks leaving both the US dollar and US Treasuries unanchored and as increasingly risky claims on an increasingly risky sovereign balance sheet. We judge that QE3 would significantly increase such concerns. 7 – We think QE3 will be both unavoidable and a grave policy mistake in the hard landing outcome. We think it (QE3) is unavoidable because under this outcome, where we expect a significant slowdown in global growth in H2, driven by an EM slowdown and an end to the global super-cycle in manufacturing, it is the only „stimulative? policy option left, and Bernanke and Obama both seem fixated with stimulus, at any cost it seems. Once this slowdown is apparent it should quickly become obvious that risk asset valuations are way too high, only supported by both overly optimistic growth expectations, and, as a result of QE, by a mispriced CoC; that the Fed has destroyed its credibility; and that there is no, or nowhere near enough “sustainable” growth in the US, in the UK, or in any of the DM. And we think it would be a policy mistake because it would represent all-out debasement and monetisation, which would seriously risk the safe-haven/risk-free/reserve status of the US, of the US dollar and of US Treasuries. And this would only be made worse if the euro zone does indeed solve its problems over the rest of this year, as we expect. We feel that QE3 would risk a very negative outcome whereby US Treasuries start being priced as a risky credit asset (with real yields rising sharply) and where the US dollar would no longer be viewed as any sort of useful store of value.

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