QE3 likely; Germany may give go ahead on ESM: Rabobank

The US Federal Reserve and the German constitutional hearing are the two talking points for the market and Jan Lambregts of Rabobank International believes the German parliament will not block the affirmation of the European Stability Mechanism (ESM). He is also hopeful of seeing another round of quantitative easing from the Fed.

Here is the edited transcript of the interview on CNBC-TV18.

Q: We have the German Constitutional hearing plus the Federal Open Market Committee (FOMC). Between these two events what do you think is more important for global equities and commodities?

A: I think first of all it would be the German Constitutional Court. It's pretty much a Bernoulli Variable as its 0 or 1 outcome. Will they or will they not allow it? We think along with the broad consensus out there that they will not block the affirmation of the European Stability Mechanism (ESM), the German Parliament has already agreed to vote in the ESM shortly after.

The big question though to German Constitutional Court is whether they will restrict for the future any European projects and there is a likelihood that they will. If they will, they will make the limits, the borders on what Europe can do without having a referendum to the German people more restricted.

Secondly, of course there is indeed the FOMC. We think it is likely that they will in any case extend the rate pledge there. So extend the rate pledge further out, but it could already engage into the third round of QE as well going by the comments of Mr. Bernanke at Jackson Hole recently.

Q: What exactly are your expectations from both - Germany and the FOMC i.e. will it actually be a positive outcome from both the German Constitutional Court as well as a possible QE3 from the US?

A: No. I believe that from Germany we will indeed get a go ahead on the ESM. I think there is a good likelihood though that they will restrict in the future what can be decided. So that could still be a little bit of an unexpected blow I think compared to consensus.

Second one on the FOMC, I believe we will see indeed that rate pledge extension and already that third round of quantitative easing, very likely, if not this month next month. Pretty much that is what we expect there. If you have dissected what Mr. Bernanke said at Jackson Hole Wyoming, it was pretty much, "We the Fed have done an awful amount of things in the past couple of years. We have been very successful at having an impact on yields, as in lowering the yields and because we have been very successful, have faith in us. We have a lot of instruments still at our availability and we intend to use them."

Whether that's a correct read of history, I sincerely doubt it. I don't think the Fed has as much instruments left anymore and I also don't think they are as effective as Mr. Bernanke thinks. But the fact is I am not on the FOMC. They also don't call me before they make the decisions. Mr. Bernanke has pretty much spelled it out, more easing to come.

Q: According to you what will be the effectiveness of a QE3 if it is announced?

A: Quantitative Easing 3 or quantitative easing in general has a couple of impacts. The first is a confidence type of impact and that is what the Fed has been pretty much going on about. They are saying this is a blank cheque that the Fed is writing you to buy equities. We are trying to boost equity markets as more fundamentalists, the economists looking at this and the fundamentals of this is of course very awkward.

These stocks are not fundamentally becoming worthwhile. These companies are not becoming more profitable essentially just as more money is being printed and hence, this is a form of asset price inflation. I am not too enthusiastic about that. The other elements of QE3 are more targeted. If the Fed implements QE3 and aims at buying Agency Mortgage-Backed Securities, it is also providing support to these Agency Mortgage-Backed Securities’ markets and therefore indirectly to the housing markets.

There is a different agenda out there playing out as well and that one is of course also important. If you work at the Fed like Mr. Bernanke does, you could actually apparently calculate exactly. As Mr. Bernanke has come up with quite detailed calculations of what quantitative easing did in the past for example, saying quantitative easing in its second incarnation had a 50 bps yield impact.

We think it's actually very difficult to really distinguish this. We don't know what the counter-effects will be. There are so many things going on in the world like safe haven flows. It's hard to say whether that was really over third. In any case we believe that as we approach now to the third installation of this program, the effectiveness starts to dull and you have to wonder whether there is a risk reward sort of trade-off here. Obviously, the risk we are running in terms of long-term inflation starting to outstrip the rewards were actually ripping.