End of QE2 won’t impact Canada

The expiration of the U.S. Fed’s second round of quantitative easing—dubbed QE2—will have little or no implication for the Canadian market according to experts north of the border.

The post-QE2 outlook started garnering considerable interest as the Federal Reserve announced it will turn off its $600 billion tap in June as planned in light of strengthening U.S. employment data and economic recovery.

“I don’t think stopping or not extending QE2 will have a major impact on the Canadian market,” said Serge G. Pepin, head of investments, BMO Investments Inc. “We’re relatively well served here in Canada but Canadian investors must not lose sight of things outside of our borders because of the wonkiness of our own market.”

The Canadian market is largely resource-based and only comprises four per cent of the global equity market. This inevitably forces investors in search of diversification to look beyond Canadian borders.

The domestic market has a strong correlation with the U.S. market, concedes Jurrien Timmer, director of investment research, Fidelity Canada, but adds that on the currency adjusted basis, there are differences.

“The U.S. dollar is clearly still weakening and the dollar index is now at 73.20 which is pretty darn low, so the marketplace seems to be saying that Fed is going to stay loose longer that people believe,” said Timmer. “This is an important distraction, because the Fed doesn’t actually have to do more easing, which it could only do through QE3, but if the Fed just stays where it is and growth and inflation continue to advance while the rest of the world is tightening, [it] could force the dollar to go down further.”

After drawing attention to the notion of QE3, Timmer promptly proceeds to negate its probability in the near future. “They want to go from easy to neutral and that means no more QE2 but also I don’t think the Fed can get away with QE3,” he said. “From an investor’s point of view, you have to wonder if QE3 would work as well as QE2 did; at some point it may backfire [if there’s] more weakness in the dollar, which means more inflation and if the dollar goes down, oil prices go up.”

The Fed, he adds, is looking at how and when to exit QE2 not how and when to introduce QE3. “Things would have to really deteriorate for them to go to the other extreme.”

Timmer likens the current U.S. economic situation to a patient in on intensive care unit, which makes the Fed an EMS squad and QE2 defibrillator.

“The U.S. economy has been on an IV drip in the emergency ward; the patient seems to be getting better so now it’s time for the doctor to take the IV out of the patient’s arm and see how the patient does without the medication.”