Markets will learn to welcome QE3 The expansion of the Federal Reserve's quantitative easing programme has raised a number of fundamental questions, namely: Will QE work in boosting the economy? Will it lead to an upturn in inflation? And what will the impact be on asset prices, notably global equity, bond and commodities markets? Although previous QE programmes by the Fed and other central banks have arguably reduced tail risks to economies and markets, clearly economic growth in the US and the OECD area has been unsatisfactory. In his recent press conference, Ben Bernanke, Fed chairman, repeatedly referred to the slow progress being made in reducing US unemployment, the low level of demand and the lack of acceleration in real GDP growth. Although the Fed has expanded its balance sheet from $800bn in September 2008 to close to $3tn, signalled the Fed Funds rate will stay historically low for an extended period and extended the duration of its US Treasury holdings, the impact of these moves so far has been muted. Over a period when banks are deleveraging, when consumers are increasing their savings and reducing their borrowings, when companies are running historically high levels of excess liquidity and when fiscal policy is having a negative impact on GDP growth, it is clearly difficult for monetary policy to be effective, except as a backstop. However, the US economy is showing signs of being at a turning point. The housing market has formed a base and it is realistic to forecast house prices will recover 5 per cent or more in the next year. Real consumption has improved with a trend recovery in personal incomes. Over the next 6-12 months real consumption could increase 1.5-2 per cent. There has been an upturn in consumer credit availability. High levels of corporate liquidity have started to decrease, driven by increased share buy backs, higher dividends and an improvement in real investment spending. In contrast to Europe where significant work is still required to restructure the banking sector, the US banking industry has now largely been repaired with the rise in profitability and easier lending conditions. Consequently, at a time when the deleveraging of the consumer, corporate and banking sectors is showing signs of stabilising, the impact of QE should be more powerful, particularly when the Fed has left the timing and amount open-ended, has confirmed that interest rates will stay low until 2015 and has maintained the "twist" in its US Treasury holdings. The Fed has also indicated that the extent and timing of QE will be very dependent on the improvement in macro indicators and that, in the event of an upturn in activity and inflation, it will only reverse policy slowly. In any event, given spare capacity in the US and the global economy, the lack of wage pressure and the limited impact of commodity prices on core inflation, it is premature to forecast that inflation will accelerate significantly. As we may be at a turning point in the effectiveness of monetary policy, QE may likewise finally have a significant impact on investor behaviour. Although a number of equity markets, notably in the US and northern Europe have generated high positive returns so far in 2012, investor sentiment still remains subdued with a high degree of scepticism over the outlook for growth and corporate earnings. While there has been a clear flow of investor capital out of money markets into corporate, high yield and emerging debt, capital flows into equities have been relatively muted. Given the probability of near zero returns in money markets for at least the next 2-3 years, negative real returns in most bond markets and the now narrow spreads in corporate and emerging debt markets, QE should drive funds into equity markets. This equity positive flow would be justified if growth improved with an associated turnround in corporate earnings in 2013. The impact on equity markets would occur at a time when investors were defensively positioned, markets undervalued by historical standards, when share buy backs and dividends were rising and when there were signs of improving M&A activity. Consequently, the outperformance of defensive sectors relative to cyclicals should reverse while undervalued emerging markets should benefit from increased investor appetite. While a policy mix of exceptionally easy monetary policy and more austere fiscal policy is negative for the US dollar, particularly against the emerging currencies, the impact of QE on commodity prices - excluding precious metals - is less clear. Energy prices will depend more on Middle East geopolitics and industrial metal prices will be driven by a possible upturn in Chinese demand. Therefore, although risks remain, in particular resolving the US "fiscal cliff," investors may be surprised by the improved effectiveness of QE and the positive impact on markets. Robert Parker is senior adviser to Credit Suisse