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The massive central bank QE-Infinity influence already seems to be waning just two weeks after ringleader Buzz Lightyear “To Infinity and Beyond” Bernanke inspired the latest asset price surge. While others either preceded (ECB) or quickly followed the Federal Reserve’s leadership in this area, there is little doubt that initiating the steps the FOMC took two weeks ago was easily the most extensive and extended (i.e. “…highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens…”) central bank commitment to massive liquidity expansion. That said, there is still the question of whether this will do much good with a broken ‘monetary policy transmission mechanism’ (i.e. the real root of economic weakness being in misguided fiscal and regulatory regimes.)
And beyond the sheer consideration that it may fail to influence the economy as expected, there are significant risks of not just that failure but of more general central bank authority dilution. That has been reviewed in this blog and our full research both previous and over the past two weeks. It includes the concerns of some very well respected regional Federal Reserve bank presidents and other economic observers, complaints from other countries this is nothing more than a protectionist, beggar-thy-neighbor ‘currency war’ strategy, and the degree to which (at least so far) the impact is as transitory as many of the skeptics had warned.
It seems that the anticipation of the Fed’s QE3 was much more influential than the actual fact. As we have noted recently, now that the central banks are ‘all in’ on this major liquidity expansion effort, the real risk is it may impugn their ability to effectively intervene in a future crisis. And that is where we draw the analogy with the old Pie in the Face comedy routine, which we will discuss below.
But first, review of another key factor is relevant: the degree to which the Fed becoming ‘the market’ in long-dated US bonds and agency debt is pernicious. Among the most consistent critics of the implementation of this policy has been Newedge Senior Director Larry McDonald. As he noted two weeks ago today (i.e. the day after the Fed QE3 announcement), “There’s a new hedge fund… and it’s the Fed.”
For quite a bit more on that and McDonald’s views on Spain, and that dysfunction in the mortgage securitization market and much else, click into the video clip of his appearance on the Fox business News ‘After the Bell’ show that Friday. It seems that events since then have borne out his assessment.
And if the Fed is indeed nothing more than a new hedge fund in town…
…then it is like Long-Term Capital Management (LTCM) owning a printing press. For those who were not around at that time, LTCM was one of the first major (both in size and the scope of its portfolio) ‘macro’ view hedge funds, and had among its in-house team some preeminent financial engineering academics. Interestingly enough it was enlightened in pursuing the European ‘convergence’ trade early in the cycle. The problem was that they were so sure of their overall assessment that they significantly overleveraged their positions. Is this beginning to sound a bit familiar?
A relatively modest market correction in the late 1990’s was enough to force them out of positions. That would’ve created a major market crisis if the Fed had not stepped in to stop the bleeding by arranging a bailout by the major banks who were the primary investors in LTCM. While that was a privately funded rescue effort, in its way the Fed orchestration was the primogeniture of the controversial public funding for private banking and securities firm rescue efforts that have become so depressingly familiar.
And here’s the dilemma: if the Fed is the massively positioned hedge fund, then who is going to rescue them? Will they simply ignore the major open trade losses on the bonds if interest rates push-up, because they are holding them to maturity? At the very least the Fed’s massive position and fears over its potential to disgorge even a modest amount of its holdings will create a more nervous and less liquid long-dated US government bond market. It will be just the sort of thing Larry Donald (among others) has already noted is occurring in the agency paper market.
Pie on the Table
The Pie on the Table routine is an old Vaudeville comedy skit that begins with a man sitting at a table in a café. Another man enters the café carrying a whipped cream pie. He sets the pie down on the table, and takes a seat opposite the first man. He smiles at the first man and looks down at the pie and smiles at the first man again. All of which brings some laughs. He reaches down and puts his fingertips under the rim of the pie with both hands as if to pick it up, but only adjusts it with a one quarter turn. He once again looks at the other man, the pie, and smiles at the other man again. More laughs.
This goes on for a while, garnering even greater degrees of mirth from the audience as the comedic anticipation rises. Yet at some point the second man actually picks up the pie and hits the first man in the face with it. Still more laughs, as the first man looks out at the audience. As he blinks his eyes the whipped cream peels off, and two eyeballs are staring out from the amorphous whipped cream face. Very funny ‘sight gag’.
But that’s it. The joke is over. As funny as the final affront to the first man and his reaction and appearance might’ve been, there are no more laughs to be garnered from the Pie on the Table ‘anticipation’ or ‘event’. And so it seems to be with the recent QE innuendos and ultimate announcement. Especially as the actual program announced by the FOMC and more fully articulated by Chairman Bernanke at his press conference two weeks ago was indeed so over-the-top compared to even the most aggressive QE advocate’s expectations.
But that’s it. The very bullish program ‘anticipation’ is replaced by the ‘event’ being discounted by the markets. And all of the expectations for how large it might be are noweven more than exceeded not just by the FOMC program, but by the aggressive participation (or clear contingency plans on the part of the ECB) of so many other significant central banks. Fair enough, except for the fact that equities have run up so far on weeks of anticipation, and knee-jerk reaction to the announcement.
The question now is what further progress can those markets make if the economic data and outlook remain relatively weak, or shift into a more depressed state? While they might indeed improve instead, all of the forward-looking indications out of Europe and China, and globally in the most recent OECD Composite Leading Indicators do not bode well. And then there is the additional risk for the Fed (beyond reputational and confidence) of the equities falling significantly at any point after all of this massive additional quantitative easing (QE-Infinity) has been announced and at least partially implemented.
What happens if the equities enter another disorderly selloff phase after the Fed has provided massive quantitative easing at the top of a four year rally? While we do not offer it as a definitive prediction, consider the scenario for a moment of weak economic data (or corporate earnings) causing the lead contract S&P 500 future to drop back below the important previous top-of-the-range support in the low-1,400 area. That was the vigorously tested high from April, which it held so well after pushing above it in mid-August. Being back in an entire lower range below that area has previously caused the market to revisit important lower support bounds, even within that broad lower range.
What if the lead contract S&P future below 1,400-1,390 suffers a psychological failure that’s puts it back down quickly to the low-1,300 area, or even the mid-1,200 area?Interestingly enough, the latter is the late 2012 extension of the major UP channel support from the major cyclical 666 March 2009 low (i.e. the broadest channel up from that low, which was already tested and held at the major 1,068 selloff low back in October of last year.)
Will any further pronouncements from the Fed on expanding its balance sheet even further (those “other tools” that Mr. Bernanke referred to in his statements) actually be enough to squeeze the bears if the market has dropped that far in the wake of such extensive Fed action at this time? After announcing low rates through the middle of 2015, and almost another $1 trillion of agency paper purchases in the next two years along with extended continued purchases of US treasuries, what more is it the Fed will be able to saythat will mean anything?
Whether or not the Fed has squandered what precious little ammunition it had left at the wrong time in a way that impugns the effectiveness of further interventions is yet to be seen. Having already gone to QE-Infinity, will ‘Buzz Lightyear’ Bernanke really be able to figure out exactly what ‘…and Beyond’ means? And will it be as effective in countering any future disarray in equities as keeping his powder dry and using it more judiciously might’ve been?
We will just have to wait and see. Unfortunately, based on so many of the economic indications remaining weak and the Fed having already seemingly used all of its ammunition at the top of an equities rally into new four-year highs, we are more likely than not going to find out at some point fairly soon.
General Market Observations
Market implications are fairly clear-cut in the near-term. December S&P 500 future back below the major violated 1,445-40 lead futures contract resistance makes it look like the highly constructive equities responses to ECB and Federal Reserve quantitative easing in early September might have done nothing more than create a temporary squeeze.However it ends up in the longer term, the slippage back below there is damaging to the upward momentum, and that is the case for Europe and Asia that depend on US economic and market leadership as well.
Yet, there is a dilemma for both the bulls and bears at this point due to the sharpness of the previous run up: that leaves the heftier recent congestion, Fibonacci and broader trend channel support back down in the 1,415-10 area. That creates a very much lower critical zone that the bears must get the market to violate (and ultimately knock it below 1,400 as well) to achieve any sort of significant reversal of the overall uptrend.
Of course, the dilemma for the bulls who choose to fight the current slippage is that they also will not know whether the market is still good or not until at least 1,415-10 and into the 1,400 area. In the meantime we suspect that the next rally back up into the 1,445-40 area (or possibly a squeeze slightly above it to 1,450 or so) will stall now that the market has shown quantitative easing alone is not likely sufficient to overcome all of the general economic and specific European bailout concerns.
EXTENDED TREND IMPLICATIONS
▪ What does this mean to the other asset classes? With classical intermarket relationships restored, primary government bond markets and US Dollar Index are strengthening on the back of the equities weakness. And of course the commodity currencies, euro, Gold and Crude Oil are weakening. That said, the relative resilience of Gold is a sign that even the massive global quantitative easing announced of late may not be enough to bolster the economic activity and equities. It speaks of the degree to which the yellow metal is expecting even more massive liquidity expansion, and commensurate fiat currency degradation across the intermediate term. Possibly the saddest commentary on just how ineffective the misplaced liquidity expansion efforts are in the face of what are actually fiscal and regulatory drags on the individual countries and global economy.
Given the significant nature of that December S&P 500 future 1,445-40 reinstated lead contract resistance, our suspicion is that any further slippage below there will significantly reinforce the rally in the govvies and US Dollar Index. That said, on recent form the govvies responding to the suspicion that quantitative easing will not deliver economic improvement and the recent disarray in Europe will continue has left them significantly outperforming the US dollar on the rally.
All the rest is the same as Current Rohr Technical Projections – Key Levels & Select Comments that are updated as of Thursday’s US Close, and are available via the link in the right hand column.
Thanks for your interest.
