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You have to admire the Fed for nothing quite so much as the sheer audacity of putting forth another major round of Quantitative Easing (QE3… or is it even more than that? See below.) Before our critique, let’s allow some Sympathy for the Devil (or whatever it is the fiscal and monetary conservatives consider Mr. Bernanke.) The Fed is in a really bad spot of having that dual mandate, which requires them to make some significant efforts in the realm of full employment.
It was painfully obvious that concerns over the weak US jobs picture was a primary driver for the extreme quantitative easing communication in today’s FOMC statement, which was fully confirmed at the Federal Reserve Chairman’s press conference. With Europe barely feeling its way along toward its own Sovereign Debt Crisis cure, and the rest of the world for the most part in a weaker state than the US, Bernanke & Company felt compelled to eliminate the “tail risk” of any further weakening of the US economy.
Will it help? There are some serious doubts based on a whole range of factors. But at least the logic is now perfectly clear, as Mr. Bernanke was extremely specific about the rather loose transmission mechanism he hopes will carry the day. It can be generally described as the ‘Portfolio Cure Channel’: asset prices moving higher includes the stock market, and that makes people feel better, and maybe they will go out and buy something. We will obviously need to seriously monitor whether those sorts of current Fed tactics actually amount to anything in the real economy.
Just as with our previous posts on QE is the Opiate of the Perma-Bulls, we remain more than a bit skeptical. But the one thing we know for sure is the Good Doctor has certainly administered a massive dose of meds to help the patient get past the pain of the inept, ineffective regulatory policy in Washington DC. Yet there is much in the current market response, longer-term economic data and even the more conservative quarters at the Fed that leads us to doubt this will end well…
…such as the monthly Organization for Economic Cooperation and Development (OECD) Composite Leading Indicators (CLI) that were released just this morning, some observations and citations in yesterday’s excellent Washington Post opinion on the Fed by George Will, and the sheer market responses in the other asset classes outside of the equities.
This is both very complex, and yet very simple at the same time. So we will try to be as brief as possible and let the supplemental content do much of the talking for us. In the first instance, there was at least no mystery by the time the good Chairman sat down at the press conference. Today’s FOMC statement was very clear about the Federal Reserve expanding its balance sheet by an additional $40 billion per month. They use the artifice of purchasing agency paper in the form of mortgage-backed securities (MBS) to get around recent criticism of the potential risks in their purchases of US government debt.
And as was apparent in paragraph 4, the Fed is no longer content just to throw the kitchen sink at the employment problem. As Steve Liesman of CNBC noted, this amounts to throwing the stove and refrigerator at the problem as well. To wit, “if… …the labor market does not improve substantially, the Committee will continue its purchases (of all manner of assets), and employ its other policy tools as appropriate…” There was a surfing movie quite a few years back by the title of Endless Summer. It seems the Fed has opted for Endless QE.
The only problem is that everything they’ve done so far (QE1 and QE2 with a couple of Twists thrown in for good measure) hasn’t accomplished anything more than those higher asset prices. And that only benefits those who are well off enough to benefit from the ‘Portfolio Cure Channel’ by owning equities. In spite of the Fed trying to play the hero in turning around a fiscal problem with monetary policy, the rest of the world remains in bad shape with a negative outlook.
Consider this morning’s OECD Composite Leading Indicators. Since stalling a couple of months ago there was a question of whether previous modest growth in the US and Japan was gaining momentum. As of last month it was apparent they were both also turning more negative along with the rest of the world being and somewhat dire straits. The concise OECD commentary on the graphs tends to be a bit charitable toward this negative situation.
You can draw your own conclusions, but we feel using the term “moderating growth” for the developments in the US, Japan and Canada is overly optimistic. “Continued weak growth” in Germany looks more like further deterioration, as does Russia crossing into negative territory from highly positive just a couple of months ago.
Possibly all the more reason for the Fed to feel pressured into acting now, because help from anywhere else in the world is unlikely to materialize anytime soon. And yet, this is all occurring just as inflation is beginning to pick up a bit again. And without going into too terribly much detail, increases in energy and material costs as well as grains have offset much of the benefit from previous rounds of quantitative easing. (A bit more on the market activity below.)
And it is important to note what George Will had to say in yesterday’s Washington Post opinion A different kind of inflation problem. It was both creative and pointed on longer term risks as well as near term inefficiencies.He was referring in part to the inflation of the Fed’s mandate to compensate for the inability of Congress and the Executive Branch to achieve proper fiscal and regulatory policy to encourage economic growth and employment. To cut to the chase, his extremely pointed assessment near the end of his opinion was, “It also is a preposterous arrogation by the Fed of a role as the economy’s central planner, a role beyond the Fed’s — or anyone else’s — competence, and incompatible with its independence.” Whoa!
All of which might be nothing more than the grumbling of a conservative commentator if it were not for the sources he cites on the degree to which the current Fed action might engender risk without much potential for upside reward. Not the least of those is Kansas City regional Federal Reserve Bank President Esther George.
It is impressive that there is anyone in the extended environs of a central bank trying so hard to both modernize and at the same time expand its remit who has expressed the same concerns of many of the skeptics out here. Will cites her speech several weeks ago questioning, “Is there anyone not borrowing today or purchasing a house because interest rates aren’t low enough? Do we expect that businesses will hire if their long-term rates are lower?” Breathtaking in its candor. How many businesses indeed are hiring tomorrow or next week based on the Fed action today?
And the balance of Will’s opinion goes on to cite Ms. George and others on the same sort of things many of us have questioned about the efficacy of all this quantitative easing.Three-and-a-half years ago when the markets and banking system were still at risk of failing, Fed actions, the TARP program and (almost forgotten in the wake of the extended rally) the Financial Accounting Standards Board (FASB) suspending the requirement that banks mark-to-market illiquid securities (like all the toxic MBS they were holding) made a lot more sense.
Even two years ago, with the economy stalling in the third quarter of 2010, the original round of QE might have been reasonable. But today with equities at new four-year highs, and inflation already kicking back up it seems like an action designed to highlight the Fed’s efforts more so than bring about a definitively positive result. And while the equities are up for now, there are signs from other quarters that this may not be the panacea some would hope for the still sluggish US economy and employment situation.
General Market Observations
▪ September S&P 500 future above the highly significant 1,440.70 and its 1,445 (weekly topping line) Tolerance certainly looks prepared to carry on much higher levels. 1,440.70 was the May 2008 high of the bounce from the March 2008 Bear-Stearns capitulation low, and ‘last hurrah’ rally (interestingly enough on central bank enthusiasm) prior to the bear market returning with a vengeance into the October 2008 debacle and early 2009. And technically it is the last significant resistance threshold this side of the low-1,500 area.
That said, there might be some drags on the market from the strength of commodities. And it will also pay to watch tomorrow’s important US economic data, like Retail Sales and Industrial Production. However, just as in previous phases when the equities have exceeded important resistance levels, the burden of proof is on the bears to put the lead contract S&P 500 future (September now, but the December at the end of next week) back below the significant technical level. Of course in this case that means back below the 1,440 area at the very least.
EXTENDED TREND IMPLICATIONS
And there are some things in other asset classes which appear odd in the context of today’s extended rally in equities on the back of the surprisingly expansive Federal Reserve QE3 announcement. Those are the price activity in primary government bond markets, and some of the key currencies.
▪ As we have noted throughout this week, while the US T-note benefits from further QE anticipation, the Bund has crumbled on the prospect of German ESM funding, and Gilt is dragged down by the Bund in spite of the relative weakness of FTSE. As we expected, theDecember Bund future was capable of testing 140.00-139.60 area, and its 139.34 critical Tolerance, as has occurred over the past couple of trading sessions. What is most interesting is the Bund holding up very well in extended electronic trading this afternoon (US time) and spite of the sharp surge in equities prices. So here we go again. Is this a case of the bond market being smarter than stocks, and anticipating that some factor will come along to weaken the equities in the near-term? Or is it just the German Bund being so oversold on its recent selloff that it is capable of bouncing from major support? We shall see.
▪ The other interesting, and questionable, factor if all of the additional greenbacks sloshing around are actually going to help the global economy is the underperformance of the euro today. After pushing up to the top end of the EUR/USD 1.2950-1.3000 resistance in the wake of the FOMC statement release, it was kind of surprising it could not push through that key level. The same goes for why the British pound stalled not too much better thanGBP/USD 1.6150. Certainly something to keep an eye on over the next couple of days.
On the other hand, the commodity currencies did improve quite a bit. That was likely the effect of the combined FOMC QE today along with the previous Chinese economic stimulus program announcements. It will still be important to keep an eye on AUD/USD to see if it maintains its push above 1.0450-1.0500, and whether the US dollar manages to recover back above failed support against the Canadian dollar in the USD/CAD .9725 area.
▪ Gold and Crude Oil also seemed a bit less strong than one might’ve expected under the circumstances, even if the energy market is high enough now to represent a drag on any of the benefits provided by the current round of Fed quantitative easing. Which is something we have seen in the past. The same can be said for the December Copper future pushing back above 3.65 after its recent tests of the 3.30 area. More on those soon, and the Technical Projections and Select Comments that were just updated this morning still have all the useful extended levels to use in the meantime.
Thanks for your interest.
