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"Blood in The Streets" As QE2 Could End in April?
By Dian L. Chu, EconMatters
Federal Reserve Bank of St. Louis President James Bullard, when speaking to reporters in France on March 26, stated,
“If the economy is as strong as I think it is, then I think it may be reasonable to send a signal to markets that we’re going to start withdrawing our stimulus, and I’d start by pulling up a little bit short on the QE2 program… We can’t be as accommodative as we are today for too long, we’ll create a lot of inflation if we do that.”
So, it seems that QE2 will get a serious review during the Federal Reserve`s April meeting, and could be cut short by two months in order to send financial markets the message that they will not allow inflation to get out of control (See chart below comparing the Dollar Index to Crude, Silver, and Copper post Bernanke's Jackson Hole Speech on Aug. 28 2010).
The problem is that the current market perception is at odds with the possibility that QE2 could end early.
Wall Street Camp #1 –QE3 Cheerleaders
There is a camp in Wall Street that still believes that QE3 is a distinct possibility, and they have invested accordingly. These investors would be in for a rude awakening if QE2 was cut short – think in terms of Silver investors who bought at the top of the market thinking silver was destined for $50 an ounce.
Wall Street Camp #2 – QE2 Partiers
Another camp in Wall Street believes that QE2 will continue through to its scheduled June conclusion without any hiccups along the way. This is the more moderate camp who have parked capital in Gold, Silver and Oil, who didn`t buy at the top of the market, but had planned to close out positions once QE2 ended in June.
This camp would also be caught off guard if the current asset buying program ended ahead of schedule – this group would include hedge funds, pension funds and money managers who are overly weighted in commodity oriented funds currently, and would start reducing their exposure to reflect the changing monetary policy.
Wall Street Camp #3 – QE2 Front Runners
Now, there’s also the third Wall Street camp that already knew that QE3 was a non starter, and QE2 would probably finish according to schedule, but wanted to front-run the selling by positioning themselves for the inevitable asset realignment by being in position in late April (after April options expiration for example).
Well, this group of investors would also be caught flat-footed and would have to speed up their timetable by getting into position immediately. This would means getting out of any commodity related positions ASAP, and then entering additional short positions, buying puts, and going long the US Dollar.
Biased Towards Commodities
Remember, there are a whole lot of crowded trades in areas all revolving around the QE2 Monetary Program that were initiated as far back as the Jackson Hole Speech. Therefore, an early end of QE2 would bring some considerable unwinding, disproportionately biased towards commodities, as the broader equity market would still have support from increasing corporate profitability, and relatively reasonable valuations, as compared to commodities.
Off Guard Mass Unwinding
In other words, expect significant selling in commodity related funds as a result of major players unwinding large positions – the selling could go on for months if QE2 ended abruptly. This is in large part why the Federal Reserve likes to send signals ahead of time, which Bullard appeared to be doing, to prepare market participants so the unwinding of positions is done in an orderly fashion.
One thing for sure is that nobody on Wall Street is currently positioned for an ending of QE2 in April. If the Federal Reserve through its various communication channels of member speeches, media conduits, and personal interviews starts in the next few weeks reinforcing this notion of QE2 ending ahead of schedule over the next couple of weeks, i.e., sending Wall Street the ‘get prepared’ signal, one could expect a whole lot of market volatility as fund managers try to reposition themselves accordingly.
‘Blood in The Streets’?
Since commodity prices tend to move in unison across the board, there could be some massive selling ahead - the proverbial “Blood in the Streets”, at least for anything commodity related, where large and liquid commodity index linked funds, popular with institutional funds (pension, 401k, etc.) such as Goldman Sachs Commodity Index (GSCI), Fidelity Series Commodity Strategy (FCSSX), could see huge volatility with large liquidation.
Good Jobs Report, Bad news for Commodities
Furthermore, as the U.S. 4th quarter GDP was revised up to 3.1%, there is a fairly good possibility that strong numbers could be coming out of the unemployment report due out on Friday, April 1. Since this is the last major economic data release before Fed’s April meeting, good jobs numbers would actually be bad news for commodities, as that would add to the argument that Fed should end the QE2 early.
Hangovers - Commodities & Producers
For investors, if more hints from Fed officials regarding ending QE2 early start surfacing in the media, coupled with stronger jobs numbers, then take them as a collective indication that the time has come to cash in on some of the profits from commodity related investments.
In addition to the index funds mentioned earlier, this category also includes commodity ETFs such as SPDR Gold Trust (GLD), iShares Silver Trust (SLV), United States Oil (USO), as well as producer stocks like Freeport-McMoRan Copper & Gold Inc. (FCX), Monsanto Co. (MON), Dow Chemical (DOW), Exxon Mobil (XOM), Mosaic Company (MOS) and BHP Billiton (BHP).
Short-term Poppers - U.S. Dollar & Bonds
An early end of QE2 would strengthen the U.S. Dollar on a short term temporary basis, and could bring headwinds to commodity-based currencies such as the Aussie and Canadian dollars.
Ironically, one of the Fed’s objectives that QE2 has failed to deliver – to lower the U.S. long bond interest rate—would likley be achieved after Fed stopped the treasury buying program (QE2).
Although interest rate would still likely trend up in the long term, the short-term pop of the U.S. treasury brought on by the unexpected early end of QE2 would make Bill Gross regret not keeping some of the U.S. bond holdings in his Pimco Total Return Fund.
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Exactly right. Let us not forget that the USG is virtually bankrupt with QE2 in effect. Stopping the printing press would bring an immediate stop to government.
Exactly right. Let us not forget that the USG is virtually bankrupt with QE2 in effect. Stopping the printing press would bring an immediate stop to government.
Well, the Fed could just buy directly from the Treasury, you know national emergency, tanks in the streets, blah, blah...
Who is going to cry foul, China, Japan? Both desperately need to maintain their exports. It's like one of those B-movies where the bad guys are all standing in a room pointing guns at each other's heads. Which one has the empty clip?
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A pull back for PMs is more bullish than an unabated rally. Re-Buy in June
The FED may state QE is ending but that will be a lie. The FED will either hide additional QE or come up with a new excuse to restart QE again.
They will give it a new name like Dynamic Liquidity Provisioning which will be a euphemism for printing hundreds of pallets of thousand dollar bills.
Wrong. Not either.
They will do both.
The Fed's worried about looking impotent so it's going to do it's best to try and create the impression that it's in front of the curve.
Hahaha.
Well done on commodities. Nutso on bonds. The delta matters, a lot. How do rising rates help bond prices? Oh, I see. The market is supposed to believe Ben can kill inflation in 15 minutes. LOL.
ok..16 min...
666 minutes
Wall Street Camp 4...get the FED to do a head fake and then announce QE3. Create volatlity and make a shit load on trading.
>> Wall Street Camp 4...get the FED to do a head fake
BINGO
+1 Even if QE is stopped, it will be temporary.
BTFD.
I think we'll take what's behind wall street camp door #4 for $1.5 trillion.
Hey, at least they have a handle on things...last week we were looking at a real possibility of QE3 and now they have QE2 on life support. It's only redeeming value is a thesis or 2 in 60-80 years where someone may discover a better way to prevent a Depression by prolonging it. Maybe they've seen some actual facts and figures posted here. (doesn't Fin Viz mean "seeing the end"?)
Qston, we have a problem.
That is a great read, thank you!
The only clearer signal we will get is if Greenspan starts mumbling in the press about the dangers of inflation (didn't he just ramble on about something recently?)
The inflation that the FED is not creating in commodities ... my but the price of jet fuel for my F-16 has gone up alot hasn't it?
Longs puts on Uncle Ben's Plastic Rice !
The FED is lying. They must buy USTs. There is no option but to inflate the govt out of its predicament. But they cannot admit that. So, they will have QE forever. Listen to Jim Rikards at
http://kingworldnews.com/kingworldnews/Broadcast/Entries/2011/3/27_Jim_Rickards.html
The selloff, turmoil and economic retreat from such a move would provide them cover for QEIII. I don't see who else would buy the treasuries, but they will want political cover for the monetization.
The selloff, turmoil and economic retreat from such a move would provide them cover for QEIII. I don't see who else would buy the treasuries, but they will want political cover for the monetization.