Over the past 6 months, Zero Hedge has presented its extensive thoughts on QE 1.5, 2.0, and all the upcoming ones all the way through version infinity. Here are Rosenberg's.
U.S. FEDERAL RESERVE — QE2 THOUGHTS
There was nothing in the Fed press release yesterday that was really surprising. In fact, the market’s initial dramatic reaction (all over the map) was what’s most surprising. The Fed is going to be buying $600 billion of Treasuries (in the 5-10 year part of the curve) through mid-2011 and another $250-300 billion via coupon reinvestments, which they were going to do anyway.
The “number” that was key for the markets is that $600 billion figure, which is about $75 billion per month. That is in the middle of consensus expectations of $50-100 billion. Not “shock and awe”, based on what was broadly expected, but not “light” either considering that the economy, at least so far, has managed to avoid double-dipping.
For all the excitement, this further expansion of the Fed’s balance sheet will add between 0.25-0.5% to real GDP growth; however, this will take the size of the Fed’s balance sheet to a Japanese-style 20% of GDP!
What the Fed is clearly trying to do is reflate asset values in order to generate a more positive wealth effect on personal spending and pull the cost of debt and equity capital down in order to re-ignite business “animal spirits” and hence corporate investment and hiring. In a balance sheet or deleveraging cycle, success is not always guaranteed even by the most aggressive of monetary policies.
Through its actions, the Fed creates excess reserves in the banking system. But with one-third of the household sector gripped with a sub-620 FICO score, 1-in-7 mortgage debtors are either in arrears or in the foreclosure process, and with an estimated 25% of homeowners “upside down” in their mortgage (negative equity), there is at least some non-trivial probability that, as was the case with QE1, there will be no visible impact on the willingness to borrow, the money multiplier or velocity, which is what we would need to see to declare this radical policy experiment a success.
In a nutshell, with core price trends running below 1% and the economy past the peak of growth for the cycle, the Fed is not far off the mark in its deflationary concerns. The critical aggregate here is the unemployment rate — policy is aimed at redressing the glaring “gap” or chronic excess capacity in the labour market.
Go back two years ago when the Fed was on the brink of cutting the Fed funds rate to zero and the central bank was expecting to see, by now, a 7% unemployment rate. On the eve of QE1 in the opening months of 2009, the Fed’s base case was an 8% jobless rate by now. Instead, the jobless rate is sitting near 10% and only an atypically low participation rate has prevented the official unemployment rate from being higher than 12%. Moreover, counting in the vast degree of “under-employment”, the real unemployment rate is closer to 17%.
The one asset that has responded miserably to the Fed announcement is the long bond — it is getting clobbered, in part because the Fed bond buying is in the mid-part of the curve. Looking at the huge spread between 30-year bonds and the 5-year note, if inflation does not rear its ugly head, the best risk-reward is now really at the long end, which is universally despised and may be one reason to like it even more!
The U.S. dollar is on the verge of breaking down — the recent countertrend rally in the DXY may well be snuffed out quickly. The 50, 100, and 200-day moving averages in gold are all in major uptrends despite the corrective phase from overbought levels.
It’s difficult to see how equities can rally on this Fed move alone or the election results for that matter seeing as a GOP victory in the House and QE2 had both been widely discounted in recent months. There have been no surprises here over the past 24 hours. Just confirmations on what had already been priced in.
Meanwhile, risk assets from equities, to credit, to emerging markets have, in recent months, become correlated with a weaker U.S. dollar in an unprecedented fashion. A weaker dollar, in turn, fits in very well with Ben Bernanke’s reflationary strategy by cheapening exports and buying jobs from abroad, not to mention adding extra impetus to foreign-currency translated corporate earnings. The question is whether the dollar’s descent becomes destabilizing or what the responses to this overt weak dollar policy will be in other parts of the world. Currency wars tend to lead to trade wars and trade wars do not tend to end very well (gold being an exception).
- The five million 99ers who are about to lose their jobless benefits (can even a lame duck Congress be that heartless?);
- The looming tax hikes on January 1 if a GOP-White House deal isn’t brokered, and;
- The bite into discretionary spending from the spike in food and energy prices — at exactly the most important shopping time of the year.
Look out for a big bite out of GDP from what will likely prove to be at least a sharp upward move in the price deflator (have a look at Food Sellers Grit Teeth, Raise Prices on page B1 of today’s WSJ as well as Apparel Makers To Lift Prices on page B2).
The equity market loves the liquidity boost but as I said, it is priced in. There are twice as many bulls as there are bears in the sentiment surveys and the stock market is trading near the top end of the 2010 range. Moreover, the two “critical” events that got Mr. Market all excited in the last two months are now yesterday’s news. The recent Barron’s Big Money Poll smacked of the complacency we saw in the fall of 2007 when nobody seemed to see a recession looming. Today, 4 in 5 surveyed in the Barron’s poll are dismissive of double-dip risks, perhaps prematurely. The mistake here may be in confusing derailment with delay.
MORE THOUGHTS ON QE2
The Fed, in some respect, did as little as possible yesterday. Not so much in size, though they could have done more on that score (equivalent to a rate cut of 50-75bps), but more in terms of where the central bank is focusing its bond buying activity. The bulk of the bond purchases are in the mid-part of the curve where yields are already 1%. What good is another handful of basis points decline really going to do for the economy at this part of the curve? Not much. Only 6% of the bond buying is in maturities of 10 years or longer and that is what matters most for the economy and that is the only part of the curve where there is any juice left, in terms of basis point yield impact.
It would be one thing if the Fed radically shifted its forecast, we could understand why the Fed did the least amount of easing possible under the situation of having boxed themselves in. Household spending is increasing, though “gradually”, and at the same time “constrained” by a variety of impediments. Housing is “depressed” and the recovery “continues to be slow”. Business spending is rising “less rapidly”, and nonresidential construction activity is deemed to be “weak”.
So while the Fed may not have downgraded its forecast, as it seemed to be thinking at the last meeting that the economy could be double dipping by now, the description of the economic backdrop in the press release was certainly one of a listless recovery at hand.
I can only surmise that the Fed had a view six-weeks ago that the economy would be contracting by now and it clearly isn’t. Or that Bernanke would have faced more dissents had he targeted the 10-year and above part of the Treasury curve, which would have been far more stimulative. It is truly hard to believe that targeting a part of the curve that is already yielding 1% is going to have much of a macro effect. And, much of what happened was already priced in. Perhaps the biggest news is that, as soft as it is, the U.S. economy is not falling apart at the seams and that seems to be all the equity market needs to see to grind higher. The two outcomes from yesterday that have some certainty attached to are: (i) the steeper Treasury yield curve, which along with a GOP controlled House, is positive for the financials that have been lagging, and; (ii) a further weakening of the U.S. dollar (good for anything negatively correlated with the greenback, from basic materials, to energy, to precious metals).
Bottom line: While the Fed could have done more yesterday, it didn’t because the economy is doing better than expected at this juncture, even if still quite fragile. Auto sales, for example, did rise to 12.3 million at an annual rate in October from 11.8 million in September (best result since August 2009). However, recall that motor vehicle sales also jumped 2.4% in September and all that translated into was a +0.08% inch-up in total real consumer spending, which was one of the weakest months of the year. Consumer spending excluding auto will now be key to watch.
I have to admit that the news out of MasterCard SpendingPulse is amazing considering what wage growth is doing (perhaps the stimulus from strategic mortgage defaults is at play here): “retail sales showed a noticeable improvement versus a year earlier, fueled by online sales and strong demand for luxury goods, jewelry and apparel” (see page A2 of the Investor’s Business Daily). And for Q4 GDP, the critical question will be real final sales growth and the extent to which net exports swing positively, if at all.
In the past, Bernanke discussed how useful the Fed’s communication skills can be in terms of being a policy tool. One of the reasons why the Fed did not have to resort to ‘shock and awe’ or target longer-term Treasuries is because all the talk since late August had already produced the desired results. This is what Bernanke had to say about it in today’s Washington Post:
“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”
Notice how he mentioned the stock market twice — in just one paragraph. And, as the legendary Dennis Gartman emphasizes in his commentary today, what former Fed Governor Larry Meyer had to say yesterday on CNBC was very telling indeed (“What happens over time to the equity market”). Asset prices have always played a role in monetary policy and in the wealth effect on spending but never as much as is the case today. And, just by talking the talk for the past two months, the equity market has managed to rally 14% — creating $1.7 trillion of incremental “paper” wealth without having to lift a finger (yet). Poof! Yes indeed, for Dr. Bernanke, it is a case of the hand being quicker than the eye.
Finally, it seems that a new theme has emerged, which is that the risk-on/risk-off trade is taking its cue increasingly from the U.S. dollar. The correlations are high, intensifying and unprecedented.
- Over the past six months, the inverse correlation between the trade-weighted dollar and the S&P 500 has risen to 80%; and to 90% in just the past two months.
- The inverse correlation to emerging market equities is even stronger, at 90% in the past six months and 92% over the past two months.
- The positive correlation with corporate spreads is now 70% on a six-month basis and 80% over the past two months.
- There has always been a strong inverse correlation with the CRB index but that relationship has firmed dramatically to 90% in the last six-month and 95% in just the past two months.
- Even with the VIX index, the positive correlation is now running at 80%.
In other words, all one needs to do today is follow the greenback to be a successful investor. Hard to believe it’s that easy, but this seems to be the environment that Ben Bernanke et al have managed to create in their quest to reflate the global economy.