When $40 Billion Isn't Enough or, Pray for the Retail Investor
As Mark Grant so poignantly reminded us yesterday, the Fed is printing $188 million per hour. That is the cost of Dow 14,000 -- that is the price we pay to see Jim Cramer and company consecrate the new bull market via impromptu CNBC specials. This hourly rate is of course implied by the $85 billion of assets the Fed now buys each and every month. Why $85 billion? The official answer is that given by the FOMC in December:
"The Committee remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. "
Of course, "policy accommodation" has proven somewhat ineffective when it comes to promoting "sustained improvement in labor market conditions." Worse, it might reasonably be argued that Fed policy has proven entirely ineffective at ameliorating general economic malaise. Even Bernanke himself admits that "obtaining precise estimates of the effects of these operations on the broader economy is inherently difficult, as the counterfactual --how the economy would have performed in the absence of the Federal Reserve's actions-- cannot be directly observed." As I noted in a recent article, this essentially means that the clueless public is supposed to simply take the Fed's word for it when it comes to evaluating how the economy would be performing in the absence of successive iterations of quantitative easing even as the entirely observable and in many cases quantifiable risks produced by LSAP continue to accumulate and feed off each other.
If the positive effects of Fed policy are illusory and/or unobservable at best and may not even exist at worst, why bother printing another $45 billion per month? The answer might well be that what the Fed thought was going to happen after the announcement of QE3 didn't in fact happen. Recall Bernanke's explanation of the so-called "wealth effect" he hoped to create by purchasing $40 billion per month in MBS:
"…if people feel that their financial situation is better because their 401(k) looks better or for whatever reason -- they're more willing to go out and spend, and that's going to provide the demand that firms need in order to be willing to hire and to invest."
Blame it on whatever you like -- fiscal cliff jitters, the election, the weather -- but the fact is that stocks fell in the wake of QE3 and as such, people's retirement accounts did not look better. Put simply: $40 billion in flow wasn't enough. The Fed should have known this -- after all, Goldman knew it. Recall that back in the summer of last year Goldman's Jan Hatzius said the following about the possibility that the Fed would move to a "flow" model as opposed to a "stock" model for its asset purchases:
"…it is also possible that the program would be specified as a "flow" of purchases of perhaps $50bn-$75bn per month. Although there has been little talk about the latter option, it enables the committee to respond more flexibly to changing economic conditions and may be optically more attractive if the committee is worried about a political backlash domestically or abroad against further balance sheet expansion."
From a metaphorical perspective, an addict always needs a higher dose to achieve the same high so one might have known that $40 billion per month wouldn't be enough given that over the course of a year, that would only amount to $480 billion, $120 billion short of QE2. From a more practical perspective, Goldman was projecting $50-$75 billion if the Fed went the "flow" route so it's clear that the Fed fell short of at least one major firm's expectations. Anyway you cut it the market wanted more -- the addict was chasing the dragon and there was no hope of catching it at a $40 billion per month clip. Consider the following graph which shows the cumulative change in the Fed's SOMA Treasury holdings from November 1 of last year through December 31 plotted with the daily closing price of the S&P 500 (note that the SOMA Treasury holdings are set to zero on November 1 here, so the chart shows just the increase over the specified period, not the total holdings):
Note that as long as the Operation Twist was still operational (that is, as long as the only unsterilized flow coming into the market was via the Fed's MBS purchases), stocks struggled to gain any traction. Now have a look at a second chart which shows the cumulative change in the Fed's SOMA Treasury holdings from January 3 of this year to March 5 when the Dow hit its all-time high (again, the SOMA Treasury holdings are set to zero on January 1, so the chart shows just the increase from the first of the year through March 5, not the Fed's total holdings) :
One can see that as soon as QE-eternity was implemented (i.e. as soon as the addict's dosage was upped to a $1.02 trillion per year pace as opposed to a mere $420 billion per year clip) stocks took off and made new highs in just a little over two months. Let us not forget amidst all of the celebrating that these are merely nominal highs. Stocks are down some 48% and 84% respectively since 2007 when priced in Swiss francs and gold values. This matters not to the financial punditry -- highs are highs. What is disturbing is the general failure on the part of the mainstream financial media to adequately convey the danger in throwing one's money behind a market that is entirely beholden to the Fed. On Wednesday, Jim Cramer told the investing public that "when the time comes, I can get you out of stocks" so investors shouldn't listen to "the worry mongers." The sad fact is that for many a retail investor, Cramer's word is gospel -- those poor, poor souls. Say a little prayer for them and for their portfolios.
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