Last Friday I wondered aloud if perhaps China and the US had struck a “backroom” deal regarding their roles in the ongoing “currency wars.”
My primary reason for wondering this stemmed from a dramatic change in Treasury Secretary Tim Geithner’s rhetoric concerning the US Dollar, combined with China’s sudden decision to raise interest rates.
After all, the US had been branding China a currency manipulator and blaming it for the former’s financial and economic woes for months. China, in turn, had responded by lowering the rate of its purchases of Treasuries, charging that the US Fed was damaging global balances and issuing veiled threats that it might consider the “nuclear” option of actively dumping US debt.
In this context, the sudden change in Geithner’s rhetoric, combined with China’s move to raise interest rates, marks a MASSIVE change in monetary posturing. It is, in a sense, a 180 on the US’s part combined with an “actions speak louder than words” move on China’s part.
Seeing these two developments, I couldn’t help but wonder if the world’s two super powers (one on the decline, the other on the rise) had struck a “backroom” deal on currency issues: the US to stop demonizing China while destroying its own currency and China to make monetary gesture signifying it won’t continue to “manipulate” its currency lower (yes I know the two currencies are pegged, but China’s move is a gesture towards strengthening the Yuan).
Of course, this is mere conjecture... for now However, given how lopsided the “inflation trade” is and given just how much this latest stock market rally has been fueled by expectations of the US Federal Reserve announcing an enormous ($1 trillion+) QE 2 Program at its November 3 meeting, these developments could have a MAJOR impact going forward.
Indeed, this change in China/ US rhetoric provides a new, totally non-discounted backdrop to the market’s expectations of a QE 2 program from the US Federal Reserve. Everyone assumes the Fed WILL announce a massive program. But in light of these recent developments, I wonder if it actually CAN.
Consider that over the weekend the G20 meeting saw Germany, India, and China all blasting US monetary policies for creating bubbles and damaging global trade balances. We’re already seen hints of trade wars between China and the US with rare earth elements. And we’ve also seen a currency war break out globally with Brazil, Colombia, Peru, Russia, South Korea, Serbia, Romania, Switzerland, and Thailand all actively intervening in the currency markets.
This last point is key as it indicates foreign powers are more than willing to engage in outright intervention in order to fight the Fed’s anti-Dollar policy (cheaper Dollars means appreciation in foreign currencies, which in turn squeeze exporting margins). In this context we have to seriously ask, CAN the Fed really announce a MASSIVE QE 2 program?
After all, if the Fed DOES announce such a program, then we are undoubtedly heading into outright trade wars, tariffs, and even MORE currency intervention.True, Bernanke has ultimately got his sights set on destroying the US Dollar. But with global tensions growing, he’s got to walk a fine line between saving Wall Street and pissing off the US’s biggest creditor (and the only country that still owns more US debt than the Fed).
However, if the Fed DOESN’T announce ANY QE 2, then we are likely heading into a Crash for stocks. Remember, the only thing that kept us above 1,000 on the S&P 500 in July (and that caused stocks to rally from mid-August onward) was hints and promises of more liquidity and hopes of more QE. If the market is disappointed by NO QE 2 announcement, then we are wiping out the 12+% rally from September in short order and likely heading to 1,000 on the S&P 500.
Obviously, neither of these options is too appealing for the Fed. So it seems to me that the most likely outcome is more “half measures” similar to the current QE lite program which involves the Fed buying US debt WITHOUT (supposedly) printing money to do it.
Thus, I expect that the Fed’s November 3 meeting will unveil something along these lines: a program that involves the Fed buying more US debt in a way that doesn’t piss off the US’s creditor nations or the US populace too much.
A good example would be for the Fed to announce another $100-200 billion or so in debt purchases (a decent amount but not nearly the HUGE amount the stock market expects). The Fed could always sugar coat this disappointment with promises of additional stimulus if needed so as to mitigate the damage to stocks.
My primary point is this: the Fed WANTS to announce a large QE 2 program. But it might NOT be able to do this without rocking the global monetary boat too much. Consequently, we may be approaching a fantastic trading opportunity to the downside after the Fed’s November 3 meeting. The market has already priced in a massive QE 2 program. So any disappointment could result in a sharp reversal and correction.
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