Market Talk

It’s almost embarrassing to watch the contortions the Federal Reserve is engaging in to absolve itself of any role in fueling the run-up in commodity prices since the end of August.

The latest comes in the form of an “Economic Letter” from San Francisco Fed economists Reuven Glick and Sylvain Leduc. That’s right, who better to objectively state that the Fed’s policies aren’t pumping up commodities…than a branch of the Fed? This four-plus pager, best I can tell, rests on the conclusion that the Fed’s QE measures aren’t to blame for the spike in commodity prices because “commodity prices actually tended to fall” following Fed announcements on large-scale asset purchases.

Sounds as if Glick and Leduc aren’t familiar with the old adage “buy on rumor, sell on news.”

For my money, the only “announcements” that mattered were Bernanke’s late-August Jackson Hole speech, which got the whole commodities complex (not to mention stocks) a-running, and the fait accompli announcement November 3rd with the program details. And whether or not commodities dipped on those days — or any other LSAP announcement days — is irrelevant because the trend has remained higher since Jackson Hole.

While some Fed officials have been more frank about the role of QE II in pushing up commodity prices, others have dismissed it out of hand, instead placing the blame squarely on supply and demand and surging growth in emerging markets. Indeed, that’s the official story from the central bank, as if that global growth trend only became obvious seven months ago, coincidentally at the same time Fed chair Bernanke first suggested QE II was a real possibility.

We’ve taken issue with the Fed a few times before (here, here and here) over this “don’t-look-at-me” attitude, pretending its free-flowing liquidity measures aren’t affecting commodity prices. In some cases, like cotton, we’re sure there are legitimate supply and demand issues. But we’re not buying that story for every commodity across the board.

Silly exercises like the one from the San Fran Fed are wholly unconvincing and, as we’ve noted before, only serve to further undermine the central bank’s credibility.

As with many others, I’m keenly interested in what happens when the Fed’s QE2 program ends. Will there be a QE3? Will the markets crash without the Fed in there proffering support? Will anyone even notice what the Fed does if Charlie Sheen keeps talking?

One thing I’m wondering is this, and I don’t have a good answer for it although I’m asking around: let’s say the Fed decides not to do another round of asset purchases. It’s still sitting on more than $2 trillion of securities. Let’s say the Fed decides to hold them to maturity, something that been talked about. If that’s the case, sans a bond-selling program that would effectively drain some of the liquidity it put out there, the Fed can sit on its zero-percent interest rates and bloated balance sheet and still have interest rates that are negative on an inflation adjusted basis.

In other words, they don’t need to do a QE3 to still be very loose with their policies. There are issues of timing and reinvesting maturing debt on the balance sheet, but in general I think the Fed can keep monetary policy wide open without undertaking another big program.

It seems reasonable to me to see it that way, but I don’t have a PhD in economics. Actually, I don’t have a PhD in anything, but that’s another story. Gluskin Sheff’s David Rosenberg has contemplated a world without QE3, and comes to the conclusion that it’ll look a lot like the world without QE2, an era that lasted from approximately April to August 2010.

WHAT HAPPENS IF THERE IS NO QE3?

We are now being asked this constantly and the follow-up is “who picks up the slack if the Fed stops its bond-buying program”?

The answer(s) is hardly complicated since we have a template for this in 2010. It is a very simple guidepost.

Last year, from April 23rd through to August 27th, the Fed allowed its balance sheet to shrink from $1.207 trillion to $1.057 trillion for a 12% contraction as QE1 drew to a close. Go back a year to the Federal Open Market Committee minutes and you will see a Federal Reserve consumed with forecasts of sustainable growth and exit strategy plans. A sizeable equity correction coupled with double-dip fears were nowhere to be found.

Now over that interval …

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“Only don’t tell me you’re innocent. Because it insults my intelligence — and makes me very angry…”
-Michael Corleone, The Godfather

Listening to Ben Bernanke repeatedly deny that the Fed’s QE2 program has played any role in jamming up commodities prices stirs the same emotions Michael felt when his brother-in-law Carlo denied fingering Sonny for Barzini’s people.

Bernanke continues to insist that rising commodity prices are due to supply and demand dynamics, and denies any culpability of the Fed’s easy money monetary policy. Senators at today’s testimony on the Hill let that assertion go unchallenged. Would’ve been nice if someone asked Bernanke to reconcile ISM’s February manufacturing survey today, listing roughly 30 commodities up in price, none down, but only three commodities — capacitors, cocoa powder and electric components — in short supply.

It’s a simple enough question: Dr. Bernanke, there’s a laundry list of commodities up in price, and many of their run-ups began in late August, coincident with early mentions of potential QE2. Less than a handful of commodities were reported by manufacturers as being in short supply. So how can supply and demand dynamics alone explain the sharp run-up in commodities during the past six months, when there appear to be few, if any, supply constraints?

For an organization like the Fed where credibility is crucial, it’s amazing that its officials continue to stand by such a flimsy rationale for high commodity prices. Continue reading…

US stocks rally to cap off a volatile February as oil prices remain elevated but off panic highs.

DJIA rises 96 (0.8%) to 12226, up about 2.8% on the month; S&P 500 gains 7 (0.6%) to 1327, Nasdaq Comp adds 1 to 2782. That makes three monthly winners in a row for the Dow, and five of the past six since Ben Bernanke started talking up QE2.

But, hey, it wasn’t such a bad month for crude, either. Nymex crude was up 5.2% in February, closing at $96.97. This benchmark is up six months in a row, rising 35% during that run. A move that big could be due only to fundamentals, right? Right.

Stock investors today jumped on a raft of economic reports, although we’re hard pressed to see how incomes rising as result of the payroll-tax cut is fundamentally good. No matter, apparently. The NAR says pending home sales didn’t fall quite as much as expected, so you know things are good.

You can expect a good day for stocks tomorrow, too, unless the world explodes overnight. The first trading day of the month has been a very reliable friend to the bulls.

Elsewhere, market’s starting to drill down to QE2′s scheduled end; so is the Fed. The central bank’s James Bullard and William Dudley were out today on the circuit talking about it, and Chairman Bernanke is sure to be asked about it tomorrow and Wednesday when he trudges over to Capitol Hill.

Whether this program gets cut off, tapered out or even fully extended is taking on more significance; it’s been a major source of the stock market’s rally since August, and indeed despite the Fed’s insistence it’s been a major source of the rally in commodities as well, so how the Fed plans to end it is a major concern.

Missed this item earlier, which crossed the tape while I was sleeping at 3:43 a.m. EST today, from Andrea Hotter, DJ Newswires assistant managing editor in London:

The current overall commodity markets find themselves near the most historically overvalued levels, on a short-term basis, in over 200 years, says Shawn Hackett of commodity brokerage Hackett Financial Advisors.

Adds that if history does repeat itself, “then a major correction in commodities can begin at any moment without warning.” Sees “extreme caution” as being necessary with only natural gas, coffee, milk and rice being attractive, although “all would suffer to some degree if a major intermediate term correction were to unfold in overall commodities.” LME copper, tin are at record highs above $10,000 a metric ton and $31,300/ton respectively, Liffe May sugar recently hit 30-year highs around $750/ton.

But don’t sweat it folks, it’s all supply and demand. Has nothing to do with oceans of hot money looking for a home.

Let’s take John’s car-chase metaphor a step further. So we’ve had this particular car chase going on since August. Has it endured so long because of the driver’s skills? Because he’s got some souped-up Olds 442? Or is it the gas in the tank?

It’s the gas.

This particular grade of fuel has been refined by the Fed. It is both the actual $600 billion the Fed’s spreading around via its QE2 bond-buying program, where the Fed has literally created $600 billion out of thin air and injected it into the economy, and the implicit “Bernanke Put.” The Fed has made it clear to all involved, without necessarily saying so to the unwashed masses, mind you, that it’ll stand behind the so-called risk trade. Stocks are the prime beneficiary, but so are commodities, for that matter. High yield’s been having a nice run, too.

The only concern for the market is whether or not there’s going to be a QE3, because these days, as Barry Ritholtz more or less said, it pays to follow the Fed. Not Egypt, not Europe, not politics, not unemployment, not even corporate profits for that matter. QE.

Make no mistake, a big, big part of the stock market recovery (as reader Chance pointed out) has been the Fed’s bond-buying programs, and the efforts to push investors out into the risk trade. It is no coincidence that the Fed started buying mortgage bonds at the height of the panic in November 2008 and announced its big, $1 trillion bond-buying program in March 2009, the same month stocks put in their recession lows. It was a rocket trip from there.

That program (QE1) ran out in March 2010, but the program had one feature that actually allowed it to sort-of run past its deadline: the time lag between when the Fed agreed to a specific purchase, and when it settled that account. That time lag was a period of several weeks. So while the program “officially” ended March 30, the payments kept running through April and into early May. A lot will depend upon how the Fed spreads out its purchases toward the program’s end.

The market put in a high in late April, and the sell-off began in earnest in May. It didn’t end until August, when Fed Chairman Bernanke first brought up the idea of QE2. The only time, since the lows of March 2009, that the market has appreciably sold off was when the Fed wasn’t actively buying bonds.

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Okay, I think I’ve got my question for the Fed chairman. But before I tell you what it is, read this snippet from Newswires’ Michael Derby, who’s covering Bernanke’s speech at the National Press Club:

MARKET TALK: Bernanke Lays Out QE2′s Successes

12:40 (Dow Jones) Here are the reasons why Bernanke thinks QE2 is working: “Equity prices have risen significantly, volatility in the equity market has fallen, corporate bond spreads have narrowed, and inflation compensation as measured in the market for inflation-indexed securities has risen from low to more normal levels.” As for the rise in bond yields, the chairman says that’s what you would expect in light of a monetary policy accommodation.

Okay, got it? So here’s my question:

Are you kidding me?

The first thing, the first thing the Fed chairman trots out as a justification for creating $600 billion out of thin air and pumping it into the economy, is that it’s driving up stock prices? Seriously? That’s part of the Fed’s mandate now?

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Today’s quote of the day — well, it’s more than a quote, really, it’s like a passage, but nobody says the passage of the day, sounds like a weird Henry James novel or something, The Passage of the Day. So, today’s quote of the day comes from one of our favorite market observers, the stubbornly realistic David Rosenberg of Gluskin Sheff, who’s talking about the illusion of recovery, as opposed to the real thing.

Policymakers have done an admirable job of creating the illusion of recovery, and it has worked because it would seem based on asset pricing that the vast majority of investors have bought into this illusion hook, line and sinker. Doubters are either cast aside as traitors, idiots or stubborn perma-bears who don’t get it…the “it” being that the government will simply not allow another bear market or downdraft in economic growth from taking hold again!

The business cycle has miraculously been repealed, and the shorts have been scared off for good. But you can’t tinker with human nature for very long. What people should put in their back pocket is how surreal this so-called recovery really is. With yesterday’s data, housing starts are now down 9.3% since the recession apparently was stopped in its tracks in June 2009. Go back to every other post-WWII economic recovery, and never before — 18 months into it —were housing starts still down from the point that the recession ended…until now, that is.

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Hope you’re not still wondering about the effectiveness of the Fed’s QE2 program, as there should be no more debate: Dow Industrials close at their highest level since August 2008; S&P 500′s highest close since early Sept 2008; go back almost three years to see Nasdaq close at this level.

Fed officials have proffered that one ambition for QE2 was to help increase stock prices. Well, mission accomplished so far. Sure, it’s lighter, pre-holiday trading, but gains are gains, right bulls?

Feel wealthy, citizens? Case closed.

Financials soar, followed by materials and energy. CAT, IBM and JPMorgan contribute 50% of the Dow’s gain. DJIA rises 55.03 to 11533.16, and Nasdaq Comp climbs 18.05 to 2667.61. S&P 500 ends 7.52 higher at 1254.60. Continue reading…

Yesterday we took issue with St Louis Fed President James Bullard’s assertion during a CNBC interview that there was no evidence that QE2 is a factor in jacked-up commodities prices, though he conceded that their relationship should be studied.

Well, study this, Mr. Bullard: today US corn futures close at their highest level since July 2008 at $6.02 a bushel. Nymex Feb crude futures hit their highest close since October 2008, at $89.82 a barrel, and up 6.8% this month. Nymex heating oil at a fresh 2010 high at $2.5164 a gallon. Cotton hits a fresh post-Civil War (yes, that Civil War) high at $1.59 a pound. Comex copper futures settled at an all-time record high at $4.276 a pound.

Now, we’re not saying it’s all because of QE2 and no influence from supply/demand, China, whoever, but come on. All of these different commodities hitting fresh or all-time highs simultaneously?

Meanwhile, an asset class that Fed officials admitted QE2 was, in part, aimed at — stocks — also rose today to fresh two-year highs.

Not a coincidence. Study complete. Good luck at the gasoline pump or grocery store, citizens.