Market Talk

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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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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It doesn’t take a rocket scientist to see that the bond market started selling off after Fed Chairman Ben Bernanke went on “60 Minutes” to defend himself and the central bank. But exactly what did he say that set off the bond market?

Ed Yardeni, of Yardeni Research, says that what The Bernank said made the bond market question his “grasp of reality,” and you know that isn’t something you want to question about the head of the world’s most important central bank. It’s one thing when cartoon bears make fun of the Fed chairman. It’s quite another when the bond market is wondering if the guy even understands that “Jersey Shore” is just a TV show.

From Yardeni:

I believe that the Fed Chairman’s interview on “60 Minutes” on Sunday, Dec. 5, was a major contributor to the recent plunge in bond prices. In conversations with institutional investors in recent days, all of them questioned his grasp of reality. His cocky assertion that he is “100%” confident that he can control inflation was especially incredible. He declared, “We’ve been very, very clear that we will not allow inflation to rise above two percent or less.” So, if the Fed is in control, how did inflation get so low that Bernanke & Co. had to resort to QE-2.0?

He came across as particularly disingenuous claiming that QE-2.0 had no impact on the money supply or the federal deficit. Here is what he had to say about the money supply: “One myth that’s out there is that what we’re doing is printing money. We’re not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we’re doing is lowing interest rates by buying Treasury securities. And by lowering interest rates, we hope to stimulate the economy to grow faster.”

While the Fed certainly isn’t printing Federal Reserve notes, QE-2.0 is pumping up excess bank reserves. Every Economics student learns that the Fed completely controls the supply of “high powered money,” which is the sum of currency and total bank reserves. This measure of the money supply soared to record highs as a result of QE-1.0 and now will soar even higher under QE-2.0. Students are taught that the Fed does not have full control of broad measures of the money supply such as M2 because it also depends on decisions made by banks and their borrowers. While M2 is up only 3.3% y/y through the week ending November 29, it could certainly explode to the upside given the extraordinary supply of high powered money. Ironically, that could happen if QE-2.0 succeeds all too well by overheating the economy and inflation.

US stocks inched up Wednesday, with the Dow hitting a fresh two-year closing high, as investors had a largely anticlimactic reaction to the highly anticipated midterm elections and Fed statement.

DJIA closes up 26 (0.2%) to 11215, its fourth-straight rise and highest close since September 2008. Newswires’ Tomi Kilgore highlights the importance of the blue-chip index hitting a fresh high:

The DJIA cleared a short-term technical hurdle by closing above April’s closing high of 11205. The next target for bulls is to close above the 11246-11258 range, which includes the 61.8% retracement level of the October 2007-to-March 2009 bear market and the April 23 intraday high. If that is cleared, there should be resistance at the 11750-11850 area, which was strong support in March 2008 as well as strong resistance in August 2008, followed by the May 2008 highs around 13100. DJIA closed up 26 at 11215, the highest close since Sept. 19, 2008.

S&P 500 gains 4 (0.4%) to 1198 and Nasdaq Comp rises 7 (0.3%) to 2540, its 17th gain out of the last 20 sessions and highest close since June 2008. Benchmark indexes bounced around minutes after the FOMC statement was released. But they finished with modest gains as the Fed’s QE2 program didn’t offer any major surprises to derail investor sentiment.

VIX volatility index drops 10.4% to 19.56, its biggest single-day drop since late August and perhaps the clearest signal of relative calm in the market.

“This suggests to me that traders believe the Fed’s hand is still firmly supporting the benchmark indexes and dollar sensitive stocks in particular,” OptionMonster’s Jon Najarian tells Dow Jones reporter Brendan Conway.

Focus now shifts to labor market. Private-sector employment rose by 43,000 in October, according to ADP, topping economists’ expectations. Jobless claims due tomorrow and October nonfarm payroll data expected Friday.

US stocks post steady gains on hopes that the midterm elections will yield a change in leadership and the Fed tomorrow will announce a sufficient amount of quantitative easing.

DJIA closes up 64 (0.6%) to 11189, led by Home Depot, American Express and Microsoft. The blue-chip index rose for third-straight day and registered its biggest gain since Oct. 20. But, as Newswires’ Tomi Kilgore reported, the Dow failed yet again to close above 11200. From Kilgore:

The DJIA made it’s fourth intraday foray above 11200 in two weeks but once again failed to close above it. The DJIA hit an intraday high of 12220 but closed at 11189. The DJIA had hit intraday highs of 11214 on Oct. 21, 11248 on Oct. 25 and 11244 yesterday, only to close those days at 11147, 11164 and 11125, respectively. The last time the DJIA closed above 11200 was April 26 (11205).

S&P 500 climbs 9 (0.8%) to 1194, fueled by utilities, energy and consumer discretionary sectors. Nasdaq Comp rises 29 (1.1%) to 2534.

ADP’s monthly private payroll forecast, ISM non-manufacturing data and September factory orders on tap for tomorrow. But the spotlight will remain on the Fed (as its arguably been for the last few months) and its highly-anticipated QE2 announcement, expected tomorrow afternoon.

It’s been a rough ride for the US dollar over the last month and a half. All the QE2 chatter has ripped the currency to the tune of a 7% drop since mid-September. And with the Fed poised to act in a few weeks, it’s not looking pretty for the greenback. Here’s my Technically Speaking column that ran on the earlier today:

The U.S. dollar can’t catch a break.

The dollar has been on a precipitous decline since mid-September, falling through some significant support levels and prompting market technicians to take an even more cautious view on the struggling currency.

The U.S Dollar Index, which tracks the U.S. currency against a trade-weighted basket of currencies, has dropped 7.2% over the last month and a half. The decline has come amid increasing chatter that the Federal Reserve will ramp up its efforts to stimulate the economy.

Stocks and commodities have surged while the dollar has dropped as potentially more bond buying by the central bank would increase the money supply, thereby hurting the dollar’s value.

It is assumed the Fed will announce some sort of what are known as quantitative-easing measures at its next meeting on Nov. 3 to jump-start the economy. Until then, technicians don’t see the slumping dollar substantially reversing its downward trend anytime soon.

Richard Ross, head of global technical strategy at Auerbach Grayson, noted that the dollar index plunged convincingly through 80 about a month ago, which was viewed as a key support level. It also recently dropped below 77.60, which represented a 76.4% Fibonacci retracement of the currency’s advance from the November 2009 low to the June high. Under the Fibonacci theory of technical analysis, once a market surpasses 76.4% of the original move, it is then governed by the new trend, which in this case is a bear trend.

“The bearish momentum is pervasive,” Ross said. A breakdown to 74, which would represent another 4% drop from current levels, is “imminent,” he said. And a test of its all-time low near 70, hit in the summer of 2008, should also be considered a strong possibility, according to Ross.

“From a purely technical standpoint, this appears to be a classic broken chart,” he said. “The stars are lining up for continued weakness in the dollar.”

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Above the din – this furiously gleeful, Fed-induced, QE-inspired rally — there’s something very mystifying about it all.

It comes down to this: While a parade of Fed officials have gone to bat for QE II and espoused its supposed benefits, we’ve heard maddeningly little from them on the transmission. How exactly will it really (no BS) help get us out of our current economic predicament?

Stop with the academic blah, blah, blah and the hypotheticals, the ifs, ands and buts. How will QE create jobs?

Here’s the best Bernanke could do in a speech yesterday: “Additional purchases have the ability to ease financial conditions.” No mention of whether he said that with a straight face. Ben, please. Ease financial conditions? ZIRP, going on two years now. Enough said.

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US stocks surge, as does just about every “risk” asset, after the Bank of Japan tries again to arrest the yen’s rising, the most note-worth move among several from different central banks, including those in Australia and Brazil as well as the looming bond-buying program from the Fed, that have “currency war” written all over them.

DJIA jumps 193 (1.8%) to 10945, its highest close since May 3. S&P 500 rises 24 (2.1%) to 1161, Nasdaq Comp surges 55 (2.4%) to 2400.

It’s not just stocks: gold, crude, the euro all rise sharply, as investors are betting on a widespread bout of competitive devaluations among central banks. That’s good for nominal asset prices right now, but seems to us it’s bad for everybody in the long run.

It isn’t clear why the Fed seems so intent upon launching into all this dollar bashing, unless they think the economy is weaker than they’re letting on. If the recession’s over, and the economy’s recovering, why do something so dangerous destabilizing?

The Chicago Fed’s Charles Evans today said the central bank should do “much more” for the economy. Why’s that? “In the last several months I’ve stared at our unemployment forecast and come to the conclusion that it’s just not coming down nearly as quickly as it should,” he said. “This is a far grimmer forecast than we ought to have.”

This Friday’s jobs report will be an interesting one. While the sell siders and White House tout the private-sector jobs created, the fact of the matter is that over the past three months, the economy on the whole has shed jobs. Now, the jobs market doesn’t have to disgorge half a million workers a month for it to be bad. The economy needs to create at least 100,000-150,000 some-odd jobs just to keep up with population growth. To get the unemployment rate down, it’ll have to be closer to if not more than 200,000. So losing 54,000 may not sound so bad, but it is, because it just means the the employment picture is slipping for another month.

If we’re not creating jobs, it also stands to reason that wages aren’t growing, since there’s no upward pressure on employers to keep employees. If you ask me, the Fed’s afraid that this situation will slowly drag the economy back into recession. Coming as it would with an economy that hasn’t recovered from the first recession, the worst in our lifetimes, and coming as it would with a nasty bout of deflation to boot, it appears the Fed has plenty to worry about.

This is just a brilliant insight from Peter Boockvar of Miller Tabak, writing at The Big Picture. The bubble isn’t in gold, or bonds, or even stocks. No, sir. The bubble is in printing money.

If you have it, the Bank of Japan will buy it. The BoJ cut interest rates from .1% to a range of zero to .1% and announced a 5T yen fund to buy not just JGB’s but corporate debt, commercial paper, ETF’s and Japanese REIT’s. If you live in Japan and thought about selling stuff in the closet on EBAY, hawk it to the BoJ instead. Bernanke in the Q&A of a speech on Fiscal Sustainability last night responded to a question about QE and said “I do think that the additional purchases…have the ability to ease financial conditions.” Another round of QE seems inevitable with the size and pace being the only question. It’s no wonder that gold is rising to another record high. Gold is not in a bubble, money printing is. Emerging economies however are not happy with the rise in their currencies. Brazil doubled the tax on foreign purchases of fixed income and South Korea said banks who do FX trades will face audits.

We may have gotten an insight today into the Fed’s real thought process when it come to quantitative easing, the so-called QE2 everybody’s expecting. Brian Sack, the head of the New York Fed’s markets group, was speaking today about the benefits to the economy that could come should the Fed decide to launch into a big bond-buying program.

There has been fierce debate on the subject, even within (or, more precisely, especially within) the Fed itself. But most people still think this is a fait accompli, that the Fed, in not so many words, will be cranking up the printing press. What will they accomplish by this? Well, you can imagine that interest rates will stay low, if not move lower. How’s that an accomplishment when rates are already at historic lows? Well, it isn’t, but it also isn’t really the point.

From Mike Derby’s write-up of Sack’s speech:

While asset buying is an “imperfect policy tool,” Sack said “balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be.”

“…by keeping asset prices higher than they otherwise would be.” Bingo! John’s the one that noticed that in the speech and jumped all over it. Because what’s he actually saying there, in typical Fed jargon, is that the central bank is looking to keep asset prices artificially high. That one of the goals of QE2 is to keep asset prices artificially high.

In less polite circles, that’s called market manipulation, and it often leads to perdition.

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