Daily Market Reports | Nov 04 2010
By Greg Peel
The Dow closed up 26 points or 0.2% while the S&P gained 0.4% to 1197 and the Nasdaq added 0.3%
America's problem, as perceived by the Fed:
“Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters. Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.”
The solution,as decided upon by the Fed:
“To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings.
“In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month.”
But these numbers are not set in stone, rather:
“The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.”
The sentence from last night's Fed monetary policy statement which I have emboldened here is the sentence we've been agonisingly waiting for for several months. It is QE2. Just imagine playing Monopoly against your friends. While your friends appear to be amassing reasonable wealth, you're slipping behind. That's okay, because you, and only you, are permitted to draw more funds from the bank whenever you like.
Although the Fed has indicated that its $600bn of what is effectively freshly printed money (the Treasury provides new bills, figuratively speaking, to the Fed so the Fed can them lend them back to the Treasury) might be tweaked depending on how things play out, the good news is that the world's most influential central bank has given us an amount and a date. We can now get on with life without having to endlessly worry about what the Fed might do next. We will, however, be keeping an eye on the economic data and speculate as to whether QE2 is working or not, and whether more or less new bills might be needed.
Wall Street has had an eternity to speculate about what QE2 might look like ahead of last night's announcement. General consensus was that US$2 trillion might ultimately be needed but first up a discrete starting amount would be announced. Guesstimates on that figure ranged from $500bn to US$1 trillion over six months. Therefore US$600bn over about eight months is not a shock to either side.
Nor was it a shock for Americans to learn last night that the Republican party has returned with a significant majority in the House, but that the Democrats have managed to hang on to the Senate. This was also built into current stock index pricing, just as the QE2 result was near enough to correctly priced in. Despite the worst fears of fully evolved humans, the Tea Party managed to gain some representation but nothing too substantial. The Tea Party would have been particularly disappointed that Christine O'Donnell, a reformed witch running on a platform of banning masturbation, missed out in Delaware.
2010 has now delivered a hung parliament in the UK, a hung parliament in Australia, and a hung parliament in the US. It just goes to show that economic recessions are all about uncertainty. While the UK and Australia have not had such an experience for some time, both Clinton and Reagan found themselves with a House minority after the mid-terms of their first four-year term. They were both re-elected. But at least for the next two years, the US Congress is expected to suffer from “gridlock”.
Gridlock is nevertheless seen as a positive on Wall Street, or at least a lot more positive than a Democrat majority in the House. Obama's socialist reforms, both passed and pending, will be watered down. Free market capitalism has been seen as the victim of these reforms, and it is anathema to American capitalists that a free market should ever be restricted. Never mind that it was the free market which got us into this mess in the first place.
So the election result is a positive for stocks. QE2 is also a positive for stocks given the Fed is hellbent on maintaining “price stability” and on promoting a “stronger pace of economic recovery”. Stock prices are the ultimate reflection of economic growth. The Fed is now committed to standing behind the stock market with access to that endless Monopoly bank.
But surely there are dangers as well?
There was one dissenter on the FOMC committee last night, and Kansas City Fed president Thomas Hoenig has been at odds with Ben Bernanke ever since the idea of QE2 was floated. It was noted in the statement that:
“Mr. Hoenig also was concerned that this continued high level of monetary accommodation increased the risks of future financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy.”
Mr Hoenig sees the potential for hyperinflation and asset price bubbles ahead. Mr Bernanke believes he can deftly manage the Fed balance sheet to avoid such risks. Mr Hoenig can point to the “easy money” policy of former Fed president Alan Greenspan and the GFC which resulted. Mr Bernanke can point to Japan.
So the election result and QE2 should mean higher stock prices? Not in isolation. Wall Street has already priced in these results in its 14% run up since late August. Clear the slate – we're starting from scratch. What we haven't seen – yet – is any “sell the fact” divestment. But we'll wait until this time tomorrow to dismiss the notion. Post-Fed meeting strategies are rarely implemented by the market in the short period from the 2.15pm announcement to the 4pm closing bell. A quick glance at this intraday graph will explain why:
Quite simply, the real money lets the market settle before moving in.
The intraday graphs of the US dollar index and the US ten-year bond yield look similar, but the end result is a Dixie down 0.5% to 76.33 and a ten-year yield down one basis point to 2.58%. Someone in the US nevertheless had a red hot go at dumping gold positions (“sell the fact”) right from the opening bell, and again when the QE2 announcement was made.
Spot gold fell US$30 from the New York open, rebounded US$15 to the close of Comex futures (2pm, before the Fed announcement), fell US$20 on the announcement, and immediately rebounded US$25. So gold is down US$8.00 on the day to US$1348.30/oz.
Now can we all please be upstanding for the Australian national anthem. At my mark of 7.30am, the Aussie was trading at US$1.0049.
Let us not forget that “parity” is just a number like any other number. It is effectively little different to US$0.9990 or US$1.010. It does not mean the Australian economy is now bigger than the US economy. It does imply that the Australian economy is in better shape than the US economy, but it is quantified by the balance between the number of Aussie dollars in the world and the number of US dollars in the world. Today's Fed announcement is all about increasing the supply of the latter.
And let us not cheer, other than to perhaps briefly gloat and blow a raspberry at the Seppos. The strong Aussie is purely and simply acting as a dampener to Australian economic growth given Australia is an export economy and nothing else. In reality, the Seppos can blow a raspberry at us. It is their money printing that is impeding our, and every other export nation's, economic future.
However, while Ben Bernanke might be hellbent on injecting life into the US economy, he has also suggested he cannot go it alone. The Fed needs the support of both the government and the private sector in stimulating economic recovery. QE2 cynics maintain that Ben's money will just head straight out the door and into more rewarding emerging market investments. Australia is a more open yet more secure proxy for investment in Asia.
Commodity markets all closed prior to the Fed announcement. Oil was up US79c to US$84.69/bbl and base metals closed a tad weaker in London.
We can now move on and evaluate the US stock market based on data alone – just as stock markets should be evaluated – albeit with a new line in the sand. The first data of note in the new regime were actually released before the Fed decision was announced.
US factory orders rose for the third month in row in September. The 2.1% gain beat expectations of a 1.6% gain. The US private sector added 43,000 new jobs in October, according to the ADP report. This is not enough to shift the needle on US unemployment, but it is better than the 22,000 expected. The official non-farm payrolls number and October unemployment rate are due on Friday.
Let the games re-begin.
The SPI Overnight was up 8 points or 0.2%.
Today in Australia sees the release of retail sales and the trade balance in September. What did Glenn know? News Corp has just released its quarterly result and showed a 36% jump in profit.
Read the full Fed statement here.
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