The Overnight Report: QE Confusion And The Big Sell Order

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By Greg Peel

The Dow closed down 80 points, or 0.5%, while the S&P lost 0.8% to 1655 and the Nasdaq fell 1.1%.

Last night Fed chairman Ben Bernanke testified to Congress, as is the chairman’s frequent obligation. The testimony takes two forms, being a prepared presentation and a Q&A session. The prepared presentation is released to the market in the morning, while the Q&A takes place in the afternoon. In his prepared remarks, Bernanke suggested:

“A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further.”

On that news, Wall Street kicked straight into bullish mode, sending the S&P further into blue sky and the Dow up 150 points, also in blue sky. The assumption? No QE withdrawal just yet. But when it came to the afternoon’s Q&A, the tone changed.

In response to a question, Bernanke noted there had been “some improvement” in the US jobs market, that the Fed was keeping a close eye, and that there was “confidence that [improvement] is going to be sustained”. Then came the clanger: “In the next few meetings, we could take a step down in our pace of [bond] purchase”.

Down went Wall Street. Then at 2pm, out came the minutes of the policy meeting held at the beginning of May. The minutes indicated that a large cohort of Fed officials, both inside and outside the FOMC, were all for starting a tapering off of QE as early as June. And that was that. The Dow fell to be down 120 points down before finding some late support.

Not since the November election result has Wall Street traded in such a wide range, in this case 270 Dow points. Volume was strong. Technical analysts are now slavering, because last night’s high was higher than Tuesday night’s high, and the low was lower than Tuesday night’s low. According to the tea leaves, this is an “outside reversal day” which could indicate a change in market direction. Could.

If this proves to be the case, and we do finally see some sort of meaningful pullback on Wall Street, it will all be put down to Ben Bernanke’s testimony. However, when stock prices started dropping like a stone in the late afternoon, the talk around the NYSE was that the computers were in. A big programmed sell order had been triggered not by Ben Bernanke, but by the combination of a rising S&P 500 and falling ten-year bond price. When the yield on both converged, such that the S&P was no longer offering a yield above the ten-year Treasury, a computer woke up.

That’s the talk.

Coming back to QE, Wall Street is now thoroughly confused. As to why, I’m personally at a loss. Where Wall Street sees contradiction, I see pretty straightforward clarity. Where Wall Street expects the Fed to be omnipotent and omniscient, I see a collection of human beings, one of whom, Ben Bernanke, has more than once admitted he has no idea where his unprecedented policy might lead.

There is disagreement among Fed members as to whether QE should be continued or withdrawn. Is that such a surprise? There is heated disagreement on Wall Street. The market wants the Fed to tell them exactly what’s going on and what’s going to happen. What the Fed has told the market is that the US economy appears to be improving, that the FOMC is confident that improvement could be sustained, and if so, the Fed could begin to ease off on the stimulus and see what happens. But the Fed does not want to kill off the recovery with too hasty a withdrawal, so any reductions in bond purchases will be initially careful and measured.

Couldn’t be much clearer, if you ask me.

Reactions in other markets were predictable, if we assume the Fed is now looking closely at just when it might want to start easing off the stimulus to avoid inflation. The US ten-year yield jumped 8 basis points to 2.03%, at some point exceeding the dividend yield on the S&P 500. The US dollar index rose 0.5% to 84.27, sending the Aussie down a cent to US$0.9701. Gold has already fallen substantially on all the lead-up hawkish talk, so it fell only US$6.80 to US$1369.70/oz.

Base metal trading on the LME closed after Bernanke warned against too quick a withdrawal and before he suggested a tapering off could start in the next few meetings. Hence we can ignore the fact all metals were up around 1%. It’s a different story for the oils, with Brent falling US$1.02 to US$102.60/bbl and West Texas falling US$1.98 to US$94.20/bbl.

Spot iron ore is down US20c to US$123.20/t.

The SPI Overnight fell 20 points, or 0.4%.

Is a pullback now on the cards? I really hope it is, because this rally remains the most unloved in history and many investors remain reluctant to get in when there is too much “bubble” talk. But somehow I don’t see that much scope for a major pullback, because the buyers are ready and waiting. We could get a pullback if the Fed starts withdrawing and the US economy falls in a heap, but let’s not hope for that particular outcome.

It’s “flash” day today, with China (HSBC), the eurozone and the US all releasing estimates of their May manufacturing PMIs before tomorrow morning. The UK will release its March quarter GDP result. On the local front, James Hardie ((JHX)) will release its full-year profit report.

Rudi will appear on Sky Business today at noon and again at 7pm for the Switzer Report.
 

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