Stocks Soar, Dollar Dives on QE2: Here's What You Need to Know

Posted Nov 04, 2010 04:35pm EDT by Joe Weisenthal

From The Business Insider

A mini taste of Zimbabwe today? It kind of felt like it:

But first, the scoreboard:

Dow: +222
NASDAQ: +35
S&P 500: +23

And now, the top stories:

* Well, obviously "today" started yesterday at 2:15 PM ET when the Fed announced its quantitative easing initiative. What's funny is that it didn't actually move the markets all that much Wednesday (after some initial chaotic trading).

* But stocks surged higher in Japan last night, and that set the tone for a monster global "risk-on" rally around the world. China had a monster night as well.

* Of course, "risk-on" is codeword for "dump the dollar and buy everything else in sight" so there were huge rallies in Treasuries, precious metals (new highs in gold and silver!) industrial commodities, agricultural commodities, and of course stocks.

* Notably weak: PIIGS debt. Spreads are blowing out wildly in Ireland and Greece, though the effect on the euro really is almost non-existent. After all, the euro isn't the dollar, so it is something to be held. Also, there were riots and bombs around Athens all day, but again, nobody cared. (See: Us vs. Them: U.S. Opts for More Bailouts, Europe Takes Road to Austerity)

* In the U.S., the big macro data of the morning was the weekly jobs report which jumped and was worse than expectations.

* Did we mention that gold surged? Yes, we did, but it's worth mentioning again. It's above $1390.

* As for stocks, well, they surged all day, ending right near their highs. And look, Bernanke literally said last night that higher stock prices were part of his goal, so if you're betting against stocks, you're betting against the guy with the biggest long-only fund in the world. (See: What's Bernanke Smoking? "A Complete Mystery" How QE2 Helps the Economy, Galbraith Says)

* The bottom line: Everyone is terrified by the severity of the 'everything-but-the-dollar' trade lately. Hopefully Ben Bernanke knows what he's doing. (See: Bernanke Christens QE2: Fed "On a Very Dangerous Path," Axel Merk Says)

Doubts grow over wisdom of Ben Bernanke 'super-put': Soaring bourses may have stolen the headlines, but equities are rising for an unhealthy reason.

Doubts grow over wisdom of Ben Bernanke 'super-put'

The early verdict is in on the US Federal Reserve's $600bn of fresh money through quantitative easing. Yields on 30-year Treasury bonds jumped 20 basis points to 4.07pc

By Ambrose Evans-Pritchard, International Business Editor
Published: 7:58PM GMT 04 Nov 2010

60 Comments

Mr Bernanke is targeting maturities of 5 to 10 years with purchases of Treasuries. Photo: GETTY

It is the clearest warning shot to date that global investors will not tolerate Ben Bernanke's openly-declared policy of generating inflation for much longer.

Soaring bourses may have stolen the headlines, but equities are rising for an unhealthy reason: because they are a safer asset class than bonds at the start of an inflationary credit cycle.

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Meanwhile, the price of US crude oil jumped $2.5 a barrel to $87. It is up 20pc since markets first concluded in early September that 'QE2' was a done deal.

This amounts to a tax on US consumers, transferring US income to Mid-East petro-powers. Copper has behaved in much the same way. So have sugar, soya, and cotton.

The dollar plunged yet again. That may have been the Fed's the unstated purpose. If so, Washington has angered the world's rising powers and prompted a reaction with far-reaching strategic consequences.

Li Deshui from Beijing's Economic Commission said a string of Asian states share China's "deep bitterness" over dollar debasement, and are examining ways of teaming up to insulate themselves from the tsunami of US liquidity. Thailand said its central bank is already in talks with neighbours to devise a joint protection policy.

Brazil's central bank chief Henrique Mereilles said the US move had created "excessive dollar liquidity which we are absorbing," forcing his country to restrict inflows. Mexico's finance minister warned of "more bubbles."

These countries cannot easily shield themselves from the inflationary effect of QE2 by raising interest rates since this leads to further "carry trade" inflows in search of yield. They are being forced to eye capital controls, with ominous implications for the interwoven global system.

In London and Frankfurt the verdict was just as harsh. "In our view, this is one of the greatest policy mistakes in the Fed's history," said Toby Nangle from Baring Asset Management.

"The Fed is gambling that the so-called 'portfolio balance channel effect' – pushing money out of government bonds and into other assets – will lift risk asset prices. The gamble is that this boosts profits and wages, rather than simply prices. We remain unconvinced. How will a liquidity solution correct a solvency problem?" he said.

"A policy error," said Ulrich Leuchtmann from Commerzbank. The wording of the Fed statement is "potentially dangerous" because it leaves the door open to a further flood of Treasury purchases if unemployment stays high. "It is a bottomless pit," he said.

Of course, it is precisely this open door that has so juiced risk trades, from Australian dollar futures, to silver contracts, and junk bonds. Goldman Sachs thinks QE2 will ultimately reach $2 trillion, with no exit until 2015. Such moral hazard is irresistible. It is the Bernanke 'super-put'.

Yet the reluctance of investors to leap back into the US Treasury market as they did after QE1 is revealing. The 30-year segment of the Treasury market is too small to matter, but symbolism does matter. Vigilantes sniff stealth default. "If long bond investors continue to throw their collective toys out of the cot, it risks upending the Fed's policy," said Michael Derk from FXPro.

Mr Bernanke is targeting maturities of 5 to 10 years with purchases of Treasuries. These bonds have behaved better: 10-year yields fell 14 points on Thursday to 2.48pc. However, Mark Ostwald from Monument Securities said foreign funds may take advantage of QE2 to dump their holdings on the Fed, rotating the money emerging markets rather than US assets.

Bond funds are already restive. Pimco's Bill Gross says the great bull market in bonds is over, denigrating Fed policy as the greatest "ponzi scheme" in history. Warren Buffett has chimed in too, warning that anybody buying bonds at this stage is "making a big mistake",

Fed chair Ben Bernanke uses the term 'credit easing' to describe his strategy because the goal is to lower borrowing costs. If he fails to achieve this over coming months - because investors balk - the policy will backfire.

No clear rationale for fresh QE can be found in orthodox monetarism. Data from the St Louis Federal Reserve show that M2 money supply stopped contracting in the early summer and has since been expanding at an accelerating rate, topping 9pc over the last four-week bloc.

The Fed has used the 'Taylor Rule' on output gaps as a theoretical justification for QE, but Stanford Professor John Taylor has more or less said his theories have been hijacked. "I don't think (QE) will do much good, and I also worry about the harm down the road," he said.

It has not been lost on markets that the Fed's purchases of $900bn of Treasuries by June (with reinvested funds from mortgage debt) covers the Treasury's deficit over the same period. The slipperly slope towards 'monetization' of public debt beckons.

Global investors mostly accepted that the motive for QE1 was emergency liquidity, and that stimulus would later be withdrawn. But there are growing suspicions that QE2 is Treasury funding in disguise.

If they start to act on this suspicion, they could push rates higher instead of lower, and overwhelm the Bernanke stimulus. That would precipitate an ugly chain of events for the US.

http://www.telegraph.co.uk/finance/economics/8111153/Doubts-grow-over-wisdom-of-Ben-Bernanke-super-put.html


Note:


Pimco's Bill Gross says the great bull market in bonds is over, denigrating Fed policy as the greatest "ponzi scheme" in history. 


Warren Buffett has chimed in too, warning that anybody buying bonds at this stage is "making a big mistake",

Fed to Spend $600 Billion to Speed Up Recovery

Andrew Harrer/Bloomberg News

The Federal Reserve building in Washington.

By DAVID E. SANGER and SEWELL CHAN

Published: November 3, 2010

WASHINGTON — The Federal Reserve, getting ahead of the battles that will dominate national politics over the next two years, moved Wednesday to jolt the economy into recovery with a bold but risky plan to pump $600 billion into the banking system.

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Bernanke Explanation of Fed Action (washingtonpost.com)

Related

• The Fed Discusses the Rationale for Its Securities Action(November 4, 2010)

• Economix Blog: Will Additional Fed Action Help the Economy?(November 3, 2010)

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Richard Drew/Associated Press

At the New York Stock Exchange on Wednesday, all eyes were on the Federal Reserve.

A day earlier, Republicans swept to a majority in the House on an antideficit platform, virtually guaranteeing that they would clash with the Obama administration over the best way to nurture a fragile recovery.

The action was the second time in a year that the Fed had ventured into new territory as it struggles to push down long-term interest rates to encourage borrowing and economic growth. In a statement, the Fed said it was acting because the recovery was “disappointingly slow,” and it left the door open to even more purchases of government securities next year.

The Fed is an independent body, its policy decisions separated from the political pressures of the day. But it acted with a clear understanding that the United States, like many other Western countries, seems to have taken off the table many of the options governments traditionally use to give their economies a kick, particularly deficit spending.

The Republicans regained control of the House for the first time in four years in part by attacking the stimulus plan — begun by the Bush administration and accelerated byPresident Obama — as a symbol of government spinning out of control, contributing to a dangerously escalating national debt.

This political reality has left Washington increasingly reliant on the Fed to take action, though its chairman, Ben S. Bernanke, has said the Fed cannot fix the problem alone.

But in stepping in so aggressively, the Fed is taking risks. The action not only expands the Fed’s huge portfolio ofTreasury bonds, it makes it a target of a Congress whose new members include some who are hostile to the Fed’s independent role.

On Wall Street, analysts said the move appeared to be a balancing act that met expectations and stock prices rose.

Ordinarily the Fed’s main tool for spurring economic growth is to lower short-term interest rates. But those rates are already near zero. With no more room to go, it has to find another route to stimulate demand.

That route is to buy government bonds, which increases demand for them and raises their prices, pushing long-term interest rates down. “Easier financial conditions will promote economic growth,” Mr. Bernanke predicted in an essay for Thursday’s Washington Post.

Representative Mike Pence of Indiana, the outgoing chairman of the House Republican Conference, said shortly after the announcement that the Fed was overstepping its bounds. “Diluting the value of the dollar by continually increasing the supply of money poses an incalculable risk,” he said. “Instead, Congress needs to embrace progrowth fiscal policies to stimulate our economy rather than masking our fundamental problems by artificially creating inflation.”

In making that argument, Mr. Pence and his allies are replaying a dispute that permeated Washington in the mid-1930s, when the economy was crawling out of the Great Depression. Conservative Democrats pushed Franklin D. Roosevelt to cut back on spending, and argued for tight monetary policy. Many economists argue that the result was a second downturn just before the outbreak of World War II, but others say the conditions today differ in so many ways that the comparison is misleading.

While the Fed step was telegraphed to the markets in recent weeks, most experts had expected $300 billion to $500 billion in purchases of Treasury debt. Still, the pace — $75 billion a month for eight months — disappointed some investors.

The Fed said it would also continue an earlier program, announced in August, of using proceeds from its mortgage-related holdings to buy additional Treasury debt, at a rate of about $35 billion a month, or $250 billion to $300 billion by the end of June.

So in total, the Fed will buy $850 billion to $900 billion, just about doubling the amount of Treasury debt it currently holds.

If the Fed’s bet is right, lower long-term rates should ripple through the markets, pushing down rates for mortgages and corporate bonds. That could encourage homeowners to refinance into cheaper mortgages, though it would not help the millions of Americans facing foreclosure. It could push businesses to make investments instead of sitting on piles of cash.

In a sign of its willingness to do even more, the Federal Open Market Committee, the central bank’s policy arm, left open the possibility of even more purchases beyond June, saying it would “adjust the program as needed to best foster maximum employment and price stability.”

Only one committee member dissented, for reasons that are similar to the complaints that some Republicans are likely to raise. Thomas M. Hoenig, an economist who is president of the Federal Reserve Bank of Kansas City, said he believed the decision could create more risk for the financial system by enticing too much borrowing.

There are other risks, as well. The actions are likely to further drive down the dollar. That could worsen trade and exchange-rate tensions that have threatened to unravel cooperation among the world’s biggest economies.

Moreover, the Fed is exposing itself to the risk that the assets it has acquired could shrivel in value when interest rates eventually rise. That could reduce the amount of money the central bank turns over to the Treasury each year, and expose the Fed, already vulnerable for its failure to prevent the 2008 financial crisis, to even more criticism.

On Wednesday, the standoff between the parties was on display as the two sides argued over tax cuts and the desirability of government investment to create jobs.

It was this impending gridlock that might have pushed Mr. Bernanke to move, said Laurence H. Meyer, a former Fed governor. “Bernanke has said that fiscal stimulus, accommodated by the Fed, is the single most powerful action the government can take for lowering the unemployment rate, when short-term rates are already at zero,” Mr. Meyer said. “He has nearly pleaded with Congress for fiscal stimulus, but he can’t count on it.”

But Leonard J. Santow, an economic consultant, said he feared that the Fed was reacting to one mistake — the failure of fiscal policy — by adding another. “The main problem is on the fiscal side, and there is nothing wrong with the Fed chairman making budget recommendations and admitting there is not a great deal left for monetary policy to achieve when it comes to stimulating the economy,” he said.

One of the main questions raised by the Fed’s action was whether it had waited too long. While economists disagree on that, the Fed’s announcement completed a U-turn. Earlier, speculation was that the Fed would gradually raise interest rates and tighten the supply of credit, as it would normally do after a recession..

But this downturn and its painful aftermath have been anything but normal. Markets were set back in the spring by the European debt crisis. By late summer, as continuing high unemployment, slow growth and low inflation became clear, Mr. Bernanke became convinced that the Fed needed to act again.

http://www.nytimes.com/2010/11/04/business/economy/04fed.html?src=me&ref=business

Emerging-Market Countries Criticize Fed Decision

Emerging-Market Countries Criticize Fed Decision
By BETTINA WASSENER
Published: November 4, 2010

HONG KONG — Policy makers in emerging markets criticized the Federal Reserve on Thursday for its decision to pump more money into the U.S. economy, a measure that they fear could escalate the worrisome influx of cash into fast-growing economies.

Officials from countries like Brazil and Thailand threatened more measures to curb the flood of money that has pushed up currency values and fueled concerns that asset price bubbles might be in the making.

The unusually sharp backlash against the Fed’s action underscores the disagreement among some of the largest economies in the world over appropriate economic policy and is likely to overshadow a gathering of leaders of the Group of 20 top economies in Seoul at the end of next week.

The Brazilian foreign trade secretary, Welber Barral, said the Fed’s policies would impoverish “those around them and end up prompting retaliatory measures,” according to Reuters. In South Korea, the Finance Ministry said it would consider ways to limit capital flows.

While some inflows, particularly long-term investments, are welcome ways of bolstering economic development, the capital influxes into emerging market stocks, bonds and property have increased rapidly in recent months, totaling more than $2 billion a day, according to estimates by DBS in Singapore.

Analysts and policy makers are concerned that the Fed’s injection of more liquidity into the U.S. economy — through purchases of Treasury securities to the tune of $600 billion — could lead to yet more inflows as investors seek higher returns.

“As long as the world exercises no restraint in issuing global currencies such as the dollar — and this is not easy — then the occurrence of another crisis is inevitable, as quite a few wise Westerners lament,” Xia Bin, an adviser to the central bank of China, wrote in a newspaper managed by the People’s Bank of China.

In Thailand, Finance Minister Korn Chatikavanij said the central bank governor had “confirmed discussions with central banks of neighboring countries, which are ready to impose measures together, if needed, to curb possible speculative money flowing into the region,” according to Reuters.

Norman Chan, chief executive of the Hong Kong Monetary Authority, warned that the Fed’s new measures — informally known as QE2, denoting the second round of what is called quantitative easing — added to the risk of asset bubbles, including a bubble in the city’s housing sector.

“For emerging markets, QE2 means a guarantee of the ‘low for longer’ scenario through the first half of 2011, which suggests inflows into emerging markets will continue, if not strengthen,” Richard Yetsenga and Pablo Goldberg, analysts at HSBC, said in a note on Thursday. “The tide generated by the liquidity from abroad is bigger than whatever wall emerging market countries can put up.”

Misgivings about the Fed action appeared confined to emerging markets, but Germany’s economy minister, Rainer Brüderle, also weighed in. “I view that not without concern,” Reuters quoted Mr. Brüderle as saying. It said he added that measures were needed to stimulate growth in the United States and that it was not enough to add liquidity alone.

The French economy minister, Christine Lagarde, said Thursday that some emerging countries’ angry reactions to the Fed’s latest round of easing highlighted the need for an overhaul of the global monetary system. Asked about some emerging countries’ reactions, Ms. Lagarde said: “It confirms the imperative need to forge tools for monetary calm,” according to Reuters.

The president of the European Central Bank, Jean-Claude Trichet, said he did not think the U.S. was pursuing a weak dollar policy, Reuters reported from Frankfurt.

Mr. Trichet said he had “no indication that would change my trust” that the Federal Reserve, the U.S. Treasury and President Barack Obama “aren’t playing a tactic of a weak dollar,” Mr. Trichet said. “I have no reason to think that.”

While the United States argues that China in particular should allow its currency to appreciate more rapidly, China and other emerging markets are loath to do so. They argue that the additional round of quantitative easing by the Fed is hurting the value of the dollar artificially while prompting more cash to flow into emerging nations as investors seek the higher interest rates in such countries.

Although finance ministers who gathered at a preparatory meeting in South Korea last month pledged to refrain from weakening their currencies and to let the markets exert more influence in setting foreign exchange rates, a concrete agreement on current account limits, proposed by the U.S. Treasury secretary, Timothy F. Geithner, is likely to prove elusive.

Many emerging-market countries and Japan have been intervening in the foreign exchange markets in an effort to slow the rise in the values of their currencies, which they fear could harm export industries by making exported goods and services more expensive for overseas consumers.

Partially as a result of currency inflows, the yen is up 15 percent against the U.S. dollar this year. The Thai baht is up 11 percent, and the South Korean won has gained 5 percent.

Some countries have also already announced or signaled steps to discourage capital inflows. Brazil and Thailand, for example, raised taxes last month on foreign investment in government bonds, a step designed to deter excessive inflows.

Capital controls have so far not been “too Draconian,” said Yougesh Khatri, senior Southeast Asia economist at Nomura, in a conference call from Singapore on Thursday. But the risk is that such measures might escalate in the longer term, he added, while more foreign exchange intervention is likely.

The Hang Seng index in Hong Kong rose 1.6 percent Thursday, while the Nikkei 225 index in Japan played catch-up after a public holiday, gaining 2.2 percent.

The Kospi in South Korea edged up 0.3 percent, while the Straits Times index in Singapore was up 0.5 percent by late afternoon.

http://www.nytimes.com/2010/11/05/business/global/05global.html?_r=1&src=me&ref=business

High unemployment in Fed cross-hairs

November 5, 2010 - 7:06AM

The United States faces the prospect of high unemployment for some time as the Federal Reserve embarks on a risky and unproven course to bring back solid economic growth.

All eyes will be on the October labour market report on Friday, expected to show a dip in job creation and an unemployment rate stuck at 9.6 per cent for the third consecutive month.

The Federal Reserve announced on Wednesday it would inject an additional $US600 billion ($A598.12 billion) into the struggling economy, through the purchase of new Treasury debt from financial institutions at a rate of around $US75 billion ($A74.76 billion) a month.

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Fed chairman Ben Bernanke said the extraordinary action was necessary because the central bank has a duty to help promote increased employment and sustain price stability.

Though the current low level of inflation was "generally good" it poses the risk of morphing into deflation, a dangerous cycle of falling prices and wages, Bernanke said in an opinion article published Thursday in the Washington Post.

But it was the suffering job market that spurred the stimulus move, known as "quantitative easing."

Bernanke said that in the panel's review of economic conditions, "we could hardly be satisfied."

"Unfortunately, the job market remains quite weak; the national unemployment rate is nearly 10 per cent, a large number of people can find only part-time work, and a substantial fraction of the unemployed have been out of work six months or longer," he said.

"The heavy costs of unemployment include intense strains on family finances, more foreclosures and the loss of job skills."

The Fed action came a day after Tuesday's nationwide congressional and local elections that handed big victories to Republicans, who have called for less government interference in the US economy.

Republicans won control of the House of Representatives and whittled the majority of President Barack Obama's Democrats in the Senate.

At the top of voters' complaints was persistently high unemployment more than a year after the recession officially ended, along with massive federal spending to rescue the economy from recession that has produced record deficits.

The government's weekly snapshot on unemployment trends reinforced the picture of a depressed labour market treading water.

Initial unemployment claims rose more than expected in the week ending October 30, up 4.6 per cent from the prior week, the Labor Department reported.

"Unfortunately, there is nothing in the data that suggests the employment sector is on the cusp of entering a prolonged hiring expansion.

"Instead, the stability suggests that employment growth is going to be slow and sluggish for the foreseeable future," said Jeffrey Rosen at Briefing Research.

Andrew Gledhill at Moody's Analytics noted that businesses remained anxious about economic conditions and were being cautious about payroll decisions, while layoffs were still climbing at a rate consistent with minimal job growth.

"The stalled labour market will not significantly break out of this trend until the second half of next year," Gledhill said.

"Even once widespread hiring resumes, it will take considerable job creation to restore employment to its pre-recession level; we forecast that won't occur until 2013."

AFP

http://www.smh.com.au/business/world-business/high-unemployment-in-fed-crosshairs-20101105-17g4d.html