IS QE2 DEAD ON ARRIVAL?
QE2 hasn’t been initiated yet, but we’ve seen some remarkable moves in the markets since rumors of QE2 began circulating. As I noted the other day input costs have been rising almost across the board as the dollar declines and investors fear the “money printing” of the Fed. The bond market, however, doesn’t appear to be responding so favorably. Since the rumors of QE2 began on August 3rd the 10 year treasury yield has moved just 34 bps. Since Mr. Bernanke’s Jackson Hole speech the yield hasn’t even budged!
This is reminiscent of QE1 when interest rates actually ROSE throughout the entire program. Despite claims that QE will have a broad interest rate effect the historical evidence corroborates no such thing. In Japan, interest rates rose marginally during their QE efforts. During QE1 here in the USA interest rates moved higher throughout the entirety of the program. Why is this all important? Because Mr. Bernanke believes he can create a refinancing effect that will boost aggregate demand. If he can talk down rates and create a refinancing effect for debtors (which would subsequently help aggregate demand) then there is an argument that QE will be beneficial.
What Mr. Bernanke didn’t consider was the potential for QE to spark a massive move into commodities. This is increasing the input costs across the commodity markets as investors misinterpret QE as “money printing”. As we’ve already started seeing at various companies, these input costs are not being passed along easily because end demand remains very weak. So what Bernanke is actually doing is creating inflation for producers while disinflation continues at the consumer level. What does it all mean? It means margin compression. And margin compression means no hiring. And no hiring means no increase in aggregate demand.
I’ve maintained since day one that QE would fail with flying colors. The markets see this as some great recipe for economic growth. I have called it the “greatest monetary non-event”. That might be wrong. It actually might be the greatest economic destruction plan since the bank bailouts.
If the recent trends in the markets continue we have to begin asking ourselves if QE2 isn’t actually HURTING the economy?
TPC,
Your analysis on all of this has been tremendous. Kudos to you and thanks.
I want to see what happens to this market when investors realize that the Fed is powerless.
I refuse to believe that Bernanke&Co. are dummies or are incompetent, that’s highly unlikely. It’s much more likely that their goals/mandate is to maximize banker pay, which they have achieved with astounding success. Whatever happens to the economy is just collateral damage.
So, he’s either ignorant or a criminal? Iceland is putting their Bernanke equivalent on trial. At this rate, Ben is headed there as well. This stuff should infuriate people. He is NOT helping the economy at this point and you could easily make the argument that he has hurt it all along….
What about all the politicians that are knowingly willing to write terrible laws that are bad for the country to get some measly campaign donations from the banking lobby and get a ride on a private jet? How’s Bernanke any different?
If QE2 is about the FED lowering interest rates via treasury purchases to stimulate demand , it would seem that a byproduct of these purchases would be lower yields in treasuries. But since QE2 has been in the offing, long term treasuries have dropped in price and the yield risen. TPC , I’d appreciate your take on this, Thanks
TPC, if you were to brainstorm, who IS benefiting from QE2? I think that’s the most important question. Clearly main street will not.
What the Fed is doing is completely rational in my mind.
Rational not so much for the economy, but rational in the context of their own self-interest.
They have two options here as they try to fulfill their dual mandate, both are bad, one is worse.
1) Do nothing
2) Do something
Under 1) they lose their independence tomorrow. A Fed that admits it is powerless need not exist anymore. Congress is smart enough to figure this out and will act accordingly, given the existing power the Fed has and they have tried to curtail in the past.
Under 2) they may lose their independence, assuming the world figures out the emperor wears no clothes, but nobody can foretell in advance. What if for some miraculous reason the economy improves in spite of, not because of QE2? Guess who will get the credit just like he did for saving us from the desctruction of the same mess he caused in the first place? Anybody remember last year’s Time Person of the Year?
So, why are we all so shocked about what’s going on here?
And what’s really interesting is that the Fed will keep choosing number 2) as long as they have the abililty to do so. Again, option 1) is far worse than 2), so even if 2) is failing it will be because “we haven’t done enough”.
So, this isn’t really an argument about the economy at all. It’s a political/social argument and needs to be framed not so much around will QE work or not, but what are the social costs to the policy and what happens when an entity as poweful as the Fed, that answers to nobody, has run amok?
The consequences of all we discuss on this blog and elsewhere go far beyond the economy and the market.
TPC, isn’t it about time you write another letter to the Fed?
QE 2 is never to lower interest rate, the goal is really to boost stock market, it’s Greenspan’s classical strategy. But you are right, QE 2 will boost the commodity market as well, that’s the unintended consequence. The end result is not clear, Benanke knows that, but he needs to gamble here, there is no alternative in his playbook. The stock market will continue to rise until clear signs appear that inflation in commodity price is killing economy.
One can only hope.
The “buy the dip” mentality right now is even worse than it was in April. No one cares about fundamentals or risks anymore. I am trying to be rational, but at the same time I have to wonder if someone on another thread was right when they said that none of this really matters and it’s all just computers chasing returns. When it turns it’s fast, harsh and lasts a few months.
I’ve been an investor for three decades now. I can’t remember ever feeling such mistrust in the markets. From the Fed all the way down to the computers. None of it seems to be helping us.
Ben wants inflation expectations to run around 1.75% – not too hot, not too cold. Difficult needle to thread.
But alas, he has succeeded in causing a stampede into inflation hedge assets, and out of the dollar. As TPC correctly noted, this puts a heck of a squeeze on our economy. This is continued warfare against our citizens to protect the banks balance sheets.
So QE may actually be a non-event, but perception is reality. And people perceive this as inflationary – For now anyhow.
All this may change by the end of this week. Stay tuned to QE-TV. All QE, all the time.
I still think he’s doing this so he has the program in place when he wants to buy more MBS. That is a backdoor bank bailout. He could care less about Kimberly Clark’s margins and what Mom and Pop are paying for juniors diapers. He wants this program in place so he can save a bank when the housing market double dips.
I can’t think of any other logical reason for QE. The historical evidence that it helps the economy is poor at best. He knows the economy could totally melt down if we saw a repeat of 2008 and the politicians didn’t have the will for another bailout. QE gives Bernanke an out without needing Congressional approval. Pure speculation of course….
QE is to :
1) inflate stock market: trickdown economics playbook
2) buy time: a) hoping something good happens b) help banks recover over time
It’s never to lower interest rate.
The whole point of QE is to lower interest rates. The NY fed and the Federal Reserve have said this a million times. Lower rates is supposed to entice borrowing, create a wealth effect and reduce pressures on debtors. If they don’t lower interest rates the program is a failure.
No, it’s not about interest rate, they say so, but that’s not the real intention, every serious economist admits interest rate is not the problem here.
Here comes a close at the high of the day. What was the news today? QE is causing higher costs, housing is double dipping, and consumer confidence is at recession levels.
Oh, I forgot the reason for the European sell-off. The Greek bailout might not be on the table anymore. But nothing matters here in the USA! It’s all good. Buy the dip! Stocks never go down! It’s a David Tepper market! You can’t lose!
Give it some time Dan. This market will realize that Ben has failed. But don’t expect anything huge to happen before the election and QE.
Since the FED actions have gotten fiscal already, and there are plenty of doubts on QE2; I would like to propose a much simpler plan that will work. Print enough money to buy and demolish 2 million housing units and keep the land; then sell it at a later more favorable time. You smart people figure out the details and costs and you will see the net cost is well under 400 billion (IMO, under 300 billion once the land is sold). Think about it; You obliterate the housing excess inventory, generate inmediate and future employment. Revive the housing industry so that we finally get out of the recession; and last but not least, we get the inflation Benny so desperatly wants, sinse my plan puts the cash in people’s hands instead of bank reserves. I know mine is a ridiculous plan but no more so than some of Benny’s plans such as the helicopter plan and qe2 when qe1 didn’t work.
Crazy market. We’re getting close to insanely overbought levels on many metrics. We could maybe rally up to 1200 or 1220, but the S&P has MAJOR resistance at both levels. After such a huge run it won’t take much to knock stocks down 5%.
I think Jeremy Granthams comment in his latest letter sums things up quite well;
“In almost every respect, adhering to a policy of low
rates, employing quantitative easing, deliberately
stimulating asset prices, ignoring the consequences
of bubbles breaking, and displaying a complete
refusal to learn from experience has left Fed policy
as a large net negative to the production of a healthy,
stable economy with strong employment.”
I have a feeling the Fed will not be independent by the time this is all said and done….
Another great insights TPC.
Here is another view from WSJ Marketbeat Blog when QE 2 was announced:
Why hasn’t QE2 sparked a risk rally?
In a note Wednesday, David Gilmore of Foreign Exchange Analytics says it’s a bad, bad sign:
“Part of the intent of the Fed is to use monetary policy (QE) to support asset prices and risk taking…this is key to breaking (or in this case preventing) the psychology of deflation … The success of the first round of QE from the Fed in 2009 was to incentivize investors to hold riskier assets like bank stocks, corporate bonds and anything with yield. Rising asset prices yields a positive wealth effect, a sea change in psychology. But what we are learning some 2 years after the crisis is that consumers no longer believe in the stock market and face insurmountable wealth losses from their main asset…the home…which overpowers any feel-good effect the Fed might achieve with QE and near infinite zero-cost funds to the banking system. Deleveraging need trumped the policy response.
Tuesday was a day when investors on balance awoke from a drug induced coma, looked around and decided the world still looks very risky and return of capital rather than return on capital is key. Surely the Fed must have considered this risk ahead of time…it is the worst outcome to the news of a policy change the Fed could have hoped for.”
That’s a good note. The Fed has to be scared about what they’re seeing. Sure, the rise in equities is nice, but the much more rapid rise in commodities must have them wondering what they’ve sparked and whether this is a road they want to go down….
OK; checked the comments and no one had put this in.
TPC what do you think of Hussman’s take here?:
http://www.hussmanfunds.com/wmc/wmc101025.htm
Hussman hit a homerun with that letter. It’s absolutely correct.
my guess is the fed is in panic mode. i think TPC is right on all accounts. the housing market (which leads economic recovery is in shambles and about to get worse). no jobs are being created. good lord the main driver of jobs from 2001 -2007 was in the housing industry. MEW accounted for most of gdp growth. i am short now but must stomach more than 500billion of QE which is gimme. there is no way uncle ben can disspoint the casino now. he has put himself as usual in a pickle. the casino thrives on momentum and there is a possibility of 1.5 to 2 trillion QE. that will pump the casino even to higher ponzi levels.
Agreed:
It [QE2] actually might be the greatest economic destruction plan since the bank bailouts.
TPC,
You are not the first in your assessment that QE2 is to set up taking care of the big banks. I believe Whalen and a few others I have read have felt that that was his goal also. And your analysis is correct imo. Hopefully also as I have said before, Bernanke,Geithner et.al. will be prosecuted for what they have done to our economy in the name of taking care of the big banks ( where they all intend to get good jobs after their government stint). They have truly wreaked havoc on the main street economy.
Beware, if Ben has any sense he will take the opposite side of the market and spark a commodity price collapse.