Saturday, November 6, 2010

Sitting on a Signal: What Happened

The FOMC meeting held earlier this week resulted in the QE2 announcement. They will use the Fed's balance sheet to enable the additional purchase of $600 billion of Treasury securities using a monthly purchase plan until the end of 2Q2011. This is in addition to the reinvestment of principal payments on their MBS portfolio, estimated to average $35 billion per month, that they announced at their meeting in August.
The following comments on the plan from foreign government official's are from Bloomberg News articles found on November 5. Obviously concern about the plan is global because the US$ is a reserve currency and also the denomination of trade of many commodities.

Bernanke came under fire today from officials in Germany, China, and Brazil, who said his plan to pump cash into the banking system may jar other economies and fail to fuel U.S. growth. Critics including Michael Burry, the former hedge-fund manager who predicted the housing market’s plunge, have said Fed policy is encouraging investors to take on too much risk and threatens to undermine the dollar.
“It’s our problem as well if the U.S. is no longer certain that the old recipes don’t work anymore,” German Finance Minister Wolfgang Schaeuble said today in Berlin. The Fed’s injection of $600 billion was “clueless” and won’t revive growth, he said.

Brazil’s central bank president, Henrique Meirelles, said “excess liquidity” in the U.S. economy is creating “risks for everyone.” In China, Vice Foreign Minister Cui Tiankai said “many countries are worried about the impact of the policy on their economies.” He also said the U.S. “owes us some explanation on their decision on quantitative easing.” 
Asked by a student if “skyrocketing” commodities prices may threaten his inflation outlook, Bernanke said rising commodities prices are “the one exception” to a broad reduction in inflationary pressures. Overall, excess slack in the economy will make it difficult for producers to push through higher prices to consumers, he said.
“Emerging markets are growing quite quickly,” Bernanke said. “Demand for those commodities is pretty strong. That is going to be a contributor to inflation in the U.S. because it will affect gas prices, for example, and so on.”

Relieved that the U.S. shift didn’t spark a surge in the yen, the Bank of Japan yesterday said it will buy real-estate investment trusts rated AA or higher, providing new information on a 5 trillion-yen ($62 billion) fund unveiled last month. It kept its overnight call rate between zero and 0.1 percent, while maintaining a 30 trillion-yen program to encourage bank lending.
“The Federal Reserve is the big guy -- the Bank of Japan is following suit in a smaller way,” said Jesper Koll, head of equity research at JPMorgan & Co. in Tokyo.
The Bank of England kept its emergency aid program unchanged at 200 billion pounds as the strongest two consecutive quarters of growth in a decade and inflation above their target persuaded Governor Mervyn King and colleagues to hold fire a month after they shifted toward doing more. They now await the effect of the biggest tightening of U.K. budget policy since World War II and the loss of 490,000 public jobs. 
At the ECB, President Jean-Claude Trichet was resolute in signaling his bank intends to outline possible steps to withdraw aid next month as its economy recovers and some policy makers warn easy monetary policy risks triggering inflation. The ECB is committed to handing banks unlimited liquidity in its weekly, monthly and three-month refinancing operations until the end of the year.
“The ECB does not seem willing to deliver short-term solace for governments if they are not doing their part of the job,” said Carsten Brzeski, an economist at ING Groep NV in Brussels. “Looking ahead, the ECB has clearly no intention to follow the Fed or other central banks with further stimulus.”
Central banks in emerging or commodity-rich nations are already withdrawing support for their economies. The Reserve Bank of Australia cited medium-term inflation risks for an unexpected decision to raise its benchmark rate a quarter point to 4.75 percent, while India’s central bank boosted its key rate for a sixth time this year to reach 6.25 percent.
The criticism may grow louder next week when Group of 20 leaders meet in Seoul. Central banks in the advanced economies may also find themselves having to do more to stimulate their economies if the Fed’s measures keep forcing up their exchange rates against the dollar.
“We’re in quantitative easing wars,” said Blanchflower, a Bloomberg contributor.

The graphs that follow are updated to November 5, unless noted. The US dollar index line is in these graphs to illustrate the level of correlation to the currency which has been strong since the end of May in many markets. One further change is to move to weekly time periods to better reflect my interest in medium term trends.

Here is a look at the condition of large US banks, looking at the non-performing loans in a couple of different ways through June 30. The blue line illustrates the percent of banks whose allowance for loan loss reserves
exceeds their non-performing loans, looking only at banks with assets greater than $20 billion. The red line shows the total of non-performing loans as a percent of assets at all banks. The message in this graph is that banks in general have not been in a worse condition to lend since this data collection series was started in 1988.

Here is a look at the bond market from several types of bond indexes. The primary view is of the Barclay's aggregate bond index. This index is about 60% treasury bonds, 20% agencies and 20% corporate credits. The US dollar index line is in the primary view, and clipped in below is the ETF that tracks the Barclay's 1-3 Yr Treasury Bond. Below it is the ETF that tracks the Barclay's 1-3 Yr Credit Bond. This ETF also includes 25% exposure to foreign quasi-sovereign credit. Are bond prices turning higher in a sustainable move? Is the US Dollar the driver with Ben Bernanke at the wheel?

Some stock market sectors can be early indicators of the mood in the market. The horizontal bars show buy (gray) and sell (red) volume by price. Is volume vanishing as these sectors extend? Semi-conductors are one sector. Are they making a path to the moon on the weak US$ or simply on their own fundamentals? Emerging markets appear to be holding hands with the US$. And in its own world, look at the ETF of gold mining companies. Adding to the data is the US Dollar index solid dark line.

After considering the condition of the major lenders, trends in the bond markets, several unique stock market sectors now look at currency from the US dollar perspective. The next graphs illustrate how much foreign currency the US$ will purchase. For a brief and helpful description of how currency rates are determined, read the article by John Hussman dated August 23, 2010.

Lastly, consider the number of stocks in the S&P 500 making a price that exceeds their 150 day moving average. Obviously, a sign of breadth of optimism and strength in those company prices. The clip on the bottom of this graph illustrates the S&P 500 price for a simple comparison.

In the weeks following the official definition of QE2, the global reaction will playout in global markets and there will be some US stock market gain from the weakened US$.  More likely is the anticipation in the markets of QE2 being extended in June 2011. The markets priced in the initial announcement, beginning on September 1. Another outcome of QE2 is that the struggling consumer is going to get higher food and energy prices. So far, indications support the view that the Fed’s move will further stimulate unfolding global booms, although the breadth of investor participation remains low, based on mutual fund flows reported by ICI for the weekly period, ending over a week ago...

Washington, DC, November 3, 2010 - Total estimated inflows to long-term mutual funds were $3.32 billion for the week ended Wednesday, October 27, the Investment Company Institute reported today.
Equity funds had estimated outflows of $2.34 billion for the week, compared to estimated inflows of $2.07 billion in the previous week. Domestic equity funds had estimated outflows of $2.91 billion, while estimated inflows to foreign equity funds were $569 million.
Hybrid funds, which can invest in stocks and fixed income securities, had estimated inflows of $356 million for the week, compared to estimated inflows of $1.01 billion in the previous week.
Bond funds had estimated inflows of $5.31 billion, compared to estimated inflows of $6.48 billion during the previous week. Taxable bond funds saw estimated inflows of $4.76 billion, while municipal bond funds had estimated inflows of $545 million.