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Federal Reserve Decides to Print $600 Billion Dollars For the Next Eight Months
$600 billion dollars to do what exactly you may be asking, to buy up government debt. In effect subsidizing (aka monetizing) our government spending spree in the name of “stimulating the economy”, unfortunately the only result of this QE program is going to be a weaker dollar and higher inflation as the economy recovers. Recent research has indicated that the effectiveness of QE is lower now then past recession not because there is a supply side problem (as Ben Bernanke thinks) but because there is a demand problem. (Putting more apples on the shelves to stimulate demand does not mean the grocer is going to sell more.) This is economics 101, but in the mean time the American People get stuck with the consequences from the decisions that a select few make. Ever since the financial crisis in 2008, the Government and Federal Reserve have been trying to prop p this “house of cards” but to no avail. They fail to realize that things are different this time and what worked in the past are not working this time. One of the Fed’s mandate is for low unemployment but how is printing $600 billion over the next 8 months to buy US government bonds going to hire 8 million Americans? Sure, it will lower bond yields and act as a mini stimulus, but the US is currently going through what I would call de-leveraging.
In fact, the similarities between Japan’s deleveraging and the U.S. presently are eerie. Japan’s total debt to GDP increased from 270% when their secular bear market started to just about 350% 8 years later (1998) before declining to 110% presently. The U.S. increased their total debt to GDP from 275% of GDP when our secular bear market started in 2000 to 375% presently (10 years later), and we suspect the total debt to decline similar to Japan’s even though the Japanese government debt tripled during their deleveraging. The government debt relative to GDP was about 50% in both the U.S. and Japan when the secular bear market started. We also suspect that our government debt will grow substantially just like it did in Japan as the private debt collapses. The private debt in Japan decreased substantially from the peak 7 years after the secular bear market started (dropping from 270% of GDP to 110% presently). If the U.S. were to follow Japan’s deflationary road map, we would expect our government debt to increase from about $7 trillion (net government debt not including the debt used to fund Social Security) to about $21 trillion and the private debt to decrease from about $39 trillion to around $20 trillion. Also, the Japanese stock market doubled during the three years preceding their secular bear market in 1987, 1988, and 1989 while the U.S. market also doubled during the three years preceding the beginning of our secular bear market in 1997, 1998, and 1999.
There also a few significant differences between the U.S. and Japan. The private debt in Japan was almost the reverse of the U.S. where most of our excess debt was in the household sector and most of the excess debt in Japan was in the corporate sector. Our sources on the above Japanese debt figures came from Ned Davis Research and the Federal Reserve Bank of San Francisco. NDR’s report, “Japan’s Lost Decade– Is the U.S. Next?” have great statistics and information and the Fed’s report “U.S. Household Deleveraging and Future Consumption Growth” is well worth reading. Just recently Hoisington and Hunt have used charts in their quarterly review that confirm the numbers used above with the source being the Bank of Japan.
The Fed study charted the peak of the debt related bubble of the stock and real estate assets in Japan in 1991 (1989 for stocks and 1991 for real estate) and overlaid it with the peak of U.S. debt associated with the same assets in 2008. They concluded that if we are able to liquidate our debt at the same rate as Japan we would have to increase our savings rate from the present 6% (artificially high due to the recent stimulus paid to households) today to around 10% in 2018. If U.S. households were to undertake a similar deleveraging, the collective debt-to-income ratio which peaked in 2008 at 133% (H/H debt vs. Disposable Personal Income) would need to drop to around 100% by 2018, returning to the level that prevailed in 2002.
If the savings rate in the U.S. were to rise to the 10% level by 2018 (following the Japanese experience), the SF Fed economists calculate that it would subtract ¾ of 1% from annual consumption growth each year.
Other problems we have in the U.S. that will exacerbate the deleveraging are excess capacity, unemployment rates (putting a damper on wages), credit availability contracting, and dramatic declines in net worth. Excess capacity in the U.S. has just dropped to record lows with the manufacturing capacity dropping to under 65% and total capacity utilization is just a touch better at 68%. It is very hard to imagine corporations adding fixed investment at this time. With unemployment rates close to 10% , it is unlikely that wages will grow anytime soon. The charts on credit availability and net worth reductions are self explanatory and will also put a damper on consumer spending rising anytime soon.
We expect that the U.S. deleveraging will follow along the path of Japan for years as real estate continues to decline and the deleveraging extracts a significant toll from any growth the economy might experience. We also expect that, just like Japan, the stock market will also be sluggish to down during the next few years as the most leveraged economy in history unwinds the debt.
We, however, don’t believe that the U.S. massive stimulus programs and money printing can solve a problem of excess debt generation that resulted from greed and living way beyond our means. If this were the answer, Argentina would be one of the most prosperous countries in the world. This excess debt actually resulted from the same money printing and easy money that we are now using to alleviate the pain. Thats like going to the doctor with a broken arm to get fixed and the doctor telling you that they have to break your other arm to fix the one you broke initially, anyone still with me?
In conclusion, we believe that the US economy will continue to slowly grow despite the government and Federal Reserve best efforts, and unemployment will remain above average around 8-9%. This is what PIMCO has termed the “new normal”, and we are inclined to agree with them.
For immediate release – November 03, 2010: FOMC Statement
Information received since the Federal Open Market Committee met in September confirms that the pace of recovery in output and employment continues to be slow. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts continue to be depressed. Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. 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.
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. 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 Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Sarah Bloom Raskin; Eric S. Rosengren; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
Voting against the policy was Thomas M. Hoenig. Mr. Hoenig believed the risks of additional securities purchases outweighed the benefits. 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
Is USD/CHF the Canary in the Coal Mine?
10/26/10 - Click to Enlarge
For the past few weeks we have been expecting the dollar to rally and today we finally got another confirmation that the US dollar could finally be turning the corner. USD/CHF closed above the bearish trend line that has been in place since early June and consequently we think that the dollar could extend gains against the major currencies. For the dollar to extend its gains, we would like to see Gold go below $1,300 an oz. Gold is currently trading at $1,335 well off its all time record high at $1,387. We have been keeping an eye on Federal Reserve statements and at this time we believe that at least 3 of the 5 voting members for next month FMOC meeting are hesitant about more QE. We are expecting QE around $500 billion, the market has priced in a QE program of around $1 trillion so anything that is less then $1 trillion in QE should support the US dollar. And of course, if the Fed doesn’t do any QE next week then the US dollar will rally. At FXIB we believe that more QE is pointless and will have minimal impact on the recovery due to bond yields being near record lows. More QE will only create higher inflation as the economy recovers. In regards to US bonds, bond yields have finally broken out of their bearish trend line. The stronger yields have been supportive of the US dollar today, and is another confirmation that the US dollar could extend recent gains.
For the rest of this week we are looking for the dollar to continuing rallying against the Swiss Franc, Euro and commodity currencies.
US Dollar Shorts Take Cover
110/19/10 - Click to Enlarge
The tide could be turning on US dollar pairs. This morning we saw a lot of dollar shorts liquidating their trades, and as such we could be entering a new trend in which we see the dollar rally further.
Trading Outlook
EUR/USD: a close below 1.3770 would probably open the way to 1.3650.
AUD/USD: a close below .9750 and we could see .9570. Also, we still have a sizable gap on AUD that has yet to be filled down around .9280. We could possibly see that gap get filled over the new few weeks.
If any of these levels break, I’d look to sell rallies.
Gold selling off is another confirmation in our analysis that we could be entering a new trend. We believe that QE2 is fully priced into the markets. At this point, it’s just a matter of how much we get. We think anything less then $500 billion will be dollar bullish considering that most of the articles we’ve been reading, people have been talking about $1 trillion for QE2. The Fed earlier today hinted at $100 billion a month in QE ( provided no timetable though). Secretary of the Treasury comments yesterday also may be making dollar shorts a little nervous because Timothy said “that the US can not devalue its way to prosperity” (finally someone has some common sense). However, the mixed signals from the Treasury and the Fed is creating some confusion among traders. We expect volatility to increase this week due to the mixed signals and will keep an eye on the Federal Reserve statements for any change in policy.
US Dollar Shorts Hit High Established in Mid-2008
In mid 2008, EUR/USD was trading at 1.60. When the trend changed (traders reducing shorts), it fell to 1.23. We firmly believe the fundamentals of Europe do not support the EUR/USD to be at 1.38. Primarily because Europe still has a debt crisis and the stronger Eur0 is starting to affect smaller countries like Greece and Ireland which need to actually have the Euro depreciate to be more competitive.
Even though EUR/USD is not trading at 1.60, it is interesting that not only are we approaching previous resistance at 1.3810 but that dollar shorts have reached a high. Given that the US dollar has sold off across the board over the past few weeks, I think we could see the US Dollar rally if EUR/USD is unable to put in a meaningful close above 1.3810 next week. We will be keeping an eye on any Fed statements as to if or when they will start QE. If they do, then we could see the US dollar slide further.
This Week in Review 09/19/10 – 09/24/10
This week we saw the dollar sell off across the board, primarily due to the Fed’s statement that they could start up the printing presses towards end of the year to boost the recovery. We do believe that the market over-reacted to the statement since the Fed only said it was an option available and they had not yet reached a final conclusion on more QE. The one benefit of a weak dollar is that it makes our goods cheaper overseas and will help our economic recovery, kind of a mini stimulus itself. Eventually countries that export to the US will need to weaken their currencies to prevent growth from stagnating or creating deflation, so we do foresee currencies like AUD, EUR, CAD, and JPY weakening towards end of the year.
EUR/USD – This week the pair rallied strongly overcoming resistance at 1.3310 and closing at its highs up at 1.3490. At this point, we do not see resistance till 1.3810. Support lies down around 1.3300 on any pull backs.
GBP/USD – This pair had another good week and finally managed to break out of its range bound trading zone for the last few weeks. Next resistance lies up at 1.60 and support lies down around 1.5675.
USD/CHF – This pair had another bad week that saw it slide as low as .9779, but closes at .9836. The all time low for USD/CHF was established during the GFC (Global Financial Crisis) in which it fell to .9636. At this time we are continuing to buy USD/CHF on dips as we expect a strong short covering rally once a bottom is put in place.
USD/JPY – This week the pair gave back all of its gains from last week. It almost closes at the level where BoJ intervened last week. It closes at 84.20 from opening at a high of 85.80. It seems that the BoJ intervention from last week was largely unsuccessfully. We feel that the USD/JPY is too low to comfortably short it, but at the same time we don’t want to go long cause we do not know when this pair will finally bottom out.
AUD/USD – For the second week in a row this pair has had another solid performance against the USD. It overcame .9410 resistance early in the week and closes near its high at .9591. The all time record high for AUD/USD is at .9849 and if it manages to break .9600 then we could see .9800. Support lies at .9385 for pullbacks.
USD/CAD – This pair did not benefit as much from the weaker dollar like AUD did, however it still ends marginally lower then it opened. It closes this week at 1.0243. China was a stronger buyer down around 1.0220 earlier this week limiting the Canadian dollar gains. USD/CAD still remains range bound between 1.0100 and 1.0650. Resistance lies up at 1.0385 and support down around 1.0180.
NZD/USD – This pair did rally along with AUD, but gains were muted. It closes the week at .7340. Resistance lies up at .7420 and support lies down around .7250.
Federal Reserve Sets the Stage for Possible QE2 at End of Year
The FOMC “will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate”. This statement released earlier today from The Fed is what made traders dump dollars and pile into other currencies across the board. Traders and investors fear that The Fed could devalue the dollar with another round of Quantitative Easing, or to put it more bluntly The Fed is saying they could start up the printing presses and print a ton more dollars to buy anything from treasury bonds to Mortgage Backed Securities. As much as I would hate to see the value of my money decline in my pocket as a consumer, The Fed is tasked with supporting the economy through any means necessary.
Forex Market Highlights; 09/21/2010:
EUR/USD – Already well supported in anticipation of a dovish Fed, roared higher as the FOMC indicated its stands ready to loosen monetary policy further in the months ahead, if needed. The market stuttered for a moment, testing intraday support at 1.3105 before rallying to a fresh high of 1.3288 before Chinese offers finally made themselves apparent. On the post-FOMC rally we overcame the 76.4% retracement of the 1.3334/1.2588 drop at 1.3158 and broke through the 200-day average at 1.3220.
AUD/USD – Was a star performer today, rising above .9500 this morning, triggering a barrier option before consolidating around 0.9475 ahead of the Fed. There was no holding it back after the FOMC statement. AUD and gold both took off like they were fired from a slingshot. AUD reached 0.9564 and spot gold reached $1290.
USD/CAD – The Canadian dollar fared less well then the AUD and had a roller coaster of a ride after the FOMC statement. USD/CAD initially rallied to 1.0335 but eventually sold off to 1.0215 where Chinese buying of USD/CAD ahead of rumored 1.02 barriers turned that pair higher to 1.0270.
The FOMC statement was more bearish then we anticipated, but we do think that the market overreacted to the FOMC statement as we do not actually foresee the Fed having to resort to more QE to support the economy. We believe that this summer the economy hit a soft patch, and the recovery will strengthen towards end of year. We will be paying close attention to any unemployment data over the next few weeks as well as leading economic indicators. If the US starts showing signs of a stronger recovery, then we could see traders and investors go back to US dollars.
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