Archive
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.
FXIBonline Third Quarter Report 2010
In the third quarter we saw the dollar sell off across the board, due to the Federal Reserve board being bearish on the US economy and considering more Quantitative Easing towards the end of the year if need be. We do not foresee the Fed needing to institute more QE because we believe this summer was a soft patch in the economic recovery and will strengthen going into the fourth quarter. The US dollar has recently declined to a six month low against the Euro, the stronger Euro is already negatively impacting smaller European counties such as Greece and Ireland that actually need the Euro to depreciate to remain competitive and finance their debt. It is also interesting to note that US dollar shorts have hit a high not seen since mid-2008. In mid-2008, the EUR/USD was trading at 1.60 and eventually sold off to 1.23 as traders and asset managers reduced their dollar short positions. A benefit of the weaker dollar is it will help our exports creating a positive impact on our economic recovery. The weaker dollar will act as a mini “stimulus” and should help the manufacturing sector which has been leading the recovery. A recent report by Bloomberg utilizing a purchasing power basis estimated that the Australian dollar was overvalued by as much as 67%. Not only does a strong Australian Dollar have a negative impact on the Australian economy, but it means that at some point Australia will need to take steps to curb the strength of their currency to prevent deflation.
Commodities
This past quarter we saw commodities prices at record highs. Wheat hit 815.50 a bushel and currently is trading around 700, up almost 67 percent from its low in early June of 474. Corn hit a high of 536 from its yearly low of around 356 also established in June. This price action was prevalent throughout the commodity sector during the third quarter, including gold and silver which are enjoying all time highs. What is causing this? Russia was an unfortunate recipient of poor weather this year resulting in damaged crops with the consequence being a cap on their commodities exports. Australia has also struggled with production given their weather patterns however, the U.S. has managed to remain fairly consistent because of our technological advances such as irrigation and types of seed. One exception to this quarter’s commodity rally is oil. Oil has not enjoyed this surge in pricing primarily due to the underlying economic factors surround global expansion. Not even the massive oil leak in the Gulf of Mexico was able to push prices significantly higher. These kind of price increases remain unsustainable in the short term given that the US still has a 9.5% unemployment rate. Many market participants including us at FXIB compare this current situation to that of oil in the summer of 2007. When prices of commodities rise this high this fast the shock to the global system hits in waves, these waves cause mini bubbles in prices not only for food producers and consumers but in how banks structure loans and lines of credit based on overcapitalized hard assets. As a result of these bubbles when markets do re-align themselves, (and they will as we saw with oil) you are left with over priced bonds, loans and market valuations that will not be able to be sustained at these historical price levels. What does this mean for the average investor? Be careful buying commodities or commodity tied investments at these prices. Based on our research, gold is not an effective hedge against inflation, but is rather more effective as a hedge against the debasing of the US dollar. If the US Federal Reserve does start more Quantitative Easing, commodities could rally further however, we do not believe the Fed will need to do another round of Quantitative Easing.
Fourth Quarter Outlook
Given this backdrop, we expect commodities and commodity related investments to sell off in the fourth quarter and possibly into the first quarter of next year. We expect the US dollar to recovery some if not all of its recent losses and will keep a close eye on the US Federal Reserve statements as to any clues or direction they may take in regards to Quantitative Easing. We are also keeping an eye on the Chinese Currency Bill that just recently passed the US House of Representatives. The bill labels China as a currency manipulator and gives US companies the ability to levy charges on Chinese imports. If this bill is signed into law, we should see AUD/USD sell off as a proxy for the USD/CNY exchange rate. This bill is the toughest response by the US in regards to China’s polices. A currency war is already raging behind the scenes in which each country is trying to devalue their currency to stimulate economic growth. (what we call a race to the bottom). We do expect volatility to remain about the same, and we will continue to keep on eye on the leading economic indicators for the US economy.
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.
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.
Fxibonline's Blog 