If the Recession Is Over, What Now, Ben?

Fed Chairman Ben Bernanke declared Tuesday that the recession was over but the recovery is weak: “Even though from a technical perspective the recession is very likely over at this point, it's still going to feel like a very weak economy for some time.”

What now, Ben?

Is Quantitative Easing a roach motel?
Does the Fed take its foot off the accelerator in its quantitative easing? Former Federal Reserve governor Laurence Meyer believes that there is widespread angst among Fed officials about exit strategies.

This chart from the Center for Geoeconomic Studies shows that the Fed’s balance sheet is going into harder to unwind assets, which makes exit strategies harder:

Is quantitative easing becoming a roach motel? It’s easy to get into but hard to get out?

Markets haven’t digested what this means
On the interest rate front, St. Louis Fed governor Bullard declared that interest rates are likely to stay low for a very long time, but the markets still don’t get it [emphasis mine]:

Financial markets have not fully understood that the U.S. Federal Reserve's pledge to keep interest rates exceptionally low for an extended period means they will stay low beyond when officials normally would raise them, a top Fed official said on Friday.

"I don't think markets have really digested what that means," St Louis Fed President James Bullard said in an interview.

The Fed's strategy is aimed at promoting a future rise in inflation, which should provide an immediate boost in activity in anticipation of a future boom, but that hasn't happened, Bullard said.

What does this mean for the markets?

USD hostile and commodity friendly
All that spells I-N-F-L-A-T-I-O-N, which will ultimately be USD hostile and commodity friendly. Barry Ritholz at the Big Picture weighs in on the Fed’s conundrum and investment implications:

If a strong recovery somehow takes hold, then rising inflation expectations should help the metals and be an even bigger tonic for mining shares. If the economy slips back into a funk, then a new round of policy responses (that we cannot afford) will gush forth, harming the dollar and thus helping the metals. The only way precious metals could really get hurt is for Bernanke and his central banking colleagues around the world to guide the global economy to a perfect, soft, noninflationary landing. If you think Bernanke and his buddies can usher in a painless return to the Goldilocks era, then avoid precious metals. Stocks, bonds, commodities, and the precious metals can all – in the short run – benefit from the liquidity provided by overly easy monetary policies. The recent positive correlations among these asset classes may be sending just such a message. Eventually, however, the asset classes will have to part ways. I think the central bankers will find a way to overstay their welcome, leaving the only monetary asset they can’t print as the asset of choice.

Inflation-Deflation Timer says inflation
Meanwhile, my Inflation-Deflation timer is telling me to stay with the reflation trade.

Comments

[Larry House:]

As long as money is flowing like water, one has to assume reflation. For how long is another issue.

Sep 18 11:17 AM

[David Braun...:]

I strongly disagree with you Mr. Hui. Our experience with Japan shows that you can have zero interest rates and deflation at the same time as the currency falls. Much has been written about the cash for clunkers giving the economy an artifical lift. Bernanke indicated he will stop buying treasuries and agencies by the end of October. Manufacturing usually peaks in August to September leaving the next six months highly dependent on consumer spending. With high unemployment and low bonuses (except for the bankers who received TARP money of course), my bet is that consumer spending over the next six months will be weak. We now have high inventories of raw materials and finished goods going into a weak consumer period. Sounds like the perfect recipe for a downturn in commodities and the stock market while the dollar stays weak.

Sep 18 02:23 PM

[E Nuff Sed:]

The "roach motels" are the banks - unless the prices of "risky assets" on their balance sheet rises they are unlikely to release the soaked up liquidity from the Fed into the market. Without liquidilty there is not going to be inflation. We may be in for a Goldilocks stock market for a while. The stock market recognizes this virtuous circle.

The virtuous circle may start to fade as distressed and illiquid assets start to appreciate and the banks start selling these and shrinking the balance sheet. It is going to a long process. Till then enjoy the ride.

Sep 18 06:30 PM

[LKofEnglish:]

equity markets have called out the fed. this could never be japan because japan (and china--rightfully so in my view) look at the wealth production of this society, blanch and want in. only a professor of economics would say the solution is free money and higher borrowing rates. this is no "roach motel." this is roaches FLEEING from the motel hoping for a better meal at 'that other joint.' the bond market is taking dead aim at this clown fed chairman and his moron cronies. won't be long before the president himself starts wonderin' if this outrage really isn't spot on after all. not like his poll numbers are going up anytime soon!

Sep 18 07:01 PM

[JCC:]

In the last 3 recessions the FED has waited for lengthy periods before they started to tighten. In todays economy, there is no reason to think that they will engineer a quick exit strategy.

Lakshman Achuthan's ECRI WLI (weekly leading index) has reached the highest level since August 29th 2008. This interesting index is pointing to a recovery that is expected to be fairly robust and with no indication of double dip.

www.rubbernet.com.sg/e...

I will watch carefully to see what type of exit strategy the FED develops, but I don't expect to see much indication for one to two years.

In the meantime, from an investment perspective, this run looks like it has a ways to go, and I will continue to take advantage with profits to the bank.

Sep 18 09:48 PM

[enigmaman:]

Makes sense, what % of liquidity pumped into market is estimated to be held by financial institutions?


On Sep 18 06:30 PM E Nuff Sed wrote:

> The "roach motels" are the banks - unless the prices of "risky assets"
> on their balance sheet rises they are unlikely to release the soaked
> up liquidity from the Fed into the market. Without liquidilty there
> is not going to be inflation. We may be in for a Goldilocks stock
> market for a while. The stock market recognizes this virtuous circle.
>
>
> The virtuous circle may start to fade as distressed and illiquid
> assets start to appreciate and the banks start selling these and
> shrinking the balance sheet. It is going to a long process. Till
> then enjoy the ride.

Sep 19 06:14 AM

[Michael Clark:]

I agree with you, Mr. Braunstein. We've had 18 years of the Demiurgos, Inflation of the World Bubble; now we get 18 years of the Angry God, punishing us for thinking we were actually the God of Creation. No inflation in sight until 2019.


On Sep 18 02:23 PM David Braunstein wrote:

> I strongly disagree with you Mr. Hui. Our experience with Japan
> shows that you can have zero interest rates and deflation at the
> same time as the currency falls. Much has been written about the
> cash for clunkers giving the economy an artifical lift. Bernanke
> indicated he will stop buying treasuries and agencies by the end
> of October. Manufacturing usually peaks in August to September
> leaving the next six months highly dependent on consumer spending.
> With high unemployment and low bonuses (except for the bankers who
> received TARP money of course), my bet is that consumer spending
> over the next six months will be weak. We now have high inventories
> of raw materials and finished goods going into a weak consumer period.
> Sounds like the perfect recipe for a downturn in commodities and
> the stock market while the dollar stays weak.

Sep 28 12:05 PM