Low Inflation Concerns to Serve as a Launching Pad for Stocks

Despite the Fed policy meeting's decision being announced later today, it's given that the Fed Fund rates will be maintained at close to zero. The question is if they will give any indications as to how long they will keep rates at low levels and if the $1.25 Tril purchase mortgage backed securities purchase program will be extended beyond the planned December end date.

Given that banks are still mostly unwilling to lend to the US consumer as they shore up their balance sheets, the Fed may have to keep its accommodative policies intact for a while longer. This despite the huge amounts of liquidity the Fed has provided to banks. As such, we could possibly see an extension (with more funding or possibly a "watered-down" version) or a new replacement (providing similar liquidity) for the MBS purchase program. The data below shows the total bank loans based on releases from the Fed (chart courtesy of Bloomberg). Total loans right now are at $6.8 Tril, still down from the peak of $7.3 Tril in 2008.

What this all means is that inflation is clearly not a concern as of the moment. This may be why bonds have recently been performing well along with equities. Gold may have a choppy ride, but low rates should keep the dollar weak, thus gold should remain relatively strong. For stocks however, it is a more complicated scenario since equities are mostly more forward-looking than other asset classes. It means a longer path towards inflation, prolonged accommodative policies to help businesses recover (until lending kicks in), as well as higher valuations for stocks on lower discount rates.

Comments

[User 143167:]

The headline CPI at the year end with current oil price unchanged will be 3%. If the Fed does not do anything, the negative real yield will soon make itself into an asset bubble and inflation by releveraging.

Sep 23 11:52 AM

[Mad Hedge F...:]

cft Reviewing the current political and monetary landscape, I would be remiss, irresponsible, even negligent, if I didn’t revisit one of my favorite ETF’s, the Proshares Ultra Short Treasury Trust (TBT). This is the 200% leveraged bet that long Treasury bonds, the world’s most overvalued asset, are going to go down. While the Fed is going to keep short rates low for the indefinite future, it has absolutely no direct control over long rates. The only political certainty we can count on it the continued exponential growth in the supply of government bonds of all maturities. Like all Ponzi schemes, their eventual collapse is just a matter of time. It’s simple a question of how many greater fools are out there (sorry China). Look at how they are trading now. We currently have the greatest liquidity driven market of all time, and the ten year is only eking out a 3.40% yield, pricing in near zero inflationary expectations. The average yield on this paper for the last ten years is 6.20%, a double from the current level. Get the yield back up to 5%, a distinct possibility in 2010, and that takes the TBT from the current $45 to $70. Sure we may get a sideways grind in yields for a few months, which will be expensive due to the mathematic idiosyncrasies of the 2X ETFS. But a security that is unchanged if I am wrong, and doubles if I am right is the kind of risk/reward ratio that I will take all day. And I believe that in my lifetime Treasuries may lose their vaunted triple “A” rating and be priced closer to subprime (warning: I am old). That could enable the TBT to deliver the holy grail of trades, your proverbial ten bagger.

Sep 23 02:12 PM