Both cannons have fired. First, the European Central Bank (ECB) has promised "unlimited" action, and now the Fed has joined it with a promise of indefinite buying of mortgage-backed securities (MBS). Traders reflexively bought both decisions, because that is what the playbook tells you to do, but what will it mean for the real economy and investors, as opposed to traders? The dynamics for stock prices often depend on the calendar, and the last four months may be very different from next year.
In the wake of the Fed's decision, there was talk about whether or not Dr. Bernanke and the Fed are attempting to steer the election, and indeed a Fox news representative asked the chairman point-blank during the press conference what he would say to such talk. We're only thinking about employment, averred Bernanke. Even the CNBC crew had sympathy for the notion that he seems to be the only one trying to tackle the issue head-on.
The chairman has good reason to be talking about employment. We noted a couple of weeks ago in our review of Bernanke's Jackson Hole speech ("Preparing the Helicopters") that he had taken particular care to couch his case for further accommodation on the basis of employment and the Fed's dual mandate. Criticism of the Fed's actions has grown louder as the election approaches, and whatever the motivations behind it may be, however much the bank avers it is above politics, every Fed chair has to deal with political reality.
You may recall that at the time of the Lehman Brothers debacle, Bernanke was still reeling from the criticism that the bank had received over its role in conveying the dying investment bank Bear Stearns to JPMorgan (JPM). In the weeks and months that followed Lehman's bankruptcy filing, one of Bernanke's principal excuses for doing nothing was that the central bank lacked specific legal authority to intervene.
Whatever you think of that line (we didn't really buy it ourselves), it does convey how much the chairman wants to have a firm legal basis for bold acts, no doubt due at least in part to the number of politicians that want to "fix" the bank, if not do away with it entirely. The current Fed is also aware of some of the vociferous criticism it gets from advocates of a stable or fixed money supply, hence the frequent references to employment in recent weeks alongside the dual mandate of price stability and full employment.
He has to expect that many Republicans won't like more stimulus either - it's only natural that many would prefer a recovery starting around mid-November, for they can well remember that a fading summer of 1992 helped Bill Clinton nick George Bush senior in the November election. They'd like to return the favor.
All that said, we think that despite the good doctor's protests, it isn't really current employment that has the Fed most worried right now, but an economy approaching stall speed and a couple of central banks - ours, and the one in Europe - trying desperately to head off a gradual slip into global recession that could have very negative consequences. Buying MBS instead of Treasuries may be positioned as more virtuous and centered on the common man, but they both increase the money supply in the face of manufacturing weakening around the globe, as illustrated by falling global PMI indicators.
One thing that's sure is that the European recession, which Bernanke alluded to several times as a headwind, is nowhere near resolution. In fact, a bigger crisis is virtually a precondition for forcing reluctant politicians into hard decisions. ECB President Draghi succeeded in lowering bond yields without spending a penny last week, yet in doing so, he promptly freed both Italy and Spain from any thoughts about more spending cuts or listening to the IMF. That ought to play well in Berlin. In the lengthy piece that George Soros wrote for the New York Review of Books last weekend, he fretted over "the indefinite extension of the crisis" and sentiments of "xenophobia, anti-European attitudes, and extremist political movements."
Soros also added in a last-second preface that German chancellor Angela Merkel's accession to bond-buying by the ECB - over the objections of the head of her country's central bank - assures the future of the euro. Yet like Draghi and Merkel, he isn't saying who is going to be in it. No one is sure at this point, and neither are we. The one thing we are sure of is that the eventual omelet recipe will include some broken eggs.
Back in the U.S., employment trends in this country haven't really changed in recent months, last Friday's August job number notwithstanding. Admittedly, employment is a lagging indicator, but Bernanke has to know how much seasonal adjustments have messed with headline numbers this year.
Using actual, unadjusted data for both claims and employment is illuminating. The year-on-year monthly improvement in employment has been quite stable for the last two quarters, ranging between 1.3% and 1.39%. Despite the volatility created by seasonal adjustments and headline numbers, both July and August had identical rates of improvement, at 1.38%. In fact, every month of 2012 has had the best year-on-year percentage increase in actual jobs since 2006.
Looking at the unadjusted weekly claims data, 2012 has averaged a 9.7% year-on-year decrease in monthly totals this year. The last three months have followed a normal seasonal pattern, with claims rates increasing in July (mid-year and the end of the year are the two big separation months) and then falling again, such that the August rate was back to about a 9.4% improvement (our four-week periods do not exactly overlap the calendar months). The job market has not slowed, not yet.
The chairman is right to say that job additions are at below-average rates: they are about half the rates of those in the 80s and 90s. But we've just had the big credit recession, and just about everyone in this business knows the Reinhart-Rogoff assertion that credit recessions have much slower and more subdued recoveries.
So what are the implications for the market and the economy? In this regard, we'd like to cite a couple of floor observations from CNBC's Rick Santelli. While Santelli is a dyed-in-the-wool monetarist and a tea-party favorite, we have always given him credit for trying to keep his reporting separate from his polarizing (not to say loud) opinions. He noted that whatever traders in the Chicago futures pits may think about QE3 (and he himself is very much against it), they were afraid to fade it, because the "sugar high" can last longer than people think.
We agree. Inflating asset prices is exactly what the FOMC is trying to do. Opinions range widely over whether the buzz lasts a few days or a few weeks; stocks fell off a bit over the last 90 minutes on Thursday, betraying a certain edginess on the matter. Friday's data could be a buzz-kill if industrial production and retail sales disappoint. Yet while prices won't go straight up, absent fresh calamities, we think 1500 on the S&P is going to happen by next month. We will rally on any postponement of a Greek exit from the eurozone, rally if there are no wars in the Middle East, and rally so long as China doesn't say it can't pay its American Express bill.
On the other hand, we could run into some real trouble before year-end. Two of the biggest carrots are gone: the Fed has acted, and so has the ECB. When earnings season comes in October, what is the market going to live off of to ignore falling earnings? The other side of the easing coin that the market always overlooks initially is that the bigger the central-bank move, the more worried it must be. It isn't unreasonable to wonder why.
Business isn't great, in case you've dropped that part of the scorecard while watching the Liquidity Cup. Remember those PMI indicators? The Fed also cut its outlook for the rest of the year, to 1.7%-2.0% growth. It did raise its outlook for 2013 - presumably on the basis of its own stimulus - but we suggest that you compare that longer-range forecast with its 2012 forecast from a year ago (if you're lazy, we'll tell you that in June of 2011, the projection for 2012 GDP was 3.3%-3.7%).
Santelli's other observation, in case you're wondering, was that the Fed's plan won't mean a single extra person getting a mortgage on Friday that they couldn't get on Thursday. We can't argue with that. We would even go further and say that knowing the banks as we do, what they will do (and are already doing) is further crowd the upper-income and luxury home lending space, where there is considerable appetite for jumbo loans. At least initially, the biggest winners are going to be those who already have the most assets.
As for inflation, there shouldn't be any coming at the core level yet - the Census Bureau reported that real median family income declined for the second year in a row and is still lower than a decade ago. It's hard to get core inflation going under such circumstances. On the other hand, global food and energy prices ("non-core") are near record highs. If you haven't already listened to what must be the investment world's most widely heard webcast this year (superstar bond manager Jeff Gundlach yesterday), you should, even if you may feel like you need a drink afterwards.
There are other caveats, with the head of the list being that the globe's real problem lies in Europe: until it restructures, no one is getting out of this. Number two is that while there are always, always a few potential hyenas ready to make trouble somewhere in the world, right now the central banks are just about out of bullets. Rates are nearly zero and they're printing money in "unlimited" amounts with no end-date. What else is there left to do? The next one that comes along is going to get through.
The final warning is to go fill your gas tanks. Gasoline is already at a record (nominal) high for this time of year, and if traders continue to believe this rally, we could be living with $100 fill-ups by year-end, along with record heating bills. Just what the global economy needs.
It won't be all bad - if the Saudi economy reignites (one of the only positive PMIs in the world), at least they might start buying big rigs from Caterpillar (CAT) again. And if you can't afford an oil drill, haven't you heard? You can buy an iPhone 5 and save the U.S. economy at the same time. Has anyone found the app for heating the house yet?