To Buy Or Not To Buy The QE Rally? That is the question
How to clean up in the new era of monetary dysentery
Given the magnitude of the likely huge new money printing schemes hitting the world in stereo, from both the ECB and Fed, the likely big market movers will be the ongoing reaction to both programs
ONGOING EFFECTS OF QE 3 AND OMT
As in prior weeks, actual economic data is likely to remain a mere sideshow. The big question is, how much longer can markets ignore worsening data and rally based on sheer anticipation of asset price inflation from QE 3 and OMT as markets scramble to put all that cash somewhere?
Fed QE 3
Last week's main market driver was anticipation and reaction to the big Fed QE 3 announcement.
For those who missed it, here are the key details:
-The Fed will buy $40 billion of mortgage backed securities every month for as long as is needed to get unemployment down.
-Combined with the ongoing Operation Twist to the end of the year (at least), this totals to $85 billion in the next 4 months
-Then at least $40 million until unemployment drops to a desired figure (7% perhaps)
-For perspective, QE 1 cost about $1.7 trillion, QE 2 was about $600 billion, and QE 3 will add another….well, who knows?
There has been talk that asset prices have already discounted a big new QE 3 program, but how do you discount an unlimited money printing scheme?
Let's put aside any discussion of the dubious wisdom of this plan after 2 similar programs of more limited magnitude failed to make any clear improvement in employment.
As with the Fed's QE 3, markets remain positive about the short term effects of the ECB's OMT. It is believed to have deferred the near term default risk for Spain and Italy. In essence, the ECB prints money and uses it to buy a sovereign nation's bonds and so keep that countries borrowing costs low. In return, that nation promises to meet a variety of politically unpopular conditions to cut its deficits.
Likely Short Term Effects Of Both Programs
The consensus for the near term is clear. The new QE 3, combined with the effects of the ECB's version (OMT), it's a risk-on party time with more risk asset price inflation, regardless of the worsening state of the major economies. That is:
Stocks and other risk assets, especially commodities and related risk currencies, are expected to head higher.
The most likely winners are the popular USD and EUR hedges, like gold and oil, given the enormous long term hit these two most widely held currencies are likely to take. One can debate how much higher most risk assets can go in the near term, and whether or not they're due for a big pullback longer term. However the long term value of currency hedges is much harder to ignore in this new era of monetary dysentery.
Conversely, safe haven assets and currencies like the USD are going down.
Beyond the coming weeks, things are less clear, though the bias remains, 'don't fight the Fed.'
What Might Spoil The Party? The Same Ongoing Threats
US Fiscal Cliff: A failure to resolve the coming fiscal cliff: If US consumers are hit with higher taxes and benefits cuts, lower interest rates won't do much good in spurring new spending and hiring.
Worsening Data: The weight of the reality of slowing growth might at some point outweigh the psychological effects of money printing
The EU: Personally, I suggest that the current trust in the EU leadership to keep another crisis at bay for long is grossly misplaced. As we noted in last week's post, the OMT is no more likely to succeed than prior programs because it's got the same flaws and doesn't deal with the EU's real problems. For a full look at what's needed to fix the EU and how to identify real solutions from the usual fakes, see 7 Criteria For Distinguishing Real Eu Crisis Solutions From Fakes.
Of special near term concern:
Greece is not able to meet its bailout obligations, so the EU must soon choose between letting Greece default or losing credibility with other bailout nations by not enforcing its own agreement and giving Greece cash. If that happens, how credible is the whole OMT program anyway, which is founded on the assumption that 'conditionality' is enforceable?
The ECB's OMT has ironically made Spain less willing to take a bailout because its borrowing costs are now lower and it doesn't want the obligations that would come with a bailout. That means Spain doesn't reach any near term resolution (no one is dealing with longer term ones, like haircuts for bondholders) until Spain is at risk of default and the EU is back in crisis mode.
Longer term, same old problems doom the EU. See the above articles for details.
This past weekend's meetings may produce some market moving news early in the week.
For all its troubles, it's still the only big economy with significant growth. We'll the HSBC mfg PMI data, in addition to any unforeseen news on China's ongoing slowdown and political turmoil.
Likely Longer Term Effects Of Both Programs
The consensus is as bearish as the short term one is bullish
Unlimited money printing devalues currencies.
Inflated asset prices fall once the printing is believed to be slowing or stopping, though anything believed to be a currency hedge like gold, oil, fine art or farmland, should outperform financial assets and may even hold its value barring an economic collapse and runaway deflation.
Sovereign bonds of the big money printers collapse as markets demand higher interest to compensate for being repaid in depreciating currency.
Other Event Risk From This Week's Calendar
The coming week is a typical mid- month calendar of middling event risk. Top reports include:
- Tuesday: Australia monetary policy meeting minutes, German ZEW sentiment survey
- Wednesday: Japan rate statement and press conference, US building permits, existing home sales
- Thursday: China HSBC flash mfg PMI, French, German, and EU flash mfg and services PMIs, Spain 10 year bond auction, ECB President Draghi speaks, US Philly Fed mfg index
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.