‘If only, if only…If only me aunty had bollocks she’d be me uncle’
Or to paraphrase Ben Bernanke, ‘If only the US economy would start growing sustainably will we consider scaling down our QE program.’
If only, if only…
Nothing really changed last night with Bernanke’s speech, except the market’s perception of what’s going on. Bernanke confirmed that the Federal Reserve may or may not ‘taper’ — it all depends on the incoming data. But whatever he said, the market wasn’t listening.
Try this headline from Bloomberg this morning:
‘Bernanke Says Fed on Course to End Asset Buying in 2014’
But in the meat of the article comes this quote from Bernanke:
‘“If you draw the conclusion that I just said that our policies — that our purchases will end in the middle of next year, you’ve drawn the wrong conclusion, because our purchases are tied to what happens in the economy,” he said. “If the economy does not improve along the lines that we expect, we will provide additional support.”’
The market isn’t listening to what Bernanke says…it’s panicking. Just about everything got hit overnight. Equities, bonds, commodities, precious metals, all were slammed as the US dollar rallied. The Aussie collapsed 2 cents…that’s a massive move in FX land.
The speculators got it wrong. They positioned for a soothing Bernanke statement. But they just got more of the same. That is, if the economy moves into a sustainable expansion, we cut out the asset purchases…if it falters, we’ll ramp them up.
That sounds pretty straightforward, but it led to a massive unwind of leveraged bets in anticipation of the beginning of the end of easy money.
Is it really though? The ‘end’ of quantitative easing (QE) might just be the thing that ensures it remains a part of the financial lexicon for years to come.
Well, bond yields are on the rise. The US 10-year bond yield, a benchmark for the global cost of credit, traded around 1.6% at the start of May. Following another sharp sell-off overnight, it’s now at 2.33%, the highest level in over a year.
In general, global market interest rates follow the lead of the US 10-year Treasury bond. So rising rates represent a tightening of monetary conditions in financial markets. Which means the US economy, for years heavily dependent on easy money, will come under pressure soon as higher interest rates begin to bite.
And if the US economy comes under renewed pressure, Bernanke won’t cut QE anytime soon. So no end to QE…long live QE!
But what if the US economy really is recovering? And what if this recovery DOES end QE sometime next year and then interest rates move back to normal in subsequent years?
That, dear reader, is not going to happen. It comes back to the ‘Holden Moment’ we talked about yesterday. The whole structure of the US economy (and much of the global economy to be honest) depends on easy money. Car sales, home sales, government spending, consumer spending…all depend on cheap money.
Years of zero interest rates have robbed the system of real savings. In its place, the level of total debt has ballooned to keep up the façade of healthy and sustainable growth. And in the meantime, the structure (industry, incomes, employment, profits taxes etc) of the economy grows around this ongoing provision of cheap and easy money.
If you try to take it away, the economy will fall in a heap. That shouldn’t be a big deal but we’re talking about the world’s largest economy, and consumer of last resort here. The US’ ongoing propensity to consume more than it produces is made possible by easier and easier money.
As money becomes cheaper, debt levels grow to fund consumption. The whole economic structure of the world economy grew out of this falling US interest rate/rising debt/excess consumption model.
You think we’re going to get out of it easily? You think the Federal Reserve can all of a sudden put an end to this multi-decade trend without major problems? Throw in the world’s second largest economic zone, (Europe) which is in the throes of its own painful structural adjustment…and the world’s second largest economy, China, which is about to experience what it’s like when a credit bubble goes bust, and…well, Houston, we have a problem.
As an aside, check out China’s inverted yield curves (on the right hand side) here. Usually, in a non-QE monetary environment, inverted yield curves portend a major economic slowdown…
So if QE can’t really end, where to from here?
We’ll go back to our comments from a few weeks ago. That is, confidence in the Federal Reserve and Bernanke is receding, and liquidity will soon follow. One of the most beneficial impacts of QE is that it instils confidence. Confidence creates liquidity which creates asset price inflation.
In the Q&A following the press conference, someone asked about sharply rising bond yields over the past few weeks, and how that reconciles with the Fed’s view that it’s the stock of assets it holds on its balance sheet that determines yields.
Bernanke responded that ‘we were puzzled by that’, and then tried to explain it away by citing other factors like potential optimism about the outlook for the economy (optimism not shared by any other asset class, by the way).
When you admit to being puzzled by the effects of the largest monetary experiment in history, which you implemented, it’s a confidence drainer. And with confidence goes liquidity.
So where do you hide in a market that has lost confidence in its chief puppeteer? Gold? It’s falling too, right? There’s more to that question than meets the eye.
More on that tomorrow…
for Markets and Money
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