Bernanke bounce Part II - Another day of gains

Last month, he created havoc on global markets with his talk of winding back the great American monetary stimulus program.

Now he’s having the opposite effect. Day two of the Bernanke Bounce is likely to see further gains for Australian stocks after a heady run yesterday, fuelled in equal measures by the US Fed chairman’s quips that the stimulus had some way to run and speculation that China may join the stimulus party.

It was celebration time on Wall Street overnight with the Dow Jones Industrial Average and the S&P 500 both pushing into record territory as traders embraced the concept that interest rates would stay lower for longer.

Gold advanced further overnight, along with silver and other precious metals. More importantly, for Australian investors, Doctor Copper jumped 2.6%, although oil prices shed some of their recent strong gains (see Carr's Call: Four danger signals for domestic investors).

After punching through US93c yesterday, the Australian dollar this morning had settled back below US92c as profit takers trimmed yesterday's strong gains.

Has Bernanke shifted his position? Not at all.

His comments in May and June merely stated the obvious; that the unprecedented money printing program that has supported the American economy in the past four years would have to come to an end as a recovery takes place.

It was a softening up statement, designed to allow a gradual transition in attitudes from traders who for years have piled into US Government bonds and risk assets in emerging markets. Right now, the Fed is providing  90% of the demand for US Government bonds. Clearly, that is a situation that cannot continue.

What the Fed chairman underestimated was the manner in which markets work. Subtlety is not a part of Wall Street’s psyche. Over-reaction is the norm.

The sharp rise in the US dollar and the lift in bond yields during the past two months, since his initial comments, threatened to strangle the nascent US recovery.  More than 20% of the S&P 500 earnings come from foreign markets and a sharply stronger dollar threatened to undermine corporate earnings.

His comments this week were designed to slow down the market lurch back to a non-stimulus world. Instead, currency, commodity, bond and equity markets again have reacted wildly as they try to come to grips with the idea that stimulus will need to be removed, but that the flood of support will slowly be wound back to a drip feed.