SCOREBOARD: QE confusion

Uncertainty over US economic policy continues to confuse markets, but Fed speeches this week should bring more clarity.

Friday’s session racked up what was the fourth consecutive week of solid gains for US stocks. The S&P500 rose more than 1 per cent (1667), the Dow was 121 points higher (15,354) and the Nasdaq was up 0.97 per cent (3498). For the week that sees gains of more than 2 per cent, with the ‘Spring swoon’, as I think Goldman Sachs termed it, seeing gains of 10 per cent or so for the market thus far. Not bad for a ‘swoon’.

A spike in US consumer confidence – that swoon again – no doubt helped a bit in seeing the market push higher, as the 10 point gain to 83.7 sees consumer confidence at its highest in about six years. Even if the survey is volatile, like most sentiment surveys these days, the fact is it just adds to the positive flow of global economic data.

Once again this highlights the curious price action across commodities. They continue to be completely unresponsive to the strengthening global dataflow and strong gains in equities. Crude and copper did manage to push a bit higher on Friday and were both up 0.9 per cent for the session, but they've really just been range trading. Precious metals weakened though and gold sold off a further $22 to $1364.

Some of it of course is the confusion over US economic policy. Many in the market rightly think that QE will or at least should be reined in given the substantial improvement in some of the key economic indicators. I agree with that. Consequently, the US dollar has appreciated and had a good run. In the rates space, the US 10-year yield shot up almost 10 bps on Friday night to 1.95 per cent. All of this makes sense to me in a reasonable world.

Unfortunately though, monetary policy has become increasingly unpredictable. Remember the initial rationale for QE of deflation and depression? QE was an unusual or extreme policy measure, warranted because of the threat of depression according to its supporters. Of course as we know, the post-GFC recovery was much stronger than expected and we are nowhere near a depression.

Deflation was always a myth too. Doves or pessimists have been humiliated time and time again, and the best they can come up with now is to try to distort history and economic discussion. In an attempt to try and salvage some respect they now say, "See, hyperinflation didn’t eventuate, concerns about inflation were wrong!”. Some even suggest that the absence of hyper-inflation now means the Fed and even the Reserve Bank should provide more stimulus. The reality is though that inflation has accelerated as expected and sits around trend rates in the US and Australia. Concerns over inflation have been right – and this economic recovery is going according to that script. Nothing has changed.

But the increasingly desperate and erratic arguments of those who just want to keep printing are in the ascendency. The US recovery is actually strong, inflation at trend. These are facts. They are overlooked though by supports of QE who state the recovery is fragile and inflation low, with disinflation the threat. This is why so many Fed presidents and governors continue to support QE. Indeed, on Friday the president of the Federal Reserve Bank of Minneapolis suggested more stimulus may be required. Rates were not low enough.

The grounds to end or at the very least taper QE are strong. Yet the rhetoric from the Fed hasn’t changed and if anything is even becoming more dovish in some quarters. We’ll get a better idea this week when New York Fed president and policy extremist William Dudley speaks on Wednesday night, followed up on Thursday by Ben Bernanke in his testimony to congress.

Whatever your view, the inconsistency on US monetary policy highlights one thing: just how fragile or fickle this current sell-off on the Australian dollar is. It's now at 0.9748, which is little changed from late Friday but down almost a cent from earlier on Friday. If Bernanke and Dudley signal no change to QE that could change dramatically.

In terms of the other global data that could swing things there isn’t a great deal. Flash China manufacturing PMI, European PMIs for May and then in the US, new home sales Thursday night, along with house prices and jobless claims. Friday sees the German IFO survey and US durable goods.

I suspect most of the domestic focus will be on the Reserve Bank's minutes on Tuesday (1130 AEST). The Reserve Bank's last statement made it quite clear that the Australian dollar was the target here, and this was supported by the positive jobs numbers out a few days later. I think the minutes will probably try to play this down and maybe emphasise expectations for below-trend growth and low inflation, although growth is actually currently around trend and inflation in the middle of the band. This has been the template followed by many central banks though who, like the Fed, have cut in the face of a stronger than expected recovery – you just keep forecasting weakness and keep smiling when that forecast is wrong!

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