SCOREBOARD: QE frenzy

The Federal Reserve's decision to boost its stimulus efforts is more a PR stunt than a significant change in policy.

I thought they might wait, but I thought wrong. It’s not such a big deal though, I mean they were always going to print and last night, the Fed opted to starting printing another $45 billion per month (after operation twist ends in December) in order to buy government debt. That is – monetise debt. Don’t forget that’s in addition to the $40 billion they are spending on buying mortgage backed securities.

Just in case you are confused as to why the Fed is adopting such extreme measures, just take a look at the first paragraph of the statement:

”Information received since the Federal Open Market Committee met in October suggests that economic activity and employment have continued to expand at a moderate pace in recent months, apart from weather-related disruptions. Although the unemployment rate has declined somewhat since the summer, it remains elevated. Household spending has continued to advance, and the housing sector has shown further signs of improvement.”

Do you see? It’s a crisis!

One aspect of the Fed’s decision that got a lot of attention was this idea to link exceptionally low rates to economic targets. It was new and the idea is they will maintain ultra-low rates ”at least as long as the unemployment rate remains above 6.5 per cent, inflation between one and two years ahead is projected to be no more than a half percentage point above the committee’s 2 per cent longer-run goal, and longer-term inflation expectations continue to be well anchored”.

Many people will argue that this is a significant development and it is front page news. The reality is different, indeed in my opinion it is little more than a PR stunt.

I say this because there are really no practical implications. Does it offer enhanced forward guidance? Well no. Consider how the Bank of England treated its inflation target. They have had inflation well above target for some years and the way they get around this is by perpetually forecasting that it will fall below target over the next two years.

This is why there is this focus on forecast inflation rather than actual. Note that the Fed starts off with at least as long – which effectively waters down the targets as he introduces them.
Moreover, the statement implies that all three conditions need to be met before the Fed would raise rates – and even then it isn’t a promise to raise rates!

Now momentum being what it currently is, the unemployment rate will be at 6.5 per cent well before 2015. Under good conditions maybe even by the end of next year. So my guess is that the Fed will indeed follow the same tactic as the Bank of England and just keep forecasting inflation to be below 2.5 per cent over any two-year horizon. That is, even if current inflation should to be well above. At the moment, the Fed only expects one of these conditions to be met during 2015 – sub 6.5 per cent unemployment – and indeed that is with forecast inflation still well below 2.5 per cent. In truth, the link to economic targets has no practical significance or use for markets. Bernanke basically admitted as much when he offered the caveat that "policy was not on auto pilot”.

Despite the Fed’s decision to buy bonds, US Treasuries actually sold off. The 10-year yield up about 2 bps to 1.68 per cent, while the 5-year sits at 0.64 per cent and the 2-year at 0.24 per cent. Australian futures sold off too, with the 3s down to 97.285 and the 10s to 96.830. Not much of a reaction but you’d think yields would have come down – much priced in I guess.

One of the more ominous moves was on the Australian dollar – it initially spiked uncomfortably close to $1.06, hitting a high of $1.0585. As I write it’s a little weaker, but only a little. And that is still some 40 pips higher than yesterday afternoon – and 1 full cent or so higher than prior to the December rate cut.

Rate cut loonies will probably start screeching that the Reserve Bank should cuts rates to lower the dollar again – oblivious to the fact that this hasn’t worked. Indeed it hasn’t helped confidence either. Or lending! You can tell there is no thought or reason in what they say though – after recent confidence figures many quickly spat that the Reserve Bank should cut rates. Honestly!

Anyway, forex moves elsewhere saw the euro up 80 pips to 1.3082, the yen is at 83.15 from 82.62 and sterling is 40 pips higher at 1.6157.

Now as for stocks, the S&P500 closed flat at 1427.79 – it hit 1438 at the high, the Dow dipped 0.1 per cent to 13,235.53, and the Nasdaq ended 0.4 per cent lower at 3010.35, so markets obviously didn't get a boost from Bernanke’s fanaticism. But commodities made some gains – crude is up 1.3 per cent to $86.89, which is one of the bigger moves in a while. Gold was then up $5.70 to $1715, while copper rose 0.8 per cent.

Bits and pieces otherwise. On the price action, European stocks were modestly higher – the Dax was up 0.3 per cent, CaC was up 0.01 per cent, while the FTSE rose 0.4 per cent.

The more interesting news was on the bond front. Specifically, Spanish and Italian bonds, yields of which dropped sharply overnight – Spanish bonds were down 7 bps to 5.38 per cent, while the Italian equivalent was 8 bps lower at 4.58 per cent.

So looking to the day ahead, the SPI suggests Australian equities will be 0.4 per cent higher. There isn’t a a lot otherwise, car sales today at 1130 AEDT. Tonight the key data to watch includes US retail sales, jobless claims and producer prices.