THE DISTILLERY: QE overflow

Federal Reserve chairman Ben Bernanke has hinted he could start pulling back QE3 by the end of the year and absolutely no one is surprised. But there’s much to analyse with Bernanke’s expectations for the US economy, the extent of the sell-off in global markets and the benefits of a lower Australian dollar.

The Australian Financial Review’s Capital Markets columnist Jonathan Shapiro notes that there were a number of aspects to Bernanke’s statement.

“One is that he appears remarkably sanguine about the back-up in interest rates since last month’s comments. Rising US bond yields have already lifted US mortgage rates up by about a percentage point, which some fear could cool demand for housing, a key factor in the US economic improvement. But Mr Bernanke said that if bond rates were rising for the right reasons – because economic growth was improving and the bond markets were accurately forecasting the future path of interest rates – then that was a good thing.”

Business Spectator’s Stephen Bartholomeusz observes, as many commentators have, that Bernanke’s comments about the increasingly positive state of the US economy are in step with the market’s thinking … and yet stocks plunge when he says QE3 is going to be scaled back.

“That might suggest that the QE3 program has, in one aspect at least, been too successful. The combination of a federal funds rate around zero and the large-scale purchases of bonds and mortgages were designed to encourage/compel investors to shift up the risk curve, and they did. Equity markets have generally been very strong this year and there have been massive flows of funds into emerging markets and elsewhere in search of yield and returns. Until recently, the Australian dollar had been propped up by those flows, despite the ending of the resources boom and the weakening performance of the wider economy. Over the past month markets have been exceptionally volatile, gyrating in both directions as investors tried to second guess the Fed’s intentions. The big sell-off last night, which saw the Australian dollar tumble below US93 cents, would appear to be an admission by investors that they had acquired too much risk in the belief that the Fed would maintain the QE3 program at its current levels for quite some time yet.”

The Australian Financial Review’s Chanticleer columnist Tony Boyd reminds his readers that Bernanke has been bashed from many corners for being too bullish on the US economy.

“But history shows that private sector economists were far too bearish about the recovery in the US economy in 2013. The revisions in relation to monetary policy issued by Bernanke this week suggest that FOMC participants have changed their views on some key fundamentals in the US, according to economists at Nomura Securities. Changes including productivity growth and labour force participation suggest that it will take less growth in the economy than previously assumed to generate a tightening of labour markets. Bernanke is like any good sharemarket investor. He anticipates changes in the macroeconomic environment and acts accordingly.”

Indeed, the situation now is that for the Australian sharemarket the great hope is the US and the great concern is China, as pointed out by The Australian’s John Durie. Just moments ago it seemed to be the other way around.

“Investor nerves were underlined by the overreaction to one set of manufacturing numbers from China yesterday which spooked an otherwise orderly reaction to US Federal Reserve chief Ben Bernanke's future plans. A lower Australian dollar is a key, long-term bullish driver for Australian stocks but short term it has created uncertainty, in part because offshore investors will flee the local bourse in droves because the value of their holdings will slump.”

Interestingly, The Australian’s Barry Fitzgerald puts the dollar’s slide into its proper context in relation to the miners. It’s assumed that the lower dollar means cheaper exports and so on, but…

“There is no bonanza for the miners in the dramatic slump in the dollar, even if mineral commodities are priced in US dollars. The problem for the miners is that the dramatic plunge in the exchange rate has also been accompanied by a slump in commodity prices in response to growth fears in China and the US easing back on economic stimulus.”

In company news, The Australian Financial Review’s Matthew Stevens notes that the 40 per cent export limit imposed by Israel on its gas fields will be “as unwelcome as it is welcome for prospective investors in Woodside Petroleum”.

With Woodside’s deal in Israel yet to be sealed, the argument goes that the uncertainty over the export restrictions is probably the biggest thing holding it up. Woodside mightn’t like the idea of a cap, but it would dislike the uncertainty more.

Now it knows and things can move forward.

Still in resources, Fairfax’s Elizabeth Knight noticed the share price hit that Fortescue Metals took yesterday, explaining that the iron ore producer is still highly leveraged to the positive and negative.

The Australian’s Bryan Frith believes there are some “puzzling” aspects to the decision by Genting Hong Kong to bump up its stake in Echo Entertainment, but the timing suggests it’s trying to send a message to someone. But who?

And finally, Fairfax’s Adele Ferguson and Chris Vedelago report that the Senate is investigating the revelation that the corporate regulator took 16 months to act on information about misconduct from the Commonwealth Bank's financial planning unit.

It was Ferguson and Vedelago who broke the story. The Distillery sends hearty congratulations to them.