Good Evening: With global market participants continuing to pay more attention to sporting events like the World Cup and Wimbledon than to political events like the G-20, U.S. stocks were fairly quiet for a second straight day today. Some investors had hopes the G-meetings (G-8 & G-20) over the weekend in Toronto would bring forth fresh policy guidance from world leaders, but the squawking, er, debates about the need for economic stimulus yielded little. The Obama administration would like Europe to provide a fiscal boost to its flagging economies and would also like currencies in Asia (especially the yuan) to strengthen. Europe resisted, citing budget woes and the need for austerity, while the Chinese simply pointed to its recent press releases about letting the yuan float as reason to close off any further discussion.
The only real stimulus gain coming out of these sessions was a reported $1 billion price tag for the elaborate security in Toronto. At least the relatively responsible government in Ottawa can afford it, even if it left Canada’s financial center a little worse for wear. Perhaps some good will come from this confab. I can think of no better example of post-9/11, post-bubble, trickle-down economics than if all the Mounties working overtime recently decide to cross the U.S. border on shopping sprees. And if world leaders are either unwilling (in the U.S., Congress has recently started to utter the word “no”) or unable (austerity is the watchword in the U.K. & Europe) to stimulate their economies through fiscal measures, just which policy tools remain open to governments if economic growth continues to slide? In preview, let’s just say the central banks will called upon to do all they can to “help”.
Stocks were mixed in Asia overnight, but the Bourses in Europe were nicely in the green prior to this morning’s open in New York. As for our index futures, they tried to rally but didn’t have their heart in it. After opening slightly higher, equities pulled back 0.5% before mounting a comeback of similar proportions. The indexes spent the rest of a fairly dull session dodging around unchanged before some weakness in the final hour of trading. Losses for the major averages ranged from the fractional (Dow Industrials) to 0.7% (Dow Transports). Rumors of an imminent resumption of Quantitative Easing by the Federal Reserve may not have helped stocks, but they certainly helped Treasurys. U.S. government paper was firm all day as yields declined between 2 and 9 basis points. The best gains came in the carry-friendly middle of the yield curve. The dollar (+0.5%) was sought in this flight to quantity environment, and commodities responded by falling. With energy and precious metals leading the way down, the CRB index shed 0.75% on Monday.
As U.S. housing has suffered after the expiry of a tax credit for home buyers, many economists, strategists, and even an intrepid reporter or two are again worrying aloud about the potential for deflation to swallow the world’s economies. The latest battle cries among those in the deflationist camp went up after two recent articles in the U.K. Telegraph by its International Business Editor, Ambrose Evans-Pritchard (see below). In his first article, which hit the news stands on the eve of the G-20 meeting in Toronto, Mr. Evans-Pritchard revealed that Fed Chairman, Benjamin S. Bernanke, is considering a renewed round of Quantitative Easing. He also reported that once QE II set sail, it would be even more massive than the round announced in March of 2009. Mr. Bernanke won’t stop this time until the Fed’s balance sheet foots to an astonishing $5 trillion, claims Mr. Evans-Pritchard.
Every bit as interesting as his controversial article of last week, however, was the ensuing reaction to it that Mr. Evans-Pritchard chronicled in a follow up article published yesterday. In this latest piece, he quotes sources at RBS, UBS, and Societe Generale who fully expect another round of massive money-printing from the Fed. Andrew Roberts, credit chief at RBS, goes so far as to say that “the Fed will shift tack, resorting to the 1940s strategy of capping bond yields around 2pc by force majeure.” (source: final article below) Where did Mr. Roberts come up with such a bold notion? Why from Mr. Bernanke himself, of course. On November 21, 2002, then newly appointed Fed Governor Bernanke gave a seminal speech entitled, “Deflation: Making Sure “it” Doesn’t Happen Here”. The Fed would be far from powerless should deflation take hold when short rates are already at the “zero bound” (as they are today), said Bernanke. One of the Fed’s many tools, and one that was used during the decade ending in 1951, would be to “cap” long term bond yields. In his own words:
“Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities. The most striking episode of bond-price pegging occurred during the years before the Federal Reserve-Treasury Accord of 1951.10 Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade. Moreover, it simultaneously established a ceiling on the twelve-month Treasury certificate of between 7/8 percent to 1-1/4 percent and, during the first half of that period, a rate of 3/8 percent on the 90-day Treasury bill. The Fed was able to achieve these low interest rates despite a level of outstanding government debt (relative to GDP) significantly greater than we have today, as well as inflation rates substantially more variable.” (source: Bernanke 11/21/02 speech — see below)
Whether or not Mr. Evans-Pritchard and the investment banking sources he quotes will be proven right in the days to come is an open question, but I think another round of QE is coming before the end of this year. Media reports say that the Obama administration wants to take further action to support the U.S. economy, but the appetite in Congress for fiscal stimulus is shrinking even as risk appetites do the same. Moreover, rising tax rates next year will turn government fiscal policy negative, turning what had been a tailwind into a headwind. Governments in Europe face similar problems, as do state and local governments in the U.S.
If you read the entire text of Mr. Bernanke’s 2002 speech, you will probably reach the conclusion that our Fed Chairman is more than just intellectually opposed to deflation; he is on the record as being the type of cross-his-heart-and-hope-to-die central banker who will fight it with every dollar he can conjure up out of thin air. It won’t matter to our Chairman that the fiscal well has just about run dry; QE measures don’t come up for a vote in Congress. All Mr. Bernanke requires is a majority of raised hands around the conference table at the FOMC. For his part, Mr. Market needs no reminders from Mr. Evans-Pritchard. The old gentleman has seen fit to lift both bonds and precious metals in recent weeks, and both markets would benefit in the short run from the sailing of QE II, especially if it involved caps on Treasury yields. The long run harm caused by massive money-printing is an issue for another day, but the investment implications are clear enough that even Jim Cramer is now advising his viewers to allocate more of their portfolios to a certain yellow metal. I’m referring, of course, to the one form of money no central banker can create at a keystroke. With apologies to the milk industry, I think all investors should be asking themselves a question: Got Gold?
– Jack McHugh
U.S. Stocks Drop, Led By Commodity Shares, as Oil, Metals Fall
Treasury 10-Year Yield Falls to Lowest Since ’09 on Concern About Recovery
Ben Bernanke needs fresh monetary blitz as US recovery falters
Deflation: Making Sure “It” Doesn’t Happen Here, by Ben S. Bernanke, 11/21/02
RBS tells clients to prepare for ‘monster’ money-printing by the Federal Reserve
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