The Fed was sort of as expected: a little less money on a monthly basis, a little longer in terms of the duration of the program.
The next issue is how much ends up in the wider economy, rather than gathering dust in bank vaults.
The Bank of Japan meeting tomorrow is a different story. The change in timing of the BoJ meeting is not terribly subtle and suggests that Japanese monetary policy will be conducted as some kind of “Pavlovian” reaction to U.S. monetary policy.
The Federal Open Market Committee says in its statement: “The Committee ‘intends’ to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.”
Interestingly, former Fed Governor Randall Kroszner, who is now a professor at the University of Chicago Booth School of Business, comments: “This is buying some insurance against that tail risk … the FOMC needs to keep deflationary ‘expectations’ from taking root … The Fed, through a second round of long-term asset purchases, needs to ‘be ahead of the curve’ … there is a chance of deflation expectations coming up and it is important the Fed prevent that from happening.”
Well, it’s an indisputable fact most economists agree they have literally no idea whether this second round of quantitative easing will work.
Really worrisome is that at the same time, everybody knows that the Fed’s monetary policy alone won’t do the job of reducing U.S. unemployment considerably. Yes, that’s where Washington will have to come in from the regulatory side for stimulating hiring. What will come out Washington is still the big unknown for everybody.
On deflation expectations, we could say QE2 “could” be great for higher equities, bonds as well as real assets prices (from cotton to gold) — and perhaps could even cause runaway inflation.
But let’s look for a moment on the Fed’s promise to buy more bonds hereby hoping to spur inflation “somewhat but not too much” while raising the price of these bonds while lowering their real value, which is in fact nothing more than complying with the perfect definition of a bubble.
Of course, Mr. Bernanke doesn’t see it this way. Most investors will agree that bonds are already ludicrously overvalued.
Let me explain: For long-dated U.S. Treasuries to match their historic real annual return of 3 percent, we need inflation to average less than 1 percent for the next 30 years.
Everybody agrees the U.S. is growing less quickly than the emerging economies and therefore its real exchange rate should be declining. Relatively low U.S. inflation is an efficient way to do just that, but the Fed clearly disagrees.
Investors betting the same way are really at risk of getting burned once again.
As the Fed has now officially launched QE2, overnight we also noticed remarkable howls of protest from around the world in the aftermath of this decision.
Here are some of them:
People’s Bank of China (PBOC) advisor Xia Bin says: “As long as the world exercises no restraint in issuing global currencies such as the U.S. dollar, and this is not easy, then the occurrence of another crisis is inevitable, as quite a few wise Westerners lament.”
Li Deshui, vice director of the Economic Commission of the Chinese People's Political Consultative Conference, writes in an essay published in the China Information News that China could team up with other countries dissatisfied with the dollar’s fall to “prevent excessive depreciation of the currency,” which is, of course, the dollar. He adds that other countries also "deeply feel the bitterness of the dollar's depreciation.”
It seems to me that forex intervention is not far away.
Henrique Meirelles President of the Brazilian Central Bank comments: “The result of QE2 is a big expansion of liquidity, which is not being totally absorbed by the United States. This flows out onto other countries, including Brazil, which is growing. The consequence is an excessive liquidity of dollars which we are absorbing ... There was the decision of raising Brazil's IOF tax that applies on foreign purchases of bonds, and prudential measures aimed at preventing this from creating credit bubbles in the Brazilian economy."
Also, Welber Barral, Brazilian Foreign Trade Secretary says: “The Fed's decision is cause for concern. They are policies that impoverish those around them and end up prompting retaliatory measures. And then you have this type of cancer which is protectionism that spreads very fast.”
So far, there is remarkably little comment out of Europe notwithstanding that there is the real risk that QE2 could pressure the euro to higher levels, hereby confirming, in case that happens, that the eurozone will pay the price, as emerging market authorities will inevitably stymie the reciprocal appreciation of their own currencies by sustained intervention and the recycling of a portion of their accumulated dollars into the most suitable liquid vehicle, which is, of course, the euro.
The eurozone economy has held up fairly well all considered, but the pain of a rising euro on its exporters is intensifying and the elusive objective of fiscal stability in the eurozone now seems another step further away.
In my view it’s certainly not overstatement to say that eurozone’s weak sovereigns look once again to be in trouble. I think that our point of focus at this moment should be on Ireland.
We should note that creditors holding a “blocking position” of Anglo Irish subordinated bonds and their opposition to a debt exchange worth 20 percent of their holdings has already contributed to a sharp rise in Irish/German spreads; and although there have been a number of catalyst behind the recent malaise, there has been one common denominator: the EU’s push, led by France and Germany, to modify the Lisbon Treaty.
Calls for the “orderly insolvency” of those countries in financial purgatory have undoubtedly led many fixed-income investors to recoil from the risk of holding their bonds that no longer enjoy the guarantees they used to have whilst this is entirely reasonable on the basis of “moral hazard,” it is questionable whether now is again the right time to begin addressing that issue given what is at stake. We could say the EU is biting the hand that feeds it.
In the meantime, the Irish-German 10-year bond spread has ballooned to 520 basis points (bp) and it is very difficult not to draw direct comparisons with the Greek crisis that came to a head in April for which a spread of 500 bp was a pivotal point in its escalation.
The credit default swap on Irish 5-year debt has also soared into the stratosphere, having risen almost threefold in cost since the end of August, and again, this is reminiscent of the onset of crisis in Greece earlier in the year.
I agree while Ireland may be fully funded until April, its ability to return from wholesale markets with affordable funding is now seriously brought into question just as its ability to raise revenues has become more demanding – a fact that will hinder Irish banks and their access to conventional sources of revenue.
If tensions across the eurozone’s debt markets grow from current, elevated levels, then questions may soon be directed at the EU’s ability to come to the rescue of Ireland once more.
All this is developing at a time when QE2 puts the euro at risk of rising further.
Whether investors as well as the world’s currency reserve managers would have a re-think at this point is open to debate. Believe me, it won’t be a simple exercise. We are in completely unchartered waters all over the world … and tensions are rising.
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