The Fed has not been shy about taking credit for the recent equity price increases. They claim that this so-called “wealth effect” will spill over into the real economy and create a “virtuous cycle” where nominal wealth creation leads to real wealth creation (they have that part backwards – real wealth creation leads to nominal wealth creation, but who needs facts anymore?). But the Fed has also been quick to claim no part in the recent commodity price spike (also no mention of the continuing house price declines, but again, who needs all the facts when you can better prove your point by leaving most of the facts out of the equation?).
I have claimed that the Bernanke Put is a direct cause of a severe psychological imbalance in the market where investors begin to act irrationally based on false promises made by the Fed. The truth is, the Fed’s ability to influence the real fundamental economy via QE is limited (this has become abundantly clear when one actually studies the intended transmission mechanisms of QE), however, they are having a powerful impact on market psychology. This is where many economists lose sight of the forest for the trees. They entirely ignore the human reaction to policy measures. And in an environment where the Fed is maintaining low rates and literally telling people that they will keep “asset prices higher than they otherwise would be” it is simply foolish to believe that they are not inducing some level of speculation in various markets.
The recent bout of inflation in China and the floods in Australia have laid the perfect foundation for a fundamentally driven rally in many commodities. Add in the Fed’s direct message to buy risk assets and you have all the ingredients for rampant speculation. To believe that this speculation is stopping at equities is naive at best. The fundamental story in the emerging markets and hence the commodity markets is far superior to the modest growth story in most US equities. So, it’s only natural so see investors pouring into the commodity markets with the expectations of higher gains on the misconception of the Fed’s “money printing” and a sound fundamental backdrop.
The problem is, investors and speculators are taking the Fed’s words to heart and they are acting on them. This remarkable video from Bloomberg (via Ed Harrison at Credit Writedowns) proves that speculators are in fact hoarding commodities. It’s no secret that the Chinese believe the USA is largely causing their inflation problems via QE. They’ve responded with their own Quantitative Tightening. And while the fundamental story behind the Fed’s actions holds little water there is a dramatic and meaningful psychological impact and we are seeing it in real-time with our own two eyes (yes, that is a pile of cotton that a Chinese speculator is hoarding in his living room).
Quantitative Easing was never necessary to begin with. The Fed panicked over the summer of 2010 due to a few negative data points and now they are attempting to justify a severe policy mistake rather than simply admitting wrong and removing the destructive Bernanke Put. Recent market data proves that QE is nowhere close to achieving the goals it was initially set out to meet. And now there is clear cut evidence that it is having a disastrous impact on the marketplace by causing severe instability in commodity prices. It’s not merely coincidence that signs of this speculation began in August when the Fed initiated its “money printing” program.
(cotton prices have more than doubled in 6 months)
It’s time for the Fed to take responsibility not only for the equity rally, but also the rise in commodity prices. Perhaps more importantly, it is time for the Fed to admit that it is having a highly destructive impact on market psychology and is only helping to fuel a speculative frenzy that is likely to increase price instability and market disequilibrium.
QE has failed to generate any sort of job growth in the USA. There are now signs that it is creating severe price instability in many markets. Therefore this policy measure is counterproductive to both of the Fed’s mandates. It’s time to reconsider Fed policy and whether this approach is appropriate in the current environment. To me, it is clear that it is not.
take responsibility? fat chance.
They can’t stop the program. It would destroy their credibility (the little that they have left). They will let it run through June and we’ll see the massive commodity bubble grow larger. When it pops the emerging market economies will all crash and they will directly blame the USA. Great policy there Ben.
not to mention the political instability they are causing in emerging markets where food costs can represent 50% or more of one’s total pay. hungry masses take to marching and protesting. we end up exporting our pain to the rest of the world. it is most unpleasant.
We’re in a runaway. Throw out your technical indicators, sentiments and historical data, this baby is going to the moon. You know this doesn’t end well….but in the mean time, JUMP ON OR GET THE HELL AWAY FROM IT!
I think China was already beginning to show substantial signs of weakness before this whole mess came about in the first place. Now we have a situation where their issues are being compounded by the fed rather than directly caused by it. This most certainly will not pass without direct blame though. China’s empty growth and infatuation with becoming the largest economy in the world overnight was built on a toothpick base that would have cracked whether or not the Fed decided to create the current headwind. I laughed listening to the chinese media’s questions at the last presidential visit where every other question was regarding China’s power grab. The fact simply remains that Bennie’s decision makes a perfect scapegoat to a poorly planned economy.
What I noticed about this video is that the hoarder is playing a risky game. His entire cotton harvest is stored a few yards away from his kitchen. A small mistake and his yearly income could go up in flames!
How does the Fed begin the exit process? Can they? Trim tabs calculates that the Fed has been the only true buyer of equities over the last year or so. The public has been pulling money out. Insiders have been net sellers of their own stock, etc.
Funds might flow out of mutual funds, but that doesn’t mean money is leaving stocks. All securities issued are always held by someone. So, if the public is net selling then someone is net buying. If households are selling stocks then it means institutions are net buying. The Fed, by law, cannot buy stocks.
TPC..from what I heard (runor or fact I don’t know) the fed is buying futures. Whether it be through x, y and z PB’s I don’t know. But by propping up the futures, the coinsiding etf’s are jumping to catch up to the futures. They are using specific weighted stocks within the tef to drive them to par with the futures..and why we are seeing massive moves in the high flyers like aapl-nflx and some others.
The etf markets has hit 1 trillion dollars this year..the highest ever. I have heard that many hedge funds are leveraging their capital at the highest levels seen since 2007 and using the double/triple etf’s. So they are leveraging on top of leveraging with their capital.
So as real money is leaving the market, but has started to switch and come back just recently..the excess selling over the last year from investors has been soaked up by the 2x/3x etf’s. Now I am not sure if the fed can buy etf’s.if the answer is yes, then they may just be buying them instead of stocks..so they don’t break the law..like that really matters to Ben..lol
They’re not legally allowed to buy futures. Now, the PD’s could do it and I have to admit that I have seen some extraordinarily odd trades during QE. For instance, the other night I was on the other side of 2 different large trades where the institution was clearly trying to jam the price higher. I have no idea why this trader would enter such large trades at the ask in a thin market at 3AM. And I’ve seen this many times. And almost every time it happens in the overnight market you can guarantee the market will rally 8 ES points the next day. I am not a conspiracy theorist, but I see this with my own two eyes.
So, it’s definitely not the Fed, but that doesn’t mean there aren’t institutions jamming the prices up….
Haha, you finally admit it. So the effect is not purely psychological, but direct manipulation up by the PDs. Conspiracy or symbiosis b/w the Fed and PDs – who cares?
This is you “psychological channel”, it is very real. Because the S&P 500 is the leading risk asset in the world, every risk asset is up.
InvestorX
the fed will never exit. there is no exit strategy. that is absurd. the last time they talked about an exit strategy they ended up increasing their balance sheet. it is downright comical now. good post cullen
Right. How can they reverse this now? They’re too invested in it and they’ve published too many papers in recent months explaining how great it is….We’re going to see reversals and whatnot, but how do we not trade at all-time highs in most commodities by the time June rolls around? As long as the Fed is viewed as a money printer this speculative frenzy will continue….
QE will not be removed unless some outside factor forces the Feds hand – this is far from irrational speculation we are seeing; it is merely the markets rationally taking the irrational policy of QE to its most logical extreme. The Fed is knee deep in it now…
Well it might create employment if security guards need to be hired to guard the hoarded piles of commodities!
Of course as soon as the bubble ends, you have a pile of trained security guards with nowhere to go. Rinse and repeat.
The guards will switch to racket, do not worry for them.
Cullen, it seems the Fed has been more about trying to repair asset bubbles rather then prevent them and Greenspan, who i assume mentored Bernake, was the king of this policy, but know that interest rates are pushed almost as low as we can go, whats next? Gold, commodities? I sit on an investment committee for a hospital where the consultant is recommending a 7.5% exposure to commodity futures and how can you argue with all the uncertainty about the future?
Right. And they’re bubbles that they help create via their direct promotion of a financialized USA. Bernanke builds great big piles of tinder, doesn’t see when they catch fire, then puts them out, pats himself on the back and then builds a big pile of tinder again….
Forcing honest mark to market would cause a lot of the money being used to goose markets to promptly be sucked into a black hole.
Problem is that the Fed is now the proud owner of a huge stash of toxic ABS and because it did not acquire that garbage under a repurchase agreement (to the best of my knowledge) it has consequently lost the ability to suck back in the specific cash it pushed into speculation via reserve swaps.
The swaps were highly specific but the reverse swap can only be general (unless they invent a new mechanism) meaning that a whole lot of innocent third parties get hammered while harmful speculation is not entirely eliminated.
The Fed let the genie (cognitive-emotional bias) out of the bottle and now can’t get the genie back in the bottle without breaking the bottle. This is not going to end well, and it will be interesting to see the finger pointing then. I don’t think that the Fed is going to walk away from this unscathed.
I never thought that I would see a worse president than Jimmy Carter, but then along came Obama. And I never thought that I would see a more irresponsible Fed Chairman than Greenspan, and then along came Bernanke. Basically between the two of them we are scr***d.
Bernanke is obviously in over his head. But let’s not let the others off the hook – where is Obama? Geithner? Congress?
I think the one thing that seems fairly certain is that when the correction does finally come, it’s going to be huge. Imagine if the markets creep up like this for another several months, another several PPI & CPI reports, etc. Then, in a speech, or in the minutes of a Fed meeting, it finally comes to light that not only are we going to wind up QE2 but also start unwinding the Fed’s balance sheet as quickly as possible. How does that not result in a very steep ski slope? The air is going to come out of this souffle a lot faster than it went in. I am speculating that the collapse will erase between 50 and 61.8% of climb from 1050 to wherever we end up. The good news is, that will probably be the best entry point this year. The bad news is there’s a lot of risk in just waiting for it. One way or another, I’ll be putting cash to work starting sometime next week. (And billw, for the record, I think Obama is a GREAT President — even if you think this run up in stocks is b.s. [which it is], the recovery in the economy is real. You have to give the guy credit for not screwing that up. All you need to do is look at the 1930s to see how foolish policy mistakes can make an economic downturn a LOT worse.)
Obama has played no role in the rise in equities. That’s Uncle Ben.
uncle Ben’s boss is Obama. If Ben is not doing what the boss wants he could be fired.
And Jamie Dimon and Lord Blank are Obama’s bosses, so if Obama fires their official representative Bennie, then they fire him.
what happens if mr margin comes calling
Where have the deflationist all gone ?
http://www.bloomberg.com/news/2011-02-17/g-20-stung-by-faster-inflation-as-paris-dispute-rages-on-global-imbalances.html
The better question is, when will the hyperinflationists admit they were wrong?
And before anyone decides to take my outlook out of context I’ll remind them that I called for deflation in 2009 (which was right), disinflation in 2010 (which was right) and am now calling for inflation below the historical average.
http://pragcap.com/why-deflation-remains-the-greater-risk
http://pragcap.com/where-is-inflation-headed
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