What’s the Fed’s tolerance for pain?
Dave and I have been traveling this week, with conferences in both Denver and Dallas. Comments today will be abbreviated as a result.
The longstanding denial factor in US stocks finally showed signs of cracking during Friday’s trade. Shares sunk on what turned out to be meager gains in the non-farm payroll report. Only 115,000 jobs were created (while the rate declined to 8.1%) – far short of “expansionary” levels. Prior to the jobs report, stocks were kept aloft with dreams of QE upon the release of every piece of bad economic data both here in the US and abroad (see box scores).
Besides the US ISM services index, which showed some mild improvement, manufacturing and production (factory orders) indexes in both the US and Europe failed to inspire – falling to three-year lows in some cases. Stocks in Europe took the bad news to heart, as the Euro Stoxx 50 index shed over 4% by week’s end – while stock bulls in the US attempted to shrug matters off, pushing the Dow to new interim highs prior to the jobs report. Even after Friday’s walloping, the bulls seem in control with the Dow hovering north of 13,000.
That fact highlights a quandary: Without pain, there is no need for QE, but with no QE stocks cannot continue to advance. If stocks do not advance, neither does the economy. So the question becomes, how much pain is needed before the Fed steps in to support the markets?
Overseas, this tolerance for pain is apparently razor thin. The Aussies cut by 50 basis points (25 expected) on not-so-bad economic news, while Brazil eased for a second time in as many months, reducing its reserve requirements.
Oddly enough, while cutting was in progress “down under,” the Fed was busy reducing its balance sheet by $14.5 billion – tightening instead of easing. Like the speculators, perhaps the Fed was expecting a better jobs report, or it may be keying open market activities to the stock market. Intervention patterns have tended to indicate the latter alternative. Weak stocks have prompted the Fed to print, while strong stocks have produced the opposite effect. Former Fed Chairman Alan Greenspan reiterated this week the importance of stocks acting as collateral for loans in the due course of economic progress. An incestuous bit of logic when examined, but it highlights, we believe, the prevailing attitude.
Clairvoyance into matters pertaining to the Fed often proves elusive – even as the Fed’s behavior defies common sense. But if we had to produce a forecast, it would be that the Fed aims to “backstop” the markets in a measured and “just in time” basis – trying to avoid, at all costs, a debilitating spike in inflation that would result from a giant-sized QE program. The good news for metals investors is that QE is most likely a constant (until the battle cry for austerity emerges), even if it is just a trickle at the moment. For this reason and others discussed here in recent weeks, gold seems not to “sell off” well, and may instead be in search of a reason to advance. Mining shares, though posting expected or slightly better quarterly results among the majors (with a few exceptions), continued to trade off, despite a relatively stable gold price – suggesting that the price action among the shares has been one based on pure sentiment rather than intrinsic value.
VP Investment Management