All “QE’d” Up and Nowhere to Go – Sept 14, 2012

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

All “QE’d” Up and Nowhere to Go …

Giving the crowd what they want is rarely a good thing, but that’s precisely what the Fed did in Thursday’s FOMC policy meeting. $40 billion in newly printed dollar bills will be spent accumulating mortgage-backed securities on a monthly basis. This will be in addition to the $45 billion the Fed is already recycling into longer-dated assets under “Operation Twist.” The kicker in this case came when Bennie refrained to quantify either a time or dollar limit to the plan, leaving those in the MSM and Wall Street to assume that this time it’s “QE to infinity.” Immediately following the Fed release, the market responded in textbook form – stocks spiked higher while bonds and the dollar collapsed, which in turn helped the metals (see box scores).

Judging by the market response, it appears that “QE to infinity” necessarily also denotes “stocks to infinity.” Were it not for the real threat of inflation, we would most likely lean in that direction. But this is not the 1990s anymore, and this Fed, unlike the previous one, has a $100 crude oil price to reckon with, not a $20 price. Theoretically, whether it’s now or later, one dollar printed will lead to one dollar’s worth of inflation – or, at best, economic stagnation.

US Retail sales figures released today suggested just that. If not for the nominal hike in gas prices and some favorable revisions, August sales would have shown absolutely no growth whatsoever. The August CPI revealed some similarities, where a fairly sharp increase of 0.6% (MoM) was reduced to 0.1% ex food and energy. Petrol prices were up 9.0% in August by the way. As we have noted here before, real wages for consumers have not made any progress since QE began in March of 2009 – this is a first in the last several decades.

It’s also perplexing that the Fed would opt for perpetual QE when at no time in the recent past has stimulus been beneficial to the bond market – thus counteracting the intended purpose of lowering borrowing costs for consumers. Rates on the 10-year Treasury rose nearly 14 basis points following the Fed’s announcement, and have now risen 47 basis points from their lows set in July. Consequently, consumers may not be able to refinance in coming months, even as the cost of living accelerates higher.

As to what motives lay behind the Fed’s policy change, one can only guess, but Ben couldn’t realistically believe that economic progress was one of them. If that were true, then he has learned nothing from previous bubbles and even less regarding inflation. Instead, we consider it more likely that this QE plan was concocted for the sole benefit of debtors (banks and homeowners alike) at the expense of savers once again.

That said, it’s still unclear how far the rally in stocks will go before realizing there’s not much economic rationale for what are now lofty valuations. Corporate preannouncements have been negative thus far from the likes of Intel, Lexmark, Walgreens, and Fed-ex, where downward revisions in revenues and earnings and surprise layoffs have been commonplace – a trend we expect to continue. The irony in this instance is that the worse things get, the more the Fed prints; and the more the Fed prints, the worse things get.

Best regards,

David Burgess
VP Investment Management