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In recent weeks, the dollar has been the centerpiece of speculation surrounding the outlook for global economies, rising protectionist threats and the resurgence of global asset prices. And it all derives from Fed policy.
Bernanke’s speech yesterday and the latest statement by the FOMC clearly confirm that the Fed is DEFINITELY prepared to roll out another wave of its “quantitative easing” program — expanding the money supply with the hope of stimulating demand … igniting inflationary pressures … and ultimately creating incentives for employers to hire and invest, and for consumers to borrow and spend.
This perceived guarantee of more QE has served as a market catalyst for another “reflation trade,” similar to that which was widely embraced in 2009. As a result we’ve seen a sharp rise in global stocks, commodities and currencies … and a sharp fall in global interest rates and the U.S. dollar.
The big questions: Is it warranted? And … will it last?
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For that answer let’s take a look back at 2009. When the Fed announced its first QE program last March, that marked a bottom for stock markets, a top in the dollar and gave way to a nine-month rally in risk assets of record proportions.
The widespread sentiment then was that the Fed’s policies had given everyone the green light to jump on-board a tide of asset prices that was on an indisputable path higher — a no-brainer trade. The experts were dead certain on imminent destruction of the dollar and hyperinflation … the biggest economy in the world, turning into Zimbabwe.
The Fed ultimately expanded the assets on its balance sheet from $800 billion to $2.2 trillion.
Meanwhile, when it was all said and done, the net result for the dollar was nil. As quickly as it declined for much of 2009, it recovered nearly all of those losses into the first of 2010.
As far as the economic impact of QE1? Futile.
If we look at the cornerstones of economic activity in the U.S., consumption and investment, it turns out all of that “money printing” did little toward achieving the desired result.
Despite more than $1.7 trillion pumped into the financial system, consumption has NOT recovered. And investment in the U.S. is still down in the neighborhood of 15-20% from its peak levels.
As for unemployment, the other part of the Fed’s mandate, it still hovers a fraction shy of 10% based on narrow and distorted official measures, but as much as double that if you measure unemployment more comprehensively.
So what about inflation? Of course, all of this money printing had to create mass inflation, right?
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Well, without the appetite to spend, borrow or invest, there is no pickup in inflation.
In fact, inflation has actually fallen in the period since the Fed rolled out its first round of quantitative easing. The year-on-year core inflation rate was running 1.9% when the Fed rolled out QE1. Now it’s less than 1%. Even if you dispute the measure, you cannot dispute that the measure has fallen almost in half.
Of course, that’s why, out of desperation, they’re trying it again. Had the first round achieved the desired effect, we would have no discussions about a QE2.
Yes, market participants are still holding onto the hope that, this time, the Fed can reflate and take them along for the ride. But history gives us no reason to believe this time will have a different result in producing the desired effect for the Fed.
For these reasons and others I’ve laid out here in Money and Markets in recent weeks, it’s fair to expect this “reflation trade” to end abruptly, as it did last year, and for the focus to turn back to the real risks to global economies, unsustainable sovereign debt, broken economic models and a long road of deleveraging and rebuilding.
Regards,
Bryan
