U.S. stocks halted a five-day winning streak as concerns over European sovereign debt issues are beginning to flow again – although stocks held up very nice despite the fact that Irish government bonds spread are blowing out; surely Bernanke’s obvious commitment to the stock market is helping to ease these concerns.

Energy, basic materials (Fed plays) and tech were the only three of the 10 major industry groups to close the session higher.  Financials, utilities and industrials were the session’s biggest losers.

The CRB (for new readers, this is an index that tracks a basket of commodities) gained ground for the 11^th session in 12, led by silver, cotton, natural gas, coffee and hogs. Outside of the six months in late 1979/early 1980 silver spent above the current level of $28/oz., the metal continues to make new highs (it’s following gold, which has hit $1420/oz.); cotton has surged to a new high, up 64% since late August; coffee remains about 30% below its 1970s and 1990s spikes, but has jumped 50% over the past few months. 

According to the Fed’s latest survey, banks eased standards and loan terms a bit further over the past three months – this marks the second-straight quarter in which banks have eased standards for commercial and industrial loans, but the report illustrated that demand for loans remains weak.  Standards were slightly tighter though for prime mortgages.

November 9, 1989: the day the Berlin Wall began to crumble – kind of a big day.   

Market Activity for November 8, 2010

Defending the Policy

Fed Chairman Bernanke was out this weekend trying to defend the Fed’s decision to travel further down the road of quantitative easing – his second attempt in four days and he’s looking desperate.  The chairman new the Fed’s symposium at Jekyll Island was just a couple of days away – the perfect time to spend some time talking about the latest QE twist.  Why did he feel compelled to pen the Washington Post OP/Ed on Thursday knowing he had the weekend event coming up?  And his attempt seemed awfully unpersuasive to me, particularly with regard to the unwind of all of this.  Bernanke says he’ll be able to reverse course at the right time, but the Fed has no history of great timing – a function of their recalcitrance; always focusing on lagging indicators instead of incorporating more forward-looking data into their models.

But beyond the effort, if the economy is in a state of depression (for those who believe a few positive GDP prints means such an event is off the table, they should remember that most everyone believed we had climbed out of the Great Depression by 1936 but by late 1937 found it was hardly the case), then Bernanke’s implementation of unprecedented easing is somewhat justified – although manipulating the prices of riskier assets is likely to have an unhappy ending. 

I’m not in the depression camp, but as you all surely know I think economic growth will remain below trend for a couple of years due to many factors, and I can’t rule out another quick dive to recession if Bernanke’s reflation of assets scheme backfires. 

However, if we have moved simply to a slow growth period over the next couple of years then there is no justification for what the Fed is doing as it will cause major problems when QE ends and probably major issues when they have to implement the actual unwind.  This won’t only be a private sector problem, but a massive issue for the public sector.  You’ve got most of government debt financing in the 4-5 year maturity range.  Where is the interest payments/GDP ratio going to climb to when this debt has to be refinanced at 5-6% instead of the current 1.1% in which the Treasury currently enjoys?

And the risks of this policy stretch beyond our shores.  We see German finance ministers calling Fed policy “clueless.”  Asian ministers are close to going apoplectic as they know what a surge of capital flows means (this money the Fed is printing doesn’t all stay in the U.S., it hunts for yield in other countries); it doesn’t only hurt their export markets – for which they depend – as the capital flows push their currency values higher, but it also causes major dislocations on the other side – the Latin American and Asian currency crises that ran 1994-1997 is one example.  In the case of China, they continue to hold their currency value constant relative to the dollar (they did allow it to rise by 23% from 2005-2008 but had to halt that move when the financial crisis hit), and a lower dollar value hurts them even more as the bonds they have to own to keep the currency peg constant fall in a real sense due to the dollar’s decline. 

Good luck at the G-20 U.S. policymakers.  Geithner’s attempt to manage everyone’s current account balances was already a non-starter; Bernanke is making the job of implementing trade pacts even more difficult.  I find it hard to believe that the Fed doesn’t think about these issue, but you’ve got to wonder.

And on top of it all, U.S. firms are beginning to run into the challenge of managing rising input costs (higher commodity prices) in an environment with which businesses have very little, if any in some cases, pricing power.  It seems to me, while rising stock prices give everyone a good sensation, there are plenty of negative byproducts of additional quantitative easing that may very well make the whole thing a huge net negative.  How long before we pay the price for this policy...six months, a year, two years?  I don’t know, but the bill will come due, and it’s going to be significant. 

Slow Data Week

Today we get back to the data with the NFIB’s latest look at small business confidence along with wholesale inventories.  It’s a quiet week though with the bond market closed on Thursday for Veterans Day.  We’ll get initial jobless claims on Wednesday, instead of the normal Thursday event, as a result. 

Sign up to receive the Daily Insight and other Acropolis publications here.

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900