U.S. stocks rallied in fine fashion yesterday after several firms announced takeovers (yes, another Merger Monday) and tensions appear to have eased in Egypt, offsetting a disappointing German factory report. 

Financials, industrials and utilities outperformed yesterday.  Telecoms and health care were the losers.

Treasury yields were pretty stable, up a bit (bond prices sold off slightly), but very tame after last week’s substantial increase in yield.

Acquisition and merger activity has really heated over the past few weeks.  While this is good for stock prices, it’s not a great sign for job growth.  Look, economic growth should have run at a 5% rate over the past four quarters, at a minimum (following the three prior worst recessions in the postwar era GDP averaged over 7% at this stage), instead it’s been 2.8%.  Firms are using their cash to buy sales; they remain reluctant to substantially add to payrolls.  I do think we’ll see payroll growth pick up over the next few months, but the acceleration in buyout activity is likely to put pressure back on the job market when these pending acquisitions occur – mergers generally lead to net layoffs.

The Dollar Index (DXY) failed to extend even its mini rally of the past three sessions.   The euro tried to weaken in early trading following that worse-than-expected decline in German manufacturing activity but rallied late in the session to push the DXY lower.   

Further, eurozone finance ministers failed to make progress this weekend during their summit to make the “zone” more competitive as other ministers rebuffed German-Franco suggestions – obviously Germany and France want to engage in real reforms as they are mostly on the hook for these debt issues.  The rest of the zone wants to continue kicking the can down the road.  Even so, the greenback still couldn’t close higher.  Outside of a large event that fosters return of the safety trade, pressure will remain on the USD until the Fed halts QE. 

Market Activity for February 7, 2011

Sector Activity for February 7, 2011

QE2 “On-the-Run”

Bloomberg News reported on Monday that the Fed began to increase its manipulation on Treasury rates in January as 40% of the central bank’s government bond purchases were auctioned in the past 90 days (also known as “on-the-run” Treasurys – the most recently auctioned) – up from 15% in November.  Buying the newer securities gets them the biggest bang for their buck as primary dealers will buy up the securities at auction, caring little about valuation as they know they’ll be able to quickly unload them to the Fed.  Thus, the Fed assumes all of the interest-rate risk (or actually, taxpayers assume all of the risk because when the Fed’s 83 times leveraged balance sheet goes the way of Lehman Bros. (which was leveraged 33 times capital) the Treasury Department (on the back of the taxpayer) will simply re-liquidate Bernanke & Co. 

With the Fed buying nearly half the curve (and such activity is completely transparent via the FRBNY’s website), I’m not sure what’s happened thus far in February as interest rates are on the rise again.  Obviously, yields would be considerably higher without the Fed’s tactics of manipulation – although we can’t know how much higher because the market is being subverted – but the fact that yields have increased with the Fed so in the game is telling. 

On the other hand, this also means that those expecting yields to rocket higher may be in for a rude awakening as Bernanke is determined to keep rates low, as Cliff suggested on Friday via the Fixed Income Weekly.   Recall, Mr. Bernanke tacitly suggested last week in his comments to the National Press Club that there may just be an extension to QE2 (and don’t call it QE3 as QE2 was always open-ended).  

In addition, the economy continues to face a number of big challenges -- Asian tightening, European sovereign debt, our own debt servicing challenges (both gov’t and households), a supply glut within the housing market, and heightened geopolitical event risk -- that are likely to keep growth subdued and thus a lid on domestic interest rates. 

Regardless, the Fed’s QE2 is beginning to roll and it’ll be interesting to watch this play out – not merely in the very near-term but when the market suffers its Bernank Attack at the point the Fed has to unwind. 

Consumer Credit, and Beyond

Consumer credit rose $6.099 billion in December (whipping the $2.4B increased that was expected) to $2.41 trillion, marking the third-month of gain.  The measure gauges credit card debt, auto and student loans – mortgage loans are not included. 

Non-revolving credit (auto and student loans) rose $3.9 billion to $1.609 trillion, marking the fifth month of increase.  Revolving credit (credit cards) rose $2.3 billion to $800.5 billion, the first increase in 28 months as consumers laid down the plastic for the holidays. 

So commercial and industrial loans have barely budged from the low hit in July, but consumer credit has edged higher.  Now, loan activity is hardly rolling, but this is what we’ve been keeping an eye on.  As banks release these funds, the velocity of money increases and that’s when all of this money the Fed has pumped into the system turns into a big inflation problem. We’re not there yet, outside of food and energy prices, (and I’m not sure credit is really set to explode, there’s likely to be another round of overall economic weakness first in my view) but when it does the Fed will be forced to reverse course, interest rates will rise in a secular manner and all of the assets that have been driven higher by this monetary policy charade take another turn for the worse. 

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900