U.S. stocks rallied hard on Friday as traders were juiced by comments from FOMC Governor Daniel Tarullo – he gave a speech Thursday night suggesting the Fed will buy more mortgage-backed securities.  The move sent the broad market, as measured by the S&P 500, to the highest level since the slide began in early August.  At its worst recent levels the S&P 500 was off by 20% from the April 29 three-year high.  Currently, the market is little more than 9% below that multi-year peak.

Consumer discretionary, basic materials and financials led the rally.  Telecoms, tech and consumer staples lagged, but all 10 of the major industry groups did close in positive territory. 

In that speech from Fed Governor Tarullo on Thursday he pointed to a very troubled housing market as he assesses this is the reason the money multiplier is dead.  Essentially what he means by that is the normal mechanism by which the Fed lowers rates, pumps money into the system and the velocity of money increases.  Today that is not the case as money isn’t changing hands as frequently as would otherwise occur in a normal environment.  Tarullo thinks it is housing; specifically it’s just too much debt as lower interest rates do not have the capacity to spark things right now. 

The thing I found most interesting about Tarullo’s comments was that he made a point of mentioning that such action (more bond buying) may have just a temporary and marginal effect on economic activity.  That is, they are willing to become even more aggressive, manipulating the market to a greater extent even as they suspect that the action cannot get us out of this mess.  I wonder if the geniuses within the FOMC ever think about the longer-term distortions they create by taking such action – namely by conditioning the market to ultra-low rates and pushing investors into risky assets merely because they erase the return (from a rate perspective) on safer assets.  I don’t pose this as a question because I know they don’t.  They are always willing to experiment, hardly worrying about adverse consequences, because they never accept blame for the troubles they wrought. 

More on what’s going on this morning below the click…

Market Activity for October 21, 2011

Sector Activity for October 21, 2011

In this morning’s news, I believe we’re going to get an announcement on new refinancing rules sometime today.  One suspects the government will clear the way for those underwater on their conventional mortgages to refi without an appraisal – which is already in place but a couple of things stand in the way.  First, the loan must have been owned by Fannie or Freddie prior to June 2009 – thus, from what I understand (hasn’t been much by the way of specifics), no matter when Fannie or Freddie bought the loan, the borrower will be able to refi.  Second, the servicer will not be hit with any penalties if the loan ends up going back – currently the process of refinancing has been thwarted because the servicer is on the hook for penalties if the loan goes late. 

And from the greatest show on earth, EU ministers are meeting in Brussels again, to come up with a new, new, new plan – the third proposal since March that’s going to fix all of Europe’s ills.  I think it’s safe to assume that this one too will prove to be a day late and a euro short; we’ll find out on Wednesday as they are expected to unveil the latest “solution.” 

They’re in a lose-lose situation here.  If they were to do nothing the European banking system would have imploded and bank runs ensued; however, on the other hand by delaying and providing backstop upon backstop the bad assets are never removed and the eurozone economy cannot grow.  One can say the same is true in the U.S.  Time is ultimately the only elixir to a debt problem.  Time and another hard landing.  Smart policy can ease the hard landing part, but instead our policymakers continue to pretend they can solve a debt problem with more debt.  That means more of the economic same, I’ve sorry to say. 

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Have a great day!

Brent Vondera, Senior Analyst