Sunday, 30 September 2012

Duo of Weak Asia Data

Heading into the work week, some economic indicators were just released for Asia...none of which were all that encouraging.

  • Japan Tankan Business Sentiment
    • As expected with the strong yen and weakening China growth, the BoJ's quarterly Tankan survey had a -3 result, vs -1 in June.  This indicates pessimism from large manufacturers for the short term, 
  • China Manufacturing Activity Index 
    • PMI index came in at 49.8 for September, which is higher than the 49.2 August reading but still indicates a contracting manufacturing industry.  Overall, not a surprise as China is known to be softening.  So the 49.8 reading is relatively neutral as it doesn't look to be dropping further.  

As of this writing, Japan Nikkei 225 Index is down 0.83% on this result.  And the US stock futures?  Not so great so far but not enough of a change to really say much of what'll happen in the morning.  My expectation is still some weakness this week (as always, this is in the absence of market altering news).



Index FutureFuture DateLastNet ChangeOpenHighLowTime
DJIA INDEXDec1213,322.00-33.0013,358.0013,365.0013,317.0022:59:44
S&P 500Dec121,428.80-5.401,431.001,434.401,428.1022:57:10
NASDAQ 100Dec122,781.50-10.502,785.252,790.502,780.7523:08:24

Friday, 28 September 2012

Random Amusing Video

For a little bit more lightheartedness on a friday.  From Bloomberg: What college majors are most promiscuous.  Relevency here?  Apparently economist are the highest...  I didn't see engineering on there, it must've been at 0. 

Thursday, 27 September 2012

Marketwatch Columnist Contest

One of the more trafficked financial websites that I use for news is, they provide pretty good up to date news and alerts of market events and changes.  Their commentary and trading ideas in my opinion are ok but sometimes questionable.  They suffer from what I would call CNBC syndrome in which they tend to focus on quantity and sometimes borderline sensationalism as opposed to truly calm and collected data and idea focused discussions.

They are currently having a contest for a new columnist so I thought it would be fun to try anyway.  If you've found any of the articles here useful or helpful, I encourage you to visit my article and vote for it!

My article can be found here.

Quick Technical Charts - Utilities Sector ETF (XLU)

Meant to post this yesterday but here's a chart update on the Utilities Sector ETF.

XLU is an ETF representing the utility equities and so is typically a defensive play and/or a dividend play.  As you can see below, XLU hit a peak at $39 back at beginning of August after an extremely strong run from the lows of $33.5 back in April.  As a defensive play, XLU normally is relatively stable so the run to $38 is a bit fast so it was overdue for a drop.  It fell to a low of $35.8 a week ago and looks to have formed a short term bottom.  Various indicators look like XLU is positioning itself for a rebound (doubly so if the equities market drop back down as it has been for the last few days).

XLU is yielding almost 4% so as a safe play, its a decent one.  At worse, you end up with 4% much are your treasuries again?  There is a significant risk in that this drop never took it back down to its recent lows so it was never retested and confirmed as a support point.

Disclaimer: Took a small short term position in XLU as way to hedge a market drop.

Wednesday, 26 September 2012

Global Fuel Economy Readiness

Especially for those of us in the US, the ever creeping up gas costs (though still very low by international standards) stares us in the face every day as we drive past the gas stations.

However, fundamentally, crude oil is a finite commodity and we will run out of easy oil eventually.  For places like the US, its a big potential problem as the entire country is designed around easy and cheap gas since outside of a couple of cities, you need to drive to get anywhere.

So important policy decisions need to be made to address this eventual issue.  For fuel economy, how ready is the world for it?

At The Economist, they put together a readiness index status.  As you can see below, Europe is relatively prepared, US barely, while the poorer countries and developing countries are in for a pain someday in the future if they don't get started soon.

How Successful is Dow Theory?

If you're following the market, you've probably seen this everywhere - Dow Theory is currently predicting a market drop.

From the WSJ, a good summary of this idea and how successful its been:

Some investors subscribe to "Dow Theory," which posits that share prices of airlines, railroads and trucking companies offer a glimpse of future movement in stocks across a range of industries. According to the theory, which dates back to the early 20th century, demand for goods should be reflected in the amount of cargo carried by oceangoing vessels and deliveries made to consumers' doorstops, as well as manufacturers' level of output.

A symbiotic relationship between the industrials and transports often underscores a healthy economic environment, according to this view. For some strategists and investors, that is casting a shadow on the market's recent rally. While the Dow has approached five-year highs, the 20-company Dow Jones Transportation Average has tumbled: Last week's 5.9% drop was the biggest weekly decline since November 2011. The index is down 1.2% year to date.

While transportation stocks have a mixed record as a leading indicator, some traders, investors and analysts are putting more faith in the index now. For one, the manufacturing sector has played a major role in the recent economic recovery. Also, much of the recent gain in stocks has been attributed to news about stimulus measures from the Federal Reserve and other central banks.

To be sure, investors wagering on Dow Theory have been proved wrong at pivotal moments. For example, transportation and industrial stocks were simultaneously hitting multiyear lows in March 2009, which typically would signal more trouble ahead. But the stock market bottomed that month and recovered sharply, leaving followers of Dow Theory in the dust.

A recent sell signal came this past May, according to Mary Ann Bartels, a technical analyst at Bank of America Merrill Lynch, when the Dow industrials were hitting new highs but the Dow transports failed to follow suit.
That call worked in the short-term, as the Dow industrials slumped nearly 10% from early May through early June. But the selloff proved to be short-lived: Stocks quickly recovered, and earlier this month the Dow industrials hit their highest level since December 2007.
Chart watchers and technical analysts have differing viewpoints on when Dow Theory buy- and sell-signals actually are triggered, making it difficult to analyze which indicators work and which ones don't. According to market-research firm Birinyi Associates, the theory isn't the best predictor of how stocks perform, at least over the short term. Since 1990, when Dow Theory "buy" signals cropped up, the market rose an average of 0.04% one month later. By comparison, the market was also up, by an average of 2.07%, one month after "sell" signals, according to Birinyi Associates.

Marketwatch also had this article about Dow Theory though not nearly as supported by any shown data.

Tuesday, 25 September 2012

QE3 Announcement & After Effects on Asian Stock Indices

QE3 has been announced and the world saw a big pop in the stock market on that date.  The followup action however has been quite a bit less convincing in the US where the S&P is almost at the same level as before the announcement (but after the hints).  See below for the S&P 500.

As mentioned earlier, the US market is not so hot after.  How did India Sensex (ETF suggestion: EPI) fare?  Relatively well actually with a big pop (note that Asia was delayed a day vs US time) that day.  It was tettered back and forth a bit but still holding a good 3.8% above where it was before the announcement.  Note that India has been on a relatively good upward trend beforehand so QE3 looked to reinforce the move.

The Shanghai market (ETF Suggestion: FXI) didn't fare nearly so well, but that's to be expected as China has been making new low for a while now.  While QE3 gave it a nice pop, it is now down 1.3% after being up 4% at one point.  Again, similar to India Sensex, QE3 has reinforced the downward trend that was taking root beforehand.

Looking at Tokyo Nikkei (ETF Suggestion: EWJ), a similar story where it was up 3.3% vs the pre-announcement but is now only up 1%.  Still better than nothing.  There does look to be a resistance line and support line for the Nikkei at this point however and a narrowing trading channel.  If the trading channel is correct, Nikkei still has a bit to go before it hits support, though it is at the 200 day moving average. 

Lastly, lets look at Philippines (ETF Suggestion: EPHE).  Ok I know what you're asking - India, China, Japan?  Definitely the big names of Asia, but Philippines?  Well if you've been reading the blog, you'll notice my previous post  making the case that Philippines has the potential to be one of the biggest emerging market opportunities in the next few decades as the current BRICs slow down.  So is that call justified?  Lets look at QE3 impact.

After QE3 announcement, the Philippines PSE Composite Index  jumped and has since subsequently moved down to 1.5% gain, respectable but in the middle of the pack with Japan.

So overall, India has been the biggest winner at 3.8% gain, followed by Philippines at 1.5%, Japan at 1%, and China rounding the bottom at -1.3%.  If you read my previous post about the historical effects of QE on emerging markets, you'll see that while emerging markets have done well in QE, they did underperform the US markets.  So while India looks ok so far, be wary of playing emerging too much.

VIX Indicator Update - Market Top Possibility

Pretty rough day in the market today, finally breaking 1% down after over 60 days.  While this is a sudden drop vs the last few weeks, its not necessarily surprising as the market has been demonstrating significant weakness ever since the QE3 announcement.

As you can see below, the market peak so far was the day after QE3 and the market has been trading sideways to down ever since.  Even the MACD indicator are showing a market reversal.

In my previous post, I showed the VIX had a good correlation to market tops and the VIX was at close to its historical lows:

Looking at the recent VIX results:

The VIX hit a low of ~14 around mid August and the S&P was starting to demonstrate weakness at this same period.  However, QE3 intervened and pushed the VIX back down.  In the last week, VIX hit its low again and is now trying to bounce back up.  Today's weakness is evidence of that trend.

Is today's drop an indication the market is trying to reassert its downward trend that was interrupted by QE3?  Hard to tell but the VIX doesn't have much more room to go down and the market is at a very strong high.

If you don't want to reduce your exposure, considering some hedges at least would be a good idea.

How US State Economies Compare to Countries

A very interesting chart from The Economist showing what is the closest country approximation for each US State.

For example, California is equal to Italy while Texas is comparable to Russia.  It would also show Greece is only about the economy of Washington State.  Gives good perspective why Europe is much more scared of Spain and Italy failing than they are of Greece, which is more important - Washington (sorry guys!) or California?

Monday, 24 September 2012

Facebook....falls flat on its face.

Sorry but that was too easy.  Facebook today dropped 9%.

As you can see below, FB was finally starting to pull out of its downward trend at the beginning of Sept, increasing a respectable 28% before retracing its steps today.

With today's drop, it falls below its 50 DMA.  However, since its a big gap down, expect it to not be as meaningful as a longer term drop.  As well, there's considerable price support in the $18-19 range so it should take a while for it to drop below its recent lows.

What was the catalyst for today's drop?  Take a look at Barron's front cover page:

That says it all.

MACD - How it Works

Good article at Money Show on how one of the most popular technical indicators - MACD work.

What is the MACD? It is essentially a complex, triple moving average system. First, the MACD is calculated by taking the difference or spread between a 26- and 12-period exponential moving average; then, the signal line, which is a nine-period exponential moving average of this difference, is calculated. In past issues we have discussed using weighted moving averages. Exponential moving averages are just one type of weighted average where the most recent data is given more weight using an exponential formula.
The most basic interpretation is that when the MACD is above the signal line, it is giving a positive signal; conversely, when it is below the signal line, it is negative. Traditionally, these were plotted as two lines, but I found that by plotting the difference as a histogram, which I called the MACD-His, positive and negative divergences were revealed. In summary, whenever the MACD crosses the signal line, the MACD-His crosses the zero line. Sharp increases in the MACD-His reflect a dramatic rise in upward momentum while sharp declines reflect that selling pressure has increased.

Sunday, 23 September 2012

China Continues Its Slide - Current and Past Valuation Check

As an update to last month's post on the status of the BRIC countrie's YTD performance, we'll take another look at where China is.

As I have mentioned several times, the Shanghai stock market has shown very different behavior compared to the rest of the world.  Whereas most indexes have recovered significantly (assuming they're not in a huge recession ala Greece) since the 2009 bottom, China never really recovered from it.  That's especially strange as they continued to grow through it and are still showing GDP growth per year of 5-6%, something the US would kill for.

So why is it dropping?  This is an excellent case to remember this face: the Stock Market is NOT the economy.  It is related to it and in theory should show a lot of similarities to it.  One common thinking is that the US stock market predicts the economy 6 months down the line, etc.  But China...well look at the YTD chart below and the 3 yr chart too.

Now compare that stock market chart to China's GDP growth rate chart...

China GDP Annual Growth Rate
That's quite a disconnect isn't it?  For a country to be growing 7-11% and yet for its stock market to be dropping around 40% or more during the last 3 yrs.  As Bloomberg points out, the Shanghai index is now back at levels seen during the financial crisis bottom.

So either something is massively off with its previous valuations, there's something massively wrong about China companies/economy, or China is the best undervalued deal in the world.

Lets check its historical valuations:

Well...Shanghai index definitely looks historically overvalued for arguably most of the entire time period (assuming fair value PE is ~15 but China should be higher as a growing economy), especially in 2007 with a nosebleed 50 PE.  So lets look at where it is today:

According to Bloomberg's chart, China is at a current PE of 10.9, a valuation that's never been seen in the last 10 years.  In contrast, the US market have a PE ratio of 15 for the Dow 30 and 16.91 for the S&P 500.  Note again, the US is expecting almost zilch GDP growth vs China's 5-7% growth.

So the only explanations possible:
  • Shanghai index was massively overvalued pre-financial crisis and it had to drop from there to become more reasonable.
  • Assuming there's no massive fraud with China's economic numbers, and/or its corporate earnings numbers (a big assumption to be honest), it is massively undervalued at its current price.
  • The China slowdown scare is a big catalyst for the drop but doesn't explain the entire drop (as it never actually recovered from the 2008-09 crash).  Even the huge stimulus only gave it a 60% bump before crashing again.      
While from a purely fundamental basis, China stocks look attractive, there's a whole lot of uncertainty with how its economy will land and also the strong multi-year momentum downward.  

So even though valuation looks interesting, if you really want to jump in, make sure you get your vomit bag ready as its gonna be a bumpy ride.

Thursday, 20 September 2012

China Dependency Index

Interesting interactive graphic from The Economist showing the rough amount of exposure various companies have to China.

Surprisingly, it indicates Intel has the highest exposure followed by Apple and IBM.

Wednesday, 19 September 2012

US Treasury Yield Curve Pre & Post QE3

Lets take a quick look at Treasury Yields.  Since QE3 is primarily intended to purchase bonds to reduce interest rates, lets take a quick look at the treasury curve the week before, during, and after QE3.

As you can see...there really wasn't much of a change (at least vs Sept 4). While yield has increased (and interest rate decreased), it was only from 1.12% on Sept 13 to 1.18% on Sept 19.  Relatively insignificant as interest rates are already close to the lower bound...


Tuesday, 18 September 2012

Japan Increase Stimulus to ¥80 trillion

Big news...Japan is providing more monetary stimulus due to their slowing economy.  Global QE, here we go?  In any case, Japan seriously needs this as they have so many headwinds that to some degree, this is probably not enough in any case.

Where is the money going to go?
The ¥10 trillion increase in the asset-purchase program will be split equally towards additional purchases of treasury discount bills and Japanese government bonds, the Bank of Japan said.
So how's the currency market reacting? - The chart below says it all (UPDATE: See updated chart).  However, I'm still somewhat skeptical that this would do much long term as the fundamental structural issues in Japan still remains unresolved...

Lets also take a look at US stock futures...

Index FutureFuture DateLastNet ChangeOpenHighLowTime
DJIA INDEXDec1213,551.00+52.0013,508.0013,556.0013,501.0000:56:49
S&P 500Dec121,458.60+5.701,453.801,458.801,453.4000:57:16
NASDAQ 100Dec122,861.25+11.252,853.502,862.002,851.7500:48:16

Nice...potential for a nice up day tomorrow.

UPDATE: While there was a quick yen boost, the updated chart below shows exactly what I mean.  Another classic case now of Japan trying to influence the market but too little too late.  As of Thurs, the yen exchange rate is back down below where it was before the announcement.  Disappointing for the Bank of Japan.

Most Overbought Stocks?

Lot of stocks are admitted above the 50 day moving average.  This is one indicator of potential overbought stocks.

From the chart below, you can see we are currently close (85%) to the highest values in the % of stocks that are over their 50 DMA.  Its rare for stocks to move above 90% though a simplistic analysis of the below would say it haven't yet formed the top yet.

In any case, from, is a list of the most overbought stocks based on this similar measure:

Monday, 17 September 2012

World Stock Markets - Performance YTD

Quick update from with a good chart showing the Quarter to Date and Year to Date performance of various country stock markets.

You'll see some odd names on there for high YTD performance.  I mean...Estonia?  Not followed that much I suppose.  Greece is also up surprisingly as well as Spain/Italy/Germany (thanks ECB!).

India has also done surprisingly though China is still in the doldrums...

Stay Tuned

...unfortunately been busy lately so haven't had a chance to post but stay tuned for the next couple of days as I'll have a good follow up on historical QE performance vs various asset classes.

Sunday, 16 September 2012

Monday Futures

After several days of euphoria over QE3, where does Monday lead off?  If futures hold, seems as if the euphoria is subsiding a little bit and a small amount of profit taking may be in store.  With the futures currently mildly down, it doesn't look as if it'll be a big move to start us off the week.

However, you never know what can happen overnight...


Index FutureFuture DateLastNet ChangeOpenHighLowTime
DJIA INDEXDec1213,481.00-37.0013,490.0013,492.0013,481.0022:22:17
S&P 500Dec121,454.50-4.501,458.601,458.801,454.2023:02:20
NASDAQ 100Dec122,842.25-8.002,847.002,847.002,842.2522:59:24

Friday, 14 September 2012

Recommended Books - The Intelligent Investor by Ben Graham

Heading into the weekend with the nice fall weather starting to roll in, its a good idea to sit down and start reading some books.  I forget who it was from but there's a quote: "I never met a wise person who didn't read."

One my reading list right now is The Intelligent Investor by Ben Graham.  See below for both the physical book and for the kindle ebook link from Amazon.

For those who don't know, Ben Graham is generally considered the father of value/fundamentals based investing.  He was the teacher of Warren Buffett and taught him the underlying ideas of value investing which Buffett used to create his Berkshire empire.  As Warren Buffett said of The Intelligent Investor: "the best book about investing ever written."  While I also look at technical trading, fundamentals of a company is something you have to understand and use to really get the best return for the risk.

If you're going to read one book about real investing investing (as opposed to speculation/trading), you should read this one.

Quick Technical Chart Summary - Caterpillar (CAT)

Meant to have this posted yesterday but didn't get the chance.  A quick chart summary of Caterpillar shows a very favorable short term bounce potential.  While CAT hit a high of $115 back in Feb, it entered a steep and steady decline due to slowing China and global growth.

With CAT being exposed heavily to construction (i.e. US Real Estate) and emerging market infrastructure spending, the drop was no surprise (though a 30% drop was a bit much).  However, with QE3 and the recently announced China infrastructure investment program, CAT saw a nice bounce.  The technicals also show a wedge formation which typical indicate a strong move incoming.  In this case, the stock has begun to move up and break out of its trading channel.

If the trend is confirmed, look for a pretty significant upside to at least in the $96-$100 range for a nice 7-9% pop.

Disclosure:  Added a small CAT long position yesterday based on this data.

After Thoughts & Questions on QE3

Great post from FT Alphaville on thoughts & questions of QE3.  (Reposted below)

1) We went into the presser wondering what “substantially” means; we left it wondering what “ongoing, sustained” means.
Bernanke gave a good answer for why he didn’t want to tie the end of the open-ended purchases to the unemployment rate: it can rise or fall for various reasons that don’t always reflect changes in employment (changes in the participation rate).
But his answer for what a labour market that is improving “substantially” means called to mind the old line about pornography; he’ll know it when he says it:
“We’re looking for ongoing, sustained improvement in the labor market… What we’ve seen in the last six months isn’t it.”
Bernanke added that although the FOMC had discussed “policy reaction functions”, the members hadn’t agreed on the right criteria.
The natural question is whether this lack of explicit targets undermines the message somewhat, as David Beckworth notes. The Fed is depending on the signaling strength of the other language in the statement (and reinforced in the presser) to be enough.
2) What else might be next for FOMC communications tools?
But we’re not ruling out the possibility of more explicit targets to be announced later. Bernanke brought up more changes in its communications after our colleague Robin Harding asked him what else the Fed could do as a follow-up if today’s announcements didn’t work. Here’s what he said:
We continue to work on how best to communicate with the public and how best to assure the public that the Fed will remain accomodative long enough to ensure recovery… Clarifying our response to economic conditions might be one way in which we could further provide accommodation.
Of course, Bernanke also might have been softening the ground for explicit targets: Evans Rule, NGDP targeting, etc…
Less importantly, we also wonder if he was referring to the ongoing project to arrive at a consensus forecast rather than continuing to produce frustratingly anonymous bubble charts and graphs. We’ll probably find out more about this in the minutes to this meeting.

3) Some have noted that the size of the new purchases, $40bn a month, is much smaller than both QE1 and QE2. So what?
For one thing, as bad as things are now, the circumstances leading up to those previous rounds were a lot worse (severe financial market strains before QE1 and a real threat of deflation before QE2).
But more to the point, we think the initial small size of the programme is feature rather than bug. Well, maybe.
We won’t repeat all of our thoughts from an earlier post. But the Fed’s previous easing programmes, though successful in their main objectives, were also flawed in that they both removed safe asset collateral from the financial system and failed to disabuse markets and economic agents of the belief that 2 per cent was an inflation ceiling. On Thursday, Bernanke tried the opposite script — smaller purchases to start and clear signs that 2 per cent is not a ceiling.
Will it work? We’ll see, but the hope is that the messaging itself is strong enough that the Fed will generate more economic activity per dollar of balance sheet expansion (precisely because the program is open-ended) than with lump sum purchases. In monetary policy parlance, the portfolio balance channel works better when accompanied by use of the expectations channel.
4) What will happen at the end of the year?
Operation Twist is scheduled to run only through the end of 2012, and the FOMC left itself the flexibility in the statement to make additional asset purchases later on as part of QE3. It’s quite possible that the Fed will continue to purchase longer-term Treasuries, but probably without the short-end Treasury sales that to this point have been neutralising the impact on the monetary base, as its supply of these Treasuries to sell will be close to exhausted.
The Fed has previously argued that the stock of holdings matters more than the flow of purchases, but…
… [the Fed] also recognizes that the stock of securities purchased, in 10-year note equivalent terms, will begin to decay on January 1 in the absence of additional Treasury purchases. …
We projected the Fed’s longer-term Treasury purchases through the end of Twist, then modeled the decay in duration that would occur on a monthly basis beginning in January if no additional Treasury purchases were to be announced. We find that the Fed would need to purchase approximately $12 billion per month in 10-year notes simply to prevent the stock effect of its previous purchases from leaking back into the market.
Comments and estimates from Credit Suisse strategists.
Anyways, the answer to the question of what happens at the end of this year also depends heavily on whether politicians have reached an agreement on the fiscal cliff during the lame duck session, more on which below.
5) There were no questions about market dysfunction in the presser, and Bernanke seems satisfied that this won’t be a problem. We’re still worried.
Our own questions — mainly about removing collateral from short-term lending markets and about liquidity in Treasury and MBS markets — remain. Here we’ll quote at some length from a couple of analyst notes in response to today’s meeting, each of which does a good job of explaining how this might get complicated later on.
RBC first:
While the $40bn of agency MBS purchases is smaller than the consensus expectations, it’s still large enough to create some unusual technicals in the MBS market.
Net MBS production this year has averaged $4bn per month. So the Fed purchases will take net supply deep into negative territory. The scarcity of new supply could create unusual delivery issues for the To-Be-Announced market, particularly if rates move abruptly.
At one point during QE1, the Fed had been buying the new current coupon (4s). Dealers assumed that they would be able to fill TBA sales with new production. However, rates rose abruptly and new production shifted to the 4.5s. At this point, the Fed owned more than 100 percent of the float of 4s. At the time, the price dislocations were modest because the cost of failing to deliver was small. But today there is a 200bp fails fee, meaning sellers will need to factor into the price their ability to source the cheapest to deliver pool and the price difference between the cheapest to deliver and the second cheapest to deliver pools. Again, these delivery issues will be most acute if surprise movements in mortgage rates shifts production to a different coupon.
And Credit Suisse, which notes how Treasury market liquidity might also be impaired if additional purchases are announced in December:
Another aspect of the announcement was the Fed’s decision to let its extended maturity extension program (“Twist”) run separately from, and in parallel to, its new unsterilized MBS purchase program for the next few months. There are a number of reasons we believed the Fed would choose this path.
First, the current pace of purchases in the Treasury market is already substantial in the “Twist” program. Monthly purchases consume more than 48% of new Treasury issuance in the 7-year sector, 64% of issuance in the 10-year sector, and 93% of monthly bond issuance. If one considers the Fed’s self-imposed per-issue holdings limit, the purchasable supply being introduced to the market each month is only 70% of the actual auction sizes. As a result, monthly purchase volume comprises an even more imposing proportion of new purchasable supply, with Fed purchases consuming 70% of purchasable issuance in the 7-year sector, 91% of 10-year supply, and 148% of bond supply.
Of course, the Fed is not limited to purchasing new issuance, with the majority of purchase volume consisting of far-off-the-run issues. Indeed, on its face, remaining purchase capacity for the Fed still appears relatively robust. However, much of this seasoned supply is stashed away by investors that aren’t necessarily interested in selling to the Fed, at least not at prices close to the market.
As a result, the brisk pace of purchases relative to new supply has the potential to impair liquidity over time. The steadily declining participation in Fed purchase operations, in our view, is evidence that the Fed is chewing through the inventory of bonds investors are willing to sell. If purchases were to be increased in order to facilitate QE3, the potential for purchases to impair liquidity would only grow.
These issues matter because they go right to the idea of these purchases being open-ended. If difficult market dynamics assert themselves, then the Fed will have to reconsider what else it can do; and it would also risk some damage to its credibility.
In the most recent minutes, and then during Jackson Hole, Bernanke suggested that further asset purchases were unlikely to lead to market disruption problems. The NY Fed also tries to head off some possible concerns in this Q&A. Today’s announcement essentially confirms that Bernanke isn’t yet worried about this.
But that could change. Consider a scenario where a fiscal cliff deal isn’t reached by the start of the year, and to credibly signal that the Fed will do all it can to make up for the aggregate demand shortfall, the FOMC is compelled to announce more asset purchases than it had expected. This remains, of course, a low-probability scenario for now.
Oh, and do check out this stat from SoberLook.
6) Lowering or eliminating IOER won’t happen anytime soon.
This was one idea that Bernanke didn’t mention in response to Robin’s question (and others). We might also find out more about these discussions in the minutes, but at this point we’d be willing to bet that IOER won’t be lowered until NGDP has begun to accelerate meaningfully, when the Fed can safely do this without disrupting money markets.
7) On credibility and NGDP targeting, just what did Bernanke mean?
He made some fascinating remarks in the presser when asked about Michael Woodford and NGDP targeting:
The thrust of [Woodford's] research is that forward guidance is in fact… the most powerful tool that central banks have when interest rates are close to zero. He advocates policies like nominal GDP targeting that would essentially require credibility lasting many years, the implication being that the Fed would target the level of nominal GDP and promise to do that years into the future even inflation rose as a result of that policy.
His own perspective is that credibility is the key tool that central banks have to get traction at the zero lower bound.
Whether we have the credibility to persuade markets that we’ll follow through is an empirical question. The evidence… is that when we’ve announced extended guidance, financial markets have responded to that, private sector forecasters have changed their estimates of what unemployment and inflation will be when the Fed begins do accomodation. So the empirical evidence is that our announcements do have credibility.
There’s a good reason for that. We’ve talked a lot, both publicly and privately, about the rationale for keeping rates low even as the economy strengthens, and the basic ideas are broadly espoused within the committee. So there is a consensus that even as personnel changes and so on going forward that this the appropriate approach and that by following through we will have created a reserve of credibility that we can use in any subsequent episodes that occur.
We’re not exactly sure what Bernanke was getting at here, but we can think of a few possibilities:
– He is saying that the Fed has the credibility to do what it is doing now, but not yet adopt explicit targets.
– Relatedly, he is saying that a buildup of credibility that will result from following through on today’s announcement could allow the Fed to make the bigger leap to NGDP targeting later.
– He is suggesting that what he is doing now is pretty close to NGDP level targeting anyways.
– None of the above.
Also notable were his thoughts on personnel changes. He could be talking about worries that a less-doveish FOMC voting membership (and certainly this year’s is very dove-ish) would be more likely to tighten, which might cast doubt on today’s commitments to keep rates low for years into the future.
But he also might talking about the fact that his own chairmanship ends in January 2014, and he is unlikely to be reappointed. This might lead some to question the Fed’s commitment given that the language guidance now goes to mid-2015. By saying that his views are widely shared by the committee, he minimises the impact of such doubts.
8) It’s impressive how much Bernanke was able to sway the committee from previous meetings.
Related to the point above, this too could mitigate somewhat the concern that he’ll probably be gone come January 2014.
It’s amusing to see those two single members on the extreme flanks. Best guess: Lacker is one, Evans the other.
9) Continue keeping an eye on how mortgage rates track MBS yields.
That this spread has widened because of impairment in mortgage markets is commonly known. Don’t forget about it. But as we noted here, one reason banks might have been hesitant to ramp up origination capacity was that they didn’t believe the low-rate environment would last. The commitment today to lower rates for longer could change some of their minds.