Wednesday, October 20, 2010


Plosser doubts that the benefits of further easing outweigh the costs.

Plosser also fears that doubling excess reserves doubles the challenge of exit.

Plosser feels that policy steps with no effect would damage credibility.

A Lighter Shade of Beige

The Beige Book is slightly upgrading the economic growth picture.

This could put some downward pressure on stocks, as it brings into question the need for a large QE program.

Smooth Media Talkers

We're hearing a lot of glibness in the media about the merits of stock ownership.

Increasingly, especially on "up" days, talking heads on CNBC and in other media platforms are growing glib with regard to the merits of equity ownership (both absolutely and relative to bonds) -- despite the sharp ramp over the last several months.

The words "obvious" and "of course" are the most common words being used in discussing the stock market's future course.

I can accept the comments of David "the Finini" Tepper ... but not from many others who have never seen a market or economy they didn't like (Read: Bill Miller). Mr. Market has a way of slapping investors in the face just when no one expects it.

I am beginning to expect the slap.

But it might be on my wrists!

Recommended Reading

Run, don't walk, to check out the Roubini Sentiment Index.

It was only a matter of time before a Roubini Sentiment Index was established in an attempt to forecast market movement.

Merry Medley

Medley Global Advisors suggests that the Fed intends a $500 billion Treasuries-buying program over the next six months.

This announcement helped the markets.

Wells Fargo Wagon Carries the Market Forward

The market (and financial stocks) seemed to rally on WFC's statement that loan demand is improving.

The Turn of the Screwflation

We all recognize the intended theoretical benefits of QE 2, but I am uncertain whether the theory will become a reality.

"In my darkest moments, I have begun to wonder if the monetary accommodation we have already engineered might even be working in the wrong places."

-- Dallas Fed President Richard Fisher

This morning, Bill King (The King Report) weighs in with the following remarks regarding Richard Fisher's speech yesterday, which modify my concerns of screwflation and other matters expressed yesterday.

Fisher's inconvenient truths about quantitative easing:

1. For mid- and large-size nonfinancial firms, capital is fairly abundant in America, and it is unclear how much they would benefit from lowering Treasury interest rates.

2. The reality of fiscal and regulatory policy inhibiting the transmission mechanism of monetary policy is most definitely present and is vexing to monetary policy makers. It is indisputably a significant factor holding back the economic recovery.

3. Yet, far too many of the large corporations I survey that are committing to fixed investment report that the most effective way to deploy cheap money raised in the current bond markets or in the form of loans from banks, beyond buying in stock or expanding dividends, is to invest it abroad where taxes are lower and governments are more eager to please.

4. A great many baby boomers or older cohorts ... are earning extremely low nominal and real returns on their savings.... Further reductions in rates earned on savings will hardly endear the Fed to this portion of the population. Moreover, driving down bond yields might force increased pension contributions from corporations and state and local governments.

5. Debasing those savings with even a little more inflation than what is above minimal levels acceptable to the FOMC is also unlikely to endear the Fed to these citizens.... [I]f it were to prove out that the reduction of long-term rates engendered by Fed policy had been used to unwittingly underwrite investment and job creation abroad, then the potential political costs relative to the benefit of further accommodation will have increased.

6. Besides, it would be hard to build a case that the main recipient of further credit extensions, namely the U.S. Treasury, and borrowers whose rates are based on historically low spreads over Treasuries have difficulty accessing the capital markets.

7. [I]t raises the specter of competitive quantitative easing. Such a race would be something of a one-off from competitive devaluation of currencies, a beggar-thy-neighbor phenomenon that always ends in tears. It implies that central banks should carry the load for stymied fiscal authorities -- or worse, give in to them -- rather than stick within their traditional monetary mandates and let legislative authorities deal with the fiscal mess they have created. It infers that lurking out in the future is a slippery slope of quantitative easing reaching beyond just buying government bonds (and in our case, mortgage-backed securities).... Going beyond investment grade paper, however, opens the door to pressure on a central bank to back financial instruments benefiting specific economic sectors. This inevitably leads to irritation or lobbying for similar treatment from economic sectors not blessed by similar monetary largess.
-- The King Report

Here is Fisher's complete speech.

We all recognize the intended theoretical benefits of QE 2:
o Lower real intermediate- and long-term interest rates are expected to stimulate credit-sensitive spending. Authorities expect housing and refinancing activity to expand (through lower mortgage rates), and a rate reduction is forecast to reduce the consumers' debt service expense.

o Higher stock prices are expected to buoy personal consumption spending through the wealth effect and reduce the cost of capital to corporations.

o A lower U.S. dollar narrows our trade deficit.
It should be clear in my writings over the past month, however, that I am less certain than most that the theory behind QE 2 will become the reality of QE 2. As it relates to quantitative wheezing, in November I still see shucks and aww, not shock and awe. (Morgan Stanley's Steve Roach raises similar concerns this week.)

Here are some additional questions that should be asked in determining the ultimate efficacy and effect of QE 2.
1. With regard to the transmission mechanism in respect to higher equity prices:

A. Is there any physical method whereby the Fed forces equity prices up?
B. Is it pure jawboning that does it?
C. Or is it painfully low rates force more people into equities?

At this point, it can't be choice C given where yields already are, can it? If it's choice B, how much powder is left? If it's choice A, how do they do it? Or is there a choice I am missing?

2. For the wealth effect of equities to matter, how much does the equity market need to go up from here to get a real kicker? Then, does the slope of the line matter? Is there a difference in the impact of the wealth effect if we get a step-function 20% increase vs. a smooth 20% increase over next two years, for example?

3. Does the wealth effect of equities matter much (understand housing does as widely held)? Are equities so widely held by enough of the population that they matter, or is their impact on spending much less meaningful than housing?

4. While QE 2 makes bank lending more attractive, given the rep and warranties issue that has come to the fore (and the general regulatory climate toward strengthening capital ratios), is it reasonable to expect banks to leverage up their balance sheets now?

5. Then, importantly, to the extent that quantitative easing helps increase asset prices, by definition and in fact, this also means that it increases the price of commodities and other inputs as well. (It's already happened again.) Shouldn't the benefit of the wealth effect be offset by an expense effect (not to mention the fact that now huge portion of the population can't earn any interest on their savings, which is also a huge cost)? And is it possible that, for the average American, the expense effect hurts more than the wealth effect of equities helps? Why is the expense effect not considered in a lot of the analysis? Could it be the wealth effect may help in total (huge benefit for the wealthy) but when the expense effect is considered, 70%-plus of the population comes out on the short end of this trade? I think the expense effect is much greater than it has been in the past. Whatever quantitative easing (or "easy money") does to increase equity prices now also flows directly into commodity prices (potentially more rapidly than into equity prices). Do the new Fed models account for this increased expense effect? Do they account for screwflation?

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