Our market rallied explosively yesterday afternoon, ostensibly on rumours that there’d be a QE3 announced last night.
There wasn’t. But Wall Street has rallied just as hard at the close this morning after QE3 failed to materialise. In fact the Dow had its best day since March 2009.
The Federal Reserve’s announcement this morning did lock in “exceptionally low” interest rates for two years – albeit with three dissenters against! – but it passed on the further round of Fed bond purchases that investors had apparently been anticipating, while leaving the door open for more.
Changing the wording of the Fed statement when referring to the duration of “exceptionally low rates”, from “for an extended period” to “at least through mid-2013” is a little bit significant I guess. Certainly those in the business of “parsing” the Fed statement got briefly excited this morning.
The statement added: “The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate,” which the market took as a sign that the FOMC is leaving its options open. But it always leaves its options open.
However QE3 is not actually needed. That’s because, the US 10-year bond yield has fallen from 3.16% at the end of QE2 in June to 2.23% this morning.
As Fed chairman Ben Bernanke explained last year, the purpose of “quantitative easing” (a term he didn’t like or agree with) was to lower long-term bond yields and force up asset prices generally. The liquidity flood that the market focuses on was not the main goal.
No action is needed now to either lower bond yields or supply more dollars: yields are super-low and the world is awash with dollar savings and what’s more, inflation expectations are now rising so the deflation that Bernanke was worrying about last August is no longer a threat.
Moreover the futility of the Fed’s policy last year has been on display these past two weeks: as the bond yield has collapsed, so has the sharemarket. It’s clear that falling bond yields do not, on their own, result in rising asset prices, and a flatter yield curve does not lead to economic expansion.
In both QE1 and QE2, the liquidity boosted market sentiment but most of the cash went straight to bank coffers.
The fiscal and monetary authorities in the US – that is, the Fed and Treasury – are now completely bereft of ideas and ammunition; American economic policy is parked at the side of the road, steam coming from under the bonnet.
Treasury has now been told by Congress and the president to cut the deficit: no more stimulus, it’s time to start reducing debt. And unless Bernanke pulls a rabbit out of his hat at the annual Jackson Hole seminar later this month, monetary policy is at a standstill as well.
In Europe, fiscal policy is likewise focused on debt reduction, but there is still some room for monetary policy.
As Oliver Marc Hartwich explains this morning (Setting a European time bomb), the ECB’s decision to start buying Italian and Spanish bonds is hugely significant, a game-changer. To make a difference, he says, they will have to spend nearly €1 trillion, which would have to be created out of “thin air”.
Sounds like a European version of QE, and maybe that’s the real reason markets are now rallying.
After all, the threat of a European financial crisis – GFC Mark 2 – seems more pressing and more dangerous than the threat of another US recession.
This article first appeared on Business Spectator.
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