Jon Hilsenrath, a well known WSJ journalist, often seen as the U.S. FED’s inside man, published an article on WSJ’s Saturday edition about the central bank possibly exiting from its current QE program. The article didn’t reveal anything substantial, but it is particularly strong at transmitting some basic ideas: the FED now has an eye on the end of its current QE program – ahead of schedule which was supposed to be when the unemployment rate hits 6.5%. It is particularly concerned with the stock market’s potential reaction, and so it is putting out the “feelers”.
The financial crisis peaked in early 2008 and in the process posed some very serious problems for the American economy. In fact, in order to avoid a liquidity dry up and potential depression, the FED cut its interest rates and provided the required liquidity to avoid a broad-based insolvency crisis.
Even though the FED solved the main problem that of economic collapse, it wasn’t happy with the second part of its dual mandate – economic growth – and so has tried to, and in the same spirit of former Fed Chairman Alan Greenspan’s actions, to go a step further and engage in unconventional measures of monetary policy in the hope of driving growth higher.
Over three asset purchase programs, the FED has injected trillions of dollars into the U.S. economy and has seen its balance sheet grow from $869 billion on August 7, 2007 to the current $3.3 trillion. Every time the stock market went down, the FED entered the game with a new asset purchase program culminating in the current open-ended $85 billion-month program.
Now almost six years into the monetary expansion experiment, the FED has gone all in on the U.S. economy, even assuming traditional fiscal policy targets like bringing down unemployment to 6.5%. With the average inflation rate between 2007-2012 being just 2.2%, the FED did not see any reason to put a brake on its policy.
With virtually no inflation and economic indicators only modestly improving, many still argue in favour of a continuing QE policy but we believe Bernanke and other open committee officials are starting to be concerned with the possible effects deriving from this massive experiment, and that’s why they’re testing us through the press.
If we look at the labour market data, we definitely see an improvement over time. Payrolls have been rising; unemployment claims are at a five and a half year low and the unemployment rate dropped from 10% at the peak of the crisis to the current 7.5% level. But this data isn’t quite as good as it seems.
The average payrolls number for the last eight months, since the start of QE3, is 193,000. That is a mild number, still below the healthy 200,000 figure investors traditionally point to as being a number capable of bringing down unemployment. But if you look at the above table, you see that payrolls grew at a pace of 178,000 a month in the eight months prior to QE3 being implemented and, at a pace of 185,000 if we consider a 12-month period. That’s not a big difference to the current pace, is it? Does it justify a $85 billion a month asset purchase?
It is where the stock market is concerned however that QE has really come into its own. The S&P 500 is up 13% since QE3 started. Since the beginning of the year however, the market has really begun to motor, rising by an impressive 24% YTD.
So, definitely QE3 is working from the perspective of asset reflation, strip out the stock market though and its effects are relatively mild. The economy hasn’t recovered from the financial crisis while the main equity indexes just keep on beating record highs. There’s a lost link between asset prices and the economy, something which is called a bubble.
With all this in mind, the FED knows it must put an end to QE much before the unemployment rate hits 6.5% but Ben Bernanke and his team just don’t know how or when without creating an even bigger problem. In the parlance, they have put themselves in a box. A box with Q and E painted squarely on it. They’re afraid of the market reaction because they know equity markets have been on life support from QE, and may possibly crash as soon as the FED reverses its policy. So, the FED is using Jon Hilsenrath and several regional bank presidents to test the market before they commit to anything.
But, we believe they will have to do something before the end of the year, even though they may opt for just slowing the pace of QE in a first instance. One way or another, we like the saying, Sell in May and Go Away!