Hypersensitive Monetary Policy?
After the torrential decline in the so-called ‘risk assets’ over the past week, it would seem that the investment community at large has got QE3 on the brain. Will they? Or won’t they? Indeed, does it matter? As Marc Faber said in an interview on Friday (paraphrasing); ‘Now we will find out if Mr Bernanke is a true money printer, or just an amateur money printer’.
Here, I present the usual weekly Federal Reserve balance sheet charts and show why we believe that the coming weeks will involve ‘hypersensitive monetary policy’… That is to say; regardless of the type of monetary policy to be implemented, it’ll be a rough ride!
[The first chart shows the Federal Reserve's assets as recorded on the 'factors affecting reserve balances' statistical release. The second chart shows those assets on a proportional basis. That is, the latter chart shows the Fed's various assets as a percentage of its total assets.]
The balance sheet of the Federal Reserve System expanded by around $3.5 billion last week. The Fed continued to accumulate US government securities (holdings of US Treasury notes & bonds increased by around $2.7 billion) however, unlike in recent weeks, the Fed ceased to discard its Federal Agency Debt and Mortgage-backed securities.
The general slow-down in the pace of expansion of the Fed’s balance sheet should be evident from the charts above. Moreover, the latter chart should demonstrate that the quality of the Fed’s assets has improved (if only slightly and by consensual standards). Federal Reserve notes (& reserve balances) have become increasingly ‘good for’ US government securities and decreasingly ‘good for’ Mortgage-backed securities. So, although QE2 was dilutive for Federal Reserve notes (& reserve balances), it did have the effect of making them qualitatively better (again, by consensual perceptions at least). As we have reiterated over the past few months, this isn’t good for producers of ‘IOU claims’ upon money (that is, commercial banks). Moreover, as was neatly articulated by the Elder Mr Dawes of the Dawes Tomes Mousley Grubbs Fidelity Fiduciary Bank (in Mary Poppins!):
While stand the banks of England, England stands. When fall the banks of England, England falls!
After all the contempt and ridicule thrown upon conservative financial speculators over the past year, it turns out that none of it mattered anyway!
The S&P 500 is down on the year in dollar terms and is even trading at lower levels than in May 2010. Of course, dollars have been sinking in and of themselves. In real money, the past year has been a disaster for US equities:
Our understanding is that balance sheet expansions are more dilutive when currencies trade at ‘greater discounts from par’. With the recent increases in the dollar prices of gold and US government bonds, Federal Reserve notes (& reserve balances) are very oversold and a significant expansion in the Fed’s balance sheet would really debase the dollar:
So, regardless of whether QE3 is imminent or not (our guess is that it is not), the coming weeks will probably be quite interesting!
[NOTE: Even if the Federal Reserve does engage in another quantitative easing program in the very near future, there is no guarantee that the dollar prices of US equities will levitate miraculously! As we have mentioned in the past, equities – generally – are dependent on the status quo in the price structure. An imminent QE3 may easily distort the price structure beyond our imaginations! We continue to believe in the long-term generational decline in the Dow/Gold ratio.]
Recommended: Charting the Federal Reserve's Assets - 1915 to 2012