Courtesy of Lance Roberts via STA Wealth Management,
QE Is Dead, But Likely Not Gone
As I wrote on Monday, the end of quantitative easing (QE) has come. While it was announced during Janet Yellen's post FOMC meeting press conference on Wednesday, the last official permanent open market operation (POMO) was this past Monday.
The question that remains to be answered is whether the economy and the financial markets are strong enough to stand on their own this time? The last two times that QE has ended the economy slid towards negative growth and the markets suffered rather severe corrections as shown in the chart below.
Asset prices have a coincident effect with the starting and ending of QE programs. As liquidity is extracted from the markets, the propulsion of asset prices has faded. The economy, not surprisingly, lags changes in monetary interventions as the decline in asset prices eroded consumer confidence that weighed on growth.
As I discussed recently, the Fed's ongoing QE programs have had little effect on the real economy. While the liquidity push drove asset prices higher, only the small percentage of the economy with assets to invest received a benefit.
"While the ongoing interventions by the Federal Reserve have certainly boosted asset prices higher, the only real accomplishment has been a widening of the wealth gap between the top 10% of individuals that have dollars invested in the financial markets and everyone else. What monetary interventions have failed to accomplish is an increase in production to foster higher levels of economic activity.
With the average American still living well beyond their means, the reality is that economic growth will remain mired at lower levels as savings continue to be diverted from productive investment into debt service. The issue, of course, is not just a central theme to the U.S. but to the global economy as well. After five years of excessive monetary interventions, global debt levels have yet to be resolved."
Alan Greenspan recently reiterated this point in a WSJ Report:
“'Effective demand is dead in the water' and the effort to boost it via bond buying 'has not worked. Boosting asset prices, however, has been 'a terrific success.'”
“I don’t think it’s possible for the Fed to end its easy-money policies in a trouble-free manner….Recent episodes in which Fed officials hinted at a shift toward higher interest rates have unleashed significant volatility in markets, so there is no reason to suspect that the actual process of boosting rates would be any different."
Greenspan has this correct; there is an underlying belief that the Fed can raise interest rates without "pricking" elevated asset prices. The removal of liquidity from the markets by the ending of the latest QE program is indeed a "tightening" of monetary policy. The raising of interest rates in a 2% economic growth environment is a stranglehold. (Read: Will Rising Fed Rates Cause A Problem for a complete explanation)
However, as Dr. Lacy Hunt states in a recent CNBC interview:
"The Fed has spawned this 'buy now, pay later' scheme of the American consumer… but there comes a point when the 'pay later' overwhelms the 'buy now'… and when that happens monetary policy is basically ineffective"
Dr. Hunt hits on the right points in suggesting that we are unprepared for what the future holds. The structural shift in employment, a growing demographic issue, and ballooning entitlement programs have only been masked by the Fed's monetary interventions. As Dallas Fed President, Dr. Richard Fisher, previously pointed out:
"1) QE was wasted over the last 5 years with the Government failing to use "easy money" to restructure debt, reform entitlements and regulations.
2) QE has driven investors to take risks that could destabilize financial markets.
3) Soaring margin debt is a problem.
4) Narrow spreads between corporate and Treasury debt are a concern.
5) Price-To-Projected Earnings, Price-To-Sales and Market Cap-To-GDP are all at 'eye popping levels not seen since the dot-com boom.'"
So, as the latest round of QE fades into history, I would suggest that we have not seen the last of it.
Oil Prices Due For A Bounce – But Lower Lows Likely
Oil prices have fallen sharply in recent months due to the slowdown in global economic growth and rising deflationary pressures. However, there is also a growing supply/demand imbalance that is being driven by the "shale boom" as I discussed recently.
"First, the development of the “shale oil” production over the last five years has caused oil inventories to surge at a time when demand for petroleum products is on the decline as shown below."
"The obvious ramification of this is a “supply glut” which leads to a collapse in oil prices."
In the short-term the collapse in oil prices has reached a technical extreme. As shown in the weekly data chart below, oil prices (as represented by West Texas Intermediate Crude) have fallen by more than 3-standard deviations from the 50-week moving average. I have highlighted past historical periods where such declines from extreme overbought to oversold conditions have existed.
While the current extreme oversold condition suggests that a bounce in oil prices is likely, historically bounces from such early extremes have led to either a period of consolidation with retests of recent lows, or further declines.
Many investors have gotten trapped in energy related issues by chasing either yield or returns in a "hot sector" over the last year. Therefore, it is advisable that bounces in oil prices, which should lead to a relative bounce in energy stocks, be used to reduce exposure to the sector until the current storm passes.
US Dollar Rally Likely Over
The US dollar has had an extremely strong rally in recent months as the global slowdown driven by deflationary pressures has driven money into the safety of the USD. However, utilizing the same technical setup as above for oil prices, the USD is now more than 3-standard deviations above its 50-week moving average.
Historically, such extremes have marked the end of counter trend rallies in the US Dollar. This time will likely be no different as not much in the world has changed over the course of the last several years (i.e. accelerating economic growth, wage growth, etc.) What is beneficial to the U.S. dollar currently is that it just is not as bad as everywhere else. Since oil is priced in US dollars in terms of trade, a strong dollar also has a negative impact on global growth, this is not something that our foreign trading partners are likely to tolerate for long.
However, IF, and this is a fairly big "if," the ECB can indeed launch some type of quasi-quantitative easing program in the months ahead, it will likely reverse flows from the USD back into the Euro. If that analysis is correct, this could provide a lift to depressed European asset prices relative to US related investments in the short term.
Just some things to think about.