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ZT from pro:

Will Bernanke Rock the Boat?


Wednesday gave us 2 of 3 big events we were focused on this week. First, the German constitutional court ruled favorably on the legality and proposed uses of the European Stability Mechanism [ESM] bailout fund. Then Apple presented its latest and greatest smartphone, the aptly named iPhone 5.

As positive as they were, the market basically yawned over both potential catalysts. Now today brings a very significant FOMC meeting. Why is this one any more important than the last or the next? Because it is one of the special quarterly Fed parties where we get fresh economic forecasts on GDP, inflation, and unemployment. And we get a Big Ben press conference too.

Throw in there wide expectations for some type of new Large-Scale Asset Purchases (LSAP, aka QE3) in a range of $200 to $500 billion and you've got the makings of a pretty big Fed day. I don't care whether the economy needs more stimulus or not. I just care what big market players think and want right now – especially ahead of the election.

Guesses and Facts

My educated guess is that the current market environment is fairly independent of new QE, and that the heavy lifting that needs to be done is already coming from Europe. If Ben and Co. do offer new actions, it will be viewed as just another tweak to ensure that bond and housing markets stay on their smooth course of supporting the economy.

If they don't, maybe they are being prudent, saving their ammo, and staying clear of the political fray. Either way, I think the market continues to rally up to the election.

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ZT:

as of today, three of four near-term ST trend indicators are edging downward and two have declined from being overbought. There is slight evidence the near-term trend indicators will form bases near current levels for the DJIA and S&P500 index from which to rally more. Once bases are consolidated, the DJIA is expected to climb to 13,500 and the S&P500 index to 1,450.

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One of the running themes of economists’ expectations is for another round of quantitative easing that involves the buying of mortgage-backed securities. The thinking is simple: employment numbers will be lifted quickly by more construction worker hirings. However, the need of a Fed boost to the housing industry is also debatable, given the recent rally in housing shares reflective of good news from the housing sector. Housing shares had another good run yesterday after Goldman Sachs (NYSE:GS) confirmed the thesis that the housing sector is enjoying a rebound after remaining stagnant since 2009. The PHLX housing index rose 3.1%, with KB Home (NYSE:KBH) up 4.3% and Lennar (NYSE:LEN) up 4.4%. PulteGroup (NYSE:PHM) was up 6%, also boosted by an upgrade from Williams Financial Group from “hold” to “buy.”

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Despite an afternoon wobble yesterday that looked suspiciously like the result of Apple-inspired trading truancy, equities finished with another day of gains on increased Fed easing hopes. The DJIA rose 10 points, for a 0.1% climb to 13,333. The S&P500, fueled by strength in telecommunication company shares, climbed 0.2% to 1437. The NASDAQ, lifted by technology shares, rose 0.3% to 3114, with activity emboldened by a new Apple (NASDAQ:AAPL) iPhone launch and by positive comments from Facebook’s CEO. Apple rose another 1.4% and Facebook jumped 7.7% during the session.

The DJIA’s rise was paced by gains in Verizon (NYSE:VZ), up 1.4%, and General Electric (NYSE:GE), 1.4% higher. Verizon’s CFO said the firm may begin buying back shares in 2013, that wireline margins are improving and its customers are buying bigger than expected data packages. General Electric said its is considering the sale of its $2.2 billion stake in Thailand’s Bank of Ayudhya . DuPont (NYSE:DD) headed losing components down 1.6%, followed by Bank of America (NYSE:BAC), off 0.7%.

Among the ten S&P500 industry sectors seven marked increases including: telecommunications (+0.7%), industrials (+0.5%), financials (+0.5%), technology (+0.5%), oil and gas (+0.4%), consumer services (+0.3%), and health care (+0.1%). Losing ground were the following groups: consumer goods (-0.7%), utilities (-0.5%), and basic materials (-0.2%).

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No wonder then that there is much fence-sitting today. Asian markets closed mixed; European bourses are lower; US futures point to modest declines at the open. The euro is trading up 0.1% with the US dollar off 0.03% against a currency basket. Crude is trading 0.2% higher in electronic trade, reflecting not only easing hopes but also pricing in the increased risks of growing Middle East tension, grown more worrisome as Israeli complaints over Administration actions enters the US political sphere. Gold is little changed, off 0.02% at $1733.40. Copper, most reflective of China growth, is also little changed, down 0.01% at $3.69.

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Lowered expectations for Beijing stimulative actions sent the Shanghai Composite down 0.8% today. Australia’s S&P/ASX 200 fell 0.5%, affected by reports that iron ore maker Fortescue Metals is having difficulty making debt payments, highlighting difficulties faced by the nation’s important resource firms due to falling demand, especially from China. Hong Kong’s Hang Seng eased 0.1%. Japan’s Nikkei bucked the region’s downward trend, up 0.4% as the yen’s advance against the dollar, now up 0.2%, takes the currency to levels that have previously provoked central bank intervention.

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Europe’s bourses are lower today, led by a 0.7% drop in France’s CAC, with Germany’s DAX down 0.4% and the UK FTSE 100 off 0.1%. The weakness follows a strong equities rally in European shares since the early August Draghi effect went into play, and shows trades sidelined by today’s key FOMC policy action. Indeed, there was good news this morning after Rome’s first primary auction since the ECB OMT announcement saw borrowing costs the lowest in nearly two years. Yields on Italian 14-year debt fell to 5.3% from 5.9% at the last, similarly dated sale.

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As has been made clear in the market’s rally from early this summer, equity prices have reflected the assumptions of combined central bank easing actions to support slowing global economic growth. China’s intentions seem the most opaque, further clouded by news that its central bank issued 28-day reverse-repurchase contracts for the first time in a decade, undermining hopes for reductions in banks’ reserve requirements, viewed as a longer-term stimulus measure. Furthermore, the official Xinhua News Agency reported today that any massive stimulus would be “detrimental” to China’s long-term growth. Besides worries about the last stimulus’ inflationary impact and concerns over ill-fated projects that saw bridges falling in Beijing and roads buckling in rural areas, the government is also undergoing a leadership change. Premier Wen Jiaboa promised early this week that Beijing had the means and will to boost slowing growth, but he will be replaced in October, perhaps undermining such claims.

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The eurozone sovereign debt crisis has come back from the brink that the Fed faced during its last two-day policy deliberation. ECB President Draghi made good on his promise to do whatever it takes to save the euro, detailing the OMT program to put a lid on peripheral nations’ high borrowing costs; Germany’s constitutional court has opened the door for the E500 billion ESM bailout fund; Dutch elections returned the pro-euro Prime Minister Rutte to power with a centrist government the likely result. The euro, currently trading up 0.2% at 1.2906 against the US dollar suggests a consensus view that the European Union has recovered a great deal of previously lost support from the populace, permitting the kind of fiscal union needed to maintain a diverse cultural base within a single currency union.

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The Fed, therefore, may not feel compelled to make a preemptive policy move to add liquidity to a financial system frozen with fear from eurozone stress. Indeed, liquidity issues do not plague US markets, with corporations and markets awash with cash. It is the problem of confidence among company boards and executives that keeps inventories lean, investments delayed and, most importantly, hirings slow. The Fed, therefore, must not only consider the means to increase employment levels, but also the psychological impact that a major accommodative move would engender, as action itself bodes ill for the economy’s state, as lowered Fed GDP assumptions would likely underscore.

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Even so, the latest polls show Wall Street economists have grown increasingly optimistic that further easing plans will be announced today. A Reuters poll posted yesterday showed 65% of the economists polled anticipate Fed action today, up from 60% in August; according to Bloomberg’s tally, two-thirds of the respondents asserted another round of bond purchasing is likely. The nature of the accommodation is, of course, another matter, ranging from expectations of an extension of forward interest rate guidance to 2015 to an open-ended program of bond purchasing that depends upon the inflow of ongoing data.

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the reading of most indicators went lower now!

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The Real QE3 Question: What Can It Really Achieve?
By Michael Aneiro
Strategists continue this week to churn out predictions about what QE3 will look like, since it seems to be an accepted fact that there will be a QE3 announcement from the Fed later Thursday. (Some dissenters posit that the Fed may still opt to punt on QE3 for now, but will likely deliver later this year.)

The bigger question, of course, is what can further bond-buying, or stretching out the Fed’s low-rate forecast from 2014 to 2015, really achieve?

With the Fed already pinning down rates on riskless bonds, flows into fixed-income assets with riskier credit profiles than Treasuries, particularly high-grade and high-yield corporate bonds, continue at a torrential pace, even though yields are at or near record lows. Consensus is that the Fed will announce more bond buying, including the buying of mortgage-backed securities designed to more directly aid the housing market, but mortgage rates are also already pegged near record lows.

Jeffrey Rosenberg, BlackRock’s chief investment strategist for fixed income, notes that there’s little more that can be done to further incentivize risk-taking and borrowing:

You can lead a horse to liquidity…but you can’t make him borrow. That summarizes our take on global monetary policy post-financial crisis. Despite the Federal Reserve’s best efforts detailed in Chairman Bernanke’s recent Jackson Hole speech, monetary policy remains frustrated in the attainment of its goals for this simple reason. More of the same liquidity likely won’t help either to accelerate economic growth but will accelerate financial asset prices.

Despite raising the availability of borrowing and reducing its costs, credit usage across the economy remains below what normal policy accommodation would imply. Initially following the 2008 crisis this feature of lack of credit demand following policy accommodation could be seen across the economy. Neither businesses nor households utilized the cheaper credit. In this immediate post-crisis period, both households and businesses focused on repairing their over-levered balance sheets. However, we can see that for businesses, beginning around 2011, credit usage accelerated. For households however, the key source of credit demand – housing – remains impaired.

Furthermore, in the short term, it’s hard for many to see a post-QE3 bump in prices of stocks or bonds, seeing as markets have basically priced QE3 in already, leaving the Fed the choice between simply meeting existing expectations or disappointing markets altogether. From Michael S. Hanson and Priya Misra, rates strategists at Bank of America Merrill Lynch:

[W]e believe it is possible that the Fed will announce QE3 this week: we see a 50% probability of that happening, but an 80% chance by yearend. In that case, the Fed may simply ratify market expectations, as QE3 appears to be largely priced in. Our model for QE indicates a nearly 85% chance of further asset purchases being priced in to the market…

However, with Operation Twist continuing through December and with additional stimulus likely coming from the extended forward guidance, Fed officials may decide to hold off on QE3 this week. After all, “easing” need not necessarily imply QE. They also might need time to agree on an “open-ended” asset purchase plan that is tied to improvement in the economy rather than a fixed amount and date.

In this case, risk assets would likely selloff, led by stocks, gold, and foreign currency against the US dollar. However, the selloff might well be limited by the very dovish language in the statement and by Chairman Ben Bernanke’s comments during the press conference — both of which should signal that QE3 is just a matter of time. The rates market reaction in this scenario is likely to depend on the extent of the disappointment in risk assets. We expect the curve to flatten in a risk-off trade.

Of course, the most intransigent variable in all of this is employment, and there’s little sense that QE3 can represent anything beyond a marginal, incremental aid to what ails the labor market.