Fed Governor Bullard spoke earlier this week in France and as usual he has been tapped to attempt to send out feelers about future Fed policy. What I've noticed is that Bullard is sent out to discuss future Fed strategy to test the reaction of markets and sentiment. This speech is no different as he makes efforts to spin that the economy is improving and perhaps we just don't need the remaining QEII.
From the Bloomberg article -
"St. Louis Federal Reserve Bank President James Bullard said policy makers should review whether to curtail a plan to buy $600 billion in Treasury securities, noting that the U.S. recovery may not need that much stimulus.I'm not buying what Bullard is selling here, or probably better stated, I'm not buying the suggestion that the Fed is desiring to remove QE from markets because they are healthy and ready to get back on track. I believe that the Fed is actually concerned about commodity prices and the impact it is going to have on corporate margins and also the ability of the market to function with $100 oil.
“The economy is looking pretty good,” Bullard said to reporters in Marseille, France, on March 26. “It is still reasonable to review QE2 in the coming meetings, especially this April meeting, and see if we want to decide to finish the program or to stop a little bit short,” he said, referring to the second round of so-called quantitative easing.
"The oil price increases so far are “not enough to derail the U.S. recovery at this level,” Bullard said. “If oil prices stabilize where they are, we’ll be fine.” Prices would have to go substantially higher for there to be a “significant and material effect,” he said.Hmmm. So if you are the FED and you are concerned about higher oil prices that could impact the recovery what would you do? Right! You might talk about how you are going to end the one program that is the cause of all of this commodity inflation! You don't have any intention of stopping early, but you would at least send out your lacky to talk about the possibility.
“We have to weigh those in the decision” on whether to stop the Fed’s QE2 program earlier than planned, Bullard said.
So, if Bullard is trying to signal that the FED may begin to wean the markets of its fiat version of crack, what would be their steps to attempt to detox the market and kick the habit?
"While the economy may still suffer shocks, the “balance sheet should be contingent” and the Fed should be ready if the economy turns down, he said.
“If the economy is as strong as I think it is then I think it may be reasonable to send a signal to markets that we’re going to start withdrawing our stimulus, and I’d start by pulling up a little bit short on the QE2 program,” Bullard said. “We can’t be as accommodative as we are today for too long, we’ll create a lot of inflation if we do that.”
If the Fed opts to start withdrawing stimulus and tighten policy, it should start with the “balance sheet” by selling bonds first, then changing its wording about keeping interest rates near zero for an “extended period” and then raising interest rates, Bullard said.You need to read that statement again --- "We'll create a lot of inflation if we do that". Yes, for once Bullard and I are in total agreement. If the Fed doesn't act they will create a lot of inflation (have created a lot of inflation). What he doesn't say is that they have already created a lot of inflation in asset price terms (stocks and commodities) and we've discussed how this has led to the two year rally from the depths of the abyss and also led to the oil and food price rallies that have caused unrest and misery throughout the world. Recall that Bernanke likes to say that he can inflate stock prices, but never admits to the inflation of food and fuel prices.
Bullard has warned since last July about a risk of Japanese-style deflation in the U.S. while calling for purchases of Treasury securities to reduce the threat. Bullard, 50, voted in favor of the Treasury purchase program in November and has rotated this year into an annual non-voting position.
TRAPPED BY A CREATION OF THEIR OWN MAKING
The next few months are going to be entertaining as the Fed starts with their balance sheet like Bullard suggests. We'll see exactly how much appetite there is in the world market for over-priced treasuries that provide below market interest. The FED is in a box and we'll get to view what impact selling bonds has on the market while the Treasury is trying to sell more and more bonds to meet the budget requirements of the ever-growing beast called the US Government. The Treasury and goverment needs rates to remain low because we cannot service the debt if interest rates rise to market based rates, and I believe that we'll be able to witness just how handcuffed the Fed is once they try to remove themselves.
SINCE WHEN DOES THE FED TIME ANYTHING CORRECTLY?
We should all be very worried about Bullard's last statement below.
“It looks like inflation is bottoming out and if we continue that, I think we will have gone past” the worst, he said. “We seem to be turning the corner there, but I would want to see more data on that.”I haven't seen a Fed Chairman that has been able to engineer a move in the economy that didn't overshoot one way or the other by injecting too much liquitity or tightening too much. It is frankly just too hard. If Bullard says that we are at the bottom of the inflation turn, it is probably more accurate to state that we have already made the turn and it is too late.
This week the FED did sell $2 Billion of their bonds yesterday under the TOMO program. This is a very small amount, but could be construed as a test sale in the market.
I believe that the best FED approach would be to announce that they see significant improvement in the economy and that the QEII program will be strategically altered by changing their allotment of allocated money. This would be done by reducing the remaining purchases on a monthly basis, but should then suggest that the progam is not ended, in fact, it is extended through year-end with the remaining portion of the $600 Billion as ammunition. In addition, they plan to begin asset sales from the balance sheet with the expectation that they will raise interest rate at the end of the year or early 2012. By proceeding in this manner, they essentially make the statement that the economy is getting better, they will try to improve their balance sheet, but they stand ready anytime with already approved liquidity to step in if markets seize up (or in the eyes of the Fed, if stock markets decline).
What are markets thinking about the notion that Bullard says that inflation might be around the corner?
Today and tomorrow make up the period we often call "window dressing" period where portfolio managers begin buying the hot stocks and selling the losers because they are required to disclose their positions at the end of the quarter. Portfolio Managers don't want to answer questions like "Why didn't you own NetFlix?" if they can help it, so they go out and buy those stocks that have performed well and they sell the ones that haven't. This has the effect to push up the market leaders over the last few days of the quarter. It is often noted though that these same managers unwind those same positions near the beginning of the quarter. If you don't like it, sell it! I mention this so that we are clear to avoid getting sucked into the bullishness of these next couple of days.
I am concerned about commodities right now and therefore suggest that you do not add to new positions over the next couple of days. Copper is extremely weak and most commodities follow the trend created by copper. There are some very fundamental and specific reasons (specific to copper), but that doesn't mean that a big drop in copper won't bring the rest of the commodities market down too. There are rumors of Chinese businesses buying copper and storing it in warehouses in the effort to then borrow against that asset because they cannot get traditional bank financing as the government has tightened loan availability. There is talk that there is a huge amount of copper supply just sitting essentially as a funding source. If copper declines significantly there will be effectively a margin call against those copper supplies and businesses will be forced to sell at the prevailing market rate to get out of their positions. This squeeze could get really ugly really fast. This is just another item to watch over the next couple of weeks.
JJC (copper etn)