The day after the dust settled following the Fed’s dramatic balance sheet expansion provision, European leaders meeting in Brussels seem set to agree on doubling the value of loan commitments from €25 to €50 billion. That tone is cautiously undermining the appeal of the euro in Friday trading, with traders also likely locking in profits following the largest one-day gain in the decade-long history of the euro. The euro is down from a $1.3738 high Thursday to a more sober $1.3545 today.
There is also plenty of analysis of the implications of the Fed’s move occurring. In typical Wall Street fashion, the announcement shocked the street, where expectations were for a more gradual ‘wait and see’ approach from the Fed. And so the question doing the rounds based upon this unprecedented expansion of the balance sheet is, what does the Fed know that we don’t?
We can only guess that, with some analysts pointing to the need for several more trillions to be printed, the Fed knows the likely second and third round implications of not acting forcefully and without sufficient gusto. The word is, according to some, that the entire nation is set to go out and refinance its mortgages and in so doing will free up copious amounts of cash, which will inevitably end up finding its way into a return to profligate spending habits.
We can’t deny that the Fed’s move isn’t a step in the right direction but equally we can’t say for sure that the spending habits of households with lower monthly mortgage commitments will change to the point that the consumption part of the GDP equation changes materially. While tax incentives for new homes are in place for those buying a first home before December 1 are also in place, affordability still has some way to go before confidence might return.
The fear over whether the Fed is planting inflationary seeds is likely to be a key and central issue going forward. On the one hand its actions can be viewed somewhat like the internal transmission of an engine in which it simply enables the movement of other, currently seized, parts to start turning over. That flow of money is essentially within the engine and not necessarily flowing into the real economy. One must remember that there is a massive displacement here of private versus public spending. The vast amount of likely refinancing isn’t lending predicated on homeowners buying second homes, rather their primary residence at a better rate of interest. The Fed clearly sees this huge one-off refinancing of the entire national zip code as a gamble worth taking if it can boost consumption.
If indeed the market perceived that the Fed was debasing the dollar, wouldn’t it be highly likely that the selling would have accelerated and momentum gathered pace across treasuries too? We must remind readers that the flip side of the dollar fall since Wednesday was a huge slide in yields where the 10 year note lost 50 basis points to 2.5% on the announced purchase of government debt.
As investors flipped out of the dollar they jumped into traditional inflation hedges including gold, which surged $50 per ounce, as well as other commodities. And while the dollar’s fall was broad based, of course it did buoy the commodity related Canadian and Australian dollars, which are currently at two month highs. The Fed’s master plan is a necessary first step to free up capital markets, and we understand the debasing argument, but what we where we would sound a note of caution is on the blind optimism that higher commodity prices are a sign of stronger underlying demand for commodities. Investors need to be aware of the illusion that the so-called comdols are heading higher because of greater purchases of oil, copper and other minerals.
We know for a fact that crude oil is higher for two reasons. First, refineries operate less as the price of crude oil falls given diminished profitability. Second, OPEC has been successful in ushering in supply cuts. This rise in recent retail sales statistics again created the illusion that the U.S. consumer was doing better, but the reality was that higher gas prices were the culprit. Without the higher value of gasoline sales, February’s retail sales contracted.
It will be of interest to watch these developments going forward. While there are no guarantees, the odds remain in favor of continued lousy domestic data in each economy and it remains highly likely that trade will remain depressed. And while the refinancing on Main Street might create more cash for American consumer it doesn’t mean it will end up rebuilding the global economy.
Option traders continued to buy Swiss put options on Thursday as they predict that the Fed’s action will spark a reaction from the Swiss National Bank. Late on Thursday one SNB member noted that deposit rates on Swiss cash could indeed be turned negative in an effort to remove the appeal of holding the currency. Those investors added more puts using the April 84.00 strike, while the underlying today continues to strengthen versus the dollar at 89.41, which means the Swiss franc buys exactly $1.12.
Elsewhere, we also noted a rash of call buying on the British pound as some investors appeared to expect a continued rush back into the pound. The Bank of England’s provision to buy U.K. government debt has set off worries that it too is debasing or at least happy to see a weaker currency. Of course, while the Bank’s purchases might be a decent role model for the Fed, its value is nothing compared to the magnitude of that announced by the Fed, hence, the call buying. However, today the pound is also a little easier and buys $1.4470.