Home > Uncategorized > 2012/01/26: FOMC de facto QE3 helps everything except US dollar

2012/01/26: FOMC de facto QE3 helps everything except US dollar

© 2012 ROHR International, Inc. All International rights reserved.

Looks like Helicopter Ben has morphed into Gusher Ben. Due to both the economics and current elevated fiscal focus, it is impolitic right now for the Fed to expand its balance sheet beyond already bloated levels. That would be the equivalent of dropping dollar bills from helicopters. So instead it seems to have opted-in to a consensus that the Federal Funds rate should remain effectively at zero for much longer than the middle of next year projected at their last meeting.

Aside from the fact that a prediction of where interest rates are going to be fully across the next several years seems quite an overreach in its own right, there are the other knock-on effects. By attempting to inspire confidence with free liquidity indefinitely guaranteed, Mr. Bernanke and the rest of the Fed is actually attempting to push psychology upward from underneath hoping that the enthusiasm will pop like an oil ‘gusher’. This is nothing less than a mind game version of quantitative easing (i.e. de facto Q3.)

Unfortunately for them, the first things that are shooting up once again are the prices of risk assets, as the return of the ‘risk-on’ trade assists everything except the US dollar. Is it just us, or does it feel an awful lot like spring of last year once again? In any event, the increase in commodity prices represents what now seems to be the next round of the Risk Asset Hot Potato game in a zero interest rate environment, which typically raises more questions than real economic activity.

As we have already alluded to the return of the ‘risk-on’ trade in the wake of the FOMC statement and Chairman Bernanke’s press conference, it seems only fair that we at least share our market observations right away (instead of the typical wait until the end of the discussion.) The most obvious, and somewhat perverse, tendencies are reverting back to those that were in place prior to the beginning of last week’s selloff in the government bond markets. In essence, with the notable and rightful exception of the US dollar, we have returned toit’s all going up together“.

This would be less unusual it were not for the highly focused macro-technical structure of the intermarket indications we discussed late last week. There is not really much of a problem with the equities and govvies rallying together at various points for a limited amount of time. (We suggest you review last week’s posts if you’re not familiar with the reasons behind that.) However, in this case the March S&P 500 future was up against some very important technical resistance in the 1,310-15 area. If the push above it manages to maintain for Friday’s weekly Close, it would be back up in an entire higher range where a test of 1,340-50 resistance would appear to be the next step.

Beyond that, it might also be signaling that the entire top from the first half of last year is no longer viable; as in the market would be ready to push above the early May lead contract 1,367 exhaustion high. This would be similar to the second round of Fed quantitative, easing (QE2) fomenting the push through the 1,216 April 2010 high in the fall of that year. And in this case as well it would be overrunning the previous extreme high (i.e. tip of the head) of a Head & Shoulders Top at 1,367. If so, next resistance would not be until at least the interim 1,385 last seen in June 2008, with the more formidable 2007–2008 resistances not until the 1,425-40 range.

All possibly fine and good, except that the intermarket indications are quite a bit different, at least so far. Just as an aside (with a further discussion below) commodity prices are already more so significantly elevated than they were back in the summer of 2010. And beyond that, quite a few of the intermarket indications are going to be very strained as well unless something gives again in the relationship between the equities trend and that of the other asset classes. Allowing that it has all come around to being a significantly convoluted and perverse situation once again, there are certain technical trend points and conceptual references which deserve our attention.

The first of these is that the primary government bond markets rallying so strongly from the bottom of the recent selloff even as US equities push to a new high of their rally (followed by Europe this morning) is a bit odd. Even allowing further explicit quantitative easing through direct long-dated bond purchases remains a possibility, if the Fed’s latest unlimited cheap liquidity effort is really going to foment any economic strength, the govvies should be doing just the opposite. That’s one of the big differences between now and summer-fall of 2010, when the European govvies anticipated the effect of QE2 in 2010 by selling off as soon as it was hinted in August; followed by the US govvies beginning a significant slide right into the official announcement in early November 2010.

However, at present all of the primary govvies have rebounded sharply from tests of key lower supports around this week’s early lows. Unless levels like March T-note future 129-24, March Gilt future 115.00-114.85 and March Bund future 137.50 – 30 are broken, we must presume that govvies are still more so focused on the threats from the real world than the higher commodity prices the return to a ‘risk-on’ mentality will encourage. And the govvies rebound also reinstates the other perverse aspect which reflects general destruction of fiat currencies through inflation (even if that is not glaringly apparent at present): those strange bedfellows have gotten back together, as the govvies rally is occurring along with a significant rally in the Gold market.

The latter has seen February Gold future not only push back up above its significant DOWN Break and weekly MA-41 in the 1,615-30 range two weeks ago; it has now breached higher resistance in the 1,680-1,700 area that represents a fresh UP Break out of its September-November down trendline. Only a failure back below that area might represent a weak sign in a market that seems to have fundamental reasons once again for remaining strong. Yet, in the metals complexes as well there is a further inconsistent indication that we also highlighted last week: the trend of Copper has not yet returned to full strength even if back at elevated levels.

What we mean by that is the current push back up toward the 3.92 mid-September 2011 weekly Close (which the market gapped down from so viciously in the week ending September 23rd) only essentially fills that gap so far. That gap is also at the bottom of the much heavier early-mid 2011 congestion that ranges up to the 4.60 area, and the 4.00 lead contract Copper future major DOWN Break (from its up channel off of the very major 1.475 December 2008 low) still looms above the market.

Along with the still elevated prices of many other commodities, this is one of the issues surrounding the return of the ‘risk-on’ trade: while encouraging inflation anticipation buying, will the central bankers’ easy money policies (now seemingly including the ECB along with the Bank of England and the Fed) really be enough to stimulate “final demand” that will be able to absorb elevated commodity prices? One of the major components of the equities stalling out last year was the degree to which still weak consumers did not have the capacity to fuel that “final demand”, as the only time inflation can accompany economic growth for an extended period is if it is of the ‘demand-pull’ variety driven by higher wages.

Given the general austerity push in Europe with the US soon to follow, and any increase in commodity prices likely setting off alarms once again in the emerging economies and China, it’s a good question where the sort of consumer activity that will support economies and elevated equity prices is going to come from? Especially if the economic forecast of Europe heading into recession turns out to be accurate. Even though forecasts are always a bit problematic, the signs outside of Germany, and its continued insistence on major spending cuts as a condition for funding the sovereign debt rescue efforts (see previous posts on that), do not bode well. We shall see.

And all of that background about the ‘risk-on’ trade encouraging inflation through a game of short-term investment/trading with free money from the US certainly reinforces the return to weakness of the US dollar as the one outlier in the “it’s all going up together” scenario. There are quite a few aspects there that deserve review. In the first one on both a technical and psychological level is that any significant weakness of the US Dollar Index below its .7950 UP Break (out of its major down channel from the .8870 June 2010 high) is a significant failure.

That would not only point to a retest at the very least of the interim congestion back down in the .7700 area, but would also create a psychological condition very similar to last spring. And by that we mean a full return to a US dollar “carry trade” mentality. After all if there is really little risk of any higher interest rate that would incur a short-term loss, why would any reasonable speculator not be happy to borrow short-term in US dollars, and sell them to put the money to work in a higher return environment?

That is now showing up in various other currencies strengthening against the US dollar. The euro pushing up back up above EUR/USD 1.3050-1.3100 has established a base that may well see this weakest of the weak sisters at least retest its mid-upper 1.3300 resistance, even if there is more formidable resistance at higher levels. Of course, that is contingent upon it doing no worse than 1.3000-1.2950 (recent UP Break) over the near term.

No secrets as well that the commodity currencies are doing better on the potential for all that liquidity to turn into Uncle Ben’s Gusher, which will supposedly go well for US demand and a Chinese soft landing. AUD/USD has maintained its push above 1.03-1.04 Tolerance at 1.05, appearing on its merry way to at least the next significant congestion and oscillator resistance in the 1.0750-75 area. That said, the Canadian dollar has been the commodity currency laggard of late, with USD/CAD only down to the lower of its significant 1.01-1.00 supports. Even below that, weekly MA-41 in the previous hefty congestion and up breaks await in the .9900-.9800 support range.

However, the true testament to the weakness of the US dollar is the rebound of GDP/USD from its most recent test of major 1.5245-25 support all the way up to near its recently stubborn 1.5750 resistance. And that’s from a currency of a country that just this week confirmed that might be headed into recession. How the heck do you attract flows out of the ostensibly growing US to the currencies of countries headed into recession so definitive as in Europe and potentially likely like the UK unless this is all on pure short-term interest rate differentials and opportunistic commodity purchase trading?

And so we proceed once again into a “greater fool” international capital markets and trading environment. As long as assumptions about Europe being able to inoculate its banks against the Greek debt default, China achieving a soft landing (even if current commodity price escalation is going to set off monetary policy alarms), the US is growing well enough to maintain the sentiment that good corporate profits will fuel a recovery in spite of still-depressed job creation, we suppose that there will be a rush to be invested prior to the next individual getting there first.

Thanks for your interest.

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