Peak Theories Research LLC
The Weekly Peak
November 12, 2010
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Well, Mr. Bernanke chose something much better than jawboning. He chose its uptown cousin called
.And he did so well before August by setting the stage in late July in talking about the “unusually uncertain” times and then reinforcing that viewwith the aforementioned downbeat assessment from the August FOMC meeting. In so doing, Mr. Bernanke provided himself with a bottom tolaunch from on the spring of another potential round of quantitative easing or what was dubbed QE2.Specifically, Mr. Bernanke said, “Should further action prove necessary,
policy options are available to provide additional stimulus
.”Remembering the rather positive effect QE1 had on the stock indices and commodities in 2009, investors started to play opposite Mr. Bernanke’sbluff by bidding up stocks and commodities on the back of an implicitly-Fed supported decline in the dollar. Investors did this while looking pastthe fact that such money-pumping was unlikely to do little to stimulate the economy itself while also looking past the fact that QE2 was not adefinite and if it did occur, its specifics were unknown.However, it was the Fed’s September 21 statement and its pledge “to
provide additional accommodation
if needed to support the economicrecovery” that moved investors into full rally mode.Without spending a penny or committing to a particular plan around another round of quantitative easing, Mr. Bernanke’s communication causeddouble-digit percentage gains in stocks, gold, silver, and oil along with many other commodities between his August speech and the actualannouncement of QE2 on November 3.Not bad for three words and behind it Mr. Bernanke’s mastery of psychology and with it
a psychology of wealth and confidence
thepsychology required to get the economy moving more quickly again
.In addition, Treasury yields moved to early 2009- and, in some cases, record-low levels by early October when by mid-October the price of thesesecurities started to fluctuate and even decline as judged by the 10-year’s yield moving above 2.70% from below 2.40% before the November 3QE2 announcement. And this brings us to an interesting point.While one of the goals of QE2 is to lower borrowing rates, the mere anticipation of QE2 caused yields and thus rates to drop to absurdly low levels.This goal, then, was achieved pre-QE2.As I wrote yesterday and while I don’t have the math to back it up, it seems to me that there’s little absurdly low rates will do to stimulateborrowing activity in a weak economic environment beyond what historically low rates might do. And so, if the 10-year’s yield moves up from itscurrent 2.65% to say 3.0% or even 3.25% on the relatively benign inflation risk introduced by the monetary part of QE2, borrowing rates will moveup slightly but will remain historically low while the Fed may succeed in moving away from disinflation and avoiding deflation.And so it seems that everything Mr. Bernanke could have hoped to have achieved by actually buying Treasury securities was achieved by simplycommunicating its possibility. The Fed planted the QE2 seed and investors did the rest.Rates are down with room to move up modestly while still remaining low, the stock market and other risk assets have been bid up creating a senseof prosperity, and the dollar’s decline may help with U.S. exports while introducing a touch of real world inflation through more expensive imports.
The critics of QE2 are many
though with the critiques ranging from currency manipulation to asset bubble promotion here and abroad to moralhazard to runaway inflation to skepticism over the wealth effect.While each of these points is valid, I think
QE2’s many critics miss
what I have been writing about here or
.Trying to determine the exact effect of the stock market’s rise or even QE2 itself on GDP is interesting but stoking life into an economy on the brinkthrough monetary policy is as much about art as it is science. When traditional policy is no longer an option, I think it becomes a matter of creating the aforementioned psychology of wealth and confidence to induce, potentially, increased corporate and consumer spending. It is aboutcreating an environment of certainty in which both corporations and consumers are going to be willing to borrow and spend while banks will bewilling to lend.Such a sensibility cannot be captured by math and without it, the economic recovery cannot be supported nor can price stability be sustained.In other words,
this is about restoring complete confidence to a system that was shaken to its core by the worst financial crisis in a century
andin the face of fiscal paralysis.While it’s unknown how such confidence is re-established or how long it takes, it seems that Mr. Bernanke has been successful in reigniting thissort of a psychology and one that may have a chance of becoming a self-fulfilling prophecy if the spark truly takes hold.