Chris Gaffney

Well, the FOMC didn’t disappoint the equity markets, though Bernanke certainly disappointed Chuck! The Fed decided to institute another round of bond buying in order to try and boost the housing and labor markets. The markets had counted on the Fed announcing some sort of plan, but Bernanke’s use of unlimited funding was even more dovish than most had predicted. The equity market shot up, the dollar fell, and precious metals got a boost.

The Fed took a page out of the ECB’s playbook by keeping their program open-ended, with a promise to continue injecting liquidity into the markets until the jobs market improves. The announced stimulus plan is actually a combination of two different ones; first they announced a new plan to purchase up to $40 billion a month of agency mortgage-backed securities, and they also announced an extension of their Operation Twist.

Combined, these two programs will have the Fed purchasing up to $85 billion of longer term securities per month through the end of the year. And if the labor market doesn’t improve, the program would be extended and could also be expanded. Finally, the Fed said they would keep short-term rates (the only ones they can directly impact) near zero until at least mid-2015, a bit longer than their previous estimate of late 2014. Apparently the Fed has all but forgotten the first part of its ‘dual mandate’. How can they guarantee inflation won’t show up until 2015? But I guess that is a bit easier when they are the ones reporting the inflation numbers.

Chuck should be patting himself in the back right now as he predicted that this would be the meeting stimulus was announced long before the Big Boys! He called the desk just after the FOMC announcement to let us know just how upset he was regarding this latest round of stimulus. Here is a quote from our conversation: “Unfortunately I don’t think this was the right call by the FOMC. I am incredibly upset the Fed decided to send us down this dangerous road and believe this decision will end up being looked back on as a horrible one for our country. A bad day for the US…”

The FOMC voting members have definitely turned a blind eye on inflation, and are clearly focused on making sure the equity market remains strong. But that doesn’t even justify unlimited debt creation. As I pointed out the other day, the US stock market is currently trading near the same levels we were at back in 2008, before the debt crisis. So with equity markets already near record levels, the Fed couldn’t have been focusing on them. Maybe FOMC policy makers really think they can create jobs with lower rates. The problem is that with the exception of the thousands employees who directly work for the Fed, Bernanke and his policy makers really don’t have any way of directly impacting US employment.

And Bernanke doesn’t even buy into this line of thinking, and questions the Fed’s ability to lower the nation’s unemployment rate. “I personally don’t think it’s going to solve the problem,” Bernanke said, a point he made several times. He pointed to congress and the President to do something about the fiscal cliff which he fears will send the US economy back into recession. “I don’t think our tools are strong enough to offset a major fiscal shock,” Bernanke said. But Bernanke apparently felt he had to do something in this election year, and was therefore compelled to announce another round of bond buying. It is pretty sad when the Fed Chairman admits the actions the Fed has just announced probably won’t work. Sounds pretty desperate, doesn’t it?

But stimulus it is; and a bunch of it! The dollar continued to sell off after the news of the stimulus plan, and the precious metals also shot higher. In fact, the only currency which sold off after the announcement was the Japanese yen which was widely seen as the other ‘liquidity’ option during the crisis. Equity investors were absolutely giddy with excitement after the announcement and moved out of their ‘safe havens’ in the US treasury bonds and back into stocks and other higher yielding investments. The 10-year US treasury yield rose almost 10 basis points with yields rising to 1.82%. Wait a minute, isn’t this the exact opposite of what the FOMC wanted to see? Yep the Fed announces an unlimited program of bond purchases in order to push interest rates down, and immediately following the announcement the 10-year bond yield shoots up 10 basis points. It shows you just how complicated of a job the policy makers at the Fed face.

Data released yesterday confirmed the US recovery is still mixed. Producer prices here in the US rose 1.7% during August after a 0.3% gain the month prior. Prices were up 2% YOY compared to an increase of just 0.5% last month. Both figures were above economists’ projections, and show inflation is definitely starting to creep back into the economy. Today we will get a reading on consumer prices which are predicted to have rose 0.6% during August after remaining flat in July. The yearly figure is predicted to show that prices paid by consumers are increasing at a 1.7% rate. While this data doesn’t sound alarm bells, the direction of the figures is concerning. The Fed may be ignoring the possible inflationary impact of their stimulus programs, but investors are wise to keep an eye on price moves as I believe once we start to see inflation it may be too late for the Fed to do anything about it.

The weekly jobs data was also released yesterday, and was overshadowed by the FOMC announcement. The administration was probably glad no one focused on the weekly numbers anyway as they showed an increase in the number of new unemployment claims. Weekly jobless claims increased to 382K from last week’s revised 367K number. Continuing claims fell slightly as workers continued to drop off the rolls.

The euro (EUR) continued to climb, forcing some of the Wall Street banks to capitulate on their earlier calls for the euro to weaken. Morgan Stanley had predicted the euro would be trading at $1.19 at year end, but moved their projection for the euro up to $1.34 after the ECB and FOMC moves. Even the $1.19 call was seen by many as too strong just months ago, with many ‘experts’ predicting the euro would fall below parity. It just illustrates how hard it is to predict short term movements in the currency markets, and even medium term trends. The key is to invest in currencies which are from countries with strong economic fundamentals. These are the currencies which should do well in the long term, and that is the view investors should take.

The top 5 currency performers versus the US dollar over the past 24 hours were the Mexican peso (MXN) (up 1.54%), New Zealand dollar (NZD) (up 1.24%), South African rand (ZAR) (up 1.17%), Canadian dollar (CAD) (up .80%), and the Australian dollar (AUD) (up .77%). Of course all of these currency returns were dwarfed by the precious metals, which saw some eye-popping price jumps; Silver was up 4.24%, Platinum up 2.36%, and Gold up 2.10% in just one day! Do you see a pattern here? The commodity bull market is back in force, and the investors are moving back into the commodity currencies.

The metals markets were helped by the ongoing strikes in South Africa. Platinum miners at Lonmin Plc, the third largest global platinum producer, rejected a wage offer from the company and continued to stay away from the mines. The strikes at the Lonmin mine have spread across the South African mining industry, raising prices of metals and capping the rise of the South African rand. But while the rand is facing some selling pressure, the commodity rally has the currencies of the Australian and Canadian dollars heading higher.

It was definitely a risk-off day, and a great one for anyone who had diversified away from the US dollar. The high-yielding currencies of Mexico and New Zealand joined the party as investors sought out higher interest rates. The Fed’s action has investors in a better mood, and as long as you are diversified out of the US dollar, QE3 is probably a good thing for you. Unfortunately it is not so good for the US economy in the longer term.

Then there was this… I know Chuck usually uses this section to report on stories that peek his interest, either because they make a very good point or they get his blood boiling. But I’m going to use this section to report an error I made yesterday. I wanted to talk about the Danish krone and its peg to the euro and I came across a story which reported the results of Dutch elections and mistakenly combined the two. I can blame lack of sleep or the time pressure to get the Pfennig out the door, but there is really no excuse, I just messed up. The elections weren’t in Denmark; they haven’t had elections in over a year. The elections were held in the Netherlands where they re-elected the incumbent prime minister. He is a centrist and ally of Germany’s Chancellor Angela Merkel and the results were seen as a vote of confidence in the euro. Sorry again for any confusion I caused, and thanks to all of the sharp Pfennig readers who caught my error.

To recap. Chairman Bernanke announced QE3 which entailed unlimited purchases of mortgage backed bonds and another round of operation twist. The stimulus program was actually a bit more aggressive than the markets had predicted, and the equity markets rallied as a result. The dollar was sold like funnel cakes at the county fair as every currency — with the exception of the Japanese yen (JPY) — rallied. The inflationary actions of our Fed also pushed metals prices higher, shooting silver up over 4% in a few minutes.

Chris Gaffney
for The Daily Reckoning

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Chris Gaffney is vice president of EverBank World Markets and the alternate author of the popular Daily Pfenning newsletter. Mr. Gaffney has been involved in the global marketplace since 1987, and is director of sales for EverBank World Markets. The Daily Pfennig is delivered via e-mail to tens of thousands of market watchers globally, providing commentary that allows them to stay on top of economic, currency, and market happenings. He is a Chartered Financial Analyst and holds degrees in accounting and finance from Washington University in St. Louis.

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