Last night we went to bed reading rumours of Vladimir Putin’s plan for a new world reserve currency to replace the U.S. dollar. This morning, we wake up to the news that the Federal Reserve will buy $300 billion in U.S. Treasury bonds and another $750 billion in mortgage-backed securities. Gold was up six percent.
What we have now-with crystal clear clarity-is asset inflation. Bonds and shares will benefit first, if benefit is the right word. If the up-tick rule is reinstated and mark-to-market accounting is suspended, you could see a pretty impressive rally in stocks over the coming weeks and months.
But you’ll also see that inflation spread beyond share markets to tangible assets. Do you think this news comforted the Chinese? Will they be glad the Fed is buying long-term bonds? Or will they be selling?
Locally, shares may follow Wall Street and head up on the Fed news. But the real winner already is the Australian dollar. It was up three percent to sixty seven cents against the greenback.
And why wouldn’t it be? The Fed is now “monetising” American debt in an effort to bring mortgage rates down and put a floor under Treasury prices. By “monetising” we mean it is trading freshly printed cash for Treasury bonds owned by other investors.
The Fed hopes that cash will shoot out into the credit markets as new loans and un-freeze things. Maybe it will. Maybe it won’t. But it’s pretty obvious you can’t pump up the money supply by a few hundred billion dollars and not expect the general price level to rise.
There are two parts to this story really. The first is the fate of the U.S. dollar and what will happen in the Treasury market. The second is the U.S. housing market. Let’s deal with the second first.
The real goal of the Fed policy change is to bring mortgage rates lower and engineer a refinancing boom. How do we know? The Fed said so.
“To provide greater support to mortgage lending and housing markets,” the FOMC statement read, “the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.”
It’s hard to see how re-financing activity leads to a clearing of the huge and growing inventory of new and existing homes. But maybe the Fed thinks lower mortgage rates will kick off new home buying-or at least stabilise the fall in house prices nationwide.
If it did that-a nearly inconceivable IF-it might prevent a lot of those Option ARMs we wrote about yesterday from re-casting into negative equity. It also depends on which mortgage-backed bonds the Fed is buying. Is it buying newer vintage stuff from Fannie and Freddie? Or is it dipping its toe into the toxic pools, hoping to establish a price for this stuff that will give banks and private capital some price clarity? We’ll check into that.
In the mean time, the Fed added that, “to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.”
“I have a strong feeling,” writes our colleague in the States Dan Amoss, “that today’s decision has sealed the next big up move in gold, oil, and other valuable tangibles (by big move, I mean multiples of current prices over the next few years). We might have seen the end of deflation scare, or we are at least much closer to the end.”
“With the Fed now explicitly supporting the Treasury note and Treasury bond market, how else will the ‘bond vigilantes’ express their displeasure with the inflationary policies emanating from Fed/Treasury/Congress?
“Who has the guts to short the Treasury market now? I don’t think Bernanke is bluffing about monetizing the deficit this time, as bluffed in December.
“So the Chinese and other creditors will probably just accelerate their moves into the small market for tangibles. They can think one step ahead and see the looming dollar devaluation. Maybe they’ll hit the Fed’s bid in the Treasury markets and plow the proceeds into something of lasting value. They can dump a big chunk of their T-bond portfolio without setting off a violent, internationally destabilizing move up in T-bond rates. Why not?
“Longer term, one wonders how big institutional bond investors will react, knowing that they are investing in a much more rigged market (although since they’re all Keynesians anyway — including Bill Gross — they like operating in rigged markets).
“Econ 101 tells us that government-imposed price floors (in this case, for Treasuries) lead to persistent gluts/surpluses…think of farm price supports during the Depression and dumped milk. So today’s action will unfortunately only encourage the crooks in Congress to float even more Treasury bills for their pork projects.
“We’re just that much closer to a Banana republic after today. The only relief valve for today’s decision that comes to mind is accelerated decline in the dollar’s value against anything tangible.
On a completely un-related note, your editor visited the doctor earlier this week and received some unorthodox advice. “Are you sleeping well,” the doctor asked?
“Stop drinking coffee. It wakes you up at night. And if you’re reading in bed-which you shouldn’t do-put the book down as soon as you get sleepy. Don’t finish the chapter. Books are not like television. Television is terrible anyway. But with books, you can start reading at the same spot. You should do that.”
“Okay…but about the coffee…how else can I get the same caffeine kick I get from coffee? Should I drink apple juice or something?”
“No. You should laugh.”
“Haha. Very funny.”
“No really. You should laugh. He he he. Laughter is an excellent stimulant. You can take classes in the parks. People laugh. It’s healthy. Laugh. Ha ha ha. Ha ha ha ha ha. See?”
“He he he…uh..ha ha…uh…are you kidding?”
“Ha ha ha! No. Goodbye Mr. Denning! Ha ha ha,” he said as he handed us the bill.
for The Daily Reckoning Australia