Say What?
Last week, we took a look at “the gathering storm that may accompany the end of QE2.” Since then, the storm has indeed been gathering, with the financial pages of the newspapers bursting with articles about bond fund managers who say the end of QE2 will cause interest rates to rise and other bond fund managers who promise that the end of QE2 will be a non-event.
The argument for the latter is pretty compelling. The markets have had plenty of time to prepare for the demise of the program that has seen the Fed buying up hundreds of billions’ worth of Treasury securities. Arguably, if the markets were going to react to the Fed putting QE2 out of its misery, the changes would already be priced into the market.
There is, however, a fly in this logical ointment. Specifically, we haven’t any idea what exactly the Fed will do. It could extend QE2, or alter the program slightly and hold on to a revised version, or stop buying Treasury securities very slowly, or engage in any number of arcane maneuvers that few of us understand (“Oh, we’ll just issue more debt and call in reverse repos and flood the market with CDOs”). Or it could start pocketing the pay-offs when its Treasury securities reach maturity, rather than using the money to buy more securities. Or, as several experts wisely proclaim, it could simply remove the phrase, “for an extended period,” from its monthly statement about keeping short term rates low. Welcome to the fun zone.
In any case, we’ll have some insight into the Fed’s plan, if it really has any, in the Wednesday announcement after this week’s meeting of the Open Market Committee. Fed Chairman Bernanke even promises a press conference of sorts.
Then there’s the question of how and when the Fed will start to put the squeeze on short-term rates. Experts—if it’s possible to be an expert on the unknowable—believe the Fed will be slow to start…possibly swinging into sluggish action by the beginning of next year. And, of course, we don’t know exactly what it will do. In this case, we’re pretty sure the Fed doesn’t entirely know either.
I should add that Bill Gross, who runs PIMCO, is relatively certain the end of QE2 will bring on a lot of volatility and take rates higher. He may be right, of course. The most impressive fact about the winding down of QE2, as we’ve seen, is that no one seems to know how it will be done or when. Without knowing those essential pieces of the puzzle, how can we predict what will happen?
We can’t.
Investor markets, of course, aren’t keen on uncertainty. As we have seen all too many times in the past few years, they tend to flop around like a mackerel thrown into the bow of a fishing boat when they don’t know what to do next. They also tend to rush into safe haven investments, like gold and Treasury securities.
Which raises perhaps the final issue to be watching carefully in the coming months. The turbulence—around questions of how and whether the U.S. is going to be able to handle its debt—has caused the dollar’s exchange value to decline of late, and inspired ratings agencies to look askance at the dollar, and foreign central bankers to consider other currencies for trading oil, gold and other items. These be rather dangerous times, matey, though most of this is more fury than substance.
Nonetheless, it’s hard to imagine that we’re looking at economic and political trends that will be conducive to low interest rates for very much longer. Surely this limb we’ve been crawling out on has bent nearly to the breaking point—though its strength seems capable of surprising us almost indefinitely. The bottom-line truth is that we just don’t—and can’t—know much. But listen carefully to Ben this week.
by: Bill Fisher
