Just what depths of political stupidity are markets discounting? The partial shutdown of the US government passed with little or no impact on the markets that stood to be most affected, even though there was uncertainty about it to the end.
Almost all European stock markets opened higher, despite the news from the US. The dollar index dropped 0.35 per cent in the minutes following the realisation that the shutdown would happen, and then recovered somewhat. The yield on the benchmark 10-year Treasury bond gained 5 basis points to 2.66 per cent – still far below the 3 per cent it briefly touched a few weeks ago. So what has happened so far – the failure to agree on a budget and an initial shutdown of the US government – has evidently been priced in.
Is it more accurate to refer to QE∞ instead of QE3? Unlike the previous doses of US QE, this campaign of asset purchases has no official limit, and will carry on until the unemployment rate has improved “substantially” – a word that the Federal Reserve can define, and redefine, as it sees fit over the years ahead.
I have already argued that this should be regarded as stunningly aggressive. In the latest Note video, Gavyn Davies, a fellow FT blogger, agrees. The key point, he suggests, is that over the last year the Fed’s reaction function has changed. It is not just that the employment situation has worsened but also that, for whatever reason, it has decided to give the full employment part of its mandate greater emphasis than before. There are plenty of possible reasons for this, which we discuss in the video:
The Federal Reserve has given the markets all it hoped for and more: unlimited quantitative easing (QE3), in the form of $40bn a month of mortgage bond purchases, an extension into 2015 of the zero-rate forecast, and a change in the reaction function to say the Fed won’t raise rates until an economic recovery is well under way.
Is this Ben Bernanke’s final shot? His own words suggest not. Here’s a handy checklist of what he’s done so far, and what could be to come, as set out in his 2002 speech on how to fight deflation. These are in the order he set them out in the speech, rather than the order in which they’ve been tried so far.
Whether it likes it or not, the Federal Reserve has been pulled into the political thickets. The demand is for it to “do something”. Whatever it does at its meeting this week will have political ramifications, and you do not need to belong to the Ron Paul faction to question whether further QE of any kind is necessary at this stage.
As James Mackintosh pointed out in the Short View, inflation expectations and asset prices are both rising now, rather than falling as they were before QE1 and QE2. This Fed has a philosophical aversion to deflation, but there appears to be no imminent danger of that.
The most profitable way to be wrong over the past five years was to bet that frantic printing of money by central banks would create inflation – so buy gold. Since the start of 2007 gold has risen at an annualised 19 per cent, a tasty return, particularly when compared to equities.
Yet, there’s been no sign of consumer price inflation, even as the US Federal Reserve explicitly targets asset price inflation (Fed jargon calls this the “portfolio channel” for monetary transmission of quantitative easing; in English that translates as rigging the market).