How Temporary is Temporary

Monetary stimulus is supposed to be temporary in nature, both in terms of how long it is kept in place, and in how long it provides benefits to the markets and economy. With the Fed's decision to keep policy accommodative ad ifinitum, will the effects of Fed policy last as long? There is evidence that the benefits of Fed policy wanes over time. We believe that QE3 will be largely ineffectual in terms of job creation. Even if the Fed could lower mortgage rates 50 basis points, it would do little to spur new borrowing or more refinancing. Consumers who can refinance would probably use the newfound cash to pay down other debts. This might benefit the economy down the road, but not immediately. However, the most likely result would be to keep many households, which are now struggling to get by, from imploding financially. As we demonstrated with several charts this past week, households have a long way to go just to reach a sustainable debt to income ratio. We expect the rally in commodities and decline in the value of the dollar to be temporary. Why? Because governments around the world are also trying to devalue their currencies. Once foreign central banks work their magic, we believe that we will see long-term yields settle in and the dollar slide to halt or, even, reverse. Here are some interesting charts: U.S. 10-year since 2009 (source: Bloomberg):

As you can see, the yield of the 10-year rose during the times surrounding QE1 (2009) and QE2 (late 2010). Each time the 10-year yield reset back to or below the levels seen prior to QE (admittedly helped by the “twist,” which is not going away). During 2012, the 10-year yield has been influenced by a slowing global economy. This has caused a flight to safety among investors. As we mentioned previously, foreign central banks have also done their share to keep a lid on long-term U.S. interest rates. We expect this to continue. A similar pattern exists in the value of the euro versus the dollar:

Notice that the biggest spikes were around the times of QE1 and Qe2 (2009 and 2010). We expect Europe to remain dysfunctional is looking to engage in open-ended money printing of its own. If history repeats itself, currency speculators may be singing “there’s no place like home for the holidays” by year end. Oil prices demonstrate somewhat different, but not altogether dissimilar pattern:

Oil prices began to rise on 2009 with the discussion and eventual launch of QE1. It spiked with the launch of QE2. It fell with the soft patch in mid-2011 and spiked on the mild winter, which provided market participants with false hope that the economy was gaining traction. Oil fell again with yet another soft patch before spiking following Fed (and ECB) comments that more easing is on the way). We believe oil prices could remain elevated heading into the winter. The weaker dollar (albeit probably temporary) and, what many meteorologists are forecasting to be, a harsh winter in the Northeastern United States (the region which carries most of the nation’s demand for home heating oil) maintain upward price pressures for crude oil. However, unless our elected officials can make real progress on fiscal policies, we could see another soft patch begin to materialize in the second quarter of 2013. If we fall off the so-called “Fiscal Cliff,” the soft patch could coincide with the 2013 calendar. Tom Byrne tom@bond-squad.com. www.bond-squad.com www.mksense.blogspot.com 347-927-7823 Twitter: @Bond_Squad Disclaimer: The opinions expressed in this publication are those of the author. They are not, nor should they be considered solicitations to purchase or sell securities.