$SPY vs. Federal Reserve QE and EPS Deflation (10/23/2012)

The S&P 500 ETF ($SPY) broke through April 2012 support today and is now testing a 1-year uptrend line and rising channel, which formed during the 2011 equity crash when Congress raised the debt ceiling and Standard & Poor's downgraded U.S. government debt. It is interesting that the S&P 500 peaked when the Fed announced QE3 on September 13, 2012. David Rosenberg, chief economist and strategist at Gluskin Sheff, said it is because "corporate earnings are on the down escalator." So QE is now battling EPS deflation.


source: freestockcharts.com


But if $SPY breaks down here, it could still find refuge (possibly) at the ultimate bull market uptrend line. That will be a fun line to watch when it gets tested, and even better if there is lower than average volatility.

Going forward, I wouldn't be surprised if we saw a repeat of 2011's sideways action for six months, which eventually created a perfect head and shoulders or diamond top formation to risk short positions (in size!). Also, the bull market took about 6 months to officially end in the second half of 2007. Even with the Fed's open-ended backstop in place, I still think there are significant downside risks for the S&P. We have the potential for fiscal tightening in 2013 when tax cuts and spending programs expire at the end of the year (the fiscal cliff), which Bernanke said the Fed couldn't fight. And the economy is already sluggish, and mostly being propped up by the Fed's QE programs, leveraged agency MBS REITs, and private equity and hedge fund managers (123) buying up distressed subprime MBS, real estate, and foreclosed homes (and sometimes for quick flips). But there is the same amount of price manipulation and distortion today as there was in 2006-7 with mortgage-backed securities, CDOs, and credit default swaps. Hopefully the Fed won't be forced to act against its long-term strategy to battle a currency crisis, inflation, or geopolitical conflict ☂.


Source: freestockcharts.com


The FOMC (Federal Open Market Committee) meets today and tomorrow (Oct 23 and 24) and traders are trying to figure out if QE4 will come at the end of the year, or if the Fed will change its "language" on rates. In the FOMC's September 13 statement (see below), the committee announced QE3 in the form of agency MBS purchases, or QE infinity since it is open-ended, and that zero percent interest rate policy would last through at least mid-2015. So this time around, or in the near future, instead of just saying the committee "currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015, the FOMC could target a specific unemployment rate. Read more at FT's Money Supply Blog (What to expect from the FOMC – October 2012), MarketWatch (Fed considers upping QE3 size and language), and CNBC (Fed Maintains Dovish Stance as Earnings Ruffle Markets). Either way, all of this can move the market and economy, so watch how indexes react to all of this Fed manipulation.

For reference, below is the previous FOMC statement on QE3 and ZIRP through mid-2015, and information on the meeting from the Fed's minutes release. I will put up the new FOMC statement tomorrow.


Source: http://www.federalreserve.gov/monetarypolicy/fomcminutes20120913.htm

"Committee Policy Action
Committee members saw the information received over the intermeeting period as suggesting that economic activity had continued to expand at a moderate pace in recent months. However, growth in employment had been slow, and almost all members saw the unemployment rate as still elevated relative to levels that they viewed as consistent with the Committee's mandate. Members generally judged that without additional policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Moreover, while the sovereign and banking crisis in Europe had eased some recently, members still saw strains in global financial conditions as posing significant downside risks to the economic outlook. The possibility of a larger-than-expected fiscal tightening in the United States and slower global growth were also seen as downside risks. Inflation had been subdued, even though the prices of some key commodities had increased recently. Members generally continued to anticipate that, with longer-term inflation expectations stable and given the existing slack in resource utilization, inflation over the medium term would run at or below the Committee's longer-run objective of 2 percent.

In their discussion of monetary policy for the period ahead, members generally expressed concerns about the slow pace of improvement in labor market conditions and all members but one agreed that the outlook for economic activity and inflation called for additional monetary accommodation. Members agreed that such accommodation should be provided through both a strengthening of the forward guidance regarding the federal funds rate and purchases of additional agency MBS at a pace of $40 billion per month. Along with the ongoing purchases of $45 billion per month of longer-term Treasury securities under the maturity extension program announced in June, these purchases will increase the Committee's holdings of longer-term securities by about $85 billion each month through the end of the year, and should put downward pressure on longer-term interest rates, support mortgage markets, and help make broader financial conditions more accommodative. Members also agreed to maintain the Committee's existing policy of reinvesting principal payments from its holdings of agency debt and agency MBS into agency MBS. The Committee agreed that it would closely monitor incoming information on economic and financial developments in coming months, and that if the outlook for the labor market did not improve substantially, it would continue its purchases of agency MBS, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability. This flexible approach was seen as allowing the Committee to tailor its policy response over time to incoming information while incorporating conditional features that clarified the Committee's intention to improve labor market conditions, thereby enhancing the effectiveness of the action by helping to bolster business and consumer confidence. While members generally viewed the potential risks associated with these purchases as manageable, the Committee agreed that in determining the size, pace, and composition of its asset purchases, it would, as always, take appropriate account of the likely efficacy and costs of such purchases. With regard to the forward guidance, the Committee agreed on an extension through mid-2015, in conjunction with language in the statement indicating that it expects that a highly accommodative stance of policy will remain appropriate for a considerable time after the economic recovery strengthens. That new language was meant to clarify that the maintenance of a very low federal funds rate over that period did not reflect an expectation that the economy would remain weak, but rather reflected the Committee's intention to support a stronger economic recovery. One member dissented from the policy decision, on the grounds that he opposed additional asset purchases and preferred to omit the calendar date from the forward guidance; in his view, it would be better to use qualitative language to describe the factors that would influence the Committee's decision to increase the target federal funds rate.

At the conclusion of the discussion, the Committee voted to authorize and direct the Federal Reserve Bank of New York, until it was instructed otherwise, to execute transactions in the System Account in accordance with the following domestic policy directive:

"The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output. To further its long-run objectives, the Committee seeks conditions in reserve markets consistent with federal funds trading in a range from 0 to 1/4 percent. The Committee directs the Desk to continue the maturity extension program it announced in June to purchase Treasury securities with remaining maturities of 6 years to 30 years with a total face value of about $267 billion by the end of December 2012, and to sell or redeem Treasury securities with remaining maturities of approximately 3 years or less with a total face value of about $267 billion. For the duration of this program, the Committee directs the Desk to suspend its policy of rolling over maturing Treasury securities into new issues. The Committee directs the Desk to maintain its existing policy of reinvesting principal payments on all agency debt and agency mortgage-backed securities in the System Open Market Account in agency mortgage-backed securities. The Desk is also directed to begin purchasing agency mortgage-backed securities at a pace of about $40 billion per month. The Committee directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve's agency MBS transactions. The System Open Market Account Manager and the Secretary will keep the Committee informed of ongoing developments regarding the System's balance sheet that could affect the attainment over time of the Committee's objectives of maximum employment and price stability."

The vote encompassed approval of the statement below to be released at 12:30 p.m.:

"Information received since the Federal Open Market Committee met in August suggests that economic activity has continued to expand at a moderate pace in recent months. Growth in employment has been slow, and the unemployment rate remains elevated. Household spending has continued to advance, but growth in business fixed investment appears to have slowed. The housing sector has shown some further signs of improvement, albeit from a depressed level. Inflation has been subdued, although the prices of some key commodities have increased recently. Longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook. The Committee also anticipates that inflation over the medium term likely would run at or below its 2 percent objective.

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee's holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The Committee will closely monitor incoming information on economic and financial developments in coming months. If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability. In determining the size, pace, and composition of its asset purchases, the Committee will, as always, take appropriate account of the likely efficacy and costs of such purchases.

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. In particular, the Committee also decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015."

Related Posts

Comments

HTML Comment Box is loading comments...