... don't worry Henderson - Bernanke will catch you anyway.
Apologies for the delay, some technical gremlins caused us a touch of trouble. A most interesting few trading days was bookended by Tuesday's massive relief rally, a move ignited by The US Fed's promise to keep interest rates pinned at essentially zero for another two years. As we've said repeatedly on these pages this should come as no surprise: too much of America's debt is short-term in nature so any increase in interest rates would swiftly skewer them (if people think the US has a debt problem now then imagine the mess if rates were twice as high). Ergo rates simply can't go higher, and so it has proved: the Five Year Treasury is today returning less than 1% per annum; the Ten Year close to 2%! This is an unprecedented situation - unless, of course, you are Japanese in which case it is boringly familiar. One should also note that Japan disproves the idea that America's recent debt downgrade will hike interest costs, Japan hasn't been a AAA credit since back in 1998 (at one point being rated below Botswana!) but rates have remained entirely subdued over the intervening years, her current Ten-Year debt yields just 1%! It's simply undeniable that there is increasingly little lost in translation when one compares the Japanese experience to America's current predicament.
There were perhaps two particularly interesting aspects of the Fed announcement (apart from the above rate commitment): firstly they essentially confirmed that they see the onset of a fresh recession and that it will be accompanied by its usual deflationary playmate; secondly the statement contained little indication of a distinct "Quantitative Easing 3" project, i.e. fresh asset purchases by the Fed or targeting a specific rate much further out the curve. Perhaps one reason we won't endure another round of the recent quantitative easing programs can be seen in the following chart, it built nothing but a big bubble:
(The Jackson Hole reference is the speech at which Bernanke fist announced his QE program)
Despite the lack of an explicit commitment to QE, stocks rallied strongly higher with many participants suggesting that investors, faced with another two years of earning zero interest, will be forced into the stock market to earn a return. There's undoubtedly some truth behind this and the likely beneficiaries of such a move would be the safer dividend paying plays (Eli Lilly, for example, pays about a 5.5% dividend and trades at 9 times earnings; a saver who puts $35k in Eli Lilly stock gets paid $500 by the pharmaceutical giant every three months, if they put the $35k in a bank then in real terms they'd likely be down in two years time, they certainly won't be up). The chase for yield can be a powerful force and it will be interesting to see if it presses higher yielding currencies back up after their recent declines. It is certainly difficult to see the medium term outlook as being positive for the Dollar (unless the Euro crisis drastically worsens) and global tensions will be piqued by Bernanke's latest statement: another two years of zero rates will irritate the emerging markets who are already struggling with inflation; it will certainly irritate the Swiss who have an absurdly strong currency to deal with (one analyst pointed out on Bloomberg this evening that a Big Mac in Zurich now costs $17!) now there's less reason to move out of Francs into Dollars; and it will irritate the Russians because, well, they're irritable at the best of times.
More commentary as we dissect the market reaction...
