QE2 hasn’t been initiated yet, but we’ve seen some remarkable moves in the markets since rumors of QE2 began circulating. As I noted the other day input costs have been rising almost across the board as the dollar declines and investors fear the “money printing” of the Fed. The bond market, however, doesn’t appear to be responding so favorably. Since the rumors of QE2 began on August 3rd the 10 year treasury yield has moved just 34 bps. Since Mr. Bernanke’s Jackson Hole speech the yield hasn’t even budged!
This is reminiscent of QE1 when interest rates actually ROSE throughout the entire program. Despite claims that QE will have a broad interest rate effect the historical evidence corroborates no such thing. In Japan, interest rates rose marginally during their QE efforts. During QE1 here in the USA interest rates moved higher throughout the entirety of the program. Why is this all important? Because Mr. Bernanke believes he can create a refinancing effect that will boost aggregate demand. If he can talk down rates and create a refinancing effect for debtors (which would subsequently help aggregate demand) then there is an argument that QE will be beneficial.
What Mr. Bernanke didn’t consider was the potential for QE to spark a massive move into commodities. This is increasing the input costs across the commodity markets as investors misinterpret QE as “money printing”. As we’ve already started seeing at various companies, these input costs are not being passed along easily because end demand remains very weak. So what Bernanke is actually doing is creating inflation for producers while disinflation continues at the consumer level. What does it all mean? It means margin compression. And margin compression means no hiring. And no hiring means no increase in aggregate demand.
I’ve maintained since day one that QE would fail with flying colors. The markets see this as some great recipe for economic growth. I have called it the “greatest monetary non-event”. That might be wrong. It actually might be the greatest economic destruction plan since the bank bailouts.
If the recent trends in the markets continue we have to begin asking ourselves if QE2 isn’t actually HURTING the economy?
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.