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What More Fed Easing Means For Markets: 'America On Sale'

Wednesday, 22 Sep 2010 | 1:28 PM ET

For investors, the Fed's looming round of money-printing looks like a fairly easy call: Go long on dollar-denominated assets and short on the dollar itself.

Traders work on the floor of the New York Stock Exchange.
AP
Traders work on the floor of the New York Stock Exchange.

That means commodities—particularly gold and grains—look especially inviting. At the same time, bond prices should keep going up and the stock market ought to improve marginally at least.

The dollar, meanwhile, likely will weaken against the euro, the Swiss franc and the British pound as its global competitors keep their currencies strong and the US looks to make its goods more valuable through debasing of the currency.

Easy, right? For the most part.

"Most commodities are benchmarked against the US dollar, so basically America is on sale," says Todd Horwitz, chief strategist at the Adam Mesh Trading Group in New York. "The Fed is going to do whatever it takes to support this market. They don't care what it is."

Yet investors haven't exactly been dancing on Wall Street since the Fed released its Open Market Committee pronouncement Tuesday that many observers took to indicate a second round of quantitative easing to goose the economy.

Stock trading has largely meandered on weak volume and little conviction. Correlation, or the movement in the same direction by all asset classes, remains strong, as measured by the CBOE S&P 500 Correlation Index.

So it's not exactly a ringing endorsement of the Fed's renewed easing push, and investors might want to keep one foot dangling off the bandwagon.

"Investors are looking at what the news is and they're reacting to it, and the reaction isn't necessarily a healthy one at all times," says Andre Julian, CFO and senior market strategist at OpVest Wealth Management in Irvine, Calif. "They've lost perspective on the long term: What are we going to do with inflation? What are we going to do when the dollar isn't worth as much?"

There were, for sure, some definite market movements Wednesday.

Gold soared to new highs, with the ever-surging precious metal creeping towards $1,300 an ounce before backing off a bit. But the big metal winner of the day, in fact, was palladium, which jumped more than 3.5 percent, while copper also had a strong day.

On the grain markets, cotton advanced more than 1 percent, but corn did little.

Over on the equity markets, the mood was slightly negative, especially so in the technology area.

"When the dollar goes down it props up other commodities because they're dollar denominated. Gold prices stay firm, the grain prices are staying firm, sugar prices, the softs prices—those are helped," Julian says. "When it comes down to the stock market, it's going to be a mixed bag."

Indeed, the dollar did go down, sagging against a basket of foreign currencies and particularly dropping against the euro and Swiss franc .

But there were misgivings over the impact QE2—as the new round of easing is being called—will have on the economy and the broader impact it can have on asset prices and in particular stocks.

"QE can provide a short-term bounce to the economy, but to have a lasting impact companies must be willing to hire workers to reduce unemployment and increase personal income," Jim DeMasi, managing director and chief fixed income strategist at Stifel Nicolaus in Baltimore, wrote in a note to clients.

"Despite holding short-term interest rates near 0% for more than 21 months and expanding the size of its balance sheet to over $2 trillion in total assets, a double-dip recession and broad-based deflation remain very real risks."

Bonds were largely stronger in the day's trading, with the 30-year long bond gaining more than a point in priceand the benchmark 10-year note's yield falling to 2.52 percent in midday trading.

But that, too, had a down side: Some traders wondered how long foreign investors will keep buying up US debt now that the Fed has made clear it has no intention of veering from policies that will keep yields so low.

"They're greenlighting a massive orgy in speculative assets," says Kevin Ferry, president of Cronus Futures Management in Chicago. Ferry says foreign investors, who have become critical buyers in the government's issuance of more than $2 trillion in debt, may not be able to afford Treasurys in the future.

"Foreigners at these rates can no longer tolerate the currency going down where there is no return. The Treasury market becomes a store of value," he says. "If the dollar goes down dramatically, a reasonable decline in the currency would put these people on the cuff for a decade. We're going to get a test soon in the auction process to see if the domestic demand is strong enough to support this issuance."

Other areas of the capital markets are reflecting the quandary: Treasury Inflation Protected Securities 5-year rates have dipped below zero, while classic inflation-protection areas real estate and gold are the most popular classes of all specialty equity funds, according to TrimTabs market research.

Indeed, as hedge fund manager Dennis Gartman writes in his daily newsletter, "the game has changed" for the Fed as its dual mandate to maintain employment and fight inflation morphs into surviving what looks to be prolonged joblessness and the actual promotion of at least some level of inflation.

"Now we know that its dual mandates are to try to do what it can to push the unemployment rate lower AND to fight deflation," he wrote in The Gartman Letter. "It will do what it can, where it can, using what weaponry it has at its disposal to accomplish these tasks, and that means easier rather than tighter monetary policies going forward."

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