Demonstrating the modification of Albert Einstein’s famous quote, the markets reacted to the news of the Peoples Bank of China raising their interest rate by .25% by drubbing stocks, commodities, precious metals and just about every asset class but the Dollar. I discussed yesterday why this was illogical and is more than likely a short term technical trade that was looking for a catalyst to allow the algorithm number crunching machines to do their dirty work lining Goldman’s and Morgan’s pockets(would not want to miss out on those bonuses). This could be a case of buy the rumor and sell the news for the US Dollar, which someone once said is currently the best looking horse at the glue factory or the tallest midget your choice. We all know that the Dollar along with every other Fiat currency is flawed. The rationale explaining yesterday’s move in the Dollar was that a deal was struck with the Chinese that they would raise their rates thereby allowing the Yuan to rise and the FED would limit its QE.
I believe that this is all baloney as there were two articles appearing yesterday floating trial balloons regarding QE2. The first article release in the morning was quoting the FED’s Lockhart who in a CNBC interview stated that ‘If we're going to pursue another round of quantitative easing, it has to be a large enough number to make a difference.” "As a monthly number ($100 billion) is fairly consistent with what we did before, and so I think it would certainly be in the range of numbers one might consider ... but if you were talking about $100 billion as simply the overall program, I think that's too small," he said. So if you tabulate the figure of $100 Billion a month that is another $1.2 Trillion, hey but what is a few Trillion Dollars between friends, right?
Lockhart not a voting member of the FED board until 2012 is stating publicly the $1.2 Trillion figure while analysts are expecting a large round of easing but totaling in the $500 Billion range. I suspect that as always this is a trial balloon and depending on the data the figure will fall somewhere in between. In follow up article to the Lockhart piece further bolsters by the statements from New York FED President William Dudley and echoed by Chicago FED President Charles Evans both of whom in speeches suggested again that, ”some officials would like to consider explicitly raising the Fed's inflation target for a time, a controversial proposal.”
There is some dissent on the FED regarding the efficacy of the past and potentially future stimulus from Dallas FED President Richard Fisher and Minneapolis FED President Narayana Kocherlakota, however, it appears that they may be dissenting votes but not the majority opinion. My guess is that we will get QE2 whether we want it or not as this “Helicopter Ben’s” modus operandi.
The incredible part of this whole mess is that the emerging market economies are complaining that there is a flood of capital chasing higher rates in their markets due to FED easing and the lower dollar. The response is to raise rates ...Yes that will drive those yield seeking investors out of their markets and back in to the US Dollar. You can’t make this up!
So to add to this whole mess there is the whole bombshell that just came out regarding Pimco, The New York Federal Reserve and Bank Of America Bond Holders who are seeking to force Bank of America to buy back as much as $47 Billion in Mortgage related bonds via a demand letter. I believe that this is the first of the shoes to drop and others will follow suit. It also shines a light on the fact that the FED along with others who hold trillions in securitized mortgage debt also known as colateralized mortgage obligations or derivatives that are not suitable to be held by these institutions. A demand letter is a legal document that states a legal claim making a demand for performance or payment of an obligation. The fact that the FED itself has file a demand letter shows the subpar quality of the underlying asset and that the bundle of mortgages are a potential legal mess. Bank of America is just the tip of the iceberg and this will in the near future cause big problems for the markets stock and real estate, the FED and the almighty Dollar. The FED is not going to eat this they will extract their pound of flesh either by ramming down the banks throat or performing a little QE for themselves. The FED should never have taken these toxic assets if you can call them assets on to its balance sheet in the first place, because all they have done was delayed putting the system at risk. Once this multi trillion dollar fiasco begins to unwind the confidence in the FED and Dollar will be severely damaged possibly irreparably and could be the catalyst for the money capacitors to discharge.
So even though the markets acted irrationally on Tuesday the long term trends for the investment vehicles I have been mentioning have not changed, in fact once the dust settles the case should be even more compelling. None of this can end well especially since the underlying problems have not cleared up in fact they probably just added a new dimension to the problem with the unraveling of the securitized debt market which has even ensnared the FED to the tune of a couple Trillion Dollars. For now the mainstream media will be pumping the Dollar trade but that is all it is a trade.