Wall Street doesn’t want to believe it, but money rarely falls from the sky. Anyone who thinks otherwise is probably seeing a mirage.
The Federal Reserve’s Quantitative Easing program isn’t a mirage, of course. It is all too real — but it might end this week. What will the end of QE mean for your non-imaginary money?
On Oct. 28, Tuesday morning, Janet Yellen will gavel the Federal Open Market Committee to order for its latest two-day gabfest. The FOMC sets monetary policy — which for the last six years mostly meant, “Print More Money!“
Fed officials now say they want to “normalize“ policy. That means the Fed will stop buying bonds and slowly start raising interest rates. They say the economy can stand on its own feet now.
Should we believe them? I’m not sure they believe it themselves. Yes, they want to end QE, but not because it worked. They’re going to end QE because it didn’t work and is probably starting to backfire.
Today’s Wall Street Journal carried an interesting opinion piece by Romain Hatchuel, a money manager in New York. The title is The Fed Rate Hike May Be a Mirage. You may not be able to read it unless you are a WSJ subscriber, so I’ll give you a short summary.
Here is how Hatchuel begins.
For six years the Fed has bought trillions of dollars’ worth of U.S. Treasuries and mortgage-backed securities in an attempt to jump-start the U.S. economy. As a result, its balance sheet has increased to a record 25% of the nation’s gross domestic product—higher than at the end of World War II or at the heart of the Great Depression. Attention has already shifted to future interest-rate hikes, the next logical step in this dreaded tightening cycle, which the market believes will begin somewhere between the middle of next year and the beginning of 2016.
Those who have criticized what they consider a period of monetary lunacy will praise the normalization of Fed policy. Others will lament it and issue dire forecasts. Yet, there is every reason to believe that this month’s highly anticipated end to so-called quantitative easing will be nothing more than a tactical retreat by the U.S. central bank, and that next year’s rate increase won’t materialize.
Hatchuel goes on to give five reasons the Fed won’t raise rates next year:
- The U.S. economy remains stubbornly weak. The Fed itself has cut its 2014 forecast from 3% last December to 2.1% now. Some economists think this is optimistic. If force-feeding trillions of dollars into the economy can’t produce any more growth than that, it is hard to see how raising interest rates will help.
- Europe is going into recession and/or deflation. The European Central Bank released its latest bank stress test results over the weekend. The good news is that Europe’s banks seem generally stable. The bad news is no one in Europe wants to borrow money from them.
- China’s slowdown will keep the developing world from bailing out the West. Yes, 7.3% annual growth is nothing to sneeze at, but the growth trend is what counts. China is retrenching, which means resource-driven economies like Brazil will slow down even further.
- The strengthening U.S. Dollar will hurt U.S. exports, making higher U.S. interest rates a risky move. A stronger dollar makes it more expensive for foreigners to buy U.S. goods. The dollar will get even stronger if the Fed hikes rates. A competitive currency war with Europe and Japan is more likely.
- Finally, any number of events could set off a market shock: Ebola, Russian aggression, a large bank collapse, Mideast instability, you name it. Raising interest rates are rarely the best response in those situations.
I don’t believe any of these factors will change the Fed’s mind on QE. They will almost certainly take the program down to zero this month. The bigger question is when they will actually raise their benchmark Federal Funds rate.
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Right now, the consensus is they will hike rates in the second half of 2015. I don’t think it will happen, except maybe as a small test-the-waters move.
We’ll get the Fed’s QE3 verdict at 2 p.m. EST on Wednesday, Oct. 29. You have between now and then to make sure your portfolio is ready.
U.S. stock market gauges were mixed today in slow Fed week trading. The main driver was weakness in the energy sector.
- Goldman Sachs (GS) issued a bearish outlook for oil prices and energy shares. Wall Street saluted and followed orders.
- West Texas Intermediate crude broke below $80, with the spot December contract trading as low as $79.44 before moving back over the line.
- Low oil prices pummeled energy stocks, especially energy service names like Halliburton (HAL) and Nabors Industries (NBR). HAL dropped 6.1% while Nabors closed with a 6.7% daily loss.
- On the positive side, the Lundberg Survey said average U.S. retail gasoline prices are at the lowest level since December 2010, almost four years ago.
- Ebola fear went political over the weekend as several state governors decided to tighten quarantine requirements despite White House objections.
- A five-year-old boy is under observation in New York’s Bellevue hospital for possible Ebola infection. News reports said he had been with his family in West Africa within the last 21 days.
- Apple’s (AAPL) new iPhone payment system is hitting resistance from retailers. Drug chains CVS and Rite-Aid along with Wal-Mart (WMT) stopped accepting Apple Pay even though their store terminals support it.
- A retail consortium is working on a competing smartphone payment app and its members apparently fear giving Apple a head start. Their own app won’t be ready until sometime next year.
Good Luck and Happy Investing,
Uncommon Wisdom Daily