You are probably sick and tired of pontifications about just what will occur when QE2 "officially" breathes its last. Well, I promise not to as absolutely no one really has any certainty of what's to come. But what I would like to do is simply a little compare and contrast relative to circumstances we witnessed when QE1 breathed its last. Personally, I fully expect QE3 at some point, but not quite yet. Very much like the wait and see conclusion of QE1. It just took a while until an implicit mandate of sorts developed as the headline economic stats rolled over, in part as we are also witnessing now. Although it seems very counterintuitive, we all need to remember that US Treasury rates rose point to point during QE1 and peaked at its conclusion subsequently heading straight down until QE2 was announced (or at least implicitly announced by Bernanke at Jackson Hole) in late August. And from there rates went straight up again. Remember?
So will the conclusion of QE2 bring a similar outcome? Lets do a little compare and contrast with just where we stood in April of 2010 relative to the present on a number of fronts. Have a look at the following table and we'll have a few comments.
You already know that the ECRI weekly economic indicator peaked in April of 2010 at the number you see in the table above. It has not seen that number since, but did indeed drop meaningfully into the summer of last year prior to recovering. This was not lost on Bernanke and friends and certainly was justification in terms of the timing of the QE2 announcement at Jackson Hole. I’ve spoken of the in place divergence between new highs in equities and the lack of a new high in the ECRI numbers many a time. It remains for now one of the most important divergences I see. Remember, history is clear in that the ECRI numbers vindicate equities directionally. So far, no vindication.
Since April of last year, official headline payroll employment count is up 1.2 million. We just need to remember that 45% of this increase is accounted for by the wonderful BLS birth/death model estimates. Inclusive of the positive influence of the birth/death numbers, total US payrolls are up 1% over the prior year. Theoretically the rationale for Fed QE's so far has been to spur job growth. Failed mission up to this point. Now worries as that "rationale" was only cover as opposed to reality.
Very noticeable and an important differential are inflationary expectations. Both the Conference Board and University of Michigan inflationary expectations subcomponents of each survey have gone to new multi-year highs with recent readings. I'll spare you the charts as you’ve probably seen them in the recent past. Just so you remember, inflationary expectation numbers seen last April were near historic lows of the last three decades. This is a much more than noticeable differential as we approach the end of QE2. If nothing else, the Fed won the game in raising inflationary expectations. Lastly, and again I won’t drag you through the charts, the TIPS breakeven relationships at various maturity levels along the curve likewise show ever rising inflationary expectations since QE2 commenced, very much pronounced at the longer end of the curve. Under QE1 we also saw the TIPS breakeven levels rise just a bit, but along with Treasury interest rates in general the TIPS inflationary breakeven rates peaked with the end of QE1 and declined meaningfully and only bottomed at the onset of QE2. Will it be the case again with QE2 when we see inflationary expectations peak? We’ve seen a little back off as of late in conjunction with the margin reset inspired drop in energy related commodity prices and suggest this and the consumer confidence numbers for inflationary expectations will be key watch points directly ahead. This could easily be a "what's different this time" set of indicators. Stay tuned. Very quickly, headline consumer confidence has risen from April of last year, but we need to remember that in May of 2010 immediately after QE1 the CC headline number hit 62.7, a stones throw from where we now stand. So even headline consumer confidence is virtually unchanged.
Indeed the apparent dual mandates of quantitative easing were to increase domestic employment and provoke an increase in bank lending (general credit creation). On the employment front it has been an outright bust. Turns out it's the same deal on the bank lending side of the equation point to point since the end of QE1. As you can see above, C&I loans in the banking system in April of 2010 stood almost exactly where we find them today. To be honest, they actually dipped after QE1 and have recently come back up to just above where we saw them a year back. But for all intents and purposes it has been a flat line response. And of course this is especially important because M2 has grown, banking system excess reserves have grown by almost a half trillion and finally the Fed's own balance sheet is up almost another 0B+ and counting. In essence, all of the sound and fury of money printing has never made its way into the real economy. But of course all of us do know exactly where it has found a home. In part we see it here. As you know, this is just another compare and contrast of conditions at the QE1 finale and now.
Of course what you see above cannot be seen by the Fed, except the 16% gains in the Russell 2000. That apparently Bernanke can see all too clearly. Finally in the first table you can see the decline in revolving consumer credit outstanding over the last year. Virtually all of the gain in the headline consumer credit numbers over the last few years has been due to an increase in Government sponsored student loans. Strip those out of the equation and the totality of consumer credit balances has been in uninterrupted decline for years now.
So in short, there you have it. I believe THE key differential between the conclusion of QE1 and the to come conclusion of QE2 directly ahead is the more than overt change in inflationary perceptions and expectations, seen both in the stated consumer confidence surveys and the reality of the current fixed income markets as expressed in TIPS inflation breakeven rates. Moreover, the rise in energy prices, precious metals and commodity prices in general only corroborates this thinking. There has been no increase in employment. There has been no increase in bank lending or revolving consumer credit outstanding. These two key Fed mandates remain completely unfulfilled. So although labor market and bank/consumer credit numbers remain for all intents and purposes unchanged over the prior year, the rise in commodity price pressures as well as expectations infuses a much different risk profile to a post QE2 economic and financial market environment. As I've addressed probably too many times over the last few months, corporate profit margin pressure lies dead ahead. That pressure may have existed post QE1, but that's because the general economy was slowing. This go around, corporations can thank the Fed for what will be meaningful margin pressure in 2Q and beyond. And crazily enough, we all know mainstream economists are now one more time also lowering GDP forecasts for future quarters. Deja vu anyone?
Source: ContraryInvestor.com
