Rate Watch #781 QEII - What Did It Do?
Rate Watch #781 QEII - What Did It Do?
June 24, 2011
by Dick Lepre
dicklepre@rpm-mtg.com
www.loanmine.com
Fundamentals
GDP:
1stQ2011 second revision was +1.9%. Most telling in the report is this: "Final sales of domestic product were revised to an annualized 0.6 percent from the initial estimate of 0.8 percent." Final sales of domestic products is the "core" of GDP. The heart of GDP growth is much weaker than the headline number.
Durable Goods Orders:
New Orders - Month/Month change 1.9 %
New Orders - Year/Year Change 9.0 %
Ex-transportation - Month/Month 0.6 %
Ex-transportation - Year/Year 7.2 %
The gains in durables were broad-based.
Jobs:
Initial Jobless Claims for last week were 429,000 - above previous and consensus. Initial Claims have been above 400,000 for the past 11 weeks. It has become impossible to look at this data and think that the jobs market is anything other than extremely weak.
Housing:
New Home Sales for May were 319,000 (annualized.) That was below previous but above consensus.
Mortgage Applications:
Purchase Index - Week/Week Change -2.8 %
Refinance Index - Week/Week Change -7.2 %
Composite Index - Week/Week Change -5.9 %
FHFA Single-family Housing Price Index:
Month/Month change 0.8 %
Year/Year change -5.7 %
Existing Home Sales - 4.81 Million (annualized)
Existing Home Sales - Month/Month Change -3.8 %
Existing Home Sales - Year/Year Change -15.3 %
Home Sales remain weak. Inventory is large. In addition there is a large shadow inventory of preforeclosures.
Retail Sales:
Redbook Year/Year +4.2%
ICSC-Goldman week/week -0.7%. Year/Year +2.2%
Analysis
This was an important week. No one can make the case that either Keynesian fiscal policy or expansionary monetary policy has gotten the economy growing. The sad fact is that while the recession is over GDP growth is anemic. This is GDP % growth since 4thQ2009 5.0, 3.7, 1.7, 2.6, 3.1, 1.9. The damage created by the mortgage mess has harmed the economy in a manner which may well take another decade to recover from.
Lurking in the background, at present, is the Greek debt thing. The EU keeps avoiding this, putting off the problem for another day. I suppose that as long as this beast persists it will help U.S Treasuries.
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QE II
Some folks think that because the Federal Reserve will soon stop its daily purchases of Treasuries per QEII Treasury prices will go down and yields and mortgage rates go up. I think this view is completely inaccurate.
As QE II ends it serves to try to figure out what it did. QE (Quantitative Easing II) was a $600 billion increase in the money supply.
This worked by having the Federal Reserve create money each day and use that to buy Treasuries on the open market. The first order result is that the Fed has the Treasuries and the people who previously owned them have cash. Essentially all of that was redeposited into the banking accounts of those who previously owned this debt. This created an immediate increase in money supply.
The idea is that putting money money into play stimulates the economy.
Is this what happened? Absolutely not.
What happened to the QEII dollars? Something like this: the Fed creates money and buys Treasuries. Those dollars are now in a bank account of whoever owned them before. The client who owned those dollars may have purchased equities or commodities with them increasing the price and passing his dollars along to the previous owner of the equity or commodity. That dollar keep moving a few times and the effects were 1) higher commodity prices 2) a weaker dollar and 3) higher equity prices. The dollars all wind up as excess reserves but these are not dead dollars. They are still available if the account holder wanted to bid up equities or commodities (or something else.) The buying up of commodities was done by wealthy individuals, hedge funds, and commercial banks. Those folks, mutual funds, and individuals also contributed to buying up of equities.
QEII 1) pumped up equities 2) increased commodity prices 3) weakened the dollar (consequently increasing GDP) and 4) prevented deflation. At the point where equities and commodities were bid up to the point where no one was stupid enough to believe they would go up any more, the bidding up of equity and commodity prices stopped.
Whatever QEII may have been it was not stimulus. Interestingly, this past week Bernanke increased his estimate for inflation slightly. The cause of this inflation was QEII. The bidding up of equities created a bit of good feeling but little wealth effect (when people spend more because the value if their assets increased.)
What will the end of QEII mean? Lower commodity prices, lower equity values, and a stronger dollar which will after 6 months weaken exports and increase imports lowering GDP. A weak dollar caused by QEII helped GDP by increasing exports and decreasing imports.
QEII did not result in more bank lending. The net amount of bank loans which were closed during QEII was about half the size of QEII. Bank lending is not the root cause of economic stimulation but marches hand-in-hand with it. The cause of economic growth is a combination of consumer confidence and new things such as the commercialization of the Internet. Banks will make loans when there are profitable loans to be made.
In a sense what the end of QEII means (and I thank Jim Grauer for formulating this) is a move from commodities to paper. With the economy flat and commodities being bid down there will be little to no concern about inflation and we will see that Treasuries are bid up and the 10-year yield move down near 2.5%. The fact that the Treasury techs are bullish indicates that investors are already presuming this. Treasuries will become a safe-haven because 1) commodity prices will fall 2) The dollar will be strong 3) confidence in the economy is weak 4) alternatives (the Euro and the Yen) have their own problem. Treasuries will be the "best of the worst."
Bill Gross and many other folks have assumed that the values of Treasuries would go down and gotten out of them or even shorted them. If Jim Grauer's view is accurate then Gross will have a lot of 'splaining to do.
The sad part of QEII was that by weakening the value of the dollar and increasing commodity prices (which are all priced in dollars) the average guy was hurt by higher energy and foods costs. In addition the increase in the value of equities was offset by the weaker value of the dollars in which they were priced. This could result in increased public distrust of the Federal Reserve. This will become another song for politicians desperate for reelection.
In addition that $600 billion is now parked as the Fed as excess reserves. For now this is not a problem but it makes more difficult drawing down the money supply at some future date when it becomes necessary to stem inflation.
Look at this Federal Reserve report of aggregate banking reserves http://www.federalreserve.gov/releases/h3/current/
When QEII started, the 4th column Excess Reserves parked at the Fed was $972 billion. On June 15 excess reserves parked at the Fed was $1.610 trillion. Since the start of QE II excess reserves went up $638 billion. This is larger than the $600 billion QEII. While the money from QE II wound up back at the Fed, it did not get there directly but was spent several times pumping up equities and commodities but not the economy. That money is still out there and available to the owners of the banks' deposit liabilities to deploy. They are unlikely, in the next couple of quarters to be deployed into commodities or equities.
If the sum of Bernanke's case for QEII was that it prevented deflation my reaction is "Yeah, right." I do not believe that we were ever in danger of a deflationary spiral. The only significant deflation has been in home values but that is a correction of the damage done by the National Homeownership Strategy, bad lending practices by banks and bogus mortgage secutitization assumptions by the (then) three debt rating firms.
The economy will not grow until the consumer has more confidence. Right now there is nothing (in the short term) to feel confident about. The citizens have near zero confidence in the President and Congress regarding fiscal policy and little understanding of the role of the Fed. The folks in D.C. have been given a blueprint for fiscal sustainability (Simpson-Bowles) but see their own reelection as being more important. Simpson-Bowles is not an austerity plan. It is a blueprint for substantial changes in the tax code and fiscal policy in general.
We are faced with an extremely ugly situation: a dead flat economy which will likely become a prolonged slump and massive deficits. The worst part is that because Japan is hurting and there is a sovereign debt crisis in Europe Treasury yields are low and the pain of these massive deficits is being deferred. Absent some budget balancing plan such as Simpson-Bowles the pain in 2-3 years will be much worse that what we are seeing at present. The national deficit will be a lot higher and the cost of borrowing could rise considerably.
Dick Lepre
RPM - SF
1400 Van Ness Avenue
San Francisco, CA 94109
DRE License # 01143973
NMLS Individual ID 302379
California Department of Real Estate - real estate broker license #01201643
dicklepre@rpm-mtg.com
Web site: www.loanmine.com
(415) 244-9383
