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The European
Central Bank and the Federal Reserve have both telegraphed that another round
of currency depreciation is in the offing. The ECB's Mario Draghi has pledged to do "whatever it takes" to
save the Euro currency by setting specific targets for Italian and Spanish
bond yields. And the Bernanke Fed has stated that addition monetary
stimulation is warranted soon unless there is a "substantial and
sustainable strengthening in the pace of the economic recovery." Fed
Presidents Charles Evans and Eric Rosengren have
both recently indicated what action would be taken by saying that the U.S.
central bank needs to expand its balance sheet until more favorable targets
are reached on the unemployment rate and nominal GDP.
But there is
little doubt, unfortunately, that both the European and American economies
continue to falter. A composite index of Europe's manufacturing and service
sectors contracted for the seventh straight month is August. Meanwhile, U.S.
capital goods orders fell 3.4% in July, which was the largest decline since
November 20011 and the fourth decline in the last five months. That can
hardly be misconstrued as evidence of a substantial or sustainable economic
recovery. Even the four-week moving average of initial jobless claims rose
3,750 last week as the unemployment rate in the U.S. continues to rise. In
addition, EU 17's unemployment rate now stands at a Euro-era record 11.2%.
Therefore,
there is now little doubt that more central bank money printing is coming in
September. They are playing a game of poker with the markets but aren't very
good at hiding their cards. Promises and threats of more monetary
intervention have already caused commodity and equity prices to rise in
anticipation. The 24 raw materials in the S&P GSCI are up 21% since June
21st and have just entered new bull market. Gold prices have increased over
$100 an ounce and oil prices have soared 25% since mid-June. Even the S&P
500 index has risen 10% since the June low and the Spanish IBEX has soared
21% since July 25th.
The problem
now is that unless the official announcements of quantitative easing from the
ECB and Fed are surprisingly massive, much of the move in economically
sensitive commodities and equities may have already been priced in. And after
we receive the September decisions on monetary policy from Mario Draghi and Ben Bernanke, there isn't much to carry those
prices higher until the U.S. presidential election is concluded. However,
what could weigh on markets between then and November is the continued
political paralysis in Washington over how to reduce America's out of control
deficits and the likelihood of $200 per barrel oil resulting from an Israeli
attack on Iran's nuclear facilities.
Therefore,
investors should pay close attention to what the ECB does on September 6th
and what the Fed does on September 13th. Unless the QE plans are "significant
and sustainable", equity and industrial commodity prices could be in for
a sharp decline. However, gold and oil ETFs should provide the best
protection if war breaks out in the Middle East and/or if central banks
decide to launch a "significant and sustainable" attack on fiat
currencies.
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