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This week, in the second in a series of
less-than-impressive press conferences, Fed Chairman Ben Bernanke offered
market observers little hope that any additional quantitative easing programs
are on the horizon. The Chairman continues to cling to the position that the
economy is improving (with the recent "soft patch" attributable to
external forces) to the extent that additional Fed support will be
unnecessary. Left unsaid was any guidance as to who the Chairman believes
will buy the massive amounts of Treasury debt formerly swallowed up by the QE
II program?
The logical conclusion is that Bernanke
believes that there will be massive private sector demand for U.S. Treasury
securities. If so, how long can it be expected to last? If the economy
improves, as Bernanke expects, would it not be logical to assume that private
investors would direct capital to more promising sectors than ultra low yielding U.S. sovereign debt? Clearly something
does not add up. Judging by the Chairman's halting delivery and sheepish
demeanor, it appears as if he knows his position is untenable.
We have argued repeatedly that the
inflation created by the unprecedented Fed monetary expansion remains hidden
beneath the larger deflationary forces of a major recession. When banks
inevitably start more aggressively pushing their Fed-supplied funds out to
the broader economy through increased lending will the full inflationary
impact of quantitative easing be felt.
If the Fed were
true to its word, and could hold in abeyance any additional quantitative
easing programs, inflationary concerns would justifiably drop and precious
metal prices should be expected to dip. Given that many market participants
are giving credence to these intentions, this very well may happen in the
short term.
However, we do not believe that we have
seen the last of QE. In fact we see the launching of the next monetary
juggernaut as a nearly foregone conclusion. It is very likely that if the
economy fails to improve as Bernanke anticipates he will reflexively reach
again into his monetary bag of tricks. Nothing he has said has ruled out
another round. If the door remains open, we should assume he will use it if
the going once again gets rough.
For now however, the global winds may
strengthen Bernanke's hand. New and troubling developments in the long
running Greek debt crisis have unleashed a knee jerk "flight to
quality." Investors have purchased U.S. dollars, giving it unexpected and
to some extent unwarranted strength. More significant demand for U.S.
Treasuries pushed yields down to fresh lows for the year.
Today, one-month bills earn only 0.01
percent. Five-year Treasuries yield only 1.48 percent, ten-year less than 2.9.
These historically low yields are killing living standards of retired and
middle-income investors who rely heavily on interest generated from bonds.
Although the returns are minimal, these securities are nevertheless
dangerous. They are backed by a government that has over $100 trillion of
unfunded debt, whose published Treasury debt is forecast to reach 70 percent
of GDP by year end, and which has embraced currency debasement as a national
economic policy. When market perceptions focus more intently on these risks,
and when the more meaningful returns offered by other asset classes become
irresistible, private demand for Treasuries will evaporate.
But there is no logical scenario that
will allow the status quo to persist. If the economy improves, inflation will
flare and risk assets will become more attractive. This will reduce demand
for Treasuries, and cause interest rates to rise, thereby impelling the Fed
to launch more QE in a single handed effort to keep U.S. interest rates low.
On the other hand, if the economy continues to deteriorate more, QE
will be "needed" to keep the current recession from becoming a
depression.
Either way, those betting that a Fed retreat from intervention will
push up the dollar over the long term, or spell the end to surging inflation
expectations, will likely be disappointed.
John Browne
Senior Market Strategist
Euro Pacific Capital, Inc.
20271 Acacia Street, #200 Newport Beach, CA 92660
Toll-free: 888-377-3722 / Direct: 203-972-9300 Fax:
949-863-7100
www.europac.net
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