A Central Banker's Cocktail Party: Tequila or Water?

What is Quantitative Easing? A government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

Now that's out of the way we can dissect the size, announcement, and long-term affects of the easing on the Global Financial System.

First let us say congratulations to the United States Federal Reserve, in eight months time you will maintain a $3 Trillion balance sheet. The Central Bank is now the largest Hedge Fund in the World. Kudos, no really. Let's take a few moments to put this number into perspective. In, 2009 the U.S. GDP was $14.25630 Trillion. The IMF forecasts growth in 2010 of 2.6%. A back of the envelope calculation puts 2010 output at 14.627. Thus, in June 2011 the Federal Reserve will control assets worth 20-21% of 2010 Gross Domestic Product. In 2007, The Fed's Balance sheet was worth only 6.4% of Gross Domestic Product. All we can say is Kudos.

Consequently, the NY Federal Reserve has a tall glass to fill:

The FOMC directed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to purchase an additional $600 billion of longer- term Treasury securities...Taken together, the Desk anticipates conducting $850 to $900 billion of purchases of longer-term Treasury securities through the end of the second quarter 2011.

I expect on-campus recruiting to increase at the next NYU career fair. Anyone want to take the opposite side of this trade?

Looking Back,today's market action after the FOMC announcement was incredibly entertaining. We observed The S&P 500 oscillate down to 1183 and then rocket back to 1199 to close the session. The EUR/USD fluctuated 190 pips, a range that would make any Black Box trader proud. Gold dropped from 1348 to 1327 and now trades at 1355. Ironically, Natural Gas was unchanged throughout. The fourth of July came late this year, hope you did not miss it!

SPX

Dollar Index

Moving forward, Quantitative Easing will surely inflate Global Asset Markets. Will it? Regardless, this is the current thesis the Fed operates with. The goal of 'QE II' is to re-inflate the U.S. economy. Specifically, the Federal Reserve desires an asset re-allocation trade. The FOMC hopes to push investors out of 'safe-haven' Government Debt instruments and squeeze them into more risky asset classes such as equites, commodities, junk-bonds, and real-estate. Why would the fed want to turn the proverbial risk switch off? Don't jump to conclusions, keep reading!

The second leg of this trade hinges on the 'wealth effect', The premise that when the value of stock portfolios rise due to escalating stock prices, investors feel more comfortable and secure about their wealth, causing them to spend more . Miller Tabak estimates this effect will carry a multiplier of 3x. Hence, the $600 B of Quantitative Easing will create new consumer wealth of $1.8 Billion. The Fed supposes a multiplier of this magnitude will allow consumers to feel comfortable parting with their hard earned Dollars and spend without discretion. Therefore the economy will grow, inflation will rise, unemployment will fall, and The 'Red, White, & Blue' will flourish in economic and financial prosperity once again.

Personal Savings Rate

Even Though The FOMC's policy makers and economists are a collective of the smartest and brightest in the United States of America, Quantitative Easing II sounds too good to be true. Why you ask? First, any good trader knows timing the market is nearly impossible. Second, who is to say consumers will look at their 401k statements, feel wealthier, and decide to spend. Lastly, 'QE II'has never been done before. The original U.S. Quantitative Easing was executed during the heart of the credit crisis. The impetus for the current version is plainly different. Also, Japan's attempts fell flat and failed miserably. In short, we are critical here because we are uncertain of the outcome. The Fed should be too.

To clarify we will attempt to explain our thoughts in a simple thought experiment:

Suppose you are two hours late to a cocktail party. There is food, drinks, and irresponsible adults galore. You head to the bar for your first drink of the night. The bar tender informs you the only beverages still available are water and tequila. At the same time you approach the bar an irresponsible adult, who consumed five beverages prior to your arrival, also approaches. You think, I hate tequila because it makes me sick. Instead you decide to drink water and enjoy the experience without alcohol. Meanwhile, the irresponsible adult orders another drink. Mind you this is his 6th drink and first of tequila. You think, 'I wish I was indulged in his level of intoxication'. Though, your next thought is 'I am so happy I am not that guy, he won't be able to get out of bed tomorrow'.

Is the Fed an irresponsible adult or a water drinker? Take from this simple thought experiment what you will.

Undoubtedly, we are entering uncharted territory. Here's to watching and waiting for events to unfold. Hey, if you get bored check the BOE decision at 08:00 EST and the ECB decision 45 minutes later. Surely the ECB won't surprise!

Cheers,

--Patrick M. Ambrus

Sources: Investopedia.com, The Gartman Letter, FederalReserve.gov, NewYorkFed.org, BEA.gov

Disclosure: We are Long the GBP and short the USD.

Lost in Transition

As the memories of summer dawn upon us and autumn's head-winds transition us into colder months, we remain stuck in a period of cryptic transition.  The green leaves are slow to transform into  red, yellow, and orange decay.  Throughout September and early October, temperatures here on the Eastern United States remain elevated with splashes of summer, spring, and autumn surprising us on a daily basis.  I seek clarity in these matters.   Moreover, when will a new forceful trend form and carry us into colder, cooler, and darker days?

This same phenomena can be easily applied to current market conditions.  We are at a a cliff looking over the edge and waiting to be pushed by "someone or something."  For the past month of trading the impetus for asset price appreciation came at the behest of the U.S. Federal Reserve.  Mr. Bernanke made it clear at the Fed's anual Jackson Hole Summit:

Notably, since December 2008, the FOMC has held its target for the federal funds rate in a range of 0 to 25 basis points. Moreover, since March 2009, the Committee has consistently stated its expectation that economic conditions are likely to warrant exceptionally low policy rates for an extended period. Partially in response to FOMC communications, futures markets quotes suggest that investors are not anticipating significant policy tightening by the Federal Reserve for quite some time. Market expectations for continued accommodative policy have in turn helped reduce interest rates on a range of short- and medium-term financial instruments to quite low levels, indeed not far above the zero lower bound on nominal interest rates in many cases....


In support of the stock view, the cessation of the Federal Reserve's purchases of agency securities at the end of the first quarter of this year seems to have had only negligible effects on longer-term rates and spreads. 

Many Market participants took statements like these as indicative of greater 'Quantitative Easing' measures in the near-term with an emphasis placed on purchases of longer-term maturing Debt instruments.  Thus, the cruise ship 'QE2' set sail and every trader, analyst, investment banker, and speculator jumped aboard.  The rumors of 'QE2' allowed an appreciation  of equity prices, commodity prices, and a continued rally in the bond market.  However, many market participants fight a potentially painful hangover as they wait for another round of cocktails to tide them over.  Until 'QE2' becomes a reality, the current run-up in asset prices will continue to be predicated on rumors supported by ubiquitous supply & demand, fundamental, and sentimental data.

Consequently, The USD has taken the brunt of the pain over the past month of trading.  The US Dollar Index is down 6.8% in the period from September 1st -October 11.  Even though this downward trend has been in place since early June, the recent rumor mongering has certainly contributed to the Greenback's precipitous plunge in value.

EUR/USD has appreciated by 9% since September 1st.

OK so what, why does a weak dollar matter? As the emerging markets transition into developed economies won't the USD need to allow the wealth to spread to other currencies, 'new reserve currencies'?  In the future, the USD may no longer be the benchmark for which emerging market rates are pegged or for which all central bank reserves pile into.  However, these structural changes will not placate current financial psychology for some years time.  Hence, we must look at the short-term trends to discern directionality.  Disregard, financial profits, journalists, and fund managers who say otherwise.  Trade the trends.  Block out the noise.


-Patrick M. Ambrus

Sources: Stockcharts.com, Federalreserve.gov

Illustrious Imperfections

This evening I was perusing FT's Alphaville blog and came across a great piece written by Mohammed El-Erian. The PIMCO Chief Investment Officer breaks down Bernanke's speech from Jackson Hole.

Link:http://ftalphaville.ft.com/blog/2010/08/27/328906/el-erian-how-to-read-bernanke%E2%80%99s-jackson-hole-speech/

Some questions for the FED

El-Erian alludes to some great points....

1. Is the FED over-estimating its 'grip' on the U.S. economy?
2. What happens when Treasury purchases become the new norm?
3. How does the FED's current monetary policy measures stack up against those of other central banks (ECB, BoE, and BoJ)?
4. The main question that trumps all, is the FED comfortable maintaining a $2 Trillion Balance Sheet over the next 10 years?
4a. If yes, will Quantitative Easing become the new tool to re-inflate economies?

Seems to me 'Helicopter Ben' did his homework on the lost decades in Japan.

Patrick M. Ambrus
Analyze Capital LLC
Twitter: AnalyzeCapital

FOMC Decision

Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Bank lending has continued to contract. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.

To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature

federalreserve.gov

Thomas M. Hoening was again the lone FOMC dissenter. Since Helicopter Ben uttered the phrase 'nascent recovery' on Capital Hill, cryptic language has proceeded. Clarity from the FED going into the 4th quarter is unquestionably salient. Perhaps, we (market participants) should sit tight until Jackson Hole concludes. Surely, transparency will become abundantly apparent after the curtains close at the Committee's annual Wyoming refuge.

Uncertainty is apparent in risk/reward security markets. At this point in time, The FED maintains relevance and reverence on the Streets plastered with Investment Banks rather than cafe's and bakeries. Ergo, Monetary Policy must remain stable as U.S. fiscal policy shifts political party lines. The Bush tax cuts abide while politicians play musical chairs.

Something tells me Precious and Industrial metals may be the best play in the 4th quarter as risk aversion reigns supreme. Unless of coarse one likes Government Debt.

Related ETF's: iShares Barclays 10-20 Year Treasury Bond Fund (TLH:US), GS Connect S&P GSCI Enhanced Commodity Total Return Strategy Index ETN (GSC:US), ETFS Palladium Trust (PALL:US), E-TRACS UBS Long Platinum ETN (PTM:US)

Literature: Karl R. Popper's The Open Society and Its Enemies 2 Hegel and Marx

Sports: T-Mac finally gets another shot. Former Superstar Tracey McGrady officially Signed with the Detroit Pistons today. Detroit's backcourt is crowded.

Patrick M. Ambrus
Analyze Capital LLC
Twitter: Analyze Capital

PPI, Industrial Production, Deflation, and Hypothetical Bantar

PPI
Lower food costs unexpectedly weighed on producer prices with energy also helping. Overall PPI inflation fell 0.5 percent, following a 0.3 percent drop in May. The June decrease was larger than the market consensus forecast for a 0.1 percent decline. At the core level, the PPI eased to 0.1 percent from a 0.2 percent boost in May. Analysts projected a 0.1 percent rise.

For the overall PPI, the year-on-year rate decelerated to 2.7 percent from 5.1 percent in May (seasonally adjusted). The core rate eased to 1.0 percent from 1.3 percent the month before. On a not seasonally adjusted basis for June, the year-ago increase for the headline PPI was up 2.8 percent while the core was up 1.1 percent.

Bloomberg.com

Industrial Production
After almost a year of strong gains, industrial production slowed in June. And it would have been negative without a surge in utilities output-likely weather related. Overall industrial production in June edged up 0.1 percent, following a 1.3 percent gain the prior month. The June increase was above the market forecast for a 0.2 percent drop.

However, manufacturing fell 0.4 percent in June, following a 1.0 percent jump in May. For other sectors in June, utilities output was up 2.7 percent while mining gained 0.4 percent.

Bloomberg.com

Is deflation imminent in the near future? This question resides on the collective brain-power of the FOMC. In addition, Empire State Manufacturing released today reported a slow down in growth led by a decline in new factory orders and shipments. There are three things to do with this data:

1. Ignore it.
2. Wait and seek confirmation before acting.
3. Panic

The economic point of no return may come sooner than later in America. Rather, will the U.S. Gov. and Fed collaborate to pump up the economy with further stimulus checks and or/Quantitate Easing, or will Policy Makers put their feet in the sand and hold true to their proposed intentions of reducing the overwhelming fiscal/budget deficits? If our Politicians/Policy Makers have any desires to keep their respective words options number 1 and 2 will suffice, as reasonable rational responses. If option number 3 is the choice modus operandi expect obtuse action:

1. More stimulus
2. More QE
3. More government borrowing
4. More dovish talk from the Fed
5. A pop in Equities.

At present, sentiment driven trading is ubiquitous in the Global Equity Markets.
Rebuttal; "But good sir isn't equity trading more or less always sentiment driven, or all trading for that matter?"
Response: "In times like these I trust my gut instincts above all else, other traders will as well."
Rebuttal: "Why the bleak outlook, stimulus is a good thing for growth and prosperity, no?"
Response: "It depends on how long you plan on living."
Rebuttal: "I disagree, China will buy our debt forever, they need us to buy their products in order to support/sustain global growth."
Response: "Be that as it may, Japan may be the country worth worrying about. With political instability, deflation, and inconsistent budgetary reform policies simultaneously imminent, the Japanese Politicians my decide it is time to stop supporting the U.S., and sell Treasury holdings to supplant their own debt typhoon."
Rebuttal:"Don't pick on Japan. You have never been to the island, you don't know what it is like, you can't relate to Japanese culture."
Response: "I'll be in Tokyo on Monday, care to grab lunch?"

CPI data comes tomorrow morning. Good luck trading today!

Patrick M. Ambrus
Managing Partner
Analyze Capital LLC
ambrus.anlzgroup@gmail.com

Bull or Bear: perhaps just business as usual

via bloomberg:

Hedge funds lost an average of 2.7 percent through May 27, according to the HFRX Global Hedge Fund Index, as the sovereign debt crisis in Europe triggered declines in stocks, the euro and commodities, and the gap in yields between U.S. short-term and long-term debt narrowed. It was the biggest decline since November 2008, when hedge funds lost 3 percent in the wake of Lehman Brothers Holdings Inc.’s bankruptcy two months earlier.

Almost every strategy lost money in May, according to Hedge Fund Research Inc. in Chicago, as the Dow index of 30 big stocks sank 7.6 percent including dividends amid speculation that Greece’s debt problems would spread to nations such as Spain and Portugal. Some of the best-known funds saw their gains for this year erased.

“Attempting to manage risk in an environment where everything that could go wrong does go wrong seems like a fruitless endeavor,” said Brad Balter, who runs Balter Capital Management LLC, a Boston firm that invests in hedge funds for clients. “The only defense that seems to work in months like these is being in cash.”.......

The price swings in May haven’t changed managers’ views on whether global economies are rebounding or shrinking.

“Managers who are positive are still positive, and negative managers are still negative,” said Charles Krusen, head of Krusen Capital Management LLC, a New York-based firm that invests in hedge funds for clients."

The market's performance in May has triggered yet another round of debates on the nature of the recent rally. One thing interesting about such debate is that every time it occurs, someone will bring up a resembling incident in the past in order to give strength to his(her) take on the market. Talking about "this really looks like the 19xx, when the stock market rebounded xx% in x months and then crashed....."

It is important to recognize that the future is always somehow different from the past, and that there could never be two identical market phases. Just because stocks have gone up a lot doesn't mean the market will drop down any time soon. On the other hand, even if the market is really overheated, rallies might still go on. Indeed, differentiating artificially cheap stocks from real bargains has become much more difficult than a year earlier. Making perhaps just one transaction, out of hundreds of analysis, is after all the nature of the business. How will the asset management industry do a year from now, it seems, is a question that could only be answered with the help of hindsight.

This is a time full of uncertainty, and in assessing prices we have to first ask ourselves which standard we would like to use. By the standard of crisis, such as the one in 2008, stocks do not look cheap. However, if we buy the argument that 2012 is not the end of human civilization after all, as investors we have a harder decision to make. Although personally I am more concerned with individual companies than the general market, I'd like to point out that the many things our governments have done in the last two years (quantitative easing, bailouts, deficits, etc..), dealt unwisely in the slightest, will definitely materialize considerable consequences in the future. The question is, do we want to invest and live with the uncertainty, or divest, sit on cash and completely throw ourselves into the hands of the "unknown unknowns" of the future?



Yi Gao
Research Analyst
Analyze Capital LLC

Existing Home Sales- 05.24.2010

Via Bloomberg:

April's expiration of second-round stimulus fed a 7.6 percent jump in existing home sales to a 5.77 million annual rate. But, in a big disappointment, supply on the market jumped 11.5 percent to 8.4 months. Heavy supply together with the absence of stimulus point to the risk of price erosion in the months ahead. But at least for April, prices did firm, up 2.1 percent to a median $173,100.

Details show comparable gains for both single-family homes, up 7.4 percent, and condos, up 9.1 percent. The Northeast led the regional breakdown while the West lagged.

Uncertainty over the housing outlook is a key negative for the economy. Should the jobs recovery weaken, foreclosures and distressed sales could make for new trouble in the housing sector. Stocks firmed off session lows following today's report. New home sales for April will be posted on Wednesday.

I am interested to see how the Fed incorporates these statistics into winding down their QE policy. Specifically, I am speaking about the sales of MBS which have helped bloat the U.S. Central Bank's balance sheet. Wednesday brings new home sales.

I was in Boston today taking in State Street. It does not have the outright intensity or ubiquity of Wall Street. However, the feeling of deal making still looms on State Street. This evening I saw an epic Celtics vs. Magic game 4 of the Eastern Conference Finals. The C's lost, but then again I am a Knicks fan...

Patrick M. Ambrus

Managing Partner

Analyze Capital LLC

Twitter: AnalyzeCapital

Consumer Price Index A.K.A. Inflation

Temporarily soft energy costs pulled down the headline CPI for February while weak shelter costs kept core inflation very sluggish. Overall CPI inflation for February eased to no change from 0.2 percent the month before. The latest came in just below the market forecast for a 0.1 percent uptick. Core CPI inflation rebounded a modest 0.1 percent, following a 0.1 percent dip in January and matching consensus expectations. A number of weak components point to the fact that inflation pressures, indeed, are subdued. Shelter costs were flat in the latest month while declines also were seen in apparel and recreation.

Looking at detail, the energy component of the CPI declined 0.5 percent in February after jumping 2.8 percent the month before. Gasoline temporarily eased 1.4 percent, following a 4.4 percent jump in January. Food inflation slowed in February to 0.1 percent from 0.2 percent in January.

Year-on-year, overall CPI inflation fell to 2.2 percent (seasonally adjusted) from 2.7 percent in January. The core rate was slipped in February to 1.3 percent from 1.5 percent the month before. On an unadjusted year-ago basis, the headline number was up 2.1 percent in February while the core was up 1.3 percent.

Today's report leaves a lot of room for the Fed to keep rates low for some time. On the news, Treasury yields edged down and equity futures rose slightly. At the same time, initial jobless claims came in very close to expectations.


My only take from this report is that the economy is not inflating. Meaning QE will likely remain in some form until the Fed raises rates.

It is a beautiful day in New York. Take some time away from the terminal and get some spring air. I am likely heading up to Newport, RI later tonight. Enjoy the rest of the trading week.

Mr. Trichet Speaks to the Masses- 03.04.2010

"If there's one thing I learned in prison it's that money is not the prime commodity in our lives... time is."
--Gekko, MNS


Highlights from ECB President Jean-Claude Trichet’s Statement

Rates remeain unchanged at 1.00%


Euro Zone Inflation and Growth

•Inflation expectations remain firmly anchored inline with the Governing Council’s aim of keeping inflation rates below, but close to, 2% medium term

•2010 Inflation forecast .8% to 1.6%

•2011 Inflation forecst .9% to 2.1%

•Euro area has continued to benefit from significant macroeconomic stimulus

•2010 GDP growth forecast .4% to 1.2%

•2011 GDP growth forecast .5% to 2.5%

•Loans to non-financial corporations can be expected to remain weak for some time after economic activity has picked up

•We expect price stability to be maintained medium term, supporting the purchasing power of euro area households


Quantitative Easing

•We decided to continue conducting both the main refinancing operations (MROs) and special-term refinancing operations with a maturity of one maintenance period as fixed rate tender procedures as long as necessary

•The Governing Council will continue to implement phasing-out of the extraordinary liquidity measures

•Banks should use improved funding conditions to strengthen their capita; bases and take full advantage of government support for recapitalization


Greece and The PIIGS

•High levels of public deficit and debt place an additional burden on monetary policy and undermine Stability and Growth Pact as a key pillar of Economic and Monetary Union

•All countries will be required to meet their commitments under excessive deficit pressures


Conclusion

•Key challenges in order to reinforce sustainable growth and job creation is to accelerate structural reforms

•Sound balance sheets, effective risk management and transparent, robust business models are key strengthening banks and ensuring access to finance


This commentary is similar to what I read int he Fed's Beige Book yesterday. Economic growth will be slow at best. Inflationary pressures remain subdued. The Central Banks will begin to unwind QE and pull some liquidity from the system.

Patrick M. Ambrus
Managing Partner
Analyze Capital LLC
ambrus.anlzgroup@gmail.com