On Target
Comment of the Day

November 14 2013

Commentary by Eoin Treacy

On Target

Thanks to Martin Spring for this edition of his ever informative report. In this issue he returns to comment on Crowd Money but here is a section on Janet Yellen

he American central bank has continued with its easy-money policy on a massive scale. What has it achieved?

“Even by the Fed’s sunniest calculations, aggressive QE over five years has generated only a few percentage points of US growth,” Huszar reports. Experts outside the Fed, such as Mohammed El Erian, joint chief of the world’s biggest bond fund manager, Pimco, suggests that the Fed may have created and spent more than $4 trillion “for a total return of as little has 0.25 per cent of GDP… a mere $40 billion bump in US economic output.

“Both of those estimates indicate that QE isn’t really working.”

So is the Fed cutting back on its massive money creation? Far from it. Its backing away from “tapering” and the appointment of an easy-money enthusiast as its new chairman suggests that cheap funding will keep alive vulnerable companies until late 2016/early 2017, says FT commentator Michael Mackenzie.

That assessment may be optimistic!

Incoming chairman Janet Yellen is a more aggressive interventionist than Ben Bernanke whom she is replacing. Some analysts now suggest she will set lower the unemployment target for curbing QE while raising the inflation target. One consequence could be that the Fed pumps even more, not less, into its easy-money programme, whose bond-buying already exceeds $1 trillion every year.

Eoin Treacy's view

I have been waiting for the most recent data point on the Velocity of Money to be released and this was updated by Bloomberg late last week. The Index has dropped to another new low. Considering it has more than 50 years of history, this is a negative outcome for how we might perceive the health of the US economy. What we can also conclude is that with Velocity of Money extending its downward trend, the Fed is unlikely to feel any pressure to reduce its increases in the supply of money.

This overlay of the S&P500 with the Total Reserves Held by the Fed suggests everyone gets the message. Correlation has increased steadily over the last year with investors willing to accept the hypothesis that as long as the Fed is pumping everything will be OK. One is reminded of former Citigroup CEO Chuck Prince’s comment: “As long as the music is playing, you’ve got to get up and dance”.

While an outcome similar to the credit crisis is unlikely, a mean reversion pullback similar in size to those posted in 2010 and 2011 is to be expected when the Fed eventually does taper. Meanwhile, a sustained move below 1760 on the S&P 500 would now be required to indicate an upside failure.

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