Commodity prices boosted as Fed returns to the printing press

The US Federal Reserve returned to the money pump Wednesday and the market reacted accordingly by sending the dollar lower while stocks and commodities rose strongly.
The amount of US 600 billion that will be spent buying US treasuries over the next eight months was on the high side of expectations hence the subsequent reaction. In a statement the Fed committee once again reiterated their commitment to keep an exceptionally low fed funds rate over an extended period.
The purchase will primarily be directed towards government bonds in the five to ten year maturity range. This should provide the best support for mortgage bonds thereby keeping borrowing cost for homeowners under control. The flipside is the emergence of the US Federal Reserve as the speculators best friend as his attempt to drive the dollar lower will help to drive commodity prices higher. Whether this eventually will lead to another bubble remains to be seen.
Below is illustrated how different sectors performed in the months before and after the now famous speech by Fed chairman Ben Bernanke at Jackson Hole on August 22. This speech kicked off the expectations for additional quantitative easing. The rally in commodities and stocks accelerated after August as the dollar came under increased pressure. It is also worth noting that future inflation expectations had been falling before the speech only to increase strongly up until today.

 The S&P 500 index has returned to levels not seen since September 2008 as a prolonged period of low interest rates increases the attractiveness of stocks and commodities. Meanwhile the dollar has now lost more than 14 percent versus a basket of currencies and is getting close to the previous low point recorded in November last year.
In Europe the government debt problems have re emerged with yield spreads between the safe haven of German government bond and especially Ireland and Greece widening again. This is one of the short term clouds on the Euro horizon which could potentially reverse some of the recent gains versus the dollar.
The month long rally in commodities went into a higher gear after the Fed announcement. The Reuters Jefferies CRB index gained four percent on the week from a broad based rally with the index heavy energy sector (minus natural gas)  rallying strongly on the back of Saudi comments combined with the weaker dollar. Adverse weather also continues to support the already strong rally among agricultural products.

 Crude oil shifted up a gear this week leaving the recent trading range behind and setting out on a journey towards 90 dollars per barrel. The rally which began before the Fed announcement came about as the Saudi oil minister shifted the upper limit off their comfort zone from 80 to 90 dollars. The announcement was probably in response to the weaker dollar seen these past few months but also a belief that the global economic recovery can be sustained despite higher prices at the pump.
For now though the US Federal Reserve will not stand in the way of further price appreciations as they attempt to drive the dollar lower.
The Fed announcement and subsequent dollar sell off triggered the move above 85 dollar with 90 now being the target, this level represents a 50 percent retracement of the 2008 to 2009 sell off.

Natural gas had another bad week after the rally the previous week as the weekly storage data surprised to the upside sending prices lower. The complete lack of good news continues to haunt this beleaguered product and the only support seems to stem from the relentless buying associated with long-only indices and exchange traded funds. Unless we see a change in the whether forecast for the approaching winter record storage levels will cap any major rallies.
Gold climbed to a new record high Friday and silver reached a 30 year high after the resumption of quantitative easing. Some profit taking was seen Wednesday ahead of the announcement which left both markets in a better position to react to the news. The combination of weak dollar and continued increased inflation projections brought investors back in droves and the speculative long positions through futures and ETF’s will have risen as a consequence.

 The psychological level at 1,400 on gold should provide some near term resistance while the market decide whether the dollar should be sold even lower at this stage. Looming uncertainties about sovereign debt in Europe has the potential of keeping the market supported even if a dollar correction materializes.

Euro nervous ahead of Greek election

Risk appetite has exploded higher in the wake of QE as volatility collapsed and complacency seems to know no bounds. How long can we sustain the QE fantasy? Also, we’ve a Greek election over the weekend that is weighing on the Euro.

US employment report was….awful?
The supposed strength of the nonfarm payrolls report notwithstanding, we must also consider the household survey, which is used to create the Unemployment Rate. That survey showed a drop of 330k jobs in October and the participation rate dropped to a paltry 58.3% from 58.5%, which is the lowest level since the beginning of the year.

Graphic: US Household employment data
The graphic below shows the data from the household data, which many consider better than the payrolls data for showing the overall employment level. (Source of graphic: http://www.bls.gov/news.release/pdf/empsit.pdf) Draw your own conclusions, but we would note a couple of things: the overall unemployment rate supposedly topped out exactly one year ago at a shade over 10%, but the total number of workers with a job is now actually 27k less than it was a year ago (meaning all of the change in the unemployment rate has come via a reduced participation rate as discouraged workers are not declared unemployed). Second, the 35-54 year old men and women have been hit the hardest – these are the people with professional, higher paying jobs. All in all, this segment has lost well over a million jobs since last October – when unemployment was supposedly at its worst? This is awful and worrying. And to think that a lot of the consumption data might be looking stronger these days because strategic defaults and people continuing to live in “free” houses they have not yet been kicked out of means that they are able to continue to consume goods and services at the same rate as previously because they are not paying their mortgages any more.

Risk
Now that we have all of yesterday’s data in for our Carry Trade model, we can see that nearly all measures of risk appetite jumped higher in the wake of the FOMC meeting yesterday. Junk bond spreads in particular have shot higher – amazing to think that investors are desperate to go after junk issues yielding less than 200 basis points on top of treasuries if the baseline fear here is that fiat currencies are meant to collapse here. The “logic “is so awful, it’s almost unbearable. One interesting note: EM spreads have not joined the party to the degree that volatility and other risk measures have. Just today, news emerged of HSBC warning of “bumps in the road” ahead for emerging markets. EM spreads and relative performance will be key parameters to follow in coming weeks.

We should remember that cost-push inflation from QE is a bigger risk and higher likelihood than healthy organic growth and it’s already happening. This is the worst kind of inflation - inflation that will squeeze margins for companies, who don’t and won’t have any pricing power in an environment where weak labor markets mean no pricing power for labor either and more money on the part of wage earners dedicated to bare necessities. Thanks, Ben!
 At the rate things are going on commodity inflation, it will only be a matter of weeks before the Fed experiences almost unbearable pressure to cease and desist. That pressure starts at 100 dollars a barrel in crude oil. The only way the Fed is allowed to continue with QE beyond the next few months is if the fears of an economic slowdown are able to collapse the QE speculative bubble on itself and we quickly see a collapse in the twin commodity/equity bubbles.
 

Looking ahead
Greek election is up on Sunday and the government has promised to call a snap election if the result is a clear rejection of the austerity program. Will Greece belong to the EuroZone this time next year?  It is very important from a technical standpoint that EURUSD is closing the week here well back below the 1.4160 old high. The election is a key event for either setting a new cycle of PIGS fears in motion or seeing the market getting back on the old “Respect for the tight, non-devaluing ECB” trade. The Euro’s star may have peaked for now in our view, as the EuroZone’s own internal strife may finally drag the currency down into the mud of more easing, liquidity facilities, and other attempts to hold the shaky edifice together, or we’ll see the PIGS address the real need to default and a massive hit to European banks that this would entail. Alternatively, the PIG countries can exit the union and devalue their currencies (lowest odds). Which way adds up to a stronger Euro? That’s what we thought…. We stick by our EURUSD 1.12 forecast for 12 months from now.