Wow, the Dow finished the day at -634. Pretty fierce, considering we had a number of negative triple digit days already last week. As of 11pm ET tonight, the Dow futures are down another 285. So tomorrow promises some very interesting market action.
Importantly, Bernake is scheduled to speak tomorrow. At this press conference last year, he announced the programs which are commonly referred to as QE2 (Quantitative Easing), though evidently, the Chairman doesn't actually like that term. Others refer to it as "money printing," which I would guess he prefers even less so.
A few points on what QE actually means. First, most people think of QE as "printing money" and use it as an excuse to join the Tea Party. I can see why people cringe at the idea of "money printing" because it evokes the idea of turning a crank and making something out of nothing. However, QE is slightly different from that. When the Fed engages in QE, they are really just buying US Treasury bonds and giving people "cash" for their bonds. So, yes, it is "printing money" in the sense that there is more actual money in the system, but it is not creating money out of nothing. It's trading cash for bonds. It's like the US economy is getting money out of the ATM, but here the Fed is forcing people to go to the ATM.
The effect that QE has is that it puts a lot, A LOT (hundreds of billions of dollars) of cash into the portfolios of organizations that usually hold treasury bonds. Now that they have cash, they have to go invest that money elsewhere. Typically that money goes into the stock market, the commodities market, and also the corporate bond market. I haven't studied the data, but a common view is that the stock market tends to go up on heavy POMO (Permanent Open Market Operation) (i.e. Fed buying) days.
QE has had a number of interesting effects on the markets. Some good and some potentially bad:
Possibly Good:
- More cash in the system helps to push up asset prices. This partially offsets the billions of dollars lost from the system because of the housing crash and subsequent loss of incomes during the "great recession."
- Having an additional buyer in the treasury markets helps to keep bond prices up and interest rates down. This is the functional way that the Fed is able to lower interest rates, even though they are at 0% already.
- It allows the US to stay artificially under the debt cap. The Fed gives the interest it earns on US Bonds right back to the Treasury. So that's more cash for the US Treasury, but it's a little circular and kind of false.
Possibly Bad:
- QE increases the already HUGE size of the Fed's balance sheet. It was already bloated after all the TARP and bailout related actions in 2008. QE1 & QE2 have actually made the Fed the #1 holder of US Treasury debt, even surpassing China.
- More money means higher prices. Inflation is much better than deflation, but it is unclear if the Fed will be able to keep a handle on prices while nursing a sick economy with negative interest rates.
- Inflation hurts creditors and savers. All those responsible people (or countries) out there with savings will see their debt repaid to them with money that is worth less (though not "worthless")
I hope that tomorrow the Fed Chairman will indicate that plans for QE3 are in place and the program will begin sometime in the next month. The more forward he is with details, the more positive impact he will have on the markets. The worst case scenario is he says, "we aren't prepared to do it yet" or perhaps "we have no plans to engage in more POMO." Then we will be looking a sea of red. Of course, Bernake knows this. So, I expect that the likely case is that is they are prepared and will begin some level of POMO, but not establish a set amount and time limit. This should be enough to stabilize the broad markets...and send commodities higher.
I think he speaks at 2:15 tomorrow. I would be long going into that meeting.
MONKEY BUSINESS:
Buying: FAS @ $12.50, ERX @ $40.20
Selling: VXX @ $34.70 ($23.55)
Holding: AGQ ($159.70)
