The economic data of the past week strongly suggest we’re entering a double dip. Payrolls, inventories, and economic optimism are all terrible. Yesterday, all eyes were on the Federal Reserve. They met market expectations by extending quantitative easing. They acknowledged that the economy is not rebounding the way they anticipated, so they will be reinvesting the proceeds from their mortgage purchases into treasuries. The $2 trillion dollars they threw into the economy will not gradually fade out of existence. That extra money will be shifted from mortgage backed securities into treasury securities to keep interest rates very low. Many analysts estimate the Fed will not raise interest rates for 2-3 years. Just a few months ago, many were predicting a rate hike within 6-12 months.
The market sold off today because investors recognize that this was the last bullet. Long-term interest rates are already incredibly low, and it’s just not enough. 2-year interest rates are at 0.5% and 10-year interest rates are at 2.7%. Our situation is very reminiscent of Japan in the 90s when central bank policy ceased having predictable impact. When interest rates on mortgages and long-term investment grade debt are already incredibly low, the Fed is “pushing on a string.”
While the fed is out of bullets, they do have a remaining nuclear option. They could directly purchase stocks. The Fed has never done this before, but Bernanke has openly discussed the possibility. The Fed is extremely reluctant to do this because it sets a terrible precedent and would create all sorts of nasty market dislocations. I also believe there isn’t the political will for this. Just a few weeks ago Bernanke was brought before Congress and attacked for spending too much taxpayer money on bailouts.
In trader lingo, the “Bernanke Put” may have expired but Bernanke can still declare “limit down” on the stock market. Although, I wouldn’t count on it.
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Alpha is an investor and an entrepreneur. Ari is a proprietary derivatives trader. The views here are personal to the authors and do not represent the views of any other individual or organization.