This note was originally published September 13, 2012 at 14:35 in Macro
It seems 99% of Wall Street was correct as QE3 was extended. Usually fading consensus is a great strategy, although perhaps not as it relates to the Fed, at least yet. But for starters, let’s look at the Fed’s statement from earlier today, the key points are as follows:
“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.”
That’s actually not a key point, although it does emphasize, as we will touch on shortly, the mandate that the Fed has struggled to fulfill.
First on QE, the Fed effectively, as Keith would say, extended QE to infinity and beyond with this statement:
“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”
On a basic level, this will start with increasing purchases of longer-term securities by about $85 billion each month through the end of the year, included in this will be $40 billion of mortgage paper. As it relates to interest rates, the Fed indicated that a zero to 0.25% federal fund rate is likely to be warranted at least through mid-2015.
In the chart below, we show the aggregate growth of the Federal Reserve balance sheet. The first chart shows the massive growth in the Fed balance sheet since 2008 with close to $3 trillion dollars being printed over the course of that period. As a ratio of nominal GDP (just shy of 20%), this is a meaningful quantity as the following chart highlights. Unfortunately, we have not seen a corresponding increase in economic activity.
The broader issue with extending QE is that it has been largely ineffective at fulfilling the Fed’s dual mandate. Ironically, or not, the key economic data out this morning before the Fed’s statement enforced this. On price stability, August’s producer price index came in at +1.7%, versus last month’s +0.3%. This is near a three year high in terms of MoM acceleration. Jobless claims also came in higher than expected at +382K versus +370K consensus, and +367K in the prior month.
While the employment data is only marginally bearish, the PPI data point is far more critical. At +1.7% MoM growth in producer prices, this is the largest increase in PPI since June of 2009. Our key issue with QE / money printing is that it is bearish for the dollar, which conversely inflates key commodities that are priced in dollars. As Keith noted in the Early Look today, the CRB index currently has a -0.94 correlation to the dollar over the past month.
Obviously, the most relevant commodity to the U.S. consumer is crude oil and the derivative price of gasoline. Given that there are 254 million registered vehicles in the U.S., the relevance of gasoline costs to consumer spending and growth should not surprise anyone. That question, as always, though, is when does increasing commodity inflation start to matter?
In the chart below, we show that prices at/north of $4 per gallon at that the pump have had a definitively negative impact on growth and the stock market over the last few years. Gasoline exceeded $4 per gallon in mid-2008, mid-2011, early 2012, and now. In each instance there was a corresponding sell off in equities. Perhaps this time is different, though we have our doubts.
Daryl G. Jones
Director of Research