How’s That Wealth Effect Workin’ Out For Ya?…We all know that the “target” of Mr. Bernanke’s second quantitative easing experiment has been equities. But to be honest, and despite all of our rantings and ravings, there’s been an academic method to the madness here. Certainly what Bernanke and friends wanted to create was macro portfolio rebalancing, to be charitable in characterization. Hopefully in brief, by buying Treasuries in an amount that would offset US Federal Government debt issuance since September of last year, the Fed was academically trying to preclude investors from buying the same by essentially bidding up the price and making Treasury purchases unattractive to hold if truly looked at from a risk and reward standpoint ultimately embedded in price. And not just for general investors, but also banks specifically, hoping that by bidding up prices and attempting to buy Treasuries from the banks that the banks themselves would prefer to lend as opposed to using capital to simply buy more Treasuries as an investment of capital option. Although the numbers are not yet publicly available for 1Q of this year, the banks actually sold Treasuries very modestly in 4Q of 2010, so it was partial mission accomplished for the Fed in the period. But as we all know, bank lending has been anemic at best. This Fed intended outcome for the banks has not materialized. Although it’s just our perception, the banks used the money to trade the financial markets (remember that banking system excess reserves can be used as collateral for futures and derivatives contracts – how convenient). So in the absence of bank lending, just what else was QE2 supposed to have done to incite macro economic acceleration? Easy, it was to have sparked the fabled wealth effect among consumers.
QE being this at least quasi-provoked portfolio-rebalancing scheme, by academically making the purchase of Treasuries theoretically unattractive as the Fed bid them to prices above where they otherwise may have traded, the Fed essentially hoped capital would flow to other investment asset classes and inflate their values. And flow it did, but not into real estate as a potential asset class destination (that would have implicitly helped heal household balance sheets and levitated the value of the largest household asset). It flowed into equities, exactly as the Fed had hoped all in the interest of helping to bring the so-called virtuous wealth effect into play. And it also flowed into commodities, not something the Fed has been pleased with as per their “thou doth protest too much” arguments concerning the so-called lack of QE provocation of commodity price acceleration.
So here we find ourselves with the Fed and assorted market “regulators” (and we use that term incredibly loosely) trying to cool down the commodity price acceleration with blatant and targeted manipulation of futures margins. Also, as we’ve discussed many a time over the last month, the dollar rally that as been occurring “had” to occur. Certainly what the Fed would like to see is non-commodity oriented equities continuing to ascend, and actual commodities as well as dollar related hedges heading off into the sunset. Anyway, the upshot here is that since “portfolio rebalancing” was a failure in terms of generating an expansion in bank lending, that leaves the wealth effect as the apparent front runner legacy of QE2. So, how’s that wealth effect workin’ out for ya?