Is the Fed in a Pickle?

The Fed finds itself in a pickle
As governors sound somewhat fickle
Is QE to end?
Or will they extend
Bond buying much more than a trickle?

Markets remain unhappy this morning with volatility the main theme.  After yesterday’s dramatic sell-off in the Nikkei, overnight we saw a further 3% decline before it recovered and finished up about 1% on the day.  The yen is following in the Nikkei’s footsteps, strengthening when the Nikkei falls and reversing alongside any rally.  Will this type of price action continue?  I doubt it.  Market participants have too much trouble keeping up with this type of movement profitably, and so they will step away from the market when losses start to mount.  Has the long-term situation changed?  I think not.  If anything, what we learned is that the Fed discussion about ending QE seems to be the only one they are having.

To recap what we have learned this week; the Fed may or may not taper off bond purchases depending on what happens to inflation and the employment situation.  SF President Williams made sure to tell us that just because the Fed starts down the tapering road it doesn’t mean they won’t reverse course.   St Louis President Bullard is more focused on inflation, saying he would like to see that number rise before considering ending QE.  Bernanke was able to confuse everyone on Wednesday by saying the Fed had no intention of ending QE right before he answered a question by saying QE could end within the next several months.   It is this clarity of thought that has given the market fits, and will probably prevent any further equity rally until things are more settled.  In a similar vein, BOJ Governor Kuroda has been confusing things by saying his plan is to lower interest rates but that as the economy improves, rates could go higher.  So which is it?

Equity futures this morning are pointing lower once again, somewhere between 0.5% and 0.75%, but remember yesterday things opened terribly and wound up virtually unchanged.  The data still matters, and not only did we see better IFO data from Germany this morning, but we have Durable Goods to look forward to this morning in NY with expectations for a rebound from last month’s terrible print of -6.9%, to +1.5%, +0.5% ex transport.

No market moves in a straight line, but underlying trends are powerful drivers of market activity.  I continue to believe that the Fed will purchase their $85 billion of bonds each month for the rest of the year.  I continue to believe that the BOJ will push the envelope on even more stimulus if the Japanese inflation data does not start to improve shortly.  I continue to believe that the ECB is going to be forced into further policy ease as the Eurozone fails to show economic improvement and the devastating employment situation across the continent forces them to look beyond their inflation mandate.  And so, I see no reason to expect anything other than a weaker yen on the basis of continued policy ease, a weaker euro, on the basis of an increase in policy ease, and an overall stronger dollar on the basis of improved economic growth and the eventual end of QE.  But right now, the market is confused and concerned.

For hedgers, this means that orders remain the best tool for managing risk.  Choose a level and wait for it to be achieved.  Given the current volatility, if it is within 2-3%, it has a real chance to be done over the course of the next week.

Good luck and have a great holiday weekend
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