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Is Bernanke Saying “Deflation Is Here”?
So the Federal Reserve has embarked on the great experiment of our time, quantitative easing; also known as monetization of the debt; also known as creating money out of thin air – to buy U.S. Treasuries in a desperate effort to stop deflation.
The television pundits were all acting surprised at the size and boldness of Ben Bernanke’s actions, as if they didn’t know that the Fed has already bought $100 billion in agencies. That agency commitment has now exploded to $750 billion. The Fed’s balance sheet will balloon to $3 trillion, while the universe of allowable assets will expand under the Term Asset-Backed Securities Loan Facility (TALF) program. The Fed will print money, use it to buy Treasuries, then loan them for assets of dubious quality.
Wednesday’s announcement is the equivalent of Fed Chairman Bernanke standing on a soapbox, waiving the white flag of surrender and shouting, “deflation is here.”
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As I warned my subscribers on Wednesday, this news led to the sort of emotional reaction in the market’ that is usually quickly retraced. Sure enough, the 30-year June Bond contract closed on Wednesday nowhere near the intraday high. Part of the problem is that the $300 billion allocated to “long-dated Treasuries” will have no direct effect on the 30 year Bond, as the target issues are between 2 and 10 year Treasury Notes. The Federal Reserve desperately wants a steep yield curve, so I believe the majority of the Fed’s buying will be weighted toward the 2 to 5-year Notes, to suppress the short end of the curve.
This is not to say that more announcements and purchases can’t or won’t be made. If bailout mania and all the Fed machinations have taught us anything, it’s that deficits are meaningless within this desperate bid to reflate, or recapture, inflation. If Bernanke is dissatisfied with the outcome of this round, the Fed may expand its balance sheet even more. Should that require $2 trillion of purchases of 30-year Bonds in the future, then so be it.
Keep in mind that the Treasury is issuing debt at the clip of $100 billion a month, so this program will be all but spent in less than a quarter. After Wednesday’s announcement, I actually heard one guy say, “This is great, now we have a buyer where there weren’t any before.” Uh…right. Did you see how hard the U.S. dollar fell after the news? I wouldn’t be surprised if at some point the dollar's travel is inversely proportional to the size of the U.S. deficit.
Bill Fox has been involved in the markets since graduating in 1988 from Vanderbilt University. He joined EWI in 1994; most of his subscribers are professional traders spread around the globe.