Bernanke QE2 Averts Deflation, Spurs Rally, Expands Credit as Program Ends
Ben S. Bernanke’s $600 billion strike against deflation is paying off, as stock and debt markets rise, bank lending grows and economists forecast faster growth.
The Standard & Poor’s 500 Index has gained 13.5 percent since the Federal Reserve chairman announced on Nov. 3 the plan to buy Treasuries through its so-called quantitative easing policy. Government bond yields show investors expect consumer prices to rise in line with historical averages. The riskiest companies are obtaining credit at the cheapest borrowing costs ever and Fed data show that commercial and industrial loans outstanding are rising for the first time since 2008.
“Looking at market indicators, you have to be convinced it’s been a success,” said Bradley Tank, chief investment officer for fixed-income in Chicago at Neuberger Berman Fixed Income LLC, which oversees about $83 billion. “When you get into periods of aggressive central bank easing, and we’re clearly in the most aggressive period of easing that we’ve ever seen, the markets tend to lead the real economy.”
The Fed said last month it won’t need to extend the $600 billion buying program beyond its scheduled end next month. Payrolls expanded by 244,000 in April, the biggest gain since May 2010, after a revised 221,000 increase the prior month, the Labor Department said May 6. The jobless rate climbed to 9 percent, the first increase since November, a separate survey of households showed.
‘Stopped the Hemorrhaging’
“We are starting to see the impact, albeit slowly,” said Jim Sarni, managing principal in Los Angeles at Payden & Rygel, which oversees more than $55 billion in fixed-income assets. “The unemployment rate has slowly started to come down. We have a long way to go, but at least it stopped the hemorrhaging.”
Bernanke’s quantitative easing program, dubbed QE2 by analysts and investors because it followed an earlier round of $1.7 trillion in bond purchases in 2009 and the first quarter of 2010, was criticized by officials around the world.
Chinese Premier Wen Jiabao said that the policy would foster financial instability and asset bubbles. Six days after the Fed suggested at its Sept. 21 meeting that it was ready to start buying Treasuries, Brazilian Finance Minister Guido Mantega said governments were engaging in a “currency war.” German Finance Minister Wolfgang Schaeuble called the asset- purchase program “clueless” on Nov. 5 and suggested it was designed to erode the value of the U.S. dollar.
Back in November, the biggest concern for the Fed was preventing a general decline in prices, which can paralyze an economy by hindering investment, as the jobless rate held at 9.5 percent or higher for 14 months. Core consumer prices rose 0.6 percent in October from a year earlier, the smallest gain since records began in 1958, government data at the time showed.
“Measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate” of promoting full employment and containing consumer prices gains, the central bank’s Federal Open Market Committee said in a Nov. 3 statement.
Since reaching a 20-month low of 2.18 percent in August, a bond market measure of inflation expectations the Fed uses to help determine monetary policy has risen to 2.87 percent. The five-year forward breakeven rate projects what consumer price increases may be beginning in 2016, smoothing blips in inflation expectations from swings in oil prices and other temporary events.
The gauge is down from 3.28 percent in December even with energy and food costs reaching record highs in a sign that investors expect Bernanke will be able to withdraw the unprecedented stimulus before inflation gets out of hand. The current level compares with the average of 2.71 percent in the five years before credit markets seized up in 2008. The core inflation rate has increased to 1.2 percent.
“We’ve seen a bit of a lift in breakeven inflation rates, but it’s not dramatic,” Tank of Neuberger Berman said.
The Fed’s policy of pumping cash into the financial markets risks longer term damage, according to Bruce Bittles, chief investment strategist at Milwaukee-based Robert W. Baird & Co., which oversees $85 billion. He compared the Fed’s current policy to the one it adopted following recession of 2001-2002, when policy makers slashed its target rate to 1 percent in 2003 to spark the housing market and the economy.
“It was a failure,” Bittles said. “I don’t think it’s very healthy to artificially boost stock prices. What are the long-term consequences of that? We don’t know. The Fed did this with housing back in the last decade, and the unintended consequences were a disaster.”
QE2 has contributed to a 12 percent decline since August in the dollar based on Bloomberg Correlation-Weighted Indexes, which measure its performance against nine of the most-traded currencies in the world, including the euro, yen and pound.
Gold and silver reached records in April as investors sought to hedge financial assets against the weakening dollar and accelerating inflation. Gold advanced 25.8 percent in the past year, while silver more than doubled as investors increased their holdings in exchange-traded products to a record 15,518 metric tons on April 26.
Rising commodities may be restraining the economy. The Commerce Department said April 28 that the gross domestic product rose at a 1.8 percent annual rate in the first quarter after a 3.1 percent pace in the final three months of 2010. The Bloomberg Consumer Comfort Index fell to minus 46.2 in the week ended May 1, the lowest level since the end of March, as the highest gasoline prices in almost three years soured Americans’ views of the buying climate.
“What’s important for people to understand is the Fed is simply stepping in to create some credit in a situation where the banking system apparently is unable to create credit,” said Paul Kasriel, chief economist at Northern Trust Corp. in Chicago. “The patient right now is incapable of breathing on its own, and it needs the help of the Fed’s ventilator.”
Credit provided by the Fed, commercial lenders, savings and loans, and credit unions increased 1.67 percent in the last three months of 2010, according to a Northern Trust report. That compares with a long-term average of 4.58 percent since 1953. Treasury yields may fall after QE2 ends as investors seek to protect themselves from a worsening economy, Kasriel said.
Yields on 10-year Treasuries, which are a benchmark for everything from home mortgages to corporate bonds, have fallen to 3.18 percent from this year’s high of 3.74 percent on Feb. 8, according to Bloomberg Bond Trader prices. Treasuries of all maturities have returned 1.76 percent this year, while corporate bonds have gained 4.1 percent, including reinvested interest, Bank of America Merrill Lynch indexes show.
In deciding to end QE2 as scheduled in June policy makers are betting that economy will rebound. The median estimate of 73 economists surveyed by Bloomberg is for GDP to exceed 3 percent in the remaining three quarters of the year.
“The labor market is improving gradually,” Bernanke said at a press conference after the Fed’s two-day meeting ended April 27. “The longer it goes on, the more confident we are.”
Bernanke said the Fed would initially hold its balance sheet, currently with $2.723 trillion in assets, steady after completing the purchases by reinvesting the proceeds of maturing Treasuries and mortgage bonds it during QE1.
The Fed has bought about $470 billion of government debt under the program, said David Ader, head of government bond strategy at Stamford, Connecticut-based CRT Capital Group LLC. That money has encouraged investors to wade into riskier assets.
Speculative-grade companies have sold $131.5 billion of junk bonds this year, compared with $106.3 billion at this time last year, when sales set a record $287.6 billion, according to data compiled by Bloomberg. Yields on debt rated below Baa3 by Moody’s Investors Service and less than BBB- at S&P average 7.23 percent, down from 8.88 percent a year ago and 14.7 percent in 2009, according to Bank of America Merrill Lynch indexes.
Banks eased lending terms in the first quarter as they forecast improvement in the U.S. economy and companies sought more loans, a Fed survey released this week of loan officers at 55 domestic banks and 22 U.S. branches and agencies of foreign banks conducted from March 29 to April 12 showed.
Fifty-five percent of domestic banks surveyed reported improvements in the credit quality of large and middle-sized loan applicants, the Fed said. About 35 percent reported improvements in small firms, according to the survey.
Commercial and industrial loans totaled $1.25 trillion as of April 20, according to the Fed. While that’s down from the peak of $1.62 trillion in October 2008, it’s up from last year’s low of $1.21 trillion in September, marking the longest sustained increase since 2008.
Household credit limits rose about $30 billion in the first three months of this year from the previous period, the first increase since the third quarter of 2008, the New York Fed Bank said May 9 in a report. Foreclosures declined 17.7 percent and bankruptcies fell 13.3 percent.
QE2 “slowed the pace of deleveraging, and it clearly helped to mitigate the risk of deflation,” said William Cunningham, co-head of global active fixed income in Boston at State Street Global Advisors, which oversees $2.1 trillion. “It had a positive impact on net.”
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