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Loose lips sink markets

February 20, 2013

Cracks are beginning to show in the FOMC. There was a hint two weeks ago that some members of the FOMC were having second thoughts about ultra-easy credit. The release of the FOMC minutes today confirmed this and markets headed lower.

The Federal Open Market Committee (FOMC) is the key US monetary decision-making body. The minutes showed policy makers were divided about the strategy behind Chairman Ben S. Bernanke’s program of buying bonds until there is “substantial” improvement in a U.S. labor market burdened with 7.9 percent unemployment, with some saying an earlier end to purchases might be needed, and others warning against a premature withdrawal of stimulus.

The FOMC at its January meeting decided to continue buying $45 billion a month of Treasuries and $40 billion in mortgage- debt without setting a limit on the duration or total size of the purchases. Policy makers also affirmed their pledge to keep the target interest rate near zero “at least as long” as unemployment remains above 6.5 percent and inflation is projected to be no more than 2.5 percent.

Fed Governor Jeremy Stein said this month some credit markets, including leveraged loans and junk bonds, show signs of potentially excessive risk-taking. The asset purchases could also complicate the central bank’s strategy to return its balance sheet to more normal levels. The Fed in 2007 held less than $900 billion in assets. Now its balance sheet exceeds $3 T.

Today gold dropped 1.2%, other commodities dropped as well including oil.


Investor sentiment turned bullish on gold and commodities as the Fed showed signs that it may rethink its ultra-stimulative policies - zero interest rates and $85 B per month in debt market purchases. Why would such an action be so bearish for gold et.al. ? If the Fed changed to a neutral policy the US dollar would rise—the Europeans and Japanese are just as stimulative as the US. So if the US stopped it would become an attractive place to park funds.

The Fed policy is unsustainable and is introducing risk to financial markets. Pension funds and long term investors are forced to chase yield in a zero-interest rate (ZIRP) world. Securities that should be high risk and high return are attractive to pension fund managers scrambling earn a decent return.

The north depends on commodity extraction for major projects and for its economic growth. So when the markets tank, as they did today, it sours investor sentiment towards northern commodity investments.