Party Pooper at the POMO Party

January 05, 2013

A month ago the US Federal reserve said it would keep its foot on the monetary gas pedal until unemployment fell to 6.5%, and maybe even lower than that. The economic forecasts that it released showed a consensus estimate for unemployment staying above the magic 6.5% until at least 2015.

The Fed backed up its new long-term commitment to boost the economy by doubling up with QE4 – another $45b a month of POMO buys (Permanent Open Market Operations) of long term bonds.  With each POMO buy, the primary dealers have cash money in their pockets, and they have to spend it. So they buy “stuff”. The stuff they buy with the loot from QE ranges from Treasuries, to junk, to equities. The constant demand from the Fed is the gas that makes these transactions happen. Many believe that when POMO stops, so does the party.

Case in point. Since the start of the year the capital markets reacted with enthusiasm to the fiscal cliff deal, with the DOW jumping more than 200 points in one session. Then on 3-Jan-2013, the Federal Reserve minutes were released and showed several officials thought it would be appropriate to slow or stop asset purchases well before the end of 2013. They cited concerns about financial stability and the size of the Fed balance sheet. Within minutes the price of gold had sunk by 1%, with gold stocks declining even more.

 

Commentary

The Fed will not stop QE abruptly. There will likely be a 3-6 month wind-down of the POMO buys. We have been here before, with QE1. Well before the Fed stopped buying, markets started to react to what was then perceived to be the end of the QE party. Markets could tank quickly and unexpectedly if the POMO party stops. This does not affect the north more than any other area, but what the Fed does affect world markets.

Meanwhile, interest rates have been creeping higher. The great bond rush may be over. Since 1980, some 33 years ago, bond yields have declined until late in 2012. The US 10 yr. Treasury rate has been spiking in the last 2 months, rising 30 basis points to 1.92% in the past 60 days.

The perceived rise in interest rates may indeed be bullish for equity markets as investment capital seeks safety.  However, higher interest rates will raise the capital cost of northern projects, they will increase the cost of housing and they will suck more money from profligate governments.

Sources

• a)http://www.businessinsider.com/bernankes-legacy-problem-2013-1



• b)http://research.stlouisfed.org/



• c)http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20121212.pdf



• d)http://www.cnbc.com/id/100353417/Gold_Falls_to_412Month_Low_After_Fed_Minutes