No news from Bernanke has been interpreted as good news

Precious metals had consolidated ahead of the speech given by Fed chairman Bernanke at the Kansas City Fed seminar in Jackson Hole, Wyoming. After the release of the text of his speech, precious metals rallied in line with US Treasury notes and bonds. Stock markets were initially disappointed but later pared losses, which was a further support for precious metals. Only the PGMs did not rally strongly enough to end the week with a gain compared to the previous Friday.

The behavior of most markets last Friday contradicts academic theory that markets are information efficient, which means that not only public available but also inside information is already discounted in the prices. Many market commentators expected the Fed chairman to provide a clear signal that the FOMC would implement a third round of quantitative easing at the next meeting, which is scheduled to take place on September 12 and 13, 2012. However, Ben Bernanke only repeated information, which was already provided by statement and minutes of the recent FOMC meeting. Thus, Mr. Bernanke did not provide any news the market had hoped for. As markets had already priced in more details about the implementation of QE3, the normal reaction expected would be a drop of prices for US Treasury paper and precious metals. However, these markets switched to rally mode – a very strange behavior.

Also the part of Mr. Bernanke’s speech, in which he defended quantitative easing, has to be seen more against the criticism, especially from republican lawmakers. Presidential candidate Mitt Rommney even declared as US president, he would sack Fed chairman Bernanke. While we fully agree that QE1 and QE2 as well as “operation twist” have their merits and helped the US economy to recover pretty well after the financial crisis of 2008, we have doubts about the effectiveness of a third round.

After the rally of last Friday, the yields on 10yr US Treasury notes stay at 1.55%. This is very close to the record low of around 1.4% reached just a few weeks ago. If this already historically low yield level on 10yr US Treasuries does not induce corporates to invest more, which difference would QE3 make? Furthermore, the yield on 2yr US Treasury notes is at 0.22%, thus, the steepness of the yield curve, often measured by the spread between 2- and 10yr T-notes, is 133 basis points. In a historical comparison, this is a rather flat yield curve level to have a strong stimulating impact on the economy.

For business fixed investments, the yield level of corporate bonds is more relevant than funding costs of the US government. Therefore, QE3 would have a stronger impact if the Fed would buy corporate bond ETFs or mortgage backed securities instead of US Treasury paper. Furthermore, companies do not just invest because the yield level is low. As James Tobin has shown with his famous q-ratio, funding costs have to be low relative to the expected rate of return on real capital. If business leaders are unsecure about the economic outlook, they hesitate to invest and postpone investment decisions into the future.

In this context, the stock market comes into play as it is often regarded as a leading indicator of future economic growth. So far this year, the US stock market has performed quite well and just about two weeks ago, the S&P 500 reached the highest level since May 2008. However, the US stock market reacts negatively in the case that hopes for QE3 get dampened. But it is well known that economic policy is to a large extent also changing the psychology of market participants. In this respect, QE acts like a drug, once injected it gives traders and investors a high feeling, but the hang-over is not far away. And then a higher dose is requested. Considering QE3 is already an indication that the Fed would not be convinced that the US economy will improve. How could the Fed expect business leaders as well as stock market investors would view the economic outlook more optimistic?

We do not deny that the US economy also faces some head-winds. Growth in China is slowing, which also has an impact on the US economy. The political leaders in the Eurozone are unable to come up with a solution to fix the debt crisis. All they do is buying time. And some necessary measures to stabilize the euro are torpedoed by the German Bundesbank. However, against these headwinds, the Fed can do relatively little. QE3 could even be negative for stabilizing the situation in the eurozone as a rally in US Treasury notes also pushes German Bunds higher. But a rise of Bund prices leads normally to selling of Spanish and Italian government bonds. Nevertheless, QE3 could have an impact to increase the competitiveness of the US economy by weakening the US dollar. However, if this would be the real hidden purpose of QE3, then the FOMC should better declare openly that they aim to weaken the US dollar.

Ben Bernanke’s speech keeps the door open for QE3 at the September FOMC meeting but it is not a pre-commitment that measures will be taken in mid-September. A lot will still depend on further economic data released ahead of the FOMC meeting. The most important is certainly the US labor market report due next Friday. This report will also have a strong impact on precious metals markets. However, a positive surprise in the number of new jobs created or the unemployment rate would dampen QE3 hopes, but as pointed out two weeks ago, no further quantitative easing is not necessarily bad for precious metals as a stronger economy is also supportive for precious metal prices.