Markets' 'liquid courage' sapped

Source: Barrons

LIQUID COURAGE. If you're not acquainted with the term, or more improbably never experienced it, it is the lowering of inhibitions from the consumption of alcohol that allows one to approach strangers you find attractive or confront others whom you think have threatened or insulted you.

At the time, your actions seem reasonable, even suave in the former instance or justified in the latter. Only later, when the euphoric effects of the source of the liquid courage have worn off, does the stupidity of your bravado become evident to you (although it was apparent to everyone else.)

Besides the hangover, the after-effects of the ill-advised encounters will be all too obvious. Brawls leave cuts and bruises while boozy assignations result in worse regrets. As the country song of some years back (well before political correctness) sums them up, "I've never gone to bed with an ugly woman, but I've sure woke up with a few."

For the past two months, global markets have rallied on the courage of the liquidity they expect to come pouring forth after the two-day meeting of the Federal Open Market Committee next Tuesday and Wednesday. Since Fed Chairman Ben Bernanke began suggesting in his speech in Jackson Hole, Wyo., that additional monetary stimulus may be needed to stave off deflation and lower stubbornly high unemployment, so-called risk markets have rallied, adding about $1.7 trillion to the wealth of holders of U.S. stocks.

That inflation of asset values was based on expectations of QE2, the second phase of quantitative easing consisting of the purchase of, coincidentally enough, of $1.7 trillion of Treasury, agency and agency mortgage-backed securities, embarked upon in March 2009. Expectations of the size of QE2 have ranged as high as $2 trillion, as suggested by Goldman Sachs' economists over the weekend, to a virtual regatta of smaller vessels, consisting of a few hundred billion at a time.

The latter seems to be tack that the skippers at the Fed have chosen for QE2. According to Wednesday's Wall Street Journal the central bank appears to have settled on a compromise of several hundred billions of dollars in Treasury purchases, a middle ground between those calling for a trillion-dollar-plus buy and those who want nothing.

As I pointed out in the print edition of this column in this week's Barron's while the anticipated influx of liquidity had boosted the stock market, it simultaneously had the offsetting effects of driving down the dollar and sending commodity prices jumping. The 13% spurt in the Standard & Poor's 500 since late August has been nearly matched by the rise in the price that I'm paying at the gasoline pump.

Moreover, in just one of the perceptive, indeed searing, observations made by Jeremy Grantham—the "G" in GMO, the highly regarded institutional money manager—in his most recent investment commentary, ultra-low interest rates may provide no stimulus whatsoever to the economy. The loss of income to retirees, who need it, offsets the benefits to big corporations, which don't need the ability to borrow cheaply. (To get the full scope of Grantham's scathing assessment of Fed monetary manipulation, go to www.gmo.com.)

Moreover, QE2 (or the anticipation of its arrival) has ceased to produce its intended effect—a reduction in bond yields. Observes Uwe Parpart, Cantor Fitzgerald's keen-eyed Asia strategist, the Treasury 10-year note yield has increased to 2.72% from 2.33% on Oct. 8. "What the bond market is tell the Fed is: you can't have it both ways, on one hand ramping up QE and wishing for higher inflation and at the same time wanting rates to stay ultra-low," he writes in a note to clients Wednesday.

With the Fed likely to dump less hooch in the monetary punchbowl, risk markets reversed course Wednesday. The stock market ran into resistance right at its April highs while bonds continue to slump but the dollar's slide paused, as Barrons.com technical guru, Michael Kahn, points out in his Getting Technical column.

Bartender Ben Bernanke may not be pouring as generously as the slightly tipsy markets had been hoping. The markets may thank him the next morning.

URL to original article: http://www.housingwire.com/2010/10/28/markets-liquid-courage-sapped