Friday, January 6, 2012

2011 and 2012 -- Years that the central banks drove markets

A very large factor in the overall market performance this last year has been the actions of the world central banks. Martin Feldstein, at NBER, stated that most of the stock market appreciation last year (2010) was due to the Fed's QE2. See: According to Marty Feldstein, the income effect of the rising market made consumption go up temporarily increasing GDP.

In other words, the economy was extremely weak, which necessitated the worldwide QE programs, but the printing of money at the Fed made the market go up even as economic conditions deteriorated. So, one could say, the market would be a lot weaker if the central banks didn't step in, and, further if the weak economic conditions continue in 2012 (which, considering the weakness in southern Europe and potential weakness in China and unprecedented deficit spending in the US, is likely) central bank's actions will determine the fate of markets in 2012.

In 2011, the Fed finished up $600Bn of Quantitative Easing then went on a $400Bn Operation twist. Operation Twist lowered long term interest rates to even closer to nothing -- meaning bond prices appreciated. QE2 (coming after QE1 which totaled approx $2Tr) was meant to supply cash to financial institutions, with the intention that they lend this cash to the private sector.

It seems the money from the QE2 went directly from the financial institutions back to buying government bonds, as well as other high grade corporate bonds. Further, according to a paper by M Singh at the IMF, the largest component of the shadow banking system (money market funds, hedge funds, off balance sheet vehicles) is lending to hedge funds and other investment vehicles. So it seems some of this money was lent to these hedge funds and other investment vehicles, which put the money into investments such as stocks and commodities.

The Swiss Central Bank finished up an approximate $100Bn QE program in August buying Swiss Francs to lower the Swiss Franc, while the ECB had a Euro600Bn QE program in November.December to buy up southern EU debt.

Bank of Japan also did a large QE over approx $100Bn to lower the value of the yen this year.

What makes it stressful from an investor's standpoint, is that the central banks are very secretive and hush-hush -- Bernanke for example does not want the Fed audited publicly (and also secretly pushed for a new accounting rule at the Fed that subprime bonds at the Fed can never be marked down). The ECB didn't really announce it's buying program until a few days before -- in fact comments from the ECB made it sound as if the ECB was not going to buy southern EU debt.

So it total, this past year has been really stressful and unusual -- note the Federal Reserve and the ECB had never done any money printing (Quantitative Easing) in their respective institutions' histories. 2008-2011 for the Fed and 2011 for the ECB have been "groundbreaking" years, even as they have kept this information somewhat behind closed doors.

1 comment:

Rabbit said...

Just read this article after searching for analysis of what happens when/if the Greeks default. I appreciate your non politicized commentary and your understatement. We are in the soup.