(Updated at 4:25 p.m.) The Federal Reserve announced that it will begin selling shorter term US Treasury securities and use the funds raised to buy in to the 6 to 30 year space. They also indicated more easing in the mortgage-backed security market. Stock and commodity markets had a knee jerk reaction lower, selling off on the statement’s release. The total size of the program is expected to be about $400 billion — but there is no balance sheet expansion, just swapping of securities. Notably the Fed did not reduce interest rates on bank reserves, thus there is no expectation that banks will lend more when they are poised to make even less because of the yield curve compression.
I believe that this is the beginning of more aggressive approach that the Federal Reserve will implement to lower borrowing rates for consumers on both fixed-rate mortgages and revolving lines of credit. Whether this action has any material impact on the ailing economy remains to be seen, but I am highly skeptical as I don’t believe the Federal Reserve is capable of doing much more than delaying the deleveraging that must happen in all sectors of the economy.
Because of the renewed pressure on equities and the lackluster reaction to the policy release, I now expect the head and shoulders pattern to play out on major US indices. These stock market indices have decisively broken down below the 10 day moving average, indicating a loss of upward momentum.
A sell-off down to the 10,000 area on the Dow could occur within the next week or two, and if that area does not provide technical support to markets, additional downside pressure could bring markets to the 9,750 to 9,500 area in relatively short order. If frenzied selling occurs, perhaps as a result of news-driven events in Europe or more bombshells being revealed in the American banking sector we could see the 9,000 area give way to much lower stock prices.
Curiously silver is outperforming gold today, with gold weaker and silver spending much of the trading day in the green. Even more interesting, however, was the difference in action in the paper and physical markets. SLV and silver futures took a hit after the announcement and did not recover, but PSLV (the Sprott Asset Management physically-backed silver fund) saw selling and then filled the gap almost immediately, albeit temporarily. Does this bifurcation in trading indicate that investors are more confident in the real thing or is it only a blip that will be arbitraged by the quants? At this point it looks like an aberration as the gains have been given back, and then some.
Overall I think this monetary policy shift should be bullish in the long term for hard assets, especially gold and silver, as the maturity “twist” diminishes the interest rates on long-dated fixed-income securities and provides less “safe havens” for investors to seek returns in the paper markets. In the short to intermediate term a longer period of consolidation and possibly a correction across the commodity spectrum is growing more likely.
Full Fed statement here: http://www.federalreserve.gov/newsevents/press/monetary/20110921a.htm