The Federal Reserve’s FOMC meeting was the most important event of last week as Ben Bernanke unveiled another round of quantitative easing.
And while it was no surprise that the Fed kept its federal funds rate between 0% and 0.25%, the Committee decided to extend its expectation for exceptionally low interest rates to at least mid-2015 (from late 2014).
The U.S. dollar fell in response to the announcement, while gold prices jumped US$50 per ounce intraday and the Canadian dollar almost touched US$1.04.
If the Federal Reserve is going to print money and purchase billions in mortgage-backed securities, each U.S. dollar is now worth less.
North American markets continued to rally on the news, while Asian and European markets played catch-up on Friday.
While the Federal Reserve certainly dominated headlines, there were other news items of note, including a German Constitutional Court ruling that essentially gave the green light to the European ESM (i.e. bailout) program, a Dutch election which was considered a victory for pro-Euro parties, and a U.S. inflation report which suggested that inflationary pressures south of the border remain subdued.
So is the economy safe?
Not yet. Sovereign debt levels are still too high and continue to rise because countries are spending more than they can afford.
As a result, the cost of borrowing (yields) has risen making it more difficult for these countries to meet their financial obligations, which eventually leads to a vicious circle that can end in default.
So, do debt purchases by the European Central Bank or Federal Reserve actually solve the debt crisis? No, but it does buy more time for indebted countries to sort out their fiscal mismanagement.
As you may recall, recent bearish declines in the market over the past couple of years have been the result of interest payment or debt refinancing deadlines (Greece should come to mind).
Time was running out, but action was taken to give countries like Greece more time to reduce its deficit. With 10-year yields in countries such as Spain and Italy breaking through the 6%-to-7% level over the summer, it became clear that such costs of financing were unsustainable and that these countries needed more time to lower their deficit so that more tax revenue could be reinvested instead of used to make rising interest payments.
So what we’ve seen the ECB and Fed do in the past week is not a solution to the debt crisis, but it is action that can provide politicians and bureaucrats more time to get their act together and work towards a financial path that will provide more budgetary stability.
Central banks have taken action to help us get back on track, thus helping sentiment and stock prices.
In corporate news, it was a very quiet week as most quarterly reports have ended for Q2. However, Apple once again made headlines; this time for the unveiling of the new iPhone 5.
Accommodative monetary policy and thus a weaker U.S. dollar have resulted in appreciating commodity prices since July. We’ve already noted the impact monetary policy has had on gold and energy prices, but crude oil was also pushed higher this week as tensions in the Middle East are on the rise.
Israel and Iran continue a war of words over Iran’s nuclear program and anti-American sentiment spread throughout the region, which unfortunately led to the death of the U.S. Ambassador to Libya and three other consular staff.
TRADING WEEK AHEAD
We won’t see a great deal of economic or corporate activity until third-quarter reporting season kicks off in early October. With that said, there are a few things that are on our radar over the next week.
First, when it comes to economic activity, U.S. housing will be at the forefront as we’ll see the most recent data for U.S. housing starts, existing home sales and the National Association of Homebuilder’s Index.
We expect all of these indicators will show continued, but modest improvement, in the U.S. housing sector.
Second, corporate news will likely be light next week as FedEx Corp, General Mills Inc, and Oracle Corp are the only major U.S. companies that will provide us with a quarterly report.
Finally, commodities and the U.S. dollar will remain in focus following the QE3 announcement. However, the market has likely already priced in a lot of the impact of these new policies, so we don’t see a great deal of upside for commodity prices and the loonie based on U.S. dollar weakness alone in the immediate future.