Quantitative Easing and Correlations
With my previous article I introduced a study about the policy done in last years by central banks: the purpose was to analyze the impact into stock markets (since correlated with forex) to better understand the current situation and possible developments in the coming days/weeks.
With this article I will show my study about U.S. monetary policy, the impact occurred in some world markets, and my attempt to understand whether this policy has produced the desired effect or not.
As previously underlined, QE is an unconventional monetary policy used by central banks to stimulate the national economy when conventional policy has become ineffective. When I read this sentence for the first time, I thought that in any other circumstance in which this type of expression is used, it simply means that the situation is far more serious than you think, and normally any kind of extreme solution will cause serious damage in some other macro/micro systems directly or indirectly connected.
In our contemporary history, this type of policy has been introduced (and widely used) by the American central bank (FED) with a 2 trillion dollars (12 zeros) of new money created. After briefly visiting the impact on the value of the Dow Jones and Nasdaq, which are nothing but the indices of the largest U.S. companies, I'm now interested in assessing the effects of this policy eventually appearing in other sectors.
THE US DOLLAR
To measure the value of this currency, in 1973 was created the USDX: an index calculated by correlations between the USD and 6 major world currencies (EURO, JPY, CAD, GBP, CHF, SEK). The index started with a base value of 100: this means that actual 82.60 is overall a loss of about 16% since 1973, in correlation with those 6 major currencies.
Here is an USDx weekly chart, where I drawn main QE dates.
Chart 1 - USDx Weekly.
I would like to know what makes 'some people' to be sure that during QE programs, the national currency doesn't lose strength. Maybe I got it wrong or my charts are mirrored upside down.
Looking at chart, we clearly see a strong loss corresponding to the beginning of both QE programs, and a fast recover once programs ended. The US Dollar is also very important when talking about commodities, since all (or nearly) their prices are expressed in USD.
By ‘commodity’ we mean a class of goods for which there is demand and which is supplied without qualitative differentiation (for the market it is not important who extracted those Xn Oil Barrels, or who produced those Xn tonnes of Corn, or if major supply comes from a capitalist or a producer). What counts, is the price at the end of the day, and price fluctuations are caused by many factors like for example weather conditions, increasing demand from emerging countries, or due to changes in habits like for example the introduction of bio-diesel and other “agricultural fuels” .
Among commodities, we find some extremely important ones since largely used by people worldwide and/or largely used by producers of services/goods. Due to article length, I summarized my attention in 2 of these: Corn and Cotton.
Chart 2 - CORN
In this chart we see that CORN price was quite stable during the first QE program, but then found a strong increase during QE2. Many factors caused that uptrend, and it is not certainly only due to the FED policy, but on the other hand we can’t deny that the price took a boost exactly in those months. Furthermore, the USDx lost a lot of ground also during first QE, while commodities stayed flat.
With the horizontal line (maroon), I finally divided what in my opinion were “natural” conditions, from the "QE" ones: everything above that line was due to a kind of “buy-mania” occurred during QE2.
Chart 3 - COTTON
Cotton price chart is very clear: price moving in “standard mode” during QE1, then up in “maniac - mode” during QE2, stop and reverse down just 3 months ahead of program ending date, and finally “crash - mode” in summer 2011 to stabilize where it came from. Analysts could explain this move with the best reasons ever, and half world could come here and comment below and say: "Hey you fool, that move was caused by this and that" but I will not change my mind: this move was 90% caused by huge amounts of speculative money flows.
Almost all commodities have the same weekly chart, even Oil WTI (together with Brent, Heating Oil etc..).
What I see in these charts, is that at a certain point, every 'risk-on asset' was good to buy, no matter if this caused heavy damages in cotton industry (and related) or in fuel prices or retail prices around the whole world, or even if this could cause a civil war somewhere. In my opinion the FED should have expected this situation and so they should have prevented it. But you know... with opinions we don't make money at the end of the day.
Main purpose of QE policy, was to give stimulus in National Economy, buying treasury bonds/notes and other assets like mortgage bonds so lowering interest rates thus making borrowing and spending more attractive than savings. Spending is very important in our society: producers will keep producing if consumers will keep consuming.
Now that "games are done" I can look-back into some of main economic data to understand if targets have been met and if this policy gave the expected stimulus. To do this I went through some of main economic data and I will now introduce them, but will go deeper in next articles, due to the importance involved in some. All following charts are courtesy of www.tradingeconomics.com.
Chart 4 - GDP
The situation, seen from a GDP's point of view, is quite good in my opinion. This data however is complex and many calculations are involved with it and this will be completely explored in another article.
Chart 5 - Industrial Production
This chart is very representative of the situation occurred between 2008 and 2010: the industrial production fell in deep recession and this is the worst scenario to fight with for a Government and a Central Bank. The immediate effect is no job creation, see chart 6-7:
Chart 6 - N.F.P.
Chart 7 - Unemployment Rate
It is notable the dip in NFP and the strong rise in unemployment occurred starting from 2008 and we clearly see that the situation is still not going very well. Last NFP numbers shown an increase but is still very small. Unemployment rate, indeed is showing problems to go back below 8% and this is a clear sign that there is still a lot of work to be done.
Looking at these few data, and in my small point of view, I agree with Ben Bernanke (FED Chairman) when he said that if they did not act with this policy, things would have been even worst. Looking at Chart 5, I would not like to know the impact in worldwide economy if that value was flat at lowest level for whole 2010. Maybe I would not be writing this article now.
On the other hand, I think is not possible to understand how much this policy really impacted in worldwide, due to strong rise in commodities: fuel and flour prices first.
In recent press conferences, all reporters' attention was about new QE program: QE 3 or not? While all Bernanke's attention was to say that main problems now are in Employment reports.
Looking at these data, and doing some correlation with those shown in previous article, I think that the QE program is done. A new QE program will not be a solution for jobs creations: a bank, even if it is the FED, can't create Jobs from the air like they did with those 2 trillion $. To create Jobs a Country needs new laws, less taxes for employee etc...
I hope you enjoyed this quick journey into fundamentals, and I hope it will give a better perception of what is happening all around our 22"screen (lol).
Good luck in your trading.