QE, commodities and stocks

The Federal Reserve announced its first foray into QE, or quantitative easing, when it communicated to the public at the end of November 2008 – see statement – it would buy up to $100 billion in GSE obligations and up to $500 billion in mortgage-backed securities.

Falling commodities and stocks, surging unemployment and emerging fears that deflation might eventually engulf the economy led the Fed to vastly expand QE, now  referred to as the first round of quantitative easing, as it now included $1.5 trillion in agency debt and mortgage-backed securities purchases and $300 billion in Treasuries.

Initially set up to go through December 2009, the Fed decided to extend and draw out the purchases of agency and MBS until the end of Q1 of 2010 in order to smooth transition in the markets – see statement.


(click chart to enlarge)

Defined as the purchases of government debt over and above what is needed to keep short-term rates at zero, the Fed’s extraordinary action has prevented a much deeper recession from taking hold.

But the  massive purchases have had little impact stimulating a more aggressive recovery, as much of the newly created money returned to the Fed in the form of excess reserves – Economic impact of QE2 looks limited.

Nonetheless, as the chart above reveals, the implementation of both QE1 and QE2 does appear to have had a profound impact on commodities and stocks.

Commodity prices (orange), as tracked by the Thomson Reuters/Jefferies CRB Index, didn’t bottom until Q1 2009 as risk averse investors shunned all but the safest assets, while a sharp slide in global manufacturing triggered a surplus of raw materials.

The end of QE1 marked the temporary end to the rise in raw material prices. In fact, the decline during the first quarter of 2010 can probably be traced to declining purchases of government securities and the expectation new buys were about to come to an end, as Fed moneys dried up.

The blow up in Greece during the spring of 2010 and the modest impact on the credit markets encouraged investors to briefly trade their commodities and stocks for the safety of the dollar.

However, the mere mention at the end of August 2010 by Fed Chief Ben Bernanke that policymakers were considering a second round of QE2 sent astute speculators back into the commodity markets.

And the eventual implementation of $600 billion in longer-term Treasury buys has helped to fuel the dramatic rise in raw material prices.

Stocks (green), as measured by the S&P 500 Index, have tracked a similar path, with the bull market being interrupted by the end of QE1 and the negative effect of the credit crisis in Greece on economic activity and financial markets.

The avoidance of a double-dip recession last year and the favorable impact from a growing economy on corporate profits has reignited bullish sentiment; however, the flood of new Fed money has also provided a stiff tailwind for stocks, in my view.


(click chart to enlarge)

A closer look at the CRB Index and the first and second rounds of QE are available in the chart above.