Saturday, September 17, 2011

QE3 : Operation Twist...will the stock market rally again?

FOLLOWUP: Interestingly, the announcement of Operation Twist had unforeseen and unintended short term consequences. Within minutes of Operation Twist announcement the Dow Jones Index plunged by 280 points and a further 380 points the following day- even before the Fed started the operation itself! Given this was a widely expected move by the Fed, it was hardly surprisinng yet its disruption the markets was massive - the effects was widespread the Korean stock market, for example,  fell by 6%...I think the move is comparable to those after the 911 event. Analysts at a loss to explain this had to come up with something - some say the selling was due to worsening economy, others say it is due to the problems in Europe etc. However, why did all the selling occur just after the US Fed announcement? Why did gold which as been a safe haven also fall if markets are worried about Europe and global economy?

If you go back to the seconds after Operation Twist was announced, you will notice that short term interest rates moved up. No surprise since Twist was suppose to move up short term rates and move down long term rates and bond markets anticipate the effects of the 'twist' reacted accordingly.  Next sequence in the chain of events is the US$ spiking up due to the movement of short term rates. Short term rates is one of the factors that affect the exchange rate between countries i.e. if rates move up, the currency strengthens. Now that takes us to the connection between US$ and risky assets - when US$ falls, risky assets such as commodities and foreign stocks go up. This connection is due in part to the US$ carry trade in whcih speculators borrow cheaply US$ to speculate in all sorts of markets - when the US$ is falling, money will flow into these markets as speculators can profit when the assets they are holding is converted back to the falling US$ ..they will be motivated to borrow more to speculate.  However, when the US$ rises, the reverse happens - money pulls out from markets such as Asian stocks, commodities etc and cause sharp falls.


I think most savvy investors know of the individual links between rates and US$ ...and US$ and risky assets. However, it is the ferocity of chain reaction that caught many by surprise - much of which caused by computerised trading algorithms that automatically sell certain assets when parameters of their model change. I went through analysts forecast of what will happen if Operation Twist was announced and the consensus was nothing much since it was expected a few predicted it will be short term positive for stocks. Apparently, the collective behavior of man, machine and feedback loops eluded everyone. The main opponents of Operation Twist didn't like it because they fear it risks inflation and they believe it will prove ineffective  - nothing to do with what we have seen since the announcement in fact inflation fear should subside since price of commodity and oil fell . I don't think the US Fed figured it out ahead of the announcement because the chain reaction triggered by Operation Twist was so large and disruptive, it may undermine what Operation Twist set out to achieve.

So after the stock market falls, will we see a rally once chain reaction stops and reverses? The US$ spike up 8% in 3 weeks vs S$, my take is once it starts to weaken against $S, we may see a reversal of 'negatives'....and it may come sooner that anyone expects.



UPDATE : Despite criticism that the earlier QE1 & QE2 did little for the actual economy, thee is another perspective to this. Despite high unemployment, it could be the US economy might be in far worse today if not for QE1 & QE2. A research paper published recently estimated the UK's QE boosted its economy by roughly 2% in 2010[Link]. It is easy for critics to point to the poor shape of the US economy and say various stimulus and Fed action have failed but the Financial Crisis of 2008 could have resulted something far worse if not for the actions of the Fed. The poor US economy is likely to by used in the 2012 US presidential elections by various right wing groups such as the Tea Party to promote ideologically driven solutions. Lets not forget how we got here into this global mess - globalization, banking deregulation, privatization and free market capitalism as the cure for everything. 
Here's a chart that shows the movement of the US stock market relative to the point in time the US Federal starts its money printing operations better known as QE1 and QE2. QE2 ended sometime and in Jul 2011 and when it ended the stock market plunge shortly after that. Same with QE1 when it ended in May 2010, the stock market fell sharply until QE2 was in effect.

Printing money is no free lunch. It causes inflation and basically erodes the savings of retired Americans who have their money in fixed deposits. Tharman has so far protected Singaporeans by allowing the S$ to appreciate against the US$ each time the US Fed turns on the printing press. This keeps the price of imported food and fuel steady in S$ There is a limit to how much MAS can do this - our exporters are suffering due to the strength of the S$ and their profit margins are getting squeezed.

The Fed will do another round of QE despite the political opposition he faces - one Republican president threatened to do something unspeakable to Bernanke if he does another round of QE [Link]. While it is politically unpopular due to its inflationary effects, each time they stop doing QE the economy and the stock market seems to start sagging. QE gives 2 kinds of boost - first it keeps the US dollar down and US exports competitive and it hopes to keep interest rates low to encourage consumers to borrow and spend...and businesses to borrow and expand. The unintended effect is a lot of the money is borrowed for speculation causing unwanted flows into developing/asian countries - the speculators borrow US$ cheaply and move it into S$ to buy Singapore property and stocks to make money from capital appreciation and the strengthening S$.

The Fed is expected to announce QE3 this week. It uses a different mechanism from QE1 & QE2 and is expected to have roughly 70% of the effect of QE2.  Here is a professor who made a video to explain Operation Twist and potential problems clearly:


It will be interesting to see if the stock market rallies again on QE3. QE3 buys some time for the US economy ....but unless the economy improves dramatically, I suggest you watch out for the end date of this QE because so far the end of earlier QE has coincided with very nasty market selloffs.

35 comments:

Anonymous said...

"....I suggest you watch out for the end date of this QE because so far the end of earlier QE has coincided with very nasty market selloffs."
Lucky Tan

End date of this QE?? Hahahaha. Then they will have another round QE! It can be endless, as long as USD remains the de facto international currency.

And despite the S$ strengthening, inflation is very high. I do regular grocery shopping, so I know.

By the way, the resale HDB prices in my area continues to shoot up in August, increasing by tens of thousands every month.

Anonymous said...

Agreed with Anon 17/9/11 23:30.

Before the crisis and with the benefits of hindsights, the US economy was charged up by irresponsible & inconsiderate extravagances and the whole world danced along with it.

And the whole world is still fixated on what the US & Fed do and whether they will catch the next sneeze.

The crazy thing about modern capitalism is that it tends to be inflationary given the many options for people to purchase things even before they have earned it (e.g instalments, easy credit, credit card, etc, etc) and for the bigger national systems to print money and borrow money to avoid further crisis & collapse (e.g US QE and Europe Bonds) and sometimes for national govts to indulge in their own costly pet & iconic projects.

Anonymous said...

It may appear endless.

But rest assured, there will be consequences. The heart of this entire crisis stems from confidence.

The confidence that your savings, money or whatever our notion of value is being shaken right to the core. We are not certain if our homes, cars, shares, even gold is worth anything to exchange with.

It is now all about personal values, beliefs, that will keep us from being turned into animals.

It will be interesting if we could pay our income tax with water & vegetables. Money as we know it will no longer be valid.

Without jobs, stable jobs, people are not going to spend neither wil they borrow.. they realised their mistakes when borrowing to buy homes.

So I do not see how this "twist", QE1+2+3 is going to put money into the hands of ordinary people.
The banks, investment houses, will be the only ones able to take advantage.

Perhaps, to test the confidence of the people, they should sell bonds in denominations of 1000 rather than in millions. It may generate more interest and create a market.

But this is a scheme designed for elites and it hangs on to the power that they hold.

I am glad I wont be around when this thing implodes.

Anonymous said...

China's 6.6 millions graduates looking for work today would love it here. Just close our universities and "policy studies" schools. Save billions.

Anonymous said...

The QE is to contra the unwillingness of China to revalue the yuan upwards. Guess who is the biggest loser.

Bernanke's shadow said...

When elephants fight..., the grass suffers.

USA can deal with this problem very easily. Just knock down buildings and rebuild.. rebuild roads, airports
dockyards.. focus on infra structure projects. This will create jobs.

The government should spend. They are spending now, but the money goes straight into stock markets,and banks. The real economy does not get a sip of it.

Build new trains. dig more tunnels.
See? Singapore has been doing this technique for years!.. just dig, even if there is no reason, dig.
Pull out cables, put them back in.

Create work!

Anonymous said...

Whatever lah, even if 3 room HDB flat cost $1 million or chicken rice $10 per plate at hawker center, there will still be peace and stability in Singapore.

Simply because 60% are still happy.

Anonymous said...

Come 2016 PAP fate will lies whether their front man LKY still around. Its very probable opposition parties become a two third majority in parliament. This will tilt the balance and drew in the cynicals, bystanstanders, fencesitters, PAP AND PA grassroot leaders, and lastly new citizen to try and switch side to grab a slice of the newly emerging political pie from 2021 election and beyond.

Anonymous said...

the old man isn't fading into the sunset. With PM losing people faith, is he rallying up his remaining political clout at the very ends of political lifespan to win over the voters and prepare the ground for his 3rd generation to be inducted. My bet is that the next 2 years or so, a new surprise candidate may be announced in the new lineup .

DanielXX said...

Operation Twist is NOT QE. It is monetary neutral. It involves selling ST bonds to buy LT bonds. I don't know how ppl get it into their heads that this is QE3. Basically it is the end of the ppty market, because ST rates will rise. LIBOR will rise. SIBOR will rise. The ppty whores will have a hard time from here.

The developers will be panicking.

nabeh! said...

Well, monetary neutral or watever.

Bankers, investment houses.. all should be charged for fraud, tried and sentenced to jail for the next 50 years.. inlcuding a fine equivalent to their share of this debt.

The rogue trader is just a scapegoat who got caught. If he made 2 billion, he will be like george soros.

But he lost it, so he becomes an evil man.

Property developers are in tango with the banks. Lovers till death do them part.

I am just gonna sit and watch the chaos.. damn shiok.. watch how the gah'men ask all the NGO to "help".

That society must stay together
That we are people that care
That we must remain united
That we will come out stronger

Ha! ha! ha!...

suddenly its "we" this and "we" that!

Where is my job?
Where is my 15% wage increase?
Where is my "swiss standard"

Nabeh...

Anonymous said...

No worries lah... By early 2012, 3-rm HDB will be $1M and chicken rice will be $50. By end 2012, 3-rm HDB will be $80K and chicken rice will be $0.80. Just learn to be flexible lah...

Anonymous said...

Republican *Presidential Candidate*, not president.

Anonymous said...

Hey Lucky, you should stick to what you're good at, namely, bashing the hell out of the PAP (which deserves it entirely).

This sort of monetary policy analysis is really not your forte and, frankly, it bores the shit out of your readers, who are here to see you give PAP the whipping it deserves. If I want to read about QE3, I can go on Financial Times and Wall Street Journal's websites.

Now that Temasek Review is dead, you have become our only remaining torch (whip?) bearer. I eagerly await my daily fix of PAP-whacking. You're now the only provider in town.

Anonymous said...

only way next few years many unpopular rising prices would be reverse is by a global depression but with stagflation climate being more likely, so only chance for popular policies is via a 3rd gen sucession plan by the old man on top of winning back current electorate by impressing them with eloquent sharing social and political thesis.

Anonymous said...

lets pick a fight with the neighbours

it will draw attention away from pap and financial problems..

Anonymous said...

Ha ha "lets pick a fight with the neighbours

it will draw attention away from pap and financial problems.."

Absolutely we used it a few times aredi lah so getting stale for us. But hey it works all the time on the natives & moreover we have a little arragement with the neighbours around here, that they should feel free to play the same card if they ever need a whore of a nation for some ass-whippin.

Anonymous said...

Hey Lucky, you should stick to what you're good at, namely, bashing the hell out of the PAP (which deserves it entirely).

Totally agree. Not that yr economic insights arent good. Its just that your FamiLee & PAP analysis is better & i get a kick reading the comments.....
Ok to blog financials but keep the bashing up more regularly.....after all we get so regularly bashed up by them ......most singaporeans are actually quite addicted to Pain. Afterall that is said & done , more is said then done....they got Tony OCBC Tan into Istana cos he is more educated , presidential , stately blah blah blah ...but what has he done for Singaporeans all these years ..
In fact all of them are highly educated & connected & previledge , but what have they done after you put them in power.... We end up serving them & paying them each and every day in every way.
Where is public service.......presidential my ass !

Anonymous said...

Half of Malaysia's graduates who graduated last year were able to secure jobs within six months; the other half are warmly welcome here as FTs.. we Luv foreign things.

Anonymous said...

As always, when you start writing about financial matters you only make sense to yourself and not others. Please learn from veritas lux...both of you guys should lower that technicalities through pre-selected videos that explain your points clearer. Always work on the assumption of "Blah blah for morons" rather than making assumptions that your readers understand.

You did well for political discourses but you sorely miss your audience on every other postings that is not on politics or ethics.

Do the same with the graphs you did on PAP's political philosophy as you do with financial issues.

Otherwise, you're talking only to yourself. And you lose your audience.

Anonymous said...

"Otherwise, you're talking only to yourself. And you lose your audience.
- 21/9/11 21:38"



maybe it is just u who is lost, bcos u are probably less schooled in financial matters? well, go learn something.

Anonymous said...

By the way i like yr financial stuffs too.... But keep up the heat on them !

DanielXX said...

Operation Twist will be the capital gains tax of 1997. The papers will not report it, but it will be clear within 6 months as banks hike up board rates and property demand will be hit badly by this.

Look at the USD .... up over 7% vs the SGD within a fortnight! The hot money pushing down SGD rates will soon leave.

The end is nigh. And yet look at those clowns like Oxley, Heeton, KSH still bidding to the moon for a West Coast site.

Il Mango said...

Can someone explain to me how is it possible for your governement investment arm to loose 6 billion of your money and not a single singaporean is asking them to explain? I thought your governement was an example of transparency and good governance....All I read in the local propaganda is that singapore is asking for the head of UBS to be chopped. And this is fine. But what about the head of GIC ?

Anonymous said...

The free world isnt ready to let the commies rule.. with the euro safely out of the way... USD remains the only safe haven .. a looming US recession, the ensuing dollar liquidity crunch all add to the perfect storm...


The USD rally unfolding before your eyes should squeeze the silly balls off the noobs and novices... this is how fools like our stupid northern neighbours lost their pants EVERY TIME. 2020 boleh? kiss my arse lah!

Anonymous said...

No need for QE 3 - Singapore GIC / TH already providing free money...kekekek

Anonymous said...

Singtel a TLC is quoted today 46% profit comes from countries like associates in Philippines, india. So it can get into a country closed sector like telcom w/o any corresponding show of sincerity from us? it seemed like granting easy PRs, citizenship, for their FTs at sg'rean expense is the married deal.

Anonymous said...

Would congress approve QE3 without convincing proofs? I thought only we are daft?

Anonymous said...

Whatever you say lah, only the gullible would pay premiums to believe the developer's hype of their so called Designers apartments, when they are really second rated anywhere else. Today in fashion, tomolo's junk and resale dilemma maybe why a fool and his money are soon parted.

Anonymous said...

Singtel need to pay the earth to get into australia. Our FTs policy as a sweetener does not appeal to a spacious, rich and lucky country like aust the way it can for people from overcrowded asian countries.

Anonymous said...

Don't forget your helmets. The re-entry is Friday give or take a day.

Anonymous said...

Agree completely with anon 10:59.

Anonymous said...

As expected, old man is now on the charm offensive. First, income equality, now more flats. Just like he did in the 50s and 60s , old man political salemanship is again wielding its magic.

Vapir No2 Vaporizer said...

Quantitative easing can be used to help ensure inflation does not fall below target. Risks include the policy being more effective than intended in acting againstdeflation or of not being effective enoug.

Anonymous said...

To the people who complain about Lucky's postings on economics.

Don't be daft!!! It's his blog. He is entitled to his own opinion. Why should Lucky stop his posting on economics to suit you???

If you don't understand the economic jargons etc, go read up on your own. Self educate!!! The internet, newspapers, books are there for those who take the step to learn rather than cry father cry mother dunno this dunno that.

If you dun like his opinion, then stop reading. No one force you to read. Kaoz.