The forgotten market factor that cries wolf
Jul 28, 2011
Guest blogger Mike Hogan, manager of Stewart-Peterson's Market360 service, takes a look at the impact quantitative easing, or QE1 and QE2, has had on the markets and assesses what a third round might mean.
You’ve heard the Aesop Fable The Boy Who Cried Wolf. A shepherd boy repeatedly tricks villagers into believing a wolf is attacking his flock of sheep. At a certain point, the villagers stop believing. When a wolf actually does show up, no one rushes to the shepherd’s aid, and the wolf wipes out his flock. Factors influencing market moves are like the shepherd, constantly setting off alarms. You hear them every day: weather, USDA acreage reports, global factors, political bickering over the debt ceiling, the Federal Reserve Bank’s second quantitative easing policy, or "QE2," and so much more.
What do markets do when alarm bells constantly ring? Usually they react, sometimes severely, sometimes without merit. Other times they shrug. You, as a marketer, are left to sort it out.
Let’s look at the quantitative-easing alarm. It doesn’t receive enough credit for moving the market, and it may soon go off.
In the year-long rally we’ve seen in grains and commodities in general, U.S. monetary policy has been an underrated aide. Credit for the rally often goes to decreased yields and increased demand for ethanol. Yet, we have been to these carryout levels before without the $8 price tag. If the dollar were valued at 120 instead of 75, it’s likely our prices would not be as high as they are today.
Looking back to July 2010, when the Fed talked about implementing QE2 to simulate the U.S. economy after QE1 lost efficacy, we saw the market rally substantially. It may even be that QE2 spared us a correction on several commodities – corn, wheat, beans, cotton, precious metals.
Quantitative easing is a Fed tactic that fundamentally weakens the U.S. dollar and thus creates an inflationary environment. A weaker dollar and inflation are bullish for grains.
QE2 ended on the last day of June this summer. We saw a broad-based sell-off during June, likely in anticipation of QE2’s end. (As a note, the normal seasonal on corn usually shows a sell-off on the last half of the month.)
On July 14, Fed Chairman Bernanke sent commodity markets higher during senate testimony on the economy when he said the Fed would act if the economy weakened, read: implement QE3. The very next day, he clarified his comments by saying the time for stimulus hadn’t yet come. Markets immediately corrected.
Would a QE3 be a solid indicator of higher prices? There are a few possible scenarios for you to consider as we all wait for Bernanke’s next QE move.
One, Bernanke is bluffing. The Fed won’t print more money, causing markets to grind lower as sellers look back over their shoulders. Two, the Fed implements QE3, the market loses confidence and a sell-off ensues. The rationale here is if the Fed is compelled to do something, the markets will conclude the economy really is weak and wonder, if QE1 and QE2 weren’t enough to start a sustained recovery, why would QE3 be any different? Three, we get QE 3, the market gains confidence and commodities go higher.
It’s difficult to say which, if any, of these scenarios will play out. I wouldn’t assume a third stimulus would have the same effect as the first two. The key point here is to remember there’s no way to know, which makes planning for all possible scenarios critically important. That way, if cries of "wolf" sound, you won’t be tricked and find yourself on the wrong side of the market.
Scott Stewart is president and CEO of Stewart-Peterson, a commodity marketing consulting firm based in West Bend, Wis. You may reach Scott at 800-334-9779, email him at email@example.com.
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