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Jun
27
Jonathan Yates
Will Bernanke Talking Up the Markets Bring Stocks Back to Stay?
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In the week after bringing down the markets due to statements that Quantitative Easing III woul be ending, Federal Reserve Chairman Ben Bernanke has been busy talking the Dow Jones Industrial Average back up to its previous levels.  So far, it appears to be working as the Dow Jones Industrial Average is back over 15000, closing at 15024.49.  Both the Standard & Poor’s 500 Index and NASDAQ have rebounded, too.

But there is a fundamental problem ahead.

Eventually, the Federal Reserve balance sheet will have to be restored to its previous equilibrium.  Before The Great Recession, the Federal Reserve balance sheet was around $700 billion.  Now it is well over $3 trillion.  By the end of the year, it will be close to $4 trillion.

Common sense dictates that if the Federal Reserve was able to lower interest rates by acquiring over $3 trillion in securities, chiefly Treasury Bonds and mortgage-backed securities, then the opposite will happen when the reverse course is taken.  This fear has manifested itself in recent market action, with interest rates rising.  As a result, interest-rate sensitive investment such as utility stocks have been battered.

That is what took down financial markets around the globe.  In addition to the United States,central bankers in Japan and England have initiated massive quantitative easing measures.  As the chart below reveals, these efforts by the Bank of Japan have taken the value of the Yen (YCL) much lower than the value of the US Dollar (UUP).

 

As detailed in a previous article on this site, this bull market rally has been driven by the liquidity from global central bankers, primarily the Federal Reserve.  It appears as if China will be joining in as it recently reached a currency swap line agreement with the United Kingdom.  That will most likely compensate for the pullback by the Federal Reserve, when that comes.

This is another measure to buy time, hoping that the global economy will grow enough to allow for the balance sheets of central banks to be restored to the previous size.    As the United States just revised downward first quarter economic growth to 1.8%, it is obvious that trillions in assets from central banks cannot be moved back into the financial system without delivering a blow to the financial markets.

The damage the past week has just been from speculation.  Bernanke has said that the Federal Reserve will allow for its mortgage-backed securities to mature.  That may or may not be the case: the market has a way of imposing its will.  As it has demonstrated, the results will not be pretty when the flow of funds is reversed by global central bankers.

 



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