Bullard Comment on Fed's Asset Purchase Program

Amazing how the quote below, uttered by Federal Reserve Bank of St. Louis President James Bullard to reporters yesterday, is propelling the markets to a near 2% move today. Just goes to show that so much of this rally is being driven by the market’s perception that the Fed will retain its accommodative stance for far too long.

"I have advocated to keep the asset-purchase program open but at a very low level, and wait and see what happens, and as information comes in about the economy we can adjust that program while the federal-funds rate remains at zero," Mr. Bullard told Dow Jones Newswires in an interview Sunday. He said "no decision has been made" about the program's fate.

While bubbles appear to be forming in every asset class outside of the US dollar, the Fed has done nothing to temper these concerns (some would even contend that this is precisely the Fed’s goal!) While the contrarian in me believes that a sharp reversal is in the offering (I am actually considering buying long-term treasuries as a portfolio hedge), the massive rotation out of the dollar could be sustained for some time, particularly with Bernake & Co. at the helm. Interestingly, the collapse in near-term treasury yields has now made the US dollar a cheaper funding source than the Japanese yen. With the dollar replacing the yen as the primary vehicle for the carry trade, the momentum underpinning the declining dollar may only be beginning, particularly as these carry trades are typically executed using substantial leverage.

The short-term impact of a leveraged short against the dollar can be self-perpetuating and I believe we are currently in the midst of this phenomenon. Hedge funds and other leveraged investors are buying any number of assets – junk bonds, emerging market bonds/equities, oil, and gold & other base metal commodities, etc. The assets may be different, but the funding source is essentially the same (i.e. the US dollar). While everyone is currently consumed by their investing acumen, correlations between seemingly uncorrelated assets have never been higher (in many cases approaching one). The momentum in the markets is not dissimilar to what we saw in the summer of 2008 and we know how that ended.

Again, while I remain invested in gold and believe the Fed’s policy of zero interest rates provides investors a license to speculate in risky assets, I am becoming increasingly concerned by the uniformity underpinning this thesis, particularly as leveraged investors enter the fray. Selling my gold today would be a mandate on the world’s central banks ability to heal their economies without stoking inflation – at this juncture, I remain far from convinced that such an outcome will play out. However, to the extent that central banks begin to withdraw the artificial stimulus underpinning this asset bubble (or at least give us a credible timeline for doing so!), Lumpy Investor will not be shy about reevaluating his year long bullish view on gold. Until then – gold $2000!!