Fed easing depends on Saudi oil
The world's central bankers are preparing a response to a marked slowdown in economic growth and the simmering EU debt crisis -- all thanks to a huge drop in crude.
Stocks are finally bounding up and out of a multimonth trading range thanks to one thing: hope for a massive, coordinated stimulus push from the world's major central banks. This comes as the situation in Europe deteriorates (shaky Greek election this weekend, Spanish bond yields above 7%) and the global economy stalls (terrible industrial production data).
The People's Bank of China and the Bank of England have already acted. Next up are the Federal Reserve, with a policy decision next Wednesday, and the European Central Bank. Thanks to a big pullback in inflation on a dramatic drop in crude oil prices -- as Saudi Arabia covers the world in cheap energy to the consternation of its OPEC peers -- the door is wide open for the Fed and the ECB to take action.
On that last point, the economic data are increasingly supportive of new easing. Inflation is falling away as energy prices cool. Here at home, the Consumer Price Index in May fell 0.3% in its worst month-on-month performance since the depths of the 2008-09 financial crisis. Producer price inflation is also falling fast.
Year over year, headline CPI has dropped back to levels seen in summer 2010 before the Federal Reserve launched QE2. As long as Saudi Arabia maintains its elevated production levels -- and soothes the market with talk of increasing its maximum production potential to cap future spikes in energy prices -- this dynamic will continue.
So far, the ECB and the Fed have yet to take action with another injection of cheap money. But their peers already have.
The People's Bank of China recently cut interest rates for the first time since 2008. And three times since last November, it has cut the reserve requirement ratio that banks are required to hold. Earlier this week officials noted that with inflation risks falling and deflation risks rising, two more rate cuts and three reserve requirement ratio cuts are likely before year end.
In Britain, the Bank of England and finance ministers have launched a new strategy to ease credit conditions and offer more liquidity to an economy tipping into a new recession because of budget austerity measures. The British unveiled two new initiatives -- adding to the $500 billion worth of quantitative easing the BOE has already done and its push to hold short-term rates at 0.5%, a record low.
The first will be a five-year offering of liquidity to banks in exchange for lending to the "real economy," such as households and nonfinancial institutions. The second will be an expansion of collateral acceptance terms, giving banks the ability to pledge a wider range of assets to the Bank of England in exchange for cash loans.
Overall, these actions are very similar to what the ECB did late last year with its two separate three-year liquidity offerings. The main difference is the BOE's focus on where the money is going.
Now the ball is back in the Fed's court, with a policy decision due on June 20.
Fed Chairman Ben Bernanke is one of the most vociferous deflation fighters out there because of his academic obsession with the Great Depression. He is very, very familiar with the dangers of a debt-deflation spiral that results when an overleveraged economy like ours is faced with falling prices -- pushing up the real value of indebtedness and making it harder to pay down.
So he will take action, even if it's just a short extension of the current $400 billion Operation Twist. More likely, it will be the unveiling of a "sterilized" bond purchase program that would see the Fed buy up long-term bonds and mortgage securities, and use short-term bank deposits to fund the purchases. There is plenty of money to be had: Excess reserves at Fed member banks totals $1.5 trillion. If the banks aren't willing to use the cash, the Fed will.
That is, as long as the Saudis keep crude down and fight off attempts by hardliners in Iran, Iraq and Venezuela to play politics with oil. Another potential motivation for the Saudis, according to hedge fund manager Barton Biggs, is that Saudis are using cheaper oil as a weapon against its enemies in Iran and Iraq, cementing the Kingdom's position of power in the region against its Shia rivals.
So there you have it: The fate of the economy, and the stock market, depends on the actions of a group of academics in Washington deciding the price of money and a group of oil ministers in Riyadh controlling the price of energy.
Expectations for another round of monetary policy stimulus continues to boost the Edge Letter Sample Portfolio's precious metals positions. Highlights include a near 10% gain in the Market Vectors Junior Gold Miners (GDXJ) and a 9% gain in the VelocityShares 3x Gold (UGLD).
I'm adding one more health care name to my holdings, Spectrum Pharmaceuticals (SPPI), as high beta pharma/biotech stocks push higher.
I found both SPPI with the help of technical screens developed with Fidelity's Wealth Lab Pro back-testing tools, which you can find here. (Fidelity sponsors the Investor Pro section on MSN Money.)
Disclosure: Anthony has recommended SPPI to his newsletter subscribers.
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OPEC affects the price of oil? Get a grip. They need to sell to pay bad debt. Think they are going to quit selling? They're drowning in oil.
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