Saturday, November 1, 2014

04/01/2011 Q1 and QE2 *

For the week, the S&P500 gained 1.4% (up 5.9% y-t-d), and the Dow advanced 1.3% (up 6.9%). The broader market was quite strong. The S&P 400 Mid-Caps surged 2.7% (up 9.8%), and the small cap Russell 2000 gained 2.8% (up 8.1%). The Banks rose 1.2% (up 0.4%), and the Broker/Dealers gained 1.2% (up 0.4%). The Morgan Stanley Cyclicals gained 2.0% (up 7.0%), and the Transports jumped 3.1% (up 5.2%). The Morgan Stanley Consumer index increased 1.3% (up 0.9%), and the Utilities rallied 2.1% (up 1.7%). The Nasdaq100 increased 1.1% (up 5.6%), and the Morgan Stanley High Tech index added 0.5% (up 2.6%). The Semiconductors slipped 0.8% (up 5.1%). The InteractiveWeek Internet index gained 1.5% (up 3.4%). The Biotechs jumped 5.6% (up 6.2%). With bullion little changed, the HUI gold index increased 0.8% (down 0.6%).

One-month Treasury bill rates ended the week at 2 bps and three-month bills closed at 6 bps. Two-year government yields rose 7 bps to 0.81%. Five-year T-note yields ended the week up 8 bps to 2.24%. Ten-year yields were little changed at 3.45%. Long bond yields ended the week down one basis point at 4.49%. Benchmark Fannie MBS yields were up one basis point to 4.28%. The spread between 10-year Treasury yields and benchmark MBS yields widened one basis point to 83 bps. Agency 10-yr debt spreads declined 5 to negative 3 bps. The implied yield on December 2011 eurodollar futures slipped 3.5 bps to 0.61%. The 10-year dollar swap spread was little changed at 10.5 bps. The 30-year swap spread was unchanged at negative 22 bps. Corporate bond spreads were mixed. An index of investment grade bond risk declined one to 94 bps. An index of junk bond risk rose 25 bps to 438 bps.

Investment grade debt issuers included Time Warner $2.0bn, Home Depot $2.0bn, Arcdher-Daniels Midland $750 million, Dell $1.5bn, MetLife $1.0bn, Citigroup $750 million, Campbell Soup $500 million, Analog Devices $375 million, Keyspan Gas $500 million, Verisk Analytics $450 million, Brandywine $325 million, New York Life $300 million, Delta Air $300 million, and Atlantic City Electric $200 million.

Junk bond funds saw inflows of $510 million (from Lipper). Issuers included First Data $750 million, Ameristar Casino $800 million, CDW $725 million, Visteon $500 million, Inkia Energy $300 million, Liz Claiborne $205 million, Park-Ohio $250 million, and Kennedy-Wilson $200 million.

Convertible debt issuers included Mentor Graphics $220 million, Greenbrier $215 million, Interdigital $200 million and A123 Systems $125 million.

International dollar debt issuers included KFW $4.0bn, HSBC $2.5bn, BNP Paribas $2.5bn, Nordea Eiendomskreditt $2.0bn, Westpac Banking $1.4bn, Banque PSA $1.0bn, Asciano $1.0bn, Cemex $800 million, Eksportfinans $1.5bn, Kommunalbanken $500 million, Winsay Coking Coal $500 million and Shinhan Bank $500 million.

U.K. 10-year gilt yields jumped 11 bps this week to 3.72% (up 21bps y-t-d), and German bund yields rose 9 bps to 3.37% (up 41bps). Ten-year Portuguese yields skyrocketed 73 bps to 8.41% (up 176bps). Spanish yields rose 14 bps to 5.30%. Irish yields declined 15 bps to 9.77%, while Greek 10-year bond yields rose 22 bps to 12.67%. The German DAX equities index jumped 3.4% (up 3.8% y-t-d). Japanese 10-year "JGB" yields rose 6 bps to 1.275%. Japan's Nikkei rallied 1.8% (down 5.1%). Emerging markets were mostly higher. For the week, Brazil's Bovespa equities index gained 2.2% (down 0.1%), and Mexico's Bolsa jumped 2.7% (down 2.0%). South Korea's Kospi index advanced 3.3% (up 3.4%). India’s equities index gained 3.2% (down 5.3%). China’s Shanghai Exchange slipped 0.3% (up 5.7%). Brazil’s benchmark dollar bond yields were unchanged at 4.59%, while Mexico's benchmark bond yields rose 5 bps to 4.46%.

Freddie Mac 30-year fixed mortgage rates rose 5 bps last week to 4.86% (down 22bps y-o-y). Fifteen-year fixed rates gained 5 bps to 4.09% (down 30bps y-o-y). One-year ARMs were up 5 bps to 3.26% (down 79bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up 8 bps to 5.49% (down 34bps y-o-y).

Federal Reserve Credit jumped $15.2bn to a record $2.597 TN (21-wk gain of $316bn). Fed Credit was up $190bn y-t-d and $307bn from a year ago, or 13.4%. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 3/30) rose $5.9 to a record $3.408 TN. "Custody holdings" were up $388bn from a year ago, or 12.8%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $1.543 TN y-o-y, or 19.7%, to a record $9.382 TN.

M2 (narrow) "money" supply added $2bn to $8.895 TN. Over the past year, "narrow money" grew 4.4%. For the week, Currency increased $3.2bn. Demand and Checkable Deposits jumped $21.5bn, while Savings Deposits fell $20bn. Small Denominated Deposits declined $3.5bn. Retail Money Funds added $0.8bn.

Total Money Fund assets increased $4bn last week to $2.736 TN. Money Fund assets were down $74bn y-t-d, with a decline of $247bn over the past year, or 8.3%.

Total Commercial Paper outstanding increased $1.7bn to $1.081 Trillion. CP was up $112bn y-t-d, although it was down $28bn, or 2.5% from a year ago.

Global Credit Market Watch:

March 31- Bloomberg (Anabela Reis): “Portugal reported a budget deficit of 8.6% of gross domestic product last year, missing a government target of 7.3% and causing a jump in borrowing costs that increases the risk of a bailout… The agency also revised the 2009 budget gap to 10% from 9.3%...”

April 1 - Dow Jones (Kellie Geressy-Nilsen and Lynn Cowan): “Wall Street borrowing ballooned during the first quarter and equity issuance ran at a high seasonal level in a sign corporations are feeling more comfortable with the economic recovery. Borrowers tapped the high-grade market in near record numbers during the first quarter, with nearly $275 billion of U.S. marketed investment-grade bonds sold during the period. And stock issuance during the quarter ran higher than normal, with companies raising $77.1 billion, the largest first-quarter amount since 2000, according to… Dealogic.”

Muni Watch:

March 30 – Bloomberg (William Selway and Henry Goldman): “The real-estate crash is catching up to U.S. municipalities. Cities, counties and school districts had been sheltered from the full impact of the slump because of the lag between when realty prices fluctuate and values are reset by local tax assessors. That’s changing as property rolls are adjusted to the current market and residents push to have their taxes cut. Local officials are now facing the consequences. Property- tax revenue dropped in the last three months of 2010 at the fastest pace since home prices slipped from their peak more than four years ago…”

March 30 – New York Times (Michael Cooper and Lizette Alvarez): “Michigan, whose unemployment rate has topped 10% longer than that of any other state, is about to set another record: its new Republican governor, Rick Snyder, signed a law Monday that will lead the state to pay fewer weeks of unemployment benefits next year than any other state… All states currently pay 26 weeks of unemployment benefits, before extended benefits paid by the federal government kick in. Michigan's new law means that starting next year, when the federal benefits are now set to end, the state will stop paying benefits to the jobless after just 20 weeks.”

March 28 – Bloomberg (Darrell Preston and Aaron Kuriloff): “Harris County-Houston Sports Authority bonds that financed venues for the Houston Texans and two other sports teams have fallen as much as 34% amid speculation the agency may default on payments.”

Global Bubble Watch:

March 29- Bloomberg (Noah Buhayar): “Global high-yield company bond sales set a record in March as borrowers including CIT Group Inc. and satellite operator Intelsat SA sold debt, according to Bank of America Corp. Sales surged to $41.2 billion this month through last week, beating the earlier full-month record of $40.9 billion in March 2010…”

March 31- Bloomberg (Jason Webb and Lilian Karunungan): “Emerging-market borrowers completed the busiest ever start to a year, selling $195 billion of bonds on international markets to secure funding while interest rates in the U.S. and Europe stay at all-time lows. Governments from Turkey to Hungary and companies including Banco do Brasil SA boosted offerings above last year’s record for a first quarter by $23 billion… “

March 28 – Bloomberg (Lynn Thomasson and Whitney Kisling): “U.S. executives are starting to spend the record $940 billion in cash they built up after the credit crisis… Takeovers topped $256 billion this quarter, the most since the collapse of Lehman Brothers… Standard & Poor’s 500 Index companies authorized 38% more buybacks in 2011 than a year earlier and dividends may increase to a record $31.07 a share in 2013…”

March 31- Financial Times (Helen Thomas in New York and Anousha Sakoui): “US companies have returned to large strategic deal-making, helping to boost global mergers and acquisitions activity by 26% in the first quarter. Thanks to a flurry of big deals, US M&A activity jumped 84% to $267bn in the first three months of the year, compared to the same period in 2010. The US now accounts for almost half of global activity, up from about a third last year.”

March 30 – Bloomberg (Zachary R. Mider): “Corporate executives in the first quarter paid the most for takeovers since before the collapse of Lehman Brothers Holdings Inc., kicking off what investment bankers say may be the busiest year for deals since 2007. Acquirers paid a median 9.2 times earnings before interest, taxes, depreciation and amortization for companies in the period, the most since the second quarter of 2008…”

April 1 - Dow Jones (Lynn Cowan): “Stock-related sales in the U.S. raised more money in March than in any March since 2000, according to… Dealogic. The U.S. recorded 103 deals that raised $41.6 billion in March, up 62% from the year-earlier month when 109 deals raised $25.6 billion… Transactions included initial public offerings, follow-ons and convertible stock issuance.”

Currency Watch:

The U.S. dollar index declined 0.5% to 75.82 (down 4.1% y-t-d). On the upside for the week, the Brazilian real increased 3.4%, the South African rand 2.3%, the South Korean won 2.1%, the Norwegian krone 2.1%, the New Zealand dollar 1.8%, the Canadian dollar 1.8%, the Swedish krona 1.3%, the Mexican peso 1.3%, the Australian dollar 1.2%, the Danish krone 1.1%, the Euro 1.1%, the Taiwanese dollar 0.7%, the British pound 0.4% and the Singapore dollar 0.1%. On the downside, the Japanese yen declined 3.2% and the Swiss franc 0.4%.

Commodities and Food Watch:

March 30 – Bloomberg (Elizabeth Campbell and Tony C. Dreibus): “Cattle futures surged to a record on bets that meat demand in Japan will increase amid concerns that farmland and animals were tainted after the March 11 earthquake and tsunami damaged nuclear units. Retail-beef prices in the U.S. last month climbed to an all-time high. The nation’s cattle herd dwindled to the lowest since 1958, and meat exports have surged, spurred by a demand in emerging markets. Shrinking domestic supplies are increasing costs for supermarkets and restaurants.”

April 1 – Bloomberg (Patrick McKiernan): “Hog futures for June delivery rose as much as 0.5% to $1.0435 a pound, the highest for a most-active contract since at least 1986.”

March 30 – Bloomberg (Maria Kolesnikova and Kateryna Choursina): “Ukraine, once the world’s largest barley exporter, extended curbs on grain shipments, potentially driving prices higher and denying supply to consumers including the 1 million camels owned by Saudi Arabia’s Bedouin… Feed-barley futures traded on the Australian Stock Exchange jumped 51 percent in the past year as Russia also restricted exports and crops from Canada to Kazakhstan were ruined by flooding and drought.”

March 31- Financial Times (Leslie Hook and Gregory Meyer): “China plans to rebuild a cotton reserve this year to help encourage domestic production as farmers fret that prices could tumble from historic highs… Beijing said it would buy cotton for a ‘temporary’ reserve from September 1 2011 to March 31 2012…”

The CRB index added 0.4% (up 8.4% y-t-d). The Goldman Sachs Commodities Index jumped 1.8% (up 15.8%). Spot Gold was little changed at $1,429 (up 0.6%). Silver gained 1.8% to $37.73 (up 22%). May Crude jumped $2.54 to $107.94 (up 18%). May Gasoline inflated 3.3% (up 30%), while May Natural Gas declined 2.9% (down 1%). May Copper dropped 3.6% (down 4.2%). May Wheat gained 3.6% (down 4%), and May Corn surged 6.7% (up 17%).

China Bubble Watch:

March 31- Bloomberg: “The northern Chinese province of Ningxia will raise minimum wages by an average of 24.9 percent from Apr. 1, according to… the local government’s website…”

March 31- Bloomberg (Frederik Balfour): “China’s growing ranks of millionaires are set to buoy sales at Sotheby’s spring auction in Hong Kong as collectors seek Qing Dynasty porcelain, Chateau Lafite wines and multi-million-dollar paintings. The event may bring in as much as HK$2.4 billion ($310 million), said the… auction house. The eight-day marathon… features two private European collections of ceramics and contemporary art, including an 18th-century Chinese vase worth more than $23 million.”

March 31- Bloomberg: “The Chinese government will start controlling vehicle ownership in cities of more than 10 million people from 2011 through 2015 to help ease jams and air pollution, the Economic Observer reported… The government is talking to two cities about taking measures to cap vehicle purchases, the report said.”

India Watch:

March 31- Bloomberg (Abhijit Roy Chowdhury): “India’s population is provisionally estimated at 1.21 billion, based on the 2011 Census…”

Latin America Watch:

March 31- Bloomberg (Matthew Bristow): “Brazil’s budget deficit after interest payments widened to a record 11.2 billion reais ($6.9 billion) from 1.53 billion reais in January… The figure was higher than the median forecast of 8 billion reais…”

Unbalanced Global Economy Watch:

March 28 – Bloomberg (Katya Kazakina): “Wealthy Chinese buyers competing for their cultural heritage pushed New York’s week of Asian art to a record, topped by a delicate pear-shaped Chinese vase, estimated to fetch just $800 to $1,200. The lot soared to $18 million, the most expensive in a dozen Asian Week auctions at Sotheby’s and Christie’s International. Together, the auction houses took in a record $202 million, 56% above the previous high in 2007. Sotheby’s described the modestly-estimated vase, decorated with birds and peonies, as of ‘probably Republican period’ (early 20th-century). Yet it had a Qianlong seal and anything of that 1736-1795 era commands higher prices, said dealers.”

March 31- Bloomberg (Johan Carlstrom and Kim McLaughlin): “Sweden’s economy will grow 4.2% this year as employment reaches the highest level in two decades, underpinning consumer demand in the largest Nordic economy, the National Institute for Economic Research said.”

Crude Liquidity Watch:

March 29 – Financial Times (Sylvia Pfeifer, Javier Blas and David Blair): “Opec… will reap $1,000bn in export revenues this year for the first time if crude prices remain above $100 a barrel, according to the international Energy Agency. The cartel has been one of the main beneficiaries of high oil prices, which have soared in recent weeks amid the civil uprising in the Middle East and north Africa.”

March 31- Bloomberg (Dahlia Kholaif): “Kuwaiti inflation accelerated to 5.3% in February…”

U.S. Bubble Economy Watch:

April 1 – Wall Street Journal (Stephen Moore): “If you want to understand better why so many states—from New York to Wisconsin to California—are teetering on the brink of bankruptcy, consider this depressing statistic: Today in America there are nearly twice as many people working for the government (22.5 million) than in all of manufacturing (11.5 million). This is an almost exact reversal of the situation in 1960, when there were 15 million workers in manufacturing and 8.7 million collecting a paycheck from the government. It gets worse. More Americans work for the government than work in construction, farming, fishing, forestry, manufacturing, mining and utilities combined. We have moved decisively from a nation of makers to a nation of takers.”

Real Estate Watch:

March 30 – Bloomberg (John Gittelsohn): “About 1.8 million homes that are delinquent or in foreclosure loom as additional supply for the struggling U.S. housing market, according to CoreLogic Inc. The so-called shadow inventory amounted to a nine-month supply of properties as of January, about the same as a year earlier… Rising inventory threatens to further depress home values as sales slump. There was an 8.6-month supply of homes for sale on the open market in February…”

Central Banking Watch:

April 1 – Bloomberg (Steve Matthews and Maryam Nemazee): “Federal Reserve Bank of Kansas City President Thomas Hoenig, the U.S. central bank’s longest-serving policy maker, said additional purchases of U.S. Treasury securities could lead to higher asset prices and higher inflation. ‘My view is QE2 was unnecessary,’ Hoenig said… My concern would be if there were any further easing into a recovery is that you do accelerate imbalances that then cost you dearly later.’”

March 28 – Bloomberg (Scott Hamilton): “St. Louis Federal Reserve Bank President James Bullard said policy makers should review whether to curtail a plan to buy $600 billion in Treasury securities, noting that the U.S. recovery may not need that much stimulus. ‘The economy is looking pretty good,’ Bullard said… ‘It is still reasonable to review QE2 in the coming meetings, especially this April meeting, and see if we want to decide to finish the program or to stop a little bit short,’ he said, referring to the second round of so-called quantitative easing.”

March 30- Bloomberg (Vivien Lou Chen): “The Federal Reserve’s ‘highly accommodative’ monetary policy is partly to blame for rapidly increasing global commodity prices, said Kansas City Fed President Thomas Hoenig, who called on colleagues to raise the benchmark interest rate toward 1% soon. ‘Once again there are signs that the world is building new economic imbalances and inflationary impulses,’ Hoenig, the central bank’s longest-serving policy maker and the lone dissenter at Fed meetings last year, said… ‘The longer policy remains as it is, the greater the likelihood these pressures will build and ultimately undermine world growth.’”

California Watch:

March 30 – Bloomberg (Michael B. Marois and James Nash): “California Governor Jerry Brown’s campaign pledge to fix perennial budget jams with his ripened political acumen failed to overcome the government dysfunctions that ensnared his predecessor, Arnold Schwarzenegger. Brown… who was governor from 1975 to 1983, conceded yesterday he lacks Republican support for a June referendum to keep higher sales, income and vehicle taxes from expiring. Extending them five more years, he had said, was crucial to closing a $15 billion gap in his $84.6 billion budget without slashing funds for schools and public safety.”

New York Watch:

March 31- Bloomberg (Michael Quint): “New York legislators approved spending bills closing a $10 billion deficit just after midnight, the first time since 2006 they passed a budget before the start of the fiscal year.”

Q1 & QE2 :

Federal Reserve holdings inflated $190bn, or 7.9%, during the first quarter to conclude Q1 at a record $2.597 TN. Such expansion is unprecedented in a non-crisis environment, with recent growth in Fed Credit surpassed only by 2008’s extraordinary third and fourth quarters. Keep in mind that the Fed’s balance sheet ended April 2008 at about $860bn. International central bank reserve assets increased $358bn during the quarter (as tallied by Bloomberg) to a record $9.382 TN. Global reserves were about $6.5 TN back in the spring of ’08. Too routinely, the dollar index declined 4.0% during the just completed quarter.

For the first quarter, Crude oil jumped 13% and gasoline surged 21% (to the highest price levels since September 2008). The Goldman Sachs Commodities Index rose 14.8%. For the quarter, Cotton jumped 39%, Pork Bellies 23%, Silver 23%, Gasoline 21%, Corn 10%, Cattle 10% and hogs 9%. It is worth noting that Hershey raised prices this week by almost 10%, while Wal-Mart’s CEO warned that American consumers face “serious” inflation in the coming months.

And while Federal Reserve (and global central bank) liquidity operations have fueled one heck of an inflationary boom throughout commodities and equities markets, arguably more consequential effects reverberate throughout Bubbling global fixed income marketplaces. Despite a lengthening list of market concerns, first quarter total global securities issuance was down only 4% from exceptionally strong year ago issuance to $1.96 TN (Dealogic). At $279 billion, Q1 investment-grade debt issuance was up 19% from a year ago to the third highest level on record. Here at home, a booming quarter of corporate debt issuance ended on a strong note. Corporate sales rose to about $33.4 billion this week, the third-largest week on record, while pushing y-t-d U.S. issuance to a record $399.5 billion (from Bloomberg).

Globally, high yield bond sales jumped 30% y-o-y to about $90bn. March saw a record $41.2bn of junk bonds sold. For the quarter, total high yield finance issuance jumped to $113.8bn, up 35% from a year earlier to surpass the record level set the previous quarter. And from Dow Jones (Katy Burne): “Two years ago, the average market premium on high-yield debt over comparable government debt was 16.9 percentage points, compared to 4.76 percentage points now…” According to Bloomberg, leveraged loan volumes jumped to $149bn, the strongest quarter since Q4 2007.

As always, deal-making luxuriates in loose “money.” Global mergers & acquisition volume jumped 16% from a year ago to $716.3bn (Dealogic). U.S. volumes surged 45% to $290.8bn. European deal volume rose 10% y-o-y to $192.3bn. M&A volume in Asia jumped 29% from Q1 2010 to $146.2bn (Dealogic), the strongest first quarter volume since 2008’s $155bn. Emerging market M&A posted record Q1 volumes of $205.7bn (up 1% y-o-y). According to Bloomberg (Zachary Mider), “acquirers paid a median 9.2 times earnings before interest, taxes, depreciation and amortization for companies in the period, the most since the second quarter of 2008…” Analysts see global deal volume jumping 15-20% this year, this following 2010’s 27% rise.

On the equities side, global initial public offerings (IPO) volume of $43.6bn was down somewhat from the year ago $51.9bn (Dealogic). U.S. IPOs raised $12.5bn during the first quarter compared to $3.7bn from Q1 2010.

Clearly, the first quarter was replete with monetary excess. The second quarter monetary backdrop is less certain. On the one hand, the Fed still has three long months of weekly Treasury purchases in the offing. On the other, the markets should begin to contemplate a post-QE landscape. Divergent comments from various members of the Fed are not offering much in the way of clarity for what is shaping up to be unusually muddied monetary prospects.

Federal Reserve Bank of St. Louis President James Bullard – an early and leading proponent for “QE2” – said this week that the Fed should consider wrapping up its quantitative easing program $100bn short of its original $600bn objective. Today, Federal Reserve Bank of Philadelphia President Charles Plosser and Federal Reserve Bank of Richmond President Jeffrey Lacker both stated the possibility of the Fed hiking rates later this year, a day after Federal Reserve Bank of Minneapolis President Narayana Kocherlakota suggested the same. A chorus of “hawkish” Fed comments – along with a decent jobs report – this morning had the dollar catching a bid and the bond market living on the edge. That was, until a series of dovish headlines from New York Fed President William Dudley’s speech crossed the wires.

A “still tenuous” recovery is “far from the mark” – “We must not be overly optimistic about the growth outlook” – “The coast in not completely clear” - “I don’t see any reason to pull back…” Mr. Dudley’s dovishness was what the market wanted. The dollar immediately weakened, bond prices strengthened and the “risk-on” trade, well, it was further emboldened.

It’s difficult to take issue with the markets’ view that Team Bernanke/Dudley (vice-chairman of the FOMC) will win the day – and that an increasingly divided Fed will bicker, float mixed signals and, at the end of the day, stick with ultra-loose for the foreseeable future. And as much as a few prominent policymakers would like to contemplate - and begin planning for - an unwind of the Federal Reserve’s bloated balance sheet, Mr. Market listens politely while speculating “a cold day in hell.”

Yet, markets will most likely three months from today be operating without additional Fed liquidity injections. As policymakers had hoped, QE2 provided a powerful jolt. Continued massive issuance of Treasury debt has been accommodated; equity prices have surged; confidence has been boosted; corporate debt issuance has boomed; leveraged lending has been fully revived; an M&A boom has been unleashed; the hedge fund industry has more than recovered; intensive “animal spirits” have been enlivened throughout – and some private-sector jobs have returned.

But has The Jolt incited ample momentum within the private-sector Credit system and throughout the economy to now enable a successful “hand-off” from massive public-sector stimulus to a self-sufficient private-sector Credit up-cycle? Examining recent corporate debt issuance, stock prices, M&A, and global risk asset prices generally, there is a case to be made for a sustainable expansion cycle. On the other side of the ledger, moribund housing and mortgage Credit, along with vulnerabilities in municipal finance, point to ongoing system Credit stagnation. Total bank Credit contracted during the quarter, and most likely total mortgage debt posted little or no growth. And in the midst of booming debt issuance, it is worth nothing that, at $46.4bn, first quarter muni debt sales were only about half the year ago level and the lowest amount since Q1 2000 (Thomson Reuters).

It’s been my view that the power of QE2 was not so much with the $600bn. It was, instead, that the Fed was right there guaranteeing more than ample marketplace liquidity at the first sign of market tumult. It was the markets’ perception of “Systemic Too Big to Fail” – confirmed, just as the markets expected. And why not speculate on risk assets, assured that central bankers would be quick to bolster the markets at the first sign of trouble? Why not, especially appreciating that Fed interventions would both add liquidity and pressure the dollar – bolstering a powerful Monetary Process now deeply entrenched in traders’ psyche. Why not just ignore risk and speculate, emboldened by the reality that systemic fragilities ensure a potent punchbowl filled to the brim. QE2 was one more in an ongoing series of mistakes by our central bank.

As we begin the second quarter, it’s increasingly difficult for the Fed to ignore mounting inflationary pressures. Commenting on tame “core” CPI is not going to resonate. Yet, as a committee, they surely will disregard inflation and cling closely (as Mr. Dudley did this morning) to their “full employment” mandate.

Still, some Federal Reserve Presidents and governors are growing uncomfortable with a prolonged loose policy stance. There will be louder talk of the inevitability of rate increases – and some will push for the unwind of QE2. I doubt the market will be all that intimidated by the prospect of a few little Greenspan-style “baby-steps” commencing sometime near year-end. It will, however, be a different story if this idea of the Fed liquidating QE2 holdings gains momentum. Especially after the QE2-induced inflation of global risk assets – and with massive Treasury issuance as far as the eye can see – the marketplace will become only more sensitive to potential liquidity issues going forward. QE2 makes it quite difficult for the Fed to now reverse course and attempt to normalize market liquidity and market perceptions.

I’ll assume the Fed will attempt to pull back on liquidity operations, while at the same time working to ensure the marketplace that its liquidity backstop support remains very much in place. And we’ll soon have the vantage point of press briefings in which to view this juggling act. From reading and listening to comments from some prominent (“hawkish”) members of the Fed, it seems that they are clearly more focused on inflation risk and much less wedded to a liquidity backstop function than Team Bernanke/Dudley. Today was the first day of what will be an intriguing quarter for our central bank.