Today 15th of October Ben Bernanke has confirmed what the market already knew, that the second leg of Quantitative Easing (“QE2”) is about to start. He could not disclose the size or the timing because he didn’t want to undermine the rest of the FOMC members that are meeting on the 2&3 of November.
I am not going to criticise Mr. Bernanke because he has one of the toughest jobs in the world right now, getting families and companies to spend again so jobs are created. As he described, the labour market recovery is painfully slow. However, $500-750 billion will not bring jobs back. The market does not need more liquidity. Particularly, the credit markets. As an illustration the 5yr iTraxx Crossover series 13 is right now at just 397bps (close to historical tights) and Mexico has managed to sell $1billion of 100-year bonds yielding 6.1%. There is plenty of liquidity in credit markets.
Unfortunately, Ben looks like an ugly teenager desperately sending roses to the most popular girl in the school. It is a nice gesture but, it never works. More liquidity will push US Treasury yields lower but it won’t create stable jobs or families and companies to spend. The system does not need more leverage or liquidity. The system has been adding leverage for the last 20 years. Now, western economies are faced with de-leverage. Liquidity is not the solution.
Most credit hedge funds are sitting (pretty annoyed) on big balances of cash. The excess liquidity and the hunt for yield is making longs look expensive but, shorting is not an option given the strong technical bid. Distressed investment opportunities are also limited with default rates below 3%. In September, the only sizeable company filing for Chapter 11 was Blockbuster Inc. affecting $930mio of high yield bonds that are trading around 58 cents.
Best credit hedge fund managers are delivering around 10% (a pretty decent return) by being nimble, trading around specific credit events and avoiding beta landmines such as last May. In 2009 investors had problems indentifying the best credit managers as everyone was making money. In 2010 investors will be able to separate the wheat from the chaff.
Ben talks about low inflation but I am pretty sure he is all day thinking about the “D” word. If Ben’s QE2 fails and we get deflation the US economy is going to be in big trouble because the Fed is running out of ammunition as interest rates are already close to zero. However, most credit hedge funds will be happy. There will be plenty of great cheap shorts while all yield chasers head for the door.
