Global capital markets rallied dramatically today on the back of yesterday’s announcement by the FOMC that the Fed will expand its balance sheet by another $600 billion though the purchase of US Treasuries at a rate of $75 billion/month. This is in addition to the announcement in August that the Fed would reinvest principle payments from its portfolio of mortgage-backed securities. In total, the Fed is expected to purchase $850 to $900 billion in US Treasury debt, or about $110 billion/month, through June 2011. According to the New York Fed, purchases will have an average duration of five to six years.
While stocks, bonds, and commodities all rallied, gains were paced by the commodity complex. The Dow Jones-UBS Commodity Index rose 2.70%. While strength was broadly based, performance was led by the precious metals, softs, and to a lesser degree, the industrial metals. The precious metals and the softs both gained more than 4% and the industrial metals rose more than 3%. Further quantitative easing, or QEII as the additional monetary ease has been dubbed, will likely result in continued depreciation of the US Dollar. This, in turn will place upward pressure on commodity prices because commodities are priced globally in the US Dollars. The impact of QEII on the Dollar was the driving force behind today’s gains in commodity prices in general and precious metals in particular, which one would expect to rise when the world’s largest fiat currency is devalued.
We are far from market technicians, but we do note that the Dow Jones-UBS Commodity Index has risen to a new 52 week high. While this is generally supportive of further price gains, commodities have rallied 20% over the last four months and the index is currently trading just below the range-bound levels at which it spent roughly 21 months from 2006 through 2007. As such, it may encounter some resistance or suffer a correction in the near-term. Yet the Fed’s decision to implement additional quantitative easing is clearly negative for the US Dollar and therefore supportive of higher commodity prices. While a near-term correction is certainly possible, the path of least resistance over the intermediate term is higher.