Bernanke and Bond Buying, and Some Thoughts about Early Next Week

Federal Reserve Chairman Bernanke will tell the "60 Minutes" audience on Sunday that he does not rule out buying more than $600 bln of Treasuries.  This helped lift the euro to new session highs late in the day.  This is important and caps a volatile day and week.  

There are several take-aways from this week.  First the debt dynamics in Europe are worsening and pressure on Italy and Belgium is new, or the intensity of it is.

Second, the ECB's Trichet engineered a savvy short squeeze by extending the liquidity provisions and broadcasting loudly the stepped up bond purchases.

Third, after a month of strong and mostly stronger than expected releases, the US employment data was a major disappointment.  It is a volatile series and most economists GDP forecasts are not going to change based on it, but if it is repeated again this month (data in early Jan) it will be particularly problematic.

Fourth, Bernanke's comment is significant.  There were some who thought QEII could be cut short based on economic and political considerations.  There were some who thought there was nothing in the Fed's justification for QEII that ruled out QEIII, which is what the market will call an extension of the $600 bln Treasury purchases.  

Technically this is nothing new.  When the Fed announced the program they indicated it would continuously be under review.  The door to more and less was always open.  But the timing gives it extra potential.

Bernanke taped the show before he knew today's jobs data, and all of the indicators he was looking at, the same ones I suppose that I was looking at as were other market participants, pointed to a stronger report.  Regardless, observers will hear his comments after the major disappointment over jobs and will connect the two.  They will see his comments as heightening the risk of QEIII.   

The euro finished the session just below the trend line drawn off the Nov 4 and Nov 22 high, which comes in around $1.3430.  There is a retracement objective that comes in near $1.3480. 

The key on Monday is how much European bonds the ECB bought.  The first week of the program that bought $16 bln.  One official acknowledged that the buying was more robust.  The extension of the ECB's liquidity facility also may have encouraged some European banks to buy higher yielding sovereign bonds.

There is also a euro-zone finance ministers meeting on Monday.  There is some talk that the EFSF could be increased, but on balance, I lean again it.  Why increase the size?  It would likely be seen as a signal that they think Spain is going to need it.  For Ireland it is barely going to be tapped (~8 bln euros).  There is plenty in the kitty for Portugal.  Probably not for Belgium too, who, if the funding is to cover 3-years, likely needs something around 220 bln euros.  

On Tuesday the Irish parliament votes on the 2011 budget.