In the good old days one used to be able to apply economic logic to market movements.  Bonds would rally and stockmarkets would fall during recessions. Stockmarkets would rally and the yield curve would back up during economic expansions.  Bonds would go down and Gold would rally when inflation was rampant.  Paul Volcker’s Saturday Night Special in October 1979 marked the end of the inflationary 1970s, Gold peaked in Jan 1980 then went to sleep for 20 years and a long bond bull market started in 1982.  Gordon Brown called the bottom in Gold when he sold 395 tonnes of Britain’s gold reserves near the $250 bottom in 1999 (thanks Gordon – and thanks for all the debt & deficits you left us with too).

Hence in the good old days market conditions were such that all three assets did not rally simultaneously.

However during recent weeks bonds have been going up, gold has been going up and stock markets have been going up too.  Hence many commentators have viewed these market conditions as unsustainable and are waiting to see which of the three asset markets is about to go into reverse.

Well, at the risk of falling into the old “this time its different” trap, we may well find ourselves in a situation where bonds, gold and stockmarkets all carry on rallying and the reason is because the Fed signalled in its latest Fomc statement that they are about to engage in another round of quantitative easing (printing money to buy US Treasury bonds).  It does not pay to fight the Fed – they control the printing presses and can create more US Dollars than even North Korea can counterfeit.  Bernanke is well versed at this and made a speech about  fighting Deflation in 2002.  The Fed is sure to announce a QE2 program of sufficient size to shock & awe the markets.  Anything less would be a disappointment to markets which are already sceptical about whether QE1 worked in the first place and the Fed would lose the respect of the markets if it underwhelmed them this time around.

In reality the Fed has little option other than to print Dollars to stimulate the economy with US interest rates stuck at 0.25%.  Their job is to keep inflation contained and to maximise employment.  Current policy settings have resulted in unemployment bobbing along between 9.5% and 10% which is far too high and needs to be brought down.  Therefore as inflation is currently well under control the Fed logically has to stimulate the US economy further.  Cue another round of QE.  So Gold rallies because the US currency is being debased further.

Stockmarkets also rally in this scenario because the economic recovery (which has seen GDP growth slow now that an inventory bounce has worked its way through the system) is being underwritten by further Fed stimulus.  Companies on the whole are currently doing ok in an economy which is growing slowly – they are making profits and continuing to pay down their debt at an impressive rate.  Those companies which feel they have paid off enough debt are starting to buy their rivals as a way of attaining growth amidst a slow-growing economy.  This nascent takeover boom showed up first in the commodity sector but is now spreading to other sectors of the stockmarket.

And finally bonds also rally because the Fed is going to keep interest rates at 0.25% for longer than the market’s current time horizon and in the meantime the Fed is going to buy the bonds of anyone who doesn’t believe that yields can go lower and wishes to sell their bonds.  At the extreme limit is the recent example of Japan where interest rates have been essentially zero since 2001 and 10-year Japanese Government Bonds have yielded 1% or so over the last few years.

So the Fed is forcing the entire US yield curve lower as it attempts to stimulate the US economy into creating more jobs, gold is rallying as more US Dollars get printed and the stockmarket is going higher because corporate profits are going to grow and we are in the very early stages of a takeover boom.  Leave the bond bubble to professional traders, join the stockmarket party and don’t fight the Fed.