Rally loses steam as Bernanke offers little surprise

North American markets, which have been rallying since Ben Bernanke's speech on August 27^th, appeared to lose steam this week. For the week, the S&P 500 was up 1% to 1,176.19, while the Dow edged 0.5% higher to 11,062.78. The S&P 500 has gained 12% since the end of August, reaching its highest level since May 3^rd on Wednesday.

US dollar weakness continues 

Quantitative easing (QE2) and U.S. dollar weakness continued to be the centre of attention this week. The US dollar fell to a 15-year low against the yen, the Canadian loonie jumped past parity, and the Australian dollar also rose past parity for the first time in 30 years. 

 

Ben Bernanke stated on Friday that with US inflation being so low and unemployment at a high level, the US Federal Reserve will take further action. However, he did not give details about the size of QE2. Thus, the US dollar stopped declining on Friday, and rose slightly after his speech. Gold also edged lower to end at $1,368.26/ounce, after hitting another record high of $1,380.18 on Thursday.

Emerging Markets shine

With the promise of cheap money by the US Fed, investors poured money into emerging markets in an attempt to obtain faster growth and higher yield. According to Reuters, JPMorgan’s EMBI+ index showed investors buying up emerging markets government bonds. In addition, EPFR Global stated that at the end of last week, emerging market equity fund flows hit a 33-month high, and emerging market bond funds absorbed $1 billion in one week.

Housing turns ugly

The consistently weak US housing market got even uglier, as allegations grew that lenders have improperly seized hundreds of thousands of houses. In fact, Bank of America has stopped all sales of foreclosed houses. This is expected to halt a large portion of the US housing market for the next several months. In fact, one hedge fund has pointed out that Bank of America could face a loss of US$70 billion as a result of the incident. As a result, Bank of America and other US bank shares fell on Friday.

Trade war looking less likely

The possibility of a trade war between the US and China decreased significantly on Friday, after the US Treasury Department delayed a decision of whether to label China as a currency manipulator until after the November 2^nd elections and the G20 summit on November 11^th. However, tensions remain because of QE2 driving down the US dollar, making other currencies less competitive.

Outlook

With North American markets having gone up significantly, investors could be facing a rude awakening when the Fed announces further actions on November 3^rd. With the S&P 500 having risen 12% since September began, investors are pricing in a US$1 trillion QE2 to be announced. However, to date, the US Fed has not given any indication about the size of QE2, and Friday's speech hinted that the Fed's action will be cautious. Thus, an announcement for QE2 of less than US$1 trillion could leave investors disappointed and stocks heading lower. In addition, with the steep rise in equities in recent weeks, markets will likely be trading sideways or slightly lower into the Fed's decision.