Treasury market asserting itself
Bond investors still have the power to stifle the Fed, although they may do it much more quietly than had been expected.
This week brought another installment of "As the QE-driven world turns," starring Federal Reserve Chairman Ben Bernanke, who held a news conference June 19 following the Federal Open Market Committee’s latest policy meeting.
First of all, regarding the presser, let me be clear that there was nothing in what Bernanke said that could have led anyone to think that the Fed is inclined to take actions that could remotely be considered tightening.
Bernanke went out of his way to say that even when Fed officials got around to reducing the amount of Treasurys they were purchasing, they would, to use his metaphor, still be stepping on the accelerator, just at a reduced rate.
He also took great pains to point out that there would be some lag between whenever the Fed reduces its bond buying and when interest rates might rise, or that the Fed's balance sheet might actually shrink. Further, he noted that everything was data-dependent.
If it looks like a dove and talks like a dove . . .
I realize that, in the aftermath, people have been trying to argue that Bernanke used more hawkish language on June 19 and that must mean the economy will improve, but neither is the case.
He did indicate that a cessation of money printing, "…would basically say that we've had a relatively decent outcome in terms of sustained improvement in growth and unemployment." But he also noted that none of their economic targets were "triggers" that would lead to automatic action; rather, they were "thresholds," meaning they would be dissected and discussed. Finally, he stated, "If things are worse we will do more. If they are better we will do less."
Bottom line: The Fed chief couldn't have been much more dovish, unless he had said, "Look, we will never stop QE." Short of that, what he said was not remarkable at all.
On the subjective side, given that the economic data have been decent only when graded on the curve of the last few years, it is hard to imagine how anyone could think it will get strong enough for the Fed to taper, as Bernanke envisions, let alone act more aggressively.
The reason I make such a strong point about what Bernanke had to say is because of the response of the bond market. As regular readers know, I have been of the opinion that the Bank of Japan has overdone it with its bond-buying-driven attempts at quantitative easing (aka money printing) and we are in the early stages of seeing Japan's bond market take the printing press away from the central bankers.
They can't talk their way out of this one
Though there has been a large backup in U.S. rates recently, I had thought that might have been a consequence of misguided fears over tough "taper talk." However, seeing the bond market roughed up as badly as it was this week after Bernanke was as friendly as he could be makes me consider the possibility that America, too, might be in the very early stages of seeing the bond market take away the printing press. If so, the ramifications are immense.
Since the Fed's fourth round of QE commenced in December, 10-year Treasury rates have risen about 80 basis points, from 1.6% to 2.4%. Rates on 30-year Treasurys have not risen as much, having been driven only from approximately 2.9% to 3.5%. But the point is that rates have risen very aggressively here and in Japan despite massive purchases on the part of our respective central banks.
In the past, when I have discussed the possibility of a funding crisis or a bear market in bonds, I would always be asked how bonds could decline given the aggressiveness of central bank purchases. I would always try to explain that once it changes its mind, no one is bigger than the market, as we have seen with U.S. and Japanese bonds declining aggressively in the face of mammoth central bank bond buying.
What I, and like-minded others, may have missed is that the bond market here in America could already be starting to react to what has transpired so far, as well as to what is expected to occur next on the part of the central banks. After all, it is no secret that real inflation is higher than the coupon rate. And if you are no longer worried about deflation, why would you accept negative real rates on any fixed-income investment?
QE exit signs are not up to code
A point I have made many times is that the end of the fear of a deflationary collapse in Europe would be the end of the bond market, and that could, in fact, have occurred.
In a QE-driven world, many of us have become used to the predictability of markets doing what central banks want and have operated under the assumption that exit signs would be in giant neon lights.
If, in fact, bond markets are quietly revolting against the nauseating central planning by incompetent economists with Ph.D.s. That is going to be very big news, and it will mean much weaker equity and bond prices.
Of course, at some point all of that weakness feeding back into the economy brings up the subject of additional QE, but if the bond market has changed its tune, that will be even more problematic.
I don't want to get too far ahead of myself, as we are talking about ephemeral macro crosscurrents, but I wanted to raise the possibility that maybe, just maybe, the bond market is asserting itself and life may get trickier than folks expect in the not-too-distant future.
Lastly, I want to touch on two other points. The first is the reaction by the stock market, which has caused all headlines to be written in a way that suggests the Fed is going to be hawkish and is a perfect example of how the stock market creates its own spin.
Stocks were bid up on the massive QE by the BOJ and Fed, which caused people to imagine that the economy would soon start accelerating "just enough" (a.k.a., Goldilocks). When stocks have been boosted so high on easy money, hot air and leverage they are vulnerable and can fall fast if psychology changes (or the bond market tanks), which is what is happening. However, the weakness of stock markets is causing most to misinterpret the Fed's intentions.
That brings up a second, related, point. There is an (incorrect) view that the Fed "knows" the economy is getting better and therefore must prepare for its eventual "exit" from money printing. To that I say, the Fed has been wrong at every juncture in the last 10 years, never understanding what was driving the economy and overestimating growth (since 2007 or so). Bernanke is so clueless, he thought subprime was "contained" in late 2007. I rest my case.
In summary, disregard all headlines claiming that Fed intentions have caused stocks to drop. Stocks are tanking because bond markets have been crushed, not because of what the Fed supposedly has planned. Bonds are weak because central banks have lost control.
Eventually, folks will realize that the Fed is not only clueless regarding the economy (they haven't fixed anything), but also trapped. That means it and other central banks should have zero credibility versus the huge amount they have had up to this point. That mindset should lead people to worry about stagflation instead of dreaming about Goldilocks, but more events have to play out before we get to that point.
Very good, Bill... well-written informative article. Using your words... "Further, he noted that everything was data-dependent." (Referring to Bernanke).
This is the key. Data is-- BS. Anyone can selectively create what they want out of data, as two Harvard Professors showed us. Since 100% of US business platforms can't conduct business without regular infusions of QE, where does that data identify that? Bernanke constantly creates the hot air confidence that he knows how to drive the car but his eyes are never open. "Eventually, folks will realize that the Fed is not only clueless regarding the economy (they haven't fixed anything), but also trapped. That means it and other central banks should have zero credibility versus the huge amount they have had up to this point." Indeed... but the least of our worries is stagflation, the greatest mimicking a Japanese condition... generations left on the bench that cannot perform or sustain. Better to: Close the banks, end the Federal Reserve and get RID of Wall Street, which would send those Ph.D's towards the dumpsters for dinner. It will happen... and soon.
I can't think about this right now, I'm so upset. The Food Network dropped Paula Deen.
The Nikkei 225 is down 20% from its peak of 15,627 to a low of 12,445 this month. Currently, it's only off 15% this month from its peak. Interest rates on Japanese Government Bonds are increasing rapidly.
"Mr. Bernanke said in a congressional testimony that the FED's purchases only add up to about 16% of the bonds available. So the other 84%-the market is on a hair-trigger, and could demmand higher interest rates. A real possiblity is our volatile world."
History suggests that level of potential volatility negates credibility for those instruments. Imagine being "all in" in bonds and having the world call them JUNK and you lose it all.
My thought is when O is gone the QE will be gone....O is to arrogant to let the country fail while he is in charge and for all those poor folks from outside the US not to have health care and cellphones and heaven forbid a check every month.
He is possibly the beginning and the end.
It's about time we took the country back from the criminally insane inside the beltway . If it all starts with bond vigilantes,
it works for me. Maybe the people of this country can take away a message from it...maybe not, there are minions of morons I'm sad to report...........
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ABOUT BILL FLECKENSTEIN
This column is a synopsis of Bill Fleckenstein's daily column on his website, FleckensteinCapital.com, which he's been writing on the Internet since 1996. Click here to find Fleckenstein's most recent articles.
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As the devil-may-care bravado of Wall Street marches on, history warns that -- in the end -- there will be the devil to pay.
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