It all seems so surreal. After being mesmerized by the Fed's hallucinogenic "Quantitative
Easing," (QE) drug, and seduced by the Fed's Zero Interest Rate Policy (ZIRP),
and rescued by the Fed's clandestine intervention in the stock index futures
market, for the past 4-½-years, it's easy to forget that there was
once a time when the Fed's main policy tool was simply adjusting the federal
funds rate. It's even harder to recall that two decades ago, the Fed's raison
d'être was combating inflation, whereas today, the Fed's main mission
is rigging the stock market, and inflating the fortunes of the wealthiest
10% of Americans.
"Thecentral bank's purpose is to get ahead of the inflation curve," declared
Wayne Angell, one of the seven governors of the Federal Reserve on June 1st,
1993. Angell had a reputation as a Fed hawk, and he was pushing for a tighter
monetary policy, even before an uptick in the inflation rate showed-up in
the government's statistics. "If we're ahead of the curve, our credibility
and the value of our money is maintained. Some of my economist friends tell
me, 'We don't feel much inflation out there, but we feel better knowing that
you're worried about it." Thus, there was a time when savers received a positive
rate of return on their money.
Two decades ago, the Greenspan Fed was stacked with hawkish money men. And
because their tenures lasted for 14-years, they felt immune to the winds of
politics. Thus, if the Fed governors were to make unpopular decisions to hike
interest rates, in order to bring inflation under control, or burst asset
bubbles, so be it. Of course, it's much different today - the Fed is stacked
with addicted money printers that are beholden to the demands of their political
masters at the Treasury and the White House. How did Fed policy swing so radically
from Angell's day - when Fed tightening meant lifting the federal funds rate
and draining excess liquidity, to today's markets, - where a small reduction
in the size of the Fed's massive QE injections is considered to be a tighter
money policy?
The Treasury Bond Vigilantes, - is a nickname that was used to refer
to a legendary band of renegade bond traders, who used to fire-off warning
shots to Washington, by aggressively selling T-bonds in order to protest any
monetary or fiscal policies they considered inflationary. The jargon refers
to the bond market's ability to serve as a brake on reckless government spending
and borrowing. The last major sighting of the bond vigilantes was in Europe,
as they wrecked havoc upon the debt markets of Greece, Ireland, Italy, Portugal,
and Spain.
James Carville, a former political adviser to President Clinton famously remarked
at the time that "I used to think that if there was reincarnation, I wanted
to come back as the president or the pope or as a .400 baseball hitter. But
now I would like to come back as the bond market. You can intimidate everybody," he
remarked. However, the so-called T-bond vigilantes appeared to be dead and
buried over the past few years, as the US-Treasury was able to borrow trillions
of dollars, largely financed by the Fed at the lowest interest rates in history.
Keeping the T-bond vigilantes on ice, is a key linchpin of the Fed's Ponzi
scheme, that's used to inflate the value of the US-stock market and keep it
perched in the stratosphere.
However, last month, (May '13), something very strange began to happen. It
looked as though the long dormant T-bond vigilantes were suddenly beginning
to awaken from their slumber. Indeed, - the long-end of the US Treasury bond
market suffered its worst monthly decline in 2-½-years, as yields jumped
to their highest levels in 13-months. Ticker symbol TLT.N, - the iShares Barclays
20+ Year Treasury Bond fund lost -7% of its market value. It looked as though
Wall Street's bond dealers were whittling down their holdings of T-bonds,
- acting upon insider information from the New York Fed, - that the biggest
buyer in the T-bond market could soon reduce the size of its monthly purchases
and thereby cause T-bond prices to fall. Interestingly enough, T-bond yields
jumped +50-bps higher even though US-government apparatchiks said inflation
was only +1% higher than a year ago.
During Greenspan's tenure, the Fed would try to push T-bond yields higher,
by lifting the overnight federal funds rate. But in today's hallucinogenic
world of QE, - near zero-percent short-term T-bill rates, and historically
low bond yields, - if the Fed begins to reduce the monthly size of its T-bond
purchases in the months ahead, - it could have the same effect as a quasi
tightening. That's because the Fed has so badly distorted and inflated market
prices over the last few years. If the heavy hand of the Fed is gradually
withdrawn from the marketplace, the big question is: what would it mean for
the $21-trillion US-equity market?
The Bernanke Fed is coming under increasing criticism. On May 29th, the 85-year
old icon of central banking, - the greatest warrior against inflation in US-history,
- former Fed chief Paul Volcker waded into the debate over when the Fed should
start unwinding its radical QE operation, arguing that the "benefits of bond-buying
are limited and is like pushing on a string." Volckerlaunched a scathing
critique of the Bernanke Fed, inferring the central bank had become a serial
bubble blower. "The Fed is effectively acting as the world's largest financial
inter-mediator. The risks of encouraging speculative distortions and the inflationary
potential of the current approach plainly deserve attention," he warned.
Volcker reminded the new breed of Fed lackeys that the central bank's basic
responsibility is to maintain a "stable currency," and that it should unwind
its reckless scheme of massively increasing the US-money supply and blowing
bubbles in the stock market. "Credibility is an enormous asset. Once earned,
it must not be frittered away by yielding to the notion that a little inflation
right now is a good a thing, a good thing to release animal spirits and to
pep up investment.The implicit assumption behind that siren call must be that
the inflation rate can be manipulated to reach economic objectives. Up today,
maybe a little more tomorrow and then pulled back on command. Good luck in
that. All experience demonstrates that inflation, when fairly and deliberately
started, is hard to control and reverse," Volcker warned.
Last week, the Treasury's 10-year yield climbed above the 2%-level, following
Volcker's remarks. The 85-year old Fed hawk still commands a lot of respect
on Wall Street and his voice is not easy for the Fed's rookies to tune out.
The recent plunge in T-bond prices did trigger a knee-jerk sell-off in the
stock market, that briefly knocked the Dow Industrials lower to the 15,100-level.
But in a June 3rd note, Goldman Sachs (GS) released a message to the financial
media, telling investors to remain calm amid the bond market sell-off. GS
reiterated its Bullish stance on the US-stock market, - saying further gains
lie ahead, and that S&P-500 companies have plenty of cash on hand, that
can be deployed to offset the negative effect of higher interest rates, -
by increase their dividends +11% this year and +10% in 2014. If correct, that
would lift the S&P-500's dividend yield to a meager 2.3-percent.
Still, yields on 10-year T-Notes increased by a half-percent in the month
of May, including a jump of +16-bps on May 28th, - seen as a signal that the
Fed's would scale back its QE-injections. "A slowing in the pace of purchases
could be viewed as applying less pressure to the gas pedal, rather than stepping
on the brake," said Kansas City Fed chief Esther George on June 4th. "It would
importantly begin to lay the groundwork for a period when markets can prepare
to function in a way that is far less dependent on central bank actions and
allow them to resume their most essential roles of price discovery and resource
allocation. I support slowing the pace of asset purchases as an appropriate
next step for monetary policy. Waiting too long to prepare markets for more-normal
policy settings carries no less risk than tightening too soon," Ms George
added.The Kansas City Fed chief cited signs of overheating markets, including
margin loans at broker-dealers at a record $384-billion in April.
"We cannot live in fear that gee whiz the stock market is going to be unhappy
that we are not giving them more monetary cocaine," added Dallas Fed chief,
Richard Fisher on June 4th. Still, many traders don't believe that the Bernanke
Fed could ever kick the QE-habit and act to tighten the money spigots. Since
May '12, traders have played the "Great Rotation" - shifting out of bonds
and moving into stocks, seen as the best way to profit from the Fed's radical
schemes. However, there's a good chance that going forward - the "Great Rotation" could
morph into the "Dangerous Divergence." If left unchecked, an extended slide
in the T-bond market could trigger an upward spiral in the 10-year yield towards
3-percent, which in turn, would threaten to blow up the Fed's Ponzi scheme.
Already, the ratio between the value of the Dow Industrials and 10-year T-note
futures has reached the 116-level, - doubling from the 58-level - where it
bottomed out in March '09, and is within striking distance of its 2007 high.
A last gasp rally in the US-stock market could be the catalyst that triggers
a sharp sell-off in T-notes. At that point, the "Dangerous Divergence" could
reach the breaking point, leaving the bond vigilantes to do their dirty work.
Minor Earthquake in Tokyo Bond market, - The recent sharp slide in
US T-Notes was preceded by a tremor in the world's second largest bond market
in Tokyo. On April 4th, the Bank of Japan's (BoJ) new governor, Haruhiko Kuroda,
unveiled the most radical scheme ever, - designed to "shock and awe" Japanese
bond traders into complete submission. The BoJ said it would double the amount
of yen in circulation over the next two years, in order to whip-up inflation
in the world's third largest economy. The BoJ said it would trump the Fed,
by printing ¥7-trillion each month, to be used to buy Japanese government
bonds (JGB's).
The BoJ was certain that it could continue to arm-wrestle Japanese banks and
persuade its loyal citizens into buying 10-year JGB's at yields of less than
1%, even as the BoJ says its aim is weaken the value of the Japanese yen,
increase the costs of imports, and increase the consumer inflation rate to
+2%. In other words, the BoJ expects investors to lock in negative yields
for the next ten years. However, the gambit began to backfire, whenyields
on 10-year JGB's rebounded from a historic low of 0.315% and surged to as
high as 1% on May 23rd, - triggering a -7.3% crash in the Nikkei stock index.
It was the Nikkei's biggest one-day fall in 2-years, and kicked off an extended
-17.5% slide to 13,050 by June 3rd.
It was later revealed on May 30th, that Japan's biggest banks decided to slash
their holdings of JGB's to ¥96.3-Trillion, in the month of April, - a
sign that their selling played a major role in pushing up yields to 1%. Japanese
banks were unusually rebellious, and dumped 11% of their JGB's holding onto
the BoJ's balance sheet, fearing a major rout in the future. For the BoJ,
trying to force JGB yields lower, when its trying to weaken the value of the
yen and whip-up inflation, - is like trying to submerge a helium balloon under
water.
If this exodus from the JGB market continues, it could blow apart the BoJ's
Ponzi scheme. Japan's outstanding debt is equivalent to 245% of its annual
economic output, and 92% of the debt has been financed by domestic savings.
But this may not continue. A government panel's draft report has reportedly
warned that there is "absolutely no guarantee" that domestic investors will
keep financing government debt. The BoJ has calculated that a rise in JGB
yields of just 1% would lead to market losses equivalent to 10% of the core
capital for the top Japanese banks, and 20% losses for the smaller regional
banks.
So far, the immediate impact of the BoJ's Big-bang QE scheme has been a rapid
and parabolic rise in Tokyo stock prices. These increases were fuelled by
a frenzy of speculation by foreign traders. But rather than reflecting an
economic recovery, the booming share markets are indicative of what the former-CEO
of Citigroup, Chuck Prince, famously noted in July 2007, "As long as the music
is playing, - you've got to get up and dance." Nikkei Bulls are hopeful that
the BoJ can keep the music playing, by boosting the size of its monthly JGB
purchases if necessary. However, Tokyo cannot act in a vacuum - it would have
to receive permission for an expanded QE scheme from its "Group-of-Seven" co-conspirators.
And that's unlikely.
"Stock markets are under the spell of QE," In fact, both the BoJ and
the Fed are in the crosshairs of the Bank for International Settlements (BIS),
which warned on June 2nd, about the dangers of their ultra-cheap money policies
that are driving up stock prices, despite worsening economic news. "Investors
have ignored poor economic news as stocks have risen, leaving markets vulnerable
to unsettling volatility and potential losses. Excessive monetary easing helped
market participants to tune out signs of a global growth slowdown. But the
rapid gains left equity valuations vulnerable to changes in sentiment, as
witnessed in the recent bout of volatility in Japan," the BIS warned.
"Yen Carry" Trade lifts London Stock Exchange, "With yields in core
bond markets at record lows, investors turned to lower-rated European bonds,
emerging market paper and corporate debt to obtain yield. Abundant liquidity
and low volatility fostered an environment favoring risk-taking and yen carry
trade activity," the BIS noted. Whether by extraordinary good luck, or by
clever design, the FTSE-100 index didn't need the help of the Bank of England's
(BoE) money printing machine, in order to climb sharply higher to the 6,800-level
this year. Instead, the Footsie hitched a ride to the rising tide of liquidity
flowing from Tokyo, - via the "yen carry" trade. It was a smart move by the
BoE to kick the QE-habit back in November. The maneuver provided a solid foundation
for the British pound to rally strongly against the Japanese yen, thereby
encouraging carry traders to borrow cheaply in yen, and plow the cash in high
yielding Footsie blue chips.
In its report, the BIS went on to say that stock markets "are under the spell
of monetary easing to the point where negative news such as downbeat economic
data doesn't stop stocks from going up. Every time an economic indicator disappointed,
traders simply took that as confirmation that central banks would continue
to provide stimulus," such as near zero percent interest rates or QE schemes
that increase the supply of money in the economy.
Such was the case on June 3rd - when the ISM's index of US-factory activity
fell to a reading of 49 in the month of May, down from 50.7 in April. That's
the lowest level in nearly four years and the reading under 50 indicates contraction.
The unexpected drop in the headline figure reflected contractions in both
the new orders index which fell to 48.8 in May from 52.3 in April, while the
production index plunged to 48.6 from 53.5.Europe remains mired in recession
and is buying fewer US-goods. In the first three months of this year, US-
exports to Europe fell -8% compared with the same period a year ago. Despite
the negative news, the Dow Jones Industrials soared to the 15,300-level, as
traders reckoned the Fed would utilize it as an excuse to continue to print
$85-billion per month of high octane liquidity.
BIS warns Bondholders - prepare for further losses, - However, Stephen
Cecchetti, head of the BIS monetary and economic department, issued a warning
to bankers and wealthy investors to prepare for an eventual normalization
of interest rates that would cause additional losses for bond holders. "The
losses, when they do occur, will be spread across banks, households and industrial
firms." He stressed it's important that banks make sure their finances are
strong enough before central banks end their QE programs and start raising
interest rates. "Robust balance sheets with high capital buffers are the best
ways to guard against the possible disruptions that this can bring," he said.
On May 22nd, Bank of Korea Governor Kim Choong Soo also warned that when the
Fed pullbacks from QE, it would spur risks worldwide from rising bond yields. "If
the Fed begins to exit from quantitative easing policies, the world will be
facing interest-rate risks, in terms of how much would bond yields rise," he
said. Also, IMF economists warned in May that a "potential sharp rise in long-term
interest rates could prove difficult to control."
Thus, while Goldman Sachs might be proven correct, and that another upward
leg for the 51-month old Bull market still lies ahead, in the humble opinion
of the Global Money Trends newsletter, it's best to heed the advice of the
legendary trader, Bernard Baruch, "I'll give you the bottom 10% and the top
10% of any move, if I get to keep the middle 80%." In other words, for "Buy-and-Hold" investors,
it's a better strategy is to take advantage of any possible rally in the US-stock
market to lighten up on long positions, rather than to add any new long positions
at the tail end of a bubble.
This article is just the Tip of the Iceberg of what's available in
the Global Money Trends newsletter. Global Money Trends filters
important news and information into (1) bullet-point, easy to understand reports,
(2) featuring "Inter-Market Technical Analysis," with lots of charts
displaying the dynamic inter-relationships between foreign currencies, commodities,
interest rates, and the stock markets from a dozen key countries around the
world, (3) charts of key economic statistics of foreign countries that move
markets.
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