The Department of Labor’s (DOL) jobs number was a big miss! So much so, that it led me to think that it might have been “a fix.” The reactions of many ranged from dis-belief to comments of the markets being nothing more than “a casino” as one trader remarked on the Talking Stocks Forum message board.
Now, at putting myself at risk of sounding like another “conspiracy theorist crackpot,” let me explain my rationale on this idea. Of course, readers should decide for themselves, but I only ask that readers consider the evidence.
First, keep in mind that the ADP payroll report showed 100,000 more private payroll jobs just the day before the DOL release. ADP is a very large payroll processing firm, and they have direct access to the payroll systems of many private employers. So, it stands to reason that ADP can see first hand if private employers are adding to or subtracting from their payrolls.
In the recent past, many popular media and government pundits have attempted to diminish the ADP numbers as being less reliable than the DOL’s numbers, but this attempt at slighting ADP’s results seems to be more of a miss direct attempt to inflate the value of the government report versus the actual payroll results of a top vendor in the payroll services sector.
The government report uses many adjustments including seasonality factors and a birth-death model for businesses that many experts question. The ADP number on the other hand, at least as it relates to private payrolls, is pretty much an un-doctored number.
So, if one assumes that the ADP monthly jobs report is is closer to reality (at least with private payroll figures), then let’s move on to some reasons that would be motivations for the Fed to hold interest rates steady (and keep bond interest rates low).
The first reason is the monthly Treasury bond auctions which occur this week in the U.S. As I have noticed time and time again, bond yields tend to fall in the week of each re-funding. However, there has to be some sort of fear of bad news in the air to drive down interest rates, and this bad news often seems to arrive in the week of each month when the Fed holds its largest bond auctions.
With our large sovereign debt ($19 trillion), it makes sense to try to auction off new treasury notes and bonds at as low of an interest rate as the markets will accept. As it is now, the US can only cover its interest rate payments, and that is at a stretch without sacrificing other areas of the bloated budget.
So, from the federal government’s position, it makes sense to try and auction off new treasury notes and bonds at the lowest possible interest rates. During times of fear, investor money typically rotates into US treasuries as they are perceived to be both liquid and safe investments. Bond prices tend to rise (and interest rate yields fall) during times of fear, due to the safety perception of this investment.
Yet, the Federal Reserve had been preparing us for another rate hike either in June or July, which is contradictory to the directions that yields take during times of worry. A rate increase seemed to be increasingly likely, and the short end of the yield curve was rising in anticipation of it. Rising interest rates create a problem of interest rate coverage– a financial concept that says that net tax receipts have to at least cover the interest rate payments on the treasury notes and bonds.
So, if the Treasury can auction off those debt instruments at lower interest rates, then those low rates remain intact to maturity some ten to thirty years out. Since interest rates are at near historic lows, and the amount of US debt is very large, it only makes sense for the government to try to auction off their paper at the lowest possible rates.
Now, back to the Fed. The US central bank had one caveat to its forecasts, and that was that an interest rate hike would be “data dependent.” On Friday, that data came in weak. So, the stunning low jobs number did “the dirty work” for the auctions by driving bond yields down and delaying a threatened Fed hike in June.
The low jobs number also helps several other concerns as far as keeping interest rates low:
Those examples include “Brexit,” China, and Europe. In the case of Brexit, the Fed can now avoid a mistake of raising rates right before the Brexit vote in the UK. A vote to leave the European Union could un-glue markets worldwide, and so keeping the US interest rates on hold (and thus keeping the US dollar soft) lessens the chance of large capital outflows from Europe and the UK, which could trigger a financial crisis.
And the lack of a Fed rate hike also keeps China from doing a devaluation of the yuan. The last major yuan devaluation occurred on August 24th of last year, and so take a look at your stock charts to see what happened last year on that date and you will understand why it is important for the Fed not to raise rates while China’s economy is weak!
China’s currency is weak but still pegged to the US dollar, so with the greenback now conveniently weakened, that takes pressure off China having to de-value its currency. A weaker dollar is in essence, a de facto devaluation of the Chinese currency relative to other currencies around the world. Yet, since China does not have to officially de-value its currency, the world financial markets remain calm.
So, regardless of whether you buy into my thesis that the weak jobs number was contrived, there is no denying that the result plays right into the hands of what the global elite were secretly hoping for.
So, welcome to the casino! The house welcomes you to pull up a chair, and place your bets on the next roll of the roulette wheel. The markets continue to gyrate without any consistent direction because the global elites (who control the financial institutions) are trying to keep a weak and sensitive financial system from falling out of balance.
So, we lurch from one crisis point to the next. While the Fed and other central banks talk about a controlled economic recovery, what they really seem to be doing is trying to keep currency crosses moving in a narrow channel so as to avoid a sudden spiral of financial conditions.
NOW, if all of what I have speculated on seems to make no sense, then I ask that you at least consider that the US dollar daily chart shows the buck was hitting the late January down-trend resistance line. That line is also very close to the down-trending 50 day line. So, when the greenback hit that yellow-dotted line on my chart, that was a natural resistance point where a reversal could take place….and it sure did!
Take a look….
So, was the Jobs number a fix? Whether or not you accept the theory of a contrived report, then perhaps we can agree on this: the US dollar chart was set up to reverse, and it was conveniently right for it to do so as far as “the house” was concerned! The Fed saves face because it cannot raise rates in the wake of weak data, and the day of reckoning in the financial markets is delayed yet again.
My belief is the Fed will be foolhardy to raise interest rates in September, with China dumping its treasuries. By selling their US assets, China is forcing interest rates higher, especially on the 10 and 30 year treasuries. The only reason the long bonds aren’t rapidly losing value is that we are in the grips of a new bear market, and stock investors are fleeing to the relative “safety” of bonds. Yet, bonds are failing to reach new highs because of the overseas selling of them.
By the way, China’s dumping of US treasuries has created QT….Quantitative Tightening! In other words, China has acted ahead of the Fed!
But this is QT in the worse way possible because selling tons of long bonds into the open market can create huge pressures on the debt and credit markets as well as equities–in effect, market disequilibrium! In the past, when the Fed raised rates, they would sell short term treasuries into the open market….but never long bonds! This QT by China with the long bonds is doing the work of the FED by raising rates (on the long end of the curve) even before the FED can act at its mid-September meeting. However, the sale of long bonds creates undue pressures on mortgage markets and other longer term markets in this country.
And China holds a lot of our treasuries ( and they can disrupt markets if they sell a lot of these). This is why I own one call on TBT….and I may buy more.
And I am keeping a close eye on gold because investors could suddenly lose confidence in owning bonds…..that could cause a dumping of the dollar and nearly all other assets….so, I suggest to keep an eye on gold for any sudden breakouts.
With the Fiscal Cliff situation looming for the USA toward the end of year 2012, I have been doing a little research on the subject for a white paper project. This led me to come across an interesting site called the National Priorities Project (nationalpriorities.org) which is an excellent interactive site about the Federal government’s spending and revenues. The site is a real eye-opener for those of us who wonder where all that money goes that our government spends.
One thing that catches my eyes is that interest on our national debt is our fourth largest expense item at 6.76% of the projected 2013 Obama budget. When one considers that the US Treasury is paying out the lowest interest rates in 60 years, this should be raising some concerns as to what we will do when the day comes that interest rates return to their historical averages–or worse! For example, the 10 year Treasury Note now pays out at about 1.65% interest…but historically, over the last 50 years, I would say the going interest rate for this note was around 4% to 6%. If one assumes an average of 5% for the 10 year, and perhaps 2% or so for the 1 year notes (which now pay about 0.3%), then interest rates would triple or more from where they are currently.
Does this mean that the cost to service our debt could triple if interest rates return to their historical norms? Well, I guess the answer is, “it depends.” For example, some debt is probably long term debt at a fixed rate of interest and may not fluctuate much.
Yet, even if we assume there are some long term fixed payouts in our national debt, even a doubling of the payouts could push US interest debt on our Treasuries to around 13% or more of our total annual government budget and leaving it closer to the annual cost of our military’s overall budget. Also, one would have to assume that if interest rate debt is consuming a larger part of the annual outlays, then the percentage of some other expenses such as the military could suffer cutbacks.
The prospect of a large increase in the service of our national debt should clash with fiscal austerity as many people are pushing for smaller deficits in 2013 and beyond. We cannot continue to roll over our interest payments or re-structure then forever without coming face to face with some tough decisions. At such point, would the Federal Reserve defer to just printing more money (like Quantitative Easing) just to ease the pain and circulate enough money to pay down the debts? If so, imagine what that might do to the value of the US dollar? Or to future interest rates, especially if the major ratings agencies should lower the US’s high ratings.
A significant drop in the US’s ability to re-pay its debts would only cause more money printing, I fear. Or do we just walk away from our national debt at some point? Good luck with that, because it would crush the value of the American dollar and cause great pain to the American people!
Ultimately, I do believe that the Fed and most other central banks plan to print–and print!– more money to try to monetize our way out of the sovereign debt fix that so many countries are now involved with –but they will only do that after they see that other programs just aren’t doing much good. When their backs are against the wall, the world’s central banks, led by our own Fed, will choose the easy way out–print more money!–even if it should bring on a large dose of inflation. The Fed and most central bank leaders fear deflation more than they fear inflation. Inflation is like a hidden tax–most people don’t see its effects day to day but only notice it over time. Deflation is easily seen right away in fewer jobs, depressed wages, lack of growth, and of course lower prices which few can appreciate since they aren’t earning much money! Given the fears of deflation, most central bankers realized that inflation is an easier animal to deal with in keeping the masses satiated enough not to throw our government leaders out of office. However, that’s a subject for another day.
All in all, this site offers a lot of interesting interactive displays on the Federal Budget. I don’t know much about the supporters of the site–it seems to be formed by some independent-minded intellectuals looking to better educate Americans on what goes on in Washington. I suppose some would say this is a “commie liberal” site but I try to remain objective, and what I see here is pretty much not politically motivated–just the hard facts. But even if a reader is suspicious of the site by its intellectual tone (which I know some people affiliate with liberalism) of the site, I still think everyone should keep an open mind and evaluate the data that is here objectively, whether or not one agrees with “the tone” or message of the site operators.
The Federal Reserve’s decision to extend its Operation Twist program out to the end of this year seems to many observers to be a fairly benign attempt to keep some juice flowing into a skittering US economy. There were some market observers who were calling for an outright quantitative easing program (most likely dubbed as “QE 3”) to be launched, but the Fed was not ready for that sort of ammunition. So the continuation of Twist seemed a palliative approach to appease those arguing for more monetary stimulus.
Operation Twist is a program where the Fed “trades” its short term notes (mostly US treasury bills of 3 years or less duration) in for longer duration notes and bonds of somewhat greater risk (on average). The duration of US treasuries purchased is a minimum of 7 years and as long as 30 years. In addition, the Fed program will continue to acquire mortgage-backed securities and other long-dated mortgage type paper in an attempt to keep mortgage rates low and stimulate a mostly moribund housing market and slowly expanding business community.
Singer/dancer Chubby Checker delighted audiences some 50 years ago with his dance songs called “the Twist.” The Fed’s Operation Twist derives its name from that dance.
Recent economic reports show a slowing US economy on many fronts from jobs to retail store sales to regional industrial activity reports. A lot of the blame can be placed on the financial mess in Europe as well as fear that China’s exports are hurting due to the European recession. Furthermore, as this is a presidential election year where both parties remain polarized over many issues, it seems to many observers that nothing of importance will occur between now and the election in November. Also, with fears of what “America’s Fiscal Cliff” dilemma could do to this country during the period of the lame duck Congress, the Fed has decided that some form of monetary stimulus must remain in place until the end of this year to try to over-ride the effects of weak fiscal stimulus from the US government.
In his meeting with the news media after Wednesday’s Fed announcement, Chairman Bernanke said that by the end of this year, the Fed’s balance sheet would reflect almost no short duration debt assets (in banker’s parlance, debt instruments are actually called “assets”). Almost all of the debt that the Fed expects to hold by January 2013 will be long-dated maturities. The Wall Street Journal points out in its June 21st edition that the Fed’s balance sheet will be approaching $3 trillion, and almost none of that debt paper will be short-term maturities.
When one sharp reporter asked Bernanke about the state of the Fed’s balance sheet and how that affects the Fed’s ability to stimulate the economy to meet its jobs mandate, Bernanke admitted that the extended duration of the balance sheet would limit any further action with a balance sheet strategy–his eyes shifted from right to left as if to imply he didn’t know where to go from here. Hastily, he added a wishy-washy answer “that we would have to take other kinds of steps to create stimulus in the economy.” He shifted nervously in his chair after making that statement. For me, this was the key moment of the last few years of Fed policy! (You can see it and hear it at about the 40 minute mark of this C-Span video.)
Bernanke quickly moved on to another question before any reporter asked for further clarification. Not one reporter (save perhaps the one from The Economist who asked the question) in the room seemed to grasp the immense meaning of this remark–or at least they did not wish to pursue it. The big question in my mind became, what are these “other kinds of steps?”
In short, without boring you dear reader, the implications of the extension of Operation Twist leads me to draw the following conclusions, and not necessarily in this order, but rather as random thoughts that rush into my mind…
1) The Fed intends to keep short-term interest rates near zero until at least year 2016. Up to now, the Fed has explicitly said that short-term rates will remain near zero until late 2014, and in one of my previous blogs, I spelled out the real reaons why the Fed had made this unprecedented announcement to keep interest rates low to a future target date many months off. Yet, as the Wall Street Journal points out, the Fed’s balance sheet will not have any sizable maturing assets until January 2016 due to all the longer-date maturities it will have on its balance sheet. So, how can the Fed begin to raise short term interest rates if it will have no short term paper to sell? Indeed, Mr. Bernanke admitted in the June 20th press conference that “large asset purchases increase the size of the balance sheet…and makes an exit a more extended process.” Therefore, in translating this Fed-speak, I predict that before too long, Bernanke will announce that short term interest rates will be kept low through for at least another year beyond the previous target (well into year 2015 and possibly into early 2016). The reason will be that the Fed will be trapped in a corner with virtually no ammunition to fight rising interest rates before then –but the Fed will not give this as an official reason as it would cause panic in the markets. Instead, the excuse will be blamed on a continuously weak economy.
2) OK, so if the Fed has no short term paper to sell, should it need to raise interest rates sooner, it will have only one real option: it could sell the long-dated paper on its books. The problem with this strategy is very dangerous for two reasons: first, the selling of long-dated maturities would force up the cost of mortgages and capital loans to businesses, thus choking the economy as well as possibly fueling more inflation (as long bonds with rising interest rates are usually the barometer for higher inflation) and this would do little to stop the fuel of inflation which requires interest rates to rise on shorter-term paper. Additionally, if the Fed sells any meaningful amounts of this long-dated paper, it basically exposes itself to mark-to-market values for those bonds, thus exposing the Fed to insolvency since the Fed has little capital on its balance sheet compared to the debt it holds. What would the world think of an insolvent central bank that stands behind the world’s main reserve currency? The answer to this question would not have a pretty result, I fear.
3) In the same Wall Street Journal story, the reporter said that the Fed could always print more money
to work its way out of a corner–this raised my eyebrows, since printing more money is inflationary to the economy. Sure, if the economy remains weak and deflationary forces remain, then printing money (quantitative easing) is certainly a tool that remains for the Fed. However, in a scenario where the Fed confronts future inflation, money printing would not be an option. There is also the basic mechanical problem to consider, which is the Fed would have no short term paper to sell back into the market which would force up short term interest rates and thus slow inflation, as one of Bernanke’s predecessors (Paul Volcker) did so brilliantly in 1980 during a very inflationary time in the US.
So, here I harp again, but I foresee this Fed strategy as quite risky in the long run for our economy. As I have elaborated before, China is doing just the opposite of the Fed, in that it is trading its longer-dated US maturities for our short term paper. In other words, as the Fed sells the short term debt, China is most likely one of the biggest buyers of this debt. At the same time, we know from the Fed’s own published reports, that foreign buyers appear to be buying less of our longer-dated debt in the past year; while the Fed is the largest de facto buyer of this type of debt which foreign buyers seem to want less of.
In that same Wall Street Journal edition of June 21st, another report indicated that China was preparing to open up its markets more to foreign investment (including its stock market) as it works toward making its currency one of the global reserve currencies (currently the US dollar and the Euro are the two main world reserve currencies). China intends to create a liquid bond market in Chinese sovereign bonds and its stock markets. In other words, China is working in a very obvious way to position its yuan to assume the role of reserve currency for the world by year 2020, I believe, if not sooner.
If the Fed is boxed in a corner should inflationary pressures build before 2016, it will have no bullets to fight inflation. Should the Fed attempt to sell its long-dated paper in an attempt to absorb some demand from the economy, then that would choke off certain parts of the economy while also exposing the Fed to insolvency. This would put China in the cat-bird’s seat as it would create a new flight to safety toward Chinese bonds and other investments should its markets be at least partially developed by such time.
There would also be a flight to quality, in my opinion. That flight to quality would be to the world’s one asset currency….gold (and it’s sister currency, silver). In this scenario, I can foresee gold doubling or even tripling from today’s price near $1,560 an ounce.
The Fed chairman has remarked many times that his strategy with Operation Twist as well as Quantitative Easing is an experimental one. Indeed, all past leaders of the Fed followed a much more conservative strategy of owning mostly short term treasuries and some short term high-grade corporate debt. No Fed, except this one, has chosen to experiment in such a way with long term debt and with debt of questionable quality (mortgage-backed securities as example).
The one thing that strikes me the most is that the financial media and our leaders in Washington seem to not understand what a grand experiment this has all been….and I fear, this is one experiment that should have been tested more in the laboratory of our economic schools before being unleashed into the real economy. If a chemist took his experiment out of the lab before seeing the potential results, would that chemist not cause great trouble for his community?
Perhaps things will all work out and my fears are overblown? I’m sure many who read this blog will think so. Well, there would be one easy way out for the Fed…if the economy were to truly remain weak until year 2016 and the velocity of money remain weak too, then the Fed might possibly be able to get out of the fix it is already into. If this is to be the result, then is all of this talk about monetary stimulus just a lot of noise and a waste of time and resources?
Now I begin to understand how we may be repeating the lost two decades that Japan has experienced…is not the safest and best solution for the Fed to see us going down the same road as Japan has done? Sadly, a zombie economy for years to come may be the safest solution.
Computers gone wild!
tonight’s action in gold is an example of how the computers can FLASH
CRASH any commodity, any bond or any stock at any given time.
far as I can tell, it’s all because the Bernank kinda said he doesn’t
have any QE3 plans right now….that’s why I sold my HL as quick as I
could, but I did not have time to unload my PPP before the market
closed–I was away from the office and could only make one trade on my
smartphone app before the close (DRD I sold a couple days ago for a nice
CEF I never sell….always hold that one.
I think it’s temporary….reading thru Jim Rickard’s work with Currency
Wars….he is an esteemed economist who values gold somewhere between
$3400 and $12,000 based on what monetary base is used (M1 and M2 as
examples) and what percentage base is in gold once the dollar returns to
the Gold Standard.
We are not anywhere near those TRUE
Valuations…again, this is only a “talk it down” game by the
Bernank….and he is a master of talking things down or up everytime his
lips move….between him and CNBS, all they ever have to do is say
something that scares markets….no one ever actually does anything any
more…it’s all come down to innuendo!
BUT DON’T BE SWAYED BY
SHORT-TERM manipulations….on the other hand, if one is only trading
some PM stocks, then wise to grab some profits when possible….that’s
one reason I instantly sold HL earlier today once I heard the Bernank’s
Actually, Gold’s price has already rallied back $30 from its low of the evening! Ahhhh, you gotta love them computers!
On August 6th, I first wrote about the Federal Reseve’s (the “FED”) future plans with a strategy known as “Operation Twist.” Since the time I first wrote about it, the strategy has become more widely known as the financial news media has promoted the idea forward.
In short, the strategy is intended to lower long term bond rates while mildly lifting shorter term note rates–in essence, the Fed would redeem money from shorter term notes and re-invest them into longer term bonds and notes (mostly 10 and 30 year yields). With this strategy, the FED can keep rates low for homeowners who want to re-finance their homes or for new home buyers which would help to lift the depressed housing industry in this country. Also, lower longer term rates would be attractive to businesses that wish to expand which in turn would help to improve the job hiring picture for Americans. Moreover, the strategy would be acceptable to those who reject the Keynsian approach of Ben Bernanke to solving the economic troubles of this country, because the FED would not be buying any additional treasuries…but rather would be simply trading shorter term duration paper for longer date ones.
All in all, this seems like a good strategy, given that the FED is now constrained by opposing political forces which do not want to see it expanding its balance sheet any further…and yet it gives the FED another tool to apply to its ailing patient, the American economy. At the same time, the FED realizes that the Fiscal Policy of this nation is in poor shape, as witnessed by the inability of Congress to come to any agreements on how the future budgets of the Federal Government should appear…and on the inability of a president to get compromise from either party…and on a presidential administration that continues to sue, counter-sue and put more regulations on anything and everything that is business. Washington is essentially in gridlock…and businesses are so unsure of the future that they are not hiring. The August Jobs Report came in at virtually zero jobs added…a very poor result in the year before a presidential election and the 3rd year of recovery from a bad recession.
So, Operation Twist appears to be the best band-aid among the few that the FED can apply without too many repercussions at this time. However, as I have continued to weigh the strategy and its potential effects, it has become apparent to the FED that inflation is on the rise, even in the government’s official reports. (Many consumers already knew inflation was on the rise…but the Fed was in denial about this, at least officially.) With rising inflation, including Bernanke’s prized measure, the core inflation rate, the effects of Operation Twist could take on a more macabre aspect.
Consider the following: with inflation rising, one would expect the longer dated treasuries (10s and 30s) to be rising in yield. However, if the FED begins to buy the longer dated treasuries, it in effect is creating an artificial rate that hides the true result of inflation. Is this partly why Operation Twist is apparently the FED’s next move? If inflation is rising, the FED may be thinking it can buy time for the economy by keeping longer term rates low, which keeps the housing market and long term corporate expansion supported (as feeble as it may seem). This is all well and good for the average American, but…
What will be the reaction of the bond market investors? If they know that inflation is rising, and yet the long bonds are not reflecting the proper yield, does this scare them away? And does this leave the FED to be the only buyer in town?
If inflation should continue to escalate in this country, and the long end of the bond market is artificially induced to be at a lower yield, does this set up the currency traders to take out their punishments on the US dollar? This is a key question in my mind. The beleaguered dollar has already suffered much…
Yet in theory, when the shorter maturities yields rise (as Operation Twist intends), this should strengthen the US dollar. Most currencies trade day to day based on short term interest rates…at least this is what is taught in beginning macro-economics courses. Yet, in this topsy-turvy world we live in these days, nothing is as it should seem. If the long bonds are being ignored by the bond market (particularly foreign investors like China) because the rates are artificially too low, does this set up a crushing blow to the dollar? You see, when our money goes overseas to buy products from places like China, Korea and and the OPEC nations, we count on some of it to get reinvested at least into our debt paper here as it has been for the past many years. But what if the foreign bond buyers decide that they have had enough of the Fed’s tricks?
…And will the dollar shorts seize on this disparity and induce more selling of US dollars? One can already see some effects in the markets…indirect bids on some US treasury auctions have dropped of late…meanwhile, gold continues to rise to new highs….sometimes violently! Indeed, gold is the one currency that no country can print at will. As the Swiss recently announced they will be printing more money to keep the value of their currency in check (and why I took profits on FXF near its all-time high–see my earllier posts), gold has now become the only currency that does not get printed…it is the only “true” currency left. And what of the dollar itself…even as many fearful investors have flocked to US treasuries of recent in a “risk off” world, why is it that the US dollar has not strengthened by much? Even against the Euro currency where money has fled the banking system over there, the widely anticipated rise of the Dollar against the Euro has not appeared. Why is that?
So, if the US dollar gets punished over a strategy like Twist, does this in turn induce imported inflation for Americans. Considering that the balance of trade is such that many products we buy come from overseas, it would seem that American citizens would be the scapegoat (once again!)…savers would be hurt. Consumers of everyday products and foodstuffs might suffer. Only those who have failed to control their spending–those with large mortgages might find some peace with this plan. Yet, the average American will be left out on the street corner as his/her own situation is eroded by runaway inflation caused by a falling dollar–possibly?
Also, Operation Twist, at least to this non-credentialed (in economics that is*) observer, is somewhat contradictory of the most recent FED strategy, which was Bernanke’s announcement to keep the discount rate at near 0% until the middle of year 2013. The contradiction is that he will allow the shorter term Treasury notes’ interest rates to rise a bit…and so what you would have would be a yield curve that starts at zero (discount rate on overnight loans to banks), then rises on the 3 month, 6 month, 1 year and 2 year paper….then perhaps flattens out a bit in the middle of the curve, then rises again toward longer dated ones…but the longer dated end of the yield curve would still be lower than it is today, especially the 30 year bonds. So, you would have banks borrowing at 0%, and able to loan out their money at higher rates, even to short term borrowers. Longer term buyers would have somewhat lower borrowing rates than today.
However, the bond investors would see that they are getting paid less on the longer term paper, even as inflation rises. This contradiction, it would seem, would cause bond buyers to look elsewhere for investments…and leave the FED to buying more longer dated paper that is not really valued correctly.
Indeed, this raises another question, (and is probably a blog for another day), as this subject is no
t relevant to this discussion…but if the FED is to buy a lot more long dated treasuries at artificially contrived (lower) rates, what happens to the FED’s balance sheet when it must sell some of this paper later? Or does the FED believe that it can hold this longer dated paper until expiration and not face the headwinds of rising inflation and a bond market that might later refuse to buy back these bonds except at much higher rates?
Operation Twist could prove to be a serious mistake for the Fed as it could load its balance sheet with greater average duration. Should inflation take hold and force up interest rates, it could cause large losses on the Fed’s balance sheet. In turn, this leaves the Fed in a position where it could not sell off assets to dampen monetary growth in an inflationary environment, thus rendering itself incapable of controlling a rampant inflation. Couple this with dollar weakness as I mentioned earlier, and one can envision a recipe for disaster!
I think this is an important issue that is not being widely addressed or even understood by most of the public, including the so-called experts; but the implications could be profound for all Americans and the world. The problem for the Federal Reserve is that every time it tries to fix a problem, it creates new problems which in turn bring this country’s finances…and its currency, closer to the brink of Armageddon.
* I do not hold any degrees in economics, but I was always a star student in high school and college economics courses. Indeed, if I could start my life over, I believe I would have pursued a degree in the dismal science. However, I do hold a bachelor’s and a master’s degree in business disciplines and have been a mid-level executive in business for a number of years.
The TED Spread is definitely telling us things are not all right with
the banks and financials…last week’s rally was likely a short cover
event and somewhat of a smoke screen to steer investors’ attention away
from what is going on in Europe.
The TED SPREAD ($TED) or sometimes affectionately called ‘the TEDDIE’
tracks the yield spread between the historically ‘safe’ 3 month US
Treasury Note and the 3 month LIBOR Rate, which is the European base
lending rate for banks overseas. Generally, when the spread is low,
stock markets tend to perform well.In 2008, the Teddie rose dramatically
which foretold of a significant and damaging credit even which
eventually came to pass. Now the spread is widening again, and though
not anywhere as high as 2008’s eventual highs, the breakout is
significant as a warning shot for risk on markets.
Stocks and ETFs to watch in the coming days and could be prominently
affected by the TED Spread include SPY, SDS, SSO, FAZ, FAS, GLD, CEF,
FXF as well as any other stocks/ETFs that relate to financials and/or
Look, the German DAX was falling like a
rock last week…the German stocks are usually the Rock of
Gibralter…for their market to plummet like it did is definitely a
warning shot to the world…
And the TED SPREAD
keeps racheting higher each day and its already in bearish territory
(bearish for stocks that is)…it appears that capital is fleeing the
European banks…of all stripes and colors…and this goes a long way
toward explaining why US Treasuries are near record low rates…a lot of
that European bank money is hiding in Treasuries right now….and Gold.
last week, we saw how the “authorities” tried to destroy the demand for
gold by once again lifting margin requirements and suggesting that the
FED was about to unleash Operation Twist (to some extent, I was duped by
this notion too–but I was only reacting to what I saw that the quants
were preparing for….I still do think Operation Twist might be started
up after the Fed’s mid-September meeting)…
We have this great threat of our free capital markets becoming unglued once again (as in 2008)…but at the same time, there are incredible bargains out there in stock land right now…I find it difficult to be both bullish and bearish at the same time…I am slowly snapping up great companies (especially the good dividend payors) while also concerned that in the near term, I could suffer more losses….so I also keep hedged.
Currently, I am hedged with SKF…an ultra short ETF on the financials…as we wait to see what is going to happen to the European banks and the spillover that might have on us here.
Finally, in closing this discussion tonight, I can see that my suspicions are confirmed by quite an expert in these matters, and so I leave you with this link…
A white paper released by the San Francisco Fed in April regarding a Quantitative Easing strategy used back in 1961 by the JFK administration is making the rounds of some pro traders and institutions. The gist of the white paper is that the FEDERAL RESERVE would buy longer dated treasuries rather than shorter ones. The idea is to stimulate long term borrowing needs of businesses and home buyers (through mortgages).
The lack of stimulus to short term treasuries might slow down the carry-trade which also stimulates the risk on trades such as gold and commodities. This past week, we witnessed a sharp drop in longer dated Treasuries and we also saw gold and other commodities including oil take a hard spike downward as the short end of the yield curve began to rise some. When the short end of the curve rises, that gives strength to the US $ relative to other currencies.
During the middle of this past week, I saw the downturn in OIL coming on my momentum charts, and I quickly bought some calls on DUG (an ETF that double-shorts oil) and I realized 200% gains in only 24 hours. However, I wasn’t as quick to catch the reversal in gold, and I got caught with some losses on some gold plays that I had set up only a couple days earlier.
Indeed, though the charts helped me to spot these big moves in the markets this past week (including the big downturn in equities which I called “a major sell” on Monday, August 1 prior to the 800 pt drubbing in the Dow for the week), what I did not understand was why these events happened as they did.
Now, it becomes a little more clear to me that at least some explanation for these dramatic changes can be placed on the possible circulating discussion on a QE3 strategy with resemblences to a 1960s strategy known as “Operation Twist.” Such a strategy would be designed to strengthen the US dollar, at least in nominal terms, lower imported inflationary costs of commodities and imports, and stimulate growth in long term business strategies. The actions of the markets this week seem to dove-tail very closely with the strategies as mentioned in this white paper. Yet, though no such strategy has been formally announced, we should know that the markets often anticipate the moves of the Fed or other agencies ahead of the time. As I have said, this white paper was apparently on the lips of some traders at the big houses this past week–they apparently placed their bets early before the FED should make such an announcement, which could occur at their annual Jackson Hole meeting later this month?
It’s also a curious thing to me how this discussion of possible Operation Twist strategy suddenly occurs as the S&P ratings agency has downgraded US debt from its pristine AAA status. Could it be that the FED plans to deploy this strategy soon to allay the concerns of bond holders of US debt?
…And could such a strategy derail the efforts of speculative traders who have been anticipating another downward spiral in the US $ which should feed the risk on trades? Only time will tell, but I see that I may need to better fine-tune my strategies on a weaker dollar…I will be paying close attention to the movements of the US $ and commodities, including gold, in the coming days and weeks.
My most recent momentum charts switched suddenly to weakness in gold and oil and to dollar strength about the middle of this past week…let’s see if the momentum shift continues?
If it should continue, it goes to point out one thing I continue to believe, and that is the shrewd strategies of Ben Bernanke and his Federal Reserve strategists, who have done more than any other organization on the surface of the Earth to keep us from falling into a world-wide depression these past few years. Though their efforts and strategies are reviled and repudiated by many, we should understand that Bernanke is a scholar of the Great Depression, and his moves and counter-moves are designed to keep us from falling into the abyss once again.
Only time will tell….!
Tick-tock…tick-tock…goes the countdown clock toward the August 2nd date when the US Treasury has said it will no longer have enough money to pay all of its bills on time. The raising of the Debt Ceiling for the US government is the issue at hand…and now, suddenly it’s becoming front page news.
For many weeks, I have warned that we would be coming up on that date with financial Armageddon without any political resolution…I encouraged investors to consider moving at least a portion of their Cash Sweep Accounts or any of their money invested in CDs, savings accounts, money market funds and bond funds and move those funds into foreign-based investments including Swiss Francs (the ETF symbol is FXF), the Australian dollar (symbol FXA)* or gold/silver bullion (my favored fund is under Amex symbol CEF and secondarily into ASA or GLD, though I have some reservations about GLD).
I have had people tell me I have lost my sense of direction in the markets….others have called me “a goof” and have said that it will never happen! The US will never default on its loan obligations…and they have told me that the US dollar is not about to lose its reserve currency status for at least another generation.
Some investors (and “enlightened experts”) have told me that if there were any trouble with the US suffering a technical default on its bonds, we would be seeing rising yields and a rush out of bonds…they point to actions that are just the opposite…bond yields have fallen in recent weeks and bond prices have risen to 2 year highs. They proudly proclaim that “the smart money” is not running in fear of US Treasuries, but rather, its embracing them.
Their argument is a good one! ..and up until now, except for some substantial gains I have experienced in some gold trades in recent days and some decent return on my sizable, but “temporary cash sweep account” investments in FXF and FXA, since starting a buy program in both several weeks ago…the so-called experts have been right. Financial armageddon has not occurred in the US…and those bond yields are historically very low.
Indeed, there has been talk swirling about, mostly from the conservative “tea party” side of politics that a technical default by the US would be “a minor event”…and that such an event might make for a great tactical weapon in forcing the hand of the Democrats and Obama to give in on spending cuts in a more meaningful way. Such speculation, trumpeted by Congressman Paul Ryan and encouraged by the likes of Representative Cantor and many other tea party supporters, puts forth the notion that a technical default by the US would be only temporary and would do more good in flushing out the same old game of spend, spend, spend by the Democrats.
…at least this is the notion being bounced around!…and as the pollsters have demonstrated, the idea of a forced technical default has the support of the majority of American citizens.
Indeed, the citizens reason, why should the government be allowed to spend beyond its means and act like a drunken sailor with a credit card, when the rest of us are held in check with our own household debts and expectations of maintaining some semblance of money management?
What the public doesn’t quite seem to grasp is that “high finance” of the likes run by our Federal government is not one that can operate well under the same rules of finance that apply to individual households….moreover, what particularly perturbs me is that many of our elected officials in Washington (read “Tea Party”) are also operating under the same notion that a balanced budget must be forced upon our government…and that the only way to cure the economy’s ills is to drastically cut spending.
It is the naive understanding of the general public…and the equally naive thinking of some members of Congress that makes for a particularly scary situation that we face as the August 2nd deadline approaches.
To you, dear reader, do you understand what a technical default might mean for the US’s standing in the world? Do you, dear reader, understand that a default could have very serious consequences for every American? Every man, woman and child in this fair land of ours? Do you know that 97% of money market funds in this country are invested in US treasuries? Why? Because they are supposed to be as safe as grandma and applie pie!
Unfortunately, I have only limited space to say all that needs to be said on this subject…but I can summarize matters by refuting some of major points of the Tea Party leaders and their crowd and of the so-called experts of high finance who say that there is no worry in the markets about a technical default….so without further ado, let me try to explain the flip-side argument to each of their points:
1. “It will never happen! The US will never default. They will come to some kind of agreement.”
Re-tort: This is all I have heard for many weeks, yet here we are only days away from a technical default and neither side seems ready to give in to the other side. I have already won this argument…those who questioned this warning of mine with such “vim and vinegar“, go ahead and eat your hats!
2. “It’s just political posturing…okay, maybe this thing goes down to the wire, but one side or both sides will eventually cave into demands…and the debt ceiling will be raised for the time being.”
Re-tort: Oh??? Okay, though that hasn’t happened up until now and both sides still seem far apart, let’s just assume that they do extend the debt ceiling by August 2. Do you think the problem will be swept under the rug? Let’s face it, if an extension of the debt ceiling is granted, it will probably be viewed as a band-aid and a further kick of the proverbial can down the road…if so, do we face the stark reality of the ratings agencies like S&P, Moody’s and Fitch down-grading the US debt anyway? And if and when our AAA credit rating is lost, how much will interest rates rise in this country?…that will be like a burdensome new tax on the citizens of this country!…and unlike a Washington imposed tax, most of this tax will be sent to our creditors overseas! Interest rates will rise on mortgages, credit cards, car loans, etc!…Americans will encounter a whole new series of cost increases in an economy that is anything but robust as it is…. And what about the many states in our union and their own credit ratings which are backed by the US AAA rating?…and what about our financial institutions that rely on a AAA sovereign debt rating of the US government? Banks, insurance companies and many pension funds are heavily invested in US treasury paper.
3. “Oh, so what if the ratings agencies say our debt is down-graded a notch? This has happened before to many sovereign nations, and little damage has been done in most cases.”
Re-tort: But this isn’t just any nation defaulting…this is the largest government economy on the face of the earth that would default!
Do you accept there is a law of gravity? If yes, then you should know there is a financial law of sorts that says that the US treasuries are the safest place to invest one’s money on the face of the earth. US bonds are supposed to be like the sun rising every morning! Like the law of gravity! They are “there.” They are dependable…always!
BUT, with a technical default, it would be like Dorothy discovering that the Land of Oz is ruled not by a great wizard, but rather by a droll little man hiding behind a curtain! The let-down would cast a funky spell over our creditors…and destroy the faith of investors worldwide!
4. “The so-called financial experts from top think tanks in Washington to the veteran hands on Wall Street point to the fact that the yields on US treasuries have held steady, and even dropped in recent days as if to say that the bond market does not view the US Debt Ceiling debate as a threat
Re-tort: OK, they seem to make a good point…but wait, one major reason the US treasuries have gone up in price (and yields have dropped) has to do with the equally bad credit situation in the sovereign nations of Europe. So, scared money has to go some place…and I believe a lot of that scared money doesn’t really know WHERE to go? …so, like Pavlov’s dogs, that scared money does what it has learned to do in the past…seek the safety of US treasuries…they’re still safe, right?
BUT, this specious argument misses some key warning signs…for one, the US dollar has continued to erode against the Euro…if Europe is in such dire straits compared to the US, then why is the Euro at near historical highs against the dollar?
And why is the Australian dollar at such strong position against the US dollar? Could it be that the Australian dollar of a country with vast natural resources is viewed as a proxy for China’s vibrant economy? (Conversely, notice that the Canadian dollar–sourced from another vast resource-rich country– is much weaker than the Aussie dollar, because Canada’s major trading partner is the US!)…and as manipulated as the bond market has been in the US the last couple years, can we really count on the bond market to tell us that everything is going to be all right? I think the bond bulls are missing the signals coming from the currency markets! If all is right with the US economy and our sovereign debt, then the US dollar should be strengthening against other currencies, especially the euro…but this is not what we see!
5. “Look, if the technical default causes a freeze up of credit or in some way causes money markets and bond funds to lose value, the FED will step in to provide liquidity…just like they did in September of 2008!”
Re-tort: This argument is a favorite of the economic experts from the finest think tanks and universities across our land–that somehow, if things spiral out of control, the man who saved the economy once before, Ben Bernanke, will show up on his white horse again–ready and willing “to prime the pumps” with lots of liquidity! Of course, liquidity is a nice little word for saying that the Fed president will be printing lots of money…and we all know that the US debt is backed by the full faith and credit of the Federal Reserve.
However, just like the US treasuries are now being called into question as AAA paper by some ratings agencies, what leads us to believe that the rest of the world will still accept the Fed as the only financier in town? What is that the FED owns that gives it it’s special powers?
If I may borrow that Land of Oz analogy again, what happens when our largest foreign creditor, China, pulls back the curtain on Ben Bernanke? What will it find?
Loads and loads of debt paper is what it would find…money that is owed by our US treasury to the Fed…money that could be called in as “due all at once because of a technical default”…well, does our Treasury have $14.3 trillion laying around that it can pay off this debt all at once? Not unless the Fed prints off that much…and what would China, Japan, and Russia, three of our largest creditors say to that?
Also, consider the largest holder of US treasuries is not any foreigner at all, but our own Federal Reserve…and the Fed also owns lots of damaged mortgage paper that it has accumulated the past couple years to try and stop the hemmoraghing of our banks, pension funds and financial
institutions…what will the world think if it begins to question its faith in a central bank that owns nothing but debt paper, most of it US debt that can’t be paid back overnight or even 20 years from now…which goes to point up the fact that the FED draws its power and strength from the world’s faith in it as the depository for the world’s reserve currency.
But what if that faith is suddenly shaken as the curtain is drawn back on the Fed’s pile of debts?
Could China play its trump card in year 2011? I never thought that such a moment could come so soon!…but it is China that holds a very strong, positive balance of trade…it is China’s government and its citizens who own so much gold…and have few debts (though there are surely some debt-ridden banks in China, the aggregate debt situation of these banks pales in comparison to our overall debt exposure in the US)…
It is China that has a burgeoning military that already threatens the US dominance of the Pacific rim nations…it is China that is owed so much money from the US (and other creditor nations too)…and if the US defaults on its debts, China has the wherewithal to “write off these debts” and still have a much better financial position than that of the US once a technical default happens.
Which all goes to point out how critical it is that the US government at least reach some sort of temporary extension of the Debt Ceiling in the next few days…otherwise, I can guarantee you that things will not be pretty here in the US.
Again, the argument goes that the Congress and the President would not be so dumb to let our government default on its debt–but I believe that there are roughly 80 to 100 members of Congress who don’t understand how world economics works…and I worry that our own president does not fully understand the situation at hand either, though I am sure his advisors have warned him.
Those who up to now have ignored my calls of seeking safety in foreign currencies, foreign bonds (or bond funds) or in gold and silver, I say, you may be the ones left standing on a street corner in the proverbial barrel on suspenders… but I hope not, dear reader!
I hope I am wrong about this bad feeling I have…I hope for once that the majority is right…and I am wrong…for if I am way off base, I think I will still have money left when I bail out of the Swiss Franc ETF and the gold bullion funds…and you can say “I told you so.” Yes, I would welcome hearing that once...to know that the American Dream is still intact?…rather than being on the precipice of a 21st century dark age where the ruling countries of the world will be led by communist leaders. I cannot fathom a world led by such a ruling class…for the future of our children and grandchildren!
*post-script 7/23/11: Some currency traders I have listened to recently suggest that the Aussie dollar will fall rapidly on a US debt default or downgrade. My reasoning for including the Aussie $ in this protective move has to do with its trade connection to China. In other words, in a worse case scenario, my thinking has been that money would seek safety in Asian assets, which the Aussie $ is the only “western” currency that is closely intertwined with China and Asian trade. The currency experts speak of a Aussie short against the Swiss Franc, but curiously they do not mention a US $ short against either. Keep in mind that FXA (and FXF) are currency ETFs that are priced in US dollars, and so they are a play on the US dollar against the Franc and Aussie buck. This being duly noted, and the fact that I am not a currency expert, only speaks of how much uncertainty there is out there for the right protective strategy. However, if enough currency traders are of the opinion that the Aussie $ might collapse, I would suggest lightening the investment in FXA and staying more to gold and FXF.