John Taylor Explains What Will Happen When The Chairman Removes $125 Billion In Free Monthly Liquidity, And Hikes Rates

Tyler Durden's picture

With many once again believing that a rate hike is just around the corner (as has been the case for the past 2 years... the same with expectations that NFPs will finally push higher any month now), here is a reminder of what happened the last time there was a concerted effort by the Fed to contract liquidity. And this is just hiking rates. Never before has the US stock market had to ween itself off $125 billion in QE-related monthly liquidity. All in all, no matter how long Bernanke tries to delay the end of QE2, the outcome will become a self-fulfilling prophecy which will slam stocks, and by the Chairman's definition, the economy, making a QE3 episode inevitable (not to mention the $2 trillion in debt each year that has to be monetized). We are on the same side of the Peter Shiff bet who has given Steve Liesman 5 to 1 odds for $10,000 that QE3 is imminent.

A Strong US Economy
February 10, 2011
By John R. Taylor, Jr. Chief Investment Officer

When it comes to the US economic outlook, we seem to be among the most pessimistic out there as our more optimistic view sees a staircase decline, with the picture deteriorating each quarter: 4%, 3%, 2%, and 1%. We are feeling a bit sheepish as last summer we had called for the economy to go into recession during this quarter. Although that was before Jackson Hole and the deal that Obama crafted with the Republicans in December, we didn't envision those further stimuli and we should have. Somewhat stubbornly, we still see these fiscal and monetary boosts losing their power as the first half comes to an end and doubt that the US consumer, capital spending or trade can pick up where Washington lets off. Those who told us that one should never bet against the US consumer have been right so far; and as credit card debt expanded in December for the first time in two years, we can see they could be right all year. The credit market seems to be sensing the same thing as it is now projecting the first Fed hike in December, with the second one next March. Our credit market cycles call for yields to rise for another few weeks and possibly into late April. If long-rates really move up, the date of the first Fed hike could get much closer.

But what happens if the Fed hikes rates? Even with a tiny hike, the good times are over. Higher short- term rates do not mean that the economy turns down — in fact, it could have a positive impact — but it will mightily disrupt the credit markets and asset markets. Just look at what happened in February 1994, when the Fed first hiked rates after the 1991 recession, several years after the economy was back on its feet. It's hard to remember how scared the US authorities were when faced with the saving and loan crises and with the lack of economic response when they dropped overnight funds from over 9% to 3%. With rates at these rock bottom levels, the Asian tigers roared and Eastern Europe and Russia were given the breathing space to become capitalist economies. This was a thrilling time to own emerging market equities, but this was not true after February 1994— and they did not bottom until the 2001 to 2003 period. Although we think of the 1990's as great equity years, stocks were down almost everywhere and in some cases dramatically in the 6 to 9 months after the February surprise. The government bond market was a total shambles and portfolios suffered their worst year since Volker had taken control in 1979. Currencies went every which-way, but those that had a need for offshore capital were crushed as inflows quickly became outflows. Several weeks after the rate hike Mexico began its slide into the currency collapse in December, and the old Communist countries saw their currencies go into a long decline, which in some cases culminated in the 1998 crisis. With the sharp reversal in liquidity, 1994 burst a lot of hopeful balloons and was a terrible year for asset managers.

With average developed market overnight rates significantly below the 1% level, a Fed hike would be a splash of very cold water, much colder than that of 17 years ago. The results should be more dramatic now. It seems clear that all equity markets in all countries will be moving lower, with those in the emerging countries faring the worst. Government markets should be moving lower, but it looks to us as though they are already anticipating this move so the shock should be much less here than in the equity markets. Countries with current account problems could be the biggest currency losers: Turkey, Australia, New Zealand, South Africa, and (of course) the US, come to mind. Last time around Mexico was the biggest loser, but Turkey dropped in half in two months. Despite all this market activity, if things are the same, it will have minimal impact on the real economy. Wall Street will be punished and the US heartland will cheer. The political fallout should be interesting.

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Alcoholic Native American's picture

"The credit market seems to be sensing the same thing as it is now projecting the first Fed hike in December, with the second one next March."


Emm, they have been saying this for a while.

Obaminator's picture

Actually the 2011 December FF funds future contract dropped in the past week, as did the March 2012. There is now a 0.25% difference between the October and December contracts, where previously it was about 0.1%

Seems insignificant, but last time the Futures contracts diverged, Fed Fund rates indeed changed almost exactly as predicted. in fact the first jump last time was 1 month early, so people buying options on the month before the tell-tale contract made out like bandits.

The Fed Reserve gives gifts like this on rare occation...take it. Just dont bet the farm on it.

Boilermaker's picture

Will the REITs finally fall 0.05%?

Alcoholic Native American's picture

The discount window should go negative and only let a select few die hard trickle down groups get access to it.  That way they can shit and piss all over us with the money you give them ben.

Boilermaker's picture

Oh shit, REITs just violently reversed (gasp) and are now heading straight up again....oh my.  Who would have thunk it?

43 Steelie's picture

Went to a dinner with Atlanta Fed President, Dennis Lockhart, last night:

Asked whether QE3 would include Munis, he said he didn't see it as a possibility. (So in other words Munis will probably be included in QE3)

Asked how he arrived at the magical $600 million number for QE2, he said it was the size his trading desk felt comfortable with and "wasn't too high and wasn't too low." (In other words, "I have no fucking idea, we polled the banks who said $500 million and just one upped them). 

snowball777's picture

You slipped 3 decimal places.

43 Steelie's picture

Haha, my mistake. I lost count after the first 8 zeros

Obaminator's picture

What does it matter...Were already using the 'T' word all the time...Million, Billion, Trillion...shit, whats the difference anymore.

I still get happy when I break out a benji bill and spend it on crap from china I dont need.

just fkn wit ya'all.

Soon enough Hundreds of Billions (you know, 10X more than LTCM $10B that 'almost blew up the world') will be replaced with "10T in new bonds were issued last year" and the average joe will be making $250K/yr and still only able to buy bud lite and drive a 10-yr old truck.

spartan117's picture

Raise rates?  Go ahead.  Let's see how our government pays the interest on existing debt.  Forget about what higher rates will do to this economy, and in turn, what it would mean for the annual fiscal deficits.

dark pools of soros's picture

just split the rates..  like us fools and 20% credit cards, the gov will just pay a set tiny rate forever but raise rates for everyone else


why play by any rules at all?



Obaminator's picture

Raising Fed Fund rates = Income for the Fed Reserve/Treasury, not an expense. Now, naturally that rate hike would cause the rates to be paid out n US T's to go up, an expense to the UST. But, the thing that happens is Existing outstanding UST's DROP Big-Time in Value...allowing the Fed and UST to Buy Outstanding Treasuries at a Discount..a big one. They Issue and sell a new $100M UST Bond with a high yield for more money than they buy the old Bond with low yield for, and they actually offset and can "make" money in the process. Anyone buying US Treasuries with more than a 2-yr maturity right now is insane! A 1% rise in yields will slaughter the value of the outstanding Treasuries...

Would you Buy an existing 5-yr $100K bond at 1.5% for face value when you can buy a Newly issued one yielding 2.5-3% ?

This is an age-old game, and they are very good at it. They have managed to devalue the dollar 95% (20 times) since 1930...dont believe me...$5 in 1930 buys you the same common-day staples, the same amount of gold, as $100 buys you today.

Raising rates is a stealth way of DEVALUING ALL Outstanding Debt...its genius! HAHA

Obaminator's picture

Now Imagine a raise in rates of say 2,3,...5...9% over the next 5 years.


AN0NYM0US's picture

Those who told us that one should never bet against the US consumer have been right so far; and as credit card debt expanded in December for the first time in two years, we can see they could be right all year.


malls are packed, roads are busy throughout the day, parking lots are full. One bellweather for me is the local Home Depot, which during the depths of the recession was dead with its parking lot never more than half full, today just the opposite.

reading's picture

Harry is that you with a bag over your head?

east paris trader's picture

I'm a part time trader, part time contractor.  In Lowes about four times a week.  Dead as a fucking door nail.... last Saturday morning the clerk told me I was the second customer of the morning --- at 10:15 (she opened at 7:00).

gorillaonyourback's picture

this guys sees one person in front of him with only one cash register open and thinks its game on again lolololol.  sry but its dead as a door nail like the guy before me said.

gorillaonyourback's picture

i really believe our goverment employs propaganda blogsters.  i remember years ago i sat clicking on politcal poll question on the internet trying my best to persuade puplic opinion, by clearing the cookies every time in clicked and there was someone on the otherside doing the same thing.  so when i see this crap by this guy and harry, and his (mini me) hamy. im sure there are thousands of people on the payrole to maintain the propaganda bullshit.

earnyermoney's picture

"Democrats" have Center for American Progress, Think Progress, etc. "Republicans"have the equivalent. Point is, both are really fascists looking to divide and conquer.

MayIMommaDogFace2theBananaPatch's picture

malls are packed, roads are busy throughout the day, parking lots are full.

In what part of the country are you hanging out?

QQQBall's picture

I do not see contractors rolling huge orders to the registers. In my area, Lowe's and HD are essentially 120,000 SF hardware stores. A few decks, roofing material, etc., but no real building. The sales people at Lowe's have become particularly helpful when i go looking for stuff- before it was like they were running away from you. I have been doing a couple of remodels for a year and I do not see that much activity at HD and Lowe's, although HD is typically busier of the two.


If it continues slow, Lowe's and HD will finally figure out that they are canibalizing themselves and each other. They site competing stores literally across the street from one another every 3 miles or so along the freeway. We do not need 250,000 SF of hardware stores 3 miles apart.


Next time you are in HD and Lowe's look at the reduced inventories. The shelves are "faced", but there is no stock behind it.

ebworthen's picture

Perceptual spending on credit, not real recovery.

Same as the stock market; pumped by QE and debt spending.

Perception is not reality, and it is perception that is being pumped up with more debt.

Sudden Debt's picture


crosey's picture

He did not bother with this stuff.  Left it to Caesar.  He was focused on more permanent priorities.

Sudden Debt's picture



Or his scam where he convinced the crowds that with 1 bread you could feed a crowd!






wolfsonite's picture

Scam? At least the crowd demanded REAL stuff and that's whe he gave them. And it seemed like there weren't any "kill the scamster" riots afterwards ... today's masses are perfectly fine to receive paper promises by Bernankenstein and the like. And I wouldn't be surpised it the mob eventually rises up against this very real scam.

MayIMommaDogFace2theBananaPatch's picture

Check out the Caesar story...You don't have to be a Christian to appreciate the message about money.

trav7777's picture

Paul Kruger is dead tho...guess I am just gonna hafta hang onto them for myself

snowball777's picture

"...none of them along the line, know what any of it is worth." - Bob

Only the old binties with alabastrons seem to really get it. ;)

naughtius maximus's picture

He'd punch everyone playing forex right in the kisser!

Boilermaker's picture

REITs are pulling some Jedi mind trick know, positive in the face of a broadly down market even after death-defying run ups...

That shit is RESILIENT!!

topcallingtroll's picture

Surely anybody that is.systemically risky is hedged for higher interest rates? Benny boy is walking a tightrope here, but rates must go up at some point. Someone must take the losses. I suspect ultimately it is the average saver and third world mercantilists who will take the hit.

arkady's picture

Does anyone here believe that we will actually a see rate hike within...let's say...3-6 months?  I have lost all hope that Bernanke will actually do the right thing and deliver the tough medicine given his fatal obsession with stopping the evil deflation.

RobotTrader's picture

Retailers barely selling off.

Banks barely selling off.

FXI has gone straight up off the lows.

No shorting for me yet.

Bay of Pigs's picture

So what's yout point? QE and POMO are going along as we speak.

And where's Billy Bastard who uses QE ending as his justification for gold going down? He ignores the treads like this that provide him with the answers.

Much like you Robot.

TruthInSunshine's picture


All that can't end well, won't end well. All that will end catastrophically, will.

JJSF's picture

They did it during the early 30's to extract the last bit of wealth from the last segment of the economy that was actually making a  Why would they not begin raising rates again to pull the same wealth transfer once again? That would be the final wealth transfer before ushering in the new "solution" which would inevitably more banker control of society, full police state etc..

JW n FL's picture

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RobotTrader's picture

Transports green.

Oil stocks green.

COF, SBUX, ANF, WFC all green.

Bears better stand back.

Bicycle Repairman's picture

This is what will happen when the FED raises rates.

Oh, and the FED isn't raising rates.

Nostradamus's picture

When did Schiff make this bet with Liesman? I want to see that clip.

gwar5's picture

If the Feds raises rates, commercial loans will go under like the housing market.

If announces QE to stop the stock market goes down hard.

Do you know where your money is? Do you know where your next meal is?


Printfaster's picture

The Fed has a tiger by the tail.

The moment that there is a hint of a stockmarket decline of any magnitude, the market will not stop.  The can try to put a bid under things, but there simply are too many stock issues to put a bid under, and the arbs and computers cannot react fast enough.  There would be a flash crash of supernova character, sucking everything into a black hole.

Basically, the fed cannot let go of the tiger, or it, the stock market and the economy will get eaten.

ghostfaceinvestah's picture

Never before has the US stock market had to ween itself off $125 billion in QE-related monthly liquidity.

Not exactly true.  Last spring, QE1 ended officially the end of March, though with MBS, trades settled through May, so the liquidity pump really ended in volume in April.

What happened to the equity markets?  SPX went from the 1200 range the end of April, to the 1050 range the beginning of June, before QE1-lite was announced.

Given that we are at higher SPX levels now, and we are monetizing more debt, if QE ends this time, we should see a monumental crash to rival 2000 and 2008

raya123's picture

Myth #1:  This market can't go down.

It can and it will.  Now, in fact.  Watch the euro, as they are joined at the hip and will be for several months.


Myth #2:  Gold will correct down with the S&P 500.

Not necessarily.  Gold has and may continue to trade inversely to the euro as a safe haven.  Exactly as it is doing right now.

Robslob's picture

It comes down to this...sell off in everything if there is ever any sell off...ever?