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In Preparation Of The Fed's Last Doubling Down: David Rosenberg Believes QE3 Will Be Nothing Short Of "Operation Twist 2"

Tyler Durden's picture




 

It is no secret that to a deflationist like David Rosenberg bond yields have to go lower... Much lower. With the 10 Year flirting with a 2 handle one would think he would be content. Alas no. In fact, as he suggests in his piece from today, Rosie is convinced that the next iteration of QE will be nothing short of a redux of the 1961 initiative to kill the then gold exodus known as "Operation Twist" (recently dissected by the San Fran Fed). Incidentally it was the same Fed that compared QE2 to Operation Twist. It is only logical that Rosie would then suggest that QE3 would be nothing short of a complete clearing of the 10 Year bond in the market via the Fed in order to anchor expectations that the 10 Year rate would never go up (or reasonably "never") in the biggest gamble of all: that the Fed will attempt to both control its balance sheet and target Long-Term interest rates, a mission doomed to fail...But not like that will prevent the Fed from setting off on such a mission, especially following today's official confirmation of the Housing Double Dip (someone page Jim Cramer). As Rosie says: "Now it is doubtful that the Fed would ever target the long bond. In fact, the Fed may even want it to be higher in yield to ease the pressure on radically underfunded pension funds. While the Fed can either target its balance sheet, which it has been doing with these QE measures, or target interest rates, it cannot do both at the same time. So the next 'QE' will not be called 'QE' but rather something else — maybe Operation Twist 2 (OT2 — you heard it here first). The Fed would buy up all the 10-year notes needed to clear the market at the target "price" (yield). So depending on supply conditions and demand from the private sector, the Fed would basically lose control of its balance sheet, but if in return this policy is the one that blazes the trail for a turnaround in the housing sector and a durable revival in the economy, so be it." And keeping in mind that the true unspoken reason for Operation Twist 1 was to terminate the outflow of gold from the US to foreign bank vaults, we find ourselves agreeing with Rosie that an insane idea such as OT2 is precisely what the Fed would do to avoid a recurrence of the 1961 gold exodus (and attempt to give housing one last failed boost). As many birds would be killed with one stone, the only downside, that of a complete balance sheet implosion following OT2, certainly seems quite acceptable to a central bank now officially run by sociopaths.

From Breakfast with Rosie:

Since just about everything that has to do with the economy is either directly or indirectly priced off the 10-year part of the curve, it stands to reason that this is the segment that matters most for the economy. The 10-year part of the curve is the oxygen tank for the market and macro backdrop, yet the Fed in its latest QE round centered its efforts more on the front- and mid- part of the curve.

There is little doubt that the housing market is suffering from a variety of obstacles, but what is clear from the consumer survey data is that households do not believe that interest rates will come down any further. The Fed can only do so much to deal with a de facto vacancy rate of 10% for the homeownership sector (double the norm) but every little bit helps at the margin and certainly it can do a much better job at influencing affordability levels to stimulate some demand growth.

People need to be convinced that once they make the decision to finance a purchase that they won't run into a period of rising rates that could impede their debt-servicing capabilities. This is where the Fed can play a role in influencing expectations and it is critical (this is particularly true for borrowers who are up for variable-terms mortgages).

Look, we know that: (i) Bernanke is a disciple of Milton Friedman, and (ii) one of Friedman's classic pieces of economic research pertained to the 'permanent income hypothesis', which postulated that it is changes that are deemed to be permanent, not temporary, that induce a permanent change in economic behavior. This is why the "permanent" Bush income tax cuts in 2000 worked so much better than the temporary rebates unveiled in early 2008.

Therefore, at the margin, in order to do even more to solve the ongoing depression in the housing market, which continues to pose as a dead-weight drag on the entire economy, it may well behoove the Fed in its next round of stimulus, whenever that may occur (but it will, just not at 1,330 on the S&P 500), to signal to the public its intent to take down and hold down the most critical interest rate of all for the mortgage market — and that is the 10-year note.

Don't think for a minute that this not being discussed — Bernanke talked about embarking on such a scheme, if necessary, when he was still governor back in 2002:

Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time — if it were credible — would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt ... Lower rates over the maturity spectrum of public and private securities should strengthen aggregate demand in the usual ways and thus help to end deflation. Of course, if operating in relatively short-dated Treasury debt proved insufficient, the Fed could also attempt to cap yields of Treasury securities at still longer maturities ... Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities. The most striking episode of bond- price pegging occurred during the years before the Federal Reserve-Treasury Accord of 1951. Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade.

Ben Bernanke, Deflation: Making Sure "It" Doesn't Happen Here, speech to the National Economists Club, Washington, D.C., November 21, 2002.

This was otherwise known as 'operation twist'. There is certainly nothing preventing the Fed from targeting the 10-year Treasury-note any more than the Fed funds rate. But the funds rate is already near zero and as such there is no incremental move there that can benefit the economy. But targeting the 10-year note in much the same fashion is probably worth a try and if there is anything else we know about Ben Bernanke. It is that...

(i) he will be late, not early. So, by the time this comes the economy may well be back in recession, which in balance sheet cycles tend to occur every three years, so mark 2012 down in your calendar;

(ii) he is willing to be very aggressive when the time comes — he has certainly proven that. Back in 2007 or 2008 for that matter, who believed that short rates were going to vanish entirely and that the Fed would be buying assets by early 2009?

Now it is doubtful that the Fed would ever target the long bond. In fact, the Fed may even want it to be higher in yield to ease the pressure on radically underfunded pension funds. While the Fed can either target its balance sheet, which it has been doing with these QE measures, or target interest rates, it cannot do both at the same time. So the next 'QE' will not be called 'QE' but rather something else — maybe Operation Twist 2 (072 — you heard it here first).

The Fed would buy up all the 10-year notes needed to clear the market at the target "price" (yield). So depending on supply conditions and demand from the private sector, the Fed would basically lose control of its balance sheet, but if in return this policy is the one that blazes the trail for a turnaround in the housing sector and a durable revival in the economy, so be it.

If the Fed were to be concerned about the impact that any further balance sheet expansion could have on the U.S. dollar, it could always nudge the short end of the Treasury curve up in support of the greenback (short-term spreads matter more in the FX market). By doing this, the Fed would also lend some much-needed support to the troubled money market fund industry (for more on this front, have a look at Low Rates Put Pressure on U.S. Money Markets Funds on page 13 of today's FT). So much can be accomplished with such a policy—the upside potential will be worth it.

However, politically, the Fed has to wait for the next downturn in economic activity and reversal in the stock market so that those on Capitol Hill that are lamenting the Fed's interventionist efforts end up begging for more. This could come sooner than you think, but likely not until we see the whites of the economy's eyes — and early signs are showing a visible sputtering in growth.

One last item to note. If, say, the 10-year note were to be capped at 2 1/2%, where it was at ahead of the QE2 program last fall, compared with the current 3%-plus level, the total return for a 10-year strip would come to over 10% in a 12-month span. Now put that in your pipe and smoke it!

 

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Tue, 05/31/2011 - 13:24 | 1325795 km4
km4's picture

As SPOOL wrote over at CR QE3 is not a substitute for a thriving economy, it is a simulacrumIt will have to suffice.

Yes of course otherwise the gig is up on 'Extend and Pretend' and 'Kicking the Can Down the Road'

 

Tue, 05/31/2011 - 13:29 | 1325802 SheepDog-One
SheepDog-One's picture

QE3 and debt ceiling raise is already priced in X-times into this market so it will make no difference. Its not exactly 2008 anymore and QE is 'no big deal' now, just an expected knee jerk.

Tue, 05/31/2011 - 13:26 | 1325803 mayhem_korner
mayhem_korner's picture

Housing market turnaround - YES! 

...I think he ordered hash browns for breakfast but got hashish.

Tue, 05/31/2011 - 13:40 | 1325851 SheepDog-One
SheepDog-One's picture

'Housing market turnaround' HA HA yea soon all the bankrupt and unemployed will be lining up for a NEW mortgage to get kornholed all over again! These billionaires make me laugh....hashish browns lol exactly.

Tue, 05/31/2011 - 13:31 | 1325809 camoes
camoes's picture

So should we short the 5 and 30 year bond and go long the 10 year to frontrun the Fed? How can I make money on this? GIMME GIMME!

http://www.youtube.com/watch?v=BR-6uG8HEmw

Tue, 05/31/2011 - 13:31 | 1325812 cswjr
cswjr's picture

Yay to "riding the yield curve" again... 60 years later.

Tue, 05/31/2011 - 13:32 | 1325813 Übermensch
Übermensch's picture

Humans are the only species who will follow an unstable pack leader.

Tue, 05/31/2011 - 13:33 | 1325821 oogs66
oogs66's picture

This makes sense.  Ben has followed through on his words before.  It might make it harder for people to fight as now there would be an arbitrary target for the yield, rather than an arbitrary target for the amount of money to be 'created'.  It would look like he really cares about rates, when his real goal is still to pump enough new money into the system that stocks go up.

Tue, 05/31/2011 - 13:37 | 1325825 SwingForce
SwingForce's picture

C'est impossible, your mind is playing games with you.  Only if you don't care about the RETURN of your principal- maybe you'll be dead, both figuratively & financially- would you play this game.

Tue, 05/31/2011 - 13:34 | 1325830 TooBearish
TooBearish's picture

Banks NIC will git crushed on this latest Rosie wish list - the FED would end up paying interest on close to 3 trillion in reserves?  How the fuk is this supposed to help?

I would prefer if the FED just gave up with the financial system and STARTED TO BUY REAL ESTATE OUTRIGHT, much like they have been in Spoos for the last 2 years!

Tue, 05/31/2011 - 13:38 | 1325834 RobotTrader
RobotTrader's picture

Tough to be bearish when REITs and XRT are pinned at 52-week highs showing no signs of weakness whatsoever.

No need to listen to all these "experts" who are wrong more than they are right, just follow the tape.  If the market is going to fail the tape will tell us several weeks in advance.

Tue, 05/31/2011 - 13:41 | 1325859 SheepDog-One
SheepDog-One's picture

Tough to be as huge of a douchebag as you but you pull it off pretty well.

Tue, 05/31/2011 - 13:50 | 1325863 SwingForce
SwingForce's picture

Right on, RoboTT baby. And don't forget XLP despite the bad press, it contains all the old Philip Morris siblings, and if reconstituted makes more than 24% if index, add SBMRY for Miller beer. Somebody should do a 30 year study of the old MO+ divds, it beats anything Buffay has held.

CAUTION: MO would always pop at the very end of a move up, like even on the very last day was the shining moment- like an equity "flight to quality".

Tue, 05/31/2011 - 13:55 | 1325910 Muir
Muir's picture

Right on robo!!

Tell it like it is.

" Just follow the tape," yeah baby!

Tue, 05/31/2011 - 14:07 | 1325964 SheepDog-One
SheepDog-One's picture

Pretty easy to follow Momo's 'trading technique', get up in the morning look at 'the tape' and see what stock is up, post endlessly about it being your 'long-time trusty portfolio stalwart'.

Tue, 05/31/2011 - 14:16 | 1325989 lieutenantjohnchard
lieutenantjohnchard's picture

so with no sign of weakness in the market or willingness to fight the fed you're now 100% invested rather than the paltry 30% stake with your widows and orphans portfolio of hd, vz and mo.

go look yourself in the mirror and get a good long look at what a fraud looks like. you don't take your own advice which is less advice and more an emotional need to post something at zh per article in between checking computer logs of 1099's, or so you say.

btw: did silver give several weeks notice in advance of a drop?

Tue, 05/31/2011 - 16:02 | 1326273 Miles Kendig
Miles Kendig's picture

Investors said the same thing about German prospects on June 21, 1941

Tue, 05/31/2011 - 13:35 | 1325835 CrashisOptimistic
CrashisOptimistic's picture

The Fed doesn't care about gold.  Period.

The Fed has a dual mandate to ensure growth and keep unemployment at 4.5-5% (though you will soon see a major clamoring to redefine normalcy for that number higher (for the election)).  But gold is not involved.  It's not required by civilization.

Tue, 05/31/2011 - 13:39 | 1325837 centerline
centerline's picture

Debt saturation.  Unless incomes rise, it is game over.  And the likelihood of that is nil.  Anything else is like solving one side of an equation only... still leading to an imbalance.  The effect might only be to kick the can again (and raise the stakes).

Tue, 05/31/2011 - 13:44 | 1325871 SwingForce
SwingForce's picture

When individuasls JUST SAY NO! its nice to know their governments will assume that extra debt on their behalf, no co-signer necessary.

Tue, 05/31/2011 - 13:58 | 1325919 centerline
centerline's picture

You couldn't have said it any better.

Tue, 05/31/2011 - 13:37 | 1325841 Re-Discovery
Re-Discovery's picture

I hate Central Banks.  Such supurflous bullshit.

(It's amazing watching all of these economist/Fed watchers tie themselves into knots.  And I like Rosie.)

Tue, 05/31/2011 - 15:58 | 1326263 Cthonic
Cthonic's picture

+1337

Nicely timed, and I agree with your sentiments.  Someone (TD?) here called Fed watching the new Kremlinology.  However, big difference in that Kremlinology was relegated to a tiny handful of people, whereas we're all forced to be Fed watchers now.  What a waste.

Tue, 05/31/2011 - 13:38 | 1325844 Robslob
Robslob's picture

It seems the Fed will end up being the "only" buyer of "any" bonds at their current pace...good luck with the assumption that nothing else moves when they do this...

On another note about tungsten plated gold...how does one validate that APMEX actually sends the real thing if its weight can be so easily reproduced?

Tue, 05/31/2011 - 13:41 | 1325855 ??
??'s picture

posted earlier

Rosenberg on Bloomberg this AM and spoke of Canadian economy - does not see a bubble in Canadian housing and views Canuck household debt as an issue only if debt service costs are hit with higher interest rates e.g. +300 bp - comparison to US circa 2006 does not hold due to tighter credit requirements.  If there is a bubble he said Vancouver would be the only candidate with the rest of the country in solid shape. His view is that there is a supply issue as in no excess supply and in fact shortages in some markets buoyed by a  robust immigration effect.

(Given Rosies' track record probably a good time to dump your Canuck real estate)

Tue, 05/31/2011 - 13:45 | 1325860 steve from virginia
steve from virginia's picture

First: Warren Mosler has been calling for the Fed to target rates for quite some time. Announce a target and do what is necessary in the market to meet the target.

Second: this is a fine idea, so is masturbation. Nobody gets pregnant and no feelings are hurt.

Third: where's the output? Targeting rates fixes what, exactly? Which crook goes to jail? Do any crooks go to jail?

Fourth: where's the output, deux? How can you have 'growth' when input costs are bankrupting? Read that USA-Today article about high gas prices crimping consumpton. The 'money' in our economy is finance lending to finance to boost asset prices. Add expensive USA housing, overhand of legacy loans, long commutes in expensive carz burning expensive gas and the sum-total is negative.

Interest rate reductions cannot render the unprofitable economy otherwise. This is what Bernanke, Mosler and the pseudo- monetarists miss.

We need four more Saudi Arabias all pumping feverishly and a second new atmosphere that we can pollute. To have the 'growth' we need to double the national highway system and build another 2 million tract hosuses a year (for past five years, we are behind); we need another, larger shadow banking 'black market' and another $500 trillion in derivatives added to the $600t we already tremble under. We need these things because exponential growth cannot exist without them.

Otherwise nothing changes we just get broker.

Peak Oil, Bitchez.

Tue, 05/31/2011 - 13:50 | 1325897 dxj
dxj's picture

Has Rosie ever been right about anything? Even a broken clock is right twice a day.

Tue, 05/31/2011 - 14:34 | 1326011 Boston
Boston's picture

One last item to note. If, say, the 10-year note were to be capped at 2 1/2%, where it was at ahead of the QE2 program last fall, compared with the current 3%-plus level, the total return for a 10-year strip would come to over 10% in a 12-month span. Now put that in your pipe and smoke it!

That's EXACTLY what I've been yapping about here for the last two months.

Fuck you, Bill Gross!

 


Tue, 05/31/2011 - 14:44 | 1326061 slaughterer
slaughterer's picture

This analysis by Rosie of OT2 (2012) is the best thing he has written all year.  As I read and re-read it, I am convinced that this is the form that Bernanke will next intervene in the market.  Thanks Tyler. 

Tue, 05/31/2011 - 14:44 | 1326051 Hondo
Hondo's picture

Who in their right mind would buy the mortgage paper at such low rates but the government......they would have to pull off the twist by lowering TSY rates and then accept the mortgage paper (Fannie, Freddie, etc) which would most certainly be at a loss with the only willing buyer being the government (even then I would still have my doubts that people would think it permanent.....would you buy a house you might be able to afford but then never be able to sell????).  Interesting conjecture but I don't think it works.  I can believe Rosie came up with such a lame and insane idea.

Tue, 05/31/2011 - 20:10 | 1327088 Yancey Ward
Yancey Ward's picture

I can believe Rosie came up with such a lame and insane idea.

So can I- he is only trying to predict what Bernanke will do.  Insane and lame is a good place to start.

Tue, 05/31/2011 - 14:44 | 1326060 Double down
Double down's picture

Just make the curve:)

Swaptions and 10 year note buying, it is going to be sooooo expensive.

Bitches

 

 

Tue, 05/31/2011 - 15:56 | 1326230 Miles Kendig
Miles Kendig's picture

The 10yr will hit a 2 handle before it hits a 5.  Been saying it and will continue to.  Unlike DSK, Ben Bernanke has the ability to blow himself off so the prices paid metric really doesn't matter.  Especially since his ever more self paid rebates simply go to help maintain his stable of ancillary fluffers at the treasury & PD's.

Tue, 05/31/2011 - 16:46 | 1326510 ella
ella's picture

QE3 will morph into  QEI.  For infinity of course!

Tue, 05/31/2011 - 17:32 | 1326656 jaxville
jaxville's picture

  Gold covered tungsten is only possible on larger, poured style bars. Tungsten is too hard to be struck as a coin or easily machined. It's high melting temperature makes it very difficult to cast smoothly so a phoney bar will require a substantial gold coating. We need much higher gold prices before we see fake 1 oz bars and coins. Don't worry about smaller units for now.

  On the main topic....It's too late for such a plan to work with interest rates as low as they are. Not enough room for expectations of even lower rates.

Tue, 05/31/2011 - 17:59 | 1326732 jaxville
jaxville's picture

 Sorry...I had to deal with a call while attempting my post. I own a gold and silver exchange and the easiest way to test suspect bars is with an ultra sonic thickness tester. You can get a cheaper one for a couple of hundred dollars on line. Try ebay.

  I suspect that the hollowed out 100 oz silver bars are little more an urban myth with those posting photos on line actually making the fake bars. Even a part time dealer would easily see the bars have been tampered with. The fake gold bar shown online that Heraus Refinery received was spotted quickly by one of their employees. It was clearly bought by an unsophisticated (or corrupt) bank employee.

  I am sure we will see all sorts of counterfeits surface soon with the higher prices. Jewellery buyers in Asia have already realized great losses from jewellery manufactured with a sophisticated alloy that mimics gold on electronic testers and is relatively acid resistant like high karat gold is on scatch tests. For that reason we are presently preparing to buy an xrf tester for the shop.

  The gold coins that are likely to be counterfeited are the alloy coins (22K). It is only a matter of time before bogus eagles, sovereigns, and krugerrands start showing up in quantity. Your best defense is a reputable dealer on whose expertise you can count on to sort things out.If you have something you know is real, a comparison examination should settle any issues.

  The counterfeits will start showing up when dealers have little to offer a desperate public and unsophisticated buyers who have never even seen a gold coin are forking over cash to individuals. Remember....there is no panic like a gold panic.

Tue, 05/31/2011 - 19:19 | 1326968 jackinrichmond
jackinrichmond's picture

he's right..  there is still a shortage of housing in vancouver.  60K people move into this market annually.  line ups to buy condos.  pricing is strong.  buyers buying with cash. 

Tue, 05/31/2011 - 23:04 | 1327486 flow5
flow5's picture

"Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities"

I didn't know Bernanke was that stupid.  He needs to be replaced immediately.

"Operation Twist 1 was to terminate the outflow of gold from the US to foreign bank vaults"

That makes no sense because the gold exodus was SOLEY due to the PENTAGON's overseas expenditures.

Tue, 06/14/2011 - 18:07 | 1369139 ebworthen
ebworthen's picture

Rotate hips, swivel feet and legs, swing your arms - Twist Baby

http://www.youtube.com/watch?v=DZAtzcthSxM&feature=related

(lots of feet swiveling, arm swinging, and especially hip twisting - with a couple from 1962- in this collection of clips with Chubby Checker's original song).

Do NOT follow this link or you will be banned from the site!