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Taxes, the Deficit, QE and the Long Bond
David Axelrod, the new WH Senior Adviser (what does that title mean?)
leaked an e-mail today that a “compromise” had been reached on what to
do with taxes for the next few years. All of the Bush tax cuts will be
extended for another 24 months. AMT will also get “patched” up for a few
years. So the great public debate on this critical issue actually never
happened. The outcome was not really in doubt. That said, this is a
pretty big deal. Consider this graph from the CBO:
The graph shows the impact of extending and patching versus a base line
estimate of the deficit. If we extend/patch the deficit goes up by $147b
in 2011 and by $208b in 2012. So the compromise that was not discussed
or debated will cost us $355b over two years. Poof!
As a result of this non-legislating the deficit will go up by more than
half of all of Ben Bernanke’s $600b QE. Yes, he will be buying more than
Treasury will be selling for the next seven months. But right after
that Timmy G. will have at least another trillion and a half of wood to
chop over the following eighteen months.
The old adage of “Don’t fight the Fed” is probably wise as
you look at their massive buy program. But after a few months we are
going to get numb to the constant POMO operations. At around that same
time people will be looking at the Fed’s dwindling buying power and the
wave of supply around the corner. The news on taxes today just makes the
problem worse. Would you lend those prolific spenders your reserves? At
a negative return?
Bernanke's announcement eight days ago knocked the long bond off its
feet. The Fed committed less buying power to the 17-30 year maturities
than was anticipated. But the 30 year has been trading like a wet sack
of cement ever since QE-2 was announced. That price action is not all
about some overestimates on the Fed’s intentions. Those bad bets were
washed out after the first 24 hours. At this point the bond is pricing
in a market sentiment that says, “If the Fed isn’t buying it, don’t own it.” I can’t think of a worse market response to the cauldron of trouble that Ben has cooked up.
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Well then, it makes perfect sense for gold to sell off as the dollar takes on even more of the appearance of that which is used to wrap dead fish or wipe bottoms.
Why would the USD end up there? QE doesn't involve money printing, the argument that it causes inflation is weak. FTR, I'm long USD short EUR.
Bruce the Senators of Rome lamented the fall.
Skippy...got a bum buddie?
I don't think that the Fed would hang the Treasury out to dry like that. My money is on the Fed's positions being rolled until such time as the economy really does start recovering....ie indefinitely. Front-running that roll could be one of the easiest trades out there although, that said, if the Fed see enough bids it might just back off and let others take down the yield, replenishing reserves to make available if needed at the next maturation.
ps: I never said it before, but I love your work Bruce. One of the only "contributors" who actually contributes anything worth reading.
you are kidding, yes?
"let others", like who? or have you been confusing the FED's proxies as real entities?
+1 I love your cynicism. Yeah, everyone with half a brain knows that 90% of the bids are Fed proxies or friendly foreign CBs and their proxies playing the back-scratching game: "you buy mine if I buy yours".
I guess I just had a brainout.
To understand how screwed the US government's finances are and why there is no hope, all you need to do is look at who the people have sent to Washington. They cannot admit their own folly, nor can they admit that there are limits to what can be spent. They are part of the machine that propagates the myth of America, which the dumb sheep fall for every time.
It makes me think of the alcoholic, who's drinking has reached such extremes that there is no hope they will see sense, can no longer think rationally and has become a danger to themselves and those around them. The only course of action is an intervention - this is where the US government has found itself. Drunk on power, addicted to spending and utterly delusional. The only question is, who will intervene and how?
I'm going to learn Mandarin.
91% rates under Eisenhower, but more than 35% under Obama would be socialism.
It would have been smarter for them to extend the middle class portion indefinitely, and extend the top part to re-battle in two years.
No matter when they set the tax rates to, though, they always normalize to collect 18% of GDP after three years or so.
1) The elite who organised and implemented stuff called credit cards, credit, debt etc. They knew it would implode, and now it has.
2) Bush, greenspan, bernanke are all part of the same boys club. They do not care about anyone but themselves. When we are screaming about high cost of things, then those in charge of the NWO will have us right where they want us. Time to prepare was yesterday.
Go have a look at http://www.forecastfortomorrow.com those guys have been spot on about the elections and what is coming very soon.
OOOO, I got some:
Sun will rise in the east on Friday.
The Pope will remain stubbornly Catholic.
Gravity will continue to pull everything towards the center of mass until at least 12/25/2010.
Gotta admit, hell of a business model those guys have. How much do they pay you, or are you the principal?
No surprise that the Fed is avoiding the long end. I don't know why people were surprised by this. Expect to see Treasury playing ball and avoiding issuance of long-dated paper as well.
Deficit is not a problem provided the Fed stays at the plate (and it will).
What's happening here, as I said earlier, is that the USA is being turned into some bizarre "bankalized" USSA. It won't surprise me at all if, in the years to come, the Fed raises reserves to 40%, blows it all on bonds, absorbs a few member banks and the govt employs 80% of the population.
Said another way: if you can't beat 'em, join 'em, the USA is becoming China.
[edit: also add that I would expect to see the Treasury sneak in some auctions on the long end when (inevitably) the S&P rapidly loses 50% and commodities also crash down as markets become aware of reality].
Forgive my ignorance but I have been trying to wrap my skull around bonds for years...
What difference does it make if the Fed buys shorter or longer term bonds vis-a-vis the SPX? You say...
"...also add that I would expect to see the Treasury sneak in some auctions on the long end when (inevitably) the S&P rapidly loses 50% and commodities also crash down as markets become aware of reality..."
Please explain.
:D
Didn't know you were gonna have a quiz, huh? Ha!
Thanks.
I believe the Fed is trying to paint a picture. If the economy were healthy and growing people would have long-term inflation expectations. This would be reflected as increased yields for long-term bonds. So the Fed is trying to draw a bond yield curve that reflects a healthy economy. We don't have one of course, we have 20% unemployment, 40M people on foodstamps, 2+ years of housing overhang. The Fed wants to muddle through this by painting a picture of a healthy economy's treasury yield curve with QE money. They could drive 30-year tresury yields to 100 basis points by buying all of them. QE2 is large enough to buy all of them. But they now recognize that zero interest-rate policy (ZIRP) is not re-lighting the economy, so they are trying something new, simulating a healthy economy in the treasury bond market.
What should not be forgotten is the fact that the long bond is used as a reference level for both mortgage rates, but just as importantly, pension funds. Having a low rate on the long bond, does help those looking to refinance, but it kills the solvency of pension funds, because it is this rate that is the benchmark for discounting liabilities of funds. A lower yield increases the present value cost of the pension obligations, which does more harm to the solvency of funds than the boost to equities. I suspect a large part of the actions of the Fed are linked to the fact that the finance industry has persuaded the dumb money to buy all sorts of crap over the years and the behavior of assets (REITS being a case in point) is all about protecting the banks from a tsunami of lawsuits from school teacher pension funds etc.
What you need to consider is the Fed is trying to disguise the fraudulent activities of the banking system first and foremost - the rest is just noise.
Good points, I haven't forgotten, but I'd hazard to say that many funds have responded to the loss in fixed income by chasing equities (at their peril). (As I stated in an earlier BK post, I suspect this is a major factor in the S&P being so overvalued). Secondly, I suspect that a large chunk of QE2 is pointed towards this very problem. It's going to end up in govt-run pension funds to fill the growing hole in future obligations. The Fed doesn't care how the money gets spent into the economy, just that it is, and through pensioners kills two birds with one stones. This is just speculation though, I don't have hard data to prove/disprove it.
You bet! That's why QE1 was QE1. The very first thing the Fed did was disguise a large chunk of that fraud...by buying it. Move the fraud to the Fed's books, where it can sit indefinitely.
I wrote a lot about it in this thread: http://www.zerohedge.com/article/guest-post-alert-qe-ii-has-lit-fuse
Just search for my name over the two pages (the one with all the junks) ;-)
In short, it's about the roll. QE1 was aimed at stabilizing banks but it didn't come with the bonus prize (increased lending). The problem here (as I see it) is that the peons have lost the desire or ability to borrow. When that happens, the govt has to borrow on behalf of the peons in order to prevent deflation.
So QE2 is aimed at the govt. (Maybe QE3 will be direct at the peons?). So when the Fed swaps reserves for gov bonds, it wants to retain the ability to reverse that at short notice if necessary. Focusing on the short end of the bond spectrum gives the Fed higher resolution control over money supply.
If inflation gets out of check then the Fed reduces the roll, forcing Treasury to find cash, which gets implemented as austerity measures. If the Fed is on the long end of the spectrum, then it doesn't have the kind of control offered on the short end.
As a few other people have noted, Treasury is absolutely insane not to be taking advantage of low yields on long dated bonds. Who in their right mind actually believes that GDP growth + inflation is going to remain below current yields for an extended period? So why the hell isn't Treasury taking advantage? Because there isn't actually a market there, just a sham and the Fed isn't really interested in going there, it just does so to keep yields in the target range.
But put yourself in the Treasury's shoes. If reality (gravity) returns to markets, we're going to see a closing USD/EUR and some flight to US bonds. Some funds might even be dumb enough to look for long bonds. A sneaky (and smart) Treasury should exploit that. I would.
Thanks for the detailed response. I do appreciate it.
Supposing the SPX tanked, then the Fed would come in and buy longer-term maturities just to demonstrate confidence, which would make everything better?
What if the sucke...er, traders...don't get fooled?
Bluffing might work in normal economic times, but not now. The Fed stopped bluffing a long time ago, everything you see now is very, very real.
The problem for the Fed now is that it's in a very tight spot. QE1 worked to stabilize banks (by shifting fraud to the Fed's books). It failed to stimulate the economy because banks still lack confidence to lend and, more importantly, peons lack confidence to borrow. This is highly deflationary.
Like Japan, when people won't borrow, the govt steps in to "represent" the people and borrow on our behalf. QE2 is an agreement between the Fed and Treasury to make it all happen. The problem here though is that by participating in bond auctions, the Fed suppresses yields artificially. This then destroys income for retirement funds that depend on yields being high (to drive fixed income assets). These funds are then forced to hunt for cash elsewhere and they end up chasing equities (and getting front-run by bots). Now we have a disaster unfolding. The S&P is destined to fall 50%, these funds will be killed which is highly deflationary because it means retirees lose the money they would otherwise have spent. Ironically, much of the QE2 cash will end up being pumped into these funds to rescue them when it's the QE program that helped cause the problem in the first place!
Another reason that the Fed needs to stay the hell away from the long end.
If I were Ben I would have just said "fuck it" and gone for the helicopter drop. Let the banks fight to attract deposits from consumers and start marking those toxic assets to market.
short-term bonds only, super-low-yield,...so....more leverage!, bigger margin calls (doh!), more liquidation (of whatever is on hand that isn't in the shit).
voila: le plunge.
Now I have to wrap my head around that.
Was that like a "rap" we can do on the corner of Wall and Broad?
I'm sorry. What?
Bruce: "WH Senior Adviser, what does that title mean??"
It means the same thing as it does when one of your Republican cocksucker heroes is President.
Didn't know Bruce to be a Republican.
Yeah! I'm a Commie!
To my knowledge, Larry Craig has never been President.
Any decision or non-decision will be equally inpalatable. Best to leave it to 2012 so they can stick it to the Republicans.
Axlerod? Like he cares.
/:
>>Best to leave it to 2012
Greenspun: "I don't think markets(oligarcy) will allow them to do that"
http://www.bloomberg.com/video/63579250/