This page has been archived and commenting is disabled.
The Great Squeeze: Asset Prices Will Fall, While the Cost of Living Will Rise
Graham’s note: this is an excerpt from a recent client note I sent out to subscribers.
As I predicted the US Federal Reserve disappointed in a big way with its January 25 FOMC meeting. There was no announcement of QE 3. Instead the Fed promised to maintain its Zero Interest Rate policy (ZIRP) until 2014: an innocuous and mainly symbolic gesture.
In truth the Fed is now trapped. Because of political pressure, it cannot announce QE 3 or any other large monetary program without a Crisis first erupting.
However, if the Fed were simply to announce that its view of the economy had worsened and not throw the markets a bone, then we could very well have seen a Crash in multiple asset classes as the entire financial system is trading primarily based on the notion that the Fed and other Central Banks can somehow manage to prop this house of cards up interminably.
As a result of this, we got more of the same with the Fed January FOMC: promises to act if needed, and a symbolic promise of future accommodation in the form of promising to extend ZIRP for years to come.
The reality is that the Fed is stuck in ZIRP and will never be able to leave it. In 2011, the US made $454 BILLION in interest payments. And that’s with interest rates at or near 0%.
Things are only going to get worse. According to the Congressional Budget Office, the estimated interest that will be due on the US’s debt load by 2015 will be $533 billion: an amount equal to 1/3 of all federal income taxes collected that year.
And of course, if interest rates rise in any fashion, the interest payment load will rise as well. This is part of the reason why the Fed cannot raise interest rates in the future… ever.
A second reason the Fed is trapped in ZIRP pertains to corporate leverage levels, which we detailed in an earlier letter. Any rise in interest rates, particularly on the short-end of the curve, will mean that corporations will see a massive increase in interest payments due on the $7.3 trillion in debt they currently owe. That could put a serious dent in the “earnings” side of the P/E valuations sell side analysts are touting to claim stocks are cheap today.
Finally, we need to consider the over the counter derivatives market. Currently 82% of the $248 trillion in derivatives sitting on US commercial bank balance sheets are based on interest rates. If even 2% of these contracts are “at risk” and one quarter of those “at risk” contracts blow up, you’ve wiped out all equity at the five largest US banks.
Suffice to say, the Fed doesn’t want interest rates to rise in any way shape or form.
So the Fed is trapped at a ZIRP rate and will not be raising rates until the market forces it to do so.
This in turn means that inflation, which has already crept into the financial system as a result of QE 1 and QE2, will be gaining further traction in the months to come. As I’ve stated before, inflation and deflation are not mutually exclusive. And while the Fed is focusing on stopping the dreaded debt deflation (a la 2008) hitting the financial system, it’s let the inflation genie out of the bottle resulting in higher costs of living and civil unrest around the globe.
For more of our free daily market commentary, investment strategies, and several FREE reports devoted to help you navigate the coming economic and capital market changes safely swing by www.gainspainscapital.com.
Best Regards,
Graham Summers
- advertisements -
Obiwan
I don't think 'investor needs" matter much. If the
Fed, with its infinite supply of dollars, buys enough treasuries the rates CAN be kept low.
Sooooo
If the Fed must keep interest rates low then they must keep buying treasuries (which conveniently funds the government).
We should be able to look to the governments needs to calculate a minimum of Treasury buying (it must fund 42% of the budget less what foreign buyers take in as things currently stand).
Knowing this minimum we should be able to calculate the growth in money supply and therefore pinpoint the date of the begining of the end.
Unfortunately my HP12C is out of battery juice...could you give me that date? I do not want to be late for the financial apocalypse.
The Fed's extension of its zirp commitment is hardly an "innocuous and mainly symbolic gesture."The dollar index is down 4% YTD, spreads have tightened, and more important than treasury yields still being near record lows, mortgage rates are at or near all-time lows.
For you to make this claim means you haven't read any of the widely available work Bernanke and his colleagues have done on conducting monetary policy at the zero bound, and you have serious gaps in your understanding of how markets work. How can you claim to understand the Fed's intentions without having taken the relatively insignificant amount of time to study what our central bankers have to say on the matter?
The author is dead wrong about the Fed needing a crisis for QE3. They couldn't care less about political pressure. In their world, central bank independence is key. Some sort of QE3 is coming in March, as we work towards a new mandate (implicit or explicit) of nominal GDP targeting. See DeLong and Summers recent work on unemployment...the left/Keynsians are laying the groundwork for this in a systematic way. Good chance QE3 is mainly focused on MBS, to provide backdoor bailouts for the banks/pension funds/insurance companies who hold these mortgages that are about to be written down. This impending "bailout of main street" could end up being the biggest bank bailout in history. Obama is an evil fucking genius.
There is a playbook for all this, and it's available free on the Fed's website.
"They couldn't care less about political pressure."
And... golly... they let me read their "playbook" too.
http://en.wikipedia.org/wiki/Bernanke_doctrine
"The author is dead wrong about the Fed needing a crisis for QE3."
If the FED executes QE3 absent a crisis does that not give ammunition to the "Audit the FED" and the "End the FED" congressional members and other activists. I would think the FED fears an audit and it must certainly fear its own dissolution.
The first rule of any bureaucracy being to ensure its own survival.
The second rule is to expand its powers, I don't hink an audit would help there.
the FED fears nothing
Beg to differ. The Fed fears they have got it wrong. And the rest of us should fear that too.
Bernanke's quivering lip recalled Nixon lying on camera.
Ask JFK if the Fed is afraid of doing whatever they want.
Hey. It's totally fair. The bailout will help 5 homeowners -- and 5 banks. See? Fair and equitable.
hyper
so the take away is "do not worry we will all be taken care of?"
comforting
No, the take away is we're all fucked. But if you want to have a chance at surviving what's ahead, you need to understand where these men behind the curtain are coming from.
Can you direct me to the page in the playbook that details unwinding their holdings at the long end?
http://en.wikipedia.org/wiki/World_War_III
your statement : "In 2011, the US made $454 BILLION in interest payments. And that’s with interest rates at or near 0%."
Interest payments on older bonds are certainly Not Near zero percent.
Regards, The Fly
Yes. US can lower its payments by borrowing $15 Trillion for 10 years. Kick THAT can!
Newly printed money is created as credit. They just want us to believe that it is created as debt. New money is a tax on existing money. What the Fed is doing is kind of like if you were to steal something valuable from one of your children, then con them into paying you back for having stolen it from them
...the notion that the Fed and other Central Banks can somehow manage to prop this house of cards up interminably.
Fact is that they CAN. Central banks do one thing well: buffer decline. Japan is exhibit one that it can go on for decades.
Yep, and did you notice where Japan's stock market is compared to its peak? Its only a matter of time before the S&P500 looks a lot more Japanese...
Business as usual!
How do you like the 'new' (old) economic atmosphere?
Trading? There are no markets anymore. Only interventions.
Ludwid von Mises said it best many years ago;
"Capitalism means free enterprise, sovereignty of the consumers in economic matters, and sovereignty of the voters in political matters. Socialism means full government control of every sphere of the individuals life and unrestricted suppremacy of the government in it's capacity as central board of production management."
Trading free markets? Give your head a shake!
Graham Summers formula for newsletter writing:
1) Listen to Peter Schiff Show
2) Paraphrase everything Peter said and write it down on paper
3) Repeat
is it 2010 ?
still
Come on Graham, give us something we can trade. this is all old news, same as it ever was.
I've got an idea. Instead of long term investing why not trade your elderly's current life style and your young generations future for a short term buck?
Yeah we can have HFT and rigged trading games use rehypothetication and when it goes bad we can make sure the poor people pay for the rich. Lets call it the financial stability act or some other grand name. Brilliant.
/nasal whiny voice
Yeah Graham give us somehting we can trade.