The Perils Of Exiting

Tyler Durden's picture

From Monument Securities

The Perils Of Exiting

The Bank for International Settlements (BIS) has an admirable record in flagging potential threats to global financial stability. When the cadre of central bankers and finance ministers who presided over the financial meltdown of 2008-09 are taken to task for failing to anticipate trouble, their stock response is to say nobody saw it coming. Well, the BIS had given ample warning that much had gone wrong in international banking. If those with their hands on the levers of power had paid heed to these concerns, they might have saved themselves, and the rest of us, a great deal of distress. For the most part, a new set of policymakers has taken the controls, as the generation of 2008-09 troops off into the pages of history. They have a chance to show they are more alert than their predecessors to risks in the financial system. For the BIS, once again, is sounding the tocsin.

In its annual report last month, the BIS invited central bankers to consider what the implications would be of an interest rate shock occurring as central banks seek to quit their current ultra-accommodative monetary stances. The BIS drew attention to the risks that crystallised in 1994 as the Federal Reserve exited a prolonged period of unusually low short-term interest rates. We should recall that the FOMC decided to move to a less accommodative policy at its meeting on 4 February that year. Between February and May, the federal funds target rate rose from 3.0% to 3.5% but that precipitated a surge in the Treasury 10-year benchmark yield from 5.81% to 7.49% in that same three-month period. The bond market guessed correctly that the funds rate would go higher still; it reached 4.25% by end-June 1994. The BIS acknowledged that much had changed since 1994. However, we might well fear that, even if changes that have occurred since 1994 make it, on balance, no more likely now than then that bond markets would suffer a shock should central banks ever initiate an exit from ultra-accommodation, any shock they did suffer would probably now be more severe. It might not be fanciful to envisage long-dated yields rising by as much as three percentage points in such circumstances. For US, UK and German government bonds, that would merely restore them to their long-run historical relationship with rates of inflation. But a rapid movement in yields on that scale could inflict serious damage on the financial system and, even if this were by luck avoided, higher long-dated yields might snuff out corporate demand for external capital and crush business investment. In the USA, higher long-dated yields might also cut short recovery in the housing market. The results could be disastrous.

If bond yields were to escalate, as the BIS is warning, it seems unlikely that central banks would fail to respond. They might be expected to try to counter this movement by indicating that, in moving away from accommodation, they intended to pursue a gradualist strategy. If that were not enough to contain the rise in yields within acceptable bounds, they might even declare that they were postponing their exit. Indeed, should the rise in long yields threaten economic recovery, central bankers might have no difficulty persuading themselves that there were sound fundamental reasons for prolonging the monetary accommodation. Fed officials have rehearsed these stances in recent weeks as they have struggled to limit the markets’ reaction to indications they do not intend to purchase bonds at a monthly rate of $85bn forever. What we, and they, cannot know in advance is how extensive the chain-reactions will be in bond markets when they do decide to moderate their assetbuying (leaving an accommodative policy not quite as ‘ultra’ as at present). As a precaution, the FOMC has signalled that it might raise, as well as lower, the pace of its bond-buying. The Fed might well hope to meet a menacing rise in long-dated yields with re-expansion of its buying programme, while passing off the situation as quite normal.

There is a further potential source of financial instability in central banks’ exiting ultra-accommodation. They will not be moving together. The economies of the USA, the UK, the euro zone and Japan are at different stages of recovery from the 2008-09 episode and its aftermath. Their respective central banks are operating under differing constraints. These central banks are very unlikely to adhere to the same schedule as they attempt to withdraw accommodation. In a global financial system awash with mobile capital principally seeking yield on investments, this situation creates a clear risk that massive international capital flows will occur, back and forth, during the central banks’ exit process. These flows could well be reflected in extreme volatility in exchange rates between the major currencies. Doubtless, the G7 will issue statements claiming that what is happening is fine because central banks are acting with purely domestic monetary goals in view. Nevertheless, the impact of exchange rate fluctuations on international trade and economic growth, even if there is no ill intent, could be so severe as to give significant impetus to protectionism. Further, we have so far assumed that central banks would have it within their power to moderate upward pressure on long-term rates during the exit process. This might not be realistic.

If central banks keep tacking and trimming as they edge away from accommodation, it may come to pass that none of their statements will carry much credibility. They could then lose control of long rates or, at best, stability in long rates might call for ever greater market intervention on their part. The end-result would be to render monetary measures largely useless as instruments of policy because central banks, with their controls jammed open, could never be sure of effecting any intended plan. Mr Bernanke and his co-thinkers may soon discover that, in taking a different line in coping with the current depression from that followed in the 1930s, they have fallen unsuspectingly into a trap from which escape will be painful.

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q99x2's picture

Exiting is another word for the transfer of wealth to Goldman Sachs and JP Morgan.

DaddyO's picture

The outcome will be the same no matter how many people write articles explaining what went wrong and why!

Do yourself and your family a favor and disconnect from the system as much as possible.

It is only going to get more tentacled as we move deeper into the matrix...


Go long beans, bullets and bandaids.

spine001's picture

I completely disagree that the otcome was unforeseeable. With the right tools and models, extrapolated to economics from engineering (without hiding behind the supposed unpredictability of human behavior), you could easily predict the current situation we are at now, and the one we will be in the future as I have written here many times over: fractal bifurcations and chaos until a new attractor is reached.

Anusocracy's picture

Exiting means that all of the failed policies will have to come out of the closet.

eclectic syncretist's picture

Hell, President Woodrow Wilson realized it almost 100 years ago shortly after he signed the Federal Reserve Act!

Woodrow Wilson signed the 1913 Federal Reserve Act. A few years later he wrote: I am a most unhappy man. I have unwittingly ruined my country. A great industrial nation is controlled by its system of credit. Our system of  credit is concentrated. The growth of the nation, therefore, and all our activities are in the hands of a few men. We have come to be one of the worst ruled, one of the most  completely controlled and dominated Governments in the civilized world no longer a  Government by free opinion, no longer a Government by conviction and the vote of the majority, but a Government by the opinion and duress of a small group of dominant men. -Woodrow  Wilson

DosZap's picture

On Woody Wilson the Racist POTUS.

I have unwittingly ruined my country

This is one line I do not believe for a second, the SOB KNEW exactly what he did.Traitorus POS.

DosZap's picture

As usual on cue, the ALL green ramp up on PM's till Bernie lies some more.

DeadFred's picture

All eyes will be on the FOMC minutes and Bennie's subsequent speech trying to parse out the true intentions of the wizards. All except the insiders who knew long ago, likely because they told the FOMC what the playbook was to be.

I doubt that they will say "Oops, just kidding". They will at least pretend the taper is on and this latest ramp will be gone by the end of the week. My guess, don't trade on it.

JFKFC's picture

Name's Bond, Junk Bond.

Jim in MN's picture



SheepDog-One's picture

It's scary to see so many who actually buy into this nonsense that there's some 'exit strategy' coming....that will only be in the form of mushroom clouds, or maybe nationwide EMP blackout.

Homo Sapiens, the only species that spends all its time actively working to destroy itself.

eclectic syncretist's picture

Absolutely, for many currently powerful people the exit strategy is, and will be right up until the ugly end, to use any means possible, legal and illegal, to grab all they can grab for themselves as quickly and quietly as possible, fuck any sense of patriotism, the hell with everyone else, and get the hell out of dodge before anyone realizes what just actually happened.

DosZap's picture

Absolutely, for many currently powerful people the exit strategy is, and will be right up until the ugly end, to use any means possible, legal and illegal, to grab all they can grab for themselves as quickly and quietly as possible, fuck any sense of patriotism, the hell with everyone else, and get the hell out of dodge before anyone realizes what just actually happened.

We are already way past this point, the time is SWIFTLY approaching when if you utter this word, your a dead man.

Stoploss's picture

Let me ass ist.

When you lose control of the curve, there is no getting that back.



MrSteve's picture

Trouble With the Curve is a pretty good flick and its title is more prescient than even Rowdy Yates knows!

NoDebt's picture

With the debt we (and really all developed economies) have stacked up, plus the fact we continue to stack on more at a rate well beyond gains in growth and productivity, there is really only one interest rate level that can be tolerated.  Hint: rhymes with 'hero.'

This is not 1994.  We have an unservicable level of debt that needs to be serviced and effectively zero real economic growth.  The Spice must flow, the money will be printed to pay for it. 


d edwards's picture

0bama isn't going to let Ben doing anything to rock the boat before the 2014 elections, just keep the Titanic afloat a little while longer.

SheepDog-One's picture

Well using that hypothesis then they'll never 'let' anything happen ever because there are bullshit elections every 2 years. 

NoDebt's picture

Now you're getting it, SheepDog.  Now you're getting it.

doggis's picture

i am getting my passport and travelling to THE LAND OF "IF".......

so much "if" this, and "if" that - "IF" must be a terrific place to go....


"IF" a young child takes a temper tantrum because you stopped them from eating ONLY COOKIES - well take a step back and let that happen. eventually they will exhaust themselves......

Notarocketscientist's picture

I've been in touch with (he actually does respond to that email) and suggested he blow off cnBS and jump to ZH and be the front man for ZH TV. 

Perhaps if enough of us encourage him he will make the move!

Dr. Engali's picture

Joe is that you?..You silly trickster.

Bob Sacamano's picture

He is not articulate and deviates conversations into strange off-topics that distract from anything meaningful being said and frequently into things focused on him.  He has gotten worse over the past couple of years and is a good part of the CNBC audience decline. 

terryfuckwit's picture

i would love zh to get its own tv channel good to see bob english doing lots on rt....

FranSix's picture

It might not matter if there was an exit to QE, at least two QE programmes have failed, QE3, QE4, since long dated U.S. treasury bond prices are in decline to the point where they're below when those programmes were announced.

moneybots's picture

The cart: The Perils Of Exiting.


Why does everyone talk about cart?  Why is there a peril of exiting?  Because the peril of the horse of entering came first.


greenspan did not have to create a housing bubble.  In fact he knew NOT to do it.  Yet he rode the horse in anyway, pulling his crash cart along behind.  There would have been no housing crash if greenspan had not created a housing bubble.  the peril is NEVER in exiting, the peril is in ENTERING.  An equal and opposite reaction results from the action.

The peril was in entering QE, not exiting QE.  Digging a deeper hole does not get one out of a hole.

Bob Sacamano's picture

True.  Not entering requires no exiting.

Mentaliusanything's picture

.I think its time for a little Talking heads - once in a lifetime. no link just understand. And moneybot has it right, the danger was entering a theory without testing the exit. Fuck you Ben Bernanke. Im so glad someone understand Newtons Laws. Ben sure failed that

RhoneGSM's picture

Repeat after me: There is no voluntary exit from ZIRP.  It's all jawboning.


KingTut's picture

When Obama made his public rebuke of Bernanke, and make no mistake it was as close to a public humiliation as you're going to get in DC. Bernanke responded a few days later with his we're "gonna stop printing" speech.  The markets shuddered like it was 2008.  That sent a very strong message to Obama about who is really in charge.  But now Obama will never renominate him, and so Bernanke will leave in 2014.

We can speculate on Bernanke's motives.  Perhaps, he has tired of being the banking system's whipping boy.   Perhaps, he sees that bankers have no intention of fixing this system, ever.  They like it just the way it is.  Perhaps he has been reading Austrian economics late at night and is realizing he has done more harm than good.

Regardless, he's a humiliated lame duck.  His power and respect within the Fed have evaporated over night.  Anything radical he might try would be over ruled by the board of governors as they scramble to be the next chairman.  Thus, we are left with a leaderless Fed drifting through a policy fog.  This is not good.

At this point they must have a nagging suspicion that their treasured theories don't work.  These are not stupid people.  Internally they have John Williams shadowstats at their disposal, they compute the real numbers.  They know what is really happening. They will always spout propaganda in public, but the evidence that too much debt is very bad for the real economy is becoming obvious.  The Krugman tirade that more debt will fix everything is starting to look like the crackpot nonsense it is.  

The Fed is a private bank owned by the other banks, mostly the big money center banks.  The Fed exists to tap taxpayer money to save the banking system from itself.  That is, because of the Fed, they can behave like the drunken frat boys they are, vandalizing the the world for fun and profit, and they know there will be no hangover.  The chairman is a lightning rod for any ciriticism of the banking system.  Here at ZH, Bernanke is the object of vitriol and ridicule, but we are playing right into their hands.  Bernanke is their puppet, and you can throw anything you like at him, it's his job to deflect attention away from the real culprits.  

Now we want to think Dimon, Blankfein et al are the culprits, but they are only managers.  They just work for the real culprits: the owners of the banks. Who are they?  I don't know.  There are numerous conspriacy theories that are probably wrong in detail, but correct in their basic idea: a small group of financiers and bankers own the banks and from there run the world.

So when you talk about EXITING, remember there is no exiting from this essentially oligarchic system.  We are all stuck within something that benefits a very few at the expense of everyone else.  It has always been that way.

malek's picture

Summary: Doing the easy thing first and the hard thing later, can get difficult when phase 2 arrives.

And nobody could have seen that one coming!

Seychelles's picture

Of course exiting will be painful.  Duh.  Central banks and fiat currencies always end up as disasters.  Important point being that persisting with damaging policies that obviously do not work will only make the eventual resolution more disagreeable.  The 99% are already screwed.  Keeping these ZIR policies in play just gives the pirhanas more time to think about how they are going to eat each other.