Fed Officials Trying to Warn Bond Markets

EconMatters's picture

By EconMatters



The Purpose of Complacency Talk


The Fed officials have been coming out in speeches the last couple of weeks with rhetoric about ‘complacency’ and other such code words for chasing risk ahead of what the Federal Reserve knows is going to be an abrupt change in monetary policy over the next six months. 


The Fed is concerned because they know they want an orderly transition in markets and not causing major dislocations in markets by massive selloffs. However, the getting is so good with interest free money that participants are going to push this edge they have in markets right up until the last possible exit minute.


So despite the fact that QE ends in October with no more bond buying by the Fed, the 10-Year is still sitting at 2.50% with participants making money hand over fist with the borrow at 15-25 basis points and investing in yield instruments with massive leverage trades that has been so popular and irresistible by investors looking for ‘free money arbitrage’ opportunities.


An Orderly Unwind


The problem that the Fed has rightly identified is that they are not going to get an orderly exit at this pace, the unwind is going to be massive, jarring, and definitely not ‘orderly’! The Bond markets, take the 10-year yield could literally have a 25 or 35 basis point move over a 24 hour period that would wreak a lot of havoc on fund flows, asset classes and financial markets. 


This turmoil in the bond market could really be disastrous because the Fed participants realize the bond market isn`t being priced currently where the Fed is moving to in terms of monetary policy. The Fed should be alarmed because the unwind is setting up for a possible 100 basis point move in two months’ time frame type of fund dislocation and reallocation of capital, and that is going to be problematic for markets! 

But the Fed only has themselves to blame for this predicament as in this case you cannot have your cake and eat it too! Janet Yellen cannot be so dovish at Fed news conferences given her reputation as a dove among doves, and get any respect from market participants; the trade is going to be all-in and one-sided without the slightest regard for the risks associated with being so aggressive. 


In short, Janet Yellen has encouraged the one thing that Fed governors should always avoid being so ‘transparent’ that market participants go full boar on a trade, one-sided, highly levered, unhedged, and nothing could possibly happen with this dovish a Fed Chairperson at the helm trade! In a nutshell they have become too ‘complacent’ or they have taken her dovishness for granted.


Pigs at the Bond Trough 


The pattern has been quite clear in Bond Markets wait until after the 200k plus Employment Report blows the 10-Year up to 2.70%, and come in and buy bonds like there is not tomorrow with huge leverage, until they have to get out of the way of the next CPI, GDP or Employment Report – as this process has repeated itself over the last four months of financial markets. The Levered Yield Trade has been the trade of the year so far in 2014 - the strategy of investing in anything with yield from over-valued utilities, pricey bonds and even stodgy low growth Big Caps with some semblance of a dividend yield! 


Janet Yellen cannot have her Dovish Cake, and eat it too in the form of an “Orderly Unwind”!


So the Fed has to realize that sending out the minions of the Fed isn`t going to counteract Janet Yellen`s dovishness. If they want markets to start unwinding trades ahead of policy adjustments that are coming and not wait until the last possible minute, then Janet Yellen herself is going to have to send a shot across the monetary bow so to speak! 


She is going to have to come out with a hawkish tone to garner some healthy respect for normalization of fed policy by markets. She is dovish we get that, but the Fed is about to change monetary policy, and much sooner than is currently priced into many asset classes, and it is going to take some considerable time if participants started repositioning today to unwind many of these massive positions in markets, any sense or orderliness necessitates a little at a time versus all at once!


Janet Yellen has got to start talking hawkish to get this process started otherwise her worst fear is going to materialize in spades as market participants are all going to wait until the last minute trying to make that last dollar on the yield trade, and cause huge market turbulence when they all try to get out at once!

The Data Indicate 1st QTR 2015 Rate Hike at the Latest!


The Employment numbers, the inflation numbers, and the risky valuations in financial markets all point to the Fed needing to start raising rates sometime in the first quarter of next year. This is much sooner than Janet Yellen`s Dovish talk has markets pricing in with their forecast for late in 2015 for the first rate hike. 


Market participants are far too levered up, all on the same side, and well behind the monetary normalization curve of when the first rate hike is actually going to occur. This is a recipe for disaster, and that seminal light bulb moment in financial markets when everybody realizes, that moment in Margin Call where the analyst drops the ear-buds out saying internally holy shit, that they need to liquidate everything right now. In other words, the entire market all hits the sell button at the same time! 


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ebworthen's picture

The FED isn't trying to warn anyone; they blow the bubbles for the banks and are told when to pop them.

The only thing the talk could be is for a future evening news broadcast or congressional testimony.

Plausible deniability and "no one saw this coming" head shaking for the impoverished masses.

Dingleberry's picture

So when JPM or another member bank gets slammed cuz they lever themselves 40-1 with derivatives....and Cramer does his tirade on CNBC (again).....what will the Fed do?

Who will blink first?

The markets seem to know the answer.

This is not our first rodeo.

Not Goldman Sachs's picture

Even w/ an orderly unwind, are not the buyers still left with the bag? The trade requires buyers for those sellers. Someone always wins...someone else always loses. Or I could be mistaken!

Duck and Cover's picture

What make anyone think that Yellen is calling the shots?

What conditions did it take to get the nomination as head of the Fed?

Did our "Dear Leader" get a No Crash guarantee?

Next up - look for a civil war to break out at the FOMC meetings.

lasvegaspersona's picture

The fed has proven (since greenspan) it will not allow a crash..and in an election year...pure fantasy!

asking4it2k's picture

So what happens to the big banks and the interest rate derivative market if the FED raises rates ??

Will they fail again ?

buzzsaw99's picture

they know yellen is full of shit and will never let anything bad happen. that would be my bet too. QEinfinity will resume december of 2014 at the latest and everyone knows it.

LawsofPhysics's picture

QE is blatant theft, but ZIRP (NIRP in real terms) is far, far more destructive. 

buzzsaw99's picture

it's zirp 4evah. acceptance is the final stage of grief.

LawsofPhysics's picture

Raise rates you say?  Go ahead, I'd love to get a decent return on my savings. 


Now about those government liabilities...


Tick tock motherfuckers...

Yancey Ward's picture

I think there is literally zero chance the Fed will raise the short rate.  I think the next move will actually be to find some way to make it negative.

As for the bond market, even if the Fed is "warning" them, what would the Fed expect?  Someone has to buy the bonds from the current owners, so the unwind, if it comes, has to be disorderly- there is no other choice.

AdvancingTime's picture

Regardless of what you name it the "Federal Reserve Nightmare" or the "Yellen conundrum", the box Ben Bernanke made when he painted both himself and the Federal Reserve in a corner remains. Bernanke has by passing the chairmanship to Yellen escaped from the QE trap but left the rest of us fully in its grasp.

With a policy of loose and cheap money  and an inflation target of just 2% the Federal Reserve  continues to please those gambling that not fighting the Fed guarantees profits. As many Americans are forced to pay higher food, gasoline, and health insurance premiums, I wish someone would let the Fed know we are already there. Any thought that inflation is not higher has come from the false illusion brought from lower payments on things like auto loans and mortgages, this is a one off and will not continue. Trouble lurks ahead as interest rates will have to rise. More on this subject in the article below.


DavidC's picture

"...sending out the mignons of the Fed...."

I find it difficult to take an article seriously when its author doesn't know the difference between mignon and minion (unless it's a typo).


lasvegaspersona's picture

apparently  the little guys in Dispcable, the movie, are called mignons...the Fed employs them now?...or... Are the really sending out pieces of meat?

Yancey Ward's picture

I don't know, perhaps they need to be grilled...... literally.

the grateful unemployed's picture

you dont understand, the fed went from monetary policy to fiscal policy to foreign policy, all during obamas second term. the fed is now god, so what does god do? obviously the jews beleive he is an old testament god who will smite the heathens. the president believes the fed god has set the world in motion and is no longer directly involved (then who are these people on the FOMC?) the congress knows the fed is an omnipotent god, because the fed now controls the money supply , fiscal and foreign policy. madame chairman we kiss your ring. the question like always, what is god going to do? and those priests in the fomc, must remain true to gods word. (despite those calvinists in the EU) yes its tough being god, what does god do? and since god has his favorite people, he must favor them, and to that end we must make a policy that empowers us, in an enlightened way. so that gods monetary love is there for all to see. but it tough being god

TimmyM's picture

Yea whatever, maybe you don't understand. We are in a global depression.
We had our Minsky moment and now the debt trap is on.

AdvancingTime's picture

 It might soon become apparent the economic efficiency of credit is beginning to collapse and the additional money poured into the system coupled with lower rates can no longer drive the economy forward.  When this happens we are at the end game.

At some point the return on loaning money is simply not worth the risk!  Why do you want to loan money if most likely you will never be repaid or repaid with something that is totally worthless? When this happens the only safe place to store wealth will be in "tangible assets" and the only lenders will be those who print the money that nobody wants.

The collapse of credit can pose major problems such as what we saw when many sellers were forced to demand payment up front before shipping goods in 2008. More on this subject below.



Marco's picture

The Fed alone can not ensure continued lending, but the Fed together with government can.

Lending might be a losing proposition, but taxation and capital controls can ensure everything else is an even greater losing proposition in real wealth terms (and it only needs to be a winning proposition in fiat terms for the banks to stay solvent).

Bindar Dundat's picture

It's never over.    When this happens and deflation rises they will call an audable at the line and reconnect the U.S. dollar to gold at $10,000/oz.  


Never over for these jerks....they will not stop until they have it all!