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Peak Debt, Peak Doubt, & Peak Double-Down
Via Scotiabank's Guy Haselmann,
Time to Hike Rates
It makes little sense to me why the market is only pricing a 6% probability of a rate hike at the October meeting, 30% for December, and only a near 50/50 probability all the way out to March 2016. The statutory mandates of the Fed as stated in the Federal Reserve Act are “maximum employment, stable prices, and moderate long-term interest rates”. All three have been fully realized.
The unemployment rate is 5.1% (full-employment). Core CPI has been stable for years and printed 1.9% yesterday; remarkably close to the Fed’s self-imposed target of 2%. For a few years, Treasury rates have been stable at near-historical low levels. In addition, the 4-week moving average of Unemployment Claims fell to its lowest level since 1973. The most recent employment report was a bit weaker than expected, but it fell within a standard margin of error. Yet, the Fed continues to remain at the emergency rate of 0.0%.
At the September meeting, the FOMC talked up the economy, but refrained again from hiking rates, citing “international developments”. By making this decision, the Fed has to be careful it does not also provide an ‘emerging markets put’.
As the October meeting approaches, international developments have settled down. Emerging market stocks indexes and currencies have bounced since the September FOMC meeting. Chinese markets in particular have calmed down and have traded higher. The US stock market is higher. The trade-weighted dollar is lower. Credit spreads are tighter. The arguments for a hike at the October or December meeting should have increased not decreased.
The recalibration in rate hike probabilities could be the result of the “data dependent” language which has never been adequately defined. It is suspect to believe that monetary policy for an $18 trillion complex global economy is being determined by a backward looking piece of monthly economic data. Since Fed officials often cite the 24-month lag upon which monetary policy works, how can the Fed be both back-looking and forward-looking? Thus, it is really about cumulative progress over time, not monthly data.
It is dangerous that over the last year or so, whenever an economic number is released that is slightly weaker than forecasts, moral hazard kicks-in with a full-steam-ahead risk-on market reaction. Fed officials are ignoring this dynamic, but it should be a warning about ‘financial-instability’ and investor behavior.
Since that meeting, Fed officials continue to give mixed messages. Dudley, Brainard, Evans, and Kocherlakota suggest rates will not rise in 2015. Alternatively, Bullard, Lacker, Mester, Fischer, and most importantly Yellen, intimate ‘lift-off’ at the October or December meeting. This divide is exacerbating market volatility. The sooner the FOMC speaks with a unified voice, the better for all. Fortunately, clarity looms as the outcome is ultimately binary.
Indebtedness
The best, but highest-risk, argument for risk-seekers is that the Fed may have generated a condition where it is trapped forever at the zero lower bound and must perpetually fuel a condition of ever-rising financial asset appreciation and credit expansion to prevent a catastrophe. Moreover, the window to extract itself from this dangerous state might be closing. Let me explain.
One of my biggest concerns is the massive amounts of global indebtedness springing from the Fed’s low rate policy. Low rates incentivize borrowing which in turn steals from future growth (particularly due to how the debt proceeds are being used). As debt levels aggregate, a state of perpetual and exponential expansion in debt levels might be needed just to maintain the current state. In the early 1980’s, $4 of debt was needed to generate $1 of additional real GDP, but last decade it took $10 of additional credit, and since 2006, the amount has risen to $20.
Is this the situation Hyman Minsky warned about in his “Financial Instability Hypothesis”? He described the impact of debt on the behavior of the financial system by defining three stages: “hedge”, “speculative” and “Ponzi financing”. Growth and prosperity were initially created through early loans, which increase confidence and in turn drive speculation. If and when higher rates slow revenue, the ability to pay principal and interest might be jeopardized, leading to Ponzi financing or default.
With large amounts of indebtedness, cash flow shortages could result in asset sales to meet obligations. Since assets are typically used as collateral against debt, deflation could have the same result. Deflation lowers the value of assets, making liabilities harder to pay back as money due has less purchasing power. This is the basis of Irving Fisher’s “Debt Deflation Theory”, a likely concern of the FOMC.
Where are we today? Let me answer it this way. Legendary investor Benjamin Graham distinguished the difference between investing and speculation by stating that an investment should afford, “Promises of safety of principal and a satisfactory return……operations not meeting these requirements are speculative”.
If the Fed is indeed worried about any of these dynamics, then waiting to extract itself from this state is only made more difficult by waiting. The longer it waits, the greater the probability that it gets trapped in a powerful vortex from which the only way to extract itself is to allow economic destruction and massive debt defaults. The point of no return may have already passed. Global indebtedness is at least three times what it was less than 10 years ago, and accelerating at a lofty pace.
What Should Investors Do?
Investors are too complacent (the Minsky-Moment). Too many are still trying to profit from the Fed subsidy of past stimulus. Investors remain loaded in risk assets, incentivized by the need to beat peers and benchmarks and comforted into complacency by the Fed ‘put’. The true level of risk is being ignored.
The pervasive mentality of seeking maximum risk has become a terrible risk/reward trade for two main reasons.
- Firstly, the Fed has fueled a massive stampede into financial assets, yet it can no longer provide any additional fuel in the form of interest rate cuts or via a growing balance sheet (QE4 will never happen). Promises of merely maintaining the current level of stimulus will be inadequate.
- Secondly, high prices mean lower future returns and greater downside. The fact that the Fed is close to ‘lift-off’, and close to shrinking its balance sheet (in 2016), means that downside risks are much greater than investors realize. The herd has not yet adequately de-risked.
Let me deviate here as some of you may still be focused on my comment that “QE4 will never happen”. Let me explain it very simply. The Fed is already under great scrutiny and criticism from many in Congress. Should the Fed attempt QE4, Congress would likely try to re-structure the Fed; likely jeopardizing its independence. In addition, the Fed does not want to ‘become’ the Treasury market (in spite of the Japan precedence). The Fed is already hoarding over 40% of all outstanding Treasuries longer than 10 years; and, in doing so, it is having a major impact on the repo market.
The time has arrived for asset managers, and those who construct portfolios or control investment money, to shift exposures. Most portfolios’ exposures primarily consist of stocks and bonds, many with a ‘60/40’ mix as their starting point. Adjustments typically take place through diversification and overlay factors consisting of variations in time, sector, and geography. Unfortunately, stock and bond diversification alone will not be enough to adequately protect a portfolio during the years that follow zero rates and global QE programs.
Comments and a “to-do list”:
- It is time to find ways to preserve capital. Return of capital strategies now trump return on capital pursuits. Particularly as uncertainties are growing due to: disjointed and confusing Fed communication; an opaque Chinese slowdown; the wild west of US politics and its elections; and EU refugees, to name a few.
- Where possible, transition from financial to real assets. As investors reduce beta and hidden beta exposures, consideration should be given to real assets, such as, real estate, farm land, collectables, art, and other non-correlated and less-cyclical assets.
- Cash has never had better optionality or a lower opportunity cost.
- I remain a bond bull in long Treasuries for regulatory, technical, and fundamental reasons. As I have outlined in several earlier notes, long-dated Treasuries still remain an excellent place invest.
- Find companies and countries with low levels of debt and stable cash flows.
- Despite recent bad press, alternative investments should be considered. Some specialized hedge funds are attractive, simply because they ‘hedge’ and are experts in a given areas.
- Place larger premium on market liquidity and counter-party risk.
Bottom line: As a result of central bank actions, many assets today pose too much risk for too little return.
“Never delude yourself into thinking that you’re investing when you’re speculating.” - Benjamin Graham
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How about peak manipulation of markets by the Fed?
NIRP is next - peak manipulation of interest rates
It's the Peak of Peaks! Look out below!!!
It makes little sense to me why the market is only pricing a 6% probability of a rate hike at the October meeting, 30% for December, and only a near 50/50 probability all the way out to March 2016.
A problem with the above: it makes little sense to you that the TPTB (the organizers) do not reasonably see a Fed rate increase in the upcoming year or next; well, I believe it is time to stop believing that they have incentive to instill solutions when and where needed. True, they could employ a number of solutions, but that is not on the table.
"consideration should be given to real assets, such as, real estate, farm land, collectables, art, and other non-correlated and less-cyclical assets."
But not gold and silver of course..
This article assumes economic sanity and clarity are actually anywhere at the table to receive his recommendations. It seems the author just realized that there are major systemic problems, but has yet to recognize that it is not due to incompetence or ignorance, it's INTENTIONAL.
or peak lows
OR..... we could continue down the Japan path for a few more decades, which has always been my core thesis since I came to ZH. If the Fed never raises rates the "Minsky Moment" can be put off indefinitely.
Say they raise rates. What happens? Dollar appreciates relative to other currencies, instant recession from which the Fed would need to quickly retreat. Also, the precious interest expense on that $18T in government debt starts to eat into sacred-cow spending priorities. They know this. They know all of this shit that we think only we know. They will lie indiefinitely but they will still monetize government debt and support the market with liquidity, from which they can't retreat because there is no way to gracefully retreat from a liquidity trap.
As for this:
"Should the Fed attempt QE4, Congress would likely try to re-structure the Fed; likely jeopardizing its independence."
Yes, in the unlikely scanario that the Fed loses it's "independence" it would only to become a government agency whose first priority will be to DIRECTLY monetize government debt issuance instead of doing it indirectly through the banks.
We're on our way to a mandatory .gov-run single payer healthcare system. Why not banking as well?!?
QE4 won't happen but our congress will "restructure" the FED? Is this guy living in an alternate reality? QE2 happened, QE3 happened, it follows that when QE doesn't work there is another one, then another one, because once you go QE you can't go back.
It doesn't follow that congress will "restructure the FED" (whatever that means) if QE fails because it already did twice and congress didn't blink.
Doesn't the FED/BIS fully fund and run the Congress?
The gvt will default and take QE4 with it, hows about those apples?
The Japan path theory does not account for the sheep growing restless, 3-4 more decades of increasing poverty and staglfation seems to unrealistic when the inevitable choice of revolution or starve to death comes home to roost.
This guy is too smart by half.
It's got to the point where they must be amazed they got thru the week without a black swan event. Collapse. Only to have to do it all OVER again on each Sunday Night. Seems like a pointless exercise to me. RESET.
NIRP creates a powerful incentive to hold and use cash versus credit/debit cards. This is bad for the globalist agenda, and practically, there isnt enough cash.
Digital cash by law.
haha good joke: The statutory mandates of the Fed as stated in the Federal Reserve Act are “maximum employment, stable prices, and moderate long-term interest rates”. All three have been fully realized.
the stupidity of the last statement aside, the fed's true mandate is all about stealing everything from the peasants. i assume the rest of the article was bullshit based on a bunch of totally false premises stemming from the original error. the fed will never raise rates because doing so would crash the system. wouldnt know because i stopped reading immediately.
A-fuckin-men
The last sentence is true - that true risk isnt priced into many asset prices.
The paragrphs before that are filled with false statements.
Maybe the very first few words provide a clue - - the guy works for a bank.
Please, stop it! There is NO risk. It's like f..g a pillow.
Fuck it, they're gambling with our money, not theirs.
Of course, they will keep any incidental profits. They will pretend that they knew what they were doing if everything goes well. But if it doesn't go well they will pretend like it was impossible to predict. This is getting to be a very old story.
RISK ON!
No, its their currency not your money. Youre just forced to use it (by laws their owned politicians put into effect).
This is how they view it.
So as Bernanke/Yellon did everything possible not to repeat the CB mistakes of the 1930s he/she instead creates a completly new situation, ie trapped in ZIRP, which ends up as the same result.
Central Bankers - those who back themselves into corners they themselves create...
Moral of the story: Do NOTHING, let the markets do their thing, history proves they do it very well.
They know they are repeating the same thing; only they want to do a more complete job of it.
https://www.youtube.com/watch?v=jt377DV2BKs
I call it PEAK KEYNSIAN. It doesn't end well.
Nice to see Tylers use a Peak Oil "You Are Here" graph as a thumbnail
Peak tits-up.
how can you read past the first paragraph? The whole argument is based on bullshit...
I'm printing out a blank copy of my sales reports...I'll just fill in the numbers that I want....yeah I ready did $10,000,00. in sales for Q3...and I made 10k cold calls and didn't have a single return.....now come review time I should get a huge raise....this is a wonderful new system...
Dear Mr. Haselmann,
If they raise rates it is game over; therefore rates will not be raised until the end is in play. The only thing that matters now is propping up the stock markets and pumping out the "everything is awesome" propaganda. No charge!
Sincerely,
????????
Fractional Reserve banking exists for the sole purpose of promising the same asset in total to two separate entities, like a car salesman who sells the same car to two buyers, and then manages pick-up and drop-off times and authorised parking locations hoping the buyers will never realize they are sharing a car they thought they owned.
That is theft because the banker isn't ceding control to the new owner.
It is fraud because the banker is collecting 'sales' money in the form of interest but actuall implementing a trumped up rental.
A 'Flexible Currency' managed by a 'Central Bank' exists for one and only one reason...to keep this banker theft and fraud from being detected until it has become so pervasive that entire national and international monetary systems collapse.
The elites in the west fail to realize that for them to receive something-for-nothing via a rental charged and advertised as a sale, someone productive must receive nothing-for-something. That is a recipe for less makers of 'somethings' and more banker-like and banker-lite fraudsters.
Too few 'somethings' being made under the crushing weight of officialdom will result in robber and robbed starving together.
What the multitude of parasites masquerading as humans fail to understand is that when they rob the productive they also rob themselves.
Calling the PPT; you are needed at your HFT stations - NOW!
wrong about inflation and jobs - everyone of those metrics is made up.
right about peak debt - sucks when you have to pay the bills, don't it.
right about low rates fueling more speculative debt - CAPEX, what? I want a bonus. Can you say "Buybacks"
wrong about congress restructuring the FED. - Congress is praying that the FED bails them out. Those fuckers haven't LED anyone or anything for decades. They're all about talking big but avoiding any real responsibility.
Wrong about QE4. It's coming. in one form or another. Yellen will be shitting her pants when the world economy can't pay it's bills... see peak debt.
finally: Everything is Speculative now-a-days. Including cash. ask yourself just how stable the american dollar is? or land. Go ahead. buy that overpriced rental on credit. see what happens when the renters can't pay anymore. and the bank still sends you the mortgage bill. how about PM's. like they won't continue to be heavily manipulated as they pose a threat to the currency. hell, they'll probably be confiscated.
Time for a terror attack to blame for collapsing everything. Aggression against the US can be seen everywhere.
"The unemployment rate is 5.1% (full-employment). Core CPI has been stable for years and printed 1.9% yesterday; remarkably close to the Fed’s self-imposed target of 2%."
Stopped reading right there. GIGO.
Not a terrible article, but notice this:
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#1: long-dated Treasuries still remain an excellent place invest.
#2: Find companies and countries with low levels of debt and stable cash flows.
Right. Long-dated treasuries... from the most indebted entity in the history of the universe? Seems a bit of a contradiction to me!
Of course, if this guy invests with a week or month timeframe, that might work. But on any longer timeframe... very bad advice.