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The Fed's Confidence Game Is Ending

Tyler Durden's picture




 

Submitted by Joseph Calhoun via Alhambra Investment Partners,

Immediately after the Fed hiked interest rates last Wednesday – after sitting at 0% for 7 years – markets acted pretty much as one might expect. The Fed tightens monetary policy when the economy is strong so rising stock prices, rising interest rates and a strong dollar are all things that make sense in that context. I am sure there were high fives all around the FOMC conference room. Too bad it didn’t last more than one afternoon. By the close Friday, the Dow had fallen nearly 700 points from its post FOMC high, the 10 year Treasury note yield dropped 13 basis points, junk bonds resumed their decline and the dollar was basically unchanged. Not exactly a ringing endorsement of the Fed’s assessment of the US economy.

I’m not saying the Fed’s rate hike is what caused the negative market reaction Thursday and Friday. The die for the economy has likely already been cast and right now it doesn’t look like a particularly promising roll. Raising a rate that no one is using by 25 basis points is not the difference between expansion and contraction. And a bit over a 3% drop in stocks isn’t normally much to concern oneself with; a 700 point move in the Dow ain’t what it used to be.

The pre-existing conditions for the rate hike were not what anyone would have preferred. The yield curve is flattening, credit spreads are blowing out and the incoming economic data is not improving. Inflation is running at a fraction of the Fed’s preferred rate and falling oil prices have been neither transitory nor positive for the economy, at least so far. The Fed is not unaware of this backdrop – they may not like it or acknowledge it publicly but they aren’t blind – but seems to have decided the financial instability consequences of keeping rates at zero longer are greater than any potential benefit. A sobering thought that.

The stock market drop, the rally in Treasuries, the falling commodity prices, the rout in the junk bond market – none of these are particularly new developments and the Fed’s action last week changed none of them for longer than a few hours. The stock market, in case you missed it, peaked almost 18 months ago and the average stock is already nearing bear market territory regardless of what the averages might say. The 10 year Treasury yield is unchanged in the last year, something that seems impossible considering all that has happened in that time. The path to those unchanged levels was a roundabout one – volatility is up about a third from last year – but the message is pretty clear. If economic growth was expected to accelerate bond yields would be higher. If corporate earnings were expected to rise, stock prices would be higher.

It may be too late to avoid the financial instability issues that have the Fed concerned. As is often the case, the Fed now finds itself monitoring a potential problem created by its own policies. The junk bond bust has been characterized as mostly about energy and that is still more true than not. But you can’t have the bust without first having a boom, this one, like the housing boom before it, a direct result of the Fed’s easy money policies. A weak dollar and cheap credit were the fuel for the shale boom. It only took the end of one of those to usher in the bust and now the Fed is trying to end the second, closing the barn door long after the horse has absconded to the back forty.

I have no idea yet how the Fed’s rate hike will impact the economy and markets. I am certain the Fed doesn’t either no matter how much they might pretend the opposite. We don’t know if the tools they are using to raise rates will be effective or even what effective means. Will the Fed’s use of reverse repos shift deposits from banks to money market funds? That seems to be the consensus but what would it mean for the economy? And what if it doesn’t happen? It seems to me that may depend on whether return of or return on capital is more prized. What about interest on excess reserves? Will there be any impact on lending or are banks’ energy and leveraged loan portfolios already a constraint? I’d bet on the latter right now.

The Fed seems to have been operating on the theory that their own views on the economy determine its path. That is probably true to some degree; certainly a Fed chair’s words have at least a short term impact on markets and therefore the economy. But recently the Fed has taken the principle to an extreme never seen. Yellen may well have just hiked rates expecting, hoping, that the mere act of showing confidence in the economy would produce an economy worthy of confidence. The Fed’s hope of influencing the course of the economy with their words is undermined by their use of tools no one understands. One fears that includes the Fed.

The Fed was more concerned last week with how their action or lack of action would be perceived by the market than whether it was the right policy. Having spent a year preparing the market for a rate hike and disappointing those expectations more than once, they had little choice but to finally follow through. The problems in the junk bond market took a back seat to the Fed’s reputation. The problem with the Fed’s communication policy, as I’ve pointed out repeatedly, is that its success is dependent on the Fed’s forecasting ability. Their lack of skill in that department means that a policy intended to reduce uncertainty – about future policy – has instead produced more.

The course of the economy and markets will not be materially changed by the Fed’s policy adjustment last week. It does not change my view of the economy or markets one bit. The stock market has been making a broad top, producing no gains for the last 18 months. Treasury note and bond yields are low but preferable to credit risk at this point in the cycle. A recession, when it comes, seems likely to push those yields a lot lower while there seems little risk of inflation in a world beset by excess capacity in almost every industry. In short, duration seems a better risk than credit right now.

The Fed has dominated the narrative for years now, investors and traders hanging on every word. Last week that started to change, the market repudiating the Fed’s outlook over a 48 hour period that must have produced some second guessing at the Fed. The heavy exertions of the world’s central banks have coincided with an economic recovery but that does not mean that monetary policy created the recovery. It may be that the weakness of the recovery is what we should be ascribing to monetary policy not its existence.

The Fed’s ability to influence the economy through its words was always an illusion anyway. The economy is far larger than the Fed and it will do what it needs to do. When investors decide they don’t want to take the risk of owning junk bonds they will sell them no matter what the Fed does with interest rates or rhetoric. When they do there are real world economic consequences as credit availability is reduced at the margin. Volatile currency markets have an impact on capital flows and investment, changing the global economy in ways the Fed can’t anticipate and can’t factor into its models. The Fed is no different than any other government planning agency, falling victim to the fatal conceit, the pretense of knowledge sufficient to shape events in knowable ways.

The Fed’s confidence game is coming to an end.

 

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Mon, 12/21/2015 - 11:08 | 6948776 UndergroundPost
UndergroundPost's picture

FED = Fucked Every Day

Mon, 12/21/2015 - 11:24 | 6948843 SoilMyselfRotten
SoilMyselfRotten's picture

Hmm, FED, I was thinking, Facilitating Earthlings Demise

Mon, 12/21/2015 - 23:02 | 6951570 philipat
philipat's picture

Are they really so full of their own omnipotence that they believe they can change reality? As Ayn Rand said "You can ignore reality but you cannot ignore the consequences of realty".

Mon, 12/21/2015 - 11:08 | 6948780 franzpick
franzpick's picture

The fed: MISSION IMPOSSIBLE

Mon, 12/21/2015 - 11:08 | 6948781 Boscovius
Boscovius's picture

Yellen jumped the shark.

Mon, 12/21/2015 - 11:09 | 6948784 youngman
youngman's picture

You bet they are running scared...they know they should have not raised...but they backed themselves into the corner with all their talk.....so now they did..and at just the wrong time....watch the first quarter numbers crash

Mon, 12/21/2015 - 11:54 | 6948991 Rip van Wrinkle
Rip van Wrinkle's picture

There aren't many things I'll assure you about in this crazy, crazy world but one thing I will assure you of: you will never, ever see first quarter, secong quarter, in fact any quarter numbers 'crash'. You will be told what the authorities want you to hear and you will be considered a 'conspiracy nut' if you disagree. In fact, you'll be deemed 'psychologically damaged' and whipped off to the nearest insane asylum for re-education.

Mon, 12/21/2015 - 12:09 | 6949066 DeadFred
DeadFred's picture

The confidence game may be ending but it isn't over yet. 

Mon, 12/21/2015 - 11:12 | 6948795 Kolchak
Kolchak's picture

Ended a loooong fucking time ago around here.

Mon, 12/21/2015 - 11:14 | 6948798 NoDebt
NoDebt's picture

1937.

Mon, 12/21/2015 - 12:39 | 6949217 KnuckleDragger-X
KnuckleDragger-X's picture

1984

Mon, 12/21/2015 - 11:21 | 6948827 pndr4495
pndr4495's picture

The English word economy was born out of the Greek word OIKONOMOS - bursar, butler, steward - manager of a household. Put up a graph of the purchasing power of a $ and grade the Fed on their stewardship of the US Economy since 1913. The citizens' wealth was siphoned into the owners' coffers.

Mon, 12/21/2015 - 11:26 | 6948829 Dre4dwolf
Dre4dwolf's picture

There are no " real " jobs out there.

The economy we have now is pretty much everyone who is unemployed going to the bar paying for other people who are employed to give them finger food and beer.

Not a very productive economy.

Not to mention the longer term health issues such an economic model creates...... during a time where government has made health care completely unaffordable for average middle class families....

 

Quite frankly this economy sucks and if you aren't connected to the club of counterfeiters (The Fed/Big Mega Super Evil Corp Banks) you aren't going to do well because none of the scraps falling off the table during the countries collapse will get to you.

And global demand isn't there to really support the re-birth of a " real economy " where people produce products in the U.S. and ship them abroad to fix the trade imbalance.

Laws, Taxes and Government penalties pretty much ensure that the trade deficits can never really be fixed and that real jobs cant form in America, not when your competition (China) essentially has a population willing to breath mercury vapor at work to produce cheap chinese products to ship to the U.S. consumer who doesn't have the disposable income to pay more for a product made in the U.S. because.... he doesn't have a job in the U.S. making U.S. products.

 

Bullish Precious, and Guns.

Mon, 12/21/2015 - 11:23 | 6948840 rsnoble
rsnoble's picture

I'd say confidence is going right out the window.  Thus the big gun control push.  It's hard for them to make their psychological games work when we can call pure bullshit based on hard evidence on the internet in mere seconds.

Mon, 12/21/2015 - 11:34 | 6948869 two hoots
two hoots's picture

From an earlier ZH article on can simply replace "US foreign policy" with the "Federal Reserve/they" and that is where we are in all things gov

retired U.S. Army Colonel Lawrence Wilkerson tells Abby Martin, adding that "today the purpose of US foreign policy is to support the complex that we have created in the national security state that is fueled, funded, and powered by interminable war."

  "today the purpose of Federal Reserve policy is to support the complex that they have created in the Central Bank state that is fueled, funded, and powered by interminable financial turmoil." 


Mon, 12/21/2015 - 11:32 | 6948883 mayhem_korner
mayhem_korner's picture

 

 

The Fed's Con game is ending.

Mon, 12/21/2015 - 11:37 | 6948906 two hoots
two hoots's picture

Their control of the US money supply will never end, and that leaves us where?

Mon, 12/21/2015 - 15:50 | 6950072 TheDanimal
TheDanimal's picture

When nobody gives a shit about the USD at all, why would the level of supply matter?

Mon, 12/21/2015 - 11:39 | 6948913 THE DORK OF CORK
THE DORK OF CORK's picture

Bit of a liberal cat fight going on in Naked capitalism blog land.
This at least brings a smile to my face.
MMT / Fed talk = usury and pointless economic expansion
Those bastards will not allow discourse.
They are playing a classic propagandistic campaign.
As in you must adopt their language and framework or be cast out as a ignoramus.
Even some of the remaining ass lickers who have not been expelled are beginning to have doubts

Mon, 12/21/2015 - 11:44 | 6948932 gmak
gmak's picture

Realistically, one could say the con game goes on.  The way the FED raised rates is not by withdrawing liquidity from the system so that the FED Funds' Rate become a price discovery mechanism for loans between banks. They did it by allowing the NY FED to pay interest on deposits.  If banks have too much money they can either park it with the NY fed or lend it to banks who don't have enough (to meet capital and liquidity overnight requirements). 

 

IF the FED had drained liquidity, the FED Funds Rate rises because banks have to pay more to get a scarcer resource for their regulatory needs. Instead, they just raised the deposit rate which means that banks needing to borrow have to pay more because the lender could simply deposit it at the NY FED for the higher rate. This also shows up in the fact that banks' deposit rates did not rise. If you have sufficient funding, you don't have to pay more to attract deposits because you don't really need them.

 

In other words, the FED Funds Rate is saying nothing about the market and everything about the money printing con. It goes on. Markets should stabilize for a while now that the "market" sees what the FED is really doing.  It took a day or to for the system to realize that it was business as usual. Hint: Watch the reverse repos daily action - NO CHANGE.

Mon, 12/21/2015 - 11:47 | 6948951 THE DORK OF CORK
THE DORK OF CORK's picture

What they are clearly attempting to do is to get you transfixed.

To observe the world through the prism of financial capital and accept its reality.

They put their financial architecture over and above the physical world.

 

My simple but correct observations that one must travel further and further to access the Industrial surplus therefore reaches only dead air as they have defined observational reality and not outside observers of that reality.

Mon, 12/21/2015 - 11:56 | 6948999 Ignorance is bliss
Ignorance is bliss's picture

Banks have 25 Billion on deposit at the Fed. The interest rate moved from 1/4 point to 1/2. Interest paid on those reserves =  1.25 Billion. Where does all that money come from? From the crack of the Fed's ass. Not bad for doing absolutely nothing productive. Welfare for the well connected.

Mon, 12/21/2015 - 23:12 | 6951600 philipat
philipat's picture

Correct BUT the excess reserves on deposit at The Fed is around 2 TRILLION, so the interest quickly adds up. It sure beats working or taking any risk lending into the real economy...

Mon, 12/21/2015 - 11:59 | 6949019 DOGGONE
DOGGONE's picture

WHY does the Fed not show us this:
http://showrealhist.com/yTRIAL.html

BECAUSE the establishment are CONPERSONS first.

Mon, 12/21/2015 - 12:01 | 6949025 THE DORK OF CORK
THE DORK OF CORK's picture

At 12.30 in the above video.

 

Goodmans false perception of reality comes from price and not the physical world.

 

This was what the FED /MMTers want to project.

That their price system resides above the physical world.

Mon, 12/21/2015 - 12:02 | 6949033 InnVestuhrr
InnVestuhrr's picture

FED's decision to raise rates NOW was not dependent upon economic data.

The FED makes decisions based upon many more factors than economic data, and those other factors are NEVER reported to the public by anyone by any means, especially the highly crafted-to-achieve-specific-goals FED minutes not even the FED's unofficial WSJ mouthpiece.

I predict that the FED will also hike again at the Mar meeting, regardless of USA market and economic data, unless there is an economic crash.

Mon, 12/21/2015 - 12:03 | 6949037 THE DORK OF CORK
THE DORK OF CORK's picture

 

At 12.30 in the above video.

 

Goodmans false perception of reality comes from price observations  and not the physical world.

 

This was what the FED /MMTers want to project.

That their price system resides above the physical world.

 

Mon, 12/21/2015 - 12:29 | 6949160 xyzcracker
xyzcracker's picture

Maybe the false flags will end also

Mon, 12/21/2015 - 14:08 | 6949668 jmeyer
jmeyer's picture

 "The Fed is no different than any other government planning agency, falling victim to the fatal conceit, the pretense of knowledge sufficient to shape events in knowable ways."

The Fed IS different. It has CONTROL and POWER. The Banksters have been chasing this goal for over 250 years, staring with the Rothschilds and even maybe with the Knights Templar long before them. There are BIG power moves and cycles in play. Central banks now see the light at the end of the tunnell and they are trying to have the main seat in the chamber of those who rule the world ( IMO of course ).

Mon, 12/21/2015 - 14:21 | 6949729 tictawk
tictawk's picture

At the end of the day the Market is bigger than the Fed.  In the short term, ZERO cost of money has a huge impact because those who can borrow at that rate can play lots of leveraged games.  Our debt problems were only temporarily offset because the Fed fueled debt based growth via ZIRP.  But you cannot solve a debt based problem by creating more debt.  At some point all debt must be reconciled. 

Mon, 12/21/2015 - 21:37 | 6951198 Barrack Chavez
Barrack Chavez's picture

The Fed was only as powerful as the government that sponsored it. Since Uncle Sam is functionally bankrupt ($20 trillion on-balance sheet debts, additional $80 trillion off balance sheet debt, many more trillions in empty unfunded "promises"), with two idiots at the helm (Obama / Ryan), and slim pickings for the next "leadership" (maybe Trump can fix finances, but he sounds like a police state extremist... Hilary is just a liar). Politicians go from armored cars to armored helicopters to special 5-star conferences and never interact with the people they tax.

Decades ago, the Bank of England used to be important, but then its host government followed Keynes advice and went bankrupt.

Same sh!t, different year.

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