The last time Hilsenrath tried to be relevant, back on May 22 [10], he essentially said to ignore anyone who tried to time the Taper (but don't call it a Taper) when he said: "when the Fed shuts off bond buying, it won’t be abrupt and it won’t be predictable." So just to make sure market expectations of tapering are actually very predictable, if at least on the short end, moments ago Hilsenrath once again hit the tape with the following: "Fed Likely to Push Back on Market Expectations of Rate Increase: Federal Reserve officials have been trying to convince investors for weeks not to overreact when the central bank starts pulling back on its $85 billion-per-month bond-buying program. An adjustment in the program won’t mean that it will end all at once, officials say, and even more importantly it won’t mean that the Fed is anywhere near raising short-term interest rates. Investors aren’t listening." So here comes the Hilsenrally to save the day by making investors listen, even if not so much for the benefit of stocks this time, as for bonds, which little by little are starting to lose it.
Some more hand-holding by Bernanke's proxy [11]:
Prices have been dropping in Eurodollar and fed-funds futures markets, for example, where investors make bets on future short-term interest rates. Those declines suggest investors expect higher short-term rates by late 2014. In the fed-funds futures market, for example, the expected fed funds rate in December 2014 is 0.35%. In the Eurodollar market, investors see 3-month rates borrowing rates rising to 0.67% by December 2014.
A similar message is coming from swaps markets, where the market is pricing in an average 0.37% fed funds rate between June 2014 and May 2015, according to BNP Paribas. That is up from an expected rate of 0.17% in early May.
The fed funds rate — which is an interbank borrowing rate — was 0.08% yesterday.
These movements aren’t huge and could quickly reverse, but they merit attention.
There are three possible explanations for the movements in expected short-term rates:
1) Money markets are out of whack for technical reasons.
2) The market is pricing in a stronger economy, which it in turn expects to prompt Fed rate increases.
3) Investors are starting to doubt the Fed’s commitment to keep short-term rates down.
Many market participants say it is the latter. “The market is saying, ‘The fundamental economic outlook really hasn’t changed much, but we are getting more worried about Fed policy,’” says Jan Hatzius, chief economist at Goldman Sachs.
Since last December the Fed has been promising to keep short-term interest rates near zero until the jobless rate reaches 6.5%, as long as inflation doesn’t take off. Most forecasters don’t see the jobless rate reaching that threshold until mid-2015
The confusion:
At the same time, however, the Fed is talking about pulling back on its $85 billion-per-month bond-buying program. The chatter about pulling back the bond program has pushed up a wide range of interest rates and appears to have investors second-guessing the Fed’s broader commitment to keeping rates low.
This is exactly what the Fed doesn’t want. Officials see bond buying as added fuel they are providing to a limp economy. Once the economy is strong enough to live without the added fuel, they still expect to keep rates low to ensure the economy keeps moving forward.
So we are back to the old regime where the Fed will continue unlimited easing in perpetuity, where any tapering will merely be a catalyst for imminent untapering, and where bad and good economic news is good news... for stocks.
The bottom line is that with the Fed controlling both the short and the long end, Bernanke thinks the market is nervous that just because the Fed is slowly losing control of the long end, the market thinks the short end will follow too. This of course is 100% wrong, just as Japan has shown in the past three weeks. It is not about short vs long end - it is about how the market reacts when there is a shift in the regime, and when the Fed's monthly Flow is impaired, even modestly. Also, note: despite the market reaction, this is not a validation that there will be no taper. Quite the opposite. It is merely a promise that the Fed will not let go of the short end. Period.
The biggest winner, as expected, are bonds, which almost got dragged to the intellectual level of idiot equities and have been selling off like crazy in the past few weeks: as if the Fed will ever stop monetizing the US deficit.
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