Just over an hour ago the Fed disclosed that as part of its most recent reverse repo operation, it had handed out to 93 dealer banks and other financial intermediaries, both foreign and domestic, some $242 billion in Treasurys in what is now the biggest reverse repo operation in history, a privilege for which the collateral-starved banks paid the Fed the king's ransom of 0.05% in annual interest, i.e., nothing.
"The idea that stimulation, even if only in form but not reality, can be withdrawn without draconian economic results is simply false. Chair Yellen is truly dedicated to full employment and is going to go into shock over the next few short months at the divergence between her economic modeling, the behavioral economic projections and the degree of economic contraction in the US." The US (and world) economy are not growing. Ben Bernanke and his counterparts in other countries pumped like mad to hide the dysfunction. Flooding with liquidity did nothing to heal the distortions and made them worse.
Chart 1 proves it is crystal clear that every time the US Federal Reserve acts to "save us" from one crisis, it directly sows the seeds for an even bigger crisis in the future.
As promised, the Johnson/Crapo bill has finally arrived. There are 442 pages of legal mumbo jumbo, guaranteed to cure all forms of insomnia and those suffering from low blood pressure. The agencies have been providing cheap financing to borrowers, courtesy of the Fed. The agencies have been providing cheap and bullet proof insurance for bond investors, courtesy of the Treasury. The Bill somehow expects some mysterious private capital will come in to insure the first loss position and the Government (including the FOMC) can gracefully exit its role in the mortgage monopoly. That is more than overly optimistic. Can anyone quantify that in dollars as well as mortgage rates? In summary, the Bill is going to increase mortgage compliance costs. It will confuse, rather than clarify, the mortgage application and approval process. It is a disaster. Fortunately, we suspect the Bill has no chance of passing in its present form.
Apparently China did not get the memo that the Fed's apologists are furiously scrambling to packpedal on Yellen's "6 month" guidance in virtually all media outlets. The is the only way to explain why Vice Minister of Finance Zhu Guangyao said overnight that "the U.S. Federal Reserve will begin boosting interest rates within six months after exiting “unconventional” monetary policy, and that will have a “significant impact” on the U.S. and world economy, as Market News International reported earlier. Zhu told China Development Forum this weekend “we believe a the Fed meeting this October, the exit of their quantiative easing will complete." In other words while the spin for public and algo consumption is that the Fed will continue placating those long the stock market until everyone's price target on the S&P 500 is hit and everyone can comfortably sell into an ever-present bid, China is already looking for the exits. But while the end of QE appears a given, at least until the market realizes there is no handover to an economy that is a moribund as it has ever been in the past five years, and the Fed has no choice but to untaper and return with an "even more QE" vengeance (it certainly won't be the first time - just recall the "end" of QE1, QE2, Op Twist, etc), a bigger question surrounds whether China, already sliding in credit contraction and suffering a plunging stock market with its housing sector also on the edge of a bubble bust, is about to take over from the Fed and proceed with its own stimulus program. The answer is no.
The red flags contained in the national and global headlines that have come out thus far in 2014 should have spooked investors and economic forecasters. Instead the markets have barely noticed. It seems that the majority opinion on Wall Street and Washington is that we have entered an era of good fortune made possible by the benevolent hand of the Federal Reserve. Ben Bernanke and now Janet Yellen have apparently removed all the economic rough edges that would normally draw blood. As a result of this monetary "baby-proofing," a strong economy is no longer considered necessary for rising stock and real estate prices. But unfortunately, everything has a price, even free money.
Despite the total collapse (flattening) in the Treasury yield curve in the last 2 days, Citi's FX Technicals group is convinced that we have seen a turn in fixed income that will see significantly higher yields in the years ahead and notably higher yields by this yearend also. Furthermore, they believe this will initially come from the belief in a continued taper, and the curve will initially steepen (2’s versus 5’s and 2’s versus 10’s). This normalization, they add, will be a good thing - QE encourages misallocation of capital and poor business decisions which has a negative feedback loop into the economy - but add (as long as yields do not go too far too fast like last year).
Once again there has been little fundamental news or economic data this morning in Europe with price action largely driven by expiring option contracts. In terms of key events, Putin says Russia should refrain from retaliating against US sanctions for now even as Bank Rossiya discovered Visa and MasterCard have stopped servicing its cards, and as Putin further added he would have his salary sent to the sanctioned bank - the farce will go on. Continuing the amusing "rating agency" news following yesterday's policy warning by S&P and Fitch on Russian debt (was that a phone call from Geithner... or directly from Obama), Fitch affirmed United States at AAA; outlook revised to stable from negative, adding that the US has greater debt tolerance than AAA peers. Perhaps thje most notable move was in Chinese stocks which rallied overnight after major domestic banks said to have stopped selling trust products which were blamed for encouraging reckless borrowing and diluted credit standards. Speculation of further stimulus and the potential introduction of single stock futures also helped the Shanghai Comp mark its biggest gain of 2014 closing up 2.7%.
Why Mainstream Economists Like Krugman Are So WRONG and So DANGEROUS
There are three things that are often spotted, widely believed, and actively sought after with little evidence they actually exist: Big Foot, Ghosts and Economic "Soft Landings." Over the past 159 years, there is not much evidence that an economic "soft landing" has ever occurred. However, it is not without precedent that as the economy reaches the latter stage of the growth cycle that the words "soft landing" are uttered by economists and Federal Reserve members. Why do we bring this up? Bihnamin Appelbaum, via the New York Times, recently interviewed John Williams, the President of the Federal Reserve Bank of San Francisco, who stated: "John Williams, president of the Federal Reserve Bank of San Francisco, is feeling pretty good about the economy. He is ready to continue the Fed’s retreat from bond-buying and forward guidance. And he says he’s optimistic that this time, the Fed will manage to produce a soft landing."
From a strictly empirical perspective, the Keynesian theory is a disaster. Positivism wise, it’s a smoldering train wreck. You would be hard-pressed to comb through historical data and find great instances where government intervention succeeded in lowering employment without creating the conditions for another downturn further down the line. No matter how you spin it, Keynesianism is nothing but snake oil sold to susceptible political figures. Its practitioners feign using the scientific method. But they are driven just as much by logical theory as those haughty Austrian school economists who deduce truth from self-evident axioms. The only difference is that one theory is correct. And if the Keynesians want to keep pulling up data to make their case, they are standing on awfully flimsy ground.
A critical element for investors to consider is that the Fed is not forward thinking when it comes to monetary policy. Indeed, if we reflect on the last 15 years, we see that the Fed has been well behind the curve on everything.
Perhaps it was his comments today that "a construction boom is coming... tune out the noise and enjoy the bull market" due to lower oil costs and improving weather; but it appears JPMorgan and the permabull are about to part company after 15 years:
*JPMORGAN U.S. CHIEF EQUITY STRATEGIST THOMAS LEE DEPARTS FIRM
*JPMORGAN ANNOUNCES LEE'S DEPARTURE IN INTERNAL MEMO
It is unclear if Lee's next career will be as waterboy for Ben Bernanke on his $250,000/speech global speech tour. What is, however, likely is that in his place JPM will simply unleash an algorithm that keeps raising JPM's "official" S&P500 price target to 100 points above wherever the S&P may be at any given moment.
"Higher equity prices will boost consumer wealth and help increase confidence, which can spur spending" - Ben Bernanke, 2010 But history suggests the opposite: it is higher savings rates which lead to economic prosperity. Examine any economic success story such as modern China, nineteenth century America, or post-World War II Japan and South Korea: did their economic rise derive from unbridled consumption, or strict frugality? The answer is self-evident: it is the savings from the curtailment of consumption, combined with minimal government involvement in economic affairs, which generates economic growth.
In setting the price of money, we have given central bankers the power to effectively set the price of... everything. Make no mistake, this is a form of price controls; and one day (probably soon), future historians are going to look back and wonder how so many people could be bamboozled. We have somehow been conned into believing that the path to prosperity is for the grand wizards of the financial system to conjure paper currency out of thin air. Yet this notion of 'money backed by nothing' is an absurd fantasy that has failed every single time it has ever been tried before in history. We bring this up because the following chart highlights the Fed's margin of safety before confidence wanes...