Dallas Fed's Fisher: "We Own A Significant Slice Of Critical Markets. This Is Something Of A Gordian Knot"Submitted by Tyler Durden on 08/05/2013 10:56 -0500
"This is a delicate moment. The Fed has created a monetary Gordian Knot. Whereas before, our portfolio consisted primarily of instantly tradable short-term Treasury paper, now we hold almost none; our portfolio consists primarily of longer-term Treasuries and MBS. Without delving into the various details and adjustments that could be made (such as considerations of assets readily available for purchase by the Fed), we now hold roughly 20 percent of the stock and continue to buy more than 25 percent of the gross issuance of Treasury notes and bonds. Further, we hold more than 25 percent of MBS outstanding and continue to take down more than 30 percent of gross new MBS issuance. Also, our current rate of MBS purchases far outpaces the net monthly supply of MBS. The point is: We own a significant slice of these critical markets. This is, indeed, something of a Gordian Knot."
There are very few segments of the U.S. economy that are more heavily affected by interest rates than the real estate market is. When mortgage rates reached all-time low levels late last year, it fueled a little "mini-bubble" in housing which was greatly celebrated by the mainstream media. Unfortunately, the tide is now turning.
- "Ooops": Barclays reveals £12.8bn balance sheet hole (FT), Barclays Bows to Pressure With Share Sale (WSJ)
- Bank of Italy Inspecting Top Lenders' Books (WSJ)
- Obama to propose 'grand bargain' on corporate tax rate, infrastructure (Reuters)
- China injects funds into money markets, quelling fears (FT)
- Berlusconi faces verdict that could endanger Italian government (Reuters)
- Shale Threatens Saudi Economy, Warns Prince Alwaleed (WSJ)
- Qatar Finds Revolution Abroad Not as Easy as Stock Picks (BBG)
- Cities Begin Hiring Again (WSJ) - not to mention filing for bankruptcy
- Big Question Hangs Over Small-Caps (WSJ)
- China Politburo Pledges to Press On With Restructuring Economy (BBG)
- Bank Revenues Surge on Trading Over What Fed Will Do (BBG)
If there was any doubt that the Fed would proceed with tapering its monthly deficit monetization (i.e., $85 billion in POMO/S&P500 flow injection) over the next few months, those were just laid to rest courtesy of the Treasury's quarterly refunding statement which was filed moments ago, and specifically its Marketable Borrowing Estimates.
Here’s a question– if you’re in the Land of the Free, do you think those green pieces of paper in your wallet are dollars? They’re not. Those green pieces of paper are Federal Reserve notes. “Notes” in this case meaning liabilities to the central bank of the United States. That makes you, me, and anyone else holding those green pieces of paper essentially creditors of the Federal Reserve, whether we signed up for it or not. And at this point, thanks to a long-standing policy of wanton money printing, the Fed has more liabilities than ever before in its history. By an enormous margin. Given that the Fed’s assets are so closely tied to the finances of the US government, the outlook should concern independent, thinking people. The US, Japan, and Europe are already too indebted to bail out their central banks. An insolvent government cannot bail out an insolvent central bank.
The optimism over the housing recovery has gotten well ahead of the underlying fundamentals. While the belief was that the Government, and Fed's, interventions would ignite the housing market creating an self-perpetuating recovery in the economy - it did not turn out that way. Instead it led to a speculative rush into buying rental properties creating a temporary, and artificial, inventory suppression. The risks to the housing story remains high due to the impact of higher taxes, stagnant wage growth, re-defaults of the 6-million modifications and workouts and a slowdown of speculative investment due to reduced profit margins. While there are many hopes pinned on the housing recovery as a "driver" of economic growth in 2013 and beyond - the data suggests that it might be quite a bit of wishful thinking.
Have you ever seen a disaster movie that is so bad that it is actually good? Unfortunately, we are witnessing something just as ridiculous in the real world right now. In the United States, the mainstream media is breathlessly proclaiming that the U.S. economy is in great shape because job growth is "accelerating" (even though we actually lost 240,000 full-time jobs last month) and because the U.S. stock market set new all-time highs this week. The mainstream media seems to be absolutely oblivious to all of the financial storm clouds that are gathering on the horizon. The conditions for a "perfect storm" are rapidly developing, and by the time this is all over we may be wishing that flying sharks were all that we had to deal with.
As Erskine Bowles notes "Everyone claims that they’re not going to let our nation default. And Lord knows we all ought to pray that they don’t. But, could it happen? You bet." But it seems the world has forgotten that between the "grand bargain' negotiations and the looming final-final debt ceiling deadline, the US fiscal situation remains troubled at best. While Washington is "only capable of focusing on one big issue at a time," dominated currently by espionage, immigration, and scandals, Bowles notes, from mid-September to mid-November the fiscal issues will be forced into the headlines and he believes there is only a 20-25% chance a deal is struck. As Stone & McCarthy notes, the Treasury will exhaust its extraordinary measures to create borrowing authority on October 31, and run out of cash on November 1.
When mistakes are made, lawsuits happen and lawyers, and guys with capital make money.
It seems that US investors has become so institutionalized in the new normal world of government bailouts and handouts that when the central planners make a decision that is not instantly accretive to the equity shareholders' bottom-line, the first instinct is to sue them. Following the conservatorship that was forced upon FNM/FRE in 2008, which required the companies to pay a quarterly dividend of 10% on the government's near-80% stake (and obviously implicitly benefited the tag-along bailout riders), the decision in 2012 to change the bailout terms to instead hand over most of their profits to the government (since they moved into profitability - thanks to a Fed-sponsored MBS market). This action "impaired shareholder value" according to Perry Capital - who, Reuters reports, is suing the government, noting "investors had every right to expect these rules to be followed." Indeed, just as the 'rules' have been followed in every bailout that has occurred since 2007.
Not much in terms of economic data but lots of corporate news with the official Q2 earnings season kick off, as well as a plethora of Fed speakers which in a centrally-planned world, is all that matters.
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- Thomson Reuters Halts Early Peeks At Consumer Data (WSJ)
- Larry Summers Circles as Fed Opening Looms (WSJ)
- S&P to Argue Puffery Defense in First Courtroom Test (BBG)
- Geithner joins top table of public speakers with lucrative appearances (FT)
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- Pilot Error Eyed in San Francisco Plane Crash (WSJ)
- Investment group sues U.S. over Fannie, Freddie bailout terms (Reuters)
- Egypt officials 'order closure of Islamist party HQ' (AFP)
- Heinz Kerry Transferred to Boston Hospital for Treatment (BBG) - a boating accident?
Mortgage rates have increased more than 1 percentage point since early May, jumping half a percentage point since last week’s FOMC meeting, raising concerns that this rapid rise may derail the housing recovery and dim the outlook for the broader economy, especially in the context of generally tighter financial conditions. As Goldman notes, the rise in mortgage rates may impact the economy through two broad channels: (1) the direct impact on construction activity and home sales, which feed into the residential investment component of GDP, and (2) the indirect effects of lower home prices and less refinancing activity on consumption. Goldman estimates Housing Starts could plunge 11% in the coming quarters, total home sales could drop 7%, residential investment may fall 6 percentage points, could weigh on home prices, and pull up to 0.4 percentage points from real GDP growth - presenting a significant downside risk to their somewhat rosy current outlook.
"What just occurred [in the mortgage-backed-securities (MBS) market] is indicative of just how important QE is," as government backed US mortgage bonds suffer their largest quarterly decline in almost two decades. As Bloomberg reports, the $5 trillion market lost 2% in Q2, the most since the 'bond market massacre' in 1994 (when the Fed unexpectedly raised rates) as wholesale mortgage rates spiked by the most on record in the last two months. The reason these bonds have been hardest hit - simple - fear that the Fed's buying program is moving closer to an end. "The Fed, at times during this period, was the only outlet in terms of demand for securities," explains one head-trader, as the Fed’s current buying provided demand as other investors retreated and has grown as a percentage of forward sales by originators tied to new issuance, which is set to fall as higher rates reduce refinancing. With Fed heads talking back what Bernanke hinted at, there was a modest recovery in the last 2 days in MBS but the potential vicious cycle remains a fear especially now that “what was once deemed QE Infinity is no longer viewed that way."
- Fashionable 'Risk Parity' Funds Hit Hard (WSJ)
- No 1997 Asian Crisis Return as China Trembles (BBG)
- Greece Faces Collapse of Second Key Privatization (FT)
- China Bad-Loan Alarm Sounded by Record Bank Spread Jump (BBG)
- Iranian official signals no scaling back in nuclear activity (Reuters)
- Asmussen Says Any QE Discussions at ECB Not Policy Relevant (BBG)
- Flat Japanese consumer prices aid Kuroda (FT)
- Vietnam Devalues Dong for First Time Since ’11 to Boost Reserves (BBG)
- World Bank Sees ‘Vulnerable’ Food System on Climate Change (BBG)
- Fed big-hitters seek to quash QE fears (FT)
- EU Leaders Set to Slow Support for Ailing Banks (BBG)