Bonds & Interest Rates

Pimco: Fed May Be Giving Investors ‘Too Much Guidance’

Posted by El-Erian - Pimco CE)

on Thursday, 27 June 2013 7:51

The Federal Reserve’s increased transparency, such as indicating last week that it may taper quantitative easing (The Fed’s massive easing itself can hurt markets, El-Erian tells CNBC. 

“The longer they stay unconventional, the deeper they venture with these experimental policies, the more the costs and the risks start to become large relative to the benefits,” he notes. 

But, “there’s a second really interesting issue, which is, are they giving us too much guidance?” 

The openness can accelerate market declines, El-Erian says.  (Ed Note: 

Just look at the amount of information the Fed has given investors, he states, adding that the Fed has thrown out lots of numbers for when it will start tapering QE, such as a 7 percent unemployment rate, a 6.5 percent unemployment rate, a date this year and a date next year.

“When you give so much guidance to the market, you risk over-determining,” El-Erian explains. “So what happens, people jump to the terminal values. They don’t even wait for the journey. They go immediately to the destination and the re-price. Then the bad technicals kick in.” 

Even St. Louis Fed President James Bullard questioned whether Bernanke went too far in specifying the central bank’s intentions.

Bullard said in a statement that he “felt that the committee’s decision to authorize the chairman to lay out a more elaborate plan for reducing the pace of asset purchases was inappropriately timed.”

Ed Note: It would seem investors are favoring the strategy indicated by both of these charts

usapowerfederal-reserve

 

The Bear Market in Bonds

Posted by Bill Bonner - Diary of a Rogue Economist

on Wednesday, 26 June 2013 18:28

Screen shot 2013-06-26 at 10.19.30 AM“We know it has to happen. And when it does, we’ll get out.”

One of the speakers at a conference we attended in London last week, a professional money manager, talking about the most important bit of investment information you are likely to get in your lifetime.

He was probably speaking for thousands of his colleagues. All confident that they would be able to spot the turn in the bond market when it happens… and all leave the party in good order.

We’re still in the wee hours of a bear market in bonds that will probably last until the middle of the century. In fact, we’re so early that when the sun finally rises we may find we are not yet in a bear market after all. The action over the last two months – and especially the last two weeks – may be just another of Mr. Market’s famous fake-outs.

(We think Mr. Market is doing a great fake-out job in gold, by the way. More on that tomorrow…)

But in the bond market, it looks like the real thing. The Dow rose 100 points yesterday. Gold fell by a couple of bucks an ounce. And Treasury bonds continued their slide. And, since it has to happen sometime, we will suppose that the bond market has put in its top now. If we are too early… we’ll enjoy a leisurely cup of coffee while other investors are scrambling for the doorway.

Rushing for Exits

 

Meanwhile, the New York Times reports that the exits are getting jammed:

Wall Street never thought it would be this bad. A bond sell-off has been anticipated for years, given the long run of popularity that corporate and government bonds have enjoyed. But most strategists expected that investors would slowly transfer out of bonds, allowing interest rates to slowly drift up.

Instead, since the Federal Reserve chairman, Ben S. Bernanke, recently suggested that the strength of the economic recovery might allow the Fed to slow down its bond-buying program, waves of selling have convulsed the markets.

The value of outstanding United States government 10-year notes has fallen 10% since a high in early May.

The selling has been most visible among retail investors, who have sold a record $48 billion worth of shares in bond mutual funds so far in June, according to the data company TrimTabs. But hedge funds and other big institutional investors have also been closing out positions or stepping back from the bond market.

“The feeling you are getting out there is that people are selling first and asking questions later,” said Hans Humes, chief executive of the hedge fund Greylock Capital Management.

That, by the way, is our advice. Get out now. You can ask all the questions you want later.

Everyone saw (or still sees) a turn in the bond market coming. Bonds have been going up for 33 years. They can’t go up forever. What can’t last forever has to stop sometime. This seems like as good a time as any.

But everyone cannot get out of their bond investments at the same time in a calm, orderly way. After three decades of bringing investors into the room, no trade is more crowded. When bond prices begin to go down… as they did the first week of May… the longer you wait to get out, the more you will lose.

So what do investors do? They head for the exits. All at once. And the bond market becomes an “owl market.” Everyone wants to sell. But “to who… to who?”

Owls are not trained in English grammar. They don’t know that the preposition “to” is followed by “whom,” not “who.” But they are good investors. And they know a developing disaster when they see one. Clever bond investors chose to stay at the party – even when they saw a little smoke rising in the corner. Now they have to decide what to do.

Some will hesitate… wait too long… and then, every bounce will encourage them to wait longer, hoping to recover their losses. Others will stumble and be crushed underfoot, selling their bonds at panic prices.

Is the panic happening already?

No. We’ve only smelled the first faint whiffs of fear. The 10-year T-note still yields only 2.58%. The really nasty odor will come later… when smoke fills the room… someone hits the fire alarm… and those clever investors find the exits blocked.

Regards,

bbonner-sig

Bill

About Bill Bonner

Bill Bonner founded Agora Inc. in 1978. It has grown into one of the largest independent newsletter publishing companies in the world. In 1999, along with Addison Wiggin, Bill founded The Daily Reckoning. Today, this daily e-letter reaches over 500,000 readers around the globe.

Bill has also co-written two New York Times bestselling books, Financial Reckoning Day and Empire of Debt. He has written or co-written other widely read books as well, and has penned a daily column at The Daily Reckoning for over 12 years. Recently, Bill decided to “retire” from his role at The Daily Reckoning and begin writing his Diary of a Rogue Economist.

Bill Bonner’s Diary of a Rogue Economist is your gateway to Bill’s decades of accrued knowledge about history, politics, society, finance and economics. Sometimes funny, sometimes frightening – but always entertaining and packed with useful insight, Diary of a Rogue Economist can help you make sense of the complex world we live in today.

 

China Acts to Calm Markets – Stock Market Rebounds

Posted by Mike "Mish" Shedlock: Global Economic Analysis

on Wednesday, 26 June 2013 8:13

Stock Market Rebounds From 6% Plunge After Central Bank Pledges More Liquidity; Wet Nurse Action

In the past few week, China intraday lending rates as measured by SHIBOR got as high as 25% (See China Cash Crunch: 1-Day Interest Rate Spikes to Record High 25%).

With rates spiking, global stock markets plunged.

On Monday China insisted banks had significant liquidity sending a message that banks need to manage their own risks.

A translated message by the People’s Bank of China on liquidity states “Commercial banks should concentrate storage for taxes and statutory reserve deposit and other factors impact on liquidity in advance to arrange sufficient positions to maintain adequate levels of reserve ratio, to ensure the normal settlement” while warning“expansion of credit and other assets too fast may lead to liquidity risk“.

That message sent the Shanghai stock market index down about 6% as shown in the following chart.

Shanghai Stocks

…….read more HERE

A Reason To Be Optimistic

Posted by Morgan House

on Tuesday, 25 June 2013 18:49

Ed Note: In line with Morgan’s Optimistic thinking & much to the surprise I am sure of pessimists, a Majority of U.S. Economic Data Beats Expectations this morning. Of the large number of economic releases that came out, 11 of the 12 beat estimates and some where well above expectations. Also, durable goods, new home sales, consumer confidence, and manufacturing all trended higher this month, with consumer confidence and new home sales near 5-year highs. You can read

Why I’m an Optimist

The 2002 book Bringing Down the House told the true story of how six MIT math geniuses mastered blackjack card counting and took Las Vegas for millions. It had money, sex, drugs, and power. People loved it.

But part of the story often went misunderstood. The card-counters didn’t win every hand of blackjack, or anything close to it. The casino normally has a slight edge over players. The MIT crew’s strategy tipped those odds just barely in their favor. That meant they still lost a lotof bets. “Even the most complex systems seemed to aim at an overall edge of around 2 percent,” author Ben Mezrich wrote.

But that tiny edge was all the crew needed to succeed, provided they played long enough. When the odds are even slightly in your favor, you will win over time, even if you lose often in between. 

That’s why I’m an optimist on the economy and the market. Maybe even a permanent optimist. 

Take a look at this chart, showing GDP per capita adjusted for inflation since 1850:

realgdppc large

……continue reading HERE

 

 

Tapering the Taper Talk

Posted by Peter Schiff - Europacific Capital

on Monday, 24 June 2013 22:11

As usual the Federal Reserve media reaction machine has fallen for a poorly executed head fake. It has fallen for this move many times in the past, and for its efforts, it has tackled nothing but air. Yet right on cue, it took the bait once more. Somehow the takeaway from Wednesday’s release of the June Fed statement and Chairman Ben Bernanke’s press conference was that the central bank is likely to begin scaling back, or “tapering,” its $85 billion per month quantitative easing program sometime later this year, and that the program may be completely wound down by the middle of next year.

Although this scenario is about as likely as an NSA-sponsored ticker tape parade for whistle blower Edward Snowden, all of the market segments reacted as if it were a fait accompli. The stock market – convinced that it will lose the support of ultra-low, long-term interest rates and the added consumer spending that results from a nascent housing bubble – sold off in triple digits. The bond market, sensing that its biggest and busiest customer will be exiting the market, followed a similarly negative trajectory. The sell-off in government and corporate debt pushed yields up to 21 month highs.
 
10-year-treasury-june-24-13
 
In foreign exchange markets, the dollar rallied off its four-month lows based on the belief that Fed tightening will support the currency. And lastly, the gold market, sensing that an end of quantitative easing would eliminate the inflationary fears that have partially fueled gold’s spectacular rise, sold off nearly five percent to a new two-and-a-half year low.
 
All of this came as a result of Bernanke’s mild commitments to begin easing back on permanent QE sometime later this year if the economy continued to improve the way he expected. The chairman did not really elaborate on what types of improvements he had seen, or how much farther those unidentified trends would need to go before he would finally pull the trigger. He was however careful to point out that any policy shift, be it for less or more quantitative easing, would not be dependent on incoming data, but on the Fed’s interpretation of that data. By stressing repeatedly that its data goalposts were “thresholds rather than triggers,” the chairman gained further latitude to pursue any stance the Fed chooses regardless of the data. 
 
Yet the mere and obvious mention that tapering was even possible, combined with the chairman’s fairly sunny disposition (perhaps caused by the realization that the real mess will likely be his successor’s problem to clean up), was enough to convince the market that the post-QE world was at hand. This conclusion is wrong.   
             
Although many haven’t yet realized it, the financial markets are stuck in a “Waiting for Godot” era in which the change in policy that all are straining to see will never in fact arrive. Most fail to grasp the degree to which the “recovery” will stall without the $85 billion per month that the Fed is currently pumping into the economy.
 
What exactly has convinced the Fed that the economy is improving? From what I can tell, the evidence centered on the rise in stock and real estate prices, and the confidence and spending that follow as a result of the wealth effect. But inflated asset prices are completely dependent on QE and are likely to reverse course even before it is removed. And while it is painfully clear that expectations about QE continuance have made a far bigger impact on the stock, bond, and real estate markets than any other economic data points, many must be assuming that this dependency will soon end.
 
Those who hold this belief have naively described QE as the economy’s “training wheels.” (In reality the program is currently our only wheels.) They are convinced that the kindling of QE will inevitably ignite a fire in the larger economy. But the big lumber is still too dampened by debt, government spending, regulation, and high asset prices to catch fire – all we have gotten is smoke instead. A few mirrors supplied by the Fed merely completed the illusion. The larger problem of course is that even though the stimulus is the only wheels, the Fed must remove them anyways as we are cycling toward the edge of a cliff. 
 
Although Bernanke dodged the question in his press conference, the Fed has broken the normal market for mortgage backed securities. While it’s true that the Fed only owns 14% of all outstanding MBS (the “small fraction” he referred to in the press conference), it is by far the largest purchaser of newly issued mortgage debt. What would happen to the market if the Fed were no longer buying? There are no longer enough private buyers to soak up the issuance. Those who do remain would certainly expect higher yields if the option of selling to the Fed was no longer on the table. Put bluntly, the Fed is the market right now and has been for years.
 
A clear-eyed look at the likely consequences of a pull-back in QE should cause an abandonment of the optimistic assumptions behind the Fed’s forecast. Interest rates are already rising rapidly based simply on the expectation of tapering. Imagine how high rates would go if the Fed actually tried to sell some of the mortgages it already owns. But the fact is the mere anticipation of such an event has already sent mortgage rates north of 4%, and without a lifeline from the Fed in the form of more QE, those rates will soon exceed 5%. This increase will greatly impact the housing market. Speculative buyers who have lifted the market will become sellers. More foreclosure will hit the market, just as higher home prices and mortgage rates price any remaining legitimate buyers out of the market. Housing prices will fall to new post bubble lows, sinking the phony recovery in the process. The wealth effect will work in reverse: spending and confidence will fall, unemployment will rise, and we will be back in recession even before the Fed begins to taper.
 
In fact, the rise in mortgage rates seen over the last month has already produced pain in the financial world, with banks reporting a rapid decline in refinancing applications. By the time rates hit 5%, the current rally in real estate will have screeched to a halt. With personal income and wage growth essentially stagnant, individual buyers are extremely dependent on the affordability allowed by ultra-low rates. A near 50% increase in mortgage rates, which would result from an increase in rates from 3.25% to 5.0%, would price a great many buyers out of the market. Higher rates would also cool much of the housing demand that has been coming from the private equity funds that have been a factor in pushing up real estate prices in recent years. Falling home prices would likely trigger a new wave of defaults and housing related bankruptcies that plunged the economy into recession five years ago.
       
A similar dynamic would occur in the market for U.S. Treasury debt. Despite Bernanke’s assurances that the Fed is not monetizing the government’s debt, the central bank has been buying nearly 70% of the new issuance in recent years. Already, rates on 10-year treasury debt have creeped up by more than 50% in less than two months to over 2.5%. Any actual decrease or cessation in buying – let alone the selling that would be needed to unwind the Fed’s multi-trillion dollar balance sheet – would place the Treasury market under extreme pressure. Since low rates are the life blood of our borrow and spend economy, it is highly likely that higher rates will lead directly to lower stock prices, lower GDP growth, and higher unemployment. Since rising asset prices and the confidence and spending they produce is the basis for Bernanke’s rosy forecast, new lows in house prices and a bear market in stocks will likely reverse those forecasts on a dime. 
 
Lost on almost everyone is the effect higher interest rates and a slowing economy will have on federal budget deficits. As unemployment rises, tax revenues will fall and expenditures will rise. In addition, rising rates will not only make it more expensive for the Fed to finance larger deficits, it will also make it more expensive to refinance maturing debts. Furthermore, the profit checks Fannie and Freddie have been paying the Treasury will turn into bills for losses, as a new wave of foreclosures comes tumbling in. 
 
It’s fascinating how the goal posts have moved quickly on the Fed’s playing field. Months ago the conversation focused on the “exit strategy” it would use to unwind the trillions in bonds and mortgages that it had accumulated over the last few years. Despite apparent improvements in the economy, those discussions have given way to the more modest expectations for the “tapering” of QE. I believe that we should really be expecting a “tapering” of the tapering conversations.
 
As a result, I expect that the Fed will continue to pantomime that an eventual Exit Strategy is preparing for a grand entrance, even as their timeline and decision criteria become ever more ambiguous. In truth, I believe that the Fed’s next big announcement will be to increase, not diminish QE. After all, Bernanke made clear in his press conference that if the economy does not perform up to his expectations, he will simply do more of what has already failed. 
 
Of course, when the Fed is forced to make this concession, it should be obvious to a critical mass that the recovery is a sham. Investors will realize that years of QE have only exacerbated the problems it was meant to solve. When the grim reality of QE infinity sets in, the dollar will drop, gold will climb, and the real crash will finally be upon us. Buckle up. 
 
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