Bonds & Interest Rates

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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Nightmare Scenario? How China’s Problems Affect Canada

Posted by Ivan Lo - The Equedia Letter

on Monday, 24 June 2013 19:18

 A Potential Financial Disaster That’s Bigger Than Subprime

MacLean’s’ most recent issue gives us 99 reasons why Canada is better than America. It says we’re happier, fitter, and richer – and our kids are smarter too.

While much of it may be true, there are economic factors unraveling that might give every Canadian a reason to be scared.

While our economic numbers have been strong, we need to look at the bigger picture.

Strong Growth or Just Getting Lucky?

Last month, statistics Canada released Q1 data that shows a surprisingly strong 2.5% annualized growth between January and March.

That means growth in the first quarter outperformed every three-month period over the past year and a half. And exports – particularly shipment of oil products to the United States – made a nice 1.5% gain.

It may sound like Canada is doing great, but the numbers don’t tell the whole story.

Most of Q1 growth came from trade with the U.S., and partly due to a one-off rebound in energy exports – also to the U.S. – that are now pretty much recovered after the disruptions to production from last year.

Domestic demand was soft and outlook is weak. If it wasn’t for the contribution from government, which showed the strongest component of domestic demand, the numbers could’ve been a lot worse. Expect the weakening trend to continue as the housing market softens, and consumption spending shrinks as Canadians tackle their highly elevated debt levels

According to TransUnion, the average Canadian’s non-mortgage debt – which includes credit cards, car loans, installment loans and lines of credit – reached a whopping $26,935 in the first quarter. In BC alone, the debt per person has now reached a staggering $38,619, surpassing Alberta’s $36,223.

Factor in housing costs and we’re looking at a country that is living well beyond its means (I’ll talk about the housing situation next week).

Are we living beyond our means? Share your thoughts by CLICKING HERE

You know there are growth issues when government spending is one of the strongest component of domestic demand – especially when the budget balance for Canada has been negative since late 2008 and the government is trying cut back on spending.

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……read more HERE

Initial “Sell” Signal Is In

Posted by Lance Roberts: The X Factor Report

on Monday, 24 June 2013 17:24

Screen shot 2013-06-24 at 8.04.51 AM

After eight straight months of advance in the markets what the media absolutely believed could not happen finally has – the market quit going up. However, you can’t really blame the media for believing in an “unstoppable” rally, after all, like a “Bigfoot” sighting, they clearly saw evidence of an urban legend.

However, as we have been discussing for many weeks, such market advances that push prices to extreme divergences from their historic norms are ultimately due for a correction. Without such corrections the markets become distorted, unhealthy and subject to severe crashes.

This week we will review our analysis from last week, set targets for the current correction and discuss recommended actions for portfolios currently.

However, before we jump into the analysis I want to give you a few updates to the coming changes to the newsletter and website.

“Streettalklive.com” is merging into “STAWealth.com.” Only the look is changing – all the great features will remain the same.

This weekly newsletter will actually become three different HTML documents that you will be able to print, read on your tablet and phone, share with friends post to your social network. The three pieces will be:

            – Portfolio Management: Market analysis & Investing Strategy

            – Market/Sector Analysis: Analysis of 15 major sectors /markets

            – 401k Plan Manager: Expanded and improved model/analysis

Also, more frequent postings to the daily blog that are short reads, quick analysis or video/audio analysis of investing ideas, economics, strategies or tips.

As we get closer to the rollout of the new site I will keep you informed of all of the changes. I hope you will find the new website to be more useful and informative in the management of your financial future.

……read the 17 page report HERE

Markets Top as Market Psychology Ignores “Rational Expectations”

Posted by Victor Adair - PI Financial

on Monday, 24 June 2013 15:18

The bond market had its worst week in many years last week as yields soared following the June 19 Fed meeting and Bernanke’s Q+A…and as bond prices tumbled so did stocks, gold, foreign currencies and commodities…while the US Dollar soared. You might ask, “Was anybody really all that surprised by what Bernanke had to say? Don’t you think that the market has over-reacted?” Well, in terms of Rational Expectations, perhaps the market has over-reacted…but…in terms of Market Psychology Bernanke’s June 19 comments, just like his comments on the May 22 Key Turn Date, were not the “Cause” of the market price action…they were just the “Catalyst” for a market that was dangerously “out of balance”…and the price action last week adds to my conviction that the May 22 KTD signaled a Major turn in Market Psychology.

My definition of a Key Turn Date is when a number of different markets reverse course on or around the same date due to a (dramatic) change in Market Psychology. Such a “Reversal” implies that Market Psychology was “overdone” prior to the reversal. For instance, if bullish Market Psychology had become WAY overdone prior to the May 22 KTD…on the back of expectations of more and more easy money…then the slightest hint that the supply of easy money would diminish would catch the market “wrong-footed” and precipitate a scramble to rebalance.

I think the essence of the current “rebalancing”  in the markets is leverage reduction…either voluntarily or otherwise. The price action June 19 through 21 when stocks, bonds, gold, commodities and foreign currencies all fell at the same time looks like deleveraging….likely forced in some cases. From the perspective of Rational Expectations the hard sell-offs appear to be over-done…at least in the very short term.

Rational Expectations may have a moderating impact on the “mood swings” of Market Psychology…but it’s the “overdoneness” of Market Psychology that defines the market’s highs and lows. Why did we have a house price boom, and then a bust, in the USA, or Spain, or Ireland or…? Why did APPL or Crude Oil or the 1980’s Nikkei soar and fall? Surely we have answers that come from the “dimension” of Rational Expectations…but just as surely we have answers that come from the “dimension” of Market Psychology.       

One aspect of Market Psychology: When a market is rising and a Player is long…using leverage to add to his position…he knows that he is right and he knows that he knows what is going on…when that same market reverses and starts to fall the Player begins to doubt his “knowingness”…and as his losses mount he becomes convinced that “somebody” knows something that he doesn’t…so he either cuts his position or shifts into fear, anger and denial.

I believe that the dominant feature of Market Psychology for the past few years has been that Players assumed that the Fed and other CBs “had their back”…the Bernanke put etc…but if the Last Buyer has been discovered, and a Major Top was made on May 22, then Players may start to doubt their “knowingness” about CB policies and edge closer to the exits.

Players have “added to their positions” through various forms of leverage during the bullish phase of Market Psychology and “edging closer to the exits” may simply mean reducing leverage…pulling back from emerging markets, for instance, or taking a little money off the table…and in these circumstances, Market Psychology may become increasingly bearish.

Trading:

Was the sell-off late last week overdone? It depends on your time frame…you have to keep the time frame of your trading in sync with the time frame of your analysis…for instance, I can imagine that the 6 month leg higher in US and European stock indices…from KTD Nov 16 to KTD May 22…courtesy of the Japanese “cherry on top” liquidity injections into world markets…was the LAST LEG higher and that global stock indices are headed lower over the 6 month time  horizon…or more…that interest rates made their lows in 2012 and are headed higher…and so is the USD.

Charts:

The bond market had a very RARE Monthly Key Reversal Down in May…reversing the “hope” that was in the April “buy the dip” rally. Not surprisingly, the bond market has continued down in June…last week was its worst week in at least 10 years.

bond

The gold market broke the key $1540 support level in April then took another leg down last week to its lowest levels in nearly 3 years. Gold ETF sales continue. Gold is extremely over-sold (short term.)

gold

The ratio of gold to gold shares rose to a 12 year high…with gold shares falling closer to their 2008 lows. This blog has repeatedly warned against buying “cheap” gold shares.

gold2

The S+P registered a Weekly Key Reversal Down last week continuing the downtrend begun on KTD May 22.

 stocks

The VIX jumped to its highest level in over a year last week (save for 2 days at the very end of 2012) but the VIX rally seemed to peter out late on Friday, June 21…perhaps indicating that the sell-off was overdone. Perhaps.

 VIX

WTI Crude oil had a Weekly Key Reversal Down last week after trading up to its best levels in nearly a year. My view has been that bullish Market Psychology is in an uphill battle with growing supply…and perhaps with a global downturn in demand…and its best “hope” is for Mid-East geo-political risk premiums.

 crude

The Euro currency had a Weekly Key Reversal Down last week after trading up to its best levels since February. I’ve been puzzled over “Why” the Euro has rallied since May 22…my best guess is that European banks are badly under-capitalized…that they have been reducing EM loans (EM markets and EM currencies have been weak) and repatriating funds home to Europe…boosting the Euro. The precedent for this “flow of funds” idea driving the Euro higher is similar to Japanese insurance companies selling overseas assets and repatriating capital immediately after the Tsunami in March 2011…driving the Yen higher.

 Euro

The Canadian Dollar had a RARE Monthly Key Reversal Down in May and has continued lower in June…hitting its lowest levels since November 2011. I’ve decreased my long term holdings of CAD in favor of USD.

 Canadian

The US Dollar Index hit 3 year highs in early May…then fell for 4 consecutive weeks…it had a big reversal higher last week.

 dollar

The Australian Dollar has tumbled over 14 cents from its early April highs…it’s a “proxy” for commodities and for China…its trading volume in the FX world (4th after the USD, Yen and Euro) is far above its “ranked” place in world GDP…it’s a high “Beta” currency and its decline since early April may have been foreshadowing bearish Market Psychology…on China and commodities.

 aussie

Emerging Markets stock indices have had 5 consecutive weeks down since the May 22 KTD…a graphic on how money is flowing away from the Periphery and back to the Center.

 emerging

 
…..to read the 12 messages Victor has taped to his market screen go HERE

A Must Read on the History of Money

Posted by Martin Armstrong: Armstrong Economics

on Monday, 24 June 2013 14:42

“HYPERINFLATION has ONLY taken place in minor peripheral economies. It has NEVERtaken place in a major economy. All major economies implode from deflation because as they need money, they attack their citizens destroying their own economies as we are doing right now. So while you wait for HYPERINFLATION, your taxes will rise, your rights will vanish, and you will see tanks on your streets before $30,000 gold that will still be the cost of a men’s suit. Forget this HYPERINFLATION and fiat nonsense. Government began getting involved with money first out of just standardizing the weight to facilitate trade as pictured above. That was it.”

“All money is fiat if you define it incorrectly as intangible money rather than An arbitrary order or decree. As long as money floats in value and it is legal tender meaning government accepts it in return for taxes, then it is not fiat in real terms. The idea that money must be tangible also has no basis in fact. Money has been many things to many people. The entire basis of money is you will accept something as money as long as you have CONFIDENCE that in turn someone else will accept it from you.”

……read the entire article “Forget the Fiat – It’s CONFIDENCE” HERE

Obama-Trillion-Bill

 

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