Greg Weldon – Markets are praying

Posted by Greg Weldon - Weldon's Money Monitor

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Ed Note: Michael Campbell calls Greg Weldon – “The One Analyst other Analysts can’t Wait to Read.”


As long time readers know, I am a big fan of Greg Weldon. This week he has very graciously allowed me to reproduce his client letter from last Thursday on some of the issues of Bernanke and Quantitative Easing 2. It prints a little longer than usual because of his format and all the charts, but this is one letter you should take the time to read.

You can get a free trial (his service is not cheap but if you are a global macro fund or trader, you really should have it!) by going to
John Mauldin

Outside the Box

Time Loves a Hero

I was fortunate to have met the late Lowell George, lead singer of ‘Little Feat’, prior to the band’s performance at Colgate University in 1979. The band was using the men’s basketball locker room as their ‘hospitality suite’, relegating the team to the local high school. As we returned from practice to store our gear, George was in the room, and he asked us if anyone could use the pair of size 21 basketball sneakers that a fan had tossed on stage during the previous night’s gig at Cornell.

We note lyrics from Little Feat within the context of today’s macro-monetary focus on the US …

“Well they say time loves a hero.

But only time will tell.

If he’s real, he’s a legend from heaven.

If he ain’t, he was sent here by hell.”

Markets are praying that time will tell us … that Ben Bernanke was a monetary legend from heaven, and a hero to the masses who are starving for a macro-reflation, specifically as it relates to the housing and labor markets.

But, if the ‘cost’ of creating jobs is a price-inflation spiral … then there could be ‘hell-to-pay’ in the markets, particularly in the fixed-income arena, and Boom-Boom’s legacy could be one of the ‘anti-hero’.

Of course, there is a decent chance that even the most heroic of efforts by the Federal Reserve could FAIL to generate the ‘desired’ outcome, leading to an increasingly ‘devilish’ debt-deflation.

Or, things could just stay … sideways, with both an upward tilt, AND a downward skew.

Thus, the odds of the Fed looking heroic … 2:1 … against … with one scenario considered a draw (status quo), while two of the other three potential ‘scenarios’ (hyper-inflation, or a debt-deflation) leading to some kind of hellacious reaction in stock, bond, and currency markets.

Indeed, we do NOT envy Ben Bernanke, and his ‘job’.

Frankly, few do it better than Boom-Boom, who has managed to create a most unique ‘circumstance’ with his pledge to monetize as much US Treasury debt as necessary, to insure that an overt debt deflation does not become ‘the’ dominant macro-force. Ben has fostered an environment where BOTH bond prices AND inflation expectations, are on the rise.

The Fed has made it crystal clear … they are pursuing higher inflation.

Five years ago, in my book “Gold Trading Boot Camp” we discussed at length the conundrum currently facing the Fed, stating that the Fed would, someday, be forced to acquiesce to higher commodity-price inflation, (particularly Gold) in order to circumvent a deepening macro-deflation.

Bingo, this is EXACTLY what is happening.

This is WHY Gold is screaming to the upside.

This is WHY the TIPS are screaming to the upside.

This, thanks to the fact that the Fed has orchestrated a PLUNGE in US short-term interest rates, US Treasury Note yields, and US Treasury Bond yields …

… in synch with a massive COMPRESSION in the Yield Curve.

We have been discussing the Yield Curve for months since our March-18th Money Monitor entitled “March Madness”, in anticipation of the compression we are now seeing … and we focused on the intensifying flattening taking place in the mid-curve, within the 2-Year, 3-Year, and 5-Year maturities, as recently as our September 24th Monitor, “Dancing with the Devil.”

Yes, the Fed has offered the ‘soul’ of the US currency, in return for a monetization-derived ‘reflation’, in the hope that an asset-price-reflation will, somehow, finally, spillover into the ‘real’ underlying macro-economy.

But only time will tell. If he’s real, he’s a legend from (monetary) heaven.

The problem is, that the Fed may have been ‘too heroic’, by talking-the-talk, without really ‘walking-the-walk’, not yet anyway, not to the degree to which their TALK has sparked a feeding frenzy …

… one that is ‘validated’ by the horrific scene in the macro-economy …

… and yet one that is ‘refuted’ by the price action in Gold, the US Dollar, along with emerging market equity indexes and currencies.

For sure, without much actual debt monetization by the Fed over the last six months, things in the markets are looking increasingly ‘bubblicious’.

The Fed is NOT directly responsible for the ‘froth’.

But their ‘talk’ is, as investors, banks, and global central banks have snapped up Treasury debt as if the Fed did offer a ‘put option’, by which it would be willing to step in as the buyer-of-last resort, in the event that owners of Treasuries stopped buying …

… or … worse yet … gasp … if they started to sell.

The ‘odds’ lengthen, when we contemplate the following thought process:

— IF there is in fact a BUBBLE in the Treasury market, and IF that bubble is ‘pricked’, the FEDERAL RESERVE will be EXPECTED to buy as MANY BONDS AS IT TAKES, to stop the escaping air from deflating the bubble. .

The Fed has put itself in a VERY tough spot, and when (not if) they are finally required to walk-the-monetary-walk, all hell could already be breaking loose.

Indeed, for this reason, we believe that the odds stack up against a Fed strategy that implicitly (as suggested by many, including the St Louis Fed President) seeks to monetize Treasury debt slowly, over a longer-time frame and in ‘smaller’ increments, than was the case in the 2009-10 experience.

To date, the Fed has NOT been leading the charge.

As we detailed in our Dancing with the Devil Monitor of September 24th, US Households, US Commercial Banks, and Foreign Official Accounts (ie: Central Banks) have purchased, in total, MORE than $2.5 trillion in Treasury debt since the beginning of 2008 … whereas the Federal Reserve has purchased only ONE-PERCENT as much (more on this, later). 

Indeed, Treasury Note Yields are plummeting to record lows, and the Fed has only JUST STARTED ‘talking-the-talk’, as evidenced by a plethora of comments on the offer from Fed officials since the middle of last week.

We note the following quotes ..

… starting with the would-be-hero, maybe-headed-for-monetary-hell,  Fed Chairman, Ben Boom-Boom Bernanke himself …

… “I do think that additional purchases, although we do not have precise numbers for how big the effects are, I do think they have the ability to ease financial conditions.”

Next we note commentary that sparked Monday’s extension lower in US Treasury Note yields, from New York Fed President William Dudley …

… “Fed action is likely to be warranted unless the economic outlook evolves in a way that makes me more confident that we will see better outcomes for both employment and inflation before too long.”

Indeed, the Fed will keep pumping, until it sees the proverbial ‘whites-of-their-eyes, as it relates to inflation, and job growth.

……read more and view multiple charts HERE