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Fed and Treasury Steer Their Unsinkable Ship toward Iceberg This past week we got to observe Fed Chair Jerome Powell and the US stock market and the US bond market do everything I said they would do in their complicated shuffle of ships-and-icebergs:
While bond yields had already begun to rise and compete against stocks, the Fed stayed the course, iceberg dead ahead. As a result, longterm bond interest rose even more because the Fed did nothing to jawbone the idea of increasing its bond-buying QE to take interest rates back down (which it accomplishes by purchasing US government bonds from banks to take them off the market, putting them on its own balance sheet). You see, the Fed is — I believe — caught in its own catch-22. Usually, to lower interest (in order to stimulate the economy and hit the higher inflation number the Fed says it is targeting), the Fed would buy more bonds; however, buying bonds and adding them to its balance sheet tends to create more money in the system, and the bond market is already afraid of rising inflation because much of the new money is now going into the hands of average people. (This game only worked when all new money was going into the stock market.) As a result, aiming for higher inflation by purchasing more bonds will cause the reinvigorated bond vigilantes to up their demand on bond yields to cover inflation, making it impossible to lower longterm yields by purchasing bonds. The Fed’s old game isn’t working like it used to. My prediction for this March’s meeting of the Fed minds was that the Fed would do nothing because it is stuck. Or, as I put it,
The Fed is caught between the rocks and an iceberg … and that’s a hard place to be. The Fed doesn’t want to do more QE anyway, but they also cannot do less. Thus, as Sven Henrich agrees below, the Fed can’t stop, and it has no end-game: Henrich, noted as I do, that the Bond vigilantes did not let up from hammering the Fed over its decision at the FOMC meeting:
As I was arguing, the Fed cannot stop interest rates from rising, even if it were to buy more bonds. Henrich illustrated that with the following graph: Said Henrich,
Although the stock market actually shot up right after Powell’s press conference and bond rates relaxed for the remainder of the day, making it look like I was going to be wrong about rising bond rates killing the stock market in the weeks ahead, I can tell you with candor I had no concern. I felt completely confident the day’s moves would the very next day prove to be nothing more than a knee-jerk reaction of investors hitting the hopium, and both stock and bond investors would see the light with clearer heads by the next day. They did. As one commentator on Seeking Alpha summarized that day and what would ensue, stocks shot up because …
A force to be reckoned with The NASDAQ has struggled excruciatingly against the backdrop of rising bond rates, and, after a week or so of reprieve earlier this month, it reverted back to that downtrend as a result of the past week’s FOMC meeting: As Sven notes, what the NASDAQ does, as the former leader of the stock market, is now critical if it cannot continue to lead, as its failed recovery attempt indicates:
In 2000, that took six months or so to play out. However, we MAY have seen the start of the rest of the market capitulating at the end of the week as the Dow and S&P both, in my opinion, seemed to realize the bond vigilantes are serious and are in the game to stay. The Dow plunged pretty significantly on Thursday and Friday as cooler heads digested the Fed meeting. MarketWatch, reported the end-of-week event this way: “Dow retreats from record while surge in bond yields sends Nasdaq down 3%“ Zero Hedge reported it this way:
You can dream all you want, as many do, about how the volatility of the last couple of weeks is just a rotation from growth stocks into value stocks; but I think we have a much bigger change in play here, and the downdraft of the leaders (the tech stocks that dominate the NASDAQ) will suck the overall market down like a sinking ship takes down swimmers that are too near its disappearing hull. Or, as Barclay’s phrased it in more technical terms:
A sinking ship drowns all life boatsThat is the gist of it. The downdraft in the wake of the hugely overbought tech stocks that are sinking is a much bigger flow than is likely to be offset by the buoyancy of prices in value stocks. That is, in part, because some of the outflow from tech will now go into higher-yielding, safer bonds now that bonds are waking up from their decadal sleep (not to be mistaken with bond funds that are full of lower-yielding bonds at this point, so may lose investor money — one of the major weirdnesses of the supposedly safe-haven yet highly speculative bond market). How deeply the rising yields in bonds will tear into the stock market at this point, I won’t say because there are so many government and Fed stimulus lifeboats floating around that would normally cause the stock market to rise. So, we’re caught in a complex interplay of competing forces. It’s not going to be an easy course to predict or navigate, but my primary thesis is that Fed effectiveness is falling apart because the costs of its interventions (interest and inflation) are weighing heavily against the benefits. (In other words, the Law of Diminishing returns is on the downside of its curve now for the benefits of Fed stimulus actions.) ZH, in the article above, referred to this interplay between stocks and bonds as
You see, it is not just bond competition that is syphoning money out of stocks, but that new dynamic between bonds and stocks is also having its own impact on the risk appetite (i.e., sentiment) of the newbie players that came to dominate the stock market in 2020 — the Reddit Raiders and the Robinhood crowd:
Also, as I noted in my earlier articles, bond yields aren’t likely to swamp stocks with too much savagery until the ten-year hits 2%. The newbies may regroup after they figure out what is happening here and the cheerleaders like Dave Portnoy take them on new adventures into value stocks; however, we’ve seen many times in history how the worst market crashes happen on the backs of the newbies as the older “smart money” sells into their vain, testosterone-fueled enthusiasm (sentiment) and lets them take the losses. I’ve warned before about how often the ecstatic newcomers, who have bragged about how easy they suddenly discovered it was to make big money in stocks, become the ready stooges the smart money sells to on the way out the back door. That’s how “old money” gets to be old money. The treasury’s ship is breaking apart Yields are rising, prices are falling. One of the areas that Powell was completely silent about — vocally silent about by stating the Fed will wait to deal with it later — is a Fed restraint on banks called SLR, which controls how much of a bank’s reserves can be held in treasuries. To support all the COVID stimulus last year, the Fed removed the restraint last April, but that moratorium on the restraint, is set to expire this month, and that is where the sell-off in treasuries resulted in falling prices for existing bonds — a.k.a, rising yields on all bonds — back in February:
For now, the Fed chose to keep it a mystery; but this is where the bond vigilantes have, as I said in my last article, their guns in the Fed’s back. The noted disaster in treasury auctions will become much worse down the road if the Fed allows the SLR moratorium they have in place to end in March. First, banks will be forced to sell treasuries at the same time the federal government is emptying its massive Fed bank account of money in the form of stimulus checks. The confluence of these two large cash flows could create a lot of monetary turbulence, which could become even more disorderly than what we’ve already seen:
Later, if the federal government’s big infrastructure stimulus programs are approved, the government will no longer have those banks that just tried to reduce their bond holdings to sell bonds to in order to fund the programs. The Fed may, then, have to suddenly reverse itself on the SLR moratorium, and the Fed doesn’t like losing face that way, even though it keeps losing face in major ways as it did with its original unwinding of its balance sheet and the 2018 stock crash and 2019 repo crisis pileup that it created until it fully reversed course. In short, it’s all getting more complicated, and the Fed’s ability to navigate is being constrained. To put it in blunt but appropriate terms, the Fed is the market’s bitch right now. When the Fed finally does raise its interest targets, it will be merely to try to get back to looking like it controls the financial market, instead of the market controlling it. It will, in other words, just be matching its targets to what the marketplace has already done. Or, as another Seeking Alpha commentator called it,
The commentator applied the same metaphor I did in my article last week:
The fact that things are not responding to mere Fedspeak and are even doing the opposite of what Fedspeak is intended to accomplish is, I think, partially why the Fed put off dealing with the SLR situation … twice. It didn’t want the news about that to upset what was already considered a nearly impossible situation for Powell’s announcements last week. I think an even greater factor is that the Fed is reluctant to take action that it will likely have to reverse, making itself look even more incompetent, just as it had to do to end the Repocalypse it created. I posit the SLR situation is serious enough and difficult enough that the Fed decided it merited a meeting of its own and an announcement of its own, or it would overshadow anything the Fed did and announced last week. As noted in the Newsmax article, US treasures saw record low demand in a recent auction of seven-year bonds. They’ll see much lower demand if banks are no longer buying due to the reinstatement of SLR restrictions AND the resulting offloading of those treasuries the banks already have at the same time. So, the Fed needs to massage this through … or keep the SLR moratorium in place for a much longer time as the government looks to be needing more banks to buy for the foreseeable future, not less. While the Fed may want to end its SLR moratorium, doing so could crash the bond market, which is far bigger than the stock market but which would also crash the stock market by sending longterm yields soaring, making bonds all the more competitive to stocks. (Falling bond prices means the same thing as those who already own bonds or who want to issue new bonds having to offer higher yields to investors. One can also look at it this way: when bond prices plummet, it becomes more attractive for people to take money out of stocks in order to scoop up bonds — existing or new issuance — at bargain prices.) Rising bond yields are damaging to stocks for a number of other reasons as well:
Even so …
As always, the Fed has no end gameAs Sven said, “What’s the end game here?” (And as I’ve often said, “The Fed has no end game.” The Fed just keeps boxing itself in tighter with all of its interventions. Back in February,
The Fed’s solution for all the market distortions that are starting to gang up against it has been either to attempt to back away from its interventions and then fail at backing away from its interventions so it has to jump right back to more of the same … or to kick the can further down the road, which avoids the unresolvable problems for now at the cost of making them worse in the future. The bind the Fed is in is getting outwardly and obviously dangerous:
As Fed interventions pile up, so does the difficulty of managing their side effects.
That was all written in late February, and the Fed made the same punt this past week.
Investors didn’t get that … again … in March, and so the treasury sell-off picked up pace after the March meeting. Treasury tightens the Fed’s room to navigate And the challenge isn’t being made any easier by former Fed chair Janet Yellen, now the US treasurer.
For the present round of stimulus, you see, the government has already borrowed all the money it needs, which it has started pumping out as cash into the hand’s of ordinary “consumers” — you and me. Yet, it’s future programs, such as the much-talked-about infrastructure programs, will require even more borrowing. Last summer, the Wall Street Journal noted,
On and on the market dysfunction goes, and I’m not saying the party is going to suddenly come to an end. I’m just saying that the Fed’s number of problems that it is managing is getting endlessly bigger with each intervention, and the Fed is appearing to do, as I said last spring would be the case in the present crisis, worse and worse at keeping all the plates spinning. I don’t expect any market is going to give up quickly here, but clearly the fight is on in the bond market between Feds and vigilantes and between the bond market and the stock market, which is all to say, it’s looking, so far, exactly like I expected it would look after the Fed’s March meeting. The chaos will continue until things fall apart The stock market will be the last to see it coming, so probably the first to break. The bond market seems to have already seen, at least, one major iceberg dead ahead — inflation. Short-term interest rates are likely to fall due to Yellen’s treasury dumping so much cash from the government’s bank account into the bank accounts of all tax payers this month, while longterm yields continue to rise due to inflation expectations from all that cash, steepening the yield curve. At short end of the yield curve, some analysts even expect short-term rates to go negative again. The complications are everywhere. As I noted in my last article,
That is exactly what we saw play out at the Fed’s March meeting and its aftermath. Even as the Fed kept a solid aim on allowing more inflation as the core of its meeting press statement, it saw longterm interest rates shoot up the day after the statement due to fear of inflation.
Many, including Goldman Sachs, thought the Fed, at its March meeting last week, would hint at earlier interest-rate increases than it had been indicating. It did not. It held firm, as I was certain it would do, but to no avail. As I wrote at the start of the week,
We saw at Jerome Powell’s press conference following this past week’s March meeting of the Federal Open Market Committee, which attempts to steer the entire US economy under Fed monetary management, that the Fed did not shrink from its plan of creating more inflation at all. However, we also saw that the bond vigilantes did not shrink from unloading their guns into Powell’s backside …
I also noted in my last article,
As I figured, Powell was completely sanguine about inflation, but the markets (both stocks and bonds) reacted strongly, and the aftershocks are still playing through. Concluded Newsmax:
We might, indeed, see the end of the Everything Bubble. Behold the Titanic. Behold the iceberg. And now for something totally ridiculous I’ll close with this complexly ditzy comment of the week about the FOMC meeting and Powell’s press conference where the credit for lame ignorance goes to Crazy Cramer: You have to be both dishonest and retarded to believe that. As Henrich points out, what the Fed has done for the past decade for the underclass looks exactly like this: Only Cramer could say something so stupid and so sold out to Wall Street. Joyous times, indeed, for Cramer and his cohorts at the top. Liked it? Take a second to support David Haggith on Patreon!
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