There have been prior indications – though Wall Street brushed them off. During Fed Chair Janet Yellen’s testimony to the Senate Banking Committee in mid-July and in the Fed’s Monetary Policy Report, some of the most glaring bubbles that the Fed has so strenuously inflated since the Financial Crisis suddenly appeared on the Fed’s official worry radar.
Yellen lamented “valuation metrics” of stocks that appeared “substantially stretched.” She pointed at biotech and social media. PE ratios were “high relative to historical norms.” She even acknowledged the greatest credit bubble in history by fretting about the “‘the reach for yield’ behavior by some investors” and how “risk spreads for corporate bonds have narrowed and yields have reached all-time lows.” And she bared the disconnect between the markets and the Fed: increases in the federal funds rate “likely would occur sooner and be more rapid than currently envisioned.”
Other Fed heads have chimed in with warnings of their own, telling the markets that rates could rise sooner and more rapidly than the markets were pricing in. But it all fell on deaf ears. Stocks have risen since, including the very sectors that Yellen tried to prick, and yields have dropped.
But now the San Francisco Fed got down and dirty, using actual evidence of sorts to make the point that this isn’t just idle banter. It seems these folks are getting serious about manipulating the markets into acknowledging that QE Infinity was just temporary and that ZIRP – the foundation of the economy for so long that no one can even envision life without it – would fade away.
And they chastised the markets that so eagerly believed all the promises of QE Infinity and eternal ZIRP for not believing the end of ZIRP. They’re worried about the market’s reaction if there is a sudden recognition, rather than a gradual one, that the endless manna would end. They’re worried about financial instability.
And so two economists of the San Francisco Fed issued another warning about the disconnect between where the Fed is going and what the markets want to believe:
An ongoing concern has been that the public might misconstrue the Fed’s forward guidance about future monetary policy and underappreciate the extent to which short-term interest rates may vary with future news about the economy. Evidence based on surveys, market expectations, and model estimates show that the public seems to expect a more accommodative policy than Federal Open Market Committee participants. The public also may be less uncertain about these forecasts than policymakers.
Yellen herself, they wrote, had fingered low “volatility” – the idea that assets only go up, rather than up and down – as a hazard and that “some investors may underappreciate the potential for losses.”
The markets simply haven’t taken the Fed’s cues about rate increases seriously and might be taken by surprise, which could cause a violent reaction, hence market instability. To make sure that this time, investors get the message, they added:
Prices of financial assets, such as stocks and bonds, are sensitive to unexpected changes in interest rates because their present values are determined by discounting future cash flows. Thus, the low volatility in asset markets could, in part, reflect market participants’ relative certainty about the future course of interest rates.
False certainty, they point out.
The Fed has been using its forward guidance to jawbone markets into doing what the Fed wants them to do. It worked like a charm in trying to inflate the greatest credit bubble in history, along with a magnificent stock market bubble, even another budding housing bubble [Who the Heck Is Going to Buy all these ‘Overpriced’ Homes?].
But now that the Fed is trying to jawbone markets into the other direction, it suddenly isn’t working anymore.
Markets aren’t giving “enough weight to how dependent the central bank’s guidance is on both current and incoming data,” they complained. “Thus, the public could underestimate the conditionality and uncertainty of interest rate projections. And that was an “important concern.”
To demonstrate the disconnect with semi-hard data, they compared the federal funds rate projections of FOMC members, based on the Summary of Economic Projections (SEP) in June, to where market participants think the rates will be. To get a grip on investor expectations, they used three sources: surveys of economic forecasters and primary dealers; market prices of federal funds futures; and estimates from a financial-econometric model.
They found that market participants’ expectations of the Fed funds rates going forward were out of line with the projections from FOMC members themselves. Market participants were pricing in “a later liftoff date” for ratcheting up the federal funds rate and a slower pace of tightening, and they were relatively certain about it, in line with their certainty that stocks and bonds would always go up. They were in fact more certain “about the future course of monetary policy than FOMC participants.”
Don’t fight the Fed?
After years of using its scorched-earth monetary policies to engineer the greatest wealth transfer of all times, the Fed seems to be fretting about getting blamed for yet another implosion of the very asset bubbles these policies have purposefully created. And it is harnessing various resources, from Yellen on down to some economists at the remote San Francisco Fed, to spook markets into backing off gradually, rather than all at once. But for now, these markets can’t be spooked – not by the Fed, and not by anything else.
With home prices rising for three years across the country and soaring in a number of metro areas, the inevitable is happening: sales stalled. Something has to give. And it’s not going to be maxed-out American consumers. Read… But Who the Heck Is Going to Buy all these ‘Overpriced’ Homes?
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So the Fed is going to raise interest rates? Really?
Rising interest rates will cause asset prices to plunge. That includes all of the grotesquely overvalued asset classes – stocks, bonds, and real estate.
Moreover, even a measly 25 basis point increase in interest rates will rock the foundations of the banksters’ worldwide quadrillion dollar derivatives bubble, perhaps causing the derivatives bubble to implode.
My view is that what the Fed is trying to do is to restrain the bubbles they have created, without actually raising rates. Like Mario Draghi, the pathological liar who runs the ECB, the Fed heads are trying to manipulate the markets without actually doing what they say they will do. I think the Fed heads are LYING when they say they are going to raise interest rates.
Watch their actions, not their lips.
As you said, the Fed heads may well be “lying,” or rather manipulating the markets with their words, because that’s what they do best. But they DO have two big issues:
1. Financial instability (when bubbles implode). So if they can deflate these bubbles gradually, or at least keep them from inflating more, they hope they can avert a meltdown.
2. A glaring lack of tools in their toolbox when the next recession hits. So if they raise interest rates enough until then, they can lower them with great fanfare, and thus have something they can trot out to appear in control and look credible.
I don’t predict what they’re going to do. I’m just trying to understand what they’re really telling us. And their increasingly loud cacophony, including disagreements among themselves, is pointing to an end of ZIRP, just like it pointed to an end of QE Infinity last year (QE will likely be tapered out of existence this year).
They got the nation addicted to this ZIRP/QE dope. Now that it appears the nation is a junkie, the Fed is getting a little concerned and wants to wean us off of the stuff. It wants us to keep feeling good, but without the drugs. This is a tricky endeavour. Withdrawal can be a real drag, possibly fatal to the junkie. Coming off of the stuff can be more painful than anything a man has ever experienced. So what is the Fed, who is concerned, by the way, going to do when they raise rates and then find the nation in the fetal position, puking on the floor and shaking like a leaf in the wind? Well, look at what they did in 2008 and you will find your answer. You see, when the DJIA starts losing 300, 400, 500+ points on a daily basis, the Fed isn’t going to see a junkie going through the cleansing process of withdrawal, it is going to see a sick patient in need of more oxycodone. The Fed will ease. The market knows this. The Fed knows this, but wants to pretend that it’s a tough parent, when in reality, they are the parents who throw summer beer parties for high school junkies.
I agree with you that the Fed heads are trying in some manipulative fashion to head off the next meltdown. And like you, I spend a lot of time trying to figure out what these clowns are really planning to do.
This issues you identify are big ones.
The problem with bubbles is that they keep inflating until they don’t. Then they explode. I’m not sure it’s possible to let the air from a financial bubble hiss out gently. My analogy is that when people want to leave a burning building, all of them generally rush to the exit door at the same time, and a significant number of them wind up trapped inside and dying.
I think the Fed is being forced to end its QE programs for a variety of reasons. First, there’s no empirical evidence to suggest that the money-printing regime has been materially beneficial or stimulative to the economy as a whole. What has happened is entirely predictable. Asset prices have exploded higher, while the formerly middle class has been stuck with the inflation bill in their rent, food and energy costs. Also, It gets pretty hard to justify a trillion a year of money printing to buy bonds when annual Federal deficits are down to the 500-600 billion range. Lastly, the low interest rates that result from the Fed holding a huge percentage of longer-term Treasury securities wreak havoc upon life insurance and annuity companies and cause a serious shortage of collateral for overnight repos in the banking system.
True, the Fed heads may feel the need to raise interest rates so as to appear to have some tools in the toolbox when the next crisis hits. But recall, when Alan Greedscam left the Fed in 2006, his successor, Ben Bennochio, pushed through 3 more .25 point hikes in the Fed Funds rate to a level of 5.25%, where it sat from 6/29/06 to 9/18/07. At that point there were serious strains in the banking system, though the stock market continued to rise until October 2007. I would anticipate that rate hikes today would create similar strains in the banking system, just as they did 6 or 7 years ago, though I could be wrong on that point.
Lastly, I’m very skeptical that monetary policy is as effective as its proponents claim. We’ve been enduring these “emergency measures” from the money printers for 6 years now, and the world economy is still basically stuck in a twilight zone somewhere between full stop and first gear.
It may be true that the emergency measures (ZIRP, QE) headed off something worse back in 2008-09, but in my view these same emergency measures have operated to inhibit anything resembling a traditional economic recovery.
As far as I’m concerned, the clowns that inhabit the Eccles building in DC have reduced their credibility to approximately zero.
Is the entire economy a game of perception and psychic ability? Every investor spending their time and energy to read between Yellen’s speeches, trying their best to understand what she does say, and what she leaves unsaid. She is hinting rate hike at one moment, then she talks about ZIRP well into 2015. It is almost like she says she will do it, but she wants us to pretend she did not say it. The winner is not the ones who can identify values and productive capacity, but the ones who can penetrate the metaphors and rhetoric.
It feels like an old headmistress giving forward guidance to a bunch of kids, telling them what to do and what not to do via metaphors and nice sounding words. I have only one word. ROFLMAO.
ZIRP must end; and in fact the FED must end someday. The difficulty is in predicting the timetable of these events. Everyone – both the FEDs and their enemies – suffer from the impossibility of being able to see the “big picture” when the big picture is millions of people making trillions of economic decisions every day amidst a whirlwind of unreliable information from a cacophony of media. This blindness to their own blindness – what Hayek called the “fatal conceit” will, if we are lucky, cause the whole circus to derail soon. If we are unlucky, The train-wreck of global economic central panning will continue on for another century or more before people finally realize that the seers of the big picture are all liars and parasites.
It is hard to figure out what the Fed actually expects here, though. Even if people start selling bonds and stocks (or hedging their holdings more), someone has to take the other side of the damned trade- someone is always going to end up in a position where they will feel the need to react violently to losing their shirt. These sorts of jawboning exercises just leave me with even less respect for the Fed governors’ intelligence.
If we assume that the purposes of the Fed is what they claim it is, we must question their intelligence; but if we assume that their purpose is to get away with massive counterfeiting for 100 years and counting, merely by flapping their jaws, then we must count them as rhetorical geniuses.
Chalk it up to Helicopter Benny for his impeccable exit timing before you know what hits the fan. And Janet got what she wished for. My aren’t the Feds the happy family.
Market is drunk with QE stimulation and refuses to sober up. I mean QE III AKA to Infinity (to date mother of all QE with $1.6+ trillion) is akin to giving drunk enough alcohol so the drunk is in drunken stupor in a bid to to delay the inevitable hangover.
This QE should have had an end date as it’s been in place since Sept 2012 (to support Obummer’s re-election) and any hint of its demise or fudged unemployment rate whacks the market. I suspect the foolish buying will continue as window of opportunity to wind down long passed. Besides the Fed and the government is doing the darnedest to play down the inflation but any spike in oil price given precarious situation in the Middle East may usher in the STAGFLATION. BTW – last stagflation of late 70’s with high inflation and double digit mortgage was brought on by OPEC embargo resulting in Volcker cramming down high interest rate.
We learn history as not to repeat it…
Back in the 1970’s there was, compared to now, almost no outstanding debt. Flooding the economy with more credit coincided with high inflation and high interest rates, but the effect on previously existing debt was small. Relatively little value evaporated.
Now, we have unimaginably large quantities of debt in existence, its growth a function of 30 years of declining interest rates while IOU’s were rolled over and doubled, rolled over and doubled, wash and repeat.
When conditions change (The Fed stops loading its balance sheet, foreigners stop accepting the flood of $-IOU’s in return for useful stuff under their bizarre export-mercantilism, etc.) then rates have no where to go but up, and this will cause trillions of dollars of value to evaporate from bondholders’ balance sheets.
In a fiat money world where debt-is-money, debt destruction is out-and-out deflation. The history that should have been avoided was repeating the Roaring 20’s on a scale never seen before. We face something much worse than the 1930’s, I think.
Good points. Debt is either paid off or defaulted.
Rolling the debt over AKA kick the can down the road may 1 day not be feasible once major foreign Treasury holders like Chinese wake up 1 day and figure out the risk is higher than the meager near zero % return (EU depositors now earn negative interest rate thanks to Mario). I suppose IOU from Uncle Sam is better than billions of hidden non-performing loans Chinese are sitting on but I digress. Treasury holders may figure out that they are becoming the bagholders of devalued USD paper and for that matter Fiat currency and resort to buying gold to defend and bolster their own Fiat currency. BTW – heard that both China and Russia have actively been buying gold while central banks in EU have been busy clearing gold from their vaults (and afraid to do physical inventory of their gold holdings held by US in their behalf).
And I don’t think the world was flooded with derivatives back in the 70’s either. I was living in Orange County CA when it went bankrupt due to wrong derivative bets by dumb controller where the Government Sacks of the world made it out like bandits.
As for bondholders taking a bath – it happened to me on Government Motors bond holdings when the bondholders got taken to cleaners while UAW was arbitrarily given equity and ahead of the bondholders. Which goes to show that bondholders can easily get hosed and become bagholders at whim of the government. Let’s not forget what happened to Cypress depositors too.
We are indeed living in borrowed and interesting times…
$60 trillion in debt (or is it $1.25 quadrillion, if counting every possible IOU) exists today at nearly par, reflected by extremely low interest rates.
What happens if the Fed does NOT backstop the US Treasury market, and there’s an auction where the auction price of a Note or Bond falls significantly, its yield suddenly much higher than before?
The value of ALL EXISTING DEBT resets, too, just as happens when 1 share of IBM trades for a dollar less than the prior trade: The market cap of IBM drops by $1 x every outstanding share in existence. Value for ALL is set at the margin, at the LAST TRADE. All it takes is ONE active trader, whose action affects the wealth of every other holder of that asset.
The Fed is already hosed. What happens when the value of All That Debt enters a sustained downtrend? With interest rates near zero, reflecting absolutely zero worry on the part of bondholders, there’s only one way rates can go: UP! A downward spiral is effectively guaranteed.
Unless everyone remains in this antebellum fairytale “End of History” where rates stay near zero for 2015, 2020, 2200, and on until the sun burns out, rates will rise sooner or later, taking the underlying value of a galaxy of IOU’s into oblivion. The longer this insanity continues, the larger Congress & corporate America are making that galaxy. No one is paying down a dime of it.
This was the monetary collapse of 1930-32, and nothing the Fed then could do reversed it until the collapse in bond value ran its course.
Perhaps Yellen is finally beginning to grasp the size of the tyrannosaur whose tail she’s yanking.
So the dying patient on life support will survive without life support?
I dont think so. QE forever!
If we’re not already, we might as well all stop producing anything (food, electricity, iPhones, etc.) and just buy SPY.
If it’s QE to infinity and beyond, anyone who still actually MAKES something of value is a fool. Why work when everyone surrounding you is getting rich on their capital gains and dividends, right?
You give the central banks too much credit.
Wall Street does not need the central banks’ help to lend money to itself. It uses the credit to buy its own assets; the left hand lending to the right, the right buying from the left. This is an updated version of the ‘Mississippi Bubble’.
Credit will expand until service costs cannot be met with new loans.
The idea is to lower the rubes into poverty slooooowly… no crashing. If the frogs are suddenly AWARE they are in boiling water they’re liable to be annoyed at the cook.
Bunch of nonsense. The fed does not raise rates, borrowers do. And not that many people/large banks are borrowing enough money to support and grow the economy. The fed can try to reduce the liquidity of the banks in order to raise raise rates but again, there are not enough borrowers to support the economy: fractional reserve. So, a policy of inflation is pursued in vain in hopes of keeping the big banks afloat and to provide a growing tax revenue for various governments entities. If the market collapses so do the taxes that fund the government and things like social security, public education, and the military. The is the beginning of the end of the so called state. All of this is to prop of the welfare, corporate, and military states. Without it the current world becomes unrecognizable.
Guess who has been soaking up the Treasury papers not to mention front running the auctions? Good ol Fed of course. The Fed and the Treasury are supposed to work together on monetary cabal policies but it seems to me that the Fed is artificially controlling the demand of Treasury bonds by controlling the rate by buying the bonds in open market using freshly created USD?
Check out this link from the Bloomberg with title of “Treasury Scarcity to Grow as Fed Buys 90% of New Bonds”
We are not watching a failed attempt to revive the economy. We are seeing a very successful attempt to loot the economy – the global economy – and concentrate all the real wealth (not the money) into the hands of a few very powerful counterfeiters.
Their looting is occurring at a very rapid rate now, as they seem to understand that more and more people see through their rhetoric. So I predict a crash soon, but I’ve been wrong so far and I am surprised at how long this flagrant looting has lasted.
Take your cap gains taxes and head for greener pastures overseas.
This country is going down the tubes.
Don’t be the last one to go down with the ship.
Interesting comments. By the time I reached the end, I had forgotten what the article was about and had to go back to the beginning.
One piece that I wonder if its important is the dollar hegemony is breaking down as more and more countries agree to trade outside the dollar.
I thought this wouldn’t happen as the dollar is backed by our courts and our military but it is happening anyway.
This should force $trillions back into the US over time. Money that was sitting in foreign accounts to settle trades will no longer be needed and as that comes back into the US it should/could supplement or replace QE as the fuel for the bubbles..
Like the FED QE, it won’t add any thing real to our economic out put, unless it is used to purchase US goods or services, which it probably won’t. It would though keep interest rates down and stock prices up.
But in the end, this Capitalism requires purchasers of the goods and services and inflation appears to me to subtract from purchasing power rather than add to it. So does debt. So in the end, no matter who this is all sliced and diced, when all these dollars are looking for yield and there really isn’t any, there will eventually be a re balancing. Debt does have to be repaid and when the repayee hasn’t the means, it will be defaulted upon.
No matter how this is sliced and diced… not who!