The minutes of the FOMC’s March meeting make clear just how hard it is for the Fed to even think about the possibility of unwinding what they’ve wrought. After six-plus years of interest-rate repression, absurdity has become the established norm. Now they can’t even figure out how to get out of it without bringing down the whole construct.
They handed the fruits of their monetary policies to folks who bought assets with them. Assets values have skyrocketed, yields have plunged, and risks have disappeared from the calculus. You can still get run over by a car, but you can’t lose money in stocks or junk bonds. That’s the established norm.
This stream of money created asset price inflation and funded the fracking boom, the tech bubble, and a million other things that produced a lot of supply. But demand remained lackluster because they didn’t hand this moolah to the folks who’d spend it on gadgets or food or gasoline, the folks who’d actually create demand. The economy languished, and consumer price inflation, though bad enough for consumers, remained mostly below the money printers’ lofty goals.
Now the Fed is trying to figure out how to unscramble the omelet. Meanwhile the ECB and other central banks are adding to it, accomplishing an absurd feat: even the crappiest sovereign bonds – except those of Greece – are soaring, and yields are plunging, many of them into the negative.
Then on Wednesday, a new thing happened: Switzerland sold 10-year government debt at a negative yield. They’d been selling debt at negative yields for a while, but with a 10-year maturity. No country had.
The little country with piles of money is defending itself against the influx of euros by repressing interest rates and making it in theory unpalatable to hold Swiss francs. But it isn’t working. What dreadful thoughts are rumbling through the heads of these investors that would scare them into lending their money to the Swiss government for ten years, not to earn a fair return, but for safekeeping apparently, and they’re even willing to pay for it!
Germany’s 10-year debt is following closely behind, yielding a still positive but practically invisible 0.15%. About €1.8 trillion in Eurozone sovereign bonds entice “investors” – if you can call them that – with negative yields, which now includes Spanish 6-month T-bills.
These inflated debt prices are great for borrowers. They’re flocking to Europe to sell debt to investors desperate to escape the negative yield trap laid out for them by Mario Draghi. Junk-rated corporate America caught on to it in no time [read… Dumping American Junk in Europe, Draghi Asked for it].
And Mexico, which had its share of debt crises by borrowing in foreign currencies, got wind of it. It is now hawking 100-year euro bonds to these desperate investors, enticing them with a yield of about 4.5%. “Pretty attractive,” is what Marco Oviedo, chief economist for Mexico at Barclays, called them. He expects healthy demand. An awesome deal in a risk-free environment.
Years of promised QE, actual QE, near-zero or negative interest rates, and the idée fixe that these conditions are permanent have sent asset prices soaring. Many, like German stocks, are disappearing from view.
Same in Japan, where the Bank of Japan just voted 8-1 to push QE at full tilt. It’s buying every Japanese Government Bond that isn’t nailed down. It’s buying J-REITs and equity ETFs every time the market dips to make it head the other way. Absurdities are playing out with increasing intensity. The JGB market has dried up under the BOJ’s relentless bid. And even conservative pension funds are dumping JGBs into the lap of the BOJ to buy equities at inflated prices.
And inflated they are: the Nikkei is up 135% in three years though the economy has languished. Real household incomes have been whittled down by a bout of inflation and a sales tax increase. The Olympics are coming, real estate values are soaring in Tokyo and some other places as foreign buyers and developers are pouring in, armed to the teeth with cheaply borrowed money, even as the hollowed-out middle class gets to hold the bag.
Oh, and Chinese stocks! Shanghai’s SSE Composite Index has nearly doubled in 12 months.
Absurd monetary policies are easy to start, the announcements are fun, and the market rallies they engender are vertigo-inducing. Central bankers look like heroes, as if they’d single-handedly saved the economy or something. Now there are financial bubbles everywhere. Mega-fortunes are tied up in them. And home prices have soared.
Unlike financial assets, homes are something people need. When prices get to the point where only free money makes ownership possible for the middle class, and when even rents become unaffordable for many people – then there are some serious problems in the main-street economy.
But how the heck do you stop this madness before something BIG breaks? How do you get out of it without bringing down the whole construct? You’d think that six-plus years of these policies would have given central bankers enough time to figure it out. But no.
The Fed doesn’t know how, according to the minutes from the March FOMC meeting. To its credit, it’s at least discussing it. But it doesn’t even know how to raise interest rates, now that the huge balances of excess reserves the banks keep at the Fed render the traditional way ineffective.
So they’re playing with novel mechanisms. But they might pose “risks to financial stability” – market swoons, in Fed speak. One of these mechanisms would be to sell some assets that mature in a relatively short time. A minor move, a total no-brainer, you’d think. But even the mere announcement, according to the minutes, “would risk an outsized market reaction….”
The “public” – the speculators the Fed has been feeding with free money – might see this as a “signal of a tighter overall stance of monetary policy than they had anticipated.” And it could make this whole construct come unglued. The mere announcement of such a minor move!
At least, FOMC members are discussing an exit, even if they have no clue how to get the financial markets through it in one piece. Other central banks are now focused on getting even deeper into it. They don’t have time to contemplate what comes after. And none of them have a plan for the moment something BIG malfunctions as a result of their absurd policies.
The ECB and other European banking regulators slept through it. But the competition folks at the European Commission have gotten wind of it. And they have real teeth. Read… This Could Sink Banks in Greece, Portugal, Spain, and Italy
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.
The way I look at this growing acceptance of negative yields is that buyers of this debt are expecting to see serious cost deflation (or negative inflation). That is what this growing bond buying is really saying. But this is setting up a huge contradiction. If serious deflation is coming, then stock markets are moving in the wrong direction.
Or as my grand father used to day (who worked/lived through the Great Depression) … “part of something is better than all of nothing”.
I think it is safe to say a lot of assets out there will look a lot like nothing when this finally rolls over, thus the demand for any asset that has the perception of being (reasonably close to) par after it really comes apart are in high demand.
If you think about it … the CBs really screwed up!
Regards,
Cooter
Yes more deflation ahead.
What the bond market may be expecting:
1) profitability will fall further. Interest rates positively correlate with profitability. So interest rates are on their way down.
2) Central banks money printing will only fan the flame of deflation. Free money available to bankrupt operations facilitates continued overproduction (kind of like what Chinese government is doing directly to enterprises it owns). Nothing engenders more overproduction like overproduction.
Overproduction engenders deflation. Deflation should lead to credit crisis but for now free/easy credit postpones & makes the eventual crisis that much more severe.
So then where is a safe place to park money in a historically low interest rate environment?
3) Not banks. Cypress experience showed that bank deposits can be expropriated.
4) A safe place is government bonds even if you have to pay interest (a fee for safekeeping?) because governments of major industrial countries will not default on their obligations because they can print money.
Correction: Meant Cyprus not Cypress.
The unwind is so absurdly easy to figure out that even a smart 6th grader could do it.
The Fed starts by allowing the trillions in bonds they have purchased to simply mature on schedule. As those bonds mature and roll off their balance sheet, the balance sheet shrinks. Private sector investors will wind up buying all the new bonds that are issued.
That would be a de facto tightening. Under normal circumstances, it would be a prerequisite to an actual hike in interest rates.
Since the eggheads at the Fed don’t seem to have seriously considered this approach, it leads me to believe that one of the prerequisites for obtaining a PhD in Economics is to undergo a lobotomy.
Ladies and Gentlemen,
ZIRP is not good enough so the global CB cabal is introducing the NIRP. Just channel your FIAT money AKA forced to speculating into equity and real estate markets ever expanding bubbles. In the mean time the banksters and smart money will be selling their booties to the dumb money fleeing NIRP for a song.
Round and round it goes but where/when it stops nobody knows as coming mother of all collapse will make the 1929 stock market crash and the Great Depression child’s play…
Surely, it’s more about pushing until FIVE really big things break. Why wait for one when you can break the world repeatedly?
There is this saying about no use fixing the barn door after the bulls escape. That is fix it now before the bulls go bonkers in full stampede towards the broken door.
” Now they can’t even figure out how to get out of it without bringing down the whole construct.”
It’s well established that to kill an asset bubble you have to increase rates early in the cycle. Otherwise inventories appreciate and they are used as collateral for further advances.
The bubble was the plan (see- Taylor rule), and the coming bust will be orchestrated to the benefit of FED and Friends. This notion that even a 0.25% increase in the FED funds rate will implode the economy hints at massive leverage.
So some bonds default? But that’s what CDS is for! Of course that’s assuming your counter-party pays up! And of course the FED will step to buy your junk should there be anything serious. I’m sure the FED will buy that toxic ECB sludge too.
But of course the opaque nature of CDS and derivatives contracts makes them beyond regulation. No one knows how these instruments are all linked together , or not, or what they say, but that’s well known isn’t it?
The Fed is the global buyer of last resort and the markets know it.
All these FOMC members are stockholders with great personal fortunes. Do you really think they aren’t aware that their policies are making them richer by the day? And that if the markets get dinged, so do they?
Why should something break? I think everybody’s missing the point: it’s a pass the parcel game which continue forever……or till the man in the street erupts with anger.
US bonds are being purchased by ‘Belgium’. Who? What? Where? Nobody knows – it’s the Chinese OR it’s Draghi OR it’s, well, take your pick.
US is broke? ECB will buy up their junk. ECB is broke? Japan will buy up their junk. Japan is broke? US will buy its junk. And around and around.
Where it will hurt is the man who sees those with money become richer and richer while he runs as hard as he can to stay where he is. That’s the only thing that can break….. Maybe we’re toying with Marx all over again – Karl….or Groucho?
What we are dealing with here Ladies and Gentlemen are True Believers. Like a monkey in a lab pressing a bar to get his treat or a gambler pulling the the handle, as the returns diminish the monkey begins to hammer the bar to the exclusion of all else. The gambler goes into hock looking for the big payday, and even if he gets one he doesn’t stop, but puts it back in. This is the reason that during a crisis the players ride it down to the bottom. It is human nature that is behind this time it’s different. Only those who’ve lived long enough to see the pattern, or learn what history can teach are able to stop in time. This is a tiny percentage. The party will go on until it no longer can. With luck the civilization suvives to learn from its mistakes. If not it disappears from the face of the earth leaving ruins behind.
I like the idea of simply allowing the bonds to mature, but since there are so many, how long would that method take to start taking effect?