Fed Tightens, “and so far, Nothing Has Blown Up”

Gundlach frets about bonds during QE unwind, rate hikes, tax cuts, and rising deficits.

“A tax cut will reduce revenue and it will grow the deficit and therefore, it will probably grow bond supply, and perhaps boost economic growth,” DoubleLine Capital CEO Jeffrey Gundlach said on an investor webcast on Tuesday. And if it does, “it is going to be bond unfriendly.”

And possibly in a big way.

It’s a “strange environment” for cutting corporate taxes as the economy is already in its eighth year of expansion, he said, according to Reuters, which reported the webcast. He reiterated his prediction that the 10-year Treasury yield could reach 6% over the next “four years or so.”

Let that sink in for a moment. The last time the 10-year Treasury yield was at 6% (on the way down) was in August 2000! Four years from now, 6% would be a two-decade high-water mark.

“I don’t think it is at all strange to think we can tack on something like 75 basis points, on average, with volatility of course, per year for the next four years or so,” he said.

The 10-year yield is currently 2.36%, and sliding, as opposed to the shorter maturities whose yields have surged: the three-month yield reached 1.30% today and the two-year yield jumped to 1.83%, the highest since September 2008.

When bond yields rise, bond prices fall by definition. The 10-year yield is still very low. But if it rises from this level to 6% over the next few years, there will be a lot of wailing and gnashing of teeth along the way by bond investors, and it’s not going to be a fun time for a bond-fund manager to navigate this environment.

When Gundlach talks, he is talking his book, and his book is full of bonds, including US Treasuries (DoubleLine manages over $115 billion in assets, as of September 30). So it would seem he’d try to talk down yields, which he has famously done before, which would create capital gains and paper profits for his fund, which would make him look like the “Bond King” that Wall Street has called him. But not this time. This time he is worried about the opposite.

“Growth has accelerated already, and the deficit is already going up, so why cut taxes?” he told Reuters in a follow-up interview.

“It is going to be very interesting to see how the markets can hang on to the easy gains that were made in 2017,” he said. “It’s just so far, so good. The Fed has tightened four times, they’ve embarked on quantitative tightening.”

Fed chair Janet Yellen is leaving a “pretty good legacy,” he said: “She got us off of zero and she started us on the wind down – the quantitative tightening – and so far, nothing has blown up.”

When things don’t blow up, that’s always encouraging in these crazy days of ours.

And during these crazy days of ours, everyone gets asked about Bitcoin, since everyone is talking about it, even on sports shows on the radio, and so Reuters asked him, and he said that he wasn’t at all surprised by Bitcoin:

“It’s a sign of the times. Like the dot-coms back in the day,” he said. Gundlach added that he does not own Bitcoin “just like I never bought a dot-com stock back in the day.” Bitcoin powered to a record high of $11,850 on Tuesday.

It’s now at $12,269. Blink and it has moved $1,000 up or down.

That bitcoin now gets into everything, even a discussion with a bond-fund manager about rate hikes, US Treasury yields, and the tax cuts is further evidence that this mania has completely blown off the lid of the “everything bubble,” which the Fed is trying to figure out how to contain.

The tax cuts and “elevated asset prices” are on the Fed’s table. Read…  The Fed Might “Surprise” Markets with its Hawkishness in 2018




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  67 comments for “Fed Tightens, “and so far, Nothing Has Blown Up”

  1. Rates
    Dec 5, 2017 at 10:12 pm

    Then a 1% raise would be no problem!!!

  2. UnionLeague
    Dec 5, 2017 at 10:21 pm

    A six percent yield on the 10 year Treasury would probably cause a massive reset in equity valuations. I’m not sure being an equities investment manager would be much fun either.

    • fajensen
      Dec 6, 2017 at 2:54 pm

      Well, personally, I don’t care about direction. I care about Delta.

      I think the current market is choking off real growth.

      First, by allowing failed investments to persist and never clear because it doesn’t cost anything to service the debt on them, no matter how stupid and leveraged the project was.

      Second, by driving stupid, no insane, valuations of investments such as property, stocks, bitcoin and whatnot so all the money available – even infinite – is sucked up into inflated assets and nobody gives a hoot about risks, because there is none – at ZIRP one can just roll the book forward and get paid for never realizing the loss..

      I’d say that 6-7% ought to be about the proper rate on a 10 year treasury.

      PS:
      I paid 18% p/a on a mortgage back in the day, we still did OK.

      • Smingles
        Dec 7, 2017 at 12:22 pm

        “I’d say that 6-7% ought to be about the proper rate on a 10 year treasury.”

        Based on what?

        “I paid 18% p/a on a mortgage back in the day, we still did OK.”

        Dramatically different times. There’s no comparison.

  3. Leviathan
    Dec 5, 2017 at 10:25 pm

    Is Gundlach a knave or an idiot? If he thinks grandma Janet left us a “pretty good legacy” perhaps it’s a combination of both. We can talk “tightening” when that bloated balance sheet is back below a measly trillion or so.

    • van_down_by_river
      Dec 6, 2017 at 5:52 pm

      During his confirmation hearing Powell said $3 trillion is the new floor for the Fed balance sheet so any “normalization” would involve a reduction of no more than $1.4 trillion. I find it curious that this admission was not even mentioned on financial news sites. I don’t think anyone cares – he only pointed out a fact many of us came to accept a long time ago. The Fed is funding government deficits and house purchases – most Americans are happy with those efforts (not me – but all outcomes have winners and losers).

  4. van_down_by_river
    Dec 5, 2017 at 10:29 pm

    A couple years ago, when the S&P 500 was trading around 2000, Gundlach said the risk/reward for stocks was terrible because there was only 2% upside vs 20% downside so stocks should be avoided. Central Banks were flooding the world with currency with the explicit intention of further inflating asset prices yet somehow Jeff could only see upside of 2%. Predictions are a fools game, but it would seem some fools are more foolish than others – Gundlach has no credibility.

    • Dec 6, 2017 at 12:51 am

      When it comes to predicting the future, NO ONE has credibility. No one knows the future. We nevertheless think about the future and try to figure out what it might bring and try to think through different scenarios.

      • d
        Dec 6, 2017 at 7:22 am

        People who put dates or numbers on things set them selves up to Fall.

        Whitney was correct many munis are time bomb’s.

        Not in the Time frame, she projected.

        Gundlach is another whom got trapped by the illogical QE Market.

        As get’s written her constantly. Fundamentally the market should not be where it is..

        All those fundamentals, belong to a NON QE Market.

        There is an upside to all of this illogical Market behavior.

        If the FED can correct the Market’s/Economic bubbles with out bursting them violently.

        They will know how to do it both ways, again. And possibly work out how to do it better when necessary.

      • russell cohen
        Dec 6, 2017 at 9:30 am

        “It is very difficult to make predictions,especially about the future”
        Old proverb,once attributed to Neils Bohr

      • alexaisback
        Dec 6, 2017 at 11:50 am

        I know the future.

        The tax ” cuts ” for corporations

        will be used by the corporations for share buy backs

        Nothing will trickle down, and no new jobs will be created.

        Short term gain for the corporations and compensation
        based on share growth.

        Long term loss for everyone else.

        — Here is a simple question

        RIGHT NOW the Estate Tax Level is 6 MILLION DOLLARS
        you pay NO, None, Zero Tax if you have less than 6 MILLION dollars.

        So who benefits from the Estate Tax removal ?

        ………………………………………………

        • Dan Romig
          Dec 6, 2017 at 1:04 pm

          Entrepreneurs who have succeeded while abiding by the law and paying taxes as they accumulate wealth in their estates. I worked for one of these in 1984; his name is Richard Schulze, founder and retired CEO of Best Buy.

          Mr. Schulze is wealthy and generous in his philanthropy. When he dies, should Uncle Sam take a large percentage of his estate, or should it go to his heirs and the numerous foundations, charities and Universities he donates to?

          http://www.startribune.com/schulze-plans-billion-dollar-foundation-on-research-education/211919851/

          When you play by the rules, pay your taxes and succeed, the fruits of your labor upon death should not be stolen by the government just because you’ve accumulated more than most others have!

        • Dec 6, 2017 at 4:13 pm

          Donations to charities are tax deductible and thus escape the estate tax anyway.

        • d
          Dec 6, 2017 at 5:17 pm

        • Bobber
          Dec 6, 2017 at 1:24 pm

          Dan, you are being deceptively selective. Your average estate tax payor attempts to pass money to family members tax-free, not to charities. Their goal is to elevate their families above all the rest and create a dynasty, even though most of these family members have done nothing productive to earn any money.

          More importantly, concentration of wealth is not good for the economy.

        • Dan Romig
          Dec 6, 2017 at 1:58 pm

          Bobber and those who support the estate tax, one of the rule-of-law principles of the U. S. Constitution calls for equal protection of the law. Why not have the estate tax collected on everyone regardless of the amount they have accumulated?

          Do you have a clause in your will that upon death, you will give the federal government 40% of your total wealth? If so, then more power to you. If not, then why should others be forced to do what you won’t? Oh yeah, they’re rich and most of their family members have done nothing productive to earn any money; therefore they don’t deserve it.

          I agree that wealth inequality is unhealthy for the economy. The Fed’s policies in the last decade have been a conduit to wealth transfer; so that would be a good place to start.

          A few years back, I stopped a thief who was breaking into my neighbor’s car to steal some of his belongings. The idiot took a swing at me before I put him in a rear-naked choke hold and waited for the cops to arrive. Currently, Uncle Sam says that all you can pass on to your heirs without the government stealing some of it is just under $6,000,000. The thief I stopped is equally repugnant to Uncle Sam’s estate tax. Thankfully the repeal of the tax will probably happen because Sammy is to powerful for me to put into a rear-naked choke. He deserves it though!

        • Wolfbay
          Dec 6, 2017 at 2:54 pm

          The old dead white guys (the founders) seem to be discredited these days but I agree with them about estate taxes. They were rightly concerned about a new aristocracy of huge inherited wealth.

        • Smingles
          Dec 7, 2017 at 1:02 pm

          @Dan Romig

          “When you play by the rules, pay your taxes and succeed, the fruits of your labor upon death should not be stolen by the government just because you’ve accumulated more than most others have!”

          You’re so completely off base here. The point of estate taxes is to prevent the mass accumulation of wealth/assets/land over time by a few select families. In other words, to prevent an aristocracy, which is inherently opposed to a democracy. Your only rebuttal to that is “but they worked for it!” Who cares about the health of our democracy, those people worked for the right to buy up increasing amounts of stock, land, you name it. Except… they didn’t earn it, since they’re inheriting mass amounts of wealth without actually doing anything to earn it. Their dead relative did.

          “A power to dispose of estates for ever is manifestly absurd. The earth and the fulness of it belongs to every generation, and the preceding one can have no right to bind it up from posterity. Such extension of property is quite unnatural. There is no point more difficult to account for than the right we conceive men to have to dispose of their goods after death.” – Adam Smith

          “I agree that wealth inequality is unhealthy for the economy. The Fed’s policies in the last decade have been a conduit to wealth transfer; so that would be a good place to start.”

          Lame double-speak.

          “Bobber and those who support the estate tax, one of the rule-of-law principles of the U. S. Constitution calls for equal protection of the law. Why not have the estate tax collected on everyone regardless of the amount they have accumulated? ”

          Try again: “Another means of silently lessening the inequality of property is to exempt all from taxation below a certain point, and to tax the higher portions or property in geometrical progression as they rise.” – Thomas Jefferson

          Jeff Bezos is worth $100 billion right now. Assuming growth of 3% PA (very conservative), untaxed that will be worth nearly half a TRILLION dollars in 50 years. Where does that money go? It goes into assets like real estate. It crowds out future generations who did not hit the sperm lottery.

          So far off base. You may as well be Christine O’Donnell, who claimed estate taxes– despite the claims of such influential thinkers such as Thomas Paine, or Adam Smith, or Thomas Jefferson– were Marxist. Great job.

        • Dan Romig
          Dec 7, 2017 at 5:02 pm

          Smingles, Jeff Bezos is not my favorite entrepreneur, but I truly believe that his estate belongs to him, and upon death, Uncle Sam has no right to confiscate 40% of it above an arbitrary amount.

          Perhaps to those who advocate an estate tax, “We can agree to disagree.”

          As far as Fed policies contributing to income inequality, I was merely pointing out a fact that a large cause of today’s income inequality has been driven by the Fed’s ZIRP and QE. Bobber stated, “More importantly, concentration of wealth is not good for the economy.” I do agree with this, but does pointing out that the Fed is driving much of this inequality equate to “Lame double speak?”

          I do not claim that influential thinkers who advocated for an estate tax were Marxist, nor do I claim that the tax itself is Marxist. I do claim that the estate tax is both repugnant and it is theft.

      • gary
        Dec 6, 2017 at 12:51 pm

        Jeffrey Saut seems to have a lot credibility. Why are the others so dense?

      • van_down_by_river
        Dec 6, 2017 at 5:36 pm

        Don’t get me wrong, I enjoy reading what Jeff has to say. Crystal balls and Ouija boards are fun and his prediction of a 6% 10 year treasury yield is certainly a wild attention getter. It’s fun to imagine a world with 6% rates but it seems a bit out of touch with reality.

        How would the government pay the bills if rates were 6%. The Fed (and other central banks) provided a flood of liquidity that enabled the government to run up a huge debt (and structural deficits) and now the flood of cheap, easy money is a requirement not a policy choice. The Fed chose a path from which they can never turn back. They chose to monetize government debt – there is no turning back from that choice. The bond vigilantes are dead and gone and interest rates will never again be determined by the free market (my crazy prediction).d

        If the U.S. had to survive without central bank easy money the government would need to raise taxes and cut spending – we are doing the opposite. The Fed will continue to fund government spending. Eventually confidence in the currency will be destroyed and there will be a currency crisis – I’m shocked to see how little those responsible seem to care. Bernanke actually wrote a book calling himself a hero in the title – the vanity and arrogance is beyond belief. The die has been cast, accept your fate.

        • Dec 6, 2017 at 6:25 pm

          Don’t forget that bonds mature over time and are redeemed over time. The $20.5 trillion in debt consists of bonds of all maturities. So bonds with 3, 10, 15, or more years left in 2020 before they mature won’t be affected by higher yields in 2020/21. Only bonds that are issued at the time will be affected. So the interest expensive for the government (and corporations) will creep up only as they refinance maturing bonds. And this transition takes many years.

          Also short-term bonds will have lower yields, and borrowing might shift more toward the shorter term as long-term yield rise toward the pain threshold.

          So during this run-up of the yields – assuming it occurs – US government interest expense will pick up only slowly and won’t alarm anyone for a while.

          Also, if the 10-year yield hits 6%, I think a lot of people will assume that it won’t stay there very long because at the next recession, the Fed will cut its rate targets. So if the yield stays in that range for a year, only long-term bonds issued during that year will carry the hefty yields.

          This interest expense is now running at an annual rate of $475 billion, and no one cares. If it doubles in 5 years, people might get a little nervous, but these days, it’s just not a hot-topic item and unlikely to cause any kind of political pressure.

    • chris Hauser
      Dec 6, 2017 at 4:03 pm

      he’s a pretty smart guy, but if he was always right he would keep it to himself.

      hmmmm, i have to think about this.

      but predicting that lending long at low rates is risky, is well, not hard.

  5. GSH
    Dec 5, 2017 at 11:39 pm

    2 year treasuries will be 2+% when the Fed raises rates later this month. With that, who in their right mind would buy 10 year treasuries at 2.4%? No one. It will finally force the long-end interest rates to go up.

    • Mark
      Dec 6, 2017 at 8:01 am

      If the bond market continues to believe long term growth and inflation will continue to grind lower, the 10 and 30 year will also continue to decline.

      There are plenty of examples when the yield curve has gone flat where there is a bid for longer dated bonds at the same yield as shorter dated bonds. Personally, I wouldn’t be betting on economic liftoff causing higher real yields on Treasuries this deep into the current cycle.

      • van_down_by_river
        Dec 6, 2017 at 6:01 pm

        The bond market believes 2.4% U.S. treasury yields are a better deal than 0.3% European yields. Draghi is carrying the baton for now Powell will jump in and help with QE4 soon enough.

    • Dec 6, 2017 at 12:18 pm

      Someone who is short that ten year actually owns it, correct?

    • Smingles
      Dec 7, 2017 at 1:20 pm

      The short end is driven by the Fed. The long end is driven by growth/inflation.

      Thought experiment to illustrate: you want to buy a bond. Say the 2-year and 10-year yields are equal, both at 2.4%. Equal coupon payments of $2.40 (annual to simplify) on a $100 investment. Why would you ever buy the 10-year? Well, let’s say the Fed continues to raise rates, maybe to 3%– that will drive the value of your 2-year bond lower, even though you still get an interest payment of $2.40. And let’s say that the bond market is right and growth/inflation remain subdued, and rates on the 10-year actually go lower than the 2-year, to 2%. Well, that will drive the value of your 10-year bonds higher, and you’re still getting $2.40– except now you have capital gains that you could take. You could then sell for a profit, and buy a 2-year bond with a 3% coupon. Now you have a profit you didn’t originally have, plus better interest payments.

      So really, it all depends on two things: what the Fed does, and what economic growth/inflation do. And those two things should theoretically be related– if growth/inflation are slowing, the Fed should not be raising rates. When you see people worried about a Fed policy error, that’s exactly what they’re talking about.

      If you think the Fed will raise rates and growth/inflation will pickup, you’d stay on the short side of the curve. But the fact that the longer end of the curve isn’t moving higher tells us one of two things: inflation/growth are going to remain low, or the bond market is wrong.

  6. Dec 6, 2017 at 3:05 am

    Jeff Gundlach’s prediction of a 6% 10-year treasury yield in 4 years is nuts. If it were to actually occur, it would imply armageddon in every other asset class out there.

    I also find it odd that everybody is intentionally trying to ignore the flattening yield curve. If Japan has taught us anything, it is that you don’t need a traditionally inverted yield curve to presage a recession when the central bank is holding down the short end of the curve.

  7. Pete
    Dec 6, 2017 at 7:06 am

    The great maestro’s ‘Conundrum’ lives on…in a global world , pension funds etc. gotta buy debt and US debt looks pretty good. I know wolf u’ve pointed this out a zillion times. Plus with fiscal policy FINALLY coming into play there could be an offset next year between a US fed decelerating, so to speak, and a US Congress accelerating. Maybe the world won’t come apart after all, and they’ll be peace in Jerusalem (oh…how foolish am I to suggest such an outcome during this Holiday Season)… PJS

  8. Rob
    Dec 6, 2017 at 7:08 am

    I dont know Wolf there are wobbles and tremours in many markets, even the venerable USD looks like its ready for a final sustained rally and the Fed has only just started shrinking its 300lb hambeast balance sheet profile down to a more normal level.

    • van_down_by_river
      Dec 6, 2017 at 6:04 pm

      What is a “normal” balance sheet level? Powell said $3trillion is the new normal. Expect that number to increase relentlessly.

  9. Tom
    Dec 6, 2017 at 7:38 am

    This corp. tax reduction Should have included a total elimination of all fed. subsidies To direct funds to the hole this would create: Instead of stock buybacks. Win-Win.

  10. Mike R.
    Dec 6, 2017 at 8:13 am

    I pay zero attention to any of these ‘talking heads’ of Wall Street. They are part of the game, part of the problem and should be given no notice.

  11. Paul Morphy
    Dec 6, 2017 at 8:34 am

    Every other asset class is priced off the value of the bonds. Bonds prices are the bedrock of the entire financial system.

    If yields begin to increase, by definition bond prices decrease.

    With the quantity and value of bond debt outstanding, any increase in bond yields means that a country will have to set aside more of it’s tax receipts to repay the higher yield. Or it will have to create new taxes to service higher yields.

    Given the level of outstanding US government debt, every uptick in bond yields puts more and more pressure on US tax receipts/taxpayers.

    If bond yields hit anywhere close to 6%, given the level of outstanding US government debt, America would be very very hard pressed to service it’s debts. In fact, I’d say 6% yield is sovereign bond default time for US government debt.

    Remember 3% was the yield tolerance threshold being flagged in January 2017 as bond yields began to rise. That 3% threshold was predicated on US government debt at $19.0 trillion outstanding.
    US government debt is at $20.5 trillion outstanding now.

    • lenert
      Dec 6, 2017 at 11:11 am

      Currently, interest payments on the debt net of the money rebated by the Federal Reserve Board, come to approximately 0.8 percent of GDP. That compares to more than 3.0 percent of GDP in the early 1990s. That sum apparently didn’t bankrupt us 25 years ago, so why should we be shaking in our boots over the current burden?

      Yes, adding $1.5 trillion will increase the burden. If we assume an average interest rate of 3.0 percent, that comes to $45 billion a year. In a decade that will be equal to less than 0.2 percent of GDP.

      • Paul Morphy
        Dec 6, 2017 at 11:50 am

        Gross Domestic Product data is a fudge.

        Let’s speak in nominal terms. In nominal terms, US Government debt was far lower in 1980’s, 1990’s, compared to 2017.
        By the year 2000, US Government debt was “only” $6 trillion.
        By 2017, the debt is over 300% larger, and compounding.

        In this era of super low yields, compared to historical yields, the interest payable on $20.5 trillion is awkward but manageable.

        What happens when super low yields begin to increase? The compounded US government debt will require more and more taxation to be ringfenced to service the interest payable on that debt.

        For 2017, America will pay $460 billion in interest on it’s $20 trillion public debt.
        https://www.treasurydirect.gov/govt/reports/ir/ir_expense.htm

        If bond yields increase the interest bill will increase expotentially from $460 billion figure.

        • Kent
          Dec 6, 2017 at 12:36 pm

          The federal government pays for its debt before collecting taxes for it. The treasury check book can go infinitely negative. There’s no who can actually make them pay for an overdraft.

          So if the government has to pay $500 billion for bond interest, it just prints the money and pays it. Now the economy has $500 billion more dollars (almost all sitting in banks). Then the government can just issue $500 billion in new bonds, and banks are required to buy them. But they already have the new money to do so.

          That’s why we’ve been able to grow deficits for decades now and still cut taxes. The system actually works very differently than most folks think it does.

        • Dec 6, 2017 at 4:08 pm

          It’s not quite how it works.

          The Treasury (part of the government) collects taxes, maintains a large cash balance at the Federal Reserve (its banker), spends money as required by Congress, and (since it spends more than it collects) regularly issues bonds not only to redeem maturing bonds but also to borrow new money to spend.

          The Treasury publishes its accounts on a daily basis. Here is the one dated December 5. Note the cash balance at the top:
          https://www.fms.treas.gov/fmsweb/viewDTSFiles?dir=w&fname=17120500.txt

          The Federal Reserve, via the New York Fed (not part of the government) “prints” money and buys bonds with this money, which it did as part of QE.

          The government doesn’t “print” money, not in the US. That’s the job of the Fed.

      • van_down_by_river
        Dec 6, 2017 at 6:22 pm

        These days we are funding the retirement of a giant herd of elderly baby boomers plus the huge government and military the baby boomers (in all their wisdom) created for later generations to deal with. So not a valid comparison to the 1990’s.

        Get ready to pay and pay and pay. The typical baby boomer feels life just begins at 70!!!! and they expect everyone else to be excited for them and pay up willingly. So everyone dig down deep to pay for their insulin – the bonus is their drug stocks go up because they passed legislation barring the government from negotiating pricing with drug companies.

        But not to worry, the baby boomers found a solution. They run the Fed and have assured us they will supply all the necessary funds to pay for their entitlements.

    • lenert
      Dec 6, 2017 at 11:19 am

      The amount of money that the government commits us to pay in the future with patent and copyright monopolies dwarfs the amount of money we spend on interest on the debt. In the case of prescription drugs alone, we will pay more than $450 billion this year for drugs that would likely sell for less than $80 billion in a free market. The difference of $370 billion is almost 2.0 percent of GDP.

      And this is just prescription drugs. If we add in the cost of patent and copyright monopolies in medical equipment, software, and a wide range of other areas it would surely be at least two or three times as high.

  12. timbers
    Dec 6, 2017 at 8:38 am

    FWI,

    My 12 month CD’s at 1.35% are maturing, and I’m putting them into same type CD’s which today rung about 1.65%…unless that ticks up a bit after the presumed fed increase this month.

  13. Drango
    Dec 6, 2017 at 8:50 am

    It’s kind of odd that there is an institution like the Fed that intentionally drives up stock prices as a matter of economic policy. Stock prices are supposed to be a hive mind estimate of economic conditions, not a source of value itself, except insofar as opinions differ on those conditions. If the Feds actions do drive down stock prices, it’s only because the Fed artificially inflated them in the first place. Having stock prices based on actual economic conditions isn’t a bad thing. What has been bad is the incompetence the Fed has shown in making the economy dependent on the financial gimmicks that are the Fed’s specialty.

    • Drango
      Dec 6, 2017 at 9:04 am

      And the bond market has been voting thumbs down on the Fed for quite some time. The bond market is the only true judge of the economy now, and its not at all impressed by the economic outlook, or the Fed’s ability to improve it.

    • Dec 6, 2017 at 3:46 pm

      “It’s kind of odd…” That’s the understatement of the month on WOLF STREET ;-]

  14. DK
    Dec 6, 2017 at 9:39 am

    Doesn’t a series of fed rate hikes and balance sheet reductions usually lead to a recession?

    • Thomas R Kauser
      Dec 6, 2017 at 12:27 pm

      Short of a big bank failure , recession is a 90’s term for pre- dip buying acumen or a depeche mode album title?

    • cdr
      Dec 6, 2017 at 12:39 pm

      DK, all your questions become clear when you understand that recessions and expansions are a function of liquidity and risk.

      Interest rates on existing debt are historically a reaction to liquidity. When liquidity disappears, prices for assets fall because people sell what the have for whatever they can get. Interest rates rise when prices for debt falls.

      Central banks can affect the price of debt via direct rate setting and massive balance sheet operations where they crowd out market forces in favor of their artificial levels.

      Recessions occur when people stop spending money and commercial activity slows. People stop spending money when their income goes down or they fear it will in the near future. Paradoxically, raising interest rates can increase personal income if it causes people to invest their savings in fixed income securities and then spend the income as it is paid. Nearly all pundits ignore this fact.

      Given that interest rates have been artificially low for many years, raising rates will likely increase economic activity. However, those who make lots of money with low rates will scream like it’s the end of the world when they are taken away. Unfortunately, these people are also the same people who central banks like to cater to. Not us, the people who would love to earn interest once again.

      • cdr
        Dec 6, 2017 at 1:00 pm

        or, to put it differently … in the languages of econ 101 … income is derived from a return on labor and from a return on capital.

        For the past few years, central banks have tried to substitute asset price bubbles for a return on capital from interest income. Hence, deflation since it caused a decline in liquidity because the gain on asset prices never made it to the spending money used on main street like interest income would have done.

        Since this is common sense, it makes you wonder about the real game for the central banks.

      • Mark
        Dec 6, 2017 at 1:21 pm

        CDR, I have to disagree with you about higher short term interest rates increasing economic activity. Raising rates may be helpful for your economic situation, but not for the economy in aggregate.

        Hiking the FFR just 75-100 basis points will flatten or invert the yield curve, severely crimp lending, and then bring about the next recession as stocks and real estate are repriced lower. Central banks have forced you to play their game and that’s getting and staying long risk assets. There is still money to be made there. We are late in the economic cycle, but this could continue for another year or two. You may need to be more vigilant and nimble, but the alternative of sitting around in Treasurys yielding 2% is for suckers. You’re barely being compensated for the inflation risk at 2%.

        • cdr
          Dec 6, 2017 at 5:13 pm

          Politely disagree. While you recite the current catechism of interest rates, inflation, and other current dogma, I believe much is truth base hype that most believe because it is repeated ad nauseum by all.

          Current rates are low … artificially … not due to market forces. This negates the dogma. Once market forces control rates again, then there is some correctness in your belief.

        • Rates
          Dec 6, 2017 at 6:20 pm

          The delusion in this thread is just insane. Helping the economy?
          If this had been a “normal” economy, I would agree, but raising rates slowly just would mean more debts for the serfs meaning when the correction arrives later, it might actually be worse than if the correction happens now.

          Manufacturing debt (i.e. financial activity) adds to GDP. Doesn’t mean we should.

          With the tax cut passed, there’s just no way this ends well in any way at all.

        • d
          Dec 6, 2017 at 6:33 pm

          ” I would agree, but raising rates slowly just would mean more debts for the serfs meaning when the correction arrives later, it might actually be worse than if the correction happens now.”

          If the correction happens now.

          The FED has no interest rate buffer, one of the its first correction fighting tools.

          QE Is a waste of time in a new correction, as the excess liquidity from the last QE program’s. IS STILL in the system, causing Huge problems.

          So with no interest rate buffer, you have a tool-less FED.

          Which Means you will Effectively have. A 1929 FED sitting on it’s hands response in the next correction. As there is not Interest rate buffer to cut.

          1929 worked out really well in America, for Joe average, didnt it?

          Think about all those bubbles out there today, all imploding in a domino effect. QE unable to prevent that, along with no interest rate buffer.

          The heavily suppressed Interest rates must riser and the asset bubbles MUST be SLOWLY and Carefully Deflated. Or there will be Financial Mayhem, the likes of, never seen or imagined before.

        • Rates
          Dec 6, 2017 at 10:46 pm

          d,

          Having an interest rate buffer didn’t help during the 2009 crisis. Or at least it didn’t help on its own, TARP and a bunch of other things combined with the cuts helped.

          Your thinking is basically: the next crisis will be like the last crisis which is why you are thinking of a buffer. No, the next crisis will NOT look like the last one.

          Also when has the Fed ever been able to magically deflate an asset bubble quietly?

          That’s why I called this delusion. People look at the instigator of crises to fix crises. Heck, someone said doing the same thing again and again and expecting different result is the very definition of madness.

          I agree with Wolf that no one knows the future, but that doesn’t mean there’s a future a couple of years from now where average citizens come out ahead. All choices are very bad.

        • d
          Dec 7, 2017 at 1:07 am

          “Your thinking is basically: the next crisis will be like the last crisis which is why you are thinking of a buffer. No, the next crisis will NOT look like the last one. ”

          No Two events are the same.

          The FED has a limited set of tools.

          Hence it needs all of them ready, to attempt resolve any future, Overdue problems.

          ” Also when has the Fed ever been able to magically deflate an asset bubble quietly?”

          So you are saying they shouldn’t try to, again.

          So where does America buy a new Economy?? as nobody but the FED, is even attempting to repair the current one.

          ” People look at the instigator of crises to fix crises.”

          Thats wright.,

          NO Matter what goes wrong in the Economy, the FED, and only the FED, caused it.

          Repealing glass steagal Etc had nothing to do with it.

          Only the FED is responsible when something goes Economically awry.

          .

      • Smingles
        Dec 7, 2017 at 1:44 pm

        “Paradoxically, raising interest rates can increase personal income if it causes people to invest their savings in fixed income securities and then spend the income as it is paid. Nearly all pundits ignore this fact.

        Given that interest rates have been artificially low for many years, raising rates will likely increase economic activity.”

        It will decrease economic activity. Raising rates can increase income (via higher yield) IF you are a net saver. You’re forgetting the other side of the balance sheet, cdr. Most Americans are net debtors.

        According to CNBC (Sept 13, 2017: “How much Americans have in their savings accounts”), about 40% of Americans have ZERO savings. About 20% of Americans have > $1 but < $1000 in savings. That's 60% of Americans who have less than $1000 total in savings.

        Even if you have $10,000 in savings, an extra 2% a year (which is generous) amounts to only $200 more a year. That's picking up pennies in front of a steam roller. That also assumes those people don't have credit and won't be facing higher debt payments.

        "Current rates are low … artificially … not due to market forces. This negates the dogma. Once market forces control rates again, then there is some correctness in your belief."

        Are they? The bond market would disagree… low growth, low inflation = low rates.

        • cdr
          Dec 8, 2017 at 9:42 am

          “Are they? The bond market would disagree… low growth, low inflation = low rates.”

          Certainly. Don’t you read the paper. The Fed and other central banks buy lots of bonds at below market prices to enforce low rates. The fairies don’t do it and neither does the market. This is why central banks maintain huge balance sheets. This is everyday life in the Eurozone.

          Also …

          Believe it or not lots of people save money. Perhaps more did in the past when there was a purpose for it … known as interest income. Some people actually don’t like guessing about stock market valuations. All the ‘experts’ are just sales people who earn commission from funds they invest for others. Answer this … if they really knew how the market worked with respect to future valuations, why would they need you or me for anything?

          Really, econ 101 is informative. Income comes from a return on labor and a return on capital. Nowhere else. Period! Low rates eviscerate income from capital, reducing income overall. The Fed tried to substitute return on capital by QE and asset price pumping. Bernanke even bragged publicly about it in 2010. Few spent the income gains from asset price pumping, hence deflation. Thus, the Fed caused the same deflation is claimed to wants to cure.

    • Dec 6, 2017 at 3:47 pm

      They’re trying to avoid that by going very slowly.

  15. Thomas R Kauser
    Dec 6, 2017 at 12:09 pm

    Eventually people will care as much about the national debt as the physical reserves in fort Knox Kentucky? First down…..!

  16. Dec 6, 2017 at 12:14 pm

    So far flooding the global system with bonds hasn’t driven rates higher. As a bond buyer you might get 6%, and it might cost you 20 bps at auction, and there might not be a bid to cover. (Collateral is disappearing and the real cash is bottom fishing the stock market)
    Or the issuer sets the yield at 3% and accepts a discount to par, but sells everything. Much like getting a 120% appraisal on a home mortgage. Buyers can hedge the purchase by going short the currency, because government(s) are in massive devaluation to gain some economic edge.

    • Thomas R Kauser
      Dec 6, 2017 at 12:37 pm

      Flooding markets with bonds? The Fed is pulling forward demand or nothing is really created in a vacuum? We paid for a Ferrari economy and got yugo parts? Now the yugo needs a fuel filter and its eleven dollars and you only got 10! I smell big oil problems like 1974?

  17. cdr
    Dec 6, 2017 at 12:19 pm

    Nothing will ‘blow up’ until rates normalize with respect to history and Wall Street perceives the Fed as a bystander, rather than a backstop. The Fed has yet to prove it’s not still the corner bank for the Globalists (low rates, easy money, low wages, open boarders, goofy theories to support their activities and decisions). It’s way too soon to declare victory. One bad election and negative rates are still a logical outcome.

  18. walter map
    Dec 6, 2017 at 2:35 pm

    “When Gundlach talks, he is talking his book”

    Evidently. No reasoned analysis supports his position, which accounts for why he doesn’t offer one.

    Mr. Market correctly surmises that the Fed isn’t going to do anything to upset investors, so nothing is going to be ‘blown up’ if the Fed can help it. The Fed likely can anticipate how much ‘tightening’ it can do before Mr. Market becomes concerned, and the Fed will back off anyway if Mr. Market sneezes.

    It is hazardous to try to anticipate forward financial events in such a grossly-corrupted environment, but all investors do it simply by virtue of being investors, aka gamblers, and it’s such a fun and easy game to play:

    (1) The Fed will never be able to clear its balance sheet or restore the financial markets to their ‘normal’ historical state, for the simple reason that Mr. Market becomes dependent on macro distortions whenever they are introduced. The Fed cannot change that, and financial regulators won’t.

    (2) First-quarter 2018 would be an auspicious time to initiate a crash, shortly after passage of the currect US tax legislation.

  19. chris Hauser
    Dec 6, 2017 at 4:09 pm

    “Then the government can just issue $500 billion in new bonds, and banks are required to buy them. But they already have the new money to do so.”

    paying it forward, so to speak.

  20. Smingles
    Dec 7, 2017 at 2:13 pm

    Six months ago (June), Gundlach said the 10-year would finish the year around 2.8%. He also said the S&P 500 had made most of its gains for the year.

    It’s currently sitting at 2.35%, and the S&P 500 is up about 9% since his call. It’s only fair play to point out how wrong he was on those calls.

    ““It is going to be very interesting to see how the markets can hang on to the easy gains that were made in 2017,” he said. “It’s just so far, so good. The Fed has tightened four times, they’ve embarked on quantitative tightening.”

    Fed chair Janet Yellen is leaving a “pretty good legacy,” he said: “She got us off of zero and she started us on the wind down – the quantitative tightening – and so far, nothing has blown up.””

    But financial conditions today are looser than they were at the start of the year. They’ve been loosening all year, not tightening.

    • Dec 7, 2017 at 7:05 pm

      In terms of the yield, you gotta wait till the year is up before you pass judgment on Gundlach’s call of “around 2.8%” by year-end.

  21. Dec 11, 2017 at 10:14 am

    The Fed interfered (socialism for the rich) with the markets by introducing QE and ultra low interest rate policies in order to save big corporations at the expense of savers and pensioners. We have been fooled. We want our money back. Petition your government representative and the the Fed to stop rigging the bond market and interest rates. DEMAND they cease buying bonds no one with half a brain will buy and to raise interest rates higher faster.

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