http://www.prudentbear.com/2013/06/latent-market-bubble-risks.html#.UcViQ_Yd54U
( full Bulletin at the link , just the essay below.. )
Latent Market Bubble Risks
June 21, 2013
It was a rout: EM, Treasuries, municipal bonds, MBS, commodities and even some stocks.
The hours leading up to Wednesday’s FOMC statement and Bernanke press conference provided good television drama. CNBC’s Rick Santelli offered one of the better rants in a while: “Ben, what are you afraid of?” Mr. Santelli returned minutes later with a provocative back and forth with Wall Street Journal Fed-watcher John Hilsenrath.
After Santelli challenged him to more forcefully hold Bernanke and the Fed accountable, Hilsenrath politely snapped back: “Part of my holding people accountable is holding people like you accountable. People have been saying inflation, inflation, inflation. Show me, show me... How about the dollar? How about the dollar? ...Where are the bad things that you said were going to happen?”
As much as I appreciated the respectful exchange between Santelli and Hilsenrath, I was left disappointed that fundamental aspects of the QE debate remain unexplored. For years now, there’s been this ongoing debate of the costs and benefits of the Fed’s (and others’) aggressive monetary easing. The supposed benefits have been easy to articulate: lower market yields and mortgage rates, higher stock and asset prices and additional stimulus for a weak economic recovery.
The costs of monetary inflation have always been more challenging to explain – only much more so in recent years. Opponents of quantitative easing, in particular, have focused on the threat of inflation and dollar devaluation. It has been difficult for this camp to sway public opinion, especially with securities markets at record levels and CPI relatively contained. The lurking cost of unstable financial markets hasn’t been part of the discourse, although this issue jumped into the limelight this week.
I’ve been arguing that the greatest risks associated with Fed and global central bank inflationary policymaking have been in the realm of asset inflation, dangerous Bubble dynamics and ongoing global financial distortions and economic maladjustment. This type of analysis is so removed from conventional thinking that it resonates with few and basically has no impact on the broader discussion. This is a curious dynamic, especially since I believe strongly in the value of the analysis and analytical framework.
It was quite a week. I’ve been arguing the “global government finance Bubble” thesis for more than four years now. From my vantage point, a strong case can be made that the Bubble is now in serious jeopardy – if not already bursting. There are a few important aspects to Bubble analysis that may help place current vulnerabilities into context.
Total U.S. debt ended March at $57.0 Trillion. In spite of so called “de-leveraging,” total debt jumped almost $6.2 Trillion over the past five years. Debt has expanded much more rapidly globally, especially in the booming emerging-market (EM) economies. Total Chinese “social financing” jumped $1.0 Trillion during the first quarter alone, indicative of one history’s most spectacular Credit booms.
The world is awash in debt – virtually everywhere. The Fed and fellow central bankers have resorted to previously unimaginable measures to “reflate” global Credit and economies. They have manipulated short-term interest-rates to near zero. They have directly purchased Trillions of bonds and other instruments, in the process injecting Trillions into overheated securities markets. Over time, policy measures have come to dominate markets.
This has ensured the ongoing rapid expansion of global debt, too much of it non-productive. The upshot has been unprecedented price inflation for most securities trading all over the world. Moreover, there has been the ongoing inflation in the already massive pool of speculative finance, derivatives and financial leveraging. Such Bubble Dynamics leave debt, securities market and economic structures acutely vulnerable to any reduction in Credit growth and/or central bank liquidity.
This continuing Credit expansion has exacerbated latent fragilities – vulnerabilities that have been met with unprecedented central bank market intervention. When the European debt crisis was on the brink of unleashing global crisis last summer, global central bankers responded with incredible measures. Overextended Bubbles – along with attendant fragilities – inflated precariously worldwide. Global speculative excess was spurred to even more dangerous extremes. Bubbles throughout the developing world turned only more unwieldy. The historic Chinese Bubble’s “terminal phase” of excess was pushed into precarious overdrive.
Fundamental to my Bubble thesis is that tens of Trillions of global debt has been mispriced in the marketplace. Market yields have been forced lower (fixed-income prices higher), which has worked to inflate equities prices as well. Near zero returns on savings have forced Trillions into assorted risk markets, certainly including EM securities and U.S. fixed income and equities. This week’s bout of market instability reflects how quickly distorted Bubble markets can succumb to illiquidity and near-panic.
In an email to CNBC, David Tepper wrote, “All the concern in the markets is because the Fed sees the economy stronger in the future.” I don’t buy into this line of reasoning. Instead, I believe that key Federal Reserve officials are begrudgingly coming to terms with the reality that the risks of ongoing huge QE outweigh the rewards. This would be consistent with my view: the overall economic impact has been muted at best, while financial markets have become increasingly speculative and generally overheated. As I’ve argued in previous CBBs, there’s been a widening gulf between inflating asset Bubbles and problematic economic fundamentals. The markets’ behavior this week provides important confirmation of inherent fragilities.
There are reasons to fear how things might unfold. Importantly, it appears the “sophisticated” leveraged speculating community has been caught unprepared for the abrupt market reversal. Over the years, those (hedge fund, mutual fund, sovereign wealth fund, etc.) managers most adept at profiting from policymaking outperformed the markets - and in the process attracted incredible amounts of assets under management (AUM). The “sophisticated” speculator market universe became one big “crowded trade.”
After struggling with challenging macro analysis and unsettled “risk-on, risk off” market dynamics over recent years, Draghi’s “do whatever it takes,” Bernanke’s $85bn QE a month, and Kuroda’s “shock and awe” “Hail Mary” seemed to ensure a breakout “risk on” year in 2013. The enticing backdrop worked to ensure the speculator crowd became fully committed – only to now see global risk markets abruptly reverse course. Anytime the crowd suddenly seeks the exits, risk markets will confront immediate liquidity issues. This dynamic is compounded by the fact that thousands of funds have “weak hands.” It wouldn’t take significant market losses before redemptions and viability become pressing issues.
Troublingly, today’s market liquidity issues go way beyond hedge funds and myriad sophisticated leveraged speculative bets across the globe. Over recent years, as the Bernanke Federal Reserve pressured savers out of the safety of deposits and money funds, Wall Street has been busy creating instruments to harvest this torrent of return-seeking household finance. Bloomberg used the number $3.9 TN in quantifying the “money” that flowed to global emerging market funds. Apparently, the value of exchange-traded funds (ETFs) has swelled to $2.0 Trillion.
I’ll leave it to others to discuss the structural weaknesses of ETF products. For my purposes this evening, I’ll focus on ETFs as a focal point in the world of Latent Market Bubble Risks. ETF products have enjoyed incredible flows and growth. Many of the major ETFs are highly liquid, and have been the perfect instrument for speculators playing the Bernanke Bubble, as well as for savers keen to escape the Fed’s “financial repression.” They have provided a most convenient vehicle for playing about any market, theme or sector - anywhere.
For those wanting to invest like the “sophisticated” players, there’s a bevy of ETF products in which to build your “investment” portfolio. You want exposure to the latest hot emerging economy or simply a basket of the emerging markets? “Bond” funds that always return significantly more than lowly deposits? Dividend-producing equities? How about higher-yielding corporates or mortgage-backed securities? Tax-advantaged municipal debt? Would you prefer put or call options? How much leverage would you like to employ?
Well, as multi-billions flowed WEEKLY into fixed-income funds and various ETF products – no one seemed the least bit concerned with the possibility of a significant reversal of flows. It hasn’t mattered that many of the most popular ETFs hold huge portfolios of illiquid securities. It didn’t matter because the “money” just kept rolling in. It matters now that serious “money” has been lost and the flows have reversed course.
As an analyst of Bubbles, I have issues with financial instruments that work to distort perceptions of market risk. Bubbles, after all, always involve important market misperceptions. Over the years, I’ve noted that a Bubble financed by junk bonds wouldn’t get all that far – wouldn’t expand long enough and big enough to equate with major financial and economic structural distortions. On the other hand, a Bubble financed by “money” or “money”-like Credit instruments (“perceived liquid stores of nominal value”) have potential to inflate as long as confidence is retained in the “moneyness” of the underlying Credit.
From a global Bubble perspective, determined central bank market liquidity support has been instrumental in shaping market risk perceptions. On a more micro basis, the perception of liquidity and low-risk throughout the ETF complex has been crucial in funneling household savings into instruments that savers for the most part would have never purchased directly. Never has the U.S. household sector made such a huge bet on the emerging markets. Never have so much savings flowed indirectly into illiquid mortgage securities and municipal debt. I don’t believe many “retail” investors appreciated the myriad risks associated with today’s highly inflated and distorted financial markets. I suspect the vast majority made ETF purchases with the perception that risk was limited.
From my analytical framework, this was a critical week. I believe the “sophisticated” speculators came to realize they are suddenly on the wrong side of a rapidly changing financial and economic landscape. I suspect that many of these market operators have held the view that this will all end badly – they just thought the Fed, BOJ and other central banks ensured they had more time to build on their vast fortunes. Meanwhile, the less market sophisticated - that had funneled savings directly and indirectly into long-term bonds, corporate debt, MBS, emerging markets, municipal debt and equities – will come to realize there is significantly more risk in these markets than they had perceived (and been led to believe). The perception of endless liquidity now confronts the reality that global central banks and myriad financial products and speculative excesses have worked to foment very serious inherent market liquidity issues.
Yet this week was critical beyond the Fed and risk market dynamics. In a potentially momentous development, an intriguing story seemed to gain some clarity this week in China. Uncharacteristically, the People’s Bank of China waited until short-term and inter-bank lending rates had spiked higher before providing targeted and limited liquidity injections in the Chinese money market (see “China Bubble Watch” above).
I have chronicled China’s historic Credit Bubble for years now. I have posited that the post-2008 U.S., Chinese and global crisis response propelled the Chinese Bubble to precarious “terminal phase” excess. As a tenet of my Bubble analysis framework, I have often stated that major Bubbles become impervious to “tinkering.” To actually rein in Bubble excess policymakers must inflict pain, alter perceptions and behaviors - and accept the inevitable consequences of bursting Bubbles.
For a while now Chinese authorities have tinkered with little effect. They’ve implemented various measures to contain house price inflation – yet the Chinese housing (apartment) Bubble has only gathered further momentum. They have watched the economy slow while Credit growth has exploded. They have surely seen enough of the surge in “shadow banking” to appreciate that they have a very serious financial issue to contend with.
There were indications this week that the new Chinese government may be very serious about reform – economic, financial, political, environmental and social. This is an enormous population that has had expectations inflated throughout the protracted Credit and economic boom. But inflationary consequences include massive debt, deep economic maladjustment, housing Bubbles, inequitable wealth distribution, horrific environmental degradation and widespread corruption. The Chinese people increasingly fear they are being poisoned by toxic air, food and water. They are increasingly fed up with corruption throughout the government and economy
The conventional market view is that Chinese officials will manage the situation to ensure an ongoing economic expansion – if not 10% growth at least 7-8%. My view is that it will require some tough medicine if Chinese authorities are determined to rein in Bubble excess – especially in a runaway Credit inflation. I believe they’re determined.
I’ll assume that the new communist government is now ready to get on with it. They have stated their intention to target strategic industries for development. It would appear they have decided to move in the direction of central control over the allocation of Credit. There were indications this week that they have commenced the process of restricting liquidity to segments of their financial system that they don’t see as supporting their view of sound economic growth. And, best I can tell, there is an enormous infrastructure that has evolved to finance all types of assets – apartments, commercial real estate, commodities, commercial ventures and likely all kinds of fraud.
The increasingly unwieldy Chinese Bubble has to end at some point. The increasingly unwieldy Bernanke Fed-induced global Bubble has to end at some point. It was a bit astonishing to watch such important developments unfold this week in Beijing and Washington. And the emerging markets now face the perfect storm.
The global risk backdrop has quickly become less latent – economic and market backdrops much more uncertain. Powerful de-risking/de-leveraging dynamics are now in play. Global market yields (and risk premiums) are adjusting to new risk and liquidity dynamics. Financial conditions have tightened meaningfully, especially in the now troubled "emerging" economies. Higher yields and risk premiums put a fragile Europe back in the spotlight. Forecasts for global growth must now come down, which implies risk to elevated earnings expectations. I would strongly argue that stock market multiples in the U.S. and elsewhere are much too high considering extraordinary risks and uncertainties. If the global government debt Bubble has begun to succumb, there are very challenging times ahead.
The hours leading up to Wednesday’s FOMC statement and Bernanke press conference provided good television drama. CNBC’s Rick Santelli offered one of the better rants in a while: “Ben, what are you afraid of?” Mr. Santelli returned minutes later with a provocative back and forth with Wall Street Journal Fed-watcher John Hilsenrath.
After Santelli challenged him to more forcefully hold Bernanke and the Fed accountable, Hilsenrath politely snapped back: “Part of my holding people accountable is holding people like you accountable. People have been saying inflation, inflation, inflation. Show me, show me... How about the dollar? How about the dollar? ...Where are the bad things that you said were going to happen?”
As much as I appreciated the respectful exchange between Santelli and Hilsenrath, I was left disappointed that fundamental aspects of the QE debate remain unexplored. For years now, there’s been this ongoing debate of the costs and benefits of the Fed’s (and others’) aggressive monetary easing. The supposed benefits have been easy to articulate: lower market yields and mortgage rates, higher stock and asset prices and additional stimulus for a weak economic recovery.
The costs of monetary inflation have always been more challenging to explain – only much more so in recent years. Opponents of quantitative easing, in particular, have focused on the threat of inflation and dollar devaluation. It has been difficult for this camp to sway public opinion, especially with securities markets at record levels and CPI relatively contained. The lurking cost of unstable financial markets hasn’t been part of the discourse, although this issue jumped into the limelight this week.
I’ve been arguing that the greatest risks associated with Fed and global central bank inflationary policymaking have been in the realm of asset inflation, dangerous Bubble dynamics and ongoing global financial distortions and economic maladjustment. This type of analysis is so removed from conventional thinking that it resonates with few and basically has no impact on the broader discussion. This is a curious dynamic, especially since I believe strongly in the value of the analysis and analytical framework.
It was quite a week. I’ve been arguing the “global government finance Bubble” thesis for more than four years now. From my vantage point, a strong case can be made that the Bubble is now in serious jeopardy – if not already bursting. There are a few important aspects to Bubble analysis that may help place current vulnerabilities into context.
Total U.S. debt ended March at $57.0 Trillion. In spite of so called “de-leveraging,” total debt jumped almost $6.2 Trillion over the past five years. Debt has expanded much more rapidly globally, especially in the booming emerging-market (EM) economies. Total Chinese “social financing” jumped $1.0 Trillion during the first quarter alone, indicative of one history’s most spectacular Credit booms.
The world is awash in debt – virtually everywhere. The Fed and fellow central bankers have resorted to previously unimaginable measures to “reflate” global Credit and economies. They have manipulated short-term interest-rates to near zero. They have directly purchased Trillions of bonds and other instruments, in the process injecting Trillions into overheated securities markets. Over time, policy measures have come to dominate markets.
This has ensured the ongoing rapid expansion of global debt, too much of it non-productive. The upshot has been unprecedented price inflation for most securities trading all over the world. Moreover, there has been the ongoing inflation in the already massive pool of speculative finance, derivatives and financial leveraging. Such Bubble Dynamics leave debt, securities market and economic structures acutely vulnerable to any reduction in Credit growth and/or central bank liquidity.
This continuing Credit expansion has exacerbated latent fragilities – vulnerabilities that have been met with unprecedented central bank market intervention. When the European debt crisis was on the brink of unleashing global crisis last summer, global central bankers responded with incredible measures. Overextended Bubbles – along with attendant fragilities – inflated precariously worldwide. Global speculative excess was spurred to even more dangerous extremes. Bubbles throughout the developing world turned only more unwieldy. The historic Chinese Bubble’s “terminal phase” of excess was pushed into precarious overdrive.
Fundamental to my Bubble thesis is that tens of Trillions of global debt has been mispriced in the marketplace. Market yields have been forced lower (fixed-income prices higher), which has worked to inflate equities prices as well. Near zero returns on savings have forced Trillions into assorted risk markets, certainly including EM securities and U.S. fixed income and equities. This week’s bout of market instability reflects how quickly distorted Bubble markets can succumb to illiquidity and near-panic.
In an email to CNBC, David Tepper wrote, “All the concern in the markets is because the Fed sees the economy stronger in the future.” I don’t buy into this line of reasoning. Instead, I believe that key Federal Reserve officials are begrudgingly coming to terms with the reality that the risks of ongoing huge QE outweigh the rewards. This would be consistent with my view: the overall economic impact has been muted at best, while financial markets have become increasingly speculative and generally overheated. As I’ve argued in previous CBBs, there’s been a widening gulf between inflating asset Bubbles and problematic economic fundamentals. The markets’ behavior this week provides important confirmation of inherent fragilities.
There are reasons to fear how things might unfold. Importantly, it appears the “sophisticated” leveraged speculating community has been caught unprepared for the abrupt market reversal. Over the years, those (hedge fund, mutual fund, sovereign wealth fund, etc.) managers most adept at profiting from policymaking outperformed the markets - and in the process attracted incredible amounts of assets under management (AUM). The “sophisticated” speculator market universe became one big “crowded trade.”
After struggling with challenging macro analysis and unsettled “risk-on, risk off” market dynamics over recent years, Draghi’s “do whatever it takes,” Bernanke’s $85bn QE a month, and Kuroda’s “shock and awe” “Hail Mary” seemed to ensure a breakout “risk on” year in 2013. The enticing backdrop worked to ensure the speculator crowd became fully committed – only to now see global risk markets abruptly reverse course. Anytime the crowd suddenly seeks the exits, risk markets will confront immediate liquidity issues. This dynamic is compounded by the fact that thousands of funds have “weak hands.” It wouldn’t take significant market losses before redemptions and viability become pressing issues.
Troublingly, today’s market liquidity issues go way beyond hedge funds and myriad sophisticated leveraged speculative bets across the globe. Over recent years, as the Bernanke Federal Reserve pressured savers out of the safety of deposits and money funds, Wall Street has been busy creating instruments to harvest this torrent of return-seeking household finance. Bloomberg used the number $3.9 TN in quantifying the “money” that flowed to global emerging market funds. Apparently, the value of exchange-traded funds (ETFs) has swelled to $2.0 Trillion.
I’ll leave it to others to discuss the structural weaknesses of ETF products. For my purposes this evening, I’ll focus on ETFs as a focal point in the world of Latent Market Bubble Risks. ETF products have enjoyed incredible flows and growth. Many of the major ETFs are highly liquid, and have been the perfect instrument for speculators playing the Bernanke Bubble, as well as for savers keen to escape the Fed’s “financial repression.” They have provided a most convenient vehicle for playing about any market, theme or sector - anywhere.
For those wanting to invest like the “sophisticated” players, there’s a bevy of ETF products in which to build your “investment” portfolio. You want exposure to the latest hot emerging economy or simply a basket of the emerging markets? “Bond” funds that always return significantly more than lowly deposits? Dividend-producing equities? How about higher-yielding corporates or mortgage-backed securities? Tax-advantaged municipal debt? Would you prefer put or call options? How much leverage would you like to employ?
Well, as multi-billions flowed WEEKLY into fixed-income funds and various ETF products – no one seemed the least bit concerned with the possibility of a significant reversal of flows. It hasn’t mattered that many of the most popular ETFs hold huge portfolios of illiquid securities. It didn’t matter because the “money” just kept rolling in. It matters now that serious “money” has been lost and the flows have reversed course.
As an analyst of Bubbles, I have issues with financial instruments that work to distort perceptions of market risk. Bubbles, after all, always involve important market misperceptions. Over the years, I’ve noted that a Bubble financed by junk bonds wouldn’t get all that far – wouldn’t expand long enough and big enough to equate with major financial and economic structural distortions. On the other hand, a Bubble financed by “money” or “money”-like Credit instruments (“perceived liquid stores of nominal value”) have potential to inflate as long as confidence is retained in the “moneyness” of the underlying Credit.
From a global Bubble perspective, determined central bank market liquidity support has been instrumental in shaping market risk perceptions. On a more micro basis, the perception of liquidity and low-risk throughout the ETF complex has been crucial in funneling household savings into instruments that savers for the most part would have never purchased directly. Never has the U.S. household sector made such a huge bet on the emerging markets. Never have so much savings flowed indirectly into illiquid mortgage securities and municipal debt. I don’t believe many “retail” investors appreciated the myriad risks associated with today’s highly inflated and distorted financial markets. I suspect the vast majority made ETF purchases with the perception that risk was limited.
From my analytical framework, this was a critical week. I believe the “sophisticated” speculators came to realize they are suddenly on the wrong side of a rapidly changing financial and economic landscape. I suspect that many of these market operators have held the view that this will all end badly – they just thought the Fed, BOJ and other central banks ensured they had more time to build on their vast fortunes. Meanwhile, the less market sophisticated - that had funneled savings directly and indirectly into long-term bonds, corporate debt, MBS, emerging markets, municipal debt and equities – will come to realize there is significantly more risk in these markets than they had perceived (and been led to believe). The perception of endless liquidity now confronts the reality that global central banks and myriad financial products and speculative excesses have worked to foment very serious inherent market liquidity issues.
Yet this week was critical beyond the Fed and risk market dynamics. In a potentially momentous development, an intriguing story seemed to gain some clarity this week in China. Uncharacteristically, the People’s Bank of China waited until short-term and inter-bank lending rates had spiked higher before providing targeted and limited liquidity injections in the Chinese money market (see “China Bubble Watch” above).
I have chronicled China’s historic Credit Bubble for years now. I have posited that the post-2008 U.S., Chinese and global crisis response propelled the Chinese Bubble to precarious “terminal phase” excess. As a tenet of my Bubble analysis framework, I have often stated that major Bubbles become impervious to “tinkering.” To actually rein in Bubble excess policymakers must inflict pain, alter perceptions and behaviors - and accept the inevitable consequences of bursting Bubbles.
For a while now Chinese authorities have tinkered with little effect. They’ve implemented various measures to contain house price inflation – yet the Chinese housing (apartment) Bubble has only gathered further momentum. They have watched the economy slow while Credit growth has exploded. They have surely seen enough of the surge in “shadow banking” to appreciate that they have a very serious financial issue to contend with.
There were indications this week that the new Chinese government may be very serious about reform – economic, financial, political, environmental and social. This is an enormous population that has had expectations inflated throughout the protracted Credit and economic boom. But inflationary consequences include massive debt, deep economic maladjustment, housing Bubbles, inequitable wealth distribution, horrific environmental degradation and widespread corruption. The Chinese people increasingly fear they are being poisoned by toxic air, food and water. They are increasingly fed up with corruption throughout the government and economy
The conventional market view is that Chinese officials will manage the situation to ensure an ongoing economic expansion – if not 10% growth at least 7-8%. My view is that it will require some tough medicine if Chinese authorities are determined to rein in Bubble excess – especially in a runaway Credit inflation. I believe they’re determined.
I’ll assume that the new communist government is now ready to get on with it. They have stated their intention to target strategic industries for development. It would appear they have decided to move in the direction of central control over the allocation of Credit. There were indications this week that they have commenced the process of restricting liquidity to segments of their financial system that they don’t see as supporting their view of sound economic growth. And, best I can tell, there is an enormous infrastructure that has evolved to finance all types of assets – apartments, commercial real estate, commodities, commercial ventures and likely all kinds of fraud.
The increasingly unwieldy Chinese Bubble has to end at some point. The increasingly unwieldy Bernanke Fed-induced global Bubble has to end at some point. It was a bit astonishing to watch such important developments unfold this week in Beijing and Washington. And the emerging markets now face the perfect storm.
The global risk backdrop has quickly become less latent – economic and market backdrops much more uncertain. Powerful de-risking/de-leveraging dynamics are now in play. Global market yields (and risk premiums) are adjusting to new risk and liquidity dynamics. Financial conditions have tightened meaningfully, especially in the now troubled "emerging" economies. Higher yields and risk premiums put a fragile Europe back in the spotlight. Forecasts for global growth must now come down, which implies risk to elevated earnings expectations. I would strongly argue that stock market multiples in the U.S. and elsewhere are much too high considering extraordinary risks and uncertainties. If the global government debt Bubble has begun to succumb, there are very challenging times ahead.
and...
http://www.zerohedge.com/news/2013-06-22/end-easing-or-start-tightening-12-charts
The "End Of Easing" Or "The Start Of Tightening" In 12 Charts
While the market's jarring response to Ben Bernanke's (very much un)surprising Taper pre-announcement has been extensively documented and discussed, and is most comparable to the tantrum unleashed during the summer of 2011 debt ceiling negotiation when the market's ultimatum that US spending must go on or the wealth effect gets it, the key question at the heart of the market's confusion is whether Bernanke has telegraphed the start of tightening or merely the end of easing. Stock bulls, obviously, defend the latter while those who dream for a return to normal, uncentrally-planned markets are hoping for the former. But what do the facts say?
The charts below show the 10 previous Fed cycles with the dates of the last rate cut vs. first rate hike. The average time distance between the last rate cut and the first rate hike has been around 15 months.
As per JPM's compilation, the behavior of the 5 asset prices a year before and after the last Fed policy rate cut is shown below. Yields declined in the year before and rose in the year after the last rate cut. It is worth emphasizing that the moves in yields are not adjusted for carry and that most of the 60bp of the average yield increase after the last Fed policy rate cut would have been offset by carry. The UST curve steepened in the year before and was little changed in the year after the last rate cut. Credit spreads exhibited negative correlation with yields, widening in the period before and tightening in the period after. Equities were in a bull market, rising before and after the last rate cut. The dollar was little changed overall.
The behavior of the 5 asset prices a year before and after the first Fed policy rate hike is shown in the next chart below. Yields started rising 3 months before the first Fed policy rate hike. The cumulative increase in the 10y UST had been around 80bp, starting 3 months before the first hike up until 6 months after the first hike. Again a large chunk of this yield increase would have been offset by carry. The US Treasury market experienced bear flattening post the first rate hike. Credit spreads and the S&P500 had been rising consistently before and after the first rate hike. In contrast, the dollar had been weakening.
JPM's take?
Which period is the most comparable to the current one? Strictly speaking, the QE stock approach suggests that it is the one-year period before the last Fed policy rate cut that is more comparable to the current period, assuming the Fed ceases bond purchases in June 2014. The Fed’s forward guidance complicates the comparison though, as a case can be made that a change in rate guidance is now the same as an outright rate change. This makes it more likely that the market reaction is shifted earlier and will be more similar to the period after the last Fed policy rate cut.
Strategically, JPM sees a perfect goldilocks in either case: rising stocks (good luck with that), slowly rising rates, and improving credit.
By looking at market moves post the zero mark... this would imply a benign environment of modestly higher UST yields, rising equities and tighter credit spreads.
In other words, precisely the opposite of what the market has indicated so far!
Of course, the reason why this time really is different when it comes to the dislocation of the Fed from the market, is that never before has the Fed been so inextricably involved from both through stock (20% of US GDP held hostage by the Fed) and flow (injecting 0.5%+ of GDP into the stock market in the form of low-powered money each month). Add to this the sheer market terror that the flow impact from the BOJ may and likely will fade very soon, and of course the ongoing unwillingness of the PBOC to join its reckless 'developed markets' central bank peers, and it becomes quite clear why both charts above are completely meaningless.
However, the will provide macro tourists countless hours of deeply uninsighful watercooler conversations over the next 7 days, and shallow pundits hours of regurgitation why even a tightening by the Fed is bullish for stocks (was Tepper busy buying shovels to bury the shorts in the past few days?) and why grandma would be an idiot not to BTFD.
and...
http://www.zerohedge.com/news/2013-06-21/treasuries-worst-week-50-years-stocks-worst-week-2013
Treasuries' Worst Week In 50 Years; Stocks Worst Week In 2013
5Y yields rose a stunning 37% this week - the most in the 50 year record of Bloomberg data. The 38bps increase in yields is also among the worst absolute shifts over that period but off such low levels it is quite a shock. Credit markets saw hedge protection bought early on in the week and then covered as real money started to sell their bonds on the back of redemptions in the last two days. The high-yield bond ETF had its biggest weekly loss in 13 months (notably clinging to the Lehman ledge levels). Equity markets suffered too (down 3.5 to 4.0% from the FOMC) with the S&P's worst week of the year (even as it bounced off its 100DMA). Most sectors hung around the 3-4% drop but homebuilders are down over 8% since the FOMC. The USD surged over 2.1% on the week with JPY's worst week in 43 months. VIX ended the day down 1.7 vols at 18.8% but beware as OPEX and hedge unwinds into underlying covers seems prevalent. Gold's worst week in 21 months left it back under $1300.
Treasuries (especially the belly) were crushed...while in context the move may be small, what most forget is the increasing leverage that has been applied to this constantly compressing market in order to generate returns
HYG's worst week in 13 months leaves it back at the Lehman ledge...
FX markets were not pretty either - JPY's worst week (Abe's happy we assume) in 43 months...
Gold's worst week in 21 months...
Since the FOMC, indices are down notably (even with today's Hilsenramp interruption)...
and Homebuilders are on their own as momo-chasers realize that high-beta is a two-edged sword...
Credit markets did not 'believe' the Hilsenramp but OPEX dragged stocks higher...
and the Hilsenramp was all no volume - with the crack lower into the close perfectly ending at VWAP...
The week in Commodities, FX, and Bonds...
Guest Post: Everything Is Being Sold
- Bond
- Central Banks
- Chris Martenson
- Germany
- Greece
- Guest Post
- Housing Market
- Italy
- Japan
- Portugal
- Real estate
- Sovereign Debt
- Yield Curve
Submitted by Chris Martenson of Peak Prosperity,
Global financial markets are now in a very perilous state, and there is a much higher than normal chance of a crash. Bernanke's recent statement revealed just how large a role speculation had played in the prices of nearly everything, and now there is a mad dash for cash taking place all over the world.
After years of cramming liquidity into the markets, creating massive imbalances such as stock markets hitting new highs even as economic fundamentals deteriorated (Germany) or were lackluster (U.S.), junk bonds hitting all-time-record highs, and sovereign bond yields steadily falling even as the macro economics of various countries worsened markedly (Spain, Italy, Greece, and Portugal), all of this was steadily building up pressures that were going to be relieved someday. Just over a month ago, Japan lit the fuse by destabilizing its domestic market, which sent ripples throughout the world.
[ZH: Must-watch clarifying few minutes with Chris - grab a glass of Absynth, forward to 1:40in the following clip and listen]
The Dash for Cash
The early stage of any liquidity crisis is a mad dash for cash, especially by all of the leveraged speculators. Anything that can be sold is sold. As I scan the various markets, all I can find is selling. Stocks, commodities, and equities are all being shed at a rapid pace, and that's the first clue that we are not experiencing sector rotation or other artful portfolio-dodging designed to move out of one asset class into another (say, from equities into bonds).
Here's the data. Let's begin with the place that the most trouble potentially lurks – bonds – and here we have to start with the U.S. Treasury 10-year note, as that is the benchmark for so many other interest-rate-sensitive items, such as mortgage bonds.
Here there's been a very interesting story that predates the recent Fed announcement by nearly two months. This chart of the price of 10-year Treasurys tells us much (remember, price and yield are exact opposites for bonds; as one moves up, the other moves down):
The first take-away is that the current price of 10-year Treasurys is now lower that at any time since late 2011. The second take-away is that this has happened despite both Operation Twist and QE3.
That is, after all the hundreds and hundreds of billions of dollars of thin-air money-printing and bond-buying, Treasurys are now lower in price than when the Fed initiated Operation Twist and QE3.
And it's not just 10-year rates; the entire yield curve from 5-year to 30-year debt is now higher than it was a month ago:
This is very, very important. On the one hand, it tells us that the Fed may not be omnipotent after all, because you can bet your bottom dollar that the Fed simply does not want long rates to rise and that this was an unplanned and unwelcome move. On the other hand, rising rates will do much to a fragile economy and over-leveraged speculators and institutions.
I may need more hands here, because there are other undesirable effects of rising rates, including falling equities (we'll get to that in a minute), fiscal difficulties for heavy borrowers (many sovereign entities belong to this club), and mortgages becoming increasingly expensive.
An early casualty of rising U.S. interest rates, of course, was mortgage rates, which have climbed approximately 40 basis points (0.40%) over the past month:
Obviously, anything that will impact the housing market at this point is entirely unwelcome by the Fed, which has openly stated that it wants people buying homes – and for a variety of reasons, people tend to take out fewer mortgages when rates rise. This is especially true for refinancing mortgages, an important source of revenue for financial institutions.
If it were just U.S. rates that were rising, that would be one thing, but rates have been on the move in Europe and Japan. In this next table, you can see two things: (1) much of the one-month rise in rates can be attributed to the past 24 hours (red arrows), and (2) quite a number of the most problematic nations have bond yields that are below their recent highs (as seen in the green circle).
(Source)
What I gather from this is that countries like Spain, Portugal, Greece, and Italy do not deserve the ridiculously low rates they now enjoy, and that those old highs in yield will be revisited.
Where the U.S. had a change in yield trend in mid-May 2013, Spain was leading the charge by reversing course in early May:
Who was buying all that junky sovereign debt at inflated prices as Spanish yields fell? Institutions and speculators. The institutions were entities like Spanish banks and the Spain pension system, buying Spanish debt for reasons that seem far more political than financially prudent. For a while, that strategy worked, as rising bond prices delivered both nice yields and capital gains, but now pretty much anybody who bought those bonds in 2013 is (at best) roughly even for the year, leaving plenty who are nursing losses.
The speculators in this story represented the hottest of the hot money, involving hedge funds jumping on any trades that seemed to be headed in the right direction and/or offered useful yields for spread trades, both of which conditions were met by southern European sovereign debt. But that hot money is best described by the phrase easy come, easy go. It arrives fast and leaves even faster.
Okay, so what we can say at this point is that bonds are being sold off around the world. This is very bad for equities, because there's a connection between falling yields and rising equities. As yields fall, the risk-appetite of investors climbs because they need returns, and so they put more money into equities and real estate. This is especially true when interest rates are negative, meaning that they yield less than the rate of inflation, and that is precisely what the Fed engineered. On purpose.
However, this coin has two sides, and the less virtuous face combines rising bond yields with falling equities. It is simply the reverse of the Fed's desired and manufactured outcome of the prior several years.
If we look at the U.S. stock market, as typified by the S&P 500, we see that it peaked in May (to no one's surprise, I hope) and has been steadily falling over the same period that interest rates have been rising.
1600 is now the magic 'round number' for the market to break through if it is heading lower, which I think it is. We'll also note that the 50-day moving average (the rising blue line) has been critical support for the S&P 500 throughout the entire advance (green circles), and that it has been soundly violated on this drop.
Commodities have been heading down, too, but seemingly as a part of a larger move that's been underway for a couple of years:
Note that commodities are now beneath their 200-week moving average, which is a very bearish indicator (green circle).
Collectively, the move away from commodities, bonds, and equities in all markets globally tells us that there's nowhere to hide and that this is a 2008-style dash for cash. Everything is being sold, as it must, to meet margin calls, pay down leverage, and get out of positions; all are signs of the end of a speculative phase.
I know it's a lot to claim that we are at that turning point, but the evidence that we are there is now more than a month old, and it's time to consider that we are entering the next phase of our date with destiny.
What's Coming Next
In Part II: The Ride Down from Here, we look at the increasing number of flashing indicators warning that a 2008-style – but worse – sell-off is arriving. We say "worse" because this time it looks like it will be accompanied by a vicious cycle of rising interest rates. Plus, governments and central banks have used up all of their major options already. There are no more white knights to hope for.
We examine the likeliest course from here for asset prices and what to expect from the central planners as desperation increasingly drives the decision-making. We also look at what defensive steps individual investors should be considering. Because, as we've been advising for months, now is a time for safety.
Buckle up. It's going to be a bumpy summer.
http://www.zerohedge.com/news/2013-06-21/chart-scared-bernanke-straight
Is This The Chart That Scared Bernanke Straight?
With the confusion over Bernanke's comments - "have no fear as the economy is bad enough that the Taper will never come" confused with "the economy is picking-up and that's great so we don't need the Fed anymore" - one has to ask, as we have numerous times, is there another reason for the Fed to start the ball rolling on the Taper talk? In the last few weeks, the Treasury market's yields have risen notably but much more critically, the fails-to-deliver has surged.
This critical indicator of both collateral shortages and technical carry trade unwinds is a little-discussed indicator of just how broken the market is thanks to the overwhelming ownership of the Fed. It's getting worse - as Barclays warns the weakness in bonds is feeding on itself as more people want to short and so the need to borrow from the Fed (as dealer inventory is so low) increases and raises the cost (special-ness) of that short.
Simply put, the main reason the Fed is tapering has nothing to do with the economy and everything to do with theTBAC presentation (rehypothecation and collateral shortages) and that the US is now running smaller deficits!!!
Source: NY Fed
http://www.stuff.co.nz/world/europe/8829748/Banking-collapse-bail-in-dispute
( dash for cash highlight bail in risk .... )
Europe failed to agree on how to share the cost of bank collapses today as Germany resisted attempts by France to water down rules designed to spare taxpayers in future crises.
Almost 20 hours of talks late into the night could not forge a way for countries to set up an EU-wide regime that would first impose losses on shareholders and bondholders when a bank fails, followed by depositors with more than €100,000 (NZ$160,000).
Ministers will make a fresh attempt to break the impasse at a meeting on Wednesday, on the eve of an EU leaders summit, and resolve one of the most difficult questions posed by Europe's banking crisis - how to shut failed banks without sowing panic or burdening taxpayers.
''I think we can reach a deal if we take a few more days,'' said Michel Barnier, the European commissioner in charge of regulation.
''We are not far off now from a political agreement.''
The European Union spent the equivalent of a third of its economic output on saving its banks between 2008 and 2011, using taxpayer cash but struggling to contain the crisis and - in the case of Ireland - almost bankrupting the country.
German Finance Minister Wolfgang Schaeuble blamed the complexity of the issue and conflicting interests for not being able to reach a final result on Saturday. One EU official, who asked not to be named, described the meeting as chaotic.
At the heart of the disagreement, chiefly between Germany and France, was how much leeway countries should have when imposing losses on bondholders or large savers, a procedure known as ''bail-in''.
Such an approach was first tested out in Cyprus' bailout in March, but making it the EU norm would mark a radical departure from the bloc's crisis management in which taxpayers have footed the bill for a string of rescue programmes.
Britain, Sweden and France worry that forcing losses on depositors could cause a bank run or rattle confidence, and want countries to have wide-ranging freedom in deciding whether to take such bold steps.
Spain's Economy Minister Luis de Guindos underscored the sensitivity of the issue.
''What's fundamental is there is agreement over the bail-in hierarchy and the protection of small depositors,'' he said.
Germany, however, wants strict norms. Schaeuble said the new rules should not vary across the 27-nation European Union because that could put some banks at a competitive disadvantage.
''There's clear disagreement between France and Germany. That's why the meeting broke up,'' said one EU diplomat.
France's Finance Minister Pierre Moscovici tried to play down any divisions and said a deal was possible next week.
'DANGEROUS'
While there is no immediate deadline for an agreement, indecision could hurt confidence in the ability of Europe's politicians to repair the financial system, encourage banks to lend and help the continent emerge from economic stagnation.
An agreement on European rules for closing banks is also a step required by Germany before it will sign off on a scheme for the 17-nation euro zone's bailout fund to help banks in trouble, potentially important in helping Ireland.
''The fact that the euro zone countries are trying to push a solution is very dangerous for the rest of us,'' Sweden's Finance Minister Anders Borg told reporters.
The regime to ensure that troubled banks are closed in an orderly way sets an important precedent for the euro zone, which is pursuing a project called banking union to supervise, control and support banks to rebuild confidence in the currency.
This scheme aims to form a common front across the single currency area when tackling failed banks, rather than leaving it to countries to manage alone.
At the wider EU level, the so-called resolution rules are needed so that the euro zone can mould its own regime and decide how the bloc's rescue fund helps banks.
Its rules, for example, on pushing losses on large savers, could be made stricter, in particular for banks seeking help from the fund, the European Stability Mechanism.
Euro zone finance ministers agreed late on Thursday to set aside 60 billion euros for banks via the fund.
If agreed, the rules would take effect at the start of 2015 with the provisions to impose losses coming as late as 2018.
No comments:
Post a Comment