Notes From Underground: Paging Dr.Bernanke … The Stress Tests Results Have Arrived

Tuesday brings the release of the FED’S FOMC STATEMENT. Will it see its shadow or will the light be blocked by an extended period of darkness? Since the January 25 statement that announced the FED‘s intentions of holding rates at ZERO until mid-2014, the employment situation in the U.S. has improved, Europe has been “RESOLVED” and China has lowered reserve requirements. In the same time frame the S&Ps HAVE GAINED ALMOST 4%, while 10-year notes are virtually unchanged in price. Let us all bask in the success of Chairman Bernanke’s PORTFOLIO BALANCE CHANNEL. What now?

After the FED‘s ill-conceived white-paper on housing, it appears that the only job left to the FED is to find some way to remove the vast overhang of supply in the housing market and lift the construction sector out of its doldrums. This seems to be the intention of the recent Jon Hilsenrath piece about the FED’s potential use of buying MBS while sterilizing the purchases by doing REVERSE-REPOS and removing the liquidity add from the system. If this is the FED‘s intention WE SHOULD PROBABLY HEAR IT IN TOMORROW’S FOMC STATEMENT.

It seems that this action will be coupled with Thursday’s release of the BANK STRESS TESTS, for if all the BANKS PASS THE “SEVERE TESTS” then the FED will allow the banks to increase the dividend payouts, a prognosis of good health. If the PROGNOSIS IS OF GOOD HEALTH, THE FED MAY MOVE TO FLATTEN THE U.S.CURVE AS IT WILL NOT NEED TO INSURE THE BANKS FREE MONEY BY CURVE SURFING. A FLATTENING CURVE MAY ACTUALLY MOVE MANY BANKS TO BEGIN LENDING TO THE PRIVATE SECTOR RATHER THAN JUST PURCHASING GOVERNMENT DEBT.

Let’s watch the FOMC for any hint of this by announcing that it is ramping up its purchases of MBS and longer-dated Treasuries. Again, the FED’s WHITE PAPER ON HOUSING reflected the great concern that Chairman Bernanke has about the damaging effects of a moribund housing sector.

In a BLOOMBERG article, Dawn Kopecki draws out the FED‘s fear about the housing market and its effect on the consumer. According to the article, the FED‘s “projections [on bank exposure to consumers] have in some cases been almost double those of the banks…”

Further, “The FED generally has predicted firms would suffer greater losses on mortgages and credit cards than what banks estimated in capital plans submitted in January….” If the FED allows for increased dividends paid by banks it had better have a plan in place to ensure against the worst case scenarios presented in the STRESS TESTS, so Hilsenrath’s piece begins to make more sense. The sense of the FED will be found in any reference  about  intentions on the longer end of the curve.

***Last week it was noted that the Brazilian Central Bank lowered its lending rate by a larger percentage than forecast. Today, the Brazilian government extended its tax on foreign loans and bonds issued by local companies abroad and extended the duration out to five years.

There is no question that the Brazilians are worried about the overly strong REAL and are trying to have a controlled depreciation to some level that will slow manufactured imports. As reported by BLOOMBERG, “President Dilma Rousseff pledged last week to take all necessary measures to protect Latin America’s biggest economy from what she dubbed a ‘monetary tsunami’ unleashed by rich nations seeking to devalue their currencies.”

If the yield curve in Brazil continues to steepen it will signify that the Brazilian government, with the help of the central bank, is having an impact in weakening the currency and driving inflation expectations higher. The BANK has a great deal of work to do as Brazilian rates are still offering some of the most positive real returns in the world. Stay focused on this because it is an important indicator for the sensitivity of many of the G-20 nations. The media reports about all the camaraderie in the G-20, but Brazil’s latest concerns indicate there is far more dissonance than kumbaya hand holding.

***One more quick hit: I have often cited the work by Carmen Reinhart on FINANCIAL REPRESSION. Bloomberg today ran an op-ed  piece by Dr.Reinhart, “Financial Repression Has Come Back to Stay.” For those who have not read the original study, the op-ed piece is a very good summation. Read it several times and then e-mail it to your FAVORITE FED OFFICIAL.

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