Notes From Underground: Searching for Clarity in the Age of Monetary Policy On Steroids

The much-awaited piece from Jon Hilsenrath about FED “tapering” appeared in the weekend WSJ, and, as promised by the abundant tweets, it delivered very little in providing any new insights into Fed halting of security purchases. The headline, “Fed Maps Exit From Stimulus,” wasn’t a map of any kind and merely seemed to provide the philosopher’s answer to question of what to do when confronted with the fork in the road … TAKE IT. The FED is caught on the horns of a dilemma for it wants to provide some clarity as to how it will end the large-scale asset purchases (LSAP) without sending the market into a downside tailspin. The massive increase in the FED‘s balance sheet has provided the rocket fuel to boost the demand for all types of risky assets but how do they know the economy has enough strength to sustain the rally on its own. It seems that the most important voice now will be Fed Governor Jeremy Stein–more important than Jon Hilsenrath–for he seemed to unnerve Chairman Bernanke with his April 19 speech in which he warned about the distorting impact the Fed was having on risk assets. It seems the Chairman has awoken to the idea that the FED has blown an asset bubble, especially now that the Japanese have added to global liquidity.

The Europeans are  most in need of an economic boost but have been the most reticent in providing the necessary actions. The ECB has actually removed some of its QE programs by having some banks repay the LTRO money early, and again, remember that the outright monetary transactions (OMT) have never been called into action. Europe has room to move but on liquidity adds but the Germans provide a barrier to the type of FED-influenced QE efforts. It’s not a coincidence that ECB President Draghi has put forward the idea of an ECB program of purchasing asset-backed securities (ABS). 

This would enable European banks to bundle bad loans into a bond that could be placed in the pool of ECB assets, basically creating a bad bank. By removing the poor quality loans the ECB is hoping that banks will again begin lending to small and medium enterprises (SME) and thus get money flowing to the backbone of many EU economies. European banks are fearful of lending to the SMEs because of the large increase in non-performing loans. Push the loans onto the ECB and banks will be freed to begin lending again and the velocity of money will help energize the economy.

The G-7 meeting provided little and no communique was provided, but my take on the purpose of the meeting was to get EUROPE TO GET BEHIND DRAGHI’S ABS PURCHASE PROGRAM AND AS A QUID PRO QUO THE U.S. WOULD BEGIN TO REDUCE ITS BOND PURCHASES. The Japanese have  provided a boost and the U.S. would like Europe to do the same, but to placate the Germans and others the U.S. WOULD REDUCE ITS EFFORTS SO AS TO NOT BLOW THE GLOBAL ASSET BUBBLE TO EVER GREATER HEIGHTS. The U.S. is muddling through and is the best of the G-7 but Europe is needed to help the global economy. The meeting failed though as the German finance minister is opposed to the ECB buying ABS. In a Spiegel article, Schaeuble maintains that ABS purchases by the ECB “would be ‘covert state financing’ and would violate present rules.” Schaeuble also noted that he was worried about the danger of “relatively high levels of liquidity” flowing around the global economy.

Finally, in staying with the importance of curtailing FED bond purchases, I quote from a Rick Santelli interview with Dallas Fed President Fisher:

“No central bank anywhere on the planet–has the experience of successfully navigating a return home from the place in which we now find ourselves.”

This is a quote that prompted me to think: The present FED modelers think of themselves as scientists with their math-based projections. In this regard, the issue President Fisher begs the question: If the FED is seen as getting the economy to the moon through massive LSAP would anybody deem NASA a success if they failed to bring the Apollo mission back to the Earth? Ending the present program means returning the economy to health without crashing it again. This has let to be determined and thus the success of the Bernanke program has not been completed. Will FED withdrawal be a mission accomplished with a soft splashdown in a sea of liquidity? FED withdrawal will depend upon European compliance for liquidity creation.

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7 Responses to “Notes From Underground: Searching for Clarity in the Age of Monetary Policy On Steroids”

  1. JB Says:

    Yra, In my estimation, the BoJ is providing cover for the Fed to play this little tapering game for 4-6 months. I will forward my thoughts about it, and feel free to elaborate in your underground notes if you like. John Bougearel

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  2. JB Says:

    Several events have conspired to allow the Fed the flexibility to reduce its $850 billion a month purchases of US treasuries and mortgage backed securities over the next 4-6 months. First, the Bank of Japan jumped into the fray with $78 billion a month purchases of JGBs. Indirectly, this allows Japanese pension funds and insurance companies to seek out foreign assets such as US treasuries over the course of the next two years. This new support for the Treasury market allows the Fed to not be the buyer of last resort for US debt, at least over the medium term. Japanese investors can do some of the heavy lifting and carry the Fed’s water for them. Secondly, the “statutory” debt limit will be reached in less than two weeks on May 18 but the “effective” debt limit won’t be reached until this fall. According to Bruce Krasting, there will be a reduction of new Treasury debt issued after May 18. “Under normal conditions, the Treasury would have about $200b of wiggle room on the debt limit before there is a crisis. But in the summer and fall of 2013 the Treasury will reap an additional $60b of revenue from (incredibly) Fannie and Freddie. Based on this, the debt limit will not be a problem until sometime in October. So the reality is that over the next six months or so, there will be a shortage of new issue Treasury paper. This fact gives Bernanke the opportunity to reduce QE without a a big sell off in the bond market.” The new US Treasury Secretary Jack Lew concurs, stating this weekend that “because the one time payment [$59.4 billion] that Fannie has announced makes it pretty clear that we are not going to hit the “effective” deadline until at least Labor day. The statutory debt limit will be reached in just a few days when it expires on May 18, but because of the extraordinary measures that are available and cash flows that we now can predict it [the effective debt limit] will not be [reached] until at least after Labor Day”. This confluence of events sets up yet another Potemkin messaging — that this new “tapering-monetary policy” is the beginning of a viable exit strategy from unconventional monetary policies. I am not so sure this is the proper inference that one should draw. Yes, the experiment with the new tapering monetary policy will be largely successful because of the extra-ordinary measures and the cash flows that are available to the US Treasury over the next 4-6 months. But what happens to the tapering-policy when these extra-ordinary measures and one-time payments are no longer available to the US Treasury? Will the Fed then have to flip flop from tapering policies and back to more conditionally-unlimited QE policies to accomodate the new expanded debt limit in the fall? Short Term Summary of Tapering Policies on Various US Asset Classes The tapering-monetary policy should be dollar supportive and bearish treasuries, gold, and equities. The dollar strengthened while treasuries and gold weakened last week. Will there be follow through, or will the effect of the announced tapering be muted? Some believe the effect will be muted and I tend to concur. I think there is much less than meets the eye to this tapering policy, and risks being undermined or supplanted by further QE policies when the debt limit is reached in the fall. As for US equities, at last check, they had a 0.85 positive correlation to Fed policy. A tapering of the Fed policy for 4-6 months suggests US equities could “taper-off” here a bit. They have certainly arrived at a technical reversal pattern on the daily chart known as Three Little Indians. Will the pattern work? I don’t know. The time cycles of the pattern are fairly reliable and useful, though the pattern has not proven to have much predictive value overall. The trend remains extremely bullish and year to date we have only seen two minor corrections — a 5 day correction threw the SP500 back to its blue quarterly average price in April and a 3 day correction in February related to the Italian elections. What intrigues about the bearish 3 Little Indian reversal pattern is that the high of each Indian on March 15, April 11 and May 9th all occurred on Thursdays. And the last Little Indian occurred on the eve of the Fed’s adopted shift to a new “tapering-policy.” Obviously a breach of Thursday’s May 9 high would likely begin to negate the power of this potential daily reversal pattern.

    Source: CQG, Inc. C2012 All rights reserved worldwide. http://www.cqg.com

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  3. yra harris Says:

    JB–repsonding to your first post–I agree with your assessment which is why I think they are pushing hard on Draghi to also pick up for the Fed and do some of the lifting–but it is also why we continue to focus on Germany–for that is where the plocy will ultimately be sourced from —which also plays well with why there is no pushback on the BOJ and ABE for it is also impacting in a negative way the German economy

  4. john bougearel Says:

    Yra, your closing observation that “mission accomplished” for the Fed withdrawal of QE policies and a safe re-entry into the Earth’s atmosphere must entail the further “European compliance for liquidity creation” will be important to bear in mind as the month’s unfold.

    I am reminded now of what an EU finance minister said, that no serious EU debt restructuring would take place until 2014 – after the German election in Sept 13. The definition of debt restructuring has changed since Cyprus in March 13. I’d imagine some of the European compliance for liquidity creation will come from additional bail-ins.

  5. Pat Lynch Says:

    It appears Bernanke will leave Fed before the ship returns to earth. So I smell “the set up man or fall guy” act in the making. It does not matter politically if Fed fails as long as there is someone to blame and the person blamed is no longer tied to a political party in power.

  6. Chicken Says:

    Seems like a lending vacuum opportunity foreign entities might be eager to fill while European financial institutions are struggling.

  7. yra harris Says:

    JB–that is a great post and should get the conversation and dialectic going–much there.Don’t know the three little indians–my technical skills are rudimentary but the issue of tapering,I hate that term, will now be with us for awhile.Will look at this tonight thru the eyes of the other ubiquitous term–natural roll off of the fed’s balance sheet–this will be a major discussion in the near term

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