Notes From Underground: The FED Is on the Horns Of a Bullish Dilemma

If the FED deems the market to be healthier than conventional wisdom it will TAPER to the high-end of market expectations–$20 billion and probably in Treasuries, not MBS as of now. A supposition must be made: If the FED were to do nothing, would the stock market first rally and then break as investors fear that the FED is afraid of a weaker economy in the months ahead? The FED therefore has to TAPER so as not upset the positive spin that has helped the stock market and other assets rally. Because the FED HAS TO TAPER the emphasis will be on academia’s newest catch phrase: FORWARD GUIDANCE. This phrase has been all the rage in the ECB, Bank of England and the BOJ press conferences. Its main thrust is that the central bank can DIRECT market behavior by talking the global economy into a glide path of growth by promising the continued supply of easy money and low interest rates.

THE TAPERING WILL COME WITH FORWARD GUIDANCE IN WHICH THE UNEMPLOYMENT THRESHOLD WILL PROBABLY BE LOWERED SO AS TO ENSURE THE CONTINUATION OF NEAR ZERO INTEREST RATES. Through the use of FORWARD GUIDANCE the Fed gets the luxury of DO AS WE SAY NOT AS WE DO! If the FED were not to taper the bonds would be volatile as the idea of a softer economy would catch many of the recent bond sellers wrong footed. Patience is the keyword for the FOMC release and remember that Bernanke has a press conference a half-hour after the FOMC release at 1:00 p.m. CST.

***The battle over Europe YES/NO was in play today. In the Financial Times, German Finance Minister Wolfgang Schaeuble had an op-ed piece titled, “Ignore the Doomsayers: Europe Is Being Fixed.” It is more interesting that the FT published an op-ed piece by a sitting German finance minister four days before the key German elections. Herr Schaeuble applauds the efforts of the German-led austerians to right the European economy and maintains the present state of Europe an unmitigated success. In a barb to the eurosceptics he states: “Systems adapt, downturns bottom out, trends turn. In other words, what is broken can be repaired. Europe today is the proof.”

In a blog, my favorite European newspaper journalist Ambrose Evans-Pritchard wrote a stinging reply to the German FM: “My Grovelling Apology to Herr Schaeuble.” It boggles the mind that each gentleman is writing about the same economy. I urge you to read both as to get a full flavor the vast chasm between economic outlooks. More importantly, you should maintain a healthy skepticism about the European economy and mere correlation of equity values to other global corporations need to be well analyzed … correlation is not causation.

***In a heads up on the European financial scene, the Portuguese 2/10 curve has begun to flatten again as it is nearing the lows of 125 basis point differential made on July 15, 2013. This reflects the fact that the Portuguese government is having problems funding in the short end of the debt markets as TWO-YEAR YIELDS HAVE RISEN TO 5.57%, the highest since September 2012. In a world chasing yield but nervous in regards to the FED, the European peripheral nations may be the best barometer of market angst. If the July 15 low breaks, the ECB will be forced into some type of action and it will be post-German election.

Portuguese 2-Year Yield

***Lastly, in a Bloomberg article, “Merkel Says German Election Is Decision Time For Euro’s Future,” Chancellor Merkel makes it clear that the election is a reflection about the CDU‘s handling of the European economic crisis. Merkel claims that under her guidance the German’s have gotten the best deal on the resolution of the financial crisis. “We offer aid when we get something in return.” I only bring this up as a possible clue to some change in voter outcomes taking place for the most part the EU bailouts have not played in the campaign. Suddenly, Chancellor Merkel is speaking to an issue that was the bailiwick of the AfD, which has gotten nearly a word about its platform in the mainstream media. Is there a shift in the POLLS? As Mick Jagger asked, “Angie, Angie, where will it lead us from here?”

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6 Responses to “Notes From Underground: The FED Is on the Horns Of a Bullish Dilemma”

  1. kevinwaspi Says:

    Or, as David Paich wrote for Toto’s “Angela”,
    “Cold moon, dark sky
    I’m watching my mind disappear
    She sits alone not knowing
    That I am so near
    Why can’t she hear my voice
    As I call out her name?”
    Toto – Angela Lyrics | MetroLyric

  2. asherz Says:

    We are years overdue in expanding the Fed’s mission statement which includes stable prices, moderate long term rates and maximizing employment. As you put it above, calibrating the degree of tapering which will keep asset prices moving in a positive direction is in their purview as well (and has been for some time.) How far we have come in the last century in giving over to a handfull of individuals the ability to control so much of our economy based on their judgment, leaving the invisible hand inoperative. And what a great job they’ve done in the last 15 years! Lord help us.

  3. Chicken Says:

    Apparently NO TAPER initial response results in extended rally.

  4. Kevin Says:

    I hope the incorrect call is addressed, not ignored. Why were you so certain of taper, given that the markets would fall apart with any meaningful taper?

  5. yra Says:

    Kevin–the call was WRONG in that the Fed did not taper but as preparation is the key to trading ,the Fed’s lack of action led to phenomenal profit opportunities.Missed the obvious rally in the metals but many other opportunities presented themselves and that is the caution i advised—-the fed’s not tapering is it s problem and it will be deemed a severe miscalculation.Being wrong and being prepared to a tactical change is what trading is all about.The equity markets did hold their rally but the SPS proved to be the most disappointing of asset classes.

  6. Chicken Says:

    Everyone was anticipating TAPER, expect the unexpected. I distinctly recalled reading this here as the news hit and not in many other places:

    “If the FED were to do nothing, would the stock market first rally and then break as investors fear that the FED is afraid of a weaker economy in the months ahead?”

    Although, I’m not sure what tomorrow brings, perhaps more of the same unexpected?

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