Notes From Underground: The Market Remains a Tribute to the Balance Sheet Recession (KOO KOO K’KOO)

Janet Yellen as her first meeting as Chairwoman:

I am he as you are he as you are me and we are all together

See how they run like pigs from a gun,see how they fly

I’ m Crying

Fear not purveyors of nonsense, a Fed tapering will not be the be all end all of the global financial markets. IF THE FED TAPERS IN DECEMBER, then it will be done with announcement of the Fed’s intentions to keep rates at the ZERO RANGE for an “extended period” based on a lowering of the unemployment threshold to 5.5 or 6 percent. The market action since the unemployment number on Friday has befuddled many as the BONDS and NOTES have rallied, stocks have rallied, the DOLLAR HAS WEAKENED and the PRECIOUS METALS HAVE RALLIED, a contradiction of conventional wisdom. Equity strength is the only anticipated outcome as “good news” finally convinces equity buyers that the rise in the S&Ps, NASDAQ and DOW are genuine as the economy is gaining some traction. But for the other asset classes confusion reigns. If interest rates are expected to rise with better data, the dollar OUGHT to be strengthening but yet the selloff continues with the EURO approaching 52-week highs and the British pound making two-year highs. Even the emerging market currencies have stabilized in the face of a projected tapering.

Either the market has been LONG DOLLARS in anticipation of the FED‘s move to shrink its QE program and is covering its positions before year-end, or the market understands that the PUNDITS are wrong about the outcomes from possible Fed actions. Compounding the confusion is the way the U.S. yield curves have reacted to Friday’s unemployment data.

U.S. 2/10 Yield Curve U.S. 5/30 Yield Curve

The favored trade of Pimco’s Bill Gross has been the 5/30 spread (below), which the BOND KING has opined on buying 5 years and selling 30 years in anticipation of the Fed’s tapering moves, thus removing a large buyer from the long end while it asserts its power to keep SHORT RATES very low. The 5/30 steepener made highs on November 20 at 253.5 basis points but the surge in better economic data has seen the CURVE flatten to 237.5 today. The 2/10 CURVE (above) made its 52-week high on December 5 at 256.6 basis points and has since flattened to 250.7 as of today.

There has been a great deal of money made in the steepening of the curve and we may merely be seeing profit taking before year-end. Credit markets are always difficult in December because of the need for pension funds and insurance companies to adjust their positions. As always, I advise checking support levels on the yield curves to see where any type of correction OUGHT to hold. The same applies to resistance levels in the precious metals as year-end short covering may be the factor driving the buying in of profitable short positions. But, the weakness in the DOLLAR is a problem for that has been a momentum trade and its price action flies in the face of perceived wisdom, especially with the continuing problems in Europe.

There is much talk about the ECB and Brussels coming to a compromise, prompted by Berlin and Paris, on an EU-wide bank regulator and a single mechanism for resolving the problem of  insolvent banks. I warn my readers to be cautious because the Eurocrats are trying to portray a positive spin to a very difficult problem. The Germans still do not want to absorb the legacy costs and desire for any resolution be for all credits beginning at a designated start date. Anything prior to the start date will be the responsibility of each sovereign regulator and central bank. And yet with continued uncertainty and a lack of growth in Europe the DOLLAR CANNOT RALLY VERSUS THE EURO. Things are getting curiouser and curiouser.

***Tonight’s title is a tribute to Richard Koo, who identified the depths of the 2008 as a BALANCE SHEET RECESSION, which would take many years to resolve. As banks and consumers both retrenched simultaneously it was incumbent  upon the Fed and the government to do “whatever it takes” to counteract the contraction in demand and asset prices. While Bernanke was famously predicting no real concern about housing, Richard Koo and others were warning about the growth in credit to record levels, which would require a massive repair to the balance sheets of corporates and households. So, where does the Fed say we have done enough and now it is time to retreat and declare victory? Is there an end point to liquidity providing? I salute Mr. Richard Koo but I am at the same time waiting for PIGS TO FLY in anticipation of the Fed freeing itself from enslavement to its models. As Zerohedge reminded us today in its 10 worst economic predictions, on January 10, 2008 Ben Bernanke said: “The Federal Reserve is currently not forecasting a recession.”  I’m Crying.

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16 Responses to “Notes From Underground: The Market Remains a Tribute to the Balance Sheet Recession (KOO KOO K’KOO)”

  1. silverbug2155 Says:

    FX is the biggest game in town and built on confidense in who is managing it. That is being called into question. So now your seeing this flow of capital move into stocks,preciuos metals,and oil. Govt. Bonds & Notes will weaken over the long haul is my guess. They are paying negative interest rates. I understand their is a lot of money looking for a place to park itself,but I’m a big believer in these waves of Public to Private investment. Seems when Govt gets themselves in fiscal trouble capital shifts more towards private investment. Something thats probably not bankrupt.Like a good stock,tangible investments like gold or record selling artwork and collectibles.So even though we see low earnings ,stocks have rallied. Did not the DOW rally some 60% in the midst of the Great D back in 1933-35 ? Europe was being bombed and all the capital shifted here.

  2. Ronald Ferrill Says:

    After listening to the short discussion with Greenspan and Taylor last night, at 3 a.m. I awoke with a question. Not sure how it got there or if it makes any sense, but sure is bothering me now at 5:30 a.m. What if yield curve simply flattens or reverses? Could that happen, and if so, what are the ramifications? Thinking here is that short terms rise but long terms don’t. No real growth and commodities are sluggish. Would rather that I’m just wrong – too difficult for my brain to conceive.

  3. GreenAB Says:

    i suspect that the dollar weakness is about flows. into commodities.

    let me explain.
    when you look at the latest data you see that over the last months intistitutional investors have been sellers of the stock market, while retail is rushing to buy.
    with tapering on the horizon bonds aren´t very attractive.

    so where do you go, when neither bonds or stocks look attractive?
    to the third asset class. that has been forgotten over the last years and feels underowned (i have no other than COT data).
    it´s the same rotation cycle over and over again.

    not only look commidities underowned, but the fundamentals are strengthening. the world population is still growing, the US looks to stand on its own, Europe is slowly coming out of the hole.

    ->so i think we´re at the beginning of repositioning into commodities, which leads to dollar weakness.

    (on a side note: anyone remember the early QE programs when the fed asset buying led to rising commodity prices? until Bernanke came out and said publicly that the fed isn´t happy with that. suddenly with the next QE program no more commodity buying by the banks. you don´t want to bite the hand that feeds you. now that tapering looks more and more likely this silent deal between the FED and the banks could be coming to an end… (lots of speculation on my part, so don´t take it seriously 😉 )

  4. Joe Says:

    Yra, well deserved salute to Richard Koo, but I couldn’t help think of Chicago’s Eggmen. Can’t recall hearing the Fab 4 on Fulton or South Water Market though.

    All three preceding comments make some very good points.

  5. Shocked to Find Gambling Says:

    Yra- Dollar/Euro is baffling to me. You would think the dollar would be gaining under almost any scenario. What do you think……..Is the market saying something horrible is about to happen in the USA or something great in the EU?

  6. Shocked to Find Gambling Says:

    GreenAB- take a look at the weekly CRB index an Copper charts.

  7. GreenAB Says:

    ShockedtofindGambling: not sure what you want to say. CRB is outperforming over the last 3 weeks, which coincides with Dollar weakness 😉

  8. GreenAB Says:

    correction: last one should read: “CRB is outperforming SPY over the last 3 weeks…”

  9. hershel h herrendorf Says:

    December 12, 2013


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  10. Shocked to Find Gambling Says:

    GreenAB- To me,CRY looks like a massive top, on the weekly charts. Yes, has outperformed the last few weeks.

  11. yra Says:

    Herschel–all good points .But the Fischer speech from September that warned against the overuse of forward guidance in communicating fed policy may cause some friction btw Fischer and the more dovish members of the Fed.It may be dangerous to have the professor sit watch over his disciples—too much eating of their own cooking.Stanley Fischer has proven himself to be of a pragmatic nature when setting policy,let us hope some of that rubs off on the modelers

  12. Dustin L. Says:

    Yra- Something I have been thinking a lot about lately has been the affect the improving economy and the Fed taper is having on their ability to control reserves and inflation. It is clear that the Fed has been taking large losses of late on their bond holdings. Correct me if my thoughts are misdirected, but this would imply to me that the Fed now has a problem of large pools of liquidity that they pumped into the system starting to no longer be hoarded and traded by the big banks but actually enter other avenues of economic activity and this looks set to accelerate over the next few years. The whole time, rates rising further damaging the Fed balance sheet. The problem comes later when they are trying to fully end QE and drain excess liquidity from the system as inflation starts to exceed comfort. The assets they can sell to drain liquidity from the system have declined in value so much that they lack asset value to drain the liquidity. What does this imply? The Fed’s liabilities (the USD) will have to fall an equal value to balance the Fed’s balance sheet as confidence in the Fed’s currency management crumbles. This would seem a few years away and I am actually a USD bull right now. But, I can’t help but think that the improving economy will actually be the biggest risk to the Fed going forward. There are always unintended consequences to one’s actions. The private sector faced up to it’s balance sheet problems from 2007-2011. They were also helped along by public sector bailouts. Now the risk sits on Government and Central Bank balance sheets, and they are very sensitive to rising interest rates. Something to watch a few years in the future I think.

    P.S. It is great to have yourself and your hard earned experience to run these thoughts by. So, thank-you for engaging with us all.

  13. yra Says:

    Dustin–excellent analysis and as I have discussed with Santelli and in the blog for a long time—it is the problem of the massive reserve build up which will be the real problem—remember when Bernanke folllowed in the path of the Brit Adair Turner and discussed the exit strategy as just letting them roll off????

  14. Dustin L. Says:

    Yra- The ability to let vast amounts of the balance sheet just roll off seems unlikely if the economy can outperform (big question mark). It would seem Bernanke played it perfect as the unwind won’t even be his problem anymore. But as you have said, a gentleman would start the taper before leaving. We shall see.

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