Notes From Underground

Has the Federal Reserve lost its MIND!?!? The front page of the Financial Times’ headline read: “Fed Fears Over Bond Fund Run.” Fed officials are publicly ruminating about the need to impose EXIT FEES on bond funds so as to prevent a RUN BY INVESTORS. The Federal Reserve worries that the massive buildup in bond funds makes the market vulnerable to a classic run in an event of a some type of market destabilizing event. The idea, according to ex-Governor Jeremy Stein, is to slow redemptions in a crisis because corporate bond funds are the “… essence of shadow banking … giving people a liquid claim of illiquid assets.”

The bottom line for investors is that the Fed is seeking to discourage investors from acting rashly by making it costly by paying an exit fee. THE FED HAS PUSHED PEOPLE TO TAKE MORE RISK AND NOW THAT INVESTORS HAVE HEEDED THE CALL THE FED WANTS TO INVOKE MORE PAIN BY LOCKING THEM INTO LONGER TERM INVESTMENTS THROUGH LONG REDEMPTION PERIODS. If the Fed goes down this path it will have acted to further erode its credibility. The FED has not only shoved people to riskier corporate bonds through Bernanke’s beloved PORTFOLIO BALANCE CHANNEL through forced repression of yields, the model builders in Washington want to punish those who followed the Fed’s advice. The victims of financial repression are being locked  in the stocks and publicly humiliated. The world’s central banks and regulators have become concerned about the growth of the “shadow banking ” world. If you want to see investors flee to the shadows, enact exit fees on what we’re assumed to be liquid short-term investments.

***Today, the Italian Banking Authority announced that non-performing loans reached 160 billion euros or more than 8% of all loans versus 3% in June 2008. More importantly, loans in May were down 3.4% on the year as banks are not eager to make risky loans. It is much cleaner to borrow from the ECB and buy sovereign debt then to lend to small, medium enterprises in a no-growth economy. This is why Mario Draghi’s targeted long-term refinancing operations (TLTRO) will be slow in fomenting the type of lending that the ECB is attempting to promote to unlock the clogged arteries of European commercial banking. As Joseph Schumpeter noted eight decades ago, you can raise interest rates to prevent borrowing but if returns on capital are so low you will not entice an entrepreneur to borrow: THIS IS PUSHING ON A STRING.

***The U.S. inflation data was higher than expected prompting some pundits to conjecture that the FED will hint at some type of early tightening in tomorrow’s FOMC release. This is nonsense. The FED has shown that it will remove its thresholds without notice. Remember the 6.5 percent unemployment rate as a tripwire for tightening? Well, the 2 percent inflation rate is as meaningful as the unemployment threshold. A bigger problem for Janet Yellen will be the rise in inflation with stagnant wages. The failure of wages to keep pace with headline inflation will be a drag on consumer spending. In a Bloomberg News article by Smialek and Chandra they note: “The May increase in prices meant that hourly earnings adjusted for inflation dropped 0.2 percent for a second month, according to another Labor Department report today. Over the past months, real hourly pay decreased 0.1 percent.” Chair Yellen has repeatedly voiced her concern about poor wage growth. Removing forward guidance is one thing, raising interest rates in a depressed wage environment is a serious dilemma for an avowed labor economist.

Tags: bond fund, ECB, Fed, FOMC, inflation, Janet Yellen, Mario Draghi

This entry was posted on June 17, 2014 at 8:55 pm and is filed under Debt Market, ECB, Fed. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.