Notes From Underground: Hey Fed, Are We At Absolute Zero?

In the realm of physics, absolute zero is the temperature at which every element freezes and molecules are no longer in motion. The FED and other global central banks seem to be mimicking their scientific betters by keeping rates at a low enough level to prevent the movement of capital from their balance sheets and into the real economy. Yes, the ECB, Riksbank, Swiss National Bank are at negative interest rates but it is the velocity that measures absolute zero rather than the relative level of interest rates. This brief analysis is based on the CONTINUED FRUSTRATION of trying to understand the basis of FED communication and signalling to the markets.

The ubiquitous speeches from Fed governors and presidents reverberate with the need to get off the ZERO BOUND as the U.S. economy recovers and unemployment continues to recede, thus providing the impetus to remove the emergency unconventional tools of monetary policy. The Fed has continued to stress that the employment conditions are strong but the inflation numbers are too tepid to insure the success of meeting its DUAL MANDATE. When it seemed that September would be the month for the Fed to finally move off the zero bound, Chair Yellen and the FOMC invoked a third prong to its mandate by injecting into the statement, “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”

In today’s FOMC statement, the FED removed this sentence and added in, “… whether it will be appropriate to raise the target range at its next meeting” (of course dependent on fulfilling its dual mandate). This change in language, coupled with the removal of the dour outlook about the global financial system led traders and investors to believe a December rate rise was CERTAINLY IN PLAY,ESPECIALLY AS THE PROBABILITY OF A HIKE REACHED ALMOST 50%. The concept of the next meeting is not new for the markets have been advised since the spring that every meeting going forward was LIVE for a Fed rate HIKE.

Yet, the FED is stuck at zero and the ECB, PBOC, Riksbank and BOJ  all remain vigilante to the need for more QE as the IMF continues to warn of a continued slowing global growth. The FED seems to see the world with rose-colored glasses compared to the IMF and Ms. Lagarde. One wonders what happened to the fears of the headwinds to growth from an overly strong dollar. The U.S. dollar has strengthened 4 percent since the last week’s Draghi statements and the Fed’s “hawkish” predilections today.

In the third quarter, U.S. corporate earning shortfalls were all the result of an overly strong dollar. What would happen to corporate profits if the U.S. dollar strengthened and wages increased enough for the FED to feel it achieved its dual mandate and interest rates needed to be raised? It seems in an absolute zero world all money is frozen into the stock market for any chance of a positive return on capital.

Corollary outcomes to the FOMC statement:
1. SPOOS initially broke but after further thought turned and rallied to make two-month highs and retraced all the losses for the second half of August. It seems that the FED raising rates in December will be deemed good news as it will reflect less stress in the world economy.
2. The GOLD and SILVER markets had strong rallies before the FOMC release but had erased gains. The GOLD broke $28 off the high to close $10 lower on the day. The market accepted that the December rate increase is probable so time to sell the precious metals and other haven asset classes.
3. The U.S. dollar had a strong rally post-FOMC as good U.S. economic data will become a repository for foreign investors. Therefore, an equity market rally suggests all is good in the U.S.A. If the dollar continues higher than the ECB and BOJ will not have to do more QE for the dollar will be performing on its own strength. This view most likely helped to push the GOLD and SILVER lower as the strong dollar with a possible 25 basis points is deemed a quality asset in realm of financial assets. How strong of a dollar rally will it take before the FED speakers all revive the strong currency headwind discussion?
4. The yield curves reversed the previous two days of trade and flattened in dramatic fashion as the short-end of the curve was sold while the 30-year bond held up very well. The 5/30 curve closed at 141 basis points from a pre-FOMC 150 basis points, a very robust moved in response to the mere Fed rhetoric. Certainly, these are words we have heard before.
While trapped at the ZERO BOUND the markets’ reaction function is ABSOLUTELY UNKNOWABLE so trade accordingly.
***The Reserve Bank of New Zealand (RBNZ) released its official  cash rate announcement two hours after the FED. The RBNZ held rates steady at 2.75 percent, as expected, but in its statement, Governor Graeme Wheeler said: “However, the exchange rate has been moving higher since September, which could, if sustained, dampen tradables sector activity and medium-term inflation. This would require a lower interest rate path than would otherwise be the case.” Governor Wheeler remained very concerned about an overvalued currency and slowing growth in China and East Asia. The Aussie/kiwi cross will be an indicator of continued concerns about an overly strong currency–presently the cross is trading at 1.0625.
Last night after weak inflation data from Australia the Aussie/kiwi traded to a five-month low of 1.0535, which should be a low risk point if wanting to trade on a possible rate cut by New Zealand. In an example of the topsy-turvy world of central bank zero interest rates, last night the Aussie dollar dropped 100 pips following a lower CPI number. In a “normal” world, lower inflation would be deemed a strong fundamental as it would be a signal that a central bank was maintaining stable prices resulting in an INCREASED REAL YIELD. Yet in today’s world, lower inflation infers a coming cut in interest rates and thus a reason to sell a currency. The markets are dynamic and as traders we can not afford to be frozen in thinking while at ABSOLUTE ZERO.

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11 Responses to “Notes From Underground: Hey Fed, Are We At Absolute Zero?”

  1. Asherz Says:

    “SPOOS initially broke but after further thought turned and rallied to make two-month highs…”.
    Abe Lincoln seems to be proven wrong when it comes to our markets. You CAN fool all of the people all of the time. The PPT coming in after the initial drop and created a massive rally and gold plunging almost $30 is to this observer so obvious it is embarrassing. Why the mere repeated feint of a .25 increase in FF 2 months from now should be the cause of exuberance is beyond me. Do it already, and I suspect they will only to keep the market participants (the algos) as believers.
    A blimp broke away from its moorings in Maryland yesterday and crashed. It brings to mind the Hindenburg Zeppilin (no not the rock group to the young readers). The incendiary gas being pumped by the central bankers in the form of ZIRP and QE to keep the financial markets afloat as the underlying economies weaken should send shudders to all watching this slow moving tragedy. Paul von Hindenburg was the last leader in Weimar Germany before Adolph came to power. And the Hindenburg Omen is just another technical devise that has been made useless in this age of the financial elites interventions. Air ships that have insecure groundings are a menace.
    Honest Abe would have been surprised to witness the credulity of the market players.

  2. yra Says:

    aherz–beautiful summation but as you as well as anyone possibly can know–all we are left with on a day in and day out exercise is the collective wisdom of the market hoisted upon its own petard of ZERO INTEREST RATE EASY MONEY

    • asherz Says:

      Yra of course you are right. But it is awfully hard to make money when markets are not allowed to operate as a weighing machine (Ben Graham) when a heavy finger is lurking around.

    • yra Says:

      yes the central banks have their fingers on the scale–nobody gets an honest count—can’t afford it

  3. ShockedToFindGambling Says:

    Yra- Good interpretation, as to what happened yesterday (and today).

    I fail to understand why the markets react so strongly to possible future actions, based on FED projections of what is happening and what will happen.

    The FED’s record of forecasting the economy is dismal, and best case equivalent to a coin toss.

    This is the same FED that missed the biggest financial scam in history (CDOs) and the 2008 crisis.

    In just the last 3 weeks, housing, employment, consumer confidence have all weakened substantially.

    So of course, now the FED is more bullish on the economy.

  4. yra Says:

    Shocked–it seems that some are in a hurry for the “courage to act”

  5. kevinwaspi Says:

    Great discussion on the general market response, I love it. Taking it a step beyond, did you notice the performance of “the banks” Wednesday? Whether a commercial bank or investment bank, all of Pavlov’s dogs bought the “if rates rise, then bank margins improve” bell. I wonder:
    1) Did anyone see the treasury curve flatten yesterday?
    2) Does anyone know that most bank funding is short term deposits/borrowings?
    3) Does anyone know that bank gap reports show few banks to be asset sensitive, and most of them liability sensitive?
    4) Would anyone believe that the first three conditions would lead us suspect bank margins would CONTRACT?

    The world is all about Central Bank Omnipotence (if X, then Y) and the result is a lack of critical thinking, replaced by dog drool.
    Thank you oh sages of wisdom, I kiss thy ring!

  6. Chicken Says:

    Feels like someone’s in that shack beside the tracks asleep at the switch.

  7. ShockedToFindGambling Says:


    Excellent points.

    Most bulge bracket bank loans are floating short term libor, so this yield curve steepening advantage is nonsense.

    The community banks that hold unhedged mortgages are taking on huge extension risk.

  8. Chicken Says:

    Assuming US Treasuries do sell off, where’s that money gonna go? And I’m so used to seeing PMs rally when rates fall that’s going to be a weird feeling to see that correlation break down.

    Yes I do believe still, rates could rise and PMs rally. That didn’t happen today.

  9. Chicken Says:

    More than half of growth companies are US government contractors?

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