Notes From Underground: Walking Through the Valley of the Shadow of Death

There is no question that the world’s central banks are all living under the shadow of doubt as investors and financial markets are questioning the efficacy of the zero lower bound. The sense of always doing more in an effort to attain a self-conjured 2% level of inflation has led to the continued downward slide in interest rates.

On this note, last week we saw the Powell Fed lower the target range for the fed funds rate by 25 basis points — and its interest on excess reserves rate by 30 basis points — as congestion in the financial plumbing sent overnight rates soaring. (For those who are interested in the nuances, I am linking to one of many splendid pieces from Bloomberg reporters Liz McCormick and Alexandra Harris detailing out the repo market mess.)

The New York Fed announced Friday it will continue to add reserves via a series of overnight and term repo operations as a way to ease pressures in the overnight FUNDING market.

There are several reasons for the recent volatility, but the issue is not like 2008 as it is not a concern of SOLVENCY of the institutions but the MARKET ITSELF. Was it rising U.S. Treasury supply, corporate tax payments, Saudi oil issues, the impact of Basel regulations? Yes — it’s possible, but there may even be another so-called x factor that may take time to be realized.

Regardless, the FED has been the subject of criticism as it has been unprepared for what had been predicted by several participants in the short-term interest rate marktes. The pressure is building for the ECB, BOJ and FED as the world is questioning the theoretical basis of global monetary policy.

For years, the financial media has presented central bankers as “Oracles” as it genuflects at the Delphic status of Alan Greenspan. Financial markets have praised the idea of ongoing low interest rates supporting asset prices on a sea of liquidity. All central banks have invoked the tool of FORWARD GUIDANCE as the most effective device in the box to secure the support of the equity and credit markets, except it has come at a great cost. Every central banker has made the use of FORWARD GUIDANCE its SHADOW OF DEATH. When then-Fed Chairman Ben Bernanke announced his intention to TAPER the Fed’s QE purchases in May 2013, the market voiced its displeasure by sending BOND prices higher and equity prices lower. This weakened the FED‘s monetary ROD and undermined the research of its STAFF.

The TAPER TANTRUM sent a message to the world’s central banks that failing to deliver on its forward promises would result in significant financial disruptions. When the ECB cut rates on September 12 and added a new round of asset purchases, it was fulfilling the promises made by Mario Draghi so as to not cause a market tantrum. The post-press conference criticism by ECB members revealed that the policy was one of promises, not current economic conditions.

It seems that the FED was in the same bind as Powell proceeded to cut rates 25 basis points so as not to disappoint markets. Chairman Powell seemed to acknowledge this by attempting to distance the current FED from A PRESET PATH  while also ridiculing the media’s use of the FED’S DOT PLOT.

Powell noted that the dot plot proved to have a weak forecasting history, undermining their use as a tool of FORWARD GUIDANCE. Locking central banks into a PRESET COURSE has proven to be a flawed policy, beginning with the Bernanke response to the market in 2013. Do not fear the shadow of death for it creates the sense that central banks only FEAR market response to disappointment rather than RESPECTING markets’ ability to SIGNAL actual economic information. FORWARD GUIDANCE HAS PLACED DRAGHI AND POWELL INTO A CONTINUAL STROLL THROUGH THE SHADOW OF DEATH with an uncertain destination.

What has been the markets reaction function to the benevolence of central banks?

  1. The continued increase in BOND PRICES as markets turn the tables on long-held asset management. As one analyst /trader noted, it used to be standard practice to buy BONDS for income and stocks for capital appreciation. It seems that the actions of central banks have led to the opposite market behavior as BOND prices rise in anticipation of further central bank rate cuts. S&P dividends on high-quality value stocks are higher than sovereign and corporate bond yields.
  2. Precious metals have sustained the gains of the last 11 years after enduring some sizable corrections. The recent awakening to the failure of central bank policy has supported a gold rally even as equity prices continue to press all-time highs. The GOLD has performed well versus all FIAT CURRENCIES as the credibility of all global monetary policy is being challenged.
  3. The DOLLAR has held its strength because of the FED‘s initial desire to attempt to NORMALIZE its interest policy, as well as its balance sheet. But the Powell pivot has questioned how long the interest rate differential will continue to support the DOLLAR in the face of expanding deficits during times of relatively strong growth. (Especially as President Trump attempts to strong-arm Chairman Powell into lower for longer in response to tariff conflicts created by the White House. Tweeting has become the tool of Presidential bullying instead of invitations to a Texas ranch.)

Carmen and Vincent Reinhart wrote a piece for Project Syndicate titled, “Jerome Powell’s Dilemma,” citing how the Fed’s reaction to the heightened economic uncertainties created by the Trump tariffs push Powell to follow a path aiding the economic designs of the White House. The Reinharts highlight the impact of FED policies on global currency values. They wrote:

“When the Fed tightens its policy ,other central banks do not always follow, preferring to allow their currencies to depreciate. In contrast, when the FED eases its policy, far fewer international partners are willing to let their currencies appreciate so the dollar can depreciate. No one volunteers because everyone fears upward exchange-rate pressure.”

This challenges the benign neglect view offered by ECB President Draghi that the G-20 nations do not target exchange rates but use monetary policy solely to affect domestic economic conditions. If the Reinharts are correct — and I believe they are — then the move from MONETARY STIMULUS to FISCAL STIMULUS ought to provide some inflows into economies looking to sustain growth through massive infrastructure projects. This may be a perceived as a short-term benefit but the tale of the tape will be found in the relative performance of equity markets.

The U.S. has shown that markets will look beyond fiscal irresponsibility in seeking financial gains, at least until a better something better is on the offer. Two things to think about, which were overlooked during last week’s turmoil:

  1. GM workers went on strike for the first time in many years
  2. The U.S. won a significant WTO ruling against Airbus, which would allow the USTR to place tariffs upon the EU in response

The White House could be more conciliatory in response to China while increasing the tariffs on myriad EU products. Any Trump response could actually result in a lift to the EURO as the union attempts to lessen the trade tensions, especially if the EU embarks on the PROMISE of Fiscal Stimulus as desired by Mario Draghi in his farewell address.

There is much to watch, but as the world’s central bankers WALK THROUGH THE VALLEY OF THE SHADOW OF DEATH, there is little new to comfort us. Certainly not their STAFF forecasts.

***Set your alarm: I will be on CNBC with Rick Santelli at 9:40 a.m. CDT.

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4 Responses to “Notes From Underground: Walking Through the Valley of the Shadow of Death”

  1. Trader1 Says:


    With India cutting Corp tax rates and Modi in USA – doest this put more pressure on China to cut some kind of deal??

  2. ShockedToFindGambling Says:

    Yra- Great article.

    One factor about the Repo fiasco that no one is talking about is Credit Risk.

    Bank deposits over $250K have no explicit protection on return of capital….they are simply a promise to repay, IF the bank is solvent.

    For every other asset, you have some type of credit guarantee FDIC or Agency, or at least a guarantee that you actually own an asset (stocks, bonds, real estate. private equity. commodities).

    With a bank deposit, you have no guarantee of ownership of anything… the event of bankruptcy, you get in line with the rest of the creditors.

    As we are late cycle, I believe people are withdrawing cash from bank deposits over $250K, and putting the money into assets, where they are at least sure of their ownership.

    IMO. this is partially behind the domestic bank deposit shortage.

  3. mikegre2014 Says:

    The problem is caused by the Fed trying to reduce its balance sheet this year. Expect the Fed to reinstitute bond buying in order to keep the system liquid.

    • yraharris Says:

      Mike–this was the issue as presented by many but found most succinct in Druckenmiller’s phrase –double barreled approach which he criticized as did many in this BLOG—-one or the other –normalize the EFF rate or the balance sheet but not both simultaneously—Yellen maintained it would be like watching paint dry—well it has certainly not that and the NYFRB ought to have hired Harry Potter after they tossed Simon Potter overboard

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