Category Archives: federal reserve

Tapering the Taper Talk


Peter Schiff

Friday, June 21, 2013

As usual the Federal Reserve media reaction machine has fallen for a poorly executed head fake. It has fallen for this move many times in the past, and for its efforts, it has tackled nothing but air. Yet right on cue, it took the bait once more. Somehow the takeaway from Wednesday’s release of the June Fed statement and Chairman Ben Bernanke’s press conference was that the central bank is likely to begin scaling back, or “tapering,” its $85 billion per month quantitative easing program sometime later this year, and that the program may be completely wound down by the middle of next year.

Although this scenario is about as likely as an NSA-sponsored ticker tape parade for whistle blower Edward Snowden, all of the market segments reacted as if it were a fait accompli. The stock market – convinced that it will lose the support of ultra-low, long-term interest rates and the added consumer spending that results from a nascent housing bubble – sold off in triple digits. The bond market, sensing that its biggest and busiest customer will be exiting the market, followed a similarly negative trajectory. The sell-off in government and corporate debt pushed yields up to 21 month highs. In foreign exchange markets, the dollar rallied off its four-month lows based on the belief that Fed tightening will support the currency. And lastly, the gold market, sensing that an end of quantitative easing would eliminate the inflationary fears that have partially fueled gold’s spectacular rise, sold off nearly five percent to a new two-and-a-half year low.
All of this came as a result of Bernanke’s mild commitments to begin easing back on permanent QE sometime later this year if the economy continued to improve the way he expected. The chairman did not really elaborate on what types of improvements he had seen, or how much farther those unidentified trends would need to go before he would finally pull the trigger. He was however careful to point out that any policy shift, be it for less or more quantitative easing, would not be dependent on incoming data, but on the Fed’s interpretation of that data. By stressing repeatedly that its data goalposts were “thresholds rather than triggers,” the chairman gained further latitude to pursue any stance the Fed chooses regardless of the data.
Yet the mere and obvious mention that tapering was even possible, combined with the chairman’s fairly sunny disposition (perhaps caused by the realization that the real mess will likely be his successor’s problem to clean up), was enough to convince the market that the post-QE world was at hand. This conclusion is wrong.
Although many haven’t yet realized it, the financial markets are stuck in a “Waiting for Godot” era in which the change in policy that all are straining to see will never in fact arrive. Most fail to grasp the degree to which the “recovery” will stall without the $85 billion per month that the Fed is currently pumping into the economy.
What exactly has convinced the Fed that the economy is improving? From what I can tell, the evidence centered on the rise in stock and real estate prices, and the confidence and spending that follow as a result of the wealth effect. But inflated asset prices are completely dependent on QE and are likely to reverse course even before it is removed. And while it is painfully clear that expectations about QE continuance have made a far bigger impact on the stock, bond, and real estate markets than any other economic data points, many must be assuming that this dependency will soon end.
Those who hold this belief have naively described QE as the economy’s “training wheels.” (In reality the program is currently our only wheels.) They are convinced that the kindling of QE will inevitably ignite a fire in the larger economy. But the big lumber is still too dampened by debt, government spending, regulation, and high asset prices to catch fire – all we have gotten is smoke instead. A few mirrors supplied by the Fed merely completed the illusion. The larger problem of course is that even though the stimulus is the only wheels, the Fed must remove them anyways as we are cycling toward the edge of a cliff.
Although Bernanke dodged the question in his press conference, the Fed has broken the normal market for mortgage backed securities. While it’s true that the Fed only owns 14% of all outstanding MBS (the “small fraction” he referred to in the press conference), it is by far the largest purchaser of newly issued mortgage debt. What would happen to the market if the Fed were no longer buying? There are no longer enough private buyers to soak up the issuance. Those who do remain would certainly expect higher yields if the option of selling to the Fed was no longer on the table. Put bluntly, the Fed is the market right now and has been for years.
A clear-eyed look at the likely consequences of a pull-back in QE should cause an abandonment of the optimistic assumptions behind the Fed’s forecast. Interest rates are already rising rapidly based simply on the expectation of tapering. Imagine how high rates would go if the Fed actually tried to sell some of the mortgages it already owns. But the fact is the mere anticipation of such an event has already sent mortgage rates north of 4%, and without a lifeline from the Fed in the form of more QE, those rates will soon exceed 5%. This increase will greatly impact the housing market. Speculative buyers who have lifted the market will become sellers. More foreclosure will hit the market, just as higher home prices and mortgage rates price any remaining legitimate buyers out of the market. Housing prices will fall to new post bubble lows, sinking the phony recovery in the process. The wealth effect will work in reverse: spending and confidence will fall, unemployment will rise, and we will be back in recession even before the Fed begins to taper.
In fact, the rise in mortgage rates seen over the last month has already produced pain in the financial world, with banks reporting a rapid decline in refinancing applications. By the time rates hit 5%, the current rally in real estate will have screeched to a halt. With personal income and wage growth essentially stagnant, individual buyers are extremely dependent on the affordability allowed by ultra-low rates. A near 50% increase in mortgage rates, which would result from an increase in rates from 3.25% to 5.0%, would price a great many buyers out of the market. Higher rates would also cool much of the housing demand that has been coming from the private equity funds that have been a factor in pushing up real estate prices in recent years. Falling home prices would likely trigger a new wave of defaults and housing related bankruptcies that plunged the economy into recession five years ago.
A similar dynamic would occur in the market for U.S. Treasury debt. Despite Bernanke’s assurances that the Fed is not monetizing the government’s debt, the central bank has been buying nearly 70% of the new issuance in recent years. Already, rates on 10-year treasury debt have creeped up by more than 50% in less than two months to over 2.5%. Any actual decrease or cessation in buying – let alone the selling that would be needed to unwind the Fed’s multi-trillion dollar balance sheet – would place the Treasury market under extreme pressure. Since low rates are the life blood of our borrow and spend economy, it is highly likely that higher rates will lead directly to lower stock prices, lower GDP growth, and higher unemployment. Since rising asset prices and the confidence and spending they produce is the basis for Bernanke’s rosy forecast, new lows in house prices and a bear market in stocks will likely reverse those forecasts on a dime.
Lost on almost everyone is the effect higher interest rates and a slowing economy will have on federal budget deficits. As unemployment rises, tax revenues will fall and expenditures will rise. In addition, rising rates will not only make it more expensive for the Fed to finance larger deficits, it will also make it more expensive to refinance maturing debts. Furthermore, the profit checks Fannie and Freddie have been paying the Treasury will turn into bills for losses, as a new wave of foreclosures comes tumbling in.
It’s fascinating how the goal posts have moved quickly on the Fed’s playing field. Months ago the conversation focused on the “exit strategy” it would use to unwind the trillions in bonds and mortgages that it had accumulated over the last few years. Despite apparent improvements in the economy, those discussions have given way to the more modest expectations for the “tapering” of QE. I believe that we should really be expecting a “tapering” of the tapering conversations.
As a result, I expect that the Fed will continue to pantomime that an eventual Exit Strategy is preparing for a grand entrance, even as their timeline and decision criteria become ever more ambiguous. In truth, I believe that the Fed’s next big announcement will be to increase, not diminish QE. After all, Bernanke made clear in his press conference that if the economy does not perform up to his expectations, he will simply do more of what has already failed.
Of course, when the Fed is forced to make this concession, it should be obvious to a critical mass that the recovery is a sham. Investors will realize that years of QE have only exacerbated the problems it was meant to solve. When the grim reality of QE infinity sets in, the dollar will drop, gold will climb, and the real crash will finally be upon us. Buckle up.

Market blow: India FII flows to dry as Fed eyes end to easy money

by Jun 20, 2013

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New York: The Federal Reserve will keep its monetary ‘printing press’ running a while longer, though Chairman Ben Bernanke said the central bank could start winding down its $85 billion-a-month bond-buying program later this year and end it altogether by mid-2014. That sent a chill through the US markets.

The emerging markets, including India, which have also been invigorated by the fuel of the Fed’s easy-money policies, will not take the news happily when markets open on Thursday.

US markets sold off on the news with the Dow Jones industrial average plunging 206 points, or 1.35 percent on Wednesday to close at 15,112 points.

The Fed’s plan for unwinding its bond-buying program is based on optimistic new economic forecasts for next year, including a projection that the jobless rate, which was 7.6 percent in May, will fall to 6.5 percent by end-2014.


Representational Image. Reuters

Although this is not a formal announcement, Bernanke for the first time offered a timeline for winding down the bond purchases. But tapering the program will be dependent on positive economic data, Bernanke stressed during a press conference following the Fed’s two-day policy meeting.

“Policy is in no way predetermined,” Bernanke said.

He said the wind-down could begin “later this year” if growth picks up as the Fed projects, unemployment comes down, and inflation moves closer to the central bank’s 2 percent target.

Using a car as an analogy, Bernanke said the Fed’s tightening policies will be akin to “letting up on the gas pedal as the car picks up speed.”

“The fundamentals look a little better to us,” Bernanke said. “In particular, the housing sector, which has been a drag on growth since the crisis, is now obviously a support to growth.”

Stock markets have soared for three years under Bernanke’s program and analysts are expecting a sell-off and market volatility when the Fed announces a firm date for scaling back the purchases. The Fed chief was given the “Helicopter Ben” moniker during the financial crisis when he suggested dropping money from a helicopter to fight deflation.

The US central bank has added over $3 trillion of monetary stimulus to the economy and over $1 trillion of bailout loans to financial firms since the 2008 financial crisis. This was done to prevent a widespread banking crash and help the wider economy. Part of the stock market rebound from the March 2009 lows is based on market fundamentals, but a big chunk is courtesy Helicopter Ben.

Liquidity party over for India

The Fed’s $85 billion-a-month bond-buying program, known as quantitative easing, was aimed at spurring the US economy, but for years now it has also had the effect of sending waves of inflows into high-yielding emerging markets like India. Market watchers say that an end to US monetary stimulus could lead to portfolio outflows, pushing the rupee lower and, in turn, delaying any rate cuts from the Reserve Bank of India.

“Stocks that have been overbought might see sale. Investors that are using leverage, mainly hedge funds, may also want to reduce their holdings because of the carrying cost of debt combined with the expected decline of stock prices,” Seth Freeman, CEO and chief investment officer at San Francisco-based EM Capital Management LLC, told Firstpost.

“Indian small and mid-cap stocks are going to be the most affected by the Fed’s decision to the extent of foreign investment in those stocks. It’s not going to be risk-off but risk-reduced. US investors looking at India are likely to become more selective. They will look more closely at India’s larger companies,” said Freeman, who advises foreign investors and funds on implementing investments in India. He has managed an US listed India-dedicated mutual fund that owned both large and mid-cap companies.

Foreign institutional investors have been sellers of Indian shares for six consecutive sessions, totalling Rs 3,431 crore as per exchange and regulatory data.

Freeman said the money locked into exchange-traded funds may not trade out and that might be a backstop. A slew of exchange traded funds focused on India flourished after the 2008 financial crisis as US fund managers looked East for higher yields and Americans looked for exposure to the Indian markets.

How Ben Bernanke ‘saved the world’ with easy money

by Jun 20, 2013

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The writer Truman Capote noted famously that more tears were shed over answered prayers than unanswered ones. The story of King Midas, who wished that everything he touched would turn to gold, but ended up losing his daughter and everything else in the world that he treasured, serves as a cautionary tale that validates much the same idea: that you ought to be careful what you wish for.

For years now, US Federal Reserve chairman Ben Bernanke has been pilloried by absolutist fiscal conservative politicians in the US and around the world, media commentators and the echo chamber of the TV chatterati that the “endless money printing” he had unleashed would force a collapse of the US economy and the US dollar.

US Federal Reserve Chairman Ben Bernanke. AP

US Federal Reserve Chairman Ben Bernanke. AP

And since central banks around the world were similarly resorting to loose monetary policies in response to the crippling after-effects of the global economic slowdown following the financial crisis of 2008, the whole global economy was going to hell in a basket, we were told.

In one of his characteristically blustery television appearances in 2011, soon after the Japanese tsunami disaster, investor Marc Faber, who publishes the Gloom, Boom and Doom Report, sneeringly referred to “helicopter” Ben’s exertions to get the US economy back on its feet through unconventional monetary policies and by buying up Treasury bonds and through the Quantitative Easing (QE) program. And while there had at that time been only two rounds of QE, Faber said he was certain that the Fed would go ahead with a QE3, QE4, QE5, QE6, QE7 and QE8 and so on.

The CNBC interviewer, who was not unused to the epic mouthing of utter nonsense on air by his guests, was flummoxed, and asked Faber if he was jesting when he said there would be eight rounds of Quantitative Easing.

At which point Faber, clearly savouring the moment, waded in even deeper. What he actually meant to say, he added, was that there would even be a QE 18! The money printer will continue to print, and because Bernanke “doesn’t know much about the economy, and only cared where the (stock index) S&P’s was”, the Fed would keep at it, he said. “There’s nothing else they can do.”

Indeed, other commentators of a similar ilk have spoken blithely of “QE Infinity” – suggesting that the “money printing” by the US Fed would go on from here to eternity.

How wrong they were, how wrong. Overnight, in one fell swoop, Bernanke set the cat among the market pigeons by noting that the US economy was healing sufficiently well for him to visualise a scenario even later this year when the QE program could be eased – and perhaps wound down by mid-2014.

If that economic forecast turns out to be true—and it is a big if—it would validate the merits of the unconventional policymaking that Bernanke, a student of the Great Depression of the 1930s, resorted to during his time on the job. As economic commentators like Paul Krugman have repeatedly pointed out, the economic discourse in the US was being sought to be hijacked by deficit hawks and other assorted alarmists and scare-mongers who wanted the administration to end the stimulus program and the easy money policy – even before the economic recovery had kicked in.

The alarmists were joined in by gold bugs and other charlatans who were profiting from the stampeding into gold from a fear of “hyperinflation”, “currency debasement”, and “the coming economic collapse”.

The market has suddenly turned against these profiteers, which is why they are shedding tears over their “answered prayers” for an end to the “money printing”.

Even given the fact that US economic data is still anaemic, and unemployment still overs around 7.6 percent, the US economy is today in a far better place than it was in 2009, when Barack Obama took office. Even so, Bernanke’s artful wording during his scenario-building at the press conference overnight gives him plenty of room to keep his foot on the accelerator if the economic data turns against him.

But what is today well established is that by persisting with easy money policy (without stoking hyperinflation) at a time when the US economic growth engines were not firing, and by looking to wind it down now that the economy is showing signs of revival, Bernanke has proved his critics wrong. It’s true, of course, that it was ‘easy money’ policy of an earlier time that fed the housing bubble which collapsed spectacularly in 2008. But it is equally true that being held hostage to past follies would have dragged the US economy further into the ditch.

Just the fact that he  and other policymakers have steered the US economy (and in a larger sense the global economy) through the choppy waters of the 2008 financial crisis—and are within striking distance of bringing the ship to a safe haven—holds an important lesson for policymakers.

There will always be ill-informed critics, besides malicious profiteers, who will seek to hijack policy in a manner that maximises their capacity to profit from chaos. By ignoring these critics, and by proceeding bullheadedly with his course of action, Bernanke has won the intellectual argument –and ‘saved the world’, so to speak. As commentator Martin Wolf noted recently, America owes a lot to Bernanke. Critics of the Fed policy action, he noted, “lack imagination or are indifferent to what would have happened had it not acted”. Broadly speaking, he added, “the Fed has done the right thing in trying to bring the US and world economies through the crisis. It deserves praise”.

Indian equity and currency markets have of course taken Bernanke’s words to heart and tanked. Given the inherent vulnerability of the Indian economy—and the excessive dependence on foreign inflows—this risk was always on. But in a larger sense, the nature of India’s economic problems are vastly different from—and more serious than—the US economy’s. Whereas the US Fed is fighting disinflation, India’s problem is on the other side: of stubborn inflation. That, as many commentators have pointed out, arises not from a failure of the central bank, which hasn’t been shy of keeping interest rates high. But even sound monetary policy cannot tame inflation when it is being stoked by supply-side deficiencies and by fiscal profligacy, as it is in India’s case.

The UPA government’s mismanagement of the economy does come in for much merited criticism from media commentators, which it has by and large chosen to ignore, in much the same way that Bernanke soldiered on by being deaf to his critics. But whereas Bernanke’s unorthodox policy measures are showing signs of validation in the improved US economic data, the UPA government has if anything driven the economy further into the ditch. In the latter case, though, being deaf to critics isn’t exactly proving to be a virtue.

FOMC: Press Conference on June 19, 2013