Posted on 06/21/2013 5:07:43 PM PDT by blam
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.
when has anyone in this administration been candid about anything?
I would have to agree with this analysis
finding anything positive that would lead to strengthening of the economy is near to impossible
Talk of reducing QE is like an addict taking about cutting down his Oxy dosage.
Great analysis ... until the last paragraph.
“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. “
This is not a given. It may happen, but there is a great deal of inertia when it comes to the dollar. In fact, an argument could be made that all of this will strengthen, not weaken, the dollar. Peter Schiff apparently doesn’t recognize that while we have enormous problems, the problems in China, Japan, and Europe, are even greater (by a sizable amount). And far, far greater in most of the so-called emerging markets.
Also, recognition of a bubble does not immediately cause puncturing of that bubble. Investors may be well aware that QE is the only thing holding up prices in RE, bonds, and equities, but until there is some trigger pushing everyone out, the bubble may exist for quite some time. This is especially true, as investors in Europe, Japan, and China look to get out of their domestic economies (a phenomena that is already occurring).
The Fed was pushed hard by certain interests to say that it would tighten up later this year, only if certain parts of the economy improve by then (employment, production, etc.). Some are happy, when bond yields increase, but that’s what to watch out for (interest rate hikes, government unable to pay debts, vicious circle of decline in activity, government unable to pay debts and so on). Really, domestic manufacturing increases are the way to recovery, and large numbers of new, small manufacturing starts would require repeals of regulations and fees at every level of government.
Yeah, ignoring the fact that 10 year bonds are now up to 2.5 percent from about .5.
But go on, tell us how the inflation demon has been slain!
Agree, but the 10 year US T-Bill never got to .50. It got down to about 1.50. Still to move about 1.00 over a 6 month period is dramatic. To move about .75 in less than 60 days has been very painful to those of us in mortgage banking and our clients.
I paid all my debts in 2008, and have been debt free for 5 years now. I’ve put off buying a house for precisely this reason.
You are very fortunate. I have 2 college age kids. One just graduated and the other has another year to go. Once they are both out of the house, I hope to use the savings to pay off much of the debt I acquired. I will not be debt free, but I will be somewhat unshackled.
blam, I appreciate your posts, it's just that there's at least two issues at hand:
(a) limited audience @ FR - posts like this one that were originally posted @ ZH garner 10-20x replies/comments over there;
(b) waste of time & energy - really, it's all over, and all this financial chattering is just nervous energy trying to put off the looming shadow, which of course is political - FR's meat & potatoes.
See #13
I was in agreement with this article about a month ago, that the Fed couldn’t end QE without shattering the economy due to all the fake numbers and fake markets.
There is one reason for them to do so that comes to mind, and there are probably others I’ve just not been introduced to yet.
Someone might want intentionally to crash the economy. The numbers are certainly in position to do exactly that. But, what would be the benefit of it?
1. Someone wants to push the reset button and rebuild the economy based on reality. Bite the bullet and begin the slow trek back to real prosperity.
2. Create a crisis.
Ultimately, the question goes all the way back to first principles: Why did the US institute a debt money system in the first place? That is, why did the US adopt a system that required the monetary base to grow (that is, take on add'l debt) each & every day - for perpetuity - in order to pay accrued interest on the previous day's existing balance?
By any definition, this kind of endless feedback loop describes a perpetual growth machine aka "ponzi scheme". Since it cannot physically exist other than through artificial means of fraud & deceit, its very survival depends wholly upon misinformation and manipulation.
That's why I gently chided you regarding your thought that the article was perhaps naive; to me, it's just another endless stream of propaganda. Apparently blam thinks these kinds of articles provide some kind of meaningful basis for discussion, yet even over @ ZH where they are sourced, the patience for a willingness to continually dance around the main point appears to be losing favor.
As to who would benefit, why, the entire history of mankind is one of attempted domination of another. Some prefer brute strength approaches, while others are far more devious. In the end, it's all the same: an attack on sovereignty. This brings it back to the political realm, which is why FR could still yet play an important part.
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