Monday, September 10, 2012

On Sub-Zero and Decoupling


On the IOER and Hilsenrath


Bernanke has to do something this week. Most pundits are suggesting it will be more LSAPs (QE). I have trouble with this scenario. To be of any benefit, a new QE would have to be for $600Bn. If QE3 were to be only a paltry $200Bn, it would be received very poorly. I don’t see Ben shooting off a pop-gun this week. He would be better off doing nothing, than something that will fall flat. I think he knows that.

There is also the issue that there is no justification for more QE right now. We are not in an emergency, stocks are at four year highs and there really are negatives to a policy of perpetual ZIRP. Also, a big splashy QE would be perceived as being very Pro-Obama. Taking sides in a national election is not something the Fed really wants to do. Republicans tend to have very long memories.

Extending the ZIRP language for another few years is idiotic. It is a promise that can’t and won’t be met. It also has zero value to the current economy. Extending the language is a ho-hummer that will accomplish nothing other than to demonstrate that the Fed is out of arrows.

That gets us to changes in the overnight deposit rate (IOER). Currently at a 1/4%, it could be cut in half to 1/8. This seemingly insignificant change would actually have profound effects.  I wrote about this recently (Link), but much more importantly, so did Jon Hilsenrath of the Wall Street Journal. His thoughts from Friday night on the IOER (Link):

Another possibility, which is more controversial internally and might not happen, is a small reduction in the 0.25% interest rate that the Fed pays banks for reserves held at the central bank.

If you believe (as I do) that Jon’s words are scripted by Bernanke, you could read through this sentence and conclude:

A) Ben has told Jon that a cut in the IOER will be discussed and voted on next week.

B) The words “small reduction” is new to me in this context. The discussions to date have been that the IOER might be cut to “0”, rather than something in the middle.

C) There is opposition to this step from at least two voting members. While Bernanke has the votes to do as he pleases, he wants there to be a consensus of opinion that includes only one dissenter. (This about the “Optics”)

D) Ben is pushing for this. He wants to prove he has more arrows. He does not want to confront Republicans with a major QE at this time. But he has to do “something”, the IOER might be it.

E) The words, “might not happen“, could also be read as “might happen“. A cut in the IOER is (at least) 50-50 if you read through Jon’s words.

Three and six month T-Bills are now .10 and .13 respectively. Post an 1/8th cut in the IOER they would be -.03bp  and 0.00bp. Does that matter? I think it would be a very big deal indeed.



On FX, Equities and Bonds

My most recent efforts in FX have led to a loss. I had a bear spread on the EURUSD with the near leg at 1.2350. That went off the sheets last week, option premium went out the door.

I don’t dwell on losses. They are part of the game. But I do try to evaluate why I am wrong in an effort to avoid the same mistake again. In this particular trade I completely missed the market sentiment that Draghi’s plan has created.

I didn’t believe that Draghi could ever say the words, “Unlimited Intervention”.  But he did, and I’m the poorer for it. I’m as certain that I can be that Draghi has made a promise that he can’t deliver on, but for the time being he seems to have the upper hand.

Don’t shed too many tears for me, the past month has been one of my best in the equity market for years. The hedge funds I invest with have done very well. But of course that is all paper, and the future is uncertain.

I spoke with a guy who runs a fund (with a couple of bucks of mine) this weekend. He was happy as can be. His fund’s performance has past the upside mark, so he was getting a free 20% of any additional gains. Like all equity guys, he’s bullish for the rest of the year. His thinking is that common stocks of companies with good balance sheets, positive cash flow that are buying back stock have much more upside to them. Google at 800+ is in the cards, according to him.

He made one interesting observation. He believes that equity prices have decoupled from the business cycle. Stocks can do well when the economy is struggling and government financing is in ruin.

That sounds crazy to me. But it is exactly the status quo today. Stocks are four year highs, while government financing (globally) is in the toilet, and about to be flushed. His justification for the optimistic outlook for stocks was:

Who in their right mind would buy any government bonds today?

We shall see if the decoupling of stocks and the broad economy/public sector financing continues, but you can’t ague with what the guy says. Bernanke and the other central banks have converted the debt market into a very unlovable asset class. There is no return on the bonds; there is credit and yield risk. Bonds are a total downside story at this point.




  1. BK;If the us economy is depending on consumer spending,what happens to equities when they stop(cant)spend?We have already seen soft earnings in the second quarter 2012.So it seems to me,sure equities have decoupled from the bussiness cycle,just like home prices did till the bubble burst.

  2. Thanks for the update of your EURUSD investment. Been watching the Euro climb and wondering about that. You have some good insights. Check your page daily.

  3. Anyone else notice that Geithner is on a bank selling / cash raising spree?

    All the sudden, Turbo Timmy is selling “our” stake in AIG (which no one but Geithner wanted in the first place). And today the Timmy Treasury is selling the preferred shares in four regional banks that got bailouts — I mean TARP money.

    Seems like Geithner has another self inflicted liquidity problem

    • I think it can be explained by political factors. O probably wants to be able to praise himself when the debates roll around in October about how he has gotten all the taxpayers’ money back (ignoring, as he will, the cost of Fannie and Freddie and maybe auto).

  4. Dave from California says:

    Wouldn’t lowering the IOER also be viewed as pro-Obama? I don’t think he can do anything other than jaw-jaw without seeming political.

  5. Personally I like a Euro short this week as a hedge against an unfavorable German Constitutional Court ruling. Otherwise, agree with this post. Wish there were more time between the German ruling and the FOMC because they’re both pretty major.

    Was there once a time when government actions did not drive the market? What was it like?

  6. Enough, with the Keynesian printing press pump priming. The question I want to know, Is the Federal Reserve, quietly, possibly even secretly, buying gold? If so, how much and over how long a period of time. I have read some information, indicating that various central banks around the world are in fact, increasing their gold reserves. If this is accurate, the central banks are playing games like magicians who get their audiences to pay attention to the distraction, but not the business. I fear, that the trick will wind up with the masses losing big time. While the central banks and their governments headed by the likes of George Soros, Barack Obama and other socialist – crony capitalist con and steal the wealth while maintaining the world as their plantation.

    • Hi!, Mr. Byers Et Al:

      The Fed. is archaic but Bernanke’s no stupid fool, as attested by my mechanics’ main question as to what prevents the Fed. using its’ printing press from buying whatever gold it wants at any price it wants? In fact price is a problem for the masses but not the Fed. buying gold, because the Fed. can pint up whatever the market will bear which is printing press money it prints anyway. Now that gold has joined the Tier 1 family of Fed. assets, why shouldn’t the Fed. lead the way in geting off the purchase of T Bills & Bonds Band Wagon, to purchase Tier 1 gold which pays better than interest as a hedge againt the Fed’s own inflation? So, is the Fed. buying gold or put another way is the Bernank such a fool as not to buy gold; and add it to its’ private Tier 1 family of securites? You can do your own DD from here!!

      RUSS SMITH, CALIFORNIA (One Of The Broke States)

  7. Bruce– do you ever give interviews? Please let me know! I am interested in talking with you about research for a book. Many thanks, Erin

  8. Turn on the printing press. I am invested in gold

  9. To be of any benefit, …

    Question: Of what benefit would it be? And who would reap those benefits? You don’t really spell that out.