Easy Money Becomes Even Easier

Last week the FOMC surprised the markets with a rare inter-meeting rate cut. As the FOMC statement released on the occasion reveals, the decision to cut the  federal funds rate by a hefty 50 basis points was unanimous. The much-lamented “zero bound” is coming closer rather quickly.

 

A happy little money tree… from “The Joy of Printing”

 

As Mish notes here, Mr. Powell stated the following in remarks to the press after the announcement:

 

“We do recognize a rate cut will not reduce the rate of infection, it won’t fix a broken supply chain. We get that,” Mr. Powell said.

 

Wise words, chair-person, wise words. Why cut rates then, if none of these objectives can be achieved? The explanation according to Mr. Powell:

 

“But we do believe that our action will provide a meaningful boost to the economy. More specifically, it will support accommodative financial conditions and avoid a tightening of financial conditions which can weigh on activity and will help boost household and business confidence.”

 

Looking around the inter-tubes, we noticed that this prompted numerous people to wonder at what level of the federal funds rate precisely they would feel the urge to book their next cruise. The stock market at first bounced in typical knee-jerk fashion after the announcement, but then sold off rather significantly.

As confidence boosters go, this rate cut appeared to leave a lot to be desired. In fact, one had the impression that it was undermining rather than boosting confidence, by conveying the message that the monetary mandarins are quite worried.

 

Following Market Rates

They probably are quite worried, and there is reason to believe that yet another rate cut will be implemented at the regular FOMC policy meeting this month. Consider the following charts:

 

US interest rates and yield curve spreads: 3-month t-bill yield, 2-year t-note yield, 10-year t-note yield as well as the 10 year – 2 year spread and the 10 year – 3 months spread. The decline in yields in the past two weeks is unprecedented; the Fed is simply following the lead of the markets and is actually still lagging substantially behind recent market moves.

 

Note that the spreads between 10-year note yields and shorter term yields have begun to rise after inversions were recorded previously. This is usually a major recession warning. We currently don’t really see any good reason for short term yields to recover, but even if they do bounce a little, the federal funds rate will probably remain too high relative to the rest of the yield curve:

 

3 month t-bills rate minus the Federal Funds rate – the current steep inversion strongly suggests more rate cuts are on the way.

 

With more rate cuts highly likely, one can begin to speculate when the recent bout of “not-QE” will officially morph into the next round of “QE”:

 

Total assets held by the Federal Reserve system. Under the recent “not QE” debt monetization program, the Fed’s balance sheet is rapidly approaching its former peak.

 

Conclusion

More monetary pumping is on its way, not only in the US but also elsewhere in the world. However, as Mr. Powell correctly noted, this can neither fix supply chain disruptions nor persuade the COVID-19 virus to magically disappear. We suspect that while “not-QE” and whatever asset purchase program follows in its wake will continue to boost money supply growth, the effects will probably be offset by rising demand for money.

This is highly likely because the risks from the spreading COVID-19 infection are not really quantifiable at this stage. Both individuals and companies will probably want to increase their cash balances as a result – and this means that the “usual” effects of strong money supply growth on asset prices may not occur this time. If e.g. share buyback programs are curtailed, a significant source of demand for stocks will disappear.

In the near term the market may be sufficiently “oversold” to prompt a bounce (even that is actually far from certain), but caution continues to be advisable. There are times when the old adage “don’t fight the Fed” does not work as advertised.

 

Charts by stockcharts, St. Louis Fed

 

 

 

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16 Responses to “Rate Cutters Unanimous”

  • philc2:

    Gold down to US$1,530 as I post this. The massive liquidity provided by the FED is driving shares up and gold down. But for how long?

    • utopiacowboy:

      Anecdotal evidence suggests a disconnect between the price of paper gold and physical gold. Paper gold will continue to plummet even as shortages of physical gold exist and premiums skyrocket.

      • RedQueenRace:

        Kitco shows the spot gold bid/ask at the close of Friday as 1529.90 / 1530.90. The CME shows a “last” price for the April contract, which is the front month, as 1528.90. The March contract close was 1517.80. But the March contract has never been the front month and is thinly traded. Friday’s volume for the March GC was 89 and open interest is 51. Volume in the April was over 550,000.

        The April contract is what matters. It is for near future delivery and it is only $1-2 below spot gold.

        The dealers may have shortages of specific products or inventory in general but that isn’t automatically indicative of a gold shortage. Given that gold is not used up and the world’s stockpile continues to grow there are no shortages. It’s simply a matter of what price has to be paid to obtain it. It would be a shortage if gold could not be obtained no matter what the bid was. Otherwise sharp changes just mean there is a price range in which few people are willing to buy / sell (drops / rises sharply) relative to those who want to do the opposite.

        Along with the cratering in the futures is a substantial drop in open interest in the April GC. First Notice Day is 3/31 and the open interest is dropping fast. At the end of the first trading day of March it was 460,877. After Friday’s close it has dropped to 272,462, a decline of 188,415 contracts or almost 41% in just 7 trading sessions. Once again, those who keep looking at open interest versus COMEX registered and eligible gold will not see any FTDs because they simply do not understand how the gold futures market works and all the beliefs about what is going to happen to “the big bullion banks” whose positions in the futures, much less their net positions, these folks think they can infer from CFTC reports, are not going to pan out.

        • RedQueenRace:

          I better clarify that when I state there can be no shortages I am speaking of gold generically. A shortage of a specific form can definitely happen. There may be a shortage of, say, Gold Eagles but that is not a shortage of gold.

          • utopiacowboy:

            Of course there is always gold available – it’s just a question of price. When the paper gold price is $1532 but you cannot find any physical gold for less than $1600 there is an obvious disconnect. Its quite telling that even after the Fed lowers rates to zero and the USD drops, paper gold still cannot find a bid.

            • RedQueenRace:

              The first place I went to yesterday when I saw your post was Colorado Gold, from whom I have bought before. The most expensive 1-ounce product the Stotts had was the American Gold Eagle, which is always at a steep premium compared to other products. It was $1585. All were under $1600. Their Valcambi 1-ounce bar was about $1550, $20 or so over the paper price.

              I am going to emphasize this: Not one 1-ounce product there was $1600 or higher.

              ColoradoGold does not carry inventory. They are brokers and buy for you through A-Mark. So they do charge a commission ranging from 0.5% to 1% depending upon order size, but their prices also include the mark-up that A-Mark has for their profit.

              “Its quite telling that even after the Fed lowers rates to zero and the USD drops, paper gold still cannot find a bid.”

              I am not seeing a physical vs paper problem. In addition to the slightly over 1% premium on the gold bar, I looked at some gold ETFs yesterday and AAAU and OUNZ, both of which allow the individual investor to redeem shares for gold, were down just as sharply as the supposedly paper ones, such as GLD. And AAAU is guaranteed by the Western Australian Government. On Friday:

              GLD was down 3.05%
              OUNZ was down 3.06%
              AAAU was down 3.06%

              GLD should be down considerably more if this is truly a loss of faith in paper gold as redemption there is out of the reach of individual holders. All the idiot GLD naysayers on Seeking Alpha who have told me they can’t trust GLD because it is not possible to redeem for physical are going to have to explain the above to me. The ETFs that will exchange shares for physical are doing no better.

              There are numerous forces at work in the futures market. The market got very / extremely overbought and a sharp drop happens all the time in markets after this. Markets that do this will usually first have a limited sharp break and then a rally back. They can make a new high or fall short but regardless if it makes a new high the momentum oscillators will typically make a lower high. That usually precedes a much sharper break. They can also make a new high at a lower RSI without more than a mild pullback and if it has been a big run it will often precede a big break. That’s why I bought DGLD. It wasn’t because I saw a supposed paper / physical disconnect coming. It was based on technical market action. I have utilized this technique successfully many times before. I will do something similar if the same happens on the downside with GLD or maybe even a leveraged long gold ETF.

              Also, as I said originally, First Notice Day on the April GC is coming up. Outside of commercials / users, very few want to or can take delivery as the cost is $150,000+ per contract (at current prices). How many speculators do you think actually have that kind of money?. Open Interest is collapsing as FND approaches as always happens. The speculators do not have the staying power to wait around for a rebound and are likely panicking out. I am also not the only person who takes a technical approach to markets. For many, the futures are just leveraged short-term bet on the underlying and it is going against the longs with little time for a favorable move.

              • RedQueenRace:

                “That usually precedes a much sharper break”

                I meant to say “bigger,” instead of “sharper.” It can be sharper but the steepness of the decline can vary a lot.

        • utopiacowboy:

          I just looked at one well known site apmex.com to see what they are selling American Eagle one ounce coins for. In quantities of 1-9, $1604.99. In quantities of 10-19, $1599.99.

          • RedQueenRace:

            That’s fine, but that’s today. Prices are up considerably as yesterday ColoradoGold’s prices were on several occasions lower than Friday’s close. They are still below $1600 on all products but the Eagle is now at $1594 and could have gone over $1600 today.

            Over the weekend you said gold was not available under $1600 anywhere. That was false because

            1) Colorado Gold had product for less than that

            2) the premiums elsewhere were for **products** that consisted of amounts of gold bought by retail. Spot gold was very close to the futures price. Spot gold is for a raw ounce of gold for immediate delivery as Apmex states on their site. The futures are not for immediate delivery, obviously, but April delivery assignments are close. If there had truly been disconnect between paper and physical the spot would have been well above the futures. It wasn’t and still isn’t. Conclusion: the shortage is of products based on gold, not gold itself.

            After a refresh the 12:52 NY time spot bid/ask of gold is shown at Kitco as 1528.40 / 1529.40.

            Although it is not a contract I trade I do have the April GC (GCJ20) contract chart up on my trading platform. It is displayed with 1-minute candlesticks. The 12:52 candlestick range was 1528.30 – 1530.70. Compare to the Kitco bid/ask. Spot gold is not diverging from paper.

            The unavailability or premium of products tells you what is going on with those products (or type of products). But it does not tell you what is going on with gold itself. So the US Mint may not be able to satisfy demand for Gold Eagles or Buffaloes and there is a shortage of them. But that does not equal a shortage of gold.

            It is also possible that with the rapid decline in the gold price that dealers held back inventory that they bought at a higher price, i.e., it dropped sharply before they could sell and they do not want to sell at a loss. Large, experienced dealers might hedge in the futures, but smaller ones probably don’t.

            • RedQueenRace:

              This discussion has caused me to revisit the whole gold spot issue, which I looked into 4 or 5 years ago as I wanted to know what exactly the spot price was and how it was determined.

              My initial investigation led me to believe that it was derived from the gold futures price. It sense because as I far as I could tell there was no centralized reporting spot for actual bullion trades. More research led me to believe that, no, there were quotes pooled from multiple places that determined it.

              Having revisited it I am now back to “it’s based off the futures, specifically the front month.” I have found many more explanations that state this. I do not believe ‘front’ month is technically the right term. The most actively traded month is likely to be used. I have always used “front” for the month with the heaviest volume as that is the term that was used by the brokers that I broke into futures trading with. Technically that is not correct. It’s a bit petty detail but it can be meaningful in a discussion where 2 people interpret ‘front month’ differently. I will continue to use it to mean the most active month.

              Anyhow, if gold is derived from the front month then if that month is closing in on expiration the spot price is obviously not going to diverge much. How much it does diverge is likely to be along the lines of how the S&P futures premium is determined and include perhaps interest rates and definitely time to expiration. I think we should be able to test that belief when the April contract rolls as the difference between the futures and spot should widen.

              So watching the spot against the futures doesn’t tell us anything. But it doesn’t change anything either. If folks need gold and the sellers demand way over spot the party in need can go into the futures market and take delivery. Remember, the spot is for raw (unrefined) gold so buyers aren’t likely to be buying just a few ounces of it and a futures contract is a viable option.

  • utopiacowboy:

    Actually I pay very close attention to gold, silver and the mining stocks. Gold is getting hammered today on a market down day. The mining stocks have been saying for some time that they don’t believe gold should be anywhere near $1600. They are the same price as when gold was at $1200. I find that any move in gold which is not backed up by the miners is only temporary.

  • utopiacowboy:

    The stock market goes down. Gold goes down. The stock market goes up. Gold goes down. Gold and the mining stocks are hated right now and it’s probably time for a new bottom.

    • RedQueenRace:

      There are times you seem serious but you often come across as a troll. Either that or you are not paying close attention to the markets.

      Graphing $GOLD against $SPX at stockcharts will show this “gold goes down no matter what the stock market is doing” claim to be wrong. It certainly did not hit two highly overbought conditions in the momentum oscillators at the beginning of the year and mid-to-late February (less than a month ago) by going down.

      The high of this current gold up move of $1704.30 was made just 2 days ago. As I write this the GC is trading at $1650+ per my trading platform. The March low is $1576.30, all inconsistent with something that supposedly is only going down.

      Maybe gold will not go much lower here given what is going on. The $1704.30 top is a little bit higher than the previous high of $1691.70 on 2/24. The 2/24 high was accompanied by a very overbought reading on the RSI. The higher 3/2 high was made with a significantly lower RSI, a negative divergence indicating momentum on the new high had slowed drastically and some type of pullback was likely coming. Right now that’s all that’s gone on, a bit of a pullback off the new high. With the divergence this could turn into a double-top and a deeper pullback, but with the FOMC meeting next week I wouldn’t be making any (additional) bets either way. I made a small amount of money on my initial DGLD short but gave most of the gains back before getting out. I am in again with a small position and am currently down on it. I’ll hold the position but I won’t do anything else until I see what happens after 2 pm on 3/18.

      • utopiacowboy:

        Dropping like a rock today. The commodities are getting trashed and gold along with the rest of them.

        • RedQueenRace:

          As I said, potential double top. My DGLD is back in the black. The FOMC announcement next week could make it move big either way.

          This looks like a rush for liquidity. As I write this, Bitcoin is down over 25%. Some “safe haven” (according to many of its supporters on Seeking Alpha) it turned out to be.

          • RedQueenRace:

            Closed out the short. DGLD’s RSI was about 65 when I sold. That’s not overbought (inverse of gold being oversold) but I don’t like to be a pig. I’d rather get flat and wait to fade the next extreme, whichever direction it is in.

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