Should We Get Up And Dance?

Wednesday's FOMC announcement and Ben Bernanke's subsequent press conference (a first) were awaited by market participants with bated breath. As everyone knows, 'QE2' is scheduled to end in June. What wasn't known was whether the more hawkish tones emanating from the likes of Charles Plosser and Richard Fisher (both of whom have a vote at the FOMC this year) actually meant that there was a shift toward a more hawkish stance underway at the Fed. James Bullard – who doesn't have a vote this year, but is considered influential – even mentioned that he thought it may be time to consider cutting the current 'QE2' program short. Subsequent speeches by Janet Yellen and William Dudley from the Board of Governors should have laid such worries to rest, but they lingered nonetheless.


You can read the FOMC statement in its entirety here.  The statement does not differ in substance from its predecessors over the past year or so, but here are the salient points that evidently mattered to the markets:


The unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. Increases in the prices of energy and other commodities have pushed up inflation in recent months. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations.“


(our emphasis)

This is quite the stunner actually. While the structure of the first sentence invites a repeat reading just to make sure one has understood correctly what it says, it sounds as though the committee thinks 'inflation is still too low'. By this they mean to convey that prices are not rising fast enough just yet (obviously, monetary inflation is anything but low – with money TMS-2 growing at or above 10% annualized for 25 consecutive months).

Commodity traders were happy to hear it and right away did their best to ensure that the increase in prices accelerated somewhat. Alas, that should not worry us, since it is all 'transitory'. We would note to this that a continuation of the inflationary policy could end up throwing a monkey wrench into the works of this happily transitory situation (the rise in commodity prices has been considered 'transitory' for quite some time now).

Further from the statement:


“To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and will complete purchases of $600 billion of longer-term Treasury securities by the end of the current quarter.”


(our emphasis)

As trained Kremlinologists we will attempt to interpret this emanation from Gosplan … sorry, the committee. One thing is crystal clear, there won't be an 'early exit' from 'QE2'. What isn't 100% clear is if the 'policy of reinvesting of principal payments from securities holdings' is or isn't subject to a similar deadline. Again the sentence such as it stands would suggest that no such deadline exists at this point – in other words, 'QE Lite' will continue past the end of 'QE2'. The Fed's balance sheet won't be allowed to shrink. As we have asked (rhetorically) before, does anyone know of a time when the Fed's balance sheet has actually shrunk? There may have been such a period, but if so, we were not aware of it. Since there are no charts available for the factors affecting reserve balances prior to 1989, we did the next best thing and looked  at the monetary base, which represents the bulk of the liabilities side of the Fed's balance sheet. The result: it apparently has shrunk at times – for the briefest of periods and by tiny amounts.



A long term chart of the monetary base: it is difficult to see that sometimes, its growth has actually been slightly negative – click for higher resolution.



A chart of the yearly rate of change of the monetary base shows more clearly that there has been the odd instance of negative growth – usually following big spikes higher and never lasting very long. Interestingly, the biggest annualized decline happened during the 1921 Harding recession – a recession that saw a bigger deflation than was experienced during the 1929 to 1932 downturn, but was nevertheless over very quickly. The government did absolutely nothing to intervene – for the last time in history – click for higher resolution.



Further from the statement:


“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”


'ZIRP' is here to stay. Party on, dudes!

And finally, the vote:


“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.”


What has happened to dissent? It appears dissent has died with the departure of Thomas Hoenig from the FOMC. In spite of all their hawkish talk, Plosser and Fisher continued to vote in favor of extremely loose monetary policy. There's no longer a single party-pooper in sight when it would actually count for something. What was that former Fed chairman William McChesney Martin once said about 'taking the punch bowl away just as the party gets going'? The man is probably rotating in his grave in view of this bunch of punch bowl spikers.

We can conclude that all the hawkish talk continues to be nothing but hot air.

To answer the question we posed above: the FOMC is telling us, yes, get up and dance!

Ben Bernanke's press conference (exclusively attended by soft-ball lobbers) did not add any great surprises. The markets hesitated for a moment to see if he would perhaps say anything that may be remotely considered as hawkish – alas, nothing untoward was uttered. A mini-melt-up followed. A synopsis of the press conference 'highlights' can be found at Reuters.


The Reaction Of The Markets

Below is an intra-day chart of GLD that shows nicely how the markets reacted during the day to the dovish choir (a.k.a. The 'Committee').



GLD intra-day: prior to the release of the statement, nervousness and low volume, with prices staying slightly below the previous close. At 12:30, a high volume spike up, right as the statement hit the wires. From 14:00 to 14:15 (beginning of the press conference) a slight pullback (what will he say?). As the press conference went on, another rise to even higher highs, closing right at the high of the day – click for higher resolution.




We have commented in our previous missive on the serial capitulation of the bears, but thereafter became aware that it has now become even more pronounced than we thought. One of the most prominent bears in the mainstream investment world, former Merrill Lynch chief economist, now working for Gluskin Sheff, David Rosenberg, officially declared his capitulation during the day.

As CNBC reports (we excerpt the pertinent parts below):


“David Rosenberg, the curmudgeonly senior strategist and economist at Gluskin Sheff in Toronto, told clients Wednesday in his daily newsletter that he’s finally given up his long-held position that the market is heading for a thud, if not an all-out crash.

Even as the major averages have risen 90 percent off their March 2009 lows, Rosenberg hasn’t been convinced, arguing that the economy is still too weak and investor sentiment way too giddy to justify such a relentless rally.

No more.

“This is not about throwing in the towel,” he writes, “it is an acknowledgement of what the market internals are flashing at the current time from a purely tactical and technical standpoint.”

For more than two years now Rosenberg has been advising clients not to trust the rally, defending bonds against “inflationistas” and warning that deflation remains the far greater danger.


“The (US dollar) is on a one-way ticket south and so far has been orderly—will that be sustained is anyone’s guess,” he writes. “For now it is being viewed as fodder for the global liquidity and risk-on trades.”


"Anyway, Rosenberg cites the “wall of worry” argument that the market will keep moving higher despite its many obstacles.

These moments when major market bears give it up are often the signs of a peak in sentiment, but anyone so far who has tried to step in front of this rally has gotten crushed.

“Market internals are too strong to ignore right now—NYSE advancers beat decliners by a 3-to-1 ratio (Tuesday); the Dow transports soared 1.9%; and the small caps beat their major benchmarks,” Rosenberg says. “My overall macro concerns have not gone away, but these market facts on the ground are tough to ignore.”


He's a bit late to cite the 'wall of worry' argument. Alas, we concede that the 'market facts on the ground' he makes note of are, as he puts it, 'hard to ignore' – they are what they are. Except for one small, but perhaps important fly in the ointment – if even Rosenberg is throwing the towel (even though he says that he really isn't), then who is left to argue the bearish case? As we have pointed out, the answer is actually: virtually no-one. Having said that, we concede that sentiment is always a function of price movement to some extent, and excessively bullish as well as excessively bearish sentiment must be discounted by this fact. Actionable information requires either a divergence or a rare extreme. However, we have been assailed with rare extremes in the sentiment data for many months – and yet, here we are, with the market at a new high for the move.

Since we first talked in these pages of the fact that 'risk is high', the SPX has tacked on nearly 200 points. Luckily, from our point of view, we have been bullish on gold, but it has to be said here that both gold and the stock market are running up based on the same premise: the continual devaluation of the dollar. The dollar too has proved weaker than we expected it to be – even though it still remains within the confines of the trading range it has inhabited since 2008. This is true of DXY, but it is no longer true of the Fed's trade-weighted dollar index as we have pointed out a few days ago. Back in late December we attempted to explain how it was possible for the stock market to ignore what were in the past fairly reliable danger signals.

We wrote:


“There may be some parallels between the current time period and the year 1999/2000 blow-off in the Nasdaq. At the time some pretty wild sentiment extremes were established as well. For instance, unusually large amounts of call options in internet/optical equipment and similar market darling stocks were well in the money at the time, with prices easily vaulting over the resistance normally posed by large call open interest. The only really significant put buying/hedging at the time was done in NDX jumbo options.

The Rydex overall bull/bear asset ratio went to 92:8 at the March 2000 top, still an unbeaten record. The Greenspan Fed engaged in massive monetary pumping in the final months of 1999 – the 'Y2K bug' fear was in the air and the Fed was afraid the payments system may become dysfunctional, so it stuffed the banking system with extra liquidity.

The Bernanke Fed is no slouch in the monetary pumping department either of course, currently adding some $100 billion gross ($75 billion net) to the size of its balance sheet per month. Consequently there could be similar effects in train.”


As it has turned out, similar effects have indeed been in train.



The SPX over the past year – not only has it ignored all warning signals on the sentiment front for months, but its rise actually seems to be accelerating lately – click for higher resolution.



The SPX, T.R.'s VIX-based proprietary volatility indicator, and the gold-silver and gold-commodities ratios. The subtle non-confirmation of the gold-commodities ratio continues and there is a first slight hiccup in gold-silver (not big enough to cause concern yet, but worth keeping an eye on). Also, the volatility indicator diverges slightly from price – click for higher resolution.



The question is now, for how much longer can the market levitate on the fumes of monetary pumping? We confess we still don't know the answer. It has broken out to new highs for the move, a fact that as Rosenberg states is hard to ignore. On the other hand, every market top in history has by definition occurred after a move to new highs and higher prices have not suddenly magically lowered market risk – they have increased it.

The major factor that has been so supportive of the rally in 'risk assets' – the US dollar – continues to present a near perfect mirror image to the stock market:



A monthly chart of DXY – while still in the trading range it has inhabited since 2008, this remains a weak chart – click for higher resolution.



Thinking the situation over, we wonder of course whether the closeness to a major area of technical support will turn the dollar around or whether it means it is about to sink to fresh multi-decade lows. In case a low is established and the US dollar turns up, it will likely go hand in hand with a sell-off in 'risk assets' and a rally in US government bonds. On the other hand, what happens if it just continues to sink?

For the first time in a while we feel compelled to consider the possibility of this happening. We wonder if the stock market would still regard it as benign if the dollar index were indeed to break to new 40 year lows as its trade-weighted cousin has already done. Needless to say, sentiment on the US dollar is so darkly bearish (the daily sentiment index shows only 5.4% bulls) that a reversal still seems the higher probability bet. Alas, sometimes when a market is very 'oversold' and sentiment has turned extremely sour, a panic can ensue. Somehow we can not imagine a dollar panic to be good for stocks.

In a hilarious interlude, so to speak as a humorous accompaniment to the dollar's steady sinking beneath the waves, treasury secretary Tim Geithner just reiterated that he actually pursues a 'strong dollar policy'. If he hadn't told us about it,  we would likely not have noticed it. As Bloomberg reports:


“Treasury Secretary Timothy F. Geithner today reaffirmed the U.S. commitment to a “strong dollar” and said the country won’t weaken the currency to gain an advantage over its trading partners.

“Our policy has been and will always be, as long as at least I’m in this job, that a strong dollar is in our interest as a country,” Geithner said in remarks at the Council on Foreign Relations in New York. “We will never embrace a strategy of trying to weaken our currency to try to gain economic advantage.”

Geithner’s comments, in response to a question about the dollar’s recent decline, show his efforts to reassure investors that the U.S. will restore long-term economic growth and stability. The Treasury chief said the U.S. must earn investor confidence “over time” and said there’s “fundamental” trust in the U.S. ability to cope.”


All we can say to that is, let's hope that the 'fundamental trust' doesn't suddenly evaporate. In that case we might have a real problem.

Lastly, here is a chart of gold against a basket of currencies that includes the strong 'commodity currencies' AUD and CAD. As can be seen, gold is now making new highs against this basket as well – although the advance is most pronounced against the US dollar, this shows that all fiat monies continue to sink against gold.



Gold against a basket of fiat currencies – a new all time high has been reached – click for higher resolution.




As Zerohedge reports, one of Mr. Geithner's predecessors, John 'Money Is More Lethal Than A Bullet' O'Neill has spotted 'terrorists' in Congress. Given what the recently 'wiki-leaked' files on Guantanamo reveal (people were held on the 'flimsiest grounds' as the Guardian puts it) we hope that the poor boys won't get 'renditioned'. After all, the new boss has left the 'Enabling Act' introduced by the old boss firmly in place (with regards to that there clearly was more hope than change). If he wants to, he can declare anyone an enemy combatant – a status that means for the persons concerned that they no longer enjoy any legal protection.

O'Neill, verbatim:


“The people who are threatening not to pass the debt ceiling are our version of al Qaeda terrorists. Really. They’re really putting our whole society at risk by threatening to round up 50 percent of the members of the Congress, who are loony, who would put our credit at risk.”


Well, we won't argue too much with the notion that loonies might be found in Congress. It seems at least possible. Haggling over the debt ceiling is nothing new however. As we recall, the Newt Gingrich-led Congress used the tactic to wring major concessions on spending from Bill Clinton. The Republican Congress raised the debt ceiling six times between 1995 and 2007. In Clinton's days, a budget surplus eventually made a brief appearance, to everybody's vast surprise. There is however a difference between then and now.

As CBS reports:


“So far, the Treasury has nearly drained a $200 billion cash-management account at the Fed, providing a cushion of money to pay bills without new borrowing. Next, Geithner is likely to take a series of "extraordinary actions," such as suspending the issuance of special securities that help state and local governments manage their own finances. Once the debt hits the limit, Geithner may declare a "debt issuance suspension period," permitting him to borrow from the pension fund for federal workers.

Rubin pioneered these strategies in 1995, at the start of the budget battles between President Bill Clinton and Republicans led by House Speaker Newt Gingrich (R-Ga.). As the fight dragged on through two government shutdowns, Rubin had to juggle the nation's bills for 135 days. Finally, Clinton threatened to delay Social Security checks, spurring Congress to approve more borrowing to make sure the checks went out on time.

Then, as now, a new GOP House majority was pressing a Democratic president to shrink the government. Congress grudgingly raised the debt limit six times between 1995 and the loss of GOP control in 2007, while the Treasury repeatedly resorted to extraordinary measures.

Geithner can use the same tactics, Rubin said, but "the trouble is the numbers are much bigger this time." In November 1995, the debt stood just under $5 trillion, and the government was spending less than half what it does today. The measures Rubin used to stay under the debt limit for more than four months would now last "a few days to a few weeks," according to GAO auditors.”


(our emphasis)

Oops. This sounds as though we may actually end up with a few spending cuts after all.  The horror! Paul Krugman already grows more apoplectic by the day, judging from his op-eds. Unless we immediately tax and spend more, the world will surely stop turning.

Charts by: Bloomberg, St. Louis Fed



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3 Responses to “FOMC To Speculators: The Music Is Still Playing”

  • Wow, with Rosenberg gone, who’s left? It seems that Robert Prechter is the only major person who’s outrightly bearish on most things now..

  • Floyd:

    We have been hard-working-savers, living within our means, and managing our savings conservatively.
    The unfortunate reality is that during the past decade loss of purchasing exceeded our saving capacity.
    Makes one wonder …

    If the 2002-2005 Fed reflation craze is a relevant example, it could take years before the next bust.
    By this time the US debt could be in the epicenter of the bust, in which case the USD is probably not a good place to be.
    I don’t know that this is in our future, but I have hard time to eliminate this scenario.
    Imho, the further out the next bust occurs, the more likely the US debt to play a major role in it.

    I’m really skeptic about the US being able to rehabilitate itself from debt addiction.
    The US has absolutely no institutional memory guiding it what happens when a country has too much debt.
    Thus, if I was a betting person, I would bet on the US facing challenges in Treasury bond markets…

    Am I missing something?
    Am I too pessimist?

    • I agree, eventually there should be a problem in the treasury market – but probably we are still some time away from that. The current reflation period is different from the 2002-2007 one insofar as the private sector is so far not yet actively increasing its debt load – instead the increase in credit and money is largely a government-led enterprise at the moment. This fact may well cut the current reflation episode short.

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