I’m getting rather defensive up here.
The squeeze is starting folks, although you certainly wouldn’t know it from the move in the stock market yesterday. That move was all driven by the financials, with JP Morgan leading when they “broke embargo” with their mid-afternoon announcement that preempted The Fed.
Incidentally, doesn’t anyone think that’s a bit odd? Jamie Dimon basically shoving Bernanke down on his knees and unzipping in front of him? And the banks, incidentally, knew the results before we did, which begs the other question — why are they permitted to trade when market-moving news will be in their possession before the rest of the market has it?
You don’t think they were out in the market buying futures and such in the few hours before the press release blitz started, do you? Why of course they were. But not only would proving insider trading be difficult the SEC was too busy watching porn to care.
Now, however, the fun begins. See, the TNX moved up strongly — the 10 year yield. This in turn will force The Fed to sit on its bond holdings to maturity, lest they take a market loss (and given their thin capitalization that would bankrupt The Fed instantly!), which in turn ties Bernanke’s hands to a large degree.
I know many will argue that The Fed can always “print more”, but that’s not how it works. This is a negative feedback situation and triggering a run out of the long end of the bond curve isn’t so much a problem for The Fed as it is for the Federal Government’s financing and deficit numbers.
Take a look at the FVX (5yr Treasury Yield) and you see a materially-more-frightening thing. Yields have backed up from 0.7% to 0.97%. Sounds trivial. It’s not — it’s a huge move, close to 40% on yield since the end of January!
This matters because the Federal Government’s deficit spending in February is what has been driving the “improving” economic numbers, just as it has been for the last three years. This is a pincer move; while yields have to normalize if and when they start to move in this direction that move will also choke off federal deficit spending capacity.
The Depression featured this sort of attempt at “repression” by The Fed and government and it was unsuccessful. It looked successful for a while, but eventually the math caught up with them and we slumped back into the morass. Our “exit” was war; we blew up all of our industrial competitor’s output capacity and by doing so rejiggered demand. That’s a rather bleak way of looking at what was “death by all forms” for the common man, but from an economic perspective that’s what happened. But “war as a solution” since that time hasn’t “worked” (and in fact can’t) since small-ball wars run into the broken-window fallacy; you can’t “win” by breaking windows as the economic damage from a war exceeds the benefit. For war to be a “winning” strategy you have to literally flatten your economic competitors so that even with the economic damage you wind up with a net benefit.
Such a conflict in the modern era has a high risk of turning nuclear and then everyone loses.
In the next few days the market is likely to trade on euphoria from the financial sector, but I don’t buy it at all. Repression destroyed net interest margin in gross earnings terms irrespective of the spread and makes earning a profit much more difficult. Most of Europe is in recession now and that’s a huge market. The ECB has no room to maneuver and further QE by The Fed will declare that the so-called “recovery” is false.
Bernanke, Obama and Congress have swam into the jaws of the shark and now the trick is to try to get back out before the teeth clamp down on all of us. The problem is that extrication in one area will produce undesirable moves in another. If the Federal Government pulls back on deficit spending then the economy softens materially, unemployment goes back up and with a falling labor participation rate tax receipts collapse, adding to the problem. If The Fed pulls liquidity then interest rates go up, the deficit goes up, Congress finds itself up against the debt ceiling again in short order and a pullback on deficit spending will become inevitable. If The Fed engages in aggressive acts to try to prevent the yield curve from backing up on them then oil will likely skyrocket, gas prices will go through $5 and we all know what comes next. Finally, the corner we’ve painted ourselves into has occurred into a cyclical profit cycle peak.
Finally, the parade of pumpers on CNBC and elsewhere that are all on their knees before Bernanke performing obscene acts of thanks is nauseating — and historically, is almost always wrong. Anyone remember Mozilo in his gaudy suits and ties on CNBC just before it all went to crap in the mortgage market? I sure do, and yet a large number of people bought into his BS and wound up broke when Countrywide detonated shortly thereafter.
Meh. Yeah, the market is up some 11% this year thus far.
It’s certainly possible that the can-kicking will continue to work in some form or fashion, but eventually when you’re playing with the spinning plates on sticks you put one too many up there and they all come down. The election season is a prime time for mistakes of this sort as well, as despite the so-called “common logic” that “they’ll never let it happen during the election” the fact of the matter is that elections tie hands as the scrutiny level goes up a lot and the temptation to press into excess to try to jigger the election, when you’re the Federal Government and close to a quarter of the economy, is just too great to resist. 2008 is just one of many examples — 2000 was another when “happy days were here again” and we all know what happened in 2000, right?
Finally, last night the Shanghai index collapsed in the last bit of trade when China said it was not going to back off on halting property speculation. The move was huge — about 4% straight down right at the end of the session, and it drew almost no notice in the media here and no reaction came through in our markets either.
This may look like a beautiful dawn but that thing over on the horizon is in fact a rolling wall cloud.