Not content with its massive effort on the financial suppression front, the Federal Reserve has supposedly been discussing an imposition of fees on certain bond funds in an effort to avoid potential market dislocation. This causes us an unlimited amount of consternation for a number of reasons 1) They, and they alone, created the atmosphere whereby investors of all risk tolerances are forced to step out on the risk curve in an effort to earn anything 2) Charging exit fees in an effort to stem basic market forces is one more effort to cement their position as the ultimate arbiter of unforeseen events. We always have to pause in instances like this for fear of sounding like a conspiracy theorist, but one has to believe that this has the potential to open the fee floodgates with respect to any market that suddenly could become illiquid (note: this is every market).While some hard assets are criticized by many as non-yielding and thus unworthy of holding in ones portfolio, at least there is no fee imposed by the powers that be on this allocation decision. Sell Paper, Buy Stuff
I can’t help but feel like Bill Murray in the movie Groundhog Day, whereby it appears that every day in the Capital Markets is a repeat of the day prior. Forget the new normal, or the great moderation, we are now in the midst of the Groundhog Day Market. In this nirvana, Stocks rally, bonds rally or at least stay range bound, commodities sell off and volatility across the board stays stubbornly low. Investors in this new era, would appear, like Bill Murray, to be in some kind of twilight zone where it’s not “no news is good news”, its there is no new news. Every day the background noise is the same: “Stocks are the place to be given where rates are”,” The Fed will not raise rates until…”,” Inflation is dead”,” De-flation is the greatest risk”. This world would indeed be nirvana if not for the faulty premise that underlies all of this complacency; namely that Central Bankers have it (whatever it may ultimately be) under control. What concerns us is not the occurrence of some black swan event, but rather the high level of disjointedness which will occur given the significant mis-allocation of capital across all global Capital Markets.Major dislocations in markets usually do not stem from one single “event”, but rather from the collective group -think that believes that all events are simply one-off in nature and thus can be controlled. Market dislocations occur when the macro suddenly overwhelms the micro, thus rendering simple solutions (Central Bank action) relatively ineffective. Don’t mistake sameness for safety, Buy Stuff.
The minutes from the last Fed meeting were released yesterday, and as usual, the mindless chatter was soon to follow. A great deal was made about the discussion of the continued taper and more importantly how, or if, they would shrink their $4Trillion balance sheet. Without going into details, except to tell us that rates would not normalize any time soon, the committee felt they had a sufficient number of unproven methods to either reinvest their runoff proceeds or not. Depending on growth, or employment, or inflation the Fed feels confident that rates will remain low, or not, and that they will make adequate adjustments to policy, or not, depending on whether conditions warrant. Fed speak has been reduced to the most abject level of nonsense, which everyone feels somehow compelled to comment and act on. What was classic in yesterday’s minutes was the discussion of risks whereby some Fed members felt there were potential risks out there involving financial markets, namely tight credit spreads and low levels of overall volatility possibly hinting at extreme levels of complacency. The general feeling was however that it would be” helpful to continue to explore the appropriate regulatory, supervisory and monetary policy responses to potential risks to financial stability”. In other words, stay at the party everyone, we will clean up the mess afterwards- trust us.Trust in Central Bankers at your own risk. Buy Stuff.
Once again, another year has passed and we are now inundated with the end of year projections as to what will happen in 2014. We generally find these projections without merit, but we have a particular distaste for such guesstimates given the self-reinforcing behavior that currently overwhelms todays capital markets. Early on in these various monetary science experiments market participants looked at the potential mismatch between objectives and the measures taken. Today, however, it would appear that this analysis has fallen by the wayside along with any concern over the possible unintended consequences. There is no longer talk of whether we should be going down this path, but rather what will be the harm if we shift to another path. Forget the fact that the current path may take us in directions or places we never imagined. Many scoff at comparisons between today’s Central Bank actions and those of the Central Bank of Japan during the 90s and beyond. However, recent comments by the BOJ Governor should validate those comparisons. In a recent FT interview, the BOJ Governor remarked that they were the first to enact quantitative easing back in 2001, and even though it has essentially accomplished nothing, they continue to push forward with a program to double (at least) its holdings of JGBs. The recent actions by the BOJ are driven by a desire to break the deflationary spiral that has existed in Japan for over a decade, the question however becomes at what price. If Inflation comes purely as a result of a rapidly depreciating currency, and does not necessarily translate into wage growth then the “benefits” of inflation for the population in general is moot. More importantly, the BOJ Governor also does not rule out using other more radical tools should the current ones prove, yet again, unsuccessful. What also stands out from this interview is the disconnect between what is happening on the monetary side and what is occurring on the fiscal side. The Governor acknowledges the potential for a sharp rise in rates as a result of their current strategy, however he soft peddles the effect such a rise would have on Government finances. The BOJ has travelled down this QE path for years, but rather than shifting to another possibly more advantageous side road, they have instead chosen to simply proceed at a higher rate of speed. If the definition of insanity is doing the same thing over and over and expecting different results, choose rational thought: Buy Stuff.
I have been thinking a lot about anchors lately. Not to get too nautical here, but my thoughts have centered on the anchors, or perceived anchors we currently see all around us. The front end of the Treasury Curve anchored by the various forms of QE, the attempt to anchore investor expectations by all global central banks, the lack of any attempt by those in Washington to provide any kind of anchor to the credit worthiness of the U.S. Government, the complete lack of anchor associated with any fiat currency. Maybe what got me thinking in this vein was an interview with former Fed Chairman Alan Greenspan. The wide ranging interview, which mostly consisted of trying to box the former chair into some critique of current Fed policy, stood out for two divergent points that were made by the Maestro. When asked about the difficulty with stepping away from Central Bank balance sheet management, Greenspan stated that “it really is not that difficult, it is merely a bookkeeping entry”. The fact that the Fed could conjure up $4Trillion in reserves, and just as easily un-conjure a like amount speaks to the anchorless world in which we live. However, the former Chairman was not done there. When asked about the presence of a Bitcoin bubble, he responded ” I don’t understand where the backing is… there is no intrinsic value”. Buy real anchors(Stuff) Sell perceived anchors(paper).
Recent suggestions in Japan that public and private pensions disavow themselves of their JGB holdings in exchange for more risky assets, imply that the Government is possibly beginning to suggest more firmly that the private sector take a more active role in the reflationary process. While our Central Bank has preferred to be more subtle, perhaps this subtlety is about to end as evidenced by comments from a commercial banker when asked about the potential for The Fed to start charging banks for excess reserves. The banker comments about charging interest are as follows ” it would turn it into negative revenue-banks would be disincentivised to take deposits and potentially charge for them”. While the actions of Central Banks over the past several years might have only slightly resembled command and control, an environment whereby Central Banks are expressly encouraging the extraction of rent from those not predisposed to risk taking is a whole new ball game. Our suggestion that investors begin to allocate a greater portion of net worth into hard assets was derived from our belief in a nascent secular shift away from paper assets and into hard assets. However, recent Central Bank actions such as these might imply that investors should start thinking about such shifts as protection against Central Bank confiscation.
The most recent backup in rates across the long end of the U.S. Treasury curve has prompted much speculation as to the exact cause. The general group -think credits the strength in the U.S. economy, particularly the housing market, as the most likely culprit. However, we would argue that the sharp rise in yields that we have experienced over the past several weeks have really been driven more by the Fed’s ambiguous comments as to the ultimate disposition of their burdensome balance sheet. Chairman Bernanke’s May 22nd testimony was particularly troublesome to the Treasury Market, as it introduced the possibility that the Fed reserves the right to resurrect QE at any time should conditions warrant, even in the event that near term tapering might be soon forthcoming. The subtle message to the market was ‘ we may take away the punch bowl, but at the slightest hint of market DT’s, that punch bowl will be right back’. While the stock market enjoyed such overt support for market “calm”, the Treasury Market seemed to convulse at the message sent by a Central Bank so seemingly obsessed with healthy ( a.k.a. rising) capital markets. We recently spoke to the burgeoning credibility gap that the Fed is creating with such comments, and we believe that the rise in rates substantiates the Treasury Markets increasing distrust. Some in the gold market have commented that the movements in gold reflect an increasing/decreasing trust in fiat currencies. We would maintain that, much like Gold, interest rates are now becoming a barometer for the Treasury Markets view on the soundness/saneness of Central Bank policy.
We were waxing nostalgic recently for the bygone days of risk on-risk off. Our affinity for such periods does not stem from some kind of masochistic love for extreme volatility or a desire to feed our inner trader, but rather we miss the days when people actually gave some credence to the latent risks that still exist out there. While markets may ” climb a wall of worry”, todays’s markets prefer to leave the worrying to the Central Bankers and focus solely on the climbing part. It never ceases to amaze us how quickly perception changes in markets. It seemed like only yesterday we were dealing with a budgetary crisis which threatened to push us into another recession. However, today I read an analysis which argued that the Treasury Market, and the economy, should be able to withstand any Fed tapering given the shrinking budget deficits. While it is true that the sequestration has allowed both sides to make progress on the budget, it was only supposed to be a stop-gap measure designed to get both sides more actively engaged. In fact, Moodys just commented on the lack of real discussions, saying that the U.S. is risking another downgrade if no real progress is made on budgetary talks. While a downgrade may be irrelevant in a world where the Fed is the largest captive buyer, we assume that this will matter at some point to non- Central Bank buyers. It is curious that the more voluminous the talk on deflation becomes, the more amped up the capital markets become. We wonder whether these same markets truly grasp what the ramifications of a deflationary spiral would mean, particularly in the context of a still over-leveraged global economy.