I was shocked to read this, as it neatly encapsulates what I was thinking about Fed Policy…..key exerpt from below:
“In my opinion, we are literally witnessing a financing operation of the profligate US government. The seeming scientific language about growth and inflation merely fits the bill for pursuing the primary objective.”
What happens when ordinary people discover this, and prices skyrocket?
from Ken Landon, J.P.Morgan Strategy, NY (Sep 22, 2010)
* FED – What did the Fed accomplish with its easing bias and focus on low inflation? UST yields have fallen across the curve, with the 2Y now at new lows near 0.4%. The 10Y UST has plunged 16 bps to the current level near 2.54%. The conventional view is that lower rates along the curve and the Fed’s intention to keep Fed funds close to zero is a bullish factor for the economy and “risk” assets. I do not agree. In fact, I find it amazing that the Fed is literally recreating the policy errors of the BoJ, which has undermined growth and rates of return on capital in Japan over the past decade.
What makes me so unenthusiastic about the Fed promise of so-called “stimulus”? The first thing to point out is that although the yield of the 10Y UST is down 16 bps since the close on Monday, the yield of the 10Y TIPS is down by 26 bps to just 0.66%, which is an historic low (see attached chart). As a result, the 10Y inflation breakeven is up by nearly 10 bps. The Fed’s actions are literally lowering investors (i.e., savers) expectations about the real rate of return on capital in the United States. With lower expected returns, there is much less incentive to invest. Keeping capital idle or liquid in very short-term investments is increasingly likely. Just ask the Japanese. They have plenty of experience with this sort of thing.
Second, the state of the economy improved on the margin since the August FOMC meeting, regardless of the Fed’s expressed concerns. Equity and credit markets have been improving and the European sovereign credit crisis is gradually fading as a global macro factor. Since the FOMC meeting in Aug, the USD has weakened against major currencies and gold has surged in price. And yet, the Fed is expressing concern about low inflation, which may be based on the fact that backward-looking measures of inflation (e.g., CPI, PCE) have been been subdued (but not much new info has been gleaned since the Aug FOMC).
Furthermore, I do not accept the somewhat widespread belief that the Fed “knows something that we don’t know.” Their history of missing major turns in the economy and failure to foresee even near-term changes suggests that they do not have a monopoly on knowledge. In fact, market indicators have proven to be better indicators of future growth and inflation.
All of this leads me to believe that the Fed is merely fulfilling its *primary* objective — the reason why it was created by an act of law in 1913 — which is to be a source of funding for the central government. By locking short-term rates near zero *and* promising additional debt monetization (i.e., “QE”), the Fed, like the BoJ, can push yields lower across the Treasury curve. The main beneficiary of these lower UST yields is the issuer, which is none other than the US Treasury. In my opinion, we are literally witnessing a financing operation of the profligate US government. The seeming scientific language about growth and inflation merely fits the bill for pursuing the primary objective.
Yes, I do expect many readers to write back in outrage. Many people believe the Fed is acting because it has no other option (is that an argument for taking action that is widely expected to have little positive impact, if at all?). How could I question the motives of the Fed? I question it because I want to understand the true driver of monetary policy in this country. Hopefully, an understanding and different perspective can shed light on the seeming “conundrum” of quickly falling UST yields and skyrocketing gold and commodities prices. As I see it through my framework, it now makes sense that a sensitive indicator of inflation like gold can in fact move higher even when UST yields are falling. Real yields are being decimated in the US. This is an ominous sign for future growth. The inflation breakeven is starting to trend higher again (major low was hit in late-Aug).
To conclude, the Fed is creating incentives for investors to avoid risk-taking and to take the sure bet: buy USTs and you are guaranteed that the Fed will not disrupt things by hiking rates. The BoJ did this exact same thing. And like Japan over the last 20 years, the US government keeps coming up with new fiscal spending packages, which have to be funded in some way. The BoJ played its part and so, it seems, will the Fed. The net result will be capital being syphoned from the private sector — from productive use — to fund consumptive activities of the central government. Is it any wonder, then, that real yields are plunging and the USD is sliding lower against all major currencies?
I have been bearish toward the USD even before the FOMC meeting, which merely intensified my conviction. Gold is surging and inflation breakevens have been trending higher since late-Aug. This is the perfect environment for the commodity currencies that benefit from decent global growth and higher rates of inflating by the Fed.
Conslusion? Sell U.S. dollars because the Fed exists solely to assist the treasury lowering the interest rates on its paper!
“In my opinion, we are literally witnessing a financing operation of the profligate US government. The seeming scientific language about growth and inflation merely fits the bill for pursuing the primary objective.”
What happens when ordinary people discover this, and prices skyrocket?
from Ken Landon, J.P.Morgan Strategy, NY (Sep 22, 2010)
* FED – What did the Fed accomplish with its easing bias and focus on low inflation? UST yields have fallen across the curve, with the 2Y now at new lows near 0.4%. The 10Y UST has plunged 16 bps to the current level near 2.54%. The conventional view is that lower rates along the curve and the Fed’s intention to keep Fed funds close to zero is a bullish factor for the economy and “risk” assets. I do not agree. In fact, I find it amazing that the Fed is literally recreating the policy errors of the BoJ, which has undermined growth and rates of return on capital in Japan over the past decade.
What makes me so unenthusiastic about the Fed promise of so-called “stimulus”? The first thing to point out is that although the yield of the 10Y UST is down 16 bps since the close on Monday, the yield of the 10Y TIPS is down by 26 bps to just 0.66%, which is an historic low (see attached chart). As a result, the 10Y inflation breakeven is up by nearly 10 bps. The Fed’s actions are literally lowering investors (i.e., savers) expectations about the real rate of return on capital in the United States. With lower expected returns, there is much less incentive to invest. Keeping capital idle or liquid in very short-term investments is increasingly likely. Just ask the Japanese. They have plenty of experience with this sort of thing.
Second, the state of the economy improved on the margin since the August FOMC meeting, regardless of the Fed’s expressed concerns. Equity and credit markets have been improving and the European sovereign credit crisis is gradually fading as a global macro factor. Since the FOMC meeting in Aug, the USD has weakened against major currencies and gold has surged in price. And yet, the Fed is expressing concern about low inflation, which may be based on the fact that backward-looking measures of inflation (e.g., CPI, PCE) have been been subdued (but not much new info has been gleaned since the Aug FOMC).
Furthermore, I do not accept the somewhat widespread belief that the Fed “knows something that we don’t know.” Their history of missing major turns in the economy and failure to foresee even near-term changes suggests that they do not have a monopoly on knowledge. In fact, market indicators have proven to be better indicators of future growth and inflation.
All of this leads me to believe that the Fed is merely fulfilling its *primary* objective — the reason why it was created by an act of law in 1913 — which is to be a source of funding for the central government. By locking short-term rates near zero *and* promising additional debt monetization (i.e., “QE”), the Fed, like the BoJ, can push yields lower across the Treasury curve. The main beneficiary of these lower UST yields is the issuer, which is none other than the US Treasury. In my opinion, we are literally witnessing a financing operation of the profligate US government. The seeming scientific language about growth and inflation merely fits the bill for pursuing the primary objective.
Yes, I do expect many readers to write back in outrage. Many people believe the Fed is acting because it has no other option (is that an argument for taking action that is widely expected to have little positive impact, if at all?). How could I question the motives of the Fed? I question it because I want to understand the true driver of monetary policy in this country. Hopefully, an understanding and different perspective can shed light on the seeming “conundrum” of quickly falling UST yields and skyrocketing gold and commodities prices. As I see it through my framework, it now makes sense that a sensitive indicator of inflation like gold can in fact move higher even when UST yields are falling. Real yields are being decimated in the US. This is an ominous sign for future growth. The inflation breakeven is starting to trend higher again (major low was hit in late-Aug).
To conclude, the Fed is creating incentives for investors to avoid risk-taking and to take the sure bet: buy USTs and you are guaranteed that the Fed will not disrupt things by hiking rates. The BoJ did this exact same thing. And like Japan over the last 20 years, the US government keeps coming up with new fiscal spending packages, which have to be funded in some way. The BoJ played its part and so, it seems, will the Fed. The net result will be capital being syphoned from the private sector — from productive use — to fund consumptive activities of the central government. Is it any wonder, then, that real yields are plunging and the USD is sliding lower against all major currencies?
I have been bearish toward the USD even before the FOMC meeting, which merely intensified my conviction. Gold is surging and inflation breakevens have been trending higher since late-Aug. This is the perfect environment for the commodity currencies that benefit from decent global growth and higher rates of inflating by the Fed.
Conslusion? Sell U.S. dollars because the Fed exists solely to assist the treasury lowering the interest rates on its paper!
