The Market Ticker
Commentary on The Capital Markets- Category [Federal Reserve]

The amusement is strong from this one....

The economy has made great gains and is approaching an acceptable normal. Policy should shortly acknowledge this reality. The Fed took extraordinary policy measures in response to extraordinary economic conditions. Conditions are no longer extraordinary.

Compared to earlier in the year, we know a lot more and can shelve some concerns. We appear to be past the most acute concerns of a spillover from Europe. I have more confidence in the resilience of the economy today compared to even a few months ago. I am much less concerned about a reversal of economic fortune. We are getting closer and closer to what feels like a healed state of the economy.

For me, the cumulative evidence of the economy's healing, and the likelihood the economy is on a path to achieving the Fed's mandated objectives, makes me comfortable that the economy can handle a gradually rising interest-rate environment.

Fed Chair Janet Yellen has stated she expects conditions to jell, justifying a start to policy normalization sometime later this year. I agree. I think the point of liftoff is close.

As the Committee approaches what I consider a historic decision, I am not expecting the data signals to point uniformly in the same direction. I don't need this. I'm prepared to see mixed data. Data are inherently noisy month to month and quarter to quarter. Given the progress made over the recovery and the overall recent tone of the economy, I for one do not intend to let the gyrating needle of monthly data be the decisive factor in decision making.

Read the entire piece; this set of paragraphs is just one of amusingly-idiotic prose, full of rationalization but bereft of recognition.

Here's reality: A "normalization" of policy means removal of several trillion in assets from The Fed's balance sheet.  To whom will those assets be sold, at at what price?  Since bond yields are the inverse of price, such a flood into the market will inevitably drive yields much higher, and faster, than is being discussed.

But the problem doesn't lie with whether the economy "can handle" such a move or not.  It lies in what happens to all of those who have borrowed through doubling-down into a 30-year+ declining rate environment.

Let me remind you how this can work and has over the last ~30 years -- all the way back to the very high inflation days of the early 1980s.

Let us say you borrow $1 million at an interest rate of 10% (which, I remind you, was a very good rate at that time.)

You must pay $100,000 in interest a year to keep that money outstanding.

Now the rate of interest falls to 5%.  You could pay $50,000 in interest, or you could borrow another million and spend it, keeping the payment at $100,000.  Which do you think both corporations and governments did?  They borrowed the second million and spent it.

Now the rate falls to 2.5%.  You could once again pay $50,000 in interest, or you could borrow another two million.  Again, what do you think they did?  Yes, there is now four million outstanding that has been spent!

This continues until today, when "good credits" can borrow at 1%.  Instead of $1 million you can now have $10 million outstanding, and most of these firms and governments do.  

Now the punch line: What happens when the rate of interest goes to 2% for those "good credits" -- a mere 1% rise?

The interest payment required to keep the $10 million outstanding doubles to $200,000.  If you can't come up with it then only way to reduce it, other than bankruptcy, is to pay down $5 million of the $10 you have out.

But you don't have $5 million; you spent it.  That was, after all, the entire point of borrowing it!

This is the trap and from the size of it you can see the problem The Fed has.  Even a modest interest in rates, to say 1%, will drive "good credit" borrowing costs in the short term to roughly 2% or so, which will instantly double the interest due or force a paydown of half of the debt outstanding.

The latter is impossible and so is the former.

By the way, a huge percentage -- half or more -- of the move in stock prices is directly related to this outrageously low interest rate environment.  When it ends so will the fuel for said appreciation -- but equally important, even if The Fed holds and does nothing it is not the low rates but the move lower in rates, which now cannot continue as zero is a fixed lower boundary, that drove the move in the first place.

Next question for you: What happens when the "blip" in Chinese data turns into an all-on rout and comes back around through Europe and the United States before The Fed has shed its balance sheet assets and returned short-term rates to the long-term average around 5%?

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One thing I've said repeatedly over the years is that on the evidence The Fed doesn't actually "set" rates; rather, it follows the market.

This is not universally true, but an overlay of actual short-term rates with the Fed Funds rate shows that most of the time, by a wide margin, the market moves first and the Fed basically gets dragged by the nose in the direction the market wishes to go.

If you think about it this makes sense; nobody can subsidize an uneconomic transaction forever, yet this is exactly what you'd have to do if you were going to "fight" the market on a permanent basis.  Either you can lead the market or you can't, but if you can't then you must conform to it because otherwise you will run out of money -- it is simply a matter of when.

So with that backdrop, you might want to read this...

NEW YORK (Reuters) - As traders, market pundits and economists jaw over whether the Federal Reserve this year will lift its benchmark lending rate for the first time in almost a decade, several corners of the U.S. bond market are not waiting around.

A wide range of short-term interest rates, which tend to be the most sensitive to Fed policy expectations, has been quietly grinding higher for weeks, or in some cases much longer. Several have even surpassed their levels of two years ago during the bond market's "taper tantrum," when prices dropped steeply and yields shot up as the Fed pondered whether to halt its massive asset-purchase program.

This has nothing to do with what traders "expect"; it has everything to do with the fact that below-market rates rob people and eventually those who are getting robbed revolt by demanding a higher coupon!

The Fed wants you to believe that it can drag the market around by the nose.  It cannot; at best it can jawbone and threaten, and if you believe them then you will do what they want.

But if not it is The Fed, not the market, that has to make the adjustment.

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You have to chuckle at the roughly 10-point ramp in the S&P, commensurate with a roughly 1% dump in the dollar and more than 3% move south in 10 year Treasury yields that corresponded with this release today.

Compensation costs for civilian workers was little changed at 0.2 percent, seasonally adjusted, for the 3-month period ending June 2015, the U.S. Bureau of Labor Statistics reported today. Wages and salaries (which make up about 70 percent of compensation costs) was also little changed at 0.2 percent, and benefits (which make up the remaining 30 percent of compensation) was little changed at 0.1 percent. (See chart 1 and tables 1, 2, and 3.)

That's the weakest increase in a long time, beating even the low points reached in 2008 and early 2009!

The reason for the rampjob was that the market seems to think this means The Fed won't raise rates in September.

However, I believe they're wrong for several reasons, the most-important of which being that The Fed's actions have almost-nothing to do with trying to "prevent or control inflation."  Instead they have to do with the fact that they have and are blowing a monstrous credit bubble that is filtering through to both higher-end housing (but leaving middle-class and lower-income housing untouched!and corporate buybacks and M&A activity.

It is not going into productive investment.

Further, The Fed has effectively no tools available if and when the inevitable business downturn comes.

The most-destructive component of what has occurred is in fact in the corporate action / buyback arena along with the outrageous amount of federal borrowing that has taken place.  The States, for their part, appear to be cognizant of what's going on -- or they're (properly) frightened out of their wits by the impending detonation of all of their pension and health care obligations for retirees as a direct consequence of these low rates.

In short Bernanke's thesis has been disproved; you can't lift the economy with these monetary actions.  At best you can blow a bigger bubble, which may give the illusion of prosperity for some but the broader public doesn't get any of the participation from it, and they get all of the downside.

Look out below.

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