"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Friday, July 6, 2012

Payrolls Number Disappoints - Risk Off

If you recall one month ago, when we got that abysmal jobs number, gold initially moved lower, only to then rebound with a ferocity that caught market watchers and traders completely off guard. Risk off trades were being slammed on as longs bailed out and bears began pressing the downside. Literally, on the drop of a dime, the entire complexion of the market reversed with the bears running for their lives as new longs entered the fray. The reason - the number was so crappy that everyone just "knew" that the Fed was going to immediately launch the next round of QE. In other words, the more rotten the economic data, the more the risk trades were being put on.

Today, as is becoming the pattern in these screwed up markets, the exact opposite has occured. The payrolls number in this morning's release was horrific. Down went gold, and silver, and nearly the entirety of the commodity complex, along with the equity markets, and up went the Dollar. This time however we are not as of yet getting any sign whatsoever that traders are expecting the Fed to act on the basis of the weak payrolls number. I see no upside reversal at this hour in any of these markets - just more selling pressure.

I am beginning to suspect that we are seeing more and more traders/investors coming around to the view that no matter what one might want to call it, QE, additional liquidity, monetary easing, bond buying programs, etc., none of it is going to do the least bit of good in the medium to long term. In other words, one has to wonder whether or not the bloom is off the rose of Central Bank powers. It seems to me that the CB's are losing the war against the global economic slowdown in the minds of more and more traders. What is even worse ( in the minds of some), is that they are losing their status as the all-powerful demi gods of the finance world.

Again, at the risk of beating a dead horse, the problem is not one of liquidity - there is plenty of that - the problem is too much debt and not enough velocity of money. You can lower interest rates all day long until the cows come home but if people do not want to borrow or are afraid to borrow, what good does it do?

In other words, money is simply not changing hands fast enough. As a matter of fact, this morning the ECRI reported that their future inflation gauge, or USFIG dropped to 101.2 from 102.3 in May. Their comment: "US inflation pressures are clearly in retreat".

This is where the pressure is coming from on the Continous Commodity Index and why the bond market is moving higher and yields lower once again. Until something occurs that will change this "lack of inflation" psyche, upside trending moves in the commodity sector are going to be few and far between for all but that sector which has the strongest set of fundamental factors going for it. Right now, that is the grain sector, but even they are beginning to show some signs of stress due to the larger macro economic picture.

IN this environment, gold is going to perform better than silver as the latter must have an inflationary environment present if it is going to run higher. The Yellow Metal cannot seem to clear the resistance level noted on the chart which just so happens to be the BOTTOM OF THE FORMER TRADING RANGE in April of this year. Until it does, it is range bound at a lower price with solid buying down below $1580 on down to $1550. Only a strong weekly close through the $1630 - $1635 level gives Ol' Yeller a shot at getting some upside fireworks going.

Take a look at the following chart of the commodity complex via the Continuous Commodity Index or CCI. It has made an almost textbook retracement halfway or 50% of the distance from the peak in late February of this year to the recent low in early June, and has now stalled out. If the inflationary psyche does not return, it will move lower towards the 541 level to see if it can garner some buying there. If not, further back down it goes. For the bulls to get anything going, they must take the sector through the 560 level for starters.


  1. Once again, Bernanke is flexing his muscle as he deftly manages the markets with ease. As usual, gold is brutalized while the retail sector like XRT is spared. Bubble stocks like AAPL and SPG remain unfazed, as every "Risk Off" event has the algos scrambling to sell any and all commodities, creating an instantaneous "tax cut" for the U.S. consumer.

    Not only that, Bernanke has managed to convince foreign investors to develop a love affair with the S & P 500 vs. gold, as SPY is breaking out in many foreign currencies while GLD languishes.

    More debt can be piled into the system at ever decreasing interest rates as the TLT continues its 35-year bull run, and inflation expectations have been totally quashed by repeated Algo/Igor/Robo selling of anything materials or oil based.

    I doubt that the "Bernanke Miracle" will ever be repeated again, and historians will be marveling at the "Great Bearded Magician" for years to come in economics classrooms.

  2. I'm glad to see Dan finally talk some sense about the Fed's likely propensity for additional QE - or more likely, the lack thereof. First of all, if the price of gasoline and other consumer goods fall due to a rising dollar, caused in part by no QE, that in itself is a form of stimulus without the Fed having to do a thing. In his last press conference, Bernanke even mentioned there could be silver linings of slowdowns in China and Europe - namely, a fall in gasoline prices. Do people really think the guy is so stupid he's not going to see some benefit of a bit of disinflation? If we get some falling prices due to a lack of QE, and/or from slowdowns in China and Europe, why would he object? If it goes too far I'm sure he'll start worrying, but modest declines in prices of certain things are probably welcome.

    Second, anyone who thinks the Fed will be willing to expand its balance sheet to infinity is fantastically naive. Somewhere else recently Bernanke expressed a bit of concern about the eventuality of having to sell off all its treasury holdings. It's neither desirable nor practical for the Fed to continue buying US debt forever; at some point they'll have to stop and undergo their own process of deleveraging.

    That said, here's a deviously brilliant fact about aforementioned balance sheet: Especially at this point with Operation Twist having gone on for some time, the vast majority of the Fed's holdings are in long-dated treasuries. Let's say they start selling those next year. What will happen? When a large holder of something starts selling that something, the price will inevitably tumble. So, *long-dated* treasuries will fall, and their yields will go up.

    At first glance this sounds bad - after all, wouldn't rising interest rates kill the economy?

    No, not necessarily. Since the Fed will overwhelmingly be selling *long-dated* treasuries, this means yields on long-dated bonds will go up while the Fed can keep short-term interest rates low. In other words, their act of selling off their balance sheet will steepen the yield curve. And THAT is another form of stimulus! At this point, the Fed will have traded stimulus in the form of low interest rates for stimulus in the form of a steep yield curve. Maybe this will be the point where Dan gets his MV picking up speed.

    The only thing that could ruin this plan is if, somehow, the Fed loses control of rates at the short end and both short-term and long-term rates rise in tandem. But since the Fed usually has much better control of rates at the short end of the yield curve, I don't consider that a likely scenario.

    1. This is a great thread and provokes so many theoretical questions that it is almost hard to know where to start, but let me just try to ask a few questions and maybe you can reply... you've clearly thought about this so I'd be curious.

      While a steeper yield curve is good for banks and would induce more lending, what would happen to the credit of consumers were we to get to that point. If the Fed were in a "panic sale" mode, I think it is safe to assume that it would be because the whole complex had gotten FAR WORSE. So now, we have a flat yield curve, great for consumers....but the banks won't lend. Were we to enter a fed panic sale mode, wouldn't we just be in a scenario where the banks would want to lend in a yield curve vacuum, but become unwilling to because consumer credit quality would've deteriorated to the point that it wouldn't be worth it?

    2. Ben,

      I don't think the Fed would ever get into "panic sale" mode. As I said in my other response below, I suspect they'll sell off their holdings slowly. Some have argued that once the bond market knows the Fed is going to start selling off its treasuries, a sort-of panic mode will ensue and everyone else will sell off their treasuries knowing that the Fed is going to do so. But I don't think that will happen: The bond market is a huge and liquid market with billions of dollars of holdings being sold every day (alongside all the buying of course). If the Fed announces, say, that it will sell $5-10 billion per week over the next couple years or so, that's a very small amount at each sitting, and it'll have only a minor effect on the bond market (though, likely enough to do some steepening of the yield curve, I would suspect). The key, I believe, will be the Fed's communication strategy and the pace at which they sell. If they set out a clear schedule and a slow-and-measured pace, the bond market will see the Fed does not intend to suddenly flood the market with T-bills, so there'll be little reason for panic selling in response.

      BTW, as for banks not lending, pretty much everything I've read lately indicates the reason banks aren't lending much is because, 1) consumers have been in a deleveraging mode for several years now and haven't wanted or been able to take on large amounts of new debt, and; 2) corporations these days have large cash hoards and/or are financing operations through the bond market rather than bank loans (thanks to rock-bottom yields). So the issue of a lack of lending is more of a demand-for-loans problem than a banks-not-wanting-to-loan problem.

      Of course if bond yields head up as I imagine they will, you might see more corporate lending.

    3. Incidentally, here's one possible scenario in which the Fed selling off its balance sheet would have no effect on interest rates at all (not even my yield-curve-steepens scenario).

      Let's pretend that congress and the president actually manage to work out even just a moderately aggressive budget deficit reduction plan, and the economy continues to expand at least modestly. Under this scenario (or anything more optimistic), the federal government will drastically reduce its need to tap into the debt markets to funds its operations. If we got a reduction in the budget deficit by, say, $200 billion per year over 2-3 years, the Fed could sell off $200 billion of its balance sheet per year over 2-3 years and the balance of the two actions would have no aggregate effect on the bond market at all.

      I'm not saying that will happen, but it could happen. Point being, there are a lot of factors to take into account before deciding whether the Fed selling off of its balance sheet will raise interest rates or not.

  3. Unknown;

    Those are some very well thought out comments. Thanks for sharing them.

    I too am wondering what is going to happen to long term rates when the Fed has to eventually unload all those longer dated Treasuries on its balance sheet. They cannot do it now or anytime soon from what I see of the economic strength or lack thereof as any rise in the long end of the curve would crush the real estate market and probably hurt the automotive and boat businesses as well.

    If they do lauch another round of QE and balloon out their balance sheet then it becomes even more dicey when they move to eventually try to reverse the process.

  4. I suspect they'll start selling their balance sheet off when:

    A) They feel the economy is steady enough to withstand higher long-term rates; if they sell them gradually the impact can be lessened. And remember, higher interest rates aren't necessarily bad for the economy - as recently as the spring of 2010 the yield on the 10-year approached 4%, and the economy was weaker back then than it was now. And again, the key is the yield spread. not necessarily the level of rates; a steep yield curve can compensate for higher long-term rates.

    B) They see Washington doing at least a semi-serious job about reducing the budget deficit. That way they can let treasury yields gradually rise without having a huge impact on federal finances. And anyway, the economy should pick up steam as the yield curve steepens, which in turn means more tax revenue, so theoretically it should balance out.

    My hunch is that the first act of Fed "tightening" will be some selling off of long-dated bonds rather than raising the Fed Funds Rate. I'm thinking they could very well keep the FFR under ~0.5% (1% at the very most) for another 5 years, maybe as long as 10, while they gradually sell off their balance sheet. This is going to be a long, drawn-out process.

    Lastly, due (in part) to one form or another of Fed stimulus in place for at least the next 5 years, and possibly 10, I think those expecting another recession in the US any time soon are going to be disappointed, though for sure there will be soft spots which might come close. At worst we could get a short, mild one. I know I'm in the minority on that point, but I've got other reasons why I believe that is so.

  5. It is difficult to see how the Fed could ever sell any of their long dated bonds. It they even just tried their balance sheet would immediately be wiped out, i.e. they be bankrupt in heartbeat.
    The treasury is demanding a supply of 1.3 – 1.5 Trillion of new paper every year and the rates are artificially held down by IRS manipulation by likes of MS and the ESF in collusion.
    One day very soon the market will go on strike and refuse to buy any more of that endless supply of paper, and then the rig is up with the IRS racket and either the Fed is forced to buy all the bonds or the interest rates will have to skyrocket, with the associated decrease in the book value of the Fed’s balance sheet.
    Either way the Fed is totally trapped and is on the way to bankruptcy; there is no way out for them!
    There is no more fancy footwork left for Ben.

  6. check out michael pento's comment today on king world news. he describes how the fed could pay nothing on the 1.42 trillion that commercial banks hold at the fed, on which the fed is presently paying 25 bps. if paid nothing, the commercial banks would be given a very strong incentive to make loans. the fed could also go as far as charging on those commercial bank deposits if paying nothing for them did not prove efficacious enough. it is the velocity of money that would surge dramatically in the event of a massive increase in lending, and with it the pm's, because that dramatic surge in velocity would spike inflation, as well as give, at the very least, a temporary pick-up in the economy just in time for the november election. do you really think the fed will ignore that cry in the wilderness emanating from the oval office, or will it hear that sound as an invitation to a dance?


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