A “Spooked” Fed

So what spooked the Fed?

 

DRIVER$: A "Spooked" Fed

So what spooked the Federal Reserve?

Clearly the Driver$ of the global markets is the sudden and unexpected change in expectations regarding "TAPER".

If we can understand the real reasons behind the Federal Reserve's abrupt face we may be better able to determine the Macro Driver$ and Trigger$ going forward.

THE OFFICIAL WORD FROM THE FED WAS:

                        REASON                                    CONCERN

•   Tighter Financial Conditions                   Mortgage Rates
•   Policy Uncertainty                                 Upcoming Fiscal Debate
•   More Data Needed                                Labor Market

WHAT THE FED DIDN'T SAY:

•   Decelerating GDP growth. 
•   Soaring part-time work and diminishing full-time
  •  60% of new jobs for women pay less than $10/hr
  •  Health care law encourages companies to move workers to part-time; “Part-Time Nation”?
•   Huge coming increase in health insurance expense for businesses and individuals.
•   The debt ceiling debate adds uncertainty.
•   Cities finally starting to go bankrupt: Detroit and now maybe Chicago.
  •  Chicago pensions 31% funded
  •  Pension Liability is $61,000 Per Household ($23,000 Per Capita)
•   Median household income has fallen from $55,000 to $51,000 since 2006.

• Mortgage applications down for 15 of the last 18 weeks.

WHAT REALLY SPOOKED THE FED

There were a litany of reasons but I distill it down to three.

Remembering that the Fed’s decision to postpone any tapering is a result of its own blunder. It misread the impact of its May decision to begin discussing the strong possibility of reducing bond purchases in a few months.  It subsequently compounded the error through press conferences, congressional testimony and numerous speeches.  Both Chairman Bernanke and various Fed governors strongly hinted at imminent tapering until very recently. 

Fed officials THEMSELVES heavily influenced investor expectations to a point where the overwhelming majority of “the street” expected at least a minimal reduction in bond purchases at the September meeting.  The Fed, through its numerous spokesmen, allowed encouraged this consensus to form with little attempt to walk it back.  

1. G20 PRESSURE
   1.   Emerging Markets facing Potential Asian Crisis Redux
   2.   Global Contagion and Accelerating Rising Rates due to Reserve Currencies are being sold to shore up Emerging Market Currencies

The G20 Summit in St Petersburg shed light on the seriousness of the concern surrounding the plummeting currencies in three of the BRICS (Brazil, India and South Africa).

Away from the glare of the media, the BRICS cobbled together an emergency $100B currency reserve 'Firewall Fund'. 

Additionally, urgent side meetings were held separately to finalize the BRICS-led New Development Bank. Urgently negotiated were its capital structure, membership, shareholding and governance with an initial subscribed capital of $50 billion from the BRICS countries.

It would appear there was more urgency to the G20 discussions than simply an escalating G20 focus on the Syrian conflict.

When EM did participate in the main G20 session, it was clear what the BRICS agenda was.

Their focus was the impact of the US monetary "TAPER" direction and the apparent US disregard for the global consequences.

The BRICS veiled contempt towards US policy was a direct result that since 2008 they have had to fight the hot money flows that accompanied multiple US Quantitative Easing programs, with resulting rise in currencies hurting exports, while FDI artificially pushing up bond prices, creating overdevelopment and inflation pressures.

Now with the US reversing course the BRICS feel the 'back lash' as money flees, investment stops, currencies plummet and rates rapidly rise. Moreover, the BRICS see themselves facing serious economic, social and political problems which they feel are not of their making.

They see themselves facing a 'no win' decision of:

"Impose capital controls OR let the Fed run their economy"   Jackson Hole Summit

If it hadn't been for three stunning developments occurring following immediately the G20 meeting in St Petersburg the economic unwinding in the Emerging Markets, which was well underway and rapidly gaining momentum, would have quickly washed ashore in the developed economies. The selling of Emerging Market Currency Reserves held in US Treasuries, to stabilize their currencies was becoming problematic for rising developed economy interest rates, which were nearing critical levels above 3%:

1. FIRST, An abrupt reversal in the US’ immanent attack on Syria by initially President Obama unusually deferring to Congress, and then just as surprisingly negotiating a temporary diffusion of the situation. We have seldom ever seen such an abrupt face in US Policy Stance.

2. SECONDLY, Laurence Summers stunning withdrawal of his name from consideration as the next Chairman of the Federal Reserve. The emerging markets leaped on news of Summers withdrawal. Emerging market stocks hit a three month high and the bonds of developing countries climbed by the most since mid-July. All major currencies climbed against the dollar, with those of emerging markets making the, the Hungarian forint added 0.9 per cent and the Turkish lira – also helped by the easing of tensions over Syria – gained 1.4 per cent.

3. THIRDLY, the Federal Reserve’s shocking deferral of the initial stages of “Taper”. A decision which left Fed and market watchers miffed. Global markets and the Emerging Markets specifically, exploded higher including the troubled emerging market as Bill Gross of PIMCO heralded the “risk on” trade was back on.

1.   US RECESSION
   1.   A First Look At Christmas Stocking Orders Which Are a Disaster.
   2.   Housing, Jobs and Retail Rolling Over

 

Christmas Stocking Orders Signal Significant Problem

1.   YELLEN ‘S  FED POLICY
   •   Couldn’t Have A Policy Reversal if Yellen became Fed Chairperson.
   •   She sees PCE Inflation as Too Low,
   •   She sees the 6.5% Unemployment Target as being in Jeopardy

FED LOSING CONFIDENCE IN THEIR OWN POLICY DECISIONS - Yellen Would not Support TAPER now!

CONSEQUENCES

 

ON THE SURFACE THE CONSEQUENCES ARE LIKELY:  

• With economy decelerating and interest rates already rising, Fed can’t end QE.
• Massive infusions of new dollars for as far as the eye can see.
• Rising danger of instability.
• Hot money flows back into emerging markets, destabilizing them AGAIN.
• Weaker dollar?
• Rising precious metals?
• Stock market? Technically ready for a major correction, but all that new money…
• Bonds? Fed will keep trying to force long rates down. Will they succeed?

IN REALITY THE CONSEQUENCES ARE:

•   A Glimpse At What Will Be a Much Larger Problem
  •  Fed Was Caught Off Guard in June
• Have Past the Event Horizon
  •  Return Near Impossible without a Crisis
  •  Credibility Shaken
  •  We Have Global “Abenomics”
•  Serious Shortage of Risk Free Collateral
  •  TBAC Warning Left Unheeded
•  Mispricing & Mal-Investment
  •  Moral Hazard and Unintended Consequences
• Currency Wars
  •  “Risk-On” Hot Money Flows

CURRENCY CROSSES

We suggest you watch carefully the US Dollar and the EURO:US Cross.

Between the German Election and the Feds abrupt reversal as the worries of a US Recession loom, the US$ is likely to surprise most and begin rising.

 

 

Nothing is ever certain but seldom have we seen the perfect inverse Ellipses as shown above.

 

Gordon T Long    

Publisher & Editor

[email protected]     

Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that you are encouraged to confirm the facts on your own before making important investment commitments.

© Copyright 2012 Gordon T Long. The information herein was obtained from sources which Mr. Long believes reliable, but he does not guarantee its accuracy. None of the information, advertisements, website links, or any opinions expressed constitutes a solicitation of the purchase or sale of any securities or commodities. Please note that Mr. Long may already have invested or may from time to time invest in securities that are recommended or otherwise covered on this website. Mr. Long does not intend to disclose the extent of any current holdings or future transactions with respect to any particular security. You should consider this possibility before investing in any security based upon statements and information contained in any report, post, comment or suggestions you receive from him.