Thursday, March 19, 2009

The Fed Goes On A Long Trip

And then they went out - out on the yield curve, that is.

Yesterday the Fed announced it would buy as much as $300 billion in longer Treasury bonds (2-10 years and perhaps as long as 30 years) plus another $850 billion of mortgage securities in order to bring down rates at the far end of the yield curve and thus make borrowing cheaper for mortgage seekers and corporations looking to issue debt.

This is very unusual, as the Fed does not normally venture out beyond the immediate area of its purview, i.e. money market instruments with maturity of up to 12 months. There are two reasons it is doing so:
  1. The inverse of the Greenspan conundrum: long rates are stubbornly high despite near zero short rates. The spread between 10-year Treasurys and Fed funds is near record levels (see chart below, click to enlarge). The Fed wants to lower long rates so that household mortgage and corporate borrowing costs come down and the economy gets to carry a lighter debt-service burden. Refinancing is going to be a booming business for quite a while, I think.
  1. The Fed wants to replace "private" money destroyed by loan defaults with "public" money it creates itself, effectively out of thin air and at will. Mr. Bernanke has explicitly stated that he will use every tool at his disposal to avert further deflation in the economy and he means to be taken at his word.
Mr. Bernanke's bottom line, right now? Don't fight the Fed. Yes, he is saying, we screwed up with Lehman and sent you guys in the market the wrong message. You thought we were not willing to bear the cost of (your) foolishness and not firm enough to be "the enforcer" against the big egos of failing Wall Street CEOs. We did scare the pants and s(t)ocks off you, didn't we? We're truly sorry, but that's all done and finished now; all hands are on deck and the helicopter is already off the tarmac. Let's party - or else!

My bottom line, for market purposes? The same: Don't fight the Fed.


  1. My bottom line, for market purposes? The same: Don't fight the Fed.

    I fully suscribe to the comment. My comment as an echo, do not fight the Chinese authorities once they have changed their long-term financial strategy. Remember that in the end Chinese money is an enormous party including HK,Singapore and Taiwan.

    They are certainly long to move. But alas will be I-M-P-O-S-S-I-B-L-E to bring back to the party once they quit the lending table. IMHO within 18 months.

    Consequences :
    - high REAL money lending rates around the globe,
    - incredible levels of monetization in countries zones that are widely indebted, private or public,
    - very few safe haven for cash mostly Scandinavia, gold and a very limited number of Asian places.

    Why so few Asian places? Because the geo-strategical risk is now high.

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  3. In moving to quantitative easing, Bernake has moved outside of his knowledge of history. I cannot even fathom the coming inversion of the curve to fight the hyper inflation this is likely to cause.

    Lower rates are not what caused the problem and in a period of deleveraging they will not cure the problem. Banks will not lend to those with low credit scores today as they did in the past to expand their volumes. Moreover, consumers are repairing their balance sheets and that will take time as Richard Koo's work pointed out.

  4. Moreover, consumers are repairing their balance sheets

    Yep - Consider how much *faster* your balance sheet will become repaired once you move all your debts onto a fixed-rate 4%, 30 years mortgage and rates begin to rise again (provided one own property, still have a job, and has not maxed out the mortgage by MEW)

    Mortgage conversion has been The Game for a long time here in Scandinavia - possibly a measurable part of our "economic growth" comes from being short the right long bonds at the proper times.

    However, Thanks to stupid government intervention on the short rates more or less everyone are "penned" into the 1 year ARM's, ready for slaughter on the reset next year - Unless the government intervenes again in December 2009 OR they follow the lead of propeller-head Bernanke and intervenes in the long rates.

    If they intervene everyone will go for the long fixed-rate because it's simply too good to last: You HAVE borrow as much as possible under these conditions, effectively shorting the long bonds. Because your debt will soon become worthless - the intended effect.

    BTW: There is *no way* that long, fixed-rate mortgages depreciating by about 50% will not cause huge 1970s-style inflation and enormous rises in interest rates - but who cares about "later"?

  5. We all knew this day was coming. At least those of us who understand the nature of fiat. This is the end game where the Fed buys its own debt.

    All fiat currencies end this way, this is truly the fire and brimstone you alluded to yesterday.

    This also confirms my contention they will never give up their power and will instead destroy the system.

    History repeats, it's as simple as that.

    Joe M.

  6. A number of great posts in a row.

    However I am a little confused by your statement "This is very unusual".

    While it clearly it is unusual (has the Fed ever done anything similar to this before?), what I am more confused by is:

    1) Whether your view of the Fed's actions has changed your view of whether we are a little like the Argentinians?

    2) How you think this will all end (as you have been recently suggested we are reaching a bottom)

    Thanks as always

  7. Dear Thai,

    Temporary bottom, perhaps.

    Financial stocks are way over-discounting something that Bernanke simply won't allow to happen, at least right now and before he exhausts his monetary weapons and all of their associated ammunition.

    Clearly, what he is saying is "don't mess with me" and is very willing to fight the battle. If he will eventually win the entire war is another question altogether - and I don't know the answer right now.


  8. The Fed's major salvo in the global war of beggar-thy-neighbor will be met with resistance. Which country will respond the soonest with their own money printing/currency devaluation salvo. The race to the bottom has accelerated.

    This is all a sad attempt to try and sustain the unsustainable. The world is engaged in a paradigm shift away of a credit/debt based monetary system. The US cannot continue to represent 5% of global population and consume 25% of global resources. A generational move to balance of 1:1 is underway.

  9. I would say that it looks like the Fed and its actors are in major DENIAL.
    Printing money out of thin air ? When your are NO LONGER the strongest, or most important player on the field ???
    Like I said before in another comment, pulling a rabbit out of a top hat ?
    Are there people out there who are going to be fooled this time ?...

  10. Absolutely "yes".

    Though I am not sure "fool" is the word I would use. I might chose "different visions of what society should look like".

    A neighbor of mine walked up to me yesterday happily excited the Fed had finally done it. He absolutely understands what it means. He is not "fooled" one bit. He simply has a different vision of society than I do.

    By the way, I never responded earlier, imo a universal visions we all colelectively agree on would easily create the "faith" in each other you rightfully acknowledge as the source of all our collective strengths.

    The problem is getting agreement on what the universal vision should be.

    Right now it seems to be somewhere in the various mantras of "equality". I know I am certainly not smart enough to solve that problem and am yet to see anyone who is/can.

  11. Hello Hell,

    My latest piece...

    P.S. Have you had more time to think about cross posting at the RGE?

    Let me know. chainsawrh at

  12. p.s. "evaporflation" It is the new reality!

    Is it time for a fresh start? how about the greenback?!?!?

    Miss America

  13. Bernake could make a great modern Oedipus if he really really just wants to save the system instead of having some hidden agenda.

    We'll probably see and learn in a year or so if "Operation Twist" is followed up by "Unternehmen Weimar", but then again I'm no prophet.

    If somebody older & more educated & more experienced can tell me how Ben could lead USA out of trouble or at least make things managable even with current habits of massive spending, I'm eager to hear.

    And... hey, this might be very appropriate for these trying times, how come ObamaJugend never used it:

  14. I want to plan for the hyper-inflation scenario. How concerned should I be ? What are the factors that can prevent hyper-inflation despite FED's actions today (and possibly more in the near future) ?

  15. has the Fed ever done anything similar to this before?


  16. Anon, you don't happen to know of a link I can read up on?

    Or even just an approximate date when the Fed engaged in such heavy QE in US Treasuries so I (others) can Google it ourselves?


  17. Is it time to buy a bunch of these million dollar mcmansions that are wasting away round here?

  18. Buying property cheaply? Hmm.
    Might be a good idea in real estate maret downturns (even if risky), but some are calling our current sit. the Greater Depression already, it affects more than one specific market and who knows when it's over and you get to cash in and how much? Propert taxes must be rather big, and if it get's worse, you better prepare for marauding looters and anarchists, discounting the occasional hurricane!

  19. Good to see you, Thai.
    I was beginning to wonder where you had gone to...
    I should have been more precise in qualifying "the people who will NOT be fooled". They live OUTSIDE the U.S....

  20. Good grief, wake the &%%! up. The Fed has no more chance of winning "the war" than a high school football team has of beating the Pittsburgh Steelers... or come to think of it, the appallingly bad Detroit Lions for that matter.

    It's the spreads people. BB can't get those to narrow even though the rates on sovereign debt have come down (for now). The U.S. will be a financial leper colony before the clueless CIC's first term is up. We don't have, among other necessary conditions, the productive capacity in this nation to pull out of the deep hole we are in.

    Got physical?

  21. hi Hell -
    One thing I dont understand that if Ben opted to print money (he called it credit easing, not Quantitive Easing), we should expect, in general, it will end up in a probable uncontrolled inflation, so it should be dollar bearish. The near term impact, however, does seem to me that these "money" would just disappear with the blackhole resulted from debt de-leveraging. Thus there should be a rather netural / if not bullish impact to the USD. And this also does not mean an immediate reflation of the economy. Thus I am quite puzzled why the market is rallying quite strongly in end March and the USD was depreaciating sharply against other currencies liek the Euro, AUD and EUR. Maybe esp to the EUR, which I think is in fact is potentially more problematic then the US.

  22. Dear Gosh,

    I think that you are answering your own question.

    The money being provided by the Fed is to replace that lost in the current crisis via debt destruction, i.e. there is no new money being created net-net. And that's certainly not inflationary.

    The reason markets are rallying? No one EVER knows with markets but in my opinion they went too far on the downside discounting something that will NOT happen, i.e. another Great Depression.

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