Mother Nature Has Pre-empted the Fed's 'Taper'

By: Bob Hoye | Tue, Aug 27, 2013
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The following is part of a report that was published for our subscribers August 21, 2013.


"Fed Vice Chair, Janet Yellen, doesn't see 'Significant asset bubbles that would threaten financial instability'."

- Bloomberg, April 16

"Investors are favoring the riskiest, hardest-to-trade junk bonds by the most in 17 months. Confidence mounts that central banks will prop up debt markets through year-end."

- Bloomberg, April 11

The high for JNK was on May 8. The purpose of the buying program was to lower long rates.

Why does Wall Street and academe continue to discuss when the Fed is going to reduce its bond buying program? It has been a weighty decision and while this riveting debate has been going on there have been a few noteworthy events.

After a speculative surge lower-grade bonds accomplished an outstanding reversal in May. This was on schedule and the plunge in prices amounted to a "Mini -Panic".

Mid- way in the decline, Bernanke mumbled something about tapering the pace of bond buying. At the time we cynically thought that the utterance was made so that the Fed would look like it was in control.

The Mini-Panic became very oversold and on the rebound the "talking heads" discussed that the Fed would defer the monumental decision about "tapering" until the fall. This added some zest to rebounding lower-grade bond prices.

The bond future set its high price for the year at 148.60 in early May and it plunged to 129.75 yesterday. With this, the yield increased from 2.82% to 3.93%.

Representing lower-grade bonds, the High-Yield (HYG) set its best price at 94.83 in early May. The panic low was 87.39 and the rebound made it to 93.55.

Support at 90.5 only lasted for a few days. Now it is at 89.85.

Other low-grade ETFs such as JNK, EMB and Munis (MUB) have suffered similar technical failure.

One possibility has been that the failure would become evident in the latter part of September, but the break has been early and has become oversold. Perhaps enough to release a rebound for a week or so. Within the instability found at the end of a bull market often a "feel good" can erupt in early September.

The bigger picture takes us back in time.

Despite the Fed's massive bond buying program interest rates rose all through the 1960s and 1970s, reaching an unprecedented high in 1981 of 15% in the US and 19% i n Canada.

It was a trying time for ambitious policymakers who were convinced that their intrusive recipes would lower long rates. Frustration led to even more dedication to bring rates down.

Regrettably, untempered ambition led to shady dealings and if one had talked to a veteran bond trader in Canada at the time, one would hear of manipulations.

Manipulations that would put a private trader in jail.

These included wash trading which is one account trading an issue back and forth to provide the illusion of volume.

Another ploy was the attempt to push the overall market by buying a thinly traded issue. Then there was the scheme to time news releases to boost bond prices.

Of course, this does not suggest that any of today's central bankers are doing this.

Today's "chosen" are acting altruistically - after all they are on a mission to improve the lives of the masses. And artificially lowering interest rates is about as pure and altruistic as it gets.

What's more, this does not force speculation in asset prices. Academics assure us that soaring prices are caused by "inflation expectations".

Well, we are trying to be serious, but it is hard to avoid interventionist jargon.

As noted last week, the report on Fed buying for the week ending on August 14 included $61 billion of buying. Of that, $54.9 billion went into the dreadful Sup-Prime Mortgage bonds. Despite being a much thinner market than Treasuries it had little influence on the overall plunge in bond prices.

As to the possible offense of advantageous timing news releases, there has been a steady drum beat of cheerleading from the Fed.

Using the bond future and a number of measures, the decline became oversold yesterday. The rebound could run for a week or so.

From time to time, the Fed and other central bankers like get the feel of the street and host get-togethers with some top names in research. One invitee in the latter part of 2010 came away from the meeting with the conclusion that Fed staff were "Absolutely convinced that they had saved the world.".

This shows a remarkable combination of audacity, ego and, we dislike saying it, ignorance. The ignorance is that interventionists still fail to understand that markets clear August 21, 2013

themselves. The 2008 Crash, although huge, fit the traditional model of a financial collapse. Including the exhaustion of vulnerable speculators.

For what it's worth, all six of the Great Bubbles crashed in the fall. On one, the 1825 example was the worst in living memory and forced selling did not clear until January 1826. Nevertheless, a Bank of England staffer wrote that the Bank's inspired efforts prevented the panic from running forever.

The Fed and other central banks must be getting close to being offside on a good part of their position in bonds.

Unfortunately their reckless speculation is not just limited to bonds. On April 25th, Bloomberg reported:

"Central bankers, guardians of the world's $11 trillion in foreign exchange reserves are buying stocks in record amounts."

Our May 22nd "Special" noted that "It is possible that market forces are preempting [Bernanke's] big decision.".

This has been the case. The reckless buying of bonds has been dangerous enough but central bankers have been speculating in equities as well. After 100 years of intervention and the whimsy of the PH.D monetary standard, the world's financial condition is extremely precarious.

In the past, markets have eventually trashed the influence and abilities of financial adventurers. One of the most notorious was the first reckless central bankers. This was the inspiring John Law who headed up the Banque Royal in Paris during the great bubbles that climaxed in 1720.

With the crash, the public demanded to see that the currency plates were seen to be destroyed. Law had some 8 printing presses going in Paris and he was fortunate to escape France with his life.

Reckless central banking is about to implode.

Mother Nature and Mister Margin are waiting.

Bubbles: Most recently published April 25, 2013

"Fed Vice Chair, Janet Yellen, doesn't see 'Significant asset bubbles that would threaten financial instability'."

- Bloomberg, April 16

"Extraordinarily loose monetary policy risks sparking credit bubbles that threaten to tip the world back into financial crisis."

- IMF Warning, Financial Times, April 18

Financial bubbles are not new and the following quotes from our files date back to 1599.

Bubble: A delusive commercial or financial scheme (1599)

- Shorter Oxford Dictionary

"The use of the term 'Bubble' in this connection is often supposed to have been the creation of the South Sea period, and it is sometimes derived from 'Bob'. Shakespeare has a 'bubble reputation', and Wycherley describes one of his characters as 'Bubbled of his mistress'. The plates in HET GROOTE TAFEREEL DER DWAASHIED, 1720, show that the word was understood literally, and was closely connected with air bubbles - as something unsubstantial, which was capable of 'being blown up' rapidly and was liable to burst."

- William Robert Scott, 1911, The Constitution and Finance of English, Scottish and Irish Joint-Stock Companies to 1720 The pamphlet, The Bubblers Mirrour of English Folly, published in 1725, provided:

"A list of ye bubbles with the prices they were subscribed at, and what each sold at when highest, together with Satyrical Eppigrams upon each, by ye author of ye S. Sea Ballad."

- quoted by Charles Duguid in The Story of the Stock Exchange One such "eppigram" is provided in JOHN LAW: The Father of Paper Money, by Robert Minton:

"My shares which on Monday I bought were worth millions on Tuesday I thought; So on Wednesday I chose my abode; In my carriage on Thursday I rode; To the ball-room on Friday I went; To the workhouse next day I was sent."

Fed Chairman, Alan Greenspan, stated that a bubble could not be identified until it was over. In the final stages of the infamous 1720 South Sea Bubble the term was used by participants in real time, with no ambiguity.



Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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