During the Inquisition, the first step in extracting a confession or recantation of heresy was to show the accused the instruments to be used in the next stage. A glance at tongs, or the rack, and many would sing on the spot.
So it was this week. The Fed inflicted no pain at all, just talked about the potential decision ahead, not yet made, considering at some point, maybe, depending, and if made, whenever, just a little pinch.
You’d have thought every bond trader on the planet had been hanged upside down by precious body parts. However, even their shrieking was hard to hear though the yammering by the alternate-universe mobs.
First reality, then the choirs of confusion.
Perfesser Bernanke, visibly exhausted, did very smart things this week. Talk of tapering QE exposes any parties excessively leveraged, deflating the bubble potential in QE. And some are: a group of REITs has a couple-hundred-billion bet on MBS levered with short borrowing, and junk bonds are too hot. Stocks… all you need to know about silliness: today marks the first three-day decline in stocks in all of 2013.
NYFed Prez Dudley laid out specifically how the Fed will exit the emergency. First: taper buys of Treasurys and MBS (and he said tapering is even-money with buying in bigger quantity). Second: stop reinvesting payments received on bonds. Third: begin to raise the overnight Fed funds rate. Fourth: maybe, if the economy really runs hot, sell some Treasurys, but in almost all events hold MBS until they mature.
Most professional observers chewed on the Fed all week long for sending a garbled message. Look back a ways. Mr. Greenspan was famous for obfuscation except when he really had something to say, and ran a one-man band, all others at the Fed forbidden to speculate on policy. And in his last three years of an over-long 17-year stay failed to listen to others about a credit bubble that damned near killed us. Perfesser Bernanke introduced faculty-club style, everyone allowed to argue opinions and to vent, and far too many Fed-watchers still chase around the outlying speakers the way dim hunting dogs can’t lay off rabbits.
The Fed did nothing more this week than to acknowledge new doubts lying in plain sight. Nobody knows the slope or durability of recovery. At best, the economy might be entering the outer edge of self-sustainability. In prior periods when the economy ran away from the Fed, the absolute precondition was a surge in credit, which today without QE is still contracting. Inflation appears to be falling for several reasons, but Bernanke was careful to say this week that long-term expectations are not declining.
Doubt creates volatility — true, up-down-up-down. The 10-year T-note, stabilized by QE in the second half of 2012 in the range 1.60%-1.85%, took three months this year to blow up to 2.05%, then 50 days to run all the way back down to 1.65%, then just 20 days to zip back to 2.05%. Expect more short-cycle wockety-tong. Still, mortgage rates have yet to cross 4.00%, even though MBS/10T spreads have widened. You can be certain the Fed does not like that widening, a sign of ongoing distress in markets still preferring ultimate safety, and will trade to keep that spread narrow.
Making all of this so difficult to process: the expensive-suited, highly-regarded, and well-connected, so seriously interviewed on the telly, but who may as well be standing behind your head slamming a ladle into a skillet. They’ve just about worn out the money-printing-inflation line, so now ooze to arguing the inevitable failure of central banks. Another group intones the failure of austerity and the need for stimulus, although the world is drowning in the deflationary excess production and debt born of runaway stimulus. One top twit after another imputes Japan’s situation to ours, or to Europe’s, or to China’s, or vice-versa, while all four are very different.
The US economy is uncertain enough without adding imaginary threats from overheating or Fed tightening. Or by offering fantasy prescriptions. More volatility, yes, but slow recovery and low rates probably for years ahead.
Everyone points to the rapidly weakening yen as a result of BOJ end-game QE:
However, a longer view provides context. The BOJ thus far has only part-way weakened the yen from wildly over-strong, caused by its status as safe haven during the Great Recession. If the yen blows through 120, then we may have something to worry about, but not now:
10-year Japanese Government Bonds (JGBs). This chart has an especially good time scale, but updates only quarterly and misses the run in the last month to .94% yield. The rapid reversal is concerning, but the cause is the same as the yen move and not a worry unless runs above 1.50%:
S&P500 (thx to Hussman Funds), vertically compressed. Got too hot, cooled off, looks like three times. Where it goes next or why, nobody knows, but exciting to watch: