Bernanke's Swan Song


Can the Fed chairman put us back on the path to normal?


This week, the markets' reputation for anticipation will be put to the test.

Will the Federal Reserve begin scaling back its easy-money stimulus? The market seems to think so. Investors have been paring back bonds susceptible to rising interest rates, and the 10-year Treasury yield has already jumped this summer from 1.6% to nearly 3%, far faster than the pace of economic improvement. Last week, a Wall Street Journal survey of 47 economists found that two out of three think the Fed will begin tapering after Wednesday's policy powwow.

Ideally, the Fed should cut back its monetary medicine only after our fitfully recovering economy is strong enough to leap tall buildings in a single bound. But there are reasons not to wait until Miley Cyruslast seen swinging naked from a wrecking ball—is old enough to buy a beer (which she will be Nov. 23watch out!). Since the Fed began buying $45 billion of Treasuries and $40 billion of mortgage securities every month, our unemployment rate has fallen from 8.1% to 7.3% and 2.2 million jobs have been created. That's "significant cumulative progress" toward the Fed's objectives, notes Joseph Kalish, Ned Davis Research's chief global macro strategist. The effectiveness of further bond-buying in stimulating our economy also is debatable, and the Fed won't want to inflate new bubbles. Besides, Ben Bernanke might want to put us back on the path to normal before he retires early next year.

Clearly, the market thinks—or hopesany stimulus reduction will be small and data-dependent, which is why stocks are crouching expectantly just 1.3% below all-time highs. Phil Camporeale, executive director at J.P. Morgan Asset Management, thinks the Fed will reduce monthly purchases from $85 billion to $70 billion or $75 billion. Mindful of how rising mortgage rates can undermine the housing recovery, Kalish thinks the Fed will cut Treasuries buying by $10 billion and mortgages by just $5 billion.

Already, risky stocks outperformed during August's pullback, and they continue to thrive now as the market turns higher. Since late-August, the 50 largest stocks within the Standard & Poor's 500 have gained just 3.2%, but the 50 smallest jumped 5.3%, notes Bespoke Investment Group. Stocks paying the richest dividends rose just 0.5%, while those offering no yield surged 5.5%. Heavily shorted stocks outperformed, as did those sporting the richest valuations.

Are stock buyers hoovering up risk because they aren't afraid of unruly interest rates? On the contrary, August marked the first time in six years when the paths of the S&P 500 and the 10-year yield diverged, with stocks retreating while yields climbed. "Normally, rising rates are not a problem for stocks until the 10-year yield gets above 5%," when inflation becomes a peskier problem, notes Jeffrey Kleintop, LPL Financial's chief market strategist. "But the pace at which yields head higher matters at any level."

So why are stocks rallying? Economic growth is picking up, and Wall Street hopes Fed tapering is increasingly priced in, and that the steepest rate surge is already behind us. Rising yields on five-year, 10-year, and 30-year Treasuries have stopped just shy of 2%, 3%, and 4%, respectively. If they breach these round-number thresholds with gusto, hold your hat.

Not everyone agrees with the consensus huddle. Ethan Harris, Bank of America Merrill Lynch's economist, thinks there's a 55% chance the Fed won't taper in September, and a 30% likelihood the Fed might taper by just $10 billion to $15 billion. Frank Beck, chief investment advisor at Beck Capital Management, thinks the Fed might be better off cutting monthly bond-buying by a tiny but steady amount each month until we reach zerofor instance, buying $4.25 billion less each month over 20 months. After all, announcing a new level of bond-buying, say, $70 billion each month, merely keeps investors guessing before future Fed meetings and anxious about how the program will change again. "We'll have the same guessing game, and the resultant volatility in the markets," Beck says. In contrast, a small incremental monthly reduction maps out the path back to normal, letting investors adjust to that pace, "and debt, equity, and emerging markets could start acting on fundamentals again."


Fed Tapering Is Backed Into a Corner

Thursday, September 12, 2013 08:49 AM

By: Ashish Advani

I was watching President Obama's address to the nation the other night about Syria. For a person with great oratory skills, it seemed like his heart was not really in it. He seemed to get his scripted message across, but lacked conviction or passion. The prime cause? The Russian offer to mediate.
If we analyze the whole situation, following a scripted path is easier when you are either ready to act or when you know all the facts and your belief is unshaken. In this case, he made a passionate plea to attack Syria, had a change of heart in asking Congress for approval and then became sidelined in his conviction when diplomatic initiatives started popping up. He is now in the unenviable classic proverbial "Damned if you do, damned if you don't" situation.
Mind you folks, I am completely against this and the past two wars that America entered into. But if you are not going to follow through on your words, why utter them at all?

It is better to stay silent and let the world wonder if you are a fool, rather tan open your mouth and dispel all doubts.

So what does all this have to do with tapering?
Let's go back to May of this year when Federal Reserve Chairman Ben Bernanke made the announcement that the Fed might start tapering its stimulus program. While his intent of giving the markets a heads up may have been noble, it has now landed him in the same proverbial soup that I described above for Obama.
When he made the announcement, he indicated that the tapering would be data-driven and that unemployment had to be at 6.5 percent or lower before he would consider reversing track.

He then seemed to show unnecessary haste in solidifying the market conviction about the timing being sooner rather than later. I am not sure what Bernanke's motivation was in indicating haste when he made the half-baked tentative announcement of tapering, giving himself giant back-out clauses of data dependency. If he was not sure what the data would prove, why whip the market into a frenzy?
Was his guilt at leading this world into the financial abyss leading him to try to atone for his sins before leaving office? Or was he just plain old misreading the situation?
The housing market boom, which was touted as the major indicator of the recovery of our economy, has its wheels coming off. Mortgage applications are at five-year lows and large banks are laying off mortgage staff in massive numbers. Bank of America has laid off a massive number of staff, and Wells Fargo has dismal results in mortgages and will soon follow.
The main cause? Rising mortgage rates and no real jobs, which give people income to buy homes.

As a result, this tapering talk by the Fed is the main reason the fledgling economic recovery (if there ever was one) is crushing any remnants of the mirage of a recovery.
As I warned you

a few weeks ago, this euphoria around rising rates will diminish by end of summer or early fall. So far, it seems like the script I had written is playing out.

Now if the Feds do not taper in September, they will look weak. And if they do, the rates will jump up even more and definitely crush the housing recovery.
Damned if they do, damned if they don't.

I suspect they will taper by $10 billion and then send a message to the market that they will stay at that bond-buying rate for a long time to come. They will continue to fuel America's addiction to cheap money and help them avoid taking the bitter medicine and start down the road of a real recovery.

Stay long Treasurys and avoid this short-term trap in the rates market.

© 2013 Moneynews. All rights reserved


September 14, 2013 6:10 pm

Realpolitik is the winner in US-Russia weapons agreement
Syrian disarmament plan sees Moscow and Washington compromise
US Secretary of State John Kerry, right, Russian Foreign Minister Sergey Lavrov, left, walk with the UN-Arab League envoy for Syria, Lakhdar Brahimi, center, into a meeting at the United Nations offices in Geneva
Who has got the better of whom in the negotiations between the US and Russia over Syria’s chemical weapons?
Poring over the text of the agreement signed by John Kerry and Sergei Lavrov in Geneva, there would appear to be advantages for both the Kremlin and the White House in the deal that has been done.
On the one hand, there is a clear victory for the Russian side on one point. Its Syrian ally is being told to hand over its chemical weapons for destruction or removal within nine months. But the pact does not threaten Syria with military action if it fails to comply.

The US and Russia agree that their joint plan will be enshrined in a forthcoming UN Security Council resolution. But the US has accepted Russia’s demand that the resolution will not authorise military action by world powers if the Assad regime obstructs the operation to secure its chemical stockpile. It merely commits to another Security Council discussion.
On the other hand, there are two key wins for the Barack Obama administration. First, the US has not been forced to take its threat of military action against Syria off the table. At a press conference in Geneva, Mr Kerry reiterated that President Obama reserved the right to act to protect US interests if he saw fit. “And, if diplomacy fails,” Mr Obama said later, “the United States remains prepared to act.”
Secondly, what will have surprised many diplomats is the ambition and detail of the plan that Russia has agreed to. It is structured around a series of deadlines which will allow the world to judge whether it is being adhered to or not.

Bashar al-Assad must provide an inventory of his chemical weapon stocks within seven days. He must allow the destruction of those stocks by the middle of next year. He must also give the world’s chemical weapons watchdog and UN “the immediate and unfettered right to inspect any and all sites in Syria.”
The US believes these deadlines make it hard for the Assad regime to obstruct progress. Western diplomats will also argue that by signing up to such a detailed agreement, Russia is putting its credibility on the line – and that it cannot allow the Assad regime to flout an agreement to which the Kremlin has put its name.

Still there will be at least three reservations on many minds.
First, how will the outside world know that Mr Assad is telling the truth when he publishes his inventory?

The US is certain to look at Mr Assad’s declaration of his chemical assets very sceptically. But it may not be easy for the Assad regime to hide the truth.
One of the remarkable developments of the last three days in Geneva is that the US has been sharing intelligence information about the stockpile for the first time with Russia. The White House and Kremlin now have a much more detailed picture of what the regime has. Both the US and Russia have established, for example, that Syria has around 1000 metric tons of chemical stocks.
Secondly, how difficult will it be for the UN and international bodies to complete such an ambitious plan in the midst of a civil war?
The scale is certainly daunting. Syria is thought to have the third largest chemical weapons programme in the world. Finding enough experts to secure and destroy the stockpile will be challenging.

“There are only two groups of people that have the experience and skills to do an operation like this and they are the US military and the Russian military,” says Aaron David Miller, a former state department official now at the Wilson Center.
That said, Mr Kerry was keen to emphasise on Saturday that the deadline for the destruction of the stockpile is achievable because the Assad regime has been continually moving its chemical weapons into areas that are not affected by the conflict.

“These weapons are in areas of regime control predominantly,” he said, suggesting that the Assad regime should have no difficulty providing access to them.

Finally, are we not going to see the Assad regime obstructing the inspections on the ground?

Many will say this is almost certain. UN inspectors investigating the August 21 chemical attack in Damascus were shot at as they approached the scene. The regime could easily instigate a repeat of such events, say diplomats, leading to debate over whether the Assad regime is culpable or not.
The Assad regime will also want to argue that opposition rebels must be questioned over their alleged holdings of chemical stockssomething that will prove difficult if not impossible for the UN to achieve.

Copyright The Financial Times Limited 2013.