The Zero Hedge Daily Round Up #127 – 09/14/2012

I don’t know what to write, but I guess that’s what the show’s for. *face palm*

Having a cheeky listen before, I’ve only just realised that I completely screwed up the pronounciation of ‘Yemen’. haha I’m sure there are others, but it doesn’t bother me too much. 

This is the Zero Hedge Daily Round Up.

1. Anti-American sentiment spreads throughout Middle East. 2. Egan Jones downgrades U.S. to AA-. 3. Mortages 28bps from being safer than treasuries. I know. 4. U.S. decline. Spain bleeding from the inside. 5. Krugman: QE3 not enough. 6. Anti-American sentiment: take two! 7. Chinese Caterpillar dying. 8. Crude hits $100. 9. Marc Faber speaks truth.

Alternatively, you can download the show as a podcast on iTunes or any RSS capable device.

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Julius Reade

P.S. For those paranoid about the government:

BofA Sees Fed Assets Surpassing $5 Trillion By End Of 2014… Leading To $3350 Gold And $190 Crude

Yesterday, when we first presented our calculation of what the Fed’s balance sheet would look like through the end of 2013, some were confused why we assumed that the Fed would continue monetizing the long-end beyond the end of 2012. Simple: in its statement, the FOMC said that “If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.” Therefore, the only question is by what point the labor market would have improved sufficiently to satisfy the Fed with its “improvement” (all else equal, which however – and here’s looking at you inflation – will not be). Conservatively, we assumed that it would take at the lest until December 2014 for unemployment to cross the Fed’s “all clear threshold.” As it turns out we were optimistic. Bank of America’s Priya Misra has just released an analysis which is identical to ours in all other respects, except for when the latest QE version would end. BofA’s take: “We do not believe there will be “substantial” improvement in the labor market for the next 1.5-2 years and foresee the Fed buying Treasuries after the end of Operation Twist.” What does this mean for total Fed purchases? Again, simple. Add $1 trillion to the Zero Hedge total of $4TRN. In other words, Bank of America just predicted at least 2 years and change of constant monetization, which would send the Fed’s balance sheet to grand total of just over $5,000,000,000,000 as the Fed adds another $2.2 trillion MBS and Treasury notional to the current total of $2.8 trillion.

In other words, for once we actually were shockingly optimistic on the US economy. Assuming BofA is correct, and it probably is, this is how the Fed’s balance sheet will look like for the next 2 years:

Or, in terms of US GDP, the Fed’s balance sheet will have “LBOed” just shy of 30% of all US goods and services.

It gets worse:

Since the Fed is effectively becoming the marginal player in both the MBS and Treasury markets, a very relevant question is how much private market debt is left to sell. Short answer: not much. According to BofA’s calculation, the Fed will own more than 33% of the entire mortgage market by 2014.

 That’s half the story.

On the Treasury side, in just over 2 years, “Fed ownership across the 6y-30y portion Treasury curve is likely to reach about 50% by end of 2013 and an average of 65% by end of 2014.” You read that right: in just over 2 years, the Federal Reserve will hold two thirds of the entire bond market with a maturity over 5 years (which by then will be part of the Fed’s ZIRP commitment, yield 0% and essentially be equivalent to cash).

No wonder that David Rosenberg is worried that the Fed will soon run out of securities to buy (well, there are always equities of course, but the Fed will not monetize those until some time in 2015 when hyperinflation is raging).

And speaking of hyperinflation (and our earlier note that nothing “else is equal”) the real question is if indeed the Fed will own $5 trillion in “assets” in 27.5 months, what does that mean for gold and crude? The answer is plotted below:

In case it is unclear, the answer is:

  • $3350 gold
  • $190 oil.

Luckily the Fed has already factored all these soaring input costs (and “alternative money” prices) in its models, and there is nothing to worry about. Lest we forget, the Fed can crush inflation cold in 15 minutes cold… somehow. Even when unwinding its balance sheet would mean sacrificing 30% of US GDP and, let’s be honest about it, civil war.

* * *

That’s it in a nutshell. Those who are interested in the nuances of the BofA analysis, which is a replica of our own, can read on below:

The Fed Bazooka

Given our growth forecast, we expect the Fed to follow up the expiration of Operation Twist with an open-ended outright Treasury purchase plan at the December meeting. We expect the pace could be between $45 billion (which would be equal to the current size of Twist) and $60 billion/month for two years [in 10 year equivalents]. We expect a long program given the slow improvement in the labor market as well as the Fed’s focus on a “substantial and sustained improvement” in the employment situation.

Table 2 compares different asset purchase programs by the Fed in terms of the net notional and duration take-out. Were the Fed to engage in renewed Treasury purchases post the end of Twist (in the same maturity distribution), this could easily become one of the largest programs in terms on monthly 10y equivalent demand from the Fed. Note that even MBS buying takes duration out of private hands, which would put downward pressure on rates

Mortgages: Fed buys most of monthly issuance

We estimate that Fed purchases will take out about 60% of monthly MBS production. However, our mortgage strategists note that historically the Fed has concentrated its buying in 30y conventionals. For example, in August the Fed bought $23bn of conventional 30s, $2.5bn of conventional 15s and $3bn of GNs. This compares with gross issuance at $122bn, which is split into $88bn in conventionals ($66bn in 30s, $22bn in 15s) and $34bn in GNs. In other words, the Fed has concentrated 80% of its purchases among conventional 30y. A similar pattern would suggest that the Fed would buy an additional $30bn in this sector, which could end up being almost 90% of all issuance in conventional 30y. This explains the significant tightening in the mortgage basis, and would argue for the Fed to buy some other sectors as well.

In terms of outstandings, we expect the Fed to end up owning more than 33% of the total market by the end of 2014, which is also significant since many mortgage investors tend to reinvest paydowns. These investors would need to be persuaded to sell MBS to the Fed, which would require tighter spreads.

Treasuries: Fed will own a 45-50% in the long end in a year

Given our growth forecast, we expect the Fed to follow up the expiration of Operation Twist with an open-ended outright Treasury purchase plan at the December meeting. We estimate further what the potential ownership of the Fed could look like in the Treasury market over the course of the next two years. We assume that: 1) Purchase sizes are in the same distribution as Twist, sans the sales; 2) Treasury coupon auction sizes remain constant; and, 3) The Fed does not change the 70% per issue maximum SOMA limit.

Table 3 and Table 4 simulate the Treasury universe during the course of 2013 and 2014. Fed ownership across the 6y-30y portion Treasury curve is likely to reach about 50% by end of 2013 and an average of 65% by end of 2014. Given the current issuance schedule, we believe it is very likely that the Fed changes its purchase buckets through the next round of Treasury purchases. In particular, the Fed will begin to run out of issues in the 8y-10y bucket and will be forced to buy newly issued 10y notes should they choose to maintain the same distribution. We believe this is unlikely, and that the Fed is likely to redistribute its purchases and possibly include the 5y portion of the curve to provide some room.

Rosenberg: "If The US Is Truly Japan, The Fed Will End Up Owning The Entire Market"

David Rosenberg, Gluskin Sheff: BernanQE Plays With A New Deck


It would be glib to ask “well, wasn’t QE3 priced in?”

What the Fed did was actually much more than QE3. Call it QE3-plus… a gift that will now keep on giving. No maximum. No time limit. The Fed also lowered the bar on what it will take, going forward, for even more intervention.

The Fed announced that it will buy $40 billion per month in MBS (together with the on-going Operation Twist program, this brings total asset purchases to around $85 billion monthly through year-end), but the press statement contained an open-ended commitment to QE until labour market conditions not only improve, but do so ‘substantially”. This is a radical shift.

Before, the QEs had an explicit maximum limit in magnitude duration. That is no longer the case — $40 billion in MBS buying month in, month out, perhaps until such time that the Fed owns the entire market (the Fed already has $843 trillion of Agency MRS on its balance sheet as it is — if this is truly Japan and it takes another ten years for the economy to improve “substantially”, the Fed will end up owning the entire market).

Prior QEs seemed predicated on relapses in economic growth (or at least no follow-through). This was the case with QE1 in March 2009, QE2 in November 2010 and Operation Twist just over a year ago. Now the economy has to strengthen dramatically and if it doesn’t – the Fed is clearly targeting the jobs market and specifically on the unemployment rate here – then the spectre of even more balance sheet expansion will remain fully intact. We could soon be attaching Roman numerals to future QE actions (January 31st 2014 is Bernanke’s last day as Fed Chairman and that is a loooong way away).

The payroll data always move the market but now more than ever and the Fed’s explicit goal of generating “substantial” improvement in the jobs market will ensure that this ‘bad news is good news’ psychology will remain fully intact (why the stock market so easily managed to shrug off last week’s data – this new normal of bad news being good news is now going to be more fully entrenched for the market). And with the Fed targeting mortgages, it is clear that it views housing as the transmission mechanism for its objective of strengthening the jobs market. So each housing indicator going forward is also going to very likely elicit a stronger market reaction than normal – remember, because the stock market is addicted to QE, weak data can still be expected to be supportive. A notable improvement in the data will be even more supportive because the Fed will still keep the hope alive of more QE even if economic conditions get better.

I have to stress this but anything less than “substantial” is just not going to cut it for the Fed – I don’t know how that is defined numerically, but if the economy and specifically the jobs market does not go gangbusters, more QE can be expected. And it won’t always be in MBS – the Fed came right out and said that it will also “undertake additional asset purchases and employ other tools as appropriate until such improvement is achieved in the context of price stability”.

That reference to “price stability” is a bit comical because in the prior rounds of unconventional stimulus: market-based inflation expectations (from the TIPS market) were sub-2% and falling. Going into today’s meeting, they were 2.6% and rising. This, for a central bank that spent an inordinate amount of time talking about how important it was to prevent inflation expectations from becoming unhinged when it was busy tightening policy in the 2004-2006 rate-hiking cycle. The times, they are a changin’ (in other words, the price stability objective has a big fat R.I.P. on its tombstone). This is why gold swung from a moderate decline to a huge gain yesterday afternoon, and the DXY is breaking. It is clear that out of its dual mandate, a lower unemployment rate right now clearly trumps any concern over higher inflation expectations (whether justified or not).

Equities have ripped to the upside. Commodities are bid. Gold has broken out. The U.S. dollar is sliding. Yet the bond market refuses to buy in. The yield on the 10-year note has remained stable through this entire dramatic response to QE3 (and pledges for more). The Fed announced that it was buying mortgage-backed securities, not Treasuries, so it is curious as to why the bond market is not selling off dramatically. I can count numerous Fed meeting days when the stock market rallied sizably and bonds sold off alongside the reflationary view. I recall all too well the June 26, 2003 FOMC meeting when the Fed cut rates for the last time in that cycle and told the market it was on its own because the economic clouds had finally parted. The Dow ran up more than 100 points from the intra-day low that session and the 10-year note yield jumped 17 basis points, basically ratifying the view of the equity market at the time. But this time around, the Treasury market remains the odd man out on this new pro-growth view evident in the pricing of other asset classes. For any perma-bull out there, Mr. Bond is like having a mosquito in your ear on the putting green.

So from a markets standpoint, let’s talk about what all this means.

  • The Fed is setting us up for more risk-on/risk-off volatility. Long-short strategies or relative value strategies are perfectly appropriate.
  • The Fed extended the period of ultra low policy rates through to mid-2015 (one FOMC member is at 20161) from the end of 2014, which will nurture a low yield environment even further. Not only that, but the Fed said that “a highly accommodative stance of monetary policy will remain appropriate fora considerable time after the economic recovery strengthens” which means that even if growth miraculously manages to accelerate earlier than expected, the Fed is not going to begin raising rates. The age of “pre-emptive” tightening is long gone. This nurturing of a low policy rate environment for years to come will continue to underpin the income (dividend) theme in the stock market.
  • The fact that the Fed is embarking on an even more aggressive course with inflation expectations on the rise should be viewed constructively for gold and other precious metals (and gold mining stocks).
  • The Treasury market is like the brake lights on a car – we need to acknowledge that it is not signalling better growth ahead. Screen for earnings visibility and less cyclicality. Bonds usually have the economy right.
  • Corporate bonds should be a beneficiary as the Fed continues to anchor a low interest cost environment and as such, correspondingly keep debt- servicing charges and default risks at bay.


I don’t think this latest Fed action does anything more for the economy than the previous rounds did. It’s just an added reminder of how screwed up the economy really is and that the U.S. is much closer to resembling Japan of the past two decades than is generally recognized. Maybe in the central bank world of the “counterfactual” these QEs prevent a worse outcome but the most radical easing in monetary policy ever recorded has not stopped this post-bubble-bust American economy from posting its weakest recovery ever whether measured in real, nominal or per capita terms.

The economy is saddled with too much debt, a shortage of skills, bloated government, an uncertain tax rate outlook, the costs associated with Obamacare, banking sector re-regulation and a spreading European recession. Home prices may have revived of late, but there are still an amazing 22% of debt-ridden homeowners who are upside-down on their mortgage. Monetary policy is best equipped to deal with the vagaries of the business cycle but is a blunt way to deal with deep structural, fiscal and regulatory hurdles. QE has done squat for the economy and I don’t expect that to change. Even the Fed cut its 2012 real GDP growth projection for this year to 1.85% from 2.15% – for a year when typically growth is closer to 4% – and so the bump-up in 2013 to 2.75% from 2.5% has to be viewed in that context (in fact, it would seem as though for all the bluster, the level of real GDP is actually lower now at the end of next year compared to the pre-QE3 forecast… maybe this is what the Treasury market has latched on to).

It would seem as though the Fed’s macro models have a massive coefficient for the ‘wealth effect’ factor. The wealth effect may well stimulate economic activity at the bottom of an inventory or a normal business cycle. But this factor is really irrelevant at the trough of a balance sheet/delivering recession. The economy is suffering from a shortage of aggregate demand. Full stop. Perhaps most importantly, in order for the Fed’s action to have a lasting impact on the direction of the equity market, it must foster at least some significant belief that the action will lead to self-sustaining economic expansion. The scars of real family median income declining for two years in a row – the Fed’s action in a perverse way perpetuates this by forcing essential basic material prices higher – and an unprecedented five-year decline in household net worth are lingering, and exerting far more powerful dampening effect on spending and confidence than the Fed’s repeated attempts to generate risk-taking behaviour.

To the extent that the Fed is at least temporarily successful in nurturing a risk-on trade for portfolio managers, the reality is that changing the relative prices of assets does not create demand.


It just perpetuates the inequality that is building up in the country, and while this is not a headline maker, it is a real long term risk for the health of the country, from a social stability perspective as well.

Ben Wins – Who Loses?

The most significant market adjustment since Bernanke used the "Unlimited" word is not in stocks, bonds or PMs. It's in inflation expectations. Have a look at this chart. Focus on the incredible spike in the past 24-hours.



The sick part of this is that if Bernanke saw this graph, he would cry with tears of happiness. This is exactly what he was praying for. Ben thinks that inflation is a good thing. That it will cause demand to be pulled forward as people realize that things are going to cost more tomorrow than they do today.

I suspect Ben is right. Higher inflation expectations in the US will filter around the globe. Post the extraordinary steps Ben took yesterday, people will be stocking up on "stuff". Things like rice, flour, cooking oil, soy, wheat and sugar. If you can eat it, buy it now. It will be more expensive in a month. While your at it, fill up the gas tank, the price is going up next week and every week for the next few months.

Ben doesn't care about that stuff. He ignores this altogether. Maybe he's right, after all, food and energy are really not so important to the 7Bn folks who happen to be passing through this decade, right?

Some day the history books will study this period of time and ponder how so many people gave up control of key elements in their lives without ever having a say in the outcome. How could one person have gotten so powerful? Somehow we have anointed Ben as the new God. An omnipotent decider that is nether elected or whose power is somehow checked. Don't think for a minute that he's one of those benevolent gods, he's not.




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