Courtesy of John Nyaradi of Wall Street Sector Selector
After nearly five years of quantitative easing, Ben Bernanke and his Federal Reserve now find themselves in a box.
For several years, the only game in town has been “The Reflation Trade,” engineered by the U.S. Federal Reserve’s quantitative easing program and the Fed’s unprecedented effort to jumpstart the U.S. economic recovery. Now it seems that Dr. Bernanke wants to dial back the $85 billion/month in bond buying but finds that market forces and current conditions have him trapped in a spot from which there might be no escape.
Regarding the potential end of quantitative easing, Warren Buffett has said it would be the “shot heard round the world,” and markets got a little taste of what that world might look like when Ben made comments in May that sent markets on a wild ride.
Equities dumped, gold dumped, interest rates spiked as investors contemplated just the possibility that Ben might pull the punchbowl away.
Since then, we have seen a parade of Fed Presidents and even the Chairman, himself, saying, in effect, that they were “just kidding” and that their easy monetary policies were here to stay for a long, long time. Clearly, the trial balloon regarding the end of quantitative easing went over like a lead balloon.
Today’s unfortunate situation:
1. The Fed can’t withdraw easily from quantitative easing, if at all. Markets have made this more than clear with the sharp response to even the hint of quantitative easing coming to an end, i.e., the “taper tantrum.” All recent market action reflects today’s environment which is all about the Fed. Recent assurances that the easy money would continue have been successful–major indexes are now back at levels last seen before Dr. Bernanke’s first comments.
2. The Fed has to withdraw from quantitative easing eventually. The long run of easy money has created asset bubbles and is laying the framework for higher inflation. Continuing down the current path will only make the eventual withdrawal even more painful and dramatic.
[Economatters argues that QE Policy has been a failure when it comes to the economy, anyway. The economy is not the stock market… Lee Adler predicts “Bernanke will eventually go down as the most reviled Fed chairman in history.”]
3. The Fed is quickly descending into confusion and disarray. Last week saw yet another Bernanke Rally triggered after his mid-week comments, while Friday saw dueling Fed Presidents Charles Plosser and James Bullard presenting conflicting views of “to taper or not to taper.” In between, Fed Governor Elizabeth Duke, resigned and her departure further muddies the waters. On top of that, it’s now becoming widely accepted Dr. Bernanke will also be leaving the scene when his term expires in January and markets will be eagerly watching to see who his replacement will be. The first hint of this came when Dr. Bernanke announced that he wouldn’t be attending the Fed conclave in Jackson Hole in August which is like Santa Claus missing Christmas, and any uncertainty regarding his successor will likely be met with significant volatility in global markets.
This confusion and disarray within the Fed could prove to be dangerous should investors lose faith in the central bank’s seemingly invincible power. The markets will continue to be whipsawed by Fedspeak and “taper talk” and we’re due for another significant round this week when Dr. Bernanke treks up to Capitol Hill on Wednesday and Thursday for testimony before the House and Senate.
So “Ben in a Box” presents the potential for danger as well as opportunity. We’ve already witnessed the adverse reaction from markets as they threw a temper tantrum at just the thought of the easy-money punch bowl running dry. One can only imagine what market reaction might be if and when the $85 billion per month in Federal support actually starts seeping away.
Over the past several years, “buy the dip” has been the name of the game, but there could soon be a new game if Ben can’t get out of the box and a new age of austerity and even recession is at hand.
Put options: Just because the “Bernanke Put” might be history, doesn’t mean you can’t go out and buy your own to protect profits or hedge against potential downside moves.
Inverse/bear ETFs and mutual funds: Bear ETFs and mutual funds are designed to help investors avoid the risks of falling markets and might also offer downside hedges to long positions should the market continue its recent decline.
Cash: Cash is the ultimate hedge in times of stress, and when markets go south in a big way, cash is always king.
U.S. dollar/Treasury bonds: While there will be few safe havens if things get really ugly, the U.S. dollar and U.S. Treasury bonds will most likely be the ultimate flight-to-quality trade. The United States might be a passenger on the Titanic, but it will be the last passenger to drown. If Titanic goes down, we can only hope that the Carpathia will arrive in time.
I think the easy money party will be coming to end soon, and that Dr. Ben is set to turn out the lights. We’ll find out more this week, but no central banker in history has ever attempted to do what he is doing, and nobody can know how this will turn out. But, as always, danger and opportunity arrive hand in hand, and this time will be no different.
Wall Street Sector Selector remains in “yellow flag“ status, expecting a high risk environment ahead.
For another view on the death of QE and the Treasury market, see Lee Adler’s No, Joe, No One Owes Bernanke An Apology.
John Nyaradi and Lee Adler present somewhat similar views of Chairman Bernanke’s unprecedented QE policies. However, their projections of how the game will end are different.
John speculates that cash and Treasuries will be the last refuge for investors when the SHTF (Ben In A Box).
Lee believes that Bernanke’s foolhardy actions will torpedo the bond market. “As a serial bubble blower, he already should be, but he has Joe Weisenthal and the rest of the Fed apologist crowd spinning the facts and misleading people prone to believe in the tooth fairy, Santa Claus, and helicopter money as a cure for economic ills. Their illusions will face a day of reckoning soon. As the collapse of the US Treasury market, the greatest Ponzi scheme of all time, progresses, it will reach an inflection point that will take the stock market bubble, the latest housing bubble, and the economy with it. Bernanke’s legacy will be sealed once and for all.” (No, Joe, No One Owes Bernanke An Apology).
Paul Price of Market Shadows votes to avoid bonds: “Holders of long-term bonds are taking huge risks. A 1% rise at the long end of the yield curve could send 30-year bond prices down 17%. A 2% increase could drop principal values much more. Years of coupon payments could be wiped out on a total return basis.” (Death by Leverage.) Paul has no idea of when the bubble will burst, but believes that it will.
What do you think?
Picture via: Jr. Deputy Accountant