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Bonds & Interest Rates

Jim Grant: "The Federal Reserve Is The Vampire Squid Of Vampire Squids"

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Posted by Zerohedge.com

on Thursday, 03 May 2012 16:19

Munch's "The Scream" may be all the rage today, but to Jim Grant, in his latest interview on Bloomberg TV, the record price paid for the painting is not so much a manifestation of modern art as one of modern currency: "This is the flight into things from paper" . Thus begins the latest polemic by the Grant's Interest Rate Observer author whose topic is as so often happens, the Federal Reserve (for his latest definitive expostulation on why the Fed should be disbanded and why a gold standard should return, delivered from the heart of Liberty 33 itself, read here). The world in which we invest is a world of immense wall to wall manipulations by our friends in Washington. And people get off on Goldman Sachs because it has done this and this, it is pulling wires... The Federal Reserve is the giant squid of squids, it is the vampire squid of vampire squids."

He continues: "They - the vampire squids - have manipulated virtually every single price and valuation in the capital markets. People ought to recognize when they invest that one of the unspoken risks is the risk that this hall of mirrors, this Barnum and Bailey world that the Fed has created for us is going to vanish one day because they will not be able to hold it any more... It's not as if there is nothing to do in investing, but one must always keep in mind that the valuations that we see, that the prices that we watch flicker across the tape are prices that are fundamentally manipulated by these well-intended, dangerous people in Washington called the Federal Reserve". And to think that 3 short years ago Grant would have been branded a loony, tin-foil hat wearing gold bug, while now it has become trendy for hedge fund managers to bash the Fed with impunity. It is all downhill from here.

To Watch the Video CLICK HERE

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Bonds & Interest Rates

America's Most Important Slidedeck

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Posted by Zerohedge.com

on Wednesday, 02 May 2012 08:53

Every quarter as part of its refunding announcement, the Office of Debt Management together with the all important Treasury Borrowing Advisory Committee, which as noted previously is basically Wall Street's conduit telling the Treasury what to do, releases its Fiscal Quarterly Report which is for all intents and purposes the most important presentation of any 3 month period, containing not only 70 slides worth of critical charts about the fiscal status of the country, America's debt issuance, its funding needs, the structure of the Treasury portfolio, but more importantly what future debt supply and demand needs look like, as well as various sundry topics which will shape the debate between Wall Street and Treasury execs for the next 3 months: some of the fascinating topics touched upon are fixed income ETFs, algo trading in Treasurys, and finally the implications of High Frequency trading - a topic which has finally made it to the highest levels of executive discussion. It is presented in its entirety below (in a non-click bait fashion as we respect readers' intelligence), although we find the following statement absolutely priceless: "Anticipation of central bank behavior has become a significant driver of market sentiment." This is coming from the banks and Treasury. Q.E.D.

Some highlights specifically from the TBAC component of the presentation.

First, the TBAC discusses key changes to the Fixed Income markets over the past few years:

  1. Reduced liquidity of spread product
  2. Likely a consequence of investor risk aversion and regulatory reform. Treasuries remain liquid
  3. Prevalence of “risk on / risk off” mentality
  4. Extreme valuations, correlations rising, excess returns becoming more volatile
  5. Role of government
  6. Extraordinary monetary policy (ZIRP, balance sheet growth, communication/transparency)
  7. Regulatory reform
  8. Changes in market participant behavior
  9. Cyclical (risk tolerance) and secular (demographics / LDI strategies), customized solutions
  10. Growing role of electronic trading
  11. Driven by increased efficiency and regulatory reform

Supporting visual data:

And what matters for bond traders everywhere: Implications of Reduced Corporate Bond Liquidity, which are mostly the lobby group's efforts to neutralize the Volcker Rule:

 

  • A reduction in liquidity / wider bid-offer spreads has both an upfront cost to existing investors (who have to mark their existing holdings at wider levels) as well as an ongoing cost for issuers and investors
  • Per a recent study, a strict implementation of the Volcker Rule for the corporate bond market may cost $90-315bn upfront plus $12-43bn/yr for issuers and $1-4bn/yr for investors in future transactions
  • Analysis by Barclays** indicates that the liquidity premium has risen from ~20bps in Jan ’07 to ~40bps in Mar ’12
  • Policy makers should carefully consider the impact on market liquidity when introducing new financial regulations, such as the Volcker Rule
  • SIFMA, the Credit Roundtable (a group of large fixed income money managers), and other market participants have submitted comments on this topic
  • Given the size of the bond markets, it would be difficult, if not impossible, for the banking sector to reintermediate the capital markets (replacing bonds with loans) in response to a prolonged market dislocation

To Read More CLICK HERE

 



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Bonds & Interest Rates

The 'Mistake of 1937'

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Posted by Steve Saville

on Tuesday, 01 May 2012 07:47

Below is an excerpt from a commentary originally posted at www.speculative-investor.com on 19th April 2012.

The US Great Depression lasted from 1929 until 1945, but the deflationary phase of the Depression effectively ended in 1932. Regardless of whether you define deflation and inflation in terms of money supply or prices, there was almost continuous inflation in the US after 1932. The inflation was, however, briefly interrupted during 1937-1938, when a leveling-off in the money supply and a sudden economic downturn led to sharp declines in equity and commodity prices. The 1937-1938 downturn is sometimes called the "mistake of 1937" by those who believe that it only occurred because the Fed tightened monetary policy prematurely. According to the believers in this theory, the US economy would have continued to recover from the collapse of 1929-1932 if not for the Fed's premature tightening. Significantly, Ben Bernanke is one of the believers.

Believers in the theory that the collapse of 1937-1938 was caused by the Fed's premature tightening of monetary conditions are partially right in that modest Fed tightening during the second half of 1936 and the first half of 1937[1] was probably the catalyst for the collapse. The question that this theory fails to address is: if a genuine economic recovery had got underway in 1933, then why did the recovery fall apart so rapidly and so completely following only a minor tweaking of monetary conditions? The answer is that the recovery wasn't real; it was an illusion based on increasing money supply. When economic growth is mainly the result of increasing money supply then stopping, or even just slowing, the rate of money-supply growth will likely bring about a collapse.

(As an aside, the recovery's flimsy monetary underpinning is part of the reason why, like the recovery that began in mid 2009, it was essentially "jobless" (the unemployment rate remained very high throughout the 1933-1937 rebound). However, there was more to the relentlessly high unemployment of the 1930s than the Fed's counter-productive monetary machinations. Actions taken by the Hoover and Roosevelt administrations to raise the price of labour can also be given a lot of credit for keeping people out of work.)

This prompts the question: shouldn't the Fed have continued to 'support' the economy with a constant flow of new money until a real recovery was able to take hold?

The above question ignores the fact that the flow of new money (monetary inflation) leads to more mal-investment and thus not only gets in the way of a real recovery, but also further weakens the economic structure. Had the Fed continued to provide monetary support for an additional year then the collapse would have commenced in mid 1938 rather than mid 1937. Also, it would have been even more devastating thanks to an additional year of mal-investment. As Ludwig von Mises pointed out long ago: "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

The above question also ignores the fact that in real time the central bank finds itself between the proverbial rock and a hard place. Even when the economy is subject to natural deflationary forces, as it was in the mid-1930s, the unnatural creation of new money by the central bank will eventually cause evidence of an inflation problem -- in the form of rising prices for important commodities and some goods and services -- to emerge. After a while, the pressure on the central bank to curtail the inflation problem can become greater than the pressure on the central bank to 'support' the economy with a continuing flow of new money.

By the third quarter of 1936 the pressure on the Fed to curtail the inflation problem had become dominant, but if the Fed had ignored this pressure and instead persisted with its price-boosting policies -- the path that Monday-morning Keynesians[2] now say should have been taken -- then the end result would have been an even more severe economic downturn once monetary conditions were eventually tightened. Alternatively, the Fed could have chosen to rapidly inflate the money supply indefinitely, in which case the end result would have been total catastrophe for both the US dollar and the US economy.

A picture of what happened during 1937-1938 is displayed below. On the chart the 1937-1938 downturn looks minor in comparison to the 1929-1932 downturn, but it was substantial nonetheless. The Dow Industrials Index lost more than half of its value, but perhaps of greater significance was the quick one-third decline in manufacturing output. Considering the relative importance of manufacturing in those days, this effectively means that the economy quickly shrunk by one-third.

The chart also shows that the Fed made no attempt to tighten via a higher official interest rate. As explained in Note (1) below, the Fed used other means to restrict the flow of new money.

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That many of today's most influential policymakers and economists believe that a severe downturn could have been avoided during the late-1930s if only the Fed had maintained its ultra-easy monetary stance means that the wrong lesson has been learned from history. This, in turn, almost certainly means that the Fed will stay loose for longer in the face of blatant evidence of an inflation problem this time around, and that the Fed will be quicker than ever to engineer a money-supply boost in reaction to the next bout of economic weakness.

[1] The Fed started tightening the monetary reins in August of 1936. It never went as far as hiking the official interest rate (the "Discount Rate"), but it did increase bank reserve requirements and took actions to prevent gold in-flows to the US Treasury from boosting the Monetary Base. The result was a leveling-off in the money supply during the 2-year period beginning in late-1936.

[2] A Monday-morning Keynesian is an economist who always knows, with the benefit of hindsight, how much 'stimulus' should have been provided to the economy to bring about a sustainable recovery. Since these economists begin with the premise that monetary and/or fiscal stimulus helps the economy, if an economy tanks despite the concerted application of stimulus measures they inevitably conclude that the stimulus was insufficient. They never seriously question the correctness of the underlying premise.

We aren't offering a free trial subscription at this time, but free samples of our work (excerpts from our regular commentaries) can be viewed at: http://www.speculative-investor.com/new/freesamples.html



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Bonds & Interest Rates

Lonesome dove

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Posted by G.I. - The Economist

on Friday, 27 April 2012 09:13

by G.I.

For the blogosphere, the most entertaining part of the Federal Reserve's meeting today was Ben Bernanke's defence during the press conference against Paul Krugman’s charge that he has betrayed his academic past in failing to ease more aggressively and aim for higher inflation.

That is a pity because while it was great theater, it obscured a more important revelation. Not only is Mr Bernanke still a dove, he is increasingly an isolated dove, and that isolation has significant consequences for monetary policy, the economy and the markets.

The statement released by the FOMC was largely as expected and a non-event for markets: “economic growth [will] remain moderate over coming quarters and then … pick up gradually,” inflation will fall from its temporarily elevated levels to 2% or lower, and the Fed expects to keep interest rates “at exceptionally low levels … at least through late 2014.”

The projections released along with the statement were far more interesting. FOMC members reduced their forecasts for the unemployment rate, and nudged up the outlook for inflation. That hawkish combination was made doubly so by the fact that just four of the 17 FOMC members think the Fed should start tightening after 2014, down from six in January.

The hawkish impression was reinforced by Mr Bernanke’s defence against Mr Krugman (whose name never came up but whose New York Times Magazine article, judging by the questions, had been read by all the reporters in the room). Mr Bernanke flatly rejected the accusation that he is acting inconsistently from the advice he gave the Bank of Japan over a decade ago, noting that Japan was in deflation then and America is not now, in no small part thanks to the aggressively easy monetary policy the Fed has pursued. He went on to argue that deliberately targeting higher inflation as Mr Krugman advises (because it would reduce real interest rates) in pursuit of a slightly faster fall in unemployment was a “reckless” tradeoff. Judging from my twitter feed, Mr Krugman’s partisans outnumber Mr Bernanke’s by a hefty margin. Mr Krugman himself dismissed Mr Bernanke’s response as “Disappointing stuff.”

To Read More CLICK HERE

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Bonds & Interest Rates

The Burgeoning Scam Market

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Posted by Bill Bonner

on Thursday, 26 April 2012 10:12

By Bill Bonner

“Monetary policy cannot fulfill each and every market expectation.”

So said the head of the Bundesbank, Jens Weidmann.

Why not, investors want to know.

Mr. Weidmann was talking to The Wall Street Journal. He was explaining why Germany was sticking to its guns. They don’t use that expression in Germany. But you know what he meant.

“The crisis can be solved only by embarking on often-painful structural reforms,” he insisted. “If policy makers think they can avoid this they will try to.”

Mr. Weidmann is talking about the present. He is also describing the future. In the old world there is a backlash growing against the Germans and their financial guns. Austerity doesn’t seem to work. Countries try it. They cut spending. They fire people. They get nothing from it. Their budgets are still far out of balance, with deficits way above the 3% limit demanded by the European Union. Unemployment goes up. GDP goes down. Unhappy mobs start breaking windows. Why bother?

Look what is happening in Britain, for example. The Telegraph reports:

The unexpected 0.2pc contraction in UK growth followed a 0.3pc fall in gross domestic product (GDP) in the fourth quarter of 2011, signalling a technical recession and Britain’s first double-dip since 1975.

Economists had expected the Office for National Statistics data to show the economy grew by 0.1pc between January and March.

The Prime Minister said the figure was “very, very disappointing” but added that that it would be “absolute folly” to change course and jeopardise Britain’s low borrowing rates. He told Parliament:

“We inherited from [Labour] a budget deficit of 11pc. That is bigger than Greece, bigger than Spain, bigger than Portugal [...] The one thing we mustn’t do is abandon spending and deficit reduction plans, because the solution to a debt crisis cannot be more debt.”

Of course, you might look at these facts and conclude that they are not trying hard enough. Instead of making smallish cuts…why not make big ones? Why not actually balance government budgets so that they can tell German central bankers to drop dead?

Everyone agrees that that would be too radical. It would invite “social upheaval.” Apparently, actually living within your means is no longer politically or socially acceptable. You have to live beyond your means… The only question is ‘who will pay for it?’ The answers to that question are not easy. When debt levels were low, the answer was probably ‘future generations of taxpayers.’ At today’s debt levels it is unlikely that the debt will ever reach future generations. And with so much of the debt now being taken up by the central bank the burden shifts, from lenders to borrowers, taxpayers and consumers. Good debts may fall on debtors…even those who are not even born yet. But bad debt and inflation float down like leaves…blown by the winds…and eventually dropping down on innocent passers-by.

READ MORE: The Burgeoning Scam Market

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