Sunday, August 4, 2013

The Economy is Deflating - The "Bond Bubble" Is Bullshit...

Those pushing the Treasury bond "bubble" thesis were merely advancing their own interests and otherwise ignoring the basic facts staring them in the face. The reality is that during the periods when the Fed has been active, bond prices have fallen (interest rates rose), but as soon as the Fed takes its foot off the gas then bonds rise and interest rates fall. All of which is highly consistent with the the fact that this sick and broken economy is already in deep deflation...

The whole "bond bubble" theme was just a fabricated excuse used by investment advisors to push their clients out of bonds and into stocks - even as Wall Street is doing the opposite...

Below we see a chart of 30 year treasury yields (red) overlaid with the stock market (black). The blue boxes highlight the periods during Fed Quantitative Easing. As we see, plain as day, Fed policy has been reflationary as intended. The primary beneficiary has been stocks and Wall Street takes advantage of the Fed bond buying to sell back to the Fed. Interest rates rose all three times that QE was deployed. The only fall in interest rates came during Operation Twist (green box) when the Fed sold short-term bonds to buy long-term bonds which they then abandoned in favour of QE3 and QE4 i.e. indefinite bond buying. In other words bonds rallied (yields fell) during the period when the Fed was the least accommodative and bought the fewest long-term bonds.


Key Takeaway 2: Stocks are the Primary Beneficiary of QE
Aside from disproving the bond bubble bullshit, the other key takeaway is the fact that stocks have been the overwhelming beneficiary of Fed stimulus. Every time the Fed programs end, the stock market takes a serious shit. Given that various Fed members are already discussing QE 'tapering' and most analysts expect it to occur prior to year-end, then clearly the stock market has not fully digested that eventuality the way it did the last two times. Every time interest rates peaked the past two times, the stock market rolled over soon after...

Key Takeaway 3: Houston, We Have a Fucking Problem...
Clearly the Fed does not control long-term interest rates the way most people are assuming they do. The goal of Fed policy has been to reflate the economy and stock market, not to buy down interest rates. Quite the contrary, interest rates have been inversely correlated to Fed policy. The Fed wants inflation. Along these same lines, it's abundantly clear from the rise in interest rates that each iteration of "QE" is having less and less economic impact. Back in 2009, the economy was in the worst recession since the Great Depression yet interest rates rose a full 2% in 6 months. This time around, interest rates have risen a mere 1% in 12 months even though even more monetary stimulus has been applied than was applied in 2009...

This is why interest rates are not rising more - 
Monetary stimulus is no longer moving the economic needle and the economy is deflating...


Just Another Pump and Dump
Suffice to say, not a good time to have GDP hitting stall speed when the largest QE program is set to wrap-up and interest rates are already showing a lower high in terms of economic reflation. The disconnect between bonds and stocks has never been wider i.e. stocks are assuming a much higher level of economic output than bonds. As usual, the less exuberant bonds have it right, whereas stocks are putting on the usual public dog and pony show, now on mere fumes in terms of volume. Worse yet, all indications are that after four years of trying, investment advisors finally convinced small investors to embrace the "great rotation" theme from bonds to stocks, just in time for Wall Street and corporate insiders to bail out of stocks.  Funny how that works...