July 18th, 2014
in Op Ed
by EconMatters, EconMatters.com
ZIRP Policy & Asset Valuations
The conditions in so many asset classes are unsustainable from a price perspective once interest rates rise even under a "new normalized rate environment" and the longer rates stay at ZIRP status these unsustainable price levels continue to move in the wrong direction from a sustainability standpoint, i.e., the underlying fundamentals apart from ZIRP policy would not support said asset prices in a natural price discovery process.
Janet Yellen Always One Step Behind
Janet Yellen threw a bone to the valuation crowd with her brief discussion about certain parts of the market being overvalued, "Valuation metrics in some sectors do appear substantially stretched-particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year". This is an obvious canned response since this question is routinely asked of the Chairperson in any question and answer session these days, "Do you see a bubble in markets?" And her previous canned response was according to our metrics of valuations....blah, blah, blah.....asset prices aren't out of line with historical standards to paraphrase.
Social Media Bubble - Historically High Risk Reward Plays
Let me just say right here that forget talking about bubble conditions in Bio-Techs or Social Media as high valuations are pretty commonplace for these sectors in market history and investors know what they are getting into given their historic volatility and boom and bust cycles both in terms of stock prices and business sustainability.
Treasuries Aren't Supposed to Get Bubbly Conditions as an Asset Class
Treasuries on the other hand haven't had a history of speculative fervor in regards to 'Bubbly' conditions. Investors have always considered these safe places to hide out in terms of market turmoil and uncertainty and a very conservative asset class historically. It takes quite a feat to take a conservative asset class and turn it into a bubble!
Read More >>> Bond Kings to be Dethroned in Second Half of the Year
US Treasuries have never been this mispriced and incongruent with an economy that is on pace to produce more jobs than any other time in the last 15 years, and this included the credit and housing booms with a Fed Funds Rate at 5.5%!
And I don't want to hear that crap about these being low level service jobs, you still need a vibrant economy to have enough people and entities that need to be served to create this many 'service jobs'! The numbers that are being created means a whole lot of people need more goods and services produced to justify businesses hiring more workers and not just the 1% crowd.
The Federal Reserve has gone off the rails, yeah this economy isn't perfect far from it, but there is no way the Fed Funds Rate should be 25 basis points. Why would a bank ever lend when they can borrow at 25 basis points all the money they want, then buy some 'safe' Treasuries, and capture what they perceive as a risk-free arbitrage? This is the reason the GDP numbers are lagging, everything from CAP EX spending sacrificed for stock buybacks to banks chasing yield instead of creating small business loans is all part of this ridiculously out of touch ZIRP Insanity by the Federal Reserve.
Read More >>> Fed Officials Trying to Warn Bond Markets
And this is where you get so much insanity that you turn a conservative asset class like Treasuries into the biggest Financial Bubble in the History of mainstream asset classes. And the Fed thinks Exit Fees on Bond Funds is going to in any way mitigate the bursting of the Bond Market Bubble?
Deny Inflation to Justify ZIRP Religion - Reason Retail Sales Lagging Sector
Just look at the inflation numbers, another new data point came out today in the PPI for June being up another 0.4%, and the CPI next week will continue to show inflation numbers well above the Fed's own target rate. Moreover, these inflation metrics underreport inflation due to Hedonic real world means which never show up in the data. Just a case in point is my brokerage inflation, yes the data fee packages are up massively on a year on year basis, but then there are the Hedonic inflation measures of reducing existing services, like instead of offering three DOMs of Deep Book Prices for Futures Markets, now they only offer two DOMs.
Read More >>> No Inflation ...Thanks to ObamaCare
Extrapolate this trend to all areas of market transactions to my plumber only doing part of the work, installing lines to that Kitchen Faucet is another charge apart from installing the actual faucet, i.e., previous items which were included in a price are now a la carte. Whether I am ordering a meal, getting my car repaired, or role players in the NBA getting 15 Million Dollar contracts inflation is everywhere you look in the actual real world economy. The point is that the Fed is basing their case on low inflation levels used to justify ZIRP policy that are severely understating inflation pressures in the real economy, and even at that the numbers are coming in well above their target levels for more than five months and counting!
Irresponsible Risk Taking in Bonds
One can make the case of what the "Normalized Fed Funds Rate" should be going forward, but given the current economic conditions it definitely should not be essentially zero right now! This is just irresponsible and reckless behavior, it is tantamount to AIG selling Credit Default Swaps to gain commissions and premiums with liabilities greater than the Insurance Firm's overall assets. What the heck is the Fed doing at this point? I am sorry Janet but your ineptitude is growing by the hour, extended valuations in Social Media.....Really? What about the Freaking Bond Market.....how sustainable are those prices with these outsized Debt to GDP Ratios? And guess what... ZIRP Dogma in terms of incentives is the sole reason investors are buying bonds at these levels in the form of highly levered speculation plays based upon effective zero percent borrowing costs used to Buy ANYTHING with a YIELD attached to it. Literally prostitutes should not be selling sex; they should just offer up a YIELD, the Big Banks will come running!
10-Year Duration is a Long Time
Anytime there is essentially zero percent borrowing costs, huge leverage will follow, and inappropriate and misallocation of capital will occur, and this is the current state of financial markets. And no market is more representative of this than the Bond market, and I am referring to the entire Bond market from the Periphery Euro Bonds Yields on outright bankrupt countries to the 10-Year Treasury Yield of 2.5%.
Where is this same 10-Year Yield going to be trading 10 years from today? Who knows for certain but given historical levels, there is no rational investor in their right mind thinking this is a level that is based upon the fundamentals, and that this is a sound level to be investing in right here when evaluating the entire risk/reward profile for this duration of asset class.
Entitlements Cost Curve Negative for Longer Bond Duration Expected Value
This same 10-Year period encompasses the sharp escalation of the entitlements curve associated with the large baby boomers population hitting the books starting around 2017, what do you think DEBT to GDP will be in 2020? Yeah Janet there is a bubble, but the big and important bubble which is going to cause the next major collapse is in the Bond Market, that is the Bubble you are responsible for creating, and that is the Real Bubble you need to be worried about!
If People start to ask you "Are You Fat?" Then You Are Fat!
You better start raising rates immediately as you are already behind the curve, and the fact that everybody is asking "Is the Fed behind the Curve" and "Does the Fed see any Bubbles" ought to concern the Federal Reserve. When the cabbie starts asking you if you are behind the curve, you are so far behind the curve it isn't even debatable!
Furthermore, the longer you delay raising rates the worse the situation gets, just ask yourself why are these questions even being raised? If the layperson can see it, there is a problem; and if the Fed Oracle cannot see it, this exacerbates the problem.
Complete denial and Fed Procrastination regarding ZIRP as a Fiat Godsend and the obvious Bubble in Bond Prices only makes the Crash evermore devastating and damaging with its legacy more profound given the fact that warning signs abound everywhere for all to see except the Clueless Federal Reserve!