by EconMatters, EconMatters.com
Yellen’s Talking Points
During Janet Yellen’s Senate Banking Committee testimony to paraphrase she said that she doesn’t see a bubble in stock prices based upon some of the metrics they utilize at the Fed, and she mentioned that the rise in the 10-year Bond Yield approaching 3% caused the Fed to delay their previously telegraphed taper move in October.
There are a couple of disturbing points that came out of her take on bubbles and the rationale behind not tapering a mere 10 or 15 Billion dollars given the monthly commitment of 85 Billion in Fed Purchases every month.
Since when did the Fed outright Buying of Bonds become Normal?
Just the mere notion given the history of markets and the Fed’s participation in Markets that the Federal Reserve buying $85 Billion of Monthly Asset Purchases is somehow normal or not just an exceptionally unusual participation in financial markets is quite troubling.
First problematic issue is that they do not think this policy is extraordinarily unusual, and second problematic issue is that such an extraordinary policy might not have some unintended consequences or side effects for financial markets.
Are Markets Free or Social Instruments?
The Federal Reserve has no business whatsoever in affecting market prices of stocks and commodities, and it seems that the original purpose of easing monetary policy by lowering the Fed Funds Rate to near Zero is one thing, and yes this derivatively will effect Bond Prices and the Bond Markets, but they have no business artificially influencing the Bond Market through outright purchases of government Bonds.
This is far overstepping their purview and it vastly distorts market prices, which is bad enough in and of itself, markets exist for a reason to set prices given fundamentals of supply and demand that reflect economic conditions in the real world.
But to not expect the massive influencing of the Bond Market to then have derivative effects into other markets like commodities and equities and that somehow prices could appreciate to unsustainable levels that come crashing down once the intervention is discontinued is just the height of irresponsibility and short-sightedness.
Market & Trading Experience in Short Supply at the Federal Reserve
Anybody that has actual market experience, someone who regularly through good and bad business cycles trades stocks, bonds, commodities and currencies recognizes how these instruments trade under all conditions.
This is what the Fed lacks is any understanding of what constitutes normal price discovery in financial markets. Economic theory may be great for setting interest rate policy from a Macro level, but once the Fed started directly intervening in Markets, then they need some trading experience to spot bubbly conditions of asset prices, i.e., how the instruments normally trade versus the current market price action.
Distorted Price Discovery in Markets
Whenever traders get to the point where they know they can buy every dip for the last five years because the Fed was always going to bail them out either by restarting another QE Initiative, or the current backstop of 85 Billion of Direct Market Asset Purchases this distorts in a highly artificial manner true market price discovery.
It also leads to borrowing heavily on margin further incentivized by exceptionally low borrowing costs that adds additional fuel to the fire in elevating asset prices to unusually highs levels relative to the actual fundamentals of the market under normal price discovery conditions.
Isn’t this the same Methodology & Psychology of the Last Bubble Cycle?
The most irresponsible portion of this behavior is that this is precisely the behavior that led to the financial crises, the housing crash and resultant mortgage, bank and financial system bailouts of Wall Street firms like AIG, Bear Sterns, Lehman Brothers and Citibank.
Every regulator, politician, Fed Policy figure and Bank Executive all agreed that they had learned the lessons of using excessive leverage, excessive risk taking, and that the Federal Reserve especially was going to set the precedent of “Moral Hazard” in that they were going to go out of their way to avoid the monetary policies of excessive intervention that led to the overly disproportionate risk taking responsible for the Housing Bubble.
And yet in just five short years we have forgotten all this wisdom and learning points and have thrown prudent risk management strategies regarding monetary policy out the window and summarily fail to recognize the Fed’s hand in creating a massively unsustainable bubble in financial markets once again.
10-Year Yield & 3% Threshold – Really?
If the Federal Reserve was threatened by the 10-Year Bond yield approaching 3% so much that they couldn’t taper a mere 15 Billion dollars, then what does that foretell for the future of these markets? The Fed ought to ask themselves this very question, and it ought to keep them up at night!
This says more about the problem that the Fed has gotten itself into with regard to this unusual monetary policy initiative to intervene in financial markets – than at what price level constitutes bubbly conditions in stock prices.
They cannot even approach un-intervening in markets because they have overstepped any normal fed policy boundary or any market policy for that matter that the level of artificial influence is to such a high degree that they basically are the entire market in certain pricing dynamics – unless they are prepared to be the market (whole other set of unintended consequences) then going from an interventionist market back to a free market means absolute chaos – and the classic example of an artificial bubble!
This is the 10-Year Bond Yield; the fact that a 3% yield threatens the Federal Reserve is absurd. This is not the 1-Year Yield, we are talking about a 10 year time period; shoot the Fed Funds Rate was 5.5% just 6 years ago!
Get a grip Fed because you’re worried about the least worrisome dynamic of your Fed Policy’s unintended consequences – what happens when you have a Bond Market after five years of intervention that returns to market forces all the sudden and the US is facing a 12% interest payment on its debt? This is what the Federal Reserve should be worried about down the line.
My parents actually had mortgage rates in the 18% range during their lifetime – this degree of escalation in higher yield is not so unprecedented as some might think. It can happen once again!
This isn’t my First Bubble Rodeo!
I have been a market participant for the last fifteen years and have seen the Tech Bubble, The Enron-World Com Bubbles, The Housing and Financial Crisis Bubbles, and I can tell Janet Yellen asset prices including stock prices are in bubble territory.
When I look at how easily the Google’s, Tesla, Netflix, Priceline’s, Twitter, Amazons of the world have reached these lofty price levels over the last five years the Fed has set the stage for massive price depreciation in stocks and people’s portfolios once the interventionist Fed policy is taken away – these are not normal market conditions Janet Yellen!
Accordingly you may have an economic background, and have economic and financial models that lead you to believe that stocks are not in bubble territory Janet, but from a trading perspective, someone with actual experience in buying and selling financial assets over the last fifteen years – there is no true price discovery, i.e., instruments don’t trade in a two-sided pricing discovery process.
It is Risk-On all the time with no consequences yet for the inevitable unintended consequences of such behavior – the inevitable crash when conditions get unsustainable under any intervention policy.
Now or Later – That is the Question!
This is the real danger to forestall the cessation of intervention for longer, to delay the stepping away, to the point where asset prices get so elevated, that even with an $85 Billion Monthly Asset Purchases, the decline and losses from such elevated levels, means that stocks just crash right through levels in humongous freefalls.
This is the scenario where losses exacerbated by out of this world leverage, cause that 85 Billion to be nothing but a mere entry point for more shorting, as the Market Crash takes hold, and stocks freefall dropping chunks of losses along the way that has fund managers selling without Algos – just get this stuff out the door at any price – this is where we were in 2007 with 15 Billion Quarterly Write-Downs by the Banks!
Hence you can pay now or pay later, but you’re going to pay Janet! So until you get some actual market experience, you keep to worrying about how to create jobs, and let me tell you when there are bubbles in stock prices Janet!
Yes Janet I am smarter than you when it comes to Stock Market Bubbles, and we are currently in a stock market bubble. Consequently when do you want to Pay Janet – it is going to cost you either way, Pay now or Pay Much More Later on down the line!