Season of Goodwill

Age of Wisdom, Age of Foolishness (9)

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A lot of giving of other peoples’ (American taxpayers’) money was evident this Festive Season. Incoming Federal housing stimulus Czar Mel Watt opened up the cold fist of the FHA, which had been clenched by the outgoing Ed “Scrooge” DeMarco, by delaying the rise in G-Fees. Watt’s cryptic Christmas Message hinted that the rise in G-Fees would follow a similar epiphany to the non-existent tightening in the “Taper” announced the week before. He opined thus:

“I intend to announce that the FHFA will delay implementation until such time as I have had the opportunity to evaluate fully the rationale for the plan”.

Presumably, the threat of rising interest rates will lead to an “extended period” of evaluation during which Mr Watt will decide that there is no rationale whatsoever; and will probably decide that there is in fact a rationale for actually cutting G-Fees, as his next act of seasonal largesse, in Christmas 2014.

The Bond Market delivered an early Christmas present to the Fed, in exchange for the non-existent “Taper” gift delivered by the FOMC in the previous week[i]. The big yield curve steepening which had discounted the “Taper” was reversed; and became the big flattening after the FOMC decision. The flattening now anticipates slower economic activity as a consequence of the “Taper”. This flattening caps the rise in long-term interest rates, which had been acting as an economic headwind. The Fed has therefore seized back the control of long-term interest rates, which it had lost during the second and third quarters of 2013. By appearing to tighten, although actually reducing the pace of easing by $10 billion a month, the Fed has therefore capped the rise in long-term interest rates; whilst pretending to execute a policy which should allegedly lead to them rising. Observers will now look at the flattening yield curve as a sign of the success of Fed policy. Equity traders wasted little time in understanding all this and immediately bounded further up the “Wall of Worry”. The real kicker, in this nativity story, is to be found on the Fed’s balance sheet. Thus far, the rise in yields has choked off the creation of assets for the Fed to buy. In addition, the rise in yields had also led to substantial losses on the Fed’s balance sheet holdings. Going into the last FOMC meeting, the Fed was facing a situation of rising capital losses; and also the loss of assets to buy in order to drive yields lower to turn the existing balance sheet losses into gains. In short, the Fed was facing the situation in which it had lost the control of long-term interest rates, with disastrous consequences for itself and the economy. The knee-jerk yield curve flattening now unlocks the creation of more assets for the Fed to buy, whilst simultaneously removing the mark-to-market losses on existing holdings. The Fed is back in control.

As a result, American corporate credit risk appears to be where the Alpha is. Seasonal excess is therefore very evident in the level of American corporate bond yield spreads. A flattening yield curve only adds to the bubbly excess.

Congress joined in the festive giving atmosphere, long enough for the President to sign into law a new bipartisan debt cutting bill which does not rely solely on the arbitrary “Sequester”. It would seem that the Chinese threat to the “Pivot”, in its latest aggressive posturing with a new air defence zone, was enough to close ranks along national security lines. Going forward, America’s defences are no longer threatened by partisanship; so that they can face down external threats.

The immediate issue following these festivities is to present all this fiscal and monetary largesse as a gift to “Main Street” rather than a continued gift to “Wall Street”. The asset bubbles and champagne bubbles on “Wall Street” always seem burst on “Main Street” however.

The people on “Main Street” who may need convincing the most are the Students[ii]. Student Debt continues to run out of control; and must by now be flashing a buy signal on the Fed’s acquisitive radar screen. It must also be flashing a red light at the White House. It is this demographic who voted for the “Change” which they were supposed to “believe in”. So far they look more like the Turkeys who voted for Christmas.


  1. The big steepener unwind
  2. CHART OF THE DAY: Here’s One Thing That’s Actually Getting Much Worse In America

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