Out of the Box: Stepping it Up-And Down
The mold has been broken. It took place this morning, as the 30-year Treasury hits a 2.06%, as I am writing my commentary. This is the lowest yield for this security going back decades and decades. It is astounding, really, as the central banks of the world have changed course, with $15.9 trillion in negatively yielding debt, and the Fed, in my opinion, is going to get dragged along, like it or not.
I had predicated, some months ago, that American yields were heading in this direction and that the former all-time low yields would be broken. I stuck my neck out, at the time, and, here we are this morning. You may ask, “What now old sow?” The answer is that we are heading even lower, as the Fed has been backed into a corner and it is going to be forced to “go along” if for no other reason than to protect American interests, as that is the “Purpose”, of the Federal Reserve Banks.
Wall Street often talks about the “Mandates” of the Fed. Ahead of the “Mandates,” in my view, is the “Purpose.” The Fed was created by the Federal Reserve Act of 1913 and signed into law by President Woodrow Wilson. The “Mandates” of the Fed have been changed several times, by Congress, since inception. Congress initiated the Fed, and Congress has the power, and the authority, to direct its actions, or even revoke its Charter.
The Federal Reserve Act declares: “The Federal Reserve System is the central bank of the United States.”
You will note that it does NOT say that the Fed is the central bank for the world, as is often touted in the Press. With our interest rates currently positive, we are about the last man standing in the above Zero zone. In the Eurozone, Switzerland, Japan and Scandinavia, official interest rates are negative. The Fed may not wish to go here but I assert that the economic pressure, from the other major central banks, are about to force the Fed’s hand towards lower rates.
You can forget President Trump and you can forget the Socialism of some of the Democratic Presidential contenders. That is nothing more than “show and tell” and tweet to your heart’s content. There is now acute pressure, in my opinion, on the Fed to protect American interests and remain competitive both in raising money, and in maintaining our economy, when confronted with $15.1 trillion of negatively yielding sovereign and corporate debt, including some High Yield names. The United States is under the gun and, as the Dollar gains momentum, this will become even more clear.
In a little more than a month’s time the strain is going to get worse as the European Central Bank announces its new measures, it’s “latest trick.” Several weeks ago, Mario Draghi, President of the European Central Bank, suggested that it was “unquestionable” that fiscal measures would be required if the Eurozone economy deteriorates further. Make a special note here as the recent economic data from Germany suggests an economy that is deteriorating further. I am expecting “shock and awe,” at the next ECB meeting, as I believe their Quantitative Easing program will be expand, their balance sheet will get levered up, once again, their purchase of corporate bonds program enlarged and possibly even equity purchases by the ECB to commence.
In the old days, long gone now, governments had to pay for their budgets, and social programs, by raising taxes or selling off assets. This was the way of it for thousands of years but that paradigm has now been broken. Now the central banks create money from nothing but keystrokes and then buy bonds, and other securities, to force down the interest rates for the countries they represent, so that they can pay for their budgets. This “Manufactured Money” has become some form of “Fairy Tale Currency“ long dreamt of, but never realized before.
Another policy, already being practiced by the Bank of Japan, and the Swiss National Bank, and recently advocated by the Chief Global Investment Officer at the investment firm, BlackRock, is that the ECB should consider buying stocks to maintain the value of the equity markets. This might work for the ECB, though I am afraid that America’s Democratic socialists would be screaming from the rafters. Congress would undoubtedly have to pass some law, allowing this, and I don’t see a shot in Hell of this happening in America, from either side of the aisle.
The ECB, itself, has also recently come out with their own new radical departure to save the Eurozone, once again, as the economies in many European countries, including Germany, are cratering. The fancy words that the ECB uses for it are “targeted long-term refinancing operations.” What this is, at its baseline, is a policy of dual interest rates which involves giving money to both borrowers and savers. The ECB is proposing to cut the interest rate, on money they lend to banks, subject to the money being lent to individuals, and that they raise the interest rate paid on deposits, to individuals.
I point out, once again, that the European Union, who controls the ECB one hundred percent, is engaging in all of these tactics because the nations of Europe cannot afford their own budgets, or social programs without raising taxes, which they cannot do without political upheaval. So, they have taken the lessons they learned from the financial crisis of 2008/2009 and expanded them, and enlarged them, so that they can pay for stuff with “Manufactured Money,” all created from a wink and a blink and a nod.
I don’t know if we are going to fall down the rabbit hole, and have negative yielding debt. However, I can tell you, that we are going to peek down the hole and be forced to make a decision. In the meantime, it is the “Bewitching Season” for borrowers as anything and everything is going to come down in yield and be re-financed. I also point out that there is going to come a time when lower and lower rates no longer move the needle and then, well, hold your breath.
“Begin at the beginning,” the King said, very gravely, “and go on till you come to the end: then stop.”
Please pay attention to the King’s advice!
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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