Out of the Box: Thursday is Going to be One for the Record Books
The Fed is going to do something on Thursday. Exactly what, is unknown, but it will mark a departure from the former policies of the Fed. They are highly likely to lower America’s interest rates, perhaps announce that they will only be buying Treasury securities from now on which, I point out, will widen the spread of Agencies to Treasuries if the Fed is exiting the Agency market. They might also announce that they will start buying Treasury Bills which will steepen the Yield Curve, no doubt. Whatever they actually do announce it will be significant because it will mark an absolute reversal from the former monetary policies of the Fed where interest rates were raised, and raised again, and therefore slowed down the economy of the United States and, in my opinion, unnecessarily.
“All right,” said the Cat; and this time it vanished quite slowly, beginning with the end of the tail, and ending with the grin, which remained sometime after the rest of it had gone.”
-Lewis Carroll, Wonderland
The Fed was created by the Federal Reserve Act of 1913 and signed into law by President Woodrow Wilson. The Fed is not some off-shore institution, or some separate entity, from the American government. Also, it is not the “world’s central bank,” as it has been so often termed in the Press.
The Federal Reserve Bank has been formulated to protect the interests of the United States. While it is true that they are “Independent,” that they can make their own decisions, they are not above the wishes of the government, or of the people. It is my opinion, therefore, that the President, a Senator, a Congressman, has the right, if not the obligation, to ask just what the Fed is doing, when they do not seem to be operating in the best interests of the country.
The Fed, itself, declares: “The Federal Reserve System is the central bank of the United States. It performs five general functions to promote the effective operation of the U.S. economy and, more generally, the public interest. The Federal Reserve conducts the nation’s monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy; promotes the stability of the financial system and seeks to minimize and contain systemic risks through active monitoring and engagement in the U.S. and abroad; promotes the safety and soundness of individual financial institutions and monitors their impact on the financial system as a whole; fosters payment and settlement system safety and efficiency through services to the banking industry and the U.S. government that facilitate U.S.-dollar transactions and payments; and promotes consumer protection and community development through consumer-focused supervision and examination, research and analysis of emerging consumer issues and trends, community economic development activities, and the administration of consumer laws and regulations.”
Let me address the “Yield Curve.” The Fed is the eight hundred-thousand-pound beast in the room. I describe the Fed this way because the “800-pound gorilla” litany does not adequately describe the power of the Fed. These people are the “only” people in the United States that cannot go to jail for counterfeiting as one of their functions is to print money. They are entrusted, in fact, to make this money out of keystrokes, when necessary, and add it to the national supply.
One of their “Independent” decisions has been not to buy short term debt, Treasury Bills, to date, and since they have not entered that room yet, the “Yield Curve” is distorted by their absence. I would further state that historical observations are not accurate, as to an “Inverted Yield Curve,” simply and exactly because the Fed has not held such a dominant position before in the markets.
They were once part of the “Game.” They now are “The Game,” as it is absolutely impossible for any financial institution, or money manager, to compete with the people that make the “Coins of the Realm.” I prophesize that they will soon decide to buy short dated Treasuries and then the “Inverted Yield Curve” will straighten itself out, very quickly, when this occurs. Consequently, the “Inverted Yield Curve” is not signaling any sort of Recession, in my opinion.
The Fed has also indicated that they are about done with buying Agency securities. There is a pitfall here. This means that Agencies are going to widen out against Treasuries, when they step out of this room. This means that the funding for the Agencies is going to become more expensive and, therefore, that the costs of mortgages will rise unless, which I think will happen, that the Fed lowers rates once again and possibly even adds, again, to their balance sheet in the process.
The greatest defect, in analyzing the Fed, in my view, by American institutions, is that they only consider American issues. American economists tend to be myopic in their thinking. This was the case with the recent release of the Jobs Report. The market reaction was a very insular, and incorrect, observation, in my humble opinion. The Fed is but one of a myriad of central banks, each representing a nation, or nations, as is the case for the ECB, and our central bank is entrusted to protect our country, especially when other central banks, and nations, are all protecting theirs.
The central banks of Switzerland and Japan are off buying sovereign debt, corporate debt, equities, Exchange Traded Funds and the like which not only props up their bonds markets, but their equities markets, with money created from nothing but the blink of some banker’s eye. Then the ECB is going to soon start buying more European sovereign and corporate bonds, as they have already indicated, and Ms. Lagarde, if confirmed as the next head of the European Central Bank, knows full well how to please her new Masters in Brussels and Berlin. Who knows, the ECB, in Mr. Draghi’s last “Save the World” act, before he turns over the keys to Ms. Lagarde, may even follow their brethren into equities, in September.
Any new move by the ECB, in my estimation, will “Force,” the Fed to respond even further than whatever they announce on Thursday. There will just be no choice, as the interests of the United States must be protected by our central bank. One more piece of information, from “Grant’s Book of Revelations,” is what will happen because of all of this. It is just not lower yields, heading our way, but a vast reorganization of currency levels as our “Game of Thrones” with China widens out to include the European Union. Gird for battle!
The nations of the world have found a way to pay for their budgets, their social programs, and their aspirations, without raising taxes. They have learned that they can accomplish all of these things by having their central banks create money, and this will be the way of it for the foreseeable future, in my opinion. This is not just a “Different This Time” moment but a “Frigging, Unbelievable, Unreal, and
Radical Departure,” from historical norms. When you have $13.7 Trillion in negatively yielding debt, including High Yield debt, then you know that something historical has taken place.
Alice has identified the problem. We are all living in a sort of “Wonderland,” you know, created by governments that have finally found the Alchemist’s dream of creating money from nothing and then spending it as they like. She states it exactly.
“Either the locks were too large, or the key was too small.”
-Lewis Carroll, Alice’s Adventures in Wonderland
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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