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Out of the Box: We Are Bonding

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There it sits. The 800-pound Gorilla in the room. We stare at it. It stares at us. Every little move it makes, every little breath it takes, we are watching him. There is nothing, as in nothing, more important to both the bond and equity markets than this fellow. Not China, not the tariffs, not the Dollar, nothing. This fellow is, of course, the Federal Reserve Bank of the United States.

The current version of the Fed was founded in an Act of Congress in 1913. The Fed has been disbanded a number of times by Congress, over the years, and it has the right to do so when they wish. After all of the talk of the Fed’s Independence, it is, in fact, independent, until Congress decides that the independence is over. The Fed, without any question, is a part of the government of the United States. It is not some off-shore entity. The Presidents and Governors have a fourteen-year term and they can be removed for cause but their independence is clearly grounded in what the Congress may decide at any point in time.

The First Bank of the United States (1791–1811) and the Second Bank of the United States (1817–1836) each had a 20-year charter. President Andrew Jackson vetoed legislation to renew the Second Bank of the United States, starting a period of free banking. Jackson staked the legislative success of his second Presidential term on the issue of central banking. “Every monopoly and all exclusive privileges are granted at the expense of the public, which ought to receive a fair equivalent. The many millions which this act proposes to bestow on the stockholders of the existing bank must come directly or indirectly out of the earnings of the American people,” President Jackson said in 1832. Then from 1832 until 1863 there was no central bank of the United States.

It is my opinion, therefore, that any President, any Congressman, any Senator, has an absolute right to criticize the Fed and/or ask them just what they are doing, when they see fit. Independence, in my mind, is not sovereignty. Independence does not mean that they are “above the law or outside the law.” What the Fed’s independence does signify is that they have a right to make their own decisions, under the umbrella of a Congress, that permits them to do so.

In the financial history of the United States, and the world, there are not many “It is different this time,” events. Generally, new events are just off-shoots of old ones, or paths that have a lineage over time. However, after the financial crisis of 2008/2009, which is known as “The Great Recession,” we have had an event that is not only “Different this time,” but an event never seen in the history of the world going all the way back to the money changers on the steps of Solomon’s Temple in the eons preceding Christ.

I speak here of “Negative Yielding Bonds.” They have never, ever happened before the present time. They were $16 trillion in size at one point, then declined to under $10 trillion and now Bank of America reports that they are growing again and stand at $13 trillion presently. They are likely to expand further as the central banks of the world engage in both overt, and covert, easing. This, by the way, is taking place right up until this day. Just take a look at the ECB, the central bank of Switzerland, the Bank of Japan and on they go.

The Fed has been on pause. Some thought, for a period of time, that QE for the moment was finished. Don’t be quite so sure. Don’t be so sure at all!

Many have speculated on the inverted Yield Curve and have pointed to a coming Recession. I do not think this assertation is correct. You see, the Fed has not been buying Treasury Bills or other shorter dated maturities either in Treasuries or Agency paper. Consequently, the 800-pound Gorilla has not entered this space, yet, and so the Yield Curve is inverted by the lack of the Fed’s buying in this space.

I also point out that while the Fed has not been increasing its Quantitative Easing that it is still, to this day, using the assets from its QE program to influence the markets. This, in fact, has never stopped since it started its QE program and so it is incorrect, in my view, to say that the FED has stopped QE as it uses the assets from it. What is correct to say is that the Fed, unlike virtually all of the other central banks, is not currently “expanding” its QE initiative but that may soon change as pressured not only by the President but also the cost of the nation’s borrowing as more and more Treasuries are put up for auction to fund the desires of Congress and the President.

As a matter of fact, our interest rates are so much higher than either Europe or Japan that there is plenty of room to maneuver at these levels. The Fed may say, “the economy” or “Inflation” or the “Trade Wars” to divert your attention but it may all get down to lowering the borrowing costs for the United States that spurs any forthcoming rate cuts but don’t expect that to be stated in public by our central bank. Fed Fund futures prices on the CME Group website, meanwhile, are pricing in an 86% chance of a December rate cut, while those linked to a September move are implying a 62% chance, up from just 50% last week.

Meanwhile Bloomberg’s American Investment Grade Corporate Bond Index is tightening to Treasuries along with Bloomberg’s American High Yield Index. The hunt for yield is on as the equity markets bumble one way and another awaiting a Fed move, a resolution to the “Game of Thrones” war with China and the possibility of tariffs on Mexico relating to our immigration crisis at the border.
Make no mistake here. The Fed, and the other major central banks of the world, now control and dominate the markets and have done so since the 2008/2009 financial crisis. You can make what decisions you like, but you cannot win, when facing off with the people that make the money out of a nod and a keystroke. You have no chance in Hell of beating these people because you cannot make money and they can. Once this is clearly understood then your strategies must be changed to take all of this into account.

“You will not apply my precept,” he said, shaking his head. “How often have I said to you that when you have eliminated the impossible, whatever remains, however improbable, must be the truth?”

-The enviable Mr. Sherlock Holmes

The Fed, and the other major central banks, control the markets and that is just the truth of it now!

Mark J. Grant
Chief Global Strategist, Fixed Income
Managing Director
B. Riley FBR Inc.
U.S. 954-468-2366

Information herein is for general use; is not unbiased/impartial; is current at publication date, subject to change; may be from third parties; and may not be accurate or complete. Opinions are the Author’s, not B. Riley FBR, Inc., or their respective affiliates or subsidiaries. This is not a research report or solicitation or recommendation to buy/sell the subject securities. Investment factors are not fully addressed herein. B. Riley FBR Inc. and their affiliates may have a proprietary position in the subject securities.
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