Yesterday was a good day for almost everyone on Wall Street. The Dow rose 198 points. Gold rose $15 an ounce.
But long-dated Treasury bonds sold off. The bond market is worried its biggest buyer – the Janet Yellen Fed – will bow out.
The proximate cause of rising prices and falling ones was the news from Washington.
First, Congress voted to raise the debt ceiling, without quibbles or conditions, until next year.
Second, Janet Yellen made her debut on Capitol Hill as Fed chairwoman with this question from Republican Congressman Jeb Hensarling, from the sovereign state of Texas:
“Are you a sensible central banker, and if not, when will you become one?”
It was a coded challenge, based on Yellen’s 1995 statement that a sensible central bank follows formulae… and transparent rules… rather than making ad hoc decisions.
Yellen replied that, yes, she was sensible and that, yes, a central bank should follow transparent rules…
…but that she would continue making it up as she goes along. Christian Science Monitor reports:
For more than a year, the Fed’s policy committee has said it wouldn’t consider a hike in the short-term interest rate until unemployment dipped to 6.5%, as long as inflation didn’t exceed 2%. Today, with the jobless rate already down to 6.6%, Fed officials including Yellen are saying the 6.5% rate is not a “trigger” for raising rates.
In practice, Yellen told lawmakers on Tuesday that she would be looking at a range of labor-market and inflation data to assess when to raise rates. It’s likely the Fed will maintain ultra-low interest rates “well past the time that the unemployment rate declines below 6-6.5%,” she said in the written testimony prepared for Tuesday’s hearing.
So, QE could go on…
Manna from Heaven
It looks as though financial author Richard Duncan was right. He told us that the Fed fuels “excess funding” of America’s credit needs… and that this excess funding drives the stock market.
There should be enough to keep the stock market up during the first half of 2014, he said. But if the Fed keeps to its tapering promises, watch out.
This source of funding is like manna from heaven. No calloused hands earned it. No drop of sweat stains it. No furrowed brow figured out how to make it.
Five years ago, we were certain the Fed could not expand its balance sheet to $4 trillion without grave and ghastly consequences. But month after month goes by with no such consequences… nor even the top of their masts visible on the horizon…what are we to think?
When the global financial crisis arrived in 2008, our prediction sounded like a tour itinerary: first Tokyo, then Buenos Aires.
We meant that the US economy was entering a period of deleveraging, much like that of Japan at the start of the 1990s. Paying down, defaulting on, writing down and writing off debt would be long and hard, we reckoned. When that was over, we would find ourselves in a period of inflation, maybe even hyperinflation. This could come about in one of two ways.
When the deleveraging was complete, people would begin to borrow and spend again. This would increase the money supply – possibly virulently, given the Fed’s ultra-low interest rates – and drive up consumer prices.
Or desperate and impatient to revive the go-go days before the crisis began, the Fed might resort to direct monetary stimulus (some sort of helicopter drop).
The Fed surely has a contingency plan. A sensible central banker wouldn’t think of doing it. But despite what Yellen told lawmakers yesterday, we are in an age of “improv” monetary experimentation. We shouldn’t rule anything out.
US consumer prices – by the official measure – rose 1.5% over the last 12 months. Economists aren’t worried about too much inflation, but about the lack of it.
We are still in Tokyo, not Buenos Aires.
Emerging Markets – 33% Off
From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners
The Fed is being held partially responsible for the recent upset in the emerging markets.
Ever since the Fed hinted that it would taper its bond buying, emerging market assets have had a rough ride. And year to date, the MSCI Emerging Market Index is down nearly 7%.
The good news for value-minded investors is that panic over the emerging markets has opened up a big discount on emerging market stocks relative to developed market stocks.
As you can see from the chart below, emerging markets are on sale.
There is now a 33% discount, on a price-earnings basis, on the MSCI Emerging Market Index relative to the MSCI World Index (which tracks stocks across 23 developed markets).
Of course, nobody knows what the future holds for emerging markets. But nobody knows what the future holds for developed markets either.
As Bill puts it, what kind of investments do you want to be holding when you find out?
Ones you paid dearly for, with plenty of downside?
Or cheap stocks that could surprise in the other direction?