Category: Economy

The federal reserve has begun to expand its balance sheet for the first time since the end of 2014.

It is loading up on treasury bills, but it is still selling MBS.

The more I hear the FOMC members talk, the more I think they are total clueless about what they are doing. All of these new “tools” they have made since 2008 and all of this balance sheet tinkering and changes risk blowing the economy sky high.
Money supply growth is at risk of climbing to double digits in the next few months which is a rare event in the US. One issue with elevated money supply growth and credit growth is that if it is not pulled back price inflation can spike rapidly. The other issue is shrinking it without causing a recession. All of this tinkering is reminiscent of Dr. Bernanke’s mad monetary operations leading up to the 08 crisis. Sometimes it is hard to tell if they are clueless or disingenuous. This is how I will always remember Dr. Bernanke.

 

Earlier this week, the overnight repo market spiked above 9%. Even the effective funds rate spiked slightly above the upper target. There are a lot of theories about why this happened. The truth is no one will ever know what happened. We do not have enough information on these operations. The important point is the fed had $83 billion in total bids submitted for yesterday morning’s operation which was over the size of the $75 billion operation. In other words, they are going to print money as needed.
Historically, repos used to be a regular part of Fed operations prior to 2008. After Bernanke created a massive amount of money in 2008, these operations seized to be part of fed operations since the banks were sitting on 2.4 trillion dollars of excess reserves. Excess reserves now stand at 1.3 trillion dollars. This is about half of what it was 5 years ago. Even though excess reserves stands at 1.3 trillion dollars, we do not know which banks are holding these excess reserves. It is possible the amount of excess reserves is becoming irrelevant. Maybe they are being held by conservative banks and not really reflective of the market as a whole. Or this could just be a minor technical glitch.
Bottom line- This seems to be a temporary dislocation in the overnight interbank lending market and not a sign of stress.

The US markets are still my favorite. The inverted yield curve been a cause of worry.

Just looking at data and trying to create empirical relationships is pointless in social sciences. This idea has long been debunked. My favorite book on this is, “The Counter-Revolution of Science”. Yet empiricism is the dominate ideology in the field of economics. Go figure.
The important question is why does an inverted yield curve precede a recession. Money supply growth and credit are critical factors to watch. An inverted yield curve tends to upset these two factors. As of right now, there is zero indication that there is stress in the system. In fact, just the opposite. They both remain very strong. This does not mean a 20% or 30% correction in markets is not possible. It just means it will be a buying opportunity.

With the fed meeting next week, traders are expecting a 25 basis point cut.

The federal funds rate has become meaningless since 2009. But traders still watch it and it moves the market. More important is the IOER, which no one cares about. With pressure from the white house, the Federal Reserve looks like it is taking the funds rate back to zero.

When the yield curve inverts, a recession is not far behind.

This is because of the nature of banks. The duration of how they borrow and lend. Typically, when the yield curve inverts a recession follows sometime in the next 2 years. Here is a close up before 2008:

The yield curves inverted in 2006. The market peaked in late 2007, but the real plunge didn’t start until mid 2008.
Similar events took place in 2001:

If you look at past inversions, the stock market tends to have the greatest returns (about 20%) between the point of inversion and the top of the market.  I still believe there are further gains to be had in US stocks. I do not see any signs of stress at the moment.

The movement in markets to the tariffs are completely over blown. The charts below put this into perspective. Total USA exports to China only amounts to 9%.

The “trade war” with China has amounted to a small slice of the economy and a fraction of each countries GDP’s. The share of Chinese soybean imports from the USA this growing season peaked under 40%. It usually climbs to 80%. The trade war with China is hurting Trumps constitutes more than anyone else. As the 2020 election gets closer, I think Trump will tone down his rhetoric on this subject. This will give the market less of a reason to have big down days like Friday.

Everyone gives a reason why the market moves a particular direction. With the US market correcting, we read about all the reasons: weak global economic data, trade wars, inverted yield curves, etc. Just using technical analysis, it became obvious the market was looking for a reason to go down. See my post on “Correction Coming“. This correction will run its coarse. I believe it will be another buying opportunity.
The Federal Reserve is now considering using its new “tool” established in 2016 called counter-cyclical capital buffer. It also established a real-time payment and settlement service called FedNow. I honestly do not know what to make of these programs and it is hard to know what the fed is up to. Jerome Powell is not very good at “fed talk”.
The excess reserves keep declining and the money supply has been growing through the summer. This is very unusual.

If the M2 money supply growth goes to double digits, this will be very bullish for stocks and real estate.

Yield curves across the Euro-zone have compressed toward zero over the past few months. Germany’s entire yield curve has gone negative.

This looks like an intermediate top for these bond markets in Europe.

The fundamentals for the US market to continue its rally are still in place. Buybacks were a huge component for driving US stock markets post the financial crisis. They look set to continue for the remainder of the year.
Money supply has been growing.

This is unusual. Money supply tends to have a downward slope in week 23 of the year. This could possibly be due to the fed having the IOER lower than the effective fed funds rate. Either-way, this is bullish for stocks. The inverted yield curve is cause for concern, but no signs of stress are showing up in the data.

With Germany’s 10 year bonds well into the negative territory, Germany’s 30 year bonds are about to join the party.

Understanding cause (why something happened) and effect (what happened) is essential for getting by in life. This lesson is usually learned very young- after you touch the hot stove and burn your hand. Apparently, there is an entire segment in American society that never learned this lesson. The documentary, “Default: the Student Loan Documentary”, shows this on full display.

Causes:
1-Federal student loan guarantees of the 1960’s.
2-Federal government gives loans directly.
Effects:
Guess what happens when the federal government guarantees loans and than makes it illegal to discharge the debt? Lending institutions throw caution to the wind and begin lending money to any one with a pulse. More money is available for education. People bid up prices. The government funnels money into the education sector and inflates the prices.
Let me put this another way. The government sends everyone in America a $100. This $100 is special though. It has a distinct mark on it that allows the consumer to only buy apples. What do you think would happen to the price of apples? If you answered: “The price of apples would tend to rise”, than skip to the head of the class.
The effect is displayed in one chart.

The students in the documentary are clueless. They want more of the same. They spent $100K on a four year education and didn’t learn about cause and effect. The only lesson the students seemed to learn is how compounding interest works.