One of the themes that I have been strongly promoting in my enrolled member area is the idea that most of what we are seeing in the financial world these days is more of a reflection of the perverse influence of a liquidity flood than anything meaningful. Watching how the markets were instantly recovered from the Dubai Debacle on Friday and today (Monday), and seeing gold and stocks and bonds all floating along despite the crisis is just further confirmation for the idea that the world’s liquidity pumps are set to “maximum power.”
I am truly amazed at what I am seeing out there in the markets these days. I also understand and share the frustration of the many analysts who know what “should” be happening but is not.
What should be happening is massive, self-reinforcing deflation caused by debt destruction and resulting from the housing bust and retreat of consumer borrowing.
These are harrowing figures:
Consumer credit falls for 8th month
NEW YORK (CNNMoney.com) — Consumer credit fell in September for the eighth straight month, the longest streak of declines since the Federal Reserve started keeping records in 1943.
Total consumer borrowing fell a seasonally adjusted $14.8 billion, or 7.2%, to $2.456 trillion in September, according to the Federal Reserve.
One in Four Borrowers Is Underwater
The proportion of U.S. homeowners who owe more on their mortgages than the properties are worth has swelled to about 23%, threatening prospects for a sustained housing recovery.
Nearly 10.7 million households had negative equity in their homes in the third quarter, according to First American CoreLogic, a real-estate information company based in Santa Ana, Calif.
There is simply no doubt that a finally defeated US consumer is in full retrenchment mode. With one-in-four houses now with a mortgage ‘underwater,’ and record breaking declines in consumer credit, the great consumer credit bubble is well and truly over. Deflation should be driving down assets (like stocks and commodities).
However, our financial markets are telling a very different story, with signs of plentiful, if not rampant, liquidity everywhere.
First, in the largest market of them all (by sheer size) is the bond market. There we find staggeringly large Treasury auctions being held week after week with stupendously low yields and suspiciously high ‘indirect bidders’ (foreign central banks) showing up each week.
Check out the results from this past week (November 23-25).
Monday November 23
11:37 [UST3MO] Treasury sells $31 billion 6-month bills at 0.142%
11:37 [UST3MO] Treasury sells $30 billion 3-month bills at 0.041%
Monday November 23
1:04 [UST2YR] Treasury sells $44 bln in 2-year notes at 0.802%
1:04 [UST2YR] Bidders offer $3.16 for each $1 in 2-yr debt sold
1:04 [UST2YR] Indirect bidders buy 44.5% of 2-year note auction
Tuesday November 24
1:05 [UST5YR] Indirect bidders buy 61% of 5-year-note auction
1:05 [UST5YR] Treasurys extend gains after 5-year-note sale
1:04 [UST5YR] Treasury sells $42 bln in 5-year notes at 2.175%
1:04 [UST5YR] Bidders offer $2.81 for each $1 of 5-yr debt sold
Treasurys gain, straight through 2-year auction
NEW YORK (MarketWatch) — Long-term Treasury prices advanced Monday, maintaining higher ground as the government’s 2-year-note sale received sufficient demand, kicking off $118 billion in debt sales scheduled for this holiday-shortened week.
Gains made earlier in long-term Treasurys stemmed from Federal Reserve officials’ comments that eased concerns about rising interest rates by suggesting that the U.S. central bank may need to continue its asset-buying programs and keep interest rates low for a very long time.
Excuse me, but what? To me it is counterintuitive that interest rates should remain low, because the Federal Reserve has promised to flood the world with ever more freshly-printed dollars. It seems to me that normal market forces would operate in the exact reverse direction from what we are currently seeing.
Of course, as my long-time readers know, I happen to believe the mystery can be solved by simply understanding that our bond markets are now subject to large and frequent interventions by so-called non-economic players (i.e. central banks), which do not care about gains or losses.
Evidence of the Liquidity Flood
Let’s look at the various components that have caused me to be extremely careful about hopping on the deflation bandwagon. I fully suspect that I will at some point, but for now, the markets are telling me that we are awash in money.
Exhibit A – Bonds
Below we will look at the bonds that were auctioned this week: the 3-month T-bill, the 2-year and the 5-year note.
The funny stuff I recently saw in the 3-month bill has really left me scratching my head. Marked on the chart is one example. I am left wondering why it is that investors show up at auction and pay so much that they receive a 10x worse rate of yield than they could secure in the open market the next day. Who does that? Not regular investors, we can be sure.
Why does the media never question the odd behavior of Treasuries becoming more expensive right before or on the day of a massive auction? In a normal world, huge quantities of new supply to sell would drive the price down, not up.
There has been a massive flood of money coming into the 2-year issuances as well. That’s quite a run from August.
Ditto for the 5-year. There has clearly been plenty of money coming into these markets.
There’s really nothing else to say, except that lots of money has been pouring into the bond markets and the major source is not really in doubt – central banks. Naturally this makes sense, as they are dead-set on getting the credit markets back moving again, even if this means punishing savers with low yields and forcing people to take more risks in the stock market. In fact, that last one is a desirable outcome.
Exhibit B: Stocks
Given the fundamental stories out there, including the precipitous drops in state sales tax revenues, unemployment, plunging government income tax receipts and the like, the fundamental view would be that stocks should be mired near their recent lows.
But that is simply not the case.
Normally when stocks go up, bonds go down but we are living in an environment where both are going up. What does this mean? That’s easy, it means that there are gobs of money flooding into the paper markets.
Exhibit C: Commodities
Copper is often called “Dr. Copper” for its keen ability to tell what’s going on in the world economy. When the economy is booming, copper goes up. When the economy turns south, it goes down. Many traders listen carefully to the good doctor.
What’s he saying?
In the past 8 months, Dr. Copper has more than doubled in price. Does this smell like deflation? Not to me, it doesn’t.
And it vexes me because I simply cannot square up the news reports I am reading about the state of the world economy and this price chart. Has the good doctor lost his abilities? Does he no longer predict anything?
What’s going on here, I believe, is that copper is merely signaling that there’s entirely too much money floating around searching for something to do.
Think of the money the Federal Reserve (et al) has poured into the big banks like jelly squeezed in a fist. It’s got to go somewhere.
So instead of telling us something clever about the health of the world’s economies, I think Dr. Copper is merely drunk on a bunch of funny money. His voice is garbled and we’d do better than to follow his staggering gait around town.
Still, at least we know there’s a party going on somewhere they are serving high-quality hooch.
Exhibit D: Gold
I do not view gold as an inflation hedge. I think of gold as, first and foremost, my protection against a currency decline or accident. Secondarily, it protects me in the event of a systemic financial accident or crisis.
The recent price action of gold is indistinguishable from that of copper or bonds or stocks so I consider its current price to be mainly reflective of a liquidity flood.
The Dollar
At the same time that we are seeing a pronounced liquidity flood manifest throughout numerous financial and commodity markets, the dollar has been steadily losing value.
To me this looks like an entirely orderly and coordinated process. In theory, with foreign central banks snapping up record amounts of Treasuries, there should be a pretty good bid under the dollar. However, it just keeps leaking away, month after month.
This is exactly what I predicted would happen, simply because it is the only policy that makes sense. The US is insolvent, and the only hope of reconciling current debts with a future economy is by having a devalued dollar make those debts appear smaller.
If you were to fashion such a program for the government, you, too, would quickly derive a three point plan consisting of a lower dollar, low interest rates, and massive deficit spending. We are seeing all three of these, and they are really not all that surprising to me. What is surprising is the fact that the foreign central banks and governments are going along with the plan.
Conclusion
All in all, I think what we are seeing in the markets is most consistent with, and best explained by, a simple policy of dumping lots and lots of money into the markets. At the same time the dollar leaks away.
When do markets cease to be markets? When they are so distorted by monetary interventions that they no longer provide useful or rational price signals.
Until some form of useful price information is allowed to once again enter the markets, I will consider them to be largely untradeable for anybody but the very good, the lucky, or the well-connected.
I am not sure when this ends, but I am reasonably certain that it ends in tears, because I doubt that policy can trump reality.
While I sympathize with the challenges facing the monetary and fiscal leadership of the world, I remain stubbornly unconvinced that a problem rooted in too-cheap money and too much debt can be fixed with cheaper money and more debt.
And I am not the only one raising such questions. In the NYTimes this article recently ran:
Wave of Debt Payments Facing U.S. Government
WASHINGTON — The United States government is financing its more than trillion-dollar-a-year borrowing with i.o.u.’s on terms that seem too good to be true.
But that happy situation, aided by ultralow interest rates, may not last much longer.
Treasury officials now face a trifecta of headaches: a mountain of new debt, a balloon of short-term borrowings that come due in the months ahead, and interest rates that are sure to climb back to normal as soon as the Federal Reserve decides that the emergency has passed.
I invite you to read the rest of the article, as it really pulls no punches and lays out what should (there’s that word again) be an iron-clad case against buying Treasuries at these ridiculous levels.
As always, I will continue to watch the markets very closely for any signs of change. For now we remain stuck with the liquidity pumps on “full.”
In case you want to track Treasury bond prices yourself, just print out these symbols to use at the free charting service http://stockcharts.com:
$DJCBTI Dow Jones CBOT Treasury Index
$FVX 5 Year Treasury Note Yield
$TNX 10 Year Treasury Note Yield
$UST10Y 10-Year US Treasury Yield (EOD)
$UST1M 1-Month US Treasury Yield (EOD)
$IRX 3-month T-bill Yield
$UST6M 6-Month US Treasury Yield (EOD)
$UST1Y 1-Year US Treasury Yield (EOD)
$UST20Y 20-Year US Treasury Yield (EOD)
$UST2Y 2-Year US Treasury Yield (EOD)
$UST30Y 30-Year US Treasury Yield (EOD)
$UST3M 3-Month US Treasury Yield (EOD)
$UST3Y 3-Year US Treasury Yield (EOD)
$UST5Y 5-Year US Treasury Yield (EOD)
$UST7Y 7-Year US Treasury Yield (EOD)
$USTU 2-Year US Treasury Note Price (EOD)
$USB 30-Year US Treasury Bond Price (EOD)
$USFV 5-Year US Treasury Note Price (EOD)
$UST 10-Year US Treasury Note Price (EOD)
$TED Treasury – EuroDollar Spread
by jdownie