Interest Rate Puzzle — Paul Craig Roberts and Dave Kranzler June 4, 2014 | Categories: Articles & Columns | Tags: Fed, interest rates, | Print This Article Print This Article Interest Rate Puzzle
Paul Craig Roberts and Dave Kranzler
One of the biggest puzzles in the financial markets this year has been the considerable fall in interest rates despite the Fed’s program of tapering or cutting back the Fed’s bond purchases known as Quantitative Easing. A year ago, when Fed Chairman Bernanke announced the possibility of tapering QE on May 22, 2013, the 10-year Treasury yield was 2.03%. The yield quickly moved up close to 3% after Bernanke’s taper comments, forcing the Fed to retract or “clarify” them. Since January 2014, however, when the Fed actually began tapering, the 10-year yield has steadily declined from over 3% to it’s current yield of just over 2.5%.
The puzzle is: why did a mere mention of tapering send interest rates up while actual tapering sent them down?
The Fed’s stated goal for QE back in late 2008 was to stimulate an economic recovery by forcing down interest rates with bond purchases. If the Fed reduced its bond purchases this year because QE succeeded in improving the economy, interest rates should be rising as companies and consumers bid for loans. Rising interest rates are one of the primary indicators of an improving economy.
How to explain this anomaly?
Perhaps the answer is that QE did not stimulate the economy and that realization of this fact among more savvy investors is resulting in money moving out of the more risky stocks into the relatively safety of Treasuries.
Most of the $3.47 trillion in new money that the Fed has created since December 2008 did not find its way into the economy. Instead, 73%–$2.53 trillion– of the new money is sitting on the balance sheets of the big banks, earning interest being paid by the Fed in the banks’ Excess Reserves (free cash) account at the Fed.
Excess reserves are the amount of cash held by banks at the Fed which are greater than the amount of required reserves (required reserves are the cash and cash-equivalent securities held as reserves against bank liabilities).
It looks like the true purpose of QE was to shore up the banks, and that tapering began in order to shore up the dollar.
Prices of debt instruments tend to move in the same direction. By pushing up bond prices, the Fed’s purchases raised the prices of the debt-related derivatives on the banks’ balance sheets, making the banks appear more solvent. After years of QE, the banks have $2.53 trillion in excess cash, on which they are earning interest, as a cushion.
Just as important to the Fed’s goal of injecting a massive amount of liquidity onto the big bank balance sheets, the Fed also wanted to stimulate the perception of an improving U.S. economy. It achieved this goal by forcing interest rates to such a low level that it triggered a large movement of capital out of the bond market and into the stock market as investors chased higher rates of return. The inexorable rise in the stock market, despite deteriorating economic fundamentals and all-time high stock price-earnings ratios, sends the “message” that the U.S. economy is improving.
In what will end up being even more problematic for our system, by forcing interest rates to an unnaturally low level, the Fed triggered an enormous movement out of lower yielding relatively risk-free assets like high grade corporate bonds and Treasuries and into much riskier – but higher yielding – junk bonds and other low grade fixed income investments. This is turning out to be an exact repeat of risk-taking, casino-bet style of investing that culminated with the 2008 financial crisis.
With the first revised estimate of the first quarter U.S. GDP now lowered from an initial 0.1% rise to a 1.0% decline, it is now apparent that the Fed’s stated goal of QE to stimulate the economy has failed.
Wall Street and the presstitute financial media insist on blaming the relentless rise in Treasury bond prices — and the concomitant decline in interest rates — on a “short squeeze” in the Treasury market. This is the cover story in order to deflect scrutiny from the real reason for the decline in interest rates despite the Fed’s reduction in bond purchases.
The real reason for the large, unexpected decline in interest rates since tapering began in January is that the economy never recovered from the recession that started in 2006. Consequently, current stock prices reflect a recovery that doesn’t exist.
Large investors have gained awareness that the U.S. economy is at risk for a negative second quarter, which would officially move the economy into recession. While the Fed is busy propping up the stock market, large institutional investors are moving out of stocks and into the relative “safety” of Treasury bonds. While not apparent from looking only at the Dow or S&P 500, small stock indices like the Russell 2000 and the Nasdaq Composite and homebuilder stocks have been declining since early March. The average Russell 2000 stock is more than 22% below its 52-week highs, and the S&P 500 all time high has been reached despite fewer and fewer individual stocks setting new highs. The cash from selling the riskier small cap stocks is flooding into Treasury bonds, which is forcing yields lower.
The question that needs to be asked is, what will the Fed do if 2nd quarter GDP is also negative? As QE did not revive the economy, if the economy heads into an official recession, what policies will the Fed implement in an attempt to revive the economy?
21
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Negative interest rates are coming like in Europe. The fed will no longer provide interest on the $2.5 Trillion in reserves held by the banks. Maybe forcing the banks to either loan out the money or maybe even create an even bigger bubble in the stock market. Lot of companies are already sitting on large cash reserves, so they don't need to be loaned money.
The OP can be a scholarly article. For those that yearn for the unvarnished truth, go through that article without the usual prejudices and parse each sentence. Research the effects of m2m on the credit markets, and lender assets, and their ability to loan against those assets, when a lender has to value a performing loan on the theoretical bids in an otherwise collapsed market infected with non-performing sub-prime lending. It really is that good.
vaulation is what it is. What something used to be worth or what it might someday be worth are meaningless when wanting to know what it is currently worth. The point of changing mark to market was to hide current, decreased value and insolvency of the asset holders. If everyone believes they are solvent, they are as good as solvent.
Is it really a good idea to change the yardstick increments when you don't like the measurement? Why bother to measure?
Does it make sense to write down an asset by 70% only to mark it back up 300%?
Dont individual investors follow the same accounting scheme? Shouldnt they have marked down their gold and silver holdings by 30-60%, instead of saying they dont have a loss because they didnt sell? Whats the difference between a bank holding a mortgage on a house that lost 50% and a person who bought silver at $40?
<< <i>Whats the difference between a bank holding a mortgage on a house that lost 50% and a person who bought silver at $40? >>
No difference until valuation is used to affect the decisions of outsiders. If that $40 silver were to be used as collateral on a loan, it is required to be measured in current value. The difference is that the bank gets to lie about asset value and the individual using his silver (or anything else) as collateral does not get to lie. What good are bank balance sheets (or any balance sheet) if they are built on fiction?
Approved Accounting Standards for all market participants are what allow an investor to compare balance sheets knowing that he is comparing apples to apples. When these standards are changed, but only for a select few, one must hope he knows how to compare apples to oranges. It is important to note that the FASB standard change was done against the advice of FASB and under threat from a congress who funds FASB.
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June 4, 2014 | Categories: Articles & Columns | Tags: Fed, interest rates, | Print This Article Print This Article
Interest Rate Puzzle
Paul Craig Roberts and Dave Kranzler
One of the biggest puzzles in the financial markets this year has been the considerable fall in interest rates despite the Fed’s program of tapering or cutting back the Fed’s bond purchases known as Quantitative Easing. A year ago, when Fed Chairman Bernanke announced the possibility of tapering QE on May 22, 2013, the 10-year Treasury yield was 2.03%. The yield quickly moved up close to 3% after Bernanke’s taper comments, forcing the Fed to retract or “clarify” them. Since January 2014, however, when the Fed actually began tapering, the 10-year yield has steadily declined from over 3% to it’s current yield of just over 2.5%.
The puzzle is: why did a mere mention of tapering send interest rates up while actual tapering sent them down?
The Fed’s stated goal for QE back in late 2008 was to stimulate an economic recovery by forcing down interest rates with bond purchases. If the Fed reduced its bond purchases this year because QE succeeded in improving the economy, interest rates should be rising as companies and consumers bid for loans. Rising interest rates are one of the primary indicators of an improving economy.
How to explain this anomaly?
Perhaps the answer is that QE did not stimulate the economy and that realization of this fact among more savvy investors is resulting in money moving out of the more risky stocks into the relatively safety of Treasuries.
Most of the $3.47 trillion in new money that the Fed has created since December 2008 did not find its way into the economy. Instead, 73%–$2.53 trillion– of the new money is sitting on the balance sheets of the big banks, earning interest being paid by the Fed in the banks’ Excess Reserves (free cash) account at the Fed.
Excess reserves are the amount of cash held by banks at the Fed which are greater than the amount of required reserves (required reserves are the cash and cash-equivalent securities held as reserves against bank liabilities).
It looks like the true purpose of QE was to shore up the banks, and that tapering began in order to shore up the dollar.
Prices of debt instruments tend to move in the same direction. By pushing up bond prices, the Fed’s purchases raised the prices of the debt-related derivatives on the banks’ balance sheets, making the banks appear more solvent. After years of QE, the banks have $2.53 trillion in excess cash, on which they are earning interest, as a cushion.
Just as important to the Fed’s goal of injecting a massive amount of liquidity onto the big bank balance sheets, the Fed also wanted to stimulate the perception of an improving U.S. economy. It achieved this goal by forcing interest rates to such a low level that it triggered a large movement of capital out of the bond market and into the stock market as investors chased higher rates of return. The inexorable rise in the stock market, despite deteriorating economic fundamentals and all-time high stock price-earnings ratios, sends the “message” that the U.S. economy is improving.
In what will end up being even more problematic for our system, by forcing interest rates to an unnaturally low level, the Fed triggered an enormous movement out of lower yielding relatively risk-free assets like high grade corporate bonds and Treasuries and into much riskier – but higher yielding – junk bonds and other low grade fixed income investments. This is turning out to be an exact repeat of risk-taking, casino-bet style of investing that culminated with the 2008 financial crisis.
With the first revised estimate of the first quarter U.S. GDP now lowered from an initial 0.1% rise to a 1.0% decline, it is now apparent that the Fed’s stated goal of QE to stimulate the economy has failed.
Wall Street and the presstitute financial media insist on blaming the relentless rise in Treasury bond prices — and the concomitant decline in interest rates — on a “short squeeze” in the Treasury market. This is the cover story in order to deflect scrutiny from the real reason for the decline in interest rates despite the Fed’s reduction in bond purchases.
The real reason for the large, unexpected decline in interest rates since tapering began in January is that the economy never recovered from the recession that started in 2006. Consequently, current stock prices reflect a recovery that doesn’t exist.
Large investors have gained awareness that the U.S. economy is at risk for a negative second quarter, which would officially move the economy into recession. While the Fed is busy propping up the stock market, large institutional investors are moving out of stocks and into the relative “safety” of Treasury bonds. While not apparent from looking only at the Dow or S&P 500, small stock indices like the Russell 2000 and the Nasdaq Composite and homebuilder stocks have been declining since early March. The average Russell 2000 stock is more than 22% below its 52-week highs, and the S&P 500 all time high has been reached despite fewer and fewer individual stocks setting new highs. The cash from selling the riskier small cap stocks is flooding into Treasury bonds, which is forcing yields lower.
The question that needs to be asked is, what will the Fed do if 2nd quarter GDP is also negative? As QE did not revive the economy, if the economy heads into an official recession, what policies will the Fed implement in an attempt to revive the economy?
21
Menomonee Falls Wisconsin USA
http://www.pcgs.com/SetRegistr...dset.aspx?s=68269&ac=1">Musky 1861 Mint Set
Box of 20
Is it really a good idea to change the yardstick increments when you don't like the measurement? Why bother to measure?
"Who needs risk management when you’ve got guaranteed bailouts? - Jesse Felder
Dont individual investors follow the same accounting scheme? Shouldnt they have marked down their gold and silver holdings by 30-60%, instead of saying they dont have a loss because they didnt sell? Whats the difference between a bank holding a mortgage on a house that lost 50% and a person who bought silver at $40?
Knowledge is the enemy of fear
<< <i>Does it make sense to write down an asset by 70% only to mark it back up 300%? >>
As an active trader you are a 100% mark to market guy aren't you?
When I was actively trading stocks I marked everything to market and I do the same with my PM stack.
<< <i>Whats the difference between a bank holding a mortgage on a house that lost 50% and a person who bought silver at $40? >>
No difference until valuation is used to affect the decisions of outsiders. If that $40 silver were to be used as collateral on a loan, it is required to be measured in current value. The difference is that the bank gets to lie about asset value and the individual using his silver (or anything else) as collateral does not get to lie. What good are bank balance sheets (or any balance sheet) if they are built on fiction?
Approved Accounting Standards for all market participants are what allow an investor to compare balance sheets knowing that he is comparing apples to apples. When these standards are changed, but only for a select few, one must hope he knows how to compare apples to oranges. It is important to note that the FASB standard change was done against the advice of FASB and under threat from a congress who funds FASB.
"Who needs risk management when you’ve got guaranteed bailouts? - Jesse Felder