Monday, May 13, 2013 - Tapering Off – A Taste of Honey

Tapering Off – A Taste of Honey

by Sinclair Noe

DOW – 26 = 15,091
SPX + 0.07 = 1633
NAS + 2 = 3438

10 YR YLD + .02 = 1.92%

OIL – 1.16 = 94.88
GOLD – 17.30 = 1431.80
SILV - .22 = 23.75

The Murdoch Street Journal ran an article Friday claiming the Federal Reserve has mapped out a plan to exit Quantitative Easing, the Fed's $85 billion dollar per month bond buying program. The article said the Fed will cut its bond-buying program in careful and potentially halting steps, though the timing of when to start is still being debated. Now, you might think this is good news; the Fed thinks there is a way to exit QE; they are eager too manage market expectations and to prevent chaos; and the entire idea of an exit would possibly indicate an improving economy.

Not so fast.

Maybe the Fed is getting worried about risks from zero interest rate policy. In a speech devoted to the vulnerabilities in the financial system, Bernanke identified the search for yield, the threat of a run on money-market funds and the possibility that short-term wholesale markets could dry up in a crisis.

At a speech at a Chicago banking conference, Bernanke said: “In light of the current low interest-rate environment, we are watching particularly closely for instances of ‘reaching for yield’ and other forms of excessive risk-taking, which may affect asset prices and their relationships with fundamentals.”

Bernanke again drew attention to money-market funds, noting the Treasury no longer has the legal authority to guarantee investors’ holdings in funds, as it did after the 2008 panic, when the Reserve Primary Fund “broke the buck”.  Bernanke also repeated concerns about short-term wholesale markets, which have the potential to dry up in another Lehman Brothers-like situation. While Bernanke did not draw the link in the speech, the potential for these markets to dry up is a reason regulators are concerned with mortgage REITs. And he said the legacy from the financial crisis of four years ago remains, with the economy still not regaining lost jobs and with the financial system struggling to deal with the economic, legal and reputational consequences. In the question-and-answer session, Bernanke put himself in the camp that more needs to be done on the issue of “too big to fail” banks.

Good timing by the Fed; they dropped this little bombshell in the Murdoch Street Journal on a Friday, allowing for a weekend of digestion, and so today, it was watered down and inconsequential.

The S&P 500 is up a whopping 145% off the March 2009 crisis low. And year-to-date, it's had a remarkably steady rally, adding up to a 15% gain. Earnings growth is slowing down. Top line and bottom line are not as good as they used to be, but margins are high. They could correct, somehow, over time.

But you have the gravitational forces of slow economy leading eventually to correction, but then the levitational forces of QEs, zero policy rates, more money coming in the market – not just from the US, but from other economies – it's going to levitate asset

The arguments for a bull market are not built on a belief in economic strength. They always revolve around asset inflation via money printing.

How bullish can the crowd be if no one is bullish on the real economy? I suppose it's easy to be bullish on Wall Street, but at some point the financials need reinforcement from the real economy.

The Fed doesn't have an easy job. While we hear about the Fed tapering off of QE, or altering the mix of bond buying; all the while trying to keep Wall Street from jumping out a window, don't forget the Fed has another mandate – jobs.

The Fed's forward guidance on unemployment is in danger of giving misleading signals about the need for tightening, and it probably needs to be changed. The difficulty is that unemployment is declining towards the announced threshold in part because large numbers of people have left the labor force altogether as the recession has dragged on, and this probably means that the official unemployment rate is no longer acting as a consistent measuring rod for the amount of slack in the labor market.

The upshot is that the Fed will probably want to keep short rates at zero until unemployment has dropped a long way below 6.5 per cent.

It is a distortion which the Fed cannot afford to ignore. Its mandate requires that it should aim for “maximum employment”, not “minimum unemployment on the official statistics”, which is what it risks doing under its current forward guidance.

Bernanke may have been trying to test the waters to see how the markets react to the idea of tightening too early, but he has a mandate that seems to indicate he should wait until he sees solid evidence of a revival in employment. Maybe the market reaction was really a realization that the Fed is nowhere near to an exit just yet.

Is it possible to have too much central bank easing? For an answer to that question, we turn to Japan, where the dollar/yen has now broken above 100, and it is widely believed the drop in the yen is going to have a positive impact on Japanese imports.  In fact it seems like most economists think that the easing of monetary policy we have seen in Japan is about the exchange rate and the impact on Japanese “competitiveness”.

But if you look at the way Japanese monetary easing is taking place, a funny thing becomes clear. Japanese exporters are not changing prices, but instead just allowing the impact of the weaker Yen to fall straight through to the bottom line. That won't last forever; they will soon turn their attention to leveraging the weaker Yen to cut prices and take market share; and the most likely place to feel a pinch in their market share is Europe.

If Germany and by extension Europe experiences weaker growth, European policymakers will need to respond. And they are not likely to respond by buying Yen to hold its value up. They are likely to respond by stimulating their domestic economy directly via easier monetary policy and, hopefully, easier fiscal policy. In other words, successful domestically-orientated policy in Japan will have second-round effects that will induce further policy easing in Europe.

And specifically, it would be easing for German manufacturers; and if that happens, it will be difficult for the Germans to claim they need further policy easing without allowing easing across Europe. In other words, Abenomics in Japan may be required to break the German grip on austerity for the rest of Europe.

And now, on a completely different note.

Nearly one in three commercial honeybee colonies in the United States died or disappeared last winter, an unsustainable decline that threatens the nation's food supply.

Multiple factors - pesticides, fungicides, parasites, viruses and malnutrition - are believed to cause the losses. We're getting closer and closer to the point where we don't have enough bees in this country to meet pollination demands. Beekeepers lost 31 percent of their colonies in late 2012 and early 2013, roughly double what's considered acceptable attrition through natural causes. The losses are in keeping with rates documented since 2006, when beekeeper concerns prompted the first nationwide survey of honeybee health. Hopes raised by drop in rates of loss to 22 percent in 2011-2012 were wiped out by the new numbers.

The honeybee shortage nearly came to a head in March in California, when there were barely enough bees to pollinate the almond crop.

Had the weather not been ideal, the almonds would have gone unpollinated - a taste, as it were, of a future in which honeybee problems are not solved. If we want to grow fruits and nuts and berries, this is important. One in every three bites of food consumed in the US is directly or indirectly pollinated by bees.

Scientists have raced to explain the losses, which fall into different categories. Some result from what's called colony collapse disorder, a malady first reported in 2006 in which honeybees abandon their hives and vanish. Colony collapse disorder, or CCD, subsequently became a public shorthand for describing bee calamities. Most losses reported in the latest survey, however, don't actually fit the CCD profile. And though CCD is largely undocumented in western Europe, honeybee losses there have also been dramatic. In fact, CCD seems to be declining, even as total losses mount. The honeybees are simply dying. It may have something to do with the way bees are trucked around the country as part of an industrialized pollinating business; it may be widespread use of pesticides; it might even be climate change.

We can debate monetary policy, but without honeybees, there is no debate – we would have a really big problem.