Friday, August 23, 2013 - QE Giveth and QE Taketh

QE Giveth and QE Taketh

by Sinclair Noe

DOW + 46 = 15,010
SPX + 6 = 1663
NAS + 19 = 3657
10 YR YLD - .08 = 2.82%
OIL + 1.39 = 106.42
GOLD + 21.70 = 1398.80
SILV + .90 = 24.18


Yesterday, the Nasdaq crashed for about 3 hours; trading was halted; we still don't know why. It now has a snappy name, the Flash Freeze. It happened after shares of Apple got stuck at $498, then everything froze. In time we'll hear a good story about why it happened. My best guess for now is that it has to do with high frequency traders; the algo traders have a tendency to clog the trading pipes with all their bids, offers, and canceled orders as they try to scalp and front run trades. The market exchanges claim the high frequency traders provide liquidity, but I didn't see any liquidity for about 3 hours yesterday; zip, nada.

The markets had a pleasant and quiet day today, following a couple of weeks of fretting about Fed taper. America has created a whopping entitlement for the biggest Wall Street banks and their top executives, who, unlike most of the rest of us, are no longer allowed to fail. They can borrow from the Fed at almost no cost, then lend out the money at 3 percent to 6 percent or 30 percent; or they can take the money and gamble in markets they have rigged: derivatives, interest rates, energy, aluminum. It's all rigged; the big wheel spins round and round and the little ball always falls in the same spot. All told, Wall Street's entitlement is the biggest offered by the federal government, even though it doesn't show up in the budget. And it's not even a public good. It's just private gain.

And this whole idea of a taper, according to the primary dealers in the Federal Reserve banking system the taper is likely to start in September and wind down by the middle of 2014; well, it's not a done deal, and even if it is done there might be unintended consequences. Today, Christine Lagarde, the head of the International Monetary Fund, speaking at the Fed's Jackson Hole soiree, she noted that central bank policies “in one corner of the world can reach all corners.”

There’s little question that the Fed’s unprecedented flood of cash into the financial system since the financial crisis has rippled across the globe. Earlier that sometimes prompted complaints from developing nations that there was too much capital flowing into their markets, bringing inflationary pressures and hurting exports as their currencies rose in value. Now the concern for Lagarde and many others is on the other side and the increased risks of a sharp economic slowdown in emerging markets.

Bearish sentiment has gripped emerging markets in recent weeks. Cash is flowing out, pushing down the values of stocks, bonds, and currencies in India, Indonesia, and elsewhere; the Indian rupee has thrown itself off a cliff. Brazil's problems have been well documented and are boiling over. China's long guaranteed growth is unsure but likely quite a bit slower. Europe is starting to show signs of life but don't look for a V-shaped recovery; there are too many imbalances between the various economies of the Euro-zone. There's still too much debt, and too much bad debt, and the demographics are worse than in the US. Lagarde is correct on one point, the US economy doesn't operate in a vacuum.

And then there is the whole question of whether the Fed's QE has actually worked. There is little question that it has had an effect, but has it worked?

A secondary goal of QE is to accelerate the housing recovery. There are some signs that has happened. Home prices bottomed out in 2012 and have been rising by double-digits, year over year. Existing home sales are up 17% from last summer. But new home sales figures out this morning fell to a 9-month low. That might be a fluke, but it might also be the first tangible sign that rising mortgage rates are slowing the housing recovery before it gathers much momentum. It's hardly a ringing endorsement for tighter money.

The primary goal of QE is to prop up the banks, and to this end the Fed has done quite well. Refi's soared earlier in the year, and that is a big moneymaker for the banks. They write the refi's, extract the fees and dump the mortgages onto the lap of the government owned Fannie Mae and Freddie Mac. Refi's accounted for 70% of all mortgage lending in the first half of this year, but now they're drying up. Mortgage rates have jumped a full percentage point since early May. Wells Fargo Bank is the biggie in mortgage lending, and the refi business is down 50%, so they're firing 2,300 workers. QE giveth, and QE taketh away.

Elsewhere, retail sales aren't shining; even Wal-Mart is struggling. Car sales are up, but so are gas prices, and newer cars are more fuel efficient, so you buy a new car and cut your gas bill – it's a wash.For the Fed, the trick is to put the brakes on QE in the early stages of an economic rebound, because waiting too long could flood the economy with too much money, causing inflation, asset bubbles or worse. Yet it’s remarkably tricky to know in real time where the economy is headed, which is why the Fed and many other forecasters have misjudged the recovery during the past few years.

And then don't forget the Fed's dual mandates of price stability and maximum employment. We do not have maximum employment; not even close. Maybe it's too much to expect the Fed to deliver jobs; certainly it is too much to expect the Fed to deliver jobs with the tools of QE. Maybe it would be easier if the Fed just waits until they hit their target of 6.5% unemployment; clear, clean, and unambiguous

 It’s understandable that everybody wants more clarity, especially as we approach the end of the Bernanke era. But the Fed itself probably doesn’t know what it’s going to do, given the conflicting picture painted by all the data it looks at. And when the Fed finally does change policy, it will probably be incremental, and I'm not confident it has been priced in, not yet; that cake hasn't been baked yet.

Speaking of half-baked; financial reform has been on a back burner for years. Earlier this week President Obama called the regulators to the White House for a progress report, something, anything that might provide assurances that there won't be a repeat of 2008. Administration officials and some lawmakers have expressed frustration that the Dodd-Frank act, remain unenforced as an alphabet soup of federal agencies wrangle over how to adopt it, and the bank lobbyists constantly try to rewrite it.

Last month, Treasury Secretary Jack Lew complained in a speech that the regulators were moving too slowly to confront the dangers of banks that are so large that governments cannot allow them to fail for fear of bringing down the economy. The administration has said it wants to end the era of Too Big To Fail; they have stated flatly that there will be no more bank bailouts, but they still don't have the actual reforms in place. For too long, financial watchdogs were asleep on the job, allowing Wall Street megabanks to become too complex to manage and regulate and ‘too big to fail. As the banks have returned to profitability there has been growing impatience with the pace of bank regulation.

The banks have been feeding at the trough of QE, and now the Fed is talking about removing QE. This means the banks had damn well better be strong enough, they had better set aside enough reserves to weather problems. It wouldn't look good to pull away QE, have a big bank fail, and then have to go through this whole bailout process all over again. And make no mistake, QE1, QE2, and QE3 have all been an ongoing, drawn out bailout for the banks.

If we could ever get past the fear of another global financial meltdown scenario, maybe we could take all the trillions of dollars that have been funneled to the banskters, and instead funnel that money onto Main Street. Theoretically of course.

Speaking of half-baked; Congress is in recess, so they haven't been messing things up. Actually, this Congress hasn't done anything even when they are in session. This has been the most gridlocked Congress in decades. When they get back from recess they might actually do something; and that is not necessarily a good thing. There is a decent chance Congress might close down government. Yesterday,  about a third of the Republican caucus sent a letter to House Speaker John Boehner and Majority Leader Eric Cantor urging them to oppose any annual spending bills that include funding for Obamacare.

Today Boehner responded by saying that when Congress reconvenes on September 9 after the summer break, “Our intent is to move quickly on a short-term continuing resolution that keeps the government running and maintains current sequester spending levels."

This weekend you'll likely hear quite a bit about the 50^th Anniversary of the March on Washington; it was August 28, 1963, and it was actually called the “March on Washington for Jobs and Freedom”. The march was intended to raise awareness of civil rights and economic issues, because social and economic justice are just branches of the same tree.