A key but unreported aspect of the Fed announcement

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strabes's picture
strabes
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A key but unreported aspect of the Fed announcement

A very very important detail of the Fed's announcement that it will move aggressively into the long-term bond market has gone unreported/unanalyzed across the entire media, and in Chris' post about this issue:

The Fed purchases "will occur across the nominal Treasury and TIPS yield curves."
 
What does that tell you?  What's the importance of those tiny 2 words "and TIPS?"  Why would the Fed move for the first time into the TIPS arena?  Any bond traders out there?  
 
This is a critical data point in the debate between inflationists and deflationists.   
 
They're going into TIPS to announce that they'll try to protect against hyperdeflation.  Yes, that's DE, not IN.  It is a signal to the deflation hawks (the big money players of the bond market that have made it real clear what they're expecting) that the Fed will try to prevent seriously entrenched deflation.  The TIPS spread shot lower in anticipation of the market crash and has remained lower since, and would potentially even go negative if hyperdeflation, long-term demand collapse, was anticipated. The Fed is now saying it will more creatively fight the deflation risk because it remains the dominant force despite its efforts to reflate.  
 
So the Fed still has at least 1 foot solidly in the deflationist camp along with the rest of the big, good bond traders in the world. Deflation is the primary perceived risk in the markets.  
 
Now, I'm not saying their efforts will work...they aren't capable of saving the economy (they in fact destroyed it).  Nor am I disagreeing with those who say the Treasury and the Fed are endangering the foundation of our monetary system as Schiff and the inflationists are saying.  I am however saying that until that systemic collapse occurs (the bond markets aren't expecting it for a long time...those are really smart people), we're in deflation.  
 
 
 
 
 
strabes's picture
strabes
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Re: A key but unreported aspect of the Fed announcement

Sorry for the run-on paragraph...don't know why the HTML editor didn't read the carriage returns.  Why does this site's editor do that so often?  Ugh.  Here it is with the paragraphs...

 

A very very important detail of the Fed's announcement that it will move aggressively into the long-term bond market has gone unreported/unanalyzed across the entire media, and in Chris' post about this issue:

The Fed purchases "will occur across the nominal Treasury and TIPS yield curves." What does that tell you?  What's the importance of those tiny 2 words "and TIPS?"  Why would the Fed move for the first time into the TIPS arena?  Any bond traders out there? 

This is a critical data point in the debate between inflationists and deflationists.  

They're going into TIPS to announce that they'll try to protect against hyperdeflation.  Yes, that's DE, not IN.  It is a signal to the deflation hawks (the big money players of the bond market that have made it real clear what they're expecting) that the Fed will try to prevent seriously entrenched deflation.  The TIPS spread shot lower in anticipation of the market crash and has remained lower since, and would potentially even go negative if hyperdeflation, long-term demand collapse, was anticipated. The Fed is now saying it will more creatively fight the deflation risk because it remains the dominant force despite its efforts to reflate.  

So the Fed still has at least 1 foot solidly in the deflationist camp along with the rest of the big, good bond traders in the world. Deflation is the primary perceived risk in the markets.  

Now, I'm not saying their efforts will work...they aren't capable of saving the economy (they in fact destroyed it).  Nor am I disagreeing with those who say the Treasury and the Fed are endangering the foundation of our monetary system as Schiff and the inflationists are saying.  I am however saying that until that systemic collapse occurs (the bond markets aren't expecting it for a long time...those are really smart people), we're in deflation.  

 

 

 

 

 

 

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Re: A key but unreported aspect of the Fed announcement

strabes,

Your ongoing keen analysis of economic conditions is a benefit to us all. Thanks for bringing out that which is often missed by those of us who are not so astute!

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Re: A key but unreported aspect of the Fed announcement

The Fed is acting as the "buyer" of last resort in purchasing government bonds.  We're spending at a rate that has killed the bond market.  No doubt, they would like to jump start the lingering deflation but that seems to be a big gamble at best and one that puts on course of a dollar collapse and big time inflation.  

Larry

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Re: A key but unreported aspect of the Fed announcement

The buying TIPS issue is a good thing to point out, but I draw the opposite conclusion.   It seems to me that the intent in doing this is to get TIPS out of people's hands in order to facilitate inflation efforts.

Basically, the Fed is paying out hush money to the Chinese and Saudis and protecting itself against Treasury's wanton spending. If they didn't, prices for TIPS would be going down and yields would go through the roof with all the crap Treasury is doing.  Why would YOU buy TIPS?  Because you want protection against inflation....no?  Who pays for this inflation protection in the end?  Taxpayers.  So, the Fed is telling Treasury, we'll print some money and hold all your crappy debt...but it is going to cost you (us).  

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Re: A key but unreported aspect of the Fed announcement

strabes,

Can you explain to me how the big players in the bond market have been expecting deflation and how that translates into the bond market as of late?  You mean they have been snapping up all kinds of long bonds, or bills?  If they favor bills how is that a sign of deflation expectations?

Your analysis states the Fed intend to buy the whole curve, right? 

 

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Re: A key but unreported aspect of the Fed announcement

I would also point out that hyperinflation is generally understood to be initiated by a significant uptick in the velocity of money. It is possible for this to be due to a political loss of faith event and not so much due monetary policy or quantity. Yes, we are in deflation, yes it might continue longer. But I think that there is a significant risk that the inflation will hit harder and faster than anyone at the Fed is preparing for. If and when people lose confidence, there will be a very rapid cascade of events and the Fed might very well not even have a chance to "soak up" the excess money fast enough - if they even bother to try.

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strabes
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Re: A key but unreported aspect of the Fed announcement
ragnar wrote:

It seems to me that the intent in doing this is to get TIPS out of people's hands in order to facilitate inflation efforts

The opposite occurred...when the Fed announced this (and note, they haven't bought anything yet), demand for TIPS went up, they re-liquified the market, more people got them in their hands.  TIPS was dying because nobody with money was expecting inflation.  The TIPS spread has been approaching zero!  (see chart below)  That means people purchasing US bonds for 10, 20, 30 years were willing to pay almost the same price for nominal bonds (not protected from inflation), and that means nobody sees any inflation risk.  Since the announcement, the TIPS spread has expanded back to >100 basis points, still not the normal level, but it's at least a sign of life.  

plantguy wrote:

Can you explain to me how the big players in the bond market have been expecting deflation and how that translates into the bond market as of late?  You mean they have been snapping up all kinds of long bonds, or bills?  If they favor bills how is that a sign of deflation expectations?

Your analysis states the Fed intend to buy the whole curve, right?

For your first question, see chart below...long term yields on standard Treasuries (red line) have plummeted.  Also note the TIPS spread (difference between red and blue line) basically went to zero.  Both are significant indicators that bond traders expect deflation (debt deflation...default on all other forms of debt/equity except the safest debt in the world, US Treasuries).  Now some would say the Fed has manipulated the red line down to create a bubble.  Not possible.  The Fed is small compared to the collective size of the institutions in the bond market.  The Fed follows the market...it reacts to the long end of the yield curve, it doesn't drive it.  

For the last question, yes their announcement says not only will they conduct open market operations (OMO) on the short end of the curve as usual, but they will now play with the entire curve.  And beyond that, they said they will play with the TIPS curve as well. 

 

INSERT DESCRIPTION


strabes's picture
strabes
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Re: A key but unreported aspect of the Fed announcement

And quick followup to the chart above...

If the Fed sees inflation expectations coming, indicated by a significant rise in long term rates (the red line in the chart) or in the data of the U Mich survey, they will sell the short end of the curve like crazy to drive up the Fed Funds rate, driving up short-term rates, inverting the yield curve, which kills the economic engine, drives money velocity back down, and puts a brake on inflation...that's their specialty, Volcker demonstrated how to do it...I'm willing to bet Volcker will be basically in charge when inflation sticks its ugly head back into the markets.  

If you're wondering what the U Mich survey says about inflation, see below.  Inflation risk is lower than normal.  If inflation was a serious threat, this survey would be back up at the levels you see around 1980.  That's when Volcker took over and created a recession to kill inflation.   

 


Graph: University of Michigan Inflation Expectation
 
plantguy90's picture
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Re: A key but unreported aspect of the Fed announcement

How does one reconcile the deflation going on in the macro economy 1) asset prices plunging 2) less demand 3) unemployment 4) negative feedback loop  - with what one individual experiences in the micro economy? 

The plunge is steeper in malinvested assets and the materials used for those assets.  Food prices are not significantly down (a couple of percentage points vs 25-70%), Neither has the crash in commodities really driven prices for goods that low either.  I look around my area which is agricultural and it turns out a majority of the land was purchased by people with no interest in farming, but rather putting in a house and selling it off.  For sale signs are everywhere.  We also purchased our land during the bubble and paid quite a premium, but since our intention was to make the property productive, I'm not under that risk but again, but that money isn't around to buy equipment or develop the property.

The Fed intends to print enough money to shore up those prices, therefore destroying the value of our remaining savings.  We create horticultural products and so are hit by deflation on the sell side, but we do not see any corresponding benefits on the buy side.  Dollar is crumbling, gold is expensive, products that are still in demand maintan their pricing.  I dont need a new car, with big equipment we can only afford seriously used equipment, I'm not seeing deflation there.  In fact, with regards to everyday goods our struggling business consumes, prices are still at 2007 levels.  Struggling local govt not only taxes, but also introduce new and raise old "fees," which is a GIANT HIDDEN TAX on small business.

My point is deflation is hitting hardest to those who participated in the FIRE economy.  For others still fighting the good fight inflation is everywhere.

strabes's picture
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Re: A key but unreported aspect of the Fed announcement

I don't think there's a good overall answer for what's happening in each person's micro economy.  At least, I don't know an answer.  My guess is that as the main st economy experiences the crash that the wall st economy has experienced, as commercial real estate crashes, etc that you will experience it on both sides of your business.  But I don't know.  I think there are usually micro markets that don't follow the macro trends.

The issue of small govt raising fees is another sign of deflation...govt revenue depends on the steady inflation that the Fed usually creates.  They go broke in deflation so they try to raise fees/taxes to extract more wealth from citizens.   

The dollar is not crumbling.  It's in a corrective phase right now, and some are forecasting that it will break into a new high on the next up wave.  Here's the yearly chart showing it hasn't crumbled...it's 15% above a year ago: 

PowerShares DB US Dollar Index Bullish (UUP) 

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Re: A key but unreported aspect of the Fed announcement

 

Strabes,

 

In my view the strength or weakness of the dollar should not be measured by how many euros, yen, pounds, francs you can buy with a dollar but what a dollar buys in terms of what you need today versus what you could buy with it last year , 2 years ago or 10 years ago. I know that for me the dollar does not go as far as it used to and the speed of depreciation seems to be accellerating.

Ken

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Re: A key but unreported aspect of the Fed announcement

Maybe this should go back to the gold threads, but its interesting to note that gold intially deflated in 2008, but since appears to have unhinged from the rest of the commodities, in spite of signs of weakening demand from its regular markets. 

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