18 July 2013

Fed Road Trip to Septaper Keeps on Rolling

Ben Bernanke behind the wheel, US Treasury in the passenger seat, Conglomerates in the back, Regulators in the boot and the People in tow - Welcome to the New Normal.

The full text of Bernanke's speech can be found here, illustrated below:

Yesterday’s testimony and subsequent Q&A by Ben Bernanke was market moving but did not shed any further light on Fed tapering plans. Fed policy is "data dependent" which on other words means, Fed policy will be set on the fly, just the way speculators like it.

As the global trading community focused on Bernanke being the most important event of the week, we couldn’t help noticing just how ridiculous and dysfunctional the financial system has become. The words of one person regularly sway all asset classes, in all markets, in all time zones. Not new data, or a new empirical study, or performance, or some other gauge of ‘real’ activity. Instead, market participants hang on the words of one man, who has the power to dictate economic policy to the World. The words uttered by Bernanke rarely say anything valuable or have reference to anything tangible. In fact they are often na├»ve and out of touch:
“Wall Street hasn’t benefitted more than Main Street”
“Fed is very focused on Main Street”
 -Ben Bernanke, Chairman of the U.S. Federal Reserve (17th July, 2013)

The fact that Fed policy has so much influence (and growing) but delivers almost nothing aside from fostering market dependency and maintaining an elitist status quo, should be rather worrying. If it doesn’t worry you, then you are not paying enough attention.

Governors at other central banks are mere pawns compared to King Ben because the global banking system is reliant on Fed capital creation and the U.S dollar while every company or individual relies on the global banking system. In the financial markets, capital is like oxygen – the problem is that the Fed has become its only source. At this rate, we can expect to see communism-era style announcements of capital allocation as if food were being rationed out to a long line of serfs, all eager to survive. Capitalism has become communism, democracy has become tyranny and fundamentals have become speculation in an increasingly centralist market environment.

The speech and the wider issues

Bernanke covered all the bases and where the official statement sent equity markets higher, Bernanke soon talked them down again via his Q&A.

It seems that the Fed is more worried about playing cat and mouse with speculators, ensuring that market volatility and market direction are smoothed out, than it is about directing prudent monetary policy. What is prudent about inflating the balance sheet as high as $3.5Trn, bailing out insolvent banks, incentivising cash hoarding, over-leveraging, artificial market support, market manipulation and persisting with fractional reserve banking? Not much. Yet, highly educated economists/analysts/investment bankers/media outlets continue to parrot on about recovery, forward guidance, GDP estimates and what Bernanke said in a speech probably not even written by him. On top of all that he is voted person of the year in 2009 by Time Magazine.

In September 2008 the excess reserves major banks held at the Fed totalled $9bn. After the Lehman Brothers default, excess reserves have now risen to $2 trillion – an annual increase of approximately $400bn. The eye-watering level of capital provision and accumulation has created huge event risk for all asset classes, business and whole economies – if this is what is called good monetary policy that deserves an award then something has gone terribly wrong.

Liquidity Trap

The definition of a liquidity trap:

"A liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels"

Due to accommodative, leverage based Fed policy spanning the past 30 years (not just since 2008), the U.S economy is now suffering from a phenomenon Japan experienced for decades. An ageing population, growing indebtedness, poor fiscal policy and a tendency to rely on monetary policy has created a deflationary environment where monetary policy has a diminishing rate of return as economic fundamentals become weaker and more anaemic. At this stage, continued monetary interventions will do little more than induce the next asset bubble/boom-bust cycle.

If the Fed tapers and tightens monetary policy the markets are likely to plummet (as seen on June 19th-July 2nd following the initial taper speculation), lead to sharp deleveraging and sharp declines in macroeconomic indicators such as employment, GDP, investment, sentiment, confidence etc. If the Fed keeps its ZIRP/QE policy going, it will inflate the next asset bubble and ultimately lead to ever larger busts compared to the one seen in 2007. The Fed is in a lose-lose scenario – both choices create negative outcomes so the Fed is seemingly trying to bluff its way out by delaying the onset of reality. One other possibility (one that is also based on history) is that a significant geo-political conflict (war) helps the U.S. to spend its way to nominal GDP growth. A major war could be the saving grace of the U.S. economy – another indicator that today’s global political/economic systems have become simply unbelievable.

Not just a U.S. problem

The issues discussed are no longer domestic U.S issues. Given the Fed’s influence, pretty much all central banks around the globe now focus on Fed policy in their own publications and is a prime topic of discussion at interest rate/board meetings. Additionally, most G20 central banks are engaged in QE-style policy, spearheaded by the Fed in 2008. On paper, the Fed is placing all its hopes on the ‘wealth effect’ whereby infusion of liquidity at the top, eventually trickles down to the bottom thus stimulating the economy. In reality, the Fed is focused on consolidating market power and influence away from elected officials in the U.S. over to unelected technocrats abroad. The underlying theme is global market centralisation and inequality expansion. For over 4 years we’ve had QE policies but despite the inflation of asset prices, higher corporate profits, more capital on reserve and lower interest rates there is no evidence to suggest QE has helped the real economy in any country that has utilised it. In terms of market influence, thousands of smaller regional banks have collapsed worldwide, having been assimilated by larger entities over the same period.

What next?

The Fed’s tapering plans were cut short by market rebellion in late June/early July and yesterday’s speech by Bernanke has not changed market sentiment significantly - which leaves future expectations uncertain. Will the Fed taper or not? If so, when? These are the 2 questions all short-term traders are pondering. The most probable answer is that the Fed will taper but not as soon as most market participants expect. Official Fed commentary suggests it could be as early as September 2014 (aptly titled ‘Septaper’), but in reality this date is probably too optimistic given the anemic macro data coming out of the U.S. over the past few months. If Fed policy remains accommodative and market appeasing, then we expect USD/JPY to continue its upward trend and print new highs. On the other hand, if the Fed affirms its signal to taper in the next 6 months, USD/JPY has the potential to fall back below 94.33 (long-term trend line).

Commissioned by Think Forex