True Ultra-Dovishness
DOUG NOLAN
Friday, March 20, 2015
The S&P500 rallied 45 points (2.2%) intraday on Federal Reserve Wednesday, to end the session with a 1.2% gain. The dollar index traded with an intraday range of 99.83 to 96.63, with bloody currency market chaos breaking out with the Fed statement release. EM currencies enjoyed huge rallies. The Russian ruble jumped 3.4% Wednesday, with the Hungarian forint gaining 2.8%, the Polish zloty 2.6%, the Mexican peso 1.9%, the Turkish lira 1.7%, the Colombian peso 1.2% and the Brazilian real 0.9%. After trading down to $42 Wednesday morning, WTI crude surged above $45 in the post-Fed melee. As with the currencies, most of the move came in three minutes. The Goldman Sachs Commodities Index spiked 3.6% on the Fed announcement.
A few notable post-Fed headlines: “Dollar Tumbles Most Since 2009 After Fed Cuts Rate Projections.” “Emerging Currencies Set for Biggest Weekly Rally in Year on Fed.” “Asian Currencies Advance Most This Week Since 2012 on Fed Signal.” “Asia Bond Risk Slides Most in Six Weeks After Fed Lowers Rate Forecast.” “Onshore Yuan Heads for Biggest Three-day Gain Since 2007.”
For the week, risk markets rallied sharply. The S&P500 gained 2.7%, back to within a percent of all-time highs. Not surprisingly, the more speculative segments of the marketplace enjoyed the strongest gains. The Nasdaq Composite rose 3.2%, trading Friday to the highest level since March 2000. The Nasdaq Transports jumped 5.8% and the Nasdaq Biotechs rose 6.2% this week. The NYSE Arca Biotechnology Index (BTK) surged 4.1%, increasing y-t-d gains to 23.3% and one-year gains to 51.6%.
March 19 – Bloomberg (Julie Verhage and Joseph Weisenthal): “Investors are kicking themselves if they listened to Fed Chair Janet Yellen and the Board of Governors last July and sold their biotech stocks. …The Nasdaq Biotech index is up well over 40% since Yellen’s valuation comments.”
It’s worth noting that the Biotechs have increased almost 200% since the Fed announced open-ended QE back in the late summer of 2012. The Semiconductors have doubled. The Nasdaq Composite has inflated 75% and the NDX (Nasdaq 100) almost 80%. The Dow Transports have gained 85%. The S&P500 has returned about 55%.
So why the panicked reaction in the currency markets to the Fed’s statement and chair Yellen’s press conference? Key market takeaways from the Fed statement: “export growth has weakened.” “Inflation has declined further below the Committee's longer-run objective…” The statement also listed “readings on financial and international developments” as indicators the Fed will be assessing as it determines when to begin raising rates. “The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2% objective over the medium term.”
Yellen’s press conference underscored key points from the statement: “Compared with the projections made in December, most participants lowered their path to the federal funds rate consistent with the downward revisions made to the projections for GDP growth and inflation as well as somewhat lower estimates of the longer-run normal unemployment rate.” “We noted that export growth has weakened. Probably the strong dollar is one reason for that.” “So we are taking account of international developments, including prospects for growth in our trade partners in making the forecasts we have here.”
The markets went a little berserk. Importantly, the Yellen Fed signaled a concern for the strong dollar, along with market and international developments. A meaningful increase in rates will wait until the committee is more confident in achieving its 2% inflation rate target. With Fed attention now directed at the dollar, international fragilities and global disinflationary forces, market participants rest fully assured that the Fed has no intention of even timidly “leaning against the wind” of record securities prices, record corporate debt issuance and conspicuous market excess.
Recently released Fed transcripts from the 2009 crisis-management period revealed vice chair Yellen as a notably assertive dove. Wednesday confirmed to the world that Yellen and the Yellen Fed are the most dovish chair and FOMC ever.
“Terminal Phase Excess” is fundamental to my Credit Bubble macro analytical framework.
There reaches a momentum phase in prolonged Bubbles where systemic risks rise exponentially. Typically, there’s some combination of expanding quantities of riskier debt, market misperceptions and distortions, leveraged speculation, real and financial resource misallocation, and economic imbalances and deep structural maladjustment. Importantly, the increasingly conspicuous risk of a bursting Bubble ensures that policymakers err on the side of ongoing accommodation. Things really run amuck.
As I’ve written repeatedly, I’m convinced that the Fed’s extraordinary 2012 move to open-ended quantitative easing (QE) was in response to acute global financial fragilities.
The U.S. unemployment rate was mere subterfuge. I – and clearly others – saw in this week’s Fed statement and Yellen’s comments an admission that the international backdrop now openly dictates Fed policymaking. In the Fed’s “surprising” Dovishness, I see confirmation of the global acute fragility thesis.
March 17 – Bloomberg (Margaret Collins): “Jeffrey Gundlach said if the Federal Reserve raises interest rates in the middle of 2015 the central bank will have to reverse course. The billionaire co-founder of DoubleLine Capital made the comments in an investor presentation… that covered bond markets, U.S. housing, global demographics and currencies. He criticized the Fed for not learning from errors made by global counterparts, which raised interest rates and then had to cut them, and Chair Janet Yellen for spending too much time with foreign officials. ‘The Fed is intent on being a blockhead,’ Gundlach said…”
March 17 – Bloomberg (Kelly Bit): “Ray Dalio, founder of the world’s largest hedge fund firm, Bridgewater Associates, told investors there’s a risk that the Federal Reserve could create a market rout similar to that of 1937 if it raises interest rates too fast… ‘We don’t know -- nor does the Fed know -- exactly how much tightening will knock over the apple cart,’ Dalio and Dinner wrote. ‘We think it would be best for the Fed to err on the side of being later and more delicate than normal.’”
Sometimes I feel as if I’m living on a different planet. As much as I respect the intelligence and market acumen of Jeffrey Gundlach and Ray Dalio, I take strong exception with some of their comments on Fed monetary policy. Dangerously flawed policymaking is only perpetuated by further delays in rate normalization. I also reject the comparison to 1937. Even at its 1937 highs, the Dow remained about half the 1929 peak. Unemployment sat above 14%. Today’s parallels are much closer to 1929. Regrettably, the Fed drew the wrong lessons from the “tech” and mortgage finance Bubble episodes. Now, everyone wants this party to last forever.
March 19 – Bloomberg (Jeff Kearns): “Federal Reserve Bank of Chicago President Charles Evans, who votes on policy this year, said in a research paper that interest rates should remain near zero for longer amid ‘substantial uncertainty’ about inflation and employment. ‘The biggest risk we face today is prematurely engineering restrictive monetary conditions,’ Evans wrote in a paper released Thursday that was co-written with reserve bank researchers Jonas Fisher, Francois Gourio and Spencer Krane. They said the risk of premature liftoff exceeds the risk of delaying too long, and that the central bank’s credibility will suffer if officials are forced to backtrack on policy. ‘It therefore seems prudent to refrain from raising rates until we are highly certain that the economy has achieved a sustained period of strong growth and that inflation is on a clear trajectory to return to target,’ Evans wrote…”
The belief that “the risk of premature liftoff exceeds the risk of delaying too long” is flawed and dangerous. I recall clearly a talk given by the astute Henry Kaufman back in September 1999.
He explained how the Fed had missed it’s timing in tightening monetary policy. “And as in all things in life, if you miss your timing there are costs.” The Fed has really blown it this time.
They blew it once again this week.
It’s now been almost two years since Bernanke’s talk of winding down QE and commencing a normalization of monetary policy. The Fed’s current focus should not be the dollar, CPI or even the employment rate. The primary consideration after six years of zero rates and $3.6 TN of monetization should be Financial Stability.
The Fed needed to be prepared to counter securities market and speculative excesses. They have failed to do the obvious, and Wednesday’s meeting confirms they will remain firmly in Bubble accommodation mode.
I have argued for a number of years now that it was imperative for the Fed to begin extricating itself from market intervention and manipulation. It was never going to go smoothly, but when it comes to dealing with market distortions and Bubbles the earlier the better. The scope of the Bubble has now grown to unprecedented dimensions – throughout virtually all securities and asset markets – and it's global: stocks – small caps, mid-caps, large-caps – risky and “defensive” – growth and income; bonds – sovereign, corporate, “developed” and “developing”; and all varieties of derivatives. Anything providing a yield.
The fundamental issue is a desperate need for the Fed to commence a process of normalizing the pricing of market risk. Savings needs to generate a positive real return.
The enormous ongoing flow of (unsuspecting) savings into grossly inflated risk markets only exacerbates systemic risk.
The Bubbling corporate debt market needs to be tested – and some market discipline reinstated. The ETF and “bond” fund complexes, recipients of Trillions of flows, need to be tested – and market discipline allowed to run its course. The self-reinforcing stock buybacks, M&A and other “financial engineering” need to be tested by a period of tighter finance and associated risk aversion. Will they stand up?
I am convinced the underlying finance driving the markets and, increasingly, the economic boom is unstable. I believe the best kept secret is that enormous amounts of global “hot money” are flooding into king dollar asset markets – U.S. stocks, bonds, real estate and business investment.
It is an unsound dynamic and it’s unsustainable.
Over recent weeks the king dollar dynamic has turned increasingly destabilizing. EM currency and bond market contagions were gaining important momentum. Especially with Greece and Brazil facing serious issues, global Bubble markets were at heightened vulnerability to a surprising bout of speculative de-risking/de-leveraging. Policymakers responded, just as market operators have assumed – as they’ve done repeatedly. The ECB moved forward with QE. The Bank of Japan – along with Japanese financial institutions – have pushed forward with liquidity-boosting measures. Chinese fiscal and monetary measures have become more aggressive – including PBOC currency intervention. And this week the Fed showed its True Ultra-Dovishness.
The progression is now complete. Central bank market intervention moved from short-term interest rates, to long-term bond yields and the yield curve, to risk market prices more generally - to now wanton manipulation of the currency markets.
Long dollar, short EM, short crude and commodities trades had become crowded. This week the crowd was caught on the wrong side of a number of trades – and got slapped around a bit.
Could the dollar have put in a short-term peak? It’s possible, but I don’t believe Fed talk can end the reign of king dollar.
Interest-rate differentials are important, and the Fed delaying its first rate increase provides help on the margin to the rapidly expanding list of troubled global borrowers. At the same time, aggressive Fed policymaking continues to provide a competitive advantage to U.S. risk markets at the expense of faltering EM. This is really the essence of king dollar – an inflating U.S. Bubble’s strangulation of deflating EM and commodities Bubbles.
There’s another problem that’s not going away anytime soon. Years of central bank market intervention, manipulation and monetization have cultivated a massive pool of global speculative finance. So long as global speculators were contently positioned leveraged long across global markets, there was the appearance of peace and prosperity for all. Those days are long gone.
“Terminal Phase Excess” is fundamental to my Credit Bubble macro analytical framework.
There reaches a momentum phase in prolonged Bubbles where systemic risks rise exponentially. Typically, there’s some combination of expanding quantities of riskier debt, market misperceptions and distortions, leveraged speculation, real and financial resource misallocation, and economic imbalances and deep structural maladjustment. Importantly, the increasingly conspicuous risk of a bursting Bubble ensures that policymakers err on the side of ongoing accommodation. Things really run amuck.
As I’ve written repeatedly, I’m convinced that the Fed’s extraordinary 2012 move to open-ended quantitative easing (QE) was in response to acute global financial fragilities.
The U.S. unemployment rate was mere subterfuge. I – and clearly others – saw in this week’s Fed statement and Yellen’s comments an admission that the international backdrop now openly dictates Fed policymaking. In the Fed’s “surprising” Dovishness, I see confirmation of the global acute fragility thesis.
March 17 – Bloomberg (Margaret Collins): “Jeffrey Gundlach said if the Federal Reserve raises interest rates in the middle of 2015 the central bank will have to reverse course. The billionaire co-founder of DoubleLine Capital made the comments in an investor presentation… that covered bond markets, U.S. housing, global demographics and currencies. He criticized the Fed for not learning from errors made by global counterparts, which raised interest rates and then had to cut them, and Chair Janet Yellen for spending too much time with foreign officials. ‘The Fed is intent on being a blockhead,’ Gundlach said…”
March 17 – Bloomberg (Kelly Bit): “Ray Dalio, founder of the world’s largest hedge fund firm, Bridgewater Associates, told investors there’s a risk that the Federal Reserve could create a market rout similar to that of 1937 if it raises interest rates too fast… ‘We don’t know -- nor does the Fed know -- exactly how much tightening will knock over the apple cart,’ Dalio and Dinner wrote. ‘We think it would be best for the Fed to err on the side of being later and more delicate than normal.’”
Sometimes I feel as if I’m living on a different planet. As much as I respect the intelligence and market acumen of Jeffrey Gundlach and Ray Dalio, I take strong exception with some of their comments on Fed monetary policy. Dangerously flawed policymaking is only perpetuated by further delays in rate normalization. I also reject the comparison to 1937. Even at its 1937 highs, the Dow remained about half the 1929 peak. Unemployment sat above 14%. Today’s parallels are much closer to 1929. Regrettably, the Fed drew the wrong lessons from the “tech” and mortgage finance Bubble episodes. Now, everyone wants this party to last forever.
March 19 – Bloomberg (Jeff Kearns): “Federal Reserve Bank of Chicago President Charles Evans, who votes on policy this year, said in a research paper that interest rates should remain near zero for longer amid ‘substantial uncertainty’ about inflation and employment. ‘The biggest risk we face today is prematurely engineering restrictive monetary conditions,’ Evans wrote in a paper released Thursday that was co-written with reserve bank researchers Jonas Fisher, Francois Gourio and Spencer Krane. They said the risk of premature liftoff exceeds the risk of delaying too long, and that the central bank’s credibility will suffer if officials are forced to backtrack on policy. ‘It therefore seems prudent to refrain from raising rates until we are highly certain that the economy has achieved a sustained period of strong growth and that inflation is on a clear trajectory to return to target,’ Evans wrote…”
The belief that “the risk of premature liftoff exceeds the risk of delaying too long” is flawed and dangerous. I recall clearly a talk given by the astute Henry Kaufman back in September 1999.
He explained how the Fed had missed it’s timing in tightening monetary policy. “And as in all things in life, if you miss your timing there are costs.” The Fed has really blown it this time.
They blew it once again this week.
It’s now been almost two years since Bernanke’s talk of winding down QE and commencing a normalization of monetary policy. The Fed’s current focus should not be the dollar, CPI or even the employment rate. The primary consideration after six years of zero rates and $3.6 TN of monetization should be Financial Stability.
The Fed needed to be prepared to counter securities market and speculative excesses. They have failed to do the obvious, and Wednesday’s meeting confirms they will remain firmly in Bubble accommodation mode.
I have argued for a number of years now that it was imperative for the Fed to begin extricating itself from market intervention and manipulation. It was never going to go smoothly, but when it comes to dealing with market distortions and Bubbles the earlier the better. The scope of the Bubble has now grown to unprecedented dimensions – throughout virtually all securities and asset markets – and it's global: stocks – small caps, mid-caps, large-caps – risky and “defensive” – growth and income; bonds – sovereign, corporate, “developed” and “developing”; and all varieties of derivatives. Anything providing a yield.
The fundamental issue is a desperate need for the Fed to commence a process of normalizing the pricing of market risk. Savings needs to generate a positive real return.
The enormous ongoing flow of (unsuspecting) savings into grossly inflated risk markets only exacerbates systemic risk.
The Bubbling corporate debt market needs to be tested – and some market discipline reinstated. The ETF and “bond” fund complexes, recipients of Trillions of flows, need to be tested – and market discipline allowed to run its course. The self-reinforcing stock buybacks, M&A and other “financial engineering” need to be tested by a period of tighter finance and associated risk aversion. Will they stand up?
I am convinced the underlying finance driving the markets and, increasingly, the economic boom is unstable. I believe the best kept secret is that enormous amounts of global “hot money” are flooding into king dollar asset markets – U.S. stocks, bonds, real estate and business investment.
It is an unsound dynamic and it’s unsustainable.
Over recent weeks the king dollar dynamic has turned increasingly destabilizing. EM currency and bond market contagions were gaining important momentum. Especially with Greece and Brazil facing serious issues, global Bubble markets were at heightened vulnerability to a surprising bout of speculative de-risking/de-leveraging. Policymakers responded, just as market operators have assumed – as they’ve done repeatedly. The ECB moved forward with QE. The Bank of Japan – along with Japanese financial institutions – have pushed forward with liquidity-boosting measures. Chinese fiscal and monetary measures have become more aggressive – including PBOC currency intervention. And this week the Fed showed its True Ultra-Dovishness.
The progression is now complete. Central bank market intervention moved from short-term interest rates, to long-term bond yields and the yield curve, to risk market prices more generally - to now wanton manipulation of the currency markets.
Long dollar, short EM, short crude and commodities trades had become crowded. This week the crowd was caught on the wrong side of a number of trades – and got slapped around a bit.
Could the dollar have put in a short-term peak? It’s possible, but I don’t believe Fed talk can end the reign of king dollar.
Interest-rate differentials are important, and the Fed delaying its first rate increase provides help on the margin to the rapidly expanding list of troubled global borrowers. At the same time, aggressive Fed policymaking continues to provide a competitive advantage to U.S. risk markets at the expense of faltering EM. This is really the essence of king dollar – an inflating U.S. Bubble’s strangulation of deflating EM and commodities Bubbles.
There’s another problem that’s not going away anytime soon. Years of central bank market intervention, manipulation and monetization have cultivated a massive pool of global speculative finance. So long as global speculators were contently positioned leveraged long across global markets, there was the appearance of peace and prosperity for all. Those days are long gone.
I recall back in 1997 when futures trading firms ran commercials (on CNBC and elsewhere) non-stop on how to profit from the Asian Tiger currency collapse. Markets, economies and societies were being pushed to their limits – so why not short their currencies and make some easy money. The global pool of finance was a fraction of today’s size, yet when the speculators pressed bearish bets it was enough to crush those markets into a state of illiquidity. I doubt the Fed at this point can dissuade the EM short trade.
The Yellen Fed inflicted some pain this week. And it was said that the People’s Bank of China intervened in the currency market to punish those shorting the renminbi. The upshot was a week of wild currency and commodities market volatility. It was a good week for EM – but it was also a good week for the U.S. Bubble. It was a notably unimpressive week for Brazil’s bonds and currency. It was as well an ominous week for Greece.
Greece illustrates the disastrous consequences of having one’s debt discredited. Let’s hope the same fate does not await Brazil and many others.
The Yellen Fed inflicted some pain this week. And it was said that the People’s Bank of China intervened in the currency market to punish those shorting the renminbi. The upshot was a week of wild currency and commodities market volatility. It was a good week for EM – but it was also a good week for the U.S. Bubble. It was a notably unimpressive week for Brazil’s bonds and currency. It was as well an ominous week for Greece.
Greece illustrates the disastrous consequences of having one’s debt discredited. Let’s hope the same fate does not await Brazil and many others.
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