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“Central banks
sold a record amount of US Treasury debt last week and bond funds suffered
the biggest investor withdrawals on record as global markets shuddered at the
prospect of the US Federal Reserve ending its quantitiative
easing program.”
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“People are
throwing in the towel. It’ll drag the market down lower over the course
of the summer.” Markus Rosgen, chief Asia
equity strategist at Citigroup
Link
If “people are
throwing in the towel” as Mr. Rosgen suggests,
Bernanke will find himself in an all-new conundrum quite the opposite of the
one in which Alan Greenspan found himself in 2005.
For the Fed, the
Treasury debt selling creates a twofold problem:
First, the supply of
bonds in the open market will continue to drive up rates. When the goal is to
keep rates down, it presents a new kind of conundrum — a Bernanke
version the exact opposite of Greenspan’s. Greenspan wanted higher
rates. The market gave him lower rates by accelerating its purchases of Treasuries,
thus the conundrum. Bernanke wants the exact opposite, that is, lower rates.
The market is giving him higher rates by accelerating the sale of U.S.
government debt — a conundrum opposite to the one Greenspan
encountered. Then and now, the market pundits fret that the Fed is losing
(has lost) control of interest rates.
Second, if the world
is selling Treasuries, some entity will have to pony up with the purchases of
newly-issued U.S. government debt. That entity is the Federal Reserve —
the government’s lender of last resort. The new Bernanke conundrum will
force the Fed to continue its QE program until such time that other private
and public sector buyers of U.S. debt materialize. Ironically, the stock
market might already be reacting correctly to the new rate reality (although
in a confused state), while gold’s sudden demise, if indeed caused by
the so-called “paring down of quantitative easing,” might have
been false. If that is the case, a make-up rally could be in the offing…..in
fact it might already have been launched.
In an earlier
article, I advised that we should take heed of what the Fed does, not what it
says. In a certain sense, as you see in the two graphs below, the Federal
Reserve may have already launched QE4 while simultaneously talking about
ratcheting monetization down. The two graphs together show cause and effect
and tell the real story of what is happening at the Fed. For a while, it
wasn’t clear why bank reserve credit (QE) was rising. When you marry
that chart to 10-year Treasury maturity rates, the reason becomes quite
clear. The Fed is battling the market to keep rates low and the government
(along with the rest of the economy) financed at favorable rates.
 
Greenspan’s conundrum
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