The Collection Agency - Weekly Report
Welcome to the Weekly Report. This week the Federal Reserve made its intentions clear and set a course into uncharted waters, taking the US citizen to the land of deflation. We look at the reaction in the fixed income markets, take a long term view of the Dow using 2 propriety indicators to help identify long term trends and wonder what Fitch has done to upset MBIA.
The Federal Reserve has decided to acknowledge that the Banking system is in total disarray and is now unable to meet its own obligations. Some of you may remember I referred to the banking cartel as being "sub-prime". I also pointed out a couple of weeks ago that the Banks no longer have any capital reserves that are usable. In other words all capital is now employed in current leveraged positions. Losses in those positions that result in margin calls, requiring more capital, are now being met by the Federal Reserve through repos (repurchase) and the TAF (Term Auction Facility). As the stock markets slid into further losses on Friday the Fed announced new measures to attempt to bolster the cash at hand for the banks.
Let me make one thing abundantly clear, this is NOT an attempt to save indebted US citizens, Funds, Hedge Funds or any other Capitalist Venture. This is a major bailout of the whole US fiat monetary system. It is designed to save the current banking structure of the USA and by indirect means support the world banking system. No country is immune (except Zimbabwe, whose currency might appreciate against the dollar) that uses a leveraged fiat monetary system.
Here is a prediction that might be seen as somewhat risky. By the end of 2009, I expect at least one trading currency in the world adopt a gold standard and regulate against leverage.
Back to the Federal Reserve and its new measures aimed at keeping leveraged trading in all markets possible and that all but officially announced it is now the Bank of Last Resort. There were 2 statements on Friday, the first concerns the TAF, the second related to the repo markets, covering both temporary and permanent operations. We had a warning that conditions are deteriorating as mentioned last week and now the Fed has been forced to take action.
The Fed announced that the TAF in March would be raised to $100Bn and continue to operate over at least the next 6 months. The Fed said that the action was to "address heightened liquidity pressures in term funding markets" and "to provide increased certainty to market participants" until market conditions improved sufficiently to allow the TAF to be discontinued. The Fed will accept Treasuries, Agency debt and Mortgage Backed Securities as they do in normal repo operations.
In conjunction with the increase in the TAF limit, normal temporary open market operations would also be increased in size, totalling up to $100Bn using 28 day repo agreements.
Both the TAF and the new 28 day repos could be increased in size "if conditions warrant". However the Fed then made it very clear, beyond the statements made above, that this increase of $140Bn (TAF was already at $60Bn) was to directly help bank balance sheets and not to increase monetary liquidity by also carrying out a permanent open market operation. The Fed trading desk announced it was selling $10Bn of US Treasury Bills to the markets "in order to maintain a level of reserves consistent with trading at rates around the operating objective for the overnight federal funds rate." The Fed trading desk also announced this little snippet:
"The Desk will continue to evaluate the need for the use of other tools to add flexibility to its open market operations. These may include further Treasury bill sales, reverse repurchase agreements, Treasury bill redemptions and changes in the sizes of conventional RP transactions"
We have conclusive proof that Fed is attempting to drain cash from the economy to support rates (and indirectly the $) whilst pumping funds directly into the balance sheets of the banks. Therefore the whole series of measures are not to deal with a liquidity issue but are to combat a breakdown in the capital reserves of the banks and a freezing/tightening/collapse of the credit markets.
US banks are being nationalized, temporarily, whilst they attempt to take cash away from all sectors of the economy, by either de-leveraging positions or calling in all debt owed to them on the flimsiest of excuses. Any non-performance in debt servicing by either Corporations or private citizens, for whatever reason, will result in immediate and swift foreclosure and an asset grab. I expect most credit lines to be withdrawn and limits imposed on the size of cash transfers and withdrawals in the very near future. All of these actions are to bolster bank reserves and the Fed itself believes this will take a minimum of 6 months. Some believe that is not enough. Kansas City Fed Pres. Hoenig called for the TAF to be made permanent.
It should be noted that if you use leverage or margin to trade markets, be prepared for that facility to be curtailed or withdrawn completely, forcing you to close your positions. Why would this occur? To enable further deleveraging and reallocation of capital and it's a very effective way of removing private investors from the markets. The Financial Institutions (FI) are in pain, they wouldn't like to have to move cash in the direction of private investors.
Am I being hysterical in my reaction to recent events? No I am not. The Fed and the FI's have yet to surprise me in their response to this self imposed crash; as conditions worsen I expect further draconian measures to be visited upon us.
For some, this is already happening in their everyday lives:
The green line shows CPI for all urban consumers minus energy, the red line is CPI for all items (both right scale). The argument that consumers are spending more on energy and less elsewhere is weak. What we do see is that rising CPI is not causing an increase in $ spending by consumers as seen by the blue line, showing retail and food services sales y.o.y (left scale). CPI is climbing higher but the amount spent is deflating year on year, as can be seen by the minus reading.
The price of goods may well be rising but the consumer isn't buying. I have said before, it doesn't matter how expensive an item is priced if no one buys it. Market forces will ensure that either prices fall to meet the reduced ability to spend or goods are no longer produced if that re-pricing makes it an unprofitable enterprise.
It should not be ignored that this deflationary effect is starting from a much lower base than the previous period covering the recession in the early 00's. The cushion of consumer spending power has been removed. Consumers are already suffering from a monetary deflation. I believe the cause is due to higher costs for servicing all debt and yet again the financial system will rebalance the capital reserve ratios at the expense of the US consumer.
There are possible signs that the credit market turmoil has spread to the Corporate Bond market. Whilst rates in Treasuries have been falling and have been followed down by the Fed Fund Rate, Corporate Bonds have maintained their yield levels from the beginning of 2007. Although the Corporate Bond yields have moved within a range there was a slight downward bias that occurred as Tsy's and the FFR fell, as you would expect in such an environment. Indeed even lower rated Corporate Bonds followed this pattern as can be seen in this chart:
The message I believe we see here is that the Corporate Bond Markets thought corporations would not be affected by the credit turmoil and that the requirement for a risk premium was purely down to the specific credit market problems. That is, there would be no spillover to the economy and therefore no requirement to price in a specific company risk premium.
I think that message has changed. To read why and for the rest of the Weekly Report, visit my blog here.