FED Policy Errors–Rates Plunge

Of course I am partially talking my book–no doubt.

BUT the FED made an error that they have made before—they are ending quantitative tightening when the stimulus is least needed.

It’s one thing to lower interest rates at a time when it isn’t called for – and another thing to compound the rate cut effects by adding $10 billion in weekly demand to the government bond market. So instead of continuing to run off the balance sheet when demand is high they stop.

You can bet your bottom dollar that the balance sheet will be needed for quantitative easing when the rest of the globe decides they no longer want our government junk so let’s keep running off those balance sheet assets.

You can see the double barrel effect in the 10 year treasury–now at 1.87% after trading as high as 2.07% on Wednesday.

I realize that there is a concern with the strong dollar–but does that mean we are going to chase European negative yields down the rat hole? I guess it does mean that we are going to chase.

I smell a “black swan” event in our NOT distant future–I can’t lay my finger on it (if I could it wouldn’t be a black swan), but it seems like it is closer rather than further out.

34 thoughts on “FED Policy Errors–Rates Plunge”

  1. I am sitting with 1/3 of my investments in cash, the rest are in strong dividend-bearing companies with good balance sheets. 2020 is going to be a tough year.

  2. Thanks for the post, Tim. Insightful as usual, but I don’t quite understand why so many (not necessarily saying you are included) think we’re headed to a zero interest rate environment in some imminent type of timeframe. While I certainly understand taking a few chips off the table, some of the comments from my fellow regulars make me feel like I should be stocking K-rations and digging a deeper bunker in my yard.

    I read pretty much every single posting here on the site, but I must’ve missed a major announcement besides the crummy (and stupid and unnecessary and baffoonish and and and) 1/4 point cut this week… Not calling anyone out for being right or wrong, just thinking out loud – I am.

    Just once, in my lifetime, I’d like to see the Fed NOT screw things up like clock work.

    1. The biggest threat to the markets IMHO isn’t the Fed, it’s the uncertainty over the upcoming elections. If there is a black swan-a-swimming, that’s it as far as I can see. We all know how much the markets are intolerable of uncertainty. Here we go with the punchbowl analogies again…

    2. A4I–no k-rations anymore–just MREs. I have actually always thought we would go to the moon with interest rates–and I think we may yet. I have misjudged the wisdom of investors on a global basis–I thought they might demand more than 2% on a 10 year treasury, but the European countries have ruined that though with continual negative rates. I have actually put money to work–but am keeping a decent stash of dry powder–which is more bearable now that we actually get a couple percent.

      I have little faith in the FED at this point in time, but I am sure not “running for cover”.

      1. Words of wisdom,Tim – thanks. Like you, I am baffled by ‘global’ investors. Why some pay a bank to hold their money is a bit beyond my comprehension. But, I guess if we had to live like that – it would make more sense. You can only put so much in your mattress and sock drawer. I cannot even fathom investing for a 2% return. Must be my age and tolerance for risk. Let’s hope the Fed doesn’t crash the party and still keeps a lil punch in the bowl.

        1. A4I

          This is THE global problem with rates now – non-US fixed income investors seeking safety and positive return. This rotation continues into the US and drives our yields even lower as demand increases. Some non-US countries are taking advantage of this and floating their own high yield (my characterization) sovereign debt. Italy recently floated a 50 year bond at 2.65%, I believe. This is an incredible development as no one would expect several years ago that Italy would have any chance to pay this back. The biggest buyer of this debt was Germany since their entire yield curve is negative. It looks like we could have a “circle the drain” scenario here where more and more debt gets issued which is chased even lower by global investors. Maybe the next best tax increase will be mandatory negative yields?

          Another development could be the companies who are in the liability business (insurance companies, etc.) that have mandated minimum guarantee rates will need to swoop in before its too late and acquire as much Treasury debt before it drops down below their minimums?

          1. You are saying, in probably a more sane sounding fashion, what I have been trying to express. What is the Fed selling , to whom and at what price. Nothing says they have to use the open markets as the did not when they scooped the crud off the top in recent history and just contrived a price. More than half the Market trade dark. This dark door can be a form of massive manipulation. Mark to market is a sophomoric concept as is transparency and the Good Ole Prudent Man Rule, but performance of the balance sheet as you mention above can only be engineered so long, and by favors from whom, at what price? My hackles are up and I am sleeping with an eye open by instinct. Terms are not market driven, good…or fair.
            The Money Men have disclosed their hands and as Jerry sang,
            “Just like New York City, just like Jericho,
            Pace the halls and climb the walls and get out when they blow.
            …Sitting plush with a royal flush, aces back to back”

      2. Tim, I’m wrestling with how much ‘dry powder’ is right for my needs in this particular crazy environment. Would you mind giving a ballpark percentage of total investable resources you have as ‘dry powder’? Any other scary to share that info?

        I’m at roughly 10% at the moment and feeling like that may be too low.

  3. I’m a little sympathetic to Powell on this one. If you think the economy is weak, and rates need to come down, then selling balance sheet assets seems to work at cross purposes with lowering the Fed funds rate. I thought they had said they would stop the runoff in September, so changing to August isn’t that much of a move. I also question (as in genuinely question, not trying to make a rhetorical point) how much of a difference it makes. A quick google search tells me that about $500 billion in US debt trades every day. That’s 2.5 trillion in a week. So an extra $10 billion per week in demand does make a difference at the margin, but I’m just not sure how much it influences 10 year rates. (But I think your point is that this is a good time to sell assets at good prices, so the Fed has lots of capacity when it needs to start buying again. Correct?) At this point, everything Powell does will be questioned as to whether he is or is not trying to please Trump or hold his job. My guess is that he is trying to do what he thinks is right. It’s hard enough to try to predict economic activity and cycles, but the entire Fed Board is to some extent guessing about how unpredictable developments in trade negotiations will influence global and US growth. Thanks for the good discussion.

    1. Hi Roger–you are probably correct in that the $10 billion is minimal, but yes–sell when the selling is good and be prepared for the future which we all know is going to require substantial FED support since DC can’t get their act together on the debt.

      1. To Roger and Tim’s point that $10 Billion is minimal, isn’t that in itself a commentary that Powell is likely doing things to mollify his biggest potential critic? He is probably calculating what is the smallest amount he can go with to keep the man off his back.

    2. I have been saying for several years that the debt runoff was BS. The large part is and will stay permenately monetized. There never was going to be a serious runoff despite the smoke signals.

      1. I want to know exactly what they are running off, to whom and where is it ending up.. Remember the contrived Euro crisis and PIGS bonds near 20%. The whole thing was made up and the new financing all in crisis at 15%+. Why is everything so much better now, same bonds, same countries, in low single digits? Now anyone might ask, “where are those bonds today that rates at 2-4% and they were long term instruments?” Well look into public asset funds of EVERY sort pushed onto an unwitting public in dribs and drabs. Funds are loaded with them now. The public holds them, CEFs, ETFs, pension plans, etc. Do the math on the returns to private money printing bankers who held the paper gun to Europe’s head.
        Do I make any reference to asking what and where is the “mystery Fed runoff” going? Just thinking!… and asking for the rest of the story. The public will get saddled, THAT is the Playbook. The Fed is there to serve the BANKING system only. One man’s experience and opinion. PS : I tried to buy some of those sovreign euro bonds back then, at 1980’s US coupon rates near 20% and could find nothing but laughing brokers. I was locked OUT! But suddenly I can buy then NOW.

        1. Just anecdotal but most of us probably remember growing up when money wasn’t so easy. I grew up in the 60s and 70s, one bathroom, two parents, 4 kids, one car. My wife and I went to a country fair tonight, about 20 miles from where I live now. The whole area is mostly rural, the place we went to tonight I don’t travel much anymore but I was struck by the cul-de-sacs and McMansions all over the place. I don’t fully understand where it all comes from. I think debt is exponential, meaning a little bit more added to the load requires more actual money to pay it off due to the drag of interest, even at these low rates. I’ve always lived frugally, but well, if that makes sense and I think the easy money of the past couple of decades has made people unable to accept doing without. Not doom and glooming, just watching, not sitting on my hands as far as investing, but trying to be very careful. When things have been so good, for so long, there is usually a reversion to the mean. Story to be so wordy, but like true country fair, there were a couple of craft brewers there, and I am Irish…so Slainte 🍻

          1. Tim – Thanks for sharing! Only thing I’d add is that I remember no air conditioning in our house or in the schools … and this was in south Florida.
            Things got ripe real fast in August LOL.

          2. In Italy, we tend to have a low level of consuption, and high level of private saving. For this reason, our economy is performing poorly.

            1. Mauro, With the prevalance of low/negative rates in EU and given the current economic scenario, into what vehicles in Italy are citizens saving?

              1. Hello alpha8

                1371 out of 4287 billion € that are owned by Italian families are saved in current accounts. The interest rates are very low, spending is very low, and investments are very low. Families tend to be very cautious with money: savings have reached 8.1% of their disposable income, that is, 8 out of 100 € earned by a family go into savings (Bollettino Economico of Bank of Italy). During the last 10 years, investments in corporate and treasury bonds have been reduced by 62%, while the growth of high-risk products, like shares, has been of only 7% since 2013. Treasury bonds in the Euro zone have a dismal or even negative yield; the newly issued corporate bonds have come out with size varying from 100.000 to 200.000 €. The products that are preferred by Italians are those linked to the Insurance Industry, like Pension Funds. These, while registering a growth of “only” 71% since 2008, are the first form investment here. Their total value has reached 1000 billion €, i.e., one quarter of the total value of investments in our country. Looking for good yield, 25% of my portfolio is US Dollar denominated (Corporate Bonds, Baby Bonds, and Preferred Shares). It goes without saying that I accept the risk of an exchange rate that I have no way to control.

  4. I like PFF for 3-4 days a month, 2 days before ex-div and 2 days after. Then that 35% goes back to cash. I like muni bonds mutual funds and ETF’s. I like a few select CEF’s and some individual preferred. About 40% of my preferreds are Canadian issues pay 6%+ that are way down in their market price from 1 year ago. Likely I will dip my small toe in Bell Canada soon.

    MY overall view is the shit will hit the fan sooner than later, Cash, muni’s, CEF’s(will be sold), utility preferreds, and canada utilities will be the safest ports in the sroem.

    1. Sorry Steve–this one initially hit the trash because you said shi- Maybe I’ll take shi- out of the filter since a lot of it will hit the fan in the future.

  5. exited NI-B today, booked more than 9% gain . . . that’s how crazy it all seems to me. is this the time to raise cash? I sure as shootin’ have no idea. took profits by closing a number of winners in the past few weeks: SF-A, STAG-C (both small holdings) and GLOP=A near par where I bought in a couple of years ago. also dumped a couple of losing common and fund holdings. what seems to have worked for me are some of the low-yield 4% or so floor preferreds. entered GS-D back in February, sold out a 1/3 position a few days ago at 10% + gain and it’s up another couple percent since. took on a couple of (for me) full positions in GS-A about 10 days ago, snagged the ex-date and they’re presently up more than 2%. looking at MS-A, BML-L, GS-C. any ideas or comments? yikes!

  6. Everything already picked over twice. Smallest credit spread I remember. New IG issues very skimpy terms. Now market started wondering if bad news still means good news. Maybe the news is not bad enough or maybe it’s too bad I don’t know. Everything looks hyper and crowded to me but I can’t see clearly obscured by fixed income smoke, thick, coming out of my computer again today. I read sometimes preferred can like stocks rather than bonds not reassuring. My small issue callable 1yr CD just got called with 5 months left? Come on. Libero already got a years worth, lol.

  7. Tim you read my mind. I was at a loss why they would stop decreasing the balance sheet into a massive bond rally?!?

  8. The Fed has a bad record going all the way back to the early 1900’s. Some times its non-financial influence while other times they do just what they do – raise or lower interest rates. The timing is usually wrong and the magnitude is too great both ways.

  9. I have been buying TLT not for the income but for the possible capital gains if we go to zero. I a,m already up 2.5% in a couple of days.

    1. I feel the same way the big bull is over, some black swan coming. Im sticking to fixed income short term Preferreds. No common stocks or Cef’s.

      1. I’ve felt that way for a good month or so as I mentioned a few weeks back and because of call risk premiums I’m out of all my preferred holdings. I think my exact words were “something doesn’t feel right”. I’m not sure that going with a unquantifiable gut feeling is a valid investment philosophy but… I agree with Tim that something bad may be in our near future. Hope we’re both wrong.

        I’m still holding some of my ETF’s…SCHD, HDV, DGRO, SPHD, VGT on the equity side and ICSH, SHV, VCLT on the bond side and…my gut is still a little queasy. If we get a bounce next week I may be reducing the equity side further. My portfolio was down 1.2% this week,. S&P down 3.76%, NASDAQ down 4.6% so I consider myself lucky.

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