Debtor's Prison

Greetings fellow inmates:

This week was a relatively quiet one in FedWorld Live! especially compared to last week. The size of each side of the FedBS shrunk by $40bln to about $2.08tr. On the asset side, this was mostly due to a reduction in the outstanding amount of Term Auction Credit which dropped by $36bln to $337bln. Outstanding central bank liquidity swaps have also kept decreasing, dropping by $10bln this week to $166bln. Remember that central bank liquidity swaps have decreased in large part due to the liquidity pumped on the liability side of the Fed balance sheet to banks in the US, which has percolated into banks worldwide. These short-term dollar shortages have been ameliorated by all the dollars sloshing around in the base foundations of the financial system. That being said however, we estimate that central bank liquidity swaps will slow their rate of decline and settle at a relative equilibrium sometime soon. On the liability side, as usual, the decline was achieved through the reserve balances. We remind our dear readers that bank reserve balances held at the Fed are an extremely powerful reservoir of money since it is the monetary base and banks could theoretically use this money to lend out if they so chose. In spite of this, Uncle Benny has been wildly and wantonly creating them out of thin air with his trusty computer (they are purely digital after all). The way things are working now, the different components of the asset side of the FedBS evolve as they will and then reserve balances are adjusted to reflect this change.

Asset purchases were relatively slow this week. Uncle Benny bought $16bl of Treasury notes and bonds to a total of $556bln. He also purchased $3bln Agency debt to bring the total to $84bln and he sold $200mm of MBS debt. The Treasury and Agency purchases were in line with their smooth-sailing rate of the past few months. MBS debt purchases have been non-existent for three weeks in a row now. We are willing to take a small bet with any of you that next week Uncle Benny will purchase a big chunk of them, or we will eat our words.

The long bond continued to get pummeled this week, with yields rising to 4.70% from last week’s 4.58%. This even includes a significant reduction in yields today after a 30-year auction went better than expected. Though we are referencing a Bloomberg article, we are borderline disgusted with the positive “spin” they present in this particular article. Bloomberg articles constantly do this and we caution our readers against taking them too seriously for anything other than the pure facts one can extract from them from time to time. More specifically, the article mentions how indirect bidders, a group that includes foreign central banks, bought a larger percentage of the auction than previously. Seriously, this is not a big deal, and it certainly doesn’t imply, as the article makes it seem, that foreign creditors will continue providing financing at the long end of the curve. The bottom line is that 30-year yields keep rising. Again, this does not mean we won’t see a drop in yields in the near future, especially if stock markets and economic perceptions take a turn for the worse as we expect they will. What it does mean is that coincidentally, 30-year yields have surged higher at the same time Uncle Benny ramped up QE. Every week that goes by and yields continue higher just strengthens the correlation between QE and higher yields. The long bond has been compromised and it ain’t coming back.

The dollar continued to slide, for the ninth week in a row. Once again, let us remind you that this does not necessarily mark the beginning of the end for the USD, but it does strengthen the correlation between QE and a lower USD. We have prognosticated that QE will be to blame, as we expect it will be ramped up even from its current levels, for a massive decline in the value of the USD that will be severe enough to threaten the viability of fiat currencies themselves. While it’s impossible to predict exactly when this will happen (we think within the next 1-3 years), this formidable decline in the dollar since the announcement of QE is certainly a canary call, courtesy of Mr. Market.

Commodities continued to surge this week as measured by the Rogers International Commodity Index. The index rose 3.7% this week alone and is up 34% since its low on March 11^th, which was, again, eerily coincident with the onset of QE. This makes perfect since, as investors worldwide being to distrust “paper” securities backed by toxic debt and pile into natural resources as a natural protection. Moreover, the deleterious effects of QE will be felt in lower purchasing power of the reserve currencies versus commodities. The cost of the necessities will go up for everyone. Take a moment right now and contemplate what has happened since QE was announced in early March: 30-year yields are 110bps higher, the USD has dropped by 9% and commodities have risen by 34%. There is more to come, and once all is said and done, these indicators will have revealed the immense costs to everyone thanks to Uncle Benny’s wacky adventures in BMSTBMM. Of this we are certain. Tune in next week for more pain.

May your capital be safe and your investments prosperous,

MAAA