Prognostication: FOMC In An Hour
Courtesy of Karl Denninger at The Market Ticker
Let’s take a look at what may be going through Bernanke’s mind as the decision on rates and such is deliberated.
Nobody expects a rate change – myself included. Let’s take that off the table.
But traders seem to be speculating on an "enhancement" to debt monetization – the fuel that has driven this rally (anyone who doubts this can simply look at the fact that very little money has come out of money markets and fixed income; what has powered this rally is printed money monetizing Treasury and MBS debt – period!)
There is one small problem with that belief – the dollar.
In March when Ben announced his monetization of the federal debt (Treasury buyback) the DX was hovering up near 88, a new several-year high.
The problem is that below 71 or thereabouts there is literally no floor, and if you remember, we got there on the dollar being trashed from rate cuts and other forms of "excess liquidity’. When we were at risk of the floor disappearing on the dollar Bernanke drained system liquidity (quietly, but he did!) to defend the dollar – an act that I argue initiated the crash last fall.
Nowhere is the impact of this more evident than in oil prices; the high in the DX corresponds with the low in oil prices and vice-versa. This should not be a surprise; since we import virtually all of our oil the owners of that resource can (and do) demand payment in dollars based on where they think the dollar might go, not just based on where it is. In addition, speculators drive the price as well based on the same movements.
So Ben has a little problem here. If he adds to his Debt Monetization Binge (which, by the way, he did say he would not do at all in sworn Congressional testimony!) the dollar could move downward in a very disorderly fashion. A move back to the low 70s could easily precipitate a move in oil well over $100, killing any hope of economic recovery and driving gas prices well north of $4.
Worse, here’s the 10 year Treasury:
That’s a very nasty little pennant on the TNX – it implies a potential rate of about 5%. A rate that, by the way, that would take us back to mid-2007 levels.
That would imply a 30 year mortgage rate around 6% or perhaps 6-1/4, which would in turn thrash what’s left of the housing market – a market that, according to Bloomberg and the NAR, is still seeing record price declines driven by foreclosures.
The worse news is that so-called "QE" (more accurately called Debt Monetization) has not resulted in what Bernanke claimed would happen – that is, a stable 4% to 4.5% long-term mortgage rate. This was in fact a key part of his "Master Thesis" paper – we now know that it doesn’t and hasn’t worked. There’s no argument that can be made about whether Bernanke can force 30 year money rates to 4% any longer – he can’t, as despite spending more than a trillion in committed purchases between MBS and Treasuries, it simply hasn’t happened.
Damned if you do, damned if you don’t Ben; which way would you prefer to meet Lucifer?
On balance I believe the harm from a dollar move and ramping energy prices are higher. This may be the minority view, but it is my analysis. We’ll survive as an economy if we clean out the shysters and shadow inventory on the banks, along with all the "hidden" foreclosures (that were NOD’d and then ignored.) Yes, this will force even more bank failures, and perhaps even a second round of "bailout-itis", but if we kill the economy with ramping energy prices there will be no escape anywhere, and Bernanke knows it.
The latter is far more likely to bring out pitchforks and torches than more foreclosures and failures on Wall Street.
When the BOE came out with their expansion of their QE program, which was a LOT smaller than Bernanke’s, the pound got shredded instantly:
But the BOE had lots of room on the Pound – it was at the top of the recent range, and indeed, the top of a trading range it had held for months, prior to their announcement. While the move was dramatic (and has continued!) there was no threat of breaching key technical levels on the pound, as there is on the dollar.
So my call (which may be proved incorrect in an hour or so) is this: Bernanke will not take action here on the "QE" program – that is, he will not announce an extension/expansion of the Treasury Buyback. He may make noise about an "improving tone" in the economy and pledge to be "watchful", but I believe an announcement of an expansion of the Treasury Buyback is too dangerous given where the dollar is and the probable effect.
We’ll see if you get to laugh at me in an hour or not!
Updated: NAILED IT. Q/E to be exited in October, NO INCREASE IN SIZE. The Dollar sported wood immediately.