Why The Fed Will End QE On Wednesday

Submitted by Lance Roberts of STA Wealth Management,

This week we will find out the answer to whether the Federal Reserve will end its current quantitative easing program or not. Today is the last open market operation of the current program, and my bet is that it will be the last, for now. Here are my three reasons why I believe this to be the case.

1) Much Smaller Deficit Restricts Treasury Bond Issuance

Over the last few years, the Federal deficit has shrunk markedly as infighting between Republicans and Democrats has restricted government spending to a large degree while taxes were increased across a broad spectrum of American taxpayers. The good news is that the U.S. government is closer than in many years to running a balanced budget, although it is has been more by accident rather than through a logical approach of budgeting and waste reductions. The bad news is that deficit spending has been a major contributor to economic growth in the past and the reduction of such has been a drag on economic growth recently.

The chart below shows the level of federal spending, revenue and the deficit. I have added the Federal Reserve’s balance sheet which has been a major buyer of U.S. debt in recent years.

Deficit-FedBalanceSheet-102714 

One of the reasons the Federal Reserve will allow the current QE program to conclude is because the shrinking deficit is reducing the number of bonds being sold by the Treasury.

“But in the economic recovery phase, the federal deficit commenced shrinking sooner than the Fed commenced tapering. There reached a point at which the Fed was acquiring more than 100% of the net new issuance of US government securities. At that point, the Fed’s buying activity was withdrawing those securities from holders in the US and around the world. Essentially the Fed was bidding up the price and dropping the yield of those Treasury securities, and it was doing so in the long-duration end of the distribution of those securities.

The Fed has taken the duration of its assets from two years prior to the Lehman-AIG crisis all the way out to six years, which is the present estimate. It is hard to visualize the Fed taking that duration out any farther. There are not enough securities left, even if the Fed continues to roll every security reaching maturity into the longest possible available replacement security.”

The chart below illustrates this point.

Fed-Balance-Sheet-Treasury-Issuance-102714 

As you can see, the net change to the Federal Reserve’s balance sheet swelled during each of the quantitative easing programs. The liquidity supplied flowed into the financial markets driving asset prices higher.  Importantly, notice the extreme level of balance sheet expansion during QE 3 which caused assets to surge in 2013. However, since the beginning of 2014, the balance sheet expansion has markedly slowed and along with it the inflation of asset prices.

Importantly, with the Treasury issuing fewer bonds due to reduced funding needs, the Federal Reserve can not keep the current pace of purchases going without the risk of potentially creating a liquidity problem within the credit markets. I am quite sure that the Federal Reserve is aware of this issue which is why, despite many bumps in the market this year, they have continued their pace of reductions without pause.

For investors this is critically important to understand, as shown above, there is a very important correlation between the Fed’s QE programs and the liquidity flows that support asset prices. As that liquidity push is extracted from the financial markets, there will be a corresponding increase in market volatility. “Tapering” is in effect a “tightening” of monetary policy which historically slows the growth rate of asset prices.

2) Not Ending Program Could Send Wrong Message On Economy

Boston Federal Reserve President, Mr. Rosengren, recently stated that: the Fed’s asset purchases have achieved their stated goal, the jobs report for September is already in and his economic forecasts have not changed.

“There has been substantial improvement in labor markets, and as a result I would be pretty comfortable [ending purchases] at the end of the month.”

    “Fed Speak” holds much sway over the markets. After each meeting, as Janet Yellen gives her press conference, market participants are quick to parse her words and place market bets on what they think she is implying. Up to this point, each post-meeting confab has been a reaffirmation that the economy is improving enough to expand without the support of monetary policy. 

    It is very likely that if the Federal Reserve decided to keep its current pace of bond purchases in place it would likely be interpreted that the economy is indeed not as strong as the statistical headlines [20] suggest. Such an interpretation could lead to a repricing of risk, and a sharp decline in asset prices, that would potentially destabilize consumer confidence. This is not the outcome that the Federal Reserve is looking for.

    3) Must Normalize Policy Before Next Recession

    Most importantly, the economy is now more than five years into the current expansion. As shown in the chart below, we are now in the fifth longest economic expansion on record. This sounds great until you realize that has been achieved with the lowest level of economic growth of any post-WWII recovery.

    Historical-Economic-Recoveries-102714 

    While much of the mainstream media, analysts and economists ignore normal economic cycles, it is very likely that we are closer to the next recession than not. This is not a bearish prognostication, but rather just the realization that despite the Fed’s best intentions, normal economic and business cycles have not been repealed.

    The problem for the Fed is that with the effective interest rate near ZERO, one of their most important monetary tools to offset recessionary drags within the economy has been removed. The chart below shows the history of the Fed’s overnight lending rate as it compares to economic growth, the market and recessions.

    Fed-Funds-Crisis-102714 

    Historically, each time there has been a crisis, or recession, the Fed has responded by dropping the effective Fed funds rates in order to induce borrowing and lending within the economy. As stated, with the rate near zero, the Fed is trapped without an important policy tool if the economy slips into a recession in the near future.

    This is why they have been so vocal about raising short-term interest rates. The Federal Reserve needs to normalize monetary policy before the next recession hits in order to have some “working room” to stem off any potential future crisis. Ironically, there is a case to be made that the Fed’s interest rate policy manipulations are a cause of economic crises and recessions.

    For these reasons, I highly suspect that the Federal Reserve will announce the end of the current “QE” program during their post-FOMC conference on Wednesday. How the markets respond initially will be focused on what she “says,” however, going forward the“lack of liquidity” may become a much more important issue. 

US Interest Rates Can Never Rise

It’s not just the public who has to worry about rising interest rates, the Federal government might soon get a taste of its own medicine.

With the Federal Reserve doing all it can to stimulate inflation, increases to interest rates are taking a front seat amongst borrowers’ fears. From the admittedly partisan Republican Senate Committee on the Budget comes this report outlining how federal interest outlays will dovetail with other expenses in the future.

To summarize:

The U.S. gross federal debt currently stands at $17.548 trillion, and net interest payments to our creditors are the fastest-growing item in the budget. In 2014, the Congressional Budget Office projects that the nation will spend $233 billion on interest payments. By the end of the budget window in 2024, however, CBO forecasts that interest payments will nearly quadruple to an astonishing $880 billion. Every dollar spent paying our creditors is a dollar wasted—money for which we get nothing in return. Interest payments threaten to crowd out every other budget item.

To put the $880 billion, single-year interest payment in perspective, here is what we currently spend on other budget items:

    • Federal Courts – $7.4 billion
    • Department of Education – $56.7 billion
    • Secret Service – $1.8 billion
    • Food Inspection – $2.3 billion
    • Census Bureau – $1.0 billion
    • Border Patrol – $12.3 billion
    • National Parks – $3.0 billion
    • NASA – $17.6 billion
    • Centers for Disease Control – $7.1 billion
    • Federal Prison System – $6.9 billion
    • Workplace Safety Inspections – $0.9 billion
    • Immigration and Customs Enforcement – $5.6 billion
    • FDA – $2.6 billion
    • Federal Highway Budget – $40.4 billion
    • Coast Guard – $10.0 billion
    • Small Business Loans – $0.9 billion
    • Veterans’ Health Care – $55.3 billion
    • FBI – $8.3 billion

Every debt incurred today must be paid off in the future. The graph above may be shocking to some, but it’s only a very small part of the picture. This is just interest on debt, and doesn’t even include the costs of repaying the principal. Of course, the principal never really gets repaid as the government just borrows anew to paper over its old debts, but the interest must be covered or savers will stop lending money to the government.

Nor is this only a concern for the future. Last year the government spent more on interest payments (c. $700 bn.) than it did on Medicare (a little under $600 bn.).

About That “Recovery Summer”: Its Deja Vu All Over Again

Baseball great Yogi Berra had a saying “It’s déjà vu all over again”. Every year around this time, we are reminded of those words.  As we have once again, happened upon that magical time of year I call, recovery summer déjà vu. It’s the time of year when Wall Street and Washington apologists trot out their dog and pony narrative, in an attempt to spin the actual data, proving we have finally embarked on the summer that will launch sustainable economic growth.

And this year is no exception, as those same people appear to be downright giddy about the prospect that we finally have something to feel optimistic about.  For instance, they are euphoric about the most recent jobs report, some suggesting that there is absolutely nothing to find fault with.  Of course, they fail to mention anemic wage growth, the lower quality and part-time jobs created; or the discouraged workers who have left the work force.

Yes, they will admit that they were stunned when GDP contracted in the first quarter, but that was a mere weather-related incident.  It was the blizzard of Q1 2014 that left GDP buried under 2.9 percent of negative growth.  In truth, a more accurate reason for the economic slump was the move in the 10 year note from 2.48 percent on October 23rd, to 3.03 percent on December 31st of 2013.  And the move over 3 percent was the peak of the cyclical advance from the low of 1.63 percent on May 2nd. The doubling of interest rates, although still to a historically low level, was enough to send this debt-laden asset-bubble driven economy into the freezer. But why allow facts get in the way of a good weather story.  So once again we hear cheers for another summer recovery.

The truth is, since 2010 every second half recovery has disappointed and this one will be no exception.  The first quarter of 2014 gave us 2.9 percent negative growth.  I am in agreement with most economists that the 2nd quarter will come in somewhere around 3 percent, resulting in an economic flat line for the first half of 2014.  This puts enormous pressure on the second half of year to bring us out of stagnation that has led to the most anemic recovery since WW II.  Let’s review:

  • GDP shrank in both 2008 and 2009,
  • growth returned in 2010 by 2.5 percent,
  • in 2011 GDP fell back to 1.8 percent,
  • GDP then went up slightly in 2012 to 2.8 percent,
  • then down again in 2013 to 1.9 percent.

The inability to obtain growth above 3% in each year since the economy collapsed during 2008-2009 underscores this tremendous economic failure to bounce back after the Great Recession.

united-states-gdp-growth

So why do they think this year will be different?  After all, if you subscribe to the Keynesian fairytale of money printing and deficit spending, it was easy to see why they were excited back in the summer of 2010.  The economic spigots were over flowing with a treasure trove of demand stimulus and monetary elixirs.

In the summer of 2010 optimism was in the air… Time magazine’s 2009 man of the year Ben Bernanke was poised to save the day, ready to do whatever it took to get this economy growing again.  Today, despite lack luster growth, the Fed is retreating.  Essentially conceding—at least for now–printing money didn’t solve the problem; QE is set to wind down in just 90 days.

But for a Keynesian it gets worse.  Instead of an Obama phone, we have the roll-out of the job-killing Obama-care plan this year and next. In addition, profligate tax-payer subsidized loans that funded the likes of Solyndra, have been supplanted by a capital goods strike.   “Shovel ready” has been replaced with anemic real income growth and record debt levels.

Putting the Keynesian fantasy aside, the truth is there isn’t much ahead that will stimulate real growth.  The middle class, which was already saturated in debt, has not been the beneficiaries of the Federal Reserve’s money printing.  Instead, those dollars have been funneled into the creation of new asset bubbles and have led to an increase in food and energy prices—like it always has in the past.  Stagnant wages are being stretched further to pay for the necessities of living.  We still don’t have the regulation and tax reform that catapulted the Reagan revolution. Companies that have cash flow would rather make stock purchases to increase their Earnings per Share than invest in property, people, plant and equipment.  And, unless the economy is headed back into a severe recession, the economic boost from a lower cost of money will be absent.

The truth is there is not much at all on the economic horizon to warrant optimism. Yes, the cheerleaders are hoping if they yell loud enough, a recovery-summer will finally manifest.  Unfortunately, until free-market forces are finally allowed to deleverage the system, it will be a disappointing second half recovery–all over again.

By Michael Pento at Pento Portfolio Strategies

The Federal Reserve and Bubbles

Many market pundits argue that the Federal Reserve is too dumb or too inept to identify asset bubbles.

By focusing on the Fed’s mental acuity (or lack thereof), these pundits are overlooking a key factor: the Fed wants asset bubbles.

Why?

Asset bubbles, at least according to the Fed’s models, will paper over the steady decline in quality of life that began in the US roughly 50 years ago.

This fact is staring everyone in the face, though few people can see past the smoke and mirrors erected by our government to identify and understand it. . Back in the 1950s, the average American family had one working parent and was able to get by just fine. Today, most families have two working parents, sometimes working more than two jobs and they’re still not able to afford a prosperous life.

A 2012 study by NYU Professor Edward Wolff found that the median net worth of American households was at a 43-YEAR LOW. The average American in the 21st century was in worse shape than his 1970s counterpart.

This process began to accelerate in the late 1990s. Looking at real media household income, one can see clearly that things have generally been downhill for nearly 20 years now.

Real Household Income

It is not coincidence that the Fed began blowing serial bubbles starting in the late 1990s. The Fed is aware on some level that quality of life in the U.S. has fallen. The Fed’s answer, rather than focus on solutions to the problems of job growth, income growth, etc. has been (and is) to blow bubbles to paper over this decline.

This is why we’ve had bubble after bubble after bubble in the last 15 years. The Fed doesn’t have a clue how to create jobs or boost incomes. Why would it? Most of the Fed’s Presidents are academics with no real world business experience.

Instead, the Fed believes in the “wealth effect” or the theory that when housing prices or stock prices increase, people feel wealthier and so go out and spend more money. This theory is baloney. People spend based on their incomes, NOT the value of their homes or portfolios.

Assets only convert into cash once the owner sells the asset. Anyone who goes out and spends more money because their home went up in value will only end up with credit card debt or home equity debt, which combined with their mortgage, puts an even greater strain on their financial resources.

The Fed wants asset bubbles because they hide the rot within the US economy. If the Fed didn’t raise stock or housing prices, people might actually start to wonder… “hey, why is my life getting more and more difficult despite the fact that I’m working all the time?”

The Fed wants bubbles. So we’re doomed to keep experiencing them and the subsequent crashes.

Originally published by Phoenix Capital Research

The Never Ending Recession — Should I Trust the Government?

We know the BEA has deflated GDP by only 32 percent since 2000. We know the BLS reports the CPI has only risen by 37 percent since 2000. Should I trust the government or trust the facts and my own eyes? Americans know what it cost for food, energy, shelter, healthcare, transportation and entertainment in 2000, but they unquestioningly accept the falsified inflation figures produced by the government. The chart below is a fairly comprehensive list of items most people might need to live in this world. A critical thinking individual might wonder how the government can proclaim inflation of 32 percent to 37 percent over the last fourteen years, when the true cost of living has grown by 50 percent to 100 percent for most daily living expenses. The huge increases in:

  • property taxes,
  • sales taxes,
  • government fees,
  • and income taxes

aren’t even factored in the chart. It seems gold has smelled out the currency debasement.

Living Expense

You should not trust government statistics – any government statistic. They have systematically under-reported inflation. The reality that we remain stuck in a fourteen year recession is borne out by:

  • the continued decline in vehicle miles driven (at 1995 levels) due to declining commercial activity,
  • the millions of shuttered small businesses,
  • and the proliferation of Space Available signs in strip malls and office parks across the land.

The fact there are only 8 million more people employed today than were employed in 2000, despite the working age population growing by 35 million, might be a clue that we remain in recession. If that isn’t enough proof for you, than maybe a glimpse at real median household income, retail sales and housing will put the final nail in the coffin.

The government and their media mouthpieces expect the masses to believe they have advanced their standard of living, with median household income growing from $40,800 to $52,500 since 2000. But, even using the badly flawed CPI to adjust these figures into real terms reveals real median household income to be 7.3 percent below the level of 2000. Using a true inflation figure would cause a CNBC talking head to have an epileptic seizure.

household-income-monthly-median-since-2000

The picture is even bleaker when broken down into the age of households, with younger households suffering devastating real declines in household income since 2000. I guess all those retail clerk, cashier, waitress, waiter, food prep, and housekeeper jobs created over the last few years aren’t cutting the mustard. Maybe that explains the 30 million increase (175% increase) in food stamp recipients since 2000, encompassing 19 percent of all households in the U.S. The increase credit card, auto and student loan debt over the fourteen year period 2000 to 2014 is likely an attempt by households to maintain their standard of living via debt.

household-median-income-by-age-bracket-2012-table

When you get your head around this unprecedented decline in household income over the last fourteen years, along with the 50 percent to 100 percent rise in costs to live in the real world, as opposed to the theoretical world of the Federal Reserve and BLS, you will understand the long term decline in retail sales reflected in the following chart. When you adjust monthly retail sales for gasoline (an additional tax), inflation (understated), and population growth, you understand why retailers are closing thousands of stores and hurdling towards inevitable bankruptcy. Retail sales are 6.9 percent below the June 2005 peak and 4 percent below levels reached in 2000. And this is with millions of retail square feet added over this time frame. We know the dramatic surge from the 2009 lows was not prompted by an increase in household income. So how did the 11 percent proliferation of spending happen?

Retail-Sales-ex-gas-adjusted-for-population-and-inflation

The up swell in retail spending began to accelerate in late 2010. Considering credit card debt outstanding is at exactly where it was in October 2010, it seems consumers playing with their own money turned off the spigot of speculation. It has been non-revolving debt that has skyrocketed from $1.63 trillion in February 2010 to $2.26 trillion today. This unprecedented 39 percent rise in four years has been engineered by the government, using your tax dollars and the tax dollars of future generations. The Federal government has complete control of the student loan market and with their 85 percent ownership of Ally Financial, the largest auto financing company, a dominant position in the auto loan market. The peddling of $400 billion of subprime student loan debt and $200 billion of subprime auto loan debt has created the illusion of a retail recovery. The student loan debt has been utilized by University of Phoenix MBA wannabes  to buy iGadgets, the latest PS3 version of Grand Theft Auto and the latest glazed donut breakfast sandwich on the market. It’s nothing but another debt financed bubble that will end in tears for the American taxpayer, as hundreds of billions will be written off.

The fake retail recovery pales in comparison to the wolves of Wall Street produced housing recovery sham. They deserve an Academy Award for best fantasy production. The Federal Reserve fed Wall Street hedge fund purchase of millions of foreclosed homes across the nation has produced home price increases of 10 percent to 30 percent in cities across the country. Withholding foreclosures from the market and creating artificial demand with free money provided by the Federal Reserve has temporarily added $4 trillion of housing net worth and reduced the number of underwater mortgages on the books of the Too Big To Trust Wall Street banks. The percentage of investor purchases and cash purchases is at all-time highs, while the percentage of first time buyers is at all-time lows. Anyone with an ounce of common sense can look at the long-term chart of mortgage applications and realize we are still in a recession. Applications are 35 percent below levels at the depths of the 2008/2009 recession. Applications are 65 percent below levels at the housing market peak in 2005. They are even 35 percent below 2000 levels. There is no real housing recovery, despite the propaganda peddled by the NAR, CNBC, and Wall Street. It’s a fraud.

MBAMar122014

It is the pinnacle of arrogance and hubris that a few Ivy League educated economists sitting in the Marriner Eccles Building in the swamps of Washington D.C., who have never worked a day in their lives at a real job, think they can create wealth and pull the levers of money creation to control the American and global financial systems. All they have done is perfect the art of bubble finance. Their policies have induced unwarranted hope and speculation on a grand scale. Greenspan and Bernanke have provoked multiple bouts of extreme speculation in stocks and housing over the last 15 years, with the subsequent inevitable collapses. Fed encouraged gambling does not create wealth it just redistributes it from the middle class to the elites. The Fed has again produced an epic bubble in stock and bond valuations which will result in another collapse. Normalcy bias keeps the majority from seeing the cliff straight ahead. Federal Reserve monetary policies have distorted financial markets, created extreme imbalances, encouraged excessive risk taking, and ruined the lives of working class people. Take a long hard look at the chart below and answer one question. Was QE designed to benefit Main Street or Wall Street?

sp-500-vs-federal-reserve-balance-sheet1

The average American has experienced a fourteen year recession caused by the monetary policies of the Federal Reserve. Our leaders could have learned the lesson of two Fed induced collapses in the space of eight years and voluntarily abandoned the policies of reckless credit expansion, instead embracing policies encouraging saving, capital investment and balanced budgets. They have chosen the same cure as the disease, which will lead to crisis, catastrophe and collapse. 

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” – Ludwig von Mises