Thursday, November 12, 2009

Zero Interest Rates Can't Last Forever

Hi All!

I apologize for being so quiet this week. I am exremely busy recently so please forgive me!

Alrighty, let's get to these wacky markets.

I wanted to share some thoughts with all of you around the US dollar and the current "easy money" interest rate policy of the Fed.

Before I get into this, let me start by saying the market makes no sense right now when it comes to fundamentals(Surprise! Not!). A strong dollar is usually associated with a strong economy in most countries.

Our stock market is doing the exact opposite right now as the banks continue to buy the S&P using US taxpayer dollars.

The trend that's been working recently is short the dollar/long equities trade. Whenever the dollar strengthens(like today) the trade reverses and the market tends to fall apart.

This of course makes no sense. However, Should this really be a surprise when it comes to the crazy price action in our market lately?

The way I see it, the market is basically caught between a rock and a hard place as the economy continues to suffer. The only way for the banks to make money right now is in a zero interest rate environment.

This allows for them to borrow from the Fed at practically zero and then buy things like longer term treasuries that yield 3-4%. This is a sweet spread for the pigmen.

Ironically, the pigs on Wall St have no desire too see a recovery in the short term because the profitability of the trades like the one I explained above are beautiful in their eyes. This low rate environment basically enables the banks to make sweet profits with very little risk compared to lending out money to J6P.

The current scenario described above is also having an effect on how the stock market trades:

Stocks today tend to rise as the economy continues to suffer because Wall St understands that the Fed cannot take away the punch bowl and raise interest rates as Rome burns.

As a result, traders and investors buy equities and gold based on the idea that the dollar will fall. This is the "reflation trade" that you hear about on CNBC all day.

This trade has been extremely successful recently as gold and equities have soared. Gold now sits near an all time high of over $1100(this must make the Fed nervous). The Dow has flattened out a tad recently but still sits over 10K.

However, when the dollar reverses and rises, equities begin to sell off as the world begins to fear deflation. We saw this type of price action today as the dollar stabilized. This stabilization often occurs as a result of countries buying our dollars in an attempt to stabilize the buck in order to keep their own exports attractive.

A weaker market as a result of a stronger currency is the exact opposite of what should happen. A strong national currency usually is representative of a country that has a strong economy. This should be a boost for stocks during normal times.

As we all know, these are not normal times.

So what do you do when the market is zigging when it should be zagging after a 50+% bounce? Stay away IMO. I am tempted to short at these levels. In fact, I bought a few short contracts two days ago for **its and giggles.

For the most part as you all know, I continue to sit in cash and go long metals as the dollar continues to depreciate as a result of endless bailouts.

The risk of buying stocks with PE ratio's of over 100 is simply too risky for my taste.

So where are we headed?

IMO, I don't see why the dollar will strengthen anytime soon. As long as the fraud on Wall St continues and real price discovery continues to be ignored, the dollar is going to continue to get crushed.

The economy will not recover in such a scenario because the prices have not been allowed to "revert to the mean".

This forces buyers to sit on the sidelines thinking that prices are still too high which then kills the economy. Rising unemployment only exacerbates this problem. We now sit at a staggering 17.5% U-6 unemployment rate.

Don't forget: The real economy is dead folks. The government stimulus is the only thing keeping things afloat. Remember, the Feds would never spend like this and risk inflation/hyperinflation if they believed the economy could sustain itself.

As a result, the Fed's continued massive spending binge will dig us even deeper into trillion dollar debts. The US dollar will continue and take a beat down as a result..

Eventually this game will end because there will be no one left to borrow money from in order to keep the game going. Also keep in mind that the quantitative easing by the Fed is about to come to an end.

The Fed's treasury purchases are just about done, and the MBS QE purchases should be completed by March in my estimate. When this buying binge ends in the spring the market is in for a VERY rude awakening.

I predict interest rates are going to soar as the world's appetite for treasuries disappears once they realize the Fed is no longer a buyer!

Take a look at Japan if you want a preview of what happens to rates when a central bank stops QE'ing:

The Bottom Line:

As you can see above, once Japan's QE spending binge ended, rates began to rise. Are they still ridiculously low? Yes. However, Japan's famed deflation was not nearly as serious as it is usually depicted.

I expect a violent rise in interest rates next year when our QE ends. I also predict that the short dollar/long equities trade will fall apart once the dollar gets below the 72 area.

When the dollar falls to a certian level, it will be hard for the pump monkeys to continue and smoke the bull crack pipe when oil goes back up to $150 as a result of our collapsing currency.

The Fed is on a bridge to nowhere. They can't raise rates because the economy is too fragile, and the dollar will continue to fall the longer rates stay at zero. This will of course will create tremendous inflationary pressures on the economy.

Heading into early next spring I believe higher interest rates are inevitable as the various QE programs come to an end.

If the Fed ignorantly decides to extend these programs in an attempt to continue and bailout America, you better go out and a skateboard because it will be the only way you will be able to afford to commute to work.

Disclosure: Short a couple contracts via SPY for fun. Long Gold.


Complacent Panda said...
This comment has been removed by the author.
getyourselfconnected said...

I used to think that ZIRP could not last forever, but I am beginnign to waffle. If you check out Mish's unemployment projections, 7-9% UE could last until 2020! I know crazy sounding, but take a look. If so inflation will remain subdued in th eyes of the FED.
Good to see you.

jeff said...


Thanks man.

Things have been crazy recently so I haven't had a chance to write much.

2020? Wow. I believe it. I see no reason why not.

Inflation will remain subdued in the eyes of the Fed. What scares me is how does the rest of the world view it?

From the looks of gold prices I think the world is very concerned about inflation.

getyourselfconnected said...

I would have to agree, but of course we both are hive mind perma bears so who knows.

I sent you an email the other day as well to say hi.

jeff said...


Got it. Sent you one back.



ANON said...

The Fed won't care if we have some inflation, it helps with the debt. Low (and current zero) interest rates keep the stock market artificially propped up (at least numerically)--perfect for all those Americans who have no clue about foreign exchange rates, but do look at their 401(k) statements. Can you imagine Obama's (or anyone in Government) approval rating would be if the market wasn't up? God awful. If the economy were allowed to strengthen in a healthy manner, the populace would vote them out. J6P doesn't know what's good for him, but politicians know what will make J6P vote for them...whether it's good for the economy or not. Why would they stray from the votes?

It's a mess. Other countries are going to be pissed off at a weak dollar, though. And, furthermore, it's not like the US is alone in its ridiculous debt to GDP ratio. Japan is ahead of us (I'm glad I don't have to deal with that mess) and there are other countries who have, although smaller, terrible ratios. Things are fucked up.

But, we gotta keep up appearances (well, those things that people look at). You have people looking out for their own short term interests who will, ultimately, harm the long term interests of this country.

At least you know what's going on. Most people don't know any stats besides the 10% unemployment numbers released (often in the business section). Others don't realize the dollar carry trade. Etc. Hopefully, you can protect your assets. Hopefully, you can take advantage of the situation. I know most people are going to be hurt.

Jeff said...


I agree with you 100%.

Japan is nearing 200% on debt vs. GDP. Starting to think they are toast because their export economy is going to take a beating as the US consumer collapses.

I am trying to protect my assets the best that I can but I am beginning to feel like nothing is safe.

The Fed wants a orderly drop in the dollar, the problem with the markets is they are rarely orderly.

I expect some type of violent move down on the dollar at some point. Who knows what happens then.

Scary times.

CT-Hilltopper said...

Jeff, I agree with your post above.

I'm trying to cover my ass for whatever scenario, but I'm still not sure. I don't think any of us can be 100% sure about anything at this point. Or 50% sure. Or even 25% sure.

The key to making it through this thing is to have as little debt as possible and being able to lay your hands on as much cash as you can. And hoping like hell that the cash that you can lay your hands on is worth something and isn't worth, like, Confederate cash.

I agree with you about the dollar too. I'm keeping my eye on it closely. Not that I can do anything about it though. I'm not going to lose any sleep about it either. I'll just make my preparations and let what happens happen.

PS...I missed you!!! although I haven't had a lot of time to come online and post either.

jeff said...



I missed you guys as well. I am in the same industry as you so I can only imagine what you are going through.

All we can hope for is the syatem gets through this. I really hope the dollar doesn't get destroyed. All of us have worked so hard to save this stuff and it would really suck if it turns into toilet paper.

I guess we all need to just let this play out best.


flipdippy said...

You have no idea the sorts of moneyshines playing out behind the scenes in DC. I am not any sort of prophet or messiah, but something is truly fucked up behind the scenes. Particularly at Treasury.

Anyone who can accurately forecast what 2010 will bring will be a flipping genius, as it seems everything is still on the table only stakes are higher for failure.

All my personal economic indicators are all over the place.

Maxim magazine is no longer the leaflet it was last fall, it's thicker with advertisements. So ads must be picking up. Yet other magazines seem to be shutting down like wildfire.

Software is my business. If you are over 45, you may as well throw yourself down a flight of stairs now so you can collect long term disability before you get fired for being too old and expensive. Layoffs and firings are way up. Productivity is way up. Sales to commercial entities are down.

Auto sales are up. Auto prices are up. Auto volume/inventory is still down. I know because I'm shopping yet again for a larger crossover for my family and dealers are not budging much on price. They're willing to sit on the smaller inventory they have until they get their price.

International cargo shipping dead unless it's raw materials. Yet more evidence surfacing China is hoarding goods while they can acquire them cheap.

Deflation is kicking in hard at the grocery store. $250 worth of groceries a year ago now costs about $200-215 at least at Wegmans's in baltimore. Yet, gold is up. Oil is up.

Every financial prognasticator has a strong hypothesis for why equities will moonshot or crash or grind or are being manipulated by the government. I am sure nobody is ready for whatever is coming in 2010. Dow 10k, 20k or 2k wouldn't surprise me.

flipdippy said...

Re: the above, something is fucked up at treasury because it is affecting my business in a weird way. They are someone my company does business with and their decisions lately as they affect my company leave little room for interpretation.

Publius said...

Jeff, nice to see you back. I think we have to look at the dollar relative to the other currencies. Every other country is using QE, ZIRP and devaluation just as much as we are.

Other countries are not going to sit by idly and do nothing while we devalue our currency and make it impossible for them to export to the US. The issue now is that everyone is solely focused on the US and not the rest of the world. How could the dollar drop relative to the Pound? That is the worst currency in the worst economy.

I have a question, although QE has technically ended, isn't the scenario you laid out the same as QE? The Fed gives the banks free money and they use that money to buy treasuries. Isn't that just QE with a middle man?

getyourselfconnected said...

What the heck is up with the Bengals? I guess 8 years of 1st round draft picks finally catches up eventually? Oh man I had the Steelers winning that one, I have been wrong about almost every game today.

jeff said...



Great point around the potential "bank QE".

They are also flush with cash because they don't have to take any losses because they no longer have to mark to market.

Loans with huge losses are allowed to be marked at 100%.

The whole thing is insane. Like FLip just said: If they can keep this game going for awhile the market may continue to rise.

Regarding other countries watching our currency decline you also make a good point.

I don't think these smaller countries have enough capital to prevent it from happening.

Besides, there are benefits of a cheap dollar. Everything in the US becomes cheap as hell.

Dollar down again tonight. Gold up to 1027.

My gut tells me that the markets are taking down the dollar in order to force the Fed to explain their exit strategy.

Interesting times.

jeff said...


Bengals were the better team. they are legit. that's one hell of a defense.

Super Bowl contenders.

Anonymous said...

You are right Mr Faber ;)
(mms video stream)

This is simple and great game, more cheap dollars for banksters and more unemployment for J6P. :D

More & more debt, any savings (~0% ?!!), just pump it up with us. :D

Incredible how fast (~8 months) some markets (especially in Asia and South America) recovered from March bottoms to almost all time highs. Mr Bernanke, you are wonder-worker. Keep doing this great job. Long live creative accounting. This is new era of never-ending bull market. :D
Stock Market has not a lot in common with real economy. It has always been just like CASINO. ;)

Anonymous said...

link once again...