Sunday, June 30, 2013

It's time to be afraid.....

Hello friends!

I post only one chart today because the 10 year bond is all that matters.  I haven't posted much because things have become rather calm, but I am afraid things regarding the stock and bond markets are about to heat up again.

So everyone is talking about the Fed's tapering so let me give you my take...

The Fed has basically backed themselves into a corner via QE.  The Bernanke is basically screwed either way,  Zero Hedge had a great piece explaining why he is being tortured:

 OK, I'll add a second chart:

Here is the Fed's dilemma.  If they continue to buy bonds at the rate they have been buying they risk owning nearly all of the bond market within 6 years.  The reason for this is because the deficit has been shrinking and fewer MBS have been created following the housing crash in 2007/2008.  This means there are fewer and fewer bonds that the Fed can buy. 

As a result, the Fed has no choice but to taper.  I say this because if they don't taper they risk owning the whole bond market(or close to it).

If this happens then the risk for volatility dramatically increases because there will be fewer and fewer bonds that are traded as the Fed continues to buy.  For example:  If they owned 90% of the market then the 10% that was left  would be spooked and would likely flee or perhaps during tough times in the stock market they would come back.  Either way it creates a situation where volatility would surge and the markets would eventually panic because the float would be so small. 

The Bottom Line:

I think the Fed is hell bent on tapering even though they don't want to because they know Wall St. will hate them for it.  The problem they have is if they continue on their QE path they eventually risk owning all of the bond market.

By doing so they would essentially be monetizing our debt which Bernanke has promised he would never do.  We all know Ben is leaving next year so I believe he is concerned about his legacy. He doesn't want to be the guy that printed money until he crashed the dollar.

In the long run I believe the person that replaces him will do exactly that.  In the meantime, I think it's smart to play the taper trade.  Get out of the bond market, short treasuries, and go long the dollar.  I have personally bailed on most of my bond positions and have gone to cash and the USD.  I remain invested in blue chip stocks and gold because I see nowhere else to hide. Be careful out there folks.  The Fed's antics have created an environment where owning bonds are more risky than owning stocks IMO.

If rates continue to rise as I expect it's going to get really ugly in both the stock and bond markets. 

Stay tuned...


Marty McFly said...

Good to see you back.

I agree that the Fed is backed into a corner. The timing of when things get ugly has been extremely difficult to predict. If interest rates keep on rising, the house of cards will come crumbling as the cost to service debts will be impossible. The dollar will go up and gold will go down in an era of deflation until everything gets flushed out.

Jeff said...

Thanks Marty

I agree.

Watching interest rates rise when oil is at $102 is scary.

It puts the Fed in a box. If they try and QE now to keep rates in check what happens to oil when the dollar falls on such an announcement??

I wouldn't want to be the Bernake right now!