Federal Reserve Chairman Ben S. Bernanke seemed a little nervous at his June 19 news conference. His recent comments about the future course of monetary policy had rattled investors and driven bond yields up, tightening financial conditions in a way the Fed didn't want. Formally unperturbed, Bernanke said he was leaving policy unchanged -- but in trying, yet again, to elucidate the Fed's thinking, he tacitly admitted that something had gone wrong.
Fortunately, the policy itself, I think, is basically good -- but that's despite, not because of, the ever-evolving formulas used to explain it.
Growth in the U.S. is still sluggish, unemployment is still high and inflation is (a) running well below the Fed's target and (b) falling. That suffices to justify interest rates at zero until further notice, together with additional large-scale asset purchases -- which is what the Fed intends.
There are dangers in this policy, to be sure. Quantitative easing is an experiment and involves risks. Bernanke summed these up drily in a recent speech: There's the risk that long-term interest rates will remain low (leading investors to recklessly "reach for yield") and the risk that they won't (imposing losses on investors when rates rise and bond prices fall). The point is, in current circumstances, every course involves risk. Tightening monetary policy prematurely, as Bernanke has often explained, courts the greatest danger -- that of bringing a hesitant recovery to a stop. On a balance of risks, aggressive monetary stimulus still makes sense.
David Fuller's view The problem is not with Mr Bernanke who's
every word and gesture is uber analysed; it is with the markets. Trillions of
various currencies are invested or gambled in an effort to make more money.
People pile in and pile out, as they always have, only the numbers are bigger
and the technology faster.
In government bonds, which we could call a crowded trade, the traditional buyers have increased positions over the years because they were still making money in a secular bull market. In recent years, battalions of additional investors joined them, buying bonds because that was what the Fed was also doing.
These momentum trades are logical strategies, until the music stops, to coin a phrase. The problem is, one seldom knows when that will happen. Moreover, reasonably consistent one-way traffic in markets can lull most people into a false sense of security. The temptation when nervous is to listen to what one's companions with similar positions are saying.
People who are piggybacking on the Fed think they can get out when the central bank stops buying. However, some people conclude that that might be a crowded trade, so they anticipate. If they sell too soon, they will have to scramble to get back in at a higher price. If they time their exit correctly, their biggest challenge will be to avoid rushing back in prematurely when the crowd is panicking.
So where are we today? I think one of the most revealing charts is the Merrill Lynch 10yr+ US Treasury Total Return (historic monthly & weekly). I believe that it has done something which we have not previously seen. First, it broke up out of a trading range as we have seen on plenty of previous occasions. Then it had an upside failure, as we have occasionally seen. Finally, it followed that upside failure with a clear break beneath the above mentioned trading range's lows.
To repeat myself, I do not think that we have seen this upside failure and subsequent break of the previous lows before, and it is a bearish signal. In an uncertain world, I would give it the benefit of the doubt, unless it rallies back above the early-May high near 2028.
Additionally, these 10-year weekly charts for US 30-Yr and US 10-Yr Treasury Bonds show how quickly yields can rise and I do not think we will see the lows near 2.5% and 1.38%, respectively, tested again. However, watch for a reaction and consolidation before long, eventually followed by additional gains.
(T-Bonds are discussed in more detail in today's Big Picture Audio.)
(See also Friday 7th June 2013)