There’s an old joke about how to become a millionaire. Start with $2 million and then lose $1 million. The joke is all about perspective, which is exactly what’s required when considering the Fed’s actions yesterday.
It’s like a thief who comes by every night and takes $10 out of your wallet. You know who it is, and you know how he operates, but you can’t stop him. Finally, he tells you that he might stop. That’s good news! You get excited. Then he tells you that instead of taking $10 every night, he’ll only take $9.
Suddenly, you don’t feel so good. But that’s OK, because the thief wasn’t keeping the money. He was distributing it to a bunch of other people. They were quite worried that the thief would slow down the money train. So when he told everyone he would simply steal a little less, well, the recipients were pretty excited.
That about sums up the taper… and explains why the markets were so thrilled with the initial reaction yesterday.
We’ll see if that holds.
The end result is that the Fed is going to (ever so gently) slow down its bond buying, which is not fueling an economic recovery but is crushing savers.
This should lead to higher interest rates down the road, but not today. It all depends on how quickly the Fed slows its bond buying.
Keep in mind that the Fed is on track to buy the equivalent of almost 80% of the bonds the U.S. Treasury issued this year. That doesn’t leave a lot of inventory for other people to pick from, so long-term interest rates should remain low, or edge up only slightly as 2014 progresses.
If the Fed changes its rate of bond purchases, then interest rates will respond (buying fewer bonds should push rates higher).
But this doesn’t even touch the real topic at hand. That is, short-term interest rates. This is where Wall Street makes money.
The Fed announced that short-term interest rates will remain zero-bound for an “extended” period of time. This means beyond the estimate of 2015.
Our view – which I’ve written on several occasions – is that short-term interest rates will remain exceptionally low into 2017. This means the interest rate on which margin rates and portfolio margin rates are set will remain exceptionally low for years.
So all of those investment funds and investment banks that use leverage (borrowing against assets to buy even more assets) can continue using cheap debt to fuel their returns. What a gift!
Of course, it doesn’t work out for everyone.
Gold buyers got another black eye when gold fell out of bed and sank below $1,200 an ounce because the Fed wasn’t seen as stoking inflation. Really, these guys are in for more beatings as we expect gold to fall well below$1,000 an ounce.
The modest drop in bond buying is being viewed as a prop to the U.S. dollar, given that the Japanese will have to print more yen while the euro is at its recent highs even though the euro zone is languishing. Dollar strength equals gold weakness. That’s gotta hurt a little.
Unfortunately the full scope of the Fed announcement was that Wall Street will continue to rake in bucks, savers won’t get much relief, and those preparing for a death blow to the U.S. dollar took another hit.
As for what happens in the future, well, let’s keep an eye on the housing market.
While New Home Starts shot higher last month, mortgage applications fell like a rock this week, and have been dropping for several weeks in a row. If the housing market reacts badly to the Fed’s tiny taper, look for the Fed to put further reductions on hold “until the economy improves.” At which point more fuel will be added to the equity fire while fixed income savers are left out in the cold.
At this point, we have to stick to our guns, like our Boom & Bust portfolio, and watch the move of interest rates carefully. If we see any sustained move higher, it could be the right time to buy fixed income before we get the next leg down in the economy. Of course, we’ll also keep our bullish stance on the U.S. dollar.
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Ahead of the Curve
According to RealtyTrac, September 2013 pre-foreclosure filings were down 38.9% from last year. The same study shows bank-owned REO (real estate owned) filings are down 25%.