Capital Markets

Friday June 21, 2013******************************************* By Lou Barnes The days are getting shorter now, football closer — at least the Fed can’t take that away from us. Given its fantastic bungling this week, it might try. First, get the fairy tales out of the way. No, Obama has not asked Bernanke to leave; the Perfesser is exhausted (which may explain some of this week), and orderly competition to succeed him began in January. And no, the market wrecks this week do not invalidate the QE campaign. It was exactly the right thing to have done. Perfesser Bernanke is an American hero, his inventiveness and courage is without parallel in our peacetime history. However, the skills and instincts necessary to save us in the post-Lehman event are completely different from those required to manage a gradual tightening of policy. Perfesser Bernanke on May 22 did an expert and appropriate job of mumbling. Markets needed to be warned that QE might taper in the next several months, and be reminded that someday QE would end altogether, and in the long run Fed policy would normalize. The Perfesser’s muffled jawbone took the 10-year T-note from a broad range 1.70%-2.05% into June’s 2.08%-2.25%, mortgages just above 4.00%. The economy may or may not be self-sustaining, but asset prices in 2013 might have begun to pre-bubble. Maybe. New Fed governor Jeremy Stein began to thump the bubble tub immediately on arrival. Household net worth jumped $3 trillion in the first 90 days of the year, all on stocks and houses. The delicate conundrum: rising asset values were a principal purpose of QE and have the economy doing better; at what point do they become a bubble? Hedge the bet by bubble-burble. The June Fed meeting concluded on Wednesday and the written statement was harmless. Then in the post-meeting press conference Barnanke gave the most unfortunate public performance by a Chairman in my memory. He is compelled to transparency and specifics of future intentions, which made QE work, but are disastrous in a tightening cycle. And he clearly does not understand why. In the press conference, regarding the jump in rates after May 22: “We were a little puzzled by that.” He went on into tired, old, tightening-is-not-tightening, “Just letting up on the accelerator, not touching the brake.” But the Fed is not a car, it is a two-button machine, one marked “Go,” the other “Not Go.” QE began at Thanksgiving 2008. In herky-jerky stages since (Go, Not Go), the Fed by last summer finally convinced the bond market that it was safe to buy bonds. QE3 was open-ended, the Fed would keep the world safe for bonds until it got economic recovery. Along the way much academic jaw-jaw about whether the cumulative volume of QE was more important than the flow, but neither mattered to markets. Treasurys and Agency MBS in circulation are about $20 trillion, not counting infinite synthetics (swaps, etc.). Whether you buy $85 billion per month, half that, quadruple, or five bucks per month is immaterial. Are you going to keep me safe, or not? Bernanke destroyed the game at the press conference by delivering a multi-year if-then, if-then economic/policy forecast leading to Fed normalization, and death for anyone invested in bonds. A tidy, academic schedule. He seems to think that the “ifs” — if the economy is not so hot, we won’t kill you — would cause bond investors politely to retreat on his schedule, each lining up quietly for a future turn at the guillotine. That was bungling beyond imagination. The bond market’s mission is to collapse the future into the present. If you tell markets that it’s going to be unsafe to own bonds next year, then it’s unsafe now. Right now. Sell and keep selling, each stage exposing another layer, encouraging profit-taking, shorting, and sell-hedging. Worst of all: there is no way the Fed can un-bungle, to tell markets it’s safe again to own bonds. After this exercise it will be along time before the bond market trusts the Fed. At this instant the 10-year has crested 2.50%, mortgages 4.50%-plus. Temporary pauses ahead, but no end to this until something in a real economy cracks, or the Fed conceives a sensible exit strategy, beginning by watching data and shutting up