What The Fed Doesn't Want You To Know About US Debt
Graham Summers
September 29, 2009
The Fed's FOMC announcement came out…
We got exactly what I expected, a kind of wishy-washy, "hedging our bets" statement from the Fed. You have to remember that Bernanke was Greenspan's right hand man for much of the bubble days of the '90s and early '00s, so the guy is an expert at walking both sides of the line when it comes to policy and public statements.
For instance, the Fed announced it would keep interest rates between 0% and 0.25% for an "extended period." No surprise there. As I've noted previously, 80%+ of the $200+ trillion in derivatives sitting on US commercial banks' balance sheets are related to interest rates.
For the Fed to hint at raising rates (let alone raise them) would kick off a systemic implosion that would wipe out the very guys the Fed has been bailing out. Suffice to say the Fed won't be raising interest rates now or anytime too soon (within the next 3-5 years, unless inflation destroys the dollar).
The Fed also announced it would be slowing its purchase of Mortgage-Backed Securities (what I call the Fed's "cash for trash" program). The Fed has stated previously that it will buy $1.45 trillion in mortgage-backed securities from US banks and that this program will end by the end of 2009. However, last week the Fed said it will be extending the program (but not the amount of money spent) until the first quarter 2010.
Again, this is not much of a surprise. The Fed performed a similar act with its Quantitative Easing Program (extending but not increasing the amount). However, given the increasing public outcry about the Fed's balance sheet, this issue of buying toxic debt (and the mortgage backed securities the Fed is buying are nothing if not that) may become a hot topic in the near future. If there is ever a successful audit of the Fed's balance sheet kiss the big banks' equity good-bye (and share prices) goodbye.
The Fed DID announce that it would let its Quantitative Easing program end in October. If you're not familiar with this program, it's basically a fancy way of saying that the Fed has been buying US debt in order to finance Obama et al's massive deficit.
This particular development is key. A little known fact (and one totally ignored by the mainstream media) is that the Fed accounted for nearly HALF of all Treasury purchases in the second quarter ($164 billion out of $339 billion). In fact, the Fed bought more Treasuries than the next three largest purchasers combined!!
The Fed's purchases outnumber foreign holders (foreign governments), US household, and Primary Dealers (mega banks) COMBINED. One should also note that Foreign holders reduced their purchases of US debt from $159 billion in 1Q09 to $101 billion in 2Q09 (a 40% DECREASE).
To read the below chart, you need to know that SOMA refers to the Fed.
In simple terms, these numbers indicate that if it were not for the Fed, the US Treasury market would have almost assuredly had numerous failed auctions in the second quarter. It also shows us that foreign holders (China, Japan, etc) are reducing their purchases of US debt at an incredible rate. This tells us two things:
- China and pals are putting their money where their mouths are: refusing to service our debt as they did in the past
- Treasuries will have to become a LOT more attractive (higher yields) for foreign investors to start buying again
I've often stated that the Fed will have to sacrifice stocks or the US dollar. If the Fed does in fact end Quantitative Easing in October (as it has stated it will in last week's FOMC), then we'll see what the market REALLY thinks of US debt as an investment class. It's clear from the above data that foreign holders want higher rates (yields) in order for them to start buying more heavily. However, as I've stated before, the Fed CANNOT afford higher interest rates without blowing up US banks.
Keep your eyes on the Treasury market going forward. This could very well be the next major crisis brewing. It will certainly be our first taste of how a market operates without life support courtesy of the Fed.
I'm guessing the results won't be pretty. If the dollar truly rolls over, we could see a major spike in gold.
On a final note, the Fed stated it will continue to use "a wide range of tools" to battle the Financial Crisis. This was taken as less aggressive that the Fed's August statement of using "all available tools." God knows what either statements really mean (remember we're dealing with a Central Bank whose head has no issue committing perjury).
However, one thing is clear: the US stock market took the news hard.
Stocks initially exploded higher after the Fed announcement before entering a virtual free-fall. Peak to trough, stocks fell 1.6% in less than two hours. Even more importantly, the volume swelled with the selling indicating that contrary to the "tons of money on the sidelines" myth, most investors are just waiting to sell this rally (see chart below).
The Money On the Sidelines is Fleeing
The "money on the sidelines" myth also took it on the chin from the latest flow of mutual funds report which shows that money has NOT flowed into stock-based mutual funds since August 12. In fact, $7 billion flowed OUT of mutual funds in the last month. This combined with the fact that insiders are selling at record numbers and corporate buybacks are at a record low and down 72% from last year, tells us that this latest market rally has literally nothing to do with money on the sidelines.
Notice the MASSIVE volume spike at the end of yesterday
The question for every investor remains, "is this a bear market due for another collapse or is this the start of a new bull market?" We'll let the market answer this question with a review of the weekly chart and its 88-weekly moving average: THE measure for determining bull or bear markets.
As you can see, stocks have risen to just test the 88-weekly moving average. On the intraday charts, we've seen the S&P 500 hit 1,080. But we've yet to see a weekly close above 1,073. As I stated in last week's issue a weekly close ABOVE 1,073 is KEY for this to be the start of a new bull market.
48% and Still NOT In a Genuine Bull Market
The fact that the Fed just issued a statement announcing it would continue to inflate the markets with "a wide range of tools" and stocks took a nosedive, indicates that we may very well see stocks fail to break above the 88-weekly moving average, which would be a clear signal that the bear market is NOT over and that stocks are in for a major correction.
As the below chart shows, the last time stocks failed to break above this level (May '08), we had a truly nightmarish time. The fact that stocks have been virtually parabolic since June of this year certainly does not bode well should stocks reverse course and begin the next leg down.
I also would like to note that the last time stocks entered a genuine bull market by breaking above the 88-weekly moving average (2003), they didn't have to rally nearly as much to do so. Indeed, a quick glance at the 12-year weekly chart for the S&P 500 shows that in 2003, stocks only rallied 20% to break above the 88-wekly moving average, compared to the staggering 48%+ we've rallied this time around.
Put another way, this time around stocks have come more than twice as far to enter "potentially bullish" territory… and they still HAVEN'T broken the 88-weekly moving average.
The stage is set for a major collapse in US stocks. To that effect, I've put together a FREE Special Report detailing THREE investments that will explode when stocks start to collapse. I call it Financial Crisis "Round Two" Survival Kit. These investments will not only protect your portfolio from the coming carnage, they'll also show you enormous profits: they returned 12%, 42%, and 153% last time stocks collapsed.
Swing by www.gainspainscapital.com/roundtwo.html to pick up your FREE copy!!
Good Investing!
Graham Summers
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