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Signals From The Banking World

March 15, 2006

A few key signals should gain attention as the investment community struggles to fix on accurate indications for US Federal Reserve policy changes. A review is offered to paint a broader picture than a mere glimpse at the Treasury Yield Curve and its future shape. At the same time, a claim is made that debt rating agencies have been solicited to join the USFed policy. Lastly, FedSpeak is an exported practice of deception, now used in Tokyo, Brussels, and Vienna (OPEC) in order to attempt to control important markets.

This essay is an update to "Bankers Versus USFed" penned in Oct2005. We really cannot define what "neutrality" is, where the neutral level might be. It is far too elusive. With a USEconomy dog driven by the financial sector tail, a vast dichotomy is presented. My estimate is that a 2% or 3% short-term bond yield might be too tight on the commercial side, and again, a 6% to 8% short-term bond yield might be appropriate for bond speculators to cease and desist their deadly craft. They have forced a crippled evolution. Before too long, USTBonds might be forced to pay junk bond yields, especially if the famed yen carry trade fully unwinds.

The end of higher rates might be soon, or might be a long time coming. Who knows, because who knows what their motives are really? Last June, the hack novice Dallas Fed Governor Fisher shared his wisdom on the incredibly deceptive and inept "ninth inning" call in a clear piece of disinformation to control the stock and bond market. It fooled me briefly and with embarrassment. Have we had four rate hikes since then, or five? Can they or anyone define the elusive "neutrality" term in any meaningful way? At one time, my unconventional view was that "neutral" meant fixed mortgage rates equaled adjustable rates, motivated by ushering millions of homeowners into fixed contracts in safe fashion. They must be protected from continued tightening and escalating household monthly mortgage costs. That event occurred (almost) a few months ago, when the 15-year fixed rate hit the ARM rate. At a later date, my view changed on neutrality more toward what rate would adequately defend the USDollar, in an effort to satisfy Asians and Persian Gulfers unhappy with low paying Treasury yields. They had begun dreaded diversification of their foreign dowries won from hapless consumption hogs in the United States. A long-term bond premium yield of 6% to 8% might be necessary for foreigners to hold tight on their mountain of reserves holdings. They are breaking ranks overseas.

An excellent bond market signal can be put forth, the BKX banking stock index. Two months ago, my view was that this index signaled an end to the excessive USFed rate hikes. Rates are highly likely to go too high. The BKX index addresses the lending market profitability in a true sense, to provide inherent value. It also to some degree reflects big bank trading desk profitability, such as with bond and currency speculation. Lending is a nuisance side show of sorts, tragically, since big banks have evolved (progress in Greenspan's eyes) into hedge fund business segments knee deep in casino operations.

In the last few weeks, my view has changed again. The BKX index might more appropriately signal successful management of the Treasury yield curve itself, in the managed shift away from inversion and toward a gradual steepening. If the short end rises (with USFed rate hike decisions) but the long end rises faster, then the Treasury yield spread trade remains profitable. In fact, the BKX might in time signal successful management of coordinated tightening among the USFed, the ECB, and the BOJ. If the rate differential is maintained among the Americans, the Europeans, and the Japanese, then the carry trades can remain somewhat in place. The reality behind the carry trades must reflect not only the rate spreads, for instance between the short Japanese rate and the long US rate), but also the currency differences.

One is led to wonder to what extent the Japanese yen currency has been pushed down hard in the last 8-10 months in order to satisfy the carry trade players. If the underlying borrowed money currency (the yen) goes down, then the carry trade profits are reinforced. The coordination of the USFed decisions, yield spread management, and inter-relationships with foreign currency signals are covered in the March Hat Trick Letter issue.

My view is that the BKX index is a signal of something much bigger, of health for the carry trades and spread trades. If the central bankers of the world wish to control the bond markets like the octogenarian Soviet Politburo hacks, then they risk disasters of a larger scale. Refer to the Black Monday of 1987, to the Asian Meltdown of 1997, to the LongTerm Capital Mgmt (neither long-term nor well managed) of 1998, to the Russian Bond Default of 1998, to the Tech-Telecom Stock Bust of 2000, to the upcoming US Housing Debacle in 2007. They all have roots in central bank tightening to excess or easing to excess. The BKX has broken out upside. The signal might mean only banking sector profit health. It might mean an avoidance of the deadly yield curve inversion, whose importance was denied, but with avoidance suddenly has been heralded a positive relief. It might mean that the giant yen carry trade will be actively managed so as to preserve it.

The uniform rise in term yields across the Treasury spectrum might relieve the threat of inversion, but it poses a different problem. Gone might be the reliable longstanding signal (fully denied by Wall Street joy boys). However, new on the billboards is a signal of global tightening, lost liquidity, and dark clouds over the entire stock market and economic landscapes, from the United States to Europe to Japan. Rather than show the Treasury Yield Curve graph, let's look at a forward indicator on the future shape of the yield curve itself. This chart shows the ratio of the 10-yr TNote yield (TNX) to the 3-month TBill yield (IRX). Instead of the typical spread difference in yield, it is the ratio. It reveals a bottom formation in progress and some upward momentum in the weekly stochastics.

What we definitely do not want to see is a uniformly higher Treasury yield curve which eventually turns into an inverted state, but at a higher level, at a later date down the road. Like a TNX at 5.4% yield against an IRX at 5.75% yield in November 2006. We might see this condition if the USFed hikes five more times, true to their historical practice of going too far. This would mean we again have the recession signal along with much higher borrowing costs across the board. It is humorous really, that a recession signal was denied from yield curve inversion all this winter. An excuse is offered that global savings have pushed money into the long end. So global factors negate the signal? Here is a different view. Global factors make the US Treasury Yield Curve inversion a negative signal on a global basis. It was signaling a global recession, not just a USEconomy recession. If global factors work to invert the term curve, then global factors are ripe on implications of recession. This is basic science.

Lately, my view has again shifted to the realities and vagaries of markets in movement. Neutrality is not the issue to Bernanke, who is a control freak, guided by his desire for bond megalomania. He wishes the control the bond world, to manage the Treasury yield curve, and has embarked in my opinion on a truly historic and monumental mission to coordinate the yield curve and yield differentials at an international level. The USA, Europe, and Japan are all in the midst of simultaneous tightening, or at least we are given unmistakable indications from Tokyo that their five-year Zero Interest Rate Policy (ZIRP) is soon to end, even as Europe hiked a second time. By the way, the jackass did not believe the "one time hike" announced by the Euro Central Bank in January, where they denied a new trend of tightening had begun. My view is that Bernanke is attempting to coordinate rate hikes with the Euro Central Bank (ECB) and Bank of Japan (BOJ) together with the cooperation of critically important debt ratings agencies. Is it a coincidence that the ECB in Brussels decided to hike right before Bernanke took the helm, then again weeks after he was installed as USFed Chairman? Is it a coincidence that Tokyo decided to issue pronouncements of an end to the ZIRP and monetary ease only weeks after Bernanke took over? Methinks NOT on both counts. The financial world has become a more dangerous place in the last five years. More firm control is seen as urgently needed by the Bond Politburo members.

Last summer, General Motors and Ford suffered a series of debt downgrades. To the novice investor and clueless public observer, such downgrade decisions were unrelated to the USTBond market. Not so. Just as the Asians discontinued almost all new Treasury Bond purchases with trade surpluses, GM and Ford credit default swap derivatives unwound. Profit was taken on the credit default contracts. USTBonds, which underpinned that spread trade, were bought back (like a short cover). The Detroit woes were timed perfectly to pick up the lost Asian demand and growing slack, a gaping hole more accurately depicted. Standard & Poor, Moody, and Fitch in my view have become partners with the USFed in coordinated policy. Then once more, the Fitch ratings agency downgraded Icelandic govt debt two weeks ago. Their decision was timed one week before the Euro Central Bank hiked rates by 25 basis points. The Iceland krona currency loss was the euro's gain, as well as the USDollar's gain. Money rushed out of emerging market govt debt and back into European govt debt precisely when liquidity would be highly desired.

In the last few years, a remarkable phenomenon has developed, a true tribute to sheeplike behavior within the investment community. The financial markets routinely respond to spoken words and not to actions taken. To be sure, many actions are hidden and not so transparent. A bizarre trend has spread like a mouth-to-mouth communicable disease. The ECB attempted to control the bond market with the spoken word in January, telling us that their first rate hike was not the first of several, a lame attempt to set opinion on a single "one off event" which did not fool me. They wanted to avoid the appearance of a new series of their own "measure pace" rate hikes. Such a trend perception would do harm to the USDollar. The ECB failed in FedSpeak. They need more practice in the art of deception.

The next student for the deceptive practice is OPEC, led by the Saudi Oil Minister Al Naimi. Last autumn he spoke incessantly (and with occasional anger) about how increased Saudi oil production output would satisfy the shortfalls brought upon by the Gulf Coast hurricane damage. Well (not oil well, just well now), it turns out that OPEC oil output in January was actually below the Oct2004 output incredibly. Saudi output has not increased, and whatever newer production has hit the market is sour crude anyway. Al Naimi is hounded like a porcupine by hunting dogs as press reporters seek clarification, like in Vienna last week when OPEC ministers met. The Saudi oil minister has engaged in numerous attempts to control the important crude oil market. They promise again more increased oil output. They speak of accommodating a market overheated in oil price.

Last spring 2005 OPEC ministers threatened possible output cuts in response to oil price declines. There is less need to threaten such cuts when Mother Nature has a firm grip on depletion and production declines. A key event is worth citing from the same Vienna OPEC meeting last week. The Kuwaiti oil minister made a strong statement that his tiny nation would continue in its oil output in order to stabilize the oil market. Well (very much oil well), just three weeks ago the Kuwaiti govt issued a formal statement that their giant Burgan oil field has officially entered a long slow depletion decline. So either the Kuwaiti oil minister "forgot" that Burgan went into decline, or he is actively engaged in FedSpeak, a tactic learned from his colleague Al Naimi. My guess is FedSpeak was being spoken in broken English, to win favor with the USGovt, who protects this bunch of guys who hijacked the nation for personal gain long ago.

In a more frightening development, dangerous rumblings from the Bank of Japan have been recorded on seismic charts. The BOJ has alerted the financial markets that cost-free money will soon end. How the Wall Street Journal, Barrons, the New York Times, the Financial Times, even the Paris Match and National Inquirer don't cry in loud wails that the financial world has been upside down, turned inside out for almost a decade is beyond me. Imagine buying a car for 0%. Oops, we do that also. Imagine buying a jacuzzi or plasma television for 0%. Oh, we do that too. These days might soon come to an end, with a surefire extreme test for both the speculative and commercial economies to conduct its business without cost-free money. One is left to wonder if and when the BOJ will indeed raise rates. Given they are nil now, even a 0.1% (ten basis point) rate hike would be significant. Clearly BOJ head Fukui can move the markets with his words, more FedSpeak. So call the Japanese prime minister Koizumi. The only missing piece to the FedSpeak assault on our markets, where sentiment indexes have eclipsed hard data, is for the debt rating agencies to issue regular statements about possible downgrades for GM, Fanny Mae, Merck, or Wal-Mart debt. Well, they do so already.

Here is where, once again, absolutely frightening signals can be heard. An inverted yield curve is the result of excessive USFed tightening, which might sound strange. What is tight for consumers might be loose still for bond speculators. We live in two worlds under a single monetary policy, a highly dangerous situation. We need a bond world cost of money and a separate commercial world cost of money. Without separation, we will continue to experience havoc and periodic crises.

USFed governors have displayed a clear pattern which seems not to be acknowledged or recognized by the gold community. The signal is of incompetence practiced to the extreme, risk raised to the extreme, in my field of statistical analysis and forecasting. Economic statisticians are paid to deliver forecasts and to advise policy makers to ANTICIPATE conditions and set policy accordingly. We have for several months been told by USFed Governors that they will REACT to economic data. This is incompetent, unprofessional, reckless. Neither Wall Street nor the gold community has addressed the situation. USFED POLICY MAKERS WAIT FOR A PROBLEM INSTEAD OF RELYING UPON FORWARD INDICATORS TO AVOID A PROBLEM??? Tragically, this is the world we live in with our breed of economists at the controls. Just why does the USFed have a habit of overshooting, whether in tightening or easing? The answer is easy. They rely upon faulty statistics. They depend on less than the best forward indicators. Worse, they react to concurrent data, instead of proper forward indicators. In other words, THEY ARE INEPT & INCOMPETENT.

The US Federal Reserve has avoided using reliable forward indicators, and has relied too heavily on CONCURRENT consumer data and growth data. The USFed has discarded Conference Board expertise and its competent track record. Former Chairman Greenspan even distorted that track record to promote his unwise forward indicator, the "real Fed Funds rate" which is the Fed Funds rate minus the highly suspect and grossly distorted Consumer Price Index. The actual CPI is approximately 4% higher than the reported CPI to the public.

Below is a very typical utterance by a Fed Governor, taken in part from a Reuters story. The Federal Reserve has moved interest rates into a range where policy makers have to be sensitive to the possibility of raising rates too far. San Francisco Fed Bank President Janet Yellen on Monday spoke to an economic conference. She offered the usual mumbo jumbo on price inflation being in "pretty good shape" with a focus on the core rate excluding food & energy. More mumbo jumbo on how the USEconomy is near full employment, despite hundreds of thousands having given up looking for work. She openly admits they are setting rates by the seat of their pants or petticoats, with USFed hikes governed "now very much a matter of judgment" on how much further they still should be increased. This is pure heresy without the public hue and outcry. She admits the USEconomy stands hostage to the housing market. This is the housing bubble they urged, they fostered, they nourished, they denied, and now they pop.

"I think we're in a range where Fed decisions have become quite data-dependent and there does need to be sensitivity to the possibility of overshooting. I don't see wage pressures there yet that would be threatening to price stability. We probably do need to see some cooling off in the housing sector. We won't get a slowdown in the economy, I think, unless there is at least some moderation in the pace of house price increases. We do need to be careful about overshooting and (policy) lags. I consider us to be in a range where further moves depend on how the data transpires, but I don't see weakness out there yet."

In her conclusion, she denies much monetary tightening has occurred since long-term rates remain at a low level. So unless we have a severely inverted yield curve, we have endured little tightening? Wow! That is lunatic after fourteen rate hikes. She closed with yet another pep rally statement that our economy remains robust. My view is that our national statistics department remains robust and vibrant, while the actual economy has stalled in a horrible situation where it have grown critically dependent on asset bubbles. At the same time wages are in decline on an inflation adjusted basis for the last four years.


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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 24 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at For personal questions about subscriptions, contact him at [email protected]

Jim Willie

Jim Willie

Jim Willie CB, also known as the “Golden Jackass”, is an insightful and forward-thinking writer and analyst of today's events, the economy and markets. In 2004 he launched the popular website that offers his articles of original “out of the box” thinking as well as content from top analysts and authors. He also has a popular and affordable subscription-based newsletter service, The Hat Trick Letter, which you can learn more about here.  

Jim Willie Background

Jim Willie has experience in three fields of statistical practice during 23 industry years after earning a Statistics PhD at Carnegie Mellon University. The career began at Digital Equipment Corp in Metro Boston, where two positions involved quality control procedures used worldwide and marketing research for the computer industry. An engineering spec was authored, and my group worked through a transition with UNIX. The next post was at Staples HQ in Metro Boston, where work focused on forecasting and sales analysis for their retail business amidst tremendous growth.

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