The Bernank has spoken. All hail the Bernank.
According to Ben Bernanke, Chairman of the US Federal Reserve, the US is doing swimmingly and he will be able to start lowering Quantitative Easing (QE) towards the end of the year.
The key news points that came out of the press conference, as reported on ZeroHedge, were:
‘BERNANKE SAYS JOB GAINS, HOUSING INCREASED CONSUMER CONFIDENCE’
‘BERNANKE SAYS MONETARY POLICY WILL CONTINUE TO SUPPORT RECOVERY’
‘BERNANKE SAYS FOMC `MAY VARY’ PURCHASE PACE ON ECONOMIC DATA’
‘BERNANKE: FOMC MAY `MODERATE’ PACE OF PURCHASES LATER IN 2013′
‘BERNANKE SAYS FED MAY END PURCHASES AROUND MID-YEAR 2014’
‘BERNANKE SAYS FED WILL EASE QE PACE IF ECONOMY IMPROVES’
‘BERNANKE SAYS PURCHASE REDUCTION REPRESENTS FOMC CONSENSUS’
Credit markets reacted swiftly to the news and sold off aggressively. US 10 year Treasury rates increased by 16 or so basis points to a yield of 2.36%. That’s the highest level in over a year. Stocks plummeted, with the S+P 500 falling by 22 points or 1.4% to 1629.
How markets react over the next few days will be very interesting to watch. If the initial knee jerk reaction to sell gathers steam and the S+P 500 falls below the last couple of weeks’ low of 1598 my conviction levels will increase dramatically that further large falls are in the offing…
I have to say I’m surprised by Bernanke’s comments that the US economy is healing and will be strong enough within the next few months to withstand a tapering of QE. It doesn’t really stack up against the flow of soggy data we’ve seen in recent weeks.
As you can see in the chart below the current flow of macro data is far from rosy:
US Macro Data Still Weak
I can’t see how Bernanke could justify tapering based on a strengthening in the US economy. My view is that the Fed is scared stiff it has created a monster by blowing so many bubbles all over the world. So they have decided that the sooner they take some steam out of the markets the better.
I’m sure their main aim is to ensure they don’t create a crash, but instead engineer a slow deflation from lofty levels.
The first act in this saga involved hinting loud and clear to the market that tapering was on the table as an option.
The hugely volatile swings we saw across all markets as a result, with carry trade unwinds leading to a large rise in rates and massive currency swings, are sure to have frightened the hell out of them.
Watch These Two Countries
The carry trade has become an incredibly crowded trade. It has been the catalyst for the big rallies we’ve seen over the past year. The mere hint that this game was going to become riskier saw punters heading for the door. And we know what happens when everyone wants out at the same time.
The interesting things to watch from here are the reactions in Japan and China. Japan’s bond markets have been under increasing pressure due to the crazy money printing policies of the Bank of Japan.
They have somehow managed to keep rates below the 1% threshold after intervening in the markets the last time that level was tested a few weeks ago.
But a large rise in US rates will necessarily place upward pressure on Japanese rates as investors switch out of JGB’s and into US bonds.
You also need to watch China closely from here due to the large cracks appearing in their shadow banking system.
We’re starting to see the initial signs of stress in the Shibor (Shanghai Interbank offer rate) with the rate spiking towards 10% recently.
Shibor Rate Spikes
The Shibor is the Chinese equivalent of the Libor (London interbank offered rate) which is the rate banks charge each other for overnight loans. It’s an important rate which shows signs of stress within the banking system when it shoots higher.
An article in the Age on Tuesday by Ambrose Evans-Pritchard has caused quite a stir. It arrived in my inbox from multiple sources.
The opening line says, ‘China’s shadow banking system is out of control and under mounting stress as borrowers struggle to roll over short-term debts, Fitch Ratings has warned.‘
Apparently Bank Everbright (unfortunate name really…) defaulted on an interbank loan a couple of weeks ago amid the big spikes in the Shibor that you can see in the chart above. I’m sure they’re not feeling so bright after all. According to the article:
‘Fitch warned that wealth products worth $US2 trillion of lending are in reality a "hidden second balance sheet" for banks, allowing them to circumvent loan curbs and dodge efforts by regulators to halt the excesses.
‘This niche is the epicentre of risk. Half the loans must be rolled over every three months, and another 25 per cent in less than six months. This has echoes of Northern Rock, Lehman Brothers and others that came to grief in the West on short-term liabilities when the wholesale capital markets froze.‘
The other very interesting point made in the article was the potential for an exodus of hot money out of China once the US Fed starts tightening monetary conditions.
In the article it states that China’s security journal said ‘foreign withdrawals from Chinese equity funds were the highest since early 2008 in the week up to June 5, and withdrawals from Hong Kong funds were the most in a decade.‘
So with US rates spiking higher on the fear of a withdrawal of monetary morphine by the US Federal Reserve, we may see the unintended consequences of their actions unravelling fragile markets all over the globe.
Editor, Slipstream Trader
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