Weekly update by A.D


Dear all,

It has been a while since the last time I wrote a weekly update. I think that sometimes it is good to take a pause and take a bit of distance in order to get a better judgement. Btw, in my last note I stated that gold and silver represented good buying opportunities. Since then they have gained 10% and 17% respectively. In today’s note I am going to focus on Bernanke’s latest shocking decision not to taper. I will try to explain why he did this and what the consequences of such decisions could be.

1. Bernanke is completely trapped! 

I must say, even though I kept repeating that Bernanke wouldn’t taper in Sept because he just couldn’t (will explain later), I was still quite shocked by his decision given his latest comments (May and June).

The consensus expected a USD 10-15 bn taper amount and Bernanke decided not to taper. While the markets immediately cheered following Bernanke’s speach and reached new historical highs, they have since shown some skepticism and are now below the pre “no taper” rally. See below:


Source: www.dshort.com

This skepticism is completely justified as by taking such decision, the Fed has completely lost its credibility and this decision could cause severe consequences (more details below). But before going through those consequences, let’s try to explain why Bernanke did this:

  • First, the US economy is not going too well: US consumers are starting to feel the consequences of the “Sequester”, the medial real income keep going down and their saving rate is already very low (they are therefore not able to tap much more into their savings), consumer confidence droped last month and the housing market is looking bubbly
  • By just hinting that he could taper in September, Bernanke triggered a massive bond sell-off from May to September. Such increase in yields in such a short period was never observed before and Bernanke feared that by tapering the sell-off would continue and become completely uncontrolable. He also knows that the US economy is way too weak to cope with an interest rates increase. Mortgage rates moved much higher as well and gained 1 full point (from 3.5 to 4.5% for the 30Y) in a short space of time. This was the sharpest increase (in such a short period) since 1987. So Bernanke also feared some severe consequences (of rising interest rates) for the housing market. Despite 5 years of Treasuries and Mortgages buying for an amount of USD 3 000bn, a 300% increase of its balance sheet, the Fed has only managed to bring housing starts at the level of … the 4 previous crisis (see below)!

owned housing


Source: Bloomberg

  • The worse fear of the Fed is deflation and currently the CPI and PCE numbers are below the Fed’s targets

Now that we have the reasons of such move, let’s analyse the potential consequences:

  • The Fed has lost its credibility. It indeed announced last May and June that it would be likely to taper in Sept provided the economy kept improving, and despite an ugly monthly unemployment report for August, economic data news were rather positive (see below the economic surprise index). So if you give the condition to your next move, that such conditions are met and you don’t deliver, how can someone believe in what you will say next?!!! Also, QE was supposed to be exceptional and short lived, but we now are at QE3, 4 years after the 1st QE … 

economic surprise US


Source: Bloomberg

  • Foreign Treasury holders could, and should be tempted to get rid of their Treasuries. Why would they keep USD denominated assets while the Fed keeps pushing the USD lower? This movement (foreign Treasury holders getting rid of their US bonds) has actually already started and is likely to gather pace in the future. See below the evolution of the US Treasuries foreign holders since 2000. The recent drop (even though modest) is the sharpest since 2000

treasury holders


Source: Bloomberg

China has stopped buying Treasuries since 2010 even though its trade balance with the US has been largely positive and China has had USD to recycle. Russia has actually started to get rid of its US Treasuries and other emerging countries have made similar moves.

  • If such trend continues (foreign Treasuries holders dumping their Treasuries) and the Fed keep printing USD, the dollar could plummet and its international trade currency status could eventually get challenged. I don’t know if you paid attention but during the US and France attacking Syria episode, the USD didn’t attract flows and didn’t play its safe heaven role as it used to in the past in such situation. The USD has kept dropping since 2002 (see graph below) and this trend could continue.

USD index


Source: Bloomberg

  • QEs have created massive market disruptions / imbalances and by no tapering the Fed keeps inflating all sort of bubbles (equity markets, bond markets etc.). When the Fed launched QE1, rewards (pushing yields lower, “wealth effect”) were higher than risks (bubble creating, inflation etc.) but following QE2 and QE3 those risks are now much higher than those benefits that have proven to be very modest, especially for the real economy.

The Fed is now completetly trapped as tapering could trigger a big move upward for interest rates, which would lead to a return in recession for the US economy and probably a market collapse; but not tapering keeps fueling bubbles that will eventually burst …

2. Last week’s market action



Equity and bond markets were up following Bernanke’s decision to keep pumping USD 85bn a month into the markets. Having said this, the post announcement euphoria was short lived. Equity markets have made very healthy YTD gains and are now clearly overvalued and completely disconnected with economic fundamentals. I therefore recommend you to stay away from those markets unless you want to gamble. You could make another 5 or 10% but the risks of losing 20-30 or 40% are much higher. The forthcoming events could also create some volatility:

  • debt ceiling debate which should, as usual, create short term dramas
  • some Eurozone issues should come back now that German elections are behind us (Market probably asked other Eurozone members not to disturb her campaign). Another Greek haircut is likely to happen, a Portuguese one as well etc
  • Syria: I doubt that Bachar will comply with NATO’s requests
  • the housing market could get badly hurt by the rise in mortages rates (many banks have laid off workers from their mortgage selling units recently)
  • etc.

Enjoy the reading!



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