The Federal Reserve has cut its QE purchasing pace, and yet the US Treasury Department doesn’t seem hampered by a shortage of bidders for its record-setting note auctions. Far from “too many” Treasuries, prices are once more unequivocal how there aren’t enough. With or without Powell, the auction record is clear and, unlike those constantly talking up the BOND ROUT!!! that never happens, honest.
Yesterday, it was the 3-year maturity. An astonishing $46 billion was sold, new high, with a high auction yield of just 19 bps, new low.
Today, the benchmark 10-year. The high yield came in at 65.3 bps, also a new record low. More importantly, the low yield at auction dropped to 50 bps even. In other words, there was so much demand that a significant number of bids (5%) were submitted well below the going market, and auction, rates (you can go here for an explanation of what that means and why it matters).
Surprising some, last week the FOMC appeared to back off of the recent global official rush into yield caps (or yield curve control). Spurred on by the usual misread of the bond market during central bankers’ worst hours (as always), they began to more loudly decree that the biggest danger to the world going forward was actually rising interest rates.
What actually happened during March in UST’s was the same thing that happened in October 2008 – not that anyone at the Fed was paying attention this time, or then. In other words, Jay Powell’s gang performed so poorly that the (collateral) problem got in the way of Treasury market function; the purported deepest market ever imagined by human minds.
The FOMC minutes [for March 2020 meeting] just described a situation that was so bad, collateral-wise, financial participants (which we know were largely foreign official entities) were forced to sell whatever they could, including UST’s, choosing only those which were OFR. At the same time, everyone had to pile into the OTR stuff, including all the bills, because that’s all that was left as acceptable. A true funnel or bottleneck.
When even OFR UST’s are no longer as acceptable in repo, and the collateral system begins to break down along OTR and OFR lines within the UST side of that market, when the functioning collateral list gets pared down to just OTR UST’s and nothing else (I’m overstating this, but not that much), it should go without saying that this would be an enormously bad situation.
To anyone remotely familiar with the modern monetary system, no explanation was necessary for this bifurcation (collateral). Since central bankers don’t do money, and didn’t learn a single thing from 2008, they completely mistook the situation for “too many” Treasuries. The very same excuse they had been using for two years prior up to that time no matter how the market kept on disproving the entire premise.
With “too many” Treasuries back on the table, therefore yield caps.
The small selloff in the Treasury market up to early June seemed to further validate the idea, and the need. It did for the media, anyway, which hyped up what really was an extremely minor back up in yields. Along with huge QE purchasing, the view of “too many” once more gained widespread acceptance.
Without Powell, who would ever buy these safe instruments given the flood of money and therefore its guaranteed future inflation?
Concurrently, there was quite a lot of talk about 1948, too. This was the last time the Fed had been in the business of capping yields and the one time it had acted to “enforce” those limits. As I wrote last week, however, by 1949 it became clear that was, as always, an aggressive overreaction to another very minor back up in yields; the primary lesson from the episode being how monetary officials haven’t learned a thing from history, bonds, and especially bond market history (you’ll notice this persistent theme).
In June 2003, the FOMC commissioned its staff to examine this particular piece of arcane history. The resulting memo wasn’t “declassified” and released to the public until April of 2016, but the timing of its authorship should jog your memory.
I’ve written about the June 2003 FOMC meeting many times over the years. Why? Because that was the one time the Fed had come face to face with reality. Japan’s QE experiment had utterly failed, and everyone knew it; more than that, they all agreed that it had.
As Alan Greenspan’s policy body debated taking the fed funds target down to 1% for the first time, it brought the US system in sight of Japan’s situation hard against the zero lower bound. What would the FOMC do if presented with that ugly possibility?
For one thing, they had to explain what happened over there in Tokyo. In one of the few passages contained within the transcript of that meeting which expressed some honesty and open-mindedness, Alan Greenspan sort of wondered how, given the Bank of Japan’s situation, maybe modern monetary policy in its expectations-based version wasn’t actually all that.
Maybe QE had failed because, gasp, they really didn’t know what they were doing.
CHAIRMAN GREENSPAN. One is that I don’t think we know enough about how the private financial system works under these [JPS Note: or any] conditions. It’s really quite important to make a judgment as to whether, in fact, yield spreads off riskless instruments—which is what we have essentially been talking about—are independent of the level of the riskless rates themselves…We need to know how the system tends to work to be able to make the necessary judgments without asking one of our skilled technical practitioners to go off and run three correlations between X, Y, and Z. So I think the notion of building up our knowledge generally as a basis for functioning effectively is exceptionally important…Even if we never have to use the knowledge for the purpose of fighting deflation, I will bet that we will find it useful for other purposes.
Rather than follow that thought all the way to its logical conclusion (the monetary, deflationary consequences of money-less monetary policies), the FOMC instead said, nah, QE in Japan failed because the Japanese didn’t do it right. Sound theory, bad execution.
What might have been had, in June 2003, Greenspan’s bunch looked themselves in the mirror with only a few years left to spare before the eurodollar system’s destructive reckoning. Perhaps the damage of the last thirteen years to some extent mitigated, or maybe taking the opportunity of GFC1 to do something about the system rather than letting it all go on in dysfunction for another destructive decade.
But how could they have better determined which view had been true? The bond market, in that case JGB’s.
Despite massive “money printing” in yen bank reserves, bond yields weren’t impressed. Instead of “too many” JGB’s even given the Japanese government’s constant fiscal deficit “stimulus”, it always seemed that there were never enough.
The idea of yield caps was brought up in that June 2003 memo as a way of trying to bridge the divide. One reason the Japanese might’ve failed with this otherwise awesome policy (QE) was that they allowed their own potential success to be at least some part of their downfall.
If QE does work, and is inflationary as it works, then there will have to be a bond market reckoning at some point. If there isn’t, rather than admit that QE failed central bankers better have some way of explaining why rates remain low, demand for JGB’s as other riskless assets undisturbed.
In one sense, the FOMC’s staff memo actually agreed – particularly as it related to 1947-49 and the Fed’s big inflation panic back then. Its authors wrote that one explanation for what did happen was that the bond market may not have agreed with the official assessment over inflation and monetary conditions.
In spite of the jump in inflation, long-term interest rates remained low throughout 1946 and the first half of 1947 — either because the rise in prices was perceived as transitory, or because of a belief that the Federal Reserve would act at some point in the future to restrain inflation.
But, they also couldn’t let go of their training and indoctrination. Maybe bonds didn’t see inflation; or, giving the orthodox another try, maybe bonds were just waiting for the Fed to see it this way, too. Even when they get it right, they still manage to twist everything back to a central bank centered model. That’s the corruption.
Either way, however, the yield caps were unnecessary as the bond market had judged all along. Treasuries were never in danger of losing demand. The only question was how you wanted to characterize this opposition: as true opposition; or as some bastardized version of agreeing by disagreeing.
And that brings us up to post-2008 QE, and the irreconcilable situation the bond market presents central bankers. Former Dallas Fed President Richard Fisher accidentally said it best in 2014:
MR. FISHER. In summary, I want to mention that, as I said earlier, most of these variations that have been suggested are very un-Bagehot-like. And what I mean by that is, twisting [or QE and yield caps] entails purchasing assets that investors are fleeing toward, not assets that they are fleeing from.
Exactly. So long as demand for safe, liquid assets is unflinching, what’s the f-ing point? No, really.
By market as well as auction prices, this is where we are right now. The bond market, like Treasuries in 1948, and JGB’s, well, throughout the whole stupid QE charade, are if anything constantly overbid. So, what’s the point of QE, yield caps, the entire puppet show?
There is only one answer: as the dichotomy expressed in the June 2003 memo suggests, to perpetuate the myth, yes myth, the Fed (or any central bank) is in control. All this monumental crap, colossal failures one after another after another, nothing more than to keep the central bank central in everyone’s perception. Failure actually is an option, but to central bankers and their Economists it can’t be the answer.
It’s a doctrine not in service of humankind or even the real economy, it is dogma whose true purpose is itself. The Federal Reserve is not a central bank, and not truly a domestic bank regulator, either. It is a bureaucracy.
I wrote during the worst of GFC2, on March 13 of this year, that we should all expect nothing more, certainly nothing better:
Does bond buying actually work? The bureaucrat doesn’t care. They only desire that there be some expressed need to do it, so that the operation itself gives them their purpose. Efficacy becomes a defect, actually.
They said we wouldn’t be Japan.
The United States Federal Reserve is about to embark on a course beyond the already renewed full-scale QE. I have no special inside knowledge on the matter, no direct line to Jay Powell (I doubt he’d take my calls if I did). Call it a hunch, an entirely reasonable one that I believe most observers already share.
Two days later, QE6-4EVA. And where did it get us? A BOND ROUT!!! because of all the success? Finishing the job in a way the Bank of Japan never could? No. Nothing has changed.
Think about that. Since the first half of March 2020, when the whole world went nuts (for the second time), nothing has changed so far as bonds tell it. Trillions in balance sheet expansion, a trillion and a half in new bank reserves. Still an overwhelming demand for the safest, most liquid instruments. Jay Powell’s got nothing to do with it.
When I tell people that they need to reinvent their worldview, moving central banks out of its center so as to more appropriately interpret conditions and circumstances, they often tune it right out. It’s too much of a leap, too different from what they “know” must true because everyone says the other way has always been true.
Not everyone. Not always. Never true, actually. The evidence is all around you and always has been. Yield caps are a toddler sticking their fingers in their ears and shouting nonsense so as to drown out the uncomfortable truth of it.
Only, in our monetary case, the toddler neither grows up nor suffers the consequences of these tantrums; never grows up because they never suffer any consequences.