First Quarter Doldrums Amp Up Stock Market Fear Factor
Stock-Markets / Stock Markets 2014 May 18, 2014 - 08:41 PM GMTBy: Money_Morning
Shah Gilani writes: Based on preliminary first-quarter data, U.S. gross domestic product (GDP) growth is 0.1%.
That’s not much.
But then again, what do you expect for $3.4 trillion of Federal Reserve spending to boost the economy.
First of all, the preliminary GDP number, which is the total output of goods and services produced by labor and property minus imports, will be revised on May 29, 2014.
Most economists are already revising this estimate down into negative territory. The consensus view expects the revised first-quarter GDP number will show the economy contracting by 0.5% to 1%.
However, the second quarter is not expected to be bad just because of a slow first quarter. In fact, most pundits, including the Federal Reserve itself, are saying because the first quarter was so bad the economy will rebound in the second quarter.
But if they’re wrong and the second quarter shows negative growth, that’s really bad.
It’s bad because two consecutive quarters in a row of negative GDP growth is the technical definition of a recession.
So, how did we end up with non-existent economic growth or, worse, negative growth and possibly another recession looming when the Federal Reserve, since September 2008, has spent $3.4 trillion to prime the economic pump?
You’re not going to like the answer to that rhetorical question. The truth is frightening…
Since the credit crisis, which spawned the Great Recession, the Federal Reserve has been trying to build a bridge to growth. And they’ve spent trillions on their bridge efforts but can’t deliver the destination.
What’s frightening is that what seems like misguided Federal Reserve policies to stimulate economic growth by printing egregious amounts of money was never a misguided policy of trying to stimulate the economy. It was a massive liquidity and profit-making program designed to first save and then enrich the nation’s biggest banks.
Economic growth was only a hoped-for by-product of this “trickle-down” banking bonanza.
The reason we’re not seeing that trickle-down growth is because the banks aren’t lending as the Fed expected them to. The big banks aren’t lending robustly because they’ve had to pay out billions of dollars in fines and legal costs; their former speculative trading gambits with depositor money are being shut down thanks to Dodd-Frank and the Volcker Rule; and they are facing their worst free-market enemy, a flattening yield curve.
We all know that the nation’s too-big-to-fail banks would have all failed if the Fed hadn’t bailed them all out. Any one of them collapsing, after what happened when Lehman Brothers imploded, would have brought down all of them like the tenpins facing a professional bowler throwing a 50-pound ball down an alley with gutter guards.
There can be no economic activity without banks. So, the Fed did what it had to do to save the big banks and return them to massive profitability. It flushed them with trillions of dollars. It took bad loans off the banks’ books, opened up its discount window to all comers, and took in underwater mortgage-backed securities and bad loans as collateral for the cash it lent them.
And after the banks got their footing back, the Fed then embarked on quantitative easing.
Quantitative easing is another giveaway program for the big banks. The Fed buys tens of billions of dollars a month in U.S. Treasury securities and mortgage-backed securities from the banks, in cash, which they lend overnight to each other, paying only the federal funds rate, which the Fed has set at essentially 0%.
With their borrowed cash, the banks buy more Treasuries and mortgage-backed securities to sell next month to the Fed. It’s a great way to make risk-free money and for the big banks to improve their capital ratios and reserves and profits. All of which makes them flush enough to raise dividends, which makes their equity stock look better to investors.
The icing on the cake: The big banks get to raise dividends to entice more investors. It’s a great game.
Too bad the banks are the only ones benefiting directly. The whole trickle-down thing – it isn’t working.
Besides hoarding money to pay ongoing and future fines for criminal activities, all the big banks are terrified of the shape of the yield curve.
The yield curve is a graphical representation of interest rates. On the vertical left axis are interest rates rising from zero to whatever height they attain. The horizontal axis is time, with one day all the way on the left and going out to 30 years on the right end of the axis.
Banks borrow from each other, usually for a day at a time, at what’s called the federal funds rate, which is a market rate the Fed tries to control. The fed funds rate is somewhere between 0% and .025% now, which is where the Fed manipulated it to a few years back.
As the line that traces interest rates moves to the right, it trends higher. That’s because you pay a higher interest rate to borrow money you intend to pay back over a longer time.
Normally, the yield curve slopes upward steadily. So, interest rates to borrow for a day might be 0.25% (on an annualized basis) and 5% or 6% or more for a 30-year mortgage.
However, the current yield curve is flattening, not steepening. This is happening for a few reasons.
Investors are buying 10-, 15-, and 30-year bonds because their yield is better than what they would be paid if they bought shorter maturity bonds. One reason longer term interest rates aren’t as high as they are expected to be is because rates are so artificially low (courtesy of the Fed manipulation).
And so, investors are going further out on the “risk spectrum,” meaning they’re willing to lend out money for longer to get more yield. Yet another reason there’s so much interest in longer dated bonds is because investors are seeking a safe place to park their cash in anticipation of falling yields because of a market crash or some global macro event that panics markets.
In other words, investors are fearful.
Investors are fearful, for one thing, because they don’t believe the Fed’s low interest rate policies are creating growth. That lack of growth, they fear, could send the economy back into recession, which would cause yields to fall even further. So, investors want to lock in whatever higher yields they can get now.
The flattening of the yield curve is bad for banks. When they lend out for a long period of time, they want to charge as much interest as they can. But if the yield curve is flat and investors are willing to take less interest, the banks can’t charge as much interest as they would like. If you’re a bank and you make loans, you price them according to your risk of being paid back and how long you’re making the loan for.
Banks don’t want to make long-term loans and not get paid – that’s too much risk. That’s why they’re not making loans hand over fist, even though they have the money to lend.
Thanks to the Fed’s qualitative easing, banks are better off doing business with each other and the Fed than with the public.
If there’s no credit, there’s no economic growth.
And that’s the dilemma we’re facing.
The Fed’s balance sheet had $922,187,000,000 in assets on January 1, 2008. On September 1, 2008, it had $905,253,000,000. That jumped to $2,187,137,000 on November 1 2008. It was $2,859,807,000 on December 1, 201, and ballooned to $4,296,339,000 on April 23, 2014.
What are the Fed’s balance sheet assets? They’re bonds and securities the Fed bought from banks with cash that they essentially printed in their basement.
So, if you want to know why there’s no growth in the U.S. economy and how at the same time the big banks are making record profits, look no further than the Federal Reserve’s bridge to bank profits policies.
And this is what’s most frightening of all. The consequences of no growth and the Fed’s money printing are about to devastate equities (again), some bond investments, commodities, real estate (again), and other asset classes.
Don’t say you haven’t been warned.
NOTE: Speaking of Treasuries, due to a dramatic move into them, the U.S. 10-year yield is moving into new lows. I talked about just that and more on Fox Business’s Varney & Co. earlier this week. Check it out here. I save my best stuff – both my strongest opinions and sharpest advice – for you, my readers, but I wanted to share this with you. Thank you for reading!
Source : http://www.wallstreetinsightsandindictments.com/2014/05/first-quarter-doldrums-amp-fear-factor/
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