the Internal Conflict Inside the Fed’s Bubble of Fear

so what’s going on here?  Stocks have rallied to new highs, supposedly on better economic data, but on very little volume.  Bonds got crushed in a violent FOMC unwind yet held and have rebounded.  The specs are still shorting a 6 months rally in stocks and now the long end of the curve.  According to ISI fund flow data, retail continues to abandon stocks in favor of bonds and just over the last 3 weeks domestic equity flows were -7.33b while taxable bond fund flows were +22.33b.   The ViX continues to remain near the cycle lows yet according to Bloomberg put/call skew on the $SPX is as high as its been since 5/07 which denotes strong demand for downside volatility exposure.  It seems that despite the rally to new highs, no one still likes the stock market.

Bernanke certainly doesn’t.  He comes out this week trying to fade the rally in the face of the best Q1 equity performance in a decade.   Just today, again per Bloomberg:

“It’s far too early to declare victory,” Bernanke said, according to a transcript of an interview with ABC News anchor Diane Sawyer provided by the network. “The recent news has been good. But I think we need to be cautious and make sure this is sustainable. And — we haven’t quite yet got to the point where we can be completely confident that we’re on a track to full recovery.”

Asked if another round of quantitative easing, or large- scale bond purchases, remains “on the table,” the 58-year-old Fed chief said, “we don’t take any options off the table.” He added: “We have to be prepared to respond to however the economy evolves.”

Give me a break..   He’s doing it again.  He’s spreading fear.  Is this how he wants to stimulate risk appetite? Never mind putting capital to productive uses such as financing growth, the economy isn’t really recovering so stick to lifting 100%/GDP negative coupon USTs and gold.   This is the Fed’s Bubble of Fear and it’s distorting the market discounting mechanism while driving an internal conflict among investors and a mass misallocation of capital.

If the 10YR is at 2% that means nominal GDP is growing at 2% and if nominal GDP is 2% then there is virtually no real growth and if there is no real growth I don’t want to own equity, I want to buy bonds.  Yes, bonds…

The Fed has convinced the market to buy negative coupons by making them more negative?

The flip side to lower interest rates is that someone has to make that loan or buy that paper.  If bond investors are earning a negative real return then capital is evaporating into inflation.  Negative interest rates can’t be stimulative, in fact as we suggested with the bond market’s reflexive process, these yields might actually be causing slow growth they are purported to discount.

Meanwhile, stocks continue to rally making it hard to short but even harder to buy.  For bonds its the opposite, they are hard to buy but even harder to short.  There is a definite internal conflict that is in the process of being reconciled.  It feels like there is a lot of tension built up and it may be time for some fireworks.  We envision a stock market correction that everyone has been waiting on for 2 months to ignite thoughts of QE 3 and a bond market rally, perhaps to new highs.  But the big trade is after that move, not from here.  From here the inverted risk-on/off boys look for another ride.

Whether he just got spooked over the violent back up in bond yields and is trying to talk them back down or if he’s really prepared to launch QE 3 is unclear.  What is clear is that he has displayed a propensity towards blowing up his own trade and the biggest one of all is long the inverted risk-on/off bubble of fear.


About exantefactor

capital market veteran of over 15 years covering multiple asset classes. Focused on analyzying markets ex ante (before the event).
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