Tapering Will Spike Interest Rates Guaranteeing Recession

Sep
12

By Charles Biderman

In my last video before taking some time off I said that I expected a weak August jobs report and an imploding housing market to postpone the start of taper time. Well, the August jobs report was weaker than expected and mortgage bankers today reported that new mortgage applications have plunged to levels not seen since the 2008 low. Regardless of the weakness, the bond market apparently still believes that even if the Fed might not start tapering this month, tapering will start before year end.

 

To repeat what I said yesterday to Rick Santelli on CNBC, as long as the markets believe that the Fed will soon start reducing and eventually stop buying bonds, interest rates will keep going up.

 

Why will interest rates keep going up? Duh! The Federal Reserve is the biggest bond buyer and when the market started to believe this past May that the Fed, the biggest buyer ever, was getting ready to slow and then stop buying, everybody started selling. Today the 10 year yields are approaching 3 percent up from 1.63 percent at the May low. What’s more my bet is that interest rates will spike the day the Fed actually announces a Taper Time start date.

 

Remember, the Fed has been buying $85 billion monthly of financial assets. And this is why by early May of this year the 10 year Treasury bond was yielding all of 1.63 percent; down more than half from 3.5 percent just 12 months before in May 2012. So, if the 10 year Treasury just goes back to 3.5 percent from 2.9 percent today, that means mortgage rates will be topping 5.5 percent and maybe even the amount of money available for auto loans will slow.

 

What amazes me is that anyone is surprised that interest rates are and have been rising. Not only are bond market pros not buying, but individuals have redeemed a huge $130 billion out of bond mutual and exchange traded funds since May, even though the average bond fund is only down 8 percent in price. I just recommended to a 90 year old relative that he sell his bond mutual funds.

 

So unless the Fed changes its tune and says tapering is off the table for the foreseeable future, interest rates will keep rising. Higher interest rates have already popped the housing bubble. By the way it is no secret that this recent housing bubble was intentionally created by the Fed at the September 2011 FOMC meeting with Operation Twist.

 

Besides housing, the Fed’s zero rate policy has also created a bubble in auto sales. Today anybody with a pulse and no outstanding arrest warrants can get an auto loan. Just like the good old days in the 2005 2006 housing market. A year from now, many of this year’s auto loans will be in default and good bye auto sales bubble.

 

The reason higher interest rates will send the US economy into a recession is that wages and salaries are already barely growing and even a minor slowdown will create both a sequential and year over year decline in the US economy. Based upon adjusting the withheld income and employment tax reported in each day’s Daily Treasury Statement; wages and salaries are at most growing at one percent year over year before inflation. So if the Fed actually does taper, and with fools in charge in Washington, there is very little chance of the US economy averting a recession.

 

And if the US economy gets a cold, how sick will the rest of the world get?

 

Hopefully we will not screw up the next recovery as badly as we have this one.

 

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15 Responses to Tapering Will Spike Interest Rates Guaranteeing Recession

  1. Don Borden on September 12, 2013 at 5:11 pm

    JOBS:

    Although the BLS jobs report for August, at 169K jobs added, didn’t meet the 177K consensus expectation, it was one heck of a lot higher than your estimated BLS 25-100K spread. Trimtabs had estimated 79K jobs added for August.

    True, the BLS did reduce their July report from originally 162K jobs added down to 104K. Trimtabs’number was way down at 23K. (The modified BLS June number of 172K was very close to Trimtabs’ 182K.)
    This all said, it doesn’t pay to be too precise in trying to target BLS estimates. You, yourself, have said that the BLS can significantly modify its data for up to a year or more; further, the BLS monthly jobs data is based upon info that is only current through the middle of the month.

    Beyond all this, the question I have, is, do part-time jobs explain part of the BLS(revised) – Trimtabs data difference?

    TAPERING:

    Regarding tapering, if the Trimtabs jobs added (and wages earned) data convey a much truer story than BLS data (and I believe Trimtabs does), then we would face a recession. Certainly as you point out the bond market believes that tapering is coming. Further, as you also emphasize, higher bond interest rates reinforce the coming of a slowdown.

    Another indicator of tapering forthcoming is perhaps gold, although a thin and mercurial market. Now that the Syria mess is potentially being solved in a peaceful manner, the price of gold, which has been correlating closely to the adjusted monetary base (read quantitative easing), is tumbling significantly.

    What I guess I don’t understand is why the equities markets are holding up so well?

    • cbiderman on September 12, 2013 at 5:25 pm

      You comment is as if the BLS data is real. The BLS initial employment reports are a WAG guess based upon a survey sent to 140,000 employers — including all governments and most big businesses. That is less then 10% of all employers. It takes the BLS three months to get each month’s survey back. That is why the August numbers will again be revised in October and November. Even the revised numbers are just a guess.

      The BLS does have accurate data three years in arrears via income tax returns provided by the US Treasury.

      On the other hand we at TrimTabs track withheld income and employment taxes paid by all employers daily. We then adjust for year over year changes in tax rates, wage gains and income tax bracket creep. Our initial estimate has been within 15% of the final BLS data based upon tax returns.

      The equity markets are holding up because money available to buy shares is growing faster, due to the Fed’s largesse — than the number of shares available to be bought.

  2. black dog on September 13, 2013 at 2:48 pm

    I just recommended to a 90 year old relative that he sell his bond mutual funds.

    and

    So if the Fed actually does taper, and with fools in charge in Washington, there is very little chance of the US economy averting a recession.

    how do you reconcile these two points?

    don’t recessions equate with falling interest rates?

    fwiw, i’m still “all in” on my long bond funds … the old saw that the cure for high interest rates is even higher interest rates (until a recession collapses yields) … the worst thing for bond bullz would be a gradual rise in rates (allowing economy time to adjust) … we’ve had anything but since may.

    • cbiderman on September 13, 2013 at 4:07 pm

      If the largest bond buyer says they will start buying less and eventually stop buying altogether, who will then buy the $100 billion of new bonds necessary each month to fund the US government?

      • black dog on September 13, 2013 at 4:14 pm

        Historically the stock market falls somewhere between 35% to 40% in a (garden variety) recession. Money fleeing the stock market will be looking for a home.

        • Ed_B on September 14, 2013 at 10:14 pm

          “Money fleeing the stock market will be looking for a home.”

          Indeed it will but a really good question at that point is, “Will it be finding one?”. Bonds are very unattractive investments in a rising interest rate environment. Cash and cash equivalents? Perhaps. Precious metals? Maybe. Foreign stocks and bonds? Not if the US is in recession.

          Speaking of recessions, we seem to still have one here in the US. No, Wall Street is not in recession but Main St. certainly is. We keep hearing the term “jobless recovery”. That seems an oxymoron, if ever there was one. This is a mythical figment of someone’s demented mind. Has there ever been a jobless recovery? Not that I know of. Why should there be one now? Perhaps because it is convenient for the US Gov and the Fed to show that their policies are working, even though it is pretty clear that they are not. If they were working, the US economy would be growing and not shrinking. 1-2% “growth” that they claim is occurring in a 9% inflation environment (per shadow stats dot com) is not growth, IMO, just as having millions fewer employed in the past 5 years does not herald a growing economy.

      • Pam on September 13, 2013 at 7:36 pm

        So, less demand for bonds leads to lower bond prices, higher bond yields. Makes sense. But what if Fed only tapers 5 billion from the 85 billion a month, and so begins a long, slow taper. What are the risks in this scenario? If this small a taper throws economy into recession, maybe we just need to let it happen and get it over with, imho.

        • Ed_B on September 14, 2013 at 10:22 pm

          Pam… a slow steady taper is probably the best thing that the Fed can do at this point. It would slowly reduce their bond / mortgage buying and not roil the markets too badly. There would be an element of certainty in this that should calm the markets somewhat. A taper of say $7B a month would not be an extreme move on the Fed’s part, yet would end the latest version of QE is just about a year.

          My prediction is that if the Fed tapers slowly, as you suggest, the markets will have their usual knee-jerk hissy-fit for the 1st 4-6 weeks after tapering begins. But soon after this time period elapses, they will begin to realize that they are not being hurt, will stop whining about tapering, and will get on with the business of making money. While QE embodies a very large financial aspect, it also embodies a considerable psychological aspect. Once this is over-come, tapering will be seen as something that is necessary and not anything to be feared.

      • davidh on September 18, 2013 at 12:34 am

        The Treasury bonds are for sale, and if the Fed does not buy them, someone else will.

        The big questions are:
        what is the clearing price for Treasury bonds absent the Fed.
        what side effects will a lower Treasury price(higher yield) create in other instruments

        I think Stockman has it pretty well summed up. Dislocation.

        • Ed_B on October 7, 2013 at 10:20 pm

          David… my impression is that the Fed is buying most of the Gov bonds these days specifically because other buyers are not buying them. The Fed is the bond buyer of last resort and if they do not buy Gov bonds, very few others will either. When this happens, it is called a “failed auction” because there are fewer bids than there are bonds to sell. This puts enormous upward pressure on interest rates as the Gov tries to entice lenders to part with their cash and buy these bonds.

          By buying Gov bonds at the offered rate, the Fed has been able to short-circuit the usual bond vigilante actions that force interest rates up. Since the Fed always buys bonds at the offered rate, there is no pressure on the Gov to raise rates. When the Fed reduces or stops doing this, market forces will push interest rates higher or the bond auctions will fail to achieve the desired interest rate and volume of bonds.

          A great deal of the bond buying that is not being done by the Fed is being done in knee-jerk fashion by mutual fund managers simply because that is what they have always done and not because bonds are a good investment these days. In fact, Gov bonds are guaranteed to lose money because their coupon rate is less than real inflation and the “gains” are then taxed. It would be difficult to come up with a worse investment in a world that is awash in debt in general and sovereign debt in particular.

  3. jim white on September 17, 2013 at 6:23 pm

    Charles, your assumptions about tapering/ending QE causing rising long term bond yields flies in the face of the facts. All three Fed QE’s so far have caused bond prices to decline and long term rates to rise. Each time QE has ended (QE 1 and QE 2), bond prices have rallied and long term rates fell. When QE 3 was announced, the long bond was averaging around 2.60. a few months later, it was ranging between 3.25 to 2.90. The first two QE’s each caused rates to go up, both times from approximately 3.60 to 4.80. Bonds only rallied when the QE’s were ended. As a long bond trader, I noticed this in real time, but few other people did. Recently, the great economist Paul Kasriel noted exactly what I am saying in an article on Business Insider and another great economist, Lacy Hunt, noted the same thing in the latest Hoisington letter (2nd Qtr review). Fed buying of bonds (probably because of inflation fears from all the perceived “printing”) HURTS bond prices, it does not help them.

    • black dog on September 18, 2013 at 2:16 pm
      • Jim White on September 18, 2013 at 10:48 pm

        I’m impressed, you are one of the few who noticed this, thank you for giving me the link. Why does everyone miss this? What the media reports and what people like Charles say on this subject is the exact opposite of the truth and the truth isn’t that hard to see, it’s really been pretty obvious. It doesn’t seem intuitive, I know, maybe people just don’t bother to check their assumptions against actual reality.Anyway, thanks, good job.

  4. Rick on September 21, 2013 at 3:26 pm

    Charles,
    Why doesn’t the government issue weekly and monthly employment data corrected for working age population? Surely the immigration stations and demographic experts can provide at least a good estimate of working age population changes – better than the WAG guess of jobs themselves. That way instead of seeing “positive” 160,000 jobs numbers, we could see real jobs per 100 million working age people, for example.
    Why not? Probably because “positive” looks better for the government, is my cynical guess.

  5. Shizzrd on September 24, 2013 at 11:58 pm

    If you understand that the long end of the curve reflects GDP growth and an inflation premium you can then understand that the Fed doesn’t control this rate. The bond market sets the price and the Fed follows — eventually. They are always behind the curve.

    QE was implemented to generate negative interest rates via higher inflation expectations. Once the bond market realized that GDP growth wasn’t coming and that consumer spending was weak it started discounting the inflation premium.

    Interest rates went up because The Bernank changed the goalposts from a quantitative (QE until employment and inflation hit an exact target) to a qualitative Forward Guidance (QE until we think the economy has recovered). Huge leveraged positions were immediately unwound on the initial taper talk and real interest rates went up — tapering is tightening.

    The spread between the 10 yr rate and nominal GDP tracks very closely through our history and today that rate is right around 2.75% — finally getting price discovery in the bond market.

    Ultimately the Feds buying $5 billion a day in a market that trades $800 billion is jack squat. But once they decommitted to saying they were going to keep interest rate volatility low, then all hell broke loose.

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Charles BidermanCharles Biderman is the Chairman of TrimTabs Investment Research and Portfolio Manager of the TrimTabs Float Shrink ETF (TTFS)

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