If Ben Bernanke were a Gymnast
During a press conference on the week of June 17th, Ben Bernanke began the impossible task of informing a suckling financial market that, over the next year, they would need to alight from the Federal Reserve's teat of liquidity. The response across equity and bond markets were fierce, with further declining values in bond and equity portfolios alike. I noted in my end of May Weekly Wrap that treasury bond portfolios had declined starting the 16th of May, and the mention of "tapering" from the Federal Reserve (a reduction in the monthly bond purchases) continued the erosion of value from this seemingly safe haven.
At the time, I must admit I was surprised by the news that the Fed was going to taper. GDP was revised downward to 1.8% and deflationary pressures were persisting which, in my mind, posed the greatest risk to the US economy. Why would Bernanke announce there was going to be a reduction in bond purchases at a time where it wasn't evident that the U.S. Economy was truly out of the woods?
A little more than one month later, not only was his logic clear, but, as a gymnast of eleven years, I have to say Dr. Bernanke has done nothing short of "sticking the landing." To continue the analogy, it's important to note that I'm analogizing his performance to a single event in a competition and that the larger competition of "Sustainable, Unsupported Economic Growth" is far from over (and it turns out he will not be around to finish the competition as Dr. Bernanke is stepping down).
Bernanke's Incredible Dismount:
First and foremost, we've seen inflationary expectations discontinue their decline and return to healthier levels closer to 2% (see the graphic above). Recall, that monetary easing is inherently inflationary, so the increase that has taken place in expectations is in lieu of his comments and not because of them. This indicates to me that the timing of his statement was surgical.
Secondly, parsing the words of the Chairman of the Federal Reserve is never easy. If you watch markets closely (as in "intra-day closely) you'll always note that when Bernanke speaks to the public, the financial markets can swing wildly. So it takes no small leap of the imagination to understand that divulgence of a reduction in monetary easing, unquestionably, had the chance to crush global markets… in fact, if you refer to the first graphic of the post, you can see the wild impacts on treasury prices after the Chairman's comments. However, since that time, we've seen five factors that in my mind, illustrate that this event has been effectively executed.
- Average correlations have come back down in the equity markets. When correlations are high, that's a general sign that "risk assets" are being seen from a perspective of binary outcomes, also known as "Risk On Risk Off."
- Credit spreads have come back down, indicating reduced anxiety in the bond market
- Bond outflows have tapered off, indicating that retail investors have ceased their exodus en-mass
- Equity flows have returned to positive territory, indicating that one month after Dr. Bernanke's comments, risk appetite is returning to the markets
Lastly, treasury yield volatility has come back down and rates have settled to more appropriate ranges (see the graphic below). As treasury rates are the sole instrument affected by Federal Reserve's monetary stimulus via direct causation (i.e. the Fed reducing its purchase of Treasuries reduces the demand for the asset, thereby directly impacting rates), a return to levels with low amounts of volatility shows that nerves of the treasury market have quelled, even in light the Chairman's comments.
The Final Event
This acrobatic competition is far from over. The most recent releases show $3.5 Trillion dollars of assets which will either need to be held to maturity or returned to the market to return the Federal Reserve's balance sheet back to pre-crisis levels. However, up to this point I think it's clear that Chairman Bernanke, under all of his scrutiny and public ridicule has performed spectacularly, and he's a gymnast I would unquestionably want on my squad to do the job he's done. If January is in fact his departure (as it's currently set), whomever steps into his role has a yawning pair of shoes to fill.
Noteworthy Reads / Events of the Week
- Point… Prime Minister Abe: Japan posted its highest rise in core inflation in nearly 5 years, at a year over year increase of 0.4%. It may not seem like much, but to a country that has experienced deflation for over 15 years, this is hugely bolstering hope that Prime Minister Abe's policies will prove effective at beating deflation.
- The Eurozone's Growing Mountain of Debt: Debt numbers for the Eurozone came out on Monday and provided another sobering reminder of Austerity's shortcomings. Debt as a (%) of GDP increased from Q4 2012 to Q1 2013 to 92.2% from 90.6%. Greece's numbers went from 156.9% to 160.5%, Spain from 84.2% to 88.2%, Italy from 127.0% to 130.3%, Ireland from 117.4% to 125.1%, and France from 90.2% to 91.9% and Portugal from 123.8% to 127.2%
- Are Bonds a Bargain?: Jeff Gundlach continues to make the case that bonds are undervalued and Business Insider makes the case that that bond have never seen a protracted drawdown, and that current levels are a great buying opportunity
- From Negative to Barely Positive: The 6 consecutive quarters of Eurozone decline may be nearing an end ... to "no growth." Markit's Purchasing Manager's Index ("PMI") jumped to 50.4 in July. Starkly contrasting China, whose PMI fell to an 11 month low of 47.7 in July.