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Is "the taper" even possible?
Old 06-25-2013, 01:23 PM   #1
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Is "the taper" even possible?

While I understand that many here are agnostic about the financial future, other than an overall optimistic outlook, some of us are curious about ways to up our returns or cut our risks with some directional bets.

A big question now, will the Federal Reserve actually cut back on its QE operation? The market seems to have accepted Bernanke's statement at face value, and produced an enormous selloff across a wide range of fixed income instruments, the 10 year as an example is trading at ~2.60% today, and was a bit higher several days ago. Similarly, agency and non agency RMBS have hit the fan.

I certainly have no answer, but I sure have a few questions. How robust is this recovery? Housing seems to be a big part of it, and Bernanke has been directly buying $40 billion of agency MBS every month. If this is stopped, or even meaningfully slowed, what will happen to mortgage rates? What effect will this have on home sales, and perhaps even more important from some points of view, on home building, which has been a bright spot in the economy lately.

True that QE has pretty well allowed the banks to clean up their balance sheets, but is that all that counts? I kind of doubt it. Next year is an election year, and Mr. Obama could breath easier about his program if he at lest holds the senate and even better takes the house. True his position is not directly at stake, but I cannot imagine asking for economic weakness going into an election year.

My wild guess is that the taper doesn't happen, or happens in a very mild way, and the 10 year treasury interest rate is close to its peak for 2013.

Your ideas or opinions?

Ha
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Old 06-25-2013, 01:32 PM   #2
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It probably will happen in a mild way. If the economy stumbles at all, the Fed will increase their easing. Same if inflation continues to drop. The amount of debt available to buy is shrinking anyway due to the deficit dropping, so even if the Fed buys less debt it may still have a strong easing effect.

This is more of a market panic reaction which tells me there has been a lot of leverage and hedges used, and when those unwind it tends to be very violent. The dust has to settle. For nimble investors, it can be a buying opportunity.

There was probably no way to signal the markets of a Fed policy shift, no matter how tiny, without causing this strong reaction - too many speculators.

Actually I don't know if 2.65% will be the peak this year. I can see how panic could drive it higher, but I think it would be temporary.
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Old 06-25-2013, 01:52 PM   #3
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With the general caveat that interest rates are just as hard, or harder, to predict than the stock market, I tend to agree that the recent surge in interest rates is likely to level off soon. It's awfully risky to base major investment decisions on this kind of expectation, however. Since interest rates are still at historically low levels, expecting them to stabilize or even go back down is perhaps a bet against history.

For what it's worth, I have been cautiously buying bonds and REIT shares recently, mostly under the guise of rebalancing, but also in hopes that interest rates won't continue to rise. If I'm right, the new purchases might pay off soon. If not, I'm just adding to my losses.
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Old 06-25-2013, 02:07 PM   #4
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The government is still spending more than it makes. We still have budget battles to survive. Less government spending or more taxes will ding the GDP. I'm still looking for a downturn. but it's been a long time coming so far...
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Old 06-25-2013, 02:08 PM   #5
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Bill Gross seems to agree that the 10-year has reached a peak for this year. But given his fund's performance over the past few weeks, he clearly was not anticipating the big bond sell off we have seen. Does he know any better now? As for me, I don't know where the 10-year's yield is going. Personally, I would be pretty happy to see rates normalize in short order (kind of like ripping a bandage). But I also think that the economy is still too fragile to absorb a big interest rate shock right now and that the Fed will have to step back in if that happens. A large increase in interest rates would probably kill the real estate recovery while negatively impacting both the stock market and bond market. I could also strengthen the dollar, which would create a headwind for exports. The negative wealth effect would probably cripple our barely-growing economy. The last few weeks have shown that "tapering" in any controlled way is going to be very challenging, so I expect a lot of volatility.
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Old 06-25-2013, 02:14 PM   #6
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Lots besides the Fed's QE affecting the markets (stock & bond). China, Japan, & European central bank's behavior also can have big impact.
Overseas investors hold over $5.6 trillion (with a "T") in US Treasury debt instruments, which is roughly 1/3rd of circulating US Federal debt (debt held outside the Fed & other intra-gov't agencies).
http://www.treasury.gov/resource-cen...uments/mfh.txt
Debt to the Penny (Daily History Search Application)

Since US mortgage rates are linked to Treasuries and Treasury yields are linked to foreign buying patterns, if the rest of the world slows its purchases of Treasuries US mortgage rates are bound to rise whatever happens with QE 2/3/infinity.
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Old 06-25-2013, 02:35 PM   #7
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I have stopped selling our 30 year TIPS. I thought .30 percent wouldn't last for years for the yield. I am not so sure now about ~1.5% now. That number is getting closer to the ballpark of historical average yields.

I think housing prices will start to drop as mortgage rates rise and investors can make money else where with less hassle than real estate. I would like to downsize before too long and do a little profit taking on the house before the prices drop back down. But we haven't found the perfect next house or location yet that everyone is happy with, so we might have to stay put awhile.
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Old 06-25-2013, 03:01 PM   #8
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Bernanke has said what could happen (the Fed will back off the QE pedal) and it has seemed to be interpreted as what will happen. CBSMarketwatch had an opinion article (that I can't find anymore) that resonated with me. It said that basically half or more of the forecasts were missed for Q1 of this year, on the downside. If that happens again, the Fed isn't as likely to back off the pedal as soon.

We think the economy is doing well, but, basically it still sucks, and we can't even hit the forecasts let alone knock one out of the park.

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Old 06-25-2013, 03:09 PM   #9
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I thought the Feds comments about tapering in Q4, IF THE ECONOMY IMPROVES, seemed very measured and reasonable. Seem like the market didn't hear the IF caveat, and it makes me wonder what might happen when the IF becomes a certain.

Still seems bonds have been oversold, but I am not looking to add any more of them to my port at this time. Now if we could just get the banks to start paying some interest.
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Old 06-25-2013, 03:09 PM   #10
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Quote:
Originally Posted by daylatedollarshort View Post
I have stopped selling our 30 year TIPS. I thought .30 percent wouldn't last for years for the yield. I am not so sure now about ~1.5% now. That number is getting closer to the ballpark of historical average yields.

I think housing prices will start to drop as mortgage rates rise and investors can make money else where with less hassle than real estate. I would like to downsize before too long and do a little profit taking on the house before the prices drop back down. But we haven't found the perfect next house or location yet that everyone is happy with, so we might have to stay put awhile.
I am curious Daylate, what is the more traditional rate on the 30 yr. TIPS? I have thought about moving some dead money there as a long term investment. Possibly moving all my I Bond money into it. I am no expert, but I do enjoy tracking the government bond rates. I found this mildly interesting compared to a year ago in this mornings paper. 3 month TBill - .05 vs. .08 a year ago. 6 month TBill - .09 vs .14
1yr TBill - .13 vs. .17 2yr- .39 vs. .30 5yr. - 1.45 vs. .76. 10yr - 2.54 vs. 1.68 30yr. - 3.55 vs. 2.76

Clearly the movement is in the 5yr. and 10 yr. with the shorter durations still lower than a year ago.
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Old 06-25-2013, 03:15 PM   #11
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Historic debt levels are the overarching macroeconomic fact of our times. Broadly, IMHO, they preclude a return to normal rates. Central bankers have painted themselves into a corner from which there is no obvious escape.

I have no doubt Ben had his legacy in mind a few days ago when he gave his speech. And I'm sure he'd genuinely like to leave Ms. Yellen (or whomever his successor ends up being) a better situation than they will in fact inherit. They may diddle around with the numbers. They may drop the current $85B to $65B or thereabouts. But I see no way for the Fed to meaningfully unwind what they have created.

Look for crisis. Then look for QE5.
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Old 06-25-2013, 03:33 PM   #12
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Originally Posted by haha View Post

My wild guess is that the taper doesn't happen, or happens in a very mild way, and the 10 year treasury interest rate is close to its peak for 2013.

Your ideas or opinions?

Ha
My thoughts are along this line. Payroll receipts were moving along at around +4% annual increase through December, which is barely above stagnant. PCE increases have come from decreased savings, and most of that is the result of a 50 year low in household debt servicing levels. Neither US households nor the US government can service their debts and maintain spending if rates rise above their current levels, and employment is not growing nearly fast enough to change that anytime soon. I see rising rates as strongly recessionary.
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Old 06-25-2013, 04:21 PM   #13
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Originally Posted by Mulligan View Post
I am curious Daylate, what is the more traditional rate on the 30 yr. TIPS?
Before the super low interest rates of the last couple of years, I was getting ~2% yields on the thirty years. When they first came out I think the yields on 30 years were more like 3 - 4% but I didn't know about TIPS back then and never bought any at those rates. I suspect now that they are not a new product with a ready secondary market, the 3%+ day may never return.

I found a list of the historical yields at
Historical TIPS Bond Search
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Old 06-25-2013, 05:29 PM   #14
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Quote:
Originally Posted by daylatedollarshort View Post

Before the super low interest rates of the last couple of years, I was getting ~2% yields on the thirty years. When they first came out I think the yields on 30 years were more like 3 - 4% but I didn't know about TIPS back then and never bought any at those rates. I suspect now that they are not a new product with a ready secondary market, the 3%+ day may never return.

I found a list of the historical yields at
Historical TIPS Bond Search
Thanks, Day. I am hoping for 2% and will be patient. May have to be patient for a long time, though.
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Old 06-25-2013, 06:06 PM   #15
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I think last month marked the end of my 6 years bond selling campaign.

At 2.6% for the 10 year, bonds have gone from me preaching from the mountain top (at 1.6-1.8%) "your insane to loan Uncle Sam money for 10 years at under 2%", to me now thinking "well if it help you sleep at night you'll probably almost break even after inflation and taxes go ahead keep some money in bonds".

I am temperamentally biased against bonds, but if rates rise another 100 basis points I'll start buying some for my mom's account and if they go up another 150 basis I'll move my AA to its default 75/20/5.

As for what the Fed should do? I think they have two choices, both very bad.
Option 1, let interest rates return gradually to a market rate, risking another recession. Option 2 continue loading up the Fed's balance sheet with overpriced government bonds and hope that US debt market remains the least bad choice for sovereign debt.

My greatest fear with option 2, is that more and more current purchasers of US bonds, like China, start thinking like myself and many other investors (obviously ones with billions not millions). Collectively there is a buyer strike on US bonds which leads to a crisis of confidence, the RMB, the Euro, gold, or hell even bitcoins replace the US dollar as the reserve currency. At which point we are truly screwed.

I vote to take our medicine now, but freely admit, I have no clue if that really the right strategy.
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Old 06-25-2013, 06:10 PM   #16
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My opinion is that some form of accommodation will go on, until the $ crashes in 5 to 10 years from now. Maybe 15-20 years. But the drop in the US $ will be brutal and historic.
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Old 06-25-2013, 06:19 PM   #17
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Originally Posted by audreyh1 View Post
This is more of a market panic reaction which tells me there has been a lot of leverage and hedges used, and when those unwind it tends to be very violent. The dust has to settle.
I've always counted on "the market" to overreact on the downside and the upside - don't "they" always?

Quote:
Originally Posted by audreyh1
There was probably no way to signal the markets of a Fed policy shift, no matter how tiny, without causing this strong reaction - too many speculators.
As you know, after the May statements, I don't know how he could break the news more subtly. Especially as everyone knows QE can't go on indefinitely.
Quote:
The Fed is aiming to keep short-term interest rates near zero until the unemployment rate falls to 6.5% or inflation exceeds 2.5% a year. By the Fed's own forecasts, that scenario is not likely to happen until at least 2015.

The Fed expects to wind down quantitative easing before then, but the timing is not yet clear. Fed watchers have recently been parsing every word out of officials' mouths for hints. Bernanke offered few clues in his testimony Wednesday, but Fed minutes released later in the afternoon mentioned that some members would like to start tapering QE as soon as next month.

"A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting," the minutes from the April 30-May 1 meeting said.
Bernanke warns of 'premature tightening' in monetary policy - May. 22, 2013
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Old 06-25-2013, 06:35 PM   #18
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I think the ten year is going to 4%. I thought the fed would ease into it over the next 18 months and may still but it's going faster than I thought. I don't see a big problem with it. We were just there 24 months ago.
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Old 06-25-2013, 07:43 PM   #19
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snip...

My greatest fear with option 2, is that more and more current purchasers of US bonds, like China, start thinking like myself and many other investors (obviously ones with billions not millions). Collectively there is a buyer strike on US bonds which leads to a crisis of confidence, the RMB, the Euro, gold, or hell even bitcoins replace the US dollar as the reserve currency. At which point we are truly screwed.

I vote to take our medicine now, but freely admit, I have no clue if that really the right strategy.
And where exactly is the alternative investment that they would put their bets into?

Gold?.... 25%+ drop

Europe?.... Euro, Greece, Italy, Spain and so on....

China?....Massive bubbles in just about everything...

Russia, Brazil? - get serious...

Which country or region on this good earth could handle the truly massive amounts of money involved?

I'am afraid the good ol' USA is going to be it for a long while.
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Old 06-25-2013, 09:57 PM   #20
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Hard not to look back at this.........

Lost Decade (Japan)

http://en.wikipedia.org/wiki/Lost_Decade_(Japan)

http://en.wikipedia.org/wiki/Zombie_bank
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