By Pam Martens: June 25, 2013
The frightening “L” word is now making the rounds on Wall Street, resurrecting fears of the early days of the 2008 financial crisis. According to Wall Street veterans, liquidity has dried up in finding buyers for what hedge funds are desperate to sell: large blocks of lower rated bonds.
Since Federal Reserve Chairman Ben Bernanke held his press conference on Wednesday, June 19, of last week, hedge funds have been stampeding to unwind trades, driving down the value of not just bonds, but stocks, exchange-traded funds (ETFs) and gold as well. Even U.S. Treasury notes, the typical safe haven amidst panic selling, have lost significant value. The Treasury selloff is likely a result of the liquidity of the instrument; when hedge funds must raise cash quickly to meet margin calls and there are no bids for some of their other asset holdings, they have no choice but to sell the most liquid investments.
It also didn’t help that Bernanke made his remarks the week before the U.S. Treasury was set to auction $179 billion of Treasury bills and notes. The increase in interest rates resulting from the panic selling has forced the U.S. government to offer higher interest rates on its debt auctions this week.
Bernanke, a man of measured words, clearly did not mean to set off a panic. So what was it that the bond vigilantes found so repugnant in Bernanke’s press conference of June 19:
First, Bernanke said the Fed might actually sell some of its holdings of mortgage backed securities at some point: “One difference is worth mentioning. While participants continue to think that, in the long run, the Federal Reserve’s portfolio should consist predominantly of Treasury securities, a strong majority now expects that the Committee will not sell agency mortgage-backed securities during the process of normalizing monetary policy, although in the longer run, limited sales could be used to reduce or eliminate residual MBS holdings.”
The problematic part of those two sentences are the words “difference” and “worth mentioning.” This signaled a change in thinking and that’s what the market seized upon.
Next, Bernanke fumbled his statement on the Fed’s $85 billion in monthly purchases of bonds that have been keeping interest rates low and propping up the bond market: “Although the Committee left the pace of purchases unchanged at today’s meeting, it has stated that it may vary the pace of purchases as economic conditions evolve.”
The problematic word here is “although.” If you are a hedge fund leveraged up to your eyeballs in esoteric debt instruments, you don’t want to hear any suggestion at all that the Fed is changing course.
Bernanke can’t afford to look like a fool and retract a statement he made just a few days prior. So his pals at the regional Fed banks are doing it for him.
Last Friday, June 21, James Bullard, the President of the Federal Reserve Bank of St. Louis, released a statement that included this excerpt:
“…the Committee’s decision to authorize the Chairman to lay out a more elaborate plan for reducing the pace of asset purchases was inappropriately timed. The Committee was, through the Summary of Economic Projections process, marking down its assessment of both real GDP growth and inflation for 2013, and yet simultaneously announcing that less accommodative policy may be in store. President Bullard felt that a more prudent approach would be to wait for more tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement.”
Narayana Kocherlakota, President of the Federal Reserve Bank of Minneapolis, released this statement yesterday:
“…depending on economic conditions and assessments of policy effectiveness, it may be appropriate for the Committee to buy additional assets even after the unemployment rate falls below 7 percent. And, depending on economic conditions, it may be appropriate for the Committee to keep the fed funds rate extraordinarily low even after the unemployment rate falls below 5.5 percent.”
Apparently, it now takes a small village of thinkers to speak Bernanke’s mind, a dangerous conundrum for the markets. In a column in the New York Times yesterday, economist Paul Krugman warned as follows:
“…what the Fed says often matters as much as or more than what it does. This is inherent in the relationship between what the Fed more or less directly controls, namely short-term interest rates, and longer-term rates, which reflect expected as well as current short-term rates. Even if the Fed leaves short rates unchanged for now, statements that convince investors that these rates will be going up sooner rather than later will cause long rates to rise. And because long rates are what mainly matter for private spending, this will weaken growth and employment.”
That has already happened. Fixed mortgage rates are based on the interest rate of the 10-year Treasury note. Bernanke’s words have raised that rate and, along with it, what home buyers and those hoping to refinance will pay on their mortgage.