The Non Event

Yesterday the Fed announced its first interest rate hike since June 2006. Result: stocks soared. Yawn. Is that supposed to happen?  No, well, yes of course…..   Sorry for doing a Draghi.  The answer is yes — when there is this much at stake.  The Fed -and by extension the other major central banks- cannot afford to have the great unwashed (hold mirror up here) figure out that all that really matters is whether central bank actions and threats are able to move stock markets higher. It needed an example wherein it tightened and stock markets did not drop. Wish granted — via the efforts of every major central bank’s spare liquidity — and the efforts of the shadow banking system that has profited so handsomely over the past few years from the Fed’s QE programs.

It is popular sport to bash the Fed for keeping interest rates so low for so long, for failing to assist ‘main street’ while sustaining an environment wherein its shareholders –banks– earn great profits.  I too am guilty of being critical of the Fed.  That said, I understand why the Fed bailed out the banks, then held interest rates low for so long. It’s really quite simple.  The Fed had to do what it did to ensure the systemically important banks in its footprint could become solvent (or could at least fake being solvent via a fudged stress test that is endorsed / legitimized by the Fed).  “The Bernanke” indicated -years after the fact- that the U.S. financial system was insolvent back in October 2008.  You didn’t expect him to tell you the truth when it would have been really inconvenient did you?  You can’t. For obvious reasons the great unwashed have to be lied to from time to time.  As of now, the Fed is certain the systemically important banks in the U.S. have sufficient capital buffers they could withstand a similar mess to 2008-09. (good. they’ll have to.)

The ECB has been slower to react because it has the Bundesbank to convince regarding hugely inflationary policies. As a result I suspect there remain several important European banks that are insolvent.  As long as there are systemically important banks in Europe at risk of failure, the ECB will “do whatever it takes” (whatever the Bundesbank will let) to maintain the illusion -as the Fed did- that all is well. If they bluff long enough –and have the ammo to pull off that bluff– they’ll eventually not be lying.

So how much of that yummy ECB QE frothiness is working its way to this side of the N. Atlantic?  Not very much.  Not near enough to support the lofty equity prices. If the Bundesbank will allow, the ECB will be forced to increase its QE program in Q1 or Q2 and drop further into the red its requirement to not buy sovereign bonds with yields under minus 0.2%.  Imagine a -0.5% yield on the 10yr Bund and a +1.0% yield on the US 10yr Tnote.  That’s where we’re headed late in 2016.

 

This game is far from over.