What is NIRP
What is NIRP, quite simply it is the unimaginable just a short time ago. It is when the central bank takes rates negative. It sounds absurd and it is. During the height of the crisis, back in 2009-2010, as the Fed was figuring out what to do, they considered taking short-term (Fed Funds) rate negative – but even in the height of a crisis the Fed was not willing to go there.
Back in October 2014 I wrote about the possibility of the Fed taking rates negative. For if the economy doesn’t get jump started so the Fed can begin to unwind, there is nowhere really to go. When I referenced it back in 2014, even I said it with a sarcastic undertone. Yet here we are, seriously considering the once unimaginable.
On January 29th Japan took the step off the Keynesian cliff and was the first to take rates negative. While I wrote and joked about it, it didn’t get too much coverage in the media. Perhaps the media and the rest of the world really didn’t understand the significance or perhaps they thought, “Oh that’s Japan it will never happen here.”
Why is negative rates a problem?
Why are negative interest rates unimaginable? At the very core it rips away the very fundamental function of interest rate, which is interest rates are based on the perceived risk inherent with the loan and inflation. At negative rates there is theoretically a role reversal as the lender pays the borrower. Unless there is a perceived value to do so, which there is no reason why you would lend money and pay to do so.
The Spin, I suspect we will start hearing the Fed and other Keynesian economist justify negative interest rates with something as silly as PAYING interest to save money in dollars. As if dollars have some inherent value. The reality is you are just accelerating the loss of buying power.
We are truly venturing into the experimental realm of unknown, which unfortunately is where we have been since the first QE and ZIRP (Zero Interest Rates).
Courtesy of bloomberg
Yellen’s Congressional testimony yesterday was a historical occasion. While it is unfortunate our Congressional members, for the most part, are beyond ignorant when it comes to economics, math, interest rates, and fiat currencies (see Maxine Waters for example), there were some interesting exchanges. One might feel sorry for Yellen as it seemed that some Congressional members were beating up on her, but she has a lot to answer for and just will not answer. It was mentioned she had been subpoena for some documents, and still has refused to turn over that information. Amazing to think that Congress has little if any oversight over the very institution that they created.
The particular issue was that of NIRP. Yellen was asked, can she (the Fed) legally take interest rates negative? Sure, there is no law that says they can’t. The question arose because it is unfathomable and outside the realm of fundamental economics – even farfetched for Keynesian economic theory. So I am not surprised by the question, is it legal? The Fed has proven, regardless of legality, they will do what they want, when they want to. We saw that when the Fed first started printing money to monetize government debt (buying bonds) prior to the official QE. Bernanke was raked over the coals in his Congressional testimony, he was asked is it legal. No one bothered to figure out if it was or not and Bernanke claimed “emergency powers” for the reason of his action. He got a slap on the wrist and QE was officially born. The Fed’s motto is simple: Better to ask forgiveness than to ask permission.
NIRP Market reaction.
The big unknown is how is the market going to adjust to NIRP?
On some level it can certainly buy more time to inflate the equity markets and in a broader sense kick the economic can down the road. What will be interesting is the bond market, we are already seeing the 10-year yield collapse as bonds rally. However, at some point when yields start getting really low (as if they are not already) and the bond prices peak out – you start losing buyers who can no longer participate in appreciation, and therefore certainly will not be buying bonds on the 10 year for less than 1%, let alone short-term bonds/bills for negative rates.
At that point, when they have gone as far as they can and can’t go any farther, that is when the bond bubble pops.
Now it may not really pop, creating a bond collapse, simply because the Fed has proven that they have a mighty printing press and can keep bond yields floored (it just takes enough money). So while it may not pop, we could see the dollar devalue fast which will spike inflation. We could even see a disconnect in the currency trade, which would only further exacerbate inflation and devaluation.
What are the outs (options)?
So what are the outs and how much time do we have?
There are only three outs (poker parlance):
1. Option one, Private sector becomes robust and the economy roars back, giving room for the Fed to raise rates and unwind their trillions in bonds and mortgage back securities. This is what the Fed is betting on. Unfortunately, the economy has been limping along for years (regardless of what government headline data says) and the expansion we see is based on debt expansion. So Option one is and has been a fantasy.
2. Option two, the more responsible and accountable option, is also the most unpopular. The Fed raises rates (regardless of economic conditions), begins to unwind their balance sheet (regardless of market price), allows the yield curve to steepen, and risk deflation and slow growth. We would certainly see some companies fail, unemployment rise, and stagnation or even a recession. However, we need to deleverage and reduce the size of the debt bubble we have created. It will not be fun, but it is the responsible thing to do. Certainly not going to happen.
3. Option three, which is what the Fed is doing, is the most popular and most likely. They will NOT raise rates, NIRP becomes a possibility, they will come-up with a variety of stimulus efforts (QE, Operation Twist, TALF, or some other crazy scheme). The bond bubble will get larger, the market will rally – in the short-term, and in the end this whole thing will implode. This is the most likely option.
The timing, well that all comes down to faith. With option 3 being the most likely option (as that is what we are doing now), the question is how much more time will it buy? My guess is perhaps 2017 or 2018. It will not happen in 2016, because the Fed needs to ramp-up first and that will spike bonds and the equity market first.
The end comes when the Fed runs out of room as they ramp-up monetizing government deficits and debt and we start seeing a dollar dump by institutions and foreign nations. Much like the 1970s, after coming off the gold-standard, this nation saw the biggest exodus of dollars. There was a time in the late 1970s – early 1980s, that Volcker (then the Fed Chair) thought that HYPER INFLATION could strike any day. We saw inflation rocket 100s of basis points over night and the Fed responded by taking rates up over 100 basis points a clip.
It’s the dollar dump, the devaluation, the loss of faith in the dollar as a Fiat currency that has the highest probability if we continue with Option 3 and we see the Fed move to a NIRP and increase Dovish policy.
If you don’t have an inflation position on or hedged – then you are riding in a volatile equity market and I feel for you. I hope your broker/adviser has some answers for you or at least hedging your positions.
For you traders, this is a huge time of opportunity. These are the days I wish I was back on the trading floor, where Gamma rules and Vega plays can make windfalls.
Support & Resistance
We will certainly break down through 15,800 this morning, the question is how will we close. 15,600 is a low support area. If we close on a rally above 15,800 then we could be forming a double bottom and could see a short-term rally. If we close down in the 15,600 level, we could be in for another big down day tomorrow.
Is 4000 resistance now? I am not sure, this tech heavy index can move fast and gap large. Stocks in this index can see 2% moves in a blink of the eye and gap 5% without thinking about it. Expect volatility and I would look at a sloppy and highly volatile range between 3900 and 4000.
One would hope this would be a consolidation area and building a double bottom area. However, there remains some big volatility and if we can’t hold in the 1850 area and close solidly above it, we look to visit 1800. I would watch the close and 1850 for any signs of a double bottom and bounce.
I just don’t know. Of all the indices the broadest has broken down through the recent low support of 980. If the Russell was the sole measure, then there is no double bottom and we are facing a free fall situation, which is fueled by margin calls. I don’t know where the bottom is in this index and frankly, until the Russell finds a bottom, then the narrow based indices are just playing a roller-coaster game. I still think we could have a double bottom, but the market has to believe the Fed is ready to ease (cut rates).
Yellen will be testifying today before the Senate. It should be loaded with more fireworks, but who knows. Her vague and coy answers only led to more uncertainty and a loss of confidence. Hyping the U3 unemployment breaking down below 5% and then in the same breath say there is still significant slack and structural problems in the labor market is hypocritical and the people are not really buying the spin (aka Fed BS) anymore. We are getting wise to the spin vs. reality.
I have said for years and have written detailed (math and logical) reasons why:
The CPI does NOT measure inflation, but rather an adjusted cost of living (COLI) that is directly impacted BY inflation.
The U3 unemployment is NOT a representation of the actual unemployment level (once you look at participation rate and how the data is counted). The U6, while better is also not accurate.
The GDP number is bloated with non-tangible assets whose market value is nothing more than mark-to-myth, much of it with billions of debt.
Yet it is these three massive economic data points the government and more importantly the Fed waves around as to the health of the economy. Yet for all their trillions printed, zero interest rates, bond buying and mortgage buying – and their CPI showing no inflation, U3 reporting 4.9% unemployment, and GDP showing positive growth – the Fed continues with their easy monetary policies and is NOW considering Negative Interest Rates (NIRP).
So anyone with an ounce of logic and reason in their head would have to ask, there must be something wrong. If the economic data is so great, then why is the Fed still printing money and now considering negative interest rates?
Because the headline data is frankly shit and the Fed knows it.