Dark Money Will Push Gold Higher

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Even though it’s on rate-cutting hold, the Fed nonetheless keeps engaging in aggressive oversubscribed repo ops, or as we like to call the process, “QE4R.”

QE4R involves offering money to banks in return for short-term U.S. Treasury and mortgage bonds, in shades of 2009.

The fact that the Fed is expanding its balance sheet through these repo operations allows it to pretend it is merely auctioning “adjustment-based” policy moves, rather than problem-based ones, to keep rates from rising and money becoming too expensive for banks.

This provides the Fed a kind of cover during which it can hold off on rate cuts until it deems that data clearly suggest they do otherwise.

Regardless of the reasons for QE4R, this new flow of dark money has the ability to stimulate the stock and bond markets — along with gold. Although gold prices have rallied on the back of the Fed’s recent balance sheet growing exercise, gold has been rising less quickly than it did during the initial phases of QE in the post-financial crisis period from 2009 through 2011.

However, the stock market has been rising steadily (with some bumps along the way) since the start of the Fed’s QE4R operations. There are several reasons for this phenomenon.

Computer algorithms, ETF-related trading and asset managers for pensions and other forms of retirement funds seeking yields above those of bonds have pushed the market up. So have corporate stock buybacks. There is also the steadfast (and proven true) belief that the Fed will step in whenever it “has to,” as would other central banks around the world.

There’s a reality behind the dark money-infused market euphoria, though. It’s that U.S. economic growth, as well as that of the global economy, has been slowing down and will likely continue to slow.

Shrinking corporate profits in conjunction with lower rates and increased debt loads is not a classic recipe for a prolonged bull market. The fact that bulls continue to run is a mark of just how much dark money can keep markets elevated.

In the past, slowing profits along with more debt and cheap money has more closely reflected a bear market (consider the U.S. stock market in 2000–02, 2007–09 and the Japanese stock market since 1989). Japan’s stock market would be even lower were it not for various QE and ZIRP moves by the Bank of Japan.

U.S. corporate margins may well have already hit a multiyear peak. As we head toward the 2020 U.S. election, it’s hard to see many corporations diverting their debt loads into R&D or investment programs. This could hold true after the elections regardless of which political party wins.

Another reason that the Fed began QE4R is the global shortage of U.S. dollars in money markets. This also happened at the start of the financial crisis in 2008.

The last thing Fed Chairman Jerome Powell wants under his stewardship is a repeat performance. Repo lending rates spiked in September because of this shortage and liquidity problems at the big banks. This continues to this day, as evidenced by the Fed’s term repo lending facilities being often oversubscribed by the largest Wall Street players.

Since Monday, the Fed has pumped $97.9 billion into the market in two parts. One was through overnight repurchase agreements of $72.9 billion. The other was through 42-day repos. The result is that the Fed’s balance sheet has topped the $4 trillion mark and looks to rise from there.

Also, the Fed again increased the amount of short-term cash loans it plans to offer banks to ensure rates remain stable. It now plans to offer $25 billion in cash loans for the 28-day period ended Jan. 6, up from $15 billion previously.

Last week, it increased the size of its 42-day facility for the period ended Jan. 13 by $10 billion, too. This was also based on its recent bank supervisory findings that 45% of U.S. banks holding more than $100 billion in assets have supervisory ratings that are less than satisfactory.

All of this means that the Fed’s easing this year was very much a defensive maneuver. And it continues to act pre-emptively against the potential for a dollar funding squeeze as derivative-trading banks close their books into year-end 2019 through its repo operations.

Though different from the longer-term QE operations the Fed actioned between 2009–2014 that inflated stock, government and corporate bond prices, the result is the same. An artificial stock market rally. And more debt.

The big difference is all of this money manufacturing is now occurring against a backdrop of economic weakness and trade-war and geopolitical uncertainty.

For now, and heading into 2020, there remain six key economic trouble spots in the U.S. alone:

  1. Trade Wars. China trade talks are still going nowhere specific. President Trump has threatened to “raise the tariffs even higher” on Chinese imports if a trade deal cannot be reached by Dec. 15 and went so far as to indicate that he’d be fine if a deal didn’t occur until after the 2020 election. So “phase one,” which was announced over a month ago, has made no real progress…keeping markets knee-jerking on any positive or negative rumors.
  2. U.S. household debt at a high of $14 trillion — $1.3 trillion higher than its prior peak in Q3 2008. This could eventually hurt consumer appetites and dampen U.S. GDP.
  3. U.S. GDP is growing but decelerating. In this 11th year of expansion and easy monetary policy, the expansion may be longer, but it’s also shallower that past expansions.
  4. U.S. $20 trillion national debt is at 104–105% of GDP, having passed 100% in Q3 2012. Though Jerome Powell has stressed to Congress that it must find a way to fix this, the Fed continues to be the largest buyer of U.S. Treasuries, thereby pushing the problem forward of debt growing faster than the economy.
  5. Money supply (M2) has grown since the 1980s, but money velocity (VM2) has declined since 1997, particularly since the financial crisis. That means that local businesses aren’t working together enough to stimulate the foundation of the U.S. economy.
  6. Ongoing quest for risky assets could backfire. These problems were created by central banks. The longer rates are low, the more risk asset managers — i.e., investment funds, pensions funds and long-term insurance companies — take on to meet liabilities. This is exacerbated by slowing economies and means more global exposure to credit and liquidity risk. This increases the underlying instability in the international markets.

Given all of this backdrop, I believe that markets will continue to rally on the back of dark-money operations with volatile periods. However, gold is increasingly an attractive safe-haven investment.

Thus, it’s only a matter of time before gold has a catch-up rally.

Regards,

Nomi Prins
for The Daily Reckoning

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The Fed Is on High Alert

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It’s hard to believe the end of the year is upon us and 2020 is right around the corner.

In many ways, it went by very quickly. For economies and markets, it was a year marked by uncertainty over economic slowdowns, trade wars and a complete pivot in “dark money” policy initiated by the Federal Reserve and subsequently followed by other central banks around the world.

Notably this year, it wasn’t just the major nations that engaged in copycat monetary policy easing. It was a plethora of emerging-market central banks jumping on the same dark money bandwagon.

So as we head into the final FOMC meeting of the year next week, we know one thing for certain: The Fed won’t be cutting rates this time. And it’s recently used some fairly hawkish language.

But reinforcing the dovish outlook it adopted at the start of the year that precipitated three 2019 rate cuts, the Fed remains on high-alert mode.

There are two clear signs why…

First, the Fed keeps creating and dumping money into the front end of the U.S. yield curve through repo operations that it initiated in September.

How healthy is the banking sector overall?

The Board of Governors of the Federal Reserve System recently published their annual Supervision and Regulation Report.

The report measures the financial condition of major U.S. banks, including loan growth and liquidity in the banking system.

Overall, 45% of U.S. banks with more than $100 billion in assets received a supervisory rating of “less than satisfactory.”

That’s not good. As we learned during that crisis, the stability of these large banks is essential to the health of our banking system.

Tellingly, the Federal Reserve report does not say which banks have these less-than-satisfactory ratings.

This should not sit well with hardworking Americans who bailed out many banks during the last crisis in 2008.

When bank lobbyists keep pushing for more deregulation, remember what happened a decade ago with bank bailouts and a market crash.

I would argue that we need more regulation, not less, if banks continue to receive less than a “C” grade on their report cards.

The second indication the Fed is in high-alert mode is because of its language. It continues to note possible risks coming from more economic slowdowns and further strains due to trade wars.

Just this week, President Trump re-slapped steel and aluminum tariffs on Brazil and Argentina, accusing them of devaluing their currencies and thereby hurting U.S. farmers. Though that segue might seem complex and Brazil is supposed to be a friend of the U.S., the takeaway is simple.

The White House reserves the right and the practice of trade war tactics, which will continue to insert uncertainty and thereby hamper investment and economic planning around the world. Not to mention lower overall trade and benefits of the global supply chain.

Last year, when the Fed raised rates in December, the markets greeted the move with disdain. This caused the Fed to do a quick about-face in January.

We could see a similar story unfold next year. If we get a terrible December like we did in 2018 or at the end of 2015, the Fed might be more likely to consider cutting rates in the spring.

Meanwhile, other countries are continuing to cut their rates or otherwise finding ways to inject liquidity into their local markets. This remains particularly true of developing countries.

Regards,

Nomi Prins
for The Daily Reckoning

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Get Used to the “Powell Put”

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In the land of the Federal Reserve and its market-manipulating mechanisms, there’s now an unofficial market term called the “Powell Put” or the “Powell Pivot.”

It is in direct reference to Fed chairman Jerome Powell. Before he became chairman, Wall Street referred to prior heads’ policies with terms like the “Greenspan Put” the “Bernanke Put” and the “Yellen Put.”

In layman’s terms, what the term means is that if the markets fall by too much, the Fed will swoop in and try to save the day, the month, or the year. A “put” in options terminology is insurance against a drop in prices. Nowadays, the “Powell Put” is the market’s insurance that the Fed will act to stimulate the markets if necessary.

Markets had been waiting for it to materialize. But Powell had previously talked about the need to raise rates to give the Fed “enough ammunition to fight the next crisis.” The size of the Fed’s balance sheet would also have to be reduced enough to provide it enough room to grow if needed.

Markets began to worry the Powell Put might never materialize when he raised interest rates in December, when the market was in the middle of a severe correction (that nearly culminated in a bear market). He also said the balance sheet reductions, or quantitative tightening, would run on “autopilot.”

Markets tanked on his comments. But then on Jan. 4, after stocks fell nearly 20%, the “Powell Put” finally materialized.

In comments addressing the American Economic Association, Powell said he was “prepared to adjust policy quickly and flexibly.”

And about the balance sheet reduction policy that was on autopilot in November, he said

“We wouldn’t hesitate to change it.

Powell has subsequently emphasized the need for “patience.” The Dow has continued to rally behind his newfound dovishness. In fact, this January was the best January in 30 years. If the rally continues, the market could soon be testing its early October highs.

What this means is that the Fed isn’t going to raise rates anytime soon. As my colleague Jim Rickards has explained, “patience” isn’t just a word. It’s a signal to markets that the Fed will not be raising rates anytime soon, and that it will give them notice when it is.

The Fed is also unlikely to reduce the size of its balance sheet in a bold way, as long as economic headwinds from around the world continue. That in turn, means dark money will remain available to boost markets.

There are two main ways the Federal Reserve can unleash dark money into the financial system. One is by keeping interest rates (or the cost of money) low or at zero percent. The other is through quantitative easing (QE) or bond-purchasing, where the Fed creates money electronically and uses it to give to banks to buy Treasury or mortgage bonds from them.

Reducing the cost of money, or interest rates to zero, was done for the first time by the Fed in the wake of the financial crisis. The Fed did this supposedly as an emergency measure to inject money into the system because banks had stopped lending. In addition, QE was enacted because interest rate policy wasn’t effective enough. Again, supposedly, it was supposed to be an emergency measure.

But we saw how the stock market reacted when Powell said QT would run on autopilot. Now the Fed is ready to finalize plans that would leave the balance sheet at a much higher level than it previously envisioned. Again, that means additional support for markets.

In the latest development, as Brian Maher discussed in yesterday’s Daily Reckoning, Federal Reserve Bank of San Francisco President Mary Daly suggests that the Fed could decide to use its balance sheet as a routine part of how it guides the economy, not just as a last-ditch measure to deploy in emergencies.

That means what was once supposed to be an emergency measure could become just another regular policy tool if normal interest rate policy isn’t enough to stimulate a non-responsive economy. We’ll have to wait and see if this idea gains traction within the Fed. Either way, reducing the balance sheet to “normal” levels is no longer a priority for the Fed.

But it’s not just the Fed that is putting additional tightening on hold. Central banks around the globe have been re-calibrating their policies to reflect the weaker economic environment.

As one Wall Street Journal article recently reported, “Central bankers have geared their messages toward pausing on tightening steps rather than imminently launching new stimulus.”

Central banks from South Korea, Malaysia, Indonesia and Canada, who all raised rates last year, are now questioning such plans. The Bank of Japan and European Central Bank also indicated last week that their negative rates are here to stay for the foreseeable future.

The truth is it’s all about the $21 trillion of dark money fabricated by, and dispersed from, the world’s major central banks. The volatility periods, including last year’s nearly 20% correction, are related to the fear that dark money supplies will go away.

These factors will keep sparking intermittent fear and volatility this year — but dark money collusion will not be going anywhere. While there will be some minor rate hikes here and there, and mild tweaking of massive asset books, the overall story will remain the same. You should expect major central banks to end the year, on average, with asset books in total size right where they started.

Once again, that means dark money will continue to be available to markets.

The fact is, dark money is the #1 secret life force of today’s rigged financial markets. It drives whole markets up and down. It’s the reason for today’s financial bubbles.

On Wall Street, knowledge of and access to dark money means trillions of dollars per year flowing in and around global stock, bond and derivatives markets.

I learned this firsthand from my career on Wall Street. My first full year working on Wall Street was in 1987. I wasn’t talking about “dark money” or central bank collusion back then. I was just starting out.

Eventually, I would uncover how the dark money system works, how it has corrupted our financial system and encouraged greed to the point of crisis like in 2008. When I moved abroad to create and run the analytics department at Bear Stearns London as senior managing director, I got my first look at how dark money flows and its effects cross borders.

That dark money goes to the biggest private banks and financial institutions first. From there, it spreads out in seemingly infinite directions affecting different financial assets in different ways.

Yet these dark money flows stretch around the world according to a pattern of power, influence and, of course, wealth for select groups. To be a part of the dark money elite means to have control over many.

These is not built upon conspiracy theories. To the contrary, alliances make perfect sense and operate publicly. Even better, their exclusive dealings and the consequences that follow are foreseeable — but only if you understand how the system works and follow the dark money flows.

Dark money rules the world, and it could keep the bull market running longer than most people expect, even though the eventual turnaround could be ugly.

Regards,

Nomi Prins
for The Daily Reckoning

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The Fed Is Panicking

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This week I’ve been in Washington, D.C. for high level meetings focused on the economy. While meeting with senior officials and members of the House and Senate, it became clear that a troubling phenomenon is building.

Nomi at the Eccles Building in D.C.

Your correspondent at the Eccles Federal Reserve
Board Building in Washington D.C.

In the wake of recent stock market volatility and uncertainty surrounding monetary policy, it seems that political figures are starting to grow concerned.

There is growing consensus that the makings of a financial crisis of some sort is building — and could drop sooner rather than later. While there is speculation over whether it will be as big as the last one, and whether it will come in waves, the belief is that something is wrong.

With those fears, I turned the Federal Reserve itself. While meeting at the Fed, I was given the impression that bank regulators have been routinely chastised by Wall Street bankers. What I learned is that some of the biggest playmakers in finance don’t want to disclose the true nature of their positions and money-making schemes. This confirmed my own experiences as an former investment banker.

In addition, it became clearer that Fed Chairman, Jay Powell, and Vice Chairman, Randal Quarles, will be closely studying real economic and bank data when rendering decisions about the path of interest rates. Many have speculated about such dealings, and whether they will be swayed by President Trump’s pressure.

The truth is that the leaders at the Fed have a firmer understanding of what’s really going on in the economy than they allude to publicly. Even though the Fed has been able to avoid another financial crisis the last decade, with quantitative easing (QE) policy — or what I call dark money — their “toolkit” might not render us “safe enough.” They need to grapple with this reality.

Jerome Powell

Jerome Powell, left, and Randal Quarles.
AP Photo/Cliff Owen.

You see, the Fed manufacturers dark money that the markets have come to rely on. Through quantitative easing (QE) the central bank has accumulated a balance sheet that hit a high of $4.5 trillion of assets last year.

By having purchased these assets with electronically created money, the Fed was able to keep rates at the middle and longer end of the yield curve low, while they specifically set low rates for the short end of the yield curve, too.

Just to remind you, the yield curve is the difference between short- and long-term interest rates. Long-term rates are normally higher than short-term rates. When the two converge, it often means markets are anticipating low growth ahead. When the yield curve inverts, when long-term rates fall below short-term rates, it’s almost always a sign of looming recession, historically speaking.

Currently the Fed’s book of assets has been reduced by only a bit — to about $4.1 trillion — but it’s still historically large.

If the Fed continues to sell those assets (which consist of treasury and mortgage bonds) there is a risk that their value will drop too much, too quickly. If bond values drop, then rates will rise in the middle and longer end of the yield curve. This would make it more expensive for most companies to repay, or extend, their corporate debts.

The Fed knows it is currently in a catch-22. That’s why over the last two weeks, it has barely sold any of its assets as volatility in the markets picked up.

Here’s something else you might not know: Two weeks ago, it even quietly increased its book of assets. That’s the opposite of the policy of unwinding, or selling its assets through quantitative tightening (QT), which is what Chairman Powell promised he would be doing.

That’s another sign that the Fed is afraid of a possible new financial crisis. For more proof, consider that former Fed Chair, Janet Yellen, just did a 180 on her prior comments related to the possibility of another crisis. Last June, she said that she didn’t think there would be another financial crisis in her lifetime, attributing this to banking reforms made since the 2008 financial crisis.

Now, everything has changed. Earlier this week, she told the New York Times that, “Corporate indebtedness is now quite high and I think it’s a danger that if there’s something else that causes a downturn, that high levels of corporate leverage could prolong the downturn and lead to lots of bankruptcies in the non-financial corporate sector.”

She noted that CLOs could be a real problem, as I’ve been warning for months. CLOs, or collateralized loan obligations, are a Wall Street product stuffed with corporate loans. If that sounds familiar to you, there’s a reason. Wall Street is doing exactly what they did with mortgage loans before the 2008 financial crisis, but with corporate ones.

Her timing was not random. Just because she’s no longer running the Fed doesn’t mean she has no contact with its new leader, who was her number two. The people and connections within central banks and Wall Street are always in play.

The danger in her analysis is that she’s largely mistaken that “current holders of corporate debt do not appear to be levered to excess, mitigating risk of any credit ripple effects.” The data bears this out.

Companies are holding $9.1 trillion of debt now in contrast to the $4.9 trillion in 2007 before the last financial crisis. The financial system, and those who take money from banks, are more highly levered than they were prior to the last financial crisis.

In its inaugural Financial Stability Report, the Fed stressed lurking dangers in corporate debt. Although the Fed also used the opportunity to pat itself on the back for how well capitalized banks were, just as Janet Yellen did, the trouble was still highlighted.

The Fed noted that corporate debt relative to GDP is at record highs, and that credit standards have gotten worse again. The amount of junk bonds and leveraged loans or “risky debt” has risen by 5% in the third quarter of 2018 to over $2 trillion in size.

The central bank pointed to a number of other risks facing the markets. Those include the outcome of Brexit, Italy’s finances and a slowing European economy which could lead to more dollar appreciation. If the dollar were to continue to rise in value, it would make it harder for foreign companies that took out dollar-denominated debt to repay it.

The Fed also used the report to warn that trade wars, geopolitical tensions and slowdowns in China and other emerging market economies could negatively impact the U.S. economy and markets.

All of these factors could not only impact the markets, as we’ve seen over the past several weeks, but also begin to creep in on how companies are able to repay their debts.

Next week is the big Fed meeting. I don’t believe the Fed will raise rates this time, which would give markets a boost heading into the new year. If they do, the announcement will be accompanied with much more dovish language and guidance for 2019. Regardless, the problems aren’t going away and neither is volatility.

Regards,

Nomi Prins
for The Daily Reckoning

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