Hedge Fund Blogs From HedgeCo.Net


The following article proposes the fed take action to prevent a yield curve inversion that is imminent causing a massive recession. Can monetary policy manipulating the yield curve fool the market into avoiding an otherwise determined recession?


So in 2008 there was TARP to bail out banks (who followed government policy into the abyss) buying their bad mortgages forcing mergers to free the prime money markets for businesses to operate. QE ensued in 3 iterations. The immediate effect was lower long yields but that quickly dissipated.

The idea behind QE was to buy Long Treasuries to increase money supply with low rates to effect output and employment. It didn’t work. Enough said to that point. Now, the question becomes whether there will be an inversion of the yield curve and if so can QE prevent that?

No on the latter. On yield inversion, that means long rates are lower than short rates which foretells a recession. A recession is about lower output, i.e. GDP and employment which causes the effect of lower long rates.

So, first point is that if you are trying to treat the “effect” to forestall inversion using monetary policy – that is akin to removing the battery out of your smoke alarm to prevent a fire. Second point is that QE does nothing. That is because the market will quickly adjust long term rates viz. to GDP and employment expectations.

Short rates are more easily manipulated by the Fed and have an effect on pricing risk and borrowing. The Fed by keeping rates low (monetary policy) are attempting to spur borrowing and stimulate demand and employment. Most loans are Libor based and low Fed Funds rates theoretically induce banks to lend. Instead they have been just earning a net interest margin on investments.

The effect of the Fed’s intrusion using monetary policy to fix low GDP is like using a hammer when you need a screw driver. The Fed is now using a jack hammer of monetary policy that will never fix underlying fiscal and regulatory problems. Obama has used trillions and all he has gotten is 1% GDP. Participation rates are moving down toward 60% so the unemployment number is meaningless in jobs that pay less. Average pay has declined over $4000 since he’s been in office spending trillions on his economic policies while cutting military and other necessary programs. If there is any light in the U.S. it is that technology has increased productivity lowering costs increasing profits.

Last point, you don’t fix GDP growth with QE or manipulate the yield curve out of inversion to hide recession. Certainly there are grave ramifications for the Fed’s monetary policy subsidizing low rates that causes RISK to be mispriced. Stock market multiples are bloated because dividends are much higher than the 10y yield. Bonds are bloated because of overly tight spreads due to the mis-pricing of risk caused by monetary manipulation.

The real danger of using a monetary policy jackhammer that truly requires a screw driver of regulatory and fiscal reform is the mis-pricing of risk that causes pricing bubbles. Bubbles exploding are extremely dislocating and harmful whereas, the market-based pricing of risk is a self-correcting mechanism. I believe that we are about to face rising interest rates causing a deep recession. While treasury rates are low, Libor has doubled over a short period. Some of this is due to forcing money out of the prime money markets into treasuries due to regulation. The costs of extreme monetary policy and government policies will result in a sea of debt with only the choice of doubling the debt in fiscal policy to revive us. The United States Dollar can survive only for as long as it remains the medium of commodity exchange. In that case, the Fed is like the the priesthood of the second Jerusalem temple requiring exchange into temple coinage for service. The eventuality of the USD is what Paul Volcker characterized as a unified currency with my added nuance that it can be used on side of local currency in a cryptocurrency. Think of the markets that can be created and the leverage for peace!

Pj de Marigny
DITMo Analytics

This entry was posted in Hedge Fund Commentary, op ed and tagged , , , , , , , , , , , . Bookmark the permalink.

Comments are closed.