The World After "FoGu"

“Nothing of significance will happen at the Fed meeting that starts today,” says our Jim Rickards. The Fed has already committed to leave rates alone until at least mid-June.

There, that was easy. Now your eyes can skip over every Fed headline you encounter today and tomorrow. You’re welcome.

On the other hand, the last Federal Reserve meeting that took place six weeks ago “is highly significant for understanding the future path of Fed policy and its impact on markets,” Jim tells us.

And the elite media, as usual, have been clueless. Today’s as good a day as any to dive in.

But first, the word from a little closer to home, since you’ve likely seen pictures of Baltimore burning: Everyone at Agora Financial is safe.

Indeed, none of Agora Inc.’s buildings in the Mount Vernon neighborhood was touched last night. Alas, the favored lunchtime hangout of our executive publisher Addison Wiggin wasn’t so lucky…

As if the management here somehow bears responsibility for a young man’s death in police custody.

Your editor is severely sleep-deprived. I left the office around 3:45 yesterday afternoon. From 4:00 until after midnight, my wife and I holed up, monitoring scanner traffic, Reddit and TV (listed in descending order of timeliness and reliability). Sleep has been brief and shallow.

Our only close call came around 5:00 p.m. Someone driving home from work opened the automatic door to the parking garage across the alley from us. It was just enough time for four or five troublemakers to dart in and steal a scooter.

They spent what felt like forever, maybe four feet from our window, trying to figure out what the hell to do with it. In the end, they abandoned it and moved on. Someone else, alone, came along a few minutes later and walked it away.

The rest you’ve probably heard about. The National Guard is rolling in. A 10:00 p.m. curfew kicks in tonight. The mayor looks as if she’s on ‘ludes.

Today’s episode of The 5 comes to you from the home office. It’s a nice spring day, but the windows are closed. We’ve pulled the cat carriers out of the closet and we have a full tank of gas. Just in case.

Now back to our regularly scheduled programming… “On Wednesday, March 18, the Federal Open Market Committee of the Federal Reserve formally ended its long-standing practice of forward guidance,” says Jim.

There’s that ugly buzzword again. Recall the definition of “forward guidance” from the Essentialist’s Glossary at The Daily Reckoning…

For a while, we used our own shorthand of “FoGu” — in part because it sorta rhymes with the Fed’s attitude toward savers.

And make no mistake — FoGu was all about helping the big banks shore up their balance sheets at your expense.

Fair warning: Jim is taking us into some tall weeds here. But it helps to understand the mechanism by which you’ve been screwed the last six years.

“The impact of forward guidance has to do with how markets price longer-term Treasury securities,” he says. “The basic idea is that a long-term note is priced using today’s expectations about the future path of short-term rates.”

The key players here are the so-called “primary dealers” — the 20 or so firms that bid at every Treasury auction, including all the too-big-to-fails.

“The primary dealers must stand ready to buy or sell Treasury securities at the request of their customers,” Jim explains. “To do this, they carry inventories of Treasury notes. These inventories are financed on a short-term basis, sometimes overnight, using repurchase agreements — the so-called ‘repo market.’

“The repo market rate is close to the fed funds rate; both are near zero. Ten-year Treasury notes have traded with a yield-to-maturity of about 2-3% for the past several years. A dealer who buys 10-year notes and finances them in the repo market can make spreads of over 2% with almost no credit risk. If this trade is leveraged 10:1, the return on dealer equity can be 20% or more.

“It sounds almost too good to be true, but there’s a catch,” Jim goes on.

“The dealer is financing a 10-year asset with overnight funds. If the repo rate rose sharply, the dealer could find that its profitable spread disappears. In a worst case, the spread could go negative and the dealer might have to dump the 10-year note at a loss.

“Facilitating this profitable spread trade was the hidden purpose behind forward guidance. The Fed took the risk out of the trade by guaranteeing that overnight rates would not go up. In effect, the Fed was saying to dealers, ‘Go ahead, use leverage and take maturity risk. We’ve got your back.’
“This was a way to allow banks to make excess profits to restore the capital they lost in the 2008 crash. As long as the Fed offered protective forward guidance, the dealers could safely do this spread trade knowing that repo rates would not go up. Keeping rates low hurt the everyday saver, but the Fed did not care. The Fed’s job was to help the big bank dealers, not everyday Americans.”
[Ed. note: Looking for a way to “make the Fed pay” for its sins? Click here.]

The entire history of FoGu was one of making it up as the Fed went along.

When the Fed slammed the fed funds rate down to near zero in December 2008, we were told it would remain there “for a considerable time.” Then the Fed began setting target dates for when the rate would rise. Then it switched to a target unemployment number. Then it switched to a time frame based on the end of QE3. And when QE3 ended last fall, the Fed said it would remain “patient”… until it dropped the word “patient” six weeks ago.

“Federal Reserve officials have told me privately that they have no idea what they are doing,” Jim reminds us — “something they never say publicly.”

In lieu of FoGu, we now have a new buzzword — “data dependent.” The Fed relies on the squishy unemployment, inflation and GDP numbers to make policy and issue forecasts.

“The problem with Fed forecasts,” says Jim, “is that no major institution has a worse forecasting record.”

As evidence, it’s time to revisit one of Jim’s favorite charts. “The black line with dashes shows actual GDP growth 2009-2014,” he explains. “The colored lines represent Fed forecasts given at various times over the past five years as indicated. They are situated along the part of the timeline to which the forecast relates:

“Given this dismal track record, we should expect that future Fed forecasts will be wrong also and that actual growth will be weaker than expectations.

“Meanwhile, the economy is showing weakness consistent with the late stages of an expansion and the early stages of a new recession. This leads to two possible outcomes.

  • “Scenario A is that the Fed sees the weak economic signals before they raise rates. In that case, they will not raise rates in 2015 and may even go back to QE in early 2016. Stock markets might maintain momentum and even reach slightly higher levels as continued ease offsets the drag from deflation and weak growth
  • “Scenario B is that the Fed overestimates growth based on their flawed models and relies on the employment data while ignoring other danger signs. In that case, they might raise interest rates in September or December of this year. Stock markets around the world could crash as liquidity dries up. Emerging markets would suffer the most because of a stronger U.S. dollar combined with a global dollar shortage. But U.S. markets would not be immune from this misguided and premature tightening.

“I find Scenario A the most likely path, but Scenario B cannot be ruled out,” Jim ventures. “The key for investors is to identify asset classes that can perform well in both states. The best protection comes from 10-year Treasury notes.” Jim says they’ll continue to perform well under Scenario A… and even better under Scenario B as Treasuries rally on fears of a slowdown.

[Time-sensitive announcement: 10-year T-notes will protect you as the Fed figures out its next move in the global currency wars. But there’s also huge upside potential to the currency wars… and you can unlock it with Jim’s IMPACT system.

“This proprietary strategy uses the very same secrets I helped develop for the CIA to predict terrorist attacks,” Jim says. “Based on 20 years of back-tested winning trades, IMPACT is the only way we’ve ever found that could have allowed you to profit an extraordinary 1,246% (or more) from currency wars…

“Keep in mind that my IMPACT system is not forex trading — and it has nothing to do with the stock market. This is a brand-new way to make money.”

But time to seize on it is now — before the Fed settles on its next move. Jim shows you how IMPACT works when you follow this link.]

The major U.S. stock indexes are drifting upward as we write, making up for yesterday’s losses. The S&P 500 is up about three points, to 2,112.

Gold is holding onto most of its gains from yesterday, the bid at last check $1,212.

Crude popped for a while this morning on word Iran’s Revolutionary Guard intercepted a cargo ship in the Strait of Hormuz. But with reliable information scarce, a barrel of West Texas Intermediate is now down a tad from 24 hours ago, at $57.11.

In earnings-land, Ford swung and missed. But two of the biggest Big Pharma players, Merck and Pfizer, both beat expectations.

That said…

“I think we may have seen a major shift in biotech yesterday,” advises our science-and-wealth maven Stephen Petranek. “The shift could be short term or long term, but it likely is significant.”
Biotech is what’s powered the Breakthrough Technology Alert portfolio since Stephen joined our team 18 months ago. A quarter of his picks have doubled or quadrupled. Only a handful are in the red, and not by much. With one exception.

Celladon Corp. got clobbered yesterday. A Phase 2/3 study of its heart-failure therapy disappointed. “Few details have been released,” says Stephen, “and the company, clearly as shocked as investors, said it was preparing to analyze the data, but that will take months.

“This result has so rocked biotech investors that it apparently had an effect on hundreds and hundreds of stocks yesterday.”

Stephen is confident his picks will ride out the turbulence, since his readers bought in so early.
“Nonetheless, we may see a shift of capital away from biotech,” he cautions.
“Many fund managers who really don’t understand biotech have jumped on the momentum bandwagon in recent months, pushing prices up. Now they will be scared and move on to cloud computing or cybersecurity or whatever they perceive the next new thing to be. If that happens, biotech stocks will go down as a sector.

“But… eventually, smart heads will prevail. If there is a biotech bubble of sorts, it’s primarily in the stocks that have weak pipelines or tricky drugs in trials.” Not so for the companies Stephen is following. Including one unusual play described here.

This is the part of The 5 where we try to bring you something quirky. But we’re tired and distracted, and the best we can do today is regurgitate some of the amusing user-contributed headlines from the business section at…

  • Volkswagen Chairman Gets Das Boot
  • Cheetos-Flavored Popcorn Is Becoming the Most Popular Snack at Movie Theaters, Now Offered Only at Locations Which Have Completely Orange Seats
  • Huge Fire Guts Recycling Plant, Filling Area With Secondhand Smoke.

“Another water venture you may or may not be aware of,” writes a reader after our Bush-family water expose on Friday, “is the Ted Turner purchase of north central Nebraska ranch land used to raise buffalo.

“While this makes a nice story to showcase his environmental views, don’t forget that this ranch land sits on top of the Ogallala Aquifer. It also sits in an area not depleted by irrigation or other uses.

“There has already been talk of moving water by rail to water-deficient areas of the country. This water basin, only several feet under the surface, is already very close the Burlington railroad that hauls coal from Wyoming and also has immediate access to the West Coast and central U.S., and is close to Bailey Yard, the largest Union Pacific rail yard and the largest in the world.

“I don’t think it is ‘conspiracy theory’ to think that Ted Turner would like to control what some people believe to be ‘the last reliable source of drinking water’ that we may have left to use.”

The 5: And to be hauled by Warren Buffett’s railroad? Cue Kent Brockman: “I for one welcome our new aquatic overlords.”

“Reading this brought a rush of Yogi Berra’s ‘deja vu all over again’ quote,” writes a reader reacting to yesterday’s riot/prepper episode of The 5.
“I managed a brokerage office in Newark, New Jersey, during the race riots there. Gunshots were audible, and my commuter train did not stop at several stations, as the cars were pelted with rocks and bottles.

“Next day, I called my boss in New York and three months later had transferred to Fort Lauderdale. History does tend to repeat itself.”

The 5: Hmmm… We did add a small office in Delray Beach in 2013.

As irony would have it, the best Internet aggregator of everything going on here in Baltimore is a guy on Reddit… who lives in Florida.

Best regards,
Dave Gonigam
The 5 Min. Forecast

Dave Gonigam

Dave Gonigam

Dave Gonigam has been managing editor of The 5 Min. Forecast since September 2010. Before joining the research and writing team at Agora Financial in 2007, he worked for 20 years as an Emmy award-winning television news producer.

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