A Hiccup… or a Meltdown?

  • Mainstream picks up on a warning The 5 conveyed two weeks ago. Are you ready?
  • How the Fed will make the next “flash crash” even scarier
  • Consumer comeback? Uhhh…
  • The $3.5 billion bailout we’ll all pay for
  • Millennial luck: Even if you get a job, you can’t get a house
  • “The cost of frugality” and other amusing takes on “myCPI”

  From Jim Rickards’ lips to the Financial Times’ ears: The salmon-colored rag is fretting over the bond market.
Two weeks ago today in The 5, Jim shared a hair-raising and confidential dinner conversation he had with an “insider’s insider” in the bond market.
Jim began by describing what he saw as an alarming lack of liquidity in U.S. Treasuries.
The insider’s reply? “Jim, it’s worse than you know… Liquidity in many issues is almost nonexistent. We used to be able to move $50 million for a customer in a matter of minutes. Now it can take us days or weeks, depending on the type of securities involved.”
As a reminder, that lack of liquidity can result in something like the “flash crash” in 10-year Treasury rates on Oct. 15 last year — a sudden and massive swing…

  The Treasury market is “definitely not functioning as normal,” affirms Jack Flaherty to the Financial Times. Mr. Flaherty is a bond fund manager at GAM.
More from the FT: “While the 10-year Treasury yield has risen from below 1.9% in mid-April to a peak of almost 2.5% this week, traders say the increase has been driven by lower amounts of trading than the steepness of the climb would suggest.”
Deutsche Bank maintains a gauge of liquidity in the Treasury market. It’s down 70% from its peak in 2006-07.
Blame on the Federal Reserve and “quantitative easing.” The Fed has bought so many Treasuries since 2009… and other central banks have also snapped up Treasuries to build currency reserves… that fewer Treasuries are available for day-to-day trading.
The FT article goes on to describe a domino effect, not unlike the one Jim’s insider friend laid out two weeks ago: “The holdings of the Fed and big overseas investors also have a knock-on effect on the ‘repo market,’ which greases the global financial system by allowing investors to trade safe collateral — such as Treasuries — for short-term funding. Stricter regulation has gummed up the repo market, and in turn weighed on the liquidity of the underlying securities.”
  None of the foregoing alters Jim’s call that Treasuries are set for a major rally.

Recall Treasury prices move inversely to yields. So in recent weeks, prices have gotten whacked hard as yields have risen.
But Jim says that’s a fleeting thing: “The ‘May Massacre’ in bond prices should be seen as a technical cascade triggered by a Bill Gross blog, which resulted in position squaring by hedge funds with leveraged long Treasury positions in an overcrowded trade. The stop loss algos kicked in, and the cascade fed on itself.
“Nothing fundamentally changed in May. The secular downtrend in rates, which has persisted since 1981 and accelerated since 2007, is still intact. The end of QE3, combined with tough talk from the Fed, will weaken the economy further and result in lower inflation expectations and reduced yields in the months ahead.”
  But expect volatility along the way: That gets us back to the liquidity issue.
“Illiquidity can cause markets to ‘crash’ up or down,” Jim reminds us. “Recall that the bond ‘flash crash’ of October 2014 was a crash in yields, which resulted in a super-spike in prices. It caused instantaneous monster gains for longs (and crushing losses for shorts).”
If history repeats, Jim’s long-standing Treasury recommendation — the Wasatch-Hoisington U.S. Treasury Fund (WHOSX) should soar in value.
[Ed. note: The clock’s almost run out on access to Jim’s IMPACT system. That’s short for “international monetary policy and currency trading.” It’s a proprietary strategy that aims to squeeze out big short-term profits from the volatile moves that central bankers make inevitable.
As we said when we first brought IMPACT to your attention back in April, it’s the ultimate way to “make the Fed pay.”
The charter-subscriber discount comes off the table at midnight tonight. After that, access to IMPACT won’t be available for a while at any price. Here’s where to act.]
  The major U.S. stock indexes are adding to their big gains from yesterday: At last check, the S&P 500 was up a quarter-percent, at 2,110.
Treasury rates are backing off their eight-month highs reached yesterday. As we write, the 10-year yield is back to 2.44%.
The greenback is rallying, the dollar index back above 95. That’s knocked gold back to $1,178 and crude to $60.41.
  The big economic number of the morning is retail sales… which for once doesn’t suck.
The Commerce Department says the figure notched a 1.2% increase from April to May. Even if you back out auto sales (which are volatile) and gasoline sales (which rose because gas prices are higher), the growth is still 0.7%.
Not surprisingly, the number has set off a lot of mainstream chatter about the mighty American consumer finally coming out of his wintertime hibernation.

Here at The 5, we will withhold our applause until we see the trend hold for another month or two. And nothing about either this number or first-time unemployment claims — still near 15-year lows — alters Jim Rickards’ outlook: The Federal Reserve’s hands are tied, and it won’t raise the fed funds rate in 2015.
  Since when are U.S. taxpayers put on the hook for others’ acts of fraud? Well, outside the banking sector, that is?
The question crosses our mind this week with a White House announcement that students who took out federal loans to attend Corinthian College will have their debt forgiven. Corinthian was a for-profit chain that collapsed in bankruptcy this spring. Last year, the feds accused it of lying about how many of its graduates were landing jobs.
But Corinthian execs won’t eat the cost of those forgiven loans. You and I will — to the tune of $3.5 billion.
“This is one more reason it was a bad idea to make the U.S. Department of Education the banker for students as well as the regulator of their colleges,” rightly complains Sen. Lamar Alexander (R-TN). “If your car is a lemon, you don’t sue the bank that made the auto loan; you sue the car company.”
  “I can imagine this becoming a feeding frenzy for lawyers on the scale of asbestos,” ventures our Dan Amoss, who heads up Jim Rickards’ research team.
“The legal lobby teams up with progressive politicians (seeking millennial votes) to pillage the so-called student loan ‘assets’ sitting on the Department of Education’s balance sheet.
“As I’ve long predicted, there will eventually be a multihundred-billion-dollar bailout, which must be appropriated by Congress, to replenish the hole that will develop in the loan portfolio sitting on the Department of Education’s balance sheet.
“Circling back to one of Jim’s themes… Student loans, once they’re forgiven, amount to ‘helicopter money’ that’s been sprinkled on youngsters steadily since 2009. All that cash has been borrowed, spent and then not destroyed by debt repayment — that’s a way to get QE more widely distributed!”
  Heh… And the millennials still can’t afford a home in the few places they can find jobs.

Bloomberg crunched some numbers this week to see how affordable housing is for young adults in the 50 biggest metro areas.
In 13 of them, homes are out of reach. That is, salaries fall well short of what’s needed to buy a home, at least according to Bloomberg’s standards.
And those 13 metro areas happen to be the most prosperous ones, where the young and educated stand a chance of finding work — the high-tech centers of Silicon Valley and Boston, the financial center of New York, the government center of Washington. (We’re not sure what’s up with LA and San Diego…)

Even Bloomberg concedes its “affordability” standards are optimistic. It assumes millennials can save up a 20% down payment.
Good luck with that when families whose head of household is under 35 have a median net worth of $10,400.
  “This was so superficial it was comical,” a reader writes as we sift through more responses from people who calculated their alleged personal inflation rate at the Atlanta Fed’s myCPI website. “But should we expect anything else from a government entity?
“They stated mine at 1.2%, which is nowhere close to reality. Even adding one additional category, kids in college, would change the numbers significantly (we have five in grad school or college).
“As you well know, the dramatic inflation of college tuition will change those numbers for most. Of course, there is no reason to consider the real world when fabricating government numbers!”
  “According to their calculations,” writes another, “myCPI is 0.954%. Sure, it is.
“I have an appointment with the local appraisal district tomorrow, because they’ve raised our home’s value 17% in the last two years, while the tax rate has remained constant. Based on the current assessment, our property taxes will go up 7% this year.
“My cable/phone/Internet service went up 10% this year. Most of that is Internet cost, and since I work at home, it isn’t optional.
“I could cite more examples. Let’s just say that I think my real CPI is probably around 6 -7%.”
  “My CPI came in at 1.25%,” writes a third. “That number is not even close. Our meat prices have climbed quite high over the last year, and our egg prices are going to up because of the bird flu that wiped out millions of chickens here in Iowa.
“These guys at these Fed banks haven’t a clue about the real world. The numbers are fixed, and anybody with a lick of common sense knows this just by everyday life.”
  “Wow,” writes a fourth. “0.97%! I’m rich!!

“We’re pretty frugal here, and the cost of frugality has been going up faster than that. But without doing a detailed analysis, I’d have to guess our costs are within 5% of what they were a year ago.
“What’s most humorous on the Atlanta FRB result page is the graph of myCPI change over the years. The cost of money goes up and down, and my cost of living is supposed to follow its trajectory. Something wrong with that assumption — do they really expect me to refinance or buy a new house every year?”
The 5: Yes, it’s your patriotic duty.
  “They didn’t even ask me where I live, for crying out loud!” notes a fifth. “How accurate could this be?
“I’m engaged to be married, with no kids, in their lowest age bracket, in their highest income bracket, own my home (not outright yet) and have greater than a college degree.
“Using this info, the Atlanta Fed believes that my April 2015 one-month annualized CPI rose 0.45% and that my 12-month CPI has fallen 0.52%.
“Anecdotally, my rough budget spreadsheet tells me that my total monthly expenses have risen 3.9%, while my take-home pay has risen 6% (managed to get ahead!) since June 2014.
“Add me to your aggregate results!”
  “The calculator showed my results as being 0.954% annual,” writes our final correspondent. “Doesn’t seem to match my experience.
“Utilities, primarily electricity and ‘city services’ (water, sewer, trash removal), have increased over 10% during the past year. Food seems relatively stable over the past year, but there were large increases in the year prior. And let’s not forget the increase in our health insurance premium (even if the employer picks up a large portion).”
The 5: Yeah, but remember: Every extra dollar your employer pays for health insurance is a dollar that doesn’t go into your paycheck.
We’re pretty sure myCPI doesn’t account for that either.
Best regards,
Dave Gonigam
The 5 Min. Forecast
P.S. This is it — your last chance to put the IMPACT system to work in your portfolio. As of midnight tonight, our charter subscriber discount expires and Jim Rickards’ invitation will be pulled offline. It’s now or never.

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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