It’s there, literally in black and white, Jerome Powell, who has just stepped into the undistinguished and justifiably widely disrespected shoes of Yellen, Bernanke and Greenspan at the Chair of the US Federal Reserve clearly and specifically acknowledges Fed policy will create “big losses”.
In light of our current situation, that was originally precipitated by rising bond yields and talk, if little action, of rolling back into the market all those QE purchases the following insights into Powell’s thinking are, I think rather important. As you will see this is a man who understands markets, in a way not shown by anyone since possibly Volcker in the 1980’s. This also begs a question of how he will respond if markets continue to deteriorate……wade in, or let nature take its course, at least for a little while.
To be fair to the man (and at this point we’d like to be) “big losses” is part of a larger quote. Indeed it is from his testimony to the October 2012 Fed Market Committee meeting where they discussed how QE3 should be implemented and I think it is worth providing the full paragraph for context (emphasis added):
“I think we are at a point of actually encouraging risk taking and that should give us pause. Investors really do understand now that we will be there to prevent serious losses. It is not that it is easy for them to make money but they have every incentive to take more risk, and they are doing so. Meanwhile, we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates go up down the road. You can almost say that is our strategy”.
(Page 193, Meeting of the Federal Open Market Committee on October 23rd-24th 2012)
There you have it.
Fed Policy: Encourage risk taking by manipulating markets…..knowingly blowing up risk bubbles….acknowledge they will be eventually burst by your own policy….and accept, by logical extension, that is in effect your strategy.
Brilliant. Absobloodylutely Fan’kingtastic.
Interestingly, in light of current events two paragraphs later he discusses how the Fed’s book of bonds accumulated through QE might eventually be unloaded:
“It’s about $1.2 Trillion in sales; you take 60 months, you get about $20 billion a month. That’s a very doable thing, it sounds like, in a market where the norm by the middle of next year is $80bn a month. Another way to look at it, though, is that it’s not so much the sale, the duration; its also unloading our short volatility position. When you turn and say to the market “I’ve got $1.2 trillion of these things, it’s not just $20 billion a month – it’s the site of the whole thing coming.And I think there is a pretty good chance you could have a quite dynamic response in the market.”
Now some did wonder if this meant the Fed was explicitly shorting the VIX to keep markets stable, although this looks very unlikely (a bit more below) however it does show a very sophisticated understanding of what the second/third order impact of the Feds actions is (supporting risk assets through QE, which naturally feeds through into a suppressed VIX – and the options that it is theoretically priced off – creating an implicit short volatility position, which then encourages investors to take an explicit short position…and so on).
If this is the case then at least we now have a Fed chair who gets how markets work better than most on Wall Street, a contrast to Janet Yellen, whose testimony in the same minutes reflects her academic devotion to numbers with little signs of humanity, or market knowledge, on display.
Finally moving back to Powell’s point on being Short the VIX it is interesting to see how this entire complex erupted into view during the summer of 2012, just months before this meeting, in a way never seen before:
Source: The Felder Report Click/Tap to Enlarge
This is the smoking gun that could point towards the Fed having an interest in the Short VIX complex, however it is also worth noting that July 2012 saw Draghi’s famous (and extemporaneously panicky) “Whatever it takes” comments so it could simply be the Hedge fund community deciding all Central Banks are on board so let’s pile in.
Interestingly the OMT (Open Market Transactions) that was set up hurridly by the ECB to copy QE never officially occurred, being superseded by actual QE before ever being officially put into practice. However in several places in the Fed’s minutes they do talk about ECB bond buying as if it was really taking place at the time.
Maybe they thought it occurred, when it never did, maybe they just meant future, or implied bond buying…or just maybe the ECB fibs.
Either way we have to say – Fed Minutes: Not as boring as you might think!