Gary Tanashian | Jul 08, 2013 08:54AM ET
Mail from a friend: “I think your taper-to-carry idea has legs, but I’d really appreciate it if you went over the basic theory and how you see the dots connecting, if you decide there’s space and time in this weekend’s edition at least. What I’d really want is a simple road map, the logical chain if you will. Nothing fancy, just the way it may (repeat may) play out and what its consequences might be.”
When this request came in I had already been thinking about trying to put this all together in a logical sequence since ‘T2C’ was graduated to an actual plan from a thesis last week.
The idea was first introduced in NFTRH 241 on June 2, which was the week that the BKX-SPX ratio broke out to the upside and long-term Treasury bond yields broke up from bottoming patterns. In the ensuing 5 weeks the macro fundamentals and technicals have only become firmer in support of T2C.
At its most basic level, I think that a potential carry trade by the banking sector using the Fed’s Zero Interest Rate Policy (ZIRP) on the shortest end (Fed Funds) and a rebelling T bond market throughout the rest of the curve – where banks do their lending – represents a logical extension of the ZIRP and QE (money creation) that have been promoted thus far. Think of ZIRP/QE as the thrust and a yield ‘carry’ by the banks as an afterburner, which finally incentivizes the banks to get the money ‘out there’ into the public’s hands.
This would theoretically relieve the velocity of money problem that has plagued the economy since the great bull market in stocks and an era of ‘real’ (i.e. not inflation-fueled) economic growth ended in the run up to the recession of 2001.
The chart above shows a compelling picture of the ‘Banks to S&P 500’ ratio in positive correlation with the yield on the 10 year T bond. The moment I saw the TNX (and TYX) begin to break above the neckline and then saw the BKX-SPX ratio make a breakout of its own, NFTRH was on alert – new buzz phrase and all – for ‘Taper to Carry’ (T2C).
If there is to be a measure of success with T2C, the implication is that inflationary issues would follow. That is the traditional message of rising Treasury yields after all. A long-term chart of the BKX-SPX ratio reveals that the initial thrust of Greenspan’s Age of Inflation onDemand in 2000-2003 saw the banks strongly leading. *
As we know, the banks led the stock market into the crash of 2008 and the rest – ZIRP and all sorts of other ‘hands on’ policy making – are not only history, but current fact. FrankenMarket lives on.
We can eventually expect either inflated chickens coming home to roost with rising prices or the salad turning back into excrement as the operation fails like the Greenspan era version did last decade when it resolved into an epic financial market liquidation. In other words, a bond carry trade (born of interest rate manipulation) could ultimately create more economic distortions, despite short-term benefits. T2C Bullet Points:
But here the analysis hits a holding pattern because I am not a Swami and I do not make predictions. What we will do is watch the banks closely in nominal terms as well as in ratio to the S&P 500.
If the operation is to succeed, the banks would one day be looked back upon as inflation’s delivery mechanism if the velocity graph above takes one of its little interim upward hooks within its secular downtrend. This one graph is however, the ultimate picture of the case for deflationary resolution to the ongoing age of Inflation onDemand, which is inflation promoted against ongoing deflationary pressure.
This segment started out with the intention of being simple, “nothing fancy” per request. But as often happens it got wordy, a little complicated and that is just how we’ll have to roll. I do not seem to have the ability to boil complex things down to easy to digest nuggets. It’s chicken salad after all, not Chicken McNuggets. We continue to refine and clarify the message as events unfold.
* In reviewing the BKX-SPX ratio, I thought of something that looked very similar; namely the HUI-Gold ratio. We’ll introduce a correlation between these two on page 18.
NFTRH 246 then went on to cover stock markets, commodities, precious metals, currencies and finally wrapped up with more macro work.
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