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This week’s FOMC Press Conference left me bewildered and confused.  The FED did its standard expected 10 billion dollar taper cutting monthly purchase to 35 billion.  The confusion came during the press conference.  Yellen stated that Fed “currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal“.  Are you kidding me?

First the Fed has a mandate and that mandate, when I last checked, was unemployment at 6.5% and inflation at 2%.  Well unemployment is at 6.3% and CPI, the tool used to measure inflation, is at 2.1%. So we should see Feds inflation target met by 1st quarter of 2015.  So why was Yellen so dovish?  Well it doesn’t add up.  The Fed continues to taper, hawkish, but sounds like a dove, jawboning.  Lets pull back the curtain and see what’s really happening.

We had a few new members on the voting committee this time around.  Let’s look at how the committee members look at the end of ZIRP taken from the Median Federal Funds Rate Estimate.



2014 0%
2015 1.25%
2016 2.50%
Long run 3.75%
*from the 16 members of the Federal Open Market Committee

There it is.  We see that the committee sees a 1.25% rate hike in 2015.  Nothing for 2014 in the cards.  Still bellow nominal levels but a start.  We could see this either in the 1st or 2nd quart, in my opinion.  April Fed meeting maybe the moment when ZIRP ends.

Now when will the asset bubbles that the Fed has created and continues to do so to this day pop?  I have made my prediction of a 21-2200 top in S&P.  It may go higher but doubt it.  What is my reasoning for thinking this?  First we cut through 1900 without much pull back.  Second the P/E ratios are still low.  I subscribe to a service that give me a more accurate P/E ratio adjusting for recession and interest rates.  It sets below 22 as I write this.  A lot more room to grow.  Lofty P/E ratios stood at 38 in the dot com bubble and at 25 just before the global financial crisis. So up and away.

Even after rates are raised we could see stocks continue up.  Remember people see a raise in interest rates as a sign that the economy is doing better.  So stocks could do another jump on that news as well.  This is why taper doesn’t weaken the drive up in stocks.  Its looked at as the economy is doing better.  We don’t need the Fed QE drug anymore. This is a hard pill to swallow because we know that this economy is built on a bubble and all bubble must pop.  So again when is it?

The answer to this question is guess work but here goes nothing.  The right answer is when “future potential benefits in the market is not worth the risks”.  When P/E ratios get 25 or higher.  When VIX starts heading to the upside.  The VIX, let’s look at it here.



We see that lows where established December of 2006.  From the bottom it took over a year before we saw the great crash in the fall of 2008.  We are now approaching those lows again and I believe we will hang around here for the next few months.  IE stocks should continue their gains. Volatility should pick up in 1st quarter of 2015 maybe because ZIRP will come to an end.  Maybe.  We like volatility.  It makes us $$$.  Heavens knows we haven’t seen it this year and volumes would defiantly increase on a hike in interest rates. So if we are to use history to gage our future, I would say stock prices should make a major shift and head south in the latter part of 2016.

Another chart I use to gage pull backs in S&P is the $BSPSPX.  We see that we are approaching the highs in this index.  Before the crash, we see that it held high for sometime before moving down, circled in pink.

noname (1)

Look for all time highs to be reached in this chart.

When we hit all the extremes, the reversal will be at hand.  Be patient.  This move will make many millionaires for those who are position for it and the wealth transfer will be huge.

On my last entry, I wrote about how the US is creating false GDP.  Basically by counting the government spending, debt, as growth.  Another way of putting it, is if I had a job(the economy) but wasn’t making enough to buy some clothes.  So I used a credit card(selling bonds) and I went out and bought clothes(fake GDP) and went into debt to do it.  I would then say the purchase of the clothes is growing the economy.   As we can see, it’s not really growing the economy because we are doing it with debt that needs to be paid back at some future point with interest.  In other words we are spending money we don’t have or that we think we will have sometime in the future. If we had an economy that was really growing, we wouldn’t have to go into debt each year to a tune of about 600 billion.

Now the Fed is tapering and we are reducing our debt spending in government.  All this happening at about the worst time.  This should have taken place in September of 2013 of last year when we had more growth. Second and third quarter GDP of this year will tell a lot.  The growth thus far has not been impressive.  See chart below.


Why am I harping on growth so much?  Well my argument has been that the US has never really escaped the deflation it felt in 2008.  There is still more to go before we can grow again.  QE and debt spending have both given us a false picture and hope.  The implementation of these vices have only created more money supply and expanded our debt to unheard of levels. At some point these instruments or tools won’t make a dent in growth.  Look at Japan. All these years of QE and still growth is nowhere but their debt is 240% of GDP.

We talked about foreigners buying our bonds.  This week the 30 year was in high demand as the bid-to-cover ratio rose to 2.69 from a 2.45 average.  This is the highest level in 16 months.  The 30 year since the auction has posted further gains and is up 30/32 in price and its yield has fallen further to 3.417%. Are investors moving back into safety? Do they see the deflation move on the horizon?

Having deflation take over at this point would be extremely dangerous to total credit market debt. Credit markets are an indication of the overall health of the economy.  These markets are much larger than the equity markets in dollar terms. The credit market shows us that companies are seeking to raise funds through debt issuance. Companies raise funds because they expect growth or are having growth.  Also if there is more demand from investors it will prompt companies and lenders to issue more bonds, and this will spill over into the equities market.

Below is a chart of Total Credit Market Debt.


Credit markets are an indication of the overall health of the economy.  These markets are much larger than the equity markets in dollar terms. The credit market shows us that companies are seeking to raise funds through debt issuance. Companies raise funds because they expect growth or are having growth.  Also if there is more demand from investors it will prompt companies and lenders to issue more bonds, and this will spill over into the equities market.

Below is a chart of Total Credit Market Debt.  You see the small dip that occurred during 2008.  We are beginning to flat line at the top and looking at this with a technical eye, that means a correction or a credit contraction. Another sign of deflation at our doorstep and another sign that dollars will evaporate as defaults increase, job layoff become more abundant and prices fall. Banks may be force to write down these loans in the billions. Their dollar liabilities may out way their dollar assets. Instead of rolling over this debt, cough China, they may buy dollars in the spot market to repay debt. When dollar evaporate, dollar strength increases.  Less of something, it becomes more valuable.

Another item we must look at is the unwinding of the carry trade.  If the idea of deflation is here to stay grabs hold of the markets, we could see an unwinding in the carry trade.  When financial markets become very volatile, modest day-by-day yield differentials captured by carry trades pale in comparison to possible daily losses. So investors at that point would reduce their exposure to risk. So currencies like the Kiwi and Aussie with lucrative yields would suffer the greatest losses.  Hence my NU, GN, EN prediction of being a Kiwi bear. On the other hand the funding currencies like the JPY, USD or CHF would appreciate.  I would add EUR to the list of funding currencies now with their last drop in rates.

What about countries that have accumulated dollar assets well beyond their dollar deposits?  They may be funding the deference in the interbank and other wholesale markets.  If they are doing this in currencies besides their own, it could cause an imbalance. If for example a bank in Great Britain invested in assets over in the US and the US didn’t invest equally in assets in Great Brittan, and there was a crisis where these banks had great exposure, the interbank market would dry up. They would rely on the swap lines but as they would swap pounds for dollars there would not be the same demand from US banks from dollars to pounds creating a shortage in dollars.  US bank expand their foreign claims more conservatively. This could also strengthen the dollar.

So our augment for dollar strength is this.  First, low to no real growth in GDP.  Second, a possible flight to safety by the purchase of long term bonds.  Third, the deleveraging of debt in the credit markets and banks exposure to debt. Fourth, the possibility of the unwinding of carry trades due to volatility.  Fifth, banks of other countries that have accumulated dollar assets beyond their dollar deposits.  We see these possibilities forming and will be vigilant in watching when these forces begin to take over creating dollar strength.


Let’s talk a little about the US economy since our dollar trade relies so much upon what is happening in the good old US of A.  First of all we need to examine where the US economy is and how it functions at this point in the financial game.  Below are some statistics.

  • US Total Market Value = $100 Trillion
    • $40 Trillion Bonds
    • $35 Trillion Real Estate ($27 Trillion Residential / $8 Trillion Commercial)
    • $25 Trillion Stocks
    • BTW – $100 to $200 Trillion US unfunded liabilities (net present value)…this is a discussion for another day.
  • $16.8 Trillion US economy, 2013 (gross domestic product)
    • $2.8 Trillion Federal tax revenue (taxes in)
    • $3.5 Trillion Federal budget (spending out)
      • -$680 Billion budget deficit (bridged by sale of Treasury debt spent now and counted as a portion of GDP)
    • = $550 Billion economic growth?!? (If that doesn’t look a little funny, look again).

FYR – Reminder; Million —> Billion (1,000 million) —> Trillion (1,000 billion)

Yes we are counting deficit spending as growth.  So Congress designates money to be spent but doesn’t supply the means to collect it.  So the Treasury issues debt to be spent now and paid back latter. Who buys part of this debt, the Federal Reserve which enables the US government to spend without having the revenues to pay for it.  All the US does right now is it pays the minimum interest only on a $17.5 trillion dollar debt which is about $221 billion annually. Our debt is growing a lot faster than our GDP.

  • ’00 —————>   ’07 ———–>   Mar ’14
  • $9.2 Trillion —–> $13.7 T ——-> $16.8 T (US Gross Domestic Product (GDP) = 80% increase)
  • $5.7 Trillion —–>   $9 T    ——-> $17.5 T (National debt = 305% increase )


Now the head scratcher.  I have been looking at the ten year yield.  It looked to be breaking out at the end of 2013 as Ben announced the taper.  See chart below.


The green circle is the breakout. As we can see since then we have dropped to a low of 2.43.  This has been troubling me for the last few months being that the Fed is tapering and that less money will be in the system.  Rates should be going up. Plus with less QE growth should weaken and we should see a less robust GDP number for the remainder of 2014 as our budget deficit shrinks to $500 billion by end 2014.  So why do yields continue to hold low?  Well there are three types of buyers of US debt.  The Fed, foreign buyers and domestic buyers. I would like to focus on the foreigners because they are buying a lot of US debt over the last few years.

  ————–> ’00 ————–>     ’07 ———–> Mar ’14

  TOTAL –> $375 Billion —-> $1 Trillion —–> $2.45 T (245% increase) -> Creditor Rank

  China —–> $60 Billion  —->  $400 B ——–> $1.27 Trillion —————————–>(#1)

  Japan —–> $315 Billion —>  $600 B ——–> $1.18 Trillion——————————>(#2) –


  —————->  ’00     ———->  ’07 —–> Mar ’14

  TOTAL —-> $210 Billion —-> $376 B -> $1.55 Trillion (400% increase) –> Creditor Rank

  Belgium —–>$28 Billion —-> $13 B —> $381 B ———————————–>(#3)

  “Caribbean banking centers”

  —————-> $35 Billion —-> $68 B —> $312 B ———————————–>(#4)

  UK ————> $50 Billion –> $100 B —> $176 B ———————————–>(#8)

  Switzerland -> $18 Billion—> $34 B —-> $176 B ———————————–>(#9)

  HK ————> $39 Billion —-> $52 B —-> $156 B ———————————->(#10)

  Luxembourg -> $5 Billion —-> $60 B —-> $145 B———————————->(#11)

  Ireland ——–> $5 Billion —–> $19 B —> $113 B ———————————->(#12)

  Singapore —> $30 Billion —-> $30 B —–> $91 B ———————————->(#14)


You hear that countries don’t want to hold US debt anymore.  Well according to these statistics that just isn’t so.  Why are foreigners wanting US debt when the Fed is tapering its purchases?  I mean where is the ROI in bonds?  I still haven’t found an answer to that question.  If anyone knows why, let me know. In any case this high demand from foreigners is what’s allowing the Fed to cut the QE program but still keep the rates low. Just a note here.  Who the heck would have thought Belgium would ever be the US’s third largest foreigner holder of debt? That’s whack.

OK I have a theory here of why foreigners are buying our bonds.  Wasn’t going to do this but need to take a stab at it. First we see that the two biggest buyers are China and Japan.  Both these countries have a vested interest in exporting their deflation, especially China now that its Chinese Copper Financing Deals (CCFD) is coming to an end which will cause a huge unwinding in the credit markets creating more downturns in the China economy.  More on that in a different post. A positive current account is the life blood of these countries and things aren’t looking to great as of late. This new regulation in China is going to create more havoc on it’s current account. So the idea is keep buying the US debt so the Government has plenty of money to spend and create higher GDP and encourage that spending from the US consumer to get the foreign  exports up and humming again.  Higher rates in the US would cap any hopes of that happening.  Foreigners as well as the Federal Reserve want to keep rates low which equals borrowing, thus creating spending, which equals needs for foreign goods from these countries. That’s my idea in a nut shell.   Will it work?  LOL!

As a global community we will continue to try and defeat the ugly head of deflation, but it’s not going to happen. Eventually we will grow to weary in the fight and it will consume us in the end. A debt adjustment will have to be made if we ever want to clean out all the old garbage that’s in the system. It’s a good thing and doesn’t have to be catastrophic if we loosen our tight grip on trying to control the economy.

In almost every developed nation I see underlying deflation and if the US economy gives into this ugly monster, all the other developed nations will certainly follow. Therefore keep rates low and hope for the best.  Looks dollar long to me.


As is well known our fund is based on two ideas.  Dollar strength due to US deflation or US growth and emerging markets risk off due to China slow down. This and following post will give updates as to where we see short term moves going to and why both on a fundamental and technical basis.

First up is Euro/Dollar.  Last week Mario Draghi cut rates by 10bps points to help the Euro Zone out of its deflationary state.  What are the short term impacts of the decision? We should see more flows going into the Euro as cheaper rates mean barrowing which would mean growth.  Well that may be true for the rich, but f0r those of the middle to lower class see no such hopes as their savings slowly get chiseled away.  Thus, the rich get richer and the poor get poorer. Expect a short term move up in the EU which means dollar weakness for now.  We are looking at this as a pull back to gain a possible position.  A move back to 1.38 would be excellent.  However, it is very hard to see the extent of stupidity and if 1.3850 was to be broken, a new high could be in the works.  See chart below.



We hope that this is not the case, but we are prepared if it turns out to be so.


Next our short term outlook for risk off in emerging markets.  We believe this will be due to a China slow down.  We are trading the New Zealand Kiwi short against the US Dollar and the Aussie short against the US dollar.  We expect a pullback in NZD/USD this week as we believe the RBNZ will continue to raise rates another 25bsp to 3.25%. One of the main reasons for these rate hikes is to curb a housing bubble from forming.  Construction growth due to rebuilding from earthquake damage plus flows from China coming into buy real-estate has been some of the main catalyst of growth.  However, we have recently seen weaker numbers in exporting and this gives cause to pause  and think why is the RBNZ encouraging a stronger Kiwi by raising rates? It touts that it wants a weaker currency, but does the opposite not only raising rates but continuing with each rise to jawbone how aggressive they will be in continuing to raise rates in the future.  China’s great desire to drink gallons of milk have now shifted to the US as it has become very expensive to purchase from New Zeeland. The US milk manufactures have supplied deep discounts to China taking away a good percentage of exports of milk from New Zeeland.  A move which New Zeeland can hardly afford. Our view for NZD/USD is that if we can reach a pull back of .8630 we could see an end of the year target of .8250. We would add to our current position at .8688. See below.


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