Saturday, December 27, 2014

The Fed and Interest Rates Are Just Political Theater

Last week was a wash.

It was, after all, a holiday week. Most traders on Wall Street had left their trading desks well before Wednesday. Volume was light allowing those traders who were still manning the helm will have a free-for-all pushing the market this way and that.

So trying to make sense of this week is a pointless exercise. We are much better off concerning ourselves with the big picture.

The Big Picture is that the Fed has stopped its QE programs. As a result, investor attention has shifted to when the Fed will begin raising interest rates. Will the first rate hike come in mid-2015? Earlier? Later?

In reality, most of this is political theater. We have not had a Hawkish Fed in well over 20 years (possibly 30). As far as Greenspan, Bernanke, and Yellen have been concerned, the answer to any and all problems in the financial system has been to keep interest rates too low, print money, and buy assets from Wall Street (a kind of “cash for securities trash”)

Why does this matter? Because the last 20 years has shown us that the Fed immediately cuts rates and turns on the printing press at the first sign of trouble. Given the fragile state of the global economy and financial markets, the likelihood of the Fed raising rates in a significant or unexpected way is next to none.

Indeed, Ben Bernanke told a group of hedge fund insiders that rates will likely not be normalized in his lifetime (he’s currently 61, so he’s talking 20-30 years).

Again, all of this is political theater. The big story for the markets is not interest rates. It is the US Dollar. For over 40 years, the world has been borrowing US Dollars to finance real estate development, infrastructure projects,  mergers and acquisitions, Research and Development projects, and the more. Today, globally, corporates and investors have borrowed over $9 TRILLION in US Dollars to finance other investments.

To put this number into perspective, it is equal to the economies of Japan and Germany combined (they are the third and fourth largest economies in the world by the way).

Why does this matter?

Because when you borrow in US Dollars to invest elsewhere, you are effectively shorting the US Dollar. If the US Dollar begins to rally (strengthen) you can blow up very VERY quickly.

Take a look at this chart.

This is the single largest chart pattern in financial history. It is a gigantic falling wedge pattern spanning over 40 years. When it breaks out to the upside, we’re potentially facing a 5+ years US Dollar bull market that will see the US Dollar rising to 120 if not 130.

And we just began to break it this year.

The world is awash in debt, most of it borrowed in US Dollars. When the Great Deleveraging truly begins, the US Dollar will rise rapidly as investors are forced to either pay their debts back (shrinking the amount of Dollars in the financial system) or default (ditto).

This would fuel a massive collapse in inflated asset prices around the globe. Anything and everything that was financed by cheap Dollars would collapse. Entire companies would go bust… as would multiple sovereign nations.

And this process has just begun. This is why emerging market currencies are collapsing. Brazil’s Real has lost over 20% of its value against the US Dollar in the last six months. The Australian Dollar has lost 16%. And on and on.

The real story for the world is not interest rates… it is that the era of cheap US Dollar financing everything on the planet has ended. What’s coming will not be pretty for anyone or anything that relies on cheap Dollars (this includes stocks, bonds, and the like).