September 25th 2011 – Let’s twist again

The Fed’s latest cunning plan seems to have been misinterpreted by many, but not by Mr Market. This is less of a money printing exercise, a la QE1 & 2, than an attempt to flatten the yield curve. The Fed has a stack of short dated bonds, so they are going to sell $400 billion of these and buy longer dated issues, which Timmy already has on the starting blocks, with the proceeds. Borrowing rates are priced off the long end of the curve so theoretically there will be a boost to housing and commercial lending. A similar gig was tried in 1961, when Chubby Checker was introducing us to the dancing craze of the time, which by comparison makes the Fed’s current gyrations look almost sensible; almost but not quite…

The markets have seen through the futility of this manoeuvre. Mortgage rates are already at multi decade lows and by flattening the curve the banks will have less margin and less propensity to lend at a time when their capital ratios are already coming under pressure. If by accident (unintended consequence?) the curve inverts, ie long rates lower than short, we will be firmly in recessionary territory. And then we get QE3? As the chant from the terraces to the errant referee goes, “You don’t know what you’re doing”…

By Friday lunchtime the pundits in the main stream media were reckoning that only the “second coming” would save us. We then had a 120 point rally in FTSE into the close and the banking index was up on the day. Such is the stuff of bear market behaviour and don’t be surprised if the squeeze lingers awhile.

The real carnage though was in the precious metals; especially silver which has fallen over 25% in just two days. This is not as surprising as it seems as the silver market is probably the most rigged offering on this planet. To put things into perspective the silver price is now back to where it was on St Valentine’s day earlier this year – $30 –  and all the bulls who participated in the run up to the $50 high in April have now been unceremoniously “massacred”. The bullion banks, who created the supply for this run out of thin air, by shorting silver that they almost certainly didn’t have in their vaults, can look forward to bonus time…ex UBS, although in fairness this was probably one market their Delta One desk wasn’t punting!

“What about gold?” I hear you say. Well it has shown some resilience by only falling 7% since Wednesday. There have been rumours of some forced sellers and it won’t be long before someone suggests (so it might as well be me) that the European central banks hold a lot of the stuff and it might come in useful to prop up their terminally ill patient the euro. The Swiss National Bank has already done this, to provide the cash to buy fistfuls of euros, to artificially drag down the Swiss franc, which they will no doubt come to regret. The “gnomes” will soon find themselves back in the garden for a spot of fishing…

The idea of returning to a gold standard has been roundly rejected by the great and the good of central bank world, so why not go the whole hog and follow Gordon Brown’s example and sell the lot? Unlikely I grant you, as they would then be at the end a very long creek with no paddle; mind you they’re already half way up it without invoking any more ludicrous dance crazes…