20 November 2008

Make-A-Wish Foundation Rings Opening Bell, Tanks Stocks. Seismic Collapse in Bond Market Yields Benefits Non-Profits Everywhere. Quantitative Easing!

The Make-A-Wish foundation destroyed the stock market today. Charity is even more out of style than clowns and Kiss.

This is ironic because a properly run foundation should have the majority of their investments in bonds. Well lets hope they do because the entire yield curve collapsed to below the rates where the Treasury has ever issued bonds. Assuming Make-A-Wish is properly run, they racked up massive gains today as the collapse in Treasury rates make their bond holdings extremely profitable.

As the market moves to price in quantitative easing, banks are aggressively hedging their exposure to the bond swap market, in which they have guaranteed long term rates for borrowers. This has kept swap rates below the bonds they're linked to... previously considered to be a mathematical impossibility. This is because banks normally charge a premium over the market rate on bonds to compensate them for the long term risk they're taking on.

Let's review the Bernanke playbook for conducting monetary policy in a zero Federal Funds rate environment which we spoke about a week and a half ago.

1) Take the Federal Funds rate to zero. Check.

2) Lower the rates on long term (5-30 year) bonds, by either promising to keep short term rates low for a number of years or commit to make unlimited purchases of long term bonds until their interest rate falls. Check.

3) Push down interest rates on private securities by buying them as well. Check for Commercial Paper (short term debt) Not much impact on long term corporate bonds, unfortunately.

4) Intervene in the Foreign Exchange market to weaken the dollar and raise the price of imports. No action yet.

5) Coordinated easing of both monetary and fiscal policy, for example tax cuts financed by issuing money so there is no increase in government debt. Check, sort of.

So it appears the majority of their gunpowder remains only in Foreign Exchange intervention. This is an extremely politically sensitive measure and is unlikely to be implemented except as a last resort.

But what is truly shocking about this whole thing is that the Fed has not come out to announce these courses of action. Very strange for a Fed that prides themselves on transparency.

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