Today saw the largest high to low drop intraday (down over 2.3%) in the S&P 500 for five weeks as it fell back to the 'Tepper Top'. Volume was the 3rd highest of the year. As expected, high-beta muppets were hurt most; Trannies were the worst performer in the major equity indices (down 1.6% on the day and 2.5% from the Bernanke highs early on); homebuilders dropped 3.7% from their earlier highs, and Morgan Stanley slumped 4% from its earlier highs. VIX (up most in 5 weeks Read more.....

Today saw the largest high to low drop intraday (down over 2.3%) in the S&P 500 for five weeks as it fell back to the 'Tepper Top'. Volume was the 3rd highest of the year. As expected, high-beta muppets were hurt most; Trannies were the worst performer in the major equity indices (down 1.6% on the day and 2.5% from the Bernanke highs early on); homebuilders dropped 3.7% from their earlier highs, and Morgan Stanley slumped 4% from its earlier highs. VIX (up most in 5 weeks at 14.0%) and credit markets (biggest widening in 4 weeks and HYG dropped by its most in 6 months from its intraday highs) saw major weakness (extending the bearish divergence with stocks). The USD rallied back to unchanged on the week and commodities slipped lower (gold and silver end the day slightly higher on the week). What's so special about today? The S&P 500 dividend yield just equilibrated with the 10Y yield for the first time since April 2012... where would you rather 'reach for yield'...

Quite a day...

Small bounce into the close but not a pretty day...

Exuberance - the S&P 500 broke above its six-month trend channel today... final straw?

as the S&P 500 broke down to Tepper's Top

Bonds and Stocks yield the same...

'Most-Shorted' names recovered the week's squeeze and slumped back to in-line with the Russell...

The USD rallied back to unchanged on the week - which weighed on commodities in general...

Charts: Bloomberg and Capital Context

This seemed to sum it up nicely...

Submitted by Chris Martenson of Peak Prosperity blog,

As the global equity and bond markets grind ever higher, abundant signs exist that we are once again living through an asset bubble – or rather a whole series of bubbles in a variety of markets. This makes this period quite interesting, but also quite dangerous.

With equity and bond markets at or near all-t Read more.....

Submitted by Chris Martenson of Peak Prosperity blog,

As the global equity and bond markets grind ever higher, abundant signs exist that we are once again living through an asset bubble – or rather a whole series of bubbles in a variety of markets. This makes this period quite interesting, but also quite dangerous.

With equity and bond markets at or near all-time record highs, with all financial assets consistently shrugging off bad – or worse – news as the riskiest of assets continue to find consistent upward bids, we find ourselves in familiar and bubbly territory.

I can summarize my thoughts in one sentence:  How could this be happening again so soon?

In times past, it took one or more generations between bubbles for people to financially recover and forget the painful lessons before they would consider doing it all again. Yet here we are, working our way through our third set of bubbles in less than two decades, which must be some sort of world record.

I will confess to my biases right up front: I have always been deeply skeptical of both the practice of running up debts at a faster pace than income (the common practice of the entire developed world over the past several decades) and the idea that the solution to too much debt is more debt, enabled by cheaper money courtesy of thin-air money printing.

In short, instead of seeing central banks as sophisticated stewards of intricate monetary policies, I view them as serial bubble-blowers and reckless debt-enablers whose only response, when confronted with the inevitable consequences of their actions, is to serve up more thin-air money at an even cheaper rate. And when that doesn't work, then they simply try even more of the same, but in larger quantities.

While I think central banks are populated by earnest people with impressive credentials who have rationalized their actions as being necessary and in service of the greater good, I also think that the biggest ones hold an entrenched set of institutional views that are dogmatic, fail to incorporate the idea of economic and resource limits, and are seemingly immune to healthy introspection.

Somewhere along the way, I would have hoped they might have noted that each new crisis is larger than the one before – necessitating an even larger response that begets an even larger crisis next time, etc., and so on. A corporate bond hiccup in 1994 led to monetary loosening that enabled the development of the Long Term Capital Management (LTCM) fiasco of 1998, which was followed by the tech bubble, and then the housing bubble, and here we are with a now global equity and bond bubble that is larger than all the prior bubbles combined. Much larger.

It was famously said that the market can remain irrational longer than you can remain solvent. And if the trading maxim, don't fight the Fed, is worth heeding, then surely one should absolutely not take on all of the central banks at once, either. So, the risk I run here in seeing things through my 'common sense' filter is that perhaps this time the Fed, et al., have got it right, and a true and lasting recovery is at hand.

With that caveat, in this report I lay out the five most worrisome signs that horrific market losses await the unwary, the careless, the reckless – and those who possess all three characteristics (i.e., your average central bank).

These are not normal times. The degree of separation between reality and today's financial markets is extreme, which means they have a tremendous degree of potential energy stored up that could erupt in a downward cascade at any time.

While we can’t predict the exact time or trigger of a market avalanche back down to reasonable levels, I can definitely advise that you do not want to be standing in the valley when it happens.

Four Signs That We're Bubbling

Here are the four things that convince me that we are in truly bubbly territory:

Sign #1: Junk Bond Prices at Record Highs

The Fed, et al., have been buying up all of the 'safe' bonds, with the twin intents of driving down interest rates and chasing investors into riskier assets. With lower yields comes (hopefully) more borrowing; and when investors move towards riskier assets, this drives up the equity markets – which, as the thinking goes, will paint a rosier picture of the economy plus boost consumer confidence and spending.

Along with this, however, we find speculators and investors, starved for yield, chasing the junkiest of the junk.

Indeed, the prices of these "assets" have recently been driven to all-time record highs, which means that their yields have hit record lows.

And not just "low" prices, but a brand new record low in all of financial history.

Sign #2: Junk Sovereign Debt Being Chased to New Highs

It was just over a year ago when Greece ten-year debt was yielding a whopping 30%, reflecting the poor economic fundamentals of the country and concern that the European Central Bank (ECB) might stop loaning Greece the principal and interest payments needed to prevent another default.

Oh yes, and let's not forget that just a year prior, more than $130 billion had been lost by Greek bond investors, which created a ripple effect across Europe, including recently crippling Cyprus' key banks.

Today? Greek ten-year debt is under 10%.

Greece Bulls Charge Into Corporate Bonds

May 15, 2013

 

Investors are returning to Greece, lured by receding fears that the troubled country will leave the euro and the high returns offered by many of its battered assets.

 

It is a remarkable turnaround. Only a year ago, Greece was toxic territory for investors. A debt restructuring had just wiped out more than €100 billion ($130 billion) in government bonds. The stock market stood at one-tenth its 2007 levels. A political earthquake had the country poised for a chaotic election.

 

But now the markets have turned. Months of relative calm in Europe – and the pressure to go somewhere, anywhere, for yield in a low-interest-rate world—has investors taking another look. The Athens stock market has rallied more than 80% in the past 12 months, with the Athex Composite Index rising 0.8% on Tuesday. Greek government bonds have been on a tear since June.

 

The real story here, about speculators – not ‘investors’ – returning to Greece, is that the world is so utterly starved for yield that even Greek debt seems reasonable now. In Greece, even as the trend towards buying Greek debt was building, the country's economy (as measured by unemployment and GDP) deteriorated sharply.

As compared to 2008, Greek GDP in 2012 shrank by 20%, and current trends continue to show 5%-6% shrinkage in 2013:

(Source)

In what sort of a world does serious economic contraction, spiking unemployment, extremely high levels of debt-to-GDP, and falling bond yields go together? A bubbly world, that's where.

Sign #3: It's Not Official Until It's Denied

The poster child for a bubble market has to be Japan, where the main stock index of the island nation, the Nikkei, is up an astonishing 70% in the past six months (!) in a vertical index rise that is well outside of our personal experience:

This isn't some penny stock, but the entire stock index for the world's third largest economy. Of course, the 'reason' for this rise centers on the actions the Bank of Japan is taking to debase its currency. The people of Japan are realizing that they cannot trust their cash and had better put it to use somewhere besides their bank accounts before its purchasing power is drained away.

After such an obviously unstable spike in the market, what's left to do but officially deny that it's in a bubble?

Stock Boom Isn't a Bubble, Says BOJ's Kuroda

May 15, 2013

 

TOKYO—The Bank of Japan's governor played down worries that the stock-market boom is a bubble and that a weak yen will stir cost-push inflation, signaling his resolve to press ahead with the bold monetary easing that has fueled stock prices and driven down the currency.

 

Grilled by lawmakers during a session of the upper-house budget committee, Haruhiko Kuroda flatly rejected an opposition-party member's argument that the recent rapid rise in the Tokyo stock market is out of line with Japan's real economy.

"At this moment I do not think they are in a bubble," Mr. Kuroda said.

Driving this bubble is the determined resolve of the BoJ to make the yen worth less, perhaps even someday worthless. For a major world currency, the chart below is quite startling.

If something is not official until it's denied, then the Japanese stock market is most definitely in a bubble. It should be noted that there are similar examples of stock indexes making new highs on bad news and weak fundamentals the world over, so we're not just picking on Japan alone here.

Sign #4: Making Up Crazy Excuses

My final sign of that we are in bubble territory is when the folks who consider it their job to make sense of the high and spiking prices offer up thin, sometimes stretched-to-the-breaking-point, rationalizations for why the current price action make sense.

In the late 1990s, when the third most recent Fed bubble was cooking along, stratospherically valued technology shares were justified with strange metrics such as 'impressions' and 'eyeballs' and other contorted valuations contained in no standard finance methodologies.

In the 2000s, when the second most recent Fed bubble was cooking along, housing prices were justified with trite slogans such as "they're not making any more land, you know" and bizarro claims that housing had never gone down in price over time – which it most certainly had.

Today is no different. We're seeing the same sorts of 'explanations' to justify high prices fueled by central bank printing. Perhaps the central cheerleader for the benefits of perpetuating central banking policy errors is Paul Krugman, who recently swept aside arguments for an equity bubble by saying something that Irving Fisher might recognize:

O.K., what about stocks? Major stock indexes are now higher than they were at the end of the 1990s, which can sound ominous. It sounds a lot less ominous, however, when you learn that corporate profits— which are, after all, what stocks are shares in — are more than two-and-a-half times higher than they were when the 1990s bubble burst.

 

Also, with bond yields so low, you would expect investors to move into stocks, driving their prices higher.

(Source)

This sounds reasonable until you consider the context of this argument about corporate profits, of which an economist like Krugman ought to be fully aware. Corporate profits are in very, very unusual territory (one could even say record territory), and to say that equities are fairly valued now because of their relationship to corporate profits is to argue that such profitability is a new and permanent feature of life.

The economist Irving Fisher somewhat famously and regrettably opined in 1929 (right before the stock market crashed) that a new corporate model and economic era was in play that had led to a "permanent plateau of prosperity." The rest is history.

In life and investing, there's nothing quite so powerful as reversion to the mean, which in the case of corporate profits is nearly 50% lower than where they currently are. By the time that economists are dismissing the notion of an equity bubble by pointing out heightened corporate profits, without providing any of the necessary context, we are in full-blown rationalization mode – which is another bubble indicator.

Also, the fact that Mr. Krugman is citing "low bond yields" as a justification for moving into stocks rather delightfully skips over the reality that it is the central banks themselves that are responsible for those low bond yields. Krugman presents the information as if such intervention were a normal market condition to which investors were rationally reacting, rather than a completely fake circumstance engineered by central banks conducting the biggest monetary experiment in human history.

Next, we have this tidy explanation from Goldman Sachs, groping for reasons to explain why stocks always seem to go up no matter what:

"while equity prices respond more to dovish surprises than hawkish surprises, the results suggest that equity prices typically go up regardless of whether the Fed policy surprise is positive or negative (“good news is good for equities, and bad news is good for equities”). But it is not at all clear why the equity market should systematically buy into this pattern."

 

(Source - Zero Hedge)

This is at least as honest an appraisal of the situation as I can find. Goldman Sachs is basically waving its hands in the air and saying that it's somewhat puzzling why markets should be acting this way. An even more honest statement would continue by noting that such periods of irrational exuberance are quite often found during bubbles, and that bubbles have a bad habit of destroying wealth.

As is common in life, such justifications merely expose the 'human factor' of bubbles. Bubbles require a belief system to be installed in the beholder, and two things that beliefs are exceptionally good at are gathering supporting data and rejecting contradictory data (if such data is even seen in the first place).

The human mind does this all the time with respect to our own level of ability, our luck, our good looks, our children's performance – you name it – this is just part of our innate mental programming.

The really odd part in this story is that once upon a time, bubbles were separated by a generation or more, so that the lessons (and pain) of the prior one could be culturally forgotten before the next one could take hold. Yet here we are, working on our third bubble in a row – larger than the prior two that just happened within the past 15 years. (Of course, with a wide enough lens, we might say that each bubble was just a subset of the largest credit bubble in all of history that began building some 40 years ago).

For some reason, we are forgetting the lessons of the past faster than ever before. Such willful ignorance invites a series of reality-based reversions more punishing than ever before, too.

My advice: Keep a journal. These are interesting times; possibly not to be repeated in many, many generations.

Conclusion to Part I

There are abundant signs that the world's equity and bond markets are ignoring risk and chasing yield to dangerous extremes. Various denials and justifications are being offered to rationalize these behaviors as sensible or prudent. Taken together, this tells me we are once again in bubble territory, and that, as with all bubbles, this one will end badly. Or rather, these bubbles (plural) will end badly together.

I'm sure that most market participants have it in their minds to dance as long as the music is playing and to be among the first to reach the exits when the music stops. However, everybody is thinking this, and given that only the most well-connected of market players have the opportunity to exit first (literally in the blink of an eye), very few will actually make it through the doorway unscathed.

As is always true in life, the point of a bubble is to separate the most people from the most wealth. The wealth doesn't actually vanish; it's just simply transferred from the last purchasers to those who sold before the bursting.

I truly have no idea how much longer all this craziness can continue. I suspect the answer is a lot longer than anybody suspects, myself included. But I also know that reversals tend to happen quite quickly, all on their own, with very little warning. This leads to my personal motto: I'd rather be a year early than a day late.

In Part II: Protect Your Wealth in Advance of the Bubble's Bursting, we detail our rationale that all this ends in a wrenching market crash (Phase I), which will be followed by even larger, more desperate, and unusual central bank actions (Phase II) that will initially set the stage for what seems like a recovery but ultimately terminates in the largest currency crisis of modern times, if not human history (Phase III).

The difficulty will be avoiding being whipsawed throughout, losing wealth at every step. After all, the primary outcome of every attempt at money printing in the past has been a massive wealth transfer from a very large proportion of the afflicted society to a much smaller one.

Click here to access Part II of this report (free executive summary; enrollment required for full access).

In the meantime, trade safe. My advice here is to use extreme caution whether investing or speculating, whichever you are involved in.

As the world of equity asset-gatherers is desparate to point out the 'bubble' talk must mean bonds, we offer a few charts as a gentle reminder of reality... And as Doug Kass noted the last two times the S&P 500 hit all-time high and closed down more than 1% from that high were 10/11/07 & 3/24/00... 330 Ramp Capital has their work cut out today with volume already near the highest of the year in the S&P 500 e-minis.  

Where's the bubble?< Read more.....

As the world of equity asset-gatherers is desparate to point out the 'bubble' talk must mean bonds, we offer a few charts as a gentle reminder of reality... And as Doug Kass noted the last two times the S&P 500 hit all-time high and closed down more than 1% from that high were 10/11/07 & 3/24/00... 330 Ramp Capital has their work cut out today with volume already near the highest of the year in the S&P 500 e-minis.  

Where's the bubble?

Credit has been nervous for 2 weeks...

as has VIX...

Charts: Bloomberg

What is 410 words and is released precisely 180 seconds after the FOMC's minutes? Why Jon Hilsenrath's FOMC minute-parsing piece of course. Which we can only assume means Jon was on the "preapproved" list for early distribution and pre-analysis, because not even we can analyze and type that fast. We are confident he did not breach the embargo. Because that would not look good for the Fed already being investigated by the Inspector General for last month's humilating breach.

Read more.....

What is 410 words and is released precisely 180 seconds after the FOMC's minutes? Why Jon Hilsenrath's FOMC minute-parsing piece of course. Which we can only assume means Jon was on the "preapproved" list for early distribution and pre-analysis, because not even we can analyze and type that fast. We are confident he did not breach the embargo. Because that would not look good for the Fed already being investigated by the Inspector General for last month's humilating breach.

So what did Hilsy have to say this time? This:

Federal Reserve minutes from its April 30-May 1 policy meeting suggested it is heading toward some difficult debates on when to pull back its bond buying program.

 

Below are key passages in the minutes and how to read them:

 

1) “A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth; however, views differed about what evidence would be necessary and the likelihood of that outcome.”

 

WHAT IT MEANS: The Fed will debate at its June 18-19 meeting whether to reduce its $85-billion per month bond-buying program, but officials don’t appear near a consensus on the matter. Fed chairman Ben Bernanke suggested in testimony to Congress earlier in the day that he wanted to avoid moving prematurely toward pulling back.

 

2) “Several participants pointed to the improvement in interest-sensitive sectors, such as consumer durables and housing, over the recent period as evidence that the purchases were having positive results for the economy.”

 

WHAT IT MEANS: The Fed talks about the costs and benefits of its policies. So far, they think the bond buying program is still helping the economy.

 

3) “Economic data releases over the intermeeting period were mixed, raising some concern that the recovery might be slowing after a solid start earlier this year, thereby repeating the pattern observed in recent years. Various views on this prospect were offered, from those participants who put more emphasis on the underlying momentum of the economy, noting the strengthening in private domestic final demand, to those who stressed the growing fiscal restraint or the other headwinds still facing the economy.”

 

WHAT IT MEANS: Fed officials are hesitant about their next step on monetary policy in part because they’re especially uncertain about how the economy unfolds in the next few months, in the face of tighter fiscal policies.

 

4) “Both headline and core PCE inflation in the first quarter came in below the Committee’s longer-run goal of 2 percent, but these recent lower readings appeared to be due, in part, to temporary factors; other measures of inflation as well as inflation expectations had remained more stable. Accordingly, participants generally continued to expect that inflation would move closer to the 2 percent objective over the medium run.”

 

WHAT IT MEANS: The Fed’s favored inflation measures have dropped well below its 2% target, but officials aren’t deeply concerned about it yet.

Trust Hilsenrath to miss the most important part of the minutes, which was this - the first "on the FOMC record" admission by some that the Fed is officially blowing a bubble:

"a few participants expressed concern that conditions in certain U.S. financial markets were becoming too buoyant.... One participant cautioned that the emergence of financial imbalances could prove difficult for regulators to identify and address, and that it would be appropriate to adjust monetary policy to help guard against risks to financial stability."

WHAT IT MEANS: It is self-expanatory

Well that escalated quickly... the S&P is now 30 points off its earlier highs and it seems (for once) that it is stocks and none of the other risk-assets that are taking the brunt of the disappointment. And no, it wasn't the mention of a June taper that spooked markets: as the Fed itself said that will be a function of the economy, and as everyone knows there bad news and good news are both goods news. What spooked the market is that finally someone on the FOMC is not only acknowledging a Read more.....

Well that escalated quickly... the S&P is now 30 points off its earlier highs and it seems (for once) that it is stocks and none of the other risk-assets that are taking the brunt of the disappointment. And no, it wasn't the mention of a June taper that spooked markets: as the Fed itself said that will be a function of the economy, and as everyone knows there bad news and good news are both goods news. What spooked the market is that finally someone on the FOMC is not only acknowledging asset bubbles, but putting it in writing: "a few participants expressed concern that conditions in certain U.S. financial markets were becoming too buoyant.... One participant cautioned that the emergence of financial imbalances could prove difficult for regulators to identify and address, and that it would be appropriate to adjust monetary policy to help guard against risks to financial stability." Now this is a problem because unlike the economy where QE may or may not trickle down to the unemployment rate (it won't as QE is causing it but fear not - more QE is just around the corner to fix a problem caused by QE) asset bubbles only get bigger and bigger and bigger, until QE has to be not only tapered, not only stopped, but actually unwound. And with some finally on the record, the blame will be cast squarely at those who ignored the first warnings.

Post-FOMC Performance: ES 1658 -8.5, 10Y 2.01% Unch, Gold $1361.25 -$2.25, DXY 84.28 Unch

It appears (as we noted here) that the size of the balance sheet, difficulty of the exit, frothiness of markets, and not-totally-dismal labor headlines have even the doves a little more hawkish about the possibility of an exit at some point - though obviously the minutes are clear that the 'flow' can increase (as well as decrease) based on the data.

• FOMC MINUTE Read more.....

There appears to be only three words that matter any more and they all begin with the letter 'T' - Tepper, Tuesdays, and Tapering. It seems today, the apparent start of Bernanke's gentle communication policy that he might possibly maybe one day will remove the punchbowl is being modestly priced out of stocks. The S&P and Nasdaq are now down 1% from post-Bernanke 'Moar' euphoria.

Read more.....

There appears to be only three words that matter any more and they all begin with the letter 'T' - Tepper, Tuesdays, and Tapering. It seems today, the apparent start of Bernanke's gentle communication policy that he might possibly maybe one day will remove the punchbowl is being modestly priced out of stocks. The S&P and Nasdaq are now down 1% from post-Bernanke 'Moar' euphoria.

With part two of today's Fed-a-palooza due out shortly in the form of the May 1 FOMC meeting minutes, here is an informative recap of the current roster of assorted birds at the FOMC via Bank of America. Of course, since every decision always begins and ends with Ben, and soon his replacement Janet, all of below is largely meaningless.

Hawks, doves, owls and seagulls

Speeches by FOMC participants often get a fair bit of attention, and that has been part Read more.....

With part two of today's Fed-a-palooza due out shortly in the form of the May 1 FOMC meeting minutes, here is an informative recap of the current roster of assorted birds at the FOMC via Bank of America. Of course, since every decision always begins and ends with Ben, and soon his replacement Janet, all of below is largely meaningless.

Hawks, doves, owls and seagulls

Speeches by FOMC participants often get a fair bit of attention, and that has been particularly true of late. The markets are very sensitive to any hint that the Fed might scale back QE3 soon. Unfortunately, given the diversity of views on the FOMC, it is not always easy to separate the signal from the noise when Fed officials speak. The best advice is to listen to the voters (Table 1), especially the core members: Chairman Ben Bernanke, Vice Chair Janet Yellen and New York Fed President Bill Dudley (and vice chair of the FOMC).

While FOMC participants are typically split along a hawk/dove spectrum, in the current group there are several Fed officials with more nuanced views. For example, there are some arguably hawkish (or formerly hawkish) participants who nonetheless favor additional accommodation. Conversely, there are those who are typically thought of as doves yet who advocate scaling back QE more quickly. These conflicting cross-currents only add to the market’s confusion.

To understand most Fed officials’ policy preferences, it helps to step back and consider their philosophical bases — which for many goes back to their training in economics. Specifically, many of the divisions on the FOMC reflect differences between “freshwater” and “saltwater” schools of thought in economics — so named for the location of the US graduate schools (inland versus the coasts) where each has been most prevalent. In brief, freshwater economists emphasize market efficiency, rational expectations and policy ineffectiveness, while saltwater economists see market failures, multiple equilibria and a role for countercyclical
demand management.

Oceans apart

Some key differences between these two schools of thought as they relate to monetary policy are listed below:

• Monetarists versus New Keynesians: The basic modeling framework for freshwater economists is often monetarist, where the key responsibility of a central bank is long-run price stability. Saltwater economists use a New Keynesian framework that suggests policy can help stabilize markets.
• Inflation vs. unemployment: Freshwater economists see inflation as having a clear priority in the Fed’s dual mandate, and are skeptical that unemployment (or slack more generally) has much to do with inflation. Saltwater economists see reducing unemployment as its own objective in the short-run. Both sides agree that a central bank should credibly commit to a long-run nominal anchor, like an inflation target.
• Structural vs. cyclical labor market factors: Freshwater economists tend to see a significant portion of current unemployment as structural; equivalently, they see underlying equilibrium unemployment rate as relatively high right now — and not amenable to monetary policy stimulus. Saltwater economists believe that the labor market suffers mostly from cyclically weak labor demand. Some have suggested that policy needs to be very easy to prevent persistent cyclical unemployment from becoming structural. They forecast the NAIRU (the unemployment rate consistent with steady inflation) to be relatively low (perhaps 5%); saltwater types think it is higher.
• Transmission mechanisms. Monetarist channels of greater liquidity and credit creation are key for freshwater views; these are seen as currently ineffective in promoting growth but a risk for higher inflation. The New Keynesian view associated with a saltwater approach emphasizes low interest rates stimulating demand and higher asset values allowing for balance sheet repair and creating a wealth effect.
• Inflation expectation risks: Freshwater adherents see inflation as determined by the pace of money printing and policy credibility; they worry that large central bank balance sheets risk rising inflation expectations. Saltwater economists counter that persistent low inflation and large output gaps risk inflation expectations deteriorating below long-run inflation targets.
• Costs vs. benefits of QE: Freshwater economists are skeptical of any benefits from QE for real activity, and worry about the potential costs in terms of inflation and financial instability. Saltwater economists see unconventional policy as simply an extension of easing when at the zero lower bound; the way it should work is similar to “normal times.” Both sides are uncertain of the efficacy of continued QE, but saltwater economists tend to be more optimistic of its effectiveness.

From theory to practice

Freshwater programs are associated with universities such as Chicago, Minnesota and Rochester. Saltwater views are more common at institutions such as MIT, Princeton and Yale on the East Coast, and Berkeley on the West. A similar pattern is found at the regional Federal Reserve Banks: those on the coasts tend to  have saltwater orientations, while those inland skew more toward freshwater views. But in both cases, there are interesting exceptions that we discuss below.

For most FOMC participants, the freshwater/saltwater divide mirrors the hawk/dove categorization — Chart 1 plots a fairly standard spectrum for the current FOMC participants. Thus, for example, the steady hawks have strong freshwater connections. The research records of Philadelphia’s Charles Plosser and Richmond’s Jeffrey Lacker belie the East Coast locations of their Banks. While Dallas’s Richard Fisher and Kansas City’s Esther George are not trained as economists, they hail from solidly freshwater Banks. The backgrounds and affiliations of each FOMC participant are listed in Table 2.

These four members have cast the majority of dissents in recent years (in addition to George’s predecessor at Kansas City, Thomas Hoenig, who also was a serial dissenter). They have been critical of QE since its first round, and have lately called for its early end, arguing the costs exceed the benefits. Of this group, only George is a voter this year, and we expect her to dissent at least until the Fed starts to taper QE3. As Chart 2 shows, a core group of hawks have been a persistent source of dissents during Bernanke’s time as chairman — nearly 60% of FOMC meetings have not been unanimous since he took the helm in 2006.

At the other end is the more dovish majority. This group includes Chairman Ben Bernanke, Vice Chair Janet Yellen, and New York Fed President Bill Dudley, as well as Boston Fed President Eric Rosengren. All are voting members this year. We expect the other Board members who are not trained as economists — Sarah Bloom Raskin, Elizabeth Duke, Jerome Powell and Daniel Tarullo — to vote with the majority, as all have indicated support for the current policy stance within the past few months. And while some in the market have speculated that Governor Jeremy Stein has a hawkish streak after his 7 February speech on “Overheating in Credit Markets,” we note that he characterized his discussion as “an extended hypothetical” and concluded that any potential losses are “confined” and a “relatively limited” source of systemic risk.

Neither fish nor fowl

Other Fed officials do not fit into this hawk/dove categorization quite so neatly. Atlanta’s Dennis Lockhart and Cleveland’s Sandra Pianalto are typically centrists who vote with the majority; lately Lockhart has been generally supportive of the current QE plan, while Pianalto has raised some concerns. Neither is a voting member this year, but Pianalto will be a voter in 2014.

The “owls”

Three Midwestern Fed bank presidents are less hawkish than their counterparts at Dallas or Kansas City, despite their freshwater training: Chicago’s Charles Evans, Minneapolis’s Narayana Kocherlakota, and St. Louis’s James Bullard. Both Evans and Bullard are voters this year, while Kocherlakota votes in 2014.

We consider them the “owls” in our classification, given their tendency to make model-based arguments around policy — and to have taken more dovish policy positions recently. All three have given their support to QE3 purchases, for example, and Evans and Kocherlakota both have enthusiastically promoted the use of  economic thresholds for forward guidance.

St. Louis’s James Bullard

Bullard is arguably the most traditionally hawkish of the owls, describing himself as the “north pole of inflation hawks” — despite regularly drawing on New Keynesian models in his research. He also has been the most vocal advocate of making small changes to the purchase pace for QE. In his most recent speech on 21 April, he said that QE “remains the best monetary policy option” in the current situation and recommended continuing at the current pace.

Note that Bullard is regarded as having been early in calling for QE2, although he also has been an opponent of forward guidance — so his track record as a barometer of where the rest of the FOMC may go has been mixed. Bullard has argued for beginning to taper QE3 as the unemployment rate gets close to 7% and  growth rises to around 3 ¼%. While he has seen these outcomes as possible by the end of this year, the March projections by the FOMC suggest most of his colleagues don’t expect to hit those criteria until later next year.

Minneapolis’s Narayana Kocherlakota

Kockerlakota has a relatively short history on the FOMC — he became President of the Minneapolis Fed in October 2009 and first voted in 2011 — but it has been
a colorful one. In 2011 he twice joined Fisher and Plosser in hawkish dissents: against introducing a calendar date for forward guidance in August, then against additional accommodation in the form of Operation Twist in September. However, in September 2012, Kocherlakota had a road-to-Damascus conversion. He completely changed his song, and called for the Fed to adopt a “liftoff plan”: keep rates low until the unemployment rate hits 5.5% — provided that inflation was no more than 25 basis points above target. Since then, he has said that more stimulus would be “desirable.”

In our view, Kocherlakota is the owl most likely to change his feathers and become more hawkish again. However, we would not expect that to happen while inflation is running (well) below the Fed’s long-run 2% objective. If the outlook for PCE inflation one- to two-years ahead were running above 2.25% or so, we would then expect him to revert to a hawkish stance. But as of now, that looks rather unlikely for next year, when he is once again a voter.

Chicago’s Charles Evans

Evans has been the most avidly and consistently dovish of the owls, supporting aggressive Fed easing as a voter in 2009 and 2011 — and dissenting twice, in November and December 2011, in favor of additional policy accommodation. In late 2011, Evans developed and refined what would ultimately become the threshold approach to forward guidance that the FOMC as a whole adopted in December 2012. Evans’s advocacy for this approach was cited by Kocherlakota as a strong influence over Kocherlakota’s own thinking.

Evans is a voter again this year. In his most recent public remarks on 20 May, he sounded more optimistic about the outlook for growth and employment, although he said he would like to see at least a few more months of data before thinking about tapering. Evans also repeated his condition of several months of greater than 200,000 in monthly payroll growth as a marker for a “substantial” improvement in the labor market. He observed that the Fed is missing on both its employment and inflation objectives, and said the Fed needed more time to assess the effects of policy. He also noted that it was important that policy makers did not become complacent given the still powerful headwinds facing the economy. On net, we interpret Evans’s remarks as suggesting the earliest he would support tapering would be early fall, and mid-year slowdown would reset the clock.

The “seagulls”

Whereas the owls are dovish-sounding FOMC participants who have hawkish (freshwater) backgrounds or inclinations, the “seagulls” are saltwater doves who have flown far from shore and are starting to sound more hawkish. While some might put Stein or the latest remarks by Evans in this category, we currently see one main member of this group: San Francisco Fed President John Williams.

San Francisco’s John Williams

Before becoming the president of the San Francisco Fed, Williams worked as a staff economist at the Board of Governors in Washington DC and at the San Francisco Bank. Much of his research has been in a New Keynesian framework. And he has been relatively dovish in his speeches since becoming president in 2011. Lately, however, he has been talking about a possible early end to QE3.

In his most recent speech on 16 May, Williams discussed the progress made since QE3 began, noting that the labor market has “improved considerably” but not yet “substantial improvement” — that will take “further gains.” However, he went on to say that “assuming my economic forecast holds true” and “appreciable improvement” occurs in “various labor market indicators” in “coming months,” then the Fed “could reduce somewhat” the purchase pace “perhaps as early as this summer.” “If all goes as hoped,” the Fed could then conclude QE3 “sometime late this year,” according to Williams.

There are a lot of conditionals in those statements, and they require a lot of things to go right. In effect, Williams has outlined more of a “best case” than a “base case” for tapering and ultimately concluding QE3. He has had a similarly optimistic outlook for the past few months, while acknowledging many of the downside risks that have kept his more dovish colleagues cautious and less willing to advocate for a quick end to QE3. That, in our view, makes his current views less representative of the FOMC majority. Given the markets typically view the San Francisco Fed as particularly dovish, he also may be trying to create a more balanced impression and avoid being labeled an über-dove. Most importantly, however, he is not a voter again until 2015.

Birds of a feather

A number of current FOMC participants do not fit so easily into a simple hawk/dove division. While it is still possible to broadly characterize the 19 Fed officials at the FOMC meetings along such a spectrum (as we have done in Chart 1), that can increase the risk that the views of certain members are misconstrued as giving greater insight into the likely policy choices of the Committee than is warranted. As we noted at the outset, most attention should be given to the core of the Committee: Chairman Bernanke, Vice Chair Yellen and New York Fed President Dudley. In addition, it pays to focus mostly on the FOMC voting members — and the current group skews dovish, in our view. Fade the hawks, but also be cautious about interpreting the owls and seagulls — they sometimes fly far from the majority.

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The system is circling the bowl

So Ben has established control

He's helping the rich

By flipping a switch

And they're handed wealth that he stole

The Limerick King

HOW IT REALLY WORKS

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Bernanke is headed to space

He's seeking an alien race

He needs some fresh meat

For financial defeat

Their fiat he plans to debase

The Limerick King

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Following the first quarter rout in AAPL stock, some wondered if there would finally be rotation at the top floor of the hedge fund hotel of stocks held by most hedge funds. The answer is no: as of March 31, AAPL still retains the title of stock with the largest number of hedge fund investors at 188, more than GOOG with 184 and above AIG with 180.

Most held as of March 31:

Read more.....

Following the first quarter rout in AAPL stock, some wondered if there would finally be rotation at the top floor of the hedge fund hotel of stocks held by most hedge funds. The answer is no: as of March 31, AAPL still retains the title of stock with the largest number of hedge fund investors at 188, more than GOOG with 184 and above AIG with 180.

Most held as of March 31:

And as of December 31:

The quarterly hedge fund holdings of AAPL stock: the trendline is clearly broken now.

And as bonus: here are the largest hedge funds in the US ranked by equity assets: