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Rates and DXY Fail to Break Higher, Throwing Tapering Playbooks Out the Window


Right now, interest rates are still low and the charts indicate that they will remain so for the foreseeable future.

The system's insolvent. No one knows what to do next – except repeat the insanity until the next bubble blows. That'll be the one… the big one… the tipping point just like the tulip.
Michael Douglas' Gordon Gekko in Wall Street: Money Never Sleeps

Last week's narrative for the global markets was all about the US Fed's tapering program finally getting under way – even if it was "TINO" or tapering in name only. On Wednesday, the Federal Reserve announced that it was cutting back on the amount of bonds it purchases every month from $85 billion to $75 billion. While skeptics scoff at the minimal nature of the taper, everyone must admit that any growth over a baseline of zero is "something." However, the truth is that Mr. Gekko may have had it right in that the Fed seemingly is backed into a corner where TINO is about all they will be able to do for the foreseeable future. There are simply too many forces at work that are converging to keep rates in check and keep Gekko's bubble thesis intact almost five years after the Fed's corrective measures were put into place.

Tapering Has Not Brought About a New Bull Market in Interest Rates Yet

Right now, it looks as though the markets are sending the message that despite the Fed's announcements last week, we should not yet be repositioning our portfolios for some type of massive tapering-related bear market in fixed income. This could just be a temporary phenomenon, but the action following Wednesday's news has just not confirmed the thesis that bonds and gold are in trouble and that the DXY is set for take-off.

What has happened instead is that yields and the DXY have failed thus far to break their key upside correction resistance levels, while only gold has followed the script. Interestingly, silver has not broken to new lows yet. This leaves open the possibility that the breakdown in gold was a "head-fake." However, if silver joins gold and its miserable technicals, I will be more apt to believe that rates and the DXY will follow the pre-Fed playbook.

Unless and until that happens, we are left to speculate as to the possible forces involved in keeping rates and the US Dollar down. I've mentioned here recently that the Fed may know something awful about the underlying economic data that we do not. Another potential reason I put forth was something disturbing on the geo-political front could be in the offing – but that would almost certainly be reflected in stocks. Based on the recent price action in stocks, that is not the case. The third reason I put forth for the lack of upside in rates and the DXY was the looming implementation of Obamacare and the domino effect of its unintended consequences. Given the portion of the GDP pie that healthcare represents, it would absolutely make sense for the FOMC to tread very lightly with tapering right now.

One More Major Reason for the Low Rates/Low DXY Environment Exists

Today, let me offer another more macro reason why rates and the DXY may remain at depressed levels for quite some time (barring some spike in inflation or a meaningful change in this country's employment/economic picture -- neither of which is very likely). What is that reason? Simply put, so that we as a country can stay afloat financially.

To keep things manageable in terms of our federal budget, our country can only do a combination of three things:

1. Keep the cost of servicing our debt as low as possible.

2. Raise revenues however possible.

a. Through organic economic growth, as happened during the tech boom.

b. Through the raising of tax rates.

3. Finally, cut overall federal spending everywhere that it makes sense to do so.

The latter of these three items seems a practical impossibility when we are about to roll out Obamacare and when we have the biggest segment of our population getting ready to head into the Medicare and Social Security years.

So, can we raise enough revenues to create a budget surplus once again? Sadly, probably not. One of the other characteristics of the surplus years was that the baby boomers were in their peak years for earnings and creativity. That group spawned Steve Jobs, Bill Gates, and all of the other folks largely responsible for the technology renaissance. What demographic group and/or what new "boom" do we have now that is going to create a similar impact on our growth? Anyone? Bueller? Bueller?

How about raising taxes? No country anywhere in the history of this planet ever taxed its way to long-lasting GDP growth. That being noted, raising taxes has already occurred here. It has occurred overtly via higher tax rates and more subtly (or not so subtly if you ask many of your neighbors) by incorporating them in programs like Obamacare. These tax increase efforts are not going to create the massive growth in GDP and net increase in tax revenues necessary to cure our budget and debt problems.

What does that leave us with? Management of the cost of servicing our debt. The Fed needs to keep rates low, but not for unemployment or any of the reasons put forth previously by the FOMC. It must do so because it is trying to buy enough time for the next great boom to hopefully occur. The problem is that there is no timeline on that. It is – as I alluded to with Obamacare's ramifications earlier – a huge unknown.

Where Does That Leave Us?

One large, scary, looming void is bad enough (Obamacare's ramifications). But to have a second massive unknown – the solution to our deficit and national debt problems – is enough to turn one downright bearish on things. However, even Gordon Gekko would tell you that being bearish based on such macro theses can be hazardous to your health. Trading on that is like betting things are going to get a little tough for the markets when Harry Stamper and friends are called in to fly into space to blow apart an asteroid heading towards Earth.

We have to trade and invest now based on what can be reasonably anticipated to occur in the relatively near future. Right now, rates are still low and the charts indicate that they will remain so for the foreseeable future. For those not in love with technical analysis, some of today's chart-free article should have helped you understand why we may see conditions remain relatively equity-friendly for the foreseeable future.
There will be corrections in stocks -- that is a certainty. You can hedge your bets appropriately (seek the help of a market pro for that, by the way) as it may help you sleep better at night. But, for now and until we see signs from bonds and currencies that the FOMC is losing control of things, those inevitable corrections in risk assets are to be bought in my humble opinion.
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No positions in stocks mentioned.

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