alice

Fed’s Bag of Tricks: Op-Twist 2?

Yesterday we reviewed the Scariest Chart in the World, an overly sensational tongue in cheek title for a chart that has bearish historical implications for the S&P 500.  Here it is again.  Whether the Fed is looking at this exact combination of data points or something similar, you can bet they are aware that things have come to the brink.  The spread in the bottom panel is trying to turn up and that condition has not worked well for the stock market on the last two cycles.

30-5 yield, SPX and t bills

Here is a simpler view that we routinely follow in NFTRH’s Macro Indicators segments…

spx and 30-5 spread

Here is the weekly S&P 500 right on the brink…

spx weekly chartAnd here is a Fed Chair who is going to speak to Congress today…

janet yellen

Ms. Yellen has stated that her Fed does not manage the stock market, it manages the economy.  And that may be so, but watching things like yield curves and even the stock market is in fact watching early economic signals.  So let’s put that to rest now, they are watching the stock market and the damning macro indicators that have put it in a precarious state.

What can the Fed do to change the current atmosphere where gold is now out performing stock markets and market participants are losing confidence left and right?  Well, last time the big brained Bernanke Fed cooked up a little macro manipulation called Operation Twist.  This was the act of brilliance that simply painted inflation right out of the picture by “sanitizing” (the Fed’s own word, which is important to note) the bond market.  In this case “sanitizing” meant selling short-term Treasury Bonds and buying long-term Treasury bonds.

You will recall that in 2011, the Fed was under fire for the post-2008 inflation problem it had promoted (cue the reference of Bond King Bill Gross’s famous and ill-fated short of the long bond with the expectation that yields were finally going to break out… and cue our favorite macro chart, the 30 year yield, AKA the Continuum)…

tyx, the continuum

The yield did not break the limiter (100 month EMA) that time or any other time.  The Fed was a buyer on the long end, a seller on the short end and voila, the macro was under control!

op twist

Here is what happened to gold vs. the stock market.  Another round of un-sanitized QE was thrown in for good measure and the cycle of confidence was well on its way.

gold and spx

So today here we are.  There is much bearishness out there, and confidence is draining, slowly but surely.  Here is the barometer on that, gold vs. the S&P 500 on a weekly view.

gold vs. spx

This is a trend change and gold bugs may think they have it in the bag.  All else being equal, they do.  But I am very interested to see what Yellen has to say today; what subtle hints or overt messages she may or may not send.  The macro backdrop has come right to the brink (along with the weekly S&P 500 chart above) and the Fed is now front and center.

If confidence remains intact, the market will take any positive Fed signals and confidently run bullishly with them.  If we are in a different era however, the market could react positively for a short while, but then begin to rebel again.  If the Fed chooses to go full frontal, they could surprise us all with Op/Twist 2 or something along those lines.  That would be the nuclear option.

What ever happens, it is going to be interesting from this point forward.  Counter-cyclical forces have the ball and it remains to be seen whether the Fed will be able to take it away this time.  It depends on confidence, as always.

Post Script: It is important to note that in 2011 Op-Twist was promoted against an inflationary backdrop.  Today the backdrop is the opposite.  The 30yr-5yr curve is rising while nominal yields fall under deflationary pressure.  It is beyond my pay grade to be able to answer exactly what that distinction might mean on this cycle.

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