Most Important Number in Finance is Slipping Out of the Fed’s Control

The Federal Reserve is the most powerful financial institution in the world and yet it is like the emperor without clothes. Ironically, the very force the Federal Reserve is most afraid of may be the only thing to save the Treasury.

Mirror mirror on the wall, what is the most powerful financial institution of them all?

The S&P 500, Dow Jones and pretty much all other markets seem to dance to the tune of the QE rhythm … and yet the Federal Reserve resembles the vain king portrayed in Christian Andersen’s “The Emperor’s New Clothes.” How so?

Rogue Interest Rates

The chart below shows the Federal Reserve’s monetary base sandwiched by the S&P 500 (SNP: ^GSCP) and the inverted 10-year Treasury Yield (Chicago Options: ^TNX).

The purpose of the chart is to show QE’s effect (or lack thereof) on stocks (represented by the S&P 500) and bonds (represented by the 10-year Treasury yield).

The 10-year Treasury yield has been inverted to express the correlation better.

I’ll leave the big picture interpretation of the chart up to the reader, but I have to address the elephant in the room.

Since the Federal Reserve stepped up its bond buying in January, the 10-year yield hasn’t responded as it ‘should’ and that’s very odd (the chart below shows the actual 10-year yield performance along with forecasts provided by the Profit Radar Report).

As of December 5, 2013, the Federal Reserve literally owns 12% of all U.S. Treasury securities and by some estimates 30% of 10-year Treasuries.

Icahn More Powerful Than Fed?

The Federal Reserve basically keeps jumping into the Treasury liquidity pool without even making a splash. If Carl Icahn can allegedly drive up Apple shares (with a 0.5% stake), why can’t the Fed manipulate interest rates at will?  This is just one of the many phenomena that makes investing interesting and keeps the financial media in business.

Conclusion

We do know why the Fed wants low interest rates. Rising yields translate into higher mortgage rates, and a drag on real estate prices. Eventually higher yields make Treasury Bonds (NYSEArca: IEF) a more attractive investment compared to the S&P 500 (NYSEArca: SPY) and stocks in general.

Ironically, what the Fed is trying to avoid (higher yields) may be the only force to save the U.S. Treasury. How can the Federal Reserve ever unload its ginormous Treasury position without the help of rising interest rates?

The emperor without clothes maintained his dignity (at least in his mind) as long as everyone pretended to admire his imaginary outfit. Perhaps a market wide realization that the Federal Reserve isn’t as powerful as it seems may ‘undress the scam.’

Regardless, the Fed’s exit from bonds would likely be at the expense of stocks, a market the Federal Reserve has been able to manipulate more effectively than bonds.

The Federal Reserve owns 12 – 30% of the U.S. Treasury market, but how much of the U.S. stock market has the Federal Reserve financed?

This stunning thought is explored here: Federal Reserve ‘Financed’ XX% of all U.S. Stock Purchases

Simon Maierhofer is the publisher of the Profit Radar Report. The Profit Radar Report presents complex market analysis (stocks, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. We are accountable for our work, because we track every recommendation (see track record below).

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

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Most Important Number in Finance is Slipping Out of the Fed’s Control

The Federal Reserve is the most powerful financial institution in the world and yet it is like the emperor without clothes. Ironically, the very force the Federal Reserve is most afraid of may be the only thing to save the Treasury.

Mirror mirror on the wall, what is the most powerful financial institution of them all?

The S&P 500, Dow Jones and pretty much all other markets seem to dance to the tune of the QE rhythm … and yet the Federal Reserve resembles the vain king portrayed in Christian Andersen’s “The Emperor’s New Clothes.” How so?

Rogue Interest Rates

The chart below shows the Federal Reserve’s monetary base sandwiched by the S&P 500 and the inverted 10-year Treasury Yield (Chicago Options: ^TNX).

The purpose of the chart is to show QE’s effect (or lack thereof) on stocks (represented by the S&P 500) and bonds (represented by the 10-year Treasury yield).

The 10-year Treasury yield has been inverted to express the correlation better.

I’ll leave the big picture interpretation of the chart up to the reader, but I have to address the elephant in the room.

Since the Federal Reserve stepped up its bond buying in January, the 10-year yield hasn’t responded as it ‘should’ and that’s very odd (the chart below shows the actual 10-year yield performance along with forecasts provided by the Profit Radar Report).

As of December 5, 2013, the Federal Reserve literally owns 12% of all U.S. Treasury securities and by some estimates 30% of 10-year Treasuries.

Icahn More Powerful Than Fed?

The Federal Reserve basically keeps jumping into the Treasury liquidity pool without even making a splash. If Carl Icahn can allegedly drive up Apple shares (with a 0.5% stake), why can’t the Fed manipulate interest rates at will?  This is just one of the many phenomena that makes investing interesting and keeps the financial media in business.

Conclusion

We do know why the Fed wants low interest rates. Rising yields translate into higher mortgage rates, and a drag on real estate prices. Eventually higher yields make Treasury Bonds (NYSEArca: IEF) a more attractive investment compared to the S&P 500 (NYSEArca: SPY) and stocks in general.

Ironically, what the Fed is trying to avoid (higher yields) may be the only force to save the U.S. Treasury. How can the Federal Reserve ever unload its ginormous Treasury position without the help of rising interest rates?

The emperor without clothes maintained his dignity (at least in his mind) as long as everyone pretended to admire his imaginary outfit. Perhaps a market wide realization that the Federal Reserve isn’t as powerful as it seems may ‘undress the scam.’

Regardless, the Fed’s exit from bonds would likely be at the expense of stocks, a market the Federal Reserve has been able to manipulate more effectively than bonds.

The Federal Reserve owns 12 – 30% of the U.S. Treasury market, but how much of the U.S. stock market has the Federal Reserve financed?

This stunning thought is explored here: Federal Reserve ‘Financed’ XX% of all U.S. Stock Purchases

Simon Maierhofer is the publisher of the Profit Radar ReportThe Profit Radar Report presents complex market analysis (stocks, gold, silver, euro and bonds) in an easy format. Technical analysis, sentiment indicators, seasonal patterns and common sense are all wrapped up into two or more easy-to-read weekly updates. We are accountable for our work, because we track every recommendation (see track record below).

Follow Simon on Twitter @ iSPYETF or sign up for the FREE iSPYETF Newsletter to get actionable ETF trade ideas delivered for free.

The Most Important Number in Finance is Falling … For Now

What’s the most important number in the financial world? You could ask Congress … but of course they couldn’t agree on it. The most important number in finance pulls almost every financial market in its wake. One more hint: The Federal Reserve (thinks it) is in control of it.

What is the most important number in finance?

GDP, unemployment rate, consumer confidence, or CPI?

The most important number in finance is the 10-year US Treasury Yield (Chicago Options: ^TNX).

When this number changes, almost every other number in finance changes.

The 10-year yield nearly doubled since May. The 7-10 Year Treasury Bond ETF (NYSEArca: IEF) dropped as much as 10%, a huge move for Treasury Bonds. The iShares Barclays 20+ Treasury Bond (NYSEArca: TLT) fell as much as 16%.

With rising yields came higher mortgage rates. But it doesn’t stop there. The yield rally also stifled stocks’ performance in two ways:

1) Low interest rates make bonds less attractive to investors and force them to move into stocks (NYSEArca: VTI). Bernanke calls this much-desired side effect the ‘wealth effect’ (although it robs retirees of their income).

2) Rising interest rates cause higher loan rates for businesses. This puts a squeeze on the profit margin and ultimately the stock price.

Yes, the 10-year yield is arguably the most important number in finance and therefore the chief target of Bernanke’s QE programs. The Federal Reserve buys its own Treasury bonds in an attempt to drive interest rates lower.

In the financial heist game it’s called an inside job.

Ironic QE Revenge

Ironically for much of 2013, the 10-year yield has been revolting against its puppet master (the Fed). The almost unprecedented 2013 yield rally is the opposite of the Fed’s objective.

The chart below plots the S&P 500 against the 10-year Treasury Yield.

1) The green box highlights the unwanted, unexpected and unprecedented yield rally.

2) The solid red lines marks yield resistance mentioned by the September 8 Profit Radar Report: “Yields have been rising dramatically, but may be at or near a top (at least a temporary one). As long as yields stay below 3%, odds are starting to favor falling yields and rising Treasury prices.”

Yields tumbled as much as 12% since.

3) The dashed red line shows what the S&P 500 (NYSEArca: SPY) has done since the meteoric yield rally: The S&P 500 is essentially flat and has been range bound since May. Apparently QE money is still finding its way into stocks, but rising yields prevented further gains for stocks.

4) A closer look at the correlation shows that rising yields are not always bad for stocks and shouldn’t be used as a short-term indicator.

Yield Outlook

The long-term trend for the 10-year yields seems to have changed from down to up. Over the short-term, yield may drop a bit further to digest the recent rally.

As the U.S. politicians are ‘impressively’ demonstrating (debt ceiling battle), U.S. Treasuries are not without risk. Even if/once an agreement is hammered out, the long-term futures for Treasuries doesn’t look bright.

As mentioned earlier, the Federal Reserve is deliberately inflating Treasuries. At one point the much-feared taper will begin. Via a brilliant preemptive move – probably in an effort to deflect responsibility – the Federal Reserve has already warned of a market crash (not caused by the taper of course). More details about the Fed’s market crash warning can be found here:

Surprising Fed Study – Is it Warning of a Market Crash?

Simon Maierhofer is the publisher of the Profit Radar Report.

Follow Simon on Twitter @ iSPYETF or sign up for the FREE Newsletter.