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THE FED CAN MAKE IT HAPPEN!

It’s a busy day in the financial markets. The Federal Reserve has said they will be “data dependent” on whether to hike rates again at the end of June, or pause for a time at the 5% level. This morning we got data on durables goods orders being much worse than expected and new home sales much better than expected. The conflicting data heightens the debate whether the Fed should raise rates again or not, but all the while this is happening, the U.S. Treasury is busy borrowing a cool $36 billion from the markets via the sales of bonds today and tomorrow. The high energy costs and higher interest rates are clearly working to slow growth in the economy, and I will extend that by saying the entire global economy, not just here in the USA. Stock prices got a bounce higher with the strong housing data, but have rolled-over to negative territory in early afternoon trading. We have conflicting data, but a sharp rise higher for the U.S. dollar and a pounding for gold along with energy prices lower across the board.

I found it quite interesting the dollar is launching higher today with most of the market spin revolving around the great news for new home sales. I’ve been saying for some time now that the Federal Reserve and the U.S. Treasury have every intention to try and keep the U.S. dollar as the sole reserve currency to use in global trade.  It is their mutual tool of influence and control used around the world. It is imperative the dollar be preserved and with today as an official government borrowing day, it’s no surprise to see the dollar higher, bonds reversing to move higher, and gold getting absolutely hammered. If the Working Group on Financial Markets has anything to say, they would be screaming to “Buy our paper…paper dollars and debt!” “Do not buy that barbarous relic called gold!” and finally, “Watch us keep a lid on the oil price!” All those objectives are being met with the action in today’s trading.

I’ll come back to the Fed’s influence along with the U.S. Treasury’s influence over the markets, but first I digress to a few of the news headlines out this morning. Please remember that a successful debt auction is of utmost importance for today and tomorrow. We simply MUST sell the paper! Bloomberg gives the details as follows:

The Treasury sold $22 billion of two-year notes today. The monthly sale will be followed by a monthly auction of $14 billion in five-year notes tomorrow. The two-year notes were sold at a yield of 4.933 percent, below the 4.951 percent pre-auction average estimate of 11 bond-trading firms surveyed by Bloomberg.

The last auction of two-year notes drew a yield of 4.975 percent, the highest since December 2000. Two-year notes are more sensitive than longer-maturity debt to changes in the rate set by the Fed. The central bank raised its target for the overnight lending rate between banks for the 16th straight time on May 10, to 5 percent from 4.75 percent.

'Surprising'

The auction results were "surprising, given the next move by the Fed is one of restraint and tightening," said Richard Schlanger, who manages about $4 billion of fixed income assets, including Treasuries, at Pioneer Asset Management in Boston.

While two-year yields are lower than the Fed's target rate this month for the first time since mid-2003, demand is being bolstered by concern that declines in global stock markets foreshadow an economic slowdown, and by the historically narrow margins by which longer-maturity yields exceed two-year yields, William O'Donnell, head of U.S. government bond strategy at UBS Securities LLC in Stamford, Connecticut, wrote in a report today.

The analyst quoted in the article was surprised to see such strength in the bond market, but I am not surprised. The market was conditioned to receive the paper. Commodity prices have been moving lower and got nailed lower again today, gold was hit for a loss of $36, and the U.S. debt offering was well received by the marketplace. This is telling me we are definitely going to see an economic slowdown and the Fed probably wants to pause in their rate hikes sooner rather than later. I believe the Fed has wanted to slow the housing market from its previously torrid pace, but they don’t want to collapse all the “wealth” created in the housing bubble. They need to back-off!

If the U.S. economy is going to slow, you can believe the entire global economy is going to slow. As the dollar was falling recently, the spin on CNBC has investors moving into “emerging markets” to get a piece of the global growth, but the recent tumbling of overseas markets says the slowdown will be broad based. As money exits some of the emerging markets, it looks for a comparable home. Today’s report on strong new home sales just helped to increase investor confidence in the overall U.S. economy. I see this as somewhat of a flight to safety as the money invested in overseas emerging markets is now buying dollars to come home. Bonds are getting a bid with the thinking the Fed needs to lay-off on the rate raising cycle because the economy is already slowing.

Economic Reports

Aside from the Treasury debt auctions today, we got data on orders for durable goods and new home sales. Durable goods orders were expected to decline by 0.5%, but instead fell by a much larger 4.8% according to the Commerce Department. According to MarketWatch, “This was the first and sharpest decline in durable goods orders since January. The decline was broad-based. There was a sharp drop in aircraft orders. Only orders for metals and electrical equipment increased in April.” A slowdown is ahead and should work to keep downward pressure on stock prices overall and work to keep a bid in bond prices to keep interest rates from going through the roof. The Fed has wanted to slow down the booming housing market, but not cave-in the whole economy.

New home sales rose 4.9% to 1.198 million units annualized in April while expectations actually called for a decline to 1.135 million units. Sales rose in all regions except the Midwest and the median price rose 2.8% from the prior month to $238,500. With higher interest rates, the median price of a new home is only 0.9% higher than a year ago. Hot markets have seen some declines and overall, the price of a new home is not keeping up with inflation. The market makers are spinning this as a good report, but how much of the surprise sales increase is due to builders offering incentives to move inventory and also due to buyers accelerating the pace of their purchases before rates move any higher?

Probably the most serious question being bantered about in the market is whether or not the Fed can orchestrate a soft-landing for the housing market overall, or if we are going to see a “hard-down” for real estate prices. The Fed is going to slow down the economy, but, I believe, MUST stop soon to keep housing alive and inflating at a “healthy” rate. They need a soft landing for the housing market, therefore a pause in the rate hikes.

The Mortgage Bankers Association said today its application index fell 6.0% with the purchase index lower by 7.1% and refinancing lower by 4.3%. From one year ago, the application index is lower by 24.3%, the purchase index is down by 17.8% and the re-fi index is down by 31.7%. The 30-year fixed mortgage rate fell six basis points to 6.61% and the average one-year adjustable rate mortgage fell five basis points to 6.02%. It is obvious the housing market has slowed and the Fed needs to take a break from raising rates to make a soft landing for the real estate bubble, so they have to pause on the rate hikes for a good six months to let the markets absorb or catch up to the changes. A big question remains…how can the Fed stop raising interest rates if commodity prices are shooting higher, inflation is heating up, the dollar has moved sharply lower in recent weeks and gold recently tore through the $700 level?

The Fed and the government have been managing the markets with rhetoric and understated inflation data to contain INFLATION EXPECTATIONS. The Fed MUST continue to inflate, but make it look like the inflation is not really all that bad. The easiest way to attract buyers to the bond market, especially on an auction day is to hammer inflation EXPECTATIONS by driving gold, oil and gasoline lower. The money exiting commodity markets can easily find a home in Treasury Notes and Bonds. Simultaneously, an overall economic slowdown causes money to leave the stock markets and easily find a home in Treasury debt.

Right now, the Fed needs to show an overall slowdown, but also provide a soft landing for the housing market.  They need to contain inflation expectations in order to justify a pause in raising interest rates. I believe they will err on the side of caution and stop raising rates rather than risk a deflationary contraction that could lead to the ultimate demise of the U.S. dollar as global reserve currency.

Not Really My Idea

I have been looking at today’s market activity through the lens of some comments that I read two weeks ago. As I watch the inter-market movements between stocks, bonds, currencies and commodities, I believe Mr. Scott Middleton of Puplava Securities, Inc. nailed this one down! Back on Friday, May12th, Mr. Middleton wrote:

Time for a Correction?
by Scott Middleton

The commodities markets have been on a tear year to date. Some believe it’s the continuation of a bull market, some feel it’s representative of a blow-off top. Which camp an investor is in dictates how s/he would like to see their account managed. As a result, there are times when the short-term expectations have blinded one’s view of the long-term trend. We have been striving toward creating a balance between the short-term view and the long-term view, for all of the portfolios regardless of their objective.

From our perspective, commodities--all of them--are due for a correction of some sort. How deep and how long of a correction is difficult to determine at this point. It’s possible this expected correction started this week, then again it may not. Liquidity is still extremely accommodative in the markets for a continued bullish advance. However, it’s Jim’s belief that the Fed is set on taking a pause in the near term; however, he thinks that in order for them to do that, they first have to slow the commodities markets down. A correction in the prices of both Oil and Precious Metals could be just what the Fed ordered to initiate their pause. Furthermore, should the Fed be successful in creating such a correction, it likely would only be brief, as any pause in the Fed’s rate rising cycle will be viewed as a negative for the US Dollar and Bonds.

Based on the market activity today, it looks like Jim Puplava and Scott Middleton made the right call two weeks ago and were dead on their game! At the brokerage firm, Chris Puplava also makes contributions to the investment committee with his macroeconomic and fundamental analysis, while Ryan Puplava provides input with his technical analysis of financial charts. These guys have a strong team and I believe they are correct on what the Fed is trying to orchestrate. Looking specifically at today’s market, the Fed got EXACTLY what the doctor ordered!

The dollar moved higher with the good report on new home sales, government debt was well received at the Treasury auctions as a slowdown appears imminent, stock prices crawled back to slightly positive for the day with the U.S. economy being a safe haven relative to emerging markets, and commodity prices along with precious metals were pounded lower to calm inflation worries. The USA is still boss-dog of the global fiat currency markets and between the Treasury and the Federal Reserve, intends to remain in that position. With a Fed-induced economic slowdown ahead, I’ll be most curious to see if they will be able to continue attracting foreign investors to buy our paper, and simultaneously provide a soft landing to the housing bubble. The Fed began the rampant inflation by dropping interest rates to 50-year lows, now it will be up to them to stop the inflation without killing home prices and the global economy. The correction is here for commodities and precious metals, but remember this is merely a correction in a long-term bull market!

Have a Great Evening!

Mike Hartman

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