FED DECISION - EQUITIES WIND UP? OR UNHOLY UNWIND?

I know that I have written about the coming equities market correction for about 3 months now. I am also acutely aware that there will be a growing band of my readers beginning to doubt the call.
It is also evident even some of the brighter economic thinkers are questioning if there is an equities bubble!  Are they joking? Poking at me for a reaction? SERIOUSLY!

With all this in mind, the Fed decision tomorrow is the biggest decision since October when the infamous taper “head fake” caught the market by surprise. It seems to be some kind of game for the Fed, jawboning, taper talk, on again off again. Is it a test of market reaction? If it is then the Fed members are clueless. Market reaction should be obvious, just look at how it panned out in October!

The fact is, the decision that will be handed down tomorrow is HUGE. Make no mistake, I would love to see a taper for the economy, to end this insanity. I want my readership to understand that the underbelly of debt cannot be sustained and that that the only thing preventing the ultimate deleveraging depression is the Fed intervention in the bond market, the $85bn in QE life support.

So what do I see happening tomorrow? What will the Fed do? How will that play out for the equities market? What impact will it have on both the USA domestic economy and the global economy?


WHAT DO I SEE THE FED DOING TOMORROW?
Tomorrow I am tipping something special. Firstly I am going to go on the record tipping NO TAPER. The Fed has said time and time again that a tapering of QE is DATA DEPENDENT. If you take the Fed at their word, then how could they taper into the weakest employment environment in over 35 years?

It is not just the weak employment environment that is of concern. If you delve deeper into the data recently released on personal income and outlays for October, the case for a Fed NO TAPER is all the more evident. Looking at the report, it states that personal savings as a percentage of income had fallen to 4.8% from 5.2%. It also lowlights the fact that proprietors income decreased by $19.7bn. Below is the link for your perusal.


http://www.bea.gov/newsreleases/national/pi/pinewsrelease.htm


 If the Fed were to taper into weakness it will trigger an equities market correction, the “unholy unwind” as investors are forced into deleverage mode amidst rising interest rates and increased margin demands. There is no doubt in my mind thata December taper will only be temporary and its effect on markets will have the Fed doing the UNTAPER dance early next year, followed by the INCREASE QE groove not long after.

With household savings at a mere 4.8% of total household income, the economy would fracture if a Taper induced interest rate rise were to manifest itself. To give readers an idea, an interest rate hike from say 4.5% to 5% on a $350,000 mortgage would cost the borrower around $110 per month extra on their mortgage.

 Assuming that the borrower has an income of $800 per week, saving 5% of that is $40 per week or $160 per month. That 0.5% interest rate hike reduces household savings by $110 per month on the mortgage repayments alone. This in effect, reduces the borrowers’ ability to save by more than half!

With savings already at critically low levels this taper inflicted interest rate blow would take all the steam out of the property market. It is for this reason along with the poor employment outlook that the Fed, in my opinion, will maintain the status quo of QE $85bn per month.
I feel that if the Fed maintains the status quo the equities market will flat line, rather than rise as the law of diminishing returns reduces the boost the standard $85bn gives to the markets.

Setting aside the NO TAPER which I feel is a given, what could the Fed do to try and get some more activity out in the economy? When you analyse the recent Fed minutes the topic of lowering the 0.25% interest the Fed pays banks for excess cash reserves is mentioned as a solution to stimulating bank lending into the economy. Right now the banks have around $2.5Tn dollars in excess reserves parked at the Central bank earning a pitiful 0.25%.

I believe the Fed will maintain the $85bn in QE and at the same time reduce this 0.25% interest rate to perhaps 0.15% in an attempt to drive banks away from hoarding cash at the Fed and lend a part of the $2.5Tn in reserves into the economy.


The reason I believe this reduction in interest rates WILL take place is simple. There is not enough credit being created, or money loaned into the economy to sustain current asset prices. Margin loans used to prop up the stalling equities market have surpassed levels prior to 2007 and available “margin credit” is almost dry.

When this margin credit dries up, there is no more play money to continue inflating the asset prices and the game is OVER.  Below is an article in Zero Hedge that supports my argument that margin debt has peaked and that the equity markets are now stalling due to “the ongoing collapse in investor net worth”


http://www.zerohedge.com/news/2013-11-26/margin-debt-soars-new-record-investor-net-worth-hits-record-low


The above article suggests that the collapse in investor net wealth means available “credit” with which to continue increasing leverage into the market is approaching critically low levels. The article was written at the end of November and it appears that the Dow Jones Industrial Average peaked on November 27th at 16,100 points. Since then there has been some deleveraging in an attempt to try and free up some credit and as I type this blog the Dow closed at 15,875 points.


A link to the DJIA monthly chart is copied below :


http://au.finance.yahoo.com/q/bc?s=%5EDJI&t=1m&l=on&z=l&q=l&c=

The margin loan credit availability case has strength and merit. It supports my view that the equities market is on the edge, a debt bubble edge! The market is screaming for gas, sputtering like an old beat up car running on fumes hoping the Federal Reserve gas station is just around the corner.


The Fed knows that QE is now not enough to keep the equities and property market bubbles from bursting. It needs to get the banks creating the endogenous money gasoline and lend to the economy, something they have been unwilling to do as is evident by the mushrooming $2.5Tn in excess cash reserves.


The Fed will, in my opinion surprise everybody tomorrow with NO TAPER and at the same time a cut in the interest rate they pay for excess cash reserves. This must happen if the Fed want to keep the economic improvement illusion going.


If they do that tomorrow, Gold goes much higher, equities go higher also, and the bearded man BERNANKE gives Yellen the hand pass from hell, the ultimate poisoned chalice… couldn’t have happened to a nicer man… oops I mean Woman!