Bernanke's Operation Twist II Has Failed

Last Dec the Fed hinted at Quantitative Easing (QE), where among other actions the Fed would print money by buying bonds in the open market (creating money by putting fresh Dollars into the seller's bank accounts without any offset somewhere else).  Last Mar the Fed Chmn Bernanke announced a specific plan of $1.2B of open market purchases, of which $300B would be Treasuries (later clarified as $1.25B of mortgage-backed securities and $300B of Treasuries).  His stated intention was to lower interest rates by paying above market prices for the bonds (higher bond price results in lower interest rate).  He is about half-way through with this plan, and yet interest rates have risen quite a bit, with 30-yr mortage rates now around 5.8%, much higher than Bernanke's 4% target.  The WSJ will report tomorrow that the Fed is reconsidering this method of QE.  As the article notes: 

Yields on 10-year Treasury notes fell Thursday to 3.862%, after Wednesday's brush with 4%. But they remain sharply higher than March's 2.5% ... If government-bond rates rise too much too fast, they could short-circuit a recovery by choking off consumer and business borrowing and spending.

What is interesting about the rest of the article is how confused the punditry is.  Are rates rising due to inflation fears?  Or a recovering economy?  Or foreign buyers swapping down to short-term bonds?  (In an interesting juxtaposition, a recent WSJ columnist recommended bying shorter term CDs to manage the uncertainty of inflation vs recovery risk).  Or is it due to the bond market calling Bernanke's bluff?  If the latter, Bernanke is about to blink. 

I find the confused rationale for rates rising a bit much.  The Fed watchers need only look at history to see the limits of the Fed's ability to manage rates in this fashion.  I have written before on Operation Twist, an ill-fated attempt by the Fed to use the same QE technique to keep rates low.  It flopped - rates rose during the whole time of Operation Twist - and it left a horrific legacy: the Great Inflation of 1966-1982. 

So why are they really confused?  Prechter put out one of his better EWT's tonight, laying out why the fears of inflation and the hope of recovery are all about to be washed away in the coming events.  Worth a close read.  The current circumstance is an example of where his Socioeconomic viewpoint is helpful to cut through the confusion.  Man is a herd animal and the herding instinct is strong, but split into two cmaps: inflation vs recovery. The stock market counter-trend rally has emboldened the bulls, and sentiment is rising to expect a recovery just around the corner.  Same sort of psychology marked 1930.  Hence the confusion is really over which herd to join: the ones fearing inflation, or the ones expecting recovery?  It is NOT over the soundness of QE, which has failed when attempted previously, by the Fed and others (such as Bank of Japan.)  And now is another example of the Fed's impotence. 

Comments

[RNB]

Yelnick,

Maybe the Fed knows that we are in a deflationary environment? Thus, purchasing bonds will result in a profit (assuming that the issuer does not default). The QE was used to change the market psychology. From the March lows, the rise in the markets have allowed the big bank holding companies the opportunity to recapitalize.

Thus, in this case it was "Mission Accomplished".

[Mamma Boom Boom]

This is the way I have described it on my site:

[Bonds]
LONG TERM: - Sell - Yield spreads reached a record high this week. Nobody wants to own the long end. Can you blame them? The government has now become the enemy of debt securities. It seems impossible that, collectively, we have elected 536 'children' to manage our affairs. But, that's what has happened.

[I. Sosceles]

It's interesting to see how many bankers and politicians are still gaming the system. We are NOT capable any longer of controlling the rot.

[Mamma Boom Boom]

DG,

You made the statement "there is no evidence that the move from the March lows in an impulse, so since it is corrective, the majority of it will have to be retraced."

How can a so-called accomplished neo-waver make a statement like that?

I await your defense, on pins and needles.

You friend

[DG]

Ned,

I simply followed the NeoWave rules on Impluse wave construction and deduced that the move has been corrective. Even if one doesn't have the patience to wade through the text of the rules in Chapter 3 of MEW, one can look at the diagrams in Chapter 5 and see that the move up from March doesn't fit any of the Impulsive structures. Has the rally been substantial? Sure, there is no denying that, but that is a different issue from the Impulsive/Corrective issue.

Since the move is not the A-wave of a Zigzag formation (otherwise it would take on the form of an Impulse), it can, at best, be the A-wave of another type of Corrective pattern. Since all other Corrective patterns aside from a Zigzag typically retrace at least 61.8% of the initial move, I say that the "majority" of the move will be retraced.

Now, that's if I were under the impression that the move from the March lows was in fact the initial leg of an Elliott Wave pattern, which I am not, since the pattern playing out, in NeoWave terms, is much more bearish than even that.

[Mamma Boom Boom]

>>Has the rally been substantial? Sure, there is no denying that, but that is a different issue from the Impulsive/Corrective issue.<<

That's not what I question. I agree that it most certainly is corrective. The same analysis is on my website. And since you have decided to be civil, I'll tell you what I do question.

Isn't it true in N.W. as well as in E.W. that if a move is corrective then the prinary trend is the other direction. That being said, the move in question would have to 'more' than be retraced.

[DG]

Ned,

In the context of my statement, I was responding to a question about the possibility that the pattern Neely thinks is in effect might be the wrong pattern. I was saying that even if Neely's current wave count (which does imply that the move since March will be more than retraced), is incorrect, the corrective nature of the move up since March AT LEAST implies a significant amount of it will be retraced, even if the entirety of it isn't.

[Mamma Boom Boom]

Makes no sense...........

[DG]

What doesn't make sense about it? Someone asked me "What pattern might be in play if Neely is wrong?" I said, "I'm not exactly sure, but since the move from the March low is corrective, the majority of it will be retraced".

For example, if the move from March was the A-wave of a Flat ending a Complex Correction that began last October, in which the move down from January to March was the X-wave, the current move up would be Corrective, but not necessarily be completely retraced, but it would be retraced at least 61.8% (hence the word "majority" in my initial response). That retracement would then be followed by a C-wave up to approximately where we are now or a bit higher. That C-wave would then be completely retraced once the primary trend took over.

If the move from March was a Triangle, a similar scenario would play out in the initial retracement level, since the B-wave of a Triangle typically retraces more than 61.8% of the A-wave.

[anon_aka_TERA BAAP]

it is IMPOSSIBLE for this market to make a meaningful move lower!!!

any dip, ANY RED whatsoever will be bought!

be LONG, or be WRONG!

man, i am loaded to the GILLS with calls on GS, XOM, and SPY!!

i usually sell my calls at Friday's close to blow some free cash on the weekend..but next week is gonna be HUGE UP!!

i wonder what LIQUIDTY INDEX is saying?

HAHAHAHAHAH

[Mike McQuaid]

NDX is making a fractal formation subsequent to May 26 that mirrors in miniature the impulsive running correction thats imbedded in the action from March 9 to May 26. The April 2 gap is the "big brother" to the gap on June 1, both occupying the early action of the B wave of their respective running corrections. I used both daily and 60 minute charts to observe this action.
So the primary degree 2 wave label is May 26.
If this scenario continues, the summer should hold out a rally that goes like gangbusters.

[cole]

This gangbusters rally is about to enter it's steepest upward part, a parabolic rise that should last 3-5 years minimum and carry the DJIA to 22,000.

[Mr. Elliott]

This gangbusters rally is about to enter it's steepest upward part, a parabolic rise that should last 3-5 years minimum and carry the DJIA to 22,000.

Posted by: cole | Friday, June 12, 2009 at 07:59 PM

This rally has been going for 3 months. Even if I assume that somewhere in all that overlapping grind up from the beginning of April, there was a wave 2, I'm now supposed to believe that wave 3 will last 12 to 20 times as long as wave 1, at a minimum? The "with the trend" waves of an impulse formation are more likely to take approximately the same time, although the extended wave has a faster velocity, enabling it to cover more ground than the other two "with the trend" waves.

[Forkoholic Serge]

FSN with Steven Hochberg
http://cid-233c658fde78d41a.skydrive.live.com/self.aspx/Public/FSNTW061209.asx

a lot of "Not quite sure" and "maybe" "could see" "not 100% sure" "usually" :)

[cole]

My method is a combination of 1. fundamentals and 2. fading consensus on this and four other "Elliott" websites. It's nothing against the people here because you're bright and hardworking but there is just something eerily (errily?) wrong about the predictions. Whoever has said Prechter --to take another example-- offers bad advice has undoubtedly never tried fading it. Prechter has been an extaordinarily reliable moneymaker for me.

[Upstart]

That was one of the better Theorists. Psychology toward inflation seems to be another example of the majority looking in exactly the wrong direction right at the turn.

I would be interested in the opinion of you wise people as to whether the bear market began in 2000 or 2007. I think it has implications for how long this wave 2 can last.

Heads up: If the market holds up as little as 6 more trading days, we'll be in week #89 from the top.

[Upstart]

Yelnick, I know you've said somewhere, but I can't remember your take on whether 2002-2007 was a b-wave or wave 5. Could you share that? Thanks.

Upstart

[yelnick]

Upstart, let me answer that question in a high level post.

[Upstart]

That would be great, yelnick.

I guess I feel like the rally up to 2007 had the ultra-phoniness of a b-wave when you consider the economic fundamentals, and the rally up to 2000 attended a stronger economy and seemed to be where the general public was extremely engaged in stocks, CNBC (or whatever it was called then) was really booming, etc. - that seemed like a fifth to me.

[vipul garg]

with T notes indicating 'flight to safety' soon, gold consolidating before a surge for 'safe heaven' , .. equity markets have little or no time ..
it will be a slow and steady fall accelerating only when eurodollar reverses.
so next leg of severe weakness should come from eurozone.