Fear of withdrawal

The chairman of the U.S. Federal Reserve testified before Congress this morning/now and he mentioned when questioned that it may be possible to raise interest rates at a sooner schedule than he and the Fed had previously forecast. The markets, which had been on a moonshot prior to the comments, immediately reversed course.

Most notably the inflation trade.

A junky who hears through the grapevine that his supplier is in trouble with the law and may not be there to provide the drugs he desires has an immediate surge in adrenalin and anxiety. He has been through withdrawal before and just the thought provokes a form of withdrawal even before the body has started to withdraw.

The world capital markets are addicted to easy money. This is not a recent addiction. Since the days of "Easy Al" Greenspan this phenomenon has persisted.  Any "crisis" in the money markets worldwide has since then been assuaged with increased

liquidity and lower interest rates.

If the economy is in fact curing itself the markets will eventually recover even if stimulus and easy money is withdrawn. BUT it will not be easy. Time will tell, of course, but the thought of tightening of monetary policy will temper the enthusiasm. And given the exuberance of late, a correction would be appropriate this summer.

It occurs to me that while one part of Congress is violating the public servants of the IRS another committee is politely questioning the head of the federal reserve bank. I wonder if Bernanke feels any threat of persecution if he makes a mistake in monetary policy. Or continues to make mistakes. Depending on your money philosophy......



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Later today:
The stock market ends down sharply. The threat of a rise in interest rates has historically had a chilling effect on the stock markets.
In 2007 the bond market had made a large head and shoulders pattern and price looked set to plunge through the floor. (Interest rates to go up) The result was the bursting of the housing bubble and the end of thecommodity bull market as well as the financial markets the world over.

Every time these cheap money addicts smell a rise in rates coming they panic. Compare a long term chart of the bond market with a long term chart of the stock market. Note that whenever interest rates are poised to rise and bond prices are poised to fall the stock market swoons.

It may happen again. Todays decline may be the opening shot of an adjustment that the world markets may have to make if we ever want to live in a world where the markets are truly free and businesses make money the old fashioned way. "By earning it".

It will take a while. Market tops are broad. They take time. A market top is a process, not a discrete event. Bottom pickers will come back in, for they missed the rally the first time. The public is coming in to the market. That is another good reason for a top.... Who else is left to buy when the public is in.

The big BUT is all of the money in the bond market. For all that money to go into stocks, bonds have to go down. But if the FED props up the bonds when the stock market gets weak, mistaking the stock market for the real economy, the money will stay in the bonds.... A conundrum. In other words the economy has to actually get STRONGER for interest rates to go up AND for the stock market to go up.

Corporations have to actually have good earnings in an environment where credit is tighter. And it is a big leap of my imagination to think that the consumer of corporate goods will spend more while consumer credit is restrained. This is because the worker/consumer has no bargaining power. Wages do not keep up with inflation. Credit has been used as the crutch to support the consumption of goods, in the place of  wage inflation and worker participation in the increases in productivity.
This is why myself, and many, do not have faith in an economy enduring rising interest rates.

Look at the charts...................

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