Yield Curve Control! That sounds like a tagline from a Judd Apatow movie, but instead it is the new mantra of the Jerome Powell-led Fed. Apatow movies are often marketed as being "From the Guys Who Brought You...", so we market participants should be aware that this is the same Fed that brought us Operation Twist and countless other cockamamie policies. The basis of yield curve control is the Fed's admission that, historically, it has only been able to control short-term interest rates, but that most of the money invested in the bond market is invested in longer-term maturities.
The bond market is relentlessly efficient, much more so than the bubble-loving U.S stock market, in my opinion. Look at Bloomberg's U.S Rates and Bonds page and feel free to draw conclusions from a yield curve that really isn't curved at all. When the peak of the curve -- out 30 years mind you -- is yielding 1.38%, one could make the case that there is no yield curve in the U.S. It's just a long slightly-less-than-flat line that reaches a crescendo at a level that for many of the prior 80 years of the Fed era would have been considered a very low short-term rate.
So there is no yield curve and therefore there is nothing to control. It's just a wall of free money. But who does that really hurt? Isn't everyone happier to pay a lower monthly payment on their home, car and credit cards? Sure, that's true. History has shown us that lower interest rates are stimulative. The problem the Fed boxed itself into (and this was Powell's predecessor, Bernanke) is that once you go to zero-percent short term rates -- as the Fed first famously did on December 16, 2008 -- there really is nowhere to go from there. So what does a meddling, feckless, drunk-with-power Fed Chair do? Well, go after long rates, and that is exactly what the Fed has done with its quantitative easing programs, which also started under Bernanke in November 2008.
This is already a verbose Real Money column, so I would point you to this article from the St. Louis Fed if you would like to educate yourself on the history and undertaking of yield curve control. It's horrifying. It's like going into a government office and waiting 2.5 hours to have some pinhead explain something to you in excruciatingly basic terms that are geared for the average 5-year old. But this is who we are dealing with here. Powell and Co. think they have all the answers, but today's horrible initial jobless claims figures show, once again, that they have no grasp on the extent of the Covid-19 depredation in the real economy, and certainly no idea how to fix that problem.
But, hey, the Nasdaq's at an all-time high today, and the S&P 500 is very close. Who cares? Well, unbridled inflation is not good for everyone. The first casualties of prolonged extended periods of inflation are the banks. They simply can't match the risks inherent in lending long with the costs of collecting (via deposits) short, so margins are squeezed. Chase is already paying zero on my checking account, so I don't think they are going to go any lower than that.
The Financial Select Sector SPDR Fund (XLF) has been a dog this year, with a nearly 10% decline to today's level of $24.34, but it is up more than 40% from its 52-week low of $17.49 reached in late-March. But which stocks compose XLF? Well, just who you would expect. Berkshire Hathaway (BRK.A) (BRK.B) represents about 15%, JPMorgan (JPM) more than 10%, and Bank of America (BAC) more than 7%. Buffett is a genius at pulling earnings rabbits out of his hat, as he did with BRK's second quarter, but this is a horrible time to be running -- or investing in -- financial institutions. That was evident in Berkshire's disposal of Goldman Sachs (GS) (the 10th largest constituent in XLF) in favor of gold in the second quarter.
The Oracle himself is telling you that this is a difficult time for the U.S. financial system. The problem, of course, is our dependence on that very system. I have seen this movie before. Nasdaq investors talk of "disruption" or "page views," or whatever the buzzwords are these days, and believe that equity financing (through elevated stock prices) is all that is needed to keep the tech economy going.
That's not true. Big tech companies have banking relationships just like you do. When the banking system is not healthy at its core, neither is the stock market regardless of its current price level. I wish I had confidence in the Fed to take the actions needed to control inflation and allow banks to make a decent return on their capital. I do not. So, I am sticking with some very obscure names -- in sectors like oil tanker shipping -- and watching my firm, Excelsior Capital Partners, deliver very strong returns since March. I believe those returns are sustainable, and I couldn't be more convinced that Powell's Mirage -- and its impacts on the broader U.S. economy -- are quite the opposite.