May the source be with you, but remember the KISS principle ;-)
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Vanguard Treasury Inflation Protected Bonds Funds (VIPIX, VAIPX)

News Coming Bond Squeeze Recommended Links Slightly skeptical view on core CPI Inflation, Deflation and Confiscation Vanguard High-Yield Corporate Adm (VWEAX) Pimco Total Return Fund
401K planning, Financial Groupthink and 401K Investors Delusions Investments Scams Notes on 100-your age investment strategy behavior in rigged markets 401K Investing Webliography Financial Humor Humor Etc

TIPS are government issued bonds designed to provide a certain pre-tax real return when held to maturity. You don't pay any commission or spread to purchase TIPS from the treasury, and if you hold to maturity, then there's no selling cost. This way you can isolate yourself from wide swings typical for Vanguard.  TIPS partially hedge inflation (the part of real inflation measured by CPI) and therefore could be a valuable addition for some investors in a 401(k) plan. You do not pay federal tax on interest so it can be help outside of tax deferred account. In other words do not buy TIPs funds buy actual bond from Treasury.

Vanguard TIPs funds should be viewed as a rolling ladder of individual TIPS which have a specific duration. This structure exposes investors to realized gains and losses as well as huge fluctuations in value. For long term regularly scheduled contribution (and distributions !), those impacts would theoretically average out.

There is a growing sense that the monetary and fiscal policies required to exit the great recession of 2008/2009 are laying the groundwork for future inflation. This sentiment alone can have an impact on TIPs prices, regardless of the future course of inflation and it did in June 2013. Also Vanguard TIPS fund is an  intermediate term bonds fund and as such it is very sensitive to potential move of interest rates. All that said the drop in May-July undermines confidence is this type of funds, as volatility is way too much for 401K investor close to retirement (and as such having substantial holdings) to digest.

In case of mutual fund if can hold TIPs for the period longer then duration, you might be able to solve the problem of fluctuation of TIPs mutual fund prices. Which again are considerable (more then 10%).

According to Hewitt research, specialty bond funds, including TIPS funds, increased by 10% in 2009. Vanguard’s 2009 retirement plan survey data indicated 19% of its 401K plans offer a TIPS funds.

TIPS pay interest twice a year, at a fixed rate. The rate is applied to a principal value which is adjusted for accrued CPI inflation. Interest payments rise with inflation and fall with deflation. When a TIPS matures, investors are paid the greater of its adjusted principal or original principal, providing a hedge against both inflation and deflation.

The yield on a conventional Treasury bond that pays a fixed coupon must also include an expected inflation component to compensate the investor for future inflation. Its yield therefore includes two components:

With TIPS, the coupons and principal adjust relative to CPI so its yield is simply the real interest rate. The difference between the two yields reflects, among other things, expected inflation.

Traditional retirement portfolio planning suggests that as plan participants approach retirement they should increase their allocation to bonds to avoid the volatility of equity and other inflation hedging assets such as real estate or commodities. However, as their bond exposure grows, inflation replaces volatility as a primary risk. At a modest 3% inflation rate, prices can double over the life expectancy of the average retiree.

401 plan typically offer very few bond funds. The majority of 401(k) plans offer either a stable value fund or a money market fund and maybe an intermediate bond fund or two. None of these funds hedge inflation. Long term  bonds can perform very poorly in the expectation or real inflation  or rate spike as yields increase. With time they catch up, but the timing of this catch-up depends on the nature of the bond fund.

Money market returns are likely to increase after an inflation spike, but their response depends on monetary policy and have limits. Stable value funds and short term bond funds can adjust to inflation  better than money market funds, but there is a lag. The extent of the lag  depends on their portfolio structure, duration and cash flows.

TIPS investments can provide a conservative way for 401(k) plan participants to diversify their fixed income portfolios and hedge a slow growth, inflationary environment.

Vanguard  Inflation-Protected Securities Fund (VIPSX and  VAIPX)

Vanguard  Inflation-Protected Securities Fund (VIPSX ) is $43 billion actively managed fund , which has a duration of 8.5 years and an average maturity of 9.3 years. You're paying Vanguard 0.2% a year, so over 10 years (1.002^10), you're paying approximately 2% or one year interest.  Admiral TIPS Fund (VAIPX) has lower expense  .11%

While TIPS mutual funds are better then nothing as an inflation hedge or as a fixed income portfolio diversifier in a 401(k) plan, there are three aspects that should be considered in determining their suitability:

  1. While TIPS are relatively risk-free in the long run, they can be quite volatile in the short run. Naïve investors might assume that the inflation adjustment is the primary source of total returns for TIPS. However, the change in real interest rates, positively correlated with investors’ inflation expectations, has historically had a more significant impact on TIPS returns. TIPS mutual funds like Vanguard VIPSX can lose around 10% of its value, even with rising inflation expectations (as happened in July, 3013, when the fund dropped from 12.11 to 10.58 in six month).
  2. If TIPS mutual fund is held for the period smaller that average maturity, investors lose their fixed real rate of return.
  3. Fluctuations in the yield on newly issued TIPS result in changes in the prices of existing securities, exposing mutual fund investors to capital gains or losses.  This market price exposure means that holding TIPS mutual funds for short periods of time negates their inflation hedging capabilities and exposes investors to almost a similar level of price risk as nominal Treasuries. Ideally you should hold mutual fund forever: only at this point you have no risk of capital losses due to changed interest rates.

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[May 12, 2015] An Open Letter to Bill McNabb, CEO of Vanguard Group

Economist's View
Stephen G. Cecchetti and Kermit L. Schoenholtz (sort of a follow up on the claim that financial reform is working -- perhaps -- but as noted in the post below this one there is more to do):
An Open Letter to Bill McNabb, CEO of Vanguard Group: Dear Mr. McNabb,
We find your WSJ op-ed (Wednesday, May 6) misleading, short-sighted, self-serving, and very disappointing.
Vanguard has been in the forefront of providing low-cost, reliable access to U.S. and global capital markets to millions of customers, including ourselves. Following the financial crisis of 2007-2009, the firm naturally should be a leader in promoting a more resilient financial system. Your op-ed sadly goes in the opposite direction.
Let's start with the most stunning example: your defense of money market mutual funds. MMMFs are simply banks masquerading as professionally managed investment products. Like banks, they engage in liquidity and maturity transformation. Like banks, they faced runs in 2008 that ended only when the federal government provided a guarantee that put taxpayers at risk. Even with that guarantee, the government still had to support many healthy U.S. corporations with household names that – having previously relied on MMMF purchases of their commercial paper – suddenly faced a severe credit crunch. And, to limit a fire sale amidst the crisis, the Federal Reserve had to provide special funding to buyers to help MMMFs unload their assets.
Unsurprisingly, fund sponsors and their clients – both creditors and borrowers – want to keep these opaque federal subsidies (especially the implicit guarantees that only become explicit and transparent in a crisis). Like them, you make the false, but popular claim that power-hungry regulators (who wish to limit the subsidies that make future crises more likely) are attacking (taxing!) Main Street instead of Wall Street.
In fact, the investment company industry captured its primary regulator long ago, and hasn't let go. The Securities and Exchange Commission's 2014 "reform" of MMMFs is exhibit A. It almost surely makes these funds more, not less, liable to runs (see here and here). And – what a surprise – Congress seems to find protecting U.S. taxpayers from contingent liabilities (like implicit financial guarantees to your industry) less attractive than the largesse of financial lobbyists. Even the voluminous Dodd-Frank Act didn't address MMMFs! :

After quite a bit more, they conclude with:

As the CEO of one of the largest mutual fund companies in the world that is dedicated to serving and protecting small investors, you should be in the vanguard of advocating reforms that enhance stability.
Instead of complaining about regulation under the guise of protecting Main Street, you should highlight the vulnerabilities in our financial system and make the case for efficient regulation that treats all activities equally. You should also promote investment vehicles that are likely to prove robust in a crisis, while warning about existing products that probably won't be.
Only greater resilience in the system can make investors confident that capital markets here and elsewhere will remain strong. That is in Vanguard's interest, too.
Stephen G. Cecchetti and Kermit L. Schoenholtz
anne -> anne:

Stephen Cecchetti and Kermit Schoenholtz are intent on undermining the most important stock and bond investment vehicle for moderately wealthy investors. Vanguard sets the finest of examples for the entire investment industry.

pgl -> anne:

Maybe you are being paid by Vanguard but you are wrong. You are not qualified to comment on financial economics. Stephen Cecchetti and Kermit Schoenholtz are.

And they are not trying to undermine anyone. They are simply telling the truth. Repeat your garbage all you want but it is garbage.

mulp -> anne:

Anne, unless you call the FDIC bailout of the money market funds, and the Fed providing liquidity to them in 2008-9 totally wrong and you should have suffered losses in your holding in MMMF as they marketed to market (breaking the buck) and froze withdrawals until they could liquidate their holdings, or alternatively, declared bankruptcy, then you are totally bought into the free lunch economics of Friedman, Reagan, and all the bank lobbyists dependent on government handling the losses while they reap the profits.

I remember the debate in the late 60s and early 70s on money market funds. We (the People) were assured that MMFs would never be seen as banks by any one investing in them because everyone would know the MMF would someday lose value and in the process freeze the assets for some length of time until the fund could be liquidated.

In other words, not one person putting money in a MMF would see it as a bank that pays higher interest. More importantly, no business or corporation would ever confuse a MMF with a bank.

In 2008, it is clear that the promises made four decades earlier to allow unsophisticated investors access money market funds without lengthy notice of intent to withdraw funds was all a lie, or a belief in tinker bell, pixie dust, and free lunches.

The money market funds should have been left to collapse in 2008 to destroy all faith in them as safe for individuals to use, and in the process, "destroy trillions in wealth" held by tens of millions of upper middle class workers.

I would have lost more than I did in 2008, but the demand for greater government control of the financial sector plus greater social safety nets would have followed.

This is the first time I've seen someone besides me state that mutual funds are banks as we knew them in the 60s, except they pay nothing for the protection of FDIC and Federal Reserve membership.


May 9, 2015

Fees on Mutual Funds Fall. Thank Yourself.

Wall Street is reaping mounting revenue from mutual funds and exchange-traded funds, yet investors are paying lower fees.

That sounds like a good deal for the millions of people who use the funds to invest their savings, and a great deal for the companies that run and sell the funds.

But that win-win situation is not quite as benign as it would seem. Many investors are still - often unwittingly - paying huge fees that cut into retirement savings.

A new Morningstar study offers an excellent explanation of what is happening. The report, "2015 Fee Study: Investors Are Driving Expense Ratios Down," found that, by one measure, mutual fund and E.T.F. fees paid by individual investors had dropped significantly - 27 percent - over the last 10 years. But it isn't mainly because Wall Street fund managers have been reducing fees. The study found that investors have been voting with their feet, moving money from expensive funds into cheaper ones, like index funds. That drives down the asset-weighted cost of mutual funds, skewing the statistics.

"It's not mainly thanks to the efforts of the fund companies," Michael Rawson, an author of the Morningstar study, said in an interview. "It's mainly because people have gravitated toward lower-cost funds."

There's a good reason for the migration to lower-cost funds: They tend to outperform higher-cost ones. As I've written recently, most actively managed mutual funds don't beat the market; those that do beat it rarely manage the feat consistently. Many consumers have gotten the message. Of the 100 lowest-cost funds on the market in March, 95 were index funds that merely try to match the market, not beat it, according to an unpublished study by the Bogle Financial Markets Research Center. Many investors have chosen index funds.

Yet because of the peculiar economics of the asset management industry, fund companies are still doing great. The companies that run the funds have been reaping outsize rewards because as fund assets have grown - thanks in part to the market's terrific performance over the last six years - the companies' own costs have declined.

That's because of economies of scale that the companies don't share fully with customers. "The cost of individual funds has dropped, but the assets have gotten so much bigger that the companies' revenue from fees has grown tremendously," Mr. Rawson said. "They could be sharing more of those revenues with consumers, but they're not."

Using publicly available documents, the Morningstar researchers estimated that in 2014, fee revenue from all stock and bond mutual funds and E.T.F.s reached a record high of $88 billion, up from $50 billion a decade earlier. Assets under management grew 143 percent, and industry fee revenue surged more than 75 percent. The asset-weighted expense ratio - the funds' publicly declared expenses divided by the actual money that investors put into them - declined, too, but only by 27 percent. "The industry - rather than fund shareholders - has benefited most," the report said. Mr. Rawson, a Morningstar analyst, wrote the report with Ben Johnson, director of global E.T.F. research at the company.

The details are fresh, but the economic machine that propels the asset management business has been whirring along for decades. In a telephone interview last week, John C. Bogle, the founder of Vanguard, the industry's low-cost leader, said that in some ways, running a fund company is like operating a factory. As you ramp up production, it becomes cheaper to produce additional items because important costs - fixed costs - don't rise.

For an asset management company, he said, a stock or bond portfolio is the core product and the intellectual exercise of selecting stocks and bonds for it is a fixed cost. "When you set up and run the portfolio, it's not much more expensive to do it when your fund has, say, $1 billion in assets, than when it had only $30 million," Mr. Bogle said.

"Unless you cut your fees drastically, you're going to generate a lot more money for your company as assets grow," Mr. Bogle said. "But do you think the industry wants you to understand that? Absolutely not. Most fund companies aren't passing those savings on to investors."

Vanguard, which is owned by shareholders of its funds, passes along most of the savings. Morningstar found that Vanguard's average asset-weighted expense ratio in 2014 was 0.14 percent, lower than any of the other top asset management companies and lower than 0.64, the current asset-weighted expense ratio for all funds.

Mr. Bogle says companies should charge a modest, flat fee for setting up a portfolio - not a percentage of assets, charged annually, which is the current practice - and give fund investors the rest of the money. That would not generate the splendid profits that asset management companies and their owners have enjoyed, however.

No wonder that in a rising market, shares of publicly traded asset management companies tend to outperform their own stock portfolios. For example, since the beginning of March 2009, the start of the current bull market, through April, the stock of BlackRock, the giant E.T.F. company, returned 27.1 percent, annualized, compared with 20.8 percent annualized in the iShares Core S&P 500 E.T.F., a BlackRock fund that tracks the Standard & Poor's 500-stock index, according to Bloomberg. You would have been better off investing in BlackRock, the company, than in its own S.&.P. 500 index fund.

Why should mutual fund and E.T.F. investors care about the economics of fund expenses? Because it's the dark side of compounding, a force that can be magical when it works in your favor:.


Vanguard 500 Stock Index Fund

Average annual returns as of 3/31/2015

3/31/2014 ( 12.56%)
3/30/2012 ( 15.93)
3/31/2010 ( 14.29)
3/31/2005 ( 7.89)

08/31/1976 ( 11.05)

Vanguard Long-Term Investment-Grade Bond Fund

Average annual returns as of 3/31/2015

3/31/2014 ( 14.54%)
3/30/2012 ( 8.42)
3/31/2010 ( 10.34)
3/31/2005 ( 7.49)

07/09/1973 ( 8.71)

anne -> anne:

This is what Vanguard has meant for modestly wealthy conservative long term investments since the 1970s. From Warren Buffett to David Swenson, the chief investment officer at Yale, Vanguard has been the recommended vehicle for ordinary stock and bond investors.

Harming Vanguard would be a tragedy.

anne -> anne:

"Harming Vanguard would be a tragedy."

The point is harming Vanguard would be harming the ordinary investors who in effect own Vanguard since Vanguard is indeed a "mutual" fund company, a company owned by fund investors.

Dan Kervick -> anne:

The well-being of modestly wealthy long-term investors is only one factor to consider in relation to the well-being of the entire US and global economy. Shouldn't we broaden the discussion?

anne -> Dan Kervick:

Vanguard forms a model for investment well-being in the United States.


Anne, having liquidity requirements is not a tax on investors. When McNabb represents it as such, he is lying. There are no new fees or taxes imposed. It just requires that stock funds hold a percentage of assets in safe bonds in order to handle redemptions in panic situation rather than rely on taxpayer bailouts.

Investors are still entitled to 100% of the returns from the fund. Yes, it is true that the total return may be somewhat less because bond returns are typically less than stock returns. However, that isn't a tax or fee on investors.

Almost no investors maintain a 100% stock portfolio. The typical investor my have anywhere from 20% to 80% bonds. So with the liquidity proposal, some portion of the bond assets they hold anyway will be in their stock fund. They can adjust their stock vs bond allocation accordingly, taking into account the bonds held in their stock fund. After this adjustment, they will receive exactly the same total portfolio return as previously.

The idea that this is a tax or fee is simply a lie. Investors still receive 100% of their investment return.

Dan Kervick -> anne:

Well, it seems prima facie plausible that the ability of some firms to deliver very high returns at low cost is due to the amount they have invested in high-risk, high-yield assets. An economy filled with many such firms is going to be an economy with a higher level of systemic risk. If we want a financially safer world, then some rich people are going to have to get richer much more slowly than they did in the past.

JohnH: I don't believe Vanguard needs any liquidity requirements because none of its investments use leverage. If money is needed, they would just sell the assets at the current market value and disburse the proceeds.

MMMFs are a little different, because there is the presumption that that value of each share will always be $1, which it will be if short term treasuries are kept to term. In case of a run, the Fed could also buy the treasuries and keep them a few weeks to maturity, as they do under QE.

For funds that use leverage, the risk of a run is entirely different:


My interpretation of Anne's issue is that she simply favors individualism's credo for the "moderately wealthy" over the rest of our society, and rationalizes her position by believing (in faith) that Vanguard is immune to failure and thus would not be a participant in any new liquidity meltdown, ergo the nation's taxpayers should shoulder the burden of for profit financial investors when such financial markets fail.

I'm not sure what Anne's position is/was related to the meltdown just past.. but she's caught on the horns of dilemma --- either taxpayer's bail out private investors or they suffer an even greater financial and economic calamity.

The whole point of Cecchetti & Schoenholtz open letter is that a) Vanguard is not immune, and b) taxpayers should NOT be placed on the horns of that dilemma again, and thus the Vanguard letter was indeed self-serving and misleading.

EMichael -> Longtooth:



Well, the critiques may be technically accurate enough as far as they go.

But I fail to see how attacking one of the last pockets of low-fee, consumer-facing investment helps anyone in the long run, except those who wish to herd all money into complex, opaque, high-fee vehicles.

Money Market "reform" may have found some reasonable-sounding talking points on which to promote itself, but stepping back, one cannot help but see it is simply one more wave in the voracious plunder and elimination of any and all alternatives to the relentless and jealous Wall Street flim flam machine.


A democratic investment company is a company that is investor owned, that offers the finest quality long term stock and bond funds with minimal transactions or turnover at low management cost for investors with $10,000. For those men and women who prefer to deal with a Goldman Sachs, a suggest giving that company a call and finding the difference.

The idea that a Warren Buffett is paid by Vanguard for recommending Vanguard only shows a failure to understand that Vanguard is owned by investors and there are no payments made to financial advisers for recommending the company.

DeDude -> anne:

If you think the leadership if Vanguard is controlled by and serving its investors - then you need to get out of the Ivory tower a little more.

Leadership in any Wall Street company are always serving themselves first, second and third. It is just that some of them are better at hiding that fact than others.


As much as Vanguard is trying to sell itself as the investors friend on Wall street, their leadership is just as much a part of the Wall street vampire tribe as the rest of them. Yes, they suck less less blood from each victim, but they are still blood-suckers. When I see Vanguard offering a fund that restrict its investments to companies that compensate CEOs less than average (for that industry and size), then I will know they have left the blood-sucker tribe. The one product that would truly serve the interest of investors is not available from any investment company, because as useful as it would be for us it is dangerous for them.


The descent to profane and violent language on this thread, the descent to intimidation and bullying, is intolerable, horrifying, and meant only to destroy this thread and this blog.

EMichael -> anne:

Personally, I think the constant repetition of a Edwardian rant about language is "intolerable, horrifying, and meant only to destroy this thread and this blog."

As Keynes said, "words ought to be a little wild".

Syaloch -> EMichael:

Amen to that.

Syaloch -> anne:

Am I missing something? Neither "vampire" nor "blood-sucker" is profanity -- unless you mean it in the sense of blasphemous, i.e. criticism of something sacred.

Do you think that this "class of people" who work on Wall Street are holy deities and therefore beyond reproach?

You attitudes toward Vanguard certainly seem to point in that direction:

anne -> Syaloch:

These very terms were used to characterize and dehumanize a class of people in the 1930s. These are terrible, fearful terms to use to describe and stereotype people.


The use of profanity and a metaphor from the 1930s in describing a class of people is intolerable. Paul Krugman made a serious mistake in using a 1930s metaphor in description, both for the dismissing of the decency of the humanness of an entire class of people and for setting an example as to use of the metaphor.

Millions of people were methodically murdered during the 1930s in the wake of a campaign to stereotypically deny their decency, to deny their humanness by using dehumanizing metaphors to describe them.

likbez -> anne:

While behavior that you mentioned are unacceptable, a part of the blame is on you: you demonstrated a perfect example of the psychology of rentier, Anna.

Rentier capitalism is a term used to describe the belief in economic practices of parasitic monopolization of access to any kind of property, and gaining significant amounts of profit without contribution to society.


No, I think people are just having a little fun with your stuttering failure to address the issues. However, I will stop now (before being called a Nazi again – but don't think your bullying has worked, its just that I am tired)

DrDick -> DeDude:

Nothing I love more than passive-aggressive bullies, but that is Anne's schtick.


The key question to Anne is whether Vanguard is really better for unmanaged funds then ETFs. You need to provides us with solid evidence or all your post with belong to the category that Prince Hamlet defined as:

The lady doth protest too much, methinks.

And for managed funds Vanguard experienced several high profile disasters such as with their flagship Primecap fund around 2008. In this sense there is not much to talk about here. Thir managed funds is just a typical example of "go with the crowd" approach.

Issue of fees was important in 90th. But now IMHO Vanguard belongs to "also run" category: for each Vanguard fund you probably can find other fund or ETF with comparable fees.

So why you so adamant in defending Vanguard Anne? It' just one of Wall Street sharks which was broght to the surface by establishing 401K in 1978

P.S. I also consider Vanguard to be among more decent category of Wall Street sharks. But it is still a shark.

[Mar 19, 2015] The Central Banks Will Not Be Able to Control This by Phoenix Capital Research

Mar 19, 2015 | Zero Hedge

The biggest issue facing the financial system today is the US Dollar rally.

The Fed and other Central Banks are trying to maintain the illusion that they have everything in control by talking about interest rates, but the reality is that the US Dollar carry trade is ABOVE $9 trillion in size. That is almost as big as ALL of the money printing that occurred between 2009 and 2013.

And it's imploding as we write this.

Globally, the world is awash in borrowed money… most of it in US Dollars. The US Dollar carry trade is north of $9 trillion… literally than the economies of Germany and Japan COMBINED.

When you BORROW in US Dollars you are effectively SHORTING the US Dollar. So when the US Dollar rallies… you have to cover your SHORT or you blow up.

And the US Dollar has been rallying… HARD. Indeed, the move that began in July 2014 is already larger par in scope with that which occurred during the 2008 meltdown.

Moreover, this move has occurred with little to no rest. The US Dollar barely corrected 2% after rallying a stunning 16+% in a matter of months before beginning its next leg up.

You only get these sorts of moves when the stuff hits the fan. CNBC and the others are babbling about the Fed's FOMC changes, but all of that is just a distraction from the fact that a $9+ trillion carry trade, arguably the largest carry trade in history, has begun to blow up.

Rate hikes, QE, all of this stuff is minor in comparison to the carnage the US Dollar is having on the financial system. Take a look at the impact it's having on emerging market currencies.

... ... ...

[Mar 18, 2015] Here Is Why The Fed Can't Hike Rates By Even 0.25%

Mar 18, 2015 | Zero Hedge
There was a time when Zoltan Poszar was the most important person at the Fed (and Treasury), because he was likely the only person in the government's employ who grasped the enormity and complexity of the then-$30 or so trillion US shadow banking system. A quick refresh of his bio from the Institute for New Economic Thinking:

Mr. Pozsar has been deeply involved in the response to the global financial crisis and the ensuing policy debate. He joined the Federal Reserve Bank of New York in August 2008 in charge of market intelligence for securitized credit markets and served as point person on market developments for senior Federal Reserve, U.S. Treasury and White House officials throughout the crisis; played an instrumental role in building the TALF to backstop the ABS market; and pioneered the mapping of the shadow banking system which inspired the FSB's effort to monitor and regulate shadow banking globally. Prior to Credit Suisse, Mr. Pozsar was a senior adviser to the U.S. Department of the Treasury, where he advised the Office of Debt Management and the Office of Financial Research, and served as Treasury's liaison to the FSB on matters of financial innovation. He also worked with the Federal Reserve Board on improving the U.S. Flow of Funds Accounts.

While Zoltan is currently working in the private sector at Credit Suisse, he is perhaps best known for laying out, back in 2009, the full topographical map of the US shadow banking system in all its flow of assets (or is that contra-assets when it is a repo) beauty.

Which is also why we bring him up, because in a much welcome follow up to his previous work title "A Macro View of Shadow Banking" which we will discuss further in the coming days because it is not only Zoltan's shadow banking magnum opus and must read for anyone who wants to get up to speed with all the latest development in the unregulated shadow banking space, but because Poszar also provides perhaps what is the most important chart which explains why the Fed is so very terrified of even the smallest possible incremental rate hike of 0.25%.

Specifically, we look at Poszar's findings about the implied leverage within the fixed income asset space in America's just a little levered buyside community. This is what he says:

Although no precise measures are available, the presence of leverage among hedge funds with credit and fixed income strategies has been recognized since the LTCM crisis (see Figure 21), as is leverage in separate accounts in the asset management complex.

While hedge funds and separate accounts are allowed to use leverage liberally – in fact, leverage is the sine qua non of these investment vehicles – it is widely underappreciated that bond mutual funds that are typically thought of as unlevered and long-only also have considerable room to use leverage.

The extent to which this room to use leverage is utilized is up to bond portfolio managers to decide, and it is not uncommon for the largest bond funds to maximize the leverage they may bear in their portfolio within the limits allowed by the Investment Company Act of 1940, and the SEC's interpretation of the portfolio leverage and concentration incurred through the use of derivatives.

However, the creep of leverage into what are traditionally thought of as long-only bond funds was missed by the mainstream economics literature and textbooks entirely. For example, recent works that identify asset managers as the core intermediaries behind the "second phase of global liquidity" focus solely on indirect forms of leverage (FX mismatches) embedded in bond portfolios through holdings of dollar-denominated emerging market sovereign and corporate bonds (see Shin, 2013).

Other works state even more explicitly the widely-held assumption that fixed income mutual funds are unlevered, and analyze episodes of market volatility induced by redemptions without any regard to how direct forms of leverage embedded in fixed income mutual funds may amplify volatility during periods of rising redemptions (see for example Feroli, Kashyap, Schoenholtz and Shin, 2014, Chapter 1 of the International Monetary Fund's October 2014 Global Financial Stability Report, Chapter 6 of the BIS' 84th Annual Report, and Brown, Dattels and Frieda, 2014 (forthcoming)).

But all of these views sit uncomfortably with the hard evidence presented above, and recent revelations about "perceived" alphas (see Gross, 2014b) and price action in the interest rate derivative markets amidst soaring redemptions from the largest bond portfolio in the global financial ecosystem – the PIMCO Total Return Fund (see Mackenzie and Meyer, 2014). More concretely, a look at the portfolio of this specific fund provides good examples of the forms of leverage discussed above.


More broadly, the above example demonstrates the evolution of the traditional core product of the asset management industry – long-only, relative-return funds – as it came under pressure from two directions: from hedge funds, offering absolute return strategies, and from passive index-replication products in the form of low-cost exchange traded funds (ETFs). Core-satellite investment mandates became the trend, with hedge funds providing alpha and index-replication vehicles delivering beta at low cost. Traditional asset managers responded to this challenge a number of ways: some by launching their own, internal hedge funds, and some by incorporating into their core products many of the alternative investment techniques used by the hedge funds. These industry trends were the sources of competitive push that drove the above-mentioned creep of leverage into the industry's traditional, long-only, relative-return bond funds (and hence the rise of levered betas), all designed to stem the flow of assets to the hedge fund competition and command higher fees as the profitability of traditional core products was squeezed (see Bank of New York, 2011 as well as Haldane, 2014).

And visually:

In short, what Poszar is saying is that in a world in which the traditional broker-dealers and banks have indeed reduced leverage and instead use $2.5 trillion in Fed reserves as fungible collateral against which to buy credit derivatives (for example as in the case of JPM's CIO office and its attempt to corner the IG9 market) the buyside community, which as we have long discussed has largely avoided equities due to fears of a spectacular market implosion (and certainly minimized levered exposure in the space with the exception of several prominent HFT participants) has instead been forced to chase after fixed income products. And chase with leverage that would make one's head spin as can be seen in the outlier chart above.

And while Poszar may be quite correct in stating that most have missed the leverage creep he observes above...

Perhaps the key reasons why economists have missed the creep of leverage into the traditionally long-only world of fixed income mutual funds are the conceptual gaps in the way in which the U.S. Financial Accounts (formerly the Flow of Funds) depict the global financial ecosystem, and by extension, the limited mental map it gives to economists who use it to understand asset prices.

... one entity that does understand all this and grasps the momentuous implications of even the smallest quantum of interest rate increase, is the entity where Poszar previously worked: the US Treasury and the Federal Reserve itself.

And so, the next time someone asks "why is Yellen so terrified of even the smallest possible rate hike", show them this chart above and explain that the Fed vividly remembers what heppened when LTCM blew up. What the Fed doesn't want, is not one but one thousand LTCMs going off at exactly the same time in what is now the world's most levered trade...


So the dollar isnt going up because of America's sound fundamentals? But rather because its newly minted QE is being used to make leveraged, unhedged gambling bets in derivatives markets (ie. CDOs that cant be paid by counter parties like AIG to losers like MF Global) by primary dealers as repo collateral instead of being released into the economy and increasinging the money velocity?

So the Fed is lying when they say they will soon raise interest rates? Even though raising interest rates .25 % would add 100s of billions in interest to the over 18 trillion dollar debt?

So there is a quadrillion dollar hidden -shadow- banking system beyond the site of Congress and investors at large? That is potentially worse than a 1000 Lehmans?

So then shouldn't we be using our overvalued dollars to buy suppressed under valued gold


I found this helpful:


Crap... It's just like the movie SPEED with Sandra Bullock and Keanu Reeves back in '94 when a former banker rigs a bus loaded with muppets to explode unless he get's paid a million$$ ransom.

If Yellen let's the speed fall below 50 MPH then the bomb goes off and everyone dies.

Meanwhile she's desperately looking for an off-ramp called ECONOMIC GROWTH but it ain't there... and now she's running out of road and there's a hole in her gas tank...


we look at Poszar's findings about the implied leverage within the fixed income asset space

Do you have any idea what the avg rate on the 10 year bond is?

Of course it is about leverage, it has always been about leverage. There are two ways for control freaks to fight a deleveraging: 1) print money, and 2) re-lever. And since the fixed income markets are by far the largest, guess where the leverage (mostly in the form of swaps) was placed?

And in order to keep this leverage from blowing up, interest rates have to stay zero, forever. This is not rocket science. Neither, however, is it reality, but that is what they are trying to do.


1. Average all-time historical return is 0 or negative. Inflation beyond a few tenths of a percent only became a standard phenomenon during the industrial age. This is one of the key points of metallism and one of the reasons monetarists and chartalists (more like charlatans) hate metallism.

2. Savers should not have their money in the bank (or brokerage) if they don't want the banks to use it.

To my knowledge the long-run average coupon on government debt in all places was 3%-5% or less, it was the preferred asset class (in addition to farmland, of course) of the rentier parasites of recent centuries. This high rate is part of why we got national income taxes; careful what you wish for.

There is no point in calling fiat currency stolen, any more than there is in calling a unicorn stolen. It is all debt, not money. The theft begins as soon as it is loaned into existence. Beyond that, the interest means it by nature requires theft from the future.

aVileRat's picture

Fun fact,

The mean 'seed' fund runs at around 120% gross and you would think one would do a 'hedged' book, you know, at best 100% leverage, maybe 120% gross in extreme periods right ?

Saw a fund yesterday, small, about XYZ MM under management, running on 197% gross and 300% net. Yes, you are reading that correct. US Institutional qualified, with more than 10 accounts.

Now either I'm getting really old, or my idea of risk management is totally shot to shit at this stage in my career, but this guy was balls deep in fixed credit and swaps. Refused to give over his VaR metrics, or altman score, but had a stupidly great sharpe ratio. Some days, when I think about how some junk companies inflate by 20% a day, I think about this guy, and his fund.

And I wonder, what if this is the new normal. If Bill, Leon, George.... old crew is working away, and there are a whole bunch of wingnuts like this ZYZ nutter who are chasing yield with every risk hedged to keep below your Prime guidebook, but in reality are running at ratios Myron Sholes would have shit himself at.

Just a food for thought.

Toten is 100% correct, risk free is a economic concept derived from post-war 1918 sov. growth rates vs. the real 400 years of economic history; While Case Shiller's often trot out CAPE model works great at predicting rate moves using smoothing, that whole thing assumes underlying growth conditions which are not normal; namely a baby boom, accretive fixed capital rates, technical revolutions every 5 to 10 years and monetary stability. Throw CAPE into some funky currency wars, like the 1750's with only 3 varables ? busted like TRIPS.

Fed policy is going to give stability, which we expected

Now the rest needs to come from the rest of the world. Arguably the US technocrats are more inclusive and forward looking than the fractionalized govts in Japan (no offense Abe!) so Fiscal policy, has a fighting chance of at least respecting the structural reforms required by US gov, lest major allies switch to RNB; creating the bi-material system Austrians badly want. Where RNB is the 'silver' and UST is the 'gold standard'.

If they fail to act, and US corps/US Trading partners will continue to plan outlays for tax management & accretive ROE's to optimize their USD purchasing power, and will invest abroad. Which is pretty much what happened when economic powers dropped gold or bi-standard switching the last time this happened; when the world had a band of iron to every corner of the globe.

In this scenario, US investors can certainly rely on price stability, but as Janet Yellen said in press scrum today: the world is responsible for their own portfolios and yield valuations. Fed does not promise a risk free rate, nor does it target a risk free rate; only inflation & job growth.

As ZH has spoke about ad nausum, job quality is shit, and projected tax planning & wage growth, when millennials hit 40 is going to be nowhere close to sustaining the AA rating of the USA, let alone its G8+7 trade allies. So until we see 57% of U-5 semi-attached workers actually get with something approaching post-war wage & family formation rates, achieving a 8% risk free world is beyond us. Which is where a Fiscal & technocratic solution comes into play; and requires a global coordinated effort which is inclusive of all the key countries. The alternative ? They'll just fuck off and hit up China, turning a blind eye to middle kingdom 2.0, which was a key behind the dead global growth post- 1 AD, and likely even pre-1AD given Chinas total inability to govern that cesspit since the Bronze Age.

In this scenario, I think back to that tool, and his reach for yield hyper-LTCM trading vehicle. When that martingale hits zilch, what happens to them? Will it matter at that point ? Will credit origination matter at all when NIRP becomes accepted as a cost of trade, and we simply trade in 1 oligarchy and swap in UST? where the UST becomes a scarce form of barter like gold was in 1500 ?

Will Primes and Institutional investors be able to tell the difference between technical and productive growth at that point ? Or will the fear of risk, or perhaps the lack of education on industry specific risk lead to a total lack of interest in exploration & moonshot capital ?

Fun fact, the cotton gin is thought to have been 'invented' in at least 5 instances in history, but it only was when some Jews with a some funny names decided to arb their trade float for a merchant capital fund. This was amid a raging stagflation enviroment, and it worked out well for us since 1680.

If we are staring down the barrel of another 40 year stagnation ecosystem (at least), and if we assume Washington/NATO gridlock extends as long as the Holy Roman Empire's decline; we could be in for a good long time of NIRP.

On an end note. ZH lobbied for 'healthy' deflation for 4 years, and now its happening. You cant have a rate hike, and price deflation at the same time. We are done with the Keynsian real time lab study, and now we're onto the Austrian study:

Austrians propose that Federal reserve money printing is the bane of all evil, and the Fed is the sole originator of all credit default which starts the busines cycle. The fed is now accomodative, and neutral, as 'the market' desired. Now its time for the Austrian system to prove money is all locked into one closed economic system; and fixed capital can thrive in a liquidity moderating system.

Our current economic model based on the 1929-1941 experiment proved flawed, so lets see what happens. Ball is in 'the market' and ZH's court to prove this works, in my view.

And for the little meth-Myrons out there, lets hope this NIRP works. If 92/95 happens (it still could with the natural move in rates down by currency flight to USD; esp if ECB is limit bound by QE assets), that is our best solution out. And Gold is at best, a marginal utility vehicle for wealth preservation; which makes Goldbugging a moot point if we're arguging (happily I might add) for creative wealth destruction to prosperity.


- Credit risk is a passing fad, they will flame out if growth is going to its pre-1880 level of stangation to -3% for most of Europe; without Antilla's creative destruction no less. Its about 10x worse today than when Rockstar did his very well done study on shadow risk, and how its warping leins & economic momentum.

- USA's trade partners will eventually conclude its a bad trade partner due how a strong dollar is killing both domestic wealth effects, and the USA's increasing protectionism, USA global policy becomes inert as the USA Dol & T's become a Giffen good

- Last time something barbaric happened, large debts and a useless Technocratic fiscal govt. had their way with the world, we ended up with a badly FUBAR Europe, and all 14 eras of Chinese society.

- Settle in, unless the last 2 generate something constructive; you are all fucked. But thats good for doom porn lovers.

- Yellen looks at the same shit as ZH. In fact, she straight up said she knows it just as well as TD1, and until you see the same numbers they do, which they do, and real time u-5 wages and job quality improves, forcasts changed, because Saudi Arabia had a Taper Tantrum, and while inflation is one part of the puzzle, data dependance is just as transparent as a post on ZH.

And to hike rates would bail out wall st. Pensions, at the further expense of 'the middle class', and pretty much the entire world. As predicted.


wake up! look at the jefferies numbers of the other day. it is nearly impossible for banks to make money under these conditions. sure they saw some MTM on their rates books back in '10/11/12, but the rest of "earnings" for years running has been from mark-to-fantasy, headcount reductions, buybacks, offshoring, and loss avoidance (delaying foreclosures and repossessions on NPLs). this the-Fed-is-saving-the-banksters meme, while popular, doesn't fit the observable realities. fed policy is--as tiny timmah geithner confessed--the best progressive economics in action.

it is direct monetary financing of our bloated federal government. when you see a person doing something most people infer the motivation for the action is the reward for the action. in the case of the fed we need to adjust our optics to understand they are doing things not to be rewarded but to avoid consequences (like the Dutch boy with his finger in the dike, no Yellen pun intended). what would happen if they allowed a return to market economics?

the federal government would have to fund its ever growing shortfall in the rates market. that would probably be possible at first, but the higher rates would slow the remains of the "economy", which would increase demand for services AND retard tax receipts, which would increase the funding shortfall, which would push up rates, which would choke the economy, which would...well, you get the picture. without the Fed, the overlevered federal candy machine would quickly tear itself apart.

I think the Fed is going to try to raise in order to re-set the shock absorbers before the coming sell off in order to maintain at least the illusion they can stimulate the economy. but it is too little, too late. we will quickly be back to the Fed protecting the politicos by trying to slow the collapse. (to keep this simple I have avoided the obvious asset-inflation scheme as a tool to keep large donors happy, but even analyzing that will bring you back to the same place: the Fed must protect the politicians or die trying.) this is the slow motion death rattle of America's nanny state.


This is a very popular view, but it is wrong. We are talking about fractions of a percent. Declining oil prices have given them an undeserved window, in which to begin normalization.

It's true there is no exit strategy. There never was. This is their one last chance to let market rates emerge without complete chaos. They are too stupid to take it. Unfortunately, the consequences will fall on us all.


The FED has over 4 Trillion on their balance sheets now compared to 852 billion in 11/08.. The US Government has over 17 Trillion dollars of debt compared to 9.23 Trillion in 11/08... need I say more? That is unless they don't have to pay interest> Were all Japanese now and if inflation forces the 0% interest Ponzi to raise interest rates you might just as well bring the whole herd of deer out Tyler because it will be carnage


9/11 Truth: Judges shocked by first time seeing video of WTC 7 collapse in Denmark court


"Magic" number 7

US is run by gangsters. Greatest criminal enterprise ever conceived in the history of man.


The hellicopters will come but they won't be dropping money.

Some folx ain't waitin till September..

coming to a theater near you.

Frankfurt (AFP) - Violent clashes between anti-capitalist protesters and German police left dozens injured and a trail of destruction in Germany's financial capital as the European Central Bank opened its new headquarters Wednesday.

Draghi, addressing some 100 invited guests at a low-key ceremony, rejected blame for the suffering brought by budget cuts and austerity policies amid the financial crisis in Europe.


um...those are europeans rising up against their masters. Not americans.

Americans are cattle and will never do so. At least white americans never will.


"There was a time when Zoltan Poszar was the most important person at the Fed (and Treasury), because he was likely the only person in the government's employ who grasped the enormity and complexity of the then-$30 or so trillion US shadow banking system."

The FedRes is NOT a part of the governmnet, but a PRIVATE branch of the PRIVATE Zionist banking cabal that owns and controls the DC US.

The FedRes only wants to comprehend the ramifications of their actions the same as a thief does. And like a thief, they wish to keep their loot, and to remain free to thieve more in the future.

The banksters need to repay us. Guillotine the Fed. Audit the heads.


LOL, the Federal Reserve can't raise rates.

Just BS the markets for months and later years.

The markets may have just figured it out.

[Sep 12, 2014] Tips fall below 200 days simple average...

[Jul 15, 2013] Gross Adds to Holdings of Treasuries After TIPS Losing Bet By Susanne Walker

Jul 15, 2013 | Bloomberg

Pacific Investment Management Co.'s Bill Gross added to holdings of Treasuries in his flagship fund in June while betting incorrectly on gains in U.S. inflation-indexed securities during the first half of the year.

The proportion of U.S. government debt in the $268 billion Total Return Fund rose to 38 percent, from 37 percent in May, according to data on Pimco's website. The Newport Beach, California-based company doesn't comment directly on monthly changes in holdings or specific types of securities within an market sector such as the percentage of Treasury Inflation Protected Securities in the U.S. grouping.

Gross had been buying TIPS on a bet that money printing by the world's central banks would push up consumer prices, making Treasuries the largest portion of the fund. When yields began to rise in May on expectations the Federal Reserve would slow its bond-buying program, inflation expectations didn't, amplifying the losses on inflation-hedged U.S. debt. The world's largest mutual fund fell 4.7 percent in May and June, prompting $9.9 billion in withdrawals last month, the most on record.

While the yield on 10-year Treasuries soared as high as 2.75 percent on July 8, from a low of 1.61 percent on May 1, yields on inflation-indexed debt climbed even faster and further. As a result, the narrowing in the difference between yields of Treasuries and TIPS, known as the break-even rate, showed that investors viewed inflation as less of a threat in the short term and thus were cutting the price they would pay for insurance against it.

The break-even rate on the 10-year bonds dropped to 1.81 percent on June 24, the lowest since October 2011. The rate was 2.08 percent yesterday.

Gross, co-founder and co-chief investment officer at Pimco, also added to his holdings of mortgage securities, the fund's second largest holdings. The proportion rose to 36 percent last month, from 34 percent in May.

He cut non-U.S. developed nations' debt to 5 percent, from 7 percent in May. Investment-grade credit holdings were unchanged at 6 percent in June.

The Total Return Fund (PTTRX)'s emerging-market debt holdings were also steady at 7 percent from the previous month.

Over the past five years, the Total Return Fund has returned 7.2 percent, outperforming about 91 percent of competitors. It gained 0.15 percent over the past year, placing it in the 66 percentile of its category, according to data compiled by Bloomberg.

The Total Return Fund's government and Treasury debt category includes fund holdings of U.S. Treasury notes, bonds, futures and inflation-protected securities.

Pimco, a unit of the Munich-based insurer Allianz SE (ALV), managed $2.04 trillion in assets as of March 31.

[Jul 09, 2013] Fed Watch: On That September Tapering

"They talk of tapering but the rationale seems incoherent. Has whatever problem it was meant to solve now been solved? Low and lowering inflation, high and stable unemployment, low and declining growth. What signal says 'enough already'?"
July 8, 2013 | Economist's View
kievite said...

John Wagooner once said "Back in the Goode Olde Days, people spent uncounted hours trying to forecast the future. If they had a cat, they could try felidomancy, which is the art of using cats to predict the future. If they had feet, they could try pedomancy. Nowadays, people indulge in fedomancy, which is the art of predicting interest rates by observing the Federal Reserve Board. It's a difficult practice."

Jokes aside I think that some additional factors are important. The first is percentage of US foreign debt that is hold by foreigners. Right now it is around 50%. And printing money via quantitative easing was essentially one way to help the US government to pay the interest on this portion of the debt. That's why Putin at one point called Bernanke "a hooligan".

From this point of view current switch to "calendar action" were strange. First it provoke market panic. Second, while existence of "green shoots" in labor market (were good paying jobs are still replaced by McJobs) might be temporary, payment on the debt in a form of issuing new treasuries with higher interest rate is permanent.

My feeling is that unless creation of panic was the real intent this was a blunder and this panic again will cost a lot of money 401K investors who already were fleeced twice during the last 20 years. When Vanguard TIPs fund drops almost 8% for the year without rate change on the horizon and pretty stable inflation, something is really wrong.

ellen1910 said in reply to kievite...

TIPs compete with standard treasuries (USTs).

Vanguard TIPs duration is 8.5 years and is negative 8.00% ytd. A portfolio composed of 1/3 Vanguard Long-Term treasuries (15.5 years) and 2/3 Vanguard Intermediate treasuries (5.6 years) has an equivalent duration. That composite portfolio is negative 4.983% ytd. Note: The yield spread between the TIPs fund and the composite portfolio is 2.087%.

Can anyone explain why the TIPs experienced much greater losses?

[Jun 14, 2013] Classic Cognitive Errors On Display In These Markets

Seeking Alpha /The Inflation Trader

Numerous classic cognitive errors are on display at once in these markets. We have "overconfidence," with large bets being made on the basis of strongly-believed models and forecasts -- but these are forecasts of the dynamics of a system whose configuration is distinctly unlike anything we have seen before, even remotely. What does a "taper" do to rates? How can we know, since we have never even had QE, much less a taper, before? How aggressively does it make sense to bet on the outcome of such a transition period, given rational-sized error bars on the estimates?

We also see naïve extrapolation of trends. TIPS go down every day, it seems, for no better reason than that "core inflation is low, and the Fed is no longer going to be maintaining as loose a policy." Ten-year TIPS yields have risen 83bps since April 25 (five-year TIPS, +107bps since April 4). Ten-year breakevens have fallen from 2.59%, within 15bps of an all-time high, on March 14 to 2.03% -- the lowest since January 2012 -- now. What has changed? Our model identified TIPS as cheap to Treasuries (that is, breakevens too low for the level of nominal rates) and went nearly max-long when breakevens were still at 2.30%. It is some solace that this position has fared better than a long position in TIPS, but when markets simply follow recent momentum mindlessly it can be painful.

Year-ahead core inflation is priced in the market at roughly 1.50%, despite the fact that current core inflation of 1.7% is only at this level because of persistently soggy core goods prices (and core goods are much more volatile than core services prices). Meanwhile, although core services prices remain buoyant, housing rents have not even begun to respond to the sudden boom in housing prices. To realize the core inflation priced into the one-year inflation swap, core goods prices need to remain low and trends would need to decelerate, while a shortage of owner-occupied housing drives the prices of existing homes skyward. It is possible, but it would be a very unusual economic occurrence.

As I have previously written, we are maintaining our forecast for core inflation in 2012 at 2.6%-3.0%; although we may tweak that lowers if next week's CPI is disappointing, we will not be changing it dramatically. Based on both top-down and bottom-up forecasts, we think the inflation market right now is very wrong. However, in accordance with my first paragraph above, our 80% confidence interval for that estimate would be quite wide. Still, we feel that most errors looking out at least one year are going to be in the direction of higher inflation, not lower inflation.

[Jun 02, 2013] 'Little Cause for Inflation Worries'

Five years can be enough for the next crisis to be at doorsteps. The only question is whether it hit in 2014, 2015 or 2016.

Remember those predictions that we'd have runaway inflation by now?:

Little Cause for Inflation Worries, by Catherine Rampell, NYT: Periodically I am asked whether we should worry about inflation, given how much money the Federal Reserve has pumped into the economy. Based on the Bureau of Economic Analysis data released Friday morning, this answer is still emphatically no.
The personal consumption expenditures, or P.C.E., price index, which the Fed has said it prefers to other measures of inflation, fell from March to April by 0.25 percent. On a year-over-year basis, it was up by just 0.74 percent. Those figures are quite low by historical standards...
When looking at price changes, a lot of economists like to strip out food and energy, since costs in those spending categories can be volatile. Instead they focus on so-called "core inflation." On a monthly basis, core inflation was flat. But year over year, this core index grew just 1.05 percent, which is the lowest pace since the government started keeping track more than five decades ago. ...

realpc said in reply to pgl...

The Federal Reserve's predictions about inflation are meaningless nonsense.

pgl said in reply to RobertWaldmann...

Krugman is noting the recent rise in the nominal interest rate on 10-year bonds and frets that this is a sign that the FED is doing premature tightening. I check on what is happening to the corresponding real interest rate. Last month negative 65 basis point. May 30 - negative 5 basis points. The rise in nominal rates is not an increase in expected inflation but a rise in real rates. Bad news.

John Cummings said in reply to pgl...

or there was a production surge in April that the indexes missed through lag and we are getting a flight from saftey as investers realize the accleration.........which Krugman has wanted time after time after time.

The econ bears don't seem to realize what is going on.

The Blorch said in reply to John Cummings...

It's not a flight from safety. Its a rotation where the smart money sells their 10 yr bonds at an enormous profit. This raises cash with which to from run the market's next big move.


Oh on the usual me dumping on QE, it is way too early for QEIII to show up in inflation (so I claim that the new data do not provide any particular support for my views).

Shifts in inflation follow shifts in output and employment (hence the 100 times too large but 1% of tons is scores of pounds literature on dynamically inconsistent optimal monetary policy). The peak effect on output of a monetary policy shift tends to come in around 6 months (so March) but I think it's still early for inflation.


How early? Six months early? Another year early? And how much inflation do you expect? 10 basis pts/year? 10%/year? More? I think in 1980 we got up to 20%/year rates. Or was it 1981? Of course circumstances were quite a lot different. Do you have any explanation for why the markets disagree with you? Greenspan says the markets are mistaken/broken, which is quite funny coming from him.

Oh, and can you please parse, "...hence the 100 times to large but 1% of tons is scores of pounds literature on dynamically inconsistent optimal monetary policy." I'm guessing "to" is a typo for "too." "1% of tons is scores of pounds" makes sense on its own; 1% of one ton is 200 pounds, which could be stated as ten score pounds, but thatdoesn't seem to connect with the words which follow.

Young Economist said...

Frankly low inflation is from high output gap or high slack of resources. If economy can sustain at higher rate, we could see higher inflation; however, we are facing the fiscal cliff that starts to bring down economy. The monetary stimulus is supporting the higher inflation and growth but its effect is so small compared to fiscal cliff.

FOMC put the expectation of QE tapering since Q1 2013 and this causes no much effect of monetary stimulus since then. We could see bottoming of long term bond yields and mortgage yields. We can realize market is going to interpret the low PCE inflation as permanent effect from the TIPS market sell-off. Some may interpret sell-off in TIPS market due to expectation of QE tapering but breakeven inflation also drops to lowest level this year.

If PCE inflation is still keeping low in Q3/Q4 2013, we could see permanent expectation of deflation from TIPS market and surely FED will have to change to expand more QE because I think FED are wrong to forecast the stronger economy and send early signal of QE tapering without strong economy.

I think we could see jump in bond prices from change in FOMC stance of QE tapering and economic reflation will be needed again. Surely dollar will be likely drop sharply from here.

bakho said...

This is why Bernanke is berating Congress over the sequester and other fiscal contraction. The Fed cannot meet its inflation or unemployment targets and Congress has its foot on the brakes while the Fed is trying to push out of the ditch.

pgl said in reply to bakho...

True until recently but check out Krugman's post today. He fears we are seeing a little premature tight money. Really bad news if true.

jurisdebtor said in reply to bakho...

Glad the GOP has fulfilled its mandate in being a party of polemicists rather than policymakers.

The Blorch said in reply to bakho...

I think the correct metaphor is pushing on a string. "... trying to push out of the ditch." is novel but inappropriate here.

Darryl FKA Ron said...

Little cause for full employment worries then. Little cause for wage boom then. In what world is this good news?

Oh, rentiers of the world unite. Already done that.

anne said...

May 31, 2013

The 3 month Treasury interest rate is at 0.06%, the 2 year Treasury rate is 0.30%, the 5 year rate is 1.04%, while the 10 year is 2.15%.

* Remember, the Vanguard yields are after cost. The Federal Funds rate is no more than 0.25%.

anne said in reply to anne...

Investing in bonds as opposed to speculating is really simple, no matter what analysts may claim, simply look at the current yield and look at the duration of a bond portfolio and ask yourself whether you would be willing to accept that yield as your yearly return through the duration period.

A look at the range of yields and durations of Vanguard bond portfolios has been telling us since last year that the long term profound bull market in bonds is over, no matter what the Federal Reserve may do for several months or even a couple of years and no matter the current strength of the economy. No reasonable investor of new money is going to accept a yearly return of 2.12% over the coming 5.3 years duration for the intermediate-term investment grade bond fund.

The Blorch said in reply to anne...

The market has called a top and the sell side pressure is profit taking as the smart money always sells at the top. Cash raised will be rotated into stocks, front running the next big market move. This is the recipe for how the SP500 reaches 1900 by the end of the year.

anne said...

June 1, 2013

What We Have Here Is A Failure To Communicate By Paul Krugman

Interest rates are rising! Head for the hills!

OK, maybe not quite yet. Some perspective on recent moves:


The 10-year bond rate, in perspective. The 10-year bond rate, in perspective.

Still, a rise in bond rates is not helpful just as there are signs the economy is gaining momentum despite the best efforts of politicians. So what is happening?

Well, recall my little typology of rate rises: *

Bond Prices - Stock Prices - Dollar Values

Eek! Debt! ( down) ( down) ( down) Tougher Fed ( down) ( down) ( up) Stronger Recovery ( down) ( up) ( up)

With stocks down and the dollar up, this looks like a market that has upgraded its estimate of the chances that the Fed will tighten too soon. And yes, I mean too soon, for sure. Look not at the unemployment rate, which to some extent reflects people dropping out of the labor force, and instead look at the employment-population ratio - focusing on prime-age workers to avoid demographic issues:


Employment-population ratio, ages 25-54.

Our labor market has barely begun to recover. Meanwhile, inflation is dropping well below target, even as a growing number of analysts believe that the target itself has been set too low.

So unless Bernanke and company mean to signal their intention to tighten much too soon, and derail recovery, they had better start getting their message out better.


anne said...

January, 2013

Ten Year Cyclically Adjusted Price Earnings Ratio, 1881-2013

(Standard and Poors Composite Stock Index)

May 31 PE Ratio ( 24.20) April PE Ratio ( 22.67)

Annual Mean ( 16.47) Annual Median ( 15.88)

-- Robert Shiller

anne said...

January, 2013

Dividend Yield, 1881-2013

(Standard and Poors Composite Stock Index)

May 31 Dividend Yield ( 1.94) April Dividend Yield ( 1.98) *

Annual Mean ( 4.44) Annual Median ( 4.38)

* Vanguard yield after costs

-- Robert Shiller

realpc said in reply to anne...

Any bull marktets the Federal Reserve brings us are just pyramid scams. They will crash, the only unknown is when.

Amileoj said...

"...whether we should worry about inflation, given how much money the Federal Reserve has pumped into the economy."

It's continuously astonishing how much of a hold the corpse of monetarism still maintains on the economic imagination.

The only thing QE "pumps into the economy" are bank clearing balances, which accumulate to excess in reserve accounts at the Fed. Meanwhile an equivalent value of bonds are "pumped out of the economy" in the same way (securities accounts are debited). Why should this portfolio reallocation cause inflation? What is the mechanism supposed to be?

There may of course be a channel from the resulting compression of the yield curve. Relatively lower long rates are not the official target of QE but they are it's one practical means of influence over private sector behavior. But surely that outcome is quite uncertain and indirect, at best, for it depends on the marginal propensity to spend of qualified borrowers as compared to that savers who experience reduced interest income?

The point is that even if such a channel exists, it has nothing whatsoever to do with "pumping money into the economy." To the extent the interest rate channel proves successful, an increase in the supply of money (via private sector credit/debt expansion) would be an *outcome* of the policy. It would not be the *mechanism* used to achieve that outcome.

Why then do economists and economic commentators still talk as if this were the case? Isn't it worth a little extra effort to get the independent and dependent variables straight?

Schumpeter's Disciple Pittsburgh, PA

"What would be the budgetary/debt effects of interest rates rising to a variety of levels - say, 4%, 6%, 8%..."

It's easy to do the math. Right now we're paying an average of 2.4% on our federal debt, which is fast approaching $17 trillion. Even if this debt were to stop growing (unlikely since we're still running annual spending deficits), here is what a spike in rates would do to our (gross) debt servicing burden:

Rate Interest Cost

2.4% $400 Bn.
4.0% $680 Bn.
6.0% $1,020 Bn.
8.0% $1,360 Bn.

Total federal spending is running at $3,800 Bn. a year. An increase in rates would wreak havoc and painfully crowd out other expenditure items. So if you think our federal budgeting process is a dysfunctional mess now, just wait until rates go up.

Rate Stories

green shoots again?

I've been getting some questions about the recent rise in long-term interest rates. Those rates are still at levels that would have seemed absurdly low not long ago - but they are up significantly from a few months ago. What should we make of this move?

Well, rather than offering a commentary on the market, I thought I might be most helpful by talking about how to figure things like this out on a more general basis. And the way you do this is by trying to tell several alternative stories that might explain what's happening in one market, and then ask what those stories imply for other markets.

So when long-term interest rates rise, there are three main stories you hear. One is that the bond vigilantes have arrived, and are selling US debt because they now believe in the horror stories. Another is that the Fed has changed, that it may be ready to snatch away the punch bowl sooner than previously believed. And the third is that the economy is looking stronger than expected, which means that the Fed, although just as soft-hearted as before, will nonetheless start raising rates sooner than previously believed.

All three of these stories would imply falling bond prices, that is, rising interest rates. But they have different implications for other markets, in particular for stocks and the dollar. Debt fears - basically, a run on America - should send stocks and the dollar down along with bonds. A perceived tougher Fed should send stocks down but the dollar up. And a better recovery should send both stocks up (because of higher expected profits) and drive the dollar higher.

OK, there are possible complications; you can manage, just, to tell stories that don't quite work as I've described. But these are surely what you should have in mind in your first pass at the issue. Here it is in a table:

And while day by day there are variations, basically what you see over the last month or so is line 3: falling bond prices accompanied by rising stocks and a rising dollar. So this looks like a story about macroeconomic optimism.

Leon E Alexandria, VA

Ok, in Japan bond prices and stock prices are both going down but the yen is going up. Not in the table. What's up with that?

John Hartford

OMG the ten year moves from around 1.75 to for the hills the world is coming to an end. Talk about grasping at straws.

Michael O'Neill Bandon, Oregon

It is a metrology problem. Macroeconomics is rife with them. In order to measure any variable you have to have an acceptable yardstick. Bonds, stocks and cash are all money with varying degrees of liquidity. When you talk about the Japanese economy you either need to measure everything with a stable exogenous ruler, or you have to qualify the Yen.

FRHorton New Mexico

Hello Leon

Bond vigilantes can be home-grown

The Bank of Japan has been known to intervene in FOREX directly.

JcN nj

"So this looks like a story about macroeconomic optimism"

What you left out was: "Which is misguided, though one could hope" Some large international conglomerates are showing "caution" for future earnings.

To me that translates into: business stinks right now.

banicki michigan

Being myopic on the topic. I believe the rise in interest rates has a lot to do with the rise of housing prices. The largest asset held by most Americans is their house. In 2008 when that market collapsed everyone conserved assets and feared a depression.

Housing prices are now rising and the consumer is watching his net worth growing again. As a result, he is in a better mood to consume. As FreeFreeMarkets said in 2008, "Hangovers Hurt". ...

JohnK Durham

There are some suggestions among these comments that the budget sequester has kick-started the economy, with the arrival of the long-awaited confidence fairy. Here are the recent federal deficit numbers (as share of GDP) along with GDP growth (measured in line with the federal fiscal year):

deficit GDP growth 2007 1.2% 2.47% 2008 3.2% -0.62% 2009 10.1% -3.34% 2010 9.0% 2.80% 2011 8.7% 1.55% 2012 7.0% 2.60% 2013 7.5% 1.43% (through March 2013)

It should be obvious that we are not yet experiencing a period of high growth. It should also be clear that there is no simple relationship between the federal debt and GDP growth - it's a more complicated story.

Moving forward, consumers, businesses, and local governments all have stronger balance sheets than at the bottom of the recession. Increased spending from these groups will help to offset contractions in federal spending. We're going to have growth, though we'd be doing better without the sequester.

Mikael Olsson Sweden

I find it interesting to see so many talking about economic recovery just because the stock market index goes up.

Really? How is the stock market index a sane indicator of how the economy is working?

The stock market is up up up up up for a long time now and there's been barely a change in the normal every day economy where we all live.

Have fundamentals changed? Are companies making more business suddenly? Or are we just inflating P/E across the board? Or did some major corporations suddenly decide to start paying out profits like they should have done a long time ago instead of keeping liquid assets in their coffers to the detriment of the everyday economy?

scott365 Texas

A story of macroeconomic optimism you say?

But what about the zero bound? But what about the effects of austerity? What about the mean Republicans ruining everything?

Maybe you have some other stories to tell about why you were wrong?

Will you conclude that you were too smart to be wrong, and therefore you must have been mendacious?

Greg K. Cambridge, MA


Or the fourth is that all these traders really don't have a clue and are sheep following what their golf buddies told them to do, or what the latest fad is. Or it's just the 0.01% playing with their money because they certainly don't have the brains or ability to invest it wisely. Too many MBA's, stock brokers and lawyers in this world...need a lot more engineers and teachers to really get the economy going properly again.

Young Economist NY

The next phase is that we will see inflation will drop below 1% for the third quarter, maybe 0.7-0.8%. Bond prices will be up, Stock may be up from higher growth and less concern on FED tapering but Dollar will drop sharply.

Let' see what is going to happen. This Friday we will see the real trend of inflation.

Leopold New York

I agree with your some of thoughts. Except: how do you reconcile the higher growth/higher stock prices with falling inflation?

A.Swift Cary, NC


Stock Market - chump change, who cares? It's the little casino.

Dollar - manipulated for the Derivatives Market.

Interest Rates - Major lever for the Derivatives Market, notional value of interest rate derivatives is about $800 TRILLION dollars. This is the Big Casino. Does anyone actually think that with that much money on the line, that anything would be left to chance? Although, I wonder if someone is smart enough to beat the House?

Scientella palo alto

Boy Americans have short memories.

The Fed prints money at a huge rate. This enables the rich and gamblers to speculate on Wall Street and on real estate - which means wall street and real estate improves. The Fed cannot do this ad nauseum. People talk asset bubbles. Indices at high rates. Palo Alto real estate up 40 percent in one year. Investors crowding into 1 percenters investment. Eg. Assuming Palo Alto Real estate is for the 1 percent it is a sure bet.. Next suburb over - not so sure. This is all about beggering the 99 percent, so next pop they will get it in the solar plexus as usual. Now everyone jumping back in. Banks will start lending to the insolvent. And the next boom bust boom will be on.


the next bust will come - and all the worse America will be for it.

Game over.

China kleptocrats in charge.

George Dover Los Angeles, CA

Krugman analyses the very small increase in interest rates on 10-year treasuries. He is probably right that it does not signal the arrival of the bond vigilantes.

The overall theme of Krugman's blog has been: we need more economic stimulus and higher interest rate targets, say 4%.

More economic stimulus, particularly stimulus that pays for itself in the future, when we need to shoulder a heavier debt burden is indeed needed. I have repeatedly expressed my disappointment that Obama did not press for more spending on infrastructure and education. Indeed, contraction in the states has caused many of the universities to increase tuition and expand class size which cuts quality. This contributes to one of the six "headwinds" discussed by Robert Gordon in a recent essay, namely the plateau of educational attainment in the US, although it may be more appropriate to say the decline of funding for education.

This is a long term problem---population increased by 36% in the last 30 years, while positions in medical schools increased by only 16%.

While Krugman talks about small changes in rates, Congress debates "immigration reform" without a prior discussion of the economic impacts of immigration, or of whether the increased population growth that results from continued immigration is sustainable.

The fact that the NY Times effectively censors a full discussion of this issue (with alternate viewpoints) provides a clear example of how political correctness destroys democracy.

Tom Silver Barnstable, Massachusetts

Precisely. So at what point in this apparent recovery will Prof. Krugman rethink, or downsize, his call for more stimulus? It's easy to be a financial pundit because, unlike with a money manager, you're never held accountable for your predictions. Very few remember, devoted acolytes excepted - and they can be counted on to facilitate the "explanations". What would be the budgetary/debt effects of interest rates rising to a variety of levels - say, 4%, 6%, 8% - on both short and long term bases? The Professor doesn't say, despite his contempt for those who do worry about debt and deficits.

[Feb 03, 2013] Net Asset Value Premiums of Certain Precious Metal Trusts and Funds

Premiums remain almost shockingly thin even as gold and silver rally.

Gold has not quite returned to its pre-end-of-year smackdown that began in December of last year, needing to hit 1720 for that to happen.

Commentary on the precious metals has been riding the 'downward spiral of dumbness' in the past week, as gold bears become emboldened and begin to abandon mere negativity in favor of sheer ridiculousness.

What was most suprising this morning was not the negative GDP print, but the negative chain deflator that went along with it, and facilitated a 'better' GDP number than we would have otherwise seen. That is, instead of the expected 1.6% chain deflator as an indication of inflation, the negative deflator that was used was -0.6%. Otherwise the real GDP number printed would have been quite a bit worse.

I don't think we have seen a negative deflator since the Great Crash of 2008, and not often before that either.

Still I doubt they will take this one seriously since they can blame it on Hurricane Sandy, uncertainty over the fiscal cliff, and the dockworkers strike.

Chain deflators with plenty of leeway are a wonderful way to overstate growth, hide decay, and mask the effects of monetary inflation. Unfortunately they cannot provide real growth, economically viable jobs, and a decent standard of living. Only reform and transparency can do that for the West.

So far the metals are still in a broad trading range. I have some optimism that we will see a breakout, and a new rule set for a cup and handle in the face of extreme market pressure. But one thing at a time. Do not expect this to be easy as the currency war intensifies.

[Feb 03, 2013] The Disingenuous James Bullard

October 05, 2012 | Economist's View

Tim Duy:

The Disingenuous James Bullard, by Tim Duy: St. Louis Federal Reserve President James Bullard is making some headlines today. He fears that inflation expectations are becoming unglued:

Is this happening? Distant inflation expectations from the TIPS market seem to suggest that investors do not completely trust the Fed to deliver on its 2 percent inflation target.

He seeks to prove this claim with this chart:


I just can't let this one go. I honestly don't know if I should laugh or cry. I have a whole new respect for Federal Reserve Chairman Ben Bernanke if this is any indication of the kind of grief he needs to deal with on a regular basis.

This is disingenuous on two levels.



Nothing to see here, folks. Move along.

Bullard starts down this path as a response to suggestions for higher inflation to reduce real debt burdens. This appears at least partly in response to his realization that the work of Professors Reinhart and Rogoff is not as obviously supportive of his position as he previously believed. Rogoff has offered up the possibility of higher inflation to address the debt load. Bullard offers a number of bullet points in response:

The partial default would occur against savers, mostly older U.S. households, and against foreign creditors.

Alas, in economics there is no free lunch.

A partial default today through higher inflation would be paid for via higher inflation premiums in future borrowing. 

There is an important point here - a partial default will have winners and losers. But guess what? So will no default, hard or soft. Just ask the people of Greece (worst of all worlds, partial hard default). Or Ireland. Or Spain. As I said with regard to the Japanese situation:

They are all taxpayers and bondholders. They take the hit in taxes, spending, or capital position. The longer they wait to take that hit, the bigger it will be....

...In other words, you can take your inflation medicine a little bit at a time, or a whole bunch at once. But a even a little bit at a time becomes increasingly more difficult politically as the debt load grows larger.

Pay attention to the last line; Bullard is already identifying older households as a class resistant to taking a capital loss. But they are also struggling with low returns. Now they can't win. This is exactly the trap Japan found itself in - those who initially lost from the zero bound lose again if they were to exit the zero bound. The zero bound is a very bad place to be for an extended time. I don't think the Federal Reserve takes this problem seriously enough.

In short, Bullard wants to pretend that the only costless option is the strict low inflation option. That's simply not true. It has a cost as well, in a particular distribution of winners and losers. A higher inflation target will result in a different distribution of winners and losers that may be more beneficial to domestic residents if, for example, the burden of higher inflation were to fall disproportionately on foreign central banks who have acquired large holdings of dollar assets for mercantilistic reasons (hint, hint). There is also the issue of using inflation to lower the real rate at the zero bound.

It very well may be the case that the US economy normalizes such that output returns to a level that the fiscal impulse can be lessened and debt to GDP ratios level off and decline while interest rates climb such that the Fed returns to using the fed funds rate as their primary tool throughout the next cycle. In such a scenario, there may be no need to exercise the inflation option. But other equilibriums are possible. Japan never experienced sufficient lift-off to break its reliance on fiscal stimulus. Policymakers should be aware of the possibility and adopt a flexible response, one that does not a priori rule out what may be the most cost-effective options.

Bottom Line: If Bullard wants to take a hard line against higher inflation, so be it. In reality, that hard line has been adopted by the vast majority of Fed officials. They aren't inclined to touch the inflation option for fear, I think, that it would work. Then what's to stop 4% from becoming 6%? And 6% from becoming 8%? And I do believe this question would need to be addressed. But don't pretend that not pursuing the inflation option is costless. Just different costs. And please don't use an obviously disingenuous data analysis to fuel inflation fears. We expect better from our policymakers. Or at least we should.

Vanguard To Challenge Pimco TIPS ETF By Cinthia Murphy

Jul 24, 2012 Yahoo! Finance

Vanguard, the third-largest U.S. ETF provider by assets, filed regulatory paperwork to market a short-term inflation-protected securities index fund that would include an ETF share class that would compete with similar products from Pimco and iShares.

Under Vanguard's unique structure, its ETFs are a share class of mutual funds. The prospectus detailed plans for a Vanguard Short-Term Inflation-Protected Securities Index Fund that would track the Barclays U.S. Treasury Inflation-Protected Securities (TIPS) 0-5 Year Index, and invest in inflation-protected U.S. Treasury securities that have a remaining maturity of less than five years.

The fund would serve up four share classes, including an ETF share class that would cost 0.10 percent in fees, or half the price tag of competing funds.

Interest in inflation-protected bonds has been on the upswing amid growing concern among investors that excessive monetary stimulus from central banks such as the Federal Reserve is creating inflationary pressure that will rear its head before long.

More broadly, the fact that Vanguard plans to undercut both iShares and Pimco is par for the course for the firm, which is known for its low-cost funds. As a mutually structured company that is owned by holders of its funds, Vanguard runs its products at cost, giving it an advantage over most firms.

The Details

Vanguard's index fund has an effective duration and an average maturity of roughly 2 1/2 years. It would join the company's $43 billion actively managed Inflation-Protected Securities Fund, which has a duration of 8.5 years and an average maturity of 9.3 years, the company said.

Vanguard said in the filing it aims to have the registration statement become effective on Oct. 10, meaning a launch could come shortly after that.

Aside from the ETF share class, the planned index fund will also offer an Investor Shares class that will cost 0.20 percent, an Admiral Shares class that will cost 0.10 percent and an institutional share class costing 0.07 percent.

The classes are divided by amount of initial investment, with Investor Shares, Admiral Shares and Institutional Shares requiring minimum investments of $3,000, $10,000 and $5 million, respectively.

"To offset the transaction costs of purchasing TIPS, the fund will assess a 0.25 percent purchase fee on all shares, excluding ETF shares," the company added in the release.

Vanguard manages some $700 billion in fixed-income-linked assets, including $235 billion in bond index fund assets and $37 billion in bond ETF assets. The Valley Forge, Pa.-based company had ETF assets totaling more $208 billion, according to IndexUniverse's latest "ETF League Table


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