Saturday, October 17, 2009

Potential Harm of a Continuation of the Fed's Crisis Accommodative Policies/China & U.S. Dollar/Sold 50 ISM/More on Fidelity & Online Bond Trading

1. China and the U.S. Dollar: The major beneficiary of the dollar's fall against the major currencies has been China. The Chinese currency is pegged to the U.S. dollar, and has consequently weakened against the Euro and other currencies which have strengthen against the dollar. This has made Chinese exports even more desirable from a cost standpoint. This point was driven home to me as I read this article from the NYT that highlights the trade issues related to China pegging the Yuan to the dollar. Since early March the Yuan has fallen 16% against the Euro and 31% against the Australian Dollar. The Aussie dollar, which I own through FXA, has enjoyed a robust rally as the Aussie dollar gained value against the dollar. But, by gaining value against the U.S. dollar, it also gains value against the Yuan which makes Chinese exports cheaper in Australia. The Aussie dollar buys far more U.S. dollars and Yuan compared to early March.

A video from the TheStreet TV, featuring Peter Navarro, explains why Chinese currency manipulation has damaged U.S. manufacturing. Navarro makes an argument that China will eventually have to allow its currency to appreciate against the dollar and recommends that investors start to buy Chinese Yuan. I have no idea whether that day will come during my lifetime. Politicians in the U.S. are scared to label China a currency manipulator, which it is, because China is financing the U.S. budget deficit. Navarro may be right that there is little downside to buying the Yuan, but there is little upside now or for the foreseeable future, as far as I can see. Eventually, China will allow its currency to float freely, or to increase more against the dollar, and eventually I will die too. I do not have a problem buying about a $1000 to $1500 in Yuan, just in case Navarro is right, but I am in no hurry to do so. I already own CEW, a emerging market currency ETF, that has the Yuan as one of its 11 "constituent currencies" WisdomTree - WisdomTree Dreyfus Emerging Currency Fund (CEW)

2. Sold 50 ISM at $12.25 in IRA (see Disclaimer): I decided to go with OSM as my only Sallie Mae floater tied to the CPI. I am keeping my 200 shares of OSM. There is only one reason for my preference for OSM over ISM. OSM matures in March 2017 and ISM matures in January 2018. For a Sallie bond, the sooner the better would be my preference. The small difference in the spread over CPI in favor of ISM, plus the small difference in share prices, is not enough compensation for the longer maturity, at least for me right now. (OSM: ; ISM: I will need some positive news about Sallie Mae before I would consider adding to OSM, except that I may use the proceeds from the sell of ISM to buy OSM at anytime.

3. Barrons Calls for the Fed to Increase Federal Funds to 2%: In a prior post, I commented that the currently abnormally low Federal funds rate, hovering in the 0% to .25% range, is doing more harm than good now. I would agree with Andrew Bary that the Fed needs to increase the Federal funds rate to 2% now, and I would anticipate a swift move to 2% over the course of three meetings, once the Fed decides to end this extreme accommodative monetary policy. Item # 7: Comparing Floaters/Fixed Coupon Corporates Uninteresting That kind of move only removes the Federal Reserve's extreme monetary stimulus, and returns to federal funds rate to a more normal rate based on current inflation numbers, which are starting to trend up. Bary argues that the Fed is not making a distinction between accommodative monetary policy and "crisis accommodative policy". The need for crisis accommodative policy is in the past, yet the Fed apparently intends to maintain that policy into next year based on the reasoning contained in their last minutes.

The crisis policy, which includes far more than the abnormally low Federal funds rate, has already created distortions and early stage bubbles. Low rates certainly penalizes the most responsible people in our society, who end up paying for the profligacy and irresponsibility of others. That is sort of an obvious point made by Bary. But I am not making a moral argument. The crisis accommodative policies have already caused vast sums of money to move into bonds, first in U.S. treasuries and more recently into corporate bonds, in response to the low short term rates available on money funds and other short term debt instruments including treasury bills. The Fed is directly and entirely responsible for that herd response. The Fed has already created another bubble, as demand for anything with a yield has driven prices to levels that can not be justified by a return of even modest inflation. And, it would be reasonable to predict that the creation of artificially low mortgage rates through the Feds quantitative easing, coupled with the low yields from alternative investments such as savings accounts, money funds and bonds, will actually contribute to another real estate bubble in a few years, as prices start to increase to unaffordable levels for most families based on far slower increases in their incomes. Yet another stock market bubble is not out of the question.

Paul Krugman, who was arguing a few weeks ago for another massive spending program on top of the 787 billion program enacted earlier in the year The Entitlement Society , wrote another column recently arguing that the Fed should not raise the Federal Funds rate from near zero until the unemployment falls to less than 7%. NYT That would most likely mean a continuation of the crisis accommodative policy well into 2012. If the Fed followed that kind of recommendation, then I would expect a collapse of the dollar and inflation starting to run hot in the 3 to 5% range. Ultimately, following Krugman's recommendation, imbued more with his liberalism rather than any economic or practical thought, would cause more unemployment over a longer period of time. But the Fed appears to be leaning more toward Krugman's view than the views of some Fed members and many others who already concerned about the dangers of continuing the crisis accommodation for more than a few more months.

4. In Effect, Fidelity Has Ended Online Bond Trading for Individuals: I have tried about 20 times to trade bonds at Fidelity since that brokerage firm introduced highly restrictive and unfavorable rules about the mere placement of an order. To even enter an order to buy or to sell a bond online, the order must be within the following excessively narrow confines:

Trade Message
(010422) The limit yield/price you have entered is too far away from the current price for this security. Your limit buy order cannot be more than 10 basis points (0.10%) above the current offered yield, or more than 1% below the current offered price. Your limit sell order cannot be more than 20 basis points (0.20%) below the current bid yield, or 2% above the current bid price or last estimated market close when a bid price is not available. If no current bid yield is available the order will be evaluated on the price parameters stated above. Please contact a Fidelity Fixed Income representative at 800-544-5372.

More on Fidelity Investments & Online Bond Trading/Third Party Pricing of Bonds Even when I place an order within these narrow limits, I receive the same message. Last week, I wanted to sell a bond, and noted some trades had just been reported to FINRA. I attempted to place an order within the narrow confines of Fidelity's excessively restrictive policy and still received the same "Trade Message". I then followed the policy about using the last closing price on another day, and the order was not allowed to be placed. I tried many different prices, all around the current trading or last close, with none of them even being allowed to be entered for a possible trade. I think that it would be better for Fidelity to advertise this new policy so that individuals who wish to trade bonds online are familiar with it before opening an account. Now, why would I even bother to use Fidelity to trade bonds online? I have never seen anything remotely resembling this kind of hassle since I started using discount brokers in 1982.

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