Now they have extended the overnight funding to the next several weeks. This is another canary in the coal mine. Why all the dollar funding shortages? I know why. Banks are required to hold excess reserves due to Basel II rules, plus they earn risk free rates on excess holding at the Fed. It's a no brainer for them. That means they aren't lending out overnight to cover dollar funding shortages. So now the Fed is performing its function...lender of last resort. If the need continues, what we're going to see is this will metastasize into QE4. Why might it continue? Simple. We have a wall of deficits coming from Congress and the need to borrow and borrow more. That's going to continue to create unresistable pressure for the Fed to sop up those Treasuries. QE4 is on its way. That is a high probability event.
Now what to invest in? This is the conundrum of all time. We're on the brink of a recession. Does the recession hit first or QE4? I don't know. So this is a guessing game. If I had to guess, I'd say the recession hits first, because Powell has shown himself to be more hawkish and slow to respond to recession than Yellen. In addition, he has to show himself to be independent of Trump's incredible pressure to lower rates. That argues for Powell going slow, which means recession hits first. So here's what you invest in depending on the scenario:
* Scenario 1 - Recession comes before QE4, which puts Trump's re-election in jeopardy: invest in short dated bonds and hold lots of cash
* Scenario 2 - QE4 comes first, which delays recession until after Trump is re-elected: invest in gold, real estate, and stocks
I am already betting it will be Scenario 1. Right now, I am 40% cash, 60% short dated bonds. If I'm wrong, I lose out on opportunities. I'm ok with that. If you were to bet on scenario 2 and you are wrong, then you could lose 50% of your money. If you win on scenario 2, then you get limited upside, because stocks are already frothy. So I see very little opportunity cost or risk by investing in scenario 1. That's my take. |
