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10-Year Yield Watch and the Fed: Best of Kass

Doug Kass

NEW YORK ( TheStreet) -- Doug Kass of Seabreeze Partners is known for his accurate stock market calls and keen insights into the economy, which he shares with RealMoney Pro readers in his daily trading diary.

Among the posts this past week were entries about the 10-year yield and the Fed.

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10-Year Yield Watch
Originally published on Friday, July 5 at 9:32 a.m. EDT.

Here is my view of what the 10-year yield should be.

The time to have shorted bonds might have been in 2012 when no one wanted to.

As I exhibited in my Value Investing Congress presentation on shorting bonds in May over a year ago, over time, as many have observed, the 10-year yield typically trades between 0.8x and 1.0x times nominal U.S. GDP.

If we assume that real growth is about 2.25% and inflation is at 1.40%, then we have nominal growth of 3.65%.

I believe strongly that structural headwinds and the residue of the depth of the last recession will continue to constrain growth, so 0.8x (at low end of the range) seems a more reasonable multiplier -- 0.8x 3.65% = 2.82%, not far from the current yield of 2.69%.

That said, as I wrote in beware the interest rate cliff, I believe many market participants are underestimating the vulnerability of the U.S. economy to our addiction (in the private and public sectors) to lower interest rates.

It is different this time.

Very different.

The Fed Is Between a Rock and a Hard Place (Part Deux)
Originally published on Wednesday, July 3 at 10:33 a.m. EDT.

The Fed has already said too much and has been too transparent.

The Fed could be jammed if the economic data continues to come in OK (even on the surface).

Oddly, a weak jobs report may be what the Fed is hoping for. With a strong number, how exactly can it do anything but taper and maintain any credibility?

The Fed has already said too much and has been too transparent.

Fed Chair Bernanke being "puzzled" by the interest rate spike because he placed more value in the stock of bonds held by the Fed then flow and momentum forces just shows how much of an academic he truly is. It is akin to a trader staring "puzzled" at his screens over the rise in Apple to $700, Tesla to $120, General Electric's crash below $7 bucks, Greece trading like a AAA credit, etc., and then running to the library to try to understand it from an academic perspective.

Again, the addiction to and dependence on low rates is unprecedented, because this low-rate regime has been unprecedented in the duration and magnitude of how easy money has been. Governments all over the world need rates way below historic levels to finance themselves, corporations need rates way below historic levels to keep margins at 60-year highs and profits strong, consumers need rates at historic lows to continue their spending, and housing needs rates at historic lows to continue to rebound.

Beware of talking heads evaluating 2.50% on 10-years against historical levels.

At the time of original publication, Kass had no positions in the stocks mentioned.

The Fed Is Between a Rock and a Hard Place
Originally published on Wednesday, July 3 at 9:33 a.m. EDT.

Markets are starting to pull away from policy, and natural price discovery likely lies ahead.

It is my view that a growing number of Fed heads now believe that quantitative easing is either not working or is having little incremental beneficial impact on the domestic economy.

As much as the Fed might hate to admit it, the evidence is accumulating that the costs of QE are greater than its benefits.

Though the economic data is mixed, the voices within in the Fed are growing louder with respect to tapering QE.

That said:

Bottom line: The Fed and the markets might now be stuck between a rock and a hard place. The Fed, in particular, has put itself in the worst possible box and has no idea what to do, which is why we have received all the garbled and inconsistent communication from its members.

For now, the markets continue to be artificial (though less so than a month ago), with limited discovery in the prices of many asset classes owing to the very visible hand of monetary policy. But, in the fullness of time (probably less than more), I see more natural discovery as policy changes or the markets rebel.

That hand of policy, I fear, is increasingly heavy, sloppy, arrogant, naive and academic. The hand might even be politicized.

So what do you do as a policymaker when what you are doing is really bad and stopping is really bad?

A rock and a hard place, I tell ya, as it is likely that market turbulence lies ahead.

Err on the side of conservatism.

  • Many Fed members are now fearful that the damage of stopping QE could be greater than the damage of continuing QE even though it is a bad thing (especially compared to never having done it in first place). Ergo, they seem to have concluded that QE is a negative, but stopping QE now that it in place is a greater negative.
  • Markets (bonds and stocks) reacted violently at the mere hint that tapering might begin, and it has likely spooked them (thus, the Fed fiesta that backtracked on Bernanke's comments).
  • As an example, just look at the climb in mortgage rates on a hint of tapering and a loss of market "artificiality." (Note:The percentage rate rise is one of the largest increases in history over such a brief period of time.)
  • Some are spooked about a similar reaction from the markets as occurred in 1987 when rates were raised, which would be terribly embarrassing for them (even though after that market crash, things moved steadily up and to the right).
  • It is my view that the Fed and market participants have little clue about the degree to which the economy is addicted to low interest rates.
  • Finally, it is increasingly clear that the Fed doesn't control the market; the market controls the Fed.

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