The Federal Reserve has lost control of the financial markets


There are ideas that are so ubiquitous that it would be considered blasphemous to oppose them. A common one is that you cannot fight the Fed.

If you can’t believe your own eyes based on the action in the bond market over the past six months, then allow me to provide you further proof that central banks are not in control anymore.

We often hear discussions about the Federal Reserve as the PPT, the Plunge Protection Team. So what is this “team”?

Since 1987, no one could fool themselves into believing that we have not experienced periods of significant volatility, despite the Plunge Protection Team being ‘on the job.’

‘Working group’

After the stock market crash of 1987, President Ronald Reagan created the President’s Working Group on Financial Markets to recommend solutions for enhancing U.S. financial markets, preventing significant volatility and maintaining investor confidence. The group consisted of the secretary of the Treasury and the chairmen of the Federal Reserve, the Securities and Exchange Commission, and the Commodity Futures Trading Commission.

This “working group” became known as the Plunge Protection Team, and many believed the team would intervene at the appropriate moments to prevent significant volatility in the markets, which would, thereby, prevent market crashes in the future. As the myth has been perpetuated, it can supposedly do this by convincing banks to buy stock index futures, or by having the Federal Reserve do the buying. The goal was supposedly to allow markets to correct in an “orderly” fashion so as to “maintain investor confidence” in our equity markets.

Since 1987, I don’t think anyone can fool themselves into believing that we have not experienced periods of significant volatility, despite the PPT/central bank being “on the job.” In fact, the following instances are just some of the highlights of volatility since the supposed inception of the Plunge Protection Team:

February 2001: Equity markets declined of 22% within seven weeks.

September 2001: Equity markets declined 17% within three weeks.

July 2002: Equity markets declined 22% within three weeks.

September 2008: Equity markets declined 12% within one week.

October 2008: Equity markets declined 30% within two weeks.

November 2008: Equity markets declined 25% within three weeks.

February 2009: Equity markets declined 23% within three weeks.

May 2010: Equity markets experienced a “flash crash.” Specifically, the market started out the day down over 30 points in the S&P 500

SPX, +0.02%

 and proceeded to lose another 70 points within minutes. That is a loss of 9% in one day, but the market managed to close down only 3.1%.

July 2011: Equity markets declined 18% within two weeks.

August 2015: Equity markets declined 11% within one week.

January 2016: Equity markets declined 13% within three weeks.

January 2018: Equity markets declined 16% within three weeks.

October 2018: Equity markets declined 12% within three weeks.

December 2018: Equity market declined 16% within 3 weeks.

Based on those facts, you can even argue that significant stock market “plunges” have become more common events since the advent of the Plunge Protection Team, especially since we have experienced more significant drops within the 20 years after the supposed creation of the “team” than in the prior 20-year period.

Currency control

Moreover, I have outlined in the past that central banks are not even in control of their own currencies, despite strong belief to the contrary.

Back in July 2011, I was expecting a multi-year third-wave rally to take hold from the low 70s in the U.S. Dollar Index

DXY, +0.20%

with an ideal target of 103.5. Now, I want to remind you that when I made this call, the DXY hit a low of 73.4. So that meant I was expecting a 41% rally. That’s a massive move in the currency world.

Moreover, I also want to remind you that I maintained this expectation when the Fed was throwing their quantitative easing (QE) bazookas at the market. For this reason, most market participants at the time were quite certain that the dollar was going to crash. So most viewed my call for a multi-year rally in the dollar as ridiculous, and that is putting it mildly.

Even with all that QE being thrown at the dollar, we still saw a massive rally in the DXY that I was expecting. Yes, this was certainly counter-intuitive to common market expectations. But this was a clear case study in the fact that the Fed did not control this market, while market sentiment was the clear driver of price, as our analysis of market sentiment kept us on the correct side of what was an “unexpected” market rally.

Moreover, as the Fed began to increase interest rates, many were certain that it will be a catalyst for the dollar to rally strongly. However, I was looking for the dollar to enter into a multi-year pullback once we struck our long-term target. Now, despite the Fed raising rates, once the market slightly exceeded our long-term target (the high struck in the DXY was 103.8, whereas our target from 2011 was 103.5), the DXY began to pull back as we have expected.

Yet, most who believe that the Fed controls this market seem to be in disbelief, as the DXY “should” have been rallying when the Fed was tightening. You see, commonly understood economic theory suggests that reducing the available debt through the quantitative tightening (QT) process “should have” caused the dollar to rally. But, clearly, that is not what happened.

The same has happened with the Chinese yuan. By the middle of 2017, China spent 1 trillion U.S. dollars (a quarter of its currency reserves) over the prior three years in an attempt to prop up the yuan. However, the yuan still lost close to 14% of its value against the dollar over this period.

Ultimately, when truly tested, as in the situations above, the markets have moved completely opposite the “manipulation” attempts by central banks. They have proven themselves powerless in the face of market forces. The market will do what the market will do despite the actions of the central banks. Believing otherwise is ignoring the truth in the market, as presented by history and price action, and replacing it with the logical fallacy that correlation equates to causation. But I can assure you that those who maintain these fallacious beliefs will feel significant financial pain when the next crash does occur, and the Fed will be powerless to stop it.

Bond market

Let’s now look at the bond market. Several years ago, the folks at Elliott Wave International put together a long-term study of Treasury bill rates between 2000 and 2012, representing how the Fed clearly follows the market and does not lead. And, you can see that chart here.

If you are still not convinced, of late, we have seen yet another example of how the Fed and the market seem to be at odds.

First, in October, I began preparing members for an impending change of trend in the iShares 20+ Year Treasury Bond ETF

TLT, +0.18%

The ETF seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than 20 years.

As you can see on our daily TLT chart, I was looking a bit lower in the TLT before a strong expectation of a turn higher in this fund. Moreover, when price in the TLT turns higher, it means rates are turning lower.

Now, in November, you will see that we hit my “major support” target in the TLT. At the time, I noted that I was going to be a buyer at the 113 region, with my longer-term target pointing to at least 128, with the potential to rally as high as the 131-136 region. Again, take note that my expectation was that we would see a rally off this support region. Moreover, consider that this was during a period of time in which the Fed was quite clear of its intentions to continue raising rates.

As we now know, the Fed continued to raise rates, but the bond market began a strong rally. Do you think the Fed was in control?

The market told us clearly that it was going to rally from the 113 region to at least the 128 region, and that was no matter what the Fed did or did not do. And the fact that the Fed continued to raise rates, yet the market reacted exactly as we had expected provides even further evidence that the Fed cannot and does not lead the market, but only follows the market.

This tells me that the Fed will likely be forced to lower rates in 2019 unless it wants to lose all confidence in the market.

See charts referenced in this article.

Avi Gilburt recently founded, a live forum featuring some of the top fundamental analysts online today to showcase research and elevate discussion for traders and investors interested in fundamental, rather than technical, analysis.

Source : MTV