Mish interprets the fed hike as trying to appease the bond market

Mish has an interesting post recently which you can read here.  His take away points are:

Two Important Points

1. The tightening of the yield curve so early in the lead-up and initial stage of Fed rate hikes is both unprecedented and recessionary-looking.
 
2. It’s highly likely that tightening reflects bond market concerns about a slowing economy and various economic bubbles that are about to pop.

Item number 1 is just an observation, no real conclusion can be drawn from it.  However, I will note that models are in widespread use in the financial world and models make assumptions that things which happened before will happen again.  Models draw relationships and then tend to profit from predictions based on them, just like you see done using EW in these pages each day.  What modelers fear more than anything is that some condition will occur which leads one to think that something else must then occur only to have that something else actually occur.  In EW, it would be something like a 4th or B HT wave occurring which does not then lead to a 5th or C.  This is supposed to be a hard and fast rule.

We see the folly of too much belief in common economic models when we review the collapse of LTCM a few decades ago.  They had models set up which created a series of relationships which were supposed to contain counterbalancing risk.  Thus, these fools believed, they could gamble huge sums of money at ridiculous levels of leverage because they supposedly had factored out ALL risk.  Thus they were free to make a small percentage gain on a huge sum risk free.

The result was supposed to be unlimited profits forever.  It was the belief that markets are some kind of bottomless pit of wealth from which free wealth can be extracted forever without consequence if only you just played it right.  The truth is of course that all of these schemes eventually become a victim of their own success.  Everyone eventually figures out what you are doing and all of the people run over to your side of the ferry to participate in the easy gains.  Then the completely unprecedented and unexpected happens: the ferry capsizes.

My point is that systemic risk rises dramatically when we begin to see new things happening because so many models rely on new things NOT happening.  Mish thus appears to miss the most important take away of his own observation.

The second point is actually the one I want to focus on here because of an ongoing chicken and egg debate between me and reader ChanceNation regarding who controls the interest rates of treasuries, especially 10 year and longer.  Mish writes, "It’s highly likely that tightening reflects bond market concerns...".  "Tightening" in this case is a direct reference to recent action by the fed to increase the fed funds rate by 25 BP.  I thus interpret the overall statement to mean that Mish is saying that the fed is not leading anything but in fact reacting to bond market concerns which is completely in agreement with my side of the Chance debate.  The fed is getting feedback from the bond market which says that it sees increasing risk and thus it demands to be compensated for such risk.  The fed is saying "OK, maybe there is additional risk as you say so we will meet your demand by formally increasing the interest rate toward the level that you are ALREADY commanding in the free market".

Do you see this?  Folks, Chance's argument is wrong at the most fundamental level because buyers set the terms of any sale!!  Look at all the things that go unsold on Ebay!  Sellers cannot compel anyone to buy; there is no stick in their hands, only a carrot.  Sellers (the fed is selling here) can have MSRP, etc. but if no buyers show up based on those terms then eventually they have to give better terms in order to incentivize buyers to buy.  Higher interest rates are better terms for bond buyers.  

The recent move by Yellen has nothing to do with an improving economy.  The middle class IS the economy and the middle class is sliding off the table.  The increase by Yellen was done in order to calm the bond market and to promise them an increasing risk premium (higher interest rates) over time if they just remain calm.  It is a desperation move because the bond market is ALREADY getting much better terms than she is offering with her recent fed funds rate increase.  Her move is for face saving of the fed con game and nothing else.

Of course, chances that the bond market will remain calm are low.  The market sees Yellen as weak and now that it has the first concession from her it will continue to raise interest rates on its own and then tell Yellen to match that as well.  Again, the market is leading Yellen here, not the other way around.  The data is clear on this matter.

Buyers set the terms of any sale, period.