What caused the Fed’s dovish turn?

Gavyn Davies

Several commentators (see here, here and here) have noted recently that the Federal Reserve has made a major shift in its attitude towards the future path for US interest rates. When the FOMC increased rates last December, they seemed quite confident that the 0.25 per cent hike was the first in a long line of similar increases each quarter, driven by the need to “normalise” interest rates gradually over time.

At that stage, they also seemed fairly sure that they knew what “normal” meant. Now, they seem to have lost that certainty, and have simultaneously shifted their central assessment of the “normal” level for short rates sharply downwards. This has not surprised the markets, which moved in that direction well ahead of the FOMC. But it has strengthened the conviction among investors that the doves are now firmly in control at the Fed.

Last week, Ben Bernanke released an important blog, analysing the main reasons for the FOMC’s change of view, and largely giving his seal of approval. Although the former Fed President has of course been inclined towards dovishness ever since 2008, it is significant that he views the shift as being underpinned by deep fundamental forces inside the US economy, not by minor fluctuations in incoming economic data.

Mr Bernanke is certainly right that domestic fundamentals have changed, but I think his blog has underplayed another significant reason for the Fed’s shift, which is a dawning realisation that events in foreign economies are far more important in determining the equilibrium level of US rates than has previously been accepted. In fact, this has probably been the main factor in the Fed’s U-turn this year.

Until this changes, the Fed will err on the dovish side whenever a key decision is taken.

The Bernanke blog attributes the dovish shift to three main factors: a drop in the FOMC’s estimate of the long run economic growth rate (y*); a fall in its estimate of the natural rate of unemployment (u*); and a very large drop in its estimate of the neutral or “natural” rate of interest (r*) [1].

It is clear that each of these factors could reduce the Fed’s expected path for actual short rates in the next few years. Not only is the final destination for rates (r*) reduced, but the urgency in getting there is also lessened. This thinking is likely to be reflected in Janet Yellen’s speech at Jackson Hole on 26 August.

Of the three Bernanke factors, the most important is undoubtedly the drop in the median estimate of r* made by the FOMC’s participants. The slightly odd feature of this change is that it seems to have happened long after the financial markets came to the view that r* had declined.

In the graph, we compare the real equilibrium interest rate that appears in the Fed’s projections with that built into the yield curve for US treasuries. Note that these are not the same rates, because the Fed only publishes its “long term” forecast for the Fed Funds rate, while the market rate chosen is the 5 year real rate, 5 years forward [2].

Nevertheless, the difference is stark. The market seems to have given considerable credence to the likely permanence of ultra low US interest rates ever since 2011. Meanwhile the FOMC has very belatedly adjusted its view downwards towards that of the market, accelerating the speed of its downward adjustment only after the middle of 2015.

What has caused the sudden drop in the Fed’s estimate of r* since mid 2015, and particularly in the first half of this year? Interestingly, this has not occurred because the Fed has been surprised by the behaviour of the economy since then. The FOMC’s median forecasts for both GDP growth and core inflation have barely changed over this period:

Of course, it is possible that the FOMC has reacted to earlier evidence of slowing productivity growth and a falling u* only with a very long lag, which would be embarrassing if true. But it is also possible that something else came along to change the FOMC’s estimate of r*. And that something must surely have been the impact of international factors, including the dollar, on Fed thinking this year.

If we look closely at the timing of the change in the Fed’s guidance about “normalisation” of rates, it came predominantly around the time that the dollar peaked (and equities collapsed) in February/March this year. This did not lead to any change in the Fed’s estimates of either GDP growth or inflation, but it did lead to a change in their expected mix between the exchange rate and domestic interest rates in delivering the tightening in financial conditions that they desired at the time. A higher dollar essentially forced them to accept lower interest rates in order to deliver roughly the same path for overall financial conditions in the economy.

Furthermore, this was not expected to be just a temporary shift in the mix. The drop in r* indicates that it is expected to be long lasting. Why is this?

The best analysis of this issue from inside the Fed has come from Lael Brainard, a relatively new member of the Board of Governors with a particularly strong international orientation in her thinking. To her credit, she pointed to all of these international factors before the FOMC raised rates last December (though she then went along with the change).

In her latest speech in June, she again emphasised the importance of global deflation risks, especially in China. These risks will lead to a very long period of aggressively easy monetary policy outside the US, which in turn will make the dollar far more sensitive to US rate hikes than has been the case in some earlier periods. The Fed should not, she argues, ignore this when setting US rates: the equilibrium interest rate in America has been reduced by events overseas.

This analysis lies outside the Fed’s normal comfort zone, and contradicts the standard analysis produced by Stanley Fischer among others last year. It was overlooked entirely by Ben Bernanke last week. But it does seem to have determined the behaviour of the FOMC for much of this year.



[1] Mr Bernanke also draws attention to recent work by James Bullard which suggests that the Fed should not alter interest rates until the economic “regime” changes. This is an important theoretical development, but it does not seem to have gone mainstream on the FOMC yet.

[2] The 5-year real bond yield in the TIPs market, 5 years forward, is often used by investors as a guide to the market’s view of the natural long run rate of interest. If the term premium is positive, as is usually assumed, then the difference between the Fed’s and the market’s implied estimate of the natural long run rate of interest is larger than shown in the graph.

Monetary policy

When 2% is not enough

The rich world’s central banks need a new target

LIKE other areas of public policy, central banking is prone to fads and fashions. From limits on money-supply growth to pegging exchange rates, orthodoxies wax and wane. Yet the practice of inflation-targeting has proved remarkably long-lived. For almost three decades, central bankers have agreed that their best route to stabilising an economy is to aim for a specific target for inflation, usually 2% in advanced economies and a little higher in emerging ones.

This orthodoxy is still intact in many emerging economies where inflation is yet to be tamed.

But in the rich world the consensus is beginning to fracture. As central bankers gather this weekend for their annual shindig in Jackson Hole, Wyoming, John Williams, head of the San Francisco Fed, has caused a stir by suggesting it is time for a rethink on what central banks should aim for. He is right.

The reason is that the rich world’s central banks are working in a different context from the 1990s, when today’s inflation-targeting doctrine was formed. Then, it seemed that inflation would spend as much time above target as below it. And the “natural real rate of interest”—the inflation-adjusted price that balances the supply of, and demand for, savings in a full-strength economy—was as high as 3.5%. But inflation has been below the central bankers’ target for years. And the underlying real natural rate of interest has fallen to 1% or lower, probably because population ageing has boosted saving even as lower expectations of growth have cut investment.

This matters because low inflation and a low natural interest rate limit the effectiveness of central bankers’ traditional policy lever: setting short-term interest rates. Since nominal interest rates are the sum of real rates and inflation, the rich-world central banks cannot, under today’s regime, expect their policy rates to rise much higher than 3% (the 2% inflation target plus a 1% real rate). That leaves very little room to cut when the next recession strikes. In the three most recent recessions the Fed slashed rates by 675 basis points (hundredths of a percentage point), 550 basis points, and 512 basis points.

Fear of future impotence is the main cause of today’s misgivings over a low inflation target. But there are other drawbacks with the current regime. First, a target for annual inflation gives the central bank no leeway to make up for periods during which inflation has been too high or too low. If central bankers could credibly promise that they would allow a burst of catch-up inflation, they might be more successful at boosting too-low inflation today. Second, when supply shocks such as a sudden rise or fall in the oil price send inflation and economic growth in opposing directions, central bankers face a tricky choice of which to respond to.

How might these problems be fixed? One possibility is simply to raise the inflation target to, say, 4%.

Credibly enacted, that ought to alleviate the risk of impotence. If investors and consumers believe inflation will reach 4%, nominal interest rates should eventually rise to 5% or so even if real rates stay low. But rich-world central banks have undershot their targets for so long they may struggle to persuade the public to expect higher inflation. And a higher target would still leave central banks with a dilemma when economic growth and inflation diverge. Neither would it make up for big misses.

Who ate all the pi?
A more radical option is to move away from targeting inflation altogether. Many economists (and this newspaper) see advantages in targeting the level of nominal GDP, the total amount of spending in the economy before adjusting for inflation. A nominal-GDP target would allow for temporary variations in inflation. Downturns would be tempered by an expectation of protracted stimulus later on to make up lost ground. In better times, a rise in real GDP would provide the lion’s share of the required nominal-GDP growth and inflation could drift lower.

Changing targets is not something policymakers should do lightly; their credibility depends on stability. And, like every regime, a nominal-GDP target has its drawbacks, not least that few non-economists have ever heard of the concept. It will not be easy to build a consensus for it.

But it is right to start doing so. A 2% inflation target is ill-suited to the rich world today.

Doubling it would be an improvement, but targeting nominal GDP would be better still. Time for a new era.

Exploiting Insanity -- Part II

By: Sam Brown

In the first article of this series (in the Safehaven archive) I described the starting point of a development that will ultimately lead to hyperinflation in many parts of this world. This second article revolves around the Negative Interest Rate World.

Many observers and analysts struggle with this concept and hope that it is a temporary and short lived phenomenon. Bond King Bill Gross, the sage of the bond market, advises investors to reduce risk and to accept lower than historical returns. He states in his August 2016 investment outlook for Janus Capital: "I don't like bonds, I don't like most stocks; I don't like private equity. Real assets such as land, gold, and tangible plant and equipment at a discount are favored asset categories."

Comments on his recommendations indicated to me that his message is difficult to understand for an audience that does not follow his work studiously. There is an article that Bill wrote in February 2013 when he was still at PIMCO. It is called CREDIT SUPERNOVA. It is a superb and prophetic analysis of the state of global financial markets. It should be read alongside his August 2016 outlook to understand the thinking behind Bill's recommendations. He describes and forecasts in great detail how the exorbitant expansion of credit ultimately fuels inflation and threatens capital and savings. I concur with his findings and my observations are similar. For investors timing is crucial and I want to sketch a timeline for the future. Economic developments can be divided into different stages and the question is what are the stages and how long do they last?

We have now arrived in the stage of the Negative Interest Rate World and try to find our way around.

This world is unknown to us and feels very strange. Like in the times of Christopher Columbus, many sailors fear that sea monsters may assault them and that their ship will ultimately fall into the abyss because the world is flat. I may very well be the reckless adventurer, boarding a rotten old Caravel, setting sail never to be seen again. Presumably eaten alive by a gigantic squid or something equally dreadful.

The amount of bonds with negative interest rates is rising steadily. At this point in time more than 10 trillions of sovereign bonds have negative yields. This is the result of the creation of the equivalent of USD180 billion of new money every month by the Bank of Japan (BOJ) and the European Central Bank (ECB). This money flows into the financial markets and relentlessly drives down bond yields.

Money creation by the Swiss Central Bank and from now on by the Bank of England (BOE) reinforces this trend. The present, official stance of the boards of Federal Reserve Bank and the BOE is that they are sceptical about the usefulness of negative interest rates as a policy tool. The Federal Reserve maintains that they will raise interest rates in a gradual pace, depending on the state of the US economy and global developments. Unfortunately the business cycle is working against them.

Most economic indicators show that we are now in the last innings of the current economic expansion. GDP growth in the US has trickled down to 1 per cent in the first half of this year and factory orders have been falling on a year on year basis for 20 months in a row. Almost half of all US households live pay cheque to pay cheque and more than 22 million US households receive food stamps to protect them against starvation. The confidence of US firms in the future is so low that the general measure for business investing, Durable Goods Orders, has been decidedly negative for most of the past 20 months. Corporate profitability keeps on falling; S&P earnings have been sinking for almost two years now. The payroll numbers are touted as proof of a strong economy. If the expansion of labour in serf like conditions together with seasonal adjustments were proof of a thriving economy, the Dark Ages would have been the all time pinnacle of economic success.

Global growth is slowing too. Even the IMF, famous for its overoptimistic growth forecasts, had to downgrade its world GDP growth expectations to 3.4 per cent for 2016. It needs to be stressed that this forecast includes wildly overstated growth figures of 6.7 per cent for the Chinese economy for the first half of this year. A study of the PMI figures suggests that it is in recession or very close to one.

Is this a reason for concern? US financial markets seem to think not. The S&P Index has just climbed to a new all time high. Treasury bond prices are close to a record high and the property market is up year on year. The VIX volatility index, a gage for investor fear is close to record low levels. There are good reasons for this. Investors have learnt that central banks are backstopping the markets. Not via explicit policy but implicitly by their actions. The Federal Reserve Bank has not only tried anxiously to avoid anything that could disrupt US markets. Whenever the market flagged, a mysterious buyer, mainly of futures contracts, gave it a lift. But foreigners are active too. The Swiss National Bank has identified itself as a major investor in the US stock market. At the end of the second quarter of this year its holdings of US stocks rose to a record of USD 62bn. In Japan the BOJ is the biggest investor in the bond and equity market and in the US it is the biggest foreign investor in the stock market. In Europe, the ECB vigorously supports stock markets with its sovereign and corporate bond purchases.

US and European financial markets appear to be safer than ever for investors due to the limitless support of central banks. In a fiat money world there is no limit to the amount of money central banks can create. Unlike in Weimar Germany trillions can be created within seconds as most of today's money is just a number on a computer. Central bank firepower has never been greater. All doom sayers, announcing Armageddon for the financial world, have so far been proven disastrously wrong.

Central banks have followed a consistent policy of steadfastly supporting financial markets. They know that there would be serious economic and political repercussions if they were to be seen to plunge the world into another Great Depression. There is even room for a valid legal case to force central banks to stay on course. If an institution follows a certain policy whether explicitly or implicitly for a period of time a legal claim can arise for the beneficiaries of this policy. A very common case is labour law where i.e. a firm pays its employees a 13th monthly salary without a legal obligation. If it maintains this practice for a number of years, employees gain a legal claim to keep on receiving this benefit in the future. The same could be argued for companiesÂ  (i.e. a bank) and other entities that are dependent in their existence on central bank policy. Let us assume that the Federal Reserve Bank would bankrupt the US financial industry, the US government, the world financial industry and foreign governments because of a policy error. Politically and legally it would be billions against twelve members of the Federal Open Market Committee. Who would win this battle?

On 2 August the Japanese broker Nomura forecast that the yield for the US 30year Treasury bond could go to zero as 900 trillion yen (8.9 trillion USD) tied up in Japanese bonds with negative yields are looking for a new home in the US. European investors may be hot on their heels as they too experience negative interest rates. The Federal Reserve will be powerless to stop this arbitrage without the introduction of capital controls. The inclusion of the US into the realm of negative interest rates appears to be inevitable. It is an upside down world. Bonds are being bought for capital appreciation and equities to generate an income.

This creates a new thinking and radically changes companies business plans. Before the Great War a citizen of repute did not have any permanent debt. After World War One hire purchase contacts became popular and little by little a debt culture developed. Today, most people do not know what life without debt is, they are debtaholics. Their big time has come because debt is starting to generate an income thanks to negative interest rates.

Zero or negative interest rates allow almost every company to be profitable regardless of its debt situation. Just take on debt if you need an additional income stream. It also lowers the break even level and makes previously unprofitable projects profitable. Massive over production and over investment are one result, the case of the US shale oil industry comes to mind. Over production and over investmentÂ  leads to increased competition and depresses prices. In that respect central bank policy has been a failure. Lowering interest rates and introducing Quantitative Easing has not brought them closer to their inflation targets. Quite the reverse; It has unleashed powerful deflationary forces.

Even the weakest companies can survive as losses transform into profits, if they are financed by additional debt at negative interest rates. The Negative Interest Rate World will beget a new company type; the debt accumulator. Its main purpose will be to borrow money. The proceeds from the loan are hoarded or invested in gold. The negative interest rate is booked as revenue and profit of the company. Almost unlimited amounts of debt can be amassed if lending standards are sufficiently lax.

Governments will be jubilant. Debt becomes an asset and social security liabilities something to relish. Taxes could be reduced even further and benefit payments can be increased. Some countries may even introduce a minimum income sponsored by the welfare office. Governments and large corporations will want to make the most of this new situation. Treasury or investment grade corporate debt at 3 per cent will become a thing of the past. The new normal will be a perpetual bond with 1 basis point of interest.

Banks, insurance companies and other financial institutions have been suffering for a while in the Zero/Negative Interest Rate World. It reduces their profit margins and endangers their survival.

Insurance companies with a sizeable annuity business are threatened by bankruptcy. Currently European banks are in the headlines because of increasing worries about their solvency. According to a recently published stress test based on the US methodology, the 51 systemically most important banks in the European Union (EU) have a combined capital deficit of 123bn Euros. Deutsche Bank, Germany's biggest bank, appears to be in a tough spot with a deficit of 19bn, more than its market value of 17bn (Zero Hedge, 10 August). Governments are restricted in their capacity to recapitalise banks by EU laws and their own horrendous indebtedness. This may prompt the ECB to expand its money creation operations and to march forcefully into the territory of negative interest rates to restore the financial health of governments, banks, insurance companies, pension funds and other entities via the printing press. How far into negative territory can negative interest rates go? This will be determined by the perceived size of the insolvency problem. The deceptive nature of public and private accounting methods suggests that we only see the tip of the iceberg. Most governments have not accounted for entitlements. They produce a fiscal gap, an ever widening chasm between tax receipts and expenditure for state liabilities like social security payments, health care and Medicare payments, Medicaid payments, and defence programs. In the United States it is more than 200 trillion USD. The US fiscal gap rises by many trillions each year. This issue is almost completely ignored by the media and the financial markets. 17 Nobel Laureates in Economics are backing the introduction of the "Inform Act" to force the government to account for this debt. So far they have been blocked by politicians.

What does it mean for individuals if fiat money generates negative returns? That it has lost its role as a store of value and as a useful means for savings. One might even say that it highlights fiat money as a toxic asset that holders will endeavour to dispose of as soon as possible.

Negative interest rates are reinforcing an existing trend. Since the year 1900 all major currencies with the exception of the Swiss Franc have lost 99 per cent of their value if measured against gold. This is a creeping process and therefore not much noticed by the public. Gresham's law kicks in. It states that "bad money drives out good". If a new coin ("bad money") is issued with a lesser amount of precious metal than an older coin ("good money") with the same face value, then the new coin will be used in circulation (and spent as quickly as possible) whilst the old coin is retained and taken out of circulation. In our context it means that fiat money drives out gold.

The Negative Interest Rate World was created by central bank policy. In their exuberance, central bankers in the European Union, Japan and the US have taken on the roles of masters of the economic universe, pretending to be able to solve our nation's structural problems. In previous times, this was done by governments. For a good reason. Only governments have the appropriate tools, i.e. legislative powers. The policy of negative interest rates is a logical expansion of central bank decisions after the Great Financial Crisis of 2008 to bail out and subsidise debtors at the expense of savers and the value of the currency. Unfortunately their policy has backfired badly. Today the indebtedness of governments, corporations and individuals is worse than before and growing far faster than the economy. It has also lead to a most amazing asset bubble in bonds and equities. At this stage there are only bad choices left.

Pricking the bubble risks a global depression. Feeding the bubble will only delay the final explosion and make it far worse. In December last year the Federal Reserve Bank had its finger on the trigger. They hiked and planned four more interest rate hikes for 2016. Now it looks as if there will be none. I conclude that this means that they have decided to feed the bubble.

The lack of an exit strategy has serious consequences for all of us. The longer the zero or negative interest rate regime persists, the more individuals, companies, governments and economies will adapt to this environment. Savings and capital formation will diminish. Being over-indebted is the new normal. For many individuals, companies and governments, a point of no return will be reached where the repayment or a mere servicing of the debt will not be possible in a positive interest rate environment. On 10 August Bloomberg published an article titled: "Soaring Debt Has U.S. Companies as Vulnerable to Default as 2008". Ouote: "Corporate leverage in the U.S., excluding financial firms, is at the highest level in 10 years, driven by a combination of low interest rates and slowing profits, S&P analysts Jacob Crooks and David Tesher wrote."

A reversal to the old normal would cause an enormous upheaval in the world economy, with large scale bankruptcies and mass unemployment.

How long can the Negative Interest World last? Until the public understands that fiat money represents a wicked scam at their expense. Awareness is rising slowly and it steadily erodes central bank power. The renaissance of gold as an investment for the global elites is a result of this development. Unfortunately most people are still unaware of the magnitude of the problems we are talking about. They do not even understand what money is. In all likelihood this subject will not become relevant in the next 6 months. I will deal with this later in this series.

Witness The Butterfly Effect

by: The Heisenberg

- Look out, here comes another Heisenberg reality check.

- Behold the effect of new regulations.

- "Folks don’t always see the connection to their lives, in reality, it is so consequential".

If I could go back and give one piece of advice to the 19-year-old Heisenberg, it would be this: think about life the same way you think about investing - holistically.
I've made a lot of bad decisions in my time (judging from the rich, peaty aroma wafting up from the short glass in front of me, this Balvenie DoubleWood 12 neat isn't one of them), and owing to a seemingly ingrained sense of entitlement mixed with narcissism and a dash of arrogance, I rarely considered how my decisions affected others. That is, I didn't take a holistic approach to life and I didn't put much effort into evaluating consequences.
On the other hand, I've always thought about investing holistically; as an inextricably linked set of markets (NYSEARCA:SPY) that can only be understood by reference to an overarching interconnected liquidity regime. The speed with which money moves these days makes that conception all the more crucial.
It's with that in mind that I wanted to revisit what's going on with LIBOR, which is sitting at 7-year highs.
I've talked quite a bit about why this is the case and I encourage you to review those discussions (here and here). Deutsche Bank sums it up with three bullets:
  • Prime fund outflows
  • Dollar liquidity squeeze
  • Fed expectations

Again, I'm not going to recount the details because I've done so exhaustively in the pieces linked above, among others, but here are some visuals for you which depict prime funds reducing exposure to commercial paper, the stress in cross-currency basis swaps, the LIBOR-OIS spread, and Deutsche's LIBOR projections:
  (Charts: Deutsche Bank)
Now note that four out of nine of Deutsche's projections have LIBOR remaining elevated, but sticking below 1% by year-end.
Well, that's not going to make investors in CLO equity tranches very happy. Here's the problem. More than 90% of loans have LIBOR floors.
(Chart: Goldman)
I know, I know, this sounds complicated already, but don't lose me here, I've got your back.
Ok, so you're a CLO (collateralized loan obligation). You bundle loans, slice them up, and sell them to investors. Your assets are the loans, your liabilities are payments to investors in the CLO. After the crisis, the market puts LIBOR floors in place to make sure lenders don't get shafted if the post-crisis easy money regime drives rates into the ground.
Typically, the floor is 100 bps. Basically, you - the CLO - get 100 bps guaranteed plus a spread. If LIBOR rises above the floor, you get whatever LIBOR is plus that same spread.
Simple enough, right? Now think about this. Your liabilities don't work that way. Investors in the CLO get the floating rate. Whatever's left over after all the other tranches get paid goes to the equity tranche. Well, as long as LIBOR is below 100 bps (the floor), the spread between the LIBOR floor and whatever LIBOR actually is is basically just free money for the equity tranche. Let's say you're in the equity tranche and LIBOR is 25 bps. Well, if you're leveraged 10 times, you're picking up 7.5% per year. Here's how Goldman explains it:
Rising Libor rates has most directly affected holders of CLO equity tranches, who have benefited from the "subsidy" gained from the spread between Libor rates and the Libor floor on the asset side, while liabilities "float," and are paid without Libor floors. In the low Libor environment over the past few years, CLO equity investors have benefited from this disconnect between assets and liabilities. A year ago, for example, the 75bp subsidy from the asset side of equity CLOs-calculated as the differential between the spot Libor rate (25bp in July last year) and the average Libor floor (100bp) - would increase total cash payments to equity holders by 7.5% on an annualized basis for CLO equity investors that are 10x levered. 
However, as Libor has increased recently, the income that CLO equity investors have earned on the floor vs. Libor arb has stagnated. With only a 20bp differential between Libor spot (80bp) and Libor floors (still at 100bp), the equity distribution from the Libor floor decreases to only 2% per annum compared with 7.5% a year ago.
"If Libor spiked tomorrow to anything less than 100 basis points, CLO equities would be under extreme pressure and new CLO formation would probably stop in its tracks," Bruce Martin, who ran non-distressed corporate credit at Angelo Gordon, said in an e-mail Bloomberg got ahold of last May. Here's how Reuters explained the situation earlier this month:

Libor floors have directly benefited holders of CLO equity, the most junior slice of the funds. When Libor was 25 basis points and most loans had floors of 100 basis points, the extra 75 basis points increased annual cash payments to equity investors by around 7.5 percent for CLOs with 10 times leverage, said Mia Qian, a CLO analyst at Morgan Stanley. 
CLO equity returns fall when Libor rises but remains below the level of the floor.  
Loan interest payments to CLOs remain constant because of the floors in place.  
CLOs do not have floors, however, and the rate funds pay to their debt investors rises as Libor increases, which eats up the excess spread that equity holders would otherwise have received.

And here's Moody's warning about the same dynamic way back in 2014:

Increases in short-term rates, widely expected to take place next year, would be a "credit negative" event for U.S.-based CLOs because of the resulting reduction in credit enhancement called excess spread. This is the difference between the interest rate on the notes issued by CLOs and the interest rates on the loans that they acquire. Interest rates on both their liabilities and assets are expressed as a spread over the London Interbank Offered Rate, or Libor. 
Moody's warned that the impact of a spike in three-month Libor would be more pronounced in newer CLOs because a "greater portion" of the loans backing so-called CLO 2.0s, those issued since the financial crisis, include Libor floors. These floors, which can range from less than a percentage point to 1.5 percentage points or more, are designed to protect loan investors from falling interest rates, since the spread on a loan cannot fall below the floor, guaranteeing a minimum return. But when interest rates rise, the Libor floor also acts as an anchor. 
"The most direct, and likely most significant, impact of rising rates on CLOs would be a roughly 75 bps decline in excess spread, which is a source of credit enhancement for CLOs," the report, for which Moody's researcher Jeremy Gluck was lead analyst, states. "This loss of excess spread would occur because the interest rates paid on CLOs' mostly floating-rate liabilities will rise nearly in tandem with Libor, while the yields on CLOs' floating-rate assets would not rise until Libor exceeds the relevant floor levels."
Ok, now let's think about what this means for the market. Here's CLO issuance YTD:
(Chart: Goldman)
As you can see, there's waning interest in the market. That's of course partly due to new regulations on the horizon which some issuers say pose an existential threat to a key funding source for corporate America (read more on that here).
Now the thing is, spreads have continued to grind tighter thanks largely to the irrational exuberance created by continued central bank accommodation. The same can generally be said for leveraged loan spreads. "Despite the signs of rising idiosyncratic risk in US, European and US CLO liability spreads have followed tightening in loan spreads, but still have a little room for further compression," Citi noted, late last month.
But note that the longer-term picture is less sanguine. Have a look at the 12m CLO new issue spread changes for the more junior tranches and also the 12m spread change for CCC leveraged loans.
  (Charts: Deutsche Bank)

Ok, now have a look at this:
(Chart: BofAML)

Think of that as the percentage of US CLO collateral pools that's comprised of crap. For 2.0s, it's now above 6%. Do you know what happened to 1.0s back in 2008 when that figure rose above 6%? This:
  (Chart: Morgan Stanley)

Basically, the equity tranche was screwed. Here's what Moody's had to say on Friday in the rating agency's latest quarterly review of the space:

While the pace of rating downgrades slowed as Moody's completed its review of commodity companies, and liquidity stress eased, other measures of credit quality weakened in the second quarter. The US speculative-grade default rose, as did the percentage of high-yield loans with covenant-lite structures, and the long-term refunding index deteriorated. All told, four of Moody's seven CLO collateral risk measures weakened.
In the past quarter, Moody's downgraded junior and mezzanine notes from 10 CLOs in their amortization periods due to tail risk stemming from credit deterioration.
So tying this all together, the effect the new money market fund regulatory regime is having on LIBOR has the potential to strike yet another body blow to a CLO market that's already in effect dying out thanks in part to still more new regulations ostensibly designed to keep markets safer.
"It is just one more negative sentiment that will weigh on a currently weak market," Steven Oh, global head of credit and fixed income at PineBridge Investments, which oversees about US$77.6 billion of assets told Reuters late last year.
Why should you care? Well, because CLOs buy some 60% of the leveraged loans used to finance things like M&A. Here's how Gretchen Bergstresser, a senior portfolio manager at CVC Credit Partners, put it to Bloomberg, referencing the new risk retention rules for CLOs:
Risk retention has the potential to significantly reduce CLO formation, and by extension this would hurt the loan market and the availability of financing to U.S. companies.
Great. So just think about this for a second. You've got one set of regulations (MMF reform) that's set to reduce financing for corporates by reducing the pool of cash available for the purchase of commercial paper by up to $800 billion. That, in turn, is driving up LIBOR which gradually erodes an effective subsidy for CLO equity tranche investors at a time when i) still more regulations are already weighing on CLO issuance, and ii) equity tranche investors are already staring down an inevitable default cycle. And again, CLO issuance is another key funding source for corporations.

Way to go Washington.
In the end, this is what I mean when I say that you have to think about markets holistically; never in isolation. It's the butterfly effect in action.
Hopefully, you can see why all of this is important when it comes to thinking about your investments. These are the kinds of structural shifts that, if mismanaged, can lead to "accidents."
Let me close with a quote from Meredith Coffey, the Loan Syndications and Trading Association's executive vice president, who spoke to Bloomberg:
While risk retention is esoteric, and folks don't always see the connection to their lives, in reality, it is so consequential to the loan market, companies and the economy that of course the LSTA has spent years educating many folks on these issues.

Thanks for your efforts Meredith. But trust me, you'll need to spend many more years and endure many more crashes before "folks" get it.


It’s Time to Hedge Bets on Gold Positions

With gold ETFs finally showing signs of weakness, it’s worth considering a few exit strategies.

By Steven M. Sears          

Bloomberg News
The gold trade is showing signs of weakness. Two key gold mining exchange-traded funds fell 7% Wednesday -- at a time when circumstances indicate their values should rise or at least stay steady.

The declines in the VanEck Vectors Gold Miners ETF and the more volatile VanEck Junior Gold Miners ETF may signal that some investors are rearranging portfolio allocations ahead of an event-heavy central bank calendar.
The moves coincide with strength in beaten-down, rate-sensitive sectors, including the financials, which have been trending higher.

In totality, the multi-sector trading action is a potential indicator that some investors are preparing for U.S. interest rates to rise by year’s end.

Those two exchange-traded funds are up 122%, and 160%, respectively, so far this year, but profit-taking tends to be less disruptive than what happened on Wednesday.

The VanEck funds traded Wednesday in a fury that often coincides with institutional investor groupthink. When word spreads from one desk to another that a major fund is doing something, it often is acted upon as a leading indicator. It is an admittedly soft data point, but it is deeply rooted in the financial industry.
Though we advised investors in June to secure profits, locking in triple-digit gains and maintaining exposure with upside calls, it is hard for many to give up great trades. They would rather maintain a bullish position -- especially when it is outperforming everything else in the market -- until it actually weakens. Then, and only then, do they make a move. Investors who were rattled by Wednesday trading can simply buy puts to hedge.

With the VanEck Gold Miners trading recently at $27.68, investors can buy the December $23 put for 73 cents. If GDX drops to $20, the put is worth $3.
Wednesday’s volatility is an indication of how violent this ETF can behave in a downspin. Rather than “spreading” to create a trading range, it is arguably better to pay full-freight to hedge. This simple trade now seems best. Who knows if the fund will try to retest the bottom of its trading range.

The 52-week range is $12.40 to $31.79.
Investors concerned about the stability of the VanEck Junior Gold Miners should sell their positions and lock in the extraordinary gain. The liquidity in the options market seems to lack the robustness needed to effectively hedge.
Hedging after a sharp decline is like buying insurance during a fire. A fear premium has already lifted options prices, and investors will pay top-dollar to buy puts. But if you are concerned that the downside is just beginning, or that you need to lock in the bulk of your profits, the added friction is the cost of business.
In candor, interpreting trading flows is difficult. It is like palm reading, but it is one of the mainstays on Wall Street. To make the analysis more meaningful, you have to consider broader issues in other sectors. 
We know many institutional investors entered second-quarter earnings season by buying calls, and then shares, on beaten-down, high-growth stocks.
This led to a quiet rotation away from slow-growth, high-dividend sectors into sectors like technology and banking
The trades anticipated that corporate earnings would be better than expected and that economic growth would improve, thus securing profits in the stock and options market. That scenario mostly occurred, and it is not unreasonable to conclude that this is leading to a rearranging of portfolio allocations for reasons ranging from relative value to anticipating a rate hike. After all, constructive economic conditions are a prerequisite to a rate hike.
If the Federal Reserve raises rates, the gold sector trade is not as attractive as financial stocks. Banks make more money off higher rates.
An anti-rotation thesis can also be argued. It is hard to see the Fed significantly raising rates when the global economy is weak, but the event calendar represents risk to the gold thesis.
Even if the Fed does nothing at its next three meetings, the risk to gold is high. Bank governors can be counted upon to talk about how conditions favor a rate hike. Sell-side banks, so desperate for trading volumes, can be counted upon to gin-up rationales for event-driven trading. You can fade the near future, and let your profits ride in GDX and other areas of the gold sector. If you do, though, recognize that you are gambling, not investing, and definitely not trading.


Central Bankers’ Main Challenge: Staying Relevant

Decline in the natural interest rate gives authorities less ammunition to counteract economic shocks

By Greg Ip

Former Treasury Secretary Larry Summers has advocated deficit-financed government infrastructure as a cure for slow growth, but central bankers are nervous about coordinating with politicians. Photo: David Paul Morris/Bloomberg News

When central bankers gather this week in Jackson Hole, Wyo., they will be consumed not with some pressing crisis in the global economy but by an existential threat to their relevance.

The threat stems from the realization that the sluggish economic growth that has prevailed since 2009 may be here to stay. If so, then so are today’s low interest rates.

Central banks set interest rates to balance investment and savings and thus keep economies fully employed and inflation stable. The interest rate that achieves that balance is called the natural rate.

The fact that inflation and growth are now so sluggish despite ultra-easy monetary policy shows that the natural rate has fallen—by 1 to 2.5 percentage points since 2007 in the U.S., Canada, Britain and the eurozone, according to a recent Fed study. Fed policy makers think the U.S. natural rate is 3%, down from 4.5% before the recession. That’s 1.5 percentage points less ammunition to counteract the next shock to the economy.

Initially, central bankers thought the drop in the natural rate was transitory as households, businesses and governments tried to pay down debt or borrow less. With time, it has become clear more deep-seated forces are at play: A slump in productivity growth has depressed the return on, and demand for, new equipment. An aging population needs fewer malls, office buildings and houses. Rising inequality has tilted more income toward the high-saving rich.

Risk aversion world-wide has heightened the demand for safe government bonds.


In dealing with this new normal, policy makers are considering three possible responses, all of which have drawbacks.

Accept the status quo: The growth slowdown may not be permanent. Or, the economy may have changed in ways that make future recessions less severe: For example, housing is less important and inflation is better anchored.

And the Fed has ammunition beyond just short-term rates. In a recent paper, David Reifschneider, a Fed economist, calculates that the unconventional tools the Fed has employed in recent years, such as buying government bonds by creating money or committing to keep rates at zero, can make up for the inability of rates to go much below zero.

Still, this is hardly ideal. Another round of bond buying would further expand the Fed’s share of publicly held federal debt, now at 18%. Critics think this may give fiscal considerations too much sway in monetary policy. More worrisome, these less orthodox steps can incentivize speculative excesses, as even advocates of the policies acknowledge. “Does a low-rate…environment that lasts for a long time create conditions that might pose risks to financial stability?…I think the answer is probably yes,” Fed governor Dan Tarullo said last month.

Fix underlying growth: Former Treasury Secretary  Larry Summers, now at Harvard University, has been the most vocal advocate of curing slow growth directly with deficit-financed government infrastructure. This would both raise public investment and, by easing bottlenecks, incentivize private investment as well.

The Fed would have no direct role in this. It could, however, team up with the Treasury by promising to buy the bonds that finance the infrastructure, a largely untried form of stimulus dubbed “helicopter money.”

But central bankers are nervous about coordinating with politicians. Even ordinary deficit financing has proven unpopular with debt-wary governments. For maximum effect, all countries would have to expand their deficits. If only the U.S. did, it would push up interest rates and the dollar, sucking in imports and thus diluting the benefit.

And policy fixes are much more limited if slow growth is driven by demographics or a dearth of technological advances. “Monetary policy is not well equipped to address long-term issues like the slowdown in productivity growth,” the Fed’s vice chairman, Stanley Fischer, said this week.

Change the target: Central bankers settled on a 2% inflation target to minimize the inflationary boom-bust cycles of 1966 to 1982 and the inefficiencies bred by frequently changing prices. Yet there’s little evidence that 3% or 4% inflation would do more harm than 2%. Because higher average inflation translates to a higher natural interest rate, the higher target would provide more scope to ease without turning to tools such as quantitative easing.

Economists in the past have argued for a different target. The Fed has demurred, until now.

Last week John Williams, president of the Federal Reserve Bank of San Francisco and a respected monetary scholar, put the idea out for discussion.

Would simply announcing a higher target matter, considering central banks have struggled to get inflation even to 2%? It took massive bond buying for Japan to push inflation back above zero but 2% remains elusive. It might be possible to let the economy overheat long enough to push inflation higher, but as Goldman Sachs GS -0.47 % economists note, it might take a recession to cool it off.

For central bankers, all the choices are unsettling. But at least, Mr. Williams notes, they know what they’re up against: “We can wait for the next storm and hope for better outcomes or prepare for them now and be ready.”

Market’s Tight Range Signals Sharp Move

The VIX fear index is low, but the very narrow trading range on the S&P 500 is much more ominous.

By Michael Kahn

Pundits are obsessing over the CBOE Volatility Index, saying its very low levels suggest the stock market is near a top. While the VIX is useful at finding market bottoms, it is not that good at finding tops. The indicator, in fact, has been even lower during rallies in the past and higher when the market actually did find its peaks.

More interesting is that the Standard & Poor’s 500 index is now in its tightest percentage range since September 2014, which was just ahead of a sharp correction to the downside. Granted, the Ebola scare was in the news then — which could have affected trading — but the tight range did indeed portend the explosive move that followed.
While the S&P 500 itself now trades in a tight 2% range since early July, the so-called Bollinger Bands suggest that noose has tightened further (see Chart). These trading bands, named after their discoverer John Bollinger three decades ago, are a mainstay of any technical analysis and charting software package. They draw an envelope above and below trading action based on volatility rather than a fixed value or percentage, allowing them to expand during volatile times and contract when things are quiet.

When the bands are as narrow as they are now — roughly 1.5% — they tell us the market is preparing for a significant move. Bollinger posited that volatility cycles from high to low and back to high again, much like price does. Thus a quiet market will likely give way to something more exciting.

Unfortunately, the bands themselves cannot tell us the market’s likely direction. We will need other tools to make that forecast.

Bands this narrow are a rare occurrence. The S&P 500 saw bands this tight in 2006 and 2012 — and did suffer corrections both times. However, the previous occurrences in 1993 and 1995 instead saw steep continuations of the bull market that was already in effect.
Why is the market so tight? There are many theories, from the end of the summer to the unusual political season. Yet the most likely explanation is uncertainty about the Federal Reserve’s timetable to raise short-term interest rates. Opinions on the merits of a rate hike are quite strong on both sides.
From a charting point of view, the reason does not matter. All we need to know is that the market is very quiet right now — almost too quiet — and that cannot last.

To be sure, other indexes such as the Nasdaq 100 and the small-cap Russell 2000 are narrow but not at historical levels. The large-company S&P 100 and the Dow Jones Industrial Average mirror the S&P 500, and that is enough for me to conclude that the market is poised to move.

Given the very low VIX, weakness in income-oriented sectors creating a divergence with the rest of the market, and a yield curve that continues to maintain a flattening trend, it would seem that a significant decline is more likely than a significant gain.

Depending on what Fed Chair Janet Yellen says later this week, we may have to wait for a breakout or breakdown before determining the next directional move. It is that anticipation that is sure to make the normally quiet last weeks of August as exciting as it gets.


One Helluva Fella: The Horrifically Contemporary World of Hieronymus Bosch

By Ulrike Knöfel
Hieronymus Bosch, "The Garden of the Earthly Delights"
Museo Nacional del Prado, Madrid/ Depósito de Patrimonio Nacional
Hieronymus Bosch, "The Garden of the Earthly Delights"
Impaled heads and burning bodies: Hieronymus Bosch, the great Dutch painter whose images depicted the horrors and terror of the past, present and future, died 500 years ago. In the era of Abu Ghraib and Islamic State, his work feels as contemporary as ever.
The artist Hieronymus Bosch probably had the most prodigious imagination of his day. He was the great surrealist of the waning Middle Ages. His paintings were both a promise and a threat, intended to convey an idea of what would happen in paradise and, even more so, in hell. He created labyrinths of atrocities and a vocabulary of the bestial. He depicted devils and monsters, but also people being tortured, naked people whose throats were being slit, almost as if they were part of a scene in the latest propaganda video from the self-proclaimed Islamic State (IS). And then there are images and motifs that seem comedic in their sheer absurdity.
Bosch, this mysterious painter whose motives were unclear, died 500 years ago, in August 1516. One thing is certain: The Dutchman from the Duchy of Brabant did not spare his audience. He painted what no one had painted before him. And he must have had his own dark humor. In one painting, he depicts a dwarflike being with an upper body that resembles an egg, while the lower body is reminiscent of a lizard. But the gaunt face is that of a human being, with glasses perched on his nose. It is often speculated that this may have been the face of Bosch himself.
He painted this curious being in the corner of a plate, next to Saint Mark the Evangelist foreseeing the End of Time. Did Bosch also perceive himself as a visionary? As someone who wanted to make mankind squirm as it learned of its future? Are his paintings a painted version of gallows humor?
A Unique Universe
This visionary is being celebrated in 2016, eulogistically, of course, with exhibitions, books and films. Almost all museums in his native Brabant are honoring him this year, including the Van Abbemuseum in Eindhoven, which is billing him as a role model for modern artists, and the Brabant Museum of Nature in Tilburg, which is devoting an exhibition to the animals and astonishing mythical creatures in Bosch's art. His paintings can be seen at the Prado in Madrid, and he is also the main event at the Bucerius Art Forum in Hamburg. Franco-German public broadcaster ARTE will broadcast a documentary on August 21, and a longer version titled "Hieronymus Bosch, Touched by the Devil" will open in cinemas in September. The filmmakers spent years accompanying a Dutch team of experts that had set out to painstakingly study the life and works of Bosch, and it became a witness to the tension in the international community of near-obsessive Bosch specialists.
There are only 25 oil paintings, some in multiple parts, that art historians more or less agree came from Bosch himself. These works hang in European and American museums. There are also a similar number of drawings. Institutions that own one of these rare pieces possess an invaluable treasure. The Prado in Madrid long believed it had six originals, until art historians from the Netherlands attributed three of them to Bosch's employees or successors. In the film, the experts barely manage to maintain a polite tone when interacting with one another.
In fact, it is not easy to determine what Bosch painted himself. Because business was good, he had employees who tried to paint in his style as best they could. Many others simply copied him, both during his lifetime and long afterward. Panels were even treated with smoke in chimneys to make them seem older and more original.
But the few works that are clearly attributable to Bosch form a unique, exciting universe. He created science fiction that was inspired by the afterlife, and to this day, no one can explain how he came up with his ideas. Of course, people in the Middle Ages had notions of what demons could look like. They appeared (as a deterrent) as decorations in church architecture, but they lacked the imaginative, abstruse and narrative qualities of Bosch's works.
Take, for instance, the bird-like figure in the painting "The Garden of Earthly Delights" that has pitchers for feet instead of claws, eats people while sitting on a toilet chair, then excretes them out in undigested form into a blue, balloon-like bubble, which opens into a hole in the earth filled with brownish water into which the damned souls are deposited as two others vomit and defecate into it.
His studio produced many other images as well. In one painting, an arrow penetrates two giant ears, which appear to be going somewhere. A man is impaled by the strings of a harp. Demons keep pouring wine into the mouth of a man who is already bloated. There is a female head without a body, but with shod feet. There are heads with feet, fish with feet, beings that are part animal and part human, monster-like humans, machine-like humans and tree-like humans with strange things happening in their open trunks. There are curious flying objects and flying fish. Some fantasy animals appear to be wearing diving bells instead of shells, and some buildings look like breathing, organic creatures.
Modern Parallels
There are also many details that hardly seem comic and feel horrifically contemporary. Images of people falling from burning ruins into an abyss are reminiscent of images of the attacks of Sept. 11. There are impaled bodies and severed heads hanging from sticks, with blood dripping from them, as if in anticipation of the images that IS terrorists would one day disseminate. And a figure seen beating Christ with a rope uses the same hand motion as the angry man in Istanbul who was photographed whipping arrested coup plotters with a belt.
The Hieronymus Bosch painting "Christ Carrying the Cross" from around 1500.
A man uses his belt to hit Turkish soldiers involved in the July 16 coup attempt in Istanbul.
Getty Images
There are bodies lying on red-hot stones and burning in open furnaces, and there are human beings drowning in cesspools, being hanged or impaled, their stomachs seeming to explode. The figures that are still alive appear to have given up hope. Amid images of raging fires, it seems as if the entire world had been split open.
A few years ago, there was a debate over whether it was appropriate to show images that documented US soldiers torturing inmates at Abu Ghraib prison in Iraq. The scenes Bosch painted centuries ago are no less gruesome. But he wasn't painting the future. He had found images depicting an archaic sadism, and he could have only guessed that, half a millennium later, people would still be behaving as they had done thousands of years before his time. His painted oak panels show how far the present has fallen back into brutish patterns.
He repeatedly inserted ordinary elements into his scenes, such as familiar landscapes, churches, windmills, everyday faces and everyday clothing. But this harmlessness, this generic reality, which he treats like the Promised Land, can topple at any time. Hell is never far away. This was how he conveyed his sense of the uncertainty of life.
        Abu Ghraib prison in Iraq: Bosch could only have guessed 500 years ago that, half a milleinnium later, eople would still be behaving as they had done thousands of years before his time.      REUTERS / The Washington Post

But mankind remains ignorant. Bosch also illustrated this in his allegories. People, whether rich or poor, chase pleasure and, to an even greater extent, money (symbolized by a haywain in Bosch's works), and they continue to cling to their earthly possessions even after death, to the delight of the demons under their deathbeds. In one image, nuns and monks are celebrating on a ship, making fools of themselves like everyone else, but they too are unknowingly heading for the realm of the devil. The source of inspiration for this composition was likely the popular morally satirical book, "Ship of Fools," by the Basel-based legal scholar Sebastian Brant, who also believed that man was "only three finger-widths away from death."
Bosch translated this attitude, and he did so with great virtuosity, and with brisk, confident brush strokes. He knew how to create loud and quiet dramatic art. He placed the small shadows of people in front of the light of a blazing fire, and added a touch of red paint to the eyes of an exhausted Jesus, essentially painted in close-up.
Where did he learn to do this? Painting was the craft with which he had grown up and that his family had mastered. His great-grandfather and his grandfather were painters. So were his father, his uncle, his two older brothers and his nephews.
Demanding Innovation
He was born Jheronimus van Aken in 1450, but he was called Joen. His place of birth was the commercial city of 's-Hertogenbosch, or The Bosch. As a painter, he later took the name Hieronymus Bosch, in reference to the city, and that was how he signed his paintings -- in large, unmistakable letters. The little surviving information about his works includes written mentions of the fact that he had taken on the name, even though it was not his real name.
Bosch's parents purchased a house in 1462, on the eastern side of the market square, in an area where many other craftsmen lived (painting was a trade like any other). Bosch was still a boy when the family moved into the house. A fire destroyed large portions of the city a year later.

Such fires, life-threatening and yet breathtaking, later appeared in his paintings.
Around 1480, he married a well-situated merchant's daughter named Aleid van de Meervenne, a woman he may have known since childhood. They moved into a house that Aleid had inherited. It too was on the market square, but in a more upscale location. Apparently the couple had no children. He advanced in local society and became a "sworn" member of a religious brotherhood. Swans were served the three times he hosted the group's annual meeting.
His customers ranged from dignified to high-ranking. They included important church congregations, the upper class and even the high aristocracy, most notably the Hapsburgs. The son of Emperor Maximilian I ordered a "Last Judgment," and he gave his powerful father another work, a "Temptation of St. Anthony." The most famous Bosch work today, the "Garden of Earthly Delights," was apparently created for the Counts of Nassau, who were also influential people in the Habsburg realm.
Bosch must have been aware of his uniqueness. He wrote on one of his drawings: "Poor is the mind that always uses the inventions of others and invents nothing itself." The demand for innovation revealed an attitude that already reflected the thinking of the Renaissance. Perhaps he did view painting as more than simply a craft, but as a higher art.
A panel from the Hieronymus Bosch triptych "The Last Judgement," from around 1506
        An image from the Abu Ghraib prison in Iraq in 2004
ullstein bild
An image from the Abu Ghraib prison in Iraq in 2004

The painter was about 65 when he died, or possibly somewhat younger. He died in an epidemic, not of the plague, but apparently of a similarly sinister disease. His funeral on August 9, 1516 was celebrated with singers.
Bosch remained an admired figure. A year after his death, the secretary of a Roman cardinal praised his paintings for being "enchanting and fantastic." Bosch's works also reached Spain and court of the Spanish king early on. In 1605, a book was published by a Spanish abbot, who described Bosch's paintings as the "most ingenious" and "artful" thing "one could imagine."
But this scholarly monk, José de Sigüenza, also had to protect the works from those who berated the painter as a heretic after his death. Without his paintings, Sigüenza said, man would be "so blind that he is not aware of the passions and vices that keep him transformed into a beast, or rather so many beasts." Sigüenza described the Bosch works he knew as a "satire in paint on the sins and ravings of mankind," saying that this painter had drew his absurdities from "the reality and actuality of the world."
We Can Only Speculate over Meaning
His allusions and his excessive symbolism were probably better understood at the time, but much of the knowledge of the day has been lost. Today we can only speculate over what Bosch meant, and how it was understood in his time. In the documentary film, an American art historian says that his profession is about predicting the past.
Bosch spent his first 40 years living in an era when there were no certainties, not in his immediate environment and not in the portion of the world that was known at the time. Wars and high taxes triggered unrest. The economy was in decline, and this only changed in his city in the late 15th century, when prosperity began to increase again. But the feeling of being at the intersection between two eras, of literally lurching between two periods and not knowing what was next must have been a formative influence on Bosch and many others around 1500.

Anything could happen at any time, violent escalations were a constant threat, and the all-important church was also faltering. The desire for a renewal of the faith existed before Martin Luther. The period would later be characterized as an emergence into the modern era, which sounds lighter and more optimistic than it actually was for the people of the day.
A movement called "Devotio moderna" gained momentum early on in the Netherlands. Human beings were viewed as individuals, not as part of a devout mass of people, and this included their relationship with God. Experts suspect that Bosch wanted to show his audience that man was a traveler "on the path through life." According to Bosch, this traveler, and not a higher power, was responsible for his own decisions. That too is a surprisingly modern concept.
Translated from the German by Christopher Sultan