Posts Tagged ‘Federal Reserve’
Thursday, March 14th, 2013
Authored by Lee Quaintance and Paul Brodsky, QBAMCO,
The Fed’s Exit
The markets have begun to wonder whether the Fed (and other central banks) will ever be able to exit from its Quantitative Easing policy. We believe there is only one reasonable exit the Fed can take. Rather than sell its portfolio of bonds or allow them to mature naturally, we believe the Fed’s only practical exit will be to increase the size of all other balance sheets in relation to its own.
This “exit” will be part of a larger three-part strategy for resetting the over-leveraged global economy, already underway. The first stage is policy-administered monetary inflation – QE in which the Fed is de-leveraging bank balance sheets by adding bank reserves. The second phase will be policy-induced price inflation – hyper-inflating the general price level enough to diminish the burden of debt repayment and gain public support for monetary system change. (Imagine today the Fed proclaims all one dollar bills are ten dollar bills. Goods and service prices would increase 10x, more or less, as would wages, asset prices, revenues, costs, etc. The only item on the balance sheet that would not increase 10x would be the notional amount of systemic debt owed.) We believe the third phase of the strategy will be a monetary reset that recaptures popular confidence following the hyper-inflation.
Below, we list a progression of facts and reason supporting these conclusions:
As the Fed monetizes Treasury debt (or, as it claims, temporarily adds Treasuries and MBS to its balance sheet prior to selling them or letting them mature sometime in the future, thereby draining reserves), the obligations of the US Treasury (i.e., obligations of US taxpayers) to the US banking system are increasing dollar for dollar.
The US banking system is: 1) the largest American creditor to the Treasury; 2) the largest warehouse of US taxpayer wealth (via deposits); 3) the largest (infinitely capitalized) intermediary for public US capital markets, and; 4) the monopoly issuer of US dollars and USD-denominated credit. In short, the US banking system is the issuer of the world’s reserve currency and supports conditions to maintain USD hegemony.
Thus, it seems reasonable to assume that the interests of maintaining a healthy US banking system rise above or are at least equal to the economic interests of Americans, and to a large extent their government.
Significantly higher US interest rates would implicitly harm the Fed’s balance sheet (which is not marked to market) and explicitly harm the loan books (assets) of private bank balance sheets (marked to market), potentially placing bank capital ratios in jeopardy and undermining confidence. (While significantly higher interest rates would ostensibly increase the value of adjustable rate bank loans not near their cap levels, they would also decrease the creditworthiness of borrowers’ loan collateral values, lowering lending activity.)
The Fed’s balance sheet is infinite and the Fed creates the currency with which its balance sheet may grow. The Fed will always have more money at its disposal with which to buy bonds and set benchmark interest rates than the quantity of bonds for sale, sine qua non.
Thus, it seems reasonable to assume that there will not be a sudden rise in US market interest rates unless the Fed wants such a rise. Nominal economic growth or even price inflation will not necessarily act as a trigger for higher Treasury yields (but it may be reasonable to fear higher yields within tertiary bond markets in which the Fed/banks do not have significant exposure).
The relevant issue for Treasury investors is not the risk of capital loss from bond price depreciation, but rather the risk of capital loss in real terms – negative real returns as coupon interest and principal repayment do not keep pace with price inflation (i.e., the loss of future purchasing power of Treasury P&I vis-à-vis consumer goods, services and equity assets).
The mix of economic growth (leading to higher tax receipts) and/or government austerity needed to reverse ongoing debt growth over time is mathematically impossible to achieve within the context of a stable social environment. The US public sector and US households are in a compounding debt trap in which there is no exit. Thus, debt is growing and being shifted presently, not being extinguished, and this portends the likeliest future path.
Real output growth from current debt/leverage levels cannot be generated from a coincident increase in more systemic credit/debt. So, the policy solution cannot be issuing new credit and transferring debt with the goal of generating increasing demand and nominal output growth. (And we further argue that wealth concentration that results directly from asset price inflation is a very relevant and direct constraint on real economic growth.)
The US economy (and all indebted advanced economies) is shrinking in real terms presently and fiscal measures are incapable of providing a sustainable remedy. This is precisely the catalyst forcing today’s aggressive monetary policy action.
The only solution is true systemic de-leveraging (banks, households and governments). Banks are already in the process of being de-levered through QE in the form of bank reserve creation.
There are only two ways to de-lever balance sheets: 1) letting debt deteriorate naturally, which would cause a 1930s style deflationary depression, and/or; 2) creating new base money in the form of bank reserves (first) and circulated currency (second). Both reduce leverage ratios (unreserved credit-to-money available with which to repay systemic debts).
The only two ways for the US government to de-lever without creating a deflationary depression would be: 1) Treasury sells assets (e.g. land, resources, shipping lanes etc.) and uses the proceeds for debt repayment, and/or 2) Treasury has the Fed devalue (inflate) the US dollar against a monetary asset on its balance sheet. The former would threaten US sovereignty and the latter would threaten the purchasing power of US dollars (i.e., the perceived current savings of US dollar holders).
To gain US public and geopolitical support for policy-administered deleveraging through
devaluation and a fundamental shift in the world’s monetary system, confidence in the current regime would have to be lost. The most effective tool for achieving this broadly would be price inflation.
Over the last forty years, the rate of price inflation has been about 2% per year (about a 125% compounded growth rate), which has diminished the purchasing power of the USD by about 55%. In other words, one dollar in 1972 is worth about forty-six cents today. Policy-administered US dollar devaluation would apply the same principle, but the inflation would occur suddenly and, discretely. Following a hyper-inflationary episode, the public would be conditioned for another resetting of the global monetary system (its fifth in one hundred years).
Central banks, led by the Fed, would have to re-price and monetize an equity asset rather than debt assets. The only monetize-able equity asset on official balance sheets is gold (which may explain why central banks of emerging economies are voracious buyers presently).
Re-monetizing gold would be popular within indebted advanced economies and therefore politically expedient. While net savers of US dollars would be harmed from the devaluation, net debtors would be helped. (The burden of repaying existing debts would be greatly diminished vis-à-vis inflated wages and asset prices.) Thus, those holding cash and bonds would suffer and those with mortgage, school, auto, and consumer debt would benefit. On balance, a policy-administered USD devaluation would be greatly welcomed within advanced economies. It would position politicians and central banks as economic saviors.
For the first time in memory all global currencies are baseless, including the lone reserve currency, and there is no other scarce currency that provides an alternative for global savers seeking a better store of future purchasing power. This implies that the Fed, with or without the encouragement of the BIS Global Economic Committee of thirty global central bankers, may unilaterally and effectively expedite a global currency devaluation. A policy-administered USD devaluation would force all other fiat currencies to respond in kind or to adopt the US dollar as its currency (maintaining USD hegemony).
The global system would revert to the gold/dollar exchange standard used between 1945 and 1971 (i.e., Bretton Woods). Currency devaluation against precious metals has long precedent (including the USD in 1933).
As we have discussed in the past, the mechanics for currency devaluation are straightforward and would be simple to exercise.
Global banks, having already been de-levered and finding the quality of their loan books to be pristine following the devaluation, would be eager to lend again. (The fractional reserve banking system would not be altered.) The devaluation would be economically stimulative.
In our view, public arguments by Fed members and observers of future balance sheet reduction using normal asset sales or amortization seem specious. The most visible, politically expedient and most likely path seems to be the path usually taken: inflation. In the case of the Fed and other central banks, we assert the magnitude of the systemic leverage problem will be met with equal inflationary force.
Tuesday, August 21st, 2012
by Russ Koesterich, Chief Investment Strategist, iShares
Come September investors might feel as if they are trapped in their own version of Groundhog Day. Last year, the Dow dropped 6% in September. Given the month’s consistently negative bias and lingering headline risks, there is a reasonable chance markets will come under pressure again this year.
While investors often pay too much attention to the calendar, September is the notable exception. Looking at data on the Dow Jones Industrial Average, which stretches back to 1896, September has historically been the worst month of the year, with an average return of slightly worse than negative 1%. This is the only month of the year for which the seasonal bias is so great as to be considered statistically significant.
The tendency for markets to fall in September is also evident when you look at the win rate – how often equities move higher. The win rate in September is barely 40%, versus nearly 60% for the other 11-months. Finally, this phenomenon is not limited to the United States. September has historically been the worst month of the year in a number of European markets – including Germany and the United Kingdom, as well as in Japan.
In addition to a negative seasonal bias, there are three other reasons to be concerned about the headline risk to the markets in the coming weeks:
- On September 12, the German Constitutional Court will rule on the constitutionality of the European Stability Mechanism (ESM). Investors currently expect a favorable ruling, so any other outcome is likely to be disruptive.
- The Netherlands holds an election, also on September 12. This is risky for markets as the outcome may very well be a fragmented government, which will call into question the commitment of the Dutch to further fiscal integration and their support for the southern European countries.
- Closer to home, the US Federal Reserve will begin two days of deliberation on September 12 about the economy and monetary policy. Many investors are still expecting, or at least hoping for, an extension of the Fed’s quantitative easing program, but there is considerable scope for disappointment should the central bank stand pat.
In addition to headline risk, there has been a growing complacency in global equity markets. This trend is particularly evident when looking at implied volatility, or the VIX Index. In mid-August the VIX went below 15, well below its long-term average. While there are several technical reasons that the VIX is this low, it should still concern investors. A low VIX reading indicates weak demand for put protection, suggesting that investors are not particularly concerned with downside protection. Previous readings in this vicinity – in March of 2012 and the spring of 2011 – coincided with short-term tops.
How should investors position their portfolios? While I still prefer equities over the long-term, this is probably a reasonable time to consider trimming back on positions and looking for instruments that offer the potential for downside protection. One way to achieve this is to re-allocate from a cap-weighted exposure into a minimum volatility fund, or other instruments which tend to have a lower market beta.
For investors looking for global exposure, I like the iShares MSCI ACWI Index Fund (NYSEARCA:ACWI), the iShares MSCI All Country World Minimum Volatility Index Fund (NYSEARCA:ACWV), or the iShares S&P Global 100 Index Fund (NYSEARCA:IOO).
The author is long IOO.
In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Minimum volatility funds may experience more than minimum volatility as there is no guarantee that the underlying index’s strategy of seeking to lower volatility will be successful.
Index returns are for illustrative purposes only. Indexes are unmanaged and one cannot invest directly in an index.
Tags: Chief Investment Strategist, Constitutionality, Deliberation, Dow Jones, Dow Jones Industrial, Dow Jones Industrial Average, European Markets, European Stability, Federal Reserve, German Constitutional Court, Groundhog Day, Investors, Koesterich, Month Of The Year, Negative Bias, Netherlands, Phenomenon, Russ, Southern European Countries, Tendency, Us Federal Reserve
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Monday, July 30th, 2012
by Patrick Rudden, AllianceBernstein
A famous Business Week article, “The Death of Equities,” concluded, “Today, the old attitude of buying solid stocks as a cornerstone for one’s life savings and retirement has simply disappeared.” Sound familiar? The article was published in August 1979.
The Business Week article discusses how, with “stocks averaging a return of less than 3% throughout the decade,” investors were fleeing equities in favor of cash and real assets such as property, gold and silver. “Further,” it states, “this ‘death of equity’ can no longer be seen as something a stock market rally—however strong—will check. It has persisted for more than 10 years through market rallies, business cycles, recession, recoveries and booms….For better or worse, then, the US economy probably has to regard the death of equities as near-permanent condition.”
The primary economic problem back then was high inflation, which had devastated returns for stocks and bonds but had greatly buoyed the value of real assets such as gold. Of course, Paul Volcker, then Chairman of the Federal Reserve, was soon to unleash his war on inflation, which set the stage for a prolonged period of strong equity and bond market returns.
But the article says other factors contributed to the death of equities: “The institutionalization of inflation—along with structural changes in communications and psychology—has killed the U.S. equity market for millions of investors. We are all thinking shorter term than our fathers and our grandfathers.”
Inflation (at least of the consumer-price variety) has not been the problem it was in the 1970s, but I would argue that structural changes in communications and psychology have been, if anything, more severe. We are all subject sooner and sooner to more and more information. And, as a consequence, we are thinking shorter term than our fathers and grandfathers and, I should add, mothers and grandmothers.
Equities are no more likely to be dead now than they were in August 1979. Indeed, the expected return advantage of stocks versus government bonds is unusually high at present, in our opinion. However, shorter-time horizons may require us to revisit our investment portfolios. In addition to longer-horizon strategies like value and growth, investors may need to consider shorter-horizon strategies, such as equity income or low-volatility stocks.
Finally, for those investors worried about the return of the inflation bogeyman, holding some exposure to real assets is a good insurance policy.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Patrick Rudden is Head of Blend Strategies at AllianceBernstein.
Copyright © AllianceBernstein
Tags: Bond Market, Booms, Business Cycles, Business Week Article, Chairman Of The Federal Reserve, Economic Problem, Federal Reserve, Gold And Silver, Grandfathers, Grandmothers, inflation, Institutionalization, Market Rally, Paul Volcker, Prolonged Period, Real Assets, Recession, Rudden, Stock Market, Stocks And Bonds
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Thursday, July 26th, 2012
by Mark Hanna, Market Montage
Gold has been sidelined for many months as it has been in an intermediate term downtrend. Since the Hilsenrath article it has shown some strength. As you can see below it has made a series of lower highs throughout most of 2012, and it is now coming to touch the trend line. If we see gold begin to blast off it would put credence into the idea that action from the Federal Reserve is imminent.
As for the general market, we have a rally in the Euro and weakness in the dollar. With that this incredibly strong relationship continues to be rooted in the market and equity buyers step in. S&P 1340 continues to be an incredibly strong magnet. While this selloff has been sharp the S&P 500 did not actually create a new lower low. So the potential remains for the range bound action we have seen for the past 2 months…
That said I mentioned housing related as a relatively immune sector, and true to form this is an area seeing a lot of selling today. It continues to be impossible to buy almost any strength as these areas get attacked. At this point the only theme I see working ok is perhaps agricultural stocks, due to the U.S. drought. A few REITs also stand out but the way things are going, those will be the next area for selling to occur. The lack of themes or groups working in concert showcases an underlying weakness in the tape.
Tags: agricultural, Amp, Blast, Credence, Drought, Federal Reserve, GLD, Gold, Magnet, Mark Hanna, Nbsp, Rally, Reits, Relationship, Selling Today, Selloff, Showcases, Stocks, Term Downtrend, Trend Line
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Sunday, July 15th, 2012
by Guy Lerner, The Technical Take
Our bond model has issued a sell signal.
The bond model is based upon intermarket variables including inputs from commodities and utilities. The model first issued a buy signal on March 30, 2012. Since that time the Vanguard Total Bond Market Fund (symbol: BND) is up 1.9%. This ETF also closed at a new all time high on Friday. The i-Shares Lehman 20 + Year Treasury Bond Fund (symbol: TLT) is up 15% since March 30, 2012. The out performance of TLT is thought to be due to Operation Twist, as the Federal Reserve has been actively buying at the long end of the yield curve to push down interest rates. From March 30, 2012 to July 14, 2012, the SP500 loss 3.7%.
It has been my contention that the buy signal back in March was an early sign of economic weakness. This has turned out to be the case over the past 3 months as important data inputs, like ISM and unemployment, have been softer than expected. I don’t believe we are in recession (personal data), and at best, the US economy has stabilized with growth being below trend.
From a technical perspective, TLT looks like one of the best charts in my Chart Book. See figure 1, a weekly chart. Price must remain above the 128.52 key pivot point (support level) to avoid being a double top. Considering that our fundamental model has issued a sell signal, I would suspect TLT will struggle going forward.
Figure 1. TLT/ weekly
Copyright © The Technical Take
Tags: Bnd, Bond Fund, Bond Market, Contention, Data Inputs, Economic Weakness, ETF, Federal Reserve, Fund Symbol, Fundamental Model, Guy Lerner, I Shares, Lehman, Personal Data, Pivot Point, S&P500, Technical Perspective, Tlt, Year Treasury Bond, Yield Curve
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Saturday, July 14th, 2012
The Federal Reserve and other central banks manipulate interest rates every day, James Grant of Grant’s Interest Rate Observer told CNBC’s “Closing Bell” on Thursday. “The Fed is in the business of trying to manipulate markets, the macro economy, interest rates, unemployment and inflation through various monetary means, including the twisting around of yield curves and interest rates,” Grant said. Grant added, “The Federal Reserve fixes rates on principle. They have ‘operation twist’ that manipulates the credit markets. They have quantitative easing that manipulates bond yields.”
Tags: Bond Yields, Central Banks, Closing Bell, Cnbc, Credit Markets, Federal Reserve, Grant Federal, inflation, Interest Rate Observer, Interest Rates Unemployment, James Grant, Macro Economy, Principle, Quantitative Easing, Yield Curves
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Thursday, July 12th, 2012
While the technical definition of recession commonly used is negative GDP two quarters in a row, it is actually something far less simple.
ECRI has been calling for recession for a few quarters now and with the data coming in, it is looking more accurate now – especially if you use the definition on the NBER website:
The Committee does not have a fixed definition of economic activity. It examines and compares the behavior of various measures of broad activity: real GDP measured on the product and income sides, economy-wide employment, and real income. The Committee also may consider indicators that do not cover the entire economy, such as real sales and the Federal Reserve’s index of industrial production (IP).
Lakshman Acuthan visited Bloomberg early this week for an extended interview – email readers will need to come to site to view:
Tuesday, July 10th, 2012
by Guy Lerner, The Technical Take
Last week’s comments will certainly suffice to explain how sentiment is impacting the current price action, so here they are: “From a sentiment perspective, the data remains consistent with a market top rather than the next launching pad to a new bull market or even a sustainable bull run. For several weeks, I have been of the opinion that whatever bounce develops would not carry too far because sentiment really wasn’t too bearish at the bottom. Large rallies usually start with real extremes in investor sentiment and consensus among the sentiment data, which we did not see despite the SP500 dropping about 10% over 8 weeks from the April highs. Although the “dumb money” was bearish (i.e., bull signal), corporate insiders were neutral. Throw in the fact that investors have been primed to front run anything that sounds like quantitative easing or bail out, you can understand why investors weren’t too concern. Don’t worry some central banker has your back.”
What I find fascinating is that investors know what is exactly driving this market. It is bailouts, quantitative easing, asset purchases or whatever you want to call it. These plans can be real or just come from the mouths (i.e., jawboning) of central bankers. I was listening to CNBC earlier in the week, and the disappointment of the hosts over the market’s response to the European Central Bank’s rate cut was palpable. With the pre-market futures down about 0.5%, they immediately understood that some entity (i.e., Federal Reserve) would need to step in and do more. Mind you this is pre-market action, and the SP500 is still only a couple of percent below the recent cyclical highs! No reason to hope for a good jobs report or better earnings. Maybe that is asking for too much. Or maybe investors understand that positive data points takes more QE off the table.
The promises to fix the economies (i.e., equity markets) of the world with more debt are coming almost daily now. The market’s response to each of these “fixes” seems to be getting less and less. In addition, whether QE is the right policy still remains in doubt. After all, it hasn’t turned the US economy around yet and some would argue, asset purchases and debt creation have put the US economy on a weaker foundation. It would seem that investors are in a pickle. More of the same is not working, and it just may require lower equity prices for investors to get what they really wish for.
The “Dumb Money” indicator (see figure 1) looks for extremes in the data from 4 different groups of investors who historically have been wrong on the market: 1) Investors Intelligence; 2) MarketVane; 3) American Association of Individual Investors; and 4) the put call ratio. This indicator is neutral.
Figure 1. “Dumb Money”/ weekly
Figure 2 is a weekly chart of the SP500 with the InsiderScore “entire market” value in the lower panel. From the InsiderScore weekly report: “Insider trading volume began a seasonal decline last week. Companies generally close trading windows for insiders 10-14 days prior to quarter’s end and reopen them following their subsequent earnings announcement. Volume will continue to dissipate over the next few weeks and getting a macro read will be difficult because of the limited number of insiders who are free to trade.”
Figure 2. InsiderScore “Entire Market” value/ weekly
Figure 3 is a weekly chart of the SP500. The indicator in the lower panel measures all the assets in the Rydex bullish oriented equity funds divided by the sum of assets in the bullish oriented equity funds plus the assets in the bearish oriented equity funds. When the indicator is green, the value is low and there is fear in the market; this is where market bottoms are forged. When the indicator is red, there is complacency in the market. There are too many bulls and this is when market advances stall. Currently, the value of the indicator is 63.72%. Values less than 50% are associated with market bottoms. Values greater than 58% are associated with market tops. It should be noted that the market topped out in 2011 with this indicator between 70% and 71%.
Figure 3. Rydex Total Bull v. Total Bear/ weekly
Tags: Asset Purchases, Cnbc, Corporate Insiders, Cyclical Highs, Disappointment, Dumb Money, Extremes, Federal Reserve, Guy Lerner, Investor Sentiment, Launching Pad, Market Futures, Mouths, Pickle, Pre Market, Qe, Quantitative Easing, Rallies, S&P500, Sentiment Data
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Friday, July 6th, 2012
For better or mostly worse, the Federal Reserve has been governing the monetary system of the United States since 1914. The visual history below maps the rise of the Fed from its origins as a relatively minor institution, often controlled by Presidents and The Treasury to its supposedly independent and self-aware current position as, arguably, the most powerful entity in the world. And because we always like to be ‘fair-and-balanced’ we juxtapose this clarifying truth of the maniacal growth of the Fed’s balance sheet and shift from passive to hyperactive – highlighting every major macro-economic and political event on the way – with G. Edward Griffin’s 1994 speech on ‘The Creature From Jekyll Island’.
Full Infographic available here.
And The Creature From Jekyll Island:
Tags: 1914, Balance Sheet, Creature From Jekyll Island, Current Position, Federal Reserve, Federal Reserve System, G Edward Griffin, History Maps, History Of The Federal Reserve System, Island History, Jekyll Island, Monetary System, Nbsp, Origins, Presidents, Treasury, Truth, United States, Visual History
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Sunday, June 10th, 2012
The Economy and Bond Market Radar (June 11, 2012)
After hitting record lows last week, bond yields moved higher this week in what could be best described as a mini “risk on” trade. Economic data remains weak, Europe is still in turmoil and we saw interest rate cuts in China and Australia. It is somewhat counterintuitive that bonds would sell off under such a scenario but this is a similar pattern to other periods when the Federal Reserve enacted quantitative easing. The market has already priced in the easing, and by the time it actually happens, the market is already looking ahead.
- China surprised the market by cutting interest rates by 25 basis points on Thursday. It has been speculated the rate cut was a preemptive move, anticipating weak economic data that China is scheduled to release over the weekend.
- Australia cut interest rates by 25 basis points to 3.5 percent, which is the lowest since 2009.
- The ISM Services Non-Manufacturing Index remained solidly in growth territory in May at 53.7.
- Factory orders fell 0.6 percent in April and have been very weak so far this year.
- The eurozone Purchasing Managers’ Index (PMI) in May fell to the lowest level since June 2009.
- Both the Fed and European Central Bank (ECB) did not offer any additional monetary measures for the market this week, which disappointed the markets.
- Bonds continue to grind higher and appear to be forecasting benign inflation and slow growth.
- The Fed appears willing to increase monetary accommodation if necessary, which would be a boost to the bond market.
- China’s economy is slowing faster than expected and government policy makers responded this week by cutting interest rates. This likely indicates weak economic data in the near term.
- Europe remains a wildcard with austerity programs under pressure, creating significant uncertainty.
Tags: Austerity Programs, Basis Points, Bond Market, Bond Yields, China, China Economy, China S Economy, ECB, Economic Data, Federal Reserve, Government Policy Makers, Interest Rate Cuts, Ism, Market Radar, Monetary Measures, Pmi, Preemptive Move, Purchasing Managers Index, Record Lows, Turmoil, Wildcard
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