cross currents

I wasn’t sure whether to send this, as it reveals my lack of clarity on current events, but decided to send it to make the point.

Here’s what I see:

Markets are already discounting a large QE and are also discounting that QE actually makes a difference:

The dollar went down
Gold went up
Commodities went up
Interest rates fell
Stocks went up

So we have a big ‘buy the rumor sell the news’ leading up to the Fed meeting.

AND a potential ‘QE doesn’t work anyway’ let down.

I’ve never seen a more confused set of circumstances.
I recommend all traders stay out of this one.
Making money on this probably falls into the ‘better lucky than good’ category.

One of two things will happen- QE will or will not happen, data dependent

1. Good news for the economy means QE might not happen.

So the dollar reverses, and it went down for the wrong reason anyway, as QE fundamentally doesn’t alter the dollar, so it’s probably net short.

But how about the euro? It’s fundamentally strong with no end in sight, and good econ news helps them as much as anyone.
But an over sold dollar reversing can rally it against most everything while the unwinding goes on.

Stocks up, as that would be good news for stocks?
Or stocks down as rates go up and the dollar goes up, and the world goes to ‘risk off mode?’
(Stocks were helped by the weak dollar and lower rates.)

Is good econ news good or bad for gold? More demand in general is good, but less risk, less fear, and a strong dollar hurts. And it could be over bought in the QE craze as QE in fact has nothing to do with demand, currencies, or gold. It’s just a duration shift for net financial assets.

10 year notes? QE buying reverses and they go higher in yield.
But strong dollar and weak commodities and weak stocks and the Fed still failing on both mandates means low for long is still in place, even without QE.

It’s been strange enough that rates fell with a weak dollar (inflation) and rising commodities, so who knows what actually happens when whatever has been going on is faced with some combo of no QE and/or the realization that QE doesn’t do anything of consequence.

2. Bad news for the economy means QE happens.

Dollar keep falling? Or already discounted?
Gold and commodities keep rising? On bad econ news? And when already discounting QE working?
Stocks keep rising? On bad econ news? And already discounting QE working?

To a point, based on the presumption that QE actually works to add to domestic demand.
But has it already been discounted? And if markets believe QE works won’t they discount the Fed hiking after it works and the economy ‘takes off’???

The answer?

Don’t think of the medium term, just the short term.
Short term technicals will rule due to what’s been discounted.

The dollar is the pivot point, as it’s moved the most and for the wrong reason (except maybe vs the euro).

If nothing else, the dollar will appreciate if:

No QE due to good econ news
Buy the rumor sell the news/already been discounted forces
There is awareness that QE doesn’t do anything in any case
Foreign govt buying (currency war, etc.)

The dollar continues to fall if QE is larger than expected and the belief that it does something holds.

Recent economic news and Fed speak indicate that is not likely.

The other short term market moves will be reactions to the dollar move, and not so much reactions to what made the dollar move.

I do continue to like BMA forwards.
The one thing there is to be know is that high end marginal tax rates won’t go down, and that forward libor rates won’t fall below 50 bp.

ECB’s Weber Says Emergency Support Must Be Tied to Conditions

Confirming suspicions of what’s been happening somewhat behind the scenes.

They may even understand that as long as ECB support does not add to spending there is no inflationary effect.

ECB’s Weber Says Emergency Support Must Be Tied to Conditions

By Simone Meier and Rainer Buergin

October 15 (Bloomberg) — “A temporary financial support for member states should remain an option at best used only if there’s a clear, considerable contagion risk for the rest of the currency union and if, secondly, the use is tied to strict and painful conditions,” ECB Governing Council member Axel Weber said. Funds should be raised by individual member nations rather than through a joint measure such as Eurobonds, he said. “Measures for crisis management need to be tailored in a way that entails as little as possible distortion of incentives” for member states, Weber said. “That’s why it’s indispensable to credibly anchor the no-bailout principle.” Weber, who is also head of Germany’s Bundesbank, called for a system of “automatic sanctions” for countries breaching the region’s budget rules. It’s important not only to monitor countries’ shortfalls but also their debt, he said.

Now that claims didn’t fall…

Claims didn’t fall, they went up some.

So dollar still weak/commodities and stocks still moving up, and bonds only a touch off their recent highs.

With the large output gap and unit labor costs well contained, it can be said it’s not so much the dollar is weak but the other currencies strong, particularly the euro, where it looks like they are trying to force deflation with their austerity measures during a time of high unemployment. And the yen, too, is still struggling with deflation.

If I recall 1980 correctly silver has been lagging and ‘caught up’ with gold just before it all came apart? Silver peaked at maybe $60 while gold peaked at maybe $880?

The Reagan expansion that followed the end of the oil shock was not a good time for gold and silver.

And today they are going up for the ‘wrong’ reason- market participants believe and are shifting portfolios as if the Fed and other central banks were ‘printing money’ when they are not. And this can persist for a considerable period of time.

If initial claims fall again

If today’s initial claims fall again, indicating underlying employment improvement, there is a lot to think about.

The Fed might decide QE isn’t needed- yields back up due to the Fed not buying and the concern rates might not be low for all that long.
The low for long/QE 2 scenario is almost entirely based on employment showing no signs of life.

The dollar might suddenly reverse as short dollar positions that were placed due to qe2/low for long outlooks are reversed.

Messages more mixed for stocks and commodities.
Employment growth indicates more demand is possible.
But fears of money printing induced inflation (whatever that actually means doesn’t matter for short term trading) subside.
Dollar strength causes dollar prices of commodities to fall.
Commodity stocks hurt by falling prices, internationals hurt by rising dollar/earnings translations/falling export margins, etc.
Valuations hurt by higher term structure of rates.

Basically a partial unwinding of the massive qe2/low forever/weak dollar market of the recent past.

deficits vs corporate profits since 97

>   
>   (email exchange)
>   
>   On Tue, Oct 12, 2010 at 11:31 PM, Michael wrote:
>   
>   Thought you might like this. There is a hugely strong relationship between deficit
>   spending and corporate profits 1 year later. This is corporate profits with a 1
>   year lag, regressed against Quarterly debt to GDP.
>   

Yes, the old Levy profit equation from the 30’s maybe!

>   
>   From 1970 on, this is a strong relationship, except for a few quarters around 1997.
>   I’ll follow with another chart in a minute.
>   
>   The Senate run is improving your visibility – plus I am seeing Chartalism everywhere
>   now. It used to be fringe, now many people use it as a given…
>   

Good to hear it, thanks!

Weber Says ECB Should Start to Phase Out Bond Purchases ‘Now’

>   
>   (email exchange)
>   
>   On Tue, Oct 12, 2010 at 1:17 PM, Kevin wrote:
>   
>   Warren
>   
>   I am interested in your views on this development
>   
>   It would strike me as either blather or a dramatic reversal of fortune for
>   the continent
>   
>   Any thoughts?
>   

Weber has been against it from day one, which tells me he doesn’t get it at all. For now he’ll keep getting over ruled, but that can change down the road when ECB management turns over.

Yes, if this were to happen in this kind of economy it could all head catastrophically south very quickly again, and, as before, not end until the ECB resumes writing the check.

The problem is he doesn’t understand that inflation and currency weakness would follow from excess spending by the national govts, which is both not the case and under control of the ECB while they are funding. Instead he thinks the bond purchases per se somehow matter, though with no discernible transmission channel.

Weber Says ECB Should Phase Out Bond Purchases ‘Now

By Gabi Thesing and Christian Vits

October 12 (Bloomberg) — European Central Bank Governing
Council member Axel Weber said the ECB should stop its bond-
purchase program and signaled that it’s time for officials to
show how they will withdraw other emergency measures.

“As the risks associated with the Securities Markets
Program outweigh its benefits,
these securities purchases should
now be phased out permanently,” Weber said, according to the
text of a speech delivered in New York today.

“As regards the two dimensions of exit consisting of
phasing-out non-standard liquidity measures and normalizing our
clearly expansionary monetary policy, there are risks both in
exiting too early and in exiting too late,” Weber said. “I
believe the latter are greater than the former.”

Weber’s comments are the strongest so far from any official
on how the ECB will withdraw its emergency stimulus measures.
They come as governments and banks in some euro nations such as
Ireland and Portugal struggle to convince investors about their
financial health and as other major central banks signal their
willingness to add more stimulus to their economies.

The remarks also come less than a week after ECB President
Jean-Claude Trichet’s last policy statement, when he declined to
comment on the timing of the ECB’s exit strategy.

The bond purchases were opposed by Weber when they were
started in May as part of a strategy to keep the euro region
together after the Greek crisis threatened to undermine the
currency. The ECB stepped up its bond purchases at the end of
September, buying 1.38 billion euros ($1.9 billion) in the week
to Oct. 1, as tensions reemerged in Portugal and Ireland.

Unfunded state and local pensions

Not to worry – as long as they keep full allocations to equity markets the coming doubling of equity prices over the next few years will bail them out.

Provided the political leadership doesn’t get too serious about federal govt deficit reduction with tax increases and spending cuts.

US Cities Face Half a Trillion Dollars of Pension Deficits

By Nicole Bullock

October 12 (FT) — Big US cities could be squeezed by unfunded public pensions as they and counties face a $574 billion funding gap, a study to be released on Tuesday shows.

The gap at the municipal level would be in addition to $3,000 billion in unfunded liabilities already estimated for state-run pensions, according to research from the Kellogg School of Management at Northwestern University and the University of Rochester.

Comments on China’s temporary hike of Reserve Requirements

The lesson should be changing reserve requirements for a non convertibility currency, as the yuan is domestically for all practical purposes, doesn’t alter liquidity, but does alter balance sheet composition and pricing necessary to hit return on equity targets.

And looks to me more like their stealth inflation problem hinted at previously hasn’t yet been reigned in to their satisfaction?

  • 50bp hike in RRR for six large banks, valid for two months
  • the unusual temporary move reflects the central bank (PBoC)’s concern over strong lending appetite and hot money inflow
  • the PBoC is likely to follow up with more measures based the effectiveness of current policy
  • a lesson to the developed country on how difficult it is to rein in excessive liquidity

According to Reuters, China has raised reserve requirements by 50 basis points for six large commercial banks to 17.5%. It is reported that the move is only temporary and will be in place for two months. However there is no official statement from the central bank yet.

These six banks account for around 40% of China’s total lending and nearly 50% of the total bank assets. The 50bp hike in reserve requirement ratios will lock up about CNY150 bn of deposits.

We think the unusual temporary measure reflects the PBoC’s concern over excessive liquidity in the domestic economy on the backdrop of a robust growth. The total banking lending from January to August has reached 76% of the full-year target (CNY7.5 trillion), which means the monthly lending needs to be below CNY450 bn. However the domestic credit demand still seems to be very strong. Another possible reason for this move is the mounting evidence that the hot money is flowing back due the increasing pressure on the yuan appreciation.

The PBoC move speaks of the problems in managing a generous liquidity policy and stands as both a warning and a contrast to those other central banks considering a further round of quantitative easing. Once a generous liquidity policy is in place, it becomes difficult to wean dependent companies off the cheap and easy liquidity flow. Whereas the PBoC is not “pushing on a string” and there is genuine demand for this liquidity, the warning to the US federal reserve is clear. Even for economically well-administered economies, the latter stages of generous liquidity policies become very difficult to manage. Zombie (cheap liquidity dependent) companies, potential asset bubbles and the intractability excess liquidity are all legacy issues central banks
considering QE2 must consider.

Except that those are not the result of QE, but of what is functionally fiscal support for zombies, and the only effect zombies have on the real economy is that they waste valuable labor hours. Unfortunately no one seems to know how to keep fiscal drag low enough to sustain full employment so they see political benefit to useless employment.