CLSA's Chris Wood Says Bernanke Will Continue "Mad Experiment" Until He Kills US Dollar Paper Standard, Looks Toward QE3
CLSA's Chris Wood is in fine form today.
From CLSA's Fear and Greed
The announcement of QE2 has come in as expected, namely an incremental approach. Still, the approach is sufficiently gung-ho to continue to give the benefit of the doubt to the risk trade. Investors should remain overweight Asia and emerging markets which will again prove to be the major beneficiaries of quanto easing. Macro investors should also remain long Asian currencies against the US dollar, with the Singapore dollar remaining GREED & fear’s favourite currency on a risk-adjusted basis.
GREED & fear’s view on QE2 remains that it will not precipitate releveraging of the American economy, just like the first version did not. But it will probably take some time for the equity market to work that out reflecting the natural bullish bias. Still when the releveraging hopes are dashed attention will then turn to QE3, which next time may include a formal inflation target and purchases of private sector debt.
Billyboy will likely carry on with his mad experiment until he precipitates the collapse of the US dollar paper standard. The Fed’s attempt to combat the perceived problem of deflation will end up creating a far bigger problem. That is the systemic risk posed by the anticipated ratcheting up of QE. This is why the view here remains that America will turn out to be a case of “Japan-heavy” not “Japan-lite”.
GREED & fear continues to be surprised that US financial markets are not more concerned about the continuing foreclosure mess. There is also the separate but related issue of faulty representations and warranties made by originators of non-agency mortgage loans in the mortgage-backed securitisation process. The issue is whether this is institution specific or system wide.
There is a small but not zero risk that this securitisation-boomerang problem could turn out to be systemic in nature in terms of the losses it could impose on prominent commercial banks and investment banks in terms of billions of dollars of mortgage exposure being put back to them.
One way US consumption has been boosted at the margin in the recent past is the growing practice of “strategic default” where people stop paying mortgages but continue to live “rent free” on the increasingly correct view that the banks will take an increasingly long time to foreclose on them. Such a trend can only serve to delay further a housing recovery.
The US housing crisis is somewhat unique in the sense that it is a product of a home financing bubble rather than a house price bubble. This is why house prices can get ridiculously cheap in the US before there is a final bottom. The systemic risk posed by the socialisation of the mortgage market is growing not receding.
With some politicians already calling for a nationwide moratorium on mortgage foreclosures, it is surely only a matter of time that the same sort of people will be calling for mandatory mortgage debt relief. This is a good reason for investors to sell exposure to US mortgage paper and US financial stocks.
The fundamental reason why such a mess exists is clearly that the repeal of the 1933 Glass-Steagall Act occurred without a realisation that such deregulation only made sense in the area of financial services if there was a similar deregulation in terms of allowing bad banks to fail. The most likely end game of a foreclosure crisis that turns systemic is another wave of taxpayer funded bank bailouts.
The renewed rise in PIGS spreads has not been accompanied by renewed euro weakness. This market action presumably reflects the news that the German efforts to impose some discipline on Euroland’s fiscal targets gives the euro more credibility. Still given the way both the Germans and the ECB blinked when the Greek crisis came to a head, it would be dangerous not to assume a similar reaction the time a crisis hits.
The Indian central bank is about the only central bank in Asia fundamentally comfortable with tightening independently of the US. This reflects the longstanding domestic demand driven nature of its economy and the resulting almost total absence of the export-orientated mercantilist bias so deeply entrenched amongst East Asian central bankers.