Rosenberg On The Probability Of Another QE Round
While Zero Hedge is confident that Bernanke will have absolutely no option but to continue with bond monetizations well beyond June, if for no other reason then because foreign Treasury buyers continue to be on a buying strike (except for the "UK" buyers of course) as confirmed by today's TIC data, which coupled with another $3 trillion in deficit funding needed over the next two years, means the Fed will increasingly have to step in and fill the debt issuance void which is now entirely picked up by the Frost-Sack FRBNY dynamic duo. That said there is one major trade off, and it is surging commodity price inflation, which as we have been predicting for over a year, will take the world by storm (literally and metaphorically) as excess liquidity finds new and unmet markets (and leading to such side effects as now well-publicized revolutions). Then again, Ben does not see it and thus it must not exist. By now everyone is aware that Benanke's self delusion is unmatched by any previously in the history of the world, so this can and will go on for a long time, until the same "excess slack" which forced the presidential overthrow in Tunisia reverberates around the developed world. And while we are confident that Bernanke will not stop at anything in his plan of global genocide to provide for infinite banker wealth, others such as David Rosenberg are not quite as sure. Here are Rosie's latest thoughts on the probability of yet another round of QE to follow once the current one is completed in June.
There is simply not a bailout plan, globally, that investors do not absolutely love (where exactly does the money come from and where would it have gone absent the need for these financial lifelines?). The U.S. dollar, in turn, is back in sick-bay as it slips back below its 50- and 100-day moving averages after a failed test, and this in turn is adding some impetus to the rally in commodity prices. The Canadian dollar has responded in kind (as have other resource-based currencies) by firming to its highest level in 2½ years.
Ben Bernanke’s QE program may well have induced a nice positive equity wealth effect but by inducing investment flows into all asset classes, food inflation has emerged, along with energy, as a potential source of global economic weakness and strife as prices soar in China and India and riots start to break out in Africa. Gold is rallying today though the chart does look quite choppy and sloppy right now — while we remain long-term bulls, one must wonder if things are starting to become a little nutty when you read stories (as we did this morning on Bloomberg News) that vending machines selling bullion are starting to be installed in Japan.
As we said before, movements in oil prices still exert a statistically significant impact on the economy and earnings with a 12-24 month lag. In other words, growth was still receiving a tailwind from the sharp downdraft in crude prices experienced from mid-2008 to early 2009 right through last year. But the gig is up and the economy is going to feel the effects of the near-120% surge in oil prices for the balance of 2011 and into 2012 barring a reversal. Only once in the past did the U.S. economy fail to sputter or head into outright recession after such a two-year surge in oil prices (food will only make matters worse in terms of depressing real wages) and that was in 2006 when the economy generated over two million jobs, the unemployment rate was 4.5%, wages were rising at a 6% annual rate, home prices rose an average of 8%, and bank credit expanded 10%. Those offsets are not in play this year.
And the question is whether the Fed would dare embark on QE3 with headline inflation in acceleration mode (even if core is still well contained). It’s one thing to bring on QE1 when oil prices are at $45/bbl and the CRB spot index is sitting at 325 (futures at 215) as was the case in March 2009. And then to announce QE2 nearly 18 months later when oil is sitting at $75/bbl and the CRB is sitting at 380 (futures were at 270). But can the Fed really be serious about yet another round of balance sheet expansion to please the stock market when oil is now above $90/bbl and the CRB is at a record high of over 530 (futures now north of 330)? Talk about rolling the dice with the bond market vigilantes.
Also, have a look at The Latest American Export: Inflation in the op-ed pages (A17 to be precise) of the WSJ. Indeed, not only has the Fed managed to create an illusion of prosperity by stepping up the print press and swinging the stock market around with QE2 chatter last summer, but now it is actually helping the government cause a de facto real appreciation of the yuan by pursing a back-door policy of boosting inflation in China. Bernanke is a true magician, no question about it.
Then again, the name of the game seems to be to kick the can down the road as far as it will go, buy as much time as possible, and hope that the economy can manage to grow out of all its imbalances from bad debt elimination, excess supply of housing, and pregnant government balance sheets. Bringing back mark-to-model accounting in the banking sector was the first move. Using TARP money as an industrial bailout strategy was next and right out of the 1930s FDR playbook. Goosing the fiscal system and adding to a deficit that was already running at nearly 10% of GDP was another, including a raid of Social Security and not allowing a 10-year tax cut to expire that was always destined to do so (a tax cut that was implemented to deal with the 2001 tech-wreck recession, not the 2010 stuck-in-the-mud recovery). The Fed was going to start shrinking its balance sheet a year ago, but instead re-expanded it by the end of the summer and is now thumbing the nose of the new Congress by hinting at doing even more to keep the speculative stock market rally alive. And the ballyhooed financial overhaul continues to miss deadlines and in fact has no teeth as it is — why cook the goose that lays the golden credit egg and must play a role in a leveraged economic expansion?
The complexity in the banking system remains as opaque as ever and now the lenders are generating profits by drawing on their loan loss reserves at a time when the unemployment rate is still perilously close to double-digits. The can has indeed been kicked down the road. Outside of selected state legislatures (see what Vallejo is doing to pension and benefits on page A6 of the WSJ), the tough decisions have been delayed and as a result, the next bear market and recession may end up looking just as bad as the last one. The only thing we seemed to have learned coming out of the credit bubble was to add even more debt to the overall national balance sheet. But as we saw in Ireland, not even the lucky can expand its debt at a faster rate than nominal income forever, especially now that the ratio in the U.S.A. is heading to unprecedented heights for a peace-time economy and to levels that end up impairing growth in the nation’s private sector capital stock. Borrowed time, that’s what the bulls have on their side. But we’ll see for how much longer, especially as the debt ceiling file plays out (see New Calls on GOP Side Not to Lift Debt Limit on page A8 of the WSJ).
With portfolio managers cash ratios back close to levels that they were at in the fall of 2007 and still just a trickle of inflows into mutual funds, the only source of buying power we can see in the equity market is leverage (the surge in margin borrowing) and massive short covering (short interest on the NYSE plunged 5.5% in the second half of December, which largely explains why the stock market absolutely rocketed during the month). If you want to have a good look at the consensus view see the editorial by BlackRock’s Bob Doll on page 22 of the FT (Prepare for Another Fine Surprise from U.S. Equities). Bob and I part ways on the outlook but we are old friends and collegues and he is still worth listening to.
And even if Bernanke's QE decision is independent of bond demand considerations, the truth is that the economy continues to slug through (and outperform only exclusively due to trillions in fiscal and monetary stimuli). Here are the most notable headwinds before the economy as evident to Rosie:
It is truly difficult to understand why it is that everyone is so whipped up about U.S. growth prospects. Even the latest set of data points has been less than exciting. Retail sales, payrolls, and consumer confidence have all been below expected and all of a sudden we see that jobless claims are moving back up. The deceleration in core capex orders is quite telling and housing remains firmly in the doldrums. To be sure, we have a slate of “diffusion” surveys telling us that businesses are feeling better — the ISMs, the IBD/TIPP survey, the NFIB and the array of regional manufacturing surveys too, but over 70% of the U.S. GDP is the consumer and we did seem to close out 2010 with real spending and wages roughly flat. Is that good? Or perhaps there is now this widespread belief that the government will stop at nothing to achieve the holy grail of sustainable economic growth and revived animal spirits among the investing class. The Fed has made it quite clear that the road to prosperity lies through the equity market, and that the primary objective of quantitative easing was to generate a positive equity wealth effect on consumer and business spending. So far, the stock market is biting because the rally has been non-stop in nature for months now and whatever givebacks we see are brief affairs and widely treated as buying opportunities. Hope springs eternal, so much so, that even soft economic data like we saw last Friday are treated with little more than a shrug of the shoulder.
The S&P 500 may still be some 17% away from its prior peak, but the Wilshire 5000 just closed at a new high after last week’s 1.8% advance, and in the short span of just 22 months, has managed to double (+100%). In other words, from the March 2009 lows, $8.3 trillion of paper wealth has been created. Thanks Ben! The S&P 400 midcap index is at a new high too, as is the Wilshire small-cap index, piercing its old high set back on July 13, 2007.
The Dow has now gained ground in each of the past seven weeks. The last time it did that was back in the week ending April 23, 2010. Ahem. A month later, it was down 1,200 points. You see, nothing lasts forever, not even a speculative bounce. The Shiller cyclically-adjusted P/E ratio has expanded for six months in a row and at 23.3x in January is now at its highest level in nearly three years. Sentiment is wildly bullish. The market is seriously overbought, and it is expensive on a “normalized” earnings basis.
In any event, as we look to the months and quarters ahead, what do we see? We see that the Federal government just announced a bonanza of $858 billion of stimulus measures towards the end of last year. Of course, almost all of that just ensures that Washington will not be a source of contraction this year, but the psychological impact has been huge so far. The Fed has allowed its balance sheet to explode even further to obscene levels of $2.43 trillion or triple what it was before the financial crisis took hold. In the past three years, the Fed’s balance sheet has expanded by $1.5 trillion and nominal GDP has only managed to rise over $500 billion. Fascinating. And we had the U.S. public debt explode by $5 trillion over that same time frame — the country is 244 years old and over one-third of the national debt has been created in just the past three years. Incredible. The U.S. government now spends $1.60 in goods and services for every dollar it is taking in with respect to revenues which is unheard of — this ratio never got much above $1.20, not even during the previous severe economic setbacks in the early 1980s and early 1990s.
So we have federal fiscal support, which at the margin is subsiding. And we have massive monetary support, and on this score the Fed is going to be facing much more intense congressional scrutiny going forward.
At the same time, it should be remembered that about half of last year’s GDP growth was inventory accumulation. That is about to come to an end.
Net exports in 2010 received support from accelerating global growth and the tailwind of a roughly 5% decline in the U.S. dollar from a year earlier. Now we have half of U.S. exports being negatively affected by policy-induced decelerations in Europe and non-Japan Asia.
The slowing trend in capital goods orders suggests that business spending growth will end up being half the 15% increase we enjoyed in 2010.
Illinois just raised taxes that will drain $6.5 billion from the regional economy and California is planning $12.5 billion in spending cuts.
All told, we could easily see $65 billion of fiscal restraint from the lower levels of government this year, which is akin to a 0.5% drag from baseline GDP growth.
If the GOP in Congress gets its way, in order to get the debt ceiling passed, we will see $50 billion of federal spending restraint this year too.
If home prices go down another 10-20%, as even some Fed district banks think is possible, that could end up curtailing consumer spending by a full percent via negative wealth effects on the personal savings rate. The question here is whether an overvalued stock market can serve as an antidote.
Vacancy rates are still far too high to believe that construction spending, residential or commercial, will be contributing to overall economic growth this year.
Interest rates are no longer declining and in 2010 this offered $100 billion of debt service support to the household sector.
Finally, the food and energy bill combined can be expected to drain $100 billion out of household cash flow this year too. As we saw in December, real spending looked flat and real wages are now down in three of the past four months. And the salutary effects of the payroll tax cut will only be felt incrementally this quarter. Look for air pockets thereafter.
Bottom line: Growth projections of 3-4% for 2011 look quite spurious to us even if the markets seem to have recently been buying into this supercharged consensus view.
The bottom line, to us, is that denial, and existence in a mythical world where facts absolutely don't matter can only continue for so long. As always, the best way to bet on the moment this arrangement fails is to buy the cheapest possible fat tail insurance one can find. And for that we once again refer readers to the most recent comprehensive presentation put together by SocGen on tail risk. We can only urge everyone to protect their gains, be they in gold, treasurys or Apple stock (preferably in the cheapest possible way).