Bank of Japan

"Perhaps the success that central bankers had in preventing the collapse of the financial system after the crisis secured them the public's trust to go further into the deeper waters of quantitative easing. Could success at rescuing the banks have also mislead some central bankers into thinking they had the Midas touch? So a combination of public confidence, tinged with central-banker hubris could explain the foray into quantitative easing. Yet this too seems only a partial explanation. For few amongst the lay public were happy that the bankers were rescued, and many on Main Street did not understand why the financial system had to be saved when their own employers were laying off workers or closing down." - Raghuram Rajan

The only story this morning remains Bernanke's after hours speech, which solidly trumped the FOMC minutes in market impact, and which, in addition to ramping US equity futures to just about new all time highs, sent the EURUSD soaring by almost the same amount (+300 pips) as the actual QE1 announcement on March 18, 2009. Such is the power of verbal currency warfare, when Bernanke hasn't acutally done anything and merely hinted the Fed is as confused as ever about what to do. Of course, as Commerzbank notes this morning, the U.S. economy would have to lose a lot of momentum for the Fed to cancel tapering, and the central bank would only expand the purchase program if the economy collapses, but none of that matters to the "wealth effect" for the 1% where economic destruction simply means more wealth.

The U.S. economy weakened appreciably in the first quarter of 2013. But what if this weakness persists into the second quarter just completed, and worsens still in the second half of this year? Q1 GDP, as reported on June 26th, was revised lower to just 1.8%. And various indications suggest that Q2 could come in slightly lower still, at 1.6%. Might the U.S. economy be guiding to a long-term GDP of 1.5%? That’s the rate identified by such observers as Jeremy Grantham – the rate at which we combine aging demographics, lower fertility rates, high resource costs, and the burdensome legacy of debt. After a four-year reflationary rally in just about everything, and now with an emerging interest rate shock, the second half of 2013 appears to have more downside risk than upside. Have global stock markets started to discount this possibility?

This week's events placed in a broader context.  

Brief discussion of the price action that is lifting the dollar at expense of nearly every other currency.  

An unprincipled, deceitful, unreliable scoundrel. A vicious and solitary animal. An organism that shows a variation from the standard. What are we talking about? Rogue Traders! Does the cap fit?

The volatility of recent weeks is but a mere small taste of the volatility in store for all markets in the coming months and years. The global debt crisis is likely to continue for the rest of the decade as politicians and central bankers have merely delayed the day of reckoning. They have ensured that when the day of reckoning comes it will be even more painful and costly then it would have been previously.

Here's my take on the key events for investors in the week ahead, with an attempt to place them in a somewhat larger context.

It is easy to get the impression that the naysayers are wrong on Europe. After all the predictions of Armageddon, ten-year government bond yields for Spain and Italy fell to the 4% level, France which is retreating into old-fashioned socialism was able to borrow at about 2%, and one of the best performing bond investments has been until recently – wait for it – Greek government bonds! Admittedly, bond yields have risen from those lows, but so have they everywhere. It is clear when one stands back from all the usual euro-rhetoric that as a threat to the global financial system it is a case of panic over. Well, no. Europe has not recapitalized its banking system the way the US has (at great taxpayer expense, of course). Therefore, it is much more vulnerable. Where European governments and regulators have failed to make their banks more secure it is because they tied their strategy to growth arising from an economic recovery that has failed to materialize. The reality is that the Eurozone GDP levels are only being supported at the moment by the consumption of savings; in orther words, the consumption of personal wealth. Wealth that is not infinite; and held by those not likely to tolerate footing the bill for much longer.

Overview of the great unwind, which I suggest has three components--tapering talk in the US, Japanese selling foreign assets and the liquidity squeeze in China (squeezing another carry carry trade).

Until now, we have refrained from trying to explain Fedspeak to the masses. The truth is it's not opaque. It's not indecipherable. It's simple. Or at least you can choose to believe it is, as we have. At last week’s press conference, Federal Reserve Chairman Ben Bernanke fielded questions from reporters employed by some of the world's most esteemed news organizations. Here is a summary, translated from Fedspeak into ordinary American English and heavily condensed for easy tweeting.

Europe is a disaster-zone. Here’s the round-up of what’s going wrong right now. The longest day? It would have been a long day, whatever happened, so you might as well enjoy it.

After Thursday night's global liquidation fireworks, the overnight trading session was positively tame by comparison. After opening lower, the Nikkei ended up 1.7% driven by a modest jump in the USDJPY. China too noted a drop in its ultra-short term repo and SHIBOR rate, however not due to a broad liquidity injection but because as we reported previously the PBOC did a targeted bail out of one or more banks with a CNY 50 billion injection. Overnight, the PBOC added some more color telling banks to not expect the liquidity will always be plentiful as the well-known transition to a slower growth frame continues. The PBOC also reaffirmed that monetary policy will remain prudential, ordered commercial banks to enhance liquidity management, told big banks that they should play a role in keeping markets stable, and most importantly that banks can't rely on an expansionary policy to solve economic problems. Had the Fed uttered the last statement, the ES would be halted limit down right about now. For now, however, communist China continues to act as the most capitalist country, even if it means the Shanghai Composite is now down 11% for the month of June.

Japan’s attack in the Currency War was SUPPOSED to make it more competitive in international trade

Kyle Bass covers three critical topics in this excellent in-depth interview before turning to a very wide-ranging and interesting Q&A session. The topics he focuses on are Central bank expansion (with a mind-numbing array of awe-full numbers to explain just where the $10 trillion of freshly created money has gone), Japan's near-term outlook ("the next 18 months in Japan will redefine the economic orthodoxy of the west"), and most importantly since, as he notes, "we are investing in things that are propped up and somewhat made up," the psychology of negative outcomes. The latter, Bass explains, is one of the most frequently discussed topics at his firm, as he points out that "denial" is extremely popular in the financial markets. Simply put, Bass explains, we do not want to admit that there is this serious (potentially perilous) outcome that disallows the world to continue on the way it has, and that is why so many people, whether self-preserving or self-dealing, miss all the warning signs and get this wrong - "it's really important to understand that people do not want to come to the [quantitatively correct but potentially catastrophic] conclusion; and that's why things are priced the way they are in the marketplace." Perhaps this sentence best sums up his realism and world view: "I would like to live in a world where it's all rainbows and unicorns and we can make Krugman the President - but intellectually it's simply dishonest."