As long as politicians and media keep talking about disinflation and central bank inflation targets, and all they talk actually about is consumer prices, we will all fail to acknowledge what’s happening right before our very eyes. That is, the system is imploding. Deflating. Deleveraging. And before that is done, there can and will be no recovery. Indeed, this current trend has a very long way to go down. So far down that you will have a very hard time recognizing the world, and its economic system, on the other side of the process. But then again, you have a hard time recognizing the world for what it is on this side as well.
Tomorrow morning Mario Draghi is widely expected to if not announce an extension, or expansion, of the ECB's QE program, than to at least jawbone sufficiently, and push the EURUSD lower from its recently anchored level in the 1.10-1.20 range. But what are the specifics of Draghi's announcement: will he merely expand the monetization limit per security, as he did in early September, will he increase the universe of eligibile securities, or will he simply extend the maturity of the non-open ended QE from September 2016 to some indefinite date? The following list, courtesy of Bloomberg, summarizes what the sellside universe believes Draghi will unveil in just under 12 hours.
Paul Volcker announced his intention to squeeze inflation out of the system soon after he became Fed chairman. Too bad he didn’t save a better system. Not many men can resist the appeal of free money. Americans proved they were no better at it than others. Falling interest rates and the paper dollar gave them a way to impoverish themselves – by spending money they hadn’t earned. They took the opportunity offered to them. They borrowed and spent... and drove the entire world forward at a furious pace. But now that stage is over.
Global Capitalism is trapped in its own Prisoner’s Dilemma; fourty four years after the end of the Bretton Woods System global central banks have manipulated the cost of risk in a competition of devaluation leading to a dangerous build up in debt and leverage, lower risk premiums, income disparity, and greater probability of tail events on both sides of the return distribution. Truth is being suppressed by the tools of money. Market behavior has now fully adapted to the expectation of pre-emptive central bank action to crisis creating a dangerous self-reflexivity and moral hazard. Volatility markets are warped in this new reality routinely exhibiting schizophrenic behavior. The tremendous growth of the short volatility complex across all assets, combined with self-reflexive investment strategies, are creating a dangerous ‘shadow convexity’ that will fuel the next hyper-crash.
"Then tell me, future boy, who's President of Brazil in 2016? Then who's vice president?"
The uncertainties are awkward, but we’re all trapped in a gigantic mess not of our own making. As Voltaire is believed to have said, doubt may be uncomfortable, but certainty is absurd. Almost as absurd as believing that a tiny group of unelected bankers can read the runes of the global economy and manage the price of money accordingly.
Investors are too complacent (the Minsky-Moment). Too many are still trying to profit from the Fed subsidy of past stimulus. Investors remain loaded in risk assets, incentivized by the need to beat peers and benchmarks and comforted into complacency by the Fed ‘put’. The true level of risk is being ignored. The pervasive mentality of seeking maximum risk has become a terrible risk/reward trade for two main reasons...
"The only way to get velocity to pick up in a benign way is to write off the debt by a meaningful amount. That would have helped in the 2008 global financial crisis if more losses had been imposed on creditors. But that obviously did not happen in 2008 as the policymakers demonstrated that they did not believe in capitalism. Otherwise, the only other way velocity picks up is by an unhealthy hyperinflationary surge reflecting a loss of confidence in central banks, an outcome that becomes more plausible the more extreme the resort to quantitative easing."
The entire global financial system is leveraged to the 'Modern Portfolio Theory' concept that stocks and bonds are always anti-correlated. It is impossible to estimate how many trillions of dollars are managed according to the simple 60/40 mantras but let us just assume something north of $1.4 trillion and something south of "more money than God." However, the truth about the long-term (132-year) historical relationship between stocks and bonds is scary. The last three decades of extraordinary anti-correlation has been an era of falling rates, globalization, accommodative monetary policy, and very low volatility of CPI. With the global economy now at the zero bound, those days are over.
"The Squeeze Has Run Its Course" - According To BofA "The Rally Needs Central Bank Action To Continue"Submitted by Tyler Durden on 10/19/2015 12:42 -0500
"This positioning squeeze should have now run its course. Both positioning analysis based on our proprietary flows and the CFTC data suggest that the market is now short USD and long risk for the yea. A further increase in risk appetite will depend on central bank action, starting with the ECB this week."
For the second time this year, China's GDP deflator turned negative, meaning that in addition to any deliberate misrepresentations, Beijing may also be overstating GDP by way of a statistical shortcoming. Ultimately, they're habitually understating inflation for domestic output which means that "real" GDP is probably less "real" than nominal GDP.
The Fed has worked overtime since the 2008 crisis to produce a stability, a sense of normalcy in the economy and markets. It is a stable equilibrium now but almost any minor shock could change that dynamic for the worse and quickly. Widening credit spreads, Treasuries and gold outperforming stocks indicate that some parts of the market are already preparing for the storm. Stocks are about the only asset yet to batten down the hatches. If this is the calm before the storm, stock investors are about to get swept overboard.
The key overnight event was the much anticipated, goalseeked and completely fabricated Chinese economic data dump, which was both good and bad depending on who was asked: bad, in that at 6.9% it was below the government's 7.0% target and the lowest since Q1 2009, and thus hinting at "more stimulus" especially since industrial production (5.7%, Exp. 6.0%) and fixed spending also both missed; it was good because it beat expectations of 6.8% by the smallest possible increment, and set the tone for much of Europe's trading session, even if Asia shares ultimately closed largely in the red over skepticism over the authenticity of the GDP results. Worse, and confirming the global economy is now one massive circular reference, China accused the Fed's rate hike plans for slowing down its economy, which is ironic because the Fed accused China's economy for forcing it to delay its rate hike.
Goldman Mocks "Constitutionally Dovish" Fed, Sees December Rate Hike Odds At 60% To Offset "Credibility Problem"Submitted by Tyler Durden on 10/18/2015 13:52 -0500
Q: Why do you still expect the FOMC to hike rates in December?
A: Because the FOMC leadership has said that a rate hike by the end of the year is likely if the economy and markets evolve broadly as expected. Our near-term forecast is similar to theirs, so our baseline is also that they hike.