European equities opened higher, risk appetite boosted following overnight comments from Chinese Premier Wen that easing inflation in China left more room for monetary stimulus. However, summer thin volumes saw these gains pared, with particular underperformance in the FTSE 100, which currently trades in negative territory, despite stronger than expected UK retail sales for July. European CPI data for July was in line with market expectations, with no reaction seen across the asset classes following the release. Elsewhere, reports that Spain is to accelerate the bank bailout and is about to receive an emergency disbursement from the EUR 100bln bailout failed to support domestic bond market; the Spanish 2-year spread with respect to the German equivalent trading 6bps wider, though the Spanish 10-year spread is tighter on the day by 3.2bps and the 10-year yield is lower on the day, currently at 6.852%. The Spanish IBEX is outperforming on the back of this news, led by Bankia and Banco Santander.
The lunatics are running the asylum. This is the only conclusion one can come to when considering the nonchalance with which what was once considered an extraordinary policy with a firm 'exit' in mind is now propagated as a perfectly normal 'tool' to be employed at the drop of a hat. We refer of course to so-called 'quantitative easing' (QE), which really is a euphemism for money printing. Apart from his sole focus on short term outcomes, an important point that seems not be considered by the FOMC's Rosengren this week is the question of what should happen if the 'open-ended' QE policy were to fail to achieve its stated goals. He seems to assume that it will succeed in lowering unemployment and creating 'economic growth' as a matter of course. It goes without saying that money printing cannot create a single molecule of real wealth. If it could, then Zimbabwe wouldn't be a basket case, but a Utopia of riches. We must infer from Rosengren's idea of implementing open-ended QE until certain benchmarks in terms of unemployment and 'growth' are achieved, that in case they remain elusive, extraordinary rates of money printing would simply continue until the underlying monetary system breaks down.
Expansionary monetary policy constitutes a transfer of purchasing power away from those who hold old money to whoever gets new money. This is known as the Cantillon Effect, after 18th Century economist Richard Cantillon who first proposed it. In the immediate term, as more dollars are created, each one translates to a smaller slice of all goods and services produced. How we measure this phenomenon and its size depends how we define money.... What is clear is that the dramatic expansion of the monetary base that we saw after 2008 is merely catching up with the more gradual growth of debt that took place in the 90s and 00s. While it is my hunch that overblown credit bubbles are better liquidated than reflated (not least because the reflation of a corrupt and dysfunctional financial sector entails huge moral hazard), it is true the Fed’s efforts to inflate the money supply have so far prevented a default cascade. We should expect that such initiatives will continue, not least because Bernanke has a deep intellectual investment in reflationism.
Promises Of More QE Are No Longer Sufficient: Desperate Banks Demand Reserves, Get First Fed Repo In 4 YearsSubmitted by Tyler Durden on 08/03/2012 12:03 -0400
While endless jawboning and threats of more free (and even paid for those close to the discount window) money can do miracles for markets, if only for a day or two, by spooking every new incremental layer of shorts into covering, there is one problem with this strategy: the "flow" pathway is about to run out of purchasing power. Recall that Goldman finally admitted that when it comes to monetary policy, it really is all about the flow, just as we have been claiming for years. What does this mean - simple: the Fed needs to constantly infuse the financial system with new, unsterilized reserves in order to provide bank traders with the dry powder needed to ramp risk higher. Logically, this makes intuitive sense: if talking the market up was all that was needed, Ben would simply say he would like to see the Dow at 36,000 and leave it at that. That's great, but unless the Fed is the one doing the actual buying, those who wish to take advantage of the Fed's jawboning need to have access to reserves, which via Shadow banking conduits, i.e., repos, can be converted to fungible cash, which can then be used to ramp up ES, SPY and other risk aggregates (just like JPM was doing by selling IG9 and becoming the market in that axe). As it turns out, today we may have just hit the limit on how much banks can do without an actual injection of new reserves by the Fed. Read: a new unsterilized QE program.
The Hilsenrath-Haggle Federal Open Market Committee (FOMC) is likely to ease monetary policy at the July 31-August 1 meeting in response to the continued weakness of the economic data and the persistent downside risks from the crisis in Europe. While we expect nothing more exciting than an extension of the current “late 2014” interest rate guidance to "mid-2015", Goldman adds in their preview of the decision that although a new Fed asset purchase program is a possibility in the near term if the data continue to disappoint, their central expectation is for a return to QE in December or early 2013.
As markets continue to yo-yo and commentators deliver mixed forecasts, investors are faced with some tough decisions and have a number of important questions that need answering. On a daily basis we are asked what’s happening with oil prices alongside questions on China’s slowdown, why global trade will collapse if Romney wins, why investors should get out of stocks, why the Eurozone is doomed, and why we need to get rid of fractional reserve lending. Answering these and more, Mike Shedlock's in-depth interview concludes: "The gold standard did one thing for sure. It limited trade imbalances. Once Nixon took the United States off the gold standard, the U.S. trade deficit soared (along with the exportation of manufacturing jobs). To fix the problems of the U.S. losing jobs to China, to South Korea, to India, and other places, we need to put a gold standard back in place, not enact tariffs."
Two weeks ago we observed that the broadest money aggregate tracked by the Fed, M2, was less than $10 billion away from crossing the historic $10 trillion mark. As of this week, this number now officially has 14 digits for the first time ever, or $10,035,100,000,000 to be precise (technically the non-seasonally adjusted number crossed $10T last week, but for some reason bank deposits need to be seasonally adjusted, so waiting for the traditionally fudged data seemed appropriate). And we have a $50 billion increase in savings deposits, aka deferred buying power to those who still have the capacity to save, in one week to thank for putting $10 trillion in the rearview mirror.
While in principle central banks around the world can talk up the market to infinity or until the last short has covered without ever committing to any action (obviously at some point long before that reality will take over and the fact that revenues and earnings are collapsing as stock prices are soaring will finally be grasped by every marginal buyer, but that is irrelevant for this thought experiment) the reality is that absent more unsterilized reserves entering the cash starved banking system, whose earnings absent such accounting gimmicks as loan loss reserve release and DVA, are the worst they have been in years, the banks will wither and die. Recall that the $1.6 trillion or so in excess reserves are currently used by banks mostly as window dressing to cover up capital deficiencies masked in the form of asset purchases, subsequently repoed out. Which is why central banks would certainly prefer to just talk the talk (ref: Draghi et al), private banks demand that they actually walk the walk, and the sooner the better. One such bank, which has the largest legacy liabilities and non-performing loans courtesy of its idiotic purchase of that epic housing scam factory Countrywide, is Bank of America. Which is why it is not at all surprising that just that bank has come out with a report titled "Shipwrecked" in which it says that not only will (or maybe should is the right word) launch QE3 immediately, but the QE will be bigger than expected, but as warned elsewhere, will be "much less effective than QE1/QE2, both in terms of boosting risky assets and stimulating the economy."
Will the Fed then just keep printing forever and ever? As an aside, financial markets are already trained to adjust their expectations regarding central bank policy according to their perceptions about economic conditions. There is a feedback loop between central bank policy and market behavior. This can easily be seen in the behavior of the US stock market: recent evidence of economic conditions worsening at a fairly fast pace has not led to a big decline in stock prices, as people already speculate on the next 'QE' type bailout. This strategy is of course self-defeating, as it is politically difficult for the Fed to justify more money printing while the stock market remains at a lofty level. Of course the stock market's level is officially not part of the Fed's mandate, but the central bank clearly keeps a close eye on market conditions. Besides, the 'success' of 'QE2' according to Ben Bernanke was inter alia proved by a big rally in stocks. But what does printing money do? And how does the self-defeating idea of perpetual QE fit with the Credit Cycle relative to Government Directed Inflation (or inability to direct inflation where they want it in the case of the ECB and BoE)?
While some have talked of the 'credit-easing' possibility a la Bank of England (which Goldman notes is unlikely due to low costs of funding for banks already, significant current backing for mortgage lending, and bank aversion to holding hands with the government again), there remains a plethora of options available for the Fed. From ZIRP extensions, lower IOER, direct monetization of fiscal policy needs, all the way to explicit USD devaluation (relative to Gold); BofAML lays out the choices, impacts, and probabilities in this handy pocket-size cheat-sheet that every FOMC member will be carrying with them next week.
Why a new LIBOR based on Fed Funds (OIS) is determined by back door dealings between government sponsored failures (Fannie/Freddie) and a handful of compromised TBTF banks
Independent from Congress … or from the American People?
As Messers Frank and Paul take on the Bernank this morning, we reflect on the four easing options that the illustrious fed-head laid out in a statement-of-the-obvious that still managed to get the algos ripping. As Goldman notes, his prepared remarks were terse (and lacking in 'easing options' discussion) - cautious on his outlook, concerned at Europe, and fearful of the 'fiscal cliff' - but his response in the Q&A were a little more revealing as he laid out his choices: asset purchases, discount window lending programs, changes in communication about the likely path of rates or the Fed balance sheet, or a cut in the interest rate on excess reserves. We discuss each below but note, just as Goldman believes, that while we think that a modest easing step is a strong possibility at the August or September meeting, we suspect that a large move is more likely to come after the election or in early 2013 (and not before), barring a very rapid further deterioration in the already-cautious near term Fed economic outlook (which we assume implicitly brings the threat of deflation).
"A week after Bernanke spoke last year we saw the highs for H2 2012 (1345) before moving aggressively lower into the low 1100s through August- October as Europe’s problems intensified and the US debt ceiling problems came to a head. One year on and the biggest H2 risks are probably similar. US data is weakening, Europe’s problems could easily come to a head again and the fiscal cliff could become a major issue, albeit slightly later in the year. We also now have a China slowdown to contend with. So the parallels are there."
When it comes to insight into what is on Ben Bernanke, nobody is quite as capable as the firm that runs not only the NY Fed, but virtually every other central bank in the world: Goldman Sachs. Below we present Jan Hatzius' thoughts on what to expect when Bernanke takes the stand at 10 am today when he delivers the first day of his semi-annual Humphrey Hawkins presentation to Congress. Many expect him to hint at more QE, and lately a tempest in a teapot (to use the parlance of our times) has erupted over the possibility that the Fed will lower IOER to 0 or even negative. Here is what Goldman has to say about that: "we do not expect an IOER cut at this time." In fact, Goldman is rather skeptical Bernanke will hit at much if anything, especially with bond yields already at record lows: after all, how much more frontrunning of the Fed's bond or MBS purchases is there? Instead look for much more grilling on the Fed's role in Lieborgate: congress is now realizing it is woefully behind its UK political cousins when it comes to reaping points from years of global Libor manipulation. More importantly, Maxine et al have finally finished all those "Libor for absolute corrupt idiots" books they ordered almost a month ago so they are truly prepared.