Alarm bells in the European banking system have been ringing for quite a while but nobody seems to be listening. The roaring capital markets are just too loud. But we have been keeping track of a few things.
With U.S. rates higher than those of major foreign markets, investors are provided with an additional reason to look favorably on increased investments in the long end of the U.S. treasury market. Additionally, with nominal growth slowing in response to low saving and higher debt we expect that over the next several years U.S. thirty-year bond yields could decline into the range of 1.7% to 2.3%, which is where the thirty-year yields in the Japanese and German economies, respectively, currently stand.
"Excess credit creation is at the heart of much of China’s GDP growth, and why this means that China must choose between a sharp slowdown in GDP growth as credit is constrained, or a continued unsustainable increase in debt. The key point is that we cannot simply put the bad debt behind us once the economy is “reformed” and project growth as if nothing happened. Earlier losses are still unrecognized and hidden in the country’s various balance sheets."
"... it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally.... Never before have central banks tried to push so hard... Few are ready to curb financial booms that make everyone feel illusively richer. Or to hold back on quick fixes for output slowdowns, even if such measures threaten to add fuel to unsustainable financial booms.... The temptation to go for shortcuts is simply too strong, even if these shortcuts lead nowhere in the end."
The central banks have created moral hazard on a scale which is simply unbelievable and set a stage for a bonfire of the vanities seldom, if ever, seen in history. Professional Investors who have spent a lifetime playing these contrarian opportunities offered by human behavior are being carried out on stretchers as historic market behaviors fail to materialize. "Never in my 30+ year career as a market observer have I seen so many out on a limb which is about to be sawed off." Those who live within the matrix are fully loaded for a recovery which is not and will not appear. But when the leverage fails, the world’s developed economies will be thrust into the next leg of the cleansing process of deleveraging and the destruction of it will be equally bigger. This conclusion is firmly on the horizon; let’s call it the great insanity.
Today you can’t go 10 minutes without tripping over an investment manager using the phrase “Minsky Moment” as shorthand for some Emperor’s New Clothes event, where all of a sudden we come to our senses and realize that the Emperor is naked, central bankers don’t rule the world, and financial assets have been artificially inflated by monetary policy largesse. Please. That’s not how it works. That’s not how any of this works.
"... the Fed is overpromising and over-reaching on what it can actually deliver. It has always been quite a leap of faith to believe that ever-rising asset prices would create a wealth effect adequate enough to boost consumption, so as to make progress on the Fed’s dual mandates without causing adverse financial markets conditions.... After the 2008 crisis, policymakers have tried to end this mindset by becoming more proactive in trying to prevent financial crises. Though well-intentioned, this new approach has arguably led to Fed policy itself becoming a source of systemic risk... Markets are likely headed for a difficult period as the FOMC tries to gradually wean investors off of its liquidity addiction. It is too late for the FOMC to do much other than to try to limit the damage.... The bottom line could simply be that QE means ‘risk-on’, while ending QE means ‘risk-off’."
The mainstream media is latching on to the idea that all is not well in the world of 'markets'. The FT's Gillian Tett notes that, as we have vociferously explained, almost every measure of volatility has tumbled to unusual low levels, "this is bizarre," she notes, "financial history suggests that at this point in an economic cycle, volatility normally jumps." But investors are acting as if they were living in a calm and predictable universe, "[Investors in] the options markets are not pricing in any big macro risks. This is very unusual." In reality, as Hyman Minsky notes, market tranquility tends to sow the seeds of its own demise and the longer the period of calm, the worse the eventual whiplash. Tett concludes, that pattern played out back in 2007... and there are good reasons to suspect it will recur.
After the crisis, many expected that the blameworthy would be punished or at the least be required to return their ill-gotten gains—but they weren’t, and they didn’t. Many thought that those who were injured would be made whole, but most weren’t. And many hoped that there would be a restoration of the financial safety rules to ensure that industry leaders could no longer gamble the equity of their firms to the point of ruin. This didn’t happen, but it’s not too late. It is useful, then, to identify the persistent myths about the causes of the financial crisis and the resulting Dodd-Frank reform legislation and related implementation...."Plenty of people saw it coming, and said so. The problem wasn’t seeing, it was listening."
We have a few things to say about the recent debunking of established monetary theories. Effectively, the BoE joined forces with the rebels in economics who’ve long argued that standard models are bunk. Moreover, the BoE’s report discredits many well-known pundits, some more so than others. We’ll pick on one from the “more so” category: Paul Krugman.
More Reasons QE Is a Dud
With everyone and their mom confused at how bonds can rally when stocks (the ultimate arbiter of truthiness) are also positive, we have seen Deutsche confused (temporary technicals), Bloomberg confirm the shortage, and BofA blame the weather (for a lack of bond selling). Today, we have two more thoughtful and comprehensive perspectives from Gavekal's Louis-Vincent Gave (on why yields are so low) and Scotiabank's Guy Haselmann (on why they' stay that way).
Bank of America, whose stubborn, and quite abysmal "short Treasurys" call, has been one of the worst sellside trade recos in recent history and cost investors countless losses, has an update. Only instead of doing a mea culpa and finally admitting it was wrong, the bailed out bank has decided to provide humor instead. Namely it too has joined the ranks of countless others providing an "explanation" (or in its case, an "excuse") for the relentless bond bid. The punchline: "cold weather."
Having warned just 6 weeks ago that high-yield credit and small high-tech firms may be in a bubble, Fed Governor Tarullo, ironically speaking at the Hyman Minsky Financial Instability Conference, suggested that the recuction in share of national income for "workers" (i.e. income inequality) is troubling. Furthermore, he added, "changes reflect serious challenges not only to the functioning of the American economy over the coming decades, but also to some of the ideals that undergird the nation's democratic heritage." His speech, below, adds that since there has been only slow growth so far, expectations for a growth spurt are misplaced and that the Fed-policy-driven recovery has "benefited high-earners disproportionately."
"It is clear to us that speculative and Ponzi finance dominate China’s economy at this stage. The question is when and how the system’s current instability resolves itself. The Minsky Moment refers to the moment at which a credit boom driven by speculative and Ponzi borrowers begins to unwind. It is the point at which Ponzi and speculative borrowers are no longer able to roll over their debts or borrow additional capital to make interest payments.... We believe that China finds itself today at exactly this juncture."