Monetary Policy

Brief and concise summary of the week's key bullish and bearish events.

"What we have on our hands is a good old fashioned quagmire" is how Morgan Stanley's Mike Wilson sets up his surprisingly non-sheep-like perspective on the troubles that US equity investors may be about to face. Expanding on MS's bearish strategic (fundamental) forecast, that we discussed earlier in the week, Wilson combines the 'liquidity vs negative-real-rate' thesis (that the Fed's liquidity is perhaps no longer 'good' for stocks) with his own views on ECRI's weakness (very 2008-like in relation to ECO surprises), household debt deleveraging (more and longer), how much QE3 is already priced in and what will its effect be when it comes (less and less positive in nominal and real terms), investor sentiment (very bullish), long-term technicals (weak breadth), and short-term earnings expectations (deteriorating and weighted to 'weak' financials to end with the pragmatic realist perspective that perhaps 'the gig is up'.

Summary of the yawn-inducing minutes via Bloomberg:

• SEVERAL ON FOMC FAVORED CHANGE TO MID-2013 RATE VOW BEFORE LONG
• FOMC SAID GLOBAL FINANCIAL STRAINS POSE `SIGNIFICANT' RISK
• FED PLANS TO RELEASE OFFICIALS' FED FUNDS RATE FORECASTS (this is not news, and if the Fed is as accurate in "predicting" - note not setting - FF rates as it is in forecasting everything else, woe is us)
• FOMC MEMBERS SAW LONG-TERM INFLATION EXPECTATIONS AS STABLE
• FOMC MEMBERS SAW ECONOMY `EXPANDING AT A MODERATE RATE'
• FOMC MEMBERS SAID CONSUMER SPENDING `STRONGER THAN EXPECTED'
• MOST FOMC MEMBERS PREDICTED INFLATION WOULD `MODERATE'
• 'A NUMBER' OF FOMC MEMBERS SAW POSSIBLE NEED FOR MORE EASING

When it comes to the fabled President's Working Group on Capital Markets, also known as the Plunge Protection Team, the myths about the subject are certainly far greater than any underlying reality. To be sure, vast amounts of popular folkflore has been expounded into the public arena, with most of it being shot down simply due to it assuming conspiracy theories of such vast scale that the human mind is unable to grasp the complexity, and ultimately the inverse Gordian Knot makes an appearance with the claim that vast conspiracies are largely untenable simply because it is impossible to keep a secret from so many people for so long. Yet what if the secret is not a secret at all but is fully out in the open, and is only a matter of interpretation, and contextualizing? Why just 3 years ago it would appear preposterous to allege the capital markets are a ponzi and that the Fed does everything in its power to keep stocks higher. Well, what a difference three years make: now the Chairman himself in a Washington Post OpEd has admitted that the sole gauge of Fed success is the loftiness of the Russell 2000, neither unemployment nor inflation really matter now that the Fed's third mandate has been fully whipped out. Furthermore, Keynesian economics, and the entire top echelon of the educational system have also been accurately represented as a paradigm which merely perpetuates the status quo as the alternative is the realization that the whole system is a house of cards. As for the global capital markets being nothing short of a ponzi, we merely point you to the general direction of Europe, the ECB and the continent's banks, where the monetary interplay is nothing short of the world's biggest pyramid scheme. Yet the PPT, or whatever it is informally called, does not exist? Consider further that only recently did it become known that the former SecTres Hank Paulson himself was exposed as presenting material non-public information to a bevy of Goldman arb desk diaspora hedge funds, headed by with none other than the head of the President's Working Group on Capital Markets Asset Managers committee David Mindich. So, if contrary to all the evidence that there is some vast underlying pattern, if not a conspiracy per se, one were to take the leap of faith and take the next step, where would one end up? Well, most likely looking at the Exchange Stabilization Fund, or ESF, which Eric deCarbonnel has spent so much time trying to unmask. Is it possible that the ESF, located conveniently at the nexus between US monetary policy, foreign policy and last but not least, a promoter of the interests of the US military-industrial complex, is precisely the  organization that so many have been trying to expose for years? Watch and decide for yourself.

Continuing our tradition of listing what according to Zero Hedge readers were the key news events of the year for the third year in a row (2009 and 2010 can be found here and here), we present, as is now customary, the most popular posts of the year as determined by the number of page views, or said otherwise - by the readers themselves. So without further ado, here are this year's top 20.

What a guy ...

Yu Yongding: "Europe’s courtship of Beijing is moving to a more intense level. Klaus Regling, the chief of the eurozone bail-out fund, is in Beijing discussing possible support. Just a few days ago French President Nicolas Sarkozy conferred with Hu Jintao, his Chinese counterpart, to win Beijing’s support. They should not hold out their hopes too high. The two will have had a courteous hearing: China is willing and able to help. Since the beginning of Europe’s sovereign debt crisis, Beijing has repeatedly expressed its wish to offer “a helping hand” to Europe. Eurozone countries, however, have to understand that they will have to save themselves. Expectations of a “red knight” riding to the rescue are sorely misplaced."

With actual economic data now largely irrelevant, and why should it be : "got a recession? There's an EFSF for that" it is hardly worth noting that the third notable economic data point of the day, the first being GDP which came in line on an inexplicable surge in consumer spending in Q3 despite an epic collapse in consumer confidence, and a drop in the market to 2011 lows; the second being the nth consecutive print in initial claims over 400, which was the pending home sales update from the NAR which printed at -4.6% on expectations of an increase of 0.4%, and down from last month's -1.2%. This is the third consecutive monthly slide in sales data, and merely adds to yesterday's near record drop in median home prices, once again simply confirming that the biggest source of US "wealth" housing still has a long way to drop. And while we ridicule him all the time, even the NAR's Larry Yun has figured out that operation twist and monetary policy in general is a failure: "The Federal Reserve evidently has been attempting to lower mortgage rates, yet more consumers are faced with taking out jumbo loans that carry higher interest rates." Speaking of Jumbo loans, PrimeX jumped earlier today on the European news, and has since been drifting lower. It will continue doing so once some semblance of rationality returns.

Gold has fallen in all currencies today as equity and commodity markets have seen weakness due to concerns about Chinese economic growth after China's economy eased somewhat. Germany’s pouring cold water on the likelihood of a speedy resolution of the euro zone's debt crisis and the summit this weekend has also increased market jitters. Gold continues to be correlated with equities in the short term but we are confident that this correlation is short term in nature and the inverse correlation between gold and equities and bonds will again be seen in the medium and long term. Peripheral European debt markets are showing weakness again. The recent trend of falling yields appears to have ended which is worrying. Should yields begin to rise again this should create added safe haven demand for gold. UK inflation rose to match a record high of 5.2% (CPI) and retail price inflation (RPI), a measure of the cost of living used in wage negotiations, accelerated to 5.6% (from 5.2%), the highest since June 1991. The figures were again worse than expected by the BoE, economists and many economic experts who have been underestimating the threat of inflation for some time. The BoE, like the Federal Reserve, continues to follow an ultra loose monetary policy in an effort to boost an economy teetering on the brink of a double dip recession.

A fascinating insight from Graham Giller of Giller Investments, who analyzes over 55 years of Treasury data to point to what is the crux of the problems of monetary policy since Greenspan took over the Fed. The Greenspan [and Bernanke] era monetary policy has altered the distribution of changes in interest rates in a way that exchanges a reduction in day-to-day 'normal' variability for a considerably higher (perhaps catastrophically higher as we are finding out this week) likelihood of extreme shocks.

Still confused by the last two days of Ben Bernanke testimony which in under 24 hours had elements of glaring contradiction? A) You are not alone and B) Judging by the market's response to the Congressional and Senatorial portions of Bernanke's testimony, not even he knows what monetary message he was trying to convey. And since all of his decisions are ultimately predicated by Goldman Sachs (either in the form of current GS employee Jan Hatzius, or former GS employee Bill Dudley) here is Goldman's take on the "Q&A on the Monetary and Fiscal Policy Outlook" based on Alec Phillips and Sven Jari Stehn's take of Humphrey Hawkins events in the past two days.

Remember the whole UK stagflation scare, where the misery index recently hit a 20 year high, as both inflation and unemployment surged to two decade highs, keeping the GBP strong on expectations of rate hikes by the BOE? Well, the stagflation is still there, but according to just released BOE minutes, there has been a sudden 180 within the Monetary Policy Committee, which has now flipflopped, and just as we predicted, has fallen back to the traditional central bank fall back plan, namely "buy more bonds" as despite surging inflation, the country's central planners once again view deflation as a greater threat. As Bloomberg reports: "Bank of England minutes showed some policy makers see a potential need for further bond purchases as the economic recovery struggles and “downside” risks to growth and inflation mount. For the majority of the nine-member Monetary Policy Committee, “the fiscal challenges in the euro-area periphery highlighted the potential for further adverse shocks to demand,” according to minutes of the June 8-9 meeting published today in London. “For some of these members, it was possible that further asset purchases might become warranted if the downside risks to medium-term inflation materialized." So the spin now is not to worry about that surging inflation: it's "transitory"... just as the imminent UK QE2 will be: "While U.K. inflation was 4.5 percent in May, more than twice the central bank’s target, Governor Mervyn King said last week that the current price surge is temporary as he defended keeping the key rate on hold to aid the economic recovery during the government’s budget cuts. Paul Fisher said yesterday that adding to the bank’s bond program remains “very much on the table” as a policy tool." Next up: a major quantitative easing episode out of Japan as the two "peripheral" developed economies attempt to fill the void left by the Fed and fail miserably, at which point Bernanke will have no choice but to get involved as well.

Another indicator of what the US "recovery" looks like come courtesy of the Chicago Fed National Activity Index. As can be seen in the chart below, one can only wonder just what recovery the US would have if it did not spend $3 trillion to kickstart the virtuous (or better make that virtual) economic cycle when it did. And by the looks of facts (and not Tim Geithner spin), the downward inflection point has now arrived. Next up: another $1-1.5 trillion in monetary stimulus, although admittedly in a form that may be slightly different from the LSAPs we have all grown used to love and expect each and every day at 11:00 am EST.

Yesterday, when we presented the Bloomberg interview of Princeton economist and former Fed vice chairman Alan Blinder, we speculated that his statement that "more easing is necessary" was the first shot across the QE3 bow. Today, Goldman's Sven Jari Stehn has fired the second one in a paper just released titled: "Fiscal Adjustment without Fed Easing: A Tall Order" in which he basically takes our conclusion from the Blinder interview to the next level. As Blinder said previously, in order to improve the once again deteriorating labor picture, more fiscal stimulus would be necessary. That, however, is impossible, especially in a Congress where everyone is now promising $4 trillion of deficit cuts over the next few years. The only difference is how this cutting will be achieved: republicans want spending cuts, while democrats are demanding tax hikes for the richest. While neither approach will work in the US without the shock of a bond-crash induced austerity, Goldman conducts an thought experiment in which it evaluates the effectiveness of a tax-based and a spending-based fiscal consolidation. While finding that on average spending based deficit reduction is more effective, it only truly works in parallel with assistance from monetary policy: be it an interest rate decrease (impossible due to ZIRP) or further Large Scale Asset Purchase (QE) program. In other words, the only thing that can prevent an economic contraction in the next 2 years of semi-austerity, will be more monetary easing.

Goldman's Take: "Overall a healthy payroll report, but not a very large surprise relative to consensus expectations. In our view, the latest job readings will not have an immediate affect on the monetary policy outlook."