In his parting act, Federal Reserve Chairman Ben Bernanke has decided to continue printing some $85 billion per month (6% of GDP per year) and spend those dollars on government bonds and, in the process, keep interest rates low, stimulate investment, and reduce unemployment. Trouble is, interest rates have generally been rising, investment remains very low, and unemployment remains very high. As Lawrence Kotlikoff points out, echoing our perhaps more vociferous discussions, Bernanke’s dangerous policy hasn’t worked and should be ended. Since 2007 the Fed has increased the economy's basic supply of money (the monetary base) by a factor of four! That's enough to sustain, over a relatively short period of time, a four-fold increase in prices. Having prices rise that much over even three years would spell hyperinflation.
"Debt matters... even if it is possible to pretend for many years that it doesn't," is the painful truth that, author of "Avoiding The Fall", Michael Pettis offers for the current state of most western economies. Specifically, Pettis points out that Japan never really wrote down all or even most of its investment misallocation of the 1980s and simply rolled it forward in the form of rising government debt. For a long time it was able to service this growing debt burden by keeping interest rates very low as a response to very slow growth and by effectively capitalizing interest payments, but, as Kyle Bass has previously warned, if Abenomics is 'successful', ironically, it will no longer be able to play this game. Unless Japan moves quickly to pay down debt, perhaps by privatizing government assets, Abenomics, in that case, will be derailed by its own success.
While today's big event is the October Non-farm payrolls print, which consensus has at 120K and unemployment rising from 7.2% to 7.3%, there was a spate of events overnight worth noting, starting with Chinese exports and imports both rising more than expected (5.6% and 7.6% vs expectations of 1.9% and 7.4% respectively), leading to an October trade surplus of $31.1 billion double the $15.2 billion reported in August. This led to a brief jump in Asian regional market which however was promptly faded. Germany also reported a greater trade surplus than expected at €20.4bn vs €15.4 bn expected, which begs the question just where are all these excess exports going to? Perhaps France, whose trade deficit rose from €5.1 billion to €5.8 billion, more than the €4.8 billion expected. Of note also was the French downgrade from AA+ to AA by S&P, citing weak economic prospects, with fiscal constraints throughout 2014. The agency added that the country has limited room to maneuver and sees an inability to significantly cut government spending. The downgrade, however, was largely a buy the EURUSD dip event as rating agencies' opinions fade into irrelevance.
When it comes to US equities today, the picture below summarizes it all... the only question is whether the NYSE breaks to celebrate the year's overhyped social media IPO.Aside from the non-event that is the going public of a company that will likely not generate profits for years, if ever, the overnight market has been quiet with all major stock indices in Asia trading modestly lower on the back of a modestly stronger dollar, although the main currency to watch will be the Euro (German Industrial production of -0.9% today was a miss of 0.0% expectations and down from 1.6% previously), when the ECB releases its monthly statement at 7:45 am Eastern when it is largely expected to do nothing but may hint at more easing in the future. On the US docket we have the weekly initial claims (expected at 335k) which now that they are again in a rising phase, have been the latest data item to be ignored in the Bizarro market, as well as the latest Q3 GDP estimate, pegged by consensus at 2.0%.
The extreme experiment of current US monetary policy has evolved (as we noted yesterday), from explicit end-dates, to unlimited end-dates, to threshold-based end-dates. Of course, this 'threshold' was no problem for the liquidty whores when unemployment rates were extremely high themselves, but as the world awoke to what we have been pointing out - that it's all a mirage of collapsing participation rates - the FOMC (and sell-side strategists) realized that the endgame may be 'too close'. Cue Goldman's Jan Hatzius, who in today's note, citing two influential Fed staff economists, shifts the base case and forecasts that the Fed will lower its threshold for rate hikes to 6.0% (and perhaps as low as 5.5%) as early as December (as a dovish forward-guidance balance to an expected Taper announcement).
Looking ahead, Thursday will be a busy day with the ECB (plus Draghi’s press conference) and BoE meetings. Some are expecting the ECB to cut rates as early at this week although most believe the rate cut will not happen until December. Draghi will likely deflect the exchange rate’s relevance via its impact on inflation forecasts. This could strengthen the credibility of the forward guidance message, but this is just rhetoric — a rate cut would require a rejection of the current recovery hypothesis. They expect more focus on low inflation at this press conference, albeit without pre-empting the ECB staff new macroeconomic forecasts that will be published in December.
Just as Friday ended with a last minute meltup, there continues to be nothing that can stop Bernanke's runaway liquidity train, and the overnight trading session has been one of a continuing slow melt up in risk assets, which as expected merely ape the Fed's balance sheet to their implied fair year end target of roughly 1900. The data in the past 48 hours was hot but not too hot, with China Non-mfg PMI rising from 55.4 to 56.3 a 14 month high (and entirely made up as all other China data) - hot but not too hot to concern the PBOC additionally over cutting additional liquidity - while the Eurozone Mfg PMI came as expected at 51.3 up from 51.1 prior driven by rising German PMI (up from 51.1 to 51.7 on 51.5 expected), declining French PMI (from 49.8 to 49.1, exp. 49.4), declining Italian PMI (from 50.8 to 50.7, exp. 51.0), Spain up (from 50.7 to 50.9, vs 51.0 expected), and finally the UK construction PMI up from 58.9 to 59.4.
Since 2008, the Federal Reserve has been trying one program after the other in order to kick-start the US economy. It culminated in currently buying around $1 trillion of bonds a year. But economic growth remains weak. Why does the Fed continue its ultra-lax monetary policy despite evidence it doesn't help much? The people at the Fed are not stupid, so there must be a rational explanation. This is an attempt to figure out their 'game plan'.
The Fed will have to increase QE (not taper it) because systemic debt is compounding faster than production and interest rates are already zero-bound. Lee Quaintance noted many years ago that the Fed was holding a burning match. This remains true today (only it is a bomb with a short fuse). Thirteen years after the over-levered US equity market collapsed, eleven years following Bernanke’s speech, five years after the over-levered housing bubble burst, and four years into the necessary onset of global Zero Interest Rate Policies and Long-Term Refinancing Operations, global monetary authorities seem to have run out of new outlets for credit. In real economic terms, central bank policies have become ineffective. In other words, the US is now producing as much new debt as goods and services.
In the 1977 Eagles song, Hotel California, a luxury hotel appears inviting and offers a tired traveller comforting relief from his journey. It turns out to be something of a nightmare, however, and he finds that "you can check out anytime you like, but you can never leave". BNP's Paul Mortimer-Lee asks "does that sound a little bit like QE and the Fed?" The FOMC signalled its intention to check out of QE at its June meeting, but by September, it found it could not leave. Is that not just like QE1 and QE2, the scheduled ends of which had to be reversed within relatively short periods? The question now is whether or not we should expect repeated market obstacles to a QE3 exit. Why? Because, as we have noted numerous times, flows matter.
There was a time when the Fed's QE was, at least on paper, supposed to generate jobs (the broad inflation will come on its own, in due course). After all, the prospect of injecting $85 billion in liquidity into a market with the sole goal of pushing the stock markets that benefit the purchasing power of about 10% of the population would hardly have received broad approval even by the co-opted Congress. So, to all those who still naively claim Fed is not the sole reason for the market's relentless march higher, those billions in liquidity must go into the economy, and specifically into job creation, right? As a result, we decided to back into what the average private sector job has ended up costing the US population in pure dollar terms (which in turn ultimately manifests itself in terms of unsustainable government debt and pent up inflation) via the Fed's monetary pathway. Well, according to the ADP data released earlier, in which a paltry 130K private sector jobs were created in a month in which the Fed, as always, injected $85 billion, the bottom line came to a whopping $654K per job! And taking the average job growth throughout 2013, this number, as can be seen on the chart below, is a laughter-inducing $553K!
Now that the prevailing mainstream media consensus has finally caught up with our "tinfoil" view, which for years was mocked by the same media, usually on an ad hominem basis, and even the Fed has realized (confirmed by the latest Jackson Hole symposium) it is in a trap as it understands it has to end the market's dependency on monetary heroin but has no idea how to do it without in the process undoing five years of central planning, we have seen some spectacular opinion flip flops take place. Which aside from the occasional headscratcher such as David Rosenberg going bull-retard (we once again wonder: just what does Ray Dalio serve in his cafeteria?) have been almost exclusively from optimistic to pessimistic, or as we call it, realistic. And as the case may be, such as with John Mauldin and his latest missive to potential clients, A Code Red World, a very deep and red shade of pessimistic.
The Fed's capabilities to engineer changes in economic growth and inflation are asymmetric. It has been historically documented that central bank tools are well suited to fight excess demand and rampant inflation; the Fed showed great resolve in containing the fast price increases in the aftermath of World Wars I and II and the Korean War. In the late 1970s and early 1980s, rampant inflation was again brought under control by a determined and persistent Federal Reserve. However, when an economy is excessively over-indebted and disinflationary factors force central banks to cut overnight interest rates to as close to zero as possible, central bank policy is powerless to further move inflation or growth metrics. The periods between 1927 and 1939 in the U.S. (and elsewhere), and from 1989 to the present in Japan, are clear examples of the impotence of central bank policy actions during periods of over-indebtedness. Four considerations suggest the Fed will continue to be unsuccessful in engineering increasing growth and higher inflation with their continuation of the current program of Large Scale Asset Purchases (LSAP)...
Since all US rating agencies (Fitch is majority French-owned) have been terrified into submission and will never again touch the rating of the US following the DOJ's witch hunt of S&P, any US rating changes on the margin will come from abroad. Like China's Dagong rating agency, which several hours ago just downgraded the US from A to A-, maintaining its negative outlook. The agency said that while a default has been averted by a last minute agreement in Congress, the fundamental situation of debt growth outpacing fiscal income and GDP remains unchanged. "Hence the government is still approaching the verge of default crisis, a situation that cannot be substantially alleviated in the foreseeable future."
The latest Q2 US Flow of Funds data revealed that the corporate financing surplus declined to zero, for the first time since the Lehman crisis. The financing surplus is a measure of corporate savings, and in principle the lower this financing surplus the more expansionary the corporate sector is. Typically the corporate sector is dis-saving, i.e. capex typically exceeds cash flows from operations. However, the sharp decline in the US corporate surplus is less positive than it appears at first glance because it was driven by a rise in dividend payments rather than a rise in capex. As we have pointed out time and again, with the Fed's ZIRP, the only thing that matters is the share price and with firms increasingly focused on dividends rather than capex, to the extent that it continues, points to lower productivity and potential growth going forward.