Output Gap

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David Rosenberg: "What A Joke" - A Realistic Thanksgiving Postmortem





We remain in the throes of a secular era of disinflation. We also are in a long-term period of sub-par economic growth and below-average returns. This has become so well entrenched that U.S. pension plans now have more exposure to bonds than to stocks, as we highlighted two weeks ago. Look, this is not about being bearish, bullish or agnostic. It's about being realistic and understanding that in our role as market economists, it is necessary to provide our clients with information and analysis that will help them to navigate the portfolio through these stressful times. Our crystal ball says to stick with what works in an uncertain financial and economic climate — in other words, maintain a defensive and income-oriented investment strategy.

 
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David Rosenberg: "Hope And A Prayer"





It is not going to be a new government that necessarily ushers in a whole new era of growth, prosperity and confidence. Even under the revered Ronald Reagan, the period of secular growth and bull market activity took two years to unfold — it didn't happen right away. It took the inflationary excesses to be wrung out of the system and concrete signs that the executive and legislative branches could work together to usher in true fiscal reform — and to get blue Democrats on board with reduced top marginal tax rates.  Hope isn't generally a very useful strategy, but there is reason to be hopeful nonetheless. The critical issue is going to be how we get Washington to move back to the middle where it belongs. This requires bipartisanship which in turn requires leadership. Reagan's whole eight-year tenure in the 1980s occurred with the House being in Democrat hands the whole way through. Bill Clinton's second term coincided with both the House and Senate controlled by the Republicans.

It can be done! 

With this in mind, the best that can happen is a Reaganesque and Clintonesque return to compromise on the road to fiscal reform.  It will be painful. We all know it will be painful.

 
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On Europe As Japan 2.0





With Greece and Spain (and arguably Portugal and a few others) stuck in dramatic debt-deflation spirals, the political need for maintaining these nations in the euro far outweigh the economic 'benefits'. As UBS notes, looking at the euro area today, one cannot help but notice the parallels to Japan of the early 1990s. Europe today, as with Japan a generation ago, is an aging society with structural rigidities, pockets of corporate excellence, but wide swathes of inefficiency; but the two most striking similarities (and not in a good way) lie in the banking system (bloated from over-leveraging, under-capitalization, and bad loans); and fiscal policy (which is inherently pro-cyclical - as the politics of monetary union preclude national level stimulus - leaving ineffective monetary transmission channels unable to help fiscal failure). As UBS concludes, the current euro's similarities to Japan are key impediments to growth - and as such we should expect sclerotic economic activity for a five-year period.

 
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Bank Of Canada Fires Shot Across Bow, Says "Withdrawal Of Stimulus Will Likely Be Required"





With the entire world engaged in global coordinated easing, slashing, burning, and overall lowering rates and printing money by the wheelbarrow, the Bank of Canada just fired a shot across the bow. Here is the kicker: "Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1 per cent. Over time, some modest withdrawal of monetary policy stimulus will likely be required." Surely they must be punished for this blasphemy in the holy church of Saint John Maynard and the apostles of collapsing fiat.

 
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Guest Post: GDP And Durable Goods - Heading To Recession?





The recent release of the final estimate of Q2 GDP, and the September's Durable Goods Report, confirmed that indeed the economy was far weaker than the headline releases, and media spin, suggested. While the media quickly glossed over the surface of the report there were very important underlying variables that tell us much about the economy ahead. The problem is that there is little historical precedent in the U.S. as to whether maintaining ultra-low interest rate policies, and inducing liquidity, during a balance sheet deleveraging cycle, actually leads to an economic recovery.  This is particularly troublesome when looking at a large portion of the population rapidly heading towards retirement whom will become net drawers versus net contributors to the economic system. The important point for investors, who have a limited amount of time to plan and save for retirement, is that "hope" and "getting back to even" are not successful investment strategies.

 
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Bernanke At J-Hole: What He Will Say And What He Won't





With Draghi stepping aside, the headliner can shine and while Goldman does not expect Chairman Bernanke's speech on Friday morning, entitled "Monetary Policy Since the Crisis", to shed much additional light on the near-term tactics of monetary policy beyond last week's FOMC minutes; their main question is whether he breaks new ground regarding the Fed's longer-term strategy. An aggressive approach would be to signal that the committee is moving closer to the "unconventional unconventional" easing options that Goldman has been ever-so-generously advocating for months, although even they have to admit that expectations are that any moves in this direction will be gingerly.

 
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Guest Post: 2nd Quarter GDP - Weaker In All The Wrong Places





The first estimate of the 2nd Quarter GDP was released at a 1.5% annualized growth rate which was just a smidgen better than the 1.4% general consensus. There has been a rising chorus of calls as of late that the economy is already in a recession.  For all intents and purposes that may well be the case but the GDP numbers do not currently reveal that.   What we are fairly confident of is that with the weakness that we have seen in the recent swath of economic reports is that the 2nd quarter GDP will likely be weaker than reported in the first estimate. It is this environment, combined with the continued Euro Zone crisis and weaker stock markets, as the recent rumor induced bump fades, that will give the Federal Reserve the latitude to launch a third round of bond buying later this year.  While the impact of such a program is likely to be muted - it will likely push off an outright recession into next year.

 
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Charting America's Ever Shrinking "Revisionist" Economy





This has been the recovery of downward revisions - each annual revision to payrolls and GDP since the recovery started in 2009 revealed an even sharper contraction and weaker recovery. BofAML believes this year’s revision, which is released with the Q2 GDP report on Friday, will once again show an even slower start to the recovery with growth revised lower in 2009 and 2010, and modestly higher in 2011. While it is good news that growth could be revised higher in 2011, it appears that it will only be marginal. The downward revisions to growth in 2009 and 2010 will still leave the level of GDP lower and, hence, the output gap larger. This shows that the economy has made even less progress in healing from the deep recession. The severity and duration of the recession was understated in real time and the recovery was overstated. This suggests that monetary policy may not have been easy enough over the past several years - and therefore the current slowdown is even more significant.

 
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Why A 9-Year Trade-Weighted Low In The Euro Won't Help EU GDP





The euro has depreciated to its lowest level in nearly nine years when measured in trade-weighted terms. Common wisdom is to assume that this might trigger a GDP forecast upgrade for the common currency area. UBS says "no", while at first sight, this 'devaluation' should boost output, the exchange rate response is simply part of the bigger, well-known picture of economic stress in the common currency region. Simply put, the currency has depreciated on fear and risk aversion - and economic growth tends to suffer rather than flourish in that environment - and furthermore, the two structural measures that help determine the outlook for the currency - the internal balance (output gap) and the external balance (current account) - point to further weakness.

 
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Is The Swiss National Bank Faking It?





Some time ago we said that in a world in which virtually every risk and liquidity benchmark is manipulated by either private banks (thank your Liebor) or central banks, if one needs to know the true state of events in Europe, the only real remaining, unmanipulated benchmark remain Swiss nominal bond yields. And at -23.5 bps for the 2 Year it is telling us that nothing is fixed. As usual. Also judging by the SNB's new head Jordan statements which just hit the tape, in which he says that he would not rule out capital controls or negative rates if the crisis worsens, the SNB gets it. Or does it? Jordan also said that the SNB is ready to defend the FX market with unlimited market purchases if necessary. However, as the note below from JPM shows, the SNB may simply be faking it, hoping it too can get away with simple jawboning, instead of actually putting its money where its mouth is. As it turns out the SNB has indeed been intervening in huge size in the month of May to keep the EURCHF peg. The previously undisclosed news is that it has also been sterilizing its purchases. As JPM further notes: "This is highly significant and undermines the credibility of the SNB’s claim that it is willing to do whatever it takes to hold EUR/CHF 1.20. For the floor to be credible the SNB needs to surrender control over the Swiss monetary based, i.e. it has to be willing to deliver both unlimited and unsterilised FX intervention. The intervention in May was certainly unlimited; it most definitely was not unsterilised." How long until the FX vigilantes decide to test just how far the SNB is truly willing to go in defending the peg? And what happens when Swiss nominal yields hit record negative numbers once again?

 
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Fed Vice Chair Yellen Says Scope Remains For Further Policy Accommodation Through Additional Balance Sheet Action





That former San Fran Fed chairman Janet Yellen would demand more easing is no surprise: she used to do it all the time. That Fed Vice Chairman, and Bernanke's second in command, Janet Yellen just hinted that she is "convinced that scope remains for the FOMC to provide further policy accommodation either through its forward guidance or through additional balance-sheet actions", and that "while my modal outlook calls for only a gradual reduction in labor market slack and a stable pace of inflation near the FOMC's longer-run objective of 2 percent, I see substantial risks to this outlook, particularly to the downside" is certainly very notable, and confirms everyone's worst dream (or greatest hope assuming they have a Schwab trading platform or Bloomberg terminal) - more cue-EEE is coming to town.

 
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Strategic Investment Conference: David Rosenberg





david-rosenberg

Stocks are currently priced for a 10% growth rate which makes bonds a safer investment in the current environment which cannot deliver 10% rates of returns. We are no longer in the era of capital appreciation and growth. The “baby boomers” are driving the demand for income which will keep pressure on finding yield which in turn reduces buying pressure on stocks. This is why even with the current stock market rally since the 2009 lows - equity funds have seen continual outflows. The “Capital Preservation” crowd will continue to grow relative to the “Capital Appreciation” crowd.... According to the recent McKinsey study the debt deleveraging cycles, in normal historical recessionary cycles, lasted on average six to seven years, with total debt as a percentage of GDP declining by roughly 25 percent. More importantly, while GDP contracted in the initial years of the deleveraging cycle it rebounded in the later years.

 
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Bernanke's Right Hand Dove, Janet Yellen, Hints At ZIRP Through Late 2015





Last week we had the Fed's hawks line up one after another telling us how no more QE would ever happen. We ignored them because they are simply the bad cops to the Fed's good cop doves. Sure enough, here comes Bernanke's right hand man, or in this case woman, hinting that one can forget everything the hawkish stance, and that ZIRP may last not until 2014 but 2015! Which, by the way, is to be expected: since ZIRP can never expire, it will always be rolled to T+3 years, as the short end will never be allowed to rise, until the Fed has enough FRNs in circulation to absorb the surge in rates without crushing the principal, as explained yesterday.

 
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On The Pain In Spain





Much has been made, and rightly so, of the echoing crisis that is evolving in Spanish bank and sovereign credit (and equity) markets in the last few weeks. The impact of the LTRO on the optics of Spain's problems hid the fact that things remain rather ugly under the surface still and with the fading of that cashflow and reach-around demand from the Spanish banking system, the smaller base of sovereign bond investors has shied away. Stephane Deo, of UBS, notes that while the Spanish budget is a positive step (with its labor market reforms), Spain's economy remains weak and will face a severe recession this year followed by still significant contraction next year. However, he fears the measures announced may not be enough to calm investor angst as he doubts the size of fiscal receipts numbers and the ability to half the deficits of local authorities. Furthermore, the measures will have a large impact on corporate earnings - implicitly exaggerating the dismal unemployment numbers (which is increasingly polarizing young against old) with expectations that the aggregate unemployment rate could well top 26% and youth well over 50%. This will only drag further on the housing market, which while it has suffered notably already, is expected to drop another 25% before bottoming and credit is contracting rapidly (compared to a modest rise overall in Europe). Spanish banks remain opaque in general from the perspective of the size and quality of collateral and provisioning and Deo believes they are still deep in the midst of the provisioning cycle and tough macro conditions will force restructuring and deleveraging. Spain scores 5 out of 5 on our crisis-prone indicator and markets, absent intervention, are starting to reflect that aggressively.

 
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Overnight Sentiment Bubbly Ahead Of Retail Sales, FOMC





While US equity futures continue to do their thing as the DJIA 13K ceiling comes into play again (two weeks ago Dow 13K was crossed nearly 80 times), ahead of today's 2:15pm Bernanke statement which will make the case for the NEW QE even more remote, none of the traditional correlation drivers are in active mode, with the EURUSD now at LOD levels, following headlines such as the following: "Euro Pares Losses vs Dollar as Germany’s ZEW Beats Ests" and 20 minutes later "EUR Weakens After German Zew Rises for 4th Month." As can be surmised, a consumer confidence circular and reflexive indicator is the basis for this Schrodinger (alive and dead) euro, and sure enough sentiment, aka the stock market, aka the ECB's balance sheet expansion of $1.3 trillion, is "improved" despite renewed concern over Spain’s fiscal outlook after better than expected German ZEW per Bloomberg. Next, investors await U.S. retail sales, which have come in consistently weaker in the past 3 month, and unless a pick up here is noted, one can scratch Q1 GDP. None of which will have any impact on the S&P 500 policy indicator whatsoever: in an election year, not even Brian Sack can push the stock market into the red.

 
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