Output Gap

More insight from a just released interview with Pimco's Paul McCulley. Nothing that McCulley has not said before but sheds some additional light on PIMCO's specific portfolio exposure currently. Of course, as Goldman has taught us all too well, anyone talking their book who is as big (and smart) as Pimco, could just as easily hld the other side of the trade, and just be looking for willing lemmings, of the variety that stood 24 hours in line for a big and blendable iPod.

"What I would like to do today is to explain in some detail the logic underlying this expectation that economic conditions will warrant exceptionally low levels of the federal funds rate for an extended period...There has to be a further demand impulse— be it a decline in household saving rates, a rise in business investment relative to profits, a further expansion of fiscal stimulus or an improvement in the net trade balance via an increase in exports relative to imports." Bill Dudley of Goldman Sachs, wait, formerly Goldman Sachs, now just of the New York Fed, who implores Americans to be patriotic and stop saving. Dudley hints at the inevitable endgame: "The fact that our foreign indebtedness is for the most part denominated in our own currency is a huge advantage in the event the dollar were to come under significant downward pressure."

Earlier Alan Greenspan shared some Fed insight, explaining the diagonal rise of the stock market, which can be summarized as follows - "stock prices determine the economy, not the other way round." In one simple sentence, Greenspan demonstrates that the Fed is not only chock full of people who can't read economic textbooks good (sic) but is populated by a subset of people suffering from cause-and-effect inversion disorder (it is also chock(er) full of new and improved stock traders and algos populating Liberty 33, doing all they can to make sure that in 13 up days, there is just one down). Yet in a market which has broken all laws of rationality, is the Fed's flawed self-fulfilling prophecy gaming the only thing that the amazing American's recovery is based on? To be sure, the main reason why economic skeptics such as Rosenberg, Edwards, Janjuah, and (ever decreasing) others retain their pessimism is that while the marker has now priced in one of the most ebullient, V-shaped economic recoveries in the history of the world, the underlying economy has stagnated and even downshifted into a double dip along numerous metrics, even despite ongoing fiscal stimulus and monetary pumpatude. So what is going on? Simple - the Fed, and by implication the administration, believe that once confidence and the market reach a given level, Joe Consumer will forget that the mortgage bill has not been paid in 12 months, the credit card in 3, that all neighbors lost their jobs a year ago and still can't find a new ones, and instead will merely look at the Dow (not the S&P - for some reason government/Fed workers still don't realize that nobody follows the DJIA, but whatever) and the UMich consumer confidence, for a barometer of economic health. The fallacy of this proposition is of course beyond preposterous, but these and such are the thoughts of the Federal Reserve.

Appropriately, Goldman's Sven Jari Stehn has just published an analysis looking at whether there is a two-way relationship between asset prices and the economy (merely the latest in a long line of such queries), and most relevantly: monetary policy.

Before delving into an ECB speech chock full of insight, a deflationist rant 'Through the Looking-Glass' of social mood as per:

[1] the management of inflation expectations;

[2] the implications within central bank (CB) exit strategery; and

[3] 'what Alice is likely to find' in Mr. Market's immediate future. If you think Bernanke an idiot and see hyperinflation-a-coming, you probably don't wanna read this.

We think that China is an indestructible economic juggernaut but its economy is very fragile and it is sitting on a property bubble which will burst. What China does in response has major implications for their economy and the rest of the world. This is the third part of a three-part series on this topic: The Consequences.

We think that China is an indestructible economic juggernaut but its economy is very fragile and it is sitting on a property bubble which will burst. What China does in response has major implications for their economy and the rest of the world. This is the second part of a three-part series on this topic.

Just because, you know, we still need the market to go up a little more so we can short the crap out of it even as we tell everyone how stocks have about 100 upside on average (link to Goldman's most recent conviction list, which incidentally benefits massively from a weak dollar, and a strong euro). Furthermore, by going long the euro will not be breaking any soon-to-be-misconceived laws, whereby shorting to EUR or, and we await for official Congressional confirmation on this, buying the dollar, will be seen as an act of treason.

One of the big puzzles over the past several months has been the apparent plateau in the unemployment rate, even despite a double dip in initial claims and an overall sentiment that the economy is ready to take a second, post-stimulus, leg down. Aside from the traditional allegations of data fudging by the BLS, one concept often presented has been the unprecedented surge in labor productivity, which despite overall declines in hours per worker and a deterioration in the labor force, has allowed GDP to not only regain its losses from the recent lows, but to stage a dramatic improvement. Today, in a must read paper, the San Francisco Fed tackles precisely this topic, and comes to the unpleasant conclusion that unemployment rate forecasts may well be too rosy for 2010 and beyond, especially if companies continue to sacrifice workers at the expense of ever increasing "worker productivity" which in itself is about as "credible" as any other data series presented by the government over the past year.

Tomorrow's Bernanke testimony will be eagerly watched by all, not so much for anything that may be revealed in the prepared remarks (those will not disclose anything not already known), nor for the Q&A (because unfortunately the people in Congress who understanding the first thing about monetary policy can be counted on two fingers), but because it is not every day that the undisputed and underrepresented ruler of the not so free world gets to sit down in a kabuki theater in which he pretends to be accountable to some 300+ million peasants and a couple million compulsive gamblers and kleptomaniacs. All in all good, wholesome, TiVoable, and, luckily, just biannual fun. Yet for those who hope to get something out of this meeting than merely a popcorn overdose, we recommend the following Testimony Preview from Goldman's Hatzius & McKelvey, which goes through not only the background of the spectacle but focuses on some oddly relevant questions which our Congressmen may be wise enough to ask. We point out the latter, because we know full well that nobody will ever ask the really relevant questions (until it is too late), unless of course Alan "Taz" Grayson is wearing his dollar tie, In which case all bets are off.

With regard to risk factors for economic activity, members concurred that, while there were some upside risks such as faster growth in emerging and commodity-exporting economies, there remained downside risks such as the possible consequences of balance-sheet adjustments in the United States and Europe as well as potential changes in firms' medium- to long-term growth expectations. They also agreed that attention should be paid to the effects of various recent international financial developments on Japan's economy, such as increased concerns about sovereign risk and developments in financial regulation and supervision around the globe. - Shirakawa et al.

For all you skeptics out there, let there be no doubt that the U.S. recovery is more than just fluff. Strength in manufacturing is picking up steam and services (66% of the economy) are expanding. And even after the Fed's latest move, policy remains far too accommodating...

Goldman is known for changing its estimates within 24 hours of an NFP number. Today, there is no change, and it stays at -25,000, coupled with an estimation of the unemployment rate at 10.1%. Additionally, some bearish observations on the US economy via Goldman uber economist Jan Hatzius, who is now convinced this is a U- and not a V-shaped recession, follow.

"Equities tend to do well when real rates are rising, but there are risks that it could be different this time if higher yields are driven by an inflation scare and/or heightened fiscal concerns. 'Start of tightening' remains our dominant theme of the year, and we continue to expect a consolidation in equities associated with the start of tightening. Market volatility around the start of Asian tightening and announcement of more onerous financial regulations confirms our long held view that the start of tightening could be many things other than the first Fed hike. With the general willingness of authorities to move away from crisis mode in recent weeks, we believe the tightening phase has now started and will intensify, and we expect positive payrolls will lead to a change in Fed language and the start of excess liquidity withdrawal in the next few months. We see 6% downside to MSCI Europe in the next 12 months and recommend selling into strength." - Teun Draaisma, Morgan Stanley

A talking point that has gripped the media in light of the sudden weakness ahead of the Ben Bernanke reconfirmation process, is the question of who should succeed the Fed Chairman, should he fail to obtain the requisite number of votes to continue. Many have said "Ben is bad, but anyone that would come after him would likely be even worse." While this is true for any of the potential successors (Donald Kohn, ex-Morgan Stanley banker Kevin Warsh, community-banker Elizabeth Duke, Daniel Tarullo, or ex-Goldmanite Bill Dudley, and speaking of the New York Fed, where Jeff Immelt is a Class B director: did Jamie Dimon, whose membership expired on December 31, 2009, get the Goldman renewal vote?), this is not an exclusive case. Which is why Zero Hedge proposes the candidacy of Stanford economist, and "Taylor Rule" creator, John Taylor for the post of Chairman of the Federal Reserve.

And you thought JP Morgan was aggressive. Goldman just threw out the last trump card in its current sell-side arsenal by increasing Q4 GDP estimates from 4% to a paroxysmal attack inducing 5.8%. While Zero Hedge long ago gave up discussing corporate fundamentals due to our long-held tenet that currently the only relevant pieces of financial information are contained in the Fed's H.4.1, H.3 statements, and, when Ron Paul's attempt at Fed deobfuscation is finally successful, the Fed's daily Sources and Uses of Funds statement, it would appear even macro economic data now is essentially one big joke. We are confident that JPM and Goldman are right on the money, and that the government will present the economy as having grown by nearly 6% in Q4. What is troubling is that after having taken over the housing and treasury market, and according to some others, the equity market as well, the Treserve (thank you Marla) has also singlehandedly added several log scale orders of magnitude of volatility to the general economy itself. Too bad GETCO does not have some predatory algo floating around, and overextending GDP momentum in any one general direction, as at this rate we would not be in the least surprised if Obama's Disinformation Czar (TBD) were to announce that the US is now competing for 10% GDP growth with China. As the two countries' centrally-planned economic systems now differ, well, not at all, it is only a matter of time before the race to the bottom in currency devaluation is enjoined by a competition as to who can fabricate, manipulate, inflate, stimulate and other "-ates", the fastest.