Quantitative Easing

Imagine the world economy as an armada of ships passing through a narrow and dangerous strait leading to the sea of prosperity. Navigating the channel is treacherous for to err too far to one side and your ship plunges off the waterfall of deflation but too close to the other and it burns in the hellfire of inflation. The global fleet is tethered by chains of trade and investment so if one ship veers perilously off course it pulls the others with it. Our only salvation is to hoist our economic sails and harness the winds of innovation and productivity. It is said that de-leveraging is a perilous journey and beneath these dark waters are many a sunken economy of lore. Print too little money and we cascade off the waterfall like the Great Depression of the 1930s... print too much and we burn like the Weimar Republic Germany in the 1920s... fail to harness the trade winds and we sink like Japan in the 1990s. On cold nights when the moon is full you can watch these ghost ships making their journey back to hell... they appear to warn us that our resolution to avoid one fate may damn us to the other.

It sounds good when said and credible and positive but the problem is that it is one more absurd illusion. Spain, this morning, says the next round of budget cuts are going to come from Education and Health benefits which is all very nice except they do not totally come under the purview of the Spanish Federal government. The way that Spain is currently constructed these expenditures are mostly under the control of the regional governments and so that these kinds of promises by the current administration in Spain are wisps of cultivated air floating from Madrid to Berlin. Even if the Federal government could get the cuts accomplished it will take them months and perhaps months and months so that the headlines of what Spain is going to do has all of the substance of the milky froth atop some cup of coffee in Valencia that resembles a cappuccino.

Treasuries vs. Stocks (for now)

Let us take another step down the Holmesian path. As the economies in Italy and Spain deteriorate who will be seriously affected: Germany. Two of their largest buyers of their goods and services will radically cut back on their purchases and the German economy, for the first time in this cycle, will suffer as buyers are no longer able to afford various services. The circle always completes and the consequences will not be pleasant; this circle, in fact, will resemble a noose that is pulled tighter and tighter with each passing quarter and the pay master for the European Union will shrink as their economy, currently at the $3.2 trillion mark, sinks back towards $2.5 trillion during the next year. There will be screams of anguish aplenty and you might begin now to make the necessary adjustments to this coming reality. Then as Italy and Spain soon line up at the till you will see the Real Hurt being on which is why Europe is begging the IMF, the G-20, China and Japan for funds because they now have the burning smell in their nostrils of damaged flesh that has been singed and is about to be cooked and served up fresh in the begging bowls of those urchins turned out into the street.

Before even taking into account the aftermath of the “unexpected” NFP result, it has been amazing to see over these past few months the number of experts, especially those that reside solely within the “science” of economics, proclaiming a successful engineering of the long sought-after recovery.  That this has been the third such claim in as many years is lost in the noise of confusing “headwinds” that are somehow beyond the control of those that now control most everything within the financial arena.  Stock speculators are beneficial components to the healthy financial transmission mechanism into the real economy (even when all they are supposed to do is provide liquidity 20,000 times per second), but anybody that dares speculate in the far more vital energy sector (or any real commodity) is the pure incarnation of evil.  That these two apparently disconnected speculative classes are really one and the same shows just how obtuse (not always intentionally) economists and the pandering classes really are.

Liquidity never solves issues of solvency and the time that it buys is generally of a relatively short duration. After the $1.3 trillion loan by the ECB to the European banks which helped drive up the prices for European sovereigns what do we now find as the liquidity ebbs? Yesterday’s Spanish auction was abysmal and the French auction today did not go too well with rising yields and less demand. The austerity measures are driving Europe into a worsening recession and the financial positions of Spain and Italy are deteriorating even as new measures are put into place. In fact there are only two ways out of the European mess which are growth, not happening, and Inflation which may be the ultimate strategy employed by the EU and the ECB if the construct holds to the point of changing strategies which is surely no outlier event.

Even Zhou Xiaochuan, Governor of the mighty People’s Bank of China, is worried....

Anyone who hasn’t sensed a mood change in this country since the 2008 financial meltdown is either ignorant or in denial. Millions of Americans fall into one of these categories, but many people realize something has changed – and not for the better. The sense of pure financial panic that existed during September and October of 2008 had not been seen since the dark days of 1929. Our leaders used the initial terror and fear to ram through TARP and stimulus packages that rewarded the perpetrators of the financial collapse rather than helping the middle class who lost 8 million jobs, destroyed by Wall Street criminality. The stock market plunged by 57% from its 2007 high by March 2009. What has happened since September 2008 has set the stage for the next downward leg in this Crisis. The rich and powerful have pulled out all the stops and saved themselves at the expense of the many. Despite overwhelming proof of unabashed mortgage fraud, rating agency bribery, document forgery on a grand scale and insider trading based on non-public information, the brazen audacity of Wall Street oligarchs is reminiscent of the late stages of the Roman Empire.   

European cash equities are trading in the red heading towards the US session, with particular underperformance in the periphery as financials continue to remain the biggest laggard. The EU session so far has consisted of downbeat commentary in regards to both Ireland and Portugal. An EU/ECB report noted that, Portuguese debt is now predicted to peak at 115% of GDP in 2013 and that contraction in 2012 is likely more pronounced than thought. Elsewhere, the Irish Fiscal panel said Ireland may need extra budget cuts to reach its 2012 target and 2012 growth has weakened. In terms of economic releases the UK observed a stronger than expected reading on its Construction PMI hitting a 21-month high, which saw some brief strength in GBP.

As markets crave their next fix of the money-printing elixir, perhaps it is worth noting the ever-decreasing impact that the quantitative easing experiments have had on 'measures' of the real economy. This seems to suggest that either: "we're gonna need a bigger boat" and the ongoing QEs will need to be exponentially larger than the prior in order to enact change in the 'measures' of real economy; or, the Fed has hit its limit as yet another 'multiplier effect' has been proved wrong in the limit and all we get to play with is the unintended consequences of a hidden inflation peering into view. Of course this is typical Keynesian dogma: if at first you don't succeed, do it again but bigger, more global, and with more geopolitical danger.

The week ahead will offer significant inputs to our views. ISM and payrolls will likely set the market tone for the next few weeks. Despite the softer signals from regional surveys, Goldman expects the ISM to improve at the margin relative to last month’s print. In contrast, it expects payrolls to grow by 175k, down from last month’s 227k jobs gain. FOMC minutes will likely show that Fed officials had a discussion on further easing but are unlikely to offer strong hints about the likelihood and possible timing of a third round of Quantitative Easing.

Inflection point, yes. There yet, no. 

European markets got off to a bad start following early reports that the Greek PM has not ruled out a further aid package for the country, however European cash equities are now trading higher as US participants come to market. Markets have been reacting to the announcement from EU’s Juncker that the Eurogroup has agreed upon Eurozone bailout funds of EUR 800bln. Elsewhere in the session, FPC member Clark commented that the FPC should not aim to stimulate credit growth in the UK, adding that direct intervention in the mortgage market is too politically volatile, but may be considered in the coming years. Following the reports, GBP/USD spiked lower around 15 pips, however it remains in positive territory, moving above the 1.6000 level in recent trade. In terms of data, the Eurozone CPI estimate for March came in just above expectations at 2.6%, 0.1% above the 2.5% consensus. The market reaction to this data, however, was relatively muted as participants await Eurogroup commentary. Looking ahead in the session, participants await commentary on the Spanish budget, US Personal Spending and Canadian GDP.

All you need to read and more.

There is noise and fluff and soap bubbles floating in the wind but don’t be distracted. Like so many things connected to the European Union it is just hype. In the first place do you think that any nation in Europe is actually going to put up money for the firewall no matter what size that they claim it will be? Let me give you the answer; it is “NO.” The firewall is just one more contingent liability that is not counted for any country’s financials, one more public statement of guarantee that everyone on the Continent hopes and prays will never be taken too seriously and certainly never used. Any rational person knows that some promise to pay in the future will not solve anything and it certainly won’t create some kind of magic ring fence around any nation. Think it through; what will it do to stop Spain or Italy from knocking at the door of the Continental Bank if they get in trouble and the answer is clearly nothing, not one thing. The firewall is just a distraction to lull all of you back to sleep and all of the headlines and discussion about it makes zero difference to any outcome and so is nothing more than a ruse. “Look this way please, do not look that way, pay no attention to the man behind the curtain, put up your money to buy our sovereign debt like a good boy and everything will be just fine.”