Quantitative Easing

Despite the mainstream analysts' calls for a "great rotation" by investors from bonds to stocks - the reality has been quite the opposite.  While the 10-year treasury rate rose from the recessionary lows signaling some economic recovery in 2009; the decline in rates coincided with the evident peak in economic growth for the current cycle that begin in earnest in 2012 - "With rates plunging in recent weeks the indictment from the bond market concurs with the longer term data that the economy remains at risk." Despite the calls for the end of the "bond bubble" the current decline in interest rates are suggesting that the real risk is to the economy.  The aggressive monetary intervention programs by the Federal Reserve, along with the ECB and BOJ, continue to support the financial markets but are gaining little traction within the real economy. Of course, this is likely why the current quantitative easing program is "open-ended" because the Fed has finally realized that there is no escape.   The next economic crisis is coming - the only questions are "when" and "what causes it?"  The problem is that next time - monetary policy might not save investors.

It has been well known for years that PIMCO's Dr. Jekyll and Mr. Gross, the original bond king in charge of Allianz' $1+ trillion bond portfolio, has been a vocal critic of QE even in the face of his daily tweet barrage, which often recommends positions in complete contradiction to what said king opined on in his expansive monthly essays. What will come a great surprise, however, is that the "other" fund, which is just as big, is run by Wall Street's shadow king Larry Fink, and which has been advocating to go all in stocks for over a year (preferably using ETFs) interim drawdowns be damned (after all everyone by now should have an infinite balance sheet) - BlackRock - just went all out against QE.  As the FT reports, BlackRock's fixed income guru, formerly at Lehman Brothers, Rick Reider, "has called on the Federal Reserve to rein in its programme of quantitative easing, saying its bond-buying tactics are a “large and dull hammer” that have distorted markets and risk stoking inflation." Why, it is almost as if we wrote that... Oh wait, we did. Back in 2009.

• Finally the MSM catches up to reality: Workers Stuck in Disability Stunt Economic Recovery (WSJ)
• China opens Aussie dollar direct trading (FT)
• National Bank and Eurobank Fall as Merger Halted (BBG)
• Why Making Europe German Won’t Fix the Crisis - The Bulgarian case study (BBG)
• Nikkei hits new highs as yen slides (FT)
• Housing Prices Are on a Tear, Thanks to the Fed (WSJ)
• Why is Moody's exempt from justice, or the "Big Question in U.S. vs. S&P" (WSJ)
• Central banks move into riskier assets (FT)
• N. Korea May Conduct Joint Missile-Nuclear Tests, South Says (BBG)
• North Korea Pulls Workers From Factories It Runs With South (NYT)
• Illinois pension fix faces political, legal hurdles (Reuters)
• IPO Bankers Become Frogs in Hot Water Amid China Market Halt (BBG)
• Portugal Seeks New Cuts to Stay on Course (WSJ)

The downside technical correction in the dollar that we have been anticipating appears to have begun against most of the major currencies.  The drift lower against the yen over the past month has ended, and although we are skpetical of the impact of the stimulative monetary and fiscal policies in Japan, technically it is difficult to resist the momentum for additional yen weakness.  

The “Marshmallow Test” is a landmark study in child psychology which tests a toddler’s ability to delay gratification in return for the promise of a reward in the future.  Those who can wait 15 minutes unattended to eat a marshmallow are rewarded with a second treat. ConvergEx's Nick Colas, however, notes that more recent work on the topic, however, shatters the notion that innate self-control defines future success.  The real answer is, Colas adds, not surprisingly, trust.  If the child doesn’t believe their environment to be sufficiently predictable, they will be much more likely to gobble up the first treat regardless of any promised reward for waiting.  Since all investing is ultimately a game of delayed gratification, trust plays an under-appreciated role in the success of any macroeconomic policy on long term capital market and economic outcomes. What it essentially says is that you can’t keep whacking away with novel policy programs until one catches hold.  Trust in the system is what keeps the population playing along.  And when that trust erodes, the next iteration of confidence-boosting measures is less effective.  Repeat that cycle a few times and you end up with a population that will take the first marshmallow, gobble it down, and move on.

While the crisis in Europe is first in Goerge Soros' mind because it is the "hottest" risk flare currently, his biggest concern in what he calls the "disarray in global cooperation," or what we would call 'dueling central banks'. "The almost universal adaptation of quantitative easing," worries him and he notes that "Europe is the last bastion of orthodoxy," in this regard as the aging hedgie warns, "Europe is entering a situation that Japan is desperate to escape from," as "Japan has just abandoned - after 25 years of stagnation - a process that Germany is just in the process of imposing on Europe." But perhaps his clearest concern in this brief clip is that no matter what we are told, the central banks' actions are 'creating' increasing financial instability because, "let's face it, quantitative easing is really and directly competitive devaluation." But it is his comments on the actions of the BoJ that should be most concerning as he stated to CNBC, "What Japan is doing is actually quite dangerous because they are doing it after 25 years of just simply accumulating deficits and not getting the economy going," as he fears, should they actually get something [inflation] started, "they may not be able to stop it." If the yen starts to fall, which it has done, and people in Japan realize that it is liable to continue, and want to put their money abroad, then "the fall may become like an avalanche."

One of the simplest, most overused and popular assertions is that claim that stocks must rise because interest rates are so low.  In fact, you cannot get through an hour of financial television without hearing someone discuss the premise of the Fed Model which is earnings yield versus bond yields. The idea here, once formalized as the "Fed Model," is that stocks' "earnings yield" (reported or forecast operating earnings for the S&P 500, divided by the index level) should tend to track the Treasury yield in some fashion. This simply doesn't hold up in theory or practice.

QE "is not a Buzz Lightyear policy," Dallas Fed's Fisher explains to Bloomberg TV's Stephanie Ruhle, "this will not go on forever." He admits there are limits to their (and implicitly the ECB or BoJ) policies - "we just have to figure out what they are." The always outspoken fed head goes on to explain why he believes the Fed's policy should be "dialed back... Not go from wild turkey, the liquor by the way, to cold turkey; but certainly slowing it down now." The too-big-to-fail banks are absolutely gaining from a substantial cost-of-funding advantage (over smaller banks) with their implicit government guarantee and Fisher expresses disappointment in the reams of pages that constitute new regulation adding that he would prefer "a simple statement saying they understand there is no government guarantee... It could be written by a sixth grader," as Dodd-Frank "needs repair." His fears are exacerbated by Cyprus as he notes, "[in Cyprus] you have an economy that is held hostage by bank failure and institutions that are too big to fail. We cannot let that happen in the U.S. ever again and the American people will not tolerate it."

Krugman compared apples to oranges to make his point.

Last week saw a full court press in defense of the current money printing exercise. As we have frequently pointed out, modern-day economic policy is evidently in the hands of utter quacks. It matters little to them that their prescriptions have failed time and again for hundreds of years – they do the same thing over and over again, as though they were escapees from an insane asylum.

The smart money is selling Hong Kong and Singapore property. This implies real estate prices may be topping out, with far-reaching consequences.

Far from being a unique situation, the fragile exposure of unsecured depositors across the Euro zone is the norm; and their fragility was further increased in the last twelve months thanks to policies created by the same authorities who now refuse to honor their promise of a banking union, and instead impose capital controls, which have effectively destroyed any credibility on the safety of capital in the Euro zone. However, even if one accepts my view, the unintended outcome begs the following question: Why was there cheap money available for subordinated debt holders to cash out, but there is none now to protect the savings of depositors?

Bloomberg reported recently that Russia is now the world's biggest gold buyer, its central bank having added 570 tonnes (18.3 million troy ounces) over the past decade. At $1,650/ounce, that's $30.1 billion worth of gold. Russia isn't alone, of course. Central banks as a group have been net buyers for at least two years now. But the 2012 data trickling out shows that the amount of tonnage being added is breaking records. Based on current data, the net increase in central bank gold buying for 2012 was 14.8 million troy ounces – and that's before the final 2012 figures are in for all countries. This is a dramatic increase, one bigger than most investors probably realize. To put it in perspective, on a net basis, central banks added more to their reserves last year than since 1964. The net increase – so far – is 17% greater than what was added in 2011, which was itself a year of record buying. The message from central banks is clear: they expect the dollar to move inexorably lower. It doesn't matter that it's been holding up against other currencies or that the economy might be getting better. They're buying gold in record amounts because they see a significant shift coming with the status of the dollar, and they need to protect themselves against that risk. Embrace the messages central bankers are telling us – the ones they tell with their actions, not their words.

Events in Cyprus stem from precisely the same source as the surge in US home prices, namely monetary expansion by the Fed.