Real Interest Rates

"Perhaps the success that central bankers had in preventing the collapse of the financial system after the crisis secured them the public's trust to go further into the deeper waters of quantitative easing. Could success at rescuing the banks have also mislead some central bankers into thinking they had the Midas touch? So a combination of public confidence, tinged with central-banker hubris could explain the foray into quantitative easing. Yet this too seems only a partial explanation. For few amongst the lay public were happy that the bankers were rescued, and many on Main Street did not understand why the financial system had to be saved when their own employers were laying off workers or closing down." - Raghuram Rajan

Since 1694 and the ensuing three centuries’ of Bank of England history, the base rate has never been this low (see chart). Draghi, emulated his fellow Goldman Sachs banker, Carney and kept rates at 0.5%. Ultra loose monetary policies involving record low base rates have been in place in the UK since March 2009, a lengthy 4½ years. In the Eurozone 0.5% record low rates have been seen since May this year. 

The adjustments in core rates markets driven by repeated Fed commentary about its QE policy led to widespread selloffs in EM assets - and as we explained yesterday, this has potential vicious circle implications for developed markets. The significance of the EM selloffs has raised concerns about whether investors could abandon the asset class and trigger 'sudden stop' scenarios as they prepare for a post-QE world. Barclays believes we have likely entered a 'bumpy transition' towards a normalization of core market interest rates, and while they agree with us that the fundamental vulnerability to an end of QE may still reside with many DMs (eg, euro area periphery), rather than EMs, the large capital inflows into EM economies makes them extremely vulnerable to a rapid outflow of external capital.

The biggest bond fund manager on the planet likely had a bad day today and judging by his comments during the following Bloomberg TV interview, he is not too impressed with the current Fed head, who is "driving in a fog," or the front-runner to fill Ben's shoes, Yellen "is a Siamese twin in terms of policy... [preferring someone] who would emphasize Main Street as well as Wall Street - which has been the emphasis for the past three or four years." The mistake the Fed is making, Gross explains, "is blaming lower growth on fiscal austerity and expects towards the end of the year once that is gone, all of the sudden the economy will be growing at 3%," or more simply the error of their policy-making ways is "to think that is a cyclical as opposed to a structural problem in terms of our economy." The bottom-line is that Gross sees less Taper (due to disinflation) and warns "those who are selling treasuries in anticipation that the Fed will ease out of the market might be disappointed."

Almost exactly 8 years after Greenspan's now infamous "conundrum" comments about the unprecedented persistence of low, long-term interest rates, Bernanke is now "puzzled" at the dramatic rise in interest rates following his recent Taper remarks. Have no fear though, just as Greenspan noted, "I'm reasonably certain we would not automatically assume that it would mean what it meant in the past, " Bernanke said today that the "sharp rise in rates", was not about the Taper but "due to other factors, including optimism about the economy." Perhaps more importantly, today for the first time someone, not Hilsenrath of course, had the guts to ask Bernanke the hardest question: is the Fed's "Stock not Flow" worldview broken, and was it wrong all along? Of course, the implications of the Fed being wrong on this most critical aspect of monetary theory opens up a hornet's next of Pandora's boxes: just what else is the Fed wrong about, and how much will Bernanke be "puzzled" when one by one all of his flawed theories are revealed to be nothing but religious dogma.

Nike recently published a series of ads declaring “winning takes care of everything,” in reference to Tiger Woods’ recapture of the world #1 golfer ranking. The slogan went over with certain critics like an illegal ball drop. Many economists insist that “economic growth takes care of everything,” and the related debate is no less contentious than the Nike ad kerfuffle. Listening to some pundits, you would think there’s one group that appreciates economic growth while everyone else wants to see the economy crumble. It seems to me, though, that growth is just like winning – there’s no such thing as an anti-winning camp, nor is there an anti-growth camp. More fairly, much of the growth debate boils down to those who think mostly about long-run sustainable growth and those who advocate damn the torpedoes, full speed ahead growth. I’ll break off one piece of this and consider:  How much of everything does growth take care of?

"Part of my advantage, is that my strength is economic forecasting, but that only works in free markets, when markets are smarter than people. That’s how I started. I watched the stock market, how equities reacted to change in levels of economic activity and I could understand how price signals worked and how to forecast them. Today, all these price signals are compromised and I’m seriously questioning whether I have any competitive advantage left. Ten years ago, if the stock market had done what it has just done now, I could practically guarantee you that growth was going to accelerate. Now, it's a possibility, but I would rather say that the market is rigged and people are chasing these assets, without growth necessarily backing confidence. It's not predicting anything the way it used to and that really makes me reconsider my ability to generate superior returns. If the most important price in the most important economy in the world is being rigged, and everything else is priced off it, what am I supposed to read into other price movements?" - Stanley Druckenmiller

There's no way to sugarcoat the dismal performance of the precious metals in recent months. But a revisitation of the reasons for owning them reveals no cracks in the underlying thesis for doing so. In fact, there are a number of new compelling developments arguing that the long heartbreak for gold and silver holders will soon be over.

Emerging markets have tanked but some of the reasons for their underperformance will prove overblown, providing opportunities for long-term investors.

To get a sense of the momentous volatility in Japan, consider that the Nikkei225 is more or less in the same numeric ballpark as the Dow Jones, and that each and every day now it continues to have intraday swings of more than 500 points! Last night was no different following swing from 13100 on the high side to 12548 on the low, or nearly 600 points, with all this ridiculous vol culminating in a close that was just red however for a simple reason that the rumor of the Japanese Pension Fund reallocation taking place hit shortly before the close sending the USDJPY higher by 200 pips...  only for the news to emerge as an epic disappointment when it was revealed that the GPIF would raise its target allocation to domestic equities from 11% to... 12%. So much for the "Great Japanese Rotation."

The problem is central banks have created a vast pool of credit-money that is far larger than the pool of sound investment opportunities.  Why are asset bubbles constantly popping up around the globe? The answer is actually quite simple. Asset bubbles are now so ubiquitous that we've habituated to extraordinary excesses as the New Normal; the stock market of the world's third largest economy (Japan) can rise by 60% in a matter of months and this is met with enthusiasm rather than horror: oh goody, another bubblicious rise to catch on the way up and  then dump before it pops. Have you seen the futures for 'roo bellies and bat guano? To the moon, Baby! The key feature of the New Normal bubbles is that they are finance-driven: the secular market demand for housing (new homes and rental housing) in post-bubble markets such as Phoenix has not skyrocketed; the huge leaps in housing valuations are driven by finance, i.e. huge pools of cheap credit seeking a yield somewhere, anywhere:

India should monetise their huge gold stockpiles of over 20,000 metric tonnes according to the World Gold Council (WGC) as reported by Bloomberg this morning.

“In the long term gold could be monetized as a financial asset," Aram Shishmanian, the CEO of the WGC said in India overnight.

The World Gold Council has approached the Reserve Bank of India (RBI) to work with it so that bullion could be used as a financial asset, rather than just a physical asset. 

Some of my first memories of television are of a series called The Rocky and Bullwinkle Show, which was a witty combination of animated cartoons about the exploits of the title characters, Rocket "Rocky" J. Squirrel and Bullwinkle J. Moose and their nemeses, two Pottsylvanian nogoodniks spies, Boris Badenov and Natasha Fatale. The show was filled with current event commentary, political and social satire. The show was also filled with commentary on economic and market conditions that resonated with the parents watching the show while the kids focused on the cartoons. Each show ended with the narrator describing the current cliffhanger with a pair of related titles, usually with a bad pun intended. So let's adapt some of my favorite Rocky and Bullwinkle episode titles to modern day; we might see that there are some political and economic challenges that are timeless, as it appears we have been doing the same thing over and over for decades and expecting different results.

It is not just the massive short positioning in Gold futures that has BofAML's commodity strategists concerned; but the regime changes in the precious metal's volatility structures suggests risks are significantly mispriced relative to equities, rates, and other commodities. Following the most abrupt price collapse in 30 years, near-dated implied volatility in gold spiked dramatically in the past month. The term structure of implied gold volatility has also changed shape and the market now shows a marked put skew. Even then, the spike in precious metals volatility had remained a rather isolated event until this week’s sharp drop in Japanese equities. As the following chartapalooza demonstrates, while large-scale QE has tempered volatility across all asset classes for months, we remain concerned about the recent sharp price movements in gold or Japanese equities, and see a risk that other bubbling asset classes may follow.

With the first arrow of Abenomics perhaps hitting its limit, it will be the second and third arrows that need to occur quickly and aggressively to carry this momentum forward (and for the economy to grow into stock valuations). Barclays lays out 15 of its most frequently asked questions below but concerns remain as the BoJ’s planned absorption of nearly 80% of new JGB issuance from the markets this fiscal year has triggered a dramatic change not only in JGB supply/demand and ownership structure but in the JGB market risk profile itself, which has moved from “low carry, low volatility and high liquidity (superior to other assets from perspective of risk-adjusted returns or Sharpe ratio)” to “low carry, high volatility and low liquidity (inferior from same perspective)”. Barclays added that with a wave of major political and policy events ahead, starting with a crucial Upper House election, there was no big change in the basic belief among foreign investors that Japan is likely to be the main source of surprise for the global economy and of volatility in financial markets.