When it comes to diving trends in the Fed's take over of the Treasury market, there are those who haven't got the faintest clue about what is going on, such as Paul Krugman, who naively looks (as Bernanke expects all economists to) at the simple total notional of securities held by the Fed and concludes that the Fed is not doing anything to adjust fixed income risk-preference, and then there are those who grasp that when it comes to defining risk exposure in the bond market, and therefore in equities, all that matters is duration, expressed in terms of ten-year equivalents. Sadly, this is a data set that not every CTRL-V major or Nobel prize winner (in order of insight) can grab from the St. Louis Fed - it is however available to those who know where to look. And as the chart below shows, even as the Fed's balance sheet has remained flat in notional terms, its Ten Year equivalent exposure has soared, rising by 50% during Operation Twist alone, from $900 billion to $1.313 trillion. What this means in practical terms, as Stone McCarthy summarizes, is that the Fed now owns 27.05% of the entire inventory in outstanding ten-year equivalents. This leaves less than 75% of the market in private hands.
What kind of plan is that?
In simple terms this tells us that inflation is hitting “lift off” in the US at the very same time that we are entering a recession that could be on par with that of 2008. And with corn and soybean prices at or near record highs, we could be on the verge of a stagflationary disaster combined with a food crisis at the very same time.
Europe’s new mantra has become that of “why just one”? Spain is returning to the table asking for yet another bailout. Of course you will hear the cries of conditions this, targets that… With rampant unemployment and an untenable political position, expect Rajoy to nod his head in acquiescence to the ECB while at the same time ignoring his pledge the very next minute.
So after 2 hell of positive weeks with fairy dust sprinkled by the CBU (Central Banks United), things seem a little out of breath here.
Post-Central Bank intervention depression, so to speak, as the question on everyone’s mind is “What’s next?
Add to that soured geopolitics that stirred spirits in Asia, MENA and to some extend in regional Spain.
It is hard to tell why the Federal Reserve moved so quickly into QE3 this past week. Was this move necessary with mortgage rates already in negative territory?
Dick Fisher speaks: "Just recently, in a hearing before the Senate, your senator and my Harvard classmate, Chuck Schumer, told Chairman Bernanke, “You are the only game in town.” I thought the chairman showed admirable restraint in his response. I would have immediately answered, “No, senator, you and your colleagues are the only game in town. For you and your colleagues, Democrat and Republican alike, have encumbered our nation with debt, sold our children down the river and sorely failed our nation. Sober up. Get your act together. Illegitimum non carborundum; get on with it. Sacrifice your political ambition for the good of our country—for the good of our children and grandchildren. For unless you do so, all the monetary policy accommodation the Federal Reserve can muster will be for naught.”"
As we reported first thing this morning, Spain, while happy to receive the effect of plunging bond yields, most certainly does not want the cause - requesting the inevitable sovereign bailout. To paraphrase Italy's undersecretary of finance, Gianfranco Polillo: "There won’t be any nation that voluntarily, with a preemptive move, even if rationally justified, would go to an international body and say -- ‘I give up my national sovereignty." He is spot on. However, the one thing that will force countries to request a bailout is the inevitable outcome of soaring budget deficits: i.e., running out of cash (as calculated here previously, an event Spain has to certainly look forward to all else equal). Which simply means that sooner or later Mariano Rajoy will have to throw in the towel and push the red button, knowing full well it most certainly means the end of his administration, and very likely substantial social and political unrest for a country which already has 25% unemployment, all just to preserve the ability to fund its deficits, instead of biting the bullet and slashing public spending (and funding needs), which too would cause social unrest - hence no way out. But why would a bailout request result in unrest? Reuters finally brings us the details of what the Spanish bailout would entail, and they are not pretty: "Spain is considering freezing pensions and speeding up a planned rise in the retirement age as it races to cut spending and meet conditions of an expected international sovereign aid package, sources with knowledge of the matter said...The accelerated raising of the retirement age to 67 from 65, currently scheduled to take place over 15 years, is a done deal, the sources said. The elimination of an inflation-linked annual pension hike is still being considered."
- Europe’s crisis will be followed by a more devastating one, likely beginning in Japan. (Simon Johnson)
- Porsche, Daimler Indicate Europe’s Car Crisis Spreading (Bloomberg)
- No progress in Catalonia-Madrid talks (FT)
- Hilsenrath speaks: Fed's Kocherlakota Shifts on Unemployment (WSJ) - luckily QEternity made both obsolete
- Lenders Reportedly Consider New Greek Haircut (Spiegel)
- Fed Officials Highlight Benefits of Bond-Buying (WSJ)
- ESM to Launch without Leverage Vehicle Options (WSJ)
- Japanese companies report China delays (FT)
- Borg Says Swedish Taxes Can’t Go Into Ill-Managed European Banks (Bloomberg)
- Greek Leaders Struggle With Spending Reductions (Bloomberg)
- Asian Stocks Rise as iPhone 5 Debut Boosts Tech Shares (Bloomberg)
- China government's hand seen in anti-Japan protests (LA Times)
The overnight session has been dead, leading to continued trading on the two regurgitated rumors appearing overnight, one coming from the FT that the EU is in "fresh" talks over a Spanish rescue plan - something which is not news, but is merely the occasional catalyst to get algos snapping up EURUSD and to keep it from sliding far below the 1.3000 barrier. This rumor has subsequently been swatted down later when Italy's undersecretary of finance, Gianfranco Polillo, in an interview in Rome, repeated what has been known to most for over two months, namely that Italy and Spain won’t request bailouts unless there a new surge in bond yields (just as we explained first thing in August), and adding that "There won’t be any nation that voluntarily, with a preemptive move, even if rationally justified, would go to an international body and say -- ‘I give up my national sovereignty." A surprising moment of lucidity and truth for a European. Naturally the reemergence of the rumor is supposed to draw attention away from the real news, which is that broke Catalonia is ever closer to bluffing its independence in exchange for a bailout, or else. The other real news is that as Confidencial reported, the Spanish government has asked Santander, Banco Bilbao Vizcaya Argentaria and CaixaBank to take 30% stake in the Spanish bad bank, something which will hardly make shareholders in these companies happy for the simple reason that no bank in Spain is "not bad" if the current rate of deposit outflows continues. Finally, a second rumor appearing late yesterday is that Greek lenders are considering a new Greek bond haircut. This too has since been refuted when German Finance Ministry spokesman Martin Kotthaus told reporters in Berlin at a regular press conference that this report is without basis. In other words, as we said, rumors refuted, leaving us with essentially no real news overnight.
What Do Economic Indicators Show? What Do Economists Say?
It appears it is after all not Scott Sumner who 'saved the US economy' by urging the helicopter pilot to create even more money ex nihilo than hitherto. What will save us instead is Apple, or rather, its latest product, the iPhone 5. Who needs Bernanke when this wondrous device stands ready to pull the economy up by its bootstraps? A story has made the rounds lately – propagated by 'economist' (we should use the term loosely…) Michael Feroli at JP Morgan, that sales of the iPhone "could potentially add from one-quarter to one-half of a percentage point to the growth rate of U.S. gross domestic product in the final quarter of the year”. If we were to assume that he is correct, then what this would mainly tell us is how useless a statistic GDP actually is. However, what really takes the cake is a small posting of Krugman's on the same topic entitled “Broken Windows and the iPhone 5”. This view is erroneous – economic laws are not dependent on economic conditions. This is akin to arguing that the laws of nature will cease to be operational on Wednesdays. In Krugman's capable hands, a fallacy becomes a 'theory'.
The last straw: invoking Japan to rationalize Fed policies and government deficits
There is a reason why we called the graph of youth unemployment in Europe 'the scariest chart' as quite simply, it is the leading indicator for what most call 'social unrest' - but some would call 'uprising'. In somewhat stunning news today, not only do a majority (54%) of Greeks no longer trust any political party, but the popularity of the ultra-nationalist Golden Dawn has risen dramatically since May. According to Ekathimerini, the popularity of Golden Dawn's leader Nikos Mihalolioakos has risen ten points since May to an incredible 22%. More than 1 in 5 Greeks now support the neo-nazi party as the general disillusionment with mainstream political parties - who are seen as lying to get votes - grows stronger. 85% believe that the new measures planned by the government to take affect them personally or another member of their family and 68% are against the terms of the EU's bailout.