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.
Just to confirm that in a world in which China and Russia (and Caracas... and Cuba) are increasingly seen as the paragons of liberty, virtue, and civil rights and the US is slowly but surely sinking into the role of the turnkey totalitarian tyranny antagonist, we just go this from House Intelligence Committee Chairman Mike Rogers: "Edward Snowden's reported choice to fly to Cuba and Venezuela undermines his whistleblower claims... Everyone of those nations is hostile to the United States, the Michigan Republican said on NBC's "Meet the Press" news talk show. "When you think about what he says he wants and what his actions are, it defies logic," said Rogers. Actually, Mike, when "you think about what he says", his actions make all the sense in the world, and certainly validate his "whistleblower claims."
Moments ago Edward Snowden landed at Sheremetyevo airport in Moscow, but since the American citizen has no Russian visa he will remain in the transit zone. And as Reuters reports, we now have some details on his next destinations, at least according to an Interfax source at Aeroflot: first Havana, Cuba, and finally Caracas, Venezuela as had been speculated earlier (although this may well be misdirection). Oddly enough, no Iceland (for now).
From Wikileaks: "Mr Snowden requested that WikiLeaks use its legal expertise and experience to secure his safety. Once Mr Snowden arrives at his final destination his request will be formally processed. Former Spanish Judge Mr Baltasar Garzon, legal director of Wikileaks and lawyer for Julian Assange has made the following statement: "The WikiLeaks legal team and I are interested in preserving Mr Snowden’s rights and protecting him as a person. What is being done to Mr Snowden and to Mr Julian Assange - for making or facilitating disclosures in the public interest - is an assault against the people"
Edward Snowden is no longer in Hong Kong. About an hour ago, the Hong Kong Authority released a statement which says that the NSA whistleblower has left Hong Kong today "on his own accord through a lawful and normal channel" which was yet another slap in the face of the US, saying the US provisional arrest warrant "did not fully comply with the legal requirements under Hong Kong law." In fact, not only did the HK authority defy the US arrest warrant, but it officially demands that the US clarify its own hacking of Hong Kong computer systems:"Meanwhile, the HKSAR Government has formally written to the US Government requesting clarification on earlier reports about the hacking of computer systems in Hong Kong by US government agencies." Having been given the blessing of HK to defy the US, Snowden is now supposedly en route to Moscow, from where he is said to continue further to Iceland.
People at the Fed are people in politics, who need to promote their allies and maintain their patronage networks. So perhaps it’s significant that the last two times the Fed tightened, it was in a President’s second term. It’s safer to anger an incumbent who is leaving, and dangerous to anger one who may have another six years in office. The party that lost the Presidency after one term, as a result of a crash in financial markets, would never forgive the Fed for its intervention. So if you are in the business of blowing up bubbles to win points with incumbents, and popping them at times when that is less of a concern, of course the President’s second term is when you do the popping. In this scenario, beliefs about an economic recovery play no role in motivating the tapering talk. It seems more likely that what’s really driving everything is the American electoral cycle. Well, what did we expect?
It's as if we have two economies: the simulacrum one of stocks rising dramatically in a few months, and the real one of household earnings (down) and hours worked (down). It is difficult to justify the feeling that we are living in an extraordinary moment in time, for the fundamental reason that it's impossible to accurately assess the present in a historical context. Extraordinary moments are most easily marked by dramatic events such as declarations of war or election results; lacking such a visible demarcation, what sets this month of 2013 apart from any other month since the Lehman Brothers' collapse in 2008? It seems to me that the ordinariness of June 2013 is masking its true nature as a turning point. Humans soon habituate to whatever conditions they inhabit, and this adaptive trait robs us of the ability to discern just how extraordinary the situation has become.
A new meme is spreading in financial markets: The Fed is about to turn off the monetary spigot. US Printmaster General Ben Bernanke announced that he might start reducing the monthly debt monetization program, called ‘quantitative easing’ (QE), as early as the autumn of 2013, and maybe stop it entirely by the middle of next year. He reassured markets that the Fed would keep the key policy rate (the Fed Funds rate) at near zero all the way into 2015. Still, the end of QE is seen as the beginning of the end of super-easy policy and potentially the first towards normalization, as if anybody still had any idea of what ‘normal’ was. Fearing that the flow of nourishing mother milk from the Fed could dry up, a resolutely unweaned Wall Street threw a hissy fit and the dummy out of the pram. So far, so good. There is only one problem: it won’t happen.
Extreme Developed Market (DM) monetary policy (read The Fed) has floated more than just US equity boats in the last few years. Foreign non-bank investors poured $1.1 trillion into Emerging Market (EM) debt between 2010 and 2012 as free money enabled massive carry trades and rehypothecation (with emerging Europe and Latam receiving the most flows and thus most vulnerable). Supply of cheap USD beget demand of EM (yieldy) debt which created a supply pull for EM corporate debt which is now causing major indigestion as the demand has almost instantly dried up due to Bernanke's promise to take the punchbowl away. From massive dislocations in USD- versus Peso-denominated Chilean bonds to spiking money-market rates in EM funds, the impact (and abruptness) of these colossal outflows has already hit ETFs and now there are signs that the carnage is leaking back into money-market funds (and implicitly that EM credit creation will crunch hurting growth) as their reaching for yield as European stress 'abated' brings back memories of breaking-the-buck and Lehman and as Goldman notes below, potentially "poses systemic risk to the financial system."
"It is getting to the point where the mark of international distinction and service to humanity is no longer the Nobel Peace Prize, but an espionage indictment from the US Department of Justice." - Julian Assange
Typically bond and stock prices are inversely correlated - providing what your friendly local asset allocator/wealth manager calls diversification or balance. However, at times of crisis, things get a little out of hand. In the last 6 years, there have been two instances of extreme high correlation between stock price returns and bond price returns - the first was at the peak in stocks in 2007 and led to a calamitous plunge in equities and rally in bonds; the second was amid full crisis mode in the fall of 2010 when QE2 was announced to save the world (followed by an equity and bond price rally). So, this time, with correlations running high, what happens next?
What are we supposed to do with all the “Dow 15,000” hats now? Keep them handy for another trip on the “Index Round Numbers Express” or just put them up on eBay in the “curios and collectibles” section? ConvergEx's Nick Colas suggests one way to think about the question is to deconstruct the Dow into its 30 components and see which stocks got us to these still-respectable YTD levels in the first place. For example, Colas notes that just seven stocks – MMM, BA, JNJ, AXP, DIS, HD, and HPQ – make up more than half the gains for the Dow in 2013. Most of these names have a distinctly cyclical flavor, of course. And while the Dow has its share of “Defensive” names, it pays to remember that the top 10 companies by weighting take up 54% of the Average. And they need a decent economy to grow earnings...
While the market's jarring response to Ben Bernanke's (very much un)surprising Taper pre-announcement has been extensively documented and discussed, and is most comparable to the tantrum unleashed during the summer of 2011 debt ceiling negotiation when the market's ultimatum that US spending must go on or the wealth effect gets it, the key question at the heart of the market's confusion is whether Bernanke has telegraphed the start of tightening or merely the end of easing. Stock bulls, obviously, defend the latter while those who dream for a return to normal, uncentrally-planned markets are hoping for the former. But what do the facts say? The charts below show the 10 previous Fed cycles with the dates of the last rate cut vs. first rate hike. The average time distance between the last rate cut and the first rate hike has been around 15 months.
From Part 1's post-2009 faux prosperity to Part 2's detailed analysis of the "wholy unnatural" recovery to the discussion of the "recovery living on borrowed time" in Part 3 (of this 5-part series), David Stockman's new book 'The Great Deformation" then takes on the holiest of holies - The Fed's Potemkin village. The long-standing Wall Street mantra held that the American consumer is endlessly resilient and always able to bounce back into the malls. In truth, however, that was just another way of saying that consumers were willing to spend all they could borrow. That was the essence of Keynesian policy, and to accept the current situation as benign is also to deny that interest rates will ever normalize. The implication is that Bernanke has invented the free lunch after all - zero rates forever. Implicitly, then, Wall Street economists are financial repression deniers.