Monetary Policy

While US equity futures continue to do their thing as the DJIA 13K ceiling comes into play again (two weeks ago Dow 13K was crossed nearly 80 times), ahead of today's 2:15pm Bernanke statement which will make the case for the NEW QE even more remote, none of the traditional correlation drivers are in active mode, with the EURUSD now at LOD levels, following headlines such as the following: "Euro Pares Losses vs Dollar as Germany’s ZEW Beats Ests" and 20 minutes later "EUR Weakens After German Zew Rises for 4th Month." As can be surmised, a consumer confidence circular and reflexive indicator is the basis for this Schrodinger (alive and dead) euro, and sure enough sentiment, aka the stock market, aka the ECB's balance sheet expansion of $1.3 trillion, is "improved" despite renewed concern over Spain’s fiscal outlook after better than expected German ZEW per Bloomberg. Next, investors await U.S. retail sales, which have come in consistently weaker in the past 3 month, and unless a pick up here is noted, one can scratch Q1 GDP. None of which will have any impact on the S&P 500 policy indicator whatsoever: in an election year, not even Brian Sack can push the stock market into the red.

A month ago Zero Hedge, based on some Goldman observations, asked a simple question: is Okun's law now terminally broken? Today, with about a one month delay, the mouthpiece of the New York Fed (which in itself is nothing but a Goldman den of central planners, and Bill Dudley and Jan Hatzius are drinking buddies), Jon Hilsenrath shows that this is just the issue bothering his FRBNY overseers. In an article in the WSJ he ruminates: "Something about the U.S. economy isn't adding up. At 8.3%, the unemployment rate has fallen 0.7 percentage point from a year earlier and is down 1.7 percentage points from a peak of 10% in October 2009. Many other measures of the job market are improving. Companies have expanded payrolls by more than 200,000 a month for the past three months, according to Labor Department data. And the number of people filing claims for government unemployment benefits has fallen. Yet the economy is barely growing. Many economists in the past few weeks have again reduced their estimates of growth. The economy by many estimates is on track to grow at an annual rate of less than 2% in the first three months of 2012. The economy expanded just 1.7% last year. And since the final months of 2009, when unemployment peaked, the economy has expanded at a pretty paltry 2.5% annual rate." Hilsenrath's rhetorical straw man: "How can an economy that is growing so slowly produce such big declines in unemployment?" The answer is simple Jon, and is another one we provided a month ago - basically the US is now effectively "printing" jobs by releasing more and more seasonally adjusted payrolls into the open, which however pay progressively less and less (see A "Quality Assessment" Of US Jobs Reveals The Ugliest Picture Yet). After all, what the media always forgets is that there is a quantity and quality component to jobs. The only one that matters in an election year, however, is the former.  As for whether Okun's law is broken, we suggest that the New York Fed looks in the mirror on that one.

While hardly expecting anything quite as dramatic as the default of a Eurozone member, an epic collapse in world trade, or a central banker telling the world that "he has no Plan B as having a Plan B means admitting failure" in the next several days, there are quite a few events in the coming week. Here is Goldman's summary of what to expect in the next 168 hours.

For all this talk and hype, QE 3 is nowhere to be found. And it won’t be showing up anytime soon unless a full-scale Crisis hits. The reason for this is that the political landscape in the US has changed dramatically with the Fed becoming more and more politically toxic. As a result of this, the Fed (with few exceptions)  has begun to shift into damage control mode.

The Fed can get more market gains from Charles Evans than $600 billion in QE. Hey Bernanke, here’s an idea: just stop bothering with monetary policy at all give Charles Evans his own TV show. Heck, we'd get the same effect with less Dollar devaluation. 

The German criticism of a mess they themselves have enabled (and benefit from via peripheral current account deficits funded via TARGET2 as shown previously here) at the ECB continues, and following public protests by Bundesbank head Jens Weidmann about recent ECB activity, it is the turn of former ECB executive board member Juergen Stark to take center stage. In an interview with the Frankfurter Allgemeine, warned that following the massive expansion in the ECB's balance sheet, in which it is clear to anyone that the ECB will accept used candy bar wrappers as collateral, that "the balance sheet of the euro system, isn't only gigantic in size but also shocking in quality."

As expected, no rate changes from the ECB. Former Goldman alum Draghi is also not expected to say anything provocative at the press conference due in 45 minutes.

All you need to read.

Oil is battling hard with Greece to top the tail-risk-du-jour in financial markets recently. As Credit Suisse notes, the US economy so far seems to have shrugged it off as 'gasoline-sensitive' economic data for Feb have ignored the price rise for now. The extreme (warm) weather may be shielding the economy from the effect of these higher energy costs, as are consumers habituation with relatively high prices, and while CS remains more sanguine than us on energy's negative impulse they set forth some useful implications (rules-of-thumb) for what oil means for gas prices, headline inflation, real disposable income, and GDP growth pointing to $150 Brent as a critical threshold for the economy (or equivalently $4.50 retail gasoline prices). Of course, Fed policy precedents and implications are necessarily situational as the hope for this being a 'temporary' situation but the circular reaction to the consequences of any growth drag will merely exacerbate the situation. Was Bernanke's recent less unconditional dovishness an implicit effort to 'tighten' expectations and manage the war-premium out of oil prices?

The latest in a series of reports evaluating the future of the energy markets, especially in the context of the increasingly inevitable Iranian conflict, may just be the best and most comprehensive one (not just because it looks at the commodity from an "Austrian" angle). In 82 pages, Austrian Erste Group has extracted the key aspects and variables for the world oil market and come up with a simple conclusion: "nothing to spare." To wit: "We see the risks for the oil price heavily skewed to the upside. At the moment, the market is well supplied, but the smouldering crisis in the Persian Gulf could easily push oil prices to new all-time-highs should it escalate. We believe that new all-time-highs can be reached in H1, at which point we could see demand destruction setting in. We forecast an average oil price (Brent) of USD 123 per barrel between now and March 2013...The latently smouldering Iran crisis seems to be close to escalation. The most recent manoeuvres, ostentatious threats, sanctions, embargoes and the shadow war currently ongoing, have heated up the situation further. It seems we may soon see the last straw that breaks the camel's back. Even though Iran could probably only maintain a blockade of the Straits of Hormuz only for a very limited period of time, the consequences would still be dramatic. The oil price would definitely set new all-time-highs and could reach levels of up to USD 200." Enjoy those price dips while you can.

All you need to read.

Insolvency will keep dragging the Euro-Area economy down until sovereign and bank balance sheets are repaired, but as Lombard Street Research  points out: eliminating the Ponzi debt without fracturing the entire credit system is impossible. The Lehman default occurred 13 months after the US TED spread crossed 100 basis points. The European equivalent crossed 100 basis points in September 2011, so its banking crisis would occur this autumn if a year or so is a normal incubation period. A Greek or any other significant default will precipitate a European banking crisis in the foreseeable future. Markets are already speculating on Portuguese negotiations for haircuts and Ireland can’t be far behind and the contagion to US (and global) banking systems is inevitable given counterparty risks, debt loads (and refi needs), and capital requirements (no matter how well hidden by MtM math). The contagion will likely show up as a risk premium in the credit markets initially as we suggest the recent underperformance of both US and European bank credit relative to stocks is a canary to keep an eye on.

And now for some pure irony, we have a member of the Fed, granted a gold bug, but a Fed member nonetheless, one of the same people who not only enacted ZIRP, but encourage easy money every time there is a downtick in the market, complaining about, get this, Wall Street's "continued preoccupation, bordering upon fetish" with QE3. The irony continues: "Trillions of dollars are lying fallow, not being employed in the real economy. Yet financial market operators keep looking and hoping for more. Why? I think it may be because they have become hooked on the monetary morphine we provided when we performed massive reconstructive surgery, rescuing the economy from the Financial Panic of 2008–09, and then kept the medication in the financial bloodstream to ensure recovery....I believe adding to the accommodative doses we have applied rather than beginning to wean the patient might be the equivalent of medical malpractice." So let's get this straight: these academic titans, who for one reason or another, are given free rein to determine the fate of the once free world with their secret decisions every two or three months, are completely unaware of classical conditioning, discovered by Pavlov nearly 90 years ago, also known as a salivation response. The same Fed is shocked, shocked, that every time the market dips, the red light goes off, and the "balls to the wall" crowd scream for more, more, more free money. Really Fisher? Really? Oh, and let us guess what happens the next time the S&P slides into the tripple digits: will the Fed a) do nothing, thereby letting the market slide to its fair value in the 400 point range, or b) print. Our money, in the form of hard yellow metal, is on the latter, just like we predicted, correctly, back in March 2009 in " Bailoutspotting (Or The Search For The Great Financial Methadone Clinic" that nothing will ever change vis-a-vis the great market junkie until it all comes crashing down.

"Emotions exceeding known parameters cause extreme events, such as stock market booms and busts. They are self-reinforcing spirals upward and especially downward that, once established, keep diverging from equilibrium until the driving forces fade or stronger counter forces reverse them. Ever-increasing desires for accumulating ever greater wealth faster and faster ignited a credit bubble that spiralled upwards until it burst in 2007 from a lack of new borrowers. The multi decade credit bubble and its bursting were extreme events. No model recognized the credit bubble or its collapse and no model is giving any indication of the plethora of problems now brewing in Europe."

While everyone was busy ruminating on how little impact a Greek default would have on the global economy, the IIF - the syndicate of banks dedicated to the perpetuation of the status quo - was busy doing precisely the opposite. In a Confidential Staff Note that was making the rounds in the past 2 weeks titled "Implications of a Disorderly Greek Default and Euro Exit" the IIF was doing its best Hank Paulson imitation in an attempt to scare the Bejeezus out of potential hold outs everywhere, by "quantifying" the impact form a Greek failure. The end result: "It is difficult to add all these contingent liabilities up with any degree of precision, although it is hard to see how they would not exceed €1 trillion."  In other words, hold out at your own peril. Of course, what the IIF does not understand, is that for hedge funds it is precisely this kind of systemic nuisance value that makes holding out that much more valuable, as they understand all too well that they have all the cards on the table. And while a Greek default could be delayed even if full PSI was not attained by Thursday, it would simply make paying off the holdouts the cheapest cost strategy for the IIF, for Europe and for the world's banks. Unless of course, the IIF is bluffing, in which case the memorandum is not worth its weight in 2020 US Treasurys.