"There’s a problem with kicking the can down the road" - Ben Bernanke, (December 12 2012)... We’ve taken this quote out of context - Bernanke was actually talking about the fiscal cliff, and not monetary policy; but kicking the can down the road is exactly what Bernanke is doing in his domain. Instead of letting the shadow banking bubble burst and liquidate in 2008, Bernanke has allowed it to slowly deflate, all the while pumping up the traditional banking sector with heavy, heavy liquidity. The reduction in shadow liabilities remains a massive deflationary and depressionary force (and probably the main reason why a tripling of the monetary base has not resulted in very severe inflation). Trillions and trillions of liquidity later, Bernanke is barely keeping the system afloat. We chose the path of Japan (which has spent the last twenty years depressed) not the path of Iceland (which is emerging from its depression). We chose to kick the can down the road. The system is rotten, and the debt load is unsustainable.
Regardless of the reasons, Ben’s got a major problem on his hands. That problem is the fact that Treasuries are on the verge of breaking their upward sloping trendline. If Treasuries begin to collapse at a time when the Fed is buying up over 70% of debt issuance, then the Great Treasury Bubble is finally about the burst:
The strength of the Japanese stock market over the past few weeks has been at once heralded as anticipation of Abe's policies and the renaissance of this island nation's faltering reality. However, as Bloomberg's chart of the day points out, this performance trend (just as we saw in sentiment and market performance in the US) is absolutely normal heading into an election. As the chart below shows, the election day (on average) has marked a significant short-term top in the market 12 of the last 13 previous cycles. So while Jeff Gundlach is short JPY and long NKY, we suspect there will be a better entry point for the latter 'lomg' leg just a few days after the election landslide. As Daiwa's Soichiro Monji noted "Investors buy on promises and ideals up until the election. When the parliament starts a normal session, they will start trading on reality."
Consider the consequences of the efficient subsidizing the inefficient. As long as the surplus generated by the efficient is larger than the cost of supporting the inefficient, the system can continue. But once the cost of subsidizing the inefficient exceeds the surplus generated by the efficient, the system is doomed to eventual insolvency. There is one way to fill the deficit, of course: borrow money. This is the strategy being pursued by the Status Quo in developed and developing economies alike. As long as the inefficient are protected from competition and amply subsidized, there are no incentives to become more efficient. In effect, becoming more inefficient is rewarded. What happens when the efficient sectors that are propping up a vast array of inefficient sectors falter? The politically expedient answer is of course to borrow more money. But that creates another kind of financial fragility. Borrowing money only masks the fragility for a time, while adding another layer of fragility beneath the apparently prosperous surface.
Ever get the feeling that the entire global economy is one big experiment conducted by several former Keynesian economists from MIT with a bent for central planning, who sit down in conspiratorial dark rooms in tiny Swiss cities and bet it all on green until they double down so much nobody even pays attention to the game? No? You should. Jon Hilsenrath, of all people, explains why.
The accumulation of reserves is primarily limited to developing countries. There are two notable exceptions among the high income countries. Japan, which is traditionally willing to intervene in the foreign exchange market to curb the yen's strength. The last intervention took place in Oct-Nov 2011, when the BOJ bought over $100 bln.
The other exception is the Switzerland, where the SNB has capped the franc against the euro, leading to something on the magnitude of tripling their reserve holdings.
The announcement that Sweden's Riksbank will boost its reserves drew our attention. The Riksbank currently holds about $40 bln worth of currency reserves. It will boost it by about 37% or around $15 bln (SEK100 bln). The reasons behind its decision is interesting and reflective of more modern thinking about currency reserves.
Today is probably the first day in a while in which minute-by-minute rumors on the Fiscal Cliff will not be on the frontburner (with yet another late day rumor yesterday of an imminent deal turning out to be a dud, when it was reported that Obama's latest grand compromise was to lower his initial tax hike demand from $1.6 to $1.4 trillion, or still $600 billion more than last summer's negotiated number), with Ben Bernanke and QE4 taking center stage instead. By now it is a foregone conclusion that Ben will proceed with extending Twist as first predicted here, into an unsterilized bond buying operation, in effect confirming that there has been zero improvement in the economy, as another $1 trillion is about to be injected until the end of 2013, and more trillions after that. The good thing is that all pretense that the Fed cares about anything but the market is now gone. The bad thing is that the Fed will continue to take over the capital markets until it and the other central banks are the only traders remaining. The only question is whether the market, now well into massively overbought territory, will fizzle and snap back after Bernanke's news announcement, and will QE4EVA (as we believe QE3+1, aka QEternity-er, should be called) have been fully priced in by the time it was announced?
Now that is a rattling sabre. While markets for now are seemingly shrugging off this 'fly-by', we suspect the people of Okinawa were more than a little surprised:
NORTH KOREA LAUNCHED ROCKET AT 9:51 AM LOCAL TIME: YONHAP
N. KOREA ROCKET LAUNCHED IN SOUTHERLY DIRECTION,JAPAN GOVT SAYS
N. KOREA ROCKET PASSES OVER JAPAN'S OKINAWA, NHK SAYS
JAPAN GOVT: NO ORDER GIVEN TO SHOOT DOWN N.KOREA ROCKET
N. KOREA ROCKET EXPECTED TO FALL IN SEA EAST OF PHILIPPINES:NHK
What is most surprising is not the rocket launch: it was largely expected and overdue after the humiliation from the last one; it is that Korea has brazenly defied US warnings and the threat of sanctions just to make a rather meaningless political point. The imminent escalation in sanctions and N.Korea's response is what is the true variable here, confirmed by the markets who have not even blinked as a result of the rocket launch.
Jeff Gundlach presents his latest thoughts in the following 75-slide presentation and webcast. Briefly summing it up, he expects considerably more volatility to re-appear in Europe, thinks JPY is a short (and NKY a buy) and Japan is to be closely watched, prefers Gold to stocks as a vehicle to play more quantitative easing, and is anxious of the fiscal cliff - noting that the problem was created from years of budget deficits. Some notable quotes include: "A lot of that GDP is phony"; "Japan is really out of policy tools"; "Many countries can be net debtors if central banks are monetizing debt."
Markets recovering quite nicely from the Italian shock. Add some better outlook figures and we’re all friends again. The Spanish bill auction was less punishing than could have been feared. US opening stronger. Everything else is all good again. Greek bonds stellar.
"(Ain't That) Good News" (Bunds 1,32% +2; Spain 5,45% -9; Stoxx 2623 +1,0%; EUR 1,299 +60)
- Fed Seen Pumping Up Assets to $4 Trillion in New Buying (BBG)
- China New Loans Trail Forecasts in Sign of Slower Growth (BBG)
- U.S. "fiscal cliff" talks picking up pace (Reuters)
- Insider-Trading Probe Widens (WSJ)
- U.K.'s Top Banker Sees Currency Risk (Hilsenrath)
- Three Arrested in Libor Probe (WSJ)
- Nine hurt as gunmen fire at Cairo protesters (Reuters)
- Egyptian President Gives Army Police Powers Ahead of Vote (BBG)
- Pax Americana ‘winding down’, says US report (FT)
- Japan Polls Show LDP, Ally Set for Big Majority (DJ)
- HSBC to pay record $1.9 billion U.S. fine in money laundering case (Reuters)
"They say this is not massive money printing, but first they are wrong; and second, monetary authorities in the United States did not see the crash coming and the unsoundness of the financial system. In fact, right up until the crash they were saying that nothing like what happened could ever happen... This monetary policy, $3 trillion of bond buying in the United States, $3 trillion in Europe and another $2.5 trillion to $3 trillion in Japan, is unprecedented. ... If and when people lose confidence in paper money because of repeated bouts of quantitative easing and zero-percent interest rates—it could happen suddenly and in a ferocious manner in the commodity markets, in gold, possibly in real estate—interest rates could go up at the long end by hundreds of basis points in a very short time. I’m quite concerned as a money manager that we have to manage money, not just for the boundaries of what’s in front of our faces—maybe we’ll have a little tax increase or not, the fiscal cliff, or the stock market might go up or down 10% or 15%—but for a basic shift. The thing that scares me most is significant inflation, which could destroy our society."
Since the crisis first began in 2006, developed world equities are still lower, real GDP has struggled to grow above its pre-crisis peak in most countries, core bond yields are sharply lower with peripheral yields higher and with credit yields generally performing well albeit it with fairly extreme volatility. Credit has been helped by the fact that the authorities way of dealing with this crisis to date has been through money printing and liquidity facilities to help prevent mass defaults which, as is is clear in the chart below, has led to a weakening in the normal relationship between GDP and defaults. Just as one of the features of the last 20 years in Japan’s post-bubble adjustment and lost growth period is that defaults have remained very low; it appears as long as money printing props up the debt market, defaults are likely to be much lower than the underlying economic environment suggests they should be. However, as we noted previously, the mark-to-market volatility on the way may just become too much to bear for all but the most long-term bond rotators.
Everyone interested in real estate is asking the same question: Is the bottom in, or is this just another "green shoots" recovery that will soon wilt? Let’s start by reviewing the fundamental forces currently affecting real estate valuations. ZIRP has created a "crowded trade" in low-risk investments with attractive yields such as corporate bonds, dividend stocks, and real estate, which is being fueled by a self-reinforcing perception that "the bottom is in." The question now is will these forces continue pushing prices higher? If these forces deteriorate or lose their effectiveness, then the “green shoots” of investor interest may wither as the U.S. economy joins Europe and Japan by re-entering recession.
Surprisingly stable Risk. BTPs shot down in style. Italy? Down. Chinese data? Partially weak. Japan? In recession. French data? Weak. German data? Strong. Wow! Better have Friday’s PMI numbers really good. Analysts having to reinvent themselves once more as political experts to glare into a smoky crystal ball… Italian contagion contained, for now. Uh…Uh…!
"Uh...Uh - Bingo Bongo " (Bunds 1,30% unch; Spain 5,54% +9; Stoxx 2598 +0,0%; EUR 1,293 -20)