In the realm of unintended consequences, one of the side effects of QE2 is that going forward US economic data will be broadly ignored from a global macro standpoint: as bad economic data is masked by expectations of further Fed involvement, and further Fed inflation stimulation, while any actual improvement is misperceived as a one-time response from a liquidity kicker, the rest of the world will no longer have an anchored trade and thus FX view based on incremental data developments, be they good or bad, as an objective distinction is now impossible. What this means practically is still too early to determine, as the world has never existed in such an information limbo, but the closest approximation of the perversions to the very matrix of cause and effect is that the market now sells good news and buys bad news with impunity. This is a recipe for disaster. It also means that with the US economy irrelevant as an indicator of pretty much anything, decision-makers will be forced to look elsewhere for catalysts. BNP Paribas has done of the better summaries of precisely this sad state: "The Fed has acknowledged that there is substantial slack in the US economy indicating that it will take potentially years to bring the unemployment rate down to levels associated with full employment. Hence, a strong number will still leave the Fed committed to the USD600bln asset purchase it announced Wednesday. A weak labour market report will make the market assume that the Fed might have to do even more asset purchases. Hence it will not be US data disturbing the risk on trade, the trouble will likely come from Asia or Europe." What we believe this means, is that very soon the dynamics of globalized economics, and of stock markets, will be defined by the polar opposites of an emerging market bubble (Asia), and a developed economy, floundering deeper into fiscal austerity and borderline insolvency (Europe). Thus soon the ideological tug of war will be one of whether the Asian bubble implodes first, or whether it will be preceded by the failure of peripheral European countries.
At this point it is still too early to determine either way. However, the very surprising drop in the EURUSD on Friday, may be a harbinger of what we have been saying for a long time, namely that a Europe which can not feasibly sustain its core export economy with an FX threshold over 1.40, will be willing to sacrifice a peripheral country, while attempting to still retain the united currency. Of course, should that fail, Europe will always have the option to finally pull the plug on the EUR, put the Euroskeptics out of their misery, and end the experiment, thereby affording the European continent an equal footing in the terminal race to the bottom, albeit on a nation-state basis, and not on some artificial, and failed, experiment in fiscal, monetary and cultural cohesiveness.
Probably the most important hint that this has already started, is another nuance from the BNP FX Daiy Strategist November 5 edition, in which we read:
Russian sovereign wealth funds removing EMU peripheral bonds from their investment list was echoed by Norway's petroleum fund which is also considering cutting holdings of EMU's peripheral sovereign bonds.
We discussed the Russian breakaway from the EMU periphery before, however we had no idea that the recently staunchest supporter of Greece, Norway's sovereign wealth fund, is now essentially saying to throw them to the lions. This is a huge change in perception, and one that nobody in the mainstream media seems to have caught.
And possibly the most important implication is that the last savior of the European periphery is not the core, which it seems is more and more resigned to letting the PIIGS go (Germany and Norway), but, China of all places. China, which previously expressed an interest in becoming Greece's lender of last resort, is now becoming that for Portugal. Next up: Ireland, Italy, Spain? Somehow we get the feeling that in a few months, Europe's periphery will be demonizing Germany, and praising China, as the next step in the Chinese axial expansion is finally manifest.
Which begs the question: now that the Europe core has said enough to the experiment in keeping the peripheral zombies alive, why is China stepping in? Two possible explanations: 1) China is all too aware that decoupling is a myth, and will shoulder the burden of keeping the EUR alive on its own, even as the bulk of Europe may have well decided to drop the whole idea; 2) After recreating the axis with Russia, and being on very good terms with Germany, is China merely setting up the dilemma of aligning with the Eurocore or the Europeriphery. Surely, its overtures recently will sour its relations with Germany, even as it is perceived as a savior in the PIIGS nations. Or just maybe China is that stupid to believe that Portugal and Greece are viable enough on their own. We doubt it.
In other words, while the impact of QE2 on the stock market was immediate and palpable, and at this point the question is simply when does one fade the rally, the much greater impact on geopolitical axes of influences will only now start to be perceived, and it will involved both an ascendent China and a deteriorating Europe. Of course, since this also juxtaposes a massive bubble and an experiment where growth is merely a one return to FX rationality away, could we also be witnessing the upcoming inflection points in the global power sine wave, one where China's peak is about to occur, while Europe's nadir, and subsequent ascent is imminent? Even is that is the case, what does that mean for the US? Alas, that answer is infinitely more complex, although the one thing it most certainly is not, is the patently wrong explanation of events presented by America's central bankers, who, if anything, are luckily always wrong.