As the world's Reserve Currency the US has enjoyed what is referred to as "Exorbitant Privilege". The US has been able to 'print' money but not suffer the consequences of the associated inflation and currency debasement that comes with such irresponsibility. This is because the 'exorbitant privilege' effectively allows the US to export its inflation. This inflation returns initially as higher import costs, but eventually as hyperinflation, as the world slowly abandons the US dollar and its reserve currency status. This 'exorbitant privilege' continues to work until something which was well understood prior to the US going off the gold standard no longer works. That is a concept referred to as the "Triffin Paradox".
The US Council on Foreign Relations aptly describes why Triffin's dilemma becomes unsustainable: "To supply the world's risk-free asset, the center country must run a current account deficit and in doing so become ever more indebted to foreigners, until the risk-free asset that it issues ceases to be risk free. Precisely because the world is happy to have a dependable asset to hold as a store of value, it will buy so much of that asset that its issuer will become unsustainably burdened."
MORE>> EXPANDED COVERAGE INCLUDING AUDIO & MONTHLY UPDATE SUMMARY
THE P/E COMPRESSION GAME: An Old Game with a Different Twist to Misprice Risk
We are manipulating markets metrics in such a fashion as to intentionally Misprice, Misrepresent & Hide RISK. Prior PE reference boundary conditions which reflected risk have decoupled. Never has the game of forward operating earnings (versus historically trailing earnings) been more inappropriate than presently. Forward PE's can only be of value in rapid revenue and profit growth eras. This is not what we have presently. It is the wrong tool for the wrong job! Unless you are a sell side analyst, then it is exactly the right too for the difficult selling job you have. We have an era of Peak earnings growth RATES, slowing profit growth RATES and Peak PEs which are reflective of rapidly contracting PE's. We have a secular bear market in REAL terms but PE's are not contracting at a sufficient enough rate to reflect this. Though PEs in nominal terms net out inflation, they don't reflect the underlying downward trend in real terms. MORE>>
It is an explosive 'cocktail' when the present levels of uncertainty and complacency coexist. The drama and political intrigue of the Fiscal Cliff is temporarily distracting investors from the magnitude of the global economic slowdown underway. Europe is entering a serious recession, the US is at stall speed, corporate revenues and margins are under attack, and analysts are steadily reducing earnings. Peak earnings have likely been achieved for this economic cycle and the ammunition of QE∞ at the disposal of the Central Bankers, no longer yields the same response. The market is setting itself up for an "Oh Sh#7T Moment", likely before the Q1 quadruple witch.
MORE>> EXPANDED COVERAGE INCLUDING AUDIO & EXECUTIVE BRIEF
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Latest Public Research ARTICLES & AUDIO PRESENTATIONS
Back in June, we wrote an article titled "On The Verge Of A Historic Inversion In Shadow Banking" in which we showed that for the first time since December 1995, the total "shadow liabilities" in the United States - the deposit-free funding instruments that serve as credit to those unregulated institutions that are financial banks in all but name (i.e., they perform maturity, credit and liquidity transformations) - were on the verge of being once more eclipsed by traditional bank funding liabilities. As of Thursday, this inversion is now a fact, with Shadow Bank liabilities representing less in notional than traditional liabilities.
In other words, in Q3 total shadow liabilities, using the Zoltan Poszar definition, and excluding hedge fund repo-funded, collateral-chain explicit leverage, declined to $14.8 trillion, a drop of $104 billion in the quarter. When one considers that this is a decline of $6.2 trillion since the all time peak of $21 trillion in Q1 2008, it becomes immediately obvious what the true source of deleveraging in the modern financial system is, and why the Fed continues to have no choice but to offset the shadow deleveraging by injecting new Flow via traditional pathways, i.e. engaging in virtually endless QE.
What is more important, the ongoing deleveraging in shadow banking, now in its 18th consecutive quarter, dwarfs any deleveraging that may have happened in the financial non-corporate sector, or even in the household sector (credit cards, net of the surge in student and car loans of course) and is the biggest flow drain in the fungible credit market system in which the only real source of new credit continues to be either the Fed (via QE following repo transformations courtesy of the custodial banks), or the Treasury of course,via direct government-guaranteed loans.
And while the chart that is the topic of this post is the following, which shows that the red line - traditional bank liabilities - have once again overtaken shadow...
... The most important chart of the modern monetary system, and hence the one which you will see nowhere else, continues to be the one below, showing that on a blended notional basis, total traditional and shadow liabilities have not budged at all in the last three years despite the massive injections from the Fed!
Translated, the Fed continues to fight a losing battle, in which it has no choice but to offset any ongoing deleveraging - be it through maturities, prepays, or counterparty failure, or just simple lack of demand for shadow funding conduits - in the shadow banking system.
And a notable tangent continues to be that between the peak of the credit bubble and the most recent data, there continues to be a $3.7 trillion credit hole on a consolidated financial credit basis, which is precisely the reason for the ongoing Economic Depression from a simple Austrian money supply perspective, why the Fed and the government are forced to misrepresent the true state of the economy (far worse than current economic "data" represent), and why should the Fed ever halt its monthly flow into markets which is now $85 billion each month, there will be a dramatic stock market crash... and Bernanke knows it.
However, the bigger problem as more and more deposit-based liabilities take place of deposit-free shadow equivalents, is that the systemic propensity for runaway inflation rises with every quarter in which Fed reserve conceived deposits -prone to spilling over into the broader market based on the irrationality of individual psychology -serve to offset delevering shadow conduits. As explained in July, shadow banking was nothing more than a massive inflation buffer whose historic build up allowed the Fed to inject trillions without this money leading to a collapse in the USD value, now that it is actively deleveraging. But with every "shadow dollar" that is taken out of the system, said buffer gets smaller and smaller...
Finally, those curious which components in the shadow banking system were responsible for the most recent deleveraging in Q3, the chart below sums it up:
And the shadow deleveraging on a consolidated quarterly basis in all its glory:
To summarize, the Q3 change in shadow liabilities:
GSE & Agency Mortgage Pools: ($16.2) billion
Asset Backed Securities issuers: (39.3) billion
Funding Corporations: ($49.5) billion
Repos: ($33) billion
Open Market Paper ($4.8) billion
Money Markets: +$39 billion: the only net addition in Q3
How was this drop offset? Simple - by a $177 billion increase in the liabilities of U.S.-Chartered Depository Institutions, which rose to a record $12.224 trillion in Q3, primarily due to a rise of $140 billion in Small time and Saving Deposits, a topic discussed previously here.
EXCESS RESERVE PATHWAY
The shadow banking collapse continues, and is offset via the Fed "excess reserve" injection pathway entering M2 thanks to the ~4.5x M1 to M2 conversion pathway.
Remember Fed's excess reserves are a component of M1: these then get "fractionally reserved" into M2 as per the multiplier shown below:
To summarize: all hope abandon ye who think the Fed will stop monetizing debt, and thus injecting flow, at some point in the next several years.
For more on the topic of Shadow Banking, we suggest the following reading material:
For months now we have been 'told' that the US is the cleanest dirty shirt, that the US has decoupled, that US markets are the deepest and therefore will inevitably be the sinkhole of global liquidity; but things appear to be shifting - quite rapidly. This week has seen Europe's VIX (16.6%) drop below US VIX (16.8%) for the first time this year and Europe's Euro Stoxx 50 (Dow equivalent) is dramatically outperforming the US Dow (+13.5% vs +7.75% YTD). What is most dramatic, and highlighted by today's gap-like behavior in EURUSD, is the total dislocation between EUR and US equities. Are we seeing a wholesale capital outflow beginning as US' Fiscal Cliff fears trump any year-end shenanigans potentially coming from Europe (post-Summit)? One thing is for sure, certain media individuals will have to change their tune now Europe is the year's winner and the US becomes the center of the world's event risk focus.
Stocks (upper pane) and volatility (lower pane) are winning in Europe...
and this week has seen the repatriation of capital quite clearly from US to Europe...
and incase you were wondering from where and to where those funds were flowing... AAPL is about to lose its battle with European banks in terms of market cap...
PATTERNS - Volume Continues to Deteriorate & Be Ignored
From a March 9, 2009, close of 6,547, the senior index climbed to 13,610 on Oct. 5, 2012.
Moreover, the Dow achieved this feat in the face of a weak-kneed economy, and it has grinded forward now for three and a half years.
The persistent rise has emboldened stock market prognosticators.
S&P Could Still Hit 1,600 Year-End
--CNBC, Oct. 23
All the while, fewer and fewer investors have been participating in the so-called recovery.
People have started ignoring volume because bears have been talking about declining volume ever since 2010. But it is extremely important. Volume overall has been shrinking ever since the market's low of March 2009. This line that I've drawn tracks the volume on the rising portions of the rally from 2009. Every time the market gets hit very hard-such as in the collapse of 2008, the "flash crash" of May 2010 and the market plunge in August last year-volume picks up.
This is not a picture of a bull market. In a bull market, the opposite happens. Volume should be going up during the entire period, and it should be declining every time the market corrects. But we're getting exactly the opposite situation.
--The Elliott Wave Theorist, October 2012
Volume is an important momentum indicator that many overlook.
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - Dec 9th - Dec 15th, 2012
"The real problem is that regardless of the resolution it will not solve anything. We have passed the point of no return. We cannot mathematically solve this debt problem. We can only slow its progression."
Via Art Cashin of UBS:
Demographics, Destiny And The Fiscal Cliff – Somewhat lost in the posturing is the fact that the Fiscal Cliff was put in place to force Washington to address the exploding government debt problem. That problem is greatly exacerbated by the rapidly changing demographics in this country. Bill Gross, Bill Frezza and others have recently explored this connection and complication. Here's a bit from a tenured veteran of Wall Street, Jim Brown of the Option Investor:
That December 7th attack launched the greatest economic boom of our time once the war was over. That was the baby boom generation. A population explosion in the years after the war increased births by more than four million a year. The "leading edge" boomers (1946-1955) total more than 38 million and the "late boomers" 1956-1964 accounted for another 37 million. Since population demographics have shown the most consumptive years are those between age 40-55 we are heading into a period where consumption (spending) is going to decline sharply as the boomers retire.
Bill Gross penned an article this week showing per capita spending drops off a cliff once people turn 65 and retire. Currently boomers control over 80% of personal financial assets, more than half of all consumer spending, account for 80% of leisure travel, 77% of prescription drugs and 61% of over the counter drugs. Starting in 2011 more than 10,000 boomers retire every day and that will continue for the next 19 years. More than 36% claim they have nothing in retirement savings. More than 35% over age 65 rely entirely on Social Security for their sustenance. A recent AARP survey found that 40% plan to work until they die because they did not plan ahead.
In 1950 every retiree on social security was supported by 15 active workers. By the end of 2010 there were only 3.3 workers for each retiree. The government believes there will only be two per retiree by 2025. A Wall Street Journal editorial a couple weeks ago highlighted the fact the government is facing not a $16 trillion debt but an $87 trillion debt if you take into account the unfunded liabilities of social security, Medicare and Medicaid. If you fast forward 20 years until all the boomers are retired that soars to $202 trillion according to Boston University.
Treasury Secretary Tim Geithner called the fiscal cliff discussions in Washington "orchestrated drama." I call it political theater or basically the same thing. The real problem is that regardless of the resolution it will not solve anything. We have passed the point of no return. We cannot mathematically solve this debt problem. We can only slow its progression. Arguing on whether the 2013 deficit will be $800 million or $1.2 trillion is wasted breath. It is still a deficit. Cutting spending does not mean you only increase the budget over the prior year by $700 billion instead of $900 billion. Until lawmakers can make voters understand the math of ever increasing spending and the disaster that is headed our way, they are just rearranging the deck chairs on the USS Titanic.
Wow! As the Boomers mature, $202 trillion. Hopefully, more on this quandary in coming days.
Risk: We don’t know what is going to happen next, but we do know what the distribution looks like.
Uncertainty: We don’t know what is going to happen next, and we do not know what the possible distribution looks like.
In other words, the future is always unknown — but that does not make it “uncertain.”
A statistical approach perfectly clarifies the falsity of the uncertainty meme.
When we don’t know what any future outcome will be, but we understand the probability distribution — think of dice or a multiple choice exam — we have risk, but we do NOT have uncertainty. We never know what the roll of the dice will be, but we do know its one of six choices.
Is that uncertainty? The answer is of course not — it is an unknown outcome with well-defined possibilities. We may not know precisely which outcome will occur in advance, but we do know its either 1, 2,3, 4, 5 or 6. Call that risk or an unknown future, but do not call that uncertainty.
I am pushing against a usage that conflates “Uncertainty” with”Unknown.” Since the future is, by definition, always “unknown,” then what purpose does it serve to say there is Uncertainty? By that definition, there is always uncertainty. As currently heard in the MSM, this renders the word utterly meaningless.
Consider alternatively what is the true definition of Uncertainty: That occurs when we have no idea of what the possible outcome might be. The probability distribution is unknown (or so extremely large as to functionally be the same as unknown).
The so-called fiscal cliff is a perfect example — we know what the possible outcomes are, and we have a very good idea what their impact will be.
The US Census Bureau reported that in October, the total deficit with China hit a record $29.5 billion. What did America need to export so much that it is willing to impair its GDP (net imports are a GDP drain) and boost the GDP of China? "Primarily computers and toys, games, and sporting goods." In other words, gizmos and iPhones. And no, China did not buy US bonds - recall that China has boycotted US Treasurys for precisely one year - so the age old equality that we export China worthless paper in exchange for just as worthless gizmos, yet somehow everyone benefits, is no longer valid. What the US does, however, export to China, is inflation, courtesy of the USDCNY peg, and is the reason why the PBOC is still terrified, and certainly will be after Bernanke announces QE4EVA (RIP QEternity) tomorrow, to ease more as the last thing it can afford is to create its own inflation in addition to importing America's.
4 - China Hard Landing
JAPAN - DEBT DEFLATION
SMALL BUSINESS CONFIDENCE - Plunges to -35% - Its worst level on record
While Europe's confidence-inspired rally is floating all global boats in some magical unicorn-inspired way, the reality is that on the ground in the US, things have never looked worse. The NFIB Small Business Outlook for general business conditions had its own 'cliff' this month and plunged to -35% - its worst level on record - as the creators-of-jobs seem a little less than inspired. Aside from this unbelievably ugly bottom-up situation, top-down is starting to be worrisome also.
In a rather shockingly accurate analog, this year's macro surprise positivity has tracked last year's almost perfectly (which means the macro data and analyst expectations have interacted in an almost identical manner for six months). The concerning aspect is that this marked the topping process in last year's macro data as expectations of continued recovery were dashed in a sea of reality (both coinciding with large 'surprise' beats of NFP). We suspect, given the NFIB data, that jobs will not be quite so plentiful (unadjusted for BLS purposes) the next time we get a glimpse.
NFIB Small Business Outlook for General Business Conditions 'crashed'...
And the US Macro Surprise Index (which tracks both macro performance absolutely and relative to expectations) has tracked last year's rise almost tick-for-tick. This stunningly close analog suggests we have reached a peak in this macro cycle...
33 - Public Sentiment & Confidence
CONSUMER CONFIDENCE - Plunges After Election as Fiscal Cliff Realization Faced.
As recently as September, about half of consumers were largely ignoring the issue, according to a regular survey by RBC Capital Markets. But in the most recent survey, completed last week, 71% of respondents said they were following the cliff debate, and more than half said the threat had hurt their confidence or led them to hold back on spending. Will Churchill is already seeing the issue affect his business. Mr. Churchill, co-owner of Frank Kent Motor Co. in Fort Worth, Texas, saw strong sales growth at his Cadillac and Honda dealership until early November.
But sales started to slow after Election Day, with many customers attributing their caution to the Washington budget debate. "Fifty percent of the customers we talk to, it comes up at some point," he said. "They're in the market, they want to buy, but the hesitation is that they don't know what's going to be the result in Washington."
33 - Public Sentiment & Confidence
UNCERTAINTY - What Always Stops Business Investment
When it's unusually hard to tell where the economy and government policy are going, businesses will be reluctant to invest and hire.
The notion isn't new. It was central to Federal Reserve Chairman Ben Bernanke's Ph.D. dissertation in 1979. "Increased uncertainty provides an incentive to defer investments in order to wait for new information," he wrote. With a lot of equations, Mr. Bernanke argued that investing and hiring decisions are hard to reverse. When there is a lot of doubt, businesses wait.
But the possibility that uncertainty about government policy might make a weak economy worse is timely. There is growing angst about the U.S. "fiscal cliff," the spending cuts and tax increases set for the beginning of January. There are signs that fears of going over the cliff are contributing to slower business investment and gloomy forecasts about fourth-quarter growth. There are doubts about the longevity of the euro and whether European governments can pay their debts.
And now economists Steven Davis of the University of Chicago and Scott Baker and Nicholas Bloom of Stanford have a way to measure policy uncertainty, which they attempt to link to the vigor of the economy. Half of their economic-policy-uncertainty index comes from a computerized reading of relevant references in 10 newspapers. (That makes this journalist wonder if the press is causing uncertainty or merely reflecting it.) The other half relies on a tally of expiring tax-code provisions and statistical measures of disagreement among forecasters about inflation and government spending.
As the chart shows, uncertainty about economic policy has been rising since the onset of the financial crisis and spiked during the August 2011 showdown over the federal debt ceiling. An alternative gauge that counts references to uncertainty in the Federal Reserve's periodic "beige book" review of regional economies shows a similar pattern.
During the presidential campaign, this turned partisan. Republicans accused President Barack Obama of crippling the economy by layering uncertainty on top of uncertainty. Mr. Obama's allies blamed Republican intransigence, pointing particularly to the debt-ceiling confrontation.
"Uncertainty" became the all-purpose diagnosis for the economy's ills, though polls of executives found many worried more about demand for their wares than about government policies. Other executives pleaded for certainty—as long as it didn't mean higher taxes.
With the election over, the focus is back on figuring out just how much uncertainty actually hurts an economy. It could lead consumers to save more and spend less. It could deter already-wary executives from taking risks. And by making investors uneasy, uncertainty could make financing more costly for companies.
At the University of Chicago, Lubos Pastor and Pietro Veronesi wondered why, for instance, pronouncements by officials in Greece—whose economy is smaller than Michigan's—move global stock markets so much.
After some thinking, they concluded that
1), there is more uncertainty when the economy is bad because that is when governments are more likely to actually do something (for better or worse), so that is when markets are particularly sensitive to clues in politicians' rumblings; and
2), stocks tend to move in unison when there is little clarity about government policy because it is hard for investors to discern which companies will be winners and which will be losers.
Professors Baker, Bloom and Davis used statistical techniques to match the ups and downs of their index to the ups and downs of the economy. They estimate that the upturn in uncertainty between 2006 and 2011 foreshadowed a 16% drop in private investment within nine months and a loss of 2.3 million jobs within two years.
Skeptics challenge the cause-and-effect hypothesis. "We do not doubt that uncertainty shocks depress economic activity, or that uncertainty has risen substantially since 2006," Goldman Sachs GS -0.54%economists Jan Hatzius and Sven Jari Stehn wrote recently. "But we don't believe that the economy's poor performance has been caused by an…increase in U.S. policy uncertainty." A lousy economy is more likely to produce uncertainty than the other way around, they said. (They also said that worries about Europe were more of a factor than worries about Washington.)
Right now, we are all lab rats in the economists' experiment. The fiscal cliff is less than a month away, and no one knows if we are going over it.
You don't need an index to tell you that there is a lot of uncertainty. It would be both convenient (for the economists) and refreshing (for the rest of us) if Mr. Obama and Congress manage to cut a deal. That would reduce uncertainty, and we would find out just how much of a weight it has been on the U.S. economy.
When trying to get a handle on investor sentiment, the benchmark of choice for many market-watchers is the CBOE S&P 500 Volatility Index, or VIX. However, this popular “fear gauge” only offers a snapshot of implied volatility, or relative pricing levels, for equity index options, which might not necessarily tell us all we need to know about the mood on The Street.
In theory, stock traders could be overreacting to equity-specific developments that are not relevant to other markets.
That said, there is data that suggests the high levels of complacency in the stock market are also being seen elsewhere. As the chart shows, gauges of implied volatility levels for equity, bond, currency, gold, and oil markets are at or near multi-month lows, indicating that “the crowd” is unanimous in its belief that nothing untoward is going to happen in the immediate future.
By now there can be no doubt that due to Bernanke et al's endless intervention in any and all capital markets, the "market" is no longer a mechanism that discounts the future in any way. In fact, instead of predicting the future, all the market has become is a backward looking race in which collocated algos respond to historical data - flashing red headlines - and attempt to out run each other in who can buy or sell more free for all, knowing full well at least one other greater fool will be behind them to pick up the pieces.
Sadly, fundamentals as a driver to valuaton no longer exist. But such is life under central planning.
Yet there is one thing that the market responds to - it is politicians and the uncertainty that political risk brings with it. This certainly includes that most political of organizations, the Federal Reserve, whose stimulative intervention into capital markets two months before the presidential elections was without precedent. Yet even here, the market has managed to decouple from reality, and is trading at level far greater than what political uncertainty risk implies.
As the chart below from Citi's Matt King shows, a correlation between BBB spreads and a broader proprietary uncertainty index, there is currently a roughly 50% political risk premium that is not being priced into stocks.
This is certainly evident in stock prices, as with just 23 days left until the end of the year, politicians are nowhere nearer a Fiscal Cliff resolution than when they started the debate. Yet the biggest catalyst that could force an immediate compromise - the Dow Jones Industrial Average (D.C. continues to be oblivious about the SPX) - refuses to decline on the expectations that the cliff will be resolved. The paradox is that it won't unless the market tumbles.
So who blinks first, and what does the complete failure of any capital market to accurately reflect any and all risks (largely onboarded by every central bank in the world), macro, micro and political, mean for the future of asset prices?
One thing is certain: in a market addicted to $85 billion in monthly Fed-funded Flows each and every month: a nominal amount needed to avoid an all out collapse, the last thing the Fed will ever be able to do, is unwind its balance sheet which is now a $3 trillion (rising to $5 trillion by the end of 2014) buffer between myth and reality.
In the context of the above, no explanation is also needed that quietly, and without much fanfare, French car-maker, Peugeot, and Europe's second largest after VW, was recently GMed, and received a government bailout.
Carmaker Peugeot gets $9.1B government bailout
The French government has agreed to underwrite up to €7 billion ($9.1 billion) of bonds issued by Banque PSA Finance SA, the financing unit of carmaker PSA Peugeot Citroen SA, allowing the French automaker to offer low-cost credit to its dealerships and clients amid a slump in sales.
Peugeot announced the deal on Wednesday, Oct. 24. It also said it had agreed the basis of a €10.5 billion restructuring of existing loans and asked banks to provide a further €1 billion of new debt to its finance unit.
The deals effectively immunize Peugeot's credit unit against recent downgrades of its parent's debt rating. That had threatened to drive the lending arm's rating to junk and would have forced it to increase the rates on loans to its own dealerships and to clients, hurting car sales that are already suffering from a Europe-wide slump.
The government, in return for the debt guarantees and its role in cajoling the banks to extend new loans to Peugeot, has demanded that Peugeot pay no dividends, undertake no share buybacks and issue no new share options to its managing board until the debt guarantees expire. Family-controlled Peugeot also agreed to add a workers' representative and a government appointee to its board.
"The government has no intention of making gifts without demanding anything in return," French Prime Minister Jean-Marc Ayrault told France Inter radio on Wednesday. "We ask the PSA group not to pay dividends, stock options or buybacks - that would be scandalous - and to concentrate on turning the company around."
Expect many more such bailouts as a relentlessly socialist and protectionist Europe does all it can to preserve much needed votes jobs in the critical, if greatly uncompetitive, carmaking sector, and all other sector, soon to follow.
Financial markets are doing well both on the equity and debt front. Germany's engine is revving again. PMI data hit its lowest level in 8 months.
But as always, the biggest risk in Europe is, well, how long will the people tolerate recession? How long can they handle dismal growth.
New data from Eurostat provides a really depressing snapshot of the state of the consumer, at least as of October.
In October 2012 compared with September 2012, the volume of retail trade fell by 1.2% in the euro area (EA17) and by 1.1% in the EU272, according to estimates from Eurostat, the statistical office of the European Union. In September, retail trade decreased by 0.6% and 0.2% respectively. In October 2012, compared with October 2011, the retail sales index fell by 3.6% in the euro area and by 2.4% in the EU27.
Click to enlarge the chart. It's really ugly.
33 - Public Sentiment & Confidence
MACRO News Items of Importance - This Week
GLOBAL MACRO REPORTS & ANALYSIS
US ECONOMIC REPORTS & ANALYSIS
US EXPORTS PLUNGE - US Import Partners are all wrapped in a major Recession
The boost to GDP from the declining US trade deficit is over. While the September trade deficit number was revised further lower, to $40.3 billion from $41.5 previously, October saw a pick up to $42.2 billion, slightly less than the expected $42.7 billion, but a headwind to Q4 GDP already. As a result, expect a modest boost to Q3 GDP in its final revision, even as Q4 GDP continues to contract below its consensus of sub stall-speed ~1%. The reason for the decline: a 3.6% decline in exports of goods and services.
This was the biggest percent drop in exports since January 2009 as the traditional US import partners are all wrapped in a major recession.
What helped, however, was the offsetting drop in imports by 2.1%, the lowest since April 2011, as US businesses are likewise consumed by a concerns about the global economy. And without global trade, whose nexus just happens to be Europe, there can be no global or even regional recovery. So far, all hopes of a pick up in global economy have been largely dashed. Yet one country benefits from the ongoing US slump is China:
Imports from China - consisting primarily of gizmos and iPhones:
- jumped 6.4% to a record $40.3 billion, offset be a modest rise in exports - primarily soybeans - to $10.8 billion, bring the China deficit to a record $29.5 billion from $29.1 billion in September. Of course, one wouldn't get that impression looking at the Chinese side of the ledger: the Chinese Customs department, reported a September and October trade surplus with the US amounting to $21.1 and $21.7 billion. One wonders, somewhat, where the over $16 billion difference has gone.
Combined trade deficit:
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
US MONETARY POLICY - Fed Actions versus "Market Health" Index
It may seem like a rhetorical question but Citi's credit stretgy team fears that the Fed may be pushing a bit too aggressively at this stage. The chart below shows monetary policy (defined as the funds rate and the Fed's balance sheet) vs. a "market health" index comprised of economic factors, systemic risk metrics, and valuation metrics. Historically the two have tracked well, but not recently. The health index is firming, but policy is getting easier, not tighter. Is the Fed out of its depth here, or do they know something we don't?
Mr Carney, the current Bank of Canada governor who takes over from Sir Mervyn King next June, said central bankers should consider committing to low interest rates until inflation and unemployment met “precise numerical thresholds”, or even changing “the policy framework itself” to stimulate a desperately weak economy.
His words were directed at the Bank of Canada but will be seen as a hint that he will push for radical action in the UK, where the economy has been stagnant for two years. On his appointment, he said that he would be going “where the challenges are greatest”.
Addressing the Chartered Financial Analyst Society in Toronto, Mr Carney said that in major slumps: “To achieve a better path for the economy over time, a central bank may need to commit credibly to maintaining highly accommodative policy even after the economy and, potentially, inflation picks up.
“To 'tie its hands’, a central bank could publicly announce precise numerical thresholds for inflation and unemployment that must be met before reducing stimulus.”
He added: “If yet further stimulus were required, the policy framework itself would likely have to be changed. For example, adopting a nominal GDP level target could in many respects be more powerful than employing thresholds under flexible inflation targeting.”
The proposals would be anathema to Sir Mervyn, who has publicly refused to abandon the inflation target or commit to long-term low rates.
Only arrogant fools think they can overpower markets without causing even more severe problems down the road.
If fiscal and monetary stimulus worked, Japan would be a glowing success today instead of having a debt to GDP ratio approaching 250%.
The US housing bubble is another case in point.
By holding interest rates too low, too long Fed chairman Alan Greenspan bailed out banks then deep in hock with nonperforming loans to South America and dotcom companies going bust. The end result was a housing bubble far bigger than the dotcom tech bubble that preceded it.
Indeed, Fed policy has spawned bubbles of ever increasing amplitude over time. The only beneficiaries of those bubbles have been the banks and the already wealthy.
Carney the "Talented" Speaker
Carney is a talented speaker, able to speak out of both sides of his mouth at once, each saying opposite things.
“Our current guidance indicates that some policy action may be necessary, encouraging a degree of prudence in household borrowing,” Mr. Carney said in his speech, echoing the warnings of the Bank of Canada’s last policy statements.
As it has said in the past, the biggest domestic threat to financial stability “continues to stem from the elevated level of household indebtedness and stretched valuations in some segments of the housing market.”
Nothing like warning about debt and low interest rates, while pledging to keep interest rates low until artificial central planning targets are met.
Carney stated the central bank "would clearly say we are doing so" if it chose to act on consumer debt.
Yep, I don't doubt that. Indeed, I suggest that Carney would notify banks in advance of any major policy moves.
Goldman Sachs Background
Let's back up a bit and look at Carney's background as listed on Wikipedia.
Carney spent thirteen years with Goldman Sachs in its London, Tokyo, New York and Toronto offices. His progressively more senior positions included co-head of sovereign risk; executive director, emerging debt capital markets; and managing director, investment banking. He worked on South Africa's post-apartheid venture into international bond markets, and was involved in Goldman's work with the 1998 Russian financial crisis.
Goldman's role in the Russian crisis was criticized at the time because while the company was advising Russia it was simultaneously betting against the country's ability to repay its debt.
From a Goldman Sachs and JP Morgan standpoint, Carney is the perfect candidate to head the Bank of England. Who could possibly be better than a currency crank promising clear signals, with a background of advising Russia while betting against it?
As a practical matter, however, should Carney actually implement his "radical action" policies, I suggest the UK would quickly be in ruins.
UK / CANADA
CENTRAL BANK POLICY
FOMC - "Unsterilized" QE4 Will Grow Fed Balance Sheet $1 Trillion in 2013
WHAT YOU NEED TO KNOW
Just as consensus demanded expected, the FOMC transformed sterilized 'Twist' into unsterilized QE4 in addition to QE3's MBS buying and lowered economic forecasts - dropping calendar-based rate guidance unchanged with a shift to "Evans-Rule"-like threshold-based guidance.
FED BOOSTS QE WITH $45 BILLION IN MONTHLY TREASURY PURCHASES
FED TO KEEP BUYING MORTGAGE BONDS AT PACE OF $40 BLN PER MONTH
FED SAYS MONTHLY PURCHASES TO TOTAL $85 BLN
FED ADOPTS ECONOMIC THRESHOLDS FOR POLICY TIGHTENING
FED: RATES TO STAY EXCEPTIONALLY LOW WITH JOBLESS ABOVE 6.5%
FED: RATES TO STAY LOW WITH INFLATION SEEN AT 2.5% OR LESS
Operation Twist converted to Outright QE - "Maturity Extension Program" (MEP) of $45B/M
Fed will add ($45B + $40 MBS) $85 in 2013 = $1 Trillion Balance Sheet Growth
Fed-Eligible Treadury Purchases includes all Risky Paper from Banks
Evans Rule Adopted (As expected) with a 6.5% Unemployment rate if inflation remains neaar Fe's 2%. A 6.5% Unemployment rate will never be met (unless everyone leaves the work force as the current trend indicates). Basically the statements is a guise for "endless and unstoppable money printing"
QE is more stimulus than Twist.
CENTRAL BANK POLICY
QUANTITATIVE EASING - How The Equties Markets Been Reacting?
It has been three years and nine months since the Fed announced 'real' QE1. Presented for your convenience below is the market's reactions then and for comparison we have included today's reaction. It seems the markets - whether Gold, FX, or Treasuries - have become numb (or engorged) on the Fed's actions. This leaves us with the sad conclusion, which the Fed will be last to acknowledge: the ammo, it's gone. It's all gone.
EURUSD - rose 370 pips on the announcement of QE1, rose 45 pips on QE4...
Gold- rose 5.4% on the announcement of QE1 but today (on QE4) Gold jumped 1.3% then faded back
Treasuries - When QE1 was announced Treasury Prices exploded in the then 10Y by over $4, today saw the same (now 7Y) bond price drop by around 4 Ticks...
Under the rule, the calendar guidance would be replaced with economic conditions based parameters tied to the level of unemployment and to the outlook for inflation. This has been a topic of extensive discussions by the FOMC and according to Bernanke, the talks have been promising. Evans has recently revised his 7%/3% plan to 6.5%/2.5%, moving closer to Kocherlakota’s proposed thresholds of 5.5%/2.25%. The movement towards the middle suggests that the committee may be getting closer to reaching a compromise. While we cannot exclude the possibility of an announcement today, we believe that the more likely timeframe for adopting quantitative thresholds is Q1 2013.
Even if the rule is not officially announced next week, it may be useful to view the FOMC’s new economic projections in the context of the proposed quantitative thresholds. Of particular interest should be the terminal point of the unemployment rate trajectory and when it crosses the 6.5% threshold.
Based on the September forecasts, the new Evans rule would trigger the first rate hike NO SOONER THAN 2015 which is in line with the current calendar guidance.
We don’t expect that the terminal forecast for unemployment will change materially next week as any downward revision to the GDP path will be mitigated by a lower starting point for unemployment
"FLY IN THE OINTMENT" - Particpation Rate
"Regime Change": The Critical Message In Today's FOMC Announcement 12-12-12 Zero Hedge
It will take the market some time to figure it out, but there were two main parts to the Fed's announcement: the actual breakdown of the $85 billion/month QE4EVA which were priced in as far back as the day QE3 was announced and were not a surprise at all; and the employment and inflation hard-targeting part, the so-called Evans Rule, which is, or at least should be, a shock to the market, only it hasn't quite realized it yet. Why shock? Because starting today, every incremental economic data point that is materially better, brings us closer to an explicit end of Fed intervention. Because at least before the Fed's calendar target was as soft as it gets; now the Fed will have no choice but to terminate its monetization once the unemployment rate plunges (be it entirely due to part-time jobs or 68 year old workers, as has been the case lately). It also means that as the economy continues along an "improving" glideslope, whether real, manufactured or doctored, the market will start pricing in its own "flow"-based demise. Because once the Fed's $85 billion/month in new Flows ends, it's game over.
Indicatively, using a simple forecast, based on LTM trends across all key employment metrics reveals something very troubling, for the Fed and stocks that is: the 6.5% unemployment rate will be breached in July 2013! Now granted that is simply idiotic, and there is no way that the US economy could possibly recover that fast, but that is precisely what is implied based on the ongoing collapse in the Labor Force Participation, and the concurrent plunge in the Labor Force Participation rate, which has been the biggest marginal driver for the unemployment rate, far more than the number of people who have jobs, or are unemployed (readers can recreate our calculation on their own in 10 minutes with excel).
The yellow arrow in the chart below shows at what point in the future the US Unemployment Rate is projected to dip below 6.5% assuming the current ongoing rate of contraction in the labor force participation rate.
Which then brings up the question: will the participation rate mysteriously start soaring beginning with the December data, as mysteriously all those people who had left the work force - supposedly all of the retirees if one listens to the "expert pundits" - start rushing back into the work force?
And if so, how will these same pundits reconcile their demographic based explanation that had justified the unemployment rate sliding so far, with the oposite trend which however has no demographic explanation?
After all, hitting the 6.5% unemployment threshold rapidly now is the wordst possible thing that can happen to stocks!
Perhaps, the best news of the day is that, finally, the narrative will be one where bad news are no longer both bad news and good news in the eyes of the market trading algos, but where good news, going forward, will be decidedly bad news for the stock market.
And after 4 years of benefits accruing only to stockholders even as the economy constantly suffered, this sounds like a very equitable trade off.
CENTRAL BANK POLICY
OPERATION TWIST ENDS - QE4 Begins
OPERATION TWIST - Maturity Extension Program (MEP)
PRE-ANNOUCEMENT EXPECTATIONS via SocGen (Background)
Deciding what to do about the Maturity Extension Program which is set to expire at the end of the month will top the agenda at today’s FOMC meeting. At December 31, the Fed will have no short-term Treasury holdings left in its portfolio; hence extending the program is not an option. We believe that the Fed will opt to continue buying Treasuries outright and finance the new purchases by increasing excess reserves. In other words, the growth of the Fed’s balance sheet will accelerate from the current pace of $40bn/month.
There is strong consensus that Treasury purchases will continue beyond December. The size, however, is more uncertain. Our own expectation is that the Fed will continue buying at the long end of the curve to the tune of $45bn/month. This view was challenged last week by St Louis President Bullard who suggested that the pace could be scaled back to $25bn/month. His rationale was that outright QE is more simulative than the twist, allowing the Fed to buy fewer Treasuries while still providing the same amount of accommodation. However, we see several arguments against scaling back the size significantly below $45bn.
The following chart is perhaps the best glimpse of the excessively optimistic 'hope' relative to the rest of the world that US equity markets (and their extrapolators analysts) currently possess. Since the start of 2012, analysts, guided by both macro uncertainty and company expectations, have crushed 2013 EPS expectations across all global markets - well nearly all...
So far US EPS has held up relative to the Resof the World...
How do you think investors in Japan felt when all of a sudden 'expectations' were slashed - as opposed to a gradual slide that everyone has been pricing in? coming to a US equity market near you soon...
It would seem that the rest of the world is expecting 2013 to be a little more difficult than they did at the beginning of 2012... the US analysts, however, not so much...
Charts: Morgan Stanley
ANALYTICS - The Global Financial Markets Await the Fiscal Cliff Resolution
We take a look of some of the more interesting charts in the various assets, indicies, and commodities we cover.
Apple Probably the most talked about death cross in ages. Apple’s 50-day moved through its 200-day moving average last week leaving the stock technically vulnerable. This sell-off probably ends in a massive short squeeze sparked by some positive fundamental news, in our opinion.
Mexican Bolsa Sneaky rally to new all-time high. Mexico’s stock market has been the tortoise of Aesop’s Fables. Slow, steady grind higher.
Brazil Bovespa Mexico’s Bolsa must make Brazil’s Bovespa the hare of Aesop’s Fables. The index has been weighed down by the China slowdown and the government’s use of some of large cap stocks, such as Petrobras, as piggy banks.
India’s Sensex The index has been one of the best performers in local currency terms this year. It is also closing in on an all-time high.
Hang Seng It’s no wonder that equity markets are rallying into the close for the year. The Hang Seng is are favorite indicator species of global risk appetite. The index has performed remarkably well given the Shanghai Composite if just off a 3-year low.
Shanghai Composite The Shanghai bounced hard after making a 3-year low on Tuesday. This index is the odd man out this year, the only major equity index with a negative return. It could be setting up as the trade of 2013, but still needs more technical work, such as taking out the 200-day moving average.
Japan’s Nikkei The Nikkei has had a huge snapper rally based on the expectations Shinzo Abe will become Japan’s prime minister next Sunday and will lean heavily on the Bank of Japan to implement massive quantitative easing. The yen has weakened considerably and taken the Nikkei up. This policy will not be without big risks, however.
Australia’s All Ords Not far from a 52-week high. Australian are caught in between the risk on rally and weaker commodity markets, in our opinion.
U.K.’s FTSE It will be interesting to see if the FTSE can break to new highs by the end of year on the back of the DAX and CAC breakouts. We think traders, led by Santa Claus, will have the Christmas Spirit in them to move the index over 6000 by the New Year.
Euro The euro has been in a definitive range over the past three months. Having difficulty breaking above 1.31625. Let’s see if Italy’s political problems and economic weakness can take out the downside at 1.2700
Yen If they don’t sell the Abe news next week, the yen looks ready to break to new lows. Feels like traders are setting up the Japan trade next year. Long the Nikkei, short the yen. Two death crosses this year! Outch!
Copper Clearly bouncing with the Shanghai. Tough one here.
Gold Gold has been a very difficult trade this year. If QE∞ can’t move the yellow metal to new highs, something must be wrong. Though the actual printing of money has lagged greatly QE rhetoric. The last time we looked the U.S. monetary base is slowly shrinking and the ECB has yet to engage in OMTs. Maybe the rise to Shizno Abe as Japan’s Prime Minister will be the spark. And, maybe, not. We have learned the hard way never to fall in love with a position.
Wheat Cool chart. Big spike and big, long flag formation. A breakout to the upside would not be positive for the overall economy and global political stability.
Transitioning to a “whatever is convenient” Policy
The Fed changed the fundamental postulate from zero short rates until 2015 to zero short rates that are now dependent upon other factors.
These are a line in the sand for Inflation and an unemployment figure of more than 6.50%. There is no way around it; the Fed had promised one set of circumstances and in the middle of the game they changed the rules and so any reliance upon what the Fed puts out must be viewed with a skeptical eye. It may be true for a time or until it is less convenient but we just learned that what the Fed states cannot be counted on with any certainty and so much for the credibility of Mr. Bernanke. No one really wants to talk about this, of course, and no one wants to mention that the Fed Chairman has changed the rules of the game in the middle of the game but there you are; a backsliding Federal Reserve Bank whose statements are only crafted for the moment and future moments may be brief; we just don’t know. Apparently we have transitioned to a “whatever is convenient” policy at the Fed and we all should bear that in mind when assessing probable actions.
When money talks, nobody pays any attention to the grammar.
The world’s economies have been fostered and sustained since 2008 by the central banks of the planet working in tandem to make sure that the entire globe did not slide into the hellhole of Depression. To that extent the concept has worked but we are still on the lifeline to date and no one seems to want to get off of it. It is similar to a person being hooked on heroin with the inability to withdraw and so the habit continues. There are consequences of this behavior of course including irrational behavior, overblown promises and the increase of the risk that when withdrawal comes that the patient slips into convulsions. Those, however, are long term and systemic problems that will continue to haunt us but in the meantime more mundane issues abound.
Here is what the Fed has done to date in the Treasury market:
In the 6-8yr. sector they have bought about 50% of the gross issuance
In the 9-20yr. sector they have bought about 70% of the 10yr. gross issuance
In the 24-30yr. sector they have bought 100% of the gross issuance
In the MBS sector they are buying $45 billion a month all across the curve
The Treasury issues, the Fed prints money and buys, the cost of financing for the country is incredibly low and the yields for investors are paltry. The needs of The State overwhelm the needs of the citizens. The game works because this is what every central bank in the world is doing, one way or another, and so with no way to invest off-world, investors are stuck in the confined space that has been provided by the central banks. All of the new money buoys the equity markets, causes massive compression in the other Fixed Income markets besides Treasuries, decreases the yields of Treasuries the trend is set firmly in place. In the risk markets there will now be a demand as instigated by the Fed, that overwhelms the supply of new issuance. Between the coupons paid and the maturities for 2013 the figure is about $1 trillion in excess demand more than estimated forthcoming supply. Given the 36% loss in wealth that took place in America during the 2008/2009 period the odds of an asset allocation shift out of bonds and into equities is de minimis in my opinion and so the “Great Compression” will continue.
“There is no art which one government sooner learns of another than that of draining money from the pockets of the people.”
Buy as far out and with any credit you can stomach and you will win this game for the time that it exists. Buy anything with a discount and anything that throws off a decent yield and you will be rewarded for your savvy good sense. There will be a moment when the battleships, the star cruisers, the aircraft carriers who are the huge money managers will have to turn on a dime or hedge up their positions in some fashion but we are not there yet; not anywhere close to there yet. Now the money flows, the coupons pay, bonds mature, the supply of new issuance is limited and bought up by the Fed in Treasuries and Mortgages and the balance sheet at the Fed grows to equal the ECB at $4 trillion and the present day artifice prevails.
“Giving money and power to governments is like giving whiskey and car keys to teenage boys.”
CNBC's Rick Santelli clarifies (in a much-needed manner) that we do not live in a monarchy or dictatorship (hoping for benevolence) - no matter how many Democratic senators and congressmen believe the President was given a mandate leaving him "holding all the cards" - we live in a republic (where the sovereignty rests with all individuals) and removing 'debt ceiling' checks and balances (for example) is a ride down a slippery slope.
The chagrined Chicagoan then goes on to discuss the fact that the Fed, having unloaded another package of potentially infinite unsterilized money-printing, was actively discussing its exit strategy.
"mark my words, the market will decide that exit - and the Fed had better be ready when it comes.'
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