Macro Brief: FOMC Minutes with a surprise and inflation expectations could start to rise

 

Wrote this piece post the FOMC March notes: http://www.tradingfloor.com/posts/fomc-minutes-less-than-the-liquidity-junkies-hoped-for-1545086186

 

But more importantly, the key sentence in the FOMC Minutes was the following:  (Source: Edmund W. Schuster: News from the Fed is moving the market)

 

"A potentially important debate emerged at the Fed at its policy meeting last month about the U.S. economy's growth potential, the minutes showed. Most economists believe the economy can grow by around 2.5% annually without causing inflation. If the economy's potential is less than that, that could mean that even a small amount of growth could push consumer prices higher and force the Fed to rethink its easy money policies."

 

Many believe that the U.S. economy has to grow at 3.0 - 3.5% just to absorb new entrants into the workplace.

 

Further, if there is a chance that inflation could tick up if growth exceeds 2.5%, then the chances of rapid growth above 3.5% seem unlikely. Usually there is a strong inverse correlation between inflation and economic growth.

 

 

This is big news and moves the needle on further easing away from “infinite cheap money” forever…..AND as I have state a few times: Velocity of money continues to be the key component in understanding the inflation risk: Good old economics states: M *V = P* Y, M is money supply, V is velocity, P is price level and Y is quantity of output.  This can be converted into: P = M* V/Y

 

With the math out of the way,  look at this chart from St. Louise FED which is the lending change year-on-year from all commercial banks:

 

 

Wow, banks in the US are lending – and the two major ways velocity changes is through loan demand – or losing faith in the purchasing value of the currency (Think Hyperinflation in Germany in the 1920s/30s….

 

It seems that in the “real world” we have for the first time a rising velocity of money potential through loan demands combined with easy monetary policy – leading me to conclude, again, inflation expectations have reached a low, and if anything, could start to increase, a sign would be steeper yield curve:

 

 

 

So how does this change the FOMC outlook and the liquidity junkies need for more? Not a lot for now- I still think the “path of least resistance” is lower rates, but it seems the “unconventional” is gone for now, or at least delayed and that in itself will make for an interesting talk on investment meetings this next week. The market now NEEDS a weak non-farm to get Bernanke and Dudley back into leaking their intentions(QE 3 to QE Infinite) to WSJ.

 

We, at Saxo, see a non-farm number in line with January and February, so no big down-side.

 

Note also the long term  channel I have addressed several times remains solidly in place:

 

 

 

Conclusion:

 

Market was clearly disappointed in the lack of dovishness – and the material change was on growth potential being changed DOWN to 2,5% down from 3,0% to 3,5% - that makes a huge difference and with the wrong assumption on the labor market from Bernanke(he believes in cyclical, we believe in structural), we are now for the first time in five years at risk for higher inflation expectations, that is the last thing the market needs, and probably why it will get it!

 

Strategy:

 

We still like US Dollar – a view we have held since late 2011 – access to capital, political stalemate(good for business), and higher innovation/productivity than Europe. We overall think the US Dollar is about to start major up cycle which will negate most of the loss seen since 2000 (EUR/USD @ 0.8400 in 2000) – there will many false starts, but the US is about to outperform relatively on growth although as Fed now realize from a lower level, but so is the rest of world including China.

 

Safe travels,

 

Steen

 

 

 

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Macro Brief: Governments need to have both shepherds and butchers.

Governments need to have both shepherds and butchers.
Voltaire

 

This week is all about whether Germany will or will not fully commit to fire-wall. Clearly this weekend's press have the compromise ready: Chancellor Merkel will allow ESM and EFSF to run simultaneously, but only for one year while the EU led for Olli Rehn is looking for a more permanent size.

 

The math is as follows:

 

440 billion EFSF (200 billion committed to Greece, Ireland and Portugal) + 500 ESM = 940 billion EUR-200 billion EUR=  740 billion EUR.

 

In the German version this only run until July 1^st 2013, while EU Commission and Club Med wants it to be permanent: Whatever happens I think the below chart from Bloomberg Brief indicate the real size needed in to make the fire-wall attack free: (The numbers are only bonds maturing up-and-to 2013). Market is looking for 1.5-2.0 trillion as the magic number – a number big enough to buy time for reforms.

 

Maturing debt from now to end of 2013:

 

As always it is all eyes on Germany – will they or will they not – that's the only question we need to ask. What all other countries do or think is irrelevant – get used to the new Europe – one master, one decision maker – no wonder the fathers of Europe is concerned!

 

Meanwhile in Spain where the title race is still relatively open between Real Madrid and Barcelona J, things are going from bad to worse – this weekends local election in Andalucia, where Spain's centre right People's Party failed to secure an outright majority, leaving Prime Minister Rajoy without a mandate to carry on with tough austerity – was a bad start to week where we on Thursday will see a major general strike aimed at… Yes, you guessed it: Austerity measures.

 

 

The European story remains one of major promises and no actual reforms. A low interest rate and an extreme sense of "security" created by the illusion of easy money and low interest rates forever, but as I wrote  in the piece: Interest rates: the market has it all wrong  this weekend, we could be on route to an exit strategy from central banks which at a bare minimum will be a goodbye to "unconventional measures" and if so, the low in interest rate cycle is in place – and the interest rates will continue on down-ward projection in 10-30 years, but increase in the very short-term (0-2 years) as the focus needs to be on reforms. The only way central banks creates a proper exit from unconventional is to hand over the torch to reforms from governments and politicians. Unlikely,yes, needed? Absolutely, otherwise we are doomed to 30 years of Japanisation.

 

 

Otherwise we have a busy week with plenty of data  - note how US data has been disappointing keeping the "mean-reversion" we firmly believe in: (Market goes from expecting too little improvement to believing in too much growth):

 

 

Macro Brief: Interest Outlook - Voltaire: 'A sovereign state that owes money only to itself could not become poorer'

 

Voltaire, 1738: "A sovereign state that owes money only to itself could not become poorer" (Source: Gilles Bransbourg, NYU & Bloomberg Briefs)

 

To say the last four year since the financial crisis broke out for real in 2008 has been slightly atypical would be the understatement of the century. The central banks across the globe have been deep into their toolbox to find what they call "unconventional measures" – which is really short for cutting interest as low as possible for as long as possible – when rates hit the floor (zero interest rate) in the short-end (0-2 year),  they moved their effort further out on the yield curve buying most of the bonds issued by their own governments Treasuries. Decades ago that would have been called a Ponzi scheme, but in today's world it is sold as the "only alternative".  Voltaire saw it coming.

 

Traditionally the central banks have only controlled the interest rate curve from Overnight to one year through their policy setting rates, but the severe drop in equities in 2008/2009 and the huge fiscal imbalances created from biggest fiscal stimulus in history created a need for securing "orderly business" through ample liquidity at low rates. That was followed up with a PR blitz from central bank and policy makers telling us: It's all ok – we got everything under control! Sure you do! We then migrated from one bubble to another, and ended up in a debt trap, where governments and banks remains thinly capitalized and often without access to further credit.

 

The world government and commercial banks now takes so much of "credit cake" – that the private sector is only left with  crumbles. The private sector which is traditionally the risk taking and profitable side of the economy has been cut off from its oxygen : Credit. The macro side of the economy have taken over the micro. Trust me you want the micro economy, you as a person and individual companies, to have the maximum flexibility and access to capital and risk, instead they are cut off, overtaxed and overregulated.

 

In 2012 so far we have a gradual normalization of interest rates. The move this month has been dramatic and lead to talks of changing fundamentals and a potential for mainly the US for having turned a corner. We were constructive on the US back in Q4-2011 as we saw the expected future growth by consensus economist being too low (Remember the talk of double dip?) – now fast forward to Q1-2012 and the market is, in our view, too busy to project recent "stabilization" into long-term growth. It's too early, if anything our forward looking indicators remains constructive but showing signs of a slow down , hence we believe the US will still be the star of 2012 but only because everyone else will do much worse.

 

This leaves the recent interest hike as almost a counundrum: Have the interest cycled bottomed – are this the new normal or is it back to mean-reversion? The world needs low interest rates to carry the gigantic debt in front of it, so the outcome to this question will a large impact on future growth and investment climate.

 

Chart: US 30 year Yield since 1993 – Source: Stockchart.com

 

 

We presently see three potential scenarios:  (the percentage probability is consensus expectations)

 

-          Much lower interest rates going forward(60%) – based on infinite monetary expansion. The reflation trade. This is the one option favored by politicians as it is of balance sheet and off accountability for them (Stealth crisis help from central banks). These facts makes this the most likely scenario and if you look at charts also very appealing. Ever lower interest rates in downward channel as seen above.

-          Lower in a channel but all-time low in place(30%) – rates have seen the low overall. The "unconventional measures" needs to exited. The biggest policy mistake historically has always been staying too low for too long. The politicians are clearly getting "hand shy" for continuing the "unconventional measures". Another game stopper could the law of stock versus flow. The policy makers have printed in excess of 3 trillion US dollar globally to keep the financial market and government afloat. This means to have additional impact the net new issuance of money needs to be much bigger in nominal terms(10% of 1.000 is 100. – 10% of 7.000 is 700 – so to get 10% impact in this examples you need to print 600 more for same impact). This is our preferred outlook path now

-          Crisis 2.0(10%). Our old theme which is really the loss of faith in government and its ability to repay its debt. To some extent we have had Crisis 2.0 in Club Med, but it is yet to pass on to major economies like Germany, France, US, Japan and the US. This is the least probable scenario, but IF… we break the higher channel in the above chart if would signal a start to a whole new paradigm where FIAT money no longer is sustainable.

 

If we are right and the market is wrong, then the move away from "unconventional measures" is a major game changer. The banks- and government are dependent on the false sense of security low interest rates creates. Even a historic normal expected move in interest rates from the bottom- to the high-end of the present long-term trading range 3.0% to 4.75% would have dramatic impact on debt crisis.

 

Across Europe and the US house owners remains under pressure – any move – small or large would put 100.000s further under water in equity value. That is the negative impact of a debt trap, the inability to create any economic environment where you can exit from the pain of the debt service – look at Japan. The stock- and house market topped in 1980 – now 32 years later the stock market is 75% below its peak. Too negative? Probably, but a long life in trading has taught me a few long-term facts: 1. Everything mean-reverts – What comes up must come down. (Think stock market, house prices, excess, state intervention) and more importantly 2.  We never lean any from history

 

Safe travels,

 

Steen

 

 

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Macro Brief: Do worry be happy

 

 

It is time for a brief macro update – I had spent the week reading a serious amount of research of which I would recommend a few:

 

Albert Edwards: Always worth a read and one of the few more bearish than me…..Talks about the seasonality of the improvement in the US data – which also gets him on to the view that this year Groundhog Day – same swings, maybe for different reasons, but he is very determined US rates is going to new lows:

 

http://ftalphaville.ft.com/blog/2012/03/21/932261/albert-for-all-seasons/  & http://www.zerohedge.com/news/treja-vu-albert-edwards-expects-new-lows-bond-yields-equity-rally-turning-dust-just-it-did-2011

 

James Montier of GMO – explains very elegantly how everything mean-reverts (where have we heard that before) and that the massive improvement in MARGINS is due to government consumption – yes government consumption. Take 15 min to read it. Important macro lesson for all to have:

 

https://www.gmo.com/America/CMSAttachmentDownload.aspx?target=JUBRxi51IIBtbYEu0yy2D233Qql0krF9YIWDpyU9bC1DsIW9OxrQN38JW598obIegPVL5Vm43jTd74zJ0R1rY2lRRYvkFggPe%2bdZF4oUF%2bEun279ii1ThA%3d%3d

 

Finally, Goldman Sachs is out with massive recommendation for buying stocks called: Long-Good-buy. I am tempted to say…. No, I will not…. J

My in-house Audi-dealer (I call all equity analyst' Audi dealers – as if you walk into a Audi store – what car will they sell you? Yes, of course an Audi) was all excited about the report, and it is always good to test your own bias vs. a well-researched opposition:

 

http://www.scribd.com/doc/86194691/Long-Good-Buy

 

---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

 

Away from the academia, which all of above is, the real market is in state of confusion. All clear – Alles klar Kommisar!  Europe has turned a corner(Sarkozy told us so…), but… hang-on what's going on in Spain?

 

 

What? How can they? Spain has seen higher 10 YR rates and higher 5 YR CDS most of this month – can you spell – R-E-T-R-O-A-C-T-I-V-E-L-Y changing Bond terms?

 

This is the price for bailing out ECB(and pretending they made a profit!) and for Spain for ignoring the fiscal compact and real reforms.

 

The Spanish Labor law is not a real reform – it's political posturing: 40% of working force in Spain is in temporary jobs . The 60% have fully protected jobs. Rights which dates back to Franco's time and reducing the lay-off period from 45 days to 33 days is not going to change that. The Spanish labor system is one of two separate systems. One with too many rights, and with no rights, and the worst ting being there is no new jobs being created in either side of the system, as austerity, lack of reforms is continuing to inflict a vicious circle of higher unemployment, more social costs, and lower growth.

 

I hope, and it's hope like in a church, that Spain will pull through but I do not see the political mandate in place. The general strike on March 29^th is not a good sign for reform and change is it?

 

The big discussion though remains that of how far in the "normalization" of interest rates. I wrote piece last week which talked about outlook that this was a reduction of the tail-risk for the world overall, this leads to less propensity to buy bonds, which unwinds some of the overboughtness of fixed income:

 

 

– That's all fine and plausible. Where from now? There are two or three paths from here:

 

-          Much lower interest rates going forward(60%) – based on infinite monetary expansion. The reflation trade. This is the one option favored by politicians as it is of balance sheet and off accountability for them (Stealth crisis help from central banks). These facts makes this the most likely scenario and if you look at charts also very appealing. Ever lower interest rates in downward channel. Albert Edwards, Soc. Gen in above link makes a very elegant case for this: More of the same. World needs growth and low interest rates to deal with the debt crisis. It may get the later but probably not the first …hence….the winner is….

-          Lower in a channel but all-time low in place(30%) – rates have seen the low overall. The "unconventional measures" needs to exited. The biggest policy mistake historically has always been staying too low for too long. The politicians are clearly getting "hand shy" for continuing the "unconventional measures". Another game stopper could the law of stock versus flow. The policy makers have printed in excess of 3 trillion US dollar globally to keep the financial market and government afloat. This means to have additional impact the net new issuance of money needs to be much bigger in nominal terms(10% of 1.000 is 100. – 10% of 7.000 is 700 – so to get 10% impact in this examples you need to print 600 more for same impact). This is my present thinking

-          Crisis 2.0(10%). Our old theme which is really the loss of faith in government and its ability to repay its debt. To some extent we have had Crisis 2.0 in Club Med, but it is yet to pass on to major economies like Germany, France, US, Japan and the US. This is the least probable scenario, but IF… we break the higher channel in the above chart if would signal a start to a whole new paradigm where FIAT money no longer is sustainable.

 

 

Strategy

 

We are shortly introducing a more detailed strategy where we will have pro-active positioning with track-record in order to be more accountable. The positions presently in our model is:

 

Short AUD.USD. China story. Slowing growth. RBA looking to cut rates. Curve is steeping.

Short Coffee. Better and better harvest.

Short Natural Gas. US just became biggest exporter in the world.

Short EUR.USD – strategic trade we think end of April is crunch time with ESM votes, French election, Spanish strikes, and probably forecast cuts across Club Med.

Long S&P vs. short STOXX50. Our model is long S&P – we are short STOXX50 against it.

Short IEF – as proxy for US rates.

Short Gold – our model have gone short, but risk is option expiry next week which generally leads Gold much higher.

Short CRUDE (May) – our model sold Crude today @ 105.68

Long EUR.SEK- we still like EURSEK long-term but respect the model.

 

Overall strategically we have: 50% cash, 30% in corporate credit, and now 20% in macro bets above.

 

Safe travels,

 

Steen

 

 

 

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Macro Brief: How real is real?

 

"All truths are easy to understand once they are discovered; the point is to discover them."  Galileo Galilei

 

 

The 60 bps move in US rates have so far had little impact on the risk-on vs. risk-off market. Yes, AUD vs. USD is small down and yes fixed income is having a negative year (outside: Club Med)….but how real is this move and why is it happening?

 

We see a major change here which will be confirmed tonight if 10yr close again above 2.1000 – there is something  changing in the "perception" vs. "reality" trade. The easy part of not fighting Fed is done – now comes the hard work.

 

My great and educated colleagues Peter Garnry, Mads Koefed and John Hardy have provided me with some ammunition which could be of interest to you:

 

 

Mankiw model looks at where Fed should be for them to be in line with a dual mandate. Looking at the chart Greenspan's major policy mistake in 2003/2005 stands out (Red line lower to flat while inflation and labor market took off) – now we are entering EQUILIBRIUM – but as the great George Soros  says: No market is ever in balance for more than a nano-second, and the present management at US Monetary Printing Inc. – sorry Fed is unlikely to react, like Greenspan, before they are behind the curve.

 

What is also interesting is that the forward curves is moving up – so not only is 10 year yields higher – the whole curve is higher including periods inside UNCHANGED Fed.

 

Add to this my piece from yesterday about volatility being paid in 1 year and 2 year – the "truth" – whatever it is – is hard to ignore – something have changed.. It may only be that the probability of PRINTING INFINITE have become PRINTING for decades but something is clearly happening – the believe in "unconventional measures is waning" – and fast it seems.

 

All the research I get this morning talks about the move higher in yields being overdone (funny how it's never the case the other way around?) but…I think Galilei was probably smarter than today's pundits. (He did not need to update his Facebook profile so he had more time to actually think about things?)

 

 

 

Likewise Bunds and Spanish yield is apparently breaking recent trend – is this the price for retrospectively changing legal language – the impact of Tier-1 capital deleveraging or?

 

 

I think it's all of above. The banks are still underfinanced – take away LTRO and Europe banks are toast – the leverage has risen not decreased in Club Med banks as they have bought more of the toxic government bonds which almost made them go under in the first place; But if you are sacked whatever happens as CEO of a Club Med bank why not put everything on Red? Game-theory at its simplest – and most convincing.

 

My conclusion is this:

 

The early riding the wave of easy money is over- Fed will still try to engineer further easing, but the truth is harder to ignore – and sometime soon even the dogmatic FOMC will need to consider an attempt for an exit strategy – is that not the whole point of this "new" open communication policy they have introduced with great fanfare?

 

Nice weekend

 

Steen

 

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EU summit: extend and pretend continues | TradingFloor.com

Dear All,

My take on EU Summit so far, but done from a far in Singapore with full moon and everything. Nice week-end

http://www.tradingfloor.com/blogs/steens-chronicle/eu-summit-extend-and-pretend-continues--2134051758

Steen
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Relative growth cycle - more than EU debt crisis dictates a serious look at potential for much lower EURUSD.

 

INTERNAL NOTE ONLY.

 

 

My colleague Peter Garnry was kind enough to quickly program a small excel thing which can track changes to growth by consensus using the ECST function on Bloomberg. This is the result.

 

One of my main themes over the last quarter has been a "relative outperformance" of the US economy relative to consensus. This has materialized and our call was almost entirely driven by Consumer Metric data which over the last three years has outperformed any other relevant predictor. This is now slowing down slightly, but still elevated. Meanwhile Europe start election cycle where Spain goes to the election in less than two weeks, while Sarkozy starts his re-election campaign when he is done playing Napoleon in European politics.

 

The outlook for 2012 is a "Perfect Storm" with increased austerity, higher unemployment, and weaker global growth(read: China).

 

European consensus growth by market consensus

 

Source: Bloomberg & Saxo Bank

 

European growth coming off hard and has been in almost free fall since end of July.

 

US consensus growth by market consensus

 

Source: Bloomberg & Saxo Bank

 

Meanwhile US growth have seen low and looks higher, but……there is a number of issues ahead:

 

1.       The Super Committee needs to finalize its work by this weekend in order to secure proper processing Congress. WSJ journal this morning says sources tell them some progress is being made and main point for now are: A. Limiting tax deductions replacing tax hikes. B. Getting permanent Bush tax as payment and most importantly for FX markets: C. HIA – Republicans seems fighting for repatriating capital back to the US at tax rate of 5.25% vs. presently 35% - this topic has even been on 60 Minutes, so to me it looks like "deal to be done shortly" as it plays nicely to create "Job creating program.

2.       The headwind from fiscal tightening will equal negative 1.00 pc of GDP – this is federal, state and local communities trying to cut back mainly, but also investment remains meeker.

 

Conclusion

 

 

 

A long life have taught me that everything "mean-reverts" – when I moved back from the US in 2000, the EURUSD was trading below 0.8400 – since then the US has pursued a policy a "benign neglect" and succeeded in making the US extremely weak by all definitions.

 

Clearly the US has debt issues on their own, but currencies are relative trades. To me we are entering long-term up cycle for the US dollar. The final QE/Printing of money will come in Q1 of 2012 and could cement the low, but I am willing to start overweighting US dollar relative to Europe, not Japan, and further down the road to go full in. I suggest for European to initiate the first 25% now as EUR/USD is out of touch with relative rates, funding needs, and relative dynamics of the economies.

 

There are four major components to my long-term bullishness:

 

1.       The EU debt crisis – when ECB becomes lender-of-last-resort we will see 10 figure move lower.

2.       Relative growth differences – The US is more dynamic and with only "one master" . – i.e. Congress vs. Europeans 27 members and lacking fiscal union.

3.       Competitiveness. US will able to compete on labor costs with close to 20 pc real unemployment and incoming tax incentives..

4.       HIA – Homeland investment Act – as stated above the Super Committee is trying to get a reduced tax of 5.25% in place.

 

These things are floating. My bullishness is relative, but the biggest contributors to long-term wealth tends to be your choice of currency. I have a target of 100 in DXY for next year, so a 25% rise in the US dollar during 2012 – and in EURUSD terms the expected move is changed range from 1.30/1.40 now to 1.20/1.30 on ECB rolling over, another 5-6 figures on interest rates, and then HIA II we end around 1.10-1.15 for 2012 end target. Having predicted this I will, as always, add, my own believe in me being able to predict anything remains 0.001 pc.

 

Safe travels,