Who’s going to pick up the tab?

http://www.tradingfloor.com/posts/steen-jakobsen/steens-chronicle-whos-going-to-pick-up-the-tab-3512

29 April 2011

Steen's Chronicle: Who's going to pick up the tab?

Steen Jakobsen, Chief Economist
America is a country that doesn't know where it's going but is determined to set the speed record getting there - Laurence J. Peter
Last night I had the pleasure of speaking at a Saxo EBANK seminar in Copenhagen with the world famous blogger Mike "Mish" Shedlock -he of the Mish's Global Economic Trend Analysis blog.

First, I must note that it was a novel experience for me in my twelve years of speaking engagements to be out-gunned on the negative side on my investment outlook. In the past, so many have asked me after my presentations: 'Steen, you are always selling everything – what are we supposed to BUY?  Clearly, I need to bring Mish along on more of these speaking gigs and play off his gloom to make my views appear a bit more cheery.

Mish raised several critical themes and issues in the current financial environment, but the most interesting was the often forgotten focus on leverage in the US – which we all know is high, but  do we really understand exactly how high?
 
Financial leverage in the United States
Fed Balance Assets – white line, MZM – broad money – Yellow, Public Debt – Green and finally Credit Market Debt  - Red line


Source: Bloomberg

The US Fed has more than tripled its balance sheet since 2008, and US public debt has followed suit. Meanwhile, the broader money measure, as a benchmark for baseline money in the economy, has remained stable. The point here is not rehash the well publicized fact that the Fed has printed money, but more to point out that when you have this kind of leverage, even small policy errors can have major implications.

I will never forget how in the pre-Financial crisis day, I listened in on a Lehman CFO analyst call in which she boasted that they had brought down their balance sheet leverage from 40 times to less than 30! In retrospect, it's so easy to point out that this means it only takes a 3.34% move in the wrong direction in underlying assets to wipe you out rather than a 2.5% move – not a huge difference.

My piece yesterday on the possibility of an upcoming US dollar crisis drew some attention, but I must say the more I think about the main issue: How the Fed and to some extent the ECB continue to write off any material changes in the economic reality as "noise" or "transitory effects", the more I believe that all economists, a.k.a. dismalists need to own up to the fact that all models in economics are flawed – They are all fair-weather models that work when we have a tailwind and clear visibility, but as soon as things start going down the drain, the model continues to see clear skies ahead instead of a thunderstorm of uncertainty.

Here's what you get when you compound the erroneous assumption that these economic models work with the scary cherry of financial leverage on top: Main Street suffering, Wall Street celebrating, a lack of real traction in the economy, whether investment or job creation, spiking inflation expectations, US dollar weakness, and a flight to tangible assets and other seemingly tangible assets like stock. This paradigm can gain and has gained incredible inertia over a certain period of time – but we are now entering the part of the party where someone needs to go to the bar and cough up some cash to pay for the drinks. I fail to see anyone at the party willing or even able to do so. The two or three giants: Asia (China+ India), the Middle East, and to some extent Germany have domestic issues that are too pressing for them to continue to bail-out everyone. And while on the one hand the political establishment does know it needs to strike a deal, on the other hand, a wait-and-see mentality seems to have no downside risk in the meantime and hence we will continue to see plenty of non-solutions and decision-making delays on offer. Meanwhile, silver, gold, and stocks continue their upward spiral and the US dollar keeps dropping.

The current market environment seems relaxed about it probably being too easy and therefore very dangerous. Please realise that high leverage always means high risk and if nothing else that is probably the best advice I can give anyone, not that anyone asked for it. This was also the bottom line of Mish's presentation yesterday. Yes, it is appealing to join the crowd, but sometimes it is also better risk-reward to say like Groucho Marx: " I don't care to belong to any club that will have me as a member".

Fed distances itself from high oil price

Excellent balanced comment from FT editor – and the conclusion is simply: Scary!

Anyone who does not believe in debasing?

Nice week-end

http://view.ed4.net/v/8P1R88/S3E9NO/EXCYA0X/0GTGP/

Note from the editor

Fed distances itself from high oil price

By Javier Blas The US Federal Reserve has a message for the commodities markets: it was not us and we plan to ignore you. Let me explain. Over the past few days, the US central bank has published a number of research pieces about monetary policy and commodities prices in which it argues that its loose monetary policy is not behind – as some critics claim – the spike in commodities prices. The research also concludes that the Fed should ignore the impact of high commodities prices on inflation – again, something that critics dispute vehemently – and focus instead on core inflation. The research by the Federal Reserve Bank of San Francisco and the Federal Reserve Bank of Chicago shows, in any case, the growing importance that commodities play in monetary policy nowadays. As the Chicago Fed puts it: "The recent run-ups in oil and other commodity prices and their implications for inflation and monetary policy have grabbed the attention of many commentators in the media." Yes indeed, they have: over the past few weeks, oil has hit $125 a barrel, copper a record of more than $10,000 a tonne and corn an all-time high of almost $8 a bushel. Difficult to ignore this stuff, even if the Fed would prefer that the media – and the market – looked elsewhere. The San Francisco Fed, which published the paper on the impact of US monetary policy and commodities prices, says that its analysis does not provide evidence that large-scale asset purchases, better known as quantitative easing, fuelled the rise in commodity prices. "It shows that, despite the fall in long-term interest rates and the depreciation of the dollar, commodity prices fell on average on days of large-scale asset purchases announcements," the research paper concludes. "Some critics argue that Federal Reserve purchases of long-term assets are fuelling this rise by maintaining an excessively expansionary monetary stance. However, daily data indicate that Federal Reserve announcements of large-scale asset purchases tended to lower commodity prices even as long-term interest rates and the value of the dollar declined," the San Francisco Fed's research paper adds. The analysis, however, ignores the impact pre- and post-announcements of large-scale assets purchases. The Fed communicated well its intentions to the market, so it is hardly surprising that investors bought the rumour and sold the news. Hence, the findings of the Fed. Once the San Francisco Fed has felt reassured that the US central bank has nothing to do with high commodities prices, the Chicago Fed has looked at how it should react to them. The Chicago Fed has concluded in a research paper – signed by its own president Charles Evans – that it could ignore them. The study says that "sharp increases and decreases in commodity prices have had little, if any, impact on core inflation", the preferred measure of inflation of the Fed. The bank argues that the share of commodities in the US economy is decreasing and adds that, in the case of oil, the price increases do not need to force the central bank to tighten its monetary policy as oil price "increases tend to slow the economy even without any policy rate increases". The bank further argues that it would need to act only if high commodities prices spill over to core inflation. But it concludes that is an unlikely case: "Assuming there is a generally high degree of central bank credibility, there is no reason for such expectations to develop – in fact, in the post-Volcker period, there have been no signs that they typically do." The Fed has a point here, particularly on the fact that high commodities prices are self-correcting to the economy slowing economic growth. The main problem is that some other central banks – particularly in emerging countries – are taking home the message of the Fed. For them, however, high commodities prices are a problem: the share of raw materials consumption per unit of gross domestic product is higher and the credibility of other central banks is usually less than the Fed.

Steinhardt talks the trust - amazingly honest interview - must see..

http://video.cnbc.com/gallery/?video=3000014541

 

 

 

Classic dilemma - calling the bluff?

We are now stretched in major asset classes, particularly in US dollar and equities.  From the mean-reverting perspective we are certainly entering buy levels, but this could be one of those black swans - the situation in Japan is clearly not contained: tepco-director-weeps-after-disclosing-truth-about-fukushima-disaster & also this week-end we could see military action in Libya. I have scaled down the exposure but keep options on dowside in stocks and long metals. Took the USDJPY off, but looking to resell US as we are most likely seeing a start of serious weaker US Dollar.

This stakes in this poker game are high, Governments are all in, Central bank likewise - now the market is looking across the table considering whether to call the bluff, knowing odds are 70/30 their way - still there is 30 pct chance of them having the four aces!

This is one of the more reliable mean-reversion indicators:

Oversold McClellan Oscillator

http://www.mcoscillator.com/market_breadth_data/

 March 18, 2011
Our chart this week is the same one that we feature every day on our Market Breadth Data page, in the free portion of our web site.  This is the original McClellan Oscillator, originated in 1969, and calculated based on the difference between the numbers of advancing and declining issues on the NYSE.  You can learn more about its calculation and interpretation here.
Investors' worries over the earthquake, tsunami, and nuclear crisis in Japan led to a 6.8% total selloff in the NYSE Composite Index, and produced a deeply oversold reading of -269.6 in the McClellan Oscillator.  Readings below -200 are pretty rare, and in the past year we have only seen it dip down that low or lower on four previous occasions.
What happens in the days and weeks after we see one of these extreme excursions depends on what else is going on.  The McClellan Oscillator is a great tool, but it should never be used all by itself, and without an understanding of what else is going on.  By itself, a McClellan Oscillator low below -200 says that the market is oversold and due for at least a bounce.  But it depends on other factors to determine whether that bounce turns into a resumption of an uptrend, or instead just serves to temporarily relieve the oversold condition.
During the May 2010 Flash Crash, we saw the McClellan Oscillator get down as low as -388.  It bounced almost all the way up to the zero line, before falling back down again to an even lower low of -426, which is the all-time low on a raw basis (not adjusting for the larger number of issues).  It took a lot more pattern development in the weeks that followed to get the market started on the upward path again.  And it did not hurt that the Fed started its second round of quantitative easing (QE2) on Aug. 17, 2010.
The first round of QE had ended on Mar. 24, 2010, a month ahead of the April 23 price top.  So the Fed's liquidity was not there during the May 2010 Flash Crash to help smooth out the liquidity problems that month.  By contrast, the post-election selloff in November produced a McClellan Oscillator reading of -266 at a time when permanent open market operations (POMOs) were still underway.  That turned out to be just a quick dip, and the market got back to trending higher.
Now, we have another McClellan Oscillator reading below -200, at a time when POMOs are still underway.  And we are also still in a period of favorable seasonality right now.  Both the POMOs and the positive seasonality are scheduled to end in June, and so from that point onward we can adopt a different interpretation of the meaning of an extreme McClellan Oscillator reading.
Tom McClellan

USD at critical level.........

http://stockcharts.com/h-sc/ui?s=$USD&p=D&yr=1&mn=0&dy=0&id=p25646417572&a=223442909

I`m so naive about finances. Once when my mother mentioned an amount and I realized I didn`t understand, she had to explain: `That`s like three Mercedes.` Then I understood. (1981) Brooke Shields - Macro Note

I`m so naive about finances. Once when my mother mentioned an amount and I realized I didn`t understand, she had to explain: `That`s like three Mercedes.` Then I understood. (1981) Brooke Shields


Dear Friends,

A short update on the macro picture:

I have basically not traded for a full month but only kept the same old positions in place:

• long silver
• long Crude
• Short S&P
• long Fixed income
• Short EUR/USD

The P&L has been volatile around a big fat zero for most of the time, but last weeks rally in Silver, Fixed Income & Crude gave some nice gains.

I took off Silver, Crude and Fixed Income on Friday close due to the sneaky but still firmer talks of tighter monetary policy coming from not only China but now also U.K and ECB - we have even had some Federal Reserve Governors talks about an early exit from asset purchases in the US, but seriously let's not kid ourselves: We will see QE3 and QE4 before Obama leaves office.

His reflation trade is not working and hence he and his loyal partner Geithner and Bernanke will continue to pump money into the system while pretending to make step towards curtailing spending.

I find it laughable that Obama talks about 10 bln. in cuts and Congress about 60 bln, while the MONTHLY DEFICIT in February was 200 bln. USD!  Yes 200 bln. USD in February alone. It's a lot of Mercedes to keep it in Brook Shields terms!

Federal Payroll Tax Deposits - An early estimation of growth and employment



Source: Shadowstats.com

The evidence provided in the tax receipts above indicate we will have classic seasonal outcome on growth in the US. Q1 will be revised down - the Ivory Tower banks will maintain Q2 and Q3 only to revise everything down in Q4.

It's classic in an economy which is "managed" in terms of analysis and input, but in real terms growth will continue to fail as the tailwind of public sector spending goes away leaving the high unemployment, the growing cost of financing the debt and a slowing world economy as the residuals to create growth. Again we have put ourselves into a corner of too much optimism based on nothing but belief. The normalcy bias is alive and kicking.

Meanwhile the stock market sectors seems to be trailing the overall index performance. Are we seeing signs of fatique here? I do not know - I am still convinced the market "Plan Economy Management", PEM, will continue to do everything in their power to take S&P higher still - the technical target will be something like 1385.00 before everything becomes too excessive even for Bernanke, who only have one hit going for him, the stock market which he keeps claiming does not create Asset Inflation!

Europe P.I.G yields to new highs


In Europe this morning we saw new highs in nominal yields for Portugal and the spread of Italy vs Germany exceed the magic threshold of 5.00%. We, Limus Capital, has been long this spread for a while and used the spike to take some profit, but both of us feels this could go further, but we are entering the "Promise Timezone" - as the European politicians fly to Brussels Friday for early talks about EU, we will see yet another desperate attempt by everyone involved to buy some more time.

We had a long and serious talk about potential outcomes from the EU Summit end of March. The bottom line being; They can only buy more time by using loose terms like: Commitments, principle agreement, new committee formed to deal with... etc. etc. The language for: We disagree too much to move this forward, but we have a strong political will to keep this game going as the alternative is too serious for us to deal with.

Germany and Merkel will not bring anything to the table, at a maximum they could agree to slightly cheaper funding for Greece and Portugal(they will apply shortly for emergency help), but not without consessions they are not about to get from the weaker Southern countries. Am I the only noticing that the countries in trouble all have Socialdemocratic or Socialist governments? In Germany SPD saw biggest gain in decades in Hamburg a traditional Liberal area - yes 2011 will see major shift of political leadership from Blue to Red, which will only reinforce the buying more time concept as dirigism remains the weapon of choice when dealing with this crisis.

Hair-cut and restructuring will not happen before the ECB have sold off their 75 bln. EUR of trash P.I.G bonds on their balancesheet to the EFSF, as this would be major loss of face and money for them.

Do not forget taking a loss also will impact the massive REPO ECB does with collateral being the same junk, but as my partner Jesper said: Well, really it's simple, you just convert your loans from being with collateral to being unsecured - right indeed - effectively we are all giving everybody unsecured loans presently as the FIAT money system is being dissolved slowly but nicely.

End of the day the most likely path from here becomes one where the US engage QE3 by August/September(despite present hawkish talk), EU find a way to extend the pain for everyone is Europe yet another year or two, while the amount of "Mercedes" we need to finance becomes ever bigger. It's clear to me that it is not only Brooke Shields who fail to understand an amount, the numbers are now so big that eveyone seems to think it's really just a game, a live-version of Monopoly.

Copenhagen, March 9th, 2011

ECB just ended the cycle of low subsidized capital ==> Cost of capital will rise .....

http://www.bloomberg.com/apps/quote?ticker=GDBR10:IND

http://www.bloomberg.com/news/2011-03-03/ecb-holds-benchmark-rate-at-1-as-trichet-grapples-with-surging-oil-price.html

ECB have just increased the odds of Europe going into a tail-spin by indicating they will raise rates at next meeting.

Trivia: When did ECB raise the rates last time: Answer: June 2008 - they NEVER LEARN - this is a dangerous world, as the ECB now has opened the bottle of ever higher rates, impact?

1. Much higher financing costs for already hard hit P.I.I.G.S - already big.
2. Stocks WILL GET HURT from this - cost-of-capital / the cycle of excessive low interest money has ended!
3. EUR should have a couple of days of rally, but watch Non-farm tomorrow in the US (I expect higher than expected print approx. 500K)....
4. DO NOT be long banks from here ......

It's so comforting that policy makers NEVER LEARN from history and keep repeating their mistakes.