Tuesday, April 19, 2011

Today's links

1--Bernanke May Sustain Stimulus to Avoid ‘Cold Turkey’ End to Aid, Bloomberg

Excerpt: Federal Reserve Chairman Ben S. Bernanke may keep reinvesting maturing debt into Treasuries to maintain record stimulus even after making good on a pledge to complete $600 billion in bond purchases by the end of June.

The Fed chief’s top two lieutenants said this month the economy and inflation are too weak to warrant the start of a monetary-policy reversal. Investors and economists including David Kelly at JPMorgan Funds see that as a signal the Fed will keep its balance sheet at current levels by replacing about $17 billion a month in maturing mortgage debt with Treasuries.

Ending the reinvestment policy and the $600 billion program at the same time would be like quitting stimulus “cold turkey,” said Kelly, who is based in New York and helps oversee $400 billion as chief market strategist at JPMorgan. “It does make sense to reinvest for a while,” he said. “Then they could watch how bond yields react to that.”

2--The Granddaddy of All Bubbles?, Peter Coy and Roben Farzad, BusinessWeek

Excerpt: It's as if 2008 never happened. Once again the world's investors are pumping up bubbles that will probably explode in their faces. After the popping of a real estate bubble led to the first global recession since the 1930s, world markets are frothing like shaken Champagne. Pundits claim to have spotted price increases that are unsupported by economic fundamentals in assets ranging from U.S. farmland to Israeli biotech to Australian housing to Chinese cemetery sites.

Commodities have soared. Global junk-bond issuance hit a record in the first three months of the year. And Yale's Robert Shiller calculates that the Standard & Poor's 500-stock index is trading at 23 times earnings normalized over the past 10 years, compared with a historical average of 16. "I fear this is the granddaddy of them all, an almost-encompassing bubble right at the heart of monetary systems," says Doug Noland, senior portfolio manager of the Federated Prudent Bear Fund.

Cassandras, pointing to the bankruptcies, taxpayer-financed bailouts, and joblessness caused by the last bubble, argue that today's bubbles need to be deflated now before they get dangerously large. Many blame the Federal Reserve for keeping interest rates too low and pumping out a flood of money in search of yield that feeds bubbles around the world. Chinese authorities want the Fed to raise rates to relieve inflation in China. On Apr. 7 the European Central Bank raised its benchmark lending rate a quarter-point, to 1.25 percent. In the U.S.,

"What we've created is beyond moral hazard," laments Brian Wesbury, chief economist at First Trust Advisors, a Wheaton (Ill.) fund shop. "People are coming to think that the market cannot go higher if the Fed isn't helping it."

3--Global bull market may soon face biggest test, Howard Gold, MarketWatch

Excerpt: After two years of rallies and only one major correction, the global bull market may soon face its biggest test. The impending end of the Federal Reserve’s latest easy money program ("quantitative easing" or QE2), along with seasonal weakness in stock markets and other events, could cause investors to doubt this bull once again. The potential turbulence could resolve the big question that has been hanging over the markets: Is a real, sustainable economic recovery driving stock prices higher or, as the bears claim, is it just an illusion pumped up by excess liquidity, especially from the U.S. government’s printing press?...

But first there are some hurdles to clear. The biggest, of course, is the imminent conclusion of QE2. By the time the program winds down in June — and it won’t end early, that’s for sure — the central bank will have bought $600 billion in additional Treasury securities as part of its plan to support what looked like a much weaker economy last year. I don’t know if it’s worked or not, but in the ensuing months measures of consumer and business confidence have risen. (They’ve slipped again, however, in the wake of the Libyan uprising and Japanese earthquake, tsunami and nuclear accident.)

Stock and commodity prices have soared, too, although I believe the impact of QE2 has been exaggerated here: The broad measure of the money supply, M2, has risen by only 2.4% this year, and the extra money the Fed has pumped in is only about 1% of global gross domestic product in 2010.

What the end of QE2 portends

Still-strong growth in emerging markets like China, India, and Indonesia have driven demand for commodities much higher, and their growing surpluses also have added to the flood of money washing around the globe. But oil and commodities prices have eased recently from their recent highs, and I think that might keep inflation from taking off over the next few months.

So, when QE2 ends, I’m not looking for the end of the world, or even the end of the recovery — just some slowing for a quarter or two. Once investors see that, a lot of the fear looming over that event will dissipate.

4--Bailing Out The Thimble With The Titanic, The Automatic Earth

Excerpt: Dr. Steve Keen, the ever-insightful Australian economist who runs the Debt Deflation website, wrote an excellent piece in March of 2009 entitled Bailing out the Titanic with a Thimble. It essentially argued that the U.S. government's fiscal stimulus and the Fed's liquidity injections would be wholly insufficient to restart growth in the private credit markets, and so far this analysis has been spot on.

Ilargi and Stoneleigh, who run The Automatic Earth, have also been preaching this same message for several years now, and have repeatedly stated that the U.S. dollar and Treasury market would be the beneficiaries of the debt deflationary trend. It was most recently repeated in Ilargi's latest post, Our Prosperity is Owed Back Plus Interest....

...what matters most right now are the systemic dynamics of deterioration in private finances and social mood, rather than the fundamentally unsustainable nature of deficit spending. A major component of these dynamics is the monetary objectives and policies that will be undertaken by the financial elites through their proxy, the Federal Reserve....

The Zero Hedge piece contained the following argument regarding a peak in total margin debt used by hedge funds, and the lowest level of free cash since 2007, when the latest credit bubble also peaked:

At ($45.9 billion) this number is just below the ($52.8) billion last seen just before the August 2007 quant wipe out which blew up Goldman's quant desk, and arguably was the catalyst for the beginning of the end. In other words, as we have shown, everyone is now purchasing on margin and the level of investor net worth is the lowest in over 3 years. Which means that should the market decline from this week persist and the Fed be unable to stop it, the margin calls will start coming in fast and furious, and unwinds in otherwise stable products like gold and silver are increasingly possible as hedge funds proceed to outright liquidations. [3]....

...When global equity and commodity markets begin their downward cascade in response to the ongoing debt deflation and a temporary end to quantitative easing, margin calls will indeed be coming in fast enough to make your portfolio spin. The demand by institutional investors for a "safe haven" will emerge as quickly as the daylight descends into pitch black, and it will then become clear that the intent was never to bail out the Titanic with a thimble, but the other way around....

The bond markets of Japan and Europe simply can't make the grade, and, as referenced in Jumping the Treasury Shark, there really isn't enough gold to soak up all of that capital. Instead, the U.S. dollar and Treasury bond, because of their fundamental weakness, will be the refuge of choice and design, and this will also serve to aid the Fed's Mafioso protection scheme for controlling rates. The world has been flooded with dollar-denominated debt for decades, right up until now, and soon all of those liabilities will come pounding on the front door. And who will answer? Why, the Fed and the financial elites, of course.

They will invite the debt deflation in with open arms, because now they are holding vast sums of cash, and Treasury bonds that simply cannot go bad.

5--The literal Bernanke put, FT Alphaville

Excerpt: The theory itself, raised this weekend by Eric deCarbonnel at the Market Skeptics’ blog, relates to the Fed using derivative instruments to keep rates suppressed instead of other alternative measures like quantitative easing or interest rate ceilings.

Specifically, it suggests the Fed can and may already be selling put options directly to the market. (Although we’re obviously not too sure about the latter point.)

What we will say though is that according to the minutes of the Fed’s June 24-25, 2003 meeting the idea of selling puts to the market was mentioned as a way of influencing yields by the Committee in the past.

Note, for example, the following remarks by Vince Reinhart, Fed secretary and economist at the time, and then SOMA manager Dino Kos (our emphasis):

The Committee could sanction the use of various derivative instruments on conventional Desk operations as a way to influence longer-term yields, which is outlined in exhibit 8. Options of some form are a possibility, as are forward operations. For example, we could sell a sequence of options on term RPs, covering interlocking time segments that collectively extend as far into the future as desired.

In this way, longer-term yields could be influenced and a visible signal of the Fed’s desired path of interest rates could be demonstrated. Forward operations in term RPs could be structured in a similar fashion. Alternatively, we could sell put options on longer-term Treasury securities at strike prices associated with desired longer-term yields.

Of course, the operating objectives set for the sale of derivative instruments would determine their proper structure and should be carefully formulated first. I’ll come back to this subject after going through some of the logistical issues. I’m also going to focus primarily on options for RPs specifically, as these have certain advantages over forward operations for the kinds of policy purposes under consideration.

6--Bob Janjuah – told you so America, Ft Alphaville

Excerpt: Nomura’s skeptical strategist Bob ‘the bear’ Janjuah is feeling very pleased with himself, following S&P’s decision to revise its long term outlook on the USA to “negative”....Only last week Bob wrote the following:

We think QE3 will be both unavoidable and a grave policy mistake in the hard landing outcome. We think it (QE3) is unavoidable because under this outcome, where we expect a significant slowdown in global growth in H2, driven by an EM slowdown and an end to the global super-cycle in manufacturing, it is the only "stimulative‟ policy option left, and Bernanke and Obama both seem fixated with stimulus, at any cost it seems….

… We find it extremely worrying that over the mid-February to mid-March global equity sell-off, where the drivers of the sell-off were not particularly US-centric, the US dollar nonetheless sold off over this period. This is the exact opposite of what has been seen for more than the past two years, and not what the market expected. We worry that it may reflect growing concerns about the US sovereign and US policymakers who may now be turning into the central risk. If this is the case, and, as a result of QE3 the US dollar and US Treasuries become unanchored and are no longer seen as the world‟s risk-free assets nor as the ultimate stores of value, then the entire foundations for valuations in financial markets could be at risk.

7--David Levy: Deficit Spending Is HELPING (not Hurting) the Economy, The Big Picture, Good explanation of the need for more deficit spending (Video)

8--Investment Funds Allege Banks Conspired to Manipulate Libor, Bloomberg

Excerpt: Three investment funds accused banks including Bank of America Corp., JPMorgan Chase & Co., HSBC Holdings Plc, Barclays Bank Plc and Credit Suisse Group AG of conspiring to manipulate the London interbank offered rate. The lawsuit was filed April 15 in New York federal court.

The banks allegedly sold Libor-based futures, options, swaps and derivative instruments “at artificial prices that defendants caused,” thereby harming investors, FTC Capital GmbH of Vienna, FTC Futures Fund SICAV of Luxembourg and FTC Futures Fund PCC Ltd. of Gibraltar contend in the complaint.

Between 2006 and 2009, the banks “collectively agreed to artificially suppress the Libor rate and, in early 2008, ‘‘during the most significant financial crisis since the great depression,’’ the rate remained steady when it ‘‘should have increased significantly,’’ the funds contend in court papers....

Counts in the civil complaint include fraudulent concealment, violation of the U.S. Commodity Exchange Act, antitrust violations, and unjust enrichment.

9 --So About that S&P Outlook Cut: The Bond Market Doesn’t Care, Wall Street Journal

Excerpt: At least, not as much as it did earlier. Check out this chart of the 10-year yield this morning. (Remember your bond market see-saw, Marketbeaters. Higher yields = lower prices, and vice versa.)

So you can see initially folks sold Treasurys, sending price of the 10-year note lower and the yields higher. And then, the entire effect pretty much evaporated, and we’re about where we were before.

So what gives? Why doesn’t the Treasurys market seem to care any more?

From our view, it looks like there’s scarier stuff actually going on elsewhere in the financial world today. For instance, the specter of a default — oh, sorry, we mean restructuring — in Greece, seems to have spooked folks about the eurozone, driving some safety flights back into Treasurys.

10--

1--We’re Not Greece, But We Could Be the Next U.K., Marshall Auerback, New deal 2.0

Excerpt: Current proposals from both the President and Paul Ryan for serious deficit reduction involve several trillion dollars of “savings” over the next few years. I put quotes around the word “savings” because the concept is largely predicated on the idea that cutting government expenditure axiomatically creates “savings” when in fact, such “savings” could well induce a greater economic downturn and therefore increase the deficit as a percentage of GDP, as the Irish experience is now demonstrating. The President’s counter to the Ryan proposals will simply set the stage for a bidding war on fiscal austerity.

Ask your favorite economists what that does to GDP. My guess is that they’ll tell you it will shave a few more percentage points off GDP growth. And maybe a 50% increase in unemployment as the output gap skyrockets from already insanely high levels. In other words, we could well see years of flat to negative growth unless the private sector (including non-residents) spending somehow increases at least by that much. AND THE DEFICITS WILL GO HIGHER AS A RESULT!

For household consumption or business investment to fill the current output gap in private sector spending, there would need to be an increase in that sector’s debt (which is likewise measured as a drop in private sector savings). That got us into the mess we’re now in.

Borrowing to spend on houses and cars — the traditional engine of consumer growth — rising to levels sufficient to close the output gap seems highly unlikely and cannibalizes tomorrow’s growth because private debt (as opposed to public government debt) is externally constrained. Particularly when federal deficit reduction is cutting incomes and savings. We want a growth strategy that emphasizes growth in incomes, not credit....

....Our low output/high unemployment is telling us — screaming at us — that the federal deficit is actually too small. As contrary to current conventional wisdom as it sounds, Congress should be arguing over whether they should cut taxes and/or increase spending. Right now, we need federal government spending programs to provide jobs and incomes that will restore the creditworthiness of borrowers and the profitability of for-profit firms. We need a swift and detailed investigation of financial institution balance sheets and resolution of those found to be insolvent. We need to downsize “too big to fail” financial institutions, while putting in place new regulations and supervisory practices to attenuate the tendency to produce a fragile financial system as the economy recovers. We need to investigate fraud and jail the crooks. We need a package of policies to relieve households of intolerable debt burdens. In addition, given that the current crisis was fueled in part by a housing boom, we need to find a way to deal with the oversupply of houses that is devastating for communities left with vacancies that drive down real estate values while increasing social costs. And we’ve got to rein in the money managers who seem to be dictating policy.

The next crisis will come because we mistakenly continue to believe that we could be the next Greece and face a federal funding crisis. Instead, we’re going to turn into the next UK.

11--Bob Janjuah – told you so America, Ft Alphaville

Excerpt: Nomura’s skeptical strategist Bob ‘the bear’ Janjuah is feeling very pleased with himself, following S&P’s decision to revise its long term outlook on the USA to “negative”....Only last week Bob wrote the following:

We think QE3 will be both unavoidable and a grave policy mistake in the hard landing outcome. We think it (QE3) is unavoidable because under this outcome, where we expect a significant slowdown in global growth in H2, driven by an EM slowdown and an end to the global super-cycle in manufacturing, it is the only „stimulative‟ policy option left, and Bernanke and Obama both seem fixated with stimulus, at any cost it seems….

… We find it extremely worrying that over the mid-February to mid-March global equity sell-off, where the drivers of the sell-off were not particularly US-centric, the US dollar nonetheless sold off over this period. This is the exact opposite of what has been seen for more than the past two years, and not what the market expected. We worry that it may reflect growing concerns about the US sovereign and US policymakers who may now be turning into the central risk. If this is the case, and, as a result of QE3 the US dollar and US Treasuries become unanchored and are no longer seen as the world‟s risk-free assets nor as the ultimate stores of value, then the entire foundations for valuations in financial markets could be at risk.

12--David Levy: Deficit Spending Is HELPING (not Hurting) the Economy, The Big Picture, Good explanation of the need for more deficit spending (Video)

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