October 2009 - Posts
Please, click here to read this article in pdf format: www.sibileau.com
With yesterday’s $1.94BN purchase of 2013/16 Treasuries, the Fed
finalized its $300BN purchase program. If you have been following my
comments since April, you will know I never thought this program would
come to an end. In fact, I can’t accept it has, given that nothing has
improved on the fiscal side. Thus, the big question now is how 2010
will be financed. Not that these $300BN would solve the problem, since
this is not a significant figure on a relative basis, but it surely
helps. From the other side, the policy side, I guess everyone by now
agrees that this program did nothing else but contribute to inject
liquidity to the market.
And with this in mind and the GDP (i.e. activity) numbers released
yesterday, the markets pulled back on the downtrend big time. I know
some analysts disagree with my positive comment here, but to me, the
reversal was important: It took place in every major market (equities,
corporate credit, fixed income, foreign exchange, agency debt, energy).
During a conversation with a friend and reader yesterday morning, I
was asked what my view was on inflation and whether or not equities
would work as an appropriate inflation hedge. I bring this issue up
today, because it is gaining some popularity lately. My answer was that
yes, equities are a hedge and that in fact, they have already hedged you against inflation. How so?
Inflation is not a reading on the CPI. It is not a jump in a price
index. It is not directly related with the level of activity, as
everybody wants us to believe. Inflation is a process in which relative
prices of assets change, driven by an exogenous demand that had not
existed until this process started, a demand that was ignited by a
central bank through the purchase of securities. When the relative
price distortion affects a market in particular, and it does, people
speak of asset bubbles. From then on, the changes in relative prices
take a life of their own, until they reach consumption goods. This may
take years, but before then, stocks see their prices increase a whole
lot earlier.
For instance, in 2009, one could reasonably track the relative price distortions as follows:
1. Central banks bought agency debt, mortgages = the spread of these
securities vs. Treasuries compressed to the extent that investors had
to shift their moneys to corporate debt, to reach for yield
2. Corporate credit spreads compressed, facilitating the refinancing of
short-term debt for longer-term debt. The process boosted equity
valuations (because equity is the call option on the firm’s assets).
3. The process regenerated the net wealth effect (a.k.a. Pigou effect), stopping the bleeding in housing prices and commodities
4. Going forward, if the virtuous cycle continues, capital expenditures should pick up, increasing production costs.
5. If the demand remains solidly driven by monetary expansion, increasing production costs will be passed on to customers
6. Readings on the CPI (Consumer Price Index) will show inflation.
Therefore, the rally we saw in equities worldwide since
March is already hedging those investors who bought and held them
against the loss in purchasing power that will occur, once
demand picks up to such level where companies are capable of passing on
rising production costs to final customers. The rally in equities would
have never taken place, had central banks not established their
quantitative easing programs.
On the other hand, once these production costs are passed on to
final customers, once the CPI readings show that prices are up and
start driving wage increases, it may be late to invest in stocks, if
the credit expansion caused by the government was a so called
“once-and-for-all exercise”, as the $300BN limited Treasury purchase.
However, stocks will keep rising in nominal value if the monetization
of fiscal deficits continues at a steady speed. Under this scenario,
inflation later spirals and becomes hyperinflation, as investors’
expectations incorporate this constant speed of money supply. Soon, if
hyperinflation takes place, stock valuations cannot keep up, because
hyperinflation destroys value, but that is a conversation for another
day.
The bottom line here is that if you think that central banks will
begin tightening and fiscal deficits will be dealt with swiftly, the
run in the S&P500 from 666 to 1,100 may be pretty much all the
hedge you will get from stocks, for the upcoming inflation.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
Yes, we are experiencing a correction. No news here. Yesterday too,
the Norges Bank raised its benchmark rate by 25bps, signaling the
beginning of the end in accommodative policies.
From wherever one sees the markets, profit taking is at the order of
the day. The minimal hint that the recovery process will take longer
than expected launches a new selling wave in risky assets and
strengthens the USD. Has anything material occurred during the last
week? No. Has the outlook on the recovery (slow) materially changed?
No. Has the Fed signaled that they are willing to err on the side of
caution and increase rates early? No. Has liquidity become more
expensive (3-mo Libor – OIS spread)? No. Have emerging markets engaged
in dangerous accommodative policies? No. Do we have political tensions
in the world? The answer again is “No”!
What then is driving the correction? The law of marginal returns,
mixed with constant risks. At the levels we had reached in equities and
credit, the risks outweighed the feasible short-term marginal returns.
And there is really not much more one can add here. Will central banks
find it harder to quit the monetary easing under a correction? Yes,
they will. Will governments see in the general weakness an excuse to
remain under deficit? Yes, they will.
Can a correction spiral into a more serious sell off? With the
information at hand, it is very difficult to see this happening.
Something more material should be here, interrupting the liquidity
normalization process. Could it be the idiocy of asking banks to be
better capitalized? When the 2001 crisis unfolded in Argentina, banks
had fractionary reserves of the order of 30% of assets, and of course,
that was not enough.
In general, if this correction continues, it may present us with an
opportunity to step in. For now, the general economic backdrop remains
constructive in my view, and although the new home sales figures or oil
inventories disappointed today, I see these issues anecdotic and it
would be naïve to expect a recovery process to go unidirectional, from
the lower left to the upper right.
Lastly, I thought I would quote here a paragraph found on Chapter XXXI
“Currency and Credit manipulation”, of Ludwig Von Mises’ “Human
Action”, published in 1949 (can be found at http://mises.org/humanaction/chap31sec5.asp ). These comments remain sooo relevant…:
“…The idea which generated what is called qualitative credit
control [p. 796] is to channel the additional credit in such a way as
to concentrate the alleged blessings of credit expansion upon certain
groups and to withhold them from other groups. The credits should not
go to the stock exchange, it is argued, and should not make stock
prices soar. They should rather benefit the “legitimate productive
activity” of the processing industries, of mining, of “legitimate
commerce,” and, first of all, of farming. Other advocates of
qualitative credit control want to prevent the additional credits from
being used for investment in fixed capital and thus immobilized. They
are to be used, instead, for the production of liquid goods. According
to these plans, the authorities give the banks concrete directions
concerning the types of loans they should grant or are forbidden to
grant.
However, all such schemes are vain. Discrimination in lending is
no substitute for checks placed on credit expansion, the only means
that could really prevent a rise in stock exchange quotations and an
expansion of investment in fixed capital. The mode in which the
additional amount of credit finds its way into the loan market is only
of secondary importance. What matters is that there is an inflow of
newly created credit. If the banks grand more credits to the farmers,
the farmers are in a position to repay loans received from other
sources and to pay cash for their purchases. If they grant more credits
to business as circulating capital, they free funds, which were
previously tied up for this use. In any case, they create an abundance
of disposable money for which its owners try to find the most
profitable investment. Very promptly, these funds find outlets in the
stock exchange or in fixed investment. The notion that it is possible
to pursue a credit expansion without making stock prices rise and fixed
investment expand is absurd…”
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
“A View from the Trenches” is back, after some health complications... A lot has happened since I last wrote last week, and at the same time, there is really nothing too meaningful that we can single out.
Indeed, the market seems to be drifting toward some correction, particularly in equities, but at the same time, one has to wonder what would cause a dramatic correction, in light of the continuous liquidity injections from central banks, overall “acceptable” Q3 earnings and a controlled USD devaluation. Can there be a correction? Of course, but at this point I believe there are too many yield-hungry investors that would immediately put a damp to any significant move.
Having said this, I can think of two main themes dominating the macro picture these days. The first one is the idiotic rhetoric campaigns carried out by monetary authorities worldwide. The same is based on two pillars: The continuous threats on potential unanticipated rate movements and the further intervention/regulation of capital markets to build a “solid” system.
A good example of this disgraceful situation can be found in the Bank of Canada. Its Governor, Mr. Carney, insists on reminding us he may choose to intervene the foreign exchange market at any time (although he already does so via repurchase agreements), while he simultaneously makes redundant comments on the capitalization of the banking system. He is not alone, as this propaganda takes place in other monetary areas.
The main concern seems to be the possibility of asset bubbles. These asset bubbles are the other side of the capitalization equation. By definition, if they are bubbles, when they go bust, the drag on the system is painful. They are right about this one, but the truth is that mudding the waters with hostile comments does not make matters any better. With central banks, there are asset bubbles. There is no way around it. It is very simple. Without central banks, if investors want liquidity, they need to sell assets. When these assets are sold, their prices fall in relation to the assets they want to buy with the liquidity they purchased. Therefore, without central banks, there can never be a financial/liquidity crisis like the one we just had (and the ones will keep suffering) but only violent relative price movements, at the most.
With central banks however, if investors need liquidity, central banks provide it by purchasing assets that nobody in the market was buying until that moment. The marginal asset purchases used to inject liquidity is what generates the bubbles. For instance, in the US, the market for agency debt and mortgage-backed securities is a good example. Hypocrisy (i.e. the talk about asset bubbles) therefore is a calamity, because it triggers events like Monday’s sell off in banks’ shares.
The second theme is the future potential interest rate (and foreign exchange crosses) dynamics. Interest rates have no place to go but up. The speed at which this process will unfold is therefore the big question. Will this speed be faster than the marginal efficiency of capital (=strength of the recovery, in more pagan language) in the different countries that face the challenge? Indeed, this is hardly any news at all. But the market is extremely focused on this topic, as the maturity schedule of corporate debt (and default and recovery trends) is now clearer, capital expenditure programs can no longer be postponed and the housing sector in the US necessarily finds a bottom at some point. Again, are interest rates a problem? No, the problem is not with interest rates, but with the force that drives and restricts future policy: The size of fiscal deficits.
Almost all of the macro trades recommended these days are based on the relative sizes and outlook on fiscal deficits. These trades involve fx crosses, benchmark curve views or relative performance views within credit classes (i.e. investment grade vs. high yield) and instruments (i.e. derivatives indices vs. bonds). Interestingly enough, everybody quietly agrees on this: fiscal deficits will not be addressed, but financing strategies will. As these financing strategies are disclosed, we will learn about new winners and new losers, competing for a decreasing liquidity. But that’s another story, for another time…
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Back from a brief vacation to the land of Niccolo and Marcvs Tullivs, here is an update on my last comments.
On September 22nd, I had turned neutral on the S&P500 and, given the activity in early October, on the 6th, I said that should the S&P500 close above 1,044 pts on three consecutive sessions, I would review my opinion. The S&P500 of course did that and we are now on the 1,090+ level.
Perhaps a good way to start here is to remember the reasons for my view. I explicitly mentioned three reasons: No clarity on exit strategies, dispersion in monetary policy answers and increasing political instability. I did also mention that the central banks, through their liquidity programs, were denying us the right to “measure” fundamentals. I wrote that our world looked like an undetermined algebraic system, where we have more unknowns than equations and that the determinant for the system was going to be the release of Q3 earnings (=productivity).
The Q3 earnings releases are taking place and so far, results look positive. In my view however, the reflected productivity growth is not behind the recent increase in asset prices, which brings me to the three reasons I mentioned above. Since my last letter, I think there is more clarity on them. In terms of political instability, things in the Persian Gulf seem to have quieted down a bit. Perhaps an interesting message to Iran was the visit King Abdullah paid to Syria’s President Bashar Assad on October 9th. Within the European Union, there also seems to be a shift from the concern on internal weakness to USD weakness. And along this line as well, the perceived opinion of potential weakness in emerging markets may have radically changed. So much so, that yesterday, Brazil decided to impose a tax on foreign purchases of equities and bonds (Of course, this measure was complete idiocy of the first degree!).
In terms of dispersion in monetary policy, things are also getting clearer. The world is splitting between those who prefer to import USD inflation (i.e. Canada, Brazil) and those who do not (i.e. European Union, Australia). The case of Canada is sad. Canada has undoubtedly decided to pass on a unique chance to leverage its relatively undamaged capital markets to foster dramatic productivity changes. This is already costing a lot to Canadians, but the savings confiscation mechanism is so subtle that it goes unnoticed. You see, say two hundred years ago, if a government had wanted to take purchasing power off the table, it would have sent soldiers to confiscate cattle or burn farms. That would have brought (and in many cases did bring) a revolution, with the uprising of peasants. Why? Because the damage was very noticeable. If they took your cows and chickens and burned your warehouse, you knew you had lost purchasing power. Today, things are easier. For instance, it only takes the Bank of Canada to do a few repurchase transactions every week to keep the value of the CAD low. If it is not enough, we still have Mr. Carney saying that the CAD strength more than fully offsets recent signs of growth, to chop 2 cents off its value in a session, as he did yesterday! If this was not a plain confiscation of savings (illegal, given that Parliament did not vote on it), I don’t know what it is. In any case, the point here is that there is more clarity on the issue of dispersion in monetary policy.
The last point, the clarity of exit strategies, presented us with a major change last Monday. Indeed, the New York Fed admitted on Monday that it is working with counterparties on reverse repo tests. This is a major issue and one on which a lot has already been written and rumored about. Briefly, the Fed will eventually need to take liquidity off the market. One of the tools to achieve this is the reverse repos, where the Fed exchanges Treasuries in its balance sheet for cash (that leaves the market). The problem with this is that the volume required is so huge, that the current dealer infrastructure is not enough. Thus, money market funds, for instance, would have to participate in the effort. But if money market funds were to hold these Treasuries, the crowding out effect on the commercial paper market would be significant, affecting rates. Should this be bullish on equities?
I think I would be a bit of a contrarian if I said it would. In general, policies like this one, which seek to lead the way towards sound money are positive for the market, in the long run. Was it a coincidence that on Monday, as the news on the tests by the Fed was released at 10am, the VIX index fell 6.8% a few minutes afterward? If it wasn’t, should we not be bullish again on the S&P500? In USD terms? I think I should.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
Yesterday’s action was in line with our latest comments: The world
is leaving the USD. Nothing else can be affirmed with higher certainty
than this. Everything else is pure speculation. I can think of three
levels to analyze the fall of the USD:
1. - The short term
The fall of the USD necessarily triggers relative price adjustments.
For one, it appears that it got stronger after the “cash” rate increase
announcement by the Reserve Bank of Australia (from 3.00% to 3.25%).
Thus, the first relation that has been adjusted is in the rates market.
The rates differential triggered a steepening of the US benchmark
curve, which may/should drive negative convexity hedging flows in the
mortgage-backed securities space. The other side of a lower USD is what
the market might have interpreted as an export or Main Street friendly
backdrop. Equities had to rise and did rise. Of course, it is nothing
else but the reflection of a weakening currency, a deflator. Lastly, it
was interesting to see that the CDX IG13 index was on a solid widening
trend, while the S&P500 at mid-session was struggling to keep above
1,050pts. In credit thus, shorts won the day, which brings me to my
next level…
2. – The near term
Can we see a recovery in the US driven by the depreciation of its
currency? I am sure that by now there is enough historical evidence to
suggest that depreciating one’s currency leads nowhere. However, before
we reach this conclusion, we may as well ask ourselves whether we can
actually blame the US for this depreciation. In my view, that is the
case. The Fed and/or the Treasury could have communicated a more
convincing story on this matter. Whatever assurances the market
received that the US is better off with a strong USD came from the most
unexpected characters in this play, like the president of the European
Central Bank. Silence on the part of US authorities led to confusion,
and confusion led to deception. Nevertheless, the bottom line here is
that currency depreciations never solve problems. And there are lots of
them, beginning with a high unemployment rate. Currency manipulations
in the global economies of the 21st century, where goods are made of
components manufactured in a diversity of currency areas, represent a
real and tangible distortion in relative prices. The result is the
misallocation of resources, with labor being one of them. The other
important misallocated resource is capital, regardless of whether it is
supplied in the form of debt, hybrids or equity. In the case of capital
supplied via debt, the credit market unanimously spoke up yesterday,
when it saw an opportunity to get net short in investment grade.
Interestingly enough, emerging markets sovereign risk tightened
significantly, reminding me of the sweet ‘70s, which led to the
sovereign defaults of the early ‘80s.
3. - Longer term
The fall of the USD must also be considered as a relevant milestone. It
shows a crack in what was until now a common, united international
front against the financial crisis. Right now, it is of no consequence.
However, as monetary and fiscal policies become less internationally
coordinated, the world loses a tool that is necessary to confront a
future potential increase in bankruptcies. The 2009 refinancing wave
has only shifted default risk a couple of years away. Its success will
depend on the speed and strength of the recovery that we can enjoy
until then.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
expressed by visitors to this website are theirs and do not necessarily
reflect mine. My comments provide general information only. Neither the
information nor any opinion expressed constitutes a solicitation, an
offer or an invitation to make an offer, to buy or sell any securities
or other financial instrument or any derivative related to such
securities or instruments (e.g., options, futures, warrants, and
contracts for differences). My comments are not intended to provide
personal investment advice and they do not take into account the
specific investment objectives, financial situation and the particular
needs of any specific person.
Please, click here to read this article in pdf format: www.sibileau.com
I think at this stage, a brief summary of our latest thoughts since
our last update (Sep 22) is warranted. This may read like a monologue,
but I only want to put forth the main ideas developed since then, and
what may come in the near future:
-Neutral on equities:
Since September 22nd , I have turned neutral on equities (S&P500).
So far, the market is telling me I was right. With yesterday’s bullish
action, I now would like to see the S&P500 close above 1,044pts on
three consecutive sessions, before I review my opinion. What made me
turn neutral? Unlike the bears out there who predicate on fundamentals,
I did not turn neutral based on macro data, or lower-than-expected
revenue or earnings or even increased probabilities of default. No! I
turned neutral because I believed in the weight of these three factors:
No clarity on exit strategies, dispersion in monetary policy answers
and increasing political instability (refer www.sibileau.com/martin/2009/09/23
). So far, all three factors are proving their collective merit. The
late uncertainty over the speed or timing on exit strategies has bred a
renewed debate over the future of the USD. In the last days, every
research note on rates or macroeconomics deals with the subject. At “A View from the Trenches“, we dealt with it two weeks ago! This brings me to my next point:
-Gold:
In relation to the dispersion on monetary answers, I wrote about the
weakness in the Sterling Pound and commented on Robert Mundell’s
recommendation to fix the EUR-USD exchange rate. Although an
interesting idea from a theoretical perspective, I did not consider it
feasible on political grounds. As I showed that gold had sold off on
Thursday Sep 24, right after Mundell’s comments published at 8:53am (or
was it coincidence? Feedback welcome), I concluded that since the
convertibility of the Euro was not feasible, gold represented an
opportunity (refer www.sibileau.com/martin/2009/09/29 ). Since then, the price of the ounce rose from $992 to $1,017 (+2.5%, in the last four trading sessions).
-Liquidity:
Lastly, as my view was not based on fundamentals but on liquidity, on Sep 30th (www.sibileau.com/martin/2009/09/30 )
we noted that the trend on the 3-mo Libor - OIS spread had reversed,
rising from 10+bps to 13+bps (On this particular issue, on its Oct 2nd
publication, Bank of America’s Global Rates Strategy Team wrote an
interesting comment about its implications for curve modelling).
Simultaneously, the US yield curve had become flatter. A lot about
liquidity has been published recently, with analysts keeping track of
funds flow, issuance levels, analysis on the results of quantitative
easing programs and comments trying to elucidate what central bankers
are trying to communicate without saying anything, etc.
Thus, without any major guidance, the market has started a slow
attack on the USD. The recent activity in equities and credit is
nothing else but the reflection of a vote on a weakening currency. As
such, I cannot interpret yesterday’s gain in the S&P500 as a
“rally”. In terms of gold or other currencies, the picture looks
different.
In my view, all the liquidity programs thrown at us have left us
without sound money, if you think of money as “the” medium of indirect
exchange. Central banks have denied us the right to “measure”
fundamentals. Asset prices are meaningless except on a relative value
basis, without any relation to productivity (following Wicksell’s
notion of “natural rate of interest” or even what Keynes called “the
shape of physical supply functions”, in Chapter 13 of his “General
Theory”). However, productivity rates do exist. In the meantime, we are
thus left to navigate in an undetermined world, because we have more
unknowns than equations to answer our questions. Where is the
“determinant” for this algebraic system? It is neither in gold (yet)
nor in currency crosses (they are undetermined by definition) or fiscal
policies. The determinant will come and introduce itself with the
release of Q3 earnings. Are we ready to accept it?
Please, click here to read this article in pdf format: www.sibileau.com
If the release of employment data) we had on Friday (i.e. change in
non-farm payrolls, which surprised to the downside, would have taken
place a year ago, I am sure we would have seen a rush to the exits.
Even more so, given the recent trend in the 3-mo Libor - OIS spread,
which showed another increase to 13.19bps in the early morning.
But what did a rush to the exits look like a year ago? In general,
for instance, you would have seen an INCREASE in the value of the USD,
a decrease in the value of commodities, a widening of the CDX IG index
and an increase in the value of Treasuries. What happened instead?
Stocks finished lower (S&P500 at 1025.17 pts, -0.45%), the USD lost
against the Euro and the CAD (DXY closed at 77.09 ), both oil and gold
finished higher at $69.67/bl and 1,002.32/oz respectively, the CDX IG
Series 13 tightened from 111/112 to 105/106 while the 30-yr Treasury
closed -0.9%.
How should we read this? In my view, this is unanimously speaking of
a bearish view on the USD. In other words, this speaks to more
monetization of fiscal deficits, which by the way is NOT necessarily
bearish of stocks. This view would be consistent with early Friday
morning’s statements by Eric Rosengren, President of the Federal
Reserve Bank of Boston, as well as efforts of world leaders to stress
the need for a strong USD.
It would also be very consistent with the tightening move we saw in
credit. It is true that the technical picture there is supportive,
given that issuances are expected to slow down for the remainder of the
year. But it is also true that if liquidity conditions are to remain
USD bearish, there will be enough liquidity to keep jump-to-default
risk in check, even in the face of unwinding of quantitative easing
programs by the Fed. Perhaps an early indicator challenging this
conclusion is the trend to the upside in the 3-mo Libor - OIS spread.
Since September 22nd, when “A View from the Trenches” turned neutral on
stocks (www.sibileau.com/martin/2009/09/22
), this spread has been making higher highs, clearly on the rise, and
is now 20+% higher. I know, I know, 3 bps should be no big deal, but
until September 22nd, the trend was from the upper left to the lower
right, and since then the trend has changed. And I pay a lot of
attention to this metric, as well as to changes in its trend.
In conclusion, the market seems to be only and exclusively trying to
figure out what will happen with rates. Rates, rather than currencies,
are the priority for central bankers. As long as non-negative
fundamental macroeconomic data is taken for granted under this
liquidity perspective, surprises like the employment data we saw on
Friday are going to test our nerves, as we weight them vs. our
expectations on the liquidity picture. If we are constantly changing
these expectations, our nerves may not make it!
What is the risk to this status quo? As we highlighted on Monday 21st (www.sibileau.com/martin/2009/09/21 ),
the risk consists in a sudden currency shift that might destabilize the
existing managed set of currency crosses, driving gold to the status of
a deflator for some of them (= reserve asset) in the beginning, and to
all of them in the end. I am not a gold bug. I truly believe that if
central bankers are consistent, they can inflate our way out of this
mess. By denying us a way out via currency swaps and coordinated
reserves manipulation, they may succeed in forcing us to hold their
notes. The problem thus lies in fiscal policy. Given the non-neutrality
of money expansion, if on top of the dislocations created by central
banks governments further enact legislation that hurts price
flexibility or supports higher fiscal deficits, the little successes
central bankers might obtain will be wiped out with violence and
desperation will win the day.
The comments expressed in this
website and daily letters are my own personal opinions only and do not
necessarily reflect the positions or opinions of my employer or its
affiliates. All comments are based upon my current knowledge and my own
personal experiences. You should conduct independent research to verify
the validity of any statements made in this website before basing any
decisions upon those statements. In addition, any views or opinions
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