As expected, the ECB began buying Spanish and Italian bonds. The ECB actions brought about a drop in yields of 82 basis points on the Italian and 92 points on the Spanish. Today was one of the few days in recent memory when the Italian and German Bond Futures both staged significant rallies, meaning this was just not a rotation out of one and into another. The collapse in equity prices obviously caused a flight into DEBT as global investors ran to safety. GOLD, of course, was the greatest recipient of the search for safe havens. BUT THE BID FOR GOLD WAS HELPED BY THE ACTIONS OF THE ECB, FOR TODAY WAS THE FIRST DAY OF QE1 FOR EUROPE. Further proof for this was that the EURO FX failed to rally in conjunction with the ITALIAN BTP rally. Italian bonds up; EURO down as the ECB was creating short-term liquidity.
The markets are in turmoil as fear is dominating as so many unknowns are converging. The markets are approaching the pre-Jackson Hole levels of the S&P/BOND ratio, so it is important to watch if the market can find genuine value in EQUITIES versus extremely low interest rates. If the EQUITIES COLLAPSE FURTHER THEN THE ENTIRE EFFORTS OF BERNANKE’S PORTFOLIO BALANCE CHANNEL HAS PRODUCED NOTHING, ZERO, ZILCH. LET ME SAY THAT AGAIN: THE PORTFOLIO BALANCE EFFECT IS IN DANGER OF BEING TOTALLY ERODED. If there is no wealth effect, what will the FED do to generate some velocity in the economy? Now that the ECB has entered the fray, although we don’t know for how much, will the FED reload its monetary arsenal and try to lift the markets animal spirits.
Tomorrow the FOMC may give some hints as to what possibly lurks in the minds of the SHADOWS. What we must always remember is that Mr. Bernanke is a ’37er and he will err on the side of inflation versus the onerous impact of deflation. For all those who say that the FEAR OF INFLATION IS TIEING BERNANKE’S HANDS I WOULD DISAGREE. THE PORTFOLIO BALANCE CHANNEL IS BERNANKE’S BAROMETER AS LONG AS UNEMPLOYMENT REMAINS AT ELEVATED LEVELS. ALAS, woe to the world’s financial markets if continue to test the leaders of Europe and the U.S. and they fail to meet the challenge.
Something I want to toss out is an old idea from NOTES: It is time that the world’s financial institutions utilize their GOLD reserves by creating GOLD-BACKED BONDS to create liquidity based on responsibility. If the IMF issued GOLD-BACKED BONDS to raise capital for the financially stressed nations, it would create responsible lending as the issuers would not wish to surrender the GOLD HOARD. More needs to be thought out here but it is certainly a way for Western nations to monetize its GOLD. Difficult times require innovative solutions.