Friday’s unemployment report solidified the TRIFECTA of LIQUIDITY for the week. ECB President Draghi seeded the “liquidity clouds” at Thursday’s press conference by announcing the installation of the OTM (outright monetary transaction), which will allow the ECB/ESM to purchase unlimited amounts of sovereign debt of up to three-year duration–of course with conditions for those asking for help. Draghi is hoping to buy the whole EU project enough time so that a FISCAL UNION CAN BE FORMED WITH THE ABILITY FOR THE EU TO ISSUE A TRUE EUROBOND.
Thursday night provided the second leg of the TRIFECTA as Premier Wen Jiabao of China announced that the Chinese would embark on a $158 billion infrastructure plan, building subways, bridges and some type of national highway system. It may have been Nixon who went to China but Hu Jintao is taking a page out of the Eisenhower development playbook by embarking on a plan to build 2,000 kilometers of roads. The global equity markets and most other asset classes had rallied after the Chinese announcement. COPPER WAS LEADING THE EARLY RALLY PRIOR TO THE UNEMPLOYMENT NUMBER as the industrial metals were substantially higher while the GOLD was actually trading $10 lower. The COPPER had been the weakest of the major metals but the Chinese data infers that demand will pick up to meet the plans for the massive infrastructure projects.
When the U.S. unemployment data was released, the GOLD and SILVER rallied hard as the markets are firmly convinced that a new round of QE will be discussed and probably approved at this week’s FOMC meeting. The addition of 96,000 jobs was especially disappointing because of the September 6 ADP release of a 201,000 gain. While the actual rate dropped to 8.1% from 8.3% this was due to a large drop in the numbers of people taken off the employment rolls. (The national rate of labor participation is at a 30 year low of 63.5%.) This participation rate is being spun by all those with a political agenda, but for NOTES FROM UNDERGROUND the only comment is the number and its meaning as to the underlying structure of the job market and how the FED will interpret it. (IF YOU READ THIS BLOG FOR PARTISANSHIP, GO ELSEWHERE.)
The market is of the opinion that the FED will move to either an extension of the zero bound rate or else actually announce some type of new liquidity. I AM NOT AS CONVINCED AS THE MARKET THAT WE WILL SEE A NEW QE BUT RATHER SOMETHING MORE CREATIVE. A NEW QE MAY THREATEN THE RENEWED FLATTENING OF THE YIELD CURVE AS WELL AS PUTTING MORE STRAIN ON THE ALREADY STRESSED REPO MARKET BY DEPRIVING THE FINANCIAL SYSTEM OF HIGH QUALITY COLLATERAL. ALL LIQUIDITY IS NOT CREATED EQUAL.
So I will offer up an alternative to a QE program, which will be more stimulative than just merely having the FED increase its balance sheet. I SUGGEST THAT THE FED SHOULD FOLLOW ST. LOUIS FED PRESIDENT JAMES BULLARD’S SUGGESTION AND LOWER THE RATE ON IOER TO ZERO WITH A THREAT TO GO NEGATIVE RATES IF NECESSARY. This would help the FED punish the arrogance of the MONEY MARKET FUNDS, while not putting flattening pressure on the YIELD CURVE. In discussing this with several people I respect, the issue that was most frequently raised is that negative IOER would unduly punish the banks.
So, THE SECOND PART I SUGGEST IS THAT THE FED ANNOUNCE A PLAN SIMILAR TO WHAT THE BANK OF ENGLAND DID IN PUTTING FORTH A FUNDING FOR LENDING SCHEME. In putting forth such a program, the Fed can reward banks for making loans to qualified individuals and small businesses currently struggling to find access to credit. The MONEY FUNDS would be punished for their intransigence on the Fed’s desire for the MONEY MARKET INDUSTRY to establish a buffer and reserve funds to prevent a LEHMANESQUE RUN. This is my plan to help get some velocity into the financial markets without undertaking another QE or TWIST program. QE in search of a PORTFOLIO BALANCE CHANNEL is no virtue, but it certainly may be a vice.
Tags: Basel 3, Bernanke, BOC, Bullard, China, Christine Lagarde, collateral, copper, Draghi, ECB, ESM, EU, Eurobond, Fed, FOMC, Gold, Hu Jintao, IMF, IOER, liquidity, Mark Carney, nonfarm payrolls, operation twist, OTM, QE, repo, silver, unemployment rate, Wen Jiabao, yield curve