If the FED deems the market to be healthier than conventional wisdom it will TAPER to the high-end of market expectations–$20 billion and probably in Treasuries, not MBS as of now. A supposition must be made: If the FED were to do nothing, would the stock market first rally and then break as investors fear that the FED is afraid of a weaker economy in the months ahead? The FED therefore has to TAPER so as not upset the positive spin that has helped the stock market and other assets rally. Because the FED HAS TO TAPER the emphasis will be on academia’s newest catch phrase: FORWARD GUIDANCE. This phrase has been all the rage in the ECB, Bank of England and the BOJ press conferences. Its main thrust is that the central bank can DIRECT market behavior by talking the global economy into a glide path of growth by promising the continued supply of easy money and low interest rates.
THE TAPERING WILL COME WITH FORWARD GUIDANCE IN WHICH THE UNEMPLOYMENT THRESHOLD WILL PROBABLY BE LOWERED SO AS TO ENSURE THE CONTINUATION OF NEAR ZERO INTEREST RATES. Through the use of FORWARD GUIDANCE the Fed gets the luxury of DO AS WE SAY NOT AS WE DO! If the FED were not to taper the bonds would be volatile as the idea of a softer economy would catch many of the recent bond sellers wrong footed. Patience is the keyword for the FOMC release and remember that Bernanke has a press conference a half-hour after the FOMC release at 1:00 p.m. CST.
***The battle over Europe YES/NO was in play today. In the Financial Times, German Finance Minister Wolfgang Schaeuble had an op-ed piece titled, “Ignore the Doomsayers: Europe Is Being Fixed.” It is more interesting that the FT published an op-ed piece by a sitting German finance minister four days before the key German elections. Herr Schaeuble applauds the efforts of the German-led austerians to right the European economy and maintains the present state of Europe an unmitigated success. In a barb to the eurosceptics he states: “Systems adapt, downturns bottom out, trends turn. In other words, what is broken can be repaired. Europe today is the proof.”
In a blog, my favorite European newspaper journalist Ambrose Evans-Pritchard wrote a stinging reply to the German FM: “My Grovelling Apology to Herr Schaeuble.” It boggles the mind that each gentleman is writing about the same economy. I urge you to read both as to get a full flavor the vast chasm between economic outlooks. More importantly, you should maintain a healthy skepticism about the European economy and mere correlation of equity values to other global corporations need to be well analyzed … correlation is not causation.
***In a heads up on the European financial scene, the Portuguese 2/10 curve has begun to flatten again as it is nearing the lows of 125 basis point differential made on July 15, 2013. This reflects the fact that the Portuguese government is having problems funding in the short end of the debt markets as TWO-YEAR YIELDS HAVE RISEN TO 5.57%, the highest since September 2012. In a world chasing yield but nervous in regards to the FED, the European peripheral nations may be the best barometer of market angst. If the July 15 low breaks, the ECB will be forced into some type of action and it will be post-German election.
***Lastly, in a Bloomberg article, “Merkel Says German Election Is Decision Time For Euro’s Future,” Chancellor Merkel makes it clear that the election is a reflection about the CDU‘s handling of the European economic crisis. Merkel claims that under her guidance the German’s have gotten the best deal on the resolution of the financial crisis. “We offer aid when we get something in return.” I only bring this up as a possible clue to some change in voter outcomes taking place for the most part the EU bailouts have not played in the campaign. Suddenly, Chancellor Merkel is speaking to an issue that was the bailiwick of the AfD, which has gotten nearly a word about its platform in the mainstream media. Is there a shift in the POLLS? As Mick Jagger asked, “Angie, Angie, where will it lead us from here?”