Notes From Underground

Today we received the first look at fourth-quarter GDP in the U.S. The initial report stated growth registered 5.7% in the last reporting period of the year. The consensus was 4.7% so the result was demonstrably better with inflation well-contained. As the Wendy’s ad may have asked: Where are the jobs?

If job growth doesn’t begin soon these growth numbers will be inconsequential as we enter the 2010 political season. If the equity markets can’t generate a strong rally off of this data, we will be assured that the market has been fully priced to positive growth and other variables are most certainly in play. Our readers are aware that we believe that there are always other elements in play, which is way markets are dynamic in nature. Our job is to sift through the mess and see if  we can find some nuggets to profitably trade.

Again, our eyes turn to Europe as the noise coming from the policy markers becomes more confusing and is causing great volatility. We have heard so many experts tell us about what can take place under EU rules, but the more they talk the less they seem to know. Investors and traders should be careful as so much of what is put out in the media is just subjective opinion and not grounded in reason. The outcome of the Greek situation will be that Germany will provide the funds while it extracts a terrific political profit.

We watch to see if Axel Weber is named the next ECB head for that would be a significant event and would signal that Germany is in fact in a bargaining mood. The contagion of the Greek situation is causing stress in the PIIGS as rates continued to move higher all week (although they have narrowed a bit today). The problem for Europe is that a NEGATIVE FEEDBACK LOOP is developing. Why? As the spread differential between German debt and the peripheries widens, it means that the competitive positions of the PIIGS relative to the European growth engines continues to deteriorate. That is why the vicious cycle has to be stopped. The more Greece has to spend to finance its debt, the greater stress on its budget. The same applies to Spain and Portugal.

Yesterday we noted that the Chinese created more stress in the European debt markets by announcing they had no interest in the Greek government paper. Yu Yongding, a member of CASS, the highly regarded Chinese think tank, said,

“It is unreasonable for an economist to support a diversification away from an unsafe asset class to a much more unsafe asset class.”

The Chinese consider the Greek debt unsafe because they don’t trust the data coming from Greek officials. Is that the WOK calling the rotating spit black? Creating even more uncertainty for the Europeans, the British finance chief, Alistair Darling, mudded the debt situation even more. Darling inanely pointed out that the Greek situation was a problem for those in the European currency and not a problem for those not in the currency. This idiotic statement by the Exchequer will certainly come back to haunt the Brits.

Interestingly, the EURO/Pound cross should have been sold off as the Brits absolved themselves of responsibility. But that in fact is not what happened. The EUR/GBP cross instead rallied–and yes we are aware that the cross has been sold hard of late and the technicals appear terrible–but we did notice this price action. If Britain will not move to aid the UNION in crisis, why do they even pretend they wish to be a full political member. One day the Europeans will force the Brits to call the question on where they truly stand on the UNION. The Brits will not be able to have the best of both worlds: free market access while being able to float their currency as needed.

When it comes to Europe and the mess it is in, we wish to offer a quote we learned from our friend Bernard Connolly. It tells us a great deal about the European political entity and it comes from a 19th and early 20th century Italian Prime Minister, Giovani Giolitti: “The Law is something we apply to our enemies. For our friends we interpret it.”