Notes From Underground

All was right with the markets as the unemployment data was released and for one of the few times in recent memory, the Wall Street analysts, ADP and others were right on target. Private sector job growth continued to improve, and the state and local governments were continuing layoffs to try to balance its budgets. The softest part of the employment data was the average hourly earnings, which were FLAT. This implies that employers are under no stress to lift wages with the unemployment rate at 8.8 percent. The markets took the data in stride as the DOLLAR was rallying on the positive data. With the previous day’s comments from various FED presidents, there appeared some need to lift some of the SHORT DOLLAR positions. The short-end of the yield curve was under pressure, aiding the DOLLAR RALLY and the selloff in the precious METALS. The equities seemed to be basking in the perfect storm for no WAGE GAINS, a mere threat of 1 percent FED FUNDS with an improving JOBS PICTURE doesn’t get any better for the EQUITIES.

The the markets received the words of the GOLDMAN-turned NY FED PRESIDENT BILL DUDLEY. The METALS and CURRENCIES reversed as DUDLEY‘s words were deemed by the market to be Bernanke’s and thus carry more weight than those of Plosser, Fisher and Kocherlakota. The FED president’s from west of the HUDSON, with the exception of San Francisco and Chicago, appear to be far more concerned about the FED‘s CREDIBILITY than those FED members that are too close to Wall Street. It seems that the guardians of the money-centered banks and the believers in the impact of the PORTFOLIO BALANCE CHANNEL do not want to raise rates to upset the positive impact of the “WEALTH EFFECT” as reflected in DUDLEY‘s speech on Friday (hat tip: SPARTY):

“The coast is not completely clear–the healing process in the aftermath of the crisis takes time and there are several areas of vulnerability and weakness. In particular, housing activity remains unusually weak and home prices have begun to soften again in many parts of the country. State and local government finances remain under stress, and this is likely to lead to further spending cuts, tax increases, or job losses in this sector that will offset at least a part of the federal fiscal stimulus.”

This appears to be where the battle lines are being drawn between the HAWKS and DOVES. It is FED credibility that is on the front burner for HOENIG et al, while the DOVES are waiting for all variables to provide an all-clear signal. It is the FED‘s credibility that will prove most important, even though CREDIBILITY is not one of its mandates. If the FED pushes the QE game and zero-interest policy too far it will have a major problem unloading all the securities on its balance sheet. This is in fact what Pimco’s Gross and others seem to be warning about. If you measure the FED‘s credibility after the first round of QE, it seemed to be unaffected as the yield curve was FLATTENING and the DOLLAR was holding up as the EURO DEBT PROBLEM was considered a bigger issue.

Post-Jackson Hole and QE2 the DOLLAR has weakened, metals have rallied and the 2/10 curve has steepened. The EURO CURRENCY has rallied even as issues surrounding the SOVEREIGN DEBT ISSUES PLAGUING ITS BANKS and the SOLVENCY OF THE PERIPHERALS continue. THE DOLLAR also has failed to rally with all the turmoil in the MIDEAST, allowing the markets to assess that the U.S. DOLLAR HAS LOST ITS HAVEN STATUS, which must mean that the FED HAS DIMINISHED CREDIBILITY. If this proves to be the case, then BERNANKE is going to be astonished at the FED‘s inability to clear its BALANCE SHEET of long-term MBS and TREASURY SECURITIES.

The Chinese have awoken to this and have sold off some of its MBS holdings and are also not buying as many TREASURIES. I had often heard that when Paul Volcker was FED CHAIRMAN, he considered the GOLD PRICE his enemy, thus waging war against inflation. It was Mr. Volcker who restored FED credibility. Let’s hope that Chairman Bernanke does not destroy the gift that he was given. Dudley’s desire to rush to refill the PUNCHBOWL that was being drained by Kocherlakota leaves more questions than answers.

When the world’s LARGEST DEBTOR loses its credibility, all the models will fail to explain the price that will be needed to be paid. The DOLLAR STANDARD is based on the credibility of the FEDERAL RESERVE. PLEASE BEN DO NOT SURRENDER IT. Amazing how the DOLLAR reacted to just a hint of a rate rise to 1 percent. Again, if this economy cannot tolerate a return to 1 or 2 percent overnight rates, what shape are we really in anyways?

Tags: ADP, Bernanke, Bill Dudley, credibility, currencies, Dollar, dollar rally, dollar standard, doves, Equities, euro debt problem, Fed, flat, Gold, hawks, MBS, metals, PIIGS solvency, portfolio balance channel, QE, QE2, short dollar positions, sovereign debt issues, treasury securities, u.s. dollar haven status, unemployment, Volcker, wealth effect

This entry was posted on April 3, 2011 at 3:25 pm and is filed under Federal Reserve. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.