Today’s headline in the Financial Times, “U.S. LACKS CREDIBILITY ON DEBT-SAY IMF.” I rarely agree with the IMF but on this issue as the readers of NOTES are aware, I can find common ground with the economists at the world’s commentator on global economics. It is easy to say the U.S. lacks credibility when the world is observing the budgetary circus that has visited Washington, D.C. for the past two weeks. The CREDIBILITY issue is not solely with the president and the legislature but also with the FEDERAL RESERVE. If the FED errs in its aggressive monetary easing it will be a horrendous blow to the U.S. and the global financial system. The FED has so much at stake because it has more than $2 trillion of DEBT INSTRUMENTS on its balance sheet and if the U.S. is deemed to be an unworthy borrower just what will the value of those assets be on the market.
St.Louis Fed President James Bullard spoke in Germany today and noted that “when the Fed begins withdrawing record monetary stimulus it should sell assets and ensure that inflation remains low.” It seems that Mr. Bullard wants the Fed to begin offloading the assets it has acquired while making sure that the value of that paper is sustained. Bullard is well aware that the Fed is a HOSTAGE to the budgetary games that will be played out and wants to minimize the FED‘s exposure. It seems that the Fed has not come to any type of real EXIT STRATEGY but is merely in testing mode of various theories. Going forward, the biggest issue will be the PRIMARY BUDGET, which is all revenues and expenses before the payment cost of INTEREST ON THE DEBT.
President Obama alluded to it today in his speech as he warned Congress that if the Budget is not reined in then the cost of borrowing will explode and the interest expense will prevent the protected favored programs and entitlements from being funded. Obama rightly warned that the MARKETS will eventually exact its toll upon further budgetary malfeasance. Whether the FED wants to admit it or not it is now the prisoner of the U.S. BUDGET process. If the markets send the cost of U.S. BORROWING HIGHER, WHAT POSSIBLY COULD THE FED DO? COULD THE FED RAISE THE OVERNIGHT RATE TO ALARM CONGRESS, WITH UNEMPLOYMENT RATE ABOVE 8 PERCENT? There is no time for games as the GATES ARE CLOSING. The test of this will come when the FED ends QE2 and the market has no artificial support. This is not a doom and gloom view. This is the reality of the world.
The markets have already sent part of the message as fears of FED and Congressional ineptness has sent GOLD, SILVER and other HARD ASSETS much higher in price. The equity markets have also rallied as they have also been deemed a haven of value. Again, as Rogoff and Reinhart and many others have warned, time is running out as the cost of profligacy is increasing. Remember, the current U.S. Budget is more than 10 percent of GDP and that is with the INTEREST RATES on the DEBT at historic lows. This doesn’t mean that we can sell BONDS tomorrow and expect immediate rewards for this will take a while to play out. I advise listening closely as the term PRIMARY BUDGET BALANCE becomes the lexicon of the day. Here’s hoping that the policy makers in Washington become serious and make the view that has been laid out here: TRANSITORY.
The economic news today was of no great surprise as RETAIL SALES data showed that the consumer was spending even with the bite of higher fuel prices. The numbers were as expected but the interest rates found reason to rally anyway. Some of this weeks NOTES AND BOND strength is coming off the selloff in commodities. Goldman Sachs has announced twice this week that is was unwinding some profitable long-held positions in various different energy and metals positions. The drop in oil and copper no doubt put a bid to the BONDS but it will be of great interest to see if this rally can hold with the U.S. budget moving to the main stage.
The DEBT market has rallied even with a sizable amount of NEW DEBT auctioned off the past few days so it renders the view on the impact of the BUDGET wrong … for the MOMENT. The DOLLAR, though, has not gained any strength and that makes all of the unwinding of commodities very suspect. Past correlations are beginning to break down and for the markets that is a good thing as new relationships will provide opportunities. Be patient and let the market begin reveal what is at hand. If the pianos are going to fall let others try to catch them.
Tags: bonds, credibility, Debt, debt instruments, Dollar, exit strategy, Federal Reserve, GDP, Gold, hostage, IMF, interest on debt, interest rates, James Bullard, markets, oil, primary budget, QE2, retail sales, silver, U.S. budget