Notes From Underground: The Unemployment Data Was Almost as Disappointing as Europe

Friday’s unemployment report revealed that Thursday’s ADP data was, again, a “FALSE POSITIVE.” The 157,000 ADP gain failed to show in the BLS numbers and all the Wall Street economists were caught off guard as they spent Thursday night ramping up their guesstimates to be more in-line with the private sector prognosticator. The initial response by the EQUITIES was to sell off as the lack of job growth undermines the recent S&P and DOW rally. At day’s end, the equities staged a rally and the loss on the day was small, especially relative to the strength shown early in the week.

The late equity rally was even more impressive as it came while the news out of EUROPE turned even more negative. Sovereign DEBT VIGILANTES now have Italy in their cross-hairs and one of my favorite indicators, the ITALIAN 10s versus the German bunds closed at the widest differential since the advent of the EURO CURRENCY. Political problems in Italy are causing investors to question the ability of the Italian authorities to rein in the deficit. The finance minister, Tremonti, was rumored to be resigning over differences with Berlusconi but so far there is no verification of Friday’s rumors. The Italian 10-year note trades on EUREX, the only other long-term European debt instrument than the BUND, thus making it a target of hedge fund investors and any other entity looking to hedge SOVEREIGN RISK without trading in the CDS market.

The European elite can decry the effect of the “EMPTY CREDITORS,” but as European policy makers dither traders are searching out the most vulnerable of the peripheries. So now the ECB, EFSF and the IMF will have to add another vowel to PIG, thus PIIG is in play waiting to buy an “S.” Every time the European policymakers resolve a short-term issue, global traders seek the next weakest sovereign.

The EURO was sold off against all the world’s currencies, even the jobs challenged DOLLAR. The media reported that the DOLLAR was stronger on Friday, but that was another false positive as the DOLLAR INDEX is a poor indicator for the market’s sentiment for the DOLLAR. Also, GOLD‘s performance  was impressive, especially coming off the previous week’s selloff and the apparent technical damage that was done. It appears that much of the previous selloff was due to FUNDS taking profits as the dismal second quarter  performance came to an end.

 THE DISMAL UNEMPLOYMENT REPORT has to be causing the Bernanke FED concern as the U.S. economy has not been able to sustain enough growth to create jobs. Many pundits are now going to be pushing for a QE3. I will be surprised if the FED moves to begin another program of large-scale asset purchases so soon after the recent expiration of QE2. The FED‘s next move OUGHT to be to lower the interest on excess reserves. Friday’s BLOOMBERG CHART of the day on Friday, coupled with a short article by Saburo Funabiki, denotes that “Almost all the cash the FED pumped into the system under QE2 sits at the FED as extra reserves.”

If the FED is as worried about the lack of velocity in money coupled with the problems in Europe, IT IS TIME TO FORCE THOSE RESERVES OUT OF THE FED BY GOING TO A NEGATIVE RATE ON IOER (interest on excess reserves). The banks would have to find some other venue for all those excess reserves. If the FED does go NEGATIVE on IOER, the equity markets would rally, the DOLLAR would sell off, GOLD will make new highs and the most significant indicator, the 2/10 curve, ought to steepen to new highs.

Again, with unemployment growth tepid at best and the possibility for some fiscal austerity, the FED will be looking in its tool box. QE3 is not the right medicine but forcing those excess reserves out of the FED may be a more powerful monetary tool. Be alert for this discussion to begin taking place and watch for its impact across myriad assets.

The EQUITIES continue to reveal that the global markets are being supported by low interest rates and the lack of alternative investments. The fear of a LEHMANESQUE EVENT IN EUROPE WILL KEEP THE FED AND ECB IN A VERY ACCOMODATIVE STANCE. BARRING AN ABSOLUTE CALAMITY IN THE EU, LOW RATES SHOULD KEEP SUPPORTING RISK ASSETS.

*NOTE: A book I highly recommend to all people interested in political economy should read RECKLESS ENDANGERMENT by Gretchen Morgenson and Joshua Rosner.
Readers of Notes From Underground are aware of the significance of political economy. The expose on the U.S. financial crisis takes us into the heart of how economic decisions are so often the result of political power. Pour yourself a very stiff drink and let one of the best business journalists uncover the symbiotic relationship between Wall Street venality and Washington power. The fact that Obama appointed so many of these miscreants to his administration makes one wonder where the CHANGE is. As Art Cashen would say, “Marinate some ice cubes and enjoy.”

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7 Responses to “Notes From Underground: The Unemployment Data Was Almost as Disappointing as Europe”

  1. Kevin Says:

    The Fed “charging” interest on cash deposited by the banks would definitely push surplus reserves elsewhere. I do question your assumptions as to where, tho’. While a jump in risk assets and a steepening of the curve would likely be the immediate market response, for the banks to lend they need a willing borrower too. US households are deleveraging. Commercial real estate players have massive mortgage roll-overs over the next 2 years, and the Moody’s Commercial Property price index has just dropped to a 10 year low. Large corporates have been loving the low nominal bond yields and narrow spreads and have long-since dis-intermediated the banks. Hence I expect substantial buying of treasuries, and most likely down the curve for a yield pick up. i.e. peversely could end up with a flatter curve?!!

  2. USIKPA Says:

    What would lowering IOER make to M2 and the crude oil prices? Still think that is an effective tool?

  3. yra Says:

    Kevin–a brilliant post.I am playing with that in my mind and definitely validity to your point.But how far out the curve do you wish to go .And yes if the vast amount of reserves may in the short term head into longer term treasuries causing greater angst at the FED—remember that going into Jackson Hole 2010 the curve was flattening probably for the same reasons–and the fed was suffering angst so it will get interesting as to the fed response

  4. yra Says:

    USIKPA—it is an effective tool depending on what desired

  5. yra Says:

    USIKPA–if the goal is PORTFOLIO BALANCE CHANNEL –the effectiveness of the FED policy is successful–again how do you define success.Bernanke is the arbiter of outcomes –so how do you define an effective tool

  6. Greg Says:

    Yra, Kevin – Based on your comments above, do you think it is possible that dollars flow into the corporate bond market? All anecdotal evidence I have heard seems to suggest that there is a large notial value of corporate debt that needs to be rolled in 2013. Do banks hit the bid in an effort to deploy capital while diversifying away from treasuries?

    Also, how serious is the potential for a near-term Greek credit event? It seems to me the market is largely discounting this possibility but based on recent comments out of Europe, it seems that finance ministers are caught between the proverbial rock and hard place. We must have private involvement (de-facto default) but we cannot have (“official”) default!

  7. yra Says:

    Greg—the dilemma has been written in Notes for 20 months—when you deal in lies and more lies like the Eurocrats the financial markets can indeed be a cruel mistress.The corporate debt issue I don’t know about but if corporations are not refi ing their debt now they must have paulson and geithner as their CFO

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