Notes From Underground: Caught Between a Portfolio Balance Channel and a Fiscal Cliff

What has Ben Bernanke wrought? Since the FED CHAIRMAN uttered that Phrase “FISCAL CLIFF” at the now infamous April 25 press conference, the S&P has dropped more than 6% (take out month-end window dressing). Investors were unnerved by the Bernanke acknowledgement of a huge drop in GDP if the Washington politicos did not start to deal with the problem of fiscal retrenchment that awaits. It has been estimated that the hit from spending cuts and tax increases will result in at least a 3.5% hit to U.S. growth. It was Bernanke that lit the fuse and today the CBO weighed in with its great concern over the “fiscal cliff.”

The market now has the CLIFF in its mind 24/7 and coupled with Europe 48/14, it seems that deleveraging is all the rage. The Germans say nein to EUROBONDS so the pressure on the Bernanke FED grows by the hour. This market has been breast-fed on the concept of PORTFOLIO BALANCE CHANNEL and Greenspan’s beloved “wealth effect.” The FED now has its entire being on the line as Europe seems paralyzed by politics and all other financial powers await some type of leadership. Will there be an increase in the usage of the FED’S SWAP LINE to ensure that the Europeans have enough DOLLARS to meet OVERNIGHT FUNDING CONCERNS?

The world sits on a FINANCIAL CLIFF that can easily lead to a massive new round of deleveraging. The G-8 proved powerless to support the global system. Is there any global institution with the ability to craft together a plan of action? Fear of a deleveraging spiral is REAL. I HEARD IT THROUGH A GOLDVINE.

***Last night the Japanese Central Bank held at its present level of commitment and decided to hold off on further liquidity adds. The effect was to send the YEN rallying as the market had been expecting a new round of tepid QE. The BOJ is holding firm in its belief that the Japanese budget deficit needs to be trimmed and is waiting to see what PRIME MINISTER NODA can achieve in his quest to raise the sales tax.

It is no time for the Japanese to be worrying about its budget. A strong YEN in a globally challenged economic morass is no way to grow your economy. The Japanese have muddled through the last 20 years because global growth was strong enough to keep the Japanese export engine alive. It is time to awaken GODZILLA AND MOTHRA with some massive amounts of stimulus, especially with the EUR/YEN trading below 100.

***The Germans see the crisis as no problem as they are offering a zero coupon short-dated instrument. The SCHATZ is back at 4 basis points. More importantly, the SWISS 2-YEAR NOTE is trading at NEGATIVE  20 BASIS POINTS. There is no problem as long as you have a bureaucratic job in Brussels or are a German auto maker. Adding to the problems in Europe is that the Irish 2/10 curve has flattened quite a bit recently, adding to concern that some investors are dumping some of the shorter term Irish debt. Again, do the math and the world certainly in a state where 2+2=5.


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