It seems that if the Washington politicos fail to reach a resolution on preventing a fiscal crisis, the biggest loser will be the FED. The U.S. central bank is on record as pushing for continued monetary ease as long as unemployment remains unexpectedly high. The recent definition as forwarded by some Fed Governors and Presidents is around the 6.25% rate of unemployment. If the fiscal cliff is realized, projections are for the jobless rate to rise to between 9.5 and 10.0%. The question for the global financial markets will be: What is the FED‘s response going to be in an effort to counteract the renewed contraction in the U.S. economy?
The problem for the FED will be made more difficult because the realization of the “fiscal cliff” will, by definition, mean less of a U.S. budget deficit and with that less borrowing by the Treasury. The lowered amount of borrowing will result in less Treasury bonds and notes for the FED to buy as the SOMA (system open market account) is virtually devoid of most debt less than three years. The market is already anticipating that the FED will have to create new reserves in order to perpetuate some type of Operation Twist come the new year. More importantly, Chairman Bernanke will have to become more creative in finding a way for the U.S. to avoid a 1937 type fiscal contraction or else his entire QE and PORTFOLIO BALANCE CHANNEL runs the possibility of being deemed an abject failure. An academic beholden to his models will push to all extremes to preserve the model’s reputation … you have been warned. The question will be for us to try to anticipate what markets will be most affected by the FED‘s actions to attack a possible onset of a new recession.
***Tonight the RBA will announce its overnight rate and the market has assigned an 80% probability of a cut to 3% from the present rate of 3.25%. The Aussie 2-year note is yielding 2.62% so if the RBA decided to cut only 25 basis points, the short end of the curve would still be inverted. If Glenn Stevens wishes to right the Aussie curve he should cut the rate by 50 bips and stop chasing the Chinese news on its economy. There is no question that the Aussie economy has slowed so listen to the markets and let the Aussie market adjust to lower rates. The strength of the Aussie dollar also gives the RBA a little room to be more aggressive on the easing side of the economic equation. Besides, with Brazil slowing and the REAL softening, global commodity buyers are going to be heading to Brazil to avail themselves of the depreciated Brazilian currency.
***Credit Suisse informed foreign depositors it will be going to negative interest rates to stem the inflows of money into the haven Swiss banking system starting December 10. The result was a rally in the EUR/CHF cross to 1.21 from 1.2030. The importance of this announcement is that it emphasizes that the Swiss don’t want more funds as the authorities are pushing for greater deleveraging, thus the banks have to pay for money that they can’t utilize. UBS had already gone to this template but more Swiss banks are sure to follow. Going negative is a soft form of currency controls. As Credit Suisse says, “I don’t Wish your company anymore. Please go away.”
***After the negative rate release, the IMF put forth an endorsement for FOREIGN EXCHANGE CONTROLS. This is the equivalent of the Pope speaking in favor of abortion. Since its inception, the IMF credo has been for the free flow of global capital and the abolition of any barriers. The IMF policymakers gave a hat tip to Malaysia for the way that it handled the Asian crisis of 1998. (Malaysia instituted some foreign exchange controls in an effort to slow the hot money flows that helped distort its credit markets.) Brazil and others have recently enacted similar programs and now the IMF has given these programs its good housekeeping seal of approval. As the world’s financial system is resting on the zero interest rate policies of the world’s major central banks, the developing economies want to stem the inflows of hot money. IMF Managing Director Christine Lagarde called the shift on capital controls “the fund’s attempt to modernize.”
Any effort to impact the flows of global capital will send money searching for havens. The YEN and SWISS FRANC are trying to remove themselves from consideration. So what remains? I know the obvious answer is GOLD but today’s IMF announcement should have put a stronger bid to GOLD. As always it will be important to monitor the support levels to see where GOLD holds, especially versus the world’s currencies. There is definitely unwinding of the GOLD/EURO going on, which is keeping downward pressure on the metal. Besides gold, I am wondering what havens investors will gravitate toward. I know BONDS but not for me on a risk/reward basis. The financial landscape is the most difficult I have seen in many years. Let’s be patient and look for some clarity.
***The Italian 10-year notes have been the star performer in the European debt markets during the last week as investors have covered short positions and some brave hedgies have sought higher yields. The Italian 10-years have dropped to a yield of 4.43% today as the Greek government announced a planned buy back 10 billion euros worth of its debt–no surprise there. As Europe calms after the German decision to okay the next Greek tranche of funds, investors in search of yield are nibbling at better periphery credits. Spain will be the next issue. In a Bloomberg article, former ECB executive and head of the Dutch Bank Nout Wellink said the Draghi OMT plan has been effective in calming markets and he hopes that the outright monetary transactions will never be enacted. Wellink “envisages some execution problems when it comes to using this instrument in practice.” It is this fear voiced by Wellink which will keep us ever vigilant on the European debt Markets. Ok, now back to the thrilling story of Ben ‘the Lone Ranger’ Bernanke and the saga of the “fiscal cliff.” Anybody find the silver bullet?
Tags: Ben Bernanke, Brazilian real, capital controls, Credit Suisse, EUR/CHF, Fed, fiscal cliff, Glenn Stevens, Gold, IMF, Italian 10-year note, negative rate on deposits, Nout Wellink, portfolio balance channel, QE, RBA, SOMA, Swiss Franc, Yen
December 4, 2012 at 5:04 am |
[…] Biggest loser if we go over the Cliff. Ben Bernanke. […]
December 4, 2012 at 7:53 am |
Ben is one strange “Cat”, and epitomizes the world of 2+2 = 5
As Alice said, “curiouser and curiouser”: ‘Would you tell me, please, which way I ought to go from here?’ ‘That depends a good deal on where you want to get to,’ said the Cat. ‘I don’t much care where —’ said Alice. ‘Then it doesn’t matter which way you go,’ said the Cat. ‘But I don’t want to go among mad people,’ Alice remarked. ‘Oh, you can’t help that,’ said the Cat: ‘we’re all mad here. I’m mad. You’re mad.’
Perhaps Ben can short bills and buy L-T Greek Debt.
Kevin
December 4, 2012 at 7:56 am |
Professor Waspi–what you say in jest may well become reality and he better hurry before the BOJ/MOF start bidding up the market
December 4, 2012 at 9:10 am |
Yra- I’m not so sure the BOJ will actually begin a foreign bond buying frenzy. Japanese banks hold way too much government paper, some 900% of Tier one capital according to BIS. It would seem to me they are much more likely to monetize JGB. But, you are more in touch with Japanese trends than I. They not only have to depreciate the Yen, they also have to fund their debt. The second objective is much easier if the BOJ monetizes JGB while still achieving the first if the program is aggressive enough. All the while not blowing up the nations largest banks balance sheets. Win, win? Well maybe not for the nations people but, as seems the case globally these days, the government and banks win.
December 4, 2012 at 9:14 am |
BTW great post. All I could think yesterday when I saw the FT piece on the IMF dropping their opposition to capital controls was the World Economic War (WEW) is heating up!
December 4, 2012 at 9:19 am |
Dustin–thanks and a well thought out post–the Japanese situation will not be easy to resolve but there has been talk about buying foreign bonds but if the YEN continues to weaken there won’t have to be an actual buying
December 4, 2012 at 10:19 am |
Thanks for the info re IMF and CS. Financial repression is kicking into higher gear. OECD capital is going to be forced into lending to OECD nations regardless of their creditworthiness or lack thereof. Lagarde is looking out for France!
December 4, 2012 at 10:35 am |
Mark–as I have long argued–Lagarde is there for exactly the reason you point out and we have yet to really see her impact