I have been laying low as the news is just a constant regurgitation of old themes and the media trying to create buzz in a listless global market. The China slowdown is a story for the autumn. The FED Chairmanship is an issue that will be important for the winter. And the FED‘s possible story may be of significance in the spring. But for now it is the summer and the markets are tired and waiting for real political economic winds to blow. Even the upcoming German elections have failed to excite the markets. An Aussie rate cut last night barely moved the markets as the selloff lasted less than a HFT nanosecond and the Aussie dollar spent the rest of the day rallying. A very strong U.S. TRADE REPORT failed to elicit any DOLLAR RALLY. That, plus a nod to tapering from über-dovish Chicago Fed President Charles Evans, also failed to bring a bid to the U.S. dollar.
It appears that the markets are coming to understand that it’s not the tapering that is significant but rather why the FED has suddenly become concerned about the effect of QE on the economy. It may be that the FED has realized the damage done from QE, which was cited by Jeremy Stein in his February 7 speech. I noted back in March that the Stein speech had seemed to unnerve Chairman Bernanke about the potential damage the FED had caused through its Large-Scale Asset Purchases (LSAP) by leading to a systemic mispricing of all risk instruments.
In addition to the FED‘s fear of creating systemic risk, there’s also the theory that the FED has grown concerned that its bloated balance sheet has led to a dearth of high quality collateral to be used as the lubricant for the credit markets. Lower grade collateral means that borrowers have to take a haircut on pledged assets, which results in increased borrowing costs. Too much of a “good thing” can cause unanticipated problems. If Charlie Evans is willing to forgo his desire for NUMERICAL THRESHOLDS, there is no doubt that TAPERING IS COMING. But remember, tapering is not tightening and the markets proved that they understand that by today’s trading in the currency and bond markets.
***In the German electoral polls released by the highly regarded Allensbach Institute, Chancellor Merkel continues to maintain a comfortable lead over her main opponent, SPD leader Peer Steinbruck. The newest poll shows Merkel with 40% of the vote and the SPD garnering 25.5% with Steinbruck. What’s problematic at this point is Merkel’s present coalition partner, the Free Democrats (FDP), is hovering around the necessary 5% level. It’s necessary because under German election rules, a party must attain at least 5% of the vote to qualify for seats in the Bundestag. Last time the FDP received 8%, which provided the Merkel CDU party with enough support to form a ruling coalition. If the FDP fail and Merkel does not receive an outright majority, she may then have to form a grand coalition with the SPD.
The possibility of a grand coalition will probably mean a more flexible policy on the European debt issue, but the markets have already determined that they sense a newly reelected Merkel would be much less strident on the issues of a unified banking and fiscal union–maybe even following the course of George Soros and promoting an EU-wide EUROBOND. The markets have become very complacent in this view, which was revealed at the ECB press conference last Thursday for President Draghi’s closing words to the press were, “Have An Enjoyable Vacation.” The ECB seems to be on the same path of George W. Bush: Mission Accomplished. Hubris is a word derived from the GREEKS … enough said.