Notes From Underground: Sometimes Nothing Is A Pretty Good Hand (Cool Hand Luke)

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.


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5 Responses to “Notes From Underground: Sometimes Nothing Is A Pretty Good Hand (Cool Hand Luke)”

  1. GreenAB Says:

    “…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…”

    I agree with that. it´s not just that Merkel recognized that there´s no way around losening the grip on the rest of Europe.

    it´s also that the people over here have been coming to that conclusion too. if you hear rumors of another Greece haircut every other month (even if denied by Schäuble), then you won´t be outraged once it really happens.

    as long as the German economy is growing and unemployment stays as lows as it has been, there won´t be much of a protest. all that people care about is their personal position. Merkel can do pretty much what she wants as long as there´s no recession. and at the time of writing it looks highly unlikely with European PMIs recovering.

    another point that might not being mentioned in the US is that over the last year there have been strong rumors (although denied) that Merkel (if reelected) might opt for governing just 2 of the 4 years and then retire. so she would not have any pressure at all when it comes to difficult decisions. the same might be for Schäuble who is old and had health troubles in the past.

    bottom line is – the next coalition will be more open in assisting the rest of Europe.

  2. Michael Weiser Says:

    Hope you and Jan are well. Enjoy following Tobey’s work-the last time I saw him he was in diapers.

    Could it be that “tapering” is, simply, a tool for controlling equity price expectations? The timing of Evans’s remarks seems to rhyme with Bernanke’s introduction of tapering in May: a break point in the S&P chart. Moreover, how does an FOMC taper in September with Janet Yellen still “running” for Fed chair? (If she votes to taper, she’s out of step with the Administration and her constituency in the Senate. If she votes “no,” she’s out of step with her colleagues and exposes a dangerous fissure on the FOMC.) A December taper, in the midst of the Christmas season also seems far-fetched. Hasn’t Obama, therefore, inserted himself into FOMC deliberations (wittingly or otherwise) by confirming that Bernanke is a lame duck and setting off this contest?

    I’d love to hear your thoughts on Mel Watt’s nomination to head FHFA. Given Obama’s speech yesterday, it sure looks like some form of principal forgiveness is on the way. Won’t that be the mother of all stimulus!

    Michael Weiser

  3. Mario Says:

    Plenty of touched points above from the UNDERGROUND.
    Grab an article you can remember by searching on the front page that todays article brings about old memories and share that will your fellows. Give the others a head start. The Underground spend his TIME to share his knowledge with others for the better. Share you knowledge will all of us. Paste your favorite thoughts or ideas from previous articles that are in the near future etc. Thanks Yra for the great blog. Contact me and I can help get these out. Knowledge is power when applied with action. Thanks everyone

  4. yra Says:

    Green AB–as always a great add to the politics of Germany and Europe–rereading your posts from the previous blogs proved to have great merit–thanks

  5. yra Says:

    Mike Weiser—a great list of questions.On the Watt nomination I try to avoid the raw politics as it attracts some attention from the polar based groups that becomes a distraction.The forebearance should have been done in 2009 but Geithner was too busy protecting the large banks –the MBS should have been haircutted and others as that would have alleviated some pain for main street and I believe the TREASURY would have refied the entire system at a 15 year fix of low rates as the Government was able to borrow at such low rates—but that ship has sailed–for an indepth analysis of Geithner’s role I suggest reading Neil Barofsky and Sheila Bair.
    as for the issue of tapering,I believe it is well over blown as for its impact and the bigger question for me is the vast amount of reserves in the system if the economy is truly gaining traction.The question is what is scaring some FED members about the present condition of the QE program—as the deficit shrinks there is less “product” to buy and that really causes problems for the availability of hi-grade collateral,which results in the mispricing of credit risk across the board.But your point is well taken that some Fed members have placed themselves in a difficult position and that is what I found fascinating about Charlie Evans turn-around

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