Notes From Underground

While I was away…

Friday, the unemployment report was much as expected in terms of nonfarm payrolls, wages and hours worked. The biggest surprise was that the previous two months had downside data revisions, but certainly nothing to dispel the FED‘s upcoming move to taper its large-scale asset purchase program.

Also, on Friday the Mexican Central Bank unexpectedly cut its lending rate by 25 basis points to 3.75%. The surprise was that the Mexicans had the backbone to cut in the face of rising U.S. interest rates. The Mexican peso reacted to the rate cut by RALLYING, proving the point that correlating all emerging markets is a fool’s paradise. The inflation rate in Mexico has dropped below the bank’s desired level of 4% as slowing global growth has led to weaker growth  and slowing prices. The PESO rallied has continued during the last two days even as President Nieto’s energy and budget plans have been met with a show of public demonstrations. The peso remains well below the highs it made in May but has held up in relation to the other emerging market currencies. A currency that rises in face of an unexpected cut in interest rates is something to watch. (The reverse, of course, was the Aussie dollar and its reaction to central bank cutting rates. )

Friday and Saturday brought the circus to St. Petersburg as the G-20 met amid the drama of Obama and Putin. The Russian leader displayed his bravado over the Syrian situation and left the economic agenda to the other voices of the emerging market constituency. (Also interesting that the Mexicans cut interest rates in the midst of the G-20 meeting.) The result was the usual platitudes and promised efforts to cure the world’s plethora of problems.

The effort on the economic issues seemed to be directed towards regulating the “TOO BIG TO FAIL” institutions through the synchronization of financial regulation. The demands of the G-20 were further highlighted in a Financial Times piece today by Bank of England Governor Mark Carney. Besides heading the BOE, Mr. Carney is also Chairman of the BIS’s Financial Stability Board (FSB) that is the advisor of global financial regulation to all global banks and governments. It provides a great deal of in-depth research on the issue of systemic risk and the fault lines in the global financial system. Carney noted that, “… supervisors need to make good the pledge by G-20 leaders to agree the rest of Basel III, including the leverage ratio, and to tackle large differences in risk weights across banks.” Chairman Carney also noted: “In addition, we are committed to ending too big to fail. We have publicly identified globally systemic banks and insurers,and will subject them to higher capital requirements,more intensive supervision and credible resolution regimes.”

This is not new ground for Governor Mark Carney. In 2009 at Jackson Hole, he delivered a speech, “Some Considerations on using Monetary Policy to Stabilize Economic Activity.” The theme of the speech was that central banks have a duty to maintain FINANCIAL STABILITY (emphasis mine). There are many key passages in Carney’s speech but one that highlights his efforts and scares Wall Street: “In general, policy makers would rely on enhanced macroprudential regulatory frameworks to curb the enthusiasm in the financial system. While policy interest rate would not be the primary tool for promoting financial stability, it occasionally might be used to support macroprudential tools.”

The battle being fought over the FED chairmanship is a war over Wall Street’s control of the financial system versus what may be in Main Street’s best interests. For Wall Street, Larry Summers is a known entity and deemed a sympathetic ear. The lines are drawn and it will be President Obama who decides which Street to serve, but make no mistake about the significance of the outcome. It is interesting to see how the FED itself sees the significance of the conflict. Jeremy Stein and Daniel Tarullo, please phone NOTES FROM UNDERGROUND!

***The Australian election went as expected as the labour government was unseated and the conservatives and its coalition partners are now in power. Prime Minister Abbott presented a friendly face to the business community and campaigned on rolling back myriad regulations and environmental-based taxes imposed by the previous government. The Aussie dollar has rallied as some of the extremely profitable short positions were covered. Better news from China–whatever that means–also provided discomfort for Aussie dollar shorts.

***German election news has been on the steady side except for one story about Merkel’s coalition partner, FDP, polling below the 5% threshold. It is too early to make this important for if the Christian Democrats maintain their overall strength, some CDU voters could move to vote for the FDP to ensure they receive the needed 5%. The anti-euro AdF party is still remaining at 4% so nothing has changed with 13 days to go.

European news has been quiet with the Syrian situation garnering most of the headlines. Bloomberg has an article, “Hollande Girds for Higher French Borrowing Costs.” Ten-year French yields have risen to 2.63%, the highest since President Hollande cam to power in May 2012. There is no real concern though as the French Oat (10-year) has remained well anchored versus the German 10-year bund. When Hollande was elected the German/French 10-year note differential was 143 basis points while today it trades at 60 basis point spread. For perspective the narrowest spread was 44 basis points and the widest was 204 basis points in November of 2011. So presently, ALL QUIET ON THE WESTERN FRONT.

***In a classic depiction of why 2+2=5, yesterday the FT’s front page was about the huge flow of U.S. investment money into the European equity markets. The newspapers and airwaves are full of stories decrying how undervalued Europe is compared to the U.S. equity markets–another case of correlation versus causation. Europe is cheap and America is fully priced–the pundits desire Europe. Interesting, as it’s the same pundits warning about the emerging markets being due for further stress. It seems that if the emerging markets are potential financial problems then Europe will also struggle for 30% of Europe’s exports are to emerging markets. Also, buried on page 20 of today’s FT was a capital markets story, “S&P Raises Prospect of More Defaults In Weakened Europe.” Defaults in various sectors of the economy rose from 2.5 billion euros in the first quarter to 8.7 billion euros in the second quarter. S&P noted that the “retail sector was struggling against rising unemployment, declining real disposable incomes and depressed consumer expenditure-notably in the peripheral countries of Europe.” While I have little regard for the work of S&P, I will wait until some real positive results appear. Struggling economies, high sovereign debt and interest rates and embarking on continued plans of austerity budgets … not for me.