Last week was an appropriate tribute to a song from the 1960s in which the news is looked upon as just so much blather about drivel and evil events. The fears of EBOLA, SECULAR STAGNATION, ISIL, COLLAPSING ENERGY PRICES and EUROPEAN ECONOMIC COLLAPSE converged to create volatility and fear in all asset classes. The nervousness about global equity markets collapsing caused the bond yields to dramatically decline, which led to a capitulation by BOND MARKET SHORTS. In my opinion the volatility in the bond markets was also the results of decreased market making abilities of money center banks due to increased capital regulations. (This is not a commentary on the increased regulations but just an observation about market impacts). Also, many market actors have been selling volatility in an effort to increase returns and got burned for their efforts.
The short volatility crowd also got caught in the currency and equity markets as three months of calm created a false complacency that gave rise to a Minsky Moment. European banking and financial news will continue to create instability as the results of the ECB‘s long-awaited Asset Quality Review (AQR) are released in 10 days. Rumors are leaking into the market that many banks will fail the ECB tests and be required to raise new capital. As I have previously written, the worse the AQR results the easier it will be for Mario Draghi to push forward an aggressive, Fed-like QE program. This is something we will monitor over the next week where the most important barometer will be the European sovereign bond spreads.
****James Bullard called into question integrity of the Federal Reserve. First, the St. Louis Fed president revealed that the Fed’s policy is asymmetric at its base level. Thursday’s rally in the SPOOs was attributed to comments by Bullard about the Fed putting off the end of its bond buying program. Really? The financial news was previously filled with comments by President Bullard requiring the FOMC to possibly raise rates faster than the dots had anticipated. It seems that the dramatic fall in the SPOOS and global equities scared the Fed and maybe it was time to recalibrate the need to end QE. Really, Jim, is the equity market the most important data point?
It calls into question just how the FED sets its policy for there can be NO RELEVANT POLICY that can be subject to “GOOD NEWS WEEK.” Policy planning has to be far more forward-driven than the mere 10 days of equity moves. If a “respected” member of the Federal Reserve can be so capricious in his views how can the U.S. dollar holders have confidence in the U.S. central bank? The asymmetry of Fed policy arises because why was the FED so reluctant to remove its stimulus when the equity markets were setting continuous new highs for the last 12 months? Being from St.Louis, President Bullard navigates monetary policy like a Mississippi Steamboat Captain: More logs on the fire regardless the current.
In Monday’s Financial Times, Gavyn Davies has an op-ed piece titled, “What Is Global Market Turbulence Telling Us?” Mr. Davies goes through a litany of possible reasons to answer his self-proposed question, but raises doubts to his own analysis. He concludes with a proposition that NOTES has put forward before:
“Finally, the markets may be starting to doubt whether the central banks actually have the weapons needed to stop deflationary forces in their tracks. Robin Harding reminds us that Ben Bernanke once said, wisely, that quantitative easing ‘works in practice but not theory.’ The implication is that it only works because it shifts inflation and other economic expectations in the desired direction.If markets start to doubt this,they have entered much more dangerous waters. But the relief rally on Friday,triggered by the merest hints that central banks may consider further asset purchases, suggests that we are not there yet.”
The BOND markets have not hinted that investors are leery of the central banks as yet but pay close attention to the European sovereign bond market and the GOLD/CURRENCY spreads. It may only be Bullard of the St.Louis Fed but it is close to Kansas, the Wizard of Oz and the Yellow Brick Road. Oh well, let’s hope for better news this week.