Notes From Underground: A Short Hiatus Before Year-End Volatility Rises

For the next few days I will be resting, hoping to enjoy some peace before the potential storms that face the financial markets at the end of 2014. Now that the Japanese election has been decided there is certain to be great volatility in all Japanese investments as polls get released and money becomes nervous. It seems that Prime Minister Abe is trying to solidify his hold on the LDP by going directly to the people. In an effort to gain the voters support Abe has decided to delay the scheduled sales tax increase and also announced a corporate tax cut. The game for Abe is to get public support to overcome the fiscal hawks that the prime minister believes are stalling the economy and preventing the completion of Abenomics and the “three arrow agenda.” The stalwarts of the LDP will be defeated by an overwhelming ABE victory.

The Swiss referendum on the GOLD ISSUE will be decided on November 30 as the potential policy that is rankling the Swiss establishment will finally be determined. The outcome of this election can rattle global markets not because of its potential effects on GOLD but because it may force the SNB to cancel its policy of maintaining a floor on the EUR/CHF cross. If the SNB BLOWS THE PEG THE OUTCOME CAN HAVE SEVERE RAMIFICATIONS FOR GLOBAL DEBT MARKETS. IF THE SNB TAKES THE ALTERNATIVE PATH IT MAY MEAN A MORE AGGRESSIVE SWISS BANK AND LEAD TO MASSIVE LIQUIDITY ADDS AND NEGATIVE INTEREST RATES. The world’s central banks will be watching what direction the Swiss choose and remember that the ECB follows the Swiss referendum with a scheduled meeting the first week of December.

The ECB and Mario Draghi to taunt markets with the threat of a genuine QE program despite the concerns of the Bundesbank and other German constituencies. The French and Italians are pressing Brussels for a significant spending program on a vast array of European infrastructure projects. It seems that the pressure on Angela Merkel by her G-20 colleagues will create some type of fiscal response as the two rally in the German Dax has led the U.S. equities, which is certainly a change from the previous few months. The DAX is approaching the 200-day moving average, which ought to provide resistance but may be easily violated if there is some real fiscal and new monetary stimulus in the offing. The European bond markets have been very calm while the equities have rallied which may be further indication of Chancellor Merkel willing to get behind a European stimulus effort.

Yesterday, a Telegraph article, “ECB Could Buy Gold to Revive Economy,” quoted ECB Board Member Yves Mersch from a speech delivered in German that the ECB could theoretically “…buy assets including gold and shares.” The Luxembourgian Mr. Mersch, typically a pro-German type monetary conservative, promoted the ECB‘s ability to buy all types of asset classes and noted that even buying foreign currencies “… increases the credit risk of the buyer.” It seems that Mersch is laying out a plan that results in buying a vast array of assets to circumvent the German concern of buying sovereign debt to directly bail out European governments. This is the basis of Draghi’s plan to buy private sector ABS and covered bonds.

***The Financial Times had an op-ed piece from Professor Barry Eichengreen, an economic historian of great stature. In thinking about what the future looks like for Europe, he noted, “A Dance Over the European Debt Burden Will Not Last Forever.” The present policy for Europe is for the peripheral, heavily indebted EU countries to manage primary surpluses in order to decrease the amount of public sector debt to a Maastricht Treaty level of 60 percent. Professor Eichengreen maintains that it will take these countries 15 years to succeed and that is with assuming steady interest rates and surpluses of almost 5 percent.

The important point for a Political Economist is this: “No country can run huge budget surpluses for such extended periods without inciting taxpayer revolt.” Professor Eichengreen puts forth another alternative as it will be difficult to grow their way out of the debt in times of austerity. The alternative he poses is debt restructuring. The markets are certainly not contemplating the writing down of any European debt with sovereign bond yields at record lows. Also, because the European domestic banks are owners of massive amounts of sovereign debt, a major restructuring will result in a major credit crisis. This is not something to position for today but to be aware of a European politics collides with economic realities.

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6 Responses to “Notes From Underground: A Short Hiatus Before Year-End Volatility Rises”

  1. arthur Says:

    About Japan: what is going on with the economy that a consumption tax increase throws it back into recession?

  2. Yra Says:

    Arthur–may a fear of a repeat of mid 90’s when the MOF saw a rise in the consumption tax and it stalled out a japanese recovery.Also,the increase tax in a time of no wage growth leaves the Japanese middle class struggling to keep up which is what the third arrow was supposed to resolve–structure reform of the economy to result in higher wages—stagnant wages were tolerable in the era of deflation but stagnant wages in the time of inflation puts pressure on consumer demand—Janet Yellen has the same concerns.

  3. arthur Says:

    Yeah, I understand it. I mean, the Japanese economic problems go beyond an increase in the consumption tax. The real problem is Japan is … “domestic politics”? 19 prime ministers in 23 years, wow.

  4. Chicken Says:

    Hail the inflationary goddesses, for the peasants have squandered away their wealth. 🙂

  5. rjlafferty Says:

    Yra, is it possible for euribor to imply a negative rate (price >100)?

  6. Yra Says:

    rjlafferty–good question— i would assume yes but do not know for absolute

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