Notes From Underground

Financial repression was not the ultimate weapon in central bankers’ armories. The light saber was symbolic of market-driven levels of interest rates allowing for a genuine return on capital. The Darth Vader PUT was relegated to the outer rings of the galaxy while the VOLCKER RULE provided the rule of law and prevention of over leverage. Planet Mario was under assault as its storm troopers were defeated by the battalions of the financially repressed. All banking DOVES from the Dark Side were driven off by the foresight and power of the Millennium FALCON. A mechanical droid was given the power over all financial decisions and order was restored to the financial galaxy … in a realm far, far away. The world is calm as the DROID runs off an ALGO relying on the intelligence of an unseen oracle, devoid of emotion (or Yoda). Okay, enjoy the fantasy.

***The world is powered by the designs of the central banks. QE programs are the continued tool of choice and all the world’s major economies have utilized the power of asset purchases to try and stimulate their economies. Purchasing assets on a large-scale puts downward pressure on interest rates in an effort to stimulate borrowing to help drive the engine of economic growth. Any bank that readily drives borrowing costs to zero or below is trying to remove the burden of excess debt overhanging its economy. The experiments of the last 20 years have failed to realize any conclusive results as the Japanese, U.S., British and European economies are still saddled with anemic economic results. When the Japanese were the sole practitioners of QE it was hard to measure the program’s success because the world economy was stronger. Developing economies and European and U.S. growth was enabling the Japanese to muddle through its vicious downturn.

Now, there is not enough growth in the world to support all the financial systems struggling to sustain themselves with ZERO INTEREST RATES. The initial impact of ZIRP is always the depreciation of the currency but if everybody is pursuing lowered currencies to stimulate exports the end result is global stasis. In its annual communique the G-20 maintains that they are making great strides but the ultimate outcome is that the U.S. has to carry the financial burden since it has been the only appreciating currency for the past three years (except for the Swiss Franc, which cannot carry the world with its minute economy). The FED has aided the globe by raising rates last week but the outcome for the DOLLAR has been mixed as the EURO and YEN have both appreciated as long-held profitable positions are squared before year-end.

The question for investors is whether the FED‘s rate hike was a one-and-done and that those pricing in higher U.S. rates are going to be disappointed. If the FED is very concerned about the economic drag from a strong DOLLAR then DOLLAR BULLS will be disappointed. Remember, 2016 is a presidential election and the FED may be reluctant to have an overly strong DOLLAR as a campaign issue. If the U.S. is beginning to slow in response to foreign central initiatives to weaken their currencies, the FED will suffer the criticisms of all types of elected policymakers. We have already heard from Ralph Nader in a plea for the FED to stop its policy of financial repression of savers and pensioners. The National Association of Manufacturers will be very vocal is American exports begin to falter in response to a STRONG DOLLAR.

In Europe, the political climate is very fragile as non-status quo parties are raising the heat on the Brussels Eurocrats, and, more importantly, the ECB. Up until now a strong German chancellor has been able to shield ECB President Draghi from the criticisms of the German hard-money crowd. But as Chancellor Merkel’s political status diminishes, the voices from Germany’s saving class will be loud against the financial repression its is being forced to suffer. It seems that 2016 may be the year in which the interest rate policies of the world’s central banks come under severe scrutiny from elected officials. If my opinion bares out, the global sovereign debt markets are going to be the markets to create all sorts of investment volatility.

When France can borrow at 85 basis points for 10-year debt and Italy at 1.5 percent for their 10-year note, the markets are in for an increase in volatility. There was an article in the December 23 Financial Times by Dan McCrum and Elaine Moore titled, “Bunds’ Ride Highlights dangers of Herding.” The writers point to the ridiculous low yields on German debt that investors have accepted as the ECB‘s purchases have put a premium to the “scarce” high quality German financial paper.  My point has been– and will be going forward–that it is not the mispricing of German debt that is the problem but rather the insanity of low yields on French, Italian, Spanish and others who all rely on the high credit rating of Germany. Low European yields are only viable as long as German citizens support the ECB.

As European politics become more uncertain, watch the yield differentials between Germany and its partners to determine fissures in the EU system. As Bill Gross declared the BUNDS the sale of the century back in April 2015, I still believe it is better to own the top creditor rather than the debt of those searching for a co-signer. But I am be living in a galaxy far, far away.

Tags: Angela Merkel, Bunds, ECB, Euro, Europe, Fed, Mario Draghi, QE, U.S. Dollar, Yen, ZIRP

This entry was posted on December 27, 2015 at 7:33 pm and is filed under Currency, ECB, Europe, Fed, Germany. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.