Notes From Underground

Not a word was spoke between us,there was little risk involved
Everything up to that point ,had been left unresolved
Try imagining a place where it’s always safe and warm
Come in, she said, I’ll give you shelter from the storm

When Bob Dylan released this song 42 years ago it was on the album Blood on the Tracks. When the FED embarked on its QE1, QE2 and QE3 it was to respond to the blood coursing through the streets of the U.S. financial system. The U.S. banking system was threatened with insolvency and the FED‘s monetary injections sheltered the banking system from a storm of forced systemic liquidation of assets. QE1 coupled with a questionable TARP program did prevent a systemic liquidation but QE2 and QE3 I always believed were superfluous but in the land of counterfactuals it is an impossible point to prove.

But the program’s success will now be determined by the FED‘s ability to EXIT from the emergency liquidity injections. There was little risk involved as the FED balance sheet expanded at $85 billion a month. But as the FED has proclaimed, it is set on reducing the balance sheet as it worries about a labor shortage-induced bout of inflation. As Chair Yellen stated in the previous FOMC statement, quantitative tightening would begin “relatively soon.” It is time to let financial markets leave the safe and warm embrace of the FED‘s printing press. There are too many unresolved issues:

1. Is the U.S. economy as strong as the unemployment data shows, or is it totally dependent on the comfort of knowing the global system is flush with liquidity?
2. What is the desired outcome of what the Swiss National Bank’s (SNB) policy of weakening the Swiss franc? The Swiss currency has depreciated 6% against the EURO this year and yet the SNB intervened with another 20 billion Swiss franc asset purchase in July. Does the SNB have an exit strategy? The Swiss should be the paradigm of how to exit but its success does not indicate it’s draining any of the enormous amount of Swiss francs added to the system in the last 30 months. As I discussed with Peter Boockvar today in an FRA Roundtable (to be released soon), if the Swiss wait to long to shrink the pool of francs the end result will be a rapid appreciation of the currency, which is in contravention of what the SNB is attempting to accomplish. Is there no exit for the SNB?
3. How does the Bank of Japan exit from its QQE policy — quantitative, qualitative easing — in which it has bought equities as well as Japanese bonds in an effort to meets its 2% inflation target? The Japanese BOND MARKET is the world’s second largest and yet there are days when you have to trade by appointment. The Japanese bond market is severely broken and recent discussions in the media reveal that there is no preconceived plan for exiting from this massive monetary experiment. Last year, BOJ Governor Kuroda embarked on an auxiliary program of monetary stimulus, YIELD CURVE CONTROL (YCC) and it has been an object failure in its efforts to steepen the Japanese 2/10 curve (Wednesday it closed at 17 basis points). The BOJ keeps on adding liquidity but to what end? The QQE program has resulted in a massively dysfunctional bond market without any end in sight; and
4. The ECB has built a massive balance sheet but I believe it is for a far different purpose than just priming the stimulus pump. In a Financial Times article last week that examined the five-year anniversary of Draghi’s famous “Whatever It Takes and No Taboos” speech the reporter quotes from Draghi: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” The result is that the ECB does have a DUAL MANDATE: 2% inflation and the PRESERVATION of the EURO. If the preservation mandate is to be fulfilled then a EUROBOND will have to be created and that is why President Draghi will proceed to enlarge the ECB balance sheet and synthetically create the means for folding all the individual nations bonds into a single financial instrument. The only exit for the ECB will be Jerome Powell’s printing press. It seems that NO EXIT is required for all efforts at QT result in an existential question for all the world’s key central banks.

***Quick note on today’s trade: I always caution about buying GOLD during times of political uncertainty and war. Gold did hold its rally all day even as the U.S. equity markets rallied back from an early selloff in response to President Trump’s incendiary tweets directed at North Korea. I traded the gold versus the Swiss franc as both deemed to be are havens in time of uncertainty. But GOLD rallied to new highs even as the S&Ps recovered. I am putting this on the radar screen as it may be the GOLD that provides some shelter from the market sensing the inability of central banks to plan an exit from QE programs. GOLD closed today at the November 9 levels, which was Trump’s victory day when the GOLD failed to hold an early rally and closed $60 off its intra-day highs.

As far as the North Korean situation is concerned, it is tense but as an Asian expert informed me months ago, the key to any military action will be when the U.S. begins evacuating some of the 100,000+ U.S. citizens residing in Seoul, South Korea. As I wrote previously: The U.S. cannot just send in cruise missiles for the response from the North Koreans will be to rain missiles and artillery down upon Seoul resulting in hundreds of thousands of casualties. This is North Korea’s Trump card (pun intended). The U.S. would have to destroy North Korea’s retaliatory capacity and that would require tactical nukes. (Hopefully a path not followed.)

Does bombastic buffoonery not take a vacation? Anyway, pay attention to the GOLD as it approaches $1292, the high it made November 10 as a rally attempt failed. But I caution about buying GOLD as a hedge against the outbreak of conflict. A trade? Maybe, but of short duration. A hedge against the success of central bank policy outcomes? Absolutely.

Tags: ECB, Euro, Fed, Gold, Janet Yellen, Japan, Kuroda, Mario Draghi, North Korea, QQE, SNB, Swiss Franc

This entry was posted on August 9, 2017 at 7:32 pm and is filed under BoJ, Currency, ECB, Fed, Gold, SNB. 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.