Notes From Underground: A Tale of Three Central Banks

The BOJ released its policy statement on Tuesday and it was as expected. The central bank sustained its yield curve control (YCC) policy as the BOJ seeks to ensure that inflation reaches its 2% target. The 8-1 vote by the Governing Committee was a bit dovish as one of the two new members, Goushi Kataoka, voted to extend the purchases further out the curve to prevent 15-year yields from rising. The bank will also have REITS and ETFS to buy if JGB supply runs short. Bottom line is that the NIKKEI made new 27-year highs and the dollar/YEN rallied as the currency gave up some of its recent gains against the U.S. and euro currencies.

On Wednesday, the Federal Reserve released its FOMC statement in which it kept rates at 1% to 1.25% range. The FED seems set on raising the fed funds rate at its December meeting but the language of the statement remained the same except that some interpreted the soft in reference to non-energy inflation as dovish. In my opinion it was much about nothing as the FOMC also reaffirmed that it is not concerned about fallout from the hurricanes that battered several large U.S. states. News about the appointment of Jay Powell as the next Fed Chair also did little to move the markets in the late afternoon. If the Powell news is genuine my suggestion is to be patient and let the markets indicate the potential impact.

The U.S. 2/10 yield curve dropped to 74 basis points, but as I have advised before, this is something that will need to close below 73.5 basis points on a weekly basis. We may get this with a very strong JOBS REPORT on Friday but if the market weighs the Powell nomination as monetarily stimulative then the 2/10 MOVE OUGHT TO REVERSE. I will wait to see for the ECB and BOJ will still be active until year-end, which will help keep the U.S. long-end BID as the German 10-year is a mere 38 basis points.

On Thursday, the Bank of England will release its monetary guidance and the consensus is for a 25 basis point INCREASE to 0.50, removing the ill-advised cut from Aug. 4, 2016 after the Brexit vote. At the August meeting, the BOE also voted to increase its balance sheet through GILT purchases by 60 billion pounds. Again, consensus is for an increase of 25 basis points with an expected 6-3 vote. There is also an expectation of the balance sheet remaining at 435 billion. The most hawkish outcome would be for a beginning of balance sheet SHRINKAGE with a rate increase but would be a LOW PROBABILITY/high impact event. In anticipation of the rate rise the British pound rose against the EURO as the EURO/GBP cross fell below the 200-day moving average for the first time in five months, although it failed to sustain that level (0.8755 on CQG cash chart).

If the consensus is met, watch to see how the POUND trades against the EURO before committing to any trade. If the BOE FAILS TO RAISE RATES it will mean that Governor Mark Carney is more concerned about the strength of the POUND with the unknown outcomes of Brexit than he is concerned about a temporary BLIP in inflation. This would be a bearish outcome for the British pound but would provide a boost to the FOOTSIE EQUITY MARKET.

***I am reposting in full the NOTES FROM UNDERGROUND post from December 27, 2016 in which I talked with Rick Santelli, but also wrote about the German asset markets.

Every step I take, every move I make, I’ll be watching the DOW hit 20,000. As I’ve said before, it is insignificant as we enter 2017, the year of political uncertainty with massive amounts of global debt. The Financial Times published an article today titled, “6.6 Trillion of Debt Issuance, Borrowing Levels Beat 2006 Mark.” The world has been taking advantage of the ultra-low borrowing rates that the ECB, BOJ, BOE and the Fed have so thoughtfully accommodated the global financial system. Corporates and sovereigns have been issuers while pension funds, insurance companies and central banks have been buyers of the poorly valued risk. If U.S. rates actually sustain a rise in yields, the headwinds from bloated balance sheets will hampered the slow-growth global economy. This will be a theme that is far more important than the slow grind of the U.S. legislative process, which will impede the Trump express. The Democrats will fight rearguard actions to prevent Trump’s plans for tax cuts and deregulation from coming to fruition.

But the balance sheet recession plaguing Europe, China and the U.S. will increase the weight of interest payments, even in a zero rate environment. The KEY to Europe will be the battle between the ECB and the interests of the Bundesbank. The ECB’s balance sheet is loaded with the sovereign debt of weak borrowing STATES, but in the realm of central bank rules it is all weighted the same. Yet someone has to guarantee the SOVEREIGN DEBT for it all to carry a similar risk weight. This is fine as long as the Germans are willing participants. But In October 2017 the German elections are front and center. So the issue of who guarantees the ECB’s balance sheet will be a key in Chancellor Merkel’s quest for a fourth term. The German policymakers will have to make a determination whether the German populace will provide the wherewithal for a perpetual TRANSFER UNION, sending its current account surplus to the poorer nations of Europe.

To illustrate and explain the situation: When the euro launched in 1999, the German D-mark was 1.66 to the U.S. dollar and its CURRENT ACCOUNT was in deficit. Today, the D-Mark has an equivalent value to the DOLLAR of 1.87 and the German current account surplus was $285 billion, or 8.5% of GDP in 2015, far greater than China’s. In a non-euro world the D-mark would be appreciating in an effort to correct the massive surplus. Since Germany is unable to appreciate the euro against its largest trading partners, it means the SURPLUS will continue to grow. It is this issue that plagues the European Union. The end-game is either for Germany to leave the EURO and REVALUE or the Bundestag will be a redistributor of German wealth by transferring its current account surplus to the less fortunate states of the EU.

This is the question for Europe in 2017. Will the rest of Europe surrender their SOVEREIGNTY in an effort to harmonize fiscal policy and create an EU-wide Treasury? And what will the Germans ask of their European brethren in return for the massive transfer of wealth? The issue of immigration is merely a spark that fires the populace support of the Alternative for Deustchland (AfD) party. The key issue will be the ECB balance sheet or what will become the bonfire of the vanities. The central bank’s rush to build up its balance sheet in an attempt to trap Germany may be the greatest vanity of the last few decades–at least.

CNBC Santelli Exchange, December 27, 2016(Click on the image to watch me and Rick Santelli discuss the ECB/Bundesbank conundrum.)

A response to a query from a very astute global-macro investor. If the scenario I put forward has merit: Where would be the best place to invest in Europe? My unequivocal answer is Germany. Real estate in Germany–if it hasn’t appreciated too much already–OUGHT to be a solid investment–for if Germany capitulates to Draghi’s design then inflation within Germany will increase. I refer back my analysis on the D-mark at today’s levels. If the EU maintains the status quo the virtual German currency is undervalued by all economic fundamentals unless the EU is deemed a perpetual transfer union. But if Germany would vacate the EU project due to political change Germany will be in far better shape than its massive indebted EU brothers.

For non-hard asset buyers the EWG, an ETF based on a pool of top German corporations becomes an important vehicle to watch for as an indication of Germany’s response to the ECB’s financial designs. Do your technical homework and find the risk levels that work for you. This year promises to be full of political and central bank intrigue. Trump’s honeymoon is not registered in Europe.

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7 Responses to “Notes From Underground: A Tale of Three Central Banks”

  1. Chris Says:

    Talking about German real estate, Yra, this will make you smile.

  2. Asherz Says:

    Yra- With the market pricing mechanism broken by central bank interventions, with the Italian 10 year yielding less than the US 10 year, with the DM undervalued making the Mercedes cheaper than the Lexus or the Town Car, how can any trader use technical indicators like the US 2/10 yield curve that were designed for free markets? How can we know what AAPL price should be when the SNB has made billions by joining the other alchemists in making our markets toys to be played with by the Jay Powells who will join the Greenspan/Bernanke/Yellin Eccles building Mt. Rushmore? When the world one day realizes that the gold bars were really lead, the effects of that discovery will result in a Taliban smashing of those Rushmore stone monuments.
    Just wondering.

    • yra harris Says:

      Asherz—and so may it be.Navigating these murky waters is never easy and as we are seeing the 2/10 today flatten as the world searches for yield in the land of European junk yielding less than U.S. ten year notes–this is the definition of a bond bubble.Market prices are devoid of underlying fundamentals as the central banks continue to prime the pump

  3. The Bigman Says:

    Hey Yra After you wrote that piece, I found and bought a German Reit (DUNDF) run out of Canada. Since end of December it is up 24% and still has 6.5% annual dividend. Proves some advice is worth more than you pay for it! Thx I’ll buy a round for all at the first annual NFU meeting.

    • yra harris Says:

      Bigman—thanks and I have to tell you I tried to buy property but it wasn’t easy–you made a far smarter play—soon we will have that NFU symposium–much to discuss.If you go to Futrues Radio with Anthony Crudele you can find a 90 minute interview with Anthony,Santelli and Harris—it was like Hyman Roth with the Correlones in Havana

  4. Arthur Says:

    The solution to one problem is merely the creation of the next.

    Sincerely, The Central Banks

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