Notes From Underground

In this famous science fiction phrase from the movie “The Day the Earth Stood Still,” I extract my own meaning: Stop the printing before the world’s financial system is destroyed. Sci-fi writer Edmund North never deciphered the English translation of this “alien” phrase but I believe my interpretation applies to these tumultuous times in central banking. The ROBOT GORT is prevented from destroying the world when the words are spoken to him. Thus I say to Mario Draghi: “Mario Barada Nikto.” The continued use of large-scale asset purchases to enhance global liquidity in a period of increased economic growth is preventing the markets from stabilizing. The proof is in the continued mispricing of corporate debt. Last week, the BBB-rated French firm Veolia sold 500 million euros of three-year notes for -0.026%. Yes, a mediocre credit was able to borrow at less than zero. This is the insanity of the financial world to which the central banks continue to provide liquidity.

Corporations are able to borrow for stock buybacks and increased dividends but creditors are accumulating assets based on risk premiums established by central banks’ QE programs and are causing massive distortions in the credit markets. Central bank policies initially prevented a liquidation of global assets and a world depression, but its robotic response to keep the presses rolling is causing a dangerous crushing of risk premiums. Also, the financial repression has resulted in even-greater wealth inequality as the world’s wealthy are much better situated to ride the tsunami of wave of central bank QE programs. The distortions caused by financial repression are being felt in the rise of fringe political parties appealing to the very visible outcomes of asset inflation caused by the endless infusions of liquidity. It seems Mario Barada Nikto is necessary for the Salvator Mundi.

As the weekend closes it seems that Chancellor Merkel has been unable to form a coalition government with disagreements over immigration policy as the major sticking point. The Green Party wants assurances that German immigrants will be allowed to reunite with family members while also keeping immigration numbers higher than those put forward by Merkel’s sister party, the CSU. It seems that Chancellor Merkel may have to find support from her previous grand coalition partner, the SPD — which is doubtful — govern with a minority coalition, or create a new snap election. Many establishment politicians are fearful of a new election for they fear that the AfD (fringe right) will acquire more seats as Angela Merkel is seen as weak. The FDP party has been quiet as it waits to see how the process proceeds. The FDP seems content to be happy to bargain for the finance ministry post under the guidance of party leader, Christian Lindner.

Tonight the rumors are flying about the coalition talks having broken down and that Merkel is going to try and woo the Social Democrats into a new grand coalition. The EURO is under pressure in response to the rumors. Regardless, Angela Merkel is diminished in the eyes of Europe but this does not raise the stature of French President Emmanuel Macron. Much has been made of Chancellor Merkel being an indomitable negotiator. (This has been true in her recent dealings with European leaders as Germany controls the purse strings.) The European nations have bent to German demands because of the fear of financial repercussions. But it is a different situation when negotiations are with the major creditors of the entire European project. Mario Draghi’s continued use of negative interest rates has financially repressed German savers and the end result is political resistance. The fact that the rise of political unease in the most vibrant European economy should be a warning signal to all investors. The DAX gave us an early warning signal but a constructive resolution to Merkel’s dilemma should provide relief.

***Friday resulted a break in market complacency. The precious metals broke out of its recent ranges for lack of any of ostensible reason. Gold had the early strength and silver was a later-day participant. Both precious metals closed above recent resistance and the silver finally closed above its 200-day moving average. Will it persist? I advise patience but it is certainly something to watch. The metals advanced came on a day when the economic data was positive, following an entire week of fairly strong economic news, couple with the House passage of a tax bill. Yet, the BONDS also put in a strong week, especially the long-end as the 2/10 and 5/30 curves continued to flatten. Even the U.S. dollar struggled to rally on good economic news causing sizable losses for established bullish dollar positions. There is divergence taking place as long-established correlations are breaking down.

The rise in the U.S. two-year yield to 1.72% has not been able to support the dollar or pressure the GOLD so I advise paying close attention to the GOLD/CURRENCY crosses, which may suggest global investors are tiring of the persistent interventions by the world’s central banks. Friday may have been a one-off session, but the power of the sustained rally needs to be respected, especially following the November 15 selloff when it was rumored that a 40,000 contract order broke the gold market $12.00 in a short time span. (There was evidently a large buyer that prevailed by Friday’s close.) This is just a table setting as we head into a holiday-shortened week.

Tags: Angela Merkel, ECB, Euro, German Coalition, Gold, Mario Draghi, QE

This entry was posted on November 19, 2017 at 7:20 pm and is filed under Currency, ECB, 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.