Notes From Underground

The RBA raised interest rates last night to 4.75 percent  from 4.5 percent, throwing the predictions of economists into the trash bins of high probability outcomes. Over and over, the number crunchers miss the bigger picture that exists outside of their data machines. As we have said before, Australia is a good barometer of the global economy as it has most of the raw materials that the Asian emerging markets depend on to drive its engines of growth. As the RBA statement said:

“The global economy grew faster than trend over the year- to mid-2010. The exchange rate has risen significantly this year, reflecting the high level of commodity prices and the respective outlooks for monetary policy in Australia and the major countries. This will assist, at the margin, in containing pressure on inflation.”

Again, it is important to pay attention to the major supplier of raw materials to the global growth story. The bottom line is that the FED‘s policy is having its greatest impact outside the borders of the U.S. and as Donald Kohn openly opined in yesterday’s WSJ, the QE‘s impact on commodity prices is another story. The impact of Bernanke’s adherence to continual monetary creation is driving interest policy in other countries and the DOLLAR is the barometer as global growth potential is much greater outside Europe and America.

Now that we see that economic consensus is very often wrong, we say to BEN BERNANKE: IT IS TOO EARLY FOR MORE QE FOR YOU ARE GROPING IN THE DARK AND THE IMPACT OF ANOTHER ROUND OF QE IS IMPOSSIBLE TO MEASURE. Even the best FED analysts admit that its impact is unknown. There are things going on in the global economy that suggest it is time to let the policies that have been set in motion be allowed to work without upsetting the fragile political balance that exists in the world. The European debt problems will be made much worse as the EURO rallies and the PIIGS will have to swallow more austerity as European growth is affected by a strong currency.

Furthermore–and I cannot stress this point enough–another round of QE in the $500 billion to $1 trillion level will allow the Chinese to escape from the dollar trap in which they are caught. The Chinese have had to keep DOLLAR holdings as a massive move to sell would drive the value of those holdings much lower and then enslaves them to the U.S. By going on a large QE program, the FED would provide the Chinese with the large buyer that the People’s Bank of China would need. To top it off, the FED would be providing prices that would result in a large gain on the huge amount of paper the Chinese own as the Treasury and MBS paper is held up artificially by FED intervention. The Chinese, therefore, pay no price for the strain on the global economy that their mercantilist policies have exacted.

IF THE FED DID NOT FOLLOW THROUGH ON A QE PLAN AS PREVIOUSLY ANTICIPATED, look for the DOLLAR TO RALLY, COMMODITIES TO GET HIT HARD, AND BONDS AND EQUITIES TO SELL OFF. I WOULD LOOK TO BUY EQUITIES ON A SUBSTANTIAL SELLOFF AND ALSO BUY THE LONG END OF THE CURVE AS WE SHOULD GET A FLATTENING. THE DOLLAR WILL RALLY BUT WE WOULD LOOK TO BUY THE BETTER CURRENCIES WITH HIGHER YIELDS AS THE DOLLAR AND U.S. ECONOMY WILL STILL HAVE ENORMOUS HEADWINDS.

Get your techicals in order and be prepared for the potential that CONSENSUS is WRONG.