The question now: When does the meltup switch into a full-fledged meltdown of the global economy? In spite of all warning signs that the Fed has ignored over the past few months, the switchover is now transmitting at such a rapid pace that it could happen in either one great shock or in a series. In my view, the 320 level on the CRB was more than enough to trigger the switch, and it corresponds with the first riots in Tunisia and then Egypt. If the Fed continues its purchases, we can calculate that each new $100 billion of Treasury purchased will add about 5 percent to the commodity index and $7 to oil. It takes four weeks for the Fed to purchase $100 billion in Treasuries. What a game of chicken being played out and right before our eyes! You can sense the collision, flying glass, blood, and bones at almost any moment. If the Fed desists or scales down its Treasury buying, the stark trillion dollar question becomes who will buy them?
Prices for industrial metals have been on an impressive run, with most posting sharp gains on bets of growing demand from emerging-market economies, but as China steps on its brakes and global inflation creeps in, metals traders may want to think twice.
Prices for aluminum and nickel have both gained in recent weeks. On the London Metal Exchange, aluminum prices rose 11% and nickel was up 31% last year.
Copper prices /quotes/comstock/21e!f1:hg\h11 (HGH11 459.20, +3.50, +0.77%) on Tuesday touched their highest level ever recorded on Comex in New York after ending 2010 with a 33% gain. Read about copper’s recent record high.
Much of those gains came as data supported the idea that consumption from emerging market economies will continue to grow at a strong pace.
The Big Battle of ‘Copper Versus Wheat’ – Myra Saefong, MarketWatch
Once upon a (not long ago) time, there was a widely established set of blueprints for regimes of monetary and exchange rate policies, one expected to fit not only the full range of economies in the global arena, but also to serve as a guide for international monetary cooperation. Confidence in the effectiveness of those blueprints has been shattered by the scale and simultaneity of asset price booms and busts that led to the current global economic crisis. A reshuffle of views on monetary and exchange rate policies may turn out to be a companion to the revision of financial regulation.
It is now increasingly accepted that, to some degree and width, mainstreaming reactions to asset price moves in monetary policy is to become a new norm. It is also becoming clear that the previous world of theoretical determinacy and optimum rules of conduct is to give place to less-obvious policy choices and more discretion.
The purpose of this note is to highlight how the special complexity and indeterminacy intrinsic to international monetary-financial relations will deepen under the new regime. In the case of financial transactions between advanced financial systems and emerging markets, there is in addition an asymmetrical impact in terms of higher foreign reserve requirements on the latter.
The determinate world of inflation targeting and exchange-rate corner solutions
“The past 10 years have been the decade of inflation targeting. (…) Narrowly defined, inflation targeting commits central banks to annual inflation goals, invariably measured by the consumer price index (CPI), and to being judged on their ability to hit those targets. Flexible inflation targeting allows central banks to aim at both output and inflation, as enshrined in the famous Taylor Rule. The orthodoxy says that central banks should essentially pay no attention to asset prices, the exchange rate, or export prices, except to the extent that they are harbingers of inflation”(Frankel. 2009).
Asset price cycles were seen as basically harmless – or non-significant as a channel of transmission of monetary policy, as in the case of developing economies without financial depth. Even when the frequent appearance of bubbles started to be acknowledged, the belief – “the Greenspan doctrine” – was that attempts to detect and prick them at an early stage would be impossible to accomplish and potentially harmful. If necessary, resorting to interest rate cuts to safeguard the economy after bubble bursts would be a safer procedure.
Low and stable inflation could then be attained through a forecast-oriented, anticipatory manipulation of basic interest rates, as the single focus for monetary authorities. Movements of floating nominal exchange rates would reinforce the effectiveness of interest rates set to target inflation. Stable inflation would also lead to low risk premiums and higher financial stability.
In the case of small countries, fixing the nominal exchange rate and abdicating of monetary policy would import stability from inflation-targeting countries. The “Great Moderation” period, with developed economies exhibiting relatively low inflation rates and output fluctuations from mid-80s onward, seemed to vindicate that confidence.
This world of presumed stable and stabilizing monetary and financial spheres was shaken by the global financial crisis. With hindsight, asset price booms and busts became acknowledged as both increasingly pervasive and harmful: real-estate and stock-market booms leading to excess US household debt and to fragile asset-liability structures; a generalized bubble burst pushing the global economy to a quasi-collapse.
Endogenous creation of liquidity and the “sea of bubbles”
Chapter 3 of the latest IMF’s “World Economic Outlook” brings evidence on the presence of real-estate and stock-market asset price busts over the past 40 years (WEO – ch.3). The recent experience with widespread busts of both house and stock prices is singular in the last 40 years (Chart 1). However, one can observe not only the frequency of previous episodes, but also that those “asset price busts are relatively evenly distributed before and after 1985 – a year that broadly marks the beginning of the ‘Great Moderation’” (p.95).
The Arrival of Asset Prices in Monetary Policy by Otaviano Canuto
In the past three weeks there have been several indications that the Federal Reserve is reconsidering the extent and perhaps necessity of its extraordinary liquidity provisions to the Treasury market. How far have the chairman and governors pulled back from their quantitative easing policy?
On June 3rd Chairman Bernanke commented in Congressional testimony that federal deficits cannot continue forever. In fact the deficits can continue, but the Fed’s $300 billion Treasury purchase plan will end unless additional funding is authorized by the Fed governors. At this past week’s FOMC meeting the board specifically did not authorize further Treasury purchases. The Fed is also letting one of its emergency liquidity programs expire and curtailing two others. None of these developments is an overt change in policy, but they are assurances that the chairman and the board view these liquidity measures as crisis expedients and not as permanent institutions of monetary and economic policy.
It is easy to forget that the Fed policy of direct support for credit markets was an emergency response to the crisis of confidence that overwhelmed the financial system last fall. Fed purchases of various securities supplied liquidity to non-functioning markets; they were not intended to be permanent. The Fed said as much at the time, though in the ensuing months market focus shifted from the programs themselves to the lack of a clear strategy for absorbing the excess money supply from the economy.
In March the market reaction to the financial crisis was at its peak. Treasury prices had been driven to historical highs by sustained panic buying of US Treasuries. Treasury interest rates and rates on 30-year fixed rate mortgages were at record lows. But even though mortgages rates were extraordinarily low the Fed judged that the reeling economy could not tolerate the surge in interest rates that would occur if Treasury prices began to fall. The governors may have suspected that the Treasury market would begin to drive prices lower and rates higher on its own as credit conditions normalized
In that context the Fed announced its $300 billion Treasury purchase in the FOMC statement of March 18th. The governors may also have been worried about the impact of the federal deficit on the bond market whose reaction was then an unknown quantity. But despite the Fed backstop the Treasury market fell relentlessly after March 18 with the 10-year rate rising more than 1.5%. More dangerously the dollar index fell 10% from March 18th to June 2nd. For the currency markets the Fed Treasury program has had one meaning, monetization of the Federal debt. Judging by the subsequent rise in Treasury rates the Fed governors may have known that the $300 million committed would be insufficient to hold the line on Treasury rates. But that relatively minor amount had a deadly effect on the dollar. The merest suspicion that monetization of US debt was possible sent the dollar into a three month swoon. The inflation that would result from a rapidly falling dollar and the effect of a collapsing dollar on the Treasury market itself could undo much of the economic and rate stabilization that the Fed was striving to achieve.
The Fed concern about the Treasury market was for the economic effect of higher interest rates on the US economy, particularly on the housing market thought by many to be at the heart of the economic collapse. But higher Treasury yields and mortgage rates have not, at least so far, choked whatever positive change in the economy has occurred since March. 30-year fixed mortgages have gained more than a point but the housing market has stabilized; new home and existing home sales in May were both in the center of the range they have exhibited since January.
The Personal Consumption Expenditures Index has revived since last December. It gained 0.9% in January, 0.4% in February, 0.3% in May, was flat in April and lost 0.3% in March. The half year prior to January had six negative months in a row. Non Farm Payrolls were substantially improved in May at -345,000, with the three month moving average (-500,000) having gained almost 200,000 since March (-691,000). Consumer sentiment numbers have moved up steadily since the beginning of the quarter. The economic situation that prompted the Fed quantitative easing has returned to more normal territory.
The Treasury market has also stabilized in the past two weeks. After reaching 4.00% the yield on the 10-year note had declined to 3.54% on the Friday close. The government Treasury auctions, a record $104 billion in the past week alone, have been subscribed at higher rates than normal. The bond markets are not demanding substantially higher rates on American debt, despite the vast continuing supply of US issuance.
The key to the extension of the Fed Treasury program is the attitude of the credit markets. It is relatively simple. If bond purchasers do not demand higher yields for US debt, then whatever the long term effect of the ballooning US debt and inflation the government will not be forced to pay higher rates. If Treasury prices are not falling the Fed will not have to support the market with further Treasury purchases and the currency markets will not be stampeded away from the dollar by monetization.
Foreign central banks have been unusually critical of the US government’s fiscal and debt policy. The Chinese were so again this week. But what matters are not the banker’s words or their musings about a world reserve currency. What matters is action. As long as the Chinese, Russians, Japanese and private investors continue to buy US Treasuries, the Fed will not have to choose between supporting the US economy and supporting the dollar.
It is a delicate balance but so far the Fed has, with the cooperation of the Treasury markets, kept the pointer right in the middle of the scale. The Fed has managed to mitigate the scare it threw into the currency markets in March with its recent statements and actions.
There are still a huge amount of Treasuries to be sold over the next three months and the economic situation is still dangerous. But the Fed view as reflected in the FOMC statement, no more quantitative easing and a slight though significant withdrawal from the credit markets may be the right and artful balance between keeping down US interest rates and avoiding a dollar panic in the currency markets
Last Call for Monetization? – Joseph Trevisani, FX Solutions
The Federal Reserve is focused “like a laser beam” on an exit strategy to ensure its extraordinary efforts to stimulate the economy do not end up fuelling inflation, Ben Bernanke said on Tuesday.
“We have a plan in place,” the Fed chairman said. “We are trying to strengthen and improve it.” He said Fed policymakers spent much of their last two-day policy meeting “thinking very heavily and extensively about exit strategy”.
Gold, anyone?
I see inflation big time….as in HYPER
The evidence is building that global growth has stalled. And it’s about to get much worse.
I think the most notable development this week was Thursday’s big release of global factory activity surveys. It wasn’t pretty. Overall, the JP Morgan Global Manufacturing PMI dropped for the third straight month and fell below the 50 level — the line of demarcation between growth or contraction in monthly factory activity — for the first time since recession was descending upon us back in early 2008. Scary stuff.
Although U.S. activity was buoyant (no doubt a remnant of the sentiment tailwinds enjoyed from the market rally in October), we cannot remain an island of tranquility as Asia and Europe fall into the abyss.
Here are the highlights (any reading under 50 indicates a drop in activity):
*Brazil PMI: 48.7 vs. 46.5 prior
*Ireland PMI: 48.5 vs. 50.1 prior
*Sweden PMI: 47.6 v. 49 estimated
*Norway PMI: 48.6 vs. 50.2 estimated
*Denmark PMI: 47.7 vs. 43.6 prior
*Poland PMI: 49.5 vs. 51.7 prior
*Spain PMI: 42.8 vs. 43.9 prior
*Swiss PMI: 44.8 vs. 46.6 estimated
*Czech PMI: 48.6 vs. 51.7 prior
*Italy PMI: 44 vs. 42.8 estimated
*France PMI: 47.3 vs. 47.6 estimated
*Germany PMI: 47.9
*Greece PMI: 40.9 vs. 40.5 prior
*South Korea PMI: 47.1 vs. 48 prior
*Taiwan PMI: 43.9 vs. 43.7 prior
And, now for the big boys:
*Eurozone PMI: 46.4 — lowest reading since recession ended in July 2009
*U.K. PMI: 47.6 vs. 47 estimated — lowest since June 2009
*China PMI: 49 vs. 49.8 estimated — lowest reading since February 2009
*China HSBC PMI: 47.7 vs. 51 prior — 32-month low
In addition to signs of economic weakness — which was enough for a Chinese vice finance minster to say the global economy faces a “worse situation” than in 2008 — there was evidence that the financial system remains under severe stress despite the freak out over Wednesday’s move by the Federal Reserve to lower dollar funding costs for foreign banks (which, as I discussed at the time, wasn’t really a game changer). The European Central Bank reported that eurozone banks borrowed nearly €9 billion in overnight emergency cash — up from €2.7 billion earlier this week. Not good.
Other signs of strain could be seen in the way German 12-month bill yields dropped below zero on Wednesday as European investors were willing to pay Berlin for the luxury of lending it money. The motivation is that, if you’re holding a big wad of euros, German short-term debt is one of the few “sure bets” left out there. It’s a sign of extreme risk aversion and fear.
Of course, the epicenter for all this is Europe.
Adding to concerns were comments this week from new ECB chief Mario Draghi that while downside risks to the economic outlook have increased, he cannot ride to Europe’s rescue by engaging in unmitigated money printing and bond buying; instead, it must adhere to its founding principles, including an inability to engage in monetary financing of government debts (exactly what the likes of Italy would love right now).
Draghi’s comments were akin to yelling “fire” in a crowded theater before announcing all the fire extinguishers are empty. Whoops.
According to the team at Capital Economics, based in London, the eurozone economy is on track to contract by 1% next year and by 2.5% in 2013, with risks to the downside for both forecasts. Recession will only deepen the budget deficits at the center of the eurozone debt crisis. The only way out is growth. And the only way the likes of Greece, Portugal, and Italy can restore growth is via massive currency depreciation and domestic inflation — something that’s not going to happen as long as they’re in the eurozone.
Sure, there will be distractions like Wednesday’s move by the Fed or additional stimulus measures out of places like China and Brazil. That’s just how the market gods like it. All the better to keep the masses confused and complacent as the fundamentals just get worse and worse.
To put it differently: When you look around the theater, everyone’s still focused on center stage blissfully unaware what’s happening around them. Turn around. The balcony level is in flames.
The Economy Is About To Get A Lot Worse – Anthony Mirhaydari, MSNBC