Patience is a Virtue
Age of Wisdom, Age of Foolishness (59)
A mixture of cognitive dissonance and wishful thinking, with a little help from global policy makers, rattled the markets pre-FOMC announcement last week. Post-FOMC the panic stopped, just as it should have been increasing.
The first disconnect came when the FX market decided that Abe’s landslide win was in some way depriving him of the opportunity to drive Dollar-Yen to 200 with gay abandon[i]. Clearly the “Plunge Protection Team” didn’t want a plunge in the Yen before the FOMC announcement. The ensuing rally in the Yen therefore framed the speculators’ perspective on all subsequent events, between the election result and the FOMC announcement. This gave plenty of scope for the doomsayers to control the rhetoric which rationalised the price action.
“Time to Kowtow.”
What the sudden Yen bulls overlooked, is the fact that Abe’s victory signals the end of the Ministry of Finance’s control of economic policy. The Japanese people have spoken, even though only a few of them could be bothered to turn out to vote. They may not fully trust Abe, but they definitely don’t want the old orthodoxy either. Economic policy is now in the hands of Abe; more importantly, so is management of the exchange rate.
The MOF and the BOJ must now kowtow; and drop all pretences of being in control of economic policy. Those officials, who can’t Kowtow, must now fall on their swords. A panel of analysts, polled by Bloomberg after the election, sees the BOJ kowtowing until well after Kuroda leaves the institution in 2018[ii].
No wonder then, that his victory was downplayed by global policy makers, who were in a hurry to arrest the slide in the Yen pre-FOMC announcement. After the FOMC announcement, the weak Yen crowd tried to regain the initiative; but alas the damage has been done, as we shall soon see. Abe’s mandate is now meaningless until global events have strengthened the Yen, back to a level at which the BOJ feels obliged to dole out the next round of its own QE.
“Attractive American Relative Value.”
The appetite for US Strips has also flipped, from being the bullish leveraged duration bet on low inflation, into a bearish leveraged duration bet; based on the notion that the Fed will now have to ease to avoid Armageddon like it was in 1998. One can be bearish or bullish on risk and still load up on US Strips therefore[iii]. If the Fed needs to unload some Treasuries as it exits QE, it will now be met with a wall of Strip buyers in addition to the wall of money exiting global markets for the safety of the US Dollar. Some Fed Governors are just born lucky.
“Babble from Babel in Basel.”
Having previously warned over the risks to the global economy of continued capital flight into the US Dollar[iv], which went largely unheeded, the BIS sought to telegraph the signal that the Dollar was rising too fast pre-FOMC; by opining that the falling oil price was creating a debt crisis for the oil production sector in both the developing and developed world[v]. The BIS was ambiguous as to how exactly this would play out; leaving it open to the imagination of the speculators, in order to achieve the maximum impact.
Perhaps one is supposed to imagine the energy sector going bankrupt and then being bailed out by the taxpayers as the scenario that the BIS has in mind. It would however be hard to find a politician in the G20 nations, with the exception of the hapless Tony Abbott, who would advocate this and then expect to remain in office.
“Yesterday’s and Tomorrow’s Fish and Chip Wrapper.”
Perhaps therefore, the BIS was alluding to a repeat of the Russian debt crisis; which then saw the world allegedly “drowning in oil” back in 1999, according to the famous contrarian indicator known as the front page of the Economist. Speculators have bought into this repeat saga; and assumed that it is the end of the world again.
Said speculators however completely forgot that bank exposure to Russia has been cut back radically since sanctions began. In fact, it is fair to say that the whole point of sanctions is to create the current scenario for the oil price and Russia.
“Contingent Convertible Bonds on Aisle 3.”
Governor Carney, who is starting to fancy himself as the unofficial spokesman for the FOMC, now that Jon Hilsenrath has been sent packing, then added to the hysteria; when he opined that there was an element of contagion developing between the emerging and developed economies[vi]. The Bank of England then swiftly mitigated Carney’s guidance by releasing its stress test results[vii]. Unsurprisingly, only the basket case Co-Op bank failed. The publicly owned banks scraped through; presumably because the weary taxpayer was factored in as stepping up to the plate if and when it all kicks off again. In the tested scenario of real estate falling by 21%, economic growth slumping to 7% below the ECB prediction and interest rates rising from 0.5% to 4%, only public funds could save a UK commercial bank.
Eyebrows of suspicion should therefore be twitching at the Government’s statement that it intends to sell down its stake in Lloyds bank before the next election; which came out within two days of the stress test results being made public[viii]. An enquiring mind would surmise that the whole purpose of the stress test exercise was to facilitate this sale. A suspicious mind would then phone the Financial Conduct Authority (FCA) to enquire whether a classical scam was being perpetrated.
In the last crisis, rating agencies were paid to provide AAA ratings on what turned out to be junk. This apparent latest scam, whereby a central bank does the window dressing on behalf of the government, is something far more insidious and deserves a criminal investigation. Without the Government golden share stake, Lloyds needs to raise new capital. The Government is therefore unloading its shares before they get diluted in a new capital raise.
Just to make things even worse, it was reported that there is a new bubble being created by aggressive bank lending practices in commercial real estate. According to Cushman and Wakefield, margins on loans backed by offices and malls have fallen to 1.25%, their lowest since 2008[ix]. The banks have only just tidied up their balance sheets, thanks to the taxpayer, after five years of work-outs; so that they are now in a position to start lending to this sector right at the low point in rental yields.
The bloodbath at Tesco’s does not seem to have given them any cause for concern that the retail sector may be in trouble. In October, commercial property yields fell to 5% , their lowest since 2007. Quantitative easing has clearly inflated another illiquid bubble. Investors are chasing prices rather than yield because the yield looks attractive versus the low rates of interest which the Bank of England just stress tested for a rise to 4%.
Carney’s obfuscation, over the timing of a rise in interest rates, has got all the gamblers risking another trip round the board. The disconnect between what both Osborne and latterly Ed Miliband are saying, about the need for austerity, doesn’t seem to have filtered through to the strategists’ view, on what this means for consumer spending and rental pricing power. It seems that investors in this space are simply chasing iconic buildings, uttering the mantra “location, location, location”.
“Robert’s Thee Man.”
Clearly no attention was paid to the eponymously named Robert Stheeman, of the UK Debt Management Office (DMO) , who “rapped” last week that the UK debt mountain will take a “generation” of austerity to shrink[x]. Gilt investors have already assumed and discounted that austerity will be successful; and implied into Gilt prices that Carney therefore will be forced to keep interest rates low to avoid a painful recession.
This is fine for Sterling based investors; but for global investors however, once Gilt prices (and commercial real estate) have stopped being bought up by the domestic investors, there will be no yield premium to compensate them for holding Sterling risk. At this point, Sterling takes another dive; and domestic investors plus Carney need to start discounting the inflationary premium that they will require to hold Gilts whilst the foreign investors bail.
“Today’s Fish and Chip Wrapper.”
Age of Wisdom, Age of Foolishness (54) “Taper tantrum Redux”
Age of Wisdom, Age of Foolishness (54) “Taper Tantrum Redux” focused in on the dilemma facing Mark Carney; as he is forced to report to George Osborne why inflation is below target whilst observing the latent signs of inflation appearing all around him. Carney is alleged to have a pact with Osborne, not to raise interest rates until after the General Election. His heavily telegraphed signal that he will be writing this Dear George letter, should therefore be put into the context of this pact. Far from being a cause for concern to Carney, this inflation memo is actually part of the pact. The latest inflation data signalled that this inflation letter should be enclosed with the Christmas Card that Carney sends to Osborne.
“The Amazing Osborne.”
Readers will be familiar with what was termed the “Prestige” when it was first observed in January 2013. Government liabilities were linked to a new definition of inflation named RPIJ and tax revenues were linked to the familiar RPI. Needless to say RPI is higher than RPIJ, and has not been falling as fast. Consequently government receipts have a healthy spread over government outgoings. Osborne had hoped that this sleight of hand book-keeping would have made a great impact on the deficit; however it did not because the economic recovery has thus far been one in which wage growth has been non-existent. This situation is now changing.
“It’s Letter Time.”
As the Bank has just reported, inflation at the consumer level has now hit the 1% “letter to George” trigger limit[xi]. Unfortunately however, data released last week shows that UK wages have just started to grow faster than inflation[xii]. This can be spun into the headline that Osborne’s growth strategy is working; however it unequivocally shows that latent wage inflation pressure is a very potent threat. Companies will now respond, to higher wage costs, by passing this inflation on at the retail level. The Prestige perpetual motion engine, for reducing the budget deficit by inflating it away, is now finally cranking into gear. Osborne can now opine that real wages are rising whilst inflation is falling; when in truth consumer price inflation is eroding the value of everything. Mark Carney can opine that low inflation necessitates keeping interest rates low; indeed the Bank last week voted 7 to 2 to keep interest rates unchanged[xiii]. For the “Prestige” to work Carney has to tolerate inflation and not respond with interest rate increases. Domestic holders of Sterling assets may fall for the con-trick, but international holders will soon start to question if they are receiving a sufficient interest rate premium for their complicity.
“New BOEwatch Mystery Episode.”
Age of Wisdom, Age of Foolishness (56) “The Delusional Crowd”
Interestingly, Carney has just replaced the data providers at the National Statistics Office (NSO) with the “Hoff” in house at the Bank.
“UK Pay Always Leads the Way, Both Ways.”
Age of Wisdom Age of Foolishness (54) “Taper Tantrum Redux”
“BOEwatch This Space.”
It was the NSO who released the data that showed wages rising faster than inflation last week. The trend is clearly rising; and is something that Carney will have trouble sweeping under the carpet. Clearly Carney needs to gag the NSO; and replace its output with data which justifies his role of supporting the “Prestige”. The “Hoff” therefore has a thankless job ahead of him; which is why he gets paid the big bucks. The battle between the NSO and the “Hoff” should be hilarious to watch going forward; and will ultimately impact on Carney’s own prestige and career.
“Things Are Going “Down Under” Up Over Too.”
Australia seems to be signalling what their “Pommy” brethren in the Old Country can soon expect to be feeling. Australians will also be economising this Christmas. The government finally admitted that the deficit will be a little wider than expected; so that the civil servants will be getting pink slips in their Christmas cards this year[xiv]. The sword will be taken to the rest of the public sector in the New Year.
“His way, His Rules, No Exceptions. As the Germans Say.”
There is nothing equivocal about anything the uncompromising Jens Weidmann says. Last week, he fired off three tracer rounds pre-FOMC; in order to kill the French fiscal spending initiative and also to derail the ECB QE Express. His first shot was aimed at the EU’s move to grant France time and space to meet its deficit targets[xv]. His second headshot was aimed at Draghi, when he opined that there was no economic justification for QE in the face of falling oil prices and deflation. His third shot was potentially lethal, because he suggested that QE is in fact illegal[xvi].
“In Need of a Makeover.”
Germany is not a place of hollow rhetoric either. Whilst it criticizes its neighbours, for not applying economic reforms, it boldly sets an example. Having balanced its fiscal budget, with room to spare for a stimulus if needed, the process of reform has now moved on to the Mittelstand sub-sector which makes up a large constituent of the industrial economy.
Up until now, owners of family businesses have been able to transfer the business to surviving children, without paying estate taxes, if the asset is held for seven years. German policy makers now find that this practice has been abused by feckless children; who have run the business on idle and then sold out at the first opportunity to book a profitable sale. The Constitutional Court has thus found this degenerate practice to be unconstitutional[xvii].
A shake up in this sub-sector, which will bring efficiency and productivity to the whole economy, can thus be expected going forward; which will leave German industry even further ahead of the European game.
“Oh Yes it Is!!!”
When the speculators then started to believe that the Fed would actually not raise interest rates in order to boost the oil price, it was time to step back and see the bigger picture. The icing on the cake then came when speculators turned bullish on European risk assets, after selling them off so violently on the Russian news, because it was assumed that the ECB will now definitely do QE because the Fed is still going to tighten.
What was lacking in all the frenzied analysis, was why any of this was bad for the US Dollar which they were continuing to sell. Nobody seemed to ask why the policy makers were talking so bearishly about the global economy all of a sudden. It was almost as if they deliberately wanted to undo all the good work since 2008 and drive the global economy over the cliff again. Price action plus emotion however obscured logic and the bigger picture, as it always does. The bigger picture was clearly a very successful attempt by policy makers to prevent further acceleration in the rising US Dollar trend going into the FOMC.
“Recite Before Trading.”
Post FOMC announcement, they may begin to regret what they wished for. The words “considerable period of time” were thrown out in favour of the new word “patience”. 2015 will therefore be a year in which the markets agonize over what “patience” really means. Given that “patience” is not a virtue with which speculators are endowed, the choice of this word is ill advised at best and inflammatory at worst. The knee-jerk reaction, post FOMC announcement, was to assume that US interest rates will go up in the second half of 2015. The US Dollar therefore regained some of its composure.
The second assumption is that since the Fed is in no hurry to raise rates and the ECB despite German objections will do QE, that global equities offer value. The US Dollar and global equities therefore squeezed back by “almost” as much as they sold-off going into the Fed’s meeting. The word “almost” however signals that speculators did not have the “patience” to retrace the whole sell-off; and this suggests that there is an element of doubt present in their minds.
Age of Wisdom, Age of Foolishness (58) “Dialectics”
Age of Wisdom, Age of Foolishness (58) “Dialectics” observed that US housing is starting to weaken dramatically. Indeed, in her press briefing, Janet Yellen also highlighted this weakness.
“2011 Déjà vu.”
December Flash PMI data, which the Fed could not have had during the meeting, also suggested that the US economy is slowing rapidly.
The December Empire State Index also fell off a cliff.
“Blood on Wall St but not on the Russell and NASDAQ.”
“There Will Be Blood on Wall St.”
Age of Wisdom Age of Foolishness (54) “Taper Tantrum Redux”
The Shale Oil boom has also given American GDP a huge boost; however this will be tailing off dramatically after the oil price collapse. Oil gets shipped around by train and fracking chemicals by train and truck, so the transports (ex-airlines) should also follow the energy sector into the hole. Before one knows it, the Dow Theorists will be singing the Blues again. Weak oil is good for small business however, so the Russell should outperform.
When Yellen said “patience” she was actually saying that there is a huge question mark over whether the Fed will tighten at all. When the speculators smell that there is no tightening and that there may be an easing, NASDAQ should also get the bid. It is all starting to look like 2011 again, thanks to the Eurozone; and the early signs of contagion are now showing up in the US. The weak oil price might be good for the non-oil sectors of the economy, but there is a huge chunk of the economy that is geared to a higher oil price. How can this delayed real economy reaction be so late in appearing?
The rally in the US Dollar has sucked liquidity from the global economy into the US economy. It has created an uptick in asset prices and shielded the US real economy from the global headwinds. This liquidity driven hiatus has caused the delayed reaction. This liquidity stimulus is now waning, so the US economy is slowing; because there is no residual domestic driver or global pull.
The major risk is now that US growth stalls in Q1/2015. If and when this happens, the large long positions in the US Dollar and US assets will panic and sell-off. What is now holding everything up, is the belief in QE from the ECB and the belief that the BOJ will continue to drive the Yen lower. Currency and equity markets are already priced for these two optimal outcomes. QE from the ECB is however no done deal; and actually only becomes a possible deal if the Eurozone starts to split apart. Such an event would then test the Fed’s resolve to tighten, especially if the US economy slowed in Q1/2015.
Abe may have his mandate, but if Europe blows up it is worthless. The bottom line is that currency and equity markets are far too complacent. In America, shakeouts between equity sectors must occur, before aggregate equity indices can tell the final story. The problem for the Fed is that it must let this sectoral shakeout play out, before deciding if there has been a net economic growth or contraction. This is why the Yellen advocates “patience”. In Europe, the current valuations suggest that no Eurozone shakeout will occur; but the data clearly show that there is no economic growth either.
After the FOMC meeting, the long only boys jumped into the thin market and tried to drive equity prices back to the highs of the year, so that they can collect one more fat performance fee cheque; thus proving actually that what only active managers need are passive investors in their funds. This greed-rally therefore guarantees the fear sell-off in Q1/2015, when this faux-Christmas rally is exposed as the market manipulating scam that nobody went to jail for. Russell investors have been patient all year, in the face of the Taper, but now things are suddenly looking up as the Tightening becomes uncertain. Christmas came early for the Russell and NASDAQ longs; but the patient Dow shorts will be rewarded later in the New Year however.
“Hispanic Spring. You Heard it Here First.”
Having fluffed his scoring opportunity in front of an open goal, to have the CIA and the whole Bush Administration put on the stand for Rendition, President Obama tried to manufacture a foreign policy coup headline with an assist from the Pope. Allegedly normal relations with Cuba are on the foreign policy agenda, although unfortunately these didn’t come in time for Americans to get Cuban cigars for Christmas[xviii]. The more valuable prize of oil rich Venezuela may be the gift that Raul Castro ultimately brings to the table; which would then put the oil price well and truly sub-30$. Venezuela has a 91% probability of default, so it is cheap and also there for the taking[xix]. “Hispanic Spring” has a nice ring to it as a headline for 2015. The prospect of Russia secretly dumping crude on the markets, as it did in 1998 in order to keep its economy afloat, will then effectively keep a lid on the price. Why would Yellen save the oil price, when American national security and foreign policy is pushing it lower?
“Hear no… See no… Speak no.”
Weak oil prices also take away a lot of campaign funding for the Republican presidential hopefuls; a factor that must be included in the bigger picture. When Jeb Bush signalled that he was “exploring” his options last week[xx], he must have been mindful that his promise to his backers will have to be to get the oil price back to where it was when brother “W” was Commander in Chief.
“We Sought Him Here, We Sought Him There. His Forecasts Sought Him Everywhere.”
On a housekeeping note, as of 2016, the creation of consensus on Fed guidance will take a quantum leap towards the standard mean; as Kockerlakota follows Fisher and Plosser into the sunset. Kocherlakota was a particularly dangerous input to guidance, because he has the quaint tendency of passionately embracing extreme opinions; and then changing them to the opposite incorrect extremes at the wrong moment. He was therefore a Hawk whilst deflation was unleashed, during the Credit Crunch and became a late Dovish convert to Deflation, just as inflation started to percolate its way back into the US economy.
“A Holy Trinity.”
He will be sadly missed, for his amusement value rather than for his meaningful policy input. In some bizarre form of Fed Karma he was in the dissenting threesome, with the also retiring Plosser and Fisher at the last FOMC meeting, although for totally different reasons. This retiring dissenting threesome illustrates clearly how the extreme views will be lost for posterity, as the consensus converges on Yellen’s standard mean.
“Have a patient Christmas.”