Equity Markets: Thank Heaven for Central Bankers

November 30, 2011 will be a day to remember for many Bourse firms.

It's never a pleasant to be wrong. But it's always a pleasure to be wrong when you called the only viable option that would have made you wrong.

Finally the Central Banks convened to lower USD swap costs and consequently ease tensions within the Euro-Area. Acknowledging that the ECB (and IMF-chuckle for those that conceived that piece of gossip) could do little on their own without frustrating donors, Mr. Draghi understood the problematic and the challenge. Europe needed help from its friends: The Fed and its allies, and the Bank of China. One signaled monetary comfort; the other signaled monetary stimulus. In both cases,  the better bankers realized that a demand for the USD could get out of hand and leave an even more fragile Euro begging for crumbs at untenable rates. That setting without improvement on the Chinese economic front, global economies were in trouble.

The best part of the staging is that China is becoming a beach-head participant in the world's financial system. Mr. Xiao's next challenge is to convince his stakeholders that assisting in the European bailout is a necessary condition to not losing out on everything else, and exercise the appropriate actions. Slowly but surely, Chinese pragmatism is waving a wand that signals a change in political directions towards western rhetoric.The only other adjustment China has to make is a concession on the yuan.

The swap arrangements agreed to (who knows when) are effective December 5, 2011 and will extend for 15 months into 2013. Is there anyone that still thinks that Europe has no problem when its own banks show appetite only for USD. Is Europe out of the woods? Not necessarily. This morning, Mr. Cameron et al, are you listening, European unemployment is on a record rise with the exception of Germany, and that will reverse. Mrs Merkel will see a reversal within three months as less and less demand go her way, and more and more constraints are put on businesses.

Well, US President Obama, Fed Chair Bernanke and Secretary of the Treasury Geithner were there again and maybe someday, some inspired filmaker will find a decent moment to direct  real drama. Europe has been saved for a second time by the United States and its credible allies. Bank of China dropped its reserve requirements by 50 basis points in order to help trigger some activity on a slowing economy. This monetary easing was the first sign that November 30, 2011 was going to be a V-Day.

At this moment, there is little left that the Central Banks and Chair Bernanke can do on the monetary front. US Republicans should analyze their own pundits' results on job creation by President's Obama spending initiatives, and improve on the solutions by fine-tuning timing and sectoral interventions rather than dismiss the spending option. Most of all, they should stop battering the US Public Service. The constituents of that sector represent the most faithful spending segment of the consumer population.

Don't knock down the walls that hold back the oceans.

To the many, stay the course.

Market Analysts and Managers Irresponsible 

There's an argument circulating through the marketplace that Chair Bernanke was irresponsible by suggesting  that

there are significant downside risks to the economic outlook, including strains in global financial markets

Supposedly, the Federal Reserve made a mistake by evoking the above, and should restrain its judgement on economic conditions that affect monetary policy. Avowed is the delicately obtuse cynicism that for market analysts, managers and strategists to properly advise their clients, the Fed should be silent and keep the public ignorant of matters that affect the public's respective wealth and future. Disclosure of pertinent content is the investment manager's discretion, seems to be the underscored presumption.

It can only be a relief that some men like Chair Ben Bernanke are still around and that they have the required courage to tell it as it is. As if no one ever knew that there was an economic maelstrom, or squall as my favorite columnist and commentators from Fictional Reserve Barking characterize it, evolving on globalscapes.

Fellas, give yourselves a break. The majority of you are certainly confused, and justly so.  Consider, since when do the analysts, strategists and managers dictate appropriate communication guidelines. Basic deontology suggests that these advisors have a responsibility to seek out relevant data and give comprehensive information that will permit the client to respond appropriately to the situation.

Moreover, when the public buys and owns stocks or corporates bonds the public are shareholders and stakeholders in those companies.  The public has the right to know whether there's exposure to risk out there. It is not the discretion of the advisor to weigh the call on disclosure or not. Get real guys!

A  lot of people would never have received the floats if Mr. Bernanke had not sounded the warning of the imminent squall. Maybe some of the public were in those sell-offs. Good for them, if that was best for their visions.

One should be very pleased that individual Chair Bernanke and institutions like the Federal Reserve are unconstrained by political considerations, originating in Washington or New York. One also hopes that most cynics and whiners get canned under the circumstances not for ill-advising clients but for suggesting that the Federal Reserve had no reason to come out with their caution. That is professionally unethical. The narrative certainly makes a case for passing the buck for their own incompetence and lack of market insight. It certainly translates into a good show; but it should not be produced at the expense of the public.

Bernanke: Not Responsible for the Collapse of Markets of Sept 21-22, 2011

The announcement following the FOMC meetings of September 20-21, 2011 was expected. The infrequent decision to 'Twist'- swap short-dates Treasuries against longer date securities, particularly the very long dates, was expected.

Obviously, the respective underlying intention was to promote the consumer and housing sector with inexpensive mortgage financing, and flatten those yield curves and reward tradeoffs across the Treasury spectrum.  Whether those markets react will depend on whether or not the consumer generates demand for either new homes or refinancing existing homes. In both latter cases, the intended consequence is to alleviate pressure on household debt and unlock consumer spending into the economy.

Chairman Bernanke had nothing to do with the markets' collapse world-wide.

At first, the market reacted positively to the obvious, concluding that it had already discounted the Fed's intervention for all intents and purposes. That didn't last long. Some of the more enlightened participants realized that the most important statement had been skimmed over by the markets.  Mr. Bernanke had emphasized in explicit terms the dire prediction on the global economy that was unexpected in the announcement  and, de facto, lent a deaf ear, dismissing the GOP leadership's political rhetoric of the previous day.

Chairman Bernanke,  previously informed by Secretary of the Treasury  Mr. Tim Geithner's return from the meeting of European Finance ministers in Poland last week, characterized his caution on the world economy in the following manner: 

Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. 

The markets tumbled when players realized that the global economic situation was not tepid but turbid.  Financials leading the slide, dropped across the board, catalyzed by a Moody's downgrade of Bank of America, Citigroup and Wells Fargo on their debt. The only anomaly was Hewlett Packard rallying on a rumour that their CEO had been ousted. Talk about quality trading, as if a new, yet unidentified CEO will reverse macroeconomic circumstances. The morning should reverse the ridicule and ratify the quality of its governance.

All markets in Asia and Europe tumbled overnight. The additional information from Europe and China that the Purchasing Manager's Index (PMI) is contracting, followed by market commentaries that it may suggest deterioration in manufacturing output,  is sending signals globally to investors that the only viable route is away from equities for now- a rush to safety and US Treasuries. In fact, all currencies, except USD, all commodities including gold,  and Treasuries were down or short dates unchanged with the exception of the 6mth yield rising.

But why are BRIC indexes dropping? Fundamentally, there is no structural demand within those economies that can permeate the level of manufacturing and production that has been underlying their respective growths. Until further ado, BRIC depends on Western economies and spending. Suffice it to follow the Russian equity market this day after. Significant is to realize that BRIC cannot, at this moment of their development, drive the global economy out of its slowdown. If Japan could never act as the world engine, why should BRIC assume the role. The same is true of Europe; its lame-duck behaviour is unjustified under the conditions. Europe must put its condos in order, if the investment is to be successful.

What the headlines suggest as Mr. Bernanke's Market Debacle is absolute nonsense!

The nonsense was the GOP's leadership criticism of the Federal Reserve decisions. Boehner, Cantor & Associates' understanding of basic economic realities is unreliable and incomprehensible for that level of leadership. They should simply acknowledge that without employment there is no spending and there are no sources of Treasury revenue; and without revenue sources, there is no deficit reduction. If they persist on professing that deficit myth: that deficits matter for the US economy, they will make matters worse. They should recognize their own shortage of viable solutions, and grasp the moment to support fiscal spending programs. As for Rating Agency downgrades, they don't  matter at this moment.  Recently, they have been shrugged off by all sovereign levels.

Unless the US economy is activated, and this won't happen as a result of Federal Reserve monetary policy, the global economy will remain in a state of stagnation for a long time. It is obvious that any solution must come out of Washington. A reasonable start is to couple that  result from flattening long date yields with an aggressive mortgage refinancing program for the suffering homeowners and well-intentioned consumers.

Fitch winks a AAA...

On August 16, 2011, Fitch Ratings confirmed its AAA rating for the US sovereign debt. Whether it was an anti-climactic no-brainer after witnessing the fiasco of the S&P downgrade, or Fitch corporate insight that it may just be too early to throw the towel in on US sovereigns given the response the markets gave to the rival's downgrade is irrelevant except to seers and their jury. In fact,  the sequitur- Treasuries rose in price and equities tumbled,  the dollar surged as capital flowed into the US for the short term was predictable. Meanwhile, an overly cautious European financial system and European AAAs tried to make sense of their own regional fiasco in light of this US resurgence. It was a perfect storm for Fitch to stall on, without sinking.

Analysts Messrs. Riley, Olert, Renwick and Fitch management should be commended for their approach and narrative: 

"The affirmation of the US 'AAA' sovereign rating reflects the fact that the key pillars of US's exceptional creditworthiness remains intact: its pivotal role in the global financial system and the flexible, diversified and wealthy economy that provides its revenue base. Monetary and exchange rate flexibility further enhances the capacity of the economy to absorb and adjust to 'shocks'."

The narrative accompanying the affirmation reflects a humble appreciation of the mission of the Rating Agencies, a subtle recognition that the US financial structure can accommodate internal and external tensions and 'shocks', support the demands of its financial and trade partners, and a realistic understanding of the US position as underpinning the global economic system. It was a reasonable call in the case of the United States- a sovereign that could not default, although Fitch nudged away from that premise by mitigating the controversy with ' the risk of sovereign default remains extremely low.'  Notwithstanding the wink,

...Fitch also wagged the finger

Ten days later,  on  August 25, 2011, Fitch London Research Paper  released its conclusions on the global consequences of a hypothetical "double-dip recession" in the US.  At the time of  the original affirmation, August 16, 2011, Fitch had also confirmed its intentions to review the fiscal state and projections of the US economy in light of the latter's own commitment to reduce its deficit. The position Fitch advocates by its affirmation of the maximum rating is not as daring as some observers would judge. The reserve status of the US currency, the depth of the US markets, and the intrinsic ability of the US to satisfy its monetary obligations vis-a-vis its creditors, even in light of slowing economic growth and domestic political tension-all warrant the Fitch AAA affirmation and the ensuing qualified caution as to an imminent review, given the integral role the US plays in sustaining global economic stability. In this context, the Fitch London Research report is a timely and welcome sequitur to the affirmation of AAA.  It reiterates and confirms the soundness of those fundamental considerations that Fitch tabled and examined in the first instance to arrive at its maximum rating. It also interposes a scenario testing the consequences of a major slowdown in the US economy.  The analysis quantifies the direct, and to a much more limited extent, warns of the second round effects , including inter-financial sector effects, of a hypothetical 'double-dip' recession in the US. Fitch concludes that no country will be insulated from the adverse impact of a further deterioration in US economic activity. First, but not foremost, is China and the combined domino impact of a slowdown in the US and a commensurate drop in GDP in China on world economies will be formidable. The greatest effect of the US slowdown will be on its adjoining geographic trade partners Mexico and Canada, and seemingly the consequence will be 'severe'. The most intense will be to small and open economies. That the healthy state of the US economy is a sine qua non catalyst for any global recovery is emphasized to the point that Fitch underscores that the US dip could tip the major advanced economies into recessions, and this includes a fragile Europe and a taxed Japan. The Fitch announcement out of London preceded the prouncements by the world's leading financial figures at the 2011 Economic Policy Symposium sponsored by the Federal Reserve Bank of Kansas City and held in Jackson Hole, Wyoming  from August 25, 2011 through to August 27, 2011. Not only did it assemble central bankers and senior policymakers, but it also gave the world an opportunity to listen to a battered field's rising stars with daring visions among which named: Mr. Dani Rodrik and Mme.Esther Duflo.

The Fitch release set a balanced and cautious mood for the world's markets and audience, thereby permitting global policymakers to ponder the complexity of a situation that required serious reflection and sound discernment in a reserved setting. 

FitchRating acted very responsibly and very professionally.

h/t Fitch

Mr. Bernanke's Fed. Bravo!!!

The FOMC statement issued Tuesday August 9, 2011 at around 14:15PM was dissented by three committee members. It initially stirred confusion in all markets. Equity markets were taken by surprise as they focused on the bleak economic outlook the Fed suggested.  The Dow was down 200 points, shedding almost 450 points in 30 minutes before recouping after watching the Treasuries' plummets and appreciating the insight that maybe equity yields were favorable investments after all.  At the end of the day, the Dow had rallied back over 600 points. It was a session marked with enormous market volatility. Dow closed the day 430 points higher in the most dramatic session in decades.

The same announcement shook short date (2 years and less) Treasury markets dramatically,  generating yields that camouflage Short date Notes as fed funds- zero coupon- for all intents and purposes, and sent the US dollar into a tailspin against the meek Swiss Franc and roaring Gold,  after market players correctly interpreted that the Fed was capping rates at near-zero for the next 30 months until the end of Mr. Bernanke's term.

Most observers also correctly felt that the Fed intentionally avoided sabotaging already nervous equity markets that were showing promise with substantive earnings and a sufficient capital base. The Fed action was seen as creating favorable portfolio opportunities  for money managers to retain good yielding equity that confirm good earning and dividend profiles. The Fed idea was not to undermine potential economic benefactors and job creators. Quantitative Easing 1 (QE1) and QE2 had already successfully channeled funds through the system and filled corporate treasuries with low cost capital which is supporting the already fragile recovery. 

Others perceived the Fed move as a preparatory scenario for an another QE3-fielding the necessary signals to the market, keeping available liquidity for timely Bond releases.

Notwithstanding the above probable explanations, I think Mr. Bernanke and this Fed were engaged in a more extraordinary exercise and endorsing a more subtle stance that blindsided a myopic market, naturally  focused on its malaise. Mr. Geithner had already voiced his concerns that exogenous factors existed which also influenced US markets. Mr. Geithner minced few words when he warned the markets that European contagion was a real threat to a global recovery,  much greater than the immediate slowdown in the US economy. It was confirmed by all Central Banks that if Italy failed to refinance it might mark the collapse of the eurozone and generate a systemic collapse. The Fed was aware, as was the Treasury, that ECB and the EFSF resources would not suffice to cover the Italian and Spanish risk, if and when (within 2 years) they surfaced. There is only one player in the world that can assume the role of backstop required by the situation: enable the Eurozone to stay afloat in case of overwhelming risk, and  keep Germany, France and Italy from following into political and economic disarray, and from sending the euro through Hades, and many to Dollars and Gold,  SFr and maybe yen-but how much liquidity can they carry. The same can be said of gold: how much demand can it support.  European contagion would also dramatically undercut the engines that drive emerging market momentum which, at present, supports some of the global economic growth. Intrusion of the Fed in the short dates would have unnecessarily squeezed  Italian and Spanish offerings. It may just be that the US has saved the Italian offering.

The Fed's move was larger in scope and more daring in nature than meets the market eye. Perhaps, Frau Merkel can be more accommodating in tone when she reacts to the 'problems' in US markets and the challenges of the US Government.