When the Fed announced last week they were going to resume the expansion of their balance sheet with another edition of QE, traders immediate reaction was to sell the USD and buy commodities. Positions were assumed accordingly, but we wonder if this analysis might be too simplistic.
Yesterday in The Telegraph, Ambrose Evans-Pritchard had some insightful analysis. It is his contention that Bernanke contributed to the severity of the recession when he:
"...kept policy far too tight after the U.S. economy buckled in early to mid 2008. He allowed a collapse in the money supply to run unchecked, causing avoidable disasters at Fannie, Freddie, Lehman, and AIG later that year."
Now, with the U.S. economy slowing, the labor market contracting, and fear of the pending "fiscal cliff," Bernanke is using one of his few remaining tools. The public perceives this will be an increase in the money supply, but what they are missing, according to Evans-Pritchard is:
The Fed has been tightening this year, a fact overlooked in the Weimar/Zimbabwe slapstick of the last two weeks. Yields on ten-year inflation-indexed Treasuries or TIPS -- a proxy of inflation expectations -- have crashed zero to minus 0.7pc since January. If this is the start of hyperinflation, nobody told the bond markets.
The Fed's balance sheet has shrunk by $120bn to $2.82 trillion since February as the old schemes run off -- the `TALF' and suchlike.
Assets reached a plateau of around 16pc of GDP two years ago and have not changed much since then. This is exactly the same as in 1951 before the Fed's last great experiment was unwound. It is also lower than the balance sheets of the ECB, Bank of England, Bank of Japan, or -- arguably -- China's central bank.
So in the vernacular of the public, if the printing presses have been more active in the ECB, the Banks of England and Japan, and possibly China, why dump on the USD? Granted, the threat to buy $40B per month is frightening, but with time perhaps someone will figure out the Fed's rates and supply of money are not the answer to higher employment.
Most new jobs in the U.S. come from small businesses. Small business, confronted with the unknown cost of Obamacare -- rumored to be as much as $15,000 per year -- will not be hiring many new people until this uncertainty is resolved. Further, the U.S. has the highest corporate tax rate in the world -- a severe hindrance to forming and growing a business.
While the U.S. has problems, including the uncertainty of a presidential election, which is about tied, neither is Europe a pretty picture. In Portugal, the austerity measures are taking their toll. There, the economy is contracting, making it impossible to reduce the debt to GDP ratio.
To combat the deficit, the government had proposed to increase to social security tax contributions from 11% to 18%. Street protests were the result of this proposal, but other taxes, including taxes on assets, are going to be initiated. Look for more demonstrations in Portugal.
In Italy, former Premier Berlusconi -- quiet since leaving office last November -- said Mario Monti has been too "...servile to Germany, a hegemonic state that is dictating rules on discipline and austerity to other European state countries."
The immediate problem in the EU remains Spain. It did sell €4B in very short term paper today, but borrowing three month bills to finance a big deficit will not work. Meanwhile, Catalonia claims it is going to have a vote to become independent. Responding to this threat, some in the military have threatened to clean their weapons and get ready for a fight.
Last summer, while having dinner in Marbella, I can recall a picture of General Franco featured on the wall. As I remember, Franco vigorously ended Catalonia's last intent to become independent. This can get ugly.
Yesterday, we reviewed the most recent COT report, which showed the large specs had reduced their short position, but still carried a net short of 77.6K contracts. It is unusual to see a short position of this size to be carried this long.
In our week end review last week, we mentioned the double top around the 1.3170 (EURUSD), (FXE), (UUP) would be the top side resistance this week. The down side, we felt, would be around 1.2830. Political events may be the driver here, and there seem to be multiple festering issues of discontent. Currently, we are trading around 1.2945. It looks like we have a better chance to check out the bottom end of the range.
(click image to enlarge)