Financial Market report for October 15, 2010
I … World shares, ACWI, closed down 0.30%, the S&P, SPY, closed up 0.20%, and Exxon Mobil, XOM, closed down 0.17%, each in lollipop hanging man candlesticks, suggesting that the ongiong rally has come to an end.
Additional confirmation for an end to the European Financials Bank Stress Test And Earnings Report Rally, comes from the chart of Japan shares, EWJ, manifesting a bearish harami and turning 0.78% lower.
Consumer staples, XLP, closed up 0.25% at a new high at 28.61. Utilities, XLU, closed up 0.30% to a new high at 31.90, which is just below major resistance at 32.00. The last time Utilities were at this level was September 22, 2008 at 31.95, when they broke down falling to 29.72 the following week and 23.84 the next week. The monthly chart of XLU shows that it is in the middle of a brodening top pattern. As Street Authority relates, when you see the broadening top, the market will eventually drop. The utilities are about to drop sharply destroying the hopes of the fixed income investor.
The US Dollar, $USD, rose 0.52%; and the Yen, FXY, rose 0.03% today, after the dollar has fallen for eight weeks, and before that for 12 weeks, as seen in the chart of UUP, as yen based currency traders have rallied major currencies, DBV, and even more so emerging market currencies, CEW.
The recovery of the Euro, FXE, began in early June, 2010, with the announcement of the EFSF monetary authority. This stimulated an awesome rush into borrowing from the Bank of Japan at low interest to invest in the first tier carry trades such as the EUR/JPY. Second tier carry trades are more volatile, and thus have more profit potential, but come at higher interest.
The Yen, FXY, has risen terrificaly as invesors have “laddered up” or perhaps better said “leveraged up” currencies over the Yen. But recently some investors took the Yen higher than their carry pair twins. This jump ahead in the Yen, largely in a challenge to the Bank of the Japan to continue to intervene in stopping the rise of its currency, has created an impediment to continually going long the carry trades. It is now a “far reach” for the currency traders to go long their lucrative trading. The “yen carry trade spigot of investment liquidity” may have run dry.
So being at an impass, the currency traders may go short the various curreny trades. Notably the Euro Yen carry trade, FXE:FXY, the India Rupe Yen carry trade, ICN:FXY, the Mexico Peso Yen carry trade, FXM:FXY, the Canadian Dollar Yen carry trade, FXC:FXY, the Brazilian Real Yen Carry Trade, BZF:FXY, the Australian Dollar Yen carry trade, FXA:FXY, the British Pound Sterling Yen carry trade, FXB:FXY, and the Swedish Krona Yen carry trade, FXS:FXY.
Yen base carry trade investing has been one of the two spigots of investment liquidity; the other has been the US Federal Reserve Quantative Easing, where it traded out 1.2 Trillion in US Treasuries and took in distress securities, like those in the Fidelity mutual fund FAGIX.
Those individuals who have been well connected to either the bank of Japan and/or its banks, went on a global buying spree using Japanese carry trade loans, as the Fed started it QE in March of 2009, which is well seen in the chart of the small cap global leaders, EWX.
Carry trade loans fueled investment growth primarily outside of the US and Europe, as both are burdened by housing debt, personal debt and sovereign debt. Hot money flowed into Hong Kong, EWH, Singapore, EWS, South Africa, EZA, Peru, EPU, Thailand, THD, Turkey, TUR, Indonesia, IDX, Malaysia, EWM, India, INP, Sweden, EWP, Brazil, EWZ, international discretionary, IPD, the emerging markets, EEM, the frontier markets, FRN, Brazil small caps, BRF, agricultural stocks, MOO, copper mining, CU, the emerging market metal titans, EMT, the junior gold mining stocks, GDXJ.
Yen based carry trade investing has also driven growth in the US small cap shares, IWM, airlines, FAA, Dow Jones Internet, FDN, Nasdaq Internet, PNQI, and Intenet, HHH. But this paled in comparison to the growth outside of the US. Carry trade investors have been seeking lucrative rewards; these can come only from investing outside of the United States.
Carry trade investing has flowed in junk bonds, JNK.
And Quantative Easing and lowering of interest rates in many nations has attracted investment in emerging market bonds, EMB, and in world government bonds, BWX . These will be coming to an end as bond vigilantes become more active in driving up interest rates globally.
A steepening 30:10 US Sovering Debt Curve, $TYX:$TNX, has stimulated investement in the longer out maturity corporate bonds, BLV. But further steepeing of the Yield Curve, will likely cause corporate interest rates to rise, and BLV to fall in value.
The hammer in the chart of Junk Bonds, JNK, the doji in the chart of world government bonds, the doji in the world shares, ACWI, at resistance, the downturn of tax managed buy write opportunities, ETW, as well as a -0.59% bearish engulfing candlestick in bonds, BND, each suggests that the benefit of ”the spigot of investment liquidity coming from quatative easing” has reached full benefit.
The chart of Ford Motor Credit, FCZ, suggests that we have passed through Peak Credit. From the chart of Five Star Quality Care, FVE, it appears that we have arrived at the end of benefiting from investing in the care of others. From the chart of Blackrock Dividend Achievers, BVD, it appears that the rewards of dividend investing has peaked out.
Provided below is a list of popular currencies and today’s trading results.
The Canadian Dollar, FXC, -0.59%, has risen for seven weeks
The Brazilian Real, BZF, -0.03%, has risen in an ascending wedge for nine weeks.
The British Pound Sterling, FXB, -0.12%
The Swedish Krona, FXS, -0.88%
The South African Rand, SZR, -0.50%
The Mexico Peso, FXM, +0.16%, has risen for seven weeks.
The Australian Dollar, FXA, -0.49%; has risen in an ascending wedge for eight weeks.
The Euro, FXE, -0.69%; has risen for five weeks to the middle of a broadening top pattern
The Indian Rupe, ICN, +0.19%; has risen for seven weeks.
FXY +0.03%; has risen for four weeks.
DBV, -0.17%; has risen for eight weeks to the middle of a broadening top pattern.
CEW, -0.09%; has risen parabolically for seven weeks.
The Treasury 30-year bond yield, $TYX, rose above 4 percent October 15, for the first time in two months, after Fed Chairman Ben Bernanke said in a speech that a little inflation is not a bad thing. The truth is that the Fed is going to step up to the plate and print money out of thin air to buy US Treasuries to create demand for short term Government Debt, SHY, and IEF, so as to prevent a deflationary collapse. But this is hugely inflationary in the interest rate on the US Ten Year Note, $TNX, and the interest rate on the 30 Year US Government Bond, $TYX, causing a large loss in value in the longer out US Government Debt TLT and ZROZ. Mike Mish Shedlock wrote in Seeking Alpha article, Yield Curve Steepest in History: Is the Meaning Different This Time? of the growing disparity Green: $TYX – 30 Year Treasuries over Orange: $TNX – 10 Year Treasuries. This disparity has increased greatly since the time he wrote that article. The 30:10 US Sovereign Debt Curve, $TYX:$TNX, is now trading much higher value of 1.552. Instead of a flattening 30:10 yield curve, I expect to see an even more steeper one. If the ETF, FLAT, is a measure of the 30:10 US Sovereign Debt Yield Curve, then it will not flatten, and as a consequence will continually loose investment value.
The Fed’s QE 1, that is its TARP and other Facilities, have temporarily averted a crash in the US financial markets, and a collapse of its banks; and the ECB’s interventions have postponed a string of defaults by indebted governments for another day of reckoning. The resources for such delaying tactics are, for all practical purposes, depleted.
Now the central bank’s actions will be toxic. The Fed’s POMC and QE2 constitute monetiazation of debt by printing of money out of thin air. And the ECB is monetizing state sovereign debt by buying at over inflated prices.
The Euro, FXE, has been rescued for the moment by the European Ministers. But the fate of the Fourth Reich’s common currency rests in the hands of the currency traders and their decision to continue to go long or to now short sell the Euro Yen carry trade.
Given that the spigot of investment liquidity coming from quatative easing has reached full benefit, and the spigot of investment liquidity coming from yen carry trade investing has been probably been capped by a significantly higher yen, I expect the currency traders to sell the carry trades short.
With unwinding carry trades, I expect disinvestment from both stocks and bonds. In a debt deflationary enviornment, gold will be a stellar performer. For those looking for short selling opportunities, the best ETFs to sell short will likely be … RZV, EWO, KBE, ITB, INP, IWM, EWD, BX, TAN, BRF, PNQI, ETW, FAA, PEJ, RTH, BWX …. along with TLT, ZROZ, and URTY, RETL SOXL and most importantly, UYG over the developing crisis in the US mortgage backed securities, loan origination, securitization and servicing industry. Here is a MSN Finance chart of RZV, EWO, KBE, ITB, INP, IWM, EWD, BX, TAN, BRF, PNQI, ETW, FAA, PEJ, RTH, BWX for the period of June 7, 2010 to October 17, 2010. And here is a Finviz Screener of these ETFs.
Great austerity and adversity is coming to the most indebted countries, and to those who rely on traditional credit and banking. Thus the United States with its Russell 2000 companies, IWM, highly dependent upon easy access to low cost funding through credit businessess such as Nelnet, NNI, and American Express, AXP, Ireland, EIRL, Italy, EWI, Spain, EWP, Austria with its bankrupt Developing Europe carry trade loans, EWO, will be ground zero for suffering.
II … First up on today’s news is the developing imbroglio over the US mortgage backed securities, loan origination, securitization and servicing industry.
Tyler Durden reports on the mortgage foreclosure moratorium imbrolio relating Wells Fargo prepares for tsunami of loan repurchase demands and also Suzanne Kapner of Financial Times reports: “investors in private label lecurities have sued the large banks in an effort to recoup losses on mortgages they say were not underwritten properly. Among the investors that have filed suit are the Federal Home Loan Banks of Pittsburgh, Seattle and San Francisco, which are demanding a combined $25.6bn, according to a report published in August by Compass Point, a US research firm. And Moody’s Investor Service warned that foreclosure irregularities at a MetLife unit could force the company to hold property longer.” … Chart of WFC, JPM, C, and BAC
Tyler Durden reports on the issue of Conejo Capital Partners and the Earls family moving back in to reclaim the real estate property at 5893 Mustang Dr Simi Valley 93063. This event is also covered by Irvine Renter in article Evicted HELOC Abusers Break In And Squat in Foreclosed Home.
China is on a global buying spree using US trade deficit dollars. Elaine Meinel Supkis of Culture of Life News relates: “This puts the money we sent to them back into circulation and wherever they use this money, we see inflation. So they buy oil fields and the price of oil goes up, for example. Eventually, China will own all of our energy reserves. All the paper money we gave the world via our trade deficit will return to us in the form of higher prices for things we need to survive with all the profits flowing to foreign owners. We will be peasants.” … “People think Toyota is OK if they hire a handful of southerners who hate unions to assemble Japanese cars. But all profits flow to Tokyo and this destroys our own capital base. It doesn’t flow back into our banking system to feed future expansion, it feeds Japanese expansion which is mostly overseas (the people of Japan see little benefits from exporting, by the way, another reason to not try to export our way out of this mess!”
I state that the Ian Katz and Rebecca Christie of Bloomberg report Treasury Says Report on Currencies to Be Delayed Until After G-20 Meetings shows China has the world’s sovereign currency.
And I state that the Capitalist Chinese are busy taking over America just like the Capitalist Japanese did with automobile production. Monica Hatcher of the Houston Chronicle relates China stakes claim to S. Texas oil, gas. State-owned Chinese energy giant CNOOC is buying a multibillion-dollar stake in 600,000 acres of South Texas oil and gas fields. The United States is no longer sovereign over its territorial natural resource reserves. The US is no longer a sovereign country. Soveriegn nation states have fallen to International Capitalism, which has risen to be the sovereign world wide government system.
And International Capitalism has a spiritual twin, that being the United Nations. Hoodia Gordonii in International Discussion article Massive Challenges Highlight Key Role Of Global Governance, Ban Says provides UN.ORG News stating: “The world is facing challenges transcending borders like no other time in history”, Secretary General Ban Ki-moon told an international conference in Morocco today, underlining the pivotal role played by global governance.
Tyler Durden relates in article Bill Gross Telegraphs QE2 Green Light, Buys MBS On Margin: “Pimco has just increased its MBS holdings to the highest since July 2009, when Gross was already dumping MBS on the tail end of QE1. The biggest tell however, is that just like before QE1 abd QE Lite were announced, Bill has once again gone on margin, reducing his net cash exposure from $5 billion to ($7.6) billion. And keep in mind this is September: we are certain that once the October results come out, a few weeks after QE2 is effective, TRS will have a material margin position of more than $20 billion, and will have pumped up its MBS holdings up to $100 billion. So now that we are certain that Gross just telegraphed that QE2 is imminent, that leaves us with two questions: 1) why MBS and not USTs? Is Gross saying that Bernanke will once again be forced to come out and buy MBS in addition to USTs? or 2) did Gross just get (smashed) on his doubling down MBS? If the entire MBS model is indeed unwound as some speculate, this could well be the end of PIMCO. Yet these are considerations for the future. For now – anyone who may have had an ounce of doubt as to Bernanke’s FOMC announcement intentions, can now put it away” …. Chart of MBB.
The Star-Ledger reports tht New Jersey will bring as much as $1 billion in Build America Bonds, BAB, to market, to support its Ttransportation Trust Fund Authority, after increasing the proposed sale size following a successful refunding transaction, the state Treasury Department said.
Digital Angel, DIGA, fell 30% on Friday October 15, 2010. In press release dated 10-12-2010, Digital Angel Corporation, DIGA, an advanced technology company in the field of animal identification and emergency identification solutions, announced today that its Board of Directors has retained the investment banking firm of AgriCapital Corporation to provide advice on alternative strategies for the Company. Digital Angel’s Board previously announced its intention to engage a financial advisor to provide an independent valuation of the Company, to evaluate outside expressions of interest in the Company, and to advise the Board on all available strategic alternatives for the Company, including maintaining its independence.
Elaine Meinel Supkis of Culture of Life News relates how the yen carry trade worked with regards to LBOs: “The Japanese carry trade flooded the West with easy money which was used by banking pirates operating out of various island pirate coves protected by various Crowns so these banking investors dumped the Japanese debt onto all our businesses and properties which inflated the principal due on everything in sight. For example, they bought many businesses by bidding up the value of the business and then, when taking over, would dump this pile of IOUs onto the company and then fire half of the staff and ruthlessly run the remainder so the corporation would limp along, paying off this stupid and totally unnecessary debt until they were free again”.
Abigail Moses and Shannon D. Harrington of Bloomberg report “Credit-default swaps on bonds sold by Brazil, Russia, India and China are closing in on those tied to the world’s largest economies, which are piling on debt in an attempt to stoke growth. The average cost of contracts protecting debt of the so-called BRICs dropped to 41.4 bps more than the price of swaps on the Group of Seven countries and last week reached the lowest on record.”
Simon Kennedy and Sandrine Rastello of Bloomberg report: “Leaders of the world economy failed to narrow differences over currencies as they turned to the International Monetary Fund to calm frictions that are already sparking protectionism. Exchange rates dominated the IMF’s annual meeting in Washington on concern that officials are relying on cheaper currencies to aid growth, risking retaliatory devaluations and trade barriers. China was accused of undervaluing the yuan, while low interest rates in the U.S. and other rich nations were blamed for flooding emerging markets with capital. Finance ministers and central bankers pledged to improve cooperation, yet did little to show how they would alter their ways beyond agreeing to let the IMF study the matter.”
Ye Xie and Lilian Karunungan of Bloomberg report: “China is moving to add more emerging market currencies to its foreign-exchange reserves, a strategy central banks around the world are following to diversify their $8.7 trillion in holdings. ‘We can diversify more the foreign reserves, to consider not only smaller countries, but some emerging-market economies,’ central bank Governor Zhou Xiaochuan said. … With increased assets, ‘you can shift some to riskier, but higher-return investment instruments,’ said Zhou.”
Bloomberg reports: “China’s foreign-exchange reserves, the world’s largest, surged by a record to $2.65 trillion at the end of September… Currency holdings rose about $194 billion in the third quarter.”
Lukanyo Mnyanda of Bloomberg reports: “Currency traders may supplant so called bond vigilantes credited with enforcing government fiscal discipline in past decades as more nations ease their monetary policies through asset purchases, M&G Investments said. ‘If the authorities are actually or are merely threatening to print money, then economic agents should act vigilantly and avoid this new money by exchanging it for other currencies or assets,’ M&G money manager Richard Woolnough wrote. … ‘If the bond vigilantes are dead, who will take their place? The sequel to the bond vigilantes could well be the currency vigilantes.’”
Tony C. Dreibus of Bloomberg reports: “Commodities extended a rally to the highest in two years on speculation the declining U.S. dollar will boost investments in metals, energies and agriculture futures.”
Krishnan of Bloomberg reports: “India’s inflation unexpectedly accelerated, increasing pressure on the central bank to extend the most aggressive monetary policy tightening in Asia. The benchmark wholesale-price index rose 8.62% in September from a year earlier.”
Kartik Goyal of Bloomberg reports: “India’s industrial production growth slowed to a 15-month low in August. … Factory, utilities and mines output rose 5.6% from a year earlier after a revised 15.2% increase in July.”
Mark Drajem of Bloomberg reports: “China’s trade surplus with the U.S. jumped to $28 billion in August, reaching a record for the first time since the financial crisis began two years ago.”
David M. Levitt of Bloomberg reports: “Commercial property investors are focusing on the best buildings in major U.S. markets, driving up prices in six cities as the rest of the country hovers near the post-crash bottom, according to the MIT Center for Real Estate. … Prices for ‘trophy’ commercial properties are up 19% since bottoming in New York, Washington, San Francisco, Boston, Los Angeles and Chicago. The Moody’s/REAL Commercial Property Price Index tracking the entire U.S. has gained 1% from a seven-year low in October 2009.”
Vincentnt Del Giudice of Bloomberg reports: “The U.S. government posted its second straight annual budget deficit in excess of $1 trillion as lingering unemployment constrained tax revenue. The shortfall totaled $1.294 trillion in the fiscal year ended Sept. 30, second only to the $1.416 trillion deficit in 2009 … Federal spending fell 1.8 percent in fiscal 2010 to $3.456 trillion as expenditures tied to the financial crisis, such as TARP, were wound down. Fiscal 2010 tax receipts and other revenue increased by 2.7 percent to $2.162 trillion after declines in each of the two previous fiscal years.”
III … Doug Noland of Prudent Bear writes: Our system became a Credit glutton – and the amount of new Credit necessary to sustain the system’s maladjusted structure is in the process of inciting dangerous inflationary distortions around the world. In the past, I’ve written about the “Core to Periphery” inflationary bias. There is today a deeply imbedded propensity (“Monetary Process”) for liquidity originating within the U.S. Credit system to flow out to other venues perceived to offer better returns or provide better “stores of value.” The Treasury and Federal Reserve (the “Core”) can create Credit/purchasing power and marketplace liquidity, but the more they inflate (non-productive Credit) the greater the propensity for the flows to flee the dollar (in route to the inflating “Periphery”).
The U.S. cannot win the “currency war.” In reality, central bankers in China, Japan, Brazil, South Korea and elsewhere aren’t even battling against us. They have, instead, been waging war on the market. If foreign central bankers had not intervened and accumulated massive dollar holdings (international reserves up an incredible $1.5 TN in 12 months!) – in the process providing a “backstop bid” for both our currency and the Treasury market – it would be an altogether different market environment today.
There will be no answer for global imbalances found by the U.S. “inflating the rest of the world.” The problem with inflationism is that one year of inflationary measures leads only to the next year of greater inflation. The amount of outbound financial flows and inflationary pressures emanating out of our system have already become unmanageable.
The most recent bout of dollar weakness has incited robust inflationary biases. The Asian region – most notably China and India – is already overheated. Throughout the “developing economies, ” Credit systems are operating in excess. Most commodities have been under intense upward price pressure. This inflationary bias is especially pronounced for the commodities in demand from the booming “Periphery” economies (i.e. copper, sugar, wheat, corn, rice, cotton, rubber, etc.)
And as dollar confidence falters, precious metals prices skyrocket. And, in an over-liquefied, speculative financial world, these dynamics feed on themselves.
Back in the early-nineties through the initiation of the post-tech Bubble reflation, our policymakers enjoyed a backdrop conducive to extraordinary policy effectiveness and flexibility. A prominent global “Periphery to Core” financial flow dynamic – otherwise know as “King dollar” – ensured an inflationary bias largely contained within U.S. asset markets. We would run enormous deficits and egregiously loose monetary policy. Yet the resulting Current Account Deficits and speculative flows would be too easily recycled right back into our securities markets. We could have our cake and eat it too.
“Periphery” Credit systems and economies were at the time so prone to boom and bust dynamics, only the Greenspan Fed could ensure global market participants (especially the leveraged speculators) buoyant securities markets with ample liquidity and robust inflationary biases. There was essentially no amount of U.S. Credit inflation that could not be easily recycled through global currency markets right back to our debt markets.
“King dollar” and Greenspan’s penchant for tinkering with the markets created the most powerful monetary control mechanism the world has ever witnessed. He could flick a switch – 25 bps – and inflate the bond and stock markets, leveraged speculation, home prices, equity extraction, and GDP. Most regrettably, the post-tech Bubble reflationary war against so-called “deflation risks” provided the final death knell for the “Periphery to Core” dynamic. The reign of King dollar was over, although it was not until the bursting of the historic mortgage finance Bubble that inflationary biases vacated U.S. asset markets for much better opportunities elsewhere. Immediately, monetary policymaking lost much of its previous effectiveness. In the face of policy impotence, the U.S. was left with a terribly impaired economic structure and an addiction to cheap foreign Credit.
To simplify things, the problem today is twofold. First, to sustain the maladjusted U.S. economic structure requires ongoing massive stimulus, yet the U.S. monetary mechanism has lost much of its effectiveness in stimulating domestic output (consumption and investment). Second, inflationary biases have shifted decisively to non-dollar overseas securities markets, Credit systems, economies, and commodities markets – and these inflationary biases have, of late, gained significant momentum.
It is a myth that there can be some global resolution to today’s imbalances. Policymakers around the world can continue to accommodate our Credit excesses. This would only ensure greater Monetary Disorder, heightened inflationary distortions, a more problematic buildup of U.S. debt, and more acute global systemic vulnerabilities. We are not getting our house in order, and blaming others deflects from the real issues.
One of these days, Mr. Market might just turn on our debt markets. There is now talk of “currency vigilantes,” yet global risk markets these days absolutely feast on dollar weakness. After all, when the private market turns away from our currency, global central banks stand tall as the ever-reliable, insatiable “backstop bid.” Dollar weakness bolsters inflationary flows to our bonds and all the “Un-dollars” (gold, silver, emerging economies, commodities, equities, and global risk assets, more generally).
So – in spite of the strengthening “Core to Periphery” inflationary flows bias – dollar weakness has thus far ensured the recycling of excess dollars right back into our Treasury market (guaranteeing at least one powerful U.S. Bubble dynamic). And our politicians have become comfortable blasting the buyers of our debt as “currency manipulators” and the whole dollar-support mechanism as some “beggar thy neighbor” “currency war.” Well, I often ponder how the marketplace will function that seemingly inevitable day when the markets have to start going it on there own – without the comfort of an ever-towering “backstop.” Not easy to envision a winner anywhere in sight.
IV. … ForexLive provides the Steven K. Beckner, Market News International report Fed’s Evans: Much More Policy Accomodation Appropriate Today from Boston: Chicago Federal Reserve Bank President Charles Evans advocated “much more” monetary stimulus Saturday and said it’s not even “a close call.”
Evans, who will be a voting member of the Fed’s policymaking Federal Open Market Committee in 2011, proposed that one option for the Fed would be to announce a “price level target” in conjunction with any decision to provide more monetary accommodation. He said such a target, as distinct from an inflation rate target, should be made “state contingent” for a “reasonable” time period.
Evans, in remarks prepared for a Boston Federal Reserve Bank conference, said the economy is in a “bona fide liquidity trap” and projected that inflation could still be a sub par 1% and unemployment 8% or more by the end of 2012. (My comment is that the Fed created the liquidity trap via its TARP Facility and Excess Reserves Facility which has encourage banks to place their capital on reserve at the Fed earning low interest.)
He pulled no punches, saying that if it was possible the federal funds rate should be a negative 4%. (My comment is that frankly this is stunning, this goes beyond the Bank of Japan’s ZIRP)
“I cannot stare at our current projections for high unemployment and low inflation and think that these projections are consistent with the best monetary policies to address the Fed’s dual mandate responsibilities,” he said.
“In my opinion, much more policy accommodation is appropriate today,” Evans said, adding that “the U.S. economy is best described as being in a bona fide liquidity trap.” (My comment is that more accomodation, fuels inflation and speculation in commodities)
“Risk-free short-term interest rates are essentially zero,” he observed. “Both households and businesses have an excess of savings relative to the new investment demands for these funds. With nominal interest rates at zero, market clearing at lower real interest rates is stymied.” (I never believed that a central banker would call for negative interest rates; this concept, openly expressed, fuels an investment demand for gold.)
“In this setting, even a moderate expansion without a double dip will not lead to appropriate labor market improvement,” he continued. “Accordingly, highly plausible projections are 1% for core Personal Consumption Expenditure Price Index (PCE) inflation at the end of 2012 and 8% for the unemployment rate.” (My comment is that further accomodation, at this point in time becomes toxic as bond vigilantes and dollar vigilantes act to disinvest from bonds and stocks.)
Evans said that “the Fed’s dual mandate misses are too large to shrug off, and there is currently no policy conflict between improving employment and inflation outcomes” and therefore “we need lower short-term real interest rates than the current real federal funds rate of -1 percent.”
“Indeed, if the federal funds rate were positive, I would advocate substantial nominal reductions,” he added. “But we are effectively at zero.”
He said “typical linear Taylor rules” suggest a “minus 4 percent” funds rate is needed and “would boost aggregate demand enough to deliver substantially lower unemployment by the end of 2012.” (My comment is that aggregate demand will fall as the US Sovereign Debt Yield Curve, $TYX:$TNX, steepens, with the 30 year rate ever expanding faster than the 10 year rate, in response to such negative interest rates: the corporate borrowing rate will go up, and with higher corporate rates, businesses will shutter, and people without jobs will not be buying goods or services.)
“If you reach the conclusion that we are in a liquidity trap, or even near a perilous liquidity trap, more accommodation is not data-dependent or a close call,” he said. (My comment is that the Fed’s TARP Facility and the Excess Reserves is a most distressing and perplexing issue for which I have no solution)
Evans refrained from saying exactly how or when the Fed should increase accomodation, but made some suggestions.
“If the Federal Reserve decided to increase the degree of policy accommodation today, two avenues could be: 1) additional large-scale asset purchases, and 2) a communication that policy rates will remain at zero for longer than ‘an extended period.’”
“A third and complementary policy tool would be to announce that, given the current liquidity trap conditions, monetary policy would seek to target a path for the price level,” he continued. “Simply stated, a price-level target is a path for the price level that the central bank should strive to hit within a reasonable period of time.”
For example, he said, “if the slope of the price path … is 2% and inflation has been underrunning the path for some time, monetary policy would strive to catch up to the path: Inflation would be higher than 2% for a time until the path was reattained.”
Evans referred to this as “a state-contingent policy because the price-level targeting regime is only intended for the duration of the liquidity trap episode.”
Evans said he is “hopeful for this policy’s potential to improve upon our current liquidity trap economic conditions.”
He imagined how a price level target would work in various scenarios, first an optimstic one in which inflation returns to 2% or more and the “price gap” is closed by the end of 2012.
In that situation, he said, “Many questions regarding operational responses during this adjustment would need to be addressed.”
“If short-term interest rates remain near zero during this adjustment, real interest rates would be between -2 and -3 percent,” he said. “Perhaps that would be enough to improve labor markets and aggregate demand sufficiently, but I personally put more faith in analyses that suggest the liquidity trap is larger than this.”
Evans said that “in this scenario at the end of 2012, if resource slack remains substantial and inflationary pressures are returning toward 2% over the medium term on account of credible policy commitment, then a standard Taylor-rule prescription may still call for a relatively low federal funds rate.”
“And the size and composition of the Fed’s balance sheet might also be consistent with accommodation,” he continued.
Other situations might “require more complicated responses,” he said.
For example, he said it is possible that “inflation continues to remain very low even after an announcement that monetary policy is following a price-level path. As inflation delay continues, the ‘inflation deficit’ account builds. That is, the price gap gets larger, and implied future inflation to attain the (targeted price) path grows.”
Evans said that “would clearly be nerve-wracking for policymakers, and the credibility of our commitment to ever growing inflation rates would be crucial for the success of the policy.”
But he said “if our resolve is credible, well-functioning financial markets should get the message.” He added that he “would expect the financial press to help communicate these investment risks on a regular basis.”
Evans said another challenge might come if “the degree of resource slack in the economy is much smaller than many presume, for example if the structural rate of unemployment was upward of 8%.
“In this case, more accommodation could lead to higher inflation and a rapid closing of the price gap,” he said. “A quicker closing of the price gap harkens the exit of the state-contingent price-level policy.”
“The fact that unemployment would remain high would be a signal that increasing aggregate demand alone is not enough to address this problem,” he went on. “But monetary policy would have succeeded in moving closer to price stability with the attending benefits from achieving that policy goal.”
Another possible scenario addressed by Evans is “if inflation was surprisingly high at the point when the price gap was eliminated and policy reverted to targeting 2% inflation over the medium term.”
He called that “extremely unlikely,” but “in the unlikely occurrence that inflation accelerates beyond the levels we anticipate, we have the tools to deal with it.”
“Specifically, relative to initial baseline scenarios, the Fed could more aggressively increase the federal funds rate and interest on excess reserves (IOER), as well as drain liquidity from our balance sheet,” he said. “Furthermore, any higher inflation would almost surely be associated with stronger economic growth and job creation, so these stronger ‘exit strategy’ actions would be entirely appropriate.”
If the Fed were to adopt a price level target, he said it “would have to credibly convey to the public that this policy will end when the price gap is closed.”
He warned that “an important risk would be the temptation to keep policy easy if the labor market has not reached the vicinity of full employment.”
V . …. Year-to-date gains for the leading ETFs:
Semiconductors, SMH, 2%
Banks, KBE, 6%
Mortgage Banker, KME, -6%
Investment Bankers, KCE, -7%
Russell 2000, IWM, 13%
World Shares, ACWI, 6%
S&P, SPY, 5%
Dow, DIA, 6%
Nasdaq, QQQQ, 13%
Nasdaq Internet, PNQI, 26%
Dow Internet, FDN, 33%
Internet, HHH, 15%
Buy Write, ETW, -9%. This failed to be a viable investment opportuntiy on September 10, 2010
Utilities, XLU, 3%
Consumer Staples, XLP, 8%
Banks, KBE, 6%
Airlines, FAA, 26%. Airlines have come under the influence of QE Cool Aid
Dow Transports, IYT, 14% Transports have gotten a good portion of the QE Juice
Dow Industrials, IYJ, 12%
Small Cap Pure Value, RZV, 13%
Small Cap Pure Growth, RZG, 15%
Mid Cap Growth, JKH, 13%
Mid Cap Value, JKL, 13%
Consumer Discretionary, IYC, 13%
Small Cap Consumer Discretionary, XLYS, -1%
Solar Energy, TAN, -13%
Leisure And Entertainment, PEJ, 27%
Nanotechnology, PXN, -9%
Retail Holders, RTH, 6%
Biotechnology, XBI, 14%
Hong Kong, EWH, 22%
Singapore, EWS, 21%
South Africa, EZA, 24%
Sweden, EWD, 26%
Peru, EPU, 44%
Thailand, THD, 51%
Turkey, TUR, 43%
Indonesia, IDX, 41%,
Malaysia, EWM, 32%
India, INP, 22%
Spain, EWP, -10%
Austria, EWO, 9%
Brazil, EWZ, 7%
Brazil Small Caps, BRF, 23%
Emerging Markets Small Cap Leaders, EWX, 23%
International Discretionary, IPD, 12%
Emerging Markets, EEM, 12%
Frontier Markets, FRN, 30%
Agricultural stocks, MOO, 14%
Emerging Market Titans, EMT, 10%
HUI Precious Metals, GDX, 24%
Junior Gold Mining Stocks, GDXJ, 38%
Copper Mining, CU, 27%
Nikkei 225, ^N225, -10%, HT to Doug Noland
China’s Shanghai Exchange, 1SS, surged 8% this week, -9%, HT to Doug Noland
Gold, GLD, 25%
Silver, SLV, 43%
Commodities, DBC, 1%
Tin, JJT, 56%
Lead, LD, -5%
Copper, JJC, 11%
Agricultural commodities, RJA, 17%
Food Commodities, FUD, 18%
Corn, CORN, 43%
Grains, GRU, 15%
Cotton, BAL, 44%
Junk Bonds, JNK, 3.5%
Emerging Market Bonds, EMB, 11%
World Government Bonds, BWX, 8%
Corporate Longer Maturity Bonds, BLV, 9%
Ford Motor Credit, FCZ, 19%,
Mortgage Backed Bonds, MBB, 3%
Bonds, BND, 5%
Of the above, the best short selling opportunities are RZV, EWO, KBE, ITB, INP, IWM, EWD, BX, TAN, BRF, PNQI, ETW, FAA, PEJ, RTH, BWX and can be seen in this MSN Finance chart, for the period of June 7, 2010 to October 17, 2010. And here is a Finviz Screener of these ETFs.
Disclosure: I am invested in gold coins