Category: zerohedge

In addition to its three previously announced so far “Top Trades” for 2014 (see here, here and here), just over an hour ago Goldman revealed its fourth top recommendation to clients. To wit: Goldman is selling China equities (via the HSCWI Index), while buying copper (via Dec 2014 futs), or at least advising its flow clients to do the opposite while admitting that “for the long China equity/short commodity pair trade to “work” best, these two assets, which are usually positively correlated, will have to move in opposite directions.” For that and many other reasons why betting on a divergence of two very closely correlating assets will lead to suffering, read on. Finally – do as Goldman says, or as it does? That is the eternal question, one whose answer is a tad more problematic since the author in this case is not Tom Stolper but Noah Weisberger.

From Goldman Sachs

Top Trade Recommendation #4: Long China equities/Short Copper

•    We introduce our 4th Top Trade Recommendation for 2014:
•    Long China equities via the HSCEI Index vs. a short copper position via Dec 2014 LME futures.
•    We set an initial target of +c.25% on the combined position, and a stop loss of –c.13% on the combined position.
•    This trade highlights several important features in our 2014 set of market views:
•    the expected 2014 acceleration in global growth,
•    the desire to own equity risk,
•    the importance of EM differentiation,
•    the positive market implications of China growth stability,
•    and commodity price downside generated by seemingly abundant supplies.

1. Market round up

In Friday’s short US market session, the S&P 500 broke thru the 1810 level, only to retreat into the (early) close and finish down a fraction on the day. European equities were mixed, with the DAX up a touch, but most other markets down. And the USD continues to strengthen, particularly relative to EM currencies.
Overnight, HSBC PMI in China was a touch stronger than expected and the official PMI print was unchanged from the previous month. In Australia, building approvals were much stronger than expected in October and remain the one bright spot in the non-mining economy; however, the recovery in the housing investment sector remains insufficient to offset our forecast for contraction in the mining investment sector. As such we continue to expect economic growth to slow to 2.0% in 2014 and for the RBA to ease interest rates 25 bp by March. Today, the final print of the November PMI for the Euro Area is released too. In the US, we expect the ISM index to be slightly higher than markets expect (we forecast 55.5 vs. consensus at 55).

This week, there are seven MPC meetings: Euro Area, UK, Canada, Australia, Norway, Mexico, and Poland. In each case we and consensus expect no major announcements and the central banks to stick to the current monetary policy stance. On Friday, the Nonfarm Payrolls for November is going to be closely followed. We are expecting employment gains to be a touch below consensus (GS +175k, consensus +183k, last +204k).

2. Top Trade Recommendation Number 4: Long China equities/Short Copper

In today’s Global Markets Daily, we introduce our 4th Top Trade Recommendation for 2014: Long China equities via the HSCEI Index vs. a short copper position via Dec 2014 LME futures. Given that the volatilities of these two assets are similar, we recommend implementing this trade with equally sized positions in the two assets, with an initial target of +c.25% on the combined position, and a stop loss of –c.13% on the combined position.

Our China Equity Strategy team has a year-end target of 13600 for the HSCEI (+c.19% from current levels), and our Commodity Strategy team has an end-2014 copper price forecast of $6,200/mt (-c.13% from current levels, with the Dec 2014 LME future a bit above spot, suggesting some positive carry from a short position here too), making our combined target of +25% a bit more modest than the two separate forecasts would suggest.

This trade highlights several important features in our 2014 set of market views: the expected 2014 acceleration in global growth, the desire to own equity risk, the importance of EM differentiation, the positive market implications of China growth stability, and commodity price downside generated by seemingly abundant supplies.
This long equity/short commodity trade is a way of isolating exposure to China equity risk via a long HSCEI position, which we think is underpriced by the market given our views of stable growth and ongoing rebalancing there, while the copper short hedges out exposure to China’s economic growth, which we think will be stable but not stellar. Short copper, which is typically highly correlated to China growth outcomes and China equities too, has the added advantage of being an asset that we think will likely be facing headwinds of its own over the course of the year, with the short position potentially adding to the positions’ expected returns, and not just a hedge against unanticipated outcomes.

3. Stable China may be good enough, EM differentiation to continue

Core to our 2014 views is that global real GDP growth will accelerate a touch, from 2.9% in 2013 to 3.6% in 2014. Nearly all of that pick-up is coming from DM economies, with our views there most clearly above consensus. EM economic growth, on the whole, is expected to be stable, with growth in China forecast at 7.8%, up only a tenth of a point from 2013. Our China Economists have argued that external acceleration will help to mitigate ongoing domestic rebalancing. And on top of that, the set of reforms announced earlier this month have the potential to keep China on a steady path forward, toward a further strengthening of their underlying economic fundamentals.

While acceleration and stellar China growth per se, is not at the heart of our forecasts, external strength and stability at home ought to be enough to boost risk sentiment in China, particularly after several years of poor performance from Chinese equity indices. Chinese equities are about flat, year to date, have underperformed for much of the last several years, are well below pre-crisis highs (though those levels may be unattainable in the near term), and are also still below post-crisis, mid-2010 highs. Our Asian Equity Strategy team, which has an Overweight recommendation in the HSCEI, sees scope for multiple expansion in China and 10% EPS growth there. Importantly, China equity exposure seems to be fairly light in the data we monitor (Asian-focused funds are still significantly underweight China), which further suggests to us that very little “China upside” has been priced.

Underscoring the importance of EM differentiation, a core market view, this top trade recommendation is motivated by China risk optimism relative to a more downbeat view as priced by markets. But this is not a broader EM growth story. As such, implementation is very specific too. In the past, we have argued that a wide swath of assets – equity sectors, commodities, and commodity producing EM equity indices – all have outsized exposure to China growth. However, China equity risk, not growth, is the view we are expressing. Hence, our choice of trade implementation is long China equities directly, via the HSCEI index.

4. Commodity downside ris
ks grow

One asset that has, historically, been correlated to China growth is copper. A short copper position paired with long China equities, is one way of focusing our trade on the “risk” aspect of the equity market, while hedging out the growth aspect. Moreover, despite its usual positive correlation with China equities, we expect copper prices to face pressure this year, forecasting a decline in price to $6200/mt from about $7070/mt currently, owing primarily to abundant supply and a lack accelerating demand, even as we expect risk sentiment to boost China equities themselves.

Expectations of copper price headwinds also underscore the headwinds that we think commodity producers may be facing in the coming year. Sectors like metals and mining and energy, and equity indices with outsized commodity exposure like Brazil, and even Canada are also likely to face headwinds too. Commodity-intensive equities may benefit somewhat from a broad improvement in equity sentiment; outperformance of commodity-linked cyclical assets is less likely given the headwinds for commodities themselves.

5. Some risks to the top trade recommendation

We are cognizant of several risks to this Top Trade recommendation. First, and foremost, for the long China equity/short commodity pair trade to “work” best, these two assets, which are usually positively correlated, will have to move in opposite directions. These two assets have, since late October, already started to move apart. And the assumption from here is that “mean reversion” will be supplanted by fundamental forces pushing in opposite directions– a preference for China equity risk, amid supply-side driven downside commodity pressures, will continue to prevail.

Should China growth prove more robust than we anticipate, it is possible that both copper and China equities will respond, pushing both higher. If so, trade performance will depend on the relative size of those moves higher, and returns will likely be more attenuated than current expectations. Another possible effect of stronger-than-anticipated China growth could be further a tightening of financial conditions there, which could be an incremental headwind to the equity leg of the trade. This possible configuration of macro shocks is, in some ways, the worst possible outcome for this particular trade recommendation, with better growth outcomes supporting copper, tightening financial conditions, and damaging equities.

Finally, we are also concerned that part of the China risk optimism that we anticipate is predicated on the proposed reform agenda helping to stabilize the anticipated path forward from here. While, ultimately, the success of these reforms will only be proven in the course of the next several years, near-term sentiment could be damaged if there is any backing away from the proposed set of reforms, or if those proposals generate political or public dissatisfaction.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/2-4gWzzV7D4/story01.htm Tyler Durden

If anyone was expecting a start to the week with another fresh burst of Yen weakness, they were not disappointed and starting in the overnight session following the return of the as predicted now daily BOJ jawboning of the Yen lower, the USDJPY ramped higher reaching just shy of 103, even though tonight’s move barely moved the Nikkei which closed unchanged. There was speculation of further possible weakness and suggestion that the Yen may drop to 108 vs USD in the coming year as Japan’s main government pension fund invests more of the world’s largest pool of retirement savings abroad, former Ministry of Finance official Eisuke Sakakibara said. Of course, what Japan “may” do and what it will do are very different, especially considering that the EURJPY has already soared about 700 pips merely on hope that more BOJ QE may be coming. In other less than pleasant news for Japan’s religionomic uber shaman, Abe’s public support dropped below 50% for the first time amid a campaign to strengthen Japan’s secrecy laws, a decline that risks eroding his political capital to enact economic reforms.

Over in China, the initial enthusiasm with which the beat in both the Official (51.4 vs 51.1 forecast) and HSBC (50.8 vs 50.5 forecast) PMis were greeted, promptly faded and the SHCOMP also closed red on concerns that more monetary tightening by the PBOC was imminent. In Europe, curiously despite the stronger than expected final PMIs (see chart below), the EUR has suddenly found itself in an airpocket and the EURUSD has slide nearly 100 pips since the European open for reasons still largely unknown.

A quick snapshot of Europe’s final manufacturing print for November via Goldman: “The Euro area final manufacturing PMI printed at 51.6 in November, up 0.1pt from the Flash reading (and the Consensus expectation) and up 0.3pt relative to October reading. The French final PMI came in 0.6pt higher than the Flash; this limits the French November decline to 0.7pt. The German PMI increase was revised upwards by 0.2pt.The November PMI disappointed in Spain, but surprised to the upside in Italy.”

Previewing the rest of this week’s events, we have a bumper week of US data over the next five days, in part making up for two days of blackout last week for Thanksgiving. Aside from Friday’s nonfarm payroll report, the key releases to look for are manufacturing ISM and construction spending (today), unit motor vehicle sales (tomorrow), non-manufacturing ISM (Wednesday), preliminary Q3 real GDP and initial jobless claims (Thursday), as well as personal income/consumption and consumer sentiment (Friday). Wednesday’s ADP employment report will, as usual, provide a preamble for Friday’s payrolls.

Overnight headline bulletin from Bloomberg and Ransquawk:

• Combination of profit taking related flow, as well as market participants positioning for a slew of risk events due to take place this week ensured that stocks traded lower in Europe.
• The Office for Budget Responsibility (OBR) – the Government’s independent fiscal watchdog – is likely to upgrade its projection for UK growth in 2013 to 1.4%, from a forecast of 0.6% in March.
• Looking ahead for the session there is the release of ISM Manufacturing (Nov) M/M Exp. 55 (Prev. 56.4) at 1500GMT/0900CST.
• Treasuries decline, led by 5Y and 7Y with 10Y yields near Sept. highs and curves steepening; focus on Friday’s jobs report amid expectations Fed aims to taper asset purchases while holding short rates low indefinitely.
• China’s purchasing managers index held at 51.4 in Nov., higher than the median forecast in a Bloomberg survey
• Manufacturing in the euro area expanded in Nov., with Markit Economics’s factory index rising to 51.6 from 51.3 and an estimate for 51.5
• U.K. manufacturing rose to 58.4 in Nov., highest since Feb. 2011
• JPY may drop to 108 vs USD in the coming year as Japan’s main government pension fund invests more of the world’s largest pool of retirement savings abroad, former Ministry of Finance official Eisuke Sakakibara said
• Abe’s public support dropped below 50% for the first time amid a campaign to strengthen Japan’s secrecy laws, a decline that risks eroding his political capital to enact economic reforms
• The U.S. and Japanese governments’ split over how commercial airlines should operate in China’s self-declared air-defense zone has put carriers at the center of an escalating political dispute
• While the U.S. said yesterday that its Obamacare web site repair goals were reached, the site’s stated new capacity of 50k users hasn’t been proven in the real world and officials aren’t certain the site will hold up, according to a person familiar with the repairs
• Opponents of Ukrainian President Viktor Yanukovych are trying to shut down government buildings after he refused to sign a EU trade agreement and the authorities violently dispersed a protest
• Sovereign yields higher; EU peripheral spreads narrow as bund yields rise. Asian stocks mixed, European stocks and S&P 500 index futures gain. WTI crude, copper and gold decline

Market Recap from RanSquawk

Combination of profit taking related flow, as well as market participants positioning for a slew of risk events due to take place this week ensured that stocks traded lower in Europe. Even the release of better than expected macroeconomic data from China overnight, together with broadly higher Manufacturing PMIs out of Eurozone failed to lift sentiment and the move lower was led by utilities, with ENEL down over 3% after analysts at Deutsche Bank noted that co.’s estimated earnings show no growth for 2013/14. Also, shares in ThyssenKrupp fell 7% as investors reacted to news over the weekend of the German steelmaker’s planned capital increase.

However in spite of the evident risk off sentiment, Bunds failed to gain upside traction and were dragged lower by Gilt, which fell over 70 ticks amid the reports that the Office for Budget Responsibility is to upgrade its projection for UK growth in 2013 to 1.4% from a forecast of 0.6% in March, together with the release of two and a half year high reading for UK PMI Manufacturing. In turn, despite a firmer USD, GBP/USD outperformed its peers, with EUR/GBP falling to its lowest level in over 11-months. Of note, USD/JPY touched on its highest level in 6-months, with RKO barriers noted at 103.00 and then at 103.25. Going forward, market participants will get to digest the release of the latest ISM Manufacturing report.

Global Headlines

Goldman Sachs 4th top trade for 2014: long China stocks/short copper.
Goldman Sachs 3rd Top Ten 2014 Trade is long USD/CAD; targeting 1.14.
Goldman Sachs 2nd Top Ten 2014 Trade is long 5 yr EONIA vs short 5 yr US Treasuries.
Goldman Sachs 1st Top Ten 2014 Trade is Long S&P500, short AUD/USD.

Asian Headlines

Chinese Manufacturing PMI (Nov) M/M 51.4 vs. Exp. 51.1 (Prev. 51.4); an 18-month high.
Chinese HSBC Manufacturing PMI (Nov) M/M 50.8 vs. Exp. 50.5 (Prev. 50.9).
New Orders at an 8-month high of 51.7 vs. Prev. 51.5.
Morgan Stanley leaves China’s 2013 growth forecast at 7.6% and raises 2014 exp. to 7.2% from 7.1%.
BoJ governor Kuroda said he wont hesitate to make policy adjustment if needed and that he doesn’t think risks from sales tax rise are so high.

EU & UK Headlines

The Office for Budget Responsibility (OBR) – the Government’s independent fiscal watchdog – is likely to upgrade its projection fo
r UK growth in 2013 to 1.4%, from a forecast of 0.6% in March.

The German-Greek spread has tightened by around 10bps after Moody’s upgraded Greece’s government bond rating to Caa3 from C; Outlook stable.

BoE’s Carney warned would be British home owners to consider risks of higher interest rates amid concerns that rising house prices could create a property market bubble

Eurozone PMI Manufacturing (Nov F) M/M 51.6 vs Exp. 51.5 (Prev. 51.5)
German PMI Manufacturing (Nov F) M/M 52.7 vs Exp. 52.5 (Prev. 52.5)
French PMI Manufacturing (Nov F) M/M 48.4 vs Exp. 47.8 (Prev. 47.8)
UK PMI Manufacturing (Nov) M/M 58.4 vs Exp. 56.1 (Prev. 56.0) – two and a half year high
Swiss PMI Manufacturing (Nov) M/M 56.5 vs Exp. 54.4 (Prev. 54.2)
Italian PMI Manufacturing (Nov) M/M 51.4 vs Exp. 50.8 (Prev. 50.7) – Highest since 2011
– Italian PMI Jobs Sub-Index (Nov) 50.6 vs Prev. 49.2.
Spanish Manufacturing PMI (Nov) M/M 48.6 vs Exp. 51.1 (Prev. 50.9)

US Headlines

After holdings of US debt surged to a record USD 1.89trl in 2012, lenders from Citigroup to Bank of America and Wells Fargo are culling for the first time in six years and amassing USD amid taper risk.

Dagong Global Credit Rating Co. may further downgrade US sovereign rating if the nation fails to improve its debt service capability.

Equities

The release of better than expected macroeconomic data from China, together with an encouraging set of Eurozone based PMIs this morning failed to lift sentiment, with stocks trading lower throughout the session as market participants booked profits and positioned for a slew of risk events due this week. The move lower was led by utilities, with ENEL down over 3% after analysts at Deutsche Bank noted that co.’s estimated earnings show no growth for 2013/14. Also, shares in ThyssenKrupp fell 7% as investors reacted to news over the weekend of the German steelmaker’s planned capital increase.

FX

In spite of a firmer USD, GBP/USD traded higher, supported by the release of two and a half year high reading for UK PMI Manufacturing which consequently resulted in EUR/GBP falling to 11-month low. At the same time, combination of favourable interest rate differential flows, together with options related flow ahead of touted RKOs at 103.00 and 103.25 saw USD/JPY edge higher, touching on a 6-month high in the process.

Commodities

Heading into the North American open, WTI and Brent crude futures trade relatively unchanged despite seeing some upside in the the Asian session where it was reported that Iranian president Rouhani insisted that Tehran will not dismantle its nuclear facilities.

Iran are seeking foreign capital for oil and gas development projects and are to consider increasing the share of profits that go to foreign investors. Iran and European oil executives are to meet in early 2014 to present terms of doing business in Iran again.

Libya’s oil output around 224,000bpd as of Nov 30. up from 172,000 two weeks ago and the nations oil exports are around 130,000bpd, with the remainder used to feed Zawiya refinery. according to the Deputy Oil Minister.

Concluding the overnight event recap is DB’s Jim Reid

In the week where we’re looking to finish our 2014 outlook we have two big end week events to keep us on our toes and potentially complicate things for us. On top of that today’s PMIs (and the ISM) give us the latest barometer of global manufacturing activity. China has already slightly beaten expectations in its HSBC flash PMI this morning (50.8 vs 50.5 forecast), which followed the weekend’s official manufacturing PMI that was also above consensus (51.4 vs 51.1 forecast).

Looking to the end of the week, the ECB have their monthly policy meeting on Thursday and then Friday brings all the fun and games of a US payroll number that could decide whether 2013 ends with the FOMC reducing some of the $85bn monthly bond buying. As for the ECB, it seems they are actively considering/debating what more they can do to combat low inflation but it does seem to us that there needs to be more work done before they agree on a strategy. This is the view of our economists but they acknowledge that the recent rise in eonia – which they suggest may reflect treatment of LTROs in the end-December AQR and be encouraging the accelerated 3Y LTRO repayments – may require some policy action. Overall it’s a close call for them but the most likely is no action for now.

As for payrolls the 3-month moving average is currently +202k which is the highest since April (+224k). Our economists expect +185k (+190k private), but also +50k in upward revisions thus helping maintain the 3-month average. Consensus is for +183k and +175k in the headline and private payrolls respectively. In terms of the unemployment rate, DB is calling for at least a one-tenth decline to 7.2% which is also consistent with Bloomberg median estimates. Our economists think that if their forecasts are correct then we will get a Dec-taper. I don’t think the market is set up for this though.

Turning to markets, Asian equities have gotten off to a rocky start to the week despite some initial optimism around the twin-Chinese PMI beats at the start of the session. That optimism has been replaced by selling in Chinese equities, particularly small-cap Chinese stocks and A-shares after the Chinese security regulator issued a reform plan for domestic IPOs over the weekend. The market is expecting the reforms to lead to a higher number of IPOs in the coming quarters, and the fear is that this will bring a wave of new supply of stock to an already-underperforming market. Indeed, the Chinese securities regulator expects about 50 firms to complete IPOs by January 2014 – and another 763 firms have already submitted their IPO applications and are currently awaiting approval. A large number of small cap stocks listed on Hong Kong’s Growth Enterprise Market were down by more than 5% this morning, while the Shanghai Composite is down by 0.9%. The Hang Seng (+0.4%), Hang Seng China Enterprises Index (+0.8%) are performing better on a relative basis, and other China-growth assets including the AUDUSD is up 0.5%. The Nikkei (-0.1%) is also a touch weaker after Japan’s Q3 capital expenditure numbers came in well below estimates (1.5% YoY vs 3.6% forecast). Elsewhere Sterling continues to forge new multi-year highs against the USD (+0.3% overnight).

Previewing the rest of this week’s events, we have a bumper week of US data over the next five days, in part making up for two days of blackout last week for Thanksgiving. Aside from Friday’s nonfarm payroll report, the key releases to look for are manufacturing ISM and construction spending (today), unit motor vehicle sales (tomorrow), non-manufacturing ISM (Wednesday), preliminary Q3 real GDP and initial jobless claims (Thursday), as well as personal income/consumption and consumer sentiment (Friday). Wednesday’s ADP employment report will, as usual, provide a preamble for Friday’s payrolls.

Outside of the data flow, today’s Cyber Monday sales may provide some clues as to the health of US holiday season sales. Some surveys are suggesting that online sales could increase 20% over last year (ComScore). The anecdotal evidence from Black Friday sales suggest that bricks-and-mortar sales increased 2.3% on the same period last year, which was slightly below expectations and the slowest rate of growth since 2009. ShopperTrak forecasts are for an uninspiring 2.4% increase in sales for November and December as a whole. There was also a 3.9% decline in the average shopper’s spending during the Black Friday weekend according to a survey by the National Retail Federation. On a more positive note, there was strong growth in Black Friday ecommerce sales. Adobe Systems said its data showed record online sales for Black Friday and Thanksgiving at $1.93 billion and $1.062 billion, respect
ively.  Adobe said in a statement that Friday’s sales were up 39% from the year before and rose 18% for Thursday. Wal-mart noted that they had the most successful Black Friday sale in their history.

Coming back to the week ahead, in Europe manufacturing PMI data today and service PMI data on Wednesday are the major data releases. The BoE is also scheduled to meet on the same day as the ECB but DB expects no change in policy from either central bank. Eurozone’s 3Q GDP and retail sales are released on Wednesday. It will be a relatively quieter week in Asia with no major data releases. There is talk that the US and Japan may issue a joint statement this week calling on China to retract its recently established airdefense zone (Bloomberg). This comes as US Vice President Joe Biden makes a visit to North Asia this week.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/JLMFBJ7tJQU/story01.htm Tyler Durden

Last week, I published two articles, on Zero Hedge and Breitbart, respectively, that highlight the issue of “financial repression” via low interest rates. Below is an exchange with my dear friend and mentor David Kotok, Chairman of Cumberland Advisors. We discuss the question of whether the current policy of the Federal Open Market Committee is feeding deflation via low rate policy. This question has great significance since the stated goal of FOMC policy is to raise inflation to ~2% annually and boost employment. From my perspective working in the housing sector, the combination of current Fed policy and new regulatory strictures such as Dodd-Frank and Basel III are clearly thwarting efforts by the FOMC to reflate the housing sector and the wider US economy. — RCW

Whalen: David, I really appreciate your comments on the ZH article last week, “Default, Deflation and Financial Repression.” In particular, your focus on ultralow interest rates, Federal Deposit Insurance Corporation premiums and the flow of cash from the banks to the Federal Reserve System is very illuminating – and disturbing. As you know, I have long maintained that the FDIC’s fiscal need to fund the deposit insurance scheme is a separate matter from monetary policy, but when we have near-zero interest rates, the average FDIC premium of 7-10bp does become significant. Can you talk first about what is happening in the US money markets from your perspective?

Kotok: You wrote a very important article last week, especially the part about the Fed taking billions out of the economy and away from savers in order to subsidize the banking industry. But there is another and more nuanced part of the puzzle that we need to consider. We have a Fed Funds target of 0-0.25% in place presently. The Fed is also paying 0.25% per annum on excess reserves. This means the reserve rate is higher than the actual Fed Funds rate while the lower bound is maintained at zero. The GSEs, who are large sellers of Fed Funds, cannot legally deposit directly with the Fed. So, they sell Fed Funds, and the banks buy them and redeposit the cash with the Fed. The FDIC levies an asset-based fee on each bank and that includes the reserve deposit assets which are under their FDIC jurisdiction. So the actual Fed Funds rate, inclusive of the FDIC insurance levy, is below the gross (0.25%) reserve deposit rate. Some larger, riskier banks pay even higher FDIC fees than the average and are effectively losing money on this trade. Meanwhile the US subsidiaries of foreign banks, which are not subject to the FDIC levy, have an advantage in the short-term markets.

Whalen: So your basic point is that the fact that rates are so low in absolute terms is distorting the US money markets, in part due to structural costs like the FDIC insurance premium? The nineteenth-century economist Walter Bagehot maintained that in order to prevent bank panics a central bank should provide liquidity to the market at a very high rate of interest. Yet today the neo-Keynesian tendency that controls the FOMC believes that the fact the Fed has the virtually unlimited ability to temporarily expand the money supply refutes Bagehot’s dictum. In today’s terms, Bagehot was warning us against keeping rates too low for too long because real money would flee from financial repression.

Kotok: Antoine Martin of the Federal Reserve Bank of New York, in his important 2005 paper “Reconciling Bagehot with the Fed’s Response to September 11,” argues that Bagehot had in mind a commodity money regime in which the amount of reserves available was limited. Thus, keeping rates high was a way to draw liquidity, that is gold, back into the markets. Bagehot also understood that low interest rates fuel bad asset allocation decisions – what we call “moral hazard.” In the age of fiat money, however, economists have taken the opposite view, namely that an unlimited supply of reserves obviates the need to attract money back into the financial markets.  Remember that Martin’s paper was written two years before the start of the subprime crisis.

Whalen: His timing was impecable.

Kotok:  Bagehot’s classic text advocated a penalty interest rate secured by good collateral. He was envisioning a form of discount window mechanism similar to what central banks used in the pre-QE era. That mechanism has been mostly replaced with QE, which is a policy that we are still in the early stages of learning about.  More recent Fed papers have delved into the impact of QE on otherwise neutral interest rates. It certainly lowers them for a while and in the early stages of QE. Other researchers have noted how the central bank’s remittances to the Treasury alter the fiscal authority budget balance. And others have focused on the potential methods for terminating QE and getting to a neutral position. Still others are trying to solve the mystery of how to reduce the impact of QE and restore a more neutral policy. Lastly there are the inflation hawks, who forecast an inflationary outcome of QE. They may eventually be right, but after five years the evidence suggests that excess reserves are not by themselves very inflationary. It takes an acceleration of growth to turn post-crisis disinflation force around,.  That means rising demand is needed to obtain  rising price pressures. So far, we haven’t seen much of either in the course of our grand experiment with QE. My colleagues and I have written about these various research papers, and the links can be found on our website, www.cumber.com.

Whalen:  Well, the 2001-2007 period certainly suggests that Bagehot’s concerns about low interest rates fueling moral hazard have not been refuted. The FOMC’s aggressive easing of interest rates, combined with deregulation of the financial markets and the FDIC’s safe harbor with respect to bank asset sales between 2000 and 2010, fueled a speculative binge that nearly destroyed the western world. When Lehman Brothers failed, we had created some $60 trillion in toxic assets that were not supported by the $13 trillion asset US banking system. Now almost seven years since the bust, a large portion of that pile of crap has yet to be remediated.

Kotok: Very true, but the past is past. We must focus on the future. Whether or not you believe that a flexible reserve system like the Fed’s addresses Bagehot’s concern about attracting liquidity back into the markets, the fact is that very low interest rates do distort money flows. That is why your point about the Fed taking $100 billion per quarter out of the hands of savers is so important. But what do the banks do with that money? They deposit it with the Fed. And what does the Fed do with that money? They pay the banks 0.25% and then invest in US Treasury debt and mortgage-backed securities (MBS) at a higher rate, and thereby generate what they call a “profit.”

Whalen: So your point is that the $100 billion per year that the Fed is taking from the hands of consumers, meaning savers, is actually passing through the banking system and going to the Tr
easury via remittances from the Fed?

Kotok: Precisely. The practice of the Fed calling the spread they earn on their nearly $3 trillion portfolio of securities “profits” is a monstrous distortion of the word. What they are doing is feeding deflation in the real economy by reducing savers’ income while pushing down the federal budget deficit. Between budget sequestration and the spread arbitrage created by the low interest rate paid on excess bank reserves, US government policy is clearly operating with a deflationary bias. As you and I have discussed for several years with respect to the higher FDIC deposit insurance premiums, we need to take a holistic view of government policy. The whole playing field gets level if the Fed’s excess-reserve deposit rate is set higher and thus eliminates the false profit they now recognize via remittances to the Treasury.

Whalen: Well, you are assuming that the banks would actually lend out the additional profit that they earned in higher rates on excess reserves. Wouldn’t we need to also raise the target for Fed Funds to say 0-1% from the current 0-0.25% in order to give some of the benefit back to savers of all stripes?

Kotok: As we wrote last week in our Market Comment, in the Fed there are those who argue that the rate should be lowered or maybe go to zero. It is currently 0.25%. Others argue that the rate should be raised or that the amount of required reserves should be changed, thereby changing the excess reserves composition. All sides of this debate are passionately argued by skilled agents in monetary economics. But the real question the FOMC needs to ask is, what are we going to do if inflation continues to fall? That is, if we find ourselves in a deflationary trap. Many commentators argue that we are in one or near one. I am worried about it.

Whalen: It is perhaps not surprising that commercial bankers are against lowering the rate paid on the $2.3 trillion plus in excess reserves sitting on deposit at the Fed.  That is 20% of the assets of the entire US banking sector, again another sign of deflation.  Given the sharp drop in net interest margins in the US banking industry, the Fed may need to boost interest paid on reserves just to keep the industry from imploding.  Just as in the 1930s the Fed fueled deflation by not making credit available, today the opposite seems to be the case – low rates are fueling deflation and impeding the creation of credit to support the economy.  Where are you on the issue of when FOMC policy is likely to change?

Kotok: At Cumberland we believe the short-term interest rate will be kept low for a long period of time, which we measure in years, not months. We do not expect the Fed to deliberately shock the economy by any action that would cause another recession. The June press conference has served to chasten members of the FOMC. Some members of the Fed are already worrying about the possibility of recession. There is evidence of deflationary and/or disinflationary forces at work now. That evidence has raised the eyebrows of some policymakers and commentators. We are among those who worry about this issue. We do not think Japanese-style deflation will happen, but we worry that it could happen. We keep watching commodity prices and oil prices. Oil is especially important because it flows through so any sectors of the economy. And changes in the oil price quickly translate to gasoline prices, and that means a consumption tax increase or decrease. At an annual rate, a 1-cent change in the gasoline price adds up to about $1.4 billion in raised or lowered consumer expenditures.

Whalen: That is a big change. Let’s get back to the deflation issue. For the past year and more I have been writing about the deflationary impact of Dodd-Frank and Basel III, which are effectively offsetting the low rate policy of the FOMC in terms of consumers and households. Companies and leverage investors benefit from low rates, but the sharp drop in mortgage loan origination volumes is a huge red flag regarding deflation in my book. Imagine what the debt and equity markets will do when we see a negative print on the monthly Case-Shiller Index? Our friend Michelle Meyer at Bank America Merrill Lynch says that Q2 2013 was the peak in home price appreciation in this cycle. I agree and think a big part of the reason that housing is now slowing are the excessive regulatory constraints on lending.

Kotok: You are right to worry about housing and the banks, as usual. Many observers look only at the price level, and they miss the fact that it is the rate of change that counts at the margin. That said, the key piece of the puzzle we need to make people understand is the deflationary effect of low rates. If the FOMC increased the target for Fed Funds gradually, say a quarter point per quarter to 1%, and likewise raised the deposit rate for excess reserves, I think that move would go a long way toward curtailing the deflationary threat we now see building. The Fed could do this by widening the band from 0.0% bottom and 0.25% top to 0.0% bottom and 1.00% top. Then raise the reserve deposit rate to 0.50%. That would allow the markets to clear after the distortion of the FDIC fee. It would also allow a slightly positive numerical interest rate to be attached to REPO and to large deposits. Right now, the very large depositors are actually paying a negative rate cost to have their money in the bank. Your point about low-rate policy hurting consumers is right on target, but look at the short-term funds markets for these large institutional folks. Very low rates and structural impediments such as the FDIC insurance premium are preventing the markets from clearing and functioning in a normal fashion. We cannot rebuild the short-term funds markets until the FOMC allows rates to rise. And the longer we wait, the more painful and dangerous the adjustment process will be.  And we haven’t discussed added cost such as those coming from the FDIC’s Orderly Liquidation Authority.  I believe that public release is due soon.

Whalen: Well, if you had a 1% overnight Fed Funds rate, the 7-10bp FDIC insurance premium would be irrelevant. If we translate the fundamental concerns of Bagehot into today’s terms, he probably would agree with your view that low rates are preventing the efficient flow of capital in the markets. But our friends at the Fed just don’t seem to understand their own limits and how policy decisions create future crises. The members of the FOMC led by Janet Yellen believe that they can manipulate interest rates and the economy to a satisfactory income, but in fact the current policy mix may be leading us to another crisis – just as the FOMC did between 2001 and 2007.

Kotok: I’m not as harsh on the FOMC members. Janet Yellen knows the difficulties, and she will use her skills and experience to try to manage the transition from QE at $85 billion a month to something less and eventually to zero. A target for Fed Funds is of no significance in terms of monetary policy when we are at a zero boundary. You can make the target 0-1.00 instead of 0-0.25, and I would do that at once if I were in the decision chair. But it makes no difference until the FOMC neutralizes its balance sheet by raising the rate paid on excess reserves and by reaching a neutral position on QE. Remember that they may also have to term out the reserves to show the markets that they can manage the eventual decline in balance sheet size. Market agents
are very skeptical about that. Sometimes I wonder if our colleagues at the Fed don’t really listen to comments from outside of the temple – from the markets and from private economists and market pundits. The FOMC missed a very valuable opportunity in September to slowly begin to change policy and to start the process of adjusting market expectations. The Fed believes they can eventually manage a gradual transition from the current, extreme policy stance to something more moderate and stable. The market reaction to the unwise June 19th press conference by Chairman Ben Bernanke suggests otherwise. In September, the markets had adjusted to an expectation for some tapering. The Fed had a free shot to do something. They failed to take it.

Whalen: Look at the carnage that the Bernanke press conference caused in the mortgage market. Many banks, non-banks got slaughtered in the TBA market for mortgage financing. PennyMac Mortgage Investment Trust (PMT) missed their hedging for mortgage funding by 16% and lost half of their gain-on-sale margin. The Q3 2013 FDIC data also suggests huge hedging losses by commercial banks. The reference securities in the housing market moved 2-3x vs. the 10-year bond. As you noted earlier, only about 1% of the audience actually understands the utterances of central bankers. Obviously this does not include bond traders or most economists, who were caught flat-footed in June and then wrongly predicted tapering of Fed securities purchases in September. So David, if you were on the FOMC, what would you recommend to your colleagues?

Kotok: First, I would strongly reject the idea that lowering the interest paid on excess reserves is a viable option. Fed remittances to the Treasury are $100 billion per year and rising. If the FOMC takes interest paid on excess reserves to zero, remittances to Treasury will rise unless tapering of bond and MBS purchases resolves and ends completely and abruptly. That would shock markets and weaken the economic recovery, which is still fragile. The FOMC must be very careful here. Even if they could simply stop quantitative easing, remittances will rise since the Fed will not sell and must run off the portfolio over a number of years. The Fed could raise the reserve rate paid to 50bp for a start. That clears the FDIC fee hurdle and allows banks to earn small arbitrage on GSE cash. It also allows markets to clear above zero by a small amount, and that restores repo to neutrality. My guess is that bond yields would fall if the bond market saw this action by the Fed. Market agents would accept that the Fed’s QE would peak in 2014, and the process of discounting a return to a more normal neutral Fed could therefore commence.

Whalen: Agreed. A more enlightened FOMC would be issuing bonds to individual savers with the old 6% coupons of Series E bonds to help blunt the impact of financial repression instead of handing the supposed profit to the Treasury. Issue the bonds in $1,000 increments, with a $100,000 limit and make them non-transferable. So we both agree that the folks clamoring to reduce the rate on excess reserves don’t get it?

Kotok: I do not expect any quick return to 6%. Not even close. I guess the US Treasury could issue a small saver bond with a limit but I doubt it will happen.  Chris, we are at a zero boundary for the cost of funds in the US markets, so the only way to go is up. We are also at the near-zero bound in most of the rest of the developed world. That means the global clearing system of interest rates is distorted. Forcing an imposed negative policy under these conditions is very dangerous. Positive incentives are usually a better policy prescription than are negative rules. If we raise excess reserve rates and get the financial system to clear, we start to relieve financial repression. Savers gain; hence, consumers gain. Some banks and non-banks start to rebuild earning assets. Poorly managed banks fail or are merged by regulators. You and I both know some of these banker players. They bear shame for launching new banks a decade ago and then watching the erosion of their investors’ capital by as much as 90%. The managements and boards of these banks own some of this outcome. They point fingers at the regulators or the Fed. Meanwhile they haven’t been fired, and they haven’t paid a penalty, and few have been jailed for fraud.

Whalen: No argument here.

Kotok: Chris, your focus in your writings over the past year on falling net interest margins for banks is crucially important here. Now, if you had a counterparty as a prosecutor and if the board-management policing mechanism didn’t protect the embedded imbeciles who ran their institutions into the ground, you would really have a team approach to addressing these issues. If I were czar, excess reserve rates would be higher and terming out. The zero boundary for rates makes the US economy dysfunctional. And the longer we are in it, the worse it becomes. Japan is the proof.  And lastly, I would use Singapore law to regulate our politicians and our financial services.

Whalen: Thanks David

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/higIfHxYV0g/story01.htm rcwhalen

Last week, I published two articles, on Zero Hedge and Breitbart, respectively, that highlight the issue of “financial repression” via low interest rates. Below is an exchange with my dear friend and mentor David Kotok, Chairman of Cumberland Advisors. We discuss the question of whether the current policy of the Federal Open Market Committee is feeding deflation via low rate policy. This question has great significance since the stated goal of FOMC policy is to raise inflation to ~2% annually and boost employment. From my perspective working in the housing sector, the combination of current Fed policy and new regulatory strictures such as Dodd-Frank and Basel III are clearly thwarting efforts by the FOMC to reflate the housing sector and the wider US economy. — RCW

Whalen: David, I really appreciate your comments on the ZH article last week, “Default, Deflation and Financial Repression.” In particular, your focus on ultralow interest rates, Federal Deposit Insurance Corporation premiums and the flow of cash from the banks to the Federal Reserve System is very illuminating – and disturbing. As you know, I have long maintained that the FDIC’s fiscal need to fund the deposit insurance scheme is a separate matter from monetary policy, but when we have near-zero interest rates, the average FDIC premium of 7-10bp does become significant. Can you talk first about what is happening in the US money markets from your perspective?

Kotok: You wrote a very important article last week, especially the part about the Fed taking billions out of the economy and away from savers in order to subsidize the banking industry. But there is another and more nuanced part of the puzzle that we need to consider. We have a Fed Funds target of 0-0.25% in place presently. The Fed is also paying 0.25% per annum on excess reserves. This means the reserve rate is higher than the actual Fed Funds rate while the lower bound is maintained at zero. The GSEs, who are large sellers of Fed Funds, cannot legally deposit directly with the Fed. So, they sell Fed Funds, and the banks buy them and redeposit the cash with the Fed. The FDIC levies an asset-based fee on each bank and that includes the reserve deposit assets which are under their FDIC jurisdiction. So the actual Fed Funds rate, inclusive of the FDIC insurance levy, is below the gross (0.25%) reserve deposit rate. Some larger, riskier banks pay even higher FDIC fees than the average and are effectively losing money on this trade. Meanwhile the US subsidiaries of foreign banks, which are not subject to the FDIC levy, have an advantage in the short-term markets.

Whalen: So your basic point is that the fact that rates are so low in absolute terms is distorting the US money markets, in part due to structural costs like the FDIC insurance premium? The nineteenth-century economist Walter Bagehot maintained that in order to prevent bank panics a central bank should provide liquidity to the market at a very high rate of interest. Yet today the neo-Keynesian tendency that controls the FOMC believes that the fact the Fed has the virtually unlimited ability to temporarily expand the money supply refutes Bagehot’s dictum. In today’s terms, Bagehot was warning us against keeping rates too low for too long because real money would flee from financial repression.

Kotok: Antoine Martin of the Federal Reserve Bank of New York, in his important 2005 paper “Reconciling Bagehot with the Fed’s Response to September 11,” argues that Bagehot had in mind a commodity money regime in which the amount of reserves available was limited. Thus, keeping rates high was a way to draw liquidity, that is gold, back into the markets. Bagehot also understood that low interest rates fuel bad asset allocation decisions – what we call “moral hazard.” In the age of fiat money, however, economists have taken the opposite view, namely that an unlimited supply of reserves obviates the need to attract money back into the financial markets.  Remember that Martin’s paper was written two years before the start of the subprime crisis.

Whalen: His timing was impecable.

Kotok:  Bagehot’s classic text advocated a penalty interest rate secured by good collateral. He was envisioning a form of discount window mechanism similar to what central banks used in the pre-QE era. That mechanism has been mostly replaced with QE, which is a policy that we are still in the early stages of learning about.  More recent Fed papers have delved into the impact of QE on otherwise neutral interest rates. It certainly lowers them for a while and in the early stages of QE. Other researchers have noted how the central bank’s remittances to the Treasury alter the fiscal authority budget balance. And others have focused on the potential methods for terminating QE and getting to a neutral position. Still others are trying to solve the mystery of how to reduce the impact of QE and restore a more neutral policy. Lastly there are the inflation hawks, who forecast an inflationary outcome of QE. They may eventually be right, but after five years the evidence suggests that excess reserves are not by themselves very inflationary. It takes an acceleration of growth to turn post-crisis disinflation force around,.  That means rising demand is needed to obtain  rising price pressures. So far, we haven’t seen much of either in the course of our grand experiment with QE. My colleagues and I have written about these various research papers, and the links can be found on our website, www.cumber.com.

Whalen:  Well, the 2001-2007 period certainly suggests that Bagehot’s concerns about low interest rates fueling moral hazard have not been refuted. The FOMC’s aggressive easing of interest rates, combined with deregulation of the financial markets and the FDIC’s safe harbor with respect to bank asset sales between 2000 and 2010, fueled a speculative binge that nearly destroyed the western world. When Lehman Brothers failed, we had created some $60 trillion in toxic assets that were not supported by the $13 trillion asset US banking system. Now almost seven years since the bust, a large portion of that pile of crap has yet to be remediated.

Kotok: Very true, but the past is past. We must focus on the future. Whether or not you believe that a flexible reserve system like the Fed’s addresses Bagehot’s concern about attracting liquidity back into the markets, the fact is that very low interest rates do distort money flows. That is why your point about the Fed taking $100 billion per quarter out of the hands of savers is so important. But what do the banks do with that money? They deposit it with the Fed. And what does the Fed do with that money? They pay the banks 0.25% and then invest in US Treasury debt and mortgage-backed securities (MBS) at a higher rate, and thereby generate what they call a “profit.”

Whalen: So your point is that the $100 billion per year that the Fed is taking from the hands of consumers, meaning savers, is actually passing through the banking system and going to the Treasury via remittances from the Fed?

Kotok: Precisely. The practice of the Fed calling the spread they earn on their nearly $3 trillion portfolio of securities “profits” is a monstrous distortion of the word. What they are doing is feeding deflation in the real economy by reducing savers’ income while pushing down the federal budget deficit. Between budget sequestration and the spread arbitrage created by the low interest rate paid on excess bank reserves, US government policy is clearly operating with a deflationary bias. As you and I have discussed for several years with respect to the higher FDIC deposit insurance premiums, we need to take a holistic view of government policy. The whole playing field gets level if the Fed’s excess-reserve deposit rate is set higher and thus eliminates the false profit they now recognize via remittances to the Treasury.

Whalen: Well, you are assuming that the banks would actually lend out the additional profit that they earned in higher rates on excess reserves. Wouldn’t we need to also raise the target for Fed Funds to say 0-1% from the current 0-0.25% in order to give some of the benefit back to savers of all stripes?

Kotok: As we wrote last week in our Market Comment, in the Fed there are those who argue that the rate should be lowered or maybe go to zero. It is currently 0.25%. Others argue that the rate should be raised or that the amount of required reserves should be changed, thereby changing the excess reserves composition. All sides of this debate are passionately argued by skilled agents in monetary economics. But the real question the FOMC needs to ask is, what are we going to do if inflation continues to fall? That is, if we find ourselves in a deflationary trap. Many commentators argue that we are in one or near one. I am worried about it.

Whalen: It is perhaps not surprising that commercial bankers are against lowering the rate paid on the $2.3 trillion plus in excess reserves sitting on deposit at the Fed.  That is 20% of the assets of the entire US banking sector, again another sign of deflation.  Given the sharp drop in net interest margins in the US banking industry, the Fed may need to boost interest paid on reserves just to keep the industry from imploding.  Just as in the 1930s the Fed fueled deflation by not making credit available, today the opposite seems to be the case – low rates are fueling deflation and impeding the creation of credit to support the economy.  Where are you on the issue of when FOMC policy is likely to change?

Kotok: At Cumberland we believe the short-term interest rate will be kept low for a long period of time, which we measure in years, not months. We do not expect the Fed to deliberately shock the economy by any action that would cause another recession. The June press conference has served to chasten members of the FOMC. Some members of the Fed are already worrying about the possibility of recession. There is evidence of deflationary and/or disinflationary forces at work now. That evidence has raised the eyebrows of some policymakers and commentators. We are among those who worry about this issue. We do not think Japanese-style deflation will happen, but we worry that it could happen. We keep watching commodity prices and oil prices. Oil is especially important because it flows through so any sectors of the economy. And changes in the oil price quickly translate to gasoline prices, and that means a consumption tax increase or decrease. At an annual rate, a 1-cent change in the gasoline price adds up to about $1.4 billion in raised or lowered consumer expenditures.

Whalen: That is a big change. Let’s get back to the deflation issue. For the past year and more I have been writing about the deflationary impact of Dodd-Frank and Basel III, which are effectively offsetting the low rate policy of the FOMC in terms of consumers and households. Companies and leverage investors benefit from low rates, but the sharp drop in mortgage loan origination volumes is a huge red flag regarding deflation in my book. Imagine what the debt and equity markets will do when we see a negative print on the monthly Case-Shiller Index? Our friend Michelle Meyer at Bank America Merrill Lynch says that Q2 2013 was the peak in home price appreciation in this cycle. I agree and think a big part of the reason that housing is now slowing are the excessive regulatory constraints on lending.

Kotok: You are right to worry about housing and the banks, as usual. Many observers look only at the price level, and they miss the fact that it is the rate of change that counts at the margin. That said, the key piece of the puzzle we need to make people understand is the deflationary effect of low rates. If the FOMC increased the target for Fed Funds gradually, say a quarter point per quarter to 1%, and likewise raised the deposit rate for excess reserves, I think that move would go a long way toward curtailing the deflationary threat we now see building. The Fed could do this by widening the band from 0.0% bottom and 0.25% top to 0.0% bottom and 1.00% top. Then raise the reserve deposit rate to 0.50%. That would allow the markets to clear after the distortion of the FDIC fee. It would also allow a slightly positive numerical interest rate to be attached to REPO and to large deposits. Right now, the very large depositors are actually paying a negative rate cost to have their money in the bank. Your point about low-rate policy hurting consumers is right on target, but look at the short-term funds markets for these large institutional folks. Very low rates and structural impediments such as the FDIC insurance premium are preventing the markets from clearing and functioning in a normal fashion. We cannot rebuild the short-term funds markets until the FOMC allows rates to rise. And the longer we wait, the more painful and dangerous the adjustment process will be.  And we haven’t discussed added cost such as those coming from the FDIC’s Orderly Liquidation Authority.  I believe that public release is due soon.

Whalen: Well, if you had a 1% overnight Fed Funds rate, the 7-10bp FDIC insurance premium would be irrelevant. If we translate the fundamental concerns of Bagehot into today’s terms, he probably would agree with your view that low rates are preventing the efficient flow of capital in the markets. But our friends at the Fed just don’t seem to understand their own limits and how policy decisions create future crises. The members of the FOMC led by Janet Yellen believe that they can manipulate interest rates and the economy to a satisfactory income, but in fact the current policy mix may be leading us to another crisis – just as the FOMC did between 2001 and 2007.

Kotok: I’m not as harsh on the FOMC members. Janet Yellen knows the difficulties, and she will use her skills and experience to try to manage the transition from QE at $85 billion a month to something less and eventually to zero. A target for Fed Funds is of no significance in terms of monetary policy when we are at a zero boundary. You can make the target 0-1.00 instead of 0-0.25, and I would do that at once if I were in the decision chair. But it makes no difference until the FOMC neutralizes its balance sheet by raising the rate paid on excess reserves and by reaching a neutral position on QE. Remember that they may also have to term out the reserves to show the markets that they can manage the eventual decline in balance sheet size. Market agents are very skeptical about that. Sometimes I wonder if our colleagues at the Fed don’t really listen to comments from outside of the temple – from the markets and from private economists and market pundits. The FOMC missed a very valuable opportunity in September to slowly begin to change policy and to start the process of adjusting market expectations. The Fed believes they can eventually manage a gradual transition from the current, extreme policy stance to something more moderate and stable. The market reaction to the unwise June 19th press conference by Chairman Ben Bernanke suggests otherwise. In September, the markets had adjusted to an expectation for some tapering. The Fed had a free shot to do something. They failed to take it.

Whalen: Look at the carnage that the Bernanke press conference caused in the mortgage market. Many banks, non-banks got slaughtered in the TBA market for mortgage financing. PennyMac Mortgage Investment Trust (PMT) missed their hedging for mortgage funding by 16% and lost half of their gain-on-sale margin. The Q3 2013 FDIC data also suggests huge hedging losses by commercial banks. The reference securities in the housing market moved 2-3x vs. the 10-year bond. As you noted earlier, only about 1% of the audience actually understands the utterances of central bankers. Obviously this does not include bond traders or most economists, who were caught flat-footed in June and then wrongly predicted tapering of Fed securities purchases in September. So David, if you were on the FOMC, what would you recommend to your colleagues?

Kotok: First, I would strongly reject the idea that lowering the interest paid on excess reserves is a viable option. Fed remittances to the Treasury are $100 billion per year and rising. If the FOMC takes interest paid on excess reserves to zero, remittances to Treasury will rise unless tapering of bond and MBS purchases resolves and ends completely and abruptly. That would shock markets and weaken the economic recovery, which is still fragile. The FOMC must be very careful here. Even if they could simply stop quantitative easing, remittances will rise since the Fed will not sell and must run off the portfolio over a number of years. The Fed could raise the reserve rate paid to 50bp for a start. That clears the FDIC fee hurdle and allows banks to earn small arbitrage on GSE cash. It also allows markets to clear above zero by a small amount, and that restores repo to neutrality. My guess is that bond yields would fall if the bond market saw this action by the Fed. Market agents would accept that the Fed’s QE would peak in 2014, and the process of discounting a return to a more normal neutral Fed could therefore commence.

Whalen: Agreed. A more enlightened FOMC would be issuing bonds to individual savers with the old 6% coupons of Series E bonds to help blunt the impact of financial repression instead of handing the supposed profit to the Treasury. Issue the bonds in $1,000 increments, with a $100,000 limit and make them non-transferable. So we both agree that the folks clamoring to reduce the rate on excess reserves don’t get it?

Kotok: I do not expect any quick return to 6%. Not even close. I guess the US Treasury could issue a small saver bond with a limit but I doubt it will happen.  Chris, we are at a zero boundary for the cost of funds in the US markets, so the only way to go is up. We are also at the near-zero bound in most of the rest of the developed world. That means the global clearing system of interest rates is distorted. Forcing an imposed negative policy under these conditions is very dangerous. Positive incentives are usually a better policy prescription than are negative rules. If we raise excess reserve rates and get the financial system to clear, we start to relieve financial repression. Savers gain; hence, consumers gain. Some banks and non-banks start to rebuild earning assets. Poorly managed banks fail or are merged by regulators. You and I both know some of these banker players. They bear shame for launching new banks a decade ago and then watching the erosion of their investors’ capital by as much as 90%. The managements and boards of these banks own some of this outcome. They point fingers at the regulators or the Fed. Meanwhile they haven’t been fired, and they haven’t paid a penalty, and few have been jailed for fraud.

Whalen: No argument here.

Kotok: Chris, your focus in your writings over the past year on falling net interest margins for banks is crucially important here. Now, if you had a counterparty as a prosecutor and if the board-management policing mechanism didn’t protect the embedded imbeciles who ran their institutions into the ground, you would really have a team approach to addressing these issues. If I were czar, excess reserve rates would be higher and terming out. The zero boundary for rates makes the US economy dysfunctional. And the longer we are in it, the worse it becomes. Japan is the proof.  And lastly, I would use Singapore law to regulate our politicians and our financial services.

Whalen: Thanks David

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/higIfHxYV0g/story01.htm rcwhalen

Most people’s opinions about major political events are based upon the news that they access through mass news distribution channels. Unfortunately mass news distribution channels are all owned by the ruling class that have a biased agenda and therefore can rarely, if ever, be counted on to distribute the truth. As former CNN journalist Amber Lyons exposed, various governments around the world actually paid CNN to unethically run propaganda stories as if they were real “news” without ever disclosing that they had accepted large sums of money to run these stories.

 

In Thailand currently, massive anti-government protests originated after current PM Yingluck Shinawatra attempted to grant full amnesty to her brother, Thaksin Shinawatra, for his corrupt activities while he was Prime Minister of Thailand during 2001 to 2006 before being ousted in a military coup. Mass media coverage of this people’s uprising in Thailand has also suffered from questionable reporting, both

 

(1) in the magnitude of numbers of protesters, sometimes reported as in the tens of thousands when real numbers have been in the hundreds of thousands, as well as

(2) a circus-like, sensationalistic focus on just the violent clashes that have recently resulted instead of a more intelligent focus on the reasons why the uprising has occurred.

 

 

Former Assistant US Treasury Secretary Paul Craig Roberts, a prominent voice that exposes the fascist corruption of the US government, recently chimed in on the Thai uprising, yielding an interesting analysis that, “the corrupt [Thai] politicians the Americans have bought and paid for [the Shinawatras]…are being challenged by massive demonstrations in the streets all over the country.” Though the US is known for putting puppets in countries all over the world that support American interests and even resorting to war to replace leaders that do not, this is an angle that has not been not discussed at all in the Thai media  (Obama’s attempt to foster international support to invade Syria, allegedly based upon Syrian President Assad’s refusal to bow down to Western interests that wanted to control an oil and gas pipeline through his country, serves as a perfect example of this). On the other hand, the paramount Amnesty Bill issue so widely discussed in the Thai media has largely been absent from coverage in the Western media.

 

In Part 2 of the Misappropriation of Our Freedoms, I discuss how social media, the concept of community and especially critical thinking have all been misappropriated by the ruling class to misinform and weaken the masses upon over whom they lord. As Leonardo da Vinci wisely stated, “nothing strengthens authority so much as silence” and “anyone who conducts an argument by appealing to authority is not using his intelligence; he is just using his memory.”

 

You may view the video “The Age of Deceit: The Misappropriation of Our Freedoms, Part II” here.

Read The Age of Deceit: The Misappropriation of Our Freedoms, Part I

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/9hMgMJ5t8HI/story01.htm smartknowledgeu

When Congress’ approval rating was in the double-digits, polls showed that it was less popular among the American public than cockroaches, lice, root canals, colonoscopies, traffic jams, used car salesmen, Genghis Khan, Communism, North Korea, BP during the Gulf Oil Spill, Nixon during Watergate or King George during the American Revolution.

An October poll by Public Policy Polling showed that Congress is less popular among the American people than zombies, witches, dog poop, potholes, toenail fungus and hemorrhoids.  That was when Congress’ approval rating was 8%.

A new Economist/YouGov.com poll shows that Congress has hit an all-time low: only 6% of the American public approves of Congress.

To put this in perspective, Wikipedia notes:

Historians have estimated that between 15 and 20 percent of the European-American population of the colonies were Loyalists.

In other words, around 3 times as many colonists supported King George as the 6% which support our own Congress today.

Moreover, a May 2013 poll by Fairleigh Dickinson University found that 29% of registered voters think that armed revolution may be “necessary” in the next couple of years. In other words, the number of Americans who think that armed revolution may be “needed” dwarf the number of Americans who approve of the job that Congress is doing.

Even back in 2010, Rasmussen noted that only a small minority of the American people think that the government has the consent of the governed, and that the sentiment was “pre-revolutionary”.

Bonus: 

• What Is The ACTUAL Risk for Pacific Coast Residents from Fukushima Radiation?

• Japanese Senator: “The Path That Japan Is Taking Is The Recreation Of A Fascist State”

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/W4CLkPHEl0o/story01.htm George Washington

Let’s consider speculation and arbitrage, and look at what it really means when the cobasis is deeply negative, in that light. This is the case in silver.

Per the definition of cobasis = Spot(bid) – Future(ask), it means either that physical metal is being dumped on the bid, pressing it down, or that people are aggressively buying futures, thus lifting the ask in that market.

The price of silver has been falling all year, with a sharp correction in the first three weeks of August. The cobasis has been low and/or falling most of that time (though it has come up a little in the past few weeks). We suspect that both market actions are occurring in silver right now. That is, at times silver metal is being dumped in quantity in the spot market, and at other times paper silver is being bought aggressively in the futures market.

Who might be selling physical silver? The data does not tell us, but looking around at the world economy, we can guess that smaller inventories may be needed at manufacturers of electronics. People may be bringing their metal to “cash4gold” companies to get dollar cash to pay their bills. For whatever reason, in the world of the physical stuff supply is coming to market. In contrast, the demand for the paper stuff—futures—is still strong at the moment.

Readers may have a different experience—we would love to hear about it—but we see continued optimism in comments on investor sites, Facebook groups, etc. Surely, “the bottom is in” and as the prices of the metals takes off once again, silver will rise faster than gold.

As we have written before, analysis of the open interest in COMEX futures is not so simple, but in the context of the present discussion it is interesting to take a look at the open interest for both monetary metals.

            The Open Interest of Gold and Silver

 

The graph supports our theory that leveraged speculators (which comprise a large percentage of the change in open interest) have gotten much more excited about silver since July. By contrast, the graph suggests that they are less exuberant about gold.

Thus we have a much higher cobasis in gold at this point. The question is: will demand for silver turn around first, or will leveraged speculators capitulate first?

We would not bet our money that it will be the former.

This week was punctuated by the major American holiday, Thanksgiving. Volumes were lighter than normal and liquidity less. We take with a grain of salt both the price moves and the basis moves. The prices ended up slightly on the week.

Here is the graph of the metals’ prices.

            The Prices of Gold and Silver

 

We are interested in the changing equilibrium created when some market participants are accumulating hoards and others are dishoarding. Of course, what makes it exciting is that speculators can (temporarily) exaggerate or fight against the trend. The speculators are often acting on rumors, technical analysis, or partial data about flows into or out of one corner of the market. That kind of information can’t tell them whether the globe, on net, hoarding or dishoarding.

One could point out that gold does not, on net, go into or out of anything. Yes, that is true. But it can come out of hoards and into carry trades. That is what we study. The gold basis tells us about this dynamic.

Conventional techniques for analyzing supply and demand are inapplicable to gold and silver, because the monetary metals have such high inventories. In normal commodities, inventories divided by annual production can be measured in months. The world just does not keep much inventory in wheat or oil.

With gold and silver, stocks to flows is measured in decades. Every ounce of those massive stockpiles is potential supply. Everyone on the planet is potential demand. At the right price. Looking at incremental changes in mine output or electronic manufacturing is not helpful to predict the future prices of the metals. For an introduction and guide to our concepts and theory, click here.

Here is a graph of the ratio of the gold price to the silver price. This shows how many ounces of silver one needs, to buy an ounce of gold. There was a small gain in the ratio this week. 

            The Ratio of the Gold Price to the Silver Price

 

For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide terse commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

Here is the gold graph. The February cobasis flirted with backwardation this week.

            The Gold Basis and Cobasis and the Dollar Price

 

The rising cobasis, now in backwardation, combined with a basically flat price of the dollar—just under 25mg—means that some selling of gold futures is balanced by buying of gold metal. There is nothing extreme in this graph, and as we noted above, volume and liquidity were not normal this week, especially the latter part of the week.

Now let’s look at silver.

The Silver Basis and Cobasis and the Dollar Price

 

We see a sharp rise in the cobasis, though it’s impossible to tell if this is just the poor liquidity or if this is the start of a major move (the move is not pronounced in farther-out futures). This bears monitoring in the coming week.

 

© 2013 Monetary Metals

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/5q06XFHwu0k/story01.htm Monetary Metals

“Peak Hope”…?

 

(h/t @Not_Jim_Cramer)

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/lw16k85N_s4/story01.htm Tyler Durden

While the idea of the interventionist suppression of short-term 'normal' volatility leading to extreme volatility scenarios is not new, hearing it explained so transparently by a current (and practicing) central banker is still somewhat shocking. As Buba's Jens Weidmann recent speech at Harvard attests, "The idea of monetary policy safeguarding stability on multiple fronts is alluring. But by giving in to that allure, we would likely end up in a world even less stable than before."

 

Excerpts from Jens Weidmann – Europe's Monetary Union

Harvard, 11/25/13 (Full speech here)

In the eyes of many politicians, economists, at least if they are central bankers, cannot have enough arms now – arms with which they are to pull all the levers to simultaneously deliver price stability, lower unemployment, supervise banks, deal with sovereign credit troubles, shape the yield curve, resolve balance sheet problems, and manage exchange rates.

 

It is probably safe to say that this change in attitude is not just due to a sudden surge in the popularity of economists and central bankers. Rather, it reflects the widespread view that central banking has come to be the only game in town. And quite a few economists seem to agree with this notion.

 

To some, the notion that the primary goal of central banks is to keep prices stable has become old-fashioned. Against the backdrop of the financial crisis, they argue that financial stability has become just as important, if not more so, than price stability.

 

…

 

By tearing down the walls between monetary, fiscal and financial policy, the freedom of central banks to achieve different ends will diminish rather than flourish. Put in economic terms: Monetary policy runs the risk of becoming subject to financial and fiscal dominance.

 

Let me explain these mechanisms a bit more in detail, starting with financial dominance.

 

The financial crisis has provided a vivid example of how financial instability can force the hand of monetary policy. When the burst of an asset bubble threatens a collapse of the financial system, the meltdown will in all likelihood have severe consequences for the real economy, with corresponding downside risks to price stability.

 

In that case, monetary policy is forced to mop up the damage after a bubble has burst. And, confronted with a financial system that is still in a fragile state, monetary policy might be reluctant to embrace policies that could aggravate financial instability.

 

…

 

Public debt and inflation are related on account of monetary policy's power to accommodate high levels of public debt. Thus, the higher public debt becomes, the greater the pressure that might be applied to monetary policy to respond accordingly.

 

Suddenly it might be fiscal policy that calls the shots – monetary policy no longer follows the objective of price stability but rather the concerns of fiscal policy. A state of fiscal dominance has been reached.

 

Technically, fiscal dominance refers to a regime where monetary policy ensures the solvency of the government. Practically, this could take the form of central banks buying government debt or keeping interest rates low for a longer period of time than it would be necessary to ensure price stability. Then, traditional roles are reversed: monetary policy stabilises real government debt while inflation is determined by the needs of fiscal policy.

 

…

 

A lender-of-last-resort role would violate this principle of self-responsibility – in that same way as Eurobonds in this setting are at odds with it. Therefore, it would aggravate, rather than alleviate, the problems besetting the euro area.

 

…

 

The idea of monetary policy safeguarding stability on multiple fronts is alluring. But by giving in to that allure, we would likely end up in a world even less stable than before. This holds true especially for the euro area, where a Eurosystem acting as a lender-of-last-resort role for governments would upend the delicate institutional balance.

 

To disentangle the euro area's fiscal and financial conundrums, we should practice the art of separation – especially with regard to the sovereign-bank doom loop. Or let me put it this way: Rather than for monetary policy to waltz with fiscal and financial policy, we need to erect walls between banks and sovereigns.

 

Of course, Taleb's somewhat seminal piece on vol suppression remains a concerning glimpse of the inevitable.

ForeignAffairs

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/KZS_1FIN8MI/story01.htm Tyler Durden

While the idea of the interventionist suppression of short-term 'normal' volatility leading to extreme volatility scenarios is not new, hearing it explained so transparently by a current (and practicing) central banker is still somewhat shocking. As Buba's Jens Weidmann recent speech at Harvard attests, "The idea of monetary policy safeguarding stability on multiple fronts is alluring. But by giving in to that allure, we would likely end up in a world even less stable than before."

 

Excerpts from Jens Weidmann – Europe's Monetary Union

Harvard, 11/25/13 (Full speech here)

In the eyes of many politicians, economists, at least if they are central bankers, cannot have enough arms now – arms with which they are to pull all the levers to simultaneously deliver price stability, lower unemployment, supervise banks, deal with sovereign credit troubles, shape the yield curve, resolve balance sheet problems, and manage exchange rates.

 

It is probably safe to say that this change in attitude is not just due to a sudden surge in the popularity of economists and central bankers. Rather, it reflects the widespread view that central banking has come to be the only game in town. And quite a few economists seem to agree with this notion.

 

To some, the notion that the primary goal of central banks is to keep prices stable has become old-fashioned. Against the backdrop of the financial crisis, they argue that financial stability has become just as important, if not more so, than price stability.

 

…

 

By tearing down the walls between monetary, fiscal and financial policy, the freedom of central banks to achieve different ends will diminish rather than flourish. Put in economic terms: Monetary policy runs the risk of becoming subject to financial and fiscal dominance.

 

Let me explain these mechanisms a bit more in detail, starting with financial dominance.

 

The financial crisis has provided a vivid example of how financial instability can force the hand of monetary policy. When the burst of an asset bubble threatens a collapse of the financial system, the meltdown will in all likelihood have severe consequences for the real economy, with corresponding downside risks to price stability.

 

In that case, monetary policy is forced to mop up the damage after a bubble has burst. And, confronted with a financial system that is still in a fragile state, monetary policy might be reluctant to embrace policies that could aggravate financial instability.

 

…

 

Public debt and inflation are related on account of monetary policy's power to accommodate high levels of public debt. Thus, the higher public debt becomes, the greater the pressure that might be applied to monetary policy to respond accordingly.

 

Suddenly it might be fiscal policy that calls the shots – monetary policy no longer follows the objective of price stability but rather the concerns of fiscal policy. A state of fiscal dominance has been reached.

 

Technically, fiscal dominance refers to a regime where monetary policy ensures the solvency of the government. Practically, this could take the form of central banks buying government debt or keeping interest rates low for a longer period of time than it would be necessary to ensure price stability. Then, traditional roles are reversed: monetary policy stabilises real government debt while inflation is determined by the needs of fiscal policy.

 

…

 

A lender-of-last-resort role would violate this principle of self-responsibility – in that same way as Eurobonds in this setting are at odds with it. Therefore, it would aggravate, rather than alleviate, the problems besetting the euro area.

 

…

 

The idea of monetary policy safeguarding stability on multiple fronts is alluring. But by giving in to that allure, we would likely end up in a world even less stable than before. This holds true especially for the euro area, where a Eurosystem acting as a lender-of-last-resort role for governments would upend the delicate institutional balance.

 

To disentangle the euro area's fiscal and financial conundrums, we should practice the art of separation – especially with regard to the sovereign-bank doom loop. Or let me put it this way: Rather than for monetary policy to waltz with fiscal and financial policy, we need to erect walls between banks and sovereigns.

 

Of course, Taleb's somewhat seminal piece on vol suppression remains a concerning glimpse of the inevitable.

ForeignAffairs

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/KZS_1FIN8MI/story01.htm Tyler Durden