But
hang on. What about June's supposedly stellar job growth numbers.
Surely this points the trajectory closer towards the 6.5% unemployment target and the
end of QE given the Oracle's guidance (spin) for US GDP growth to
accelerate to +3-3.5% next year. No problem, Bernanke is making it plain
that one should check carefully for wriggle room in the fine print and
that the 'target' was merely a threshold and definitely not a trigger.
Also, he is keen to stress that he remains accommodative in keeping
interest rates low and that possible tapering should in no circumstances
be misunderstood as meaning actual tightening. Blah, blah and blah! (translation: Buy suckers!)
A
rise in rates and a stronger dollar however would mean that asset price
increases and the property revival that Bernanke has been using to
engineer the recovery would stall. He still needs the muppets to keep
buying and he is well aware that his mouth is the real policy tool.
Pressure
is building for capital markets to return to a market driven pricing of
capital and risk and the addict must at some stage be weened off its
unhealthily dependency on cheap money, at least for the banks. The
problem however is that this is a very painful process. For some, the
rise in rates will be devastating and it may well be that we have
already passed the point of no return. Does anyone really know what
sort of shit remains lurking on the 'books' for the banks. I do not use
'balance sheet' deliberately, as the recent exposure that Deutsche Bank
has been hiding some bad stuff from Brazil off balance sheet shows how
little one can still rely on their published accounts. Clearly nothing
has been learnt! Banks pass 'stress tests' then collapse (remember
Bankia) after suckering in another bunch of muppets.
For
the past four years, banks have had access to almost 'free' money from
central banks. Have they used this to repair their balance sheets and
restore funding for industry? No, the supposed balance sheet repairs
have largely been done for them by their central banks pumping up the
asset boom while corporate lending is focused at the larger end, leaving
many SME's still starved of capital. So where has all this hot short
term money gone? Asset speculation and of course sovereign debt
purchases seems to be the answer. Central banks needed banks to help
buy the debt that their Govts needed to sell to fund their unresolved
deficits - in Europe, the ECB's possibly unconstitutional OMT is an
extreme example of this. While central banks crushed rates, this was
party time for the chosen few with access to cheap money. They borrowed
cheap and short and lent higher and much longer, not only to take the
rate mismatch as income (yes, that's where the 'profit recovery' that
has supported the rally in bank shares has partly come from), but also
to book the capital appreciation of the bonds already bought. This
however is not arbitrage but merely another carry-trade which carries a
potential time bomb of duration risk. As long real rates go negative
and a supposed economic recovery removes central banks as the marginal
buyer of all that debt which Govts still need to sell to fund their
unresolved deficits, what happens next could be very ugly. Short term
rates could rise to more than the yield of recently bought long bonds
which would make the carry trade actually cash flow negative. A rise in
the long end could also precipitate massive capital losses on the Govt
debt that all these banks have been encouraged to purchase. If this is
to be painful in the US, just think what damage it would do to European
banks (eg Spanish) whose books are full of the stuff. As the bounce in
recent 10 year yields in Portugal demonstrate, the potential rebound in
yields can be much greater and faster than expected and that after years of central
bank coddling, we have become increasingly complacent to the risks.
Even in the US, when 10 year rates 'soared' to 2.5%, there was no
shortage of talking heads advising us that this was a great buying
opportunity. Quite why a probably sub inflationary return from a bust
Govt in a global market flooded with liquidity is supposedly a great
buying opportunity beats me. Unless of course you run a bond fund or
need the muppets to take the other side of your trade as the banks see
the writing on the wall and start to bale out!
So
where do I think we are? QE has not delivered the self-sustaining
recovery and is increasingly becoming the problem rather than the cure.
Govts seem incapable of tackling their structural deficit issues and QE
fixes merely encourages politicians to defer the solutions. At some
point the patient has become an addict. Do you let him go through cold
turkey (ie let asset prices and money find their true market values) or
keep feeding his habit until he dies? Unfortunately I see no evidence of
resolve from politicians who have nurtured a majority of the electorate
to be state dependents. Short term however, there may finally be an
appreciation from at least one central banker before he retires to
steady the ship and so provide some defense for his legacy and ahead of what is to come. He has to initiate a policy to end QE, but he can't afford
for markets to get spooked and unwind the asset inflation that he has
supported, hence the laboured attempts to soften the blow with recent
dovish commentary. If real rates are to rise however, real asset prices
may need to fall, particularly at the long end of the bond market.
Banks who have built up sizable holdings of the stuff though also
control the Fed, so expect more dovish spin until at least they have
unwound their positions. Now about the muppets..............
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