April 7. Problems with QE were known long ago…
“There is a lesson in all this which it behooves every thinking man to ponder.”
So ends a book that I hadn’t visited in a while, Fiat Money Inflation in France by Andrew Dickson White.
http://mises.org/books/inflationinfrance.pdf
This book outlines everything that is wrong with Japan’s (and the US’) current path of QE monetization, draws striking parallels with current affairs in the US and in France today (and the EU as a whole) and even provides historical examples which can be related to Cyprus. It’s not filled with charts and pictures, or with econometric models, but is an easy read in 68 pages. It’s copyrighted in 1896.
Here’s how it starts: “Early in the year 1789 the French nation found itself in deep financial embarrassment: there was a heavy debt and a serious deficit.” …”Statesmanlike measures, careful watching and wise management would, doubtless, have ere long led to a return of confidence, a reappearance of money and a resumption of business; but these involved patience and self denial, and, thus far in human history, these are the rarest products of political wisdom.”
This was France during 1790 to 1796…the state confiscated the lands of the church and issued assignats against this land, essentially interest bearing paper notes/currency (QE), that could be used to extinguish debts of the state, and to stimulate the economy. Some men realized the dangers of irredeemable paper money: “They had learned how easy it is to issue it; how difficult it is to check its overuse; how seductively it leads to the absorption of the means of the workingmen and men of small fortunes; how heavily it falls on all those living on fixed incomes, salaries or wages; how securely it creates on the ruins of the prosperity of all men of meager means a class of debauched speculators, the most injurious class that a nation can harbor;… how it stimulates overproduction at first and leaves every industry flaccid afterward; how it breaks down thrift and develops political and social immorality.”
With the first issuance of 400 million assignats, benefits did accrue, but the immediate gains soon dissipated and calls were made for further issuance, so the total was increased to 800 million, and finally a proposal of 2400 million was rolled out to completely eliminate the debt of the state. Exactly like succeeding rounds of QE.
There were arguments against this money issuance, a pamphlet (that someone doubtless needs to translate into Japanese) “…the truth which it presented with great clearness being simply that doubling the quantity of money or substitutes for money in a nation simply increases prices, disturbs values, alarms capital, diminishes legitimate enterprises and so decreases the demand for both products and for labor; that the only persons to be helped by it are the rich who have large debts to pay.”
However, “the great majority of Frenchmen now became desperate optimists, declaring that inflation is prosperity. [Abe, Kuroda, and let’s throw in Evans]. Throughout France there came temporary good feeling. The nation was becoming inebriated with paper money. [Rising stocks?] The good feeling was that of a drunkard just after his draught…. As draughts of paper money came faster the successive periods of good feeling grew shorter.” With each new issue came a marked depreciation of assignats.
“All this breaking down of the manufacturers and commerce of the nation made fearful inroads on the greater fortunes, but upon the lesser and upon the little properties of the masses of the nation who relied upon their labor, it pressed with intense severity. The capitalist could put his surplus paper money into the gov’t lands [stocks, farmland] and await results; but the men who needed their money from day to day suffered the worst of the misery. Still another difficulty appeared. There had come a complete uncertainty as to the future.”
“It was simply a feverish activity caused by the intense desire of a large number of the shrewder class to convert their paper money into anything and everything which they could hold and hoard until the collapse which they foresaw took place.”
How similar is this to current affairs? Capital is going into assets to “wait it out” rather than hire employees for new enterprise. The chasm of income and wealth inequality grows. The quest for inflation is confused with prosperity. Confidence is lowered and wealth seeks safety, while the middle class working man is gutted (wages have barely made any real gains). Eventually wealth is taxed or confiscated, though initial tax levies don’t bring in amounts forecast. A difference arises in the value between new and old money, in the current case it appears as if the “Cyprus” euro isn’t worth the same as a German one.
“Against DuPont, who showed conclusively that the wild increase in paper money was leading straight to ruin, Cambon carried the majority in the great assemblies and clubs by sheer audacity-the audacity of desperation. Zeal in supporting the assignats became his religion.” It just reminds me of Nigel Farage railing against the zeal of the troika in support of the euro, all to no avail. There is even (of course) an example of the current M Cahuzac who resigned as budget minister after admitting a secret Swiss bank account, although of course in those days, it meant the guillotine. “Marat followed out this theory by asserting that death was the proper penalty for persons who thus hid their money.”
April 4. BoJ “all in” on 2% inflation target
Staggering announcement by BoJ, vowing to reach 2% inflation target in 2 yrs by massive QE of $75b per month (Rtrs) “To meet its new 2 percent inflation target, the central bank will boost asset purchases to double its holdings of government bonds and exchange-traded funds (ETF) in two years.” Nikkei +2.2%, USDJPY jumped to 95.50 and JGB yield sank to 42.5 bps! Dangerous ground…as comparison US is buying $85B per month in an economy 2.5x as large as Japan’s (and US may taper off purchases). QE pushes up stocks, but the economy doesn’t necessarily benefit. Paper risk assets had been fairly well correlated to the rally in USDJPY (and EURJPY) since last November, but SP’s only up about 7 this a.m. taking back just part of yesterday’s loss… the relationship may be weakening.
–Now the ECB is on tap in the wake of softer data and Cyprus. Bloomberg reports Draghi is considering ‘plan B’ which may include a rate cut and a new round of bank loans (more LTRO). However, 54 of 56 economists expect no change in rates today. (Spain and Italy yields continue to press lower).
–Metals made new lows yesterday; gold silver and copper are all approaching bottoms made last year (Gold’s was 1527, GCM now 1546), and further strength in the dollar as we are seeing this morning, could help provide the final push to flush out longs in precious metals.
–Tensions related to N Korea are ratcheting higher, further escalation would provide marginal bid to treasuries.
–Yesterday’s US data, ADP 158k and non-mfg ISM 54.4, were weaker than forecast. Jobless Claims expected 350k. US yields fell with tens down 5 bps to 181 and curve flattened as 2/10 made a new recent low of 158. The five year guy has pretty much cleaned up the short position in 122p (+100k yest) and added to shorts in FVM 124.5 calls, open interest rose yesterday in the calls by 16k, as of yesterday’s close the strike is about 3.5 bps otm. Total OI in fives was up 18k… underlying bid in 5’s remains strong.
April 3. Resurgence of paper
–Trade in interest rate futures was dominated by put buying and call selling (in deferred euro$ contracts and tens). Mostly an unwind of Cyprus positions. However, net changes were modest as tens gained a bit over 2 bps to 1.862. Plently of news coming out over the next fews days including ECB meeting tomorrow and employment data Friday.
–In the US markets, we have a resurgence of paper assets rather than physical. While stocks press for new highs, gold fell $25 yesterday and is testing late Feb lows. Silver and copper have broken through those lows, and grains are weak. An article on ZH notes that oil tanker cargo rates have plunged (though crude oil price is firm). On the other hand, Fannie Mae announced a large profit as its portfolio has soared in value. The Fed’s strategy is “working”, just like Greenspan’s when he juiced the housing market and lauded new finacial products that allowed consumers to more readily tap home equity. In the present case, capital flows into the dollar also “help” as EU problems persist and Japan keeps pressure on the yen.
–Today’s news includes ADP expected 200k and non-mfg ISM expected 55.5.
April 2. ISM weaker than expected yesterday, Europe data weak this morning
–ISM was weaker than expected yesterday at 51.3 vs 54.2 last, supporting a rally in fixed income. Ten year yield fell 2 bps to just under 1.84. This morning’s mfg PMI numbers out of europe were weak, with Italy and Spain racing downward to catch France and Greece. (Respective numbers: IT 44.5, 7 mo low, SP 44.2, 5 mo low, FR 44.0 actually up, GR 42.1). By contrast Germany is highest at 49.0, (2 mo low).
–China yuan continues to edge higher vs USD, now at new record high 6.20 as peg was raised. In N Korea, military maneuvers including those by China and the US are raising risks.
–AAPL resumed its downtrend, not quite through the low of the move, but down 3% yesterday (SPX -0.45%). Silver and copper did make new lows yesterday, with the latter off 10% in the past 2 months, a red flag for mfg growth. Factory Orders today expected +2.9 vs -2.0 last.
–Stockton CA bankruptcy accepted by the court yesterday. No surprise there, but pensions loom as a big issue, as they do in many municipalities.
–On a related note, the sequester is about to bite. From a friend (thanks Bob), “I work for the DoD. If they don’t reach an agreement and sequestration becomes a reality, we are going to take a 20% salary hit beginning the pay period April 21. More than 50% of the people I work with are going to stop contributing to their TSP (our 401K plan) accounts. Many are also going to borrow from their accounts. I do not know if this will impact the markets, but the Gov pension plan [owns] about 9% [of the stock market].” He notes that many employees, military, border patrol etc. were exempted from pay cuts, so the cut is rather large for civilians.
April 1. Contagion jumping from Cyprus to Italy?
–The Muslim Brotherhood is calling it the EU spring.
–Big depositors in Bank of Cyprus to lose far more than than feared, 60% or more. (Who couldn’t have seen THAT coming?) According to ZH, Cyprus’ parliament head says there is “no future” under the troika. Given capital controls on cypriot euros, is a full exit that much of a leap? The contagion appears to have affected Italy as Monte dei Paschi admits billions have been withdrawn. If JPM’s CEO Jamie Dimon didn’t realize the extent of the problems in his London branch, and the Fed didn’t see the mortgage crisis coming, then how are ordinary depositors supposed to gauge the financial strength of banks? Stress tests? (Cyprus passed). Ratings agencies?
–Speaking of which, Moody’s is reportedly poised to downgrade Italy; President Giorgio Napolitano on Saturday ruled out standing down early to make way for new parliamentary elections…several sources said Draghi called Napolitano to warn that early elections could make a fragile situation worse. In any event, even a whiff of trouble will likely spark capital flight in peripheral banks. Napolitano on Sunday appointed ten “wise men” to propose reforms in a bid to make it easier to ultimately form a government, seen as a positive step in breaking the political impasse.
–The Fed’s liquidity swap lines to foreign CB’s barely rose according to Thursday’s data, but what if they start to be tapped in size? The WSJ reports that the new Chair of House Financial Services (Hensarling), “wants to limit taxpayers’ exposure to banking, insurance and mortgage lending.” If the Fed does feel compelled to ease funding in the EU, I would expect some in Congress to strongly object.
–Elsewhere, Bloomberg reports that S Korea’s Industrial Production fell in Feb, “signaling that a recovery in Asia’s fourth-largest economy may be slower than expected as a weaker yen threatens exports.”
–Russia announced, without any international warning, massive war games to be conducted on the Black Sea, ” seen by observers as Putin flexing Russia’s military muscles.” On the plus side, North Korea doesn’t appear to be targeting Chicago with missile strikes.
March 27. The Financial Accident clock ticks closer to midnight
–EUR making new low 128.11. (5:15am Chicago time). News out of the EU continues to be bleak: Bank of Portugal yesterday cut growth forecast to -2.3 from -1.9. Bank of Spain cut forecast to -1.5; official gov’t forecast was -0.5. Cyprus yesterday announced plans to increase emergency credit by €2.5-3.0b. Italy Industrial orders in Jan -1.4%, third consecutive decline, and the political situation there is no closer to resolution.
–From a BBG piece: “The loans include one linked to the difference between the 10-year British pound constant-maturity-swap and the 6-month Japanese benchmark…” Sounds like high finance for a hedge fund right? Nope, that would be terms of a loan taken by a French municipality issued by Dexia. The gyst of the article is that many towns in France are seeking help from the state due to the burden of these bad loans. WTF is a town in France doing with a loan like this??!! I don’t understand it, and I am tangentially associated with the financial industry. And of course the larger question is: How much of this stuff is out there? How can an uninsured depositor know?
Here’s the link http://www.bloomberg.com/news/2013-03-27/france-s-towns-demand-rescue-from-time-bomb-of-dexia-loans.html
–Continued underlying bid in treasuries (5 yr auction today), accompanied by lower vols going into the long weekend. TYK 131.5 straddle opened 116 bid, settled 111, which I marked at 3.8 vol. Swap spreads push higher. Ten yr swap spread started March around 8 bps, now 15.5 (+1.75 bp yesterday). Another new low in 10yr JGB, 52 bps. I didn’t read it but FT has this headline: “Global pool of triple A status shrinks 60%”. Which gives context to a yield of only 5.56% for high yield bonds (Barclays)….doesn’t seem like there’s much risk cushion there.
–US stocks also remain bid. I suppose global portfolio managers see the US as a safe haven, not only from the EU, but other markets as well. For example Brazil is down 12% since the high from the beginning of the year. Hong Kong is down 6% since late Jan high. Nikkei up up over 30% since Dec, but in a currency that the gov’t is bound and determined to destroy.
–It’s not that Cyprus is big economically, it’s the official clumsy response that saps confidence (and gums up the lubricant of the global financial system). A country that had 50% of its economy in banking is being cut in half in an instant. In the US, the govt can’t even decide to cut Saturday mail delivery without hang-wringing and soul searching. The next crisis is closer than it appears in your mirror. And it is coming at a time when central bankers have already expended the elixir of low rates. I never thought the low of 140ish in the US ten year would be revisited, but now I’m not so sure…strap in for safety.
March 26. Cyprus as “template”. Watch out below….
–A couple of quotes: “What we’ve done last night is what I call pushing back the risks,” said Dutch Finance Minister Jeroen Dijsselbloem, who heads the Eurogroup of euro zone finance ministers. From Moody’s: “the negotiations send messages to depositors and investors that will undermine the resilience of the euro area financial system to future shocks.”
–Dijsselbloem’s initial comments sent Italian stocks and peripheral banks and the euro plunging: “If there is a risk in a bank, our first question should be ‘Okay, what are you in the bank going to do about that? What can you do to recapitalise yourself?’. If the bank can’t do it, then we’ll talk to the shareholders and the bondholders, we’ll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit holders”. However, the comments were later retracted. When he said “Cyprus was a template” what he meant to say is that “Corzine is the template”, in that it has become socially acceptable to use depositor money to cover losses on sovereign bonds. Bloomberg reports this morning that BRICs plan a New Bank to bypass the World Bank and IMF. I guess they don’t feel comfortable with the current template.
–ZeroHedge ran a piece yesterday (citing Reuters) indicating that Russians still had access to funds in Cyprus Banks during the bank holiday: “No one knows exactly how much money has left Cyprus’ banks, or where it has gone. The two banks at the centre of the crisis – Cyprus Popular Bank, also known as Laiki, and Bank of Cyprus – have units in London which remained open throughout the week and placed no limits on withdrawals. Bank of Cyprus also owns 80 percent of Russia’s Uniastrum Bank, which put no restrictions on withdrawals in Russia. Russians were among Cypriot banks’ largest depositors.” Perhaps that’s why the Cypriot banks remain closed. Total protonic reversal (Dr Ray Stantz).
http://www.zerohedge.com/news/2013-03-25/have-russians-already-quietly-withdrawn-all-their-cash-cyprus
–JGB’s (ten yr) at new low of only 54 bps today.
–Today’s US news includes Durables expected +3.5%, New Home Sales at 425k, and Consumer Confidence.
March 25. Cyprus deal averts euro break-up
–Friday saw continued pressure on the front end of the curve as the Cyprus banking crisis leads to reduced confidence and a possible flare-up of bank funding costs. As of this morning, a deal has been reached that will affect depositors of two banks, Laiki which will be closed and Bank of Cyprus which will be recapitalized. Deposits under €100k were spared, but the haircut on large deposits will be a multiple of the original 10%.
–Markets have breathed a sigh of relief that a deal was reached, front euro$ contracts rallied, back contracts fell. The euro popped up to 131 but has eased off of that level. US stocks made new highs. The broader question is whether large depositors throughout the EU will begin to pull their funds; certainly confidence in the banking (and political) system has eroded at the margin. US financial markets have been the beneficiary of this capital flow, though it’s somewhat paradoxical that US stocks run higher just as demand for products from the EU declines.
–Today’s news includes Chgo Fed Nat’l Activity Index, last at -0.32 and will likely be negative again. Dallas Fed expected 3.4 from 2.2. Dudley speaks at 12:30 to Economics Club, Bernanke at 1:15 NY time with BoE’s Mervyn King on lessons from the crisis. I guess that should be “ongoing” lessons.
–Large plays Friday: New buyer of 4EU (gold Sept) 9750p 15.5 to 17.5 in 30k, delta around -32. Also a new buyer of 30k 4EZ 9750/9700 put spreads. Sales were added in 3EU 9812/9787ps 1×2, selling 2 legs over at 2, in 60k, open interest now 112k by 176k. As a seller of the 2 puts, that position is long about 7 delta.
March 22. Russia rebuffs Cyprus. Euro$ algos
–Lack of progress in Cyprus as Russia rejected proposals for financial aid. There continues to be put buying on the front end of the curve, for example, EDU3 9900p traded as high as 2.0 late, 63 bps out of the money. EDM3 9937.5 p settled 1.75, 28.5 bps out of the money with less than 3 months to go. These trades reflect concern about Cyprus sparking a wider bank run.
–Little net change in interest rate futures, with most eurodollar contracts down 1 bp. April treasury options expire today, with a shot for TYM to test 132 strike…currently 131-19.
–Wall Street Journal has a piece today about the Fed and US Treasury wanting to regulate bitcoins due to concerns about money laundering. As traditional currencies lose value and are subject to confiscation, virtual and anonymous forms of transaction have grown. http://en.wikipedia.org/wiki/Bitcoin
–A friend sent a note about algo activity in eurodollars…”An algo was placing and canceling orders in many contracts (not just the one shown here) at the rate of ~800/second in each contract: the combined rate exceeded 5,000 per second.” (Thanks AOK) http://www.youtube.com/watch?v=rx2WYffaRHc
I am not sure what a “normal” per second level of activity would be in ED contracts (cancels/replaces) but I would think the chance for an accident increases as global banking concerns could lessen liquidity in all sorts of contracts.
March 21. Troubling economic data….
–Global economic news paints a grim picture. German flash PMI down, France PMI the lowest in 4 years nearing the absolute nadir of the crisis from 2009. Cyprus remains on bank holiday, with the ECB saying it will withdraw assistance if there is no deal by Monday. Japan’s Trade deficit hit a new record low with exports -2.9%. (Partly due to the timing of China’s lunar year holiday, but China had already been shunning Japan’s goods). In the US, FedEx profit fell 31%, shares plunged 7% as customers switch from next day deliveries to slower and cheaper shipping. Caterpillar disclosed that on a 3 month rolling average ended Feb, global retail sales were down 13% from year ago: (MktWatch) Cat’s “…Sales tumbled 26% in the key Asia/Pacific region, which includes China and Australia. They were down 12% in North America and fell 9% in Europe”. ZH has an interesting chart that shows HSBC PMI up, but electricity production DOWN 14% (again, perhaps related to lunar New Year?). http://www.zerohedge.com/news/2013-03-20/wtf-chart-day-china-pmi-vs-electricity-production
From BBG: “Sales at casual-dining establishments fell 5.4 percent last month, after declining 0.6 percent in January and 1.6 percent in Dec….the first three months of consecutive declines in almost three years.” In the Bernanke press conference yesterday, a reporter noted that the past two years had been strong in the first quarter, but then rolled over. I don’t recall the exact response, it was something soothing, something about the WEATHER, that weather related disturbances had been a previous factor, but we’ll be ok this year. I thought the weather excuse was for retailers that had fallen short of sales expectations, NOT for the leader of the Central Bank…but BB probably feels that since he’s bought in to the retail mentality that stocks can and SHOULD always go up, he might as well go “all-in”.
–News today includes Job Claims expected 340k. Flash PMI expected 55, Existing Homes 5mio, Philly Fed expected -1.5 from dismal -12.5 last time, Leading Indicators +0.4%.
–In eurodollars, curve steepened a bit, pressure on near contracts eased as Cyprus is duly dismissed, though there was a buyer of 10k April 9925p for 0.25.
