Immediately after Fed head 'Helicopter' B Bernake released his latest stimulative monetary tool of 'twisting' current minuscule treasury yields investors headed for the exits in droves. Uncle Ben's stunning pronouncement that 'there are significant downside risks to the economic outlook' smacks to me of a Fed which has lost control or understanding of financial market dynamics. I hope he is reasonably sure when he says stuff like that but I have my doubts! Once again the US government is threatening to shut down which might be one of their best cost savings measures ever!
The 50 year old failed 'twist strategy' of selling (or not buying) short term bonds ($US400B) and purchasing longer term bonds (until 2013) in order to flatten the yield curve further slicing razor thin interest rates appears to be nothing more than quazi-creative accounting stick handling or desperate financial engineering. This Treasury curve shift is the most abnormal (read: unpredictable) in the last 30 years. The Feds most implicit mandate of 'price stability' appears to be now more of an after thought. Three Fed officials (Plosser, Fisher, and Kocherlakota) dissented from this 'limited' strategy - a modern day rearranging of the deck chairs on the Titanic.
A immediate negative effect will be to the financial institutions who either depend on a normally slopped yield curve/spread or those who require 'reasonable' levels of interest rates to generate income. Negative interest rates are about to become much more negative. Pension funding needs will go from bad to worse. Insurance companies may find it impossible to match risks with returns. Bank earnings will drop because of disappearing margins.
The Fed has yet to learn that record low interest rates do not necessarily increase/stimulate the demand for credit. They should learn that excessive debt will definitely drain the demand for more credit. They will eventually learn not to over borrow!
The Fed should realize that consumers are desperately trying to pay down debt based on fears of job security, retirement, inflation, and the wildly expanding unsustainable Federal debt burdens. Nearly half of all US mortgage borrowers do not have the equity or credit rating necessary to refinance at lower 'engineered' interest rates. What little confidence cash flush businesses have (left) is hardly enough for them to invest or expand.
An equally concerning caveat is the announcement that US Government (taxpayers) are about to reenter the mortgage backed securities market which more or less melted the financial system down in the first place. The tax payers balance sheet is going to look like a dog's breakfast. It looks like a major risky double down and thus a very dangerous & historic bond market bubble to me! The 'risk free' status of US treasuries may disappear as quickly just as their 'AAA' rating did!
Moody's in a 'pre-emptive move lowered the credit rating of three of the big US Banks (Citi, BofA, and Wells Fargo) and will once again focus attention on systemic derivative 'counterparty risk'. Should credit lines be cut or reduced existing trade positions may need to be unwound or assigned. The cost of 'protection' may rise for those who try to 'hedge their hedge.' Banks may need to raise capital as positions are liquidated or to cover collateral agreements. This type of run on a bank is a replay of the historic and nasty Bear Sterns/Lehman experience.
Assets in various 'troubled' Euro banks are beginning to be moved to the relatively 'safer' confines of the ECB. A move by the Germans to reinstate the Bundesbank as the leading Central Bank of Europe would be catastrophic to say the least. The latest European PMI stats suggests that GDP figures may turn negative before long. Let's hope that a financial 'Black Plague' is not the end game of this very complex and inextricably linked international economic dilemma. It is beginning to look like the strategy of throwing stimulus money (read: debt) at institutionalized debt problems may be coming to a merciful end.
Newly minted IMF chief, Ms C Lagarde, has just discovered the 'massive risks to the banking system' and financial stability. An abrupt and immediate 10% IMF downgrade for growth for the entire planet was summarily dispatched with the usual mindless encouragement of 'more easing'(?) Paul Volker (former Fed Head and architect of 1980's inflation killing 20% interest rates) in a New York Times article reminds us that 'a little inflation (2%) can be a very dangerous thing!' Modern day Robin Hood, Prez B.H. Obama, is astonishingly spending his spare time selling his pre-election 'tax the rich' class warfare as the Fed burns! Brazil is beginning to erect trade barriers and increasing tariffs. And just to add to the fun & festivities the Bank of China announced they also foresee the possibility of an accelerated economic slowdown. All that may be left are the rating agencies to declare their (after-the-fact) last of the official post mortem downgrades.
In the US, the post 'twist' reaction was an immediate massive selling liquidation of anything which resembled a listed share of stock throughout all of the industrialized and emerging world. The orderly selling swoon has been powerful and widespread irrespective of earnings or valuations. Credit has been signalling and anticipating equity weakness for some time. North America appears to be finally catching up to the recent negative 'European 30+% decline experience.' The DJIA is now down just over 15+% ytd in a very over sold but negative technical environment. North American equity markets are much more leveraged (margined) than during the lows registered during the lows of the 2009 financial cataclysm. US equity markets are on the verge of dropping into 'bear market territory' of a 20% decline. Confirmed violation of the recent Aug 9th lows of 10,600 (DJIA) suggest a quick retracement back to the Aug/2010 support level of 10,000. The longer term measurement takes the DJIA back to the mid 2010 level of 9,500. Key lower support levels for the Nasdaq are 2,340 and then 2,100 based on weekly measurements. Significant lower support for the S&P comes in 5% lower at 1,050 then 1,000.
In commodities, the instant and powerful post 'twist' rally in the US dollar had an immediate negative effect for the entire commodity sector. 'Over' speculated sectors were crushed with the news that further QE stimulus was not part of the Fed's near term strategy. Gold broke the critical US$1,800/oz level early in the week and quickly violated $US1,700/oz by the end of the week. Significant 200 dma support comes in at $US1,595/oz. Gold dropped 10% on the week - a short term very over sold condition. Friday's $US100/oz drop for gold was rumored to be liquidation by hedge fund manager J. Paulson who is the largest shareholder of GLD - the massive physical gold fund. Silver broke the key $US40/oz level and quickly imploded to just over $US30/oz - a whopping 25% drop in 5 trading sessions. Silver is currently significantly over sold but could drop a further $US2/oz before the carnage is over. The red metal, Dr Copper, the metal with a Phd on the economy, got walloped with reports of contracting world wide economies. $US3.40/lb is a critical support area for Copper. The potential exists for Copper to drop as low as $US2.80/lb the mid 2010 support level. Crude Oil did not escape the selling hysteria dropping almost $US10/bl or 12% on the week to just below $US80/bl. A clean break of this support level suggests a price in the low $US70/bl area. Lower crude oil prices (combined with record low interest rates) is/would be very welcome news for almost all of the US economy.
The Agra grain markets continue to consolidate recent profit taking. Chronic underperforming Natural Gas has held up the best in the commodity complex just under $US4/mcf.
In Canada, the Canadian dollar was the first casualty based on economic slowdown fears and the limited anticipated effect of Fed 'twist' strategy. The Canuck buck broke $US1 for the first time this year. I would be very surprised if the Canadian dollar violates $US.95. The Canadian Dollar has dropped $US.10 from the July high. That is very welcome news for the manufacturing sector in Canada. The benchmark Canadian stock index briefly dropped into 'bear market' territory based on recessionary fears, Chinese economic downgrades, and the Euro banking mess. The heavily weighted financial sector broke 'critical' intermediate support of 166 on the S&P/TSX Capped Financials Index. This index can drop another 20 points before finding reasonable support. Positive relative strength divergence is appearing on the weekly charts. Many quality material, resource, and industrial stocks have been crushed in this wide spread liquidation and now represent compelling value at current levels. 10,500-11,000 'should' provide solid support for the TSX Index.
The S&P/TSX Venture index was mercilessly crushed almost 200 points (12%) from the 1,750 level. The Venture Exchange has unbelievably lost 1,000 points (or 40%) since March 2011. This astonishing 'bear market' may be vulnerable to further tax-loss selling pressure up to the end of December 2011. Great values and opportunities await those patient investors who take advantage of this outstanding opportunity.
Bottom Line, with European Index down 30+% and North American & Asian Indexes down 20+% from recent recovery high levels a significant amount of negative economic 'discounting' has already been baked into this worse case scenario souffle. North American markets appear to be catching up to recent European credit and equity weakness. It has been easy to lose sight of the fact that US weekly unemployment claims have been dropping for 2 years, leading economic indicators readings are improving, household balance sheets continue to improve, and manufacturing production & exports numbers are at very healthy record levels. US personal saving rates have improved considerably and most multinational corporations are flush with capital.
I am not trying to downplay the serious credit issues which exist - especially if the Euro crisis escalates significantly from current levels. However, significant proportion of all these problems are banking related. The G20 and BRIC nations have stated they are ready to assist those banks which may most negatively affected by the pending Greek default.
I do believe these very difficult problems can and will be solved. I do not believe that world wide growth and consumption levels will be as negatively affected as reported by the many hysterical market pundits and media outlets. The exasperating financial mess which central & corporate bankers and over levered governments created can and will be solved. Emerging markets will continue to grow and consume. Stimulus will be added where needed. It will important not to over react or panic in these difficult times as debt unwinds and positions are squared. Confidence will return. This crisis, like most others, will create many opportunities as they often do.
North American indexes can easily contract another 5-10% from current levels but I do not expect them to revisit the imploded levels of 2008-09. The age old lesson of the danger of over leveraging and excessive debt will be painfully relearned. With any luck voters will now learn to control and limit the powers and influence their elected fearless leadership and brave policy makers crave! The price paid will be well worth it! The swamp will require lots of draining!
Life will go on!
The nine scariest words of the English language : "I am from the government and I am here to help.'
- Ronald Reagan
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