All roads lead to easing...unfortunately

It's always dangerous to update ones macro outlook on the brink of two major policy events: the FOMC tonight and the ECB tomorrow, but it's also useful to crystallize your views before and after a major policy change.

We have to remember a few key rules for these markets:

• There are no "real markets" left - most fixed income markets are governed either directly by central banks or indirectly through liquidity provision by the same central banks - some rightly suggest it is a Ponzi scheme on an unprecedented scale.
• All major macro changes comes from policy mistakes - and we are probably about to see two major such mistakes inside the next 48 hours as the panic spreads among policy makers going on holiday.
• We are in the final inning of an extend-and-pretend regime. In this last phase, policy makers have replaced thirty years of debt creation with "unconventional measures". These look like a substitute, but are really just the last crazy extension of the existing debt creation machine. QE schemes and LTRO's and all the rest are merely different forms of the same thing and the last resort since we long ago reached the zero bound in interest rates and have now even moved into negative rates which will kill appetite for risk.
• So far we have seen extremely weak results from these measures, both in terms of their economic and market impact. We are in the 12th year of non-performance of stocks and some people have, wrongly, started to talk about the "death of equities".
• Policy makers will do anything to foist their world view on the markets, including lying, stealing and cheating. The end will always justify the means, in their view. The rest of us who live in the real world know differently, but underestimating the determination of policy makers is one of the biggest mistakes that we continue to repeat.

This background is important to remember as we head into these two policy meetings. History has proven to us that whatever happens over the next 48 hours the fundamental challenges will remain the same:

Spain is still slowly sliding towards a bail-out, Greece is a lost cause, the European banking system is still underfunded, the US still faces a fiscal cliff on January 1 (if anything it will only grow bigger if FOMC helps the politicians), unemployment and production globally is extremely weak and Asia continues to slow down. Lately new concerning comments and reliable data from China have confirmed this. See this "best approximation" of Chinese growth - we are now entering sub-7% growth in China which will and does feel like a recession in China.

CHART 1   Chinese railway volume and Chinese growth

So when going into these two central bank meetings the policy makers will want to "do something" or "communicate action" rather than wait-and-see, which incidentally would be the right choice in my opinion as the less macro input we get, the better. The real economy functions via the micro economy, but that's for a fairy tale and not for this real world experiment in macro policy run amok.

Both meetings will happen in a contentious political environment: In the US, the FOMC should respect the ongoing US election, but Bernanke and his merry men, like Greenspan, no longer observe "neutrality" in election years. The agenda of the US economy is bigger than the US election in their own not-so-modest estimation and the non-performance of both the housing market and lack of progress on jobs have the doves falling over themselves to introduce cuts in the deposit rate on bank reserves, extension of the effective ZIRP out to 2015 and beyond and more.....

Draghi, the Italian President of ECB, has finally shown his true investment bank and central bank colours: You can't be too big when it comes to central bank intervention. The man who singlehanded "saved the Euro" with his LTRO (his own opinion) has raised the stakes so high that a failure to deliver will not only see him lose credibility, but also undermine the few good steps taken by European officials over the last three years.

Furthermore, the obvious "obstruction" from the Bundesbank continues and for good reason. What many people fail to understand is that if Bundesbank/Germany were to cave in on "opening the chequebook", then all of Europe lose, but Germany would lose the most. They will immediately be downgraded, the funding costs of "core-Europe" will rise massively into a deteriorating economic- and production growth scenario which has already turned very negative.

Meanwhile, the rest of Europe would secure financing of their banks and governments through the ECB, printing even more money, thus pushing needed reforms even further into the future than ever.

I give Europe a 90 percent chance of continuing its descent into a Japanisation scenario under the current policy path. You cant solve a debt problem by creating more debt. Continuing this way will mean lost decades of opportunities and an investment culture of owning your government's bonds rather than investing in credible companies with long-term returns in excess of the 6-ish per cent we have seen since 1911 according to Bill Gross and his latest Outlook.

Strategy

Going into this meeting I have my "two personalities" fighting each other. My trading instinct dictates: square positions heading into the two events - wait at least 12 hours after the ECB before going back into the market and respect whatever "verdict" the market has by then. Everything from now until 1800 CET Thursday is a waste of time and effectively what amounts to guess work and "amateur hour".

The economist in me is more sanguine. The problems will remain the same this morning as well as Friday morning. It has been proven again and again that any macro intervention is always eventually negative. Trying to control extremely complicated "live animals" like a national or global economy is impossible. So stop trying! Create conditions for growth and job creation. The present market will extend these problems and with more downside, so I/We should use ANY rally to get prepare for the summer of discontent, but also respect that a positive market verdict on these meeting could mean that we see 1417.00 in the S&P500 in the interim.

Conclusion

Something will happen at both the FOMC and ECB meetings. The conspiracy theories suggest that Bernanke, Geithner and Draghi have coordinated a macro prudential solution, but it will be smoke and mirrors, be extremely careful with risk setting and stops. Market will roll-up (rise)into the event but many of the recent major events have been sold inside of 48 hours and this may be no different.

Safe travels,

Steen Jakobsen