Article / 08 January 2013 at 15:57 GMT

Two ways to be happy

Steen Jakobsen Steen Jakobsen
Chief Economist & CIO / Saxo Bank
Denmark

"There were two ways to be happy: improve your reality, or lower your expectations” 
― Jodi PicoultNineteen Minutes

We all know which method the market uses to be happy!

I have to admit I am still fighting to understand what I think was a dramatic change in the Federal Open Market Committee Minutes, which it should be said, the Ivory Tower Wall Street banks are busy ignoring, but here are a few points:

It does reflect a change from the Fed. Is Bernanke trying to protect his legacy as Bruce Kasting cleverly suggests in his piece: Ben Bernanke is facing a legacy problem. The argument here is that Bernanke leaves in just over a year from now and wants to leave US Monetary policy closer to a "neutral stance" relative to the present "emergency levels". Greenspan did the same for Bernanke as he hiked rates from 1% to 6% over 22 months, trying to unwind the easing of monetary policy following the 2000 IT bust. Anyone inclined to ignore bureaucrats' need for securing their legacy only has to look at how Greenspan spent two to three years trying to defend his record while at the Fed after he left (with no success).

The risk-on vs. risk-off paradigm has changed. Sure, the Fed is not going to reduce its balance sheet. Sure, the Fed can come back and do more, but.... the put is much weaker now on the market. Actually, as of now the Fed's balance sheet size is stalling, even getting smaller, and clearly from the minutes we gathered that some of the FOMC members are genuinely concerned about the size of the balance sheet. My take is that "everything being equal the put on the market is now trading at less than 50 delta forward vs. 75 delta before these minutes.

The markets are clearly reacting to this. I saw the first outright negative bond call today from a major investment bank, and all of a sudden the market is looking at the negative flow in bond Exchange Traded Funds, like IEF (IShares Barclays 7-10 year Treasury).

 

IEF

The move in the 30-year US bond yield is quite dramatic (at least relative to the recent years' lack of upside risk). We saw 2.46 percent in July 2012 and are now trading at 3.08 percent. The move is even more puzzling considering that recently the US economy is going nowhere, if anything it is stalling. (Below is Citigroup's economic surprise index for the US - source: Bloomberg LLP & Citigroup.)

Source: Bloomberg LLP & Citigroup

Even more confusing is Gold. Clearly a Fed committed to expanding its balance sheet by USD 1 trillion in 2013 is inflationary - in particular, if you wrongly assume the US economy is fine. Why is this?  What really makes me concerned about Gold is that the present GSCI and DJUBS Indexing rebalancing for January should be supportive for Gold and Silver

Source: Stockcharts.com

Turned a positive corner?
There is no doubt to me that the macro direction of January will be about bond yields - and the FOMC. We can expect the FOMC to "leak" some interpretations of the minutes through newspapers, but it seems we have turned a corner, and a positive one. Everything being equal, removing the over-stimulus will be good for savers and for capital allocation. The less the central bank acts the better the economy performs.

I commented earlier this week that Overconfidence is the new black - about the extreme complacency of the market. We entered 2013 with the notion that nothing could go wrong. The FOMC was accommodative, 2013 was going to be a transition year where investing was supposed to be on autopilot. But already in the second week of the year and, at least in momentum terms, the world's biggest monetary experiment is flagging. The market will deny it for probably a week or two more, but even in finance there is gravity. 

And eventually, the gravity for finance will be provided by the real economy - and there is no Main Street, whether in Europe, the US or even Asia, where things are picking up. This week's data has again confirmed weak PMIs (below 50 most of them) and higher unemployment.

Allocation
We are still in our alpha views long some puts into month-end in S&P and European markets. We have added short GBPUSD and are still conservatively long USDCAD in FX.

Safe travels,

Steen

 

1y
federicovp federicovp
excellent
1y
Hank Hank
Short term you might be right, but how will US ever reduce its mounting debt without monetizing it, or equivalently, devaluing USD to boost exports?
1y
rogerjarema rogerjarema
The presented charts indeed provided strong arguments for your views. However, there are other factors that may support even more extensive printing:
1. Jeffrey Lacker is the only remaining voting 'hawk' at the Fed. He's going to be replaced this year. His replacement is Charles Evans, an extreme 'dove' who is fond of pre-emptive printing -- printing even when the economic conditions are still 'rosy' -- and way more extensive printing. Janet Yellen is also fond of this idea.
2. How does Bernanke regard his legacy of extreme printing? If he regards it as beneficial and positive to the economy, he may just continue with it. The difference with Greenspan is that Bernanke's background is almost strictly academic, making him more vulnerable to holding on to false beliefs.
3. Perhaps the action in the treasuries is reflective of inflation expectations?

These are just alternative views from the other side. Will greatly appreciate your insights, Steen. Keep up the awesome posts :)
1y
rogerjarema rogerjarema
I have one more point to add:

4. Bernanke believes that by his QE goosing the stock markets, spending will increase through wealth effect. So, goosing the stock market is one of his primary motives for those QEs. At least 2 questions arise from this:

a) If he slows down/stops QE and the stock market plunges, will he keep slowing down/stopping his QEs?

b) We haven't even begun looking at external factors that may come into picture, such as European crisis back again, China slowing down, Japanese debt issues, etc... all of which will place heavy downward pressure on the markets he loved to goose.
Will he stop/slow down QE if a crisis elsewhere is putting downward pressure on these markets - risking a severe crash?

These 2 questions are also closely related on how he looks at his legacy. Is his fear more towards of having a legacy with (possibly) 2 very major crashes or is it towards being more reckless monetary policy? I suspect the fear is more towards the former, which suggests?

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