Excellent article.
To not lose it I am printing it out in full.
USD
Every weakness in Euro, Gold and Sterling is seen as an opportunity to add.
Between the devil and the deep blue sea
‘Like war, one of the basic principles of stabilization policy is never to run out of ammunition. Policy stimulus is to be used in bad times, but when circumstances improve it is critical to ‘reload the canon’ to prepare for the next battle’
- Stephen Roach
Morgan Stanley
The Fed
This week the Fed Chairman was on a whir wind tour across the country, singing the recovery song and leaving hints of potential risks in the green speak. Is he warning us about the potential risks to the system, it seemed more like Mr. Greenspan was out there trying to defend his reputation and saying all the right things for once so that if some accident should happen in the future – which we feel will happen, the Chairman can sit down and say I told you so.
1. Mr. Greenspan asked the congress to limit the powers of Fannie Mae and Freddie Mac on the grounds that they have the potential of bringing down the financial system. He added that ‘most of the concerns associated with systematic risks stem from the size of the balance sheets that these GSE’ maintain. GSE’ need to be limited in the issuance of GSE debt and in the purchase of both mortgage and non mortgages that they hold’.
He further called for clarity in the relationship between the government and the GSE’ since there is a perception in the market that GSE’ are backed by the government and this is not the case. However with the GSE’ having $4trln in outstanding mortgages are already so huge that they are simply ‘Too big to fail’ and the government will have to bail them out.
2. Testifying before the house budget committee Mr. Greenspan said that the US economy is improving but there is reason for concern about the government spending as the Fed budget deficit continues to grow. Mr. Greenspan said that the economy appears to have made the transition from a period of sub par growth to one of ore vigorous expansion. If this is true then bond prices should have moved lower but something else is bugging the bon pits.
3. Stirring the hornet’ nest Mr. Greenspan said that the country can’t afford the retirement benefits promised to baby boomers and urged the congress to trim tem.
4. Speaking in California Mr. Greenspan said that we could see a pop in the employment numbers anytime soon.
In the past recessions, consumption used to decline and in turn created pent up demand that propelled the economy once the imbalances were cleared. This time around because of the Fed Reserve’ rapid fire rate cuts and the stimulus packages from Washington consumption didn’t decline. A false illusion that everything is ok was portrayed and consumer spending continued as if there was not tomorrow.
Today consumers cant keep up with the spending unless they go deeper into debt or income rises. Consumer spending rose mainly due to heavy borrowing and the low interest rates helped keep the debt burden under control. But unless rates are kept at these artificially low rates the markets look set to demand ‘something’ extra in return for investing in US assets.
The Fed Reserve is lending a helping hand to the asset price inflation in order to keep the wheels of the economy moving unless something gives which it eventually will we are likely to be in the current environment.
Household liabilities to assets ratio climbed to a record high of 0.185 in Q3 2003 and outstanding consumer credit to personal income ratio stood at a record 0.214 in December 2003. These record highs indicate that consumers will have to pullback on borrowing and consumption. Personal saving too declined to 1.3% in December i.e. consumption far exceeds savings today.
Mr. Greenspan knew that in order to clean up the mess in the post Roaring 90s era, the traditional medicine would have been painful and no one would love him. Hence he let it run and when things got hard he cut rates from 6.75% to 1%. This new interest rate medicine was good and it offered temporary relief as consumers went out and bought the second SUV.
As a result of the monetary and fiscal stimulus, a greater imbalance has been created in the system. Today as the tax stimulus runs its course and consumers are faced with record levels of debt, job creation isn’t happening the sustainability is in doubt. Mr. Greenspan knows it too, otherwise why would he try and talk up the economy.
In a typical ‘I told you so’ manner, Mr. Greenspan warned of a severe danger to the financial system from Freddie Mac and Fannie Mae, the social security mess, record level of deficits and strangely enough he asked home owners to switch to flexible rates.
If a derivatives accident happens at any one of the GSE’ it will have a domino effect bringing down the financial system. The imbalances in the economy have reached such high proportions that any attempt to slowdown one will result in a domino effect on a global scale.
In an open letter to the Fed Chairman Alan Greenspan, Morgan Stanley’ Stephen Roach asked him to raise short term rates to 3%, so that the Fed would have bullets during the next down turn.
Today if he raises rates to 3% he will be accused of bursting the various bubbles and pushing the economy into quiet possibly a deflationary environment. The devil as always is only waiting for a chance to push him into the deep blue sea.
I have great respect for Mr. Roach but this time I beg to defer. The Fed is caught in between the devil and the deep blue sea. Mr. Greenspan in hoping that the system will take care of the maladjustment made a deal with the devil and cut rates. The bubble that has been created can not be allowed to deflate.
The Dollar
Treasury Secretary John Snow said that the finance ministers and central bankers of the G7 nations were united in their call for flexible exchange rates that avoid excess volatility. In effect what Mr. Snow meant was ‘Its OK for the US Dollar to decline’.
The US Dollar is the common stock of USA Inc and when the common stock is going down that’s a signal that something is wrong with the company. Either the company has lot of liabilities or the management team has fallen out of favour. The common stock of USA Inc is giving an early warning.
Speaking in Japan the IMF’ managing director Horst Kohler said that Japan was right to intervene in he currency markets to slow the Yen’ appreciation against the US Dollar and that the intervention was a pragmatic policy that had helped Japan fight the deflation.
Last year alone Japan spent $185bln about twice its trade surplus. From January 29th through 25th February, Japan sold Y3.34trln i.e. $30.6bln to stem the Yen’ rise against the Dollar.
Interventions never work; all they do is slowdown the trend. Fundamental reality is still the same and this is the time to buy Euro, Sterling and Gold. What was strange at least to me was that when Japan issued a terror alert Gold the traditional safe haven sank. Now why would that be?
Has the ground reality changed, the US is still faced with a massive current account deficit, stocks are more overvalued today than at any other time and in the absence of the super doses of stimulus the economy might be sinking.
Round one of this great US Dollar fight was won by the central bankers, round two the market will go for a knock out. We expect volatility to pick up in the coming weeks and months.
In the absence of interventions, the US Dollar would move down to an equilibrium level and start doing its job in trying to help the US economy recover. The only thing that this intervention is achieving is creating bigger imbalances in the system.
The bond market faces another risk, if the Yen continues to weaken against the US Dollar the Bank of Japan doesn’t need to buy record amounts of US paper i.e. bond yields could shoot up.
PIMCO, the world’ largest bond mutual fund is making a bet that the Fed will belatedly acknowledge the threat of accelerating inflation. PIMCO has purchased $3bln in TIPS and may buy more in the months ahead.
Foreign central banks buying of US debt hit a new record, the 18th straight week that purchases have risen. The Fed holding of treasury and agency debt held for central banks rose $2.20bln to $1.142trln.
US debt reached a record $7trln or 2/3rds of GDP i.e. every minute the US debt increases by $7, 91,640. US budget balance has swung from a surplus of $268.7bln in Q1 2000 to a deficit of $500bln in Q4 2003. A swing of $768bln or 6.8% of GDP.
Nothing has changed at all; the US Dollar is on a one way street. We expect the US Dollar Index to touch 75 levels this year.
The Economy
The US government debt totalled more than $7trln and government spending as a percentage of GDP has never been higher except during WWII. Earlier this year President Bush unveiled a budget forecast that projected a deficit of more than $500bln, however this number doesn’t include the hundreds of billions for other costs such as military expenditure.
Consumer spending is already slowing and the decline in consumer confidence is a precursor of things to come. Consumers power nearly 2/3rds of the economy and any slowdown in their activities is likely to result in contraction. Once we get past the tax refunds the government has literally run out of bullets and with wages barely rising there is very little to keep the economy going.
Since President Bush too office nearly 2mln jobs have been lost and unless jobs start coming back in large numbers, Mr. Bush will be the first president since Mr. Hoover to preside over a net loss of payrolls.
More than 2400 employers laid off 50 or more employees in January, the third highest mass layoff. A total of 239,454 workers lost their jobs inn January according to the BLS. The interesting thing to note in this data is that manufacturing is still losing jobs but transportation, food processing and retailers were also hit.
Laying off transporters isn’t a good sign, is it possible that companies are getting less orders to ship goods across the country? Are we seeing some kind of a slowdown?
Conference Board’ consumer confidence index declined to 87.3 in February from 96.4 in January as people became more concerned about jobs. The expectations index declined to 96.8 and the present situation index declined to 73.1.
University of Michigan’ Consumer Confidence index declined to 94.4 in February from 103.8 in January as consumers grew cautious about jobs. The current conditions index declined to 103.6 and the expectations index declined to 88.5.
Housing starts declined 7.9% to 1.903mln units in January down from a record 2.067mln unit in December 2003. Building permits declined 2.8% to 1.899mln units. Sales of previously owned homes declined 5.2% to6.04mln units in January. This was the biggest decline in 9yrs.
Durable goods orders declined 1.8% in January as orders for transportation equipment declined. Durable goods orders declined to $181bln. Ex transportation durable goods orders rose 2% and demand for business equipment rose as companies placed orders. Orders for transportation equipment declined 10.4%, machinery orders declined 1.9%.
On Monday, Personal Income for January is expected at 0.3% versus the previous 0.2%. Personal Spending for January is expected at 0.3% versus the previous 0.4%. Construction Spending for January is expected at 0.4%. ISM index for February is expected at 60 versus the previous 63.6.
On Tuesday, Auto Sales for February is expected at 5mln units versus the previous 5.2mln units.
On Wednesday, ISM Services for February is expected at 61 versus the previous 65.7. Feb Beige book is expected to say that the risks are balanced.
On Thursday, Initial Jobless Claims are expected at 355,000 versus the previous 350,000. Q4 productivity is expected at 2.7%. Factory Orders for January are expected -1% versus the previous 1.1%.
On Friday, Non Farm Payrolls are expected 35,000 versus the previous 112,000. Unemployment Rate is expected at 5.7% versus the previous 5.6%. Consumer Credit for January is expected at $7.5bln versus the previous $6.6bln.
EUR
To be updated
YEN
To be updated
GBP
To be updated
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