CARNAGE
The QE trade is unwinding in dramatic fashion as the market slowly realizes that QE is not in any way inflationary. As I mentioned last week the smart money markets (fixed income and FX) were foreshadowing this as early as last week. The air pocket created by Ben Bernanke created an incredible trading opportunity for investors who weren’t blinded by confidence in the Federal Reserve. Just two weeks ago I said:
“Would add (to shorts) into any move over 1200. Would LOVE to see 1220″
My position is that the market is misinterpreting the economic impact of QE in the long-term. My market position has always been that we could rally to these levels and that at these levels the market has become overly optimistic. If I am wrong I will lose some money and move on. It’s part of the business.
Like clockwork the market touched 1220, bounced and sold-off. The carnage across markets is broad. The only things rallying are volatility, USD and US treasuries. In essence, the leveraged QE inflation trade is collapsing. You can thank Ben Bernanke for this. When you create distortions in the market you get volatility, uncertainty and ultimately a collapse in prices. Keeping market prices “higher than they otherwise would be” is not a recipe for economic growth.
The most worrisome development is dissension inside the EMU. Austria is now threatening to withhold their contribution to the Greek bailout unless Greece can prove that they have fulfilled their requirements for aid:
“The cost of insuring against default by Greece and the premium investors demand to hold the country’ bonds rather than lower-risk German Bunds jumped on Tuesday after Austria said Athens had not met aid commitments.
Five-year credit default swaps were 100 bps wider on the day at 950 bps, according to monitor Markit, while the 10-year yield spread between Greek and German government bonds was 15 bps wider at 923 bps.
Greece has not fulfilled commitments for its European Union-backed aid package, Austrian finance minister Josef Proell said on Tuesday, adding that Vienna had not yet submitted its contribution for December.”
That’s not the only concern in the markets. Municipal bonds in the US continue to crash as a market that was priced for perfection now begins to price in some risk. Commodity markets are being crushed under the pressure of failing QE and tighter monetary policy in China. And ultimately U.S. stocks have finally succumbed to reality.
(Figure 1)
(Figure 2)
(Figure 3)
U.K. Support Sought for Ireland Bailout
European finance ministers working on an international aid package for Ireland want the U.K. to make bilateral loans to Dublin as part of a larger aid package that could total up to €100 billion.
Carnage?? lol, after the last several years this is a walk in the park.
Excellent on the Muni chart – what a great reference point. Be careful here, money flowing out of bond markets has to go somewhere… And may I say, if we get a Euro default or restructure where bondholders take some kind of a haircut, F’ING FINALLY…., then I think that capital or some fraction obviously will begin to move into equities.
yet you have to expect that hot currency pulling out of Europe and $US bonds will initially go into $US treasuries – keeping a lid on stocks here;
since Japan seems to have finally admitted they need a sustained combo of stimulus/currency-supply-growth/lower-taxes, then you might expect the Yen to fall further and their equities to benefit most of anyones
Money will come pouring into US Treasuries if Ireland bond investors have to take a haircut. Equities won’t be performing too well either. I know we hit 35bps on the 2yr at one point, but who’s to say we can’t get down to 20bps.
TPC,
Great call again. I’m wondering though if the next move (very short term) of any consequence will be up? Since the focus (for today) seems to be Ireland, then, do we really believe that everyone’s just going to leave the table? I mean, I can’t imagine that they won’t come up with some kind of deal. And even though the deal will be just the latest version of extend and pretend, the market has become so conditioned to celebrate these “deals” that it will seize that opportunity to rally back up to perhaps 1220ish before establishing another top.
John,
I would be careful pinning this on Ireland. I don’t think that’s necessarily the case. I think the much more important factor here is the unwind in the QE trade and China. A lot of optimism regarding the inflation trade and the Chinese market rally caused commodities to surge and the dollar to tank in recent weeks. What we’re seeing now is an unwind of that trade. A lot of damage was done today across many markets. I’d be patient if you’re looking to buy the dips. This market still looks excessively risky to me. Not the gimme short at 1220, but still very risky.
No dip buying for me. I’ve been very defensively positioned of late, with a small short bias, wishing it was much larger than it is.
I’m just trying to think through possible scenarios to help me decide whether to add to some short positions, or wait for a bounce. If this is a EURO thing, we’ll see a bounce because the Euros won’t bring the house down on their own heads. If we are seeing the QE/China unwind, it could possibly take us much further down, perhaps even to the 200 DMA (SPX), that mythical place we last saw in August. IMO
TPC – If I were long the one thing that would really scare me would be the USD. I think the majority of the move in the dollar to the downside was irrational and nothing more than QE fear mongering about inflation, etc. I think investors are beginning to question whether QE will actually cause inflaiton (which it wont). That could mean there’s more upside in the dollar and that spells bad news for commodities and anything keyed off inverse dollar trades.
Mark Thoma on QE II:
Yield curve approach visualized.
http://moneywatch.bnet.com/economic-news/blog/maximum-utility/what-is-qeii/997/
TPC after a move from 1040 to 1226 of 186 handles you call a close at 1178 carnage? A 3-4% decline after an 18% gain is healthy and much needed for the year end rally to 1250-1270 range.
If you want to cherry pick markets then why don’t we discuss the 3 day 8% losses in Shanghai? Or the 4 day 10% loss in copper prices? Or the 6 day 15% loss in cotton prices? Or the 3 day 10% loss in CA munis?
Sure, US equities haven’t collapsed, but that doesn’t mean a lot of other markets aren’t suffering huge short-term losses.
Those losses you site are minimal compared to the rises since the QE announcement, in which you site. Ritholz had a good chart up showing returns since the QE2 announcement and corresponding asset prices. Also lets not forget this is an expiration week and there has been alot of call buying going on lately. Not trying to be critical here because I find the blog informative just taking the other side of the trade on this one into year end.
http://graphics.thomsonreuters.com/F/10/GLB_MKTQEP.html
TPC – No, it’s good to keep things in perspective and I appreciate it. I am not beating my chest over the recent reversal, but it has been essentially on cue as I called it. We’ll see what happens next. I doubt there is a huge amount of downside without substantial deterioration in China and/or Ireland, but I still prefer to be short than long here…..
Great call.
this is a really important interview with Jeremy Grantham:
http://www.cnbc.com/id/15840232?video=1640401359&play=1
executive summary: maybe one can squeeze more out of equities and securities over the short term, but nothing looks good long term except stuff coming out of the ground (not the processors of the commodities, but the actual commodities), and then only for those who will wait and wait and wait. The Fed will pretty soon run out of bubbles to blow, and S&P fair value is 900.
Ha, the world has been trying to time that trade. Sure it’s going to happen eventually, but only when most people believe it wont!
Too late to short equities now, that trade setup perfectly last week. Now we naturally bounce tomorrow, fall Thursday and fall sharply Friday before reversing on the ECB rescue, then it’s risk trades are back on, full steam ahead for the cycle leading into the Christmas holidays. Oh what a wonderful holiday it will be, unless of course you try to step in front of this rally again, for the 8th time this year!
Some services listed Bullish sentiment for stocks at 71% last week and 97% for precious metals. There were no buyers left when the bad news hit – only sellers. This was very predictable, but you have to be willing to stand in front of the train for a while.
Higher rates and higher inflation are near certainty in the future. Others are just noises. This cycle will end when China turn from boom to bust, but it will take much longer time to materialize. Remember first time we heard housing bubble is 2006, it took more than 16 months, 3 false trend breakdown before stock market topped out. And commodities extended for another 9 months into 2008. So it just takes one day sell off now everyone forgot this is mother of all bubbles?
TPC,
Great call on all these recent developments. You have been ahead of the game.
On the other hand the sell off may have nothing whatsoever to do with QE and instead be just a prudent move by people who have capital gains in equities and commodities and want to realize those gains before a possible tax hike if the bush tax cuts are allowed to expire.
TPC – I think most people would agree that the euphoria over QE2 ignited stocks higher. If Bernanke was herding people into risk assets by making them think he could perpetually keep them higher then there’s an obvious cause and effect at work. As people realize the emperor has no clothes they’re realizing they’ve overplayed their hands on this trade….
Lots of “buy the dips” on this blog still.
It’s amazing how many trained monkeys the Greenspan/Bernanke regimes have created.
Harsh words, but Christ, do some original thinking other than “the seasonal cycle” or the “presidential cycle” says we go higher into year end.
I mean, we’re talking about Euro contagion, bail-out or no bail-out there is harsh, harsh austerity coming there, mini-crashes in China amidst a property bubble and food price inflation, rapidly rising input costs for corporations that have yet to be factored into guidance, rate increases in all non-Chinese EM countries, a Fed that has run into massive opposition to QE2 and at best, a high risk of further deceleration in US growth moving into 2011.
The irony is, if the market does try to rally it will be concurrent with bigger increases in commodity costs, thus destroying the fundamental underpinnings for a rally in the first place.
Stocks may ‘rally’ tomorrow just in time for the ‘IPO” that no one wants, but the dollar rally will win out. It’s essentially a game of musical chairs wherein the players, (BOJ,BOE,ECB,FED) are playing the shell game of monetization. Remember when the euro was toast? Like magis, it rallied and the dollar caved. Now, it’s our turn. Get it?
hey TPC,
i read and listen to all sides and perspectives, ranging from peter schiff to randall wray, and out of the whole lot i feel closest to you and trust your judgment. i literally read almost everyone, as much as i can. i couldn’t list all the bloggers, economists, market commentators, etc., i follow.
lately i’ve been digging in a lot on the PK / MMT explanations, and finding very little acknowledgment or criticism of them. i know they’re correct in terms of the accounting of a pure fiat model (without regard for legal and institutional, historical structures and constraints of our monetary system). i also know they’re bat shit politically and wide eyed progressives, which makes me suspect that their perspective is narrow and myopic.
anyway, i came across the first hard money criticisms of MMT (from someone who understands it and accepts accounting reality), at this location:
http://pair.offshore.ai/38yearcycle/
sections 4.5, .6, .7 deal with MMT, within the framework of the authors larger topic. i thought you might comment on this and add your thoughts.
thanks if you get around to it,
Bill
I’ve seen that before. It’s not a very good debunking of MMT because it’s mostly based on unrealistic or incorrect assumptions. For instance, hyperinflation is the death of the currency. It occurs when the govt can no longer enforce the use of its currency. Once you’re in that world you can pretty much throw all economic theory out the window because the only thing that rules in a hyperinflationary world is guns and more guns. This debunking is essentially based on the idea that hyperinflation can occur and destroys the premise of MMT. Well, of course it does. One of the foundations of MMT is that the state can enforce taxation and usage of its monetary unit.
Any nation that is corrupt or foolish enough to lead to hyperinflation will unravel. It doesn’t matter what kind of system you’re running. Importantly, however, once you are taken out of this world where the govt is corrupt and/or unable to enforce taxes you are not longer working within a MMT framework. So, the whole debunking kind of falls on its face right there.
Also, not surprisingly, it’s written by a gold bug/Austrian economist so it’s not surprising that they reject MMT. Any theory that calls for govt intervention or control will be rejected by austrians. I don’t necessarily reject all of austrian economics, but I think it’s absurd to assume that humans and markets can regulate themselves. We’re too damn greedy and evil for that to ever become a realistic reality.
I am also highly skeptical of anyone who cites Peter Schiff in their work. Few people have misunderstood the current environment more than Peter Schiff. His calls for a dollar collapse, bond market collapse, and US equity collapse have been so far off the mark that it’s hard to even take him seriously. There are very serious disconnects that this man does not make. For instance, a crashing US dollar would crash the entire global economy so it’s absurd to say “buy emerging markets and sell US equities” as he did in 2008. Of course, that was utterly disastrous. A guy like him is towing a political line and nothing more.
One of the nice facets of MMT is that it is apolitical. I consider myself a centrist. I am open to the party that I think best serves our nation at a particular time. MMT suits that quite well. You’ve probably noticed that I criticize Krugman as well as other Republican narratives quite a bit here…..
I also noted Schiff’s bad call in 2007-8, but it might have been more an issue of timing. The timing error may be mainly because Helicopter Ben and the Progressive elitists chose to bet the next several generations of wealth on a financial holding action that will mainly result in a mere delay and intensification of the inevitable. Gold bugs may start looking like geniuses. in fact, aren’t we already 5X geniuses?
Schiff’s commodity bullishness is looking good again, but a sustained crash could evaporate commodity demand again. The dilution of our currency and its plunge may be the most important thing to happen, along with our dead banks, hollowing industrial base and spiraling entitlements/spending.
The so-calld “Recovery Summer” was a nightmare, resulting in a decision to QE another $600 billion in Treasuries and $300 bilion in other bonds– this to circumvent a new fighting mad Republican Congress. Consumer and business debt is a disaster. Non-performing loans are epic. Our banking industry is a zombie.
When I say Progressive elitists, I mean that in the broadest sense,not the partisan sense. In addition to Obama, Pelosi, Reid, Frank, Schumer, Nadler, Weiner, Dodd, Bernnake, Geithner, etc., I include “deficits don’t matter” Cheney and largest new entitlement, largest new bureaucracy Bush, Henry Paulson, John McCain, Lindsey Graham, etc.
Thanks for the reply.
Like I said I read them all and try to make sense out of it. Your blog has been helpful.
That’s a great thing. If there is one thing that I pride myself on it is keeping an open mind. I don’t pretend to have all the answers and I am always willing to change my stance if I am proven wrong. I have adapted and changed quite a bit over the years as I’ve learned more and more. I used to lean more towards austrian economics, but that has changed over the years.
I think it’s good to keep an open mind. There is no “one size fits all” in the world of economics. I’ve found that MMT explains the monetary system better than most other theories. But that doesn’t mean it is without flaws.
I started with the Austrians too. Still fond of Hayek’s body of work. We can’t forget that most of the Austrians were describing the gold standard economy, and to that extent were correct. Too many people who are not familiar with the history of economic thinking just assume that Austrian means Rothbardian, 100% reserve, etc. To the extent that much of our present economic system is a hold over from the gold standard era (it really only ended abruptly in 1971), much of present Austrian analysis is able to hit the mark. That’s why someone like Schiff can get things half exactly right and be so off on the other half. I have my doubts, however, that some of the types at New Deal 2.0 have any understanding of someone like Hayek and his ideas on capital and social order. I think if some of those types got their hands on “monetary sovereignty” we’d be on the road to central planning, high inflation, major capital misallocation, etc. Imagine California in 10 years, with its own printing press. Extrapolate 30 years, replace “California” with USA, and you can see how things might unravel. But that’s a political question, more than an economic one, I suppose.
Agreed. The one major failing in MMT and in most of economics is that it does not entirely account for psychological responses to various policy measures. It doesn’t matter how pretty your equations look on paper if one group of people view your policy as unfair, illegal or corrupt there are likely to be very damaging effects. The Austrians consider this aspect moreso than most other schools of thought and that’s where I have gained the most from austrian economics. Moral hazard is very real and has a intangible impact on society, productivity and generally everything. Although impossible to quantify it should not be lost in the shuffle….
I also rank John Hussman right up there with your blog. I find it strange he hasn’t incorporated any MMT into his otherwise cogent analysis. Do you read him, and if so, do you think he “gets it”? If he’s worried about the FED’s policy, I find it difficult not to at least respect his worries.
I think one of the reasons so many individuals fall into the trap of ideology (Austrians, among others), is that it’s distressing when so many of the most intelligent people out there have absolutely NO consensus. I think of myself as very intelligent and have devoted considerable time to studying economics and markets; but when I see people who I know are more intelligent than me with vastly different interpretations, it’s discouraging.
Learning about endogenous money, MMT, definitely helps explain why so many highly intelligent and acute observers can come up with the wrong conclusions by misunderstanding some very foundational facts about our system.
Hussman is probably my favorite analyst/fund manager around. He has a different investment approach than myself and I think he has tended to be too bearish and inflexible at times, but on the whole his understanding of the way things work is second to none.
TPC wrote:
“I don’t necessarily reject all of austrian economics, but I think it’s absurd to assume that humans and markets can regulate themselves. We’re too damn greedy and evil for that to ever become a realistic reality.”
So, the conclusion is that we put our trust in politicians who will regulate our lives for us … especially since we all know that politicians consistently refrain from ever being greedy and evil.
The unrealistic non-reality of politics operates on this basic assumption: That we (the people) are too stupid to know what’s good for us, too incompetent to run our own lives, and too greedy to be trusted. YET, we ARE intelligent enough to elect trustworthy politicians who are capable of running our lives.
That is a ridiculous fallacy that would be humorous if not tragic.
Gary, that’s just populist nonsense. Do you honestly think that banks and bankers should be allowed to transact and operate free of any regulations? Did you not live through the last few years? What in the world makes you think that humans can regulate themselves? Do we not need police? Do we not need adults? Why are markets any different? What makes markets efficient and self regulating?
I’m not claiming that politicians don’t make mistakes, but without rules and regulations we’d be living in the wild wild west….
TPC,
just for laughs… you might pick a different phrase,
The Not So Wild, Wild West
http://mises.org/daily/4108
It’s interesting how this analysis ignores the fact that the American west was formed through one of the most brutal and murderous displacements of human beings that the world has ever seen.
And at a time in history when there was not a whole lot of agreement on what was fully “human”.
One of our more difficult problems to solve in America (and elsewhere) is trying to apply social norms that are useful in thinly populated areas, to much more densely populated areas.
It’s sad that a person (especially a libertarian) could write such a detailed report while entirely ignoring the displacement of the native americans in attempting to prove a point that the American west was somehow peaceful. This was by far the worst infringement of personal rights that has ever occurred on American soil….
Exactly, the american version of the Israeli “nakba” of 1948.
“nakba” is an ethnic cleansing
Yes, I was using the Nazis as an example in a conversation last night. This paper is like arguing that the Nazi regime was actually quite peaceful and functioned smoothly. As long as you ignore the fact that they were slaughtering millions of Jews…..
one thing that encourages me is the influence of blogs and social media on the media and political landscape. just as you and i are in the process of learning, getting smarter, i think a big chunk of the blogosphere will do likewise. it will get smarter with its participants. maybe it will have some influence on policy over time and replace the traditional media with its narrow interests.
“Moral hazard is very real and has a intangible impact on society, productivity and generally everything”
Amen, brother, amen.
When the ordinary Joe considers not paying his mortgage, and the concept of honoring your debts and obligations becomes viewed as “quaint, but a little naive”, the flying excrement will have us all wondering who removed the off button on the fan.
Unless the government finds villians on Wall street (or somewhere), and exacts a meaningful punishment, that’s where this is likely heading. Jailing Bernie Madoff is not enough. At the very least, there should be claw backs of these outsized compensations and bonuses that led us into this mess.
And what happens when working folks stay out of work too long? The work ethic is a hard habit to instill (ask anyone with kids in America), and easily lost. It is TRULY is better to pay folks to dig holes and fill them, then it is to have them believe that money comes from helicopters.
As always, thanks for your clear head, and precise writing.
Here’s hoping for a better tomorrow.
‘U.K. Support Sought for Ireland Bailout.’
In a PIIGS ear!
“one thing that encourages me is the influence of blogs and social media on the media and political landscape.”
—-
As a guy without a Phd in economics or finance, I read a variety of blogs every day just to try and understand what the hell’s going on.
If the exchanges of views on this thread over the past 20 hours are any indication, there is ample reason to be encouraged about the influence of ideas expressed in this medium available to all, hopefully to include our friends in the media and political worlds.
This particular thread is one of the truly good ones. Save it someplace special for easy reference.
Excellent comments in response to an excellent blog. Wish I had more time to participate in stuff like this.
Economics is more psychological than technical. Human nature is more important than abstract algorithms, which cannot begin to emulate it.
There’s nothing magic about the dollar. There’s nothing magic about gold. it just happens to be a less imperfect store of value than a fiat currency manipulated at the whim of a self-appointed “elite.” They are only the elite because we are stupid enough to alow them to be. In the past, sticks, shells, cigarettes and other things, have all acted as “money.”
By the way, the powerz that be have been trying to eliminate gold for a long time. Fiat currencies and edicts have attempted to replace it many times over the years.
Gold’s role diminished when the Federal Reserve was founded – and again when gold was confiscated and the dollar devalued in 1933- and again when Nixon “closed the gold window” in 1971. It is back now, like a jilted lover who only looks better than the replacement lover who cuckolded you. It definitely has its downside, but will rule in the bedroom, along with its evil sister silver, for the intermediate future.
Fiat currency might have worked, if its masters had not gotten so greedy, but they always do. At this point, USA debt and spending have become increasingly unsustainable. There is no way out but default, inflation. or takeover by a larger, stronger power. So, that only leaves disaster or an act of God. Batten down the hatches, folks.
That is the most dangerous thing that MMT exposes (in the transactions matrix). Billyblog makes it obvious via CofFEE. There is a huge moral and power hazard associated w/ allowing a government to enforce full employment. It reeks of socialism if not outright fascism – and that scares me to death.
And if don’t think the federal government isn’t about an (unconstitutional) power grab, then check out the Patriot Act (wherein you can lose your rights to habeus corpus by just getting a label placed on you), or for that matter our new health care law. Hence, I believe in a narrowly constrained & focused government at all levels.
What did we not just learn about the market distrortions of QE2?
And while not libertarian (just a free man), nor austrian (but I like their fiscal restraint and conservativeness), I would prefer to only requlate various markets that are clearly cartels or perform a “public” service (can we say Big Bank?).
As to the Austrians desire for a pegged currency, I can’t go there. Currency defense issues. One of the best Austrians might be Mish. At least he gets the role of credit (ala Steve Keen).
The over-regulation of small business seems way over the top to me, and in the various blogs I read, it appears unanimous that the regulations (and real costs) associated w/ hiring is having a true force in why small businesses won’t hire (other than the obvious other reason: can’t hire until demand picks up).
2 cents
TPC, the mises.org article had nothing at all to do with war between colonists/indigenous, which is what it was. It was about the prevalence of law and order and the absence of crime among groups of colonists outside the jurisdiction of the united states. call it what you want, but i wonder how you would have behaved as a colonist (or an indian for that matter). let me guess, you would have bought a boat and went back across the atlantic? be realistic. human nature is violent and brutal in the kinds of circumstances that prevailed on the frontier, and between-group conflict (war) is a totally separate issue from within-group conflict (theft, law).
I entirely understand your point, however, I think it’s a fantastic case of datamining to try to prove that the American west was peaceful when there was in fact a brutal and horrible war going on. Not only with the native Americans, but with the Mexicans as well. It’s no different than arguing that the Nazis were a peace loving people amongst themselves. You know, when you exclude what they were doing to other people…..
(theft, crime*)