Great Graphic: European Taxes and the Division of the Social Pie

This Great Graphic was posted by Sober Look from Goldman Sachs.  It provides a good overview corporate and sales tax (VAT) in several European countries. 

Portugal is the only one that has raised corporate taxes, but five of the seven countries included here raised their VAT.

FX Positioning and Technical Outlook: Stronger USD Ahead

If the third quarter was about the reduction of tail-risk by official actions, then Q4 will be about the limitations of the policy response. It will pose a challenging investment climate after what turned out to be a favorable performance in Q3. Equities generally did well. The US S&P 500 rose 5.75% in Q3. 

The Dow Jones Stoxx 600 rose 6.9%, led by a 12.5% rally in Germany's DAX. The MSCI Asia-Pacific Index rose also 12.5%, which is all the more impressive given that the Nikkei and the Shanghai Composite both fell (-1.2% and -6.3% respectively). 

Bond markets also did well, even though the benchmark 10-year US and UK yields did rise by a few basis points. The anticipation of new supportive measures that were ultimately outlined in early September helped spark a sharp rally in Spanish and Italian debt markets. Spanish 10-year yields fell 98 bp over the quarter, while Italy's 10-year yield fell 110 bp. Two-year yields fell 196 and 191 bp respectively. Gold too rallied; appreciating 14.2% on the quarter. The low and stable volatility was also an important feature of the global capital markets. 

Ten Observations as the Week Winds Down

The US dollar is going into month and quarter end on a soft note.  The greenback had been generally firm against most of the major foreign currencies, but the Japanese yen, since around mid-month, but the news stream appears to have turned against it.  Yesterday the euro traded in both sides of Wednesday's range and closed near the highs.  The euro is posting follow through gains today.  Yesterday the S&P 500 snapped a 5-day losing streak and may have helped underpin gains in Asia.  European shares could not match suit and are mostly lower, led by utilities and financials. 

In addition to the month end and quarter-end flows and portfolio adjustments there are several other factors at work.  

1.  The generally poor US economic data released in recent days suggest Q3 GDP may not be better than Q2.  The uncertainty over the fiscal cliff, related tax uncertainty, and the debt ceiling appear to be paralyzing important business decisions.  One of the consequences of this, despite the preliminary employment revision that found the US crated another 360k jobs in the year to March 2012, is that many, if not most observers expect QE3+ to run through at least all of next year, with the Operation Twist purchases being replaced by MBS/Treasury purchases starting next year.   The early call is for the Sept private non-farm payrolls, to be released next Friday (Oct 5) to rise by around 125k.  

Great Graphic: Gold in Different Currencies

Here is a Great Graphic I saw on marketoracle.co.uk, which picked it up from Scott Barber at Thomson Reuters.  It depicts the price of gold in a number of different currencies, including the dollar since the start of 2007.  Over this period, the price of gold has appreciated 175% in dollar terms.  

There are a couple of interesting observations.  First, the divergence among the different measures of gold did not begin in 2007, when the crisis first began, but in late 2008, around the Lehman event.

Second, despite Japan having the largest debt in the world at 200% of GDP and engaged in quantitative easing for much longer than any other country, the price of gold has appreciated the least in yen terms.  After Japan comes Switzerland, where the price of gold in terms of the franc appreciated a little more than it has in yen.  Gold in sterling terms has rallied the most.  The dollar and the euro are in a dead heat for the dubious honor of being second to sterling.   

Short Note on Market Developments

The US dollar is broadly mixed in choppy turnover in the foreign exchange market.  There are four main considerations today.  First is the month-end flows and portfolio adjustments.  They are broadly thought to be negative for the Swedish krona and euro and dollar and sterling positive.  

Second, is the string of European data.  In the euro zone this included a small rise in the number of unemployed in Germany (+9k in September after +11k in August).  Yet at 6.8% unemployment, the German labor market still seems fairly robust, even if not as robust as a few months ago.

QE+ Projections: Where does it End?

While many participants continue to focus on developments in Europe as the key driver in the foreign exchange market and the broader capital markets, they continue to wrestle with the implications of QE+.  The open-ended nature is conditioned a substantial and sustained improvement in the labor market.  Many observers are trying link this to a particular level of unemployment.  

This is misleading and Bernanke himself warned against it by explaining that 1)there was not apriori target for unemployment and 2) a broad range of indicators will be used to glean insight into the labor market.  The unemployment rate gets too much attention and does not really say as much about the labor market as the participation rate.

A Few Observations about Europe on Hump Day

Two main forces seem to be at work in the global capital markets.  The first is the month-end and quarter-end portfolio adjustments.  The second is a new deterioration of the situation in Europe, led by Spain and Greece.  These forces are combining and weighing on risk-assets in general and European peripheral bonds in paticular.

This is not to minimize the lack of confidence in the effectiveness of the Federal Reserve's new QE program, but as we saw after the November 2010 announcement of QE2, and has been experienced in other countries pursuing quantitative easing, the negative implication for the local currency can be overshadowed by other considerations.

Sterling's Resilience: Agriculture Subsidies?

Sterling has been resilient.  At the end of last week, sterling traded at new highs for the year against the dollar, briefly pushing through the $1.63 level.  It is trading about 2% above the multi-year high recorded against the euro in late July.  On the BOE's broad trade-weighted measure, sterling has appreciated about 4% this year.  This performance is all the more impressive when one considers that the UK economy has contracted for three consecutive quarters and the BOE has renewed its gilt purchases (QE).  

Some observers are trying to link sterling's strength to the EU agricultural subsidies of some 3.3 bln euros.  Even though the payment won't be made for a few weeks, the exchange rate will set at the end of the week.  UK is thought to hedge the value through selling euros forward.   While it sounds like an impressive sum, average daily turnover in sterling against the dollar and euro is estimated at $35-$40 bln a day.  The agriculture subsidies could easily get lost in the normal daily flows.

Switzerland: Recycling Distortions

We have argued that the recycling of private sector surplus from the northern countries in the euro area to the southern debtors is the key mechanism that has broken down and causing a disruption in the transmission of the ECB's monetary policy. The upward pressure on the Swiss franc emanates from the same source.

The private sector is not recycling Switzerland's current account and financial account surpluses. Reports suggest that the private sector in Switzerland is content to leave their savings at home. We have noted the distortions this causes.   The SNB's currency cap is, in effect, doing what the private sector refuses to do. 

Nervous Calm Leaves Greenback Mixed

The US dollar is decidedly mixed, gaining against the euro, Swiss franc, and the Canadian and Australian dollars compared with yesterday's New York close, but lower against sterling, the yen (for the fifth day), and New Zealand dollar about half way through the 24 hour session.  While the MSCI Asia-Pacific Index eked out a marginal gain, the European bourses are lower.  Month and quarter end portfolio adjustments are making it difficult to separate the signal from noise.   Peripheral European bond yields are up across the curve.  

Spain still seems to be dancing around a formal request of assistance.  The deputy prime minister stated it most baldly today.  "We need to know to what extent the ECB will intervene in the secondary market", she was quoted on Bloomberg telling a local radio audience. 

Great Graphic: Euro Zone PMI and GDP

This Great Graphic comes from Thomson Reuters Macroscope blog by Andy Bruce.  It shows how well the euro area composite PMI from Markit tracks the region's GDP.   It does a reasonably good job.  

However, the PMI typically has greater amplitude than GDP.  Both on the upside and downside, the composite PMI tends to be greater than GDP.  

The blog quotes the chief economist at Markit saying that he expects GDP to catch-up to the weakness anticipated by the PMI surveys.  It could.  The recent data has been poor and even the German locomotive has slowed considerably.  Markit says the results are consistent with a 0.6% quarter-over-quarter contraction in GDP.  The consensus Reuters found in last week's survey (35 people polled) was for -0.2%, with the most bearish at -0.5%.  

The composite euro zone PMI averaged 46.2 in Q3 and 46.4 in Q2.  The euro area economy contracted 0.2% in Q2.  Markit had projected a 0.6% contraction in Q2.  Nevertheless, Bruce argues that Markit has done a better job than most economists over the last 12 years.   

I don't have the data that can test that claim, but there is a reason why market participants use a consensus forecasts.  Moreover, the first official estimate of Q3 euro area GDP will not be released until mid-November.  Economists will have more real sector data, in addition to the PMI surveys, as input into their own forecasts.  Personally, I think the chart can be read to illustrate that the survey (sentiment) tends to exaggerate both the good times and the bad. 

Geopolitics and the Dollar

The confrontation with Iran is widely perceived as the most worrisome geopolitical event on the horizon. It is difficult to assess the odds of overt action. Intrade.com shows about a 29% chance of a US or Israeli strike before the end of the year. The general perception is that nothing happens before the US elections. The odds of a strike before the end of next year are just above 50%.

While this is indeed worrisome, there is another geopolitical issue that is increasingly problematic and that is the face-off between Japan and China over the disputed islands. It has spoiled the 40th anniversary of the celebration of the normalization of relations (Sept 29) and is having an economic fallout.

A military threat lurks just below the surface. Intrade.com has not developed a contract for this (yet?). Japanese press played up the fact that the islands are covered by the US-Japanese security pact. However, the US position is for a peaceful negotiated resolution.

Great Graphic: Demographics and Stocks

This Great Graphic comes from Joshua M Brown's Reformed Broker Blog. He says he got it from David Wilson who got it from Citi. 

On a log scale, it plots the S&P 500 and the number of Americans aged 35-39 at mid-year.  The implication is clear.  The size of this cohort is projected to increase over the next 17 years as a result of those that were born in the 1980s and 1990s come of age.  Their savings will help fuel a new secular bull market in stocks.  

Color me a bit skeptical.  First, such arguments, even if valid, should not dissuade investors from doing their home work and fundamental analysis.  Second, demographic and other structural arguments for underlying market moves, down plays the volatility.  Such arguments, then even if valid, should not dissuade investors from disciplined money management practices.   Third, such arguments assume that the next generation of investors will do what the past generation has done with its savings.  This seem to ignore that a) most Americans do not have a significant amount of stocks and those that do is primarily through 401k schemes and b) the stock market (S&P 500) is generally flat since 2000, c) the level of debt, including student loans, may delay the accumulation phase in the life-cycle approaches. 

Drivers in the New Week

The US dollar is firm to start the new week, except against the Japanese yen,  amid a general risk-off tone.  Against most of the major currencies, with sterling being the chief exception, the dollar has recouped the lion's share its post-QE3+ losses.  

The fifth consecutive decline in the German IFO did not help matters.  Talk that the ESM can be leveraged through selling bonds to the private sector is not helping peripheral European bond markets.  Month-end and quarter-end flows and portfolio adjustments are also thought to be impacting. 

Great Graphic: Lost Decade Ahead?

Here is a Great Graphic from Pew Research Center. It shows that median household income in the US has returned to roughly the level it was at in 1990.  

That is what is so irksome about pundit claims that Americans need to brace themselves for a "lost decade". They already are on their second lost decade.  Hello?

Given the stubbornly high unemployment level, the low participation rate, and the meager pay increases, there is little reason to think that we have seen the end of the erosion of the real median household income in the US.

FX Outlook and Positioning: Getting Tired?

The days ahead will help clarify whether the US dollar's somewhat firmer tone last week was simply corrective in nature, before a new leg lower, or the carving out of a bottom of a downtrend that began in June against most of the major currencies and July for the euro.    
The key may not lie with the economic data.  The important steps announced by the ECB, Federal Reserve, and BOJ has stolen the thunder from the near-term economic performances. Instead, we suspect politics and positioning may be more important.

Word Up on Prices

The US dollar is finishing the week on a soft note after generally recouping some QE/OMT losses in recent days.  The highlight is sterling, itself, has been fairly resilient this week and has recorded a new high for the year today, briefly moving above the $1.63 level in early European activity.   The proximate trigger remains elusive and the UK did report a record large deficit for the month of August.  

Global equities are higher in a new wave of risk-on activity.  The Indian market, which has seen nearly $1.7 bln of foreign inflows this month alone (and almost $14 bln year-to-date) led the Asian markets.  The Shanghai Composite finished marginally higher today (less than 0.1%), but does not mitigate the fact that this week's 4.6% decline is the biggest of the year.  Given the weak official and unofficial data, many participants are disappointed with the lack of a more aggressive policy response.  Indeed, talk of a rate cut or a reduction in required reserves is even absent from the rumor mill, which itself is unusual for a Friday.

What's Next for Greece and Why it is Important

There has been a dramatic shift of opinion regarding a Greek exit from the EMU.   As this chart from www.intrade.com shows that market perceives the chances of a country (presumably Greece) exiting EMU down to 15% from as high as 40% as recently as early August.   

It is at the lowest since the contract began trading in late Q1 2010.  While there are different issues that may compromise the preciseness of the odds (inferred from the pricing) of this market, it does jive with reports suggesting a shift in the position of some key officials, including Merkel.  Even the tone of some officials, like Hollande and Juncker, have moderated and both have come around to the view we have consistently maintained; namely that a Greece exit would not solve any of Europe's problems, and, indeed, would likely exacerbate them.

Great Graphic: European Unit Labor Costs

This Great Graphic comes from the FT Alphaville.  It was taken from SocGen's Cross Asset Research/Economics group and shows the development of unit labor costs in the euro area since 2000.  It shows improvement in the competitiveness of Greece, Portugal, Ireland and Spain.  

However, Italy has continued to move in the wrong direction.   That Italy is still experiencing rising unit labor costs may not be that surprising, even if disappointing.  Most interestingly, French unit labor costs are also continuing to rise.   We don't expect the European debt crisis to be over until it reaches France in some fashion.

Some Brief Thoughts on European Federalism

It is widely appreciated that Europe's monetary union is problematic because it was not accompanied by fiscal union.  Transfer payments are very limited.   At the end of the day, and despite what you may you may recall from geography classes, Europe is a political and historical construct.    It is the western peninsula of the great Euroasian landmass.    The construction of Europe is a work in progress.  

Just like nationalism destroyed the globalization of the late 19th and early 20th centuries, it would seem to threaten this version of globalization as well.  Integration in Europe is primarily an elite project and that elite seems divided and jealously guard their sovereignty.  Europe has not created Europeans.

Unwinding of Risk-On Continues

The unwinding of the recent risk-on plays continues today, sparked by three factors.  First, is another month with the Chinese PMI (HSBC flash) below the 50 boom/bust level at 47.8, up marginally from the 47.6, allows anxiety to continue to run high about the kind of landing the world's second largest economy is having.   Second, the euro zone flash PMI was disappointing.  Third, the well received Spanish 3- and 10-year bond auctions today are seen as delaying  the what is now thought of as nearly inevitable formal request for aid and this appears to be weighing on Spanish bond prices.

While we have generally been anticipating the dollar to bottom,  we are not yet convinced this is it.  So far the bounce is marginal at best, barely approaching the minimum technical retracements.  We identified the Canadian dollar and the Australian dollar as the most vulnerable,   We remain impressed with the resilience of the British pound, which is  trading at pixel time about a quarter of a cent below last week's closing price.  The UK retail sales and CBI industrial trends were in line with expectations today or slightly stronger, but did not seem to prompt much of a market reaction. 

Yen Strengthens Following QE

The yen has recouped all of the losses seen after the BOJ took several measures earlier, including extending its asset purchase program.  As we noted, the BOJ actions did not disappoint the market, and in fact by taking a number of measures and increasing the asset purchases by the upper end of expectations (JPY10 trillion), the BOJ may have been more aggressive than many had expected. 

Nevertheless as this intra-day chart from Bloomberg shows, after initially rallying on the announcement, the dollar has surrendered all of its gains and more.    The same can be said of the euro against the yen. 

Dutch Politics Recapitulate Euro Area Debate

Dutch politicians continue to try to form a government. Since the end of WWII, it has taken the Netherlands about three months on average to form a government following a national election. After the last election in 2010, it took almost 130 days.

In some ways, the debate between the Liberal (41 seats of the 150 seat parliament) and the Labor (38 seats) recapitulates the debate within the euro zone.

Japan Today, Spain Tomorrow

The Bank of Japan did not disappoint and joined the ECB and Federal Reserve in taking new and non-traditional measures. The BOJ did practically everything that we outlined yesterday and justified its move by downgrading its assessment of the economy. 

It increased its asset purchase program by JPY10 trillion to JPY80 trillion. The new purchases will be equally divided between bonds and bills. The BOJ also scrapped the 0.1% minimum bid for rinban operations (regular bond purchases, separate from QE). It extended the program from the middle to the end of next year. The BOJ did seem to hint at a more open ended nature of its QE by indicating that it could be extended if the goal of 1% inflation could be foreseen. 

The dollar rose to four week highs against the yen, just above JPY79.20 (from about JPY78.60 just before the announcement). In Europe, as the euro came under pressure, unwinding of the cross and talk of Japanese-based offers, the dollar slipped back below JPY78.90. It would not be surprising to see the dollar re-challenge the earlier highs in North America today, but general unwinding of risk on trades may limit yen weakness. To summarize, the ECB adopted OMT to save the euro, while the Fed adopted QE3+ to boost employment and the BOJ expanded its ongoing QE in order to arrest deflation.

Great Graphic: Taxes and Growth

This Great Graphic comes from David Leonhardt at the New York Times.   It shows the US growth with a fiive-year lag.  So, the charts ends with Q2 07 and shows that the average growth rate for the following five years has been 0.6%.  He overlayed the major changes in US tax policy.  

As an side note, Leonhardt notes that the economy was not in a strong position even before the financial crisis hit, which is often dated to the middle of 2007. 

His larger point is that over the past quarter of a century, tax policy and growth do not appear to align themselves as one would intuitively expect.  When one stops and considers it more closely, the results may not be that surprising.  

There are other factors, after all, that impact growth besides taxes. Relatively obvious things, like technological advances, like the computers, or the end of the Cold War played a role.  In addition, tax rates rather than marginal changes may be important.  There are, of course, various types of taxes and there is no reason to think that they all impact growth the same. 

I do not see this as an argument for or against tax increases or tax cuts.  There may be some taxes that ought to be reduced.  There may be some taxes that ought to be raised.  At the end of the day, however, given the US debt and deficits on one hand and the basket of goods that is the government provides, something has to give.  

One of my key interpretative points is that capitalism is about relationships.  And through this crisis, various relationships will be forced to change.  I am thinking of relationships such as the state and citizens, employees and employers, what is private and what is public, and gender relations. Stay tuned.  

Thoughts on Disinflationary Implications of China's Slowdown

Many observers see the open-ended commitments of the Fed and ECB as setting the stage for future inflation. Others retort that the output gaps remain sufficiently large that sustained price pressures are unlikely to be seen for some time.

The kind of inflation that excessive monetary easing would create is a demand shock as investors fearful of the debasement of paper money flock to things, that as Dennis Gartman pithily put it, hurt when you drop on your feet. The sharp rise in food and energy prices appear to be more a function of supply shocks rather than demand.

The rise in the price of foodstuffs was triggered by poor weather combined with low inventories. In fact as the USDA recent estimates were not as poor as expected, some food prices have fallen. Dec corn, for example, peaked in early August and today is trading more than 12% lower and its lowest level in nearly 2-months.

Will the BOJ Do Whatever it Takes ?

The ECB has promised dramatic action to save the euro.  The Federal Reserve has announced it will expand its balance sheet until well after the economy recovers.  Attention turns to the BOJ whose two-day meeting concludes on Wednesday.  The BOJ did increase the  size of its asset purchase program in February and April, but it has been generally reticent about committing itself like the Fed and ECB "to whatever it takes" within their mandates.

While the BOJ may tweak its policies this week, pressure will likely have to mount further to get it over its hump. For example, despite a range of opinion, it appears that there is a strong sense that buying foreign bonds is too close to intervention for the BOJ to initiate it.

Europe's Balance of Payments: What Capital Flight?

Understandably the euro area's balance of payments report released earlier today was overshadowed by the Fed's QE and ECB's OMT plans. Yet, there is important insight to be gleaned, especially from the financial account.

First, however, look at the turn around in the current account. In the 12-months through July, the euro area recorded a seasonally adjusted cumulative current account surplus of almost 63 bln euros, which is about 0.7% of the region's GDP. The comparable figure in the 12-months through July 2011 was a deficit of a little more than 22 bln euros. 

The goods balance shifted from a deficit of 2.4 bln euros to a surplus of almost 56 bln euros. The service surplus rose by more than 45% to 76.7 bln euros. The investment income balance rose to 34.1 bln euros from 27.5 bln. The deficit of current transfers was little changed. 

Great Graphic: Contested Territory

This Great Graphic comes from an essay by Michael Klare in Foreign Affairs.  It puts the rising tensions between Japan and China in a larger regional context.    The tit-for-tat political maneuvering is spilling over into economics.  Not only have Chinese demonstrators attacked Japanese companies in the PRC, but some Japanese manufacturers are taking protective action and cutting output from Chinese plants.  

Nationalistic fervor is being fanned in both countries.  Japan appears to be headed for national elections in early 2013.   Nationalist forces are likely to be strengthen, with some observers seeing a return of the LDP in possible coalition with the new nationalist Restoration Party.  

Although the disputed area is thought to have some economic value in terms of gas and oil, these seem secondary to political considerations.  As China rises, it first bumps against its neighbors and there are numerous unresolved territorial disputes in the area. 

Skepticism Due to Misdiagnosis

The US dollar is generally firmer in what appears to be a consolidative phase as the market digests last week’s developments and awaits fresh developments.  News of an unexpectedly large (10.6%) drop in Singapore’s August exports is seen as reflective of broader regional weakness.  The 2.1% decline of the Shanghai Composite, the most in ten weeks, was the largest mover, amid disappointment with the lack of monetary stimulus and declining home sales and corporate profits.   European bourses are also seeing some profit-taking after last week’s advance.    Peripheral bonds are also under modest pressure after recent gains.  

There is a sense among many investors and observers that the new steps by officials have reduced the risks of a new financial catastrophe. The main risk is thought lie with inflation, which currently does not appear problematic at around 2% in the US, China and Europe. Japan continues to experience slight deflation.

This is thought to help strengthen risk-appetites, which can be expressed across asset classes. If there was a meme over the weekend, it was “don’t fight officials.” That may prove to be only the first, dare one say, knee-jerk response. While acknowledging that European officials and the Federal Reserve have taken new and bolder steps, we are not convinced that they will enjoy any more success. The diagnosis of the problem has not changed. Can there will little wonder then that the prescription hasn't worked either? 

Great Graphic: Education and Longevity

This Great Graphic comes from Economy Watch, which in turn got it from the Congressional Research Service and ultimately from On-Line College Courses.   It says nothing about financial costs of education or the problem with student loans.  It simply shows how education is correlated with longevity and suggests some reasons why this may be the case.  

FX Positioning and Technical Outlook: Trend is Your Friend?

Nearly every development in recent days has been embraced by the foreign exchange market as a reason to continue to do what it has been doing since late July, and that is to sell the dollar.   

The German Constitutional Court ruling, allowing the European Stability Mechanism to go forward, which in turn bolsters the ECB's Outright Monetary Transaction program, has reduced the extreme tail risk that had been rising after the impact of the Long Term Repo Operations had worn off.  It not only reduced peripheral yields, but has also re-opened the bank and corporate bond markets in Europe.  The Dutch election results favored pro-European parties.  The latest signals suggest that the risks of Greece being ejected from the monetary union has diminished and the odds of a country leaving EMU this year, according to the policy market at www.Intrade.com have fallen to about 15%, near its lowest level in two years.

Great Graphic: How Much Gas an Hour of Work Buys

This Great Graphic is from Thomson Reuters.  It shows how much gasoline can be bought with an hour of work at the average hourly wage in the US. 

In many ways, I think this is a critical, yet overlooked, measure of cost.  How long does one have to work to earn the money to purchase something?  I explored some of this in my book, Making Sense of the Dollar.  

As the seemingly endless debate among economists illustrate, money measured over time and space is terribly difficult and fraught with all sorts of methodological issues.  An hour's work at the average wage seems so much more revealing about the true cost of living.  

Great Graphic: Italy's GDP

Here is a Great Graphic from the Wall Street Journal. It shows the poor record Italy has had since 2000 in generating growth.  What is does not show is that Italy still appears to be losing competitiveness.   Look at the August inflation numbers for a snap shot.  Italy's CPI is up 3.2% on a year-over-year basis.  This is the highest in the euro zone and compares with the region's 2.6% pace.  Germany and France reported 2.1%.  Spain's CPI is 2.7%.  

In a broader sense, Italy's unit labor costs rose by nearly a third since 2000. While the unit labor costs of Greece, Ireland, Portugal and Spain have been trending lower since 2008, Italy's still appears to be rising.  

While it seems fashionable to believe that the combination of Draghi's plan, the German Constitutional Court ruling in favor of ESM has turned the corner, color me skeptical.  One WSJ article quotes a currency strategist suggesting that Europe's dirty laundry has been aired (but not America's), I am remain less convinced.  Ultimately, Europe is still wedded to austerity.  The Dutch election may have been a setback for the euro-skeptics, but there is no end in sight for austerity.  This has political and social implications on top of condemning Europe to prolonged slow growth if not stagnation.  

The open-ended QE announced by the Fed underscores the commitment to a growth strategy by the US and the differences with Europe.  I think that in the medium and longer term, the US better growth prospects will be rewarded by investors.  In the immediate term, as I have been acknowledging (like here and here), my reading of the dollar's technical condition warned against picking a bottom quite yet. I continue to look for some reversal pattern or indication that a low is near.  

The fiscal cliff is indeed looming and Moody's reminded us this week of the rating implications, but this is not what the market appears to be trading on.  Despite the partisanship about fiscal excesses under this Administration, the government sector has been and continues to be a drag on US growth.  The federal government simply did not spend enough money to offset the contraction on state and local levels. 

It's not Simply QE3

The outcome of the FOMC meeting is not just a new round of quantitative easing. What the Fed announced represents a new chapter in its policy response. The first distinguishing aspect of its decision is the open-ended nature of it. While it has not indicated formal labor market targets, and indeed Bernanke shied away from such at his press conference, the FOMC committed itself to expanding its balance sheet until there is substantial and sustained improvement in the labor market.

This means that there won’t be a QE4 or a QEn as some pundits have forecast. Instead, the FOMC now is willing to extend its asset purchases indefinitely, conditioned on the improvement in the labor market. This means that unless the labor market shows significant improvement in the coming months, the Fed is likely to increase its asset purchases when Operation Twist is completed at the end of the year.

Great Graphic: $2 Million a Day into Solar Energy

My brilliant webmaster just found this Great Graphic on the boom in residential solar energy. According to Green Tech Media investors are putting over $2 million dollars a day into residential solar energy through Clean Power Finance. 

This.

Is.

Insane. 

Solar energy has been a frequent topic on Marc to Market. Back in January we posted about the potential of solar energy in the United States and how solar energy beats the bank. Since then we have posted about the solar capacity installed in 2011 and how solar energy was at a tipping point.

Great Graphic: Still Feels Like Recession

This Great Graphic comes from Pew Research Center in a post by Rakesh Kochhar.  It raises an issue that seems to have been lost as policy makers and investors focus on the financial part, the circulation of capital, of the crisis.  It is an issue that we have argued and see at the crux of the matter:  Where will aggregate demand come from while households and governments de-leverage?

One way, we have argued, that this recovery has differed from past recoveries is that the government sector is not creating jobs now.  This chart shows another way this time is different.

There has been no recovery or even slowing of the pace at which median household income is falling since the economy stopped contracting.   Simply put, in terms of the median family household income, the painful contraction continues unabated.   This is as much a political (power) question as it is economic and financial.  

Economists can debate whether expanding the Fed's balance sheet lowers interest rates or excites the stock market, or stokes gold and hard assets.  Yet, here is probably not much of a disagreement about its impact on household income.  Nil.  

It makes me recall why Studs Terkel called his oral history of the Great Depression "Hard Times".  It was only a Great Depression for those who had.  For most people, it was just a continuation and intensification of what they were experiencing before; hard times.  

FOMC: Gold, Dollar and the S&P 500

There are too many moving parts for the outcome of FOMC meeting to be a foregone conclusion. Since the disappointing August jobs report, the risk of a new round of asset purchases has increased and this has contributed to the risk-on environment, which of course has also been driven by the ECB. While this had led many to conclude the QE has been discounted, there are still many key unknowns. 

First, though, let’s rule out some possibilities, like a UK-styled funding-for-lending program and a reduction in the interest paid on reserves. In their communication, it seems clear the Fed is not prepared to take such measures now.Second, let’s acknowledge a couple of things to which there is little doubt, like pushing out the rate guidance from late 2014 into 2015, complimented by reduced growth forecasts, while  maintaining that inflation expectations remain anchored. Even if it is only pushed out to mid-2015, the least anticipated, the Fed may drive home its point by underscoring that it will continue to maintain an extraordinarily accommodative stance even as the recovery gains traction.

Assuming QE, there are several issues. What will it buy? Given the communication, there is a general expectation that mortgage backed securities will feature prominently, perhaps even solely.How much will it buy?

The benchmark here is QE2, which was for $600 bln over 7-8 months. There seems to be some desire for greater flexibility and this could come from a smaller program carrying over into early next year. If it weren't for the perceptions of the political awkwardness given that the next FOMC meeting is a fortnight from the national election, it might be more acceptable to decide its purchases from meeting-to-meeting.

FT Interview: Questioning QE3

Check out this interview I did for the FT on QE3 here.

Great Graphic: Euro, Yen and S&P with QE

These first two Great Graphics come from Adam Button on ForexLive.  They depict the euro and yen with the performance against the dollar matched up with the Fed's balance sheet actions.  The only extraneous event included was Japan's tsunami.

I post these charts because I think they are provocative, but I have serious reservations about them.  Surely we can agree that currency valuation is a relative measure.  It strikes me as misleading to suggest as such charts do that only one side of the equation matters. 

 One would never know by looking at the euro chart, for example, that euro is in the middle of an existential crisis since 2009 that has ebbed and flowed.  One would never know by looking at the yen chart, for example, that Japan itself has been engaged in quantitative easing as well.

Moreover, unlike the Federal Reserve, which buys the risk-free asset of US Treasuries and mortgage-backed securities, the BOJ, like the ECB, buys those assets the private sector is shunning.  The BOJ buys ETFs, REITS and corporate bonds, for example.

German Court Decision and Data Extend Risk-On Rally

The German Constitutional Court cleared the remaining hurdle to the ESM and this has encouraged a further extension of the risk-on rally.  The US dollar is bearing the brunt of the move ahead of the other key event of the week, the conclusion tomorrow of the FOMC meeting, where the perceptions of the risk of QE are running high.  

The market appears to have its sights set on the $1.30 level for the euro and $1.6180-$1.6200 for sterling.  The Australian dollar is actually leading the move today, gaining marginally more than the euro, and resurfacing above the $1.05 level for the first time in three weeks.  While the $1.0550 area may off some resistance, there does not seem to be much stopping a run back to the early August highs, a bit above $1.06. Meanwhile, cross rate losses for the yen are helping the dollar hold yesterday's lows near JPY77.70. As is often the case when the greenback comes under pressure, the Canadian dollar is losing ground on the crosses.  Yesterday's poor Canadian trade figures may also be taking a toll.   It is largely flat against the dollar in the European morning, making it the second worst major currency so far today behind the yen.

Great Graphic: Euro and Sterling

These Great Graphics come from my Bloomberg.  The first is a daily bar chart of the euro with the 200-day moving average plotted.  I tend not to think of the moving average to be support or resistance, but really more of a mile marker.  As I noted in the previous post the euro has not traded above its 200-day average since last October.  It comes in now near $1.2835.  The early momentum the euro enjoyed, which carried it to a marginal new high has stalled a bit, but this is likely to provide early NY participants with a new buying opportunity.  Only a break of the $1.2750 area would give the late bulls a pause.  

The daily bar chart of sterling shows it has led the euro.  Its lows were on June 1, while the euro's low was not recorded until July 24.  It also shows that sterling has been holding above its 200-day moving average since breaking convincingly above it on August 21.  Sterling, like the euro, briefly rose through last Friday's highs before consolidating late in the European morning.

Support is likely to be seen near $1.60, but even if there is some minor penetration, there does not appear to be any compelling technical evidence that a high of any import is in place.  The FOMC outcome, one of the drivers, is still two-days away and many fund managers still are underweight Europe, when those assets are now generally out performing.  That said, the UK FTSE is up about 3.7% here in Q3, which is among the worst performing bourses in the G10.    Gilts have also generally under-performed other European bonds over the past three months, except for bunds. 

Dollar Soft, New Insight into Euro Rise, Japan/China Tensions

News that the German Constitutional Court will indeed make its preliminary ruling tomorrow on the ESM and fiscal treaty has helped lift the euro. As noted yesterday, new charges in light of Draghi's plan threatened to delay the much awaited decision.  The euro made a marginal new high for the move, but quickly moved back into a consolidative mode.  Near-term support near $1.2750 has been established. Market contracts report some optionality in the $1.2850 may be slowing the momentum and some note the proximity of the 200-day moving average (~$1.2835), something that has not been violated since last October. 

Sterling has been trading above its 200-day moving average for more than 3 weeks.  The upside momentum has slowed as its straddles the $1.60 area.   The UK offered the data-surprise of the day with a much smaller than expected trade deficit.  The July deficit came in at GBP7.1 bln, down from a revised GBP10.1 deficit in June and expectations for a GBP9 bln deficit.  This is the smallest monthly deficit since February and reflects both arise in exports (8.5%) and a decline in imports (-2.5%).  The non-EU shortfall was almost halved to GBP2.9 bln from GBP5.1 bln. 

Great Graphic: Consumer Credit

Here is a Great Graphic from Zero Hedge.  It shows the history of the US consumer credit report since 2007.  It tends not to be a market-mover, but the unexpected decline in July has gotten the attention of many as the North American session winds down.  

The Bloomberg consensus was for a $9.2 bln increase.  Instead the Federal Reserve reported a $3.28 bln decline.

New Twists in the Plot (German Court and Greece)

There have been two developments that are serving to keep the euro consolidating in the North American morning. The first has to do with the Germany Constitutional Court and the second involves Greece.

A new claim was brought to the German Constitutional court by a CSU member of parliament. Peter Gauweiler, a noted euro sceptic, has filed a challenge to the Outright Monetary Transaction bond buying program announced by the ECB last week. Press reports indicate that the Constitutional Court is examining whether to postpone the decision on the ESM/fiscal treaty expected late this week. Apparently, an emergency session will be held today and a decision about this latest charge will be made tomorrow.

Eventful Week Begins Slowly

The US dollar is consolidating last week's losses in largely uneventful activity.  In fact, consolidation is the general theme in the broader capital markets as well.   Equity markets are narrowly mixed, with the MSCI Asia Pacific eking out a marginal gain and the Dow Jones Stoxx 600 trading with a slight downside bias in the European morning, Spanish and Italian bond yields are firmer across the curve as ECB buying does not appear imminent.  

The economic news stream has been light.  Two developments stand out.  First, French industrial production data (July), like German data reported last week, was stronger than the PMIs had suggested.  French output rose 0.2%, led by a 0.9% rise in manufacturing output.  The consensus had expected a 0.5% decline on both the headline in manufacturing output.  Second, China's data generally disappointed.  Over the weekend, it was reported that industrial output fell to its slowest pace in three years in August, while CPI ticked up for the first time in five months.  Today's news of a wider trade surplus ($26.6 bln from $25.1 bln) was a function of a small increase in exports (0.6% on the month), but a unexpected fall in imports (-0.3%). 

FX Positioning and Outlook: No Sign a Turn is at Hand

Key policy makers are preparing new efforts to address the deterioration of financial and economic conditions.  This is seen reducing tail risks, which allowed the rally in risk assets to be extended, and undermined the dollar.  China is providing new fiscal support.  The ECB announced its new Outright Market Transactions.  The disappointing US employment figures increases the risk that the FOMC will go beyond changing its guidance and offer a balance sheet response.  In the first eight months of the year, the US economy has grown an average of 150k private sector jobs a month.  During the same period in 2011, the monthly average job growth was 10% higher  

Perceptions of  reduced tail risks, which in turn allowed a further extension of the recent moves that have lifted equity markets, rallied the European peripheral bonds, and sent the US dollar lower.  There are many who are now talking as if a major corner has been turned.  We remain suspicious and continue to look for technical evidence that will help signal an end market trends that began 2-3 months ago.  Yet to be clear, and anticipate our argument below, such evidence remains elusive.

Jobs Data Disappoints, Ignore Drop in Unemployment Rate

The US employment data is an important disappointment, especially coming on the heels of yesterday's ADP and service ISM reports that had lifted expectations.  The private sector created a net 103k jobs, well below the 143k expected and a down from the lower revised 162k created in July.  A large part of the miss comes from manufacturing where 10k growth was expected, but instead fell by 15k.  This likely reflects some distortions from the auto sector.

Other details are also poor.  Hourly earnings were flat.  The consensus had expected a 0.2% increase.  Yet we already know that Aug auto sales were better than expected and chain store sales were firm.  The workweek itself was flat at 34.4 hours after the July week was revised down from 34.5 hours.

Six Observations as Week Winds Down

There are six observations on the G10 to share ahead of the weekend. 

First, the ECB's Outright Monetary Transaction (OMT) scheme has continued to bolster perceptions that officials are moving to reduce tail risk.  Dragji's announcement did not differ much in substance from what was leaked the previous day.  As was the case prior to this week, it continues to be now.  The onus of the initiative is on Spain's shoulders.  

There is increase speculated that Spain can formally request EFSF support at the Eurogroup meeting at the end of next week, which in turn is thought to be in sufficient time to negotiate the memorandum of understanding and allow some countries, like Germany's parliament, to authorize the support prior to the large redemption Spain faces in late October.  We are more skeptical, especially with Draghi's inclusion of the IMF for conditionality. 

Independent Central Banks? R.I.P.

On the day that ECB President Draghi provided more details over his plan to support the euro and monetary union over the objections of the Bundesbank President Weidmann, it may seem counter-intuitive to say, but ultimately, Weidmann is right. 

The ECB's bond buying plan is in fact "tantamount to financing governments" even if the monetary impact is sterilized. Spain and Italy have increasingly relied on financing deficits and debt with shorter-term instruments. Weidmann intimates that this subjugates monetary policy to fiscal policy and puts at risk the independence of the central bank.

Exactly what should a central bank be independent from? In whose name does it make its decisions? 

Combination of US Jobs and Draghi's Broad Strokes Helps USD

The stronger than expected ADP employment estimate and downward revisions to growth from the ECB has seen the dollar recover earlier losses.  Draghi has indicated that the details of the Monetary Outright Purchases (MOT), which is the SMP2.0, will be released in a separate press release, as will the new collateral rules.  This will of course be scrutinized.                             

We had been looking for the market to be disappointed with what ever Draghi announced today, especially given the key obstacle to implementation--neither Spain nor Italy appear prepared to request the aid.  And that precondition was reiterated by Draghi.                                

Draghi has indicated that the bond purchases will be fully sterilized and could stop if a country falls out of compliance with the MOU that is required.   

Will Draghi Deliver or More about Modalities ?

What promises to be an eventful period, and one in which the implied volatility, either in VIX or currencies seem low, has already had a couple of surprises.  The session began with soft Australian employment numbers.  Rather than grow 5k jobs, it lost 8.8k.  These were concentrated in part-time jobs, but the full-time positions gained only 600 and the July figure was cut by 1.6k.  

That said, the Aussie, which had made new multi-week lows yesterday failed to extend its losses, which precipitated a short-covering bounce.  Some of its gains were linked to speculation that China will ease policy imminently.  Given the economic and financial weakness, many participants have been surprised by the lack of response yet by the PBOC.  

Great Graphic: Words Used at RNC

Last night Michelle Obama's speech made me want to a. be better american and b. do more pushups to develop muscle tone in my arms. (My brilliant webmaster assures me not even having the commander in chief as a top adviser can spare one horror that is middle school girl drama.)

I thought it would be interesting to share this great graphic from the NY Times on the words used at last weeks RNC.