Three Key Developments

The US dollar is generally offered today.  There does not seem to be a major catalyst.  Rather technical factors, and in particular, the euro's inability to fall through the $1.2880 area despite repeated tests appears to have encouraged the move to the upside, as the path of least resistance.

Month-end flows are difficult to anticipate but may also be playing a role today. Some 20% of mutual funds, according to Morning Star finish their fiscal year today. The closure of the markets for the last two days now leaves them with only today to make adjustments for tax purposes.  

At the same time, there is a bit of a risk-on flavor.  Global equities are mostly higher.  Spanish and Italian bond yields are lower.  Emerging market currencies are mostly bid.   The yen like the dollar is a bit heavier.  

However, short-run momentum indicators are stretched and some minor bearish divergences are emerging  NY traders, mostly returning from a weather-induced extra long weekend, have to decide whether it is going to be trend day or not.  Consolidation seems more likely than a significant follow-through buying the major foreign currencies today.

Great Graphic: Exchange Traded Fixed Income Products

It is widely appreciated that Americans, who typically prefer equities over bonds, have re-discovered the fixed income markets on the downside of the credit cycle.  This Great Graphic, from Dodd Kittsley at the  Ishares blog.  It looks at the demand for fixed income through exchange trade products (ETP).

Demand for fixed income ETPs has nearly doubled since 2009.   In the past three years, investors in this space have done what investors more broadly have done and that is to look for better returns than available in the US government bond market, including inflation-linked instruments, like TIPS).  They have shown a preference for corporate bonds, including high yield ("junk") and emerging market bonds.   Of course, the higher returns come at the price of higher risk.  

The demand for emerging market ETPs is especially pronounced.  In the past two years, the share of ETP fixed income inflows accounted for by the emerging markets more than doubled to 5%.  They have experienced inflows nearly every month for the past two years.  Ishares calculates that already in 2012, more than $6 bln of new money has flowed into the EM ETP space.  

Ishares counts some 57 EM exchange traded products that are available, including the eleven that were launched this year.  It also notes that the issuers are creating new space in niches such as EM corporate bonds and EM high yield.  

Great Graphic: QE and S&P 500 Is that All there Is?

This Great Graphic comes from Zero Hedge, who got it from SocGen  It purports to depict the performance of the S&P 500 and concludes that QE is generating diminishing returns.  

Although our eyes can deceive us, we shouldn't let it confuse our thinking.  There is a logic fallacy embedded in here:  post hoc ergo propter hoc.   Just because something happened before some else does not mean it caused it.  

The stock market rally during the period of QE1 is flattered by the end of the sharp downturn following the Lehman debacle.  The poor performance noted under Operation Twist also corresponds to weaker earnings and concerns about the looming debt ceiling and fiscal cliff.  

Feeling Sandy

Early estimates for the economic costs of the storm that hit the east coast of the United States range from $20 and $50 bln. Hurricane Katrina in 2005 still appears to be more potent. 

There are three main channels through which the economic impact is felt—property damage, infrastructure damage and lost business. Lost business averages around 40% of total costs, but some experts from the insurance industry warn that this time it may be higher because dense urban population centers have been hit. 

Other experts warn that the property damage will be severe. Here private and/or government insurance will help absorb the cost to homeowners. Initial estimate warn that infrastructure damage is also substantial. Auto sales and retail sales and the larger category of personal consumption will initially be depressed by the storm. 

The pessimists are warning that all told the storm could shave 0.5% off US annualized Q4 GDP, which seems twice as much as a back-of-the envelop calculation on the idea the fully costs are borne in Q4 and there is not offset, like increased sales for re-building. 

Many are asking about the political implications of the storm. On one hand, it is during the response to crisis that government assistance may be most widely appreciated, perhaps making it somewhat less tenable for the independent voters to accept minimal government arguments. On the other hand, most the affected area were not considered closely contested by the pollsters.

Great Graphic: Composition of SNB's Reserves

The Swiss National Bank will report the composition of its reserves as of the end of Q3 on Wednesday.  This Great Graphic comes from the SNBCHF blog, showing the composition of SNB currency reserves in Q1 and Q2.  

  

The fact that the SNB ended Q2 with a greater proportion of euro reserves (60% vs 51%) than in Q1 indicated that it was not as aggressive in diversifying the proceeds of its intervention to prevent the euro from falling through the CHF1.20 level.

Looking at the SNB's monthly figures, it appears that the valuation of its currency reserves rose by about $68 bln in Q3.  Some fraction of this increase is likely a function of the vagaries of foreign exchange prices. 

In a quarter that saw the US dollar decline against all the G10 currencies, it held up best against the Swiss franc, falling by a little less than 1%. The franc lost about 0.6% against the euro and about 2% against sterling. Less importantly, the franc lost about 0.4% against the yen and a little more than 2% against the Canadian dollar. 

BOJ Moves, Market Yawns

In the face of a deteriorating economy and stubborn deflation, the Bank of Japan extended its assets purchase plan, but the bears had been hoping for more and they bought back the previously sold yen.  

The BOJ announced that it would increase its asset purchases by JPY11 trillion.  The consensus was for JPY10 trillion, though there had been some talk of as much as JPY20 trillion.  

These new purchases will consist mostly of Japanese government bonds (JPY5 trillion) and discount bills (JPY5 trillion).  The BOJ will increase its alternative assets, ETFs, REITS and commercial bonds by a total of JPY1 trillion.

What is Rajoy Waiting For ? Some Thoughts

Spanish Prime Minister Rajoy has continued to indicate that he will formally request more assistance when it is in the country's interest, which essentially means, when he is good and ready. And he is not now.  

Following his meeting with Italy's Monti, Rajoy was quite candid.  "The most important thing", Bloomberg quotes him saying, " is that  the mechanism is there. He is acknowledging the actual value of the Outright Market Transactions (OMT) lies in its presence not operation.  

What's on Your Radar Screen?

The US dollar is posting modest gains across the board, the notable exception of the Japanese yen, on the back of what appears to be largely a risk-off day. The MSCI Asia Pacific Index shed 0.2%, while the Dow Jones Stoxx 600 is off 0.5% late in London's morning. Spanish and Italian bond yields are higher. Emerging market currencies are mostly lower.

With short-term momentum indicators a bit stretched, this week's big events still ahead and a fainter signal from the US today with the closure of the stock market to precautions ahead storm, it may be difficult to significantly build on today's price action.

Currency Positioning and Technical Outlook: Fade Breakouts ?

The US Dollar Index reached its best level in more than six weeks on Friday.  Yet it managed to only close a couple of ticks higher, as if warning short-term participants against ideas that a breakout is at hand.  This also appears to be the message of the yen's  dramatic recovery from four-month lows. 

Caught between what appears to be renewed deterioration of conditions in the euro area and US electoral and fiscal uncertainties, investors are paralyzed.   Key events this week include policy meetings by the Japanese and Norwegian central banks, the new month PMI readings, and the US jobs and auto sales reports.

Australia: Manipulating by not Intervening?

The Wall Street Journal brings to our attention the fact that the reserves at the Reserve Bank of Australia have risen sharply over the past two months.   Its reserves have risen by A$863 mln over the past two months after rising by about A$147 mln in all of Q2.

Typically when reserves increase, it is due to action by the central bank. However, as the Wall Street Journal points out, this is not the case in Australia.  Its reserves rose due to the inaction of the RBA.  It simply did not convert the foreign currency inflows as it typically does.

Europe Raises Bar, Japan Dithers

The US dollar is narrowly mixed against most of the major foreign currencies as the week winds down.  The big mover is the Japanese yen which is showing some resilience. Initially in Asia, the greenback had extended its recent gains to almost JPY80.40 before reversing to return toward yesterday's lows near JPY79.80.  A break of this area, and especially a close below there, which would trace out a potential key reversal would signal a consolidative or corrective phase has begun.  Such a phase could see the dollar return to the JPY79 area initially. 

The ostensible triggers for the yen's recovery are two-fold.  First, Japanese inflation, really deflation, was a little less than expected, with the September core CPI coming in at -0.1% rather than -0.2%.  Second, as already hinted, the government is proposing JPY422 bln in new fiscal stimulus.  However, on both scores, there is less than meets the eye.

A Few Notes on FX

The US dollar is trading heavily after yesterday's mini-reversal, with a stronger than expected UK GDP report allowing sterling to lead the charge.  The UK reported a 1% rise in Q3 GDP over Q4.  The consensus was for 0.6%-0.7% expansion after three quarters of contraction.  

The news, coupled with recent comments from BOE's King, have dampened expectations for a continuation of the gilt purchase program when the current operation is complete next month.  The gains in sterling have been sufficient to take out the downtrend line drawn off the year's high on the first day of autumn, Sept 28 and Oct 17.  It comes in near $1.6135 today.  A close above there, especially tomorrow, on a weekly basis, would be a very constructive sign.  The next immediate hurdle is near $1.6175, but the positive technical impulses suggest potential back toward $1.6300. 

Rising Volatility, Euro Out of Step

We have highlighted the contradiction between the low implied volatility and the large number of event risks on the horizon.  To us, it looked like a spring coiling.  The resolution, we anticipated, would be in favor of higher volatility, and we appreciated that there was a directional bias.  Higher volatility would likely, we thought favor lower equities and euro and a stronger yen.  

We have been right and wrong.  The S&P volatility, captured by the VIX has increased markedly.   When we first began building our case, the VIX was trading at the lower end of where it traded this year (near 14%).   Yesterday, it rose above 19% to reach its highest level in nearly 3-months.  This took place as the S&P 500 shed about 4% in four sessions.

Euro Slide Continues, Dollar-Bloc Resilient

The US dollar is broadly mixed.  The euro continued its sell-off.  With today's losses, it has shed nearly 2 cents since last week's high.  The Swiss franc has been dragged lower by the single currency.  The dollar-bloc is resilient as participants have second thoughts about the trajectory of policy, especially in Canada and Australia.  Sterling is also showing some resilience as doubts about extending QE in early November have crept in, despite poor data.   

Disappointing PMI data and a weak IFO survey ensured follow through selling of the euro in the European session. The flash October manufacturing slipped to 45.3 from 46.1 in September and defied expectations for a small improvement. The flash service reading ticked up ever so slightly to 46.2 from 46.1. The consensus expected a larger bounce. This produced a composite reading of 45.8, down from 46.1 and is the lowest since June 2009.

FOMC Preview

The Federal Reserve's two-day meeting begins today. Given the proximity of the election and the fact that an open-ended asset purchase plan was announced last month, there will be a great deal more talk than action at the FOMC meeting. 

There are two issues that market expects the Fed to discuss. The first may fall under communication, but is really more substantive. Currently the Fed uses a calendar date approach, now mid-2015 to guide expectations of the minimum amount of time the Fed will keep interest rates low. There has been some talk, led perhaps by the Fed's Evans, but clearly a topic at the Jackson Hole confab, that perhaps the Fed should provide numerical targets.

Oh Canada, What Next ?

The Bank of Canada meets today. While there will not be change in rates, the Bank of Canada governor has already signaled a more neutral stance. The previously indicated desire to remove some monetary accommodation (raise rates) will be pushed back in the face of a weaker global outlook. 

Note that tomorrow’s monetary policy statement will further drive home the message that the monetary stance is now neutral.  This will likely be reflected in new and more somber economic forecasts, including a recognition that its preferred inflation measure shows less price pressures than previously anticipated.   

Storms in Spain

Spain has returned to center stage, with Moody's downgrade late yesterday of several regions and today's official admission of what many had long anticipated; namely that Spain's relaxed fiscal targets would be overshot.  

And so it is.  

Moody's passed on cutting Spain's sovereign rating (to below investment grade) recent and the general sigh of relief has been short-lived.  Moody's cut Catalonia's rating (by two notches to Ba3) and four other regions.  The rating agency cited two main factors.  First is the deterioration in the liquidity situation of the regions, as evidenced by the low levels of cash reserves.  Second, it cited the heavy reliance on short-term credit lines.

S&P 500 and the Dollar: Weakening of the RoRo Trade

The US is in the middle of Q3 earnings reporting season. A fifth of US S&P 500 have reported (some 70% have beaten the managed expectations) and another third report this week. One theme that has been driven home by a number of companies is the two-prong challenge posed by China. Some have noted the slowdown in the Chinese economy. Others have emphasized that the cost of doing business in China is increasing.

The decline in the S&P 500 before the weekend was the largest drop in four months. Still follow through selling today has thus far been minimal. A convincing of Friday's lows would immediately signal a test on the 1425-1427 recent lows. We note that the three mini-highs recorded since early September have been recorded with lower momentum (14-day RSI readings).

Great Graphic: Fiscal Thrust High Income Economies

This Great Graphic comes from the Financial Times Gavyn Davies.  One key observation is that the austerity shift next year to the US from the euro area, though the UK has more wood to chop too.

 The magnitude of the US contractionary fiscal thrust in part depends the degree to which the automatic tax hikes and spending cuts are actually implemented.   There is significant uncertainty surrounding this, of course.  

The OECD projects Japan to swing toward restrictive fiscal policy in 2013, but this too is a very fluid situation.  First, the Noda government is looking to provide some more fiscal stimulus, though a supplemental budget at this juncture does not seem politically possible.  Second, and related, an election still seems to be possible before the end of the year, or early next 2013 at the latest.  

Noda's support continues to crumble and the LDP look to lead the next government.  The tightening the OECD projects in 2014 looks to be based on the assumption that the controversial retail sales tax hike will be implemented, but there is an opt-out clause, relating to the state of the economy. 

The other issue, and the one that Davies writes about, is the IMF's new research that claims the fiscal multiplier, which is the drag on the economy generated from austerity, is greater than before.  Previously, the IMF had estimated the fiscal multiplier at 0.5, which means that $1 of austerity generated a 50 cent decline on GDP.  The IMF's new calculations suggest the multiplier may be 0.9-1.7, as monetary policy in the high income economies cannot, as was often the case in the past, offset or mitigate the fiscal austerity. 

Drivers in the Week Ahead

This will be an eventful week.  The highlights include four central banks meetings (Reserve Bank of New Zealand, the Bank of Canada, Sweden's Riksbank and the Federal Reserve).  The first estimate UK and US Q3 GDP will be released, while the euro area flash October PMI will be reported alongside Germany's IFO.  

The RBNZ and the BoC are likely to soften their stances, even though the chances of a outright policy shift are slim to none.  The fact that the Federal Reserve had previously announced an open-ended MBS purchase plan and the proximity of the election means the FOMC is on the sideline.  That leaves Sweden's Riksbank as the most likely candidate to surprise.  Recently the governor of the central bank squashed speculation of a rate cut, fueling recovery of the krona, even this did not stop some of the dovish members from pressing their case.

Great Graphic: Political Economy and Gender Relations

We have suggested capitalism is about relationships and these relationships are being transformed.  We often think and write about the relationships between citizens and their sovereigns and employees and employers.  

This Great Graphic is from Pew Research.   It provides some evidence of another relationship that is being transformed and that is the one between genders.  

Pew Research has found that young women (18-34) now put greater emphasis on career than men 66%-59%.  In 1997, men placed the greater emphasis 58%-56%.  

Even among the next age cohort (35-64), the importance given to career has risen considerably among women over the last fifteen years.  The gap with men has virtually closed (43% men, 42% women.  In 1997, women trailed 26% to 41%).  

Women made up 46.7% of the American work force in 2010.  In 1970, woman accounted for 38% of the workforce.  The financial crisis hit industries in which men tended to dominate, such as construction and manufacturing. The reverse is true during the recovery that began in 2009, namely men have generally done better.  

Women have made great strides in education.  In October 2010, 44% of women 18-24  were enrolled in college or graduate school.  Thirty-eight percent of men were.     Pew Research found that 36% of women 25-29 had a bachelor's degree compared with 28% of men, which is a record divergence.

The increased education achievements and presence in the work place has not translated to equal pay in the workplace.  However, important strides have been made.

FX Positioning and Technical Outlook: Dollar Still Carving out a Bottom

Our big picture view is that the US dollar is carving out an important bottom, after selling off in Q3 as policy makers moved to reduce the extreme tail risks. The position adjustment that that inspired among investors appears to have largely run its course.

This bottoming of the dollar is proving to be a  more protracted process than we initially anticipated, but we think it is continuing to unfold.   Some observers suspect that the uncertainties surrounding the US election, the fiscal cliff and related debt ceiling issues also may be hampering the greenback's recovery.

Great Graphic: Social Media and the Political Dialogue

Here is a Great Graphic from the Pew Research Center.  It show by age group who and how the social media is being utilized. 

I see this dovetailing nicely with a big picture hypothesis being sketched out in this space  (here and here).  To state it succinctly:  Capitalism is about relationships and the financial crisis is going to spur changes in these relationships.   Examples of such relationships include citizens and the state, employer and employees and what is personal and what is public. 

The social media can be a medium for the expression of civic and political views.  Pew finds that two thirds of social media users do precisely this.  Enriching the political discourse, link and respond to others' content.  The younger cohorts are embracing this more than the older cohorts, but that is not surprising.  Nor does it undermine the argument. 

Civic involvement is important.  It is, I would argue, the real meaning of freedom from the ancient Greeks to the Founding Fathers of the United States:  sharing in the shaping of the community (however defined) in which one lives.  Pew Research shows that the new social media is being embraced that can create more space and broaden the dialogue.  I fully appreciate that some will argue that quality is uneven at best, but that too is part of the dialogue and is not that different from the uneven nature of town hall meetings or PTA meetings. 

Europe: Still Center Stage

There were three signals of note that emerged from the EU Summit, even if no new initiatives or measures were announced.

First, there was moral support for Greece as officials recognized “the determination of the Greek government to deliver on its commitments and we commend the remarkable efforts by the Greek people.”  By acknowledging that good progress has been made to bring the adjustment program back on track, it will be difficult to deny Greece a tranche of aid so it can service its debt that remains largely in the Troika’s hands. 

Second, German and non-euro area governments succeeded in slowing down the dash to establish the ECB as the sole bank supervisory at the start of 2013.  Instead, European officials agreed in principle to work out the details over the course of next year. 

Great Graphic: Debt Crises

This Great Graphic comes from the FT Alphaville's Joseph Colterill's post on Cyprus.  The data itself is from the IMF.  It provides some useful metric of a number of large banking crisis since 1970.  The US and European banking crises are not included.  

What stands out to me is the frequency and cost.   The costs, as depicted here, are in terms of the fiscal price (relative to GDP) and the loss of output. A better and more thorough understanding of the benefits need also need to be assessed. 

The history of banking is the history of financial crisis.  Leavings aside malfeasance, financial crisis often seem to occur on the downside of the credit cycle.  

Greece and Spain

European officials ability to reduce the tail risks appears to have been quite successful.  And they have achieved this without spending a single penny.  Yet the tension between the interests of the creditors and the interests of the debtors has not been resolved. 

This is clear the case in Greece.  Officials, including senior German officials are longer seeking a Greek exit.  The IMF has weighed in to support giving Greece more time.  The creditors, led by Germany, are not simply rolling over.  German Finance Minister Schaeuble has made a counter-offer.  

Policy Implications: Japan, UK, Sweden, Europe

There have been a few developments that may impact policy expectations.  First, in Japan, recent reports suggest a more robust policy response.  Prime Minister Noda is preparing a using funds in the FY12 budget that are not earmarked, for stimulus program.  The political difficulty is that the opposition LDP is blocking the issuance of new bonds until Noda calls for an election, which he seemed to agree to in order to get the controversial sales tax hike approved.

Although there is rightfully much discussion of the looming fiscal cliff in the US,considerably less attention is paid to the fiscal cliff in Japan, where the government has warned it will run out of money by the end of next month.  At the same time, the BOJ is expected to come under more pressure internally and externally to ease policy further at the Oct 30 meeting.  Following the government's three consecutive economic downgrades, the BOJ's new forecasts are likely to recognize that its inflation target is unlikely to be met over the next two years.

The Changing Winds

Policy makers are taking new measures to address the financial and economic crisis.  The ECB's OMT, the Federal Reserve QE3+ and the BOJ's increase in its asset purchase program is the monetary response.  To this we expect to be added a new round of gilt purchases by the Bank of England.  Australia and Sweden, which have room to cut interest rates have recently done so and are expected to do so again in the coming weeks.  The Bank of Canada signaled a shift back to a more neutral stance that will formally be announced next week.  

These monetary measures are being complimented by new fiscal measures.  Merkel has expressed some sympathy for tax cuts in Germany.  Italy surprised many with a 1 percentage point cut in the tax rate for the lowest brackets (and raising the VAT next year by 1 percentage point rather than by 2).  Japan's Noda has indicated support for new stimulus spending.  Press reports suggest Noda wants to draw on some JPY900 bln set aside in the current budget to support the economy, which his government has downgraded for three consecutive months. Government spending is also supporting the Chinese economy.

Great Graphic: Corporations Are People. Evil People

Here is a Great Graphic on the age old debate on if corporations are people.

 
Created by: OnlineMBAPrograms.org

Great Graphic: Income Inequality

This Great Graphic is from the Economist.   It shows the Gini coefficient that measures income inequality.  If every one has the same income, the Gini coefficient would be zero.  If one person received all the income the coefficient would be 1.  

The Economist reports that with the exception of Latin America, countries in most regions have experienced an increase in the Gini coefficient. 

There are, of course, numerous factors that determine the distribution of income.  Some inequality can be a motivation factor to the extent people believe (and act) that it is a meritocracy and hard work is rewarded.  However, extreme inequality can retard growth and contribute to financial crisis.  Rather than wage income funding consumption, transfer payments and debt were increasingly how aggregate demand was supported in the period leading up to the crisis. 

Government de-leveraging is may reduce transfer payments and household de-leveraging and bank's rebuilding balance sheets reduces the interest in new debt.  The key issue is where will aggregate demand come from in sufficient scale to reduce the output gap.  Reduced income inequality is one way to divide the pie; but as we have argued, this is just as much a political question as economic.  

Dollar-Bloc Update

Bank of Canada Governor Carney delivered a speech on Monday that strongly hinted that the tightening bias will be dropped at next week's rate meeting on October 23.  This is also likely to be the theme of the Bank's monetary policy report the next day.  

Carney explained that in highly uncertain economic periods, business reduces spending and employment plans.  He unequivocally indicated that next week's statement will take this into account.  His comments follow on the heels of last week's IMF cut of its world growth forecasts.

Bernanke Fires Salvo in Response to Currency War Claims

The Federal Reserve's open-end asset purchase plan (QE3+) is controversial.  Bernanke has defended its action against the domestic critics.  Over the weekend he defended QE3+ against foreign critics.                                   

Some in the emerging markets, most notably Brazil's finance minister, has claimed the unorthodox easing by the Federal Reserve in particular, but other developed countries more generally, are fueling destabilizing capital inflows.    

Three Drivers: US, Europe and China

A quiet start to the new week is leaving the US dollar little changed as North American participants return from the weekend.  Gains in early Asia were reversed in Europe.   The standout in the subdued activity is the yen, which has sporting a softer profile across the board.  The greenback is testing a two-month downtrend line near JPY78.75.  The euro, Swiss franc and, to a lesser extent, sterling, are approaching one-month downtrend lines against the yen. 

Asian stocks were flattish, but European shares are advancing, with the Dow Jones Stoxx 600 up 0.65% near midday in London, lead by a 1.2% advance in financials.   European bonds are mixed, while most peripheral bond yields are lower, Spain's 2- and 10-year yields are up 4 and 7 bp respectively.  On optimism that Greece will receive new funds the 10-year bond yields is more than 60 bp lower today. 

Lost on many observers is the fact that despite the absence of a fiscal plan in the United States, the government sector continues to be one of the headwinds on the economy.  Just before the weekend the US reported September's budget balance.  As it is the last month of the fiscal year, the 2012 fiscal year figures available.  The US deficit fell by $208 bln to $1.089 trillion and has fallen by a little more than 23% since the FY09 peak.  Receipts rose by 6.4% and outlays fell by 1.7%.

Great Graphic: China Exports and New Loans

China reported its September trade figures. Exports showed a larger than expected increase. The 9.9% increase was nearly twice the Bloomberg consensus and well above August's 2.7% pace.  

Imports rose 2.4%, after falling for the previous three months.  Of particular interest, copper imports were at their highest level in four months and iron ore imports were the largest in a little more than a year.  

On one hand, the data may have been flattered by front loading shipments ahead of the long holiday that began in late September.  On other hand,we do anticipate the Chinese economy bottoming in late Q3 or early Q4.

FX Positioning and Technical Outlook: What is Working

Market participants have to confront a stark asymmetry.  There are many ways to lose money, but there appears to be only three ways to make money. Nearly all strategies seem to come down to some variant of momentum or trend following, mean reversion, and carry trades.  

Each is associated with different market conditions and require different behaviors and tactics.  In momentum trades, one wants to buy what is going up and sell what is going down.  The use of trailing stops may be more beneficial than exiting a trade at a pre-determined level.  This seems to be the most common of the three strategies.  

Great Graphic: Obama and NYSE Composite

I spotted this Great Graphic on Business Insider. Joe Weisenthal got it from Chartist Friend in Pittsburgh.  It appears to use www.intrade.com data to assess the odds that President Obama is re-elected.  The lower chart is the performance of the NYSE composite.  

Joe's note sounded skeptical and so am I.  First, the note below the chart cites a strong correlation, but correlation is a mathematical relationship.  It cannot be eye-balled. 

Second, the conclusion does not follow from the evidence.   In fact, some observers attributed the stock market rally the day following the first debate to ideas investors hoped Romney would win.  

Third, although I too look at intrade.com, it is a starting point not the the final word.  For example, due to US regulations, it is difficult for Americans to participate.  The US presidential system, with its arcane electoral college, is complicated for Americans themselves, let alone many who live under parliamentary systems.  What follows from this is that national polls are misleading and frankly, beside the point.  What counts are electoral college votes and here Obama still looks to be the favorite.  There have been a few occasions in which one candidate won the popular vote and another the electoral college vote.  While such a scenario is possible then, it still seems unlikely. 

Great Graphic: World GDP Per Capita

This Great Graphic comes from The Economist.  It depicts world GDP per capita and shows the contribution from advanced and developing countries.   It notes that per capita GDP growth rates have returned to pre-crisis levels, though the composition has changed.  

Developing countries are contributing the lion's share of the world growth.  The financial crisis has been centered in the advanced economies. However, we note that the US is the only major advanced economy where output has surpassed the pre-crisis levels.  

There also seems to be a measuring problem here.  Do those categories even have merit or is it like the label "recession" which has no agreed upon definitionAre advanced and developing categories fixed over time?  If a country, such as Israel or South Korea, OECD members incidentally,  have higher per capita GDP than some countries in western and central Europe, should they still be considered developing ?  If some countries can move up from developing to advanced, can't other countries, such as Greece, for example, slip from advanced to developing?  

Hold the Press: The IMF Changes Sides

A significant event has taken place this week.  It will alter the balance of power between creditors and debtors and help shape the contours of the ongoing policy response to the end of historic credit cycle.  The IMF has not only delivered a mea culpa of sorts, but urges its members to do so too.  

The IMF used to stand for It's Mostly Fiscal.  The IMF articulated and defended the neoliberal solution for nearly every country's problems: Cut government spending and raise taxes, or so it often seemed. Its research now shows that policy makers have systematically underestimated the fiscal multiplier.  The IMF's World Economic Outlook (WEO) warned against prematurely and aggressively tightening fiscal policy. 

Yen Bulls Spooked

The dollar initially fell against the yen in the immediate knee-jerk reaction to S&P two-notch cut of Spain's sovereign rating. It dipped briefly below JPY78. However, it has rebounded smartly and is holding above yesterday's highs. There are four considerations today.

First, Japan reported a whopping 12.6% decline in total machinery orders in August, after a 2.6% decline in July. Core machinery orders, which serves as a better proxy for capital expenditures, fell 3.3% on the month, which was about a third larger than the consensus expected. Poor domestic and foreign demand saps the incentives to expand the capital stock. This reinforces economists' belief that the Japanese economy, like the euro zone economy, likely contracted in Q3 and the prospects for Q4 are also poor.

Australian Dollar Hops Higher on Jobs

The Australia’s jobs data surprised on the upside and is spurring some second thoughts about an RBA rate cut next month. The 14.5k increase in jobs was three times more than the Bloomberg consensus expected. 

The details were arguably even better than the optics, as a net 32.1k full-time jobs were created, while 17.7k part-time jobs were shed. In Q2, Australia lost an average of 2.8k full-time jobs a month. In Q3 it created an average of 14.1k such positions. 

Great Graphic: Declining World Trade

This Great Graphic was found on Business Insider, who got it from  a speech given by FedEx CEO Fred Smith on October 9th. via @CEP_Observer).

It depicts the slowing pace of export growth since 2010, with some countries reporting outright declines in exports.  

Of course, one country's exports is another country's imports and what is captured here in the slowdown in world trade.  We have discussed the financial disintegration.  The slowdown in world trade is a complimentary phenomenon.   This raises questions about the advantages often attributed to export-oriented economies, such as China, Germany, Sweden, Switzerland.  Such strategies, which seem increasingly like free-riders in so far as they borrow from other countries aggregate demand, seem to be at higher risk in a world were demand is de-leveraging and austerity.  

Spain Dissed by S&P

Shortly after the North American markets closed, S&P surprised investors by declaring a two-step downgrade of Spain's sovereign rating to BBB-.  This is the lowest investment grade rating.  It is matching Moody's current assessment, but it has indicated it will complete its current review this month.  Many had expected it at the end of Q3.  

Because S&P is playing catch-up rather than leading Spain's sovereign rating, it may not be materially important.  .  However, the timing was surprising.  This week's euro zone finance ministers issued supportive comments about Spain.  Many observers have been talking and writing as if Spain was turning back the financial crisis.   We remain skeptical.

Great Graphic: International Joblessness

Here is a Great Graphic I found over at Sober Look.   It is from the IMF and shows unemployment rates in different economic regions.  

What Sober Look draws our attention to is the fact that the IMF projects euro area unemployment to be above the Middle East and Northern Africa.  It will have the distinction of being the highest joblessness in the different geographic buckets that the IMF uses.

The impact of the higher unemployment is all the more stark because at the same time the basket of public goods that state provides is shrinking.  These conditions are not associated political stability.  Something is going to have to give and it is not something that can be addressed by the Outright Market Transaction scheme,  operationalized or just threatened.

It is also noteworthy that the with the notable exception of Japan, which is already experiencing a declining population and workforce, the US  unemployment rate will be lower than the other high and medium income countries, though still with plenty of slack.   The US is one of the few countries that a faster decline in the unemployment is the express goal of current monetary policy.

Four Points on Hump Day

The US dollar narrowly mixed.  It rallied in Asia, extending yesterday's gains against the euro, but has had the gains pared a bit Europe. Immediate resistance for the euro is seen near $1.2880.  A move through there could spark another half cent move.  The real take away though is that the euro is range-bound, with the $1.28 area marking the lower end and the $1.30 area denoting the upper end.  

Sterling is straddling the $1.60 area, consolidating in a narrow band at the lower end of yesterday's range. It has been a month since sterling has traded below $1.60.   The dollar is also enjoying an inside day against the yen.  The range thus far today has been less than 20 ticks.  The Australian dollar held yesterday's NY lows and has resurfaced the $1.02 level.  Australia reports employment figures tomorrow and this is understood as a key factor in market perceptions of the likelihood of back-to-back rate cuts.   The Australian dollar has spent this week so far within last Friday's range.  The upper end comes in near $1.0270-80 and a test seems likely. 

The Euro's Decline and a New Front

Various reasons have been given to explain the euro's decline.  Some accounts attribute it to a vendor posting the wrong prices for 10-year Spanish bonds.  Others attribute it to the IMF's cutting European growth forecasts. It is always difficult to disprove post-hoc narratives, as this analyst well appreciates.  However, there seemed to be something more important taking place.

A new front was opened in the running battle between creditors and debtors in the house of Europe.  Finland, Austria, Netherlands and Germany (FANG) had previously made it clear that legacy assets would not be covered by the permanent European Stabilization Mechanism.   At yesterday's meeting with European finance ministers, Germany's Schaeuble reiterated this position in no uncertain terms.

Nordic Update

Sweden reports August industrial production figures on Wednesday, followed by the Sept inflation on Thursday. The data should encourage the view that the Riksbank can cut rates against later this month when it meets (Oct 25), even though it had cut rates last month as well. 

There need not be a downside surprise in either output or inflation to strengthen such views as the consensus estimates will suffice. However, the risk do appear to be on the downside. The consensus estimates are good enough. A survey of surveys finds the consensus forecast is for a 0.5-0.9% decline in industrial output, which would fully offset July's 0.3% increase. 

Two For Tuesday: Spain and Greece

There are two developments in Europe that seem particularly telling of what to expect in the period ahead.  First, the market has been anticipating a formal request from Spain for assistance.  It is not likely any time soon.  Second, the ECB's Outright Market Transactions was not the only force to dampen the tail risk in the euro area, but there seems to be a significant shift in rhetoric regarding a Greek exit.  It too is not likely any time soon.     

Many observers had anticipated a Spanish request for aid.  Yet, Prime Minister Rajoy has played the role of a school boy wanting to know if the girl he likes will say yes before he asks her out.  And the girl does not want to answer until she knows the boy's intent. 

However, there is another dimension as well.  The threat of OMT has been enough to scare many asset managers in reducing their short European exposure.  This is an example of what former US Treasury Secretary Hank Paulson said about the presence of a bazooka may make its use unnecessary.

FX Drivers in the Week Ahead

The US dollar and Japanese yen are starting the week on a firm note, despite their respective markets closed for holidays.  The gains are concentrated against the major European currencies, with the dollar-bloc itself little changed, against the greenback.  Equity markets are lower.  China re-opened after last week's holiday with the Shanghai Composite falling a little more than 0.5%.  The Nikkei reports that Japanese auto producers in China have seen a sharp fall in sales and are responding by cutting production there sharply.

European bourses are lower, with the Dow Jones Stoxx 600 is off nearly 1% near midday in London, led by basic materials (-1.5%) and financials (-1.3%).  Peripheral bonds yields in Europe are mostly lower.  In emerging markets, the stand out is the collapse of the South African rand and a sharp decline in asset markets amid concern over the widening labor strife.