Something Doesn't Jive In This!

This doesn't make sense! If the economy is doing so well, why would central bankers need to artificially boost the markets and asset prices to bubble levels by more quantitative easing?

Fed Is Pandering to Stock Market. That Spells B-U-B-B-L-E!

I thought this was an interesting insight this morning from Bill Blain at Morning Porridge.
"US employment is at a high, the labour market is tightening, there is minimal real inflation and the stock market is off to the races because the Fed says its ready to ease if trade tensions impact the stock market economy.
"In 35 years of markets, this is perhaps the stupidest moment I’ve ever seen.
"There is a danger Powell et al seem are confusing the Dow and S&P for the health of the economy, thereby making the Fed complicit in the ultimate market distortion that’s being going on since someone dreamt up QE. The World’s most important central bank is missing the point completely, and more or less promising to bail out stock markets if Trade Tension causes them to weaken."

One of the chief characteristics of a bubble is that everyone dismisses risk. Heeeeere we go again! 

Hussman: How QE Works

July 9, 2012 What if the Fed Throws a QE3 and Nobody Comes?

John P. Hussman, Ph.D.
All rights reserved and actively enforced.
Reprint Policy

The financial markets were largely unresponsive to news of further easing by the European Central Bank, the Bank of England, and the People’s Bank of China last week. Notably, Spanish bonds plunged, while German short-term government bonds now yield -0.17%, indicating growing concern about sovereign default risk in the Euro area. Every few days will undoubtedly bring word of new “agreements” and “mechanisms” – arcane enough to mask their futility – that promise to solve the European crisis. The headwinds remain very strong. The key distinction here remains liquidity versus solvency. There is little doubt that liquidity will be provided at every opportunity, though the continual degrading of collateral standards by the ECB suggests that all the good collateral has been pledged already. More importantly, with a global recession visibly unfolding, solvency risk will only increase.

The odds remain against European countries agreeing to the surrender their national sovereignty to the extent needed to create a “fiscal union” and enable massive and endless transfers of public resources from stronger to weaker European countries. Barring a catastrophe severe enough to either prompt European countries to hand fiscal control to a central administrator, or to prompt Germany to agree to unconditional bailouts, the least disruptive move would be for Germany and a handful of stronger countries to leave the Euro first, and allow the remaining members to inflate as they wish.

With regard to the economy, I noted two weeks ago that the leading evidence pointed to a further weakening in employment, with an abrupt dropoff in industrial production and new orders. Mike Shedlock reviews the litany of awful figures we’ve seen since then, focusing on the new orders component of global purchasing managers indices: U.S. manufacturing new orders and export orders plunging from expansion to contraction, Eurozone new export orders plunging (only orders from Greece fell at a faster rate than those of Germany), and an accelerating decline in new orders in both China and Japan.

Recall that the NBER often looks for “a well-defined peak or trough in real sales or industrial production” to help determine the specific peak or trough date of an expansion or recession. From that standpoint, the sharp and abrupt decline we’re seeing in new orders is a short-leading precursor of output. As the chart below of global output suggests, I continue to believe that we have reached the point that delineates an expansion from a new recession.

On the employment front, Friday’s disappointing report of 80,000 jobs created in June may be looked on longingly within a few months, as we continue to expect the employment figures to turn negative shortly. That said, it remains important to focus on the joint action of numerous data points, rather than choosing a single figure as an acid test. I noted last week in Enter, the Blindside Recession, GDP and employment figures are subject to substantial revision. Lakshman Achuthan at ECRI has observed the first real-time negative GDP print is often seen two quarters after a recession starts. Earlier data is often subsequently revised negative. As for the June employment figures, the internals provided by the household survey were more dismal than the headline number. The net source of job growth was the 16-19 year-old cohort (even after seasonal adjustment that corrects for normal summer hiring). Employment among workers over 20 years of age actually fell, with a 136,000 plunge in the 25-54 year-old cohort offset by gains in the number of workers over the age of 55. Among those counted as employed, 277,000 workers shifted to the classification “Part-time for economic reasons: slack work or business conditions.”

What if the Fed throws a QE3 and nobody comes?

To date, the stock market has largely shrugged off the evidence of oncoming recession, in the confidence that the Federal Reserve will easily prevent that outcome and defend the market from any material losses. On that point, it is helpful to remember that the real economic effects of Fed actions in recent years have been limited to short-lived bursts of pent-up demand over a quarter or two. Not surprisingly, as interest rates are already low, and risk-premiums on more aggressive assets are already remarkably thin, the impact of quantitative easing around the globe continues to show evidence of diminishing returns.

With the help of some preliminary work from Nautilus Capital, the following charts present the market gains, in percent, that followed versions of quantitative easing by the Federal Reserve, the European Central Bank, and the Bank of England on their respective stock markets (measured by the S&P 500, the Dow Jones EuroStoxx Index, and the FTSE Composite, respectively). In order to give QE the greatest benefit of the doubt and account for any “announcement effects,” the advances in each chart are based on the 3-month, 6-month, 1-year and 2-year gains in each index following the initiation of the intervention, plus any amount of gain enjoyed by the market from its lowest point in the 2 months preceding the actual intervention. The effects of most interventions would look weaker without that boost.

Remember that quantitative easing “works” through central bank hoarding of long-duration government bonds, paid for by flooding the financial markets with currency and reserves that essentially bear no interest. As a result, investors in aggregate have more zero-interest cash, and feel forced to reach for yield and speculative gains in more aggressive assets. Of course, in equilibrium, somebody has to hold the cash until it is actually retired (in aggregate, “sideline” cash can’t and doesn’t “go” anywhere). Increasing the quantity simply forces yield discomfort on more and more individuals. The process of bidding up speculative assets ends when holders of zero-interest cash are indifferent between continuing to hold that cash versus holding some other security. In short, the objective of QE is to force risky assets to be priced so richly that they closely compete with zero-interest cash.

Understanding this dynamic, it follows that QE will have its greatest impact on financial markets when interest rates and risk-premiums have spiked higher. If interest rates are low already, and risky assets are already priced to achieve weak long-term returns (we estimate that the S&P 500 is likely to achieve total returns of less than 4.8% over the coming decade), there is not nearly as much room for QE to produce a speculative run. Leave aside the question of why this is considered an appropriate policy objective in the first place, given the extraordinarily weak sensitivity of GDP growth to market fluctuations. The key point is this – QE is effective in supporting stock prices and driving risk-premiums down, but only once they are already elevated. As a result, when we look around the globe, we find that the impact of QE is rarely much greater than the market decline that preceded it.

To illustrate, each of the Fed, ECB and BOE quantitative easing interventions since 2008 are presented below as a timeline. The shaded area shows the amount of market gain that would be required to recover the peak-to-trough drawdown experienced by the corresponding stock index (S&P for Fed interventions, EuroStoxx for ECB interventions, FTSE for BOE interventions) in the 6-month period preceding the quantitative easing operation. The lines plot the 3-month, 6-month, 1-year and 2-year market gain following each intervention, adding any gain from the low of the preceding 2 months, to account for any "announcement effects." Technically, the lines should not be connected, since they represent the gains following distinct actions of different central banks, but connecting the points shows the clear trend toward less and less effective interventions, with the most recent interventions being flops. Notice also that central banks have typically initiated QE interventions only when the market had somewhere in the area of 18% or more of ground to make up.

Of all the experiments with QE, the round of QE2 from late-2010 to mid-2011 was most effective, in that stocks recovered their prior 6-month peak, and even some additional ground. Yet even with QE2, the Twist and its recent extension, as well as liquidity operations such as dollar swaps and so forth, the S&P 500 is again below its April 2011 peak, and was within 5% of its April 2010 peak just a month ago (April 2010 is a particularly important reference for us, since that is that last point that the ensemble methods we presently use would have had a significantly constructive market exposure). The largely sideways churn since April 2010 reflects repeated interventions to pull a fundamentally fragile economy from the brink of recession, and recessionary pressures are stronger today than they were in either 2010 or 2011. Investors seem to be putting an enormous amount of faith in a policy that does little but help stocks recover the losses of the prior 6 month period, with scant evidence of any durable effects on the real economy.

In short, the effect of quantitative easing has diminished substantially since 2009, when risk-premiums were elevated and amenable to being pressed significantly lower. At present, risk-premiums are thin, and the S&P 500 has retreated very little from its April 2012 peak. My impression is that QE3 would (will) be unable to pluck the U.S. out of an unfolding global recession, and that even the ability to provoke a speculative advance in risky assets will be dependent on those assets first declining substantially in value.

Fed Extends Operation Twist through 2012

from Zero Hedge:

As always, Goldman Corzined anyone who listened to its call that an epic QE is coming. Fed did the worst possible outcome for risk- merely extended Twist, just as the credit market predicted it would 3 weeks ago:

• FED SAYS IT IS PREPARED TO TAKE FURTHER ACTION `AS APPROPRIATE
• FED TWIST EXTENSION TO SWAP $267 BLN OF TREASURIES BY END 2012
• FED TO SELL OR REDEEM `EQUAL AMOUNT' DEBT DUE 3 YEARS OR LESS
• FED TO BUY TREASURIES DUE IN 6 TO 30 YEARS AT `CURRENT PACE'
• FED SAYS EMPLOYMENT GROWTH `HAS SLOWED'
• FED SAYS INFLATION HAS DECLINED, REFLECTING OIL
• FED REITERATES ECONOMY `EXPANDING MODERATELY'
• LACKER DISSENTS FROM FOMC DECISION

This means that soon Primary Dealers' entire balance sheets will be filled with the entire inventory of Fed 1-3 year bonds. Market not happy. Full June statement here.

Mauldin: State of Global Economy

Meanwhile, Back At the Ranch

It is simply hard to tear your eyes away from the slow-motion train wreck that is Europe. Historians will be writing about this moment in time for centuries, and with an ever-present media we see it unfold before our eyes. And yes, we need to tear our gaze away from Europe and look around at what is happening in the rest of the world. There is about to be an eerily near-simultaneous ending to the quantitative easing by the four major central banks while global growth is slowing down. And so, while the future of Europe is up for grabs, the true danger to global markets and growth may be elsewhere. But, let’s do start with the seemingly obligatory tour of Europe.

What If California Were Greece?

David Zervos is the managing director and chief market strategist of Jefferies and Company. He is an astute observer of Europe and brings a very interesting perspective to the trade, with his Greek heritage. I got an email this morning from him that I wish I had written. It is hard for many of us in the US to understand just how deeply flawed the structure of the European Monetary Union is (as opposed to the actual political union which, for all its flaws, seems to work quite well). David came up with a very fun analogy that makes the problem readily apparent. What if California behaved like Greece and the rest of the US was asked to pay for its debts and other obligations? What would ensue? So, rather than paraphrase what is already a very solid if short essay, let’s turn to David:

The Separation of Bank and State

By David Zervos

“The euro monetary system is flawed. It is a system that was cobbled together for political purposes; and sadly it was set up in such a way that each member state retained significant sovereign powers – most importantly the ability to exit the system and default on debts in times of stress. There is virtually NO federal power in the Union, as witnessed by the complete breakdown of the Maastrict and Lisbon treaties. In fact, what we are seeing today is that the structure of the monetary system is so poorly designed, it actually creates perverse fiscal linkages across member states that incentivize strategic default and exit. Our new leader of the Greek revolt, Mr CHEpras, has figured this one out. And in turn he is holding Angie hostage as we head into June 17th!
[JFM note: CHEpras is David’s tongue-in-cheek name for the 37-year-old leader of the Syriza Party, Alexis Tsipras, whose rhetoric does indeed resemble Che Guevara’s from time to time.]
“To better understand these flaws in the Eurosystem, let's assume the European monetary system was in place in the US. And then imagine that a US ‘member state’ were to head towards a bankruptcy or a restructuring of its debts – for example, California.
“So let's suppose California promised its citizens huge pensions, free health care, all-you can-eat baklava at beachside state parks, subsidized education, retirement at age 45, all-you-can-drink ouzo in town squares, and paid 2-week vacations during retirement. And let’s assume the authorities never come after anyone who doesn’t pay property, sales, or income taxes.
“Now it's probably safe to further assume that the suckers who bought California state and municipal debt in the past (because it had a zero risk weight) would quickly figure out that the state’s finances were unsustainable. In turn, these investors would dump the debt and crash the system.
“So what would happen next in our US member-state financial crisis? Well, the governor of California would head to the US Congress to ask for money – a bailout. Although there is a ‘no-bailout’ clause in the US Constitution, it would be overrun by political forces, as California would be deemed systemically important. The bailout would be granted and future reforms would be exchanged for current cash. The other states would not want to pay unless California reformed its profligate policies. But the prospect of no free baklava and ouzo would then send Californians into the streets, and rioting and looting would ensue.
“Next, the reforms agreed by the Governor fail to pass the state legislature. And as the bailout money slows to a trickle, the fed-up Californians elect a militant left-wing radical, Alexis (aka Alec) Baldwin, to lead them out of the mess!
“When Alexis takes office, US officials in DC get very worried. They cut off all California banks from funding at the Fed. But luckily, the "Central Bank of California" has an Emergency Liquidity Assistance Program. This gives the member-state central bank access to uncollaterized lending from the Fed – and the dollars and the ouzo keep flowing. But the Central Bank of California starts to run a huge deficit with the other US regional central banks in the Fed's Target2 system. As the crisis deepens, retail depositors begin to question the credit quality of California banks; and everyone starts to worry that the Fed might turn off the ELA for the Central Bank of California.
“Californians worry that their banks will not be able to access dollars, so they start to pull their funds and send them to internet banks based in ‘safe’ shale-gas towns up in North Dakota. Because, in this imaginary world, there is no FDIC insurance and resolution authority (just as in Europe), the California banks can only go to the Central Bank of California for dollars, and it obligingly continues to lend dollars to an insolvent banking system to pay out depositors. In order to reassure depositors, California announces a deposit-guarantee program; but with the state's credit rating at CCC, the guarantee does nothing to stem the deposit outflow.
“In this nightmare monetary scenario, with the other regional central banks, ELA, and Target2 unable to stop the bleeding – and no FDIC – the prospect of a California default FORCES a nationwide bank default. The banks automatically fall when the state plunges into financial turmoil, because of the built-in financial structure. A bank run is the only way to get to equilibrium in this system.
“There is sadly no separation of member-state financials and bank financials in our imaginary European-like financial system. So what's the end game? Well, after Californians take all their US dollars out of California banks, Alexis realizes that if the Central Bank of California defaults, along with the state itself and the rest of its banks, the long-suffering citizens can still preserve their dollar wealth and the state can start all over again by issuing new dollars with Mr. Baldwin's picture on them (or maybe Che's picture). This California competitive devaluation/default would leave a multi-trillion-dollar hole in the Fed’s balance sheet, and the remaining, more-responsible US states would have to pick up the tab. So Alexis goes back to Washington and threatens to exit unless the dollars and ouzo and baklava keep coming.
“And that’s where we stand with the current fracas in Europe!
“Can anyone in the US imagine ever designing a system so fundamentally flawed? It’s insane! Without some form of FDIC insurance and national banking resolution authority, the European Monetary System will surely tear itself to shreds. In fact, as Target2 imbalances rise, it is clear that Germany is already being placed on the hook for Greek and other peripheral deposits. The system has de facto insurance, and no one in the south is even paying a fee for it. Crazy!
“In the last couple days I have spent a bit of time trying to find any legal construct which would allow the ELA to be turned off for a member country. I can't. That doesn't mean it won't be done (as the Irish were threatened with this 18 months ago), but we are entering the twilight zone of the ECB legal department. Who knows what happens next?
“The reality is that European Monetary System was broken from the start. It just took a crisis to expose the flaws. Because the member nations failed to federalize early on, they created a structure that allows strategic default and exit to tear apart the entire financial system. If the Greek people get their euros out of the system, then there is very little pain of exit. With the banks and government insolvent, repudiating the debt and reintroducing the drachma is a winning strategy! The fact that this is even possible is amazing. The Greeks have nothing to lose if they can keep their deposits in euros and exit!
“Let's thank our lucky stars that US leaders were smart enough to federalize the banking system, thereby not allowing any individual state to threaten the integrity of our entire financial system. There is good reason for the separation of the banking system and the member states. And Europe will NEVER be a successful union until it converts to a state-independent, federalized bank structure. The good news is that our radical Greek friend Mr CHEpras will probably force a federalised structure very quickly. The bad news (for him) is that he will likely not be part of it! I suspect this Greek bank run will be just the ticket to precipiate a federalized, socialized, stabilized Europe. Then maybe we can get back to the recovery and growth path everyone in the US is so desperately seeking.
“Good luck trading.”

Coming Together or Flying Apart?

The debate among very knowledgeable individuals and institutions as to the future of Europe is intense. There are those who argue that the cost of breaking up the eurozone, even allowing Greece to leave, is so high that it will not be permitted to happen. Estimates abound of a cost of €1 trillion to European banks, governments, and businesses, just for the exit of Greece. And that does not include the cost of contagion as the markets wonder who is next. Keeping Spanish and Italian interest-rate costs at levels that can be sustained will cost even more trillions, as not just government debt but the entire banking system is at stake. Not to mention the pension and insurance funds. If the cost of Greece leaving is €1 trillion, then who can guess the cost of Spain or Italy?
A total Greek default wipes out more than twice the ECB balance sheet. That means the remaining countries will have to put twice as much into the ECB as their present commitment, just to get the ECB back to where it technically stands today (because theassumption is still that Greek debt is good, and so the ECB is still lending money to the Greek Central Bank).
Then there are those who argue there is no way Greece can stay in the eurozone. The political costs are just too high, not only to the Greek people but to the rest of Europe. How long can Greece demand that Europe cover its government deficits, when its own citizens are not diligent in paying taxes? Listen to Alexis Tsipras, the leader of Syriza, at a campaign rally:
“There's one real choice in these elections: the bailout or your dignity…
“We want all the peoples of Europe to hear us, and we want their leaders to hear us when we say that no [country] chooses to become servile, to lose their dignity or commit suicide... We are the political party that with the help of the people will fulfill our campaign promises and cancel this bankrupt bailout deal.”
The Syriza Party appears to be ahead in the polls as I write, but that has shifted several times this week. Not only do European leaders not know what will happen, apparently even the Greeks cannot make up their minds, if we are to believe the polls. They want to stay in the eurozone but don’t want to have to endure the cuts in spending that simply moving toward a balanced budget will requirs. This is a classic case of wanting to have your cake and eat it too.
I simply don’t know what the eurozone will do in the next year, or even the next month. If Syriza wins the elections and forms the government, how can Europe back down and give them what Tsipras is demanding? And if the Greeks continue to pull their money from Greek banks (and it is now billions a week), then it will not be very long before they have their euros everywhere but in Greece, and they will in fact have little reason to stay in the eurozone, as Zervos points out.
This latter fact will not be lost on Spanish and Italian voters. If there is not that great a cost to Greece for leaving; and especially if Greece, after a period of severe recession/depression, starts to rebound; then voters all over Europe will be paying close attention. Some will ask why they should not default as well, and others will wonder why they are paying taxes to support other countries that might leave.
Even if European leaders have no real idea what will actually happen, there are some things that are more likely than others. I think the whole idea of eurobonds is dead on arrival. Who would be responsible for paying that bond structure, which would soon be in the trillions of euros? Some European authority? The EU itself, which would then need to levy taxes and set national budgets? I can’t really see any country giving up control of its budget to Brussels, let alone give the EU the power to raise taxes. And if the eurozone has a problem raising a relatively paltry €400 billion for the ESM, etc., from the various governments, how can it expect to get the authority to raise trillions? Does anyone really think the German Bundestag will agree to their share of that?
That then leaves the options of either designating the ESM or some other entity as a bank that can borrow relatively unlimited amounts from the ECB, or having the ECB monetize the debts of various governments in trouble and saddling them with a program of budgetary reforms (which are clearly not popular if you are the one being reformed!).
I still think it is likely that Greece will leave the eurozone. It makes sense if you are Greece; and even though it will cost the other eurozone members huge sums of money, I think they are getting “Greek fatigue.” But let’s stay tuned, as they say.

Europe in Recession

Germany was able to sell €4.56 billion ($5.8 billion) of two-year bonds at a 0% coupon interest rate on Wednesday. That was not a typo. Why would people give Germany money to use for two years at no cost?
I can think of several reasons, but the one I think is most likely – and the one that will not be admitted in polite circles – is that it is basically a very low-cost call option on the possibility of Germany leaving the eurozone. If Germany left, they would likely denominate their bonds in Deutsche marks, which would rise in value over those of the countries that remained in the euro.
But this also points up the fact that Germany is falling into recession, hard on the heels of the rest of Europe, which is mostly already there – some countries severely so. Leading economic indicators as well as purchasing-manager indexes are down all across Europe. But the saddest statistic is that of youth unemployment. Below is a chart from Reuters (courtesy of Frank Holmes at US Global). Only Germany is seeing its youth unemployment rate fall below 10%.

Meanwhile, Back at the Ranch

This letter is translated into Chinese, Spanish, and Italian; so I have to write with an international audience in mind, and also remember that I am of a certain age. Some concepts may not translate well, either to other languages or across generations. So let me set up the theme for younger readers and those not familiar with early 20^th-century American culture. In the dawn of film, cowboy movies were all the rage. These were typically low-budget, and most were shot on the same set and ranch in southern California. The same saloons, jails, large rocks, and dirt roads kept showing up in movie after movie; but no one much noticed, back then. The magic of movies was still fresh.
You would watch your hero (you knew he was the good guy, because he wore a white hat) chase bank robbers and cattle rustlers and duke it out with gunslingers; and there was usually at least one pretty girl involved. In the era of silent movies, there would literally be a title graphic that said, “Meanwhile, Back at the Ranch” when there was a segue between the action involving the hero and the bad guys and the doings of the people back home on the ranch.

So then, “meanwhile, back at the global economy,” let’s look at a few graphs and some data to see what is happening in the rest of the world.
First of all, China is really beginning to slow down from its torrid pace of growth. Thr growth of their manufacturing output has fallen for seven straight months, and it is now contracting. Media reports everywhere are talking about actual statistics or anecdotal stories from Chinese merchants and businesses. Construction is under real pressure, as are real estate prices. Just as in the US or Europe, when construction starts to slow it affects all sorts of smaller businesses that supply products to people building or remodeling their homes.
A few data points. Deposit growth in China is slowing rapidly, and money supply suggests a decelerating economy. The ratio of M1 to M2 growth suggests an even weaker economy than the contracting purchasing manager’s index. The M1-M2 ratio is now back to where it was in the last financial crisis.
Let’s look at two charts from Credit Suisse. I have long been concerned about the very high percentage of GDP growth in China that is attributable to direct investment, bank loans, and infrastructure spending. While all of those are good things, the levels in China are without precedent anywhere in the world that I am familiar with, and have been there a long time.
What happens when you have to slow down investment and try to become a more consumer-driven economy? The transition is generally not smooth. And what happens when you try and do that when your largest customer (Europe) is in recession? And when the bank lending from Europe that finances the spending of many of the developing nations you sell to begins to dramatically shrink?

Reports from around the world show South African and Australian mines with lower sales, growth in Taiwan slowing and Great Britain in recession. The MSCI World Index, which tracks equity markets around the globe, is down more than 9% since mid-March.

A Slowing US Economy

The US economy is also starting to slow. Job growth is getting weaker. Food stamps are at an all-time high. The effects from stimulus spending have just about gone away, and there are large numbers of people falling off extended unemployment benefits. Lakshman Achuthan, of the Economic Cycle Research Institute (ECRI), has recently reaffirmed his belief that a return to economic contraction is likely in 2012, noting that the coincident data used to officially define economic-cycle boundaries continue to signal slowing growth. Achuthan is a very sober fellow, and you have to pay attention when he makes these calls. ECRI does not make them lightly.
Let’s also look at a couple charts from my friend Rich Yamarone, the chief economist at Bloomberg. (We will be together at a symposium at the University of Texas in Austin, on June 7, along with David Rosenberg.) Rich has also been stating that he believes the US economy is headed for recession, for a different set of reasons.
At our dinner meeting last week (as indeed he has been for months) he was talking about the fall in real disposable personal income. It is hard to get growth when incomes are not rising .

And he too is worried about the fact that government stimulus (transfer payments, unemployment benefits, welfare, food stamps, etc.) has had a major effect on consumer spending, but as people fall off extended unemployment benefits (and they are, by the hundreds of thousands each month) personal income could actually drop.

Where’s My Quantitative Easing?

The recent round of global quantitative easing is beginning to ebb. Europe, Great Britain, and the US are all wrapping up their stimulus and have not announced plans for any more. China is more or less on hold until the leadership changes in October (or that is what most observers I read seem to think).
The recent QE had provided a clear boost to commodity prices and stocks, and the anticipation of withdrawal seems to be having a depressive effect on market prices. This was the third round of global QE, and each round has resulted in less real benefit than the previous one. There is reason to believe that another round would continue that trend. While it is probable that the ECB will soon take action, as Europe is clearly in recession, there seems to be no such consensus as yet in the US. And with an election coming in November, if the Fed is going to do anything, they have just two meetings left (on June19-20 and August 1) before September, at which point the economy would have to be in very serious trouble for them to do anything before the election – which then takes us out to the December meeting.
Since the recent most QE will still be in effect at the time of the June meeting, that would leave August 1 for an announcement. We will only have two unemployment reports between now and that meeting. They will therefore be of more than usual importance. We will be watching.

Big Money Selling Stocks Since Mid-March

The volume indicator shown here (circled, lower panel) shows that the big money has been selling stocks since the middle of March. The last time we saw a sell-off of this magnitude, Bernanke responded the following day with a promise of more monetization of the debt (via John Hilsenrath at the WSJ). He purchased $44 billion of U.S. debt during the month of March.

Stocks Leap on Announcement of QE3

Scrambled Greece?

I don't know how much of the overnight sell-off is due to pessimism over Greece, or if it is due to liquidations in anticipation of the Fed's FOMC meeting today and statement tomorrow. It's probably some of both, but it is typical for people to lighten up on their positions in anticipation of Fed actions, so this comes as no surprise to me. The Fed's latest statement will be released at 10:30 am MST tomorrow morning.
Last night, Goldman Sachs indicated that they don't expect the Fed to initiate any additional quantitative easing, and upon that announcement, the selling began. It still isn't enough, however, to turn the market bearish.

ECB's "Shell Game"

from Zero Hedge:
It is one thing for irreverent blogs to call a spade a spade an accuse the ECB of engaging in ponzi operations, such as Wednesday's LTRO where the European central bank will give local banks money and hope and pray the use of proceeds is to purchase sovereign debt (something we said previously is very unlikely to happen). It is something totally different when the world's biggest bond fund manager makes the same tacit accusation by saying that all the ECB does is take from one hand and give to the other - a very efficient shell game. Such as what Bill Gross has just done in a tweet from mintues ago. So how are investors, we wonder, supposed to have any faith in bonds (forget equities - they have long given up on those), when even the members of the status quo systematically undermine confidence in the global pyramid scheme (not that we are complaining).

Wall St Bets... On Inflation!

Despite a steady drumbeat of bad economic news, Wall St is buying up stocks steadily since Bernanke's speech last Friday. They are convinced that more inflationary quantitative easing by the Fed is on the way. Worse yet, they are convinced that it is necessary!
They are therefore ignoring the strong likelihood of another recession that is already under way, and are instead placing their bets... on more inflation. They are therefore bidding higher the stock market, even in the face of a growing chorus of evidence in support of the view of a new recession.
This is going to have terrible results, because the higher cost of the inflation that the Fed denies is going to contribute toward, and even accelerate the onset of that recession. The Fed, in its refusal to acknowledge its destructive role in driving us toward that cliff, is advancing the very scenario it claims it wants to prevent. By pursuing a policy that now has an evidentiary history of raising inflation and putting greater pressure on household budgets, they are increasing the likelihood of that recession. It's a classic case of shooting oneself in the foot.
And like the Fed, they either still don't get it, or, as I believe, don't care about the destructive consequences! They don't care because higher inflation and monetary policy that causes it serve their interest. They therefore pressure the Fed to create still more of it despite that it harms their countrymen and advances the very economic scenario that we are now dreading.

"Bubbles" Disappoints! No QE3! Wall Street Throws a Tantrum!

Wall Street is throwing a temper tantrum! After being up 200 points today, stocks just hit the flat line!

Market Reacts Positively to ECB Announcement of Quantitative Easing

QE3 Guaranteed to Fail

by John Defeo
NEW YORK (TheStreet) -- Whether or not the Federal Reserve opts to make more large-scale asset purchases (colloquially referred to as "QE3") remains to be seen -- but I suspect that Ben Bernanke himself is beginning to realize that QE3 is guaranteed to fail.
Bernanke told Congress on Wednesday that the Fed is ready to provide additional monetary stimulus should the U.S. see adverse economic developments. On Thursday, Bernanke qualified his statement, saying that the Fed is "not prepared at this point to take further action."
Let's analyze the situation:

So What Exactly is Quantitative Easing, Anyway?

Quantitative easing is when the United States' central bank, the Federal Reserve, buys U.S. Treasury bonds.

• Treasury bonds are a future obligation of the United States, paid out with Federal Reserve notes (dollars).
• Federal Reserve notes are a current obligation of the United States, redeemable for goods and services.

If the Federal Reserve purchases bonds directly from the United States Treasury, they are exchanging dollars (current obligations) for future obligations. This is inflationary if the amount of obligations (money) is increasing faster that the amount of capital (goods, services, products and ideas).
However -- the Federal Reserve doesn't buy bonds from the Treasury, it buys them from "primary dealers." Primary dealers are a network of banks (including Goldman Sachs(GS), JPMorgan Chase(JPM) and Citigroup(C)) that are obligated to buy bonds from the U.S. and serve as a trading partner with the Federal Reserve.
The triangular relationship between the U.S. Treasury, Federal Reserve and major banks can be a head-scratcher -- but make no mistake, this relationship is making some people rich (we'll touch on this point later).

Criteria for the [Long Term] Success of Quantitative Easing

1. If banks are facing a liquidity crisis -- and because of this fact -- are unwilling to lend to qualified borrowers.
2. If qualified borrowers want to borrow money -- and most importantly, are willing to invest in entrepreneurial ideas that will provide a return on invested capital.

Quantitative easing could hypothetically improve the U.S. economy, for the long term, if both of the above criteria are met. Unfortunately, this is not the reality of our situation.
Thanks to taxpayer-funded bailouts and the first two rounds of quantitative easing, major U.S. banks are adequately reserved (in other words, they are liquid). The problem lies in point No. 2: Statements from major banks suggests a drought of qualified borrowers.
Creditworthy individuals (however small this segment of the population might be) are not borrowing. We can blame the uncertainty of tax policies, the staggering unemployment figures or the overall fragility of the economy. But at the end of the day, creditworthy individuals aren't borrowing.
The banks don't need further reserves -- the people need confidence. And confidence comes from the leadership, foresight and conviction from our elected officials, not the Federal Reserve.

Is Quantitative Easing Helping Anyone?

Yes, unfortunately.
Quantitative easing is providing major banks with arbitrage opportunities (risk-free trading profits). Goldman Sachs can buy a bond from the Treasury on Monday and sell it to the Federal Reserve on Tuesday (at a profit) -- the blog ZeroHedge has named this game "Flip That Bond."
Quantitative easing is also helping elected officials shirk their duties to the American public -- in a sense, enabling politicians to spend money the country does not have (or make good on promises that should be broken). Forbes' William Baldwin illustrates this concept beautifully.
"The government wants to spend $1,000 it doesn't have. So it sells a bond. The [ultimate] buyer is the Federal Reserve. The Fed pays for the bond with some folding money. The Treasury spends the $1,000 on farm subsidies or whatever.
The Fed makes a show of treating the $1,000 bond as an investment. It collects $40 in interest from the Treasury. But this is a charade. The Fed declares the $40 (after some overhead costs) as profit and sends the profit right back to Treasury. In reality, the interest payment never left the Treasury building.
When the dust settles, this is what has happened. The farmer has $1,000 of cash. The government did not get this cash by collecting taxes. It got the cash by creating it."

Has Quantitative Easing Ever Been Tried Before? If So, Has It Worked?

Yes -- and to the second question, I don't see any evidence it has worked.
In 1961, the Fed embarked on a similar strategy known as "Operation Twist." But Twist was dismissed as a failure by most, while others blamed the lack of efficacy on the small scale of the operation.
Quantitative easing was attempted again -- on a larger scale -- by Japan in 2001. More than a decade later, Japan has not escaped its problems, and Masaaki Shirakawa, governor of the Bank of Japan, stated that if "short-term stimulative policy measures" are the only cure, then "[policy makers] face a risk of writing the wrong policy prescription."
Unfortunately, some prominent U.S. economists (notably, Larry Summers and Paul Krugman) don't view this history as a cautionary tale, instead suggesting that stimulus only fails when enough of it wasn't done. To this point, I wholeheartedly agree with Mike "Mish" Shedlock's statement, "The disgusting state of affairs is that bureaucratic fools in the EU, US and everywhere else, all believe the cure is the same as the disease if only done in big enough size."

What's the Worst Case Scenario for the Economy

The worst-case scenario is that the nation's banks, under political pressure to lend (see Masaaki Shirakawa's statement above), begin making loans to corporations and individuals that are not creditworthy. Of course, this is exactly how the financial crisis came to fruition, and like before, will end in tears for the greater American public.

Is Ben Bernanke the Problem

I do not think Ben Bernanke is evil or stupid (nor do I think he is insane), rather, I prefer to think of him as a kindly-yet-timid doctor prescribing an obese patient antidepressants. The doctor knows that only the patient can solve the patient's problems, but the doctor lacks the courage to tell the patient, "Go on a diet, get some exercise and get the hell out of my office!"
--Written by John DeFeo in New York City

Bernanke's Catastrophe

Interview with Lee Adler of Wall Street Examiner
Introduction by Ilene
Elliott, of PSW’s Stock World Weekly, and I began a series of interviews with Lee Adler, chief editor and market analyst at the Wall Street Examiner, on May 11, 2011. This is part 2. Lee's Wall Street Examiner is a unique, comprehensive investment newsletter that covers subjects such as the Fed’s open market operations, the impact of the Fed and the US Treasury on the markets, the housing market, and investment strategies. We often cite Lee’s analysis in Stock World Weekly and on Phil’s Stock World--his research provides invaluable information for formulating an overall market outlook.
(Here's part 1 of our interview: The Blinking Idiot & the Banking System)

Part 2: Bernankenstein's Monster 

Elliott: How should we invest in this environment - when we take into account the Fed’s huge interference in the markets?
Lee: Think like a criminal. Look, it’s a matter of knowing what the Fed’s next move is going to be, and knowing the investment implications.  You have to stay with the trend until the Fed sends signals that it is going to reverse. We’re at that inflection point. The issue is how much front running will there be? You definitely have to be out of your longs by now. When support fails after having succeeded, succeeded, succeeded, and every other previous retracement has held, then suddenly one doesn’t, it’s a huge signal.
Ilene: If the Fed wants oil and metal to go down, and the dollar to go up, is that saying it wants the stock market to go down as collateral damage? If pattern continues, the stock market will go down with the commodities.

Lee: No, the stock market is the center. Bernanke came out in November, the day they announced QE2, and did an Op-ed in the Washington Post saying exactly what he expected. He’s going to manipulate the stock market higher, and that’s going to create economic confidence and everyone’s going to be happy. His goal was to manipulate the stock market. The collateral damage, the stupidity of their policy, was that they didn’t take into account the inflationary effects on commodities. They kept denying it.  And Bernanke kept saying over and over, well, look the stock market is going up, QE2’s having the desired effect. He was willing to take credit for the stock market going up, but he refused to take responsibility for the same exact move in commodities. It’s the same, they move together. It’s just that one was an intended consequence (stocks going higher), and the other (inflation in commodities) was the unintended consequence. They took credit for the intended consequences, but wouldn’t take responsibility for the unintended consequences.
Ilene: What in the Fed’s creation gives it the power to manipulate the stock market? That wasn’t one of its dual mandates (maximum employment and price stability). Isn’t that beyond its scope?
Lee: Of course, but QE2 was a direct manipulation of the stock market.
Ilene: So the Fed knew the money they gave to the Primary Dealers would end up in the stock market. Do they have an agreement with Goldman Sachs, like “hey we’re going to print you this money and we want you to buy stocks?”

Lee: Look, Brian Sack, the head trader for the Fed, sits down with the Primary Dealer traders every morning before the NY markets open, and they have a conference call. Every morning. The Fed makes no secret of this, it’s all on the NY Fed website, the “Fed points.” They describe the whole thing. They discuss the dealers’ “positions and what their financing needs are”, but that’s code. The Fed decides what it wants, and the PDs execute the Fed’s wishes. So while government securities are usually the Fed’s focus, the dealers can trade whatever they want. Bernanke made it absolutely clear that stocks were his focus in that November 4 editorial in the Washington post.

Ilene: Even though manipulating stocks is not a legitimate focus of the Fed?
Lee: That’s what they get away with. The mainstream views pushing stocks higher as a legitimate policy. People want the stock market higher. But they don’t want to see oil prices over $100 a barrel, and gas prices over $4 a gallon, they don’t want that.

The Fed does not control what the dealers do with the money, they can only make their wishes clear. The Fed can make it difficult for the dealers, and now they are, because they finally got fed up with the commodity speculation. But the Fed does not control what Goldman Sachs does completely. In fact, it might be the other way around. There’s clearly collusion, it’s no secret.

Ilene: Why doesn’t anyone do anything to stop this?
Lee: Well, most of the FOMC members want stock prices higher. They believe the trickle down theory crap. They want to inflate, so it costs less to service our debt. But the kind of inflation we have is devastating. It impoverishes the middle class and makes the middle class unable to pay its debts to the banking system, which is a time bomb in itself.
The banks are not increasing their loss reserves at all. They’re shrinking their reserves so they can show profits when they should be going in the other direction because the ability of the public to service the debt is decreasing.
The Fed gets into these post-hoc crisis management modes where they will make another huge blunder. QE2 was a massive blunder. It did not achieve its desired goal. It got stock prices up but it didn’t get the economy turned around, and it made inflation much worse. They fucked up and the blunder will only be recognized after the fact. Mainstream media won’t get it until after the stock market collapses. By then it’s too late. But the blunder won’t be manifest till stock prices collapse, and then everyone will recognize what a damn idiot Bernanke is.

And now they’re going to sacrifice the stock market, because another problem is that they can’t afford to allow long-term bond yields to go up. The government can’t afford higher interest rates. They will sacrifice the stock market at the alter of the Treasury market. They will do whatever they can to support Treasury prices at high levels. That means they’ll force the liquidation of stocks, and once the wave of liquidation hits the stock market, the knee jerk reaction is for the money to flow towards Treasuries. Someday that’s not going to work, and I think that day may be coming pretty soon.

Ilene: What do you think about Bill Gross shorting Treasuries, is that going to work out for him?
Lee: William the Gross. Watch what he does, not what he says. The guy is a world class card player. For any public pronouncement he makes, generally, you have to consider the opposite. Think like a criminal. He’s the Godfather. When Gross comes on TV, I hear the Godfather music playing in the background. His track record of public pronouncements isn’t very good, yet he consistently makes more money than anyone else trading the bond market, so obviously you can’t be wrong all the time and make money all the time.
Ilene: So he’s front running?
Lee: If he’s making a pronouncement on CNBC, he probably has another reason for saying what’s he’s saying other than what it appears to be. He’s got a direct pipeline to the Fed. The Fed sends these coded messages. It’s not that hard to figure out by watching the data. The massive spike in bank reserve deposits at the Fed, starting right after the January Fed meeting, means something is happening there.
Ilene: You’ve concluded this game is going to stop in June?
Lee: Well, I always figured it would because commodity prices were getting out of control. The more Bernanke denied it, the more troubling it seemed he knew it was. It’s the old “[he] doth protest too much, methinks.”  Every time Bernanke claimed the inflation was transitory, the more clear it became that he knew it was a serious problem. But they didn’t do anything about till recently.
Ilene: So what is going to happen with the stock market? Will it sell off as QE ends? At what point will the Fed start a QE3 to stop the stock market from dropping - would it let stocks drop 10%, 20%...?
Lee: Oh yeah. The Fed’s job one is to preserve the Treasury market. With this enormous mountain of debt which the government is on the hook for, they can’t afford to pay 5% interest, or even 4%. They can’t afford any increase in Treasury yields. So, if necessary, they’re going to force a liquidation of stocks and spark a “flight to safety” panic again, as they did in 2008. Then, they needed to get the yields down, and they were also thinking it would help the housing market.
Ilene: But it didn’t really get to the housing market.

Lee: The problem in the housing market had nothing to do with mortgage rates but they didn’t understand that. It’s amazing how when you put all these smart people together how stupid they can be. It’s the problem with group think. When the FOMC gets together, it’s like having all these geniuses in the room coming up with idiotic decisions. They all have the same motivation - to become the next Fed Chairman. The way to do that is to comply with the mad scientist running the show. Bernanke’s whole life has been an ongoing doctoral dissertation in which he tries one experiment after another, based on the crap he wrote when working on his PhD.
The problem we’re experiencing now is that the system is imploding. It’s a slow motion implosion.
Elliott: When QE2 ends in June, will the pain of that ending be extreme enough cause the Fed to resume some form of QE3?
Lee: Yep. I don’t think it will take long.  We’re in bad shape, as bad as Greece. The only way we can pay our bills is if other countries and investors continue to lend us $100 Billion every month, and that could jump to $150 Billion a month in the summer. So we can’t pay our bills unless people lend us more money. That’s not paying bills. That’s creating a bigger problem.

Charles Hugh Smith: From Here, a Dead Cat Bounce

This is what I've been expecting. Wall Street is determined to rally stocks despite the atrocious economic news in the past three months.


Submitted by Charles Hugh Smith from Of Two Minds
The Turning Point
Some technical analysts are calling for a major rally from here, but the massive injections of financial insulin don't seem to be reviving the sagging global economy.
The stock market and economy are both at a turning point. Analyst Martin Armstrong's Economic Confidence Model (tm) set the turn date as June 13/14, 2011.

In the stock market, a number of technical analysts are issuing strong buys based on the negative sentiment of so-called "dumb money"--small investors--and the number of stocks below their 50-day moving averages.

Others such as Armstrong are predicting that Greece has no alternative to default and the Euro is untenable as "one size does not fit all."

It is rare to find a market where the technical evidence is so compelling for a strong rally yet the fundamental basis for such a rally so lacking. Exactly where do Bulls think the growth and rising profits are going to come from?

The answer for the past few years has been massive Federal Reserve/Federal intervention and stimulus, and a weakening U.S. dollar that boosted overseas profits via the legerdemaine of currency devaluation.

But three years of these policies have accomplished nothing but load the taxpayer with staggering amounts of debt: none of the causes of the 2008 implosion have been fixed or even addressed. As Armstrong notes, the massive interventions did not shorten the crisis, they have prolonged it.

This reality has filtered down to the political swamp, and now the politicos are hesitant to bet their own futures on additional trillions in stimulus and quantitative easing. For the first time in memory, the Federal Reserve is on the defensive. Simply put, its policies have failed to accomplish anything except prop up a rotten, insolvent banking sector that needs to be declared bankrupt and swept into the dustbin of history.

As I have noted here before, the next round of QE (quantitative easing) will fail to inflate the stock market regardless of its size or tricks. The fact that QE3 is needed will spook everyone who understands that it is a last-ditch effort to keep the Status Quo financialization from imploding, and since QE2's sugar-high was so brief, others will be spooked by the possibility that the next high will be even shorter.

This is the dreaded Diabetes Financial Syndrome--the Fed is pouring ever larger amounts of financial insulin into the system, but the financial "body" no longer responds to this insulin. The financial system then goes into toxic shock and implodes.

Let's look at two charts for context. Here is the S&P 500 from 1965 to 2011. Hmm, are there any aberrations visible here, any gigantic spikes of speculative frenzy? Just because these spikes of speculative, financialized frenzy have been normalized doesn't mean they are no longer speculative, financialized frenzies.



Has the economy really been healed? If not, then what is the basis of the market's spectacular rebound since 2009? We all know the answer: $6 trillion in Federal financial insulin and another $2 trillion in Federal Reserve insulin. The entire rally, in other words, is an artifact of Central bank/State intervention.

Courtesy of dshort.com, here is an inflation-adjusted chart of the S&P 500. This chart clearly illustrates that unprecedented Central State stimulus and intervention/manipulation have juiced the market higher than previous post-crash highs.


But the whole financial-insulin project is looking a bit long in tooth compared to previous post-crash markets. In the long run, perhaps we can attribute this extension of the euphoric high of "recovery" to the Fed's QE2, which pumped half a trillion dollars into stocks in a matter of months.

Short of the Fed simply buying trillions of dollars in stocks outright, then it looks like this "recovery" rally is about to have a Wiley E. Coyote moment, as it has raced off the solid ground provided by the Fed's QE2 injections and is now poised in thin air.

Of course the market could rally from here, but it's hard to see on what basis other than a technical dead-cat bounce. The Fed could announce another round of intervention, and that would certainly give the comatose body a jolt. But for how long?

If it does respond to gravity, then we might want to re-visit the definition of "dumb money:" small investors have been pulling money out of the stock market all during the QE2 insulin-rush rally while the "smart money" has been piling in, blubbering piously about the key tenet of their religious faith, "don't fight the Fed."

So which do you think is all-powerful, smart money--the Fed or gravity? We're about to find out.

Jim Rogers: Worse Crisis Coming Because of Debt

Legendary investor Jim Rogers, CEO of Rogers Holdings, offered a very glum outlook on the U.S. economy yesterday. According to him, we’re headed for a crisis worse than 2008, the Chinese Yuan will soon be safer than the dollar, and Fed Chairman Ben Bernanke will probably institute another round of money-printing, or QE3.
“The debts that are in this country are skyrocketing,” he told CNBC. “In the last three years the government has spent staggering amounts of money and the Federal Reserve is taking on staggering amounts of debt.
“When the problems arise  next time…what are they going to do? They can’t quadruple the debt again. They cannot print that much more money. It’s gonna be worse the next time around.”
He later added, “The U.S. is the largest debtor nation in the history of the world. The debts are going through the roof. Would you keep lending money to somebody who’s spending money and not doing anything about it? No you wouldn’t.”
Because of that, he said the Chinese Yuan will be a safer currency bet than the dollar. And what may even better is gold and silver: he’s hoping the price goes down on both so he can “pick up the phone and buy more.”
He’s also convinced Ben Bernanke, who he calls a “disaster,” will institute another round of quantitative easing, essentially printing money, later this year.
“They’re gonna bring it back because [Bernanke will] be terrified and Washington will be terrified,” he said. “There’s an election coming in November 2012. Washington’s gonna print more money.”
According to him “draconian” cuts will be needed to control U.S. debt:

Rogers comments come as a new poll reveals nearly half of Americans expect another Great Depression in the next 12 months.

Fed Not to Begin QE3 for Now

by John Hilsenrath at WSJ:


Federal Reserve officials are in no hurry to respond to recent indications U.S. economic growth has hit another soft patch, despite chatter in financial markets that the Fed might start a new program of U.S. Treasury-bond purchases to boost growth.
The central bank has already purchased more than $2 trillion of mortgage and Treasury bonds. The purchases are meant to hold interest rates down by reducing the supply of securities in private hands and to drive investors into areas such as stocks to encourage businesses and consumers.

Fed Chairman Ben Bernanke signaled in April that the hurdle to more "quantitative easing," as it is known, is very high and Fed officials have done nothing to indicate that Mr. Bernanke's guidance has changed as economic data has worsened in recent weeks.
In an April news conference, Mr. Bernanke said the tradeoffs that would come with additional purchases were becoming unappealing. "It's not clear we can get substantial improvements in [employment] without some additional inflation risk," he said.
Fed officials have largely held to that line. In comments last week, St. Louis Fed president James Bullard said the Fed was entering a period in which Fed policy will be on pause—meaning it won't be trying to push interest rates either higher or lower. Charles Evans, president of the Chicago Fed and a strong advocate of past programs, said earlier last month that what the Fed had done already was "sufficient."
In comments Wednesday, Cleveland Fed president Sandra Pianalto said the Fed's current stance was appropriate and added the recovery was likely to continue, even though growth "may be frustratingly slow at times."
Mr. Bernanke has argued that past bond purchases haveworked, but it has have taken a political toll on the Fed. Critics in Congress and overseas say the Fed is fueling inflation globally.
"They don't want to do QE3," said Vincent Reinhart, an economist who formerly ran the Fed's influential division of monetary affairs. QE3 is what many traders have dubbed the possibility of a third round of Fed securities purchases.The last round of quantitative easing, which will amount to $600 billion of bond purchases, is set to conclude at the end of June.
A boost from Congress, through additional deficit spending, looks equally unlikely. Republicans have crafted an agenda based on spending cuts and would likely be reluctant to embrace new efforts to stimulate growth through fiscal policy. New tax cuts would also face a tough reception, given Washington's currentfocus on reducing the long-run deficit.
The Obama administration wants more infrastructure spending in the near term, but administration officials, stung by the divisive legacy of the 2009 stimulus bill, don't call it stimulus.
Infrastructure spending, in addition to education and research and development programs already proposed by Mr. Obama, are "policies that have the potential to impact job creation now but also have the ability to increase our competitiveness," said Brian Deese, deputy director of the National Economic Council.
The current mindset could change if the economy deteriorates. Mr. Bernanke has indicated that the outlook for inflation will play a key role in his decisions about monetary policy. Rising inflation could force the Fed to raise interest rates. A declining rate of inflation could force it to consider startinga new easing program.
The Fed initiated its last program of quantitative easing in 2010 amid worries that the U.S. was slipping toward deflation, or falling consumer prices. The behavior of bond markets doesn't indicate that deflation is a serious worry right now. Prices of Treasury Inflation Protected Securities, also known as TIPS, indicate that investors expect 2.8% inflation in five years, substantially more than was the case last August when the Fed started talking about a new round of quantitative easing. Back then, expected inflation was on a downward trajectory, from 2.8% to less than 2.2% in a couple of months.
Measured inflation is also higher than it was last year. When the Fed initiated the program in November, consumer prices were up 1.1% from a year earlier, well below the Fed's 2% goal. In April they were up 3.1% from a year earlier.
"We don't think it's likely at all, but things could change," Michael Pond, a bond strategist at Barclays Capital, said of the chances of another round of easing. "If growth slows well below its trend and on top of that you have inflation and inflation expectations coming down, it is certainly possible. At this point it is not on the table."

May Economic Data Universally Bad

Wall Street may finally be sitting up to take notice! We've now all but wiped out yesterday's stock market rally, and it's only one hour into the trading day! But we mustn't dismiss Wall Street's ability to shrug off reality for its own delusional benefit! By tomorrow, the Pollyanna Party will continue, unless Friday's BLS jobs report also shows a slump and slowing. This is particularly bad timing just as the Fed begins winding down its latest quantitative easing dream. 
U.S. ISM, just as in UK and China, as indicated in this headline from the Wall Street Journal, has also slowed appreciably. Ignore that, Wall Street!  I give them 24 hours to do just that! 

from WSJ:
The U.S. manufacturing sector slowed sharply in May, according to data released Wednesday by the Institute for Supply Management...
The ISM's manufacturing purchasing managers' index fell to 53.5 in May from 60.4 in April. Readings above 50 indicate expanding activity.
Economists surveyed by Dow Jones Newswires had expected the May PMI to slip to only 57.0.

from Marketwatch:
A Chicago-area manufacturing gauge dropped by the largest amount in nearly two-and-half years in May, in a further sign that the rise in oil prices and the Japanese earthquake have affected activity.
The Chicago PMI fell to a reading of 56.6% in May, the lowest reading since Nov. 2009, from 67.6% in April.

We're All Distracted Now!

by Mike Krieger:

Printing and Propaganda
As I have been saying for the past several years, the misguided Keynesian witch doctor central planners unfortunately in charge of our economic fate are attempting a grand experiment on us based on completely insane and nonsensical theories that have no chance at success.  These clowns claim to have all sorts of “tools” but in reality they have nothing.  When faced with a complete credit collapse of proportions never seen before in recorded history there were and are only two “tools.”  It’s the two P’s:  Printing and Propaganda.

While I have written about both of these “tools” before I am going to focus on the propaganda part today since it is the most applicable to the current state of the financial markets.  We all know by now that the centrals planners believe the tail wags the dog.  So the economy doesn’t lead to higher stock prices but higher stock prices will lead to a better economy.  Insane?  Absolutely.  Is it their religion?  100%.  The other important thing for investors to be aware of now when they are comparing the current state of affairs to what many lived through in the 1970’s is that the central planners have learned some lessons.  What we must always remember about central planners is that they will never renege on their core philosophy which is that an elite academic and political class in their wisdom are better stewards than free humans interacting in a marketplace.  That said, most people do not share their worldview for obvious reasons (who wants their lives micromanaged) so the trick of the central planners is to micromanage your life while you think you are in charge.  As Goethe said “None are more hopelessly enslaved than those who falsely believe they are free.”  He didn’t just make up this clever quote, it is a tried a true method of the most successful control systems throughout history.      

So even the brainwashed masses out there understand that price controls were tried in the 1970’s and failed.  We also know why.  Therefore, the last thing the current group of central planners will want to do is announce price controls.  That doesn’t mean they don’t attempt them anyway.  They have been rigging stocks in the United States consistently for the past two years and most people get this and accept it as a part of the current state of disunion we are in.  However, as I wrote last week we have now entered Phase 2.  This was represented by the raid on commodities. 

A tried and true strategy that TPTB have used in precious metals for years has been to create such tremendous volatility in gold and silver and especially the shares that most investors stay away since they can’t stomach it.  This strategy is now seemingly being employed to a much wider spectrum of commodities, hence my warning on trading futures last week.  The entire game was perfectly summarized by a quote in the most recent 13D report where it was stated:  “Unfortunately, this battle between finding a safe haven and the authorities’ desire to render it ‘unsafe’ is only in its earliest stages.  Our manta since 2007 – governments can and will do anything to survive.”

The Bernank Bluff    
So part of the propaganda “tool” used by the central planners is the manipulation of financial markets, which seems to increased in emphasis in recent weeks.  The other consists of outright lies and disinformation.  Put yourself in The Bernank’s shoes for a moment.  This guy loves printing more than Hewlett Packard.  He is despondent beyond belief that the markets and an increasing amount of financial commentators have criticized his precious QE insanity.  Meanwhile, the economic data is starting to roll over and housing looks set to launch into another spiral lower.  So what is a Bernank to do?  Bluff the heck out of the markets.  He knows that the only way he can have cover for his printing party is to smash commodities because the rise in commodities is the biggest point of contention amongst the masses.  Unfortunately, most people don’t delve deep enough into how the system works to have the serious moral and philosophical issues with the central planning system as I and many others do.  The Bernank knows this.  Bread and circus is a tried and true method.  Problems emerge when the bread runs out.  So the period we are in right now is huge for the Bernank and his merry band of mental patients.  They don’t have to make any decision on more printing until June when the current fiasco ends.  It is during this window when they think they can have their cake and eat it too.  They can print like mad yet at the same time claim they are about to stop and maybe even tighten.  Yeah, and the Easter Bunny is sitting next to me trading LinkedIn shares.

In any event, this is The Bernank Bluff and he is milking it for all it is worth while at the same time orchestrating raids on commodity futures.  This is just a massive psychological game against the investors class to keep them from the assets that will actually provide protection.  Well Bernank you’ve got a month left.  Make the most of it because after that you need to act.  I can’t wait to see you try to tighten as the economy rolls over. 

The Slut Walk
While millions around the world from the Middle East to Europe rush into the street to protest the rape and pillaging of their respective economies by the banksters and their political puppets guess what the good citizens of Boston, the heart and soul of the first American Revolution, are protesting.  For the “right to be dirty.”  I kid you not.  The article is right here http://www.telegraph.co.uk/health/women_shealth/8510743/These-slut-walk-women-are-simply-fighting-for-their-right-to-be-dirty.html.  Now let me make one thing crystal clear.  I am not trying to be the moral police.  I could care less how people treat themselves or behave as long as it doesn’t harm me.  The point I am trying to make is that as the biggest theft in American history has just occurred and continues to occur, this is what they are protesting about in Boston.  You know what the elites on Wall Street and Washington think when they see this?  They smile from ear to ear.  What a bunch of sheep.  We just stole trillions and they are protesting for the right to be slutty.  Look, I think I am a pretty decent observer of cultural trends.  Rest assured ladies, sluttiness is in a secular bull market.  It is encouraged by the elites.  What they fear is not degeneracy but rather self-respect and logic.  They want you to behave like animals so they can justify treating you like animals.  Has anyone read Aldus Huxley’s books?  This is worth reading http://www.huxley.net/bnw-revisited/index.html.   You go girl!
   
Peace and wisdom,
Mike

Richard Koo on Why Stocks, Commodities Surged During QE2

Great analysis from Zero Hedge by Richard Koo at Nomura:


Over the past several days, quite a few readers have been asking us why we are so confident that QE3 (in some format: it does not and likely will not be in the form of the Large Scale Asset Purchases that defined QE1 and 2 - the Fed could easily disclose that it will henceforth sell Treasury puts, a topic discussed previously, or engage any of the other proposals from Vince Reinhart disclosed in June of 2003, or worse yet, do what the BOJ does and buy ETFs, REITs and other outright equities) will eventually be implemented by the Fed. Luckily, instead of engaging in a lengthy explanation of the logical, Nomura's Richard Koo comes to our rescue with his latest research piece. While we disagree with Koo on various interpretations of his about monetary theory (namely that the Fed is not in effect "printing" money and thus creating inflation - this is semantics and leads to a paradoxical binary outcome, whereby if there Fed was successful in boosting the economy, the economy would indeed be flooded with the nearly $2 trillion in excess reserves held with reserve banks. And good luck trying to contain this surge by changing the IOER - if the Fed indeed pushed the IOER to the required 5%+ level it would immediately destroy money markets, leading to the same liquidity freeze that marked the post-Lehman days, confirming the "Catch 22" nature of Quantitative Easing that we have observed since its beginning) we do agree with his analysis of what would happen to the economy if either stocks or commodities are in a bubble (and judging by the violent opinions out there, most investors believe that either one or the other has indeed reached bubble territory), should QE2 end cold turkey: "Viewed objectively, the central banks are trying to push up asset prices using quantitative easing and the portfolio rebalancing effect. The resultant rise in asset prices based on this effect represented a potential bubble—or at least a liquidity-driven event—from the start. The question is whether the real economy can keep pace with asset prices formed in those liquidity-driven markets. If it cannot, higher asset prices will be considered a bubble and will collapse at some point. The resulting situation could be much more severe than if quantitative easing had never been implemented to begin with." Bingo. "In other words, if stock and commodity prices are in fact in a bubble and if those bubbles were to collapse, the balance sheets of the financial institutions and hedge funds making investments with the expectation of higher asset prices could suffer heavy damage, exacerbating the balance sheet recession in the broader economy. an increase in DCF values, either." And there you have it: Bernanke's all in gamble that QE2 would have been sufficient to restore the virtuous circle of the economy has failed with less than 2 months to go under the QE2 regime. As such, and with fiscal stimulus a dead end, the Fed has two choices: watch as the economy collapses in flames to a state far worse than its pre-QE1 outset, or do more of the same. That's all there is. The rest is irrelevant. And since the Fed will choose the latter option, the market would be wise to start pricing in precisely the same reaction as what happened following the Jackson Hole speech...although to the n^th degree.
And some other key observations from Koo:

Government borrowing has supported money supply growth

The question, then, is how to explain the modest growth in the money supply at a time when private-sector credit has steadily contracted. A look at Japan’s experience shows that the answer lies in increased bank lending to the government. As long as the government continues to borrow, banks can continue lending (by buying government bonds) even if the private sector is deleveraging in an attempt to clean up its balance sheet.

If the government spends the proceeds of those debt issues, the people on the receiving end of that spending will deposit money with a bank somewhere, leading to an increase in the money supply.

In effect, the money supplies of both the US and the UK are being supported by government borrowing. If the two governments chose to embark on fiscal consolidation, their money supplies would contract.
Portfolio rebalancing effect was primary objective of QE2

So what are the actual problems inherent in QE2? Mr. Bernanke has stated from the beginning that QE2 would not lead to an increase in the US money supply.

If so, why did the Fed carry out QE2? The simple answer is that it believed QE2 would result in a portfolio rebalancing effect. The portfolio rebalancing effect can be described as follows. When the Fed buys a specific asset (in this case, longer-term Treasury securities), the price of that asset rises. That prompts private investors to re-direct their funds to other assets, which leads to a corresponding increase in the price of those assets.

Private-sector sentiment may improve as asset prices rise, and if that prompts businesses and households to spend more money, the economy may improve. In effect, the Fed hopes that quantitative easing will lift the economy via the wealth effect. Inasmuch as the balance sheet recession was triggered by a drop in asset prices, monetary policy that serves to support asset prices may also help pull the economy out of the balance sheet recession.

Reasons for divergence of liquidity supply and money supply

The decline in private-sector credit in the US and the UK is attributable to both the unwillingness of banks to lend and the unwillingness of the private sector to borrow. The two factors are rooted in balance sheet problems and are indications that both countries remain in balance sheet recessions.

When a bubble collapses, the value of assets drops, leaving only the corresponding liabilities on the balance sheets of businesses and households. To fix their “underwater” balance sheets, companies and individuals do whatever they can to pay down debt and avoid borrowing new money even though interest rates have fallen to zero. Banks, for their part, are not interested in lending to overly indebted companies or individuals, and often have their own balance sheet problems. With no borrowers or lenders, the deposit-growth process described above stops functioning altogether.

US banks now appear slightly more willing to lend money, although that is not the case in the UK. In neither country, however, are there any signs of greater willingness to borrow among businesses and households.

Unable to buy more government bonds or private-sector debt, investors have few places to turn
In the hope of producing a portfolio rebalancing effect, Chairman Bernanke declared that the Fed would purchase $600bn in longer-term Treasury securities between November 2010 and June 2011. This was roughly equivalent to all expected Treasury debt issuance during this period.

From a macroeconomic standpoint, these purchases of government debt meant that—in aggregate—private-sector financial institutions would be unable to increase their purchases of US Treasury securities, because all of the growth in Treasury issuance would be absorbed by the Fed.

The fact that US businesses and households were rushing to repair balance sheets by deleveraging meant that—again, viewed in aggregate—private investors would be unable to increase their purchases of private-sector debt.

With the private sector no longer borrowing and all new issues of government debt being absorbed by the Fed, US institutions found themselves with few investment options.

So funds found their way to equities and commodities
The only remaining destinations for these funds were equities, commodities, and real estate. Real estate had just been through a bubble and remained characterized by heavy uncertainty. In commercial real estate, for example, banks—at the request of US authorities—are engaging in a policy of “pretend and extend” and offering loans to borrowers whose debt they would never roll over under ordinary circumstances. That means that current prices do not accurately reflect true market prices. Housing prices, meanwhile, resumed falling late in 2010.

UK house prices have been falling since mid-2010, and the Halifax House Price Index dropped 1.4% in April 2011 alone (the decline was 3.7% on a y-y basis).

The only remaining options for private-sector investors have been stocks and commodities. That, in my opinion, is why both markets have surged since the announcement of QE2.

And the conclusion:

QE2 was Bernanke’s big gamble

When the situation is viewed in this light, we come to the realization that Mr. Bernanke’s QE2 was in fact a major gamble. It was a gamble in the sense that the Fed tried to raise share prices with QE2. If the wealth effect resulting from those higher prices led to improvements in the economy, the higher asset prices would ultimately be supported by higher real demand, thereby demonstrating that prices were not in a bubble.

However, I cannot help but feel that the portfolio rebalancing argument was putting the cart before the horse, in the sense that it is ordinarily a stronger real economy that leads to higher asset prices, and not the other way around.

It might be possible to sustain the portfolio rebalancing effect for some time if conditions were such that investors were totally oblivious to DCF values. But with market participants paying close attention to DCF values, any delay in the economic recovery will naturally bring about a correction in market prices, thereby causing the portfolio rebalancing effect to disappear.