Money, Money Everywhere (And Not A Drop Of Liquidity)
For the time being, the oscillations have resolved in favor of the bulls as stocks soared 4.6% today (and it was well more than 5% until profit-taking at the close shaved the gain). Liquidity, as it has been all week, was poor and that clearly is contributing to the severity of the swings.
The rally was not a response to news. That’s not really surprising; I cannot imagine what kind of news could be dropped into the current cycle to warrant a 5% move in equities. It certainly wasn’t Initial Claims, despite Bloomberg’s headline – on their TOP news page all day – that “Stocks in U.S. Rebound, Treasuries Fall on Decline in Unemployment Claims.” That’s just stupid. It is true that there was an improvement in Initial Claims (to 395k versus expectations for 405k), and it is true that stocks rallied, but there is no relationship between those two statements. I can state authoritatively that a 10k miss in Claims does not, and will never, cause a three-quarters-of-a-trillion-dollar rally in the stock market. If you have an equity fund manager who bought stocks up 4% “because Claims were better than expected,” change funds.
Now, as the chart below shows, Claims isn’t doing too badly. While 400k per week is not great, it’s also not a disaster (unless, after a multi-year recession, there aren’t many as many people to lay off).
Employment lags the economy anyway, and there’s nothing in this chart that excites me about either expansion or recession. Move along.
The market moves are about European news or the lack of it. Today, that news is that the European Securities and Markets Authority is considering recommending a short-sale ban in Europe. After all, the ban against selling financials short, and then an ever-widening list of stocks, worked so well in late 2008! There are many examples of this sort of nonsense, and they almost uniformly produce a rally (as short-sellers cover) followed by a decline which is sometimes made more precipitous since the longs who want out have no one to sell to now. Even given our own Administration’s penchant for over-regulation, it would surprise me to see such a ban instituted when we haven’t even seen stocks decline 20% from the highs yet – but traders know that if it’s instituted in Europe and European stocks rally 8% over a day or two as a result, our market will rally in sympathy. Late in the day, France, Spain, Belgium, and Italy instituted short-selling bans.
I suspect that is a big part of what is behind this rally, although there are also plenty of investors who simply think stocks are cheap and are buying so as to make sure they don’t miss the bottom. Volume was much worse than it has been for the last few days even though the point swing was huge, but volume was still far better than it has been for most of the year.
There may be some people who are buying because the situation in European sovereign debt appears to be improving, with Italian and Spanish yields dipping below 5% today. But what did it take to get them there? Authorities have shown repeatedly that they can produce the illusion of a solution with relative ease. The question is whether they can produce an actual solution, and I’ve not seen any sign of it yet. What will happen is that in a few short days or weeks, just as with Greece, natural sellers will unload Spanish and Italian bonds at the new, gift price, and prices will go back down. The only way the EU can keep that from happening is if they persuade the longs (not the shorts!) that the current price is fair, or even cheap, so that the owners of the bonds want to continue to hold them. I seriously doubt that any of the banks currently stuffed to the gills with sovereign paper are having meetings today saying “hey, I like our Italian bond exposure now. Let’s add to the position!”
In contrast to Italian and Spanish debt, U.S. bonds fell sharply today. TIPS yields jumped 20bps and the nominal 10y rose 22bps to 0.02% and 2.33% respectively. Dealers who bought the long bond at auction today are wearing losses, and those are big basis points. Inflation swaps were tighter in the short and middle part of the curve, and roughly unchanged at 10 years.
Commodities rallied sharply, with the exception of precious metals. Gold fell $32.80, for a change. The COMEX increased margin requirements for gold last night. When it did the same thing for silver a couple of months back, that contract was crushed; in this case, gold barely noticed. All of the other commodity complexes rallied. Crude oil rose back over $85. Grains were +2.8%, Livestock +1.6%, Softs +1.3%, and Industrial Metals +2.4%. All of this is with the dollar unchanged. I think commodities investors are thinking back to the Jackson Hole conference last year, and the blast-off that ensued when Chairman Bernanke pre-announced QE2.
Many analysts are thinking that past may be prologue and that Bernanke may kick off QE3 with a speech at Jackson Hole again. I am not one of those analysts, but I understand the thought.
However, I think the Fed has done about all that it plans to do for a while. And I’ve come up with another way to think about the “Fed Pledge” that gives the Fed a little more credit (though not much). I think it’s plain that the Fed would be content with a little bit of inflation. That’s probably been the case since 2009. Many of the problems we have would be easier to tackle if the economy produced 3-4% inflation for a few years instead of 1-2%. Well, it is easy for a central bank to create inflation: just multiply the money supply by 10x and you will get inflation. The problem is that it is very difficult to create responsible inflation. And more than that, the Fed can’t tacitly let inflation rise without response, lest it lose credibility for abandoning the inflation part of the mandate.
And this is the generous interpretation of the Fed Pledge. By tying their hands, they allow higher inflation to happen without being duty-bound to fight it. The Committee clearly doesn’t believe that there is any chance of a long tail in inflation. They believe – as every FOMC has always believed – that they can rein in inflation whenever they want. So they’re willing to take the risk that inflation rises to 3-4% over the next two years. They’d actually like that, in a way.
I am uncomfortable attributing great cleverness (as distinct from intelligence) to the current Fed Chairman. It may simply be a colossal blunder from the Fed. But if he is clever, then this could be the reason the Fed chose to beat its sword into a plowshare.
This might turn out, cleverness or not, to be a bad idea. Today’s money supply numbers were jaw-dropping. M1 was up $100bln on increases in demand deposits. M2 was up an incredible $159bln. In addition to the rise in M1, savings deposits at commercial banks rose $59bln. As the chart below shows, this takes the annual, semiannual, and quarterly rates of change up to levels last seen near the very peak of the response to the 2008 crisis.
Now, I am sure someone is going to tell me why I shouldn’t worry about all that money heading into savings accounts and checking accounts. And yet, I do worry. I insist on it. That money is eventually going to be spent on something. It is in the system. In a week, in a single week, a dollar sitting in a checking account became 1.7% less rare. I know the economy didn’t grow 1.7% last week, so there is 1.7% more money to buy the same amount of goods and services. That’s how prices rise.
I think stocks are setting up here for another leg lower, but I will change that view if the S&P can reach 1200. Some people will interpret the surge in M2 as good for stocks. I don’t, but I know that if stocks get to that level I won’t be buying stocks – I will be selling bonds.
Tomorrow’s Retail Sales (Consensus: +0.5%/+0.3% ex-auto) and August Michigan Confidence figures (Consensus: 62.5 from 63.7) are unlikely to have much impact on the market. The question for me is what markets do heading into the weekend. I assume there will be some element of ‘risk on’ if there are no big headlines tomorrow, since it will have been a couple of days since something bad happened. But I wouldn’t bank on it.
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