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Triage


If you ever go to see the comedian Gallagher in concert, you may notice that some people waiting to get into the theater are wearing raincoats. Now, if you ask one of them “Why are you wearing a raincoat to an indoor concert,” and he says “no reason, no reason at all,” what should your response be? Do you leave it at that? If you do, then you may end up splattered with watermelon juice or something else messy.

When words and actions are in conflict, it is usually smart to look at the actions. This is what interrogation experts and other body language students seek to do. If the person you are negotiating with is saying all of the right things but has his (or her) arms folded across the chest, the body language expert will say you need to make some change to your approach to get those arms un-folded or your chances of actually reaching agreement are small, no matter what your counterparty is saying. (Incidentally, a helpful book on body language is The Definitive Book of Body Language.)

It is in this context that I note German Chancellor Merkel’s party today voted to offer countries that want to leave the Euro a means of doing so voluntarily while not being excluded from the EU. Merkel has been adamant that Greece cannot leave the Euro and that to do so would be a disaster not only for Greece but for the Euro as well. Merkel and Sarkozy have both pointed out shrilly that there is no mechanism for a country to leave the Euro. Late last week, Merkel backed off her previous comments somewhat when she said “It is time for a breakthrough to a new Europe. A community that says, regardless of what happens in the rest of the world, that it can never again change its ground rules, that community simply can’t survive.” And today, the ruling party of the largest member of the Euro voted to permit the travesty of a Euro exit. I suggest that this is not coincidental, and not trivial. German Finance Minister Schaeuble said “We’re not throwing anybody out, but if a country can’t carry the burden or doesn’t want to carry the burden, and the Greek people have to carry a heavy load, then we have to respect the country’s decision.”

To me, that sounds as close to an invitation as there is likely to be.

Whether this means that Greece will default, and then leave the Euro, or leave the Euro and redenominate all bonds in New Drachma (effectively defaulting if the drachma is weak, as it presumably would be), is not clear. But it has been clear for a long time that one way or the other, Greece would have to default explicitly or effectively, and the fact that politicians have turned from trying to prevent it to instead seeking to make the event seem more graceful is a sign to me that we are possibly getting close to the actual event.

I wonder if the arrival of Italy in the triage center changed the minds of Euro ministers. Triage, you know, is the process of assigning degrees of urgency to injuries in order to decide the order (or the value) or treatment. It looks to me like Greece has been moved to the do-not-resuscitate area while the Eurozone focuses on saving the relatively-healthier Italy.

In which pile are Portugal and Spain?

I have long maintained that once Greece actually defaults, the stock market will rally. It is a little less clear now that there are other sick patients lined up, because there will be more fear of domino-ism. But I still think that’s what will happen.

So, everyone knows there are defaults coming. Greece, probably Portugal and Ireland have big debts and deficits that must be written off. There is mathematically no other way, although we can come up with scenarios where the country is propped up for a year or two before caving in. So, since we know there are going to be defaults, so we all know that whether the Euro stays together or not, there will probably be a big recession.

Now, if a recession is automatically deflationary, as we are endlessly told that it is, why isn’t that fact reflected in inflation markets? Why does the 2-year inflation swap sit around 1.70% and the 10-year around 2.40%?

There are a couple of possible answers to that conundrum. One answer that preserves the possibility that deflation could happen, despite the best efforts of the monetary authorities, is that it is possible the markets are pricing a distribution of inflation that has a much longer “tail” to higher inflation. If there is a significant chance of small deflation but a small chance of huge inflation, it could still warrant positive value for the inflation ‘insurance.’ But I don’t think that’s what the market is pricing.

But it could be that people have noticed that the last pair of recessions did not cause inflation (at least, core inflation) to go negative, and so that probability is being discounted. I think it’s reasonable to do so, especially since all central banks are much closer now to actual printing than they were in 2000 and 2008.

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Stocks declined today, while bonds rallied to put the 10-year note back to 2.05%. Volumes were very poor – by some measures, today was the lowest-volume day of the year on the stock exchange. The VIX is still hovering a little bit above 30. Stocks seem heavy, but on volumes like this it is hard to take a view: it doesn’t take much flow to cause a sharp move, which means that the liquidity option a trader is short is more expensive. Or, to put it another way, the door for position-exit is smaller. As a trader, in times like these my standards for entering positions are higher and I don’t see a compelling position at the moment even though I know how I think this likely plays out.

Economic data might even start to matter again to the extent that the European drama shifts into neutral for a few days. Tomorrow’s data includes PPI and Retail Sales (Consensus: +0.3%/+0.2% ex-autos), which should show deceleration from strong numbers last month, and Empire Manufacturing (Consensus: -2.0 from -8.48). This latter figure is threatening multi-year lows if it penetrates below -10, but it isn’t expected to do so.

At 11:00ET, Chicago Fed President Evans is giving an interview on CNBC. Evans, recall, is the gentleman who is suggesting the Fed should let inflation go a little higher until Unemployment falls to some predetermined level. If he uses the CNBC forum for his crazy talk, it’s a sign that view is starting to become more mainstream in the Fed since a speech to a private audience is one thing but an interview on national financial news media is something quite different. His appearance, and the topics, have almost certainly been pre-cleared by the FOMC. That doesn’t mean they share his views, but he won’t spend a lot of time talking about the Evans rule unless the Chairman is comfortable with him doing so…and I can’t imagine they’d be comfortable with him doing so unless there was some real debate (at least) going on about how much they can let inflation slip higher.

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As you may be able to tell from the decreased frequency of my article postings over the last week, I have been busy. This week has me going to Chicago to speak at the Global Derivatives USA Conference on Wednesday and then back to New York to deliver a full-day seminar on Inflation Modeling at the NYSSA on Thursday. Consequently, there will probably not be another article posted until the weekend.

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Categories: Europe, Liquidity, Trading
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