Central Banks Operate in Stealth Mode…
Last week we mentioned that Eagan Jones downgraded US debt to AA from AA+. This week Eagan Jones went under SEC investigation, for exactly what we are not sure. However, this was a circumstance other rating agencies found themselves in after similar downgrades, and it raises a question about the fragility of the US debt markets. We suppose that if the debt load was benign, rating downgrades wouldn’t raise so much as an eyebrow. However, in this case it obviously makes some people in Washington very uncomfortable. As they say (or used to say years ago): as goes the bond market, so goes the economy.
It appears that the Fed shares the SEC’s goal of keeping rates under control – and under the radar. This week the Fed monetized another $23.159 billion in debt, this time in mortgage-backed securities. The move, net of other items, expanded the Fed’s balance sheet by $21.75 billion – not a small sum if it intends to continue apace. In annualized terms this would come to a little over a trillion ($1.1). Granted, we may be getting ahead of ourselves on that count. But with the recent expansion in credit (which we have covered here frequently), we can see the urgency for making the market “whole” – lest market sentiment radically reverse, triggering unwanted solvency issues.
Other central banks are acting in concert with the Fed. The ECB has expressed a desire to extend its bond-purchasing program in lieu of LTROs (refi loans). The Bank of Japan is “standing ready” to “ease” in the face of its mounting deficits. India has cut its key rate (by 0.5% to 8%) for the first time in three years. Brazil cut its rate to the lowest level in two years. And the IMF has increased its bailout arsenal to $320 billion. All of this is to say that central banks and powers-that-be are not comfortable with the way the world economy is shaping up, despite efforts to communicate otherwise through the mainstream media.
Along those lines, the US economy continued to show signs of stalling out. The NY Empire Manufacturing Index, the Philadelphia Fed, housing starts, and existing home sales all came in lower and below expectations. Retail sales dropped in March (to 0.8% from 1.1% in February), which correlates to the worsening job market. Retail figures would have been worse if not for the influence of higher gas prices. Average prices nationwide are now $3.97/gal versus $3.35/gal at the beginning of the year – a 15% increase.
The French, despite all signals to act to the contrary, are ready to vote for a free lunch. Sarkozy, the incumbent conservative, is falling behind the socialist contender Francios Hollande in presidential elections. Hollande has gained the people’s ear, promising more government spending (handouts) to restore growth – abandoning Europe’s ongoing battle cry for austerity. French bonds (Oats) did not side with the shift in the polls as yields jumped nearly 10 basis points on the news. This may have been a small hit to French bonds; however, we think it noteworthy considering future ramifications of a new regime adopting a potentially extreme Keynesian policy. What with Spanish and Italian debt already under pressure, the election in France comes as an accelerated step in the wrong direction – fiscally and for financial markets.
Taking all of this into account, it perhaps goes without saying that these developments in central-bank and even voter attitudes in response to our economic woes will eventually usher in higher rates of inflation and debt saturation. Metals prices should respond favorably, but for now are in a holding pattern until more intense commitments to “ease” are revealed to the public. This may not happen until the second quarter of 2012, when a more meaningful hit to corporate earnings may be seen. Then again, markets could begin to discount these issues ahead of time. Stay tuned…
VP Investment Management