Dereliction of Duty
Once upon a time, during the reign of King Greenspan, sub-prime was the rule of the land. Someone asked his majesty what happened to the risks of these mortgages, to which the maestro replied, "the banks are very sophisticated and they know how to spread the risk around so there is no need to worry" (not an exact quote but that was his message).
Now we know the risk never went away, it was just hidden by despicable rating agencies and passed onto lazy investors who never did their own due diligence. Aside from a few hedge funds who catapulted to rock star status by betting against the loans, the country and the world paid a very dear price for Greenspan's dereliction of duty as the regulator.
There are three major changes since Greenspan's days: 1) the demise of private label mortgage backed securities (same as the dominance of agency MBS), 2) the rise of all cash transactions mainly from investors and 3) Federal Reserve intervention via its QE operations.
What happened to mortgage risk today? More importantly, pertaining to the real estate market, are we are building a solid foundation or are we looking forward to another disaster?
Fed's Monetary Pumping 'Just Right'
After a few public appearances of the two or three remaining 'hawks' among the regional Fed presidents – among them Charles Plosser, who once again noted he favors a 'tapering' of the money printing policy (Plosser made the almost unpardonable comment that he thinks 'central banks do not create wealth') – it was the doves' turn.
Charles Evans of the Chicago Fed was at his most hawkish in many months, by noting that the Fed's current pace of money printing is 'just right'. How does he know it is 'just right'? Well, as a monetary bureaucrat he has special insights we mere mortals as a rule don't have. The 'incoming data' prove his case. He even sees the future: in what might be called this year's version of the famous 'green shoots', he expects the US economy to attain 'escape velocity' in 2014. Will it leave the planet?
“The U.S. Federal Reserve has the appropriate level of monetary accommodation in place, allowing the economy to reach "escape velocity" next year, a top Fed official said on Monday.
"We continue to face powerful headwinds in the fiscal situation and the global economy," Chicago Federal Reserve Bank President Charles Evans told the CFA Society Chicago. But "the U.S. economy seems to be performing pretty well right now," he added, with the labor market improving, consumer spending up and housing stronger.
By 2014, GDP growth should be somewhere between 3 percent and 4 percent, allowing the recovery to be self-sustaining, he said.”
The Eater of Children
The EU's monetary and economic affairs commissar Olli Rehn is concerned that his reputation as the enforcer of austerity gives the wrong impression about the true nature of Olli, deep down. As the NYT reports, he wants to 'peel off' the label that has been stuck on him. One very big concern of his is to avoid the impression that he is somehow not a Keynesian.
“The European Union's top economic policy maker and scourge of debt-fueled budget deficits, is fed up with austerity. Or at least with being tarred by a term that "is clearly used to label somebody as an unworthy person who is almost eating children."
With more than 26 million Europeans out of work and the economies of the 27-nation bloc shrinking over all for six quarters in a row, Mr. Rehn, the commissioner for economic and monetary affairs, has become a lightning rod in recent months for swelling anger across Europe against the harsh belt-tightening policies generally known as austerity.
But in an interview, Mr. Rehn, 51, described himself as a "doctrinaire agnostic in terms of economic policy" who has read and found much of value in the writings of the British economist John Maynard Keynes, whose name is synonymous with the idea of economic stimulus in times of crisis.”
The Out of Touch Eurocracy
Not a day passes without the citizens of the EU witnessing new absurdities being imposed by the apparatus of compulsion and coercion in Brussels. The decrees emanating from the EU's center of power of course have to be read by the cold light familiar from morgues these days, as the bureaucrats in their wisdom have felt it necessary to ban the incandescent light bulb in the wake of heavy lobbying by industry. The pretext was that they needed to 'save the planet' and who can be against saving the planet?
Following on the heels of the solar panel duties madness that risks a trade war with China, the EU's commissars have now decided that the producers of olive oil require their protection – this time under the pretext of safeguarding the interests of consumers. Consumers will of course end up paying through the nose for this nonsense.
According to a recent Reuters report, the “EU finds time to tell restaurants how to serve olive oil”:
The 'Fair Share'
Whenever a politician appeals to either his fellow citizens' patriotism or employs the term 'fair' (as in 'fare share' or 'fair trade', to name two examples), he is about to embark on a policy that is deeply injurious to same citizens. The term 'fair' specifically means that the rapacious paws of the State are about to be thrust deep into their wallets on some pretext. Usually it is either to 'protect' favored interest groups that can afford to send their lobbyists to the centers of political power, or it is a simple tax grab due to the perennial problem that treasuries are weighed down by the deficits of the past and need new sources of income to buy the next round of votes.
What is not going to happen after citizens have coughed up the share deemed to be 'fair' is that they will enjoy an improvement in the services they never asked for in the first place. The funds just disappear in the maws of Leviathan never to be seen again. This policy of 'fairness' can be implemented up to a point; there is a threshold beyond which the economic damage it inflicts becomes so large that the government's revenue actually shrinks instead of increasing. These negative repercussions are then held to require even more interventions and so a vicious circle ensues. The eventual long term outcome is either that the system gives up the ghost in some shape or form (often by means of a destruction of the underlying currency system) or that the governments concerned decide to embark on war.
CFNAI and Rail Traffic Growth Both Decline
Even while Bloomberg reports that there is now widespread conviction (as a result of rising stock prices no doubt) that the US economy is about to achieve 'escape velocity' – whatever that is supposed to mean – economic data continue to disappoint with unwavering regularity.
One of the fund managers interviewed by Bloomberg even went as far as asserting that 'anyone who isn't long real estate is a moron' (Bloomberg's pushing of establishment approved memes couldn't possibly be more blunt than it has recently been). However, as Ramsey always points out in these pages, it is Wall Street money that is pushing house prices up – there is very little organic demand from owner users.
The ongoing series of disappointing economic data was joined yesterday by yet another decline in the Chicago Fed's National Activity Index (CFNAI), which fell from -0.23 in March to -0.53 in April. Any readings below zero indicate economic contraction. According to the Chicago Fed's web site:
The Chicago Fed National Activity Index (CFNAI) was –0.53 in April, down from –0.23 in March.”
The CFNAI is a weighted average of 85 existing monthly indicators of national economic activity. It is constructed to have an average value of zero and a standard deviation of one. Since economic activity tends toward trend growth rate over time, a positive index reading corresponds to growth above trend and a negative index reading corresponds to growth below trend.
The 85 economic indicators that are included in the CFNAI are drawn from four broad categories of data: production and income; employment, unemployment, and hours; personal consumption and housing; and sales, orders, and inventories. Each of these data series measures some aspect of overall macroeconomic activity. The derived index provides a single, summary measure of a factor common to these national economic data.”
JGBs Weaken Again
Overnight the JGB market once again weakened slightly, to 141.875 points. To be sure, this wasn't a very big move, but the fact is that JGBs continue to consolidate below the lateral support line provided by the interim highs made in the 2010-1012 period. Moreover, an uptrend line that has been in force for several years has been violated.
There is an even more important lateral support zone visible on the weekly chart at the 140 to 141 level. Since this support zone is not very far away from current prices, it is certainly conceivable that it might break fairly soon. If so, we believe the selling will probably intensify. As we remarked to a friend in a recent e-mail exchange:
“For more than two decades anyone trying to short the JGB market got burned. It has become an entrenched truism that the JGB market cannot decline because only Japanese domestic investors hold the bonds. Kyle Bass believes Japanese government bonds will eventually plunge because of Japan's high public debt, but it seems actually more likely that it could do so because Kuroda loses control of the effects of his policies. Japan's public debt is huge, but the government also holds valuable assets one must deduct from the gross figure (the result is still a very large number, both in absolute and relative terms, but it is only about half of the reported gross figure). The problem is a different one: banks, insurers, pension funds, all hold JGBs because they think it is impossible for inflation to flare up. Once just one of the bigger investors gets scared and concludes that this may no longer be true, there will be a snowball effect.”
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EU Imposes Tariffs on Chinese Solar Panels
The EU has finally decided to give in to the lobbying of an industry group that wants to get government protection against the alleged 'dumping' of goods by solar panel manufacturers in China.
Apparently no-one in Brussels deigned to ask consumers, i.e., the buyers of solar panels, if they agreed with the idea (we know what their answer would be though). Solar energy has for a long time been a money loser with a net negative energy equation that could only hope to survive by means of government subsidies. Now that prices are finally declining to a level that may make solar energy worth considering, the cries of 'dumping' go up. What the term indicates is that the bureaucracy has decided that domestic producers must be protected against allegedly 'unfair competition' from foreigners who produce and sell the same goods more cheaply. In this way, a tiny group of manufacturers is assured of higher profits on the back of the great mass of consumers. Obviously this is a self-defeating strategy. It means that society at large will be worse off. But lets move on with it anyway, and damn the torpedoes.
“The European Commission agreed to impose punitive import duties on solar panels from China in a move to guard against what it sees as dumping of cheap goods in Europe, prompting a cautious response from Beijing which called for further dialogue.
EU commissioners backed EU Trade Chief Karel De Gucht's proposal to levy the provisional duties by June 6 and make Chinese solar exports less attractive, two officials said.
Shares in German manufacturers SolarWorld, Phoenix Solar and Centrotherm rose sharply, while China's Suntech fell heavily. The investigation into accusations of dumping is the biggest the commission has launched, but Brussels is trying to tread a careful path, knowing it needs China, the EU's second largest trading partner, to help the bloc pull out from recession.
China's ambassador to the World Trade Organisation, Yi Xiaozhun, called the decision a mistake although he declined to comment on any possible retaliation. "It will send the wrong message to the world that protectionism is coming," Yi told Reuters in Geneva on Wednesday.
China's Commerce Ministry on Thursday called for dialogue. "We don't want to see a trade war between the two sides and we hope the EU can cautiously make the ruling decision on China's solar panel products," spokesman Yao Jian told reporters.
Given that Germany and France are seeking to increase exports to China, De Gucht will try for a negotiated solution with new Chinese Commerce Minister Gao Hucheng before an EU deadline in December to cement the levies for up to five years. That could mean agreeing a minimum price at which all solar panels makers selling in Europe adhere to, diplomats said. The EU duties, which will come into effect once the commission publishes the decision in its Official Journal, will be set at an average of 47 percent, officials said.
Trade specialists from all 27 EU countries will be consulted on May 15 at a meeting in Brussels and are expected to back the decision, although their position is non-binding. The European Commission declined to comment.
Chinese solar panel production quadrupled between 2009 and 2011 to more than the entire global demand. EU producers say Chinese companies have captured more than 80 percent of the European market from almost zero a few years ago, exporting 21 billion euros ($27 billion) to the European Union in 2011. As a result, Chinese-made panels are as much as 45 percent cheaper than those made in Europe, industry executives say.”
Hollande: Europe Needs More Bureaucracy, More Spending and Higher Taxes
You can't keep a good énarque down. Faced with an economy that is no longer merely circling the drain but gurgling down it at great speed, Francois Hollande has discovered what Europe needs to fix its ailments.
Perhaps not surprisingly, his epiphany, revealed to the press after his first 150 days in office, consisted of the recognition that what the EU urgently needs is yet another layer of centralized bureaucracy, complete with its own taxing power and 'harmonized' taxes (this is the codeword for 'everybody's taxes should be as high as those in France, i.e., the highest possible') across the continent.
That will fix things. For sure.
According to a Reuters report:
“French President Francois Hollande called on Thursday for an economic government for the euro zone with its own budget, the right to borrow, a harmonized tax system and a full-time president.
At a 150-minute news conference marking his first year in office, a day after economic data showed France had slipped into recession, the Socialist leader defended his record on economic reform and budget discipline and told the French people they would have to work "a bit longer" for a full pension in future. Rebutting criticism that France has lost its leadership role in Europe because of its dwindling economic competitiveness, Hollande said he wanted to create a fully-fledged political European Union within two years.
"It is my responsibility as the leader of a founder member of the European Union… to pull Europe out of this torpor that has gripped it, and to reduce people's disenchantment with it," Hollande said. "If Europe stays in the state it is now, it could be the end of the project."
He acknowledged he could face resistance from Germany, Europe's dominant power, which opposes mutualising debt among member states. Berlin is also reluctant to give the euro zone its own secretariat for fear of deepening division in the EU, between the 17 members of the single currency and the 10 others. Non-euro Britain's government already faces growing domestic pressure to hold a referendum on leaving the bloc.
Hollande said he wanted Britain to stay in the EU but added: "I can understand that others don't want to join (the single currency). But they cannot stop the euro zone from advancing."
Speaking in Berlin before the French leader announced his initiative, German Chancellor Angela Merkel said her relations with Hollande were good, and she was "very optimistic" France would strike a balance between growth and budgetary rigor.
Hollande said a future euro zone economic government would debate the main political and economic decisions to be taken by member states, harmonize national fiscal and welfare policies, and launch a battle against tax fraud.
He proposed bringing forward planned EU spending to combat record youth unemployment, pushing for an EU-wide transition to renewable energy sources, and envisaged "a budget capacity that would be granted to the euro zone along with the gradual possibility of raising debt".
He also called for a 10-year public investment plan in the digital sector, the promised energy transition, public health and in big transport infrastructure projects.
Indicator Changes Since Last Week
In part two of last week's missive on stocks we showed a few indicators which we hereby update. The first chart shows the SPX versus the gold-silver ratio adjusted volatility index as well as the JNK/TLT ratio. Briefly, both indicators should ideally confirm new stock market highs. Whenever they fail to confirm them, a warning sign is given, whereby there are frequently lead times of up to several weeks, during which the divergence is either resolved again or gets worse. The current state of affairs is that divergences that have been in evidence for some time are getting worse.
A few words on what the point of adjusting the VIX by the gold-silver ratio is. The idea is that during times of waxing economic confidence, silver tends to rise relative to gold and vice versa during times when economic confidence wanes. The gold-silver ratio thus acts a bit like a credit spread and experience has shown that it tends to give early warning signals. Of course there is no particular fundamental reason to adjust the VIX by it, except for the fact that this creates a unique indicator that has been shown to work well in back-tests.
The JNK to TLT ratio is of course also a measure of credit spreads.
JGB Rallies Back to Former Support – And Turns Down
We may just have seen what is known as a 'good-bye kiss' among technical traders in the JGB market. The JGB contract rallied back to its former lateral support at the 143 level overnight and then turned back down from there. Below is a chart illustrating the action. We hasten to add that it is still too early to call this a definitive breakdown, but it is something we are watching closely. We continue to believe that the whole world should keep its eyes glued to this market – it is the most likely source of trouble for the current 'happy consensus':
JGB, one hour chart: a classic 'good-bye kiss'? – click to enlarge.
On the long term monthly continuous chart of the nearby JGB futures contract we can see that an uptrend line that has been in force for several years has now been slightly violated. It is only a small warning sign thus far, but this market could well do the unexpected and eventually make a very big move (a non-linear hyper-volatility event is what we are thinking of here).
The JGB's price history since the bursting of Japan's bubble in 1989: the uptrend from 2006-2013 has now been violated ever so slightly – click to enlarge.