Market Ramblings: 03/03/2016

“I regard it as unwise to continue a normalization strategy in an environment of declining market-based inflation expectations” ~St Louis Fed President Bullard

After a lukewarm January jobs number, February came through in a big way with 240,000 non-farm payroll jobs added. CPI and PCE are up in February. The labor force participation rate is up as well. The Philips-curve economists at the Fed now have all the data they need to JUSTIFY a rate hike in March.

Even the dollar is down against gold and the Yen. The dollar has risen against the Euro as the market tries to front run Mario Draghi’s bazooka.  As I stated in my previous post, I think Draghi will disappoint the markets, and the Euro could rally against the dollar, giving the Fed even more reasons to hike interest rates. In short, St. Louis Fed President Bullard is going to look like an idiot come March… unless a certain nation devalues its currency.

A Fed rate hike in March would accelerate the global trends that are leading to a global recession. The dollar would strengthen, commodity prices would continue to fall, dollar liquidity around the globe would shrink, capital flight out of emerging markets would accelerate and those deflationary pressures would come home to roost in the US.

It’s hard to imagine a worse environment for economic growth. And in a growth slowing environment, the economies with the largest and most unsustainable debt bubbles are the most vulnerable.

Of course I’m talking about China here. Arguably no country is more susceptible to the negative impacts of a strong dollar, and also no country is in a position to stop a Fed rate hike, which places China and the PBoC in an unique position.

If the PBoC was to devalue the Yuan like it did last August causing risk assets around the globe to sell off dramatically and depress commodity prices even further. Another Yuan devaluation would be the PBoC’s way of beating the Fed to the deflationary punch, but in this case, instead of the Yuan rising with the dollar, it would fall, easing the deflationary pressures in China.


The alternative is that the PBoC does nothing, the Fed hikes, and the Yuan rises with the dollar putting further deflationary pressures on China’s massive credit bubbles. As the bubbles burst, capital flight would accelerate, weakening the Yuan even further. The Fed rate hike would thus lead to an eventual weakening of the Yuan.

In both cases, China is screwed. There are no easy way outs and the Yuan is headed lower whether the PBoC wants it to or not. Therefore, weakening the Yuan to prevent a Fed rate hike would not only be a step in the right direction but also prevent the Fed from simultaneously draining further liquidity from China’s economy. I’m not saying that the PBoC will devalue the Yuan to prevent a Fed rate hike, I’m merely arguing that it is in their best interest to do so.

March Madness: Central Banking Style


Right now, there’s a massive disconnect, between what the market thinks the central bankers can do and what they actually can do. What I believe the scariest thing to be, is the world’s reliance on Central Bankers increasingly ineffective toolkit at a time when political will to use these tools is waning. People like to think central banks are independent, but in today’s world, we know that is simply not true.

Political will for additional QE seems to be waning. The Fed cannot go to QE in an election year. The ECB, constrained by its German handlers cannot meaningfully expand its QE. The BoJ cannot accelerate its QE program or the BoJ will own all the JGBs in a few years.

Despite all their negative effects, NIRP has become all the main weapon in the central bankers’ arsenals. NIRP is easy to do, just change one number, and viola a weaker currency, or so the BoJ thought.

Before I go on, I’d like to preface the rest of this article with my belief that the central banks are fighting a losing battle against deflation. They can push on a string, and steal growth from else where, but in the end, no real growth is created. And due to the massive credit bubbles central bankers have shepherded over the past few decades, global growth hasn’t been this scarce since the 1930’s. In essence, central bankers are like rats fighting over the few remaining scraps their policies haven’t completely poisoned. The deflationary forces may seem to disappear for a while, but always return stronger and more powerful than before. With the central bankers running low on ammo, this is not a good time to be long central banking competency.

As it stands currently, the ECB and the BoJ cannot significantly devalue their currencies through another major QE program.There simply aren’t enough government bonds for them to buy, and even if there were, the transmission effect of lower government bond yields has almost zero impact on the real economy.

The fact, of the matter is that banks in the EU are not lending because there is no incentive for them to do so. Saddled with NPLs, taxed with NIRP, under-capitalized and forced to hold low yielding government debt the EU’s banks are struggling as is.

NIRP is proving to be worse for banks than a flat or inverted yield curve. The banks have been too afraid to pass the tax on to their depositors for fear that people will take their money out and the banks will become insolvent if they aren’t already.

Interest rates are too low for the banks to make any money on a loan. Although lots of people may be happy to borrow at 1% for 10 years, no bank in their right mind would agree to lend under such terms, which is why we see no credit growth in the European economy. With no credit growth, the economy stalls then crashes.

Any additional QE from the ECB would be a sign that the ECB is desperate to get the Euro down at all costs, even if it has almost no positive effect on credit growth. I don’t think this is as likely as a big rate cut, but I wouldn’t be surprised to see Draghi expand QE by another $20B a month, but that would only confirm my fears, that the political capital is not there for Draghi to do “whatever it takes”.  In that case, Draghi could disappoint the markets and the Euro would rally as EU equities tumble.

For me, and for the world, Draghi needs to monetize private debt off EU bank balance sheets to the tune of tens of billions a month. Much like the Fed’s MBS program, the ECB needs to clear the bad debt off Europe’s banks if the economy is to move forward. However, even a move this extreme would have little effect on credit growth in the economy. Europe’s banks are in such bad shape that it would take years and trillions of euros to solve any of their problems in a meaningful manner. At the very least, such a move could ignite a huge rally in European bank equities and probably lead to a temporary rally around the world.

The odds of the ECB monetizing private debt at the March meeting are under 5%. I just don’t see the political will to do such a thing. Europe’s banks may be on the brink, but central banks are reactionary and will only act after the crisis has come.

Hilariously with Europe’s banks on the brink, the ECB is expected to cut rates by 20bps. The damage that this will cause to Europe’s fragile banks cannot be understated. Another cut for me would signal that either the ECB doesn’t understand how negative rates work, or the ECB doesn’t realize how bad of shape the banks are in, or the ECB is out of ammo and needs to devalue the currency at any cost. Personally I think its the last one. And hey, maybe if Europe’s banks do crash, then the ECB will have the political capital to buy private debt, which is what it wants/believes it needs to do in the first place.


If it isn’t exceedingly obvious that the ECB is either is incompetent or trapped then you aren’t paying attention. I think the market is slowing coming around to this conclusion. We’ve seen hints of their disbelief. When the BoJ cuts rates and the Yen rallies. Or when the Fed says it’s going to hike yet FF futures crash. The markets are growing increasingly wary of central bankers.

In the US we’ve seen the stock market rebound, inflation and growth rebound as unemployment continues to fall, effectively giving the Fed all the ammo it needs to raise rates in March. Such a move would further drain precious dollar liquidity from a global economy that has never needed it more. In the wake of a Fed rate hike, the dollar should rise, emerging markets should succumb to more capital flows, and China should feel additional strain, none of these things are beneficial to the long term stability of the global economy, and yet I see no reason why the Fed won’t hike in March, further confusing the markets.


Timing is everything, and it’s hard to predict a loss of confidence in an institution that has done nothing to deserve said confidence in the first place. The best one can do is look at the signs and stay vigilant. At the very least, by the end of the month, after the central banks of the US, EU, Canada, England, Japan and Australia meet, we will have a much clearer picture of where the central banking competency narrative stands.