SEPTEMBER 22, 2011
Market panic as Fed disappoints: Has the famed 'Bernanke put' finally been removed?
The US Fed made the widely expected announcement of 'Operation Twist' yesterday. Earlier, analysts like David Rosenberg warned that unless Bernanke 'shocked' the market with something wildly unexpected, the reaction would likely be very negative. Good call.
In this case, markets had largely anticipated the move, though the size of the announced operation was at the high end of what was expected. Operation Twist will essentially involve the Fed selling a portion of their short-term treasury holdings in order to buy long-term treasuries. In doing so, it will provide a bid for longer-term treasuries, causing their price to rise and their associated yields to fall. Long term interest rates, like the 30 year mortgage in the US, are determined by long bond yields.
In short, it is an attempt to drive interest rates lower, no doubt with the hopes that it will revive the still-ailing housing market in the US and spur consumer spending. The absurdity of this move should be evident when we look at US bond rates in a historical context. Here is the US 10 year, of which the Fed expects to purchase roughly $100 billion dollars worth:
We're already at ridiculously low levels. Consumers in the US have wisened up and are now well into the deleveraging stage. They were not willing or able to take on additional credit to buy crap when interest rates were already at ridiculous lows, but if we can just push them....a.....wee.....bit.....lower....
This is neoclassical economic thinking at its finest. It's absolute lunacy. You can tell from the market reaction just how impressed investors are at the proposed plan.
With the markets realizing that the Fed is looking pretty exhausted and running out of meaningful options, reality has set in. The risk trade is firmly off. The capital flight into the US dollar has pushed it back above parity with the loonie, while simultaneously smacking commodities and stocks.
The loonie is now hovering around 97 cents to the US dollar after diving as low as 95. Those who predicted ongoing strength in commodity prices and a stable global economy have been left eating crow while those who foresaw the commodity weakness on the back of a slowdown in China and an intensifying Eurozone debt crisis are not at all surprised at what's been going on. I stand by my prediction that the loonie will finish the year closer to 90 cents than to parity.
All eyes on Europe while another gray swan takes flight:
Investors continue to watch Europe, and for good reason. Sovereign credit default swaps point to rising mistrust in the ability of several nations, particularly Greece, to meet their ongoing debt obligations. Increasingly, these same swaps, together with inter-bank credit conditions, are suggesting very strongly that things are not well among some of the big European banks. While I also suggested in January that they would be a fantastic short, and they have been, I think that the greater 'gray swan' just took off from China, where there is increasing evidence of a significant slowdown and the unwinding of a credit bubble of epic proportions.
It's worth reminding my readers once again that should China's growth slow from 'outrageous' (10%) to 'robust' (5%), models suggest that this alone will crush commodities to the tune of 40%, kill business investment in central Canada and the east, knock 1-2% off global growth, and all but guarantee a full blown global recession that would be most disastrous in Canada and Australia. The ridiculous growth model in China is about as sustainable as their demand for our industrial commodities, the main reason I suggested that all industrial commodities would get spanked in 2011, with copper as the worst performer. What I have no idea about is how the China unwind will unfold. I'm increasingly fearful of that 'hard landing', which I maintain is of far more concern for Canadians at the moment than what is transpiring in Europe. Time to get out the binoculars and watch this bird in flight. For that, I suggest you have a look at this video featuring renowned China watcher, Jim Chanos.
End game for the Canadian consumer:
With consumer credit growth slowing to levels not seen in 20 years, it was only a matter of time before this began to show up in retail sales. With the new rules limiting home equity lines of credit, and with Canadian consumers so stuffed with debt that they're starting to dry heave, it's no shock that both the year-over-year percent change in consumer credit, and the 3 month annualized change in consumer credit are both running at shockingly low levels:
And of course we've seen the connection between consumer credit expansion and consumer expenditures:
It certainly increases the likelihood of an outright recession after Q3 GDP results are in. It's unlikely that manufacturers will be storing up inventory amid rapidly falling sales.
More importantly, it's symptomatic of a general weakness in consumer spending, which we know has grown to contribute disproportionately to our economic growth in Canada:
Weakness in consumer spending will only worsen as the housing market rolls over, wealth effect spending all but dies, and our made-in-Canada credit bubble meets its untimely end. It's a great time to be short leveraged, over-bought, and overvalued assets. Real estate in Canada's bubblier markets is high on that list.