Mish's Global Economic Trend Analysis

Is the Fed in Control? If So, Control of What?
Compromise to Nowhere; Germany Mulls Greek Debt Buyback; More Haircuts Coming?
Drumbeat of Weaker Revenues

Is the Fed in Control? If So, Control of What?

Posted: 21 Oct 2012 08:56 PM PDT

Reader Richard is wondering about a statement I made in Problem is Demand: First IBM, then Intel, now Google.

Specifically Richard questions my statement "In spite of what everyone seems to think, the Fed is not really in control of much of anything".

Richard writes ...

Hi, Mish

I am a big fan of yours but I am shocked, however, by your quote in my subject line. How can you say that when the Fed totally controls everything in the financial markets not only in the U.S. but much of elsewhere in the world? It is single-highhandedly propping up the U.S. equity market, rendering bond vigilantes ineffective in the bond market, and creating an "echo real estate bubble" at will!

Hoping to hear an elaboration from you in your next blog.

Regards, Richard

No Echo Bubble in Housing

Hello Richard, for starters, there is no echo real estate bubble.

Home sales are at depressed levels, financial institutions are still overloaded with hugely underwater properties, and prices have bounced a bit in some areas, by 5-10% bounces following 50-60% declines hardly constitutes an echo bubble.

Had Richard said the Fed created an echo bubble in stock prices, I would have agreed. Let's step back a second and look at the three primary things the Fed wants to accomplish.

Three Things Fed Desperate to Accomplish

Stimulate Credit
Stimulate Jobs
Stimulate Housing

The Fed has failed at all three. Arguably, credit has risen, but nearly all of the rise is student loans, making debt slaves out of kids in the process, something the Fed certainly does not want to accomplish.

In September 2011, Ben Bernanke said he was surprised by weak consumer spending. I wrote about it in Bernanke, a Complete Dunce, "Puzzled by Weak Consumer Spending"

In March of 2012, Bernanke said he was puzzled over jobs. I wrote about that in Bernanke Puzzled Over Jobs, Cites Okun's Law; Six Things Bernanke is Clueless About

On October 15, the president of the New York Fed complained about the "poor performance of the U.S. economy" as well as "inadequate aggregate demand". For discussion, please see Recovery, Monetary Policy, and Demographics: NY Fed vs. Mish Analysis

How Can The Fed Be In Control When ...

How can the Fed be in control when it cannot spur jobs, it cannot spur housing, it cannot spur credit, it remains puzzled over numerous things, and in fact launched QE III in a moment of Panic!

To be sure the Fed has taken credit for the surging stock market.

However, in terms of the Fed's real goals, this is like attempting to cure lung cancer and failing, but by happenstance removing a wart from a big toe and declaring success.

The Fed is not in control, it is only an illusion. One other person commented on this recently.

Please consider the Hoisington Third Quarter 2012 Review by Lacy Hunt. The article discusses QE1, QE2, QE3, demand curves, commodities, and numerous other ideas in a six-page PDF. The article is well worth a read in entirety, but here are a few key snips ...

While prices for risk assets have improved, governments have not been able to address underlying debt imbalances. Thus, nothing suggests that these latest actions do anything to change the extreme over-indebtedness of major global economies.

To avoid recession in the U.S., the Federal Reserve embarked on open-ended quantitative easing (QE3). Importantly, the enactment of QE3 is a tacit admission by the Fed that earlier efforts failed, but this action will also fail to bring about stronger economic growth.

Three studies show that the impact of wealth on spending is miniscule—indeed, "nearly not observable." How the Fed expects the U.S. to gain any economic traction from higher stock prices when rising commodity prices are curtailing real income and spending is puzzling. This is particularly relevant when econometricians have estimated that for every dollar of gained real income, consumption will rise by about 70 cents.

Conversely, the Fed actions are causing real incomes to decline, which has a 70-cent negative impact on spending for every dollar loss. Compare that with the 0.004 positive impact on spending for every one-dollar increase in wealth. Former Fed Chairman, Paul Volcker, summarized the new Fed initiative as sufficiently and succinctly as anyone when he stated that another round of QE3 "is understandable, but it will fail to fix the problem."

Fed Without Options

Lacy Hunt concludes with ...

For Fed policy to improve real GDP, actions must be taken that either (1) shift the entire demand curve outward (to the right), or (2) do not cause an inward shift of the AS curve that induces an adverse movement along the AD curve. Accordingly, the Fed is without options to improve the pace of economic activity.

Bernanke says he is not out of options, so Lord only knows what he may try. However, Lacy Hunt's statements are accurate.

Simply put, the Fed is without options that will do any good for the economy.

Control of Stock Market? Interest Rates? What?

The Fed is not in "control" of the stock market. Creating echo bubbles does not constitute control. Bubbles, by definition, pop.

If you think the Fed is in "control" of interest rates, you need to reconsider that as well. Certainly the Fed has distorted the bond market and yields, but most likely in the direction of the trend. Regardless, distortions do not constitute "control" no matter how it appears in short-term periods.

Given the folks at Hoisington and other small select groups of individuals and bloggers know as I do, that Fed "control" is nothing more than a mirage, I need to make a slight change in my statement.

Here is the revision: In spite of what [nearly] everyone seems to think, the Fed is not really in control of much of anything.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Compromise to Nowhere; Germany Mulls Greek Debt Buyback; More Haircuts Coming?

Posted: 21 Oct 2012 08:43 AM PDT

Late last week, following a bitter feud between German Chancellor Angela Merkel and French President Francois Hollande, a compromise of sorts was reached at the latest summit.

Please consider Berlin and Paris Compromise on Bank Oversight.

European leaders have reached agreement on the roadmap to a banking oversight regime in the euro zone. Following a public back-and-forth between German Chancellor Angela Merkel and French President François Hollande, the 27 European Union heads of state and government on Thursday night found a compromise at their two-day summit in Brussels.

The agreement calls for the legal framework for financial sector oversight to be completed by the end of the year, but actual implementation won't come until later. The oversight regime will be introduced "in the course of 2013," the summit's closing statement reads.

The compromise is a victory for Merkel. Both France and Spain had been emphatic that bank oversight begin on Jan. 1, 2013. Berlin, however, insisted that any such regime be thoroughly planned and resisted efforts to move quickly, receiving support from such non-euro-zone countries as Sweden and the Czech Republic. Over a dinner of roast veal and spinach, Hollande and his allies backed down.

As the week progressed, it seemed as though the conflict between Europe's most important protagonists had escalated.

The French president in particular seemed to be on the war path. He gave a joint interview to several European dailies which included what seemed to be a direct attack on the chancellor. "Those who speak most passionately about political union are often the ones who hesitate the most when it comes to making pressing decisions," he said. His feistiness did not abate immediately upon his arrival in Brussels. Before meetings began, he insisted that the summit would be focusing on the planned banking union and not on fiscal union, Merkel's preferred project. He also accused Merkel of dragging her feet on bank oversight due to the approaching 2013 general elections in Germany.

Merkel didn't shy away from confrontation either. During her speech to German parliament on Thursday prior to her departure for Brussels, she threw her support behind Finance Minister Wolfgang Schäuble's proposal, made earlier in the week, for a super commissioner to monitor, and even veto, national budgets of euro-zone member states.

Compromise to Nowhere

Bear in mind last June the Euro leaders agreed to do this by the end of this year. Now the target, minus details, "will not come until later". The oversight regime will be introduced "in the course of 2013."

Is "introduced" the same as "implemented"? The more important question is "Does it even matter".

Catch A Falling Knife

In his Weekly T-Report Peter Tchir sums up the situation nicely.

I would love to be able to say that Europe is fixed. It isn't and this particular summit was particularly disappointing. They announced some vague plan to plan a bank supervisor. I still don't understand why people really think a bank supervisor would change anything. Just think about the Spanish bank bailout. Money was supposed to be available in July, then August, then September and as far as I can tell, not a single distribution has been made.

Spain is not asking for a bailout yet, and allegedly it wasn't even discussed. I cannot tell whether it would be worse if it wasn't discussed or that they are lying to us and it was discussed but no conclusion was reached.

Talk about various ways to manipulate the Greek debt problem. Plans range from further punishing the PSI bonds which I think would meet with incredible resistance and accomplishes nothing, to ways to get the ECB off the hook and dump losses on ESM. I am not sure there is any particularly good solution to the official sector problem because owning 10′s of billions of mismarked bonds and loans is a difficult problem to overcome.

Then there is news that France is in more frequent disagreement with Germany. That will make any longer term solution more difficult to achieve.

So why didn't markets sell-off more? At this stage everyone still believe the ECB will intervene with OMT and the ESM will provide some form of PCL along the lines of the IMF's programs (my ultimate goal is to write and entire paragraph with just acronyms).

One of these days, Europe will fail to catch the falling knife. Europe has let the situation deteriorate and then the EU cobbles together some sort of program that kicks the can for a little while. OMT and ESM should be the ultimate in can kicking, but every delay means that resistance will mount. If ESM gets immediately saddled with ECB GGB losses, how will the countries react? Will there be an immediate capital call? The ESM is supposed to be leveraged at 6.66 times and any losses that hit capital would limit how much it could currently borrow.

I see a likely scenario that the market starts to question the resolve of Europe and the dissent amongst all the various organizations and the countries rewards those who bet against Europe now. I would be selling Italian and Spanish bonds here or even short.

Meaningless Plans Roll On

Slowly but surely Greek bondholder losses approach 100%. There have been several haircuts already and now the German Finance Ministry Mulls Yet Another Debt Buy-Back Scheme.

Germany's Finance Ministry is considering a debt buy-back as a possible way of reducing Greece's huge debt pile which threatens to rise well above a target level of 120 percent of GDP by 2020, according to German news magazine Spiegel.

The Greek government could borrow money from the euro zone's permanent bailout fund and use this to buy back its own debt, which at present trades at around 25 percent of its face value. Buying just 10 million euros worth of Greek bonds could reduce the debt mountain by 40 million, Spiegel said.

Talks would have to take place with debt-holders to see if they would accept such a price for their Greek paper.

Ho Hum

Would bond holders agree to another haircut? Even if they did, would it matter?

In a report earlier this week Tchir estimated a buyback would save Greece less than a billion euros a year.

His math "Greece pays 2% on these bonds and the first maturity is 2023. Other than meeting some artificial Troika target, this plan has no meaningful impact. Greece will have to borrow money from the ESM to pay for these bonds. Depending on the price they pay and the coupon on the new debt, they will likely receive cost savings of far less than €1 billion per annum. If the average price paid is 50% of par (seems likely once the deal starts) and the borrowing rate on the ESM loans is 2%, the cost savings would be €600 million."

There's your answer: no it would not matter.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Drumbeat of Weaker Revenues

Posted: 21 Oct 2012 12:06 AM PDT

For the first time in three years, US corporations are poised to report lower sales. From technology to fast food giants, Falling Revenue Dings Stocks

America's largest companies are on track to report lower quarterly sales for the first time in three years, a broad and gloomy verdict on the health of the global economy.

The drumbeat of weaker revenue is particularly troubling to investors looking for a read on the health of the global economy because it reflects underlying demand. Companies have a lot of levers to pull to improve profits: They can sell assets, buy back stock or cut costs. But it is hard to improve sales unless consumers and companies spend more of their money.

The earnings reports are providing a counterweight to optimism triggered by a string of improvements in U.S. retail sales and home sales, data that pointed to an end to the slump in the housing market and a recovery in consumer confidence.

Several corporate chiefs said conditions worsened in the past month of the quarter and pointed to further weakness into next year. That means companies will be under pressure to cut costs and hold back spending to meet their profit targets, potentially putting a further drag on growth.

"I will tell you, one of the differences is it has been very rare that we've ever seen all of our major markets experiencing the impact of these kinds of global economies at the same time," McDonald's Chief Executive.

GE cut its forecast for revenue growth this year to 3%; three weeks ago it expected 5%. Chief Financial Officer Keith Sherin attributed the lower forecast to faster than expected downsizing of GE Capital.

Profit and revenues at the biggest U.S. companies have been expanding since the third quarter of 2009, a bright spot in what has been a lackluster recovery. But that run appears to be coming to an end this quarter. Growth in sales started decelerating in the second half of last year and ground to a near halt last quarter. Profits are expected to shrink by 1.8% for the third quarter, according to Thomson Reuters.

"You've got very slow global GDP growth," GE's Mr. Sherin said.

Belief in the Fed's ability to pull rabbits out of its hat is about the only thing this market has going for it, even though close scrutiny shows the Fed is not really in control of much of anything.

Stocks are priced beyond perfection, for growth that will not happen. When this matters no one knows, but it will matter.

Unless it's different this time (and it won't be), real returns in equities do not look good going forward.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

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Mish's Global Economic Trend Analysis

Mish's Global Economic Trend Analysis

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