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Sunday, October 23, 2011

Fear and Loathing in the Eurozone

Xcerpt from Stock World Weekly: Fear and Loathing in the Eurozone, week ahead section.
Merkozy Ambulance
(Click here for more Stock World Weekly)

Late Thursday afternoon, Jon Hilsenrath of the Wall Street Journal, a well-known sounding board for Bernanke when he wants to give signals to the markets, reported “Federal Reserve officials are starting to build a case for a new program of buying mortgage-backed securities to boost the ailing economy, though they appear unlikely to move swiftly.” (Fed Is Poised for More Easing)


This report builds on sentiments that Federal Reserve Governor Daniel Tarullo expressed in a speech on Thursday evening. Bloomberg reported “Federal Reserve Governor Daniel Tarullo’s call for resuming large-scale purchases of mortgage bonds may boost chances the central bank will start a third round of asset buying aimed at reviving U.S. growth.

“Policy makers should move the tool ‘back up toward the top of the list’ because it would help the economy through lower mortgage costs that would boost home purchases and spending by people who refinance their home loans, Tarullo said late yesterday in a speech in New York.”

Tarullo’s speech and Hilsenrath’s article both came out on Thursday, suggesting the Fed is making an effort to broadcast its seriousness about using its tools to jump-start the moribund U.S. economy. Any large-scale program of buying bonds will essentially be another round of quantitative easing (QE3), predictably leading to increases in stock and commodity prices.

However, regarding commodity prices, one event last week may put a damper on increases in commodity prices. On Tuesday, the Commodity Futures Trading Commission (CFTC) voted to put position limits on commodity markets, as it attempts to deal with problems created by runaway speculation. Phil has repeatedly reported on the manipulation in the oil markets, with articles such as last June’s “Which Way Wedne$day - Let’s Break the $peculator$.” Tuesday’s action, while welcome, is long overdue.

Screen shot 2011-10-23 at 2.52.47 PMThe six month chart of the Dollar shows the 73 to 76 range that the Dollar traded in for five months, before it broke out in early September. Now, however, the Dollar’s impressive breakout is failing. It looks like the Dollar may return to its previous trading range. Moreover, with Bernanke and Tarullo banging the drums for more QE, market participants know that QE3 is likely to weaken the Dollar. If the inverse relationship between the Dollar and the stock market persists, the depressed Dollar is bullish for equities. This is no secret and is why hints of QE3 drive the Dollar down and prop equities up.

Europe will be the focus of the financial news again next week. German Chancellor Merkel and French President Sarkozy will try to work out a deal to give additional funding and more discretionary power to the EFSF, while simultaneously strengthening “economic integration” and capitalization of European banks, all under the auspices of implementing “economic governance of the euro area.” Achieving their goals would be historic by any measure.

A primary issue at the heart of the struggle is whether the theoretically unlimited funding of the European Central Bank (ECB) can be used to ‘backstop’ the EFSF, thereby guaranteeing sufficient capital to recapitalize banks and buy distressed bonds. While Sarkozy is a strong proponent of backstopping the EFSF with ECB funding, going so far as to abandon his wife during childbirth to travel to Frankfurt to make his case to Chancellor Merkel, his efforts were in vain. Merkel, backed by ECB President Jean-Claude Trichet, adamantly refused to consider Sarkozy’s proposal.

As the UK Telegraph noted “Europe's central bank could not be used to boost the EFSF because of a 20-year EU treaty clause forbidding the union from using its cash to save European governments. Unlike the EFSF, an ad hoc inter-governmental ‘special purpose vehicle’ based in Luxembourg, the ECB is governed by the detailed chapter and verse of European law.” According to a senior EU diplomat, “If the ECB could act like a national central bank that would make life a hell of lot easier, problem solved, but that runs up against the treaties and Germany's cult of the Bundesbank. Sarkozy was told 'game over’” (France and Germany: an unstoppable force meets an immovable object)...
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