6th October 2010 by Shaun Richards
Yesterday saw quite a surge in world equity markets with the Dow Jones Industrial Average in America leading the way as it rose 193 points to 10944. This was followed by a rally in the Japanese Nikkei 225 equity index of some 172 points to 9691. As European equity markets are rallying again this morning then holders of shares have in general had a good 24 hours. Some of this was caused by the monetary easing introduced by the Bank of Japan although so far it has promised more Quantitative Easing rather than actually delivered it. However if we remain with Japanese issues we can see that if it hoped to weaken the Yen’s exchange rate with its announcements then matters are not going particularly well as it is at 83.05 versus the weak US dollar as I type. As the Euro has been strong recently the Bank of Japan has managed to sustain its improvement there and now stands at 115.1. Should the Yen rise further against the US dollar then the Bank of Japan is likely to be forced to intervene again. It started its intervention when the Yen rose through the 83 barrier against the US dollar and a fortnight later we are at 83.05! At the time the intervention started I wrote this.
Over time I expect the foreign currency markets to challenge the willingness of the Bank of Japan to weaken its own currency.
One interesting side-effect of this has been on the spread between the Japanese Nikkei and the Dow Jones Average which when the intervention began was at 1010 points whereas this morning it is at 1253 points so for all the repeated efforts of the Bank of Japan the Nikkei has again underperformed over the last 2 weeks.
The Gold Price Rises Again
One beneficiary of the recent rise in talk about Quantitative Easing has been the gold price which had a surge of its own yesterday, so gold bugs should be smiling today. The front month Comex futures price rose by a not inconsiderable 29.8 US dollars per ounce or some 2.2%. So if you priced equities in gold they would have fallen in price yesterday! So equity holders may well be grateful that we are no longer on the gold standard. This morning we have seen further rises with the price currently up another 8.7 dollars and now stands at a new high of 1348 US dollars.
If you stop to think for a moment these two moves seem unlikely to occur together. Put in a nutshell equities have hopes for the future but gold is expressing fears for the future and I am reminded immediately of Kipling’s phrase “and ne’er the twain shall meet”. However I have a third factor here and it is also contradictory and leaves us with a type of unholy trinity in this respect. US government bonds are also rising particularly at the shorter maturities. I remember remarking a while ago about the 2-year maturity’s yield falling below 0.5% and the recent QE-lite announcement took it into the lower 0.4%s well now its yield has dropped to 0.4% exactly. So now we have it equities and government bonds and gold all rallying at the same time, so much for the power of diversifying your investments!
What is causing this apparent end to investment diversification? Step forward Charles Evans
I would like to draw your attention to an interview given by the President of the Chicago Federal Reserve Bank Charles Evans to the Wall Street Journal and the emphasis is mine.
I knew it was going to be bad. And it is not improving. We’re pushing out the growth prospects. I just think it calls for much more than we’ve put in place. My view on accommodation at the moment is not data dependent. I think we’re there.”
We need more accomodation………….So yes, I’m in favor of more accommodation…………..I would clearly favor more accommodation……… I just think additional action would be helpful.
If his views remain the same in early November then we can expect supporters of Mr.Evans view to be voting for more asset purchases or what has been named QE2. Now as I already expected Mr.Bullard to vote in favour we may be beginning to build something of a quorum and we have had hints from William Dudley too. I suspect that this is the real reason behind the surge in equity,bond and gold markets. They are hoping to see a surge of liquidity from the US central bank the Federal Reserve. As an example Goldman Sachs has been banging this drum for some time and is currently forecasting some extra 500 billion US dollars worth. I am not saying this because I believe in the Vampire Squid’s predictive powers as they have been rather weak of late but I do say it as an illustration of current market expectations. So the move by the Bank of Japan which was more proposal than action coincided with a rather dovish interview from a FOMC member.To continue my theme of what I consider to be unholy trinities we had a member of the Bank of England’s Monetary Policy Committee Adam Posen calling for world Quantitative Easing only last week. Perhaps markets feel they already know what is coming next, lots more liquidity and are looking at what it did last time.
If we look at another theme of mine we again have someone in authority confirming that they are keen on more QE in spite of the fact that they are unclear what it will actually achieve.
I think that additional asset purchases would have an effect. I think it would be beneficial. I worry that that alone would not be enough to address the particular view that I have.
Regular readers will be aware that it is my opinion that we need something a little more definite than “I think it would be beneficial” before one unleashes an incredible amount of liquidity. Actually I consider it to be very close to outright negligence. Furthermore we get an implication that other measures may also be tried.
We have to think a little more carefully about the potential tools that we have available to us.
So after the recent rebuttal of the idea of raising the inflation target by FOMC chairman Ben Bernanke we are starting to get other FOMC members hinting at moves in this area. At this point they are merely talking of raising the US Consumer Price Index towards 2% but just like in recent western military interventions my concern is of what has become called “mission creep” particularly when it comes from an individual who appears willing to commit himself to extraordinary measures and I mean this in both concept and size that he only “thinks” might do some good.
So my view is that in effect the worlds markets are “front-running” expected moves by the worlds central banks. The moves of equity and bond markets are direct responses to an expected surge of liquidity or in the case of bonds expected future purchases. The gold rise is, of course, a response to an expected implication of the rise in liquidity and perhaps to the expectation of further falls in the US dollar exchange rate. However Mr. Evans when talking about his plans for inflation also said.
Convincing the public that this is what we intend to do, that could be a useful tool.
Well with a rally of 2.2% in a day he appears to have had no trouble at all convincing gold investors! I suspect,however, that they may have heard a slightly different message to what he intended to give them.
This issue of the worlds markets in effect being subverted to the whims of central bankers is to my mind a real danger for us going forwards. I have argued before that if nothing else it is way beyond the “pay grade” of our current crop of central bankers. But even if we moved ourselves for a moment into an alternative universe where central bankers were achieving their objectives would that be worth the damage being done to the worlds markets?Talk of front-running reminds me of the dangers of insider trading and also reminds me that allegedly a member of the FOMC has been briefing investors before the official minutes are released. There are a lot of dangers here and of course George Orwell got there way before me when talking about the dangers of official and government power, “All animals are equal but some animals are more equal than others”. There is very little more dangerous for markets than the concept of an “early wire”.
The International Monetary Fund
Whilst I am on the subject of official intervention I am reminded of the IMF. It has been rather busy in various ways recently and mostly not in a good way. Last week I reported that it had praised the UK’s austerity programme and indeed it did. At the end of the week however it then published some work which indicated that the UK’s austerity programme would reduce our economic growth rate.
fiscal consolidation equal to 1 percent of GDP typically reduces real GDP by about 0.5 percent after two years
So care is required if one looks at its pronouncements as it does sometimes only look at factors in isolation. This thought was on my mind when I looked at its most recent report on the global finance system. Some places have majored on this section which says that capital controls might need to be used by some countries but only “as a last resort”. These days we know how quickly a last resort becomes a first resort but if you think about it this is a rather arrogant presumption of power from the unelected IMF to elected governments. I am afraid this sort of thing permeates its work. If you look at the theme of this report that emerging economies have been doing better than established ones is true but has been obvious for some years.
There have however been much darker proposals for the IMF,in my view, which have been reported much less. These fit in with my theme today of extraordinary expansion of monetary measures. South Korea has proposed a “global stabilisation mechanism” or GSM that would allow the IMF to offer unlimited credit without conditions to several countries at once. There are immediate problems to my mind in both “unlimited credit” and “without conditions”.I have written before about the expansion of the IMF ‘s role and indeed the financing available to it which was expanded massively following the meeting in April 2009,which UK readers in particular may associate with claims on behalf of our previous Prime Minister Gordon Brown that he had “saved the world” at that time.
I suspect I may not be the only person who can see the dangers in this. Here is the IMF’s view from IMFdirect.
We are also considering a Global Stabilization Mechanism, a framework that would allow proactive provision of financing during a systemic crisis to stem contagion.
So the worlds leaders have the opportunity to allow an unelected organisation to have the money and the means to bail the same world leaders out from any mistakes they may have made. It might sound good to them but there is an enormous moral hazard for the taxpayers of the world.