Tuesday, March 02, 2010

The Day of Reckoning

Another Monday, another percent in the S&P 500. Like Colt .45, the legend of Magic Monday works every time! Tuesday, however, is a different story; although equities are largely unchanged on the day, news that Greek public sector workers are planning to strike in protest of the government's austerity measures have sent the euro tumbling lower, scotching its nascent recovery. Macro Man has thus far been unable to verify whether Greek civil servants have demanded that the population of Berlin feed them grapes and fan them as they recline on Roman-style couches.

Down Under, meanwhile, the RBA put rates up to 4%, a level that seems almost (gasp) "normal", or, in the parlance of the RBA, "average." The strip is pricing in another 100 bps of tightening over the next year versus totday's 3m bill yields of 4.25%. That's only slightly more than is priced into the eurodollar strip, even though many punters don't expect the Fed to move rates over the next year. A break of the uptrend line in IRH1 could render it a nice short against long positions in other markets.

The risk, of course, is that the Australian property bubble bursts with a resounding "pop." While there are no obvious reasons for it to do so in the near term, it is nevertheless the case that most urban property markets are bum-clenchingly overvalued relative to local incomes; while this situation can obviously continue longer than most nay-sayers can remain solvent, recent experience in the US confirms that the day of reckoning cannot be postponed indefinitely.
Source: Demographia

Yesterday Macro Man highlighted sterling as looking particularly vulnerable, and he can only hope that The Twits were limit long with maximum leverage, as "Betty" got a right slap yesterday on what appeared to be flow related to the Pru/AIG deal. Although the queen's head has recovered slightly as news emerges of a better poll showing from the Tories (the lower-case twits?!?!?!), at this juncture it's hard not to share the wide-spread enthusiasm to flush the pound down the proverbial loo.
Macro Man cannot help but think, however, that the BOE will-sooner or later- face a day of reckoning of their own. Readers are by now no doubt weary of your author's anecdotes of his travails in locating a certain type of Audi estate for Mrs. M during the second half of last year, but his adventures in car-buying reflect a real hazard to a UK economy addicted to foreign manufactures: namely, that a weaker currency produces a negative supply shock as foreign producers either raise UK prices or withold product from the British market due to abject currency weakness.

Thus, despite relatively weak domestic demand, UK goods prices in the broad RPI index were up 6.5 y/y in January. While the VAT hike can explain some of that, of course, it doesn't explain why goods prices were up 5.3% y/y in December, before the normalization of VAT.
Thus, while Merve is sweating tepid M4 growth in this green and pleasant land, goods prices for the punters are rising at their fastest rate since before the last sterling crisis (i.e., its sordid ejection from the ERM in September 1992.)

Now, the last time that Macro Man checked, the BOE's mandate prescribes an inflation, rather than a money supply, target. So at the risk of beating a dead horse, he feels compelled to reiterate his belief that at some point over the next year, the Bank will face a day of reckoning, its very own Damascene moment, and all hell will break loose in UK financial markets. He looks forward to being there to pick up the pieces.


Nemo Incognito said...

MM, if you want some good (interesting?) data on Aussie housing check our Residex or Rismark. I spent my uni days scrubbing this data pro bono in order to get it free for my thesis work.

One thing worth considering is that while Australia looks big and therefore would have elastic housing supply it seldom works out that way. Nimby politics and physical constraints (those bloody blue mountains) make the market very inelastic indeed.

That being said, if you get a big enough demand shock along the lines of China radically realigning its fixed asset investment / property spend then the AUD is in for some serious pain.

Nemo Incognito said...
This comment has been removed by the author.
cp said...

I love their logic: "inflation is high now, but due to one-off effects and base-effects, it will fall over the the forecast period".

Follow that through it's logical progression and you are forced to conclude that if we have high inflation, then policy needs to be loose to anticipate the fall in inflation over the next 2yrs. But if inflation is low now, then policy needs to be tight because inflation will be high in 2yrs.

Not entirely sure that is the sort of logic an inflation targetter should be following.

Macro Man said...

Nemo, those Demographia guys did a study a few years ago that indicated that zoning policies were the single largest explanatory variable in determining relative house prices across differrent zones. What I like about their study is that you can compare different markets across international borders to gt a sense of relative valuation.

Macro Man said...

cp, I think it's fair to say that Mystic Meg has a better inflation forecasting track record over the past few years than the ballyhooed fan charts- according to the May fan chart, the eventual actual level of y/y CPI in December wsn't even part of the distribution!

Rossco said...

Have to agree with Nemo, as crazy as the housing situation in Aus looks, put it down to 1) A severe lack of political will to release crown land 2) Left wing state governments who cannot bear to see a developer make a profit make new development uneconomic 3) A relaxation from the FIRB on non-resident ownership (HK relative value) 4) Large scale immigration (esp from UK) 5) Rental yields still holding up remarkably well
6) Full recourse home lending is the norm

So yes, it's nuts... but I suspect it'll stay nuts a bit longer.

The bigger issue IMHO is the RBA's stubborn insistence that monetary policy actually works

cp said...

Yes, I think the Vampire Squid put out a piece a couple of weeks ago that backed out the implied effect of rate moves on inflation & growth. The conclusion was that the BoE now think that policy is twice as effective as it was prior to 2009.

This of course, is simply a case of the MPC fiddling the numbers given that every other academic study of the past 15yrs has suggested exactly the opposite, with respect to policy at the zero bound.

I think it's very interesting. Until recently, the main tail-risk that markets have worried about in the UK has been either banking or fiscally-related (inflationistas/deflationistas aside). If the question of central bank credibilty is being raised then that's completely new.

Anonymous said...

Sterling is doing what the Greek currency would have done had it been able to do so.Exporters will love this ,but Kings inflation target is wishful thinking,or more likely he's buying time and hoping for the right election outcome to put a bottom under the currency.

Anonymous said...

... we would like to confirm that we always don’t want our clients use our products for some illegal purposes. However, we can not deny some of our clients buy our gold–plated tungsten bars for the illegal purposes, even maybe some national bank gold vaults have our products ...

/maybe even other national banks can google the above and order our product so that their product too will look much better on the fx/

Gregor Samsa said...

Greece and Dubai is sooo yesterday.
Now that it's the UK's turn, the question is: Who's next? Spain, Portugal, Italy, the US?
Normally, my bet would be on the US, but they just might be TBTF.

JohnL said...

Gregor: eventually we will discover an entity that is TBT'S'. Then were do we go, $gld??

leftback said...

The bailout bill may finally have become too large for one country at least:

Iceland Referendum

Gary said...

LB -- if the people I talk to are any indication, Obama faces the same probable (certain?) mutiny when he tries to raise taxes in the US

Bailing out bankers was Paulson/Bernanke/Geithner's idea, not the taxpayer. Not only was there no public support, there was widespread condemnation of the policy. There was also no historical precedence for bailouts; Continental Illinois and thousands of S&Ls were "allowed" to fail -- GASP! without paying any bonuses!

Anonymous said...

MM, you don't understand. This time it's different. Lack of land, building regs, population growth. All the same reasons that made the UK different and prevented a crash in house prices there. Oh, wait...

William said...

Gregor -- the US might be TBTF, meaning the global markets won't allow the debt to outright default.

But this is not a binary question: fail or no fail. The US probably will have to fail "some" -- by devaluing the USD faster than historical norm and/or printing money a bit faster than GDP growth... A tax on currency by whatever name

If you believe Ben "the subprime contagion is well contained" Bernanke, and you believe currency will be taxed only 3-4% per year ... a 3-4% per year loss is better than 20-50% loss in other G-7 debt and vastly superior to a 100% loss in some countries.

Personally, I don't believe Bernanke is quite in tune with the real economy. And even if he was, the Fed is too weak (economically and politically) to stand up to Congress.

But if the US loses credibility, as the UK government has, the question becomes: which G-7 debt 20-50% loss is lowest? Who is the one eyed central bank in the land of the blind?

Its great to say we will all cash in our Treasuries and Bunds and Gilts -- and buy gold ... but there isn't that much gold to buy (at any price). And if you did have a huge stack of gold bars, you would have to pay some guy to help guard it; and he isn't going to accept monopoly money as payment. You would be crazy to keep your gold in an insolvent bank or anywhere the tax max could get his hands on it.

TBTF is a political marketing gimmick to justify bailing out political cronies -- Rome wasn't too big to fail and neither is the United States. England IMHO is already circling the drain

The big question is which (reasonably liquid) sovereign debt is going to suffer the smallest loss in "real" (purchasing power) terms?

Whichever country wins that dishonorable distinction might be able to continue borrowing ... while the others will be forced to live within their means (ie make drastic spending cuts).

leftback said...

A global inability to borrow to extend sovereign debt (in other words a second phase of the credit crisis) would certainly bring about a worldwide contraction. Sooner or later someone is not going to be bailed out. The only questions to be answered are: which banks, and in what country?

Gary, welcome back, and LB agrees with the sentiment. But the difference between Iceland and the US is that we will not have a say in the bailout decisions. No referenda here.

All bubbles eventually pop when the rate of expansion exceeds the ability of surface tension to hold the materials together, the Australian housing version will be no exception, the RBA knows this and is trying to arrest it before it becomes even more superheated.

If Aussie housing bursts at the same time as China slows its building programs, the recession that results could be extremely deep and the AUD will tank. Bruce's main business is digging ore in Woop Woop and getting Wayne in Sydney to sell it to China, while Sheila sells houses in Penrith to newly arrived Pommies. An economic miracle it isn't.

Anonymous said...

The solution to the Greek crisis has been found --- GIVE BACK THE MONEY!

March 2 (Bloomberg) -- Nana Mouskouri, the Greek singer who
was also a member of the European Parliament, plans to donate
her lawmaker’s pension to the Greek government as it seeks to
cut its budget deficit, Agence France-Presse reported, citing
the Greek Finance Ministry.
The singer, who rose to fame in the 1960s and 1970s with
songs such as “White Roses from Athens,” was a member of the
European Union’s parliament for the New Democratic Party between
1994 and 1999.

Gary said...

LB -- "But the difference between Iceland and the US is that we will not have a say in the bailout decisions. No referenda here."

Um... There is a referendum already scheduled for next November, and it looks really bad for all incumbents

Also, story on the Bloomie today about all the billions in losses incurred by GIC, Tamasek, Abu Dhabi ... it doesn't take a rocket scientist (or even a sell side analyst!) to figure these sovereign funds are going to be a LOT more careful going forward

Its also pretty clear that those inside the Beltway are, if anything, becoming even more disconnected from reality. Obama has delegated the decision on the new Fed Vice Chair to Tim Geithner and Larry Summers. Ethically challenged meets the guy who nearly bankrupted Harvard. It would be entertaining, if the decision weren't so important.

leftback said...

Gary, US elections are a choice between Tweedledee and Tweedledum when it comes to economics. Not exactly a referendum.

Nice of Nana Mouskouri to cough up but they'd have to shake Demis Roussos and the entire Onassis family to solve this problem.

Gary said...

LB -- While Republicans might argue that Scott's election in Massachussets was in support of whatever mandates... I would argue otherwise.

The November referendum is between allowing Obama to implement extremist left-wing socialist policies that fly in the face of 200+ years of American values...

...or political gridlock.

If we can't get politicians who are competent, gridlock becomes the best choice.

There are LOTS of problems facing the country, but first do no harm.

Anyone who has ever seen US public housing doesn't want US public healthcare.

Maybe it works in Europe (I have doubts whether the UK's NHS will survive the peak of North Sea oil) ... but decades of incompetence (both parties) proves beyond any doubt that it won't work in the US.

Bush proposed privatizing Social Security early in his first term. The man wasn't exactly known for his mental prowess, but when it become obvious that the country did not want private Soc Sec -- Bush (or his advisors) had the brains to drop the issue.

Obama, despite all his speaking abilities, is just not as smart.

So political gridlock becomes the preferred choice, even if it is not the ideal choice.

To be sure, health care costs are out of control -- but its just insane to think bad government can't take a bad situation and make it even worse.

leftback said...

Gary, I don't want to bang on about the health care issue as MM has explained that national health systems work extremely well in many European countries and you can opt out. Nothing could be more expensive or inefficient than the current US systems.

Also, Gazza, look mate, if Obama is a socialist then Lloyd Blankfein is Mother Teresa and John Terry lives in a monastery.

Professional Gringo said...

30 year treasuries setting up for a perfect head and shoulders top?

Anonymous said...

This post has been removed by the author.

Gary said...

LB -- Nothing could be more expensive or inefficient than the current US systems.

Famous last words, leftie. We are talking about a government that spends $1 billion on an airplane and $10,000 for a coffee maker.

Many doctors in Connecticut no longer accept Medicare patients, because Medicare "price controls" don't even cover costs, much less yield profits that Obama can tax to death. Medicare doesn't work without massive subsidies from private insurance -- which is no longer able to do so.

No argument that the current system's costs are absurd -- but I think you are insane to think costs can't be made worse by a bunch of corrupt politicians

I have no idea if Obama is a socialist -- but his health care plan sure is.

More importantly, the man is an idiot. We finally got rid of a bumbling idiot, and we got a well spoken idiot instead.

Sorry LB -- but I don't think much of anyone's money abilities if you think $1.5 trillion deficits indefinitely is anything other than a fantasy

Obama's administration lacks real world experience. Only 7% of senior staff have ever held a private sector job, of any kind. Not even a cushy "daddy got me this job" like Bush had.

Obama has alienated the military, sold whatever was left of the Treasury to Goldman, and on every other issue has done nothing (at a cost of trillions).

And I don't care how much it pisses off MacroMan or the people of Europe -- I will not shut up about Obama's disasterous health proposal. MM and Europe aren't paying the bills for our system and they don't get a vote.

The US is majority rule, and even by Democratic party polls, 62% of Americans DO NOT WANT OBAMA-CARE!!!

That is an overwhelming majority. Its high time for these "elected representatives" to represent US voters.


As long as I have to read to pompous windbags at the Financial Times telling me how to run my country (after they successfully bankrupted their own country!), then the Brits can listen to me saying the idea is STUPID.

Anonymous said...

Looks as though our old friend (chap?) LB has finally drank the kool-aid as we say:

Obama as a New Party member

Facts, LB, facts. The "Frank" he refers to in his autobiography was Communist Party leader. He admits attending socialist conferences as a youth.

BTW Gary is right. I have $50 here that says LB has never ventured out of Manhattan to visit, oh, say Red Hook housing projects in Brooklyn?

leftback said...

Anon @ 10.56PM: LB has greater familiarity with living on the wrong side of the tracks than most of you will ever read about in fancy newspapers.

Anonymous said...

Those who still support US public health care are ignorant of US history.

Until the 1930s, US doctors still made house calls and everyone paid their doctor 100% out of pocket. There was no widespread health insurance.

Then came FDR's price controls, initially to prolong the Great Depression and later to control spiraling inflation that came out of World War II.

As part of FDR's price controls, FDR also implemented wage controls across the board (not just for bankers). To get around these wage controls and to attract the best workers, US companies started paying generous benefits packages, especially health care.

In short, the current US health care insurance system is the direct result of FDR's price controls.

Every time central economic planners try to "fix" something, they cause new problems somewhere else -- often delayed and usually bigger.

The US health care system is the result of an earlier US government effort to control prices.

That's why it is so screwed up

William said...

England is preparing its populace for war with Argentina (again) over the Falkland Islands.

If England doesn't find a new oil field to exploit / replace the North Sea Fields-- all of the UK will collapse, not just the National Health System

The British do not pay for their health care -- mother nature does. If the UK isn't exploiting colonies, it is exploiting the environment. Funny that they see fit to lecture the rest of the world on how to run economies.

Even if the UK manages to steal Argentina's oil fields, the mess that British management made of RBS will hold back growth for at least another decade.

Anonymous said...

LB, I stand corrected, cheque is in the mail.

Fairly obvious if you look at the NYC Establishment throughout the 20th century, they consistently pull the strings behind their pet Manchurian Candidate leftists.

There is no real effort to hide it. CFR HQ located across the street from the Soviet Embassy on 68th. Even G.W. Bush was run by a group of "former" NYC Trotskyites.

Gary said...

@Professional Gringo "30 year treasuries setting up for a perfect head and shoulders top?"

Are you speaking rates or prices?

Looking at rates, there is a recent double top around 4.75 (last week and early January) ... but that same 4.75 level also held back in late May of '09

Seasonally speaking, 30yr rates stay range bound late Feb (after the new issue) to late March, then start a multi-month climb... the high yield for the year is (seasonally speaking) late May / early June -- its a little messed up in recent years because the 30yr re-opening in May.

This year, California is likely to default sometime later this month. California will argue that they are paying their bills with IOUs -- but by law only the Fed can issue currency. The lawyers can argue what the meaning of "is" is, but it IS a default.

California was in this same situation last year, and the year before that. They "solved" each crisis by borrowing with debt, borrowing from cities, borrowing from vendors -- kicking the can down the road. The Gubernator became Gubernator because the previous CA governor was unable to pay the bills... in other words, for the exact same problem.

California spends too much, plain and simple. It is not suffering a one time cash problem related to the credit crunch.

Nancy Pelosi may be the most hated woman in the entire USA, and after the health care fiasco -- favoring one state over others isn't going to go over well.

Like Greece, California is just the first state to go defacto bankrupt. NJ, AZ, NV, and NY are close behind, with others only slightly better off.

Obama cannot afford to bail out California -- both because CA has a perennial spending problem (not a one time issue), and because there are lots of other states that would follow.

In aggregate, it would be another trillion dollar bailout -- taxing farmers to pay for hollywood's spending.

But given California's electoral status (I think it has the most votes?) -- Obama can't really tell CA to pound sand, as the EU is doing with Greece.

So Obama has two really bad choices:
1) Bail out many states (not just CA), essentially conceding the 2012 election and sending yields skyrocketing because no one trusts sovereign spendthrifts

2) Let California fail, essentially conceding the 2012 election as the economy implodes due to massive spending cuts in many densely populated states. Yields might go down (because the economy is in recession) or up (because there is no economic activity backing US Treasuries)

Obama seems to have decided to let Bush tax cuts expire this year -- and whether you agree with that politically or not -- economically it is a tax increase. Tax increases, all else equal, cause the economy to grow slower (or contract more as the case may be).

Shifting economic resources to the public sector has ALWAYS resulted in slower economic growth -- meaning less real cashflow to tax, meaning lower tax revenue.

This is why I have argued for months that Bernanke will be forced to raise Fed Funds later this year. It won't be his choice, and I assume he will keep real (after inflation) rates negative. But he will have to raise rates to attract foreign capital, to keep dollar depreciation to a low enough level that SAFE and others can ignore.

The US government is no longer in control of its own economic destiny ... a position it has not been in for well over a century. Besides no real world experience in Obama's administration, no one in Washington has any idea what it is like to be a declining world power.

Its going to be a very rough adjustment

Rossco said...

LB - I actually tend to agree with you on the Australian view but to be honest for you to procrastinate on the bubble bursting without any indication of timing isn't particularly useful. People have been calling a top in Aussie housing since 2003 ...and it's still going up. Do you not think a large pool of domestic savings (compared to the UK and the US) makes a difference ?

Anonymous said...

Obama is going to be to the US exactly what Brown has been to the UK and I can't think of a worse set of circumstamces whereby that might occur. Obama has socialist stamped all over him and I believe LB said otehrwise to which I would have to ask ,are you completely devoid of insight.Hope you hang around for a few years so we can revisit this issue.

Anonymous said...

Also, President Obama overruled Senator Obama by quietly awarding Patriot act another term...