Diary of a Financier

Whereto Now?

In Capital Markets on Thu 22 Sep 2011 at 00:35

Whither from hither? I mean, Operation Twist was the dud I expected; actually, the term I used was “window dressing.” Many point to the 10-12bp in rate erosion wrought by the 1960’s Twist. For consistency’s sake, I’m quick to point out that the early iteration employed a mere $8B or 1.5% of US GDP, versus the $400B/2.7% at hand today. That’s a bit more substantial. Nevertheless, a yield curve twist has a few pitfalls:

  1. The entire $400B will be funded from sales in the front-end (<3yrs) of the curve, which runs the risk of increasing short-term funding costs that are the lifeblood of the economy.
  2. Both modern Quantitative Easing programs failed to lower interest rates across the curve. I’ll be lenient in suggesting that buyers took the cue to invest in more risk, which left the Fed to displace the lost demand.

    IRX & TYX- QEs failed to lower rates.

2s10s- QEs failed to rally T-bonds.

Equities will drift lower due to the European crisis, a simmering Chinese crisis, and want for an upside catalyst. That I’m sure of. But, everyone suddenly seems sure of it too, which makes me skittish.

What propels us in another direction? What reverses the bear trend? In swoops a passage from Ben Bernanke’s 2002 report Deflation: Making Sure “It” Doesn’t Happen Here

I believe that, when all is said and done, the failure to end deflation in Japan does not necessarily reflect any technical infeasibility of achieving that goal. Rather, it is a byproduct of a longstanding political debate about how best to address Japan’s overall economic problems. As the Japanese certainly realize, both restoring banks and corporations to solvency and implementing significant structural change are necessary for Japan’s long-run economic health. But in the short run, comprehensive economic reform will likely impose large costs on many, for example, in the form of unemployment or bankruptcy. As a natural result, politicians, economists, businesspeople, and the general public in Japan have sharply disagreed about competing proposals for reform. In the resulting political deadlock, strong policy actions are discouraged, and cooperation among policymakers is difficult to achieve.

In short, Japan’s deflation problem is real and serious; but, in my view, political constraints, rather than a lack of policy instruments, explain why its deflation has persisted for as long as it has.

That’s the catalyst, the “Bernanke Put.” While he has tread lightly of late (to protect the Fed’s independence and save internal strife), Mr. Bernanke will not let politics foil his efforts. Why ever would they let the system fail? Since I hate to lean on such heresy, I have to find the pivot point on the charts. Looks like 1045 is the next significant support:

ES daily- supports at 1045 & 1015.

SP monthly- falling further in want of stimulus.

–Romeo (hattip Business Insider)

  1. Ypour prediction in your blog of September 21 of the Fed’s action was on target! Well done.

  2. […] on the developing big picture–a second opportunity to buy equities at generational discounts [SPX 1045] on the other side of the European fallout. That is priority #1. In the meantime, I’m quite […]


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