When you hear central bankers, investment chiefs, and politicians debate the merits and probability of further quantitative easing (QE), you have to interpret the subtext of their statements and positions.
When Ben Bernanke said in 2010 that he was still worried about the housing and labor markets, and deflation in general, this was your clue that he would keep interest rates low for much longer than any inflation hawks dared dream -- in their worst nightmares.
For this reason, I have called him the most transparent and steady of financial governors. What may not be obvious is that while he fires big monetary weapons and gives them lots of time to work, he would love to launch more if only given enough good reasons.
When Angel Merkel says that papering over Europe's fiscal problems with more debt (i.e., eurobonds) is foolish in the short-run and the long-run, she is telling you that Germans are fully prepared to let peripheral countries burn for years while the necessary cleansing occurs -- regardless of how much collateral damage occurs to the global economy.
And clearly, we should all be cognizant by now of these facts: Germany benefits from a cheaper euro and very low borrowing rates for its own sovereign debt. They would like this to continue, not drastically reverse as communal debt-sharing initiatives infect their pristine balance sheet.
Bernanke is ready for QE3 and the current economic malaise -- highlighted today by further anemic job growth -- is giving him ammo to make the case without appearing to be the stock market's crack dealer.
Brinkmanship or Principles?
And Merkel, I've been conjecturing for months, cannot be pushed into printing money to stem their debt crisis. But she might be dragged against her will. Here's how I summed it up last week in Waiting for Eurobonds... And Flying PIGS:
But, Merkel may allow herself to be forced into compromise. After all, it is far better to fight and lose on one's principles, then just to give in to the undisciplined hordes.
This is the simple logic I have used to evaluate the German stance in the past year:
Germany wins in several scenarios as things melt down. They get concessions on fiscal austerity and they get a lower euro. And if they seem like the bad guy letting Athens or Madrid burn to the ground while they stand by and watch, they don't care and won't give in... unless forced to.
Maybe Merkel wants to be forced by events and politics so she doesn't have to bend and appear to compromise. That is a dangerous game of chicken. But she is comfortable with that game as we saw last fall.
What's changing is that the Germans can't run the show forever. Compromises may be around the corner. But realistically what we will see is new financial agreements and innovations. Everything -- anything -- but eurobonds.
Germany has always held the cards and controlled the game. Are they at fault for wanting to remake Europe and the eurozone economic union by their own design?
Many call what Merkel is doing "brinkmanship," where one pushes dangerous events to the verge of "or to the brink of" disaster in order to achieve the most advantageous outcome. Kinda like the US Congress with the debt ceiling last summer.
Getting Pushed Toward the Cliff
Since we are about to give Congress another chance to prove their mettle (or lack thereof), the coming "fiscal cliff" and past brinkmanship were definitely on the minds and in the hearts of big sellers today as the S&P fell 2.5% to close below the 200-day moving average at 1,278.
And remember who coined the phrase "fiscal cliff" because he was very concerned about the propensity for politics-as-usual to mess up his recovery. It was Bernanke.
Conclusions: The probability of Fed QE3 by August just jumped from 35% to 65% in my book of odds. And the probability of Europe's pro-eurobonds leaders overpowering the staunch German wing is now at 50/50.
This doesn't mean "eurobonds" are coming. It just means that either slowly or quickly, Merkel is about to begin giving in to her cohorts' pressure. Wednesday, the EU commission called for expanded use of the permanent bailout fund known as the European Stability Mechanism (ESM), saying that it should be used to directly re-capitalize banks instead of handed over to governments.
Even the President of the ECB, Mario Draghi, wants Germany to do more so he doesn't have to
This morning, Bloomberg writer James Neuger put together an excellent article summarizing the current euro-divides. Here is an apt paragraph taken from Merkel's Isolation Deepens as Draghi Criticizes Strategy ...
Draghi told a European Parliament committee in Brussels (Thursday) that it wasn't his job to make up for the failures of policy makers. When pressed on whether the ECB can step up action to tame financial turmoil and help cap widening bond spreads, Draghi said that "it's not our duty, it's not in our mandate" to "fill the vacuum left by the lack of action by national governments on the fiscal front," on "the structural front, and on the governance front."
The bottom line: Bernanke is ready with the firehose and Merkel will be forced by events to at least grab a bigger water pail. Maybe she wants it that way.
Sidebar: On Thursday, when US 10-yr Treasury Notes were hitting new all-time low yields below 1.6% and German government 10-yr bunds were trading 1.21%, I posted a Real-Time Insight blog about "the flight to quality." I wanted to start a discussion about how much fear we were seeing among institutional investors who need to park money in the safest, most liquid places for dollars and euros on the planet.
Today, as the US 10-yr slipped below 1.5% -- and German 2-yr bunds went negative
-- on the escalation of fear, I want to share two points:
1) Most investors are typically dumbfounded when they hear about this price action. They say, "Who in their right mind would lend the government money at that rate for ten years?!?"
That's not the right way to think of this "trade." First, remember that they are merely parking cash in the safest place. Second, even if it is a view about the yield curve and the next Fed Twist, it is not necessarily a 10-year "investment." It's probably somewhere between a 10-day and a 10-month view of bonds and their potential "twists."
And they will take the risk of a short-term trading loss on the yield to have the best existing guarantee of principal in the known financial universe. That's what you do when you are worried about banking contagion, a credit crisis, or general market mayhem.
2) Zacks Chief Equity Strategist John Blank, a macro economist by training, wrote a good and quick analysis of the European debt crisis which focuses on the trade imbalance at the core. See "Who's Afraid of the Flight to Safety" for his excellent summary, which is the first comment in the thread (at the bottom of page).
Kevin Cook is a Senior Stock Strategist with
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