Market Wobble Induces PR Blitz


The recent mayhem in bond markets and emerging market currencies that has lately begun to infect stocks as well, has apparently rung a few alarm bells at the Fed. On Monday the action in the SPX began to look quite ugly. Clearly,  some verbal support was required. Following Ben Bernanke's content-wise completely inconsequential press conference (it required quite an overactive imagination to read anything 'hawkish' into Ben's well-scripted cooing, but that is what the press promptly did), the global market wobble began to take on a slightly panicky hue recently, finally grabbing hold of even that most stolid stalwart of the echo bubble era, the US stock market. Mind, the SPX merely approached lateral support near the 1550 level – as corrections go, this recent one would normally not even be worth mentioning. However, in the process an uptrend line was broken and one must not forget that the 'players' have gotten so used to the market going up every day, that they are up to their eyebrows in margin debt. Given that the rout in bond markets around the world has likely produced a number of casualties, we are facing an especially treacherous market environment.



SPXA small correction in the SPX, but not one lacking in esprit – click to enlarge.




Anyway, that was all it took to set the 'Federal Open Mouth Committee' into a small PR frenzy. For several days in a row we have now been informed not only of the fact that Bernanke was misunderstood, but that the Fed, instead of thinking about 'tapering', should actually think about doing the opposite. Readers may recall that we have mentioned a few times in the past that the chances of such a development being on its way are actually not too bad. The reason for thinking so is that all the monetary pumping to date has created a highly imbalanced, structurally weakened economy, accompanied by yet another huge asset bubble. That's a very fragile combination. Since central banks know only one recipe for dealing with the fallout from such situations, the idea that instead of 'tapering', even more money printing may be coming down the pike eventually is not as far-fetched as it appears at first glance.

Anyway, heavy propaganda artillery was deployed to stop the bleeding in the markets, especially as China's central bank on Monday appeared none too eager to help out its own liquidity-starved banks (more on that below).

And so we heard first from Jon Hilsenrath, who reminded the true believers that 'you've all missed the dovish signals in Bernanke's statements:


“The financial markets may be overlooking several dovish signals from the Federal Reserve, according to a new report by Wall Street Journal reporter Jon Hilsenrath on Friday. The report notes that Fed Chief Ben Bernanke took several steps to avoid appearing hawkish.


(emphasis added)

St. Louis Fed president James Bullard went as far as 'slamming' the repeated mention of the term 'tapering', the timing of which he regards as 'inappropriate'. Similar to Narayana Kocherlakota (who also felt compelled to send dovish smoke signals), Bullard has all of a sudden turned from a presumed 'hawk' (which he never was by the way, that is simply yet another myth cooked up by sell-side analysts and the financial press), into an über-dove.


“The Federal Reserve mistimed its announcement of a plan to end its bond-purchase program, St. Louis Fed President James Bullard said Friday.

In a statement elaborating his dissent from the Fed policy decision issued Wednesday, Bullard noted that the central bank announced that less-accommodative policy was in store at the same time that it marked down its forecasts for 2013 growth and inflation.


Bullard, who is most often classified as a hawkish member of the Fed’s leadership team, dissented for dovish reasons: He thinks the Fed might have to ease more to get inflation higher. In a separate interview with the Washington Post, Bullard said the Fed was more hawkish today than it was one week ago.


(emphasis added)

Don't you know, there's not enough inflation. To round things out, we received word from NY Fed chief William Dudley yesterday as well, who at an exquisitely timed moment (the stock market had just reached the lows of the day) stressed that – wait for it – the 'Fed isn't accommodative enough'.

You couldn't make this up.


“New York Fed President William Dudley, speaking in Switzerland to the Bank for International Settlement’s annual meeting, said the U.S. has fallen short of its employment and inflation objectives. “This suggests that with the benefit of hindsight, U.S. monetary policy, though aggressive by historic standards, was not sufficiently accommodative relative to the state of the economy,” Dudley said.”


(emphasis added)

A recent article at Zerohedge suggests that the main reason why the 'tapering' talk started at all was a recent spike in 'delivery fails' in the treasury market, as well as the fact that the federal deficit is shrinking ever so slightly. That sounds actually a lot more plausible than the idea that the alleged improvement of the economy is a reason for the Fed to entertain the notion of slowing the printing down. The economy is home to echo bubbles in stocks and housing, both of which are standing on quicksand, as they depend on continual monetary pumping (as an aside, these echo bubbles have also led to a temporary improvement in nominal tax revenues). Other than that, the economy appears to be unusually weak, especially considering the amount of monetary and fiscal juice thrown at it since 2008. The only sensible conclusion one can draw from this is that the previous credit bubbles have inflicted  severe damage on the pool of real funding and have consumed a lot of scarce capital. So much in fact, that not even the diversion of wealth into renewed bubble activities by means of monetary pumping works as flawlessly anymore as it once used to do.

Anyway, the markets seemed to finally get the message once Dudley's speech hit the wires. That seems to have done the trick, at least for a day or two. The only market not listening was once again the gold market,  which we'll get to in the next post.


Chinese Indigestion

We may have slightly underestimated the PBoC's willingness to teach a number of banks in China a lesson. On Monday the credit squeeze worsened further, leading to a crash-like move lower in the stock market, which has made new multi-year lows overnight. However, on Tuesday, the Bank of China finally relented and pumped liquidity into the system, as can be seen from the sharp pullback in overnight SHIBOR and other short term interbank lending rates. Note though that longer term maturities have not backed down.


“China's central bank moved on Tuesday to further assure markets it would provide cash to institutions that need it following days of turmoil that pushed shares to their lowest level in more than four years on fears of a banking crisis.

It said it had given cash to some institutions facing temporary shortages and would continue to do so if needed. The People's Bank of China (PBOC) wants to curtail funds that are flowing into the country's vast informal loans market and push money instead into more productive areas of the economy as it seeks to shore up growth.

But it's tough stance of allowing cash conditions to tighten, which drove short-term interest rates to extraordinary levels on some deals, had raised fears of a lasting credit crunch and roiled markets globally. In a statement late in the day that reaffirmed its drive to get banks to control their lending, the PBOC said it would provide cash to institutions that support the real economy.

"The central bank will provide liquidity support to financial institutions that face temporary shortages, but which have been lending, at prudent amounts and pace, in line with government policy and supporting the real economy," it said.”


(emphasis added)

The last sentence highlighted above is the decisive one: banks must knuckle under and act as prescribed by the government's credit dirigisme. It should be noted here that China's government is actually trying  – belatedly – to get some of the credit excesses in China under control. The very excesses it has helped set into motion with its post 2008 policies. This is quite a tightrope act. The amount of loans of dubious quality on and off  the books of China's banks is likely staggering by now. It doesn't look like a situation that can be easily  'soft-landed', but we have underestimated China's bureaucrats before, so we'll have to wait and see whether they will once again be able to kick the can down the road. It is of course always possible that the new government will actually allow a proper correction of the credit excesses and capital malinvestments to take place, but we have our doubts about that. What happens in China now will likely turn out to be of great importance to the rest of the world. In fact, it already is.



Shibor overviewShibor rates from overnight to one year rates. The credit tightness in the shorter maturities has been alleviated by the People's Bank of China on Tuesday, but the longer maturities are not backing down yet. However, the curve remains so far inverted anyway – click to enlarge.



The bear market in Chinese stocks has taken an ominous turn for the worse in recent days, but the daily candle the Shanghai A-shares index has put in on Tuesday indicates that a short to medium term reversal could now be in train (confirmation in the form of follow-through buying must still be awaited however):



SSECThe Shanghai A-share index. Note the huge inverted hammer candle that has formed on Tuesday: after breaking to new multi-year lows, the market reversed after the PBoC issued a statement designed to calm the credit markets – click to enlarge.




The recent carnage in fixed income, emerging market currencies and stocks hints at the fact that too many market participants are carrying too much leverage. A great many speculators have recently been sitting on the same side of the boat. Obviously, the markets are therefore very vulnerable to any changes in liquidity conditions, or changing perceptions about future liquidity conditions.

The risk of a crash or a mini-crash must be considered higher than normal at present. If the current stock market correction turns into a multi-week distribution pattern, it could presage a very unpleasant autumn this year. Keep in mind though that from a technical perspective, it is almost impossible to differentiate distribution from consolidation patterns. One must always keep the bigger picture in mind when assessing such a pattern as it evolves.



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