Beatings Will Continue Until Morale Improves

The debate over the efficacy of austerity as part of the adjustment programs for economically suffering nations has long been the debate (and indeed a banner) of many with their own political or academic agendas.  But austerity has rarely been discussed in the context of monetary policy in the age of QE and negative rates (mostly real, but occasionally nominal). Yet there have been a couple of triggers to change that and the markets have spent the last 36 hours adjusting to the potential arrival of monetary austerity.

But there is austerity and then there is austerity. Just as there is "being restrained" and "being given a severe beating and sent tumbling down the stairs". TMM believe that the modus operandi is, simply: "the beatings will continue until morale improves".

1) FOMC beatings - There is no easy way out of QE. No matter how far off actual rate rises may be, the Fed statement and Bernanke's presser have dished out a severe beating to equity and bond holders, with commodity and gold bulls ending up as collateral damage.  Ironically the only beneficiary across every class has been the supposedly worthless paper currency called the US dollar, which has gone up against EVERYTHING.  The baton passing of global QE saw it move from US action, to European talk (no trousers), to Japan action  and when Japan appeared to drop it recently, the world hoped that the US would pick it up again.  But Ben ain't playing anymore and the baton is lying in the dirt, leaving the markets now sure that the game is over.  US don't want to inject as they feel that a) they ve done enough to bail out the world and b) they don't have to do it as much as the others, given the relative health of the US economy (here's looking at you, Mario).  The result of this particular beating is the particularly eye-watering move in many things, but, most notably, US real yields.



2) PBOC beating - Meanwhile China is not just refusing to play ball, but instead actively turning the screws.  The downturn in economic data would traditionally suggest that rate cuts or some other form of easing would be imminent, but rates are pushing higher with 1 week hitting a  rather unfortunate 30% intraday. Hopeful reasoning is that this is a short term technical situation and will pass (these things do happen occasionally in other money markets).  But TMM are of the opinion that this is a predictive "ducking stool" remedy being dished out by the authorities on quasi-financial institutions. Hold them under water long enough, let the weak drown, rescue those you want, who will be indebted to you politically.  And those that survive? Well, they can be branded as witches anyway should the political need arise. Whilst this may be sound domestic medicine in the long run, the timing, coinciding with a market worrying about global liquidity reduction, is far from helpful.  TMM won't stick any charts here, as there's been enough ink spilled on this particular subject, with charts galore.

3) Carry Monkey beating - Rather than a cause, this is as much an effect, but it's an effect that becomes a cause due to feedback loops, so though the beating may have started with a basic whipping from funding concerns, it has exploded into an orgy of autoflagellation.  Exiting through doors the size of diffraction gratings has left many trapped inside.  Now while carry monkeys have proliferated and have infested pretty much all corners of the market, juicy EM has been one of their favorite haunts.  It's, therefore, not too surprising that there's been a bit of a curious incident of "get me the hell out of this mess".



4)  Hedge fund beating - Consequences of consequences have seen EM hedge fund teams shown the door. Apocryphal stories of dedicated funds having most of their capital redeemed and the more public release of famous hedge fund managers from even more famous hedge funds shows that the beatings have become fatal to careers.  But, really, this is EM and the famous dictum of "you live by the sword, you die by the sword" very much applies.

While beatings can be expected to improve morale in the long-term in places like US and China, there is one area where they might just have the opposite effect: Europe.  Draghi should be sh*tting himself.  We are experiencing a tightening in global liquidity when Europe, with its staggering unemployment, lukewarm economic performance and dangerously low inflation, needs all the help it can get.  To add insult to injury, ECB-specific liquidity has been dropping steadily through a combination of LTRO repayments and rising autonomous factors.  We're now fast approaching the magical €200bn barrier, where it just might start affecting EONIA (a topic in and of itself).



Global liquidity abundance has been a huge assist to Europe, doing much of the heavy lifting, leaving Dr Aghi free to crow about the success of his OMT invisible bazooka.  As we have said before, the Europeans, once cattle prodded off their domestic agenda behinds, are capable of cobbling together rescue programs when they all feel jointly threatened, but being adaptive enough in policy between the extremes of "all OK" and  "end of the world"  has never been their forte.  As we have witnessed recently, the ECB appears to be contained within traditional fences policed by the Herr Weidmann and his buddies.  Interestingly enough, in the latest bout of EM-a-geddon, European periphery has been suffering somewhat with both Italy and Spain creeping towards 5% in 10y.  Whether this is enough, together with the latest headlines out of Greece and Cyprus, to produce some sort of a response, remains to be seen.

So Dr Aghi, the stock markets you last referred to as a sign of policy success have dumped, your peripheral bond yields are motoring higher again and the market is looking under the stones for euro specific woes (Greek politics, Cypriot banks, etc).

So whatcha going to do now, son?