THESIS 2011: Beggar-Thy Neighbor -(OPEN ACCESS - 37 Pages of 217) >> GO

Sign Up for 2012 Thesis -All first six chapters now available - FREE >> SIGN-UP

OCTOBER 2012: GLOBAL MACRO TIPPING POINT - (Subscription Plan III)

STALL SPEED : Any Geo-Political, Economic or Financial Event Could Trigger a Market Clearing Fall

As we reported last month, Global Economic Risks have taken a noticeable and abrupt turn downward over the last 60 days. Deterioration in Credit Default Swaps, Money Supply and many of our Macro Analytics metrics suggested the global economic condition is at a Tipping Point. Though we stated "Urgent and significant actions must be taken by global leaders and central banks to reduce growing credit stresses" nothing has occurred even after the 19th disappointing EU Summit to address the EU Crisis. Some event is soon going to push the global economy over the present Tipping Point unless major globally coordianted policy initiatives are undertaken. The IMF recently warned and reduced Global growth to 3.5%. This is just marginally above the 3% threshold that marks a Global recession. This would be the first global recession ever recorded. The World Bank is "unpolitically'projecting 2.5%. The situation is now deteriorating so rapidly, as to be impossible to hide anylonger.

MORE>> EXPANDED COVERAGE INCLUDING AUDIO & MONTHLY UPDATE SUMMARY

OCTOBER 2012: MONTHLY MARKET COMMENTARY (Subscription Plan II)

CURRENCY WARS: The Fighting Resumes - The "Race to the Bottom" Monetary Policy Programs Accelerates

THE "UNLIMITED" & "UNCAPPED" SALVO - The macroprudential policy strategy of Financial Repression reached a seminal point last month with the announcement of the Federal Reserve's "Unlimited" QEIII/Operation Twist and the ECB's "Uncapped" OMT. We have moved into the outer limits of Monetary Policy which now forces the accelerated currency debasement of the developed economies against its Asian & BRIC competitors. The 'race to the bottom' has entered another phase which now sets the battle lines for the next set of conflicts.

In case you haven't been keeping score, here is how the "Race to Debase" currently stands. (see right) MORE>>

MARKET ANALYTICS & TECHNO-FUNDAMENTAL ANALYSIS

OCTOBER 2012: MARKET ANALYTICS & TECHNICAL ANALYSIS - (Subscription Plan IV)

The market action since March 2009 is a bear market counter rally that has completed a classic ending diagonal pattern. The Bear Market which started in 2000 will resume in full force when the current "ROUNDED TOP" is completed. We presently are in the midst of of a "ROLLING TOP" across all Global Markets. We are seeing broad based weakening analytics and cascading warning signals. This behavior is typically seen during major tops.  This is all part of a final topping formation and a long term right shoulder technical construction pattern.  - The "Peek Inside" shows the detailed Technical Analysis coverage available this month.

MORE>> EXPANDED COVERAGE INCLUDING AUDIO & EXECUTIVE BRIEF

SEPTEMBER 2012: TRIGGER$ (Subscription - Plan V)

TRIGGER$ publications combine both Technical Analysis and Fundamental Analysis together offering unique perspectives on the Global Markets. Every month “Gordon T Long Market Research & Analytics” publishes three reports totalling more then 380 pages of detailed Technical Analysis and in depth Fundamentals. If you find our publications TOO detailed, we recommend you consider TRIGGER$ which edited by GoldenPhi offers a ‘distilled’ version in a readable format for use in your daily due diligence. Read and understand what the professionals are reading without having to be a Professional Analyst or Technician.

TRIGGER$ ALERTS (SPECIAL 2 WEEK TRIAL AVAILABLE - TRIAL - 2 UPDATES PER WEEK)

2 WEEK FREE TRIAL Our Inter-Issue Updates and Alerts are Included with a Monthly Subscription to Triggers. Between issue publication receive updates on Technical Analysis, Economic Analysis and anything note worthy for your trading and investing.

• Technical Analysis Alerts would include hitting potential Trigger Points, Pivots orsome progression that requires you immediate attention.
• Economic Analysis Updates alert of any fundamental economic events that may have impact on the markets and what to expect.
• Inter-Issue Updates and Alerts allow us to keep current with the markets and provide a more fluid and stable ongoing market evaluation.

Technical Updates occur twice a week, Alerts as the markets dictate. Sign-up now

	PART I - Understanding FINANCIAL REPRESSION
	PART II - FINANCIAL REPRESSION in Europe
	PART III - FINANCIAL REPRESSION in the US & ASIA
	PART IV - Preparations for FINANCIAL REPRESSION

Password: macro

EU BANK DEPOSITS - Lack of Confidence

Data Show Euro-Area Depositors Lack Confidence in EMU 10-26-12 Bloomberg Brief

ECB President Mario Draghi has had to shore up confidence in the sustainability of the euro area over the last year to halt the deterioration of the real economy, the deposit flight from the peripheral nations and the sale of euro-area debt by international investors.

Data recently released suggests he has so far failed to solve the first two issues though he may have successfully addressed the third. The euro-area economy still appears to be contracting. The advance reading of the composite PMI survey revealed on Wednesday a decline to 45.8 in October from 46.1 in September. That is the ninth consecutive month below 50.

Money supply data, released yesterday, suggests the recession is being exacerbated by a lack of credit extension. Loans to non-financial corporations, excluding sales and securitization, plunged by 20 billion euros in September, leaving the year-over-year rate of growth at minus 1.2 percent. The same data series for loans to households showed stagnation, with an expansion of only 0.6 billion euros, leaving year-over-year growth unchanged from the previous month at 0.9 percent.

The trends in deposit growth, excluding monetary financial institutions and central government, suggest the banking systems of Greece, Portugal and Spain have become increasingly reliant on central bank funding. The latest year-over-year growth rates for those countries measured minus 15.7 percent, minus 7.5 percent and minus 11.1 percent, respectively. Greece, which failed to report its reading for September with the other euro-area nations, experienced an additional decline in August. The level of deposits fell by 8.4 billion euros. Portugal showed no signs of stabilization in September. Deposits from that category fell 1.8 billion euros in the month. That was the 11th consecutive month of decline. The reading for Spain expanded for the first time in six months, though one month fails to suggest a change in trend. It rose by 13.2 billion euros. By contrast, policy makers appear to have stemmed the sale of bonds by international investors.

Foreign investors have purchased euro-area bonds for four consecutive months, according to balance-of-payments data released last Friday. They bought 11.5 billion euros of fixed-income instruments in August, 19.9 billion euros in July, 15.6 billion euros in June and 16.4 billion euros in May. The 12-month average of foreign purchases of those bonds still paints a weak picture. It rose to 0.8 billion euro from minus 2 billion euros in the previous month. Those figures compare with a recent high of 20.9 billion euros in June 2011 and a record of 49.5 billion euros in August 2007.

The weakness over the last year was driven by a large reduction in exposure to euro-area bonds prior to the completion of the ECB’s two three-year longer-term refinancing operations. Foreign purchases of debt registered minus 22 billion euros in January, minus 60.9 billion euros in December, minus 18.5 billion euros in November and minus 17.5 billion euros in October. The flood of liquidity from the ECB appears to have been ineffective in boosting the real economy and fully convincing depositors in peripheral countries of the long-term sustainability of the monetary union. It has at least stopped the exodus of international investors from the bloc.

SENTIMENT - Widening Gulf Between Consumer & Business

Wide Gap in Business, Consumer Sentiment Unsustainable 10-26-12 Bloomberg Brief

Recently, there has been a widening gulf between measures of business and consumer sentiment; business investment has slowed while consumer spending has accelerated. A gulf between two cyclically sensitive sectors cannot persist for long. Either consumers follow the corporate sector lower or the corporate sector begins to boost investment as it “buys-in” to the consumer recovery.

The improvement in consumer sentiment seems less a harbinger of future consumption and more a merging of sentiment and spending to their long-term relationship (Chart 1). Real disposable income is the principal determinant of spending in consumption models. Normally, stronger employment growth generates stronger disposable income. Because of the sizable slack in the labor market, this relationship is broken; it is still an employer’s market.

Commodity costs have chipped away at disposable income as well. In each of the last two months, headline consumer price index inflation has been running above core inflation by 0.5 percentage points, translating to a similar hit to income. As a result, consumers have drawn down savings to offset this. With gasoline prices now beginning to decline, consumers will be more likely to pocket the modest difference to replenish savings rather than spend it.

Forecasting investment spending is not particularly difficult. Capital spending tends to respond to an “accelerator effect;” thus, as growth rises, investment tends to rise faster. The opposite is true as the economy slows down. Equipment and software spending is only slightly above its prior 2007 inflation-adjusted peak even after the fairly rapid increase in business investment over the initial phase of the recovery. This implies that the increase in investment was largely about replacement or purchases that were delayed during the last recession.

In order for new capacity to be built, corporate expectations for future growth must improve. With Europe mired in recession for the foreseeable future and growth across emerging Asian economies slowly carving out a bottom, growth expectations are unlikely to shift higher. And while we have been critical of economists who have used “uncertainty from the fiscal cliff” as a catch-all for today’s economic woes, the cliff does create an incentive for companies to defer longer-term investment. Survey measures of capital spending point to an ongoing slowdown (Chart 2).

If companies are deciding to delay investment on machinery, it stands to reason that they are willing to delay investment on people too. In other words, the pace of hiring will slow. Hiring an employee, like investing in a machine, has an element of irreversibility. The cost of getting rid of a machine or a person is high once the decision has been made. So it makes sense for a firm to be confident about the outlook before making a commitment. Ahead of the fiscal cliff, optionality would imply a firm would bring down hiring as opposed to raise the rate of firing. After all, companies want to be ready if politicians are able to avert disaster by reaching an agreement.

Recall that in a typical month, some four million people are hired while some smaller amount of people separate from their job. Ironically, in a healthy labor market, we actually want to see the rate of hiring and firings increase as old jobs are replaced with new, presumably better-paying jobs. Today, the rate of hiring and separations remain low. Indeed, much of the recent improvement in employment has come from a decline in separations, not an increase in the level of hiring. Assume a seemingly benign scenario where hiring drops by 1 percent in a month while separations are flat; the net result would be a sub-50K jobs number. That is a reminder of how fragile the labor market recovery is. Slow hiring implies slow consumption.

Investors should tread carefully into year-end. Our analysis implies that the capital expenditures-sensitive companies in the equity market respond first; namely, in the industrials and information technology sectors. To some degree this has already happened. As employment growth begins to slow, which is the last thing the economy needs heading into the holiday shopping season, consumer discretionary stocks will probably come under increasing selling pressure. (Neil Dutta, head: U.S. economics, Renaissance Macro Research LLC)

FEDERAL RESERVE - Deliberately ignoring data on both growth and inflation

FOMC In Denial 10-25-12 Merk Investments

The FOMC has crossed the Rubicon: our analysis suggests that the Federal Open Market Committee is deliberately ignoring data on both growth and inflation. At best, the FOMC’s intention might have been to not rock the markets two weeks before the election. At worst, the FOMC has given up on market transparency in an effort to actively manage the yield curve (short-term to long-term interest rates):

• On growth, economic data, including the unemployment report, have clearly come in better than expected since the most recent FOMC meeting. FOMC practice dictates that progress in economic growth is acknowledged in the statement. Instead, the assessment of the economic environment is verbatim. Had the FOMC given credit to the improved reality, the market might have priced in earlier tightening. The FOMC chose to ignore reality, possibly afraid of an unwanted reaction in the bond market.
• On inflation, the FOMC correctly points out that inflation has recently picked up “somewhat.” However, it may be misleading to blame the increase on higher energy prices, and then claim that “longer-term inflation expectations have remained stable.” Not so, suggests an important inflation indicator monitored by the Fed and economists alike: 5-year forward, 5-year inflation expectations broke out when the Fed announced “QE3”, its third round of quantitative easing where the emphasis shifted from a focus on inflation to a focus on employment. This gauge of inflation measures the market’s expectation of annualized inflation over a five year period starting five years out, ignoring the near term as it may be influenced by short-term factors:

The chart shows that we have broken out of a 2 standard deviation band and that the breakout occurred at the time of the QE3 announcement. In our assessment, the market disagrees with the FOMC’s assertion that longer-term inflation expectations have remained stable. At best, the FOMC ignores this development because they also look at different metrics (keep in mind that the Fed’s quantitative easing programs manipulate the very rates we are trying to gauge here) or has a different notion of what it considers longer-term stable inflation expectations. At worst, however, the FOMC is afraid of admitting to the market that QE3 is perceived as inflationary.

ANALYTICS - PE's at Historically Elevted Levels

Chart of the Day 10-26-12

The chart below illustrates the price to earnings ratio (PE ratio) from 1900 to present. Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive. From 1900 into the mid-1990s, the PE ratio tended to peak in the low to mid-20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s), surged even higher during the dot-com bust (early 2000s), and spiked to extraordinary levels during the financial crisis (late 2000s). Since the early 2000s, the PE ratio has been trending lower with the very significant but relatively brief exception that was the financial crisis. More recently, the PE ratio has moved slightly higher. It is worth noting, however, that even with this recent uptick, the PE ratio still remains at a level not often seen since 1990.

PATTERNS - Credit Anticipates and Equity Confirms

What Do High Yield Bonds Know That No One Else Does? 10-26-12 Barclay's Research via ZH

"credit anticipates, and equity confirms"

HY bond spreads are pricing in considerably more pain than IG bond spreads - what do they know?

Wizened old market participants are often heard mumbling into their cups of green tea that "credit anticipates, and equity confirms" and so it is once again that the credit markets - fresh from the exuberance of endless technical flows, CLOs, and PIK-Toggles - has made a rather abrupt U-Turn in recent weeks. As Barclays points out, the ratio of High-Yield bond spreads to Investment-Grade bond spreads is its highest in three years as IG has been dragged lower by QEtc's impact on MBS and rotation up the spread spectrum. Typically, this kind of push would mean high-beta credit would outperform but far from it as cash bond markets have gapped out very recently. With call constraints (thanks to ZIRP) on high-yield bonds, the extreme price dislocation (given HY's inability to rally 'enough') will likely drag IG credit out - and that is a very crowded trade. Just one more unintended consequence from the Fed.

CDS markets are not moving as much - having short-squeezed recently and just reracking with stocks. Bonds - real money accounts - are in trouble here...if this differential remains... but it seems that the crap-end of the credit quality spectrum remains active with new issuance.

EUROPE - Perceived Reduction in Risk

10-19-12 Bloomberg Brief

Yields of the bailed-out euro-area nations of Greece, Portugal, and Ireland have dropped to their lowest levels since August 2011 as investors see a decrease in the probability of a break-up of the currency union. That may prove a false dawn if European leaders fail to reach agreement on a banking union, if Spain continues to delay applying for a bailout and if the next loan tranche of 31.5 billion euros for Greece is held back.

The yield on 10-year Greek bonds fell 41 basis points yesterday to 17 percent. That is the lowest level since August 2011. Portuguese 10-year yields dropped below 8 percent this week for the first time since March 2011 while Irish nine-year interest rates have slipped below 5 percent for the first time since August 2010. That increases the likelihood Ireland may return to the debt market by the end of this year while Portugal may be able to tap the market next year.

The euro area now has less than half the chance of a breakup by the end of 2013, according to bets made at Intrade.com yesterday, compared with 60.5 percent on Aug. 7. Credit default swaps for Spain have fallen 271 basis points in the last eight weeks to 370 basis points. That means it costs $271,000 less annually to protect $10 million of Spanish debt for five years.

EUROPE - IMF Projections

Euro-Area Debt-to-GDP Ratios Set to Peak Next Year 10-22-12 Bloomberg Brief

The euro area’s debt-to-GDP ratio rose 20.9 percentage points in four years to 87.2 percent in 2011, says Eurostat, which will give updated figures at 10 a.m. The IMF forecasts the ratio will peak at 94.9 percent next year. The nations with the highest ratios at the end of the first quarter were Greece, 132.4 percent, Italy, 123.3 percent, Portugal, 111.7 percent, and Ireland, 108.5 percent. Estonia, 6.6 percent, and Luxembourg, 20.9 percent, had the lowest.

Hardly news to anyone who has not been living in a Santorini limestone cave over the past 4 years, but as was reported overnight, official Euroarea debt to GDP (excluding trillions in contingent liabilities of course: these will only be considered in due course) rose in 2011 to a record 87.3% from 85.4% in 2010. What was also announced without much fanfare, yet oddly was not swept under the Friday 5 pm rug, was the news that Greek 2011 government debt/GDP was revised to 170.6% from 165.3%. That the number deteriorated in retrospect is no surprise: the issue is that increasingly all official economic recordkeeping in Europe has fallen under a Heisenberg blur: the second you spot a number it is no longer what it was a picosecond ago. The one agency that still does believe European numbers, a key reason why it has become a laughing stock even among "serious people", is the IMF.

As the chart above shows, even the IMF expects 2012 debt/GDP to keep rising into 2013, at which point it will gradually decline. Hint - it won't, as the sovereign is now the only source of incremental leverage in a world that has run out of money good assets, and in which the consumers and corporations are receiving ever less real cashflows that can be levered on an unsecured basis (thanks to the Fed's own real money dilutive policies).

ITALY - Bad Debt Continues to Increase

ITALY - Economic Update 10-16-12 Bloomberg Brief

The Bank of Italy may be forced to revise down its growth forecasts in its quarterly economic bulletin today as austerity measures implemented by Prime Minister Mario Monti contribute to curtailing consumer spending and prompt manufacturers, including Italy’s largest - Fiat - to curb investment. That may prevent the government bringing down the debt-to-GDP ratio starting in 2014, as previously forecast.

Italy is in its fourth recession since 2001 and the economy has contracted in 10 quarters since 2007. GDP fell 0.8 percent in the first and second quarters this year. Annual growth has averaged 0.1 percent in the past decade, compared with 1.5 percent in Spain. The Bank of Italy estimated in July GDP may contract 2 percent this year and 0.2 percent in 2013. That may be revised lower as the consumer confidence gauge, which averaged a record-low 86.2 in the third quarter, points to weak domestic demand.

Foreign trade is helping prevent a deeper contraction, adding almost 1 percentage point to growth in the first quarter as imports fell faster than exports. Sales of luxury cars in Italy may drop 47 percent to 593 vehicles this year from 1,116 in 2008 after the introduction of a luxury tax, IHS Automotive forecasts. The trade balance showed a record surplus of 4.49 billion euros in July. The nation was the seventhlargest exporter in the world in 2009, according to the WTO.

The growth of bad debt in Italy may accelerate as the recession continues. Banks’ bad loans rose about 16 percent in August from a year earlier, according to the Bank of Italy. While Italian bank shares have risen since ECB President Mario Draghi vowed in August to “do whatever it takes” to save the euro, banks remain weighed down by the poor outlook for economic growth and concern their bad debts may not have yet peaked.

While the Bank of Italy revealed yesterday total government debt fell in August for a second month to 1.976 trillion euros, the debt-to-GDP ratio may decline at a slower pace than forecast as a result of weaker growth. The IMF revised its estimate of the debt peak to 127.8 percent in 2013 from a forecast of 123.8 percent in April, followed by a drop to 120.6 percent by 2017. The debt ratio increased by 12.8 percentage points between 2008 and 2010 and is the second highest in Europe after Greece.

SPAIN - Credit Downgrades

10-19-12 Bloomberg Brief

Moody’s decision to leave Spain’s credit rating at Baa3, one notch above junk-bond status, may have helped bring down yields. The 10-year yield fell to a six-month low of 5.34 percent yesterday. Spain maintains its investment grade status with the three major rating agencies though that rating is the same as that for Azerbaijan, Colombia, and Namibia. The ECB will be willing to buy an unlimited amount of Spanish government bonds once Spain has applied for a credit line from the bailout fund.

UK - QE Extension Coming

BOE Likely to Extend Quantitative Easing by 25 Billion Pounds Next Month 10-17-12 Bloomberg Brief

The Bank of England may expand its 375 billion-pound quantitative easing program by 25 billion pounds in November, rather than the 50 billion pounds some economists have forecast, because of concern among some policy makers about the effectiveness of the stimulus.

The economy has been propped up by its central bank. The QE program is equivalent to about 24 percent of annual GDP and may have added as much as 3.75 percentage points to growth, based on the BOE calculation that the 200 billion-pound first phase of QE boosted growth by between 1.5 and 2 percentage points.

Even as today’s minutes may show the nine MPC members were unanimous in voting to keep QE on hold in October, the release is likely to reveal some members are open to further easing while others highlight inflationary pressures and shift their focus toward the government’s funding for lending plan to boost bank loans.

Chief Economist Spencer Dale and external MPC member Ben Broadbent have raised concerns a further extension may do more harm than good as inflation accelerates faster than growth. The BOE estimates inflation may have risen by between 0.75 percentage point and 1.5 percentage points as a result of the first round of QE. That implies inflation would have slowed below the 2 percent target by February this year without the program.

Dale and Broadbent voted against an expansion in July, saying bank-credit measures may offset the need for more QE. Financial Services Authority Chairman Adair Turner, a candidate to become the next governor of the BOE, has suggested quantitative easing may be less potent as investors anticipate central bank actions.

Still, current Governor Mervyn King has demonstrated his support for QE and the November inflation report is likely to show inflation undershooting the 2 percent target next year.

The first phase of QE may have lowered gilt yields by 100 basis points, the bank says. It may have also been partly responsible for a 47 percent gain in the FTSE 100 stock index in the first round of asset purchases. The BOE model shows asset prices rose 23.5 percent by the first quarter of 2010 as a result of the measure. The FTSE is up 11 percent since the second round of QE began on Oct. 6, 2011, according to Bloomberg Brief calculations.

The current round ends this month. The BOE bought 5 billion pounds of gilts a week at the start of the second round, dropping to 3 billion pounds a week since July. The bank is likely to be reluctant to increase the pace of purchases.

An extension in November is likely to run up to the February inflation report. That gives a 10 week-period, assuming a twoweek break over Christmas. A 25 billionpound program would reduce the pace of asset purchases to 2.5 billion pounds a week while 50 billion pounds would increase the weekly rate to 5 billion pounds, making the former more likely.

The policy rate, unchanged at 0.5 percent for 43 months - the longest period since 1951 - is likely to remain on hold for an extended period. Investor expectations for a rate increase mounted within six months of the end of QE1, after former policy maker Andrew Sentance voted for a rise, followed by two other members a year after the end of the first round.

A double-dip recession soon brought unanimity to the rate path and policy makers may be reluctant to consider an increase any time soon.

EU - "Muddle" Stage has ended. "Crisis" Stage has Begun

"The Clock Is Running, The Cash Is Almost Gone And Make-Believe Will No Longer Suffice" 10-20-12 From Mark Grant, author of Out Of The Box via ZH

“As long as there are individual national budgets, I regard the assumption of joint liability as inappropriate and from our point of view this isn’t up for debate...The Spanish government will be liable for paying back the loans to recapitalize its banks. Plans to give the Euro rescue fund the power to inject cash directly into banks won’t be made retroactive.”

                 -German Chancellor Merkel

EU SUMMIT OUTCOME

• Cyprus needs money, Spain needs money, Portugal probably needs more money and Greece is just about out of money.
• The summit was held, the meeting is over and the worth of any accomplishments is about at Zero as the only agreement was a plan to have a plan to deal with bank supervision.
• While all of this wrangling continues the tone at the summit was no longer the nicey-nice repartee of past meetings.
• This is not an inch forward, this is not a millimeter forward; this is quicksand where they are all stuck as both money and time run out as the Socialists scream for alms while the landed gentry, utilizing head fakes and other polite deceptions, refuse to provide it.
• The clock is running, the cash is almost gone and make-believe will no longer suffice.
• The crisis phase, in my opinion, has been entered

“I would say that we have entered the crisis stage of Europe now. We have a stand-off between France and the southern nations, the troubled countries, in one corner and Germany, Austria, Finland and the Netherlands in the other. The last summit yielded nothing and worse than nothing because the two camps are worlds apart and sharply divided. They couldn't agree on the banking supervision issue. They have no agreed upon path for Spain, for Greece, for Cyprus, for Ireland or for Portugal. Germany has drawn a line in the concrete concerning legacy sovereign issues, legacy bank issues and Ms. Merkel has stated quite dramatically that Germany will not allow the new ESM to be used for old problems and that the individual nations will have to foot the bill for them. The "Muddle" is over in my opinion and the "Crisis" has now begun. The long, long road of "put it off" has reached its conclusion and there is no agreement and no compromise on how to proceed. We have finally reached the "Danger Zone" and I advise you to note the change!”

'PUBLIC SECTOR' INVOLVEMENT EXPOSED

The “Public Sector Involvement” trick was the ECB handing money to the Greek banks who then bought private sovereign debt issued by Greece, got the bonds, then pledged the bonds back to the ECB and got their money back.

IMF POSITION

The IMF has shorted the fuse box and they want the EU or the ECB to take an “Official Sector Involvement” hit which you may translate into “Debt Forgiveness” which would probably be the end of the governments in more than one Northern European nation.

Europe then is faced with writing off the debt of Greece or having the ECB take the hit which would mean a recapitalization of the ECB as they only have $18 billion of paid-in capital or the IMF refusing to fund the next tranche of Greek aid which means that the European Stabilization Funds would have to pick up the bill and that local politics may collapse without the IMF’s participation.

SPAIN

In the case of Spain it is not Mr. Rajoy “assessing the situation” but a very concentrated effort to get “Euros for Nothing and Conchitas for Free.” Not only does Spain have several of its integral regions calling for succession but it has a regional debt problem exceeding $50 billion in my estimation and a bank problem that is several multiples of that.

The Oliver Wyman bank stress tests had all of the validity of a three toed sloth residing in your living room as there was no verification, no audits and nothing but garbage pressed into the shredding machine and so “garbage in is garbage out” and let’s not deceive ourselves that it was anything else. Once again, one more time, we have an example of a country trying to get anyone else, everyone else, to pick up the bill because they cannot afford it. Germany, in the meantime, says that Spain does not need the money and so the bills go unpaid and the crisis worsens.

LEGACY LIABILITIES

Germany has been fairly clear. The new ESM fund will not pick up the check and it is up to each country to pay for their own past problems.

• You may translate this piece of jargon into a “No” to Ireland that the ESM will not pick up the bill for the Irish banks and the same response for Spain.
• This new German definition puts Portugal, Greece, Spain and Ireland back at square one and effectively closes the door on any further negotiations.

EU Leaders Agree On Bank Supervisor 10-19-12 From GoldCore Gold Bullion via ZH

“Our goal is banking supervision that’s worthy of the name, because we want to create something that’s better than what we currently have,” Merkel told reporters.

Germany and France argued contentiously about the timing.  Berlin has insisted the supervisor be effective before the ESM can begin cash injections into Spanish banks, those transactions are not foreseeable to occur until the latter half of the year, around the time of Germany’s national elections.

Angela Merkel said it would take more than a few months before the supervisor was fully effective and direct bank recapitalisation could be considered.

However, the agreement appeared to upset German finance minister Wolfgang Schaeuble's efforts to delay and limit the scope of European banking supervision.

Germany has been averse to see its politically sensitive Savings and Cooperative banks come under outside supervision. It rejects any joint deposit guarantee under which wealthier countries might have to underwrite banks in poorer states.

The final deal came after the leaders of France and Germany held a private meeting after numerous public clashes over greater EU control of national budgets.

A French government source said the European Stability Mechanism (ESM) could start recapitalising troubled banks as early as the first quarter of 2013, but a German source said it was "very unlikely" to happen so soon.

Dr. Merkel earlier demanded broader authority for the executive European Commission to veto national budgets that breach EU rules. She said a December EU summit would make decisions on these issues of closer euro zone economic governance.

The point when the ECB will effectively become the bloc's banking supervisor is important because it would open the way for the euro zone's bailout fund to inject capital directly into troubled banks, without adding to their sovereign governments' debts.

SPAIN - Regional Bailout Bailouts a Big Problem

Spain's Regional Bailout Fund: A Drop In A Bucket Of Insolvency 10-20-12 Bloomberg Breif via ZH

It will come as no surprise to many that the initial size estimates of Spain's regional bailout fund are now being questioned. The government is now 'analyzing' whether the EUR18bn 'temporary' bailout fund needs to be increased. In a word - Yes! As this chart from Bloomberg Briefs shows, the size of the 'help' is pittance compared to the debt-loads of Catalonia alone (which recently sought secession). As Bloomberg's Niraj Shah notes, Spanish regional elections in the Basque country and Galicia take place on Sunday, followed by a ballot in Catalonia on Nov. 25. Prime Minister Mariano Rajoy may prefer to seek a bailout after the elections as a series of defeats for his People’s Party could exacerbate investor concerns about the government’s ability to control spending and revenue and bring down the deficit. Perhaps our 'context' update on Spain's situation last night was rather prescient after all?

In what seems like a remarkable coincidence:

• Spanish region of Asturias will seek EU261.7m from central govt’s rescue fund for regions

Source: Bloomberg Briefs

1987 Deja vue - QEfinity Working Psychologically the same as Portfolio Insurance

Is Our Version Of The 1987 "Can't Lose" Paradigm Melting Down? 10-24-12 John Taylor, Chairman of FX Concepts

Over the past few days Bill Gross at PIMCO made some noise within the financial community comparing the “Bernanke Put”/QE-infinity currently propping the markets to the mid-1980’s concept of ‘portfolio insurance’. Of course, we all know the end result of this failed attempt at investment utopia as portfolio insurance was a primary cause of the 1987 stock market crash for both psychological and practical reasons. We agree in principle with Mr. Gross, and actually made a similar argument last year ahead of the summer meltdown in pro-risk assets. We find it funny and a little sad that so many professional investors now scoff at the notion. Is this time really that different? Is it really that far fetched to believe that the “can’t lose” aura that propelled equities higher over the first half of 1987 is precisely the exact same one that has seen pro-risk markets levitate ever higher since David Tepper made his infamous “win-win” speech on CNBC way back in September of 2010? However, here we are more than two years later and only one of Mr. Tepper’s “wins” has actually come to fruition as despite policymakers best efforts their impact is clearly having less and less impact. How long will free market forces allow this to go on? How long did institutional equity investors give firms like LOR (Leland O'Brian Rubinstein Associates, Inc) in those dark days of October 25 years ago before throwing in the towel in their trust of portfolio insurance and admitting they were not invulnerable investors? Are the markets today heading towards a similar revelation?

The price action over the past few weeks in the wake of the markets getting more from the Fed than they could have ever expected heading into an election is a clue that the times indeed could be a changing. The 1987 paradigm underwent a similar period of choppy trade before melting down. Of course, crashes by their nature are a rare breed and the probability of one occurring is astronomically low. That said, should the S&P 500 fail to hold the 1400 level over the next few days (especially on a closing basis) we wouldn’t wait around too long in anticipation that the modern day version of LOR will save the day. The chart makes it clear that quantitative easing has diminishing returns. Soon they could be negative.

OUR PREVIOUS PORTFOLIO INSURANCE ANALOGY

CHINA - Global Impact of China's Slowdown

Global Economy: The Global Impact of China's Slowdown 10-17-12 Financial Times

Click to Enlarge

CHINA - An Implicit Social Contract

China’s Political Transition Likely to Leave Economic Policy Unchanged 10-15-12 Bloomberg Brief

China’s new political leaders will probably continue to rebalance the economy to maintain a sustainable pace of growth.

Tracking the looming leadership transition requires an understanding of the relationship between the National People’s Congress and the Communist Party. The NPC represents the highest authority in the state, while the real power lies with the party, which dominates almost every branch of government.

The NPC comprises 2,987 delegates who approve decisions ranging from appointing the premier to approving the five-year plan. The NPC meets each March, while the NPC standing committee operates year-round. With a membership of close to 82 million, the party is led by the Central Committee, with the Standing Committee as the power core.

The party runs a five-year national congress with the Central Committee meeting several times in between. The 18th Party Congress consists of 2,270 representatives and delegates who will participate in the National Congress of the Chinese Communist Party in October. In this round, the congress will elect a new party leadership including members of the Central Committee, which itself con-sists of the Politburo, Secretary-General and Central Military Affairs Commission.

Under the NCCCP, there is a Central Commission of Discipline & Examination, technically independent from the Politburo. The party has its own set of rules and institutional framework that can ensure an orderly transition. The incoming leadership will consist of seasoned provincial governors and party functionaries with better educational backgrounds, on-thejob training and experience in local areas.

There is also an intrinsic policy consistency institutionalized via the five-year plans. Vice Premier Li Keqiang was given the task of leading the draft of the plan. Once he becomes premier, the 12th five-year plan may be continuously implemented, if not more vigorously. This means economic policy until 2015 is unlikely to change. Even with significant structural imbalances, we believe the party will be forced to push reforms to maintain sustainable growth.

This is largely driven by an implicit social contract that the party needs to deliver continuous improvement in the population’s well-being.

Otherwise, that contract will be increasingly challenged. This consideration will determine whether the government is able to tolerate a hard landing, especially given that policy room for maneuver is still large and the state is well endowed. That is the rationale behind our call.

We think the chances of a hard landing are low in the short term. A 7.6 percent pace in the second quarter still exceeds the target growth rate of 7 percent. In the medium term, we are optimistic about economic rebalancing and sustainable growth. Since the start of the plan in 2011, there has been a deliberate effort to improve the quality of growth.

The policy priority will be a gradual evolution from an investment-led growth model to a consumption-led model.

Indeed, the authorities have made a decision to achieve a slightly lower though more balanced growth path. Even so, average growth of 7 percent means the size of the economy may double in 10 years.

CHINA - Declining Reserve Accumulation

Central Banks’ FX Reserve Growth Slows 10-16-12 Bloomberg Brief

The sharp slowdown in the accumulation of foreign-exchange reserves by the People’s Bank of China has removed a pillar of support from the euro versus the U.S. dollar.

The Chinese central bank reported over the weekend its holdings of foreign currencies rose to $3.29 trillion in September from $3.24 trillion in June. The monetary authorities refrained from releasing a monthly breakdown this quarter. The $50 billion increase equates to about $28 billion in fresh reserve accumulation after the data is adjusted for valuation effects, according to Bloomberg Brief estimates.

The 12-month sum of Chinese reserve accumulation, adjusted for valuation effects, was the lowest since March 2004, excluding the readings from August and July when the monthly breakdowns were withheld. It registered $108.7 billion at the end of the latest reporting period versus $151.4 billion in June and $538.8 billion a year earlier.

That has had a significant effect on global reserve accumulation. The 12-month sum, adjusted for valuation effects, for the 10 countries with the largest foreignexchange reserves declined to $601.5 billion from $752.5 billion at the end of the previous quarter and $1,154.4 billion a year earlier.

Regression analysis suggests EUR/USD has been strongly influenced by demand from foreign central banks as they diversified newly accumulated reserves. Regressing the log of the 12-month sum of global foreign-exchange reserves on the log of EUR/USD produces an r-squared - the percentage of the total variation in the dependent variable explained by the independent variable - of 0.8, using data from the start of 2002, when global reserve growth began to surge.

Many emerging-market countries that attempt to maintain exchange-rate stability intervene almost exclusively versus the U.S. dollar. They hold only about 60 percent to 65 percent of their reserves in the American currency and 25 percent to 30 percent in the euro. That eventually requires sales of the former and purchases of the latter, putting upward pressure on EUR/USD.

The regression model implies the exchange rate should have gradually slid to 1.26 by the end of September from 1.43 a year earlier and a high of 1.53 in May 2010, though the European sovereign debt crisis and shifts in expectations for the interest-rate differential between the euro area and the U.S. have contributed to deviations from that level.

The fall in reserve growth leaves EUR/ USD increasingly vulnerable to the resurgence of the sovereign debt crisis. The difference between the 10-year yield on the government bonds of Spain and on those of Germany has widened to 434 basis points since hitting a recent low of 400 basis points on Sept. 12.

The exchange rate will also probably be increasingly sensitive to expectations for a prolonged period of loose monetary policy in the euro area. The two-year swap rate for the currency union is only about 6 basis points above the record low of 42 basis points hit three weeks ago. It has fallen by 104 basis points over the last year. The decline has dragged the difference between it and its counterpart for the U.S. to 11 basis points from 86 basis points one year ago.

The medium-term outlook for the European currency versus its U.S. counterpart continues to weaken.

CHINA - Slow Recovery Through 2013

China Data Point to Slow Recovery Through 2013 10-22-12 Bloomberg Brief

• China’s economic data for September point to a potential turnaround in fourth-quarter growth.
• Maintaining upward momentum next year is likely to be difficult, given the substantial slack that remains in the Chinese economy.
• Data released on Oct. 18 showed China’s economy grew 7.4 percent year-on-year during the third quarter, the seventh consecutive period of decelerating growth.
• Monthly indicators suggest this may be slowest quarter of 2012.
• Evidence of a nascent rebound was widespread in other data released over the past two weeks, starting with export growth, which exceeded analysts’ estimates at 9.9 percent.
• Trade gains were due primarily to increased orders from the U.S.ahead of the holiday season, tax breaks for exporters, weather-related shipment backlogs and a favorable base effect.
• On the surface, loan data disappointed analysts’ forecasts by nearly 80 billion yuan. This doesn’t tell the entire story. Total social financing, which includes nonbanking funding channels such as corporate bond issuance, has grown much faster, showing more resilience than loan data may imply.
• China’s corporate-bond market is booming with bond issuance up 85 percent in 2012 through September.Previously, many corporations have raised funds through traditional loan markets.
• Chinese industrial production, which is a close proxy of real GDP growth, rebounded 9.2 percent year-on-year in September, climbing from a 2012 low of 8.9 percent a month earlier.
• Year-to-date fixed-asset investment growth also exceeded analysts’ expectations in the month, at 20.5 percent, which comes on the back of the government’s fiscal stimulus measures.
• Increased infrastructure investment will likely continue to help buoy industrial production growth. This may pick up slack from the manufacturing sector, helping to support fourth-quarter GDP growth.
• China’s recovery depends on a combination of exports and credit-led investment to offset relatively weak final demand. If left unchecked, this trend will worsen the imbalance in the already lopsided economy.
• China is likely to see a jagged bottom to growth through at least the end of 2013, with range-bound expansion near the current rate. This relatively slow growth may be driven by additional infrastructure spending as the country urbanizes.
• About 50 percent of its population is in cities, which is 25 to 30 percent less than in developed countries such as the U.S. and Japan.
• The government is likely to unveil policies to bolster final demand by raising incomes and increasing the willingness of Chinese consumers to spend their $4 trillion in savings, which is double the U.S. total.
• Accommodative policy announcements may be more frequent after the country’s once-a-decade leadership transition. The 18th Party Congress is scheduled to begin on Nov. 18.
• A modest rebound with infrastructure investment as the engine may provide an opportunity for the Chinese government to implement critical reforms, including interest-rate liberalization. This may boost consumption and rebalance the economy, reducing the risks of asset bubbles.
• A slow recovery may also bode well for China’s property and construction sectors. The government may be unable to mitigate modest property gains without potentially derailing the economy, given the sector’s heavy weighting.
• Another potential scenario for China’s economy — which is currently much less likely — is a hard landing, in which government policies are unable to overcome the headwinds of weak external demand, overcapacity in domestic manufacturing and a potential rise in non-performing loans, following a 135 percent surge in bank lending since the start of 2008.

CHINA - Possible Interest-Rate Liberalization

PBOC’s Shift to Reverse Repos May Open Door to Interest-Rate Liberalization 10-17-12 Bloomberg Brief

China auctioned reverse-repurchase contracts just three times in 2012. Since then, excluding China’s Golden Week holiday, reverse-repo auctions have taken place for 16 consecutive weeks.

The reason behind this shift in policy may be twofold.

First, unlike reserverequirement reductions, reverse repos provide a temporary means of injecting liquidity into China’s financial system without necessarily stoking gains in the country’s already inflated property sector.

Second, the PBOC may be trying to pave the way for future interest-rate liberalization.

The central bank took steps in this direction when it made two asymmetric rate cuts earlier this year. Allowing banks to set their own lending- and deposit-rates would neutralize one of the PBOC’s main policy tools. As an alternative, policy makers may choose to target China’s interbank rates, which include the seven-day repurchase rate.

Historically, this rate has been very volatile, swinging between 7.7 percent 2.2 percent this year. In conducting more aggressive openmarket operations, the PBOC may be in part attempting to reduce this volatility and test the waters in terms of their ability to eventually target interbank rates.

CHINA - Has Caught the Gold Bug big time!

Chinese Gold Imports Through August Surpass Total ECB Holdings, Imports From Australia Surge 900% 10-21-12 Zero Hedge

First it was more than the UK. Then more than Portugal. Then a month ago we said that as of September, "it is now safe to say that in 2012 alone China has imported more gold than the ECB's entire official 502.1 tons of holdings." Sure enough, according to the latest release from the Hong Kong Census and Statistics Department, through the end of August, China had imported a whopping gross 512 tons of gold, 10 tons more than the latest official ECB gold holdings. We can now safely say that as of today, China will have imported more gold than the 11th largest official holder of gold, India, with 558 tons.

Yet despite importing more gold than the sovereign holdings of virtually all official entities, save for ten, importing more gold in July than in any month in 2012 except for April, importing more gold in 8 months in 2012 than all of 2011, and importing four times as much between January and July than as much as in the same period last year

with the status quo cartel in desperate need of China stepping up its monetary easing, and jumping right into the race to debase, which is absolutely critical to halt the plunge in tech company revenues and earnings, any interim slowdown in purchases is merely a springboard for even more purchase in the future once inflation does come back to China with a bang.

From the South China Seas:

Fung expects gold imports on the mainland to stay soft this month as prices have continued to remain high.

"However, gold consumption is likely to climb again in the fourth quarter, a traditionally peak season when Chinese people buy gold jewellery for weddings and presents," he added.

All rhetoric aside, one unspinnable aftereffect of China's relentless appetite for gold comes from a different place, namely Australia, where gold just surpassed coal as the second most valuable export to China. From Bullionstreet:

Australia's gold sales to China hit $4.1 billion in the first eight months of this year as it surged by a whopping 900 percent.

According to Australian Bureau of Statistics, the yellow metal became the second most valuable physical export to China, surpassing coal and only behind iron ore.

The unprecedented jump in gold sales, along with continued acceleration of export revenues for other commodities led by coal, up 80 per cent to $4bn, caused total exports to China to rise by 10.7 per cent for the year to August, the Bureau said.

Perth Mint supplied most of the gold to China through a variety of banks.

Analysts said Chinese buyers are hoarding the precious metal amid a slowing economy, property-buying restrictions and uncertain financial markets as its central bank increases its holdings.

China's foreign currency reserves of gold are low and its move to build them up will provide an important base demand for gold, they added.

In other words, take the chart above, showing only Chinese imports through HK, and add tens if not hundreds more tons of gold entering the country from other underreported export channels such as Australia. One thing is certain: China no longer has any interest in buying additional US Treasurys. What it does have an interest in is up to readers to decide.

CHINA - Shadow Banking

'Shadow Banking' In China 10-17-12 authored by James Parker, originally posted at The Diplomat, via ZH

Xiao Gang, Chairman of the Bank of China (one of the “big 4” banks the Chinese government controlls), published an interesting op-ed in China Daily on October 12th.  Although some may consider the China Daily the English-language mouth piece of the Chinese government, its op-ed columns often hold some genuinely interesting discussions and analysis of events and affairs in China.

In this op-ed, Xiao Gang takes on the issue of “shadow banking,” that hazy and complicated area of finance that in the developed economies is often associated with hedge funds. As discussed in greater detail below, things are slightly different in China itself.

Chinese finance is undergoing dramatic changes which are not yet widely understood. Historically (mainly before 2008), the vast majority of lending in China was done by the normal banking sector in the form of loans.  The process was a cornerstone of the government’s control over the economy.  The vast majority of banks in China are controlled by the government, so the “who and when” of lending was firmly in the hands of China’s leaders.

The years 2008/9 will be remembered as watershed years for Chinese finance. The financial crisis rippling out from the United States caused a dramatic reaction by China’s policymakers as exports collapsed.  Two key trends developed.

The first is fairly obvious; a wave of credit was unleashed and has continued since that time as China’s growth became more and more reliant on investment and the lending needed to support it.  This exacerbated the fears that an unbalanced Chinese economy is undergoing an unsustainable build-up of debt, much like Japan’s did during its boom years.

The second trend came later and is much harder to pin down. In late 2009 and 2010, as policymakers began to worry about the credit boom, inflation, a property bubble, and overcapacity, they attempted to put a brake on lending activities.  The reduction in formal lending forced an economy addicted to credit to increasingly turn to less usual financing channels – some of them in the “shadow banking” sector.  This trend really began taking off near the end of 2009 and has generally increased ever since. The latest data (September 2012) shows that these non-normal bank credit channels now account for a substantial amount of the financing going on in the economy.

Taking these two trends together – an economy relying increasingly on debt creation for growth, and that debt creation becoming more and more complicated and obscure, it is easy to see why so many officials and analysts are worried. 

Formal banks are key players in the “shadow banking” system, helping to create, fund and market wealth management products to their customers – products which are riskier than deposits but which potentially pay a healthier return to investors.  Their goals are obvious, if credit taps are shut off, many borrowers who are not able to repay loans will default, hitting the banks’ formal loan books hard. Hence the shadow and formal banking systems have become intertwined, and the transmission of problems from one to another, or a negative feedback loop between the two, are not hard to imagine.

As Mr. Xiao bravely states in his column, it is paramount that the government increases its regulation of the “shadow banking” sector. The difficulty is that shadow banking is just one of the main economic dilemmas facing China at present: Is an economic rebalancing necessary? Is pushing through an economic rebalancing worth than pain of slower growth?

CHINA - China' Political Transition & Ogoing Emergence as a Super Power

China, China, Everywhere; But Not A Drop Of QE To Drink 10-21-12 Zero Hedge

With this evening's news that Japan and the USA are 'backing down' from a planned 'joint security drill' to recapture a remote 'uninhabited' island in Okinawa province (apparently amid concerns of backlash from Beijing); and chatter of the PBoC gauging demand for reverse repos (instead of flooding us with newly minted Yuan which everyone believes is just the remedy), it seems very clear who the world's super-power is (militarily and economically). Furthermore, as The Diplomat explains, multi-faceted challenges to the new leadership — possible economic stagnation, social unrest, elite disunity, and a revival of pro-democracy forces — will make it more distracted and less politically capable to maintain discipline on numerous actors now involved in China's foreign policy.  The effects of such accumulated internal woes, while not necessarily aggressive, are certain to be an erratic pattern of behavior that both worries and puzzles China's neighbors and the rest of the international community.

"Be careful what you wish for.  A weaker China could nevertheless
inflict serious damage to the world order."

On China's Political Transition (via Damien Ma's interview with Foreign Affairs Magazine):

Via Minxin Pei of The Diplomat: Sorry World, What Happens In Beijing, WON'T Stay In Beijing

One of the questions on the minds of most China watchers these days is how Beijing will behave externally when it faces a far more difficult internal environment.  Of the well-recognized challenges China will encounter in the coming years are its deteriorating economic dynamism, a structure of decision-making with diffused power and uncertain authority, rising nationalism, growing demand for political reform, and widespread popular disenchantment with the status quo.

In totality, these internal difficulties will reduce the resources available to maintain and expand China's influence around the world, constrain the Chinese military's ability to accelerate its modernization, and make Chinese leaders more reluctant to assume greater international or regional responsibilities.  Most worryingly, erratic behavior driven by a mixture of lack of leadership experience and political security will most likely mark Beijing's foreign policy conduct in the coming years.

Given the high profile China has assumed in projecting its economic influence around the world, particularly in resource-rich developing countries, one might dismiss as fanciful the suggestion that looming economic hardships at home may severely limit Chinese capacity for establishing itself as an economic alternative to the West.  But a closer look at how China has been funding its investments in Africa, Central Asia, and Latin America would show that such investments are not only expensive, but also very risky.   The grants and concessionary loans China has made to various countries to gain their goodwill have totaled at least tens of billions of dollars (these are reported figures; nobody knows the real amount).  They were made when China enjoyed double-digit growth and had ample cash to throw around.

But as the Chinese economy decelerates and less money flows into Beijing's coffers, the Chinese government will obviously have less funds to sustain such economic and diplomatic offensives.  Politically, continuing a lavish foreign aid program when its own people are struggling will surely arouse fierce criticisms from the public.  Not too long ago, the Chinese Foreign Ministry was denounced bitterly when it was revealed that China donated safe school buses to Macedonia when its own schoolchildren have to ride in unsafe vehicles.

China's risky foray into developing countries will face another hurdle.  Most of the big-ticket projects China has supported in these countries are funded by loans from China's state-owned banks.  Based on previous experience, many of these projects are likely to fail.  As Chinese banks are themselves expected to struggle to deal with a wave of non-performing loans at home, the last thing they want to do is to keep funding these high-risk, low-return projects abroad.  So it is a foregone conclusion that a weaker China at home means a less influential China abroad.

Another obvious casualty is China's much-vaunted campaign to project its "soft power."  Internally called "dawaixuan" (big external propaganda), this campaign has led to a huge expansion of official Chinese media presence around the world.  Xinhua, for example, has launched its English-language television news service.  The nationalist tabloid, Global Times, has added an English edition.  The official China Daily has regularly placed high-priced full-page ads in The New York Times, The Wall Street Journal, and The Washington Post.  Judging by the worsening of Chinese image around the world, this campaign has been a flop.  When Beijing's propaganda chiefs get their new austerity budgets in a year or two, it is hard to imagine they will decide to throw good money after bad.

China's waning economic, cultural, and diplomatic influence caused by dwindling financial resources will not be the only victim of its internal difficulties.  The People's Liberation Army, which has enjoyed double-digit growth in its budget for nearly two decades, will probably have to fight harder for its share of a smaller pie.  The pace of Chinese military modernization could slow down.  To Chinese neighbors, this development will reduce their anxieties.  Washington, of course, might also breathe a sigh of relief.  However, such an outcome is by no means certain.  It is conceivable that the PLA may cite the American "pivot," and territorial disputes with Japan, the Philippines, and Vietnam, to push for more defense spending.  Should the PLA succeeds in making its case, it will have to pay a high price because the Chinese military will be competing with other equally powerful political interests, such as state-owned enterprises, the bureaucracy, and local governments, for dwindling budgetary outlays.

Some Western observers may welcome such mounting woes inside China since they will diminish Chinese influence and reduce the "China threat."  But be careful what you wish for.  A weaker China could nevertheless inflict serious damage to the world order.

One obvious casualty of China's internal weakness will be Beijing's reluctance to play a more constructive role in global and regional affairs.  Cynics might say that Chinese leaders, even when times were good, talked more than they actually delivered.  While some of such criticisms were true, a more objective assessment may show that Beijing has, on occasion, played a more positive role than it has received credit for, such as during the East Asian financial crisis in 1997-98 and in its push for regional free trade.  Even on the Korean Peninsula, it has made Pyongyang behave less belligerently since early 2011 (after failing to do so in 2010).

On Iran and Libya, China has also chosen not to be a spoiler.  On global climate talks, Beijing's evolving negotiating positions have also improved considerably.  However, even China's modest contributions to the world order could be at risk if its leaders, so distracted by domestic crises, decide not to make any contributions at all.

A piece of conventional wisdom about a weaker China is that it will be more belligerent because its leaders will have the incentives to divert domestic attention with appeals to nationalism and a more aggressive foreign policy. This is a simplistic understanding of how Beijing behaves.  To be sure, such temptations do exist, and one can expect China's new leaders, hobbled by inexperience and lack of political capital, to pander to nationalist sentiments.  But Chinese leaders are no fools.  Talking tough is one thing, but acting tough is another.   When we examine Chinese foreign policy behavior in the last sixty years, we will find that Beijing, for all its bombastic rhetoric, actually has picked its fights carefully.  Acutely aware of their own limited military capabilities, Chinese leaders have avoided getting into fights they would be sure to lose.

If we apply this insight to speculating about Chinese external conduct in the coming years, the only thing we are certain about is uncertainty.  The confidence derived from a strong economy and relative domestic stability will be gone, and so will be the self-imposed restraints on jingoistic rhetoric.  Multi-faceted challenges to the new leadership — possible economic stagnation, social unrest, elite disunity, and a revival of pro-democracy forces — will make it more distracted and less politically capable to maintain discipline on numerous actors now involved in China's foreign policy.  The effects of such accumulated internal woes, while not necessarily aggressive, are certain to be an erratic pattern of behavior that both worries and puzzles China's neighbors and the rest of the international community.

JAPAN - Exports Continue To Tumble

Japan Exports Tumble 10% as Maehara Presses BOJ to Ease 10-22-12 Bloomberg

Japan’s exports fell the most since the aftermath of last year’s earthquake as a global slowdown, the yen’s strength and a dispute with China increase the odds of a contraction in the world’s third-largest economy.

Shipments slid 10.3 percent in September from a year earlier, leaving a trade deficit of 558.6 billion yen ($7 billion), the Finance Ministry said in Tokyo today. The median forecast in a Bloomberg News survey of analysts was for a 9.9 percent export decline. Imports rose 4.1 percent.

Economy Minister Seiji Maehara pressed the Bank of Japan for more action yesterday, saying the nation is “falling behind” in monetary stimulus and is at risk of another credit- rating downgrade. The BOJ today cut its view of eight out of nine regional economies while Taiwanese unemployment rose to a one-year high, underscoring weakness across Asia after China’s third-quarter growth was the slowest since 2009.

“There’s a high chance that Japan’s economy will have two consecutive quarters of contraction through December,” said Yoshimasa Maruyama, chief economist at Itochu Corp. in Tokyo. “The slump in advanced nations is spreading to emerging economies.”

The yen weakened 0.6 percent to 79.78 per dollar as of 5:57 p.m. in Tokyo on speculation that the central bank will expand monetary stimulus. The currency’s decline pushed the Nikkei 225 Stock Average to a 0.1 percent gain, reversing losses of as much as 1.5 percent, by improving the outlook for exporters.

China Spat

The decline in shipments, exacerbated by a spat with China over islands in the East China Sea, was the biggest since May last year, when the country was rebuilding supply chains wrecked in the March earthquake and tsunami.

Shipments to China, the nation’s largest export market, slid 14.1 percent from a year earlier. Exports to the European Union fell 21.1 percent, while those to the U.S. rose 0.9 percent. Auto shipments to all markets dropped 14.6 percent.

In a speech in Tokyo today, BOJ Governor Masaaki Shirakawa vowed to conduct “seamless” monetary easing as the Japanese economy is “leveling off.” The banks’ quarterly regional report for October contained the most downgrades since 2009, with only Tohoku escaping because of reconstruction spending in the area hit hardest by last year’s earthquake.

Earlier this month, the International Monetary Fund’s Deputy Managing Director Naoyuki Shinohara said in an interview that the BOJ has room to ease further, adding international weight to calls for more action by the central bank.

Global Easing

Paul Sheard, chief global economist at ratings company Standard & Poor’s, said this month that the BOJ’s balance sheet has increased by about 36 percent since August 2008, compared with about 209 percent for the U.S. Federal Reserve and about 329 percent for the Bank of England. JPMorgan Securities Japan Co. and UBS AG expect the central bank to add to easing at its Oct. 30 board meeting.

Taiwan’s unemployment rate increased to 4.3 percent in September, the statistics bureau said in Taipei today. In Australia, the government announced spending cuts to help deliver a budget surplus. Elsewhere in the Asia Pacific region, Hong Kong reported higher-than-estimated inflation of 3.8 percent for September, while economic releases around the world include inflation in Poland and retail sales in Mexico.

Toyota Motor Corp. (7203) and Nissan Motor Co. (7201), Japan’s two largest carmakers, reported their steepest drops in China sales since at least 2008 in September, as today’s data showed that Japan’s auto exports to the country fell 44.5 percent.

Contraction Seen

The territorial dispute will knock 0.8 percentage point off Japan’s gross domestic product in the October-December period, JPMorgan said on Oct. 6. The brokerage, along with Morgan Stanley and Citigroup Inc., expects the economy to contract in the third and fourth quarters of this year.

The trade deficit was the first in the month of September since 1979 and compared with economists’ median estimate for a 547.9 billion yen shortfall. The rise in imports was higher than a 2.9 percent gain estimated by economists as the country bought more oil and liquefied natural gas.

“The reason behind the increase is very simple,” said Shohei Setoh, a Tokyo-based manager for a crude oil trading group at JX Nippon Oil & Energy Corp. “Everyone rushed to pass customs,” before a tax increase on oil imports that began Oct. 1.

The government last week said it would draw up spending measures to counter a slowdown. A yen around 5 percent from last year’s postwar high of 75.35 against the dollar is hurting manufacturers such as Sony Corp (6758), making exports more expensive and reducing the value of repatriated earnings.

Assessment Downgraded

Japan’s government this month cut its economic assessment for a third straight month, the longest streak since the 2009 global recession. Data earlier this month showed falling machinery orders and shrinking factory capacity use in August. The International Monetary Fund forecasts the world economy will grow this year at its weakest pace since 2009, saying Oct. 9 there are “alarmingly high” risks of a steeper slowdown.

Economy Minister Maehara said yesterday that Japan needs more monetary easing and policy efforts to spur growth.

“There are fiscal-easing moves worldwide, but on a monetary basis Japan is falling short,” Maehara said in an interview with Fuji Television. While “easing is not a panacea,” without that and policy moves “Japan’s sovereign credit rating may face a downgrade,” he said.

Moody’s Investors Service cut Japan’s credit rating one level to Aa3 in August last year, citing a build-up in government debt since the 2009 global recession. S&P has had a negative outlook on the country’s AA- rating since April last year.

Public support for Prime Minister Yoshihiko Noda fell to 18 percent, the lowest level since he took office in September 2011, the Asahi Newspaper reported in Tokyo today, citing an Oct. 20-21 survey.

JOB GROWTH - Middle to Small Companies are Where the Jobs Are

The mighty middle Medium-sized firms are the unsung heroes of America’s economy 10-20-12 Economist

UNEMPLOYMENT - The Fed's Response

What America's CEOs Really Think In One Chart 10-25-12 Zero Hedge

Since the start of September, announced layoffs in North American firms have soared to levels not seen since the debt-ceiling-debacle of last year (all the while - claims and the unemployment rate continue to fall).

CEOs simply do not, in reality, strategize on hope - its simple, lay off first, hope second!

Evidently - North American CEOs are not hopeful!

Charts:Bloomberg

ASEAN - An Export Demand Problem

Domestic ASEAN Demand May Be Lifted by QE3, China 10-25-12 Bloomberg Brief

Domestic demand momentum in the five largest members of Asean – Singapore, Malaysia, Thailand, the Philippines and Indonesia – was beginning to look worrisome, with a sharp slowdown through the third quarter. This may have changed following the Fed’s announcement of a third installment of quantitative easing and the improvement of China’s economic indicators in September.

While the external environment may present less of a headwind for Asean confidence and domestic demand in the months ahead, Thai and Philippine central banks are cutting their policy rates. This is not to shore up domestic demand – which it will — but rather to ease currency appreciation pressures from surging capital inflows.

■Singapore (GDP per capita $33,500): Domestic demand momentum has slowed sharply, beset by weaker business lending in recent months. The central bank’s ongoing currency appreciation bias may maintain real wages and underpin final demand. Current barometer reading 0.0 compared with 0.5 on Aug. 15.

■Malaysia (GDP per capita $5,400): Having slowed sharply since January due to consumer de-leveraging, domestic demand momentum has steadied in recent months. The stable unemployment rate along with rising real wages may underpin demand into year-end. Current reading minus 0.3 compared with minus 0.1 on Aug. 15.

■Thailand (GDP per capita $2,700): Domestic demand momentum has picked up, still buoyed by post-flood recovery spending and investment. A surge in capital inflows and another rate cut by the central bank may support consumer sentiment once the flood effect fades. Current reading 1.7 compared with 0.9 on Aug. 15.

■Philippines (GDP per capita $1,400): Domestic demand momentum has improved in recent months, helped by slower peso appreciation. A weaker peso translates into larger overseas remittances, which account for about 10 percent of GDP. Going forward, demand will be constrained by lower real wages onshore. Current reading 0.7 compared with 0.0 on Aug. 15.

■Indonesia (GDP per capita $1,200): Domestic demand has been lethargic this year, despite 100 basis points of rate cuts over the past 12 months. In September, momentum picked up sharply, with sentiment buoyed by the Fed’s QE3. Real wage deterioration remains a key internal headwind. Current reading minus 0.1 compared with 0.1 on Aug. 15.

GLOBAL SLOWING - Evidence Now Indisputable

The World In Three Charts 10-24-12 Credit Suisse via ZH

Bernanke has fired his infinite bazooka and yet markets have done nothing but slide since and macro-economic data are showing further signs of weakness (New Orders and Capex) with the reality under the headlines of a housing 'recovery' hardly green-shoots. Draghi remains sidelined with his conditionally infinite bazooka as his region of the world slides deeper and deeper into the abyss of recession/depression with IFO expectations and New Orders slumping and deleveraging continuing.

So, it seems, the hope for moar-money from central-bankers remains squarely on the shoulders of the PBoC. However, a glimmer of green shoots as a gentle acceleration PMI (and New Export Orders? to Japan?) suggest (as Goldman's Jim O'Neill would have us believe) that the Chinese have manufactured a slow landing (for now - given 'their' data). Hardly the driver for the next major round of stimulus that is so required to fill deleveraging shoes (leaving aside the question of food inflation concerns). So a 'blip' of a green shoot in China is in fact nothing to be celebrated as the world remains a closed-loop (no martians yet) and two of the world's three largest economies are lagging badly. Look at these three charts and decide which way the world is heading!

China - Tepid Growth?

Europe - Bad and Getting Worse

US - Forward-Looking Signs of Greater Weakness

Charts: Credit Suisse

ASIA - Increasingly Synchronized Markets Still Offer Opportunities

Asian Bonds Offer Investors Diverse Response to Synchronized Economic Slowdown 10-17-12 Bloomberg Brief

Asian bonds offer diversification benefits to investors even as regional economies and asset markets become increasingly synchronized. The global slowdown has not prompted a uniform monetary-policy response. The knock-on effects for sovereign yields have been even more diverse.

The central banks that have lowered interest rates the most are Pakistan, Australia and the Philippines with cumulative cuts of 200, 100 and 75 basis points, respectively. Asia Brief Taylor-Rule estimates indicate relatively loose monetary policy in Australia and the Philippines. On a Z-score basis, using a country’s historical norm as the yardstick, Indonesia’s policy has also been relatively loose.

Sri Lanka has tightened this year with cumulative rate increases of 75 basis points. Singapore’s monetary authority has also maintained a currency appreciation bias in 2012. Taylor-Rule calculations suggest China, New Zealand and Malaysia also have relatively tight stances on official interest rates. Z-scores suggest rate cuts in India and Thailand have been modest relative to historical norms.

These shifts in policy rates have not necessarily been reflected in corresponding government-bond yields. In the five-year tenor, the outperformers have been Vietnam and Pakistan whose yields are down 200 and 140 basis points, respectively. The next best performers have been Australian and Korean bonds, with yields down 74 and 64 basis points, respectively.

Sri Lankan, Chinese and Thai bonds have underperformed within Asia, consistent with the policy rankings discussed above. Indonesian bonds have also underperformed, defying the central bank’s modest rate cuts and relatively loose stance with respect to its historical norm.

Regression analysis of monthly data since May 2008 suggests five-year government- bond yields are less responsive to changes in the policy rate in Australia; a 100 basis-point change in the rate corresponds with a 25 basis-point response on average. For New Zealand and Taiwan the change is about 30 basis points.

Government yields tend to be highly responsive to changes in rates in Indonesia, Sri Lanka, Vietnam and the Philippines. There, the contemporaneous change in the five-year yield has tended to be more than the adjustment in the rate.

Statistical correlations based on daily data since May 2008 indicate five-year Indian yields are negatively correlated with Asian counterparts, with the exceptions of China, Thailand and Vietnam. Pakistani bonds have low correlations with all Asian peers, while Chinese bonds have low correlations with most peers, excluding India, Thailand and Vietnam.

The rest, except Taiwan and Thailand, are heavily influenced by movements in U.S. Treasuries. Hong Kong, South Korea, New Zealand and Singapore have correlation coefficients above 90 percent.

The five-year benchmark bonds for Japan and Hong Kong have the largest modified duration, which measures the sensitivity of the price to a change in market rates.The five-year benchmarks with the smallest duration are India and Indonesia.

For investors concerned about inflation and anticipating rate rises, bonds with lower duration (India, Indonesia), smaller yield response to increases (Australia, New Zealand) and greater diversification benefits (China, India) may appeal.

CONSUMPTION - Durable Goods in Freefall

10-17-12 Bloomberg Brief

Durable Goods Orders: The topline estimate of durable goods orders will probably be bolstered by the 143 orders for civilian aircraft during September. As the economy approaches the fiscal cliff, core capital goods orders will be among the most important barometers.

MONETARY POLICY- Current Fed Thinking

Fed considering upping QE3 size and language 10-22-12 MarketWatch

• Federal Reserve officials this week will discuss a possible expansion of the size of its third round of bond buying and better ways to guide markets about future policy actions.
• The Fed may abandon its calendar date approach to forward guidance and adopt some form of numerical target for policy.
• Charles Evans' plan (Reserve Bank of Chicago) in August is slowly being adopted by his Fed colleagues. Evans wants the Fed to tell the market that it would keep rates near zero, as long as unemployment remains above 7% and as long as inflation does not threaten to rise above 3%.
• The central bank is also considering whether to expand its bond-buying at the end of the year to take account of Treasury purchases under its Operation Twist plan that finishes at year-end.
• Last month, the Fed announced a plan to purchase $40 billion of mortgage-backed securities per month in an open-ended approach that would not be stopped until the labor market improved.
• While it may not sound like much, the Fed may buy over $1 trillion in MBS based on current forecasts, analysts at Capital Economics estimate.
• The Fed also took the dramatic step of saying it expects to keep short-term interest rates unchanged even if the recovery strengthens.
• It also pushed out the calendar date for the expected first rate hike until mid-2015.
• At the moment, the Fed is buying $45 billion of long-term Treasurys each month under its Operation Twist program, with the purchases offset by sales of shorter-term securities.
• Many economists think the Fed will decide to expand QE3 by that amount, and with Treasurys instead of MBS. But the announcement is not expected to come until its December meeting.
  

FEDERAL RESERVE - Monetary Policy Update -1

Fed’s Policy Shift Takes ‘Five Cs’ Approach to Alleviating Liquidity Trap 10-24-12 Bloomberg Brief - Central Bank Monitor

The Federal Reserve’s monetary policy shifts since the onset of the global financial crisis have integrated the “balance sheet” approach favored by Fed Chairman Ben Bernanke with an approach favored by Columbia University economist Michael Woodford and economist Paul Krugman, which emphasizes policy aimed at alleviating a liquidity trap. Contemporary monetary policy is best understood as consistent with the new “Five C’s” of monetary policy:

1. Communications – using the signaling channel to shape expectations over the path of rate policy. The use of forward guidance to shape expectations of rate policy is key, especially once short-term rates run up against the constraint of the zero boundary.

2. Commitment – a willingness to keep accommodative policies in place well past the point when the economy moves back toward its long-term growth trend and unemployment declines in line with the Fed’s assessment of full employment. This has been a staple of recent Fed policy statements and is key to understanding the trajectory of Fed policy over the next few years.

3. Conditionality – the central bank must convince the public that it intends to remain accommodative, even to the point of tying the evolution of policy to explicit developments in inflation and unemployment. This may manifest itself in what some economists refer to as an “Evans Rule”; that is, keeping rates effectively at zero until the unemployment rate falls below 7 percent or the inflation rate rises above 3 percent.

4. Composition – the use of the balance sheet tool to influence long-term rates, and variation in employment, inflation and output absent any change in the overnight rate target. Policy makers will probably continue to rely upon treasury purchases to complement the communications policy even given the open-ended nature of the Fed’s current mortgage-backed securities purchase program.

5. Credibility – assurance that now that these policies have been put in place, the Fed will not deviate from them and begin the move back toward a treasuries-only balance sheet, even if the economy were to begin moving back toward its longterm potential.

FEDERAL RESERVE - Monetary Policy Update -2

Fed Lays Foundation for Further Policy Changes 10-24-12 Bloomberg Brief - Central Bank Monitor

1. Fed will likely move towards explicit targeting of unemployment rate over the next six months (~ 7% suggested)
2. Balance Sheet likely yo expand to $4 Trillion by end of 2013.
3. Aggressive action to unclog the monetary transmission mechanism to remain in place through 2013.

Click to Enlarge

Given the substantial slack in the economy, the risk to the economic outlook due to fiscal-policy changes set to take place early next year, and the ongoing debt crisis in Europe, more action is likely from the Fed. Investors should expect further changes, perhaps at the December meeting or in the first half of 2013.

With U.S. real short- and long-term interest rates already near record low levels, it is reasonable to expect the Fed to again turn up the dial on unconventional policy measures. At the least, this implies a recognition that the U.S. economy is passing through a difficult and protracted structural adjustment that monetary tools are not well-suited to address.

The U.S. output gap, as estimated by the Congressional Budget Office, remains stubbornly near post-war record levels at about 6 percent below potential GDP. An output gap of this magnitude five years after the onset of the global financial crisis supports academic findings that recessions that follow financial crises are not run-of-the-mill slowdowns.

Throughout the financial crisis and the post-recession period, the one constant has been the Ben Bernanke-led Fed’s willingness to implement unorthodox measures to offset the economic downturn, household deleveraging, and fiscal gridlock through a massive expansion of the central bank’s balance sheet.

Until September, the Fed relied on the tool of the balance sheet to directly reduce longer-term rates by purchasing assets with longer duration in mostly the five to 10-year maturity bucket, with occasional purchases further out along the curve. These actions took place alongside

• a gradual evolution of Fed communications policy from the use of an extended period of low rates, to policy-rate projections,
• a 2 percent inflation target, and then to
• an unconditional, calendardate commitment to which rates and policy were not likely to change.
• In September, citing the persistence of excessive economic slack, the Fed announced it would add $85 billion each month to its balance sheet until the end of the year and then continue purchasing $40 billion of agency bonds until the unemployment rate moved down to an unspecified level.

The central bank thereby took its communications policy of an unconditional stance (linked to a specific date) and added a conditional policy (linked to unspecified developments in the real sector). The move is similar to what the Bank of Japan did in 1999 and is somewhat akin to the Fed pledge in 2003 that linked policy accommodation to low inflation. It is likely the next communication shift will be a move toward targeting a specific level of the unemployment rate.

In a recent speech, Chicago Fed President Charles Evans expressed his support for a contingent policy that would commit the Fed “to providing accommodation at least as long as the unemployment rate remains above 7 percent (and the outlook for inflation over the medium term is under 3 percent). If our progress toward this unemployment marker falters, then we should expand our balance sheet to increase the degree of monetary support.”

Evans explained the emphasis on the output gap, saying that the inflation target should be symmetric. That is, the costs of an inflation rate above our 2 percent goal are the same as the costs of an equalsized miss in inflation below 2 percent. “Its implication is that we should not be resistant to policies that could move the unemployment rate closer to its longer-run level, but run the risk of inflation running only a few tenths above our 2 percent goal,” Evans said.

Given the above, if one were to assume a Taylor-type rule that fit Evan’s hypothesis that in a post-crisis world unemployment is the overriding issue, the Fed should already be tightening policy, raising the nominal Fed Funds rate and, by implication, reducing the Fed’s balance sheet rather than embarking on another program of asset purchases.

When the real economy is unresponsive to changes in monetary policy – as continued sluggish economic growth and the persistently high unemployment rate seem to indicate – then the Fed may choose unconventional measures to augment its zero interest rate policy. This is shown in the chart on page one, with the distance between the zero Fed Funds rate and the “Evans Rule” estimates of the Fed Funds rate the determinant of the Fed’s balancesheet expansion (i.e., its quantitativeeasing asset purchases).

Evans calls for continued monetary stimulus at least until the unemployment rate hits 7 percent. FOMC projections put unemployment above 7 percent until the end of 2015. Evans argues that an economic target, rather than a calendar-date target, for the withdrawal of stimulus “is an important reassurance to households and businesses that Fed policy will not tighten prematurely.”

The slowness of the current recovery has led the Fed to its public announcement that the duration of its unconventional monetary-policy initiatives will be tied to improvements in the labor market. While the FOMC stopped short of explicitly stating what those targets are, Evans speech makes it seem likely that 7 percent is the likely threshold. Market participants would likely also take comfort in an explicit reminder from the Fed that it still considers 5.6 percent unemployment rate to be the full-employment target.

In the absence of a fiscal partner, it seems likely that the Fed will remain accommodative until long after the recovery is a certainty. The Fed’s additional balance-sheet expansion will give households and businesses the reassurances needed to take on additional risk at the same time that the Fed’s reshaping of Treasury yields provides relief to over-leveraged households and the federal government.

MONETIZATION - Where we are likely headed

Presenting All The US Debt That's Fit To Monetize 10-20-12 Zero Hedge

Over the past 4 years the Fed's strategy in response to the Second Great Depression has been a simple one: purchase record (and now open-ended) amounts of fixed income product (offset by releasing record amounts of reserves in the banking universe which in turn has converted every bank into a TBTF and Fed-backstopped hedge fund, as the concurrently shrinking Net Interest Margin no longer leads to the required ROA from legacy bank lending) to stabilize the bond market, and to crush yields in hopes of forcing every uninvested dollar to scramble for equities, primarily of the dividend paying kind now that dividend income is the only "fixed income" available.

So far the strategy has failed for the simple reason that the smart money instead of being "herded", has far more simply decided to just front-run the Fed thus generating risk-free returns, while the "dumb money", tired of the HFT and Fed-manipulated, and utterly broken casino market, has simply allocated residual capital either into deposits (M2 just hit a new all time record of $10.2 trillion) or into "return of capital" products such as taxable and non-taxable bonds. Alas none of the above means that the Fed will ever stop from the "strategy" it undertook nearly 4 years ago to the day with QE1 (as any change to a "strategy" of releasing up to $85 billion in flow per month will be immediately perceived as implicit tightening and crash the stock market). Instead, it will continue doing more of the same until the bitter end. But how much more is there? To answer this question, below we present the entire universe of marketable US debt, in one simple chart showing the average yield by product type on the Y-axis, and the total debt notional on the X.

The Fed, with the recent advent of QEternity, aka the incorrectly named 'QE 3',  is already engaged in the monetization of virtually everything to the right of Municipal debt (under the blue arrow in chart below). The reason why the Fed needs to continue buying up Treasurys in the 10Y+ interval is simple - in doing so it is funding the long-end of US deficit spending, aka everything that has a greater than zero duration in the age of ZIRP. However, that amount is merely enough to keep the status quo as is, in other words to keep the deficit government funded. Remember that the Fed's ultimate goal is to inflate the debt stock of both the US and the world. Which means that not even QEternity will be enough. It also means that very soon the Fed will be forced to shift its monetization appetite further to the left of the X-axis, and increasing buy up more and more higher yielding fixed income product, in a rerun of Japan, which the US has now become. Recall that the BOJ is also openly monetizing Corporate debt, as well as various equity-linked products.

Said otherwise, the "smart money" is now loading up on those debt products, IG and HY debt, munis and non-agency MBS, which the Fed will sooner or later become the buyer of first, last and only resort. And just like Bill Gross was buying up MBS on record margin in February (as we showed) in advance of QE3, so now everyone else is once again merely preparing for the inevitable next step, as the Fed proceeds to monopolize the entire marketable debt universe.

Sadly for the Fed this also means that any incremental free money will simply continue to chase more fixed income product before the Fed starts buying it (thus providing an easy bid to sell into), instead of buying up already ridiculously overpriced equities (where record profit margins are about to slam into the immovable walls of soaring input and commodity costs crushing the "cheap" P/E illusion), which in turn will force Bernanke to one day in the near future, go full Japanese retard, and announce the Fed will as a matter of policy, as opposed to simply via the PPT and Citadel in times of desperation, commence buying equities. But that's a story for another day.