PATTERNS - Asset Trends versus Bubbles

The Wealth Effect Half-Life 06-26-13 Barclays via ZH

Wild swings in asset prices have produced two recessions in the last 15 years - and, we suspect, FOMC members are keen not to see a repeat of the collapses of the last decade. As the following chart shows, measured relative to an equally nominally inflated USD-based disposable income, the wealth effect is nothing like as strong as some suggest and indeed it should be clear that time after time in the last 20 years we have seen the artificially blown 'wealth-effect-creating' bubbles implode back to what was an old-normal level of 'sustainable' wealth (and in fact the Fed is having to work harder to keep us from that level).

As Barclays notes,

There is no major asset price that could be considered depressed in any way and the rate of asset price inflation has been extremely high by any historical standard. Prior to the recent correction, household net worth as a percent of disposable income – a rough measure of asset prices – had risen by 80% as much as it did during each of the two recent asset price booms (and by twice as much as had occurred in any other post-WWII cycle).

Against a background where increasingly wild swings in asset prices have been the key factor undermining economic performance – producing two recessions in the last 15 years – it is not surprising that most members of the FOMC see that historically extreme measures aimed specifically at boosting asset prices have pretty much served their purpose.

Chart: Barclays

ANNOTATIONS BELOW BY gordontlong.com

GOLD - Prices Nearing a Practicasl Bottom of Production Costs of $1300/OZ and Cash Cost $1104

Gold Drops Below Its Average Cash Cost 06-26-13 Barclays Research

As shown two months ago, the marginal cost of production of gold (90% percentile) in 2013 was estimated at $1300 including capex. Which means that as of a few days ago, gold is now trading well below not only the cash cost, but is rapidly approaching the marginal cash cost of $1104...

Which means that of the following mines (as we showed here) which make up the gold cost curve, one by one, starting on the right and going left, production is going to go dark, even without the recent demand by South African gold miner labor unions to have their wages doubled. Until eventually virtually no gold will be produced.

It is at that point where one must apply the New Normal supply and demand curve, when one can predict a $0 per ounce price for gold, as physical demand continues unabated, while actual physical, not paper, production has now started going offline.

Joking aside, not even Bernanke and all the paper Gold ETFs in the world will be able to do much to suppress gold prices from reaching their fair value when gold production hits a standstill, and when demands, especially by China, is still in the hundreds of tons each year.

PATTERNS - Credit Leading Equities

The Credit Market Sees Things Differently 06-26-13 Barclays via ZH

Both the absolute levels and the implied volatility of credit markets are significantly divergent from the recovering exuberance in stocks. As we discussed here and here, this cannot last. If you 'believe' that Bernanke was bluffing and the taper is off then credit is grossly cheaper than stocks; if not, equity shorts seem an appropriate position into Q3.

Easy Come, Easy Flow...

Which leaves equities 9-sigma rich to credit... (approximately 3x HYG to 1x SPY delta)

Of course, the fund flows are affecting credit (as we are constantly reminded on CNBC) and as we saw here, the selling pressure is dramatic; but - as we noted previously -

there is no rotation that drives high-yield credit spreads wider without punishing equities. They are liabilities on the same capital structure and rise and fall in a highly correlated (well non-linear co-dependence) manner as the underlying business risk rises and falls. Do not, repeat do not, see high yield credit weakness as a sign of rotation to stocks - if the credit cycle has turned then stocks are set to fall. And bear in mind that while HY yields are at all-time lows, spreads are not and in fact being short stocks relative to credit makes more sense if you are you are a bear on the credit cycle here. The only problem being that the epic flows that sustained a credit market at non-economic levels for so long will exit in a hurry.

Charts: Bloomberg and Barclays

TAPER - Clearly A Bluff or Muddled Policy

The Bernanke Fed is playing with deflationary fire 06-24-13 Ambrose Evans-Pritchard, The Telegraph

I hope the Fed knows what it is doing.

It has chosen to tighten monetary policy even though core PCE inflation is actually lower right now than it was when the Fed previously thought it dangerous enough to launch further QE. America is one shock away from a slide into outright deflation, and the eurozone is half a shock away.

Anyone who still thinks the Fed has not just tightened significantly – or that markets have overreacted – should read this lament by St Louis Fed chief James Bullard in the Washington Post:

This was tighter policy. It’s all about tighter policy. You can communicate it one way or another way, but the markets are saying that they’re pulling up the probability we’re going to withdraw from the QE program sooner than they expected, and that’s having a big influence.

Here is M1 money to cheer you up:

And here is M1 velocity to cheer you up further:

Now, short-term M1 money data is very volatile, and can often flash wild signals. Nevertheless, I am frankly flabbergasted by the actions of the Bernanke Fed at this point.

They are gambling that the US economy will shake off the effects of fiscal tightening of 2pc to 3pc of GDP this year, arguably the biggest squeeze in half a century. It may indeed do so, but it may not, and the costs of making a mistake before the US recovery is safely established are asymmetric.

Scott Sumner, the spiritual father of the Market Monetarists, says the errors made by the Fed in 1937 and the Bank of Japan in 2000 did serious damage, while the US suffered little lasting effect when the Fed delayed too long in 1951.

Are we to conclude that Ben Bernanke has lost his nerve and joined the Austro-nihilists?

JAPAN - Some Policies Have Clearly Hit the Limit

The BIS Chart That Abe And Kuroda Would Rather You Didn't See 06-23-13 BIS via ZH

Earlier we noted the rather peculiarly truthful (lack of optimistically-biased bullshit) annual report from the BIS as reading ZeroHedge-sermon-like. There is a smorgasbord of data, charts, and quotes strewn throughout the 204-page melodrama but one caught our eye. Reflecting on the fact that governments in several major economies currently benefit from historically low funding costs, and yet at the same time, rising debt levels have increased their exposure to higher interest rates, the BIS projects the dismal reality that any rise in interest rates without an equal increase in the output growth rate will further undermine fiscal sustainability.

Although predicting when and how a correction in long-term rates will unfold is difficult, it is possible to examine the potential impact on the sustainability of public finances and how any normalization of rates (or Abe's success in creating 2% 'inflation' in Japan) leads the nation's debt-ratio to explode (to over 600% debt-to-GDP).

What is more concerning is that even with no negative impact from demographics (age-related adjustments) and even assuming a central bank that can keep interest rates at their ultra-low levels for another 30 years, Japan's debt-to-GDP ratio will reach almost 400% (that's a best case scenario!!)

Unsurprisingly, the higher the interest rate, the faster debt will increase; and while the BIS and the central planners of the world clearly 'believe' they can manipulate JGB yields should this happen, we suspect there is a (non-specific R&R vs Krugman based) limit that once crossed creates the qualitative perception shift that Kyle Bass has so unequivocally explained is coming.

As we noted earlier from the BIS - "some policies have clearly hit their limit."

Chart: BIS

RISK - Volatility and Increasing Instability

The Surge In Interest Rates Is Unlike Anything We've Seen In At Least 50 Years Bepsoke via BI

The yield on the 10-Year Treasury is up 13 basis points today, to 2.63%.

Interest rates have been exploding recently — at their highest levels since August 2011.

The chart below, via Bespoke Investment Group, shows just how extended we are. The 10-year yield is up to 33.3% above its 50-day moving average, the farthest it has been above its 50-day in at least 50 years.

This just goes to show how quickly rates have been surging. "Talk about extended!" exclaim the folks at Bespoke. "At what point does this see at least a short-term turnaround?"

ANNOTATIONS BY gordontlong.com

CHINA - PBOC Liquidity Squeeze

Credit Warnings Offer World a Peek Into China’s Secretive Banks 06-24-13- NY Times

BEIJING — China’s hidden banking system is coming out of the shadows as the government seeks to rein in the excessive lending that it fears could spin out of control.

The People’s Bank of China, the central bank, let the world know on Monday that it was putting the nation’s banks on notice: the loose money and the speculation it fed had to stop. It said banks had to step up risk controls and improve cash management. And they had to do it, the bank said, by avoiding a “stampede” mentality.

The banks had quietly received that very message a week earlier, which set off, if not a rush for the exits, certainly widespread worry in China and financial centers around the world.

It precipitated a cash squeeze among the banks that sent their short-term interest rates sharply higher last week.

The crackdown, appears aimed at reining in banks engaged in complex deals that involve hiding and repackaging risky loans so that regulators cannot notice them,

... also led to a sharp sell-off in stocks worldwide during the last week. Investors feared it might further slow the Chinese economy.

China, the world’s second-largest economy after the United States, has a huge influence on the world economy so the actions of its central bank are closely watched across the globe. But

its financial and banking system remains opaque to Chinese and foreigners alike.

Within the government’s own warnings about lending lies its dilemma: it needs to control where money is being lent at the same time it wants to reform a banking system that has grown dependent on government direction.

“The government knows some banks are doing things that aren’t prudent,” says Yukon Huang, a senior associate at the Carnegie Endowment for International Peace in Washington.

“Some of them are taking easy money and putting it in Ponzi schemes. The government is saying, ‘Don’t do that any more. And don’t count on the government to bail you out.’ ”

Li Keqiang, China’s prime minister, who took office last March, has promised a more market-oriented approach to managing the economy. And analysts say his economic advisers are pressing to reorganize the economy in a way that will allow it to respond better to market forces.

But to put such reforms in place, the new government is going to have to take on powerful state-run companies and interest groups that sometimes resist pressure from the center or turn to allies in the central leadership who block such moves.

The government’s target is the sharp and potentially dangerous rise in the so-called shadow banking. Banks borrow at the low interbank rate, then lend to trust companies and smaller banks who in turn make riskier loans. The fear among some analysts is that the vast amount of bad debt and hidden liabilities the shadow banking system masks could start sinking banks. Those excesses could start a chain of other economic setbacks.

Most economists say China’s financial system is not facing huge systemic risks, and that growth could even come in at 7 percent, which would still make it the world’s fastest-growing major economy. But there are mounting concerns here that the good times could be over partly because the banking sector is hiding piles of bad debt.

The Chinese government has the policy tools to deal with a crisis, including huge foreign exchange reserves and the ability to force state banks to lend in a time of crisis. The People’s Bank of China is not an independent institution, like many central banks in major economies are; it reports to the central government.

But after years of pumping money into the economy, the central bank can see signs of diminishing returns. Banks lent a huge amount of money in the first half of this year, and yet growth has been tepid. Manufacturing has begun to contract, according to a recent survey, and banks seem desperate for more cash.

Last Friday, Fitch Ratings said in a report that less money in the market for interbank loans could hamper some banks from making payouts when high-interest financial instruments for China’s rich,called wealth management products, mature later this month.

Fitch said about $244 billion would come due later this month and that the effort to make the payout could send short-term borrowing rates even higher.

Wall Street analysts are now revising their economic growth forecasts downward and warning that the Chinese central bank’s refusal to alleviate commercial banks’ cash shortages by pumping more money into the economy could lead some smaller banks to default.

They warn of other dangers facing China’s economic policy makers. If the property market stumbles, some analysts fear that could wallop the broader economy.

China’s exports, long a strength, had been buoyant early in the year, according to official statistics. But some analysts have questioned whether trade statistics were being manipulated by speculators pretending to sell goods overseas in order to bring money into the country that they would then use to speculate in the financial markets.

The most recent export figures have been less robust, possibly hurt by China’s currency, the renminbi, which has strengthened over the last year against the dollar and the Japanese yen.

The prime minister and his economic team are trying to move swiftly to guard against a crisis down the road, after years of loose credit and heavy spending on manufacturing, property and infrastructure. But if they press too hard, analysts say, an already weakening economy could lock up, and see growth dip below 7 percent, starting even more trouble with the banking sector.

“To push through their reforms I think Li Keqiang and Xi Jinping are willing to accept lower growth,” says Nicholas Lardy, an expert on China’s economy at the Peterson Institute for International Economics in Washington.

Last Friday, a large group of bankers and entrepreneurs surveyed by the central bank said their confidence in the country’s macroeconomic conditions was weakening. Loan demand was falling, said Xiang Songzuo, chief economist of the Agricultural Bank of China, according to the English language China Daily. “Even a monetary easing is not going to solve the problem,” he sai

PATTERNS - Financial Stress Index Sends Market Clue

Financial Stress Index Hits Scary Level 06-25-13 CNBC

The latest stress spike began in the second week of May and has continued unabated.

We already know that markets are in turmoil, so this isn't exactly news. But one thing to remember is that the past spikes in the index were swiftly followed by Fed action that relieved the stress. In June 2010, the Fed extended swap lines to central banks around the globe. In August 2011, the Fed announced that rates would remain low for at least two more years.

Assuming this isn't a completely spurious correlation, the recent rise in financial stress may mean that we should expect something new from the Federal Reserve soon.

—By CNBC's John Carney

INFLATION EXPECTATIONS - Contributing to Volatiltiy

The Declining Inflation Expectations Chart That Should Have Stock Investors Very Concerned 06-24-13 BI

From last night's Bedtime with BTIG note, Dan Greenhaus (@danBTIG on Twitter) points to the below chart as something that's of increasing concern to investors:

It’s all interest rates all the time it seems. For the week, the bond market was thunderstruck as the 10 year yield rose by roughly 40 bps, one of the largest yield increases in a decade. But such an increase is not exclusive to this past week; the 10 year yield was higher in seven of the last eight weeks. What has elicited a fair bit of conversation has been not the increase but the decrease in inflation expectations. Given their relationship to stock prices (see chart below), we think this conversation is warranted. For their part, stocks dropped for the fourth time in the last five weeks although as has been repeatedly noted, the cumulative drop is a relatively tame 5%.

WORLD BANK - Cuts Global Outlook

World Bank Cuts Global Outlook as China Slows 06-13-13 Bloomberg

The World Bank cut its global growth forecast for this year after emerging markets from China to Brazil slowed more than projected, while budget cuts and slumping investor confidence deepened Europe’s contraction.

The world economy will expand 2.2 percent, less than a January forecast for 2.4 percent growth and slower than last year’s 2.3 percent, the bank said in a report released yesterday in Washington. It lowered its prediction for developing economies and sees the euro region’s gross domestic product shrinking 0.6 percent. In contrast, forecasts were raised for the U.S. and Japan, which was helped by fiscal and monetary stimulus.

“Hard data so far this year point to a global economy that is slowly getting back on its feet,” the Washington-based lender said in its twice-yearly report. “However, the recovery remains hesitant and uneven.”

Efforts by European policy makers to stem the region’s debt crisis have alleviated the main risk to global growth and financial-market stability, according to the lender. The bank now sees smaller threats, including lower commodity prices and the impact of unwinding unprecedented monetary stimulus in advanced economies including the U.S., the talk of which has sent currencies from India to Thailand lower and Mexican bond yields higher in recent weeks.

Asian equities tumbled today, with the region’s benchmark index headed toward a correction, and the yen rose to the strongest in two months against the dollar after the World Bank cut its growth forecast amid concern central banks may pare monetary stimulus.

The MSCI Asia Pacific Index dropped as much as 3 percent, erasing this year’s gains. Bond risk in Asia climbed, and emerging-market stocks slid to a nine-month low, led by Chinese and Thai shares.

Debate among U.S. policy makers over when and how to dial back the Federal Reserve’s $85 billion-a-month program of asset purchases has shaken financial markets in developing nations. More than $2.5 trillion has been erased from the value of global equities since Fed Chairman Ben S. Bernanke said May 22 that the Fed could scale back stimulus efforts if the employment outlook shows “sustainable improvement.”

“In the short run, if the U.S. becomes a little more attractive, there will be some marginal movement of money,” World Bank Chief Economist Kaushik Basu said in an interview yesterday. “I don’t think this is the kind of fluctuation that will last past two months or so.”

The withdrawal of accommodative policy may have consequences in the longer run as interest rates in developing countries rise more than in their industrial counterparts, slowing investment and growth, according to the report.

The Bank of Korea kept its benchmark interest rate unchanged today after a surprise cut in May aimed at boosting an economy hit by a yen drop that gives Japanese companies an edge over Korean exporters. New Zealand’s central bank left its Official Cash Rate at 2.5 percent and cut its growth forecast for the year through March 2014 to 3 percent from 3.3 percent.

For next year, the World Bank said it expects 3 percent growth worldwide, compared with a 3.1 percent advance in its January forecast.

The World Bank predicts the U.S. will grow 2 percent this year compared with a forecast in January for a 1.9 percent expansion, though fiscal tightening is holding it back. The new forecast for the 17-country euro area compares with a 0.1 percent contraction seen in January.

Developing countries collectively were forecast by the World Bank to expand 5.1 percent, less than the 5.5 percent estimated in January.

China’s growth outlook was cut to 7.7 percent from 8.4 percent, according to the World Bank’s report. The 6.1 percent forecast for India was reduced to 5.7 percent and Brazil’s was lowered to 2.9 percent from 3.4 percent.

While China’s slowdown was expected, “it is the timing, that it happened a bit quickly that caught people by surprise,” Basu said. “Given that China used to grow at 10 percent and it was pulling so much of the world along with that, that is indeed a concern,” especially in regions that benefited from Chinese investment such as sub-Saharan Africa, he said.

The effects could be neutralized if growth picks up in Europe or Japan, which the bank now sees expanding 1.4 percent this year from 0.8 percent in its January forecasts, he said.

Japan’s monetary and fiscal stimulus is the right policy for the country, even if it’s pushed up the currencies of some nations as the yen depreciated, Basu told reporters yesterday. The bank estimates higher Japanese exports could also benefit countries such as Thailand and the Philippines, which supply parts and components to Japan.

“For growth to remain strong through 2015, however, Japan will have to implement a robust set of productivity enhancing policy changes,” according to the report.

World Bank Cuts China's Growth Forecast And Warns Of A Possible 'Sharp' Slowdown 06-13-13 BI

The World Bank has slashed its growth forecast for China's economy this year to 7.7 percent from 8.4 percent, warning of a potential "sharp" slowdown triggered by a fall in investment.

The projection is lower than the 7.8 percent expansion the country recorded in 2012, which was its weakest in 13 years, and comes as a slew of data indicate the economy is struggling to pick up pace.

"The main risk related to China remains the possibility that high investment rates prove unsustainable, provoking a disorderly unwinding and sharp economic slowdown," World Bank.

It tipped growth to pick up to around eight percent next year and in 2015 -- unchanged from the bank's previous forecast -- as "global conditions improve".

Chinese household debt is around two to three times higher than the level before 1997 when the Asian Financial Crisis hit, the report said. While the headline inflation rate is mild, price pressures remain in certain rapidly growing segments of the economy, including real estate, it added.

• "Ensuring strong and stable consumption through raising household incomes to sustain growth is a priority in China,"
• more investment should be directed into agriculture, human capital and services and increased efficiency of investment.
• The government should also try to reduce non-performing assets at Chinese banks, most of which are state-owned, that have piled up "during years of investment-led growth".

In April, China announced unexpectedly weak growth of 7.7 percent for the first quarter, surprising analysts who had expected expansion to accelerate in 2013 after showing strength at the end of last year. Other recent indicators have raised alarm bells, with exports showing almost no growth last month, while industrial output expanded at a slightly slower pace than April and big ticket investment growth also eased.

A survey by British banking giant HSBC showed China's manufacturing activity measured 49.2 in May, an eight-month low, and below the 50 mark that indicates contraction. The World Bank's forecast cuts followed a recent lowering by the International Monetary Fund to 7.75 percent from the previous 8.0 percent.

The Bank Of International Settlements Warns The Monetary Kool-Aid Party Is Over 06-23-13 BIS via ZH

When a month ago the Central Banks' Central Bank, aka the Bank of International Settlements (or BIS) in Basel where the MIT central-planning braintrust meets every few months to decide the fate of the world, warned that the Fed-induced collateral shortage is distorting the markets, few paid attention. That the implication behind said warning was that QE can not continue at the current pace, was just as lost. A few short weeks later following the biggest plunge in markets since 2011 in the aftermath of Bernanke's taper tantrum, some are finally willing to listen.

However, they will certainly not like what the BIS just released as a follow up, both in the form of the BIS' 83rd Annual Report, and the speech by Jaime Caruana to commemorate said annual meeting. For the simple reason that it reads like a run of the mill Sunday morning Zero Hedge sermon, which says, almost verbatim, that the days of kicking the can via flawed monetary policy are now over, and that the time for central banks to end the monetary morphine drip has finally come.

The BIS message, as summarized by the FT, is that "central banks must head for the exit and stop trying to spur a global economic recovery... cheap and plentiful central bank money had merely bought time, warning that more bond buying would retard the global economy’s return to health by delaying adjustments to governments’ and households’ balance sheets."

Here is a better summary of the BIS' unprecedented U-Turn on its 5 year long monetary strategy, in its own selected words:

Can central banks now really do “whatever it takes”? As each day goes by, it seems less and less likely... Six years have passed since the eruption of the global financial crisis, yet robust, self-sustaining, well balanced growth still eludes the global economy. If there were an easy path to that goal, we would have found it by now.

Monetary stimulus alone cannot provide the answer because the roots of the problem are not monetary. Hence, central banks must manage a return to their stabilisation role, allowing others to do the hard but essential work of adjustment.  

Many large corporations are using cheap bond funding to lengthen the duration of their liabilities instead of investing in new production capacity.

Continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system.

Overindebtedness is one of the major barriers on the path to growth after a financial crisis. Borrowing more year after year is not the cure...in some places it may be difficult to avoid an overall reduction in accommodation because some policies have clearly hit their limits.

Of course, it would have been more useful for the BIS to reach this commonsensical conclusion some four years ago (or roughly when we started preaching to the choir, which now includes the BIS itself), instead of allowing the global private bank controlled syndicate known as "central banks" to inject $15 trillion into global capital markets in the past 4 years, and nearly $25 trillion (a #Ref! % increase!) since 2000.

Some of the "shocking" and painfully late observations on the chart above:

Since the beginning of the financial crisis almost six years ago, central banks and fiscal authorities have supported the global economy with unprecedented measures. Policy rates have been kept near zero in the largest advanced economies. Central bank balance sheets have doubled from $10 trillion to more than $20 trillion. And fiscal authorities almost everywhere have been piling up debt, which has risen by $23 trillion since 2007. In emerging market economies, public debt has grown more slowly than GDP; but in advanced economies, it has grown much faster, so that it now exceeds one year’s GDP.

Some of the other, just as "shocking" observations: a dramatic surge in artificially low bond yields will result in crippling, systemic losses, amounting to trillions of dollars for bond (and certainly stock) investors around the globe, to the tune of 8% of GDP losses in the US, and a mindblowing 35% of GDP in losses for Japanese investors:

Consider what would happen to holders of US Treasury securities (excluding the Federal Reserve) if yields were to rise by 3 percentage points across the maturity spectrum: they would lose more than $1 trillion, or almost 8% of US GDP (Graph I.3, right-hand panel). The losses for holders of debt issued by France, Italy, Japan and the United Kingdom would range from about 15 to 35% of GDP of the respective countries. Yields are not likely to jump by 300 basis points overnight; but the experience from 1994, when long-term bond yields in a number of advanced economies rose by around 200 basis points in the course of a year, shows that a big upward move can happen relatively fast.

And while sophisticated hedging strategies can protect individual investors, someone must ultimately hold the interest rate risk. Indeed, the potential loss in relation to GDP is at a record high in most advanced economies. As foreign and domestic banks would be among those experiencing the losses, interest rate increases pose risks to the stability of the financial system if not executed with great care.

All of which Japan's "sophisticated", yet joyously cartoonish, "leaders" recently found out when they almost lost all control of the bond (and stock) market.

What's the "wealth effect" solution: why buy stocks but don't sell bonds. Or if selling bonds, do so vewy, vewy quietly. Alas, not even the BIS is dumb enough to fall (or push) for this possibility any longer.

The BIS report goes on, doing all it can to distance itself from those central banks who merely implemented policy that the BIS supported (and encouraged) for the past 5 years, but which has suddenly turned a cold shoulder. It does so by dramatically and rhetorically blasting a litany of questions to which it fully-well knows the answers:

How can central banks encourage those responsible for structural adjustment to implement reforms? How can they avoid making the economy too dependent on monetary stimulus? When is the right time for them to pull back from their expansionary policies? And in pulling back, how can they avoid sparking a sharp rise in bond yields? It is time for monetary policy to begin answering these questions.

Regardless of the politics behind the shift in BIS sentiment, the days of Mario Draghi's "whatever it takes" shriek of desperation are over. Here are some more of the key soundbites from the BIS report:

Originally forged as a description of central bank actions to prevent financial collapse, the phrase “whatever it takes” has become a rallying cry for central banks to continue their extraordinary actions. But we are past the height of the crisis, and the goal of policy has changed – to return still-sluggish economies to strong and sustainable growth. Can central banks now really do “whatever it takes” to achieve that goal? As each day goes by, it seems less and less likely. Central banks cannot repair the balance sheets of households and financial institutions. Central banks cannot ensure the sustainability of fiscal finances. And, most of all, central banks cannot enact the structural economic and financial reforms needed to return economies to the real growth paths authorities and their publics both want and expect.

What central bank accommodation has done during the recovery is to borrow time – time for balance sheet repair, time for fiscal consolidation, and time for reforms to restore productivity growth. But the time has not been well used, as continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system. After all, cheap money makes it easier to borrow than to save, easier to spend than to tax, easier to remain the same than to change.

Yes, in some countries the household sector has made headway with the gruelling task of deleveraging. Some financial institutions are better capitalised. Some fiscal authorities have begun painful but essential consolidation. And yes, much of the difficult work of financial reform has been completed. But overall, progress has been slow, halting and uneven across countries. Households and firms continue to hope that if they wait, asset values and revenues will rise and their balance sheets improve. Governments hope that if they wait, the economy will grow, driving down the ratio of debt to GDP. And politicians hope that if they wait, incomes and profits will start to grow again, making the reform of labour and product markets less urgent. But waiting will not make things any easier, particularly as public support and patience erode.

Alas, central banks cannot do more without compounding the risks they have already created. Instead, they must re-emphasise their traditional focus – albeit expanded to include financial stability – and thereby encourage needed adjustments rather than retard them with near-zero interest rates and purchases of ever larger quantities of government securities. And they must urge authorities to speed up reforms in labour and product markets, reforms that will enhance productivity and encourage employment growth rather than provide the false comfort that it will be easier later.

* * *

As governments responded to the financial crisis with bank bailouts and fiscal stimulus, their indebtedness rose to new highs. And in countries that experienced a housing bubble in the run-up to the crisis, households had already accumulated large debts. In the half-decade since the peak of the crisis, the hope was that significant progress would be made in the necessary deleveraging process, thereby enabling a self-sustaining recovery.

However, that never happened.

Easy financial conditions can do only so much to revitalise long-term growth when balance sheets are impaired and resources are misallocated on a large scale. In many advanced economies, household debt remains very high, as does non-financial corporate debt. With households and firms focused on reducing their debt, a low price for new credit is not terribly relevant for spending. Indeed, many large corporations are using cheap bond funding to lengthen the duration of their liabilities instead of investing in new production capacity. It does not matter how attractive the authorities make it to lend and borrow – households and firms focused on balance sheet repair will not add to their debt, nor should they.

And, most of all, more stimulus cannot revive productivity growth or remove the impediments that block a worker from shifting into a promising sector. Debt-financed growth masked the downward trend in labour productivity and the large-scale distortion of resource allocation in many economies. Adding more debt will not strengthen the financial sector nor will it reallocate resources needed to return economies to the real growth that authorities and the public both want and expect.

* * *

Six years have passed since the eruption of the global financial crisis, yet robust, self-sustaining, well balanced growth still eludes the global economy. If there were an easy path to that goal, we would have found it by now. Monetary stimulus alone cannot provide the answer because the roots of the problem are not monetary. Hence, central banks must manage a return to their stabilisation role, allowing others to do the hard but essential work of adjustment.

Authorities need to hasten labour and product market reforms so that economic resources can shift more easily to high-productivity sectors. Households and firms have to complete the difficult job of repairing their balance sheets, and governments must intensify their efforts to ensure the sustainability of their finances. Regulators have to adapt the rules to a financial system that is becoming increasingly interconnected and complex and ensure that banks have sufficient capital and liquidity buffers to match the associated risks. Each country needs to tailor the reform agenda to maximise its chances of success without endangering the ongoing economic recovery. But, in the end, only a forceful programme of repair and reform will return economies to strong and sustainable real growth.

* * *

Ultimately, outsize public debt reduces sovereign creditworthiness and erodes confidence. By putting their fiscal house in order, governments can help restore the virtuous cycle between the financial system and the real economy. And, with low levels of debt, governments will again have the capacity to respond when the next financial or economic crisis inevitably hits.

* * *

Continued low interest rates and unconventional policies have made it easy for the private sector to postpone deleveraging, easy for the government to finance deficits, and easy for the authorities to delay needed reforms in the real economy and in the financial system.

The BIS conclusion:

Is this a call for undifferentiated, simultaneous and comprehensive tightening of all policies? The short answer is no. Concrete measures need to be tailored to country-specific circumstances and needs. And the timing need not be simultaneous, although in some places it may be difficult to avoid an overall reduction in accommodation because some policies have clearly hit their limits.

Ours is a call for acting responsibly now to strengthen growth and avoid even costlier adjustment down the road. And it is a call for recognising that returning to stability and prosperity is a shared responsibility. Monetary policy has done its part. Recovery now calls for a different policy mix – with more emphasis on strengthening economic flexibility and dynamism and stabilising public finances.

Finally, today’s large flows of goods, services and capital across borders make economic and financial stability a shared international responsibility. Cross-border effects of domestic policy action are intrinsic to globalisation. Understanding spillovers and finding ways to avoid the unintended effects is central to the work of the BIS. And continued discussions among central banks and supervisors – discussions that the BIS facilitates and promotes – are essential for avoiding national biases in policymaking. Such national bias runs the risk of undermining globalisation and thus blocking the road to sustained growth for the global economy.

And yes, the central banks' central bank really did say all of the above. Unpossible the Keynesian Magic Money Tree growers will say: surely there is an error in the BIS excel model...

Those pressed for time, if unable to read the full 204 page annual report, should at least read the following stunning speech from Jaime Caruana, General Manager of the BIS, titled "Making the most of borrowed time." (only 9 pages - pdf here). Because, if nothing else, it validates everything Zero Hedge has said for the past 4 years.

BIS Speech

OTHER SOURCES

• Bond Losses of $1 Trillion if Yields Spike, BIS Says Reuters
• Increasing Bond Yields Risk Debt Spiral in U.S., Japan, BIS Says BL BIS Annual Report
  “As foreign and domestic banks would be among those experiencing the losses, interest rate increases pose risks to the stability of the financial system if not executed with great care...”

BIS - Central banks Are Against A Wall in Crating Time that the Private and Public sectors HAD for adjustment

The World's Central Banks May Have Just Started A Strike 06-24-13 Jaime Caruana, general manager of the Bank for International Settlements (as Ryan Avent characterized it. via BI

Paul Krugman says that the Federal Reserve may have made a historic blunder this week in signaling its intent to "taper" the pace of bond purchases, with an eye towards ending them completely sometime in 2014.

By taking a hawkish turn before the economy has recovered (it's still nowhere close on employment goals, and inflation trends are going the wrong way) the Fed may have lost any credibility to restimulate should it come to that.

Four days after Bernanke's guns-blazing press conference, we get another datapoint indicating that the central banks of the world are ready to say "no mas" in the fight against depression.

In a speech given today, Jaime Caruana, general manager of the Bank for International Settlements (which is, as Ryan Avent characterized it, kind of the central bank to the central banks), said the following:

Ours is a call for acting responsibly now to strengthen growth and avoid even costlier adjustment down the road. And it is a call for recognizing that returning to stability and prosperity is a shared responsibility. Monetary policy has done its part. Recovery now calls for a different policy mix – with more emphasis on strengthening economic flexibility and dynamism and stabilizing public finances

The title of Caruana's speech is "Making The Most Of Borrowed Time," and it's filled with warnings about what happens if central banks keep stimulating for too long. Read these three paragraphs. It's basically a white flag, saying we're done here:

Central banks have borrowed the time that the private and public sectors need for adjustment, but they cannot substitute for it. Moreover, such borrowing has costs. As the stimulus is sustained, it magnifies the challenges of normalising monetary policy; it increases financial stability risks; and it worsens the misallocation of capital.

Finally, prolonging the period of very low interest rates further exposes open economies to spillovers that are now widely recognised. The challenges are particularly severe for the emerging market economies and smaller advanced economies where credit and property prices have been rapidly growing. The risks from such a domestic credit boom at a late stage of the economic cycle are hard enough to manage. Strong capital inflows exacerbate such risks and challenges for market participants and authorities; and they expose economies to large sudden reversals if markets expect an exit from unconventional policies, as volatility during the past few weeks seems to indicate.

In short, the balance of costs and benefits entailed by continued monetary easing has been deteriorating. Borrowed time should be used to restore the foundations of solid long-term growth. This includes ending the dependence on debt; improving economic flexibility to strengthen productivity growth; completing regulatory reform; and recognising the limits of what central banks can and should do.

So you have the BIS and the Fed both signaling the end is nigh for how much central banks can do at this point. It looks like a central banker strike.

Meanwhile, this past week, we saw the People's Bank of China allow SHIBOR (a measure of intrabank lending similar to LIBOR) to surge, in what was seen as a tool to clamp down on speculation.

Ostensibly the Bank of Japan is just in the beginning of a new era of easing, though even they're internally divided according to reports.

Thanks to political gridlock (especially in the U.S.), central banks have done much of the heavy lifting in the recovery. That seems to be coming to an end. Hopefully escape velocity has been achieved.

PATTERNS - Contrarian Breadth Rule

BofA: 'EQUITY BUY SIGNAL TRIGGERED' 06-25-13 BofAML via BI

Around the world, stock markets have faltered over the past month as fears that the Federal Reserve will taper back quantitative easing sooner than expected have crept into the global marketplace.

BofA Merrill Lynch Chief Investment Strategist Michael Hartnett says at this point, the sell-off looks overdone.

In a note to clients titled "Equity Buy Signal Triggered," Hartnett says nearly every major stock market – with the exception of those in the U.S. and Japan – is now oversold:

Contrarian “Breadth” Rule Triggers Buy Signal

BofAML Global Breadth Rule triggers contrarian “buy” signal for global equities. 43 out of 45 markets now “oversold”, i.e. trading below [their 200-day and 50-day moving averages]. Historically, “buy” signal followed by 6-7% gains in subsequent 4-6 weeks. Last buy signal on 6/1/12 nailed the low (stocks then rallied 30% trough-to-peak).

Markets Stop Panicking when Policy Makers Start Panicking

The rule is contrarian and argues solely for a short-term bounce in equities. A sustained rally normally requires policy changes to force shift in investor behavior. Two further caveats: Breadth Rule failed once, in July 2008, when deleveraging across asset classes caused meltdown in equity markets; the two markets that are not currently in buy territory are the two largest, US & Japan.

What is most oversold?

Trading contrarians looking for long opportunities should note most oversold markets and sectors are all China & carry-trade related: Brazil, Turkey, South Africa, Mexico and Materials. Note our EM Flow Trading Rule is very close to a “buy” signal. Least oversold: Japan, Health Care, Consumer Discretionary & the US.

The chart below shows previous performance of the Global Breadth Rule.

SUPPORTING REFERENCES:

• Fed and ECB Draghi may be forced to react 06-26-13 Financial Times
• Financial Stress Index Hits Scary Level 06-25-13 CNBC - The past spikes in the index were swiftly followed by Fed action that relieved the stress. In June 2010, the Fed extended swap lines to central banks around the globe. In August 2011, the Fed announced that rates would remain low for at least two more years.

GORDONTLONG.CO ANNOTATION

Setting Up for our predicted 'E" Wave following the Bond Scare

CONSUMER CONFIDENCE - The Mortgage Spike "Peak Signal"

What Happened The Last 2 Times Mortgage Rates Spiked Like This? 06-25-13 Citi FX Technicals via ZH

Perhaps - as we are always reminded - it will be different this time but following this morning's surge in Consumer Confidence, we got to thinking, just why is everyone so confident? The facts are, as Citi's FX Technicals group notes, the last times we saw mortgage rates surge like they just have, that marked the peak in consumer confidence and the market followed shortly after. It seems that the Fed, by engineering ever lower rates, can lift confidence; but as is clear from this chart (and as we noted previously) there is a limit to this effect (ZIRP) and each cycle has diminishing returns.

Chart adapted from Citi FX Technicals

SUPPORTING REFERENCE:

• Zillow 30-Year Fixed Mortgage Skyrockets By Massive 50 bps In One Week To 4.38%, Most Since 2011 06-25-13 Zero Hedge

BONDS - Yields Improved, Especially Against Stock Yields

Stocks Have Lost A Major Advantage They Had Over Bonds 06-23-13 BMO Capital via BI

For several months, at least some investors seeking income have fled the bond market and headed toward the stock market because stock dividend yields were higher than than bond coupon payments.

This was a considered a tailwind for the stock market.

However, with this week's -- and this month's -- sell-off in the bond market, prices have come down so much that bond yields are now higher than stock dividends.

Here's BMO Capital's Brian Belski:

One of the biggest advantages stocks have enjoyed lately has been relatively high dividend yields when compared with bonds. Based on our work, this has provided a significant boost to stock market performance. For instance, ever since the S&P 500 dividend yield consistently exceeded the 10-year Treasury yield (in this cycle), stocks have gained an average annual return of 24.1%. This compares with 18.2% for periods where the dividend yield was below the Treasury yield and 5.5% if you exclude the “rebound” year of 2009. Needless to say, the yield advantage has clearly provided a strong tailwind for market performance, and in our view, made the “re-allocation” decision for skittish investors a little easier. Unfortunately, recent higher rates have pushed the S&P 500 dividend yield back below the 10-year Treasury yield for the first time in almost a year and a half -- a trend that is likely to continue given Fed posturing.

This is not to say stocks aren't attractive on an absolute basis. However, the relative value offered by stocks over bonds has narrowed significantly.

NEW IMMIGRATION LAW - What is the Real Driving Force?

Amnesty Capitulation Assures a Failed Society 06-23-13 BATR.org

SECURITY-SURVEILLANCE COMPLEX - NSA Whistleblower Example: Booz Hamiltion

How Booz Allen Hamilton Swallowed Washington 06-23-13 Zero Hedge

From its origins as a management consulting firm, Booz Allen has quietly grown into a government-wide contracting behemoth, fed by ballooning post-Sept. 11 intelligence budgets and Washington’s increasing reliance on outsourcing. With 24,500 employees and 99% of its revenues from the federal government, its growth in the last decade has been stunning (and until very recently with little to no knowledge from the main street that it even exists).

(click image for large legible version)

Via Bloomberg BusinessWeek,

In 1940, a year before the attack on Pearl Harbor, the U.S. Navy began to think about what a war with Germany would look like. The admirals worried in particular about the Kriegsmarine’s fleet of U-boats, which were preying on Allied shipping and proving impossible to find, much less sink. Stymied, Secretary of the Navy Frank Knox turned to Booz, Fry, Allen & Hamilton, a consulting firm in Chicago whose best-known clients were Goodyear Tire & Rubber (GT) and Montgomery Ward.

The firm had effectively invented management consulting, deploying whiz kids from top schools as analysts and acumen-for-hire to corporate clients. Working with the Navy’s own planners, Booz consultants developed a special sensor system that could track the U-boats’ brief-burst radio communications and helped design an attack strategy around it. With its aid, the Allies by war’s end had sunk or crippled most of the German submarine fleet.

That project was the start of a long collaboration. As the Cold War set in, intensified, thawed, and was supplanted by global terrorism in the minds of national security strategists, the firm, now called Booz Allen Hamilton (BAH), focused more and more on government work. In 2008 it split off its less lucrative commercial consulting arm - under the name Booz & Co. - and became a pure government contractor, publicly traded and majority-owned by private equity firm Carlyle Group (CG).

In the fiscal year ended in March 2013, Booz Allen Hamilton reported $5.76 billion in revenue, 99 percent of which came from government contracts, and $219 million in net income. Almost a quarter of its revenue - $1.3 billion - was from major U.S. intelligence agencies. Along with competitors such as Science Applications International Corp. (SAIC), CACI, and BAE Systems (BAESY), the McLean (Va.)-based firm is a prime beneficiary of an explosion in government spending on intelligence contractors over the past decade. About 70 percent of the 2013 U.S. intelligence budget is contracted out, according to a Bloomberg Industries analysis; the Office of the Director of National Intelligence (ODNI) says almost a fifth of intelligence personnel work in the private sector.

It’s safe to say that most Americans, if they’d heard of Booz Allen at all, had no idea how huge a role it plays in the U.S. intelligence infrastructure. They do now.