The French are boasting about having downed an airplane of the Libyan Air Force, and there are more worrying news coming Japan today, as if the Portuguese government`s fall were not enough to stress the trader community. Gold is appreciating along with oil and other commodities, but this should not be seen as anything other than a reflection of the general speculative trend that has been driving their prices up for quite some time.
As the week closes, the uncertainties that have so far failed to dampen speculative sentiment continue to undermine it, but the pressure will probably intensify as the aftermath of the Portuguese government`s fall becomes clearer to traders. We do not know yet how far the repercussions of this small nation`s difficulties will reach, nor do we know how likely it is that similar scenarios will play out in nations like Ireland, Spain or Italy. These problems will remain a fixture on the picture for months and indeed years to come, because they are too big to go away in short order and are always heavy in the minds of traders as a consequence of their central role in the big picture.
One should not expect the next leg of the sell-off, when and if it materializes, to significantly alter the mood or composure of traders, because all interest is on the Fed`s actions at the most basic level. The present weakness in the market will not last for very long, because the E.U. Authorities will intervene in the sovereign debt issue soon. The Libyan crisis is likewise very likely to turn into a chronic problem in a few weeks, and the Japanese issue will naturally calm down as the nuclear problem recedes from the headlines. The Fed`s determination to keep the markets afloat will thereafter surface as the main force behind trends, and it will likely be the dominant one.
Tunisians are not satisfied with just toppling their corrupt and brutal dictator Zine El Abidine Ben Ali, but would like to recover him from his place of refuge, and subject him to a trial in which he can be questioned on his numerous crimes. It is possible that he will get the death penalty unless it is abolished by that time, although nowadays the death penalty is rarely executed.
Protests have been continuing in the Arab World today, with bloody confrontation between security forces and demonstrators in Egypt claiming some lives. Egypt`s benchmark stock index fell by 6.1%, bringing this year`s fall to some 12% already, CDS rates rose by 15 bps to 344, and 10-yr bond yields rose by 7 bps to 5.89%. Investors are apparently alarmed by the turmoil, and no doubt the Israelis and the U.S. administration are even more distressed by the possibility of lasting instability in this turbulent and critical region.
Interestingly enough, Secretary of State Hillary Clinton was on the side of the Egyptian protestors with her comments today, calling for restraint from both sides, but emphasizing "that the Egyptian government has an important opportunity at this moment in time to implement political, economic and social reforms.” This stance makes sense, since the remaining lifetime of the dictatorship in Egypt is probably limited by now even if it were to survive the recent clashes through some wonderous turn of luck, especially as the decade promises a lot of fluctuations in commodity and forex prices, creating a heavy burden on the already severely pressured Egyptian nation.
Among other things today, some are speculating on the possibility of another recession if the Fed stops its purchases in June, but that seems unlikely to us. We only need to recall that the current program was only launched because of unease in the markets and stagnation in the domestic economy. When the Fed Chairman announced the purchase program he made it clear that it was only in consequence of the commitment to "do whatever it takes" to prevent a depression that the central bank was engaging in quantitative easing. He never hinted that the program would be final, or that he would be unwilling to supply more of the same if the economy failed to respond as it had been anticipated.
As long as Ben Bernanke remains in control at the Fed, we will have his clear commitment to keep printing unlimited amounts of money to depend on as we assess the future direction of the U.S. economy and the market. Since the Fed doesn`t depend on us, the Congress, the President, or anyone beyond itself in determining what to do with monetary policy, we have great clarity on which indicator we should be following while trying to decide if there will be a QE3 or not. This indicator is the Fed itself, its minutes, and statements, which alone have the power to decide whether there will be a further bout of easing. The Fed will almost certainly engage in another leg of quantitative easing in case it is found out by June that the economy will go into a deep plunge once stimulus is withdrawn. With much of the emerging market world growing at a much slower pace by then due to unavoidable interest rate rises, it is likely that the Fed will extend the term of its bond purchase program, even if it decides to wait a while before doing so. Perhaps the August-September period would supply the catalysts for such a course.
Elsewhere, the committee set up to investigate the causes of the subprime debacle has finished its 550+ page report and among its findings we will be reporting that shoddy mortgage lending, excessive securitization of loans and speculative gambling on such securities triggered the crisis, according to the New York Times. The report will assign part of the blame to Ben Bernanke and his predecessor Mr. Greenspan, while criticizing the Bush administration and Henry Paulson for adopting haphazard, ad-hoc solutions and failing to bail out Lehman. These conclusions are generally agreed to by the market, and we only disagree that a Lehman Bailout would have made much of a difference. The whole financial system was burdened with worthless mortgage paper, and counterparty risk, and if it were not Lehman, the nerves of the public and the administration would have snapped at some other firm. With hindsight, it does appear that a takeover similar in strategy to the Bear Sterns deal could have been adopted delaying the breakdown of the system in September 2008, but this would never have satisfied the short-sellers, or the bears in the market, since, as we noted, the whole system was infected with the disease, and a collapse was almost inevitable. Further, while we may have ideal scenarios in our minds about government officials acting like corporate bosses, it is not sensible to ignore the fact that their responsibility is not only towards the economy, but also to the people at large. A degree of subservience to popular will is inevitable in a democratic system, even though this sometimes leads to difficult and painful results. This analysis doesn`t consider the viewpoint that bailouts are morally and fundamentally wrong, since the case for this position has been made many times by others, and there is no need to repeat it here once more.
With respect to the Obama Administration`s deficit reduction plan, our opinion is that unless similar restraint is shown by the Federal Reserve it is like plugging one hole in the ship while it keeps leaking from three others. The impact on the USD, gold, and the economy is dependent, to a large extent, on the Fed`s choices, since, as it is widely acknowledged by markets, the monetary policy of the United States is determined by the FMOC. This is different from the situation in China where the PBOC is not at all independent, or Japan, or the UK, where the central bank is expected to coordinate its actions with those of the government, even as it retains a great degree of independence. The President`s plan makes sense in many ways, but before we can speak of a real reversal in the fortunes of the dollar, or the gold market, we have to first see the Federal Reserve restrained, and brought under closer supervision so that its chain of exotic experiments is brought to an end.
