Tuesday, August 2, 2011

Fed Policy = Global Slowdown

Yesterdays US PMI was a disaster. This is a key manufacturing index that was supposed to rise this past month. If you remember last month this unexpectedly rose triggering a nice market rally. The figure came in at 50.9 vs expectations of 54.6 and is a drop from a strong 55.3 in June.

What we have seen over the past 24 hours are CHINA, US, and the EZ all reporting respective July PMI's near the magic 50 level. Anything below 50 and manufacturing is considered contracting. The UK PMI came below 50 - How is Austerity going?

Is this directly related to the ZIRP policy by the Fed? Does QE have anything to do with this?

You can look at it a few ways. The US has had an easy short rate policy since the end of 2008. This basically exports our inflation to emerging markets. Hard US Financial assets are in deflation mode. Housing is bleeding, short term deposits are yielding nothing. Most Americans are trying to dig themselves out of debt after years of binging on cheap credit. The US Economy is going through a classic balance sheet recession. No matter how low interest rates are it wont stimulate aggregate demand. The financial system is in a liquidity trap as trillions of dollars are sloshing around in the banking sector. Does this sound familiar - Japan?

Monetary policy in a balance sheet/liquidity trap environment is completely impotent. A ZIRP just exports inflation to emerging markets.

What have we seen in China and India? Explosive asset price inflation. Rising commodity prices. These are real serious problems for the Chinese and Indians. So much that India and China are in massive tightening mode to stop the flow of cheap dollars into their economies.

ZIRP and QE has created a massive USD carry trade bubble. As Asia has been the driver of global growth for the last few years any slowdown will be felt globally most likely in the US and EZ economies. The Asian economies got way to hot and now need to cool down.

What we have seen for the better part of this year and last are Asian economies drastically trying to slow their economies via the interest rate channel. In China they have gone one step further by increasing bank reserve requirements. In short the entire Asian continent is in tightening mode. Asian currencies are pegged to the dollar creating massive trade imbalances. European and US export markets were all strong because of this. All good things need to come to an end, and from the global PMI prints this is happening. Where are we in the Asian tightening cycle? 4th inning? 7th inning? bottom of the ninth? I would venture a guess that we are n the late innings but it all depends on what type of economic policy comes out of developed nations. We have seen what austerity has done to the EZ peripheral nations and what it has done to the UK. It now looks like the US is moving into that mode. Its an ass backwards policy. The only way to get out of this mess is to grow your way out of it not by raising taxes and cutting spending. We need to have normalized monetary policy that fosters job growth not that fosters speculation.

 Asian currencies are way overvalued compared to the Euro and USD. These structural imbalances are causing massive headwinds for policy makers globally.

What I see happening is a global slowdown which means more QE from the Fed as of course its a supply problem ain't it? We will see another reflation starting with the Asian economies going into easing mode later this year. Its the hamster running around the wheel.

So what we have are overheated Asian economies being the fuel for global growth via a ZIRP/QE policy. What goes up has to come down. Those economies are slowing down because they have to. All of this is happening as QE ends? Funny ain't it. So the Fed will see this as we are the only ones who can actually reflate anything so lets do one more round of QE.

When the reasons and cure are the same we all need to duck for cover.

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