Risk On Risk Off - Correlate This!

Aha!

Is it Risk On Again to end the week? Wasn't it Risk Off to start the week? Who knows Grasshopper.

Daniel Son is getting awfully confused.

Risk On - Risk Off has rarely been apt  We saw this type of action last summer as well until Chopper Ben put it all in total Risk On Mode at his Jackson Hole speech starting the roadshow for QE2.

Will this year's annual swoon down under make Chopper Ben limber up the fingers to do some electronic printing? Who knows. I personally think that QE3 is not going to happen until well into 1st QTR 2012. My guy feeling is QE2 was 100% unnecessary. Chopper Ben was so obsessed with asset price deflation that he had it in his mind he wanted to keep asset prices higher than they normally would be. The economy had already turned up from its summer slumber last year when QE2 was announced.

We had a few rocky months in the economy starting in April going through July last year. This of course was caused by Tiger Woods escapades (Just Kidding), Yes, why not blame Eldrick for everything. No, it was Greece's first round of Sovereign debt problems that caused the havoc. Plus the ensuing contagion to Portugal, Italy, Ireland, and Spain. It was last summers edition of as Europe Burns that caused the temporary economic slowdown in the US. Also the Fed's hard date of March 31, 2010 to stop supporting/buying mortgages was a tailwind on Housing which just happen to be the entire US Economy at the moment. Isn't it funny that the PHLX Banking Sector rolled over a short few weeks later?

Take a look at this graphic of the PHLX Banking Index.

Bernanke started a whole new round of bond buying when the economy was already turning upwards. This basically was a stealth bailout of the banking sector and all stock traders/speculators in general. It was a massive Risk On announcement to Wall Street to take the Casino to another level. Commodities exploded higher causing massive problems once again not only at the pump but in foods in general. Retail gas prices as measured by the RBOB contract on the Nymex went from $1.80 in August 2010 to $3.40 in May 2011.

But of course, this is all emerging market demand from India, China and the rest of Asia. It was all demand related. Even in the face of Asian Central Bankers tightening credit all through out 2011. This was the Wall Street Meme. Its not us speculating but Asian demand. QE2 was all about creating a wealth effect channel. To keep asset prices higher than they would normally be. This is exactly the words of Brian Sack of the NYFED. Now we have the end of QE2 and Asia still in tightening mode and still remarkably the Wall Street Casino Meme is commodities are breaking down because of global growth worries. DUH! When the only three economies (AUSSIE/CHINA/INDIA) that are growing are desperately trying to slow their economies via the interest rate channel- what do you expect?


Everything else was cooling, except for financial/commodity asset prices. These were spurred on by QE2 speculation. My goodness! the ECB even raised rates a few times in the 2nd quarter of 2011, probably causing spreads in the periphery to expand even further. Global growth was slowing in a drastic pace just about the time QE2 ended. It was a perfect storm for commodity and financial asset prices. All the while Wall Street is alerting to us that its not their fault that commodity prices are going higher. It was never a global growth story that kept commodity prices higher. It was all about QE.

The Fed simply has to wait this economic slowdown out. Is this just a temporary slowdown? Is deflation a major problem going forward the rest of the year? We simply don't know. If QE3 is announced today the market I am sure would start to fly once again. Commodities even in the face of more China/India/Emerging Mkt tightening would rally higher. This by itself will hurt global growth even further. As the US starts another round of QE it only exports more inflation and speculation. This easy money policy only weakens the USD and makes Asian Central Bankers more vigilant to fight asset bubbles.

Bernanke has to wait this out. If the economy gets weaker and all odds are that it does its better to weigh on the side of caution and wait till first quarter 2012 to do so. Maybe by this time China/India/Australia will exit the tightening policy and move to neutral or easing policy? Maybe they do the work for you? Starting QE3 now would be the worst policy choice since well QE2.

On top of this we have Asset Correlations at a 2 year high.

Asset Price correlations among asset classes are at the highest levels in 2 years. The 10 industry sectors of the S&P 500 have been 97% correlated over the last month, This is higher than the 87% average over the last year, high yield bonds are at a 95% correlation to stocks, and currencies like the Aussie Dollar and Yen are at the upper ends of their historical price relationship to US financial assets. This needs to be taken seriously. If the USD strongly rallies - equities have a problem.