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Money Monitor: The Fed's Credibility


The Fed simply cannot stop raising short-term interest rates without running a very real risk of losing global credibility.


It's well past 'closing' and the global monetary authorities, noting the swagger-turned-stupor of all participants, have finally decided to Pull the proverbial 'Punchbowl' away, as last call has come and gone.

Most importantly, 'closing time' has been synchronized, globally.

China raised reserve requirements on Friday, a day after the Swiss National Bank raised interest rates. In the meantime the Fed is all over the tape, talking hawkishly about intensifying inflation expectations, while inflation data released this morning in both Europe and Asia reveals a continued broadening push higher in yr-yr CPI.

Let's dissect a few of these items:

  • From St. Louis Fed President William Poole:

    "If the inflation rate continues to be persistent like this, the Federal Reserve will simply have to pursue persistent policies that will keep inflation from increasing further."

  • From Fed Board Governor and Vice-Chair nominee Donald Kohn:

    "Inflation expectations have come a little bit unhinged, it's not a lot, it's not a big deal, but it has presented us with some issues. If financial market participants thought that the FOMC was not dedicated to maintaining long-run price stability, they would be less willing to hold dollar denominated assets, and the resulting decline in the dollar would tend to add to inflationary pressures."

  • And, from KC Fed President Thomas Hoenig:

    "The US faces a growth crisis, over time, from its large and persistent current account imbalance, which systematically lowers your potential growth rates. That does have long-term effect on your wealth position, as a nation. Codependency and complacency have a very real meaning right now."

Co-dependency...hmm, where have we heard that one before?

Bottom line, the Fed is concerned about credibility.

They are not concerned, necessarily, about the USD.

They are concerned about inflation, particularly as relates to embedded expectations, despite concerns pertaining to intensifying disinflation risk in housing and the US consumer.

Thus, they are boxed in, particularly as applies to the GLOBAL situation, where an increasing number of central banks are becoming more hawkishly predisposed, amid a broadening rise in CPI.

This is quickly evolving into a worst-case scenario for the Fed, where they are literally 'forced' to tighten more aggressively, and do so 'into' a significant erosion in growth.

At risk, paper wealth reflation.

Of course, containing inflation expectations might work, if that can be accomplished quickly, broadly and decisively, on a global basis.

In other words...FUH-geTTTT-ahhhh-BOUTTTT-it!!!

In other words, it ain't happening.

Evidence the following pair of data tid-bits released within a couple of hours of one another on Friday afternoon:

  • Russian Monetary Base … 2.455 trillion Roubles as of week end-June-13, a new all-time record high, by far, and up a whopping +70.5 billion in just the latest week, a nominal single-week expansion of three percent.

In other words, in the last week, the Russian Monetary Base expanded at a pace exceeding +150% annualized.

Moreover, and more 'tellingly,' this has been the case, for weeks, with the Russian Monetary Base having risen by more than a quarter trillion Roubles since the beginning of April alone, when it was posted at 2.172 trillion in total.

Since the end of 2004, the Russian Monetary Base has expanded by exactly +50%, nominally.

Then, just a couple of hours later, we get:

  • US Bank Commercial Bank Loans Outstanding, Real-Estate...$3.065 trillion, a new all-time record high, by far, as per the rise of +$6.3 billion reported for the week ending June 7.

Indeed, despite the deep contraction in the MBA Refinance Index, commercial bank lending to the US Real-estate sector has continued, unabated, with the total loans outstanding climbing every week since it first moved above $3 trillion in total, during April.

Further, we note the new cycle high in lending to the Commercial and Industrial sector, which increased by almost $9 billion in the latest week, to reach $1.127 trillion in total.

And, even more interesting, was the steep plunge in the amount of loans outstanding held 'against' Securities, as thoughts of intensified margin call risk are given credibility amid a huge single-week dump of $25.2 billion.

In other words, taking a macro-step back for a top-down perspective as relates to these two micro-data points, in the US and Russia, from both the external and internal monetary conditions perspective, the Fed simply cannot stop raising short-term interest rates without running a very real risk of losing global credibility.

And thus, intensifying risk of the Fed moving by fifty basis points, is now being contemplated, a la market pricing. Note the push on Friday into new high ground by the December 2007 Eurodollar Deposit Rate, seen in the daily chart below, as the implied yield extends its upside breakout above 5.5%.

Subsequently, the USD is rallying and the US Yield Curve is flattening back into a state of 'inversion,' reflective of the intensifying risk to paper asset reflation, and the US housing/consumer sector emanating from the hardening thought that the Fed will maintain their hawkish stance.

In terms of the link between the US consumer and the paper wealth reflation in the US housing market, we love to focus on Lowes (LOW), for its all-encompassing 'retail/wholesale' coverage, as per selling just about anything related to a consumer's home.

The steep multi-year reflation in the price of the stock is reflective of the entire era of the housing (debt) facilitated US consumption-import boom, the one that has led to the intensified imbalances the Fed worries about.

Simply, a breakdown in Lowes below $60 would be a technical negative, and might send a macro-message as well. Evidence the weekly chart, and focus on the technical pattern, and preliminary breakdown in On-Balance-Volume.

Another stock to monitor, for its global reach, is Big Blue, IBM, which has failed to participate in the latest reflation wave, and is now threatening to violate the secular uptrendline in place since the recession of the early-90's.

As for US housing, with the NAHB data in the spotlight, we observe the pair of weekly charts on display below. Here we plot the 52-Week (1-Year) Exponential Moving Average (red line) against the 104-Week (2-Year) Exponential Moving Average (blue line) for two of the major US home building stocks.

First, Toll Brothers (TOL):

And Hovnanian Enterprise (HOV), seen below:

From this top-down macro-technical perspective, the housing market is already disinflating, a la the 'bear-cross' in the long-term moving averages.

So, from the Fed, we move to another Central Bank that is currently coming under our spotlight scrutiny, the Bank of Croatia.

Yes sir, the Bank of Croatia is not only in play, but the situation in Croatia exemplifies the complete complacency and co-dependency that we have so often spotlighted, and as is now highlighted by KC Fed President Hoenig.

There is no alternative explanation for the fact that the Croatian Kuna has commanded a whoppingly fat-high-risk-yield of, gasp, only 3.6%.

Unfortunately, and as testament to the sudden rise in risk-awareness, that yield is no longer, as last week's auction of Kuna-Bills was met with SCANT demand, causing the Croatian Finance Ministry to re-price this week's auction to offer a 4% yield on the 364-Day Bills.

The problem is that Croatian CPI rose to 4.0% yr-yr in May, from April's +3.5% yr-yr pace.

In other words, Croatian Bill Yields are now negative despite the rise.

Can anyone say the words risk assessment?

We'd guess not enough, not nearly enough yet, not when the Kuna offers a real yield of zero, and still stimulates investor demand!!

Nothing against Croatia per-se, but come on, get real. The risk complacency is outrageous, preposterous, out-of-control, case closed.

Evidence the reflation in the Croatian CROBEX Stock Index, seen in the multi-year weekly chart on display below. From below 1,000 as recently as early 2003, to a recent peak above 2,600, the Croatian stock index has clearly experienced a significant reflation in paper wealth.

However, we also note the MACD momentum indicator, which is rolling over to the downside, and in so doing is creating a significant degree of 'bearish divergence,' implying that a serious test of the uptrend is likely unfolding.

For sure, like most all emerging markets, even the zero-yielding Kuna-based Croatian CROBEX (black bars) has far outperformed the US stock market, as defined in the weekly overlay chart below by the S&P 500 Index (blue line) over the last four years.

Thus, we are now closely monitoring the action in the Kuna, for signs to suggest that a shift in risk-assessment and global excess liquidity are becoming more intense, a dynamic we believe would be reflected in a strengthening in the USD (and EUR more specifically) against the Kuna.

VOILA, the weekly chart of USD-Kuna seen below reveals the possibility that a technically significant double top in the Croatian currency may be developing, as reflected by the USD's possible double-bottom. We spotlight the MACD indicator, which is exhibiting serious bearish Kuna divergence (USD bullish divergence), and, is reversing towards a USD bullish trend.

Taking a closer, shorter-term look as reflected in the daily chart of the USD versus the Croatian Kuna, seen below, we'd suggest that a violation of the 5.8 Kuna per Dollar level would constitute a technical breakdown in the Croatian unit (breakout in the USD), as defined by a penetration of the short-term 50-Day Exponential MA, in line with a confirming violation of the boom-bust 50-line by the Relative Strength Indicator and an expansion in Volatility.

Subsequently, the near-term action in the MSCI Emerging Markets Index (EEM) becomes all the more critical and telling. Noting the weekly chart of the EEM on display below we observe that last week's upside reversal took the index right back to its original breakdown pivot point, and, right to the 52-Week Exponential Moving Average, which was penetrated to the downside previously and has rolled over directionally.

Hence, the next sizable move in the EEM might well be a clue as to the next big move in global paper wealth assets.

When we connect the dots from an intensified push towards increasingly hawkish monetary conditions globally and the degree of complacency that has so dominated risk assessment dynamics for so long, we cannot help but think that the above mentioned 'next-big-move' will be to the downside for global equities, amid a return to two-way risk assessment, and the realization that many reflated assets have not been properly assessed, at all.

We remain 'bearish' on US stocks, from a speculative trading perspective.

From an investment perspective, amid the inversion in the US Yield Curve, we favor dancing the Rock and Roll Hoochie Koo, buying bonds, and selling the spoo.

Further, we are also bearish on a lengthening list of emerging market currencies, and equity indexes.

Finally, we remain neutral on bullion, fearing that an A-B-C corrective pattern is unfolding, with the A-wave correction to the first of the Fibonacci retracements in the $550 area, completed.

A potential C-wave extension might spike Gold back below $500, to the 50% Fibonacci retracement level relative to the entire bull market and the location of the 2-Year Exponential Moving Average.

With an increasing number of Central Banks talking tough and taking action, it will be difficult to immediately resurrect the bullion bull market, especially if the USD begins to appreciate more forcefully, versus emerging market currencies.

Hey, it looks like 'closing time,' even in Zagreb.

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