Markets Insight
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Last updated: May 1, 2012 7:57 pm
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Time to apply EM lessons to euro crisis
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By. William R. Rhodes


Mexico, Brazil, South Korea and Turkey emerged in recent decades from severe economic crises to secure dynamic and sustained rates of economic growth, financial market confidence and establish increasingly strong democratic institutions.




It is urgent that the leaders of Europe and the US learn from the experiences of the key emerging market economies in addressing today’s crucial difficulties.



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Political leaders in Europe must now confront the eurozone crisis with the boldness and realism that leaders in successful emerging markets did in the past. Further fence-sitting is unacceptable: financial market confidence in the ability of Europe’s political leaders to act is deteriorating at an accelerating tempo.


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Illustrating this point is what has been happening recently to yields of Spanish and Italian government bonds – as of May 1, 10-year yields had widened to 5.77 per cent in Spain and 5.54 per cent in Italy, from 4.9 per cent in early March for both countries.



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The seriousness of the euro area’s problems is manifest in the European Central Bank’s recently published monetary statistics showing the annual rate of bank credit growth has slowed down from a lacklustre 2.7 per cent last October to 0.7 per cent in February; consumer credit has contracted for 35 consecutive months, since early 2009.



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What really concerns the markets is the broad sense that political leaders in the leading industrialised economies are failing to set confidence-building policies to deal with profound fiscal difficulties, or recognise that their current approaches to financial sector regulation are damaging the outlook for sustainable growth.



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Successful crisis-management leaders in emerging markets, from then Finance Minister Fernando Henrique Cardoso’s Real Plan in Brazil in 1994, and South Korea’s Kim Dae-jung in 1998, to Turkish economics finance minister Kermal Dervis just a decade ago, crucially understood how important regaining market confidence was to their economies. They all put in place bold programmes that restored market accessprogrammes that combined pro-growth actions that secured domestic public support; structural reforms that enhanced competitiveness; and medium-term budget plans to expunge formidable excesses.



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Today, such forthright and comprehensive policy approaches are lacking on both sides of the Atlantic. The dangers of a protracted economic malaise seem lost on our political leaders. They seem almost as oblivious to the risks to the global economy now as they were, for example, in early 2007 when a number of us warned of the rising dangers of the US housing bubble.



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Irrespective of election pressures, European policymakers need to have the courage to change course with regard to both fiscal policies and financial regulation. They need to focus squarely on supporting policies that offer a path to sustainable growth, while pushing on structural reforms to promote competitiveness and on medium-term fiscal consolidation.


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Current pressure by the EU’s Commission and the eurogroup on Spain, Italy, Portugal and Greece, to keep slashing public spending has been overdone. It is a course that leads to recession, further weakens Europe’s financial sector and increases domestic political opposition.



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Meanwhile, in the US, fresh attempts to secure a constructive consensus over fiscal policies are also essential, including tax reform. It would be reckless to have a repeat performance this year of the debt-ceiling farce that we saw in Washington last year.



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Every emerging market sovereign debt crisis was accompanied by a banking crisis. This lesson has largely been lost on the European politicians and officials who are forging ahead with new regulations, plus increases in capital requirements ahead of the Basel III implementation schedule, while ignoring the impact of the European sovereign debt crisis and the soft economic conditions on bank balance sheets. Policies need to be rapidly assembled to strengthen the ability of eurozone banks to power credit growth at this time. Matters are certainly not helped when some political leaders continue to support the introduction of a new tax on financial transactions. In the US, the contribution by the financial sector to growth is less than it should be because of continuous uncertainties about how Dodd-Frank will be implemented.


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Two important lessons from emerging market sovereign debt crises are that contagion is always greater than policymakers anticipate, and time is the enemy. Financial markets are now signalling that the clock is running fast and that the impact of further delay in acting resolutely, especially in the eurozone, will be to deepen Europe’s problems and to spread the pain to a still greater degree far beyond Europe’s borders.



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William R. Rhodes is President and CEO of William R. Rhodes Global Advisors and author of ‘Banker to the World – Leadership Lessons from the Front Lines of Global Finance’



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Copyright The Financial Times Limited 2012.

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May 1, 2012 7:18 pm

After the bonfire of the verities

Ingram Pinn illustration




What is the future of central banks? It will be busy, because they are now expected to deliver both monetary and financial stability. It will be controversial, because the decisions they make have a huge impact on the distribution of income, people’s access to finance, the way the financial system operates and even the solvency of governments.



Before the crisis, the rise of sophisticated modern finance was thought to render redundant the role of central banks as guardians of financial stability. It had been long believed that their role as financiers of government brought only inflation. Thus, central bankers became priests of a monetary policy aimed at low and stable inflation.
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This past is a foreign country. Central banks have not abandoned the religion of price stability, though some economists have muttered heretical thoughts about the need for higher inflation. Nevertheless, central banking has been transformed, in practice and theory.


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The practical transformation is a direct result of the crisis. Central banks found themselves forced into historically unprecedented monetary easing, not just via extremely low interest rates but also via huge expansions in their balance sheets (see charts). Of the big central banks, the Federal Reserve was the most innovative, partly because of the role of non-bank institutions and partly because of the inability of the fiscal authorities to act. But the European Central Bank has been surprisingly innovative, too.


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The huge expansions in central bank balance sheets are thought to be harbingers of hyperinflation. Those who live on income from savings are enraged by the low interest rates. Almost everybody is angry about the bailout of the banks. The fact that the central bankers saved the world from a second great depression is disregarded. Nobody gains credit for eliminating a hypothetical event. It is perhaps surprising that central banks have not been even more discredited.


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The theoretical transformation is an indirect result of the crisis. The list of the assumptions that turned out to be false is lengthy: that the financial system would be self-stabilising, that managers of banks would prove competent, that financial innovation would improve risk management, that low and stable inflation would guarantee economic stability. We have witnessed a bonfire of the verities.



In short, central banks are doing far more with less political capital. To be fair, not all are tainted by failure. The central banks of Canada and Sweden, to name two examples among high-income countries, can hold their heads high. But this is part luck: these countries had crises in the 1990s. Sooner or later, as Hyman Minsky warned, complacency breeds excess and crisis.

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What, then, is to be done?



The immediate task is to manage an exit from the interventions. Critics exaggerate the difficulty of this task. The fears of imminent hyperinflation are idiotic. As Ben Bernanke, chairman of the Federal Reserve, explained in an important speech on April 13, central banks have expanded their balance sheets because those of the private financial sector collapsed.* That is what a lender of last resort is supposed to do during a severe panic. We have known this since the 19th century.



Then, as and when private lending recovers, the central banks will reverse course, selling assets into the market and reducing their credit to banks. But this will be a lengthy and fragile recovery. A far greater danger exists of premature retrenchment than of excessive delay. The risk of inadequate action and premature retrenchment is greatest in the eurozone. If so, there is a chance that the euro and much of the fabric of postwar European co-operation will be swept away. Central banks are not playing for small stakes.


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Then, if they manage the exit successfully, which we will probably not know until the 2020s, central banks will confront a new world. They will need to balance their old roles as formulators of monetary policy with new roles as guardians of financial stability.



Making this still harder will be the dire fiscal legacy of the crisis. The higher levels of public sector debt threaten a return to “fiscal dominance” in which central banks will, willy nilly, be forced to finance the government, however inappropriate that may be.


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The new world of post-crisis central banking will create significant institutional challenges.


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Domestically, the issue will be how to secure needed co-operation among the fiscal authority and the bodies charged with oversight of individual institutions, oversight of financial stability and management of monetary policy. Even where, as in the UK, the last three responsibilities are all going to be part of the central bank, relationships with the ministry of finance will be crucial. Moreover, the centralisation of authority in one institution carries its own risks of insufficient airing of differences, groupthink and ultimate failure.




Yet the world of macro-prudential policy will also generate cross-border overlaps. Banks operating in one jurisdiction have the capacity to generate large negative spillovers on to other jurisdictions. Managing these is going to prove very difficult, particularly within Europe.



Yet the most difficult challenges are not institutional, but intellectual. How, in practice, will policies aimed at securing financial stability interact with monetary policy? Consider, for example, the possibility that the committee charged with the former is trying to cool lending in, say, the property sector when the committee charged with the latter is seeking to heat it up in the economy. They could find themselves operating in contradiction.



More fundamentally, nobody can be confident that the propensity of the financial system towards huge crises can be halted. Indeed, the longer that success is achieved, the greater will be the complacency and the bigger may be the crisis. Yet the regulators, central banks foremost among them, are doomed to try. The price of past failures is their present increase in responsibility. It really is a strange and eventful history.



*‘Some Reflections on the Crisis
and the Policy Response’,
www.federalreserve.gov




Copyright The Financial Times Limited 2012.


HEARD ON THE STREET
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Updated May 2, 2012, 2:09 p.m. ET
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Fed Up With the Repo Man
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By DAVID REILLY






For the second time in less than a month, the Federal Reserve has sounded an alarm about an important, if little known, part of financial markets. With that, the time for action is at hand.


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Speaking Wednesday on efforts to strengthen regulation, and before a meeting with the heads of major banks, Fed Governor Daniel Tarullo outlined continuing risks to the financial system from the so-called shadow-banking system. This is made up of activities that typically fall outside traditional, regulated bank business.



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In doing so, Mr. Tarullo focused on money-market funds and a short-term funding area known as the tri-party repo market. Those were also called out by Fed Chairman Ben Bernanke in an early April speech.
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[tarulloherd0501] Bloomberg News
Daniel Tarullo



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Mr. Tarullo said that in the tri-party repo market, "a major vulnerability lies in the large amount of intraday credit extended by clearing banks on a daily basis." The two major clearing banks are J.P. Morgan Chase JPM -1.45% and Bank of New York Mellon BK -0.13%.



As part of the clearing function, these banks manage the daily exchange of cash and securities that make up repurchase, or repo, agreements and themselves extend temporary intraday credit as part of this. Mr. Bernanke said this credit averages about $1.4 trillion.



Although this market usually functions smoothly, there is big systemic risk involved because of the interconnectedness of the clearing banks and securities dealers. Problems on either side during a crisis could ricochet, leading to freeze-ups in short-term funding markets and straining firms' finances. The danger is all the more acute given that J.P. Morgan is the biggest bank in the country by assets and ostensibly the most interconnected since it has the largest derivatives portfolio.



An industry initiative to address tri-party repo issues, among them limiting the amount of credit, "fell short," as Mr. Tarullo said. He added that in light of this, "it now falls to the regulatory agencies to take appropriate regulatory and supervisory measures to mitigate these and other risks."



That is tough talk from the Fed's point man on bank supervision. Given banks' inability to address the problem, he needs to follow through. 

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Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved



Equities Fight to Hold Up While EU & US Data Give Mixed Signals
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May 2nd, 2012 at 8:42 pm



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Investors and traders just can’t seem to catch a break when it comes to economic news. For example Tuesday in the United States we saw strong ISM manufacturing numbers which surprised the market.


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The numbers were way above expectations and it triggered a feeding frenzy in US based investments like stocks and the green back.


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The following session Italy reported terrible PMI and unemployment rate numbers which took most of the wind out the European and US stocks. One day the data is great, next day it’s bad.


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The strong numbers in the US have everyone including myself thinking that this week’s jobless claims (unemployment rate) will be down. If this is the case then we will see stocks jump along with the dollar, much like what we saw trader do last Tuesday which is what Jim Cramer says bestBUY BUY BUY.



Normally we do not see the dollar index rally along with stocks but if EU continues to show signs of weakness then it is very likely the dollar and equities inverse relationship could decouple. Reason being investors around the globe will focus their money on the more stable US investments like the dollar and US stocks.



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The Dollar is Trading at a Major Tipping Point – Weekly Chart



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The dollar index is something that I watch very closely on a daily basis. Focusing on the weekly and 8 hour charts I look for support and resistance levels along with price patterns.



As you can see from the weekly dollar chart below, a large bull flag has formed. This pattern typically means higher prices and in this case the price target is between the 86 and 88 level.

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There are few wild cards to toss into the game on what will unfold next:

1.- Currency manipulation seems to be strong and if the US wants a low dollar value then it’s likely it will stay low. This bodes well for stocks and commodities.
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2. Depending on what happens and how things unfold in Euro-land the dollar/stock relationship could decouple meaning they could start to rise together. If we get neutral economic data out of the EU and positive data out of the US it will likely boost the value of stocks and the dollar. But strong negative data out of the EU will more than likely just sent the dollar higher and spooking investors and triggering a selloff in stock prices.

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Dollar Index Investing


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Dollar Index 4 Hour Chart



I find the dollar index to be a great trading tool in helping me time short term reversals in the equities market.



Taking a look at the 8 hour chart below you can see recurring bullish falling wedge patterns. The most recent brake out was this week and I anticipate the 79.50+ levels to be reached in the near term. If the dollar does continue to move higher then I expect sideways to lower stock prices for a couple more sessions.



That being said, the mixed economic data between the US and EU is going to cause this scenario to be unpredictable. Depending on the jobless claims this week stocks could actually rally while the dollar moves higher. Unfortunately, this week’s mixed data does not provide any trading opportunities that I feel comfortable making.
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Dollar Index Trading

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Mid-Week Market Conclusion:


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In short, I feel a higher dollar is likely to happen. As for stock prices, well they are more of a wild card at this time but my analysis slightly favors higher prices.



To quickly touch on precious metals, they are likely to be under pressure for a few sessions simply because of the rising dollar.


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I hope my analysis helps paint a picture of what to expect in the coming days.


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Happy Trading,
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Chris Vermeulen

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US Treasurys Are ‘Junk,’ Dollar Headed for Collapse: Schiff

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Published: Tuesday, 1 May 2012 | 11:07 PM ET
 
By: Jean Chua
Writer, CNBC.com
 
 

The greenback and the U.S. bond market are headed for a collapse as the U.S. Federal Reserve loses the ability to service the nation’s debt with “artificially lowinterest rates, Peter Schiff, CEO of Euro Pacific Capital told CNBC on Wednesday.

“As far as I am concerned, U.S. Treasurys are junk bonds,” Schiff said on CNBC Asia’s Squawk Box.” “And the only reason that the U.S. government can pay the interest on the debt, and I saypay’ in quotes because we never pay our bills. We borrow the money so we pretend to pay, but the only reason we can do it is because the Fed has got interest rates so artificially low.”
 
The Fed [cnbc explains] has been keeping rates on benchmark 10-year Treasurys low by purchasing bonds via quantitative easing (QE) [cnbc explains] , and this will ultimately be the U.S. economy’sundoing,” Schiff said.


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Unfortunately, we are going to get more QE than Rocky movies, because the only thing keeping this phony economy going is this QE,” he said. “And the minute you take it away, it’s going to collapse.”



Schiff’s comments come after two Fed officials warned on Tuesday that the U.S. could be heading for a fiscal cliff at the end of the year if mandated tax increases and spending cuts are implemented. On the same day, fund manager Bill Gross, who runs the world’s biggest bond fund, told CNBC that the U.S. will face a downgrade of its triple-A debt rating if it did not fix its fiscal situation.



“It’s not just $15 trillion in terms of current debt,” Gross said on CNBC’s Street Signs.” “It’s probably three to four times that in terms of Medicare, Medicaid, of Social Security, in terms of the present value.”



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“So unless the U.S. begins to make some inroads, and that’s called the structural deficit that the (Congressional Budget Office) and the (International Monetary Fund) basically identified as perhaps six to seven to eight percent, greater than any country other than Japan and the U.K. Until we address that structural deficit, then yes, we're headed to double-A territory,” he said.



Euro Pacific’s Schiff predicts weakness in the U.S. dollar, which will put pressure on commodity prices and fuel inflation [cnbc explains] . This will in turn force the Fed to raise interest rates, he added.



“The Fed will not do it; the Fed knows the only thing propping up our phony economy is zero percent interest rates and quantitative easing. And I think when the market figures this out, it’s going to put even more pressure on the dollar,” he said.



Schiff is a well-known bear who predicted in 2008 that the dollar will collapse amid hyperinflation [cnbc explains] . That did not happen, and the dollar strengthened against most major currencies by the end of 2009.



Andrew Economos, managing director and head of sovereign and institutional strategy at JPMorgan Asset Management, said what the Fed is trying to do is “buy time” by keeping credit cheap and encouraging banks to lend.



Look, I am not an apologist for the Fed, but at the end of the day (Fed Chairman Ben) Bernanke is doing the only thing that he can do, which is buying time,” Economos said on CNBC’s The Call.” “And I think that buys us time to rectify those structural problems the bears are harping about. It allows corporates and households to continue to deleverage and derisk their own personal balance sheets.”