Submitted by Lance Roberts of Street Talk Live blog,
As we wrap up a most interesting, and volatile, week there are some things that I have discussed previously that are now brewing, interesting points to consider and risks to be aware of. In this regard I thought I would share a few things that caught my attention as I look forward to wrapping up the week that was.
1) Angela Merkel Election No So Assured
Some months ago in a missive entitled “Is The Eurozone Crisis Set To Flare Up?” I discussed the potential threat to the Eurozone being the dethroning of Angela Merkel by her opponents who are staunchly opposed to further bailouts for the weak Eurozone members and would prefer to see countries like Greece be expelled.
My friend Tyler Durden at Zero Hedge picked up on worry stating:
“On the back of our detailed discussion of the inner workings of the German election (here and here), it appears that we are no nearer understanding the two major political narratives that appear dominant currently. As Reuters reports, Angela Merkel’s center-right coalition and Germany’s combined opposition are running neck and neck, a poll showed on Tuesday, five days before the national election. Crucially, if the figures are repeated in Sunday’s election, Merkel will lack the support to renew her coalition with the FDP and Germany will most likely end up with a ‘grand coalition’ of conservatives and SPD, like the one Merkel led in 2005-2009.
Chancellor Angela Merkel’s center-right coalition and Germany’s combined opposition are running neck and neck, a poll showed on Tuesday, five days before a national election that will decide who steers Europe’s largest economy through the next four years.
The Forsa poll for Stern magazine showed Merkel’s conservatives still well ahead of other parties on 39 percent, unchanged from the previous survey, and their current coalition partner, the liberal Free Democrats (FDP), were on 5 percent, down one point and only just enough to enter parliament.
The main opposition Social Democrats (SPD) and their Green allies were on 25 percent and 9 percent respectively, both unchanged from the previous Forsa poll, and the far-left Left had 10 percent. The SPD has ruled out a coalition with the Left.
If the figures are repeated in Sunday’s election, Merkel will lack the support to renew her coalition with the FDP and Germany will most likely end up with a ‘grand coalition’ of conservatives and SPD, like the one Merkel led in 2005-2009.”
The worry, as I have stated previously, is that if Angela Merkel loses control of the Chancellorship it could well mean significant turmoil to an already very weak Eurozone situation. Furthermore, since Germany is the primary funding source of the European Central Bank, a lack of financial support could well mean the end of the ECB and its Eurozone lifelines.
2) The Debt Ceiling Debate
The Republican’s on Friday passed a bill, 230-189, that would keep the government funded past the September 30th deadline but would also strip funding for the Affordable Care Act. If anyone has been paying attention the ACA represents a huge economic problem in 2014-2015 due to massive increases in the cost of healthcare for the middle class which has seen both incomes and net worth decline in recent years.
The problem is that the bill will be immediately rejected by the democratically controlled Senate. This will kick the bill back to the House once again which is becoming increasing entangled in its own division within its rank and file. The question then becomes whether, or not, the Republican controlled house will allow for a temporary government shutdown to promote a compromise on budgetary issues.
As we approach the deadline the markets could be roiled by the heated debates as the President threatens “default” if Congress doesn’t act quickly to increase the debt limit. As I stated in the recent missive “The Real Reason For No Fed Taper:”
“The problem for the Federal Reserve currently is that they are once again facing an issue that nearly cratered the markets, and the economy, back in 2011. As we quickly approach the limit of the government’s borrowing capability the threat of a government shut down and “debt ceiling” debate once again looms. Bernanke is currently fearful of such a repeat event given an already weak economy coupled with rising interest rates. Any shutdown of the government, fear of “default” or restrictive fiscal policies could collapse what incremental recovery there has been to date.”
However, Ruth Marcus summed up the risks to the economy and the markets eloquently stating:
“The chilling part is obvious. Having the government shut down, especially briefly, is stupid but survivable. (Economically, that is. The political ramifications are another matter.) We’ve been down this idiotic path before, and we may well be stumbling there again.
But leaving the government unable to borrow enough money to pay the debts it has already incurred is a different matter entirely. Breaching the debt ceiling evokes words like catastrophic and unthinkable, which is why it has never happened.
And why the notion that it might is so surprising. Astonishing, actually. Washington is used to government by crisis and deadline. Our creaky system is capable of rousing itself only when the train is bearing down the tracks.
So my usual way of analyzing these moments is to reason backward: The debt ceiling must be raised.
Therefore it will be. The situation will seem to be at an unbreakable stalemate until, suddenly, a solution appears. Everyone will breathe a sigh of relief — until the inevitable next act in our political psychodrama. Panic, solve, repeat.
And this could well happen in the coming showdown. Let’s hope so. But steady Washington hands worry that this time really could be different — and, remember, even edging close to default is costly.”
3) The “Taper” Indecision Is Back
It certainly didn’t take long for the markets to go from indecision, to decision, back to indecision on the Fed’s future actions regarding its current bond buying program. On Friday, Senior Federal Reserve Official James Bullard suggested that the current bond buying programs could begin being scaled back as early as October. This would correspond with my views above on getting past a potential debacle in Washington over the debt ceiling debate.
However, what is particularly important about his speech was that he acknowledged that Fed policy has conventional monetary impacts.
“Financial market reaction to the June and September FOMC meetings provides sharp evidence that changes in the expected pace of asset purchases have conventional monetary policy effects. Using the pace of purchases as the policy instrument is just as effective as normal monetary policy actions would be in normal times”
The importance of this statement should not be dismissed. The implication is that “tapering” is effectively the same as “tightening” monetary policy which would be a negative for the stock market in the short run.
4) In The “Economy Is Improving” Camp
If the economy is indeed improving then why do officials continue to change the way we calculate the measures of the economy. First, the Bureau of Economic Analysis changed the calculation of GDP to include pension deficit liabilities and intellectual property, such as research and development, which boosted GDP by roughly $500 billion in total.
Now, the European Union is changing the budget calculation to ease austerity. From ABC News:
“The nature of the change is very technical — changing the methodology of measuring the output gap between potential and structural growth — but it could have significant repercussions. The result is used to calculate the structural deficit figure — that is the deficit adjusted for the cyclical strength or weakness of the economy — upon which the European Commission bases its policy recommendations…”
So, if your debt is increasing to the point that it becomes unlikely you can qualify for further bailouts and supports – change the way you measure it.
While you can mask problems in the short term through accounting gimmickry, and other shenanigans, eventually the issue will have to dealt with. The problem is that by the time that point is reached it has historically been the catalyst for a crisis.
5) Syria Already Set To Miss A Deadline
“1.-Syria: While there has been a tentative agreement between Syria, the U.S. and Russia, to destroy Syria’s arsenal of chemical weapons; the reality is that this is the same “dog and pony” show we witnessed with the WMD inspectors in Iraq. Syria will agree to comply up front and then will subsequently move their weapons to other locations such as Iraq and Lebanon. They will only allow the U.N. inspectors to “see what they want them to see” and “compliance” will be nothing more than an act. Of course, this is assuming the Syrian rebels will even let the inspectors into the country as they are highly offended by this agreement as they now feel the U.S. has abandoned them in their 2-year long crusade to oust the current leadership. The reality is that in the next few months we will likely be once again talking about limited strikes in Syria as history is once again repeated.”
That certainly didn’t take long as Syria, according to the LA Times, is already set to miss an initial deadline in the U.S.-Russia chemical arms deal.
“The ambitious U.S.-Russian deal to eliminate Syria’s chemical weapons, hailed as a diplomatic breakthrough just days ago, hit its first delay Wednesday with indications that the Syrian government will not submit an inventory of its toxic stockpiles and facilities to international inspectors by this weekend’s deadline.”
It is likely that in the months ahead that the markets will once again be faced with turmoil in Syria. This is particularly the case now that a third faction has now formed in region and is now exposing rifts between the FSA and Assad’s forces in the region. Islamic State in Iraq and Syria, or ISIS, recently drove the Free Syrian Army out of Azaz. ISIS is primarily composed of Al Qaeda linked terrorists and hardline jihadists.
According to a recent IHS Janes report:
“The new study by IHS Jane’s, a defence consultancy, estimates there are around 10,000 jihadists – who would include foreign fighters – fighting for powerful factions linked to al-Qaeda. Another 30,000 to 35,000 are hardline Islamists who share much of the outlook of the jihadists, but are focused purely on the Syrian war rather than a wider international struggle. There are also at least a further 30,000 moderates belonging to groups that have an Islamic character, meaning only a small minority of the rebels are linked to secular or purely nationalist groups.
The stark assessment, to be published later this week, accords with the view of Western diplomats estimate that less than one third of the opposition forces are “palatable” to Britain, while American envoys put the figure even lower. Fears that the rebellion against the Assad regime is being increasingly dominated by extremists has fuelled concerns in the West over supplying weaponry that will fall into hostile hands.“
With President Obama recently turning over the ban to provide arms to terrorist organizations the blow-back in the future could be significant leading to further turmoil for the financial markets. This is particularly the case if you add in Lindsey Graham’s recent proposal to gain authorization for a U.S. attack on Iran:
“…We’re going to put together a use-of-force resolution allowing our country to use military force as a last resort to stop the Iranian nuclear program, to make sure they get a clear signal that all this debacle about Syria doesn’t mean we’re confused about Iran.”
6) Video Interview Of The Week
This interview with Stanley Druckenmiller earlier this week is a must watch. As per Zero Hedge:
“Reflecting on exactly what was said yesterday, Duquesne’s Stanley Druckenmiller is initially perplexed as Bernanke explained ‘financial conditions’ – not interest rates – have prompted the decision to forestall any taper. His confusion is that financial conditions are actually slightly better than they were in June and “a stock market at an all-time high would suggest we don’t have a problem with financial conditions.” While he dismisses surveys, the big-money was betting that they were going to taper as is clear from the moves in gold, bonds, and stocks; and it appears the Fed “lost their nerve.” In fact, Druck continues, the Fed “blew it… they had a freebie,” they could have started the process to “get us off the dope.” This action, or inaction, he warns “is going to make it so much harder for the next Chairman to start the process.” In fact, he concludes, that from beginning to end – once markets adjust from these subsidized prices – that the wealth effect of QE will have been negative not positive.
His discussion focuses on the transparency mistakes, the cornering they have managed, and the concerns he has over QE in general…
QE1 he supported as a crisis-fighting tool at the time – but from QE2 onwards and 5 years and he “doesn’t think the academics at the Fed understand the unintended consequences of the exit.”
At around 13:45 he also provides a clear explanation of the ‘other side’ of the Fed’s expanding balance sheet – the average investor who is ‘forced’ to sell them the bonds and take on more risk… this has forced us to buy securities at subsidized prices and when they adjust, at whatever point in the future, they will adjust immediately and on no volume.
In fact, he concludes, that from beginning to end – once markets adjust – that the wealth effect of QE will have been negative not positive.
At 15:00, he explains how this is the biggest redistribution of wealth from the middle class and the poor to the rich ever – “who owns assets” he asks rhetorically…
Druckenmiller begins at 8:03…
Complacency Not An Option
While the recent Federal Reserve inaction is bullish for stocks in the short term there are plenty of reasons to remain somewhat cautious. Stocks are overvalued, rates are rising, earnings are deteriorating and despite signs of short term economic improvements the data trends remain within negative downtrends. Investors, however, have disregarded fundamentals as irrelevant as long as the Federal Reserve remains committed to its accommodative policies. The problem is that no one really knows has this will turn out and the current assumptions are based upon past performance.
However, as anyone who has ever invested should already know, past performance is no guarantee of future results.