Central Bankers At Work
And the "Dr. Heckyll and Mr. Jive" Syndrome
By Frank Barbera CMT. March 18, 2008
"Dr. Heckyll works late at the Laboratory,
Where things are not as they seem,
Dr. Heckyll wishes nothing more desperately,
Than to fulfill all his dreams"
– Men At Work, Cargo Album 1983.
Well, another Fed meeting, another pair of huge rate cuts, and of course (how could we live with out it?), another Fed statement on the outlook of what's ahead. As I heard the post "Fed Rate cut announcement" unrelenting "talking heads" chatter, I am reminded of the 1983 parody song done by a band called "Men At Work" entitled "Dr. Heckyll and Mr. Jive." To this end, I cannot help but think of Ben Bernanke as Dr. Heckyll, and John Claude Trichet as the new Mr. Jive. Bernanke "works late in the laboratory" trying to fix the collapsing credit bubble and find the magic monetary potion which will prevent the pile of derivative instruments from exploding in his face. On the other side of the Atlantic, Trichet is the infamous Mr. Jive, who at the moment, is "jiving" or "deluding" himself, deranged by the toxins of the magic potion into thinking that somehow a US recession and monetary collapse will somehow leave Europe unscathed. Truly, when you look at, it is almost as if these two have collectively downed the "Mad Man" potion, first conjured up by Robert Louis Stevenson in his 1886 book, "Dr. Jekyll and Mr. Hyde."
Precisely where is the ECB Central Bank intervention and supporting rate cuts? Where is the Central Bank unified front? The world confronts the largest credit contraction in 60 years and all the Central Banks break ranks? Huh? Oh yes, I forgot, Europe is in the "fear of rising cyclical inflation" mode -- how dumb of me. But precisely how devastating will the forth coming exported US recession be? When it hits European shores, mark these words -- not since D-Day will those shores be so besieged. A credit collapse in Spain, a huge housing bear in the UK, a deep contraction in Italy and Greece now spreading to France, while Germany decides to stand idly by. What?
What delusional group of mad man are in control of ECB policy? Do they really believe that at this point, the path forward isn't pointing straight downhill? One wonders when the full impact finally arrives whether the EMU will truly survive, or splinter back into its original umpteen pieces. Perhaps the Long Swissy/Short Euro trade still has a long way to go.
"Letting loose with a scream in the dead of night,
As he's breaking new ground,
Dr. Heckyll is his own little guinea pig,
But he's not sure what he's found"
In the book, by day, Dr. Jekyll was the kind Doctor, and by night he became the mass-murderer, Mr. Hyde. In today's Fed action, we see more evidence of a "Jekyll and Hyde" personality hard at work. First, we see the Fed throwing out to Wall Street a hefty .75 basis point cut in the Fed Funds Rate to 2.25%, and for good measure, a hefty .75 basis point cut in the Discount Rate to 2.50%. Call it throwing out the life line for the benefit of all Wall Street cronies -- you know, the guys desperately in need of a life preserver after years of reckless financial practices, the very same one's who never have "liquidity problems" (deny, deny, deny) right up until the last moment, when financial implosion finally arrives. Will Citicorp survive? Will Fannie Mae survive? Will Ambac survive? Clearly, Fed clemency came too late for Bear Stearns, but gauging from today's big Wall Street rally, the market senses hope.
"Not long now till the Ultimate Experiment,
He's breaking all the rules,
He wants to cure all matter of imbalances,
In this world of fools,"
Of course, with the Fed indulging in this ultimate experiment, perhaps the real question to ask is, "Will the Dollar survive?" After all, that is where the global imbalances are taking the greatest toll. Just look at today's Fed Statement which bent over backwards to appeal to all quarters of the market. Will it be half point, or a full point cut? "No, we will split the difference with a .75 basis point cut" and not sounding like a group of paranoid schizophrenics in charge of the asylum, we will issue wording so vague that anyone can read into it whatever they want! Let's see, on the one hand, we will cover the Dr. Jeckyll camp, those worried about the weakening economy,
"Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress (ya think?), and the tightening of credit conditions and deepening housing contraction are likely to weigh on growth over the next few quarters."
And not to be outdone, on the other hand, and without missing even a single breath, we shall seek to appease the Mr. Hyde contingent of those fearing the return of inflation,
"Inflation has been elevated and some indicators of inflation expectations have risen. The committee expects inflation to moderate in coming quarters, reflecting a projected leveling out of energy and other commodity prices and an easing on resource utilization. Still, uncertainty about the inflation outlook has increased. It will be necessary to continue to monitor inflation developments carefully."
In the end, the sad truth of the matter is that the Bernanke Fed remains hostage to Wall Street interests, and did not have the nerve to disappoint the stock market with ONLY a half point cut. What would the market have done? How would that have affected confidence if the S&P had plunged to new lows? Answer: if the Dollar had rallied and Oil had really plunged, perhaps the stock market would have come back, taking solace in lower Oil prices. But that would have taken a whole order of determination long missing from today's US central bankers.
In our view, this lack of central bank backbone represents, in all likelihood, a serious policy error. Back in 1980, when Paul Volcker faced similar problems, the approach was to let the capitalist system purge its own excesses with the Central Bank defending the purchasing power of money. Today, the Central Bank is turning a deaf ear toward a sinking US Dollar, which while it bounced marginally, did not get the kind of boost it now so sorely needs. Notice that while stocks soared, Crude Oil did not cede ground and ended sharply higher on the day. While others may note that Gold sold off, the fact that Crude gained shows that at least one market is already looking past the Fed's carefully attenuated half measure. For the US Consumer masses, high and rising Oil prices married to the current picture of stagnant/declining real wages adds up to a stagflationary recession where rising commodity costs put relentless downside pressure on consumer spending as household budgets break. Of course, that equation was completely omitted from today's policy decision as the Fed, in continuing to cut aggressively, gives tacit support to a falling Dollar.
That's right, "Let's not rattle the Wall Street cage," goes the thinking at the Fed, yet with the ECB remaining tight and the Fed apparently flying effectively "solo," the creators of the grand experiment may soon find that the potion is eating them up from the inside out. Point of Order: The US Dollar and the 10-Year Treasury Bond. Today's action, a halting Dollar bounce and potentially by far, worst of all, a first hint of revulsion in the long term bond market with 10 year yields backing up by .14 bps, a gain of 4.23%. Unpleasantness of a new proportion will come in torrential quantities if the negative convexity of rising long term bond yields is perpetuated going forward by an unchecked and unattended falling currency market. For the Jekyll and Hyde Fed Experiment, this is how to go from very bad to a great deal more ugly from here.
"He locks the door and looks around nervously,
He knows there's no one there,
He drinks it down and waits for some reaction
To all his work and care"
Above: Top clip Europe ETF,
Middle: US Consumer Staples and lower clip, Ratio of Consumer Staples to European Large Caps.
For US Investors looking for a reasonably low risk strategy, the perverted central bank logic of the day in advocating non-cooperation and isolation suggests to us that continued decay in the greenback will bear huge fruit for US Exporters of the kind contained in the XLP, US Consumer Staple ETF, that can be Long against the European Exporters and majors, which will have to deal and likely squeal under the heavy boot of a 1.60 or higher Euro. On the short side of the trade, the Vanguard Large Cap Europe (VGK) is one of several large European ETF's that could do the job. Central Bank intervention is perhaps still a threat to this type of endeavor, but seems to be less and less likely with each passing day. For those unwilling to deal with currency fluctuations, another approach may be to harness the hitting power of recession by pairing consumer staples (XLP) against consumer discretionary (XLY) as an unchecked falling Dollar will continue to force Oil prices higher over time. While investors always need to do their own homework, it seems this ratio is destined to move still higher over time.
In the chart below, we show in the top clip the most graphic example of the recessionary forces, the fading relative strength of Transportation stocks versus Crude Oil, a gauge of contractionary economic impulses compared against the Long Consumer Staple Short Consumer Discretionary ratio on the lower curve. As stagflationary pressures continue to mount, we will all, thanks to the Fed, have less and less discretionary spending left over in our wallet.
Above: top clip Transports Versus Crude, Bottom Clip: Discretionary Retailers versus Staples.
For the Central Banks of the world, the lack of unity and policy coordination give extra meaning to the last lines of the song which go,
"This is the story of Dr. Heckyll and Mr. Jive,
Believes the underdog will eventually survive,
Sometimes they love to sing that old black magic"
For now, it is "Black Magic" indeed coming from the Central Banks,
With inflation targeted investors hoping to "eventually survive."
That's all for now,
© 2008 Frank Barbera