Wednesday, September 21, 2011

VIX Bounces Off 50-Day

by Bespoke Investment Group

As we noted last night, the S&P 500 was stymied by its 50-day yesterday. At the same time, the VIX volatility index has bounced off of support at its 50-day. Higher levels in the VIX generally coincide with a decrease in equity prices, so market bulls are hoping this is one bounce that doesn't hold.

See the original article >>


by Cullen Roche

Here’s the full FOMC statement. I highlighted a few pieces which I’ll discuss below:

For immediate release

Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased. Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.
To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.
To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.
The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.
The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action were Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who did not support additional policy accommodation at this time.”
The biggest announcement in this statement is “significant downside risks” to the economy. The Fed is becoming increasingly aware of their impotence. This could actually prove to be positive as Bernanke is likely to lean increasingly on Congress for aid in his fight against unemployment. But let’s not jump to conclusions. The bottom line is, this economy is very weak and is likely to remain so regardless of what the Fed does.

Operation Twist was basically as expected. They are buying $400B in long bonds and selling $400B in short bonds. It’s balance sheet neutral. Not that this matters a whole lot. As I’ve previously stated, monetary policy works by targeting rates. The Fed would have needed to say, “we are a buyer of 10 year bonds at 1%” in order for this to “work”. They didn’t do that. So, we can expect a lot of shuffling of the Fed’s balance sheet, but ultimately, these transactions lack a real transmission mechanism through which they can impact the real economy. In other words, this program should NOT put downward pressure on longer-term interest rates and SHOULD NOT help make broader financial conditions more accommodative.

The MBS purchases are interesting and they’re a slight change from past policy. I discussed this last year when I said this was one of the eventualities of QE2:
“He [Ben]wants to be fully prepared in case the banks relapse so he can step in with a sizable bank bailout. So, don’t be one bit surprised this week when Mr. Bernanke announces a small round of Treasury purchases with the option to buy MBS in the future. In all likelihood, this program will remain open until it’s clear that the U.S. economy is sustaining recovery and another bank meltdown is off the table. Don’t be fooled into thinking that this is some economic panacea.”
The Fed is likely disturbed by the recent house price declines and the deterioration in credit markets. As we saw during QE1, MBS purchases are an effective form of fighting a potential balance sheet deterioration and credit crisis. In this regard, the Fed appears proactive. That’s a positive. On the other hand, we shouldn’t sugarcoat this – this helps the banks and not the consumer via the mortgage market as the Fed press release implies – and yes, this is still a consumer driven balance sheet recession and NOT a banking crisis. The MBS purchases don’t generate economic growth, but could possibly help fend off credit fears. Unfortunately, the repurchases aren’t large enough to move the needle much.

In sum, this policy change doesn’t change much if anything. The Twist won’t “work” in reducing rates and the MBS purchases are an interesting and possible effective proactive measure (but not a growth measure!). The most interesting part of the statement is the “significant” economic downgrade. Ironically, the Fed might get their lower rates via a worsening economy and the lack of effective policy. The 10 year is dropping to 1.87% as I type!!

Operation "Old Twist" ...

by Kimble Charting Solutions

Don't Buy Stocks at These Levels

With several key warning signs showing up on the charts, risk is high for new buying, and more favorable entry points are likely coming soon for the major stock index ETFs.

Stocks gave up their early gains on Tuesday, and the reversal was the most pronounced in the tech-heavy Nasdaq Composite. The stock index futures are lower in early-Wednesday trading and the markets may be quiet going into the widely anticipated Federal Open Market Committee (FOMC) announcement this afternoon.

Overseas markets were mostly lower and the short-term technical studies do suggest that the rally has stalled. The weak action in crude oil is also a concern. As I pointed out a few weeks ago, there is a nice correlation between crude oil prices and the S&P 500. The November crude oil has turned lower over the past few days and volume has increased on the decline. A break below the support at $83.40 should trigger heavier selling.

Of course, a rally to stronger resistance in the $125-$127 level in the Spyder Trust (SPY) is still possible, especially with the FOMC announcement, but the risk on the downside does seem higher.

The most negative interpretation is that the entire rally from the August lows is just a bear flag which will be followed by a drop to and/or below the August lows.

An alternative interpretation is that we will see a “soft landing,” which implies a decline to the $112-$115 area in SPY. This is consistent with both the improvement in the Advance/Decline (A/D) line and also the increase in bearish sentiment.

Another drop would help to increase the level of pessimism, which is needed to fuel a more sustainable rally. Let’s look at the evidence.

Chart Analysis: The daily chart of the Spyder Trust (SPY) shows Tuesday’s failed rally attempt. There is next support in the $116.70-$118 area with the lower boundary of the flag formation, line b, in the $115 area.
  • A close below last week’s low at $114.05 is likely to trigger heavier selling with the August lows at $110.27
  • The 127.2% Fibonacci retracement target is now at $106.50
  • The McClellan Oscillator formed significantly lower highs on the last rally and has turned down. It is now back below the zero line and a break of support at line c will signal a further decline
  • There is initial resistance for SPY now at $122-$123.40
The daily chart of the Nasdaq Composite shows that it has had a much more dramatic rally from the August lows, as it has surpassed the 50% retracement resistance at 2608.
  • The upper boundary of the flag formation, line d, is at 2664 with the 61.8% Fibonacci retracement resistance at 2678.
  • The McClellan Oscillator has formed a negative divergence at the recent highs, line f. It has now dropped back below the zero line and a break of support at line g would confirm the divergence
  • There is initial support at 2550 with the lower support from the flag formation (lines d and e) in the 2490 area
  • There is a potential double bottom on the charts in the 2330 area

The PowerShares QQQ Trust (QQQ), which tracks the Nasdaq 100 Index, exceeded the upper resistance from the flag formation on Tuesday (line a), but then closed lower, which is a short-term negative. The 61.8% retracement resistance at $55.88 was decisively overcome on the recent rally, which was a positive sign.
  • Initial support is now at $55.30 with further support at $54.60. The uptrend, line b, is in the $53.50 area
  • It would take a close below the September 6 lows at $51.91 to signal a test of the August lows
  • The Nasdaq 100 A/D line overcame its downtrend, line c, last week, which suggests the A/D line may be bottoming
  • The A/D line numbers on a decline will be important, as the September lows in the A/D line need to hold to set the stage for a new uptrend
  • There is major A/D line support at the August lows
  • There is resistance for QQQ at $57.35-$58.00
The iShares Russell 2000 Index Fund (IWM) continues to act the weakest, as the recent rally peaked at $72.03, well below the prior high at $73.89.
  • The uptrend from the lows, line d, is now at $66.40 with additional support at $64.57
  • The A/D line on the Russell 2000 looks the most ominous, as it made lower lows last week, line f. The down-trending channel (lines e and f) is a sign of a weak market
  • It would take a move above the prior peak and a break of the downtrend to turn the A/D line positive
What It Means: The short-term technical outlook shows signs of deterioration, and while that does not mean that stocks have to drop immediately, it does mean that a further rally should be carefully watched.

More importantly, it suggests that those who are looking to buy stocks or ETFs should be able to buy lower, and the tech sector is still my favorite destination for new buying. I favor the “soft-landing” scenario but will be watching the market internals closely.

How to Profit: If you did not lighten up on the weak stocks in your portfolio when SPY reached the $121-$122 area, I would not wait any longer.

For those looking to hedge, selling options against existing positions looks most favorable, or else consider an option spread strategy since put premiums are high.

Alternatively, traders could buy the ProShares Short S&P 500 ETF (SH) at $43.36 or better with a stop at $41.72 (risk of approx. 3.7%). Sell half the position at $45.56 and raise the stop on the remaining position to $42.88.


by Cullen Roche

The usually bearish David Rosenberg of Gluskin Sheff is sounding bullish on the basis of more expected Federal Reserve action. In today’s research note he explains why he believes the Fed will act more aggressively than investors think and says the S&P 500 could even rally to “at least” 1250. He provided 10 reasons why investors don’t want to fight the Fed today:
1. Just go back to August 9th. The Fed was supposed to make a more emphatic comment in the press statement about “extended period” as it pertained to the length of time the Fed would stay ultra-accommodative on the rates front. Bernanke went much further than anyone thought with his pledge to keep rates at the floor to mid-2013.
2. Ben Bernanke has shown repeatedly that he is willing to take risks and be very aggressive.
3. Everyone knows the Dow finished the August 9th session with a huge 430 point gain after the FOMC press statement was fully digested. Not only that, but when Bernanke held his two day meeting in Mid-December of 2008 and unveiled QE1, the Dow soared 360 points. And last November, the day after the two-day meeting when Bernanke made it clear in his Washington Post op-ed article how key it was to ignite the stock market, the Dow jumped 220 points. It may all be just for a near-term trade, but in an industry where every basis point counts, who wants to be short in front of that?
4. At that August meeting, we know both from the statement and minutes that additional rounds of unconventional easing were discussed. And Mr. Bernanke made it very clear at Jackson Hole that they would be on the table again the coming meeting.
5. The Fed would like to be out of the picture during the election campaign (especially if Rick Perry ends up winning the GOP nomination).
6. The Fed has cut its GDP forecast at each of the past three meetings.
7. The stock market is actually little changed from where it was at the last meeting and we know based on the Washington Post op-ed, that it is equity valuation (specifically the Russell 2000) that Ben wants to see rally. Sanctioning lower bonds yields is just a means to that end.
8. There is no fiscal stimulus to bolster the economy, with the odds very high that the Obama jobs plan – some in his own party object to – will be dead on arrival on the House floor. The Fed is the only game in town.
9. Financial conditions have tightened nearly 100 bps since the spring and deserve a policy response.
10. Bernanke announced at Jackson Hole that this coming meeting was going to be a two day affair, not one day. The last time he did this was back in December 2008 and that was when he invoked QE1. There has to be a reason why it is two days, and it must be because he wants to build the case for three dissenters. The Board is being sequestered for a reason!

'Italy's Chief Problem Is Its Own Government'

by Mary Beth Warner

Prime Minister Silvio Berlusconi blasted Standard & Poor's on Tuesday, saying its downgrade of Italian debt was politically motivated. German commentators tend to agree, but they say the real problem is Berlusconi himself.

Who is to blame for Monday's downgrade of Italian debt ? Is it Prime Minister Silvio Berlusconi , who has shown a marked hesitancy in implementing tough belt-tightening measures? Or is it Standard & Poor's itself? 

After all, the economic data cited by the ratings agency in its Monday evening announcement that it had decided to drop Rome's credit rating a notch was hardly new. The world has known for years that Italy was highly indebted.

The answer, of course, is that it may not really matter. The fact that investors are quickly losing confidence in Italy is hardly a secret: Interest rates on Italian sovereign bonds have been steadily climbing for months. Furthermore, should Greece become insolvent, as most believe it will, the state of Italy's finances may well pale in comparison to the economic waves coming from Athens.

Indeed, International Monetary Fund chief economist Olivier Blanchard likewise indicated that the global economy faces larger problems than how Standard & Poor's view Italy. He warning on Tuesday that the world is in a dangerous new phase and told reporters that "there is wide perception that policy-makers are one step behind markets." He said Europe "must get its act together."

Still, how Italy deals with its debt difficulties will be a major factor in European efforts to solve the debt crisis. And Standard & Poor's indicated it has little confidence in Berlusconi's leadership. The agency's report said the move "reflects our view of the Italian economy's weakening growth prospects and our view that Italy's fragile governing coalition and policy differences within parliament will likely continue to limit the government's ability to respond decisively to domestic and external macroeconomic challenges."

In Germany, representatives from Chancellor Angela Merkel's governing coalition downplayed the news or pinned the blame on the Italian government for not doing more. Reuters reported Tuesday that German Finance Minister Wolfgang Schäuble, in discussions with colleagues, said the downgrade showed Italy has a political system that is no longer considered sufficiently serious.

German commentators on Wednesday tend to agree.

The center-left Süddeutsche Zeitung writes:

"Italy's chief problem is its own government. Berlusconi and his team act as if they are being besieged from all sides: from judges, the opposition, and financial markets. That does not build trust"

"Everyone knows that [Italy] cannot be rescued in the same way as Greece, even if the political will were there. Therefore, the decision of S&P is also a declaration of mistrust of the European institutions as a whole, and the German government in particular. And here, too, the agency is illustrating the reality on the markets: Trust has long since been lost. Now time is running short to protect Italy and Spain from being infected with Greece's virus."

"In the meantime, it's become obvious that Greece cannot solve its problems without a debt haircut of almost 50 percent. In everyday language, that's called a state bankruptcy. Nevertheless, the bankruptcy chatter among politicians in Berlin is foolhardy. It is important to efficiently prepare for the debt forgiveness, so that the affected banks will have enough capital reserves, and to assure that European taxpayers won't be the only victims, but that the private creditors will also pay their share."

The center-right Frankfurter Allgemeine writes:

"Italian politicians are not up to the Herculean task of battling serious shortcomings with extensive reforms as the Greeks have done. Berlusconi lacks credibility, the largest opposition party is slipping further to the left, away from every austerity and reform program, and the center is offering only empty political rhetoric."

"No politician wants to admit that it is Italy's precarious situation that has transformed the crisis of smaller countries on Europe's periphery into a crisis for the entire Continent. Only warnings and alarm signals can help. Without external pressure, Italy will not make progress."

The Financial Times Deutschland writes:

"There are many reasons why the Italians should want another, better head of government. The question is whether or not it is a rating agency's job to determine that. They should refrain from mixing themselves into the domestic politics of a country."

"If one considers Italy's situation on purely economic terms, there is little reason for a new rating. Sure, the country's public debt, at 120 percent of GDP, is clearly too high, and the prospects for growth are dim. But that is nothing new. And Italy, unlike Greece, has produced a solid business model, with strong world-class businesses and banks that, thanks to little involvement in investment banking, were able to easily survive the crisis."

"Italy needs reform, both political and economic. But it doesn't take a downgrade by S&P to realize that. The ratings agency only hurts itself. It is opening itself up to accusations of wanting to become involved in politics. For a company that is being paid by its clients for its objectivity, this cannot be good for business."

The conservative daily Die Welt writes:

"Unlike Greece, Italy does not have a short-term liquidity problem. The Republic will be able to pay civil servants' salaries for more than the foreseeable future. But this country in the heart of Europe has a long-term debt problem, and one that could break apart the common currency."

"That is known, and was known to the ratings agencies. So why does the downgrading come now? Prime Minister Silvio Berlusconi gave the answer himself when he criticized the move as being politically motivated. It is, of course. Italy's biggest problem is the buffoon at the head of its government."

"National debt of 120 percent of annual economic performance, interest rates of 5 to 6 percent, and marginal economic growth, that is all good reason for worry that in the medium term, the country will be overwhelmed by its debt. Greece finally understood that the time had come when it was standing on the precipice. One would hope that Italy would not follow that lead."

Sell pattern?

Morning markets:crop prices get steer from China import data


Has China bought corn? Or will harvest pressure come to bear on Chicago futures? Did Washington's announcement of a poultry trade battle against Beijing put Chinese buyers off?
"Not sure where this may lead, but we don't need to start a trade war with those folks," Mike Mawdsley at Market 1 said.
Corn futures, as in the last session, edged higher in opening deals only to fade, even by 07:40 GMT (08:40 UK time) as traders awaited answers.
"The market will be watching closely to see if the [US Department of Agriculture's] daily reporting system ends up releasing any US corn sales as we progress through the balance of the week," Jon Michalscheck at Benson Quinn Commodities said.
'$7-a-bushel magnet'
An early rise was in line with the broader market mood, with Tokyo shares closing up 0.2%, Seoul stocks up 0.9% and Shanghai shares trading up 2.7% in late deals, amid hopes for further progress in settling the eurozone debt crisis, although with the prospect of a conclusion to the US Federal Reserve's monthly monetary policy meeting injecting a note of caution.
The dollar and Brent crude were little-changed.
And for corn, there was an upward pull from the options market.
"October serial options will expire on Friday and that could be providing a magnet towards the $7.00-a-bushel level on the December contract," Mr Michalscheck said.
"The $7.00 strike price on the puts happens to have the largest amount of open interest going into today's session at 14,579 contracts and it also happens to be at the 50% level of the 108,945 total October puts that were still open as of today."
In short, all else being equal, the vote from options markets looks to be $7-a-bushel corn.
'US origin competitive'
A purchase by South Korea's largest feedmaker, Nonghyup feed, of 85,000 tonnes of corn, besides, 20,000 tonnes of soymeal, was also viewed positively.
"US origin was competitive. This was seen as a test for the competitiveness of US corn into Asian markets and indicates that the export demand destruction story from higher prices is not yet occurring," Paul Deane at Australia & New Zealand Bank said.
Furthermore, as a small insight into China's corn dynamics, customs data showed the country importing 244,500 tonnes of the grain last month, up from 172,600 tonnes in July.
Still, as Mr Mawdsley noted, "with harvest at our doorstep, it isn't the time of year to mount a big rally". The spike in supplies produced by harvests tend to press on crop prices.
There was enough uncertainty around to drag Chicago's December corn contract down 0.2% to $6.89 a bushel.
'Potentially massive wheat for corn substitution'
That put a dampener on other crops too, with Chicago wheat for December losing early gains to show a loss of 0.25 cents, at $6.74 ¼ a bushel, amid further mixed thoughts on prospects for sowing the southern US hard red winter wheat crop.
"The decent rains that fell in the eastern region of the hard red winter wheat area will allow for more planting progress this week, but many of the western areas will remain bone dry," Benson Quinn's Brian Henry said.
"However, the $8.62-a-bushel hard red winter wheat insurance price will entice producers to plant wheat, if at all possible."
Luke Mathews at Commonwealth Bank of Australia noted "reports of potentially massive wheat for corn substitution in China", encouraged by price differentials.
China's appetite
Soybeans maintained, just, a grip on positive ground, adding 1.5 cents to $13.39 ½ a bushel for November delivery, amid hopes for Chinese demand (chicken dispute or not).
Such hopes were whetted by Tuesday's announcement of China's purchase of 120,000 tonnes of US soybeans.
That said the Chinese customs data showed a slip in the country's imports of the oilseed last month, to 4.51m tonnes, from 5.35m tonnes in July, although it was South American supplies which took the hit, with trade from the US still low ahead of harvest.
Adding some support to sentiment was the first positive close on Tuesday in seven sessions by fellow oilseed canola in Canada, adding Can$7 to Can$555.60 a tonne for November delivery.
In favour, or not
In Kuala Lumpur, palm oil felt the heat from the China data, which showed imports slipping to 511,800 tonnes last month, from 595,000 tonnes in July (albeit remaining higher year on year), with Malaysia bearing the brunt of the slowdown.
Palm oil for December slipped 0.3% to 3,059 ringgit a tonne.
However, for cotton, the data showed imports rising above 207,000 tonnes, up 50,000 tonnes from July.
December cotton added 0.6% to 106.30 cents a pound in New York, for December delivery.

Food prices 'at risk of spike higher', says IMF


Food commodities escaped a downgrade by the International Monetary Fund to its outlook for raw material prices, with the "precarious" balance in crop supplies leaving markets open to "further price spikes".
The IMF, in a twice-yearly report, said that price risks in the broad commodities sector "seem more balanced" than both a year ago and in April, when the institution published its previous briefings.
"Downside risks to global growth have risen," the fund said, reducing to 4.0% its forecast for world economic expansion both this year and in 2012, cuts of 0.3 points and 0.5 points respectively.
However, for food prices, the "balance of risks… is still to the upside" thanks to the thin supplies of some farm commodities, notably corn.
"Given low global inventory levels for many crops, and significant adverse shocks… have the capacity to spike food prices higher," the fund said.
'Most immediate risk'
The "most immediate risk" to hopes for lower prices was of further poor weather, with the US extremes of a wet spring and hot summer following droughts in Europe and China.
"The recent pattern of extreme weather in major crop-growing regions seems to be continuing," the report said.
Even "modest" further cuts to crop production forecasts "could trigger a large price response, cross-commodity spillovers, and higher volatility".
And, unlike in markets for some other commodities, "demand growth momentum remains strong", with consumption of major crops set to grow by 2.25% in 2011-12, "considerably above the 20-year average".
"Rapid increases in emerging market economy food consumption are showing no signs of moderating," the fund said, noting the impact of higher incomes encouraging a shift to meat.
'Further price spikes'
The IMF said its central forecast was for food prices to "decline modestly, but remain high in real terms" through 2012, assuming a return to normal weather conditions and the absence of a rise in energy prices which would boost biofuels demand.
However, a "combination of low inventories, volatile weather, and demand uncertainties related to China and biofuels raises the prospect of further price spikes over the next 12-to-18 months".
Such an outcome was already being reflected into values of derivatives such as futures, in which, according to IMF analysis, investors were already pricing in a higher-than-average probability of a price spike over the next nine months.

Make or Break-Technicals

Yesterday we presented some European Charts. Markets have reached some resistance levels, since bouncing off the lows. Below highlights from the accurate UBS’s Technical Research Products. Make or break…as Fed is getting prepared for action.

How to Prevent a Depression

The latest economic data suggests that recession is returning to most advanced economies, with financial markets now reaching levels of stress unseen since the collapse of Lehman Brothers in 2008. The risks of an economic and financial crisis even worse than the previous one – now involving not just the private sector, but also near-insolvent sovereigns – are significant. So, what can be done to minimize the fallout of another economic contraction and prevent a deeper depression and financial meltdown?

First, we must accept that austerity measures, necessary to avoid a fiscal train wreck, have recessionary effects on output. So, if countries in the eurozone’s periphery are forced to undertake fiscal austerity, countries able to provide short-term stimulus should do so and postpone their own austerity efforts. These countries include the United States, the United Kingdom, Germany, the core of the eurozone, and Japan. Infrastructure banks that finance needed public infrastructure should be created as well.

Second, while monetary policy has limited impact when the problems are excessive debt and insolvency rather than illiquidity, credit easing, rather than just quantitative easing, can be helpful. The European Central Bank should reverse its mistaken decision to hike interest rates. More monetary and credit easing is also required for the US Federal Reserve, the Bank of Japan, the Bank of England, and the Swiss National Bank. Inflation will soon be the last problem that central banks will fear, as renewed slack in goods, labor, real estate, and commodity markets feeds disinflationary pressures.

Third, to restore credit growth, eurozone banks and banking systems that are under-capitalized should be strengthened with public financing in a European Union-wide program. To avoid an additional credit crunch as banks deleverage, banks should be given some short-term forbearance on capital and liquidity requirements. Also, since the US and EU financial systems remain unlikely to provide credit to small and medium-size enterprises, direct government provision of credit to solvent but illiquid SMEs is essential.

Fourth, large-scale liquidity provision for solvent governments is necessary to avoid a spike in spreads and loss of market access that would turn illiquidity into insolvency. Even with policy changes, it takes time for governments to restore their credibility. Until then, markets will keep pressure on sovereign spreads, making a self-fulfilling crisis likely.

Today, Spain and Italy are at risk of losing market access. Official resources need to be tripled – through a larger European Financial Stability Facility (EFSF), Eurobonds, or massive ECB action – to avoid a disastrous run on these sovereigns.

Fifth, debt burdens that cannot be eased by growth, savings, or inflation must be rendered sustainable through orderly debt restructuring, debt reduction, and conversion of debt into equity. This needs to be carried out for insolvent governments, households, and financial institutions alike.

Sixth, even if Greece and other peripheral eurozone countries are given significant debt relief, economic growth will not resume until competitiveness is restored. And, without a rapid return to growth, more defaults – and social turmoil – cannot be avoided.

There are three options for restoring competitiveness within the eurozone, all requiring a real depreciation – and none of which is viable:

· A sharp weakening of the euro towards parity with the US dollar, which is unlikely, as the US is weak, too.

· A rapid reduction in unit labor costs, via acceleration of structural reform and productivity growth relative to wage growth, is also unlikely, as that process took 15 years to restore competitiveness to Germany.

· A five-year cumulative 30% deflation in prices and wages – in Greece, for example – which would mean five years of deepening and socially unacceptable depression; even if feasible, this amount of deflation would exacerbate insolvency, given a 30% increase in the real value of debt.

Because these options cannot work, the sole alternative is an exit from the eurozone by Greece and some other current members. Only a return to a national currency – and a sharp depreciation of that currency – can restore competitiveness and growth.

Leaving the common currency would, of course, threaten collateral damage for the exiting country and raise the risk of contagion for other weak eurozone members. The balance-sheet effects on euro debts caused by the depreciation of the new national currency would thus have to be handled through an orderly and negotiated conversion of euro liabilities into the new national currencies. Appropriate use of official resources, including for recapitalization of eurozone banks, would be needed to limit collateral damage and contagion.

Seventh, the reasons for advanced economies’ high unemployment and anemic growth are structural, including the rise of competitive emerging markets. The appropriate response to such massive changes is not protectionism. Instead, the advanced economies need a medium-term plan to restore competitiveness and jobs via massive new investments in high-quality education, job training and human-capital improvements, infrastructure, and alternative/renewable energy. Only such a program can provide workers in advanced economies with the tools needed to compete globally.

Eighth, emerging-market economies have more policy tools left than advanced economies do, and they should ease monetary and fiscal policy. The International Monetary Fund and the World Bank can serve as lender of last resort to emerging markets at risk of losing market access, conditional on appropriate policy reforms. And countries, like China, that rely excessively on net exports for growth should accelerate reforms, including more rapid currency appreciation, in order to boost domestic demand and consumption.

The risks ahead are not just of a mild double-dip recession, but of a severe contraction that could turn into Great Depression II, especially if the eurozone crisis becomes disorderly and leads to a global financial meltdown. Wrong-headed policies during the first Great Depression led to trade and currency wars, disorderly debt defaults, deflation, rising income and wealth inequality, poverty, desperation, and social and political instability that eventually led to the rise of authoritarian regimes and World War II. The best way to avoid the risk of repeating such a sequence is bold and aggressive global policy action now.

Nouriel Roubini is Chairman of Roubini Global Economics, Professor of Economics at the Stern School of Business, New York University, and co-author of the book Crisis Economics.

Getting to Yes (Again) with Germany

Europe’s slow-motion sovereign-debt crisis may appear unique, but it is not. Just a few decades ago, Europe had the Exchange Rate Mechanism, which collapsed during a crisis very much akin to the one afflicting Europe today. Will the outcome this time be different?

The ERM was an arrangement that pegged most European currencies’ exchange-rate movements within limited bands. But ERM members’ monetary policies remained home-grown, which, no surprise, occasionally led to fiscal imbalances. When capital markets smelled a problem among ERM members, they invariably shorted the most vulnerable currency and pushed that country’s authorities to devalue. Authorities resisted, blamed speculators, and then, usually over a frantic few days, gave in.

Markets also tested the resolve of policymakers in otherwise sound ERM countries, particularly when there were big strikes or important elections. In those cases, even a government with the proper economic fundamentals and its financial house in order could still run into trouble. European Central Bank President Jean-Claude Trichet is well aware of this: in the early 1990’s, he confronted such a crisis as Governor of the Bank of France.

Some contemporary observers of the ERM thought that there was an easy fix for these troubles. If the central bank of the country that printed its “strong currency” (Germany) had been willing to provide unlimited support to a “weak currency,” things would have been sorted out. Germany’s Bundesbank, it was suggested, would stand ready to buy “unlimited quantities” of lire or francs, so no one would dare to short either currency.

The notion of “unlimited quantities” was important: speculators would force officials to exhaust limited quantities, with the purchasing authority (the Bundesbank) eventually bearing the loss. Monetary support would lead to fiscal transfers, making limited interventions a non-starter. With unlimited support, by contrast, every single speculator could be quashed, and no loss would be borne (since intervention to support a weak currency would succeed).

The only problem was that both the Bundesbank and the German government always fiercely resisted such an arrangement, on the grounds that it could lead to the printing of unlimited quantities of Deutschmarks, and thus stoke inflation.

Instead, Europe developed the euro, which solved the problem of speculative attacks and monetary credibility by replacing individual currencies with a new one. It was impossible to short the lira or the franc because there were no more lire or francs. But Italy and France had to give something in return for this security: the ECB was made independent of all eurozone governments.

Yet the current debt crisis has resurrected the old problem, with debt now filling the role that currencies played under the ERM. Some eurozone countries borrowed excessively and have been punished by the markets, perhaps deservedly so, while others, in the resulting climate of anxiety, have become targets for speculators. On July 21, eurozone leaders agreed to make “more extensive” use of the new European Financial Stability Facility (EFSF) by permitting it to purchase endangered eurozone countries’ debt in secondary markets.

But the EFSF’s “more extensive interventions” recalls the “unlimited quantities” of foreign-exchange intervention proposed to rescue the ERM. If “more extensive” means piecemeal limited commitments that will eventually be exhausted, the scheme runs the risk of creating losses (just as the Bundesbank would have suffered losses had it engaged in limited defense of weak ERM currencies). To rule this out, “unlimited interventions” would be needed. But with whose resources, and under whose authority?

This explains the growing excitement about issuing “Eurobonds.” The conversion of all eurozone national bonds into obligations jointly recognized by all eurozone governments is a replica of the solution to the ERM’s breakdown, which consisted in abandoning national currencies in favor of the euro. This would cost Germany control over the quality of its credit, just as the replacement of the Bundesbank by the ECB implied Germany’s loss of control over the quality of its currency (though it was given a large role in designing the ECB).

What is missing in today’s proposals is the equivalent of the ECB’s independence, which ensured Germany’s participation in the euro. It is no coincidence that one of the leading opponents – the ECB’s first chief economist, Otmar Issing – of the “unlimited interventions” policy under the ERM recently rebuked both the “extended-EFSF” and Eurobonds. The current proposals, Issing argues, are “undemocratic.”

The concessions needed to ensure German participation are likely to be enormous. With markets’ ability to monitor dubious borrowers, the guarantees will probably have to be institutional, constitutional, and political – probably formal control over European fiscal policy by a body at least as credible as the ECB, which would mean a dramatic reduction in the power of national parliaments.

Such radical changes would require the consent of all eurozone countries. And the Bundestag (not Standard and Poor’s) would have to be happy. Anything short of this is bound to fail.

Marc Flandreau, is Professor of International Economics and International History at the Graduate Institute of International and Development Studies, Geneva.

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Paying (for) Attention

It is fashionable nowadays to talk about personal attention as a commodity or even a currency. Many companies are looking for ways to automate the act of “paying attention” to individual customers on a grand scale, even as many of them also confuse attention with intention (to buy). Indeed, “attention” is becoming more interesting now that the Internet makes it easier to measure it.

But attention is neither a currency nor a commodity. It can be bought and sold, to some extent, but it cannot be traded to third parties, and it is not entirely fungible.

While companies (and some people) seek attention because they expect to earn money through it, many individuals value attention as something that is intrinsically desirable. Just as Facebook “friends” come in varying degrees of intensity, quality, and symmetry, so does attention. Real attention comes from people; “attention” from a computer is worth something only to the extent that it appears to come from a human – and can be negative if people feel deceived.

Basically, attention has three quantifiable aspects: time, completeness/division, and the value of the person who is giving it. That is, start with one person paying full attention to another for 15 minutes. That is your spouse listening to you, for example (if that ever happens), or Juan on a date with Alice.

Now, consider how that attention is divided. Is Juan talking to Alice, but looking at the woman at the next table or thinking about the deal he’s working on? If so, only Juan knows how much attention he is allocating to Alice and how much to other things. (But Alice can guess!) Any speaker addressing an audience is getting the sum of the partial attention of its members, while giving each of them only a small share of her own.

But what is the value of this attention? The challenge of determining that consists in the third aspect: who is giving it, and who is receiving it. Juan and Alice exchanging attention may or may not be a fair trade, depending on their relative “value”: Is Alice extraordinarily beautiful? Is Juan amazingly rich or powerful (per Henry Kissinger's notion of power as the ultimate aphrodisiac)? Does Alice want Juan’s attention?

One way to measure the value of attention is to look at actual transactions. Take Kissinger: would he show up to speak to you alone? Probably not. How many people would he require in a room? Perhaps 1,000 people who paid $2,995 each. But he might also show up for free to talk to 10 heads of state, or one United States president. That gives you some indication of value, though it is hardly exact.

Indeed, the value of attention can be monetized, and a contract requiring someone to pay attention (by, say, giving a speech or appearing at a photo opportunity) can be bought and sold.

At a less exalted level, we buy and sell attention all the time, usually as part of some other transaction. You pay extra in a department store for the attention of a sales clerk, and you pay extra to fly first class not just for the legroom and the drinks, but also for the extra attention from everyone from check-in personnel and flight attendants to other people in line (if you care about their deference). That kind of attention can be valued by looking at the premium that people pay for it.

The Internet is changing the economics of attention by fostering peer-to-peer interactions. People used to pay attention to those around them and to “stars”; now, they spend lots of time online paying attention to people they haven’t met. And, increasingly, individuals go online to get attention, not to give it.

Accordingly, companies need to learn how to give customers the attention that they crave, rather than demanding customers’ attention and then charging them extra for the attention that their brand commands.
Again, much of this attention is measurable, at least superficially, by watching people’s online behavior. The normal rough economic calculations apply: Who online gets most attention vs. who gives it?

Companies are now busily developing metrics for attention: the number of Twitter or Google+ followers or Facebook friends; reputation points for being a good seller, buyer, or reviewer; Klout® scores; game-player status; and the like. Individuals value these scores, but not because they want to buy or sell them (in general, they cannot). They value them in part because they want to draw more attention to themselves, from more valuable people. But, in part, they just value the status itself.

In response, many companies are now beginning to provide metrics to their customers for their behavior vis-à-vis that particular vendor. Consider airline points, for example: roughly one-third of them are never cashed in; people value the status and the attention they earn more than the supposed “actual” value. But they do pay for them, by favoring one vendor over another.

Thus, what companies are creating is not so much new currencies that can be traded, but new value systems for earning attention and recognizing (paying attention to) individual status. Each is mostly self-centered. You can move your friends from, say, Facebook to G+, but the value earned in World of Warcraft or on American Airlines doesn’t count for much elsewhere.

The question for companies is the extent to which those virtual rewards are translated back into purchasing behavior (and the ability to command higher prices).

The question for individuals is this: What do you really value – a company’s points, a salesperson’s paid-by-the-hour attention, or a friend’s genuine sympathy? Your answer – how and to whom you want to allocate your finite attention – will increasingly attract the attention of others.

Esther Dyson, CEO of EDventure Holdings, is an active investor in a variety of start-ups around the world. Her interests include information technology, health care, private aviation, and space travel.

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IMF Growth Forecast: U.S. and Europe Will Ignore Warnings, Despite Slashed Estimates

By David Zeiler

In lowering its growth forecast for the United States and Europe, the International Monetary Fund (IMF) warned of "severe repercussions" unless drastic measures are taken soon.

But don't expect the warning to spawn any real action.

"The global economy has entered a dangerous new phase," Olivier Blanchard, the IMF's chief economist said in the report released yesterday (Tuesday). "The recovery has weakened considerably. Strong policies are needed to improve the outlook and reduce the risks."

The IMF slashed its 2011 growth forecast for the U.S. economy from the 2.5% estimate it offered in June all the way down to 1.5%. Next year won't be any better: The 2.7% 2012 projection the IMF offered in June was cut all the way to 1.8%.

"Bold political commitment to put in place a medium-term debt reduction plan is imperative to avoid a sudden collapse in market confidence that could seriously disrupt global stability," the IMF said.

But with governments in Europe moving slowly to contain the sovereign debt crisis afflicting the PIIGS (Portugal, Ireland, Italy, Greece and Spain) and the United States suffering from political gridlock, the IMF's call to action will likely go unheeded.

In recent weeks, U.S. President Barack Obama has proposed a jobs plan, as well as a deficit reduction plan. But with congressional Republicans opposed to elements of those plans - primarily increases in spending and taxes - the swift policy action the IMF sees as critical will likely be stillborn .

In Europe, the IMF is calling for bold action to contain the debt crisis. It is particularly worried that a Greek default could cause many large banks - which own much of the Greek debt - to take large losses.

That U.S. banks are intertwined with European banks heightens the risk.

According to Money Morning C apital W ave S trategist Shah Gilani, "U.S. banks are widely believed to have $41 billion of direct exposure to Greece" and have loaned heavily to their European counterparts.

More sobering, Gilani says, is that "U.S. money-market funds have a hefty European exposure, too." He noted that 12% of the loans made by our biggest money-market funds were made to three big European banks - two of which, Societe Generale SA (PINK ADR: SCGLY) and Credit Agricole SA, were downgraded by Moody's Corp. (NYSE: MCO) just last week.

The third, BNP Paribas SA, remains under review. 

IMF Growth Forecast: Policymakers Are a "Step Behind"

Standard & Poor's Inc. (NYSE: MHP) cut Italy's credit rating on Monday, adding to the IMF's worries over the direction of the E urozone debt situation.

"There is a wide perception that policymakers are one step behind themarkets," Blanchard said at a news conference. "Europe must get its act together."

The 2011 IMF growth forecast for Europe was reduced from the 2% estimate released in June to 0.6%; for next year, the IMF cut its estimate from 1.7% to 1.1%.

With the advanced economies lagging, the global IMF growth forecast for 2011 also was trimmed - to 4.0% from an earlier 4.3% - and it cut estimates for 2012 to 4.0% from an earlier 4.5% .

About the only bright spot in the IMF report is the emerging markets, which are generally enjoying strong, if slowing, growth. Collectively, the IMF growth forecast for emerging markets is 6.4% for this year and 6.1% for 2012.

Standouts here include China (9.5% growth in 2011 and 9% in 2012), India (7.8% and 7.5%), and sub-Saharan Africa (5.2% and 5.8%).

"After strong growth in recent years and on the horizon, most [emerging and developing economies] are in the enviable position of being able to invest in growth and employment and to brace against future global economic volatility," the IMF report said.

Unfortunately, if the advanced economies take a tumble, they'll drag down the emerging economies with them, the IMF said.

"Global activity has weakened and become more uneven, confidence has fallen sharply recently, and downside risks are growing," the IMF said.

QE Can’t Save the Day… We’ve Been Doing a Form of It For Over a Decade

by Graham Summers

While most commentators proclaim that QE is a completely new phenomenon, we have in fact seen a version of it in the form of the Fed’s and Asia’s (especially China’s) purchases of US Treasuries/ currency pegs over the last decade or so.

Indeed, today, the Fed, China, and Japan collectively hold 61% of the $10 trillion of US debt held by “the public.” When you add in the additional $4.6 trillion in US debt held by “intragovernmental holdings” (basically the Federal Government buying Treasuries by raiding Social Security and other pension funds) you find that Asia and the Feds have monetized $10.7 trillion of the US’s total $14.6 debt (roughly 73%) over the last 20 years.

In this context, unveiling even more QE (the Fed buying US debt) is virtually pointless. Indeed, the Fed would have to unveil a QE plan of $2 TRILLION just to make its US debt ownership on par with the Federal Government’s “intragovernmental holdings.”

To put a $2 trillion QE program into perspective, that would be on par with the Fed unveiling a QE program equal to QE 1, 2 and some of QE lite combined in one single program.

Now, if QE 2 which was only $600 billion, blew the price of food and energy through the roof, how would a QE program of $2 trillion impact these items? Do you really think the Fed could unleash a QE program of that size without inciting full-scale unrest in the US, not to mention destroying the US Dollar.

And with the Fed already as unpopular as it is, Obama’s polls falling to new lows on a weekly basis, and Bernanke well aware of the potential legal issues coming his way, the odds of the Fed doing this in two weeks’ time are next to none.

Indeed, the Fed’s balance sheet is already close to $3 trillion in size. How would commodities and the US Dollar respond to a Fed balance sheet of over $5 trillion? The Fed has already proved it has no means of draining the liquidity its put into the system in the last two years. What impact would an additional $2 trillion have?

The short answer is that QE 3 of that size would kill the US Dollar, destroy the US economy, and result in Bernanke being forced to resign at the least and possibly the Fed being dissolved.

Do you think the Fed would do this? These guys are morons, but they’re not so stupid as to take note of how the Greeks responded to financial ruin.

Another consideration is that each new Dollar of QE has created less “bang” for the marketplace. As I noted in previous articles, QE 2 proved that each new Fed stimulus program is less effective than the first. At that time I wrote:

Consider that QE 1 provided $1.25 trillion in liquidity to the markets. From the date of its inception until its end, the S&P 500 roughly 540 points. Put another way, each $10 billion was worth 4.3 points on the S&P 500.

In comparison, QE lite and QE 2 put roughly $900 billion into the market (roughly 75% of QE 1) creating a 251-point rally in the S&P 500. In this case, every $10 billion in additional capital was worth 2.7 points on the S&P 500.

So in financial terms, QE 3 is not likely to have a large impact on the market. The reason is that the entire US GDP miracle has been induced by some form of QE whether it be the Fed, China or Japan buying US debt or the US raiding pension funds to buy Treasuries over the last 20 years.

Combine these facts with the inflationary pressures created by QE 2 as well as the current political climate which is increasingly anti-Fed, and it’s clear the Fed will not be able to unveil QE 3 without some kind of catastrophe hitting first. Put another way, the Fed will be acting purely reactively, not proactively going forward.

This sets the stage for a MAJOR upset to the downside in the near future. Indeed, I fully believe that we may be on the verge of a market Crash. Behind the scenes, the market is on DEFCON Red Alert. Ignore what the mainstream media and White House are saying, we are in BIG TROUBLE.
So if you’ve not already take steps to prepare for what’s coming, you need to do so NOW while the markets are still holding up.

Because once the selling pressure comes back into the markets… it’s going to be far FAR too late.

Fed Preview: Today's FOMC Meeting Will Prove That Team Bernanke is Out of Ideas

By Kerri Shannon

If you're handicapping the U.S. Federal Reserve's two-day Federal Open Market Committee (FOMC) meeting that concludes today (Wednesday), you can make the following two predictions - and you'll almost certainly be right:

  • U.S. Federal Reserve Chairman Ben S. Bernanke will announce some form of economic stimulus.
  • But the short-term benefits will be small, and any long-term benefits won't be enough to help out-of-work Americans or jump-start the wheezing U.S. economy.
"I do think the Fed will intervene," Money Morning Chief Investment Strategist Keith Fitz-Gerald said in an interview. "But I don't believe for a second that the central bank's intervention will help the U.S. economy."

Troubling Trends

If anything, the nation's economy looks worse today than it did on Aug. 9, which is when central-bank policymakers last met. The "official" unemployment rate remains at an alarming 9.1% - with no jobs added in August - and true joblessness may range from 17% to 23%. Housing starts declined last month by the greatest amount since April. And the International Monetary Fund (IMF) just downgraded its U.S. growth forecast to 1.5% from 2.5% [To see related story in today's issue, please click here].

The spreading European sovereign debt crisis continues to whipsaw stocks, oil prices and gold. And several dramatic single-day plunges - in stocks and in gold - spooked investors for days after the event.

Bernanke feels pressure to act, but the odds that Federal Reserve policy can make a meaningful splash are low indeed, Money Morning's Fitz-Gerald says.

What to Expect From Today's FOMC Meeting

Since the Fed's actions have so far done little to ignite economic growth, investor expectations were muted ahead of today's FOMC meeting conclusion.

"It looks like the market is baking in an announcement of some kind of quantitative-easing strategy," Deirdre Dennehy, portfolio manager at Rockland Trust, said in an interview. "[But] for them to announce a QE3, I'm not sure how impactful that's going to be. The more times they do that, the less the effect in the market."

Analysts expect the Fed will attack longer-term rates by adjusting its $1.7 trillion portfolio of U.S. Treasury securities.

At its last meeting, the Fed announced it would keep short-term rates near zero until 2013. Since the central bank has no more room to reduce rates, this time it'll make a move to encourage borrowing and spending.

"My guess is it's going to look something like "Operation Twist" from the 1960s," Fitz-Gerald said in a Bloomberg Radio interview. "They're going to probably print more money, buy more Treasuries. They're looking to manipulate, or twist, the yield curve by flattening it out."

The government first used this "Operation Twist" tactic in 1961. The expectation is the Fed will sell debt maturing in three years or less and buy mostly seven to 10-year notes to flatten out the yield curve so that long-term borrowing gets cheaper. The goal is to get corporations to spend their cash piles and push investors out of safe-haven Treasuries and into stocks.

"They're literally trying to force scared consumers and scared investors into the market," said Fitz-Gerald. "They're trying at the same time to free up that logjam of funds that corporations are, in fact, sitting on."

Markets have already anticipated a move like "Operation Twist," and yields on 10-year Treasury notes have slipped to 1.94 % from more than 3% in July. That's the lowest yield on the Treasury notes in more than 50 years. But the Fed move could still lower the 10-year rate by another quarter-point at today's FOMC meeting

If billions of new dollars are actually pushed into the financial markets by a central bank action, the stock-and-bond markets will see some gains. But any such gains will be short-term in nature - just as they were after earlier quantitative -easing measures, Fitz-Gerald said.

"Look at what happened when Bernanke waded into the market with QE1 [and] QE2 ... the markets tended to like that," Fitz-Gerald said. "But longer term, the economic system is very different from the market system, and that's the underlying issue here."

C entral-bank policymakers do have a couple of other policy options. According to minutes from its last meeting, the Fed could opt to trim the 0.25% rate it pays banks that store excess reserves at the central bank.

It could also institute a third round of bond buying, or QE3. But policymakers are likely to avoid this maneuver, due to the heavy criticism that followed QE2.

Anything the Fed does announce is expected to be a small initiative, with more aggressive action held until the next meeting in November.

"These are tinkering measures, not the financial bazooka, so to speak," Carl Riccadonna, senior U.S. economist for Deutsche Bank AG (NYSE: DB), told Reuters. "If we get to a period where the employment numbers turn negative - then I think there will be much more agreement on the Open Market Committee that they will have to do something bolder. We're certainly not there yet."

Regardless of what weapon the Fed chooses, investors are clearly skeptical that Team Bernanke can draw a winner from its arsenal at today's FOMC meeting.

"With banks still repairing their capital positions and interest rate levels hardly an impediment to growth, the Fed has run out of effective tools to do anything more than marginally affect markets, and whatever it does from here is basically politically driven and will have little economic impact," Josh Shapiro, chief U.S. economist at MFR Inc., wrote to clients.

The Fed is scheduled to announce any actions recommended at today's FOMC meeting at 2:15 p.m. EDT.

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