Wednesday, July 10, 2013

Politicized Science Leads to Impoverishment

by Pater Tenebrarum

Let's Destroy Some More Wealth Because 'We Can'

We recently came across an article entitled “Obama to unveil climate change plan with sweeping emissions cuts”. Evidently, president Obama urgently wants to do something about altering the recently rechristened 'global warming'. It has been rechristened mainly because the earth has stopped getting warmer 15 years ago. As such, 'climate change' is actually the perfect promotion for extending political control of the economy further: since the climate is always changing, there is now always a reason to curb property rights further, extend the sphere of central economic planning by the State, increase taxation and subsidize one's political cronies. It's perfect. And yet, from the point of view of an imperialistic State, it is really a very bad idea. This is so because it will lead to more capital decumulation and thus will over time reduce the State's ability to wage successful wars. Increased regulation does not increase anyone's income – including that of the government. It simply leads to impoverishment. Of course we cannot expect Obama to understand this. He is a lawyer specialized in constitutional law, not an economist. In fact, he is actually better described as a lawyer specialized in the subversion of constitutional law as we have recently learned. The military-industrial complex however should be duly alarmed. There will be far fewer resources available to it in the future.

But isn't it a good idea to 'curb emissions'? Aren't all emissions inherently bad? According to the article, Obama plans to outflank the democratic process by means of administrative law, which does not require any further input on the part of elected representatives. He will instead direct the EPA to issue wide-ranging rules in order to specifically cut down emissions of CO2. This is not only a disturbing process from a legal and economic point of view (someone should really curb the power of this bureaucracy before its meddling destroys civilization as we know it), but it is not exactly the brightest idea in light of current scientific knowledge either (or rather, the evident lack of such knowledge).

“Recognizing that Congress is unlikely to pass significant climate change legislation during his second term,President Obama will take some of the most sweeping measures available to him to unilaterally combat global warming.

The new plan, which Mr. Obama will unveil Tuesday at Georgetown University, is expected to include a ramping up of energy efficiency and renewable energy in addition to national preparations to deal with the meteorological and financial impacts of climate change. But by far the strongest element of the plan is a set of new regulations intended to slash greenhouse-gas emissions from existing coal-fired power plants – not just power plants built in the future.

Obama intends to issue a presidential memorandum directing the Environmental Protection Agency to implement new regulations of greenhouse-gas emissions under the authority of the Clean Air Act. The president's plan is an attempt to deliver on his promise to cut carbon emissions 17 percent below 2005 levels by 2020, White House officials told reporters in a conference call Monday.

The move has the potential to cut annually hundreds of millions of tons of carbon dioxide (CO2) – a potent greenhouse gas – and far overshadow any carbon-emissions cuts the Obama administration has achieved so far through improved fuel-efficiency standards. But it could also accelerate the closure of many existing older coal-fired power plants across the country, which are already struggling to meet current standards.

"Nothing on this scale in the Clean Air Act has ever been attempted before," says Kevin Book, an energy analyst with ClearView Partners, an energy economics consulting firm in Washington. "This step will be the catalyst for the next wave of coal-fired power plant retirements. It's almost certainly going to get hung up in the courts for years."

Obama seeks to combat global warming in a variety of ways in the new plan. Among the highlights:

  • Create new energy-efficiency standards for federal buildings and appliances.
  • Ramp up enough clean-energy production on public lands to power 6 million homes by 2020.
  • Extend $8 billion in loan-guarantee authority to accelerate investment in advanced fossil-energy and efficiency projects.
  • End public financing of coal-fired plants overseas and push for free trade in clean-energy technologies.

But a concrete plan to reach a 17 percent cut in carbon emissions is seen as the cornerstone of Obama's move. That figure is widely considered a requirement for the US to be taken seriously in ongoing international climate talks. Obama wants to reinvigorate US efforts to lead in those talks, White House officials said.

They said the plan to address existing-power-plant emissions has a firm timeline – adding credibility to the effort. The goal is to finalize power plant emissions regulations by June 2015, long enough before Mr. Obama leaves office to be solidly in force before the next administration takes over.

"We know that we have to get to work quickly in order to not only propose, but finalize the rule," said a senior White House official. "The president will be directing the EPA to start that work."

(emphasis added)

Of course many of these proposals don't make economic sense. 'Alternative energy' projects could not exist without subsidies, which ipso facto proves that they are not economically viable (apparently Mr. Obama has yet to learn any lessons from the countless bankruptcies of alternative energy companies his administration has subsidized. This is to say, their business was so atrociously bad that they could not even survive with subsidies. Solyndra was one of the more prominent examples, but by far not the only one). It also means that the overall wealth of society will decline due to their implementation, as scarce resources are employed and misdirected in a sub-optimal manner against the wishes of consumers.

However, these projects do not make any ecological sense either. As an example, a recent study shows that electric cars are not one iota 'greener' than gasoline driven cars. It is almost certain that studies of other 'alternative energy' projects would come to similar conclusions. After all, the energy to produce the means of alternative energy production must come from somewhere in the first place. Many (probably most) of these items are not only unprofitable without subsidies, they also have a negative net energy equation, i.e., it costs more energy to produce them than they will in turn produce during their lifetime.

However, the subsidization of such schemes is certainly an excellent method of rewarding political cronies and successful lobbyists, while simultaneously landing a PR coup with the deluded masses (who will pay through the nose for it all without even realizing it). So there are plenty of motives for instituting such policies, none of which have anything to do with 'saving the planet'.

And while the US may be 'taken seriously in ongoing international climate talks', it runs the danger of being laughed off future battlefields if it over-regulates its economy and begins to fall behind in military prowess as a result. The wealth required to support the giant US military machinery simply won't be created anymore if too much regulation suffocates the economy. It is certainly not that we are personally particularly concerned with the well-being of the military-industrial complex, we are merely establishing a fact here.

There are a few initiatives mentioned in the article above that we have no problem with: for example, we weren't aware that there was 'public financing of coal-fired plants overseas', and we would certainly agree it should be stopped – just as public financing of 'alternative energy' projects should be stopped. As for 'free trade in alternative energy products', we are in favor of free trade no matter what items it concerns, as free trade is always economically beneficial. Of course, since very few tradable 'alternative energy' products would exist without subsidies, this demand is probably superfluous (it should simply be replaced with: let us have free trade, period).

There can be no objection in principle to making things more 'energy efficient'. In the marketplace, this is constantly done; since economic activity is generally aimed at doing more with less, increasing energy efficiency over time is essentially a given. To the extent that a change in energy efficiency standards for federal buildings would lower government spending in the future, it is certainly not objectionable either.

Lastly, employing administrative law as a means of subverting or sidestepping the democratic process has become par for the course in modern-day regulatory democracies, but that doesn't mean one should accept it without demur. Political rule – as bad as it is – is step by step being replaced by something even worse: outright bureaucratic rule.

The Greenhouse Gas Bogeyman

Now let us briefly return to the question whether it makes sense to curb CO2 emissions specifically. This is an important question because it involves large costs, and the question is whether these can be justified by the expected improvements. In a state-less contractual society based on private property rights, one would not simply be allowed to pollute the air either, since this would clearly interfere with the property rights of others (for an in-depth discussion of the topic see Murray Rothbard's “Law, Property Rights, and Air Pollution”).

However, even though CO2 has been legally declared to be a 'pollutant' that falls under the 'jurisdiction' of the EPA bureaucracy, this is not what it represents from a strictly scientific standpoint. In fact, to declare CO2 a pollutant that needs to be regulated by a bureaucracy is ultimately legal nonsense as well if one thinks it through to its logical conclusion. Every human being exhales the stuff, and every plant needs it to survive. Does this mean the EPA is going to ban breathing?

Obviously, the only way to stop CO2 production by humans altogether would be to make breathing illegal. There are a few radical environmentalists who would welcome this idea, but they are not representative of humanity at large. See as an example the so-called 'Voluntary Human Extinction Movement', whose credo is that “Phasing out the human race by voluntarily ceasing to breed will allow Earth’s biosphere to return to good health.” Here is their web site. They are not even the worst moonbats out there actually – a few environmental radicals are in favor of an involuntary extinction process. Oddly enough, none of them have committed suicide yet, so as to lead by example. We already mentioned the academic demanding the death penalty for 'climate change deniers'.

Up until fairly recently, the debate over CO2 and its 'greenhouse gas' effect was in a way a bit abstract. Scientists who were and are not supporting the conclusions of AGW theory pointed out that: a rise in the atmosphere's CO2 level in the past tended to follow rather than lead warming periods; there have been much warmer periods than today long before any industrial activity by humans produced extra CO2; in a time when CO2 production increased rapidly (1940 to 1975), the earth cooled down so much that the scientific community was in the grip of a 'global cooling' hysteria; the most important greenhouse effect is produced by water vapor, i.e. clouds – the effect of CO2 is negligible by comparison; and lastly, the main causative agent in never-ceasing climate change is the sun, not human activity.

The proponents of AGW could always rely on one thing though: the earth was getting warmer since about 1980. This was an invaluable fact in terms of propaganda, even though it proved absolutely nothing per se. It supported the assertion that their 'GIGO' models actually 'worked' (garbage in, garbage out). No longer. Here is a recent assessment of the situation by a prominent supporter of the 'CO2 AGW' theory in Germany, Professor Hans von Storch:

SPIEGEL: Just since the turn of the millennium, humanity has emitted another 400 billion metric tons of CO2 into the atmosphere, yet temperatures haven't risen in nearly 15 years. What can explain this?

Storch: So far, no one has been able to provide a compelling answer to why climate change seems to be taking a break. We're facing a puzzle. Recent CO2 emissions have actually risen even more steeply than we feared. As a result, according to most climate models, we should have seen temperatures rise by around 0.25 degrees Celsius (0.45 degrees Fahrenheit) over the past 10 years. That hasn't happened. In fact, the increase over the last 15 years was just 0.06 degrees Celsius (0.11 degrees Fahrenheit) — a value very close to zero. This is a serious scientific problem that the Intergovernmental Panel on Climate Change (IPCC) will have to confront when it presents its next Assessment Report late next year.

SPIEGEL: Do the computer models with which physicists simulate the future climate ever show the sort of long standstill in temperature change that we're observing right now?

Storch: Yes, but only extremely rarely. At my institute, we analyzed how often such a 15-year stagnation in global warming occurred in the simulations. The answer was: in under 2 percent of all the times we ran the simulation. In other words, over 98 percent of forecasts show CO2 emissions as high as we have had in recent years leading to more of a temperature increase.

SPIEGEL: How long will it still be possible to reconcile such a pause in global warming with established climate forecasts?

Storch: If things continue as they have been, in five years, at the latest, we will need to acknowledge that something is fundamentally wrong with our climate models. A 20-year pause in global warming does not occur in a single modeled scenario. But even today, we are finding it very difficult to reconcile actual temperature trends with our expectations.

SPIEGEL: What could be wrong with the models?

Storch: There are two conceivable explanations — and neither is very pleasant for us. The first possibility is that less global warming is occurring than expected because greenhouse gases, especially CO2, have less of an effect than we have assumed. This wouldn't mean that there is no man-made greenhouse effect, but simply that our effect on climate events is not as great as we have believed. The other possibility is that, in our simulations, we have underestimated how much the climate fluctuates owing to natural causes.

SPIEGEL: That sounds quite embarrassing for your profession, if you have to go back and adjust your models to fit with reality…

Storch: Why? That's how the process of scientific discovery works. There is no last word in research, and that includes climate research. It's never the truth that we offer, but only our best possible approximation of reality. But that often gets forgotten in the way the public perceives and describes our work.

SPIEGEL: But it has been climate researchers themselves who have feigned a degree of certainty even though it doesn't actually exist. For example, the IPCC announced with 95 percent certainty that humans contribute to climate change.

Storch: And there are good reasons for that statement. We could no longer explain the considerable rise in global temperatures observed between the early 1970s and the late 1990s with natural causes. My team at the Max Planck Institute for Meteorology, in Hamburg, was able to provide evidence in 1995 of humans' influence on climate events. Of course, that evidence presupposed that we had correctly assessed the amount of natural climate fluctuation. Now that we have a new development, we may need to make adjustments.

SPIEGEL: In which areas do you need to improve the models?

Storch: Among other things, there is evidence that the oceans have absorbed more heat than we initially calculated. Temperatures at depths greater than 700 meters (2,300 feet) appear to have increased more than ever before. The only unfortunate thing is that our simulations failed to predict this effect.

SPIEGEL:That doesn't exactly inspire confidence.

(emphasis added)

In spite of seeing his expectations shattered on the shoals of reality, Professor von Storch at least behaves precisely like a scientist should: he admits that the last  word is not spoken and that quite obviously, something is wrong with the current climate models. The process of scientific discovery continues and it is time to look for alternative explanations for what is actually happening. However, these now discredited models are the very same models Mr. Obama is basing his recent wide-ranging and costly decisions on.

Just consider for a moment: the developments of the past 15 years show that there is only a 2% chance that current climate models are correct. If the earth continues not to warm for another five years, the probability that any of these models are correct will be precisely zero.

Do we want extremely costly economic decisions to be made on the basis of what by now looks largely like a promotion no longer supported by scientific facts? Again, keep in mind that von Storch is by no means someone who rejects the 'AGW' theory. In fact, as you can see above, he is still desperately clinging to it, even though he is forced to admit that the evidence is beginning to look less and less convincing. Then again, we have little doubt that he would be prepared to change his mind completely if and when clear evidence contradicting his current beliefs presents itself.

This is more than can be said of many other AGW proponents unfortunately, who continue to promote an unmitigated scare story – presumably because it ensures the continued flow of grant money (we have discussed the related expenses here; a truly giant gravy train is at stake).

more and less
Greenhouse gases, climate models and climate reality, via Der Spiegel. Something is  wrong, and it is not reality.


In conclusion, we would also note that any large scale problems humanity may face in the future  – whether they concern the climate, or an asteroid hurtling toward us through space – are far more likely to be successfully tackled the more capital accumulation takes place in the meantime. It is therefore not immaterial whether or not economic progress is hindered by climate related 'just in case' legislation. As many supporters of such legislation argue: 'even if the chance that the models are correct is only 2%, we should rather opt to make the economy less efficient, if we can make 100% sure thereby that a catastrophic outcome is averted'.

This argument is utterly false and misleading. The exact opposite is true: by slowing down capital and wealth accumulation, humanity's chance to successfully face potentially catastrophic developments in the future is clearly diminished.

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Credit Revulsion and Omnipotent Central Banks

by Pater Tenebrarum

Leverage Forces Selling of Fixed Income Securities – Mortgage REITS Flood Markets

We have recently argued that the big selling squall in bonds of all stripes in the face of declining inflation expectations was mainly an expression of a market structure problem: there is too much leverage in the market, and central bank policy is the culprit. By promising to leave interest rates at zero for as far as the eye can see and moreover continuing to buy massive amounts of bonds via  'QE' type operations, central banks have instilled a false sense of security among bond traders and investors, who have been tempted into leveraging their investments to the maximum extent possible in order to spruce up their meager yield income.

All it takes under such circumstances is for some trigger event to take place, be it Ben Bernanke's 'tapering' talk or the Bank of Japan's self-contradictory mad-cap 'reflation' policy, and all hell soon breaks loose. As we have pointed out, even those who thought they had made their portfolios bullet-proof and were prepared to deal with all eventualities, were surprised to learn that the one thing that actually happened was not on their menu.

Now we receive further confirmation that leveraged trades were indeed behind the rout:

“Annaly Capital Management Inc. (NLY)’s Wellington Denahan, head of the largest mortgage real-estate investment trust, told investors less than three months ago that reports REITs could threaten U.S. financial stability were as misleading as the media frenzy over shark attacks in 2001.

Since the May 2 comments, shares of the companies, which use borrowed money to make $400 billion in credit market bets, dropped about 19 percent through yesterday and the value of their assets has plunged after the Federal Reserve triggered a flight from bond funds by signaling plans to slow its debt-buying program.

REITs may have needed to sell about $30 billion of government-backed mortgage securities in just one week last month to maintain the amount of borrowing relative to their net worth, according to JPMorgan Chase & Co. Those types of sales deepened losses in the mortgage-bond market, which had the worst quarter since 1994, accelerated the exit from fixed-income funds and fueled a jump in home-loan rates to a two-year high.”

(emphasis added)

$30 billion of margin call related sales in one week just by REITs is a lot of wood. Regarding the above mentioned 'media frenzy', we see fairly little evidence for that – in fact, if anything, the potential danger of these leveraged bets is probably still widely underestimated. And it seems that the selling isn't really over quite yet:


The 10 year note yield has barely given back any of its recent gains. In fact, a new high for the move was reached last Friday – click to enlarge.

Credit Revulsion Could Spread

It is important to keep in mind that once such declines in a highly leveraged market begin, there is always a chance that they will spread over time to include all sorts of securities. The panic could spread to all sorts of debt paper (in fact, it has done that already) and eventually from there to equities as well. It is always possible that due to being severely oversold, all these markets will bounce sufficiently to repair stressed and overleveraged portfolios sufficiently for the party to resume.

Unfortunately, it is not very likely. It is more likely that those who failed to sell in the initial wave down will do so once a bounce gives them a chance to get out at slightly better prices – and the charts of EMB (an ETF that is a good proxy for emerging market bonds) and MUB (a municipal debt ETF) actually suggest that this is what is happening:

EMBEMB – after an oversold bounce, the market has begun to look wobbly again – click to enlarge.

MUBMUB's chart looks similar – click to enlarge.

We would guess that the situation will become clearer and potentially more volatile this fall. It is quite ironic that in spite of massive monetary pumping, weak global economic performance and declining inflation expectations, yields are doing the exact opposite of what one would normally expect. It seems to us that this is an indication of how dysfunctional and distorted markets have become in the wake of central bank interventions.

A Myth Destined to Crumble

Recently, Keynesian Joe Weisenthal of  Business Insider posted a breathless apologia of Bernanke, demanding that his critics admit that he finally got something right and apologize to him (not mentioned is the fact that the same thing could have been said of Bernanke in 2006, and yet two years later it was crystal clear that he had been 180 degrees wrong about everything).

The instant gratification crowd apparently believes that the effects of interventions on such a grand scale can be discerned within a very short time, and that anything that is liable to happen later is akin to a case of inclement weather (a very popular phrase one gets to hear when these 'unexpected' events strike is 'no-one could have seen it coming').

However, it is already absolutely certain that the Bernanke echo bubble will end in massive upheaval that may well exceed the 2008 crash in intensity – only the timing is uncertain.

The great myth that is going to be destroyed at some point in coming years is that the central planners have 'things under control'. The recent sell-off in the debt markets is a first hint in that direction. Once the myth of the omnipotence of central banks is shoved rudely aside by reality, we will enter 'interesting times' as they say in China (incidentally, China appears very close to experiencing 'interesting times' itself). There is no way to avoid the collapse of a boom brought on by credit expansion – as Mises pointed out, the only question is whether it will happen sooner due to a voluntary abandonment of the credit expansion policy, or later, as a total catastrophe of the underlying currency system.

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The Absurd Fed Minutes Ritual

by Pater Tenebrarum

Markets Become Backward Looking

As we have previously argued, financial markets don't 'know' anything, especially close to major turning points. Conventional wisdom eventually almost always turns out to be dead wrong, and quite often the valuations that are accorded to securities strike one as absurd in hindsight, even if one only considers what was already known at the time when these prices were paid.

What has become especially notable in recent years is the extent to which financial markets have become dependent on central banks and have begun to mimic the methods employed by central bankers.

These methods consist by and large of looking at the data of the immediate past, pretending that these tell us anything about the future, and then deciding on monetary policy in knee-jerk, ad hoc fashion. That is basically the degree of 'planning' employed by our vaunted central planners. It would of course not help one bit if they were trying some different method, as central planning simply cannot work under any circumstances – i.e., it will always lead to outcomes that are less optimal than those that would have been achieved by an unhampered market (perhaps an improvement could be achieved by simply throwing dice). There are no ifs or buts in this context. Mises showed that economic calculation under socialism is impossible, and one can extend this theorem to special cases such as central banking in the context of a market economy. Essentially, central banks are socialist islands in a capitalist sea. To some extent they can take their cues from market prices, but their existence as such already distorts such prices, so the information they receive is tainted from the outset. They cannot possibly gauge the extent of the harm they inflict on the economy.

Anyway, financial markets are generally held to be forward looking. Quite often this has actually been true – but the more the market is subjected to interventionist policy, the less true it perforce becomes. This has never been more obvious than in recent years and months, when the markets were most of the time yanked this way or that way by something a central bank did or a central banker said. The markets have also begun to focus on lagging economic indicators like e.g. the payrolls data, simply because it is widely known that the central bank focuses on them as well. This makes no sense whatsoever, unless one concedes that market prices are by now extremely distorted and that future price trends therefore depend mainly on whether or not there will be more monetary pumping.

The Height of Absurdity

The most bizarre monthly ritual has become the breathless anticipation of the 'Fed minutes'. Not only do these minutes contain the useless backward looking analysis of the FOMC and its advisers (who have yet to recognize a major economic trend change ahead of time after a century of fruitless trying), they are a month old by the time they are released to boot!

One feels almost stupid participating in a market that reacts to such plainly useless information. And yet, that is precisely what happens. Today the financial press was full with articles describing the 'nervous anticipation' gripping the markets prior to the release, and the subsequent relief at the receiving what at this point can only be described as 'meaningless non-news'. Here is a brief excerpt of the what the minutes contained:

“Even as consensus built within the Federal Reserve in June about the likely need to begin pulling back on economic stimulus measures soon, many officials wanted more reassurance the employment recovery was on solid ground before a policy retreat.

Financial markets have largely converged on September as the probable start of a reduction in the pace of the U.S. central bank's $85 billion in monthly bond purchases, but minutes of the Fed's June meeting released on Wednesday suggested that might not be a sure bet.

"Several members judged that a reduction in asset purchases would likely soon be warranted," the minutes said. But they added that "many members indicated that further improvement in the outlook for the labor market would be required before it would be appropriate to slow the pace of asset purchases."

Global investors have recently recovered from a mild bout of panic that followed Fed Chairman Ben Bernanke's roadmap for an end to so-called quantitative easing, which he said would likely draw to a close by the middle of next year. Financial market fears have been allayed in part by a chorus of Fed officials who have sought to reassure traders that the end of asset buys will not lead to imminent interest rate hikes.

"Many members indicated that decisions about the pace and composition of asset purchases were distinct from decisions about the appropriate level of the federal funds rate," the minutes said. Whether the markets have gotten the message is not fully clear; the yield on the 10-year U.S. Treasury note has risen a full percentage point in just two months and stands close to its highest levels since 2011. This has already slowed activity in the mortgage market, which had been key to the recent economic rebound.

At their June meeting, some Fed officials worried not only about the outlook for employment, but the pace of economic growth as well. Many economists believe the economy grew at less than a 1 percent annual rate in the second quarter, although most look for a pick-up in the second half of the year.

"Some (officials) added that they would … need to see more evidence that the projected acceleration in economic activity would occur, before reducing the pace of asset purchases," the minutes said.”

Of the Fed policymakers who argued it would be wise to curtail bond purchases soon, two thought it should be done "to prevent the potential negative consequences of the program from exceeding its anticipated benefits.”

(emphasis added)

We would essentially term all of this vapid blather. It is the same stuff we read in every FOMC press release: if the vaunted 'data' show that things are getting better, then there will be less monetary pumping. If not, it will continue or may even be intensified. At this stage, how can anyone possibly be 'surprised' by the content of the minutes? Or for that matter, by anything the Fed does or says? Just watch a few aggregate economic statistics, and you will know what they'll do, since they always adjust their actions to the events of the recent past in order to influence a future they cannot possibly discern.

There is a single point that we find mildly interesting: only two regional Fed presidents are left to argue that 'QE' may have more drawbacks than 'anticipated benefits'.


FOMC: producing decisions that harm the economy in addition to a lot of meaningless blather, in a well appointed room.

(Photo credit: unknown author)

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Many on Fed want further jobs improvement before tapering QE

By Joshua Zumbrun and Craig Torres

Many Federal Reserve officials want to see more signs employment is picking up before they’ll begin slowing the pace of $85 billion in monthly bond purchases, according to minutes of policy makers’ last meeting.

“Many members indicated that further improvement in the outlook for the labor market would be required before it would be appropriate to slow the pace of asset purchases,” according to the record of the Federal Open Market Committee’s June 18-19 gathering released today in Washington.

Today’s minutes said “several members judged that a reduction in asset purchases would likely soon be warranted.” Those members said the “cumulative decline in unemployment since the September meeting and ongoing increases in private payrolls” had increased their confidence that the labor market had improved, the minutes showed.

Chairman Ben S. Bernanke said in a press conference after the meeting that the Fed may trim its bond-buying program this year and halt it around mid-2014 if economic performance tracks the central bank’s forecast. The minutes show officials want to see that forecast confirmed before tapering their purchases.

Not all members agree on when to begin slowing the pace of purchases. Some on the panel “need to see more evidence that the projected acceleration in economic activity would occur, before reducing the pace of asset purchases,” according to the minutes.

Stocks Rise

Stocks rose and bond yields fell after the release of the minutes. The Standard & Poor’s 500 Index rose 0.1% to 1,654.57 at 2:06 p.m. in New York, while the yield on the 10- year Treasury note fell to 2.64% from as high as 2.67% earlier in the day.

The minutes refer to the 12 voting policy makers as “members” and the entire 19-person policy making group as “participants.” Only five of the 12 regional Fed presidents have a vote in any given year.

In a discussion about the appropriate path of the balance sheet among the 19 FOMC participants, “about half” indicated “it likely would be appropriate to end asset purchases late this year,” the minutes said. “Many other participants anticipated that it likely would be appropriate to continue purchases into 2014,” the minutes said, while “a few” wanted to slow or stop the purchases at the June meeting.

St. Louis Fed President James Bullard dissented from the Fed’s statement in June, saying that in light of low readings on inflation the committee should “signal more strongly its willingness to defend its goal of 2% inflation.”

‘Watching Closely’

The minutes show that “many others worried about the low level of inflation, and a number indicated that they would be watching closely for signs that the shift down in inflation might persist or that inflation expectations were persistently moving lower.”

Fed officials speaking since the meeting have sought to clarify Bernanke’s June 19 remarks after his timetable for slowing the pace for unprecedented stimulus triggered a surge in interest rates. The yield on the 10-year Treasury climbed to 2.74% on July 5 from 2.19% the day before Bernanke spoke, while the national average for the 30-year fixed-rate mortgage rose to as high as 4.46% on June 27 from as low as 3.35% in May.

Federal Reserve Bank of New York President William C. Dudley said on June 27 that the central bank may prolong its asset-purchase program if the economy falls short of policy makers’ expectations. Fed Governor Jerome Powell and Atlanta Fed President Dennis Lockhart, speaking on the same day, sought to damp expectations the central bank will increase the target interest rate sooner than previously forecast.

Clarify Approach

Bernanke has an opportunity to clarify his approach to bond buying in a speech scheduled for 4:10 p.m. today in Boston and titled, “A Century of U.S. Central Banking: Goals, Frameworks, Accountability.”

The 59-year-old Fed chief has engineered several unorthodox programs to revive credit and economic growth amid the worst recession since the Great Depression. The Fed cut its target interest rate to near zero in December 2008 and has pledged to hold it there as long as the unemployment rate remains above 6.5% and the outlook for inflation doesn’t exceed 2.5%.

The Fed began purchasing $40 billion a month of mortgage backed securities in September and announced $45 billion a month of Treasury purchases in December. The program, known as QE3 for the Fed’s third round of quantitative easing, has expanded the central bank’s balance sheet to a record $3.49 trillion.

Exceeded Expectations

Fed officials met before the Labor Department’s jobs report for the month of June exceeded expectations, with the economy adding 195,000 jobs and the unemployment rate unchanged at 7.6%.

The July 5 report reinforced speculation the Fed may reduce its pace of purchases as soon as September. Economists at Goldman Sachs Group Inc. and JPMorgan Chase & Co. said after release of the employment data that the Fed will begin tapering its purchases sooner than they had projected.

Bernanke said tapering depends on whether the economy strengthens in the second half of 2013 and aligns with central bank forecasts released at the end of the June FOMC meeting. The predictions are sunnier than those of Wall Street.

Fed officials predict the economy will grow 2.3% to 2.6% this year and 3% to 3.5% in 2014, while the median estimate of economists in a Bloomberg survey is for 1.9% growth in 2013 and 2.7% in 2014.

Budget Cuts

Tax increases and automatic federal budget cuts are inhibiting growth this year. Those cuts led to furloughs of the U.S. military’s civilian workers that began this week. The move means a reduction equivalent to 11 days pay for as many as 651,542 employees through Sept. 30, according to Pentagon figures. The furloughs are the latest step in automatic budget cuts, known as sequestration.

Growth in the U.S. was less than originally estimated in the first quarter of the year after an increase in the U.S. payroll tax took a bigger bite out of consumer spending than previously calculated in Department of Commerce reports. The economy grew 1.8% in the first quarter, down from a prior reading of 2.4%, according to a June 26 report.

At the same time, policy makers including Bernanke and Dudley have remarked about how a housing rebound is aiding the expansion. Home values in 20 U.S. cities rose 12.1% in the year through April, the biggest annual gain since 2006, according to an S&P/Case-Shiller index. Sales of new houses in May climbed to the highest level in almost five years.

The housing recovery will probably continue even as mortgage rates rise, Jeffrey Mezger, the president of KB Home, the best-performing U.S. homebuilder stock this year, said in a June 27 earnings call.

“If the economy continues to expand like it is, I think you’ll see the banks loosen up,” Mezger said. “And so if rates go up a little bit, but underwriting loosens up a bit, I think you’ll see similar demand, if not more. That’s why we’re not troubled by a little uptick in interest rates right now.”

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Declining Oil Spread Is Bad News for Refiners

By Robert Rapier

The fortunes of US refiners have been on a roller coaster ride over the past year and a half. This is nothing new for the refining industry, which has ridden a cycle of boom and bust for decades. The current cycle was largely influenced by the differential between the price of Brent crude and West Texas Intermediate (WTI), which exceeded $25/bbl at times in 2012.
Historically Brent crude was discounted relative to WTI, but for the past 2 1/2 years Brent has mostly traded at premium of more than $10/barrel. This historic flip-flop was a result of expanding US oil production, which swelled crude inventories in Cushing, Oklahoma to record levels.
This differential is important for refiners, because they can buy discounted crude from the Bakken, Eagle Ford, or Permian Basin at prices influenced by the price of WTI and then sell finished products that are generally priced on the basis of Brent crude.

Brent-WTI spread chart

Many refiners are effectively in a position to pocket most of the differential between Brent and WTI, and so when the spread grows wide refiners’ profits grow large. Thus, it should come as no surprise that refiners likeValero Energy (NYSE: VLO), Tesoro (NYSE: TSO), and Marathon Petroleum (NYSE: MPC) saw profits surge in 2011 and 2012. As a result of these favorable conditions, the share prices for refiners had a huge run-up from early 2012 to early 2013, when many of them notched triple-digit gains.

However, in 2013 refiners have been hit with a rash of negative news that’s hurt performance. The first bit of bad news was covered in a March issue of the The Energy Letter in which I discussed the issue of the looming ethanol blend wall, which is leading to soaring costs for refiners as they attempt to comply with federal ethanol mandates.

Next came a proposal from the US Environmental Protection Agency (EPA) to lower the limit on sulfur in gasoline from 30 parts per million (ppm) to 10 ppm. The cost of complying with the new regulations has been estimated in the range of $10 billion for adding new hydrotreater capacity to the refineries. EPA estimated that annual operating costs for US refiners would increase by $3.4 billion by 2030.

Those two pieces of news stalled the momentum that refiners had carried over from 2012. But one more piece of bad news is one I have warned about since last year: the Brent-WTI differential is reverting to the historical norm.

I expected the differential to shrink this year because several projects will relieve the bottleneck in Cushing. In May 2012, Seaway Crude Pipeline Company — a joint venture between Enterprise Products Partners LP (NYSE: EPD) and Enbridge (NYSE: ENB) — reversed the flow direction of the Seaway Pipeline. This allowed the transport of 150,000 barrels per day (bpd) of crude oil from Cushing to Gulf Coast refineries near Houston. But that wasn’t enough to slow the growth of inventories in Cushing, as it represented a small fraction of the increasing oil production flowing into the hub.

In January 2013 the capacity of the Seaway Pipeline was increased by 250,000 bpd to a total capacity of 400,000 bpd. Seaway is also executing a project designed to parallel the existing right-of-way from Cushing to the Gulf Coast. This project is scheduled to be completed by the first quarter of 2014, and will more than double Seaway’s capacity to 850,000 bpd.

Later this year the southern leg of the Keystone pipeline is scheduled to come onstream. This Keystone-Cushing extension will have an initial capacity to transport 700,000 barrels of oil per day from Cushing to Gulf Coast refineries (not to be confused with the Keystone XL project which is still awaiting approval by the Obama Administration). These Seaway and Keystone projects have a combined capacity of more than 1.5 million bpd, which mounts to some 70 percent of the increase in US oil production capacity over the past four years.

Cushing inventories have yet to be significantly eroded, although they have come down somewhat from their highs. Anticipation of further inventory declines may be one reason the Brent-WTI differential is shrinking. This has helped WTI maintain strength as the price of Brent crude weakened on signs that the global market may be amply supplied.

Cushing inventories chart

Whatever the reason, a declining differential will hurt refiners that have benefited so much from unusual circumstances over the past two years. But the differential is not the whole story. The profitability of a refinery can be predicted on the basis of the difference between the crude oil it purchases and the finished products sold and is expressed in terms of the “crack spread.” The price of Brent is really a proxy for the price of finished products.

The problem for refiners is that the price of those finished products is weakening. Many news stories leading up to the July 4 holiday were about falling gasoline prices. Gasoline prices typically peak some time after Memorial Day, and once they start to decline it is bad news for refiners if the price of crude is holding steady or rising.

This is exactly the case this year, which is why second- and third-quarter profits will be noticeably down from 2011 and 2012.  A lower differential has bearish implications for on other segments of the energy sector as well. 

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India's foreign reserves declining

by SoberLook

Barclays Capital had a sobering update on India today. Apparently June saw the largest outflows on record from bond and equity portfolios.

Source: Barclays

As a result, declines in India's foreign reserves are becoming material.

Source: Barclays

Moreover, India's gold holdings constitute a significant portion (more than other countries) of the nation's reserves. And the recent declines in gold price have not yet been included in the official numbers (not in the chart above).
While the reserves a currently sufficient to defend the currency if the RBI chooses to use them, these recent declines will probably make them hesitate. India has other tools it can deploy, should the officials decide to become more aggressive in defending the currency.

Barclays Capital: - ... government officials are likely to use other policy options to stem INR weakness, including further liberalisation of the financial account (eg,reducing restrictions on debt purchases by foreign investors and relaxing FDI limits) in an effort to support sentiment. Most recently the Securities and Exchange Board of India (SEBI) announced measures to reduce speculative INR trades “in view of the recent turbulent phase of extreme volatility”, which are likely to help stabilise the currency to some degree. In consultation with the RBI, SEBI has instructed relevant exchanges to reduce client position limits and increase margin requirements for currency derivatives.

Therefore for those concerned that the central bank will be forced to sell gold, at this stage there are a number of other alternatives. And given the nation's cultural attitude toward gold, politically that's just not an option. Nevertheless in the near-term the currency remains vulnerable to capital outflows, should confidence deteriorate further.

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A Return to "Normalcy"

by Marketanthropology

A Return to "Normalcy"

For all the anxiety, the "new normal" has performed a lot like the old - or at least the normal we were accustomed to in the back half of the 1990's. Perhaps not quite Livin' La Vida Loca "normal", but when you compare our equity market returns over the past 5 years with the rest of the world -  Gisele wasn't the only one to turn her back on the U.S. right before Old Glory caught another strong breeze.

Click to enlarge image

All joking aside, we have tremendous respect for Mohammed el-Erian's sharp investing acumen and intuitive market philosophies. To his credit, many of the economic, monetary and fiscal predictions outlined by him in 2009 have held up. Growth has been disappointedly sluggish and unemployment stubbornly high. He was also on the mark initially in anticipating that emerging markets would lead the way in the recovery. Where his and many participants expectations went astray was in assuming the shift in economic leadership away from the U.S. and the dollar to developing nations (particularly in Asia) - had room to run. In true contrarian fashion, the concept practically top ticked the balance of the world's outperformance (namely China) in the recovery and a major pivot for the dollar.

Click to enlarge image

Today, as conventional market wisdom has firmly embraced the notion that the U.S. under the stewardship of the Fed is the safest neighborhood to park ones capital, the original tenet of outperformance by developing nations - particularly China, is now overgrown with pessimism and stands of contrarian tinder. Perhaps all they will need is a match to burn.
While we agree it looks rather bleak in the East right now, we know markets have been discounting these conditions for some time.  Considering the Fed has written the playbook of monetary intervention, we wouldn't be surprised to see China pull a page or two in the coming months or even write a new chapter of their own. 
For reference, our Shanghai Composite comparative with the SPX, circa 1982 - may hold some clues.

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Europe’s Zombie Banks

by Daniel Gros

BRUSSELS – What is wrong with Europe’s banks? The short answer is that the sector is too large, has too little capital, and contains too many players that lack a viable long-term business model. It is the combination of the last two factors – an overabundance of banks with no sustainable way to turn a profit – that constitutes the most serious and most difficult problem.

This illustration is by Tim Brinton and comes from <a href=""></a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

Illustration by Tim Brinton

The banking sector’s size is a cause for concern because, with total liabilities amounting to more than 250% of the eurozone’s GDP, any major problem could over-burden public budgets. In short, the banking sector in Europe might be too big to be saved.

Undercapitalization can be cured by an infusion of new equity. But the larger the banking sector, the more difficult this might become. More important, it makes no sense to put new capital into banks that cannot return profits for the foreseeable future.

The difficulties in southern Europe are well known, but they differ fundamentally from country to country. In Spain, banks have historically issued 30-year mortgages whose interest rates are indexed to interbank rates such as Euribor, with a small spread (often less than 100 basis points) fixed for the lifetime of the mortgage.

This was a profitable model when Spanish banks were able to refinance themselves at a spread much lower than 100 basis points. Today, however, Spanish banks – especially those most heavily engaged in domestic mortgage lending – must pay a much higher spread over interbank rates to secure new funding. Many local Spanish banks can thus stay afloat only because they refinance a large share of their mortgage book via the European Central Bank. But reliance on cheap central bank (re)financing does not represent a viable business model.

In Italy, the difficulties arise from banks’ continued lending to domestic companies, especially small and medium-size enterprises (SMEs), while GDP has stagnated. Even before the eurozone crisis erupted in 2010, the productivity of capital investment in Italy was close to zero.

The onset of the current recession in Europe has exposed this low productivity, with the failure of many SMEs leading to large losses for the banks, whose funding costs, meanwhile, have increased. It is thus difficult to see how Italian banks can return to profitability (and how the country can resume economic growth) unless the allocation of capital is changed radically.

There are problems north of the Alps as well. In Germany, banks earn close to nothing on the hundreds of billions of euros of excess liquidity that they have deposited at the ECB. But their funding costs are not zero. German banks might be able to issue securities at very low rates, but these rates are still higher than what they earn on their ECB deposits. Moreover, they must maintain an extensive – and thus expensive – domestic retail network to collect the savings deposits from which they are not profiting.

Of course, some banks will always do better than others, just as some will suffer more than others from negative trends. It is thus essential to analyze the situation of each bank separately. But it is clear that in an environment of slow growth, low interest rates, and high risk premia, many banks must struggle to survive.

Unfortunately, the problem cannot be left to the markets. A bank without a viable business model does not shrink gradually and then disappear. Its share price might decline toward zero, but its retail customers will be blissfully unaware of its difficulties. Other creditors, too, will continue to provide financing, because they expect that the (national) authorities will intervene – either by providing emergency funding or by arranging a merger with another institution – before the bank fails. Recent official tough talk in the European Union about “bailing in” bank creditors has not impressed markets much, not least because the new rules on potentially imposing losses on creditors are supposed to enter into force only in 2018.

Starting next year, when it takes over authority for bank supervision, the ECB will review the quality of banks’ assets. But it will be unable to review the longer-term viability of banks’ business models. Current owners will resist to the end any dilution of their control; and no national authority is likely to admit that their national “champions” lack a plausible path to financial viability.

Keeping a weak banking system afloat has high economic costs. Banks with too little capital, or those without a viable business model, tend to continue lending to their existing customers, even if these loans are doubtful, and to restrict lending to new companies or projects. This misallocation of capital hampers any recovery and dims longer-term growth prospects.

What should be done is clear enough: recapitalize much of the sector and restructure those parts without a viable business model. But this is unlikely to happen any time soon. Unfortunately, until it does, Europe is unlikely to recover fully from its current slump.

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11 Signs That Italy Is Descending Into A Full-Blown Economic Depression

By Michael Snyder

When you get into too much debt, really bad things start to happen.  Sadly, that is exactly what is happening to Italy right now.  Harsh austerity measures are causing the Italian economy to slow down even more than it was previously.  And yet even with all of the austerity measures, the Italian government just continues to rack up even more debt.  This is the exact same path that we watched Greece go down.  Austerity causes government revenues to drop which causes deficit reduction targets to be missed which causes even more austerity measures to become necessary.  But if Italy collapses economically, it is going to be a far bigger deal than what happened in Greece.  Italy is the ninth largest economy on the entire planet.  Actually, Italy used to be number eight, but now Russia has passed it.  If Italy continues to stumble, India and Canada will soon pass it as well.  It really is a tragedy to watch what is happening in Italy, because it really is a wonderful place.  When I was a child, my father was in the navy, and I got the opportunity to live there for a while.  It is a land of great weather, great food and great soccer.  The people are friendly and the culture is absolutely fascinating.  But now the nation is falling apart.  The following are 11 signs that Italy is descending into a full-blown economic depression...

#1 The unemployment rate in Italy has risen to 12.2 percent.  That is the highest that it has been in more than 35 years.

#2 The youth unemployment rate in Italy is sitting at 38.5 percent, and in southern Italy it recently hit the 50 percent mark.

#3 An average of 134 retail outlets are shutting down in Italy every single day.  Overall, approximately 224,000 retail establishments have closed since 2008.

#4 Italy's economy has now been contracting for seven quarters in a row.

#5 It is being projected that Italy's GDP will shrink by 1.8 percent this year.

#6 Industrial production in Italy has declined for 15 months in a row.  It has now fallen to its lowest level in about 25 years.

#7 Overall, factory output in Italy has fallen by about one-fourth since 2008.

#8 In May, automobile sales in Italy were down 8 percent compared to one year earlier.

#9 The number of people that are considered to be "seriously deprived" in Italy has doubled over the past two years.

#10 Italy now has a debt to GDP ratio of 130 percent.

#11 It is being projected that Italy will need a major EU bailout within six months.

At this point, Italy is flat broke.

And unlike the U.S. or Japan, Italy cannot run over to a central bank and have them print up oodles of new money with which to buy up government bonds.  Italy is married to the euro, and so that greatly limits their options.  Unfortunately, the money is rapidly running out.  The following is from a recent article by Wolf Richter...

In most countries, it would be an act of mind-bending chutzpah, or perhaps a display of political insanity, but in Italy it barely made ripples: for a government official, a minister no less, to declare that the country cannot pay its long overdue bills, and not for a month or two, but for the rest of this year! Due to "technical" problems.

The Italian government is out of money. Not that the US government is in any better shape in that respect, or the Japanese government for that matter, but they have central banks that print the missing moolah with lavish abandon. Italy doesn't. It has the ECB which is run by an Italian who promised last year to print with lavish abandon to keep countries like Italy afloat. But that promise is not the same thing as having your own central bank.

On July 4, Italy's budget fiasco came to light once again. Wracked by the pretense of austerity, expenditures rose 1.3% in the first quarter, while revenues remained flat. So the deficit rose to 7.3% of GDP, up from 6.6% last year, bringing the national debt to 130% of GDP. Ballooning debt and deficits in a shriveling economy – Italy has been in recession since the fourth quarter of 2011 – is a toxic combination in the Eurozone.

While those numbers may sound really bad, the reality is that the people that are suffering the most are the average folks on the street.  Many Italians have been completely blindsided by this economic depression, and suicides are skyrocketing...

In Italy, the tragic stories of suicides apparently linked to the deep recession are becoming all too frequent. Last month, a former factory worker hanged himself near Turin because he could not find work, his relatives said. In May, a young man committed suicide outside of Rome shortly after he lost his job. The next day, Italian President Giorgio Napolitano begged the government to deliver “the utmost attention for situations of greatest malaise and need” to help stop the wave of suicides.

That is absolutely tragic.

But you know what?

The United States is headed down the same path that Italy has gone.

In the coming years unemployment and suicide will both skyrocket here too.

Those that are sticking their heads in the sand right now will be absolutely blindsided by what is coming.  But those that understand what is on the horizon and are preparing for it will have the best chance of making it through.

Italy is kind of like the Leaning Tower of Pisa.  Everyone knows that it is going to fall eventually, and when it does fall it is going to be a major disaster.

When the financial system of Italy totally implodes, that will be a sign that things are really starting to accelerate.  Expect dominoes to start tumbling much more rapidly in the aftermath.

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The S&P 500 Could Hit 2000 Before Year End

by Greg Harmon

Back in the beginning of June the broad market was pulling back. There was oodles of debating around whether this was the big one that Roubini, Faber and Prechter have been calling for since, well, forever, just a run of the mill but painful 20% correction, or a modest pullback that should be welcomed, as Ralph Acampora has put it. Then I wrote about the possibility that it could be a big pullback but that price action was suggesting maybe not. The 1593 level in the S&P 500 ($SPX) was the low at the time and I pointed to the 1553 and 1536 levels as important downside support levels. It turned out that the 1553 level held and the market has been reversing from there. Fast forward to July 10th, a month later,


and the market is starting to look very solidly like it wants to go higher. The chart above of the S&P 500 shows the pullback as a bearish Shark Harmonic with a Potential Reversal Zone at either 1677 or, a new high, 1699. The full Shark is then seen as a retracement or pause in an AB=CD pattern. That has a target of 1903 and timing of about year end. But these often extend to where CD = 127% of AB, like in the 4 thrusts that drove the market from 1343 to the high at 1687. In that case the target would be about 2000 on the S&P 500.

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Price Action Does not Mean the Euro has Bottomed

by Marc to Market.

There has been no follow through selling of the euro after yesterday's bearish price action.  Yesterday, the euro first traded above Monday's highs, then broke down to trade below Monday's low, and record new three month lows.  It finished the North American session below Friday-Monday lows, completing what technician call an outside down day. 

The euro is trading within yesterday's ranges, but the lack of follow through selling does not mean that the move has been exhausted.  Leaving aside the very near-term, the fundamentals we would emphasize and technical considerations still point to a weaker euro.  As we have since the end of last year, we expect the euro to finish the year closer to $1.20.

Economic activity in the euro zone has contracted for 6 consecutive quarters through Q1 and appears to have contracted further in Q2.  While some survey data suggests a mild recovery has begun, it is preliminary and there continues to be significant headwinds.  Some of those head winds are internally generated, but some, like knock-on effect of rising US rates, are not

When thinking about currencies in the context of policy, what is important is the trajectory of policy not just its current setting.  The verbal communication about tapering is part of the multi-step process of exiting the extraordinary monetary policy.   Some observers suspect that first tapering could be announced at the FOMC meeting late this month.   Color us very skeptical. 

The consensus is for the first announcement to be made in September and implemented in October, whereby it would reduce its long-term asset purchases to $65 bln a month, down from $85 bln (which means still translate into $450 bln of purchases here in H2).  It is expected to stop its purchases completely in mid-2014.  Indicative market prices, like the Fed funds and Eurodollar futures suggest a little more than a 50% chance of the first hike is priced in for late 2014. Even if the interpolation from market prices is inexact, there is little doubt now that the Fed will be the first of the major central banks to exit. 

The ECB has innovated.  It previously chose not to pre-commit.  This was a cornerstone of its communication policy.  This was a way to preserve and maximize its options.  Yet, sometimes as the game theorists remind us, denying oneself options is also an important part of strategizing and sending a still powerful signal.  The ECB has indicated that official rates will remain at current levels or lower for an extended period of time.  That precise measure of extended period of time is really of little matter presently.  It is clear that it means no refi rate hike until mid-2014 at the earliest.  Judging for the euribor curve,  the market does not appear to be anticipating an increase until closer to mid-2015. 

The December 2014 Euribor futures contract is difficult to read.  The 60 bp increase in the implied yield from mid-May through late June was not a sign of rate hike expectations, but it appeared to part of a larger market reaction to the tapering talk in the US.   Draghi explained that the ECB's innovation was in part a reaction to that backing up European interest rates.    The market understood and from the ECB meeting last week through earlier today, the implied yield on the Dec Euribor futures contract fell almost 25 bp. 

While we think that Fed's tapering may take place later than consensus and a hike in the Fed funds rate is unlikely in 2014, we also suspect the market does not appreciate the risk that the ECB still has to ease monetary policy   Although the ECB has not ruled out another LTRO or a negative deposit rate, we suspect another 25 bp cut in the refi rate is the most likely course.  The timing still appears a couple of months off.  We would pencil it in for October. 

We continue to come back to how well short-term interest rate differentials track the euro-dollar exchange rate.  Consider that since the global economy bottomed in mid-2009, the US on average has offered 17 bp less than Germany on two-year money.  Today it offers 28 bp, the most in three years.  The euro has averaged about $1.3480 over this time.  Today it is near $1.28.

The CFTC released the latest Commitment of Traders report earlier this week, as the July 4 holiday delayed the release.  The data is more dated than usual.  However, it is revealing to note that in the week through July 2, that it in the run-up to the ECB meeting and the US jobs data, the net speculative position swung from net long 17.4k contracts to being short 16.1k.  This shift, though reflect longs liquidating more than five times greater than the new shorts being established.  The gross short speculative position of 75.4k contracts, is less than a third of the record set last year of a little more than 250k contracts. 

The divergence between the US and European economic activity, the relative trajectory of monetary policy, not very crowded market speculative positioning underpins the case for the weaker euro.   The US policy mix itself is will be moving in a more supportive direction for the dollar.  This year's tight fiscal loose monetary mix will give way next year to somewhat looser fiscal policy (not only Federal government, but the contraction of state governments appears nearly over too) and somewhat less loose monetary policy. 

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Coffee mixed as bulls lose control in New York

By Jack Scoville


General Comments: Futures were lower on some long liquidation after bulls could not take out resistance at 125.00 NY September. London moved much higher on some industry buying tied to less offers from Vietnam on ideas that producers there are about sold out and some reports of insect infestations that could hurt production down the road. Offers from origin are still hard to find, especially with Brazil closed for a holiday. Demand was not much stronger than the offer and the cash market remains very quiet. Sellers, including Brazil, are quiet and are waiting for better prices of the next crop. Buyers are interested on cheap differentials, and cheap futures. Brazil weather is forecast to show dry conditions, but no cold weather. Current crop development is still good this year. Central America crops are seeing good rains now. Colombia is reported to have good conditions. Robusta prices are holding stronger as the Vietnamese export pace has really dropped.

Overnight News: Certified stocks are higher today and are about 2.745 million bags. The ICO composite price is now 118.15 ct/lb. Brazil should get dry weather except for some showers in the northeast. Temperatures will average near to above normal. Colombia should get scattered showers, and Central America and Mexico should get showers, and rains. Temperatures should average near to above normal. ICE said that 0 delivery notices were posted against July today and that total deliveries for the month are now 810 contracts.

Chart Trends: Trends in New York are mixed. Support is at 120.00, 117.00, and 116.00 September, and resistance is at 125.00, 126.00, and 127.00 September. Trends in London are up with objectives of 1900 September. Support is at 1820, 1790, and 1755 September, and resistance is at 1905, 1940, and 1950 September. Trends in Sao Paulo are mixed to down with no objectives. Support is at 140.00, 137.00, and 134.00 September, and resistance is at 150.00, 151.00, and 155.00 September.


General Comments: Futures were mixed to higher on follow through buying from last week and also on ideas that crop conditions are getting worse in Texas. Traders were also getting prepared for the next round of USDA supply and demand estimates on Thursday that could show decreased stocks for this year and next year. However, USDA is unlikely to make any significant changes at this time. Parts of the Southeast are getting too much rain and Texas growing areas remain mostly hot and dry. Conditions in Alabama, Mississippi, and Missouri are below average now. Futures held the short term range. It is possible that futures can work lower again as demand has turned soft, but production and weather might be more important in the short term. Weather for Cotton appears good in India, Pakistan, and China.

Overnight News: The Delta should be dry and Southeast will see showers and rains Thursday through the weekend. Temperatures will average near normal. Texas will be mostly dry. Temperatures will average above normal. The USDA spot price is now 82.23 ct/lb. ICE said that certified Cotton stocks are now 0.612 million bales, from 0.610 million yesterday. ICE said that 281 notices were posted today and that total deliveries are now 2,873 contracts.

Chart Trends: Trends in Cotton are mixed . Support is at 86.00, 85.20, and 84.00 October, with resistance of 87.00, 87.45, and 88.00 October.


General Comments: Futures closed higher again as tropical system Chantell wa moving towards the east coast of Florida. The system is expected to stay mostly to the east of the state, but it gave traders a reason to buy, anyway. It is too late to hurt the current production as the harvest is mostly over, but a big storm now could severely impact the coming production. Chantell is not forecast to have the damaging winds and rains that would damage trees and the new production. Some also expect USDA to lower production in Florida in its next production reports on Thursday morning. Showers are reported and conditions are said to have improved in almost the entire state. Ideas are that the better precipitation will help trees fight the greening disease. Temperatures are warm in the state, but there are showers reported. Brazil is seeing near to above normal temperatures and mostly dry weather.

Overnight News: Florida weather forecasts call for showers. Temperatures will average near to above normal. ICE said that 0 delivery notices were posted today and that total deliveries for the month are now 0 contracts.

Chart Trends: Trends in FCOJ are up with objectives of 145.00 and 155.00 September. Support is at 135.00, 132.00, and 130.00 September, with resistance at 138.00, 139.00, and 150.00 September.


General Comments: Futures closed mixed as traders prepared for the UNICA reports that could show reduced Sugar production later today. Sao Paulo was on holiday yesterday to keep action from there on the quiet side. Ideas are that mills had not had time to produce more Sugar due to a delayed harvest in Brazil because of rains and also because they are concentrating on producing ethanol. Futures trends remain down overall, but prices could rally a bit first if UNICA confirms less production. There is still a lot of Sugar around, and not only from Brazil. The Indian monsoon is off to a good start and this should help with Sugarcane production in the country. Northern areas are in good shape, but southern areas might be too hot and dry and some stress to the Sugarcane is possible in the short term. In addition, industry sources there told wire services that planted area is down by about 5% and that overall production would be lower even with very good weather.

Overnight News: Showers are expected in Brazil, mostly in the south and southwest. Temperatures should average near to above normal.

Chart Trends: Trends in New York are mixed to down with objectives of 1580 October. Support is at 1620, 1600, and 1570 October, and resistance is at 1650, 1665, and 1690 October. Trends in London are mixed to down with objectives of 465.00 and 448.00 October. Support is at 470.00, 466.00, and 463.00 October, and resistance is at 480.00, 485.00, and 490.00 October.


General Comments: Futures closed higher in consolidation trading. Ideas of good harvest weather and active movement of beans to ports in western Africa remain, and some selling was seen in New York on US Dollar strength. Ideas that the grind data from the US and Europe next week could be disappointing provided some selling interest. The cash market in Africa is slow right now as buyers have already bought and are now waiting to see how the main crop turns out late this year. The weather is good in West Africa, with more moderate temperatures and some rains. Some showers are appearing again in Ivory Coast this week, and the rest of the regiĆ³n is in good condition. Ivory Coast will still need more rain. Malaysia and Indonesia crops appear to be in good condition and weather is called favorable. Chart trends are mixed, but price action is weak.

Overnight News: Scattered showers are expected in West Africa. Temperatures will average near to above normal. Malaysia and Indonesia should see episodes of isolated showers. Temperatures should average near normal. Brazil will get mostly dry conditions and warm temperatures. ICE certified stocks are lower today at 4.874 million bags. ICE said that 3 delivery notices were posted today and that total deliveries for the month are 375 contracts.

Chart Trends: Trends in New York are mixed. Support is at 2165, 2130, and 2100 September, with resistance at 2210, 2250, and 2280 September. Trends in London are mixed. Support is at 1500, 1460, and 1445 September, with resistance at 1550, 1560, and 1600 September.

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Is Japan's Correction Over?

by Tom Aspray

Stocks have had quite the post-July 4 celebration as they continued to move higher again on Tuesday. The market internals were strong again with advances leading declines by a 3-1 ratio. The A/D lines on the S&P 500, Nasdaq 100, and Russell 2000 have made new highs, which is consistent with a new uptrend.

Overall the Asian markets were positive overnight as the Shanghai Composite’s recouped its recent losses but Japan’s Nikkei 225 was down 0.40%. The sentiment on Japanese stocks has taken several wide swings in the past year.

Last November, many hedge funds were expressing their bearish outlook by buying up credit default swaps on Japan’s largest companies, but this was in contrast to the positive technical outlook. By early in 2013, the bullish sentiment had picked up, and by early May had reached bullish extremes.

The 22% drop in Nikkei from the May 23 high to the June 13 low caused many to sell their long positions in Japan’s stocks and to question their long-term outlook, as well the lasting benefit of a weaker yen.

The sharp correction took the Nikkei 225 back to good support, which I thought was the dip to buy. Now that the Nikkei 225 has rallied 16% from its lows, many who turned bearish last month are having second thoughts. So is the bottom in place or will June’s lows soon be broken?

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Chart Analysis: The Nikkei 225 futures hit a high of 16,200 on May 22 before reversing the following day in reaction to the FOMC meeting, which spooked all the global markets.

  • Just 11 days after the high, the futures hit a low of 12,490 before rebounding.
  • The chart shows that this low was between the 38.2% and 50% Fibonacci retracement support levels.
  • Typically, this is a high-probability entry level, and I identified 12,400-12,900 (yellow box) as a buying zone.
  • The recent rally has taken the futures above the 50% retracement resistance with the 61.8% resistance at 14,818.
  • The daily starc+ band is at 15,393.
  • The OBV did form a negative divergence, line b, at the May highs but this downtrend has now been broken.
  • The OBV is now above its WMA but has not yet started a clear new uptrend.
  • On a short-term basis, a pullback looks likely with the rising 20-day EMA at 13,933 and further support at 13,600, line a.

The yen has had quite a drop since the fall of 2012 when the futures hit a high of 1.3356, then hit a low in May of 0.9654. This was a drop of 27% as the yen hugged the weekly starc- band for quite a few weeks in late 2012.

  • The yen is close to its previous low and the severity of the recent drop makes a period of consolidation likely before the major downtrend resumes.
  • There is first resistance at 1.0669 with the 38.2% Fibonacci retracement resistance at 1.1071.
  • The weekly on-balance volume (OBV) has dropped back below its WMA and a move back above the resistance at line d would be a short-term positive.
  • If the yen drops to new correction lows, a bullish divergence could be formed.
  • There is next support at .9766 with the weekly starc- band at 0.9518.

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The WisdomTree Japan Total TOT +0.18% Dividend Index (DXJ) hit a high of $53.95 in May, but just ten days later, traded as low as $42 in early June.

  • DXJ then formed a trading range for the next 15 days as it retested the lows on June 14 when it made a low of $42.58.
  • The surge in early July took DXJ above initial resistance as the daily starc+ band was tested.
  • DXJ is holding above the quarterly pivot at $47.01 as the 50% retracement resistance at $47.99 was exceeded.
  • A strong close above the 61.8% resistance at $49.40 would be a stronger sign that a bottom is in place.
  • The OBV moved above its WMA on June 18 and now shows a clear uptrend, line b.
  • The WMA is clearly rising, which is also a positive sign.
  • There is initial support now at $46.21 and the rising 20-day EMA with further support at $44.80.

The WisdomTree Japan SmallCap Dividend (DFJ) peaked ahead of the Nikkei 225 on May 8 when it made a high of $53.01.

  • The decline was more severe than that of DFJ as the 61.8% support at $44.80 was violated with the June 6 low of $44.07.
  • So far, the rebound has stalled below the mid-June high at $48.79, line c.
  • A strong close above this level would signal a rally to the 61.8% resistance at $49.59.
  • The daily OBV shows a more erratic pattern as the average daily volume is much smaller at 100K than it is for DFJ.
  • The uptrend, line e, has been slightly violated so the recent price range, lines c and d, could be a continuation pattern.
  • There is first support at $47-$47.40 with the monthly pivot at $46.73.
  • A drop below $45.28 would turn the focus back on the downside.

What it Means: It is my view that the decline in the yen from the 2012 highs has been enough to jump start the Japanese economy, which should have an impact into next year as it should boost exports. I think the action in the Nikkei 225 will be less dependent on the yen in the coming months. I think stocks like Toyota Motor TM +0.36% Corp. (TM), which I recently recommended should do well.

The technical evidence indicates that the Nikkei 225 and WisdomTree Japan Total Dividend Index (DXJ) have bottomed.

The evidence for the WisdomTree Japan SmallCap Dividend (DFJ) is less conclusive as it still needs a further rally to complete its bottom formation.

For those who are not long, I will be watching for a pullback to determine new entry levels so follow my Twitter feed.

How to Profit: No new recommendation.

Portfolio Update: For the WisdomTree Japan Total Dividend Index (DXJ), should be 50% long at $44.54 and 50% long at $43.26. Use a stop now at $41.77. On a move above $49.40, raise the stop to $44.22.

For the WisdomTree Japan SmallCap Dividend (DFJ), should be 50% long at $45.66 and 50% long at $44.76. Use a stop now at $44.94. On a move above $48.81, raise the stop to $46.36.

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Unlocking the secrets of Gann: Will the market crash in August?

By Pauline Novak-Reich

Come the week of Aug. 16 - 23, the world’s largest Index, the S&P 500, will once again plummet. In an all too familiar fashion, it will drag down all other stock markets, superfunds and savings. No government or economic spin can ward off this descent, because nothing else but time governs the fluctuations of markets. Given that economic formulas and models are only pale reflections of the real world, as a forecasting tool, they can be utterly misleading. The way to gain insight into the forces driving the S&P 500 Index, and predict the Aug. 16 turnaround, is by consulting its graph and William Delbert Gann’s Square-of-9 (for why all Internet depictions of this Square are flawed refer to paragraph 7 below).

The graph’s coordinates X and Y, where X represents price and Y time, provide an untainted depiction of market behaviour. In addition to reflecting ‘price changes over time’, the plot of X and Y’s intersection points reflects also the perceptions, and thoughts, of those driving the ups and downs of price. Given that X is a function of Y, and Y is a function of X, and given that X is the volatile of the two, focusing on the forward procession of Y is far less challenging than the fluctuations of X (Figure 1).

Figure 1

There is reason to believe that when billionaire George Soros broke the bank of England by shorting the British pound on Sept. 16, 2002 and the AUD on May 08, 2013, the Y parameter and Gann’s Square-of-9 dictated his trades.

The first on the ‘to do list’ in analysing a graph is to determine the direction of the dominant trend. Figure 2 demonstrates that bearish trends manifest long down-swings with short upward corrections. And, as the market changes direction, its upward swings become longer in comparison to retreats. 

The schematic in Figure 3 captures the 496 calendar day (cd) GFC decline period (Oct. 31, 2007 — March 08, 2009), and the recovery phase (March 09, 2009 — May 28, 2013). It shows that the S&P 500 Index’s recovery, which at the peak of May 28, 2013 measured 1542cd, in addition to being in an uptrend, reached an all-time high.

On June 25, 2013, the decline from the May 28 peak measured 28cd. It was 3cd shorter than its preceding 31cd upswing (Apr. 18 – May 28, 2013). Given this Index’s bullish trend, the sketch indicates that the forthcoming advance, which cannot be shorter than 31cd, will measure 52cd on August 16, 2013 (Figure 3).

Figure 3

To validate these dates, we turn to W.D. Gann’s Square-of-9, however, before proceeding to the Square, a word about identifying markets’ major peaks and troughs.

Even though pricewise the peak of May 21, 2013 was the highest point the S&P 500 reached on the chart, it was false (Figure 4). Given that it was followed by a 3cd decline and a 4cd advance, the longer swing, irrespective of price, is the one that determines the top.

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W.D. Gann (1878 -1956) was 13 when he famously declared that “the future is not unforseen.” From the age of 24, the Sqaure-of-9 — a sequence of orderly numbers spiralling outwards in an anti-clockwise manner from the number 1 at the centre (Figure 5) — generated him $50 million from trading stock and commodity markets. 

“I soon began to note the periodical reoccurrence of the rise and fall of stocks and commodities. This led me to conclude that natural law was the basis of market movements. I then decided to devote 10 years of my life to the study of natural law as applicable to the speculative markets and to devote my best energies toward making speculation a profitable profession.”

The numerals 1-9 forming the Square’s first ring inspired him to coin the device ‘The Square-of-9’, and its geometrical divisions, cardinals and diagonals.

The Australian mathematician, physicist and meteorologist, Trevor Casey — the first known man to unravel the Square’s mathematical structure since Gann — points out that all the Square’s Internet versions are mathematically wrong. In The Square Spiral— the Mathematics of Markets (BookPal 2010) he explains that this Square is a spiral mimicking the Milky Way. As such, it unfolds from left to right, in the same direction as the galaxy, and each of its rings expands twice during one 3600 revolution. The first expansion takes place upon the Square’s north-western diagonal and second upon its south-eastern arm. Therefore, in contrast to the Internet versions, the north-western diagonal runs along the numerals 1, 2, 10, 26, 50…, and the south-eastern along 1, 5, 17, 37, 65….…∞. (Figure 5)

The other point he emphasises is that the Square is a calculator designed to measure time and should not be used in forecasting price levels. The 0.618 and 0.382 Golden mean proportions, known as Fibonacci ratios, are best for determining the support and resistance levels of price.  

Gann's Square-of-9 Chart

Figure 5 – The Square-of-9 constitutes a spiral of consecutive numbers unfolding outwards from the number 1 at the centre. Its numerals follow the anti-clockwise (left to right) direction of the Milky Way’s spiral. 

Gann’s breakthrough came about when he observed that time-intervals typically adhere to the Square’s axes in that they commence and terminate upon them. A mature interval bounces off and culminates upon the Square’s same axis by completing a 3600 rotation from and back to the point at which the preceding interval ended. In cases when a swing terminates upon the Square’s opposite axis, at 1800 angle, it remains unfinished until such time it completes a 3600 rotation to the axis it had bounced off.  Given that the present recovery wave took off the Square’s eastern cardinal, and must terminate upon it, the Square-of-9 makes is possible to forecast its maturity date.

Bearing in mind that deviations between calendar-time and the Square-of-9 are subject to “Time Dilation”, excessive or shorter durations need to be adjusted to the value of the nearest cardinal or diagonal. Special Relativity Theory explains this anomaly saying that when the Earth’s speed accelerates, the motion of time slows down. The S&P 500 Index’s time-frames during the GFC and Eurozone crises, and those of the current recovery phase, demonstrate this phenomenon at work (Figures 6, 7 & 8).

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Figure 6

  1. Sep. 01, 2000 — Apr. 12, 2003 = 922cd

             [The nearest value is 916, eastern cardinal - Figure 7]

  1. Apr. 12, 2003 — Oct. 31, 2007 = 1694cd

             [The nearest value is 1702, western cardinal – Figure 8]

  1. Oct. 31, 2007 —  Mar. 09, 2009 = 496cd eastern cardinal - Figure 7]
  2. Mar. 09, 2009 —  Apr 23, 2010 = 411cd eastern cardinal- Figure 7]
  3. Apr 23, 2010 — Jul. 02, 2010 = 69cd eastern cardinal- Figure 7]
  4. Jul. 02, 2010 — Apr. 29, 2011 = 301cd

             [298 western cardinal – Figure 8]

  1. Apr. 29, 2011 — Dec. 19, 2011 = 234cd
  2. [233 western cardinal– Figure 8]

Figure 7 – Eastern Cardinal

Figure 8 – Western cardinal

Allowing that the March 09, 2009 trough terminated upon the Square’s eastern cardinal, on day 496 of the run, the subsequent 2009 – 2013 recovery wave must also terminate there. On August 16, 2013, when it measures 1621cd, it and the 496cd downswing will form a 3600 angle upon the Square’s eastern cardinal (Figure 9).

Figure 9 – Eastern Cardinal

Harking back to Figure 3, we see that the recovery wave’s top, on May 28, took place on day 1542 of the run and culminated upon the Square’s western cardinal (Figure 8). However, given that it bounced off the eastern cardinal (on March 09, 2009), its rotation has so far achieved 1800 — an indication of an incomplete move. Note that the peak of May 28, followed by a 28cd decline, touched upon the western cardinal on June 25 at a 3600 (1542 and 28, Figure 8). The final 52cd advance of the recovery wave will reach the Square’s western arm on August 16, 2013, where it will once again form a 3600 angle. However, its total span of 1621cd will fall upon the eastern cardinal at a 3600 angle with the preceding 496cd of the GFC crash.

For three millennia the pharaohs of Egypt relied upon large rocks carved with horizontal lines to record the height the Nile’s waters had reached during each day of the seasonal inundation. Indeed, Nileometer records collected from rocks scattered along the Nile are the longest data series we have. And although large chunks from the BCE data are missing, the records we have go back to 624AD, to the day Cairo’s Rhoda Island Nileometer became functional. The sheer length of this collection speaks volumes to their importance to the then pharaohs and scientists today. Ravaging floods and droughts turned the Nile settlers into brilliant problem solvers obsessed with patterns, symmetry and time sequences. Their effort yielded the Square-of-9 — Egypt’s most guarded secret, which tracked the changes in the Nile’s ups and downs over three thousand years. Subsequently, the pharaohs enshrined it in the Great Pyramid’s tiers where the block arrangement of each mimics the spiral of the Milky Way. When pulled from the number 1 at the centre, this Square morphs into a pyramid (Figure 10). With no data-processing technology, the Square and graphs sustained the pharaohs until Egypt‘s fall to the Romans in 48 BCE. One can only speculate how much richer the pharaohs would have been had they also invented the stock market.

Figure 10 – The Square-of-9 constitutes an image of one pyramidal tier.


Much like the S&P 500 Index, the Australian ASX 200 peaked on Nov. 1, 2007 upon the Square’s western cardinal. It formed a 3600 angle with the preceding 371cd down swing March 07, 2002 – March 13, 2003 (Figure 10). Given that the 2009 GFC through terminated at 1800 angle, upon the Square’s eastern cardinal on day 496 of the run, it will remain incomplete until a further decline brings its day count (from the 2007 peak) to a value denoted upon the Square’s western cardinal. When, on May 14, 2013, the recovery wave peaked, it measured 1530cd, falling 91cd short of the eastern cardinal’s 1621. It is expected to land there on Aug. 13, 2013 (Figure 9).

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Figure 11

When asked “What is the cause behind the time factor?” Gann smiled and said: “It has taken me years of exhaustive study to learn the cause that produces the effects according to time. That is my secret and too valuable to be spread broadcast…” He died of heart failure in June 1956 and was laid to rest in New York’s Brooklyn Cemetery in a grave facing his beloved Wall Street. Just as the pharaohs departed leaving no clue to the secret they buried in the Great Pyramid’s tiers, Gann left us an image of one of its tiers, yet, withheld its layout and instructions of use.

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