On reflection, the ‘mechanism’ established to rescue or save the Euro is indicative of the fact that we still understand very little and can control and short-circuit systems to some extent, yet we think we value everything.
Inflation, and dare we state it openly, serious inflation of double-digit proportions must now surely be back on the cards?
We realise that we are not the only and first publication to come up with this analysis.
Bloomberg reported on 30 September 2011 that European Inflation had unexpectedly jumped to 3%, up from 2.5% in August. Yet, this is still a long way off a double digit scenario, however, the factors mentioned in the Bloomberg report included, the Greek Default (possibility) and the ECB actions still possible in terms of containing European wide inflation.
Although most economists predict that inflation will start to wane next year, we believe that actions like the Greek Debt haircut and the increase in the EFSF’s bailout fund to €1tr sends signals to the market that the value of money is now seriously ‘delinked’ from operational reality.
We will not comment here in depth on monetary policy, as it is currently applied, however, we are beginning to get the impression that inflation as ‘the silent and stealth’ taxation it really is, is now firmly (yet behind closed committee room doors) on the agenda to help “manage” the size of the European Debt mountain.
It is worth keeping an eye on the real drivers of inflation and then there is some value in keeping an open mind.
Today (26 October 2011) is an important watershed date (or not) for Europe.
Will our leaders and the politicians be able to agree an all encompassing Framework to rescue the Euro, or will we need to think about a more modular approach for the future?
We believe that it might be in the Euro’s short-term best interest to look for a more flexible, yet fragmented modular approach. However, the capital markets might not appreciate the continuous uncertainty and political wrangling whilst we keep on looking for a ‘best fit’ modular solution and what that might entail…
Expect Mervin King to continue writing letters to the Chancellor to explain the Inflation target gap and the worsening economic landscape. It begs the question: Are the Central Bankers competent enough to sterr us through troubled waters again?
The key issue really is the lag effects before QE starts working…
In a fiercely competitive international market space the desire to aggregate banks and financial institutions and hence reduce cost economies of scale at the expense of risk accumulation is overwhelming. (Which the discredited Sir Fred Goodwin ex Chief Executive of Royal Bank of Scotland [RBS] can testify to only too well)
Let’s hope the Vickers Report is not the start of the death knell of the UK financial services sector; or perhaps in a cynical way, that is exactly what is (intended) needed to address the UK’s long-term structural reliance on the financial services sector at the expense of a more balanced portfolio of productive output and activity.
So it has finally happened. After threatening for months that a credit rating down grade was probable for the USA, Standard & Poor’s finally took the ‘big step’ on Friday 5 August, after the major markets closed.
Will the markets and market participants see the down grade as an opportunity to play an FX gain game; or has the game fundamentally shifted and will the capital markets react by demanding a higher nominal or at least Real Return on US Treasury bills?
All pointers at the moment did not indicate a problem, but time will tell on whether a fundamental shift in attitude has occurred. Remember a credit rating is only a qualitative indicator, not a quantitative one, so on a technical call a few FX traders and investors might make a profit or two; but we are all waiting to see if the entire game has changed, or not.
Other factors that might come into play soon would be QE3 and attitude hardening by major T-Bill investors.
How the US Treasury and administration now react will be crucial.
In the previous article we posted, mention was made of the (0.72)% [negative 0.72%] real return US Treasury investors can currently expect on 5 Year Treasury Bills. The Nominal (quoted) Yield Curves and Real (Inflation adjusted) Yield Curves for two specific points in time, namely Friday 29 July 2011 and 30 July 2006 are listed below.
Yield Curve 1
What is interesting to note is the very flat nature of the Yield Curve for all T-Bills at the end of July 2006, at around a 5% Nominal Return for investors. Yet the most significant fact is that the Real Yield was around 2.37% on 5 Year Treasuries, versus today’s (0.72)% on 5 Year or (0.18)% 7 Year T-Bill yields. In order to generate a very small Real Return, you have to be looking at purchasing a 10 Year T-Bill to obtain a modest 0.38% Real Return in today’s market.
A cynic might make this remark:
“Not only do you pay your taxes, but with the negative Real Yields on both 5 & 7 Year T-Bills, you are paying the government to hold on to your cash too”
Never resist the temptation to start a discussion with a pun.
In our previous article we highlighted the ‘battle royal’ on Capitol Hill to get a proposal agreed to address the possibility of a US Treasury default, whether actual or technical on or after 2 August 2011.
There is obviously a lot of back room dealing going on over this and analysts in Europe (taking their beading eyes off the Greek and now Italian and Spanish dominoes) have started to pay attention to the goings on across the pond. We heard one commentator mention the fact that the USA’ reputation has already been affected by this, irrespective of the fact that a default occurs or not.
So there you go. The fringe minority floating in the ‘Tea’ cup with a lack of the ability to look over the brim of that particular cup, might in fact achieve their overall objective of raising their own profiles, albeit at the expense of the nation’s reputation and standing as a pillar of the international capital market.
Look, we are not choosing sides here, because at the heart of the matter is the fundamental principles of civil society versus the public sphere debate raging and continuing to rage in the USA.
In our next article we will highlight some of the basic differences in opinion and views on the size and influence of government in the USA versus Europe, via the Rahn curve analysis.
Until then, it is tick, tock; tick, tock whilst we await the vote and subsequent consequences and fall-out from the US debt ceiling debate.