Greek Crisis ?
I apologize for not keeping up with the Market Preview recently. Between expanding and working on our new business www.lendacy.com, working on our new site and content, and focusing on business – I have not allocated the proper time to write the daily market preview. Additionally, dealing with family issues this year has forced me to take some time off. We are currently working on a new site not only for the Market Preview, but also for white papers and other market/economic information. We expect to have it fully operational at the beginning of the 4th quarter. Prior to launching our new website and businesses, I will keep the Market Preview updated on a weekly basis, as currently it is all that I have time for. Please note I am also writing content for Lendacy
In the meantime I have been bombarded with questions over the last couple of weeks about Greece and how does it impact our markets. Additionally, what are my thoughts on the Fed and interest rates and the general economy?
Courtesy of wikipedia
Over the last couple of years, if you have been following the Market Preview, I have frequently said that the ECB and the constant bailouts have only been buying time. Ironically the problem is not about money, but rather a fundamental flaw in the EURO system.
This fundamental flaw, once pointed out by Milton Friedman, is being realized and played out with the Greek Tragedy. The EURO system is a “Monetary System” – which focuses solely on a fiat currency and method of exchange. What the EURO system is NOT is a “Fiscal System”, meaning that the European Central Bank (ECB) is not in charge of how each member state (nation) spends its money, manages its debt, and issues taxes.
Friedman’s argument is that the Euro will eventually fail because you can’t mix a fiat monetary system with a multitude of different nations’ fiscal policies. He further stated the fiat currency value will be the collective credit worthiness of all nations. The strong, accountable, responsible nations will have to carry the weak debt ridden nations. He concluded that by sharing a common currency that ultimately the different nations will be held accountable for one another’s debt. They would not have any choice but to bailout the weak nations for risk of their own credit worthiness and the value of their currency.
Many (the majority) argued against Friedman’s hypothesis. Yet the Euro community had adopted as part of their charter that the ECB and the member nations would NOT bailout one another and also there would be a financial balance sheet test as to whether to admit a nation as a member. Market Preview – History of Greece Crisis
Unfortunately the ECB and Euro zone did NOT stick to their own charter and exactly what Friedman predicted is coming true. They have started bailing out fellow member nations, but in doing so failed to address the core fundamental problem. Now strict lending conditions that include cost cutting measures “austerity” is the pain the people of these nations are being subject to for not getting their fiscal house in order.
I had previously warned that this new young Socialist Greek Prime Minister is so ideologically blind that he will have NO problem bringing Greece to the edge. He was elected under strong Socialist promises – no austerity and more social programs. He waved his finger at the ECB and nations bailing them out with their purposed austerity as if it was the ECBs fault for their situation.
With each bailout, I stated it was only kicking the can and the Greek story would move to the back-burner and out of the 24hour news cycle, yet it is going to come back again – because the fundamental problems are not solved.
So what to expect now? I think the Socialist Prime Minister, Alexis Tsiparas, has painted himself in a corner; he can’t (after all his promises) back off and agree to austerity for ANOTHER bailout. Instead he has gone to the people for a referendum for the people to decide (voted this weekend).
Yes- they will agree to the terms of the bailout and stay in the Eurozone
No – they will default and begin issuing their own currency.
Courtesy of wikipedia
Either way, Tsiparas wins. If the people want to agree to the terms of the bailout and stay in the Euro he can blame the people that he was FORCED to compromise and take a bailout. If the people say no, then when the nation faces inflation (hyperinflation) – then he can blame the ECB and euro for the problems. I personally think the people will vote to stay in the euro and take the bailout. They do NOT have any money and emotionally really want to be part of the European community. Perhaps a last minute deal will happen, the 11th hour.
If they default is Greek something we should be concerned about? I really don’t think so, as Greece has defaulted many times in the past (prior to the Euro) and their economic history has been tumultuous at best. Their economy is not even the size of Massachusetts. It will certainly create waves that will ripple across the financial markets and bring volatility. It could even trigger a short-term general market sell-off of 5%. However, it doesn’t really have any deep implications in our financial systems.
The real problem is not Greece, but rather if we see this repeat itself with the rest of the PIGS (Portugal, Italy, Greece, Spain) – all in similar situations. Additionally, France’s credit rating was downgraded and they have huge economic problems with a very similar (not as radical) Socialist President. The reason it would be a problem if it does spread is that almost 30% of world assets and debt are priced in euro and that could have significant ripples that would hit all currency markets (mainly the Yen and Dollar).
The US markets in the short-term could see a bounce off the initially sell-off from a flight to quality trade. We could also see US bonds rally and yields fall, for the same reason. I personally see the Greek problem as a volatility situation that can bring some short-term jolts to the market. However, I do not see this as being the beginning or catalyst to a major market crash. That is not to say that it could, I just see the probabilities very low.
Interest Rates and the Fed
I have been repeating since the supposed end of “Quantitative Easing” that the nothing has really changed. While the Fed has said it has ended “QE”, it really hasn’t. By their own admission they continue to buy government bonds and mortgage back securities. Just because they are not doing it with NEW money, but using existing money (from assets that have matured) doesn’t mean they have stopped financing bonds and mortgages. Additionally the money supply continues to grow and as we well know interest rates remain at the zero bound.
All this talk about raising rates seems foolish. Not that I disagree, I think we should raise rates and stop the bond and mortgage purchases, thus securing the further value of the dollar and ending inflationary risks. However, doing so would mean a huge drop in the equity and bond markets and no one wants that.
Courtesy of wikipedia
The reason the Fed will not raise rates is that it really can’t, even if they wanted to. Additionally, the economy is not as great as we are lead to believe and lastly the ideology of the Fed is in no way interested in raising rates. Let me address each of these reasoning’s in kind:
The Fed cannot raise rates for the following reasons:
1. Higher interest rates would increase government deficits and debt. The US government expanded its debt enormously over the crisis. Last year the US government paid over $430 BILLION on interest alone. Remember we are running zero Fed Fund interest rates. The 2014 deficit was $1.27 trillion, which means 33% of our deficit was just paying interest on existing debt. So I don’t think there is much room to raise interest rates, without seeing larger deficits.
2. US bond auctions. This is a “cart before the horse” scenario. The US is still unable to find ENOUGH buyers of US bonds with the short-term yield paying zero. If we could, there would be NO REASON for the Fed to be purchasing bonds. Of course if they raise rates, which as I stated above they really can’t without impacting the deficit, they would not have to buy bonds. For now the Fed remains the “clean-up hitter” in the bond market. Remove the Fed from the bond auctions and there are only two outcomes, a bond auction failure or rates raise rapidly until they can find buyers. Both scenarios stink, so the Fed remains a buyer.
3. US Mortgage debt. The GSE horror shows which completely failed and are now for the sake of argument nationalized are still running strong. They had reported they made large amounts of money, but after further review that was just mark-to-market gains on existing debt. They continue to operate as if nothing happened. The GSEs are not the only problem and the Fed continues to be the buyer of last resort on mortgage back securities.
Another reason the Fed will not raise rates is that the economy is not as great as the headline numbers would have us believe. Even the Fed’s own FOMC statements have admitted as much. They tossed out the Unemployment U3 measuring stick for raising rates. The participation rate on unemployment remains at decades low, meaning that over 9 million unemployed people are no longer counted into the “official” unemployment numbers. They are considered “under-employed”, “discouraged”, or a host of labels that are used to justify NOT counting them into the system.
The GDP and CPI inflation numbers have also been adjusted significantly that trying to measure them against historical data is a fool’s game. There is no way to know if it is really improving or getting worse if we have no real historical data (using the same models, data, and methodologies). Suffice to say even the Fed said they are concerned about the “economic recovery” and it is now “data dependent”.
My last reason why they will not be raising rates is simply an ideological one. The Fed governors are now completely made up of Keynesian economists, all appointed (for the first time since inception) by one president. This means they are pro-stimulative and pro-easy monetary policies. Some of the Fed governors have praised Abenomics (Japan’s Uber-Aggressive QE). The two Hawks that had been in the FOMC (rotating in as Fed Presidents) butted heads, wanted to raise rates and end QE. They are now gone, the Doves rule the roost and that means there is NO rush to raise rates or end stimulative efforts.
Perhaps the Greece situation will give the Fed some spin to justify why they will NOT raise rates in September.
Support & Resistance
The 17,600 level is broad short-term support. We could visit that this week. I think we might see some buying in that range. If we can’t hold there and things go south then a drop to the 17,000 – 17,100 area is in the cards.
This seems like a general support area. There are some big tech stocks that could disrupt this index so expect some volatility.
The S&P 500 is under some pressure this morning, but has come off the initial lows in the over-night session. I would look at 2070 as short-term support.
The one amazing index over the last month has been the broad based Russell. It continues to see broad based order flow coming into the market. If it holds and closes at 1270 – it could be a positive sign for the market.
I would not be surprise to see this market rally off the lows. We may not get into the green today, but a strong rally from a flight to quality could be in the cards. Right now the perception is the US is the best market on the planet with the strongest currency. While fundamentally that might not be true, sometimes (many times) perception wins the day.
This has been a difficult and busy year for me dealing with family issues and also expanding existing businesses and launching new businesses. I am apprehensive taking any vacation, but I need one to recharge my batteries.
I look forward to getting back and updating the Market Preview – on our new site and providing our white papers and research.
Have a Happy 4th of July and I will see you in a couple of weeks. I plan on updating the Market Preview weekly when I get back and until the new site is operational. In the meantime visit Lendacy and check out the blog posts there.