John Ward – Crash 2 : Only One Leg On The Stool Is Still Working – 25 June 2013

John WardBond spikes + sell-offs: a wicked brew

Even Dan Hannan was moved to tweet today, ‘Cold turkey: the rise in UK 10-year gilts has now reversed the entire drop since the start of QE2 in October 2011′. Obsessive Anglospherist or not, it cannot have escaped Dan’s attention that the precise same thing was happening around the world yesterday. It has been pretty much since Bugs Bernanke said “That’s all folks!” last week, declaring the age of QE to be over. Although it often appears that Mr Bernanke’s public catatonia is the result of taking too much medication, the bloke is far from being dumb. Stubborn, yes; narrow, yes; stuck in a comfort zone, yes: but not stupid.

There are four things that have to be in mid-air all the time if the world’s econo-fiscal jugglers are to keep the audience’s confidence: the gold price, the stock market, the cost of borrowing, and economic growth. If they can make gold look unattractive to us (and cheap for them), prop up confidence in the stock markets via QE, depress Sovereign borrowing (and bank) costs to near zero with Zirp, and show some strong suggestions of economic recovery, then all will look good. The hedge funds, market bulls, banks, multinational shareholders, lenders and politicians can carry on saying everything’s as normal…and keep on making money.

But in the end, this was always doomed to go wrong, because (a) the pressures from one factor impinge on the others too much, and (b) what works for the banks can’t also work for a mass consumption model all the time….indeed, for much of it all. What we’re seeing now is everything going wrong at once. Which was why three weeks ago I posted to the effect that we had passed another staging post on the crawl towards the cliff – and from here on, the pace would accelerate bigtime.

It seems to be working like this: Japan’s desperate QE-squared lifts off and then sort of meanders dangerously around in the lower atmosphere. Bernanke hints that QE is over, and there’s an immediate attack of nerves on Wall Street…which doesn’t go away. Desperate not to start a flight into gold, several Sovereigns and central banks give it another jolt downwards (this enables them to buy it cheaply, a good thing for them) and so suddenly investors looking for income are left with only one genuine alternative: Bonds.

Unfortunately for the bond issuers, their need to prop up banks (by living with dried-up credit plus Zirp) has caused worldwide falls in both consumption and expansion. This has knocked China back, and so it too announced last week that growth ‘isn’t as important’ to them as it was – Politburospeak for “we haven’t got any growth left if nobody in the West is consuming”. The consumption slump is also, in turn, not helped by insane people in Brussels-am-Berlin insisting on austerity policies throughout ClubMed.

This causes confidence in three major States and a big region to drop….so although the Sovereigns want the markets to buy their hopelessly unrepayable debt, risk-aversion rules the roost, and bond yields spike….and equities start to sell off. And Chinese banking has a major wobble. And Italy is given only six months to live. Oh dear, and it was all going so well.

So this morning, we entered the nightmare that’s been staved off with Proplus since 2008: nervous stock markets, rising borrowing costs, and no signs of growth. If stock markets really start to slide, bond yields will rise further, and then there will be a battle royal between the Sovereigns and The Rest about how much gold is really worth.

There was some frightening action overnight in Asia, where the Shanghai Composite followed up Monday’s 5.3% slump by at one point plunging another 5.8%, taking the benchmark below 1,900 for the first time since January 2009. And Chinese stocks experienced another wobbly session, with investors continuing to worry that a cash crunch for Chinese banks could seriously dent growth in the world’s second-largest economy. (See earlier Smoke Signals at The Slog).

What the world needs now is some good news. My problem is, I don’t see any coming. As even American borrowing costs rise – and spiking roars back in Europe – the likelihood of defaults and bank failures grows ever larger. The Fed insists that it “won’t be bullied” into further largesse…and indeed, to allow itself to be would simply be putting off the pain pointlessly yet again. But like I say, Bernanke isn’t entirely dumb. He is now the lucky holder of the parcel, and the music just stopped.

Push is coming to shove. Stay tuned.

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