A Whimper

By: Michael Ashton | Mon, Jun 18, 2012
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With the whole financial world seeming bracing for the Greek elections this weekend, the results so far have seemed thankfully anticlimactic. There was talk late last week about a plan for coordinated central bank intervention in the event that the "wrong" party won in Greece. Dealers sent around lists of weekend contact numbers for back office personnel, and phone numbers for the overnight trading desk in Japan. Analysts circulated scorecards and "what-if" outcomes so that non-Greeks could tell who won, and whether the victory meant anything.

In the event, the pro-bailout party won. Believe it or not, that's not the end of that - now, since they don't have an outright majority, they must form a governing coalition with enough of the other parties that they have a majority of the elected representatives committed. So before anyone gets too excited, remember that that's exactly what happened last time. Same winner, but no government. No coalition was in the offing, and so new elections were ordered. In theory, this new election was a referendum on whether to stay in the Euro or leave the Euro, or stay but with drastically renegotiated terms for the "aid" received so far. If that's the case, then the referendum produced no clear answer. Are we expecting a government simply because everything is a little more desperate?

Forget the fuss: it isn't clear to me what all the calm is about.

Greece will still leave the Euro. Government or no government, austerity or no austerity - the fiscal math simply doesn't make sense unless Europe wants to pay for Greece forever. In principle, the Greeks can dig themselves out of trouble if they work harder, retire later, pay more taxes, and receive fewer government services. I do believe that people can change, and a society can change, under pressure of crisis. Remember Rosie the Riveter? But the question is whether they can change, whether they will change, do they even want to change, if the benefit of the change flows not to Greece's people but to the behemoth European institutions that have lent money to Greece?

If a person declares bankruptcy, and the judge declares that he must pay all of his wages for the next thirty years, after deducting enough for food and shelter, to the creditors...do you think that person is going to go looking for a 60-hour workweek?

I hope they do, but I don't see it.

Now, while we were busy ignoring economic data on Friday since Greece was so much more important, some more weak data came out. The Empire Manufacturing index fell to 2.29 from 17.09, reaching its lowest level of the year. Industrial Production fell -0.1% rather than rising +0.1% as had been expected. The University of Michigan confidence figure dropped to 74.1 from 79.3 - also the lowest level of the year. If you believe in government statistics conspiracy theories, then these government workers, and their cohorts in New York and Michigan, must really dislike Obama. The Citi Economic Surprise Index fell to its lowest level of the year, and the second-deepest trough since the 2008 crisis (last year's Japanese-tsunami-induced plunge was quite a bit worse).

Now we wait until Wednesday's FOMC meeting, with quite a bit of uncertainty about what the Fed may do, and cross our fingers that the Greeks will form a government. (Again, I don't think that changes the size of the crater, just the trajectory we take before impact.) With 10-year yields at 1.57% and 10-year real yields at -0.58%, I can't imagine what the Fed could possibly do to justify those levels. Further Twist would be limited in size by the size of the central bank's short-end balance sheet, but a failure to extend the Twist program would be terrible for the supply/demand dynamic at the long end of the yield curve. Several dealers have pointed out that the Fed doesn't even own many short TIPS, so the purchases of longer TIPS would be financed by sales of shorter nominal bonds, or left out of the equation entirely - which would also have the side effect of lowering inflation breakevens. Twist doesn't really do very much for the economy, it seems, other than signal that the Fed cares. It isn't the first time that I've said this, but I see more potential for higher yields than for lower yields. And, like with Greece, I don't think there's anything the Fed can do about it in the long run - it's just math.

It is a tragic fact that this short column represents my 500th online post in this forum - tragic because the 499th was, I thought, one of my best. You can find that comment here. Remember that you can (and should) follow me on Twitter @inflation_guy and receive my articles as they are distributed along with occasional other tidbits. And you can contact me directly via our company website.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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