In 1854, the surveyor general of India asked Radhanath Sikdar to calculate the height of Mount Everest using station observations 108 miles from the peak. Given the distance of the sightings and atmospheric distortions, the challenges were enormous. Using pencil, paper and trigonometry, he determined the height at 29,002 feet. The latest satellite technology today measures it at 29,035 feet. But the mountain grows by one centimeter a year so in 1854, the height was 29,030 feet. Thus, Sikdar was off by only 28 feet. Quite an accomplishment.

Now the point for Europe (yes, again) is that we do not have to wait for the latest data to confirm what we already know:

1.       the economies cannot make expansionary austerity work;

2.       households cannot pay for the banking mess; and

3.       Germany cannot continue to export to impoverished customers.

So the time for growth and easier money is now. Not when the stats are so awful and degrading that political risk (see Hungary) trumps economic failure.

This week we saw: France and Austria downgraded, Greece take a step closer to default, new bond auctions from Spain and Italy that, while below last month's, had pitifully low bid/cover ratios and Hungary lurch again in its bond prices and currency...down 11% and 22% in last three months. On the other side of the trade, Germany auctioned 6-month paper at a negative 0.012%. So this is what happens: fiscal consolidation hits private consumption and investment without (because of a pegged exchange rate system) a rise in net exports or higher lending. Mr. Sikdar would have figured this out long ago.

 

The ECB meanwhile: is a very different animal under Draghi than Trichet. There was no interest rate cut but that is undoubtedly coming. The 3-year LTROliquidity function from December is working. It's a form of QE lite, using repos rather that outright purchases. But the result has seen banks use new money to help the bond markets. The next step could be to start lending. Keep watching the ECB because it may well force the politicians into something more pragmatic than the current stand off.

 

US Bonds had a good week: including a successful GT10 auction at 1.90%, the lowest ever. The market has mostly ignored good economic news, probably because of the low growth hazards and run on the euro. We also saw new numbers for money velocity, or the rate of turnover of money, fall again. So, put the lower 10-year rate together with M2 velocity, as in the chart, along with low inflation and growth, and you can see that many of the old models are simply breaking down. More money is neither stimulatory nor inflationary. It's the same story that we've told for most of the last year.

 

FOMC more dovish: a very forthright speech from John Williams of the San Francisco Fed and a new voting member. He's part of the Fed's desire to improve communication, and rightly points out that the Fed is not out of ammunition, that securities purchases can continue and that the fed funds rate should be negative. This should keep expectations extremely well anchored and may mean GT10s stay in the 185-220 range.

 

Growth: The NFIB has been a reliable indicator for the economy. This week they said for the umpteenth time that, no, credit is not a concern and that sales represent the single most important problem. They have reduced inventories but increased capital spending which is in line with small gains in confidence. Fourth quarter growth will probably show a solid 3% level up from 1.8% in Q3. Exports had two good months and the latest confidence levels have recovered from the battering they took from the debt ceiling nonsense in the summer.

 

Bottom Line: We're still seeing price volatility in treasuries. In the last five trading days, the GT30 has moved through a 4% price swing and yields 2.9%. So almost any intra-day move can eliminate a year's coupon. Stocks can wait a while. The earnings season is going to be temperamental.

 

Sources: Wade Davis, Bloomberg, Expansionary Austerity: New International Evidence (IMF), Federal Reserve Bank of San Francisco, Federal Reserve Bank of St. Louis, National Federation of Independent Business, US Census Bureau, US Bureau of Economic Analysis, University of Michigan, Sentinel Asset Management, Inc.

 

 

 

(c) Sentinel Investments

www.sentinelinvestments.com