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Fed Bubble Agonistes Persists as Zero Rates Prompt Debate

Published: 08:14 31 Oct 2013 GMT

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Fed Bubble Agonistes Persists as Zero Rates Prompt Debate - Here is the opening to this topical item from Bloomberg:

Financial-market bubbles are proving a more pressing threat than inflation to Federal Reserve officials who've bought trillions of dollars in bonds and kept the target for short-term interest rates near zero since 2008.

"There is a threshold out there somewhere" where markets will become too frothy or thebalance sheet becomes too large and the central bank will have to react, said Michael Gapen, a former member of the Fed board's Division of Monetary Affairs and now a senior U.S. economist at Barclays Plc in New York. "The problem since the beginning of quantitative easing three is there isn't significant enough clarity for what is the stopping rule."

Policy makers and regulators see worrisome signs. The Fed and Office of the Comptroller of the Currency are recommending lenders strengthen underwriting standards for leveraged corporate loans, as the amount of this high-risk debt approaches levels not seen since before the financial crisis and their quality deteriorates.

Kansas City Fed President Esther George, who has dissented against every Federal Open Market Committee decision this year, has highlighted an increase in farmland prices as a concern, and Richard Fisher, president of the Dallas Fed, has pointed to rising home prices in Dallas and Houston as a sign of a U.S. housing bubble. Fed Governors Jeremy Stein and Jerome Powell also have warned this year that some bond yields might be too low for the risk investors are taking.

Fed Vice Chairman Janet Yellen named financial stability as the central bank's third mandate -- along with stable prices and full employment -- when she accepted her Oct. 9 nomination as chairman. This means well-functioning markets for raising money through sales of bonds or stocks and a sound banking system that can transmit the Fed's interest-rate policy to all borrowers in the economy.

"One scenario to be worried about may simply be a sharp increase in market-wide rates and spreads at an inopportune time, such that it becomes harder for us to achieve our dual-mandate objectives," Stein said Sept. 26 in Frankfurt. That "may be among the most relevant" risks to financial stability "when thinking about the costs and benefits of our current highly accommodative policies."

My view - There are plenty of nervous and concerned comments in this article. The reason is that no one knows exactly how the tapering and eventual ending of quantitative easing (QE) will play out in the markets and the economy, because we have not previously been in this situation. However, few of us will be surprised if the onset of that transformation results in market turbulence.

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German Unemployment Rises a Third Month as Growth Slows -
Here is the opening for Bloomberg's report:

German unemployment rose for a third month in October, adding to signs of a slowdown in Europe's largest economy.

The number of people out of work climbed a seasonally-adjusted 2,000 to 2.97 million, after gaining by a revised 24,000 in September, the Nuremberg-based Federal Labor Agency said today. Economists predicted no change, according to the median of 36 estimates in a Bloomberg News survey. The adjusted jobless rate was unchanged at 6.9 percent.

The German economy, which helped to pull the 17-nation euro area out of recession in three months through June, probably expanded at a slower pace in the third quarter, the Bundesbank said on Oct. 21. Sentiment among companies on the economic outlook dipped for the first time in six months in October amid uncertainty over the pace of the recovery in the currency bloc,Germany's biggest trading partner.

"Survey indicators are weakening a bit and the big concern that we have is that even German companies are not investing that much," said Anatoli Annenkov, senior economist at Societe Generale SA in London. "If we have continued growth in the third and fourth quarter, we can start to look forward to continued improvement in the labor market."

My view - Germany remains a power house within Europe but it faces three headwinds:

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Prosperity Lives in the City -
Here is the opening from this interesting column by Jim O'Neill, published by Bloomberg:

If you study the biggest and most rapidly emerging economies, as I have for many years, you are bound to be struck by the power of urbanization and the pivotal role of thriving cities. More often than not, cities are the engine that powers economic growth. When a country's cities succeed -- and I do mean cities, plural -- the economy is much more likely to prosper.

The U.K. illustrates this point rather forcefully. The economy as a whole is finally beginning torecover at a respectable pace: Real gross domestic product rose by 3.2 percent at an annual rate in the third quarter, and growth in the second quarter was pretty good, too. There's still a lot of ground to make up, but many of Britain's developed-country counterparts would be pleased with such numbers in the aggregate. The trouble is, as many businessmen and commentators emphasize, U.K. growth is not well balanced.

Britain is still too dependent on excessive borrowing and unsustainable consumption; exports and investment need to strengthen further; and real wages are still falling. The most conspicuous form of imbalance, though, is regional. The country increasingly depends on London and the southeast.

The crash hit finance -- hence the City of London and its metropolitan hinterland -- especially hard. That's one reason U.K. output has yet to recover to its pre-crash level. Now, in turn, London's recovery is supporting the broader economy. If growth were better dispersed among other U.K. centers of activity, the economic cycle would be less volatile and less likely to push wages and prices (notably house prices) out of line.

My view - The dominant role of big cities, including their satellites within an hour's commute, will only increase as the global economy continues to modernise. They will appeal to many of the best and brightest who wish to remain actively employed. They also have amenities - restaurants, culture, shops and museums - to improve the quality of life and also attract many tourists. If your younger relatives are planning to launch or expand a career, tell them to choose a city.


Enjoyable Investment Seminar at London's Caledonian Club, 14 November -
This is a bargain event which I think subscribers within reach of London will enjoy. I look forward to meeting and chatting with any of you attending on the 14th, and also hearing the other speakers, not least my friends Iain Little and Bruce Albrecht. You may know of them from their outstanding Global Thematic Investors report, which I am always pleased to post in Comment of the Day.

 

Additional commentary by Eoin Treacy

The Original Tigers The ASEAN group of countries were among the best performers from their 2008 lows but had become quite overextended relative to their trend means earlier this year and have since experienced their largest reactions in the course of the medium-term bull market. They have spent the last few months ranging mostly below their respective overhead top formations and more time is probably required to build support and revive confidence.

Thailand can be considered a representative example. The SET Index rallied from 400 to test the 1994 peak between 2008 and April this year. It has since pulled back and continues to range below 1500.

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Baidu Profit Beats Estimates on Rising Mobile Search Revenue
This article by Lulu Yilun Chen for Bloomberg may be of interest to subscribers. Here is a section:

Baidu is investing in mobile development as its search app installments rose 50 percent to 330 million users by the end of September compared with three months ago. The Internet company agreed in August to pay $160 million for 59 percent of location- based e-commerce service Nuomi Holdings Inc. and in July said it would buy app store 91 Wireless Websoft Ltd. for $1.9 billion.

The company is very willing to invest in mobile and so far results are good, Echo He, analyst at Maxim Group LLC in New York said by phone. Baidu's fourth quarter results should be better than this quarter as it will sell more advertisements to businesses during the holiday and shopping season.

My view As media consumption evolves at an increasing pace, the companies most likely to benefit are likely to be those that control infrastructure or those that make themselves indispensable to their customers. A high degree of commonality is evident across the internet portal/social media sector with impressive uptrends suggesting this remains a high growth area. The question now is just how much good news has already been priced in.

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Guinness Atkinson Energy Brief
Thanks to the authors for this edition of their monthly report. The full report is posted in the Subsriber's Area but here is a section on the medium-term outlook for natural gas:

A wall of new US gas demand is coming, starting in 2015: exports of gas via liquid natural gas (LNG); expanded export capacity into Mexico; coal plant retirements; gas' share of electricity generation growing; industrial in-shoring; natural gas vehicles. The question is: what price does a wall of supply need to meet this demand outlook? Our hunch is that in three years the gas price should be moving from 20% of the oil price ($3.50 gas is like $21/barrel oil) to 33% (if oil is $110 that is $36/barrel or $6.00 gas). That is 71% up on the $3.50 today and 118% up on 2012 average price of gas of $2.75.

My view Veteran subscribers will be familiar with the most basic law of supply and demand; when the price of a vital commodity drops, supply increases and substitution is possible - demand will increase.

 

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