Monday, March 24, 2014 - Dance With the Devil

Dance With the Devil

by Sinclair Noe

DOW – 26 = 16,276
SPX – 9 = 1857
NAS – 50 = 4226
10 YR YLD - .02 = 2.73%
OIL - .15 = 99.45
GOLD – 25.10 = 1310.60
SILV - .34 = 20.03

Manufacturing activity slowed in March after nearing a four-year high last month, but the rate of growth and the pace of hiring remained strong. The flash Markit US Manufacturing Purchasing Managers Index dropped to 55.5 from 57.1 in February.

China's manufacturing engine contracted in the first quarter of 2014, according to the flash Markit/HSBC Purchasing Managers' Index.

This week’s economic calendar includes the Case Shiller home index, FHFA home prices, and new home sales reports tomorrow; plus the March consumer confidence index; Wednesday includes the February durable goods orders; Thursday brings another revision to fourth quarter GDP, and Friday’s reports include the consumer sentiment report, consumer spending, and an update on personal spending.

Ukrainian troops and their families are evacuating from Crimea, as Kiev effectively acknowledged defeat by Russian forces who stormed one of the last of their remaining bases on the peninsula. President Obama is in Europe to kick off a week-long visit that includes a G-7 meeting. He called for European allies to adopt tougher sanctions against Russia, saying Moscow’s actions must have costs.

Mohamed El-Erian, the former co-chief at Pimco says markets have “brushed aside” concerns about Iran, Iraq, North Korea and Syria, to say nothing of rising tensions in Turkey and Venezuela. With Ukraine, the market had a single day of fear over Russia’s annexation of Crimea. He lists four key reasons for market inaction: the countries involved are less systemically important; there’s little will from outside powers to get embroiled with these situations; the story of a recovering economy in developed markets has been a distraction; and extraordinary central bank support for markets has provided a layer of insulation. El- Erian went on to say things could get much worse. Consider how ugly it would be if there was an outright war between Russia and Ukraine. Or if Russia somehow decided to tap dance around US sanctions on Iran.

The point is that things can get dicey, quick. And suddenly 2014 starts to look a bit like 2008. The long lists of visible stresses in the global financial system and the almost laughably hollow assurances that there are no bubbles, everything is under control; the Fed can exit QE with no repercussions. Yea, sure. Remember when the subprime mortgage meltdown was already visible and officialdom from Federal Reserve chairman Alan Greenspan on down were mounting the bully pulpit at every opportunity to declare that there was no bubble. First, he claimed no one foresaw the crisis, and second, he attributed this failure to a lack of insight into “animal spirits,” the emotional drivers of behavior. There are plenty of indicators we could look at, and then it’s just one little spark that gets the herd running toward the cliff.

So far, sanctions against Russia look very weak, but there has been some effect: the Russian stock market is down, the currency has weakened, and sovereign bond yields are up. Russia’s central bank unexpectedly raised its benchmark interest rate by 150 basis points after the armed takeover of Crimea triggered a rout in the ruble. Even before the standoff with the West, the worst since the Cold War, Russia’s economy was facing the weakest growth since a 2009 recession as consumer demand failed to make up for sagging investment. Russia will probably dip into a recession in the second and third quarters of this year as domestic demand is set to halt on the uncertainty shock and tighter financial conditions.

The US doesn’t have a great amount of trade with Russia, so it is credible to talk about the threat of additional sanctions. The biggest damage to Russia would come from lower oil prices, and lower oil prices might be possible if Russia does anything that might hurt developed markets such as the Euro-Union. If the purpose of sanctions was to get Russia out of the Crimea, that ship has already sailed; if the purpose of sanctions is to restrain Russian proclivity for intervention, there is still a chance.

Of course the Euro-zone economies are far from solid, but the European Commission has a plan; they are apparently willing to dance with the devil. In the immediate aftermath of the financial crisis regulators called for a tough crackdown on the $71 trillion global shadow banking sector that also includes debt market repurchase agreements, securities lending, money market investment funds and some hedge funds.

With the worst of the crisis now over, Euro-commission regulators attention has turned to growth and with it the regulatory mood music has also changed; this Thursday they will publish proposals on how to fund long-term investments to boost Europe’s economies; the plan includes a fundamental shift in how the continent raises money for investment in infrastructure like roads and technology (and maybe even energy) while at the same time moving away from over-reliance on banks for fueling economic growth.

A core element involves reviving securitization, or the bundling of loans into interest bearing bonds; you may recall this market took a hit 7 years ago in the financial crisis. Now, the market for asset backed securities is only about half its pre-crisis size, or about 700 billion euros. The EC estimates that a trillion euros is needed in long term finance for transport, energy and telecoms up to 2020 to boost competitiveness and jobs and hopes that by encouraging market-based financing it can reduce the continent's reliance on banks for raising up to 70 percent of funds for the economy.

The developments in Europe come ahead of leaders of the Group of 20 economies (G20) meeting in November to endorse new rules for shadow banking. A harsh, uniform approach across all sectors has now been ruled out; the new plan is to embrace shadow banking and regulate it a little closer. If it sounds risky, well it probably is, but the Euro-zone now recognizes they need the cash and this is one way to get it, and so they are willing to dance, and put up with the heat.

Meanwhile, the United Nation’s World Meteorological Organization is meeting in Japan, and they reckon 2013 was the 6^th warmest year on record. Thirteen of the 14 warmest years have occurred in the 21st century. The UN weather agency says much of the extreme weather that wreaked havoc in Asia, Europe and the Pacific region last year can be blamed on human-induced climate change. A rise in sea levels is leading to increasing damage from storm surges and coastal flooding, as demonstrated by Typhoon Haiyan, and Australia experienced its hottest year on record, with some temps topping 129 degrees.

The costly weather disasters included $22 billion damage from central European flooding in June, $10 billion in damage from Typhoon Fitow in China and Japan, and a $10 billion drought in much of China.

Only a few places, including the central US, were cooler than normal last year, but 2013 had no El Nino, the warming of the central Pacific that happens once every few years and changes rain and temperature patterns around the world.

If climate change continues, here’s what the panel’s report predicts in terms of consequences.

For the first time, the panel is emphasizing the nuanced link between conflict and warming temperatures. Participating scientists say warming won’t cause wars, but it will add a destabilizing factor that will make existing threats worse. Global food prices will rise between 3 and 84 percent by 2050 because of warmer temperatures and changes in rain patterns. Hotspots of hunger may emerge in cities. About one-third of the world’s population will see groundwater supplies drop by more than 10 percent by 2080, when compared with 1980 levels. For every degree of warming, more of the world will have significantly less water available.

Major increases in health problems are likely, with more illnesses and injury from heat waves and fires and more food and water-borne diseases. But the report also notes that warming’s effects on health is relatively small compared with other problems, like poverty. Many of the poor will get poorer. Economic growth and poverty reduction will slow down. If temperatures rise high enough, the world’s overall income may start to go down, by as much as 2%, but that’s difficult to forecast.

Past panel reports have been ignored because global warming's effects seemed too distant in time and location. This report finds "It's not far-off in the future and it's not exotic creatures: it's us and now. According to the report, risks from warming-related extreme weather, now at a moderate level, are likely to get worse with just a bit more warming. While it doesn't say climate change caused the events, the report cites droughts in northern Mexico and the south-central United States, and hurricanes such as 2012's Sandy, as illustrations of how vulnerable people are to weather extremes. It does say the deadly European heat wave in 2003 was made more likely because of global warming.

Earlier this month, the world's largest scientific organization, the American Association for the Advancement of Science, published a new fact sheet on global warming. It said: "Climate change is already happening. More heat waves, greater sea level rise and other changes with consequences for human health, natural ecosystems and agriculture are already occurring in the United States and worldwide. These problems are very likely to become worse over the next 10 to 20 years and beyond."

Scientists in the past may have created the impression that the main reason to care about climate change was its impact on the environment. The reality is that it's going to affect nearly every aspect of human life on this planet.