This chart of the implied volatility of equity index options is sending a powerful message: the market's level of fear and uncertainty has declined significantly in recent weeks and months. We can only guess at the reasons for this, but the improved outlook is not just a function of today's massive ECB refinancing operation or yesterday's strong housing starts.
I would argue that there is a whole host of developments that have brought more clarity and calm to the markets. Economic data have so far failed to reveal any economic collapse, despite the continued high level of stress in Eurozone financial markets (2-yr swap spreads are still in nosebleed territory at 115 bps). Markets have had 20 months to prepare for a Eurozone default, panicky investors have had plenty of time to take refuge, over-extended banks have had plenty of time to hedge themselves, and risk-loving hedge funds and distressed debt investors have had plenty of time to marshall their forces in eager anticipation of panic-driven sales. The U.S. economy shows every sign of continuing to grow, albeit at a disappointingly slow rate. Corporate profits continue to be very strong. Central banks have embraced their role as lenders of last resort, and liquidity in most parts of the world remains abundant. Profligate government spending is meeting strong resistance almost everywhere.
If there is a single message here, it is that we are not on the cusp of the-end-of-the-world-as-we-know-it. Given how fearful the market has been, that's very good news.
That's exactly why I said here a few months ago to forget all this PIIGS stuff. This is the stuff of CNBC talking heads.
ReplyDeleteA footnote about an unrelated item: Witholding tax receipts for the past month-and-a-half, adjusting for tax changes, are barely running even with the same time last year. This probably does not bode well for the upcoming jobs report, unless a disproportion of the jobs being created are low-wage and/or part-time jobs.
ReplyDeleteThis is a global downturn caused by tight money--the ECB and Fed decided to fight commodities inflation by tightening the monetary noose around the necks of productive businesses and citizens. Copy Japan, in other words.
ReplyDeleteThe Fd is at least aware of the problem, as revealed in FOMC minutes and a growing acknowledgement of targeting nominal GDP as the correct course for monetary policy.
The ECB, led by Germany, is hysterical about inflation, resulting in a one-legged monetary policy---very dangerous for all involved.
Doesn't help that Euro socialists and American militarists believe in more and more government spending.
Still, the worst may be behind us---the ECB is going to print money, and maybe the Fed will follow.
There are times for tight money---the 1980s and Volcker come to mind. The price of tight money is recessions--necessary then to kill off double-digit inflation.
The question is do you want tight money now, when unit labor costs are falling?
Seem obvious, no, now you want monetary expansionism.
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ReplyDeleteSgt RBR
ReplyDeleteThe PIIGS stuff is oh so real, not the CNBC hyperventilation and doomsday scenarios, but what SG points out is a seminal point - markets are pricing in profligacy. After a period of unreality markets are now pricing in the fact that Greece is not Germany, in fact that Greece is not even...name your country...that Portugal is not Spain and that solar power is not oil. This is a serious theme. How long before the market prices in California, Obama's deficits, cash-rich/cash-flowing US companies and all the rest???
BTW, Dr. Perry is running a chart showing the huge increase in Chinese manufacturing output in recent decades, and Japan's absolute and relative decline. The USA has done well, though just now eclipsed by China.
ReplyDeleteHard to see how a strong yen has helped Japan at all.
Indeed, the stronger argument is that a strong yen has destroyed japan.