Capital Markets Update

By Louis S. Barnes Friday, January 27th, 2012

“‘Stranger and stranger’, said Alice,” and so it was this week at the Fed, in Europe, and Mr. Obama’s State of the Union.

Some brave souls thought the Fed would surprise by rolling out QE3, and begin to buy more MBS, driving mortgage rates down. Everyone expected a pair of meaningless inside-Fed jokes (more transparency, and an inflation target) and we got those. Nobody expected this: to extend its zero-percent rate from 2013 to the end of 2014.

Bonds have rallied, the 10-year T-note back down to 1.92% and mortgages close to 4.00%, markets still adjusting. Bernanke’s term expires a year before the end of the new zero-rate period! 2014 is so far off in the economic future that nobody can know its conditions, but you can bet — bet a lot — that the Fed would make a three-year commitment only if it is seriously worried. That anxiety has penetrated even the stock market, which has sold off for the first time in years after a new easing by the Fed. The Fed’s concern was justified by today’s weaker-than-looks Q4 GDP report.

Europe… the ECB will NOT allow a bank to fail. Those dominoes are off the table. The ECB may or may not play the ultimate card, buying or second-stage monetizing Club Med wallpaper, but banks will not be the trigger for ultimate euro collapse.

However, the underlying disaster is still rolling along. Christine LaGarde, French Minister of Finance until last summer, now Managing Director of the IMF, this week delivered a speech worthy of the White Queen. “Why, sometimes I’ve believed as many as six impossible things before breakfast.” In grand French style, her speech soooo important, soooo without consequence: demand European growth measures simultaneous with cutting spending and raising taxes; a larger financial firewall but no source for the money; and deeper integration among cultures farther apart every day. Banks not in play, European economies will determine the next stage there.

“The state of the union is getting stronger.” Uh-huh. Fifteen hours and fifteen minutes after the President spoke those words, the Fed announced an economy in such peril that its previously unprecedented aid would extend over the horizon.

Okay. All Presidents have the right to use lipstick. However, forty minutes and 58 paragraphs into his words, words, and words, the President first mentioned “homeowner.” Gave it three sentences to describe a refinance proposal that does not exist and will not. Three weeks after the Fed Chairman, a Fed White Paper, and four other Fed governors and regional presidents identified housing as the most serious risk to the economy, why it is, and what to do about it… three empty sentences in the SOU.

The 12th and 69th paragraphs (only) contained the word “deficit” in self-congratulation for last year’s painful mini-cut. Nowhere in the speech was a reference to a domestic spending cut or planned spending discipline of any kind.

We are entering the second year of an inert White House. Blame the Tea party, rightly, but a second year with no meaningful, Congressional pass-able economic proposal? At all? When in modern times has the White House been so dormant?

FDR was active, heaven knows. Some still argue about what he did, but not that he tried with mighty invention. Harry Truman let no grass grow in a deadly time and with a hostile Congress. Ike knew how to use staff better than anybody; it got him time for golf, but he got stuff done, and ornery Democrat Sam Rayburn ran Congress. JFK’s two years had questionable result, but action! Statues of LBJ would be common had he not become entangled in Vietnam, as any President might in 1965. Odd, brilliant Dick Nixon was plenty productive until the last six months, and never had a Republican Congress. Gerry Ford restored faith and fought inflation. Jimmy Carter never connected, and micromanaged his way to oblivion, but was anything but asleep. Anything Ron Reagan got done in eight years had to be negotiated with Tip O’Neil. Daddy Bush faced nothing but Democrats, and Bill Clinton had to make deals with the Mad Hatter. Newt.

These last 11 years… I find no parallel except the emptiness of Harding and Coolidge. Hell, even Herbert Hoover tried hard.

Fourth Quarter GDP arrived plus 2.8%, but consumer spending rose only 2.0% (after all that media jive through the holidays), and the savings rate fell below 4%, leaving little slack in household budgets. Inventory rebuilding aside, GDP rose only 0.8%, and that was boosted by an improbable 10.9% jump in residential construction, likely to be revised closer to Q3′s 1.3% gain.