The Current Consensus: Close But No Cigar?

Over the course of less than two months, we have seen the phrase "green shoots" enter the public vernacular, and proceed rapidly towards cliche status. Now, the problem with using green shoots as a metaphor for the current economy is that it is a wholly inaccurate description. The implication of this overused phrase, insofar as the broader economy is concerned, is that growth, albeit meager, is occurring. In the current environment, there is not only a lack of evidence that the economy is growing, but there is also the existence of evidence that the economy is in fact shrinking.

The US economy lost over 500,000 jobs in the month of April. Given that the Department of Labor, by way of the Birth/Death model, has cited mythical business creation statistics that account for job gains, thus offsetting the headline number, and the fact that the same agency will undoubetedly revise April's job loss total down further, we would argue that there was nothing "green shootish" about April. We understand that the labor market is considered a lagging indicator of the direction of the economy, however, we know of about half a million people in particular who would likely classify the lagging aspect of the labor market as either irrelevant or innacurate.

The truth is, that this recession has been a largely unpredictable one. For our part, we proscribe to Mohamed El-Erian's assertion that the world economies will experience a "new normal", characterized by heightened volatility and systemic risk. That being said, we do not expect this "recovery" to proceed in any sort of typical fashion. It appears that, for now, the risks of a banking sector collapse have been averted. However, new problems could easily arise. Consider what it would mean for the banking system if the average default rate on bank's holdings of credit card backed assets reached 50%. Before you dismiss this possibility as crazy and assign a 0% probability, consider your reaction if a friend had, in early 2007, predicted the collapse of both Bear Stearns and Lehman Brothers.

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Of Nero and Fiddles

One of our favorite historical tales features the Roman Emperor Nero, who ruled during the years 54-68 CE. It was during his reign that the Capital was ravaged by what later became known as the "Great Fire of Rome". As implied by its name, this fire was particularly destructive, decimating a substantial portion of the City. According to the lore, during the fire, Nero was spotted on top of a hill overlooking Rome, playing a fiddle while the City burned to the ground. Nearly two thousand years later, remnants of this sort of behavior still exist.

The "fiddlers" of today are the chief economic policymakers of the United States. Instead of playing a musical instrument, these individuals are aggressively pushing a storyline that contains, as its foremost element, a concept described simply as "green shoots". The media has been complicit in the advancement of this fable: one morning while perusing a rather well known newspaper, we noticed that across two consecutive pages, there were six separate articles. Every article invoked the term "green shoots" in either its Headline or Sub-Headline. 

The "fire" at present is the financial system, which continues to deteriorate. The most recent flare up is the somewhat under-reported trouble at Syncora, a provider of debt guarantees, or bond insurer if you prefer, with Total Assets in excess of $5Billion. New York State insurance regulators have literally compelled Syncora to cease all payment of claims until the Company can reduce its liabilities to a more manageable level. Presumably, New York will attempt a Chryler style Creditor Coup in order to avoid bankruptcy proceedings.

Our primary issue with this latest strategy is simply that the Government's hired economic hands know better. While they may misspeak in public occasionally or fail to fulfill their tax liabilities, these men are not obtuse beings when it comes to reading the economic tea leaves. We would classify the current developments as merely part of a larger strategy-one that has been conceived for the purpose of allaying public discontent for a minimum of two years. The reasoning is simple: as long as the public perceives a recovery to be close at hand, overall levels of unrest will remain minimal. The prosecution rests.

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Federal Reserve Impotence

In mid-March, the Federal Reserve announced its intention to purchase $300Billion worth of US Treasuries, triggering an almost immediate 50 basis point decline in the 10 Year Treasury yield. At the time we proposed that the Market, being a force far superior to the Federal Reserve, would eventually counter-strike, much to the dismay of the Fed. We also stated that this initial $300Billion figure would be a mere drop in the bucket when compared to the volume of Treasuries ultimately purchased by the Fed. At present, approximately one month after the Federal Reserve officially embarked upon a program of Quantitative Easing, the Market has already counter struck, rendering the practical effect of the Fed's program useless. The yield on the 10 Year Treasury has returned to 3%, the same level it sat prior to the QE announcement.

The sheer speed at which the Market has assessed the Federal Reserve, formulated a counter strike, and implemented said strike is troubling at the least. The 10 Year is by the far the most important part of the Treasury Curve-its yield influences a vast spectrum of financial instruments, including but not limited to Mortgage Rates, the lowering of which has become a centerpiece of Government policy. That the Fed could only influence this rate by 50 basis points, for approximately one month, is a testament to that Institutions dwindling credibility and ability to manage the economy.

As for the Fed's next move, we are sticking with our assertion that Trillions more will need to be committed to the Treasury Market in order to keep the cost of capital sufficiently low throughout the economy. The alternative, allowing the Treasury Market to proceed unimpeded, would be the equivalent of dousing the purported "green shoots" with a solution comprised of 1/2 Raid and 1/2 Arsenic. We think the Fed's next move is quite clear.

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