Historically the highest prices touched by wheat prior to the French Revolution were in 1789. Between 1780 and 1788, the average price for a "setier" of wheat (setier was an old French units of capacity equating to 156 liters), was stable between 19 pounds and 13 shillings and 25 pounds and 2 shillings. Between 1786 and 1787 the price was stable at 22 pounds a setier. In 1788 it rose by 15% but in 1789 it rose by 36% in one year, touching 34 pounds and 2 shillings. The harvest for 1788 was one third lower and this impact was sufficient enough to trigger the doubling of prices in the period 1788-1789. Just before "Bastille Day" on the 14th of July, there was a tremendous storm on the 13th of July 1789 which caused massive destructions to crops.
"Le prix du blé à Pontoise en 1789" by Dr Florin Aftalion.
The proper French revolutionary period (1789-1794) was characterized by poor harvests and very similar meteorological factors witnessed in 1788 and 1789, namely very hot spring-summer periods with very bad weather followed by very cold winters (-21 degrees Celsius in Paris during the winter of 1788), of course any similarities with this year's meteorological events are purely fortuitous given we are rambling again...Are we?
Those who follow us know that we have been tracking with much interest the ongoing relationship between Oil Prices, the Standard and Poor's index and the US 10 year Treasury yield since QE2 was announced - source Bloomberg:
This time was not different. The Dollar Index fell to around 79 with Gold rising in the process as indicated in the below graph displaying the Dollar Index versus Gold since June 2011:
"Pareto efficiency is an important criterion for evaluating economic systems and public policies. If economic allocation in any system is not Pareto efficient, there is potential for a Pareto improvement—an increase in Pareto efficiency: through reallocation, improvements can be made to at least one participant's well-being without reducing any other participant's well-being." - source Wikipedia.
Therefore in this week credit conversation we would like to delve into the diminishing returns QE has on the real economy following our usual credit overview.
The relationship between the Eurostoxx volatility and the Itraxx Crossover 5 year index (European High Yield gauge) - source Bloomberg:
As well as the European High Yield market, the US High Yield market continues to perform and becoming a cause for concern as a market maker put it bluntly:
Yes, the last two weeks have seen an "avalanche" of new issues coming to the market given the prevailing tone in markets leading to 19.3 billion euros worth of new issues coming to the markets with 12 billion alone last Monday. While core non-financial issues are getting more and more unattractive, there was a flurry of new issues coming from peripheral countries, such as Energias de Portugal on Friday which came to the market with 750 million euros worth of bonds which drew 7.5 billion in orders from 475 investors at a yield of 5.875% from an initial 6.25%. It was the first issue for Energias de Portugal (EDP) in the last 18 months. Effectively EDP had been shut out of the markets since February 2011.
This directly a translation of the pressure easing on Portugal sovereign CDS 5 year spread, as indicated in the below graph displaying Portugal 5 year sovereign CDS versus Ireland sovereign 5 year CDS:
But, the severing of the link between Sovereign risk / Financial risk has yet to happen. The main concern of European authorities as indicated by the difference in spreads between the Itraxx SOVx 5 year CDS index and the Itraxx Financial Senior 5 year index has been trying to break that close relationship, expecting that the European Banking Union will finally break this relationship. We doubt it will - source Bloomberg:
In relation to the European bond picture, the move was less dramatic for peripheral bonds this week with Spanish 10 year yields around 5.80%, slightly below 6% whereas Italian 10 year yields still well below 6% around 5.00% whereas German government yields continued rising, this time around towards 1.70% levels with other core European bonds yields rising as well in the process - source Bloomberg:
As far as "Flight to quality" picture is concerned, it is clearly pointing towards "Risk-On" with Germany's 10 year Government bond yields rising towards 1.70% and the 5 year CDS spread at 52 bps converging - source Bloomberg:
Both the Eurostoxx and German 10 year Government yields are still moving in synch in "Risk-On" mode in with rising German Bund yields towards 1.70% yield level and a stronger Eurostoxx 50 at the end of the week converging with the Itraxx Financial Senior 5 year index - Top Graph Eurostoxx 50 (SX5E), Itraxx Financial Senior 5 year CDS index, German Bund (10 year Government bond, GDBR10), bottom graph Eurostoxx 6 month Implied volatility. - source Bloomberg:
We could not agree more with Cheuvreux's latest Microscope publication by Nicolas Doisy namely that:
"So far, only QE-2 is actually a quantitative easing as it has elicited banks into pure cash hoarding, while QE-1 (an emergency action) was credit easing. But QE-2's ability at capping nominal yields is stumbling against the law of diminishing returns: the impact of QE-2 is just around half that of QE-1.
While unmistakably signaling a real credit crunch, the QE-2 cash-hoarding also elicited an actual but temporary pent-up in inflation expectations.
If it has thus managed to reduce real interest rates, QE-2 has proved unable to prop up wage inflation, the effective driver of trend price inflation. Likewise, a QE-3 would just prove that monetary policy alone cannot prop up the labor market, as banks would keep hoarding cash and not lend it."
Indeed QE2 was arguably a period of credit crunch due to banks hoarding cash and QE2 did trigger inflation expectations upwards (via resumption of credit) but insufficiently to sustain credit expansion according to Nicolas Doisy's recent note:
Rcube Global Macro Research in our conversation - "Growth divergence between US and Europe? It's the credit conditions stupid...":
Because, a decline in wage inflation is indeed a clear deflationary sign (paradox of thrift). Wage inflation has kept trending down since November 2008 with the exception of a short-lived plateau in November 2010 to August 2011 according to Nicolas Doisy' s recent report. QE2 has been running out of steam since with wages driving price inflation down again:
Fed's new easing will do little to lift bank lending:
Given that in a Pareto efficient economic allocation, no one can be made better off without making at least one individual worse off, investors are facing indeed an increasingly strong dilemma, due to the growing number of US retirees and a falling yield environment:
The rest of the world also had their own "baby booms". The United Kingdom, France, Denmark, The Netherlands, and Australia are just some of the other countries considered to have had Baby booms starting around 1946." - source Keenan Overseas Investors.
As far as consumers and The Wealth effect is concerned courtesy of yet another round of QE, as indicated by Keenan Overseas Investors:
"- Many US and European property markets have significant unsold inventories.
- New generation of young adults in the US weighed down by student debt.
- Consumer demand reduced when people consider themselves poorer.
If interest rates increase, all of these problems get worse!"
The fight against deflation goes on...