The Battle of Gettysburg lasted for three days (July 1-3, 1863). It was the largest war-related carnage ever to take place on the American continent. He left a deep and still perceptible trauma in the American psyche. Perhaps to exorcise the wound, for about twenty years, extremely accurate and grandiose reconstructions of the battle have been held every July on the Gettysburg site. Everything is very serious, but there is running water, clean toilets, showers, large secure parking lots, regular shuttles to the battlefields, fire protection and 24-hour medical assistance. It is the re-enactment of a massacre, but with all the comforts of modern life, even if you sleep in camps.
No one has to get really hurt. It is in this spirit that markets around the world are preparing for the recall of the September-October correction. We will all take it seriously, ponder the serious structural problems plaguing the world, the high valuations of financial assets and the triggering event (geopolitical, financial, economic crash) that will kick off the volatility. However, we will do so knowing that there are already ambulances out there and that reinforcements will be sent from the control room in case things start to get out of hand.
Ambulances are policy indications from central banks, ready to reshape rhetoric and operational line to prevent fear and distrust from taking over. That was the case a year ago at this time when, on 18 September, the Fed, frightened by a hike in long-term rates and a correction in the stock market which, at its worst, had been 4 per cent (4, not of 10 or 20), hastened to renege on the tapering announcement that had been made at the end of June. This has also been the case whenever the jobs data hit the levels the Fed had been targeting and the market started to get nervous about a rate hike. In all of these cases, the Fed promptly shifted the stakes and introduced new targets.
As for reinforcements, or purchases of support on the stock exchange, the Zero Hedge site scandalized what it considers the smoking gun, a discount offered by some exchanges to central banks on commissions for their transactions on the SP 500 future. In principle, direct interventions on the stock exchanges do not seem more scandalous to us than those on exchange rates or interest rates, which are instead widely accepted. Bernanke, in his time, repeatedly claimed the stock purchase as one of the arrows in a central banker's bow.
The fact is that the corrections have become smaller and shorter and the Vix, the volatility indicator, has returned to its lows precisely in the days in which there was talk of tactical nukes to resolve the crisis in Ukraine, then of truce permanent and then again of frozen conflict awaiting winter. These are also days of strong American data and European data which, after being almost disastrous for a few weeks, are starting to turn positive again. Better data, however, means more uncertainty about European Quantitative Easing, the only thing that has so far seemed to really interest the market.
In short, the best or the worst may happen (or loom), but stock markets and bonds behave as if they were in a boringly quiet world, structurally sound and free from inflation and deflation. Only the euro is proceeding quickly (also without leaps and bounds, exactly as was the case for the yen in November-December last year) towards an aggressive downsizing.
For European politicians, the weak euro solves many potentially explosive problems. The first is the very survival of the single currency and the maintenance of Italy within its perimeter. The second is the supply of oxygen for the other seriously ill, France. The third is the possible postponement of the Qe, the adoption of which will trigger endless controversies and legal battles in Germany (with the Allianz fur Deutschland in continuous growth and increasingly dangerous for the Cdu). It should also be considered that devaluation, which is also a capital and income impoverishment, is not only accepted but is even invoked by many social parties, while internal devaluation (stable exchange rate and wage cuts) although in many respects the same thing, it is fiercely opposed and could in some cases lead to the very fall of governments.
Devaluation is therefore the line of least resistance, especially if it is accompanied by a further narrowing of periphery spreads. After all, Qe aims to depreciate the exchange rate and narrow spreads. However, if the same objectives can be achieved by focusing on negative rates and on financing operations (LTTRO, ABS, covered bonds) and if the size of the ECB's balance sheet is enlarged by a trillion euros, the Qe of reserve. Qe, for Germany, is the atomic weapon to use in case Putin cuts gas to Europe this winter or in case inflation does not pick up.
It is possible that the dollar will stay close to 1.30 for some time. For the German public, seeing a level that is too low can create doubts and anxieties. The devaluation of the euro, however, does not end there for the simple fact that America will raise rates, while Europe will keep them below zero for many years to come.
America is not enthusiastic about the strong dollar. A Treasury economist, Kenneth Austin, has published a rather technical article in which he proposes that the dollar give up its role as a reserve currency. Jared Bernstein, another higher-profile economist close to the Obama administration, took up the theme, arguing that America needs to start worrying about a strong dollar and prevent further appreciation.
However, it is very interesting that both Austin and Bernstein are angry with Asia (formerly Japan) and not with Europe. The ECB does not accumulate dollars to keep the euro down, while Asian banks do and in this, according to the two authors, they behave unfairly.
Seen from a political point of view, the United States accepts the depreciation of the euro as a necessary and inevitable evil, but intends to offset it at least in part with a revaluation of Asia. In reality it is unrealistic for Korea and China to agree to revalue at this stage, but the message, between the lines, is not to even try to devalue.
The structurally weak euro, the structurally strong dollar and China which will have to remain pegged to the dollar and which wants to raise its stock market lead us to the following operational conclusions.
1) Reduce positions on the US stock exchange and partially offset them with purchases in Hong Kong and Shanghai.
2) Maintain and expand equity positions on European exporters, beneficiaries of the weak euro.
3) Hold the rest of the portfolio in dollars with limited duration.
