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August 2014

Mixed Emotions for the Gold Market

August 31, 2014 by EconMatters   Comments (0)

By EconMatters

Gold Crosscurrents

The Gold market has a lot of crosscurrents at the moment with the main negative as we write that it doesn`t pay a yield, and given the abundance of cheap money chasing every utility, bond and stock that pays a yield it has lost favor in that regard the last several years.

Bearish Factors

The interest rate cycle is also a negative for gold, and as the Fed starts hiking rates Gold usually needs other strong factors to overcome this headwind. The other headwind is that there currently isn`t a momentum trade, and since Wall Street often trades with a herd mentality, in the absence of a strong trend money just doesn`t get sucked into this trade.
Bullish Factors
Some of the bullish factors for gold are geo-political concerns, but this has mainly just provided short covering rallies so far this year, no strong bullish trend emerges after the short covering. Another will be if inflation starts ramping up, and inflation expectations start spiking ahead of the Fed`s ability to get in front of the inflation curve by being too deliberate on rate hikes. 
If we start getting some insolvency issues in Europe once again Gold could start ramping based in Euros as investors try to hedge their European currency risk. There are physical buying bullish pressures as consumers generally like to own gold, and they especially feel like they are getting a bargain when prices sell off. Both for the gold bugs that envision an ultimate end to global fiat monetary systems where currency debasement runs its course in an extreme momentous collapse scenario, more moderate hedgers, and countries like India and China who traditionally favor gold on a cultural basis. 
Shark Attacks
Consequently there are a lot of cross currents in the gold market, and so far in 2014 we haven`t really had the severity of ‘shark attacks’ in the market from the big banks like we saw in 2013. You know the kind where 3 banks all downgrade gold overnight, gold drops like a rock for 200 to 300 dollars, causing forced liquidations, and then once the short covering occurs gold goes right back to where it was originally trading before the shark attacks. This is a ‘shark attack’ and many markets experience them from time to time where a bunch of players gang up on a market to make money in the short term. 

Federal Reserve
I do think for the near term gold investors should be worried about the downside, and I am talking about the futures market, (however, this still effects the physical market in the short term) as you saw some nervous exiting before the Jackson Hole speech, they just didn`t want the exposure before the event given the chance that Janet Yellen really signaled to financial markets in a strong manner to start exiting positions that were based upon 25 basis point borrowing.

Rate Hike Cycle
Along these lines, as the biggest driver is probably going to be the upcoming rate hike cycle by the Federal Reserve in the US, and the Bank of England early next year with expected rate hikes, there are bound to be some hawkish interpretations made, and gold is going to get smacked around real hard sometime in the next three to six months. 
Hot Inflation Readings 
Unless there is some counterbalancing force like inflation spiking well ahead of current market expectations around the 2% level, some of these hawkish market undercurrents with regard to monetary policy are going to play out in the gold market putting downward pressure on the commodity. Just how far it goes, and to what degree does bearish sentiment bring in players who don`t normally play in the gold market will determine how much of a sale price buyers get before they feel it is safe to come in and take advantage of lower prices for their beloved commodity. 
Forced Liquidations of 2013
What happened last year is that some buyers stepped in initially at a level they thought would hold, and the gold market took another leg down, and those forced liquidations provided a real buying opportunity for gold last year. But remember the Fed didn`t actually raise rates last year, what happens when there are actual rate hikes after seven years of easy money? We will probably follow up with an article on the technical levels to watch, but the bigger point right now is just to be aware of what is coming down the gold turnpike, there will definitely be some substantial ‘shark attacks’ over the next six months, and expect some downside pressure for the commodity. 
Gold Bears Have Wind at their Backs as Technicals likely to fail to downside over Near-Term

The feeling here is that the last six months will seem comatose to the volatility and strength of some of the moves in the gold market that are about to occur as key technical levels of support fail to hold. We not only expect these technical levels to get tested, we expect that the momentum during this period will be sufficient enough to break many key technical levels that have held so far this past year. Be selective and careful in playing the long side of the gold market in the near term as the primary catalysts and ultimate drivers are probably bearish in the near term, and gold bulls will be running against a severe headwind in the market!

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Were European Bonds Mispriced in 2012 or are they Now?

August 30, 2014 by EconMatters   Comments (0)

By EconMatters


How to properly value European Bonds
This seems to be the biggest question in financial markets for me right now because the math just doesn`t add up any way you slice it. When you look at the pricing for European bonds this conclusion jumps out from an analyst perspective, either European bonds were analyzed and incorrectly priced two years ago, or they are currently being analyzed and mispriced today! 


Possible Explanations for Large Valuation Gap 
 
Belgium 10 Year Bond Yield

One might say it is a little of both, the yields shouldn`t have been that high two years ago, and they shouldn`t be this low right now. However, the gap is just too large from a valuation standpoint to hold much water or relevance here. The next possible answer is that central banks have made interest rates for borrowing money so low that this has incentivized bondholders to accumulate more bonds in search of a yield vehicle to invest this ZIRP Money. 
Ireland 10 Year Bond Yield
Also, the US QE Program of $85 Billion per month, much of this money may have found its way into the European banking and financial markets further incentivizing liquidity driven asset purchases of all kinds in Europe. But remember, Europe itself has done very little besides the main weapon of ZIRP compared with the United States, and these are European bonds we are talking about. But if it just comes down to ZIRP offering enough of an incentive to buy what were perceived as risky bonds for investors just two years ago, why weren`t these yields much lower as soon as ZIRP began in Europe? 
One answer might be that there was a scale issue regarding liquidity, and ultimately there was a lag effect, until liquidity reached a certain threshold, first of filling the deleveraging credit gap, then there is enough to spill over into alternative investments like chasing yield trades. However this two year period also happened to correspond with the $85 Billion QE policy in the United States, and this seems to have been some of the catalyst for ditching investments like Gold in favor of Yield Investments. There is also this ‘Binary Mentality’ in financial markets in evaluating an investment risk or trading strategy, it is ‘Risk On’ or ‘Risk Off’, ‘Yield On’ or ‘Yield Off’, or European bonds are ‘Safe’ or really ‘Risky’. 
Fundamentals in Europe Haven`t Changed


Italy 10 Year Bond Yield
However when you look at the fundamentals and compare them to 2012 things haven`t really changed that much in Europe from a ‘getting their financial house in order’ standpoint, and their economies aren’t exactly booming, so these bonds seem as risky now as they ever have been from a solvency standpoint. I realize that the higher yields feed on themselves and make Europe`s outlook worse by some metrics, and that lower yields help alleviate near-term financing concerns from an interest on debt perspective, but the moves in these European bond yields just don`t make sense on a valuation standpoint, who would buy these bonds at current prices and yields? [Moreover, lower yields may be bad because it allows the governments to put off the much needing structural reforms that are necessary for fixing Europe in the long run.] The possible answer is that banks think that they can front run central banks, beg for QE, and get the central banks to take these bonds off their books. 
How Big can the ECB Balance Sheet Really Get?


Spain 10 Year Bond Yield
But remember Europe hasn`t really done any bond buying program, and it really seems like a big risk to take with your only real out being that Mario Draghi can convince policy makers to buy European bonds in any sizeable scale to make all these bonds good values here. The scale is enormous because the amount of debt that Europe needs to sustain their deficit spending weak economies that are not very competitive from a global standpoint outside of Germany is enormous each year. Furthermore, the ECB is really going to buy “all of these European bonds” from Italy to Belgium? The math doesn`t add up, just think about the Fed`s 4.5 Trillion dollar balance sheet, how big would the ECB balance sheet need to be to have any real impact in buying all these bonds from the banks that currently hold them? 
What Will Germany Sign Off On?
Would Germany really sign off on this even if it was potentially possible to buy even half the bonds of these European countries? This just seems ludicrous and I hope this isn`t a real investment rationale for buying all these European bonds, that the ECB is going to take them off their hands regardless of price. The other explanation is that these bond investors think they can get out quick enough, make enough money before ZIRP and the market reverses itself, and basically dump these bonds back onto the market without getting hurt. 
However, when you calculate the magnitude of how many bonds were bought all across Europe with deficit spending needed to sustain largess social governments, taking yields down from such heights just two years ago, this is a lot of bonds that will have to be dumped onto the market, what effect is this going to have regarding a tremendous spike in yields during this process? 
Paper Gains on Bank`s Balance Sheets Likely to Reverse to Actual Losses Again


Portugal 10 Year Bond Yield
Remember so far these banks and financial players have gained ‘paper gains’ on their books, they of course book the yield profits, but these are small relative to the price moves in these bonds. However the bonds are still on their books and nothing has changed in Europe and in reality many of these ‘paper gains’ on the books will reverse themselves. In many cases any financial institution who bought bonds over the last year in Europe at extremely high historical prices relative to recent history and the dire fundamentals of Europe from a debt to GDP standpoint is going to incur massive losses on these bonds that make the banks themselves extremely vulnerable to collapse. Basically needing to be bailed out all over again, i.e., the collapse of the Spanish Real Estate market, and the after effects of all this bad debt on bank`s balance sheets who had exposure to the overbuilding in Spain. 
The Problem with Accumulating Assets without regard to Fundamental Value means these Assets are Forever Stuck on the Bank`s Books – Nobody will buy them when they need to sell


France 10 Year Bond Yield
But based just on the fact that bond investors have no real clue what any of these bonds should be priced at just in a two year period, I have no confidence that their models over a ten year time period have any validity or insight regarding valuations and sound investment decisions. It seems more likely that somebody in Europe is going to have to take huge haircuts on these bond positions, as unlike Japan Europe relies on external funding for these bonds. It seems like the likely scenario is that yields start rising slowly at first with the extinction of the massive US QE program in October by the Federal Reserve. And pick up steam as the ECB cannot deliver relative to the expectations already priced into European Bonds, and then the technicals take over fueled by the reality that Europe was never fixed. This leads to the same scenario for these bonds getting ‘re-priced’ back into the bond market that we had just two short years ago. That most of these bondholders will have to take massive haircuts on these positions, and in two to five years European bonds are back pushing the upper limits of yield once again on an increased insolvency risk profile or EU breakup entirely.
 The German Bund is a Long-Term Short over 10-Year Duration
But the one thing that is certain is European bonds are not properly priced today on any scenario. There is a high probability that these bonds are completely worthless in ten years for some of these countries, the math just doesn’t work out in some of these peripheral countries. The German Bund also looks like a short at least back to 1.2% from the current 0.88 % yield for the 10-year duration as the market has really gotten ahead of itself in a slow summer, and as markets often do overshoot based upon one-sided momentum trading. 
European Bonds Biggest Bubble in a World of Mispriced Assets
I would also reiterate that most of these European bonds are massive shorts, just take positions, be able to stay in these markets for ten years, and most of these bonds are going to ‘re-price’ back to the fundamentals of Europe and a sustainable risk profile. Any investor buying European bonds at these prices is going to lose money on this investment when they have to sell these same bonds in an escalating yield environment. 
More Money Has Been Lost Chasing Yield the last 10 Years than any other Investment Strategy – Yet it Remains one of the most popular – so much for “Prudential Regulation” Janet Yellen as being an Effective Tool for Containing Risk to the Financial System
Remember you haven`t made money on a trade until the position is officially closed out, good luck buying European bonds in the biggest bubble of the vast universe of bubbles that currently exist in the financial universe that we find ourselves in due to incompetent Central Banks, matched only by incompetent governments who spend more than they can possibly take in regarding revenue, all cheered on by irresponsible banks who want their investment risk subsidized by others. I am a finance guy, and the math ultimately has to make sense, and it just doesn`t make any sense in Europe, and unlike the United States, the margin of error for Europe is not nearly as big to fall back on!

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Expect Another Strong Employment Report Next Week

August 29, 2014 by EconMatters   Comments (0)

By EconMatters

Sleepy August Closes Out
Lost in what is one of the lowest trading volume weeks of the year, and a really sleepy August month in general where many folks are getting to use some vacation time before markets start getting serious again in September after the Labor Day Holiday was another week of better than average economic data. 

Initial Jobless Claims

I will avoid the minor revisions, and stick with the reported numbers but Jobless claims had a stellar month of August. First on 8/7 we had 289k Initial jobless claims, then on 8/14 we had 311k jobless claims, and on 8/21 we had 298k, and we close out the month with another 298k Initial jobless claims. The 4-week average is 299,750 for the month of August.

The underlying fundamentals in the job market keep getting better each month, and the manufacturing reports and other economic surveys all showed strong employment components which likewise support the strong showing this month for Initial Jobless claims.
ADP Employment Report
We will get a first look at private payrolls next Wednesday with the ADP Employment Report which will set the tone for next Friday`s Employment report, and the jobless claims data for August suggests another plus 200k employment gain for the month, but just how robust is the question.
While much of the market focus for the month was on Fed Policy and Geo-Politics, the economic data has been coming in better than expected for the entire month; shoot even housing data on the whole has been coming in better than expected, so I am leaning towards a 250k plus Employment Report for next Friday.
Important FOMC Forecast Meeting in 3 Weeks
If we get another strong employment report next Friday, this will really up the ante for the rest of the September economic data moving into the all-important Wednesday September 17th Quarterly FOMC Meeting Announcement, FOMC Forecasts and Chair Press Conference where many market participants have noted will potentially be when Janet Yellen signals to financial markets the Rate Hiking Timeline.
Ergo expect participants coming back from vacation to watch the ADP Employment Report real carefully, and early positioning to begin ahead of the Friday Employment Report, and if we get another strong employment report next Friday, expect some major positioning in front of the critical quarterly Fed Meeting on the 17th, with all hell breaking loose from a portfolio reallocation standpoint for the fourth quarter if Janet Yellen signals the Rate Hike Timeline for financial markets, and it is sooner than currently priced into financial markets. 
Moreover, even though the mid-summer timeline for the first rate hike is theoretically priced into financial markets, in actuality as James Bullard has stated several times, the market is severely complacent with actually positioning itself for even this mid-summer rate hike, procrastination at its finest! And if the Timeline gets moved up to March, or hinted at in the FOMC Meeting, Forecast or Press Conference this will trigger the start gun for some serious ‘portfolio rebalancing’ in many asset classes.
September Fireworks
Therefore, September is not going to be nearly as sleepy as August from a trading standpoint, and probably everything that worked in August will get “taken out to the woodshed” in September. Expect a ramp up in volatility (for real this month), and traders better bring their seatbelts this month as I expect major market moves in many asset classes like currencies, precious metals, credit markets, stocks and bonds as the economic data is just too good for the Fed not to move the first rate hike up to March of 2015. It all gets started next Friday with the highly anticipated Employment Report for August!

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European Bond Market: Bubble of all Bubbles!

August 28, 2014 by EconMatters   Comments (0)

By EconMatters


European Bond Rush
Right now investors in European Bonds are running over each other all in an effort to front run what the Big Banks have been begging the ECB to begin a bond buying program similar to the United States’ QE bond buying program.


Tourism has its Limitations
It is hilarious as European yields are already ridiculously low right now, how much lower do they think these yields can go, and if they could go measurably lower what difference would it make, obviously low yields and borrowing costs aren`t what troubles Europe right now. It is the fact that these countries have one business advantage on a global basis, tourism and that is it. These countries that make up the European Union are basically socialist stores of historical wealth, outside of Germany, they just aren`t competitive on many fronts compared with the United States, South Korea and China.
Big Banks Begging for more Central Bank Handouts!
But let’s be honest the ECB doesn`t need to buy any bonds, the banks are just begging for more handouts of cheap money, and more government programs that they can take advantage of like the primary dealers did with the Federal Reserve`s QE stimulus program. It is all about ‘gaming’ the system, especially when it is too hard to actually do some research - figure out markets, and strategically differentiate between good and bad stocks, asset classes, and investment themes. Just beg the Central Banks for more “stimulus” that they can front run, or game the financial system for risk free returns that takes no real market skill whatsoever. 
Big Banks Should Be Begging for Structural Reforms by Governments!
The big banks should be putting pressure on the governments to overhaul their noncompetitive business practices in these European Countries, they should be begging for structural reforms in these countries. However that would be much too hard, when these banks can just beg the ECB for more cheap stimulus programs, like that is going to help any more than the 15 basis point current borrowing costs in Europe! 
Mario Draghi even alluded to this in his Jackson Hole speech last week, that he can only do so much for what ails Europe, and the real solution for European growth must come in the form of structural reforms, and making these countries more competitive like South Korea, China and the United States on a global competiveness scale; shoot even Mexico is starting to get their act together compared to Europe.
Who is the Bond Sucker that the Big Banks are going to Sell to?
But like I always say ‘Any idiot can buy bonds with ridiculously low yields’ just who is the greater fool that you are going to sell these duration bonds to over the next five and ten years? Remember bond yields just two years ago before central banks started incentivizing this search for yield insanity? Do you think the Debt-to-GDP Ratios for the European countries have gotten measurably better? Without major structural reforms, and don`t hold your breath anytime soon bond investors, you just got suckered into buying European bonds because you were so freaking greedy, that you have pushed European Bonds into the bubble of all bubbles, for the same bonds that three years ago you wouldn`t touch with double and triple these yields! 
Talk about greed getting in the way of rational investing, it is the trick that Grifters use to scam marks; appeal to their greed motive, and then watch as the fools step all over themselves giving their hard earn money to the Grifters! So unless there is miraculously some kind of structural reform nirvana in Europe all the cheap money isn`t going to solve the lack of competitiveness of these countries in Europe on a global basis, weakening the Euro by another 10% isn`t going to cure why no European country can compete with South Korea, China, or the United States. Furthermore, the Debt-to-GDP Ratios are only going to grow much higher than they were when investors thought the European Union was going to collapse and these same bonds that they are currently jumping over themselves to buy were absolutely worthless! [So which story are you going to stick with Bond Investor, were these same bonds mispriced then, or are they mispriced now?]
Rinse, Repeat…then Beg for Bailouts once again!
Anybody buying European Bonds, (I guess all the big banks think they will be bailed out once again when all these European bonds are completely worthless), when European yields quadruple from current yield levels, and all these worthless bonds on the banks books make the subprime mortgage write-downs look like Childs play in comparison. Talk about central banks setting up for the next financial crisis where the big banks all become insolvent again with more worthless assets on their books, all these European bonds at current yield levels are so mispriced that the losses for those that hold these on the books for five and ten years’ time is going to be staggering!
Insolvency Risk Greater than Ever!
 
Portugal 10-Year Bond Yield

For example, Portugal has a Debt-to-GDP Ratio of 129.00 with a 10-year bond yield in the 3% range; it was 16% in 2012 with a lower Debt-to-GDP Ratio. Italy has a Debt-to-GDP Ratio of 132.60 with a 10-year bond yield in the 2.4% range; it was 7% in 2012 with a lower Debt-to-GDP Ratio. France has a Debt-to-GDP Ratio of 91.80 with a 10-year bond yield in the 1.25% range; it was 3.5% in 2012 with a lower Debt-to-GDP Ratio. How about Greece, it has a Debt-to-GDP Ratio of 175.10 with a 10-year bond yield in the 5.6% range, it was over 40% in 2012 with a lower Debt-to-GDP Ratio. Spain has a Debt-to-GDP Ratio of 93.90 with a 10-year bond yield in the 2.14% range; it was over 7% in 2012 with a lower Debt-to-GDP Ratio. I could literally do this all day across the European Union, one gets for the most part the same results with lower Debt-to-GDP Ratios or slightly smaller with 10-year bond yields which just two years ago were three and four times higher, and the European Union no more competitive on a global basis then they were during the ‘Insolvency Crisis’. 
Italy 10-Year Bond Yield
Rising Debt-to GDP Ratios & Bubbly Yields Failing to Properly Price ‘Haircut Risk’!
 
France 10-Year Bond Yield

The point is nothing has changed idiot bond investors, are you really this stupidly oblivious to risk because the ‘Yield Trade’ is really in fashion right now in financial markets? Where do you think these same bond yields will be in ten years? Do they think that Europe will get their financial house in order? Do they really think half of these bonds are even worth anything in 10 years? Just two years ago, which by my math, there are a lot of two year time periods in a 10-year bond duration, the entire European Union with better overall Debt-to-GDP Ratios compared to present was on the verge of collapse, what has changed besides Central Banks incentivizing you to chase Yield? 
Greece 10-Year Bond Yield
Going to need ‘a lot’ of Greater Fools to offload this European Bond Garbage
 
Spain 10-Year Bond Yield

You do know that Yield is supposed to represent the risks associated with you as an investor getting paid back in full on the debt, do you really think the current yield is representative of the ‘haircut’ you will be forced to take on these bonds if the European Union implodes or dissolves? I love your optimism in finding a ‘greater Fool’ to buy these Grifter Bonds off of you Big Banks, I guess in a couple of years we will be back to 15 Billion Dollar Write-off Quarters like 2008, and more Bank Bailouts for Stupid Investment Decisions or should I say Stupid Risk Taking! 
Not Exactly ‘Rocket Scientists’!
Bond Investors are some of the stupidest people in financial markets, this is going to be hilarious watching this all explode in their faces once again! You would think that after the financial crisis which when you break it all down came down to loading up chasing levered yield plays, just ask Merrill Lynch about falling in love with Yield, that investors would be better able to calculate risk in trade configurations. But just as JP Morgan illustrated so succinctly in the ‘Whale Fiasco’ excessive Greed gets the Big Banks every time! Have fun picking up those Yield Nickels in front of the Bond Reset Steamroller when the European Bond Bubble Bursts!

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Even Mainstream Academia Worried about Massive Bubbles in Markets

August 26, 2014 by EconMatters   Comments (0)

By EconMatters  

Academia Finally Sounding Alarm
As stocks set new records each month even other academic economists are starting to realize that not only is the Federal Reserve behind the curve, but that they are part of the rising risk concerns that are building in the financial system, and their failure to take responsibility for valuations that are 10% over-valued even on the most optimistic valuations, is alarming given the past bubbles and the damage that has occurred through excessively low interest rates providing far too much liquidity in the system.

Far Too Much Liquidity in the Financial System

Make no mistake with QE still going on, and a 25 basis points fed funds rate, combined with Japan, China, England and the ECB all providing loads of liquidity to the financial system, risk taking is off the charts, valuations are bubbly in many markets, and the entire financial system is setting itself up for another massive, deleveraging crash once again. 

There is just too much liquidity in the financial system, and the US and England are the two economies best able to start reducing overall liquidity on a global basis, the UK with a hot real estate market, and the US with a hot job market and overheated stock market. 
The point is that there is too much systemic risk right now and it is heading in the wrong direction given the fact that Britain and the United States are both performing far too well to continue to have recession era loose monetary policies. It might make sense in Japan and Europe but when you have even well performing economies with ‘recession era level’ of interest rates providing massive amounts of cheap liquidity to the financial system, no wonder we have so many bubbles in bonds and stocks.
Don`t Be Fooled by the Lag Effect

The financial markets are not acting and trading normally, trust me I have seen many market cycles, and there is more liquidity in the financial system than there was in the credit bubble of 2006, this means things are out of hand once again, and the Fed needs to start soaking up this liquidity, and talking much more hawkish, just to ensure two-way markets, as right now there are far too many one-sided, all-in markets with ‘zero perceived risk’, and therein lies the risk problem.

Prudential Regulation is Passing the Buck
The notion floated by Janet Yellen that “Prudential Regulation” will monitor and watch for risky capital allocation strategies is flat out false. As a market participant, I can tell her “Prudential Regulation” as a tool sure isn`t working right now, and there are massive bubbles in many asset classes, the markets don`t even trade correctly and there is far too much liquidity in the financial system. 
Moreover, if Janet Yellen truly believes that “Prudential Regulation” will be the answer in avoiding financial markets becoming ‘too risky’ or dangerous from a risk-taking standpoint, i.e., posing systemic risk to the entire highly correlated financial system; if she really believes this is an effective tool, then she needs to step down immediately because she is obviously not qualified for the position of Fed Chairperson! It is dangerously close to an alarming point right here, the bubbles keep building and the Fed needs to take responsibility for creating this systemic risk in financial markets.

The Federal Reserve are the only ones that can reduce the risk of another financial crisis by reigning in some of the massive liquidity that is bursting at the seams in all kinds of places with no real place to go. I don`t think they realize just how much liquidity is currently coursing through the veins of the financial markets, it is unprecedented. 
The fact that QE was allowed to go on for basically 2 straight years, and the cumulative effects of zero percent interest rates for 7 years has finally come into financial markets with a bang. There was a lag effect, and now the liquidity overflow is out of control, we are starting to build bubbles in asset classes that have no way of long term sustainability. Some markets are as much as 25% overvalued on a five year time frame. There is no way in hell that these positions are going to be solid investments five years from now!
When Economists Recognize there is a Liquidity Bubble, We Have a Serious Problem!
Martin Feldstein, Harvard University professor alludes to what many in the financial community recognize that risk-taking is out of control, financial markets are not two-sided markets anymore, there are massive mispricing`s in many markets, all spawned by too much liquidity in the system.
The Fed needs to wake up to the risk in the system that they have created, they have become complacent because of the lag effect, well there is no more lag effect, liquidity is sloshing around the financial system right now at record levels. 

The S&P 500`s latest record 2000 run, and Bond Yields at Recession Era levels because there is so much liquidity with no place to go even in sleepy August ought to wake the doves out of their slumber fogginess, “Prudential Regulation” is not going to soak up the bubbly liquidity in the system, only Fed policy is going to reduce the current risk in the system. Stop passing the buck, and sinking your heads in the sand like ostriches, take some responsibility, and get your act together; we have a massive overflowing liquidity problem here in financial markets!

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The Fed Will Raise Rates in March 2015

August 26, 2014 by EconMatters   Comments (0)

By EconMatters

March or June?

The big question for financial markets is whether the Fed will raise rates in March or June, it used to be Whether it would be June or September of 2015, and I think as the data gets better in the second half of the year, and QE ends in October, the timeline could be moved up even further, say January of 2015 for the first rate hike.


Data Dependent creates box for the Fed
For example, what happens to expectations if besides the consistent 200k plus employment reports each month we get a 350k number? What kind of pressure will this put on the Fed to move on rates, especially sense QE has ended in October? I think there is a distinct possibility over the next five months that we have a 350k plus employment report, and the Fed line about changing data and data dependent comes into play. In this case they set the bar for moving sooner or later, and the bar would be surpassed with a 350k employment report. 

5.9% or 350k – which comes first?
Also what happens if the unemployment rate drops to 5.9% over the next 4 months, this key psychological rate number being below 6% is real close to approximating full employment by historical standards, and they are still sitting at zero percent in the fed funds rate? The questions and pressure just from their academic peers in the economics community for not addressing this change in data would be immense to say the least from a credibility standpoint.
I would estimate that there is a 40% chance that one of these two data measures in an outsized employment number of 350k plus, and/or a 5.9% reading on the headline unemployment rate comes to fruition that puts considerable pressure of the Fed to move up the first rate hike, or they have some serious explaining to do.
QE Ends in October
Things are going to be completely different when QE ends in October, they can no longer pacify markets with this kind of ‘tightening’ and financial markets are going to start re-pricing all on their own, in a sense telling the Fed where they will be going. This is what markets do, as investors try to front run Central Bank actions. And given how many participants have to switch directions, rates are going to start moving up in the second half of the year on any good economic data in the form of robust GDP reports, 250k plus employmentreports, and a drop in the headline unemployment rate.
Housing & Retail Sales
The second quarter earnings were better than expected, and if housing and retail sales start helping even a little bit, the bond market is going to start pricing in rate rises on the long end of the curve, which is where all the yield chasers have been hiding out. And once some key technical levels are breached to the upside regarding yields, the amount of stop hits and closing of positions is going to add further fuel to the rising yield momentum in the bond market as this is an extremely crowded trade, and they haven`t began to lose money off of very low yield levels. Once bond managers start to lose money in their portfolios as technical levels of resistance fail, selling begets more selling in these bond funds, and a 3% 10-year yield is here sooner than many complacent investors realize.

Re-pricing of Bond Markets

Therefore, watch for above trend economic data that comes out over the next four months; this is the key driver for forcing the Fed`s hand on ‘data dependent’ rate hikes. And if the economic data continues to move in the direction that it is currently moving I expect the Fed to raise rates by March of 2015, and this date isn`t currently priced into the bond market. 
Yield becomes a Four Letter Word
The future fund flows out of the bond market, especially at the long end of the curve over the next four months as the economic data comes in hotter each month, given the size of portfolio reallocation, is going to be staggering to watch as the realization that the Fed has to move on rates by March, and not June of 2015. Savvy investors can piggy back on this market dislocation when ‘Yield’ becomes a euphemism for ‘Sell’, as anything even remotely resembling a yield play will be sold with a vengeance over the next four to six months as the rate hike cycle begins in the United States.  Read More >>> Bond Kings to be Dethroned in Second Half of the Year

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Jackson Hole: Janet Yellen Is The Wrong Chairperson For the Fed

August 26, 2014 by EconMatters   Comments (0)

By EconMatters  


Janet Yellen is the wrong Chairperson for this Monetary Phase
It is obvious in Janet Yellen`s brief tenure as Fed Chairperson that she is too dovish to be an objective leader at the Federal Reserve, she isn`t even the most qualified representative on the current configuration of the voting members. Her approach and economic philosophy might be acceptable in a full blown recession where by accident her approach might be appropriate to the economic conditions of a recession. But in a normal economy in the business cycle, and with the Fed sitting on a 4.5 Trillion dollar balance sheet, and bubbles in financial markets everywhere one throws a rock, she is a disaster waiting to happen.

Speed of Rate Hikes versus Gradual Rise

It all comes down to this crucial point, and it is the most important point in the entire ‘free money debate’ it is not a question of if markets are in a bubble territory, they are, but by how much? Therefore, the longer policy puts off the rate hike, the faster they will have to be in raising rates, and the more damage that occurs to bubbles, market participants, and the economy when the speed of rate hikes is exponentially faster.

Irresponsible to delay ‘Rate Rises in Gradual Manner’ versus ‘Waiting and Raising Too Fast’
Given this fact, it is an economic fact that risks go up also in an exponential manner with the speed of rate rises by the Fed, it makes no sense in fact to still be buying bonds. Furthermore, it makes even more sense to start raising rates at the September Fed Meeting by 25 basis points and continue raising rates in 25 basis point increments at every quarterly Fed Meeting until the 3% Fed Funds Rate level is reached. Take a pause at that level, and see if they need to continue towards 4.5 to 5% based upon how the economy is performing, inflation, and the labor market. 
However, given what everyone knows that the 10-year bond should not be at 2.4% yield, there are a lot of market participants that need to adjust to the reality of a normalized policy world, and they are so far from this reality due mainly to an incompetently dovish Fed led by Yellen, that the amount of re-pricing that needs to occur, even if they started raising rates today is just off the charts. It is the most crowded, and off-sides trade in the history of financial markets, given the sheer size of the market involved, it in short is a disaster waiting to happen! Janet Yellen is too dovish to signal any policy change in advance for market participants, by the time she does signal it is too late to avoid major market dislocations. This is just not competently managing market expectations; it is unacceptable for anybody in this position!
Risk Reward Calculation: Where are the Risks, and on What Magnitude?
When one factors the risks versus the rewards of Yellen`s dovish approach to date, one can only come away with the conclusion that she is beyond her depth in this job. It is completely irresponsible to take these risks when weighing stability of the entire financial system versus some mystical labor slack argument that some ‘retired’ workers might want to come back into the labor market if it gets even better. Yeah and I would like to have the same energy I had when I was 16 too, but I am sure not putting my whole life on hold waiting for some magical wonder drug to bring this about!
There are risks involved, and they are much more dangerous to long-term economic stability by being so dovish where one basically has their head stuck in the sand, and completely oblivious to more normalized economic conditions, and current monetary policy still being stuck in ‘end of the world’ recession bunker mode. 
James Bullard Acceptable Replacement for Balanced Views Regarding Monetary Objectives
I would personally replace Janet Yellen with James Bullard as he is more balanced than Charles Plosser, however after listening to Plosser at Jackson Hole, I think he is the best person for the job given where the current Fed`s balance sheet is, and the fact that we are entering the necessary tightening phase. He would be best able to manage this tightening phase as his approach is the perfect fit for what monetary policy objectives need to be in matching a normalized economy!

Charles Plosser Best Mind at Federal Reserve
Any rational minded and clear thinking individual who listened to his responses and thinking process on the issues at hand regarding monetary policy realizes that he nailed it on every account. Charles Plosser is spot on with his analysis of where the Fed is, and where they need to be with regard to an adjustment in monetary policy. I realize there are a lot of politics involved in being chosen Fed Chairperson, but apart from those, he is the best person for the job given where the Fed needs to be relative to the normalization phase in the monetary policy cycle.

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Stellar Econ Data This Week

August 26, 2014 by EconMatters   Comments (0)

By EconMatters  

Fed Dominated Week

This past week was dominated by Jackson Hole, the Fed minutes, and the fact that many traders were on a beach working on their tans during this last slow period before things get in full swing after Labor Day. Missed in all of this was a week where every single econ report came in at the high end of the forecast, or outright beat expectations.

Monday

Let us review, on Monday we had the Housing Market Index where the consensus range was between 50 and 55, with the expected consensus coming at 53, and the actual number was 55, and up 2 points from the last report. The National Association of Homebuilders noted that there is a "noticeable" rise in serious buyers.
Tuesday
On Tuesday ICSC-Goldman Store Sales on a year over year basis were up 3.8% boosted by a robust back to school sales component. Also on Tuesday were Housing Starts where the Consensus Range was between 0.950 M to 1.025 M, with the consensus expected to be 0.963 M, and the Actual Number came in at a robust 1.093 M, up 15.7% for the month of July. The single-family component was up a respectable 8.3% for the month, and is slowly starting to grind higher, which is good because that is what a healthy market looks like for the housing market, slow but steady sustainable traction.

Thursday
On Thursday Jobless Claims came in at 298 K, and continue to trend lower, and at this point they basically are like the VIX at rock bottom levels, and one wonders if they can realistically get any better than this. We should see another strong Employment Report in a couple of weeks given the strength in the labor market despite all the ‘propaganda’ by various parties needing to promote an Agenda, and needing to downplay the dynamic gains in the labor market for 2014 to justify ‘behind the curve’ monetary policies!
We also had the PMI Manufacturing Index Flash which came inat 58 versus the prior reading of 56.3, which was led by the employment component, and showed strength in output and new orders with a 3-year high for export orders. The report also highlighted and increase in backlogs and delivery times which indicate stronger demand. 
The Philadelphia Fed Survey came in at 28 versus the prior reading coming in at 23.9, the Consensus Range between 17.0 to 21.0, and the consensus expected to come in at 20 for this report. So General business conditions are on the uptick in this country, despite this being the summer doldrums in financial markets with low volume levels!
On Thursday we also had Existing Home Sales with the consensus being 5.00 M, the consensus range being 4.90 M to 5.15 M, and the Actual Number coming in at the top of the range 5.15 M. The single-family component was up 2.7% for 4.55 million annualized, with the median price rising 0.4 percent in July to $222,900 (This being up 4.9% from a year ago) while the average price increased 0.2% to $268,700 (This being up 3.7% from a year ago). 
Note to Self: Inflation Higher than Reported Numbers
So for those who are on the fence regarding purchasing a home it seems prices are rising and will be up a substantial amount this time in 2015. Moreover, for those who believe that there isn`t any significantinflation in the economy (Insert Dovish Fed Members here) both rents and housing are rising above the core inflation reading on an annual basis. It is obvious that the inflation reports need to be reworked to reflect what the mainstream level of inflation is for categories that consumers have to buy and consume as the current configuration has categories that artificially drag down the overall inflation numbers and are highly discretionary in nature, and thus have no pricing power, and aren`t reflective of the actual inflation trends in the economy!
We closed out the weekly data with Leading Indicators which were up 0.9 %, with the consensus being 0.6 %, showing strength in manufacturing, employment, credit and the ISM`s new orders index. This really capped out an impressive week of economic data, and shows the overall economy is on the right track.
Maybe Jeffrey Gundlach ought to Cover that Housing Short?
For the Doom and Gloom crowd with an agenda like Jeffrey Gundlach it looks like the Housing market is starting to get its second wind after the inevitable pullback from the first wage of investment capital led by the likes of the Blackstone Group. I expect Housing to continue to slowly grind higher into year-end as the economy continues to gain steam, and retail investors start moving into the market with an improving job market and more confidence in their situation, especially since rents are rising to such an extent that it is actually cheaper to own homes in many of the top housing markets. 
Another factor is that consumers will start realizing that cheap money is going away as interest rates go higher from here as the Fed starts raising rates. And they better stop procrastinating, and get off the fence regarding making a decision – we see this trend a lot in markets with regard to future expectations of price and interest rates motivating consumer behavior! 
Moreover, I expect the Housing market to be much stronger in 2015, and probably a market leader for many of these beaten down stocks in 2015 with a better than expected Housing Market. This means there might be some underlying value in this sector relative to the broader market being that so many investors like Jeffrey Gundlach were extremely bearish on the prospects for the industry.
Economy Picking up Steam, will Inflation Spoil the Party?
All things considered the US economy is really moving up nicely from that dismal first quarter of brutal weather, and overhang of inventories from a strong closeout to 2013. Expect some robust Employment numbers, respectable GDP prints, an Improving Housing Market, and we might even get some help from Retail Sales for the second half of the year! But make no mistake; the United States has a diversified and vibrant economy and the envy of the entire world, as the recent Dollar strength indicates, the US Economy is in a bull market, now let`s hope we can keep inflation from spoiling the party!

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Negative Real Rates Show Yield Trade in Bubble Territory

August 26, 2014 by EconMatters   Comments (0)

By EconMatters  

No Financial Crisis
This is one of my main criticisms of central bank policy, especially the last three years when there was no financial crisis but all the central banks continued to keep interest rates at recession era levels which has incentivized inappropriate uses of capital allocation, and this money being used for yield arbitrage plays would be more beneficial to sustainable growth projects and overall growth in the economy if interest rates were normalized.

ECB Rates Too Low – Deflationary Capital Allocation Incentives

We see the pernicious aspects of below normal interest rates; the lower they go the more inappropriate and actually deflationary aspects in some cases of how investment capital is allocated. Take for example, the recent ECB measure to lower their equivalent Fed Funds Rate from 25 to 15 basis points, what did this incentivize? It incentivized a bunch of capital to run into European Bonds which were already at recent historical lows and chase more yield plays, so much so that the German short term debt up to two years has even gone negative on real rates.  
When you have investors flocking to investment choices all in an effort to take advantage of ridiculously low borrowing costs, really 15 basis points, more time and energy is spent on paper or in this case electronic arbitrage capital allocation strategies, that could better be spent in other areas of the European economy which actually promoted business development projects with real returns, and not more electronic arbitrage plays where all the capital stays locked up in financial markets and does no good for the economy at large, it creates no jobs in Europe!
Japan is Prime Example of the Curse of a Low-Rate Strategy
We see it in Japan, low rates for a prolonged period of time are deflationary in a sense because they encourage the wrong types of investment choices, strictly financial yield and carry trades instead of alternative and more productive capital allocation in terms of small business loans and business development projects.
Normalized Rated Get Rid of Many Non-Productive Capital Allocation Strategies
Normalized rates lead to real lending because the banks realize that they can no longer do these stupid yield arbitrage finance ‘gimmickry’ plays and must find real means of making money, i.e., make loans to businesses and produce real growth in the economy.

Read More >>> The Bond Market Explained for Mohamed El-Erian

Corporations Need Real Growth When Stock Buybacks are no Longer an Option
Furthermore, corporations also play a role in this because they no longer think gee I can borrow so cheaply let me borrow at these absurdly low rates and buy back stock, low rates for psychological reasons, and I mean rates at such abnormally low levels, actually affect the psychology regarding how capital is used by corporations. It shouldn`t make a difference but it sure does, a healthy interest rate almost mandates a healthy investment return and a productive use of capital by corporations. 
You sure don`t see corporations borrowing and loading up on debt to buy back stock when interest rates are higher! It is almost as if low rates incentive having little respect for the value of money, where with normalized rates respect for capital and the value of money is increased. I sure notice this correlation effect, when a corporation doesn`t think about buying back stock to make their EPS number look better, then they have to look for alternative ways to make their stock attractive to investors and make their numbers. This leads to more focus on growing the business, so then borrowing goes to organic growth and business development projects that add real economic might in the form of ‘additive effects’ to the economy. 
Central Banks can Promote the right kind of Capital Investments
This is how central banks can incentivize the right kinds of behavior by corporations and investors which add real sustainable growth to the economy by raising interest rates, and thereby raising the importance and value of capital. This leads to real capital allocation strategies instead of what we have today which negative real rates are illustrating via the incessant and over-reaching for yield in all areas at the expense of more productive uses of this same capital.
Zero-Bounding Rates is not the Answer for Real Growth
The ECB needs to learn the lessons of Japan that actually raising interest rates instead of lowering interest rates once you cross the 50 basis point threshold is actually simulative for growth by better incentivizing the right kind of capital investment in the region to more productive means. The proof is in the pudding: How long was the ECB rate at 25 basis points, how long under 100 basis points? And what was the growth in the EU over this time?
Basically nonexistent, once you cross and stay below the 50 basis point threshold, a central bank is actually doing more harm to their economy than good, maybe at first blush it seems paradoxical in nature, but if you examine some of the negative side effects of zero-bounding rates for an extended period of time it starts to make sense.
Once a certain interest rate threshold is reached, ‘zero-bounding’ rates for an extended period actually stunts economic growth and central banks need to come to grip with this monetary reality! Anytime there are negative or even close to negative real rates for bonds that is a sign that central banks need to change policy, they are in a sense reinforcing the very thing they are trying to avoid, they incentivize an over-reaching for yield at the cost of real growth, and this is deflationary, as it lowers the value of money. 

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The Bond Market is taking Advantage of Janet Yellen`s Dovishness

August 26, 2014 by EconMatters   Comments (0)

By EconMatters

Push the Limits
It has been a common theme in financial markets to push the limits on any possible edge, so if there are restrictions on banks and financial institutions use of leverage, lobby for change, or if activity falls under a certain governmental regulation, alter the activity so that it is classified under a different interpretation so that previous limits can be exceeded.

Talk Up the Dollar ‘Treasury Speak’

It is so common for Wall Street to front run any legislative, Federal Reserve or Treasury policy agenda that policymakers have in the past always been mindful to at least talk the market out of being so blatantly one-sided that they get way offside on the trade. Think for example about the many Treasury officials who talked up the dollar saying publicly that they want a strong dollar when the markets knew that in reality the Treasury was by practice weakening the currency, and wanted to devalue the currency. But by talking up the currency Treasury officials didn`t signal a white flag, and have everybody and their mother shorting the US Dollar, as when trades are that one-sided complications arise when everybody needs to get out on a short squeeze, plus a collapse of the dollar would be highly problematic, so they needed at least a modicum of restraint by markets.
Helicopter Ben Era versus Janet Yellen Dove among Doves Era
However, with Ben Bernanke he was known as ‘Helicopter Ben’ for his dovishness, that if things got bad in the economy, he would literally throw money out of Helicopters at the economy to keep it from sliding too far into recession territory and a downward spiral. I am paraphrasing with considerable leeway here, but you get the gist.
But even Bernanke would have balanced remarks, almost academic in nature to show that he played Devil`s advocate on the pluses and minuses of fed policy initiatives. However, Janet Yellen has taken dovishnessto an all-time high or low depending upon your perspective, there is no pretense of academic balance in her stance on monetary policy, and markets have not only picked up on this, but they are taking advantage of her dovishness to get way off sides on trades and financial markets.
Run the Fundamental Numbers
Let us just take the bond market, there are other markets that are bubbly, but let us look at the 10-year bond, as the level of irresponsible risk taking in this market is really unprecedented given the circumstances in the economy. Yes one can be irresponsible and take excessive risks in any market including those conservative bonds. We saw some of the froth come out of the high yield junk bond market last month, but treasury market speculation has been untouched, and is as one-sided as I have seen it given the fundamentals in the economy, and is really bizarre to say the least.
For example, the 10-Year Bond has a yield of 2.4%, the inflation rate is somewhere in the 2% range, and going higher as some of the lower print months drop out of the annual 12 month calculation set, so the trend for inflation is a right angle on the charts, 2% and rising. The economy has been growing around 2-2.5%, and each year is slightly stronger than the previous year. The Unemployment rate is near 6%, and the economy is producing more jobs on an annual basis than at any other time since 1997, plus the amount of available job openings are at a robust 4.7 million. The most since 2001 for those who want to employ the ‘labor slack’ argument to downgrade the robust job market of 2014. Sure the economy may not be perfect but when is it ever perfect, remember a couple of years ago when a 40k employment month was the norm?
The Numbers Just Don`t Make Sense
So on a forward basis let us just say the inflation rate is 2.1%, subtract this from the 10-year yield of 2.4%, and an investor in these bonds is getting paid 30 basis points or 0.3% to hold these bonds over a ten year borrowing time frame with budgets set to soar once the entitlements kick in during this ten year borrowing window for the government. Factor in borrowing costs of 15 to 25 basis points, let us say 15 for the sake of argument, and the investor is getting paid 15 basis points for taking this kind of risk over a ten year time frame with rates by everyone`s account set to rise sooner than later, maybe as soon as the first quarter of 2015 a la James Bullard.  
Excessive Size Leads to Excessive Losses on the Backend of the Trade
The only way this trade makes any sense is if a financial institution loads up such a massive size that the arbitrage carry makes sense on a ‘short-term’ basis, and they can push bond prices higher and realize price gains on these investments. And therein lies the insane risk to the financial stability of markets that the Federal Reserve through excessive dovishness is incentivizing with these ultra-dovish market expectations that enable excessive borrowing at extra-ordinarily low rates, and buy anything with a positive yield carry trade regardless of the long term risks involved. 
Have to Talk Up opposing side of Policy Agenda
This is why government officials from the Treasury on down have always talked up the other side of the trade that they are making to avoid extreme risk taking in financial markets, and what Janet Yellen has failed to master in her short stint as Chairperson. It is going to be her undoing as Chairperson, as basically Janet Yellen`s dovishness has been taken for granted to such a degree, that bond traders effectively think they can get away with murder, that is if excessive risk taking relative to the fundamentals of finance was a criminal offense. Janet Yellen is a dovish doormat for financial markets, and all one had to do is look at the fundamentals of financial markets to come to this conclusion, financial markets are taking advantage of her dovishness to take risks that just don`t make any rational, or fundamental sense from a risk reward perspective!
Bond Stampede
There is no way these bond investors are holding all these bonds for 10 years with a 15 basis point spread return, so Janet Yellen is setting the stage for the biggest stampede in the history of the bond market as the rate hike cycle begins, even the markets have the first rate coming at the halfway point of 2015 with a 50% certainty. 
Janet Yellen Needs to better Prepare Markets for Inevitable Rate Rises
The sheer size of the trade that she has encouraged, and the exodus from this non-fundamentally based trade, is going to severely, and negatively destabilize not only the bond market, but inflict major turmoil on many derivative asset classes as this massive stampede out of bonds begins. This moment is going to be unprecedented in the bond market, something that no one is prepared for, or taking any steps to hedge against, because where is the safe haven, gold – in a rising rate environment? Janet Yellen needs to start talking more hawkish just to lessen the severity and market destabilization of the stampede out of bonds to get some investors out before the stampede begins in full force. 
Bond Market Crash looks on the Horizon thanks to Federal Reserve Dovishness
At this pace the bond market could crash with a 2.4% yield and the Fed six months possibly from the first of many rate rises, she needs to better prepare financial markets for the inevitability of rate rises, as right now they are so unprepared like the village where the boy who cried wolf, when the wolf comes the village or in this case market participants are completely shocked and unprepared for the carnage that ensues. 
The stampede out of bonds is going to be unprecedented in nature because there is no fundamental reason in the economy to have a 25 basis point fed funds rate with a 6% unemployment rate, and a 2.4% yield on a 10-year bond. It is just bizarre once one does the math, it is the epitome of irresponsible risk taking by bond investors, and going to end very badly from the way interest rate expectations are being managed by the Federal Reserve. Get more Hawkish Janet Yellen, and start at Jackson Hole, as traders are already discounting this speech once again, in short they don`t respect you, and are taking advantage of your dovishness! 
The Federal Reserve cannot have their cake and eat it too on this one because on one hand they want to keep excessively dovish expectations regarding rate rises, but yet on the other hand expect markets not to have to ‘overreact’ when needing to re-price financial assets because now ‘interest rate expectations’ are behind the curve and need to catch up with the speed in which the Fed is forced to raise rates to have interest rate policy more in line with a 5.5% unemployment rate in 2015. 

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