LIQUIDITY TALK. THE YEAR OF THE TRADING RANGE
[Latest Global Dollar Liquidity measure: +14.1% annual growth rate; latest Endogenous Liquidity Index: -31.6%]

The trading range scenario; Bill Gross on quality spreads; liquidity @ Financial Times; the Bank of England eases!

[1] No way out of the trading range. Almost everywhere, central banks are adding liquidity — and not only for lame year-end reasons. Slowly but surely, inflation expectations are receding: the dollar is a tad stronger; oil and gold prices have eased somewhat; ten-year inflation breakevens are back at the very reasonable level of 230 bps. The VIX is running out of gas. According to Jim Cramer, the price discovery mechanism is working again inside the financial world. That's the good news. Now for the bad news — rising quality spreads. At 254 bps, the Moody's Baa spread trades at four-year highs: this is a warning sign in terms of the outlook for corporate earnings. I still think that, on valuation grounds, a 1525 target is on the cards for the S&P500. But if spreads do not improve, look for the trading range scenario to assert its rights again.

[2] Bill Gross on spreads & the Fed. It took longer than usual, but Bill Gross' December investment outlook is out. Mr. Gross dwells on the overlooked situation in terms of quality spreads: "Fed ease has lowered Treasury yields, but for the rest of the market—the segment that influences the bottom line of U.S. corporations, homeowners, and consumers—not much has changed. Those that claim that the current cycle of Fed ease will inevitably—and shortly—lead to vigorous economic growth do not really have their ears to the ground or their eyes on their Bloomberg screens. The Fed needs to bring Fed Funds levels down steadily and significantly more in order to counteract the contraction of the shadow banking system which has imposed, and will continue to require, higher risk premiums for non-Treasury securities in an increasingly risky financial environment". The PIMCO manager is looking for a 3.00%/3.50% target for the Fed funds rate. [Bill Gross: "The Shadow Knows", PIMCO Investment Outlook]

[3] More stagflation talk [Liquidity @ Financial Times]. This time from Barclays Capital's Tim Bond: "The outlook for financial markets in 2008 is not encouraging ... The US economy is heading the way, having already entered a stagflationary phase". Really? Our own market-based "Goldilocks-Stagflation" indicator is trading at levels not seen since October. While the platinum-gold ratio continues to recover, ten-year inflation breakevens have not been this low in a month-and-a-half. The stagflation hypothesis merits serious consideration: that's the reason why I follow a such an array of exotic indicators. But its proponents need to do a better job at explaining why long-term Treasury paper yields less than 4%, even as inflation is (supposedly) about to take off. [Tim Bond: "Financial assets owners need to get their heads out of the sand", Financial Times]

[4] The Bank of England eases! From the communiqué: "The Bank of England’s Monetary Policy Committee today voted to reduce the official Bank Rate paid on commercial bank reserves by 0.25 percentage points to 5.5% ... conditions in financial markets have deteriorated and a tightening in the supply of credit to households and businesses is in train, posing downside risks to the outlook for both output and inflation further ahead". [Bank of England: "Bank of England Reduces Bank Rate by 0.25 Percentage Points to 5.5%"]