The Graph attached demonstrates the Implied Volatility over 5 years, comparing the Volatilities on XJO, Commonwealth Bank, and BHP. Overlaid is the price chart for XJO.

The chart clearly demonstrates that Volatility peaked with the bottom of the market in the period of September 2008 to March 2009. Volatility is on a clear downhill run co-inciding again with the bull run from 3300 on the XJO to the current 4800.

Strategies such as selling calls over stock is proving a less lucrative cashflow available from the higher volatilities of not long ago. Although there are still clear distress signs in the World economy, the Government actions of supporting the economy by pumping large amounts of liquidity into the system has achieved their desired result of convincing investors that problems may be contained. The optimistic scenario of pushing problems down the road seems to be playing out, in the hope that Balance Sheets can be repaired. An outlier event (a black swan) is probably the only thing that will change people's mind.

Michael Cornips

Statement by Glenn Stevens, Governor: Monetary Policy Decision

At its meeting today, the Board decided to raise the cash rate by 25 basis points to 4.0 per cent, effective 3 March 2010.

The global economy is growing, and world GDP is expected to rise at close to trend pace in 2010 and 2011. The expansion is still hesitant in the major countries, due to the continuing legacy of the financial crisis, resulting in ongoing excess capacity. In Asia, where financial sectors are not impaired, growth has continued to be quite strong. The authorities in some countries are now seeking to reduce the degree of stimulus to their economies.

Global financial markets are functioning much better than they were a year ago and the extraordinary support from governments and central banks is gradually being wound back. Credit conditions remain difficult in some major countries as banks continue to face loan losses associated with the period of economic weakness. Concerns regarding some sovereigns remain elevated.

In Australia, economic conditions in 2009 were stronger than expected, after a mild downturn a year ago. The rate of unemployment appears to have peaked at a much lower level than earlier expected. Labour market data and a range of business surveys suggest growth in the economy may have already been at or close to trend for a few months. There are some signs that the process of business sector de-leveraging is moderating, with the pace of decline in business credit lessening and indications that lenders are starting to become more willing to lend to some borrowers. Investment in the resources sector is very strong. Credit for housing has been expanding at a solid pace, and dwelling prices have risen significantly over the past year. New loan approvals for housing have moderated a little over recent months, however, as interest rates have risen and the impact of large grants to first-home buyers has tailed off.

Inflation has, as expected, declined in underlying terms from its peak in 2008, helped by the fall in commodity prices at the end of 2008, a noticeable slowing in private-sector labour costs during 2009, the rise in the exchange rate and the earlier period of slower growth in demand. CPI inflation has risen somewhat recently as temporary factors that had been holding it to unusually low rates are now abating. Inflation is expected to be consistent with the target in 2010.

With the risk of serious economic contraction in Australia having passed, the Board moved late last year to lessen the degree of monetary stimulus that had been put in place when the outlook appeared to be much weaker. Lenders generally raised rates a little more than the cash rate and most loan rates rose by close to a percentage point.

Interest rates to most borrowers nonetheless remain lower than average. The Board judges that with growth likely to be close to trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. Today’s decision is a further step in that process.

The US dollar index has gone from 74.50 in December to close last night at 80.80. CNBC (tout TV as the bloggers like to call them) would have you believe that it is a vote of confidence for the US economy and all is well. It is probably more the case that the US is currently the least bad choice that investors could currently make. That and the fact that the US is the most liquid market in the World. When you want to get out you certainly don't want to be looking for a bid on 10 year Greek Government bonds. Or whether that credit insurance counterparty you bought from to protect yourself from Government debt default can now actually pay you, since, after all, a Government has just defaulted.

Hence the tendency for Governments to keep kicking the can down the road. Why would you dismantle the Euro just because a country of 8m people fudged their debt levels to get into the best club in town. It is actually good news for Export countries like Germany, because the Euro continues to fall, with imports getting more expensive. More revenue, some import inflation, great for repairing balance sheets and pushing up asset prices. After Greece, the next concern might be the UK. They will continue Qantitative easing by buying their own bonds and printing more money. Crisis diverted. Interestingly the Australian dollar currently equals .6 pounds - it used to be .33 pounds, showing just how much the currency is weakening. At least the UK has their own currency which they can devalue to make economic adjustments, which members of the Euro cannot do.

Japan's Government debt is 200% of GDP. The good news is that a good proportion of the debt is owned by the Japanese public. As money can't escape the fiat money system, the public should continue to fund Government expenditure.

The US currently has no problem in funding their massive deficits at near zero interest rates. Additionally they have their own currency as well, enabling them to make inilateral adjustments without referring it to a committee of agenda challenged member countries. The US has just announced that they will extend for another year the ability of borrowers to refinance their homes, even if the loan is 25% above the value of the house. Also, the US has announced the extension of another $81 billion to people whose already extended unemployment benefits have expired. A quick look at February's individual tax collections show that $136billion was collected, but there were $109 billion in refunds. Net Corporate tax collected for February was about $3.4 billion. Not much relative to $3,600 billion in planned expenditure for the year. Admitably, April is their big collection month, but the revenue trend is definitely down.

Australia is benefiting from the strength of the Asian region, but because of that, we are an outlet for inflationary pressure, and an ability to lift interest rates. The housing sector is booming, but the recent RBA monetary aggregate announcement on the 26th February shows that business credit lending declined 7% year over year in January.

The best case scenario for the World is to continue kicking the can down the road, with hopefully the corporate and private markets able to repair their balance sheets.

The Euro as a currency could only work if the member states agreed to work within pre-determined fiscal contraints. Normally balance of payment deficits/surpluses and high levels of Sovereign debt could be managed with adjustments to the exchange rates, changes to interest rates and cut backs in budget deficits. With the Euro though it is like locking in your exchange rate with member countries, and that exchange rate never moves. So you now have northern European countries (Germany, Netherlands) being the model of fiscal restraint. Germany has legislated balanced budgets, so that debt does not get out of hand. Meanwhile, their Southern European Euro-cousins (PIIGS, Portugal, Italy, Ireland, Greece and Spain), have levered off the strength of other members to run up large debts relative to their respective GDP's. As it turns out, Greece, who was admitted to the Euro in 2002, used derivatives  to artificially lower the level of debt, to enable access to the Euro. As easy debt flooded their economies, a housing boom was created.

So whether Germany bails out Greece is one issue, but can the fiscally distressed countries even remotely pull back their deficits and pay back debts without a complete riot from the population. Witness the current strikes in Greece.

So as the World mulls all these possibilities, the Euro has fallen in value against the US Dollar. This is good for the Europeans, since exports become more competitive and imports are more expensive, bringing a welcome dose of inflation. Inflation is good for Governments, since they need asset prices to go up, hopefully to outweigh the massive debt.

What is good for the Euro is bad for the US dollar. The US would have to prefer a lower dollar for the same reason. The US dollar index fell from a high of 88 to the mid-70's, matching a huge stockmarket bull run last year. So with the world more worried about the Euro, there is little chance that the US will lift interest rates causing the dollar to rise even further. Lifting interest rates is the weapon of choice in fighting inflation. Again, World Governments need inflation to make the debt more respectable. As mentioned last week, Japan has been fighting deflation for 20 years despite huge amounts of stimulus.

The US are unlikely to lift interest rates, which is why they were at pains to emphasis that last weeks interest rate lift only applied to emergency bank funding. Obama just might cut the stimulus to the economy, but a quick correction in the sharemarket (a la Japan over 20 years) will get their hand back to the pump.

On April 15th 2010, I will commence a walk from Australia’s Parliament House to Mount Kosciousko. Below I explain how this event came about. Though it has been triggered by me losing one part of a two-part bet on house prices, its genesis goes back much further–to when I, along with a handful of other non-orthodox economists, predicted that a serious financial crisis was just around the corner.

http://www.keenwalk.com.au/

The markets are obviously concerned about the escalating Sovereign Debt around the world as Governments are pump priming their economies to prevent a severe recession.

Is the news all bad, and will the doomsdayers eventually be right in waiting for the US to default on their debt? There is no doubt that the current flashpoints of Dubai and Greece are good causes for concern. Dubai creditors have been offered .60c in the dollar over several years. Greece has exceeded its debt limits set by the Euro Zone, and unless they can commit to a budget that lowers their debt relative to Gross Domestic Product, then the disruptions will certainly cause some market correction.

The economic framework that Bernanke and the US Federal Reserve is working under can be described as Keynsian economic theory. Private debt (70% of GDP) in the US is contracting, with the Keynsian remedy being that the Government should run a fiscal deficit to fill in the demand gap created by the contracting private sector. The deficit spending certainly has saved the world from a severe depression, which we all should be thankful for, despite the perception that Wall Street got a better deal than the man in the street. Keynsian theory also suggests that the Government should wind down its deficit spending allowing the private sector to expand. Also, interest rates should be lifted to counteract inflationary pressures.

These points are what the market is fearful of - cutbacks in stimulus spending, high debt, and rising interest rates. Economic historians point out that as the Keynsian framework was followed in the 1930's, every time the Government tried to wind back spending or lift interest rates, the economy fell back into recession.

Richard Koo, an economist working for Nomura in Japan since 1984, points out that the same thing happened to Japan in their 20 year recession from 1990 until present. Japan has been running massive deficits for 20 years, interest rates are zero, and again, every time the Government tried to reduce the deficit, the country fell further into recession. Richard Koo's point is that the Government should not be afraid of deficit spending over a long period of time, obviously against current consensus opinion. Even though the Private Sector contracted over this 20 year period, with land prices falling over 80%, consistent Government deficit spending has maintained Japanese Gross Domestic Product.

The key point Richard Koo makes in relation to Government debt is that with the deleveraging of the private sector, the savings ratio has dramatically esculated. These savings are put on deposit with the Domestic banks, which then in turn are available for the banks to invest in Government securities. In the US currently, domestic banks have $1.2 Trillion on deposit with the Federal Reserve. It is not that the banks do not want to lend, it is that the public does not want to borrow (Economist - Steven Keen's point). If Governments can borrow from the domestic savings pool to fund the deficit, then this may be the a point of equilibrium that will allow a repeat of the 20 year Japanese experience. The US strategy would then entail extending (and maybe pretending) to indefinitely roll problematic loans until the system sufficiently repairs its balance sheet to eventually to begin to expand.

The ending of the stimulus program and the lifting of interest rates is not what the US or Euro Governments wants to contemplate in the current enviroment. The Chinese Government, which is fortunate not to have an opposition party, is fairly much a closed economy. 70% of Australian exports to China remain in China. China should be able to withstand a contraction in World demand. China certainly will not allow its economy to go into recession, despite lifting bank reserves to slow down speculative demand.

A return to "the good old days" is gone. A Japanese like scenario over a long period is a likely outcome. Certainly there will be scares like Greece, Dubai, Ireland etc, but with Governments committed fiscal deficits to maintain consumption, Investors will certainly be able to position their portfolios to take advantage. Our minds will be changed should the US Government lift interest rates and contract their spending without real commensurate growth in the private sector.

First it was the PIGS (Portugal, Italy, Greece and Spain) whose credit default insurance rates were dramatically increasing. Now the market is focusing on the STUPID index as the barometer of potential market disruption. (Spain, Turkey, UK, Portugal, Italy and Dubai).

The chart indicates the escalating credit cost of these countries, as European markets shed a further 1.5% plus overnight Friday. The Spanish and Greek markets have fallen 20% since early January.

Source: Zerohedge

Michael Cornips

Heightened Sovereign credit risk, due to the possibility of a Greece debt default, has caused a selloff in World markets overnight. The cost of Government credit insurance has jumped marketably.

A perspective that Australia's credit risk has not been impacted is important in the current market. Althought the S&P 200 is also being sold off, any normalization of credit markets will see a resurgence in our market. Remember the Dubai credit default fears, and the subsequent rally. If the US Banks are "too big to fail", you would expect the Euro countries to provide assistance to Greece to head off any contagion to the World Markets.

Michael Cornips

From the Wall Street Journal:

Federal Reserve Chairman Ben Bernanke’s confirmation has become less clear in recent days as more Democratic senators have come out in opposition to his reappointment.

The Wall Street Journal and Dow Jones have compiled a tally of senators who have declared their intentions for the confirmation vote based on interviews with the senators or their offices. Amid the threat of a filibuster, Bernanke needs the support of 60 senators for his nomination to succeed.

Check the Tally.

Click to enlarge source: www.dol.gov/

The US unemployment picture is getting substantially worse. The numbers of workers on the standard unemployment benefits is 5,716,000 people. In July 2008, the Federal US Government introduced extended unemployment benefits to assist the economy with the number of jobs being lost. The number now on extended benefits jumped another stunning 540,000 to 6,016,000 people, bringing the total paid unemployed to 11,670,000. The chart tells the story.

50,500,000 people lodged an unemployment initial claim over the past 12 months. This is 38% of the workforce. In 2008 the US paid $50 Billion in unemployment benefits. In 2009 it was $139 Billion. The increase from November to December 2009 payments alone was from $11.8 Billion to $15.2 Billion. The Government pretty much funded the Christmas retail sales increase.

President Obama has pretty much got the message in the Massachusetts' election that the middle class feel like they are getting scr*wed. Watch the change in rhetoric.