MacroScope

Is Fed’s Twist working? Depends what market you ask

The first day of the Federal Reserve’s Operation Twist was a glowing success. And an abject failure. It all depends on where you look.

On the one hand, long-dated Treasury bonds rallied sharply, pushing yields lower just as the policy intended. Rates on the 10-year Treasury eased to 1.76 percent on Monday from 1.92 percent on Friday, having dipped to a 60-year low last month.

The problem is, the gains in Treasuries were due in part to steep losses in the stock market related to ongoing worries about euro zone debt — not part of the Fed’s plan. Indeed, the central bank’s policy of asset purchases or quantitative easing is supposed to work by pushing down rates of return on safe-haven assets so that investors will buy riskier securities like equities and stimulate lending and investment. 

For now at least, it looks like Europe’s debt contortions might continue to outweigh any positive effects on the economic growth outlook from Operation Twist.

Germany in catch-22 as debt insurance costs hit record

So much for Germany being insulated from the euro zone’s troubled periphery. German credit default swaps are already beginning to price in the country’s worst nightmare: that it will have to pay a hefty bill for a deepening euro zone debt crisis.

The cost of insuring 5-year German debt against default rose more than 50 percent over the past month to a record high of 118 basis points.  French CDS rose  around 11 percent over the same period to 189 basis points, according to Markit data. The rise indicates investors are beginning to associate greater risk to holding German debt, even as the triple-A rated bond continues to benefit from safe-haven flows. German Bund futures saw their biggest quarterly rise between July and September since the launch of the euro.

The problem is Germany, the largest sovereign contributor to bailout funds already agreed for Greece, Portugal and Ireland, is expected to pay a high price for any solution to the debt crisis or, given its banks’ high exposure to peripheral debt, for any failure to resolve it.

It could suffer if Greece eventually defaults, as many in markets expect, and if contagion spreads to other peripheral economies. German banks are the second most exposed to Greek and Italian debt and are the biggest holders of Spanish bonds with $177.9 billion in their books, according to data from BIS as at the end of March. Jennifer McKeown, senior European economist at Capital Economics, explains the dilemma:

Developments seem to be edging towards Germany taking on more and more risk relating to peripheral economies. And of course even if there aren’t further bailouts for those economies, Germany’s banks are exposed to the peripheral countries, so they are at risk anyway.

German CDS may also be reflecting hedging of long positions in the cash Bund market, said John Davies, fixed-income strategist at WestLB.

The extent of the burden on Germany will depend on how exactly euro zone policymakers decide to go about solving the crisis. Euro zone ministers were meeting to discuss increasing the power of the 440-billion-euro bailout fund via leveraging but without increasing guarantees that back its borrowing.

from The Great Debate:

A free lunch for America

By J. Bradford DeLong The opinions expressed are his own.

Former US Treasury Secretary Lawrence Summers had a good line at the International Monetary Fund meetings this year: governments, he said, are trying to treat a broken ankle when the patient is facing organ failure. Summers was criticizing Europe’s focus on the second-order issue of Greece while far graver imbalances – between the EU’s north and south, and between reckless banks’ creditors and governments that failed to regulate properly – worsen with each passing day.

But, on the other side of the Atlantic, Americans have no reason to feel smug. Summers could have used the same metaphor to criticize the United States, where the continued focus on the long-run funding dilemmas of social insurance is sucking all of the oxygen out of efforts to deal with America’s macroeconomic and unemployment crisis.

The US government can currently borrow for 30 years at a real (inflation-adjusted) interest rate of 1% per year. Suppose that the US government were to borrow an extra $500 billion over the next two years and spend it on infrastructure – even unproductively, on projects for which the social rate of return is a measly 25% per year. Suppose that – as seems to be the case – the simple Keynesian government-expenditure multiplier on this spending is only two.

In that case, the $500 billion of extra federal infrastructure spending over the next two years would produce $1 trillion of extra output of goods and services, generate approximately seven million person-years of extra employment, and push down the unemployment rate by two percentage points in each of those years. And, with tighter labor-force attachment on the part of those who have jobs, the unemployment rate thereafter would likely be about 0.1 percentage points lower in the indefinite future.

The impressive gains don’t stop there. Better infrastructure would mean an extra $20 billion a year of income and social welfare. A lower unemployment rate into the future would mean another $20 billion a year in higher production. And half of the extra $1 trillion of goods and services would show up as consumption goods and services for American households.

In sum, on the benefits side of the equation: more jobs now, $500 billion of additional consumption of goods and services over the next two years, and then a $40 billion a year flow of higher incomes and production each year thereafter. So, what are the likely costs of an extra $500 billion in infrastructure spending over the next two years?

from Global Investing:

We’re all in the same boat

The withering complexity of a four-year-old global financial crisis -- in the euro zone, United States or increasingly in China and across the faster-growing developing world -- is now stretching the minds and patience of even the most clued-in experts and commentators. Unsurprisingly, the average householder is perplexed, increasingly anxious and keen on a simpler narrative they can rally around or rail against. It's fast becoming a fertile environment for half-baked conspiracy theories, apocalypse preaching and no little political opportunism. And, as ever, a tempting electoral ploy is to convince the public there's some magic national solution to problems way beyond borders.

For a populace fearful of seemingly inextricable connections to a wider world they can't control, it's not difficult to see the lure of petty nationalism, protectionism and isolationism. Just witness national debates on the crisis in Britain, Germany, Greece or Ireland and they are all starting to tilt toward some idea that everyone may be better off on their own -- outside a flawed single currency in the case of Germany, Greece and Ireland and even outside the European Union in the case of some lobby groups in Britain. But it's not just a debate about a European future, the U.S.  Senate next week plans to vote on legisation to crack down on Chinese trade due to currency pegging despite the interdependency of the two economies.  And there's no shortage of voices saying China should somehow stand aloof from the Western financial crisis, even though its spectacular economic ascent over the past decade was gained largely on the back of U.S. and European demand.

Despite all the nationalist rumbling, the crisis illustrates one thing pretty clearly - the world is massively integrated and interdependent in a way never seen before in history. And globalised trade and finance drove much of that over the past 20 years. However desireable you may think it is in the long run, unwinding that now could well be catastrophic. A financial crisis in one small part of the globe will now quickly affect another through a blizzard of systematic banking and cross-border trade links systemic links.

Just take the euro zone for a start. HSBC economists on Friday said the costs of a euro zone breakup would be "a disaster, threatening another Great Depression" and far outweighed the costs of repairing the flawed fiscal backstops to the monetary union -- especially given the wealthier creditor countries within the union tend to ignore the benefits they've reaped from the euro over the past 12 years. Aided by the "entangling effects" of the euro, it showing that cross-border holdings of capital have exploded from about 20% of world GDP in 1980 to stand at more than 100% now (global GDP was estimated by the IMF to be about $62 trillion last year). By contrast, the first wave of globalisation in the late 19th and early 20th century saw cross-border holdings peak at 20% of world GDP before WW1 reversed everything.

"A euro break-up would be a disaster, threatening another Great Depression," wrote HSBC chief economist Stephen King and economist Janet Henry. " Cross-border holdings of assets and liabilities within the eurozone have risen dramatically, leading to a tangled web of mutual financial dependency. With the re-introduction of national currencies, disentanglement would proceed at a rate of knots, undermining financial systems, generating massive currency moves, threatening hyper-inflation in the periphery and triggering economic collapse in the core."

That tangled web of trade and finance, however, goes well beyond the euro zone. One of the reasons the fast-growing emerging markets look, for the second time in four years, set to succumb to the western financial crisis is that western banks -- European banks in particular -- provide them with so much finance. RBC economists, citing data from the Bank for International Settlements, shows outstanding European bank lending to emerging markets at some $3.4 trillion -- almost 10 times that of the U.S. banks and more than three times Japanese bank lending.

JP Morgan, meantime,  reckons a one percentage point decline in western real domestic spending growth (GDP less net exports) leads to a 2.7 percentage point drop in exports from emerging economies as a whole. If their forecast for a recession in the euro zone and US slowdown to 1 percent annualised growth by the middle of 2012 proves correct, then that should slow EM export growth to 6% annualized in 4Q11 and just 4% annualized in 1H12 from double digit growth rates earlier this year. While that would still be far better than 2008/2009 emerging export collapse of about 20%, the projected pace of export growth would still be weaker than at any point in the expansion of the 2000's save during the SARS scare.

Bernanke and bank rules: lessons sort of learned

Fed Chairman Ben Bernanke on Wednesday gave a speech on the lessons about sustained growth that can be gleaned from the experience of emerging markets. Bernanke said not all of the “Washington consensus” policies pushed by multilateral lenders in the 1990s had proven fruitful. In particular, he said the Asian financial crisis showed the risks of opening up financial markets to foreign capital flows until a country has implemented measures to strengthen banks and regulation.

Yet Bernanke missed an opportunity to link his speech back to the recent experience of the United States. For while his message was tailored for the developing world, he may as well have been describing the U.S. banking sector in the run-up to the 2008-2009 financial crisis:

Dismantling controls on the domestic financial industry has proven counterproductive when important complementary factors — such as effective bank supervision … were absent.

 

Fisher sees folly in Fed’s “full frontal”

Dallas Federal Reserve President Richard Fisher is not one to pull his punches. He was one of three dissenters on the Fed’s most recent move to ease policy, and has argued the move will not only be ineffective but also potentially harmful to jobs. Speaking with reporters after his refreshingly frank defense of his dissent this week, Fisher – an architect of the Fed’s new communications policy aimed at more transparency – suggested there are times when he would prefer to be a bit more demure.

Asked if the Federal Open Market Committee’s gloomy economic outlook in its post-meeting statement last week matched his own, he said: “I think the FOMC does its job to honestly state how it views things. We are in an age of enhanced transparency.”

But that’s not always a good thing, he suggested, especially when the market is not used to getting an unvarnished view. Warning that he was about to make a “bad joke” – and then proceeding with it – Fisher said:

We are an almost 100 year old institution … I don’t think that anything that’s 100 years old should give a full frontal view. We do reveal most fully what we discuss, and the markets are going to have to get used to that. It may not be a pretty view, but its a full frontal view.

from The Great Debate:

Europe’s high-risk gamble

By Martin Feldstein The opinions expressed are his own.

The Greek government needs to escape from an otherwise impossible situation. It has an unmanageable level of government debt (150% of GDP, rising this year by ten percentage points), a collapsing economy (with GDP down by more than 7% this year, pushing the unemployment rate up to 16%), a chronic balance-of-payments deficit (now at 8% of GDP), and insolvent banks that are rapidly losing deposits.

The only way out is for Greece to default on its sovereign debt. When it does, it must write down the principal value of that debt by at least 50%. The current plan to reduce the present value of privately held bonds by 20% is just a first small step toward this outcome.

If Greece leaves the euro after it defaults, it can devalue its new currency, thereby stimulating demand and shifting eventually to a trade surplus. Such a strategy of “default and devalue” has been standard fare for countries in other parts of the world when they were faced with unmanageably large government debt and a chronic current-account deficit. It hasn’t happened in Greece only because Greece is trapped in the single currency.

The markets are fully aware that Greece, being insolvent, will eventually default. That’s why the interest rate on Greek three-year government debt recently soared past 100% and the yield on ten-year bonds is 22%, implying that a €100 principal payable in ten years is worth less than €14 today.

Why, then, are political leaders in France and Germany trying so hard to prevent – or, more accurately, to postpone – the inevitable? There are two reasons.

from Jeremy Gaunt:

#ThingsStrongerThanTheKenyaShilling

Twitter does have some very strange Trends. These are the things that appear on the right-hand side of the page that show what people are talking about. They more they talk, the more likely it is that something will get listed.  More often than not they are about celebrities such as Justin Bieber.

But today's Worldwide  Trends was particularly unusual.

#ThingsStrongerThanTheKenyaShilling was right up there near the top.

As the graph here shows, the shilling has taken a heavy beating since the Lehman Brother collapse. This is one reason for the Twitter outburst.  "Kenyans are getting fed up," said @oreo_junkie, whose Twitter feed states it is from Nairobi.

And judging by some of the other "answers" to the trendline, it is not a matter for levity in Kenya. "Government's resolve to fight Corruption" was one;  "Stupidity of Kenyans to  reelect the same MPs" was another.

But other Tweeters are taking advantage of the trend to broaden the answers out.  Chances  that "Jerry Springer weds Oprah Winfrey" is apparently stronger than the shilling, as is   "Arsenal's chances of winning the League, Champions League and the FA Cup".

Inflation is so last quarter

Sure, many U.S. inflation indicators have been moving higher in recent months. But that’s because most of them are really a look into the rearview mirror, argue economists at JP Morgan. In a note entitled “The rise in U.S. inflation is yesterday’s headache,” they say the same pattern was observed in early 2008, just before a deepening financial crisis dragged prices lower across the world economy:

At first glance the rise in inflation looks anomalous against the backdrop of persistently disappointing U.S. and global growth and hints at an intractable stagflation problem. But it is very likely that the rise in both inflation and core inflation will prove temporary and soon recede. In this regard,the inflation performance in early 2008 provides a useful model. Then, as now, inflation rose while the economy was weakening. And then, as now, the rise in inflation mainly reflected the upward pressure on goods prices from much higher commodity prices and a weakening dollar.

That means the Fed, which has just announced a fresh effort to push down long-term borrowing costs, may have room to ease monetary policy further if it feels the need.

Carstens says Mexican peso undervalued

Mexico Central Bank Governor Agustin Carstens spoke to Reuters Insider on the sidelines of this year’s IMF/G20 meetings. He said the peso, which like many other emerging market currencies has taken a drubbing with the dollar’s recent rally, is undervalued. But unlike in Brazil, where an even more volatile exchange rate has prompted the monetary authorities to step in, Carstens said Mexico does not see the need to intervene.

As long as the markets continue to work well, I think central bank intervention is not required. If we guide ourselves by fundamentals the peso should appreciate soon.

Asked about the path of monetary policy for Mexico, Carstens said he backs a “neutral” stance for now given all the uncertainty in the global economy. Until recently, analysts were betting the central bank would lower borrowing costs to offset the drag from a global economic slowdown. But the peso’s steep depreciation, with its potentially inflationary implications, has muddled the outlook for Mexican interest rates, currently at 4.5 percent. Mexico is struggling to recover from a deep recession in 2009, with growth seen below 4 percent this year, and is particularly vulnerable to lower U.S. demand.