Monthly Archives: September 2012

The looming fiscal cliff in the US has now replaced the actions of the Fed and the ECB as the major macro talking point in the financial markets. Although most investors expect that the American political system will find a way out of the large fiscal tightening which is currently scheduled to take place in 2013, there is a great deal of uncertainty about how and when this will be accomplished. In the meantime, concerns about the fiscal cliff have now clearly started to damage capital goods orders in the business sector, which last week dropped in a manner which is normally seen only in recessions.

The US economy remains fragile, and a large downward shock to capital spending, which now seems inevitable in the final quarter of the year, is certainly not what the doctor ordered. It may well lead to a further slowdown in GDP growth in Q4, from the already anaemic 1.8-2.0 per cent rate which seems likely for Q3. However, unless policy makers in Washington prove unable to break free of political gridlock after the elections on 6 November, it still seems improbable that the economy will slide into recession early next year. Read more

It is often claimed by economists that the central banks have run out ammunition to boost economic activity, but they certainly have not lost the ability to have an impact asset prices. Since the latest round of quantitative easing was signalled back in June (see this blog), global equity prices have risen by 14.5 per cent, and commodity prices are up by 15.4 per cent, despite the fact that economic activity data have shown no improvement whatever over this period.

Clearly, these impressive moves in asset prices have been triggered by a sharp decline in the disaster premia that were priced into markets only three months ago. Mario Draghi and Ben Bernanke have, in a sense, purchased global put options on risk assets, and have offered them without charge to the investing community.

By doing the market’s hedging for it, the central bankers have certainly had an impact. Confidence, while not fully restored, is much improved, which is exactly what was intended. But there is no sign yet from hard data that the downward slide in global GDP growth has been reversed. Until that happens, the market rally will remain on insecure foundations. Read more

Today I would like to introduce a list of the blogs that investors can follow if they are interested in tracking the key debates on global macro in the financial markets. These are some of the blogs which shape the debates at morning meetings and investment committees throughout the financial system. To prepare for these meetings (and much else besides), follow these blogs.

I admit that I have only belatedly realised just how much essential economic information and discussion is freely available in the blogosphere. The internet has given everyone the chance to become a journalist, and many macro economists have taken full advantage. Read more

The Fed’s actions last Thursday have been widely seen as a fundamental shift in its monetary policy, and its communications with the public. The tone of the FOMC’s statement, and of the Chairman’s subsequent press conference, clearly gave much less weight to the control of inflation than usual, and much more weight to the need to achieve a substantial reduction in unemployment. Certainly, the latest round of quantitative easing is the first to have occurred with little or no threat of deflation in the offing, and markets have responded by raising inflation expectations significantly.

It is hard to argue with the markets on this. In fact, it is even possible that the Fed leadership is becoming comfortable with the notion that inflation might exceed its 2 per cent long term target for a while. If so, this would be a very significant step, representing the first such move by any of the major central banks since the 1990s.

Until now, the standard mantra among the major central banks has emphasised an inflation target of around 2 per cent, and policy has usually been set with that primary objective in mind. Unemployment, meanwhile, has been left to adjust automatically towards its “structural” rate over a horizon of several years. Mr Bernanke indicated last week that he is no longer satisfied with this approach. Read more

Ben Bernanke has boldly gone where no Fed chairman has gone before him with his third round of quantitative easing. Gavyn Davies discusses with the FT’s Long View columnist John Authers why Mr Bernanke has chosen this path – and its risks:

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Today’s decision from the German Constitutional Court in Karlsruhe is a major victory for Angela Merkel and for Germany’s preferred approach to handling the eurozone crisis. The court has approved the ratification of the ESM treaty, with only minor conditions attached.

It looks like a comprehensive defeat for those trying to mobilise political opinion inside Germany to block the treaty. As a result, the ESM and the fiscal compact can now be safely launched, and any immediate obstacle to Mario Draghi’s bond buying plan at the ECB has disappeared. What has emerged from this messy process is, in effect, an ESM leveraged by the ECB, something which seemed impossible this spring.

This represents a very large building block in the rescue strategy which the eurozone has gradually pieced together in the last three months.

The acute phase of the crisis peaked in mid June with the Greek election, which reduced the probability of a disorderly Greek exit.

Then, the eurozone summit in late June announced a roadmap for the long term reform of the eurozone. Mr Draghi was a co-author of the plan, and in retrospect it was a very important step, not least because he deemed it to be so.

These steps did not immediately settle the markets, and at times during July it seemed that the capital outflow from Spain would reach unmanageable proportions. However, at that point, Mr Draghi crucially said that the ECB considered it to be within its mandate to eliminate “convertibility risks” in the eurozone,  and that statement basically turned the crisis around. Since then, for example, Spanish equities have risen by 30 per cent. Read more

A month ago, Mario Draghi moved the goalposts by saying that it was within the ECB’s mandate to intervene in markets to eliminate so-called “convertibility risk”. He went on to imply that large-scale, possibly even open-ended, purchases of short-term government debt in the troubled economies could be justified in order to restore belief in the markets that the euro could never break up. On Thursday, we may get some details of these proposals.

In this blog, I would like to take a step back and ask whether the ECB really has the ability to eliminate convertibility risk in the long run. In many respects, the ECB is taking on the role which has previously been fulfilled by the IMF in financing balance of payments crises in fixed exchange rate systems, such as the Bretton Woods system. Sometimes the IMF was successful in preventing a currency devaluation (ie “eliminating convertibility risk”), and sometimes not. What does this comparison tell us about the prospects of success for the ECB? Read more

Market reactions to Ben Bernanke’s Jackson Hole speech have generally viewed it as slightly more dovish than expected, without being a game changer. The Fed Chairman said that the stagnation of the labour market is a “grave concern” because of “the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years”. On reflection, these are extremely strong words for a central banker. It would make little sense if they are not followed by action.

The important question, however, is what kind of action will be forthcoming. The market is disposed to believe that only one kind of action really matters, and that would be a further round of quantitative easing. That, it seems, is seen as the real litmus test of whether the Fed is serious about stimulating the economy.

Most US economists now believe that the FOMC will announce QE3 before the year end, and many say that there is a 50/50 chance of this occurring at its next meeting on 12-13 September. Based on what the Chairman said on Friday, there is certainly no reason to dissent from this view. However, there are serious grounds for asking whether another round of plain vanilla QE would be effective, and whether there should be further changes in communications policy to support it. Read more