Daily Archives: November 3, 2010

Robin Harding

Fed chairman Ben Bernanke has an op-ed in the Washington Post. He argues that QE2 will be effective:

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate this additional action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

He takes on critics who fear inflation: 

Robin Harding

It’s been a long afternoon and I need a drink but here are a few random thoughts on today’s move by the FOMC.

(1) Leaving aside all question of whether QE2 will “work” in the long-run, the Fed’s short-term execution has been a triumph. It managed to prepare market expectations so that there were almost no dramatic price moves in response to a formidably complicated policy.

(2) There is an easing bias in the statement but it’s subtle, well-coded, and I missed it on my first frantic run through. In the third par on the asset purchase programme the FOMC says: 

QE2 is sailing in the States – a bit above expectations, at $600bn. “The unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent … with its dual mandate,” said the Fed press release.

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities… the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month… 

Declining inflation expectations and a strengthening currency have prompted another substantial 75bp cut to Iceland’s key rates. The country has not stopped cutting since the financial crisis (see chart). No doubt the decision was supported by expectations of Fed easing, and the lower dollar that will likely follow.

Key rates are left as follows:

  • deposit rate (current account rate) will be 4 per cent
  • maximum bid rate for 28-day certificates of deposit (CDs) will be 5.25 per cent
  • seven-day collateralised lending rate will be 5.5 per cent
  • overnight lending rate will be 7 per cent.

Iceland’s central bank has also announced a revision to its strategy to lift capital controls. 

China’s trade surplus is beginning to rise again and the government has made only “limited progress” in rebalancing its economy towards domestic consumption, the World Bank said on Wednesday. The bank also upgraded its forecast for growth this year by half a percentage point to 10 per cent, but said that interest rates needed to rise further if inflationary expectations were to be kept in check.

The bank’s quarterly report on China is closely watched and was largely upbeat on the short-term prospects for the economy, despite fears over the summer about a possible hard landing. However, amid fierce international debates about China’s currency policy which could come to a head at next week’s G20 summit in South Korea, the bank cautioned that China needed to make a big push on its agenda of structural reforms if it was to reduce its large external surplus. “Rebalancing will not happen by itself – it will require substantial policy adjustment,” the report said.

Chris Giles

As per Robin’s Fed post, here is a quick summary of the issues for the November Monetary Policy Committee meeting.

Current policy rate: 0.5 per cent
Current unorthodox measures: £200bn of assets (almost all gilts) purchased
Consensus expectations: No change – a position held by all but outliers

Data developments of note
STRONG initial third quarter GDP – 0.8 per cent
STRONG PMI surveys for manufacturing and services
WEAK US growth offset by STRONGER European data
Still TOO HIGH inflation, but stable with CPI inflation at 3.1 per cent

Developments on Committee thinking
The October minutes were split 1-7-1 with the swing voters on the MPC dovish, but only slightly. Those in no man’s land wanted to see more evidence from data 

It looks likely the ECB has been buying Irish bonds this week as bond prices have tumbled in peripheral eurozone countries; Business Week quotes three traders confirming the central bank intervention at 2019 and 2025 maturities.

The premium investors charge to hold 10-year Irish bonds over their German equivalents – the yield spread – has risen above 500bp this morning, and credit-default spreads rose to 5.3 percentage points, a record according to Markit.

Greece’s cost of debt is also rising, not helped by the deputy PM reportedly saying: “Debts exist to be restructured.” Indeed many think the fear of debt restructure – aggravated by recent discussions of the eurozone bail-out fund, the EFSF – is what’s driving the markets, rather than fundamental deterioration in the domestic situation. Gary Jenkins, head of Fixed Income at Evolution Securities, said: