3rd November 2010 by Shaun Richards
Finally after what feels like eons of waiting we will find out today at 2:15 pm local time the actions planned by the Federal Open Market Committee to boost the US economy. It comes right on the heels of a political change in the United States as we saw a swing towards the Republican party in the elections held yesterday. The Republicans already have won a majority in the House of Representatives but have failed to gain control of the Senate which remains with the Democrats although the exact numbers are not yet concluded. The does raise issues for the status of the current Democratic President Barack Obama who runs the risk of being a President who cannot get his policies passed by Congress. So it is possible we will see a type of gridlock which poses questions for the Federal Reserve going forwards. I do not expect them to respond to that today as there will be plenty of opportunity at future meetings and because we will have to wait and see for further developments. One thing I did spot which the Fed. may do well to mull over is an ABC exit poll which suggested that 88% of Americans believed the national economy was in bad shape.
Where we stand now in financial markets?
The Dow Jones Industrial Average closed at 11,188 which was up 64 points. As to whether this welcomed a likely Republican swing or was just getting ready for the FOMC statement it is hard to say. In terms of government bond yields then the ten-year yields 2.57% and the thirty-year yields some 3.91%. Moving onto currencies then the trade-weighted US dollar index stands at 76.68. Another possible benchmark is the gold price which has a front month futures price of US $1354.
What does financial markets expect?
After a period when expectations were measured in the trillions it looks as though markets now expect something of the order of US $500 billion probably spread out over the next 6 months. So rather than the Fed. purchasing an immediate stock of assets we are expecting a flow of asset purchases. In some ways this will be similar to an expansion of the existing QE-lite which involves purchases of around US $25 billion of US Treasuries or government debt. One possible tweak the Fed could make is whether the new move replaces QE-lite or is added to it. I make this point partly because it is true and partly because many aspects of the media seem to have forgotten QE-lite.
For those who are new to my blog QE-lite is the existing Fed. programme which set the objective of maintaining the size of the Federal Reserve’s balance sheet. The reason why it was instituted was that it would otherwise reduce in size as Mortgage Backed Securities expired/matured. So going forwards when they mature and the Fed receives funds it reinvests them in US Treasury Bonds and hence stimulates the economy by providing cash to bondholders and hopefully also reduces long-term interest rates.
Care will be required with the Fed’s statement as I remember there was some confusion over the announcement of QE-lite. Why this matters is that the longer the maturity of the government bond purchased the more aggressive the strategy is and so watchers will look for that. So let’s hope that this time it will not correct itself in a later statement as this led to enough volatility last time. Indeed such moves when some are already accusing the Fed. of incompetence only feed the fire.
I wish to be clear that I would not make any move today and accordingly do not agree with any expansion of monetary measures at this time. Put another way the so-called QE2 would not set sail if my vote was significant. I have a section on this blog on Quantitative Easing which explains my thoughts in detail and their development over time but I will make some points which I feel are important.
1. Financial markets are being twisted as they attempt to “front-run” expected central bank moves. This is likely to create disequilibrium. Indeed it is creating financial bubbles in my opinion. This is an odd solution to a crisis created by financial bubbles! Moral hazard abounds.
2. The moves are predicated on economic theories which require equilibrium. Apart from the fact that we cannot prove that the world’s economy has ever been in equilibrium I would refer you to point 1 above.
3. Quantitative Easing has now been tried in various forms and it has at best been a partial success and may well have been a failure every time it has been tried.
4. Attempting to create inflation is risky and dangerous. The genie may not go easily back into the bottle.
5. If QE2 is expected to work why did the previous effort QE1 fail and why is QE-lite not helping more?
In summary I fear that it may make things worse rather than better and as I am about to introduce a musical playlist let me suggest that “It’s a mistake” by Men at Work is appropriate.
A Musical/Video playlist for the dull hours running up to the FOMC statement
For Ben Bernanke’s MP3 player
Start Me Up by the Rolling Stones
Pump it Up by Elvis Costello
Pump up the Volume – M.A.R.R.S.
Bless the Printing Press – Reversal of Man
Take it to the limit by The Eagles
More,More, More by Andrea True Connection
Bennie and the Jets by Elton John ( or perhaps that should be Bennie and the Inkjets…. as suggested by Mr.K)
Coming Around Again by Carly Simon
Just can’t get enough by Depeche Mode
Money for Nothing by Dire Straits
Everything counts (in large amounts) by Depeche Mode
Don’t stop till you get enough by Michael Jackson
Can’t Help Myself by the Four Tops
Turning Japanese by The Vapors
and as an exhortation to the economy from Ben
Jump by Van Halen.
For those opposed perhaps
I’m forever blowing bubbles by West Ham fans at every game
Never Going Back Again by Fleetwood Mac
I can’t go for that by Hall and Oates
What Difference Does it Make? by The Smiths
It’s a sin by the Pet Shop Boys
Your cash aint nothin but trash by Huey Lewis and The News
Putting Out Fire With Gasoline by David Bowie
I started out with nothing and I’ve still got most of it left by Seasick Steve
Cocaine by JJ Cale
Crime of the Century by Supertramp.
(Ground Control to) Major Tom by David Bowie
And a Visual Image
Wagner’s “Ride of the Valkyries” – think of the famous scene from Apocalypse Now – Kilgore’s helicopter assault on the beach. Does tactical victory but strategic defeat raise a theme?
In a few year’s time when Ben is on the lecture circuit
Sorry seems to be the hardest word by Elton John
and for us?
Ghostown by The Specials
Let’s hope not.
I will be updating later in the day but for now will move onto other financial developments.
The Peripheral Euro zone nations continue to struggle
It may or may not be a coincidence that as expectations for the size of America’s expected monetary stimulus has reduced then the government bond markets of Portugal Ireland and Greece have weakened and yields shave risen. On a macro level it is also true that the European Central Bank appears to be trying to exit from its Securities Markets Programme which so far has announced purchases of some 63.5 billion Euros of assets to help these countries. It has not made any further purchases for several weeks now. Also we have seen the exchange rate of the Euro rise and it is now at 1.403 versus the US dollar and has even strengthened against the Yen over the last month or so which is perhaps a better measure as the US dollar has been very weak.
So the background has not helped and the individual issues for Portugal, Ireland and Greece have led to their government bond yields rising again. In terms of today then Portugal has a vote on her governments proposed austerity programme which now seems likely to pass her parliament. Unfortunately for her she appears to be in danger of becoming a mini-Latvia in that as austerity tightens economic growth weakens. I am not suggesting that economic output will fall on the scale of Latvia’s but that the same principles hold and my article was written on the 12th March of this year. As to Greece she seems to be suffering from an outbreak of terrorism which has led her to close her international mail services for a couple of days which will hardly increase faith in her.
In terms of the numbers ten-year government bond yields closed last night as follows Portugal 6.29% up 0.12%, Ireland 7.25% up 0.18% and Greece 10.91% up 0.11%. If you look at the composition of the markets you can see other significant figures too. For example Greek 3 year yields are now over 12% and yet she is being supported explicitly by the EU/ECB/IMF explicitly over much of this period and let’s face it implicitly now for all of it. It gives a market view on credibility in my view. For Ireland there are other factors as she could go to the EFSF and receive funds at just over 5% so I look at her maturity spectrum to see over which period if any she can borrow more cheaply than that ( remember the official ECB rate is 1% and it acts as an anchor at the short end). The threshold is at April 2013 where her bond yields 5.14%. It is perhaps fortunate that she does not have to borrow again in 2010 as the best place to go to would be the IMF/EFSF.
In terms of number crunching it would appear that the banking crisis and its effects is likely to have an effect on Ireland’s finances that is equivalent to its current national debt. In case you were wondering that stands at 88.36 billion Euros according to its debt agency NTMA. Of course such estimates are subject to assumptions which may change. One thing that is unlikely to change is my view that Ireland should already have gone to the IMF as I suggested on the 17th of September.