Guest post by Doug Short.
We’re on the threshold of the last month for the latest Federal Reserve intervention, Operation Twist, which was officially announced on September 21 of last year. We’ve seen several bouts of aggressive Fed attempts to manage the economy following the collapse of the two Bear Stearns hedge funds in mid-2007 about three months before the all-time high in the S&P 500.
Initially the Fed Funds Rate (FFR) underwent a series of cuts, and with the collapse of Bear Stearns, the Fed launched a veritable alphabet soup of tactical strategies intended to stave off economic disaster: PDCF, TALF, TARP, etc. But shortly after the Lehman bankruptcy filing, the Fed really swung into high gear. The FFR fell off a cliff and soon bounced in the lower half of the 0 to 0.25% ZIRP (Zero Interest Rate Policy), now in its fourth year.
If a picture is worth a thousand words, this chart needs little additional explanation — except perhaps for those who are puzzled by the Jackson Hole callout. The reference is to Chairman Bernanke’s speech at the Fed’s 2010 annual symposium in Jackson Hole, Wyoming. Bernanke strongly hinted about the forthcoming Federal Reserve intervention that was subsequently initiated in November of 2010, namely, the second round of quantitative easing, aka QE2.
Better late than never. We are sorry for the delay today. Now, to the news section….
US benchmark borrowing costs plunged to levels last seen in 1946 and those for Germany and the UK hit all-time lows as investors took fright at what they see as a disjointed policy response to the debt crisis in Spain and Italy. In a striking sign of the flight to haven assets, German two-year bond yields fell to zero for the first time, below the equivalent rate for Japan, meaning investors are willing to lend to Berlin for no return. US 10-year yields fell as low as 1.62 per cent, a level last reached in March 1946, according to Global Financial Data. German benchmark yields reached 1.26 per cent while Denmark’s came close to breaching the 1 per cent level, hitting 1.09 per cent. UK rates fell to 1.64 per cent, the lowest since records for benchmark borrowing costs began in 1703.http://www.ft.com/intl/cms/s/0/7fc8b916-aa7d-11e1-899d-00144feabdc0.html#axzz1wQ4tZnA1
Brazil’s central bank has cut its benchmark lending rate to an historic low as part of efforts to revive growth in Latin America’s largest economy. The central bank reduced its Selic interest rate by 50 basis points to 8.5 per cent, undercutting the previous mark of 8.75 per cent reached during the 2009 financial crisis. Explaining its decision in a brief statement, the monetary policy committee of the central bank said: “At present, there remain limited risks to the trajectory of inflation. The committee further notes that given the fragility of the global economy, the contribution from the external sector is disinflationary.”http://www.ft.com/intl/cms/s/0/c3243fb0-aaae-11e1-9331-00144feabdc0.html#axzz1wQ4tZnA1
The Spanish government is under mounting pressure to open an investigation into the collapse of Bankia amid public anger at the salaries of its directors and the losses of savers who bought the rescued bank’s shares. Luis de Guindos, Spain’s finance minister, described €20m of severance pay for two directors of the bank as “unacceptable”, calling for an investigation by the Bank of Spain, at the same time as the central bank’s outgoing governor hit back at a “smear campaign” against him in the wake of the Bankia rescue. http://www.ft.com/intl/cms/s/0/d8b1b710-aa7a-11e1-9331-00144feabdc0.html#axzz1wQ4tZnA1
John Hussman is still bearish. With the massive expansion of central bank’s balance sheets, this could get nasty going forward. Thanks god they don’t need to use those mark to market models at the Fed…
For nearly two years, the massive interventions of central banks have repeatedly pulled a fundamentally weak and debt-burdened global economy from the brink of resumed recession. The Federal Reserve’s balance sheet is now leveraged 52-to-1, with assets having an average duration of over 5 years, suggesting that if those assets were marked-to-market, an interest rate increase of less than 50 basis points would wipe out the Fed’s entire capital base. Of course, the Fed takes no marks on its assets when it reports its balance sheet, though it does occasionally take down the value of the securities in the Maiden Lane shell companies that it illegally set up to bail out Bear Stearns and other entities (in violation of Section 13(3) of the Federal Reserve Act, which Congress had to amend and spell out like a See-Spot-Run book as a result).
At a 10-year Treasury yield of 1.7%, interest on reserves of 0.25%, and a monetary base now at about 18 cents per dollar of nominal GDP (see Run, Don’t Walk), further purchases of long-term Treasury securities by the Fed would produce net losses for the Fed in any scenario where yields rise more than about 20 basis points a year, or the Fed ever has to unwind any portion of its already massive positions. So further QE by the Fed would effectively amount to fiscal policy. Moreover, the benefits of central bank interventions are becoming progressively smaller and short-lived (nearly log-periodic in fact, to borrow a term from crash dynamics). None of this restricts the Fed from embarking on further interventions. It just emphasizes how far the Fed has already descended into the deep.
To the extent that our measures of market action improve on some possible future intervention, and until the point where the market reestablishes an overvalued, overbought, overbullish profile, we might have some latitude to take some speculative exposure in the event of another round of QE. But without substantially greater improvement in valuations here, there would be noinvestment basis for that exposure, so our latitude wouldn’t be very broad (we estimate the prospective 10-year total nominal return for the S&P 500 to be back down to about 5% on the basis of our standard methodology).
In case you missed it over the US long holidays, here is the FT Wolf’s interview with Krugman.
So, I ask, will the argument of the column be that “it’s all over” for the eurozone?
“No. I don’t think they can save Greece but they can still save the rest if they’re willing to offer open-ended financing and macroeconomic expansion.” But this would mean persuading the Germans to change their philosophy of economic life. “Well, the prospect of hanging concentrates the mind; the prospect of a collapse of the euro might concentrate their minds.”
I change the subject to ask how he has coped with the shift from being predominently an academic economist to being the leading spokesman for the liberal cause. How did this happen? “Well, it was funny,” he responds. “I was doing a column for Slate and then a bit for Fortune, towards the end, and then the [New York] Times came along with this offer. It was 1999. We thought I’d be writing about the follies of dotcoms and stuff like that and then it turns out that it’s a much more awesome and ominous responsibility. It was nothing I ever planned.
“Really, the rough period was the first [George W] Bush term when it seemed like the whole world was mad, save me, or vice-versa, and it’s gotten easier.
“I have to say, though, that the economic crisis has played into the things that I was worrying about 15 years ago. It’s been almost alarmingly easy to figure out what to say. But it’s a very strange thing: it’s not at all what I was imagining I was going to be doing with my life.” (Full link here).
With twitter feeds exploding over the Euro breaching the 1.25 level, and rumors of French banks preparing for a Grexit, let’s review what central planners balance sheets look like. Via Macroblog (Atlanta Fed).
Relative to before the financial crisis, the Federal Reserve’s asset holdings are currently about 3.3 times larger. Initially, the source of that increase was the collateral associated with various temporary lending facilities that the Fed used to address the financial panic. Those assets were then replaced on net by purchases under the first large-scale asset purchase program in 2009. Then in late 2010, asset holdings increased further as a result of a second large-scale asset purchase program.
Of course, size isn’t everything. While it might be tempting to try and interpret the change in the size of the central bank’s balance sheet as a summary statistic of the degree of monetary policy accommodation, as Dave Altig’s post points out, that interpretation is not so straightforward. Increasing the size of the balance sheet is not the only thing a central bank can do to ease monetary policy when short-term interest rates are very low. For example, in late 2011 the Fed began a maturity extension program that changed the composition of the assets on the balance sheet, but this program did not materially alter the size of the balance sheet.
With this caveat in mind, the following chart compares the proportionate changes in the size of asset holdings of five central banks over the period from the first quarter of 2007 through the first quarter of 2012: the Federal Reserve (FR), the Bank of England (BE), the European Central Bank (ECB), the Bank of Canada (BC), and the Bank of Japan (BJ).
Germany refused to share the debt burden of stressed eurozone peers on Tuesday, ignoring two of the most influential international economic bodies which offered support for proposals championed by Paris, Rome and Brussels ahead of a summit. Angela Merkel, Germany’s chancellor, has argued that any co-mingling of eurozone debt would remove incentives for southern economies to adopt structural reforms. The calls from the International Monetary Fund and the Organisation for Economic Co-operation and Development came on the eve of Wednesday’s EU summit.
Asian shares retreated as hopes of fresh measures to tackle Europe’s debt crisis faded ahead of a meeting of European leaders while weak trade figures weighed on Japanese exporters. The MSCI Asia Pacific index slid 1.2 per cent with Japan’s Nikkei 225 Stock Average 1.2 per cent lower, Australia’s S&P/ASX 200 index down 1 per cent and South Korea’s Kospi Composite index off 1.3 per cent. Hong Kong’s Hang Seng index fell 1.5 per cent while China’s Shanghai Composite index slipped 0.2 per cent. http://www.ft.com/intl/cms/s/0/b71e7fe0-a2ee-11e1-826a-00144feabdc0.html#axzz1vfG4GISL
Western powers are prepared to offer Iran an “oil carrot” that would allow it to continue supplying crude to Asian customers in exchange for guarantees it is not building an atomic bomb. As the five permanent member of the United Nations Security Council, Germany and the European Union prepare for talks with Iranian officials in Baghdad on Wednesday, diplomats and oil executives said Washington and Brussels were likely to hold out the prospect of a possible suspension of an EU insurance ban on ships carrying Iranian oil. They added that the US and EU are not prepared to lift other sanctions – including an EU import ban on Iranian oil – and also cautioned that a deal is unlikely to be agreed at the meeting. http://www.ft.com/intl/cms/s/0/149b7962-a433-11e1-84b1-00144feabdc0.html#axzz1vfG4GISL
European leaders are drawing up a series of crisis-fighting proposals to raise at an informal EU summit this week that have in the past been rejected by Germany putting further pressure on Chancellor Angela Merkel. The proposals, which could include empowering the eurozone’s €500bn rescue fund to directly recapitalise faltering European banks and commonly backed eurozone bonds, have been backed by some leaders in the past but forced off the agenda by the German chancellor’s objections. http://www.ft.com/intl/cms/s/0/0cc191dc-a293-11e1-a605-00144feabdc0.html#axzz1vTdMAajU
Hedge funds and private equity firms have amassed almost €60bn to buy loans from stricken European banks in coming years as many of the continent’s lenders seek to shrink their way to health, according to a PwC survey. PwC, which is advising many banks on asset sales, estimates European banks have almost €2.5tn of “non-core” assets they could sell. http://www.ft.com/intl/cms/s/0/10e07114-a105-11e1-aac1-00144feabdc0.html#axzz1vTdMAajU
Chinese consumers of thermal coal and iron ore are asking traders to defer cargos and – in some cases – defaulting on their contracts, in the clearest sign yet of the impact of the country’s economic slowdown on the global raw materials markets. The deferrals and defaults have only emerged in the last few days, traders said, and have contributed to a drop in iron ore and coal prices. http://www.ft.com/intl/cms/s/0/a1f5ddda-a26b-11e1-a605-00144feabdc0.html#axzz1vTdMAajU
Asian markets moderated gains after an early bounce in early trading Monday as investors digested comments by leaders of the Group of Eight major economies affirming they want Greece to remain in the euro and Chinese Premier Wen Jiabao raising hopes of further policy easing. Japan’s Nikkei was up 0.3%, Australia’s S&P ASX 200 gained 0.3%, and Korea’s Kospi climbed 0.8%. Other key markets bucked the trend, with Singapore’s Straits Times Index dropping 0.2%, Hong Kong’s Hang Seng Index was down 0.7%, and the China Shanghai SE Composite falling 0.3%.http://online.wsj.com/article/SB10001424052702304019404577417051172580454.html?mod=WSJASIA_hpp_LEFTTopWhatNews
…and much more below.
The Spanish government called for investor calm on Thursday as shares in Bankia, the country’s second-largest bank by domestic deposits, tumbled nearly 30 per cent and Moody’s conducted a sweeping downgrade of other lenders. Further fuelling the sense of unease among eurozone banks, the government in Cyprus announced it would underwrite a €1.8bn capital raising by Popular Bank of Cyprus that analysts said could force the tiny island nation to seek bailout assistance from Brussels. http://www.ft.com/intl/cms/s/0/1c0fd102-a046-11e1-90f3-00144feabdc0.html#axzz1vC4kvAGM
Facebook set the share price for its initial public offering at $38, giving the social-networking company a $104bn valuation and propelling it into the ranks of the top 25 US public companies. Mark Zuckerberg, the 28-year old founder and chief executive, raised $1.1bn, leaving him with a stake valued at $19bn, firmly establishing him as one of the richest men in the world.http://www.ft.com/intl/cms/s/0/e7b43504-a051-11e1-88e6-00144feabdc0.html#axzz1vC4kvAGM
An oil tanker belonging to Iran’s state-owned shipping line has been switching flags and using multiple companies to transport crude from Syria to Iran, illustrating how Tehran is helping to sidestep international efforts to choke the finances of Bashar al-Assad, Syrian president. Documents obtained by the Financial Times show the vessel, operated by the Islamic Republic International Shipping Lines, sailed from Syria to the Gulf of Oman and then Iran, using different flags and changing owners. http://www.ft.com/intl/cms/s/0/9704c760-9abe-11e1-9c98-00144feabdc0.html#axzz1vC4kvAGM
The US said it “welcomed” the evolution” of debate in Europe towards growth on the eve of a G8 summit that could see Angela Merkel, Germany’s chancellor, isolated as other world leaders push her to help stimulate the economy in Europe. In a move to make the G8 less formal and more productive, Barack Obama will host the group – whose economic policies could sway his re-election prospects this autumn – away from the media at the presidential retreat of Camp David, Maryland. http://www.ft.com/intl/cms/s/0/0668fb34-a038-11e1-90f3-00144feabdc0.html#axzz1vC4kvAGM
All news below.