Wednesday, January 23, 2013

Draghi’s Stealth Bomber
Less than six months ago, Europe topped everyone’s Wall of Worry, and seemed set to fall into a financial abyss. The Spanish 10-year government bond yield spiked up to a peak of 7.61% on July 24 of last year (Fig. 8). It has subsequently dropped to 5.10% as of yesterday.

Europe was saved not by a financial bazooka, but rather by ECB President Mario Draghi’s stealth bomber. At the end of July last year, he pledged to do whatever it takes to save the euro. So far, just that promise alone has been enough not only to avert disaster but also to ameliorate financial conditions in the euro zone, as evidenced by falling bond yields and rising stock prices. The euro zone's ZEW economic-expectations index, a gauge of investor sentiment, rose more sharply than expected in January, by 23.6 points to stand at 31.2, reaching the highest level since May 2010 (Fig. 9).

While investor confidence may be improving, there’s still plenty to worry about in Europe. Yesterday, Charles Dallara, who heads the Institute of International Finance (IIF), a Washington-based bank lobby group, told CNBC that Cyprus, rather than Spain, Italy, or Greece, poses the biggest sovereign risk to the euro zone. That’s right: tiny Cyprus.
(Based on an excerpt from YRI Morning Briefing)

Thursday, January 17, 2013

Japan Ready to Set 2% Inflation Target
At the end of last year, Japan’s new Prime Minister, Shinzo Abe, called for the BOJ to drastically loosen its monetary policy and to target 2% inflation--even before the start of official campaigning for the December 16 lower house election in which his Liberal Democratic Party won a landslide victory. Today, Kyodo news agency reported that Abe’s government and the BOJ will state an inflation target of 2% in their planned joint statement, to be released after the details are discussed at the BOJ's Policy Board meeting January 21-22.

Of course, the BOJ has been stepping on the monetary accelerator for quite some time. Reserve balances rose to a record 39.8 trillion yen during December of last year, up 142% during the latest round of quantitative easing over the last two years (Fig. 8). Abe’s goal seems to be to weaken the yen, thereby boosting both Japan’s exports and inflation. So far, he has succeeded in bringing down the yen relative to the dollar by 8.2% since December 4 (Fig. 9). January 10, 2013
(Based on an excerpt from YRI Morning Briefing)

Thursday, January 10, 2013

Draghi Sees Euro Zone Recovery Later This Year
At his press conference today, ECB President Mario Draghi declared:
Later in 2013 economic activity should gradually recover. In particular, our accommodative monetary policy stance, together with significantly improved financial market confidence and reduced fragmentation, should work its way through to the economy, and global demand should strengthen.
Needless to say, Draghi hedged his bets several times in other remarks he made during the press conference. After all, just last month, the ECB slashed its 2013 economic outlook for the euro zone to a contraction of 0.3% from a growth of 0.5%. There have been plenty of grim statistics recently coming out of the 17-member euro zone. The unemployment rate rose in November to 11.8% (Fig. 1). Industrial production fell 0.3% during November and 3.6% the past three months (Fig. 2). Even Germany’s export-led economy succumbed to the weakness of its neighbors during the Q4-2012, when real GDP contracted by 0.5% based on a preliminary estimate from annual data.
(Based on an excerpt from YRI Morning Briefing)

Wednesday, January 9, 2013

Wessel’s Kudos for Draghi
When the US jobless rate does fall to 6.5%, Fed officials are likely to regret that they didn't follow the lead of ECB President Mario Draghi. As David Wessel observed in his WSJ column today, in late July last year, Draghi “defused an intensifying crisis of confidence in the euro with two sentences scribbled in the margins of an otherwise routine speech. ‘Within our mandate, the ECB is ready to do whatever it takes to preserve the euro,’ he said. ‘And believe me, it will be enough.’ That may prove to be the most successful central-bank verbal intervention in history.” Wessel noted:
A few weeks later, the ECB pledged to buy bonds of governments shunned by markets if those governments made belt-tightening commitments accepted by fellow euro-zone countries. No government has sought that help so the ECB hasn't spent a single euro. Yet global anxiety about an imminent euro crisis has abated.
That’s been reflected in a dramatic drop in the 10-year yields on the bonds of Spain and Italy (Fig. 3). The imbalances among the members of the ECB's TARGET2 payments system have stopped deteriorating in recent months (Fig. 4). The size of the ECB's balance sheet has actually declined slightly by €146 billion since June 29 of last year through January 4 (Fig. 5). Another positive sign for the euro zone was the announcement last Thursday that not one bank has used the ECB’s emergency overnight marginal lending facility since August 2011. Banks are facing less stress, and interbank lending is rising. The FTSE Eurofirst 300 Banks Euro Index is up 8.1% since the start of the year and 44.3% since Draghi’s speech at the end of July (Fig. 6).

Contributing to the powerful rally in bank stocks was the proposal of the Council of the European Union for a Single Supervisory Mechanism (SSM) for banks in the euro zone. The SSM is the first step in the formation of the European Banking Union. It grants the ECB direct powers to supervise and regulate the euro zone banks, especially the large ones. Another boost for the bank stocks was last week’s easing of liquidity rules by the Basel Committee on Banking Supervision, as I discussed on January 2. Confidence in the future integrity of the euro zone is also reflected in the euro, which is up from last year’s low of 1.21 on July 24 to 1.33 this morning (Fig. 7).
(Based on an excerpt from YRI Morning Briefing)

Thursday, January 3, 2013

December FOMC Minutes: QE4ever & 6.5% or Bust
The minutes of the December 11-12 FOMC meeting were released today. The members of the FOMC decided to add a new policy goal. They declared that their ultra-easy monetary policy would remain in force until the unemployment rate falls to 6.5%, as long as inflation doesn’t rise above 2.5%.

According to the minutes of the meeting, instead of “calendar-date forward guidance,” the Fed now will focus on “quantitative thresholds,” which “could help the public more readily understand how the likely timing of an eventual increase in the federal funds rate would shift in response to unanticipated changes in economic conditions and the outlook.”

The FOMC also announced on December 12 that the Fed will buy $45 billion a month in long-term US Treasuries starting January, with no limit on the total amount and no termination date. That adds up to $540 billion a year, though Fed Chairman Ben Bernanke said the latest version of QE would be “flexible.”

Of course, that’s in addition to the $40 billion on mortgage-backed securities per month that the Fed committed to start buying back at the September 12-13 meeting of the FOMC under QE3. The latest program, let’s call it "QE4," replaces Operation Twist, which expired at the end of last year. Under that program, the Fed swapped about $45 billion in short-term Treasuries for long-term Treasuries.
(Based on an excerpt from YRI Morning Briefing)