After a rather mixed day for economic signals US equity markets closed broadly unchanged yesterday after at first falling and then rallying. However the calming of sentiment seemed to help Japan as her Nikkei 225 equity index rallied some 103 points to 8927. This may have been helped by an increase in Japanese car sales of 47% in August, however care is needed with these figures because a subsidy programme to aid car purchases is about to expire and this was likely to have boosted the numbers.There was little boost to be found from currency markets as the Yen continued its march against the US dollar and is now at 84.10 although it is not quite so firm overnight against the Euro at 106.95. The CRB spot index closed at 455.07 and appears to be pretty much holding station at the moment.
Federal Reserve Open Market Committee Minutes
Yesterday saw the release of the minutes from the latest meeting of the FOMC. This was the meeting at which the QE-lite programme was announced where the Fed plans to buy US government bonds with the proceeds from sales and expiring securities in its existing book of Mortgage Backed Securities (MBS) .
We got some insight into differing views on future inflation at the Fed.
most believed that inflation was likely to stabilize near recent low readings in coming quarters and then gradually rise toward levels they consider more consistent with the Committee’s dual mandate for maximum employment and price stability………Some members expressed a concern that in this context any further adverse shocks could have disproportionate effects, resulting in a significant slowing in growth going forward. While no member saw an appreciable risk of deflation, some judged that the risk of further near-term disinflation had increased somewhat. More broadly, members generally saw both employment and inflation as likely to fall short of levels consistent with the dual mandate for longer than had been anticipated.
As inflation performance at this time is in effect a proxy for economic growth and if we remember that Mr.Hoenig voted against QE-lite we can see that there are three different camps within the FOMC or at least there were at the last meeting. This is a partial explanation of why the Chairman Ben Bernanke gave such a guarded speech at Jackson Hole. When we come to the policy of QE-lite itself there were also divisions.
members noted that the magnitude of the tightening was uncertain, and a few thought that the economic effects of reinvesting principal from agency debt and MBS likely would be quite small
It is interesting that a policy which has received so much media attention was considered by those responsible for it to have a “quite small” effect. Then we get that “Most members judged”,which gives me the opinion that more than Mr.Hoenig had reservations about this policy and perhaps for this reason.
A few members worried that reinvesting principal from agency debt and MBS in Treasury securities could send an inappropriate signal to investors about the Committee’s readiness to resume large-scale asset purchases
I wrote before the meeting that this was a real fear and I believe this has happened. Regular readers will be aware that I believe that the FOMC has been prone to respond to market pressure during the credit crunch. This gives us not only an unhealthy relationship between it and markets in my view,but also makes an expanded version of asset purchases or QE 2 more likely as if the US economy continues to slow there will be a clamour for it in the media around the next few FOMC meetings.
Then we get mention of one of my themes or what plan do central banks have to exit their strategies and it would appear that in some respects Mr.Hoenig has similar concerns.
Another member argued that reinvesting repayments of principal from agency debt and MBS, thereby postponing a reduction in the size of the Federal Reserve’s balance sheet, was likely to complicate the eventual exit from the period of exceptionally accommodative monetary policy and could have adverse macroeconomic consequences in future years.
My fear is that there will be considerable consequences from the reversal of and eventual exit from policies such as QE where government bonds and private securities have been purchased by central banks. At this time it is easy when the main government bond markets have been rallying and taking many other bond yields with them to consider selling some. However even this comes with the caveat that part of the rally has been caused by the purchases themselves in a type of front-running. If there is any front-running on the exit it will raise yields and depress prices. Also as the economy will hopefully be in a recovery then yields are likely to be rising anyway and sales of QE securities are likely to exacerbate this. So it is possible that the exit strategy by raising interest rates could slow or even choke off the hoped for recovery. Should members of the FOMC feel this then the holding of these securities could become a more permanent part of the US financial landscape which to my mind is not healthy either as one day the transmission mechanism from these purchases will be operating more normally with implications for the money supply and future inflation.
One area where I will give the FOMC some credit is that there are some welcome admissions of errors in policy.
A surprising surge in imports in the second quarter widened the U.S. trade deficit…….Data on the labor market were weaker than meeting participants had anticipated……Most saw the incoming data as indicating that the economy was operating farther below its potential than they had thought.
US economic figures
These were not really first rank figures and in more normal times would probably be ignored. We got the Conference Board’s Confidence Indicator which improved to 53.5 whilst the Chicago Purchasing Managers Index fell to 56.7. So a one all draw was accompanied by the Case-Shiller U.S. National Home Price Index which rose 4.4% in the second quarter of 2010. However this rise is mostly before the period where fears of a housing slowdown linger. So no real insight was provided here and we await the next instalments!
Ireland and Anglo-Irish Bank’s problems continue
Yesterday saw half-year figures from Anglo-Irish. For those who have not followed its saga it has been like a dragging anchor on the whole Irish economy as its property loans have been revised ever more severely and as they look ever worse. This trend has continued as I recorded in my updates of and has been one of the driving forces behind the widening of the spread between Irish and German ten-year government bonds which is currently just over 3.6%.
One of the features of this saga has been the way that the situation at Anglo-Irish has continued to decline which gives the implication that a rosy scenario has been painted by its directors rather than a realistic one. This means that there is a drip drip of bad news from it. One might think that declaring a loss of some 8.2 billion Euros for the half-year might clear things up but sadly it would appear that Anglo-Irish is still at the same game of misleading about the future. You see it has been placing assets into the Irish bad bank NAMA as a way of clearing up its finances. So far it has had to take an average haircut of some 58% but going forwards it assumes that future haircuts will only be 34% which is a curious drop when you consider that the Irish commercial property market appears still to be in decline. This improves her figures by around 4.5 billion Euros.One might also wonder about the level of provisioning for property loans which are not going into NAMA which at 14% looks very light. So it would appear that there is worse to come from Anglo-Irish.
There is an interesting correlation of this and a comment on this blog recently. The comment included a letter highlighting accountancy standards at banks or more accurately perhaps, the lack of them! This was a cause of problems in the run-up to the credit-crunch and may have led for example to misrepresentation of profit levels which would have led to dividends and salaries being too high. Personally I have often wondered about the rights issue that took place at Royal Bank of Scotland a few months before it collapsed and whether shareholders were given full and proper information. I think that it is an irony that the media furore which followed (Sir) Fred Goodwin never really hit on this point as I feel that the boards behaviour at this point must be virtually impossible to justify if you think about it.
Anyway to return to today’s subject Anglo-Irish appears to be hiding behind accountancy standards which has firstly bad future implications for her and Ireland as a whole. But also it highlights how little genuine reform there has been in this area which should worry investors and taxpayers around the world as should we hit trouble again I suspect that bank profits will disappear again and the taxpayer will be left again to carry the can unlike for example the bank directors who usually retire very wealthy men regardless it would appear of their actual performance.
Foreign Exchange Markets
Some figures have been released which confirm me in my view that sovereign governments should take great care if they indulge in foreign currency intervention and,in my view, should mostly avoid it. According to the Bank for International Settlements some US $4 trillion a day is gambled/invested on foreign exchange markets and whilst some of this is computer driven algorithms which are as likely to be going north as south it still leaves big volumes with which central banks cannot compete. Just to add to the dangers in this market it would appear that leverage is as high as fifty times ( and remember this leverage limit is for retail investors not institutions). Put another way you may only need as little as a 2% stake. Those who feel that this is fine might want to take a look at recent movements in the Euro against the Yen for example.
So central banks should take great care before committing themselves to intervening in this casino as it is easy to get overrun by events.Perhaps they should all be sent the case-study of what has happened to the Swiss National Bank this year and the losses it has run-up.