Yesterday was a day which originally had stock markets on a declining trend, however they tended to recover as the European day went on and the publication of the minutes of the US central bank the FOMC helped the Dow Jones Industrial Average to close up ten points at 11,020 after being 90 points down earlier in the day. There was an opportunity this morning for the Japanese Nikkei 225 equity index to make up some ground but it too only rallied a weak 14 points to 9403 (and the TOPIX index fell marginally). Thus the spread between the two indices remains at a wide 1617 points. This was in spite of the fact that Japan’s machinery orders jumped 10.1 percent in August from the previous month and have now been improving since June of this year according to the Japanese government. If we move onto the currency situation then the Yen/US Dollar exchange rate remains problematic at 81.83 which is well above the 83 level the Bank of Japan first intervened at, although the situation against the Euro is a little weaker- weaker is good in this sense- at 114.3.
Considering the good news in other equity markets today it looks like the Nikkei is under-performing again. One area that has definitely not under-performed recently is the Commodity Research Bureau spot index which although down by a point yesterday remains up by some 30.4% on an annual basis. However as other media have just returned to concentrate on “agflation” I did have a wry smile when I spotted that the fats and oils and livestock components fell heavily yesterday although again on an annual basis they remain very strong.
The Federal Reserve Open Market Committee Minutes
The minutes from the meeting held on the 21st September were released yesterday evening. Now after their statement at the meeting and the weak US employment report which I wrote about on the 22nd September and 11th October respectively. If we return to the 22nd September the Fed said and the emphasis is mine.
The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate
With the US employment report having been weak then expectations had moved further towards an expectation of further monetary easing.
So what happened last night to inflame already fevered expectations?
I believe it came in this section.
A number of participants commented on the important role of inflation expectations for monetary policy……in such circumstances, an increase in inflation expectations lowers short-term real interest rates, stimulating the economy. Participants noted a number of possible strategies for affecting short-term inflation expectations, including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate, targeting a path for the price level rather than the rate of inflation, and targeting a path for the level of nominal GDP.
In essence the FOMC looks as if it is reaching a situation where an increasing number of its members are not only willing to raise inflation but they are also willing to look at a more aggressive price-level targeting system. This is significant as whilst these ideas have been discussed recently there is perhaps more support here than expected.
This is a question of nuance and degree I feel. Whilst markets were expecting a move from the FOMC as time progresses I think that these minutes indicated a growing level of support and this growing level of support appears to be for measures at the more aggressive end of the spectrum. If you combine price-level targeting with nominal GDP targeting then essentially you are looking to inflate the economy to replace ground lost in the recession.
In my opinion this is a very dangerous game that the FOMC may be about to start. One irony is that a justification for its moves is that at the time of the meeting inflation-expectations as measured by US index-linked government bonds or TIPS had fallen “However, TIPS-based inflation compensation had declined, on balance, in recent quarters.” Much more talk like this will fix that situation on its own! Then of course we have another problem as central bank actions are again leading the market in what I call “front-running” or another type of moral hazard.
In itself targeting nominal GDP should it be introduced will have worried people looking at the history books somewhere around the Weimar Republic in the 1920s I would suspect. In football terms in my view a central bank considering such moves at this time is a little like Wayne Rooney last night when he played for England and dropped back virtually into our defence at times. The analogy is that he is a striker not a defender and he was in the wrong place in my opinion, well so might be the FOMC soon.
Currency Wars move to Thailand
The list of countries affected by what Brazil’s Finance Minister has called “currency wars” is continuing to spread. Yesterday we saw action from Thailand on this front as the Thai Baht has been very strong recently against the US dollar ( sound familiar?) and has risen to levels last seen in the late 90s. The weakening of the US dollar that I have written about before that has taken place since June has seen the Thai Baht rise from 32.5 to 30 or 7.6%. The Thai authorities have already intervened in recent months to prevent the baht rising, but to little or no effect,again an unsurprising reality to regular readers.
This time the Thai government decided to introduce a 15 % withholding tax on capital gains and interest payments for government and state-owned company bonds. In spite of the official denials this is a type of capital control and these measures seem to be spreading like a cancer.
I wrote on the 27th September about the dangers of currency intervention and on the 23rd September about my fears that we may be about to make the same mistakes as were made in the 1930s. In essence this boils down to the competitive devaluations which took place then. This always has the problem that you have to devalue against another currency which has to revalue.
To my mind for all the hyperbole coming from US Treasury Secretary Geithner it is US policy which is causing this as much as Chinese policy. In early June the dollar index was 88.71 and it is now 77.02 for a fall of 13.2%. It appears that currency depreciation is as much a tool of US economic policy as are asset purchases and it is also true that the two moves are interrelated.
I am grateful to the Financial Times which has listed the number of countries which are currently undertaking what it feels are explicit or implicit currency interventions at this time and the number is a chilling 23 or Michael Jordan’s old shirt number for basketball fans.
An extraordinary speech from Axel Weber the Bundesbank President and ECB Governing Council Member
Regular readers will be aware that Mr.Weber was never in favour of the Securities Markets Programme which is the European Central Bank’s version of Quantitative Easing. However he has now given quite an aggressive and bullish speech in New York.
It is necessary, from a monetary policy point of view, not to postpone the exit from non-standard measures for too long…………”There are risks both in exiting too early and in exiting too late. I believe the latter are greater than the former.
There is no evidence that asset purchases have had any significant impact on average euro-area sovereign bond yields……….These securities purchases should now be phased out permanently as part of our non-standard policy measures
As you can see Mr.Weber who may well be the next ECB President is setting out to deliberately distinguish himself from what has become ECB policy under Mr.Trichet. I also wonder if he deliberately made this speech in New York as it could not contrast itself much more with the FOMC Minutes. Here we have a completely different view on stimulus measures that we have had enough and that it is now time to move on.
Implications for the Peripheral Euro zone members
Whilst this speech may well have been intended to be a shot across the bow for the FOMC it also has implications for the peripheral euro zone nations. For example Ireland has relied on the ECB’s Securities Markets Programme to support its government bond market particularly two weeks ago when the SMP spent some 1.384 billion Euros mostly on Irish assets. Should this programme now actually stop one might question also the recent improvement in Greek government bond yields where the ten-year government bond yield has dropped by around 2% in recent times and is now 9.25%.
Greece also issued 1.17 billion Euros of six-month treasury bills at a yield of 4.54 per cent compared with 4.82 per cent at a previous sale last month yesterday and the amount borrowed was also higher than the planned 900 million Euros. So we can see signs of a small improvement in her position and this is being accompanied by some hyperbole too as I notice that the Chief Economist at Alpha Bank has written the following in the Financial Times about Greece’s fiscal position.
If a good beginning is half the work done……..the budget deficit seems to have been halved……..The 2011 budget seems credible
There is some interesting use of the word “seems” here I think as if the author is not truly convinced. We also get a much more downbeat view on the revenue side of the coin.
To boost state net revenue, new as yet untapped sources, including green and gaming taxes, are to be exploited while further rises in property and consumption taxes are envisioned. Moreover, earnest efforts to arrest tax evasion will also start biting next year.
I have to admit to a wry smile the use of the words and phrases “are to be exploited”,”envisioned” and the fact that dealing with tax evasion appears to be a job for next year! This makes the article look more like a wish list than a programme. I wrote on Greece’s plans for a tax amnesty on the 4th October where I added this from the Greek newspaper Kathimerini.
Papandreou must take control of the state apparatus and close the tap that keeps pouring money into a corrupt system. If he doesn’t, the people’s sacrifices will have been in vain
This is a somewhat different view and we also have the European Union’s report on a further black hole in Greece’s finances to come. So the picture is much more uncertain than implied in the article which partly uses Greece’s recent poor inflation performance which raises nominal GDP to try to make the figures look better. Of course for the individual Greek inflation only makes the position worse.
We will have to see if Mr.Weber’s even more public stand against the SMP has an effect on the peripheral euro zone nations but one thing is for sure and that is the world’s authorities have seldom been so dis-united and that in itself sends its own message.