After the equity rallies of the first day of the new year we gathered some new information on what central banks are likely to do in 2011 yesterday. Firstly we received new data on inflation in the Euro zone and secondly the Federal Reserve released the minutes from its December meeting. The minutes were of importance because the combination of equity market rallies ( the 6% rise in the Dow Jones Industrial Average since November 30th I reported on yesterday) and some signs of improvement in the US economy and of course the tax cut/fiscal stimulus had led some to suggest that we would not see the full US $600 billion of asset purchases from the so-called QE2 programme. In a way this reflects a theme of this blog, the extraordinary scale of central bank intervention in world markets as in this instance concern over withdrawal of some of the potential intervention was considered by some to be a significant factor.
The Minutes from the Federal Open Market Committee’s meeting on the 14th December
If we look at these we find the following significant sections.
While the economic outlook was seen as improving, members generally felt that the change in the outlook was not sufficient to warrant any adjustments to the asset-purchase program, and some noted that more time was needed to accumulate information on the economy before considering any adjustment. Members emphasized that the pace and overall size of the purchase program would be contingent on economic and financial developments; however, some indicated that they had a fairly high threshold for making changes to the program.
So we see that in fact (as I suspected) changes to the policy are not particularly and some members of the FOMC seem determined not to change course. However there is a range of views and some disagreement.
the most likely outcome was a gradual pickup in growth with slow progress toward maximum employment. However, they held a range of views about the risks to that outlook. A few mentioned the possibility that growth could pick up more rapidly than expected.
Also the FOMC gave us some interesting views on dangers to US policy.
One common concern was that the housing sector could weaken further in light of the considerable supply of houses either on the market or likely to come to market. Another concern was the ongoing deterioration in the fiscal position of U.S. states and localities, which could lead to sharp cuts in spending and increases in taxes. In addition, participants expressed concerns about a possible worsening of the banking and financial strains in Europe.
So we can see that whilst there are disagreements within the FOMC it does not appear likely that it will change course. The part that I found interesting was the reference to problems in state and local government in the United States itself. The problem has not got the publicity that say the problems of the peripheral Euro zone nations have but nonetheless it is a problem. At this moment it appears that California and Illinois have the biggest problems and I notice that the Wall Street Journal has an article on 1841/2 when 8 states and Florida ( a territory then) defaulted.
After reading the minutes I feel that the underlying message is that neither unemployment nor inflation are,according to the FOMC, where they should be and until they are the FOMC will continue with its asset purchases. With its current mood further purchases are as likely as fewer and frankly maybe more so.
There was an interesting section on long-term interest rates which by the date of the meeting had risen a fair bit from the euphoria which had led ten-year government bond yields to touch 2.4% and in fact stood one point higher. Something of an irony for an agency trying to reduce them! However I will spare you the long section and simply say that they do not understand why this happened. This is of course a further indictment of central bank intervention if you think about it as many would think that if you are going to buy a trillion dollars of something it might be best to understand the market you are playing in.
Euro Zone Inflation
Here was some disturbing news for the European Central Bank as inflation over the Euro Zone rose to 2.2% as expressed by its Consumer Price Inflation measure. This is significant for two reasons,firstly the ECB targets a rate of just under 2% and also because the President of the ECB Mr.Trichet made a big deal of success on this front at the last meeting. He said the following at the Press Conference on the 2nd of December.
Well, there are German citizens in this room. They can say that the euro has given the 330 million citizens of the euro area, including their compatriots, price stability, with inflation standing at 1.97%. Nobody ever challenges this when I say it. In Germany, the figure is even better. For Germany, inflation has stood at around 1.5% since the inception of the euro, the best result for Germany and indeed the euro area as a whole in 50 years. Frankly, for an institution that was called on by the citizens of Europe to have a primary mandate of delivering price stability, I think this is worth repeating.
Unfortunately for Mr.Trichet only one month later we see that Euro Zone inflation has risen above target and furthermore that German inflation has risen to 1.9%! Oh dear, we can see that timing may not be his strong suit,something of an irony as of course as he was speaking the dealers at the ECB Securities Markets Programme were on the phone buying the government bonds of Ireland Greece and Spain. The theme here in my opinion is tactical success but strategic failure.
As to the causes of the inflation then much of it seems to have been driven by the familiar duo of oil and commodity price rises. These can ebb and flow but as measured by the CRB spot index which at 523 continues to rise there is no sign of a break in the commodity component. However crude oil prices are proving more volatile as on Monday the West Texas Intermediate benchmark rose above US $92 per barrel but today it is just under US $89.
Euro Zone government bond yields: Portugal, Ireland and Greece
In spite of the fact that the Securities Markets Programme of the European Central Bank has carried on purchasing government bonds over the holiday period we find that yields are very elevated still in these countries. There will be some further information today as the nation of these three which has been least affected so far Portugal has some 6 month Treasury Bills to issue. However whilst its ten-year government bond yield is at 6.77% much lower than that of Ireland and Greece it is at a level which would leave Portugal insolvent. Also as German yields declined with her equivalent closing at 2.9% the spread between the two is in danger of reaching 4% again.
The Irish situation remains problematic as her ten-year yields some 9% which is a very disappointing result for a nation which is a recipient of an 85 billion Euro aid package. The real problem remains her banking and housing sectors. The banking sector is unable to shake off worries that the aid to it may not be enough and cannot shake off fears of falling deposits and the housing sector has just received a new set of data saying that house prices are still falling in Ireland. The housing website Daft has just reported that asking prices fell by just under 5% in the 4th quarter of 2010 making a total fall of just under 14% for the year as a whole.
The Greek problem:rising bond yields
You might think that some 7 months or so into a rescue package where Greece only has to issue short-term bills that there would be signs of recovery in this area. Unfortunately you would be wrong as Greek government bond yields are rising again. Her ten-year bond yield is now 12.83% and even worse she has a bond which expires in May 2013 which yields 15.3%! The reason why this is worse is that it stands comfortably within the period of the rescue plan which now extends for at least 7 years. In effect the markets are saying to the authorities, “We don’t believe you” as problems remain about how the Euro Zone will change its policies in 2013. The only matter that has been settled is how far Europe’s politicians feel that they have to kick the can down the road and it is somewhere towards the end of 2013.
Whilst official bodies continue to pursue the party line that Greece will not have to default virtually everyone with an independent mind can see that she will have to do so in some form. I notice that in a speech yesterday the former IMF Chief Economist Kenneth Rogoff thinks the same. So this leads to the question when? To which the answer is when it is politically convenient, the problem is that there are no signs of such a period occurring. In the meantime we have more liquidity solutions to solvency problems from the Euro Zone and whilst they repeat this incorrect medicine then an improvement is unlikely.
Today Portugal auctioned some 500 million Euros of 6 month Treasury Bills and the yield she had to pay rose to 3.69 percent compared to the 2.05 percent at a sale of similar maturity securities in September 2010. If we put this into context of a year ago then the yield has risen by over 3% from the 0.592 % it paid then.
As we know that the ECB is supporting the market this is a poor result and we face a year where Portugal will have around 20 billion Euros of debt to issue for both new borrowing and to cover redemptions of existing stock. This will not be easy and these bills will have to be replaced in July. She has the opportunity to call for international aid before yields get really out of control but I have been calling in vain for this for some months now. If she repeats the experience of Ireland and Greece then sadly we can only expect the same (failed) result