Category: Banks & Interest Rates

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EU Deal Reached on Bank Supervisor | WSJ.com

GABRIELE STEINHAUSER And LAURENCE NORMAN at WSJ write:

European Union finance ministers reached a landmark deal early Thursday that would bring many of the continent’s banks under a single supervisor, in what governments hope will be a major step toward resolving their three-year-old debt crisis. Ministers said the European Central Bank would start policing the most important and vulnerable banks in the euro zone and other countries that choose to join the new supervisory regime next year. Once it takes over, the ECB will be able to force banks to raise their capital buffers and even shut down unsafe lenders.

This is an important step, centralizing banking control in Brussels. Though there is bound to be dissent amongst member states as to capital buffers and unsafe lending practices.
Read more at EU Deal Reached on Bank Supervisor – WSJ.com.

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Risk Seen in Fed Bond Buying | WSJ.com

KRISTINA PETERSON at WSJ writes:

The Federal Reserve should stop buying bonds, even as the central bank is poised to purchase more, according to a narrow majority of economists in a new survey by The Wall Street Journal……”It’s distorting market prices and creating problems in the future,” said John Silvia, chief economist at Wells Fargo Securities, who said the Fed’s bond-buying was making long-term Treasurys too expensive without significantly easing problems in the labor market. “The Fed needs to back away and let interest rates rise just a little bit,” he said.

If past performance is anything to go by, Fed quantitative easing (or bond buying) is ineffectual in lifting the employment rate. And the lower that they drive bond yields, the greater the backlash when yields eventually rise. Yields are likely to spike up rapidly as bond-holders attempt to offload positions in order to avoid massive capital losses.

via Risk Seen in Fed Bond Buying – WSJ.com.

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Fed’s numerical thresholds are a bad idea

The Fed effectively tied its monetary policy to a balloon bobbing in the wind. Pedro da Costa writes on Reuters:

The Federal Reserve on Wednesday took the unprecedented step of tying its low rate policy directly to unemployment, saying it will keep rates near rock bottom until the jobless rate falls to 6.5 percent. That’s as long as inflation, the other key parameter of policy, does not exceed 2.5 percent.

Both unemployment and inflation are moving targets. Unemployment primarily because results are highly dependent on the participation rate: disheartened job seekers who give up looking for work are excluded from unemployment figures. Likewise, inflation measures are highly subjective. Weightings require constant adjustment because of advances in technology and changes in consumption patterns, while cost of housing estimates, which make up 39 percent of core CPI, seem to have little connection with reality. Scott Sumner points out:

The problem seems to be that, according to the Bureau of Labor Statistics, housing prices did not fall. On the contrary, their data shows housing prices actually rising between mid-2008 and mid-2009, despite one of the greatest housing market crashes in history. And prices did not rise only in nominal terms; they rose in relative terms as well, that is, faster than the overall core CPI. If we take the longer view, the Bureau of Labor Statistics finds that house prices have risen about 8 percent over the past six years, whereas the famous Case-Shiller house price index shows them falling by nearly 35 percent…..

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Dangers of quantiative easing may be political more than technical

Glenn Stevens, governor of the Reserve Bank of Australia, in an address to the Bank of Thailand today commented on the dangers facing central bank monetary policy:

For the major countries a further dimension to what is happening is the blurring of the distinction between monetary and fiscal policy. Granted, central banks are not directly purchasing government debt at issue. But the size of secondary market purchases, and the share of the debt stock held by some central banks, are sufficiently large that it can only be concluded that central bank purchases are materially alleviating the market constraint on government borrowing. At the very least this is lowering debt service costs, and it may also condition how quickly fiscal deficits need to be reduced. There is nothing necessarily wrong with that in circumstances of deficient private demand with low inflation or the threat of deflation. In fact it could be argued that fiscal and monetary policies might actually be jointly more effective in raising both short and long-term growth in those countries if central bank funding could be made to lead directly to actual public final spending – say directed towards infrastructure with a positive and long-lasting social return – as opposed to relying on indirect effects on private spending.

The problem will be the exit from these policies, and the restoration of the distinction between fiscal and monetary policy with the appropriate disciplines. The problem isn’t a technical one: the central banks will be able to design appropriate technical modalities for reversing quantitative easing when needed. The real issue is more likely to be that ending a lengthy period of guaranteed cheap funding for governments may prove politically difficult. There is history to suggest so. It is no surprise that some worry that we are heading some way back towards the world of the 1920s to 1960s where central banks were ‘captured’ by the Government of the day.

via RBA: Speech-Challenges for Central Banking.

Hat tip to Walter Kurtz at Business Insider.

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Carney broaches dumping inflation target | FT.com

Claire Jones reports that Mark Carney says central banks should consider scrapping inflation targets and target nominal GDP instead — allowing more aggressive measures during a down-turn.

[Mark Carney, next governor of the Bank of England] suggested that a nominal GDP target, where a central bank sets monetary policy based on both inflation and growth, would do more to boost economic output. “For example, adopting a nominal GDP-level target could in many respects be more powerful than employing thresholds under flexible inflation targeting,” he said.

Read more at Carney broaches dumping inflation target – FT.com.

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The Fed's interest rate policies are damaging rather than restoring confidence and should be reversed

Vince Foster at The Fiscal Times writes about this Wednesday’s FOMC meeting:

With Operation Twist due to expire at the end of the year and because the Fed is essentially out of short-term bonds with which to finance purchases, it is virtually assured that they will opt for outright purchases financed with printed money……….Now, said Ned Davis Research in a report last week, the Fed is likely to replace Operation Twist with purchases of Treasuries, perhaps in the $45 billion a month range, bringing its total monthly purchases to $85 billion.

Outright purchases of long-term Treasuries are far more expansionary than Operation Twist purchases which are off-set by the sale of shorter-term maturities.

Foster discusses Fed motives, considering that previous QE failed to lower interest rates or lift stock market values.

It has been my contention that the main objective is not to reflate asset prices but rather to stimulate credit creation and the velocity of money. According the Fed’s H.8 Release banks are holding over $2.6 trillion in cash that’s sitting idle on their balance sheet in securities portfolios. Bernanke is trying to flush the banking system out of these bloated securities positions and into extending credit by lowering bond yields to levels where banks can no longer afford to hold them.

Foster points out that negative real interest rates may be discouraging banks from lending, inhibiting the recovery. Also that bank balance sheets — bloated with Treasuries and MBS ($2.6 trillion) purchased as an alternative to lending — are vulnerable to capital losses should interest rates rise.

The Fed’s low-interest-rate policies have created a powder keg while being largely ineffectual in stimulating credit creation and consumption. The safest approach would be to reverse these policies and raise interest rates. Raising long-term rates to sustainable levels would reduce uncertainty and help restore confidence. House prices and stocks may initially fall but this would flush any excess inventory out of the system, giving purchasers and banks confidence that the market really has bottomed. With higher rates and stable collateral, banks will be more willing to lend.

At present we are all sheltering under the shadow of the Fed’s low-interest-rate umbrella, but with a nagging fear as to what will happen when the Fed takes the umbrella away. Fed policies are no longer adding confidence but increasing uncertainty. The sooner the umbrella is removed, the sooner the system will return to normality.

QE is likely to continue — Treasury needs to print money in order to fund the fiscal deficit — but this can still occur at higher rates. The fiscal deficit unfortunately will remain with us for some time — until confidence is completely restored and deflationary effects of private sector deleveraging are consigned to the history books.

Read more at How the Fed Will Affect Economy, Market in 2013 | The Fiscal Times.

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Phoney recovery?

First signs of recovery after a recession are normally rising earnings, initially from corporate cost-cutting but followed up with rising revenues.

With massive central bank pump priming — referred to by Mark Mobius here — this time may be different. Flows of new money from central bank balance sheet expansion are likely to find their way into the stock market — and even the housing market — driving up prices. But consumption is lagging with slow growth in employment and average wages. With lackluster sales growth, earnings are likely to remain sluggish. Which means inflated stock market valuations and high price-earnings ratios as stocks are driven into over-bought territory. Not a solid foundation for a sustained recovery but another rung up the ladder of risk.

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How cancelling central banks’ holdings of government debt could be a useful thing | FT Alphaville

FT’s Kate Mackenzie writes: Morgan Stanley cross-asset strategist Gerard Minack says the remarkable thing about developed economy deleveraging is how little of it has happened:

The credit super-cycle ended four years ago, but leverage has hardly fallen in major economies: debt-to-GDP ratios remain historically high.

Debt To GDP Ratio

Minack says the problem is some of that deleveraging (particularly for households) is being tackled by saving more, but that won’t solve the problem, or at least not very quickly. This is because of what the borrowings were used to finance: mostly pre-existing assets (that were forecast to rise in value) rather than expenditure.

There is a simple reason why deleveraging is taking so long: governments are borrowing money (deficit-spending) to offset private sector deleveraging and avert a deflationary spiral. So overall (non-financial) debt to GDP ratios, which include government debt, are almost unchanged.

That is not necessarily a bad thing — unless you would prefer a 1930s-style 50% drop in GDP after a deflationary spiral. What can be destructive is funding government deficits from offshore because you eventually have to pay the money back. Far better to borrow from yourself — in other words your “independent” central bank. That way you never have to pay it back.

As for canceling central bank holdings of government debt. Why bother? Interest payments made on the debt go right back to the Treasury as central bank profit distributions. And why set a precedent? I doubt many would believe government promises that this was a once-off and would never be repeated…….until next time.

via How cancelling central banks’ holdings of government debt could be a useful thing | FT Alphaville.

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Fed set to unveil extra asset purchases – FT.com

Robin Harding at FT writes:

The other issue on the agenda is replacing the FOMC’s current forecast that rates will stay low until mid-2015 with a set of preconditions for the economy to reach before it considers raising rates. “I now think a threshold of 6.5 per cent for the unemployment rate and an inflation safeguard of 2.5 per cent . . . would be appropriate,” said Charles Evans, president of the Chicago Fed…..

The problem is that both of these thresholds are moving targets:

  • Unemployment is based on surveys and only includes those who have actively sought a job in recent weeks. It fluctuates with the participation rate.
  • Inflation is also subjective, dependent on the basket of goods measured and estimates of housing inflation that are subject to manipulation.

Targeting nominal GDP growth would be far more accurate.

via Fed set to unveil extra asset purchases – FT.com.

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