Trade volumes in FX was reported to be weak on the second trading day of the year, and while gold and commodities have seen sharp movements, it is not clear that this is the beginning of a multi-week correction trend. Gold, in particular, has lost more than $45 per ounce in another of its typical sharp swings, in anticipation of a stronger dollar, and some concern about the Chinese interest rates. FOMC minutes released Tuesday further boosted the USD-positive sentiment, since the committee appears to note some economic improvement, and refrains from making any kind of commitment to another round of QE. Core inflation, according to the minutes, has bottomed out, and while 2011 may see some upside momentum in prices, 2012 will bring price stability back. In short, we`re told, this is as far as the FOMC is prepared to go for now on QE, with no clarity provided on when on how the program will be ended.
We have seen such statements before. Even in October 2007, the FMOC member Randall Krozner was speaking about the importance of keeping rates at a reasonable level, about his concern about inflation expectations, and issuing forth stock statements in an air of seriousness, yet the same FOMC later brought rates to zero, as we all know, and there they have stayed till now. We don`t suggest that the Fed doesn`t know what it is doing, because that is the subject for a different debate, but we do mean that their statements on the outlook are no more important than any analyst report that would be issued with respect to their future actions. In other words, we don`t think that the Fed knows what it will do any better than the typical analyst, and the minutes are more valuable then analyst reports only because people short-term trade the markets with them.
The release emphasizes that the risks to the growth outlook are significant, focusing on the house price, and Eurozone debt crises. If these progress in a manner that weakens sentiment in the markets considerably, driving interest rates on mortgage, and consumer loans higher than where the Federal Reserve wants them to be, Ben Bernanke`s statements up to date ensure that the Fed will act.
On Eurozone issues, we note the impact of an article at PIMCO`s website. They seem to be getting out of Eurozone peripheral debt, which has had a rather strong impact on bunds and Treasury bonds according to reports. German unemployment was released unchanged at 7.5%, while Eurozone CPI rose above the ECB`s two percent target at 2.2%, and is not giving any sign of easing unless the Euro finds some respite from the constant talk about its demise. While the ECB`s actions are often hard to predict, we don`t expect any rate increases unless the Euro goes into a stall.
The focus has been on other issues recently, but the wave of competitive devaluations is still with us, with two central banks intervening today in local markets in order to rein in speculative inflows yet again, and Brazil threatening to alter commerce and FX regulations, as well as reduce government spending in order to control the real`s strength, and facilitate lower interest rates. Of these announcements, we think that the Brazilian one is the most interesting, because it goes beyond the usually futile intervention threats in order to discuss the implementation of controls on capital movements which echoes of times before the 2000-2010 period.
Just to the west of Brazil, we have Chile intervening by purchasing an enormous $12 billion dollars in the market, building up its reserves, and pulling the rug from under the feet of peso buyers, at least in the short term. Short-term traders were naturally gutted in the course of this heavy-handed intervention, but others note that, unless copper prices recede from their high levels, the Chilean central bank will have to keep pumping pesos into the market, as the country is producing about 35% of the global copper output. Anything less than that, and the peso will find solid demand.
Bank of Korea was also seen actively selling the won against the dollar in Asian trading, but that kind of action is fairly regular nowadays.
Hu Jintao and President Obama will have a face-to-face meeting in two weeks or so, and many people expect the Chinese to time the next leg of yuan appreciation to coincide with the visit. Yang Jiechi, the ill-tempered Chinese foreign minister, and Treasury Secretary Geithner, the main engineer of the Bush era bailouts, will meet on Tuesday to prepare the groundwork for the visit, in a process that will keep building up momentum. Just before President Hu Jintao visits the U.S., Robert Gates, the Defense Secretary will be in China to discuss some Taiwan-related arms sales issues that are understood to have angered the Chinese. So the hectic pace of U.S. - China dialogue will be maintained into 2011.
USDCNY was fixed at 6.6215 vs. 6.6227 of Friday.
We conclude by mentioning the troubles faced by DPJ`s veteran backroom dealer, career politician Ichiro Ozawa, who is facing pressure to resign after corruption and bribery investigations have been initiated against him. He has told the PM, who has been calling for his resignation, that he alone and the Japanese people will determine whether he will quit his seat at the Diet. If Mr. Ozawa quits, it will at least give the PM some calm as he makes his final attempts to salvage his disgraced government in the eyes of the voters.
Trade volumes in FX was reported to be weak on the second trading day of the year, and while gold and commodities have seen sharp movements, it is not clear that this is the beginning of a multi-week correction trend. Gold, in particular, has lost more than $45 per ounce in another of its typical sharp swings, in anticipation of a stronger dollar, and some concern about the Chinese interest rates. FOMC minutes released Tuesday further boosted the USD-positive sentiment, since the committee appears to note some economic improvement, and refrains from making any kind of commitment to another round of QE. Core inflation, according to the minutes, has bottomed out, and while 2011 may see some upside momentum in prices, 2012 will bring price stability back. In short, we`re told, this is as far as the FOMC is prepared to go for now on QE, with no clarity provided on when on how the program will be ended.
We have seen such statements before. Even in October 2007, the FMOC member Randall Krozner was speaking about the importance of keeping rates at a reasonable level, about his concern about inflation expectations, and issuing forth stock statements in an air of seriousness, yet the same FOMC later brought rates to zero, as we all know, and there they have stayed till now. We don`t suggest that the Fed doesn`t know what it is doing, because that is the subject for a different debate, but we do mean that their statements on the outlook are no more important than any analyst report that would be issued with respect to their future actions. In other words, we don`t think that the Fed knows what it will do any better than the typical analyst, and the minutes are more valuable then analyst reports only because people short-term trade the markets with them.
The release emphasizes that the risks to the growth outlook are significant, focusing on the house price, and Eurozone debt crises. If these progress in a manner that weakens sentiment in the markets considerably, driving interest rates on mortgage, and consumer loans higher than where the Federal Reserve wants them to be, Ben Bernanke`s statements up to date ensure that the Fed will act.
On Eurozone issues, we note the impact of an article at PIMCO`s website. They seem to be getting out of Eurozone peripheral debt, which has had a rather strong impact on bunds and Treasury bonds according to reports. German unemployment was released unchanged at 7.5%, while Eurozone CPI rose above the ECB`s two percent target at 2.2%, and is not giving any sign of easing unless the Euro finds some respite from the constant talk about its demise. While the ECB`s actions are often hard to predict, we don`t expect any rate increases unless the Euro goes into a stall.
The focus has been on other issues recently, but the wave of competitive devaluations is still with us, with two central banks intervening today in local markets in order to rein in speculative inflows yet again, and Brazil threatening to alter commerce and FX regulations, as well as reduce government spending in order to control the real`s strength, and facilitate lower interest rates. Of these announcements, we think that the Brazilian one is the most interesting, because it goes beyond the usually futile intervention threats in order to discuss the implementation of controls on capital movements which echoes of times before the 2000-2010 period.
Just to the west of Brazil, we have Chile intervening by purchasing an enormous $12 billion dollars in the market, building up its reserves, and pulling the rug from under the feet of peso buyers, at least in the short term. Short-term traders were naturally gutted in the course of this heavy-handed intervention, but others note that, unless copper prices recede from their high levels, the Chilean central bank will have to keep pumping pesos into the market, as the country is producing about 35% of the global copper output. Anything less than that, and the peso will find solid demand.
Bank of Korea was also seen actively selling the won against the dollar in Asian trading, but that kind of action is fairly regular nowadays.
Hu Jintao and President Obama will have a face-to-face meeting in two weeks or so, and many people expect the Chinese to time the next leg of yuan appreciation to coincide with the visit. Yang Jiechi, the ill-tempered Chinese foreign minister, and Treasury Secretary Geithner, the main engineer of the Bush era bailouts, will meet on Tuesday to prepare the groundwork for the visit, in a process that will keep building up momentum. Just before President Hu Jintao visits the U.S., Robert Gates, the Defense Secretary will be in China to discuss some Taiwan-related arms sales issues that are understood to have angered the Chinese. So the hectic pace of U.S. - China dialogue will be maintained into 2011.
USDCNY was fixed at 6.6215 vs. 6.6227 of Friday.
We conclude by mentioning the troubles faced by DPJ`s veteran backroom dealer, career politician Ichiro Ozawa, who is facing pressure to resign after corruption and bribery investigations have been initiated against him. He has told the PM, who has been calling for his resignation, that he alone and the Japanese people will determine whether he will quit his seat at the Diet. If Mr. Ozawa quits, it will at least give the PM some calm as he makes his final attempts to salvage his disgraced government in the eyes of the voters.
Central bank activity for the major currencies was again rather sparse last week, with no major rate decisions coming out.
Central bank observers had to make do with the release of the FOMC minutes and the BOE Inflation Report hearings.
Furthermore, rather little was released in the way of significant economic data last week, since the week's trading sessions were shortened by the major U.S. Thanksgiving bank holiday observed on Thursday.
Last Tuesday, the U.S. Fed's Federal Open Market Committee released its minutes for their November meeting that was held on November 2nd and 3rd. The minutes offered some insight into the Fed's plans for Large Scale Asset Purchases or LSAPs, as well as indications of the Fed's economic projections and the prospects for future monetary policy.
In addition to the FOMC minutes, the Fed also released minutes from an October 15th conference call where committee members discussed how to conduct further easing measures and the potential targeting of a term interest rate.
The minutes also showed that the most recent QE II package was approved by the committee with an almost unanimous vote of 10 to 1. Nevertheless, there was some disagreement on the amount of quantitative easing the economy would require to return to a reasonable level of growth. Despite that disagreement, the members felt that the advantages of the stimulus package would outweigh the drawbacks on balance.
The FOMC minutes also demonstrated that the Fed had downgraded its estimates for future unemployment, which is currently projected to fall within the 8.9% to 9.1% range for 2011. In addition, inflation is expected to rise in the near term but still forecast to stay below the 2% level.
Significantly, the committee also downwardly revised its growth estimate for the U.S. economy, and members now expect U.S. GDP to grow by 2.4% to 2.5% for 2010, 3.0% to 3.6% for 2011, 3.6% to 4.5% for 2012 and 3.5% to 4.6% for 2013.
Participating members also noted that real estate investment, manufacturing and trade indicators were also considerably weaker than expected and that the initial benefits from the first round of quantative easing measures were no longer providing what they deemed to be necessary support for the U.S. economy.
Finally, the minutes reflected that given the current state of the U.S. economy, the Fed's monetary policymakers do not currently see any kind of rate hike taking place until at least the fourth quarter of 2012.
Despite the less than positive economic outlook, most FOMC members continue to remain optimistic, although one member warned that Large Scale Asset Purchases could spark inflation and could therefore undermine the Fed's independence.
The Bank of England Governor and some MPC members participated in hearings on the BOE's quarterly Inflation Report on November 25th of last week. The hearings were held before the British Parliament's Treasury Committee which basically reviews the MPC's and the BOE Governor's monetary policy approach toward fighting inflation.
In his opening statement made before the Treasury Committee, BOE Governor Mervyn King commented that,
"there is no reason to expect that inflation will be significantly affected by further movements in the exchange rate, taxes or commodity prices."
He then concluded his opening statement by observing that,
"overall, a majority of the MPC have concluded that the risks are, at present, broadly balanced. But we all stand ready to adjust policy - in either direction - should the outlook for inflation demand it."
Furthermore, in his testimony before the Treasury Committee, King stated that the outlook for demand in the U.K. was considerably uncertain and that the BOE was therefore challenged in controlling inflation.
In addition, King said he sees U.K. GDP growth as coming out lower than the original MPC forecast.
Next week's central bank activity has the U.S. Federal Reserve Bank releasing its Beige Book this coming Wednesday, December 1st that is more formally known as the Summary of Commentary on Current Economic Conditions.
Released eight times per year, the Beige Book surveys anecdotal evidence from key business contacts, economists, market experts and bank officials from each of the 12 Federal Reserve districts about local economic conditions.
The FOMC uses this economic analysis to help them make their next monetary policy decision, although the FOMC also uses the Green Book and the Blue Book that are not made public and which are thought to be more influential on policy.
In addition, the ECB will be announcing its Minimum Bid Rate Decision and will hold its associated Press Conference on Thursday, December 2nd. The European central bank is currently expected to leave rates unchanged at 1.00 percent for the eighteenth straight month.
It is not surprising that the FOMC has decided not to restrict the scale of asset purchases so soon after they were initiated, and yesterday`s dismal data on home prices certainly reinforces the notion that the Fed is not being too hasty in pumping liquidity into the system. The situation of the residential real estate market in the U.S. remains grim, and it is likely to get worse under the impact of judicial processes that could drag on for a long time. The Fed`s buying of Treasuries, if it does help to reduce mortgage rates, will certainly help alleviate the pressure on the economy. Yet this is far from being certain, because the market in question is enormous, and even if the bank temporarily manages to keep it afloat by engaging in quantitative easing, it is possible that a dosage of the medicine will need to be administered continuously in order to keep the sector afloat.
And that is the main problem, of course. The market is not so pessimistic that the Fed cannot engineer a jolt to growth for the near term, and its capability of boosting inflation somewhat for a limited time period is not a matter of great doubt. But there is no indication that such a short term program will deliver the necessary impetus to sustain a longer term reversal of course leading to elimination of the masses of the unemployed, and creating a self-sustaining momentum that can prevent asset price depreciation, and encourage Americans to spend. Although, on the basis of the demographic trends in the U.S., one may argue that the chances of such a plan succeeding over a considerable period of time are better than many would admit, the uncertainty surrounding the trajectory of U.S. public finances, and the USD during the implementation of this project depresses the enthusiasm of market participants.
The threat of the Moody`s rating agency, that it may place the U.S. on negative outlook if the present policy stance is maintained was not heeded by the markets today, and the CDS market was mostly bullish, as traders seem to have some confidence in the notion that the Fed`s easing scheme will eventually contribute to an improvement in the economic situation. While there is no sign yet that the market is planning to abandon the U.S. government at any time soon, there are events that can make the market give up on U.S. assets. The degree to which the democratic process is effective in the U.S., the extent to which the best opinions are freely propagated to the public, will determine whether we`ll become witnesses to such events in the near future. The results of the November elections do not look discouraging in this respect.
Ultimately, the outcome for the public debt of the U.S. and the dollar is dependent on the outcome for the rest of the world. Those who espouse an overly pessimistic point of view on the U.S. economy are failing to place the country in a global context within a wider analytical framework. While it is true that the U.S. management monetary and fiscal policy is too adventurous and extreme in many ways, there is hardly a nation in the world that cannot be made subject to similar criticisms with a little bit of effort. Due to the increase in the velocity of money on a global scale over the past two decades, governments are unable to respond in a timely and effective manner to challenges created by capital flows. This is as true fo the Fed and the U.S. as it is for China, Brazil, the E.U. or any group of nations that is operating a sufficiently liberal economic system. The challenge is to the existing system, and not to any nation. With all its handicaps, the U.S. still enjoys a favorable status as it has the unique advantage of possessing a powerful reserve currency that almost no one wants to depreciate, enjoys a well-established and healthy system of alliances, and dominates economic and political institutions around the world. Its media channels enjoy almost uncontested supremacy in the world, which contributes to the maintenance of a reasonable positive image. It is beyond doubt that Americans possess the means to destroy all these by foolish choices over the next years, but the background for the dollar-death scenario that people continue to speculate about is a remote possibility for now.
