ECB puts the pedal to the metal

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A measure of just how wrong the ECB has got things is the fact that it released a statement last night, just three days after its governing council meeting.  In welcoming “the announcements made by the governments in Italy and Spain concerning new measures and reforms”, together with its commitment to “actively impllement its Securities Markets Programme”, the ECB looks set to start buying more bonds today, including Italian and Spanish debt.

The justification from the ECB is to “help restore a better transmission of monetary policy decisions… and therefore ensure price stability in the euro area”, a similar arguement being offered for the liquidity expansion of Thursday. Whilst welcome, the actions further highlight the absurdity of the ECB’s policy of tightenign rates both in April and even more so in June.  The ECB is fighting a fire that only last month it was throwing fuel onto.

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Commentary

The fallout from US downgrade continues. The US lost its triple-A rating on Friday evening and the fallout continues.  Most of this is political, rather than financial.  This move should not be seen as that much of a surprise, given that they odds were 1 in 2 that this would happen given that it was put on watch by S&P for a downgrade.  The political fallout is from initial errors made in S&P’s calculations and naturally the US authorities are not that happy.  Nevertheless, as we have on many occasions, S&P highlighted the fractured political process in the US as being a barrier to achieving debt sustainability.  The impact on the dollar and also bond markets has been marginal.

G7 back on the block. The G7 has supposedly been overtaken by the G20, but nevertheless met last night and issued a statement designed to offer reassurance to fragile markets.  However, there was nothing substantial in it and it appeared largely an attempt to reassure investors that, even though many of the leaders are on holiday, they are on top of events.

Latest payrolls data deeply troubling.  The headline numbers for July were better than anticipated, but scratch only a little deeper and the state of the US labour market unfortunately remains deeply troubling.  On the positive side, non-farm payrolls were better than expected, up 117K in the month, with upward revisions in the previous two months totalling 56K. However, household employment fell once again last month, down another 38K after plunging 445K in June. For the year-to-date, household employment is essentially unchanged, confirmation of just how lamentable employment conditions have been so far this year. The average duration of unemployment continues to rise, now above 40 weeks. Such is the growing pool of discouraged workers and the elevated level of unemployment that the proportion of the working age population in employment is now just 58.1%, the lowest level for thirty years. Just ten years ago, this ratio was close to 65%. Using the IMF’s latest estimate of the US population (dated 31st December), the proportion of the US population now in some form of work is just 43%. Very simply, the economy is going nowhere fast if the employment ratio is so low. The US economy remains in serious difficulty.

Banks now charging institutional investors for deposits. In response to the collapse in money market rates to near zero over recent years, some banks have apparently taken the unprecedented step of actually charging their institutional clients for depositing large chunks of money with them. On Thursday Treasury Bill yields actually fell below zero as investors flocked to safety in response to the worsening sovereign debt crisis in Europe. According to a Bloomberg story, BNY Mellon will charge its large clients 13bp for ‘excess amounts of cash’. The difficulty for these large custody banks is that there is almost no prospect of reinvesting these deposits at anything other than near-zero interest rates, but at the same time they are hit with the cost of insuring these deposits with FDIC (Federal Deposit Insurance Corporation).

The RBA’s tricky policy dilemma. Calibrating monetary policy is hardly ever an easy task, none more so than in Australia at the present time. The high exchange rate, together with the increasing trepidation being displayed by consumers, has contributed to a further substantial reduction in the RBA’s expectation for growth in the current year. Although mining sector investment remains exceptional buoyant, the RBA now expects growth of just 2% for the current calendar year, compared with an estimate of 3.25% made just three months ago. At the same time, the Australian central bank still has genuine and entirely understandable concerns regarding inflation, which could reach 3.5% YoY in the final quarter. It is also conscious of the gathering international storm-clouds, especially the deepening debt crisis in Europe. For the Aussie, these changes to the RBA’s read on growth and inflation weighed on the currency overnight Thursday. In almost the blink of an eye, the Aussie has dropped from the very top of its recent trading band to the very bottom. Notwithstanding the tremulations in global financial markets over recent days, it remains a very difficult call in terms of confidently asserting which end of the 1.04-1.10 trading range will ultimately break.

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