Saturday, December 6, 2014

Weekly Commentary, March 29, 2013: Invaluable Insight from Axel Weber

Europe is again showing heightened fragility, while U.S. equities post a big first-quarter.

The Cyprus fiasco has brought a number of important issues to the fore. It doesn’t seem an inopportune time to be reminded that the Germans just have a different view of how economic systems function. And this difference has been on increasing display. Anyone that has even casually studied “Austrian” economics certainly appreciates the stark contrast to American economic doctrine. Over the years, as our economic thinking and central bank policies have evolved ever more radically, I have looked to grounded German central bankers for sound doctrine and analysis (along with a little sanity).

I recently noted a 2004 CBB, “Issing v. Greenspan”. It was written in the midst of overheated mortgage finance and the emergent Greenspan/Bernanke doctrine of ignoring asset Bubbles (focusing instead on “mopping up” strategies in the event one burst). Analysts with an “Austrian” bent saw rather obvious dangers in the Fed’s policy of accommodating Credit and speculative excess, asset inflation and the misallocation of resources throughout the economy.

Back in ’04, I excerpted from a speech from Otmar Issing, Chief Economist at the Bundesbank and ECB, including an insight that is even more pertinent today: “Huge swings in asset valuations can imply significant misallocations of resources in the economy and furthermore create problems for monetary policy. Not every strong decline in asset prices causes deflation, but all major deflations in the world were related to a sudden, continuing and substantial fall in values of assets. The consequences for banks, companies and households can be tremendous…”

The Bundesbank decisively won that debate, although the Fed has fought hard to rewrite history. And now we’ve reached another critical juncture in economic history, with the Federal Reserve having evolved to a policy of directly inflating asset markets. One would have thought that by now the American doctrine of inflationism would have been discredited. Instead, our central bank has become only more radical, with its $85bn monthly printing in a non-crisis environment. Many central banks around the world have followed suit, with the Bank of Japan now about to aggressively expand its printing operation.

The upshot has been highly speculative and inflated securities and asset markets around the globe. Meanwhile, the Germans have been under heightened attack for bucking the ultra-easy “money” craze. They denounce unrestrained borrowings and mounting debt levels. They see myriad financial and economic imbalances and deep structural problems on a global basis.

From the German perspective, they see no substitute to financial, economic and policy reform. The Bundesbank has protested “money financing” of European sovereign debt and, more specifically, the open-ended “Draghi Plan” market backstop. Anecdotes over the years have suggested that Bundesbank officials view U.S. monetary policy with increasing alarm. With this in mind, I will this week highlight Insights from Axel Weber, UBS Chairman, and former ECB Council Member and Bundesbank President. If Mr. Weber had not resigned from the ECB in protest over the bank’s bond purchases, he might today have Draghi’s job. I believe his comments are in line with those at the Bundesbank and perhaps German policymakers more generally.

On a seminar panel with chairman Bernanke, former Treasury Secretary Larry Summers, and the Bank of England’s Mervyn King, Mr. Weber spoke this week at the London School of Economics (LSE). Seemingly intent on providing colorful material for future historians, Bernanke stated “because stronger growth in each economy confers beneficial spillovers to trading policies, these policies are not ‘beggar-thy-neighbor’ but rather ... ‘enrich-thy-neighbor’ actions.” Fortunately, Weber came prepared to share valuable insight.

From Mr. Weber: “Now, I’ve changed sides (from being a central banker), so to say. I’m now in the private sector who’s getting a lot of flack now, especially having been stabilized largely through public intervention. So I feel a bit along the side… having left office, I can speak more freely. And what I’m going to do here is basically poor some water into the wine. I think what we heard a lot here was central banks are frequently entrusted with more and more tasks. They get more and more tasks and therefore they need more and more instruments. My point is there is some expectation management in order here, because as central banks obtain a larger core role in the economy, we do have to see the downside: what this could potentially mean. And therefore this expectation management is important. It’s important to have that expectation management on unintended consequences – or side effects of monetary policy. And it’s also important for the new roles that central banks are now getting more and more into, and that is a role in the supervisory world – a role in financial stability, a key player in financial markets that increasingly deals with banks from all angles. And that gives them a special responsibility. And I think it also heightens the risk that central banks, if they get it wrong, they could get it wrong across a number of issues.

Let me start very briefly… with just giving you a very brief view on what I think are the key issues now. The question of lessons learned… we’re not really out of the woods yet. And so it may be a bit too early to draw some lessons learned. But my view is that global financial sentiment, while it has improved from last summer, and while there are some overall signs of a more stable and improving macro economic backdrop, better financial conditions and a pickup of investment is unfolding - this may be a period where the Cypriot developments that we’ve just seen over the past few days are a timely reminder that there still remain high-risks. And the handling of complexity and of stabilizing banking systems and stabilizing euro area problems is still out there. And maybe the mood that we’ve seen improve was good, maybe too good - and maybe too good to be true. So, I am still of the view that, in a sense, I fear the recent rally in financial markets that we’ve seen could be a misleading signal. It is more driven by exceptionally expansionary monetary policy - in the belief that on both sides of the Atlantic we could avoid some disasters. But, basically, the underlying progress in the economy hasn’t really made a meaningful forward leap. The big policy issues on fiscal policy, on structural policies, and on reforms are largely untackled and a fundamental rebound of economic activity is not yet clearly in sight.

And we have to continue to remind ourselves that stabilizing growth and moving to a more sustained momentum has to occur against a backdrop of a hugely elevated debt position and deficits in most of the major countries that are unprecedented for post-war history. Now, from a former central banker’s perspective, in my view, and I’d like to chime in very briefly on the discussion about the externality that is produced by quantitative easing policies. I fully agree with what was said here about the conduct of these policies and about sort of how it impacts on exchange rates. But there might be one dimension that I’m quite concerned about. And that is that the impact of quantitative policies seems to be larger in terms of impacting currencies if they’re conducted through quantitative purchases rather than short-term interest rate policies, probably because they very directly impact on the security markets which they deal with. And, therefore, while domestic currency weakness isn’t an expected desirable outcome, from the perspective of the central bank that’s easing monetary policy via asset purchases, the impact on the foreign exchange value of currencies does not create any overall global demand. It just redistributes demands away from appreciating currencies. And in that sense, the quantitative impact of those policies operating through quantitative easing seems to be stronger – and is leading to a debate whether global distortions emanating from one country and impacting on the other are really an issue that can be dealt with…

Monetary policies that have been easing over the crisis period had been adequate, in my view for a large part, into 2010. As of recently going forward, I think central banks are going to be much more pressed about giving clear answers to the questions of what an orderly exit from these policies will look like. We’ve known this for some time: central banks cannot resolve deeper structural issues. They can provide funding. This will buy time, but sustainable growth really needs to be emerging from serious policy reforms. And in that sense, there is a necessary debate whether some of the quantitative easing policies that have bought time have really bought time in the sense that this time bought was used wisely by policymakers to do the right reforms. Or, whether an unconstrained policy of that type doesn’t really over time start setting the wrong incentives and actually delays the relevant action. It has side effects also in terms of financial market stability. We’re seeing that in many areas, and I think central banks really need to weigh very carefully whether continuing on these policies will not down the road produce bigger problems. ”

During Q&A, a question from a LSE student: “My question, I think, touches upon Larry’s (Summers) sentiments. So I’d like to know from each of you, what do you feel is the purpose of economic growth and prosperity. I personally believe it’s to better and improve people’s wellbeing. But feel free to disagree with me. And how could we better leverage economic growth and prosperity to achieve that wellbeing, particularly over, say, the next twenty or so years…”

Weber: “One of the concerns I have with the current excessively loose monetary and fiscal policies is there is a set of generations that isn’t around the table. So I think a lot of what we’re seeing now is basically trying to achieve a dynamic in the economy that is unsustainable long-term, and therefore will come at the detriment of future generations. And, therefore, I’m quite concerned that keeping monetary and fiscal policies very loose for an unsustainable long period of time might generate some growth numbers that we see now that look good for current generations but actually come at the expense of future generations. So, I’m quite concerned about the intertemporal aspect here, whether we’re really trying to counter something that we look at as being cyclical. But if it’s actually more structural and we throw a lot of stimulus at it and basically undermine the future. I’m quite concerned about that intertemporal aspect of what we’re doing here in both monetary and fiscal policies.”

Larry Summers responding to the student question: “I think you got it right when you spoke of allowing people to have higher living standards, more choices in their lives and to live more comfortably. I can’t resist taking the opportunity, though, to disagree with the broad spirit of Axel’s [Weber] last comment. I do not believe that the long-run can be ceded to the avatars of austerity. Yes, I am the father or stepfather of six children. And, yes, on their behalf I am concerned about the possibility of an overly inflationary psychology will develop in my country. Yes, on their behalf, I am concerned that an excessive debt will be placed upon them. But I am vastly more concerned because I care about their long-run future that a slack economy will not provide for them with satisfactory jobs when they leave school. I am more concerned on behalf of their future that they will live in a country with decaying infrastructure that will not permit investment that maintains leadership. I am more concerned on their behalf that inadequate resources forced by countercyclical austerity will stunt the ability of their generation to be educated. I am more concerned on their behalf that excessively austerity-oriented policies will lead to slower economic growth and as a consequence to an ultimately higher debt-to-GDP ratio and more pressure in terms of higher tax burdens in the future. Those concerns, which come out of the proper management of current conditions, seem to me to be a larger concern for the long-run than the concern that somehow unstable and overly-expansionary policy – starting from where we are now – will stunt the opportunities that are open to them. Of course, if policy was starting at a different place, I would reach a different judgment. But starting where the United States or much of Europe or much of the industrialized world is today, it seems to me that the risks of profound stagnation are a more pressing concern than the risks of a resurrection of stagflation.”

Larry Summers and Axel Weber are two exceptionally intelligent, learned and highly-experienced policy experts. And in their respective responses to a question (about the purpose of economic growth and prosperity) they perhaps provided an historic exchange in contrasting economic views.

The “American” view holds that aggressive counter-cyclical monetary and fiscal stimulus spur growth, prosperity and higher standards of living for future generations. “Keynesian” policies can propel the economy back to its long-term growth path, in the process ensuring a higher overall utilization of human and other resources. More money equates to stronger demand, investment and economic expansion. More risk-taking equates to higher asset prices, greater wealth and a stronger expansion. There is little downside to expansionary policies with low utilization and minimal inflationary pressures.

And when listening to Mr. Summers, I couldn’t help but recall Time Magazine’s “Committee to Save the World” cover back in early-1999 (Summers with Alan Greenspan and Robert Rubin). “The inside story of how the Three Marketeers have prevented a global economic meltdown – so far.” I remember vividly how the post-LTCM bailout policy reflation incited a wild speculative run and a rapid doubling of Nasdaq. Then the bursting of the technology Bubble (and deflation hysteria) was followed with even more aggressive fiscal and monetary stimulus – that propelled the historic mortgage finance Bubble. These days, a protracted period of post-Bubble inflationary fiscal and monetary policies literally know no bounds. And, you know what, Mr. Summers’ justifications and rationalizations sound similar to those espoused by inflationists and monetary quacks throughout history.

Axel Weber’s analysis is more credible. At this point, no one should be able to convince us that aggressive monetary and fiscal policies don’t risk inflating problematic Bubbles. Five years into an aggressive reflationary cycle, it is clear that past policy mistakes have been responsible for deep structural impairment. And deep structural issues have provided a backdrop where the inflationists believe they’re justified in running the electronic printing presses around the clock. This issue of cyclical versus structural doesn’t get the attention it deserves. If, as I believe, our economy faces deep structural weaknesses and imbalances, throwing more money, risk-taking and asset inflation at the problem only worsens the situation. Regrettably, Washington didn’t listen to Issing - and they clearly have no interest in advice from Axel Weber.

For the Week:

The S&P500 gained 0.8% (up 10.0% y-t-d), and the Dow increased 0.5% (up 11.3% y-t-d). The S&P 400 MidCaps advanced 1.2% (up 13.1%), and the small cap Russell 2000 increased 0.6% (up 12.0%). The Banks slipped 0.6% (up 9.8%), and the Broker/Dealers fell 1.1% (up 14.4%). The Morgan Stanley Cyclicals added 0.2% (up 11.9%), and Transports jumped 1.2% (up 17.9%). The Morgan Stanley Consumer index rose 1.5% (up 16.3%), and the Utilities surged 2.3% (up 11.7%). The Nasdaq100 gained 0.6% (up 5.9%), and the Morgan Stanley High Tech index rose 1.1% (up 7.5%). The Semiconductors jumped 1.5% (up 13.7%). The InteractiveWeek Internet index increased 0.5% (up 11.1%). The Biotechs advanced 2.0% (up 18.1%). With bullion down $10, the HUI gold index declined 0.8% (down 19.6%).

One-month Treasury bill rates ended the week at 3 bps and 3-month rates closed at 7 bps. Two-year government yields were down a basis point to 0.24%. Five-year T-note yields ended the week down 3 bps to 0.765%. Ten-year yields fell 8 bps to 1.85%. Long bond yields dropped 5 bps to 3.10%. Benchmark Fannie MBS yields declined 4 bps to 2.62%. The spread between benchmark MBS and 10-year Treasury yields widened 4 bps to 77 bps (wide since August). The implied yield on December 2014 eurodollar futures declined 2 bps to 0.545%. The two-year dollar swap spread increased one to 18.25 bps (high since August), and the 10-year swap spread increased 3 to 16.0 bps (high since August). Corporate bond spreads were mostly wider. An index of investment grade bond risk was unchanged at 91 bps. An index of junk bond risk jumped 32 to 431 bps. An index of emerging market debt risk rose 8 to 300 bps (high since September).

March 28 – Bloomberg (Jennifer Joan Lee): “Credit-default swaps insuring against losses on European financial debt climbed for a 10th day, the longest streak since August 2011, as the bank crisis in Cyprus and political turmoil in Italy alarm investors. The Markit iTraxx Financial Index of swaps protecting the senior debt of 25 banks and insurers rose four basis points to 205, with the gauge heading for its worst month since November 2011. Contracts on Italy jumped to the highest since Nov. 16.”

Investment grade issuers included GE Capital $1.4bn, First Data $815 million, Carlyle Holdings $400 million, Graphic Packaging Intl $425 million, American Campus Communities $400 million, and Assurant $350 million.

Junk issuers included Navistar International $1.2bn, Frontier Communications $750 million, RHP Hotel Properties $700 million, and Wilton RE Finance $300 million.

I saw no convertible debt issued this week.

International issuers included Saudi Electricity Global $2.0bn, Bharti Airtel Intl $1.5bn, TSMC Global $1.5bn, Croatia $1.5bn, Swedish Export Credit $1.3bn, SES $1.0bn, OAO TMK $500 million, RCI Banque $600 million, Arcelik $500 million, Banco de Credito $350 million, SOC Quimica $300 million, TBG Global $300 million, and Lulwa $140 million.

Italian 10-yr yields jumped 25 bps to 4.75% (up 25bps y-t-d). Spain's 10-year yields surged 21 bps to 5.04% (down 23bps). German bund yields fell to the lowest level since last August, down 9 bps to 1.29% (down 3bps), while French yields added a basis point to 2.02% (up 2bps). The French to German 10-year bond spread widened 9 to 73 bps (wide since November). Ten-year Portuguese yields jumped 33 bps to 6.24% (down 51bps). The Greek 10-year note yield surged another 56 bps to 11.53% (up 106bps), with a two-week gain of 156 bps. U.K. 10-year gilt yields were down 8 bps to 1.77% (down 5bps).

With financial stocks getting hammered, Spain's IBEX 35 equities index was down another 4.9% (down 3.0% y-t-d). Italy's FTSE MIB sank 4.4% (down 5.7%). The German DAX equities index fell 1.5% for the week (up 2.4%). Japanese 10-year "JGB" yields declined 2 bps to 0.54% (down 24bps). Japan's Nikkei added 0.5% (up 19.3%). Emerging markets were mixed to higher. Brazil's Bovespa equities index rallied 2.0% (down 7.6%), and Mexico's Bolsa recovered 3.3% (up 0.9%). South Korea's Kospi index gained 2.3% (up 0.4%). India’s Sensex equities increased 0.5% (down 3.0%). China’s Shanghai Exchange sank 3.9% (down 1.4%).

Freddie Mac 30-year fixed mortgage rates rose 3 bps to 3.57% (down 42bps y-o-y). Fifteen-year fixed rates were 4 bps higher to 2.75% (down 47bps). One-year ARM rates slipped one basis point to 2.62% (down 16bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down 16 bps to 4.07% (down 70bps).

Federal Reserve Credit jumped $20.9bn to a record $3.187 TN. Fed Credit expanded $402bn over the past 25 weeks. In the past year, Fed Credit jumped $315bn, or 11.0%.

Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg – were up $658bn y-o-y, or 6.4%, to $10.952 TN. Over two years, reserves were $1.570 TN higher, for 17% growth.

M2 (narrow) "money" supply expanded $16.7bn to $10.429 TN. "Narrow money" expanded 6.7% ($655bn) over the past year. For the week, Currency increased $0.7bn. Demand and Checkable Deposits slipped $1.0bn, while Savings Deposits jumped $18.4bn. Small Denominated Deposits added $0.2bn. Retail Money Funds declined $1.6bn.

Money market fund assets increased $0.4bn to $2.629 TN. Money Fund assets were up $24bn from a year ago.

Total Commercial Paper outstanding gained $5.2bn this week to $1.022 TN. CP has declined $44bn y-t-d, while having expanded $84bn, or 9.0%, over the past year.

Currency and 'Currency War' Watch:

March 26 – Bloomberg (Mike Cohen and Ilya Arkhipov): “The biggest emerging markets are uniting to tackle under-development and currency volatility with plans to set up institutions that encroach on the roles of the World Bank and International Monetary Fund. The leaders of the so-called BRICS nations -- Brazil, Russia, India, China and South Africa -- are set to approve the establishment of a new development bank during an annual summit that starts today… They will also discuss pooling foreign-currency reserves to ward off balance of payments or currency crises. ‘The deepest rationale for the BRICS is almost certainly the creation of new Bretton Woods-type institutions that are inclined toward the developing world,’ Martyn Davies, chief executive officer of… Frontier Advisory… said… ‘There’s a shift in power from the traditional to the emerging world. There is a lot of geo-political concern about this shift in the western world.’”

March 25 – Bloomberg (Cynthia Kim): “South Korea’s newly appointed finance minister, Hyun Oh Seok, revived his nation’s concerns over weakness in the yen and said that the Group of 20 nations should revisit the issue. ‘Japan’s expansionary policies are having various ripple effects on many countries,’ Hyun, 62, told reporters… on his second day as finance chief. ‘The yen is depreciating while the won is gaining and this is flashing a red light for Korea’s exports.’”

The U.S. dollar index rose 0.7% to 82.98 (up 4.0% y-t-d). For the week on the upside, the South Korean won increased 0.7%, the South African rand 0.7%, the Singapore dollar 0.6%, the Canadian dollar 0.6%, the Japanese yen 0.3%, the Mexican peso 0.3%, the Taiwanese dollar 0.2% and the New Zealand dollar 0.1%. For the week on the downside, the Danish krone declined 1.4%, the euro 1.3%, the Swiss franc 0.9%, the Norwegian krone 0.8%, the Brazilian real 0.6%, the Swedish krona 0.5%, the Australian dollar 0.2%, and the British pound 0.3%.

Commodities Watch:

The CRB index increased 0.6% this week (up 0.5% y-t-d). The Goldman Sachs Commodities Index rallied 1.3% (up 1.3%). Spot Gold declined 0.6% to $1,599 (down 4.6%). Silver fell 1.3% to $28.32 (down 6%). May Crude jumped $3.52 to $97.23 (up 6%). May Gasoline rose 1.9% (up 13%), and April Natural Gas gained 1.8% (up 20%). May Copper declined 1.7% (down 7%). May Wheat sank 5.8% (down 12%), and May Corn fell 4.3% (unchanged).

U.S. Bubble Economy Watch:

March 29 – Bloomberg (Nick Summers): “Data point No. 1: Banks are back to hawking complex derivatives that magnify bets on corporate debt. Data point No. 2: For the first time since the financial crisis, JPMorgan Chase & Co. is set to resume selling securities tied to home loans that aren’t government-backed. Add a third development -- the feverish revival of the U.S. housing market, with new home sales surging to levels not seen since August 2008 -- and a meltdown-minded observer could reasonably get to thinking, ‘Here we go again.’ The return of financial products that played a role in the 2008 credit bubble provides a measure of how far the economy has come since then -- and how tempting it is for Wall Street and investors to return to old habits. It may also provide grist to lawmakers and commentators pushing to end the ‘too big to fail’ era and break up the big banks before they require another public rescue.”

March 26 – Bloomberg (Alex Kowalski): “Residential real estate prices increased in January by the most since June 2006, indicating the U.S. housing market strengthened at the start of the year. The S&P/Case-Shiller index of property values in 20 cities climbed 8.1% in January from the same month in 2012 after rising 6.8% in the year ended in December…”

March 26 – Bloomberg (Kathleen M. Howley): “More American homeowners will be able to use their properties as cash machines again after real estate equity jumped last year by the most in 65 years. Property owners recaptured $1.6 trillion as home values climbed to the highest levels since 2007. The amount by which the value of the houses exceeds their underlying mortgages rose to $8.2 trillion last year, a gain of 25%, according to Federal Reserve data.”

March 28 – Bloomberg (Heather Perlberg): “Gary Kain spent 20 years at Freddie Mac managing as much as $800 billion of bonds before the U.S. took over the company. Since 2009, he’s used his knowledge of the home-loan market to help turn American Capital Agency Corp. into the fastest growing mortgage debt investor. American Capital’s assets grew to $100.5 billion at the end of last year from less than $5 billion three years earlier, making the Bethesda, Maryland-based real estate investment trust the largest after Annaly Capital Management Inc., in an industry that’s drawing attention from investors and the Federal Reserve for its double-digit yields and rapid expansion. REITs bought more than $100 billion of government-backed mortgage securities in 2012, the most since at least the credit crisis, and will purchase another $60 billion in 2013, JPMorgan… estimated…”

March 25 – Financial Times (Stephen Foley): “Investors who bought the riskiest portions of one of the most exotic credit market instruments sold in the run-up to the financial crisis actually made more money than they forecast, despite the meltdown… The data, published by JP Morgan, helps to explain the recent soaring demand for equity in so-called ‘collateralised loan obligations’, a highly-leveraged investment vehicle that buys corporate bank loans. Demand has been so strong that CLO issuance this year so far is already close to half the total for the whole of 2012, and near the record level set in 2007. Most of the financing for CLOs comes in the form of debt, which has first claims on the interest and principal payments from the underlying loans.”

March 26 – Bloomberg (Freeman Klopott and Esmé E. Deprez): “New York is listing climate change as a risk for bondholders after Hurricane Sandy caused more than $40 billion in damage in the state… The state may be the first U.S. state to inform investors of the danger posed by rising sea levels, flooding and erosion tied to climate change, said Rich Azzopardi, a Cuomo spokesman… Sandy caused the worst flooding in the more than 100-year history of the New York City subway system, which is run by the state, and devastated coastal areas.”

Federal Reserve Watch:

March 25 – Associated Press (Martin Crutsinger): “Chairman Ben Bernanke said… that the Federal Reserve’s low-interest-rate policies are helping to boost growth around the world, rejecting criticism that they could lead to a global currency war. In a speech at the London School of Economics, Bernanke staunchly defended the Fed's policies and similar stimulus efforts pursued by other central banks since the 2008 financial crisis… Critics have argued that the low-interest-rate policies could lower a country's currency value and make its products more competitive on global markets. Some have blamed such policies for making the Great Depression worse during the 1930s. Countries devalued their currencies and raised tariffs, which made foreign-made goods more expensive and stunted trade. They became known as ‘beggar- thy-neighbor’ policies. Bernanke argued that the situation is different today because the low-interest rate policies have the primary aim of boosting domestic growth, not trying to lower the value of a nation's currency. ‘Because stronger growth in each economy confers beneficial spillovers to trading policies, these policies are not 'beggar- thy-neighbor' but rather ... 'enrich-thy-neighbor' actions,’ Bernanke said.”

March 26 – Bloomberg (Mahmoud Kassem and Jeff Kearns): “Dallas Fed President Richard Fisher said he’d like the U.S. to reduce its mortgage-backed security purchases program amid signs that the economy will probably grow at about 3% by the end of the year. ‘I’m personally in favor of tapering back our mortgage-backed security purchases… I think we’ve assisted the recovery of the housing market. We have a pretty robust housing situation right now. We don’t want to slip backwards.’”

March 26 – Bloomberg (Joshua Zumbrun): “Federal Reserve Bank of New York President William C. Dudley said the central bank should maintain its asset purchases as federal budget cuts restrain economic growth and a labor-market recovery. ‘I expect that labor market conditions will improve only slowly and that inflation will remain muted,’ Dudley said… ‘Consequently, it will be appropriate for monetary policy to remain very accommodative.”

March 27 – Bloomberg (Aki Ito): “Two regional Federal Reserve presidents said they want the Fed to keep buying bonds through the end of 2013, while a third official said the central bank isn’t doing enough to spur economic growth. ‘We should continue our large-scale asset purchases of Treasury and mortgage-backed securities through this year -- although the amount may need to be adjusted up or down, depending on how the economic situation evolves,’ Boston Fed President Eric Rosengren said… ‘This is a point when we have to be patient and let our policies work,’ with stimulus ‘firing on all cylinders,’ Chicago’s Charles Evans said… The comments by Evans, Rosengren and Minneapolis’ Narayana Kocherlakota reinforce Chairman Ben S. Bernanke’s push to sustain record easing even as some policy makers voice concern the stimulus is ineffective or harmful… ‘Monetary policy is currently not accommodative enough,’ Kocherlakota said… He said he favored easing policy by reducing to 5.5% from 6.5% the threshold at which the Fed will consider raising the main interest rate.”

March 27 – Dow Jones (Ben Kesling): “One of the most stalwart of Federal Reserve doves signaled no substantial changes to interest-rate policy in the near term or to the central bank's so-called quantitative easing this year. Federal Reserve Bank of Chicago President Charles Evans will continue to support the current Fed stimulus policy and steer clear of using any single number as a target for Fed policy, he said Wednesday during a breakfast with reporters. ‘When something is working, I want to make sure it’s not inferred ... as being a little weak in the knees,’ he said of current policy, stressing that he doesn’t anticipate any changes through 2013. ‘Exit is so far in the future, it’s not something I want to talk about,’ he said of the bond-buying program known as quantitative easing. ‘I see asset purchases continuing through the end of the year at about this pace.’”

Global Bubble Watch:

March 25 – Financial Times: “Overnight, Cyprus has become an offshore banking centre without a banking system. The agreement with its rescuers early on Monday puts Cyprus Popular Bank, the island’s second lender, into resolution: its shareholders and bondholders will be wiped out. Bank of Cyprus, the largest bank, will be restructured. All deposits under €100,000 will be spared, but deposits above that – amounting to about €4.2bn at CPB – will be bailed in. The ‘rescue’ will devastate the Cypriot economy. No wonder European Commission vice-president Olli Rehn was channelling The Beatles’ ‘hard day’s night’. The deal prevents a disorderly default by Cyprus, and its exit from the eurozone. It establishes the principle that senior bondholders are no longer sacrosanct. No taxpayer money is going directly to Cypriot banks, though the island is getting €10bn of other aid, equivalent to 60% of its gross domestic product. Cyprus’ days as a tax haven are surely numbered. Other eurozone countries with outsized banking systems must be quaking. According to the European Central Bank, Luxembourg-based ‘monetary financial institutions’ had assets of over 22 times that tiny country’s GDP in the fourth quarter of 2012.”

March 28 – Dow Jones (Art Patnaude): “The decision in Cyprus to force banks' supposedly safest bondholders to contribute to the rescue package hit European bank credit markets this week, with uncertainty over whether the Cypriot model would be used as a template for future bailouts encouraging caution among investors. Cyprus implemented the first bailout package in the euro-zone debt crisis to stipulate that senior bank bondholders must take losses. Up until now, these bondholders had been spared, leaving taxpayers to take the brunt of the responsibility for failed banks. Standard and Poor's… said Cyprus signaled a ‘significant change’ for the region. The reluctance of stronger euro-zone governments to use taxpayers’ money to rescue Cyprus could create a precedent in the euro zone, the… rating firm said… Initial reaction in credit markets to the weekend agreement on Cyprus had been tempered early in the week. But senior bank debt and credit default swaps, as well as bank bonds in the region's weaker economies, increasingly came under pressure.”

March 26 – Bloomberg (Patrick Donahue and Maud van Gaal): “Dutch Finance Minister Jeroen Dijsselbloem, who committed taxpayer funds to take over SNS Reaal NV last month, said troubled lenders in the euro area must now fend for themselves as part of future regional rescues. Dijsselbloem, who leads the group of 17 euro finance ministers, said imposing losses on depositors and bondholders can be part of the bailout toolkit after such measures were taken to avoid default in Cyprus. ‘We are looking for a way to place risks where they are taken,’ Dijsselbloem said… ‘Banks should strengthen their balances -- they have to ensure they can be unwound when they get in trouble. Next, it should be possible to make shareholders and bond holders contribute to a rescue. That’s how we move along. And then eventually you may get to a government contribution. That order was reversed in the last years.’”

March 28 – Bloomberg (Andrew Rebecca Christie and Jim Brunsden): “The European Union should fast- track rules on creditor write-downs in bank failures, after losses imposed on depositors and senior creditors in Cyprus roiled markets, a German-led bloc said. Germany, Finland, the Netherlands and Denmark say the rules should be phased in by 2015 rather than in 2018, as the European Commission has proposed… The four say investors are anticipating the new regime and delays could interfere with that process. To the extent that funding costs rise, it’s because of market forces and not due to the burden of extra regulations, the four nations said. ‘A risk premium effectively results from the elimination of the previous implicit state guarantee,’ according to the document, which was obtained by Bloomberg News.”

March 26 – Bloomberg (Tom Stoukas and James G. Neuger): “Cypriot Finance Minister Michael Sarris sought to muffle calls for Cyprus to consider a precedent-setting exit from the euro to ease the economic pain inflicted by the country’s 10 billion-euro ($13bn) bailout. The option of eventually pulling out of the currency was floated yesterday by a Nobel prize winner now advising the government, Christopher Pissarides, and Nicholas Papadopoulos, head of the parliament’s finance committee.”

March 28 – Bloomberg (Daryna Krasnolutska): “Cyprus is main source of foreign direct investment into Ukraine because of corporate tax optimization, Liza Ermolenko, emerging-markets economist at Capital Economics, says… Cyprus capital controls may disrupt capital flows into Ukraine… Ukraine ‘is extremely exposed if the Cypriot bailout triggers a fresh spike in financial market tensions.’”

March 26 – Financial Times (Courtney Weaver): “For Fedor Mikhin the deluge of overseas phone calls began on Wednesday, just five days after the EU first proposed the ill-fated tax levy on Cypriot depositors. There were the two Andorran bankers who called offering to open bank accounts for the Cyprus-based businessman in the Pyrenees, and then Mr Mikhin’s Swiss bank, which announced it would be sending representatives to Limassol to poach Russian clients on Tuesday, the day Cyprus is due to reopen its banks… While last week saw dozens of well-heeled Russians and their representatives fly down to Cyprus to check on bank accounts and confer furiously with Cypriot officials, they are being closely followed by another wave of visitors: the European bankers who hope Cyprus’s loss will be their gain.”

Global Credit Watch:

March 25 – Financial Times (Peter Spiegel): “The 10bn euro rescue marks a watershed in how the eurozone deals with failing banks, with European leaders now committed to ‘pushing back the risks’ of paying for bank bailouts from taxpayers to private investors, the chairman of the group of eurozone finance ministers has warned. Jeroen Dijsselbloem, the president of the eurogroup, said the relative market calm in recent months, coupled with the lack of market panic following the decision to force private investors and depositors to pay for the entire bailout of two large Cypriot banks, allowed the eurozone to go after private money more aggressively when banks fail. ‘Taking away the risk from the financial sector and taking it on to the public shoulders is not the right approach,’ Mr Dijsselbloem, who is also the Dutch finance minister, said… ‘If we want to have a healthy, sound financial sector, the only way is to say: ‘Look, there where you take the risks, you must deal with them, and if you can’t deal with them you shouldn’t have taken them on and the consequence might be that it is end of story… That’s an approach that I think we, now that we are out of the heat of the crisis, should consequently take.’ This new approach would mark a radical change of course since the crisis began three years ago.”

March 27 – Bloomberg (Jana Randow): “Cypriot capital controls may not prevent the country’s lenders from becoming more reliant on funding from the European Central Bank, UBS AG Chairman Axel Weber said. Capital controls are ‘maybe a step to avoid a catastrophic exit from the euro which would have had much larger repercussions,’ Weber said… ‘A catastrophe has been averted, but the impact on the Cypriot economy is going to be huge’ and ‘banks will become even more dependent on ECB liquidity because deposits will be largely drained.’”

March 29 – Bloomberg (Ye Xie): “Emerging-market government debt is off to its worst start since 1995 as rising U.S. Treasury yields dim the allure of the securities and investors shift to corporate bonds in developing countries. JPMorgan Chase & Co.’s EMBI Global Index has lost 2.3% this quarter as average emerging-market bond yields rose to 4.96% on March 27, the highest level since August, from 4.50% on Dec. 31.”

March 28 – Dow Jones (Emese Bartha): “Euro-zone countries enter the second quarter next week when bond sales promise to be significantly lighter than in the first, but with political uncertainty in Italy and the aftershock of the Cyprus bailout likely to make auction outcomes harder to predict. Gross government bond issuance from April to June will fall to 238 billion euros ($305bn) from EUR274 billion in the first quarter, Intesa Sanpaolo estimates.”

March 27 – Bloomberg (Ben Moshinsky and Jennifer Ryan): “U.K. lenders were told by the Bank of England to raise 25 billion pounds ($38bn) of additional capital, less than analyst estimates. Banks need to set aside more money to cover bigger potential losses on commercial real estate and from the euro area, possible fines for mis-selling and stricter risk models, the Bank of England said…”

March 26 – Financial Times (Ralph Atkins and Keith Fray): “The global pool of government bonds with triple A status from the three main rating agencies, the bedrock of the financial ­system, has shrunk more than 60% since the financial crisis triggered a wave of downgrades across the advanced economies. The expulsion of the US, the UK and France from the ‘nine-As’ club has led to the contraction in the stock of ­government bonds deemed the safest by Fitch, Moody’s and Standard & Poor’s, from almost $11tn at the start of 2007 to just $4tn now…”

China Bubble Watch:

March 28 – Wall Street Journal (Dinny McMahon and Aaron Back): “China moved to rein in wildly popular but opaque investment products that form a key plank of the nation’s shadow-banking system, after the high-profile failure of one product offered a glimpse of the risk they pose to the financial system. The rules issued Wednesday by China’s banking regulator came as China’s four biggest state-run banks said they had more than 3 trillion yuan ($467bn) worth of such products outstanding at the end of last year, their fullest disclosure yet of their exposure to the products and a move signaling their own caution toward their proliferation… Issuance has expanded rapidly in recent years. Fitch… estimates the total amount of outstanding wealth-management products was around 13 trillion yuan at the end of last year—equal to about 14.5% of total banking-system deposits—compared with 8.5 trillion yuan at the end of 2011.”

Japan Watch:

March 28 – Financial Times (Ben McLannahan): “Japan’s central bank governor has told parliament that the government’s vast and growing debt is ‘not sustainable,’ and that a loss of confidence in state finances could ‘have a very negative impact’ on the entire economy. The warning comes as Shinzo Abe’s administration attempts to drag Japan out of more than a decade of deflation with aggressive monetary and fiscal stimulus.”

March 29 – Bloomberg (Anna Kitanaka and Yoshiaki Nohara): “Japan’s Nikkei 225 Stock Average gained, capping its best back-to-back quarterly performance since 1972, when ‘The Godfather’ hit the screens and Atari Inc. introduced its ‘Pong’ video game… The measure added 19% this quarter, extending the 17% gain in the previous three months.”

India Watch:

March 29 – Bloomberg (Unni Krishnan and Tushar Dhara): “India’s current-account deficit widened to a record last quarter as oil and gold imports surged, adding pressure on the government to extend a policy overhaul and attract foreign investment as the rupee weakens. The deficit in the current account… was $32.6 billion in the three months ended Dec. 31, or 6.7% of gross domestic product, compared with a revised $22.6 billion gap from July through September…”

Asia Bubble Watch:

March 26 – Bloomberg (Eunkyung Seo and Cynthia Kim): “South Korea’s economy expanded last quarter at the slowest pace since the global recession, underscoring the case for stimulus by the new government and concern that a weaker yen will curb exports. Gross domestic product rose 1.5% from a year ago…” 

Latin America Watch:

March 27 – Bloomberg (David Biller and Arnaldo Galvao): “Brazil’s President Dilma Rousseff said she does not agree with anti-inflation policies that sacrifice growth… ‘Killing the patient instead of curing the disease is a bit complicated,’ Rousseff said… ‘Am I going to put an end to growth? That’s an outdated policy.’ With inflation outpacing the central bank’s 4.5% target since September 2010 amid signs that Brazil is recovering from a slowdown that has lasted more than two years, policy makers held the key interest rate at 7.25% for the third straight meeting in March. Rousseff this month cut all federal taxes on basic foodstuffs in a bid to ease the strain on families’ budgets after earlier this year reducing power prices for households and industry.”

March 27 – Bloomberg (Juan Pablo Spinetto and Veronica Navarro Espinosa): “OSX Brasil SA, the shipbuilder controlled by billionaire Eike Batista, shelved plans to sell debt abroad as a rout in its stock and bonds deepens, according to a memo from underwriters… ‘Extraordinary volatility’ in bonds from OSX and Batista’s oil producer OGX Petroleo e Gas Participacoes SA caused the cancellation, Pareto Securities said…”

Europe Watch:

March 25 – Dow Jones (Olga Razumovskaya): “Cyprus’s bank crisis remains a threat to the stability of the euro currency union, despite the bailout agreement reached early Monday, said Russia's first deputy prime minister, Igor Shuvalov. He said Russia has no exact numbers on the losses faced by Russian investors in Cyprus as a result of the deal struck with the European Union and the International Monetary fund… ‘For all the assurances we are getting from the European Commission, we fear that it (the Cyprus situation) may affect the stability of euro, the stability of euro zone,’ he said…”

March 29 – Bloomberg (Natalie Weeks, Georgios Georgiou and Tom Stoukas): “Cypriots faced a second day of bank controls over their use of the euro today as officials in Europe urged the country to move quickly to lift the restrictions, the first time they have been imposed on the common currency. Cyprus prevented panic withdrawals as banks opened for the first time in almost two weeks yesterday, with government curbs on access to cash averting runs on deposits. The Standard & Poor’s 500 Index rose above its record closing level and the euro rebounded from a four-month low. The duration of the measures is unclear.”

Italy Watch:

March 27 – CNBC (Holly Ellyatt): “Investor concern over Cyprus is rapidly being replaced by fears for Italy, as political deadlock continues and the country’s main leadership candidate reportedly said that only an ‘insane person’ would want to govern Italy now. Pier Luigi's Bersani, the leader of the center-left coalition, reportedly made the remark after the anti-establishment ‘Five Star Movement’ party headed by comedian Beppe Grillo again refused to form a coalition government with Bersani… After the latest rejection from the anti-establishment movement, Bersani said ‘only an insane person would want to govern this country, which is in a mess and faces a difficult year ahead…’”

March 28 – Bloomberg (Andrew Frye and Lorenzo Totaro): “Italian President Giorgio Napolitano took charge of the search for the next prime minister after Pier Luigi Bersani failed to assemble a majority in the divided parliament. The stalemate stems from ‘conditions I considered unacceptable’ in the demands of rival lawmakers, Bersani said… Napolitano, 87, must now find a leader capable of building consensus where Bersani… came up empty. Policy differences accumulated during the Feb. 24-25 election campaign hurt Bersani’s ability to lure his main adversaries, Silvio Berlusconi and Beppe Grillo, into backing his candidacy.”

March 27 – Reuters (Steve Scherer): “Caretaker Prime Minister Mario Monti, looking tired and distraught, said… said he was ready to leave office a day after a prominent member of his government resigned over the handling of a dispute with India… ‘This government can’t wait to be relieved of its duty,’ Monti said during testimony about the Indian affair to the lower house of parliament. Monti was interrupted repeatedly by heckles from right-wing lawmakers.”

March 27 – Bloomberg (Andrew Frye and Chiara Vasarri): “Italian Prime Minister Mario Monti can’t wait to quit his job. Pier Luigi Bersani, who has first shot at replacing Monti, said only a lunatic would want to. ‘Believe me, only an insane person would want to govern at this moment,’ Bersani said… in a meeting with rival lawmakers… Parliament was deadlocked by inconclusive elections last month, and Bersani, after nearly a week of talks, has given no signal that he can break the impasse… The incumbent has indicated his desire for a breakthrough. ‘This government, and I’ll say it in the most respectful way possible, can’t wait to have its mandate rescinded,’ Monti said… in a speech to parliament.”

March 28 – Bloomberg (Sonia Sirletti): “Banca Monte dei Paschi di Siena SpA, Italy’s third biggest bank, reported a third straight quarterly loss, missing analysts estimates, on soaring bad-loan provisions and lower income from lending. The net loss of 1.59 billion euros ($2bn) in the fourth quarter compared…”

Spain Watch:

March 27 – Bloomberg (Angeline Benoit): “The Spanish government revised up the first estimate of its 2012 budget deficit after Eurostat requested it to change the way it computes tax claims. The budget shortfall was 6.98% of gross domestic product last year, excluding aid to the country’s banking industry, instead of the previously estimated 6.74%... The central government’s deficit for the first two months of the year widened to 2.22% of GDP from 1.95% last year…”

March 25 – Bloomberg (Charles Penty): “Bankia SA, the Spanish lender that needed the most European bailout funds, had its debt rating cut by Standard & Poor’s on concern that steps to strengthen its capital won’t be as effective as anticipated. Standard & Poor’s cut its long-term debt rating on Bankia by one level to BB-… The Bankia group posted a record after-tax loss of 21.2 billion euros ($27.6bn) last year as it cleansed its balance sheet by transferring 22 billion euros of assets to a bad bank.”

March 25 – Bloomberg (Angeline Benoit): “Prime Minister Mariano Rajoy’s progress in curbing a deficit worsened by the cost of servicing Spain’s swelling debt load will be revealed this week… Rajoy last week signaled the difficulty of his task in taming a deficit as he backtracked for the first time on his pledge to haul Spain out of a six-year slump later this year.”

France Watch:

March 25 – Dow Jones (Niclas Rolander): “Finance Minister Pierre Moscovici… defended his government’s decision to give itself more time to meet its deficit target, saying to pursue the goal would mean deliberately causing a recession. ‘We have a damned good reason,’ not to reach the target in 2013, Mr. Moscovici said, responding tit-fot-tat to a remark by the president of the euro zone finance ministers, Jeroen Dijsselbloem. The Dutch finance minister said… that France would need a ‘damned good’ explanation to postpone the target. Mr. Moscovici said the economy was slower than expected. ‘I would plead and advocate to give us some flexibility,’ he said…”

March 29 – Bloomberg (Gregory Viscusi and Mark Deen): “President Francois Hollande pressed the French to accept reduced pension and welfare benefits as part of a national effort to revive a moribund economy and stem a rise in unemployment that has caused his popularity to slump. In a national television interview last night that lasted more than an hour, Hollande promised to revise a 75% levy on salaries over 1 million euros and avoid any new tax increases next year while reducing state spending.“

March 29 – Bloomberg (Gregory Viscusi): “France’s 2012 budget deficit was 4.8% of economic output, the national statistics office Insee said, wider than a government pledge of 4.5%.”

March 29 – Bloomberg (Vidya Root): “French consumer spending slid in February amid an intensifying economic slump and joblessness near its record high. Spending fell 0.2% in the month while on the year it declined 2.9%...” 

Germany Watch:

March 25 – Bloomberg (Tony Czuczka): “German Chancellor Angela Merkel said her policy has always been that taxpayers can’t save banks and that this remains the case for Cyprus… ‘We always said we didn’t want taxpayers to save banks but rather the banks to save themselves. That will be the case in Cyprus… This outcome is the right one. It puts the responsibility on those who caused these faulty developments. That’s how it should be.’”

March 25 – Bloomberg (Stefan Riecher): “While German wage demands promise to spur domestic consumption, they also risk putting longer-term pressure on Europe’s biggest economy. Even as benchmark bund yields hover close to the lowest level since reunification in 1990, offering shelter from the region’s debt crisis, analysts and policy makers said German industry will lose its edge if wages rise too fast. IG Metall, Germany’s most powerful labor union, is seeking pay increases of 5.5% for 3.7 million engineering and metal workers…”