Bank Research Consensus Weekly 05.24.10
QExit or QEntry?
Manoj Pradhan, Global Economics Team, Morgan Stanley
The ECB's recent decision to purchase debt securities in order to ease market ‘dysfunction' has certainly had the desired impact on bond yields, but it has also left many questions unanswered. Do the bond purchases represent QE or a move towards QE? What does the sterilisation via term deposits mean for the success of the programme? Since the Fed conducted large-scale purchases of assets, can we look to the Fed's balance sheet for more insight into the ECB's balance sheet? In today's lead piece, we take a closer look at these questions, with insights from our euro area and US economics teams (full notes follow this one).
The short answers are: (i) Bond purchases do not represent QE if the sterilisation operations will mean that excess reserves (ER) do not rise (which is the case at the ECB) - but that will not keep the balance sheet (b/s) from rising; (ii) Sterilising bond purchases also implies that the current stance of monetary policy will not be affected. However, the future stance of monetary policy could be looser than the central bank intends due to expansion of the b/s; (iii) While the b/s of the Fed and the ECB are of a roughly similar size and have both expanded because of QE, a comparison between the two is very difficult. The Fed's b/s originally rose because of ‘passive QE', and then maintained its size due to ‘active QE'. The ECB's b/s on the other hand, grew throughout primarily because of passive QE. This makes the ECB's strategy less risky as passive QE is likely to be much easier to unwind than active QE, in our opinion.
In elaborating on our questions for today, we work backwards, starting from a comparison between QE at the Fed and the ECB.
FX: The Euro is in Danger, Says Merkel
Arne Lohmann Rasmussen, Chief Analyst, Danske Bank
This week Chancellor Merkel said that the euro is in danger and that it is necessary to develop a process for orderly state insolvency.
It was not exactly what the FX market was looking for. If even the Germans question the stability of the euro, it is no wonder that the market does. Market sentiment towards the euro is currently very weak and we have a hard time seeing what could turn the sentiment around in the near future. We think it will get worse for the euro before it gets better. It is difficult to catch a falling knife and our advice is to prepare for weaker euro levels throughout the year. For more on the EUR/USD outlook see FX Forecast Update from 17 May.
Intervention for a stronger euro is not imminent
The rapid decline in the euro has sparked speculation that the G7 countries or just the ECB are preparing to intervene in the FX market. However, the euro is hardly undervalued by any longer-term measures. Most researchers including the IMF point to a fair level for EUR/USD close to or below the current level. We therefore think intervention is quite unlikely, not least as it would run counter to the current loose ECB monetary policy. However, we could, in the near future, see G7 or central bank comments regarding the undesirability of excess volatility in FX markets. Furthermore, there is little doubt that the rapid decline of the euro is creating nervousness among policymakers.
United States - Keeping an Eye on the Storm Battering the Other Side of the Pond
Martin Schwerdtfeger, Economist, TD Bank Financial Group
There have been significant developments and data releases both in the U.S. and abroad this week. The dominating theme has been the increase in risk aversion caused by growing concerns regarding the global growth outlook, the European debt situation, and financial regulation reforms. In response, investors have shied away from risk. U.S. Treasury yields have fallen sharply (10yrs were trading at 3.18% at the time of writing) and most major currencies, except the Japanese yen and the euro have depreciated vis-à-vis the U.S. dollar. Price volatility, as measured by the Chicago Board Options Exchange VIX index, has also registered a few spikes in recent trading sessions. On Friday afternoon, however, there was some reprieve, as markets seemed poised to pair their morning losses.
On the external front, even as the German parliament is on its way to approve Germany’s share in the EUR750- billion package announced on May 10th; fiscal austerity measures announced by most eurozone countries have sparked fears over the global growth outlook. This has, in turn, impacted commodity prices, and pushed stock markets into sell-off mode. At the time of writing, the main global stock indexes had lost more than 4% during the week. In particular, the Dow Jones and the S&P 500 were at their lowest levels since mid February, losing almost 6% this week. The unilateral move by Germany to ban short-selling of financial firms’ stocks and government bonds contributed to the growing bearish sentiment in the markets, something that could be exacerbated as stricter financial regulations see their way out of U.S. Congress.
Can the Euro-zone Survive the Greek Tragedy?
Trevor Williams, Chief Economist at Lloyds TSB Corporate Markets
Can the euro-zone survive the crisis of confidence that is currently washing over the peripheral highly-indebted countries of Europe? That is the question that speculators are now daring to ask, as the fiscal crisis in Greece threatens to spill over into Spain, Portugal, Ireland and Italy. After a decade of relative stability, policy-makers across the single currency area are now being forced to address the gaping fault-line that has been exposed in the EMU architecture – namely, whether a credible economic and monetary union can be sustained without credible and binding fiscal arrangements as well.
Arguably, it has been the lack of any binding fiscal commitment that has led to the moral hazard and hence the problems that now threaten to destabilise the region. The problems that erupted in Ireland in 2007 and 2008 provided an early warning of the vulnerabilities that the smaller more high-indebted countries faced. To its credit, Ireland was quick to respond to the challenge, adopting an unprecedented fiscal austerity package in late 2009, including painful cuts in public sector wages and pensions. Although early days, there are grounds for cautious optimism that this fiscal austerity program is working. As the civil unrest in Greece has highlighted, however, not everyone is so accepting of swingeing fiscal restraint, particularly when that restraint follows an unprecedented economic downturn they believe is not of their making.
Other Pre-screened Independent Contributors
J-Chart is an innovative charting and bias-neutral market analysis tool. Based on its proprietary theoretical concept and display of market price action, J-Chart provides a much clearer and unique insight into the market than conventional charting methods. This innovative charting and market analysis tool is designed to visualize market price action that constructs unique price patterns called "Equilibriums". Based on its "non-fixed time frame" concept and "Kinetic Equilibrium" application, J-Chart users are able to forecast markets' future movements with high accuracy.
J-Chart Weekly Newsletter
Compiled By: Michael Wright
Questions? Comments? Send them to email@example.com
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.