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from Global Investing:

Three snapshots for Thursday

The Bundesbank is preparing to stomach higher German inflation than it likes, above the European Central Bank's target level, because of the euro zone crisis, a source at the central bank said on Thursday.

Although the Bundesbank still wants stable prices across the euro zone, its latest comments show the bank recognises that upward pressure on German wage costs and property prices suggest its inflation is likely to rise above the bloc's average.

As this chart shows, historically the Bundesbank was quick to react to any signs of inflation:

The Bank of England voted on Thursday not to give the struggling economy another injection of cash as concerns over stubbornly high inflation outweighed the risk of a prolonged recession.

The number of Americans submitting new applications for jobless benefits edged down last week, easing concerns the labor market was deteriorating after April's weak employment growth.

from Global Investing:

Research Radar: “State lite”?

The FOMC's relatively anodyne conclusions left world markets with little new to chew on Thursday, with some poor European banking results for Q1 probably get more attention.  Broadly, world stocks were a touch higher while the dollar and US Treasury yields were slightly lower. European bank stocks fell 2% and dragged down European indices. Euro sovereign yields were slightly higher, with markets eyeing Friday's Italian bond auction. Volatility gauges were a touch lower and crude oil prices nudged up.

Following is a selection of some of the day's interesting research snippets:

- Deutsche Bank's emerging markets strategists John Paul Smith and Mehmet Beceren said they retain their negative bias toward global emerging market equities both in absolute and relative terms, highlighting Argentina's expropriation of YPF from Repsol as another negative. "We anticipate that so-called state capitalism will continue to be a negative driver, as it has been since mid-2010, since the poor economic backdrop makes the corporate sector a tempting target for governments wishing to boost their popularity or find additional resources to add to the relatively low levels of social protection across most emerging economies." They added that they remain overweight "state lite" emerging markets such as Taiwan, Mexico and Turkey and underweight Russia, China, Brazil and South Korea.

- Morgan Stanley's James Lord thinks the rally in Hungary's markets following Tuesday's decision by the EU to reopen negotiations on financial assistance is justified but much may now be in the price. He said MS would prefer to wait for some pullback before looking for more bullish trades.  On a relative basis, Hungary 5-year CDS is now 60bp wider than Spain's and MS said that while this gap could close much further  it was hard to see how Hungary CDS rates could trade below Spain.  "Indeed, if Spain goes into serious financial trouble, it could represent a systemic risk for all Europe, and funding stress would likely increase substantially. Given the strong dependence of Hungary towards the EU, it would be difficult to argue for Hungary to trade through Spain on any sustained basis."

- Ashmore Investment Management's Jerome Booth restates his bullish case for emerging markets with 10 points that conclude with the line:  "the best way to lose money without really trying is not to invest in emerging markets." His points include warnings about equating past volatility with risk, passive investing (where he points out that only 12% of emerging debt is represented by available indices) and seeing emerging currency volatility against the dollar as an emerging problem rather than a U.S. one ("It is the dollar which is volatile".)

- Legal & General Investment Managers' Ben Bennett argues that central bank money printing will be needed for some time as banks' bad loans are still way too high for them to be "in a position to drive the money printing presses once again". Explaining QE as a nationalisation of money printing presses normally operated by the commercial banks, he says the success of either form of money creation can only be judged by the productive nature of use to which that money is put. The pre-crisis lending into the property bubble was negative case in point, and the relative success of QE lending to the banks will be even more complex to judge.  "The investment lesson to be learnt is not to follow the money, but to analyse the usefulness of what it is being spent on."

from Global Investing:

Three snapshots for Wednesday

Spanish house prices fell 7.2 percent in the first quarter from a year earlier while Spanish banks' bad loans rose to their highest level since October 1994 (see chart).

The Bank of England is poised to turn off its money-printing press next month. Minutes of the Bank's April meeting, combined with a stark warning on inflation from deputy governor Paul Tucker on the same day, signalled a sharp change in tone that could bring forward expectations for interest rate rises.

Does the E in PE need a reality check too?

from Global Investing:

Three snapshots for Wednesday

Markets starting to worry about an end to QE/LTRO liquidity?

Forward looking PMI data is starting to show a divergence between the UK and the euro zone:

German factory orders, which tend to lead GDP growth, fell 6.1% in February from the previous year.

from MacroScope:

Who’d be a central banker?

The focus is already on the euro zone finance ministers meeting in Copenhagen, starting on Friday, which is likely to agree to some form of extra funds for the currency bloc's future bailout fund. What they come up with will go a long way to determining whether markets scent any faltering commitment on the part of Europe's leaders.

In the meantime, top billing goes to Bundesbank chief Jens Weidmann speaking in London later. He is heading an increasingly vocal group within the European Central bank who are fretting about the future inflationary and other consequences of the creation of  more than a trillion euros of three-year money. There is no chance of the ECB hitting the policy reverse button yet but the debate looks set to intensify. A combination of German inflation and euro zone money supply numbers today (which include a breakdown on bank lending) will give some guide to the pressures on the ECB.

Central bankers face a very mixed picture with U.S. recovery and high oil vying with the unresolved euro zone debt crisis and signs of slowdown in China.

Bank of England Governor Mervyn King was sitting firmly on the fence yesterday, saying he did not know whether more QE would be required in Britain or not. Tellingly, he also did not know whether euro zone policymakers will take advantage of the window of opportunity offered them by the ECB or not. King illuminated a common theme coming from central bankers, saying the onus was firmly on the politicians now, while his colleague Adam Posen noted that the reason Britain’s recovery has lagged America’s is because of the former’s tough austerity measures. That’s another debate that is echoing around the euro zone. In the States, Bernanke said it is too soon to declare victory in the U.S. economic recovery.

Back to the euro zone and Spanish media was alive with reports that the EU was pressing Madrid to take a bailout to recapitalize its wobbly banks. The denials from both centres were so emphatic that it seems not to be true. It seems  EU Competition Commissioner Joaquin Almunia spelled out three options to clean up Spain's banking sector: using Spanish public funds, finding private investment or applying for European aid.  Journalists present leapt on the latter. That may well become true in the end ... but not yet.

Spain faces a general strike on Thursday while Prime Minister Mariano Rajoy is promising Friday's 2012 budget will deliver eye-watering austerity for a country already sinking back into recession.

from MacroScope:

There be feudin’ at the BoE

The once-good relationship between Bank of England Governor Mervyn King and his most likely successor, Deputy Governor Paul Tucker, is coming  under increasing strain, according to a new book by former Daily Telegraph journalist Dan Conaghan.  It  alleges   King’s management style and and alleged disdain for the financial markets is to blame.

While the Bank of England’s Monetary Policy Committee remains reasonably collegiate, on other matters King more than lives up to the description from former chancellor Alistair Darling that he is ‘incredibly stubborn’, says Conaghan, who now worksas an asset manager.

“The governor can be particularly dogmatic,” he told Reuters. “One of the key things … is the attitude to the capital markets. One of my sources described Sir

Mervyn’s attitude as one of disdain. I’ve heard that repeatedly. Paul is much more pragmatic.”

One tangible upshot of this came at the launch of the Bank’s quantitative easing programme in March 2009, which Conaghan said led to an upsurge in failed trades on the British government bond market, until the central bank found a mechanism to lend back some of the gilts it had bought.

More broadly, Conaghan’s book The Bank: Inside the Bank of England describes something approaching a feud growing out of a philosophical split between King – who champions a purist, economics-driven approach – and Tucker, who is closer to financial market participants.

“It is widely acknowledged within the Bank’s upper echelons and elsewhere that the relationship between King and Paul Tucker … has deteriorated over the past few years. One very senior figure at the Bank describes it as being, at times, ‘a battle-ground,’ where the battles over policy, direction and structure are common. Another senior official at the Treasury concedes that they ‘do not get on, to put it mildly’.”

from Global Investing:

End of LTRO = end of equity rally 2012?

This year's global equity rally is unlikely to survive the end of the ECB's liquidity injections, warns HSBC.

World stocks have jumped 10 percent since the start of 2012, emerging markets are up 15 percent and the index of top European stocks has gained 8 percent. These gains, HSBC says, are almost entirely down to the European Central Bank's end-December refinancing operation, or LTRO, that injected $500 billion to ease banks' liquidity worries. The tentative improvement in the U.S. and global growth picture along with beaten-down stock valuations added only limited ammunition to the rally, the bank says.

The findings of HSBC's analysis? First, past episodes of quantitative easing -- Japan in 2001-2004 and the United States, Britain and the euro zone after 2008 --  provided a significant fillip to equity markets.  U.S. stocks rose an average 6 percent, UK stocks by 8 percent and euro zone markets by 15 percent in the three months following the post-Lehman QE rounds, though in Japan the gains have been short-lived. Second, unexpected changes in monetary policy produced a larger impact on stock prices than the continuation of a previous policy.

And when QE stopped, the effect on stocks was immediately negative. HSBC found:

The periods when the Fed halted QE and allowed its balance sheet to shrink (in August 2009, June to October 2010 and July to October 2011) were all periods of weakness for the stock market.

The ECB is gearing up for another LTRO round in two weeks time. But it will not come as a surprise to markets and there are no plans for more.

HSBC concludes:

from Global Investing:

Emerging market local bond rally has more legs

Just a month and half into 2012, emerging local currency bonds have already returned 9 percent, one of best performing asset classes. But the rally has further to go, says J.P. Morgan which runs the most widely used emerging debt indices. The bank is now predicting its benchmark local currency debt index, the GBI-EM, to end the year with returns of 16 percent, upping its original expectation for 11.9 percent.

There are several reasons for this bullishnesss. JPM's latest client survey reveals investors' positioning is still neutral, meaning there is potential for more gains. Cash inflows to EM local debt have been dwarfed this year by investments into dollar bonds, considered a safer, albeit lower-yielding asset than locally issued bonds. So when (and if) euro zone uncertainties abate, some of this cash is likely to make the switch.

Many emerging countries are still cutting interest rates, which will push down yields on short-dated bonds. Other countries may tolerate some more currency appreciation to dampen inflation, benefiting the currency side of the EM local bond trade. Above all, with all developed central banks intent on quantitative easing (Japan announced a surprise $130 billion worth of extra QE this week), the yield premium offered by emerging markets -- the carry -- is irresistible. On average the GBI-EM index offers a 4.5 percent yield pick up on U.S. Treasuries, JPM notes:

From an EM perspective there is little reason to fight the rising tide of monetary policy support in the near term. Comparisons to the 2009 global carry trade are unavoidable given the scope of G-4 central bank  balance sheet expansion.

So far, around 70 percent of the gains posted by the GBI-EM index have been down to currency appreciation (see here). That could change going forward as some central banks may act to slow FX appreciation.  That's already been happening in Brazil. Gains from the duration trade -- derived from interest rate cuts -- are also more or less done, analysts  reckon, because emerging central banks are more likely from here to keep interest rates on hold than to cut. J.P. Morgan adds:

While we look for approximately 7 percent in additional returns in the GBI-EM for the remainder of the year, the majority of this is due to carry (5 percent) while spiot FX returns should be muted at 1.9 percent and duration returns flat.

from MacroScope:

Fed hasn’t silenced markets, Williams says

Federal Reserve policymakers have long watched markets to gauge what investors think is in store for interest rates and the economy. Some – like former Fed Governor Kevin Warsh – have worried that the Fed’s unprecedented purchases of trillions of dollars of U.S. Treasuries and its long-term guidance on the future path of interest rates shuts off a key source of policy-guiding information. The Fed’s recent decision to publish policymakers’ interest-rate forecasts will make the problem worse, he predicted in a speech at Stanford University last month.

In some sense I have partially been made blind by these asset purchases. I, for one, consider financial markets an incredibly useful source of information. If the markets take the Fed’s projections and build that into their own, then the Fed won’t have a full set of gauges in front of them. The markets will simply be a mirror to what they say.

Now comes San Francisco Fed President John Williams with a research paper that argues, to put it bluntly, that Warsh is wrong – that markets are providing just as much information about expectations for Fed policy as they did in the days before the Fed had bought $2.3 trillion in long-term securities and began signaling short-term rates would stay low for years.

In the working paper co-authored with San Francisco Fed economist Eric Swanson and quietly posted to the San Francisco Fed’s website on Monday, Williams argued that five-year and 10-year Treasuries traders still respond with as much vigor to economic news as they did before the financial crisis. As Williams explained to reporters after a speech Monday at Claremont McKenna College:

We continue to see the markets reacting to information -- they still give a signal for what they are thinking about when the Fed’s going to do (what), what policy is going to be, what they think of the future path of the economy. The markets are still working, they are still digesting the information, and they are still responding to it.

Williams’ paper also adds to research arguing there’s plenty the Fed can still do to help the economy, even with interest rates near zero for the last three years – and likely to stay there for another three. It’s a view that several of Williams’ colleagues, including Dallas Fed President Richard Fisher, have taken issue with, but one that Williams says his paper backs up. If long-term interest rates can rise and fall on unexpected economic news, as Williams and Swanson show in their paper, the Fed too can make its influence felt on long-term borrowing costs, the reasoning goes. The authors write:

Even when short-term interest rates are constrained by the zero lower bound, there may still be considerable scope for monetary policy to affect medium- and longer-term interest rates and, therefore, the economy. On several occasions since 2008, the Federal Reserve appears to have done exactly that, by managing private-sector expectations of future short-term interest rates and by conducting large-scale purchases of longer-term Treasury bonds and mortgage-backed securities.

from Global Investing:

Financial repression revisited

At a monetary policy event hosted by Fathom Consulting at the Reuters London office today, former Bank of England policymakers were discussing the pros and cons of "financial repression".

Financial repression is a concept first introduced in the 1970s in the United States and is becoming a talking point again after the financial crisis, especially with a NBER paper last year written by economists Reinhart and Sbrancia reviving the debate.

In the paper, authors define financial repression as follows:

Historically, periods of high indebtedness have been associated with a rising incidence of default or restructuring of public and private debts. A subtle type of debt restructuring takes the form of “financial repression”.

Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks.

Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real