MacroScope

PMIs on the up

Slowing growth in the Chinese and U.S. factory sectors earlier this week did nothing to soothe frayed market nerves and put a firm focus on today’s service sector PMI surveys in Europe along with the equivalent U.S. report and a weekly jobless number there.

While the world’s two largest economies suffered a hiccup, euro zone factories had their best month since mid-2011 in January. But it is the service sector that dominates in Europe. Flash readings, which are not usually revised much, showed the euro zone services reading hit a four-month high with France lagging Germany again although even its number rose. Today we’ll get the first numbers for Italy, Spain and Britain.

The reports will be the last meaningful pieces of evidence the European Central Bank gets to chew over before Thursday’s policy decision. Emerging market tumult and its possible effect on already vanishing inflation will be bang at the top of its agenda.

It’s probably too early to force a policy move this week – particularly since the next set of ECB economic and inflation forecasts are due in March – but the market ructions are an unwelcome development at a time when inflation is already uncomfortably low, dropping further to just 0.7 percent in January, way below the ECB’s target of close to but below two percent. If turbulence persists and a by-product is to drive the euro higher, which is quite possible, the downward pressure on prices could threaten a deflationary spiral which ECB policymakers have so far insisted will not come to pass.

Central banks have already been thrown out of kilter. Turkey whacked up its key rate by a stunning 4.5 points last week without doing much good for the lira. South Africa tightened the following day. Neither move would have been considered remotely likely a month ago.

Another false start for the U.S. economy?

Since the global financial crisis ripped the floor out from underneath developed world economies, the world’s biggest one has had several false starts nailing the floorboards back in.

Stock markets have moved in almost one direction since their trough in March 2009 – up – but economic growth and job creation have bounced around.

There are some disturbing signs another false start is afoot, but it has become almost taboo to even raise the issue that the U.S. economy, for all of its progress in repairing bank and household balance sheets, may still be at risk.

Euro zone inflation falls again; economists base ECB rate cut calls on deja vu

Euro zone inflation has dipped again and some forecasters are hedging their bets on the policy response by saying the European Central Bank could either cut rates this week or sometime in the next two months.

That lack of conviction, although not a recent phenomenon, is driven by memory of the ECB’s surprise cut in November after a similar drop in inflation and a nagging belief that things have not worsened enough in the interim to warrant another.

Only two of 76 analysts - Barclays and IFR Markets – in a Reuters poll conducted before news on Friday that January euro zone inflation fell to 0.7 percent said the ECB would trim its refinancing rate below 0.25 percent this week.

ECB under pressure, March move more likely

The European Central Bank meets on Thursday with emerging market tumult bang at the top of its agenda.

It’s probably too early to force a policy move this week – particularly since the next set of ECB economic and inflation forecasts are due in March – but it’s an unwelcome development at a time when inflation is already uncomfortably low, dropping further to just 0.7 percent in January.

If the market turbulence persists and a by-product is to drive the euro higher, which is quite possible, the downward pressure on prices could threaten a deflationary spiral which ECB policymakers have so far insisted will not come to pass.
Euro zone and UK PMI surveys for January will give the latest on the state of Europe’s economic recovery this morning. The Markit/HSBC manufacturing PMI for China has fallen to a six-month low.

ECB deflation risk denial has echoes of 2009

Euro zone policymakers like to talk. They often contradict each other at separate speaking engagements on the same day. But they have struck a chorus in recent weeks, asserting that deflation is not a threat.

Members of the ECB Governing Council have been particularly vocal, insisting they will not have to alter policy to counter falling prices.

Jan 9: Mario Draghi says the euro zone may “experience a prolonged period of low inflation” — steering clear of even mentioning the word deflation.

A week before emerging-market turmoil, a prescient exchange on just how much the Fed cares

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The last seven days has been a glaring example of fallout from the cross-border carry trade. That’s the sort of trade, well known in currency markets, where investors borrow funds in low-rate countries and invest them in higher-rate ones. Some $4 trillion is estimated to have flooded into emerging markets since the 2008 financial crisis to profit off the ultra accommodate policies of the U.S. Federal Reserve, Bank of Japan, European Central Bank and the Bank of England. Now that central banks in developed economies are looking to reverse course and eventually raise rates, that carry trade is unraveling fast, resulting in the brutal sell-off in emerging markets such as Turkey and Argentina over the last week.

The Fed’s decision on Wednesday to keep cutting its stimulus effectively ignores the turmoil in such developing countries. And while the Fed may well be right not to overreact, it makes one wonder just how much attention major central banks pay to the carry trade and its global effects — and it brings to mind a prescient exchange between some of the brightest lights of western economics, just a week before emerging markets were to run off the rails.

On January 16, minutes before Ben Bernanke took the stage for his last public comments as Fed chairman, the Brookings Institution in Washington held a panel discussion featuring former BoE Deputy Governor Paul Tucker, Harvard University professor Martin Feldstein and San Francisco Fed President John Williams. They were asked about the global effects of U.S. monetary policy:

Forward guidance is not fully living up to its name

Britain’s economy may have seen one of the fastest rebounds among industrialized nations last year, but half of 56 economists polled by Reuters think the Bank of England has lost some credibility over its handling of the forward guidance policy.

The policy – an advance notice that monetary conditions will not be tightened too fast or too soon – was a way of managing market bets, at a time when the scope for stimulating economies through conventional interest rate cuts was limited.  Many say it was a necessary transition from the ultra-loose rate policy of recent years to a more normal post-crisis one. Indeed, the use of verbal intervention to guide monetary policy has been on the rise in recent years, as shown by this graphic on the Federal Reserve. 

But the BoE’s forward guidance has come under a lot of criticism and its results have been mixed, as highlighted by this Reuters story  and FT blog.

Shock now clearly trumps transparency in central bank policymaking

The days of guided monetary policy, telegraphed by central banks and priced in by markets in advance, are probably coming to an end if recent decisions around the world are any guide.

From Turkey, which hiked its overnight lending rate by an astonishing 425 basis points in an emergency meeting on Tuesday, to India which delivered a surprise repo rate hike a day earlier, central banks are increasingly looking to “shock and awe” markets into submission with their policy decisions.

A wide sample of economists polled by Reuters on Monday already expected a massive rise of 225 basis points by Turkey’s central bank to stop a sell-off in the lira. Instead it doubled the consensus and opted for the highest forecast.

Brazil’s need for dollars to shrink in 2014 – but the long-term view remains bleak

Brazil’s current account deficit will probably narrow this year. That may sound as a reassuring (or rather optimistic) forecast after the recent sharp sell-off in emerging markets, which prompted Turkey to raise interest rates dramatically to 12 percent from 7.75 percent in a single shot on Tuesday. But that was the outlook of three major banks – HSBC, Credit Suisse and Barclays - in separate research published earlier this week.

The gap, a measure of the extra foreign resources Brazil needs to pay for the goods and services it buys overseas, will probably shrink to 3.0-3.4 percent of GDP in 2014, from 3.7 percent last year, they said.

“Brazil’s external vulnerabilities are overstated,” claims Barclays’ Sebastian Brown, adding: “the central bank’s FX intervention program should limit bouts of excessive BRL weakness.”

Ker-pow! Turkey leaps to lira’s defence

 

Turkey’s central bank bit the bullet last night, despite Prime Minister Tayyip Erdogan calling for it to hold firm just hours beforehand, and what a bite it was.

After months trying to avoid a rate rise it put 4.25 full percentage points on the overnight lending rate, taking it to 12 percent. No one can accuse Governor Basci of being under the government’s thumb now. The move vaulted expectations.

The big questions for Turkey are what such a magnitude of tightening, which the central bank said would persist, does to a faltering economy and how Erdogan, who is on a two-day trip to Iran, reacts.