MacroScope

Italy’s borrowing costs over ten years drew closer to five percent after a decision by Prime Minister Mario Monti to step down early left the country’s political future unclear, hurting riskier euro zone debt.

Monti said on Saturday he would resign once the 2013 budget was approved, raising questions over who will take the reins of the euro zone’s third largest economy at a time when it remains a focus of the region’s three-year debt crisis.

His announcement, potentially bringing forward an election due early next year, came after former prime minister Silvio Berlusconi’s party withdrew its support for the government — and Berlusconi himself said he would run to become premier for a fifth time.

Justin Knight, European rates strategist at UBS says:

Berlusconi’s actions have created a degree of uncertainty in the market with regards to the Italian political scene. Part of the problem here is that investors outside of Italy are not positioned very well for this.

He was referring to the recent bout of buying in Italian debt, mainly thanks to the European Central Bank’s promise that it will provide central bank support – should a country decide to ask for aid first.

Don’t start putting out the tinsel yet. Just when we thought we had a smooth glide path into Christmas the euro zone has bitten back.

Over the weekend, Italy’s Mario Monti called Silvio Berlusconi’s bluff and said he was pulling the government down which will mean early elections in February. The budget bill will be passed and then the country will be in a potentially precarious state of limbo as parliament is dissolved. Italian bond futures have opened more than a point lower, which denotes a reasonable measure of alarm, although the safe haven Bund future has only edged up so we’re far from panic mode.

The big question is whether a government results that will stick to Monti’s agenda and whether he himself will have a prominent role to play in the administration. There are constitutional difficulties to keeping Monti as prime minister since he has said he would not stand at the election, though he has also said he would be prepared to step in again if no stable government is formed. Most likely, presuming a government is elected that supports his reforms, is that he will play a key role but not take the top job.

An unusual thing happened on Wednesday amidst all the shouting over British finance minister George Osborne’s autumn budget update which, depending on who you asked, outlined an increasingly dire or healthy state of the UK economy.

On the very near-term economic  outlook at least, officialdom actually sounded more pessimistic than most of even its harshest critics.

Britain’s independent Office for Budget Responsibility said it expects the UK economy will contract in the period ending this month by 0.1 percent — a gloomier forecast than the consensus of economists polled by Reuters, for 0.1 percent growth.

Who hasn’t heard of Paul Krugman these days? The Nobel-winning Princeton economist and New York Times columnist has emerged as a key voice in American liberalism, and is berated by the right for his support of heavy fiscal stimulus, higher inflation and a strong social safety net.

Which makes the views espoused in a 1997 missive entitled “In Praise of Cheap Labor” rather surprising. In the article, the economist attacks opponents of globalization for their soft-hearted distaste for inhumane labor conditions in developing countries.

Such moral outrage is common among the opponents of globalization – of the transfer of technology and capital from high-wage to low-wage countries and the resulting growth of labor-intensive Third World exports. These critics take it as a given that anyone with a good word for this process is naive or corrupt and, in either case, a de facto agent of global capital in its oppression of workers here and abroad.

By almost all accounts, the Federal Reserve is expected to “stay the course” on its massive bond-buying program after next week’s policy-setting meeting. That would mean a continuation of the $85 billion/month in total purchases of longer-term securities, probably consisting of $40 billion in mortgage bonds and another $45 billion in Treasuries. Laurence Meyer of Macroeconomic Advisers is one of countless forecasters predicting this, calling it the “status quo.”

Problem is, the U.S. central bank’s current policy is not simply to buy $85 billion in bonds — and if it does announce such a program on Wednesday, it should probably be interpreted as policy easing, not a continuation of current policy.

The $45 billion in longer-term Treasuries is part of a program called Operation Twist that offsets those purchases with $45 billion in sales of shorter term Treasuries. In June, Fed policymakers extended Twist to the end of the year, meaning the market — which rallies each time the Fed eases policy — should have priced in an end to the $45 billion shuffle in the Fed’s portfolio of assets. It also means that there is really only $40 billion in outright bond-buying happening today, as part of the Fed’s third round of quantitative easing (QE3). Not $85 billion.

Is the U.S.on the road to Greece, as some politicians have proclaimed?

Most economists say the comparison is nonsense. At a towering $15 trillion, the U.S. economy is not only the world’s largest, it is also more than 50 times the size of Greece’s. This gap makes any type of comparison difficult – it would be like analyzing trends in Maryland in relation to the entire euro zone.

Another key difference: Unlike Greece, the U.S. actually controls its own currency. That means a debt default is effectively impossible. This reality, coupled with strong monetary stimulus from the Federal Reserve, helps explain why U.S. bond yields remain near historic lows despite larger deficits.

Mark Weisbrot, co-director of the progressive Center for Economic and Policy Research in Washington, says a country’s interest burden is far more important than its total debt levels in determining the government’s ability to service it. He argued in a recent editorial:

Budget statements from Britain and Ireland take top billing today with UK finance minister George Osborne cutting an increasingly lonely figure in policymaking circles as an advocate of cutting your way back to growth. While the economic policy room for manoeuvre is limited this is a huge political moment. With elections due in 2015, a feeling of recovery must be entrenched in the public’s mind well beforehand if the Conservatives are to entertain hopes of governing alone next time. So measures now and in the 2013 budget in the spring are the best opportunity to change the game.

Osborne has already said he is sticking to his austerity plan – and having made it the government’s central policy plank he has little choice although the opposition Labour party have staked out the opposite ground and hopes to capitalise. Even so, Osborne is likely to have to admit that he will miss his debt-cutting targets so that the pain will have to last for longer, well into the latter part of this decade.

As the euro zone has shown, without growth cutting debt is nigh on impossible. Osborne came into government in 2010 saying the austerity drive would be complete by the time of the 2015 election. He is expected to say today that it will stretch to 2018. Labour’s significant opinion poll lead is widely seen as “soft” but it might not be for long.

A panel of economic luminaries took the stage in Chicago this afternoon to join in a tradition repeated this time of the year in cities across the country, opining on the outlook for the coming year.

Raghuram Rajan, a finance professor at University of Chicago’s Booth School of Business, began with a joke involving 973 sheep and a dog, the butt of which was the intellectual capacity of economic forecasters. He went on to predict slow world growth ahead, highlighting the geopolitical risks from conflict in the Middle East and Asia, and the limits of fiscal and monetary policy to turn things around.

Carl Tannenbaum, Northern Trust’s chief economist, focused on the still-troubled housing market and risks posed by the failure of European political leaders to resolve their financial crisis (he observed that Americans frustrated by the deadlock in Washington over resolving the U.S. fiscal cliff have only to look across the Atlantic for comfort that things, certainly, could be worse).

Social Security should not be part of the current negotiations over the U.S. budget – that was the message from outgoing Treasury Secretary Timothy Geithner over the weekend. During a veritable tour of Sunday shows aimed at addressing negotiations surrounding the “fiscal cliff” of expiring tax cuts and spending reductions, Geithner told ABC News’ “This Week”:

What the president is willing to do is to work with Democrats and Republicans to strengthen Social Security for future generations so Americans can approach retirement with dignity and with the confidence they can retire with a modest guaranteed benefit.

But we think you have to do that in a separate process so that our seniors aren’t – don’t face the concern that we’re somehow going to find savings in Social Security benefits to help reduce the other deficit.

U.S. Federal Reserve policymakers are mulling whether to expand the central bank’s current asset buys, and whether to tweak their communications by adopting numerical thresholds for inflation and joblessness to signal when rates might rise.

Since September the Fed has been buying a total of $85 billion in long-term securities each month to help push down borrowing costs. Part of that is a program known as Operation Twist, in which the Fed buys $45 billion in longer-term Treasuries and sells the same amount of shorter-term ones.

Twist expires at year end and officials will need to decide at their December 11-12 meeting whether to ramp up their separate quantitative easing program, dubbed QE3, to make up for the shortfall. Under QE3, the Fed has said it would buy $40 billion in mortgage-backed securities per month until the outlook for the labor market improves substantially.