MacroScope

European Central Bank  President Jean-Claude Trichet plans to keep a cool head at this weekend’s meeting of Group of Seven policymakers in Canada’s far north.

Large iceberg over Frobisher Bay

“I am very happy to go very far up, far up in the north of Canada,” he told journalists before hopping on a plane en-route to frostbitten Iqaluit, some 300 kilometres south of the Arctic Circle.

“We will have all the right environment to be as cool as possible in judging the situation.”

Local police have already said G7 visitors should not worry if they see men with rifles speeding around on snowmobiles, as the town is more usually host to hunters than foreign dignitaries.

In downgrading the debt to A2, Moody’s ensured that Greek (and other) banks will still be able to swap Greek bonds for cheap funding from the European Central Bank, assuming that nothing has changed by this time next year when the ECB will only accept bonds rated A-/A3 or above as collateral by at least one agency.

Both Standard & Poor’s and Fitch have cut Greek bonds to BBB-plus this month, meaning if Moody’s cuts Greece to an equivalent level, Greek banks are likely to face difficulties in getting access to liquidity as analysts estimate more than half the collateral they have submitted at the central bank is in government bonds.

Yet Moody’s explained the decision as partly due to its expectation that the ECB will keep accepting Greek debt as collateral, a decision which hinges on Moody’s itself keeping Greece’s rating above the watermark. 

German Bundesbank President Axel Weber is developing a reputation as a leading indicator for the European Central Bank.

In the same way as a pickup in confidence can foreshadow a pickup in the economy, Weber’s comments about the direction of ECB policy this year have tended to be borne out by events.

The ECB’s broad hint on Nov. 5 that it will drop its super-long, one-year loans to euro zone banks next year follows a similar suggestion by Weber a week earlier.

European Central Bank President Jean-Claude Trichet  signalled on Thursday that the days of 12-month loans to banks will come to an end soon and that will be the start of a gradual exit from unlimited liquidity injections.***”The market, as far as I see, it is not expecting that we will prolong (our) one-year operation, I will say nothing to dispel this present sentiment of the market,” Trichet said in a news conference after the 16-country bloc’s central bank kept rates at 1 percent. “The enhanced credit support … was not for eternity,” he added.******The ECB started the 12-month cash injections to help the ailing banking sector back into form, and banks reacted with joy, snapping up nearly half a trillion euros of cheap money in the first such operation in June.******But Trichet also had soothing words for banks addicted to cheap money. The ECB would keep interbank interest rates well below the main refinancing rate, he said.  But it seems banks will have to learn to play again with each other rather than relying only on the ECB’s largesse.******And before signing off, Trichet also had words of advice for the media.  “This is exactly the same language as we always have utilised. Everybody knows that, so no news there.”******That advice seemed fall on deaf ears, as most media, including Reuters, would make a lot of hay out of his words on 12-month liquidity injections and keep it the centrepiece of their coverage.

BofA Merrill Lynch Global Research economist Ethan Harris thinks all the talk of a Federal Reserve rate hike is just that — talk. Harris, a former Federal Reserve Bank of New York economist, said much of the recent hawkish commentary has come from presidents of the regional Fed banks, and that may not be indicative of the thinking on the Fed’s board.

“The signals don’t  come from Reserve Bank Presidents or advisers,” Harris wrote in a note to clients. “They come from either the overall committee — in the form of the official statements — or from the core of the committee — that means (Chairman Ben) Bernanke, (Vice Chairman Donald) Kohn, and to a lesser extend, New York President (William) Dudley.”

The Fed starts its two-day policy-setting meeting on Tuesday, and Harris is certainly not alone in thinking they’ll stay the course, keeping benchmark interest rates near zero. In fact, BofA Merrill thinks it will be the European Central Bank that hikes before the Fed.

Bankers worried about losing their bonuses might be well advised to consider a cost-benefit analysis of the contribution of their public sector colleagues.

Central bankers not only earn much less than their high-flying private sector counterparts, but over the last year have spent almost every second weekend in high-level, save-the-world meetings aimed at clearing up the mess created by Wall St and City banks.     

European Central Bank head Jean-Claude Trichet (who earns a mere 350,000 euros a year ) confessed to a group of student journalists that he spends almost every weekend working.

Professor Charles Goodhart of the London School of Economics explains the difference between inflation targeting and price level targeting in the lobby of Jackson Lake Lodge after taking part in an animated discussion of whether central banks should target price levels rather than inflation.

A paper University of California, Santa Cruz economist Carl Walsh presented at the Federal Reserve’s annual mountain retreat suggested that one lesson from the recent financial crisis is that central banks would benefit from the greater flexibility that price level targeting might give them.

A former Fed governor,  Frederic Mishkin, said that while in theory price level targeting may sound attractive, in actual practice it is more difficult to use effectively. One difficulty he cited was in explaining to consumers how it works. 

 Bernanke’s tone may have been slightly more optimistic today — but the first thing policy-makers from around the world see as they enter the conference room for the Fed’s annual Jackson Hole symposium is a large stuffed bear.

Bernanke told the conference on Friday morning that the prospects for return to global growth appear “good” in the near-term — his clearest signal yet that he thinks the global recovery is at hand.

The ECB’s Trichet, on the other hand, expressed uneasiness at what he saw as premature talk of a return to normal from a financial crisis.

Five things to think about this week

TUSSLE FOR DIRECTION
- The tussle between bullish and bearish inclinations -- with bears gaining a bit of ground so far this month -- is being played out over both earnings and economic data. Alcoa got the U.S. earnings season off to a good start but a heavier results week lies ahead and could toss some banana skins into the market's path. Key financials, technology bellwethers (IBM, Google, Intel), as well as big names like GE, Nokia, Johnson and Johnson will offer more food for thought for those looking past the simple defensive versus cyclical split to choices between early cylicals, such as consumer discretionaries, and late cyclicals, such as industrials, based on the short-term earnings momentum. Macroeconomic data will need to confirm the picture painted by last week's unexpectedly German strong orders and production figures to give bulls the upper hand.

FINANCIAL FOCUS
- The heavy financial results slate (Goldman, JP Morgan, Bank of America, Citi) will show the extent to which balance sheets are being cleansed of toxic assets and the health of, and outlook for margins, trading revenues, etc. The relative performance of the firms reporting could put the spotlight on the split between investment banking and retail exposure. In Europe, Swedbank's results will be watched for Baltic exposure while clarity is still being sought on what banks plan to do with the large chunk of ECB one-year money which they continue to park back at the ECB in the form of overnight deposits.

JAPANESE DILEMMA
- The BOJ's policy meeting poses thorny questions on quantitative easing (QE), with the policy debate complicated by sharp gains in the yen. The yen has risen as much as 10.5 percent in three months against the dollar and is nearing the 90 threshold which is viewed by the foreign exchanges as the point at which the Japanese authorities start ratcheting up the rhetoric. Further sustained yen gains will fuel market debate about the fallout for carry trades and for exporters -- and by extension economic activity.

Central bankers in the euro zone will have to get out their dictionaries and calculators to work out how often they are entitled to vote on European Central Bank decisions under a complicated new voting system.

New rules show that the size of a country’s economy, the health of its banking sector and the spelling of its name will all influence how often a governor from one of the euro zone’s national central banks gets to vote on setting ECB interest rates and other crucial policy decisions.

This could make the difference between a governor from a similar-sized economy being sidelined for as little as six months in a three-year period or as many as nine.