MacroScope

from Global Investing:

The hryvnia is all right

The fate of Ukraine's hryvnia currency hangs by a thread. Will that thread break?

The hryvnia's crawling peg has so far held as the central bank has dipped steadily into its reserves to support it. But the reserves are dwindling and political unrest is growing. Forwards markets are therefore betting on quite a sizeable depreciation  (See graphic below from brokerage Exotix).

 

The thing to remember is that the key to avoiding a messy devaluation lies not with the central bank but with a country's households. As countless emerging market crises over decades have shown, currency crises occur when people lose trust in their currency and leadership, withdraw their savings from banks and convert them into hard currency.  That is something no central bank can fight. Now Ukraine's households hold over $50 billion in bank deposits, according to calculations by Exotix. Of this a third is in hard currency (that's without counting deposits by companies).  But despite all the ruckus there is no sign of long queues outside banks or currency exchange points, scenes familiar to emerging market watchers.

So what are the reasons?  First, households and businesses seem confident of a muddle-through scenario (this view is shared by most, though not, foreign analysts). Possibly, the optimism is based on the central bank's  track record this year on defending the hryvnia. It also seems likely that with some foreign aid (bits and bobs garnered from Russia, China and the EU) and by using the remaining reserves, Ukraine can hold it together until 2015 elections are past and the government can finally knuckle down to the rigours of an IMF aid programme.

Second, people will not find it easy to turn their backs on the 14-25 percent annual rate they can earn on their bank deposits. In smaller, lower quality banks, bank deposits might earn up to 27-28 percent a year.  Inflation meanwhile is running below zero.  David Hauner, head of EEMEA fixed income strategy at BofA-Merrill Lynch Global Research, says:

Brussels looks warily at German surplus

Barring a last minute change of heart, the European Commission will launch an investigation into whether Germany’s giant trade surplus is fuelling economic imbalances, a charge laid squarely by the U.S. Treasury but vehemently rejected by Berlin.

This complaint has long been levelled at Germany (and China) at a G20 level and now within the euro zone too. Italian Prime Minister Enrico Letta urged Berlin this week to do more to boost growth.

Stronger German demand for goods and services elsewhere in the euro zone would surely help recovery gain traction. The counter argument is that in the long-run, only by improving their own competitiveness can the likes of Spain, Italy and France hope to thrive in a globalised economy.

French travails

The Bank of France’s monthly report forecasts growth of 0.4 percent in the last three months of the year, up from an anaemic 0.1 percent in the third quarter. That still makes for a fairly doleful 2013 as a whole.

France is zooming up the euro zone’s worry list, largely because of its timid approach to labour and pension reforms. Spain has been much more aggressive and is seeing the benefits in terms of rising exports (and, admittedly, sky-high unemployment). So too has Portugal.

Tellingly, both the Iberian countries have had the outlook on their credit ratings raised to stable in recent days while S&P cut France’s rating to AA from AA+. It remains at a far stronger level but the differing directions of travel are clear.

What’s happened to euro inflation?

New European Commission macro forecasts for the euro zone and the EU have been given added significance by an alarming drop in inflation to 0.7 percent which has heaped pressure on the European Central Bank to ward off any threat of deflation.

There are myriad other questions – Will the Commission predict that Italy will miss its deficit target? What will it say to those countries in bailout programmes – particularly Greece, where the troika returns for a bailout review today, and Portugal? And what about France’s sluggish economy? PMI surveys on Monday showed it is acting as a drag on the euro zone recovery.

Against that backdrop, European Commission President Jose Manuel Barroso will speak at Frankfurt’s St. Paul’s Church, the seat of the first democratically elected parliament in Germany. He is expected to outline the political priorities of the European Union in the months to come and spell out his expectations of a new German government.

It’s all Greek

The EU/IMF/ECB troika is due to return to Athens to resume a review of Greece’s bailout after some sparring over budget measures.

Greece’s president and prime minister have said they will not impose any further austerity measures and hope that their ability to run a primary surplus will persuade its lenders to cut it some more slack on its bailout loans to make its debt sustainable. The EU and IMF say there will be a fiscal gap next year that must be filled by domestic measures, be they further wage and pension cuts or tax increases.

We had a round of brinkmanship last week with EU officials saying they weren’t going to turn up because Athens had not come up with plausible ways to fill a 2 billion euros hole in its 2014 budget. But on Saturday, the European Commission said the review was back on after the Greek government came up with fresh proposals.

A market-dependent Fed?

It’s hard to shake the feeling that the Federal Reserve is about to begin pulling back on stimulus not just on the back of better economic data, but also because financial markets have already priced it in. The band-aid ripping debate over an eventual tapering of bond purchases that started in May was so painful, Fed officials simply don’t want to go through it again.

If anything, recent data have been at best mixed, at worst worrisome. In particular, August job growth was disappointing and labor force participation declined further.At the same time, inflation remains well below the central bank’s objective.

Argues Dean Croushore, a former regional Fed bank economist and professor at the University of Richmond:

from Sakari Suoninen:

Beer washes out German inflation angst

photo

Germans, many say, have inflation angst in their DNA. But there is one exception to that. Beer.

Although prices at Oktoberfest have been inflation-beating for years, consumption keeps rising. Average price of the 1-liter (35 oz) stein of beer will be 9.66 euros ($ 12.85), up 3.6 percent from last year's festivities, compared with German overall annual inflation of 1.5 percent.

Since 1985, the Wiesn Visitor Price Index has risen more than twice as fast as the country's overall inflation rate, Unicredit calculations show. But this has failed to stem the tide of more beer flowing down visitors' throats, with millions and millions of litres to be consumed again this year.

An Italian bullet dodged, but more in the chamber

Italy will sell up to six billion euros of five- and 10-year bonds at a somewhat inauspicious time.

Yields rose modestly at shorter-term debt sales on Tuesday and Wednesday with the government wobbling, and the prospect of the Federal Reserve reducing U.S. stimulus has put pressure on peripheral euro zone bond yields more broadly.

However, Italy’s restive coalition managed last night to reach a deal on a deeply unpopular property tax, showing it can still function despite fractures over Silvio Berlusconi’s future. On the secondary market yesterday, yields dipped in anticipation of a deal which will abolish the tax from the beginning of 2014 to be replaced by a “service tax”.

Post-Jackson Hole, Fed Septaper still appears on track

With all the QE-bashing that went on at the Federal Reserve’s Jackson Hole conference this year, it was difficult not to get the sense that, barring a major economic disappointment before its September meeting, the central bank is on track to begin reducing the monthly size of its bond purchase program, or quantitative easing.

If anything, the fact that this expectation has become more or less embedded in financial markets means that the Fed might as well go ahead and test the waters with a small downward adjustment of say, $10 billion, from the current $85 billion monthly pace, while waiting to see how employment conditions develop in the remainder of the year.

Atlanta Fed President Dennis Lockhart, who is not a voter this year but tends to be a bellwether centrist on the Federal Open Market Committee, told Reuters on the sidelines of the meeting that he would be ‘comfortable’ with a September tapering “providing we don’t get any really worrisome signals out of the economy between now and the 18th of September.” (Does this count? Probably not.)

St. Louis blues: Fed’s Bullard gets a sentence

Ellen Freilich contributed to this post

Talk about getting a word in edgewise. St. Louis Federal Reserve Bank President James Bullard got almost a full sentence in the central bank’s prized policy statement.

Some background: Bullard dissented at the Fed’s June meeting, arguing that, “to maintain credibility, the Committee must defend its inflation target when inflation is below target as well as when it is above target.” The latest inflation figures show the Fed’s preferred measure at 0.8 percent, less than half the central bank’s target.

Fast-forward to yesterday’s policy statement, which included the following new language: