MacroScope

One trillion euros is a lot of money. And as we have previously noted on this blog it did a lot for stock markets early this year but not much for the real economy.

But recent bond auctions in the euro zone suggest the impact of two rounds of cheap 3-year ECB funding on the region’s struggling bond market may also be fading.

Italian three-year borrowing costs surged more than a full percentage point at an auction to 3.89 percent – its highest since mid-January.

Nick Stamenkovic, strategist at RIA Capital Markets says:

Clearly it shows investor appetite for Italian bonds even at the short end has diminished recently as the effects of the two LTROs (long-term refinancing operations) from the ECB dissipate.

That was not the only patchy bond sale recently. Italy’s one-year borrowing costs doubled at a sale of short-term bills on Wednesday and, just last week, Spain had to pay dearer to borrow through medium-term bonds.

It was not a good day for Spain.

The euro zone’s fourth largest economy had to pay dearer to borrow through medium-term bonds, a sign that concerns over the country´s fiscal problems was curbing appetite for its debt. It sold 2.6 billion euros of 2015, 2016 and 2020 paper – at the low end of the target range.

In contrast, Portugal’s 1 billion euros sale of 18-month treasury bills was a successful test of market appetite for the longest-dated debt since it took an international bailout. Appetite for short-dated paper has been especially supported by the one trillion euros of cheap three-year European Central Bank funding injected into the financial system since December.

The problem is that Spain is the latest country to come into the firing line of the euro zone debt crisis. This week’s tough budget was not enough to calm investor nerves and many fear too much austerity could choke an already struggling economy where unemployment rose to a staggering 22.9 percent in the fourth quarter of 2011 – the highest in the European Union. Meanwhile, the government expects Spain’s public debt to jump in 2012 to its highest since at least 1990.

Things are  looking a bit unsteady in the euro zone’s economy.  Just ask Olli Rehn, the EU’s top economic official, who warned this week of  “risky imbalances” in 12 of the European Union’s 27 members. And that’s doesn’t include Greece, which is too wobbly for words. 

Rehn is looking longer term, trying to prevent the next crisis. But the here-and-now is just as wobbly. The euro zone’s economy, which generates 16 percent of world output, shrunk at the end of 2011 and most economists expect the 17-nation currency area to wallow in recession this year and contract around 0.4 percent overall. Few would have been able to see it coming at the start of last year, when Europe’s factories were driving a recovery from the 2008-2009 Great Recession. And it shows just how poisonous the sovereign debt saga has become.

Not everyone thinks things are so shaky.  Unicredit’s chief euro zone economist, Marco Valli, is among the few who believe the euro zone will skirt a recession — defined by two consecutive quarters of contraction — in 2012. This year is “bound to witness a gradual but steady improvement in underlying growth momentum,” Valli said, saying the fourth quarter was the low point in the euro zone business cycle.

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.

Forecasting hard data can be difficult enough. Estimating the forecasts of individual Federal Reserve policymakers is even tougher. But, in advance of the Fed’s latest effort at policy transparency, that’s just what Goldman Sachs economists have attempted to do.

The Fed announced last week it would begin publishing policymakers’ own forecasts for the path of interest rates, in addition to the growth, inflation and employment projections they already release on a quarterly basis. Goldman uses the Taylor rule of monetary policy, which governs the relationship between economic slack and inflation, to estimate when individual policymakers would likely perceive the timing of an eventual interest rate hike.

The findings are interesting, particularly because they find that, contrary to the view chronicled in this post, the publication of Fed officials’ forecasts might actually have the effect of tightening financial market conditions.

Concerns about Austrian banks’ exposure to Hungary have continued to put pressure on Austrian bonds in recent days, driving 10-year Austrian government bond yields to their highest in over a month on Friday.

In focus is Hungary’s dispute with the IMF and the EU over its financial aid package. Hungarian Prime Minister Viktor Orban’s government has been chided over its stance on a law its lenders view as infringing central bank independence. That has jeopardised negotiations for a much-needed loan deal.

The concerns have led to a sell-off in Austrian government bonds, leaving the spread between their yields and those on Germany bunds within sight of a euro lifetime high hit in November. Richard McGuire, senior fixed income strategist at Rabobank explains the linkage:

The Fed’s decision to begin publishing policymakers’ own forecasts for the path of policy may effectively constitute a minor easing of the central bank’s already ultra-loose monetary policy at its Jan. 24-25 meeting, according to Harm Bandholz of UniCredit. That’s because in doing so, officials will likely show that they expect the benchmark federal funds rate to remain near rock bottom levels until later than mid-2013 – the Fed’s current guidance on policy.

While the minutes do not say in which direction the forward guidance should be adjusted, we assume that mid-2013 is seen by many FOMC officials as too early. In that context, the decision for Fed officials to publish their projections of the target fed funds rate could provide an opportunity for a back door policy easing in January. If e.g. most participants would not pencil in any rate hike until the end of 2014, the market would certainly take this as a strong signal.

Along the same lines, David Hensley at JP Morgan says:

All else constant, these projections would further flatten the yield curve if the FOMC signals a later start to rate hikes than currently is discounted in markets.

Since the 2008 failures of Bear Stearns, Lehman Brothers and American Insurance Group, the U.S. Federal Reserve has reached deep into unconventional territory for ways to coax the economy out of its deepest slide since the Great Depression, slashing interest rates to a shade above nothing and buying trillions of dollars of long-term securities.

Now it appears the U.S. central bank is diving for new ideas in its own dumpster – or recycling bin, as the case may be. As Fed officials vet a range of communications options that could provide more certainty to markets about the Fed’s policy intentions, they are warming to the idea of providing forecasts for short-term interest rates.

Doing so, some central bankers believe, would give markets a clearer idea of the Fed’s intentions, and could head off a recovery-choking jump in rates if investors start betting on tighter monetary policy before the Fed believes such tightening is warranted.

Twitter does have some very strange Trends. These are the things that appear on the right-hand side of the page that show what people are talking about. They more they talk, the more likely it is that something will get listed.  More often than not they are about celebrities such as Justin Bieber.

But today's Worldwide  Trends was particularly unusual.

#ThingsStrongerThanTheKenyaShilling was right up there near the top.

As the graph here shows, the shilling has taken a heavy beating since the Lehman Brother collapse. This is one reason for the Twitter outburst.  "Kenyans are getting fed up," said @oreo_junkie, whose Twitter feed states it is from Nairobi.

And judging by some of the other "answers" to the trendline, it is not a matter for levity in Kenya. "Government's resolve to fight Corruption" was one;  "Stupidity of Kenyans to  reelect the same MPs" was another.

The Federal Reserve's "Operation Twist" has set the literary- and musical-allusion juices flowing.  It is all about the Fed selling or not rolling over short-term debt and buying long-term bonds instead in order to keep borrowing costs low.

But that is frightfully dull for economists, analysts and reporters trying to get attention for their work. So, so far we have heard:

-- "Let's Twist Again", a reference to the 1960's Chubby Checker record about the dance craze . Problem is that the second line is "Like we did last summer", and the Fed did nothing of the sort, launching plain old quantative easing instead.