MacroScope

Back from the brink

Pulling back from the brink. The Federal Reserve certainly has and so has Silvio Berlusconi (so far).

Not much to say about the Fed directly, except that it’s surely still only a matter of time, but it certainly takes the pressure off the central banks meeting in our region today. German Bund futures have leapt about 1-1/2 points and Italian bond futures are up more than a full point. We can expect emerging market assets to climb sharply too – the Turkish lira is up three percent, for example, giving its embattled central bank some breathing space.

Further out though, what this has done is create more uncertainty rather than giving investors a firm direction of travel. Presumably, Bernanke and co. are somewhat alarmed about the durability of U.S. economic recovery, which should give everyone pause for thought.

The Swiss National Bank, Norway’s Norges Bank and the South African Reserve Bank all have policy meetings.

South Africa’s rand has not been hit quite as badly as the lira or rupee in recent months, but hit it has been. No change is expected in policy, particularly after the Fed sat on its hands, but also because the SARB doesn’t have the firepower to prop up the currency and inflation is running above six percent, too high to cut rates from an already four-decade low of 5.0 percent.

Euro chat resumes

After the summer lull, euro zone and EU finance ministers meet in Lithuania. The “informal Ecofin” can often be quite a big deal but with German elections only nine days away, it’s hard to see that being the case this time.

During the election campaign German Finance Minister Wolfgang Schaeuble let slip that Greece would need more outside help which would not include a haircut on Greek bonds held by euro zone governments and the ECB.

Since then, European Central Bank policymaker Luc Coene has said Athens might need two bouts of further assistance and Estonia’s prime minister told us yesterday the popular bailout fatigue he flagged as a danger last year had now faded and he was open to aiding Greece with a third bailout and helping other troubled euro zone nations too.

Italian market test

Italy will auction three different bonds, aiming to raise 7.5 billion euros against a volatile domestic backdrop.

A sale of one-year bills on Wednesday saw yields rise, this after the Treasury asked parliament to raise the ceiling on this year’s net debt issuance to 98 billion euros from 80 billion, given the struggle to rein in public finances and a government commitment to pay outstanding bills to firms, which at least could give the economy a boost.

Parliamentarians have a bigger fish to fry in the form of Silvio Berlusconi. A cross-party Senate committee that must decide on whether to bar him from political life drew back from the brink on Tuesday but has caused growing tension between the coalition parties with some of Berlusconi’s allies threatening to pull the shaky government down.

UK unemployment — the monthly monetary policy guide

Of the week’s economic data, today’s UK unemployment stands out since the Bank of England has pegged any move up in interest rates to a fall in the unemployment rate from 7.8 percent to below 7.0. The rate is forecast to have held at 7.8 percent in July.

Bank of England Governor Mark Carney has struggled to convince markets of his contention that interest rates are unlikely to rise for three years because the jobless rate will fall only very slowly. Interest rate futures – short sterling – spiked higher after last week’s policy meeting which offered no change of direction and no statement.

There are some key imponderables:
1. To what extent UK firms have kept workers on but worked them less (its certainly true that the jobless rate rose less than expected during Britain’s recession), leaving plenty of scope to ramp up as growth returns without hiring large numbers of new staff.
2. The economy is still three percent smaller than it was in 2008 but no one is quite sure how much activity has been permanently lost during the financial crisis so the size of the output gap is uncertain and therefore so is the level of output at which price pressures start to build.
3. Most importantly, with the Federal Reserve poised to act, can a country like Britain possibly divorce itself from the world’s economic superpower as it sets the global terms of monetary policy?

Norway shifts tack

Norway’s centre-right swept to power last night, ousting a centre-left government that couldn’t capitalize on a solidly performing economy which escaped the world financial crisis largely unscathed (uncanny echoes of Australia’s weekend election here). The popular feeling seems to have been that a decade of strong growth was wasted and is now slowing.

Erna Solberg, Norway’s second woman premier, will have to govern with the anti-immigration, anti-tax Progress party which could be problematic. But they seem at one on the need for lower taxes at least.

Solberg also wants to revamp the $750 billion oil fund, the world’s biggest sovereign wealth fund. Changes could include breaking it up and requiring it to start investing in Norway, forbidden until now.

Italy’s High Noon

Silvio Berlusconi’s political future – upon which both Italian and euro zone stability rest to varying degrees – is up for debate when a Senate committee meets on Monday to begin discussions that could end with formal procedures to expel him from the Senate. Talks could last for days.

Members of Berlusconi’s centre-right PDL have threatened to walk out of Prime Minister Enrico Letta’s coalition government if a final vote – due in the Senate in October or maybe November – bars him from political life, following the upholding of his conviction for tax fraud.

One of Berlusconi’s key allies says he has already prepared a video message that could announce a decision to bring down the coalition government.

For markets, non-farms eclipse G20

The G20 will wrap up with entrenched positions on Syria and a little more entente over the emerging market turmoil prompted by the Federal Reserve’s impending move to slow the pace of its dollar creation programme.

The BRICS are plugging away with their plan for a $100 billion currency reserve pool to help calm forex volatility but officials admitted this is still a work in progress and won’t be deployable soon.

So, as China and Russia told India – and Washington said more broadly – it’s still incumbent upon countries to put their own houses in order.
The unsurprising rule of thumb is that countries with profound domestic problems have been the ones hit hardest since Ben Bernanke first put up his tapering plan in May. So, while the Fed may have caused the ripples, the fact the rupee is drowning is more due to India’s gaping current account deficit and general economic malaise.

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”.

Italy housing tax showdown

 

Italy’s fraying coalition cabinet meets to discuss what to do with a property tax imposed by previous premier Mario Monti.

Silvio Berlusconi’s centre-right group wants to scrap it – though that would create a 4 billion euro annual financial gap to be filled elsewhere – while the centre-left PD of Prime Minister Enrico Letta wants to keep it for the rich, which would cost only 2 billion euros. The argument has already stalled decisions on more wide-ranging economic reforms. A percentage point rise in the main rate of value-added tax has already been pushed back to October from July and will need to be discussed again too.

The big question is whether the government is effectively paralysed until a vote next month on whether to bar Berlusconi from parliament following the upholding of his tax fraud conviction. Members of his centre-right PDL are threatening to bring down the government and trigger early elections if he is expelled. If he is not barred, swathes of Letta’s centre-left PD would react with horror.

Euro zone rate cut prospects evaporate

The euro zone is growing again and while its weaker constituents face plenty of tough times yet, it seems less and less likely that the European Central Bank will cut interest rates from their record low 0.5 percent. That illustrates the problems of the new fad of forward guidance.

The ECB deliberately stayed vaguer than most – a product of ripping up its custom of “never precommitting” – saying that rates would stay at record lows or even go lower over an extended period.
Its monthly policy meeting falls next week and in a parallel transparent world Mario Draghi could consign the “or lower” part of the guidance to history after just two months. Don’t bet on that happening but it shows how quickly things can move.

If anyone in Europe, Britain or elsewhere is hoping for a cast iron guarantee that rates won’t rise for two, three or more years, forget it.
Exhibit A today will be Germany’s Ifo sentiment index which has been coming in strong in recent months and is not expected to buck that trend.
It must be only a matter of time before the government and Bundesbank upwardly adjust their forecasts for a significant slowdown in the second half of the year, following 0.7 percent growth in the second quarter.