Fed: Still Easing After All These Years – Interpretation & Asset Implications

  • In its new round of quantitative easing, the Fed’s operations are now open-ended, unlike in previous instances. What is more, in what could mark a turning point in its approach to monetary policy, it signaled that its loose stance might persist even once the recovery has started.
  • This decision appears to reflect an underlying shift in emphasis in the Fed’s dual mandate: less concern about the threat of inflation and more concern about persistently anemic unemployment.
  • If confirmed, it implies that the market rally is less likely to fizzle out quickly and that gold and risky assets will be supported beyond previous cycle highs. The USD will remain firmly on the backfoot.

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Life at 0%: What’s Next for the ECB?

  • The reduction of the ECB’s deposit rate to 0% led to an immediate Eur500 mn drop in deposit holdings but prompted a simultaneous increase in  current account holdings, leaving overall bank reserves unchanged.
  • Yet, focus on these figures is misplaced: bank lending, or M3 in general, is independent of the monetary base, i.e. high reserve holdings are not indicative of “cash hoarding” by banks.
  • What matters is how often these funds are passed around the financial system before they are redeposited at the ECB. As a result, the level of reserves – which further LTROs would boost – is less important than the ‘velocity’ of these funds.
  • The ECB has few tools to boost ‘velocity’. Uniformly lower rates, SMP purchases, QE and, most importantly, credit easing would all help though. 

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Why the Debate About EZ ‘Fiscal Union’ Is Wrongheaded, Focus on Growth Is Ill-Conceived And Ms Merkel Is Right

  • A fiscal union in the Eurozone (EZ) – whether in the form of additional financing or debt mutualization – is not only politically unrealistic but also counter-productive in dealing with the issues at hand. Transfers or grants would work, but would need to be open-ended to be credible, which is both unacceptable and unaffordable.
  • Calls for ‘growth-promoting’ policies reflect the ideals of 40+ years of Keynesian folly. To a large extent, these tried and failed policies are the source of today’s debt mountain in many countries. Even if successful, such policies can only have a marginal near-term impact on debt dynamics.
  • The only viable and politically acceptable solution is a Sovereign Debt Reduction Mechanism (SDRM) for the eurozone. This has the advantage of offering both stock-and flow adjustments, while not calling for an open-ended commitment like a fiscal union. The flipside is that it requires significant support for the financial sector in order to prevent a systemic collapse.

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Grading the 12th Eurozone Crisis Summit: Still in Search of ‘New Eurozone Man’

  • The changes to the modus operandi of the ESM agreed at the latest summit appear significant at first (sovereign bond purchase, non-preferred creditor status, direct lending to banks plus the quid pro quo of ECB-led banking supervision) and can help sever the vicious sovereign-banking nexus to some extent. But the ESM’s limited firepower keeps the economic logic of currency-or bank runs in place. Until much more is done, don’t expect a lasting recovery of asset prices.

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Currency Implications of a China Slowdown

  • Risk sentiment and commodity prices bode ill for AUD in the event of a Chinese slowdown. Effects on other G10 currencies are more ambiguous: A reduction in global liquidity and redressing of global imbalances will likely be positive for USD, but the ultimate effect will depend on the strength and timing of the respective policy responses.

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