Italy shatters some comfortable eurozone assumptions

February 26, 2013 1:28 pm by Gavyn Davies

Only one thing is clear after the Italian election. The comfortable assumption, which until now has been held by the policy elite in the eurozone, and mostly in the financial markets, that in the end “sensible” democracies will always support conventional economic policies has been shattered. Whichever way one dissects the electoral arithmetic, Italian voters have turned their backs on the respectable Europeanism of Mario Monti, and have handed power and responsibility to Beppe Grillo‘s Five Star Movement, whose entire platform denies that either concept should apply to them. A disparate group of unpredictable oppositionists now holds the balance of power in the Italian Senate. Read more

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Posted in Macroeconomics |

Challenges for the new Governor of the Bank of Japan

February 24, 2013 2:50 pm by Gavyn Davies

The major event in the global financial markets in the coming week is likely to be the nomination of a new Governor for the Bank of Japan. Very rarely does the identity of a specific individual matter so much for future central bank policy as it does in Japan right now.

The incoming government of Prime Minister Shinzo Abe has succeeded in weakening the yen by 20 per cent, and raising the Nikkei by 28 per cent, since last October. For the first time in two decades, Japan seems to have a chance of escaping from the liquidity trap. Read more

Posted in Macroeconomics |

Fed and Bank of England head in different directions

February 21, 2013 10:52 am by Gavyn Davies

The markets were impacted yesterday by two very different sets of monetary policy minutes from the Fed and the Bank of England. In the case of the Fed, the worry is that the central bank is back-tracking on its commitment to maintain open-ended QE until the labour market has improved “substantially”. Meanwhile, at the Bank of England, the concern is that monetary policy might be too easy in the context of a declining exchange rate, and an inflation outlook that will exceed the official target for at least the next two years.

Although coming at the monetary policy problem from entirely different angles, these concerns have one thing in common. It has become increasingly difficult for both the Fed and the BoE to communicate their policy regime clearly to the markets in an environment where their policy committees have become openly split about the right stance to pursue in the months ahead. Read more

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Posted in Macroeconomics |

Helicopters can be dangerous

February 17, 2013 1:48 pm by Gavyn Davies

The FT recently called for a serious debate on the idea that budget deficits should be permanently monetised by the central banks. So far the most prominent response from an active policy maker has come from Lord Adair Turner, the outgoing Chairman of the UK Financial Services Authority, and a former candidate to become Governor of the Bank of England [1].

Lord Turner is under no illusion that his discussion of this policy option will open him to ridicule or worse in some quarters. He expects to be called a “dangerous man”, which is a strange description for this typically cerebral product of McKinsey. Yet he considers this risk worthwhile because he believes there should be a rational comparison between OMF or overt monetary finance (a less inflammatory term than the usual “helicopter money”) and the quantitative easing favoured by today’s central bankers.

In public, central bankers like Ben Bernanke, Mark Carney and of course the entire ECB remain firmly opposed to this idea. But it is probably being implemented in Japan, and I have been surprised (and worried) at the willingness of mainstream central bankers in the US and the UK to contemplate the option in private. This blog serves as a reminder of the serious dangers involved. Read more

Posted in Macroeconomics |

A credit vigilante arrives at the Fed

February 10, 2013 4:31 pm by Gavyn Davies

Professor Jeremy Stein is a much respected financial economist from Harvard who in May became a member of the board of governors at the Federal Reserve. Until last week, the markets had paid him relatively little attention, but that is now destined to change. The important speech he delivered in St Louis on Thursday about credit bubbles differed significantly from one of the main planks in the Bernanke/Greenspan doctrine of the past 15 years. It does not have immediate policy implications, but it could easily do so within two years.

The speech, which is nicely summarised here by Matthew Klein at The Economist, deserves to be read in full by all market participants. (One member of the FOMC told me last week that the speech was “geeky”, but that was intended, and taken, as a high compliment!)

In summary, the speech argues that the credit markets have recently been “reaching for yield”, much as they did prior to the financial crash. Although not yet as dangerous as in the period from 2004-2007, this behaviour is shown by the rapid expansion of the junk bond market, flows into high-yield mutual funds and real estate investment trusts and the duration of bond portfolios held by banks.

Governor Stein suggests (hypothetically) that this may become a policy headache within 18 months and, in a break with the Bernanke/Greenspan doctrine, he indicates that the right weapon to deal with this might well be to raise interest rates, rather than relying solely on regulatory and other prudential policy to control the process. This would obviously come as a big surprise to the markets, which have tended to view the Fed’s stated concerns about the “costs of QE” as so much hot air. Read more

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Posted in Macroeconomics, Monetary policy, US |

ECB eschews global monetary stampede

February 7, 2013 5:52 pm by Gavyn Davies

Mario Draghi, ECB chief. Getty Images

Following today’s glut of monetary policy news, markets seem to have temporarily re-assessed their recent bullishness about the euro. However, investors should not lose sight of the fundamental gap that still exists between the ECB’s preference for relatively traditional monetary policy and the aggressively unconventional approach of the other major central banks. That has not gone away.

For example, the Bank of England remains in unorthodox monetary territory, as shown by its willingness to accept, for the first time, that inflation will remain above 2 per cent well beyond the two-year policy horizon. Mark Carney’s Select Committee evidence may have dashed expectations of a nominal GDP target, and he may have sounded lukewarm about more quantitative easing, but overall he remained extremely dovish, especially with regard to Fed-style forward policy guidance. Read more

Posted in Macroeconomics |

Who is afraid of currency wars?

February 3, 2013 5:10 pm by Gavyn Davies

Worries about global currency wars have resurfaced in recent weeks, mainly because of Japanese action on the yen. This is only the latest of several such flare-ups since the 2008 financial crash. It is hard to avoid the suspicion that the unconventional monetary policies of the US, UK and others are designed to drive down their exchange rates in order to indulge in “beggar thy neighbour” policies of the type which Samuel Brittan has condemned.

Currency wars strike dread into the hearts of most economists because they contributed greatly to the severity of the Great Depression in the 1930s, especially in the worst phase from 1931-33. The damage done to global trade in that period took several decades to repair, and a repeat of this nightmare cannot be entirely ruled out. However, there are very large differences between the policies pursued in the 1930s and what is happening now, and the results may also be very different. Read more

Posted in Macroeconomics |

Surprise shrinkage in the US economy

January 30, 2013 5:17 pm by Gavyn Davies

The decline of 0.1 per cent in US real GDP in 2012 Q4 (at a seasonally adjusted annualised rate) is a definite negative surprise for financial market sentiment, which has become very complacent about the ability of the US economy to withstand the fiscal tightening due to hit the economy.

Fortunately, the underlying picture for final domestic demand is reassuring, which is why the markets have taken these figures in their stride. Today’s figures are unlikely to signal a serious downturn.

But the US economy almost never posts a negative quarter in the middle of a robust upswing, so the figures should give us some pause for thought. Furthermore, the weakness of exports, which is more than a one quarter phenomenon, shows that the global economy had become dangerously dependent on the strength of the US consumer towards the end of last year. Read more

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Posted in Macroeconomics |

Carney rejects King and supports the Fed doves

January 27, 2013 3:54 pm by Gavyn Davies

Mark carney takes questions in Davos. Getty Images

Mark Carney’s comments on monetary policy at Davos, though not specifically about the UK, opened a wide gap between his thinking and that of outgoing governor Sir Mervyn King). The latter expressed doubts last week about the ability of monetary policy to boost the economy further, given his concerns about the UK supply side, and his related worries about the 2 per cent inflation target.

At Davos, Mark Carney showed very little sympathy for any of this, arguing that there is plenty of scope for monetary policy to boost the developed economies further, and specifically saying that it might be appropriate to allow inflation to run above 2 per cent for a time in order to achieve this. It would be very surprising if Mr Carney were willing to make such remarks unless he believesthey apply to the UK. Read more

Posted in Macroeconomics |

Mervyn King’s valedictory plan

January 24, 2013 5:44 pm by Gavyn Davies

Mervyn King. Getty Images

Mervyn King’s speech on UK economic policy on Tuesday has received relatively little attention, perhaps because he is in his last few months in the governor’s seat at the Bank of England. However, it is extremely interesting , both in its analysis of the UK’s current predicament and in its recommendations for future policy action.

It lays out a distinctive course of action, which is different from the Plan A adopted by the government and the Bank in 2010, and also different from the Keynesian alternative that Olivier Blanchard of the IMF seems to have recommended at Davos.

The King plan, tinged with both pessimism and realism, argues for a long-term fix, rather than a short-term dash for salvation. But while the fix will take a long time to work, it does have some important implications for the banks, and the exchange rate, in the near term. Read more

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