Back to 1%
The Federal Reserve cut interest rates by 0.5pp to 1% - a familiar level. China followed suit immediately, the ECB and the Bank of England will almost certainly follow next week. Inflation is no longer a concern for the Fed. The Fed’s vote was unanimous, but as an interesting article in the WSJ suggested, some members may have accepted the rate cut only reluctantly. The Fed also unveiled new swap lines with the central banks of Brazil, Mexico, Korea and Singapore. The downbeat statement gave rise to speculation of further rate cuts. (We reported yesterday that Larry Meyers thinks the Fed funds rate will come down to zero). Equity markets had a good day, though the rally reversed in New York.
Money market indicators
The Euribor continued to decline, and is now at 4.827%, which is still way to high given the 0.5% rate cut – and the next one that is already taken for granted by the financial markets. Most of the decline is still due to the lower repo rate than due to a rise in confidence. The dollar libor decline a notch yesterday, but the TED spread continues to rise. All this suggests that the money markets are still blocked.
Is the CDS market the reason behind the stubbornly high money market rates?
This is an article in Institutional Risk Analytics, aka Naked Capitalism, and it tries to explain the ongoing money market problem in terms of credit default swap liabilities in respect of Lehman, Fannie and Freddie. The article makes the point that the Lehman CDS auction was a non-event. The article says counterparty risk is not the main problem, but the failure of a large single name CDS, which forces the protection writer to raise lots of money, which is a reason for the high dollar Libor rates. The article goes on to say that “a certain German Landesbank” took delivery on $1bn in Lehman bonds that are now worth $30m. The article concludes that the Fed has so far only provided on balance sheet liquidity for banks, but no off balance sheet positions in CDS. The need to fund those on the money market drives resources away from the real economy.
Merkel and Barroso dig into the pork barrel
Angela Merkel calls it a stimulus, and the German newspapers obediently reprint this. But the measures she announces to help the economy are almost entirely structural, or rather political, in nature – more investment programmes for the KfW bank, to transform car tax into a CO2 tax, and changes to the depreciation rules. The latter is potentially the only measure with a short-term effect, as the government’s decision to end the previous system – which favoured first-year write offs – has led to fall in investment. (But this matters less in a recession when profits, and taxes, are low in any case). Frankfurter Allgemeine lists more ideas, including some direct aid for the car industry, as proposed by the European Commission, as potential responses to the recession. (It is always interesting to see the helplessness of European politicians when it comes to stimulus. They would never dream of stimulating demand, for example by sending a check through the post, they can only ever think of supply-side measures, even in a crisis like that)
Hyper Real Estate says it needs another E15bn
When financial institutions ask for help, they rarely tell you what they need. Hypo Real Estate produced an outcry when it asked for government help twice within a week. Now it is the third time, when the shadow bank said it needed another short term loan of E15bn, which is to be secured by the new blanket guarantee for the financial sector. Frankfurter Allgemeine said Hypo Real Estate will also apply for recapitalisation – which would make it the first private-sector bank in Germany. What a mess.
Gros and Micossi on the bond market
Daniel Gros and Stefano Micossi call for a unified European bond market as global investors continue to flock to the US and Japan in times of crisis, driving down bond yields there, and raising their currencies. They say as a result capital is not coming to Europe where it is needed to shore up the banking system. Even the best European government now pay 2-3pp more than the US on short term borrowing, despite the stress on public financing. They also argue that the EU still needs to set up a E500-700bn European stabilisation fund, that could also be used to fund balance of payments assistence. They also came out in support for Sarkozy’s idea of euro area economic governance.
The trouble of emerging market pension funds
Le Monde warns that fully funded pension funds are in troubles, most seriously affected are those in Poland, Hungary and the Czech Republic where pension funds have been recently privatized. Contrary to pension funds in Nordic or Anglo Saxon countries pension funds have not yet accumulated sufficient capital to resist a long and pronounced crisis. The OECD is expected to publish a first assessment of the damage in December.
Is euro membership a solution for Hungary?
In a long analysis of Hungary’s IMF/EU rescue package Edward Hugh, in A Fistful of Euros, makes the observation that Hungary will from next year fullfill all the criteria (except currency stability) for euro area membership, including those on deficits and inflation. The E30bn loan has stabilised the country for now, but it comes attached with stringent conditions, including a budget deficit cap of 2.6%, calculated on the assumption of 1% contraction of GDP, in other words, a fairly stiff target. Hugh makes the point that since Hungary is a relatively poor country, these cuts will translate into lower pensions, less healthcare. He also says that the only way out is to increase exports, which requires a lower currency, and thus an end to foreign currency mortgages.
Buiter and Sibert on Iceland
Willem Buiter and Anne Siebert have published a report on Iceland, in which they identify four reasons for the country’s vulnerability. Iceland is (1) A small country with (2) has a large, internationally exposed banking sector, (3) its own currency and (4) and limited fiscal spare capacity. Other countries with similar problems are Switzerland, Denmark, and Sweden and even to some extent the UK. Ireland, Belgium, the Netherland and Luxembourg would have similar problems if it was not for the euro.
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