WISE MONEY

Last night’s Fed Reserve meeting and Greece’s continuing struggle did nothing for risk appetite during Asia trading hours. The Reserve reemphasised the downside issues to growth and reduced its overall forecasts.

On a positive note, the Fed did acknowledge the possibility of easing options, suggesting additional QE thus giving a helping hand for risk appetite.

On the eurozone front- European politicians increased pressure on Greece by stopping the latest €8 billion aid payment and threatened to slash all financial aid if the country’s referendum now scheduled for December 4 fails to support the latest EU rescue package.

During yesterday’s emergency meeting, the Greek PM also revealed that the referendum will have a dual role; to decide the fate of the rescue package and also to ask if Greece wants to remain in the eurozone.

Of course, Greece is not the only Eurozone country under the cosh with the Italian political situation continuing to spiral out of control, as Berlusconi fails to push through legislation on structural reforms ahead of the G20 meeting beginning today.

It is questionable how long the risk rally will last, with the Euro, commodity and high beta emerging market currencies coming under further pressure.

While the urgent market focus will be on the G20 meeting starting today, the fact that leaders are now looking at the scenario of a Greek exit from the Eurozone while taking a tougher stance on the country emphasises how significant the referendum will be.

Until the referendum takes place, investors will remain highly sceptical and further risk aversion will remain.

As a result, risk assets are set for further declines.

Furthermore, as China has so far downplayed the scenario of addtional bond purchases from the EFSF bailout fund suggesting there will be no help from the far east any time soon.

The euro pushed towards a 3 week high against the US Dollar as the markets became more optimistic on a concrete deal by the end of the month for Greece and the Eurozone.  IMF officials indicated that Greece will get an 8 billion euro loan next month despite the fact that it will miss key deficit targets.

ECB president Trichet also stated that commitments made by Greece should mean that it can avoid default.

This flurry of optimism does not eclipse a still sceptical market, but it has given a boost to the single currency- so far the euro has pushed up over 1% against the USD in early trade.

Despite the above positives for the Eurozone in other news Slovakia voted no to a legislation to increase the firepower and guarantees for the European Financial Stability Facility (EFSF).

All other countries have ratified the changes but resistance from Slovakia has raised tension.

It is expected that another vote will pass the changes tomorrow- however this is at the expense of the opposition getting their back scratched in a coalition reshuffle.

In addition European banks still remain on alert as Spanish bank Banesto missed its profit targets and the Bank Of Ireland was downgraded.  In a nutshell the mix is now good news/bad news as opposed to bad news/bad news and so the Euro has managed a move to the upside.

UK data was again poor this morning with UK unemployment hitting a 15 year high at 8.1%.

The Pound has still managed to push up against the USD this morning- this is tracking the move higher in risk on EUR/USD and is not due to pound strength.

MPC member Dale noted that the vote for more QE in the UK was due to the UK economy slowing in Quarter 3 and the expectation that it will slow on Quarter 4.

Today’s unemployment certainly backs up this slowdown, however the key test for the MPC is whether CPI will remain above 5% for the medium term as the expectation is that it will fall towards 2%.

The US’s Federal Reserve Board (FED) has attempted to twist the US long term and short term interest rates to help jump start the US economy.However there is another twist- this ruse  won’t actually do much to help consumers, borrowers or the housing market.

The Fed will go on a bond-buying spree — again — in an attempt to drive long-term interest rates lower than they already are.

The much-anticipated plan, dubbed Operation Twist by observers, should help push rates lower, boost the housing market, make it easier for consumers and business owners to borrow and help create jobs. That’s the Fed’s theory and intention.

But analysts say Operation Twist barely makes a dent in the problem.

There is plenty of liquidity out there already, and interest rates are already extremely low. Interest rates are not the obstacle to growth.

After a two-day meeting, the Federal Open Market Committee announced it will sell short-term Treasury bonds and reinvest about $400 billion in long-term Treasury bonds by the end of June 2012. It will sell Treasuries maturing in three years or less to buy Treasuries maturing in six to 30 years.

“This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative,” the Fed says in its statement. “The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.”

Operation Twist differs from QE1 and QE2, the two quantitative easing programs the Fed previously implemented, because it will not require the Fed to print new money to fund the bond purchases. With Operation Twist, the Fed will simply shift its investments around rather than increase the balance of its portfolio.

Mortgage rates have been at their lowest levels in six decades, but millions of homeowners can’t refinance at the lower rates because they don’t have enough equity in their homes. Many potential buyers, who would like to take advantage of the low rates, don’t qualify for loans or are afraid to commit to a mortgage in a shaky economy.

The Fed said it will try to keep mortgage rates low by reinvesting in mortgage-backed securities as mortgages are paid off and as Fannie Mae and Freddie Mac repay debts they owe to the Fed.

Even if lower rates were the answer to dragging the economy out of the hole, Operation Twist still wouldn’t be enough to get the job done because its impact on long-term rates will be limited, analysts say.

Given the severity of the current crisis and the high unemployment rate, the United States needs the gross domestic product to grow at about a 5 percent to 6 percent pace, but that does not seem to be in the cards.

With so much doubt surrounding the effectiveness of Operation Twist, you may wonder why the Fed chose this maneuver. Simply put, it’s because the Fed had to intervene to show investors that it has not lost control of the nation’s economic situation.

And among the few tools the Fed had left in it’s shed, Operation Twist was the least controversial one.

Operation Twist met the least resistance among Fed members mostly because it differs from QE1 and QE2, the two quantitative easing programs the Fed previously implemented. Operation Twist will not require the Fed to print new money to fund the bond purchases.

With Operation Twist, the Fed will simply shift its investments around, rather than increase the balance of its portfolio- much like rearranging the deckchairs on the Titanic.

The Fed has more than doubled the size of its Treasury bond portfolio to about $1.65 trillion since the financial crisis started three years ago, and the Fed embarked on a bond-buying frenzy.

With more than 14 million people out of work, the unemployment rate stuck at 9.1 percent and no signs of improvement in the labor market, the Fed felt the pressure to act.

We got no blockbusting policy from Jackson Hole on Friday, but the Fed chairman failed to rule out further action if the US economic outlook continues to deteriorate.The markets were probably wanting something more concrete, but Uncle Ben did deliver the one thing guaranteed to lift equity markets – hope.

He talked about fiscal policy, probably paving the way for President Obama to announce stimulus measures in a speech on Sept 5th he also sounded reasonably positive on the economic recovery, which may or may not turn out to be ill judged given we have an important non-farm payroll number coming up this Friday.

Other US data of note this week include the minutes from the last FOMC meeting on the 9th August and consumer confidence, both due this afternoon.

Given the importance of Friday’s speech it is unlikely that we get anything unexpected in the Fed minutes.

Sterling should take a bit of back seat this week, it has been stuck in trading ranges against both the Dollar and Euro in recent weeks and with a lack of any substantive data due this week we can expect that to continue.

The little data that is due this week is mostly housing related and includes mortgage approvals and the Nationwide house price survey along with net consumer credit, manufacturing and construction PMI later in the week.

The Euro has started the week on a roll, gaining against both the Dollar and Sterling even without any real data to back up the rally.

The merger between two of the struggling Greek banks seems to have lifted market sentiment, but quite how two bad banks makes one good one is beyond logic!

FED Chairman Ben Bernanke has hinted that further Quantitative Easing is unlikely, saying instead the Fed is committed to keeping interest rates low until at least 2013.   Mr Bernanke indicated QE2 was on the way from Jackson Hole this time last year, and the markets responded better than even he could have predicted.

One of the aims of zero interest rates and QE is to force money into risk assets, and it looks like equity markets are setting up for the expectation of a further round of easing being announced. But they may be bitterly disappointed.

The key differences from last time are that the spectre of deflation, one of the key motivators for QE2, is not the threat it was a year ago and there is also dissent from 3 Fed board members further clouding the Feds ability to implement any new round of QE.

So how does the Fed’s announcement impact FX markets?

Safe haven currencies such as the Swiss franc, Aussie Dollar and the Scandinavian Krona’s look set to be very dependant on the outcome of Friday’s speech.

They have all benefitted from diversification out of Dollars and the prospect of further money printing by the US so we can expect significant moves in both directions depending on the content.

Special attention needs to be paid to the Swissie which has the SNB on the other side of the trade should QE3 go ahead.

Along with the US announcement (or not) Friday also sees UK GDP figures released. If we take the overall tone of recent UK data as a guide it is hard to be optimistic about UK growth.

There seems to be significant economic headwinds, set to get stronger as government spending continues to fall and companies hoard cash instead of hire workers.

In line with forecast is the best we can hope for. Later in the day, but before said speech, US GDP is also released along with the University of Michigan confidence survey.

Developments in US monetary policy last night make it unlikely that the Greenback is going to see much improvement over the coming months; at least until there are more positive signs of a US economic recovery.The US news has lead to a general rebound of exchanges around the world following heavy losses last week and early this week on fears there could be a new recession due to the euro zone and US debt problems.

Markets in London and Paris are up1.8% in opening trade, as shares in Frankfurt jumped over 2%.

The Dublin market had gained 1.9% in the first few minutes of trade.

Overnight Asian stocks fought back some recent lost ground, following a rebound in US shares, after the Federal Reserve’s unprecedented pledge on rates.

Tokyo’s Nikkei index closed 1% higher, while markets in Australia rose by 2.6% and shares in Hong Kong finished 2.3% higher.

The single European currency has been given a let off following the judgment of the ECB to purchase Spanish and Italian bonds – even though this will be short lived.

Sometime in the future EU officials will need to make tough decisions about the Euro’s future but the European Central Bank decision has given them some breathing space.

This will likely reinforce the support levels for the Euro against the major currencies for the next 2-3 months.

Finally, Sterling has enjoyed a rare period of stability, if not demand, whilst pressure mounts on the Dollar and Euro, with Gilt yields falling on an almost daily basis as overseas investors rush to buy the perceived safe haven Government bonds (still AAA …..).

The outlook for Sterling is less clear however, especially given the recent evidence weak outlook for the UK recovery and continued civil unrest.

So where does that leave the market?

Well, buying Swiss Francs and Yen primarily, with both currencies continuing to appreciate despite the best efforts of the respective Central Banks to curtail the move – the Yen is now just stronger than prior to the BoJ intervention last week, whilst the Swissy has made considerably gains since the SNB tried to hold the EUR/CHF at 1.1000.

Gold has also maintained its strong run ….

Following the carnage from both sides of the Pond last week, the money markets will aim for some form of restoration and degree of normality in the early sessions of trading this week.  This could prove difficult, following continued worries about global economic growth, concerns over the eurozone debt crisis and finally late on Friday the downgrade of the US sovereign credit.

This all comes at a time when many top policy makers are on vacation and market liquidity is thin during the summer holiday period.

It was hardly a huge surprise when the US lost its top AAA rating last week.

S&P had been warning the US for several months about a possible downgrade and when the smaller than hoped for $2.1 trillion cuts in the US fiscal deficit were announced, this left the rating agency little choice.

Some consolation will be taken from the fact that the other two main ratings agencies Moody’s and Fitch have so far maintained the top tier rating for the US, although Fitch will be reviewing this before the end of the month.

Inevitably comparisons to 2008 are being made, however there is fundamental difference this time around.

While in 2008 policy makers were able to turn on the financial and monetary taps, the financial clout of governments is now in question.

There is little room for manoeuvre on government spending in western economies as this has now been totally used up, while interest rates are already at an all time low.

One could argue the US Federal Reserve can embark on another round of asset purchases but the effectiveness of more QE is very limited.

Confidence is pretty low right now so what light if any is at the end of tunnel?

EU officials had hoped that their agreement to provide a second bailout for Greece and beef up the EFSF bailout fund would have stemmed the bleeding but given the failure to prevent the spreading of contagion to Italy and Spain it is difficult to see what else they can do to stem the crisis.

One could compare the EU attempts to sticking a plaster on a fatal wound.

Although it is unlikely that the eurozone will disintegrate (more for political rather than economic reasons) there may have to be sizeable fiscal transfers from the richer countries to the more highly indebted eurozone countries otherwise the whole of the region could fall down the plug hole.

After dipping briefly  under 1.60 over the past week, the Sterling-Dollar pair snapped back sharply in late trading last night as firstly Fed Chairman Ben Bernanke refused to rule out further QE and secondly, after threatening to do so last month, Moody’s placed the US on review for a downgrade of its credit rating. Although Mr Bernanke did not outline much more than the market already knew from the minutes from the last Fed meeting, the fact that the words came from his mouth and not in text seemed enough of a reason for traders to sell the Dollar off against the Euro and Sterling, with cable jumping one and a half cents in quick time.

The potential ratings downgrade came as US President Barack Obama walked out of budget talks, raising the fear that a deal on raising the US debt ceiling before the US Government runs out of money is looking increasingly unlikely.

Later today US retail sales are due, and will probably show a modest decline, as retail sales ten to do over the summer months.

On Friday we also have the US CPI number and the U of Michigan confidence survey.

With EU banking stress tests due late on Friday evening, we’ve had the first indication that some of the banks are struggling to pass.

German public sector bank Helaba is rumoured to have pulled out, giving regulators a real headache the day before the results are due.

The key point in doing a second round of stress tests was their credibility, and the fact that it would cover all systemically important EU banks.

If Helaba pulling out marks the first of several banks following suit, the whole purpose of the project, namely to restore confidence in the European banking system will be undermined.

After the market volatility in Italian bonds and bank shares, this morning’s Italian Debt auction takes on more significance.

With many economists suggesting Italy is too big to fail, any sign of weakness will be magnified hugely.

Speculation is mounting that the ECB or Italian central bank may buy some of the bonds to signal to the market that demand is high and to keep yields suppressed.

As we know with Greece, Ireland and Portugal when the cost of insuring the bonds raises above 400 basis points bad things start to happen; both Spain and Italy remain around 300.

Even with all the negative Euro news, the news from the US yesterday evening has pulled the Euro higher against both Sterling and the Dollar.

The Fed announcement did little to move currency markets during trading but there was a negative tone to stocks and commodities.The Fed did not show any interest in a third round of QE when this ends in June, but will maintain its balance sheet at around $,2800 billion.

The major worry for markets remains the length and severity of the existing ‘soft patch’ in the economy.

Bernanke believes it will be temporary but the fall in equity markets over recent weeks suggests that there has been a deviation between stock market expectations and reality.

The Greenback may in fact be hitting a medium term bottom with the fact that the Fed is not considering additional QE.

The negative Fed stance combined with a vigilant reaction to the Greek government’s passing of a confidence motion suggests that markets will remain watchful over the near term.

Without a doubt, comments by the Greek opposition that they will not support further austerity measures ruined any hopes of agreement and will add another obstacle towards an easing in Greek tensions.

The continued bickering between EU officials over private sector participation in any debt rollover in addition to uncertainty over how ratings agencies will respond, threatens to keep sentiment under pressure.

The EUR has remained surprisingly resilient but its muted reaction to the passage of the confidence motion has given way to some weakness and the currency remains a sell on rallies.

Sterling suffered yesterday, weighed heavily by the relatively dovish Bank of England MPC minutes in which some members were even discussing further QE.

The currency faces its toughest battle for months as it breaks through key psychological 1.60 level and currently stands 1.5987 and GBPEUR:1.1223.

The US’s Federal Reserve Board Chairman Ben Bernanke hinted in a speech last night that there are no current plans for further monetary quantitative easing.

He also said that he is satisfied that the economic conditions in the US remain positive for growth, even in light of the recent weak employment and manufacturing data over the past few weeks.

Mr Bernanke continued to suggest the US economy is producing well below its potential but the current weak data flow is a “soft patch” and there would be a pick up in activity in the second half of 2011.

US stock markets immediately reversed small gains once the Fed Chairman began his talk and finished down on the day.

The US Dollar also strengthened on the news and looks set to continue that path today with Bourses in Europe opening the day down and the risk-on risk-off see saw continuing to play out across the markets.

With the ECB not likely to raise rates this Thursday, the closely watched press conference by ECB President Jean-Claude Trichet becomes the potential market mover.

The market seems to be suggesting there is a high probability that Mr Trichet will indicate a rate increase in July.

In the strange world of Central Bank communication, he will not say this directly but indicate this by mentioning “vigilance” when talking about the Banks stance towards inflation.

Given the size of the move in the Euro against the Pound and Dollar there seems to be a big chance that the market will be disappointed.