WISE MONEY

The dollar strengthened overnight after the Fed took steps to try and bolster the fragile US economy, saying they will maintain their holdings of securities to stop money from draining out of the financial system. In a bid to avoid a double dip recession, The US central bank said it would reinvest between $200-300m of proceeds from maturing mortgage bonds from the first $1.2 trillion QE cycle.

It left its policy rate unchanged and renewed its pledge to keep rates low for an extended period.

Following the fed announcement treasuries surged as markets anticipated a renewed round of asset purchases should the economy slow further.

Figures since the last FOMC meeting in June indicates that the pace in recovery in output, manufacturing, retail, employment and housing has slowed significantly.

However Wall Street fell heavily last night down around 2.5% as investors worried about further debt increases and slowing growth.

Speculation over the announcement of another round of quantitative easing (QE2) at tonight’s Federal Reserve meeting is reverberating around the money markets at present.The consensus seems to be that that additional liquidity will be added to the system through reinvestment of maturing assets already on the Fed balance sheet, rather than return to fully blown quantitative easing.

The recent surge in commodity prices after Russia placed a halt on exports of grain is a worrying development for the Fed, it will need to consider that further down the road after it may find certain parts of the economy experiencing inflation at the same time as others are suffering from rampant deflation.

This is why this Fed meeting is seen as so important– we wait to here which way the inflation/ deflation needle is pushed (unless we end up waiting until next month!).

Sterling continued its climb against the Dollar yesterday as momentum from Fridays disappointing US jobs figures continued in early trading.

But the Dollar has regained some ground this morning after the announcement from the Royal Institute of Chartered Surveyors that UK house prices have declined for the first time in a year.

On Friday, US Employment fell for a second straight month in July as more temporary census jobs ended, as private hiring rose less than expected, pointing to an stunted economic recovery and a potential requirement for further quantitative easing. The main points were as follows: Non-farm payrolls fell 131,000 the Labor Department said on Friday, as temporary jobs to conduct the decennial census dropped by 143,000. Private employment, considered a better gauge of labor market health, rose 71,000 after increasing 31,000 in June.

The government revised payrolls for May and June to show 97,000 fewer jobs than previously reported. Analysts polled by Reuters had forecast overall employment falling 65,000 and private-sector hiring increasing 90,000.

The unemployment rate was unchanged at 9.5 percent in July for a second straight month, just below market expectations for a rise to 9.6 percent.

It was a similar sentiment in the UK as both consumer and business confidence dipped again.

The most recent purchasing managers’ index from the services sector indicates that, while growth continues business expectations have suffered a fall of about 10% since Spring. Friday’s PMI data showed a rise in cost of 5% which is rather high and pulls inflationary pressures into focus.

The other area of alarm for most is the idea that whilst interest rates remain low and are expected to stay as such until 2011 there seems to be greater comment around the fact that when they start to move they are likely to move quickly.

It is still a very fine balance to control inflation, implement spending cuts and tax hikes whilst in the meantime not cause a double dip.

The general market view seems to be that interest rate rises back towards more ‘normal’ levels can only be implemented if the economy grows confidently the idea of pushing an already fragile economy back into recession is simply not palatable.

The Bank of England has kept its economic stimulus programme and record low interest rate of 0.5pc in place yesterday amid lingering doubts among rate setters over a sustained recovery for the fragile UK economy.The nine strong Monetary Policy Committee (MPC) was not swayed by the UK economy’s rapid 1.1pc advance between April and June, with growth expected to fade in the second half of 2010 as the biggest Budget cuts since the Second World War take hold.

Mervyn King, the Governor of the Bank of England, has repeatedly emphasised that there is no guarantee that the recovery which began in the fourth quarter of 2009 is sustainable.

The MPC held rates at the historic low of 0.5pc – where they have been since March 2009 –and maintained its target for bond holdings at £200bn, when it announced its monthly decision at noon.

The MPC maintained the ultra loose policy stance it established when the crisis took hold, despite a return to economic growth and a persistent failure to meet its 2pc inflation target.

The consumer prices index – the official measure of inflation – has been above 3pc since the beginning of the year. The Bank is expected to raise its inflation forecasts when it publishes the August Inflation Report next week, to reflect above-target inflation for most of 2011.

Mr King has stated that a failure of banks to lend, as well as weakness in Britain’s key export markets, could hamper growth in the UK.

Fears that Britain’s recovery will slow were reinforced by a snapshot of the UK services sector in July on Wednesday.

Economists had expected a slight improvement to 54.5, and the disappointing news for the economy helped to drive sterling pound down almost a cent lower against the dollar, to close at $1.5877.

Today is all about monetary policy meetings with the UK and the Eurozone committees all deciding on levels for interest rates for the next month.
As with previous months it is a fairly common view that both the MPC and the ECB will decide to leave their respective rates on hold, resolving to also leave the levels of QE unchanged as well.

For the MPC, that will be it for a week or so until the minutes of the meeting are released.

I would expect Andrew Sentance to once again prove to be the lone dissenter for leaving rates unchanged although it would be a shock if there was not evidence of protracted discussion amongst the members over the stubbornly high level of inflation and its effect on the UK economic outlook.

This is also the first meeting attended by Martin Weale therefore the minutes will also be awaited to discover his thoughts and voting intentions.

Investor George Soros has warned Germany to leave the euro unless it is willing to embrace a growth strategy, calling Berlin’s current austerity plans  a threat to democracy and political stability in Europe.
“German policy is becoming a danger that could destroy the European Project. A collapse of the euro cannot be excluded,” he told the German weekly Die Zeit.

“Unless Germany changes policy, its withdrawal from the currency union would be helpful for the rest of Europe. At the moment Germany is pushing its neighbours into deflation: this threatens a long phase of stagnation, leading to nationalism, social unrest, and zenophobia. It endangers democracy,” he said.

Mr Soros saw the political effects of wage cuts first-hand during the Great Depression, and narrowly survived the Holocaust as a Jewish boy in Nazi-controlled Budapest. He has since dedicated much of his wealth to philanthropic works promoting freedom and pluralism across the globe, mostly through Open Society institutes.

His comments reflect growing alarm in influential circles on both sides of the Atlantic over the 1930s-style policies of wage cuts and debt-deflation being imposed up the Club Med bloc, Ireland, and parts of Eastern Europe by the EU authorities, at the behest of Berlin.

President Barack Obama clearly had Germany in mind when he wrote a letter to fellow leaders before the G20 summit in Canada this week that surplus countries should do more to shore up global demand. “Our highest priority must be to safeguard and strengthen the recovery: we cannot let it falter or lose strength now. Should confidence in the strength of our recoveries diminish, we should be prepared to respond again as quickly and as forcefully as needed,” he wrote.

China has deflected G20 criticism by starting to free the yuan, leaving Germany facing the full wrath of Washington.

While the German economy is not in itself large enough to shape global events, US officials fear that Berlin’s dominant influence over the European Central Bank and the fiscal machinery of monetary union is dragging most of Europe into an economic swamp. Germany has raised the bar for every eurozone country by announcing €80bn of belt-tightening from next year.

Nobel laureate Paul Krugman told the German press earlier this week that the country was committing the same error as the United States in 1936-1937, or Japan in the 1990s, by withdrawing stimulus before recovery has taken root.

“I don’t have a problem with trying to balance the budget in five or 10 years. The question is whether one should start when the economy is at 7 or 8 percent below its normal capacity and interest rates are at zero. Now is not the time to be worried about deficits.”

Professor Krugman said there was a risk of a “domino effect” reaching Spain and Italy if Bundesbank chief Axel Weber takes over as head of the ECB and fails to offer enough monetary stimulus to keep these countries afloat.

One analyst said that Mr Weber faces an impossible task. “Either they do more QE (quantitative easing), in which case it will set off inflation in Germany and cause Germany to leave EMU: or they don’t do more QE, in which case it will lead to deflation in Southern Europe and force them out of EMU,” he said.

Mr Soros said Germany was treating the deeply-flawed Maastricht Treaty as it were a “sacred text”, warning that monetary union cannot endure for long as a narrow construct based on debt and deficit ceilings.

He said wage rises in Germany are imperative to help lift the whole eurozone, allowing peripheral economies to claw their way out of trouble without fighting the extra headwinds of deflation.

“The truth is that what we have in Europe is not a currency or sovereign debt crisis as many people think, but a banking crisis,” he said.Mr Soros argued that the weaker states cannot easily fund their deficits any longer because some banks are purchasing fewer bonds as a result of damaged balance sheets.

The Bank of England is sitting on an £8 billion net profit from it’s £200 billion quantitative easing (QE) fund.
A sharp increase in gilt prices over the past two weeks, as traders pull money out of risky European investments and into UK government debt, has swung the Bank’s QE fund into profit for the first time in months.

The news underlines the fact that Britain has unexpectedly established itself as a safe haven destination during the European debt crisis.

The Bank’s original investment of £198bn of gilts (UK government bonds) is now worth £199bn. It has also earned £8bn of interest receipts, although this has been offset by £1bn it had to pay in interest on its reserves.

The result represents a significant turnaround for the Bank. Some months ago, Lord Myners, the then labour’s City Minister, revealed to the House of Lords that the fund was running a £3bn loss.

The profit on the QE account does not have any benefit for the Government, which is looking for means of reducing its £156bn budget deficit, since the money is merely a transfer of cash from one part of the public sector to another.

In fact, the Bank has signalled that it expects to make a small loss from the QE investment by the time it sells the gilts off. But it stresses that this loss will be far outweighed by the economic benefits of the policy.

Under its programme, the Bank created money and used it to buy a portfolio of gilts – essentially using this investment as the most efficient way to pump cash directly into the economy.

However, the European sovereign debt crisis has provided an unexpected boost for the Bank’s investment. Over the past two weeks, prices of gilts have leapt higher, and their yields consequently dropped from around 4pc to just over 3.5pc.

The Eurozone took yet another pounding yesterday as rigorous fiscal tightening threatens to dampen an already weak recovery.

The euro has crashed to 14 month lows of $1.25 after boosting to nearly $1.31 on Monday after the $1 trillion emergency rescue package was announced.

News that one of the “PIGS”, Portugal is attempting to cut €2 bn from its budget gap has done little to reduce the weakness in the Euro and with more tax hikes and salary cuts due, we could see ugly scenes like those witnessed from Greece.

ECB President Jean-Claude Trichet has stated the ECB is not “embarking on quantitative easing” and he reiterated that “the Governing Council will not tolerate inflation” leading to speculation a rise in interest rates could be on the horizon.

Sterling has also taken a hit this morning with news that the new coalition has already come to loggerheads. With two political parties with separate agendas leading the country, a schedule for cutting the deficit will take longer to agree, and with the credit agencies hovering, a negative outlook over the UK will remain.

A cut in the UK’s prized AAA credit rating would have disastrous consequences to the recovery. Data released yesterday showing the UK’s trade deficit widened more than expected damaged hopes for an export led resurgence.

The US Dollar has been the main winner from the negative news from Europe as investors run for their “safe haven”. The greenback has also been supported by encouraging figures from the US and expectations that the FED will be the first among the major central banks to raise interest rates.

There were no surprises yesterday as Bank of England minutes indicated the Monetary Policy Committee voted unanimously to keep interest rates at 0.50% and to maintain Quantitative Easing at GBP 200bn.

The committee however, did make reference to the pressing issue of inflationary problems evident in recent higher than expected CPI figures.

Sterling was boosted yesterday against the Euro and the US Dollar by the news that the number of people claiming jobless benefit fell by 32.9k in March, after a revised fall of 40.1k in February.

This news coupled with the heavy EUR/GBP selling this week appears to be having a positive impact on GBP/USD.

Still in the UK, Nick Clegg found himself in hot water after it was revealed that party donations were paid directly into his personal bank account. These revelations have come at a crucial time for the Lib Dem leader if he is to have any serious impression in the next political term.

The latest YouGov poll has the Tories on 33%, Lib Dems 31% and Labour 27% ahead of tonight’s second televised leaders debate. Converted into votes this would equate to Labour-Lib dem government with Labour being 68 seats short of a majority and the first hung parliament since 1974.

Back to Europe and German PMI came out at 61.3; better than expected but the market didn’t blink with the Greek issue still holding more influence at the moment. Reuters are reporting that the German/Greek 5-yr bond spread has increased by yet another 20bps highlighting the uncertainty about how Greece will resolve its debt problems.

The single currency may come under further pressures as European policy makers and the IMF will meet with the Greek government to discuss the bailout package for the debt ridden country.

Sterling shrugged of BIS comments about Britain’s potential fiscal train wreck and continued its recent strength against the Euro and Dollar helped by better than expected manufacturing and housing data yesterday morning.

Overnight we briefly moved above 1.53 on the dollar before running into resistance and 1.1451 on the Euro.

As widely expected, the Bank of England kept interest rates and QE unchanged at 0.5% and £200 Billion respectively.

The ECB also kept interest rates unchanged at 1%, but as mentioned yesterday; all eyes were on ECB president Trichet’s press conference and the planned announcement of changes to collateral policy, forced on them in part to stop Greece from being locked out from ECB funding under the previous rules.

He also continued his opposition to IMF involvement in any future bailout of the Hellenic republic. The general feeling was that Trichet’s performance was one of his poorest and the spread between German and Greek bonds, indicating the perceived riskyness of holding Greek debt, widened to its highest level ever.

Overnight against the dollar however, the euro regained lost ground yesterday and now trades at the 1.34 level.

A mixed day in the US, with data showing rising initial jobless claims offset by very positive chain store sales. Treasury Secretary Tim Geithner finished his whistle stop to China with no major announcements regarding Yuan revaluation – yet.