WISE MONEY

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.

The US Dollar continues to suffer as market hopes of additional US Fed stimulus including additional quantitative easing puts increasing pressure on the currency.There may also be some indecision to buy US Dollars before tomorrow’s Non-Farm Payrolls.

Yesterday’s US ADP jobs data were not particularly positive, so this doesn’t bode well for tomorrow’s number.

The Fed FOMC minutes earlier this week suggested there are a few in the committee who are ready to take more aggressive action which would lead to a weaker Dollar.

Ahead of the jobs data today’s August ISM manufacturing survey will offer some direction for markets but if the forecast of a sub 50 outcome proves correct it will only play into expectations of more Fed stimulus leaving the USD to weaken further.

The Euro struggled against the Dollar to break through 1.45 this week but has continued to resist various peripheral bond worries without too much damage, a trend that has been present for the past few months. Despite the fall back, EUR/USD may struggle to sustain a drop below its 100-day moving average at 1.4362.

Sterling has had problems of its own to deal with and has failed to capitalise on any USD tone while losing ground against the EUR.

Data yesterday did not help, with consumer sentiment falling for a third straight month according to the GfK confidence index.

It appears that speculation of further Fed monetary stimulus may also be rubbing off on GBP, with potential for more UK QE likely to act as a weight on the currency.

MPC member Posen added fuel to the fire in comments that he made supporting the need for central banks to undertake more QE.

Sterling looks destined for more weakness in the short term, with support around GBP/USD likely 1.6111 likely to be tested. A below 50 reading for the August manufacturing PMI today, will only add to downside pressure.

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!

It’s all about Jackson Hole and ahead of today meeting the US Dollar index is likely to maintain its place in towards the middle end of its recent 73.47 – 75.12 range helped by weaker equity markets.Expectations or hopes that Fed Chairman Bernanke will announce or at least hint at a fresh round of quantitative easing have receded allowing the US Dollar to escape further pressure.

Bernanke will likely keep all options open but there are still some in the FOMC who do not want to embark on QE3.

Although the US Dollar may be saved from a further drubbing the commitment to maintain exceptionally accommodative monetary policy through Q2 2013 has contributed to a relative reduction in US bond yields and in turn is acting to restrain the US currency.

A likely revision lower to US Q2 GDP will not help the USD in this respect.

One currency in particular that is reactive to yield differentials is USD/JPY, which registers an impressively high correlation with US – Japan yield differentials.

Attempts this week by the Japanese authorities to encourage capital outflows and a downgrade of Japan’s credit ratings by Moody’s have done little to weaken the JPY.

Even the usually bearish JPY Japanese margin traders have been scaling back their long USD/JPY positions over recent weeks while speculative investors remain overly long (well above the three-month average) JPY according to IMM data. The risk of a shake out of long JPY positions is high but unless yield differentials reverse renewed JPY weakening looks unlikely in the short-term.

So far this week euro has shown impressive resilience despite weak data in the form the German August IFO business and ZEW investor confidence surveys.

However, there is a risk of euro weakness should Bernanke not hint at QE3, with the currency already trading around the bottom of its multi-day range.

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 ….

Turmoil continued on the money markets yesterday as investors fled around the world currencies and stocks looking for safe havens. This led the price of Gold to jump above $1,700.00 for the first time in its history.

Traders, who once would have jumped into the Greenback for safety, shunned the Dollar as the markets opened following the downgrade of US Debt by S&P.

The Swiss Franc remains the only currency that has been looked as a safe bet despite the Swiss Central Bank doing everything in their power to weaken their currency.

Commodity currencies like the Canadian and Australian Dollars and the South African Rand, which have strengthened over the past 2 years, have all taken hits of 7-9% over the last fortnight.

The Dow Jones finished 634 points down.

Sterling has actually remained relatively buoyant over the recent chaos in spite of the UK’s figures continuing to range above and below expectations.

With most of the markets embroiled in the ongoing Eurozone and US problems, the UK has stayed quiet and the long-term plan of both higher taxes and reduced spending to cut the deficit seems to be starting to take effect.

An interesting bit of news out today was that the price of German CDS’s (Credit Default Swaps) rose above that of the UK’s for the first time ever.

This is potentially a huge step as Germany has been seen as a rock in the markets despite the fact they are bailing out most of Europe.

If the cost of insuring debt is cheaper in the UK, then the bond markets (which generally are the first sign of change) could be showing the way for a rise in Sterling against the Euro over the coming months.

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.

Money markets around the world crashed yesterday on fears that the worldwide recovery is faltering and we could be heading back into another crisis. Further rumours about Italy and Spain defaulting on their debt sparked panic across the board with the Dow Jones ending down over 500 points.

The already sinking markets went into meltdown after Jean-Claude Trichet failed to reassure investors that bond buying would be implemented to prevent contagion in the troubled Eurozone.

Trichet said “you will see what we do”, yet it was revealed only Irish and Portuguese bonds would be bought.

The unconvincing tone of Trichet led to huge swings in the Eurodollar with the pair ranging 3 cents in the days trading.

Investors led another surge into the safe havens as the Swiss Franc and Japanese Yen strengthened despite the measures from their 2 central banks over the previous days.

Gold reached another record high and we look set to finish the week in fear of what will happen next.

The BoE and ECB both announced no change in their interest rates with the likelihood of any rise in the short-term of the table while the economies struggle to grow.

We end today with the hugely important non-farm payrolls numbers from the US.

This takes extra importance as not only does the US need a strong figure to boost their own problems.

The world’s traders will be watching the announcement hoping that a positive result will turn the tide and bring a bottom to the recent sell-off.

Global money markets have been in turmoil for the last few weeks. We saw a rescue package in Europe and then a debt ceiling agreement in the US.

In both cases any positive market reaction has proved to be limited.

The European deal, while comprehensive, left quite a few questions in terms of execution, range and common agreements.

Back to the US and the deal to raise the US debt ceiling by $1.2 trillion pushed through between Republican and Democrat party leaders kept a possible debt default at bay but the deal is far smaller and less comprehensive in terms of deficit reduction measures than expected and may still be prove to be insufficient in preventing a credit ratings downgrade.

Investors in the US have failed to find much to rally them despite the debt deal.

Certainly, all that has happened is that attention has shifted back towards economic growth worries in the wake of a disappointing ISM manufacturing index in the US (50.9 in July, a reading which is just about in expansion territory) which follows on from a run of soft data in the US including the Q2 GDP report.

Unfortunately data elsewhere is no better as a series of weak manufacturing surveys have highlighted this week.

Weak data and the US debt deal have pushed Treasury yields lower but despite this the USD has rallied, especially against the EUR, which is not only suffering from renewed peripheral debt concerns and weaker growth, but also from a run of disappointing earnings releases in contrast to the US where earnings have on the whole beaten forecasts.

The US Dollar may have benefited from a renewed increase in risk aversion and in this respect further US equity weakness may provide the USD with further support.

The Dollar has made consistent losses this week and the continued stalemate on the subject of extending the US debt ceiling, the greater the problem for the currency. Without a doubt, it appears that the Greenback is taking the brunt of the pressure compared to other assets.

For example, although US treasury yields have edged higher, there appears no sense of panic in US bond markets.

Failure to agree on the debt ceiling does not naturally mean a debt default however it will increase the chances should an agreement not be reached in the weeks after.

Nevertheless, the impact on US bonds maybe countered by the increased potential for QE3 or safe haven flows in the event that no agreement is reached.

The worst case scenario for the USD remains no agreement on the debt ceiling ahead of the August 2 deadline but a short term solution that appears to be favoured by some in the US Congress may not be that much better as it would effectively be seen as ‘kicking the can down the road’.

The better than expected package to help resolve Greece’s debt problems last week dealt a blow to the USD as the almost perfect negative relationship between the USD and EUR over recent months.

Furthermore, the debt ceiling deadlock is making matters worse.

However, the situation can change very quickly and should officials surprise us all and find agreement the USD could rally sharply.

Things are not looking great for the EUR as most of its gains have mostly come by courtesy of a weaker USD rather than positive EUR sentiment.

The news hardly bodes well for the EUR, with data in the Eurozone looking somewhat downbeat.

For example, the Belgian July business confidence indicator dropped to a 9-month low in line with the weaker than expected outcome of the July German IFO survey last week.

In addition, there are still several questions about last week’s second Greek bailout agreement and contagion containment measures including parliamentary approvals and lack of enlargement of the EFSF which could keep markets nervous until there are clear signs that implementation is taking place successfully.

A clear indication that the EU agreement has failed to inspire as much confidence as officials had hoped for is the lack of traction in terms of narrowing peripheral bond spreads, with the exception of Greece.

This partly reflects a renewed ‘risk off’ tone to markets but this is not the sole reason.