I think the world’s central banks just validated my pessimism – the Eurozone financial system is falling apart. Will this be enough to put the pieces back together? Paul Krugman is doubtful:
I am, I have to say, somewhat mystified. Of course the Fed will make dollar liquidity available to other central banks as needed; that was never in question, because Bernanke doesn’t want to be the man who destroyed the world to save a few pennies. And reducing the interest rate on those loans seems to me to make virtually no difference; it was a trivial charge anyway.
Indeed, the only surprise here is that it took this long for somebody to push the panic button. Actually, there was another surprise – the dissent of Richmond Fed President Jeffrey Lacker to the increased swap lines. From Reuters:
“I dissented on the vote because I opposed the temporary swap arrangements to support Federal Reserve lending in foreign currencies,” Lacker said in an emailed statement.
“Such lending amounts to fiscal policy, which I believe is the responsibility of the U.S. Treasury. The Federal Reserve has provided and can continue to provide sufficient dollar liquidity through purchases of U.S. Treasury securities,” he said.
This is misguided. The Fed is responsible for protecting the US financial sector, and needs to do so, when possible, even if the threat is eminating from overseas. US banks may not be in need of dollar liquidity, but their foreign counterparties might be – and failure to provide it would more rapidly turn a European problem into a US problem.
Equity markets took the bait and ran with it. Perhaps, as Krugman suggests, market participants see this as a precursor for more to come. To be sure, the European Central Bank is almost sure to cut rates further, as well as extend liquidity facilities. But this, as well as eventual quantitative easing, are already anticipated. And if this is the final cure, why did Treasuries hold the line? Yields on the ten-year bond where up only 7bp yesterday – not exactly a signal that investors are vastly increasing their appetite for risk.
That said, I admit to being mystified by the compulsions of equity traders. I reiterate my observation that equity prices held their ground and then some in 2007, even as the Fed was beginning a rate cut cycle that would eventually take them to zero. There is no reason to expect a different story now. In fact, the data flow on this side of the Atlantic is, quite frankly, not bad at all – see Ryan Avent’s rundown. I don’t really expect equities would be hit hard unless it became evident the US would not decouple from the rest of the globe. And although I am somewhat pessimistic on that point, I also admit the jury is still out.
And how exactly is the rest of the globe? Not good. Not good at all. Eurostat confirmed the unemployment rate in the Eurozone continues to rise and now stands at 10.3% in October, although with vast differences accross countries. Austria is at the bottom with 4.1%, Spain at the top with 22.8%. Notice Germany’s unemployment rate continues to drop, from 5.7% to 5.5% in October. No wonder the German public resists more forceful crisis responses. Crisis? What crisis?
If you thought unemployment rates are high now, remember that we are only in the initial stages of this recession. It will get worse.
I call attention again to Portugal (unemployment 12.9% in October, up from 12.3% a year ago). The austerity parade marches forward. From the Washington Post:
Portugal’s Parliament gave its blessing Wednesday to the country’s severest austerity measures in almost 30 years as it scrambles to free itself from a ruinous debt crisis and help relieve pressure on the wider eurozone.
Lawmakers approved the government’s spending plans for next year, including a new round of tax hikes and pay and welfare cuts that will further crunch living standards amid a deepening recession and record unemployment….
…Finance Minister Vitor Gaspar told lawmakers the cuts are needed “to restore the confidence of the Portuguese people, the markets and our international partners.” The budget will help “put (Portugal) back on the path to sustainable development,” he said.
How fast is confidence being restored? While most of Europe was getting relief from today’s central bank action in the form of lower interest rates, yields continued to back up in Portugal, rising 42bp on the ten-year to 14.5%, extending last week’s rating cut induced rise. Doesn’t sound like much confidence to me. What it sounds more like is “private sector involvement.”
On a completely difference topic, Eurostat also released obesity statistics. Italy looks to be doing something right.
On the other side of the world, we see that where European manufacturing goes, so too does China’s. From Bloomberg:
A purchasing managers’ index compiled by the China Federation of Logistics and Purchasing slid to 49 in November, lower than all but two of 18 forecasts in a Bloomberg News survey. Readings below 50 signal a contraction. Separate reports showed slowing retail sales and an industrial slump in Australia, which relies on China as its biggest export customer.
No wonder Chinese policymakers are stepping on the gas.
Bottom Line: Central banks took a step in the right direction. But nothing in Europe is close to be solved by that action. We are still closer to the beginning of this mess than the end.
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