Euro Resilient Amid Doubts of Turmoil as Dire: Cutting ResearchSimon Kennedy
The euro has often ignored policy maker pronouncements and “danced to its own tune” during the region’s sovereign debt crisis, according to a working paper published by the European Central Bank.
The study was based on a database of more than 1,100 public statements about the turmoil by leaders at the regional and international level from October 2009 to November 2011.
While steps such as aid from the ECB and European Union bailouts may have affected exchange rates, this month’s paper suggests “financial markets might have been less reactive to the public debate by policy makers than previously feared.”
When rhetoric did influence the euro’s volatility, the authors found it tended to be by politicians from countries with top credit ratings. In particular, comments related to the contents and conditions of rescue packages, the possibility of defaults or speculation about the role of the private sector had an impact.
Meantime, statements on ECB monetary policy or on fiscal policies by stressed nations were found not to have affected the currency’s trading in a systematic fashion, said writers Michael Ehrmann and Chiara Osbat of the ECB, Jan Strasky of the Organization for Economic Cooperation and Development and Lenno Uuskula of the Bank of Estonia.
“There are instances where markets reacted with increased volatility, such as on days where several politicians from AAA-rated countries went public with negative statements, suggesting that communication by policy makers in crisis times should be cautious about triggering unwanted financial market reactions,” they said in the study.
* * *
The solution to weak U.S. hiring, paradoxically, may be higher interest rates, says William T. Gavin, an economist at the Federal Reserve Bank of St. Louis.
In the new edition of the Fed bank’s Regional Economist report, Gavin outlines how some economic models show raising nominal interest rates could lift returns in the markets for bonds and capital and lead to higher wages.
That would leave companies with an “incentive to add workers because doing so would lead to an increase in the marginal product of capital.”
“People would have an incentive to re-enter the workforce because the return to saving would increase,” said Gavin, who joined the St. Louis Fed in 1994. That’s because earning income is more worthwhile if returns on saved income are higher.
With U.S. unemployment stuck at more than 7.5 percent since January 2009 and 7.6 percent last month, Gavin says the Federal Reserve’s near-zero interest rate doesn’t seem “to be having much of the intended effect, either on spending or on job growth.”
An indication of that: The ratio of employed people to the civilian population has failed to rebound from its post-recession low. One reason is low interest rates, a factor that’s often ignored in academic studies, Gavin said.
He argues low rates mean the marginal product of capital -- the additional output of the next-added unit of capital, such as a machine -- will fall until investors are indifferent between investing in bonds or capital. In what he calls the “perverse scenario,” firms fire workers until the marginal product of capital matches the interest rate.
Gavin concludes that while these are only models, they suggest that “after more than four years of low interest rates and stagnating growth around the world, a better understanding of low interest rate policies is needed.”
* * *
Investors have little reason to fear a repeat of the 1994 “bond massacre,” when the Fed’s surprise interest-rate increases sent bond yields soaring and strained some financial institutions.
So say Goldman Sachs Group Inc. economists in an April 24 report that studied the period when the Fed doubled its key rate. It rose to 6 percent starting in February 1994 and plateaued a year later, while the central bank became increasingly aggressive in the size of shifts. U.S. Treasury yields jumped in tandem.
The Fed’s decision to communicate more openly since then and its modern inflation-fighting credibility mean it’s less likely to shock financial markets, said Goldman Sachs economists Charles Himmelberg, Kamakshya Trivedi and Noah Weisberger.
What’s also changed is the composition of the market, they said. A larger share of fixed-income securities seem to be owned by investors who aren’t buying with borrowed money. That reduces the number who would need to sell if the market turned against them. Those who do borrow to fund their investments, such as banks, have a smaller share of U.S. Treasuries now, they said.
“These factors, taken together, point to a market less exposed to a meaningful pullback in rates,” the Goldman Sachs report said.
* * *
The response of workers to the so-called polarization of the U.S. labor market differs across genders, education and ages, a study released April 23 by the Fed Bank of Kansas shows.
Polarization is a term for the shift in workforces toward low- and high-skilled occupations, emptying out middle-sector work. Explanations for it include the impact of technology, the rise of international trade and the shrinking of labor unions.
Viewing polarization as a three-decade phenomenon, economists Didem Tuzemen and Jonathan Willis looked back as far as the early 1980s to gauge its effect.
They found women have obtained more education and moved disproportionately into high-skill jobs, while men have shifted in both directions. Workers aged 55 and older have moved strongly into the high-skill areas and those already there have delayed retirement. For 16-to-25 year olds, low-skilled jobs have been the biggest draw as a growing segment of this population delays entry into the labor market by remaining in school.
Tuzemen and Willis conclude that while polarization has accelerated during recessions, the shifts in employment suggest it has neither been a driver of the business cycle nor a primary cause of jobless recoveries.
* * *
The U.S. is going back to the future, according to Ed Yardeni, the man who coined the term “bond vigilantes.”
The Standard & Poor’s 500 Index’s rise to a record close of 1,593.37 on April 11 suggests investors may be seeing similarities between the current decade and the 1990s, said Yardeni, president and chief investment strategist at Yardeni Research Inc. in New York.
As in the 1990s, the U.S. appears to be the best place for global investors looking for decent returns, he said in research reports released last week. It looks like a haven compared with Asia and Europe, while the decline in commodity prices will be a net American positive as well.
Stocks and real estate markets will outperform bonds and commodities, said Yardeni. His bond vigilante term referred to investors who protest countries’ monetary or fiscal policies by dumping their sovereign bonds.
“Of course in the 1990s, there was much greater confidence in the future than there is now,” said Yardeni. “However, now as back then, the U.S. economy seems to be best positioned to surmount the challenges and benefit from the opportunities that are ahead,” he said
* * *
American households are ending five years of thrift.
That’s the declaration of Societe Generale SA economist Aneta Markowska, who says in an April 18 report that the only thing holding back the American expansion now is tighter fiscal policy.
Even government budget cuts won’t keep growth from rising above trend for the next four years as consumers, who represent 70 percent of gross domestic product, bounce back.
After the subprime crisis helped push the economy into recession, the housing market is set to register an increase in prices of almost 30 percent over the next five years, she estimated. That will help consumers feel wealthier and boost spending, and enhance credit availability.
Household debt payments are also at the lowest in more than three decades and likely to fall even as the Fed starts to tighten monetary policy. It will begin by tapering its asset-purchase program in the third quarter, said Markowska.
* * *
Euro-area countries are more optimistic than they should be when forecasting their ability to reduce budget deficits to less than 3 percent of global GDP.
Regressions of forecasts conducted by Jeffrey Frankel and Jesse Schreger of Harvard University in Cambridge, Massachusetts, found that among 24 European countries the tilt toward optimism is 0.28 percent of GDP at the one year mark. It rises to almost one percent at the two-year horizon and 1.90 percent over three years.
The bias is even higher for the 17 nations in the euro region, even though they are technically required to obey deficit limits. Their bias is as high as 2.4 percent over three years.
The authors suggest national balanced-budget rules or independent institutions providing forecasts may help to reduce this slant. The study was published in the latest Review of World Economics by the Germany-based Kiel Institute for the World Economy.
* * *
China, India and Poland have enjoyed the greatest surge in competitiveness since 2007, while Finland, the Philippines and the U.K. have suffered the biggest fall, according to Nomura Securities International Inc.
Nomura strategists led by New York-based Jens Nordvig created new indicators to measure competitiveness using economic growth and export data among 35 countries.
China’s gain is related to the continued increase in the production of goods there, Nomura said. India’s strength lies in its role as an outsourcing destination and also its low starting point. Poland has benefited from the relocation of some European manufacturers.
Finland’s slide could be tied to the steady decline of mobile-phone maker Nokia Oyj, Nomura said in an April 18 report. The U.K.’s fall may be proof that deep structural issues are more important than sterling’s tumble.
The stabilization of the U.S.’s market share signals an end to the dollar’s structural depreciation and that the euro may be overvalued, Nordvig and colleagues said.