Investors see Hungary becoming “significantly” less risky, allowing for further reductions in interest rates, central bank Deputy Governor Ferenc Karvalits said. “Over the past few months, international risk appetite has improved significantly, the risk assessment of the region and Hungary has stabilized, and this allows for further easing of monetary conditions,” Karvalits said in an interview on Kossuth Radio today.

The Magyar Nemzeti Bank lowered its benchmark interest rate by half a percentage point to 8 percent on Aug. 24 as it works to jolt the economy out of its worst recession in 18 years. The bank has shaved 1.5 points off the key rate since July as confidence rises in the first European Union nation to get a bailout. Hungary received 20 billion euros ($28.5 billion) in an emergency loan from the International Monetary Fund, the EU and the World Bank.

The country has a “good chance” to finance its budget deficit from the market and may not need the next installment of the IMF loan, Karvalits said. The forint weakened 0.3 percent against the euro and was trading at 268.82 at 7:48 a.m. in Budapest.

You see, one of the principal reason why Hungary is in such a mess is that as inflation shot up in the months leading up to the crisis Hungary chose to loosen its peg against the Euro. At the time, the rationale seemed wise albeit very bold. In an environment where investors were willing to take risk (i.e. hunting for yield) their objectives could be aligned with that of public authorities in the sense that the former got their yield whereas the latter got the nominal appreciation needed to keep inflation in check.

It did not work quite like that.

As the crisis hastened its grip on global markets and as its locus steadily moved to Eastern Europe the Hungarian Forint plummeted and lay bare the country's vulnerabilities in the context of balance sheet (on the liability) side denominated in Swiss Francs. The result was that Hungary crashed into a recession unable to tweak monetary policy downwards because of a fear that this would scythe the Forint and thus essentially bankrupt scores of households and companies. On the other, the government also had (and has) difficulties raising funds on international capital markets.

Now however things appear to have changed at least for a moment and Hungary's central seem poised to take advantage of the relatively benign market conditions to lower interest rates to support its ailing economy. The underlying idea is simple. If you believe that risk aversion is to stay low, the Forint should not be sensitive towards the lowering of nominal interest rates since after all the carry remains plentiful. In this way, my view is that Hungary's central bank is trying to claw back the control over monetary policy by locking in a lower interest rate for the Forint. The key question which we should be asking ourselves however is of course whether Hungary could actually be forced to raise rates further down the road to defend the Forint. Clearly, bets are being made inside Hungary at the moment that this is not the case.

This is very interesting in a practical as well as a theoretical sense as I have discussed for example in this post about carry trade and global monetary policy. More recently, Edward Hugh mused on the same topic (more or less) invoking the idea of the (eternal) triangle of monetary policy in an open economy context.

In the case of the Central Europe "four", Poland and the Czech Republic opted for maintaining their grip on monetary policy, thus accepting the need for their currency to "freefloat" and move according to the ebbs and flows of market sentiment. As it turns out this decision has served them remarkably well, since the real appreciation in their currencies which accompanied the good times helped take some of the sting out of inflation, while their ability to rapidly reduce interest rates into the downturn has lead to currency depreciation, helping to sustain exports and avoid deflation related issues.

The other two countries (Hungary and Romania), to a greater or lesser degree prioritised currency stability, and as a result had to sacrifice a lot of control over monetary policy, in the process exposing themselves to the risk of much more violent swings in market sentiment when it comes to capital flows. Having been pushed by the logic of their currency decision towards tolerating higher inflation, they have seen the competitiveness of their home industries gradually undermined, and as a consequence found themselves pushed into large current account deficits for just as long the market was prepared to support them, and into sharp domestic contractions once they were no longer disposed so to do.

Edward's account here is important since it alerts us to the fact that it was only at the very end that e.g. Hungary opted for float because it was believed that it would make the inflation problem go away. At that point however, the structural imbalances and essentially damage were already embedded in the system of course. Nevertheless, it is unequivocally the fact that Hungary, at the moment, is attempting to benefit from the relative benign market conditions which means that risk aversion remains relatively subdued.

Elsewhere in Market Land ...

If our little trip to Hungary suggests that risk is on, if only a little bit and potentially in the case of Hungary news elsewhere suggest that the waters are more choppy. Of course, none of this is earth shattering by any means of the word, but since much, if not everything, seems to be revolving around China at the moment it seems worthwhile to dwell at recent news on how China are expected to "tweak" its hitherto lax lending policies to skim the worst of the mounting bubble (quote below from Bloomberg).

China’s banking regulators are “tweaking” lending policies to remove “froth” from the system while growth remains the top priority for policymakers, according to Royal Bank of Scotland Group Plc. The goal is to manage risk exposure among banks and asset quality by checking lending from going into A-shares traded on the mainland and properties, Wendy Liu, Hong Kong-based head of China research at RBS ABN Amro, said in a report dated yesterday.

(...)

The banking regulator sent draft rule changes to banks on Aug. 19 that would require lenders to deduct all existing holdings of subordinated and hybrid debt sold by other lenders from supplementary capital, said the people, who have seen the document and declined to be named as the matter is private. This may cut lending by as much as 700 billion yuan ($102 billion), China International Capital Corp. said Aug. 24.

Of course, the main bias of the Chinese stimulus program and thus the authorities' objective remain one of promoting growth through the expansion of domestic investment and, one would assume, consumption. As RBS ABN Amro's Wendy Liu is quoted of saying; "policymakers have a far greater tolerance for asset-price appreciation over the medium term than before". That sounds about right to me even if I am no sage, at all, on China.

What is interesting in the case of the recent news from China was also the following piece by Bloomberg whose headline (Yen Strengthens as China Policy Concern Spurs Demand for Safety) makes a direct link between policies in China and risk sentiment in the market and thus also the movement of the Yen and the USD (remembering of course the narrative that repatriation of profits may ultimately be the main driver of the Yen at the moment).

The yen rose for a third day against the euro in the longest stretch of gains since July on concern Chinese production curbs would slow economic recovery, fanning demand for the relative safety of Japan’s currency. The currency gained versus major counterparts including the pound on speculation Japan’s exporters are repatriating earnings to take advantage of a new tax law. A government report today may show a faster contraction in the U.S. economy than previously estimated.

“We have talks from China cutting back expanding, trying to sort out the balance sheet and prevent too much reckless lending,” said Peter Frank, a London-based currency strategist at Societe Generale SA. “But domestic factors, like capital repatriation, are driving yen’s strength right now.”

Whether there is a history to be made here is debatable, but one thing is certain. China seems to have decidedly taken center stage in the global market discourse. Finally and essentially as a small footnote, yours truly took notice of the fact that despite the decidedly positive sentiment in the core of Europe at the moment on the back of the Q2 GDP print and upbeat confidence readings in Germany, aggregate retail sales continued their steady decline.

Whether all this signifies that risk is "on" or "off" I will allow the reader to decide for themselves. Personally, I am still bearish, but it is difficult to deny that the relative calm and positive environment that has prevailed since spring seems rather strong. I would expect sentiment to change once we return to "normal" in Q4 once the elections in Germany and Japan have been resolved and, more importantly, once OECD stimulus packages start to wane. Most importantly however, there is the situation in Southern and Eastern Europe still loom as the most likely harbringers of, if you will, black swans in which case risk almost surely would be off.

Greece naturally was wonderful and although we lived close to Athens we were not affected by the fires which now, sadly, seems to be almost out of control.

I managed to thoroughly relax and did not even get to read up on that textbook I had brought. This I imagine is a good sign :). I did however read David Leavitt. I finished the Indian Clerk and Arkansas. Leavitt is an excellent writer and the Indian Cleark is a fabulous, if sometime very windy, tale whose characters are explored with an almost excessive hunger for detail by Leavitt.

The fact that Leavitt is homosexsual comes out very clearly in his writings and actually helps, in the case of the Indian Clerk, to bring nuance and depth to the description of the faculty of great literay and academic stars who roamed Cambridge during the first world war. As far as goes the stories in Arkansas some will almost surely be pushed away by the vivid display of homesexual escapades. Personally, I thought it a bit excessive (almost as if it was compulsory) at times; e.g "the Term Paper Artist" which is a pretty hefty, albeit funny, story will almost certainly make some readers frown. What is generally interesting though is that Leavitt, in my opinion, comes off much more strongly when he centers his story around a male homosexsual main character as e.g. in "the Term Paper Artist" or "Saturn Street" than when the main character is, presumably, a straight woman as in "the Wooden Anniversary".

In general though, I would warmly recommend you to have a look at some of Leavitt's works. If you like historical novels, the Indian Clerk is a definite winner.

The lion's share of the reading will hopefully be David Leavitt and to the right you can see the titles I am bringing. By no means will I get to read the lot, but since the last two are collections of short stories (The Stories and Arkansas), I hope that I will be able to read around. It all depends really on whether the usual family bug of solving crosswords completely takes over or not. We will be going five adults this time so not even the genius crosswords can count themselves too sure I think. 

My destination will be Greece and more specifically a small town 50 km outside Athens where we (my family) are renting a small flat situated right at the beach (well almost). No wifi is a given although I will be trying, of course, to see whether I can catch a wave or two from the neighboring houses. If I manage to go online I will probably drop in with some small bits.

I will return the 22nd of August.

Best Wishes

Claus

The newly launched service which is also one of the first of its kind in Europe, will offer theoretical peak download speed of 21.6 megabit per second (Mbps), a significant improvement from the present download speeds of 14.4 Mbps offered by Vodafone in Greece.

The company will initially offer this advancement in the selected areas of Athens and extend the service in other areas in due course. The company recently completed commercial rollout of HSPA+ based mobile broadband service in Portugal as the first operator in that country to offer maximum download speed of 21.6 Mbps.

HSPA+, also called HSPA Evolution, represents a major advancement in 3G-based wireless broadband technologies, aimed at improving customer experience by significantly boosting network speed. Vodafone is currently leading the way in developing services based on this technology. The company is aggressively upgrading its existing 3G network to HSPA+ in order to offer more efficient data transport management with a potential for boosting download speed to 42 Mbps.

Vodafone continues to leapfrog its two major rivals Deutsche Telekom’s (DT) T-Mobile and Telefonica’s (TEF) O2 in the European mobile broadband market in terms of technology advancements. The company is the first and only operator in Europe to offer theoretical peak download speeds of 14.4 Mbps and 21.6 Mbps which are compared to the average top speed of 7.2 Mbps currently offered by both T-Mobile and O2.

Ongoing efforts to upgrade the existing network infrastructure should result in higher average revenue per user (ARPU), higher minute usage and improved operating margins through greater network efficiency. Given this prospect, we maintain our Buy recommendation for Vodafone.

Right now, in the wake of MSCI’s reclassification of Israel as a developed market, I’m working on a rundown of the country classifications of four major index providers: MSCI, Dow Jones, FTSE and Standard & Poor’s.

The evolution of emerging markets (and sometimes devolution of developed markets—see Greece, which could lose developed-market status in the FTSE indexes) is just particularly fascinating to me. Take some of the frontier/emerging markets that the index providers cover at the very bottom rungs of the investability ladder: Latvia? Slovakia? Trinidad & Tobago? Mauritius?

Frankly, I’m dying to know what the investment stories are behind these tiny, tiny markets. And while I believe frontier markets (like, say, Vietnam) offer some awesome investment opportunities, is anyone really itching to sink some funds into an obscure eastern European country that probably has a smaller population than the number of visitors to my local mall on the day after Christmas?

I realize there are different rules and methodologies that each of the index providers use, but it all seems rather mysterious. For example, Dow Jones—which generally uses the International Monetary Fund’s designations—classifies Slovenia as a developed market, while MSCI has it labeled as a frontier market. That’s quite a disparity.

Lately, the majority of the focus has been on Israel and South Korea, though, and whether they will transition to developed-market status within the various classification systems. MSCI, of course, just promoted Israel to developed status last week, while keeping Korea in the emerging category. Given that the majority of internationally invested funds are benchmarked to MSCI indexes (at least in the U.S.), this issue has been followed fairly closely by investors. At the end of March, Israel was the ninth-largest country in the MSCI Emerging Markets Index, with a 4.0% weighting, and South Korea was the fourth-largest, with a 12.4% weighting.

Given the amount of money benchmarked to that index and the even greater amount benchmarked to the MSCI EAFE Index, which Israel now joins, that’s an awful lot of funds shifting around. South Korea is up for reconsideration in 2010 (as is Taiwan, another country straddling the emerging/developed divide).

But MSCI seems to be on the tail end of the trend: Dow Jones, S&P and FTSE all classify South Korea as a developed market, while only Dow Jones and FTSE put Israel into the developed bucket. S&P still has Israel as emerging. Of course, FTSE, S&P and Dow Jones have a lot fewer funds tracking or measured against their global indexes.

They can shift their country classifications with relative ease, as they deem appropriate, without a lot of reverberation. But if MSCI decides to promote a country to developed status, many, many billions of dollars are going to be moving around, with all sorts of economic consequences.

And not all of them will be positive: In Israel, there is concern that the country moving from relatively big-dog status in the emerging markets index to a minor position in the developed markets index will actually result in outflows from the local stock market.

(Read an article on the latest MSCI moves here. Also of interest might be a Bloomberg article on the subject here, and another article from an Israeli publication about a Deutsche Bank study on the potential negative impacts of the switch.)

Teva Pharmaceutical, Israel’s largest company, saw its price spike in June shortly before the official MSCI announcement, but there’s no telling what the longer-term effects will be. It will be interesting to see what happens with that, and even more interesting to compare the outcomes with what happens when South Korea—and its big stock, Samsung Electronics—is finally promoted to developed status.

Yeah, that was definitely the unrepentant nerd talking …

In another reduction of alternative indexes that use different valuations and business fundamentals to weight companies, Claymore Advisors is seeking to switch an existing exchange-traded fund to a more traditional market-cap size weighted benchmark.

But that isn't all.

In a filing dated May 21, the trust for the Claymore/Great Companies Large-Cap Growth ETF (NYSE: XGC) is asking the Securities & Exchange Commission to let it invest in much smaller companies. And while listed largely on U.S. exchanges, they'd be foreign-based businesses.

The new fund would be called the Claymore/BNY Mellon International Small Cap ETF.

The document notes that the new ETF's "investment objective is not fundamental" in nature. It clearly states the change will revert to a strictly passive indexing approach. (See filing here.)

The request to regulators by Claymore comes on the heels of PowerShares' decision to close 19 of its ETFs, a dozen of which were based on fundamental indexes created by Rob Arnott's Research Affiliates. (See related story here.)

While the existing XGC also follows an index, it's based on an investment approach by Great Companies Inc., a Tampa Bay, Fla.-based money management firm. Its managers rank companies by such factors as price-earnings growth rates, or PEG ratios, and various debt measures for assessing profitability.

Great Companies uses computers to crunch fundamental data to compare value characteristics against growth metrics for domestic large-cap names. Stocks are ranked and added to the ETF's underlying index according to the adviser's composite scoring system.

When it was launched in April 2007, XGC came with an expense ratio of 0.60%. It hasn't changed since then and it had slightly more than $3.7 million in assets through Tuesday.

Higher Price Tag 

When it was first coming to market, a Great Companies' portfolio manager acknowledged that XGC's price tag was higher than rival large-cap funds such as Vanguard and iShares. "But we're providing more of a managed-account product than a classic index-fund product," he said in a MarketWatch.com story at the time. (You can read the story here).

The new small-cap international ETF would face stiff competition as several newcomers have jumped into the asset class in the past few years. But one bone of contention for U.S.-based investors in often illiquid foreign waters is that it can be difficult to follow small-cap names held by their funds.

The new Claymore offering would address that concern by predominately investing in overseas firms with listings on major U.S. exchanges. The fund would hold mainly companies with American depositary receipts or global depositary receipts and market caps of $250 million to $2 billion.

At the end of March, such a makeup gave the underlying index a definite slant to emerging markets. The BNY/Mellon benchmark consisted of 92 stocks. The weightings by country then were: Brazil 21.37%; China 19.20%; India 7.28%; United Kingdom 6.88%; Chile 5.59%; Mexico 4.19%; Russia 3.64%; Japan 3.40%; Israel 3.10%; Netherlands 2.78%; Greece 2.64%; South Africa 2.57%; Italy 2.14%; Argentina 1.98%; Switzerland 1.96%; France 1.89%; Korea 1.79%; Australia 1.68%; Ireland 1.61%; Colombia 1.51%; Hungary 1.00%; U.S. 0.82%; Indonesia 0.50%; Hong Kong 0.46%; Denmark 0.45% and Germany 0.41%.

No expense ratio is listed in the filing. But if the new fund were in the same neighborhood as XGC's, it would seem to have a better fighting chance when competing in the small-cap international arena.

Prices for rival ETFs range from around 0.40% and up. For example, the group's granddaddy is the WisdomTree International SmallCap Dividend Fund (NYSE: DLS). Meanwhile, Vanguard entered the field in March with an ETF charging 0.38%. (For a more complete breakdown on competing international small-cap ETFs, see stories here and here.)

-- This report was submitted by IndexUniverse.com's Murray Coleman. 

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Here are highlights from Wednesday's Analyst Blog:

China Denies Coke Acquisition

Today, the Chinese Ministry of Commerce announced that it has rejected The Coca-Cola Company's (KO) proposed acquisition of China Huiyuan Juice Group Limited, a Hong Kong listed company which owns the Huiyuan juice business throughout China. Citing the anti-competitive effects of the acquisition, the decision reflects the enforcement of China's strengthened anti-monopoly law and the internal political pressure of the Chinese government related to protecting indigenous brands from foreign control.

For The Coca-Cola Company, the strong performance of future key markets, like China, has mitigated volume concerns in North America. In 2008, unit case volume in North America declined 1%. Management is extending Coca-Cola's reach in emerging markets not only through the introduction of water and juice products, but also through acquisitions.

For example, in early 2006 Coca-Cola bought a Serbian water bottler, and in March 2007 Coca-Cola, in alliance with Greece-based Coca-Cola Hellenic Bottling Company (CCH), bought out Multon, which controls approximately 25% of the Russian juice market. On September 3, 2008, The Coca-Cola Company made a $2.3 billion cash offer to purchase China Huiyuan Juice Group.

Nat'l Semi: Buying Opportunity

National Semiconductor Corp. (NSM) is an OEM of analog and mixed signal integrated circuits. February quarter revenue fell short of consensus expectations, although the bottom line exceeded. Forward guidance is for a revenue decline of -5% to -10% in the seasonally strong 4th quarter.

Management has refocused R&D into areas that should drive margins. It has also initiated a massive restructuring program to further lower the breakeven point. Although National has been negatively impacted by the recession, the business continues to exhibit the necessary ingredients for a strong comeback. The necessary reduction of fab loadings will have a negative impact on near-term gross margins, but we expect margins to start looking up as restructuring actions are completed.

Buy SINA Corp. at These Levels

SINA Corp. (SINA) is a leading provider of online media and value-added information services to the global Chinese community. SINA posted strong financial results for 2008. Both its revenue and EPS once again exceeded the market consensus.

However, economic growth in the country had continued to slow owing to global downturn. SINA provided weak Q1 2009 guidance on account of a drop in advertising revenue. The company is also facing severe competition in its mobile business.

Vodafone's Strong Connection

We maintain our Buy recommendation for Vodafone Group PLC (VOD), the largest revenue generating international wireless carrier. The company's recent operating results are highlighted by strong growth in overall subscriber count bolstered by record customer additions in its Indian operation.

Additionally, solid growth in service revenue from emerging markets (in Asia and the Middle East) has been accompanied by sequentially improved results across most of the major European markets. Meanwhile, Vodafone continues to accelerate 3G wireless service deployments and expanding network availability across Asia, Eastern Europe and Africa, primarily through acquisitions.

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For anyone who didn't catch it on March 12, comedian Jon Stewart put to shame many hard-nosed financial journalists when he caught CNBC's Jim Cramer in outright lies about his scamming ways running hedge funds.

Stewart, host of Comedy Central's "The Daily Show," also blasted Cramer for his less-than-substantive antics on CNBC's "Mad Money" show. 

We should all stand up and applaud Stewart's performance. But he took it too far when talking about how his elderly mother had bought into the industry's long-term investing mantra.

Stewart should've stayed on-topic, drilling Cramer and not letting him off the hot seat. Instead, he ventured too far afield when relating the apparent drubbing his mom took in the markets during the ongoing recession.

Although ex-journalist Cramer is the sort of slumdog millionaire we all should be wary of taking too seriously, he could've redeemed himself a smidgen by pointing out to Stewart that long-term investing shouldn't take the rap.

My Parents ... And The Importance Of Sound Advice

Sitting by the computer watching on Comedy Central's site the next day (see clip here), I couldn't help thinking about my parents. They're both around the same age as Stewart's mom, and while their portfolio has taken a hit as a result of this economic mess, it's still nowhere near a double-digit loss.

As some of you might remember, there was a lengthy review on IU.com's discussion boards a while ago about whether my parents should dump their (unnamed) adviser, who was unresponsive to requests for information about their allocation plan. To make a long story short, most pros and amateurs alike agreed that an unresponsive and overaggressive adviser wasn't worth keeping.

So we dropped the adviser and moved their portfolio to Vanguard. Not only did we save thousands of dollars in yearly fees to fund companies, but we also discovered an amazing statistic while hunting through the maze of paperwork and accounts the adviser had set up: My parents, in their mid-80s, had something like 80% of their assets in stocks!

We since have merged their portfolios into an easy-to-manage 70% bond allocation. By the end of last year, that was up to 80% bonds as the stock portion fell and the fixed-income index funds held their ground. With a large portion in munis, the portfolio is doing even better this year.

Back to Jon Stewart. He was correct in pointing out that investing requires monitoring and it's not as easy as it looks. But when he made the leap to condemning long-term planning, he clearly was ranting—and well beyond his comfort zone.

Someone should let Stewart know that long-term asset allocation isn't an industry-inspired plot to hold investment dollars longer. It's an ages-old strategy with a wealth of academic knowledge behind it that savvy veteran investors have long embraced.

It just takes some thought and preparation. How you allocate assets is critical. In fact, the longer-term focus your portfolio takes, the more due diligence is required in terms of making sure you've got the right plan of attack.

Consider if you had a simple two-ETF portfolio. For all domestic equities, let's take the Vanguard Total Stock Index ETF (NYSE: VTI). With bonds, let's go with the iShares Barclays Aggregate Bond ETF (NYSE: AGG).

The table below shows how asset allocation impacts this simple portfolio's returns on a percentage basis, both over the short and longer term (through 3/17/09):

Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession. Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets. The Committee will continue to carefully monitor the size and composition of the Federal Reserve's balance sheet in light of evolving financial and economic developments.

And some more fro Bloomy ...

The Federal Reserve plans to buy $300 billion in Treasury securities and acquire more mortgage and agency debt in an effort to bolster housing and hasten the end of the recession.

“To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage- backed securities,” the Federal Open Market Committee said after a unanimous vote in Washington today. “Moreover, to help improve conditions in private credit markets, the committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.”

Chairman Ben S. Bernanke is opening a new front in monetary policy after unemployment climbed to 8.1 percent and economists forecast the economy will shrink through the middle of the year. Fed officials also kept the benchmark interest rate at between zero and 0.25 percent and said it will consider expanding the Term Asset-Backed Securities Loan Facility to include “other financial assets,” the statement said.

“We are not even close to the bottom and therefore the Fed is engaging in a massive quantitative easing,” William Poole, former president of the St. Louis Fed, said in an interview today with Bloomberg News. “We still have a very serious recession in front of us,” said Poole, now a senior economic adviser to Merk Investments LLC in Palo Alto, California, and contributor to Bloomberg News.

So, time to buy some equities and other risky assets on the dip here? Not to mention to sell that buck for all its worth at least for erm a tick or two. Well, with respect to my small chart above Macro Man seems to be surprised of the relative timidness of the move; 

Im amazed
Eur should be 1.40
Crude should be 60
GC should be at new highs
SPX 850

simply, does the mkt know who they are messing w/?

On a more serious note Berner and Greenlaw from Morgan Stanley have some interesting remarks on the Fed and the next step of buying treasuries. Ok, on we go!

Obviously, the discussion which we hope to initiate here comes in two phases. First, there is the question of whether or not the ECB should be considering QE at all? I am sure that there is plenty of people out there disagreeing with the sentiments expressed below. Secondly, there is then the issue of how exactly the ECB would conduct QE. Once again, I should warn you; this is a bugger and, at times, also somewhat technical.

---

Most sports coaches - irrespective of whether they work in soccer, baseball, rugby or even American football - have playbooks; small books or pads filled with notes, decision rules and strategies for each and every possible situation they can envision. Of course, in some cases the playbooks are mental rather than physical, but every good coach lives and dies by his ability to adapt and react to new and changing situations and in order to do this effectively what he needs above all is a good playbook.

So what has all this waffle about football, baseball and whatever got to do with the ECB and how it should respond to the Eurozone's "fluid and evolving" economic and financial crisis? Well, the point surely would be that whatever playbook the ECB works with (and it is sometimes pretty hard to see clearly which one it actually is) they do not seem to have included a section on what to do when interest rates finally hit the zero bound (not this month evidently, but maybe, or possibly the one after....as Bank President Trichet said after today's decision to reduce the rate to 1.5%: “We didn’t decide ex-ante that this was the lowest point that we could attain” ). Nor do the ECB seem to have a page which explicitly handles the currently fashionable state of the art set of tools known collectively as quantitative easing. And this omission may, as the zero bound looms and outright deflation threatens, turn out to be a rather large and unfortunate one. The question is, what exactly are we going to do if (or even when) the Eurozone as a whole enters a deflationary rather than a disinflationary dynamic, and even more importantly, what happens if price movements fall into deflation mode and stay there?

 But before we get ahead of ourselves, let's go straight to the horses mouth (as it were), and take a brief look at what it is exactly the ECB has been doing all this time in order to alleviate the credit crunch and reverse that depressing cycle of decline and deterioration which currently seems to hold the Eurozone economies so tightly in its grip. Speaking at the European American Press Club on the 20^th of February ECB President Jean Claude Trichet laid out in some detail the considerable variety of measures the bank has been taking since the crisis broke out in August 2007. Reading through the text of the speech, one major detail immediately strikes the eye, and depending on your point of view the omission is a more or less disturbing one.

The fact of the matter is that at no point in his entire speech does the Central Bank President get to mention (not even once) the effects the crisis has been having on the real economy. His entire attention is focused on measures that the bank has been taking in order to ease the crunch by improving funding conditions in the interbank market, and in particular he enumerates in some considerable detail all the various classes of credit the ECB has been making available to Europe's banks. Now, you could argue that this absence is hardly surprising given that Trichet was not invited to give a talk about the state of the European economy, but rather about the steps the bank was taking to address the impact of the financial crisis and the credit crunch. But this would be precisely the point, since at the present moment in time the two are inextricably intertwined, with the credit crunch driving the real economy down, even as the rising unemployment this produces sends risk sentiment in the banking sector to ever lower levels.

This being said, the more disturbing part of the whole speech is the sense of complacency it conveys, with the impression being given that Trichet by and large believes the ECB has things nicely under control with a nominal interest rate (then) running at 2% and that despite the awkward hurdles which may still lie out there in front of us, no extraordinary measures are needed. If this is the case, maybe someone needs to pick up the phone and give the gentlemen in Frankfurt Ivory Tower a call suggesting they take a long hard look out of their window to see just what is happening in the world that lies beyond.

Possibly some may feel that the dichotomy being made here is a false one since the ECB always held that the measures it was taking to normalize conditions in the interbank market were also de-facto intended to cushion the effects of the credit crunch on the real economy. However, using this argument in the current situation is not only misleading, it is also dangerously complacent. Put in more prosaic fashion; this is all soo pre H2 2008.

The facts of the matter are all now pretty much unequivocal, and really speak for themselves (or at least they should do).

• In the first place the problem in the banking sector and the wholesale money markets was never really the main issue. This, undoubtedly real, problem was merely the outward and evident symptom of a much deeper structural problem concerning how the whole (global) economy needed to deleverage, and how the systemic character of the money market breakdown would ultimately require government and institutional intervention on a large scale.

• Secondly the crisis has now very much become an economic and not simply a financial one. We won't belabour the reader here with all the gory economic details which you are all already so familiar with, but we would like to stress that it is now pretty evident that the global economy is taking a hit on the scale that has not been seen since the first half of the last century, and most specifically, since the years of The Great Depression. So this is not a matter to take lightly, even if some economies are hit worse than others. We should also not fail to take notice of the fact that, despite many early assurances to the contrary, while the United States is certainly busily fighting its own private economic demons, the locus of the crisis has now slowly but surely moved in Europe's direction, first via the Southern and Eastern periphery and then entering into that very bastion of the Eurozone itself - the German economy.


• This is not either the time or the place to examine all the chain-links and mechanisms through which crisis transmission operates, but we should all be aware that the force of the blast we are taking at the present time is such that the very foundations of our common economic edifice - of the Eurozone and even the European Union - are now at risk. When the simple act of transferring deposits from bank accounts in one member state to those in another (in order to speculate on the future stability of a currency) becomes (and by some multiples) a potentially more profitable investment opportunity than building a factory and creating employment then the seeds of financial crisis are well and truly sown, and action needs to be taken to prevent the implicit peril coming to fruition. We simply don’t understand how anyone can deny that this problem exists at the present juncture, and that something needs to be badly and urgently done to secure the foundations of our edifice before the worst is, by omission, allowed to happen. The economies of the EU and, in particular of the eurozone, need to see the return of profitable investment opportunities as an alternative to idle speculation, and the ECB has a key role to play in this process, by returning price stability, by stimulating growth possibilities, and above all by encouraging a return of confidence to our somewhat battered and beaten economic system.

In order to address the rather urgent task which now faces us we should not, in principal, exclude the use of extraordinary action and recourse to what have come to be known as "unconventional tools" on the part of the ECB. Indeed in the difficult battle which now confronts us, no door should be closed, and no stone left unturned. Yet, all of this still remains on the level of "in principle" and in theory. Since despite all the evidence, indeed the facts on the ground speak for themselves, which strongly suggests that the Eurozone now faces not only a strong disinflation process but the advent of outright deflation (as defined by a sustained period of price declines in the core HICP index, see here and again here) we are still wallowing around in hypothetical discussions with no one actually prepared to strongly push for a very rapid biting of the most badly needed bullet. Furthermore, a new problem now presents itself, since the wreckage which is rapidly piling up in Eastern Europe risks destabilizing the whole system through the deep financial linkages which exist between the banking system in the Eastern countries and those very Western banks which have already been beaten to pulp by equity losses and debt defaults in one corner of the globe after another.

Indeed, some of us would claim that once the wheels of the present train crash were set in motion a year or so ago it was not particularly difficult to see that the lions share of the problem would end up in Southern and Eastern Europe, and in this fashion would arrive beating and hammering at the doors of the ECB in the form of both a severe Eurozone recession and a near-systemic collapse in the economies of Eastern Europe. If there was a danger of a repeat of the 1990s Asian style contagion anywhere it was always going to be in Emerging Europe, as the Bank for International Settlements and those much maligned ratings agencies never ceased to point out.

However, if we come to look at the responses to date from the ECB, we find that these have in no way been either as drastic or as urgent as those initiated by counterparts like the Bank of Japan and the US Federal Reserve (or even, come to that, by the Bank of England and the Swedish Riksbank). In fact, far from reacting rapidly and vigorously, ECB council members have repeatedly voiced concerns about the dangers of letting interest rates drop too low too quickly, and even warned of the dangers of reproducing yet more bubbles. This "conjuring of demons" seems to us to be soo terribly Japan in the 1990s-ish.

In fact the whole crisis reponse and reaction process seems to have revealed more a feeling of confusion and disarray, than one of order and "everything under control". Back in December 2008, the councils self-proclaimed hawk, Axel Weber, was busy worrying us all with his discovery of the "horrifying fact" that lowering interest rates below 2% would have implied the application of negative real interest rates (citing the fact that inflation expectations at that point for the medium-to-short term were themselves hovering at around 2%. He seemed to be blissfully unaware that with economies like the German and Spanish ones registering annual contraction rates in the 5% region, negative interest rates might be just the recipe the doctor was ordering. Just over a month ago Greek council member George Provopoulos added his voice to the chorus, cautioning that there was only limited scope for further rate cuts (towards 1%), citing among other reasons his expectation that the Eurozone economy would begin to recover by the time we reached 2010. Specifically, he noted that while there was room for interest rates to go lower if the economy and inflation expectations were to deteriorate further, this would in no case imply a move towards 0%.

This view was reiterated some weeks later by Luxembourg's representative on the Council, Yves Mersch, when he stated that he was completely opposed to the idea of the ECB adopting a Japanese (or US) type policy of ZIRP (zero interest rates). The reasons normally cited for such continued caution were what one might call the "usual suspects" - namely that while inflation was expected to reach very low levels due to the drop in energy prices it would subsequently rebound in late 2009 (due to the so-called base effects), or that the economic outlook in the Eurozone was fundamentally different that in Japan and the US where the respective central banks had gone much further in the direction of aggressive monetary policy.

Most ECB watchers view the continuing cautious stance over on Kaiserstrasse with a growing sense of unease and bewilderment. In light of the daily slew of incoming bad news it has seemed pretty odd (to say the least) for the ECB to maintain its focus on measures which were clearly lagging the pace of economic development rather than trying to get out in front of the problem and head it off. In fairness, it does now seem that some members at least of the Governing Council may belatedly be moving closer to a recognition of the full scale of what we are up against. Recently, council member Guy Quaden pointed out that it was perfectly possible for the ECB to lower rates well beyond 2% and that, in his view, there were no taboos whatsoever. Such statements certainly constitute a starting point, but still perpetually create the feeling of "too little too late", and in fact have done little to persuade financial markets that the ECB is actually in control of the situation.

This problem was further highlighted at the February meeting when rates were kept on hold and where Trichet, in his usual charming manner, simply noted that ZIRP (and thus QE) had several inappropriate drawbacks, although he did not see fit (at that point) to go further, and elaborate on what he thought these were. The markets responded as might have been expected to such obfuscation, and the yield on two year German bunds was pushed to its lowest level since 1997. Symptomatic of the then prevailing "zeitgeist" was the statement of Austrian council member Ewald Nowotny to the FT that the ECB would not move into ZIRP as this would imply negative real interest rates, apparently not understanding that this may well be precisely what we needed given the strength of the contraction.

As BNP Paribas's senior economist in London, Ken Wattret, said at the time:

“We’re desperately spinning around to get a proper handle on the issue,” (...) “The worst-case scenario is that the ECB is hoping they don’t need to do things like this because the economy will pick up again. If that’s plan A, then that’s rather disturbing.”

Part of the problem here, of course and as ever, is that there is far from unanimity on the ECB Governing Council. With t