Operation Twist and its Effects

Effectively what the Fed did today was nothing more than a punch in the face of their constituents (the banks) as banks make money by lending long term and paying for that money on the short term. Hence, why they say that a steep yield curve turns idiots into banking geniuses. The steeper the yield curve, the more money banks make on their loans, and the faster they repair their troubled balance sheets.

Helicopter Ben announced a measure whose intent is to lower long term rates.
What he fails to understand is that he is tackling the wrong issue (doesn’t he read the papers?), the impact of lower long term rates on the economy is marginal. What we need is to restructure the balance sheets of consumers and of governments. What they achieved with operation twist is that the banks will be even less likely to lend money to the real economy or that they will demand higher spreads in order to make the same profit margin that they used to make when the curve was steeper.

None of which is good for the economy.

The author is Pedro Noronha, Fund Manager at Noster Capital.

How China Manages its Yuan

To keep the yuan largely stable, the People's Bank of China buys foreign exchange inflows generated by China's trade surplus and foreign investment from commercial banks, resulting in an injection of yuan into the banking system.

The central bank then soaks up excess yuan in the system via open-market operations and higher bank reserve requirements to prevent the money from flowing into the economy and fuelling inflation.

But as long as foreign funds keep flowing into China, the central bank's efforts to soak up liquidity are not entirely effective because the surfeit of yuan in the banking system often leads banks to increase lending.

Should Greece Default and leave the Euro Zone?

Greece should begin an "orderly" default and voluntarily leave the euro in order to escape a "vicious cycle of insolvency, low competitiveness and ever-deepening depression," economist Nouriel Roubini said in a guest column published Monday in the Financial Times.

Other options, such as a sharp weakening of the euro, a rapid reduction in Greece's unit labor costs or a rapid deflation in prices and wages appear unlikely or impractical, said Roubini, a New York University professor and chairman of Roubini Global Economics.

While the process would be traumatic, a return to the drachma and a sharp depreciation in its value "would quickly restore competitiveness and growth, as it did in Argentina and many other emerging markets which abandoned their currency pegs," he said.

Leaving the eurozone would make it easier for the most distressed countries to regain competitiveness. But, if they are willing to make the necessary sacrifices, they could also remain: the EFSF would protect their domestic bank deposits, and the IMF would help to recapitalize their banking systems, which would help these countries escape from their current trap. Either way, it is not in the European Union’s interest to allow these countries to collapse and drag down the entire global banking system with them.

Preparing for the possible default or defection of three small countries from the euro does not mean that those countries would necessarily be abandoned. On the contrary, the possibility of an orderly default – financed by the other eurozone countries and the International Monetary Fund – would offer Greece and Portugal policy choices.

Moreover, it would end the vicious cycle – now threatening all of the eurozone’s deficit countries – whereby austerity weakens their growth prospects, leading investors to demand prohibitively high interest rates and thus forcing their governments to cut spending further.

Euro To Test 1.3410 Today?

The expected rally was shallower than expected. It shows the Euro is rather bearish at the moment. It hints to me that Euro will break the previous low before this counter trend rally by a more significant amount that expected.

Euro should revisit the low at 1.34985 and is likely to move lower to 1.3410, most likely today. Watch out for the drop.

Greece's membership of the euro is hanging by a thread.

While this situation seems to have finally dawned on the country's political elite this week, for most Greeks there is little real understanding of the scale of what is going on around them.

The taxi drivers are striking again over government plans to deregulate their industry, and on Saturday we can expect large scale demonstrations as Prime Minister George Papandreou delivers a speech on the economy in Thessaloniki.

Time may have already run out.

The economic situation is now incredibly grim with the latest figures indicating that this country slipped even deeper into recession during the second quarter (- 7.3 percent y/y).

There is now very little chance that any of the main conditions for international aid will be met. Germany's Finance Minister Wolfgang Schaeuble has said that unless the targets are hit there will be no more money. His word's should not be taken lightly.

No more money means a hard restructuring for Greece and a massive recapitalization of Europe's banks. I suspect that Berlin is not prepared to pull the trigger just yet but it is clear the mood in the Merkel camp has changed.

For the time being though some kind of a fudge will be found to keep the aid coming.

The Troika inspectors will return to next week and some how Athens will conjure up more unachievable cuts to keep them happy.

The inspectors may even take solace in the latest report from the OECD which indicates that Greece can avoid disaster "But [that this] this requires impeccable implementation [of reforms] from the Greek government".

So far the Greeks' implementation has been anything but impeccable. The end will probably come towards the end of the year.

When the Troika return to assess the feasibility of giving Greece its seventh tranche of aid it will be clear to everybody that the situation is out of control. In the meantime there will be a great deal of talk from desperate politicians about a lurch towards greater fiscal integration.

The idea of a eurobond riding to the region's rescue though is misplaced.

The German constitutional court on Wednesday made it very clear that any assumption of liability by Berlin must only come with greater control over other country's economic sovereignty.

This will not be acceptable to the Greek people or even the Italians.

The euro bond debate also misses the point that the initial problem with the euro lay not in its rules but with its membership.

It would have been possible to move towards fiscal integration if the likes of Greece had not been admitted in the first place.

© 2011 CNBC.com

Gold brewing bubbles or backed by fundamentals

The case thus far: Gold futures hitting the $1,800 level is of no surprise. First and foremost, the US credit rating downgrade to AA+ by Standard and Poor’s had somewhat eroded USTs as a safe haven, and gold have been increasingly demanded as a viable substitute asset to hedge against uncertainties. Secondly, renewed Eurozone fears stemming from France’s banking exposure to Greek debts and rumors of a credit rating downgrade also intensified risk aversion in the markets, driving up demand for safe havens. Lastly, Korea’s purchase of 25 metric tons of gold for diversification had signalled central bank’s continuing interest in the bullion as protection against declining paper currencies and economic uncertainties.

Key events to watch out for would be the Fed’s decision on QE3 (or anything similar to it), as well the ongoing developments on the Eurozone debt crisis. A resolution to the Eurozone debt crisis could stall the short-term gold rally, but the medium-term uptrend for gold prices remains structurally intact in our view. On the other hand, the any QE3 should prove supportive of inflation expectations, stymie the USD and in turn allow further upside in gold prices.

From OCBC Treasury Research

FOMC spelt out clearly to keep ultra loose interest rate policy through mid-2013

The US Federal Open Market Committee (FOMC) held its scheduled meeting on 9 August and explicitly spelt out that the Fed will keep the Federal Funds Target Rate (FFTR) at 0-0.25% and “economic conditions … are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013” (instead of the usual phrase “for an extended period”). The other significant takeaway from the FOMC statement was that the economic outlook was significantly weaker than expected as “indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up. Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed.” Note that this policy decision was not a unanimous one, there were three dissenting votes (while 7 voted yes, passing the statement comfortably), something that is quite rare. The last time there were three voters that dissented was nearly 18 years ago.

Implications if US were to lose it AAA rating

In time of crisis, the US dollar will tend to rise due to its safe haven status. Many investors/funds will tend to park their money in US Treasury earning a higher returns than money market deposit.

U.S. Treasury bonds could soon lose the privilege of being the only debt securities in the world whose value actually rises on the threat of a ratings downgrade.

That is because for the first time, the United States' top-notch debt rating is in jeopardy.

U.S. Congressional leaders are refusing to lift the country's debt ceiling , preventing the Treasury from raising money it has already spent.

The political deadlock is threatening the United States' prized AAA credit grade, which major rating agencies have warned could face near-term cuts.

Even billionaire Pete Peterson, co-founder of private equity giant Blackstone, appeared to be getting worried. He has spent many years and a lot of money pushing for cuts in government spending to cut U.S. debt levels.

"The dangerous irony is that a refusal to compromise on a deal to reduce the nation's debt now will only serve to increase our debt," Peterson said in a statement.

Ironically, Peterson's often flashy anti-debt campaigns are partly to blame for the impasse, since Republican leaders have the backing of a majority of Americans on the issue, according to recent polls.

Economists say many individuals oppose the debt ceiling because they think that would mean giving a green light to additional government spending — rather than simply making good on past promises, as is actually the case.

A downgrade of U.S. government debt would have unpredictable and highly disruptive consequences in financial markets and the broader economy.

Treasuries have long been used as a global safe-haven for investors shunning risky assets. They serve as a benchmark for market interest rates and investment portfolios.

Federal Reserve Chairman Ben Bernanke argued this week that failure to raise the statutory limit would have "calamitous" results, including a long-term loss of confidence in the United States and possibly a new financial crisis.

Italy Is Different?

Escalation. The shock waves emanating from the global debt crisis continue to spread. While the US is facing the threat of the loss of its AAA rating because of the deadlocked debt ceiling negotiations, the crisis in Europe has definitely reached a new level.

Italy. As if the political impasse on a second Greece bailout and the junk status of Irish bonds were not bad enough, the crisis has now spilled over to a core EMU country – Italy. Yields and insurance premiums of Italian government bonds rose strongly.

Joint liability. However, this appears to be the result of primarily a loss of market confidence in the ability of European and Italian policymakers to resolve the problems rather than a dramatic deterioration of credit fundamentals. They are very different from those of the problem countries.

Facts. Italy may have a high public debt level, but the structure and dynamic of its debt are much better compared to peripheral countries. And the austerity package is likely to be approved by parliament this evening, providing for a balanced budget as early as 2014. Over the medium term, this should bring down the country’s gearing (chart) – even if part of the recent risk premium remains.



Chances. Italy’s Achilles heel continues to be its low growth potential. Any substantial increase would require far-reaching structural reforms. Then, Italy could shoulder even higher risk premiums. If the government makes (further) progress in terms of consolidation and structural policy, the debt problems will, therefore, remain manageable (pages 2-5).

Italy: Europe's Fannie Mae moment?

Italy, while technically part of the euro zone monolith, is by itself the world'sseventh-largest economy. A debt and banking crisis there would be infinitely more problematic for the rest of the world than a combined collapse of Greece, Portugal and Ireland.

If nothing else, troubles in Italy would confirm the worst-case scenario that many have been predicting since the Greek debt crisis first begin to unfold more than a year ago: namely that Greece would be just the first euro domino to fall.

"The danger is that the problems are gathering momentum," said Frances Hudson, global thematic strategist with Standard Life Investments in Edinburgh, Scotland. "Italy's economic challenges are real because they are very indebted."

Making matters worse is the fact that the market seems to have lost all confidence in the European Central Bank's abilities to get the crisis solved in a timely fashion. That is reminding some of the heady days before Lehman Brothers went bankrupt less than three years ago.

"It's astonishing how Italian bank stocks were crushed. That's worrisome because banks are the best indicator of how a crisis is developing -- just like it was in 2008," said Andrew Busch, global currency & public policy strategist with BMO Capital Markets in Chicago.

In fact, Italian bank stocks plunged so dramatically that Italian regulators even took the bold step over the weekend to institute a partial ban on certain types of short selling in order to keep stocks from falling further.

That's not good. When regulators decide that the problem is not the underlying fundamentals but the big bad speculators and hedge funds, the battle is already lost.
That's also a lesson from 2008. The Securities and Exchange Commission waged war against so-called naked short selling and even temporarily banned short selling of several big financial stocks in September 2008 ... to little avail.

"If the global financial community has no faith in what you are doing, you can use as many Band-Aids as you want to try and slow down the speculators. But in the end, it's not going to work," Dietrich said.