World Markets Simplified

While there is speculation whether today's historic announcement by the Fed in which it dated the beginning of the end of ZIRP, and in reality just the beginning of the beginning, is some form of shadow QE3, what is certain is that there is no Large Scale Asset Purchasing component to it yet. As such while the market immediately discounted the impact of 2 years of duration risk elimination (roughly 70 ES point equivalent), this has now been priced in, and the market must now look to mechanisms by which the it will have to absorb ~ $2.0 trillion in debt issuance over the next year without Fed help (and to those sticking to some modified version of MMT, keep in mind there is only $1.6 trillion in excess reserves so even a full recycling thereof would be insufficient to match demand of funds). Enter Goldman Sachs which puts the argument to bed: "We now see a greater-than-even chance that the FOMC will resume quantitative easing later this year or in early 2012." Why? Because what was lost in the noise today is that the US economy is contracting and the unemployment rate is rising: i.e., we are reentering a recession. And what the Fed did today is absolutely powerless to change this even from the Fed's point of view. Quote Hatzius: "This would probably mean more QE if their forecast converged to our own modal view of a flat-to-higher unemployment rate through the end of 2012, let alone our downside risk case of a renewed recession." But what about the historic dissent? Ah, therein lies the rub: "We view Chairman Bernanke's willingness to live with the dissents as a strong signal that he and the rest of the Fed leadership view the need for renewed easing as more important than the institutional norm of consensus decisionmaking." So there you go. The market will wake up tomorrow with a hangover, and say the one word it always does: "More." Absent that, the slide will, as predicted, resume, and it is none other than Goldman Sachs who has once again, just like back in 2010, set the strawman up for the Fed doing simply more of the same which does nothing to actually fix the economy, but bring us all closer to that epic meltdown discussed by Andy Lees earlier, and by Zero Hedge over the past two and a half years.

From Jan Hatzius: QE3 Now Our Base Case

Summary

We now see a greater-than-even chance that the FOMC will resume quantitative easing later this year or in early 2012. We have changed our call because today's statement suggests that the committee's reaction function to incoming economic news is more dovish than we had previously thought. Although Fed officials still expect a gradual decline in the unemployment rate, they made a conditional commitment to keep the funds rate unchanged "at least through mid-2013″ and implied that they would employ additional policy tools in case their economic forecast deteriorated further. This would probably mean more QE if their forecast converged to our own modal view of a flat-to-higher unemployment rate through the end of 2012, let alone our downside risk case of a renewed recession.

Full note:

It's official: the federal funds rate is highly likely to stay at its current near-0% level until 2013 (or later). Although this has been our forecast all along, today's FOMC statement was nevertheless more dovish than we had anticipated in two respects:

1. The policy commitment to keep the funds rate at "…exceptionally low levels…at least through mid-2013″ was more aggressive than we had anticipated. Some commentators today expressed disappointment that this is still a conditional commitment, i.e., Fed officials kept an "out" if growth is much stronger and/or inflation much higher than expected. But that was not a surprise. The surprise was the fact that there is a date at all (for the first time ever in the history of Fed communications) and even more so the fact that the date is almost two years in the future.

2. The easing bias in the last paragraph of the statement was more explicit than we had anticipated: "The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate." The phrasing somewhat echoed the promise in the September 2010 statement "…to provide additional accommodation if needed…", which sealed the deal for QE2. In our view, the committee's explicit easing bias suggests that the threshold for additional easing in terms of downward revisions to the committee's forecast is relatively low.

The implication is that the committee would probably ease policy further if its economic forecast converged to our own, more downbeat view. While the committee still expects a gradual decline in the unemployment rate, our own modal forecast is a flat-to-higher rate through the end of 2012. In addition, we see a recession risk of about one in three, and if there was indeed a recession the committee would of course ease further.

If there is additional easing, it would likely take the form of QE. After all, "these tools" mentioned in the statement presumably need to be more powerful–or at least not much less powerful–than the action taken today in order to avoid a sense of anti-climax. This means that they are unlikely to consist of small incremental steps such as a commitment to keep the balance sheet large, a gradual shift of the securities portfolio into longer maturities, or a cut in the interest rate on excess reserves from 25 basis points (bp) to zero. This leaves the stronger options, which include QE as well as even more aggressive forms of easing such as rate caps (a form of QE in which the Fed promises to buy as many securities as needed to hit a longer-term yield target), a price level or nominal GDP target, or interventions in non-government securities markets (for which funding from Congress would be needed). Of these, "conventional" QE is very likely the option with the lowest hurdle, and the first one to be deployed.

Although QE3 is now our base case, it is not a certainty. We see three main ways in which our revised call could turn out to be incorrect. First, of course, the economy may turn out to be stronger than our forecast. In this case, Fed officials would not need to revise down their forecast, and would probably not ease further.

Second, inflation might pose a higher hurdle to additional easing than we have allowed. There are only tentative signs of deceleration in core inflation, and inflation expectations show few signs of breaking lower despite the recent weakness in the economic data and risk asset prices. This is a risk to our view, although the stickiness of inflation expectations might already reflect an assumption by the market that the Fed will ease, in which case inflation expectations would fall sharply if the Fed failed to deliver.

Third, the anti-Fed backlash late last year might argue against further QE. That is possible, but the problem might be reduced via a slight tweak in the policy's design. That is, Fed officials might choose to specify the policy not as a large-and-scary upfront number but a smaller monthly flow of purchases. Although the substantive differences are small–e.g. a $600bn purchase over eight months is basically the same as a $75bn-per-month purchase that is expected to last eight months–the cosmetics of the flow approach might be more appealing. Moreover, it would also be more flexible because the committee would revisit the program from meeting to meeting.

While these points could pose problems for our call, we disagree strongly with one argument against further QE that we heard frequently today–namely that the three dissents from Presidents Fisher, Kocherlakota, and Plosser indicate "the end of the line" for further Fed easing and difficulty for the chairman to get his way. On the contrary, we view Chairman Bernanke's willingness to live with the dissents as a strong signal that he and the rest of the Fed leadership view the need for renewed easing as more important than the institutional norm of consensus decisionmaking. There is no question that Bernanke will always have enough votes, and we fully expect him to use these votes to provide further support to the economy if he views it as necessary.

Who holds US Treasury? 

Ratings agency Standard & Poor's today cautioned that it could lower the sovereign ratings of countries like India, Japan and Malaysia, which are still to come out of the economic meltdown of 2008. 

"The implications for sovereign creditworthiness in the Asia-Pacific would likely be more negative than previously experienced and a larger number of negative rating actions would follow," S&P said in its report on Asia-Pacific Sovereigns. 

"Fiscal capacities of Japan, India, Malaysia, Taiwan and New Zealand have shrunk relative to pre-2008 level," it said, adding that these countries continue to bear the scars of the downturn. 

The governments, it said, would be required to use their own revenue streams to support their economies and financial sector once again. 

It further said that if a renewed slowdown comes, it would create a deeper and more prolonged impact. 

At the time of the global financial crisis in 2008, several countries, including India, had rolled out stimulus packages facilitating monetary expansion and lower taxes to mitigate the impact of the slowdown. 

Standard and Poor's downgraded its sovereign rating for the US government last week from AAA to AA+. In response, government bond yields fell in most Asian bond markets. Yields fell for all tenors in Indonesia and the Republic of Korea, and for most tenors in Hong Kong, China; Malaysia; the Philippines; Singapore; and Thailand, although yields rose for most tenors in the PRC and Viet Nam. Yield spreads between 2- and 10- year maturities widened in the PRC, Indonesia, the Republic of Korea and Thailand, while spreads narrowed in most other emerging East Asian markets. 

Consumer price inflation eased in Indonesia and the Philippines in July, while creeping marginally higher in Thailand. Indonesia's consumer prices increased 4.6% year-on-year (y-o-y) in July, down from a 5.5% rise in June. In the Philippines, consumer price inflation eased slightly to 5.1% y-o-y in July from 5.2% in June, based on 2006 inflation series data. Slower annual price hikes in energy costs and food and non-alcoholic beverages contributed to the downtrend. Meanwhile, Thailand's consumer price inflation rose incrementally higher to 4.08% y-o-y in June from 4.06% in May on the back of higher food and energy prices.

Total bank deposits in Hong Kong, China (LCY and FCY) fell 0.9% month-on-month (m-o-m) to HKD7.2 trillion, mainly due to the decline in Hong Kong dollar deposits, which shrank 1.6% to HKD3.62 trillion. Hong Kong, China's M2 money supply also fell 1.3% m-o-m in June. Japan's monetary base grew 15.0% y-o-y in July to reach JPY113.7 trillion.

Indonesia's economy expanded 6.5% y-o-y in 2Q11, growing at the same pace it did in 1Q11. Indonesia's exports grew 49.3% y-o-y to USD18.4 billion in June. In Malaysia, export growth rose to 8.6% y-o-y in June from 5.4% in May. Singapore's purchasing managers' index (PMI) fell to 49.3 in July, after a posting 50.4 in June, due to a slowdown in global manufacturing.

Issuance of asset-backed securities (ABS) in the Republic of Korea soared 34.1% y-o-y to KRW14.7 trillion in 1H11, led by Korea Housing Finance Corporation. Net foreign investment into LCY-denominated bonds in the Republic of Korea stood at KRW2.9 trillion in July-the highest monthly figure in the first 7 months of the year. Investments from Thailand and Singapore boosted the inflows, while the largest net outflows went to France.

The Philippines incurred a budget deficit of PHP17.2 billion in 1H11, which was much lower than the programmed amount of PHP152.1 billion, as the government limited spending while revenue collections by the Bureau of Internal Revenue (BIR) improved. The national government posted a fiscal deficit of PHP7.7 billion in the month of June.

China Resources Land issued USD250 million worth of 5-year senior notes with a coupon of 4.625%. In Hong Kong, China, the government issued 10-year Hong Kong Special Administrative Region (HKSAR) government bonds worth HKD2.5 billion and carrying a coupon of 2.46%. Indonesian wood processing firm Sarana Bina Semesta Alam issued 5-year USD10 million notes with a coupon of 6.0%. National Agricultural Cooperative Foundation in the Republic of Korea priced USD500 million of 5.5-year bonds with a coupon of 3.50%. 

After an emergency meeting Sunday, the European Central Bank said it will relaunch its government bond-buying program.

"The ECB will actively implement its Securities Markets Program. This program has been designed to help restoring a better transmission of our monetary policy decisions -- taking account of dysfunctional market segments -- and therefore to ensure price stability in the euro area," the ECB's Governing Council said in a statement.

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