A Tale of Two Cities

It was the best of times (if you're long credit), it was the worst of times (if you're long vol), it was the age of wisdom (according to the academics), it was the age of foolishness (as described in future history books), it was the epoch of belief (that ZIRP and forward guidance can impact Main Street), it was the epoch of incredulity (that anyone could be so naive), it was the season of Light (in the UK), it was the season of Darkness (in the Ukraine), it was the spring of hope (that the US growth rate will magically ascend to a 3% glide path), it was the winter of despair (that the ECB will ever get ahead of the curve), we had everything before us (lots of good ideas!), we had nothing before us (whoops, just got stopped!), we were all going direct to Heaven (or more accurately, Nirvana once Abenomics kicks in again), we were all going direct the other way (err.....I think we've just arrived)- in short, the period was so far like the present period, that some of its noisiest authorities insisted on being received, for good or evil, in the superlative degree of analysis only.

This week really is a tale of two cities, Washington and Frankfurt, and the central banking institutions that inhabit them.   Yesterday was about the Fed, where Ms. Yellen unsurprisingly called for a "high degree of monetary accommodation" amongst by-now boilerplate moans regarding inflation and the labour market, along with a newly-minted concern about housing.  We can now evidently add the latter to the list of items from which the Fed can cherry-pick reasons to maintain ZIRP.

At the risk of sounding monomaniacal, Macro Man cannot resist one last zinger at the expense of the Fed.  While the state of the labour market is clearly not ideal, the belief that the current unemployment rate is unusual or 'elevated' has little basis in fact.  The chart below shows the spot unemployment rate, along with moving averages for 10, 20, 30, 40, 50, and 60 year periods.   While the first of those MA's is clearly impacted by the GFC, the remainder capture a sample that is primarily populated by "normal" periods.  What do we see?  That the current unemployment rate is pretty darned close to these long term averages.   How, exactly, does that constitute an "elevated" level?

Otherwise, Ms. Yellen confirmed that reverse repos will be part of the exit strategy, as expected.   Until we know exactly how they'll be used (the same level as IOER?  Lower, forming a corridor?) and the allotment procedures (though presumably this will be full allotment), it is difficult to say too much with any degree of confidence.   Suffice to say, however, that some banks' calls for lower LIBOR and tighter LIBOR spreads to be bemusing, as it would seem to Macro Man that future times of even moderate stress should see money market funds exact a higher risk premium for bank CP, assuming that they will have access to the RRP facility (which seems very likely indeed.)   

In Frankfurt, meanwhile, the ECB meets again today.  The big talk of a few weeks ago has largely petered out, and with it the expectation that they will do anything.   Indeed, of the 58 forecasts supplied to Bloomberg, a grand total of 2 forecast a refi of something other than 0.25%.

And hey!  Why should they do anything?  CPI ripped higher to 0.7% and Germany is changing its national anthem to Deutschland: Arbeit Für Alle.  Italy and Spain can borrow at 3% over ten years and roughly the same rate as the US over five; happy days are here again.  Sure, there's a little of anemic credit growth to the private sector, and the once vaunted third pillar of M3 is showing paltry (and decelerating) growth of just 1.1%.  But hell- if you want a good M3, go to a Beemer dealership, not the ECB.

Of course, the euro isn't helping things, and they did have a go at a full-throated whinge a few weeks ago.   However, both the ECB forecast roster and the FX market would suggest that it has fallen on deaf ears.    EUR/USD is now knocking on the door of 1.40, and a quick update of the model posted a few weeks ago suggests that it ain't exactly out of place there, either.

So what are we to make of this?   Yellen can't stop moaning, and the dollar's getting trashed.  The ECB moans a bit but under-delivers, and the EUR TWI is close to post-crisis highs.  Meanwhile, consensus forecasts (normally served, it is true, with a generous helping of salt) call for US growth to outstrip the Eurozone by 1.5%-2% over the next five quarters.  If only the US and Europe could trade central bankers, this tale of two cities might have a happy ending...

Admin note:  Macro Man will be doing a live Q&A session on the Reuters Global Markets Forum Friday morning at 8 am EDT (13.00 BST.)   Any interested readers are of course welcome to join and put him on the spot.  You can sign up for the GMF here.