• Households. The US personal savings rate has literally skyrocketed to 5% in recent months. One year ago, it was near zero. The culprits are the despondent labor market, but primarily the gigantic losses of wealth. They are now equivalent to 1½ times annual income. That will drive the savings rate still higher (cf. chart), imparting a continuing drag on consumption (pages 3-5).

  • Companies. Corporate results are also coming under increasing pressure. The earnings erosion in the first year of the recession was the strongest in the last 50 years. Corporations were reacting exceptionally quickly to the crisis by cutting personnel, capping costs and slashing their capital expenditures (pages 6-8).

  • Government. The fiscal and monetary policy makers are attempting to counteract the households' new-found thriftiness. But even though the Fed’s announcement this week that it will pump trillions more into markets improved sentiment, the recession will only end in the course of the second half of the year. And the subsequent recovery is expected to be only very modest because of lingering financial pressures.

  • Outlook. But that is not all! Since we do not expect the savings rate to return quickly to the levels of recent years (not least because the wealth losses hit retirement accounts particularly hard, which are heavily weighted towards equities), the consumption and, therefore, overall GDP growth may also be held back over the medium term.

  • Further topics:

    – Weekly Comment: Pump it louder (page 2).

    – Germany: Cold winter exacerbates recession (page 9).

    – Data outlook: Business climate indices in the eurozone to stabilize; US consumption expenditures to fall further (page 11).

    – Market outlook: Fed buyback program boosts bond markets; the EUR is back in favor (page 20).


Pump it louder

This week, the Fed delivered a major electroshock to markets, announcing that it will buy up to USD 300 bn in longerterm Treasury securities over the next six months. Moreover, the Fed will more than double its planned purchases of mortgage- backed securities, to a total of up to USD 1.25 bn, and will consider expanding the TALF to include existing impaired assets. The impact was immediate, with 10Y UST yields dropping by about 45 bp, leading to a nearly 30 bp flattening of the 2Y-10Y segment of the curve, and the USD plunging, with the sharpest one-shot move in EUR-USD in a very long time, to over 1.34 from 1.31 (cf. chart). The Fed has now really stepped in with all guns blazing, showing its unequivocal determination to do all it takes to stabilize the economy and the financial sector, and fend off risks of deflation. I expect this to have a powerful impact on market sentiment, bolstering hopes that policy efforts will help the economy find a bottom in the coming months, setting the stage for a recovery by year-end. This should help equities extend their positive performance and support some further recovery in risk appetite – which in turn could take us one step closer to normalization – admittedly on a still very long road.

EUR - USD

After a major press release offensive that included an unprecedented TV interview by the Fed’s Chairman, the FOMC dropped three bombshells on a market that was poised for a relatively uneventful press release. Both the Fed and the Administration have been intensely engaged in a coordinated effort to boost confidence on both Wall Street and Main Street. But they knew very well that upbeat talk alone would not do the trick unless it was backed up by a significant stepping up of the policy effort, which the Fed has quickly delivered.

The FOMC has quickly overcome its internal divisions on whether or not to purchase government bonds. The need to engineer a decline in the cost of credit, notably in the mortgage market, has tilted the balance: the press release noted that direct purchases of USTs are meant “… to help improve conditions in private credit markets”. Longer-term bond yields had moved up significantly since the December lows, pushing up the cost of mortgage financing and thereby potentially undermining efforts to stabilize the housing market. The Fed therefore decided it was time to step in to counterbalance concerns raised by the massive increase in the government’s borrowing requirement. The Fed was probably also encouraged by the strong impact of a similar announcement by the Bank of England last week, which quickly lobbed 70 bp off Gilt yields.

The massive USD 750 bn increase in planned purchases of MBS is also a powerful reminder that the Fed means business, and is determined to expand its balance sheet to the extent necessary to allow the economy to stabilize and gradually recover. The possible extension in the scope of the TALF is also potentially explosive. The Term Asset-Backed Securities Loan Facility has been designed to provide up to USD 1 tn in loans to private investors to finance purchases of securities backed by newly originated car loans, student loans and mortgages. Extending it to finance purchases of existing illiquid securities could give a crucial boost to the Administration’s efforts to gradually get toxic assets off banks’ balance sheets. It could therefore provide a powerful complement to the public-private investment funds which the Treasury is preparing to launch.

Fed Chairman Bernanke is literally putting his money (in the form of the Fed’s balance sheet) where his mouth was seven years ago, when he argued forcefully that the Fed could prevent deflation by unorthodox monetary policy measures. Moreover, going in with all guns blazing, the Fed is also buying precious time for a Treasury that has proved slower off the mark than the markets had hoped for. The Fed’s move puts further pressure on the ECB, but I think it is very unlikely that next week the ECB will follow the Fed and BoE in deploying traditional quantitative easing measures. The most likely scenario for next week is still one last 50 bp cut in the refi rate, driving market rates effectively to zero, and buying more time to figure out how to implement Quantitative Easing in the more complex eurozone setup. But the Fed’s move this week reinforces the sense that the dramatic worsening of the macro outlook, reflected also by the latest ECB’s forecasts, requires an important further policy effort.