Highlights

  • EU government heads back Greece

  • French GDP increase rescues eurozone growth, Germany stagnates in Q4

  • Fed chairman Bernanke explains exit strategy

  • PBoC raises reserve ratio again


EU backing for Greece

Greece and its debt problems continued to have a major impact on market developments. At the beginning of the week, it was announced that an informal meeting of EU heads of state or government would be held on Thursday in Brussels; moreover, there were rumours that the EU would put together a rescue package for Greece. But the news that ECB president Jean-Claude Trichet was cutting short his visit to Sydney to attend the meeting in Brussels really unsettled market participants. In view of the possible rescue measures the EU might take, yield spreads between 10-year Greek government bonds and benchmark Bunds, which had risen to almost 400 basis points at times, began to narrow again, and are currently at around 270 basis points.

As the tension eased somewhat, the euro strengthened to about 1.38 against the dollar. On Thursday afternoon, however, after the EU summit had ended, the euro started to tumble again.

Some market players attributed the euro’s renewed weakness to the “disappointing” outcome of the summit. And indeed, the statement issued by the government leaders was vague to say the least, announcing that the eurozone member states would take “determined and coordinated action if needed to safeguard stability of the eurozone”. Greece, however, had not as yet asked for financial assistance.

At first glance, it looks as though not much has emerged from the summit, but this is a misconception The crucial point is that the EU council has assumed official responsibility. If the worst comes to the worst, the EU, i.e. the eurozone member states, has promised to help Greece. It is up to the finance ministers, who are meeting next Monday and Tuesday, to propose, and if necessary introduce, concrete measures.

But the euro’s slide to below 1.36 against the dollar on Thursday and Friday was probably due more to other factors. US equity markets have continued their recovery; furthermore, after three bad weeks, initial jobless claims have dropped to 440,000. Conversely, eurozone Q4 GDP figures, which have just been released, show a significant slowdown in growth. Growth in the eurozone as a whole was a mere 0.1% compared to the previous quarter. France was the only country to post solid growth of 0.6%; Germany’s economy stagnated, and Spain and Italy actually reported declines of 0.1 and 0.2% respectively.


Bernanke explains exit strategy

Fed chief Ben Bernanke testimony before the House Financial Services Committee was postponed because of a snowstorm, but the prepared statement was published anyway. In it, Mr Bernanke outlines the Fed’s plans to revert to a normal monetary policy stance. He indicates that the Fed is not intending to reduce the central bank’s balance sheet substantially for the time being (to do so, it would have to sell assets), and that liquidity is to be removed from the financial system by means of term deposits and reverse repo operations. The Fed is currently in the process of expanding the counterparties for reverse repo operations beyond primary dealers – to include money market funds, for example. The new term deposit facility should be available some time in the spring.

Provided that monetary policy tightening did not become more urgent, the Fed would test its liquidity draining mechanisms on a small scale initially; as a second step, the transaction volumes would be significantly increased. Raising interest rates would then be the third step. The interest rate on reserves (which now stands at 0.25%) would play a pivotal role as a monetary policy instrument.

Mr Bernanke is trying to make it clear that there are no imminent plans to tighten monetary policy. He therefore deliberately reiterates that “keeping the fed funds rate at an exceptionally low level for an extended period is warranted”. However, the Fed is not just making hypothetical plans, but pursuing a concrete goal. If, as we assume, growth in the coming months were to remain more or less robust, the US money market could start tightening around the middle of the year.


China raises reserve ratio again

The Chinese central bank, the People’s Bank of China, has raised the deposit reserve ratio by a further 50 basis points to 16.5% for large banks and 14.5% for smaller ones. China’s increased efforts to curb credit expansion are fuelling speculation that the government could allow the yuan to appreciate. In our view, however, the chances of this happening are rather slim: although exports have recovered somewhat, the export industry is probably still working below capacity. From China’s point of view, an appreciation of the yuan would slow down the less dynamic part of the economy.

One final point: according to rumours, the SNB intervened in the currency market again on Friday morning. Prior to that, EUR-CHF had fallen below 1.4650. As long as the SNB continues to intervene, there is little chance of the franc rising.