We don't believe the LTRO repayment story is over

Outlook:

Today the main event on the calendar is new home sales plus the start of preparations for next week’s payrolls. New home sales are forecast by Market News up to an annual rate of 388,000 in Dec from 377,000 in Nov for the highest rate since April 2010. The US continues to make the world safe for risk. 

Yesterday the Fed disclosed that the Fed’s balance sheet is up to $3 trillion, a scary number, with no end in sight to QE. We fully expect irate opinion pieces in the weekend press. Truth to tell, we have never seen a central bank behave like this before and we have no guidelines on how to judge it—it’s just plain scary. At Davos, ECB chief Draghi said this year will be the year of implementation of structural reforms now that last year settled the funding and liquidity issues, with at least a start on breaking the toxic linkage between banks and sovereign debt. But the US has no structural reform plans. 

At some point perception of the improving US economy has to run into the brick wall of the Fed’s balance sheet. No matter what else it means, it means we don’t not have anything resembling market prices for government paper, mortgages, and presumably plenty of other assets, maybe the whole plateful. It seems likely critics will begin to agitate for the Fed standing down sometime soon. It’s probably not fair for Draghi to claim the high ground, since the ECB did plenty of its own meddling, but still, the need for the Fed to start retreating while at the same time it has even higher moral hazard than before the crisis makes the US look structurally weak. We don’t believe the LTRO repayment story is over, but for the moment, the euro looks better.

As for the currency war theme, so far it’s background noise and not the music itself. Stay tuned.