Shades of 2008, and why the US Federal Reserve is still the banker to the world — much to the chagrin and humiliation of Europe. The moves from six major central banks weren’t the “Big Bazooka” the markets have been looking for from Europe to prove to the world that the eurozone crisis can be resolved, but they were the next best thing. The most interesting move was the apparent involvement of China in the global move to try and stop credit markets freezing over and restore confidence, a sign perhaps that it is being drawn more and more to the centre of global policymaking.
The moves are not sustainable though without further and decisive action from the eurozone in the next week or so to fix the problem once and for all and end the deepening sense of crisis. All it has done is give Europe another 10 days at best of breathing room to get its act together: on past performances, don’t hold your breath.
Led by the US Federal Reserve, six major central banks moved to ease funding pressures and China made its first monetary policy easing in three years. The two announcements were issued within an hour of each other overnight, leading some analysts to wonder if this was the first example of central bank co-ordination involving China.
Thailand also cut its rates by 0.25% in an unrelated move last night and the Brazilian central bank is expected to cut its rate in the next day, as part of the co-ordinated move, according to market reports.
Our Reserve Bank cuts its key rate by 0.25% at its November meeting and opinion had been divided if a further cut would happen at next Tuesday’s board meeting. The co-ordinated nature of the moves last night has lifted the chances of another rate cut next week.
China said it would reduce the portion of deposits that banks must hold in reserve from 21.5% to 20% for big banks (and a similar cut for medium and smaller banks to 17%), the first such cut in three years, and an indication that it is now more worried about the threat to growth than the risks of inflation. There were reports yesterday on government-controlled websites of inflation falling below 5% (annual) in November and especially December, with a figure of 4.3% mentioned. Two surveys out this afternoon will confirm that Chinese manufacturing is contracting at a rate faster than thought a month ago.
The two announcements burst over markets with dramatic effect, coming after trading has well and truly closed for the day. Markets in Europe and the US were up 3% to 5%, gold oil and copper jumped sharply and the US dollar fell, but the euro and the Aussie dollar were higher. It means the Australian market, which lost more than 4.5% last month, will start December with a rush today with the futures contract up 120 points or nearly 3% this morning. Offshore BHP Billiton and Rio Tinto shares were up 7% and more than 8% respectively as investors chased resource stocks following the Chinese move to ease monetary policy. Offshore bank shares soared as well, and ours will follow this morning.
The Australian dollar, which had risen more than 3% on Monday and Tuesday to recover parity with the US dollar, only to fade in late trading on Wednesday and slip back under the $US1 level, jumped more than 2.7% in the early hours of Thursday after the central bank and Chinese moves. It was trading close to $US1.03 this morning.
The joint announcement from Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank followed a similar announcement in September, which failed to ease the growing freeze in credit markets, especially in Europe.
While the moves are seen alleviating worries over what had become an increasingly tense situation for European banks, next week’s two-day summit of eurozone leaders (December 8 and 9), now looms as the place where a once and for all deal has to be announced to convince everyone that the eurozone has control of the situation and the euro won’t collapse. The ECB is tipped to announce plans to lend as much money as the banks wants for up to three years. That will be offered as well as the special auction of 13-month money due in the next week or so that was designed to bolster bank liquidity at the end of the 2011 and 2012 years.
The swaps will provide unlimited amounts of US dollars, and other currencies, at special low rates and the ECB has cut the discount or “haircut” it demands on securities exchanged for cash to get banks to use the swap facility. “The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity,” the banks said in the joint statement.
It was reminiscent of similar moves in 2008 when dollar liquidity tightened dramatically, especially in Europe where US investors have abandoned banks, cutting credit lines and withdrawing deposits. Then, as now it was the Fed backstopping the rest of the world.
So why do it now, and not last week? Well three things seem to have happened on Tuesday that triggered the move.First, the cost of euro-US dollar swap costs hit a three-year high on Tuesday as the freeze in European credit markets intensified, as it did through 2008 and then deepened after Lehman Brothers collapsed in September of that year.
Secondly the ECB failed to complete “sterilise” the sale of money to banks on Tuesday: after it auctions short-term loans to banks, it then issues bonds to other investors to withdraw the same amount of money from the wider market to avoid “printing” money (like the US Fed, the Bank of England and Bank of Japan have been doing via “unsterilised” bond purchases). That is a sign of banks refusing to part with their cash and preferring to hold it in either short-term German bonds or in cash, even if it’s on deposit with the ECB.
Thirdly, yields on German one-year bonds turned negative (i.e. to hold them you have to pay Germany, rather than Germany pay you a yield, however small it was), which is also a sign of the credit freeze intensifying (banks refusing to part with their cash and preferring to hold it in AAA-rated paper of the highest quality, even if it costs them money. Those bonds are more liquid than cash and are of better security).
And there were rumours, from US bloggers of a French bank having trouble Tuesday night obtaining enough liquidity.
The chief problem has been shortage of US dollars in Europe (which helped bring on the freeze and GFC in 2008) as US banks and other investors have cut credit lines, coal loans and pulled deposits in something resembling a silent run on European banks, and especially those in France, Italy and Spain. But the September swap line didn’t work because the rates were too high and the collateral rules too stiff: as a result only $US2.4 billion of those unlimited lines had been used as of last week, according to ECB data.
That’s why the key central bank in this is the US Fed: it has the greenbacks to pump into global markets, as it did in 2008 (and so far there has been no matching announcement fore swap lines with Australia’s Reserve Bank, as there was in 2008). The Fed also has the experience and the confidence to be the banker of last resort to the rest of the world, even in a US President poll run up. One member of the voting board opposed the move (the conservative Jeffrey Lacker from the Richmond Federal Reserve).
It’s why for all the huff and puff from the ECB and the Bundesbank in Germany, there’s only one central bank that matters globally, but it was also interesting to see the Chinese announcement and its near coincidental timing.