In the London Telegraph, it was reported that French President Hollande visited Greece in an effort to show solidarity with the Greek people in pledging to support growth over austerity. The French leader told the Greeks that the French would “help with privatizations, tourism and a public sector overhaul.” Hollande also urged French investment into devastated Greek businesses. In direct opposition to October’s visit by German Chancellor Merkel, the French President proclaimed, “The Greek people have has as much as they can take.” While I would not disagree about the Greek citizenry being pushed to the limit through austerity budgets and tax increases, be assured that Hollande’s public show of support is all about trying to gain as much support as possible in his coming battle with the Germans.
The French were hoping for a great show of support from the G-20 or at least from the G-7 in pursuing a growth over austerity agenda. Today the French announced that they would not meet the 2013 growth targets and thus will get nowhere near meeting the proposed budget deficit targets. Chancellor Merkel has been on the offensive within Europe touting the success of its Hartz IV program in helping make the German economy and labor force the most competitive in the EU. As a Socialist, President Hollande has a much more difficult task in reining in French workers and the present work rules that hamper French industry.
The French would rather see the EU enter the global battle of demand creation through monetary stimulus. In fairness to President Hollande, Chancellor Merkel is disingenuous when she exemplifies the East German reconstruction as a model for others in Europe to follow. The “success” of the East German economic renaissance was predicated on massive amounts of wealth transfers from the West to the East. The French, Spanish and Italians would like nothing better than for the successful Bavarian Burghers to initiate a massive program of unconditional transfers to support their economies.
Frau Merkel has to be careful as she rewrites history to support her election chances in September. This weekend’s election in Italy may provide another opportunity for the Mr. Hollande to attain the needed allies to counter the hard money forces of Frankfurt. If the Center-Left prevails in the election, another voice for growth over austerity will bring aid and comfort to the French side. While the Germans demand reform and restructuring, the debt-plagued French and the other peripheries would like monetary accommodation. If the Japanese and Americans can jumpstart their economies and growth improves in the emerging markets then Europe may be able to muddle through their current predicament. That’s a big IF.
*** In Tuesday’s Financial Times, Robin Harding and Tom Braithwaite wrote an article: “Fears at Fed of Rate Payouts to Banks.” The reporters raise the issue of what happens when the FED moves to raise overnight rates and increases the rate the Fed pays on excess reserves held by banks at the Fed. If the Fed raised rates to 2%, the size of the Fed’s balance sheet MAY mean that the FED could pay out between $50-$75 billion in interest on bank reserves to commercial banks. The article cites this issue being a concern voiced by St. Louis Fed President James Bullard. Money that is now transferred as profits on the Fed’s Treasury holdings to the U.S. Treasury would be paid over to the commercial banks as the Fed incurred huge interest costs and thus deprive the U.S. Government of a present revenue stream … illusionary as it is.
The Fed’s preconceived exit strategy from QE is to raise interest rates before it begins offloading its huge Treasury portfolio. President Bullard suggests maybe lightening the balance sheet before raising rates. Yes, there will be losses on the present Treasury holdings but the cost of interest on reserves will not result in a double hit. This is an interesting dilemma but if the Fed were to sell off assets before raising rates the outcome OUGHT TO BE A STEEPENING IN THE U.S.YIELD CURVE. This would provide a great trading opportunity to be long the twos and short further out.
A large move in the steepener would also aid the banks in their profits as they surf the curve, thus propping up bank profits to offset any negative impact from future tightening. This is definitely an issue to keep on out radar screens. It is going to be a problem for Bernanke and company further down the road. It seems that James Bullard has just given us some notice about FED thinking on this subject. The U.S. 2/10 curve today closed at 173 basis points. The high for the last 52 weeks has been 199.6 while the low was made on July 24 at 117.2 basis points. This range is now very important.