Economy

BERLIN (Reuters) – German Chancellor Olaf Scholz’s three-way coalition has agreed a budget for next year, after a month of wrangling following a constitutional court ruling that upended the government’s financial plans.In plugging a 17 billion euro ($18.33 billion) funding gap, the government plans to cut spending in some areas and also to return to a limit on new net borrowing in 2024 – at least initially. Below are some reactions to the 2024 draft budget:CHAIRPERSON OF GERMANY’S COUNCIL OF ECONOMIC EXPERTS MONIKA SCHNITZER”It makes sense to keep the justification of an emergency situation open for specific spending requirements such as aid for the flood disaster in the Ahr valley and for aid to Ukraine. It is perhaps not surprising that the coalition partners could not agree to declare another emergency situation for 2024. There would certainly be reasons for this. The fear of a new constitutional review was probably too great. It is tricky if the 2024 budget can be balanced primarily by using up the last of the reserves. This means that the financing situation for 2025 will be even more problematic than for 2024.”COMMERZBANK CHIEF ECONOMIST JOERG KRAEMER”It is good that the German government is trying not to suspend the debt brake in the coming year. Otherwise, the resolutions represent a typical compromise. Each of the three parties involved has made concessions so that the federal government can close the gap in the budget in the end. The consolidation corresponds to just under one percent of gross domestic product. This could potentially dampen economic growth by up to half a percentage point in the coming year. However, the fact that central banks in all Western countries have had to raise their key interest rates sharply in the fight against high inflation will have a much greater impact on the economy. We continue to expect (German) gross domestic product to fall by 0.3% in the coming year.”CARSTEN BRZESKI, GLOBAL HEAD OF MACRO AT ING”All in all, the announced measures seem to be manageable for the economy. However, the ongoing controversy of how to combine large-scale investments with balanced budgets will not end after today’s announcement. In fact, with fiscal policy turning restrictive and still a high degree of policy uncertainty, the risk is high that the German economy will remain in a minor recession next year.”IFO PRESIDENT CLEMENS FUEST”The budget agreement is a step in the right direction, but questions remain unanswered. It is to be welcomed that the federal government has not taken the easy route of declaring a budget emergency, but has cut spending, especially subsidies, and increased environmental taxes such as the CO2 price somewhat more. This will maintain incentives for climate protection.”($1 = 0.9274 euros) More

TOKYO (Reuters) -Japanese Prime Minister Fumio Kishida on Wednesday announced he would make changes to his cabinet as he seeks to stem the fallout from a fundraising scandal that has further dented public support for his embattled administration.The premier told a press conference he would make the changes on Thursday, just three months after a previous cabinet overhaul.”I will take the lead in fighting to rebuild the ways of the Liberal Democratic Party to restore trust in politics,” he said referring to his ruling LDP party. Chief Cabinet Secretary Hirokazu Matsuno, a powerful figure who coordinates policy across government on his behalf, is among four ministers and several deputy ministers expected to go, according to media reports. Kishida said the changes were still being finalised. The shake-up comes as prosecutors investigate whether some lawmakers in the ruling party received thousands of dollars in fundraising proceeds missing from official party accounts, according to media reports. But analysts say a cabinet clearout is unlikely to draw a line under a scandal that has raised serious questions about Kishida’s leadership and thrown his government into disarray.Koichi Hagiuda, a high-ranking official from the LDP who oversees budget proposals, has decided to resign, broadcaster NHK and Kyodo news agency reported. Kishida is also considering shelving a planned trip to Brazil and Chile next month, the Mainichi newspaper said.”The most Mr. Kishida can hope for is to arrest the current decline in his personal support. Increasing it, however, will require more than cosmetic changes to personnel,” said Corey Wallace, a political science scholar at Kanagawa University. “There’s only so many times this tactic works over a short period until diminishing returns sets in.”Public support for Kishida’s administration has slipped as low as 23% in recent polls, the lowest since he came to office in 2021. He has twice reshuffled his cabinet, replacing ministers linked to a previous scandal in late 2022, and again in September as he looked to shore up his sagging ratings. Support for his ruling LDP has fallen below 30% for the first time since 2012, when it returned to power after a blip in its near total post-war dominance of Japanese politics, an NHK survey on Tuesday showed.The prime minister does not need to hold an election until October 2025, and a fractured and weak opposition has historically struggled to make sustained inroads into the LDP’s hold on power despite its at times fractious factional politics.’UNPARALLELED SCANDAL’While the prosecutors’ probe centres on lawmakers from LDP’s powerful Seiwa-kai faction, investigators are also looking into whether Kishida’s former faction – which he headed until last week – is also involved, according to media reports.Matsuno and the three other cabinet ministers expected to be replaced all hail from the Seiwa-kai faction, often referred to as the “Abe faction” after late prime minister Shinzo Abe. Ex-foreign minister Yoshimasa Hayashi, who belongs to Kishida’s former faction, is being lined up to replace Matsuno, several news outlets reported.Kishida has also decided to appoint ex-justice minister Ken Saito as trade minister, name Tetsushi Sakamoto as agriculture minister and reinstate former internal affairs minister Takeaki Matsumoto to replace the incumbents, according to domestic media.The factions are alleged to have hidden hundreds of millions of yen of political funds over years in a scheme that saw some lawmakers receiving proceeds from ticket sales to party events that were kept off the books.The LDP is due to hold leadership elections in September, but analysts say it remains to be seen how long Kishida can hold on to his post, especially if he becomes directly implicated in one of the party’s biggest financial scandals in decades.The main opposition party earlier on Wednesday submitted a motion of no-confidence in Kishida’s administration that was comfortably voted down in a parliament where the LDP and coalition partner Komeito have a clear majority.”Prime Minister, aren’t you aware that the LDP and its factions caused an unparalleled scandal? Isn’t the lack of your crisis control capability catastrophic?,” Kenta Izumi, the head of the opposition, said in parliament ahead of the vote. More

NEW YORK (Reuters) -U.S. Treasury market participants hope the securities regulator will heed pleas for a careful phase-in of a rule it is due to finalize on Wednesday that would force more central clearing of transactions in a seismic overhaul of the $26 trillion market. The top five Securities and Exchange Commission (SEC) officials are scheduled to vote at 10:00 a.m. ET on the rule. It was proposed over a year ago in a broad effort to boost Treasury market resilience during liquidity crunches, when buyers and sellers find it hard to complete transactions.If adopted, the reforms would mark the most significant changes to the world’s largest bond market, a global benchmark for assets, in decades.”This is going to significantly change the Treasury market landscape,” said Angelo Manolatos, macro strategist at Wells Fargo Securities, citing “a lot of costs.”The rule could also potentially increase systemic risks by concentrating risk in the clearing house, he added.A central clearer acts as the buyer to every seller, and seller to every buyer. Overall, just 13% of Treasury cash transactions are centrally cleared, according to estimates in a 2021 Treasury Department report, referring to the outright purchase and sale of those securities.The draft rule, which applied to cash Treasury and repurchase agreements, was partly aimed at reining in debt-fueled bets by hedge funds and proprietary trading firms. These firms have accounted for a growing chunk of the market over the past decade but are lightly regulated, allowing few insights into their activities.Many details about the final rule remain unknown, including the effective date, whether it would be adopted in phases, the scope of instruments, and parties included.Advocates for central clearing, including the SEC, say the rule makes markets safer, while critics say it adds costs and are concerned about the possibility of a hurried phase-in.”It is critical that policymakers do not blindly tinker with (the Treasury market’s) underpinnings,” wrote Jennifer Han, head of Global Regulatory Affairs at the Managed Funds Association in a Dec. 4 letter.The MFA stressed the market infrastructure needs to be more fully developed and recommended improving the way clients access clearing. Hedge fund and market maker Citadel said in a comment letter that the clearing requirement for cash transactions should be expanded beyond hedge funds to include a broader range of investors, leveling the playing field.Another key issue is whether the SEC will require minimum “haircuts” on collateral pledged against trades, which would raise trading costs and potentially reduce market liquidity. A haircut is a percentage deduction from the collateral value. Industry practice suggests that a large share of hedge funds trading in repo markets put up no haircut, suggesting that they are fueling activity using enormous amounts of cheap debt.The Depository Trust and Clearing Corporation’s (DTCC) FICC subsidiary clears Treasuries and could be tasked to come up with rules.”The implementation timeline is quite important,” said Gennadiy Goldberg, head of US rates strategy at TD Securities USA. “And what are the haircuts? Those are the two big questions that the market is going to be asking.”STEADYING THE MARKETThe rule is part of a series of reforms designed to boost Treasury market resilience following liquidity crunches. In March 2020, for example, liquidity all but evaporated as COVID-19 pandemic fears gripped investors.”While central clearing does not eliminate all risk, it certainly does lower it,” said SEC Chair Gary Gensler in the 2022 press release announcing the proposed rule.The DTCC said in a comment letter that during times of market stress, market participants submit a greater volume of transactions for clearing to limit their credit risk.Jason Williams, director of U.S. rates research at Citi, said there were pros in having additional margin in the system but balancing that are higher costs.”It’s going to be an interesting juggling act,” he added. More

WASHINGTON (Reuters) – The Federal Reserve is widely expected on Wednesday to leave interest rates unchanged for a third straight time, but also signal that a pivot to monetary policy easing will neither come soon nor be sharp, given inflation’s bumpy progress downward.In quarterly economic projections due to be released at the end of a two-day meeting, U.S. central bankers are still likely to pencil in at least a couple of rate cuts by the end of next year, as they seek to strike the right balance between policy that’s restrictive enough to slow spending and hiring but not so tight that it sends them into a tailspin. Fed Chair Jerome Powell, however, is expected in a press conference to emphasize that any cuts in borrowing costs are contingent on further improvement on inflation, which despite a rapid decline this year is still above the Fed’s 2% goal.The Fed chief is scheduled to begin speaking at 2:30 p.m. EST (1930), half an hour after the release of the policy statement and projections.”Powell will have to walk a fine line by recognizing the ground gained towards the normalization of the economy while pushing back on the idea of early rate cuts,” and even warn that the Fed could yet raise rates again if needed, TD Securities analysts wrote as the Fed meeting got underway on Tuesday. And, indeed, the economy has normalized a lot. Inflation by the Fed’s preferred measure, the personal consumption expenditures price index, dropped to 3% in the latest reading, from more than 7% at its peak in the summer of 2022. Meanwhile, the unemployment rate in November fell to 3.7%, barely above where it was when the Fed began raising interest rates from the near-zero level in March 2022. Fed policymakers will give their views on where inflation, unemployment and GDP are likely to be in coming years as part of the updated projections. Still, a reminder of why Powell may be loathe to signal the end of the Fed’s rate hiking campaign came on Tuesday after the Labor Department reported U.S. consumer prices unexpectedly rose and underlying inflation pushed higher in November. Even so, financial markets continue to price in a full percentage point of reductions in the Fed’s benchmark overnight interest rate next year, starting in May. The U.S. central bank’s policy rate is currently in the 5.25%-5.50% range. Those bets and a decline in the 10-year Treasury yield since the Fed’s Oct. 31-Nov. 1 meeting reflect a recent broad easing in financial conditions that, if ongoing, could complicate the Fed’s efforts to bring inflation under control.Fed policymakers said at their last policy meeting that they believed the rise in long-term bond market rates was doing some of the work of slowing the economy for them. More

BUENOS AIRES (Reuters) – The relentless pace of creeping prices in Argentina provides the new president’s plan for immediate shock therapy little margin for error, with many citizens already wondering how they will survive annual inflation nearing 150%.President Javier Milei’s economy chief laid out the new government’s initial policy push on Tuesday, targeting deep cuts to public spending and a sharp currency devaluation that will stoke short-term inflation as it hopes to staunch the bleeding in the country’s worst economic crisis in decades.Economy Minister Luis Caputo, like Milei in his first few days on the job, announced the value of the peso currency will be halved, public work tenders halted and energy and transport subsidies reduced. The government will also, however, double social spending for the poorest.”What I see is everything getting more expensive almost every day, and I don’t know for how long we’ll be able to make it, because if salaries stay low and prices keep rising there won’t be enough to eat,” said 63-year-old retiree Maria Cristina Coronel.Just to survive, many people are scouring markets in a race against time to find the best prices, which are updated daily in many stores.The country’s annual inflation rate is approaching 150% and the poverty rate at 40% and growing, as many pin their hopes on Milei’s turnaround pitch, though he has said things will get worse before they get better.In his inaugural address on Sunday, the radical libertarian outsider said monthly inflation will likely range between 20% to 40% through February. He warned that hyperinflation of some 15,000% could materialize if government spending is not dramatically rolled back.”There’s no money,” Milei repeated during his somber speech, a slogan that is now emblazoned on T-shifts sold on the streets of the capital.”Last time I went to the butcher, I saw people buying just a quarter (kg) (0.55 pounds) of ground beef or chicken breast. I’ve never seen that,” said Beatriz Nunez, a 62-year-old shopkeeper, underscoring the grim day-to-day reality.”But we have to have faith,” she added. “We hope everything will change.”Many share her hope for change, which buoyed Milei to a resounding victory over a center-left Peronist government viewed by most as a failure.”I see an opportunity for them to change this once and for all because people are in favor of it changing,” said Ricardo Soccola, a merchant from the outskirts of Buenos Aires.But even as many cash-strapped Argentines want Milei to succeed, his task is made even harder due to his lack of majority support in Congress, which will also need to approve many of his proposals. More

NEW YORK (Reuters) – For a Federal Reserve that is actively weighing an end to aggressive rate hikes aimed at lowering inflation, easing financial conditions over recent weeks, on the face of it, appear more a foe than friend of monetary policy. Since summer’s end, Goldman Sachs’ closely watched financial conditions index, a measure of financial market tightness, surged to its highest point of the year amid a huge rout in the Treasury bond market, only to ease aggressively at the end of October, returning the index to where it was on the last day of August. That shift complicates the Fed’s narrative. Since the spring, policymakers have argued a broad tightening in financial conditions tied to their policy as well as banking sector stress was ginning up economic restraint and greasing the path back toward their 2% inflation target. That suggests looser financial conditions should make it harder to foster lower inflation. But current and former Fed officials and a number of private sector economists say it isn’t that straightforward, arguing the evolution of financial conditions must be viewed over a longer horizon. Moreover, some caution against focusing on broad indexes in favor of a more focused look at the real-world borrowing costs that can promote or hinder growth. On that front, things like home loan costs, access to credit and other borrowing are still stringent and likely to moderate activity. How this might be affecting Fed thinking at its Dec. 12-13 policy meeting depends on how policymakers view both the rapid tightening of conditions and subsequent pullback. William English, a former top Fed staffer who is now at Yale University, said that if the tighter financial conditions seen over part of the fall had persisted it might have affected forecasts for the economy. “But at this point,” with all that’s happened over recent months, “I assume this won’t have a consequence for the meeting coming up,” he said. PERSISTENCE PUZZLEThe Fed, in its policy meeting concluding Wednesday, is almost certain to keep the federal funds rate where it’s been since July at between 5.25% and 5.5%. Markets, broadly convinced the Fed is done with rate hikes, have turned to betting on rate cuts. Chair Jerome Powell is sure to face questions on how the recent shift in financial conditions will factor in this outlook. New York Fed President John Williams on Nov. 30 acknowledged both the tightening of financial conditions in part due to the increase in Treasury yields since summer and the more recent easing, noting that given volatility in financial markets he was taking a longer view. “I would go back to the question that was always foremost in my mind, which was how persistent is this going to be,” he told reporters, adding recent market moves appear yoked to how much compensation investors are demanding to deal with uncertainty over the future. Some economists reckon a focus on the year as a whole is the right formula for the Fed right now: Both Goldman’s index and the Fed’s own financial conditions index remain tighter than where they started the year, though one from the Chicago Fed suggests conditions are the loosest since the Fed kicked off its rate hikes in March 2022. Matthew Luzzetti, economist with Deutsche Bank, noted the real – or inflation adjusted – 10-year Treasury yield often cited by Powell is below 2% now after surpassing 2.5% at the end of October. “During the summer it was 1.5% or 1.6%, so it is still, I think, meaningfully higher than it was over the summer months,” he said.Analysts at Piper Sandler, however, said in a note the easing would be relevant to near-term monetary policy. “Much of the rationale for the Fed’s November skip has dissipated” with the recent drop in yields. From their perspective, “A December hike, one for the road, is far from off-the-table” to correct the shift in market pricing.REAL WORLD RESTRAINTOne way bond market shifts have affected the real economy is by significantly boosting the cost of buying a home. From the start of 2021, when 30-year fixed-rate mortgages sported rates below 3%, they rocketed to just shy of 8% at the start of November, before retreating toward the current 7% mark. That still-high level is “the punch line” to the financial conditions story, said Charles Evans, who retired from leading the Chicago Fed earlier this year. “When mortgage rates are 6, 7, 8 percent, that’s very meaningful for the path of the economy,” Evans said. Add to that the slower-moving rises in different corporate borrowing costs that are only catching up to much higher short-term rates, “you can see where eventually it hits,” and it’s not toward easier borrowing conditions. Meanwhile, former St. Louis Fed leader James Bullard, now dean of Purdue University’s business school, said the Fed could have spared itself this headache by not referring to financial conditions in general terms. For one thing, he said broad indexes take in stock price shifts, which are something Fed officials typically don’t care much about. What’s more, Bullard said for all the market moves, underlying interest rates tied to monetary policy remain quite restrictive, which should help keep market levels in line with what the Fed wants. His current assessment of what constitutes tight policy would have the federal funds rate between 3.5% and 5.75%. With the current rate near the higher end of that range, he said, “I think that’s probably a good place to be if you’re trying to get inflation to come down pretty rapidly.” More

TOKYO (Reuters) – Japanese Prime Minister Fumio Kishida on Wednesday urged the central bank to take into account the government’s priorities, such as pulling the economy permanently out of deflation, in making monetary policy decisions.The remark comes ahead of the Bank of Japan’s policy meeting next week, where the central bank is widely expected to make no major changes to its ultra-loose monetary settings.Kishida said the government is undertaking various steps to eliminate companies’ long-held practice of prioritising cost cuts over innovation, and achieve a cycle in which price rises are accompanied by sustained wage increases.”Specific monetary policy decisions must be made by the Bank of Japan. But in guiding policy, I hope the central bank takes into account the government’s policy goals,” he told a news conference when asked about market expectations the BOJ could soon end ultra-low interest rates.Kishida also said the government and the BOJ agree on the need to put Japan on a sustained growth path, and see inflation stably hit the central bank’s 2% target.With inflation exceeding its 2% target for well over a year, the BOJ has been laying the groundwork to phase out its massive stimulus such as by relaxing its grip on bond yields.But BOJ Governor Kazuo Ueda has stressed the need to keep ultra-loose policy until inflation is driven more by domestic demand and higher wages, rather than cost-push pressures.More than 80% of economists polled by Reuters in November expected the BOJ to end its negative rate policy next year with half of them predicting April as the most likely time. Some see the chance of a policy shift in January.In an effort to reflate growth and sustainably achieve its price target, the BOJ guides short-term rates at -0.1% and sets a loose cap around 1% for the 10-year government bond yield. More

Inflation declined to 2.4% in November and core inflation also has gone down.
Money markets are currently pricing in almost 150 basis points of rate cuts next year. 
The bank’s key deposit rate is at a record high of 4%, after 10 consecutive hikes that began in July 2022 and pushed rates back into positive territory for the first time since 2011.

Christine Lagarde, president of the European Central Bank (ECB).
Bloomberg | Bloomberg | Getty Images

FRANKFURT — The European Central Bank meets this week with investors closely monitoring to see when the Frankfurt institution might start to cut interest rates.
It will be too early to declare victory in the battle against inflation, but with inflation at a two-year low, it certainly gives the ECB’s Governing Council breathing space to focus on another important issue: its gigantic balance sheet.

“Having reached its policy rate plateau at a 4% deposit rate, the ECB can now shrink its balance sheet at a faster pace without risking too much of a blowout in yield spreads within the euro zone,” said Holger Schmieding of Berenberg in a research note to clients.
“Nonetheless, markets will probably have to correct some of their overoptimistic rate cut expectations once the ECB has spoken this Thursday.”

Inflation plunge

Inflation declined to 2.4% in November and core inflation also has gone down. With inflation falling faster than expected, investors have increased their bets for ECB rate cuts next year, especially after one of the more hawkish members of the board, Isabel Schnabel, called the consume price slowdown “remarkable” and “a pleasant surprise,” according to a transcript of a Dec. 1 interview with Reuters.

Money markets are currently pricing in almost 150 basis points of rate cuts next year. The bank’s key deposit rate is at a record high of 4%, after 10 consecutive hikes that began in July 2022 and pushed rates back into positive territory for the first time since 2011.
“The risk is now earlier and larger cuts, and an ECB more capable of decoupling from the Fed,” said Mark Wall, an ECB watcher with Deutsche Bank.

But he believes the ECB will most likely keep its cards close to its chest: “We expect the ECB to keep the guidance that maintaining restrictive rates for sufficiently long will bring inflation back to target in a timely manner.”

PEPP roll-off

Looking ahead, there will be a new round of staff projections for inflation and economic growth in March, which will give the central bank more data to back their data-dependent policy approach and possibly give it room for rate cuts.
But this week, the main policy change at the conclusion of the ECB’s meeting on Thursday might come in the form of a shift in forward guidance — specifically when it will end reinvestments of its PEPP program.
The PEPP, or the Pandemic Emergency Purchase Program, is a flexible bond purchase program introduced during the coronavirus pandemic. The ECB reinvests any maturing securities it gets from its PEPP portfolio but that could soon change. 

“We have indicated that we would continue reinvesting until at least 2024,” ECB President Christine Lagarde told European Parliament lawmakers on Nov. 27.
“This is a matter which will come probably for discussion and consideration within the Governing Council in the not-too-distant future, and we will reexamine possibly this proposal.”
Deutsche Bank’s Wall explained that “if rate cuts are moving forward, the ECB might accelerate the preliminary steps in the exit from PEPP reinvestments.” More