Is the Fed going to do QE3? Work by several Fed officials earlier in the year on buying MBS got the market excited about the prospect, but with the economy improving it is not obvious that it will actually happen. St Louis Fed president James Bullard played down the possibility this week. This is a reminder that the Fed does not really know any better than the rest of us what the economy is going to do, which is why the FOMC generally does not commit itself in advance of its actions. Tim Duy argues that it all depends on whether the Fed is trying to get the economy back to its pre-recession trend or to manage it around a new, lower trend line. A higher inflation target would be consistent with the former; but it increasingly looks like it is doing the latter — and that means QE is unlikely unless recession or deflation looks an imminent possibility.

Consistent with the idea of a new, lower growth trajectory is the falling labour force participation rate, which has continued to fall in recent months. Mr Duy also points out that the recent peaks in this series coincide with the tech and housing bubbles. Perhaps the economy really cannot return to the levels of production seen before the crisis without an asset bubble to draw people into the labour force.

The US housing market is looking marginally sunnier. Calculated Risk argues that HARP refinancing will pick up after March when new rules on reps. and warrants make refinancing less risky for lenders come into effect, and that plans in the pipeline to encourage mortgage settlements and REO-to-rental programmes will also be finalised in Q1 of this year. This should help to clear the “shadow inventory” of existing homes on which banks have yet to foreclose, although it is notable that this inventory remains large, so a pick up in single-family construction is still likely to be some time away. Multi-family housing starts have already picked up, of course, owing to the relative shortage (evident in a falling vacancy rate) of apartments on a national basis. In consequence of this, and of corporate investment in structures, construction employment has shown its first increase since 2005 (albeit a small one). The US construction sector may at least have reached a bottom — though it still has a long road to recovery.

The FT has a piece on EUR-funded carry trades. This is the idea I mentioned last week — that the abundant liquidity offered by the ECB will find its way into risk assets. There is a lot of excitement about a breakdown in correlation between EUR/USD and risk assets, but the evidence remains extremely slender so far — a few trading days when EUR/USD has been relatively uncorrelated with SPX (but not European equities or copper, for example) and a large speculative net short in EUR futures (which I think is the result of trend-following behaviour, not an indication of carry trading). I remain uncertain about whether a wave of EUR liquidity should be expected to flow into global markets: the new money created by the ECB is going at least in part to offset the contraction of the money supply caused by European banks’ deleveraging; and it is not clear that the availability of credit trumps its funding cost — i.e. that international players will borrow expensively in EUR, rather than cheaply in USD, because of the ECB’s actions.

The continued high price of Brent cannot be helpful for Europe — but it is striking how high the price is in euros. Brent in EUR has returned to its 2008 high.


German IP -0.6% d.e. Nov.
US consumer credit posted a very high monthly number in November. Households are clearly continuing with their credit-financed spending.
UK BRC retail sales monitor 2.2% YOY Dec. A good number.
UK RICS house price balance -16% Dec. Second month of improvement.
China trade surplus increased a little, b.e., on slowing export growth.
French IP 1.1% b.e. Nov.

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UK trade balance.