There is quite a lot of bad news from Europe today, with German, Italian and French Q4 GDP growth all disappointing. The immediate thought is whether the EUR might stop appreciating against USD. However, the real driver of EUR/USD of late has been the real rate differential, and the real driver of that has been the increase in US 2-year inflation expectations — so I think it would be a mistake to put too much weight on the European data flow. Other data releases included US retail sales, which came in at 0.1% as expected. Eurozone industrial production was up 0.7% in December, b.e., which was a big improvement over previous months. This reminds me of something of which I am increasingly aware — that QOQ data releases can look very different from MOM releases, and that a bad QOQ number can mask and improving trend and vice versa.

Incidentally, I think that the importance of US inflation expectations to EUR/USD is the reason for its risk-on/risk-off character over the past few years, inflation expectations being closely related to economic expectations, which also affect equity and commodity prices.

An article at ( points out that, according to the CBO, the magnitude of the US fiscal tightening over the two years between 2011 and 2013 will be larger than in any episode since WWII, with or without the sequester. The size of the fiscal tightening was part of my rationale for shorting equities earlier in the year. I still think that this trade’s time will come.

Apparently there have only been two previous periods in which the deficit has fallen by more than 2% of GDP in two years — 1960-61 and 1969-70. Both were associated with recessions. There are always other things going on, so I am cautious about taking this observation at face value, but there is growing evidence that fiscal multipliers are large, and greater than 1, when the economy is at the zero bound. I think is is reasonable to expect a strong headwind to GDP growth from this fiscal contraction; a US recession is possible.

A couple of snippets from today’s news: Bloomberg reports that copies of Kaisha Shikiho, a statistical publication on Japanese stocks, have been selling out at Tokyo bookshops — perhaps the Japanese population is buying the equity rally; and the Swiss government, on advice from the SNB, has ordered banks to hold additional capital in order to cool house prices, which have been increasing strongly.

In the FT, Martin Wolf ( discusses the lending constraints faced by banks. He argues that the level of reserves is never a constraint on bank lending in a fiat-money system: the central bank always proves willing to provide reserves if they are needed. I have been thinking about this question recently, and from a similar perspective, and wondering what constraints banks actually do face on the expansion of their balance sheets. Mr. Wolf argues that the constraints are solvency — you need to acquire assets that will not lose their value and wipe out your equity — and profitability — you have to acquire assets with a high-enough yield to make it worth your while. But presumably there are also regulatory constraints of some kind. The supply of government bonds is not infinite, and other assets are not zero-risk-weighted for capital calculations.