UK Private Pensions are in trouble

I thought I would take a look at a developing situation which affects across the age spectrum but in varying ways. We regularly note it as a consequence of other actions but it is time again to look at it directly. Earlier this month it even got a mention in the House of Commons.

“To ask the Chancellor of the Exchequer, what assessment his Department has made of the effect on pension companies of the decision by some UK listed companies to cancel dividend payments to their shareholders.”

He is opening a new front there by adding the lack of dividend payments to the lost of troubles and is mostly addressing occupational schemes but will affect personal ones too.The reply from Treasury Minister John Glen opened up the topic much more widely and the emphasis is mine.

Whilst dividend income is important for pension schemes, they have long-term investment horizons and a range of other sources including fixed income from corporate and sovereign bonds, rental income and capital gains,although many of these are under strain., 

When market conditions recover and firms have rebuilt their balance sheets we anticipate that dividends will be restored.

That last sentence about dividends is rather ominous as how often have we been told that something is temporary in the credit crunch era? Remember this from Deputy Governor Charlie Bean from a decade ago….

“It’s very much swings and roundabouts. At the current juncture, savers might be suffering as a result of bank rate being at low levels, but there will be times in the future — as there have been times in the past — when they will be doing very well.”

A decade later we have still not arrived at the “times in the future” when savers will be “doing very well”. It is hard not to have a wry smile at the fact that this complete failure at forecasting is now on the Committee of the Office of Budget Responsibility which compiles the fiscal forecasts for the UK ( for newer readers they are always wrong).Still at least his pension arrangements got a top-up in return for working half the week.

Your fee is determined by the Treasury and paid by the OBR, and will be £5,140.55 per month, less statutory deductions as mentioned below.

The Underlying Problem

Much of this has been driven by the policy of the Bank of England so by Sir Charles and his successors.They cut interest-rates to 0.5% in a supposedly emergency move and more recently Bank Rate has gone to 0.1% with expectations that it will go negative. For our purposes the next bit has been in my opinion an even stronger influence on pensions.

The Committee voted unanimously for the Bank of England to continue with its existing programmes of UK government bond and sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, maintaining the target for the total stock of these purchases at £745 billion.

This has been the factor that has driven the corporate bond and sovereign bond yields mentioned in the Treasury statement earlier, lower. This makes life very hard for pension and indeed other funds which rely on an income stream to make payments and oil the wheels. Indeed, as regular readers will be aware, up to around the 6 year maturity UK bond or Gilt yields are in fact negative at around -0.05% as I type this.Imagine having to explain to pensioners that you are investing their money for an expected loss! Also that such a loss will be before inflation which will only make matters worse.

This afternoon the Bank of England will do its best to make that situation even worse as it buys another £1.473 billion of short-dated UK bonds and hence tries to make yields even more negative. It will buy other maturities tomorrow and Wednesday meaning the total will be a bit over £4.4 billion, this week. If we look out as far as we can then even the 50 year yield is a mere 0.68% which in nominal terms offers very little and after inflation looks set to offer large losses.

If we switch to dividends we see another wasteland as the numbers below from Simon French of Panmure Gordon highlight.

The UK equity market has seen dividends cut by 31% in 2020, and has left the Top-10 dividend payers making up 52% of FTSE All Share dividends. Median dividend yield on UK equities now just 0.8%, having been 2.3% at the start of the year.

There are various technical reasons for this as well as the simple basic one that it has been a rough year for economies.For example we see that in many countries including the UK banks which used to be high dividend payers have restrictions on payments. Also the troubles of the oil and gas sector have hit dividend payments there as the latest payment from BP ( for the second quarter) was a bit under half that of last year.

As to the issue of capital gains there have been some for those who have invested in technology stocks such as the FAANGs. But on a wider more generic level the situation was sung about by Lyndsey Buckingham.

I think I’m in trouble,
I think I’m in trouble.

If we look at the UK FTSE 100 equity index it is at 5840 as I type this. So since the peak of 7877 in late May 2018 there have in back been capital losses. More grimly if we try to look back in time to avoid the ebb and flow we see that it ended the previous century at 6930. So equity investments have in fact lost and not made ground this century.

Taking a Pension

The usual system in the UK is to take an annuity as it offers a guaranteed income for life. Back on the 19th of March 2015 I looked at them.

If you crunch the numbers for a basic (single life no add-ons) annuity at age 65 then it takes around 17 years to get your money back. This is awkward and leads to the view that an annuity is bad value.

The situation is now quite a bit worse as you will get a yield of 4.79% or it will be around 21 years before you get your money back. This situation affects both final salary schemes and those with a personal pension.

The numbers get even worse if you want inflation protection. There is a payment needed foe that but you see due to all the QE bond purchases described above index-linked bonds are worth much more than the inflation in them. Or if you prefer they offer bad value too.

Comment

As you can see there are a lot of challenges for pension funds. This has been an ongoing issue as this official denial from the Bank of England in 2012 highlights.

Asset purchases are likely to have had a broadly neutral
impact on the value of the annuity income that could be
purchased with a personal pension pot.

As even by then annuities had fallen how did they get to this?

But the flipside of that fall in yields has been a rise in the price of both bonds and equities held in those pension pots.

Since then the FTSE 100 has risen by at most 100 points and many investments made on a monthly basis have been at a loss. Even they could not avoid this point.

By pushing down
gilt yields, QE has reduced the annuity rate

The impact here has been like a bomb going off for those with private pensions. For personal schemes it has been the lack of growth and for occupational it has been the way the schemes have struggled under increasing burdens leading to worsening terms and many schemes closing. If we look ahead what future is there here for those investing for their future right now?

Of course the Bank of England was right about its own pension scheme which has the equivalent of a sugar daddy as this from the Guardian in 2016 shows.

It has emerged that employees, led by the Bank’s governor, Mark Carney, received the equivalent of a 50%-plus salary contribution into their pensions last year, underwritten by the taxpayer. Most private employers pay 5-10% of salary into pensions, with many large companies struggling to cope with widening deficits in their schemes.

But for the rest of us we are left mulling the words of the Queen of Hearts.

My dear, here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.

Podcast

 

 

UK Retail Sales are seeing quite a surge

These times are ones where the news is often a combination of bad or grim.Indeed the mainstream media seems to be revelling in it. From time to time we do get some better news which I welcome.In the UK version of the pandemic that has regularly come from the retail sales data and this morning is no exception.

In September, we saw growth across all measures. The value of retail sales increased by 1.4% and volume sales by 1.5% when compared with the previous month.

The first point is that we have seen another month of growth which means that the pattern has been of a very strong recovery.

A strong rate of growth is seen in the three-month on three-month growth rate at 17.7% and 17.4% for value and volume sales respectively. This is the biggest quarterly growth seen on record as sales recovered from the low levels experienced earlier in the year.

If course a lot of care is needed because there was quite a previous fall.

In Quarter 2 (Apr to June), the volume of retail sales fell by 9.7%.

The effect of this is that we are now quite a bit above the pre pandemic level of retail sales.

When compared with February 2020’s pre-pandemic level, total retail sales were 3.9% and 5.5% higher in value and volume terms respectively.

Also one of my themes has been in play. Regular readers will recall that I argued back on the 29th of January 2015 that low inflation and indeed falling prices boost retail sales by making them cheaper in real terms, especially relative to wages. If you now look at the numbers again there has been a registered price fall of the order of 1.6% ( the difference between the value and volume figures above) and it has been associated with strong growth. This is bad news for those who argue that we need more inflation such as those setting policy at the Bank of England as they are replying on a “Wages Fairy” that has been absent for more than a decade now.

Breaking it down

The pandemic era seems to have made as hungry.

When compared with February, volume sales within food stores were 3.7% higher in September. Food retailers had suggested that the peak in March 2020 was because of panic buying at the start of the pandemic, and despite seeing a notable fall in sales following this peak, spending remained high. This may be a result of the government tightening restrictions for other services such as bars and restaurants at the end of September, which may have encouraged spending in food stores.

More seriously as the release above suggests there has been a shift here with people eating out less and therefore eating more at home. Unfortunately it is pretty much impossible to quantify. Perhaps some people still have cupboards full of tinned food and freezers full up as well.

There has also been a shift towards online retailing, or more accurately what was already happening got turbocharged.

In September, volume sales within non-store retailing were 36.6% higher than in February. Despite some contraction from the sharp rate of increase in this sector, consumers were still carrying out much of their shopping online when compared with February.

It is a case of what the Black-Eyed Peas would call “Boom! Boom! Boom!”

Despite monthly declines across all sectors except department stores, the proportion of online sales was at 27.5%, compared with the 20.1% reported in February. The proportion of online sales increased across all sectors with food stores nearly doubling their online proportions from 5.4% in February to 10.4% in September.

Putting it another way online sales are up 53% on a year ago.

I guess we should not be surprised that times like these have led to higher sales reflecting people passing the time by gardening and doing some home improvements.

Many retailers selling gardening products commented on increased demand during lockdown as consumers socially distanced in their gardens where possible.Flowers, plants and seeds stores provided strong positive contributions at 0.5 percentage points………Volume sales in household goods stores and “other” non-food stores increased to 11.0% and 10.7% above February, respectively. Feedback from household goods stores had informed us that home improvement sales from DIY and electrical goods stores did well in recent months and helped with the recovery of sales

There should be no great surprise with so many working from home that fuel sales are down.

In September, fuel sales volumes were still 8.6% below February with reduced travel as many continued to work from home, and clothing sales volumes were still 12.7% below February.

But as you can see clothing sales have suffered too. Perhaps a lack of work clothes.O have dome my bit for the October figures by buying a new sweatshirt and some running shorts.

In terms of the overall index we are now at 107.6 with 2018 as the benchmark of 100.

On the other side of the coin this was reported as well.

The GfK Consumer Confidence Index tumbled to -31 in October, its lowest level since late May and down sharply from a nine-month high of -25 in September, as well as being below all forecasts in a Reuters poll of economists. ( Reuters)

It is hard not to laugh at the forecasts.We have had a litany of simply dreadful ones in the pandemic era yet some still seem to have faith in them.As to the numbers October has its issues but I find a survey that is at -25 at a time of record retail sales in September somewhat puzzling.

Business Surveys

Today’s Purchasing Managers Index or PMI was also positive. Whilst the reading fell unlike in the Euro area we retained at least some growth.

The pace of UK economic growth slowed in October to
the weakest since the recovery from the national COVID-19
lockdown began. Not surprisingly the weakening is most
pronounced in the hospitality and transport sectors, as firms reported falling demand due to renewed lockdown measures and customers being deterred by worries over rising case numbers.

The growth that we are seeing is to be found here.

Where a rise in output was reported, survey
respondents pointed to factors such as pent up demand in the manufacturing sector, rising residential property transactions and the restart of work on projects that had been delayed at the start of the pandemic.

 

Comment

If we continue with today’s optimistic theme we see that we do have an example of a V-Shaped recovery in the UK economy. This is because retail sales are now a fair bit above pre pandemic levels. So a clear V shape. However this area has been the one which has benefited the most from income being supported by the furlough scheme which ends soon. The replacements are stronger than they were but we may see an impact from the November data. Also there are some extraordinary goings on in Wales which will be affecting retail sales there from tomorrow.

Supermarkets will be unable to sell items like clothes during the 17-day Covid firebreak lockdown in Wales.

First Minister Mark Drakeford said it would be “made clear” to them they are only able to open parts of their business that sell “essential goods”.

Many retailers will be forced to shut but food shops, off-licences and pharmacies can stay open when lockdown begins on Friday at 18:00 BST.

Retailers said they had not been given a definition of what was essential. ( BBC)

Frankly that looks quite a shambles in the making.

So in an echo of the weather as the sun has come out in Battersea we have received some good news today but sadly I suspect the Moody Blues were right about future prospects.

The summer sun is fading as the year grows old
And darker days are drawing near
The winter winds will be much colder

The Bank of England has become an agent of fiscal policy

It is time to take a look at the strategy of the Bank of England as there were 2 speeches by policymakers yesterday and 2 more are due today including one from the Governor. But before we get to them let us first note where we are. Bank Rate is at 0.1% which is still considered by the Bank of England to be its lower bound, however it did say that about 0.5% and look what happened next! We are at what might now be called cruising speed for QE bond purchases of just over £4.4 billion per week. Previously this would have been considered fast but compared to the initial surge in late March it is not. The Corporate Bond programme has now reached £20 billion and may now be over as the Bank has been vague about the target here. That is probably for best as whilst the Danish shipping company Maersk and Apple were no doubt grateful for the purchases there were issues especially with the latter. It is hard not to laugh at the latter where the richest company in the world apparently needed cheaper funding. Also we have around £117 billion deployed as a subsidy for banks via the Term Funding Scheme and some £16 billion of Commercial Paper has been bought under the Covid Corporate Financing Facility of CCFF.

The Pound’s Exchange Rate

It has been a volatile 2020 for the UK Pound £ as the Brexit merry-go-round has been added to by the Covid-19 pandemic. The initial impact was for the currency to take a dive although fortunately one of the more reliable reverse indicators kicked in as the Financial Times suggested the only was was down at US $1.15. Yesterday saw a rather different pattern as we rallied above US $1.31. However as we widen our perspective we have been in a phase where both the Euro and the Yen have been firm,

If we switch to the trade-weighted or effective index we see that the Pound fell close to 73 in late March but has now rallied to 78. Under the old Bank of England rule of thumb that is equivalent to a 1.25% increase in Bank Rate. Right now the impact is not as strong due to trade issues but even if we say 1% that is a big move relative to interest-rates these days.

Ramsden

Deputy Governor Ransden opened the batting in his speech yesterday by claiming  that lower interest-rates were nothing at all to do with the cuts he and his colleagues have voted for at all.

Over time, these developments reduced the trend interest-rate, big R*, required to bring stocks of capital and wealth into line. And policy rates, including in the UK, followed the trend downwards.

So we no longer have to pay him a large salary and fund an index-linked pension as doe example AI could do the job quite easily? Also it is hard not to note that we would not be told this if the interest-rate cuts had worked.

As a former official at HM Treasury one might expect him to be a fan of QE as it makes the Treasury’s job far easier so this is little surprise.

QE has been an effective tool for stimulating demand through the 11 years of its use in the UK .

Really? If it has been so effective why has it been required for 11 years then? He moves onto a suggestion that there is plenty of “headroom” for more of it. This is followed by an extraordinary enthusiasm for central planning.

But again my starting point is that we have plenty of scope to affect prices. While yields on longer-dated Gilts are at historically low levels, that does not mean they could not still go lower.

There is a problem with his planning though because the QE he is such an enthusiast for has given the UK negative interest-rates via bond yields. At the time of writing maturities out to 6 years or so have negative yields of around -0.06%, Yet he is not a fan of negative interest-rates.

While there might be an appropriate time to use negative interest-rates, that time is not right now, when the economy and the financial system are grappling with the effects of an unprecedented crisis, as well as the myriad uncertainties this crisis has created.

Ah okay, so he is worried about The Precious! The Precious! Curious that because we are told they are so strong.

the banking sector as a whole starts from a position of strength.

Perhaps somebody should show Deputy Governor Dave a chart of the banks share prices. That would soon end any talk of strength. Also if you are Deputy Governor for Markets and Banking it would help if you had some idea about markets.

As a generic I would just like to point out that those who claim the Bank of England is independent need to explain how it has come to be that all the Deputy-Governors have come from HM Treasury?

The Chief Economist

The loose cannon on the decks has been on the wires this morning as he has been speaking at a virtual event. From ForexLive

  • Nothing new to say on negative rates
  • BOE is doing work on negative rates, not the same as being ready to use it
  • Monetary policy can provide more of a cushion to the crisis
  • But more of the heavy lifting has to be done by fiscal policy

Actually he then went on what is a rather odd excursion even for him.

There Is An Open Question Whether Voluntary Or Involuntary Social Distancing Is Holding Back Spending ( @LiveSquawk)

For newer readers he seems to be on something of a journey as previously one would expect him to be an advocate of negative interest-rates whereas now he is against them.

Comment

There is a sub-plot to all of this and let me ask the question is this all now about fiscal policy? The issues over monetary policy are now relatively minor as any future interest-rate cuts will be small in scale to what we have seen and QE bond buying is on the go already. The counterpoint to this is that the Bank of England has seen something of a reverse takeover by HM Treasury as its alumni fill the Deputy Governor roles. Its role is of course fiscal policy.

The speech by Deputy Governor Ramsden can be translated as we will keep fiscal policy cheap for you as he exhibits his enthusiasm for making the job of his former colleagues easier. That allows the Chancellor to make announcements like this.

Chancellor Rishi Sunak is to unveil new support for workers and firms hit by restrictions imposed as coronavirus cases rise across the UK.
He is due to update the Job Support Scheme, which replaces furlough in November, in the Commons on Thursday. ( BBC )

So we have been on quite a journey where we were assured that monetary policy would work but instead had a troubled decade. Whilst the Covid-19 pandemic episode is a type of Black Swan event there is the issue that something would be along sooner or later that we would be vulnerable to. Now central banks are basically faciliatators for fiscal policy. This brings me to my next point, why are we not asking why we always need more stimuli? Surely that means there is an unaddressed problem.

UK sees a worrying rise in inflation and record borrowing

Today has brought quite a panoply of UK economic data some of it which is hardly a surprise, but there is a section which is rather eye-catching and provides food for thought. It will only be revealed at the Bank of England morning meeting if someone has the career equivalent of a death wish.

The annual rate for CPI excluding indirect taxes, CPIY, is 2.2%, up from 1.8% last month……The annual rate for CPI at constant tax rates, CPI-CT, is 2.2%, up from 1.8% last month.

The pattern for these numbers has been for a rise as CPI-CT initially dipped in response to the Covid-19 pandemic and fell to 0.4% in May. But since then has gone 0.5%,1%,1.8% and now 2.2%.

The sector driving the change has been the services sector which has seen quite a lift-off. If we look back we see that it has been regularly above 2% per annum but after a brief dip to 1.7% in June it has gone 2.1%, 4.1% and now 5%. Something that the Bank of England should be investigating as these seems to be quite an inflationary surge going on here. It is so strong that it has overpowered the good section ( -0.4% and the energy one ( -8.5%) both of which are seeing disinflation.

Nothing to see here, move along now please

Of course the official Bank of England view will be based on this number.

The Consumer Prices Index (CPI) 12-month rate was 0.5% in September 2020, up from 0.2% in August.

On that road they can vote for more QE bond buying next month ( another £100 billion seems likely) and if one policymaker is any guide they are looking ever more at further interest-rate cuts.

There is some debate about the scale of the stimulus that negative rates have imparted on these economies, but the growing empirical literature finds that the effect has
generally been positive, i.e. negative rates have not been counterproductive to the aims of monetary policy.

That is hardly a ringing endorsement but there is more.

My own view is that the risk that negative rates end up being counterproductive to the aims of monetary
policy is low. Since it has not been tried in the UK, there is uncertainty about this judgement, and the MPC is
not at a point yet when it can reach a conclusion on this issue. But given how low short term and long term
interest rates already are, headroom for monetary policy is limited, and we must consider ways to extend that
headroom.

So should there be a vote on this subject he will vote yes to negative interest-rates.

Returning to inflation measurement there has been something of a misfire. In fact in terms of the establishment’s objective it has been a disaster.

The Consumer Prices Index including owner occupiers’ housing costs (CPIH) 12-month inflation rate was 0.7% in September 2020, up from 0.5% in August 2020.

The issue here is that the measure which was designed to give a lower inflation reading is giving a higher one than its predecessor CPI. Even worse the factor that was introduced to further weaken the measure is the one to blame.

The OOH component annual rate is 1.2%, up from 1.1% last month.

OOH is Owner Occupied Housing and is mostly composed of rents which are never paid as it assumes that if you own your own home you pay yourself a rent. That is a complete fantasy as the two major payments are in fact the sale price and for many the mortgage costs and rent is not paid. This is quite different to those who do rent and for them it is included. But there is another swerve here which is that the inflation report today is for September but the rent figures are not. They are “smoothed” in technical terms which means they are a composition of rents over the past 16 months or so, or if you prefer they represent the picture around the turn of the year. Yes we have pre pandemic numbers for rent rises ( there were some then) covering a period where there seem to be quite a lot of rent falls.

Returning to the inflation numbers the much maligned Retail Prices Index or RPI continues to put in a better performance than its replacements.

The all items RPI annual rate is 1.1%, up from 0.5% last month.The annual rate for RPIX, the all items RPI excluding mortgage interest payments (MIPs), is 1.4%, up from 0.8% last month.

They still have mortgage payments reducing inflation which if the latest rises for low deposit mortgages are any guide will be reversing soon.

As to this month’s inflation rise then a major factor was the end of the Eat Out To Help Out Scheme.

Transport costs, and restaurant and café prices, following the end of the Eat Out to Help Out scheme, made the largest upward contributions (of 0.23 and 0.21 percentage points, respectively) to the change in the CPIH 12-month inflation rate between August and September 2020.

Borrowing Has Surged

The theme here will not surprise regular readers although the exact amount was uncertain.

Borrowing (PSNB ex) in the first six months of this financial year (April to September 2020) is estimated to have been £208.5 billion, £174.5 billion more than in the same period last year and the highest borrowing in any April to September period since records began in 1993; each of the six months from April to September 2020 were also records.

We looked a few days ago at a suggestion by the Institute for Fiscal Studies what we might borrow £350 billion or so this fiscal year and we are on that sort of road. As to the state of play we can compare this to what the Bank of England has bought via its QE operations. Sadly our official statisticians have used the wrong number.

At the end of September 2020, the gilt holdings of the APF were £569.2 billion (at nominal value), an increase of £12.2 billion compared with a month earlier. Over the same period, the net gilt issuance by the DMO was £22.7 billion, which implies that gilt holdings by bodies other than the APF have grown by £10.5 billion since July 2020.

That will be especially out for longer-dated Gilts which are being purchased for more than twice their nominal value on occassion. The value of the APF at the end of September was £674 billion. Looking at the calendar the Bank of England bought around £21 billion of UK Gilts or bonds in September meaning it bought nearly all those offered in net terms ( it does not buy new Gilts but by buying older ones pushes others into buying newer ones).

National Debt

The total here is misleading ironically because if the numbers above. Let me explain why.

At the end of September 2020, the amount of money owed by the public sector to the private sector was approximately £2.1 trillion (or £2,059.7 billion), which equates to 103.5% of gross domestic product (GDP).

That seems simple but a reasonable chunk of that is not debt at all and it relates to the Bank of England.

The estimated impact of the APF’s gilt holdings on PSND ex currently stands at £105.6 billion, the difference between the nominal value of its gilt holdings and the market value it paid at the time of purchase. The final debt impact of the APF depends on the disposal of these financial instruments at the end of the scheme.

Further, the APF holds £19.7 billion in corporate bonds, adding an equivalent amount to the level of public sector net debt.

If we just consider the latter point no allowance at all is made for the value of the corporate bonds. In fact we can also throw in the Term Funding Scheme for good luck and end up with a total of £225 billion. Thus allowing for all that this is where we are.

public sector net debt excluding public sector banks (PSND ex) at the end of September 2020 would reduce by £225.6 billion (or 11.4 percentage points of GDP) to £1,834.1 billion (or 92.1% of GDP).

Comment

Some of the numbers come under the category described by the apocryphal civil servant Sir Humphrey Appleby as a clarification. By that he does not mean something that is clearer he means you issue it to obscure the truth. We have seen this consistently in the area of inflation measurement where the last decade has seen a litany of increasingly desperate official attempts to miss measure it. It is also hard not to have a wry smile at one inflation measure rising about the target as the Bank of England is often keen on emphasising such breakdowns. But a suspect a rise will get ignored on the grounds it is inconvenient.

Switching to the UK public finances we see that there is a lot of uncertainty as many tax receipt numbers are estimated. In normal times that is a relatively minor matter but at a time like this will be much more material. Also government expenditure is more uncertain that you might think or frankly in an IT era it should be. The national debt is also much more debatable that you might think especially with the Bank of England chomping on it like this.

Come back stronger than a powered-up Pacman ( Kaiser Chiefs )
Oh well.

 

 

 

Greece rearms but what about the economy?

These times does have historical echoes but in the main we can at least reassure ourselves that one at least is not in play. However Greece is finding itself in a situation where in an echo of the past it is now boosting its military. From Neoskosmos last month.

Greece’s new arms procurement program features:

  • A squadron 18 Rafale fighter jets to replace the older Mirage 2000 warplanes
  • Four Multi-Role frigates, along with the refurbishment of four existing ones
  • Four Romeo navy helicopters
  • New anti-tank weapons for the Army
  • New torpedoes for the Navy
  • New guided missiles for its Air Force

The Greek PM also announced the recruitment of a total of 15,000 soldier personnel over the next five years, while the Defence industry and the country’s Armed Forces are set for an overhaul, with modernisation initiatives and strengthening of cyberattack protection systems respectively.

Some of this will provide a domestic economic boost with the extra 15,000 soldiers and some of the frigate work. Much will go abroad with President Macron no doubt pleased with the orders for French aircraft as he was calling for more of this not so long ago. As a major defence producer France often benefits from higher defence spending. That scenario has echoes in the beginnings of the Greek crisis as the economy collapsed and people noted the relatively strong Greek military which had bought French equipment. Actually a different purchase became quite a scandal as bribery and corruption allegations came to light. The German Type 214 submarines had a host of problems too as the contract became a disaster in pretty much every respect.

The driving force behind this is highlighted by Kathimerini below.

Turkey’s seismic survey vessel, Oruc Reis, was sailing 18 nautical miles off the Greek island of Kastellorizo on Tuesday morning. The vessel, which had its transmitter off, was heading northeast and, assuming it continues its course at its current speed, it was expected to reach a point 12 nautical miles off Kastellorizo by around noon.

The catch is that many of the defence plans above take many years to come to fruition and Greece is under pressure from Turkey in the present.

The Economy

At the end of June the Bank of Greece told us this.

According to the Bank of Greece baseline scenario, economic activity in 2020 is expected to contract substantially, by 5.8%, and to recover in 2021, posting a growth rate of 5.6%, while in 2022 growth will be 3.7%. According to the mild scenario, which assumes a shorter period of transition to normality, GDP is projected to decline by 4.4% in 2020 and to increase by 5.8% and 3.8%, respectively, in 2021 and 2022. The adverse scenario, associated with a possible second wave of COVID-19, assumes a more severe and protracted impact of the pandemic and a slower recovery, with GDP falling by 9.4% in 2020, before rebounding to 5.7% in 2021 and 4.5% in 2022.

As it turns out it is the latter more pessimistic scenario which is in people’s minds this week. As I regularly point out the forecasts of rebounds in 2021 and 22 are pretty much for PR purposes as we do not even know how 2020 will end. This is even more exacerbated in Greece which has been forecast to grow by around 2% a year for the last decade whereas the reality has been of a severe economic depression.

The projection of a 9.4% decline would mean that we would then be looking at a decline of around 30% from the peak back in 2009. I am keeping this as a broad brush as so much is uncertain right now. But one thing we can be sure of is that historians will report this episode as a Great Depression.

What about the public finances?

There is a multitude of issues here so let us start with the latest numbers.

In January-September 2020, the central government cash balance recorded a deficit of €12,860 million, compared to a deficit of €1,243 million in the same period of 2019. During this period, ordinary budget revenue amounted to €30,312 million, compared to €35,279 million in the corresponding period of last year. Ordinary budget expenditure amounted to €41,332 million, from €37,879 million in January-September 2019.

Looking at the detail for September there was quite a plunge in revenue from 5.2 billion Euros last year to 3.8 billion this. Monthly figures can be erratic and there have been tax deferrals but that poses a question about further economic weakness?

If we try to look at how 2020 will pan out then last week the International Monetary Fund suggested this.

The Fund further anticipates the budget deficit this year to come to 9% of GDP, matching the global average rate, while the draft budget provides for 8.6% of GDP. In 2021 the deficit is expected to return to 3% of GDP rate, as allowed for by the general Stability Pact rules of the European Union, the IMF says, bettering the government’s forecast for 3.7% of GDP. ( Kathimerini)

As an aside I do like the idea that the Growth and Stability Pact still exists! That is a bit like the line from Hotel California.

“Relax”, said the night man
“We are programmed to receive
You can check out any time you like
But you can never leave”

Actually it has only ever applied when it suited and I doubt it is going to suit for years. Anyway we can now shift our perspective to the national debt.

However, on the matter of the national debt, the government appears far more optimistic than the IMF. The Fund sees Greek debt soaring to 205.2% of GDP this year, from 180.9% in 2019, just as the Finance Ministry sees it contained at 197.4%. ( Kathimerini)

I do like the idea of it being “contained” at 197.4% don’t you? George Orwell would be very proud. So we can expect of the order of 200%. Looking ahead we see a familiar refrain.

For 2021 the government anticipates a reduction of the debt to 184.7% of GDP, compared to 200.5% that the IMF projects before easing to 187.3% in 2022 and to 177% in 2023. ( Kathimerini)

This is a by now familiar feature of official forecasts in this area which have sung along with the Beatles.

It’s getting better all the time

Meanwhile each time we look again the numbers are larger.

Debt Costs

This has been a rocky road from the initial days of punishing Greece to the ESM ( European Stability Mechanism) telling us how much it has saved Greece via Euro area “solidarity”

Conditions on the loans from the EFSF and ESM are much more favourable than those in the market. This saves Greeces around €12 billion every year, or 6.7 percent of its economy: a substantial form of solidarity.

These days the European Central Bank is also in the game with Greece now part of its QE bond buying programme. So its ten-year yield is a mere 0.83% and costs of new debt are low.

Comment

I have several issues with all of this. Let me start with the basic one which is that the shambles of a “rescue” that collapsed the economy was always vulnerable to the next downturn.I do not just mean the size of the economic depression which is frankly bad enough but how long it is lasted. I still recall the official claims that alternative views such as mine ( default and devalue) would collapse the economy. The reality is that the “rescue” has collapsed it and people may live their lives without Greece getting back to where it was.

Next comes the associated swerve in fiscal policy where Greece was supposed to be running a primary surplus for years. This ran the same risk of being vulnerable to the economic cycle who has now hit. We are now told to “Spend! Spend! Spend!” in a breathtaking U-Turn. Looking back some of this was real fantasy stuff.

 In 2032, they will review whether additional debt measures are needed to keep Greece’s gross financing needs below the agreed thresholds ( ESM)

Mind you the ESM still has this on its webpage.

Now, these programmes have started to bear fruit. The economy is growing again, and unemployment is falling. After many years of painful reforms, Greece’s citizens are seeing more jobs opening up, and standards of living are expected to rise.

Shifting back to defence we see that another burden is being placed on the Greek people in what seems a Merry Go Round. Reality seldom seems to intervene much here but let me leave you with a last thought. What sort of state must the Greek banks be in?

 

 

China reports year on year economic growth

This has been a year where China has been especially in focus. Even before it began there were plenty of eyes on its economic performance but the Coronavirus pandemic that looks to have emerged from the Huhan Province upped the ante. Today gives us the opportunity to note the official view on economic developments since then.

The economic growth of the first three quarters shifted from negative to positive, the relations between supply and demand gradually improved, the vitality and dynamic of market were enhanced, and the employment and people’s livelihood were well guaranteed. The national economy continued the steady recovery and the overall social stability was maintained.

So quite an apparent triumph with the pattern for the year show below.

Specifically, the GDP for the first quarter declined by 6.8 percent year on year, increased by 3.2 percent for the second quarter, and up by by 4.9 percent for the third quarter.

They use numbers that are compared to the previous year for that quarter so let us now switch to looking at quarterly and annual growth.

The GDP for the third quarter grew by 2.7 percent quarter on quarter……..According to the preliminary estimates, the gross domestic product (GDP) of China was 72,278.6 billion yuan in the first three quarters, a year-on-year growth of 0.7 percent at comparable prices.

So the overall picture we are left with her is of an economy which has weathered the pandemic and in fact grown albeit very slightly. If you want the pattern which has brought us here it is shown below.

The quarter-on-quarter growth of quarterly GDP since 2019 were 1.9 percent, 1.3 percent, 1.0 percent, 1.6 percent, -10.0 percent, 11.7 percent and 2.7 percent respectively.

The Breakdown

In terms of industry China is emphasising that there has been plenty of high-tech growth.

 In the first three quarters, the value added of high-tech manufacturing and equipment manufacturing grew by 5.9 percent and 4.7 percent year on year. In terms of the output of products, in the first three quarters, the production of trucks, excavators and shoveling machinery, industrial robots, and integrated circuits grew by 23.4 percent, 20.2 percent, 18.2 percent and 14.7 percent year on year respectively.

I am not quite sure why they needed so many extra trucks, excavators and shovelling machinery. Unless of course they were dealing with the swine flu problems of pork production.

Specifically, the output of poultry grew by 6.5 percent, and output of beef, mutton and pork dropped by 1.7 percent, 1.8 percent and 10.8 percent respectively, a decline narrowed by 1.7 percentage points, 0.7 percentage points and 8.3 percentage points compared with that of the first half of this year. The pig production capacity gradually recovered. By the end of the third quarter, 370.39 million pigs were registered in stock, up by 20.7 percent year on year, among which, 38.22 million were breeding sows, up by 28.0 percent.

Overall industry was an outperformer.

Specifically, that of the third quarter grew by 5.8 percent year on year, 1.4 percentage points faster than that of the second quarter.

Services

Again the picture here is of a modern thriving economy.

In the first three quarters, of modern service industries, the value added of the information transmission, software and information technology services, and financial services grew by 15.9 percent and 7.0 percent respectively, or 1.4 percentage points and 0.4 percentage points higher than that of the first half of this year.

However the overall position like elsewhere is of a services sector in decline.

The Index of Services Production dropped by 2.6 percent year on year, a decline narrowed by 3.5 percentage point compared with that of the first half of the year; specifically, that of September grew by 5.4 percent, 1.4 percentage points faster than that of August.

We see that retail sales have had their struggles by the way we are guided towards September rather than the whole third quarter.

In September, the total retail sales of consumer goods reached 3,529.5 billion yuan, up by 3.3 percent year on year, 2.8 percentage points faster than that of August, maintaining the growth for two consecutive months.

Investment

This has managed to just become positive.

In the first three quarters, the investment in fixed assets (excluding rural households) reached 43,653.0 billion yuan, up by 0.8 percent year on year, shifting from negative to positive for the first time in 2020, while that of the first half of this year was down by 3.1 percent.

Looking into the detail we see that one definition of investment ( manufacturing) fell but construction carried on growing.

the investment in manufacturing dropped by 6.5 percent, a decline narrowed by 5.2 percentage points compared with that of the first half of 2020; the investment in real estate development grew by 5.6 percent, 3.7 percentage points faster than that of the first half of 2020.

The latter is very different to what we have seen elsewhere.

Trade

This of course was a contributor to the imbalances that led to the credit crunch. As you can see it has got worse rather than better this year.

In the first three quarters…….The value of exports was 12,710.3 billion yuan, up by 1.8 percent, and the value of imports was 10,404.8 billion yuan, down by 0.6 percent.

I note that they use value rather than volume but suspect this may just be a translation issue. The imbalance situation did improve in September but as ever we need to be cautious about trade figures for a single month.

The Exchange-Rate

This merits a mention as it has not behaved as people continue to expect.There have been plenty of reports published about a weaker Renminbi but in fact in the second half of this year it has been strengthening. The nadir was on the 28th of May at 7.17 versus the US Dollar compared to 6.7 this morning.

What this means beyond the obvious is complex because the Renminbi is neither fixed nor floating and is a managed currency.

Comment

There are several layers in an analysis of this. So let me start from the beginning which is that GDP is calculated differently in China to elsewhere.

While GDP growth in most countries is a measured output that depends on volatile real economic activity, Chinese GDP is an input into the economic process in which local governments are required to add whatever additional economic activity is needed to achieve the targeted GDP growth rate, whether or not this activity adds to welfare or productive capacity ( Michael Pettis )

So a version of “tractor production is always rising” if you like. The debate has gone on for years and a new view on it is around inflation measurement which if you look at the thrust of my work raises a wry smile. Essentially it is not the basic numbers used but it is the inflation measure or deflator that has “smoothed” things since 2012. Taking that view Capital Economics in China suggest GDP has been overstated by around 12%. They back up their view in this way.

For example, the formerly tight link between construction activity and cement output stops working. (See the chart.) Industrial value-added (and monthly IP) become eerily stable, but direct measures of output from industry don’t.

It’s harder to find proxies for services (partly because much of it is lumped together as “other” services, which have apparently been growing very fast). But we see the same abrupt drop in volatility as in industry.

This fits with what we have noted in the past as for example the phase whereby electricity production did not fit what we were told. However, this is a movable feat as once the Chinese noticed this they became “smoothed” too.

So China looks as though it is doing better than us western capitalist imperialists in 2020 which I guess is no great surprise.After all they have much more experience of running a centrally planned economy.We keep stopping ours. However they have been to coin a phrase “somewhat economical with the figures” since around 2012.

There is a subplot to that too as back on the 12th of August I pointed out a really odd move in the UK Deflator.

The implied deflator strengthened in the second quarter, increasing by 6.2%. This primarily reflects movements in the implied price change of government consumption, which increased by 32.7% in Quarter 2 2020.

We failed to follow what Level 42 would call The Chinese Way however as we reduced our GDP by around 5%.

Podcast

 

The Netherlands continues to see house prices surging

Today gives us the opportunity to look at several issues. Sadly the initial opening backdrop is this.

Dutch prime minister Mark Rutte announced yesterday that the Netherlands is going into “partial lockdown”, due to the sharp rising numbers of coronavirus infections. From Tuesday evening, all bars and restaurants will be closed for at least one month. Buying alcohol after 10PM is forbidden. Hotels remain open, as well as bars and restaurants in the airport, after the security check. ( EU Observer).

So we see that another squeeze is being put on the economy To put this another way the Statistics Netherlands report below from Monday now looks rather out of date.

The economic situation according to the CBS Business Cycle Tracer has become less unfavourable in October. However, the economy is still firmly in the recession stage. Statistics Netherlands (CBS) reports that, as of mid-October, 10 out of the 13 indicators in the Business Cycle Tracer perform below their long-term trend. Measures against the spread of coronavirus have had a major impact on many indicators of the Tracer.

If we look at the situation we see that it was a pretty stellar effort to have a reading of 0.56 in April but the number soon plunged to its nadir so far of -1.95 and the latest reading is -1.21.

The picture for trade, investment and manufacturing is as you might expect.

In August 2020, the total volume of goods exports shrank by 2.3 percent year-on-year. Exports of petroleum products, transport equipment and metal products decreased in particular. Exports of machinery and appliances declined as well.

The volume of investments in tangible fixed assets was 4.5 percent down in July 2020 relative to the same month last year. This contraction is smaller than in the previous three months and mainly due to lower investments in buildings and machinery.

In August 2020, the average daily output generated by the Dutch manufacturing industry was 4.0 percent down on August 2019. The year-on-year decrease is smaller than in the previous four months.

Along the way we see how this indicator was positive in April as some of it is lagged by around 3 months. That is also highlighted by the consumer numbers.

In July 2020 consumers spent 6.2 percent less than in July 2019. The decline is smaller than in the previous four months. Consumers again spent less on services but more on goods.

Unemployment

Yesterday’s official release told us that the unemployment data in the Netherlands are as useless as we have seen elsewhere.

In September 2020, there were 413 thousand unemployed, equivalent to 4.4 percent of the labour force. Unemployment declined compared to August and the increase seen in recent months has levelled off. In the period July through September, the number of unemployed increased by a monthly average of 3 thousand. From June to August, unemployment still rose by 32 thousand on average per month, with the unemployment rate going up to 4.6 percent.

There is a clear case for these numbers to be suspended or better I think published with a star combined with an explanation of the problem.

We do learn a little more from the hours worked data although as you can see they are a few months behind the times.

Due to government support measures, job losses were still relatively limited in Q2 at -2.7 percent, but the number of hours worked by employees and self-employed fell significantly and ended at a total of 3.2 billion hours in Q2 2020. Adjusted for seasonal effects, this is 5.7 percent lower than one quarter previously.

GDP

This was better than the Euro area average in the second quarter.

According to the second estimate conducted by CBS, gross domestic product (GDP) contracted by 8.5 percent in Q2 2020 relative to the previous quarter. The decline was mainly due to falling household consumption, while investments and the trade balance also fell significantly. Relative to one year previously, GDP contracted by 9.4 percent.

House Prices

Here we have something rather revealing and ti give you a clue it will be top of the list of any morning meeting at either the Dutch central bank or the ECB.

In August 2020, prices of owner-occupied dwellings (excluding new constructions) were on average 8.2 percent higher than in the same month last year. This is the highest price increase in over one and a half years.

Yes house prices are surging in a really rather bizarre sign of the times.

House prices peaked in August 2008 and subsequently started to decline, reaching a low in June 2013. The trend has been upward since then. In May 2018, the price index of owner-occupied dwellings exceeded the record level of August 2008 for the first time. The index reached a new record high in August 2020; compared to the low in June 2013, house prices were up by 51 percent on average.

This gives us a new take on the “Whatever it takes” speech by ECB President Mario Draghi in July 2012. Because if we allow for the leads and lags in the process it looks as though it lit the blue touchpaper for Dutch house prices. It puts Dutch house prices on the same timetable as the UK where the Bank of England acted in the summer of 2012 and the house price response took around a year.

The accompanying chart will also warm the cockles of any central banking chart as the house price index of 107.2 in September 2016 ( 2015 = 100) becomes 143.4 this August. Actually in the data there is something which comes as quite a surprise to me.

According to The Netherlands’ Cadastre, the total number of transactions recorded over the month of August stood at 19,034. This is almost 3 percent lower than in August 2019. Over the first eight months of this year, a total of 148,107 dwellings were sold. This represents an increase of over 5 percent relative to the same period in 2019.

More transactions in 2020 than 2019? I know such numbers are lagged but even so that should not be true surely?

Inflation

One might reasonably think that with all that house price inflation that inflation full stop might be on the march.

In September, HICP-based prices of goods and services in the Netherlands were 1.0 percent up year-on-year, versus 0.3 percent in August.

the answer is no because the subject of house price rises is ignored on the grounds that they are really Wealth Effects rather than price rises.That, of course throws first-time buyers to the Wolves. In fact if I may use the numbers from Calcasa first-time buyers can be presented as being better off.

On average, 13.6% of net household income was required to service housing costs in the second quarter of 2020, compared to mid-2008 when housing costs represented 27.0% of net income.

Such numbers have the devil in the detail as averages hide the fact that first-time buyers are being really squeezed.

Comment

The Netherlands is an economic battleground of our times.If we start with the real economy we see that there was a Covid-19 driven lurch downwards followed by hints of recovery. Sadly  the recovery now looks set to be neutered by responses to the apparent second Covid wave. The last quarter of 2020 could see another contraction.

Yet if we switch to the asset prices side the central bank has been blowing as much hot air into them it can. Bond prices have surged with bond yields negative all the way along the spectrum ( even the thirty-year is -0.21%), So we start with questions for the pensions and longer-term savings industry. Then we arrive at house prices which are apparently surging. You almost could not make that up at this time! The inflationary impact of this is hidden by keeping the issue out of the official inflation measure or if really forced using rents for people who do not pay rent. Meanwhile their other calculations include gains from wealth effects boosting the economy.

If we look forwards all I can see is yet another easing move by the ECB with more QE this time maybe accompanied by another interest-rate cut. I fail to see how this will make things any better.

 

Do we face austerity and tax rises after the Covid-19 pandemic?

We have been in uncertain times for a while now and this has only been exacerbated by the Covid-19 pandemic. One particular area of concern are the public finances of nations who are copying the “Spend! Spend! Spend!” prescription of football pools winner Viv Nicholson. For younger readers the football pools were what people did before lotteries. Indeed if we note the latest IMF Fiscal Monitor there was an issue even before the new era.

Prior to the pandemic, public and private debt were
already high and rising in most countries, reaching
225 percent of GDP in 2019, 30 percentage points
above the level prevailing before the global financial
crisis. Global public debt rose faster over the period,
standing at 83 percent of GDP in 2019.

We get a pretty conventional response for the IMF which has this as a mantra.

And despite access to financing varying sharply across countries, medium- to long-term fiscal strategies were needed virtually everywhere.

There is a counterpoint here which is that the fiscal strategies approved by the IMF have been a disaster. There is of course Greece but in a way Japan is worse. Following IMF advice it began a policy of raising its Consumption Tax to reduce its fiscal deficit. It took five years for it to take the second step as the first in 2014 caused quite a dive in the economy. Then the second step last year saw Japan’s economy contract again, just in time to be on the back foot as the Covid-19 pandemic arrived.

The IMF is expecting to see quite a change this year.

In 2020, global general government debt is estimated to make an unprecedented jump up to almost 100 percent of GDP. The major increase in the primary deficit and the sharp contraction in economic activity of 4.7 percent projected in the latest World Economic Outlook, are the main drivers of this development.

Oh and where have we heard this before? The old this is “temporary” line.

But 2020 is an exceptional year in terms of
debt dynamics, and public debt is expected to stabilize
to about 100 percent of GDP until 2025, benefiting
from negative interest-growth differentials.

I make the point not because I have a crystal ball but because I know I do not. Right now the path to the end of this year looks extremely uncertain with for example France imposing a curfew on Paris and other major cities and Germany hinting at another lockdown. So we have little idea about 2021 let alone 2025.

The IMF is in favour of more spending this time around.

These high levels of public debt are hence not the
most immediate risk. The near-term priority is to
avoid premature withdrawal of fiscal support. Support
should persist, at least into 2021, to sustain the recovery and to limit long-term scarring. Health and education should be given prime consideration everywhere.

I would have more time for its view on wasteful spending and protection of the vulnerable if the places where it has intervened had actually seen much reform and protection.

Fiscally constrained economies should prioritize the
protection of the most vulnerable and eliminate
wasteful spending.

Economic Theory

The IMF view this time around is based on this view of public spending.

The Fiscal Monitor estimates that a 1 percent of
GDP increase in public investment, in advanced
economies and emerging markets, has the potential to push GDP up by 2.7 percent, private investment by
10 percent and, most importantly, to create between
20 and 33 million jobs, directly and indirectly. Investment in health and education and in digital and green
infrastructure can connect people, improve economy wide productivity, and improve resilience to climate
change and future pandemics.

If true we are saved! After all each £ or Euro or $ will become 2.7 of them and them 2.7 times that. But then we spot “has the potential” and it finishes with a sentence that reminds me of the  company for carrying on an undertaking of great advantage from the South Sea Bubble. For those unaware of the story it disappeared without trace but with investors money.

For newer readers this whole area has become a minefield for the IMF because it thought the fiscal multiplier for Greece would be 0.5 and got involved in imposing austerity on Greece. It then was forced into a U-Turn putting the multiplier above 1 as it was forced to do by the economic collapse which was by then visible to all.

Institute for Fiscal Studies

It has provided a British spin on these events although the theme is true pretty much everywhere we look.

The COVID-19 pandemic and the public health measures implemented to contain it will lead to a huge spike in government borrowing this year. We forecast the deficit to climb to £350 billion (17% of GDP) in 2020–21, more than six times the level forecast just seven months ago at the March Budget. Around two-thirds of this increase comes from the large packages of tax cuts and spending increases that the government has introduced in response to the pandemic. But underlying economic weakness will add close to £100 billion to the deficit this year – 1.7 times the total forecast for the deficit as of March.

I suggest you take these numbers as a broad brush as it will be a long economic journey to April exemplified by that fact that whilst I am typing this it has been announced that London will rise a tier in the UK Covid-19 restrictions from this weekend. I note they think that £250 billion of this is an active response and £100 billion is passive or a form of automatic stabiliser.

They follow the IMF line but with a kicker that it is understandably nervous about these days.

But, in the medium term, getting the public finances back on track will require decisive action from policymakers. The Chancellor should champion a general recognition that, once the economy has been restored to health, a fiscal tightening will follow.

They are much less optimistic than the IMF about the middle of this decade/

Under our central scenario, and assuming none of the temporary giveaways in 2020–21 are continued, borrowing in 2024–25 is forecast to be over £150 billion as a result of lower tax revenues and higher spending through the welfare system.

They do suggest future austerity.

Once the economy has recovered, policy action will be needed to prevent debt from continuing to rise as a share of national income. Even if the government were comfortable with stabilising debt at 100% of national income – its highest level since 1960 – it would still need a fiscal tightening worth 2.1% of national income, or £43 billion in today’s terms.

Comment

As you can see the mood music from the establishment and think tanks has changed somewhat since the early days of the credit crunch.Austerity was en vogue then but now we see that if at all it is a few years ahead. Let me now switch to the elephant in the room which has oiled this and it was my subject of yesterday, where the fall in bond yields means governments can borrow very cheaply and sometimes be paid to do it. That subject is hitting the newswires this morning.

The German 10-year bond yield declined to the lowest level in five months on Wednesday as coronavirus’s resurgence across the Eurozone strengthened the haven demand for the government debt. ( FXStreet)

It is -0.61% as I type this and even the thirty-year yield is now -0.22%. So all new German borrowing is better than free as it provides a return for taxpayers rather than investors. According to Aman Portugal is beginning to enjoy more of this as well.

According to the IGCP, which manages public debt, at the Bloomberg agency, €654 million were auctioned in bonds with a maturity of 17 October 2028 (about eight years) at an interest rate of -0.085%.

Although for our purposes we need to look at longer-term borrowing so the thirty-year issue at 0.47% is more relevant. But in the circumstances that is amazingly cheap.

In essence this is what is different this time around and it is one arm of government helping another as the enormous pile of bonds purchased by central banks continue to grow. The Bank of England bought another £4.4 billion this week. So we have a window where this matters much less than before. It does not mean we can borrow whatever we like it does mean that old levels of debt to GDP such as 90% ( remember it?) and 100% and even 120% are different now.

In the end the game changer is economic growth which in itself posts something of a warning as pre pandemic we had issues with it. Rather awkward that coincides with the QE era doesn’t it as we mull the way it gives with one hand but takes away with another?

UK National Grid

It was only last week I warned about this.

National Grid warns of short supply of electricity over next few days ( The Guardian)

Good job it has not got especially cold yet.

Is this the end of yield?

A feature of my career has been both lower interest-rates and bond yields. There have been many occasions when it did not feel like that! For example I remember asking Legal and General why they were buying the UK Long bond ( Gilt) at a yield of 15%. Apologies if I have shocked millennial and Generation Z readers there. There was also the day in 1992 when the UK fell out of the Exchange Rate Mechanism and interest-rates were not only raised to 12% but another rise to 15% was also announced. The latter by the way was scrapped as that example of Forward Guidance did not even survive into the next day.

These days the numbers for interest-rates and yields have become much lower, For example it seemed something of a threshold when the benchmark UK bond or Gilt yield crossed 2%. That was mostly driven by the concept of it being at least in theory ( we have an inflation target of 2% per annum) the threshold between having a real yield and not having one. The threshold however was soon bypassed as the Gilt market continued to surge in price terms. So much in fact that we moved a decimal point as 2.0% became 0.2%. In fact it is very close to the latter ( 0.22%) as I type this.

What happened to the Bond Vigilantes?

We get something of an insight into this by looking at the case of Italy. In the Euro area crisis we saw its benchmark bond yield rise above 7% and if we compare then to now everything is worse.

In the second quarter of 2020 the Gross Domestic Product (GDP) was revised downwards by 13% to the previous
quarter (from 12.8%)………In Q2, Gross disposable income of consumer households decreased in nominal terms by 5.8% with respect to the previous quarter, while final consumption expenditure decreased by 11.5% in nominal terms. Thus, the saving rate increased to 18.6%, 5.3 percentage points higher than in the previous quarter.

That is from the Italian Statistics Office last week. It has been followed this week by this from the IMF.

The International Monetary Fund on Tuesday raised its Italy GDP forecast for 2020 to -10.6%, from June’s -12.8%.
That is an improvement of 2.2 percentage points.
But the IMF cut its Italian growth forecast for next year.
GDP is now expected to rise 5.2% in 2021, 1.1 percentage points lower than the 6.3% forecast in June. ( ANSA)

So the IMF have made this year look better but taken half of that away next year. Actually it makes a mockery of the forecasting process because if you do better then surely that should continue? But, for our purposes today, the issue is of a large fall in economic output in double-digits. This especially matters for Italy because we know from our long-running “Girlfriend in a Coma” theme that it struggles to grow in the better times. So if it loses ground we have to question not only when it will regain it but also if it will?

Switching to debt dynamics ANSA also reported this.

The IMF also said Italy’s public debt will rise to 161.8% of GDP this year, from 134.8% last year, and will then fall to 158.3% in 2021 and 152.6% in 2025.

Those numbers raise a wry smile as we were told back in the day by the Euro area that 120% on this measure was significant. That was quite an own goal at the time but now it has been left well behind. As to the projected declines I would ignore them as they are a given in official forecasts but the reality is that the numbers keep singing along with Jackie Wilson.

You know your love (your love keeps lifting me)
Keep on lifting (love keeps lifting me)
Higher (lifting me)
Higher and higher (higher)

Actually Italy has over time been relatively successful in terms of its annual deficit but not now.

The IMF sees a budget deficit of 13% this year and 6.2% next, falling to 2.5% by 2025.

In a Bond  Vigilante world we would see a soaring bond yields as we note all metrics being worse. Whereas last week I noted this.

Italian 10-Year Government #Bond #Yield Falls To Lowest In More Than A Year At 0.765% – RTRS

This represents quite a move in the opposite direction from when the infamous “‘We are not here to close spreads. This is not the function or the mission of the ECB.’” quote from ECB President Christine Lagarde saw the yield head for 3%. That was as recent as March.

Monday brought more of the same.

Italy‘s 10-year and 30-year sovereign bond yields have dropped to all time-lows of 0.72% and 1.59%, respectively. ( @fwred)

Actually the bond market rally has continued meaning that at 0.64% the Italian benchmark yield is below the US one at 0.72%. This has led some to conclude that Italy is more creditworthy than the US, but perhaps they just have a sense of humour. John Authers of Bloomberg puts it like this.

Forza Italia! The Italian spread over German bunds is the lowest in three years, while the yield on Italian bonds is the lowest since at least 1320: (h/t Jim Reid, @DeutscheBank

)

Take care with the last bit because if I recall my history correctly Italy began around 1870.

But the fundamental point that Italy illustrates is that the Bond Vigilante theme relating to economic problems is presently defunct. In fact we see the opposite of it in markets as you make the most money from markets which start with the worst prospects as there is more to gain.

What about exchange-rate problems Shaun?

This is a subtext which does still continue. Only on Monday we noted that Turkey had to pay 6.5% for a US Dollar bond. Some of the exchange-rate risk is removed by issuing in US Dollars but not all because at some point Turkish Lira need to be used to repay it. But 6.5% looks stellar right now. There is also Argentina where yields are between 40% and 50%.

These are special cases where the yields mostly reflect an expected fall in the currency.

Comment

I have looked at Italy in detail because it illustrates so many of the points at hand. It should be seeing bond yield rises if we apply past thinking styles but we are seeing its doppelganger. The situation is very similar in Greece where the benchmark bond yield is 0.78%. If we look wider around the world we see this.From Bloomberg.

JPMorgan Chase & Co. says the stockpile of developed sovereign debt with a negative yields adjusted for inflation has doubled over the past two years to $31 trillion.

As the Federal Reserve prepares to let prices run hotter to fix the pandemic-hit labor market, the Wall Street bank has a message for investors: Get used to it.“Despite how logic defying the phenomenon is, negative real yields will likely stay with us for a long period to come,” wrote strategists including Boyang Liu and Eddie Yoon.

Adding in inflation means that the situation gets worse for bond owners. There is a familiar theme here because those who own bonds have had quite a party. But the hangover is on its way for future owners who see a market where the profits have already been taken, so what is left for them?

I have left out until now the major cause of the moves in recent times which has been all the QE bond buying by central banks. An example of this will take place this afternoon in my home country when the Bank of England buys another £1.473 billion. The market price for bonds these days is what the central bank is willing to pay. If you can call it a market price. Next comes the issue that countries are relying on this and here is the Governor of the Bank of Italy in Corriere della Sera

Then there is the average cost of debt. Right now it’s 2.4%. It is a high value.

2.4% high? So we arrive at my point which is that the central bankers will drive yields ever lower and as to any turn it will require quite a change as they sing along with McFadden & Whitehead.

Ain’t No Stoppin Us Now!
We’re on the move!
Ain’t No Stoppin Us Now!
We’ve got the groove!

UK labour market data confirm that we are in an economic depression

Today has brought news that adds to my contention that the UK is experiencing an economic depression right now. We have to look deeper than the conventional signals because tight now some of them are not working. For example the official unemployment definition set by the International Labor Organisation or ILO is missing the target by quite a lot. To use a football analogy if they took a shot at goal they not only miss it but they miss the stand as well. This is why.

Under this definition, employment includes both those who are in work during the reference period and those who are temporarily away from a job. The number of people who are estimated to be temporarily away from work includes furloughed workers, those on maternity or paternity leave and annual leave.

As we stand that covers approximately an extra 4 million people which is a huge number compared to what are being reported as unemployed as you can see below.

Estimates for June to August 2020 show an estimated 1.52 million people were unemployed, 209,000 more than a year earlier and 138,000 more than the previous quarter.

This can be misleading for the unwary and I note that the BBC Economics Editor Faisal Islam has failed to note this development.

Sharp spike up in unemployment rate to 4.5%, above 1.5 million, after revisions and the headline numbers finally catching up with grim reality. Suggests monthly number in August as furlough unwound around 5%.

If you actually think the UK unemployment rate is either 4.5% or 5% then I have a bridge to sell you. Poor old Faisal looks completely lost at sea.

Unemployment still low by historic (3 year high) and international standards – but on way up…

It is in reality as I shall explain high but recently has fallen so he is wrong in every respect.

Hours Worked

The actual signal of a depression in the UK labour market is provided here which looks through the issue of the furlough scheme muddying the waters. Let us start with the better part of it which shows a post lockdown ( which just in case we should now call Lockdown 1.0) improvement.

Between March to May 2020 and June to August 2020, total actual weekly hours worked in the UK saw a record increase of 20.0 million, or 2.3%, to 891.0 million hours. Average actual weekly hours worked saw a record increase of 0.7 hours on the quarter to 27.3 hours.

However the overall picture is of a 15% fall in hours worked. Because is we look back to this time last year ( June to August for this purpose) the number of hours worked was 1.049.2 million. Sadly we get little detail on what is the most significant number right now and the maths is mine. The bit below hides more than it reveals.

Although decreasing over the year, total hours worked had a record increase on the quarter, with the June to August period covering a time when a number of coronavirus lockdown measures were eased.

Redundancies

These provide another clear signal as we note this.

Redundancies increased in June to August 2020 by 113,000 on the year, and a record 114,000 on the quarter, to 227,000. The annual increase was the largest since April to June 2009, with the number of redundancies reaching its highest level since May to July 2009.

So in round terms the rate of redundancies has doubled. There is also a hint that things are also getting worse.

The redundancies estimates measure the number of people who were made redundant or who took voluntary redundancy in the three months before the Labour Force Survey interviews; it does not take into consideration planned redundancies.

Pay as You Earn ( PAYE)

The tax data gives us another insight.

Early estimates for September 2020 indicate that there were 28.3 million payrolled employees, a fall of 2.2% compared with the same period in the previous year and a decline of 629,000 people over the 12-month period. Compared with the previous month, the number of payrolled employees increased by 0.1% in September 2020 – equivalent to 20,000 people.

As you can see these numbers are much more timely than the other labour market data which only reach March. It also shows much more of a change than the unemployment numbers but is still undermined somewhat by the existence of the furlough scheme. There will be payrolled employees who are being subsidised by the furlough scheme until the end of October.

Wages

These are giving the same signal as we note this.

In June to August 2020, the rate of annual pay growth was unchanged for total pay but positive 0.8% for regular pay. The difference between the two measures is because of subdued bonuses, which fell by an average negative 15.3% (in nominal terms) in the three months June to August 2020.

So pay growth is no longer negative as we note an unsurprising divergence between regular pay and bonuses. This compares to where we were pre pandemic as shown below.

The rate of growth stood at 2.9% in December 2019 to February 2020 immediately prior to the coronavirus (COVID-19) pandemic,

We saw wages fall and now they are flatlining. This means that in real terms they are doing this according to the official release.

In real terms, total pay is growing at a slower rate than inflation, at negative 0.8%. Regular pay growth in real terms is now positive, at 0.1%.

So if we use a better inflation measure we see that real wages are falling by a bit more than 1% per annum. This means we are even further below the pre credit crunch peak as we note that this measure has experienced its own version of a Japanese style lost decade.

The aggregate numbers hide a few things as we note some substantial shifts within them.

The public sector saw the highest estimated growth, at 4.1% for regular pay. Negative growth was seen in the construction sector, estimated at negative 5.3%, the wholesaling, retailing, hotels and restaurants sector, estimated at negative 1.8%, and the manufacturing sector, estimated at negative 0.9%. This is, however, an improvement over the growth rates during May to July 2020.

We can learn more from the August data if we look at it as a single month. This is because wages rose from £531 per week to £550 meaning that they were 1.9% higher than a year before. A fair bit of this was the finance sector which saw weekly wages rise by £32 to £721. However there was also welcome news for construction up by £12 to £631 and the hospitality sector where they rose £8 to £364 per week.

Comment

Looking at properly today’s UK labour market release confirms the prognosis of the economic growth or GDP release from Friday. It is not that we lack some green shoots as the August wage data is one and this from the PAYE numbers adds to it albeit is too good to be true right now.

Early estimates for September 2020 indicate that median monthly pay increased to £1,905, an increase of 4.3% compared with the same period of the previous year.

But on the other side of the coin the annual fall in hours worked correlates with the decline in GDP we have seen pretty well. I hope that we can get through this more quickly than in the past but the reality is that these are falls of a size which indicate an economic depression. If reality is too much then you can take a Matrix style blue pill and follow the BBC reporting a 4.5% unemployment rate.

As a caveat all of these numbers are subject to wider margins of error right now. You may be surprised how few are surveyed for the main data source

One key data source for understanding the UK labour market is the Labour Force Survey (LFS), which usually covers around 35,000 households a quarter.

At the moment that will be less representative because in switching to a telephone based system they discovered a change that seems too big to be true.

Back in February around 67 per cent of households in their first interview in the LFS sample were owner occupiers and 32 per cent were renters. But in July this was around 77 per cent and 21 per cent respectively……… For tomorrow’s release we will therefore reweight the estimates so that the shares of owner occupiers and renters are the same as before the pandemic hit in March.