Yesterday was a day where we learned the results of central bankers from two of the world’s central banks. The Chairman of the Federal Reserve gave a speech to Congress whilst the latest minutes from the Bank of England’s Monetary Policy Committee were released. Before I get to these there were two other issues which were significant. Portugal auctioned some twelve month Treasury Bills and had to pay a much higher yield of 2.45% against the 1.036% she paid back in March 17th. This updates what I wrote on her yesterday. Whilst still way below the level that Greece would have to pay it is a significant and therefore disturbing rise in only 4 months. As Portugal is in an austerity drive an increase in expenditure of just under 14 million Euros this year does matter and of course it implies higher costs on future borrowing.
We also saw something happen which I did not expect to see at this stage of the market recovery. In London a company listed called Ocado which appears never to have made a profit in its lifetime and according to many analysts had a value way below the suggested 200-275 pence price range. Then on the day before listing the price dropped to 180 pence and approval of this was rushed through. In all the shenanigans I am left with the view that this resembled a listing at the top of a bull market but my point is we are not in such a market. If you look at this company one is left with a disturbing question, if it is way overvalued as it appears to be how were the shares sold?
The US Economy: Ben Bernanke Speaks
This speech acquired extra significance in the run-up to it because the last few weeks have seen signs of a slowdown in the US economy. The minutes of the last Federal Reserve meeting on June 22/23 had hinted that the Fed is becoming a little concerned. As it has expanded its balance sheet to around 2 trillion US dollars to encourage a recovery you can see why.
As Mr. Bernanke spoke we saw the US stock market fall with the Dow Jones industrial average going from up on the day to down 150 points quite quickly and it closed 109 down. Here are the sections which caused this.
Most participants viewed uncertainty about the outlook for growth and unemployment as greater than normal, and the majority saw the risks to growth as weighted to the downside
Of course, even as the Federal Reserve continues prudent planning for the ultimate withdrawal of extraordinary monetary policy accommodation, we also recognize that the economic outlook remains unusually uncertain. We will continue to carefully assess ongoing financial and economic developments, and we remain prepared to take further policy actions as needed to foster a return to full utilization of our nation’s productive potential in a context of price stability.
I think that US equity markets heard the words “uncertain” and “downside” and panicked. Two contrasting themes clashed here as the one supporting a panic is that central bankers often talk in coded language, Mr. Bernanke’s predecessor Alan Greenspan was very prone to this. On this basis then there may be concern as a central banker will always try to avoid forecasting a downturn in case the forecast itself contributes to it. So for a central banker such issues are rightly difficult. However the other theme is that markets should be well aware of the uncertainties that the US economy faces and recent economic figures should have had them worried about the downside anyway.
For the more thoughtful of mind the lower paragraph illustrates a dilemma about which I have written often. Central banks around the world planned 2010 to be the year where there would be a “withdrawal of extraordinary monetary policy accommodation” and yet find themselves “prepared to take further policy actions”. Another theme I have is our authorities definition of the word temporary as some of these measures are starting to look more and more permanent aren’t they? To my mind the question that is genuinely concerning is how and when will we finally free ourselves of these measure and what are the implications? I am of the view that if US equity markets asked this question we would have fallen by much more than 109 points.
Mr. Bernanke’s speech was revealing in his and the Federal Reserve’s view on US unemployment and the news was not good for America’s job queues. The phrase “attendant uncertainty about job prospects” was followed by.
After two years of job losses, private payrolls expanded at an average of about 100,000 per month during the first half of this year, a pace insufficient to reduce the unemployment rate materially. In all likelihood, a significant amount of time will be required to restore the nearly 8-1/2 million jobs that were lost over 2008 and 2009.
Those unfortunate enough to be in America’s job queues might reasonably be wondering how “long a significant amount of time” is and I would suspect their definition of it is not the same as Mr.Bernanke’s. Interestingly Mr.Bernanke goes on to discuss the issue of long-term unemployment and the effects of it which in some respects is the best part of his speech. It is good to see this issue addressed in an honest fashion.
Moreover, nearly half of the unemployed have been out of work for longer than six months. Long-term unemployment not only imposes exceptional near-term hardships on workers and their families, it also erodes skills and may have long-lasting effects on workers’ employment and earnings prospects.
One of the reasons I approve of this section of his speech is that it addresses a fundamental problem. Many to my mind have assumed that the world hit a crash made some extraordinary moves to deal with it and then will move on. In a way the current fears about a “double-dip” reflect this as again something is expected to happen quickly. However I have been concerned for some time that the build up of issues such as lack of reform of the banking sector and debt problems both private and public act as a dragging anchor and economies grind slowly forward over the next few years. A type of what was called stagflation in the 1970s ( I will deal with US inflation in a moment). Now if you imagine the effect of this on the long-term unemployed I hope my point (and my fears) become clear.
Here Mr.Bernanke is very relaxed for a man who has pumped the best part of 2 trillion dollars into the US monetary system.
Inflation has remained low. The price index for personal consumption expenditures appears to have risen at an annual rate of less than 1 percent in the first half of the year.
Here he and I disagree and I invite readers to look at my article of the 2nd July which argues that inflation in America is higher than that shown in official figures. There are bigger fans than me of the European harmonised measure but even it exposes issues with the American Consumer Prices Index.
US Treasury Bond Market
These responded with a further drop in yields. the ten-year yield closed at 2.89% and the thirty-year closed at 3.9%. If you wish to borrow for two years then you would be happy to borrow at the 0.56% the US Treasury can. This rate has dropped by 0.4% over the past year. In a way you could look at what investors think of the US economy over the next few years from this one fact. Consider it for a moment, if the market has reduced the rate of return they are willing to accept over the next 2 years from a measly 0.96% to 0.56% this is hardly a hopeful sign.
Personally my concerns over inflation mean that I think such investments are unwise. There is of course a more disturbing view that investors are willing to accept an expected loss in real terms over the next two years to be in US dollars and to have their money guaranteed by the US Treasury. That is quite an apocalyptic scenario….
On a more technical point I spotted this in the speech concerning US Treasuries.
In addition, the average maturity of the Treasury portfolio nearly doubled, from three and one-half years to almost seven years.
Those with a memory which reaches back to my article of yesterday may already be thinking of the problem with this. For those who did not read it let me point out again that the United States has been on a trend where it funds itself on an ever shorter basis. The average maturity of US government debt has been shortening. However of the longer-term debt we find that the US has been buying it off herself. This is not an inspiring combination to say the least. If you look at the yields above you can see how funding in the short-term can seem attractive.
However this is bad debt management. If the US economy prospers no doubt those responsible will congratulate themselves on how clever they have been. Should it hit trouble however and find problems in selling her debt then this will be exposed as a very unwise strategy and could even lead to a calamity. Before I move on I would just like to point out that the US has a lot of debt to sell over the next few years…..
1. The Federal Reserve is caught in a real dilemma. At a time when it planned to reduce and take away its extraordinary measures it finds itself having to consider new ones. I pointed out yesterday that if QE mark 1 fails then it is wise to at least question whether QE mark 2 ( i.e more of the same) is likely to succeed. Many economists seem to have an almost messianic faith in this as opposed to looking at the evidence.
2. US debt management has adopted a very risky strategy. Yes it reduces her fiscal deficit right now but at the expense of future risk.
3. Another theme is that “kicking the can down the road” is colliding with the fact that essentially short-term measures are ending or at least being planned to end. The long-term unemployed,for example, might seriously wonder what plans there are which will help them regain work in the medium and long-term.
4. After all the measures by economic authorities and all the vast sums spent we arrive in a position where the future is “uncertain”.
UK Monetary Policy Committee Minutes
Here we saw some similar themes to that of Mr.Bernanke and the Federal Reserve. They too are concerned about a slowdown in economic growth in the UK and worldwide. Having an explicit inflation problem they appear to feel the need to keep repeating the phrase “falling inflation”. Perhaps they feel that repeating this technically true statement according to the official figures will mask the reality that it is way over target and sooth some of the pain of having to include this section.
Near-term inflation prospects had also worsened. Although CPI inflation had fallen again in June, it was likely to be higher during the remainder of 2010 than envisaged in the May Inflation central projection. And the increase in the standard rate of VAT to 20% announced in the Report Budget was likely to add to inflation, particularly in 2011. Because of that, it was increasingly likely that inflation would remain above target for some time. This followed a period of several years in which inflation had been above target for much of the time.
Apart from the spin of “fallen again” if you consider that this is written by the MPC it is quite an indictment of their tenure. Those like me who think that their policies have contributed to the inflation problems of the UK will be concerned to see that they considered doing more of them. However the intellectual tangle the MPC appears to have got itself into is best illustrated by this.
“The Committee considered arguments in favour of a modest easing in the stance of monetary policy…………..But there were also arguments in favour of a modest tightening in the stance of monetary policy”.