Yesterday was a day which saw heavy falls in world equity prices due mostly to bad economic news from the United States. This is becoming something of a trend where US economic figures are either outright poor or are perceived by markets to be disappointing. The Dow Jones Industrial Average fell by 144 points to 10271 accompanied by heavy falls in Europe with the UK FTSE 100 falling 91 points to 5215 and overnight we have seen falls in Japan with the Nikkei 225 equity index closing some 183 points down at 9179. This means that the spread between the Nikkei and the Dow has widened again albeit only slightly. This morning European equity markets have tried a rally but seem to be selling off again as I type this article.
Commodity prices as measured by the Commodity Research Bureau spot index edged down by 0.2 to 452.61 with the only move of any significance being a drop in the fats and oils component in what you can see was a quiet day.
US Economic Figures: Weekly Jobless Claims and the Philly Fed
The day started with the Philadelphia Federal Reserve’s index of business conditions which gave markets a jolt.
The survey’s broadest measure of manufacturing conditions, the diffusion index of current activity, decreased from a reading of 5.1 in July to -7.7 in August. The index turned negative, marking a period of declining monthly activity for the first time since July 2009″
This impacted in several ways I think. Firstly there was the impact of a negative number and secondly there was the size of the fall on a month on month basis. These were added to by the fact that the consensus expectation was for +7. This really was a poor quality consensus and the football terrace chant of “you don’t know what you’re doing” comes to mind here.
Then with markets already on the back foot US weekly jobless claims figures were published by the US Department of Labor.
In the week ending Aug. 14, the advance figure for seasonally adjusted initial claims was 500,000, an increase of 12,000 from the previous week’s revised figure of 488,000. The 4-week moving average was 482,500, an increase of 8,000 from the previous week’s revised average of 474,500.
These figures impacted in several ways. Firstly there was the shock impact of the numbers hitting 500,000 on the week. This was also higher than expected as there had been hopes for a drop in the number from the previous weeks with some looking for a reasonable sized drop to around 460,000. Just to rub it in the previous weeks figures had been revised up by 4000 from a previously reported 484,000. In short they confirmed concerns about the state of the labour markets in the US.
I always counsel caution about survey results and weekly jobless claims can be somewhat volatile as a series. However these two signals do correlate with the picture of the US economy that has been emerging from the recent economic statistics. I quote the four-week average for jobless claims to show that it too is rising and to give at least a little perspective. If you look at the jobless claims figures a rough rule of thumb is that somewhere around 400,000 indicates a recovering economy and an improving employment/unemployment situation.
I am not one of those who thinks that a “double-dip” is inevitable as there remain other alternatives as for example recoveries often struggle a little due to the inventory/stock cycle. However, even so, this is starting to look troubling and is signalling amber rather than red at this point.
The View from the Federal Reserve
One member of the Federal Reserve Open Markets Committee James Bullard gave a presentation on Tuesday night and some of it gave an insight into the thinking of someone who used to be considered as an inflation hawk. Apologies if the quotes are slightly disjointed but they come from a presentation rather than a speech.
It may not be prudent to rely on low policy rates alone to keep the U.S. out of the deflationary outcome.
Instead, supplement current policy with additional QE, should inflation move lower.
So he is openly stating that should the US head towards a deflationary outcome he would look at more asset purchases or QE. Should US economic figures continue to disappoint there will be considerable market pressure on the FOMC at its next meeting (if you remember this was one of the reasons why I felt it should not have acted at the last one) particularly as a FOMC member is openly considering it. Then we get something of note for UK readers as he gives us a view of the UK version of QE.
The U.K. QE program can be viewed as more successful than the U.S. program for this reason
So a member of the FOMC is willing to imply that the UK version of QE has been succesful (if you can call it that…) in creating inflation. As I pointed out yesterday central bankers rarely say anything which might affect another one so I will leave you to decide for yourselves what this means he really thinks. It does coincide with my views on its impact. Then we get the real confirmation of Mr.Bullard’s thoughts.
Should economic developments suggest increased disinflation risk, purchases of Treasury securities in excess of those required to keep the size of the balance sheet constant may be warranted.
To my mind Mr.Bullard is indicating rather openly that he is considering a new wave of asset purchases by the US Federal Reserve and is hinting that this time round it will be based on purchases of US government debt if it happens. With such thoughts well might US Treasury Bonds have falling yields and rising prices. Also as central bankers often communicate in a very restrained code this may be more revealing than the bare text indicates. The FOMC is likely to be under a lot of pressure at its next meeting and one member at least is indicating that he is open to such pressure.
The Bank of England’s Monetary Policy Committee may receive this speech with a frown on its face as it reads the section on the impact of its actions. Its version of QE was supposed to help achieve the UK inflation target not help drive us upwards away from it. Also returning to the next FOMC meeting we could see a three-way split just like the MPC as it also has one member who is against expansionary moves (Mr.Hoenig).
Congressional Budget Office (CBO)
This independent office published its forecasts yesterday for the US Budget Deficit and forecast a small improvement for this year. However if we look at the detail its report may have troubled markets a little.
Relative to the size of the economy, this year’s deficit is expected to be the second largest shortfall in the past 65 years: At 9.1 percent of gross domestic product (GDP), it is exceeded only by last year’s deficit of 9.9 percent of GDP………..Under those assumptions, the deficit would drop to 7.0 percent of GDP in 2011 and 4.2 percent in 2012 and then would reach a low of 2.5 percent of GDP in 2014. For the rest of the 10-year projection period, deficits would range between 2.6 percent and 3.0 percent of GDP.
I think that there are two main issues here. Firstly investors may well be worried about the impact of a slowing US economy on revenue and expenditure and of course expenditure would be driven higher if the employment situation continues its deteriorating trend which after the jobless claims figures would have been on investors minds. Also please look again at the last past of the quote, at no point in the next ten years is the CBO projecting a budget surplus indeed quite the reverse. The CBO is often fairly optimistic too.
Government Bond Yields fall again
With the poor economic news US Treasury Bond yields fell again. The two-year yield fell below 1/2% to 0.47%, the ten -year to 2.56% and the thirty-year to 3.62%. So there are no worries at all at this time about the implications for future borrowing of the CBO’s forecasts. This trend was copied internationally and the German thirty-year bund yield fell below 3%.
It may or may not be sensible to loan money to the German government at 3%. However UK ten-year gilt yields also dipped below 3% for a while which of course compares with an inflation rate which is officially 3.1% or of course if you still look at RPI is 4.8%. So to all intents and purposes a negative real yield.
Now one needs to treat this with a little more care as we are comparing a ten-year instrument with a spot inflation rate. So if we think harder we have an inflation target of 2% which we consistently appear to be exceeding under current policy on the official CPI measure. The alternative is to use the usually higher RPI numbers to do the calculations. However you do them it would appear that the UK has negative real interest rates quite a long way out along her maturity spectrum. In normal times this would be very expansionary.
Are UK savers, depositors and borrowers being “ripped off” by UK banks?
The broker Seymour Pierce has produced a note which makes the following points.
Our other concern is that banks are recouping investment banking losses by expanding margins to retail and small business customers……………….In essence, investment bankers are sucking the blood from UK Retail Bank franchises.
This is a theme that I wrote about in the early days of this blog when I wrote about Competition in the UK Retail Finance Sector on the 3rd December 2009 and a subject I returned too on the 12th December in Official and Unofficial Interest Rates in the UK. In essence banks are paying savers and depositors less and charging borrowers more as a way of making profits to help them rebuild their balance sheets and financial positions.Apart from the basic unfairness of this there is also an element of cross-subsidy towards investment bankers. Yes the same investment bankers who contributed to our current difficulties creating in my view a clear moral hazard.
Not only has the average UK taxpayer had to help finance bailouts of the banks he or she is also implicitly paying via this route. Even with all this aid this is unlikely to be a final solution to the problem as to quote from Seymour Pierce again.
UK banks themselves are struggling for funding, and need to refinance up to £800bn by the end of 2012
We may not have seen the last of it and if the world economic situation continues to deteriorate it may well get worse before it gets better. I am in the camp that believes we needed to reform our banking sector and as we did not take the chance to do so then we are in danger of getting precisely the same results as before.
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