Bad US economic news leads to falling equities and UK banks are exploiting customers by raising margins

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%.

Real Yields

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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10 thoughts on “Bad US economic news leads to falling equities and UK banks are exploiting customers by raising margins

  1. Sean

    Excellent blog, yours is one of the best around in clearing the wheat from the chaff which the MSM just cannot seem to do (DT comes close but more from the readers commentary than the actual articles!)

    I agree on the widening margins the UK Banks are charging, in my view it amounts to another ‘back-door bailout/tax’ of ordinary folk, my colleagues in these institutions just cannot see this however, preferring to hide beihnd the ‘essential to the economy argument’ they are sounding more like a protertion racket by the day.


    • Hi Jason
      Thanks for the compliment and welcome to my blog’s comments section. As to the article it is part of a theme that I have been developing for some time now,which in essence is that there were other ways of dealing with the banking system than the one which was adopted. Apart from the obvious moral hazard of rewarding failure our response to a problem where banks got to big to be allowed to fail was to create an even bigger one with the merger of Lloyds and Halifax.No wonder they feel strong enough to behave as they are. If you put to one side the unfairness and in a way dishonesty you hit the biggest problem of all which is that creating what are in effect zombie banks does the economy no good either.

  2. “The larger the immediate fall in output, the larger the reallocation of
    resources away from the most productive firms, which will lead
    to future output being inefficiently low. By allowing inflation
    to rise temporarily and thereby dampening the initial output
    fall, monetary policy can mitigate inefficiently large future
    output fluctuations in subsequent periods.”..says Gertjhan W Vlieghe writing on imperfect credit markets and monetary policy. Ring any bells?

  3. Two thoughts – firstly, regarding the US economy, I wonder whether the exchange rate is a major factor? i.e. $0.7 or less per EUR until January (i.e. $ strong against Euro as a consequence of US recovery & Eurozone debt crisis) shows up 6 months later in a slump in US exports and a rise in German exports. In this case, one would expect the recent recovery in the EUR to show up some time in late autumn as a slump in German exports and a US improvement. It seems like a relay race to the bottom for the developed world currencies.
    Secondly, it does sound like the Fed will start buying more assets soon, perhaps largely Treasuries as you have highlighted – surely this would only be an effective way to combat deflation if the money is used to create demand? e.g. by giving it away to lower income households who spend it all. I guess it is more likely that nothing very effective will be done with the money created. Those who believe these assets will be disposed of at some point would also say that we are simply facilitating more government debt, which is unlikely to help in the long run. I can’t help wondering if the Fed and others feel no great urgency in creating the recovery that Obama needs for re-election. Then again, perhaps monetary policy is not the answer here.

    • I’ve had more coffee and I’m feeling better now. What I meant was ~$1.45/EUR around the New Year, declining to $1.2/EUR by June – with a lag of 3-6 months, you might expect the measured improvement in the Eurozone economy due to currency effects to show up some time around the second quarter and peak by the end of Q3. The recent strengthening of the EUR to $1.3/EUR (if it continues – more likely if the Fed eases soon) might therefore challenge this Eurozone recovery by Q4 2010 and the whole process could start again – Eurozone debt crisis round 2?

  4. Hi

    QE to me is all about protecting the assets of the richest (and yes the banks) if it was about creating demand it would be putting money into the pockets of ordinary folk. This and shielding the previous Govt’s financial incompetance I might add!

    I rue the day Northern Rock was bailed out, if it had been allowed to fail as per any other company (albeit with the incumbant pain) there is no way RBS/HBOS, etc would have carried on as they did.

    As I’ve daid before I have had discussions(!) with banking colleagues of mine who cannot see that they are no different to an employee of Woolies or any other company. They preach market forces, survival of the fittest, etc but not for themselves.

  5. I have just been reading that world bond investors are currently exposed to $91trillions of domestic and international debt. Governments in need of deficit funding and large corporates seeking to avoid bank funding are increasingly tapping security investors for credit. You have pointed to real negative returns being earned. On the one hand its a positive step to give large corporates an alternative to banks. My worry is that there could be huge volatility at the point where these positions unwind as interest rates increase or economic growth improves. Isnt this storing up another large negative feedback loop to the real economy?

    • Hi shireblogger
      The numbers are rather extraordinary aren’t they? One side of this is the way that some of the bond funds such as Pimco feel that they can give policy advice to governments. It is not clear to me that this is entirely healthy but if you project forward they are likely to become more important rather than less. I hope that corporates use the money that they can raise from bond markets but questions remain. If it is part of “the reallocation of
      resources away from the most productive firms” that you quoted from yesterday then we have again learnt little from Japan’s experience. Some may be raising the money simply because they can and are worried about a future where they may not be able too. So we may be seeing a type of disintermediation to use a word which hasnt been used for a while.
      As to negative real interest rates they appear to run a long way along the maturity spectrum now as we see low after low in government bond yields. I am one of those who feel that the Zero interest rate policy or ZIRP at the short end has made many types of monetary policy unproductive (and I have been thinking of some new articles on this subject) but I am also concerned by the headlong dash for lower longer-term rates as older models and principle may not apply. In some ways we simply do not know what we are storing up yet we are going ahead full steam…

      • I very much agree with your concerns. The role and power of the Gilt Gilt Gilt Edged Market Makers cannot be overlooked either. I have been reading about the use of syndication which has very very lucrative and succesful for the DMO and GEMMs. Interestingly,some experts say, of $38.9bn UK syndicated bonds issued this year, only 5% of those deals are with foreign investors.Pension funds and core domestic investors have been brought to these syndicated bonds very succesfully.

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