Yesterday saw a quiet days trading for the Dow Jones Industrial Average in the United States and it ended only 3 points up at 11,010. However the trend in equity markets turned overnight with the Nikkei 225 equity index in Japan falling by some 200 points or 2.1% to 9388. This means that the spread between the Dow and the Nikkei is now some 1622 points or 17.3% of the Nikkei’s value. As recently as late April 2010 both indices were at a similar level at just above 11,000 or in round terms approximately where the Dow is now.
One factor which impacted on Japan was concern about a further tightening of Chinese monetary policy. This was caused by the fact that China’s central bank temporarily raised reserve requirements for six lenders from 17% to 17.5%. The banks involved are Industrial & Commercial Bank, China Construction Bank Corp., Bank of China, Agricultural Bank of China Ltd., China Merchants Bank Co. and China Minsheng Banking Corp. However this fear did not affect Chinese equities which rose. Another impact on Japan was the continuing strength of the Yen which is at 81.93 versus the US dollar and is now strengthening again versus the Euro as it trades at 113.3 versus it. So exporters may well be hoping the Finance Minister Noda delivers on the “bold action” on currencies that he promised today. I also note that he added “if needed” to his sentence which if you consider market levels will probably be interpreted as a weakening of Japan’s resolve rather than a strengthening.
Government Bond Yields
We are entering into an era of incredibly low government bond yields. This has various impacts and not all of them are reported often.
1. The fall in yields has made it easier for governments to finance their deficits. This has proved both helpful and convenient for many governments who have received a fiscal boost from this move. Some like Spain have chosen to spend the “gains” which I consider to be risky as bond yields are by no means guaranteed to stay at these levels.
2. These levels of long-term interest rates should be providing a boost to the world economy as not only are restraints on government spending loosened a little but many private-sector long-term interest rates depend on them. So one might hope for lower corporate lending rates and mortgage rates. I have reported on here before on the falls in the Fannie Mae 30 year fixed mortgage rate. This should be giving the economies a boost.
3. In a slightly odd connection high-grade corporates can now borrow as cheaply or on occasion more cheaply than governments or sovereigns. In essence the market is saying that Microsoft is more likely to pay its debts than the US government. Whilst markets may well have a point this sits somewhat oddly with the fact that it is much cheaper for governments to borrow!
For those looking at the situation let me put some of this into numbers for US government bonds and I am comparing closing yields on the 4th January with last night. Two-year 1.04% versus 0.35%,five-year 2.65% versus 1.11%,ten-year 3.84% versus 2.4%,thirty-year 4.65% versus 3.75%.
Long-term interest-rates and the liquidity trap: QE2 is probably doomed to fail before it even starts
Quite striking is it not? However there is a clear implication for the possible success of QE 2. One of the main mechanisms of quantitative easing is to stimulate the economy by lowering long-term interest rates. However as we have already had considerable falls in this area one and economies are slowing it would appear that the economic impact has been lower than expected.
My contention is that long-term interest rates are as capable of going into a Keynesian “liquidity trap” as short-term ones are. Comments on here have mentioned that many corporates are awash with funds but I suspect that in the main these are the ones who do not need them and the one who do either cannot get funds or have to pay a high price for them. Price becomes irrelevant when the system breaks down.
Not everybody has benefitted from these trends and ones mind already turns to the peripheral Euro zone nations so if we look at ten-year government bond yields for these nations at the close on January 4th 2010 we get, Greece 5.72%,Ireland 4.78% and Portugal 4.07% much lower than the figures they have now.
UK Inflation disappoints again
We got figures for September inflation from the Office for National Statistics today and yet again they were a disappointment.
CPI annual inflation – the Government’s target measure – was 3.1 per cent in September, unchanged from August.The largest downward pressures to the change in CPI inflation came from a variety of transport costs. The largest upward pressures to the change in CPI inflation came from: clothing and footwear where prices overall rose by 6.4 per cent this year, a record rise for the August to September period,and food where the largest upward effects came from meat and fruit.
So we see trends which have been pronounced for a while. If one remembers that we keep being told that the rises in inflation are “temporary” then we should if one takes such a view seen falls in our inflation rate this summer. Instead we are seeing rises in food prices and clothing and footwear stopping this. These are being impacted by the rises in commodity prices that I have written about on here often.
The Retail Price Index was impacted by the same factors this month as CPI but managed to drop slightly from 4.7% to 4.6% although this was above the consensus expectation of 4.4%. The RPI-X which excludes mortgage costs was also at 4.6%.
Comparison with targets
The CPI at 3.1% is some 1.1% above its target whereas its predecessor RPI-X is at 4.6% and is accordingly some 2.1% over its target. This situation has persisted all year which seems to be something of a re-writing of the meaning of the word “temporary.”
Other Inflation Signals
Unfortunately for the UK economy measures of consumer or retail price inflation are not the only signals which are giving us a warning. Only on Friday I reported this.
The British Retail Consortium produced some estimates for the behaviour of shop prices in September. Overall shop price inflation increased marginally in September to 1.9% from 1.7% in August, taking it to the highest rate for five months. Food inflation increased to 4.0% in September from 3.8% in August.
These are not entirely unfamiliar trends and yet again make me wonder about the Bank of England’s definition of the word temporary. Just to add to this we have received producer price numbers for the UK this morning and according to the Office for National Statistics we got the following.
Output price ‘factory gate’ annual inflation for all manufactured products rose 4.4 per cent in September.
Input price annual inflation rose 9.5 per cent in September compared to a rise of 8.7 per cent in August.
And back on the 27th August I reported this.
There is one further implication of today’s figures,further down the report we get figures for the annual implied GDP deflator which in many ways is the best indicator of price inflation that we get as it is a wider measure than just consumer or retail prices and according to the ONS.
The GDP implied deflator rose by 4.1 per cent compared with the second quarter of 2009, up from 2.9 per cent in the previous quarter
So as one can see that it is far from only consumer prices that are showing a disturbing trend and makes me wonder if we are in danger of a move upwards rather than downwards. Obviously there are many factors at work as matters like exchange rates and oil prices can move very quickly in both directions.
A Response from the Monetary Policy Committee
A member of the Monetary Policy Committee David Miles is giving a speech today in Dublin and you might like to hear his views on our inflation prospects. He would have been aware of today’s figures.
UK inflation now sits uncomfortably above the target. But I believe that this tells us rather little about the cyclical position of the economy or where inflation will be in future. Underlying forces that were created by the financial crisis and that would have kept inflation low have been offset by other factors that have kept inflation above target for much of the past year.
I think somebody should make him aware that inflation rises are always caused by imbalances in downward and upward forces. Perhaps a course in mathematics and statistics might help. Indeed a course in asset price behaviour might also help as we also get.
Using monetary policy to reduce variability in asset prices is not likely to be effective.
You see this sentence which looks rather innocent on its own is the way the Bank of England absolves itself from responsibility for the run-up to 2007 and the problems that the boom in property prices and debt have caused. Many MPC members have slipped such references into their speeches,so often in fact that I wonder if they feel it is a type of absolution or perhaps that if they repeat it often enough someone might actually believe it.
I am also reminded looking at the speech of Mr.Miles’s attachment to “output gap” theory. Indeed if you re-read the quotes above it is plain that in a choice between reality (as best we can measure it) and theory he chooses theory. In my experience history is often rather unkind to such people.
My suggestion for the Monetary Policy Committee
Also I have a further thought and it does indicate quite a change. As the role of the Monetary Policy Committee has changed and expanded more than could have been forecast when it was introduced in 1997 there need to be new checks and balances on its power. My suggestion for a change is that MPC members should stand for election as they are currently much more powerful than many of our elected representatives.
Regular readers will be aware I have been suggesting this for a fortnight now and should my Member of Parliament favour me with a reply to my suggestion I will let you know.