How much difference has the central planning of the Bank of Japan really made?

Sometimes it is hard not to have a wry smile at market developments and how they play out. For example the way that equity markets have returned to falling again has been blamed on the Italian bond market which has rallied since Friday. But this morning has brought a reminder that even central banks have bad days as we note that the Nikkei 225 equity index in Japan has fallen 2.7% or 609 points today. This means that the Bank of Japan will have been busy as it concentrates its buying of equity Exchange Traded Funds or ETFs on down days and if you don’t buy on a day like this when will you? This means it is all very different from the end of September when the Wall Street Journal reported this.

The Nikkei 225 hit 24286.10, the highest intraday level since November 1991—as Japan’s epic 1980s boom was unraveling and giving way to decades of economic stagnation and flat or falling prices. It closed up 1.4% at 24120.04, a fresh eight-month high. The index has more than doubled since Shinzo Abe became prime minister in late 2012, pushing a program of corporate overhaul, economic revitalization, and super-easy monetary policy.

If you are questioning the “corporate overhaul” and “economic revitalization” well so am I. However missing from the WSJ was the role of the Bank of Japan in this as it has reminded us this morning as its balance sheet shows some 21,795,753,836,000 Yen worth of equity ETF holdings. Actually that is not its full holding as there are others tucked away elsewhere. But even the Japanese owned Financial Times thinks this is a problem for corporate overhaul rather than pursuing it.

According to one brokerage calculation, the BoJ has become a top-10 shareholder in about 70 per cent of shares in the Tokyo Stock Exchange first section. Because it does not vote on those shares, nor insists that ETF fund managers do so on its behalf, proponents of better corporate governance see the scheme as diluting shareholder pressure on companies.

Intriguingly the Financial Times article was about the Bank of Japan doing a stealth taper of these purchases but rather oddly pointed out it had in fact over purchased them.Oh Well!

In early July, for example, analysts noted that over the first 124 trading days of the 245-day trading year, the BoJ had bought ETFs that annualised at a pace of ¥7tn — or ¥1tn ahead of target.

That seems to explain a reduction in purchases quite easily. Anyway, moving back to the Bank of Japan’s obsession with manipulating markets goes on as you can see from this earlier.

BoJ Gov Kuroda: Told Japan Gvt Panel He Will Continue TO Monitor Market Moves – RTRS Citing Gvt Official   ( @LiveSquawk )

It was especially revealing that he was discussing the currency which is not far off where it was a year ago. Mind you I guess that is the problem! It is also true that the Yen tends to strengthen in what are called “risk-off” phases as markets adjust in case Japan repatriates any of its large amount of investments placed abroad.

Putting it another way to could say that the Japanese state has built up a large national debt which could be financed by the large foreign currency investments of its private-sector.

Monetary Base

This has been what the Bank of Japan has been expanding in the Abenomics era and it is best expressed I think with the latest number.

504.580.000.000.000 Yen


All the buying above was supposed to create consumer inflation which was supposed to reflate the economy and bring the Abenomics miracle. Except it got rather stuck at the create consumer inflation bit. Just for clarity I do not mean asset price inflation of which both Japanese bonds and equities have seen plenty of and has boosted the same corporate Japan that we keep being told this is not for. But in a broad sweep Japan has in fact seen no consumer inflation. If we look at the annual changes beginning in 2011 we see -0.3%,0%,0.4%,2.7%,0.8%,-0.1% and 0.5% in 2017. For those of you thinking I have got you Shaun about 2014 that was the raising of the Consumption Tax which is an issue for consumers in Japan but was not driven by the monetary policy.

In terms of the international comparisons presented by Japan Statistics it is noticeable how much lower inflation has been over this period than in Korea and China or its peers. In fact the country it looks nearest too is Italy which reminds us that there are more similarities between the two countries economies than you might think with the big difference being Italy’s population growth meaning that the performance per capita or per head is therefore very different to Japan.

Bringing it up to date whilst we observe most countries for better or worse ( mostly worse in my opinion) achieving their inflation target Japan is at 1.2% so still below. Considering how much energy it imports and adding the rise in the oil price we have seen that is quite remarkable, but also an Abenomics failure.

The Bank of Japan loves to torture the data and today has published its latest research on inflation without food, without food and energy, Trimmed mean, weighted median, mode and a diffusion index. These essentially tell us that food prices ebb and flow and that the inflation rate of ~0% is er ~0% however you try to spin it.


Here Japan looks as though it is doing well. According to research released earlier Japan saw real exports rise by 2.5% in 2016 and by 6.4% in 2017 although more recently there has been a dip. A big driver has been exports to China which rose by 14.1% last year and intriguingly there was a warning about the emerging economies as exports to there had struggled overall and have now turned lower quite sharply.


As you can see from the numbers above the Bank of Japan has taken central planning to new heights. Even it has to admit that such a policy has side-effects.

Risk-taking in Japan’s financial sector hit a near three-decade high in the April-September, a central bank gauge showed, in a sign years of ultra-easy monetary policy may be overheating some parts of the industry…………The index measuring excess risk-taking showed such financial activity was at its highest level since 1990, when Japan experienced the burst of an asset-inflated bubble.

One of the extraordinary consequences of all this is that in many ways Japanese economic life has continued pretty much as before. The population ages and shrinks and the per head performance is better than the aggregate one. If things go wrong the Japanese via their concept of face simply ignore the issue and carry on as the World Economic Forum has inadvertently shown us today.

What a flooded Japanese airport tells us about rising sea levels

You see Kansai airport in Osaka was supposed to be a triumph of Japan’s ability to build an airport in the sea. To some extent this defied the reality that it is both a typhoon and an earthquake zone. But even worse due to a problem with the surveys the airport began to sink of its own accord, and by much more than expected/hoped. I recall worries that it might be insoluble as giving it a bigger base would add to the weight meaning it would then sink faster! Also some were calculating how much each Jumbo Jet landing would make it sink further. So in some respects it is good news that they have fudged their way such that it still exists at all.

Here is another feature of Japanese life from a foreign or gaijin journalist writing in The Japan Times.

If you’re a conspicuous non-Japanese living here who rides the trains or buses, or goes to cafes or anywhere in public where Japanese people have the choice of sitting beside you or sitting elsewhere, then you’ve likely experienced the empty-seat phenomenon with varying frequency and intensity.

Just as a reminder Japanese public travel is very crowded and commutes of more than 2 hours are more frequent than you might think. How often has someone sat next to him?

It’s such a rare occurrence (as in this is the second, maybe third time in 15 years) that my mind started trying to solve the puzzle.








Inflation reality is increasingly different to the “preferred” measure of the UK

Today brings us a raft of UK data on inflation as we get the consumer, producer and house price numbers. After dipping my toe a little into the energy issue yesterday it is clear that plenty of inflation is on its way from that sector over time. I have a particular fear for still days in winter should the establishment succeed in persuading everyone to have a Smart Meter. Let us face it – and in a refreshing change even the official adverts now do – the only real benefit they offer is for power companies who wish to charge more at certain times. The “something wonderful” from the film 2001 would be an ability to store energy on a large scale or a green consistent source of it. The confirmation that it will be more expensive came here. From the BBC quoting Scottish Power.

We are leaving carbon generation behind for a renewable future powered by cheaper green energy.

We will likely find that it is only cheaper if you use Hinkley B as your benchmark.

Inflation Trends

We find that of our two indicators one has gone rather quiet and the other has been active. The quiet one has been the level of the UK Pound £ against the US Dollar as this influences the price we pay for oil and commodities. It has changed by a mere 0.5% (lower) over the past year after spells where we have seen much larger moves. This has been followed by another development which is that UK inflation has largely converged with inflation trends elsewhere. For example Euro area inflation is expected to be announced at 2.1% later and using a slightly different measure the US declared this around a week ago.

The all items index rose 2.3 percent for the 12 months ending September, a smaller increase than the 2.7-percent increase for the 12 months ending August.

There has been a familiar consequence of this as the Congressional Budget Office explains.

To account for inflation, the Treasury Department
adjusts the principal of its inflation-protected securities each month by using the change in the consumer price index for all urban consumers that was recorded two months earlier. That adjustment was $33 billion in fiscal year 2017 but $60 billion in the current fiscal

The UK was hit by this last year and if there is much more of this worldwide perhaps we can expect central banks to indulge in QE for inflation linked bonds. Also in terms of inflation measurement whilst I still have reservations about the use of imputed rents the US handles it better than the UK.

The shelter index continued to rise and accounted for over half of the seasonally adjusted monthly increase in the all items index.

As you can see it does to some extent work by sometimes adding to inflation whereas in the UK it is a pretty consistent brake on it, even in housing booms.

Crude Oil

The pattern here is rather different as the price of a barrel of Brent Crude Oil has risen by 41% over the past year meaning it has been a major factor in pushing inflation higher. Some this is recent as a push higher started in the middle of August which as we stand added about ten dollars. Although in a startling development OPEC will now be avoiding mentioning it. From Reuters.

OPEC has urged its members not to mention oil prices when discussing policy in a break from the past, as the oil producing group seeks to avoid the risk of U.S. legal action for manipulating the market, sources close to OPEC said.

Seeing as the whole purpose of OPEC is to manipulate the oil price I wonder what they will discuss?

Today’s data

After the copy and pasting of the establishment line yesterday on the subject of wages let us open with the official preferred measure.

The Consumer Prices Index including owner occupiers’ housing costs (CPIH) 12-month inflation rate was 2.2% in September 2018, down from 2.4% in August 2018.

For newer readers the reason why it is the preferred measure can be expressed in a short version or a ore complete one. The short version is that it gives a lower number the longer version is because it includes Imputed Rents where homeowners are assumed to pay rent to themselves which of course they do not.

The OOH component annual rate is 1.0%, unchanged from last month.

As you can see these fantasy rents which comprise around 17% of the index pull it lower and we can see the impact by looking at our previous preferred measure.

The Consumer Prices Index (CPI) 12-month rate was 2.4% in September 2018, down from 2.7% in August 2018.

This trend seems likely to continue as Generation Rent explains.

The experience of the past 14 years suggests rents are most closely linked to wages – i.e. what renters can afford to pay.

With wage growth weak in historical terms then rent growth is likely to be so also and thus from an establishment point of view this is perfect for an inflation measure. This certainly proved to be the case after the credit crunch hit as Generation Rent explains.

As the credit crunch hit in 2008, mortgage lenders tightened lending criteria and the number of first-time buyers halved, boosting demand for private renting – the sector grew by an extra 135,000 per year between 2007 and 2010 compared with 2005-07.  According to the property industry’s logic, the sharp increase in demand should have caused rents to rise – yet inflation-adjusted (real) rent fell by 6.7% in the three years to January 2011.

Meanwhile if we switch to house prices which just as a reminder are actually paid by home owners we see this.

UK average house prices increased by 3.2% in the year to August 2018, with strong growth in the East Midlands and West Midlands.

As you can see 3.2% which is actually paid finds itself replaced with 1% which is not paid by home owners and the recorded inflation rate drops. This is one of the reasons why such a campaign has been launched against the RPI which includes house prices via the use of depreciation.

The all items RPI annual rate is 3.3%, down from 3.5% last month.

There you have it as we go 3.3% as a measure which was replaced by a measure showing 2.4% which was replaced by one showing 2.2%. Thus at the current rate of “improvements” the inflation rate right now will be recorded as 0% somewhere around 2050.

The Trend

This is pretty much a reflection of the oil price we looked at above as its bounce has led to this.

The headline rate of output inflation for goods leaving the factory gate was 3.1% on the year to September 2018, up from 2.9% in August 2018….The growth rate of prices for materials and fuels used in the manufacturing process rose to 10.3% on the year to September 2018, up from 9.4% in August 2018.

So we have an upwards shift in the trend but it is back to energy and oil again.

The largest contribution to both the annual and monthly rate for output inflation came from petroleum products.


It is indeed welcome to see an inflation dip across all of our measures. It was driven by these factors.

The largest downward contribution came from food and non-alcoholic beverages where prices fell between August and September 2018 but rose between the same two months a year ago…..Other large downward contributions came from transport, recreation and culture, and clothing.

Although on the other side of the coin came a familiar factor.

Partially offsetting upward contributions came from increases to electricity and gas prices.

Are those the cheaper prices promised? I also note that the numbers are swinging around a bit ( bad last month, better this) which has as at least a partial driver, transport costs.

Returning to the issue of inflation measurement I am sorry to see places like the Resolution Foundation using the government’s preferred measures on inflation and wages as it otherwise does some good work. At the moment it is the difference between claiming real wages are rising and the much more likely reality that they are at best flatlining and perhaps still falling. Mind you even officialdom may not be keeping the faith as I note this announcement from the government just now.

Yes that is the same HM Treasury which via exerting its influence on the Office for National Statistics have driven the use of imputed rents in CPIH has apparently got cold feet and is tweeting CPI.

Should the ECB be reformed and how?

This morning has brought an intriguing opinion piece in the Alphaville section of the Financial Times. It concerns the European Central Bank and comes from what you might call a classic insider as the header suggests.

Lorenzo Bini Smaghi, Société Générale chairman, Project Associate at the Harvard Kennedy School’s Belfer Center for Science and International Affairs, and Senior Fellow at LUISS School of European Political Economy in Rome.

This covers a lot of ground as after all shouldn’t  being chairman of Societe Generale be a full-time job? This dichotomy where lower jobs are full-time but more senior ones are not seems to be ever more common. With a share price less than a quarter of what it was at its peak and furthermore it being down 25% over the past year you might think directors would be fully employed trying to make things better. Of course we are invariably told that such people can have so many roles because they are so capable and intelligent which of course then begs the question of how we are where we are?

For some reason the Financial Times header was a little forgetful of the fact that Mr Bini Smaghi was an Executive Board member of the ECB for six years from 2005. This matters as it is likely that he is being used like a weather vane, so let us take a look.

The Inflation Target

Here is the opening salvo, with which regular readers will be familiar.

The ECB’s primary objective is price stability, defined as “a rate of inflation below but close to 2 per cent”. The average inflation rate over the 20 years of the euro has been 1.7 per cent, which may suggest success.

Now even your average Martian will be aware that the last decade has not been a success but look what Lorenzo picks out.

However, the result has been less satisfactory (a dalliance with deflation) in more recent periods.

This focusing on deflation is misleading for several reasons. Firstly he is deliberately equating falling prices or disinflation with shrinking aggregate demand or deflation. This matters because Lorenzo’s “deflation” was essentially the result of a lower oil price as I pointed out at the time. Also rather than a problem, at a time of restricted wage growth lower and indeed negative inflation provides an economic boost via its positive impact on real wages. I pointed this out back on the 29th of January 2015.

However if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly.

Thus Lorenzo is flying something of a false flag here and is an example of what I predicted back then.

 If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.

You will not be surprised to find that the suggestion is a loosening of the target as seen below.

 Furthermore, research shows that the ECB’s policy decisions over the years anyway reflect a symmetric interpretation of the target around 2 per cent. So why not move to such a target? It would at least be more transparent.

This matters even more if we note that in spite of the negative interest-rates and the QE inspired balance sheet expansion the ECB has in its own terms not yet achieved its target. This is because whilst inflation is above 2% at 2.1% of that some 0.8% is energy costs which are mostly outside its control. Putting it another way it is remarkable how little consumer inflation has been created by so much monetary easing. In fact with it so low we have to question whether it also has disinflationary influences not predicted by economics 101.

Thus even what seems a minor reshuffling of the target would if we remain in a similar situation to now lead to the possibility of a large policy change. We could get QE to its current maximum in terms of Euro area sovereign bonds where they are bought up to the limit imposed by the German bond market. In a way it all comes from this misrepresentation or lie.

 reconsider the definition of price stability.

Price stability would be 0% not 2% per annum. In response my suggestion would be to lower the Euro area inflation target to either 1.5% or 1%.


The next bit is even odder.

The two pillars are analysis of economic and monetary data, but the latter — money and credit aggregates — have proved over time to be unreliable predictors of inflationary pressures……….. In July 2008, for instance, the resilient fast pace of credit growth justified the rate hike which was made, even as the real economy had started to show signs of a slowdown

Actually if we look at annual M1 growth which is the leading indicator for monetary data the annual rate of growth had fallen from 11.7% in December 2005 to 0.1% in July 2008. So the truth is that the ECB simply looked at (backwards-looking) credit growth rather than the clear signal from M1. Actually, looking at like that the series without seasonal adjustment could hardly be much clearer.


As you can imagine our bank chairman is not keen on the way countries can be excluded from this. After all who will think of the banks holding their debt? Here is his proposed solution.

Consideration should be given to return to a system based on progressive haircuts.

Share risk, as well as supervision

This would have the Starship Enterprise on yellow if not red alert. This is the current state of play.

Banks that are solvent, but do not have adequate collateral, may require the central bank to act as a so-called “lender of last resort”. That function for banks is still decentralized, with the national central banks bearing the risks.

So if an Italian bank were to fail it is the responsibility of the Bank of Italy to step in. Whereas Lorenzo wants this.

In particular, if the decision on whether a bank is solvent and is eligible to emergency lending is centralized, the risk for such lending should be shared.

So in this new universe the ECB would be responsible and not the Bank of Italy as the federal web gets more steel and perhaps titanium. The issue of being “solvent” is usually a red herring as central banks seem to find the most disastrous business models as being viable.

Exit Troika, stage left

Nobody seems to have told Lorenzo about the nomenclature change to “The Institutions”, but of course bankers often struggle with current events. Anyway it is hard to disagree with the thrust here, frankly who would want to be a member of it?

Remaining a member of the Troika is now less justified, and the unpopularity of adjustment programmes tends to erode the ECB’s reputation and independence.

Let somebody else take the blame!


The good news is the implied view that the ECB needs reform. Sadly the predictable part is that it heads in a direction which has so far caused more trouble than it has solved. For those who believe that the Euro establishment want crises so that they can present what they wanted to achieve anyway as part of the crisis resolution there is another tick in that box. My suggestion would be for a much more root and branch reform of central banking. For example inflation control has morphed into inflation creation or in consumer inflation terms attempted inflation control. Plus of course a boost for those who own assets.

However it is also true that the ECB has been left exposed and in the cold by the Euro establishment. The lack of any political response in terms of economic policy to the credit crunch left it and monetary policy with far too much to do. It has overplayed its hand in response, and must now fear heading into the next downturn with its foot still pressing down on the accelerator. At least it managed to shuffle its holdings of Greek debt largely to another Euro area body but that process and its insistence on full repayment added to the crisis at its height.

Heading forwards I would have two main suggestions.

  1. Lower the inflation target
  2. Much more questioning of what QE actually achieves.

The Dollar shortage of 2018 and maybe 19

Today we return to a topic which has been regularly in the headlines in 2018. We started the year with the US administration that looking like it was talking the US Dollar lower in line with its America First policy. Back on the 23rd of January we were mulling this.

“Obviously a weaker dollar is good for us as it relates to trade and opportunities,” Mnuchin told reporters in Davos. The currency’s short term value is “not a concern of ours at all,” he said.

However as the year has gone by we have found ourselves mulling what the US Treasury Secretary said next.

“Longer term, the strength of the dollar is a reflection of the strength of the U.S. economy and the fact that it is and will continue to be the primary currency in terms of the reserve currency,” he said.

If we look at matters from the perspective of the Euro then the 1.20 of the opening of 2018 was fairly quickly replaced by 1.25. But since then the US Dollar has rallied and has moved to 1.15. Some of that has been in the past few days as it has moved from 1.18 to 1.15. That recent pattern has been repeated across most currencies and at 114 the US Dollar us now up on the year against the Yen as well. The UK Pound has suffered this year from a combination of the Brexit process and the machinations of the unreliable boyfriend but it too has been falling recently against the US Dollar to below US $1.30 whilst holding station with other currencies.

Year end problems

The currency moves above are being at least partly driven by this from Reuters.

As the Fed raises interest rates and reduces its balance sheet, and the dollar and U.S. bond yields move up, overseas investors are finding it increasingly difficult and costly to access dollars. That much is obvious. What’s perhaps more surprising – and potentially worrying – is just how expensive and scarce those dollars are becoming.

So with US Dollar scarce it seems that some have been dipping their toes into the spot currency markets as a hedge. This is because other avenues have become more expensive.

Until this week the cross-currency basis market, one of the most closely-watched measures of broad dollar demand, liquidity and funding, had showed no sign of stress. Demand for offshore dollars was being met easily and at comfortable prices.But the basis widened sharply on Thursday, the day after the Fed raised rates for the eighth time this cycle and signalled it fully intends to carry on hiking. In euros, it was the biggest one-day widening since the Great Financial Crisis.

So last week there was a type of double whammy of which the first part came from the US Federal Reserve.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 2 to 2-1/4 percent.

So US official interest-rates have risen but something else has been happening.

Three-month dollar funding costs are currently running around 2.50 pct. Not high by historical standards and, on the face of it, surely manageable for most borrowers. But it is heading higher, and the availability of dollars is shrinking.

So as you can see a premium is being paid on official interest-rates. So we have higher interest-rates and a more expensive currency. We know that in spite of the official rhetoric that various countries are moving away from dollar use the trend has been the other way. From Reuters again.

All this at a time when the world’s reliance on the dollar has never been greater. Its dominance as the international funding currency has grown rapidly since the 2008 crisis, especially for emerging market borrowers.

Dollar credit to the non-bank sector outside the United States stood at 14 percent of global GDP at the end of March this year, up from 9.5 pct at the end of 2007, according to the Bank for International Settlements.

Dollar lending to non-bank emerging markets has more than doubled to around $3.7 trillion since the crisis and a similar amount has been borrowed through currency swaps.

Regular readers will recall that back on the 25th of September I took a look at the potential for a US Dollar shortage as we face a new era.

The question to my mind going forwards is will we see a reversal in the QT or Quantitative Tightening era? The supply of US Dollars is now being reduced by it and we wait to see what the consequences are.

Indian problems

The largest country in the sub-continent has been feeling the squeeze in several ways recently. One has been the move away from emerging market economies and currencies. Another has been the impact of the fact that India is a large oil importer and the price of crude oil has been rising making the problem worse. This morning’s move through US $86 for a barrel of Brent Crude Oil may fade away but over the past year we have seen a rise of around 53%. For the Indian Rupee this has been something of what might be called a perfect storm as it has found itself under pressure from different avenues at the same time. Back on the 16th of August I looked at the Indian crude oil dependency and since then the metric have got worse. The price of oil has risen further and partly in response to that the Rupee has weakened from 70 to the US Dollar which was a record low at the time to 74 today.

Accordingly I noted this earlier from Business Standard.

The Reserve Bank of India (RBI) on Wednesday allowed oil-marketing companies (OMCs) to raise dollars directly from overseas markets without a need for hedging.

In a post-market notification, the RBI said the minimum maturity profile of the borrowings should be three years and five years, and the overall cap under the scheme would be $10 billion. The central bank relaxed criteria for this.

It gives us a guide to the scale of the Indian problem.

The oil-swap facility was much anticipated in the market, as that would have taken the pressure away from the market substantially. Annually, the dollar demand on oil count is $120 billion, or about $500 million, on a daily basis for every working day.

And the driving factor was a lack of US Dollar liquidity

The RBI announcements on liquidity are more focused towards providing relief to the NBFCs (non-banking financial companies) and banks, rather than cooling of the rupee in the FX markets,

Let us move on after noting that the Reserve Bank of India may have had a busy day.

Currency dealers say the RBI intervened lightly in the market.


Overnight we have seen news regarding a possible impact on the US treasury bond market which is for holders a source of US Dollars. From Janus Henderson US.

Euroland, Japanese previous buyers of 10yr Treasuries have been priced out of market due to changes in hedge costs.  For Insurance companies in Germany / Japan for instance, U.S. Treasuries yield only -.10% / -.01%. Lack of foreign buying at these levels likely leading to lower Treasury prices.

This has impacted the US treasury bond market overnight and prices have fallen and yields risen. The ten-year Treasury Note now yields 3.21% instead of 3.15%. That does not make Bill Gross right ( he was famously wrong about UK Gilts being on a bed of nitroglycerine ) as the line of least resistance for markets would be to mark them lower in price terms and see what happens. Try and panic some into selling.

As to the yield issue which may seem odd the problem is that the cost of currency hedging your position is such that you lose the yield. Thus relatively high yielding US Treasuries end up being similar to Japanese Government Bonds and German Bunds.

As ever when there are squeezes on it is not so much the overall position which is a danger but the flows. For example India’s pol problem is good news for oil exporters but if they are not recycling their dollars then there is an imbalance. I guess of the sort which is why this temporary feature became permanent.

In November 2011, the Federal Reserve announced that it had authorized temporary foreign-currency liquidity swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank.

Me on Core Finance TV


The Italian job just got a whole lot harder

The last few days have brought back memories of old times as an old stomping ground has returned to the forefront of financial news. This has been the Italian bond market which has been since Friday morning a real life example of the trading phrase “Don’t try to catch a falling piano”, or in some cases knife. If we look at the Italian bond future it has fallen 6 points since late on Thursday from a bit above 127 to a bit above 121. For these times a 2 point a day drop in a bond market is quite a bit especially when we consider that one large holder will not be selling. That is of course the European Central Bank or ECB which as of the 21st of September had bought some 356.4 billion Euros of them. So we note as an initial point that  falls of this magnitude, which has been on average the old price limit for US Treasury Bond futures ( a 2 point move led to a temporary trading stop back in the day) can happen even in the QE era.

Putting this another way the yield on the Italian ten-year benchmark bond has risen to 3.4%. This means that if we look at the deposit rate of the ECB which is -0.4% there is quite a yield curve here. It starts early with for those who have been invested here quite a chilling thought. You see as recently as mid may the Italian two-year yield was negative ( last December it was -0.36%) whereas at the time of typing this it is 1.56%. So those long have had a disaster although of course they can hold the bond to maturity and just lose the yield. Although of course we would not be here if there were not at least the beginnings of fears over the maturity itself such as perhaps you not being paid in Euros. From @DailyFXTeam.

EUR Borghi comments on the desirability of Italy having its own currency push Italian 10-yr yields to 3.4%, highest since March, 2014

Claudio Borghi is the chief adviser to Matteo Salvini who is Deputy Prime Minister and has been upping the rhetoric himself this morning. Via Twitters translation service.

In Italy No one is drinking the threats of Juncker, which now associates our country with Greece.

Madness they call it madness

There has been plenty of this including this curious statement yesterday from Matteo Salvini.


If we bypass the obvious sexism he is referring to the yield spread between Italian bonds and the benchmark for the Euro area which is of course Germany. A part of the Euro project is that these should converge over time as economies also converge. Except we have seen quite a divergence recently as if we look at the ten-year gap this morning it reached 3% per annum, which if you held to maturity would be a tidy sum especially if this fantasy came true.

Borghi advocating an ECB enforced max spread to Germany of 150bps. ( h/t @stewhampton )

In recent times it would appear that the ECB has been the main buyer of BTPs but it as of this week has reduced again its purchases and will buy around 1.7 billion Euros only in October. As we stand it seems unlikely to fire up its QE programme just for Italy. It did buy Italian bonds back at the peak of the Euro area crisis but bond yields were more than double what they are now.

The Deficit

In the grand scheme of things the change here has been quite minor. From Reuters.

Italy new eurosceptic government proposed on Thursday a budget that increases the deficit to 2.4 percent of gross domestic product in 2019, tripling it in comparison with the plans of its predecessors.

Actually the real change has been from 1.8% of GDP as rumoured just over a week ago, as we find that 0.6% of GDP has turned out to be the straw that broke the camel’s back. Actually the real switch in my opinion is not to be found here but rather in the implications for the national debt.

Under EU law Italy should reduce its public debt rather than increase borrowing. Rome’s total debt is worth 133 percent of GDP.

Just as a reminder the Euro area limit is supposed to be 60% of GDP. Thus Italy is supposed to be reducing its ratio but we know that it has been increasing it over the credit crunch era. Should the higher bond yields last then they will put further upwards pressure on it and in some respects Italy will start to look a little like Greece.

The economy

This is the crux of the matter as the most revealing point is that the budget forecast relies on Italy growing at 1.6% or 1.7% next year. The catch for those who have not followed its economic trajectory is that it only grows at about 1% in the good years and has had a dreadful credit crunch era. Those who were cheerleaders for the “Renzinomics” of around 2014 need to eat more than one slice of humble pie as it never happened. Yesterday brought another same as it ever was signal.

Manufacturing operating conditions in Italy stagnated during September as output and new orders both fell marginally. Job creation was sustained, but at a much slower rate as signs of spare capacity persisted………September’s data also marked the first time in just over two years that the sector has failed to expand.
Manufacturing output fell in September. Although negligible, the decline in production marked a second successive monthly contraction in line with a similar development for new orders.

If we switch to the official monthly economic report it too is downbeat.

In August, both consumer confidence and the composite business indicator declined, influenced respectively by the worsening of economic expectations and the climate in manufacturing sector, which is further affected by the
decline in book orders and expectations on production.

So we see that Italy which grew by 0.5% in the first half of the year will do well to repeat that in the second half especially if we note the slowing of the Euro area money supply we looked at last Thursday.

Much better news came from the labour market.

In August 2018, 23.369 million persons were employed, +0.3% over July. Unemployed were 2.522 million,
-4.5% over the previous month……..Employment rate was 59.0%, +0.2 percentage points over the previous month, unemployment rate was 9.7%, -0.4 percentage points over July 2018 and inactivity rate was 34.5%, +0.1 points over the previous month.

Let us hope that is true as Italy badly needs some good economic news, but it has developed a habit of declaring such numbers and then revising them higher later. Also it remains a bad time to be young in Italy.

Youth unemployment rate (aged 15-24) was 31.0%, +0.2 percentage points over the previous month


The situation here is something which has been changed by some rather small developments. Why? Well it is a consequence of my “Girlfriend in a Coma” theme which I have been running for some years now. When you grow by so little in the good times you are left vulnerable to changes, and hence apparently small ones can cause trouble. This has been added to by the frankly silly rhetoric on both sides.

Added to this is the issue of the consequences of the QE era which has been a subject over the past couple of weeks. Italy tucked itself under the “Whatever it takes” umbrella of President Draghi of the ECB but has not reformed much if at all so as the umbrella gets folded up and put away it is vulnerable again. Since that speech was given in the summer of 2012 the Italian economy has grown by a bit over 2% and is still some 4-5% smaller than it was a decade ago. This is the real Girlfriend in a coma issue which has led to the problems with the banks and the national debt and has given us the Italian version of a lost decade. As the population has been growing the individual experience has been even worse than that.

The other way that Italy is different to Greece is that in Euro terms it is indeed systemic due to its much larger size.





QE and its role in the Dollar shortage, zombie banks and productivity woes

Overnight there have been some intriguing releases from the BIS or Bank for International Settlements, which if you were not aware is the central bankers central bank. The BIS has, although it would not put it like that been reviewing some of the problems and indeed side-effects of the QE ( Quantitative Easing) era, So what does it tell us? Well one major point links to yesterday’s post on India and indeed to the travails of Argentina and Turkey.

The second defining feature is the rise of foreign currency US dollar credit . US dollar-denominated debt securities issued by non-US residents have been the key driver of this trend, surpassing bank loans for the first time in the second half of 2017 . The overall amount of dollar credit to the non-bank sector outside the United States has climbed from 9.5% of global GDP at end-2007 to 14% in the first quarter of 2018. Since end-2016, however, the growth in dollar credit has been flat.

So the US Dollar has been used as a new form of carry trade as people and businesses choose to borrow in it on a grand scale. Also as global GDP has been growing the 14% is of a larger amount. But to me the big connection here is the way that this pretty much coincides with plenty of US Dollars being available because the US Federal Reserve was busy supplying them in return for its QE bond purchases. Correlation does not prove causation but the surge fits pretty well and then it ends not long after QE did. Or more precisely seems to have faded after the first interest-rate increase from the Fed.

The question to my mind going forwards is will we see a reversal in the QT or Quantitative Tightening era? The supply of US Dollars is now being reduced by it and we wait to see what the consequences are. But it is hard to avoid noting the places that seem to be as David Bowie and Queen would put it.

It’s the terror of knowing what this world is about
Watching some good friends screaming, ‘Let me out’
Pray tomorrow gets me higher
Pressure on people, people on streets

Things seem set to tighten a little further tomorrow should the Fed tighten again as looks likely.

Zombie Companies and Banks

This development has been brought to you be the financial world equivalent of Hammer House of Horror. All the monetary easing has allowed companies to survive that would otherwise have folded, or to put it another way the road to what is called “creative destruction” or one of the benefits of capitalism was blocked. A major form of this was the way that banks were bailed out and some of them continue to struggle a decade later but also took us down other roads. For example the debt model of the Glazers at Manchester United looked set to collapse but was then able to refinance more cheaply in the new upside down world. Ironically it was then able to thrive at least financially as in football terms things are not what they were.

The BIS has its worries in this area too.

In this special feature, we explore the rise of zombie companies and its causes and consequences. We take an international perspective that covers 14 countries and a much longer period than previous studies.

It is willing to consider that the era of lower interest-rates and bond yields which covers my whole career and some has had consequences.

A related but less explored factor is the drop in interest rates since the 1980s. The ratcheting-down in the level of interest rates after each cycle has potentially reduced the financial pressure on zombies to restructure or exit. Our results indeed suggest that lower rates tend to push up zombie shares, even after accounting for the impact of other factors.

So cutting interest-rates for an economic gain looks to have negative consequences as time passes. How might that work in practice? The emphasis below is mine

Mechanically, lower rates should reduce our measure of zombie firms as they improve ICRs by reducing interest expenses, all else equal. However, low rates can also reduce the pressure on creditors to clean up their balance sheets and encourage them to “evergreen” loans to zombies . They do so by reducing the opportunity cost of cleaning up (the return on alternative assets), cutting the funding cost of bad loans, and increasing the expected recovery rate on those loans. More generally, lower rates may create incentives for risk-taking through the risk- taking channel of monetary policy. Since zombie companies are risky debtors and investments, more risk appetite should reduce financial pressure on them.

The reason for the emphasis is that in essence that is the rationale for QE. That is something of a change on the past but as inflation as measured by consumer inflation mostly did not turn up the central banks got out their erasers and deleted that bit. It has been replaced by this sort of thing which links to the Zombie companies and banks theme.

In addition, QE can stimulate the economy by boosting a wide range of financial asset prices. ( Bank of England )

Note the use of the word can so that even the Take Two version can be erased! But the crucial point is that yet again the Zombies are on the march via central banking support. I guess most of you have already guessed the next bit.

Visual inspection suggests that the share of zombie firms is indeed negatively correlated with both bank health and interest rates.

Why are Zombies such a problem?

The have negative effects on economic life.

a higher share of zombie firms could depress productivity growth,

Could? Later we get more of a would as we see an old friend called “crowding out” return to the picture.

Zombies are less productive and may crowd out growth of more productive firms by locking resources (so-called “congestion effects”). Specifically, they depress the prices of those firms’ products, and raise their wages and their funding costs, by competing for resources.

But there is a deeper consequence.

We find that when the zombie share increases, productivity growth declines significantly, but only for the narrowly defined zombies………. The estimates indicate that when the zombie share in an economy increases by 1%, productivity growth declines by around 0.3 percentage points.


There is a fair bit to consider here. The first is the role of the BIS in this which in some ways is welcome but in others less so.  The former is an admittal of some of the side-effects of easy monetary policy but the latter is the way we are getting it a decade late. Or in the case of Japan a couple of decades or so late! To my mind intelligence also involves an element of timeliness. Although to be fair to do quantitative research you do need an evidence base. The catch as ever for the evidence in economics is the way that some many things are varying not only with each other but also with themselves over time. Or if you prefer heteroskedasticity and multicollinearity.

As to the issues they tend to be on the back burner because they are inconvenient for the establishment. The career path of economists at central banks is unlikely to be improved by research into the collateral damage of its policies especially ones which it may not be able to reverse. At the moment both ZIRP and QE are in that category even in the US. So should the period of QT lead to the issue below rising in volume get ready for the claims that it could not have been expected and is nobody’s fault.

I need a dollar dollar, a dollar is what I need
Hey hey
Well I need a dollar dollar, a dollar is what I need
Hey hey

On that subject I note that a bank borrowed 563 million Euros from the ECB overnight which is odd with so much Euro liquidity around. Next we come to the issue of the productivity puzzle which seems likely to have a few of its pieces with zombie companies on it. The same zombie companies and especially banks that have been so enthusiastically propped up. Time for some Cranberries.

Zombie, zombie, zombie, ei, ei
What’s in your head?
In your head
Zombie, zombie, zombie

The banking problems of India are mounting

We in the western world have got used to problems with our banking system but yesterday highlighted that we are far from alone. From the Reserve Bank of India.

The Reserve Bank of India and the Securities and Exchange Board of India are closely monitoring recent developments in financial markets and are ready to take appropriate actions, if necessary.

This morning we have seen the government also trying to calm matters.

MUMBAI: Indian Finance Minister Arun Jaitley said on Monday the government is ready to ensure credit is available to non-banking financial companies (NBFCs), just a day after the market regulator and the central bank sought to calm skittish investors.  ( Economic Times of India).

There are a variety of factors at play here but the common denominator is the shadow banking sector.

Yes Bank

Here there were signs of trouble on Friday as the central bank intervened. From Reuters.

 Indian private sector lender Yes Bank Ltd’s shares tumbled nearly a third on Friday, wiping as much as $3.1 billion off its market value, after the central bank reduced charismatic CEO Rana Kapoor’s term, creating uncertainty about its outlook.

Using the word “charismatic” to describe a banker is a warning sign in itself but events here were being driven by this.

Yes Bank’s bad loans spiked in October last year after a risk-based supervision exercise by the central bank forced the lender to account for 63.55 billion rupees ($881.1 million) more in the non-performing category. Kapoor had termed it a “temporary setback” and said remedial steps were underway.

Ah temporary we know what that means especially in banking circles! Yes Bank is the fifth biggest private-sector bank in India and seems to have fallen victim to the effort described below.

Indian banks have seen a surge in soured loans that hit a record $150 billion at the end of March and stricter rules enforced by the central bank are expected to have pushed the industry’s non-performing loans even higher.

So as we note that Yes Bank had been rather too enthusiastic in living up to its name we see that others were competing with it. Somewhat bizarrely it would appear that the RBI is dealing with the private banks because it feels it cannot do so with the state-owned ones.

Earlier this year, RBI chief Urjit Patel said the central bank had limited authority over state-run banks that account for the bulk of bad loans in the sector, and called for reforms to give the regulator more powers to police such lenders.

State Banks

At a time like this we have learned to be very wary of mergers where the reality is often very different from the claims. From News18.

The merger of Bank of Baroda, Vijaya Bank and Dena Bank by the government poses short-term challenges like spurt in bad assets, but will be beneficial over a longer term, a report said today.

Slippages may increase in the short-term as recognition of non-performing assets is harmonised and accelerated, India Ratings said in a note.

By contrast The Times of India appears to have taken up cheerleading.

Made in Baroda, now poised to merge and take on the world

Infrastructure Leasing & Financial Services Ltd

This morning the focus is especially on IL&FS which as Bloomberg explains below has been struggling for a while now.

Infrastructure Leasing & Financial Services Ltd. an Indian conglomerate that has missed payment on more than five of its obligations since August, is seeking to raise more than 300 billion rupees ($4.2 billion) selling assets to cut debt, according to an internal memo seen by Bloomberg.

This is a particular problem because as ever with banking issues the fear is of contagion.

Investors are concerned that defaults by IL&FS, which has total debt of $12.6 billion — 61 percent in the form of loans from financial institutions — could spread to other shadow banks in Asia’s third-largest economy. The firm, which helped fund India’s longest highway tunnel, hasn’t been able to pay more than 4.9 billion rupees ($68 million) of its obligations this year and has additional dues of about 2.2 billion rupees to be repaid by end of October, according to data compiled by Bloomberg.

If we move to the wider shadow banking sector or as India calls them non banking financial companies ( NBFCs) then according to the Economic Times of India we have seen some contagion hints.

The sell-off was sparked by news that a large fund manager sold short-term bonds issued by Indian NBFC Dewan Housing Finance Corp at a sharp discount, raising fears of wider liquidity problem among NBFCs.

DHFC was as high as 679 Rupees at the beginning of the month but in spite of a bounce back rally today it is now at 400.

Bad Debts at Indian banks

The Financial Stability Report of June 26th posted a warning shot.

The stress in the banking sector continues as gross non-performing advances (GNPA) ratio rises further……. SCBs’ GNPA ratio may rise from 11.6 per cent in March 2018 to 12.2 per cent by March 2019………… eleven public sector banks under prompt corrective action framework (PCA PSBs) may experience a worsening of their GNPA
ratio from 21.0 per cent in March 2018 to 22.3 per cent, with six PCA PSBs likely experiencing capital shortfall relative to the required minimum CRAR of
9 per cent.

Sorry for all the acronyms and SCB stands for Scheduled Commercial Banks.

As Reuters reported in May perhaps more of this will be needed.

 When the Indian government announced a surprise $32 billion bailout plan for the nation’s state-controlled banks last October, credit rating firms and the nation’s central bank saw it as a huge step to getting the industry back to robust health – and lending more to businesses and consumers.

Yet the reality as you will have seen already has been one of disappointment.

House Prices

There has been some extraordinary action here in the credit crunch era. According to the RBI house price growth averaged around 15% between 2011 and 2017. Prices are around two and a half times what they were at the beginning of that period. So you might think that the banks are safe. But maybe the times they are a-changing as The Hindu reported in July.

Residential property prices have dropped by up to 15 per cent in Mumbai, NCR, Pune and Kolkata in the first half of 2018 despite government incentives and reduced prices as developers battle with unsold inventory that will take another three years to clear up, Knight Frank said today.

We will have to wait a while for the official data but should we see a dip we will find out which lenders were assuming it would only be up,up and away.


On the face of it the weekend brought some good economic news for India as Fitch Ratings forecast that GDP would rise at an annual rate of 7.8% next year. In what is a poor country in isolation that is very welcome. But the ratings agencies were also optimistic for the western world before our banks hit the “trouble,trouble,trouble” of Taylor Swift.

In terms of bad economic news then it can be encapsulated in the way that Brent Crude Oil has risen above US $80 per barrel this morning. As well as the inflationary impact India is an oil importer so the balance of payments will be hit again by this. No doubt this has been a factor in the weakening of the Rupee through 70 versus the US Dollar (72.6 as I type this) which adds to the inflation problem. Should the RBI respond to this with another interest-rate increase then we see that there is a chain of tightening going on inside India’s financial sector. Can it take the strain?