The murky world of central banks and private-sector QE

The last 24 hours has seen something of a development in the world of central bank monetary easing which has highlighted an issue I have often warned about. Along the way it has provoked a few jokes along the lines of Poundland should now be 50 pence land or in old money ten shillings. Actually the new issue is related to one that the Bank of England experienced back in 2009 when it was operating what was called the SLS or Special Liquidity Scheme. If you have forgotten what it was I am sure the words “Special” and “Liquidity” have pointed you towards the banking sector and you would be right. The banks got liquidity/cash and in return had to provide collateral which is where the link as because on that road the Bank of England suddenly had to value lots of private-sector assets. Indeed it faced a choice between not giving the banks what they wanted or changing ( loosening) its collateral rules which of course was an easy decision for it. But valuing the new pieces of paper it got proved awkward. From FT Alphaville back then.

Accepting raw loans would also ensure that securities taken in the Bank’s operations have a genuine private sector demand rather than comprising ‘phantom’ securities created only for use in central bank operations.

In other words the Bank of England was concerned it was being done up like a kipper which is rather different from the way it tried to portray things.

Under the terms of the SLS, banks and building societies (hereafter ‘banks’) could, for a fee, swap high-quality mortgage-backed and other securities that had temporarily become illiquid for UK Treasury bills, for a period of up to three years.

Some how “high-quality” securities which to the logically minded was always problematic if you thought about the mortgage situation back then had morphed into a much more worrying “phantom” security.  Indeed as the June 2010 Quarterly Bulletin indicated there was rather a lot of them.

But a large proportion of the securities taken have been created specifically for use as collateral with the Bank by the originator of the underlying assets, and have therefore not been traded in the market. Such ‘own-name’ securities accounted for around 76% of the Bank’s extended collateral (around the peak of usage in January 2009), and form the overwhelming majority of collateral taken in the SLS.

Although you would not believe it from its pronouncements now the Bank of England was very worried about the consequences of this and in my opinion this is why it ended the SLS early. Which was a shame as the scheme had strengths and it ended up with other schemes ( FLS, TFS) as we mull the words “one-off” and “temporarily”. But the fundamental theme here is a central bank having trouble with private-sector assets which in the instance above was always likely to happen with instruments that have “not been traded in the market.”

The ECB and Steinhoff

Central banks can also get into trouble with assets that have been traded in the market. After all if market prices were always correct they would move much less than they do. In particular minds have been focused in the last 24 hours on this development.

The news that Steinhoff’s long-serving CEO Markus Jooste had quit sent the company’s share price into freefall on Wednesday morning. Steinhoff opened more than 60% lower, falling from its overnight close of R45.65 to as low as R17.57.

Overall, Steinhoff’s share price has dropped more than 80% over the past 18 months. The stock peaked at over R90 in June last year.  ( Moneyweb).

According to Reuters today has seen the same drum beat.

By 0748 GMT, the stock had slid 37 percent to 11.05 rand in Johannesburg, adding to a more than 60 percent plunge in the previous session. It was down about 34 percent in Frankfurt where it had had its primary listing since 2015.

You may be wondering how a story which might ( in fact is…) a big deal and scandal arrives at the twin towers of the ECB or European Central Bank. The first is a geographical move as Steinhoff has operations in Europe and two years ago today listed on the Frankfurt stock exchange. I am not sure that Happy Birthday is quite appropriate for investors who have seen the 5 Euros of then fall to 0.77 Euros now.

Next enter a central bank looking to buy private-sector assets and in this instance corporate bonds.

Corporate bonds cumulatively purchased and settled as at 01/12/2017 €129,087 (24/11/2017: €127,690) million.

One of the ( over 1000) holdings is as you have probably already guessed a Steinhoff corporate bond and in particular one which theoretically matures in 2025. I say theoretically because the news flow is so grim that it may in practice be sooner. From FT Alphaville.

German prosecutors say they are investigating whether Steinhoff International inflated its revenue and book value, one day after the global home retailer announced that its longtime chief executive had quit…The investigators are probing whether Steinhoff flattered its numbers by selling intangible assets and partnership shares without disclosing that it had close connections to the buyers. The suspicious sales were in “three-digit million” euros territory each, according to the prosecutors.

In terms of scale then the losses will not be relatively large as the bond size is 800 million Euros which would mean that the ECB would not buy more than 560 million under its 70% limit but it does pose questions.

they have a minimum first-best credit assessment of at least credit quality step 3 (rating of BBB- or equivalent) obtained from an external credit assessment institution

This leaves us mulling what investment grade actually means these days with egg on the face of the ratings agencies yet again. As time has passed I notice that the “high-quality” of the Bank of England has become the investment grade of the ECB.

The next question is simply to wonder what the ECB is doing here? Its claim that buying these bonds helps it achieve its inflation target of 2% per annum is hard to substantiate. What it has created is a bull market in corporate bonds which may help economic activity as for example we have seen negative yields even in some cases at issue. But there are side-effects such as moral hazard where the ECB has driven the price higher helping what appears to be fraudulent activity.

How much?

For those of you wondering about the size of the losses there are some factors we do not know such as the size of the holding. We do know that the ECB bought at a price over 90 which compares to the 58.2 as I type this. Some amelioration comes from the yield but not much as the coupon is 1.875% and of course that assumes it gets paid.

My understanding of how this is split is that 20% is collective and the other 80% is at the risk of the national central bank. So there may well be some fun and games when the Bank of Finland ( h/t Robert Pearson) finally reports on this.

Comment

There is much to consider here. Whilst this is only one corporate bond it does highlight the moral hazard issue of a central bank buying private-sector assets. There is another one to my mind which is that overall the ECB will have a (paper) profit but that is pretty much driven by its own ongoing purchases. This begs the question of what happens when it stops? Should it then fear a sharp reversal of prices it is in the situation described by Coldplay.

Oh no what’s this
A spider web and I’m caught in the middle
So I turn to run
And thought of all the stupid things I’d done.

The same is true of the corporate bond buying of the Bank of England which was on a smaller scale but even so ended up buying bonds from companies with ever weaker links ( Maersk) to the UK economy. Even worse in some ways is the issue of how the Bank of Japan is ploughing into the private-sector via its ever-growing purchases of Japanese shares vis equity ETFs. At the same time we are seeing a rising tide of scandals in Japan mostly around data faking.

Me on Core Finance

http://www.corelondon.tv/will-bond-yields-ever-go-higher/

 

 

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What and indeed where next for bond markets?

The credit crunch era has brought bond markets towards the centre stage of economics and finance. Before then there were rare expressions of interest in either a crisis or if the media wanted to film a response to an economic data release. You see equities trade rarely but bonds a lot so they filmed us instead and claimed we were equities trades so sorry for my part in any deception! Where things changed was when central banks released that lowering short-term interest-rates ( Bank Rate in the UK) was not the only game in town and that it was not having the effect that they hoped and planned. Also the Ivory Towers style assumption that short-term interest-rates move long-term ones went the way of so many of their assumptions straight to the recycling bin.

QE

It is easy to forget now what a big deal this was as the Federal Reserve and the Bank of England joined the Bank of Japan in buying government bonds or Quantitative Easing ( QE). There is a familiar factor in that what was supposed to be a temporary measure has now become a permanent feature of the economic landscape. As for example the holdings of the Bank of England stretch to 2068 with no current plan to reverse any of it and instead keeping the total at £435 billion by reinvesting maturities. Indeed on Friday it released this on social media.

Should quantitative easing become part of the conventional monetary policy toolkit?

The Author Richard Harrison may be in line for promotion after this.

Though the model does not support the idea that central banks should maintain permanently large balance sheets, it does suggest that we may see more quantitative easing in the future.

So here is a change for bond markets which is that QE will be permanent as so far there has been little or no interest in unwinding it. Even the US Federal Reserve which to be fair is doing some unwinding is doing so with baby steps or the complete opposite of the way it charged in to increase QE.

Along the way other central banks joined in most noticeably the European Central Bank. It had previously indulged in some QE via its purchases of Southern European bonds and covered ( bank mortgage) bonds but of course it then went into the major game. In spite of the fact that the Euro area economy is having a rather good 2017 it is still at it to the order of 60 billion Euros a month albeit that halves next year. So we are a long way away from it stopping let alone reversing. If we look at one of the countries dragged along by the Euro into the QE adventure we see that even annual economic growth of 3.1% does not seem to be enough for a change of course. From Reuters.

Riksbank’s Ohlsson: Too Early To Make MonPol Less Expansionary

If 3.1% economic growth is “too early” then the clear and present danger is that Sweden goes into the next downturn with QE ongoing ( and maybe negative interest-rates too). One consequence that seems likely is that they will run out of bonds to buy as not everyone wants to sell to the central bank.

Whilst we may think that QE is in modern parlance “like so over” in fact on a net basis it is still growing and only last month a new player came with its glass to the punch bowl.

In addition, the Magyar Nemzeti Bank will launch a targeted programme aimed at purchasing mortgage bonds with maturities of three years or more. Both programmes will also contribute to an increase in the share of loans with long periods of interest rate fixation.

Okay so Hungary is in the club albeit via mortgage bond purchases which can be a sort of win double for central banks as it boosts “the precious” ( banks) and via yield substitution implicitly boosts the government bond market too. But we learn something by looking at the economic situation according to the MNB.

The Hungarian economy grew by 3.6 percent in the third quarter of 2017…….The Monetary Council expects annual economic growth of 3.6 percent in 2017 and stable growth of between 3-4 percent over the coming years. The Bank’s and the Government’s stimulating measures contribute substantially to economic growth.

We are now seeing procyclical policy where economies are stimulated by monetary policy in a boom. In particular central banks continue with very large balance sheets full of government and other bonds and in net terms they are still buyers.

The bond vigilantes

They have been beaten back and as we observe the situation above we see why. Many of the scenarios where they are in play and bond yields rise substantially have been taken away for now at least by the central banks. There can be rises in bond yields in individual countries as we see for example in the Turkish crisis or Venezuela but the scale of the crisis needs to be larger and these days countries are picked off individually rather than collectively.

At the moment there are grounds for the bond yield rises to be in play in the Euro area with growth solid but of course the ECB is in play and in fact yesterday brought news of exactly the reverse.

 

A flat yield curve?

The consequence of central banks continuing with what the Bank of Japan calls “yield curve control” has led to comments like this. From the Financial Times yesterday.

Selling of shorter-dated Treasuries pushed the US yield curve to its flattest level since 2007 on Tuesday. The difference between the yields on two-year Treasury notes and 10-year Treasury bonds dropped below 55 basis points in afternoon trading in New York. While the 10-year Treasury was little changed, prices of two-year notes fell for the second consecutive day. The two-year Treasury yield, which moves inversely to the note’s price, has climbed 64 basis points this year to 1.83 per cent.

If we look long the yield curve the numbers are getting more and more similar ironically taking us back to the “one interest-rate” idea the central banks and Ivory Towers came into the credit crunch with. With the US 2 year yield at 1.8% and the 30 year at 2.71% there is not much of a gap.

Why does something which may seem arcane matter? Well the FT explains and the emphasis is mine.

It marks a pronounced “flattening” of the yield curve, with investors receiving decreasing returns for holding longer-dated bonds compared to shorter-dated notes — typically a harbinger of economic recession.

Comment

We have seen phases of falls in bond prices and rises in yield. For example the election of President Trump was one. But once they pass we are left wondering if the around thirty year trend for lower bond yields is still in play and we are heading for 0% ( ZIRP) or the icy cold waters of negativity ( NIRP)? On that road the idea that the current yield curve shape points to a recession gets kicked into touch as Goodhart’s Law or if you prefer the Lucas Critique comes into play. But things are now so mixed up that a recession might actually be on its way after all we are due one.

For yields to rise again on any meaningful scale there will have to be some form of calamity for the central banks. This is because QE is like a drug for so many areas. One clear one is the automotive sector I looked at yesterday but governments are addicted to paying low yields as are those with mortgages. On that road they cannot let go until they are forced to. Thus the low bond yields we see right now are a short-term success which central banks can claim but set us on the road to a type of junkie culture long-term failure. Or in my country this being proclaimed as success.

“Since 1995 the value of land has increased more than fivefold, making it our most valuable asset. At £5 trillion, it accounts for just over half of the total net worth of the UK at end-2016. At over £800 billion, the rise in the nation’s total net worth is the largest annual increase on record.”

Of course this is merely triumphalism for higher house prices in another form. As ever those without are excluded from the party.

 

 

Can the economy of Italy awake from its coma?

A pleasant feature of 2017 has been the way that the economy of Italy has at least seen a decent patch.  Although sadly the number this morning has been revised lower.

In the third quarter of 2017 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.4 per cent with respect to the second quarter of 2017 and by 1.7 per cent in comparison with the third quarter of 2016

The improved economic outlook for the Euro area has pulled Italy with it although you may note that even with it the numbers are only a little better than the UK so far in annual terms and we of course are in a weaker patch or an economic disaster depending what you read. In fact if you look at annual growth Italy has been improving since the beginning of 2014 but for quite some time it was oh so slow such that the annual rate of growth did not reach 1% until the latter part of 2015 and it is only this year that it has pushed ahead a bit more. Back in 2014 there was a lot of proclaiming an Italian economic recovery whereas in fact the economy simply stopped shrinking.

Girlfriend in a coma

This means that in spite of the better news Italy looks set in 2017 to reach where it was in terms of economic output between 2003 and 2004. This girlfriend in a coma style result has been driven by two factors. First is the fact that the initial impact of the credit crunch was added to by the Euro area crisis such that annual economic output as measured by GDP fell by 8.5% between 2007 and 2014. The second is the weak recovery phase since then which has not boosted it much although of course it is now doing a little better.

If we look ahead a not dissimilar problem seems to emerge. From the Monthly Economic Outlook.

In 2017 GDP is expected to increase by 1.5 percent in real terms.The domestic demand will provide a
contribution of 1.5 percentage points while foreign demand will account for a negative 0.1 percentage
point conterbalaced by the contribution of inventories (0.1 pp). In 2018 GDP is estimated to increase
by 1.4 percent in real terms driven by the contribution of domestic demand (1.5 percentage points)
associated to a negative contribution of the foreign demand (-0.1 percentage points).

When ECB President Mario Draghi made his “everything it takes ( to save the Euro)” speech back in 2012 he might have hoped for a bit more economic zest from his home country.  Even now with the Euro area economy displaying something of a full head of steam Italy does not seem to be doing much better than its long-term average which is to grow at around 1% per annum. That is in the good times and as we noted earlier it gets hit hard in the bad times.

The girlfriend in a come theme builds up if we recall this from the 4th of July.

If we move to a measure which looks at the individual experience which is GDP per capita we see that it has fallen by around 5% over that time frame as the same output is divided by a population which has grown.

There will have been an improvement from the growth in the third quarter but we are still noting a fall in GDP per capita of over 4% in Italy in the Euro era. So more than a lost decade on that measure. As I have pointed out before Italy has seen positive migration which helps with future demographic issues but does not seem to have helped the economy much in the Euro area. For example net immigration was a bit under half a million in 2007 and whilst it has fallen presumably because of the economic difficulties it is still a factor.

During 2016, the international net migration grew by more than 10,000, reaching 144,000 (+8% compared to
2015). The immigration flow was equal to nearly 301,000 (+7% compared to 2015).

Putting it another way the population of Italy was 56.9 million when it joined the Euro and at the opening of 2017 it was 60.6 million. So more people mostly by immigration as the birth rate is falling have produced via little extra output according to the official statistics.

The labour market

If we switch to the labour market we see a reflection of the problem with output and GDP.

In October 2017, 23.082 million persons were employed, unchanged over September 2017. Unemployed
were 2.879 million, -0.1% over the previous month.

So only a small improvement but the pattern below begs more than a few questions.

Employment rate was 58.1%, unemployment rate was 11.1% and inactivity rate was 34.5%, all unchanged
over September 2017.

There are of course issues with a double-digit unemployment which has as part of its make-up an ongoing problem with youth unemployment.

Youth unemployment rate (aged 15-24) was 34.7%, -0.7 percentage points over the previous month

If UB40 did a song for youth unemployment in Italy it would have to be the one in three ( and a bit) not the one in ten

Also the employment rate is internationally low which is mostly reflected in a high inactivity rate. The unemployment rate in Italy is not far from where it was when it joined the Euro.

The banks

It was only last week I looked at the ongoing problems of the Italian banks and whilst they have had many self-inflicted problems it is also true that they have suffered from a weak Italian economy this century. So they have suffered something of a double whammy which means Banca Carige is trying to raise 560 million Euros with the state of play being this according to Ansa.

Out of the main basket Carige, closed the trading of rights to raise capital, it remains at 0.01 euros.

A share price of one Euro cent speaks rather eloquently for itself. If you go for the third capital increase in four years what do you expect?

National Debt

Italy is not especially fiscally profligate but the consequence of so many years of economic struggles means that the relative size of the national debt has grown. From it statistics office.

The government deficit to GDP ratio decreased from 2.6% in 2015 to 2.5% in 2016. The primary surplus as a percentage of GDP, equal to 1.5% in 2016, remained unchanged compared to 2015.

The government debt to GDP ratio was 132.0% at the end of 2016, up by 0.5 percentage points with respect to the end of 2015.

For those who recall the early days of the crisis in Greece the benchmark of a national debt to GDP ratio was set at 120% so as not to embarrass Italy (and Portugal). As you can see it misfired.

Italy has particular reason to be grateful for the QE bond buying of the ECB which has kept its debt costs low otherwise it would be in real trouble right now.

Although on the other side of the coin Italians are savers on a personal or household level.

The gross saving rate of Consumer households (defined as gross saving divided by gross disposable
income, the latter being adjusted for the change in the net equity of households in pension funds reserves)
was 7.5%, compared with 7.7% in the previous quarter and 9.0% in the second quarter of 2016.

Comment

The issue with the Italian economy is that the current improvement is only a thin veneer on the problems of the past. It may awake from the coma but then doesn’t seem to do that much before it goes back to sleep. The current economic forecasts seem to confirm more of the same as we fear what might happen in the next down turn.

One part of the economy that is doing much better is the manufacturing sector according to this morning’s survey released by Markit.

Italy’s manufacturing industry continued to soar in
November as strong external demand, especially
for capital goods, continued to underpin surging
levels of output in the sector.
“Capacity subsequently came under pressure, as
evidenced by the strongest recorded rise in
backlogs of the series history. Companies again
added to their staffing levels as a result.

Let us hope that this carries as we again wonder how much of the economic malaise suffered by Italy is caused by output switching to the unregistered sector.

Me on CoreTV Finance

http://www.corelondon.tv/unsecured-credit-improving/

http://www.corelondon.tv/bitcoin-cryptocurrency-smashing-10000/

Bitcoin both is and is not a store of value

The weekend just gone has seen some extraordinary price moves and yet as I looked through most of the media early this morning there was no mention of it. For example I have just scanned the front page of the online Financial Times and there was not a peep. One mention on Bloomberg seems a little confused.

Bitcoin’s march toward respectability faces another hurdle as hedge-fund platforms reject the overtures of firms trading cryptocurrencies.

I didn’t realise it was marching towards respectability myself and if it was are hedge funds a benchmark? Apparently things are going badly.

It’s the latest blow for a digital currency that’s struggling to break into the financial mainstream.

The next bit I found particularly fascinating.

Joe Vittoria, CEO of the Mirabella platform, said he has doubts over bitcoin’s liquidity and where oversight might come from. There are also suggestions that the digital currency’s valuation should be below where it’s currently trading, he said.

You see that second sentence applies to so many markets right now for example many of the world’s bond markets have been pumped up by central bank buying. Others might be wondering is another example is the online food delivery company Just Eat in the UK which looks set to join the FTSE 100 as it has a larger market capitalisation than the supermarket chain Sainsburys.

For an article posted around 4 hours ago they seem rather behind the times.

While investors have embraced bitcoin, sending it soaring above $8,000.

Last night as I checked how financial markets were starting the week in the far east I noted this and put it on Twitter.

Bitcoin has been on another surge and is US$ 9396 now.

Of course it is soaring above $8000 technically but is behind events. Indeed this morning it has risen again as Reuters point out.

Bitcoin’s vertiginous ascent showed no signs of stopping on Monday, with the cryptocurrency soaring to another record high just a few percent away from $10,000 after gaining more than a fifth in value over the past three days alone.

The digital currency has seen an eye-watering tenfold increase in its value since the start of the year, and has more than doubled in value since the beginning of October.

It BTC=BTSP surged 4.5 percent on the day on Monday to trade at $9,687 on the Luxembourg-based Bitstamp exchange.

There are different pricing platforms but on the one I look at it reached US $9771 earlier. Although as ever there is a fair bit of volatility as it is US $9606 as I type this sentence.

Jamie Dimon

The Chief Executive of JP Morgan hit the newswires back on the 12th of September.

If a JPMorgan trader began trading in bitcoin, he said, “I’d fire them in a second. For two reasons: It’s against our rules, and they’re stupid. And both are dangerous.” ( Bloomberg)

Considering the role of the banking sector in money laundering and financial crime this bit was somewhat breathtaking.

“If you were in Venezuela or Ecuador or North Korea or a bunch of parts like that, or if you were a drug dealer, a murderer, stuff like that, you are better off doing it in bitcoin than U.S. dollars,” he said. “So there may be a market for that, but it’d be a limited market.”

This intervention can be seen two ways. The first is simply expressed by the fact that the price of Bitcoin has more than doubled since then. The second is ironically also that it has doubled as of course that is a building block in determining whether something is a bubble or not.

What has driven this surge?

Back on the 29th of December last year I pointed out the Chinese connection.

There have been signs of creaking from the Chinese monetary system as estimates of the actual outflow of funds from China seem to be around double the official one. Oops!

If we move onto this morning Reuters have been on the case.

By some estimates, China’s overall debt is now as much as three times the size of its economy……..Outstanding household consumer loans have surged close to 30 percent since the middle of last year and reached 30.2 trillion yuan as of October.

This has the government worried.

China’s central bank governor, Zhou Xiaochuan, made global headlines with a warning last month of the risks of a “Minsky moment”, referring to a sudden collapse in asset prices after long periods of growth, sparked by debt or currency pressures.

In such a position Bitcoin investment may seem a lot more sensible than otherwise. If nothing else those caught in the clampdown on the shadow banking sector may think that it is worth a go and the funds involved are so large it would only take a relatively small amount to have a large impact.

It was also be a particular irony if some of the money the Bank of China pumped into the system last week found its way into Bitcoin.

ECB and the war on cash

This is something which must provide some support to Bitcoin which is simply fears over what plans central banks have for cash. This particularly applies to those who have been willing to dip into the icy world of negative interest-rates such as the European Central Bank and I am reminded of this from the 22nd of this month.

The general exception for covered deposits and claims
under investor compensation schemes should be replaced by limited discretionary exemptions to
be granted by the competent authority in order to retain a degree of flexibility. Under that approach,
the competent authority could, for example, allow depositors to withdraw a limited amount of
deposits on a daily basis consistent with the level of protection established under the Deposit
Guarantee Schemes Directive (DGSD)34,

Currently those with most to fear seem to be those with money in Italian banks although just to be clear as we stand now the deposit protection scheme up to 100,000 Euros still operates.

If we look forwards to the next recession it would appear that some central banks will arrive at it with interest-rates still negative so if they apply the usual play-book we will  then see interest-rates negative enough to mean that cash will be very attractive. I have postulated before than somewhere around -1.5% to 2% is the threshold. Then they will have to do something about cash. Perhaps they are on the case.

 

Other fears may come from the way that central banks have expanded balance sheets and thus narrow measures of the money supply. The Bank of Japan explicitly set out to double the monetary base.

Comment

There is a mixture of fear and greed in the price of Bitcoin. The fear comes from those wishing to escape domestic worries in China in particular as well as worries about the next moves of central banks. The greed simply comes from the rise in the price which has been more than ten-fold since I looked at it on December 29th last year. So if you have some well done although of course the real well done comes when you realise the profit. I note others making this point.

Bitcoin’s market cap just passed 150 billion USD. For those who do not know, that is how much money NEW bitcoin “investors” will have to spend, in order for the current bitcoin holders to get the money that they THINK they have.  ( @JorgeStolfi )

That statement is true of pretty much every price although of course some have backing via assets or demand. So often we see a marginal price used to calculate a total based on an average price that is not known. Also with a price that has varied between US $8992 and 9771 today alone I would suggest that this below must have more than a few investors screaming for financial stretcher bearers. From @JosephSkinner74

Long/Short Bitcoin swings with up to 100x Leverage at Bitmex! 💰💰 Enjoy a 10% Fee Discount! 👌🏽

What could go wrong?

This leaves us with the issue of how Bitcoin functions as a store of money which depends on time. Today’s volatility shows that over a 24 hour period it clearly fails and yet if we extend the time period so far at least it has worked rather well as one.

A royal wedding

Firstly congratulations to the hopefully – our royal family has form in this area – happy couple. But fans of the magnificent Yes Prime Minister will already be wondering what it is designed to distract us from and whether Theresa May has turned out to be more effective in this regard than Jim Hacker?!

The Italian banks and how they have contributed to a possible end to deposit protection

A regular feature of recent years has been the Italian banking saga where we are continually reassured that banks are fine and then it turns out that they are not. Many of the misrepresentations have come from Finance Minister Padoan who was in fine form in January according to Politico.

Italian Finance Minister Pier Carlo Padoan has defended the way his country dealt with its banking crisis, saying the government had “only spent €3 billion” on bailouts, in an interview with Die Welt published today.

“We are the EU country that has paid the least to save its banks,” Padoan said. Out of 600 banks, only eight “have problems,” he noted, saying the “system as a whole is not in crisis,” having “withstood the financial crisis.”

Apparently this is a mere bagatelle or the Italian equivalent.

Italy’s banking system is groaning under €360 billion in bad loans,

Such is his loose association with the truth he claimed this.

“I assure you, we have no interest in state intervention,” Padoan said

whilst doing this.

The government has set aside a €20-billion fund to save banks, and is expected to provide roughly €6.7 billion of that to prop up ailing Tuscan lender Monte dei Paschi di Siena.

Oh and he had one last go at what in modern parlance is called “misspeaking”.

Everything has been done “according to European guidelines,” the finance minister added, defending the use of bail-ins, whereby creditors and depositors take a loss on their holdings to help rescue a failing bank.

Actually what was about to come drove a Challenger tank through the rules and in my opinion has contributed to potentially ominous developments for bank depositors in the Euro area. At the moment deposits up to 100,000 Euros are covered unequivocally but on the 8th of this month the European Central Bank published an opinion piece including this and the emphasis is mine.

The general exception for covered deposits and claims
under investor compensation schemes should be replaced by limited discretionary exemptions to
be granted by the competent authority in order to retain a degree of flexibility. Under that approach,
the competent authority could, for example, allow depositors to withdraw a limited amount of
deposits on a daily basis consistent with the level of protection established under the Deposit
Guarantee Schemes Directive (DGSD)34,

That has echoes of the demonetisation shambles that took place in India a year or so ago with queues around the corner for the banks. Now let us take care as the deposit protection scheme still exists as I have seen plenty of places on social media claiming it does not but there are questions about it in the future as you can see. One of my themes is in play here as we note that the ECB is much more concerned about “the precious” than the rights and maybe losses of depositors.

The ECB cautions that prolonged periods during which depositors have no access to their deposits undermine confidence in the banking system and might ultimately create risks to financial stability.

You don’t say!

Monte Paschi

Top of the list as ever is the world’s oldest bank and in terms of the terminator it’s back. From Reuters on the 25th of October.

Shares in the bank opened on Wednesday at 4.10 euros, which became the reference price for the session, and then rose to as much as 5.26 euros, up 28 percent.

That price translates to a paper loss of 1.3 billion euros for Italian taxpayers, who are set to hold 68 percent of the Tuscan bank, which was central to public and private finances in Siena and the surrounding region.

Italy’s government paid 6.49 euros a share in August, when it pumped 3.85 billion euros into Monte dei Paschi, and is spending another 1.5 billion euros to shield some of the bank’s junior bondholders, whose debt was converted into equity.

Actually since then shareholders have had a rather familiar sinking feeling as the price as I type this is 3.95 Euros as I type this. Perhaps the former Prime Minister has suggested the shares are a good buy again as of course last time in an unfortunate mistranslation that actually meant good-bye. As I pointed out last week troubles are brewing around this issue. From Reuters.

A group of bondholders challenged Italy’s rescue of ailing bank Monte dei Paschi di Siena (MI:BMPS), suing the lender over the cancellation of their investments and calling for the bonds to be reinstated.

The Italian banking enquiry looked at the state of play yesterday and there are allegations of wrong doing pretty much everywhere as losses were hidden. Indeed Germany’s banking supervisor got dragged in as there are claims it kept back information on the derivatives contracts with Deutsche Bank.

Banca Carige

Next on the list there is this from Reuters this morning.

 Italy’s Banca Carige warned that its working capital is not sufficient to satisfy its own needs for the next 12 months, the lender said in he prospectus for its imminent capital increase.

Carige also said it had not yet received the final SREP assessment by the European Central Bank, adding it could not rule out a request by the authority for additional capital strengthening measures.

The bank secured backing from core shareholders and underwriters for a vital 560 million euro cash call in a last-minute agreement signed on Friday.

Creval

Here is IlSole from Sunday via Google Translate on this subject.

A 70% collapse in less than two weeks had not been taken into account by anyone in Sondrio. Yet that is what is happening in the title of Credito Valtellinese. The Lombard bank has seen its capitalization deflating from 280 million to 95 million in a dozen sessions. And triggering sales was the announcement of the same bank to raise a 700 million capital increase.

There are obvious issues in wanting an extra 700 million Euros when your value is 280 million let alone 95 million! Anyway the share price has seen better days as it has fallen by just under 6% to 1.38 Euros as I type this.

Banca Popolare di Bari.

In a former life I used to deal with quite a few Italian banks on behalf of Deutsche Bank and am straining my memory to recall if my trip to Bari included this one. Anyway times were seemingly much better than now if this letter quoted in i due punti in September is any guide.

An important letter sent by Federconsumatori Italia to the Minister of the Economy, to the Governor of Banca d’Italia and to the President of Consob ….
It reads on the Republic signing of Antonello Cassano ” The bank has ruined our lives, we want to go back our savings. ” It is a climate of anger and despair that one breathes in the headquarters of the Banca Popolare di Bari shareholder protection committee………Investigations by the Bari Public Prosecutor’s Office describe years of irregular management, loss accounts and abnormal loans. Heavy offenses challenged at the top of Bpb, by the association for delinquency and fraud until false statements in the prospectus.

Comment

There is much to consider here as this is happening at the wrong stage in the cycle as the Italian economy has improved ( 0.5% GDP growth in the third quarter) which should be supporting the banks. Some of the non performing loans will be improving. However contrary to the boasting of Finance Minister Padoan the low bailout figure for Italy was a form of denial as problems were hidden and then ignored meaning that they got worse. A factor in this has been Italy’s problem with the size of its national debt and an aversion to adding to it.So now we find ongoing troubles instead of improvement.

Also the ongoing crisis and subversion of Euro area rules has in my view contributed to the way that the ECB is now considering changes to deposit protection. There is an irony here as its President has a past deeply entwined with all this as not only was he Governor of the Bank of Italy but there is a clue in the way that the banking regulations are called the “Draghi Laws”! Here is how he sums up the current state of play.

The other trend is the growing resilience of the financial sector.

Just for clarity in officialese banks are always resilient up to the day they collapse. But Mario is bright enough to cover himself.

Clearly this trend hides some variation among banks, which is largely driven by differences in their business models.

Can anybody think of who he might mean?

 

What is austerity and how much of it have we seen?

The subject of austerity is something which has accompanied the lifespan of this blog so 7 years now. The cause of its rise to prominence was of course the onset of the credit crunch which led to higher fiscal deficits and then national debts via two routes. The first was the economic recession ( for example in the UK GDP fell by approximately 6% as an initial response) leading to a fall in tax revenue and a rise in social security payments. The next factor was the banking bailouts which added to national debts of which the extreme case was Ireland where the national debt to GDP ratio rose from as low as 24% in 2006 to 120% in 2012.  It was a rarely challenged feature of the time that the banks had to be bailed out as they were treated like “the precious” in the Lord of the Rings and there was no Frodo to throw them into the fires of Mount Doom.

It was considered that there had to be a change in economic policy in response to the weaker economic situation and higher public-sector deficits and debts. This was supported on the theoretical side by this summarised by the LSE.

The Reinhart-Rogoff research is best known for its result that, across a broad range of countries and historical periods, economic growth declines dramatically when a country’s level of public debt exceeds 90% of gross domestic product……… they report that average (i.e. the mean figure in formal statistical terms) annual GDP growth ranges between about 3% and 4% when the ratio of public debt to GDP is below 90%. But they claimed that average growth collapses to -0.1% when the ratio rises above a 90% threshold.

The work of Reinhart and Rogoff was later pulled apart due to mistakes in it but by then it was too late to initial policy. It was also apparently too late to reverse the perception amongst some that Kenneth Rogoff who these days spend much of his time trying to get cash money banned is a genius. That moniker seems to have arrived via telling the establishment what it wants to hear.

The current situation

The UK Shadow Chancellor John McDonnell wrote an op-ed in the Financial Times ahead of Wednesday’s UK Budget stating this.

The chancellor should use this moment to lift his sights, address the immediate crisis in Britain’s public services that his party created, and change course from the past seven disastrous years of austerity.

If we ignore the politics the issue of austerity is in the headlines again but what it is has changed over time. Before I move on it seems that both our Chancellor who seemed to think there were no unemployed at one point over the weekend and the Shadow Chancellor was seems to be unaware the UK economy has been growing for around 5 years seem equally out of touch.

Original Austerity

This involved cutting back government expenditure and raising taxation to reduce the fiscal deficits which has risen for the reasons explained earlier. Furthermore it was claimed that such policies would stop rises in the national debt and in some extreme examples reduce it. The extreme hardcore example of this was the Euro area austerity imposed on Greece as summarised in May 2010 by the IMF.

First, the government’s finances must be sustainable. That requires reducing the fiscal deficit and placing the debt-to-GDP ratio on a downward trajectory……With the budget deficit at 13.6 percent of GDP and public debt at 115 percent in 2009, adjustment is a matter of extreme urgency to avoid the debt spiraling further out of control.

A savage version of austerity was begun which frankly looked more like a punishment beating than an economic policy.

The authorities have already begun fiscal consolidation equivalent to 5 percent of GDP.

But the Managing Director of the IMF Dominique Strauss-Khan was apparently confident that austerity in this form would lead to economic growth.

we are confident that the economy will emerge more dynamic and robust from this crisis—and able to deliver the growth, jobs and prosperity that the country needs for the future.

Maybe one day it will but so far there has been very little recovery from the economic depression inflicted on Greece by the policy prescription. This has meant that the national debt to GDP ratio has risen to 175% in spite of the fact that there was the “PSI” partial default in 2012. It is hard to think of a clearer case of an economic policy disaster than this form of disaster as for example my suggestion that you needed  a currency devaluation to kick-start growth in such a situation was ignored.

A gentler variation

This came from the UK where the coalition government announced this in the summer of 2010.

a policy decision to reduce total spending by an additional £32 billion a year by 2014-15, including debt interest savings;

In addition there were tax rises of which the headline was the rise in the expenditure tax VAT from 17.5% to 20%. These were supposed to lead to this.

Public sector net borrowing falls from 11.0 per cent of GDP in 2009-10 to 1.1 per cent in 2015-16. Public sector net debt is forecast to rise to a peak of 70.3 per cent of GDP in 2013-14, before falling to 67.4 per cent in 2015-16.

As Fleetwood Mac would put it “Oh Well”. In fact the deficit was 3.8% of GDP in the year in question and the national debt continued to rise to 83.8% of GDP. So we have a mixed scorecard where the idea of a surplus was a mirage but the deficit did fall but not fast enough to prevent the national debt from rising. Much of the positive news though comes from the fact that the UK economy began a period of sustained economic growth in 2012.

Economic growth

We have already seen the impact of economic growth via having some (  UK) and seeing none and indeed continued contractions ( Greece). But the classic case of the impact of it on the public finances is Ireland where the national debt to GDP ratio os now reported as being 72.8%.

Sadly the Irish figures rely on you believing that nominal GDP rose by 68 billion Euros or 36.8% in 2015 which frankly brings the numbers into disrepute.

Comment

The textbook definitions of austerity used to involved bringing public sector deficits into surplus and cutting the national debt. These days this has been watered down and may for example involve reducing expenditure as a percentage of the economy which may mean it still grows as long as the economy grows faster! The FT defines it thus.

Austerity measures refer to official actions taken by the government, during a period of adverse economic conditions, to reduce its budget deficit using a combination of spending cuts or tax rises.

So are we always in “adverse economic conditions” in the UK now? After all we still have austerity after 5 years of official economic growth.

What we have discovered is that expenditure cuts are hard to achieve and in fact have often been transfers. For example benefits have been squeezed but the basic state pension has benefited from the triple lock. Also if last years shambles over National Insurance is any guide we are finding it increasingly hard to raise taxes. Not impossible as Stamp Duty receipts have surged for example but they may well be eroded on Wednesday.

Also something unexpected, indeed for governments “something wonderful” happened which was the general reduction in the cost of debt via lower bond yields. Some of that was a result of long-term planning as the rise of “independent” central banks allowed them to indulge in bond buying on an extraordinary scale and some as Prince would say is a Sign O’The Times. As we stand the new lower bond yield environment has shifted the goal posts to some extent in my opinion. The only issue is whether we will take advantage of it or blow it? Also if we had the bond yields we might have expected with the current situation would public finances have improved much?

Meanwhile let me wonder if a subsection of austerity was always a bad idea? This is from DW in August.

Germany’s federal budget  surplus hit a record 18.3 billion euros ($21.6 billion) for the first half of 2017.

With its role in the Euro area should a country with its trade surpluses be aiming at a fiscal surplus too or should it be more expansionary to help reduce both and thus help others?

 

 

The ECB has it successes but also plenty of problems

Let is continue the central banking season which allows us to end the week with some good news. As this week has developed there has been good news about economic growth in the Euro area.

The Federal Statistical Office (Destatis) reports that, in the third quarter of 2017, the gross domestic product (GDP) rose 0.8% on the second quarter of 2017 after adjustment for price, seasonal and calendar variations. In the first half of 2017, the GDP had also increased markedly, by 0.6% in the second quarter and 0.9% in the first quarter.

It has been a strong 2017 so far for the German economy but of course whilst analogies about it being the engine of the Euro area economy might be a bitter thinner on the ground due to dieselgate there are still elements of truth about it. But we know that a rising tide does not float all economic boats so ECB President Mario Draghi will have been pleased to see this about a perennial struggler.

In the third quarter of 2017 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.5 per cent with respect to the second quarter of 2017 and by 1.8 per cent in comparison with the third quarter of 2016.

Of course Mario will be especially pleased to see better news from his home country of Italy especially at a time when more issues about the treatment of non-performing loans at its banks are emerging. Also this bank seems to be running its own version of the never-ending story, from the Financial Times.

A group of investors in the world’s oldest bank, Italy’s Monte dei Paschi di Siena, have filed a lawsuit in Luxembourg after it announced bonds would be annulled as part of a state-backed recapitalisation.

But in Mario’s terms he is likely to consider the overall numbers below to be a delivery on his “whatever it takes” speech and promise.

Seasonally adjusted GDP rose by 0.6% in the euro area…….Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.5% in the euro
area.

Inflation

This is a more problematic area for Mario Draghi as this from his speech in this morning indicates.

According to a broad range of measures, underlying inflation has ticked up moderately since the start of this year, but it still lacks clear upward momentum.

This matters because unlike the Bank of England the ECB takes inflation targeting seriously and a past President established a rather precise estimate of it at 1.97% per annum. We seem unlikely now to ever find out how Mario Draghi would deal with above target inflation but he finds himself in what for him maybe a sort of dream. Economic growth has recovered with inflation below target so he can say this.

This recalibration of our asset purchases, supported by the sizeable stock of acquired assets and the forthcoming reinvestments, and by our forward guidance on interest rates, helps to maintain the necessary degree of accommodation and thereby to accompany the economic recovery in an appropriate way.

So we will get negative interest-rates ( -0.4%) for quite a while yet as he has hinted in the past that they may persist past the end of his term. Also of course whilst at a slower rate ( 30 billion Euros a month) the QE ( Quantitative Easing) programme continues. Even that has worked out pretty well for Mario as continuing at the previous pace seemed set to run out of German bonds to buy.

Consequences

However continuing with monetary expansion into a boom is either a new frontier or something which later will have us singing along with Lyndsey Buckingham.

(I think I’m in)(Yes) I think I’m in trouble
(I think I’m in) I think I’m in trouble

Corporate Bonds

When you buy 124 billion Euros of corporate bonds in a year and a few months there are bound to be consequences.

“Tequila Tequila” indeed. What could go wrong with this.?

OK, we are officially in la la land. A BBB rated company just borrowed 500 million EUR for 3 years with a negative yield of -0.026 %. A first..  ( h/t @S_Mikhailovich )

You can take your pick whether you think that Veolia is able to issue debt at a negative interest-rate or at only 0.05% above the swaps rate is worse.

Mario Draghi explained this sort of thing earlier in a way that the Alan Parsons Project would have described as psychobabble.

By accumulating a portfolio of long-duration assets, the central bank can compress term premia by extracting duration risk from private investors. Via this “duration extraction” effect, the central bank frees up risk bearing capacity in markets, spurs a rebalancing of private portfolios toward the remaining securities, and thus lowers term premia and yields across a range of financial assets.

Moral hazard anyone?

The dangers of this sort of thing have been highlighted by what has happened to Carillion this morning.

The wages problem

It is sometimes argued in the UK that weak wage growth is a consequence of high employment and low unemployment. But we see that there are issues too in the Euro area where the latter situations whilst improved are still poorer.

A key issue here is wage growth.Since the trough in mid-2016, growth in compensation per employee has risen, recovering around half of the gap towards its historical average. But overall trends remain subdued and are not broad-based.

Indeed if we look back to late May Mario gave us a rather similar reason to what we often here in the UK as an explanation of weak wages growth.From the Financial Times.

Mr Draghi also acknowledged concerns that sinking unemployment was not leading to a recovery in well-paid permanent jobs………….Mr Draghi said he agreed. “What you say is true,” he said. “Some of this job creation is not of good quality.”

The Italian Job

As I hinted earlier in this piece there are ever more signs of trouble in the Italian banking sector. There have been many cases of can kicking in the credit crunch era but this has been something of a classic with of course a dash of Italian style and finesse. From the FT.

Mid-sized Genoan bank Carige’s future looked uncertain this week after a banking consortium pulled its support for a €560m capital increase demanded by European regulators. Shares in another mid-sized bank Credito Valtellinese fell 8.5 per cent to a market value of €144m after it announced a larger than anticipated €700m capital raising to shore up its balance sheet.

There are issues with banks elsewhere as investors holding bonds which were wiped out insist on their day in court.

Comment

As you can see there is indeed good news for Mario Draghi to celebrate as not only is the Euro area seeing solid economic growth it is expected to continue.

From the ECB’s perspective, we have increasing confidence that the recovery is robust and that this momentum will continue going forward.

The problem though is where does it go from here? Even Mario himself worries about the consequences of monetary policy which has been so easy for so long and is now pro cyclical rather than anti cyclical before of course dismissing them. But unless you believe that growth will continue forever and recessions have been banished there is the issue of how do you deal with the latter when you already have negative interest-rates and ongoing QE?

Also the inflation target problem is covered up by describing it is price stability when of course it is anything but.

Ensuring price stability is a precondition for the economy to be able to grow along a balanced path that can be sustained in the long run.

Wage growth would be improved in real terms if inflation was lower and not higher.

Also Mario has changed his tune on the fiscal situation which he used to regularly compare favourably to elsewhere.

This means actively putting our fiscal houses in order and building up buffers for the future – not just waiting for growth to gradually reduce debt. It means implementing structural reforms that will allow our economies to converge and grow at higher speeds over the long-term.

Number Crunching

This from Bloomberg seemed way too high to me.

Italy’s failure to qualify for the soccer World Cup finals for the first time in 60 years may cost the country about 1 billion euros ($1.2 billion), the former chairman of the national federation said.

Me on Core Finance

http://www.corelondon.tv/2-uk-growth-cap-unreliable-predictive-bodies-bad/