The Swedish Riksbank is facing the consequences of its own policy

The Riksbank of Sweden meets today and announces its policy decision tomorrow morning. It is facing a period where its policy if out of kilter with pretty much everything. Long gone are the days when its policy members were called “sadomonetarists” by Paul Krugman of the New York Times. These days it is in the van of those expanding monetary policy as you can see from its last policy announcement.

The Executive Board has decided to hold the repo rate unchanged at −0.50 per cent and to extend the purchases of nominal government bonds by SEK 7.5 billion and the purchases of real government bonds by SEK 7.5 billion. At the end of 2017, the purchases will thus amount to a total of SEK 290 billion, excluding reinvestments. Until further notice, maturities and coupon payments will also be reinvested in the government bond portfolio.

It is using negative interest-rates and QE ( Quantitative Easing) which is putting the pedal close to the metal but is also what can be called pro cyclical as it is expanding into an expansion.

Swedish economic activity is good and is expected to strengthen further over the next few years

Actually if you take any notice of Forward Guidance they even upped their efforts.

The first repo-rate increase is now expected to be made in the middle of 2018. The repo rate path also reflects the fact that there is still a greater probability of the rate being cut than of it being raised in the near term.

They justified this on the grounds that they expected inflation to take longer to reach its target. This shows us a facet of central bank behaviour these days. If the economy slows they use it as an excuse to ease policy but if it is doing well they are then prone to switching to the inflation rate if it is below target in an example of cherry-picking.

What do they think now?

The mid-June business survey from the Riksbank could not be much more bullish.

The strong economic situation will continue in the months ahead……Export companies are encountering ever-stronger demand from abroad. Europe stands out in particular.

Oh and as a warning for an issue we will look at in a bit there was this.

Demand has been strong in the construction and property sectors in recent years and the development of housing construction in particular continues to be very strong.

Today’s manufacturing PMI from Swedbank looks strong as well.

Sweden Jun Manufacturing PMI 62.4 Vs. 58.8 In May

The Kronor

The conventional view is that all the monetary easing should have sent it lower but in fact it has not done an enormous amount in recent times. If we look back to June 2014 the KIX effective exchange-rate averaged 106.7 and last month it averaged 114.4. So a bit weaker ( confusingly higher is weaker on this index) but this must have been a disappointment to the Riksbank especially as it has strengthened since late 2016. As we have noted before 2017 has been a year where many exchange-rates seem to have simply ignored any flow effect from ongoing QE programs.

One conclusion is that the backwash of moves in the US Dollar and the Euro swamp most of Sweden’s apparent currency independence. Especially if we note that a fair bit of the monetary easing is simply keeping up with the Euro area Joneses.

Household Debt

It was hardly a surprise after reading the above that the June Financial Stability Report rather majored on this.

Households’ high and rising indebtedness form a serious threat to financial and macroeconomic stability……….Household indebtedness and housing prices are still rising, and indebtedness is also expected to rise in the period ahead. This entails major risks for the Swedish economy.

What will they do?

Further measures need to be introduced to increase the resilience of the household sector and reduce risks.

So they will raise interest-rates? Oh hang on.

Both measures to achieve a better balance between supply and demand on the housing market and tax reforms to reduce the willingness or ability of households to take on debt are required. Further macroprudential policy measures also need to be taken.

It is interesting these days how central bankers so often end up telling central bankers what to do! Also it is notable that the rise of macroprudential policies ignores they fact that such policies were abandoned in the past because they were more trouble than they were worth.

All this came with an ominous kicker.

The vulnerabilities in the Swedish banking system are linked to its size, concentration and interlinkage, as well as the banks’ large percentage of wholesale funding and their substantial exposures to the housing sector.

A decade into the credit crunch we note that the rhetoric of reform and progress so often faces a reality of “vulnerabilities” and these get worse as we peer deeper.

Liquidity risks arise partly as a result of Sweden having a large, cross-border banking sector with significant commitments in foreign currency.

If you take the two quotes together then you have the feeling that the TARDIS of Dr.Who has transported you back to 2006. Still we know that the interest and concentration of the Riksbank will be on this issue now as the “precious” may have troubles. Oh and they have a sense of humour too.

It is essential that the banks insure themselves

In reality the Swedish taxpayer is likely to find they have got the gig and this is very different to the usual Riksbank rhetoric on foreign-exchange intervention although if you think about it the result they want would be rather likely to say the least!

At the same time, it is necessary that the Riksbank has a sufficiently large foreign currency reserve if liquidity requirements should arise in foreign currency that the banks themselves are unable to manage.

At the end of last month and after the Report Sweden Statistics updated us further on the state of play.

In May, households’ housing loans amounted to SEK 2 977 billion. This is an increase of SEK 18 billion compared with the previous month and SEK 195 billion compared with the corresponding month last year. Housing loans thus had an annual growth rate of 7.1 percent in May,

Some ( obviously not central bankers ) might think that low mortgage rates are a major driver of this.

The average interest rate for housing loans for new agreements was 1.57 percent in May.

House Prices

The Real Estate Price Index was up by 2% in the first quarter of 2017 making it some 8% higher than a year before. Last year’s UBS Bubble index told us that Stockholm was leading the way.

The sharpest increase in the UBS Global Real Estate
Bubble Index in Europe over the last four quarters
was measured in Stockholm, followed by Munich,
London and Amsterdam

Comment

The Riksbank has in its own mind invented a new type of monetary theory where you expand policy into a boom. It so far has ignored the dangers of higher household debt and booming house prices. Being a first-time buyer in Stockholm looks as grim as being one in London. As to the announcement I am not expecting much change after Friday’s wages data showed a slowing. These days wage growth is the crucial number as we looked at last week.

Total average hourly wages for manual workers in April 2017 were SEK 165.80 excluding overtime pay and SEK 168.20 including overtime pay. These numbers reflects an increase increase of 1.7 percent and 1.8 percent compared
to April 2016. The average monthly salary for non-manual workers in April 2017 excluding variable supplements was SEK 38 420 while it was SEK 39 390 including variable supplements. These numbers reflects an increase of 1.5
percent and 1.7 percent compared to April 2016.

Bank of England

I see its staff have voted to strike as Mark Carney’s increasingly troubled reign as Governor continues. My advice to the staff is to keep away from the subject of performance related pay.

 

 

 

 

Of weak wage growth and bond markets

Today I am going to look at some clear changes in the credit crunch era and the way that they link together. Let us start with a clear theme of these days about which there has been news this morning from the land of the rising sun. From Japan Macro Advisers.

The demand/supply condition in the labor market seems as tight as it could be. In May 2017, Japan’s job offers to applicant ratio soared to a 43-year high of 1.49. The increase in the job-offers-applicant ratio marks the third consecutive monthly rise. The current print exceeds the July 1990 levels (1.46) when the Japan economy was enjoying a bubble economy.

It makes you think that the labour market is on this measure stronger than it was than when Japan’s economy was at its peak albeit an unsustainable one. Actually on another measure the situation is so tight they need to look even further back.

New job offers to applicant ratio also show that there is simply not enough supply of labor in Japan. The new job offers to applicant ratio rose to 2.31 in May from 2.13 in the previous month. This marks the highest level of this ratio since November 1973.

As you can see by these measures the labour market is very tight in Japan and is reinforced by these ones reported by Market Insider.

The number of employed persons in May was 65.47 million, an increase of 760,000 or 1.2 percent on year.

The number of unemployed persons in May was 2.10 million, a decrease of 70,000 or 3.2 percent on year.

On the month ( May ) the unemployment rate did rise to 3.1% but as you can see the overall trend seems to be lower in spite of the fact that it is extraordinarily low. Indeed as we have discussed before theories such as the “natural rate of unemployment” or “full employment” are pretty much torpedoed by it as we mull how employment can be more than full?

But if we move to wage growth which according to econ 101 should be soaring we instead see this. From Japan Macro Advisers.

In April 2017, basic and overtime wages, otherwise known as regular wages, rose by 0.4% year on year (YoY), recovering from a decline of 0.1% YoY in March. While an increase in wages is a better news than a decline, the magnitude of the rise continues to be underwhelming.

Quite. As to the real wage growth promised by Abenomics and  reported by the financial  media?

The real wage growth, after offsetting for the inflation in consumer prices, was 0.0% YoY,

So Japan should be seeing wage growth but instead it is flat lining. If we are “Turning Japanese”  then the next bit of news is even worse you see that current wage index for full-time workers is 101 giving an initial though that there has not been much growth since it was based at 100 in 2015. But if you look back the peak in the series was 104.4 in January 2001 and no that is not a misprint.

A possible cause of this is highlighted below and it does provide food for thought as of course Japan is leading the way on a road that many others will be travelling.

The working age population in Japan, defined as the population of the age between 15 and 64, has been shrinking rapidly. In 2016, the work age population in Japan fell by 0.7 million people. Accordingly, job applicants have been declining by 5% per year in the last few years.

Moving On

If we look wider afield we see that wages are struggling beyond the shores of Japan as this from Reuters reminds us.

Wage growth across the developed world is weak. It’s only 2.5 percent in the United States and 2.1 percent in Britain.

It is interesting to note that the have real average hourly earnings falling at an annual rate of 1.3% in the US. The chart below shows that this particular dog is not barking.

Even the figures for Germany are no great shakes when we note this from this morning’s release on the labour market.

In May 2017, roughly 44.1 million persons resident in Germany were in employment according to provisional calculations of the Federal Statistical Office (Destatis). This was a record high since German reunification.

In the UK we have seen quite a change as fears of robots taking everyone’s jobs have been replaced by fears of a former Chancellor of the Exchequer doing so.

George Osborne, the editor of the Evening Standard and former chancellor of the exchequer, has added a sixth job to his portfolio – that of honorary professor of economics at the University of Manchester.

For some Friday humour here are some suggestions for George from the past.

Bond Markets

This week has seen bond markets fall as they try to adjust to a barrage of rhetoric and open mouth operations from central bankers. Those who immediately hid behind a sofa when Janet Yellen told us there would not be another financial crisis in our lifetimes will have missed U-Turns by the ECB and the Bank of England. Also there has been a rather bizarre PR campaign conducted by Bank of England Chief Economist Andy Haldane puffing him up to be the next Governor of the Bank of England on the grounds that he keeps forecasting wages incorrectly. Do I have that right?

We see that the ten-year yield in Germany has risen to 0.47% at one point this morning. If we stay with that whilst it is up that only takes it to around where it was in some of both February and March and indeed May. So not quite as being reported in many places. If we look at the UK the ten-year Gilt yield nudged 1.29% this morning. But if we step back these are very minor moves for markets that really believe what the central bankers are saying which is of course yet another failure for Forward Guidance.

Comment

I wanted to like these two factors ( wage growth and bond yields) because they provide a link to what has happened in 2017. I thought and wrote that it would be a rough year for bond markets based on rising consumer inflation whereas they appear to have looked at low rates of wage growth instead. Of course there have been all the central banking QE purchases but they were a known factor.

As to wages growth itself regular readers will be aware that I fear it is in fact worse than we are told due to the exclusion of the self-employed from the numbers. But also employment figures do not tell the whole story as this from Mario Draghi in Sintra tells us.

Another reason why there is some uncertainty over slack is the correct notion of unemployment – that is, there may be residual slack in the labour market that is not being fully captured in the headline unemployment measures. Unemployment in the euro area has risen during the crisis, but so too has the number of workers who are underemployed (meaning that they would like to work more hours) or who have temporary jobs and want permanent ones…….If one uses a broader measure of labour market slack including the unemployed, underemployed and those marginally attached to the labour force – the so-called “U6” – that measure currently covers 18% of the euro area labour force.

Maybe the weak wage growth is much less of a surprise than we are often told. Especially as it comes with an implied kicker that everything is okay due to this. From Reuters.

In the United States, household net wealth has soared by $40 trillion since the beginning of the expansion in 2009 to $95 trillion from $55 trillion. It is up $11 trillion in just the last two years.

Well that’s okay then is the message, except it isn’t or we would not be where we are.

 

 

The ECB “taper” meets “To infinity! And beyond!”

Yesterday was central banker day when we heard from Mark Carney of the Bank of England, Mario Draghi of the ECB and Janet Yellen of the US Federal Reserve. I covered the woes of Governor Carney yesterday and note that even that keen supporter of him Bloomberg is now pointing out that he is losing the debate. As it happened Janet Yellen was also giving a speech in London and gave a huge hostage to fortune.

Yellen today: “Don’t see another crisis in our lifetimes” Yellen May 2016: “We Didn’t See The Financial Crisis Coming” ( @Stalingrad_Poor )

Let us hope she is in good health and if you really wanted to embarrass her you would look at what she was saying in 2007/08. However the most significant speech came at the best location as the ECB has decamped to its summer break, excuse me central banking forum, at the Portuguese resort of Sintra.

Mario Draghi

As President Draghi enjoyed his morning espresso before giving his keynote speech he will have let out a sigh of relief that it was not about banking supervision. After all the bailout of the Veneto Banks in Italy would have come up and people might have asked on whose watch as Governor of the Bank of Italy the problems built up? Even worse one of the young economists invited might have wondered why the legal infrastructure covering the Italian banking sector is nicknamed the “Draghi Laws”?

However even in the area of monetary policy there are problems to be faced as I pointed out on the 13th of March.

It too is in a zone where ch-ch-changes are ahead. I have written several times already explaining that with inflation pretty much on target and economic growth having improved its rate of expansion of its balance sheet looks far to high even at the 60 billion Euros a month due in April.

Indeed on the 26th of May I noted that Mario himself had implicitly admitted as much.

As a result, the euro area is now witnessing an increasingly solid recovery driven largely by a virtuous circle of employment and consumption, although underlying inflation pressures remain subdued. The convergence of credit conditions across countries has also contributed to the upswing becoming more broad-based across sectors and countries. Euro area GDP growth is currently 1.7%, and surveys point to continued resilience in the coming quarters.

That simply does not go with an official deposit rate of -0.4% and 60 billion Euros a month of Quantitative Easing. Policy is expansionary in what is in Euro area terms a boom.

This was the first problem that Mario faced which is how to bask in the success of economic growth whilst avoiding the obvious counterpoint that policy is now wrong. He did this partly by indulging in an international comparison.

since January 2015 – that is, following the announcement of the expanded asset purchase programme (APP) – GDP
has grown by 3.6% in the euro area. That is a higher growth rate than in same period following QE1 or QE2 in the United States, and a percentage point lower than the period after QE3. Employment in the euro area has also risen by more than four million since we announced the expanded APP, comparable with both QE2 and QE3 in the US, and considerably higher than QE1.

You may note that Mario is picking his own variables meaning that unemployment for example is omitted as are differences of timing and circumstance. But on this road we got the section which had an immediate impact on financial markets.

The threat of deflation is gone and reflationary forces are at play.

So we got an implicit admittal that policy is pro-cyclical or if you prefer wrong. A reduction in monthly QE purchases of 20 billion a month is dwarfed by the change in circumstances. But we have to be told something is happening so there was this.

This more favourable balance of risks has been already reflected in our monetary policy stance, via the adjustments we have made to our forward guidance.

You have my permission to laugh at this point! If he went out into the streets of Sintra I wonder how many would know who he is let alone be running their lives to the tune of his Forward Guidance!? Whilst his Forward Guidance has not been quite the disaster of Mark Carney the sentence below shows a misfire.

This illustrates that core inflation does not
always give us a clear reading of underlying inflation dynamics.

The truth is as I have argued all along that there was no deflation threat in terms of a downwards spiral for inflation because it was driven by this.

Oil-related base effects are also the main driver of the considerable volatility in headline inflation that we have seen, and will be seeing, in the euro area………. As a result, in the first quarter of 2017, oil-sensitive items  were still holding back core inflation.

I guess the many parts of the media which have copy and pasted the core inflation/deflation theme will be hoping that their readers have a bout of amnesia. Or to put it another way that Mario has set up a straw (wo)man below.

What is clear is that our monetary policy measures have been successful in avoiding a deflationary spiral and securing the anchoring of inflation expectations.

Actually if you look elsewhere in his speech you will see that if you consider all the effort put in that in fact his policies had a relatively minor impact.

Between 2016 and 2019 we estimate that our monetary policy will have lifted inflation by 1.7 percentage points,
cumulatively.

So it took a balance sheet of 4.2 trillion Euros ( and of course rising as this goes to 2019) to get that? You can look at the current flow of 60 billion a month which makes it look a little better but it is not a lot of bang for your Euro.

Market Movements

There was a clear response to the mention of the word “reflationary” as the Euro rose strongly. It rose above 1.13 to the US Dollar as it continued the stronger  phase we have been seeing in 2017 as it opened the year more like 1.04.  Also government bond yields rose although the media reports of “jumps” made me smile as I noted that the German ten-year yield was only 0.4% and the two-year was -0.57%! Remember when the ECB promised it was fixing the issue of demand for German bonds?

Comment

On the surface this is a triumph for Forward Guidance as Mario’s speech tightens monetary policy via higher bond yields and a higher value for the Euro on the foreign exchanges. Yet if we go back to March 2014 he himself pointed out the flaw in this.

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

You see the effective or trade-weighted index dipped to 93.5 in the middle of April but was 97.2 at yesterday’s close. If we note that Mario is not achieving his inflation target and may be moving away from it we get food for thought.

Euro area annual inflation was 1.4% in May 2017, down from 1.9% in April.

So as the markets assume what might be called “tapering” ( in terms of monthly QE purchases) or “normalisation” in terms of interest-rates we can look further ahead and wonder if “To infinity! And Beyond!” will win? After all if the economy slows later this year  and inflation remains below target ………

There are two intangible factors here. Firstly the path of inflation these days depends mostly in the price of crude oil. Secondly whilst I avoid politics like the plague it is true that we will find out more about what the ECB really intends once this years major elections are done and dusted as the word “independent” gets another modification in my financial lexicon for these times

 

It is all about the banks yet again

If there is a prime feature of the credit crunch in the financial world it is the woes and travails of the banks. That is quite an anti-achievement when you consider that if you count from the first signs of trouble at the mortgage book of Bear Stearns we are now in out second decade of this period having lost one already. Before we come to today’s main course delightfully prepared first by chefs in Italy and then finished off in Brussels I have a starter for you from the UK.

The Co-op Bank

Back on the 13th of February I gave my views on this institution being put up for sale.

So the bank is up for sale and my immediate thought is who would buy it and frankly would they pay anything? Only last week Bloomberg put out some concerning analysis……..Co-Operative Bank Plc, the British lender that ceded control to its creditors three years ago, has plunged in value to as little as 45 million pounds ($56 million), according to people familiar with the matter.

Since then we have had regular reports in places like the Financial Times that a deal was just around the corner whereas I feared it might end up in the hands of the Bank of England. This morning has come news that the ill-fated sale plans have been abandoned and replaced by a doubling-down by the existing investors. From Sky News.

The beleaguered Co-operative Bank is closing in on a £700m rescue deal with US hedge funds amid ongoing talks about the separation of the vast pension scheme it shares with the Co-op Group.

Much of the issue revolves around funding the pension scheme and if I was worker at the Co-op I would be watching that like a hawk. Also the name may need some review as the shareholding of the Co-operative group falls below 5%.

We have also seen in the UK how a bailed out bank boosts the economy in return for taxpayers largesse. From Reuters.

British lender Royal Bank of Scotland (RBS.L) is planning to cut 443 jobs dealing with business loans and many of them will move to India, the bank said

The Veneto Banks

As we move from our starter to the main course we find ourselves facing a menu which has taken nearly a decade to be drawn up. The Italian response to the banking crisis was to adopt the ostrich position and ignore it for as long as possible. Indeed for a while the Italian establishment boasted that only 0.2% of GDP ( Gross Domestic Product) had been spent on bank bailouts compared to much higher numbers elsewhere. Such Schadenfreude came back to haunt them driven by one main factor which was the rise and rise of non-performing loans in the Italian banking sector which ended up with more zombies than you might expect to see in a Hammer House of Horror production. Even worse this was a drag on the already anaemic Italian rate of economic growth meaning that its economy is now pretty much the same size as when it joined the Euro.

There has been a long program of disinformation on this subject and I am sure that regular readers will recall the claims that Monte Paschi was a good investment made by then Prime Minister Matteo Renzi. There have also been the regular statements by Finance Minister Padoan along the lines of this from Politico EU in January.

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.

If we are being ultra polite that was especially “odd” as Monte Paschi was in state hands but of course over this weekend came more woe for Padoan. From the European Commission.

On 24 June 2017, Italy notified to the Commission its plans to grant State aid to wind-down BPVI and Veneto Banca. The measures will enable the sale of parts of the two banks’ activities to Intesa, including the transfer of employees. Italy selected Intesa Sanpaolo (Intesa) as the buyer in an open, fair and transparent sales procedure:

I will come to the issue of Intesa in a moment but let us first look at the cost to Italy from this.

In particular, the Italian State will grant the following measures:

  • Cash injections of about €4.785 billion; and
  • State guarantees of a maximum of about €12 billion, notably on Intesa’s financing of the liquidation mass. The State guarantees would be called upon notably, if the liquidation mass is insufficient to pay back Intesa for its financing of the liquidation mass.

This has opened up a rather large can of worms and as Bloomberg points out we can start with this.

Rome will effectively by-pass the EU’s “single resolution board” which is supposed to handle bank failures in an orderly way and the “Banking Recovery and Resolution Directive,” which should act as the euro zone’s single rulebook.

Why? Well as we have looked at before there was the misselling of bonds to retail investors.

The government could have taken a less expensive route, involving the “bail in” of senior bondholders. It chose not to: Many of these instruments are in the hands of retail investors, who bought them without being fully aware of the risks involved. The government wants to avoid a political backlash and the risk of contagion spreading across the system.

Privatisation of profits and socialisation of losses yet again. Also only on the June 8th we were told this.

Italian banks are considering assisting in a rescue of troubled lenders Popolare di Vicenza and Veneto Banca by pumping 1.2 billion euros (1.1 billion pounds) of private capital into the two regional banks

Good job they said no as they would have been over 3 billion short! Oh and Padoan described the problems as “exaggerated” whereas if we return to reality this was always the real problem.

A bail in has the problem of the retail depositors who were persuaded to invest in bank bonds.

Intesa

This seems to have got something of a free lunch here provided courtesy of the Italian taxpayer. From Reuters.

The government will pay 5.2 billion euros ($5.82 billion) to Intesa, and give it guarantees of up 12 billion euros, so that it will take over the remains of the banks.

So it can clear up the mess? Er not quite.

will leave the lenders’ good assets in the hands of Intesa,

So it is being paid to take the good bits. Heads it wins if things turns out okay and tails the Italian taxpayer loses if they do not as it will use the guarantees. Also as you can see it seems to have thought of everything.

You think Santander made a killing with Pop until you realise will even make the state pay for the redundancy package of V&V staff ( @jeuasommenulle )

It may even be able to gain from some Deferred Tax Assets but chasing down that thread is only in very technical Italian.

Comment

There is much to consider here so let me open with the two main issues. The European Banking Union has just been torpedoed by the Italian financial navy. The promised bail in has become a bailout. Next comes the issue of how much all the dilatory dithering has cost the Italian taxpayer? As in the end the cost is way above the sums that Financial Minister Padoan was calling “exaggerated”. I note that BBC Breakfast called the cost 5 billion Euros this morning ignoring the 12 billion Euros of guarantees which no doubt Italy in a by now familiar attempted swerve will try to keep it out of the national debt numbers. Although to be fair Eurostat has mostly shot down such efforts.

Over the next few days we will no doubt be assailed with promises that the money will come back. For some it already has. From the FT.

Intesa Sanpaolo, the country’s strongest lender that will take over the failed banks’ good assets, was the second biggest riser on the eurozone-wide Stoxx 600 index. Shares in the bank were up 3.6 per cent at publication time, to €2.71.

 

 

 

 

 

Of Denmark its banks and negative interest-rates

The situation regarding negative interest-rates mostly acquires attention via the Euro or the Yen. If the media moves beyond that it then looks at Switzerland and maybe Sweden. But there is an outbreak of negative interest-rates in the Nordic countries if we note that we have already covered Sweden, Finland is in the Euro and the often ignored Denmark has this.

Effective from 8 January 2016, Danmarks Nationalbank’s ( DNB ) interest rate on certificates of deposit is increased by 0.10 percentage point to -0.65 per cent.

Actually Denmark is just about to reach five years of negative interest-rates as it was in July of 2012 that the certificate of deposit rate was cut to -0.2% although it has not quite been continuous as it there were a few months that it rose to the apparently giddy heights of 0.05%.

In case you are wondering why Denmark has done this then there are two possible answers. Geography offers one as we note that proximity to the Euro area is associated with ever lower and indeed negative interest-rates. Actually due to its exchange rate policy Denmark is just about as near to being in the Euro as it could be without actually being so.

Denmark maintains a fixed-exchange-rate policy vis-à-vis the euro area and participates in the European Exchange Rate Mechanism, ERM 2, at a central rate of 746.038 kroner per 100 euro with a fluctuation band of +/- 2.25 per cent.

Currently that involves an interest-rate that is -0.25% lower than in the Euro area but the margin does vary as for example when the interest-rate rose in 2014 when the DNB tried to guess what the ECB would do next and got it wrong.

A Problem

If we think of the Danish economy then we think of negative interest-rates being implemented due to weak economic growth. Well the DNB has had to face up to this.

However, the November revision stands out as an unusually large upward revision of the compilation of GDP level and
growth……… average annual GDP growth has now
been compiled at 1.3 per cent for the period 2010-
15, up from 0.8 per cent in the previous compilation.
GDP in volume terms is now 3.4 per cent higher in
2015 than previously compiled,

Ooops! As this begins before interest-rate went negative we have yet another question mark against highly activist monetary policy. The cause confirms a couple of the themes of this website.

new figures for Danish firms’ foreign
trading in which goods and services do not cross the
Danish border entailed substantial revisions

So the trade figures were wrong which is a generic statement across the world as they are both erratic and unreliable. Also such GDP shifts make suggestions like this from former US Treasury Secretary Larry Summers look none too bright.

moving away from inflation targeting to something like nominal gross domestic product-level targeting would be a better idea.

In this situation he would be targeting a number which was later changed markedly, what could go wrong?

Also there is a problem for the DNB as we note that it has a negative interest-rate of -0.65% but faces an economy doing this.

heading towards a boom with output above the normal level of capacity utilisation……….The Danish economy is very close to its capacity limit.

Whatever happened to taking away the punchbowl as the party starts getting going?

Oh and below is an example of central banker speech not far off a sort of Comical Ali effort.

Despite the upward revision of GDP, Danmarks Nationalbank’s assessment of economic developments
since the financial crisis is basically unchanged.

The banks

This is of course “the precious” of the financial world which must be preserved at all costs according to central bankers. We were told that negative interest-rates would hurt the banks, how has that turned out? From Bloomberg.

Despite half a decade of negative interest rates, Denmark’s banks are making more money than ever before.

What does the DNB think?

Overall, the largest Danish banks achieved their
best ever performance in 2016, and their financial
statements for the 1st quarter of 2017 also recorded
sound profits…………In some areas, financial developments are similar to developments in the period up to the financial crisis in 2008, so there is every reason to watch out for
speed blindness.

Still no doubt the profits have gone towards making sure “this time is different”? Er, perhaps not.

On the other hand, the capital base has not increased notably since 2013, unlike in Norway and Sweden where the banks have higher capital adequacy.

What about house prices?

Both equity prices and prices of owner-occupied
homes have soared, as they did in the years prior to
the financial crisis.

Although the DNB is keen to emphasise a difference.

As then, prices of owner-occupied homes in Copenhagen have risen considerably, but with the difference that the price rises have not yet spread to the rest of Denmark to the same degree. The prices of rental properties have also increased and are back at the 2007 level immediately before
the financial crisis set in

It will have been relieved to note a dip in house price inflation to 4.2% at the end of 2016 although perhaps less keen on the fact that house prices are back to the levels which caused so much trouble pre credit crunch. Of course the banking sector will be happy with higher house prices as it improves their asset book whereas first-time buyers will be considerably less keen as prices move out of reach.

In spite of the efforts of the DNB I note that the Danes have in fact been reining in their borrowing. If we look at the negative interest-rate era we see that the household debt to GDP ratio has fallen from 135% to 120% showing that your average Dane is not entirely reassured by developments. A more sensible strategy than that employed by some of the smaller Danish banks who failed the more extreme version of the banking stress tests.

A Space Oddity

Politician’s the world over say the most ridiculous things and here is the Danish version.

Denmark should cut taxes to encourage people to work more, which would increase the supply of labour and help prevent the economy from overheating in 2018, Finance Minister Kristian Jensen said…

So we fix overheating by putting our foot on the accelerator?

Comment

If we look wider than we have so far today we see that international developments should be boosting the Danish economy in 2017. This mostly comes from the fact that the Euro area economy is having a better year which should boost the Danish trade figures if this from the Copenhagen News is any guide.

Denmark has been ranked seventh in the new edition of the World Competitiveness Yearbook for 2017, which has just published by the Swiss business school IMD.

But if we allow for the upwards revision to growth we see that monetary policy is extraordinarily expansionary for an economy which seems to be growing steadily ( 0.6% in Q1) . What would they do in a slow down?

We also learn a few things about negative interest-rates. Firstly the banking sector has done rather well out of them – presumably by a combination of raising margins and central bank protection as we have discussed on here frequently – and secondly they did not turn out to be temporary did they?

Yet as we see so often elsewhere some events do challenge the official statistics. From the Copenhagen Post.

Aarhus may be enjoying ample wind in its sails by being the European Capital of Culture this year, but not everything is jovial in the ‘City of Smiles’.

On average, the Danish aid organisation Kirkens Korshær has received 211 homeless every day in Aarhus from March 2016-March 2017, an increase of 42 percent compared to the previous year, where the figure was 159.

Portugal

Let me offer my deepest sympathies to all those affected by that dreadful forest fire yesterday.

The problems facing inflation targets

Today I wish to discuss something which if it was a plant we would call a hardy perennial. No I do not mean Greece although of course there has been another “deal” which extends the austerity that was originally supposed to end in 2020 to 2060 in a clear example along the lines of To Infinity! And Beyond! Nor do I mean the Bank of Japan which has announced it will continue to chomp away on Japanese assets. What I mean is central bankers and members of the establishment who conclude that an inflation target of 2% per annum is not enough and it needs to be raised. The latest example has come from the chair of the US Federal Reserve Janet Yellen. From Reuters.

Years of tepid economic recovery have Fed Chair Janet Yellen and other central bankers considering what was once unthinkable: abandoning decades-long efforts to hold inflation down and allowing price expectations to creep up.

I am not sure if the author has not been keeping up with current events or has been drinking the Kool Aid because since early 2012 the US Federal Reserve has been trying to get inflation up to its 2% per annum target. It managed it for the grand sum of one month earlier this year before it started slip sliding away again. Indeed for a while the inflation target was raised to 2.5% which achieved precisely nothing which is why the change has mostly been forgotten. From December 2012.

inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal,

Of course the Bank of Japan has been trying to raise inflation pretty much since the lost decade(s) began. Anyway here is Reuters again on the current thinking of Janet Yellen.

In remarks on Wednesday, Yellen called an emerging debate over raising global inflation targets “one of the most important questions facing monetary policy,” as central bankers grapple with an economic rut in which low growth, low interest rates and weak price and wage increases reinforce each other.

There is a clear problem with that paragraph as this week’s UK data has reminded us “weak price” increases boosted both retail sales and consumption via the way they boosted real wages. The rationale as expressed below is that we are expected to be none too bright.

The aim would be a change of households’ and businesses’ psychology, convincing them that prices would rise fast enough in the future that they would be better off borrowing and spending more today……..Raising that target to 3 or even 4 percent as some economists have suggested would shift the outlook of firms in particular, allowing them to charge more for goods and pay more for labor without the fear that a central bank would step on the brakes.

They are relying on us being unable to spot that the extra money buys less. Oh and after the utter failure of central bank Forward Guidance particularly in the UK you have my permission to laugh at the Ivory Tower style idea that before they do things consumers and businesses stop to wonder what Mark Carney or Janet Yellen might think or do next!

The theme here is along the lines set out by this speech from John Williams of the San Francisco Fed last September.

The most direct attack on low r-star would be for central banks to pursue a somewhat higher inflation target. This would imply a higher average level of interest rates and thereby give monetary policy more room to maneuver. The logic of this approach argues that a 1 percentage point increase in the inflation target would offset the deleterious effects of an equal-sized decline in r-star.

In John’s Ivory Tower there is a natural rate of interest called r-star.

Meanwhile in the real world

Whilst I am a big fan of Earth Wind and Fire I caution against using their lyrics too literally for policy action.

Take a ride in the sky
On our ship, fantasize
All your dreams will come true right away

You see if we actually look at the real world there is an issue that in spite of all the monetary easing of the credit crunch era we have not seen the consumer inflation that central bankers were both planning and hoping for. The Federal Reserve raised its inflation target as described above in December 2012 because it was expecting “More,More, More” but it never arrived. For today I will ignore the fact that inflation did appear in asset markets such as house prices because so many consumer inflation measures follow the advice “look away now” to that issue.

If we move to the current situation and ignore the currency conflicted UK we see that there is a danger for central bankers but hope for the rest of us that inflationary pressure is fading. A sign of that has come from Eurostat this morning.

Euro area annual inflation was 1.4% in May 2017, down from 1.9% in April.

Tucked away in the detail was the fact that energy costs fell by 1.2% on the month reducing the annual rise to 4.5% from the much higher levels seen so far in 2017. As we look at a price for Brent Crude Oil of US $47 per barrel we see that if that should remain there then more of this can be expected as 2017 progresses. That is of course an “if” but OPEC does seem to have lost at least some of its pricing power.

Actually today’s data posed yet another problem for the assumptions of central bankers and the inhabitants of Ivory Towers. We have been seeing am improvement in the Euro area economy as 2016 moved in 2017 so we should be seeing higher wage increases according to economics 101. From Eurostat.

In the euro area, wages & salaries per hour worked grew by 1.4%…., in the first quarter of 2017 compared with the same quarter of the previous year. In the fourth quarter of 2016, the annual change was +1.6%

What if our intrepid theorists managed to push inflation higher and wages did not rise? A bit like the calamity the Bank of England ignored back in 2010/11. As an aside a particular sign that the world has seen a shift in its axis is the number from Spain which for those unaware is seeing a burst of economic growth. Yet annual wage growth is the roundest number of all at 0%.

Comment

Much has changed in the credit crunch era but it would appear that central bankers are at best tone-deaf to the noise. We have seen rises in inflation target as one was hidden in the UK switch to CPI from RPI ( ~0.5% per annum) and the US had a temporary one as discussed above and a more permanent one when it switched from the CPI to PCE measure back in 2000 ( ~ 0.3% per annum). I do not see advocates of higher inflation target claiming these were a success so we can only assume there are hoping we will not spot them.

The reality is quite simple the logical response to where we are now would be to reduce inflation targets rather than raise them. Another route which would have mostly similar effects would be to put house prices in the various consumer inflation measures.

Oh and something I thought I would keep for the end. have you spotted how the US Federal Reserve sets its own targets? I wonder how that would work in the era of the Donald?!

Music for traders

My twitter feed has been quite busy with suggestions of songs for traders. All suggestions welcome.

 

The problems of the banks of Italy part 101

It is time to look again at a topic which is a saga of rinse and repeat. Okay I am not sure it is part 101 but it certainly feels like a never-ending story. Let us remind ourselves that the hands of the current President of the ECB ( European Central Bank) Mario Draghi are all over this situation. Why? Well let me hand you over to the ECB itself on his career so far.

1997-1998: Chair of the Committee set up to revise Italy’s corporate and financial legislation and to draft the law that governs Italian financial markets (also known as the “Draghi Law”)

It is a bit awkward to deny responsibility for the set of laws which bear you name! This happened during the period ( 1991-2001) that Mario was Director General of the Italian Treasury. After a period at the Vampire Squid ( Goldman Sachs) there was further career progression.

2006-October 2011Governor, Banca d’Italia

There were also questions about the close relationship and dealings between the Italian Treasury and the Vampire Squid over currency swaps.

https://ftalphaville.ft.com/2010/02/09/145201/goldmans-trojan-greek-currency-swap/?mhq5j=e2

But with Mario linking the Bank of Italy and the ECB via his various roles the latest spat in the banking crisis saga must be more than an embarrassment.

The inspection at Banca Popolare di Vicenza that began in 2015 was launched at the request of the Bank of Italy and was conducted by Bank of Italy personnel. Any subsequent decisions were not the responsibility of the Bank of Italy but of the European Central Bank, because in November 2014 Banca Popolare di Vicenza had become a ‘significant’ institution and was subject to the European Single Supervisory Mechanism (SSM). ( h/t @FerdiGiugliano )

So we can see that the Bank of Italy is trying to shift at least some of the blame for one of the troubled Veneto banks to the ECB. At this point Shaggy should be playing on its intercom system.

It wasn’t me…….It wasn’t me

An official denial

At the end of last month the Governor of the Bank of Italy gave us its Annual Report.

At the end of 2016 Italian banks’ non-performing loans, recorded in balance sheets net of write-downs, came to €173 billion or 9.4 per cent of total loans. The €350 billion figure often cited in the press refers to the nominal value of the exposures and does not take account of the losses already entered in balance sheets and is therefore not indicative of banks’ actual credit risk.

Indeed he went further.

Those held by intermediaries experiencing difficulties, which could find themselves obliged to offload them rapidly, amount to around €20 billion.

I suppose your view on this depends on whether you think that 20 billion Euros is a lot or a mere bagatelle. It makes you wonder why the problems at the Veneto banks and Monte Paschi seem to be taking so long to solve does it not?

Meanwhile he did indicate a route to what Taylor Swift might call “Trouble, trouble,trouble”.

At the current rate of growth, GDP would return to its 2007 level in the first half of the 2020s.

An economy performing as insipidly as that is bound to cause difficulties for its banks, but not so for the finances of its central bank.

The 2016 financial year closed with a net profit of €2.7 billion; after allocations to the ordinary reserve and dividends paid to the shareholders, €2.2 billion were allocated to the State, in addition to the €1.3 billion paid in taxes.

The QE era has seen a boom in the claimed profits for central banks and as you can see they will be very popular with politician’s as they hand them over cash to spend.

The ECB is pouring money in

The obvious problem with telling us everything is okay is that Governor Visco is part of the ECB which is pouring money into the Italian banks. From the Financial Times.

According to ECB data as of the end of April, Italian banks hold just over €250bn of the total long-term loans — almost a third of the total.

There is a counter argument that the situation where the Italian banks rely so much on the ECB has in fact simply kicked that poor battered can down the road.

“Some of them [Italian banks] are unprofitable even with the ECB’s cheap funding,” adds Christian Scarafia, co-head of Western European Banks at Fitch.

Fitch also observes that the TLTRO funding is tied up with Italy’s management of the non-performing loans that beset its banks. “The weak asset quality in Italy is certainly the big issue in the country and access to cheap ECB funding has meant that banks could continue to operate without having to address the asset quality problem in a more decisive manner,” says Mr Scarafia. (FT)

It was intriguing to note that the Spanish bank BBVA declared 36 million Euros of profits in April from the -0.2% interest-rate on its loans from the ECB. A good use of taxpayer backed money?

The Veneto Banks

For something that is apparently no big deal and according to Finance Minister Padoan has been “exaggerated” this keeps returning to the news as this from Reuters today shows.

Italian banks are considering assisting in a rescue of troubled lenders Popolare di Vicenza and Veneto Banca by pumping 1.2 billion euros (1.1 billion pounds) of private capital into the two regional banks, sources familiar with the matter said.

Good money after bad?

Italian banks, which have already pumped 3.4 billion euros into the two ailing rivals, had said until now that they would not stump up more money.

As you can see the ball keeps being batted between the banks, the state , and the Atlante fund which is a mostly private hybrid of bank money with some state support. Such confusion and obfuscation is usually for a good reason. A bail in has the problem of the retail depositors who were persuaded to invest in bank bonds.

Monte Paschi

On the 2nd of this month we were told that the problem had been solved and yet the saga like so many others continues on.

HEDGE FUND SAID IN TALKS TO BUY $270 MILLION MONTEPASCHI LOANS ( h/t @lemasabachthani )

Seems odd if it has been solved don’t you think? Mind you according to the FT the European Banking Authourity may have found a way of keeping it out of the news.

The EBA said it would be up to supervisors to decide whether to include any bank in restructuring within the stress tests, and European Central Bank supervisors have decided not to include Monte dei Paschi, people briefed on the matter said.

So bottom place is available again.

Comment

This has certainly been more of a marathon than a sprint and in fact maybe like a 100 or 200 mile race. The Italian establishment used to boast that only 0.2% of GDP was used to bailout Italian banks but of course it is now absolutely clear that this effort to stop its national debt rising even higher allowed the banking sector to carry on in the same not very merry way. This week the environment has changed somewhat with Santander buying Banco Popular for one Euro. Although of course the capital raising of 7 billion Euros needs to be factored into the equation. I guess Unicredit has troubles enough of its own and could not reasonably go for yet another rights issue!

Me on TipTV Finance

http://tiptv.co.uk/living-extraordinary-times-not-yes-man-economics/

 

The British and Irish Lions

I have been somewhat remiss in not wishing our players well on what is the hardest rugby tour of all which is a trip into the heart of the All Blacks. I am thoroughly enjoying it although of course we need to raise our game after a narrow win and a loss. Here’s hoping!