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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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?!

Why are we told some inflation is good for us?

A major topic in the world of economics is the subject of inflation which has been brought into focus by the events of the past 2/3 years or so. First we had the phase where a fall in the price of crude oil filtered through the system such that official consumer inflation across many countries fell to zero per cent on an annual basis and in some cases below that. If you recall that led to the deflation scare or it you will excuse the capitals what much of the media presented as a DEFLATION scare. We were presented with a four horsemen of the apocalypse style scenario where lower and especially negative inflation would take us to a downwards spiral where wages and economic activity fell as well along the line of this from R.E.M.

It’s the end of the world as we know it.
It’s the end of the world as we know it.

I coined the phrase “deflation nutter” to cover this because as I pointed out, Greece the subject of yesterday suffered from quite a few policy errors pushing it into depression and that on the other side of the coin for all its problems Japan had survived years and indeed decades of 0% inflation. Indeed on the 29th of January 2015 I wrote an article on here explaining how lower consumer inflation was boosting consumption across a range of countries via the positive effect it was having on real wages.

 if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly. If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.

 

Relative prices

The comfortable cosy world of central bankers and theoretical economists told us and indeed continues to tell us that we need positive inflation so that relative prices can change. That leads us to the era of inflation targets which are mostly set at 2% per annum although of course there is a regular cry for inflation targets to be raised. However 2015/16 torpedoed their ship as if we just look at the basic change we saw a large relative price adjustment for crude oil leading to adjustments directly to other energy costs and a lot of other changes. Ooops! Even worse for the theory we saw two large sectors of the economy respond in opposite fashion. A clear example of this was provided by my own country the UK where services inflation barely changed and ironically for a period of deflation paranoia was quite often above the inflation target. But the goods sector saw substantial disinflation as it was it that pulled the overall measure down to around 0%.

We can bring this up to date by looking at the latest data from the Statistics Bureau in Japan.

  The consumer price index for Ku-area of Tokyo in October 2017 (preliminary) was 100.1 (2015=100), down 0.2% over the year before seasonal adjustment, and down 0.1% from the previous month on a seasonally adjusted basis.

So not only is there no inflation here there has not been any for some time. Yet the latest monthly update tells us that food prices fell by 2.4% on an annual basis and the sector including energy fuel and lighting rose by 7.1%. Please remember that the next time the Ivory Towers start to chant their “we need inflation so relative prices can adjust” mantra.

Reality

This is that central banks are in the main failing to reach their inflation targets. For example if we look at the US economy the Federal Reserve targets the PCE ( Personal Consumption Expenditure) inflation measure which was running at an annual rate of 1.6% in September and even that level required an 11.1% increase in energy prices.

So we see central banks and establishments responding to this of which the extreme is often to be found in Japan. From @lemasabachthani yesterday.

JAPAN PM AIDE HONDA: INAPPROPRIATE TO REAPPOINT BOJ GOV KURODA, BOJ NEEDS NEW LEADERSHIP TO ACHIEVE 2 PCT INFLATION TARGET

Poor old Governor Kuroda whose turning of the Bank of Japan into the Tokyo Whale was proving in his terms at least to be quite a success. From the Financial Times.

Trading was at its most eye-catching in Japan. Tokyo’s Topix index touched its highest level since November 1991, only to end down on the day after a volatile session. At its peak, the index reached the fresh high of 1,844.05 with gains across almost all major segments, taking it more than 20 per cent higher for the year to date. But it faded back in late trade to close at 1,817.75.

It makes me wonder what any proposed new Governor would be expected to do?! QE for what else?

Whereas in this morning’s monthly bulletin the ECB ( European Central Bank) has told us this.

Following the decision made on 26 October 2017 the monthly pace will be further reduced to €30 billion from January 2018 and net purchases will be carried out until September 2018. The recalibration of the APP reflects growing confidence in the gradual convergence of inflation rates towards the ECB’s inflation aim, on account of
the increasingly robust and broad-based economic expansion, an uptick in measures of underlying inflation and the continued effective pass-through of the Governing
Council’s policy measures to the financing conditions of the real economy.

So we see proposals for central banking policy lost in  a land of confusion as the US tightens, the Euro area eases a little less and yet again the establishment in Japan cries for more, more, more.

Comment

There is a lot to consider here as we mull a world of easy and in some cases extraordinarily easy monetary policy with what is in general below target inflation. Of course there are exceptions like Venezuela which as far as you can measure it seems to have an inflation rate of the order of 2000% + . But in general such places are importing inflation via a lower currency exchange rate which means that someone else’s is reduced. Also we need to note that 2017 is looking like a good year for economic growth as this morning’s forecasts from the European Commission indicate.

The euro area economy is on track to grow at its fastest pace in a decade this year, with real GDP growth forecast at 2.2%. This is substantially higher than expected in spring (1.7%)……..at 2.1% in 2018 and at 1.9% in 2019.

So then of course you need an excuse for easy monetary policy which is below target inflation! Of course this ignores two technical problems. The first is that at the moment if we get inflation it is mostly from a higher oil price as we mull the likely effects of Brent Crude Oil which has moved into the US $60s. The second is that there is inflation to be found if you look at asset prices as whilst some of the equity market highs we keep seeing is genuine some of it is simply where all the QE has gone. Also there is the issue of house prices where even in the Euro area they are growing at an annual rate of 3.8% so if they were in an inflation index even more questions would be asked about monetary policy.

In a world where wages growth is not only subdued but has clearly shifted onto a lower plane the obsession with raising inflation will simply make the ordinary person worse off via its effect on real wages. Sadly this impact is usually hardest on the poorest.

Me on Core Finance TV

http://www.corelondon.tv/uk-housing-market-house-party-keeps-going/

 

 

 

What does the lack of wage growth in Japan tell us about our future?

As the credit crunch era has developed we have seen many countries discover that past relationships between the level of unemployment and the rate of wage growth no longer exists. Actually if we look back we see that there had been changes before the credit crunch but it has both exacerbated them and brought them into focus. This issue is particularly pronounced in Japan where the unemployment and employment numbers are very strong. From Japan Macro Advisers.

The Japanese economy keeps adding jobs. 200K new jobs were added in August 2017. The unemployment rate was unchanged at 2.8% in August, remaining at the lowest rate in 23 years.

The stand out number is an unemployment rate of a mere 2.8% which is rather extraordinary especially if we recall estimates of full employment from the past as it is below them! How can this be? Well as even economic concepts do not mean what they say as for example central bankers talk of “price stability” when they mean inflation stability usually at 2% per annum. The concept of full employment was and indeed is like that as it does not mean everyone has a job. It always assumed some frictional unemployment or people temporarily out of work and that implied a higher unemployment rate than Japan now has. If we look at other measures the numbers are also strong.

Japan’s job offers to applicant ratio also remained constant in August at 1.52, the highest ratio since February 1974. The new job offers to applicant ratio slightly declined to 2.21 from 2.27 in July, but it is still close to its historical high and continues to show there are more than two vacant jobs to one applicant.

However we also need to note that there is a particularly Japanese feature to this which is on its way to other countries with demographics issues.

The work age population in Japan, defined as the population of the age between 15 and 64, has been shrinking rapidly. In 2016, it fell by 0.7 million people. In 2017, it is projected to shrink further by 0.8 million in 2017. While the Japanese economy is making ends meet by higher labor participation from its senior citizens, the labor resource limitation is an issue Japan needs to address soon.

Work till you drop is perhaps the new theme here.

What about wages?

The story of my time online covering Japan is that since the Abe government came to power there has been prediction after prediction that wage growth will pick up. Regular readers will be aware that some news organisations such as Bloomberg have regularly reported that wage growth has picked up but the truth is that so far there has been no real sign. If we move from the past hype to reality we see that according to the official data real wages fell by 0.9% in 2013, 2.8% in 2014 and 0.9% in 2015 before rising by 0.7% in 2016. Putting it another way the real wage index which was 103.9 in 2013 was 100.7 in 2016.

If we return to Japan Macro Advisers we see this.

The wage report for August was encouraging. Total wages rose by 0.9% year on year (YoY), the highest increase in the last 12 months. Basic and overtime wages rose by 0.6% YoY, the highest rise since April 2016.

We learn a lot there as growth of a mere 0.9% is “encouraging”?! If we switch to real wages the picture is not because they were 0.1% lower than a year before. They are optimistic because of what is essentially a challenge to the unemployment data as they hint at a change in underemployment.

The report shows that 30.5% of workers covered in the survey were part-time workers, a decline of 0.2% point from a year ago. The government does not publish a seasonally adjusted series, but in our own estimation, we see a clear sign that the part-time ratio is starting to decline.

This matters because.

Part-time workers receive one-third of wages that regular workers receive. There are other important benefits such as social security, and the job security is far stronger for regular workers.

Why might wages growth remain weak?

An interesting facet of the issue was highlighted yesterday by the Wall Street Journal.

Facing the tightest labor market in Japan in 43 years, Gatten Sushi recently hired two Chinese kitchen workers and a Filipino waitress who calls out “Welcome” to customers, each for about $10 an hour.

For a country which in many respects prides itself on being homogenous the situation below represents quite a change.

Japan added 400,000 foreign workers in the four years through 2016, surpassing one million for the first time, or nearly 2% of the workforce, labor ministry data show. That is still low compared with the U.S.’s 17% of foreign-born workers but enough to sway the labor market in urban centers like Tokyo.

This is something familiar these days where countries in effect import immigrants to help cope with poor demographics such as an ageing population but there is a catch.

RDC’s Mr. Fukui said foreign workers help the company keep prices flat, especially at budget places like a conveyer-belt sushi restaurant where Vietnamese workers in masks and plastic gloves place fish atop small rice balls formed by a robot. They are useful in other ways too: Sometimes they help out by serving foreign tourists in their own languages, and Mr. Fukui hopes they will continue working with the company even when they go back home to help it expand overseas.

There is a clear implication here that foreign workers are being used as a way of keeper wages lower. This can work because whilst the wages are low for Japan they are high for elsewhere.

Minimum wage in Japan, too low to attract many native-born workers, is still generous for many other Asians. In 2015, Japan’s minimum wage was 21 times higher than that of Vietnam, 12 times higher than in Nepal, and triple that of China, data from Dai-Ichi Research Institute show.

As to this being a permanent situation well maybe not.

Most foreign workers cannot stay permanently owing to immigration rules. Mr. Abe has repeatedly said he doesn’t want large numbers of immigrants in low-paying jobs coming to Japan for the long term.

Government policy

This has been announced since last weekend’s election according to Reuters.

Japan’s government is considering expanding tax incentives for companies to encourage them to raise wages, three people involved in discussions told Reuters, as many firms remain hesitant to spend their cash reserves on salary increases.

As the existing tax breaks are not working this sounds rather like the approach to QE ( QQE in Japan) where like Agent Smith in The Matrix series of films the cry always goes up for “More”

Comment

There are lessons here because Japan has for some time run a policy of declaring pretty much full employment. What I mean by that is that when I worked in Tokyo some 20 years ago people were employed to count you walking across bridges and lifts in the Ghinza shopping district had operators to save you from the arduous task of pressing a lift button! Of course many other countries are now facing up to the issue of what low levels of unemployment really mean.

The next issue is demographics where Japan is the leader of a pack you would rather not be in. Yes it is welcome people are living longer but it has a shrinking population too. Even it has accepted some immigration but as you have seen earlier on its own terms. As the Abe administration is nationalistic that could easily change, But the immigration that has taken place looks like it has affected wages in some occupations. If we look at the restaurant sector it seems clear that to attract Japanese labour wages would have had to have risen if viable.

That conclusion is not far off dynamite as we are so often told that immigration does not depress wages as this from Noah Smith of Bloomberg reminds us.

Normally immigrants don’t depress native wages, but in Japan, given investment constraints, they actually might. Still…skeptical.

If you have workers coming in from much poorer countries to work in particular sectors then surely it must depress wages in them or make them rise more slowly. I can see that there are areas it is unlikely to affect as for example Eastern European construction workers in the UK or Vietnamese/Chinese restaurant workers in Japan may have no impact at all on many other skills but to say they have no impact in their areas seems strange. Also what happens in their home country?

But if we return to the pattern of Japan upon which immigration has been only a recent thin screen then we see that for all the media and Ivory Tower hype the road on what it has been on for 2 “lost decades” now poses a question for our future.

Wages in Japan has been steadily falling in Japan since 1998. Between 1997 and 2012, wages have fallen by 12.5%, or by 0.9% per year on average. ( Japan Macro Advisers).

But we cannot just simply assume we will be “Turning Japanese” in every respect as this from the UK Office for National Statistics has reminded us today.

UK population projected to grow from 65.6 million in 2016 to 72.9 million in 2041

 

Me on Core Finance TV

http://www.corelondon.tv/uk-gdp-0-4-pleasant-number/

 

It is party and sake time at The Tokyo Whale as the Nikkei 225 hits highs

This week has brought a succession of news which will be welcomed by supporters of what has become called Abenomics and the Bank of Japan in particular. In fact the Bank of Japan will be pleased in two ways, one as an ordinary central bank and the other in its hedge fund style role as the Tokyo Whale. From The Japan Times.

The benchmark Nikkei average rose further and marked another 21-year closing high on the Tokyo Stock Exchange on Thursday, boosted by Wall Street’s overnight advance. The Nikkei 225 average gained 73.45 points, or 0.35 percent, to end at 20,954.72 — the best finish since Nov. 29, 1996.

Today this has gone one step further or for Madness fans one step beyond,

Let us start with the most recent period from when Abenomics was first likely to be applied to now. In that time the Nikkei 225 equity index has risen from around 8000 to 21000. As this was one of the policy objectives as according to the mantra it leads to positive wealth effects for the economy it will be regarded as a success. It may also help oil the wheels in the ongoing Japanese election. But you see there is another reason for the Bank of Japan to be happy about this because since a trial effort back in 2010 it has been buying Japanese shares via Exchange Traded Funds. A more regular programme started in 2012 and this was boosted in size and scale over time and here is the current position from the September monetary policy statement.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively.

So the Bank of Japan will have some considerable paper profits right now especially in the light of a clear behavioural pattern which I looked at on the 6th of June.

The bank apparently buys frequently on days when the stock market dips in the morning, serving to stabilize share prices.

The Nikkei Asian Review analysed this development like this.

“The BOJ’s ETF purchases help provide resistance to selling pressure against Japanese stocks,” says Rieko Otsuka of the Mizuho Research Institute.

There have been various rumours over the years about central banks providing something of a “put option” for equity markets leading to talk of a “plunge protection team”, well here is one literally in action. The Japanese taxpayer may reasonably wonder why it is supporting equity investors in yet another example of a policy which the 0.01% will welcome in particular. But for now let is move on with the Governor of the Bank of Japan enjoying a celebratory glass of sake as he looks at the wealth effects of the equity market high and the paper profits in the Bank’s coffers.

The “Put Option” in practice

A paper had been written by Toby Nangle and Tony Yates on this. You may well recall Tony Yates as the person I had a debate with on BBC Radio 4’s Moneybox programme and that events since have not been kind to his views. Anyway they tell us this.

 the cumulative purchases by the Bank of Japanese equities are becoming substantial. We estimate the market value to have been just below ¥20 trillion at the end of July 2017, or around 3.2% of the total Japanese stock market, making the central bank the second largest owner of Japanese stocks after the Government Pension Investment Fund.

Indeed they find themselves producing analysis along the lines of my “To Infinity! And Beyond!” theme.

Without further adjusting the pace of ETF purchases, we project that the central bank will own 10% of the market sometime between 2022-2026, depending on the interim market performance.

First they look for an announcement effect.

We control for this by examining the excess returns of Japanese stocks versus global stocks two business days post-announcement in common currency (last column in Table 1). The relationship between the scale of purchases and the price change is positive in each episode, although the confidence we have in the relationship is not strong given such few data points.

Personally I would also be looking at the days ahead of the announcement as many of these type of events are anticipated and if you like “front-run” these days. Next we see they look for an execution effect and they struggle to find one as the Japanese market underperformed in the period they looked at compared to other equity markets. However we do get a confirmation of the put option in operation.

 we find that the Bank of Japan has timed the execution of its ETF purchase programme to coincide with episodes of market weakness, potentially with the aim of dampening price volatility.

Oh and “dampening price volatility” is the new reduce and/or stop market falls as otherwise it would also sell on days of market strength.

Will it spread?

This is slightly dubious depending on how you regard the actions of the Swiss National Bank which of course buys equities abroad which I presume they regard as the difference.

Japan has been alone in purchasing equities as part of its monetary easing programme, and the question of whether the purchase of equity securities is the next step along this path is of wider interest.

But I agree with the conclusion.

 Even if central banks in the US/Eurozone/UK achieve a lasting lift-off from the zero bound, and are able to shed asset purchases from their balance sheet, low central bank rates are discounted by markets to be a fact of life for the next decade or two, and the chance of needing to have recourse to unconventional measures appears very large.

Comment

Thank you to Tony and Toby for their paper but they use very neutral language and avoid any opinion on whether this is a good idea which tends to suggest a form of approval. Yet there are a myriad of problems.

The ordinary Japanese taxpayer is very unlikely to be aware of this and what is being done both in their name and with their backing. This is especially important if we consider the exit door as in how does this end?

There is a moral hazard problem in both backing and financing a market which disproportionately benefits the already well off. This gets added to by the latest scandal in Japan as the company below has been ( indirectly) backed by the Bank of Japan.

DJ KOBE STEEL SAYS FOUND MORE INSTANCES OF SHIPPED PRODUCTS WITH QUALITY PROBLEMS ( h/t @DeltaOne )

There are real problems here and is one of the arguments against central banks buying risky assets of this form and the clue of course is in the use of the word risky.

Next we have the issue of what good does it do? Yes some get an increase in their paper wealth and some will take profits. In a sense good luck to them, but as we note that this will be disproportionately in favour of the wealthy this is in my opinion a perversion of the role of a central bank.

On the other side of the coin is the current media cheerleading for equity markets of which this from Bloomberg this morning is an especially disturbing example.

To put this year’s gains in perspective, the value of global equities is now 3 1/2 times that at the financial crisis bottom in March 2009. Aided by an 8 percent drop in the U.S. currency, the dollar-denominated capitalization of worldwide shares appreciated in 2017 by an amount — $20 trillion — that is comparable to the total value of all equities nine years ago……… And yet skeptics still abound, pointing to stretched valuations or policy uncertainty from Washington to Brussels. Those concerns are nothing new, but heeding to them is proving an especially costly mistake.

You see congratulating people on doing well out of equity investments is very different to saying you should buy now at what are higher prices. Unless of course Bloomberg thinks they are more attractive at higher prices in which case perhaps it should be buying Bitcoin. Let me leave you with this which feels like something out of a dystopian science fiction piece.

Big companies are becoming huge, from Apple Inc. to Alibaba Group Holding Ltd.

Why have the bond markets lost their bark and their vigilantes?

The credit crunch era took us on quite a journey in terms of interest-rates. At first central banks reduced official short-term interest-rates in the hope that they would fix the problem. Then they embarked on Quantitative Easing policies which were designed to reduce long-term interest-rates or bond yields. This was because quite a few important interest-rates are not especially dependent on official interest-rates and may from time to time even move in the opposite direction. An example is fixed-rate mortgages. However if they are a “cure” then one day all the downwards manipulation of interest-rates and yields needs to stop. Of course the fact that it is still going on all these years later poses its own issues.

The United States looked as though it was heading on that road last year on two counts. Firstly the Federal Reserve was in a program to raise interest-rates and secondly both Presidential candidates indicated plans for a fiscal stimulus. When Donald Trump was elected as President he reinforced this by telling us this as I reported back on November 9th.

We are going to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals. We’re going to rebuild our infrastructure, which will become, by the way, second to none, and we will put millions of our people to work as we rebuild it.

This was somewhat reminiscent of the “New Deal” of President F.D. Roosevelt although I counselled caution at the time and of course any fiscal expansion would be added to by the plan for tax cuts. The two impacted on bond markets as shown below.

There has been a clear market adjustment to this which is that the 30 year ( long bond) yield has risen by 0.12% to 2.75%.

In the US this tends to have a direct impact on fixed mortgage-rates as many places quote a 30 year one.

What happened next?

US bond yields did rise and in mid March the 10 year Treasury Note yield rose to 2.63% meaning that it was approaching the long bond yield quoted above. Meanwhile the long bond yield rose to 3.21%. However as we look back now those were twin peaks and have been replaced by 2.07% and 2.69% respectively.

Why might this be?

Whilst there does seem to be some sort of concrete plan for tax cuts there is little sign of much concrete around any infrastructure spending. So that has drifted away and there has been an element of this with official interest-rate rises. The US Federal Reserve has raised them to a range between 1% and 1.25% but seems to be in no hurry to raise them further. It does plan to reduce its balance sheet but the plan is very small compared to its size.

The Recovery

The US economy has continued to grow in 2017 as shown below.

Real gross domestic product (GDP) increased at an annual rate of 3.0 percent in the second quarter of 2017 (table 1), according to the “second” estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 1.2 percent. ( These are annualised figures )

This has not been enough to unsettle bond markets especially if we add in that so far in 2017 inflation has if anything faded. Here are the latest numbers from NASDAQ.

Excluding food prices and fuel, core PCE measure – the Fed’s preferred measure of inflation – increased 1.4% in July year over year compared with 1.5% in June. However, it edged up 0.1% in July on a monthly basis. Therefore, it is still far from the Fed’s target of 2%.

For once it does not matter if you use a core inflation measure as it comes to the same answer as the headline! Although the annual rate has only fallen by 0.2% for the core measure since March as opposed to 0.4% for the headline. But we are left with okay growth and fading inflation which gives us a reason why bond markets have rallied and yields fallen.

What about wages?

The various output gap style theories that falling and indeed low unemployment rates would push wage and in particular real wage growth higher have not come to fruition. From the Bureau of Labor Statistics.

From July 2016 to July 2017, real average hourly earnings increased 0.8 percent, seasonally adjusted. The increase in real average hourly earnings combined with no change in the average workweek resulted in a 0.7-percent increase in real average weekly earnings over this period.

Japan

If we stay with the subject of wages here is today’s data from Japan. From the Financial Times.

 

Unadjusted labour cash earnings fell 0.3 per cent year on year in July, down from a 0.4 per cent increase a month earlier, according to a preliminary estimate by the Ministry of Health, Labour and Welfare…….Special cash earnings, which includes bonuses, were down 2.2 per cent on the same month a year ago.

If we widen our discussion geographically and look at the US where there is some wage growth we see that in other places there is not as real wages in Japan fell by 0.8%. If we stay with Japan for a moment then we see that in spite of the media proclamations over the past 4 years that wages are about to turn upwards we are still waiting. Bonuses were supposed to surge this summer. So the “output gap” continues to fail and there is little pressure on bond yields from wage growth in Japan.

QE

This of course continues in quite a few places. In terms of the headline players we have the 60 billion Euros a month of the European Central Bank and the yield curve control of the Bank of Japan which it expects to be around 80 trillion Yen a year. I raise these points as a bond yield rally in these areas would require these to be substantially reduced or stopped. We expect little substantive change from the ECB until the election season is over but some were expecting a reduction from it as the Euro area economy improved. As time passes it will have to make some changes as its rules suggest it will run out of German bonds to buy next spring and the more it shuffles to avoid that the more likely it will run out of bonds to buy in France, Spain and even Italy.

Added to this are the sovereign wealth funds as for example Norway which seems to be rebalancing in favour of US Euro and UK bonds. There are also the investment plans of the Swiss National Bank.

Comment

So we see a dog that has little bark and has not bitten. Some of this is really good news as unlike the central banker cartel I am pleased that so far inflation has for them disappointed. Although as we look ahead there may be issues from some commodity prices. From Mining.com

December copper futures trading on the Comex market in New York made fresh highs on Tuesday after the world’s number one producer of the metal reported a sharp drop in production.
Copper touched $3.1785 a pound ($7,007 per tonne) in morning trade, the highest since September 2014. Copper is now up by more than 50% compared to this time last year.

So Dr,Copper may be giving us a hint although I also note that hedge funds are getting involved so this may be a “financialisation” move as opposed to a real one.

Another factor which would change things would be some real wage growth. Perhaps along the lines of this released by the German statistics office last week.

The collectively agreed earnings, as measured by the index of agreed monthly earnings including extra payments, increased by an average 3.8% in the second quarter of 2017 compared with the same quarter of the previous year. This is the highest rise since the beginning of the time series in 2011. The Federal Statistical Office (Destatis) also reports that, excluding extra payments, the year-on-year increase in the second quarter of 2017 was 3.4%.

If we move to my home country then it remains hard to believe with our penchant for inflation we have a ten-year Gilt yield of 1.01% as I type this. Even worse a five-year Gilt yield of 0.43% as you will lose the total yield in inflation this year alone. I can see how a “punter” might buy at times front-running events or the Bank of England but how can it be an investment unless you expect quite an economic depression?

 

 

 

What makes a currency a safe haven these days?

The subject of safe havens is something that comes to mind as one considers the situation concerning North Korea. An unhinged leader combined with nuclear weapons and intercontinental ballistic missile technology does not make for a stable mix and of course there is Kim Jong-Un to consider as well. Mind you Twitter took the news of a possible Korean H-Bomb very calmly yesterday as it was soon replaced in the headlines by Wayne Rooney’s difficulties and today events are led by a headline which could refer to North Korea but fortunately McStrike is in fact the first strike at MacDonald’s in the UK.

So let us consider an environment where risk is higher and maybe a lot higher. This poses an early issue as my time in derivative and particularly options markets taught me that we as humans are very bad at quantifying things to which we give a low probability. We are even worse when it is something we do not want to happen. Establishments magnify this issue as I recall the excellent work of the Nobel prize-winning physicist Richard Feynman on the NASA Challenger space shuttle disaster. He was part of the enquiry and was officially told that the odds were millions to one whereas when he interviewed individual engineers they told him that individual parts had a one in five hundred chance of failure. It turned out that the disaster was not a surprise as the surprise was that it had not happened before.

What does risk-off do now?

The Japanese Yen

Each time the rhetoric or a North Korean missile rises the Japanese Yen follows it. This felt especially odd when one of the missiles overflew Japan and tripped civil defence alarms as well as no doubt having the self-defence force scrambling. Also the rally to 109.60 this morning against the US Dollar will have steam coming out of the ears of the Bank of Japan on two counts. Firstly because a lower value for the Yen is part of Abenomics and secondly it will send equity markets lower ( 190 points on the Nikkei 225 index).Still the Bank of Japan will be able to occupy itself by buying yet more equities.

If we look deeper into Yen strength in risky times I note this from the IMF in November 2013.

since the mid-1990s, there have been 12 episodes where the yen has appreciated in nominal effective terms by 6 percent or more within one quarter and these coincided often with events outside Japan

Why might this be?

Safe haven currencies tend to have low interest rates, a strong net foreign asset position, and deep and liquid financial markets. Japan meets all these criteria

The first point if we modify low to lower to bring it up to date gives us food for thought on what determines interest-rates. We are usually told domestic considerations but there is a correlation between strong trade positions and negative interest-rates for example. As to the foreign asset position then unlike its public-sector which has lots of debt Japan is in fact the largest creditor. From Reuters.

Japan’s net external assets rose to their second-highest amount on record at the end of fiscal 2016, driven by rising mergers and acquisitions overseas by firms and portfolio investment, the Finance Ministry said Friday.
The net value of assets held by the government, businesses and individuals stood at ¥349 trillion ($3.12 trillion) — just behind 2014’s record ¥363 trillion. It meant Japan remained the biggest creditor nation for the 26th straight year, the ministry said.

There is a twist though as you might think the Yen rallies because of the money beginning to be brought home but in fact according to the IMF not so.

In contrast, we find evidence that changes in market participants’ risk perceptions trigger derivatives trading, which in turn lead to changes in the spot exchange rate without capital flows.

In essence it is expectations of a change rather than actual capital flows. I would imagine that the carry trade ( where foreign investors borrow in Yen) are a factor in this.

Swiss Franc

Many of the same factors are at play here which is why in the early days of this website I labelled the Yen and Swiss Franc as the “Currency Twins”. We can reel off negative interest-rates, trade, carry trade and so on including with a wry smile that official policy is in the opposite direction! There are two main differences the first is that there tend to be actual inflows into Swiss Francs. The second is the way that net private assets have been replaced by the Swiss National Bank. From a Working Paper from the Graduate Institute of Geneva

At the end of 2016, the Swiss net international investment position (NIIP, the value of foreign assets held by Swiss residents, net of liabilities of Swiss residents to foreign investors) reached 131 percent of GDP ……. The net international investment position of the private sector was thus close to balance in 2015, and only amounted to 24 percent of GDP at the end of 2016.

So we have seen something of a socialisation of Switzerland’s net investment position. Does that matter? I suspect so but markets seem less worried as the Swissy has rallied against the US Dollar by 0.75% to 0.9574 today.

Euro

It is hard not to raise a wry smile at the articles saying the Euro is no longer a safe haven currency as we note its rise today! Here is Kathy Lien of Nasdaq from last week with an explainer of sorts.

However the central bank’s positive economic outlook, their hawkish monetary policy bias

In future my financial lexicon for these times will have negative interest-rates and large QE as part of my “hawkish” definition. Anyway as we note that it is the countries with ongoing types of QE who are the new apparent safe havens we are left mulling the chicken and egg conundrum. Being a funding currency in the global carry trade is another consistent factor.

US Dollar

So far the era of the military dollar seems to have ended. Maybe it awaits a proper test as in an actual war but considering the stakes I would rather not find out.

Comment

So we see that a potential factor in being a safe haven currency is for official policy to be for the currency to fall? Not quite true for the Euro at least explicitly although of course it used to be expected ( outside the Ivory Towers who still do) that negative interest-rates and QE  weaken a currency. A side effect of the official effort is clearly that the QE and supply of money aids and abets those who wish to borrow in that currency and at times like this even if they do not actually reverse course markets price in that they might. The currency then sings along to “Jump” by Van Halen. You can turn the volume up to 11 Spinal Tap style if actual carry trade reversals happen.

Also there is the issue of what is a safe haven? In terms of Japan it is clearly not literal as it is in the likely firing line. We see that front-running expected trends remains the main player here as opposed to clear logical thinking. Also we see that another safe haven only flickers a bit these days as bond markets rally a bit but nothing like they used to That is another function of the QE era as how much more could they rise? Also I note that equity markets do not seem to fall that much as the FTSE 100 is off 10 points as I type this.

So a safe haven may simply be front-running? If so it means we need to dive even deeper in future as does this below for Switzerland show strength or potential weakness?

Specifically, assets held by Swiss residents abroad represent 671 percent of GDP, while claims by foreign investors on Switzerland amount to 541 percent of GDP. With this leverage, a movement in asset prices and exchange rates that affects more assets than liabilities has a sizable impact on the NIIP.