Japan continues to see wages stagnate

A feature of the credit crunch era has been weak wage growth and in particular weak real wage growth. More than a few countries such as my own the UK have not seen real wages fully recover to their pre credit crunch peaks. If we look back we see that the assumptions of the Ivory Towers ( in the UK for example wage growth of ~4% and real wage growth of ~2%) were already built on rather shaky foundations as real wage growth was already fading. Sadly the Ivory Towers learned little as I note last week at its Inflation Report press conference the Bank of England was criticised for consistently over-estimating wage growth. Or if you like another Forward Guidance failure.

However the real front line for the malaise in real wage growth is to be found by looking east to Nihon or the land of the rising sun where there has been trouble for some time. The problem was described by the World Economic Forum back in June 2013.

According to a survey by Reuters in February, 85% of responding firms said they would maintain current wage levels or make further cuts this year. Japanese companies typically resort to wage cuts for workers with so-called life-long employment contracts rather than lay-offs to adjust for cyclical downturns or due to tougher price competition from abroad. As a result, the unemployment rate has been low, but wages continue to decline. Due to the strong protection of permanent workers, firms typically have redundant permanent workers, thus have no incentive to increase their wages.

People sometimes ask me about full employment but Japan has in some areas gone further and had a type of over employment. In the time I was working there people were employed to count numbers crossing walkways or to open lift doors. A nice service but not especially necessary. However there is another feature of the Japanese labour market which keeps wages low.

Worse yet, only a third of the Japanese labour force (typically older and male labour) has a permanent contract. The majority of the young and female labour force is working under a temporary contract with much lower salary and practically no job security, which creates a kind of caste system in the labour market.

Enter Abenomics

This was supposed to be something of a cure-all for the Japanese economy with higher inflation and GDP (Gross Domestic Product) growth boost wages. also the third arrow of Abenomics was supposed to be reforms to help deal with the labour market issues above. Regular readers will be aware that I doubted both routes from the beginning as Prime Minister Abe was an “insider” who in his previous term was guilty of what is called pork barrel politics. However places like Bloomberg and the Financial Times supported the new programme of Abenomics and have regularly produced headlines describing success even when the numbers do not describe that at all.

2016 was a better year

NHK News takes up the case.

Japan’s labor ministry says average monthly wages adjusted for inflation rose in 2016, the first increase in 5 years.

The data is the preliminary result of a nationwide survey.

The ministry says the average monthly wage, including bonuses and overtime pay, was about 315 thousand yen, roughly 2,800 dollars. That’s up 0.7 percent in real terms from the previous year.

The good news is that there was a rise albeit a small one. However there are several issues raised as we are 4 years or so into Abenomics and this is way below what was promised. There is also a clear fundamental flaw as wages were supposed to rise with higher inflation but instead we see this reported.

Lower consumer prices pushed the adjusted figure higher.

So exactly the opposite of what was intended! If we move to The Mainichi we see little sign of the promised reforms either.

The average monthly pay of full-time workers in 2016 increased 0.8 percent to 411,788 yen from the preceding year, while that of part-time workers was down 0.1 percent to 97,670 yen.

December

If we move to the data for the month of December we see an all too familiar pattern. From Reuters.

Japanese wages, on an annual inflation-adjusted basis, dropped in December for the first time in a year, government data showed on Monday, a setback for hopes that consumer spending can increase and help lift economic growth.

The decline was caused by a rise in the cost of living, which outpaced nominal pay hikes, officials said. Higher prices for items such as fresh vegetables have increased living costs.

Higher inflation driving real wages lower is somewhat awkward for Abenomics which plans for exactly the reverse! If we look at the numbers cash earnings were 0.1% higher than a year before so inflation did not have to be much to push real wages lower. The worst sector to be in was the utility one where wages fell by 2.8% and the best was the real estate sector where they rose 4.5%. This meant that real wages fell by 0.4% on a year before and December with its high level bonus payments meaning it is the peak month ( around 60% higher than the average) is the worst month for this too happen.

Prospects

Earlier I quoted from a wages survey from 2013 so how is that going now? From Reuters.

Nearly two-thirds of Japanese companies do not plan to hike their workers’ wages this year, a Reuters poll showed, a blow to Prime Minister Shinzo Abe’s campaign for higher pay to spur a recovery and a way to end two decades of deflation.

The Reuters Corporate Survey, conducted Jan. 4-17, also found that most wage gains over the past four years since Abe came to power have been minimal and that nearly one-quarter of firms have implemented none at all.

Indeed Reuters appears to have been reading me.

On the other hand, prices may increase as oil prices rebound, which will curb (inflation-adjusted) real wages and hurt households’ purchasing power,

Also this next bit makes grim reading for those in the media who have proclaimed success on the wage front in Japan.

The Corporate Survey also asked companies how much they have raised wages since 2012. Some 23 percent said they have kept overall wages unchanged, while 51 percent have raised them around 0.5-1.5 percent. Only 26 percent said wages had risen by about 2 percent or more.

Comment

Back on the 15th of May 2015 I pointed out my fears in this area.

If we look at real wages I note the number of references in rising wages in Governor Kuroda’s speech. Except real wages fell by 2.6% in the year to March which means that they have fallen in every month of the two years of QQE now.

There has been an improvement on an annual basis which you can see if I give you the real wages data, 2013 -0.9%,2014 -2.8%,2015 -0.9% and 2016 +0.7%. So it is possible to argue that there is an improving trend. Except the elephant in that particular room is that it is lower inflation which has driven that ads opposed to the higher inflation Abenomics is so keen on. Also you can see that the overall number for real wages is lower.

If we look back wages rose in Japan at the end of the last century but have fallen this and it is hard to avoid the thought that the numbers below have impacted here. From The Economist.

The number of 20- to 29-year-olds in Japan has crashed from 18.3m to 12.8m since 2000, according to the World Bank. By 2040 there might be only 10.5m of them. Cities like Tama are therefore playing not a zero-sum game but a negative-sum game, frantically chasing an ever-diminishing number of young adults and children.

It also looks at the Okatuma region.

Children have become so scarce that the large primary school is only about one-quarter full. Residents in their 70s outnumber children under ten by more than five to one

The Bank of Japan can do all the “yield curve management” it likes but even if it ends up buying the Japanese government bond market how will that improve the real economy and in particular wages? Still it could be worse you could be one of the footballers invited to play at the Fukushima TEPCO plant.

welcomes professional soccer players at Daiichi to show progress made at the power station

 

Rising bond yields are feeding into the real economy

Once upon a time most people saw central banks as organisations which raised interest-rates to slow inflation and/or an economy and cut them to have the reverse effect. Such simple times! Well for those who were not actually working in bond markets anyway. The credit crunch changed things in various ways firstly because we saw so many interest-rate cuts ( approximately 700 I believe now) but also because central bankers ran out of road. What I mean by that is the advent of ZIRP or near 0% interest-rates was not enough for some who plunged into the icy cold waters of negative interest-rates. This has posed all sorts of problems of which one is credibility as for example Bank of England Governor Mark Carney told us the “lower bound” for UK Bank Rate was 0.5% then later cut to 0.25%!

If all that had worked we would not be where we are and we would not have seen central banks singing along with Huey Lewis and the News.

I want a new drug
One that won’t make me sick
One that won’t make me crash my car
Or make me feel three feet thick

This of course was QE (Quantitative Easing) style policies which became increasingly the policy option of choice for central banks because of a change. This is because the official interest-rate is a short-term one usually for overnight interest-rates so 24 hours if you like. As central banks mostly now meet 8 times a year you can consider it lasts for a month and a bit but in the interest-rate environment that changes little as you see there are a whole world of interest-rates unaffected by that. Pre credit crunch they mostly but not always moved with the official rate afterwards the effect faded. So central banks moved to affect them more directly as lowering longer-term interest-rates reduces the price of fixed-rate mortgages and business loans or at least it should. Also much less badged by central bankers buying sovereign bonds to do so makes government borrowing cheaper and therefore makes the “independent” central bank rather popular with politicians.

That was then and this is now

Whilst there is still a lot of QE going on we are seeing ch-ch-changes even in official policy as for example from the US Federal Reserve which has raised interest-rates twice and this morning this from China.

Chinese press reports that the PBoC have raised interest rate on one-year MLF loans by 10bps to 3.1% ( @SigmaSqwauk)

The Chinese bond market future fell a point to below 96 on the news which raised a wry smile at a bond market future below 100 ( which used to be very common) but indicated higher bond yields. These are becoming more common albeit with ebbs and flows and are on that road because of the return of inflation. So many countries got a reminder of this in December as we have noted as there were pick-ups in the level of annual inflation and projecting that forwards leaves current yields looking a bit less than thin. Or to put it another way all the central bank bond-buying has created a false market for sovereign and in other cases corporate bonds.

The UK

Back on the 14th of June last year I expressed my fears for the UK Gilt market.

There is much to consider as we note that inflation expectations and bond yields are two trains running in opposite directions on the same track.

In the meantime we have had the EU leave vote and an extra £60 billion of Bank of England QE of which we will see some £1 billion this afternoon. This drove the ten-year Gilt yield to near 0.5%. Hooray for the “Sledgehammer” of Andy Haldane and Mark Carney? Er no because in chart terms they have left UK taxpayers on an island that now looks far away as markets have concentrated more on thoughts like this one from the 14th of October last year.

Now if we add to this the extra 1.5% of annual inflation I expect as the impact of the lower UK Pound £ then even the new higher yields look rather crackpot.

In spite of the “Sledgehammer” which was designed by Bank of England lifer Andy Haldane the UK ten-year Gilt yield is at 1.44% so higher than it was before the EU leave vote whilst his ammunition locker is nearly empty. So he has driven the UK Gilt market like the Duke of York used to drill his men. I do hope he will be pressed on the economic effects of this and in the real world please not on his Ivory Tower spreadsheet.

The Grand old Duke of York he had ten thousand men
He marched them up to the top of the hill
And he marched them down again.
When they were up, they were up
And when they were down, they were down
And when they were only halfway up
They were neither up nor down.

If you look at inflation trends the Gilt yield remains too low. Oh and do not forget the £20 billion added to the National Debt  by the Term Funding Scheme of the Bank of England.

Euro area

In spite of all the efforts of Mario Draghi and his bond-buyers we have seen rising yields here too and falling prices. Even the perceived safe-haven of German bonds is feeling the winds of change.

in danger of taking out Dec spike highs in yield of 0.456% (10yr cash) ( @MontyLaw)

We of course gain some perspective but noting that even after price falls the yield feared is only 0.456%! However it is higher and as we look elsewhere in the Euro area we do start to see yield levels which are becoming material. Maybe not yet in Italy where the ten-year yield has risen to 2.06% but the 4% of Portugal will be a continuous itch for a country with such a high national debt to GDP (Gross Domestic Product) ratio. It has been around 4% for a while now which is an issue as these things take time to impact and I note this which is odd for a country that the IMF is supposed to have left.

WILL PARTICIPATE IN EUROGROUP DISCUSSION ON – BBG ( h/t @C_Barraud)

 

The US

The election of President Trump had an immediate effect on the US bond market as I pointed out at the time.

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%.

 

As I type this we get a clear idea of the trend this has been in play overall by noting that the long bond yield is now 3.06%.  We can now shift to an economic effect of this by noting that the US 30 year mortgage-rate is now 4.06% and has been rising since late September when in dipped into the low 3.3s%. So there will be a contractionary economic effect via higher mortgage and remortgage costs. There will be others too but this is the clearest cause and effect link and will be seen in other places around the world.

Japan

Here we have a slightly different situation as the Bank of Japan has promised to keep the ten-year yield around 0% so you can take today’s 0.07% as either success or failure. In general bond yields have nudged higher but the truth is that the Bank of Japan so dominates this market it is hard to say what it tells us apart from what The Tokyo Whale wants it too. Also the inflation situation is different as Japan remains at around 0%.

Comment

We find ourselves observing a changing landscape. Whilst not quite a return of the bond vigilantes the band does strike up an occasional tune. When it plays it is mostly humming along to the return of consumer inflation which of course has mostly be driven by the end of the fall in the crude oil price and indeed its rebound. What that has done is made inflation adjusted or real yields look very negative indeed. Whilst Ivory Tower spreadsheets may smile the problem is finding investors willing to buy this as we see markets at the wrong price and yield. Unless central banks are willing to buy bond markets in their entirety then yields will ebb and flow but the trend seems set to be higher and in some cases much higher. For example German bunds have “safe-haven” status but how does a yield of 0.44% for a ten-year bond go with a central bank expecting inflation to go above 2% as the Bundesbank informed us earlier this week?

The economic effects of this will be felt in mortgage,business and other borrowing rates. This will include governments many of whom have got used to cheap and indeed ultra-cheap credit.

 

 

 

The economic impact of a higher dollar and interest-rate rises

We are in the middle of a central bank 24 hours and of course last night the US Federal Reserve continued its recent habit of only raising interest-rates just before Christmas.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1/2 to 3/4 percent. The stance of monetary policy remains accommodative,

On the face of it not much of a change and it is only to as they put it 3/4 percent. However in the modern era there is a significance in that it is in a world of ZIRP ( Zero Interest Rate Policy) and indeed NIRP where N = Negative. This has been highlighted this morning by one of the forerunners of the NIRP world which is the Swiss National Bank.

The Swiss National Bank (SNB) is maintaining its expansionary monetary policy. Interest on sight deposits at the SNB is to remain at –0.75% and the target range for the three-month Libor is unchanged at between –1.25% and –0.25%.

So we have another perspective which is that the spread between these two central banks is now 1.5% which is small in absolute terms but in these days is a lot. Also I note that an interest-rate of -0.75% is “expansionary” whereas one of 0.75% is merely “accommodative”. Oh and the SNB isn’t entirely convinced so we get yet more rhetoric from it.

At the same time, the SNB will remain active in the foreign exchange market as necessary, while taking the overall currency situation into consideration.

Already this morning a country which was previously expected to lower interest-rates has kept them unchanged as Norway remains at 0.5%. Although here there is also clearly an effect from the higher price of crude oil. Meanwhile later we will hear from the Bank of England which cut Bank Rate in August a move which I argued was unwise at the time and looks even worse now. No wonder Governor Mark Carney has moved onto discussing climate change rather than monetary policy or sledgehammers!

Bondpocalypse

It was only on Monday I was looking at the return of the bond vigilantes and overnight they have been active in some areas. For example the US ten-year Treasury Note yield has risen to 2.6%. It was only in early November that it was 1.78%. There have been effects in that period from the likely fiscal plans of President-Elect Trump and expectations for yesterday evening’s interest-rate rise but there was a further kicker. From the Guardian

But investors were caught out by surprisingly bullish comments from Fed chair Janet Yellen in the wake of the announcement and by projections showing that 11 of her 17 policy-making colleagues see borrowing costs rising another three times in 2017.

So not only was there an actual increase but the future path moved higher although to be more precise steeper as the Federal Reserve is really only projecting faster moves to a particular level. There is the obvious cautionary note that we were promised “3-5” interest-rate rises for 2016 by John Williams of the San Francisco Fed and got only one. But this time around the return of some inflationary pressure seems set to be on their minds.

This has seen the German 10 year yield rise back up to 0.36% in spite of the ongoing QE from the ECB. Whilst we are looking at this the “safe haven” problem they claimed to have fixed if getting worse as the two-year German yield is now -0.78%. Meanwhile the Bank of England has spent some £3 billion this week alone on a QE program described as a “sledgehammer” only for the UK Gilt ten-year yield to go back to 1.5% which is higher than when it came out of the tool cupboard. My Forward Guidance is for a sharp increase in inflation in the use of the word counterfactual.

Across the world in Japan there was plenty of work to do as the trend was against the recent promise of the Bank of Japan to keep its benchmark yield at 0%. I will explain later why they may have needed to sober up Governor Kuroda to authorise this but it must have been a busy day over there to keep it as low as 0.08%.

Dollar Hollar

If we look at the fact that the Japanese Yen has dropped sharply to 118 versus the US Dollar you will understand why the keys to the Sake cabinet at the Bank of Japan may have to have been taken off its Governor. All his Christmas wishes have come true in spite of the fact he is unlikely to celebrate it. From 115 to 118 in a manner described by Alicia Keys as “Fallin'” or by Status Quo as “Down Down” . It seems to have affected Prime Minister Abe so much he is going to join Vladimir Putin in a hot spring later.

Mario Draghi will be pleased also as the Euro slips below 1.05 versus the US Dollar as it and the UK Pound £ (1.253) get pushed lower but remain in station.

For the US itself then we see a further tightening of monetary policy via the US Dollar which has risen overall by about 1.5% since the interest-rate rise announcement. As it was expected it must be forecasts via the “dot plots” for 2017 that have changed things. Via this route monetary policy has an effect before it happens or in fact can have an impact even if it never happens something which has led to central bankers to get drunk on the implications. Care is needed though because for any real economic impact the changes and moves need to be sustained for a period.

Bank of England

This is left rather in disarray by this. If it was a schoolboy(girl) it would be in the corner wearing a dunces cap. This is the problem of having a Governor who is a “dedicated follower of fashion” when fashions change! Should the US Federal Reserve deliver on its interest-rate promises then Mark Carney will look very out of step as inflation rises above its target. Also his “sledgehammer” of QE is currently being swept aside in the UK Gilt market by worldwide trends. No wonder he is now opining on climate change and income inequality although those unfamiliar with him would do well to note his appalling record in any form of Forward Guidance. He has not be nicknamed the “unreliable boyfriend” only in jest.

Comment

As ever let us look at the impact on the real economy of this. In itself a 0.25% interest-rate rise should not have much impact but the effect via the US Dollar will be powerful. Let us start with the US economy as we have a benchmark from Fed Vice-Chair Fischer which I looked at on November 9th last year.

The New York Fed trade model suggests that a 10 percent appreciation of the U.S. dollar is associated with a 2.6 percent drop in real export values over the year. Consequently, the net export contribution to GDP growth over the year is 0.5 percentage point lower than it would have been without the appreciation and a cumulative 0.7 percentage point lower after two years

The Dollar Index has in fact risen from around 80 in July 2014 to 102.6 now so quite an effect will be taking place.

If we look abroad for an impact then the obvious place to look is Tokyo as the Bank of Japan gets what it wants with a plummeting Yen but also faces rising bond yields. It seems set to plough ahead regardless which poses worrying questions for Japanese workers and consumers as rising inflation seems set to impact on real wages.

Meanwhile out song for the day has to be this from Aloe Blacc.

I need a dollar dollar, a dollar is what I need
hey hey
Well I need a dollar dollar, a dollar is what I need
hey hey
And I said I need dollar dollar, a dollar is what I need
And if I share with you my story would you share your dollar with me

 

 

What is the economic impact of a higher crude oil price?

One piece of economic news dominated all other yesterday and it was at least a change for the Trump and Brexit circuses to take something of a break. Instead we had the OPEC circus which finally came up with something. Of course we know that announcements are one thing and implementation another but there was an immediate impact on the crude oil price. From Reuters.

The price for Brent crude futures (LCOc1), the international benchmark for oil prices, jumped as much as 13 percent from below $50 on Wednesday and was at $52.10 per barrel at 0806 GMT, although traders pointed out that part of the jump was down to contract roll-over from January to February for Brent’s front-month futures.

U.S. West Texas Intermediate (WTI) crude futures rose back above $50 briefly before easing to $49.63 a barrel at 0806 GMT, though still up 20 cents from its last settlement.

Volumes were very high too which makes a past futures traders heart lighter although of course we need to note that this is a result of yet more central planning.

The second front-month Brent crude futures contract, currently March 2017, traded a record 783,000 lots of 1,000 barrels each on Wednesday, worth around $39 billion and easily beating a previous record of just over 600,000 reached in September. That’s more than eight times actual daily global crude oil consumption.

Also as we note the influence at times of banks on commodity markets ( I believed their trading desks helped drive the last commodity price boom) maybe such high volumes are a warning signal too. But if this lasts we have the potential for a type of oil price shock as we have become used to relatively low oil prices. Also central banks may have to make yet another U-Turn as of course they may find that they push inflation above target as a higher oil price adds to all their interest-rate cuts and QE style bond buying.

Let us have a little light relief before we come to the analysis and look at this from February of this year. From Bloomberg.

Oil could drop below $20 a barrel as the search for a level that brings supply and demand back into balance makes prices even more volatile, Goldman Sachs Group Inc. predicted.

Oh well…

A higher oil price is good for us?

I made a note of this when I first saw it as it is the opposite of my view. I also note that it is Goldman Sachs again. From Bloomberg.

Higher oil prices would be a boon for the global economy, according to Goldman Sachs Group Inc.

Really! How so?

Pricey crude means economies such as Saudi Arabia take in more money than they can spend, which financial markets help distribute through the rest of the world, boosting asset values and consumer confidence, the bank’s analysts Jeff Currie and Mikhail Sprogis wrote in a Nov. 22 research note.

Apparently we can ignore the elephant in the room.

Forget the stagflation of the 1970s.

Here is the explanation.

“The difference between today and the 1970s is that oil creates global liquidity through a far more sophisticated financial system,” Currie and Sprogis wrote. “More sophisticated financial markets in the 2000s were able to transform this excess savings into greater global liquidity that increased asset values, lowered interest rates, and improved credit conditions that spanned the globe.”

Convinced? Me neither and it is hard to know where to start. One view is that the world economic expansion drove the oil price higher. Another is that greater global liquidity is an illusion as we see so many markets these days which seem to lack it. For example we are seeing more “flash crashes” like the one which happened to the UK Pound overnight a few weeks or so ago. This is of course in spite of the fact that central banks have been doing their best to create global liquidity and indeed cutting interest-rates.. Still if it created “increased asset values” the 0.01% who no doubt represent Goldman Sachs best clients will be pleased. As a final rebuttal this ignores the impact of lower oil prices on inflation and the key economic metric which is real wage growth.

Did the credit crunch never happen?

From 2001 to 2014, excess savings outside the U.S. grew to $7 trillion from $1 trillion as oil climbed, according to Currie and Sprogis. The savings helped drive up values of things like homes and financial assets and loosened credit markets for consumers.

I guess this is the economics version of all those strings of alternative universes in physics where Goldman Sachs is in another one to the rest of us, or simply taking us for well, Muppets.

They are not the only ones as the IMF got itself into quite a mess on this front back in February.

Persistently low oil prices complicate the conduct of monetary policy, risking further inroads by unanchored inflation expectations. What is more, the current episode of historically low oil prices could ignite a variety of dislocations including corporate and sovereign defaults, dislocations that can feed back into already jittery financial markets.

Are these “jittery financial markets” the same ones that Goldmans think are full of liquidity? Also you may note the obsession with central banks and monetary policy and yes asset values are in there as well.

Returning to Reality

There is an income and indeed wealth exchange between energy importers and exporters. For example Oxford Economics did some work which suggested that a US $30 fall in the oil price would boost GDP in Hong Kong by 1.5% but cut it in Norway by 1.3%. So we get an idea albeit with issues in the detail as I doubt the UK (0.8%) would get double the GDP benefit of Japan (0.4%) which of course is the largest energy importer in relative terms of the major economies. Oh and there are bigger negative effects with Russia at -5% of GDP and Saudi Arabia at -4%.

However the conclusion was this.

Lower oil prices should give a sizeable boost to world GDP in 2015 and 2016

There was a time (July 2015) when the IMF thought this as well.

Although oil price gains and losses across producers and consumers sum to zero, the net effect on global activity is positive. The reasons are twofold: simply put, the increase in spending by oil importers is likely to exceed the decline in spending by exporters, and lower production costs will stimulate supply in other sectors for which oil is an input…… the fall in oil prices should boost global growth by about ½ percentage point in 2015–16,

It would also produce a fall in inflation which will be welcome to those who are not central bankers.

Comment

Should the oil price remain higher it will reduce global economic growth and raise inflation. If we compare it with a year ago it is around 10 US Dollars higher but we also need to note that in December 2015 the oil price fell to the Mid US $30s so we need to do the same to prevent an inflationary effect. As I have been writing for some months now unless we see large oil price falls inflation is on it way back. We are of course nowhere near the US $108 that a Star Trek style tractor beam seemed to hold us at a while back. But as I note the rise in some metals prices ( Zinc and Lead in particular) commodity price rises are back in vogue. So there will be plenty of work for those economists who want higher inflation explaining how they are right be being wrong.

There will also be relative shifts as consumers will be poorer as real wages fall but say shops in Knightsbridge and the like seem set to see more Arab customers. Japan will be especially unhappy at a higher oil price. But US shale oil wildcatters might be the happiest of all right now and may even boost US manufacturing as well. In the UK there will be a likely boost for the Aberdeen area.

Me on TipTV Finance

“Outlook for RBS is dreadful”, says Shaun Richards – Not A Yes Man Economics

 

 

 

 

 

 

The ECB drives Euro area short-dated yields even more negative

The recent trend for world bond yields has been for them to rise. This has been particularly evident at the longer maturities. The clearest example of this comes from the US Long Bond or thirty-year yield which spent late summer around 2.3% and is now 3%. There was a rise before the advent of President-Elect Trump which accelerated quickly afterwards. We will never know now what effect a President- Elect Clinton would have had but I suspect it would have been similar. As to the pre-Trump rise in US bond yields this was mostly driven by hints and promises or what is called Forward Guidance from the US Federal Reserve about a second interest-rate rise. Although of course it has been hinting that for all of 2016 so far without delivering it yet.

The international context

This new trend has had effects in places like Portugal where the ten-year yield is 3.6% and Italy where it is 2.1%. This is of course nothing like the levels seen at the peak of the Euro area crisis but there are two points to note. Firstly government’s tend to spend the gains from lower bond yields ( as the gains are not widely understood politicians can take the credit for their largesse) meaning any reversal can create fiscal issues. Secondly the ECB is of course buying considerable numbers of these bonds as it purchases around a billion Euros of Portuguese government bonds and 13 billion Euros of Italian government bonds each month. So we see a rise in spite of all this buying.

A similar situation has arisen in the UK where the “sledgehammer” QE bond buying of Chief Economist Andy Haldane has been swept aside in yield terms by the recent moves. So far an extra £38 billion of Gilts purchases have been made but whilst the ten-year yield is now at 1.37% below the level at which this started it is not be much and this particular phase is underwater overall. Some of the purchases are well underwater in price terms. Perhaps this is why Bank of England Governor seems to be finding the time to do this according to the Financial Times.

Mark Carney has urged the government to seek transitional arrangements with the 27 remaining members of the EU as it negotiates Brexit in an attempt to smooth the path of leaving the EU for companies and for financial stability.

I guess anything is better than discussing why he eased monetary policy into a currency decline and economic growth which one of his colleagues ( Kristin Forbes) admitted is faster than last year’s! I guess some will also be mulling how Mark Carney rejects politicians interfering in his work yet seems happy to interfere in theirs. I wonder how he would define independence. Still if monetary policy gets any worse I guess we can expect more speeches on climate change.

This higher yield trend has also seen some bond yields depart the negative zone. For example the ten-year bund yield of Germany has risen to the not so giddy heights of 0.22% pulling other Euro area yields out of negative territory as well. Even Japan has seen its ten-year yield nudge above zero albeit marginally and ended at 0.016% today. This is a bit awkward for the Bank of Japan as yields have risen in spite of its rhetoric about “unlimited purchases” as I discussed only last Monday.

A problem for the ECB

This arises at the shorter maturities and is especially evident in Germany. As you review the chart below please remind yourselves that under its rules the ECB QE bond buying cannot buy at yields below its own deposit rate which is currently -0.4%.

This is what are called Schatz bonds in Germany and they have pulled prices on other Euro area bonds higher and yields lower as well. For example the two-years in both Belgium and France yield -0.68%. Perhaps the Italian two-year is a clearer example because in spite of the risks around the upcoming referendum the yield is a mere 0.22%. There was a time yields shot higher in response to such risks!

A Technical Issue

The essential problem here comes from something I have pointed out before which is that central bank bond buying tends to freeze up bond markets. Of course it also destroys the price discovery mechanism but volumes and liquidity dry up. This was quite noticeable in the early days of the Greek crisis where buying by the Securities Markets Programme saw volumes drop to a tenth of what they were. That remains an issue which has recurred in Japan but the current phase is being driven by the repo market. Reuters looked at this last Wednesday.

The European Central Bank is looking for ways to lend out more of its huge pile of government debt to avert a freeze in the 5.5 trillion-euro short-term funding market that underpins the financial system, central bank sources told Reuters.

Why should it care about this?

it has taken away the key ingredient for repurchase agreements, or repos, whereby financial firms lend to each other against collateral, typically high-rated government bonds such as Germany’s.

So it has inadvertently damaged the “precious” which is the banking system. Also it has shot itself in the foot as regards its own objectives.

Repo is used by investment funds to finance trading and is regarded by the ECB as a key avenue to transmit its own monetary stimulus to the economy.

A freeze in repo activity risks undoing some of the ECB’s stimulus by hampering lending between financial companies and leaving bond markets vulnerable to sharp sell offs.

The situation was so bad we even got an official denial that anything was wrong!

“The ECB’s securities lending is proving valuable for smooth market functioning, and it is being reviewed on an ongoing basis,” an ECB spokesman said.

The situation is driven by the way that derivative portfolios now need more collateral to be held against them whilst there is less top-notch collateral to be had.

With the ECB now owning more than a quarter of all outstanding German bonds, funds pay up to 1.5 percent to borrow a 10-year Bund, up from some 0.40 percent a year ago, according to Icap data.

Another problem on the list for pension funds and hence in time pensioners.

Comment

As you can see the side-effects from the ever-growing amounts of central bank QE are growing. This was met with an official denial which sat oddly with the recent changes made by both the Bundesbank and the ECB to try to ameliorate things. It sat even more oddly with the market reversal on the 23rd in response to hopes/hints of a change of policy as shown in the chart about . Since then those hopes have been extinguished, until the next set of rumours anyway. So we get a bond market where the battle between central banks ( price highs) and inflation trends leading to price falls continues.

Meanwhile thank you to @sallycopper C for highlighting an issue which I think may lead to problems for the game of paper, scissors,stone. From Bloomberg.

Paper made from rock tempts Japan’s biggest printer to invest.

Meanwhile I pointed out earlier to the Financial Times that for an article telling us this “the cost of Christmas dinners is almost unchanged from a year ago ” the headline on Twitter from its commodities editor gave a rather different impression.

Christmas pudding pricier after Brexit hits pound

As a Christmas pudding fan I in fact have already bought two rather nice ones for £3 but  one has already gone, after all I had to find out how good it was!

 

 

Will we see unlimited bond buying from the Bank of Japan?

After a difficult 2016 to say the least Governor Kuroda of the Bank of Japan has some reasons to be cheerful. So let us remind ourselves of the view of Ian Dury and the Blockheads about this.

Reasons to be cheerful, part 3
Reasons to be cheerful, part 3
Reasons to be cheerful, part 3
Reasons to be cheerful – 1, 2, 3

Part 1

If we look for reason one well that is easy as DailyFX have already pointed out.

USD/JPY hits 111.125 its highest since May 31, as reflationary Trump-trade rolls on. Perhaps only Thanksgiving can put a temporary brake on.

As the policy of Abenomics has a lower Yen as perhaps its major weapon and objective its recent fall will be welcome to the Japanese establishment. It was at 103 just before the election of Donald Trump so quite a fast decline although we should not overplay his impact as the Yen had been weakening since the near 100 of late September. Even the poor battered UK Pound £ has seen a bounce versus the Yen from the 125 of middish October to 137 overnight.  If we look at the battle of the currency depreciators of the Far East then I note that it now takes just over 16 Yen to buy in Chinese Renminbi or Yuan as opposed to just over 15 in late September. Cue smiles from Tokyo and frowns from Beijing.

Part 2

This is something which is associated with the weaker currency as we note something which all central bankers love these days. As they are keen to proclaim wealth effects then a higher equity market is close to their heart. There has been quite a push higher to 18,106 in the Nikkei 225 equity index from the below 15,000 of  June 24th. It is now in a bull market although of course that is merely another way of saying it has risen under the modern definition of a 20% rise.

Part 3

Economic growth as measured by GDP was relatively strong in the quarter just passed as Japan Macro Advisers point out.

According to the preliminary estimates by Cabinet Office, the Real GDP grew by 0.5% from the previous quarter (QoQ), or by 2.2% on annualized terms. The pace of the growth was significantly stronger than the prior market expectation.

It was to say the least export led.

The external demand added 0.5% point to the GDP growth on the account of rising exports and a fall in imports.

At this point Governor Kuroda might be considering joining the Japanese version of Strictly Come Dancing as those suggesting “innovation” in monetary policy seem to do these days. However whilst he might be smiling even the recent better silver lining had a cloud. If we stay with Japan Macro Advisers.

A key point from the preliminary estimate is that weak domestic activity continues to cast doubts on a sustainable recovery of the Japanese economy as there has been virtually no growth in private consumption nor private expenditure.

Okay so sadly same as it ever was in this regard and the day after the report Governor Kuroda did not seem that optimistic about more export growth.

Against this background, exports and production are expected to start increasing moderately.

You may wonder about the start but you see he does not think that Japan’s exports have been doing that well.

Exports as a whole have therefore been flat. Against this background, production also has been almost flat.

The past was bright

Back on the 30th of September I pointed out that using a new methodology the Bank of Japan has decided things were much better than they previously thought.

According to an experimental index prepared by the BoJ, Japan’s economy expanded 2.4 per cent in 2014, rather than falling 0.9 per cent as the official data showed.

They use the income version of GDP to get this as we not that the moral hazard meter rises perhaps even to the mythical 11 out of 10 described by Spinal Tap.

Unlimited bond buying

Back on the 21st of September the Bank of Japan introduced “QQE with Yield Curve Control” as described below.

The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain more or less at the current level (around zero percent).

Actually very little happened here as things as I have pointed out carried on pretty much as before although the change of language did obtain a fair bit of comment and claims of a clear change. For those wondering why QE is called QQE or Quantitative and Qualitative (monetary) Easing in Japan the answer is easy as so many versions of QE led to it being discredited.

On Thursday the Wall Street Journal was on the case again.

The Bank of Japan on Thursday offered to buy an unlimited amount of Japanese government bonds at fixed rates for the first time since the introduction of a new policy framework—a sign of its concerns over recent rises in yields.

There is an issue here as I note that the ten-year Japanese Government Bond yield is at 0.03% above zero. It is up 0.08% over the past 30 days according to Bloomberg which gives a different perspective on the media reports of success. Also how do claims of unlimited buying face up to the extraordinary buying which was already happening?

This is yet another market where the Bank of Japan has become the Tokyo Whale. Here is something of an update of how it is progressing on the Tokyo Whale front elsewhere.

It’s the No. 1 shareholder in piano maker Yamaha Corp., Bloomberg estimates show, after its ownership stake via ETFs climbed to about 5.9 percent…..The BOJ is set to become the top holder of about five other Nikkei 225 companies by year-end, after boosting its annual ETF buying target to 6 trillion yen last month. By 2017, the central bank will rank No. 1 in about a quarter of the index’s members.

How do “wealth effects” made by the central bank benefit the consumer?

Comment

There is much to consider here. If we consider the use of the phrase “unlimited buying” how did that work out for the foreign exchange purchases of the Swiss National Bank? That too was portrayed as a triumph until the engine blew a gasket. Also whilst the government of Japan offers a ready supply of newly printed Japanese Government Bonds via its fiscal deficit the supply is not unlimited so we have to ask what happens if they run out of bonds to buy? Not so long ago that would have seemed not far off crazy.

There is another irony for 2016 which goes as follows. When the Bank of Japan acted in 2016 things went wrong for it but when it talked but did nothing it saw the Yen fall and Nikkei rise. One in the eye for the central planners!

Another problem for the central planners in that in some ways Japan is not doing too badly. What I mean by that is that any economic growth may be an achievement compared to an ageing population which is also doing this according to The Japan Times.

Japan’s population excluding resident foreign nationals fell last year at the fastest pace yet, down 271,834 from a year earlier to 125,891,742 as of Jan. 1,……Japan’s population peaked in 2009 at 127,076,183 and has since been declining.

So the performance per head is better than the headlines. This of course brings us to something of a crunch because the official medicine for ever fewer people seems to be policies to accommodate an ever larger national debt. Also the current establishment mantra is for lower interest-rates and easier fiscal policy, well that’s Japan……..

However another issue currently on the sidelines is the price of crude oil as Japan via its lack of natural resources is perhaps the biggest gainer from lower oil prices.

Is this a genuine “currency war” or just happenstance?

It is time for us to take a look at what I have long argued is the major player in monetary policy these days which is/are exchange rates. Actually although he would not put it like that Bank of England Governor Mark Carney implicitly agreed with me on Tuesday.

“The UK economy has … had a large external imbalance and that large external imbalance as represented by a large current account deficit needed to be righted,” he said. “The exchange rate is part of that adjustment mechanism.”

I will return to the situation of the UK later but the main mover recently has Trumped (sorry) markets as we have seen the US Dollar soar. This morning Investing.com put it like this.

The dollar paused on Thursday after rising to 14-year highs against a basket of the other major currencies……..The US dollar index, which measures the greenback’s strength against a trade-weighted basket of six major currencies, was at 100.26. On Wednesday, the index hit highs of 100.60, its highest level since April 2003.

Regular readers will be aware that I have been pointing out that the US Dollar has been strong for some time. It has been rising since the dollar index dipped near 73 in April 2011 but the main move has come from just below 80 in June 2014. The Trump push has really only taken it back to where it started the year.

This poses a problem as of course we see something familiar which is the US Federal Reserve promising interest-rate rises which it was back then with the “3-5” of John Williams and now where a rise is expected by markets. We will never know if we might have been in the same place if Hillary had won.

The impact on the US economy

Most analysis concentrates on the effect elsewhere but let me open with the fact that in spite of the fact that it is still the world’s reserve currency there is an impact on the US economy from this. Just over a year ago ( November 9th) I used the numbers of Federal Reserve Vice-Chair Stanley Fischer.

The New York Fed trade model suggests that a 10 percent appreciation of the U.S. dollar is associated with a 2.6 percent drop in real export values over the year. Consequently, the net export contribution to GDP growth over the year is 0.5 percentage point lower than it would have been without the appreciation and a cumulative 0.7 percentage point lower after two years.

So there is an ongoing impact at these levels of the order of 1.5% of US economic output or GDP. If we add the impact of the currently higher bond yields we see why there are still doubts about a Federal Reserve interest-rate rise next month, although of course this is circular as these levels depend on it happening.

The rest of the world

Whilst the rest of the world in general should get a competitive advantage from a lower US Dollar it is not all one way. For example inflation will rise as so many commodities are prices in US Dollars and there is also the debt issue. From the 7th of December last year.

Dollar credit to non-banks outside the United States reached $9.8 trillion at end-Q2 2015. Borrowers resident in EMEs accounted for $3.3 trillion of this amount, or over a third. EME nationals resident outside their home countries (for instance, financing subsidiaries incorporated in offshore centres) owed a further $558 billion.

So the US Dollar is strong and yields are rising, what could go wrong? The BIS ( Bank for International Settlements) was on the case earlier this week.

A stronger 29 dollar is associated with wider CIP deviations and lower growth of cross-border bank lending denominated in dollars…….In particular, a strengthening of US dollar has adverse impacts on bank balance sheets, which, in turn, reduces banks’ risk bearing capacity.

It was also intriguing as to why the all the Ivory Towers miss this.

However, in textbooks, there are no banks.

So those places with US Dollar denominated debt have “trouble,trouble,trouble” right now and the obvious places to look would I guess be Mexico and Egypt in the way we looked at Ukraine and Russia in the past.

China

On the 10th of October I pointed out that the trend for the Yuan had been “down,down” in spite of its achievement of attaining reserve currency status at the IMF (International Monetary Fund).

The currency fell after the People’s Bank of China set the midpoint CNY=PBOCat 6.7008 yuan per dollar, its weakest fix since September 2010.

From the Financial Times.

China’s renminbi traded near at an eight-year low against the US dollar on Thursday, as the election of Donald Trump intensified longstanding depreciation pressure…The Chinese currency has weakened for seven of the eight trading days to Wednesday and is down 5.5 per cent in 2016 — on pace for its worst year since authorities depegged it from the dollar in 2005.

A type of stealth devaluation sees it at 6.88. Rather oddly the Wall Street Journal tells us it is not devaluing and then prints this.

The Chinese yuan has been steadily depreciating this year against a basket of 13 currencies that make up the underlying reference point for the currency.

Sweden

I thought I would throw this in as having been (correctly) critical of the FT  let me also say that it can also be good. From @M_C_Klein.

If I were going to hit a country for currency manipulation on day 1 it would definitely be Sweden.

Makes you think er well yes, doesn’t it?

Yen

There is no stealth devaluation here and the sound of cheering from the Bank of Japan in Tokyo at the recent fall echoes around the world. Governor Kuroda has been enjoying his sake and his favourite Karaoke song even more.

Get down deeper and down
Down down deeper and down
Down down deeper and down
Get down deeper and down

That of course would be the status quo if he had his way. Mind you his pleasure at an exchange rate of 109 to the US Dollar does have a fly in the ointment. After all it has happened after he did nothing as opposed to the currency rise following his “bold action” in January. I would suggest that Bank of Japan staff who want a career describe the recent phase as an example of the “masterly inaction” so beloved of the apochryphal civil servant Sir Humphrey Appleby.

Euro

I pointed out on twitter yesterday that Mario Draghi would be celebrating as the Euro dipped into the 1.06s versus the US Dollar. He needed something like that as you see the effective or trade weighted exchange rate for the Euro has risen in 2016 in spite of the 80 billion Euros a month of QE bond purchases. There is still a way to go from the 94.7 of now to the 92.7 of then. A Baldrick style cunning plan might be for the Euro to leave the European Union….Oh hang on.

Comment

As you can see there is much going on and if we compare this to a possible 0.25% interest-rate rise in the US we see again a bazooka and a pea shooter. Although of course the two factors are correlated so we can never entirely split them. But much is in play as we remind ourselves that unless there is life on Mars it is a zero-sum game.

I did say I would look at the UK which recently has been reversing some of its depreciation. It has a case for a lower currency due to its current account deficit but whilst the economic numbers are good now the problem will be the inflation of 2017 and maybe beyond. Meanwhile having checked the booming UK Retail Sales numbers let me say thank you ladies,women and girls one more time and I am on the case.

Is the lack of lining on UK ladies coats this season another example of and has made a quality adjustment in its numbers?

Me on Tip TV Finance

Post-trump moves: Like old times, but not exceptional times – Shaun Richards