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.

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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.

 

Fiscal policy was on the march at Jackson Hole

Over the weekend many of the world’s central bankers were guests of the Kansas Federal Reserve in Jackson Hole Wyoming. In terms of location I believe it was chosen because a previous chair of the US Federal Reserve Paul Volcker was a keen fisherman. However this late August symposium has become one which influences the economic winds of change as central bankers discussed easing policy in response to the credit crunch and in more recent times a speech was given on what were perceived to be the wonders of Forward Guidance. Michael Woodford was very clever in suggesting to a group who wanted to believe that they could influence events via mere speaking or what has become called Open Mouth Operations.

I shall argue that the most effective form of forward guidance involves advance commitment to definite criteria for future policy decisions.

They are still at that today to some extent although the definite criteria theme has mostly been ignored especially in the UK where it went wrong for the Bank of England almost immediately.

What about now?

The problem for the central bankers is that to coin a phrase that monetary policy may be “maxxed out” or as it is put more formally below.

despite attempts to set economies on normalization paths after the Great Recession and the Global Financial Crisis, the scope for countercyclical monetary policy remains limited: benchmark interest rates have continued to hover near or even below zero.

This is from a paper presented on Saturday by Alan Auerbach and Yuriy Gorodnichenko of the University of California Berkeley. In their conclusion they go further.

Although economists do not believe that expansions die from old age, the prolonged U.S. expansion will end sooner or later and there is serious concern about the ability of policymakers in the United States and other developed countries to fight the next economic downturn. Indeed the ammunition of central banks is much more limited now than before the Great Recession and it is unlikely that expansionary monetary policy can be as aggressive and effective as it was during the crisis.

Actually if monetary policy had been effective the paper would not be necessary as the various economies would have responded and we would be on a road where interest-rates were say 2/3% and central bank balance sheets were shrinking, In reality such interest-rates to quote Star Wars are “far, far away”.

Fiscal policy

If monetary policy has less scope for action then our central planners face being irrelevant so they will be grasping for an alternative and fortunately according to our two valiant professors it is at hand.

With tight constraints on central banks, one may expect—or maybe hope for—a more active response of fiscal policy when the next recession arrives.

The problem with this the familiar theme of the “bond vigilantes” turning up.

It is certainly conceivable (see e.g. Aguiar et al. 2017) that a significant fiscal stimulus can raise doubts about the ability of a government to repay its debts and, as a result, increase borrowing costs so much that the government may find its debt unsustainable and default.

This of course was last seen on a major scale in the Euro area crisis particularly in Greece, Ireland, Portugal and Spain. Of course the European Central Bank intervened by buying bonds and later followed another part of Michael Woodford’s advice by introducing a larger and more widespread QE or bond buying program. So we have seen central banks intervening in fiscal policy via a reduction in bond yields something which government’s try to keep quiet. We have individual instances of bond yield soaring such as Venezuela but the last few years have seen central banking victories and defeats for the vigilantes. In another form that continued this morning as I note that a North Korean ballistic missile passed over Japan but the Nikkei 225 equity index only fell 87 points presumably influenced by the way that the Bank of Japan buys on down days.

What about more overt fiscal policy?

Apparently this can work.

We find that in our sample expansionary government spending shocks have not been followed by persistent increases in debt-to-GDP ratios or borrowing costs (interest rates, CDS spreads). This result obtains especially when the economy is weak. In fact, a fiscal stimulus in a weak economy may help improve fiscal sustainability along the metrics we study.

Indeed this for them is essentially a continuation of past work.

This constraint on monetary policy coincides with a resurgence in activist fiscal policy (Auerbach and Gale, 2009), which has moved from a focus on automatic stabilizers to a stronger reliance on discretionary measures, reflecting not only necessity but also growing evidence of the effectiveness of such policy to fight recessions (e.g., Auerbach and Gorodnichenko, 2012, 2013).

Also I am reminded that we should never believe something until it is officially denied.

Given the nature of the sample analyzed, our results should not be interpreted as an unconditional call for an aggressive government spending in response to a deteriorating economy.

The UK

Jonathan Portes who is an advocate for fiscal policy has written this in Prospect Magazine.

The answer is very technical—£100 billion or so of the extra debt relates to the Bank of England’s Asset Purchase Facility. Briefly, the BoE makes loans to banks and buys corporate bonds, in return for cash (“central bank reserves”).

He suggests that as this has been mostly ignored( not on here) we could borrow for other purposes.

Comment

There is a fair bit to consider here as I note that North Korea has done its bit as bond markets have risen today and yields fallen. For example the UK ten-year Gilt yield has dropped to 1% giving us food for thought with inflation at either 2.6% ( CPI) or 3.6% ( RPI). A clear factor in the expected push for fiscal policy is that bond yields are so low as conventional UK Gilt yields do not go above 1.7% and other countries such as Germany Switzerland and Japan can borrow for much less. Against such bond yields theoretical analysis is always likely to look good so the first issue is whether they would be maintained in a fiscal expansion. Or to put it another way are central banks being asked here for a type of QE to infinity?

Next is the issue of how a fiscal stimulus is defined as for example countries which have stopped borrowing and run a surplus like Germany and Sweden are relatively rare. Most have continued to borrow and run annual fiscal deficits albeit usually declining ones. Thus the ballpark seems to have shifted to increasing deficits rather than having one at all which is the sort of “junkie culture” road that monetary policy went down. If we look back to a past advocate of fiscal stimulus John Maynard Keynes he was also someone who suggested that when the growth came there would be a period of payback.

What we also find ourselves mulling is the difference between the specific and the general. I am sure that everyone can think of a project that would provide plenty of benefits and gains but as we move to a more generalist position we find ourselves facing a reality of Hinkley Point and HS2. To be fair our two professors do acknowledge this.

Bridges to nowhere, “pet” projects and other wasteful spending can outweigh any benefits of countercyclical fiscal policy.

As a conclusion the Ivory Tower theory is that fiscal policy will work. There are two catches the first is that if they were even regularly right we would not be where we are. The next is that on some measures we have been trying it for quite some time.

In reality the establishment seems likely to latch onto this as we have discussed before.

 

 

The Jackson Hole symposium should embace lower inflation

Later this week the world’s central banks will gather at the economics symposium of the US Kansas Federal Reserve at Jackson Hole in Wyoming. The description can be found below.

The 2017 Economic Symposium, “Fostering a Dynamic Global Economy,” will take place Aug. 24-26, 2017.  (The program will be available at 6 p.m., MT, Aug. 24, 2017).

It is appropriate that they do not yet know the program as the world’s central bankers find themselves at a variety of crossroads which they are approaching from different directions. It is also true that after all their expansionary monetary policy and “masters ( and mistresses) of the universe” activities over the last decade or so they now approach one of the most difficult decisions which is how to exit these programs. For some this will simply mean a slowing of the expansion. This all looks very different to when a speech on Forward Guidance was eagerly lapped up by a receptive audience and quickly became policy in many countries. After all Open Mouth Operations make a central banker feel both loved and important as we all hang on every word. Oh and there is a clear irony in the title of “Fostering a Dynamic Global Economy” for a group of people whose propping up of many zombie banks has led to anything but. That is of course assuming anyone knows what the phrase means in practice!

The inflation issue

The issue here is highlighted by this from Bloomberg today.

The world’s top central bankers head to Jackson Hole amid growing unease about low inflation.

Of course central bankers and those in the media subject to their brainwashing program may think this but the ordinary worker and consumer will be relieved. Should any of the central bankers suffer from stomach problems no doubt they will be delighted to discover this from CNBC.

Hikma Pharmaceuticals Plc’s U.S. subsidiary has raised the price of a common diarrhea drug by more than 400 percent and is charging more for five other medicines as well, the Financial Times reported on Sunday……The average wholesale price of a 60 ml bottle of liquid Atropine-Diphenoxylate, a common diarrhea drug also known as Lomotil, went from about $16 a bottle to $84, the FT reported.

Central banker heaven apparently and what needs looking into in my opinion is the clear examples of price gouging we see from time to time. Also more mundane products are seeing price rises. From Mining.com last week.

The iron ore price is now trading up a whopping 43% from its 2017 lows struck just two months ago.

According to Yuan Talks the Dalian futures contract rose 6.6% today before price limits kicked in. It is not alone as the Nikkei Asian Review points out.

Three-month zinc futures were at their highest level in 10 years, at about $3,100 per ton, rising 26% over the same period.
Aluminum also rose 10% over the same period.

So as well as raising a smile on the face of the heads of the central banks of Canada and Australia there are hints of some commodity inflation about. This provides a counterpoint to the concerns about low inflation which in the Euro area and the US is not that far below especially when we allow for the margin of error.

Does QE lead to inflation?

Some care is needed here as of course we have seen waves of asset price inflation across a wide range of countries. But of course the statistical policy across most of the world is to avoid measuring that in consumer inflation. Then it can be presented as growth which for some it is but not for example for first time buyers. However one of the building blocks of economics 101 is that QE ( Quantitative Easing) leads to inflation. Yet the enormous programs in the US and the ongoing one in the Euro area have not got consumer inflation back to target and the leader of the pack in this regard Japan has 0% inflation. After all the money involved has it simply led to price shifts? That is especially awkward for Ivory Tower theorists as they are not supposed to be able to happen with ~0% inflation so I guess they sent their spouse out to fill up the car as the petrol/diesel price fell.

More deeply whilst the initial effect of QE should have some inflationary implications is there something in it such as the support of a zombie business culture that means inflation the fades. It could of course be something outside of the monetary environment such as changing demographics involving ageing populations. Perhaps it was those two factors which broke the Phillips Curve.

As to future prospects there are two issues at play. The US Federal Reserve will start next month on an exit road which I remember suggesting for the Bank of England in City-AM some 4 years ago. If you do not want QE to become a permanent feature of the economic landscape you have to start somewhere. The issue for the ECB is getting more complex mostly driven by the fiscal conservatism of Germany which means that a supply crunch is looming as it faces the prospect of running out of German bonds to buy.

Currency Wars

There are two specific dangers here which relate to timing ( during thin summer markets) and the fact that markets hang on every central banking word. Eyes will be on the Euro because it has been strong in 2017 and in particular since mid April when it did not quite touch 93 on its effective ( trade-weighted) index as opposed to the 98.7 the ECB calculated it at on Friday. It has put another squeeze on the poor battered UK Pound £ but of more international seriousness is yet another example of a problem for economics 101 as interest-rate rises should have the US Dollar rising. Of course there is a timing issue as the US Dollar previously rose anticipating this and maybe more, but from the point of Mario Draghi and the ECB there is the fear that cutting the rate of QE further might make the Euro rally even more. Although one might note that in spite of the swings and roundabouts along the way the Euro at 98.7 is not far away from where it all began.

The Bank of Japan is also facing a yen rallying against the US Dollar and this morning it briefly rose into the 108s versus the US Dollar. Whilst it is lower than this time last year the trend seemed to change a few months back and the Yen has been stronger again.

Comment

It is hard not to have a wry smile at a group of people who via Forward Guidance and Open Mouth Operations have encouraged markets to hang on their every word now trying to downplay this. If you create junkies then you face the choice between cold turkey or a gradual wind down. Even worse you face the prospect of still feeding addiction number one when a need for number two arises as sooner or later an economic slow down will be along. Or creating fears about low inflation when the “lost decades” of Japan has shown that the world does not in fact end.

If we move onto the concept of a total eclipse then I am jealous of those in the United States today. From Scientific American.

Someone said that it is like suddenly being in some sort of CGI of another world or maybe like a drug-induced hallucination that feels (and is) totally real.

No they have not switched to central banking analysis but if the excellent BBC 4 documentary ”  do we really need the moon?” is any guide we should enjoy solar eclipses whilst we still have them. Meanwhile of course there is Bonnie Tyler.

I don’t know what to do and I’m always in the dark
We’re living in a powder keg and giving off sparks.

 

 

 

 

The land of the rising sun sees rising GDP too

Today starts with good news from the land of the rising sun or Nihon. I do not mean the sporting sphere although there was success as a bronze medal in the men’s 4 by 100m relay was followed by silver and bronze in the men’s 50 km walk at the world athletics championships. There was also a near miss as Hideki Matsuyama faded at the US PGA  and did not become the first Japanese man to win a golf major. But the major good news came from the Cabinet Office as this from The Mainichi tells us.

Japan’s economy grew an annualized real 4.0 percent in the April-June period for a sixth straight quarter of expansion, marking the longest growth run since 2006, as private consumption and corporate spending showed signs of vigor, government data showed Monday.

If we convert to the terms we use there was 1% economic growth from the previous quarter which was quite a surge. Actually that is way beyond what the Bank of Japan thinks is the potential growth rate for Japan but let us park that for now and move on to the detail.  Reuters points out that consumption was strong.

Private consumption, which accounts for about two-thirds of GDP, rose 0.9 percent from the previous quarter, more than the median estimate of 0.5 percent growth.

That marked the fastest expansion in more than three years as shoppers splashed out on durable goods, an encouraging sign that consumer spending is no longer the weak spot in Japan’s economic outlook.

In fact so was investment.

Capital expenditure jumped by 2.4 percent in April-June from the previous quarter, versus the median estimate for a 1.2 percent increase. That was the fastest growth in business investment since January-March 2014.

The combination is interesting as this is something that Japan has wanted for a long time as its “lost decade(s)” of economic malaise have seen domestic demand and consumption in particular struggle. Some countries would be especially troubled by the trade figures below but of course Japan has seen many years of surpluses as this from the Nikkei Asian Review indicates.

 Japan’s current account surplus expanded in the January-June period to the highest level since 2007 as earnings from foreign investments moved further into the black, despite rising energy prices pushing up the overall value of the country’s imports, government data showed Tuesday.

 

Thus it is likely to see this as another welcome sign of strong domestic demand.

External demand subtracted 0.3 percentage point from GDP growth in April-June in part due to an increase in imports.

Those who look at the world economy will be pleased to see a “surplus” economy importing more.

Where does this leave Abenomics?

There are various ways of looking at this and the Japanese owned Financial Times leads the cheers.

‘Not a fluke’: Japan on course to record best GDP growth streak since 2000

“Not a fluke” is an odd thing to write because if you look at the GDP chart they provide we see several spikes like this one which imply it may well be er not only a fluke but another one. They are less keen to credit another form of Abenomics which is the way that the latest stimulus programme impacted with a 5.1% (21.9% annualised) rise in public investment causing a 0.2% rise in GDP on its own. Perhaps this is because of the dichotomy in this part of Abenomics where on the one hand fiscal expansionism is proclaimed and on the other so is a lower deficit! Also there are memories of past stimulus projects where pork barrel politics led to both bridges and roads to nowhere.

Actually the FT does then give us a bit of perspective.

 

Japan’s economy, as measured by real GDP, is now 7 per cent larger than when prime minister Shinzo Abe took office in late 2012, notes Emily Nicol at Daiwa Capital Markets.

That is a long way short of the original promises which is one of the reasons why the Japanese government page on the subject introduces Abenomics 2.0.  If we look at the longer-term chart below is there a clear change.

On such a basis one might think it was the US or UK that had seen Abenomics as opposed to Japan. Of course the figures are muddied by the recession created by the consumption tax rise in 2014 but the performance otherwise even with this quarter’s boost is far from relatively stellar.

Bank of Japan

It will of course be pleased to see the economic news although it also provides plenty of food for thought as details like this provide backing for my analysis that ~0% inflation is far from the demon it is presented as and can provide economic benefits. From Bloomberg.

The GDP deflator, a broad measure of price changes, fell 0.4 percent from a year earlier.

Board Member Funo confirmed this in a speech earlier this month.

The rate of increase for all items less fresh food and energy had remained on a decelerating trend, following the peak of 1.2 percent in winter 2015; recently, the rate of change has been at around 0 percent.

He of course followed this with the usual rhetoric.

The rate will likely reach around 2 percent in around fiscal 2019.

It is always just around the corner in not entirely dissimilar fashion to a fiscal surplus in the UK. As to the official view it is going rather well apparently.

Taking this into consideration, the Bank decided to adopt a commitment that allows inflation to overshoot the price stability target so as to strengthen the forward-looking mechanism in the formation of inflation expectations, enhance the credibility of achieving the price stability target among the public, and raise inflation expectations in a more forceful manner.

Make of that what you will. The reality is that the QQE programme did weaken the Yen but that effect wore off and inflation is now ~0% as is wage growth.

Comment

This growth figures are good news and let me add something that appears to have been missed in the reports I have read. Back to Board Member Funo.

In an economy with a declining population.

Thus the per capita or per person GDP numbers are likely to be even better than the headline. I would say that this would benefit the ordinary Japanese worker and consumer but we know that real wage growth has dipped into negative territory again. This provides a problem for Prime Minister Abe as when he came to power the criticisms were based around his past history of being part of the Japanese establishment. What we see nearly 5 years down the road is a lack of real wage growth combined with good times for Japanese corporate profitability. As to the reform programme there is not a lot to be seen and maybe this is why Board Member Funo was so downbeat.

In an economy with a declining population, as is the case in Japan, demand is expected to decrease for many goods and services; therefore, it will be important to adequately adjust supply capacity; that is, employees and production capacity to meet such a decreasing trend.

I do not know about you but trying to raise prices when you expect both demand and supply to fall seems extremely reckless to me.

As to the GDP numbers themselves we need a cautionary note as Japan has had particular problems with them and they are revised more and by larger amounts than elsewhere.

 

When will real wages finally rise?

One of the main features of the credit crunch era has been weak and at times negative real wage growth. This was hardly a surprise when the employment situation deteriorated but many countries have seen strong employment gains over the past few years and in some employment is now at a record high. Yet wage growth has been much lower than would have been expected in the past. As so often the leader of the pack in a race nobody wants to win has been Japan although there has been claim after claim that this is about to turn around as this from Bloomberg in May indicates.

It’s not making headlines yet, but wages in Japan are rising the fastest in decades, in a shift that’s poised to divide the nation’s companies — and their stocks — into winners and losers, according to Morgan Stanley.

No doubt this was based on the very strong quantity numbers for the Japanese economy which if we move forwards in time to now show an unemployment rate of 2.8% and a jobs per applicant ratio summarised below by Japan Macro Advisers.

Japan’s job offers to applicant ratio rose to 1.51 in June from 1.49 in May. The ratio is the highest in the last 43 years since 1974. While the number of job offers continue to rise along with the expansion in the economy, the number of job applicants are falling. With the shrinking population, Japan simply does not have a resource to meet the demand for labor.

I can almost feel the wind of the Ivory Towers rushing past to predict a rise in wages in such a situation. They will be encouraged by this from the Nikkei Asian Review on Friday.

The labor shortage created by stronger economic growth has prompted many companies to raise wages. Tokyo Electron, a semiconductor production equipment manufacturer, is a good example.

Tokyo Electron introduced a new personnel system on July 1 in which salaries reflect the roles and responsibilities of employees. Under the new system salaries will rise, primarily for junior and midlevel employees. The change will raise the total wages paid to the company’s 7,000 employees in Japan by about 2 billion yen ($18.1 million) annually.

This is something we see regularly where the media presents a company that is toeing the official line and raising wages. But I note that it is doing particularly well and expecting record profits so is unlikely to be typical. By contrast I note that there is another way of dealing with a labour shortage.

In April, Lumine, a shopping center operator, responded to an employee shortage among its tenants by closing 30 minutes earlier at 12 locations, or 80% of its stores. The risk was that shorter operating hours would cut revenue, but Lumine sales held steady in the April-June quarter.

Awkward that in many ways as for example productivity has just been raised with total wages cut.

What about the official data?

I will let The Japan Times take up the story.

Japan’s June real wages decreased 0.8 percent from a year before in the first fall in three months, labor ministry data showed Friday.
Nominal wages including bonuses fell 0.4 percent to ¥429,686 ($3,880), the first drop in 13 months, the Health, Labor and Welfare Ministry said in a preliminary report.

Up is the new down one more time. Also the official story that bonuses are leading growth due to a strong economy met this.

due mainly to a 1.5 percent decrease in bonuses and other special payments.

There is one quirk however which is that part-time wages are doing much better and rising at an annual rate of 3.1%. The catch is that you would not leave a regular job in Japan because those wages are lower and to some extent are catching up. How very credit crunch that to get wage growth you have to take a pay cut! Indeed to get work people had to take pay cuts. From the Nikkei Asian Review.

Japanese companies hired more relatively low paid nonregular employees during the prolonged period of deflation.

Now we find ourselves reviewing two apparently contradictory pieces of data.

 The number of workers in Japan increased by 1.85 million between 2012 and 2016……….Japan’s wage bill was 7% lower in May than at the end of 1997 — before deflation took hold.

Australia

You might not think that there would be issues here as of course the commodity price boom driven by Chinese demand has led to a boon for what we sometimes call the South China Territories. Indeed this from @YuanTalks will have looked good from Perth this morning.

The rally in industrial continues in . rebar limit up, surging over 6%

Yet according to the Sydney Morning Herald this is the state of play for wages.

But since 2012 and 2013, Australian workers have felt stuck in a holding pattern of slow wages growth. Wages for the whole economy increased by 1.9 per cent in the year to March just in line with inflation.

There are familiar issues on the over side of the balance sheet.

Families are also wrestling with rising electricity prices, skyrocketing property prices and high demand for accommodation has also forced up rents.

Even the professional sector has been hit.

When Sahar Khalili started work as a casual pharmacist eight years ago, she was paid $35 an hour. Over the years that has fallen to as low as $30 while her rent has more than doubled.

Actually there is something rather disturbing if we drill into the detail as productivity has done quite well in Australia ( presumably aided by the commodity boom) but wages have not followed it leading to this.

The typical Australian family takes home less today than it did in 2009, according to the latest Household Income and Labour Dynamics survey released this week.

These surveys are invariably a couple of years behind where we are but there are questions to say the least. Oh and the shrinkflation saga has not escaped what might be called a stereotypically Australian perspective.

“My beers are getting smaller,” he says.

The USA

Friday brought us the labour market or non farm payroll numbers. In it we saw that wage growth ( average hourly earnings) was at an annual rate of 2.5% which is getting to be a familiar number. There is a little real wage growth but not much which is provoking ever more food for thought as employment rises and unemployment falls. Indeed more and more are concentrating on developments like this reported by Forbes.

Starting pay at the Amazon warehouse, carved out of a large lot with a new road called Innovation Way designed for Amazon-bound trucks, is at $12.75, no degree required. For inventory managers with warehousing experience, the pay is $14.70 an hour and requires a bachelor’s degree.

The new warehouse offers 30 hour a week jobs because they slip under the state legislation on provision of benefits. In some parts of America they would qualify under the food stamp programme. No wonder that as of May some 41.5 million still qualified.

Yet the Wall Street Journal describes it thus.

a vastly improved labor market

Comment

This is a situation we have looked at many times and there is much that is familiar. Firstly the Ivory Towers have invented their own paradise where wages rise due to a falling output gap and when reality fails to match that they simply project it forwards in time. The media tends to repeat that. But if we consider the dangers of us turning Japanese we see that wages there are lower than 20 years ago in spite of very low unemployment levels. Over the past 4 years or so this has been always just about to turn around as Abenomics impacts.

My fear is that unless something changes fundamentally ( cold fusion, far superior battery technology etc..) real wages may flat line for some time yet. All the monetary easing in the world has had no impact here.