The 0% problem of Japan’s economy

Today I intend to look east to the land of the rising sun or Nihon where the ongoing economic struggles have been a forerunner to what is now happening to western economies. Also of course Japan is intimately tied up with the ongoing issue and indeed problem that is North Korea. And its navy or rather maritime self-defence force is being reinforced as this from Reuters only last month points out.

Japan’s second big helicopter carrier, the Kaga, entered service on Wednesday, giving the nation’s military greater ability to deploy beyond its shores………..Japan’s two biggest warships since World War Two are potent symbols of Prime Minister Shinzo Abe’s push to give the military a bigger international role. They are designated as helicopter destroyers to keep within the bounds of a war-renouncing constitution that forbids possession of offensive weapons.

We cannot be to critical of the name misrepresentation as of course the Royal Navy badged its previous aircraft carriers as through deck cruisers! There are of course issues though with Japan possessing such ships as the name alone indicates as the last one was involved in the attack on Pearl Habour before being sunk at Midway.

Demographics

This is a crucial issue as this from Bloomberg today indicates.

Japan Needs More People

The crux of the problem will be familiar to regular readers of my work.

Japanese companies already report they can’t find people to hire, and the future isn’t likely to get better — government researchers expect the country’s population to fall by nearly a third by 2065, at which point nearly 40 percent will be senior citizens. There’ll be 1.3 workers for every person over the age of 65, compared to 2.3 in 2015.

So the population is both ageing and shrinking which of course are interrelated issues. The solution proposed by Bloomberg is rather familiar.

It’s plain, however, that he needs to try harder still, especially when it comes to immigration……..Researchers say that to maintain the current population, Japan would have to let in more than half a million immigrants a year. (It took in 72,000 in 2015.)……..He now needs to persuade Japan that substantially higher immigration is a vital necessity.

There are various issues here as for example the Bloomberg theme that the policies of  Prime Minister Abe are working seems not to be applying to population. But as they admit below such a change is the equivalent of asking fans of Arsenal football club to support Tottenham Hotspur.

In a society as insular and homogeneous as Japan, any such increase would be a very tall order.

The question always begged in this is if the new immigrants boost the Japanese economy surely there must be a negative effect on the countries they leave?

The 0% Problem in Japan

I thought today I would look at the economy in different ways and partly as a reflection of the culture and partly due to the effect above a lot of economic and financial market indicators are near to 0%. This is something which upsets both establishments and central bankers.

Real Wages

Let me start with an issue I have been writing about for some years from Japan Macro Advisers.

The real wage growth, after offsetting the inflation in the consumer price, was 0% YoY in February.

The official real wage data has gone 0%,0%,0.1%, -0.1% and now 0% so in essence 0% and is appears on a road to nowhere. This is very different to what you may have read in places like Bloomberg and the Financial Times which have regularly trumpeted real wage growth in their headlines. There is a reason why this is even more significant than you might think because let me skip to a genuine example of economic success in Japan.

Given the prevalent labor shortage situation in Japan, there should be an economic force encouraging wages to rise. At 2.8%, the current unemployment rate is the lowest since 1993. (Japan Macro Advisers )

Actually in another rebuttal to Ivory Tower economics we see that unemployment is above what was “full employment”.

One could argue it is a matter of time, but it has already been 2.5 years since the unemployment rate reached 3.5%, the level economists considered as full-employment equivalent. (Japan Macro Advisers )

Inflation

The latest official data hammers out an increasingly familiar beat.

The consumer price index for Japan in February 2017 was 99.8 (2015=100), up 0.3% over the year before seasonal adjustment, and down 0.1% from the previous month on a seasonally adjusted basis.

If you compare 99.8 now with 100 in 2015 you see that inflation has been in essence 0%. This is quite a reverse for the policy of Abenomics where the “Three Arrows” were supposed to lead to inflation rising at 2% per annum. An enormous amount of financial market Quantitative Easing has achieved what exactly? Here is an idea of the scale comparing Japan to the US and Euro area.

As we stand this has been a colossal failure in achieving its objective as for example inflation is effectively 0% and the Japanese Yen has been reinforcing this by strengthening recently into the 108s versus the US Dollar. it has however achieved something according to The Japan Times.

Tokyo’s skyline is set to welcome 45 new skyscrapers by the time the city hosts the Olympics in 2020, as a surge of buildings planned in the early years of Abenomics near completion.

Although in something of an irony this seems to cut inflation prospects.

“This could heat up competition for tenants in other areas of the city”

A cultural issue

From The Japan Times.

Naruhito Nogami, a 37-year-old systems engineer in Tokyo, drives to discount stores on weekends to buy cheap groceries in bulk, even though he earns enough to make ends meet and the prospects for Japan’s economic recovery are brighter.

“I do have money, but I’m frugal anyway. Everyone is like that. That’s just the way it is,” he says.

Jaoanese businesses have responded in a way that will be sending shudders through the office of Bank of Japan Governor Kuroda.

Top retailer Aeon Co. is cutting prices for over 250 grocery items this month to lure cost-savvy shoppers, and Seiyu, operated by Wal-Mart Stores, cut prices on more than 200 products in February.

More of the same?

It would seem that some doubling down is about to take place.

The Abe government on Tuesday nominated banker Hitoshi Suzuki and economist Goshi Kataoka to the Bank of Japan Policy Board to replace two members who have frequently dissented against the direction set by Gov. Haruhiko Kuroda. ( Bloomberg)

Also Japan seems ever more committed to a type of centrally planned economic culture.

Japanese government-backed fund eyes Toshiba’s chip unit (Financial Times )

With the Bank of Japan buying so many Japanese shares it has been named the Tokyo Whale there more questions than answers here.

Comment

There is much to consider here but let me propose something regularly ignored. Why does Japan simply not embrace its strengths of for example full employment and relatively good economic growth per capita figures and abandon the collective growth and inflation chasing? After all lower prices can provide better living-standards and as  wages seem unable to rise even with very low unemployment may be a road forwards.

The catch is the fact that Japan continues to not only have a high national debt to GDP (Gross Domestic Product) ratio of 231% according to Bank of Japan data but is borrowing ever more each year. It is in effect reflating but not getting inflation and on a collective level not getting much economic growth either. Let is hope that Japan follows the lead of many of its citizens and avoids what happened last time after a period of economic troubles.

For us however we are left to mull the words of the band The Vapors.

Turning Japanese
I think I’m turning Japanese
I really think so

Let me finish with one clear difference we in the UK have much more of an inflation culture than Japan.

Are the currency wars still raging?

One of the features of the post credit crunch era is that economies are less able to take further economic stress. This leads us straight into today’s topic which is the movements in exchange rates and the economic effects from that. Apart from dramatic headlines which mostly concentrate on falls ( rises are less headline grabbing I guess…) the media tends to step back from this. However the central banks have been playing the game for some time as so many want the “cheap hit” of a lower currency which is an implicit reason for so much monetary easing. The ( President ) Donald was on the case a couple of months ago. From the Financial Times.

“Every other country lives on devaluation,” said Mr Trump after meeting with US motor industry executives. “You look at what China’s doing, you look at what Japan has done over the years. They play the money market, they play the devaluation market and we sit there like a bunch of dummies.”

Actually the FT was on good form here as it pointed out that perhaps there were better examples elsewhere.

South Korea has a current account surplus of nearly 8 per cent of gross domestic product, according to the International Monetary Fund, compared with just 3 per cent for China and Japan. Taiwan, meanwhile, has a colossal surplus of 15 per cent of GDP while Singapore is even higher at 19 per cent.

Care is needed here as a balance of payments surplus on its own is not the only metric and we do know that both Japan and China have had policies to weaken their currencies in recent years. So the picture is complex but I note there seems to be a lot of it in the Far East.

Japan

Ironically in a way the Japanese yen has been strengthening again and has done so by 1% over the weekend as it as headed towards 110 versus the US Dollar. So the Abenomics push from 76 was initially successful as the Yen plunged but now it is back to where it was in September 2014. Also for perspective the Yen was so strong partly as a consequence of US monetary easing. Oh what a tangled web and that.

The Bank of Japan will be ruing the rise ( in Yen terms) from 115 in the middle of this month to 110.25 as I type this because it is already struggling with this from this morning’s minutes.

The year-on-year rate of change in the consumer price index (CPI) for all items less fresh food is around 0 percent, and is expected to gradually increase toward 2 percent, due in part to the upward pressure on general prices stemming from developments in commodity prices such as crude oil prices.

Even worse for the Bank of Japan and Abenomics – but not the Japanese worker and consumer – the price of crude oil has also been falling since these minutes were composed. Time for more of what is called “bold action”?

Germany

It is not that often on these lists because the currency manipulation move by Germany came via its membership of the Euro where it added itself to weaker currencies. But its record high trade surpluses provide a strong hint and the European Central Bank has provided both negative interest-rates and a massive expansion of its balance sheet as it has tried to weaken the Euro. So we see that an exchange-rate that strengthened as the the credit crunch hit to 1.56 versus the US Dollar is now at 1.086.

So the recent bounce may annoy both the ECB and Germany but it is quite small compared to what happened before this. Putting it another way if we compare to Japan then a Euro bought 148 year in November 2014 but only 120 now.

The UK

In different circumstances the UK might recently have been labelled a currency manipulator as the Pound £ fell. As ever Baron King of Lothbury seems keen on the idea as he hopes that one day his “rebalancing” mighty actually happen outside his own personal Ivory Tower. There is food for thought for our valiant Knight of the Garter in the fact that we were at US $2.08 when her bailed out Northern Rock and correct me if I am wrong but we have indeed rebalanced since, even more towards our services sector.

However it too has seen a bounce against the US Dollar in the last fortnight or so and at US £1.256 as I type this there are various consequences from this. Firstly the edge is taken off the inflationary burst should this continue especially of we allow for the lower oil price ( down 11.2% so far this quarter according to Amanda Cooper of Reuters). That is indeed welcome or rather will be if these conditions persist. A small hint of this came at the weekend. From the BBC.

Motorists will see an acceleration in fuel price cuts over the weekend as supermarkets take up to 2p off a litre of petrol and diesel.

Not everybody welcomes this as I note my sparring partner on BBC 4’s MoneyBox Tony Yates is again calling for higher inflation (targets). He will then “rescue” you from the lower living-standards he has just created….

The overall picture for the UK remains a lower currency post EU vote and it is equivalent to a 2.5% reduction in Bank Rate for those considering the economic effect. Meanwhile if I allow for today’s rise it is pretty much unchanged in 2017 in effective or trade-weighted terms. Not something in line with the media analysis is it?

South Africa

This has featured in the currency falling zone for a while now, if you recall I looked at how cheap property had become in foreign currencies. There had been a bounce but if we bring things right up to date there has been a hiccup this morning. From the FT.

The rand plunged almost 2 per cent in less than half an hour on Monday morning after the latest row between president Jacob Zuma and his finance minister Pravin Gordhan, only moments after it had risen to its highest level since July 2015.

Perhaps the air got a bit thin up there.

The rand has been the best-performing currency in the world over the last 12 months, strengthening more than 23 per cent against the dollar, but it has suffered a number of knock backs prompted by the president and finance minister’s battles.

Back to where it was in the late summer of 2015.

Bitcoin

If we look at the crypto-currency then there has been a lot of instability of late. At the start of this month it pushed towards US $1300 but this morning it fell to below US $940 and is US $991 as I type this. Not for widows and orphans…

Comment

There is much to consider here as we wonder if the US Dollar is merely catching its breath or whether it is perhaps a case of “buy the rumour and sell the fact”. Or perhaps facts as you can choose the election of the Donald and or a promised acceleration in the tightening of monetary policy by the US Federal Reserve. But we see an amelioration in world inflation should this persist which of course combines as it happens with a lower oil price.

So workers and consumers in many countries will welcome this new phase but the Bank of Japan will not. Maybe both Euro area workers and consumers and the ECB can as the former benefit whilst the latter can extend its monetary easing in 2017 and, ahem, over the elections. Whilst few currencies are stable these days the crypto one seems out of control right now.

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!