Is Germany the new sick man of Europe?

The last twelve months have seen quite a turn around in not only perceptions about the performance of the German economy but also the actual data. With the benefit of hindsight we see that there was a clear peak at the end of 2017 when after a year of strong economic growth ( 0.6% to 1.2% quarterly) the annual rate of Gross Domestic Product or GDP growth reached 3.4%. Then things changed and quarterly growth plunged to 0.1% as 2018 opened as quarterly growth fell to 0.1%.

Actually there was a warning sign back then because looking at my post from the 3rd of January 2018 I reported on the good news as it was then but also noted this.

Although there was an ominous tone to the latter part don’t you think?! We have also learnt to be nervous about economic all-time highs.

This was in response to this from the Markit PMI.

2017 was a record-breaking year for the German
manufacturing sector: the PMI posted an all-time
high in December, and the current 37-month
sequence of improving business conditions
surpassed the previous record set in the run up to
the financial crisis.

Actually back then we did not know how bad things were because the GDP numbers were wrong as the Bundesbank announced yesterday.

In the first quarter, growth consequently totalled 0.1% (down from 0.4%), while it amounted to 0.4% in the second quarter (after 0.5%).

So as you can see we have something else to add to the issues with GDP as in this instance it completely missed the turn in the German economy. The GDP data in fact misled us.

If we move forwards to April 25th last year we see the Bundesbank had seen something but blamed the poor old weather.

The Bundesbank expects the German economy’s boom to continue, although the Bank’s economists predict that the growth rate of gross domestic product might be distinctly lower in the first quarter of 2018 than in the preceding quarters.

The “boom to continue” then went in annual economic growth terms 2.3%, 2.1%, 1.1%, 0.6%,0.9% and most recently 0.4%.If we switch to the actual level it is not much of a boom to see GDP rise from 106.04 at the end of 2017 to 107.03 at the end of the second half of 2019.

Looking Ahead

The Bundesbank has changed its tone these days or if you prefer has been forced to change its tone so let us dip into yesterday’s monthly report.

“The domestic economy is still doing well; the weaknesses have so far been concentrated in industry and exports. International trade disputes and Brexit are important reasons behind this,” Mr Weidmann said.

As you can see its President has a good go at blaming Johnny Foreigner and in particular the UK. Actually the latter is somewhat contradicted by the report itself as it points out Germany has also benefited from the UK in 2019.

In particular, exports to the United Kingdom were weak in the second quarter. A contributing factor to this, according to the Bundesbank’s economists, was the original Brexit date scheduled for the end of March. This resulted in substantial stockpiling in the United Kingdom over the winter months. This led to a countermovement in the second quarter.

Actually the report itself does not seem entirely keen on the idea that it is all Johnny Foreigner’s fault either.

“Sales in construction and in the hotel and restaurant sector declined. Wholesale trade slid into the downturn afflicting industry”, the Bank’s economists write. Only retail trade as well as some other services sectors are likely to have provided positive momentum.

So it is more widespread than just trade.In fact if we look at the details below we see that it was the 0.4% growth in the first quarter which looks like the exception to the present trend.

Construction output declined steeply after posting a sharp increase during the first quarter due to favourable weather conditions. Meanwhile, the demand for cars, pent up by delivery bottlenecks last year, had largely been met at the start of 2019 and did not increase further in the second quarter.

Ominous in a way as we wonder if it might get the same treatment as the first quarter of 2018. But if we take the figures as we presently have them then GDP growth in the first half of this year has been a mere 0.3%. But they are not expecting much better and maybe worse.

Economic activity could decline slightly again in the current quarter, the economists suggest. There are, they write, no signs yet of an end to the downturn in industry, adding: “This could also gradually start to weigh on a number of services sectors.”

They also touch on an area which concerns others.

Leading labour market indicators painted a mixed picture. Industry further scaled back its hiring plans. By contrast, in the services sectors, except the wholesale and retail trade, and in construction, positive employment plans dominated.

Is the labour market turning? This morning’s numbers only really tell us what we already knew.

The year-on-year growth rate was slightly lower in the second quarter than in the first quarter of 2019 (+1.1%) and in the fourth quarter of 2018 (+1.3%).

Maybe we learn a little more here.

After seasonal adjustment, that is, after the elimination of the usual seasonal fluctuations, the number of persons in employment increased by 50,000, or 0.1%, in the second quarter of 2019 compared with the previous quarter.

That number looks a fair bit weaker.

Markit PMI

This has not had a good run and let me illustrate this with the latest update from the 5th of this month.

The combination of a deepening downturn in manufacturing output and slower service sector business activity growth saw the Composite Output Index register 50.9 in July, down from 52.6 in June and its lowest reading in just over six years.

Yes it shows a fall but it has continued to suggest growth for Germany and sometimes strong growth when in fact there was not much and then actual declines.

Comment

The situation here is revealing on quite a few levels. Let me start with one perspective which is ironically provided by ECB President Mario Draghi when he suggested his policies  ( negative interest-rates and QE) added 1.5% to GDP. That was for the Euro area overall but if we apply it to Germany we see that the boom fades a bit and more crucially the German economy started “slip-sliding away” as soon as the stimulus began to fade. That is rather a different story to the consensus that it is the southern European countries that have depended most on stimulus policies.

Next is the German economic model which relies on exports or if you prefer demand from abroad. We have seen a phase where this has been reduced at least partly due to the “trade war” but also I think that the issues with diesel engines which damaged the reputation of its car manufacturers hit too. Whatever the reason there is not a lot behind it in terms of domestic consumption.

The issue with domestic consumption gets deeper as we note that economic policy is sucking demand out of the economy. At the beginning of the year the finance ministry thought that the surplus would be 1.75% of GDP. That seems much less likely now as economic growth has faded but it is one of the reasons why we keep getting reports that Germany will provide a fiscal stimulus which reached 50 billion Euros yesterday. With all of its bond maturities showing negative yields it could easily do so and in fact would be paid to do it, but it still looks unlikely as I note the mention of a “deep recession” being required.

As to my question in some ways the answer is yes. But we need to take care as the domestic consumption problem was always there and once export growth comes back we return to something of a status quo. I also expect the ECB to act in September but on the other side who would expect Germany to be the economic version of a junkie desperate for a hit?

 

 

 

 

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Inside the world of negative interest-rates

A feature of modern economic life is that interest-rates were first cut as close to zero as central banks thought they could and then in more than few cases they went below zero giving us the acronym NIRP for Negative Interest-Rate Policy. There was the implication that such a state of affairs would be temporary in that the medicine would work and that interest-rates would then be raised. For example I have put on here before the charts that show that the Riksbank of Sweden has been forecasting interest-rate increases for years whereas the reality was that it either cut or did nothing. Ironically it changed tack a little last December just in time for the world economy to turn down!

As to all this being temporary let me hand you over to ECB President Mario Draghi on the day he cut the Deposit Rate to -0.1% back in June 2014.

Draghi: On the first question, I would say that for all the practical purposes, we have reached the lower bound. However, this doesn’t exclude some little technical adjustments and which could lead to some lower interest rates in one or the other or both parts of the corridor. But from all practical purposes, I would consider having reached the lower bound today.

This has been a feature of central banker speak where they discuss a “lower bound” as if this type of economics is a science. The reality is that the nearest the “lower bound” has got to being a status quo has been this.

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

If we let him have the move to -0.2% as a technical adjustment we have to face up to the fact that it is now -0.4% and about to go to -0.5/6%. This has consequences as for example over the past month or so the amount deposited at the ECB at such a rate is 1.86 trillion Euros. So this is a drain on the banking system and therefore wider economic life as well as being a nice little earner for the ECB.

The “lower bound” theme has been the same in the UK as Bank of England Governor Carney asserted it was 0.5% but later decided it was 0.1%. Or you could look at the US Federal Reserve defined “normal” interest-rates as being somewhere above 3% then changed its mind and started cutting them. The truth is that the new normal is that when a central bank raises interest-rates it soon turns tail and starts cutting them.

Switzerland

The Swiss are at the cutting edge of negative interest-rates and it was ECB policy which was the supermassive black hole that sucked them into it. In terms of timing the June 2014 move by the ECB was followed by this in January 2015.

The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%.

For those who have not followed this saga there was an enormous amount of borrowing in Swiss Francs pre credit crunch because interest-rates were there. When the credit crunch hit institutional investors raced to reverse such positions which made the Swiss Franc soar which had the side-effect of crippling those who in eastern Europe who had taken out such mortgages. The SNB found itself like General Custer at Little Big Horn as the ECB version of Indians arrived and gave events another push.

Again there was an implication that this would be temporary until matters calmed down but the reality has been very different. Or to put it another way in central banker speak the word temporary now means permanent.

The signal we now have has been provided by two developments this morning. Let me start with the Swiss one.

Domestic sight deposits CHF 475.3 bn vs CHF 469.0 bn prior…………. Once again, a notable rise in the sight deposits data and that continues to suggest that the SNB is stepping in to smooth the appreciation in the franc over the past few weeks.

In case you are wondering why those numbers are looked at the SNB only occassionally declares it has intervened in foreign exchange markets and does so via other central banks and the BIS. So to find out we have to look at other numbers and thank you to Bank Pictet for this estimate.

In total, sight deposits have increased by CHF 9.8bn in the last 4 weeks, and CHF 10.3bn in the last 5 weeks.

So like The Terminator the SNB is back. Why? The Swiss Franc has been strengthening again and went through 1.09 versus the Euro. Whereas on the 23rd of April last year I noted that Reuters were reporting this.

The Swiss franc fell to a three-year low of 1.20 against the euro on Thursday as a revival in risk appetite encouraged investors to use it to buy higher yielding assets elsewhere, betting on loose monetary policy keeping the currency weak.

There were still problems though as I pointed out to a background elsewhere of something of a chorus saying the SNB had triumphed..

Any economic slow down would start currently with interest-rates at -0.75% posing the question of what would happen next?

Well we have an economic slow down and we expect the ECB to cut again which according to Bank Pictet will have this consequence.

SNB officials have emphasized the importance of the interest rate differential (mainly versus the euro area) for the exchange rate and thus the policy outlook. The SNB’s policy rate differential with the ECB’s deposit facility rate now stands at 35bp, below the 50bp in 2015 when the SNB lowered its interest rates to -0.75%.

To be fair to Bank Pictet that was from the end of July and so could not factor in the statements from Bank of Finland Governor Ollie Rehn on Friday about “overshooting” market expectations about the ECB move. So the statement below has got more likely.

In that event, should the CHF come under
excessive upward pressure, our best guess is that the SNB would cut the interest rate on sight deposits by 25 bps, bringing it down to -1.0%.

Comment

Thus we are facing a new frontier should the Swiss find they have to cut to -1% interest-rates or as the SNB might put it.

Yes we’re gonna have a wingding
A summer smoker underground
It’s just a dugout that my dad built
In case the reds decide to push the button down
We’ve got provisions and lots of beer
The key word is survival on the new frontier. ( Donald Fagen )

This will mean that the pressure for more of this will build.

UBS, the world’s largest wealth manager, told its ultra-wealthy clients on Tuesday that it would introduce an annual 0.6% charge on cash savings of more than €500,000 (£461,000). The fee, to be introduced in November, rises to 0.75% on savings of more than 2m Swiss francs (£1.7m). ( The Guardian ).

In some ways the economic situation has already adjusted to this as the Swiss ten-year bond yield is -1.1% and the thirty-year is -0.6%. Imagine the impact of this on long-term contracts such as pensions. Give me 100.000 Swiss Francs and I will give you 84,000 back in thirty-years, who would do that?

Meanwhile here is something to make UK readers very nervous.

BoE Gov Carney: At This Stage We Do Not See Negative Rates As An Option In The UK ( @LiveSquawk )

Podcast

Where next for the Euro, the ECB and the Euro area economy?

In our new financial world where pretty much everything depends on the whims and moods of central bankers one of the main leaders is the ECB or European Central Bank. Yesterday we got one version of its future from the Governor of the Bank of Finland Ollie Rehn. So let me hand you over to his interview with the Wall Street Journal.

“It’s important that we come up with a significant and impactful policy package in September,” said Mr. Rehn, who sits on the ECB’s rate-setting committee as governor of Finland’s central bank.

“When you’re working with financial markets, it’s often better to overshoot than undershoot, and better to have a very strong package of policy measures than to tinker,” Mr. Rehn said.

That is pretty cleat although there is are two self-fulfilling problems in trying to overshoot financial markets. The first is that you are devolving monetary policy to financial markets. The second is that markets will now adjust ( they did so yesterday as I will discuss later) so do you overshoot that as well?

According to the WSJ these are the expectations Ollie was trying to overshoot.

Analysts expect the ECB will announce next month a 0.1 percentage-point cut to its key interest rate, currently set at minus 0.4%, as well as around €50 billion ($56 billion) a month of fresh bond purchases under its quantitative easing program. The program had previously been phased out at the end of last year.

There is already an example of the “slip-sliding away” as Paul Simon would put it that I mentioned earlier as the monthly bond purchases were expected to be 30 billion Euros a month. So which one would Ollie be overshooting?

Even worse for hapless Ollie others seem to have a different set of expectations.

Investors currently expect the ECB to cut its key interest rate to minus 0.7% and to hold rates below their current level through 2024, according to futures markets. Mr. Rehn said those market expectations showed that investors had understood the ECB’s guidance.

So will he now be overshooting -0.5% or -0.7%? Actually it gets better as -0.6% is in there now as well.

The comments suggest the ECB might cut interest rates by more than expected in September, perhaps by 0.2 percentage points, and could start to purchase new types of assets, Mr. Ducrozet said.

So roll up! Roll up! Place your bets on what Ollie will be trying to overshoot. Also as no doubt you have spotted whilst he may be in Finland he wants to start turning Japanese.

Mr. Rehn said he didn’t rule out a move to purchase equities under the QE program, but that would depend on the assessment of ECB staff.

That is a pretty shocking as the ECB staff assessment will be exactly what the Governing Council wants in the manner explained by The Jam.

You want more money – of course, I don’t mind
To buy nuclear textbooks for atomic crimes
And the public gets what the public wants

As I have acquired quite a few extra followers in the last week or two let me explain the Japan reference which is that the Bank of Japan has for a while now been purchasing Japanese equities. According to its latest accounts it now holds 26.6 trillion Yen of them.

The Problem

It is highlighted by this.

To provide space for fresh bond purchases, the ECB could adjust the rules of its bond-buying program, which currently prohibit the bank from buying more than 33% of the debt of any individual eurozone government, he added.

This is an example of what ECB President Mario Draghi calls it being a “rules-based organisation”. It is until they are inconvenient and then it changes them! One of the ways it got support for the previous QE programme was the limit above bit now it will be redacted from history. How high can it go? Well one example is from my own country the UK where the Bank of England does not have country limits ( for obvious reasons) but it does have a limit of 70% for each individual Gilt-Edged bond.

The Euro

Part of the plan behind Ollie’s interview was to talk down the Euro. After all the new “currency war” style consensus is to try a grab a comparative advantage in a zero-sum game. In a small way he succeeded as the Euro fell against most currencies. But there is a catch as highlighted by this release from Eurostat today.

As a result, the euro area recorded a €20.6 bn surplus in trade in goods with the rest of the world in June 2019…….In January to June 2019, euro area exports of goods to the rest of the world rose to €1 163.3 bn (an increase of
3.2% compared with January-June 2018), and imports rose to €1 061.2 bn (an increase of 3.7% compared with
January-June 2018). As a result the euro area recorded a surplus of €102.2 bn, compared with +€103.6 bn in
January-June 2018.

As you can see in the first half of the year trade created a demand for the Euro of around 102 billion Euros which is a barrier against any sustained fall. Actually this is a German thing because if you look at the national breakdown it accounts for 112 billion of this. Other nations such as the Netherlands run large surpluses assuming we look away from the “Rotterdam Effect” but as a collective in a broad sweep they contribute very little. So we get something very awkward which is that the main exchange rate fall came when Germany switched the Dm to the Euro. Since then there has been a lot of hot air on the subject but in terms of the effective exchange rate the Euro is at 98.3 or a mere 1.7% from where it started.

In a purist form I should look at the full current account but hopefully you have the idea from the trade figures. Partly I am doing that because I have very little faith in the other numbers.

Even more awkward for the ECB would be a situation where President Trump actually goes forward with his plan to buy Greenland. He would pay Denmark in its Kroner but as it is pegged to the Euro this would raise the Euro versus the US Dollar which is presumably part of the plan.

Comment

There is a lot to consider here but let me open with looking at the real economy. It is struggling with some but not much growth. So far in 2019 economic growth has gone 0.4% and then 0.2% on a quarterly basis. The fear is that it will slow further based on what was a strength above ( Germany’s trade surplus) which right now looks a weakness or as Frances Coppola out it.

Thread. Germany has been importing demand from China for a long time.

I am not saying it is the only perspective but it is one. On this road we have found little economic growth because even if we take the view of Mario Draghi this created a mere 1.5% of extra GDP growth. On the other side of the ledger is the destruction wreaked on all long-term contracts such as pensions and bond markets by the world of negative interest-rates. Oh and the fact if it had worked we would not be here.

As to the real economy well if we return to Ollie we see that in fact his main concern is “The Precious! The Precious!”

To offset the impact on eurozone banks of a longer period of negative interest rates, the ECB could introduce a tiered-deposit system, under which only a portion of bank deposits might be subject to negative rates, Mr. Rehn said.

The ECB could also alleviate the stress on banks by sweetening the terms of new long-term loans, known as targeted longer-term refinancing operations, he said.

If the real economy merits a mention I will let you know….

As a final point this version of economic management combining “open mouth operations” with reading a Bloomberg or Reuters screen to see where markets are often involves what have become called “sauces” saying something different, so be on your guard.

Meanwhile liuk on twitter has a suggestion which we can file under QE for millennials.

#ECB STAFF WILL INCLUDE AVOCADO FOR NEW ASSET BUYING PROGRAM

It would be a bit dangerous putting them in the Helicopter Money drop though…..

 

Can the IMF hang on in Argentina?

There was a whiff of ch-ch-changes yesterday as we note the result of the elections held in Argentina.

Argentine voters soundly rejected President Mauricio Macri’s austere economic policies in primary elections on Sunday, casting serious doubt on his chances of re-election in October, early official results showed. ( Reuters)

As ever the politics is not my concern but the economics is and there is rather a binary choice here.

Voters were given a stark choice: stay the course of painful austerity measures under Macri or a return to interventionist economics.

This has more than a few consequences because we have a situation where the economy has nose dived as the Peso plunged and inflation soared. In response the present government negotiated the biggest IMF ( International Monetary Fund) bailout ever. Oh and the none too small matter of an official interest-rate which was 63.71% on Friday which sticks out like a sore thumb in a world which saw 6 central banks cut interest-rates last week alone.

Below is the Reuters view on the consequences for the financial world.

Argentine stock and bond prices were expected to slide when financial markets opened on Monday because Fernandez’s lead far exceeded the margin of 2 to 8% predicted in recent opinion polls.

The peso plunged 5.1% to 48.50 per U.S. dollar following early official results on the platform of digital brokerage firm Balanz, which operates the currency online non-stop.

Financial Markets

There has been a lot of rhetoric about the Peso plunging but we are still waiting for official trading to start as I type this. Balanz are wisely quoting a wide spread of 46.5 to 48.5 versus the US Dollar. I am often critical of wide foreign exchange spreads but in this instance I have some sympathy. Meanwhile I note that China.org.cn is on the case.

But the South African rand and Argentine peso have both fallen significantly against the yuan, with the rand down 9.36 percent year-on-year and the value of the peso falling 37.29 percent.

Maybe there will now be more Chinese tourists.

Moving to bond markets I am reminded that in what seems like a parallel universe Argentina issued a century or 100 year bond in 2017. Now as it was denominated in US Dollars it is not as bad as you might think for holders. Mind you it is bad enough as the price has fallen by 3 points to just above 71. If you are a professional bond investor you are left having to explain to trustees and the like how you have managed to lose money in what has been the biggest bull market in history.You would be desperately hoping nobody turns up with a chart of the Austrian century bond where the price is more like 171. Maybe you could try some humour as show this from M&G Bond Vigilantes from when the bond was issued.

Given the unusual maturity of the bond, the model choked after 50 years. However, we can see that the implied probability of default given these assumptions is already at 97% for a bond maturing in 50 years. Given this, a century bond should not be seen as being much riskier.

If you have a 97% risk of default things cannot get much riskier can they?

The economic situation

The IMF tried to be optimistic at the end of last month but we can read between the lines.

In Argentina, the economy is gradually recovering from last year’s recession. GDP growth is projected to increase to -1.3 percent in 2019 and 1.1 percent in 2020 due to a recovery in agricultural production and a gradual rebuilding of consumer purchasing power, following the sharp compression of real wages last year. Inflation is expected to continue to fall. However, with inflation proving to be more persistent, real interest rates will need to remain higher for longer, resulting in a downward revision to GDP growth in 2020.

As you can see it tries to be optimistic as after all wouldn’t you if you has lent so much money? But the reality of the wider piece was of a slow down in Latin America.

If we go to the statistics office we are told this.

Progress report on the level of activity. Provisional estimates of GDP for the first quarter of 2019
The provisional estimate of the gross domestic product (GDP), in the first quarter of 2019, shows a 5.8% drop in relation to the same period of the previous year. The level of GDP in the first quarter is 2.0% lower than in the fourth quarter of 2018.

The seasonally adjusted GDP of the first quarter of 2019, compared to the fourth quarter of 2018, shows a variation of -0.2%, while the cycle trend shows a positive variation of 0.1%.

As to trade there is good and bad news. The good is that Argentina has a trade surplus so far in 2019 as opposed to a deficit which will be providing a boost to GDP via net exports. Indeed exports are up by around 2% overall although nearly all of this took place in May. But the good news ends there because the real shift in the trading position has been to what can only be called a collapse in import volumes. As of the June figures the accumulated drop was 27.9% for the year so far. That is ominous because it hints at quite a fall in domestic consumption especially if we note what Argentina exports and imports. From the European Commission.

The EU is Argentina’s second trading partner  (after Brazil), accounting for 15.7% of total Argentinean trade in 2016. In 2016 EU-Argentina bilateral trade in goods totalled EUR 16.7 billion.

Argentina exports to the EU primarily food and live animals (65%) and crude materials except fuel (16%) (2016 data).

The EU exports to Argentina mainly manufactured goods, such as machinery and transport equipment (50%) and chemical products (22.6%) (2016 data).

If we switch to inflation then the annual rate of inflation is a stellar 55.8%. However there are signs of a reduction as the monthly rate in June was 2.7%. Of course we get a perspective from the fact that many central banks are desperately trying to get an annual rate of 2.7%. But in Argentina is suggests an amelioration and the year ahead estimate is for 30%.

Comment

There are various perspectives here but let me start with the interest-rate one. At any time an interest-rate of over 60% is a red flag but right now it is more like a double or triple red flag. No wonder the unemployment rate rose to 10.1% in the first quarter of the year. But staying with the central bank maybe it will be needing the US $66.4 billion of foreign exchange reserves.

The next view must be one of terror from the headquarters of the IMF. Back on May 21st I pointed out this.

When the IMF completed its third review of Argentina’s economy in early April, managing director Christine Lagarde boasted that the government policies linked to the country’s record $56bn bailout from the fund were “bearing fruit”.

Oh and the forecast for economic growth in 2020 was 2.1% back then as opposed to the 1.1% of now. That has horrible echoes because there was a time that Christine Lagarde was involved in a big IMF programme for Greece and forecast 2.1% growth next year when in fact the economy collapsed. She of course has put on her presumably Loubotin running shoes and sped off to the ECB in Frankfurt but sadly the poor Argentines cannot afford to do this.

Researchers at two Argentine universities estimate that 35% of the population is living in poverty, up from the official government rate of 27.3% in the first half of 2018.

Should the IMF programme fold get ready for an army of apologists telling us that it was nothing at all to do with Madame Lagarde.

Podcast

 

Are the UK trade numbers right or UK GDP?

As we look around us in the UK we see that the international environment has seen better days. One way of representing that has been the six central banks which have cut interest-rates this week as Serbia and the Phillipines yesterday joined the three we looked at on Tuesday. Those of you who have spotted I have mentioned only five, well as I do not think I have mentioned Peru before I thought it merited a proper mention.

The Board of Directors of the Central Reserve Bank of Peru (BCRP) decided to cut the reference
rate from 2.75 to 2.50 percent, thereby loosening the monetary policy stance.

Meanwhile it would appear that beds are burning in a land down under as look at this from Dr.Lowe of the Reserve Bank of Australia.

Things are going well.

He believes the economy may be at a positive “turning point”, as RBA rate cuts, tax cuts, a lower currency and infrastructure spending boost demand

So well in fact that he is considering cutting interest-rates to zero and started some QE bond purchases.

It is “possible” the RBA is forced to cut rates to near zero if other central banks do and the world economy has a serious downturn

The RBA is exploring other unconventional stimulus measures such as buying government bonds to drive down long-term interest rates if it does run out of cash rate cutting power. ( Australian Financial Review)

I have reported on this type of central banking Newspeak many times before where we get deflection ( optimism) but then the reality of what they really intend to do. Also if we note that the ten-year yield in Australia is already a mere 0.96% QE looks even more of a paper tiger than usual.

Also rather ominously bad production figures from Germany earlier this week were followed  this morning by this from France.

In June 2019, output slipped back sharply in the manufacturing industry (−2.2%, after +1.6%), as well as in the whole industry (−2.3%, after +2.0%)…….Over the second quarter of 2019, manufacturing output declined (−0.3%). Output increased slightly in the whole industry (+0.3%).

The UK

This meant that the mood music was right to be downbeat as we waited for the economic growth data.

UK gross domestic product (GDP) in volume terms was estimated to have fallen by 0.2% in Quarter 2 (Apr to June) 2019, having grown by 0.5% in the first quarter of the year.

This contrasts with what the Bank of England told us a week ago.

After growing by 0.5% in 2019 Q1, GDP is expected to have been flat in Q2, slightly weaker than anticipated in May.

That in itself was a reduction on its initial forecast of 0.2% growth so as you can see it turned out that net we ended up some 0.4% lower.

What happened?

As we have observed in France and Germany the action has been in production.

The production sector contracted by 1.4% in Quarter 2 2019, providing the largest downward contribution to GDP growth; the fall was driven by a sharp decline in manufacturing output, reflective of increased volatility in the first half of 2019.

Ouch! As we look for more detail there is this.

The quarterly fall in manufacturing of 1.4% is the strongest fall since Quarter 1 2009, due mainly to widespread weakness with 10 of the 13 subsectors decreasing; led by strong decreases from transport equipment (5.2%), chemicals and chemical products (6.2%) and basic metals (2.4%).

The transport numbers are no surprise in this environment but the chemical sector is more so. In terms of perspective this gives some food for thought.

To add further context to the volatility in growth during Quarter 1 2019 and Quarter 2 2019, the six months to June 2019 compared to the six months to December 2018 results in 0.0% growth in both the Index of Production and Index of Manufacturing.

So whilst we have had a Grand Old Duke of York half-year due to some Brexit stockpiling and unwinding the reality is that growth has disappeared. The credit crunch era pattern is now this.

Production and manufacturing output have risen since then but remain 7.1% and 3.4% lower respectively for June 2019 than the pre-downturn peak in February 2008.

Whilst we should not let a bad patch get us too down we should also wonder how and maybe if we will ever get back to that previous peak.

What did grow then?

Such growth as we got came from the services sector.

Services output increased by 0.1% in Quarter 2 (Apr to June) 2019 compared with Quarter 1 (Jan to Mar) 2019, following growth of 0.4% for Quarter 1 2019.

Not much although it looked better in annual terms.

In the three months to June 2019, services output increased by 1.6% compared with the three months ending June 2018.

Thus my theme that we are shifting ever more towards the services sector continues and they must be 80% of our economy by now.

Are we headed for recession?

Probably not if the monthly GDP figures are any guide. There is a danger because we have just seen a quarterly contraction but the monthly numbers suggest not. This is because the decline was in April when it fell by 0.5% on a monthly basis, followed by a 0.2% rise in May and then this.

Monthly GDP growth was flat in June 2019,

So we do not have much growth but we have a little and this is after downward revisions for April and May.

Trade

You may be surprised to read that this did really well.

The total trade deficit (goods and services) narrowed £16.0 billion to £4.3 billion in Quarter 2 (Apr to June) 2019, due largely to falling imports of goods.

Should this not lead to GDP rising? Well it is more complicated than that on two main counts. But let us try to get a better handle on the numbers actually going into the GDP numbers.

Excluding unspecified goods (including non-monetary gold), the trade deficit narrowed £6.2 billion to £4.0 billion in Quarter 2 2019, as imports from EU countries fell following sharp rises in Quarter 1 2019.

Even so we did better and on a monthly basis got near to balance or god forbid even a surplus.

Excluding unspecified goods (including non-monetary gold), the total trade balance remained in deficit at £0.6 billion in June 2019;

Now please forget what you were taught at school or maybe university as these are not in the output version of GDP they are in the expenditure version. So for now they get ignored! Time for me to remind you of one of Elton John’s albums.

Don’t shoot me I am only the piano player.

Okay let’s continue. The expenditure version has a problem which is this is an up and we know consumption is rising and to some extent government expenditure. So where’s the down?

GCF – which includes gross fixed capital formation (GFCF), changes in inventories and acquisitions less disposal of valuables – made a negative contribution of 4.01 percentage points to overall GDP growth in Quarter 2 2019. …………In Quarter 2 2019, changes in inventories (excluding both balancing and alignment adjustments) subtracted 2.24 percentage points from GDP growth.

 

Comment

As the above section was heavy going let me offer you some light relief courtesy of the Bank of England.

 the Committee judges that increases in interest rates, at a gradual pace and to a limited extent, would be appropriate to return inflation sustainably to the 2% target.

As Newt in the film Aliens points out “It wont make any difference” but central bankers are pack animals.

If we return to the GDP data then these numbers are a disappointment but far from a shock in the current environment. Also as I have shown there are more than a few reasons for doubt because of the current situation with trade and inventories, The water is even muddier than usual.

Or to put it another way I have already seen a barrage of tweets and the like about this being Brexit and so on. Us being better or worse than our peers. So let me help out by comparing annual growth rates.

When compared with the same quarter a year ago, UK GDP increased by 1.2% in Quarter 2 2019……..Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 1.1% in the euro area and
by 1.3% in the EU28 in the second quarter of 2019.

All within the margin of error…..

 

 

 

 

In the future will all mortgage rates be negative?

Today I thought that I would look at some real world implications of the surge in bond markets which has led to lower and in more than a few cases ( Germany and Switzerland especially) negative bond yields. The first is that government’s can borrow very cheaply and in the case of the two countries I have mention are in fact being paid to borrow at any maturity you care to choose. This gets little publicity because government’s prefer to take the credit themselves. My country the UK is an extreme case of this as the various “think tanks” do all sorts of analysis of spending plans whilst completely ignoring this basic fact as if a media D-Notice has been issued. I would say that “think tank” is an oxymoron except in this instance I think you can take out the oxy bit.

Negative Mortgage Rates

Denmark

Back on the 29th of May we were already on the case.

Interest rates on Danish mortgage loans have fallen since 2008. From an average interest rate including administration fee of close to 6 per cent in 2008 to under 2.2 per cent in August 2018. This is the lowest level since the beginning of the statistics in 2003.

Back then we also observed this.

For one-year adjustable-rate mortgage bonds, Nykredit’s refinancing auctions resulted in a negative rate of 0.23%. The three-year rate was minus 0.28%, while the five-year rate was minus 0.04%.

As you can see at the wholesale or institutional level interest-rates had gone negative and the central bank the Nationalbanken had seen reductions in the fees added to these as well.

That was then but let us pick up the pace and move forwards to the 2nd of this month. Here is The Local in Denmark.

Mortgage provider Realkredit Danmark will next week start offering Denmark’s cheapest ever 30-year mortgage, with an interest rate of just 0.5 percent per year. The fixed-rate 30-year loan is the lowest interest mortgage ever seen in Denmark, and is likely to be matched by Realkredit competitor Nordea Kredit.

That implied negative mortgage rates at shorter maturities although we already knew that but this week things have taken a further step forwards or perhaps I should write backwards. From Bloomberg.

In the world’s biggest covered-bond market, a Danish bank says it’s now ready to sell 10-year mortgage-backed notes at a negative coupon for the first time.

It’s the latest record to be set in a world that’s being dragged down by ever lower interest rates. In Denmark, where Jyske Bank will offer 10-year mortgage bonds at a fixed rate of minus 0.5 per cent, average Danes will borrow at rates far lower than those at which the US government can sell its debt.

Since then things have taken a further step as Nordea has started offering some mortgage bonds for twenty years at 0%, So we have nice even 0.5% changes every ten years.

If we look at Finance Denmark it tells us that variable rate mortgage bonds are at -0.67% in Danish Kroner and -0.83% in Euro in the 31st week of this year with a noticeable 0.2% drop in Euro rates.

This is impacting on business as we see that the latest three months have seen over 30,000 mortgages a month taken out peaking at 39,668 in June. This compares to 16/17k over the same 3 months last year so quite a surge. If we switch to lending volumes then the Danish mortgage banks lent more than double ( 212 billion Kroner) in the second quarter of this year.

Also as the Copenhagen Post points out whilst it may seem that negative mortgages are easy to get banks will behave like banks.

Banks are set to make money from the mortgage loan restructuring.

“We are in the process of a huge conversion wave, and the banks are of course also very interested in talking about that. Because they make good money every time a new loan is taken up,” explained Morten Bruun Pedersen, a senior economist at the Consumer Council, to TV2.

These days banks make money from fees and charges as there is no net interest income and on that subject we have a curiousity. On the one hand Danes are behaving rationally by switching to cheaper mortgages on the other the data from the Nationalbanken is from earlier this year but they have around 900 billion Kroner on deposit at 0% which is less rational and will have central banking Ivory Towers blowing out plenty of steam.

So whilst there are some negative mortgage rates the fees added are doing their best to get them into positive territory. The Nationalbanken highlights this here.

In 2018, Danish households paid an average interest rate of 1.20 per cent on their mortgage debt along with 0.96 per cent in administration fees.

I guess someone has to pay the banks money laundering fines

Just for research purposes I looked at borrowing 2 million Kroner on the Danske bank website and after 30 years I would have repaid 2.2 million so not much extra but it was positive.

Portugal

It has not been reported on much but there was an outbreak of negative mortgage rates in Portugal as this from Portugal on the move highlights.

The new law forces banks to reflect Euribor negative interest in home loan contracts. It was supported by all political parties in the country except the centre-right PSD which abstained.

The bill, which the banks and the Bank of Portugal tried to block, applies to all mortgages index-linked to Euribor rates.

Above all the law will benefit those with Euribor mortgages with very low spreads (commercial margins of banks), at around 0.30%.

The law allows for Euribor rates, currently in the negative across all terms, should be reflected in contracts, even after the cancelled spread, which implies a capital payout.

Typical that the banks would try to evade their obligations and notable that the Bank of Portugal could not look beyond “The Precious”

UK

When the credit crunch hit the UK saw a brief burst of negative mortgage rates. This was caused by the market being very competitive and mortgages being offered below Bank Rate and so much so that when it plunged to 0.5% some went negative. The most famous was Cheltenham and Gloucester and I forget now if it went to -0.02% or -0.04%.

This had wider consequences than you might think as banking systems were unable to cope and repaid capital rather than recording a negative monthly repayment. That was echoed more recently in the saga in Portugal above. A consequence of this was that the Bank of England went white faced with terror muttering “The Precious! The Precious!” and did not cut below an interest-rate of 0.5%. This was the rationale behind Governor Carney;s later statements that the “lower bound” was 0.5% in the UK.

If you are wondering how he later cut to 0.25% please do not forget that the banks received an around £126 billion sweetener called the Term Funding Scheme.

Comment

So we have seen that there are negative mortgage rates to be found and that we can as a strategy expect more of them. After all it was only yesterday we saw 3 central banks cut interest-rates and I expect plenty of others to follow. A reduction in the ECB Deposit Rate (-0.4%) will put pressure on the Danish CD rate ( -0.65%) and the band will strike up again.

In terms of tactics though maybe things will ebb away for a bit as this from Pimco highlights.

It is no longer absurd to think that the nominal yield on U.S. Treasury securities could go negative……..What was once viewed as a short-term aberration – that creditors are paying debtors for taking their money – has already become commonplace in developed markets outside of the U.S. Whenever the world economy next goes into hibernation, U.S. Treasuries – which many investors view as the ultimate “safe haven” apart from gold – may be no exception to the negative yield phenomenon. And if trade tensions keep escalating, bond markets may move in that direction faster than many investors think.

The first thought is, what took you so long? After all we have been there for years now. But you see Pimco has developed quite a track record. It described UK Gilts as being “on a bed of nitro-glycerine” which was followed by one of the strongest bull markets in history. Also what happened to US bond yields surging to 4%?

Maybe they are operating the “Muppet” strategy so beloved of Goldman Sachs which is to say such things so they can trade in the opposite direction with those who listen.

As to the question posed in my headline it is indeed one version of our future and the one we are currently on course for.

 

 

 

The Reserve Banks of India and New Zealand press the panic button

This morning brings to mind the famous poem from Rudyard Kipling.

Oh, East is East, and West is West, and never the twain shall meet,
Till Earth and Sky stand presently at God’s great Judgment seat;
But there is neither East nor West, Border, nor Breed, nor Birth,
When two strong men stand face to face, though they come from the ends of the earth!

Whilst we in the west like to think we are still in charge of events the economic axis of the world is plainly shifting eastwards. This has today shifted towards central bank policy because the western ones have fired so much of their ammunition and now find that events are running ahead of them. Whereas if we head east we see a barrage of action.

India

Regular readers will know I have been following closely the moves of the Reserve Bank of India this year. Indeed those who follow me will know I challenged Bloomberg a couple of months ago when (breathtakingly) they put it as a central bank unlikely to cut interest-rates. Whereas here is this morning’s RBI statement.

On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting today decided to:

  • reduce the policy repo rate under the liquidity adjustment facility (LAF) by 35 basis points (bps) from 5.75 per cent to 5.40 per cent with immediate effect.
  • The MPC also decided to maintain the accommodative stance of monetary policy.

There are various issues here beyond this being yet another RBI interest-rate cut which is the fourth this year. Then we note that it was of 0.35%! How on earth did they get to that? Some plainly wanted 0.5% but could not get it and compromised. Thus we are very near to one of the central bank group think insanities of our time which is that a 0.1% change in interest-rates is significant, as they have plainly added 0.1% to the usual 0.25%. Then as we have followed this we see that the vote for easing was unanimous ( albeit with disagreement over the size of the cut), which is a change. In the previous moves we have seen dissent to the interest-rate cuts whereas now not only is this latest cut voted for we get a hint of more from “maintain the accommodative stance.”

We have to wait to the bottom of the statement to get to an explanation of the reasoning.

The MPC notes that inflation is currently projected to remain within the target over a 12-month ahead horizon. Since the last policy, domestic economic activity continues to be weak, with the global slowdown and escalating trade tensions posing downside risks. Private consumption, the mainstay of aggregate demand, and investment activity remain sluggish.

I think they mean policy meeting. But as we mull this we note that it seems to come from an alternative reality to their GDP forecasts. Also if you are poor you are likely to be rather less keen on an inflation rise as this is happening.

 First, the uptick in food inflation may be sustained by price pressures in vegetables and pulses as more recent data suggest.

New Zealand

Even earlier today the Reserve Bank of New Zealand advanced with all the aggression of an All Black number 8.

The Official Cash Rate (OCR) is reduced to 1.0 percent. The Monetary Policy Committee agreed that a lower OCR is necessary to continue to meet its employment and inflation objectives.

In itself a 1% interest-rate is no shock but the size of the move moves me towards my whiff of panic headline so let me give their explanation from the RBNZ.

The members debated the relative benefits of reducing the OCR by 25 basis points and communicating an easing bias, versus reducing the OCR by 50 basis points now. The Committee noted both options were consistent with the forward path in the projections. The Committee reached a consensus to cut the OCR by 50 basis points to 1.0 percent. They agreed that the larger initial monetary stimulus would best ensure the Committee continues to meet its inflation and employment objectives.

How could both options be consistent with the forward path? After all they then call it a “larger monetary stimulus” in a clear contradiction.

We do see something familiar as there is a section which is the sort of thing that used to be used as an explanation for interest-rate rises.

Employment is around its maximum sustainable level…….Recent data recording improved employment and wage growth is welcome.

In fact things can only get better.

In New Zealand, low interest rates and increased government spending will support a pick-up in demand over the coming year. Business investment is expected to rise given low interest rates and some ongoing capacity constraints.

This is all a little curious as we see that they are plainly afraid of something. Perhaps it is house price falls.

The outlook for household spending was discussed with regard to the assumed dampening impact of soft house price inflation. Some members noted lower mortgage rates could contribute to a stronger pick-up in house price inflation,

You may note that “some members” are pretty explicitly calling for more house price inflation.

What central bankers never seem to acknowledge is their role in the formation of this.

The Committee noted that low business confidence had dampened business investment in 2018 and had remained weak in mid-2019.

What I mean is the psychological impact of low and indeed ever lower interest-rates on confidence. As we discuss so often the credit crunch changed economic reality and like generals central banks are open to the criticism that they are fighting the last war rather than the current one. An example is below.

The members noted that estimates of the neutral level of interest rates have continued to decline and this was consistent with generally lower interest rates over time.

I find the Kiwi move particularly significant as it is geographically about as isolated as you can get and yet it cannot escape the black hole sucking us all lower. For example like so many central banks it is worried that it is losing what influence it had.

The Committee agreed to continue to monitor and assess the impacts of monetary policy, including the transmission through to retail interest rates.

Bank of Thailand

And there there were three as the Bank of Thailand had the genesis of an idea.

I will follow you will you follow me

Although this time not everyone was onboard.

The Committee voted 5 to 2 to cut the policy rate by 0.25 percentage point from 1.75 to 1.50 percent, effective immediately. Two members voted to maintain the policy rate at 1.75 percent.

The driver here is the slow down in trade in the Pacific which we looked at last week.

In deliberating their policy decision, the Committee assessed that the Thai economy would expand at a lower rate than previously assessed due to a contraction in merchandise exports, which started to affect domestic demand.

Also it was only Monday I pointed out that nobody wants a strong currency these days.

With regard to exchange rates, the Committee expressed
concerns over the baht appreciation against trading partner currencies, which might affect the
economy to a larger degree amid intensifying trade tensions.

Comment

We have found that just like water interest-rates head downhill these days. There have been somewhere around 750 interest-rate cuts and of course we expect more. The three today will be followed by others as we note that the balance has shifted eastwards. This is for two main reasons. The trade slow down is hitting the Pacific region harder than elsewhere and because they can. Mostly they have higher interest-rates ( for now anyway) so there is some scope to cut.

Of course if the interest-rate cuts were really a game changer then we would not be where we are would we?

The Investing Channel