Is a reversal of the carry trade behind the rise of the US Dollar?

This morning brings us back to what has been a regular topic in 2018 which has been the US Dollar. Let’s look at it from the perspective of the sub-continent.

The rupee weakened further and dipped by 54 paise to 73.04 against the US dollar Monday, owing to increased demand for the American currency from importers amid increasing global crude oil prices.

International benchmark Brent crude was trading higher by 2.04 per cent at USD 71.61 per barrel.

Forex traders said besides increased demand for the US currency from importers, the dollar’s strength against some currencies overseas weighed on the domestic unit.

From India’s point of view this is not as bad as it has been as twice the Rupee has fallen through 74 versus the US Dollar. However the overall trend has been down as we recall promises it would not go through 70 and the fact it is 11% or so lower than a year ago. The recent dip – until this weekend’s OPEC meeting – did not benefit the Rupee much in comparison.

For Pakistan things have been even worse as it own troubles have led it back into the arms of the International Monetary Fund ( IMF). The Pakistan Rupee is at 134.3 versus the US Dollar or 28% lower than a year ago.

The Euro

This morning the Euro has dipped to 1.125 and Bloomberg is on the case.

The euro fell to its weakest in more than 16 months on Monday as traders fret political risks from Italy to Brexit.

Actually Bloomberg mostly ignores the Euro and concentrates on Brexit which of course is an influence but far from the only one. The weaker phase for the Euro area economy where quarterly economic growth has fallen from 0.7% to 0.2% does not merit a mention. Nor does the expansionary monetary policy of the ECB with its negative interest-rate and ongoing QE which still has a couple of months to run in monthly flow terms. On the other side of the coin is the ongoing trade surplus which supports the Euro but not so much today.

President Macron of France made a suggestion on this front on CNN over the weekend.From Politico.

Macron also talked in the interview about the need to strength the euro’s position as a global reference currency — not as a challenge to the U.S. dollar but as an alternative for purposes of stability.

I guess it and the Chinese Yuan will have to compete but I am not sure how several reference currencies would work? The Euro is of course very widely traded but still a long way behind the US Dollar.

Returning to economic policy this will give both Euro area inflation and the economy a boost. With inflation already around its target the ECB will not welcome the former but will the latter as economic growth has faded. Should it be out of play for a while in terms of monetary policy then the Euro area would have to deal with any further slow down with fiscal policy. That would be awkward after spending so much time telling Italy that it does not work.

The Dollar Index

If we broaden our view and look at an index of which President Macron would approve ( because of the high Euro weighting) we see that the Dollar Index has hit a 2018 high of just above 97.5 this morning. Whilst that is not up an enormous amount on a year ago ( less than 3%) there has been quite a push since it fell below 89 at the opening of the year.

The move has technical analysts in a spin as some see this as the start of a big move higher and others see this as an inflexion point. This proves that it is not only economists who can tell you that a market may go up or down!

US Monetary Policy

Economics 101 will be pleased that at least some of it can be brought out into the sun as the so-called normalisation of US monetary policy leads to a higher dollar. We seem set for another interest-rate increase next month as well as 2/3 more in 2019 meaning US interest-rates look set for the 3 handle.

Also there is a quantity issue as US Dollars are being withdrawn via the advent of Quantitative Tightening or QT. That is happening at the rate of 50 billion dollars a month which is a large sum in spite of the fact that these times have made us somewhat numb about such matters.

Comment

The media seem keen to find reasons for this burst of US Dollar strength which have nothing to do with the US itself. Personally I think the US holiday may be a factor in today’s move but as well as the change in monetary policy stance something else has been at play in 2018. This is the apparent shortage of US Dollars which back on the 18th of May was affecting relative interest-rates.

The problem is a spike in the differential between LIBOR and the Overnight Index Swap, or the premium over the risk-free rate non-US banks pay to borrow dollars outside of the US.

The spread has risen to 42 basis points, the highest since February 2012, and up from 25 basis points at the start of last month and just 10 basis points in November.

While the rise does not pose a systemic risk, it has nevertheless raised the cost, and reduced the availability, of dollar-denominated loans for non-US banks by a considerable margin and in short space of time. ( Bank Pictet).

That improved but has returned to some extent ( 30 earlier this month) and of course in the meantime US interest-rates are higher. On September 25th we looked at the way a new carry trade had developed but apparently stopped.

 The overall amount of dollar credit to the non-bank sector outside the United States has climbed from 9.5% of global GDP at end-2007 to 14% in the first quarter of 2018. Since end-2016, however, the growth in dollar credit has been flat.

What if that reverses? We know from what happened with the Swiss Franc and Japanese Yen that reversals of international carry trades can have powerful effects. At this time of year there is also usually demand for US Dollars for the end of the year. Although frankly if you are thinking of it now you are likely to be too late. For now at least it is time for 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

As the US observes Veterans Day let me give a plug to They Shall Not Grow Old which was on BBC 2 last night and was quite something.

 

 

 

 

 

 

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The problems of student debt and loans are mounting

The UK university system is facing trouble on more than a few fronts. Some are struggling full stop as we note talk that they will not be bailed out. That comes on top of the issue of student loans and debt which makes me wonder how useful a degree is these days? Especially at a time of struggling real wages.  Although wages for some do not seem to be a problem. From UK Parliament in June of this year.

A table of vice-chancellors’ salaries in the Times Higher Education in June 2017 showed that Dame Glynis Breakwell, the vice-chancellor of the University of Bath was the highest paid university vice-chancellor in the UK; in 2016-17 she was paid a salary of £451,000. The table showed that vice-chancellors at six other universities also earned over £400,000 in that year.

Average pay was found to be £290,000 including pension contributions. You may recall that the University Superannuation Scheme became a hot topic for a while as there were strikes after suggestions that defined benefits needed to end. That was eventually resolved with higher contributions ( but not as high as originally suggested). Previously the total was 26% of salary split 18% employer and 8% employee.

The panel recommended that DB pensions could continue to be offered with contributions rising to 29 per cent — significantly lower than the 36.6 per cent from April 2020 proposed by USS, based on the valuation as it stands. ( Financial Times)

As an aside it was a shame that the Bank of England was not contacted as its research could be used to show that in fact such pensions have benefited from its policies. In spite of course of that fact that its Chief Economist Andy Haldane confessed to not understanding them. Oh well!

Moving on, payoffs to Vice-Chancellors had become an issue such as the £429,000 payoff at Bath Spa, £230,000 at the University of Sussex, and £186,876 at Birmingham City University. Coming back to pay the HM Parliament research showed that Vice-Chancellor pay had risen at an annual rate of 3.2% when other academic staff were restricted to 0.7%.

Student Debt

A glimpse of a potential future can be seen in the United States. Last night the US Federal Reserve updated us on total student debt at the end of the third quarter and it was US $1.563 trillion. One perspective is provided by the number below it for total motor loans which is a relatively mere £1.142.8 trillion. In terms of past comparisons the number for 2013 was £1.145.6 trillion for US student loans.

Noah Opinion on Bloomberg looked at it like this.

Many educated millennials would likely agree — since 2006, student debt has approximately doubled as a share of the economy……..The increase seems to have paused in the past two years, possibly due to the economic recovery (which allows students and their families to pay more tuition out of current income) and a modest  decline in college enrollment. But the burden is still very large, and interest rates on student-loan debt are fairly high.

His chart shows student debt being around 7.5% of US Gross Domestic Product and I can update his view because unless the US economy is growing at an annual rate of 5.6% then the burden is rising again.

Also the repayment issue is similar to that we have and indeed are experiencing in the UK.

Education researcher Erin Dunlop Velez crunched data that was recently released by the Department of Education, and found that only half of students who went to college in 1995-6 had paid off their loans within 20 years. Given the vast increase in the size of loans since then, repayment rates are likely to be even worse if nothing is done. Velez also found that default rates are considerably higher than had been thought.

There is another familiar feature.

What’s more, student lending has almost certainly contributed to the rise in college tuition, which has outpaced overall inflation by a lot. When the government lends students money, or encourages private lenders to do the same, it increases demand for college, pushing up the price.

In the  UK a lot of the inflation came in one go.

In the 2012/13 academic year, students beginning their studies could be charged up to a maximum fee of £9000 for first year courses compared with a maximum of £3375 in
2011/12 ( Office for National Statistics).

Whilst the weighting for university fees is low the substantial rise had an impact on the overall numbers.

In total, university tuition fees for UK and EU students added 0.31 percentage points to the change in CPI
inflation between September and October 2012. This was the largest component of the rise in the headline rate from 2.2 to 2.7%.

The CPI measure was particularly affected as it includes international and European Union students whereas the RPI only has UK ones meaning that the weight is around three times higher. That becomes quite an irony as we note the invariably higher ( ~ 1% per annum) RPI is used in the interest-rate on student loans. The road from being “not a national statistic” to being useful is short when it is something the public are paying or indeed Bank of England pensioners are receiving.

Comment

Let me start with some welcome good news. The Times Higher Education rankings show Oxford University at number one with Cambridge second and Imperial College ninth. My alma mater the LSE slide in at number 26. So we are getting something right as whilst it feels by hook or by crook our universities are highly regarded around the world. I think we do that a lot as we focus on issues ( the impact of the PPE degree course at Oxford on our political class) and maybe lose vision on the wider picture. Our institutions are often highly regarded around the world.

Also many more people are going to university as this from Gil Wyness at the LSE points out.

The UK has dramatically increased the supply of graduates over the last four decades. The proportion of workers with higher education has risen from only 4.7% in 1979 to 28.5% in 2011 (Machin, 2014). Rather than this enormous increase in supply reducing the value of a degree, the pay of graduates relative to non-graduates has risen over the same period: from 39% to 56% for men and from 52% to 59% for women).

However the issue of pay is a complex one as of course overall pay growth has slowed which if the workforce has become better qualified looks even worse. Also there is this which needs some revision I would suggest.

The expansion of universities helped raise growth and productivity (Besley and Van Reenen,
2013),

The financing side is much more shambolic though. The upside of the student loans era was supposed to make universities compete more, does anyone believe that now? Next comes the issue that a high interest-rate (6.3%) is used to raise the debt calculated like this by HM Parliament.

Currently more than £16 billion is loaned to around one million higher education students in England each year. The value of outstanding loans at the end of March 2018
reached £105 billion. The Government forecasts the value of outstanding loans to be reach around £450 billion (2017-18 prices) by the middle of this century.

No wonder the Bank of England dropped consumer loans from its credit figures! But more fundamentally debt is supposed to be repaid and yet we know most of this never will be. Yet along the way it will affect those who have it should they look to buy a house or have other borrowing.

The average debt among the first major cohort of post-2012 students to become liable for repayment was £32,000. The Government expects that 30% of current full-time undergraduates who take out loans will repay them in full.

The anthem for this comes from Twenty One Pilots.

Wish we could turn back time, to the good old days
When our momma sang us to sleep but now we’re stressed out
Wish we could turn back time, to the good old days
When our momma sang us to sleep but now we’re stressed out

 

 

 

 

Higher bond yields and higher inflation mean higher national debt costs

The last week or so has brought a theme of this blog back to life and reminds me of the many years I spent working in bond markets. They have spent much of the credit crunch era being an economic version of the dog that did not bark. Much of that has been due to the enormous scale of the QE ( Quantitative Easing) sovereign bond buying policies of many of the major central banks. The politicians who came up with the idea of making central banks independent and then staffing them with people who were anything but should be warmly toasted by their successors. The successors would never have got away with a policy which has benefited them enormously in terms of ability to spend because of lower debt costs.

Italy

However the times are now a-changing and this morning has brought more bad news on this front from Italy. The BTP bond future for December has fallen to 120 which means it has lost a bit over 7 points over the last ten or eleven days. Putting that into yield terms it means that the ten-year yield has reached 3.5% which has a degree of symbolism. A factor in this is described by the Financial Times.

The commission issued its warning to the Five Star and League governing coalition after Rome deviated from the EU’s fiscal rules by proposing a budget deficit equivalent to 2.4 per cent of gross domestic product instead of the 1.6 per cent previously mooted by the finance minister Giovanni Tria. Although the new plans keep Italy under the EU’s 3 per cent deficit threshold, the country’s high debt levels — the highest in the eurozone after Greece — means Rome is required to cut spending to bring debt levels gradually lower.

However the chart below tells us that in fact you can look at it from another point of view entirely.

Actually I think that the situation is more pronounced than that as the ECB has bought 356 billion Euros worth. But you get the idea. It is hard not to think that a major factor in the recent falls is the halving of ECB QE purchases since the beginning of this month and to worry about their end in the New Year. In case you were wondering why the share prices of Italian banks have been tumbling again recently? The fact they have been buying in size in 2018 when one of the trades of 2018 has been to sell Italian bonds gives quite a clue.

If we switch to the consequences for debt costs then a rough rule of thumb is to multiply the 3.5% by the national debt to GDP ratio of 1.33 which gives us 4.65%. In practice this takes time as there is a large stock of debt and the impact from new debt takes time. For example Italy issued 2 billion Euros of its ten-year on the 28th of last month at 2.9%. So a fair bit less than now although much more expensive that it had got used too. This below from the Italian Treasury forecasts gives an idea of how the higher yields impact over time.

The redemptions in 2018 are approximately €184 billion (excluding BOTs) including approximately
€3 billion in relation to the international programme……..the average life of the stock of
government securities, which was 6.9 years at the end of 2017.

Oh and the tipping point below has been reached. From the Wall Street Journal.

Harvinder Sian, a bond strategist at Citigroup, thinks a 10-year yield of 3.5%-4% is now the tipping point, after which yields jump toward the 7% reached at the height of the last euro crisis

Personally I am not so sure about tipping point as the “gentlemen of the spread” ( with apologies to female bond traders) have been selling it at quite a rate anyway.

 

The United States

Here bond yields have been rising recently and let us take the advice of President Trump and look at what has happened during his term of office. Whilst back then Newsweek was busy congratulating Madame President Hilary Clinton my attention was elsewhere.

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%.

We see that it has risen in the Trump era to 3.4% although maybe not by as much as might have been expected. However if we look to shorter maturities we see a much stronger impact.For example the two-year now yields some 2.9% and the five-year some 3.07%. So if you read about flat yield curves this is what is meant although it is not (yet) literally true as there is a 0.5% difference. Thus the US now faces a yield of circa 3% or so looking ahead. This does have an impact as the New York Times has pointed out.

The federal government could soon pay more in interest on its debt than it spends on the military, Medicaid or children’s programs.

In terms of numbers this is what they think.

Within a decade, more than $900 billion in interest payments will be due annually, easily outpacing spending on myriad other programs. Already the fastest-growing major government expense, the cost of interest is on track to hit $390 billion next year, nearly 50 percent more than in 2017, according to the Congressional Budget Office.

If we switch to the Congressional Budget Office it breaks down some of the influences at play here.From its September report.

Outlays for net interest on the public debt increased by $62 billion (or 20 percent), partly because of a higher rate of inflation.

The CBO points out a factor the New York Times missed which is that countries with index-linked debt are also hit by higher inflation. As the US has some US $1.38 trillion of these it is a considerable factor.

Also the US is borrowing more.

The federal budget deficit was $782 billion in fiscal year 2018, the Congressional Budget Office estimates,
$116 billion more than the shortfall recorded in fiscal year 2017………The 2018 deficit equaled an estimated 3.9 percent of gross domestic product (GDP), up from 3.5 percent in
2017. (If not for the timing shifts, the 2018 deficit would have equaled 4.1 percent of GDP.)

Higher bond yields combined with higher fiscal deficits mean more worries about this factor.

At 78 percent of gross domestic product (GDP), federal
debt held by the public is now at its highest level since
shortly after World War II. If current laws generally
remained unchanged, the Congressional Budget Office
projects, growing budget deficits would boost that
debt sharply over the next 30 years; it would approach
100 percent of GDP by the end of the next decade and
152 percent by 2048 . That amount would
be the highest in the nation’s history by far.

I counsel a lot of caution with this as 2048 will have all sorts of things we cannot think of right now. But the debt is heading higher in the period we can reasonably project and I note the CBO is omitting the debt held by the US Federal Reserve so that QE would make the figures look better but the current QT makes it look worse.

Comment

Debt costs and the associated concept of the mythical bond vigilantes have been in a QE driven hibernation but they seem to be showing signs of waking up. If we look at today’s two examples we see different roads to the destination. If we look at the road to Rome we see that the longer-term factor has been the lost decades involving a lack of economic growth. This has made it vulnerable to rising bond yields and which means that the straw currently breaking the camel’s back has been what is a very small fiscal shift. It is also a case of bad timing as it has taken place as the ECB departs the bond purchases scene.

The US is different in that it has a much better economic growth trajectory but has a President who has also primed the fiscal pumps. Should it grow strongly then the Donald will win “bigly” as he will no doubt let us know. However should economic growth weaken or the long overdue recession appear then the debt metrics will slip away quite quickly. That is a road to QE4.

Returning back home I note that UK Gilt yields are higher with the ten-year passing 1.7% last week for the first time for a few years.So the collar is a little tighter.The main impact on the UK came from the rise in inflation in 2017 leading to higher index-linked debt costs. This was the main factor in our annual debt costs rising by around £10 billion between 2015/16 and 2017/18.

 

 

 

 

Will real wage growth ever go back to “normal”?

A constant theme of the credit crunch era is the unwillingness of the establishment to accept that past economic theories need to be put as a minimum on the back burner. Two examples of that are the concepts of full employment and the related one of the output gap. If we start with the former that does not mean that everyone is employed as the “man from Mars” from Blondie’s song rapture might think. It involves allowing for what is not entirely pleasantly called frictional unemployment, for example of individuals temporarily between jobs. There is an obvious problem with measuring that but as we discover so often the Ivory Towers are seldom troubled by issues like that.

The output gap was something of a simple concept around comparing actual output with potential. However supporters were invariably in the group who argued there was a large amount of lost output from the credit crunch and this end gamed themselves as we are still well below that and may always be. The Bank of England Ivory Tower dropped that and instead kept telling us we had an output gap of circa 1.25% of GDP. In the end they decided to drop as it was always 1.25% or so and switched to employment as a measure. Why? Well in the UK like more than a few other places it boomed so they could shoehorn their theory into a different version of reality. Sadly for them they have made fools of themselves as their estimates began at 7% unemployment went very quickly to 6,5% and are now at 4.25%. Or if you prefer silly,sillier and so far at least silliest.

Reality

The problem for all of the above has been shown in Nihon or the land of the rising sun. There the unemployment rate has fallen as low as 2.2% this year and in August was 2.4% How can it be half the natural/full rate? Please address that question to Threadneedle Street. Whilst there are suspicions about the accuracy of unemployment rates there are also other signals of what in the past would have been called an overheating jobs market. From the Japan Times last week.

The percentage of working-age women with jobs in Japan reached a record high of 70 percent in August, government data showed Friday………The figure for women in work between ages 15 and 64 is at the highest level since comparable data became available in 1968 and compares with 83.9 percent for working-age men,

Other measures such as the job offers to applicant ratio going comfortably above 2 signal a very strong labour market and yet this morning we have seen this. From Reuters.

 Japanese workers’ inflation-adjusted real wages fell in August for the first time in four months……..The 0.6 percent decline in real wages in August from a year earlier followed a revised 0.5 percent annual increase in July, labor ministry data showed on Friday.

This is a rather awkward reality for those who have trumpeted a change in Japan in line with the two economic theories described above, and I note a lack of mentions on social media. If we look into the detail we see this.

Nominal cash earnings rose 0.9 percent year-on-year in August, slower than a revised 1.6 percent annual increase in July.

The average level of monthly earnings is 276,266 Yen or a bit under £1900. The highest paid industry was the utility sector at 438,025 Yen and the worst-paid was the hotel and restaurant sector at 123,405 Yen. The fall can be looked at  from two perspectives of which the first is a fall in bonuses of 7.4% and the next is that the numbers were pulled down by falls in the care sector (3.8%) and education (3.6%).

As to the surge ( real wages rose at an annual rate of 2.5% in June) it was as we believed.

Major Japanese firms typically pay bonuses twice a year, once during the summer and once near year’s end…….Summer bonuses boosted real wages in June.

This morning has also brought a confirmation of why this is good.

Japanese households increased their spending at the fastest rate in three years in August as consumers made more costly purchases, government data showed Friday.

Spending by households with two or more people rose 2.8 percent from a year earlier, after adjusting for inflation, to ¥292,481, the largest increase since August 2015, the Internal Affairs and Communications Ministry said. ( Japan Times)

But that will now rend to fade away after the welcome bonuses are spent. Sadly the output gap style theories are unlikely to fade away as reality is always “Tis but a scratch” along the lines of the Black Knight in Monty Python.

The UK

In the UK we keep being told that wage growth is just around the corner. From the REC this morning.

Starting salaries for people placed into permanent
jobs increased at the quickest pace since April 2015
during September. Hourly rates of pay for temp staff
also rose at a faster pace than in the preceding
month.

The strongest area was this.

IT & Computing remained the most in-demand
category for permanent staff in September.

Perhaps it is the banks finally waking up to the all the online outages and problems. But the problem is that a sustained rise keeps being just around the corner. In its desperation to justify its theories the Bank of England switched to private-sector regular pay in its attempt to find any reality fitting the work of its Ivory Tower. But if you pick a sub-section it has to eventually fire up the overall numbers to be significant and the picture there is that total wage growth has surged from 2.8% in January to 2.6% in July. Oh hang on…..

Or real wage growth is somewhere around 0% on the official inflation measures or negative on the “discredited” RPI which gives a higher reading.

The US

Today brings the labour market data for September but until then we are left with this.

In August, average hourly earnings for all employees on private nonfarm payrolls rose by 10 cents to $27.16. Over the year, average hourly earnings have increased by 77
cents, or 2.9 percent.

August was a good month but if we switch to the annual rate but we see that even in an economy that according to the GDP nowcasts is keeping up its 4% per annum growth rate wages are struggling to break 3%. The US economy has recovered better than most and is doing well now and yet wage growth has not followed much. Real wage growth is as you can see minimal.

Over the last 12 months, the all items
index rose 2.7 percent before seasonal adjustment.

According to the Financial Post it is a case of O Canada as well.

Over the three years he’s been in power, real wages have averaged annual gains of just 0.3 per cent, versus 1 per cent the previous decade.

Comment

A feature of the credit crunch era continues to be the attempt to ignore the more uncomfortable aspects of reality. There is welcome news in the way that employment levels recovered but the price of that seems to have been weak wage growth and especially real wage growth. This afternoon that number from the US Bureau of Labor Statistics will be poured over again for that reason. The big picture though comes from David Bowie.

Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
Where’s your shame?
You’ve left us up to our necks in it

 

What next from the war on cash?

This morning the BBC has posted an article on a subject I was mulling last Wednesday.  As I walked into an appointment for some treatment for my knee the person before me was paying for his appointment by using his phone and transferring the money directly. I by contrast had put some cash in my pocket so I could pay in that fashion. If we move on from me suddenly feeling rather stone age and he being much more cutting edge there was one work related issue on my mind. What does paying by phone do to the money supply? It reminds us that the money supply also includes the ability to borrow and whilst everyone obsesses about banks also reminds us that it can now come from other sources. Or perhaps I should correct that to their being more potential routes these days.

Paying by phone

Here is an example quoted by the BBC.

Nikki Hesford, 32, is a convert to person-to-person payment (P2P) apps, using PayPal to pay for services and Venmo to pay back friends.

“The only time in the last year I’ve drawn out cash is for the school fete cake stall and to pay my manicurist,” says Ms Hesford, who runs her own marketing support company for small businesses.

“If I go for a meal with friends I can’t be bothered messing about with two, three or four cards,” she says.

“One person will pay on a card and the others will transfer through an app. It takes seconds rather than minutes fussing around with who owes what.”

PayPal has been around for some time but the likes of Venmo seems a real change and I can see the attraction. Who has not been out to eat with a group and been in a situation where the money collected in is short but everyone claims to have paid? For all our thoughts that millennials and Generation Z have it tough they may have stolen a bit of a march on the rest of us here. Venmo will by its very nature record each transfer and provide a type of audit trail.

In terms of scale then the position is building.

Zelle, one of the most popular payment apps in the US backed by 150 banks, launched in June 2017, but has already processed more than 320 million transactions valued at $94bn (£72bn).

A recent report by Zion market research suggested that the global mobile-wallet market in general is expected to top $3bn by 2022, up from nearly $600m in 2016.

The argument in favour is that it is quick and convenient,

Rachna Ahlawat, co-founder of Ondot Systems, a payment services platform, perceives a marked change in consumer behaviour.

“We want transactions to happen in an instant and at the click of a button,” she says. “Consumers not only want to operate in real-time, but they are looking for technology that allows them to play a more active role in how they control their payments, and are finding new ways of managing their financial lives.”

Financial Crime

The official and establishment view is that cash is a curse and the high priest of such thoughts Kenneth Rogoff wants this.

Why not just get rid of paper currency?

His opening argument is that cash is a source of crime.

First, making it more difficult to engage in recurrent, large, and anonymous payments would likely have a significant
impact on discouraging tax evasion and crime; even a relatively modest impact could potentially justify getting rid of most paper currency.

Yet we discover that even the new white heat world of person to person payments has you guessed it found that the criminal fraternity are very inventive.

“Malware injections and reverse engineering attacks can be used by hackers to understand the app’s code and silently trick you, going undetected by the typical security measures.”  ( Pedro Fortuna from JScrambler )

The truth is that whatever financial area we move into we take the criminals with us and sometimes there are already there waiting for us to make a mistake.

“With the increasing number of apps all requiring some form of authentication, it’s all too tempting to reuse passwords across multiple services. This increases the risk of your data being hacked.”  ( Sam Devaney from CGI UK ).

The banks

There is a very inconvenient reality for the likes of Kenneth Rogoff which is that so much financial crime is to be found at the heart of the system “the precious”.

Banks in Denmark, the Netherlands, Latvia and Malta have all been linked to criminal inflows from countries including Russia and North Korea. The EU has moved to centralize banking supervision, but money laundering has remained a national responsibility.

At the moment the European Union seems to be the weakest link in this area although of course it is far from unique. As an example the situation at Danske bank was so bad it even found itself being trolled by Deutsche Bank which claimed it was only accepting one in ten of past Danske bank clients. According to the Wall Street Journal around US $150 billion of transactions are being investigated according to Reuters the bank itself is discovering large problems.

the Financial Times cited the bank’s own investigation as saying the Danish bank handled up to $30 billion of Russian and ex-Soviet money through non-resident accounts via its Estonian branch in 2013 alone.

The European Union seems to be particularly in the firing zone in this area right now and much of it seems centred in the Baltic nations. That reminds me that back on the 19th of February I looked at the issues facing ABLV in Latvia which developed into a situation where the central bank Governor Ilmārs Rimšēvičs has been charged with taking a bribe.

Whilst the European Union is presently in the firing line we know that banking scandals of this sort occur regularly in most places. Yet the establishment ignore the way that the banks are the major source of financial crime in their rush to implicate cash.

Some new notes

A sign that there is indeed counterfeiting happen was provided yesterday by the European Central Bank or ECB although it chose to present it another way.

New €100 and €200 banknotes unveiled!

Sadly the excitement captured only a couple of journalists attention but the press release did hint at “trouble,trouble,trouble.”

The new €100 and €200 banknotes make use of new and innovative security features.

I think we know why! But there was another sign.

In addition to the security features that can be seen with the naked eye, euro banknotes also contain machine-readable security features. On the new €100 and €200 banknotes these features have been enhanced, and new ones have been added to enable the notes to be processed and authenticated swiftly.

It makes me wonder how many counterfeit ones are in existence. This seems likely to get Kenneth Rogoff to add those note to the 500 Euro ones he wants banned.

Comment

This is a situation which has a paradox within it. We see that technology is providing plenty of ways which provide alternatives to cash and in spite of presenting myself as something of a cash luddite earlier I find them convenient too. Yet we want more cash in the UK the £40 billion mark was passed in 2008 and now we have according to the Bank of England.

There are over 3.6 billion Bank of England notes in circulation worth about 70 billion pounds.

We are far from alone as for example in 2017 the growth rate was 7% for the US and Canada and 4% for the Euro area and Japan. Yet the Bank of England confirms that the medium of exchange case has indeed weakened over time.

Cash accounted for 40% of all payments in 2016, compared to 62% in 2006

The Bank will have something of an itchy collar as it notes that the increased demand for cash will be as a store of value and the rise accompanies its era of QE and low interest-rates. Kenneth Rogoff is much more transparent though.

Although in principle, phasing out cash and invoking negative interest rates are topics that can be studied separately, in reality the two issues are deeply linked. To be precise, it is virtually impossible to think about drastically phasing out currency without recognizing that it opens a door to unrestricted negative rates that central
banks may someday be tempted to walk through.

As Turkish points out in the film Snatch “Who da thunk it?”

 

 

Where next for US monetary policy?

So much of the economic news in 2018 has related to developments in the US economy. In particular monetary policy as the world has found itself adjusting to what is called these days a “normalisation” of policy in the United States. To my mind that poses the immediate question of what is normal now? I am sure we can all agree that monetary policy has been abnormal over the past decade or so but along that path it has also begun to feel normal. People up to the age of ten will know no different and if we allow some time to be a child maybe even those at university regard what we have now as normal. After all they will have grown up in a world of low and then negative interest-rates. The media mostly copy and paste the official pronouncements that tell us it has been good for us and “saved” the economy.

I am thinking this because the US Federal Reserve last night gave a hint that it thinks something else may be the new normal.

The staff provided a briefing that summarized its analysis
of the extent to which some of the Committee’s monetary
policy tools could provide adequate policy accommodation
if, in future economic downturns, the policy
rate were again to become constrained by the effective
lower bound (ELB)

This begs various questions of which the first is simply as we have just been through the biggest trial ever of such policies surely they know them as well as they ever will? Next comes another troubling thought which is the rather odd theory that you need to raise interest-rates now so that you have room to cut them later. This is something which is not far off bizarre but seems to be believed by some. Personally I think you should raise interest-rates when you think there are good reasons for doing so as otherwise you are emulating the Grand Old Duke of York. Also there are costs to moving interest-rates so if you put them up to bring them down you have made things worse not better.

You may also note that the Zero Lower Bound or ZLB  has become the ELB with Effective replacing zero. Is there a hint here that the US would be prepared to move to negative interest-rates next time around? After all we exist in a world where in spite of the recorded recovery we still have negative interest-rates in parts of Europe and in Japan. Indeed the -0.4% deposit rate at the ECB has survived what the media have called the “Euroboom”.

Effective Lower Bound

There are some odd statements to note about all of this. For example.

Accordingly,in their view, spells at the ELB could become
more frequent and protracted than in the past, consistent
with the staff’s analysis.

Seeing as we have been there precisely once what does “more frequent” actually mean? Also considering how long we were there the concept of it being even more protracted is not a little chilling if we consider what that implies. Also this next bit is not a little breathtaking when we consider the scale of the application of the policy “toolkit”

They also emphasized that there was considerable uncertainty about the economic effects of these tools. Consistent with that view, a few participants noted that economic researchers had not yet reached a consensus about the effectiveness of unconventional policies.

I do not know about you but perhaps they might have given that a bit more thought before they expanded the Federal Reserve balance sheet to above 4 trillion dollars! As to possible consequences let me link two different parts of their analysis which would give me sleepless nights if I had implemented such policies.

A number of participants indicated that there might be significant costs associated with the use of unconventional policies……….. That decline was viewed as likely driven by various factors, including slower trend growth of the labor force and productivity as well as increased demand for safe assets.

Policy Now

This is the state of play for interest-rates.

The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity,

How far? Well Robert Kaplan of the Dallas Fed gave a road map on Tuesday.

With the current fed funds rate at 1.75 to 2 percent, it would take approximately three or four more federal funds rate increases of a quarter of a percent to get into the range of this estimated neutral level.

At this stage, I believe the Federal Reserve should be gradually raising the fed funds rate until we reach this neutral level.

So circa 2.5% is the target and that seems to have been accepted by the bond market as we see the ten-year Treasury Note yield at 2.82% and the thirty-year Treasury Bond yield at 2.98%. When you read about the “yield curve” and in particular reports of it being flattish this is what they mean as we have a difference of a bit over 1% between the official interest-rate and the thirty-year bond.

There has been a lot of discussion about what this means but to my mind it simply means that the bond market has figured out where the US Federal Reserve intends to send interest-rates and has set prices in response. It will have noted the problems abroad that the interest-rate rises have contributed too and the discussions about possible future cuts and adjusted yields downwards. Whether that turns out to be right or wrong is a matter of opinion but to my mind whilst we have QT now ( the Federal Reserve balance sheet is being shrunk albeit relatively slowly) regular readers will be aware I think there are scenarios where interest-rates go up and the QE purchases begin again. Some such thoughts were perhaps on the mind of Robert Kaplan on Tuesday.

Despite the fact that the current economic expansion is the second longest in the postwar period, U.S. government debt held by the public now stands at 75.8 percent of GDP, and the present value of unfunded entitlements is estimated at approximately $54 trillion. The recent tax legislation and bipartisan budget compromise legislation are likely to exacerbate these issues. As a consequence of this level of debt, the U.S. is much less likely to have the fiscal capacity to fight the next recession.

Notice the reference to US debt held by the public which of course omits the holdings by the Fed itself.

Comment

There is a fair bit to consider here and so far I have left out two factors. The first is the Donald who has expressed a dislike for interest-rate rises but so far on a much more minor scale than say President Erdogan in Turkey. Next is the issue of the Dollar which is two-fold as in its exchange-rate and how many of them there are to go around. As to the dollar exchange rate then stormy times for the US President seem to have capped it for the short-term. But as to quantity the era of QT seems unsurprisingly to have reduced the supply around the world and therefore contributed to troubles in places which relied on there being plenty of them.

This brings us to the Jackson Hole symposium which starts today where central bankers gather to discuss what to do next. For example back in 2012 Micheal Woodford gave a speech about Forward Guidance which has now become an accepted part of the “toolkit”. Central bankers seem to inhabit a world where it is not a laughing-stock and instead is avidly received and listened to by an expectant population. This time around the official story is of “normalisation” as even the unreliable boyfriend has raised interest-rates albeit only a nervous once. Also the Swedes are again promising to reduce their negativity although that has become something of a hardy perennial.

But in the backrooms I suspect the conversation will shift to “what do we do next time?” when the next recession hits and for the market aware that may be added to by the recent price behaviour of Dr,Copper. On such a road the normalisation debate may suddenly become an Outkast.

I’m sorry, Ms. Jackson, I am for real
Never meant to make your daughter cry
I apologize a trillion times

The economic impact of the King Dollar in the summer of 2018

One of the problems of currency analysis is the way that when you are in the melee it is hard to tell the short-term fluctuation from the longer-term trend. It gets worse should you run into a crisis as Argentina found earlier this year as it raised interest-rates to 40% and still found itself calling for help from the International Monetary Fund. The reality was that it found itself caught out by a change in trend as the US Dollar stopped falling and began to rally. If we switch to the DXY index we see that the 88.6 of the middle of February has been replaced by 95.38 as I type this. At first it mostly trod water but since the middle of April it has been on the up.

Why?

If we ask the same question as Carly Simon did some years back then a partial answer comes from this from the testimony of Federal Reserve Chair Jerome Powell yesterday.

Over the first half of 2018 the FOMC has continued to gradually reduce monetary policy accommodation. In other words, we have continued to dial back the extra boost that was needed to help the economy recover from the financial crisis and recession. Specifically, we raised the target range for the federal funds rate by 1/4 percentage point at both our March and June meetings, bringing the target to its current range of 1-3/4 to 2 percent.

So the heat is on and looks set to be turned up a notch or two further.

 the FOMC believes that–for now–the best way forward is to keep gradually raising the federal funds rate.

One nuance of this is the way that it has impacted at the shorter end of the US yield curve. For example the two-year Treasury Bond yield has more than doubled since early last September and is now 2.61%. This means two things. Firstly if we stay in the US it is approaching the ten-year Treasury Note yield which is 2.89%. If you read about a flat yield curve that is what is meant although not yet literally as the word relatively is invariably omitted. Also that there is now a very wide gap at this maturity with other nations with Japan at -0.13% and Germany at -0.64% for example.

At this point you may be wondering why two-year yields matter so much? I think that the financial media is still reflecting a consequence of the policies of the ECB which pushed things in that direction as the impact of the Securities Markets Programme for example and negative interest-rates.

QT

QT or quantitative tightening is also likely to be a factor in the renewed Dollar strength but it represents something unusual. What I mean by that is we lack any sort of benchmark here for a quantity rather than a price change. Also attempts in the past were invariably implicit rather than explicit as interest-rates were raised to get banks to lend less to reduce the supply of Dollars or more realistically reduce the rate of growth of the supply. Now we have an explicit reduction and it has shifted to narrow ( the central banks balance sheet) money from broad money.

 In addition, last October we started gradually reducing the Federal Reserve’s holdings of Treasury and mortgage-backed securities. That process has been running smoothly.  ( Jerome Powell).

You can’t always get what you want

It may also be true that you can’t get what you need either which brings us to my article from March the 22nd on the apparent shortage of US Dollars. This is an awkward one as of course market liquidity in the US Dollar is very high but it is not stretching things to say that it is not enough for this.

Non-US banks collectively hold $12.6 trillion of dollar-denominated assets – almost as much as US banks…….Dollar funding stress of non-US banks was at the center of the GFC. ( GFC= Global Financial Crisis). ( BIS)

The issue faded for a bit but seems to be on the rise again as the Libor-OIS spread dipped but more recently has risen to 0.52 according to Morgan Stanley. What measure you use is a moving target especially as the Federal Reserve shifts the way it operates in interest-rate markets but they kept these for a reason.

In October 2013, the Federal Reserve and these central banks announced that their liquidity swap arrangements would be converted to standing arrangements that will remain in place until further notice.

Impact on the US economy

The situation here was explained by Federal Reserve Vice-Chair Stanley Fischer back in November 2015.

To gauge the quantitative effects on exports, the thick blue line in figure 2 shows the response of U.S. real exports to a 10 percent dollar appreciation that is derived from a large econometric model of U.S. trade maintained by the Federal Reserve Board staff. Real exports fall about 3 percent after a year and more than 7 percent after three years.

Imports are affected but by less.

The low exchange rate pass-through helps account for the more modest estimated response of U.S. real imports to a 10 percent exchange rate appreciation shown by the thin red line in figure 2, which indicates that real imports rise only about 3-3/4 percent after three years.

And via both routes GDP

The staff’s model indicates that the direct effects on GDP through net exports are large, with GDP falling over 1-1/2 percent below baseline after three years.

The impact is slow to arrive meaning we are likely to be seeing the impact of a currency fall when it is rising and vice versa raising the danger of tripping over our own feet in analysis terms.

What happens to everyone else?

As the US Dollar remains the reserve currency if it rises everyone else will fall and so they will experience inflation in the price of commodities and oil. This is likely to have a recessionary effect via for example the impact on real wages especially as nominal wage growth seems to be even more sticky than it used to be.

Comment

Responses to the situation above will vary for example the Bank of Japan will no doubt be saying the equivalent of “Party on” as it will welcome the weakening of the Yen to around 113 to the US Dollar. The ECB is probably neutral as a weakening for the Euro offsets some of its past rise as it celebrates actually hitting its 2% inflation target which will send it off for its summer break in good spirits. The unreliable boyfriend at the Bank of England is however rather typically likely to be unsure. Whilst all Governors seem to morph into lower Pound mode of course it also means that people do not believe his interest-rate hints and promises. Meanwhile many emerging economies have been hit hard such as Argentina and Turkey.

In terms of headlines the UK Pound £ is generating some as it gyrates around US $1.30 which it dipped below earlier. In some ways it is remarkably stable as we observe all the political shenanigans. I think a human emotion is at play and foreign exchange markets have got bored with it all.

Another factor here is that events can happen before the reasons for them. What I mean by that was that the main US Dollar rise was in late 2014 which anticipated I think a shift in US monetary policy that of course was yet to come. As adjustments to that view have developed we have seen all sorts of phases and we need to remember it was only on January 25th we were noting this.

The recent peak was at just over 103 as 2016 ended so we have seen a fall of a bit under 14%

Back then the status quo was

Down down deeper and down

Whereas the summer song so far is from Aloe Blacc

I need a dollar, dollar
Dollar that’s what I need
Well I need a dollar, dollar
Dollar that’s what I need

Me on Core Finance