The shift towards lower rather than higher interest-rates is beginning again

Yesterday was another poor day for the Forward Guidance provided by central bankers as we note developments in the US and UK. There was a flurry of media activity around the statement from Bank of England Governor that the Chinese Yuan could challenge the US Dollar as the world’s reserve currency, but really he was saying that it is a very long way away. So let us start with the US Federal Reserve and look back to September for its Forward Guidance. From Reuters.

Fed policymakers did not jack up their expectations for rate hikes in coming years, as some analysts had thought, instead sticking closely to rate hike path forecasts outlined in June that envision short-term rates, now at 2.0 percent to 2.25 percent, to be at 3.1 percent by the end of next year.

This suggested a couple of rate hikes in 2019 and at the beginning of December Bill Conerly stepped up the pace in Forbes Magazine.

My forecast for interest rates remains higher than the Fed’s September 2018 forecast. I expect the Fed Funds rate to end 2019 at 3.9%, and to end 2020 at 4.5%.

Bill seemingly had not got the memo about a slowing word and hence US economy as he reflected views which in my opinion were several months out of date as well as being extreme for even then. But what we were seeing was a reining back of forecasts of interest-rate rises. Putting that in theoretical terms the so-called neutral rate of interest showed all the flexibility of the natural rate of unemployment in that it means whatever the central bankers want it to mean.

Last Night events took another turn with the publication of the US Federal Reserve Minutes from December.

With regard to the post meeting statement, members agreed to modify the phrase “the Committee expects that further gradual increases” to read “the Committee judges that some further gradual increases.” The use of the word “judges” in the revised phrase was intended to better convey the data-dependency of the Committee’s decisions regarding the future stance of policy; the reference to “some” further gradual increases was viewed as helping indicate that, based on current information, the Committee judged that a relatively limited amount of additional tightening likely would be appropriate.

As you can see they have chosen the words “judges” and “some” carefully and the prospect of interest-rate increases this year has gone from a peak of 4 with maybe more in 2020 to perhaps none. Or for fans of Carly Rae Jepson it has gone from ” I really,really,really,really” will increase interest-rates to “Call Me Maybe”

Why? Well some may mull the idea of there being a form of Jerome Powell put option for the stock market.

Against this backdrop, U.S. stock prices were down nearly 8 percent on the period.

Widening that out it also reflected an economic weakening which has mostly got worse since.

Forward Guidance

This is supposed to help the ordinary consumer and business(wo)man but letting them know what the central bank plans to do. But to my mind this is of no use at all if they keep getting it wrong as the US Federal Reserve just has. In fact in terms of fixed-rate mortgages and loans they have been given exactly the wrong advice. Whereas we had reflected the changing outlook as I quote from my opening post for this year.

The problem is their starting point and for that all eyes turn to the central banks who have driven them there. Get ready for the claims that “it could not possibly have been expected” and “Surprise!Surprise!”

I find myself debating this on social media with supporters of central bank policy who mostly but not always are central banking alumni. They manage to simultaneously claim that Forward Guidance is useful but it does not matter if it is wrong, which not even the best contortionist could match.

Bank of England

The memo saying “the times they are a-changing” had not reached Bank of England Governor Mark Carney as he posted on the Future Forum yesterday afternoon.

 That’s why the MPC expect that any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent.

He is still hammering away with his hints at higher interest-rates although he was also trying to claim that movements in interest-rates are nothing to do with him at all.

So in other words, low policy interest rates are not the caprice of central bankers, but rather the consequence of powerful global forces.

Makes you wonder why he and his 8 interest-rate setting colleagues are paid  some much if the main events are nothing to do with them doesn’t it? I somehow doubt that when a Bank of England footman handed a copy of Mark Carney’s Gilt-Edged CV to the World Bank that it was claiming that.

Governor Carney was in typical form in other ways too as he answered this question.

In your opinion, how likely is a large spike in Inflation in the near future?

For example in a lengthy answer he used the word inflation once but the word unemployment five times and did not mention inflation prospects/trends ( the question) at all! Better still the things which were apparently “the consequence of powerful global forces.” suddenly became due to his ilk.

Simulations using the Bank’s main forecasting model suggest that the Bank’s monetary policy measures raised the level of GDP by around 8% relative to trend and lowered unemployment by 4 percentage points at their peak. Without this action, real wages would have been 8% lower, or around £2,000 per worker per year, and 1.5 million more people would have been out of work.

As we note his slapping of his own back whilst blowing his own trumpet I zeroed in on the wage growth claim which appeared in another form much later.

Although it’s true that QE helped support asset prices, it also boosted job creation and wage growth.

There is a lot in that sentence but let us start with the wage growth issue. The reality is that real wage growth has been negative in the UK and worse than our economic peers. By propping up zombie banks and companies for example there are reasons to argue that the QE era has made things worse. But apparently in a stroke of magic it has made everything better! Now whilst correlation does not prove causation it is hard to argue you have made things better in a period where you have had a major impact and things have got worse.  Indeed  the more recent trend as the QE flow has slowed has been for wages to pick up.

Also there was the “helped support asset prices” point. This is welcome in its honesty but there have been times that the Bank of England ( in spite of its own research on the subject) has tried to deny this.

What about debt?

Back in 2016 Governor Carney told us.

This is not a debt-fuelled recovery.

Yesterday he changed his tune slightly.

 Recent growth in aggregate credit in the UK has been modest, growing a little faster than nominal GDP.

Notice the shift from real GDP to the invariably higher nominal GDP. Missing in action was any mention of unsecured credit which surged into double-digit annual growth in response to the Sledgehammer QE action of the Bank of England in the autumn of 2016 and is still growing at over 7%. Nor did the surge in student loans merit a mention unlike in this from Geoff Tily of the TUC last week.

Total unsecured debt has risen to £428 billion. At 30.4 per cent of household income, this is higher than before the financial crisis:

Comment

There is a fair bit to sweep up here but the main point is that we have developed bodies called independent that do the establishments bidding on a scale politicians themselves would never have got away with. Can you imagine politicians being able to buy trillions of their own debt?! Next we are told that they can help us with the future via Forward Guidance but that when it goes wrong it does not matter. The elastic of credibility just snapped.

In my own country the UK this was added to on LBC Radio where we were grandly told yesterday that someone who used to set UK interest-rates would be on air. When Ian McCafferty came on he seemed confused by the statement that the UK economy grew by 0.6% in the third quarter and sounded out of touch with events. For example in the early part of 2018 it was true that Germany and France were growing more quickly than the UK but as this morning has reminded us to say they are doing so now makes you look out of touch at best.

In November 2018, output slipped back sharply in the manufacturing industry (−1.4% after +1.4% in October) as well as in the whole industry (−1.3% after +1.3%). ( France-Insee ).

Perhaps he will offer a retraction like he had to do when he was on LBC last August. Meanwhile you know I often tell you never to believe anything until it is officially denied don’t you? From Governor Carney yesterday.

We have also made clear that we wouldn’t set negative interest rates – the Bank’s Monetary Policy Committee, which is responsible for setting Bank Rate, has said that the effective lower bound on Bank Rate is close to, but a little above, zero.

As a hint the lower bound was 0.5% until they cut to 0.25% ( and promised a cut to 0.1% in another Forward Guidance failure).

 

 

 

 

 

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What has the Yen flash rally of 2019 taught us?

Yesterday we took a look at the low-level of bond yields for this stage in the cycle and the US Treasury Note yield has fallen further since to 2.63%. Also I note that the 0.17% ten-year German bond yield is being described as being in interest-rate cut territory for Mario Draghi and the ECB. That raises a wry smile after all the media analysis of a rise. But it is a sign of something not being quite right in the financial system and it was joined last night by something else. It started relatively simply as people used “Holla Dolla” to describe US Dollar strength ( the opposite of how we entered 2018 if you recall) and I replied that there also seemed to be a “yen for Yen” too. So much so that I got ahead of the game.

What I was reflecting on at this point was the way that the Yen had strengthened since mid December from just under 114 to the US Dollar to the levels referred to in the tweet. For newer readers that matters on two counts. Firstly Japanese economic policy called Abenomics is geared towards driving the value of the Yen lower and an enormous amount of effort has been put into this, so a rally is domestically awkward. In a wider sweep it is also a sign of people looking for a safe haven – or more realistically foreign exchange traders front-running any perceived need for Mrs.Watanabe to repatriate her enormous investments/savings abroad  –  and usually accompanies falling equity markets.

The Flash Rally

I was much more on the ball than I realised as late last night this happened. From Reuters.

The Japanese yen soared in early Asian trading on Thursday as the break of key technical levels triggered massive stop-loss sales of the U.S. and Australian dollars in very thin markets. The dollar collapsed to as low as 105.25 yen on Reuters dealing JPY=D3, a drop of 3.2 percent from the opening 108.76 and the lowest reading since March 2018. It was last trading around 107.50 yen………..With risk aversion high, the safe-haven yen was propelled through major technical levels and triggered massive stop-loss flows from investors who have been short of the yen for months.

As you can see there was quite a surge in the Yen, or if you prefer a flash rally. If a big trade was happening which I will discuss later it was a clear case of bad timing as markets are thin at that time of day especially when Japan is in the middle of several bank holidays. But as it is in so many respects a control freak where was the Bank of Japan? I have reported many times on what it and the Japanese Ministry of Finance call “bold action” in this area but they appeared to be asleep at the wheel in this instance. Such a move was a clear case for the use of foreign exchange reserves due to the size and speed of the move,

There were also large moves against other currencies.

The Australian dollar tumbled to as low as 72.26 yen AUDJPY=D3 on Reuters dealing, a level not seen since late 2011, having started around 75.21. It was last changing hands at 73.72 yen.

The Aussie in turn sank against the U.S. dollar to as far as $0.6715 AUD=D3, the lowest since March 2009, having started around $0.6984. It was last trading at $0.6888.

Other currencies smashed against the yen included the euro, sterling and the Turkish lira.

There had been pressure on the Aussie Dollar and it broke lower against various currencies and we can bring in two routes to the likely cause. Yesterday we noted the latest manufacturing survey from China signalling more slowing and hence less demand for Australian resources which was followed by this. From CNBC.

 Apple lowered its Q1 guidance in a letter to investors from CEO Tim Cook Wednesday.

Apple stock was halted in after-hours trading just prior to the announcement, and shares were down about 7 percent when trading resumed 20 minutes later.

This particular letter from America was not as welcome as the message Tim Cook sent only a day before.

Wishing you a New Year full of moments that enrich your life and lift up those around you. “What counts is not the mere fact that we have lived. It is what difference we have made to the lives of others that will determine the significance of the life we lead.” — Nelson Mandela

So the economic slow down took a bite out of the Apple and eyes turned to resources demand and if the following is true we have another problem for the Bank of Japan.

“One theory is that may be Japanese retail FX players are forcing out of AUDJPY which is creating a liquidity vacuum,” he added. “This is a market dislocation rather than a fundamental event.”

Sorry but it is a fundamental event as Japanese retail investors are in Australian investments because they can get at least some yield after years and indeed decades on no yield in Japan. This is a direct consequence of Bank of Japan policy as was the move in the Turkish Lira which is explained by Yoshiko Matsuzaki.

This China news hit the EM ccys including Turkish lira where Mrs Watanabe are heavily long against Yen. I bet their stops were triggered in the thin market. Imagine to have TRYyen stops in this market.

So there you have it a development we have seen before or a reversal of a carry trade leading the Japanese Yen to soar. Even worse one caused by the policy response to the last carry trade blow-up! Or fixing this particular hole was delegated to the Beatles.

And it really doesn’t matter if I’m wrong
I’m right

Bank of England

It too had a poor night as whilst it is not a carry trade currency with Bank Rate a mere 0.75% the UK Pound £ took quite a knock against the Yen to around 132. Having done this we might reasonably wonder under what grounds the Bank of England would use the currency reserves it has gone to so much trouble to boost? From December 11th.

Actually the Bank of England has been building up its foreign exchange reserves in the credit crunch era and as of the end of October they amounted to US $115.8 billion as opposed as opposed to dips towards US $35 billion in 2009. So as the UK Pound £ has fallen we see that our own central bank has been on the other side of the ledger with a particular acceleration in 2015. I will leave readers to their own thoughts as to whether that has been sensible management or has weighed on the UK Pound £ or of course both?!

To my mind last nights move was certainly an undue fluctuation.

The EEA was established in 1932 to provide a fund which could be used for “checking undue fluctuations in the exchange value of sterling”.

It is an off world where extraordinary purchases of government bonds ( £435 billion) are accompanied by an apparent terror of foreign exchange intervention.

Comment

I have gone through this in detail because these sort of short-term explosive moves have a habit of being described as something to brush off when often they signal something significant. So let is go through some lessons.

  1. A consequence of negative interest-rates is that the Japanese investors have undertaken their own carry trade.
  2. The financial system is creaking partly because of point 1 and the ongoing economic slow down is not helping.
  3. Contrary to some reports the Euro was relatively stable and something of a safe haven as it behaved to some extent like a German currency might have. There is a lesson for economic theory about negative interest-rates especially when driven by a strong currency. Poor old economics 101 never seems to catch a break.
  4. All the “improvements” to the financial system seem if anything to have made things worse rather than better.
  5. Fast moves seem to send central banks into a panic meaning that they do not apply their own rules.

We cannot rule out that this was deliberate and please note the Yen low versus the US Dollar was 104.9 as you read the tweet below.

Japanese exporters had bought a lot of usd/jpy puts at year end with 105 KOs so now they are really screwed … ( @fxmacro )

Me on The Investing Channel

 

 

Current bond yields imply a depressing view of the world economy

Let me welcome you all to 2019 as we advance on another new year. I hope that it will be a good one for all of you. As I look at financial markets there has been a development which in isolation is good news. This is that the US ten-year Treasury Bond yield is now 2.67%. That is good news for US taxpayers as their government can borrow more cheaply in spite of the current shut down of part of it and good news for US mortgage borrowers as it feed into fixed-rate borrowing costs. It compares to this situation which I looked at back on the 6th of December.

Now let us look at the US ten-year yield which is 2.9% as I type this and we see that in basic terms it is predicting a couple more 0.25% interest-rate rises.

I will look at why in a moment but let us now shift to the Wall Street Journal for another comparison.

The yield closed Monday at 2.68%, up from the 2.41% where it ended 2017.

The pattern is described by the WSJ below.

The yield on the benchmark 10-year Treasury note—which moves inversely to price and helps set borrowing costs for consumers and businesses around the world—climbed higher at the start of 2018 as stocks rose and the dollar weakened. Investors were content to look past geopolitical tensions, and bonds’ fixed rates, given expectations for a soaring profits and economic growth……..Now, the yield has retreated from multiyear highs hit in November, falling below 3%

The pattern was that the ten-year Treasury Bond rose to 3.26% and you may recall that there were forecasts of it going above 4% at that time. To be fair “bond king” ( CNBC) Jeffrey Gundlach was looking at the thirty-year yield but that has just dipped below 3% today in a different big figure move. Back in July the St. Louis Federal Reserve looked at why it thought US bond yields were rising.

The expected long-term inflation rate and the expected long-term real growth rate of the economy are the most important factors that influence long-term yields. If bond buyers expect higher inflation or higher real growth, they will expect higher interest rates in the future and thus will demand a higher yield on the bonds they buy today.

Central bankers love this sort of thing but I wish you the best of luck in figuring either out in reality! Especially after the past credit crunch driven decade. We can say that the US economy has performed better than its peers so there is a little light in the fog but the next bit to my mind is more important than we are told.

Bond yields also depend on the uncertainty about these factors, so the volatility of expected inflation and growth also influence long-bond yields, but these variables are harder to measure and have smaller effects.

Yes they are harder to measure but we should not use that as an excuse to say they have smaller effects just because that is all we can find. The period between when that was written in July and now shows us how powerful this can be if we look at the ch-ch-changes. Also this bit has not worn well.

The growth in expected future fiscal deficits is likely to have contributed to the rise in relative yields.

That was true but is even more true now an yet yields have fallen as I pointed out earlier. Financial markets pick and choose which factors are the most important at the time and I note the St.Louis Fed missed out the main driver of bond yields in the modern era which is the impact of the policy of the Federal Reserve itself.

The international picture

I do agree with the St.Louis Fed on this point.

The international yields usually, but not always, move together. (  the U.K., Canada, Germany, Japan, Switzerland)

The next bit is awkward for them to analyse as we are back to the impact of central banking policies again. So Germany for instance has seen its bond yields continue to be driven lower by purchases made by the European Central Bank or ECB which have just stopped. But we see that the ten-year German bund yields a mere 0.18% as I type this. Again in isolation that is a benefit for German taxpayers and borrowers but there is also a problem which is highlighted by this from the Markit PMI from this morning.

The headline IHS Markit/BME Germany Manufacturing
PMI – a single-figure snapshot of the performance of the
manufacturing economy – slipped to 51.5 in December,
down from 51.8 in November and its lowest reading since
March 2016. It marked the eleventh time that the index had
fallen in 2018, down from a record high in December 2017.

The German economy has hit a weak phase and this includes the 0.2% fall in GDP in the third quarter of 2018. But the problem is that long-term it has benefited from a lower currency via replacing the Deutschmark with the Euro and in more recent times it has benefited from low and then negative interest-rates. What else is there? Also regular readers who have followed my regular updates on the weakening money supply data in the Euro area may have a wry smile at this.

but the extent of the slowdown has been somewhat of a surprise.

Central banking policy

This has changed although as ever the rhetoric is in the wrong direction. From Reuters.

The most prominent hawk on the European Central Bank’s board still expects an interest rate hike in 2019 but concedes that this will depend on inflation data in the first half of the year………Sabine Lautenschlaeger, a German who has long called for the ECB to tighten its ultra-loose policy, still hopes for a move next year if data allows.

Actually as we have looked at above the data would be considered grounds for considering an interest-rate cut if the ECB deposit rate was not already -0.4%. In my opinion we cannot completely rule out a rise because just like we saw in Sweden before Christmas there could be an attempt to get back to 0% before things get any worse. But it would be an example of what in itself being a good idea being done with bad timing which means it should not happen.

If we move back to the US the simple fact is that the interest-rate rise of a couple of weeks ago may be the last one. Also due to technical reasons ( the amount of Quantitative Tightening or QT depends on maturing bonds) the bond sales will slow in 2019 anyway, but in a slow down there will be pressure for QE4 to head down the slipway.

Comment

What started as good news leads to a more uncomfortable picture as we note that the real shift has been in economic data. This as we looked at last year got worse as we saw a slow down in monetary data lead to weaker economies around the world. This morning has seen another sign of this. From CNBC.

The moves in pre-market trade come after a private sector survey showed manufacturing activity in the world’s second-largest economy contracted for the first time in 19 months. China’s Markit Manufacturing Purchasing Managers’ Index (PMI) for December dipped to 49.7 from 50.2 in November.

This added to the news that auto sales had fallen by 16% in November in China. We have also seen this from Chris Williamson on the Markit PMI data.

manufacturing indicates that last 3 months of 2018 saw the worst factory output growth since the Q2 2013, with firms having to eat into backorders to sustain production levels. Some temporary factors evident but trend looks worryingly weak

Stock markets have led this and I note that they are lower today although we need to note the extraordinary ups and downs of the holiday period. Also there is the role of the price of crude oil which also was volatile but overall has been falling. It supports bond prices and reduces bond yields but affecting inflation projections and also signalling a potentially weaker economy.

So there you have it as we find that what looks like good news is a signal for bad economic trends. It does show markets responding in the way that they should. The problem is their starting point and for that all eyes turn to the central banks who have driven them there. Get ready for the claims that “it could not possibly have been expected” and “Surprise!Surprise!” We already start with trillions of bonds with a negative yield so what can be gained?

The US economy is slowing but how quickly?

A feature of recent times has been the way that economic growth forecasts have been trimmed somewhat. This morning has already seen two examples of that as the Swiss National Bank has suggested it will fall from 2.5% this year to 1.5% next, must be awkward that when your official interest-rate is already -0.75%. Next came the IFO Institute in Germany which did a little pruning to 1.5% this year and more of a short-back and sides to 1.1% in 2019. That provides some food for thought for the European Central Bank today as its largest economy slows.

The situation in the United States has been somewhat different, however, at least according to the official data. From the Bureau for Economic Analysis.

Real gross domestic product (GDP) increased at an annual rate of 3.5 percent in the third quarter of 2018 , according to the “second” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 4.2 percent.

Yes it has slowed but to a rate most first world countries would currently give their right arm for. We can use the Atlanta Fed now cast to see where we stand this quarter.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2018 is 2.4 percent on December 7, down from 2.7 percent on December 6.

They updated it on the basis of this new information.

The nowcast of fourth-quarter real final sales of domestic product growth decreased from 2.9 percent to 2.7 percent after this morning’s employment report from the U.S. Bureau of Labor Statistics. The nowcast of the contribution of inventory investment to fourth-quarter real GDP growth decreased from -0.23 percentage points to -0.33 percentage points after the employment report and this morning’s wholesale trade release from the U.S. Census Bureau.

So we see that whilst the level of economic growth remains relatively good the US has not escaped the cooling winds blowing.

Money Supply

This has proved to be a good guide to economic trends in 2018 and even better it remains widely ignored. Shorter-term trends are usually best encapsulated by narrow money so let us investigate last week’s monetary base data from the Federal Reserve which incorporates this.

The release also provides data on the monetary base, which includes currency in circulation and total balances maintained.

On the 5th of this month it was US $3.444 trillion but we immediately know that as Alicia Keys would say it has been Fallin’ as it was US $3.508 trillion on the 7th of November. We need to switch to the monthly numbers for an annual comparison and when we do so we see that in November it was 11% lower than a year before. If the phrase was not in use elsewhere this would be a credit crunch or to be more specific a type of cash crunch. Not a pure cash crunch as the currency in circulation has risen to US $1.705 trillion but reserve balances at the banks.

The fall has been driven by this.

For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month…….For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

As you can see it is the central bank which is sucking reserve balances out of the system as indeed it was it who pumped them up. In a broad sweep we see that the QE era took the monetary base from a bit under US $0.9 trillion to US $4.1 trillion and now is pulling it back down.

Personally I think the main effect is coming from the reductions in holdings of mortgage-backed securities so if we pro rata that we get a monetary base reduction of say 5% but that is still a crunch.

Interest-Rates

These have been rising in the US another 0.25% still seems likely next week. An intriguing way of putting the international perspective on this has been provided by the Bond Vigilantes website.

 the de facto global discount rate, the 2-year US Treasury bond yield, has risen by almost 100 basis points (bps) over the year, and thus repriced global assets.

Higher US interest-rates effect the world economy and thus have a second order effect on the US economy via trade. Then there are the domestic effects.

the US 30-year mortgage rate hit 4.8% recently, up from 3.3% in 2016. Whilst most existing homeowners, like corporates, will have locked in those cheap rates, new borrowers face costlier loans, and this is already having an impact: US housing and real estate data is surprising to the downside at a rate that exceeds that seen even in 2008 and 2009:

So there has been something of a squeeze on the real economy from this source as well, although it will have weakened recently as US Treasury Bond yields have fallen back from their peaks.

Fiscal Policy

As we mull the developments above it seems that the fiscal stimulus provided by President Trump was not as ill-conceived as some have claimed. Of course views vary about fiscal stimuli as for example they are apparently good for France but bad for Italy. But the Donald has provided one into a slow down which has at least some of the textbook rationale. Where matters get more complex is the fact that the US has so far only really seen its boom slow and other countries such as Germany make a stronger case. But if we skip the absolute level argument the Donald does appear to have spotted the direction of travel.

Comment

We see that the US has not in fact escaped the economic changes in 2018 but it has had an advantage from starting at a higher level of economic growth. But the monetary data is applying a squeeze as are higher interest-rates and as ever we find it impacting in familiar places.

Whenever you saw the supply of unsold homes reach 7 months, a recession followed. It certainly did in 2008, despite the consensus of economic forecasters believing that economic growth would be 2.4% – it was actually negative. Why should we worry now? Well, the supply of unsold new homes is… 7.4 months (blue line).  (BondVigilantes )

That will trouble the US Federal Reserve as will this development.

BKX not far from yesterday’s low. There’s a real problem with the banks. And I don’t think I’m being an alarmist by simply saying something might be going on here that we don’t know about. ( @selling_theta )

Worries about the housing market and the banks? We know how central banks usually respond to those so no wonder the US Fed has cooled on future interest-rate rises. QE4 anyone?

 

 

 

 

The problematic nature of current bond yields

One of the features of the credit crunch era has been the falls in first world interest-rates and bond yields. The first phase saw the slashing of official short-term interest-rates and once that was seen to be inadequate, central banks directly purchased bonds to reduce yields further. It is seldom put like this but there was already an implied failure as according to the models back then the interest-rate cuts should have done the trick. Back then I was already looking ahead to when there would have to be ch-ch-changes and posted the view that central banks would delay what has become called policy normalisation.

For example back on the 24th of February 2011 I pointed out this about a speech from David Miles of the Bank of England.

 My problem with this is that when you act as they have and you have in effect used what weapons the Bank of England has virtually to the maximum by cutting interest-rates by 4.75%% and spending some £200 billion on asset purchases then you have been extraordinarily interventionist. Accordingly it is then hard for you to blame events because some of them are the consequence of your own actions……

What that illustrates is that already the truth was being manipulated and also I am glad I wrote “virtually to the maximum” as of course the amount of asset purchases has more than doubled. In addition we have seen credit easing in the UK via such policies as the Term Funding Scheme and the start of full-scale QE from the European Central Bank as well as negative interest-rates.

But the point about delaying proved to be very accurate as the Euro area is still actively pursuing QE and in net terms the UK has managed to raise interest-rates by a measly 0.25%. The opportunity in 2014/15 was meant with promises via Forward Guidance but no action.

The US

This is the one country which has taken clear action on the path to normalisation. Here is the current state of play.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 2 to 2-1/4 percent.

That is currently working out be be around 2.2% and more rises are promised. Also there is some reversing of the QE or Qualitative Tightening.

The Committee directs the Desk to continue
rolling over at auction the amount of principal
payments from the Federal Reserve’s holdings
of Treasury securities maturing during each
calendar month that exceeds $30 billion, and to
continue reinvesting in agency mortgage-backed
securities the amount of principal
payments from the Federal Reserve’s holdings
of agency debt and agency mortgage-backed
securities received during each calendar month
that exceeds $20 billion.

That combined with forecasts of another interest-rate rise in a fortnight and at least a couple next year seemed to put pressure on bond markets. However this sentence in a speech from Federal Reserve Chair Jerome Powell shook things up on the 28th of last month and the emphasis is mine.

We therefore began to raise our policy rate gradually toward levels that are more normal in a healthy economy. Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy‑‑that is, neither speeding up nor slowing down growth.

You may note we seem to have travelled from “policy normalisation” to neutral. But what the neutral interest-rate represents is an attempt to figure out what interest-rate would neither stimulate or contract the economy. Or a sort of measure of what we might aim for as a new normal. When they are trying to put a pseudo scientific gloss on things economist and central bankers call it r-squared.

However the “just below” dropped the expected path for US interest-rates by 0.5%.

Bond Markets

Let me take you to the Wall Street Journal on Tuesday.

This quarter, yields on longer-dated bonds have dropped and those on two-year Treasurys are flat. The gap between two and 10-year Treasury yields is now around 0.11 percentage point, compared with around 0.55 percentage point at the beginning of the year.

This is attracting a lot of attention in the financial media but the change of 0.44% is pretty much my 0.5% suggestion above. Now let us look at the US ten-year yield which is 2.9% as I type this and we see that in basic terms it is predicting a couple more 0.25% interest-rate rises. This will come in the next year or so if true so it is not very different to the two-year yield of 2.76%.

If we look beyond Federal Reserve policy we have seen a fall in the price of oil over the past month or two. If we look at it in Brent Crude terms then just above US $86 of early October has been replaced by below US $59 this morning as oil follows equity markets lower. The exact amount of the change varies but the path for inflation now seems set to be lower as it has been rare in 2018 for the oil price to be below where it was this time last year. That is another reason for lower bond yields.

Is this a signal of a recession? Here is the St.Louis Fed from last week.

Does the recent flattening of the yield curve portend recession? Not necessarily. The flattening of the real yield curve may simply reflect the fact that real consumption growth is not expected to accelerate or decelerate from the present growth rate of about 1 percent year over year. On the other hand, a 1 percent growth rate is substantially lower than the U.S. historical average of 2 percent. Because of this, the risk that a negative shock (of comparable magnitude to past shocks) sends the economy into technical recession is increased.

That is a fascinating way of looking at it and in my experience precisely zero bond market participants will look at it like that. It is also revealing that we seem to just assume growth will now be lower. Didn’t they save us?

Comment

I wanted to look at this subject today because of the clear changes which are happening. Now it looks much less likely that US interest-rates will pass 3% and if they do not by much. So “normalisation” will be at best about two-thirds of what it might have been considered to be pre credit crunch ( 4.5%). Some of you have suggested that we can no longer afford interest-rates and yields above 3% so well done at least if we stay where we are! If Italy folds you may get a second tick in that box.

But as we look wider we see even more extraordinary developments. Let me take a look at my own country the UK which is in political disarray yet the ten-year Gilt yield is below 1.3%. So those predicting a surge in Gilt yields are slipping back into the bushes whilst I note the extraordinary absolute level and the persistence of negative real yields which bust past metrics. Germany has a ten-year yield of 0.26% and a five-year one of -0.3% as we note again more metrics which are busted.

So my view is that we cannot rely on old recession metrics because another cause of all of this is that QE4 from the US Fed has got closer. I have worried all along that interest-rate rises might run into more QE and if they do we will be singing along to Coldplay.

Oh no I see
A spider web and it’s me in the middle
So I twist and turn
Here am I in my little bubble

 

 

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.

 

 

 

 

 

 

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