What is it about GDP in the first quarter these days?

The behaviour of the UK economy so far in 2017 has been something of a hot potato in debate as the numbers swing one way and then the other. Let me give you an example of a ying and yang situation . The downbeat ying was provided last week by the official data on UK retail sales.

The 3 months to March shows a decrease of 1.4%; the third consecutive decrease for the underlying 3 month on 3 month pattern……Looking at the quarterly movement, the 3 months to March 2017 (Quarter 1) is the first quarterly decline since 2013 (Quarter 4).

That was ominous for today’s GDP release as the consumer sector had been part of the growth in the UK economy. Our official statisticians crunched the numbers as to the likely effect.

The 3-month period ending March 2017 coincides with Quarter 1 (Jan to Mar) 2017 of the quarterly gross domestic product (GDP) output estimate. It marks the first negative contribution of retail sales to quarterly GDP growth since Quarter 4 (Oct to Dec) 2013, contributing negative 0.08 percentage points (to 2 decimal places).

However only yesterday there was a yang to the ying from the Confederation of British Industry or CBI.

Retail sales growth accelerated in the year to April, with volumes rising faster than expected, according to the latest monthly CBI Distributive Trades Survey.

Here is some more detail.

59% of retailers said that sales volumes were up in April on a year ago, whilst 21% said they were down, giving a balance of +38%. This outperformed expectations (+16%), and was the highest balance since September 2015 (+49%)…….Sales volumes grew strongly in clothing (+97% – the highest since September 2010), and grocers (+40%). Meanwhile sales volumes decreased in specialist food & drink (-43%) and furniture & carpets (-30%).

If we stay with the specifics of the CBI report its is fascinating to see clothing leading the charge again. Regular readers will recall that this was the state of play last autumn and at that time it was female clothing in particular. So ladies if you have rescued us yet again we owe you another round of thanks. In such a situation you would be the consumer of last resort as well as often the first!

But the issue here is how does this fit with the official data? There is one way it might work and it comes down to the timing of Easter which was later this year than last. Whilst the official data does make seasonal adjustments I have seen this miss fire before. Perhaps the clearest generic example of this is first quarter GDP in the United States which year after year has been lower than the trend for the other quarters hinting at a systematic issue.

House prices

If these have been leading the charge for UK economic growth then this morning’s news will disappoint.

House prices recorded their second consecutive monthly fall in April, while the annual rate of growth slowed to 2.6%, the weakest since June 2013.

The date is significant as it was the summer of 2013 when the Bank of England lit the blue touch-paper for UK house prices with a new bank subsidy programme. The latest version of this called the Term Funding Scheme has risen in size to £57.5 billion.since its inception last August. Looking forwards if we allow for the obvious moral hazard this is hardly especially optimistic.

As a result, we continue to believe that a small increase in house prices of around 2% is likely over the course of 2017 as a whole.

The GDP data

UK gross domestic product (GDP) was estimated to have increased by 0.3% in Quarter 1 (Jan to Mar) 2017, the slowest rate of growth since Quarter 1 2016.

This was driven by the retail sales slow down and this.

Slower growth in Quarter 1 2017 was mainly due to services, which grew by 0.3% compared with growth of 0.8% in Quarter 4 (Oct to Dec) 2016……The services aggregate was the main driver to the slower growth in GDP, contributing 0.23 percentage points…….The main contributor to the slowdown in services was the distribution, hotels and restaurants sector, which decreased by 0.5%, contributing negative 0.07 percentage points to quarter-on-quarter GDP growth.

The services slow down will have had a big effect because it must be pretty much 80% of our economy by now. Officially it is 78.8%.

Actually much of the economy grew at this sort of rate.

Production, construction and agriculture grew by 0.3%, 0.2% and 0.3% respectively in Quarter 1 2017.

So a slowing on the end of 2016 but here is something to think about. UK GDP growth was 0.2% in the first quarter of 2016 so ironically it is better this year but also was 0.3% in 2015. Are we developing a similar problem to the US where it seems to be something of a hardy perennial situation and if so why?

Looking Forwards

As well as the more optimistic CBI retail sales report there was this from Monday.

The survey of 397 manufacturers found that domestic orders had improved at the fastest pace since July 2014 in the three months to April. Meanwhile export orders recorded the strongest growth in six years, supported by strong rises in competitiveness, particularly in non-EU markets which improved at a record pace.

It is not the only body which is looking forwards with some optimism.

The UK economy slowed sharply in Q1, as signalled by PMI. March rise in PMI suggests Q1 GDP could be revised up from 0.3% to 0.4%………Note that Q1 GDP was based on a forecast of no service sector growth in March. PMI showed strengthening ( Chris Williamson of Markit ).

What about the individual experience?

We have settled on GDP per capita as a better guide and this was frankly poor this time around.

GDP per head was estimated to have increased by 0.1% during Quarter 1 2017.

This adds to an issue which the chart below highlights, guess which of the lines is our more recent experience?

For the people who think that their individual experience has not backed up the claims of improvement there is food for thought in that chart.

Is GDP underecorded?

Tim Worstall wrote a piece for CapX this week telling us this.

For it’s obvious to our own eyes, and when properly adjusted GDP shows it once again, that we’ve all got much richer these recent decades.

Okay why?

The CPI overstates inflation – and thus understates how quickly real incomes are rising……Of course the ONS and others do the best they can but the current estimate is that inflation is overstated by 1 per cent a year. Or real income rises understated by it of course.

There are some interesting points on goods which are free ( WhatsApp for example) and ignored by GDP.  However it completely misses out the cost of housing which in recent times has been a major inflationary force in my mind. Would you rather have housing or the latest I-Pad?

Care is needed as of course there were substantial gains in the past but on this logic we are all much better off than we realise. Really?

Comment

The issue with first quarter growth was also true across the channel as the expectation and then the reality show below.

with 0.6% growth signalled for both Germany and France ( Markit )…….In Q1 2017, GDP in volume terms* slowed down: +0.3%, after +0.5% in Q4 2016 ( France Insee ).

So as we note the Bank of France was correct we await the US figures wondering what it is about first quarter GDP? For France this is not yet a sequence as last year was better but the UK and US seem trapped in a mire that appears to have a seasonal reappearance.

Looking ahead we were expecting higher inflation to bite on real incomes as 2017 progressed. As we stand a little of the edge of that has been taken off that impact. What I mean by that is the rise of the UK Pound £ to above US $1.29 helps with inflation prospects as does the fall in the price of a barrel of Brent Crude Oil to below US $52 per barrel. Of course they would need to remain there for this to play out.

Some posted some Blood Sweat & Tears lyrics a while back and they seem appropriate again.

What goes up, must come down
Spinning wheel got to go round
Talkin’ ’bout your troubles, it’s a cryin’ sin
Ride a painted pony, let the spinning wheel spin

What is happening to US auto-loans?

One of the features of expansionary monetary policy has been that it misses some areas and concentrates in others. It reminds me of the word disintermediation which described a similar problem when central banks were trying to restrict the money supply rather than expand it with policies like QE ( Quantitative Easing) ,as the concept was the same albeit in a different direction. I have noted in the past the issue with auto-loans or loans for cars in the United States and am going to look at that in more detail as the situation is showing signs of bubbling under as we worry about it bubbling over.

What is the background?

Last November the Liberty Street Economics blog of the US New York Fed told us this.

The rise in auto loans has been fueled by high levels of originations across the spectrum of creditworthiness, including subprime loans, which are disproportionately originated by auto finance companies.

There was something of a warning tucked in there which was reinforced by this.

Originations of auto loans have continued at a brisk pace over the past few years, with 2016 shaping up to be the strongest of any year in our data, which begin in 1999……..the $1.135 trillion of outstanding auto loans by credit score and lender type, and we see that 75 percent of the outstanding subprime loans were originated by finance companies.

So there are various concerns which are the size of the market and its rate of growth which are highlighted by the way the finance companies seem to have taken over the subprime sector.

The data suggest some notable deterioration in the performance of subprime auto loans. This translates into a large number of households, with roughly six million individuals at least ninety days late on their auto loan payments.

The feeds into the theme of us “forgetting” how we got into the credit crunch or to put it another way the finance sector returning to past behaviours.

Last month it confirmed the 2016 rise.

auto debt (up $93 billion, or 8.7 percent)

Also there were some numbers to cheer any central banker’s heart.

As of December 31, 2016, total household indebtedness was $12.58 trillion, a $226 billion (1.8%) increase from the third quarter of 2016. Overall household debt remains just 0.8% below its 2008Q3 peak of $12.68 trillion, but is now 12.8% above the 2013Q2 trough.

I note that auto-loans began their recent rise in 2013 in terms of number of loans.

Used car prices

These are of course the asset in this market as the loans are backed by the cars. We live in a world where Bank of England Governor Mark Carney calls such loans “secured” and UK radio has adverts for buy-to-let cars. But earlier this month the US National Automobile Dealers Association released this.

NADA Used Car Guide’s seasonally adjusted used vehicle price index fell for the eighth straight month, declining 3.8% from January to 110.1. The drop was by far the worst recorded for any month since November 2008 as the result of a recession-related 5.6% tumble. February’s index figure was also 8% below February 2016’s 119.4 result and marked the index’s lowest level since September 2010.

As you can see prices have been falling for a while and looking at the chart of prices the rate of fall rather resembles that of 2008/09 with a difference which is that we start with prices having been in the low 120s rather than ~108. Last week we saw a warning from one of the companies involved and let me switch to Ed Harrison who has been on this case for a while.

Yesterday, Ally Financial warned that profits would underperform expectations. Now, they did not say that profits would fall or that they were taking credit writedowns. Neverthless, the warning is an important marker and should be of grave concern…………So with Ally, what we are seeing is that these problems have created enough discounting to induce a profit warning at one of the major auto finance companies. Ally is really the former GMAC, the engine of a huge amount of profit for General Motors, as are all of the finance arms of the automakers in the US. So what happens at Ally will definitely pass through to GM and the other carmakers unless the impact is arrested quickly.

There are various issues here but let us start with a clear difference with the housing market where prices have risen and thus boosted the asset value of the lenders books whereas here prices were pushed higher but are now falling. Also if we look we see that in another development familiar from the past the loans were bigger than the car value. Here is an offer I looked up from a company called DCU on what they call second chance auto loans.

Borrow up to 120% of Price – Qualified borrowers can finance up to 120% of NADA retail book value or 120% of the purchase price – whichever is less,

According to the St.Louis Fed yesterday the loans are a lot cheaper than they were.

The interest rate on a 48-month loan from a commercial bank for a new automobile purchase dropped from close to 8 percent prior to the Great Recession to an average of 4.3 percent since the second quarter of 2014.8 Meanwhile, auto finance company rates for new car loans averaged around 5 percent during this same period.

Also it points out this.

Softened underwriting standards have raised concerns regarding the risk associated with the robust growth in auto debt………..lenders have stretched repayment terms and offered higher advance rates, resulting in greater loan-to-value ratios.

In terms of its own region it is seeing this.

Serious delinquency rates among subprime borrowers in Little Rock and Memphis have now markedly increased during two years of an economic expansion.

Asset Backed Securities (ABS)

Yes they are on the scene as we look to see what is happening in a market that Mario Draghi of the ECB is very keen on. Barrons looked into it yesterday.

While delinquencies, liquidation rates and loss severities are higher across subprime ABS deals regardless of the ABS shelf, it appears that certain issuers are seeing larger increases than others. This analysis invites a few questions. Are the capital structures of deeper subprime lenders built to handle larger losses? Which structures, if any, are more likely to take principal losses in their rated debt tranches?

Comment

There are quite a few factors to consider here. Let us start with household debt which will soon pass the pre credit crunch peak. That needs to be compared to GDP ( Gross Domestic Product) which was 12% higher in 2016 than the previous peak of 2007. Regular readers will be aware of my concerns about GDP but for now let us just note that it has grown.

If we move to auto-loans there are a lot of flashing yellow lights. The trend towards subprime lending and the lending going “in-house” for the car lenders only adds to the moral hazards at play. Securitisation of the loans send a chill down the spine and now we see falling used car prices. Even worse the Financial Times has this morning told us not to panic!

Don’t panic about auto loans just yet — tax season isn’t over, after all

This is based on the fact that this year tax refunds have been particularly slow and therefore may well have influenced the February drop but of course not the ones before it. Also there is no panic here but there is a list that is gaining a growing number of ticks on it and this has just popped up under auto loans on Twitter.

Learn How to Get Fast Approved AutoLoans with No Credit Check Requirement in Texas ( @CarLoanBadCred )

Also this.

Gone are the days when you had to wait for getting bad credit auto loans. There are many online auto financing companies who offer competitive interest rates on these loans. Internet is quickly becoming the best place to get a blank check car loans with bad credit history

https://ezautofinance.net/how_to_get_a_blank_check_auto_loan_even_with_bad_credit.html

What could go wrong?

 

 

Are the currency wars still raging?

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

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

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

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

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

Japan

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

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

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

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

Germany

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

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

The UK

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

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

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

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

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

South Africa

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

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

Perhaps the air got a bit thin up there.

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

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

Bitcoin

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

Comment

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

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

Of UK Retail Sales and a 5% cut in real interest-rates

A feature of my career and time working with and analysing finance and economics has been the fall in interest-rates and yields. This of course has ended up with us now facing a period where more than a few interest-rates and bond yields are in fact in negative territory. My subject of yesterday France has a central bank ( ECB) with a deposit and current account of -0.4% and its 2 year bond yield is -0.5%. But let me give you some perspective from the Bank Underground blog of the Bank of England.

Real interest rates have fallen by around 5 percentage points since the 1980s.

Eye-catching is it not? Just to break this down they were 0% in the 1970s, 4.7% in the 1980s, then 1.9% up to the credit crunch and since 2009 have been -1.3%, Oh and that is 6% and not 5% by the way. For clarity this is for the United States one year yield minus how inflation turned out to be in that year.

So in the period since the 1980s we have seen, as I have pointed out quite a few times before quite a stimulus applied to the world economy and of course a fair bit of this has come in the credit crunch era. We then face a rather awkward conundrum because the supposed cure of lower interest-rates and yields is in response at least in part to the problems created by lower interest-rates and yields! A sort of doubling the dose response to an addiction. How does that usually work out?

Of course some want ever more as I note individuals like Kenneth Rogoff who want to ban as much cash as they can as they fear that they will not be able to repeat the “cure” next time around. This plainly means interest-rates going even more negative and more places seeing them. For example the UK now has a Bank Rate of 0.25% after over 3 years of pretty solid economic growth so what happens when the next recession turns up? Such thoughts have the problem of why a cure needs to be repeated so often at ever higher dosages and with ever more side-effects?

As to the causes of this the Bank Underground tries to dismiss fears over secular stagnation by pointing out this.

In the late 1930s, Alvin Hansen developed the term “secular stagnation” to describe his concerns that structural factors such as stagnant technological development and weaker population growth prospects would weigh on growth permanently.  We know now that these concerns over secular trends proved misplaced, and played little role in weaker growth.

Rather ominously that was really only changed by the second world war which is hardly a hopeful precedent! The author hopes that things will get better so lets join him in that but the truth is we are much less sure and there is a sort of unmentioned sword of Damocles hanging all over this which is Japan where the lost decade has become the lost decades.

Although the author would not put it like this there is quite a critique of current Bank of England policy tucked away in the blog.

When agents assign a low probability to the central bank remaining hawkish towards inflation, real rates must rise by a significantly larger amount in response to a given shock to stabilise inflation.  The required response decreases as credibility improves.

So as the credibility of Forward Guidance is only for the credulous now and the Bank of England plans to “look through” rising inflation then the logic applied there suggests real rates will have to rise substantially. Awkward.

Retail Sales

Speaking of rising inflation there was this in the data released this morning.

Average store prices (including fuel) increased by 1.9% on the year, the largest contribution to this increase came from petrol stations, where year-on-year average prices were estimated to have risen by 16.1%.

Regular readers will be aware that I was ahead of the pick-up in retail sales in the UK and quite a few other places by explaining that the lower inflation driven mostly be lower crude oil prices would raise consumption via a boost to real wages. So we are now beginning to see the mirror image of that relationship. It was only on Wednesday that I pointed out the real wage growth was fading and on some inflation measures had now gone negative. The price rise was just not from fuel as this from the food sector shows.

In January 2017, prices increased by 0.5% compared with December 2016, the largest month-on-month rise since April 2013, while the year-on-year increase of 0.2% is the highest since June 2014,

Thus the numbers today are not the surprise they have been presented as.

Month-on-month the quantity bought is estimated to have fallen by 0.3%.

If we look for more perspective we see this.

The underlying pattern as suggested by the 3 month on 3 month movement decreased by 0.4%; the first fall since December 2013.

In annual terms there is still growth but it has faded substantially for the heady days of late 2016.

In January 2017, the quantity bought in the retail industry is estimated to have increased by 1.5% compared with January 2016, the lowest growth since November 2013.

Actually so much of the change can be found in the sector where prices have risen the most.

The year-on-year increase in fuel stores is the largest rise since September 2011, contributing to the strong growth seen in the amount spent in fuel stores on the year. However, the quantity bought has decreased following the rise in fuel prices, suggesting that consumers are more cautious with spending in this sector.

Have readers noticed less traffic on the roads?

Tourism

There was some good news here albeit with an odd kicker.

Overseas residents made 9.2 million visits to the UK in the 3 months to December 2016. This was 6% higher than the same 3 months in 2015. The amount spent on these visits was unchanged at £5.3 billion.

It is no great surprise that the lower UK Pound £ has led to more visitors but I am curious that they spent no more. For a start how do we know? Does someone follow them into every shop? Also this goes against the argument made by some that past retail sales growth in the UK was added to by foreign purchasers using lower price for them.

Whatever the state of play there we do seem to be seeing more US tourists as we wonder if Trump fears are higher than Brexit ones?

Visits from North America increased by 15% in the 3 months to December 2016, when compared with the same 3 months in 2015.

Comment

We see that we have been living our lives in an extraordinarily favourable interest-rate environment. Many reading this will have lived their whole lives in it. The catch is that it has ended up being associated with trouble on two fronts. Firstly it did not avert a credit crunch and in fact ended up contributing to it and secondly if it was a cure we would not be where we are. Although care is needed as there were plenty of economic gains back in the day. As for now well some old fears have reappeared.

More Americans fell behind on their car loan payments in the fourth quarter, bringing auto delinquencies to their highest since the height of the financial crisis, Federal Reserve Bank of New York data released on Thursday showed…….

In the fourth quarter, $142 billion in car loans were generated, giving 2016 the most auto loan originations in the 18-year history of the data, the New York Fed said.

Auto debt hit $1.16 trillion, with a $93 billion rise over the year.

Sub-prime car loans anyone?

If we move to the UK then the consumer surge is fading. The numbers are erratic and influenced by the rise in the price of fuel but even taking that out annual growth fell to 2.6%. It remains a shame that the Bank of England last summer contributed to the inflation rise via the way that their rhetoric and Bank Rate cut and QE pushed the UK Pound £ lower. Before this is over I expect what was badged as a stimulus to turn out to be the reverse via its impact on real wages.

Rising bond yields are feeding into the real economy

Once upon a time most people saw central banks as organisations which raised interest-rates to slow inflation and/or an economy and cut them to have the reverse effect. Such simple times! Well for those who were not actually working in bond markets anyway. The credit crunch changed things in various ways firstly because we saw so many interest-rate cuts ( approximately 700 I believe now) but also because central bankers ran out of road. What I mean by that is the advent of ZIRP or near 0% interest-rates was not enough for some who plunged into the icy cold waters of negative interest-rates. This has posed all sorts of problems of which one is credibility as for example Bank of England Governor Mark Carney told us the “lower bound” for UK Bank Rate was 0.5% then later cut to 0.25%!

If all that had worked we would not be where we are and we would not have seen central banks singing along with Huey Lewis and the News.

I want a new drug
One that won’t make me sick
One that won’t make me crash my car
Or make me feel three feet thick

This of course was QE (Quantitative Easing) style policies which became increasingly the policy option of choice for central banks because of a change. This is because the official interest-rate is a short-term one usually for overnight interest-rates so 24 hours if you like. As central banks mostly now meet 8 times a year you can consider it lasts for a month and a bit but in the interest-rate environment that changes little as you see there are a whole world of interest-rates unaffected by that. Pre credit crunch they mostly but not always moved with the official rate afterwards the effect faded. So central banks moved to affect them more directly as lowering longer-term interest-rates reduces the price of fixed-rate mortgages and business loans or at least it should. Also much less badged by central bankers buying sovereign bonds to do so makes government borrowing cheaper and therefore makes the “independent” central bank rather popular with politicians.

That was then and this is now

Whilst there is still a lot of QE going on we are seeing ch-ch-changes even in official policy as for example from the US Federal Reserve which has raised interest-rates twice and this morning this from China.

Chinese press reports that the PBoC have raised interest rate on one-year MLF loans by 10bps to 3.1% ( @SigmaSqwauk)

The Chinese bond market future fell a point to below 96 on the news which raised a wry smile at a bond market future below 100 ( which used to be very common) but indicated higher bond yields. These are becoming more common albeit with ebbs and flows and are on that road because of the return of inflation. So many countries got a reminder of this in December as we have noted as there were pick-ups in the level of annual inflation and projecting that forwards leaves current yields looking a bit less than thin. Or to put it another way all the central bank bond-buying has created a false market for sovereign and in other cases corporate bonds.

The UK

Back on the 14th of June last year I expressed my fears for the UK Gilt market.

There is much to consider as we note that inflation expectations and bond yields are two trains running in opposite directions on the same track.

In the meantime we have had the EU leave vote and an extra £60 billion of Bank of England QE of which we will see some £1 billion this afternoon. This drove the ten-year Gilt yield to near 0.5%. Hooray for the “Sledgehammer” of Andy Haldane and Mark Carney? Er no because in chart terms they have left UK taxpayers on an island that now looks far away as markets have concentrated more on thoughts like this one from the 14th of October last year.

Now if we add to this the extra 1.5% of annual inflation I expect as the impact of the lower UK Pound £ then even the new higher yields look rather crackpot.

In spite of the “Sledgehammer” which was designed by Bank of England lifer Andy Haldane the UK ten-year Gilt yield is at 1.44% so higher than it was before the EU leave vote whilst his ammunition locker is nearly empty. So he has driven the UK Gilt market like the Duke of York used to drill his men. I do hope he will be pressed on the economic effects of this and in the real world please not on his Ivory Tower spreadsheet.

The Grand old Duke of York he had ten thousand men
He marched them up to the top of the hill
And he marched them down again.
When they were up, they were up
And when they were down, they were down
And when they were only halfway up
They were neither up nor down.

If you look at inflation trends the Gilt yield remains too low. Oh and do not forget the £20 billion added to the National Debt  by the Term Funding Scheme of the Bank of England.

Euro area

In spite of all the efforts of Mario Draghi and his bond-buyers we have seen rising yields here too and falling prices. Even the perceived safe-haven of German bonds is feeling the winds of change.

in danger of taking out Dec spike highs in yield of 0.456% (10yr cash) ( @MontyLaw)

We of course gain some perspective but noting that even after price falls the yield feared is only 0.456%! However it is higher and as we look elsewhere in the Euro area we do start to see yield levels which are becoming material. Maybe not yet in Italy where the ten-year yield has risen to 2.06% but the 4% of Portugal will be a continuous itch for a country with such a high national debt to GDP (Gross Domestic Product) ratio. It has been around 4% for a while now which is an issue as these things take time to impact and I note this which is odd for a country that the IMF is supposed to have left.

WILL PARTICIPATE IN EUROGROUP DISCUSSION ON – BBG ( h/t @C_Barraud)

 

The US

The election of President Trump had an immediate effect on the US bond market as I pointed out at the time.

There has been a clear market adjustment to this which is that the 30 year ( long bond) yield has risen by 0.12% to 2.75%.

 

As I type this we get a clear idea of the trend this has been in play overall by noting that the long bond yield is now 3.06%.  We can now shift to an economic effect of this by noting that the US 30 year mortgage-rate is now 4.06% and has been rising since late September when in dipped into the low 3.3s%. So there will be a contractionary economic effect via higher mortgage and remortgage costs. There will be others too but this is the clearest cause and effect link and will be seen in other places around the world.

Japan

Here we have a slightly different situation as the Bank of Japan has promised to keep the ten-year yield around 0% so you can take today’s 0.07% as either success or failure. In general bond yields have nudged higher but the truth is that the Bank of Japan so dominates this market it is hard to say what it tells us apart from what The Tokyo Whale wants it too. Also the inflation situation is different as Japan remains at around 0%.

Comment

We find ourselves observing a changing landscape. Whilst not quite a return of the bond vigilantes the band does strike up an occasional tune. When it plays it is mostly humming along to the return of consumer inflation which of course has mostly be driven by the end of the fall in the crude oil price and indeed its rebound. What that has done is made inflation adjusted or real yields look very negative indeed. Whilst Ivory Tower spreadsheets may smile the problem is finding investors willing to buy this as we see markets at the wrong price and yield. Unless central banks are willing to buy bond markets in their entirety then yields will ebb and flow but the trend seems set to be higher and in some cases much higher. For example German bunds have “safe-haven” status but how does a yield of 0.44% for a ten-year bond go with a central bank expecting inflation to go above 2% as the Bundesbank informed us earlier this week?

The economic effects of this will be felt in mortgage,business and other borrowing rates. This will include governments many of whom have got used to cheap and indeed ultra-cheap credit.

 

 

 

The economic impact of a higher dollar and interest-rate rises

We are in the middle of a central bank 24 hours and of course last night the US Federal Reserve continued its recent habit of only raising interest-rates just before Christmas.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1/2 to 3/4 percent. The stance of monetary policy remains accommodative,

On the face of it not much of a change and it is only to as they put it 3/4 percent. However in the modern era there is a significance in that it is in a world of ZIRP ( Zero Interest Rate Policy) and indeed NIRP where N = Negative. This has been highlighted this morning by one of the forerunners of the NIRP world which is the Swiss National Bank.

The Swiss National Bank (SNB) is maintaining its expansionary monetary policy. Interest on sight deposits at the SNB is to remain at –0.75% and the target range for the three-month Libor is unchanged at between –1.25% and –0.25%.

So we have another perspective which is that the spread between these two central banks is now 1.5% which is small in absolute terms but in these days is a lot. Also I note that an interest-rate of -0.75% is “expansionary” whereas one of 0.75% is merely “accommodative”. Oh and the SNB isn’t entirely convinced so we get yet more rhetoric from it.

At the same time, the SNB will remain active in the foreign exchange market as necessary, while taking the overall currency situation into consideration.

Already this morning a country which was previously expected to lower interest-rates has kept them unchanged as Norway remains at 0.5%. Although here there is also clearly an effect from the higher price of crude oil. Meanwhile later we will hear from the Bank of England which cut Bank Rate in August a move which I argued was unwise at the time and looks even worse now. No wonder Governor Mark Carney has moved onto discussing climate change rather than monetary policy or sledgehammers!

Bondpocalypse

It was only on Monday I was looking at the return of the bond vigilantes and overnight they have been active in some areas. For example the US ten-year Treasury Note yield has risen to 2.6%. It was only in early November that it was 1.78%. There have been effects in that period from the likely fiscal plans of President-Elect Trump and expectations for yesterday evening’s interest-rate rise but there was a further kicker. From the Guardian

But investors were caught out by surprisingly bullish comments from Fed chair Janet Yellen in the wake of the announcement and by projections showing that 11 of her 17 policy-making colleagues see borrowing costs rising another three times in 2017.

So not only was there an actual increase but the future path moved higher although to be more precise steeper as the Federal Reserve is really only projecting faster moves to a particular level. There is the obvious cautionary note that we were promised “3-5” interest-rate rises for 2016 by John Williams of the San Francisco Fed and got only one. But this time around the return of some inflationary pressure seems set to be on their minds.

This has seen the German 10 year yield rise back up to 0.36% in spite of the ongoing QE from the ECB. Whilst we are looking at this the “safe haven” problem they claimed to have fixed if getting worse as the two-year German yield is now -0.78%. Meanwhile the Bank of England has spent some £3 billion this week alone on a QE program described as a “sledgehammer” only for the UK Gilt ten-year yield to go back to 1.5% which is higher than when it came out of the tool cupboard. My Forward Guidance is for a sharp increase in inflation in the use of the word counterfactual.

Across the world in Japan there was plenty of work to do as the trend was against the recent promise of the Bank of Japan to keep its benchmark yield at 0%. I will explain later why they may have needed to sober up Governor Kuroda to authorise this but it must have been a busy day over there to keep it as low as 0.08%.

Dollar Hollar

If we look at the fact that the Japanese Yen has dropped sharply to 118 versus the US Dollar you will understand why the keys to the Sake cabinet at the Bank of Japan may have to have been taken off its Governor. All his Christmas wishes have come true in spite of the fact he is unlikely to celebrate it. From 115 to 118 in a manner described by Alicia Keys as “Fallin'” or by Status Quo as “Down Down” . It seems to have affected Prime Minister Abe so much he is going to join Vladimir Putin in a hot spring later.

Mario Draghi will be pleased also as the Euro slips below 1.05 versus the US Dollar as it and the UK Pound £ (1.253) get pushed lower but remain in station.

For the US itself then we see a further tightening of monetary policy via the US Dollar which has risen overall by about 1.5% since the interest-rate rise announcement. As it was expected it must be forecasts via the “dot plots” for 2017 that have changed things. Via this route monetary policy has an effect before it happens or in fact can have an impact even if it never happens something which has led to central bankers to get drunk on the implications. Care is needed though because for any real economic impact the changes and moves need to be sustained for a period.

Bank of England

This is left rather in disarray by this. If it was a schoolboy(girl) it would be in the corner wearing a dunces cap. This is the problem of having a Governor who is a “dedicated follower of fashion” when fashions change! Should the US Federal Reserve deliver on its interest-rate promises then Mark Carney will look very out of step as inflation rises above its target. Also his “sledgehammer” of QE is currently being swept aside in the UK Gilt market by worldwide trends. No wonder he is now opining on climate change and income inequality although those unfamiliar with him would do well to note his appalling record in any form of Forward Guidance. He has not be nicknamed the “unreliable boyfriend” only in jest.

Comment

As ever let us look at the impact on the real economy of this. In itself a 0.25% interest-rate rise should not have much impact but the effect via the US Dollar will be powerful. Let us start with the US economy as we have a benchmark from Fed Vice-Chair Fischer which I looked at on November 9th last year.

The New York Fed trade model suggests that a 10 percent appreciation of the U.S. dollar is associated with a 2.6 percent drop in real export values over the year. Consequently, the net export contribution to GDP growth over the year is 0.5 percentage point lower than it would have been without the appreciation and a cumulative 0.7 percentage point lower after two years

The Dollar Index has in fact risen from around 80 in July 2014 to 102.6 now so quite an effect will be taking place.

If we look abroad for an impact then the obvious place to look is Tokyo as the Bank of Japan gets what it wants with a plummeting Yen but also faces rising bond yields. It seems set to plough ahead regardless which poses worrying questions for Japanese workers and consumers as rising inflation seems set to impact on real wages.

Meanwhile out song for the day has to be this from Aloe Blacc.

I need a dollar dollar, a dollar is what I need
hey hey
Well I need a dollar dollar, a dollar is what I need
hey hey
And I said I need dollar dollar, a dollar is what I need
And if I share with you my story would you share your dollar with me

 

 

Is this the revenge of the bond vigilantes?

The latter part of 2016 has seen quite a change in the state of play in bond markets. If we look at my own country the UK we only have to look back to the middle of August to see a situation where the UK Gilt market surged to an all-time high. This was driven by what was called a “Sledgehammer” of monetary easing according to the Bank of England Chief Economist Andy Haldane.  This comprised not only £60 billion of Gilt purchases and £10 billion of corporate bond purchases but also promises of “more,more,more” later in the year. Not only was this a time of bond market highs it was also a time of what so far at least has been “peak QE” as central planners like our Andy flexed both their muscles (funded of course by a combination of the ability to create money and taxpayer backing) and their rhetoric.

However those who pushed the UK Gilt market to new highs following the Bank of England now face large losses as you see it has fallen heavily since. The ten-year Gilt yield which fell to 0.5% is now 1.5% as the Bank of England’s Forward Guidance looks ever more like General Custer at Little Big Horn with bond vigilantes replacing the Red Indians. Let me switch into price terms which will give you a clearer idea of the scale of what has taken place. There are always issues with any such measure but the UK Gilt which matures in 2030 can be considered as an average. Fresh with his central planning mandate Mark Carney paid 152.7 for it back in mid-August but last week he got a relative bargain at 138 and if today’s prices hold will be paying much less later this week.

This of course means that the Bank of England has made fairly solid losses on this round of QE as we wonder if that is the “Sledgehammer” referred to. So will anyone else who bought with them and I raise this as some may have been forced to buy in a type of “stop-loss” situation as we wait to see if the pain became too much for some pension funds and insurance companies. Such a situation would be a complete failure as we recall central banks are supposed to supervise and maintain free and fair markets which awkwardly involves stopping the very price and yield manipulation that QE relies on.

As we stand the overall Bank of England QE operation will be in profit but of course that has been partly driven by the new round of it! Anyway here is a picture of the Sledgehammer as it currently stands.

What has driven this?

The UK may well have been at least partially a driving force on the world scene in mid-summer but of course the recent player has been the Trump Truck on its journey to the White House. I recall pointing out on here on November 9th that this part of his acceptance speech meant that a new fiscal policy seemed on its way.

We are going to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals.

It had an immediate impact.

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 have of course more perspective now and this morning that yield has nudged 3.2%. Of course there is ebb and flow but also we have seen a clear trend.

Crude Oil

This has also been a player via its impact on expectations for inflation. This morning the announced deal between OPEC and non-OPEC countries saw the price of a barrel of Brent Crude Oil rising 5% to around US $57 per barrel. This compares to the recent nadir of around US $42 in early August. There are of course differences in taxation and so on but roughly I would expect this to raise annual consumer inflation by around 0.5%. This time around the effect seems set to be larger as we have so far replaced the price falls of the latter part of 2015 with rises in 2016. Of course the oil price will change between now and the end of 2016 but this gives an idea of the impact as we stand.

There has also been a general shift higher in commodities prices or to be more specific a surge in metals prices which has only partially been offset by the others. The CRB (Commodity Research Bureau) Index opened 2016 in the low 370s and is now 427.

US Federal Reserve

This has had an influence as well. It contributed to the bond market rally by the way its promises of “3-5” interest-rate rises were replaced by a reality of none so far. Now we face the prospect of this Wednesday’s  meeting thinking that they probably have to do one now to retain any credibility at all. Back on November 9th I wondered if they would and there are still grounds for that as we look at Trump inspired uncertainty and higher bond yields and US Dollar strength. However on the other side of the idea I note that @NicTrades suggesting they could perhaps do 0.5% this week. Far too logical I think!

But as we look back at nearly all of 2016 how much worse could the Forward Guidance of the US Federal Reserve have been?

The Ultras

No not the Italian football hooligans as I am thinking here of the trend that involved countries issuing ever longer dated debt. If we stay with Italy though Mark Jasayoko had some thoughts yesterday on Twitter.

Italy‘s 50year bond issued on Oct 5 is down 11.33% since. = 4yrs of coupons Dear bond bulls, enjoy holding on for the next half century.

Oh Well as Fleetwood Mac would say. There was also Austria with its 70 year bond which pretty much immediately fell and I note that this morning reports of a yield rise approaching 0.1%.  Those who gambled on the ECB coming to the rescue are left with the reality that such long-dated bonds are currently excluded from its QE. As for the 100 year bond issued by Ireland in March the price may well have halved since then.

Perhaps the outer limit of this can be found in Mexico which issued a 100 year Euro denominated bond in March 2015. Of course not even Donald Trump can put a wall around a bond but it puts a chill up your spine none the less.

As we look at the whole environment we see that taxpayers have done well here or more likely governments who will spend the “gains” and investors will have lost. Should the wild swings lead to casualties and bailouts the taxpayer picture will get more complex.

Comment

So we have seen a sort of revenge of the bond vigilantes although care is needed as a few months hardly replaces a bear market which in trend terms has lasted for around 3 decades. However there is a real economy effect here and let me highlight it from the United States.

Interest rates on U.S. fixed-rate mortgages rose to their highest levels in more than two years……..The Washington-based industry group said 30-year fixed-rate conforming mortgages averaged 4.27 percent, the highest level since October 2014……..The spike in 30-year mortgage rates, which have risen about 0.50 percentage point since the Nov. 8 election, has reduced refinancing activity.

That effect will be seen in many other countries and we will also see the cost of business loans rise. Also over time governments which have of course got used to ever cheaper borrowing seem set to find that the tie which was forever being loosened is now being tightened. How is the fiscal expansionism recommended by establishment bodies such as the IMF looking now?