Is there a shortage of US Dollars and if so why?

At the moment we are seeing quite a few trends combined which look as though they are returning us to a position where there is a shortage of US Dollars. This is troubling as this was an issue in the genesis of the credit crunch as back then it affected banks and particularly European and Japanese ones. It seems odd as the foreign exchange market is very liquid but maybe it is not liquid enough or at least at the right price. Back in March Pictet Bank provided something of an explainer.

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.

It is pretty much back to that level (43) after going above 60 and just for clarity that is 0.6%. Here is the first lesson  of this saga in that in our present world some interest-rates do not seem to have much impact at all as for example I did warn on the third of this month that a rise in Argentinian ones would backfire. Some 9.75% higher later I guess my point has been made for me. However here we have a 0.6% or so at the peak looks in terms of Carly Rae Jepson that it “really,really,really,really” matters. This appears to be driven by two factors the first is that it affects the “precious” otherwise known as the banks and is in US Dollars. Of course the official story is rather different as the excerpt below from the May Inflation Report of the Bank of England shows.

In the years following the crisis, funding spreads narrowed as banks repaired their balance sheets and became more resilient.

I am resilient, we are resilient , it has unexpectedly collapsed ….

US Dollar

This has been a factor as we note that recently the US Dollar has been what we might call King Dollar again. If we use the US Dollar Index or DXY for this we see that it has rallied four points since mid April from over 89 to over 93 now. The bigger turn came at the opening of June 2014 when it has dipped below 80. So the price of the US Dollar has risen too over this phase. Whilst the DXY is now out of date in trade terms as for example the Chinese Yuan is missing it does a job for this sort of analysis as the Yen and Euro are there.

US Interest-Rates and Yields

This has been a case of singing along with Jackie Wilson.

You know your love (your love keeps lifting me)
Keep on lifting (love keeps lifting me)
Higher (lifting me)
Higher and higher (higher

The US Federal Reserve has increased its official interest-rate to between 1.5% and 1.75% and nearly as importantly has been raising the rhetoric about there being more (3/4) increases this year. I am not convinced by this but if we look around markets seem to be accepting it perhaps on the grounds that unlike other central banks the Fed has at least been reasonably consistent.

Also there have been rises in bond yields with the media concentrating on 3% for the ten-year Treasury Note and then 3.1%. But for this purpose more significant is what has taken place at the shorter maturities. The chart below gives us a handle on what has been taking place there.

Let me be clear here this is a financial markets thing rather than a real economy thing but these do have a way of leaking across and tripping up the unwary. Adding to this we are seeing real world effects too as I note this from Reuters.

Interest rates on U.S. 30-year fixed-rate mortgages rose to the highest in seven years as a bond market selloff this week propelled 10-year yields to the highest since July 2011, Freddie Mac said on Thursday………Thirty-year mortgage rates averaged 4.61 percent in the week ended May 17, matching the level last seen in May 2011.

Of course they affect the banks from another route.

Quantitative Tightening

One way that the supply of US Dollars is being reduced is quite basic as the US Federal Reserve has set out to do that explicitly. From a balance sheet which just passed US $ 4.5 Trillion we now see that it has fallen to US $4.36 trillion which put like that may not seem a lot but that is US $140 billion or so. The pace is also picking up a bit so in terms of narrow money or what central bankers have loved to call “high-powered money” there is less of it to go around from this source at any rate.

Crude Oil

This too seems to have been a factor in the recent moves and there is some logic to this as of course the vast majority of oil business is settled in US Dollars. Not all of it anymore but a large proportion. Thus the rise in the price exemplified by the fact that the price of a barrel of Brent Crude Oil is now just below US $80 or some 52% over the past year has also sucked US Dollars out of the system. This is my view is of course mostly a timing thing as the oil producers will then spend them as for example one of the ways the money gets recycled is by the Gulf States buying weapons but we know that timing matters in the credit crunch era. Supposedly because we are more resilient as I look up that particular page in my financial lexicon for these times.

There are many views on this but here is one from a social media exchange I was involved in.

My thesis is the $/oil correlation is a consequence of oil market design/paradigm shift. This began 1st July 2017 & completed a couple of months ago. ie the dollar is now on an If I’m right, when (not if) oil falls the $ will fall with it ( @cjenscook )

Comment

Let us now look at it the other way from the point of view of the central bankers. Let me take you to the US Federal Reserve website where with something of a fanfare it declared this back in the day.

In May 2010, the FOMC announced that in response to the re-emergence of strains in short-term U.S. dollar funding markets it had authorized dollar liquidity swap lines with the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, and the Swiss National Bank.

They had been gone for all of three months and were supposed to go as my emphasis below returns us again to my financial lexicon for these times.

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

Very little is being used right now as one European bank has taken 80 million US Dollars worth in revolving 6 day credit or there are more than one. But this reminds me of the old wartime analogy of President FD. Roosevelt and loaning your neighbour a hose in case he has a fire. Meanwhile the emerging markets have started to be called the submerging ones.

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What are the prospects for the US economy?

As we progress through 2018 we find eyes as ever turning regularly to the US economy. Not only to see what the world’s largest economy is up to but also to note any changes. The economic growth news for the first quarter was pretty solid. From the Bureau of Economic Analysis or BEA.

Real gross domestic product (GDP) increased at an annual rate of 2.3 percent in the first quarter of 2018
according to the “advance” estimate released by the Bureau of Economic Analysis. In the
fourth quarter, real GDP increased 2.9 percent.

So whilst we see a slowing it is exacerbated in feel by the way the numbers are annualised and is much lower than that seen in the UK and much of Europe. Also the US has developed something of a pattern of weak first quarter numbers so we need to remind ourselves that the number is better than that seen in both 2016 and 2017. As to the detail the slowing was fairly general. If we were looking for an estimate of the recovery since the credit crunch hit then we get it from noting that if we use 2009 as out 100 benchmark then the latest quarter was at 120.58.

Let us move on with a reminder of the size of the US economy.

Current-dollar GDP increased 4.3 percent, or $211.2 billion, in the first quarter to a level of $19.97
trillion.

Looking ahead

There was something potentially rather positive tucked away in the Income report that was released with the GDP data.

Disposable personal income increased $222.1 billion, or 6.2 percent, in the first quarter, compared with
an increase of $136.3 billion, or 3.8 percent, in the fourth quarter. Real disposable personal income
increased 3.4 percent, compared with an increase of 1.1 percent.

At a time of weak wages growth considering the economic situation that was a strong reading which may feed forwards into future consumption numbers. I wondered what drove it but in fact it was pretty broad-based across the different sectors with the only fall being in farm income. As an aside the personal income from farming was surprisingly small considering the size of the US farming sector at US $27.9 billion.

Moving onto the Nowcasts of GDP the news has also been good. From the Atlanta Federal Reserve.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2018 is 4.0 percent on May 3, down from 4.1 percent on May 1.

They start the series in optimistic fashion so let us say that around 3% may well be where they end up unless something fundamental changes.

Moving onto the business surveys we saw this yesterday.

April survey data indicated a strong expansion in
business activity across the U.S. service sector.
However, although the rate of growth accelerated, it
remained below the series’ long-run average.
Meanwhile, the upturn in new business quickened
to a sharp rate that was the fastest since March
2015. ( Markit PMI ).

Which added to this from May Day.

April survey data signalled a steep improvement in
operating conditions across the U.S. manufacturing
sector. The latest PMI reading was the highest since
September 2014, supported by stronger expansions
in output and new orders. Moreover, new business
rose at the sharpest pace in over three-and-a-half
years. ( Markit PMI)

Thus the summary for the start of the second quarter is so far so good which again means the US is in better shape than elsewhere at least for now.

Inflation

Earlier this week I note that the US Federal Reserve was for once on target. What I mean by that was that the PCE ( Personal Consumption Expenditure) inflation rate rose by 2% in March compared to a year before. Expectations of this are what caused the addition of the word I have highlighted in Wednesday’s Fed statement.

The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.

There has been a lot of debate over this much of it misinformed. Firstly central bankers virtually never mean it and secondly they are hinting at a possible run higher after a long period when it has been below the 2% target.

Such a likelihood was reinforced by the Markit PMI surveys.

On the price front, input cost inflation picked up in
April. The rate of increase was strong overall and
the second-quickest since June 2015. (services)

Meanwhile, average prices charged rose at the
quickest pace since June 2011, with the rate of
inflation accelerating for the fourth successive
month. Survey respondents commonly noted that
higher charges were due to increased costs being
passed on to clients. (Manufacturing)

Of course having begun the process of raising interest-rates without the most common cause of it these days ( a currency collapse) the US Fed is not in that bad a place at least in its own mind should inflation overshoot the target in the summer. Although of course as I have pointed out before in terms of logic it should have been more decisive rather than dribbling out increases along the lines expected for the rest of 2018 by Reuters.

While the Fed left interest rates unchanged on Wednesday, it is possibly set to raise them by a total of 75 basis points this year.

King Dollar

This was summarised by Reuters thus.

In just two weeks the dollar has surged nearly four percent against a basket of the most traded currencies, erasing all the losses it had suffered since the start of 2018 .DXY.

Against a broader group of currencies, including those from emerging markets, the greenback is now in positive territory against half of them.

This brings us back to the topic of yesterday where the US Dollar rebound has hit the weaker currencies such as the Turkish Lira and the Argentine Peso hard. Following on from the change of heart of the unreliable boyfriend in the UK it has seen the UK Pound £ dip below US $1.36 and the Euro is below US $1.20.

Is this a return to the interest-rate differentials that had up to then been ignored? Maybe a bit but perhaps the reality is more that the modern currency trade seems to be to follow the economic growth and as we have observed above at the moment the US economy looks relatively strong.

Comment

So in terms of conventional economic analysis things look pretty good for the US economy as we stand. The danger might be highlighted this afternoon from the wages data in the non farm payrolls release. This is because rising inflation will chip away at real wages if the rate of wages increase stays at 2.7%. Of course that reminds us of the issue of the fact that wages growth is only at that level with an unemployment rate at 4% leading many economists to scrabble through Google searches trying to redact references to full employment at a higher rate.

Elsewhere there are potential concerns of which one is debt. Should growth continue on its current path then it will help the national debt withstand the pressure placed on it by the Trump tax plan. On the private-sector side though familiar fears are on the scene.

 

Yahoo Finance helpfully updates us with this.

They’re also safer than junk bonds, at least in theory, with lenders getting repaid before creditors when firms get into trouble

What could go wrong?

Finally in spite of the recent dollar strength the Yen has pushed its way back to 109 leaving me with this from Carly Simon.

Why does your love hurt so much?
Don’t know why

 

 

 

How soon will the US national debt be unaffordable?

It is time to look again at a subject which has been a regular topic in the comments section. This is what happens when national debt costs start to rise again? We have spent a period where rises in national debts have been anesthetized by the Quantitative Easing era where central bank purchases of sovereign debt have had a side effect of reducing debt costs in some cases by very substantial amounts. Of course  it is perfectly possible to argue that rather than being a side effect it was the real reason all along. Personally I do not think it started that way but once it began like in some many areas establishment pressure meant that it not only was expanded in volume but that it has come to look in stock terms really rather permanent or as the establishment would describe it temporary. Of the main players only the US has any plan at all to reduce the stock whereas the Euro area and Japan continue to pile it up.

So let us take a look at projections for the US where the QE flow effect is now a small negative meaning that the stock is reducing. Here is Businessweek on the possible implications.

Over the next decade, the U.S. government will spend almost $7 trillion — or almost $60,000 per household — servicing the nation’s massive debt burden. The interest payments will leave less room in the budget to spend on everything from national defense to education to infrastructure. The Congressional Budget Office’s latest projections show that interest outlays will exceed both defense discretionary spending and non-military discretionary spending by 2025.

The numbers above are both eye-catching and somewhat scary but as ever this is a case of them being driven by the assumptions made so let us break it down.

US National Debt

It is on the up and up.

Debt held by the public, which has doubled in the past
10 years as a percentage of gross domestic product
(GDP), approaches 100 percent of GDP by 2028 in
CBO’s projections.

Those of you who worry we may be on the road to World War III will be troubled by the next bit.

That amount is far greater than the
debt in any year since just after World War II

As you can see the water has got a bit muddled here as the CBO has thrown in its estimates of economic growth and debt held by the public so let us take a step back. It thinks that annual fiscal deficits will rise to above US $1 Trillion a year in this period meaning that from now until 2028 they will total some US $12.4 billion. That will put the National Debt on an upwards path and the amount held by the public will be US $28.7 Trillion. Sadly they skirt the issue of how much the US Federal Reserve will own so let us move on.

Deficits

These have become more of an issue simply because the CBO thinks the recent Trump tax changes will raise the US fiscal deficit. The over US $1 Trillion a year works out to around 5% of GDP per annum.

Bond Yields

These are projected to rise as the US Federal Reserve raises its interest-rates and we do here get a mention of it continuing to reduce its balance sheet and therefore an implied reduction in its holdings of US Treasury Bonds.

Meanwhile, the interest rate on 10-year Treasury notes increases from its average of 2.4 percent in the latter part of 2017 to 4.3 percent by the middle of 2021. From 2024 to 2028, the interest rate on 3-month Treasury bills averages
2.7 percent, and the rate on 10-year Treasury notes,
3.7 percent.

Currently the 10-year Treasury yield is 2.83% so the forecast is one to gladden the heart of any bond vigilante. If true this forecast will be a major factor in rising US debt costs over time as we know there will be plenty of new borrowing at the higher yields. But here comes the rub this assumes that these forecasts are correct in an area which has often been the worst example of forecasting of all. For example the official OBR forecast in the UK in a similar fashion to this from the CBO would have UK Gilt yields at 4.5% whereas in reality they are around 3% lower. That is the equivalent of throwing a dart at a dartboard and missing not only it but also the wall.

Inflation

This comes into the numbers in so many ways. Firstly the US does have inflation linked debt called TIPS so higher inflation prospects cost money. But as they are around 9% of the total debt market any impact on them is dwarfed by the beneficial impact of higher inflation on ordinary debt. Care if needed with this as we know that price inflation does not as conventionally assumed have to bring with it wage inflation. But higher nominal GDP due to inflation is good for debt issuers like the US government and leads to suspicions that in spite of all the official denials they prefer inflation. Or to put it another way why central banks target a positive rate of consumer inflation ( 2% per annum) which if achieved would gently reduce the value of the debt in what is called a soft default.

The CBO has a view on real yields but as this depends on assumptions about a long list of things they do not know I suggest you take it with the whole salt-cellar as for example they will be assuming the inflation target is hit ignoring the fact that it so rarely is.

In those years, the real interest rate on
10-year Treasury notes (that is, the rate after the effect of
expected inflation, as measured by the CPI-U, has been
removed) is 1.3 percent—well above the current real rate
but more than 1 percentage point below the average real
rate between 1990 and 2007.

Economic Growth

In many ways this is the most important factor of all. This is because it is something that can make the most back-breaking debt burden suddenly affordable or as Greece as illustrated the lack of it can make even a PSI default look really rather pointless. There is a secondary factor here which is the numbers depend a lot on the economic impact assumed from the Trump tax cuts. If we get something on the lines of Reaganomics then happy days but if growth falters along the lines suggested by the CBO then we get the result described by Businessweek at the opening of this article.

Between 2018 and 2028, actual and potential real output
alike are projected to expand at an average annual
rate of 1.9 percent.

The use of “potential real output” shows how rarefied the air is at the height of this particular Ivory Tower as quite a degree of oxygen debt is required to believe it means anything these days.

Comment

The issue of the affordability forecast is mostly summed up here.

CBO estimates that outlays for net interest will increase
from $263 billion in 2017 to $316 billion (or 1.6 percent
of GDP) in 2018 and then nearly triple by 2028,
climbing to $915 billion. As a result, under current law,
outlays for net interest are projected to reach 3.1 percent
of GDP in 2028—almost double what they are now.

This terns minds to what might have to be cut to pay for this. However let me now bring in what is the elephant in this particular room, This is that if bond yields rise substantially pushing up debt costs then I would expect to see QE4 announced. The US Federal Reserve would step in and start buying US Treasury Bonds again to reduce the costs and might do so on a grand scale.. Which if you think about it puts a cap also on its interest-rate rises and could see a reversal. Thus the national debt might remain affordable for the government but at the price of plenty of costs elsewhere.

 

 

 

 

How much will interest-rates rise?

The issue of interest-rate rises has suddenly become something of a hot topic and let me open with the words of Jamie Dimon of JP Morgan. From the Financial Times.

Jamie Dimon, head of JPMorgan Chase, has warned that the US economy is at risk of overheating, raising the prospect that the Federal Reserve may soon need to slam on the brakes to prevent wages and prices from rising too quickly.

There are more than a few begged questions here but let us park them for now and carry on.

“Many people underestimate the possibility of higher inflation and wages, which means they might be underestimating the chance that the Federal Reserve may have to raise rates faster than we all think,” he wrote. “We have to deal with the possibility that, at one point, the Federal Reserve and other central banks may have to take more drastic action than they currently anticipate.”

Okay let us break this down. Firstly we are back to output gap theory again which of course has been wrong,wrong and wrong again in the credit crunch era. If there are signs of overheating then they are to be found in asset markets where we have seen booming bond prices and house prices and until recently all-time highs for equity markets. Only on Tuesday we looked at US house price growth of 6% or 7% depending which data you use.

Wages

I have picked this out because there has been quite a swerve from Jamie Dimon as for so long nearly everyone has been hoping for higher wages. Now suddenly apparently a rise is a bad thing? The Financial Times article implicitly parrots this line.

The prospect of an overheating economy has spooked the financial markets as recently as February, when stronger-than-expected US wage growth sparked the worst Wall Street sell-off in six years.

In terms of numbers a rise in average earnings growth per hour to 2.9% was hardly groundbreaking and of course it has since faded away showing the unreliable nature of one month’s data. In reality to return to old era trends we would need wages growth of 3.5%+ for a while. But in Jamie’s world that seems to be a bad thing although apparently not always. From Bloomberg.

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon received $29.5 million in total compensation for his work in 2017, an increase of 5.4 percent from a year earlier.

So we are left mulling a view where what was supposed to be good would now be bad! Although those of you who in the comments section have argued we will not see major interest-rate rises until wage rises for the ordinary person picks up are permitted a wry smile at this point.

What is expected?

From the FT article.

Prices of Fed funds futures suggest few expect the Fed to raise rates by more than three times this year, as policymakers have indicated. Longer-term market measures also indicate that investors expect inflation and bond yields to remain subdued for years to come.

I put the second sentence in because it is positively misleading. What those measures are provide a balancing of markets now and usually have very little to do with what will happen. Returning to interest-rates we got a view this week from former Federal Reserve Chair Janet Yellen.

At Monday’s larger forum for Jefferies clients, she expressed the view that three or four rate rises were likely this year, and that recent U.S. tax cuts and a boost in government spending posed at least some risk of running the economy hot, according to the first source, who requested anonymity. ( CNBC)

This is the awkward bit about the Jamie Dimon claim which is that the existing and likely moves in US interest-rates are a response to expected higher inflation anyway as of course as we have looked at many times it is still below the target. Back to Janet.

Later, over dinner at the Manhattan penthouse of Jefferies’ chief executive, Yellen told executives from hedge funds, private equity firms and other companies that she considered inflation to be in check and unlikely to spike, so rates would stay relatively low, according to a second person familiar with the discussion.

Take that as you will as of course we discovered in her time that she does not really understand inflation.

The Bank of England

So how will it respond as traditionally it follows the US Federal Reserve?

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Oh sorry not that one. Let us move onto its favourite publication the Financial Times.

Policymakers at the Bank of England are debating whether to be more forthcoming about their future plans for interest rates, as they gear up for a crunch vote on the cost of borrowing next month.

This is fascinating stuff because it both implies and suggests they know what their forecasts are! Let me give you an example reviewed favourably by Chris Giles the economics editor of the FT.

But last month Gertjan Vlieghe, an external MPC member, broke ranks with his colleagues on the nine-member committee when he said that rates could rise above 2 per cent over the same period.

Actually if we remove the rose-tintin ( sorry but he is Belgian) he seems an excitable chap as this from the Evening Standard in April 2016 reveals.

Vlieghe’s answer is intriguing: “Theoretically, I think interest rates could go a little bit negative.”

The long discussion on negative interest-rates that took place was clearly a hint of expected policy and means that Gertjan was wrong which poses a question over why we should listen this time? Although Chris Giles has a very different view.

Not sure it matters if people believe them.

I think it matters a lot. Oh and as the Swedish Riksbank has found it.

The Riksbank has had some difficulties with its predictions.

But to be fair Chris Giles does have a sense of humour ( I think).

But there remains concern that the BoE could undermine trust in it as an institution running an important public policy if it makes predictions about interest rates that do not come to pass.

Comment

Let me open with a rather good reply to this from GreaterFool.

Any shreds of credibility that the BoE once had disappeared into smoke after the forward guidance experiment. Telling people that you’ll raise rates after unemployment falls below 7% and then dropping them again when unemployment is below 5% will do that.

In fact the hits keep coming as though in this instance from Felix2012

There are quite a few commenters here who still take MPC seriously, unfortunately.

As to clarity well we did get that from Governor Carney back in June 2014.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced….“It could happen sooner than markets currently expect.

That was taken as a clear signal back then and the next day saw a lot of market adjustments which later led to losses as it never happened. Of course the road to a Bank Rate cut after Governor Carney hinted at it was both real and fast as we discovered 3 years later.

So what can we expect? The Bank of England has rather committed itself to a May Bank Rate rise which if you look at falling inflation and some weaker economic news looks out of touch. We have seen signs of slowing in Europe too as German industrial production has shown already today. The US Federal Reserve will no doubt carry on course unless there is a shock stateside although not everyone even thinks we need any tightening. BoI is the Bank of Italy.

 

What is happening to US house prices?

If you are a believer that the extraordinarily stimulatory monetary policies of the credit crunch era have boosted house prices via their impact on asset prices then the United States currently provides food for thought. This is because of this.

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 1-1/2 to 1-3/4 percent.

For younger readers the US Federal Reserve has raised official interest-rates to extraordinary heights and for older ones it has barely got into the foothills. Either way The Fed-Home as Google now describes us thinks this.

 The stance of monetary policy remains accommodative,

In addition to the series of increases in interest-rates we have seen and continue to expect we are now in what I guess we need to call the QT or Quantitative Tightening era or as Marketwatch described it last month.

Last fall, the Fed announced plans to slowly reduce its balance sheet on auto-pilot, allowing holdings to shrink by $20 billion each month this quarter and moving up to a maximum of $50 billion per month by the end of the year.

From the peak of US $4.5 trillion the balance sheet has shrunk from US $4.5 trillion at its peak to US $.4.4 trillion as of the latest update. So QT has had an impact in terms of a small flow reduction which has led to a small stock reduction. Thus we have gone from small up to small down if we look at it like that although of course in other terms US $100 billion or so was a lot of money.

If we look ahead then Marketwatch point out that we were given a hint of a possible future late last year.

The Fed has not announced how low it wants to shrink its balance sheet. New Fed Chairman Jerome Powell discussed a target range of $2.5 trillion to $2.9 trillion in his confirmation hearing last fall.

Okay what does this impact?

A central bankers heart will gladden when they see these numbers from Money Magnify.

In the second quarter of 2017, real estate values in the United States surpassed their pre- housing crisis levels. The total value of real estate owned by individuals in the United States is $24 trillion, and total mortgages clock in at $9.9 trillion. This means that Americans have $13.9 trillion in homeowners equity.12 This is the highest value of home equity Americans have ever seen.

As they do not let me point out that such value calculations have the flaw of using a marginal price for an average concept which looks great when prices rise but not to great when they fall. If we move on we also see a consequence of the credit crunch era.

Current homeowners have mortgage payments that make up an average of just 16.5% of their annual household income.

That will be changing but not in the way that you think as the US market is mostly one of fixed-rate mortgages. So whilst both the policy changes above may affect it we see that over time QT is likely to have the largest impact. This is because the main player is the 30 year fixed rate mortgage which means that the 30 year Treasury yield is more of a factor that short-term interest-rates. When you look at what it has done you see that in a broad sweep the US Fed helped reduce it by around 1% from 2013 to late 2016 and it then rose by 1% to the current 4.44%. Actually if you look at the chart it is hard not to have a wry smile as for all the rhetoric and talk about QT the main player seems to have been the Donald as most of the rise was around the election of President Trump. Humbling for central bankers and their dreams of ruling the world! If you want to know how this took place I looked at it on the 9th of November 2016.

Before I depart the economic situation let me point out that we may well end up discussing as so often two different markets.

Today, half of all borrowers put down 5% or less. More than 10% of borrowers put 0% down. As a result, the average loan-to-value ratio at origination has climbed to 87%

Manhattan

Is this a case of a perfect storm? We have the effect of the factors above although of course they affect the 0.1% much less than the rest of us. But the winds of change as we have seen in central London have been blowing against capital city ( in which category New York is unofficially if not officially) property prices after many years of plenty. Also there has been this according to the Financial Times.

Some buyers held off buying real estate as they grappled with the impact of President Donald Trump’s changes to the federal tax code, which introduced a cap on the deduction of state and local taxes, including property taxes, from federal tax bills. It also reduced the size of mortgages eligible for interest deductions. The change is expected to hit high earners in high-tax states including New York, particularly in New York City.

This has led to this.

The number of co-op and condominium sales in Manhattan fell nearly 25 per cent during the first quarter compared to the same period last year………..It was the largest annual decline in sales in nine years, according to the report.

Okay so what about prices?

The average sale price across Manhattan fell by 8.1 per cent from the year-earlier quarter, and the average price per square foot also recorded a sharp decline, falling by 18.5 per cent to $1,697.

Perhaps fearing a lack of sympathy amongst even its readers the FT takes its time to point out what this means.

The average sales price of a luxury apartment fell 15.1 per cent, down from $9.36m in the first quarter of 2017 to $7.94m in the first quarter of this year, and the number of sales was down 24.1 per cent. The number of newly built apartments that went into contract fell 54 per cent.

As to lack of sympathy that was at play in the comments.

So now the average luxury apartment in Manhattan costs only $8 million? Not yet a bargain then? ( Genghis)

As was some perspective.

1600 usd per sqf for prime ? Still a bargain compared to London (JP1)……..I know. And positively a steal compared to Hong Kong !! (observer).

Looking wider

You might from the above expect lower prices but in fact at the end of last week we were told this. From Zillow Research.

The continuing inventory pinch helped boost the U.S. national Case Shiller index 6.2 percent in January from a year earlier, down from a 6.3 percent gain in December. Case-Shiller’s 10-City Composite rose 6 percent, while the 20-City Composite climbed 6.4 percent year-over-year.

Some places are in fact red hot.

Home prices in Seattle, Las Vegas, and San Francisco posted the highest annual gains among the 20 cities, rising 12.9 percent, 11.1 percent and 10.2 percent, respectively.

Zillow remain of the view that house prices will continue to rise as I note that rather like us in the UK there is a perception that too few houses have and indeed are being built. For perspective I note that a different piece of research tells us this.

Home values rose 7.6 percent year-over-year to a median of $210,200, with the San Jose, Calif., metro posting astonishing annual home value growth of 26.4 percent, reaching a median of $1.25 million.

Comment

We find ourselves reflecting on the words of Glenn Frey again.

The heat is on

Except not in the way that economics 101 would have predicted as we continue to see house price rises if we ignore the “international effect”. According to the Brookings Institute there may be a deeper factor as human behaviour returns to what it was.

The Census Bureau’s annual county and metropolitan area estimates through 2017 reveal a revival of suburbanization and movement to rural areas along with Snow Belt-to-Sun Belt population shifts. In addition, the data show a new dispersal to large- and moderate-sized metro areas in the middle of the country—especially in the Northeast and Midwest. If these shifts continue, they could call into question the sharp clustering of the nation’s population—in large metropolitan areas and their cities—that characterized the first half of the 2010s.

So the suburbs are back in favour so let me leave you with the thoughts of Arcade Fire on the subject.

And all of the walls that they built in the seventies finally fall
And all of the houses they built in the seventies finally fall

Maybe they got onto the consumer society as well in a different song.

(Everything now!) I need it
(Everything now!) I want it
(Everything now!) I can’t live without
(Everything now!) I can’t live without
(Everything now!) I can’t live
(Everything now!)

The Libor problem is also a US Dollar problem

There is much to consider today as we consider the actions of our lords (ladies) and masters or rather our central bankers. Last night brought something which as we have noted before was in the category of “no surprises” sung about by Radiohead.

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 1-1/2 to 1-3/4 percent. The stance of monetary policy remains accommodative,

That was of course the US Federal Reserve and I added the last bit because in a few words it tells us that they are not finished yet. Regular readers will be aware that I think it would be much better to simply raise rates to 2% and take a break as moving at at snail’s pace gives more time for something to go wrong. This brings me to two consequences of what is happening.

Libor

No not the scandals at least not yet! this time we are looking for the first time in a while at sustained increases. From Bloomberg yesterday.

The three-month London interbank funding rate rose to 2.27 percent Wednesday, the highest since 2008. The concern is that the Libor blowout may have more room to run, a prospect that borrowers and policy makers in various markets are just beginning to grapple with.

One way of looking at this is that as we expect more rises that seems reasonable and if we look at the past rather small fry.

Of course not all of us can remember 1994 and the financial world is of course to coin a phrase “resilient” at least according to the central bankers. This has led people to mull this.

“There has been sort of the perfect storm of factors tightening financial conditions,” said Russ Certo, head of rates at Brean Capital in New York. “Banks do have tremendous liquidity still, but it’s at a higher price.”

You may recall a few years back when worries about bank liquidity in US Dollars were all the rage. This was the era of central banks making agreements for foreign exchange swaps which were mostly ways of making sure they could get US Dollars for their banks from the original source ( the place that can print them at will….) if needed. Here is a refresher on the subject.

In November 2011, the Federal Reserve announced that it had authorized temporary foreign-currency liquidity swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. These arrangements were established to provide the Federal Reserve with the capacity to offer liquidity to U.S. institutions in currencies of the counterparty central banks (that is, in Canadian dollars, sterling, yen, euros, and Swiss francs). The Federal Reserve lines constitute a part of a network of bilateral swap lines among the six central banks, which allow for the provision of liquidity in each jurisdiction in any of the six currencies should central banks judge that market conditions warrant.

These exist for the opposite purpose as whilst the US Fed is describing things from its point of view and it may one day need some £’s Yen or Euros it is vastly more likely that the counterparty central bank will want US Dollars. After all if the world has a reserve currency in spite of some changes it is it and the likely song is from Aloe Blacc.

I need a dollar, dollar
Dollar that’s what I need
Well I need a dollar, dollar
Dollar that’s what I need
Said I said I need dollar, dollar
Dollar that’s what I need
And if I share with you my story would you share your dollar with me?

Oh and you may like to know that the US Federal Reserve eventually fell into line with the definition of temporary to be found in my financial lexicon for these times.

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

The banks

In the end it all comes down to the “precious” of course and food for thought has been provided by what might be called the central bankers central bank choosing this morning to put this out on social media. From the Bank for International Settlements.

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

They seem to be pointing the finger in one direction.

We find that Japanese banks pay a premium in their repurchase agreements (“repos”) with US MMFs. We show that the bargaining power of MMFs fund families, together with the particular demand for long term funding of Japanese banks, help explain this premium. ( MMF = Money Market Funds).

This has been a theme of my career which is that in terms of overseas buying ( UK Gilts, Australian property etc…) the Japanese overpay. Care is needed though as the stereotypical response of assuming stupidity ignores the possibility of a longer game being in play. In this instance they have responded.

 We provide evidence for European banks intermediating repos to Japanese banks, with economically significant estimated spreads from maturity transformation.

So any issues with the Japanese banks would also affect European ones? The mind boggles as of course contagion was supposed to be off the menu these days due to all the regulation and reform. As we look back I am reminded that it was European and on a smaller scale Japanese banks which dipped into these lines back in the day.

Would it be considered rude to point out that shares in my old employer Deutsche Bank are down another 2% as I type this? More significantly the 11.8 Euros is a fair bit lower than the 17.1 of mid-December.

Libor-OIS

As a consequence of the factors above this is also taking place. From Bloomberg reporting on some analysis from Citibank.

Strategists at the U.S. lender predict that the gap between the London interbank offered rate for dollars and the overnight indexed swap rate will continue to widen, potentially leading to a sharper tightening of financial conditions than central bankers have been anticipating. The differential between three-month rates has already more than doubled since the end of January to 55 basis points, a level unseen since 2009.

Now 55 basis points sounds much more grand that 0.55% but there is a flicker here as we try to price risk.

Comment

As you can see there are stresses in the financial system right now. Some of this was always going to take place when interest-rates went back up. But for me the real issue comes when we look at another market. This is because whichever way you look at the analysis here you would think that the US Dollar would be rising. You can arrive at that route by observing the apparent demand for US Dollars or by the higher interest-rates being paid in it or both. Yet it has been singing along to Alicia Keys.

Oh baby
I, I, I, I’m fallin’
I, I, I, I’m fallin’
Fall

I keep on
Fallin’

You can represent this by the UK Pound £ being in the US $1.41s or the Japanese Yen being in the 105s take your pick. The latter is off though because if Japanese banks are so keen for US Dollars why is the Yen so strong? To my mind that is much more worrying than Libor on its own as we switch to Carly Simon.

Why?……Don´t know why

Meanwhile returning to the shores of the UK I expect Royal Bank of Scotland to be along. After all it has been in everything else.

Is the US economy at a turning point?

Yesterday brought us some significant news from the US economy. One segment of this was the testimony given by the new Chair of the US Federal Reserve Jerome Powell as everyone combs his words looking for any signs of a change in policy. The sentence from the written testimony that has drawn most attention is below.

In gauging the appropriate path for monetary policy over the next few years, the FOMC will continue to strike a balance between avoiding an overheated economy and bringing PCE price inflation to 2 percent on a sustained basis. ( PCE is Personal Consumption Expenditure )

The reason for that is the use of the word “overheated” which brings with it all sorts of value judgements and implications. This was added to by the phrase he added to this.

My personal outlook for the economy has strengthened since December.

We also got an explanation of what was driving such thoughts.

 In particular, fiscal policy has become more stimulative and foreign demand for U.S. exports is on a firmer trajectory. Despite the recent volatility, financial conditions remain accommodative.

The nod to fiscal policy was a change of emphasis from his predecessor Janet Yellen as I am reminded of the analysis of the US Congress on the subject we looked at on February the 8th.

The Joint Committee staff estimates that this proposal would increase the average level of output (as measured by Gross Domestic Product (“GDP”) by about 0.7 percent relative to average level of output in the present law baseline over the 10-year budget window.

The underlying position

The thoughts above added to the existing situation which Chair Powell described thus.

Turning from the labor market to production, inflation-adjusted gross domestic product rose at an annual rate of about 3 percent in the second half of 2017, 1 percentage point faster than its pace in the first half of the year.

So the fiscal policy will add to an already strengthening situation and the emphasis is mine.

Economic growth in the second half was led by solid gains in consumer spending, supported by rising household incomes and wealth, and upbeat sentiment. In addition, growth in business investment stepped up sharply last year, which should support higher productivity growth in time.

The reason I have highlighted that bit is because Chair Powell had explicitly linked it to wage growth.

Wages have continued to grow moderately, with a modest acceleration in some measures, although the extent of the pickup likely has been damped in part by the weak pace of productivity growth in recent years.

If we switch to the section on employment we see a continuing theme.

Monthly job gains averaged 179,000 from July through December, and payrolls rose an additional 200,000 in January. This pace of job growth was sufficient to push the unemployment rate down to 4.1 percent, about 3/4 percentage point lower than a year earlier and the lowest level since December 2000.

Are we seeing a hint of Phillips Curve style analysis which would predict wage growth acceleration? We did get told he likes policy rules.

Personally, I find these rule prescriptions helpful

Also you may note that he hinted at a pick-up in jobs growth in January which comes when the unemployment rate tells us that according to old policy rules we have what would have been considered to be full employment. It was also interesting that he skirted what we might call the missing eleven million or so via the drop in the participation rate.

the labor force participation rate remained roughly unchanged, on net, as it has for the past several years

I am not sure that it all be blamed on retiring “baby boomers” as we were told.

So we are told that the economy is strong and got a pretty strong hint that higher wage growth is expected and of course that follows the 2.9% growth seen in January in average hourly earnings.

Wages should increase at a faster pace as well.

What about inflation?

That is supposed to pick-up as well as we continue our journey on a type of virtual Phillips Curve.

 we anticipate that inflation on a 12-month basis will move up this year and stabilize around the FOMC’s 2 percent objective over the medium term.

These days it is something of a residual item in speeches by central bankers. This is for two main reasons. The first is that they have really been targeting output and the labour market. The second is that even after an extraordinary amount of QE they failed to generate the ( consumer) inflation they promised and so they are de-emphasising it.

Overheating?

This subject flickered onto some radar screens yesterday as they observed this from the Census Bureau.

The international trade deficit was $74.4 billion in January, up $2.1 billion from $72.3 billion in December.
Exports of goods for January were $133.9 billion, $3.1 billion less than December exports. Imports of goods
for January were $208.3 billion, $0.9 billion less than December imports.

This is something which has been rising as we note this from the Bureau of Economic Analysis or BEA earlier this month.

For 2017, the goods and services deficit increased $61.2 billion, or 12.1 percent, from 2016. Exports
increased $121.2 billion or 5.5 percent. Imports increased $182.5 billion or 6.7 percent.

So we may well be seeing economic growth sucking in imports yet again or a different form of overheating. Thus the words of Chairman Powell above on exports were both true ( they are up) and to some extent misleading as imports have risen faster. This is reinforced with my usual caution about monthly trade data by  the size of the January  goods deficit which is the largest for ten years. If we allow for the fact that the shale oil and gas boom flatters the figures the numbers take a further turn for the worse.

Consumer Confidence

We return to the same theme as we note this.

The Conference Board Consumer Confidence Index® increased in February, following a modest increase in January. The Index now stands at 130.8 (1985=100), up from 124.3 in January. The Present Situation Index increased from 154.7 to 162.4, while the Expectations Index improved from 104.0 last month to 109.7 this month.

So another signal looks strong.

Comment

If we start with the analysis of Chair Powell we see that the US Federal Reserve plans to continue interest-rate rises this year and that it means to do so either 3 or more likely 4 times. This is based on the view that otherwise the economy will overheat as discussed above. Let me add a personal view to this which is the current madness of going along at 0.25%, why not raise by 0.5% in March and then sit back for a while and see what develops? Monetary policy has long lags and if you take ages to act you are at an ever greater risk of being proved wrong.

Another factor in this is the data I have looked at above as I have held something back until now which is troubling. Here is the extra bit from the consumer confidence figures.

Consumer confidence improved to its highest level since 2000 (Nov. 2000, 132.6).

Now if we look at the trade in goods figures the deficit was last higher in January 2008 a time when consumer confidence was high in many places too. What happened next in both instances?

If we continue with that line of thought we find that the oil market may be giving a hint as well.

https://twitter.com/a_coops1/status/968783142717919233

Another reason I think to act more decisively now as after all interest-rates will only be 1.75% to 2% after a 0.5% rise a level I have long argued for and then wait and see. After all we could be seeing a flicker of a road to QE4.