It is a sign of the times that Bitcoin is doing so well

The past week or two has seen quite a rally in the price of Bitcoin and as I type this it is US $16.700. This gives various perspectives and let me open with a bit of hype, or at least what I think is hype.

An independent report from Citi Bank’s Managing Director argues that Bitcoin is the digital gold of the 21st century. The devaluation of the worlds’ reserve currency—the U.S. dollar—formed the basis of the commentary. ( Crypto.Com)

As a starter Citibank have suggested that the US Dollar will fall or depreciate by 20% which has created something of a stir in itself. There are bears around for plenty of currencies tight now as others suggested that the expected December move by the ECB might put the skids under the Euro. Both roads would look bullish for Bitcoin as it is an alternative. The Citibank view starts with a comparison with Gold post Bretton Woods.

With a relatively free currency market, gold’s price grew enormously for the next 50 years.

The monetary inflation and devaluation of the greenback are the basis of Fitzpatricks’ comparison of Bitcoin with gold. ( Crypto.Com)

This is then linked to what we have seen with Bitcoin.

Bitcoin move happened in the aftermath of the Great Financial crisis (of 2008) which saw a new change in the monetary regime as we went to ZERO percent interest rates.

The next step is this.

Fitzpatrick pointed out that the first bull cycle in Bitcoin from 2011 to 2013 when it increased by 555 times resulted from this.
Currently, the COVID-19 crisis and the government’s associated monetary and fiscal response are creating a similar market environment as gold in the 1970s. Governments have made it clear that they will not shy away from unprecedented money printing until the GDP and employment numbers are back up.  ( Crypto.Com)

He then applies his technical analysis.

“You look at price action being much more symmetrical or so over the past seven years forming what looks like a very well defined channel giving us an up move of similar time frame to the last rally (in 2017).”

Which leads to this.

Fitzpatrick did not stop there; his price prediction chart sees Bitcoin price at $318,000 by December 2021.  ( Crypto.Com)

That in itself will no doubt be contributing to the present rise as it puts us in what is called FOMO or Fear Of Missing Out territory.

The Economics

The issue of the money supply and its growth is an issue of these times whereas the situation for Bitcoin is different.

Bitcoin’s total supply is limited by its software and will never exceed 21,000,000 coins. New coins are created during the process known as “mining”: as transactions are relayed across the network, they get picked up by miners and packaged into blocks, which are in turn protected by complex cryptographic calculations. ( coinmarketcap.com)

So there are two differences. Firstly there is a cap and with the present number in circulation being 18.5 million it is not that far away. Secondly whilst there is growth the process of creation is likely to be slower rather than fiat money which as I am about to discuss has been rather up,up and away.

If we start with the world’s reserve currency which is the US Dollar I note a reference to money printing in the Citibank report which we could argue is QE.

Consistent with this directive, the Desk plans to continue to increase SOMA holdings of Treasury securities by approximately $80 billion per month……Similarly, the Desk plans to continue to increase SOMA holdings of agency MBS by approximately $40 billion per month. ( New York Fed)

So we have US $120 billion a month from the main two efforts where bonds are swapped for electronically produced money.

My preferred way of looking at this is the money supply and if we do that we see that in the year to the 2nd of this month the narrow measure of the US money supply has risen by 41% over the past year. This sort of measure used to be called high powered money although right now due to the plunge in velocity it is anything but. However it has been created and I also note that having gone through US $2 trillion in August the amount of cash in circulation is also rising and was US $2.04 trillion in October. So mud in the eye for those predicting its death,especially as we note the switches to using electronic money in retail. As the Belle Stars put it.

This is the sign of the times
Piece of more to come

If we go to the wider money supply measure called M2 we see that it has grown by 23.9% in the year to November 2nd. That is quite something for a number that is now just shy of 19 trillion. So there is a money supply argument in the background. We can add to it by noting fast rises in other types of fiat money. Japan has been at the game for some time and we have seen notable expansions in Euros and UK Pounds as well.

Interest-rates

There was a time that the lack of an interest-rate from Bitcoin was a weakness. The 0% compared unfavourably to what you could get in fiat currencies. After all pre credit crunch many of the major currencies provided interest-rates of 4 to 5%. But now life is very different as we have seen the US Federal Reserve cut interest-rates to just above 0%. Indeed in some cases now Bitcoin has a relative advantage because the spread of not only negative official interest-rates but of negative bond yields ( which total around US $17 trillion now) makes it look much more attractive than before.

Who would have thought that a 0% interest-rate would be attractive? But increasingly that is true.

Comment

When we look at something like this we see that it requires a combination of reality and psychology/belief. The former gets reinforced because as I have pointed out over the past decade the direction of travel has been both clear and consistent. This morning has seen an example of part of this journey.

Italy’s Ruling 5-Star: ECB Should Cancel Covid-Related Debt It Owns – Party Blog Doing So Would Be “Not Only Fair But Easily Achievable” ( @LiveSquawk )

These sort of proposals appear and will no doubt be denied and rejected. But in a year or two’s time past history suggests it may well be on the agenda and then get implemented. It is quite a cynical game but we see it played regularly and feeds into our “To Infinity! And Beyond” theme.

Also there will be demand from those looking to park what are considered to be ill gotten gains. The official response will be around crime but it is probably more likely to be another version of this.

Many Turkish companies and individuals bought foreign currency last week even as the lira registered its biggest weekly gain in almost two decades, Bloomberg reported, citing currency traders it did not identify. ( Ahval )

Turks are using the Lira rally as a chance to buy more US Dollars in a clear safe haven trade. People will disagree about how safe that is but there will be similar flows into Bitcoin. It has its own risks as we note the issues around security and the wide swings in price. The latter are something of an irony because they are exacerbated by a strength which is the supply restrictions and limit. But this is a time of risk in so many areas.

Another way of looking at the change in perception of Bitcoin is the way that central banks are now looking at Digital Coins in a type of spoiler move as it poses a potential challenge to their monopoly over money.

I will be particularly interested in reader’s thoughts on this topic

 

 

What are the consequences of bond yields rising further?

This week has brought an unusual development for the credit crunch era. Let me illustrate with an example of the reverse and indeed what we have come to regard as the new normal from last week.

AMSTERDAM, Nov 5 (Reuters) – Italy’s five-year bond yield turned negative for the first time on Thursday as uncertainty from the U.S. election supported government bonds in Europe.

Prima facie that seems insane but of course as I will explain later it is more complicated than that. That is for best when we add in this from Marketwatch on Monday.

Investors now pay Greece for the privilege of owning its debt, an incredible turnaround from its securities being the source of global financial instability a decade ago.

Greece’s three-year debt turned negative on Friday, and then the country received more good news after the surprise decision by Moody’s Investors Service on Friday night to upgrade the nation’s debt. The upgrade, from Ba3 from B1 previously, still leaves Greek debt in junk market territory, and three notches away from becoming investment grade.

The yield on Greek 10-year debt TMBMKGR-10Y, 0.834% fell 4 basis points to 0.77%. In 2012, the yield on Greek 10-year debt surpassed 35%.

Amazing in its own way and well done to investors who got their timing right in these markets. Although a large Grazie is due to Mario Draghi who set things in motion.

US Treasury Bonds

However there has been something of a contrary signal from the US bond market. There was a hint of something going on in what is called the Long Bond which is the thirty-year maturity. Some of you may recall at the height of the pandemic panic in financial markets in March the yield here dipped below 1%. This was driven by two factors.The first was a move to a perceived safe haven in times of trouble and US Treasury Bonds are AAA rated as well as being in the world’s reserve currency. Also there would have been some front-running of the expected bond buying or QE from the US Federal Reserve. It did indeed charge in like the US Cavalry with purchases at the peak of US $75 billion per day.

But around 2 weeks ago the mood music was rather different as the debate was then about whether the yield would break above the 1.6% level that market traders felt was significant. As the election results began to come in it did so and now we find it at 1.75%.

If we switch to the benchmark ten-year ( called the Treasury Note) we see a slightly delayed pattern but also a move higher. In fact it gave us a head fake as the initial response to the election was a rally leading to lower yields and we noted it at 0.72%. But there were ch-ch-changes on the way and now we see it is 0.96%. So perhaps on the cusp of what is called a big figure change should it make 1%.

Why does this matter?

The first reason is for the US economy itself and there is a direct line in from mortgage rates.

Over the course of the past few days, 10yr yields are up roughly 0.2%.  This time around, the mortgage market hasn’t been able to avoid taking its lumps with the average lender now quoting 30yr fixed rates that are 0.125% higher compared to last Thursday.    ( Mortgage Daily News)

The housing market has been juiced by ever lower and indeed record low mortgage rates up until now. The change will feed into other personal and corporate borrowing as well.

Next comes its role as the world’s biggest bond market with some US $21.1 billion and of course rising at play here. I will come back to the domestic issues but there is a worldwide role here.For example back in my days in the UK Gilt ( bond) market the beginning of the day was checking what the US market had done overnight before pricing in any UK changes. That theme will be in play around the world and in fact on spite of the Italian and Greek moves above we have seen it.

For the US there is the domestic issue of debt costs. These have been a pack of dogs that have not barked but with the increases in the size of the bond market and hence higher levels of borrowing and refinancing smaller moves now matter. We know that President Elect Biden wants to spend more and looked at this on the 5th of this month although there remains doubt over how much of it he will be able to get through what looks likely to be a Republican controlled Senate. Even before this here are the projections of the Congressional Budget Office.

Debt. As a result of those deficits, federal debt held by the public is projected to rise sharply, to 98 percent of GDP in 2020, compared with 79 percent at the end of 2019 and 35 percent in 2007, before the start of the previous recession. It would exceed 100 percent in 2021 and increase to 107 percent in 2023, the highest in the nation’s history.

Best I think to take that as a broad sweep as there are a lot of moving parts in the equations used.

Yield Curve Control

This is, as you can see, not going so well! We have looked at the Japanese experience as recently as Monday and in the US it would be a case of recycling a wartime policy.

In early 1942, shortly after the United States declared war, the Fed effectively abdicated its responsibility for monetary policy despite its concern about inflation and focused instead on helping the Treasury finance the conflict. After a series of negotiations with the Treasury, the Fed agreed to peg the Treasury-bill yield at 0.375 percent, to cap the critical long-term government bond yield at 2.5 percent, and to limit all other government securities’ yields in a consistent manner.  ( Cleveland Fed)

The Long Bond yield is still quite some distance from the 2.5% of back then but as I have already explained the situation is I think more exposed now.

Oh and there was a concerning consequence to this.

The Treasury, however, did not wish to relinquish its control over Fed monetary policy and only acquiesced to small increases in short-term interest rates starting in July 1947, after inflation had been hovering around 18 percent for a year. The Treasury believed that it could not possibly finance its unprecedented levels of public debt at reasonable interest rates without the Fed’s continued participation in the government-securities market; in its view, only unrealistically high interest rates could coax enough private-sector savings to finance the debt.

Comment

Let me now switch to what we might expect if we had free markets. The extra borrowing we have looked at would be pushing yields higher. Another influence would be the fact the real ( after inflation) bond yields are heavily negative unless you think US inflation will be less than 1% per year for the next ten years. Even then it is not much of a return, especially compared to the 5% in one day some equity markets have just provided. The reality is that bond markets provide the prospect of capital gains rather than interest right now.

Also the modern era provides something very different from free markets as the US Federal Reserve will be thinking at what point will it intervene? Or to be more precise at what point will it do so on a larger scale as it is already buying some US $80 billion per month of US treasury bonds. It was not so long ago that such amounts were considered to be a lot. The path to Yield Curve Control may be via bond yield rises now followed by its response. So the real question is what level will they think is too much? This quickly becomes an estimate of what they think the US government can afford? As they have become an agent of fiscal policy again.

 

What are the economic policies of Joe Biden?

We find ourselves in unusual but not completely unfamiliar territory as the US election has yet to declare a result.As we stand Joe Biden looks most likely to win although any such win seems set to go straight to the courts. But we need to address what changes he plans for US economic policy? The first step according to Moodys will be more fiscal expansionism.

Vice President Biden has proposed a wide
range of changes to the tax code and government spending. In total, he is calling for $4.1
trillion in tax increases and an additional $7.3
trillion in government spending over the next
decade.

Moodys have taken the current zeitgeist in favour of fiscal policy and projected this impact from it.

The government’s deficits will be
$3.2 trillion larger on a static basis and $2.6
trillion on a dynamic basis, after accounting
for the benefits to the budget of the stronger
economy resulting from his policies.

Of course the “stronger economy” mentioned is an opinion and we have seen in my time here quite a shift in the establishment view on fiscal policy. A decade ago the views was that a contractionary fiscal policy could expand the economy whereas now we are told an expansionary one will. There has been a shift in the cost of borrowing which I will look at in more detail later, but even so there has been more than a little flip-flopping.

Detailed Proposals

Interestingly the fiscal expansionism comes with tax increases for some.

The largest source of new tax revenue in
the vice president’s plan comes from increasing taxes on corporations. Of the $4.1 trillion
in total tax revenue collected under his plan
over the next decade on a static basis, more
than half comes from higher corporate taxes.
The bulk of this results from an increase from
21% to 28% in the top marginal tax rate paid
by corporations.

So he is reversing half of the Trump tax cuts in this area. Next comes a tax on higher earners.

Another large source of new tax revenue in
Biden’s plan is the 12.6% Social Security payroll tax on annual earnings of more than $400,000.
The current earnings cap subject to the payroll tax is almost $138,000………..This change will put
the Social Security trust fund on much sounder
financial footing, and it will raise close to $1
trillion in revenue over the next decade on a
static basis, about one-third of the total tax
revenue raised under Biden’s plan

The theme is of taxing the rich and wealthy and which continues with what might in the past have been called a soak the rich plan.

The vice president would roll back
the tax cuts that those earning more than
$400,000 received under Trump’s TCJA, tax
capital gains and dividend income like ordinary
income for those making more than $1 million
in total income.

Spending

Here we are looking at a Spend! Spend! Spend! plan where the extra revenue above is spent and then some.

His proposal calls for additional spending of $7.9 trillion on a static basis, including on infrastructure, education, the social safety net, and healthcare, with the bulk of the
spending slated to happen during his term as
president in an effort to generate more jobs

Those who bemoan America’s infrastructure should welcome this effort.

Of all of Biden’s spending initiatives, the
most expansive is on infrastructure. On a
static basis, he would increase such spending
by $2.4 trillion for the decade—all of it to
be spent during his term.

Education too will be a beneficiary.

Biden is also calling for a large increase in
an array of educational initiatives. He proposes
to spend $1.9 trillion over 10 years on a static
basis on pre-K, K-12 and higher education (see
Table 3). Attending a public college or university would be tuition-free for children in families with incomes of less than $125,000.

I find the end to tuition fees for some to be intriguing as it is a reversal of the past direction of travel. Also there is this.

The social safety net would meaningfully
expand under Biden (see Table 4). He would
spend an additional $1.5 trillion over 10 years
on a static basis on various social programs,
with the largest outlays going to workers to
receive paid family and medical leave for up
to 12 weeks…….

And healthcare.

The healthcare system would also receive
a significant infusion of funding under a
President Biden primarily via the Affordable
Care Act…….. The 10-year static budget cost of the
proposed changes to the healthcare system
comes to nearly $1.5 trillion.

US Federal Reserve

There are a couple of streams of thought here. The first is that Federal Reserve Chair Jerome Powell has called for more fiscal expansionism.

Federal Reserve Chairman Jerome Powell called Tuesday for continued aggressive fiscal and monetary stimulus for an economic recovery that he said still has “a long way to go.”

Noting progress made in job creation, goods consumption and business formation, among other areas, Powell said that now would be the wrong time for policymakers to take their foot off the gas. ( CNBC on the 6th of October)

Thus he would presumably be happy to run policies to help this. He is already in the game.

At its September meeting, the FOMC directed the Desk to increase SOMA holdings of Treasury securities at the current pace, which is the equivalent of approximately $80 billion per month.

Also he has the ability to respond should he wish without a grand announcement as these days smoothing market operations cover quite a few bases.

The Desk is prepared to increase the size and adjust the composition of its purchase operations as needed to sustain the smooth functioning of the Treasury market.

We can now take that forwards to the next perspective because the market seems to have come to its own conclusion.In the past the bond vigilantes would have driven US bond yields higher but in fact the US bond market has risen and yields fallen.I established a marker on the day of the election and the ten-year Treasury Note yield was 0.87% but as I type this it is 0.73%

Comment

The caveat to today’s post is that is by no means certain that Joe Biden will win and even if he does he seems likely to face a Republican Senate. But we do seem set for a more expansionary fiscal policy which would be oiled and polished by the US Federal Reserve.That does link to the news from the Bank of England earlier when it announced an expansion of £150 billion in its purchases of UK bonds as it too is an agent of fiscal policy these days.

Looking at the economic impact we see from Moodys that the multiplier is back.What I mean by that is fiscal spending is assumed to grow the economy which then helps to pay for it. The catch is always when you do not seem much growth ( think Italy) or if the economy contracts over a long period ( think Greece). We do know that the US economy can grow and that it has been doing better than us in Europe in the credit crunch era but whether it will grow by enough is another matter. With the rise in the Covid-19 cases though it may be a while before it gets the chance to demonstrate that and for such calculations when and how long matter.

 

Central bank Digital Coins are to enforce negative interest-rates

The weekend just gone produced quite a lot of news. Another lockdown in the UK is in the offing and there is of course the not so small matter of tomorrow’s US election. But something that does not make such headlines was also very significant and it came from ECB President Christine Lagarde.

We’ve started exploring the possibility of launching a digital euro. As Europeans are increasingly turning to digital in the ways they spend, save and invest, we should be prepared to issue a digital euro, if needed. I’m also keen to hear your views on it.

Actually it looks as though they have already decided and are launching a public consultation as cover for the exercise. After all most will not understand what are the real consequences of this especially as it will be presented as being modern and something which is happening anyway. The Covid-19 pandemic has provided a push for electronic forms of payment which is really rather convenient for this purpose. So they have a good chance of getting support and if they do not well they will simply ignore it. I must say it is hard not to laugh at the “if needed” because it is the central bankers as I shall explain who need it and not the Euro areas consumers and savers.

The real problem is highlighted here.

The outbreak of the coronavirus pandemic came as a deep shock to all of us and warranted fast policy responses. I’m proud to say that we’ve delivered: our measures have been providing crucial support to the eurozone economy and to European citizens.

It is the first sentence which applies here although I have to say the tone deaf nature of “we’ve delivered” in the second is pretty shocking. The ECB already had problems with the Euro area economy as the “Euroboom” faded and growth was not only poor but the largest economy and indeed bell weather Germany was struggling. Then the pandemic hit and made everything worse.

The ECB’s Problem

This arises from the fact that in response to the issues above it has used so many monetary policy options. It was as long ago as June 2014 that it introduced negative interest-rates and there have been further reductions since. Its Deposit Rate is now -0.5% and via the TLTROs it has reduced its interest-rates for the banks to -1%. This is a crucial point in today’s narrative because they feel they cannot keep interest-rates at these negative levels without throwing some free fish to the banks. There is a lot of irony here because interest-rates were cut to help the banks but the supposed cure has turned out to be poison at the dosages required. You do not need to take my word for it just tale a look at bank’s share prices. For example my old employer Deutsche Bank has a share price which has nudged over 8 Euros this morning which is around half of what it was in early 2017 and well you do the maths in the fall from this.

The all-time high Deutsche Bank Aktiengesellschaft stock closing price was 159.59 on May 11, 2007. ( macrotrends.net )

So the banks are struggling with negative interest-rates as they are which poses a problem for a central bank wanted to go lower or in the new buzzword be “recalibrated”.

The Plan

Actually the ECB was part of a group of central banks which asked the Bank for International Settlements to look into this issue in January.

In jurisdictions where cash use is declining and digitalisation is increasing, CBDC could also play an important role in maintaining access to, and expanding the utility of, central bank money. ( CBDC = Central Bank Digital Coin)

As that is not a problem they are up to something else here. Also they are worried that it might make the problem they are supposed to stop worse.

There are two main concerns: first that, in times of financial crisis, the existence of a CBDC could enable larger
and faster bank runs; and second, and more generally, that a shift from retail deposits into CBDC
(“disintermediation”) could lead banks to rely on more expensive and less stable sources of funding.

In the end it is always about the banks in their role as The Precious. I think we get more of the truth here.

CBDC may offer opportunities that are not possible with cash. A convenient and accessible
CBDC could serve as an alternative to potentially unsafe forms of private money, offer users privacy, reduce
illegal activity, facilitate fiscal transfers and/or enable “programmable money”. Yet these opportunities may
involve trade-offs and unless these have a bearing on a central bank’s mandate (eg through threatening
confidence in the currency), they will be secondary motivations for central banks.

To my mind the opportunities are for central bankers and not for us.

The IMF lets the cat out of the bag

Back in February 2019 it told us this.

In a cashless world, there would be no lower bound on interest rates. A central bank could reduce the policy rate from, say, 2 percent to minus 4 percent to counter a severe recession.

I am sure you have already spotted why the ECB is now on the case. As to cash it turns out it has a feature which makes central bankers hate it. This is simply that it offers 0% which as the IMF explains below is a barrier to central bank “innovation”,

When cash is available, however, cutting rates significantly into negative territory becomes impossible. Cash has the same purchasing power as bank deposits, but at zero nominal interest. Moreover, it can be obtained in unlimited quantities in exchange for bank money. Therefore, instead of paying negative interest, one can simply hold cash at zero interest. Cash is a free option on zero interest, and acts as an interest rate floor.

There is an irony in this as by doing nothing it has turned out to be a powerful tool. The central bankers will be furious at the advice given by the rather prescient Steve Miller Band.

Hoo-hoo-hoo, go on, take the money and run
Go on, take the money and run
Hoo-hoo-hoo, go on, take the money and run
Go on, take the money and run.

Banning a song usually only makes it more popular. That would also be true of cash I suspect.

Comment

As so often what we are told is very different to what is the plan. A central bank digital coin is a way of imposing even deeper negative interest-rates. The IMF gave a template for this below.

To illustrate, suppose your bank announced a negative 3 percent interest rate on your bank deposit of 100 dollars today. Suppose also that the central bank announced that cash-dollars would now become a separate currency that would depreciate against e-dollars by 3 percent per year. The conversion rate of cash-dollars into e-dollars would hence change from 1 to 0.97 over the year. After a year, there would be 97 e-dollars left in your bank account. If you instead took out 100 cash-dollars today and kept it safe at home for a year, exchanging it into e-money after that year would also yield 97 e-dollars.

This brings us back to the ECB which last week told us this.

this recalibration exercise will touch on all our instruments. It is not going to be one or the other. It is not going to be looking at one single instrument. It will be looking at all our instruments, how they interact together, what will be the optimal outcome, and what will be the mix that will best address the situation.

It fears that further interest-rate cuts could cause a bank run. I agree with that and have written before that somewhere around -1.5% to -2% seems likely to be the threshold. Thus any more cuts will bring them near that especially as the LTRO rate is already -1%. So in their view a new plan is required and some of you may already be mulling their existing plan to phase out the 500 Euro note which is their highest denomination.

Putting this another way they are worried by two developments. One is Bitcoin which potentially challenges the monopoly power of central banks and also the demand for cash is rising not falling. In the Euro area it was 1.33 trillion Euros in September as opposed to 1.2 trillion a year before.

Podcast

Is this the end of yield?

A feature of my career has been both lower interest-rates and bond yields. There have been many occasions when it did not feel like that! For example I remember asking Legal and General why they were buying the UK Long bond ( Gilt) at a yield of 15%. Apologies if I have shocked millennial and Generation Z readers there. There was also the day in 1992 when the UK fell out of the Exchange Rate Mechanism and interest-rates were not only raised to 12% but another rise to 15% was also announced. The latter by the way was scrapped as that example of Forward Guidance did not even survive into the next day.

These days the numbers for interest-rates and yields have become much lower, For example it seemed something of a threshold when the benchmark UK bond or Gilt yield crossed 2%. That was mostly driven by the concept of it being at least in theory ( we have an inflation target of 2% per annum) the threshold between having a real yield and not having one. The threshold however was soon bypassed as the Gilt market continued to surge in price terms. So much in fact that we moved a decimal point as 2.0% became 0.2%. In fact it is very close to the latter ( 0.22%) as I type this.

What happened to the Bond Vigilantes?

We get something of an insight into this by looking at the case of Italy. In the Euro area crisis we saw its benchmark bond yield rise above 7% and if we compare then to now everything is worse.

In the second quarter of 2020 the Gross Domestic Product (GDP) was revised downwards by 13% to the previous
quarter (from 12.8%)………In Q2, Gross disposable income of consumer households decreased in nominal terms by 5.8% with respect to the previous quarter, while final consumption expenditure decreased by 11.5% in nominal terms. Thus, the saving rate increased to 18.6%, 5.3 percentage points higher than in the previous quarter.

That is from the Italian Statistics Office last week. It has been followed this week by this from the IMF.

The International Monetary Fund on Tuesday raised its Italy GDP forecast for 2020 to -10.6%, from June’s -12.8%.
That is an improvement of 2.2 percentage points.
But the IMF cut its Italian growth forecast for next year.
GDP is now expected to rise 5.2% in 2021, 1.1 percentage points lower than the 6.3% forecast in June. ( ANSA)

So the IMF have made this year look better but taken half of that away next year. Actually it makes a mockery of the forecasting process because if you do better then surely that should continue? But, for our purposes today, the issue is of a large fall in economic output in double-digits. This especially matters for Italy because we know from our long-running “Girlfriend in a Coma” theme that it struggles to grow in the better times. So if it loses ground we have to question not only when it will regain it but also if it will?

Switching to debt dynamics ANSA also reported this.

The IMF also said Italy’s public debt will rise to 161.8% of GDP this year, from 134.8% last year, and will then fall to 158.3% in 2021 and 152.6% in 2025.

Those numbers raise a wry smile as we were told back in the day by the Euro area that 120% on this measure was significant. That was quite an own goal at the time but now it has been left well behind. As to the projected declines I would ignore them as they are a given in official forecasts but the reality is that the numbers keep 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)

Actually Italy has over time been relatively successful in terms of its annual deficit but not now.

The IMF sees a budget deficit of 13% this year and 6.2% next, falling to 2.5% by 2025.

In a Bond  Vigilante world we would see a soaring bond yields as we note all metrics being worse. Whereas last week I noted this.

Italian 10-Year Government #Bond #Yield Falls To Lowest In More Than A Year At 0.765% – RTRS

This represents quite a move in the opposite direction from when the infamous “‘We are not here to close spreads. This is not the function or the mission of the ECB.’” quote from ECB President Christine Lagarde saw the yield head for 3%. That was as recent as March.

Monday brought more of the same.

Italy‘s 10-year and 30-year sovereign bond yields have dropped to all time-lows of 0.72% and 1.59%, respectively. ( @fwred)

Actually the bond market rally has continued meaning that at 0.64% the Italian benchmark yield is below the US one at 0.72%. This has led some to conclude that Italy is more creditworthy than the US, but perhaps they just have a sense of humour. John Authers of Bloomberg puts it like this.

Forza Italia! The Italian spread over German bunds is the lowest in three years, while the yield on Italian bonds is the lowest since at least 1320: (h/t Jim Reid, @DeutscheBank

)

Take care with the last bit because if I recall my history correctly Italy began around 1870.

But the fundamental point that Italy illustrates is that the Bond Vigilante theme relating to economic problems is presently defunct. In fact we see the opposite of it in markets as you make the most money from markets which start with the worst prospects as there is more to gain.

What about exchange-rate problems Shaun?

This is a subtext which does still continue. Only on Monday we noted that Turkey had to pay 6.5% for a US Dollar bond. Some of the exchange-rate risk is removed by issuing in US Dollars but not all because at some point Turkish Lira need to be used to repay it. But 6.5% looks stellar right now. There is also Argentina where yields are between 40% and 50%.

These are special cases where the yields mostly reflect an expected fall in the currency.

Comment

I have looked at Italy in detail because it illustrates so many of the points at hand. It should be seeing bond yield rises if we apply past thinking styles but we are seeing its doppelganger. The situation is very similar in Greece where the benchmark bond yield is 0.78%. If we look wider around the world we see this.From Bloomberg.

JPMorgan Chase & Co. says the stockpile of developed sovereign debt with a negative yields adjusted for inflation has doubled over the past two years to $31 trillion.

As the Federal Reserve prepares to let prices run hotter to fix the pandemic-hit labor market, the Wall Street bank has a message for investors: Get used to it.“Despite how logic defying the phenomenon is, negative real yields will likely stay with us for a long period to come,” wrote strategists including Boyang Liu and Eddie Yoon.

Adding in inflation means that the situation gets worse for bond owners. There is a familiar theme here because those who own bonds have had quite a party. But the hangover is on its way for future owners who see a market where the profits have already been taken, so what is left for them?

I have left out until now the major cause of the moves in recent times which has been all the QE bond buying by central banks. An example of this will take place this afternoon in my home country when the Bank of England buys another £1.473 billion. The market price for bonds these days is what the central bank is willing to pay. If you can call it a market price. Next comes the issue that countries are relying on this and here is the Governor of the Bank of Italy in Corriere della Sera

Then there is the average cost of debt. Right now it’s 2.4%. It is a high value.

2.4% high? So we arrive at my point which is that the central bankers will drive yields ever lower and as to any turn it will require quite a change as they sing along with McFadden & Whitehead.

Ain’t No Stoppin Us Now!
We’re on the move!
Ain’t No Stoppin Us Now!
We’ve got the groove!

Central banks are increasingly entering the world of politics

Yesterday brought a barrage of central banking news. So let us start with something rather remarkable from the head of the world’s number one which is the US Federal Reserve. The crucial part of the speech given by Jerome Powell to the National Association for Business Economists is below.

The expansion is still far from complete. At this early stage, I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery, creating unnecessary hardship for households and businesses. Over time, household insolvencies and business bankruptcies would rise, harming the productive capacity of the economy, and holding back wage growth. By contrast, the risks of overdoing it seem, for now, to be smaller. Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.

Some of the economics is really rather dubious. But the main driver is that he is interfering in a political decision which is fiscal policy in the middle of an election campaign. It used to be considered the the Federal Reserve would go into a type of purdah during an election campaign but apparently not now. In the past that would usually mean a period where interest-rates would not be changed.The situation is somewhat different now as interest-rates have already been reduced so close to 0% so the weapon of choice would be more QE bond buying but the principle is the same.

The Economics

The claim that the risk of overdoing policy actions is small is familiar territory for central bankers. But this is really rather extraordinary.

Even if policy actions ultimately prove to be greater than needed, they will not go to waste.

Such a situation would be likely to be one exhibiting inflation. The inflation would be most likely to be in house and other asset prices but none the less would be there, albeit it would be ignored by the main consumer inflation measures.

Also if we look at the opening speech we see some familiar cheerleading for policy.

As the coronavirus spread across the globe, the U.S. economy was in its 128th month of expansion—the longest in our recorded history—and was generally in a strong position.

So strong in fact that “Moderate growth” is considered to be “slightly above-trend”

We travel a similar journey if we look at his view of the recovery which is quite a success.

After rising to 14.7 percent in April, the unemployment rate is back to 7.9 percent, clearly a significant and rapid rebound.

But then there is quite a bit of slip-sliding away.

A broader measure that better captures current labor market conditions—by adjusting for mistaken characterizations of job status, and for the decline in labor force participation since February—is running around 11 percent.

I have pointed out more than a few times how and why the international definition of unemployment has failed us in this pandemic. So it is more than disappointing to see a central banker who should know better using it. In a familiar theme that is the behaviour of a politician.

Meanwhile if we switch to actual politicians the fiscal stimulus call had a bit of trouble with The Donald.

Nancy Pelosi is asking for $2.4 Trillion Dollars to bailout poorly run, high crime, Democrat States, money that is in no way related to COVID-19. We made a very generous offer of $1.6 Trillion Dollars and, as usual, she is not negotiating in good faith. I am rejecting their request, and looking to the future of our Country.

Top of the Class

The ECB decided to issue a career enhancing discussion paper yesterday.

Despite this renewed debate, traditional indices of central bank independence do not suggest a deterioration in central banks’ de jure independence after the GFC. ( GFC = Global Financial Crisis)

Lewis Carroll would be proud. Although there is a brief flash of insight.

The benefits of central bank independence are currently not obvious for many citizens,

Really?! However we return to a place “far,far,away” in the section on the ECB itself.

There have been no visible changes in either the de jure or actual independence of the ECB. The legal frameworks protecting the ECB’s independence have been tested,
and have served to establish its independence more firmly.

Meanwhile back on the ranch the ECB has a President who is a politician and former French Finance Minister and a Vice-President who is the former Economy Minister of Spain. So independence from political control has been established by er, putting politicians in charge! It does at least explain this bit.

Comments by euro area governments on the ECB’s policy decisions are unusual.

Why would then when it is doing their bidding? After all if monetary policy was more overtly under the control of politicians how much more could they have done?

If we switch to the Bank of Russia we get a laugh out loud section. We are assured this.

Central bank independence seems to be observed in Russia, although it was not tested in a controversy with the government in the analysed period.

The idea of independence under Vladimir Putin seems not far off insane which somewhat bizarrely they then confess.

In January 2015, the head of monetary policy was reportedly replaced by a person more acceptable to
bankers, who had called for lower interest rates.

Seems to be a similar model to Roman Abramovich at Chelsea football club albeit no manager there survives for that long.

Interest-Rate Cuts

Just when you though that this game might be over there is an early premonition of Halloween. From the Wall Street Journal.

European Central Bank President Christine Lagarde said the bank is ready to inject fresh monetary stimulus to support the eurozone’s stuttering economic recovery from the Covid-19 pandemic, including by cutting a key interest rate further below zero.

Just as a reminder the Deposit Rate and the Current Account Rate are already -0.5%. Last time this came up for discussion ( about a year ago) it was about a move to -0.6%. Does anybody believe a 0.1% move would make any difference right now?

Insane in the membrane
Insane in the brain!
Insane in the membrane
Insane in the brain! ( Cypress Hill )

There are three issues with this. The first is simply that the evidence is that this does not work as otherwise why so we need ever more doses of it? This leads her to an official denial and we know what to do with them.

ECB hasn’t yet reached the point where a fresh interest-rate cut would do more harm than good, known to economists as the reversal rate. ( WSJ)

Next comes the international impact as another interest-rate cut would affect countries which explicitly ( Denmark) and implicitly (Switzerland) set their interest-rates against the Euro exchange-rate. Thirdly we are pretty much back to trying to devalue the Euro which relates to the point before.

Comment

The problem here is that central banks have found themselves behaving like politicians.The move towards independence did not last long as the various establishments shifted towards appointing people who were and are “one of us”. That is most explicit at the ECB where an actual politician in Christine Lagarde is President. In the United States we have seen a different tack where Jerome Powell was seemingly pressurised by President Trump to do his bidding and cut interest-rates. Neither looks especially independent. As to fiscal policy in the US President Trump may already be switching his tune.

If I am sent a Stand Alone Bill for Stimulus Checks ($1,200), they will go out to our great people IMMEDIATELY. I am ready to sign right now. Are you listening Nancy?

That is the problem with playing politics as it can change daily and indeed hourly but the economy cannot.

Rather ironically a day which started with Jerome Powell calling for more like Oliver Twist and the President saying what? just like The Master in the story had another turn. Until then US bond yields were rising ( 30 year at 1.6%) meaning that we might actually see some of the promised Yield Curve Control. But the Trump Tweet ended that at least for now.

The perversion of Inflation Targeting is accelerating

Today my topic is a subject which may seem like shuffling deck chairs on The Titanic but in fact turns out to be very important. This is because it affects workers, consumers and savers ever more because of the way that both wage growth and interest-rates head ever lower. For the latter we often see negative interest-rates and for the former the old text book concept of “sticky wages” has been in play but pretty much one way as rises are out of fashion but falls do happen. Indeed we have seen more than a few cases of wage cuts recently with the airline industry leading the way for obvious reasons. So we can afford inflation if I may put it like that much less than previously as it more quickly affects living-standards.

The Fantasy World

Central bankers have become wedded to the idea of inflation targeting but have not spotted that there is a world of difference between applying it when you are trying to reduce inflation and trying to raise it. In the former you are looking to raise living-standards via real wages and in the latter you end up trying to reduce them. Hoe does this happen? In spite of over a decade of evidence to the contrary they hang onto theories like this.

If the anchor for inflation is the inflation aim, the Phillips curve – the link between the real economy and inflation – plays a central role in allowing central banks to steer inflation towards that aim. But in the low inflation environment, prices appear to have become less responsive to the real economy. ECB research suggests that the empirical Phillips curve remains intact, but it may be rather flat. ( ECB President Christine Lagarde yesterday )

It can be any shape you like according to them which means it is useless. Accordingly it follows that they have been unable to steer inflation towards its target and for reasons I shall explain later they may well have been heading in the wrong direction. But let us move on with the Phillips curve being described by Lewis Carroll.

“When I use a word,’ Humpty Dumpty said in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’

’The question is,’ said Alice, ‘whether you can make words mean so many different things.’

The next issue is that they have got away with defining price stability as something else entirely. Back to Christine Lagarde of the ECB.

Since 2003, the ECB has used a double-key formulation to set our objective, defining price stability as a year-on-year increase in inflation of “below 2%”, while aiming for inflation of “below, but close to, 2%”.

This misrepresentation was exposed back around 2016 when measured inflation fell to approximately 0% but there were price shifts because the inflation fall was driven by a large fall in the price of crude oil. We saw it in another form as goods inflation fell to zero and sometimes negative where services inflation continued and in the case of my country was little affected. So the bedrock of the 2% inflation target crumbled away.

But they cannot stop clinging to the Phillips Curve.

The intuition behind the first factor is that the Phillips curve is alive and well, but the euro area faced a series of large shocks that made it harder to measure economic activity relative to potential. ( Lagarde)

Let me give you an example where this failed utterly in my home country the UK. Back in 2013 the then new Bank of England Governor Mark Carney established his Forward Guidance based on a 7% Unemployment Rate. Within six months that was crumbling and we went in terms of a “full employment” estimate 6%,5.5%,5%, 4.5% and lastly 4.25%. I would argue it was worse than useless as it was both actively misleading and an attempt to claim he was on the verge of raising interest-rates without having any real intention of doing so.

How much difference does it make?

Central bankers live in a world like this.

Broadly speaking, three factors might explain why inflation responded so weakly to improvements in the economy in the run-up to the pandemic.

One of the reasons is that the economy did not improve that much. The previous peak for Euro area GDP was 2.47 trillion Euros at the start of 2008 which rose to 2.68 trillion at the end of 2019 on 2010 prices. The increase of around 8.5% is not a lot and compares badly with the previous period.

Next comes the fact that central bankers inflate their own efforts and policies according to Chicago University. From Bloomberg.

However, they also find that, on average, papers written entirely by central bankers found an impact on growth at the peak of QE that was more than 0.7 percentage points higher than the effect estimated in papers written entirely by academics. (This is a sizable difference considering the effect found on average across all studies was 1.57% at the peak.) In the case of inflation, the difference in the effect of QE at its peak between the two sets of papers was more than 1.2 percentage points. Central bankers also tended to use more positive language in summarizing their results in abstracts.

They have discovered a point I have been making for some years now.

They suggest that career concerns may have played a role and provide some evidence that central bank researchers who found the largest impact of QE had a better chance of receiving a promotion.

Measuring Inflation

An issue here is the way that official inflation indices have been designed to avoid measuring inflation. I noted this yesterday with reference to the Christine Lagarde speech.

We need to keep track of broad concepts of inflation that capture the costs people face in their everyday lives and reflect their perceptions, including measures of owner-occupied housing.

This continues a theme highlighted by Phillip Lane back in February.

I think we at the ECB would agree that there should be more weight on housing – but there is a difficulty and this has been looked at several times before.

Just for clarity they completely ignore owner-occupied housing which Mr,Lane admitted was up to 33% of people’s spending in a different speech. In other matters ignoring such a large and significant area would get you laughed out of town but as most are unaware it just means they do not believe the inflation numbers.

a lot of households think it is higher. ( Phillip Lane)

I wonder why they might think that? From UBS.

Use our interactive Global Real Estate Bubble Index to track and compare the risk of bubbles in 25 cities around the world over the last three years. Munich and Frankfurt top our list in 2020. Risk is also elevated in Toronto, Hong Kong, Paris, and Amsterdam. Zurich is a new addition to the bubble risk zone.

So the ECB has topped the charts and has four of the top seven. Makes them sound like The Beatles doesn’t it?

Comment

The situation here is an example of institutional failure. Central banks had a brief period of relative independence because politicians failed to get a grip on high inflation and so they sub-contracted the job. Whether they thought it would work or whether they wanted simply to shift the blame off themselves is a moot point? Either way it had its successes as inflation did fall as highlighted by the description of that phase as the NICE decade by the former Bank of England Governor Baron King of Lothbury.

The problems in the meantime are as follows

  1. Inflation is now below target partly due to the miss measurement of it. We are also in “I cannot eat an I-Pad” territory.
  2. They believe that 2% inflation is causal rather than something which was picked at random.
  3. They believe that they can influence it much more than the evidence suggests.
  4. Most breathtakingly of all they believe that raising the inflation target will make people better off via the wages fairy ( where wages growth will rise even faster).

Or you can take the view that this is all about keeping debt costs low for government’s and all of the above is simply a front.

Let me now address further the issue of how things have been made worse. Firstly there is the psychological impact of so-called emergency measures persisting and all the policy moves. Next has come the Zombification of many times of business as models which should have failed get bailed out. Also the use of negative interest-rates cripples much of the pensions and longer-term savings and insurance industry.

On the this road the 2% inflation which they cannot achieve and anyway would make you poorer seems likely to become 3% which is even worse….

 

The banks are in trouble yet again

This week has opened with what has become a familiar drum beat and bass line. The banks are in trouble again. Or rather what has now been over a decade of trouble has just got worse.

HONG KONG (Reuters) – HSBC HSBA.L and Standard Chartered STAN.L Hong Kong shares dropped on Monday after media reports that they and other banks moved large sums of allegedly illicit funds over nearly two decades despite red flags about the origins of the money.

So this started before the wave of post credit crunch bank bailouts although those two banks were only implicitly rather then explicitly supported. The driver here is explained by Reuters below.

BuzzFeed and other media articles were based on leaked suspicious activity reports (SARs) filed by banks and other financial firms with the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCen).

The revelations underscore challenges for regulatory and financial institutions trying to stop the flow of dirty money despite billions of dollars of investments and penalties imposed on banks in the past decade.

There are all sorts of issues here as we note that the supposedly reformed system has failed again.The reason for the article relating to Hong Kong is that is where the financial week has mainly started with Japan being closed for Respect the Elders day.

The share price impact is as follows.

HSBC shares in Hong Kong fell as much as 4.4% to HK$29.60 on Monday, their lowest level since May 1995. The stock has now nearly halved since the start of the year.

StanChart dropped as much as 3.8% to HK$35.80, the lowest since May 25 this year. The Hang Seng Index .HSI was down nearly 1%.

The two banks noted here have followed a typical path for banks as it was only a few short years ago that there emphasis on China and the Far East was presented as a triumph. Now HSBC has a share price at its lowest for 25 years.

Who are the main players?

According to the ICJJ report it is again a familiar list.

The records show that five global banks — JPMorgan, HSBC, Standard Chartered Bank, Deutsche Bank and Bank of New York Mellon — kept profiting from powerful and dangerous players even after U.S. authorities fined these financial institutions for earlier failures to stem flows of dirty money.

Of these one is picked out.

JPMorgan, the largest bank based in the United States, moved money for people and companies tied to the massive looting of public funds in Malaysia, Venezuela and Ukraine, the leaked documents reveal.

However in terms of scale we have a case of hello darkness my old friend.

In all, an ICIJ analysis found, the documents identify more than $2 trillion in transactions between 1999 and 2017 that were flagged by financial institutions’ internal compliance officers as possible money laundering or other criminal activity — including $514 billion at JPMorgan and $1.3 trillion at Deutsche Bank.

Market Impact

You may not be surprised to learn that my old employer DB is down 6% this morning at 7.19 Euros. This compares to over 16 Euros at various points in the “Euro Boom” of 2017. It also rallied to above 9 Euros in early June presumably buoyed by the subsidy provided by the even better than free money provided by the ECB, For newer readers banks can go to it and borrow money at -1%. This is presently the lowest official interest-rate in the world.

If we switch to the Italian banks there are not many to look at as the falls have been so large that prices now mean little. If we go back to 2015 there were more than a few presenting Unicredit as a triumph of what was then being called Renzinomics. Anyway like so often happens with an Italian bank the around 30 Euros of late 2015 has been replaced by 7.23 Euros now sown 4% or so today.

If we switch to my home country the UK I noted this from @RonnieChopra1

UK economic bellwether, Lloyds Bank shares at 24p – lowest level since 2009.

I am not so sure they are a bell weather anymore but none the less. Barclays are down 6% at 91.5 pence as is Nat West.So the pain is widespread.

Bank of England

The official view is below.

Banks’ capital and liquidity positions have remained resilient through the shock so far.

It is based on this.

The global banking system entered into this shock in a much stronger position than the global financial crisis. Major UK banks and building societies (‘banks’), in aggregate had over three times their pre-crisis common equity Tier 1 (CET1) capital ratios at end-2019.

That is good except as we have been noting from the share prices it is not enough and the ever lower share prices limit the ability of the banks to raise new equity capital. Or of you prefer it becomes ever more expensive for existing shareholders in terms of dilution or weakening of their position.

Also whoever was responsible for this last week is probably hiding down in the darkest recesses of the Bank of England cellar where even the tea trolley fears to go.

Subsequently, the MPC had been briefed on the Bank of England’s plans to explore how a negative
Bank Rate could be implemented effectively,

As it put the UK banks on the back foot before the weekend just in time for the ICIJ news to break.

Neel Kashkari

The President of the Minneapolis Federal Reserve made an interesting speech on this subject last week. He thinks they need more capital.

This analysis shows clearly that large banks should fund themselves with equity of at least 24 percent of risk-weighted assets—up from around 13 percent today. That would maximize the benefit to society and protect taxpayers because, at those levels, banks could cover their own losses.

Also he points out that the US banking sector has grown.

 But the 10 largest bank holding companies in America are around 45 percent larger than they were going into 2008, having grown from roughly $9 trillion to nearly $13 trillion in assets.2

But there has been something very worrying going on.

 In fact, combined, the eight largest global banks headquartered in the United States bought back more than $110 billion of stock in 2019 alone.

ECB

It is hinting at this today.

They said important questions for the review would be to consider how long the Pandemic Emergency Purchase Programme should continue and whether some of its extra flexibility should be transferred to the ECB’s longer running asset-purchase schemes.

More support for the banks?

Comment

If we step back and consider the situation we are facing what looks ever more a fatal mistake bu the establishment. What was supposed to rescue the banks has ended up crippling their ability to make any money. As @Goldmarketgirl put it earlier.

Banks are screaming they need higher rates on longer term loans. Their business models are based on difference between long and short term debt.

For a while this was hidden by the capital gains on their bond portfolio’s especially in Italy where the banks hold a lot of sovereign. The issue that they could never get out in that size has been ended by the purchases of the ECB. But these are one-off and once you have taken them you are back with a struggling business model. That is why the share prices are so poor.

We were promised that in return for the bailouts and all the various subsidies the banks would recover and support the economy. Does anybody still believe that?

As to money laundering this is an ongoing issue that never goes away. There was a large swerve here though because the authorities put the burden of proof on the banks partly because it shifted it from them and partly because bodies such as the Serious Fraud Office are so useless. Perhaps they need the sort of emergency pack suggested by my local council over the weekend.

Podcast

 

The Central Banks can enrich themselves and large equity investors but who else?

We are in a period of heavy central bank action with the US Federal Reserve announcement last night as well as the BCB of Brazil and the Bank of England today. We are also in the speeches season for the European Central Bank or ECB. But they have a problem as shown below.

(Reuters) – London-listed shares tracked declines in Asian stock markets on Thursday as the lack of new stimulus measures by the U.S. Federal Reserve left investors disappointed ahead of a Bank of England policy meeting.

Is their main role to have equity markets singing along with Foster The People?

All the other kids with the pumped up kicks
You’d better run, better run, faster than my bullet
All the other kids with the pumped up kicks
You’d better run, better run, outrun my gun

We can continue the theme of central planning for equity markets with this from Governor Kuroda of the Bank of Japan earlier.

BOJ GOV KURODA: ETF PURCHASES ARE NOT TARGETING SPECIFIC STOCK MARKET LEVELS. ( @FinancialJuice )

In fact he has been in full flow.

BOJ’S GOV. KURODA: I DON’T SEE JAPAN’S STOCK MARKET GAINS AS ABNORMAL.  ( @FinancialJuice)

I suppose so would I if I owned some 34 Trillion Yen of it. We also have an official denial that he is aiming at specific levels. He might like to want to stop buying when it falls then. Some will have gained but in general the economic impact has been small and there are a whole litany of issues as highlighted by ETFStream.

Koll says the sheer weight of BoJ involvement is off-putting for others who might wish to get involved in the market. “When I go around the world, (the size of the BoJ’s holdings is) the single biggest push back about Japan from asset allocators,” he says. “This is the flow in the market.”

As the Bank of Japan approaches 80% of the ETF market I am sure that readers can see the problem here. In essence is there a market at all now? Or as ETFStream put it.

So how can the BoJ extricate itself from the ETF market without crashing the stock market?

Also it is kind of theme to back the long-running junkie culture theme of mine.

As it stands, the market has become as hooked as any addict.

You also have to laugh at this although there is an element of gallows humour about it.

The recent slackening off in ETF buying might be an attempt to end this cycle of dependency,

That was from February and let me remind you that so much of the media plugged the reduction line. Right into the biggest expansion of the scheme! As an example another 80 billion Yen was bought this morning to prevent a larger fall in the market. It was the fourth such purchase this month.

The US Federal Reserve

It has boxed itself in with its switched to average ( 2% per annum) inflation targeting and Chair Powell got himself in quite a mess last night.

Projections from individual members also indicated that rates could stay anchored near zero through 2023. All but four members indicated they see zero rates through then. This was the first time the committee forecast its outlook for 2023. ( CNBC )

This bit was inevitable as having set such a target he cannot raise interest-rates for quite some time. Of course, we did not expect any increases anyway and this was hardly a surprise.

With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved. ( Federal Reserve)

So there is no real change but apparently it is this.

Powell, asked if we will get more forward guidance, says today’s update was ‘powerful’, ‘very strong’, ‘durable’ forward guidance. ( @Newsquawk).

He has boxed himself in. He has set interest-rates as his main measure and he cannot raise them for some time and the evidence is that negative interest-rates do not work. So all he can do is the “masterly inaction” of the apocryphal civil servant Sir Humphrey Applebym or nothing. Quite how that is powerful is anyone’s guess.

Brazil

The same illogic was on display at the Banco Central do Brasil last night.

Taking into account the baseline scenario, the balance of risks, and the broad array of available information, the Copom unanimously decided to maintain the Selic rate at 2.00% p.a.

They have slashed interest-rates to an extraordinary low level for Brazil and seem to think they are at or near the “lower bound” for them.

The Copom believes that the current economic conditions continue to recommend an unusually strong monetary stimulus but it recognizes that, due to prudential and financial stability reasons, the remaining space for monetary policy stimulus, if it exists, should be small.

But telling people that is a triumph?

To provide the monetary stimulus deemed adequate to meet the inflation target, but maintaining the necessary caution for prudential reasons, the Copom considered adequate to use forward guidance as an additional monetary policy tool.

Seeing as nobody is expecting interest-rate increases telling them there will not be any will achieve precisely nothing. Let’s face it how many will even know about it?

ECB

They too are indulging in some open mouth operations.

ECB’s Rehn: Fed’s New Strategy Will Inevitably Have An Impact On The ECB, “We Are Not Operating In A Vacuum”

Regular readers will recall him from back in the day when he was often telling the Greeks to tighten their belts and that things could only get better. Nobody seems to have told poor Ollie about the last decade.

ECB’s Rehn: There Is A Risk That Inflation Will Continue To Remain Too Low Sees Risk That Euro Zone Will Fall In A Trap Of Slow Growth And Low Inflation For A “Long Time”

So we see more ECB policymakers correcting ECB President Christine Lagarde on the issue of the exchange rate. Also as the news filters around there is this.

Three month Euribor fixes at -0.501% … below the ECB’s deposit rate for the first time! ( StephenSpratt)

He is a little confused as of course this has happened before but whilst it is a very minor move we could see another ECB interest-rate cut. It will not do any good but that has not stopped the before has it?

Bank of England

There is this doing the rounds.

LONDON (Reuters) – The Bank of England is expected to signal on Thursday that it is getting ready to pump yet more stimulus into Britain’s economy as it heads for a jump in unemployment and a possible Brexit shock.

Actually nothing has changed and the Bank of England is at what it has called the lower bound for interest-rates ( 0.1%) and is already doing £4.4 billion of bond buying a week.

Still not everybody is seeing hard times.

Former Bank of England (BoE) governor Mark Carney has joined PIMCO’s global advisory board, which is chaired by former Federal Reserve chairman Ben Bernanke.

Carney, who was appointed UN Special Envoy on climate action and finance in December 2019, is one of seven members of the global advisory board, alongside former UK Prime Minister and Chancellor Gordon Brown, and ex-president of the European Central Bank Jean-Claude Trichet. ( investmentweek.co.uk )

As Dobie Gray put it.

I’m in with the in crowd
I go where the in crowd goes
I’m in with the in crowd
And I know what the in crowd knows

Comment

We have arrived at a situation I have long feared and warned about. The central bankers have grandly pulled their policy levers and now are confused it has not worked. Indeed they have pulled them beyond what they previously thought was the maximum as for example the Bank of England which established a 0.5% interest-rate as a “lower bound” now has one of 0.1%. Now they are trying to claim that keeping interest-rates here will work when the evidence is that they are doing damage in more than a few areas. In terms of economics it was described as a “liquidity trap” and they have jumped into it.

Now they think they can escape by promising action on the inflation rates that as a generic they have been unable to raise since the credit crunch. Here there is an element of “be careful which you wish for” as they have put enormous effort into keeping the prices they can raise ( assets such as bonds,equities and houses) out of the inflation measures. So whilst they can cut interest-rates further and frankly the Bank of England and US Federal Reserve are likely to do so in any further downtown they have the problem highlighted by Newt in the film Aliens.

It wont make any difference.

That is why I opened with a discussion of equity purchases as it is more QE that is the only game in town now. Sooner or later we will see more bond purchases from the US Federal Reserve above the present US $80 billion a month. Then the only move left will be to buy equities. At which point we will have a policy which President Trump would set although of course he may or may not be President by them.

Oh and I have missed out one constant which is this sort of thing.

ECB Banking Supervision allows significant banks to temporarily exclude their holdings of banknotes, coins and central bank deposits from leverage ratio calculations until 27 June 2021. This will increase banks’ leverage ratios.

The Precious! The Precious!

 

 

 

The rise and rise of negative interest-rates

The modern era has brought something that has been in motion all my career, although there have been spells which did not feel like that. I am discussing bond yields which have been in a secular decline since the 1980s. Regular readers will be aware that back when I was new to this arena I asked Legal and General why they were buying a UK Gilt that yielded 15%? Younger readers please feel free to delete such a number from your memories if it is all too much. But there is another shift as back then the benchmark was 20 years and not 10. However you look at it from that perspective a world in which both the 2 and 5 year UK bond or Gilt yields were around -0.13% would have been considered impossible it not unpossible.

Germany

These have been the leaders of the pack in terms of negative bond yields. Last week Germany sold a benchmark 10 year bond with no coupon at all. We should take a moment to consider this as a bond is in theory something with a yield or coupon so as it does not have one we are merely left with money being borrowed and then repaid. Except there was a catch there too as not all of it will be repaid. The price paid was 105.13 on average and you will only get 100 back. Or if you prefer a negative yield of the order of 0.5% per year.

This year has brought something that in the past would have ended the situation as this.

The German Federal Government intends to issue fixed income Government securities with an aggregate volume of € 210 billion in 2020 to finance
the Federal Government budget and its special funds.

Became this.

The auction volume in the first two quarters of the current year amounted to € 97 billion for nominal capital market instruments (planned at the beginning of the year: € 78 billion) and € 87.5 billion for money market instruments (planned at the beginning of the year: € 31 billion)…….Due to the adjustments, the third quarter auction volume for nominal capital market instruments will total € 74 billion (planned at the beginning of the year: € 41 billion).

As you can see there were considerably more bonds on offer but it has made little or no difference to investors willingness to accept a maturity loss or negative yield. Oh and maybe even more bonds are on the way.

In non-regular reopenings on 1 and 16 April, a total amount of € 142 billion of already existing Federal securities was issued directly into the Federal government’s own holdings. These transactions created the possibility to react flexibly to short-term liquidity requirements.

So we learn that the previous reality that Germany was benefiting from its austere approach to public finances was not much of an influence. Previously it has been running a fiscal surplus and repaying debt.

Switzerland

The benchmark yield is very similar here as the 10 year yield is -0.49%. There are many similarities in the situation between Germany and Switzerland but one crucial difference which is that Switzerland has its own currency. The Swiss Franc remains very strong in spite of an interest-rate of -0.75% that has begun to look ever more permanent which is an irony as the 1.20 exchange-rate barrier with the Euro was supposed to be that. The reality is that the exchange-rate over five years after the abandonment of that is stronger at just below 1.08.

So a factor in what we might call early mover status is a strong currency. This also includes the Euro to some extent as we note ECB President Lagarde was on the wires over the weekend.

ECB Lagarde Says Euro Gains Have Blunted Stimulus Boost to Inflation … BBG

This allows us to bring in Japan as well as the Yen has remained strong in spite of all the bond buying of the Bank of Japan.

Safe Haven

The ECB issued a working paper on this subject in January.

There is growing academic and policy interest in so called “safe assets”, that is assets that have stable nominal payoffs, are highly liquid and carry minimal credit risk.

Notice the two swerves which are the use of “stable nominal payoffs” and “minimal credit risk”. The latter is especially noticeable for a place like the ECB which insisted there was no credit risk for Greece, which was true for the ECB but not everyone else.

Anyway it continues.

After the global financial crisis, the demand for safe assets has increased well beyond its supply, leading to an increase in the convenience yield and therefore to the interest that these assets pay. High demand for safe assets has important macroeconomic consequences. The equilibrium safe real interest rate may in fact decline well below zero.

They also note a feature we have been looking at for the best part of a decade now.

In this situation, one of the adjustment mechanisms is the appreciation of the currency of issuance of the safe asset, the so called paradox of the reserve currency.

Quantitative Easing

The problem for the theory above is that the central banks who love to push such theories ( as it absolves them of blame) are of course chomping on safe assets like they are their favourite sweets. Indeed there is a new entrant only this morning, or more accurately an expansion from an existing player.

The Executive Board of the Riksbank has decided to initiate purchases of corporate bonds in the week beginning 14 September 2020. The purchases will keep
companies’ funding costs down and reinforce the Riksbank’s capacity to act if the credit supply to companies were to deteriorate further as a result of the corona pandemic. On 30 June 2020, the Executive Board decided that, within its programme for bond purchases, the Riksbank would offer to purchase corporate bonds to a
nominal amount of SEK 10 billion between 1 September 2020 and 30 June 2021.

There are all sorts of issues with that but for today’s purpose it is simply that the push towards negative interest-rates will be added to. Or more specifically it will increasingly spread to higher risk assets. We can be sure however that should some of these implode it will be nobody’s fault as it could not possibly have been predicted.

Meanwhile ordinary purchases around the world continue including in my home country as the Bank of England buys another £1.45 billion of UK bonds or Gilts.

Comment

There are other factors in play. The first is that we need to try to look beyond the present situation as we note this from The Market Ear.

the feedback loop…”the more governments borrow, the less it seems to cost – giving rise to calls for still more borrowing and spending”. ( Citibank)

That misses out the scale of all the central bank buying which has been enormous and gets even larger if we factor in expected purchases. The US Federal Reserve is buying US $80 billion per month of US Treasuries but with its announcement of average inflation targeting seems likely to buy many more

Also the same Market Ear piece notes this.

The scalability of modern technology means that stimulus is going into asset price inflation, not CPI

Just no. What it means is that consumer inflation measures have been manipulated to avoid showing inflation in certain areas. Thus via Goodhart’s Law and/or the Lucas Critique we get economic policy based on boosting prices in these areas and claiming they are Wealth Effects when for many they are inflation.

We get another shift because if we introduce the issue of capital we see that up to know bond holders will not care much about negative yields as they have been having quite a party. Prices have soared beyond many’s wildest dreams. The rub as Shakespeare would put it is that going forwards we face existing high prices and low or negative yields. It used to be the job of central banks to take the punch bowl away when the party gets going but these days they pour more alcohol in the bowl.

Meanwhile from Friday.

UK SELLS 6-MONTH TREASURY BILL WITH NEGATIVE YIELD AT TENDER, FIRST TIME 6-MONTH BILL SOLD AT NEGATIVE YIELD ( @fiquant )

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