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

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

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

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

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

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

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

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

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

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

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

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

Retail Sales

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

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

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

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

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

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

If we look for more perspective we see this.

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

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

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

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

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

Have readers noticed less traffic on the roads?

Tourism

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

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

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

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

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

Comment

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

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

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

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

Sub-prime car loans anyone?

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

Rising bond yields are feeding into the real economy

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

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

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

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

That was then and this is now

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

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

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

The UK

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

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

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

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

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

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

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

Euro area

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

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

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

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

 

The US

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

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

 

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

Japan

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

Comment

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

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

 

 

 

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

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

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

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

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

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

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

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

Bondpocalypse

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

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

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

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

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

Dollar Hollar

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

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

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

Bank of England

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

Comment

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

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

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

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

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

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

 

 

Is this the revenge of the bond vigilantes?

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

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

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

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

What has driven this?

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

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

It had an immediate impact.

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

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

Crude Oil

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

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

US Federal Reserve

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

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

The Ultras

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

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

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

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

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

Comment

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

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

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

 

 

What is the economic impact of a higher crude oil price?

One piece of economic news dominated all other yesterday and it was at least a change for the Trump and Brexit circuses to take something of a break. Instead we had the OPEC circus which finally came up with something. Of course we know that announcements are one thing and implementation another but there was an immediate impact on the crude oil price. From Reuters.

The price for Brent crude futures (LCOc1), the international benchmark for oil prices, jumped as much as 13 percent from below $50 on Wednesday and was at $52.10 per barrel at 0806 GMT, although traders pointed out that part of the jump was down to contract roll-over from January to February for Brent’s front-month futures.

U.S. West Texas Intermediate (WTI) crude futures rose back above $50 briefly before easing to $49.63 a barrel at 0806 GMT, though still up 20 cents from its last settlement.

Volumes were very high too which makes a past futures traders heart lighter although of course we need to note that this is a result of yet more central planning.

The second front-month Brent crude futures contract, currently March 2017, traded a record 783,000 lots of 1,000 barrels each on Wednesday, worth around $39 billion and easily beating a previous record of just over 600,000 reached in September. That’s more than eight times actual daily global crude oil consumption.

Also as we note the influence at times of banks on commodity markets ( I believed their trading desks helped drive the last commodity price boom) maybe such high volumes are a warning signal too. But if this lasts we have the potential for a type of oil price shock as we have become used to relatively low oil prices. Also central banks may have to make yet another U-Turn as of course they may find that they push inflation above target as a higher oil price adds to all their interest-rate cuts and QE style bond buying.

Let us have a little light relief before we come to the analysis and look at this from February of this year. From Bloomberg.

Oil could drop below $20 a barrel as the search for a level that brings supply and demand back into balance makes prices even more volatile, Goldman Sachs Group Inc. predicted.

Oh well…

A higher oil price is good for us?

I made a note of this when I first saw it as it is the opposite of my view. I also note that it is Goldman Sachs again. From Bloomberg.

Higher oil prices would be a boon for the global economy, according to Goldman Sachs Group Inc.

Really! How so?

Pricey crude means economies such as Saudi Arabia take in more money than they can spend, which financial markets help distribute through the rest of the world, boosting asset values and consumer confidence, the bank’s analysts Jeff Currie and Mikhail Sprogis wrote in a Nov. 22 research note.

Apparently we can ignore the elephant in the room.

Forget the stagflation of the 1970s.

Here is the explanation.

“The difference between today and the 1970s is that oil creates global liquidity through a far more sophisticated financial system,” Currie and Sprogis wrote. “More sophisticated financial markets in the 2000s were able to transform this excess savings into greater global liquidity that increased asset values, lowered interest rates, and improved credit conditions that spanned the globe.”

Convinced? Me neither and it is hard to know where to start. One view is that the world economic expansion drove the oil price higher. Another is that greater global liquidity is an illusion as we see so many markets these days which seem to lack it. For example we are seeing more “flash crashes” like the one which happened to the UK Pound overnight a few weeks or so ago. This is of course in spite of the fact that central banks have been doing their best to create global liquidity and indeed cutting interest-rates.. Still if it created “increased asset values” the 0.01% who no doubt represent Goldman Sachs best clients will be pleased. As a final rebuttal this ignores the impact of lower oil prices on inflation and the key economic metric which is real wage growth.

Did the credit crunch never happen?

From 2001 to 2014, excess savings outside the U.S. grew to $7 trillion from $1 trillion as oil climbed, according to Currie and Sprogis. The savings helped drive up values of things like homes and financial assets and loosened credit markets for consumers.

I guess this is the economics version of all those strings of alternative universes in physics where Goldman Sachs is in another one to the rest of us, or simply taking us for well, Muppets.

They are not the only ones as the IMF got itself into quite a mess on this front back in February.

Persistently low oil prices complicate the conduct of monetary policy, risking further inroads by unanchored inflation expectations. What is more, the current episode of historically low oil prices could ignite a variety of dislocations including corporate and sovereign defaults, dislocations that can feed back into already jittery financial markets.

Are these “jittery financial markets” the same ones that Goldmans think are full of liquidity? Also you may note the obsession with central banks and monetary policy and yes asset values are in there as well.

Returning to Reality

There is an income and indeed wealth exchange between energy importers and exporters. For example Oxford Economics did some work which suggested that a US $30 fall in the oil price would boost GDP in Hong Kong by 1.5% but cut it in Norway by 1.3%. So we get an idea albeit with issues in the detail as I doubt the UK (0.8%) would get double the GDP benefit of Japan (0.4%) which of course is the largest energy importer in relative terms of the major economies. Oh and there are bigger negative effects with Russia at -5% of GDP and Saudi Arabia at -4%.

However the conclusion was this.

Lower oil prices should give a sizeable boost to world GDP in 2015 and 2016

There was a time (July 2015) when the IMF thought this as well.

Although oil price gains and losses across producers and consumers sum to zero, the net effect on global activity is positive. The reasons are twofold: simply put, the increase in spending by oil importers is likely to exceed the decline in spending by exporters, and lower production costs will stimulate supply in other sectors for which oil is an input…… the fall in oil prices should boost global growth by about ½ percentage point in 2015–16,

It would also produce a fall in inflation which will be welcome to those who are not central bankers.

Comment

Should the oil price remain higher it will reduce global economic growth and raise inflation. If we compare it with a year ago it is around 10 US Dollars higher but we also need to note that in December 2015 the oil price fell to the Mid US $30s so we need to do the same to prevent an inflationary effect. As I have been writing for some months now unless we see large oil price falls inflation is on it way back. We are of course nowhere near the US $108 that a Star Trek style tractor beam seemed to hold us at a while back. But as I note the rise in some metals prices ( Zinc and Lead in particular) commodity price rises are back in vogue. So there will be plenty of work for those economists who want higher inflation explaining how they are right be being wrong.

There will also be relative shifts as consumers will be poorer as real wages fall but say shops in Knightsbridge and the like seem set to see more Arab customers. Japan will be especially unhappy at a higher oil price. But US shale oil wildcatters might be the happiest of all right now and may even boost US manufacturing as well. In the UK there will be a likely boost for the Aberdeen area.

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“Outlook for RBS is dreadful”, says Shaun Richards – Not A Yes Man Economics

 

 

 

 

 

 

Is this a genuine “currency war” or just happenstance?

It is time for us to take a look at what I have long argued is the major player in monetary policy these days which is/are exchange rates. Actually although he would not put it like that Bank of England Governor Mark Carney implicitly agreed with me on Tuesday.

“The UK economy has … had a large external imbalance and that large external imbalance as represented by a large current account deficit needed to be righted,” he said. “The exchange rate is part of that adjustment mechanism.”

I will return to the situation of the UK later but the main mover recently has Trumped (sorry) markets as we have seen the US Dollar soar. This morning Investing.com put it like this.

The dollar paused on Thursday after rising to 14-year highs against a basket of the other major currencies……..The US dollar index, which measures the greenback’s strength against a trade-weighted basket of six major currencies, was at 100.26. On Wednesday, the index hit highs of 100.60, its highest level since April 2003.

Regular readers will be aware that I have been pointing out that the US Dollar has been strong for some time. It has been rising since the dollar index dipped near 73 in April 2011 but the main move has come from just below 80 in June 2014. The Trump push has really only taken it back to where it started the year.

This poses a problem as of course we see something familiar which is the US Federal Reserve promising interest-rate rises which it was back then with the “3-5” of John Williams and now where a rise is expected by markets. We will never know if we might have been in the same place if Hillary had won.

The impact on the US economy

Most analysis concentrates on the effect elsewhere but let me open with the fact that in spite of the fact that it is still the world’s reserve currency there is an impact on the US economy from this. Just over a year ago ( November 9th) I used the numbers of Federal Reserve Vice-Chair Stanley Fischer.

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

So there is an ongoing impact at these levels of the order of 1.5% of US economic output or GDP. If we add the impact of the currently higher bond yields we see why there are still doubts about a Federal Reserve interest-rate rise next month, although of course this is circular as these levels depend on it happening.

The rest of the world

Whilst the rest of the world in general should get a competitive advantage from a lower US Dollar it is not all one way. For example inflation will rise as so many commodities are prices in US Dollars and there is also the debt issue. From the 7th of December last year.

Dollar credit to non-banks outside the United States reached $9.8 trillion at end-Q2 2015. Borrowers resident in EMEs accounted for $3.3 trillion of this amount, or over a third. EME nationals resident outside their home countries (for instance, financing subsidiaries incorporated in offshore centres) owed a further $558 billion.

So the US Dollar is strong and yields are rising, what could go wrong? The BIS ( Bank for International Settlements) was on the case earlier this week.

A stronger 29 dollar is associated with wider CIP deviations and lower growth of cross-border bank lending denominated in dollars…….In particular, a strengthening of US dollar has adverse impacts on bank balance sheets, which, in turn, reduces banks’ risk bearing capacity.

It was also intriguing as to why the all the Ivory Towers miss this.

However, in textbooks, there are no banks.

So those places with US Dollar denominated debt have “trouble,trouble,trouble” right now and the obvious places to look would I guess be Mexico and Egypt in the way we looked at Ukraine and Russia in the past.

China

On the 10th of October I pointed out that the trend for the Yuan had been “down,down” in spite of its achievement of attaining reserve currency status at the IMF (International Monetary Fund).

The currency fell after the People’s Bank of China set the midpoint CNY=PBOCat 6.7008 yuan per dollar, its weakest fix since September 2010.

From the Financial Times.

China’s renminbi traded near at an eight-year low against the US dollar on Thursday, as the election of Donald Trump intensified longstanding depreciation pressure…The Chinese currency has weakened for seven of the eight trading days to Wednesday and is down 5.5 per cent in 2016 — on pace for its worst year since authorities depegged it from the dollar in 2005.

A type of stealth devaluation sees it at 6.88. Rather oddly the Wall Street Journal tells us it is not devaluing and then prints this.

The Chinese yuan has been steadily depreciating this year against a basket of 13 currencies that make up the underlying reference point for the currency.

Sweden

I thought I would throw this in as having been (correctly) critical of the FT  let me also say that it can also be good. From @M_C_Klein.

If I were going to hit a country for currency manipulation on day 1 it would definitely be Sweden.

Makes you think er well yes, doesn’t it?

Yen

There is no stealth devaluation here and the sound of cheering from the Bank of Japan in Tokyo at the recent fall echoes around the world. Governor Kuroda has been enjoying his sake and his favourite Karaoke song even more.

Get down deeper and down
Down down deeper and down
Down down deeper and down
Get down deeper and down

That of course would be the status quo if he had his way. Mind you his pleasure at an exchange rate of 109 to the US Dollar does have a fly in the ointment. After all it has happened after he did nothing as opposed to the currency rise following his “bold action” in January. I would suggest that Bank of Japan staff who want a career describe the recent phase as an example of the “masterly inaction” so beloved of the apochryphal civil servant Sir Humphrey Appleby.

Euro

I pointed out on twitter yesterday that Mario Draghi would be celebrating as the Euro dipped into the 1.06s versus the US Dollar. He needed something like that as you see the effective or trade weighted exchange rate for the Euro has risen in 2016 in spite of the 80 billion Euros a month of QE bond purchases. There is still a way to go from the 94.7 of now to the 92.7 of then. A Baldrick style cunning plan might be for the Euro to leave the European Union….Oh hang on.

Comment

As you can see there is much going on and if we compare this to a possible 0.25% interest-rate rise in the US we see again a bazooka and a pea shooter. Although of course the two factors are correlated so we can never entirely split them. But much is in play as we remind ourselves that unless there is life on Mars it is a zero-sum game.

I did say I would look at the UK which recently has been reversing some of its depreciation. It has a case for a lower currency due to its current account deficit but whilst the economic numbers are good now the problem will be the inflation of 2017 and maybe beyond. Meanwhile having checked the booming UK Retail Sales numbers let me say thank you ladies,women and girls one more time and I am on the case.

Is the lack of lining on UK ladies coats this season another example of and has made a quality adjustment in its numbers?

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Post-trump moves: Like old times, but not exceptional times – Shaun Richards

 

 

 

The trend towards ever lower interest-rates continues but what about bond yields?

A clear feature of the credit crunch world has been lower interest-rates and lower bond yields. This has come in two phases where the first was badged usually as an emergency response to the credit crunches initial impact. However as I warned back then central banks had no real exit plan from such measures and we then found that the emergency had apparently got worse as so many central banks cuts again. So if you like we went from ZIRP ( Zero Interest-Rate Policy) to NIRP ( N is Negative) . Along the way it is easy to forget now that the ECB did in fact raise interest-rates twice but the Euro area crisis saw it cut them to -0.4% and to deployed over a trillion Euros of QE bond buying so far. In the UK Bank of England Governor Mark Carney also retreated with his tail between his legs after a couple of years or so of Forward Guidance about higher interest-rates which turned out to be anything but as he later cut them to 0.25%!

Reserve Bank of New Zealand

Yesterday evening the Kiwis again joined the party.

The Reserve Bank today reduced the Official Cash Rate (OCR) by 25 basis points to 1.75 percent.

I have a theory that the RBNZ regularly cuts interest-rates when the All Blacks lose at rugby union and on that subject congratulations to Ireland on finally breaking their duck. Moving back to interest-rates that makes 40 central banks ( h/t @moved_average ) who have eased policy in 2016 so far which poses a question over 8 years into the credit crunch don’t you think? Central banks used to raise interest-rates when they claimed a recovery was developing.

Also we can learn a fair bit about the modern central bank from looking at the explanatory statement from the RBNZ.

Significant surplus capacity exists across the global economy despite improved economic indicators in some countries.

Perhaps only the Governor can tell us whether that psychobabble is good or bad! Anyway central banks used to cut interest-rates if the economy is either weak now or expected to be so let’s take a look.

GDP grew by 3.6 percent in the year to the June 2016 quarter, and near-term indicators suggest this pace of growth is likely to continue. Annual GDP growth is forecast to average around 3.8 percent over the next year. This strength has been a feature of the Bank’s projections for some time……….. As GDP is forecast to grow at a faster rate than the economy’s productive capacity, the output gap is projected to rise, contributing to inflationary pressure.

Oh well perhaps not. Also there is another (space) oddity if we look at a cut in interest-rates.

The combination of high population growth, low mortgage rates, and a shortage of housing in Auckland has continued to exert upward pressure on house prices…….Outside of Auckland and Canterbury, house price inflation reached a 10-year high in July, but has fallen slightly since.

Ah yes so a cut in interest-rates will help? Oh hang on as we observe this.

Mortgage rates remain around record lows

If we look at the chart we see that it is no surprise that house price inflation has slowed in Auckland because it want over 25% per annum. For some reason ( perhaps someone familiar with NZ can explain) Canterbury saw over 25% around 3 years ago. However the rest of New Zealand has seen a rise to around 10% per annum. Many would call this quite a boom and a central bank would raise interest-rates. Of course these days we are promised policies from long enough in the past that most will have forgotten they were failures back then.

This follows the announcement of further tightening of loan-to-value ratio restrictions in July 2016.

Also with the New Zealand economy growing so strongly it is hard ot avoid the feeling of beggar thy neighbour about this.

A decline in the exchange rate is needed.

The inflation argument is not so strong even for those who believe that 2% is better than 0%. Added to house prices we see this.

Annual inflation is expected to rise from the December quarter,

One area that is awkward for the central bank is this.

 On an annual basis, the net inflow of working-age migrants rose to a new peak of around 60,000 in September

Of course establishment s everywhere tell us how fantastic this will be for economic growth which makes the rate cut even odder. But we see that it will have ch-ch-changes on New Zealand that elsewhere have contributed to not quite the nirvana promised. It is hard as a Londoner not to have a wry smile at this because both socially and in business you meet so many Kiwis some who are here for a while and some end up staying. It is however of course an urban myth that they all live in one camper van in Kensington! But if the mainstream media finally gets something right in 2016 New Zealand may be about to see a flow of American immigration as well.

The RBNZ does not give us GDP per head which would be interesting to see. We do however get something that as far as I know is unique in the central banking world.

We assume that over the medium term the price of whole milk powder will tend towards USD 3,000 per tonne, and that the Dubai oil price will continue to gradually increase to around USD 60 per barrel.

Firstly you get the wholesale milk price as you note it is provided before the crude oil price!

A Challenge to the central bankers

The RBNZ kindly gave us the central bankers view of what happens next.

Policy rates are at record lows across
most advanced economies and are expected to remain stimulatory over coming years. In 2016, quantitative easing by central banks has been at its highest level since the global financial crisis. The degree of unconventional monetary policy is unlikely to increase further.

Of course Forward Guidance from central bankers has been anything but that! Also whilst they may well continue to reduce official interest-rates it looks to me as if there will be trouble elsewhere. This is because inflation looks set to rise and its impact on real or inflation adjusted bond yields. There was an element of this in the rise in the US 30 year bond yield that I pointed out yesterday after Donald Trump was elected.

Putting it another way the chart of inflation expectations below is revealing. However take care as these things are very broad brush as in useful for trends but very inaccurate in my opinion.

That starts to make current bond yields look a bit thin doesn’t it?

Comment

Today I have been looking at two opposite forces as the central banking army continues its advance but faces more potential guerilla style opposition. We do not yet know how much inflation will pick-up overall but we do know that unless the oil price falls heavily it will do so. We also know that in some areas we are seeing hints of commodity prices rising again as for example Dr.Copper has been on the move. in response bond yields are rising today and as summer has moved into autumn we have been seeing this overall. For example the ten-year bund yield in Germany is now 0.28% as I type this. This is simultaneously giddy heights compared to recently as well as still very low!

So a clash is coming as I believe that central banks such as the ECB are happy for yields to rise now so they can act again later and claim success. The problem is two-fold. If it is so good why do we always need more and secondly how does this work with rising inflation trends?