The problems facing inflation targets

Today I wish to discuss something which if it was a plant we would call a hardy perennial. No I do not mean Greece although of course there has been another “deal” which extends the austerity that was originally supposed to end in 2020 to 2060 in a clear example along the lines of To Infinity! And Beyond! Nor do I mean the Bank of Japan which has announced it will continue to chomp away on Japanese assets. What I mean is central bankers and members of the establishment who conclude that an inflation target of 2% per annum is not enough and it needs to be raised. The latest example has come from the chair of the US Federal Reserve Janet Yellen. From Reuters.

Years of tepid economic recovery have Fed Chair Janet Yellen and other central bankers considering what was once unthinkable: abandoning decades-long efforts to hold inflation down and allowing price expectations to creep up.

I am not sure if the author has not been keeping up with current events or has been drinking the Kool Aid because since early 2012 the US Federal Reserve has been trying to get inflation up to its 2% per annum target. It managed it for the grand sum of one month earlier this year before it started slip sliding away again. Indeed for a while the inflation target was raised to 2.5% which achieved precisely nothing which is why the change has mostly been forgotten. From December 2012.

inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal,

Of course the Bank of Japan has been trying to raise inflation pretty much since the lost decade(s) began. Anyway here is Reuters again on the current thinking of Janet Yellen.

In remarks on Wednesday, Yellen called an emerging debate over raising global inflation targets “one of the most important questions facing monetary policy,” as central bankers grapple with an economic rut in which low growth, low interest rates and weak price and wage increases reinforce each other.

There is a clear problem with that paragraph as this week’s UK data has reminded us “weak price” increases boosted both retail sales and consumption via the way they boosted real wages. The rationale as expressed below is that we are expected to be none too bright.

The aim would be a change of households’ and businesses’ psychology, convincing them that prices would rise fast enough in the future that they would be better off borrowing and spending more today……..Raising that target to 3 or even 4 percent as some economists have suggested would shift the outlook of firms in particular, allowing them to charge more for goods and pay more for labor without the fear that a central bank would step on the brakes.

They are relying on us being unable to spot that the extra money buys less. Oh and after the utter failure of central bank Forward Guidance particularly in the UK you have my permission to laugh at the Ivory Tower style idea that before they do things consumers and businesses stop to wonder what Mark Carney or Janet Yellen might think or do next!

The theme here is along the lines set out by this speech from John Williams of the San Francisco Fed last September.

The most direct attack on low r-star would be for central banks to pursue a somewhat higher inflation target. This would imply a higher average level of interest rates and thereby give monetary policy more room to maneuver. The logic of this approach argues that a 1 percentage point increase in the inflation target would offset the deleterious effects of an equal-sized decline in r-star.

In John’s Ivory Tower there is a natural rate of interest called r-star.

Meanwhile in the real world

Whilst I am a big fan of Earth Wind and Fire I caution against using their lyrics too literally for policy action.

Take a ride in the sky
On our ship, fantasize
All your dreams will come true right away

You see if we actually look at the real world there is an issue that in spite of all the monetary easing of the credit crunch era we have not seen the consumer inflation that central bankers were both planning and hoping for. The Federal Reserve raised its inflation target as described above in December 2012 because it was expecting “More,More, More” but it never arrived. For today I will ignore the fact that inflation did appear in asset markets such as house prices because so many consumer inflation measures follow the advice “look away now” to that issue.

If we move to the current situation and ignore the currency conflicted UK we see that there is a danger for central bankers but hope for the rest of us that inflationary pressure is fading. A sign of that has come from Eurostat this morning.

Euro area annual inflation was 1.4% in May 2017, down from 1.9% in April.

Tucked away in the detail was the fact that energy costs fell by 1.2% on the month reducing the annual rise to 4.5% from the much higher levels seen so far in 2017. As we look at a price for Brent Crude Oil of US $47 per barrel we see that if that should remain there then more of this can be expected as 2017 progresses. That is of course an “if” but OPEC does seem to have lost at least some of its pricing power.

Actually today’s data posed yet another problem for the assumptions of central bankers and the inhabitants of Ivory Towers. We have been seeing am improvement in the Euro area economy as 2016 moved in 2017 so we should be seeing higher wage increases according to economics 101. From Eurostat.

In the euro area, wages & salaries per hour worked grew by 1.4%…., in the first quarter of 2017 compared with the same quarter of the previous year. In the fourth quarter of 2016, the annual change was +1.6%

What if our intrepid theorists managed to push inflation higher and wages did not rise? A bit like the calamity the Bank of England ignored back in 2010/11. As an aside a particular sign that the world has seen a shift in its axis is the number from Spain which for those unaware is seeing a burst of economic growth. Yet annual wage growth is the roundest number of all at 0%.

Comment

Much has changed in the credit crunch era but it would appear that central bankers are at best tone-deaf to the noise. We have seen rises in inflation target as one was hidden in the UK switch to CPI from RPI ( ~0.5% per annum) and the US had a temporary one as discussed above and a more permanent one when it switched from the CPI to PCE measure back in 2000 ( ~ 0.3% per annum). I do not see advocates of higher inflation target claiming these were a success so we can only assume there are hoping we will not spot them.

The reality is quite simple the logical response to where we are now would be to reduce inflation targets rather than raise them. Another route which would have mostly similar effects would be to put house prices in the various consumer inflation measures.

Oh and something I thought I would keep for the end. have you spotted how the US Federal Reserve sets its own targets? I wonder how that would work in the era of the Donald?!

Music for traders

My twitter feed has been quite busy with suggestions of songs for traders. All suggestions welcome.

 

Problems mount for Mark Carney at Mansion House

The UK’s central bank announces its policy decision today and it faces challenges on several fronts. The first was highlighted yesterday evening by the US Federal Reserve.

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 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

UK monetary policy is normally similar to that in the US as our economies often follow the same cycles. This time around however the Bank of England has cut to 0.25% whilst the Federal Reserve has been raising interest-rates creating a gap of 0.75% to 1% now. In terms of the past maybe not a large gap but of course these days the gap is large in a world of zero and indeed negative interest-rates. Also we can expect the gap to grow in the future.

The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate;

There was also more as the Federal Reserve made another change which headed in the opposite direction to Bank of England policy.

The Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.

So the Federal Reserve is planning to start the long journey to what used to be regarded as normal for a central bank balance sheet. Of course only last August the Bank of England set out on expanding its balance sheet by another £70 billion if we include the Corporate Bond purchases in what its Chief Economist Andy Haldane called a “Sledgehammer”. So again the two central banks have been heading in opposite directions. Also on that subject Mr.Haldane was reappointed for another three years this week. Does anybody know on what grounds? After all the wages data from yesterday suggested yet another fail on the forecasting front in an ever-growing series.

Andrew Haldane, Executive Director, Monetary Analysis and Statistics, and Chief Economist at the
Bank of England, has been reappointed for a further three-year term as a member of the Monetary Policy
Committee with effect from 12 June 2017.

For those interested in what Andy would presumably call an anti-Sledgehammer here it is.

( For Treasury Bonds) the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month…… ( for Mortgage Securities) the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

Whilst these really are baby steps compared to a balance sheet of US $4.46 trillion they do at least represent a welcome move in the right direction.

The Inflation Conundrum

This has several facets for the Bank of England. The most obvious is that it eased policy last August as inflation was expected to rise and this month we see that the inflation measure it is supposed to keep around 2% per annum ( CPI ) has risen to 2.9% with more rises expected. It of course badged the “Sledgehammer” move as being expansionary for the economy but I have argued all along that it is more complex than that and may even be contractionary.

Today’s Retail Sales numbers give an example of my thinking so let me use them to explain. Here they are.

In May 2017, the quantity bought in the retail industry was estimated to have increased by 0.9% compared with May 2016; the annual growth rate was last lower in April 2013…..Month-on-month, the quantity bought was estimated to have fallen by 1.2% following strong growth in April 2017.

So after a strong 2016 UK retail sales have weakened in 2017 but my argument is that the main driver here has been this.

Average store prices (excluding fuel) increased by 2.8% on the year; the largest growth since March 2012.

It has been the rise in prices or higher inflation which has been the main driver of the weakness in retail sales. A factor in this has been the lower value of the Pound which if you use the US inflation numbers as a control has so far raised UK inflation by around 1%. This weakness in the currency was added to by expectations of Bank of England monetary easing which of course were fulfilled. You may note I say expectations because as some of us have been discussing in the comments section the main impact of QE on a currency happens in the expectations/anticipation phase.

On the other side of the coin you have to believe that a 0.25% cut in interest-rates has a material impact after cuts of over 4% did not! Also that increasing the Bank of England’s balance sheet will do more than adding to house prices and easing the fiscal deficit. A ten-year Gilt yield of 0.96% does not go well with inflation at 2.9% ( CPI) and of course even worse with RPI ( 3.7%).

House Prices

I spotted this earlier in the Financial Times which poses a serious question to Bank of England policy.

Since 1980, the compounded inflation-adjusted gain for a UK homeowner has been 212 per cent. Before 1980 house price gains were much tamer over the various cycles either side of the second world war. Indeed, in aggregate, prices were largely unchanged over the previous 100 years, once inflation is accounted for.

A change in policy? Of course much of that was before Mark Carney’s time but we know from his time in Canada and here that house price surges and bubbles do happen on his watch. The article then looks at debt availability.

The one factor that did change, though, and marked the start of that step change in 1980, is the supply of mortgage debt……….has resulted in a sevenfold increase in inflation-adjusted mortgage debt levels since then.

This leads to something that I would like Mark Carney to address in his Mansion House speech tonight.

Second an inflation-targeting central bank, which has delivered a more aggressive monetary response to each of the recent downturns, because of that high debt burden.

On that road we in the UK will see negative interest-rates in the next downturn which of course may be on the horizon.

Comment

There is much to consider for the Governor of the Bank of England tonight. If he continues on the current path of cutting interest-rates and adding to QE on any prospect of an economic slow down then neither he nor his 8 fellow policy setting colleagues are required. We could replace them with an AI ( Artificially Intelligent ) Robot although I guess the danger is that it becomes sentient Skynet style ( from The Terminator films ) and starts to question what it is doing?

However moving on from knee-jerk junkie culture monetary policy has plenty of problems. It first requires both acknowledgement and admittal that monetary policy can do some things but cannot do others. Also that international influences are often at play which includes foreign monetary policy. I have looked at the Federal Reserve today well via the Far East other monetary policy applies. Let me hand you over to some research from Neal Hudson of Residential Analysts on buyers of property in London from the Far East.

However, anecdotal evidence suggests that many of these buyers have been using local mortgages to fund their purchases.  The limited evidence I have suggests that around half of Hong Kong and Singaporean buyers use a local mortgage while the majority of mainland Chinese buyers use one.

Okay on what terms?

The main difference is that the mortgage rate tends to be slightly higher (London Home Loan comparison) and local lenders allow borrowers to have far higher debt multiples.

These people are not as rich as might previously have been assumed and we need to throw in changes in the value of the UK Pound £ which are good for new buyers but bad for existing ones. Complicated now isn’t it?

On a personal level I was intrigued by this.

Last year I visited a development in Nine Elms and the lobby felt more like a hotel than a residential block. There were significant numbers of people appearing to pick up and drop off keys with suitcases in tow.

You see I live in another part of Battersea ( the other side of the park) and where i live feels like that as well.

 

 

 

What next for the world of negative interest-rates?

There were supposed to be two main general economic issues for 2017. The first was the return of inflation as the price of crude oil stopped being a strong disinflationary force. The second was that we would see a rise in interest-rates and bond yields as we saw an economic recovery combined with the aforementioned inflation. This was described as the “reflation” scenario and the financial trade based on it was to be short bonds. However we have seen a rise in inflation to above target in the UK and US and to just below it in the Euro area but the bond market and interest-rate move has been really rather different.

Negative Official Interest-Rates

Euro area

These are still around particularly in Europe where the main player is the European Central Bank. This plays out in three main areas as it has an official deposit rate of -0.4%, it also has its long-term refinancing operations where banks have been able to borrow out to the early 2020s at an interest-rate that can also be as low as -0.4% plus of course purchasing sovereign bonds at negative yields. So whilst the rate of monthly bond purchases has fallen to 60 billion Euros a month the envelope of negative interest-rates is still large in spite of the economic recovery described earlier this week by ECB President Draghi.

As a result, the euro area is now witnessing an increasingly solid recovery driven largely by a virtuous circle of employment and consumption, although underlying inflation pressures remain subdued. The convergence of credit conditions across countries has also contributed to the upswing becoming more broad-based across sectors and countries. Euro area GDP growth is currently 1.7%, and surveys point to continued resilience in the coming quarters.

Indeed the economic optimism was turned up another notch by the Markit PMI business surveys on Tuesday.

The PMI data indicate that eurozone growth remained impressively strong in May. Business activity is expanding at its fastest rate for six years so far in the second quarter, consistent with 0.6- 0.7% GDP growth. The consensus forecast of 0.4% second quarter growth could well prove overly pessimistic………

That is better than “resilience” I think.

Sweden

This is one of the high fortresses of negative interest-rates as you can see from the latest announcement.

The Executive Board decided to extend the purchases of government bonds by SEK 15 billion during the second half of 2017 and to hold the repo rate unchanged at −0.50 per cent. The repo rate is now not expected to be raised until mid-2018, which is slightly later than in the previous forecast.

As you can see a move away from the world of negative interest-rates seems to have moved further into the distance rather than get nearer. If you look at the economic situation then you may quite reasonably wonder what is going on here?

Swedish economic activity is good and is expected to strengthen further over the next few years. Confidence indicators show that households and companies are optimistic and demand for exports is strong. The economic upturn means that the demand for labour is still strong.

We do not have the numbers for the first quarter but we do know that GDP ( Gross Domestic Product) increased by 1% in the last quarter of 2016. If you read the statement below then it gets ever harder to justify the current official interest-rate.

Rising mortgage debt is a serious threat to Sweden’s economy while regulators need to introduce tougher measures to strengthen banks against future shocks, the central bank said in its semi-annual stability report, published on Wednesday………Swedish house prices have doubled over the last decade. Apartment prices have tripled. Household debt levels – in relation to disposable income – are among the highest in Europe.

Switzerland

The Swiss National Bank feels trapped by the pressure on the Swiss Franc.

The Swiss franc is still significantly overvalued. The negative interest rate and the SNB’s willingness to intervene in the foreign exchange market are necessary and appropriate to ease pressure on the Swiss franc. Negative interest has at least partially restored the traditional interest rate differential against other countries.

You may note that they are pointing the blame pretty much at the ECB and the Euro for the need to have an interest-rate of -0.75% ( strictly a range between -0.25% and -1.25%).

Denmark

As you can see Denmark’s Nationalbank has not moved this year either.

Effective from 8 January 2016, Danmarks Nationalbank’s interest rate on certificates of deposit is increased by 0.10 percentage point to -0.65 per cent.

The 2016 move left it a little exposed when the ECB cut again later than year but it remains firmly in negative interest-rate territory.

Japan

Until now we have been looking at issues surrounding the Euro both geographically and economically but we need to go a lot further east to see the -0.1% interest-rate of the Bank of Japan. Added to that is its policy of bond purchases where it aims to keep the ten-year yield at approximately 0%. So there is no great sign of a change here either.

 

The United States

Here of course we have seen an effort to move interest-rates to a move positive level but so far we have not seen that much and it has not been followed by any of the other major central banks. Indeed one central bank which is normally synchronised with it is the Bank of England but it cut interest-rates and expanded its balance sheet last August so it has headed in the opposite direction this time around.

This theme has been reflected in the US bond market where we saw a rise in yields when President Trump was elected but I note now that not much has happened since. The ten-year Treasury Note now yields around 2.25% which is pretty much where it was back then. We did see a rise to above 2.6% but that faded away as events moved on. Even the prospect of a beginning of an unwinding of all of the bond holdings of the Federal Reserve does not seem to have had much impact. That seems extraordinarily sanguine to me but there are two further factors which are at play. One is that investors do not believe this will happen on any great scale and also that there is no rule book or indeed much experience of how bond markets behave when a central bank looks for the exit.

How much?

There was a time when we were regularly updated on the size of the negative yielding bond universe whereas that has faded but there is this from Fitch Ratings in early March.

Rising long-term sovereign bond yields across the eurozone contributed to a decline in outstanding negative yielding sovereign debt to $8.6 trillion as of March 1 from $9.1 trillion near year-end 2016.

The fall such as it was seemed to be in longer dated maturities.

The total of negative-yielding sovereign debt with remaining maturities of greater than seven years fell significantly to $0.5 trillion as of Mar. 1 from over $2.6 trillion on June 27 2016.

Since then German bond yields have moved only a little so the general picture looks not to be much different.

Comment

I wanted to point out today the fact that whilst it feels like the economic world has moved on in 2017 in fact the negative interest-rate and yield story has changed a lot less than we might have thought. It has fallen out of the media spotlight and perceptions but it has remained as a large iceberg floating around.

One of my themes has been that we will find out more about the economic effects of negative interest-rates as more time passes. Accordingly I noted this from VoxEU yesterday.

Banks throughout the Eurozone are reluctant to cut retail deposit rates below zero, wary of possible client reactions

That has remained true as time has passed and it seems ever clearer that the banking sector is afraid of a type of deposit flight should they offer less than 0% on ordinary retail savings. That distinguishes it from institutional or pension markets where as we have discussed before there have been lots of negative yields and interest-rates. Also if we look at average deposit rates there remain quite large differences in the circumstances.

For example, the average rate on Belgian deposits has dropped to 0.03%. If Belgians took their money across the border, they could get almost ten times that in the Netherlands (0.28%). In France even, rates average 0.43%.

If we move to household borrowing rates we see that there are much wider discrepancies as we wonder if at this level we can in fact call this one monetary policy?

The Finns borrow against 1.8%, the Irish pay 3.6%

Some of the differences are down to different preferences but as the Irish borrowing is more likely to be secured ( mortgages) you might reasonably expect them to be paying less. Oh and as a final point as we move to borrowing we note that rates are a fair distance from the official ones meaning that the banks yet again have a pretty solid margin in their favour, which is somewhat contrary to what we keep being told.

What are the latest trends for inflation?

It is time to review one of the themes of 2017 which is that we expected a pick-up in the annual rate of inflation around the world. This has been in play with the US CPI rising at an annual rate of 2.4% in March and the Euro area CPI rising at 1.9% in April for example. If we switch to the factor that has been the main player in this we see that energy prices were 10.9% higher in the US than a year before and that in the Euro area they had gone from an annual rate of -8.7% in April last year to 7.5% this April. If we look at my own country the UK then the new headline inflation measure called CPIH ( where H includes an Imputed Rent effort at housing costs) then inflation has risen from 0.2% in October 2015 to 2.3% in March. So we see that the US Federal Reserve and the Bank of England have inflation above target and the ECB on it which means two things. Firstly those who went on and on about deflation a couple of years ago were about as accurate as central banking Forward Guidance . Secondly that we can expect inflation in the use of the words “temporary” and “transitory”!

Crude Oil

There has been a change in trend here indicated this morning by this from @LiveSquawk.

Saudi OPEC Governor: Based On Today’s Data, There Is Growing Conviction That 6-Month Extension May Be Needed To Re-balance The Market

You may recall that what used to be the world’s most powerful cartel the Organisation of Petroleum Exporting Countries or OPEC met last November to agree some output cuts. These achieved their objective for a time as the price of crude oil rose however this was undermined by a couple of factors. The first was that it was liable to be a victim of its own success as a higher oil price was always likely to encourage the shale oil wildcatters especially in the United States to increase production. This would not only dampen the price increase but also reduce the relative importance of OPEC. As you can see below that has happened.

U.S. crude production rose to 9.29 million barrels last week, the highest level since August 2015, according to the Energy Information Administration. (Bloomberg).

Also doubts rose as to whether OPEC was delivering the output cuts that it promised. For example they seem to be exporting more than implied by their proclaimed cuts. From the Financial Times.

Analysts at Energy Aspects say tanker tracking data suggests Opec’s exports have fallen by as little as 800,000 b/d so far in 2017 as some members have supplanted oil lost to production cutbacks with crude from storage, or have freed up barrels for export as they carry out maintenance at domestic refineries.

On the other side of the coin there is the fact that for a given level of output we need less oil these days and an example of this comes from the Financial Post in Canada today.

Canada substantially boosted its renewable electricity capacity over the past decade, and has now emerged as the second largest producer of hydroelectricty in the world, a new report said Wednesday.

So the trajectory for oil demand looks lower making the “balance” OPEC is looking for harder to achieve.

Other commodities

We get a guide to this if we look to a land down under as the Reserve Bank of Australia has updated us in its monetary policy today.

Beyond the next couple of quarters, prices of bulk commodities are expected to decline………Consistent with previous forecasts, iron ore prices have already fallen significantly in the past few weeks.

The RBA also produces an index of commodity prices.

Preliminary estimates for April indicate that the index decreased by 3.5 per cent (on a monthly average basis) in SDR terms, after decreasing by 1.7 per cent in March (revised). A decline in the iron ore price more than offset an increase in the coking coal price. Both the rural and base metals subindices decreased slightly in the month. In Australian dollar terms, the index decreased by 2.0 per cent in April.

So the rally seems to be over and the index above was inflated by supply problems for coal which drove its price higher. As to Iron Ore the Melbourne Age updates us on what has been going on.

Spot Asian iron ore prices have performed worse than Chinese steel rebar futures in recent weeks, dropping 31 per cent from a peak of US$94.86 a tonne on February 21 to US$65.20 on Thursday.

If we switch to Dr. Copper then the rally seems to be over there too although so far the price drops have been relatively minor.

What about food prices?

The United Nations updated us yesterday on this.

The FAO Food Price Index* (FFPI) averaged 168.0 points in April 2017, down 3.1 points (1.8 percent) from March, but still 15.2 points (10 percent) higher than in April 2016. As in March, all commodity indices used in the calculation of the FFPI subsided in April, with the exception of meat values.

As ever there are different swings here and of course the swings remind us of the film Trading Places. There was a time that these looked like the most rigged markets but of course there is so much more competition for such a title these days including from those who are supposed to provide fair markets ( central banks ).

Comment

There is a fair bit to consider here as we look forwards. There is always a danger in using financial markets too precisely as of course sharp falls like we have seen this week are often followed by a rebound. But it does look as if the commodity price trajectory has shifted lower which is good for inflation trends which is likely to boost economic growth compared to otherwise. Of course there are losers as well as winners here as commodity producers lose and importers win. But overall we seem set to see a bit less inflation than previously predicted and over time a little more economic growth.

As to the impact of a falling crude oil price on inflation the UK calculates it like this and I would imagine that many nations are in a similar position.

A 1 pence change on average in the cost of a litre of motor fuel contributes approximately 0.02 percentage points to the 1-month change in the CPIH.

There are of course also indirect effects on inflation from lower energy prices as well as other direct effects such as on domestic fuel bills. For the UK itself I estimated that inflation would be around 1.5% higher due to the EU leave due to the lower level of the Pound £ and for that to weaken economic growth. So for us in particular any dip in worldwide inflation is welcome as of course is the rise in the UK Pound £ to US $1.29.

A (space) oddity

We are using electronic methods of payment far more something which I can vouch for. However according to the Bank of England we are also demanding more cash.

Despite speculation to the contrary, the number of banknotes in circulation is increasing. During 2016, growth in the value of Bank of England notes was 10%, double its average growth rate over the past decade.

Who is stocking up and why? Pink Floyd of course famously provided some advice.

Money, it’s a gas
Grab that cash with both hands and make a stash
New car, caviar, four star daydream,
Think I’ll buy me a football team

Share Radio

Sadly it comes to an end today and in truth it has been winding down in 2017. As someone who gave up his time to support it let me say that it is a shame and wish all those associated with it the best for the future.

 

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

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

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

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

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

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

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

Here is some more detail.

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

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

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

House prices

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

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

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

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

The GDP data

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

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

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

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

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

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

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

Looking Forwards

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

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

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

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

What about the individual experience?

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

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

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

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

Is GDP underecorded?

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

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

Okay why?

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

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

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

Comment

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

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

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

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

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

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

What is happening to US auto-loans?

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

What is the background?

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

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

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

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

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

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

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

Last month it confirmed the 2016 rise.

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

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

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

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

Used car prices

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

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

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

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

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

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

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

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

Also it points out this.

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

In terms of its own region it is seeing this.

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

Asset Backed Securities (ABS)

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

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

Comment

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

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

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

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

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

Also this.

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

https://ezautofinance.net/how_to_get_a_blank_check_auto_loan_even_with_bad_credit.html

What could go wrong?

 

 

Are the currency wars still raging?

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

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

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

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

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

Japan

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

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

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

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

Germany

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

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

The UK

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

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

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

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

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

South Africa

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

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

Perhaps the air got a bit thin up there.

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

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

Bitcoin

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

Comment

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

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