The shift towards lower rather than higher interest-rates is beginning again

Yesterday was another poor day for the Forward Guidance provided by central bankers as we note developments in the US and UK. There was a flurry of media activity around the statement from Bank of England Governor that the Chinese Yuan could challenge the US Dollar as the world’s reserve currency, but really he was saying that it is a very long way away. So let us start with the US Federal Reserve and look back to September for its Forward Guidance. From Reuters.

Fed policymakers did not jack up their expectations for rate hikes in coming years, as some analysts had thought, instead sticking closely to rate hike path forecasts outlined in June that envision short-term rates, now at 2.0 percent to 2.25 percent, to be at 3.1 percent by the end of next year.

This suggested a couple of rate hikes in 2019 and at the beginning of December Bill Conerly stepped up the pace in Forbes Magazine.

My forecast for interest rates remains higher than the Fed’s September 2018 forecast. I expect the Fed Funds rate to end 2019 at 3.9%, and to end 2020 at 4.5%.

Bill seemingly had not got the memo about a slowing word and hence US economy as he reflected views which in my opinion were several months out of date as well as being extreme for even then. But what we were seeing was a reining back of forecasts of interest-rate rises. Putting that in theoretical terms the so-called neutral rate of interest showed all the flexibility of the natural rate of unemployment in that it means whatever the central bankers want it to mean.

Last Night events took another turn with the publication of the US Federal Reserve Minutes from December.

With regard to the post meeting statement, members agreed to modify the phrase “the Committee expects that further gradual increases” to read “the Committee judges that some further gradual increases.” The use of the word “judges” in the revised phrase was intended to better convey the data-dependency of the Committee’s decisions regarding the future stance of policy; the reference to “some” further gradual increases was viewed as helping indicate that, based on current information, the Committee judged that a relatively limited amount of additional tightening likely would be appropriate.

As you can see they have chosen the words “judges” and “some” carefully and the prospect of interest-rate increases this year has gone from a peak of 4 with maybe more in 2020 to perhaps none. Or for fans of Carly Rae Jepson it has gone from ” I really,really,really,really” will increase interest-rates to “Call Me Maybe”

Why? Well some may mull the idea of there being a form of Jerome Powell put option for the stock market.

Against this backdrop, U.S. stock prices were down nearly 8 percent on the period.

Widening that out it also reflected an economic weakening which has mostly got worse since.

Forward Guidance

This is supposed to help the ordinary consumer and business(wo)man but letting them know what the central bank plans to do. But to my mind this is of no use at all if they keep getting it wrong as the US Federal Reserve just has. In fact in terms of fixed-rate mortgages and loans they have been given exactly the wrong advice. Whereas we had reflected the changing outlook as I quote from my opening post for this year.

The problem is their starting point and for that all eyes turn to the central banks who have driven them there. Get ready for the claims that “it could not possibly have been expected” and “Surprise!Surprise!”

I find myself debating this on social media with supporters of central bank policy who mostly but not always are central banking alumni. They manage to simultaneously claim that Forward Guidance is useful but it does not matter if it is wrong, which not even the best contortionist could match.

Bank of England

The memo saying “the times they are a-changing” had not reached Bank of England Governor Mark Carney as he posted on the Future Forum yesterday afternoon.

 That’s why the MPC expect that any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent.

He is still hammering away with his hints at higher interest-rates although he was also trying to claim that movements in interest-rates are nothing to do with him at all.

So in other words, low policy interest rates are not the caprice of central bankers, but rather the consequence of powerful global forces.

Makes you wonder why he and his 8 interest-rate setting colleagues are paid  some much if the main events are nothing to do with them doesn’t it? I somehow doubt that when a Bank of England footman handed a copy of Mark Carney’s Gilt-Edged CV to the World Bank that it was claiming that.

Governor Carney was in typical form in other ways too as he answered this question.

In your opinion, how likely is a large spike in Inflation in the near future?

For example in a lengthy answer he used the word inflation once but the word unemployment five times and did not mention inflation prospects/trends ( the question) at all! Better still the things which were apparently “the consequence of powerful global forces.” suddenly became due to his ilk.

Simulations using the Bank’s main forecasting model suggest that the Bank’s monetary policy measures raised the level of GDP by around 8% relative to trend and lowered unemployment by 4 percentage points at their peak. Without this action, real wages would have been 8% lower, or around £2,000 per worker per year, and 1.5 million more people would have been out of work.

As we note his slapping of his own back whilst blowing his own trumpet I zeroed in on the wage growth claim which appeared in another form much later.

Although it’s true that QE helped support asset prices, it also boosted job creation and wage growth.

There is a lot in that sentence but let us start with the wage growth issue. The reality is that real wage growth has been negative in the UK and worse than our economic peers. By propping up zombie banks and companies for example there are reasons to argue that the QE era has made things worse. But apparently in a stroke of magic it has made everything better! Now whilst correlation does not prove causation it is hard to argue you have made things better in a period where you have had a major impact and things have got worse.  Indeed  the more recent trend as the QE flow has slowed has been for wages to pick up.

Also there was the “helped support asset prices” point. This is welcome in its honesty but there have been times that the Bank of England ( in spite of its own research on the subject) has tried to deny this.

What about debt?

Back in 2016 Governor Carney told us.

This is not a debt-fuelled recovery.

Yesterday he changed his tune slightly.

 Recent growth in aggregate credit in the UK has been modest, growing a little faster than nominal GDP.

Notice the shift from real GDP to the invariably higher nominal GDP. Missing in action was any mention of unsecured credit which surged into double-digit annual growth in response to the Sledgehammer QE action of the Bank of England in the autumn of 2016 and is still growing at over 7%. Nor did the surge in student loans merit a mention unlike in this from Geoff Tily of the TUC last week.

Total unsecured debt has risen to £428 billion. At 30.4 per cent of household income, this is higher than before the financial crisis:

Comment

There is a fair bit to sweep up here but the main point is that we have developed bodies called independent that do the establishments bidding on a scale politicians themselves would never have got away with. Can you imagine politicians being able to buy trillions of their own debt?! Next we are told that they can help us with the future via Forward Guidance but that when it goes wrong it does not matter. The elastic of credibility just snapped.

In my own country the UK this was added to on LBC Radio where we were grandly told yesterday that someone who used to set UK interest-rates would be on air. When Ian McCafferty came on he seemed confused by the statement that the UK economy grew by 0.6% in the third quarter and sounded out of touch with events. For example in the early part of 2018 it was true that Germany and France were growing more quickly than the UK but as this morning has reminded us to say they are doing so now makes you look out of touch at best.

In November 2018, output slipped back sharply in the manufacturing industry (−1.4% after +1.4% in October) as well as in the whole industry (−1.3% after +1.3%). ( France-Insee ).

Perhaps he will offer a retraction like he had to do when he was on LBC last August. Meanwhile you know I often tell you never to believe anything until it is officially denied don’t you? From Governor Carney yesterday.

We have also made clear that we wouldn’t set negative interest rates – the Bank’s Monetary Policy Committee, which is responsible for setting Bank Rate, has said that the effective lower bound on Bank Rate is close to, but a little above, zero.

As a hint the lower bound was 0.5% until they cut to 0.25% ( and promised a cut to 0.1% in another Forward Guidance failure).

 

 

 

 

 

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The outlook for the economy of Germany has plenty of dark clouds

Sometimes it is hard not to have a wry smile at the way events are reported. Especially as in this instance it has been a success for my style of analysis. If we take a look at the fastFT service we were told this yesterday.

German industrial production unexpectedly drops in November.

My immediate thought was as the German economy contracted by 0.2% in the third quarter we should not be surprised by declines. Fascinatingly the Financial Times went to the people who have not been expecting this for an analysis of the issue.

German data released over the past two days have painted a glum picture for how Europe’s biggest economy performed during the latter part of 2018. fastFT rounds up what economists and analysts have said about what is happening. Anxieties over global trade wars and political uncertainty in the eurozone have taken their toll, and Europe’s powerhouse is showing signs of fatigue. Questions of whether a recession is looming have also been raised, while many economists remain cautiously optimistic in their prognosis.

If we now switch to what we have been looking at I wrote this on December 7th about the situation.

If we look at the broad sweep Germany has responded to the Euro area monetary slow down as we would have expected. What is less clear is what happens next? This quarter has not so far show the bounce back you might expect except in one area.

So not only had there been an expected weakening of the economy but there had been at that point no clear sign of the promised bounce back. What we know in addition now is this which was released on January 3rd.

  • Annual growth rate of broad monetary aggregate M3 decreased to 3.7% in November 2018 from 3.9% in October
  • Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, stood at 6.7% in November, compared with 6.8% in October

So another decline and if we look for a trend we would expect Euro area growth to continue to be weak and this time around that is being led by Germany. The link between monetary data and the economy is not precise enough for us to say Germany is in a recession but we can expect weak growth at best heading into the early months of 2019. The FT does to be fair give us a brief mention of the monetary data from Oxford Economics.

lending growth remaining robust

The problem with that which as it happens repeats the argument of Mario Draghi of the ECB is that it is a lagging indicator in my opinion as banks respond to the better economic news from 2017.

As these matters can be heated let me make it quite clear that I wish Germany no ill in fact quite the reverse but the money supply data has been clear and has worked so far. Frankly the way it is still being widely ignored suggests it is likely to continue to work.

This week’s data

Trade

This morning’s release started in conventional fashion as we got the opportunity to observe yet another trade surplus for Germany.

 Germany exported goods to the value of 116.3 billion euros and imported goods to the value of 95.7 billion euros in November 2018………The foreign trade balance showed a surplus of 20.5 billion euros in November 2018. In November 2017, the surplus amounted to 23.8 billion euros. In calendar and seasonally adjusted terms, the foreign trade balance recorded a surplus of 19.0 billion euros in November 2018.

In world terms an annual decline in Germany’s surplus is a good thing as it was one of the imbalances which set the ground for the credit crunch. But if we switch to looking at this on a monthly basis this leapt off the page at me about imports.

-1.6% on the previous month (calendar and seasonally adjusted)

A fall in imports is a sign of a weak economy as for example we saw substantial falls in Greece back in the day. There are caveats to this of which the biggest is that monthly trade data is inaccurate and erratic but such as the numbers are they post another warning. The other side of the balance sheet was more conventional in that with current trade issues one might expect this.

also reports that German exports in November 2018 remained nearly unchanged on November 2017.

Let us move on by noting that due to the way that Gross Domestic Product or GDP is calculated lower imports in isolation provide a boost before a “surprise” fall later as it filters through other parts.

Production

If we step back to Monday there was some troubling news on this front.

Based on provisional data, the Federal Statistical Office (Destatis) reports that price-adjusted new orders in manufacturing had decreased in November 2018 a seasonally and calendar adjusted 1.0% on the previous month.

So not much sign of an improvement and it was hardly reassuring that geographically the issue was concentrated in the Euro area.

Domestic orders increased by 2.4% and foreign orders decreased by 3.2% in November 2018 on the previous month. New orders from the euro area were down 11.6%, new orders from other countries increased 2.3% compared to October 2018.

Then on Tuesday we got disappointing actual production numbers.

In November 2018, production in industry was down by 1.9% from the previous month on a price, seasonally and calendar adjusted basis according to provisional data of the Federal Statistical Office (Destatis). The revised figure shows a decrease of 0.8% (primary -0.5%) from October 2018.

So November has quite a fall and this was compared to an October number which had been revised lower. This meant that the annual picture looked really poor.

-4.7% on the same month a year earlier (price and calendar adjusted)

Business surveys

At then end of last week we were told this by the Markit PMI ( Purchasing Manager’s Index) at the end of last week.

December saw the Composite Output Index fall for the fourth month running to 51.6, down from 52.3 in
November and its lowest reading since June 2013.
The latest slowdown was led by the service sector, as the rate of manufacturing output growth strengthened for the first time in five months, albeit picking up only slightly and staying below that of services business activity.

The problem for Markit is that rather than leading events they are lagging them as they are recording declines after the economic contraction in the third quarter. If we took them literally then the economy would shrink by even more this quarter! Anyway they no seem to be on the case of the motor industry. From yesterday.

Latest data indicated a worsening downturn in the European autos sector at the end of 2018. Production of automobiles & parts fell for the third month running, and at the fastest rate since March 2013. New orders fell sharply, with new export business (including intra-European trade) declining at the fastest rate in six years.

Comment

The German economy found itself surrounded by dark clouds as 2018 developed and as I am typing this we have seen more worrying signs. From @YuanTalks.

It’s the FIRST YEARLY DROP in at least 20 years. Passenger car sales slumped 19% y/y in Dec 2018 to 2.26 mln vehicles.

Over 2018 as a whole car sales fell by 6% so we can see the issue is accelerating and there are obvious implications for German manufacturers. It has been accompanied by another generic sign of possible world economic weakness from @LiveSquawk.

Exclusive: Apple Cuts iPhone Production Plan By 10% – Nikkei

Suddenly there is a lot of concern over a German recession or as it is being described a technical recession. In case you were wondering that means a recession that is within the error range of the data which actually covers most of them! Because of these errors it is hard to say whether the German economy grew or contracted at the end of last year, as for example wage growth should support consumption. But what we can say is that the broad sweep from it to the like;y trend for the early part of 2019 is weak. Perhaps some growth but not much after all even 0.2% growth in the final quarter would mean flat growth for the second half of the year.

For those who think ECB policy is set for Germany this poses quite a problem as it has ended its monthly QE purchases just as things have deteriorated in a shocking sense of timing. But to my mind just as bad is the issue that my “junkie culture” theme that growth was dependent on the stimulus also gets a tick including something of a slap on the back from Mario Draghi who seems to have come round to at least part of my point of view.

I’ll be briefer than I would like to be, but certainly especially in some parts of this period of time, QE has been the only driver of this recovery.

According to Handelsblatt every little helps.

Germany has saved €368 billion in interest costs on its debt thanks to record low interest rates since the financial crisis in 2008, according to Bundesbank calculations. That’s more than 10% of annual GDP.

 

 

 

What will happen to Bank Carige of Italy?

One of the longest running themes of this site has been the ostrich like behaviour of Italy about its banks. The official view has been that a corner is just about to be turned on what keeps turning out to be a straight road. I still recall Prime Minster Renzi assuring investors that shares in the trouble Monte Paschi di Siena were a good purchase. Here is an example of this from him in Il Sole from January 2016 via Google Translate and the emphasis is mine.

“The recent turbulence around some Italian banks indicates that our credit system – solid and strong thanks to the extraordinarily high savings of Italian families – still needs consolidation, so that there are fewer but stronger banks (…) Today the bank it is healed, and investing is a bargain. On Mps has been knocked down speculation but it is a good deal, has gone through crazy vicissitudes but today is healed, it is a nice brand. Perhaps in this process that will last a few months must find partners because it must be with others “.

Since then the bank has seen the Italian state take a majority stake and the share price is a bit less than forty times lower than when Renzi made his statement. This has been a familiar theme of the crisis where investors have been encouraged to stump up more money for troubled banks with promises of a brighter future. But it kept turning out that the future was ever more troubled rather than bright as good money followed bad in being lost.

Even worse the whole sector was weakened by the way that other types of bailout were provided by the banking sector itself. For example via the Atlante or Atlas fund which saw banks investing to recapitalise other banks and to buy bad loans. Regular readers will recall that the establishment view was that the purchase of bad loans by this and other vehicles was something of a new dawn for the sector. The reality was that as things got worse there was Atlante 2 before the whole idea got forgotten. It is rude to point out that the subject of today Bank Carige was considered strong enough to put 20 million Euros into the first version of Atlante.

A deeper perspective can be provided by the fact that the Italian banking laws are called the “Draghi Laws” after the President of the European Central Bank Mario Draghi. In his new role he has undertaken three policies which have helped the Italian banks. They have been particularly large beneficiaries of his liquidity operations called TLTROs which have provided cheap ( the deposit rate is -0.4%) for banks. Then the QE programme boosted the price of Italian government bonds benefiting the Italian banks large holdings. Then more opaquely at least in terms of media analysis it bought covered bonds ( mortgage bonds) in three phases and still holds around 271 billion Euros of them.

The catch of this from Mario’s point of view is that liquidity is only a short-term solution and soon falls short when the real questions are about solvency. Even worse the way this umbrella shielded the banks from the rain meant that the promised reforms never happened and the path was made worse rather than better. Also if we think of this from the point of Italy and its economy we see that we have part of the reason for its ongoing economic lost decade style troubles. The banks have helped suck it lower. Also and hat tip to Merryn Somerset Webb for this a letter to the FT today has on another topic covered the issue really rather well.

ECB can’t solve problems because to attempt to do so would be to admit that problems exist.

Carige

If we go back to 2017 we see that as well as a worrying departure of board directors and the beginning of an attempted asset sale which was to include bad loans there was this in December.

Italy’s Banca Carige said on Friday it had raised 544.4 million euros ($645 million) following its recently concluded new share issue, topping minimum regulatory demands. ( Reuters)

There were various features to this of which the first is that existing shareholders took a right caning or as the Italian regulator put it.

The Banca Carige capital increase has characteristics of hyperdilution.

In return there was the implication that the ECB had approved this and a corner had been turned. Less than a year later this all went sour as the ECB decided that Bank Carige needed yet another rights issue in yet another example of the themes described above. This time in spite of statements to the contrary no-one seemed silly enough to believe the official promises and this rumbled on until the New Year when the ECB decided that the first business day of 2019 was an opportune moment to do this.

The mass resignation of Carige directors that followed has given the ECB an opportunity to be creative. The central bank has used its powers of early intervention to step in to stabilise the bank’s governance. It has appointed three special administrators, including Innocenzi, tasked with restoring capital requirements. ( Reuters)

If you want some gallows humour this was described as “temporary” when it was pretty much certain to be anything but as a major shareholder ( Malaclaza) decided it had lost enough. It was hardly likely to believe the ECB again.

The Italian Government

This found itself in between a rock and a hard place as the Five-Star movement has consistently opposed both bailouts and bail-ins. Yet the government of which it is a member took I am told only 8 minutes to decide this last night.

The decree, signed off on Monday after a surprise cabinet meeting, will allow the bank to benefit from state-backed guarantees for new bond issues and funding from the Bank of Italy.

The lender, which last year failed to secure shareholder backing for a capital increase, will also be able to request access to state-backed precautionary recapitalization, if needed.

So yet again in a choice between the interests of the people and the interests of “the precious” we see that the same old status quo continues to play.

Whatever you want
Whatever you like
Whatever you say
You pay your money
You take your choice
Whatever you need
Whatever you use
Whatever you win
Whatever you lose

One of my longest-running themes of this website gets another tick in the box and we even get some Italian style humour.

EU rules permit such a scheme only if the bank is solvent.

So solvent in fact that they can no longer find anyone willing to put their own money into it. Also seeing as Bank Carige cannot even see its own nose I doubt this will be a barrier for long.

According to a financial source close to the matter, Carige would only consider a request for precautionary recapitalization if new and unforeseen problems arose.

Comment

The issue here is that on a generic basis the events described above are so familiar now that even the use of phrases like groundhog day does not do the situation justice. There are always going to be problems because regulators invariably end up being captured by the industry they regulate and banking is perhaps the worst example of this. But changes were promised so long ago and yet the Italian taxpayer will find him/herself on the hook in addition to the 320 million Euro hybrid bond that the deposit protection fund bought late last year. Even worse they may end up backing this enough for someone else to be willing to take it over and profit from. Oh and so much for hybrid!

Meanwhile in a land far, far, away I see that the Financial Times has interviewed the head of the Euro area banking resolution body.

Speaking to the FT to mark three years since the SRB became fully operational at the start of 2016, Ms König said a page had been turned in how the bloc handled bank failures — not least after its first intervention, at Spain’s Banco Popular in 2017 — but that the system remained a work in progress.

There is no mention of Italy at all which is really rather breathtaking, although there may be an implied hint.

Making sure that bank crises could be contained without resorting to taxpayer help was “an ongoing challenge”, she said.

Some claim the lack of contagion is progress, but you see there is a clear flaw in that as the problems here were evident as long ago as 2014 so what is called the “smart money” will have gone long ago. In some ways this makes things worse because in another shocking failure of regulation Italian retail depositors were encouraged to buy bank bonds.

 

The Tokyo Whale will need to get its buying boots on again

Let us begin the week with some good news for the central bank from the land of the rising sun or Nihon. That is that the Nikkei 225 equity index rallied strongly this morning and its 2.44% surge saw it regain the 20,000 level and close at 20,038. The Bank of Japan will be pleased on two counts, of which the first is the wealth effects it will expect from a higher equity market. The second is that it will improve its own position as what we have labelled the Tokyo Whale.

The Bank of Japan’s purchases of exchange-traded funds since the start of 2018 exceeded 6 trillion yen ($53 billion) on Tuesday, reaching a record high on a yearly basis and signaling the central bank has been increasingly exposed to riskier assets. ( The Mainichi).

For newer readers the Bank of Japan has been buying Japanese equities for around 5 years and has been doing so on an increasing scale.

Under Governor Haruhiko Kuroda, the BOJ announced aggressive monetary stimulus in 2013 aimed at breaking Japan’s economy out of its deflationary malaise.

The measures included increasing the central bank’s holdings of ETFs by an annual 1 trillion yen, which it expanded to 3 trillion yen in 2014 and again to 6 trillion yen in 2016.

The name “Tokyo Whale” came about because as you can see it found the need to keep increasing the size of the purchases as the expect results did not materialise. This meant that it cannot keep this going for much longer as it will run out of equity ETFs to buy. Why does it buy them? Well the bit below hints at it.

ETFs allow investors to buy and sell exposure to a basket of equities or an index without owning the underlying shares.

So the Bank of Japan can avoid claims it is explicitly investing in the companies concerned or if you like is a passive fund manager. Those of you who recall the media claims last autumn that the Bank of Japan was in the process of conducting a “tapering” of its purchases will find the bit below familiar.

The purchases have been criticized by some as artificially buoying stock prices, leading the BOJ in July this year to give itself more flexibility by saying it “may increase or decrease the amount of purchases depending on market conditions.”

The Tokyo Whale bought more and not less as the 24,000 or so of late summer was replaced by the current level.

Purchases of the investment funds swelled as the BOJ stepped in to underpin the stock market, which in October suffered huge losses amid concerns over heightened trade tensions between the United States and China.

If we step back and wonder what influence this has been then this from the Tokyo Whale itself hardly provides much support.

a challenge lies in the household sector in that the mechanism of the virtuous cycle from
income to consumption expenditure has been operating weakly.

Money Supply

We have been observing for some months now that many countries have had lower money supply growth which has then led to lower economic growth. So as you can imagine I was waiting for the monetary base data released today. What we see is that the monetary base in Japan grew by 17% in 2017 but by a much lower 7.3% in 2018 and the annual rate in the month of December was only 4.8%. Quite remarkably there were spells in December when the monetary base actually fell. That begs a question about this.

The Bank of Japan will conduct money market operations so that the monetary base will increase at an annual pace of about 80 trillion yen.

As ever in Japan picking one’s way through this is complex as we arrive at what I think is the largest number we have noted on here. You see the Japanese monetary base which is some 504.2 trillion Ten has been pumped up so much by the Bank of Japan the annual rate of growth could not be kept up. For a start there was the issue of how many bonds and the like have already been bought.

The BOJ’s balance sheet, after all, reached a dubious milestone in 2018, when it topped Japan’s $4.87 trillion of annual gross domestic product. ( Nikkei Asian Review)

Rather oddly the NAR then tells us this.

The BOJ could easily buy more government debt and ETFs.

Actually there are not many ETFs left to buy and the Bank of Japan itself is seeing dissent against the current level of purchases. That is not to say that the Bank of Japan could not use other methods as it has shown itself willing to buy pretty much anything.

If we move to the wider liquidity measure of the Bank of Japan we see that the rate of growth was 3.5% in November 2017 but only 1.8% this November. Thus both the bass line and the drumbeat from the monetary system are not only the same but they are a 2018 theme. Because of the different nature of the Japanese system it is hard to be precise about any likely effect because all the expansion seemed to have only a minor upwards effect but one would expect that to now disappear.

Oh and my largest number did not last long as Japanese liquidity is 1788.5 trillion Yen.

The Yen

It was only last week that we were mulling the “flash rally” in the Yen as yet another weak period for equity markets saw a yen for Yen. A combination of thin markets and a Japanese bank holiday saw the Yen strengthen into the high 104s versus the US Dollar. I am told that exited some of the hedges placed by Japanese exporters but there was no sign of the “bold action” often promised by the Bank of Japan. Things are now calmer and the Yen is at 108 but even that is higher over time and that has been against a relatively strong US Dollar.

As the NAR points out this will not be welcomed by the Japanese authorities.

The central problem is that Japan’s economic growth relies largely a weak yen and its capacity to boost exports. Though Prime Minister Shinzo Abe talked grandly about structural reform, the yen’s 30% drop beginning in late 2012 was the fuel behind the 12-quarter run of growth Japan experienced until its July-September stumble.

Comment

The Tokyo Whale faces quite a few problems right now. For example the third quarter of 2018 showed something it has claimed was temporary.

Quarter-on-quarter, GDP shrank a real 0.6 percent, downgraded from the earlier reading of a 0.3 percent contraction. ( The Japan Times)

According to the Markit business survey there was a bounce back. From earlier today.

“Positive survey data from the manufacturing sector
were not mirrored by Japan’s dominant service providing industry in December, where business
activity increased at the weakest pace since May if
the natural-disaster-hit September is discounted.
The survey also pointed to abating demand
pressures, as private sector sales increased only
mildly on the month.”

But then we will expect to see the impact of slowing money supply growth. So 2019 may see the Tokyo Whale do this as we wait to see how those who have presented Abenomics as a triumph deal with Elvis Costello being number one again.

She’s been a bad girl, she’s like a chemical
Though you try to stop it, she’s like a narcotic
You want to torture her, you want to talk to her
All the things you bought for her, putting up your temperature
Pump it up, until you can feel it
Pump it up, when you don’t really need it

Meanwhile here is my podcast from last week with covers my thoughts on how Japan has survived the “lost decade(s)”.

 

 

 

 

 

How long will it be before the Bank of England cuts interest-rates?

This morning has opened with some good news for the UK economy and it has come from the Nationwide Building Society. So let us get straight to it.

Annual house price growth slows to its
weakest pace since February 2013. Prices fell 0.7% in the month of December,after taking account of seasonal factors.

I wish those that own their own house no ill but the index level of 425.7 in December compares with 107.1 when the monthly series first began in January of 1991, so you can see that it has been a case of party on for house prices. If you want a longer-term perspective then the quarterly numbers which began at 100 at the end of 1952 were 11.429.5 and the end of the third quarter of 2018. I think we can call that a boom! Putting it another way the house price to earnings ratio is 5.1 which is not far off the pre credit crunch peak of 5.4.

The actual change is confirmed as being below both the rate of consumer inflation and wage growth later.

UK house price growth slowed noticeably as 2018 drew to a close, with prices just 0.5% higher than December 2017.

Also the Nationwide which claims to be the UK’s second largest mortgage lender is not particularly optimistic looking ahead.

In particular, measures of consumer confidence weakened
in December and surveyors reported a further fall in new
buyer enquiries towards the end of the year. While the
number of properties coming onto the market also slowed,
this doesn’t appear to have been enough to prevent a
modest shift in the balance of demand and supply in favour
of buyers.

Although they then seem to change their mind.

It is likely that the recent slowdown is attributable to the
impact of the uncertain economic outlook on buyer
sentiment, given that it has occurred against a backdrop of
solid employment growth, stronger wage growth and
continued low borrowing costs.

The economic environment is seeing some ch-ch-changes right now but let us first sort out some number-crunching where each UK country has done better than the average.

Amongst the home nations Northern Ireland recorded the
strongest growth in 2018, with prices up 5.8%, though
Wales also recorded a respectable 4% gain. By contrast,
Scotland saw a more modest 0.9% increase, while England
saw the smallest rise of just 0.7% over the year.

They have I think switched from the monthly to the quarterly data here as that average was up by 1.3%.

The UK economy

We have now received the last of the UK Markit Purchasing Manager Index surveys so let us get straight to it.

At 51.6 in December, the seasonally adjusted All Sector
Output Index was up slightly from 51.0 in November.
However, the latest reading pointed to the second-slowest
rate of business activity expansion since July 2016.

I am a little surprised they mention July 2016 so perhaps they are hoping we have short memories and do not recall how it turned into a lesson about being careful about indices driven by sentiment. This was mostly driven by the manufacturing sector which had Markit looking for a scapegoat.

December saw the UK PMI rise to a six-month high,
following short-term boosts to inventory holdings and
inflows of new business as companies stepped up their
preparations for a potentially disruptive Brexit.
Stocks of purchases and finished goods both rose
at near survey-record rates, while stock-piling by
customers at home and abroad took new orders growth
to a ten-month high.

So preparation is bad as presumably would be no preparation. It is especially awkward for their uncertainty theme which was supposed to be reducing output. But let us move onto the main point here which is that the UK is apparently managing some economic growth but not a lot. This matters if we now switch to the wider economic outlook.

The world economy

As I have been typing this the Chinese cavalry have arrived. Reuters.

China’s just cut bank reserve requirement ratios by 100 bps, releasing an estimated RMB1.5t in liquidity by Jan 25. expected this, but argues the central bank can do a lot more – like cutting benchmark guidance lending rates.

Reuters are understandably pleased about finding someone who got something right. But the deeper issue is the economic prognosis behind this which we dipped into on Wednesday and is that the Chinese economy is slowing. For those wondering about what the People’s Bank of China is up to it is expanding the money supply via reducing the reserves banks have to hold which allows them to lend more. So they are acting on the quantity of money rather than the price or interest-rate of it. This relies on the banks then actually lending more. Or more specifically not just lending to those in distress.

Then there is the Euro area which according to the Markit PMIs is doing this.

The eurozone economy moved down another gear
at the end of 2018, with growth down considerably
from the elevated rates at the start of the year.
December saw business activity grow at the
weakest rate since late-2014 as inflows of new
work barely rose……….The data are consistent with eurozone GDP rising by just under 0.3% in the fourth quarter, but with quarterly growth momentum slowing to 0.15% in December.

We need to rake these numbers as a broad sweep rather than going for specific accuracy as, for example, Germany is described as being at a five-year low which requires amnesia about the 0.2% GDP contraction in the third quarter of this year.

Comment

If we switch to our leading indicator for the UK which is money supply growth we see a by now familiar pattern. The two signals of broad money growth have diverged a bit but neither M4 growth at 2.2% in November or M4 lending growth at 3.5% are especially optimistic. That only gets worse once you subtract inflation from it. Or to put it another way in ordinary times we would be in a situation where a bank rate cut would be expected.

What does the Bank of England crystal ball or what is called Forward Guidance in one of Governor Mark Carney’s policy innovations tell us?

The MPC had judged in November that, were the economy to develop broadly in line with its Inflation
Report projections, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a
limited extent, would be appropriate to return inflation sustainably to the 2% target at a conventional horizon.

So “I agree with Mark” seems to be the most popular phase which should make taxpayers wonder why we bother with the other 8 salaries? Indeed one of them will be in quite a panic now as back in May Deputy Governor Ramsden told us that 8.8% consumer credit growth was “Weak” so I dread to think what he makes of the current 7.1%. Although @NicTrades has a different view.

that’s China fast!

So that is how a promised Bank Rate rise begins to metamorphose into a Bank Rate cut which will be presented as “unexpected” ( as opposed to on here where we have been watching the journey of travel for nearly a year) and a “surprise”, just like the last time this happened just over 2 years ago.

Let me finish by welcoming the addition of two women to the Financial Policy Committee as there is of course nothing like a Dame.

Dame Colette Bowe and Dame Jayne-Anne Gadhia have been appointed as external members of ‘s Financial Policy Committee (FPC)

So sadly the diversity agenda only adds female members of the establishment to the existing list of male establishment appointees. That went disastrously with the Honorable Charlotte Hogg who proved that even being the daughter of an Earl and a Baroness cannot allow you to avoid family issues, especially when you forget you have a brother.

Weekly Podcast

Including my answer to this question from Rob Wilson.

How can economies such as Italy and Japan endures decades of virtually zero growth and yet the general population don’t seem to be suffering compared to other economies with growth?

 

 

 

 

 

 

What has the Yen flash rally of 2019 taught us?

Yesterday we took a look at the low-level of bond yields for this stage in the cycle and the US Treasury Note yield has fallen further since to 2.63%. Also I note that the 0.17% ten-year German bond yield is being described as being in interest-rate cut territory for Mario Draghi and the ECB. That raises a wry smile after all the media analysis of a rise. But it is a sign of something not being quite right in the financial system and it was joined last night by something else. It started relatively simply as people used “Holla Dolla” to describe US Dollar strength ( the opposite of how we entered 2018 if you recall) and I replied that there also seemed to be a “yen for Yen” too. So much so that I got ahead of the game.

What I was reflecting on at this point was the way that the Yen had strengthened since mid December from just under 114 to the US Dollar to the levels referred to in the tweet. For newer readers that matters on two counts. Firstly Japanese economic policy called Abenomics is geared towards driving the value of the Yen lower and an enormous amount of effort has been put into this, so a rally is domestically awkward. In a wider sweep it is also a sign of people looking for a safe haven – or more realistically foreign exchange traders front-running any perceived need for Mrs.Watanabe to repatriate her enormous investments/savings abroad  –  and usually accompanies falling equity markets.

The Flash Rally

I was much more on the ball than I realised as late last night this happened. From Reuters.

The Japanese yen soared in early Asian trading on Thursday as the break of key technical levels triggered massive stop-loss sales of the U.S. and Australian dollars in very thin markets. The dollar collapsed to as low as 105.25 yen on Reuters dealing JPY=D3, a drop of 3.2 percent from the opening 108.76 and the lowest reading since March 2018. It was last trading around 107.50 yen………..With risk aversion high, the safe-haven yen was propelled through major technical levels and triggered massive stop-loss flows from investors who have been short of the yen for months.

As you can see there was quite a surge in the Yen, or if you prefer a flash rally. If a big trade was happening which I will discuss later it was a clear case of bad timing as markets are thin at that time of day especially when Japan is in the middle of several bank holidays. But as it is in so many respects a control freak where was the Bank of Japan? I have reported many times on what it and the Japanese Ministry of Finance call “bold action” in this area but they appeared to be asleep at the wheel in this instance. Such a move was a clear case for the use of foreign exchange reserves due to the size and speed of the move,

There were also large moves against other currencies.

The Australian dollar tumbled to as low as 72.26 yen AUDJPY=D3 on Reuters dealing, a level not seen since late 2011, having started around 75.21. It was last changing hands at 73.72 yen.

The Aussie in turn sank against the U.S. dollar to as far as $0.6715 AUD=D3, the lowest since March 2009, having started around $0.6984. It was last trading at $0.6888.

Other currencies smashed against the yen included the euro, sterling and the Turkish lira.

There had been pressure on the Aussie Dollar and it broke lower against various currencies and we can bring in two routes to the likely cause. Yesterday we noted the latest manufacturing survey from China signalling more slowing and hence less demand for Australian resources which was followed by this. From CNBC.

 Apple lowered its Q1 guidance in a letter to investors from CEO Tim Cook Wednesday.

Apple stock was halted in after-hours trading just prior to the announcement, and shares were down about 7 percent when trading resumed 20 minutes later.

This particular letter from America was not as welcome as the message Tim Cook sent only a day before.

Wishing you a New Year full of moments that enrich your life and lift up those around you. “What counts is not the mere fact that we have lived. It is what difference we have made to the lives of others that will determine the significance of the life we lead.” — Nelson Mandela

So the economic slow down took a bite out of the Apple and eyes turned to resources demand and if the following is true we have another problem for the Bank of Japan.

“One theory is that may be Japanese retail FX players are forcing out of AUDJPY which is creating a liquidity vacuum,” he added. “This is a market dislocation rather than a fundamental event.”

Sorry but it is a fundamental event as Japanese retail investors are in Australian investments because they can get at least some yield after years and indeed decades on no yield in Japan. This is a direct consequence of Bank of Japan policy as was the move in the Turkish Lira which is explained by Yoshiko Matsuzaki.

This China news hit the EM ccys including Turkish lira where Mrs Watanabe are heavily long against Yen. I bet their stops were triggered in the thin market. Imagine to have TRYyen stops in this market.

So there you have it a development we have seen before or a reversal of a carry trade leading the Japanese Yen to soar. Even worse one caused by the policy response to the last carry trade blow-up! Or fixing this particular hole was delegated to the Beatles.

And it really doesn’t matter if I’m wrong
I’m right

Bank of England

It too had a poor night as whilst it is not a carry trade currency with Bank Rate a mere 0.75% the UK Pound £ took quite a knock against the Yen to around 132. Having done this we might reasonably wonder under what grounds the Bank of England would use the currency reserves it has gone to so much trouble to boost? From December 11th.

Actually the Bank of England has been building up its foreign exchange reserves in the credit crunch era and as of the end of October they amounted to US $115.8 billion as opposed as opposed to dips towards US $35 billion in 2009. So as the UK Pound £ has fallen we see that our own central bank has been on the other side of the ledger with a particular acceleration in 2015. I will leave readers to their own thoughts as to whether that has been sensible management or has weighed on the UK Pound £ or of course both?!

To my mind last nights move was certainly an undue fluctuation.

The EEA was established in 1932 to provide a fund which could be used for “checking undue fluctuations in the exchange value of sterling”.

It is an off world where extraordinary purchases of government bonds ( £435 billion) are accompanied by an apparent terror of foreign exchange intervention.

Comment

I have gone through this in detail because these sort of short-term explosive moves have a habit of being described as something to brush off when often they signal something significant. So let is go through some lessons.

  1. A consequence of negative interest-rates is that the Japanese investors have undertaken their own carry trade.
  2. The financial system is creaking partly because of point 1 and the ongoing economic slow down is not helping.
  3. Contrary to some reports the Euro was relatively stable and something of a safe haven as it behaved to some extent like a German currency might have. There is a lesson for economic theory about negative interest-rates especially when driven by a strong currency. Poor old economics 101 never seems to catch a break.
  4. All the “improvements” to the financial system seem if anything to have made things worse rather than better.
  5. Fast moves seem to send central banks into a panic meaning that they do not apply their own rules.

We cannot rule out that this was deliberate and please note the Yen low versus the US Dollar was 104.9 as you read the tweet below.

Japanese exporters had bought a lot of usd/jpy puts at year end with 105 KOs so now they are really screwed … ( @fxmacro )

Me on The Investing Channel

 

 

Current bond yields imply a depressing view of the world economy

Let me welcome you all to 2019 as we advance on another new year. I hope that it will be a good one for all of you. As I look at financial markets there has been a development which in isolation is good news. This is that the US ten-year Treasury Bond yield is now 2.67%. That is good news for US taxpayers as their government can borrow more cheaply in spite of the current shut down of part of it and good news for US mortgage borrowers as it feed into fixed-rate borrowing costs. It compares to this situation which I looked at back on the 6th of December.

Now let us look at the US ten-year yield which is 2.9% as I type this and we see that in basic terms it is predicting a couple more 0.25% interest-rate rises.

I will look at why in a moment but let us now shift to the Wall Street Journal for another comparison.

The yield closed Monday at 2.68%, up from the 2.41% where it ended 2017.

The pattern is described by the WSJ below.

The yield on the benchmark 10-year Treasury note—which moves inversely to price and helps set borrowing costs for consumers and businesses around the world—climbed higher at the start of 2018 as stocks rose and the dollar weakened. Investors were content to look past geopolitical tensions, and bonds’ fixed rates, given expectations for a soaring profits and economic growth……..Now, the yield has retreated from multiyear highs hit in November, falling below 3%

The pattern was that the ten-year Treasury Bond rose to 3.26% and you may recall that there were forecasts of it going above 4% at that time. To be fair “bond king” ( CNBC) Jeffrey Gundlach was looking at the thirty-year yield but that has just dipped below 3% today in a different big figure move. Back in July the St. Louis Federal Reserve looked at why it thought US bond yields were rising.

The expected long-term inflation rate and the expected long-term real growth rate of the economy are the most important factors that influence long-term yields. If bond buyers expect higher inflation or higher real growth, they will expect higher interest rates in the future and thus will demand a higher yield on the bonds they buy today.

Central bankers love this sort of thing but I wish you the best of luck in figuring either out in reality! Especially after the past credit crunch driven decade. We can say that the US economy has performed better than its peers so there is a little light in the fog but the next bit to my mind is more important than we are told.

Bond yields also depend on the uncertainty about these factors, so the volatility of expected inflation and growth also influence long-bond yields, but these variables are harder to measure and have smaller effects.

Yes they are harder to measure but we should not use that as an excuse to say they have smaller effects just because that is all we can find. The period between when that was written in July and now shows us how powerful this can be if we look at the ch-ch-changes. Also this bit has not worn well.

The growth in expected future fiscal deficits is likely to have contributed to the rise in relative yields.

That was true but is even more true now an yet yields have fallen as I pointed out earlier. Financial markets pick and choose which factors are the most important at the time and I note the St.Louis Fed missed out the main driver of bond yields in the modern era which is the impact of the policy of the Federal Reserve itself.

The international picture

I do agree with the St.Louis Fed on this point.

The international yields usually, but not always, move together. (  the U.K., Canada, Germany, Japan, Switzerland)

The next bit is awkward for them to analyse as we are back to the impact of central banking policies again. So Germany for instance has seen its bond yields continue to be driven lower by purchases made by the European Central Bank or ECB which have just stopped. But we see that the ten-year German bund yields a mere 0.18% as I type this. Again in isolation that is a benefit for German taxpayers and borrowers but there is also a problem which is highlighted by this from the Markit PMI from this morning.

The headline IHS Markit/BME Germany Manufacturing
PMI – a single-figure snapshot of the performance of the
manufacturing economy – slipped to 51.5 in December,
down from 51.8 in November and its lowest reading since
March 2016. It marked the eleventh time that the index had
fallen in 2018, down from a record high in December 2017.

The German economy has hit a weak phase and this includes the 0.2% fall in GDP in the third quarter of 2018. But the problem is that long-term it has benefited from a lower currency via replacing the Deutschmark with the Euro and in more recent times it has benefited from low and then negative interest-rates. What else is there? Also regular readers who have followed my regular updates on the weakening money supply data in the Euro area may have a wry smile at this.

but the extent of the slowdown has been somewhat of a surprise.

Central banking policy

This has changed although as ever the rhetoric is in the wrong direction. From Reuters.

The most prominent hawk on the European Central Bank’s board still expects an interest rate hike in 2019 but concedes that this will depend on inflation data in the first half of the year………Sabine Lautenschlaeger, a German who has long called for the ECB to tighten its ultra-loose policy, still hopes for a move next year if data allows.

Actually as we have looked at above the data would be considered grounds for considering an interest-rate cut if the ECB deposit rate was not already -0.4%. In my opinion we cannot completely rule out a rise because just like we saw in Sweden before Christmas there could be an attempt to get back to 0% before things get any worse. But it would be an example of what in itself being a good idea being done with bad timing which means it should not happen.

If we move back to the US the simple fact is that the interest-rate rise of a couple of weeks ago may be the last one. Also due to technical reasons ( the amount of Quantitative Tightening or QT depends on maturing bonds) the bond sales will slow in 2019 anyway, but in a slow down there will be pressure for QE4 to head down the slipway.

Comment

What started as good news leads to a more uncomfortable picture as we note that the real shift has been in economic data. This as we looked at last year got worse as we saw a slow down in monetary data lead to weaker economies around the world. This morning has seen another sign of this. From CNBC.

The moves in pre-market trade come after a private sector survey showed manufacturing activity in the world’s second-largest economy contracted for the first time in 19 months. China’s Markit Manufacturing Purchasing Managers’ Index (PMI) for December dipped to 49.7 from 50.2 in November.

This added to the news that auto sales had fallen by 16% in November in China. We have also seen this from Chris Williamson on the Markit PMI data.

manufacturing indicates that last 3 months of 2018 saw the worst factory output growth since the Q2 2013, with firms having to eat into backorders to sustain production levels. Some temporary factors evident but trend looks worryingly weak

Stock markets have led this and I note that they are lower today although we need to note the extraordinary ups and downs of the holiday period. Also there is the role of the price of crude oil which also was volatile but overall has been falling. It supports bond prices and reduces bond yields but affecting inflation projections and also signalling a potentially weaker economy.

So there you have it as we find that what looks like good news is a signal for bad economic trends. It does show markets responding in the way that they should. The problem is their starting point and for that all eyes turn to the central banks who have driven them there. Get ready for the claims that “it could not possibly have been expected” and “Surprise!Surprise!” We already start with trillions of bonds with a negative yield so what can be gained?