The link between “currency wars” and central banks morphing into hedge funds

The credit crunch era has brought us all sort of themes but a lasting one was given to us by Brazil’s Finance Minister back in September of 2010. From the Financial Times.

“We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness,” Mr Mantega said. By publicly asserting the existence of a “currency war”, Mr Mantega has admitted what many policymakers have been saying in private: a rising number of countries see a weaker exchange rate as a way to lift their economies.

The issue of fears that countries were undertaking competitive devaluations was something which raised a spectre of the 1920s being repeated. I note that Wikipedia calls it the Currency War of 2009-11 which is in my opinion around 7 years too short as of the countries mentioned back in the FT article some are still singing the same song and of course Japan redoubled its efforts and some with the advent of Abenomics.

The Euro

It was only last week that we looked at the way Germany has undertaken a stealth devaluation ironically in full media view via its membership of the Euro. But also of course if QE is a way of weakening your currency then the ECB ( European Central Bank) has had the pedal to the metal as it has expanded its balance sheet to around 4.5 billion Euros. On this road it has become something of an extremely large hedge fund of which more later but currently hedge funds seem to be fans of this.

If we combine this with the positive trade balance of the Euro area which has been reinforced this morning by Germany declaring a 25.4 billion current account surplus in November we see why the Euro was strong in the latter part of 2017. We also see perhaps why it has dipped back below 1.20 versus the US Dollar and the UK Pound £ has pushed above 1.13 to the Euro as currency traders wonder who is left to buy the Euro in the short-term?

But let us move on noting that a deposit rate of -0.4% and QE of 30 billion Euros a month would certainly have been seen as a devaluation effort back in September 2010.

Turning Japanese

Has anyone tried harder than the Japanese under Abenomics to reduce the value of their currency? We have seen purchases of pretty much every financial asset ( including for newer readers commercial property and equities) as the Bank of Japan balance sheet soared soared to nearly ( 96%) a years economic output or GDP. This did send the Yen lower but in more recent times it has not done much at all to the disappointment of the authorities in Tokyo. Is that behind this morning’s news that the Bank of Japan eased its bond buying efforts? Rather than us turning Japanese are they now aping us gaijin? It is too early to say but it is intriguing to note that December was a month in which the Bank of Japan’s balance sheet actually shrank. Care is needed here as for example the US Federal Reserve is in the process of shrinking its balance sheet but some data has seen it rise.

Perhaps the Bank of Japan should play some George Michael from its loudspeakers.

Yes I’ve gotta have faith…
Mmm, I gotta have faith
‘Cause I gotta have faith, faith, faith
I gotta have faith-a-faith-a-faith

South Korea and the Won

Last week we got a warning that a new currency wars outbreak was on the cards as this was reported. From CNBC.

South Korea’s central bank chief said that the bank will leave its currency to market forces, but would respond if moves in the won get too big. Lee Ju-yeol said the Bank of Korea will take active steps when herd behavior is seen.

Not quite a full denial but yesterday forexlive reported something you are likely to have already guessed.

Bank of Korea is suspected to have bought around $1.5 billion in USD/KRW during currency trading today.

As we wonder what herd was seen in the Won as of course the “Thundering Herd” or Merrill Lynch is no longer with us? Also as this letter from the Bank of Korea to the FT last year confirms Korea does not play what Janet Kay called “Silly Games”.

First, Korea does not manage exchange rates to prevent currency appreciation. The Korean government does not set a specific target level or direction of the exchange rate. The Korean won exchange rate is basically determined by the market, and intervention is limited to addressing disorderly market movements.

Next time lads it would be best to leave this out.

Second, Korea’s current account surplus should not be understood as evidence of its currency undervaluation.

Of course not. Anyway the Won has been strong.

The South Korean currency surged almost 13 percent last year, as an expanding trade surplus and the nation’s first interest-rate increase in six years boosted its allure. (Bloomberg).

Another way of looking at that is to look back over the credit crunch era. We do see that the Won dropped like a stone against the US Dollar to around 1600 but with ebbs and flows has returned to not far from where it began to the 1060s. Of course we can get some more insight comparing more locally and if we look at the real trade-weighted exchange rates of the BIS ( Bank for International Settlements) then there was a case against the Yen in fact a strong one. Compared to 2010= 100 the Japanese Yen was at 73.7 ( see above) but the Won was at 113. However the claim of a strong currency might get the Chinese knocking at the South Korean’s door as the Yuan was at 121.4.

China

Perhaps the Chinese are now on the case as Bloomberg reports.

The yuan, which headed for its biggest drop in two months on the news, is allowed to move a maximum of 2 percent either side of the fixing. Analysts said the change shows China is confident in the yuan’s current trajectory, which has been one of steady appreciation.

Hedge Fund Alert

There are two pieces of good news for the modern theory of central banks morphing into hedge funds around this morning so let us first go to Switzerland.

According to provisional calculations, the Swiss National Bank (SNB) will report a profit in
the order of CHF 54 billion for the 2017 financial year. The profit on foreign currency
positions amounted to CHF 49 billion. A valuation gain of CHF 3 billion was recorded on
gold holdings. The net result on Swiss franc positions amounted to CHF 2 billion

With all that profit the ordinary Suisse may wonder why they are not getting more?

Confederation and cantons to receive distribution of at least
CHF 2 billion

Whilst the SNB behaves like a late Father Christmas those in charge of the ever growing equity holdings at the Bank of Japan may be partying like it is 1999 and having a celebratory glass of sake on this news.

Japan’s Nikkei 225 reaches fresh 26-year high; ( FT)

Meanwhile a not so polite message may be going from the ECB to the Bank of Finland.

The European Central Bank has sold its bonds of scandal-hit retailer Steinhoff , data showed on Monday, potentially suffering a loss of up to 55% on that investment. (Reuters)

Comment

So there you have it as we see that the label “currency wars” can still be applied albeit that the geography of the main outbreak has moved across the Pacific. Actually Japan was always in the game and it is no surprise that its currency twin the Swiss Franc is the other central bank which has become a subsidiary of a hedge fund. That poses a lot of questions should the currency weaken as the Swissy has albeit so far only on a relatively minor scale. There have been discussions so far this year about how bond markets will survive less QE but I do not see anyone wondering what might happen if the Swiss and Japanese central banks stopped buying equities and even decided to sell some?

For all the fire and fury ( sorry) there remains a simple underlying point which is that if one currency declines falls or devalues then others have to rise. That is especially awkward for central banks as they attempt to explain how trying to manipulate a zero-sum game brings overall benefits.

 

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Can the central banks wean themselves off their monetary addictions?

As 2017 comes to a close and we start to look forwards into 2018 many central banks are finding themselves at something of a crossroad and maybe a nexus. This is driven by two factors of which the first is welcome in that 2017 has been a good year for the world economy overall. The second is that central banking policy has been pro rather than anti-cyclical. What I mean by this is that policy has continued to be expansionary into better times rather than following the philosophy of “taking away the punch bowl as the party gets started”. The danger on this road is the “irrational exuberance” warned about by former US Federal Reserve Chair Alan Greenspan although the more modern development is to question what is irrational about front-running central banks?

Riksbank

According to the Riksbank of Sweden things are going rather well.

 Economic activity is strong and the employment rate is high.

Putting that another way the economy expanded by 0.8% in the third quarter of this year making it 3.1% larger than a year before and according to the Riksbank.

Although inflation has now been close to 2 per cent for some time, prior to this it was below the target for a long time.

There is an implication here of catching up “lost inflation” which appears every now and then from central bankers on this side of the debate whereas you do not hear them wanting to rebalance an inflation excess. If we look at the next bit we see that the central planners have become addicted to their own policies.

 It has required a great deal of support from monetary policy to bring up inflation and inflation expectations. Economic activity needs to remain strong for inflation to continue to be close to the target. It is also important that the krona does not appreciate too quickly.

This returns me to my subjects of Monday and Tuesday where I looked at economic statistics as the Riksbank here will be looking to tell people that “economic activity” is “strong” whilst in fact operating to make them poorer via higher inflation!

As to monetary policy well strong economic growth and inflation on target means that negative interest-rates seem to be from a universe far,far away.

The Executive Board of the Riksbank has therefore decided to hold the repo rate unchanged at −0.50 per cent and is expecting, as before, to begin slowly raising the repo rate in the middle of 2018

As you can see the response to talk of a change is, definitely maybe. What about QE? Here we see a fascinating development with a serve that ends up with more top-spin than even Rafa Nadal can manage. You see QE ( Quantitative Easing) officially ends with 2017. Except.

In essence, will RAISE the pace of bond buying slightly over the next six quarters (front-load) vs recent quarters. ( h/t Danske Bank)

We have got used to up being the new down but now we see that the end is not zero but more. Here is how it works in practice.

Redemptions and coupon payments in the government bond portfolio will be reinvested until further notice. Large redemptions, amounting to around SEK 50 billion, will occur during the first half of 2019. In addition, there are coupon payments totalling around SEK 15 billion from January 2018 to June 2019. To retain the Riksbank’s presence on the market and attain a relatively even rate of purchase going forward, the reinvestments of these redemptions and coupon payments will begin as early as January 2018 and continue until the middle of 2019. This means that the Riksbank’s holdings of government bonds will increase temporarily in 2018 and the beginning of 2019.

I have highlighted the bit which looks like it might have been written by an addict as possible bond redemption buying in 2019 is brought forward to next year. That is a first I think. We have also learnt how to treat the word “temporarily” when it involves monetary expansion haven’t we? Five Star QE.

System addict
I never can get enough
System addict
Never can give it up

Inflation Targets

Regular readers will have noted over time that central banks have switched between inflation targets and economic prospects to justify easy monetary policies. The Riksbank is currently justifying its policy by saying that future inflation looks weak. But there is a catch here in that old relationships do not hold as this from Eurostat yesterday implies.

In the euro area, wages & salaries per hour worked grew by 1.6% and the non-wage component by 1.5%, in the third quarter of 2017 compared with the same quarter of the previous year.

The Euro area boom has seen wage growth slow ( it was 2.1% in the second quarter) so pushing inflation higher runs a high risk of making people poorer. The old relationship(s) between wages and inflation have broken down.

The Bank of France has at least considered something I argue for. From a working paper published yesterday.

Some commentators contend that the Eurosystem should adjust to the “lowflation” environment and lower its inflation target. 

However after a consideration of the situation up is yet again the new down.

As discussed in a current US policy debate, this situation would call for an increase rather than a decrease in the inflation target.

Whilst I have sympathy for the future careers of the three economists concerned it seems that they are in an alternative universe as their response to not being able to reach the current target is to move it further away.

House Prices

Also more than a few may think that the real concern of the Riksbank is this.

the decline in housing prices……..After several years of rapidly rising housing prices, there has been a downswing in recent months.

Bank of Japan

This meets overnight UK time and it too has a fair bit to consider. After all 2017 has been a relatively good year for the Japanese economy. The third quarter saw GDP (Gross Domestic Product) growth of 0.6% making the annual rate of growth 2.1% which is faster than the Bank of Japan thinks it can grow on a sustained basis.If you add in the -0.1% interest-rate and the QE highlighted below by Japan Macro Advisers you might be expecting inflation as a result.

As of December 10 2017, the Bank of Japan held a total of 524.5 trillion yen in assets. Its JGB holding was 420.7 trillion yen, up by 59.1 trillion yen from a year ago.

Yet CPI  inflation was only 0.2% in October and the leading indicator for November ( Tokyo inflation) was only 0.3%.

Some boundaries are being tested here as Nasdaq implies.

The central bank held 40.9 percent of all government debt at the end of September, also the highest on record.

It now also owns around 2.5% of the equity market.

Comment

We find ourselves observing new events as central bankers have not had this sort of economic influence before. Except we need to be careful about our definition of this as whilst it is true in numerical terms as we note negative interest-rates and yields in abundance and ever more purchases of assets in QE programmes. But if we look at inflation rates they remain in so many places below target.  Thus we find central banks clinging to their policies in the hope that this time they will work. The catch is that even the word work may need a redefinition as if they raise inflation but wages do not follow they will have made us worse and not better off. This is before we get to a discussion of all the bubbles they have created.

The one main central bank which is trying to at least steer a new course is the US Federal Reserve and it deserves some credit for that. As to the rest of us the fear is that one day we will have to go cold turkey as a solution to the junkie culture style monetary expansion we see in what we are also told are good economic times.

 

 

 

 

The murky world of central banks and private-sector QE

The last 24 hours has seen something of a development in the world of central bank monetary easing which has highlighted an issue I have often warned about. Along the way it has provoked a few jokes along the lines of Poundland should now be 50 pence land or in old money ten shillings. Actually the new issue is related to one that the Bank of England experienced back in 2009 when it was operating what was called the SLS or Special Liquidity Scheme. If you have forgotten what it was I am sure the words “Special” and “Liquidity” have pointed you towards the banking sector and you would be right. The banks got liquidity/cash and in return had to provide collateral which is where the link as because on that road the Bank of England suddenly had to value lots of private-sector assets. Indeed it faced a choice between not giving the banks what they wanted or changing ( loosening) its collateral rules which of course was an easy decision for it. But valuing the new pieces of paper it got proved awkward. From FT Alphaville back then.

Accepting raw loans would also ensure that securities taken in the Bank’s operations have a genuine private sector demand rather than comprising ‘phantom’ securities created only for use in central bank operations.

In other words the Bank of England was concerned it was being done up like a kipper which is rather different from the way it tried to portray things.

Under the terms of the SLS, banks and building societies (hereafter ‘banks’) could, for a fee, swap high-quality mortgage-backed and other securities that had temporarily become illiquid for UK Treasury bills, for a period of up to three years.

Some how “high-quality” securities which to the logically minded was always problematic if you thought about the mortgage situation back then had morphed into a much more worrying “phantom” security.  Indeed as the June 2010 Quarterly Bulletin indicated there was rather a lot of them.

But a large proportion of the securities taken have been created specifically for use as collateral with the Bank by the originator of the underlying assets, and have therefore not been traded in the market. Such ‘own-name’ securities accounted for around 76% of the Bank’s extended collateral (around the peak of usage in January 2009), and form the overwhelming majority of collateral taken in the SLS.

Although you would not believe it from its pronouncements now the Bank of England was very worried about the consequences of this and in my opinion this is why it ended the SLS early. Which was a shame as the scheme had strengths and it ended up with other schemes ( FLS, TFS) as we mull the words “one-off” and “temporarily”. But the fundamental theme here is a central bank having trouble with private-sector assets which in the instance above was always likely to happen with instruments that have “not been traded in the market.”

The ECB and Steinhoff

Central banks can also get into trouble with assets that have been traded in the market. After all if market prices were always correct they would move much less than they do. In particular minds have been focused in the last 24 hours on this development.

The news that Steinhoff’s long-serving CEO Markus Jooste had quit sent the company’s share price into freefall on Wednesday morning. Steinhoff opened more than 60% lower, falling from its overnight close of R45.65 to as low as R17.57.

Overall, Steinhoff’s share price has dropped more than 80% over the past 18 months. The stock peaked at over R90 in June last year.  ( Moneyweb).

According to Reuters today has seen the same drum beat.

By 0748 GMT, the stock had slid 37 percent to 11.05 rand in Johannesburg, adding to a more than 60 percent plunge in the previous session. It was down about 34 percent in Frankfurt where it had had its primary listing since 2015.

You may be wondering how a story which might ( in fact is…) a big deal and scandal arrives at the twin towers of the ECB or European Central Bank. The first is a geographical move as Steinhoff has operations in Europe and two years ago today listed on the Frankfurt stock exchange. I am not sure that Happy Birthday is quite appropriate for investors who have seen the 5 Euros of then fall to 0.77 Euros now.

Next enter a central bank looking to buy private-sector assets and in this instance corporate bonds.

Corporate bonds cumulatively purchased and settled as at 01/12/2017 €129,087 (24/11/2017: €127,690) million.

One of the ( over 1000) holdings is as you have probably already guessed a Steinhoff corporate bond and in particular one which theoretically matures in 2025. I say theoretically because the news flow is so grim that it may in practice be sooner. From FT Alphaville.

German prosecutors say they are investigating whether Steinhoff International inflated its revenue and book value, one day after the global home retailer announced that its longtime chief executive had quit…The investigators are probing whether Steinhoff flattered its numbers by selling intangible assets and partnership shares without disclosing that it had close connections to the buyers. The suspicious sales were in “three-digit million” euros territory each, according to the prosecutors.

In terms of scale then the losses will not be relatively large as the bond size is 800 million Euros which would mean that the ECB would not buy more than 560 million under its 70% limit but it does pose questions.

they have a minimum first-best credit assessment of at least credit quality step 3 (rating of BBB- or equivalent) obtained from an external credit assessment institution

This leaves us mulling what investment grade actually means these days with egg on the face of the ratings agencies yet again. As time has passed I notice that the “high-quality” of the Bank of England has become the investment grade of the ECB.

The next question is simply to wonder what the ECB is doing here? Its claim that buying these bonds helps it achieve its inflation target of 2% per annum is hard to substantiate. What it has created is a bull market in corporate bonds which may help economic activity as for example we have seen negative yields even in some cases at issue. But there are side-effects such as moral hazard where the ECB has driven the price higher helping what appears to be fraudulent activity.

How much?

For those of you wondering about the size of the losses there are some factors we do not know such as the size of the holding. We do know that the ECB bought at a price over 90 which compares to the 58.2 as I type this. Some amelioration comes from the yield but not much as the coupon is 1.875% and of course that assumes it gets paid.

My understanding of how this is split is that 20% is collective and the other 80% is at the risk of the national central bank. So there may well be some fun and games when the Bank of Finland ( h/t Robert Pearson) finally reports on this.

Comment

There is much to consider here. Whilst this is only one corporate bond it does highlight the moral hazard issue of a central bank buying private-sector assets. There is another one to my mind which is that overall the ECB will have a (paper) profit but that is pretty much driven by its own ongoing purchases. This begs the question of what happens when it stops? Should it then fear a sharp reversal of prices it is in the situation described by Coldplay.

Oh no what’s this
A spider web and I’m caught in the middle
So I turn to run
And thought of all the stupid things I’d done.

The same is true of the corporate bond buying of the Bank of England which was on a smaller scale but even so ended up buying bonds from companies with ever weaker links ( Maersk) to the UK economy. Even worse in some ways is the issue of how the Bank of Japan is ploughing into the private-sector via its ever-growing purchases of Japanese shares vis equity ETFs. At the same time we are seeing a rising tide of scandals in Japan mostly around data faking.

Me on Core Finance

http://www.corelondon.tv/will-bond-yields-ever-go-higher/

 

 

What and indeed where next for bond markets?

The credit crunch era has brought bond markets towards the centre stage of economics and finance. Before then there were rare expressions of interest in either a crisis or if the media wanted to film a response to an economic data release. You see equities trade rarely but bonds a lot so they filmed us instead and claimed we were equities trades so sorry for my part in any deception! Where things changed was when central banks released that lowering short-term interest-rates ( Bank Rate in the UK) was not the only game in town and that it was not having the effect that they hoped and planned. Also the Ivory Towers style assumption that short-term interest-rates move long-term ones went the way of so many of their assumptions straight to the recycling bin.

QE

It is easy to forget now what a big deal this was as the Federal Reserve and the Bank of England joined the Bank of Japan in buying government bonds or Quantitative Easing ( QE). There is a familiar factor in that what was supposed to be a temporary measure has now become a permanent feature of the economic landscape. As for example the holdings of the Bank of England stretch to 2068 with no current plan to reverse any of it and instead keeping the total at £435 billion by reinvesting maturities. Indeed on Friday it released this on social media.

Should quantitative easing become part of the conventional monetary policy toolkit?

The Author Richard Harrison may be in line for promotion after this.

Though the model does not support the idea that central banks should maintain permanently large balance sheets, it does suggest that we may see more quantitative easing in the future.

So here is a change for bond markets which is that QE will be permanent as so far there has been little or no interest in unwinding it. Even the US Federal Reserve which to be fair is doing some unwinding is doing so with baby steps or the complete opposite of the way it charged in to increase QE.

Along the way other central banks joined in most noticeably the European Central Bank. It had previously indulged in some QE via its purchases of Southern European bonds and covered ( bank mortgage) bonds but of course it then went into the major game. In spite of the fact that the Euro area economy is having a rather good 2017 it is still at it to the order of 60 billion Euros a month albeit that halves next year. So we are a long way away from it stopping let alone reversing. If we look at one of the countries dragged along by the Euro into the QE adventure we see that even annual economic growth of 3.1% does not seem to be enough for a change of course. From Reuters.

Riksbank’s Ohlsson: Too Early To Make MonPol Less Expansionary

If 3.1% economic growth is “too early” then the clear and present danger is that Sweden goes into the next downturn with QE ongoing ( and maybe negative interest-rates too). One consequence that seems likely is that they will run out of bonds to buy as not everyone wants to sell to the central bank.

Whilst we may think that QE is in modern parlance “like so over” in fact on a net basis it is still growing and only last month a new player came with its glass to the punch bowl.

In addition, the Magyar Nemzeti Bank will launch a targeted programme aimed at purchasing mortgage bonds with maturities of three years or more. Both programmes will also contribute to an increase in the share of loans with long periods of interest rate fixation.

Okay so Hungary is in the club albeit via mortgage bond purchases which can be a sort of win double for central banks as it boosts “the precious” ( banks) and via yield substitution implicitly boosts the government bond market too. But we learn something by looking at the economic situation according to the MNB.

The Hungarian economy grew by 3.6 percent in the third quarter of 2017…….The Monetary Council expects annual economic growth of 3.6 percent in 2017 and stable growth of between 3-4 percent over the coming years. The Bank’s and the Government’s stimulating measures contribute substantially to economic growth.

We are now seeing procyclical policy where economies are stimulated by monetary policy in a boom. In particular central banks continue with very large balance sheets full of government and other bonds and in net terms they are still buyers.

The bond vigilantes

They have been beaten back and as we observe the situation above we see why. Many of the scenarios where they are in play and bond yields rise substantially have been taken away for now at least by the central banks. There can be rises in bond yields in individual countries as we see for example in the Turkish crisis or Venezuela but the scale of the crisis needs to be larger and these days countries are picked off individually rather than collectively.

At the moment there are grounds for the bond yield rises to be in play in the Euro area with growth solid but of course the ECB is in play and in fact yesterday brought news of exactly the reverse.

 

A flat yield curve?

The consequence of central banks continuing with what the Bank of Japan calls “yield curve control” has led to comments like this. From the Financial Times yesterday.

Selling of shorter-dated Treasuries pushed the US yield curve to its flattest level since 2007 on Tuesday. The difference between the yields on two-year Treasury notes and 10-year Treasury bonds dropped below 55 basis points in afternoon trading in New York. While the 10-year Treasury was little changed, prices of two-year notes fell for the second consecutive day. The two-year Treasury yield, which moves inversely to the note’s price, has climbed 64 basis points this year to 1.83 per cent.

If we look long the yield curve the numbers are getting more and more similar ironically taking us back to the “one interest-rate” idea the central banks and Ivory Towers came into the credit crunch with. With the US 2 year yield at 1.8% and the 30 year at 2.71% there is not much of a gap.

Why does something which may seem arcane matter? Well the FT explains and the emphasis is mine.

It marks a pronounced “flattening” of the yield curve, with investors receiving decreasing returns for holding longer-dated bonds compared to shorter-dated notes — typically a harbinger of economic recession.

Comment

We have seen phases of falls in bond prices and rises in yield. For example the election of President Trump was one. But once they pass we are left wondering if the around thirty year trend for lower bond yields is still in play and we are heading for 0% ( ZIRP) or the icy cold waters of negativity ( NIRP)? On that road the idea that the current yield curve shape points to a recession gets kicked into touch as Goodhart’s Law or if you prefer the Lucas Critique comes into play. But things are now so mixed up that a recession might actually be on its way after all we are due one.

For yields to rise again on any meaningful scale there will have to be some form of calamity for the central banks. This is because QE is like a drug for so many areas. One clear one is the automotive sector I looked at yesterday but governments are addicted to paying low yields as are those with mortgages. On that road they cannot let go until they are forced to. Thus the low bond yields we see right now are a short-term success which central banks can claim but set us on the road to a type of junkie culture long-term failure. Or in my country this being proclaimed as success.

“Since 1995 the value of land has increased more than fivefold, making it our most valuable asset. At £5 trillion, it accounts for just over half of the total net worth of the UK at end-2016. At over £800 billion, the rise in the nation’s total net worth is the largest annual increase on record.”

Of course this is merely triumphalism for higher house prices in another form. As ever those without are excluded from the party.

 

 

Why are we told some inflation is good for us?

A major topic in the world of economics is the subject of inflation which has been brought into focus by the events of the past 2/3 years or so. First we had the phase where a fall in the price of crude oil filtered through the system such that official consumer inflation across many countries fell to zero per cent on an annual basis and in some cases below that. If you recall that led to the deflation scare or it you will excuse the capitals what much of the media presented as a DEFLATION scare. We were presented with a four horsemen of the apocalypse style scenario where lower and especially negative inflation would take us to a downwards spiral where wages and economic activity fell as well along the line of this from R.E.M.

It’s the end of the world as we know it.
It’s the end of the world as we know it.

I coined the phrase “deflation nutter” to cover this because as I pointed out, Greece the subject of yesterday suffered from quite a few policy errors pushing it into depression and that on the other side of the coin for all its problems Japan had survived years and indeed decades of 0% inflation. Indeed on the 29th of January 2015 I wrote an article on here explaining how lower consumer inflation was boosting consumption across a range of countries via the positive effect it was having on real wages.

 if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly. If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.

 

Relative prices

The comfortable cosy world of central bankers and theoretical economists told us and indeed continues to tell us that we need positive inflation so that relative prices can change. That leads us to the era of inflation targets which are mostly set at 2% per annum although of course there is a regular cry for inflation targets to be raised. However 2015/16 torpedoed their ship as if we just look at the basic change we saw a large relative price adjustment for crude oil leading to adjustments directly to other energy costs and a lot of other changes. Ooops! Even worse for the theory we saw two large sectors of the economy respond in opposite fashion. A clear example of this was provided by my own country the UK where services inflation barely changed and ironically for a period of deflation paranoia was quite often above the inflation target. But the goods sector saw substantial disinflation as it was it that pulled the overall measure down to around 0%.

We can bring this up to date by looking at the latest data from the Statistics Bureau in Japan.

  The consumer price index for Ku-area of Tokyo in October 2017 (preliminary) was 100.1 (2015=100), down 0.2% over the year before seasonal adjustment, and down 0.1% from the previous month on a seasonally adjusted basis.

So not only is there no inflation here there has not been any for some time. Yet the latest monthly update tells us that food prices fell by 2.4% on an annual basis and the sector including energy fuel and lighting rose by 7.1%. Please remember that the next time the Ivory Towers start to chant their “we need inflation so relative prices can adjust” mantra.

Reality

This is that central banks are in the main failing to reach their inflation targets. For example if we look at the US economy the Federal Reserve targets the PCE ( Personal Consumption Expenditure) inflation measure which was running at an annual rate of 1.6% in September and even that level required an 11.1% increase in energy prices.

So we see central banks and establishments responding to this of which the extreme is often to be found in Japan. From @lemasabachthani yesterday.

JAPAN PM AIDE HONDA: INAPPROPRIATE TO REAPPOINT BOJ GOV KURODA, BOJ NEEDS NEW LEADERSHIP TO ACHIEVE 2 PCT INFLATION TARGET

Poor old Governor Kuroda whose turning of the Bank of Japan into the Tokyo Whale was proving in his terms at least to be quite a success. From the Financial Times.

Trading was at its most eye-catching in Japan. Tokyo’s Topix index touched its highest level since November 1991, only to end down on the day after a volatile session. At its peak, the index reached the fresh high of 1,844.05 with gains across almost all major segments, taking it more than 20 per cent higher for the year to date. But it faded back in late trade to close at 1,817.75.

It makes me wonder what any proposed new Governor would be expected to do?! QE for what else?

Whereas in this morning’s monthly bulletin the ECB ( European Central Bank) has told us this.

Following the decision made on 26 October 2017 the monthly pace will be further reduced to €30 billion from January 2018 and net purchases will be carried out until September 2018. The recalibration of the APP reflects growing confidence in the gradual convergence of inflation rates towards the ECB’s inflation aim, on account of
the increasingly robust and broad-based economic expansion, an uptick in measures of underlying inflation and the continued effective pass-through of the Governing
Council’s policy measures to the financing conditions of the real economy.

So we see proposals for central banking policy lost in  a land of confusion as the US tightens, the Euro area eases a little less and yet again the establishment in Japan cries for more, more, more.

Comment

There is a lot to consider here as we mull a world of easy and in some cases extraordinarily easy monetary policy with what is in general below target inflation. Of course there are exceptions like Venezuela which as far as you can measure it seems to have an inflation rate of the order of 2000% + . But in general such places are importing inflation via a lower currency exchange rate which means that someone else’s is reduced. Also we need to note that 2017 is looking like a good year for economic growth as this morning’s forecasts from the European Commission indicate.

The euro area economy is on track to grow at its fastest pace in a decade this year, with real GDP growth forecast at 2.2%. This is substantially higher than expected in spring (1.7%)……..at 2.1% in 2018 and at 1.9% in 2019.

So then of course you need an excuse for easy monetary policy which is below target inflation! Of course this ignores two technical problems. The first is that at the moment if we get inflation it is mostly from a higher oil price as we mull the likely effects of Brent Crude Oil which has moved into the US $60s. The second is that there is inflation to be found if you look at asset prices as whilst some of the equity market highs we keep seeing is genuine some of it is simply where all the QE has gone. Also there is the issue of house prices where even in the Euro area they are growing at an annual rate of 3.8% so if they were in an inflation index even more questions would be asked about monetary policy.

In a world where wages growth is not only subdued but has clearly shifted onto a lower plane the obsession with raising inflation will simply make the ordinary person worse off via its effect on real wages. Sadly this impact is usually hardest on the poorest.

Me on Core Finance TV

http://www.corelondon.tv/uk-housing-market-house-party-keeps-going/

 

 

 

What does the lack of wage growth in Japan tell us about our future?

As the credit crunch era has developed we have seen many countries discover that past relationships between the level of unemployment and the rate of wage growth no longer exists. Actually if we look back we see that there had been changes before the credit crunch but it has both exacerbated them and brought them into focus. This issue is particularly pronounced in Japan where the unemployment and employment numbers are very strong. From Japan Macro Advisers.

The Japanese economy keeps adding jobs. 200K new jobs were added in August 2017. The unemployment rate was unchanged at 2.8% in August, remaining at the lowest rate in 23 years.

The stand out number is an unemployment rate of a mere 2.8% which is rather extraordinary especially if we recall estimates of full employment from the past as it is below them! How can this be? Well as even economic concepts do not mean what they say as for example central bankers talk of “price stability” when they mean inflation stability usually at 2% per annum. The concept of full employment was and indeed is like that as it does not mean everyone has a job. It always assumed some frictional unemployment or people temporarily out of work and that implied a higher unemployment rate than Japan now has. If we look at other measures the numbers are also strong.

Japan’s job offers to applicant ratio also remained constant in August at 1.52, the highest ratio since February 1974. The new job offers to applicant ratio slightly declined to 2.21 from 2.27 in July, but it is still close to its historical high and continues to show there are more than two vacant jobs to one applicant.

However we also need to note that there is a particularly Japanese feature to this which is on its way to other countries with demographics issues.

The work age population in Japan, defined as the population of the age between 15 and 64, has been shrinking rapidly. In 2016, it fell by 0.7 million people. In 2017, it is projected to shrink further by 0.8 million in 2017. While the Japanese economy is making ends meet by higher labor participation from its senior citizens, the labor resource limitation is an issue Japan needs to address soon.

Work till you drop is perhaps the new theme here.

What about wages?

The story of my time online covering Japan is that since the Abe government came to power there has been prediction after prediction that wage growth will pick up. Regular readers will be aware that some news organisations such as Bloomberg have regularly reported that wage growth has picked up but the truth is that so far there has been no real sign. If we move from the past hype to reality we see that according to the official data real wages fell by 0.9% in 2013, 2.8% in 2014 and 0.9% in 2015 before rising by 0.7% in 2016. Putting it another way the real wage index which was 103.9 in 2013 was 100.7 in 2016.

If we return to Japan Macro Advisers we see this.

The wage report for August was encouraging. Total wages rose by 0.9% year on year (YoY), the highest increase in the last 12 months. Basic and overtime wages rose by 0.6% YoY, the highest rise since April 2016.

We learn a lot there as growth of a mere 0.9% is “encouraging”?! If we switch to real wages the picture is not because they were 0.1% lower than a year before. They are optimistic because of what is essentially a challenge to the unemployment data as they hint at a change in underemployment.

The report shows that 30.5% of workers covered in the survey were part-time workers, a decline of 0.2% point from a year ago. The government does not publish a seasonally adjusted series, but in our own estimation, we see a clear sign that the part-time ratio is starting to decline.

This matters because.

Part-time workers receive one-third of wages that regular workers receive. There are other important benefits such as social security, and the job security is far stronger for regular workers.

Why might wages growth remain weak?

An interesting facet of the issue was highlighted yesterday by the Wall Street Journal.

Facing the tightest labor market in Japan in 43 years, Gatten Sushi recently hired two Chinese kitchen workers and a Filipino waitress who calls out “Welcome” to customers, each for about $10 an hour.

For a country which in many respects prides itself on being homogenous the situation below represents quite a change.

Japan added 400,000 foreign workers in the four years through 2016, surpassing one million for the first time, or nearly 2% of the workforce, labor ministry data show. That is still low compared with the U.S.’s 17% of foreign-born workers but enough to sway the labor market in urban centers like Tokyo.

This is something familiar these days where countries in effect import immigrants to help cope with poor demographics such as an ageing population but there is a catch.

RDC’s Mr. Fukui said foreign workers help the company keep prices flat, especially at budget places like a conveyer-belt sushi restaurant where Vietnamese workers in masks and plastic gloves place fish atop small rice balls formed by a robot. They are useful in other ways too: Sometimes they help out by serving foreign tourists in their own languages, and Mr. Fukui hopes they will continue working with the company even when they go back home to help it expand overseas.

There is a clear implication here that foreign workers are being used as a way of keeper wages lower. This can work because whilst the wages are low for Japan they are high for elsewhere.

Minimum wage in Japan, too low to attract many native-born workers, is still generous for many other Asians. In 2015, Japan’s minimum wage was 21 times higher than that of Vietnam, 12 times higher than in Nepal, and triple that of China, data from Dai-Ichi Research Institute show.

As to this being a permanent situation well maybe not.

Most foreign workers cannot stay permanently owing to immigration rules. Mr. Abe has repeatedly said he doesn’t want large numbers of immigrants in low-paying jobs coming to Japan for the long term.

Government policy

This has been announced since last weekend’s election according to Reuters.

Japan’s government is considering expanding tax incentives for companies to encourage them to raise wages, three people involved in discussions told Reuters, as many firms remain hesitant to spend their cash reserves on salary increases.

As the existing tax breaks are not working this sounds rather like the approach to QE ( QQE in Japan) where like Agent Smith in The Matrix series of films the cry always goes up for “More”

Comment

There are lessons here because Japan has for some time run a policy of declaring pretty much full employment. What I mean by that is that when I worked in Tokyo some 20 years ago people were employed to count you walking across bridges and lifts in the Ghinza shopping district had operators to save you from the arduous task of pressing a lift button! Of course many other countries are now facing up to the issue of what low levels of unemployment really mean.

The next issue is demographics where Japan is the leader of a pack you would rather not be in. Yes it is welcome people are living longer but it has a shrinking population too. Even it has accepted some immigration but as you have seen earlier on its own terms. As the Abe administration is nationalistic that could easily change, But the immigration that has taken place looks like it has affected wages in some occupations. If we look at the restaurant sector it seems clear that to attract Japanese labour wages would have had to have risen if viable.

That conclusion is not far off dynamite as we are so often told that immigration does not depress wages as this from Noah Smith of Bloomberg reminds us.

Normally immigrants don’t depress native wages, but in Japan, given investment constraints, they actually might. Still…skeptical.

If you have workers coming in from much poorer countries to work in particular sectors then surely it must depress wages in them or make them rise more slowly. I can see that there are areas it is unlikely to affect as for example Eastern European construction workers in the UK or Vietnamese/Chinese restaurant workers in Japan may have no impact at all on many other skills but to say they have no impact in their areas seems strange. Also what happens in their home country?

But if we return to the pattern of Japan upon which immigration has been only a recent thin screen then we see that for all the media and Ivory Tower hype the road on what it has been on for 2 “lost decades” now poses a question for our future.

Wages in Japan has been steadily falling in Japan since 1998. Between 1997 and 2012, wages have fallen by 12.5%, or by 0.9% per year on average. ( Japan Macro Advisers).

But we cannot just simply assume we will be “Turning Japanese” in every respect as this from the UK Office for National Statistics has reminded us today.

UK population projected to grow from 65.6 million in 2016 to 72.9 million in 2041

 

Me on Core Finance TV

http://www.corelondon.tv/uk-gdp-0-4-pleasant-number/

 

It is party and sake time at The Tokyo Whale as the Nikkei 225 hits highs

This week has brought a succession of news which will be welcomed by supporters of what has become called Abenomics and the Bank of Japan in particular. In fact the Bank of Japan will be pleased in two ways, one as an ordinary central bank and the other in its hedge fund style role as the Tokyo Whale. From The Japan Times.

The benchmark Nikkei average rose further and marked another 21-year closing high on the Tokyo Stock Exchange on Thursday, boosted by Wall Street’s overnight advance. The Nikkei 225 average gained 73.45 points, or 0.35 percent, to end at 20,954.72 — the best finish since Nov. 29, 1996.

Today this has gone one step further or for Madness fans one step beyond,

Let us start with the most recent period from when Abenomics was first likely to be applied to now. In that time the Nikkei 225 equity index has risen from around 8000 to 21000. As this was one of the policy objectives as according to the mantra it leads to positive wealth effects for the economy it will be regarded as a success. It may also help oil the wheels in the ongoing Japanese election. But you see there is another reason for the Bank of Japan to be happy about this because since a trial effort back in 2010 it has been buying Japanese shares via Exchange Traded Funds. A more regular programme started in 2012 and this was boosted in size and scale over time and here is the current position from the September monetary policy statement.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively.

So the Bank of Japan will have some considerable paper profits right now especially in the light of a clear behavioural pattern which I looked at on the 6th of June.

The bank apparently buys frequently on days when the stock market dips in the morning, serving to stabilize share prices.

The Nikkei Asian Review analysed this development like this.

“The BOJ’s ETF purchases help provide resistance to selling pressure against Japanese stocks,” says Rieko Otsuka of the Mizuho Research Institute.

There have been various rumours over the years about central banks providing something of a “put option” for equity markets leading to talk of a “plunge protection team”, well here is one literally in action. The Japanese taxpayer may reasonably wonder why it is supporting equity investors in yet another example of a policy which the 0.01% will welcome in particular. But for now let is move on with the Governor of the Bank of Japan enjoying a celebratory glass of sake as he looks at the wealth effects of the equity market high and the paper profits in the Bank’s coffers.

The “Put Option” in practice

A paper had been written by Toby Nangle and Tony Yates on this. You may well recall Tony Yates as the person I had a debate with on BBC Radio 4’s Moneybox programme and that events since have not been kind to his views. Anyway they tell us this.

 the cumulative purchases by the Bank of Japanese equities are becoming substantial. We estimate the market value to have been just below ¥20 trillion at the end of July 2017, or around 3.2% of the total Japanese stock market, making the central bank the second largest owner of Japanese stocks after the Government Pension Investment Fund.

Indeed they find themselves producing analysis along the lines of my “To Infinity! And Beyond!” theme.

Without further adjusting the pace of ETF purchases, we project that the central bank will own 10% of the market sometime between 2022-2026, depending on the interim market performance.

First they look for an announcement effect.

We control for this by examining the excess returns of Japanese stocks versus global stocks two business days post-announcement in common currency (last column in Table 1). The relationship between the scale of purchases and the price change is positive in each episode, although the confidence we have in the relationship is not strong given such few data points.

Personally I would also be looking at the days ahead of the announcement as many of these type of events are anticipated and if you like “front-run” these days. Next we see they look for an execution effect and they struggle to find one as the Japanese market underperformed in the period they looked at compared to other equity markets. However we do get a confirmation of the put option in operation.

 we find that the Bank of Japan has timed the execution of its ETF purchase programme to coincide with episodes of market weakness, potentially with the aim of dampening price volatility.

Oh and “dampening price volatility” is the new reduce and/or stop market falls as otherwise it would also sell on days of market strength.

Will it spread?

This is slightly dubious depending on how you regard the actions of the Swiss National Bank which of course buys equities abroad which I presume they regard as the difference.

Japan has been alone in purchasing equities as part of its monetary easing programme, and the question of whether the purchase of equity securities is the next step along this path is of wider interest.

But I agree with the conclusion.

 Even if central banks in the US/Eurozone/UK achieve a lasting lift-off from the zero bound, and are able to shed asset purchases from their balance sheet, low central bank rates are discounted by markets to be a fact of life for the next decade or two, and the chance of needing to have recourse to unconventional measures appears very large.

Comment

Thank you to Tony and Toby for their paper but they use very neutral language and avoid any opinion on whether this is a good idea which tends to suggest a form of approval. Yet there are a myriad of problems.

The ordinary Japanese taxpayer is very unlikely to be aware of this and what is being done both in their name and with their backing. This is especially important if we consider the exit door as in how does this end?

There is a moral hazard problem in both backing and financing a market which disproportionately benefits the already well off. This gets added to by the latest scandal in Japan as the company below has been ( indirectly) backed by the Bank of Japan.

DJ KOBE STEEL SAYS FOUND MORE INSTANCES OF SHIPPED PRODUCTS WITH QUALITY PROBLEMS ( h/t @DeltaOne )

There are real problems here and is one of the arguments against central banks buying risky assets of this form and the clue of course is in the use of the word risky.

Next we have the issue of what good does it do? Yes some get an increase in their paper wealth and some will take profits. In a sense good luck to them, but as we note that this will be disproportionately in favour of the wealthy this is in my opinion a perversion of the role of a central bank.

On the other side of the coin is the current media cheerleading for equity markets of which this from Bloomberg this morning is an especially disturbing example.

To put this year’s gains in perspective, the value of global equities is now 3 1/2 times that at the financial crisis bottom in March 2009. Aided by an 8 percent drop in the U.S. currency, the dollar-denominated capitalization of worldwide shares appreciated in 2017 by an amount — $20 trillion — that is comparable to the total value of all equities nine years ago……… And yet skeptics still abound, pointing to stretched valuations or policy uncertainty from Washington to Brussels. Those concerns are nothing new, but heeding to them is proving an especially costly mistake.

You see congratulating people on doing well out of equity investments is very different to saying you should buy now at what are higher prices. Unless of course Bloomberg thinks they are more attractive at higher prices in which case perhaps it should be buying Bitcoin. Let me leave you with this which feels like something out of a dystopian science fiction piece.

Big companies are becoming huge, from Apple Inc. to Alibaba Group Holding Ltd.