Where next for interest-rates and bond yields?

2021 has opened by reminding us that the world has become increasingly bi-polar.Perhaps I should refine that to the human world. Prospects for interest-rates are doing that as well and let me give you an example of one trend.

Government bond #yield keeping higher: 10 year German #Bund yield at -0.48%, 10 year UK Treasury #Gilt yield at 0.32% and 10 year US #Treasury yield at 1.15%. (@CIMBank_News)

The player here is the United States. I noted yesterday the impact of higher US bond yields on the price of Gold and in the meantime the ten-year has nudged higher to 1.15%. Part of this has been caused by the way that the prospects for Yield Curve Control ( essentially more QE bond buying) have collided with this.

WASHINGTON (Reuters) – The Federal Reserve could begin to trim its monthly asset purchases this year if distribution of coronavirus vaccines boosts the economy as expected, Atlanta Fed President Raphael Bostic said on Monday in what amounted to a bullish outlook for the coming months.

As you can see they have been talking bond yields higher just as they were expected to be heading in the opposite direction. So much for Forward Guidance! This is more like a car crash as we wait for the handbrake turn. Just to add to the land of confusion there was also this.

In separate comments, Chicago Fed President Charles Evans also said policymakers were poised to push bond-buying in either direction – adding more if the economy seems to need it but also open to cutting back if the recovery and vaccines gain traction. ( Reuters)

On a technical level this just reminds us how useless Forward Guidance is. We have seen central bankers and their acolytes push it as a policy tool but right now they are pulling in every direction. How can anyone take guidance from this.

Mr and Mrs Market have decided to push bond yields higher and see if they break.Those who remember what was called the Taoer Tantrum and the climb down of the US Federal Reserve in the face of pressure from President Trump will no doubt be thinking when they climb down. Such thoughts are no doubt behind the rise in bond yields because so far QE has been an example of the genius of the song Hotel California.

“Relax”, said the night man
“We are programmed to receive
You can check out any time you like
But you can never leave”

Negative Interest-Rates

On the other side of the coin is the negative interest-rate enthusiast of the Bank of England Silvana Tenreyro. Yesterday she gave a speech setting out her views on them.

Financial-market channels appear to be unimpeded under negative rates, and some may even be
stronger than usual.
 While pass-through to household deposit rates can be constrained near zero, pass-through appears
to be less constrained for corporate deposit rates, which may stimulate spending by firms.
 There is strong evidence of transmission into looser bank lending conditions, even if this is
somewhat constrained relative to ‘normal’.
 There is no clear evidence that negative rates have reduced bank profits overall, and a number of
studies find positive impacts, once you take into account the boost to the economy.
 Taking these points together, the evidence suggests that negative rates can provide significant
stimulus.

Let us examine these in detail. Her view on the financial market channel is really rather extraordinary, so let us take a look in more detail. The emphasis is mine.

For example, estimates from the Bank’s suite of models suggest that financial market channels – operating via the exchange rate, firms’ cost of capital and households’
financial wealth – account for a third to two thirds of the total medium-term impact on output from Bank Rate
changes, and a half to three quarters of the impact on inflation.

Yes we are back to wealth effects again with no addressing of the issuing for younger people of how they will have to buy more expensive assets is inflation for them.We look at this usually in terms of housing. Also if firms cost of capital responded to Bank Rate in the manner hinted at we would not have had the Funding for Lending and Term Funding Schemes. 

Next is the issue of corporate deposit rates which “may” stimulate corporate spending. Well after the years of evidence now about the impact of negative interest-rates in the Euro area then if you can only say “may” it means the answer is no. Although Silvana keeps plugging away at this.

This suggests one aspect of the banking channel of negative rates which could be more powerful than usual.

How bank lending can be both “looser” and “somewhat constrained” speaks for itself so I will leave that there.

Next comes the issue of the banks. The issue her is one of profitability or rather lack of. Her Silvana finds herself trapped between her theories and real world examples where people are backing their views with their money.

Interestingly, a number of studies48 – though not all49 – find that bank equities tend to fall after policy rate
cuts below zero are announced. That seems at odds with the more sanguine results on bank profitability.

Revealingly she decides that she is right and they are wrong.

One interpretation is that financial markets initially focussed on net interest income, but did not initially
account for the indirect boost to profits from negative rates arising from improvements in other sources of
income.

Indeed they have been wrong for quite some time according to her. It would be too cruel to look at the Italian banking sector so let us go to the benchmark for the Euro area banking sector which is Deutsche Bank. Back in 2015 there were two occasions when its share price approached 29 Euros whereas now it is 9.57 Euros. If we take out the Covid-19 pandemic then we see it does not change much as in February last year it was 10.2 Euros. So the share price has plunged over the era of negative interest-rates and bond yields because markets have failed for over five years to spot the “improvements in other sources of income.” Come to think of it the accountants and auditors have missed it as well!

We seem to be entering something of an alternative universe here.

And I have previously highlighted that in the UK interest rates affect inflation more quickly than in the past.

The ECB in fact published some work a few years back suggesting the reverse. I can only think that Silvana has misunderstood what happened in the summer of 2016.

Also we already have negative UK bond yields in the UK at the shorter maturities mostly due to all the QE bond buying she does not think is that important.Meanwhile that influences the increasing number of fixed-rate mortgages. On that road Bank Rate is ever less important which she seems to miss.

Comment

There are several contexts here so let me set out my view. There is a clear asymmetry between how central bankers regard interest-rate rises and cuts. The former are a vague wish and the latter are a clear desire often implemented via panic. Indeed interest-rate rises are often reversed ( the UK is an example of this ) and the new scenario is lower. For example the Bank of England told us the “lower bound” for UK interest-rates was 0.5% whereas Bank Rate is presently 0.1%. In a sane world we would be projecting interest-rate increases but in the insane one we inhabit any further economic weakness will see more cuts.

Next comes the issue of negative interest-rates which so far have been singing along with Muse.

Super massive black hole
Super massive black hole
Super massive black hole
(Super massive black hole)

The main place that has implemented them which is the Euro area is still there. In fact last year it cut again, although contrary to the Tenreyro rhetoric it only cut by 0.1% showing it sees risks. If negative rates had the impact claimed surely things would have got better and interest-rates could have been raised or at least returned to zero? The Riksbank in Sweden has raised back to 0% but that only illustrates the issue. It cut into negative territory in a boom and ended up so unsure about it all that it raised interest-rates in a bust. If they worked surely Sweden would have them now?

 

Will 2021 be another annus horribilis like 2020?

This has been quite a year to say the least as let’s face it how many of us had ever heard of Huhan province in China before? Back at the turn of the year the issue over there was pork and swine fever. But as you can see below we did get a warning that trouble was ahead from the Bank of England via the use of the phrase “on track” that became a metaphor for absolute disaster in the Greek crisis.

On the economic front, the bar is more modest. At its December meeting, the MPC had projected that UK growth would pick up from below to above potential rates, supported by a reduction of domestic uncertainties, and a modest recovery in global growth. On balance, early indications are that both conditions underpinning the projected UK recovery are on track. ( January 30th)

Now we face a situation where economic output as measured by GDP is about a tenth lower than it was then. Although there is a problem and in fact it is one driven by the way the Office for National Statistics has chosen to measure things. An apparently small shift from inputs to outputs did this.

The ONS figures suggest that the fall in public sector output accounted for over 6 percentage points of the 22 per cent fall in total GDP in the first half of 2020. In other words, over a quarter of the UK’s reported fall in GDP in the first half of this year has, in effect, been attributed to closing schools and stopping hospital operations. This might be accurate, but had the ONS assumed that health and education output was unchanged in the first half of 2020, on the grounds that inputs – staff employed – were unchanged, the fall in UK GDP would have been 16 per cent, not 22 per cent. ( Simon Briscoe)

Actually this does feed into a point I have regularly made over the years which are that the 3 different ways of measuring GDP can come to very different answers. This 6% gap between an income and an output measure is the highest I have noted.

Interest-Rates

The next stop on our journey is here

Bank Rate should be maintained at 0.75%;

This was a bit of a curate’s egg. Having failed to raise interest-rates as promised back in 2013 the Bank had of course done a reverse ferret on its Forward Guidance by cutting to 0.25% post the EU Leave vote. Then we got a couple of rises as someone looked at the back of a disused cupboard and asked “what does this button do?”.

However we now have an official Bank Rate of 0.1% which is 0.4% below the “Lower Bound” of the previous Bank of England Governor Mark Carney. So we get another reminder of how even the Oxford English Dictionary has taken punishment in these times.

But there is more because if we look forwards to December next year via an old stomping ground of mine which is short sterling futures ( more particularly options) we see that negative interest-rates are where bets have been placed. The numbers are marginal so you can also argue for 0% in the round but we remain singing along with Alicia Keys.

Oh, baby
I, I, I, I’m fallin’
I, I, I, I’m fallin’
Fall

The reality is that in the real world we do have negative interest-rates as up to around the 6-year maturity the UK has negative bond yields. This has been quite a shift from the 0.64% of the 5-year yield as 2020 began and I pick that one out as it influences fixed-rate mortgages. If we look further out we see that the 50-year yield has (nearly) halved to 0.65%. This is a ying and yang moment because on one side the UK government can borrow historically high amounts at historically low levels. But on the other the business models of pension funds and long-term investments have been torpedoed.

This has been driven by the enormous scale of the bond buying by the Bank of England which has totaled some £290 billion this year with another £150 billion on its way in 2021.

We are all in it together

Well not quite as we mull two developments in the opposite direction. One evolved from a botched effort by the Financial Conduct Authority to reduce overdraft interest-rates. They miscalculated so badly that the 21% at the beginning of 2021 has been replaced by 33% now. This was announced by someone you may have heard of (Andrew Bailey) like this.

Our radical package of remedies will make overdrafts fairer, simpler and easier to manage. We are simplifying and standardising the way banks charge for overdrafts. Following our changes we expect the typical cost of borrowing £100 through an unarranged overdraft to drop from £5 a day to less than 20 pence a day.

Also mortgage interest-rates for weaker credit ( lower deposits) have been rising in the latter part of 2020. This starts at a 15% deposit where the 2-year fix last year was 1.71% and is now 3%. If you only have a 5% deposit then the 2-year fixed rate is now over 4%.

The UK Pound

This has had a year where it has been singing along with The Wonder Stuff.

Dizzy,
I’m so Dizzy, my head is spinning
Like a whirlpool, it never ends
And it’s you girl, making it spin
You’re making me dizzy

Against the US Dollar it started the year around US $1.31 and with it now just above US $1.36 you might wonder what all the fuss is about? Except I still recall the twitter feeds of Financial Times journalists suggesting the only way was down at US $1.15. Indeed one recently suggested parity might be on the cards at yes you guessed it the recent low in the US £1.31s.

Another perspective is provided by the Japanese Yen which has had a strong 2020. We are at 141 Yen a bit below where we began the year. This is bad news for the Bank of Japan which continues to try to weaken it and is against the trend for them trying to take manufacturing back home. Oh well!

Comment

Okay so now let me look ahead. At some point in 2020 ( hopefully the second quarter) we can declare annual economic growth as surging again. But we will still be below pre pandemic levels and will not regain them. Official forecasts will predict a rosy 2022 in the same way they predicted a rosy 2021 only a few months ago.

In terms of interest-rates I still believe the trend is down. By that I mean official ones because as we have noted above real world ones have diverged. The threshold for interest-rate increases is now very high whereas any weakness makes central banks panic and run for the cut button. The same is true of bond yields where QE as a method of yield curve control looks ever more permanent in line with our “To Infinity! And Beyond!” theme.

As to the UK Pound £ we have ended up pretty much where I expected which is US $1.35 ( so strictly a cent out as I type this). It has been an odd year on that front as the Byline Times keeps popping up with the argument that hedge funds are controlling events such that they will make a fortune on any Brexit deal by being short the £.

I shall take a short break but will be back in the New Year so Merry Christmas and a Happy New Year to you all.

 

 

Can the UK afford all the extra debt?

I thought that it was time to take stick and consider the overall position in terms of the build up of debt. This has come with a type of economic perfect storm where the UK has begun borrowing on a grand scale whilst the economy has substantially shrunk.So an stand alone rise in debt has also got relatively much larger due to the smaller economy. Hopes that the latter would be short and sharp rather faded as we went into Lockdown 2.0. Although as we look to 2021 and beyond there is increasing hope that the pace of vaccine development will give us an economic shot in the arm.

In terms of scale we got some idea of the flow with Friday’s figures.

Public sector net borrowing (PSNB ex) in the first seven months of this financial year (April to October 2020) is estimated to have been £214.9 billion, £169.1 billion more than in the same period last year and the highest public sector borrowing in any April to October period since records began in 1993.

The pattern of our borrowing has changed completely and it is hard not to have a wry smile at the promises of a budget balance and then a surplus. Wasn’t that supposed to start in 2016? Oh Well! As Fleetwood Mac would say. Now we face a year where if we borrow at the rate above then the total will be of the order of £370 billion.

If we switch to debt and use the official net definition we see that we opened the financial year in April with a net debt of 1.8 trillion Pounds if you will indulge me for £500 million and since then this has happened.

Public sector net debt excluding public sector banks (PSND ex) rose by £276.3 billion in the first seven months of the financial year to reach £2,076.8 billion at the end of October 2020, or around 100.8% of gross domestic product (GDP); debt to GDP ratios in recent months have reached levels last seen in the early 1960s.

You nay note that the rise in debt is quite a bit higher than the borrowing and looking back this essentially took place in the numbers for April and May when the pandemic struck. Anyway if we assume they are now in control of the numbers we are looking at around £2.2 trillion at the end of the financial year if we cross our fingers for a surplus in the self assessment collection month of January.

The Bank of England

How does this get involved? Mostly by bad design of its attempts to keep helping the banks. But also via a curious form of accountancy where marked to market profits as its bond holdings are counted as debt.

If we were to remove the temporary debt impact of these schemes along with the other transactions relating to the normal operations of the BoE, public sector net debt excluding public sector banks (PSND ex) at the end of October 2020 would reduce by £232.9 billion (or 11.3 percentage points of GDP) to £1,843.9 billion (or 89.5% of GDP).

So on this road we look set to end the fiscal year with a net debt of the order of £2 trillion.

Quantitative Easing

This is another factor in the equation but requires some care as I note this from the twitter feed of Richard Murphy.

Outside Japan QE was unknown until 2009. Since then the UK has done £845 billion of it. This is a big deal as a consequence. But as about half of that has happened this year it’s appropriate to suggest that there have been two stage of QE, so far. And I suggest we need a third.

Actually so far we have done £707 billion if you just count UK bond or Gilt purchases. That is quite a numerical mistake.As we look ahead the Bank of England plans to continue in this manner.

The Committee voted unanimously for the Bank of England to continue with the existing programme of £100 billion of UK government bond purchases, financed by the issuance of central bank reserves, and also for the Bank of England to increase the target stock of purchased UK government bonds by an additional £150 billion, financed by the issuance of central bank reserves, to take the total stock of government bond purchases to £875 billion.

We see that this changes the numbers quite a lot. There are a lot of consequences here so let me this time agree with Richard Murphy as he makes a point you on here have been reading for years.

The first shenanigan is that the so-called independence of the Bank of England from the Treasury is blown apart by the fact that the Treasury completely controls the APF and the whole QE process. QE is a Treasury operation in practice, not a Bank of England one. ( APF = Asset Protection Fund)

Actual Debt Costs

These are extraordinarily low right now. Indeed in some areas we are even being paid to borrow. As I type this the UK two-year yield is -0.03% and the five-year yield is 0%. Even if we go to what are called the ultra longs we see that the present yield of the fifty-year is a mere 0.76%. To that we can add the pandemic effect on the official rate of inflation.

Interest payments on the government’s outstanding debt were £2.0 billion in October 2020, £4.4 billion less than in October 2019. Changes in debt interest are largely a result of movements in the Retail Prices Index to which index-linked bonds are pegged.

As an aside this also explains the official effort to neuter the RPI measure of inflation and make it a copy of the CPIH measure so beloved of the UK establishment via the way they use Imputed Rents to get much lower numbers. I covered this issue in detail on the 18th of this month.

So far this financial year we have paid £24.1 billion in debt costs as opposed to the £33.9 billion we paid in the same April to October period last year.

Comment

The elephant in the room here is QE and by using it on such a scale the Bank of England has changed the metrics in two respects. Firstly the impact on the bond market of such a large amount of purchases has been to raise the price which makes yields lower. That flow continues as it will buy another £1.473 billion this afternoon. Having reduced debt costs via that mechanism it does so in another way as the coupons ( interest) on the debt it has bought are returned to HM Treasury. Thus the effect is that we are not paying interest on some £707 billion and rising of the debt that we owe.

Thus for now we can continue to borrow on a grand scale. One of the ways the textbooks said this would go wrong is via a currency devaluation but that is being neutered by the fact that pretty much everyone is at the same game. There are risks ahead with the money supply as it has been increased by this so looking ahead inflation is a clear danger which is presumably why the establishment are so keen on defining it away.

I have left until the end the economy because that is so unpredictable. We should see some strength in 2021 as the vaccines kick in.But we have a long way to go to get back to where we were in 2008. On a collective level we may need to face up to the fact that in broad terms economic growth seems to have at best faded and at worst gone away.

Podcast

 

 

Where next for interest-rates and bond yields?

As we find ourselves in a phase where possible solutions to the Covid-19 pandemic are in the news, the economic consequences for 2021 are optimistic. For example, it looks as though it will mean the type of Lockdown the UK is experiencing will get less and less likely. That is a relief as the issue of the Lockdown strategy is that you end up in a repeating loop. The more hopeful reality does have potential consequences for interest-rates and some of this has been highlighted by Reuters.

LONDON (Reuters) – Expectations of interest rate cuts in some of the world’s biggest economies have melted within the space of a month on hopes a successful coronavirus vaccine will fuel a growth bounceback next year.

Why? Well in line with this from Bank of England Chief Economist Andy Haldane yesterday.

LONDON (Reuters) – Bank of England Chief Economist Andy Haldane said the economic outlook for 2021 was “materially brighter” than he had expected just a few weeks ago despite short-term uncertainty from a renewed COVID-19 lockdown in England.

Except as you can see the changes are in fact really rather minor in the broad scheme of things.

Between Nov. 5-9, a period when it became clear Democrat Joe Biden had won the U.S. election and Pfizer announced its vaccine news, eurodollar futures, which track short-term U.S. rate expectations, flipped to reflect expectations of 10 bps in rate hikes by Sept 2022.

Just the previous week, markets were predicting no changes. Futures now expect U.S. rates at 0.50% by September 2023, from 0.25% forecast a month previously.

At the ECB where rates are already minus 0.5%, a nine bps cut was expected by September 2021 but that is now slashed to only five bps.

After all the interest-rate cuts we see that the US is expected to increase interest-rates by a mere 0.25% over the next 3 years. That is a bit thin if you note the promises of economic recovery. But it is in line with one of my main themes which are that interest-rate cuts are for the now and are large whereas interest-rate rises are for some future date and are much smaller if they happen at all. For example Bank of England Governor Mark Carney provided Forward Guidance for interest-rate increases in the summer of 2013. It is hard not to laugh as I type that his next move was to cut them! There was a rise some 5 years or so later to above the original “emergency” level of 0.5% which rather contrasts with the cuts seen in March.

As to the ECB which hasn’t has any increases at all since 2011 there has been this today by its President Christine Lagarde.

While all options are on the table, the pandemic emergency purchase programme (PEPP) and our targeted longer-term refinancing operations (TLTROs) have proven their effectiveness in the current environment and can be dynamically adjusted to react to how the pandemic evolves.

So Definitely Maybe, although these days interest-rate cuts may not be widely announced as for example the present TLTROs allow banks access to funds at -1% as opposed to the more general -0.5% of the Deposit Rate.

Meanwhile

I did point out earlier that interest-rate cuts are for the here and now and they seem to be rather en vogue this morning starting early in the Pacific region.

BI Board of Governors Meeting (RDG) in November 2020 decided to lower the BI 7-Day Reverse Repo Rate (BI7DRR) by 25 bps to 3.75%, as well as the Deposit Facility and Lending Facility rates which fell by 25 bps, to 3.00% and 4.50%.

Bank Indonesia did not have to wait long for company as the central bank of the Philippines was in hot pursuit.

At its meeting on monetary policy today, the Monetary Board decided to cut the interest rate on the BSP’s overnight reverse repurchase facility by 25 basis points to 2.0 percent, effective Friday, 20 November 2020. The interest rates on the overnight deposit and lending facilities were likewise reduced to 1.5 percent and 2.5 percent, respectively.

Perhaps the Bank of  Russia fears missing out.

Russian Central Bank: Monetary Policy To Remain Accommodative In 2021…….Russian Central Bank: See Room For Further Rate Cuts But Not That Big.

Probably they are emboldened by the recent rise in the oil price which is a major issue for the Russian economy.

Indonesia

We looked at the Pacific region back in 2019 as an area especially affected by the “trade war” between the US and China. Some of that looks set to fade with the new US President but the Pacific now has another one.

China is digging in its heels as the trade spat between Canberra and Beijing continues, with officials laying responsibility for the tensions solely at Australia’s feet. ( ABC)

As well as the interest-rate cut Bank Indonesia is working to reduce bond yields.

As of 17 November 2020, Bank Indonesia has purchased SBN on the primary market through a market mechanism in accordance with the Joint Decree of the Minister of Finance and the Governor of Bank Indonesia dated April 16, 2020, amounting to IDR 72.49 trillion, including the main auction scheme, the Greenshoe Option (GSO) and Private Placement.

Primary purchases are unusual especially for an emerging market and another 385 trillion IDR have been bought via other forms of QE.

Philippines

The central bank gives us a conventional explanation around inflation as a starter.

Latest baseline forecasts continue to indicate a benign inflation environment over the policy horizon, with inflation expectations remaining firmly anchored within the target range of 2-4 percent. Average inflation is seen to settle within the lower half of the target band for 2020 up to 2022, reflecting slower domestic economic activity, lower global crude oil prices, and the recent appreciation of the peso. The balance of risks to the inflation outlook also remains tilted toward the downside owing largely to potential disruptions to domestic and global economic activity amid the ongoing pandemic.

But we all know that the main course is this.

Meanwhile, uncertainty remains elevated amid the resurgence of COVID-19 cases globally. However, the Monetary Board also observed that global economic prospects have moderated in recent weeks. At the same time, the Monetary Board noted that while domestic output contracted at a slower pace in the third quarter of 2020, muted business and household sentiment and the impact of recent natural calamities could pose strong headwinds to the recovery of the economy in the coming months.

Comment

As you can see the story about the end of interest-rate cuts has already hit trouble. Central bankers seem unable to break their addiction. I will have to do a proper count again but I am pretty sure we have now had around 780 interest-rate cuts in the credit crunch era. So it seems that the muzak played on the central bank loudspeakers will keep this particular status quo for a while yet.

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

There are issues as I noted on the 11th of this month as all the fiscal stimuli puts upward pressure on interest-rates. But the threshold for interest-rate cuts is far lower than for rises. Also we get cuts at warp speed whereas rises have Chief Engineer Scott telling us that the engines “cannae take it”

Putting it another way we have another example of a bipolar world where there may be drivers for higher interest-rates but the central banksters much prefer to cut them.This gets more complex as we see so many countries with or near negative interest-rates and bond yields.

The ECB faces problems from the Euro area banks as well as fiscal policy

This morning has brought us up to date on the state of play at the European Central Bank. Vice President De Guindos opened his speech in Frankfurt telling us this about the expected situation.

The pandemic crisis has put great pressure on economic activity, with euro area growth expected to fall by 8% in 2020. ……The tighter containment measures recently adopted across Europe are weighing on current growth. With the future path of the pandemic highly unclear, risks are clearly tilted to the downside.

So he has set out his stall as vaccine hopes get a relatively minor mention. Thus he looks set to vote for more easing at the December meeting. Also he rather curiously confessed that after 20 years or so the convergence promises for the Euro area economy still have a lot of ground to cover.

The severity of the pandemic shock has varied greatly across euro area countries and sectors, which is leading to uneven economic developments and recovery speeds……..And growth forecasts for 2020 also point towards increasing divergence within the euro area.

Looking ahead that is juts about to be fixed, although a solution to it has been just around the corner for a decade or so now.

The recent European initiatives, such as the Next Generation EU package, should help ensure a more broad-based economic recovery across various jurisdictions and avoid the kind of economic and financial fragmentation that we observed during the euro area sovereign debt crisis.

He also points out there has been sectoral fragmentation although he rather skirts around the issue that this has been a policy choice. Not by the ECB but bu governments.

 Consumers have adopted more cautious behaviour, and the recent tightening of restrictions has notably targeted the services sector, including hotels and restaurants, arts and entertainment, and tourism and travel.

Well Done the ECB!

As ever in a central banking speech there is praise for the central bank itself.

Fiscal support has played a key role in mitigating the impact of the pandemic on the economy and preserving productive capacity. This is very welcome, notwithstanding the sizeable budget deficits anticipated for 2020 and 2021 and the rising levels of sovereign debt.

This theme is added to by this from @Schuldensuehner

 Jefferies shows that France is biggest beneficiary of ECB’s bond purchases. Country has saved €28.2bn since 2015 through artificial reduction in financing costs driven by ECB. In 2nd place among ECB profiteers is Italy w/savings of €26.8bn, Germany 3rd w/€23.7bn.

Care is needed as QE has not been the only game in town especially for Greece which is on the list as saving 2,2 billion Euros a year from a QE plan it was not in! It only was included this year. But the large purchases have clearly reduced costs for government and no doubt makes the ECB popular amongst the politicians it regularly claims to be independent from. But there is more.

While policy support will eventually need to be withdrawn, abrupt and premature termination of the ongoing schemes could give rise to cliff-edge effects and cool the already tepid economic recovery.

It is a bit socco voce but we get a reminder that the ECB is willing to effectively finance a very expansionary fiscal policy. That is why it has two QE programmes running at the same time, but for this purpose the game in town is this.

 The Governing Council will continue its purchases under the pandemic emergency purchase programme (PEPP) with a total envelope of €1,350 billion.

There was a time when that would be an almost unimaginable sum of money but not know as if government’s do as they are told it will be increased.

The purchases will continue to be conducted in a flexible manner over time, across asset classes and among jurisdictions.

Oh and there is a bit of a misprint on the sentence below as they really mean fiscal policy.

This allows the Governing Council to effectively stave off risks to the smooth transmission of monetary policy.

The Banks

These are a running sore with even the ECB Vice President unable to avoid this issue.

The pandemic has also weighed on the long-term profitability outlook for banks in the euro area, depressing their valuations. From around 6% in February of this year, the euro area median banks’ return on equity had declined to slightly above 2% by June.

Tucked away in the explanation is an admittal of the ECB’s role here so I have highlighted it.

The decline in profitability is being driven mainly by higher loan loss provisions and weaker income-generation capacity linked to the ongoing compression of interest margins.

The interest-rate cuts we have seen hurt the banks and this issue was exacerbated by the reductions in the Deposit Rate to -0.5% as the banks have been afraid of passing this onto the ordinary saver and depositor. Thus the Zero Lower Bound ( 0%) did effectively exist for some interest-rates.

This is in spite of the fact that banks have benefited from two main sweeteners. This is the -1% interest-rate of the latest liquidity programmes ( TLTROs) and the QE bond purchases which help inflate the value of the banks bond holdings.

Then we get to the real elephant in the room.

Non-performing loans (NPL) are likely to present a further challenge to bank profitability.

We had got used to being told that a corner had been turned on this issue even in Italy and Greece. Speaking of the latter Piraeus Bank hit trouble last week when it was unable to make a bond payment.

The non-payment of the CoCos coupon will lead to the complete conversion of the convertible bond, amounting to 2.040 billion euros, into 394.4 million common shares.

It is noted that the conversion will not involve an adjustment of the share price and simply, to the 437 million shares of the Bank will be added another 394.4 million shares at the price of 0.70 euros (closing of the share at last Friday’s meeting). ( Capital Gr).

There is a lot of dilution going on here for private shareholders as we note that this is pretty much a nationalisation.

The conversion has one month after December 2 to take place and the result will be the percentage of the Financial Stability Fund, which currently controls 26.4% of Piraeus Bank, to increase to 61.3%.

Meanwhile in Italy you have probably guessed which bank has returned to the news.

LONDON/MILAN/ROME (Reuters) – Italy’s Treasury has asked financial and legal advisers to pitch for a role in the privatisation of Monte dei Paschi BMPS.MI as it strives to secure a merger deal for the Tuscan lender, two sources familiar with the matter told Reuters on Friday.

The equivalent of a Hammer House of Horror production as we mull how like a financial vampire it keeps needing more.

Italy is seeking ways to address pending legal claims amounting to 10 billion euros (£9 billion) that sources say are the main hurdle to privatising the bank.

Even Colin Jackson would struggle with all the hurdles around Monte dei Paschi. Anyway we can confidently expect a coach and horses to be driven through Euro area banking rules.

If we look at the proposed solution we wonder again about the bailouts.

Although banks have stepped up cost-cutting efforts in the wake of the pandemic, they need to push even harder for greater cost efficiency.

So job losses and it seems that muddying the waters will also be the order of the day.

The planned domestic mergers in some countries are an encouraging sign in this regard.

A merger does reduce two problems to one albeit we are back on the road to Too Big To Fail or TBTF.

There is of course the ECB Holy Grail.

Finally, we also need to make progress on the banking union, which unfortunately remains unfinished. Renewed efforts are urgently required to improve its crisis management framework.

Just as Italy makes up its own rules….

Comment

We are now arriving at Monetary Policy 3.0 after number one ( interest-rates) and number two ( QE) have failed to work. In effect the role of monetary policy is to facilitate fiscal policy. It also involves a challenge to democracy as the technocrats of the ECB are looking to set policy for the elected politicians in the Euro area. However there are problems with this and somewhat ironically these have been highlighted by the Twitter feed of the Financial Times which starts with an apparent triumph.

Italy’s bond rally forces key measure of risk to lowest since 2018

So on a financial measure we have convergence. But if we switch to the real economy we get this.

‘There is no money left’: the pandemic’s economic impact is ‘a catastrophe’ for people in southern Italy who were already in a precarious situation

Switching to the banks we are facing the consequences of the Zombification of the sector as the same old names always seem to need more money. Although there has been more hopeful news for BBVA of Spain today albeit exiting the country where banks seem to be able to make money.

PNC to buy U.S. operations of Spanish bank BBVA for $11.6 billion ( @CNBC )

Although the price will no doubt if the speech above is any guide will be pressure to give a home to a Zombie or two.

Podcast

 

 

 

What are the consequences of bond yields rising further?

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

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

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

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

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

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

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

US Treasury Bonds

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

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

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

Why does this matter?

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

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

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

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

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

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

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

Yield Curve Control

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

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

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

Oh and there was a concerning consequence to this.

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

Comment

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

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

 

What are the economic policies of Joe Biden?

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

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

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

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

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

Detailed Proposals

Interestingly the fiscal expansionism comes with tax increases for some.

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

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

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

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

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

Spending

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

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

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

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

Education too will be a beneficiary.

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

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

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

And healthcare.

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

US Federal Reserve

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

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

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

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

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

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

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

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

Comment

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

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

 

Australia cuts interest-rates again

This morning as the world waits on tenterhooks for news on the US election there was yet another move in one of the longest running themes of my work. For that we need to travel to what is often called a land “down under” or more recently the South China Territories. So let me hand you over to the Reserve Bank of Australia.

The elements of today’s package are as follows:

  • a reduction in the cash rate target to 0.1 per cent
  • a reduction in the target for the yield on the 3-year Australian Government bond to around 0.1 per cent
  • a reduction in the interest rate on new drawings under the Term Funding Facility to 0.1 per cent
  • a reduction in the interest rate on Exchange Settlement balances to zero

So we see yet another interest-rate cut in this instance from 0.25% to 0.1% which means that we have gad around 770 in total now since the credit crunch began. There is something very curious about this action because you see that apparently things are going really rather well.

Encouragingly, the recent economic data have been a bit better than expected and the near-term outlook is better than it was three months ago.

Indeed you might also think that as this rate cutting cycle began in June last year when the rate was cut from 1.5% to 1.25% you might wait for its impact to hit, at least if you believe it will have any. After all there were cuts two months in a row meaning a 0.5% cut which should be impacting now. If they do not work how will one of less than a third of the size?

The theme above has become something of a central banking standard where they tell us things are better than expected but cut interest-rates anyway! But I do not see others calling them out for it. After all if you are the South China Territories then this is rather bullish.

The global economy has been recovering from the initial virus outbreaks, with the recovery most advanced in China.

Quantitative Easing

I am sure you have spotted that the trend to more QE is in force as well. It always goes longer in time in line with my “To Infinity! And Beyond!” theme.

Under the program to purchase longer-dated bonds, the Bank will buy bonds issued by the Australian Government and by the states and territories, with an expected 80/20 split. These bonds will be bought in the secondary market through regular auctions, with the first auction to be held this Thursday for Australian Government securities.

As well as going longer there is always “More! More! More!” as a theme too as the extra 100 billion Australian Dollars is only a starting point.

The Bank remains prepared to purchase bonds in whatever quantity is required to achieve the 3-year yield target. Any bonds purchased to support this target would be in addition to the $100 billion bond purchase program.

Of course if you are going longer and presumably feel that is a good idea then why bother keeping the 3-year yield target? But the central planners never seem to give anything up once they have gained control.

The Aussie Dollar

We do get a bit of a divergence from the central bankers rule book with the bit I have highlighted below.

The combination of the RBA’s bond purchases and lower interest rates across the yield curve will assist the recovery by: lowering financing costs for borrowers; contributing to a lower exchange rate than otherwise; and supporting asset prices and balance sheets.

So we have an actual attempt at devaluation or more strictly exchange-rate depreciation. Of course President Trump may be about to depart but should he stay will he be looking at Australia as looking for an economic advantage via a weaker exchange-rate?

If we look at the Trade Weighted Index it’s recent peak was at 65.7 at the end of January 2018. It then gently declined towards 60 and then plunged to around 50 as the pandemic hit. So there was a substantial depreciation,although with economies plunging any economic gains were likely to be small. The index then bounced to a bit above 62 in August and was 59.5 yesterday.So there was and indeed is no clear case for needing a depreciation especially if you are benefiting from some re-stocking by China.

So far this year, Australian exports of iron ore and liquefied natural gas to China have increased by eight percent and nine percent respectively year on year, according to Wood Mackenzie. China’s coal imports from Australia also far exceeded the levels before the pandemic. ( CGTN from the 28th of July).

Housing Market

I see that the Australian Broadcasting Corporation has been on the case already.

Adelaide homeowners Mark and Verity Riessen are eagerly waiting to see how much of the rate cut will be passed on to them by their lender.

“The last rate cut the RBA passed through, was not passed on to us by our lender,” Mr Reissen said.

So the banks have behaved like well banks in not passing on the previous interest-rate cut and that is a theme. What do I mean by that? As interest-rates have approached and then in some places gone below zero the responsiveness or delta of the mortgage-rate changes has clearly declined. It always was important to check the terms of your mortgage but the ones saying linked to Cash Rate ( of the RBA) will be in prime position today.Also you need to check for exemptions as some around the world have (sneakily) imposed a minimum interest-rate.

According to the RBA the Reissen’s are at 3.2% paying what is pretty much the average rate with new mortgages being at 2.69% on average.

House Prices

We only have numbers up until the end of June but here is Australia Statistics.

Weighted average of the eight capital cities Residential Property Price Index:

  • fell 1.8% this quarter.
  • rose 6.2% over the last twelve months.

The total value of residential dwellings in Australia fell $98.2b to $7,138.2b this quarter.

The idea that the number above is any sort of value is pretty much laughable as has there been a bid for the lot? But we see that the RBA may have been triggered by house price falls which central bankers hate.

The index is at 143.2 as opposed to the 100 of 2012.

Comment

Let us look at the reality of the situation. Starting with interest-rates if you are wondering what is the point of a 0.15% cut after so many you are on the right track and the psychobabble continues with this.

Given the outlook, the Board is not expecting to increase the cash rate for at least three years.

So more meaningless Forward Guidance although some seem fooled by it. From ABC.

Dr Hunter said the bank outlining it did not expect to raise the cash rate over the next three years would “provide households and businesses with some certainty over their individual borrowing rates in the near term”.

Perhaps someone should tell Dr.Hunter about the existence of fixed interest-rates! Also as the last interest-rate rise was a decade ago today who exactly expects any sort of interest-rate rise? The fact it was to 4.75% provides plenty of food for thought.

The reality is that central banks have two aims now and that is why we are seeing so much QE and credit easing. Aim one is to help government fiscal policy by keeping the rate at which it can borrow very low and also pumping house prices by reducing mortgage rates.

Meanwhile I know Halloween was a few days ago but this still chills the spine.

Dr Lowe also said the cash rate was very unlikely to drop below zero.

 

 

 

 

Greece rearms but what about the economy?

These times does have historical echoes but in the main we can at least reassure ourselves that one at least is not in play. However Greece is finding itself in a situation where in an echo of the past it is now boosting its military. From Neoskosmos last month.

Greece’s new arms procurement program features:

  • A squadron 18 Rafale fighter jets to replace the older Mirage 2000 warplanes
  • Four Multi-Role frigates, along with the refurbishment of four existing ones
  • Four Romeo navy helicopters
  • New anti-tank weapons for the Army
  • New torpedoes for the Navy
  • New guided missiles for its Air Force

The Greek PM also announced the recruitment of a total of 15,000 soldier personnel over the next five years, while the Defence industry and the country’s Armed Forces are set for an overhaul, with modernisation initiatives and strengthening of cyberattack protection systems respectively.

Some of this will provide a domestic economic boost with the extra 15,000 soldiers and some of the frigate work. Much will go abroad with President Macron no doubt pleased with the orders for French aircraft as he was calling for more of this not so long ago. As a major defence producer France often benefits from higher defence spending. That scenario has echoes in the beginnings of the Greek crisis as the economy collapsed and people noted the relatively strong Greek military which had bought French equipment. Actually a different purchase became quite a scandal as bribery and corruption allegations came to light. The German Type 214 submarines had a host of problems too as the contract became a disaster in pretty much every respect.

The driving force behind this is highlighted by Kathimerini below.

Turkey’s seismic survey vessel, Oruc Reis, was sailing 18 nautical miles off the Greek island of Kastellorizo on Tuesday morning. The vessel, which had its transmitter off, was heading northeast and, assuming it continues its course at its current speed, it was expected to reach a point 12 nautical miles off Kastellorizo by around noon.

The catch is that many of the defence plans above take many years to come to fruition and Greece is under pressure from Turkey in the present.

The Economy

At the end of June the Bank of Greece told us this.

According to the Bank of Greece baseline scenario, economic activity in 2020 is expected to contract substantially, by 5.8%, and to recover in 2021, posting a growth rate of 5.6%, while in 2022 growth will be 3.7%. According to the mild scenario, which assumes a shorter period of transition to normality, GDP is projected to decline by 4.4% in 2020 and to increase by 5.8% and 3.8%, respectively, in 2021 and 2022. The adverse scenario, associated with a possible second wave of COVID-19, assumes a more severe and protracted impact of the pandemic and a slower recovery, with GDP falling by 9.4% in 2020, before rebounding to 5.7% in 2021 and 4.5% in 2022.

As it turns out it is the latter more pessimistic scenario which is in people’s minds this week. As I regularly point out the forecasts of rebounds in 2021 and 22 are pretty much for PR purposes as we do not even know how 2020 will end. This is even more exacerbated in Greece which has been forecast to grow by around 2% a year for the last decade whereas the reality has been of a severe economic depression.

The projection of a 9.4% decline would mean that we would then be looking at a decline of around 30% from the peak back in 2009. I am keeping this as a broad brush as so much is uncertain right now. But one thing we can be sure of is that historians will report this episode as a Great Depression.

What about the public finances?

There is a multitude of issues here so let us start with the latest numbers.

In January-September 2020, the central government cash balance recorded a deficit of €12,860 million, compared to a deficit of €1,243 million in the same period of 2019. During this period, ordinary budget revenue amounted to €30,312 million, compared to €35,279 million in the corresponding period of last year. Ordinary budget expenditure amounted to €41,332 million, from €37,879 million in January-September 2019.

Looking at the detail for September there was quite a plunge in revenue from 5.2 billion Euros last year to 3.8 billion this. Monthly figures can be erratic and there have been tax deferrals but that poses a question about further economic weakness?

If we try to look at how 2020 will pan out then last week the International Monetary Fund suggested this.

The Fund further anticipates the budget deficit this year to come to 9% of GDP, matching the global average rate, while the draft budget provides for 8.6% of GDP. In 2021 the deficit is expected to return to 3% of GDP rate, as allowed for by the general Stability Pact rules of the European Union, the IMF says, bettering the government’s forecast for 3.7% of GDP. ( Kathimerini)

As an aside I do like the idea that the Growth and Stability Pact still exists! That is a bit like the line from Hotel California.

“Relax”, said the night man
“We are programmed to receive
You can check out any time you like
But you can never leave”

Actually it has only ever applied when it suited and I doubt it is going to suit for years. Anyway we can now shift our perspective to the national debt.

However, on the matter of the national debt, the government appears far more optimistic than the IMF. The Fund sees Greek debt soaring to 205.2% of GDP this year, from 180.9% in 2019, just as the Finance Ministry sees it contained at 197.4%. ( Kathimerini)

I do like the idea of it being “contained” at 197.4% don’t you? George Orwell would be very proud. So we can expect of the order of 200%. Looking ahead we see a familiar refrain.

For 2021 the government anticipates a reduction of the debt to 184.7% of GDP, compared to 200.5% that the IMF projects before easing to 187.3% in 2022 and to 177% in 2023. ( Kathimerini)

This is a by now familiar feature of official forecasts in this area which have sung along with the Beatles.

It’s getting better all the time

Meanwhile each time we look again the numbers are larger.

Debt Costs

This has been a rocky road from the initial days of punishing Greece to the ESM ( European Stability Mechanism) telling us how much it has saved Greece via Euro area “solidarity”

Conditions on the loans from the EFSF and ESM are much more favourable than those in the market. This saves Greeces around €12 billion every year, or 6.7 percent of its economy: a substantial form of solidarity.

These days the European Central Bank is also in the game with Greece now part of its QE bond buying programme. So its ten-year yield is a mere 0.83% and costs of new debt are low.

Comment

I have several issues with all of this. Let me start with the basic one which is that the shambles of a “rescue” that collapsed the economy was always vulnerable to the next downturn.I do not just mean the size of the economic depression which is frankly bad enough but how long it is lasted. I still recall the official claims that alternative views such as mine ( default and devalue) would collapse the economy. The reality is that the “rescue” has collapsed it and people may live their lives without Greece getting back to where it was.

Next comes the associated swerve in fiscal policy where Greece was supposed to be running a primary surplus for years. This ran the same risk of being vulnerable to the economic cycle who has now hit. We are now told to “Spend! Spend! Spend!” in a breathtaking U-Turn. Looking back some of this was real fantasy stuff.

 In 2032, they will review whether additional debt measures are needed to keep Greece’s gross financing needs below the agreed thresholds ( ESM)

Mind you the ESM still has this on its webpage.

Now, these programmes have started to bear fruit. The economy is growing again, and unemployment is falling. After many years of painful reforms, Greece’s citizens are seeing more jobs opening up, and standards of living are expected to rise.

Shifting back to defence we see that another burden is being placed on the Greek people in what seems a Merry Go Round. Reality seldom seems to intervene much here but let me leave you with a last thought. What sort of state must the Greek banks be in?

 

 

Do we face austerity and tax rises after the Covid-19 pandemic?

We have been in uncertain times for a while now and this has only been exacerbated by the Covid-19 pandemic. One particular area of concern are the public finances of nations who are copying the “Spend! Spend! Spend!” prescription of football pools winner Viv Nicholson. For younger readers the football pools were what people did before lotteries. Indeed if we note the latest IMF Fiscal Monitor there was an issue even before the new era.

Prior to the pandemic, public and private debt were
already high and rising in most countries, reaching
225 percent of GDP in 2019, 30 percentage points
above the level prevailing before the global financial
crisis. Global public debt rose faster over the period,
standing at 83 percent of GDP in 2019.

We get a pretty conventional response for the IMF which has this as a mantra.

And despite access to financing varying sharply across countries, medium- to long-term fiscal strategies were needed virtually everywhere.

There is a counterpoint here which is that the fiscal strategies approved by the IMF have been a disaster. There is of course Greece but in a way Japan is worse. Following IMF advice it began a policy of raising its Consumption Tax to reduce its fiscal deficit. It took five years for it to take the second step as the first in 2014 caused quite a dive in the economy. Then the second step last year saw Japan’s economy contract again, just in time to be on the back foot as the Covid-19 pandemic arrived.

The IMF is expecting to see quite a change this year.

In 2020, global general government debt is estimated to make an unprecedented jump up to almost 100 percent of GDP. The major increase in the primary deficit and the sharp contraction in economic activity of 4.7 percent projected in the latest World Economic Outlook, are the main drivers of this development.

Oh and where have we heard this before? The old this is “temporary” line.

But 2020 is an exceptional year in terms of
debt dynamics, and public debt is expected to stabilize
to about 100 percent of GDP until 2025, benefiting
from negative interest-growth differentials.

I make the point not because I have a crystal ball but because I know I do not. Right now the path to the end of this year looks extremely uncertain with for example France imposing a curfew on Paris and other major cities and Germany hinting at another lockdown. So we have little idea about 2021 let alone 2025.

The IMF is in favour of more spending this time around.

These high levels of public debt are hence not the
most immediate risk. The near-term priority is to
avoid premature withdrawal of fiscal support. Support
should persist, at least into 2021, to sustain the recovery and to limit long-term scarring. Health and education should be given prime consideration everywhere.

I would have more time for its view on wasteful spending and protection of the vulnerable if the places where it has intervened had actually seen much reform and protection.

Fiscally constrained economies should prioritize the
protection of the most vulnerable and eliminate
wasteful spending.

Economic Theory

The IMF view this time around is based on this view of public spending.

The Fiscal Monitor estimates that a 1 percent of
GDP increase in public investment, in advanced
economies and emerging markets, has the potential to push GDP up by 2.7 percent, private investment by
10 percent and, most importantly, to create between
20 and 33 million jobs, directly and indirectly. Investment in health and education and in digital and green
infrastructure can connect people, improve economy wide productivity, and improve resilience to climate
change and future pandemics.

If true we are saved! After all each £ or Euro or $ will become 2.7 of them and them 2.7 times that. But then we spot “has the potential” and it finishes with a sentence that reminds me of the  company for carrying on an undertaking of great advantage from the South Sea Bubble. For those unaware of the story it disappeared without trace but with investors money.

For newer readers this whole area has become a minefield for the IMF because it thought the fiscal multiplier for Greece would be 0.5 and got involved in imposing austerity on Greece. It then was forced into a U-Turn putting the multiplier above 1 as it was forced to do by the economic collapse which was by then visible to all.

Institute for Fiscal Studies

It has provided a British spin on these events although the theme is true pretty much everywhere we look.

The COVID-19 pandemic and the public health measures implemented to contain it will lead to a huge spike in government borrowing this year. We forecast the deficit to climb to £350 billion (17% of GDP) in 2020–21, more than six times the level forecast just seven months ago at the March Budget. Around two-thirds of this increase comes from the large packages of tax cuts and spending increases that the government has introduced in response to the pandemic. But underlying economic weakness will add close to £100 billion to the deficit this year – 1.7 times the total forecast for the deficit as of March.

I suggest you take these numbers as a broad brush as it will be a long economic journey to April exemplified by that fact that whilst I am typing this it has been announced that London will rise a tier in the UK Covid-19 restrictions from this weekend. I note they think that £250 billion of this is an active response and £100 billion is passive or a form of automatic stabiliser.

They follow the IMF line but with a kicker that it is understandably nervous about these days.

But, in the medium term, getting the public finances back on track will require decisive action from policymakers. The Chancellor should champion a general recognition that, once the economy has been restored to health, a fiscal tightening will follow.

They are much less optimistic than the IMF about the middle of this decade/

Under our central scenario, and assuming none of the temporary giveaways in 2020–21 are continued, borrowing in 2024–25 is forecast to be over £150 billion as a result of lower tax revenues and higher spending through the welfare system.

They do suggest future austerity.

Once the economy has recovered, policy action will be needed to prevent debt from continuing to rise as a share of national income. Even if the government were comfortable with stabilising debt at 100% of national income – its highest level since 1960 – it would still need a fiscal tightening worth 2.1% of national income, or £43 billion in today’s terms.

Comment

As you can see the mood music from the establishment and think tanks has changed somewhat since the early days of the credit crunch.Austerity was en vogue then but now we see that if at all it is a few years ahead. Let me now switch to the elephant in the room which has oiled this and it was my subject of yesterday, where the fall in bond yields means governments can borrow very cheaply and sometimes be paid to do it. That subject is hitting the newswires this morning.

The German 10-year bond yield declined to the lowest level in five months on Wednesday as coronavirus’s resurgence across the Eurozone strengthened the haven demand for the government debt. ( FXStreet)

It is -0.61% as I type this and even the thirty-year yield is now -0.22%. So all new German borrowing is better than free as it provides a return for taxpayers rather than investors. According to Aman Portugal is beginning to enjoy more of this as well.

According to the IGCP, which manages public debt, at the Bloomberg agency, €654 million were auctioned in bonds with a maturity of 17 October 2028 (about eight years) at an interest rate of -0.085%.

Although for our purposes we need to look at longer-term borrowing so the thirty-year issue at 0.47% is more relevant. But in the circumstances that is amazingly cheap.

In essence this is what is different this time around and it is one arm of government helping another as the enormous pile of bonds purchased by central banks continue to grow. The Bank of England bought another £4.4 billion this week. So we have a window where this matters much less than before. It does not mean we can borrow whatever we like it does mean that old levels of debt to GDP such as 90% ( remember it?) and 100% and even 120% are different now.

In the end the game changer is economic growth which in itself posts something of a warning as pre pandemic we had issues with it. Rather awkward that coincides with the QE era doesn’t it as we mull the way it gives with one hand but takes away with another?

UK National Grid

It was only last week I warned about this.

National Grid warns of short supply of electricity over next few days ( The Guardian)

Good job it has not got especially cold yet.