Fiscal Policy will now take centre stage as France has shown

One of our themes is now fully in play. We have observed over the past year or two a shift in establishment thinking towards fiscal policy. This had both bad and good elements. The bad was that it reflected a reality where all the extraordinary monetary policies had proved to be much weaker than the the claims of their supporters and even worse for them were running out of road. The current crisis has reminded us of this as we have had, for example, two emergency moves from the US Federal Reserve already, in its role as a de facto world central bank.

A more positive factor in this has been the change we have been observing in bond yields. We can get a handle on this by looking back at the world’s biggest which is the US Treasury Bond market. Back in the autumn of 2018 when worlds like “normalisation” ans phrases like “Quantitative Tightening” were in vogue the benchmark ten year yield saw peaks around 3.15%. Basically it then spent most of a year halving before rallying back to 1.9% at the end of last year and beginning of this. But this move took place in spite of the fact that we have the Trump Tax Boost which was estimated to have an impact of the order of one trillion US Dollars. I mention this because as well as the obvious another theme was in play which was that the Ivory Towers were wrong-footed yet again. The Congressional Budget Office has had to keep reducing its estimate of debt costs as the rises it expected turned into falls. Also whilst I am on this subject I am not sure this from January is going to turn out so well!

In 2020, inflation-adjusted GDP is projected to grow by 2.2 percent, largely because
of continued strength in consumer spending and a rebound in business fixed investment. Output is
projected to be higher than the economy’s maximum sustainable output this year to a greater degree
than it has been in recent years, leading to higher inflation and interest rates after a period in which
both were low, on average.

Best of luck with that.

Meanwhile we have seen a fair bit of volatility in bond yields but the US ten-year is 0.8% as I type this. Even the long bond ( 30 years) is a relatively mere 1.4%.

Thus borrowing is very cheap and only on Sunday night the US Federal Reserve arrived in town and did its best to keep it so.

 over coming months the Committee will increase its holdings of Treasury securities by at least $500 billion and its holdings of agency mortgage-backed securities by at least $200 billion.

Step Forwards France

There was an announcement yesterday evening by President Macron which was announced in gushing terms by Faisal Islam of the BBC.

The €300 billion euro fiscal support package announced by Macron for the French economy, to ensure businesses dont go bust and taxes/ charges suspended, is worth about 12% of its GDP – in UK terms that would mean £265 billion…

This morning the French Finance Minster has given some different numbers.

French measures to help companies and employees weather the coronavirus storm will be worth some €45bn, the country’s finance minister Bruno Le Maire said on Tuesday. ( Financial Times)

He went on to give some details of how it would be spent.

He told RTL radio the package of financial aid, which includes payments to temporarily redundant workers and deferments of tax and social security bills, would help “the economy to restart once the corona virus epidemic is behind us”. Previously he had referred to “tens of billions of euros”.

Now let us look at the previous position for France. We had previously note that France was in the middle of a fiscal nudge anyway as the first half of 2019 saw quarterly deficits of 3.2% and 3.1% of GDP respectively, The third quarter was back within the Maastricht rules as it fell to 2.5% of GDP but we still had a boost overall and as you can see below the national debt to GDP ratio went over 100%

At the end of Q3 2019, Maastricht’s debt reached €2,415.1 billion, up €39.6 billion in comparison to Q2 2019. It accounted for 100.4% of gross domestic product (GDP), 0.9 points higher than last quarter. Net public debt increased more moderately (€+15.0 billion) and accounted for 90.3 % of GDP.

Of course debt to GDP numbers have gone out of fashion partly because the “bond vigilantes” so rarely turn up these days. There was a time that a debt to GDP ratio above 100% would have them flying in but they restricted their flying well before the Corona Virus made such a move fashionable. The French ten-year yield is up this morning but at 0.27% is hardly a deterrent in itself to more fiscal action. However whilst it is still as low as it has ever been before this stage of the crisis a thirty-year yield of 0.8% is up a fair bit on the 0.2% we saw only last week. Another factor in play is this.

Third, we decided to add a temporary envelope of additional net asset purchases of €120 billion until the end of the year, ensuring a strong contribution from the private sector purchase programmes. ( ECB )

Whilst only a proportion of the buying we can expect monthly purchases of French government bonds to rise from the previous 4 billion Euros or so and accordingly the total to push on from 434.4 billion. Also whilst President Lagarde was willing to express a haughty disdain for “bond spreads” I suspect the former French Finance Minister would be charging to the rescue of France if necessary.

One feature of French life is that taxes are relatively high.

The tax-to-GDP ratio varies significantly between Member States, with the highest share of taxes and social
contributions in percentage of GDP in 2018 being recorded in France (48.4%), Belgium (47.2%) and Denmark
(45.9%), followed by Sweden (44.4%), Austria (42.8%), Finland (42.4%) and Italy (42.0%). ( Eurostat )

Short Selling Bans

France along with some other European nations announced short-selling bans this morning which stop investors selling shares they do not own.

#BREAKING French market regulator bans short-selling on 92 stocks: statement ( @afp )

I pointed out that these things have a track record of failure

These sort of things cause a market rally in the short-term but usually wear off in a day or two.

The initial rally to over 4000 on the CAC 40 index soon wore off and we are now unchanged on the day having at one point being 100 points off. Of course some policy work will be writing a paper reminding us of the counterfactual.

Comment

I am expecting a lot more fiscal action in the next few days. The French template is for a move a bit less than 2% of GDP. That will of course rise as GDP falls.

The French government was assuming the economy would shrink about 1 per cent this year, instead of growing more than 1 per cent as previously predicted, Mr Le Maire said. ( Financial Times)

Frankly that looks very optimistic right now. The situation is fast moving as doe example Airbus which only yesterday expected to remain open announced this today.

Following the implementation of new measures in France and Spain to contain the COVID-19 pandemic, Airbus has decided to temporarily pause production and assembly activities at its French and Spanish sites across the Company for the next four days. This will allow sufficient time to implement stringent health and safety conditions in terms of hygiene, cleaning and self-distancing, while improving the efficiency of operations under the new working conditions.

Let me now shift to the other part of the package.

Mr Le Maire said ammunition to prop up the economy also included €300bn of French state guarantees for bank loans to businesses and €1tn of such guarantees from European institutions. ( FT )

The problem is how will this work in practice? The numbers sound grand but for example the Bank of England announced up to £290 billion for SMEs only last week which everyone seems to have forgotten already! One bit that seemed rather devoid of reality to me at the time was this.

The release of the countercyclical capital buffer will support up to £190bn of bank lending to businesses. That is equivalent to 13 times banks’ net lending to businesses in 2019.

Returning to pure fiscal policy I am expecting more of it and would suggest it is aimed at two areas.

  1. Supporting individuals who through not fault of their own have seen incomes plunge and maybe disappear.
  2. Similar for small businesses and indeed larger ones which are considered vital.

Just for clarity that does not mean for banks and the housing market where such monies have a habit of ending up.

Meanwhile a country which badly needs help is still suffering from the “ECB not here to close bond spreads” of Christine Lagarde last week as its ten-year yield has risen to 2.3%. Her open mouth operation has undone a lot of ECB buying.

Welcome to the oil price shock of 2020

Today is one where we are mulling how something which in isolation is good news has led to so much financial market distress overnight and this morning. So much so that for once comparisons with 2008 and the credit crunch have some credibility.

And I felt a rush like a rolling bolt of thunder
Spinning my head around and taking my body under
Oh, what a night ( The Four Seasons)

Just as people were getting ready for markets to be impacted by the lock down of Lombardy and other regions in Italy there was a Mexican stand-off in the oil market. This came on top of what seemed at the time large falls on Friday where depending on which oil benchmark you looked at the fall was either 9% or 10%.Then there was this.

DUBAI, March 8 (Reuters) – Saudi Arabia, the world’s top oil exporter, plans to raise its crude oil production significantly above 10 million barrels per day (bpd) in April, after the collapse of the OPEC supply cut agreement with Russia, two sources told Reuters on Sunday.

State oil giant Aramco will boost its crude output after the current OPEC+ cut deal expires at the end of March, the sources said.

Whilst they are playing a game of who blinks first the oil price has collapsed. From Platts Oil

New York — Crude futures tumbled roughly 30% on the open Sunday evening, following news that Saudi Aramco cut its Official Selling Prices for April delivery. ICE front-month Brent fell $14.25 on the open to $31.02/b, before climbing back to trade around $35.22/b at 2238 GMT. NYMEX front-month crude futures fell $11.28 to $30/b on the open, before rising to trade at around $32.00/b.

The Real Economy

Let us get straight to the positive impact of this because in the madness so many are missing it.

We find that a 10 percent increase in global oil inflation increases, on average, domestic inflation by about 0.4
percentage point on impact, with the effect vanishing after two years and being similar between advanced and developing economies. We also find that the effect is asymmetric, with positive oil price shocks having a larger effect than negative ones. ( IMF 2017 Working Paper )

There is plenty of food for thought in the reduced relative impact of lower oil prices for those who believe they are passed on with less enthusiasm and sometimes not passed on at all. But if the IMF are right we will see a reduction in inflation of around 0.6% should oil prices remain here.

As to the impact on economic growth the literature has got rather confused as this from the Bank of Spain in 2016 shows.

Although our findings point to a negative influence from oil price increases on economic growth, this phenomenon is far from being stable and has gone through different phases over time. Further research is necessary to fathom this complex relationship.

Let me give you an example of how it will work which is via higher real wages. Of course central bankers do not want to tell us that because they are trying to raise inflation and are hoping people will not spot that lower real wages will likely be a consequence. To be fair to the IMF it does manage to give us a good laugh.

The impact of oil price shocks, however,
has declined over time due in large part to a better conduct of monetary policy.

That does give us the next link in the story but before we get there let me give you two major problems right now which have links. The first is that the oil price Mexican stand-off has a silent player which is the US shale oil industry. As I have pointed out before it runs on a cash flow business model which has just seen likely future flows of cash drop by a third.

Now we get to the second impact which is on credit markets. Here is WordOil on this and remember this is from Thursday.

NEW YORK (Bloomberg) –Troubled oil and gas companies may have a hard time persuading their bankers to keep extending credit as the outlook darkens for energy, potentially leading to more bankruptcies in the already-beleaguered sector.

Lenders evaluate the value of oil reserves used as collateral for bank loans twice a year, a process that’s not likely to go well amid weak commodity prices, falling demand, shuttered capital markets and fears of coronavirus dampening global growth. Banks may cut their lending to cash-starved energy companies by 10% to 20% this spring, according to investors and analysts.

That will all have got a lot worse on Friday and accelerated today. I think you can all see the problem for the shale oil producers but the issue is now so large it will pose a risk to some of those who have lent them the money.

US oil/junk bonds: busts to show folly of last reboot ( FT Energy )

I am not sure where the FT is going with this bit though.

There will be no shortage of capital standing ready to recapitalise the energy sector….

Perhaps they have a pair of glasses like the ones worn by Zaphod Beeblebrox in The Hitch Hikers Guide to the Galaxy. Meanwhile back in the real world there was this before the latest falls.

More than one-third of high-yield energy debt is trading at distressed levels. Oil and gas producers with bonds trading with double-digit yields include California Resources Corp., Range Resources Corp., Southwestern Energy Co., Antero Resources Corp., Comstock Resources Inc., Extraction Oil & Gas Inc. and Oasis Petroleum Inc. ( World Oil)

Central Banks

As the oil price news arrived central bankers will have been getting text messages to come into work early. Let me explain why. Firstly we know that some credit markets were already stressed and that the US Federal Reserve had been fiddling while Rome burns as people sang along with Aloe Blacc.

I need a dollar, dollar a dollar is what I need
hey hey
Well I need a dollar, dollar a dollar is what I need
hey hey
And I said I need dollar dollar, a dollar is what I need.

Whoever decided to taper the fortnightly Repo operations to US $20 billion had enough issues when US $70 billion was requested on Thursday, now I guess he or she is not answering the phone. Anyway the role of a central bank in a crisis like this is to be lender of last resort and splash the cash. At the same time it should be doing emergency investigations to discover the true state of affairs in terms of solvency.

This is because some funds and maybe even banks must have been hit hard by this and may go under. Anyone long oil has obvious problems and if that is combined with oil lending it must look dreadful. If anyone has geared positions we could be facing another Long-Term Capital Management. Meanwhile in unrelated news has anyone mentioned the derivatives book of Deutsche Bank lately?

The spectre of more interest-rate cuts hangs over us like a sword of damocles. I type that because I think they will make things worse rather than better and central banks would be better employed with the liquidity issues above. They are much less glamorous but are certainly more effective in this type of crisis. Frankly I think further interest-rate cuts will only make things worse.

Comment

I have covered a lot of ground today but let me move onto home turf. We can also look at things via bond yields and it feels like ages ago that I marked your cards when it was only last Thursday! Anyway we have been on this case for years.

Treasury 10-Year Note Yield Slides Below 0.5% for First Time ( @DiMartinoBooth)

Yes it was only early last week that we noted a record low as it went below 1%. Meanwhile that was last night and this is now.

Overnight the US 10-year traded 0.33%, under 0.44% now. The longbond traded down to 0.70% overnight. The bond futures were up over 12 points. Now trading 0.85%. Note how “gappy” this chart is. Liquidity is an issue. ( @biancoresearch )

This really matters and not in the way you may be thinking. The obvious move is that if you are long bonds you have again done really well and congratulations. Also there is basically no yield these days as for example, my home country the UK has seen a negative Gilt yield this morning around the two-year maturity.

But the real hammer on the nail will not be in price ( interest-rates) it will be in quantity as some places will be unable to lend today. Some of it will be predictable ( oil) but in these situations there is usually something as well from left field. So let me end this part Hill Street Blues style.

Let’s be careful out there

Podcast

I have not mentioned stock markets today but I was on the case of bank shares in my weekly podcast. Because at these yields and interest-rates they lack a business model.

 

 

 

What will happen to house prices now?

I thought that I would end this week with a topic that we can look at from many angles. For example the first question asked by the bodies that have dominated this week, central banks, is what will this do to house prices? Well in ordinary times this weeks actions would have quite an impact and I am including in this expectations of future action by the Bank of England and European Central Bank (ECB). For newer readers this is because bond yields and their consequent impact on mortgage rates move these days ahead of policy action and sometimes well ahead. Of course, maybe one day central banks will fail to ease but such beliefs rely on ignoring the history of the credit crunch so far where such events were described rather aptly by Muse with supermassive black hole and monetary tightening was described by Oasis with Definitely Maybe,or perhaps better still by Rod Stewart with I Was Only Joking.

Bond Yields

The world has moved on even since I looked at this yesterday. Perhaps even faster than I suggested it might! Well played to any reader either long bonds or long a bond fund as you have had an excellent 2020. Sadly those on the other side of the balance sheet looking for an annuity are in the reverse situation. Not many places will put it like this but the US Federal Reserve has completely lost control of events this week and has learnt nothing from the mistakes of the Bank of Japan and ECB.

What I mean by this is that the US ten-year yield is now 0.78%. It was only this week that they went below 1% for the first time ever and last week we were looking at it hitting new lows like 1.3%. It started the year at 1.9%. This has been added to by the US Long Bond which has soared overnight reducing the thirty-year yield to 1.36% or 0.21% lower. What this means is that the already much lower US mortgage rates are going much lower still and I would quote some but I am afraid they simply cannot keep up with the bond market surge. Although I do note that Mortgage Daily News is wondering if things will be juiced even more?!

One of them suggested mortgage rates have more room to move lower if the Fed decides to start reinvesting its first $20bln a month of MBS proceeds again (which it currently allows to “roll off” the balance sheet). ( MBS = Mortgage Backed Securities )

As I am typing this events are getting even more extraordinary so let me hand you over to Bloomberg.

U.S. 10-year Treasury yield drops below 0.7%

I have experienced these sort of moves with bond markets falling but cannot recall them ever rallying like this so it is a once in a lifetime move.

You may ask yourself
What is that beautiful house?
You may ask yourself
Where does that highway go to?
And you may ask yourself
Am I right? Am I wrong?
And you may say yourself
“My God! What have I done?” ( Talking Heads )

So I now expect another sharp move lower in US mortgage rates and I expect this to be followed by much of the world. For example in my home country the UK mortgages are mostly fixed-rate these days ( in fact over 90%) so the five-year Gilt yield gives us a marker on what is likely to happen next. It has fallen to 0.14% this morning and so UK mortgages will be seeing more of this from Mortgage Strategy.

Vida Homeloans has announced a series of rate cuts to its residential and buy-to-let mortgage ranges……

Still in the residential range, Vida’s 75 per cent LTV five-year fix has gone down from 5.39 per cent to 4.99 per cent, and its 65 per cent LTV five-year fix from 5.49 per cent to 5.04 per cent.

In the BTL range, the 75 per cent LTV five-year fix has been cut from 4.64 per cent to 4.04 per cent.

I have picked them out because they are specialist lenders for non standard credit. You know the sort of thing we were promised would never happen again. Also we read about turning Japanese but we seem to be turning Italian as payment holidays appear.

Lenders are “ready and able” to offer help to borrowers affected by the Coronavirus outbreak, UK Finance has pledged.

The trade body says this may come in the form of repayment relief to customers whose earnings have been hit or costs increased as a result of contracting the virus or  because of the measures imposed to stop it spreading.

It comes after a number of lenders including TSB, Natwest and Saffron Building Society offered payment holidays to borrowers who had been severely affected by recent flooding.

So we can see that this particular tap is as wide open as it has ever been and as we look around the world we can expect similar moves in many places. In terms of exceptions there is one maybe because Germany is returning to previous bond yield lows ( -0.74% for the benchmark ten-year) and via its policy of yield curve control the Bank of Japan is stopping much of this happening. The latter is another in quite a long list of events from the lost decade era in Japan and I am pointing it out for three reasons.The first is that it is raising rather than reducing bond yields as intended. The second is that therefore we will not see a housing market boost. The third is that I am alone in pointing such things out as the “think tanks” continue to laud yield curve control. After all copying Japan has worked so well hasn’t it?

Mortgage Lending

We can also expect a boost from here. There are plenty of rumours of credit easing especially from the ECB as frankly it has few other options. I would expect much trumpeting of this going to smaller businesses but by some unexplained and unexpected event ( except by some financial terrorist writers) it will go straight into the mortgage market. My home country had an example of this with the Funding for Lending Scheme where the counterfactual needed to be applied to business lending bit was not required for mortgage lending. Japan also had a scheme for smaller businesses where large companies immediately set up subsidiaries and claimed.

Comment

So far I have given these for those expecting a house price rally.

Reasons to be cheerful, part three
1, 2, 3 ( Ian Dury)

For newer readers this is not something I welcome as it is inflation for first-time buyers.

Now let me look at the other side of the coin and there are two main factors. The first is what John Maynard Keynes called “animal spirits” or the film Return to the Forbidden Planet called “monsters of the id”. With worries about jobs and quarantine will people be willing to buy? That may lead to a lagged effect as people refinance now and buy at a later date.

The next is mortgage supply. Whilst the official taps are opening and they are building new pipes as I type there will be some banks and financial institutions that will be under pressure here and thus will not be able to lend. Some we can figure out but other are unpredictable and let me give you a symbol of a big stress factor right now, Yesterday’s 14 day Repo saw around US $70 billion of demand and only US $20 billion was supplied. So dollars are in short supply somewhere and frankly the US Federal Reserve policy of reducing Repo sizes looks pretty stupid.

 

 

 

Is this the beginning of the end for yield?

This week has seen some extraordinary events and it is time to take stock. The truth is that something I have both feared and expected is on motion again. It has come with a familiar refrain that it cant happen here until it does! On this road to nowhere the Corona Virus pandemic is in fact just another brick in the wall. It concerns us now and let me express my sympathy for those affected and afflicted but the world economic system was so rigid after all the central banking intervention that something was always going to turn up.

The point is that each so-called Black Swan event has the same consequence and let me give you the main events this week so far.

 the Federal Open Market Committee decided today to lower the target range for the federal funds rate by 1/2 percentage point, to 1 to 1‑1/4 percent.

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 0.50 per cent. The Board took this decision to support the economy as it responds to the global coronavirus outbreak. ( Reserve Bank of Australia)

This was followed yesterday afternoon by this.

The Bank of Canada today lowered its target for the overnight rate by 50 basis points to 1 ¼ percent. The Bank Rate is correspondingly 1 ½ percent and the deposit rate is 1 percent.

Also there have been the central banks of Malaysia and Moldova. But that is not it as we now expect cuts from the Bank of England and ECB amongst others. Actually before the next Bank of England meeting the US Federal Reserve will probably have cut again as once you are a slave to equity markets that is what you are.

But this is merely a staging post in today’s story because when this party started central banks learnt that their Ivory Tower assumptions were wrong. They assumed that other interest-rates such as mortgage-rates and bond yields would slavishly follow, but they had minds of their own. So we got QE bond buying and then credit easing to deal with that.

Then as the credit crunch developed we saw bond yields fall substantially after various wrong turns. For example the Euro area crisis saw bond yields in double-digits before we entered the “whatever it take” era begun by Mario Draghi.

What about now?

Let me now jump forwards in time Dr. Who style and bring this up to date.

Ten-year US Treasury yields—the benchmark for global financing—got a shove below 1% after the Federal Reserve made an emergency cut to its target rate yesterday. It’s the lowest rate ever, according to records going back to 1871. ( @Ray_O_Johnson  )

It was only a week ago it seemed remarkable it had gone through 1.3% and it opened the year at more like 1.9%. So we learnt that as we expected the US was not as different as so many “experts” have tried to claim as when the going got tough its central bank unveiled the playbook which has been so unsuccessful elsewhere.

Canada is in a similar position with a ten-year yield of 1.02% although there are two subplots. It has been here before in the credit crunch era and it has seen some wild swings since its official interest-rate move with the yield going as low as 0.88%. Australia is at 0.77% some one and half percent lower than a year ago.

The economic consequences

Let me illustrate for the United States via CNBC.

The average contract interest rate for 30-year fixed-rate mortgages fell to 3.57% from 3.73% last week. That drop caused a 26% surge in weekly refinance applications, the Mortgage Bankers Association said. Compared with one year ago, refinance volume was nearly 224% higher.

And the beat goes on.

Detroit-based Quicken Loans saw record-setting volume on Monday and Tuesday, as rates fell to a record low. CEO Jay Farner said the new ways of processing loans are making it easier to handle even tremendous volume spikes.

Even the numbers above are behind events as Mortgage News Daily is reporting that the 30-year fixed rate mortgage is now at 3.16% and the 15-year at 2.88%. Actually the trend is clear but it matters who you call.

Some are offering conventional 30yr fixed rates that are as high as 3.5%–even for top tier qualifications.  On the other side of the spectrum, more than a few lenders are quoting 2.875% for the same scenarios.  The average lender is somewhere in between, but that average is nonetheless an all-time low.

So here we have an immediate consequence which central bankers seem to forget in their press releases. This is that the housing market will receive yet another heroin injection. This will be true in Canada and Australia as well and in Australia’s case will add to last year’s 3 interest-rate cuts.

Economics 101 argues that lower costs for business borrowing increase investment. However when the US Federal Reserve looked at the numbers it was much less clear.  I doubt it will stop people claiming that though.

Fiscal Policy

This has just got a lot cheaper pretty much everywhere. This does not get a lot of attention because it is a slow burner as for example the UK issues a new Gilt this week which will be at a yield at least 4% lower than before, But it will be a while before the next one and so on. On the other side of the coin yields have been falling throughout the credit crunch era as a trend so governments have been able to spend more for the same situation. This is another reason why this does not get much attention as governments of whatever hue want to take the credit for this.

On this road you can see why governments are so keen on “independent” central banks in a you scratch my back and I will scratch yours sort of way.

Comment

There are various lessons to be had here. The most basic is that interest-rates and yields continue to sing along with Alicia Keys.

I keep on fallin’
In and out of love
With you
Sometimes I love ya
Sometimes you make me blue
Sometimes I feel good
At times I feel used
Lovin’ you darlin’
Makes me so confused.

We get occassional rises but the trend is down which means that there has been a change because QE only started because official interest-rates got disconnected to bond yields and mortgage rates. Now we see the link is back. But I think that is just an illusion because some QE is still happening in Japan and the Euro area and more is expected elsewhere. Remember responses to QE now take place before it happens. Other interest-rates sometimes go their own not very merry way as the rise to 40% for unsecured overdrafts in the UK shows

This is really bad news for supporters of the UK Office for Budget Responsibility and the US Congressional Budget Office as their numbers will need large revisions yet again! The mainstream media and “experts” will of course have a case of collective amnesia about this next week for the UK Budget. But the point is seemingly too subtle for them that in the dynamic world in which we now exist such steady-state analysis is in fact misleading.

I think that this is counterproductive for three main reasons.

  1. If pumping up the housing market worked we would have been saved long ago.
  2. The evidence from countries with negative interest-rates and yields is that contrary to economic theory people look to save more which depresses the economy.
  3. Similarly if we look at Germany,Sweden and Switzerland countries with negative yields often look to reduce their debt rather than spend more.

Thus we find that the magic bullet has no magic at all and instead causes pain.

The Investing Channel

 

 

 

Was that the bond market tantrum of 2019?

Sometimes economics and financial markets provoke a wry smile. This morning has already provided an example of that as Germany’s statistics office tells us Germany exported 4.6% more in September than a year ago, so booming. Yes the same statistics office that told us yesterday that production was down by 4.3% in September so busting if there is such a word. The last couple of months have given us another example of this do let me start by looking at one side of what has taken place.

QE expansion

We have seen two of the world’s major central banks take steps to expand their QE bond buying one explicitly and the other more implicitly. We looked at the European Central Bank or ECB only on Wednesday.

The Governing Council decided to restart net purchases under each constituent programme of the asset purchase programme (APP)……….. at a monthly pace of €20 billion as from 1 November 2019.

More implicitly have been the actions of the US Federal Reserve as it continues to struggle with the Repo crisis.

Based on these considerations, last Friday the FOMC announced that the Fed will be purchasing U.S. Treasury bills at least into the second quarter of next year.7 Specifically, the Desk announced an initial monthly pace of purchases of $60 billion.

That was John Williams of the New York Fed who added this interesting bit.

These permanent purchases

Also there is this.

In concert with these purchases, the FOMC announced that the Desk will continue temporary overnight and term open market operations at least through January of next year.

Maybe a hint that they think dome of this is year end US Dollar demand. But we find that the daily operations continue and at US $80.14 billion as of yesterday they continue on a grand scale. So the Treasury Bill purchases and fortnightly Repo’s have achieved what exactly?

If we move from the official denials that this is QE to looking at the balance sheet we see that it is back above 4 trillions dollars and rising. In fact it was US $4.02 trillion at the end of last month or around US $250 billion higher in this phase.

Bond Markets

You might think and indeed economics 101 would predict that bond markets would be surging and yields falling right now. But we have learnt that things are much more complex than that. Let me illustrate with the US ten-year Treasury Note. You might expect some sort of boost from the expansion of the balance sheet and the purchases of Treasury Bills. But no, the futures contact which nearly made 132 early last month is at 128 and a half now. At one point yesterday the yield looked like it might make 2% as there was quite a rout but some calm returned and it is 1.91% as I type this.

As an aside this is another reminder of the relative impotence of interest-rate cuts these days as if anything a trigger for yields rising was the US interest-rate cut last week. The Ivory Towers will be lost in the clouds yest again.

The situation is even more pronounced in the Euro area where actual purchases have been ongoing for a week now. However in line with our buy the rumour and sell the fact theme we see that the German bond market has fallen a fair bit. In mid-August the benchmark ten-year yield went below -0.7% whereas now it is -0.26%. So Germany is still being paid to borrow at that maturity but considerably less. Indeed at the thirty-year maturity they do have to pay something albeit not very much ( 0.24%).

The UK

There have been a couple of consequences in the UK. The first I spotted in yesterday’s output from the Bank of England.

Mortgage rates and personal loan rates remain near
historical lows, with the rates on some fixed-rate mortgages continuing to fall over the past few months (Table 2.B).
Interest rates on credit cards have increased, although the effective rate paid by the average borrower has remained
stable, in part because of the past lengthening of interest-free periods.

Whilst this is true, if you are going to parade the knowledge of the absent-minded professor Ben Broadbent about foreign exchange options then you should be aware that as Todd Terry put it.

Something’s goin’ on

The five-year Gilt yield has risen from a nadir of 0.22% to 0.52% so the ultra-low period of mortgage rates is on its way out should we stay here.

If we move to the fiscal policy space in the UK then we see that the message that we can borrow cheaply has arrived in the general election campaign.

Although debt stocks are high in many developed countries, debt service ratios are very low. The UK gross debt stock has doubled from 42 per cent of GDP in 1985 to 84 per cent of GDP today, yet debt interest service has halved, from 4 per cent of GDP to below 2 per cent over the same period. It has rarely been lower. A rule using the debt stock would argue for fiscal consolidation, whereas a debt service metric suggests there is ample room for fiscal expansion. Especially as market interest rates are extraordinarily low. (  FT Alphaville)

https://ftalphaville.ft.com/2019/11/06/1573068343000/Is-it-time-for-a-shift-in-fiscal-rules–/

I have avoided the political promises which peak I think with the Greens suggestion of an extra £100 billion a year. But the Toby Nangle and Neville Hill proposal above has strengths and has similarities to what I have suggested here for some time. But I think it needs to come with some way of locking the debt costs in, so if you borrow more because it is cheap you borrow for fifty years and not five. It reinforces my suggestion of the 27th of June that the UK should issue some 100 year Gilts.

Comment

There is a fair bit to consider here and let me start with the borrow whilst it is still cheap theme. There are issues as highlighted by this from Francine Lacqua of Bloomberg.

London’s Elizabeth line has been delayed by a year, and will require extra funding, according to TfL

For those unaware this was called Crossrail ( renaming is often a warning sign) which will be a welcome addition to the London transport infrastructure combing elements of The Tube with the railways. But it gets ever later and more expensive.

There was also some irony as regards the Bank of England as in response to the sole decent question at its presser yesterday (from Joumanna Bercetche of CNBC) Governor Carney effectively suggested the next rate move would be down not up. Yet Gilt yields rose.

Next comes the issue of whether this is a sea-change or just part of the normal ebb and flow of financial markets? We will find out more this afternoon as we wait to see if there were more than just singed fingers in the German bond market for example or whether some were stopped out? After all reporting you had taken negative yield and a capital loss poses more than a few questions about your competence. Even the most credulous will now know it is not a one-way bet but on the other hand if you are expecting QE4 to come down the New York slipway then you can place your bets at much better levels than before.

Do not forget Greece is still in an economic depression

Today I intend to look at something which I and I know from your replies many of you have long feared. This is that the merest flicker of better news from Greece will be used as a way of obscuring the fact that it is still in an economic crisis. At least I think that is what we should be calling an economic depression. So let me take you straight to the Financial Times.

Today, on the face of things, the emergency is over and the outlook is bright. The authorities have lifted capital controls, imposed four years ago. Greece’s 10-year bond yield touched an all-time low in July. Consumer confidence is at its highest level since 2000. Elections in July produced a comfortable parliamentary majority for New Democracy, a conservative party committed under prime minister Kyriakos Mitsotakis to a well-designed programme of economic reform, fiscal responsibility and administrative modernisation.

Firstly let me give the FT some credit for lowering its paywall for a bit. However the latter sentence is playing politics which is an area they have got into trouble with this year on the subject of Greece but I will leave that there as I keep out of politics.

As to the economics you may note that the first 2 points cover financial markets rather than the real economy and even the first point is a sentiment measure rather than a real development. If we work our way through them it is of course welcome that capital controls have now ended although it is also true that it is troubling that they lasted for more than four years.

Switching to Greek bonds we see that they did indeed join the worldwide bond party. I am not quite sure though about the all-time July low as you see it is 1.31% as I type this compared to being around 1% higher than that in July! Perhaps he has not checked since it dipped below 2% at the end of July which is hardly reassuring. As to why this has happened other than the worldwide trend there are 2 other factors. Firstly there is the way that the European Stability Mechanism has changed the debt envelope as the quote from Karl Regling below shows.

 In total, Greece received almost €290 billion in financial support, of which €205 billion came from the EFSF and the ESM.

So the Greek bond yield is approaching what the ESM charges. Another factor is they way that it has confirmed my “To Infinity! And Beyond!” theme as the average maturity was kicked like a can to 42.5 years. Next is a factor that I looked at on the 9th of July and Klaus also notes.

The general government primary balance in programme terms last year registered a surplus of 4.3% of GDP, strongly over-performing the fiscal target of 3.5% of GDP.

This is awkward for the political theme of the article as it was achieved by the previous government. Also let me be clear that whilst this is good for bond markets there is a big issue for the actual economy as 4.3% of demand was sucked out of it which is a lot is any circumstance but more so when you are still in an economic depression.

So it is a complex issue which to my mind has seen Greek bond yields move towards what the ESM is charging which is ~1%. Maybe the ECB will add it to its QE programme as well as whilst it does not qualify in terms of investment rating it could offer a waiver.

Greek Consumer Confidence

I have to confess referring to a confidence signal does set off a warning klaxon. But let us add in this from the Greek statistics office.

The overall volume index in retail trade (i.e. turnover in retail trade at constant prices) in June 2019, increased by
2.3%, compared with the corresponding index of June 2018……..The seasonally adjusted overall volume index in June 2019, compared with the corresponding index of May 2019, increased by 2.5%.

So there has been some growth. However there is a but and it is a BUT. You might like to sit down before you read the next bit. The volume index in June was 103.5 which compares to 177.7 in March 2008 and yes you did read that right. I regularly point out that monthly retail sales numbers are erratic so let me also point out that late 2007 and early 2008 had a sequence of numbers in the 170s. Even worse this century started with a reading of 115.4 in January 2000.

So we have seen a little growth but not much since the index was set at 100 in 2015 and you can either have a depression lasting this century or quite a severe depression since 2008 take your pick. Against that some optimism now is welcome but does not really cut it in my opinion.

Economic growth

There is a reference to it.

Even before these clouds appeared on the horizon, however, Greece was not rebounding from the debt crisis with the vigour of other stricken eurozone economies such as Ireland, Portugal and Spain.

That is one way of putting a level of GDP that has fallen 18% this decade. In 2010 prices it opened this decade with a quarterly performance of just over 59 billion Euros whereas in the second quarter of this year it was 48.3 billion. I am nit sure that “clouds on the horizon” really cover an annual growth rate struggling to each 2% after such a drop. Greece should be rebounding but of course as I have already pointed out the dent means that 4.3% of economic activity was sucked out of it last year. So no wonder it is an L-shaped and not a V-shaped recovery. At the current pace Greece may not get back to its previous peak in the next decade either.

Comment

There are some references to ongoing problems in Greece as for example the banks.

A second factor is the fragility of Greece’s banks. By the middle of this year, they were burdened with about €85bn in non-performing loans. To some extent, however, liquidity conditions are now improving.

Not mentioned is the fact that according to the Bank of Greece more than another 40 billion Euros needs writing off. From January 19th.

An absolutely indicative example can assess the immediate impact of a transfer of about €40 billion of NPLs, namely all denounced loans and €7.4 billion of DTCs ( Deferred Tax Credits).

That brings us to another problem which is that the debt was supposed to fall from 2012 onwards whereas even now there are plans for it to grow. So whilst the annual cost has been cut to low levels the burden just gets larger.

Also there has been a heavy human cost in terms of suicides, hospitals not being able to afford drugs and the like. It has been a grim run to say the least. The ordinary Greek did not deserve anything like that as they were guilty of very little. The Greek political class and banks were by contrast guilty of rather a lot. The cost is an ongoing depression which looks like it will continue for quite some time yet. After all I welcome the lower unemployment rate of 17% but also recall that such a rate was considered quite a disaster on the way up.

Is this the real life? Is this just fantasy?
Caught in a landslide, no escape from reality
Open your eyes, look up to the skies and see ( Queen)

 

Will the 2020’s be a decade of currency devaluations?

Sometimes financial markets set the agenda for the week and as this week began they did so as the Renminbi ( Yuan) of China passed what some might call lucky number 7. The New York Times has put it like this.

The renminbi traded in mainland China on Monday morning at roughly 7.02 to the dollar, compared with about 6.88 late on Friday. A higher number represents a weaker currency. The last time China’s currency was weaker than 7 to the dollar was in 2008, as the financial crisis mounted.

In itself a 0.01 move through 7 is no more significant than any other. But that would be in a free float which is not what we have here. Also there has been a move of the order of 2% in total which is significant for an exchange rate which is both closely watched and would be more accurately described as a sort of managed free float. Anyway you do not have to take my word for it as in a happy coincidence the People’s Bank of China has been explaining its position.

China implements a managed floating exchange rate system based on market supply and demand with reference to a basket of currencies. Market supply and demand play a decisive role in the formation of exchange rate. The fluctuation of RMB exchange rate is determined by this mechanism . This is the proper meaning of the floating exchange rate system. From the perspective of the global market, as the exchange rate between currencies, exchange rate fluctuations are also the norm.

There are more holes than in a Swiss Cheese there as we observe an official denial that China has done this deliberately.

Affected by unilateralism and trade protectionism measures and the imposition of tariff increases on China, the RMB has depreciated against the US dollar today, breaking through 7 yuan, but the renminbi continues to be stable and strong against a basket of currencies. This is the market. Supply and demand and the reflection of fluctuations in the international currency market.

The PBOC clearly does not follow UK politics as otherwise it would know “strong and stable” means anything but these days! For example  the Reminbi has fallen by 1.8% versus the Japanese Yen if we stay in the Pacific and by 1.7% versus the Euro if we look wider.

Time for a poetic influence

I regularly report on the rhetoric of central bankers but I am not sure I have seen anything like this before.

It should be noted that the RMB exchange rate is “ breaking 7” . This “7” is not the age. It will not come back in the past, nor is it a dam. Once it is broken, it will bleed for thousands of miles. “7” is more like the water level of the reservoir, and the water is abundant. The period is higher, and it will fall down when it comes to the dry season. It is normal to rise and fall.

Perhaps the online translator does not help much here but there is a lot more going on than for example the English translation of the Japanese government always being “bold action” for the Yen.

Up is the new down

If your currency is falling then the obvious “Newspeak” response is to suggest it is rising.

In the past 20 years, the nominal effective exchange rate and the real effective exchange rate of the RMB calculated by the Bank for International Settlements have appreciated by about 30% , and the exchange rate of the RMB against the US dollar has appreciated by 20% . It is the strongest currency among the major international currencies. Since the beginning of this year, the renminbi has remained in a stable position in the international monetary system. The renminbi has strengthened against a basket of currencies, and the CFETS renminbi exchange rate index has appreciated by 0.3%

However if you are telling people this is due to the market it might be best to avoid phrases like “control toolbox,”

In the process of dealing with exchange rate fluctuations in recent years, the People’s Bank of China has accumulated rich experience and policy tools, and will continue to innovate and enrich the control toolbox.

So let me finish this section by pointing out that the PBOC has “allowed” the Reminbi to go through 7 this morning in response to something we noted on Friday.

Trade talks are continuing, and…..during the talks the U.S. will start, on September 1st, putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China into our Country. This does not include the 250 Billion Dollars already Tariffed at 25%…

As the Frenchman puts it in the Matrix series of films.

action and reaction, cause and effect.

Bond Markets

One immediate impact of this has been that bond markets have surged again and we are reminded of my topic on Friday. The totem pole for this has been the bond or bund market of Germany where we see two clear developments. Another record high as the ten-year yield falls to -0.52% and as I type this the whole curve has a negative yield. Over whatever time span you choose Germany is being paid to borrow.

Japan

I do not envy the person who had the job of explaining market developments to Governor Kuroda at the Bank of Japan daily meeting. Firstly the Yen has surged into the 105s versus the US Dollar which is exactly the reverse of the Abenomics strategy of Japan. Then there was the 366 point fall in the Nikkei 225 index which is not so welcome when you own 5% of the shares on the Tokyo Stock Exchange. At least the trading desk will have been spared the job as they will have been busy buying the 70.5 billion Yen’s worth of equities that are typically bought on down days like this. This is neatly rounded off by the Japanese Government Bond market not rallying anything like as much as elsewhere due to the “yield curve control” policy backfiring and providing a clean sweep.

Oh and the day of woe was rounded off by the South Korean’s buying much fewer Japanese cars.

Switzerland

Regular readers will recall the period that I labelled the Yen and the Swiss Franc the “currency twins”. Well they are back just like Arnie and in fact with a 2.2% rally against the Renminbi it is the Swiss Franc which is the powerhouse today. It has rallied against pretty much everything as we remind ourselves of the last policy statement of the Swiss National Bank.

The situation on the foreign exchange market continues to be fragile. The negative interest rate and the SNB’s willingness to intervene in the foreign exchange market as necessary remain essential in order to keep the
attractiveness of Swiss franc investments low and thus ease pressure on the currency.

Well they were right about “fragile”. Do not be surprised if we see the SNB intervening again which will be further bullish for overseas bond and equity markets as that is where they invest much of the money.

Mind you equity markets are falling now meaning this from last week is already out of date.

SNB‘s pile of U.S. shares hits a record $93 billion on buoyant markets ( Bloomberg)

The Ashes

As I hope that England’s sadly rickety batting order can resist the pressure from a land down under today I have been mulling something else. Both countries have weak currencies at the moment and are perhaps singing along with Level 42.

The Chinese way
Who knows what they know
The Chinese legend grows

I could never lie
For honour I would lie
Following the Chinese way

 

Comment

Just like in the 1920’s will the 2020’s open with some competitive devaluations?

President Trump seems to quite like the idea if his tweets are any guide. In the Euro area we see a central bank that seems set to follow policies which in theoretical terms at least should weaken the Euro although the ECB is swimming against the trade surplus. I have covered the Swiss and the Japanese. So let me leave you with two final thoughts.

In the confused melee has the UK stolen something of a march?

Is there a major economy who wants a stronger currency?

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