Argentina looks trapped in a now familiar downwards spiral

Just over a year ago on the 3rd of May 2018 I gave some advice on here to Argentina about its ongoing economic and currency crisis.

The problem is twofold. Firstly you can end up chasing your own tail like a dog. What I mean by this is that markets can expect more interest-rate rises each time the currency falls and usually that is exactly what it does next. Why is this? Well if anticipating a 27,25%% return on your money is not doing the job is 30.25% going to do it? Unlikely in my view as we note that the currency has fallen 5% this week.

Events accelerated later that day as the Argentine central bank the BCRA did this.

This article came to late for the BCRA it would appear as just before 5 pm UK time they raised interest-rates to 33.25%. I would place a link bit nobody seems to have told the English version of their website yet.

That backed up my point and that theme just carried on as this from Reuters on April Fools Day highlights.

Argentina has established an interest rate floor of 62.5 percent, the central bank said in a statement on Monday, as the country looks to rein in stubborn inflation and ease concerns about a run on the local peso currency.

As of yesterday the interest-rate was 71.44% which must feel somewhat bizarre to ordinary Argentine’s in a world of low and indeed negative interest-rates. Another sign of trouble is the gap to deposit rates which were 51.94% yesterday.

The Argentine Peso

Let me hand you over to the Buenos Aires Times.

Argentina’s peso, the worst-performing emerging-market currency this year, could see more volatility as investors learn how to connect the latest pieces of the country’s complex political puzzle……..So far this year, the peso has slumped by about 16 percent against the US dollar and equity assets have been shaky.

As you can see the situation has continued to deteriorate. In fact there has been something of a double-whammy as interest-rates have soared above 70% and the Peso has gone from 21.52 versus the US Dollar when I wrote my post to 45.2 as I type this. Indeed things are so bad that even Bitcoin supporters are trolling the situation.

If an Argentinian had bought Bitcoin at the highest point of the “biggest bubble in history”, in 2017, he would have been better off than leaving his money in his Argentinian bank account. So tell me again how Bitcoin is a horrible store of value. ( @josusanmartin )

Of course you can look at that the other way which is that he has gone to the outer limits of cherry-picking by choosing the Argentine Peso.

Inflation, Inflation,Inflation

The currency fall was always going to led to inflation and the situation is such that as the Buenos Aires Times reports the government has resorted to direct controls.

The government agreed with leading supermarkets that the price of 60 essential products of the food basket will be frozen for at least six months.

The list includes 16 manufacturing companies of rice, sugar, milk, yoghurt, flour, tea and coffee, among others, whose products will be available at 2,500 outlets as from April 22.

At the same time, the Macri administration agreed with slaughterhouses to offer beef cuts at 149 pesos per kilo (120,000 kilos weekly), which will be available at the Central Market and at other retail outlets.

I am pleased that they are focusing on such an important area that is regarded by central bankers as non-core.  I fear however that this is a sign that some people are in real trouble.

However the statement below is something of a hostage to fortune.

“We are entering into a new phase. Currency instability is now something of the past, which guarantees a lower inflation rate,” Economy Minister Nicolás Dujovne said at a press conference

Moving to the present situation there is this.

The government plan was announced in the same week as March’s inflation data of 4.7 percent was revealed, sending alarm-bells ringing among Macri administration officials. Prices have now increased 11.8 percent increase in the first quarter of the year and 54.7 percent in the last 12 months.

As you can see we now have a triple-play of economic woe with high interest-rates, a devalued currency and high inflation

Fourmidable

Let us advance on the economic situation with trepidation and an apology to Manchester City for appropriating their current punchline. A chill is in the air from this.

Consumption in supermarkets also dropped 8.7 percent in March compared to the same period last year, accumulating a 7.3 percent decline so far this year, according to a report by the consultancy Scentia. ( Buenos Aires Times)

The OECD has updated its economic forecasts this morning and in spite of its efforts to cheer lead for the present IMF programme it has downgraded economic growth from the -1.5% of March to -1.8% now. This is something we have become familiar with in IMF programmes as we note that last summer the government was forecasting 1.5% growth for this year. This comes on top of the 2.5% contraction in 2018. So recession and depression.

Consequently the OECD finds itself reporting that the unemployment rate has risen by 2% since 2017 to 9.1%.

100 Year Bond

Here is Bloomberg from yesterday.

Argentine bond spreads against US Treasuries rose 19 basis points to 962, double the average for Latin America……..The country’s five-year credit default swaps also rose 1.3 percent to 1,274 basis points.

There was a bit of a rally today but in general the bonds of Argentina trade about 9.3% over their US equivalents. However bonds in Peso’s yield more highly with the 9-year being at 23%.

The 100 year bond is trading at 68.5, but I suppose you have 98 or so years left to get back to 100.

Comment

Those who have followed the recent history of the International Monetary Fund will find the statement below awfully familiar.

The authorities’ policies that underly the Fund-supported arrangement are bearing fruit. The high fiscal and current account deficits – two major vulnerabilities that led to the financial crisis last year – are falling. Economic activity contracted in 2018 but there are signs that the recession has bottomed out, and a gradual recovery is expected to take hold in the coming quarters. ( Managing Director Christine Lagarde)

There are similarities with her “shock and awe” description for Greece as I note the OECD 2.1% economic growth forecast for next year is the same number as was forecast for it at this stage. I also note that the “exports fairy” is expected to make an appearance although so far the trade adjustment in the first quarter of 2019 has involved them falling slightly and imports falling by around 27%. Again familiar and as Japan showed us yesterday the import plunge will flatter the next set of GDP numbers. There is a different situation in that the currency has devalued although Argentina rather than defaulting on some of its debt is finding the foreign currency part of it ever more expensive whilst it is in the teeth of a fiscal contraction.

Even the Financial Times is questioning the IMF and Christine Lagarde.

When the IMF completed its third review of Argentina’s economy in early April, managing director Christine Lagarde boasted that the government policies linked to the country’s record $56bn bailout from the fund were “bearing fruit”.

The IMF has strongly supported the present government.

Even former senior fund officials are concerned by the organisation’s exposure to Argentina, and the potential fallout should its biggest ever programme implode.

Of course we do not know who will win the election in October but we face a situation of economic crisis which follows other crises in Argentina. Also most of us unlike the FT live in a world where Lagarde lost her credibility years ago.

In truth this was always going to be a really difficult gig along the lines of when Neil Young decided to stop playing his hits and just play his new (unpopular) album. As the comment below suggests what is really needed is long-term reform which is exactly what the IMF has not provided in Greece.

“Argentina has signed 22 agreements with the IMF, most of which ended with bitterness on both sides.”

Clearly neither side has heard the phrase ‘once bitten, twice shy’! ( Donald in the FT)

 

 

 

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Is it just some Holla Dolla or a new phase of King Dollar and why?

The last few days have brought an ongoing topic to the fore and Holla Dolla refers to another strong period for the US Dollar. This morning it has been illustrated in a couple of ways as for example the UK Pound £ has nudged below US $1.29 and the Australian Dollar is nearing (0.7008) passing 0.7.

Australia

If we stay in a land down under for a moment we see abc news reporting this.

At 7:10am, the dollar was buying 70.1 US cents.

It was a significant drop from its value on Good Friday (71.5 US cents).

The currency’s sell-off was sparked by yesterday’s weak consumer price index (CPI) — with the figures revealing that core inflation ( at 1.4pc) had drifted to its lowest level in at least 16 years.

This looks the beginnings of another success for my leading indicator which I highlighted on the second of this month.

If we look ahead and use the narrow money measures that have proved to be such a good indicator elsewhere we see that the narrow money measure M1 actually fell in the period December to February. If we switch to the seasonally adjusted series we see that growth faded and went such that the recent peak last August of Aussie $ 357.1 billion was replaced by Aussie $356.1 billion in February so we are seeing actual falls on both nominal and real terms.

It would appear that according to abc others are if belatedly, keen to join our theme.

These latest developments have led to analysts from Australia’s major banks upgrading their rate cut expectations.

“The downward surprise to core inflation in the first quarter leaves the RBA with little choice but to cut the cash rate by 25 basis points at its May meeting,” ANZ economists Hayden Dimes and David Plank wrote in a note.

They also both expected a second rate cut to happen in August.

Or if we return to Men At Work.

I come from a land down under
Where beer does flow and men chunder
Can’t you hear, can’t you hear the thunder?
You better run, you better take cover, yeah

As a technical note yet again we see a central bank responding to events rather than getting ahead of them. Whatever happened to aiming at something 18/24 months ahead? Or to put it another way forward guidance has been anything but.

Canada

If we stay with customers of the Type 26 frigate programme then there was this yesterday from the Bank of Canada.

Given all of these developments, Governing Council judges that an accommodative policy interest rate continues to be warranted.

Which replaced this in January.

Weighing all of these factors, Governing Council continues to judge that the policy interest rate will need to rise over time into a neutral range to achieve the inflation target.

Depending on how you look at this they have either capitulated or adjusted to reality, albeit just like Australia they find themselves chasing events rather than anticipating them as reflected below.

In Canada, growth during the first half of 2019 is now expected to be slower than was anticipated in January.

Along the way we saw yet another bad afternoon for supporters of output gap theory and the concept of neutral interest-rates. Both were adjusted to suit the new outlook meaning they are fitted to the decisions taken rather than being part of any scientific process.

The combination of these factors led to the Financial Post reporting this.

The value of the Canadian dollar dropped by nearly a penny to roughly 74 U.S. cents, as traders repriced financial assets to match a prolonged period of low borrowing costs.

It remains there as I type this leaving it around 5% lower than a year ago which again reminds us of dollar strength as it was only a couple of days ago we were noting that the Loonie had been boosted by the higher price of crude oil.

Japan

I am not sure who could possibly have thought that the Bank of Japan had any intention of raising interest-rates. But if you did you were disappointed this morning.

The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, at least through around spring 2020, taking
into account uncertainties regarding economic activity and prices including developments in overseas economies and the effects of the scheduled consumption tax hike.

The Yen is difficult to read this year after what happened on January 3rd with its flash rally.

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

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

So it is a case of watch this space.

Euro

This has been in a downtrend against the US Dollar for a while now. The 1.115 of this morning has replaced the 1.21 of a year ago. The last week or so has seen something of an acceleration of this trend which has been driven by various factors. The economic slow down in the Euro area has been mostly in an exporting sector with manufacturing and particularly car production under pressure. This has led to more expectations of further easing from the European Central Bank. As interest-rates are already negative (-0.4%) this may be in other areas and this is why we have seen the ten-year yield in Germany go negative again (-0.01% today). Although interest-rate futures have risen a bit too ( this suggests lower interest-rates) although they always suffer from vertigo when they go above 100 as they were never supposed too!

Maybe the shenanigans around Deutsche Bank have not helped either as the merger with Commerzbank appears to be off. Which as it share price is a mere 7.67 Euros does not leave Deutsche Bank with a lot of options.

Comment

There has been an elephant in today’s room which is that since the middle of December we have noted a change in US interest-rate policy as we wonder if Rod Stewart was on the money.

The first cut is the deepest
Baby I know the first cut is the deepest

What I think has been happening is that the change in US policy has reminded traders of two things. You can get 2.5% in the US right now via the official rate and the ten-year Treasury Note which is better than elsewhere. These days Canada (1.75%) and Australia (1.5%) are relatively high interest-rate countries however odd typing that feels. Also the US depends on external trade relatively less than other countries as this from the morning hints at.

KOREA: GDP -0.3% in 1Q v +0.3% est. Shrank most in a decade. ( @fiatcurrency)

God knows who did the forecasts there as they must have been wearing blinkers.

Next we can return to our topic of Tuesday as the higher crude oil price ( now US $75 for Brent) impacts other countries who have to exchange their currency for dollars to buy it.

So let me sum up the trend with a quiz I posted yesterday on Twitter.

Me on The Investing Channel

 

Australia faces both falling house prices and a falling money supply

This morning has brought us up to date with news from what the Men at Work described as.

Living in a land down under
Where women glow and men plunder
Can’t you hear, can’t you hear the thunder?

That is of course what was called Australis and then Australia and these days in economic terms can be considered to be the South China Territories. The monetary policy statement from the Reserve Bank of Australia (RBA)  reinforces the latter point as you can see.

The outlook for the global economy remains reasonable, although growth has slowed and downside risks have increased. Growth in international trade has declined and investment intentions have softened in a number of countries. In China, the authorities have taken steps to ease financing conditions, partly in response to slower growth in the economy.

One needs to read between the lines of such rhetoric as for a central banker “remains reasonable” is a little downbeat in reality as we note the following use of “declined” “softened” and “slower”.But he was providing a background to this.

At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.

In essence the heat is on for another interest-rate cut and if you are wondering why? There is this.

GDP rose by just 0.2 per cent in the December quarter to be 2.3 per cent higher over 2018. Growth in household consumption is being affected by the protracted period of weakness in real household disposable income and the adjustment in housing markets. The drought in parts of the country has also affected farm output.

I will come to the central bankers fear of negative wealth effects from what they call an “adjustment in housing markets” in a moment as we note they cannot bring themselves to mention lower house prices. The pattern of GDP growth looks really rather poor as we see that the trend goes 1.1%,0.8% and then 0.3% and now 0.2%. So we see a familiar pattern of much weaker growth in the second half in 2018 which if we see again in the first half of this year will see the annual rate of growth halve. Actually it may be worse than that as the only factor driving growth according to Australia Statistics was this.

Government final consumption expenditure increased 1.8% during the quarter contributing 0.3 percentage points to GDP growth.

So without it the economy would have shrunk and Australia might be on course for something it has escaped for quite a while which is a recession. Also according to the Australia Treasury Budget from earlier it is planning a dose of austerity.

The total turnaround in the budget balance between 2013-14 and 2019-20 is projected to be $55.5 billion, or 3.4 per cent of GDP.

The Government’s plan for a stronger economy ensures it can guarantee essential services while returning the budget to surplus.

This budget year will see a surplus of $7.1 billion, equal to 0.4 per cent of GDP.

Budget surpluses will build in size in the medium term and are expected to exceed 1 per cent of GDP from 2026-27.

So as you can see it seems unlikely that government spending will continue to boost the economy. Also as they are assume growth of 2.25% then those numbers as so often seem rooted in fantasy rather than reality. Next if we switch back to the RBA the austerity plan comes at this time.

 In Australia, long-term bond yields have fallen to historically low levels.

In fact they fell to an all time low for the benchmark ten-year at 1.72% recently and is spite of a bounce back are still at a very low 1.82%. So yet again we are observing a situation where countries borrow heavily when it is expensive and try in this instance not to borrow at all when it is cheap. I know it is more complicated than that but we also have this into an economic slow down.

The Government is focused on reducing net debt as a share of the economy, which is expected to peak in 2018-19 at 19.2 per cent of GDP.

The Government is on track to eliminate net debt by 2029-30.

So it may look to be Keynesian but reality seems set to intervene especially on the economic growth forecasts.

House Prices

Again we see that the Governor of the RBA cannot bring himself to say, falling house prices. It is apparently just too painful.

The adjustment in established housing markets is continuing, after the earlier large run-up in prices in some cities. Conditions remain soft and rent inflation remains low.

Even worse it has implications for “the precious”.

 At the same time, the demand for credit by investors in the housing market has slowed noticeably as the dynamics of the housing market have changed. Growth in credit extended to owner-occupiers has eased.

Indeed a central banker would have his/her head in their hands as they see the negative wealth effects in the latest quarterly national accounts.

Real holding losses on land and dwellings were $170.8b. This marks a fourth consecutive quarter of losses and reflects the falling residential property prices over the past year. ……The real holding losses have translated into the first fall in household assets (-1.5%) since the September quarter 2011. Household liabilities increased 1.0%.

Some of the latter was falling equity prices which have since recovered but house prices have not. Here is ABC News on the first quarter of 2019.

On a national basis, the average house price fell 2.4 per cent to $540,676, and apartment prices dropped 2.2 per cent to $484,552 during that period.

CoreLogic observed that markets which experienced their peaks earlier had experienced sharper downturns.

Darwin and Perth property prices skyrocketed during the mining boom, but peaked in 2014. Since then dwelling values in both capitals have fallen by 27.5 per cent and 18.1 per cent respectively.

So it seems likely that the value of the housing stock fell again. If we move to the official series we see that in the rather unlikely instance you could sell all of Australia’s houses and flats in on e go then from the end of 2015 to early 2018 the value rose by one trillion Aussie Dollars from a bit below 6 trillion to a bit below 7. Now in a development to pack ice round a central bankers heart it has fallen to 6.7 trillion officially and if we factor in other measures is now 6.6 trillion Aussie Dollars and to quote Alicia Keys.

Oh, baby
I, I, I, I’m fallin’
I, I, I, I’m fallin’
Fallin’

Comment

Australia escaped the worst of the credit crunch via its enormous natural resource base. According to the RBA index of commodity prices that has not ended.

Preliminary estimates for March indicate that the index decreased by 0.9 per cent (on a monthly average basis) in SDR terms, after increasing by 5.3 per cent in February (revised)…….Over the past year, the index has increased by 11.0 per cent in SDR terms, led by higher iron ore, LNG and alumina prices. The index has increased by 16.6 per cent in Australian dollar terms.

But now we see that the domestic economy has weakened whilst the boost from above has faded. If we look ahead and use the narrow money measures that have proved to be such a good indicator elsewhere we see that the narrow money measure M1 actually fell in the period December to February. If we switch to the seasonally adjusted series we see that growth faded and went such that the recent peak last August of Aussie $ 357.1 billion was replaced by Aussie $356.1 billion in February so we are seeing actual falls on both nominal and real terms. Thus the outlook for the domestic economy remains weak and could get weaker.

 

 

Mario Draghi and the ECB look for more expansionary Euro area fiscal policy

As we travel the journey that is the credit crunch era we pick up some tasty morsels of knowledge along the way. Some were provided by Mario Draghi and the European Central Bank yesterday which announced this.

we decided to launch a new series of quarterly targeted longer-term refinancing operations (TLTRO-III), starting in September 2019 and ending in March 2021, each with a maturity of two years. These new operations will help to preserve favourable bank lending conditions and the smooth transmission of monetary policy.

As ever “the precious” otherwise known as the banks is prioritised ahead of everything else. Also I was asked if this meant the ECB “knew something” to which the answer is simple, if they did then they would have done it last summer. But there was a much bigger pivot.

This happens in a context where the debt to GDP ratio in the eurozone is actually falling.

There was a move towards making a broad hint for more fiscal policy or easing here. Mario also went out of his way to point out that borrowing for Euro area governments is very low.

The simple action of maintaining the stock unchanged in this context actually is a continuous easing because interest rates are pushed downward by this action. You can see this because since we decided in June last year, interest rates have gone down, they keep on going down, the term premium is negative, so conditions are very, very accommodative.

Not only that but he intends to keep it that way.

If you add to this what I’ve just said, it’s the chained element of this, of the horizon over which we’ll carry out purchases to keep the stock unchanged moves together with the forward guidance.

So Mario is pointing out to government’s that if they borrow the ECB will in general be there to help keep borrowing costs low or as we shall see in a bit negative. After all we now live in a world where even Greece can do this.

On Tuesday 5thMarch the Hellenic Republic, rated B1 Moody’s/ B+ S&P/ BB- Fitch/ BH DBRS (stb/ pos/ stb/ pos), priced a €2.5 billion 10-year Government Bond (GGB) due 12th March 2029. The new benchmark carries a coupon of 3.875% and reoffer yield of 3.900%, equating to a reoffer price of 99.796%. Joint bookrunners on the transaction were BNP Paribas, Citi, Credit Suisse, Goldman Sachs Intl, HSBC and J.P. Morgan. ( Note the past behaviour of Goldman Sachs in relation to Greece seems to be no barrier at all to future business…..)

Why so cheap? Well there are two main factors. One is that it is looking to run fiscal surpluses and the other is that whilst it is not in the ECB QE programme it may well be in a future one and that is looking more likely by the day. As to the economy it is with a heavy heart that I point out this which speaks for itself.

The available seasonally adjusted data
indicate that in the 4 th quarter of 2018 the Gross Domestic
Product (GDP) in volume terms decreased by 0.1% in comparison with the 3rd quarter of 2018,
while in comparison with the 4th quarter of 2017, it increased by 1.6%.

Mario also gave us a reminder of the scale of Euro area bond buying so far.

Just to give you an idea, the balance sheet of the ECB is about 42 – 43% of the eurozone GDP. The Fed is about half of it now. In order to keep this stock unchanged, we continue purchasing something in the order of €20 billion a month of bonds.

Here are more hints on the subject with also I think a nod to his home country Italy.

Regarding fiscal policies, the mildly expansionary euro area fiscal stance and the operation of automatic stabilisers are providing support to economic activity. At the same time, countries where government debt is high need to continue rebuilding fiscal buffers. All countries should continue to increase efforts to achieve a more growth-friendly composition of public finances.

Bond Yields

Let us start with the largest Euro area economy with is Germany. We saw bond prices rise and yields fall quite quickly in response to this. The German ten-year yield fell from 0.12% to 0.06% which makes us wonder if we may see another spell of it going negative like it did in the summer and autumn of 2016? It would not take a lot as the nine-year yield is now -0.1%.

So Germany can borrow essentially for nothing should it so choose over a ten-year horizon. That is in nominal terms and if we see inflation in this period then the real cost will be negative. Yet if you read through the cheerleading it is aiming for a fiscal surplus.

The general government budget surplus
will fall from roughly 1½% of GDP in
2018 to roughly 1% of GDP in 2019.
In 2019 and subsequent years, a fiscal
impact will be made in particular by
the priority measures contained in the
Coalition Agreement and other measures.
The implementation of these measures
will reduce the federal budget surplus. ( Draft Budget October 2018).

Although those numbers are already suffering from the TalkTalk critique and on that subject RIP Mark Hollis.

Baby, life’s what you make it
Celebrate it
Anticipate it
Yesterday’s faded
Nothing can change it
Life’s what you make it

Why? Well we have indeed moved on since this as the German economy shrank in the second half of 2018.

which forecasts a real growth rate of 1.8% in both 2018 and
2019. This means that Germany’s economy is expected to keep growing at a pace that slightly exceeds potential output.

Also if we look around we see that European supranational bodies can borrow very cheaply too. Maybe not at German rates but often pretty near. After considering that now let us return to Mario Draghi yesterday.

Now, Philip Lane is an excellent acquisition for the ECB but we are not going to ask him about this Eurobond thing. The Eurobond is again not something that the ECB can force or just decide about; again it’s an inherently political decision. And of course this doesn’t detract at all from the argument that it’s absolutely rational to have a safe asset at European level.

We have seen the Eurobond case made many times and so far Germany keeps torpedoing it, but we also know that in Europe these sort of things tend to happen eventually after of course a forest of denials and rejections.

Comment

We have seen quite a few phases now of the Euro area crisis. For a while it looked like “escape velocity” had been achieved but now we see to be facing many of the same problems with quarterly economic growth having gone 0.1%, 0.2% and looking like being around 0.2% in the first quarter of this year. Although he tried to downplay such thoughts yesterday it is hard not to think of this from Mario Draghi last November.

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

Ironically he is avoiding the subject just as the evidence is pointing that way. For the moment monetary policy is to coin a phrase “maxxed out” although in this instance it is more timing than not being able to do more, as it would be an embarrassing U-Turn. So for now if Euro area government’s and especially Germany were to embark on a fiscal stimulus the ECB would turn its blind eye towards it I think.

 

 

The unfolding economic crisis in Italy as adult diapers enter the inflation basket

One of the routes that human emotions take when confronted with a problem starts with anger and then goes to denial. If there was an element of anger in the election of the so-called populist government in power in Italy then we have seen denial on a grand scale towards the end of last week..

Italy PM Conte: The country’s economic fundamentals remain strong.

That is as even the casual observer must be aware of comical Ali status but wait there is more.

’s PM Says Government Remains Positive on Growth Forecasts || denial

says that “the government is pushing ahead on the implementation of measures that have already been approved, and their effect will contribute to a progressive growth in the second part of the year” || first half is gone, sorry mate. ( @liukzilla )

Italian ministers and prime ministers operating mentally for a land far,far away to coin a phrase of course nothing new, We can recall Prime Minster Renzi recommending the shares of the bank Monte Paschi which collapsed and former finance minister Padoan who continually told us the Italian banks were in good shape as the house burned around him.

What provoked this new phase?

Something of a bombshell was released by the Italian statistics office on Tuesday as it looked at the industrial sector.

In December 2018 the seasonally adjusted turnover index decreased by 3.5% compared to the previous month (-2.7% in domestic market and -4.7% in non-domestic market); the average of the last three months compared to the previous three months decreased by 1.6% (-1.5% in domestic market and -1.8% in non-domestic market).

This is worse than it looks as turnover data includes price rises and whilst there is not much consumer inflation recorded in Italy there is some in the industrial sector.

The total producer price index increased by 4.1% compared with December 2017 (5.2% on domestic market and 1.2% on foreign market).

The situation was also grim if you looked at the likely future.

The unadjusted industrial new orders index decreased by 5.3% with respect to the same month of the
previous year (-4.6% in domestic market and -3.6% in non-domestic market).

A little care is needed as these sort of numbers are volatile but they have impacted at a time when weak numbers were feared and then arrived on an ever larger scale.

Fitch Ratings

There was some good news for Italy in that it avoided a downgrade late on Friday although it came with a familiar message.

GDP growth has stalled as domestic policy uncertainty and weaker external demand has dragged down investment, while private consumption growth has also lost momentum. Fitch forecasts GDP growth of 0.3% in 2019, down from 0.8% in 2018 (compared with the 1.2% we forecast for both years at our previous review in August), with investment growth falling to 0.4% from 3.8% last year.

There are several issues here so let us open with Fitch being wrong again and in the circumstances by quite a bit, But the theme of Italy slowing down from not very much continues and frankly it may still be over optimistic. We do not know what the latter part of 2019 will look like but as we have observed above Italy which was already in recession at the end of last year has slowed further at the opening of this. Also the investment growth in 2018 does not seem to have helped much. However you spin it we return to the “Girlfriend in a Coma” theme.

This would take the five-year average to 0.9%, compared with the ‘BBB’ median of 3.2%, and leave the level of Italy’s real GDP still 3.5% below that in 2007. We continue to assess Italy’s trend rate of growth at around 0.5%.

Fiscal Problems

Considering their changed view on the economy Fitch seems very timid on the subject of their likely impact on the fiscal situation.

Fitch forecasts an increase in the general government deficit from 1.9% of GDP in 2018 to 2.3% this year, and 2.7% next, 0.1pp higher than at our previous review.

The danger here is that the fiscal deficit starts as Paul Simon puts it “slip-sliding away.” For the moment the labour market looks okay as shown by the Monthly Economic Report.

In the labour market, employment stabilized and the unemployment rate decreased only marginally.

But if the recession leads to job shedding then falling tax revenue and higher social security spending can see fiscal numbers deteriorate quickly. I have seen this happen in the UK in the past although fortunately as last week showed the UK is presently going the other way with improvements. This moves us onto the national debt and the emphasis is mine.

Fitch forecasts an increase in general government debt to 132.3% of GDP in 2020 from 131.7% in 2018, driven by lower nominal GDP growth, and a 0.7pp weakening in the primary balance from 2018-2020. This compares with the current ‘BBB’ median of 38.5% of GDP and would leave Italy as one of the most highly indebted sovereigns we rate, exposed to downside risks and with reduced scope for counter-cyclical fiscal policy.

Whilst the increase is only marginal it depends on the rather rose-tinted view of fiscal deficit changes we looked at above. Official projections invariably show the ratio falling in a denial of reality as it keeps going up. Also pressure is being provided by the way that Italian bond yields have risen with the ten-year yield now 2.77%. Whilst that is historically low it is much higher than Italy had started to get used too.

Also there are concerns about the structure of the debt. This starts with the fact that the ECB is no longer buying each month. There is still support  from its 368 billion Euros of holdings but relative to the size of the Italian debt pile it bought less than elsewhere as it buys on a ratio (capital key) that relates more to economic performance. Next comes the fact that as well as Italian banks French and German banks piled into Italian debt. It did not turn out to be the “easy money” they hoped for and as FT Alphaville pointed out last April led to some strange developments.

It may seem surprising that the French public bank Société de Financement Local, SFIL, has a very big exposure to the Italian sovereign debt.

But then maybe not so strange.

It was set up following the bankruptcy of Dexia.

Back then this was the state of play, what could go wrong?

The national central bank reports that banks resident in Italy had a total exposure of €626.8bn to the domestic general government in January 2018.

As we look forwards we see that Italy has an active maturity schedule to say the least and should it need more borrowing the heat could be on. This year will be especially busy with some 282 billion Euros of redemptions according to the Italian Treasury.

Comment

There is a fair bit to consider and let me add another bit of context via Fitch Ratings.

The competitiveness of the Italian economy held up in 2018. Both export and import volume growth slowed (to 0.3% and 0.7% respectively) in common with eurozone peers, and a somewhat higher income balance also supported a current account surplus estimated at 2.6% of GDP in 2018, 0.2pp lower than the year before.

Looked at in this light the Italian economy looks strong and to that we can add the private savings held. But there is no balance of payments crisis as we mull how all this “competitiveness” does not make the economy do better than it does. Meanwhile money seems to escape none the less.

We forecast some moderation in the size of net portfolio outflows, which totalled 5.1% of GDP in 2017 and 6.7% in 2018, and for net external debt/GDP to remain at close to 51% of GDP in 2020, high relative to the peer group median of 8% of GDP.

So there are clear dangers ahead for Italy and it is not clear to me this will help as they channel their inner Andy Haldane.

Istat updates the Social Mood on Economy Index, the new experimental index first released in October 2018. The index provides daily measures of the Italian sentiment on the economy. These measures are derived from samples of public tweets in Italian captured in real time.

More significant as a hint of ch-ch-changes come from looking at an addition to the basket for inflation measurement.

adult diapers

Maybe that is the most significant factor today if we consider the longer term.

Podcast

 

 

Germany will be the bellweather for the next stage of ECB monetary easing

Today there only is one topic and it was given a lead in late last night from Japan. There GDP growth was announced as 0.3% for the last quarter of 2018 which sounded okay on its own but meant that the economy shrank by 0.4% in the second half of 2018. Also it meant that it was the same size as a year before. So a bad omen for the economic growth news awaited from Germany.

In the fourth quarter of 2018, the gross domestic product (GDP) remained nearly at the previous quarter’s level after adjustment for price, seasonal and calendar variations.

If you want some real precision Claus Vistensen has given it a go.

German GDP up a dizzying 0.0173% in Q4.

Of course the numbers are nothing like that accurate and Germany now faces a situation where its economy shrank by 0.2% in the second half of 2018. The full year is described below.

Hence short-term economic development in Germany showed two trends in 2018. The Federal Statistical Office (Destatis) reports that, after a dynamic start into the first half of the year (+0.4% in the first quarter, +0.5% in the second quarter), a small dip (-0.2% in the third quarter, 0.0% in the fourth quarter) was recorded in the second half of the year. For the whole year of 2018, this was an increase of 1.4% (calendar adjusted: 1.5%). Hence growth was slightly smaller than reported in January.

Another way of looking at the slowdown is to compare the average annual rate of growth in 2018 of 1.5% with it now.

+0.6% on the same quarter a year earlier (price and calendar adjusted)

If we look at the quarter just gone in detail we see that it was domestic demand that stopped the situation being even worse.

The quarter-on-quarter comparison (price, seasonally and calendar adjusted) reveals that positive contributions mainly came from domestic demand. Gross fixed capital formation, especially in construction but also in machinery and equipment, increased markedly compared with the third quarter of 2018. While household final consumption expenditure increased slightly, general government final consumption expenditure was markedly up at the end of the year.

Is the pick up in government spending another recessionary signal? So far there is no clear sign of any rise in unemployment that is not normal for the time of year.

the number of persons in employment fell by 146,000, or 0.3%, in December 2018 on the previous month. The month-on-month decrease was smaller than the relevant average of the past five years (-158,000 people.

Actually we can say that it looks like there has been a fall in productivity as the year on year annual GDP growth rate of 0.6% compares with this.

Number of persons in employment in the fourth quarter of 2018 up 1.1% on the fourth quarter of 2017.

Also German industry does not seem to have lost confidence as we note the rise in investment which is the opposite of the UK where it ha been struggling. But something that traditionally helps the German economy did not.

However, development of foreign trade did not make a positive contribution to growth in the fourth quarter. According to provisional calculations, exports and imports of goods and services increased nearly at the same rate in the quarter-on-quarter comparison.

In a world sense that is not so bad news as the German trade surplus is something which is a global imbalance but for Germany right now it is a problem for economic growth.

So let us move on as we note that German economic growth peaked at 2.8% in the autumn of 2017 and is now 0.6%.

Inflation

This morning’s release on this front does not doubt have an element of new year sales but seems to suggest that inflation has faded.

 the selling prices in wholesale trade increased by 1.1% in January 2019 from the corresponding month of the preceding year. In December 2018 and in November 2018 the annual rates of change had been +2.5% and +3.5%, respectively.
From December 2018 to January 2019 the index fell by 0.7%.

Bond Yields

It is worth reminding ourselves how low the German ten-year yield is at 0.11%. That according to my chart compares to 0.77% a year ago and is certainly not what you might expect from reading either mainstream economics and media thoughts. That is because the German bond market has boomed as the ECB central bank reduced and then ended its monthly purchases of German government bonds. Let me give you some thoughts on why this is so.

  1. Those who invest their money have seen a German economic slowing and moved into bonds.
  2. Whilst monthly QE ended there are still ECB holdings of 517 billion Euros which is a tidy sum especially when you note Germany not expanding its debt and is running a fiscal surplus.
  3. The likelihood of a new ECB QE programme ( please see Tuesday’s post) has been rising and rising. Frankly the only reason it has not been restarted is the embarrassment of doing so after only just ending it.

Accordingly it would not take much more for the benchmark ten-year yield to go negative again. After all all yields out to the nine-year maturity now are. Let me point out how extraordinary that is on two counts. First that it happened at all and next the length of time for which negative bond yields have persisted.

If we look at that from another perspective we see that Germany could if it so chose respond to this slowing with fiscal policy. It can borrow for essentially nothing and in both absolute and relative terms its national debt has been falling. The awkward part is presentational after many years of telling other euro area countries ( most recently Italy) that this is a bad idea!

Comment

If you are a subscriber to the theme that Euro area monetary policy has generally been set for Germany’s benefit then there is plenty of food for thought in the above. Indeed it all started with the large devaluation it engineered for its exporters via swapping the Deutschmark for the Euro. That is currently very valuable because a mere glance at Switzerland suggests that rather than 1.13 to the US Dollar  the DM would be say 1.50 and maybe higher. Care is needed because as the Euro area’s largest economy of course it should be a major factor in monetary policy just not the only one.

Right now there will be chuntering of teeth in Frankfurt on two counts. Firstly that my theme that the timing of what you do matters nearly as much as what you do and on this front the ECB has got it wrong. Next comes the issue that it was not supposed to be the German economy that was to be a QE junkie. Yes the trade issues have not helped but it is deeper than that.

With some of the banks in trouble too such as Deutsche Bank and Commerzbank we could see a “surprise” easing from the ECB especially if there is a no-deal Brexit. That would provide a smokescreen for a fast U-Turn.

Me on The Investing Channel

This looks like the end of the interest-rates rising cycle

This feels like one of those days where there has been an epoch shift or to be more specific the morning after the night before. It is not as if we have been caught by surprise, as unlike so many have been ahead of the curve about the world economic slow down, and hence the implications for interest-rates and monetary policy. But there will be much wider implications from this as we go forwards and let us start from the fact that the biggest economic decision of 2019 may have just been made by a technocrat.

What happened?

The US Federal Reserve is significant on several counts. There is the ordinary significance of it being responsible for monetary policy in the world’s largest economy and for its reserve currency. There has recently been an additional one as it has been the standard-bearer for voluntarily raising interest-rates. Yet last night we got a combination of this.

 the Committee decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent……… In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.

No great surprise in the lack of a move last night but the promises that peaked at 3-4 interest-rate increases in 2019 have morphed into “will be patient” or perhaps 0. Then there was an additional statement which copied a part of what has become the European Central Bank model.

The Committee is prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.

So what has been called Quantitative Tightening or QT where some of the bonds bought previously are allowed to run off has run out of steam or “economic and financial developments”. The use of the word financial is significant as frankly it only reinforces the view that past falls in equity markets have driven this and we do get a flicker of democratic involvement ( I will leave readers to decide if that is good or bad) as of course they upset President Trump.

Next comes something which regular readers will know is something I have long suspected which is that in any slow down QE4 will come down the slipway. Or to be more specific the Federal Reserve balance sheet will no longer be contracting but will be expanded again. A particular significance of this will be that it could start with the balance sheet already being over US $4 Trillion in size.

There are various consequences of all of this. Two of them are major themes of my work with one of them being the earliest. As central banks went “all in” in terms of monetary policy I feared they would delay any exit policy and thus end up in the wrong cycle. The Fed deserves some credit for at least trying ( unlike so many others) but if not too little it was too late. Next is the issue of “junkie culture” where I feared we would be unable to wean ourselves off cheap credit and yields well that looks like where we are at right now. Some of you deserve credit for pointing out that the “new normal” would mean interest-rates would not go above 3% as that is looking rather en vogue today. That is in spite of the annualised economic growth rate being reported as 3.4% and the unemployment rate being reported as 3.9%.

Along this road the concept of independence of the US Federal Reserve and Chair Jerome Powell has folded like a deck chair, although some ( often ex-central bankers) retain a touching faith in the concept.

The Consequences

Equity Markets

The issue here is summarised to some extent by this tweet from James Mackintosh of the Wall Street Journal.

The FTSE 100 dividend yield ended 2018 3.5 percentage points above the 10-year Gilt yield, the most ever. One possibility: Market pricing risk of dividends being slashed after Brexit. Another: UK stocks are cheap. Or Gilt yields far too low.

After last nights Powell U-Turn whilst Gilt yields are in my opinion too low the reality is that going forwards they look more likely to stay there than before. Therefore on that measure the equity market looks cheap. Or to express it in another form the Yellen put for equity markets which replaced the Bernanke put has not been replaced by the Powell put option. This does not mean that they cannot fall but it does mean that monetary policy will do its best to stop them falling.

This brings us to the concept of the Plunge Protection Team a phrase I do use and sometimes I am joking. But this monetary policy  U-Turn following the way that Treasury Secretary Mnuchin spoke to the largest banks just before Christmas looks like a concerted effort.

Fiscal Policy

That to my mind has just seen a shift too and it comes from bond yields. Pressure for them to rise has just ended at least from one source. If you take the view that bond yields are the sum of expected future interest-rates then the latter has been shifting lower. If we stay with the US forecasts of 4% bond yields now face a reality of a ten-year Treasury Note yield of 2.67% and a thirty-year yield of 3.02%.

Thus fiscal policy just got cheaper and in some places it is currently very cheap if we look at a 1.24% ten-year Gilt yield in my country the UK and ultra-cheap if we look at Germany with its ten-year Bund yield of 0.18%. Let me offer you some thoughts on this.

  1. I know people like to laugh at the Donald but his fiscal plan of tax cuts has coincided with an economic slow down and now has got less expensive via lower bond yields.
  2. The concept of us all turning at least partly Japanese gets another tick in the box as they have never fully escaped the easing cycle either.
  3. Was the original plan of central bank “independence” to allow policies the politicians could never get away with?
  4. Ironically the countries that can most afford a fiscal boost such as Germany are those most set against it. Of course an element of its lower yields is due to its fiscal surplus but to my mind only a small bit.
  5. Politicians seem to be more in favour of fiscal policy when it is more expensive (higher bond yields) rather than cheaper. I cannot fully explain that but it often happens, perhaps they are just slow on the uptake.

Comment

There is a lot to consider here and the truth is some of this we have been observing over the last month or two as markets have adjusted to a newer reality. I have developed a new theory in the credit crunch era which is that conventional thought once it believes something takes quite some time to change after the evidence has shifted or the complete opposite of the famous quote attributed to JM Keynes.

When the facts change, I change my mind. What do you do sir?

In reality many have continued on with thoughts about interest-rate rises in 2019 perhaps most bizarrely in the case of the ECB. Whereas for now central bankers seem to have Taylor Swift on repeat to sooth away any such thoughts.

We are never ever ever getting back together,
We are never ever ever getting back together,
You go talk to your friends, talk to my friends, talk to me
But we are never ever ever ever getting back together