How many central banks will turn into hedge funds?

One of the under appreciated consequences of all the monetary easing and intervention that has gone on in the world since the credit crunch is the impact on central banks themselves. What I mean is that they find themselves holding ever larger sums of assets which in many cases they are compounding by often holding ever riskier ones. They are taking advantage of the fact that they are backed by national treasuries – although being backed by 19 national treasuries as the European Central Bank or ECB  has a different perspective in my opinion  – allowing the view that this is somehow risk-free to proliferate. Well it may not be risk-free for the taxpayers who find themselves backing all this!

The Bank of England

So far it has mostly confined itself to what we might call bog standard QE where it purchases UK Gilts. However it has been lengthening the maturity of its £375 billion of holdings in an Operation Twist style and now for example has some £989 million of our 2068 Gilt. Too Infinity! And Beyond! Indeed…

The main risk to taxpayers is in fact even less understood operations like the house price boosting Funding for Lending Scheme. Some £69 billion of cheap loans to banks have been issue here and should house price ever fall there are risks.

Foreign Exchange Reserves

These seem to be safe but the QE era has led to changes here because you see conventional theory has central banks investing in shorter dated bonds. Some of you will be spotting the problem already! This is how the Financial Times puts it.

European and Japanese (interest) rate cuts are putting pressure on many central banks’ returns — a source of income used to cover running costs and to provide finance ministries with profits on which they have come to rely.

In other words investing at negative yields carries a guaranteed loss if you hold to maturity which is awkward to say the least when you come to explain your stewardship to auditors and indeed taxpayers. The ECB in particular is hoist by its own petard here as I recall it arguing that value on maturity was the way of valuing Greek bonds back in the day and of course that is still convenient there. But not elsewhere. We have just excluded the Euro and the Yen which of course are major markets (even now some 20% and 4% of reserve assets respectively) and logical ones to put some of your reserves. So what are they doing? From the FT.

central bank reserve managers are making or “seriously considering” buying bundles of loans repackaged as asset-backed securities or switching out of currencies affected by negative rates.

There are issues here as we move from theoretically at least safe government bonds to what are less safe assets. There are in fact two issues which the FT does not point out so let me point them out.

The good news for central banks is that a consequence of their own actions is that they have made a profit. Of course they will not put it like that! No doubt the press communiques will concentrate on skilled management and their own abilities. But the QE era has driven the prices of the bonds they hold as foreign exchange reserves higher and hence bingo. Even the own-goal by former UK Chancellor Gordon Brown when he sold gold at what is now cruelly called Brown’s Bottom will look a little better as the replacement strategy of buying bonds does well.

The catch is for future investment as what do you do now with bond prices so high? Indeed these “independent” central bankers will be under pressure from politicians who have no doubt got used to spending the profits created for national treasuries to carry on regardless as the film put it. But where do they go now to do this? The FT gives us a nod and a wink.

But central banks have shed some of their conservatism in recent years, with monetary policies such as quantitative easing forcing them to sell bonds and buy riskier instruments such as equities.

Revealing language there via “forcing them”. Really? Many central banks are not allowed to buy equities for this purpose and so they will be buying longer-dated bonds and dipping into riskier ones. I will discuss the equity buyers in a moment but here is an idea of scale for you.

Total managed reserves were $10.9tn at the end of last year, according to the International Monetary Fund.

Even in these times of ever larger numbers that is quite a lot. By the way how do the numbers keep getting larger when we are supposed to be in deflation? Anyway the UK government has net US $ 38.4 billion which the Bank of England manages. Tucked away here is the issue that gross reserves are around US $97 billion larger as we mull we have liabilities too and the phrase what could go wrong? The bit we do know is that if it should it will not be anybody’s fault.

Riskier bonds

Moving onto a slightly different field which is QE then the ECB gave us an example of this in yesterday’s update.

Asset-backed securities cumulatively purchased and settled as at 15/04/2016 €19,220 mln……..Covered bonds cumulatively purchased and settled as at 15/04/2016 €169,255 mln.

The ABS securities are the riskiest and as an aside you may wonder Mario Draghi made such a big deal of them as in the scheme of things purchases have been relatively small. The US Federal Reserve has been a big buyer in this area and as it still hold some US $1.76 trillion does not seem to have been keen on realising the value stored there.

Equities and property

Here we find what I labelled the “currency twins” back in the day as there were many similarities between the Swiss Franc and the Japanese Yen. The carry trade pushed their currencies lower originally but reversing it post credit crunch saw them shoot higher which the respective central banks resisted. Here are the consequences.

Swiss National Bank

This has the equivalent of some US $600 billion to invest as a result of its past interventions and promises to take on all-comers. Of that some 18% was invested in equities at the end of 2015 and that is why I refer from time to time to it being affected by movements in the share price of Apple for example.

The equity portfolios in the foreign currency investments were comprised of shares from mid-cap and large-cap companies (excluding banks) in advanced economies and, to a lesser extent, shares of small-cap companies. The SNB does not engage in equity selection; it only invests passively.

I wonder what Swiss watchmakers think of their central bank using their money to invest in the creator and manufacturer of the Apple watch? But as we observe this I note that of course we do have what might be considered purist hedge fund behaviour here which is punting, excuse me invested in Apple shares. The equity component had also risen from 15% to 18%.

Bank of Japan

The Bank of Japan also has large foreign exchange reserves amounting to some US $1.26 trillion. All that intervention had to go somewhere or to put it another way we see why the Bank of Japan was reluctant to intervene again as the Yen surged a week or so ago.  The Ministry of Finance is not keen on breaking this down but we do know that in its QQE (Quantiative and Qualitative Easing) policy the Bank of Japan is a keen equity and indeed property investor. From its latest Minutes.

Second, it would purchase ETFs and J-REITs so that their amounts outstanding would increase at annual paces of about 3 trillion yen and about 90 billion yen, respectively.

The Exchnage Traded Funds or ETFs are equity purchases and the J-REITs are property ones. So far just under 7.6 trillion Yen and 300 billion Yen have been purchased respectively. Indeed there are issues building here as regards market stability and structure. From Bloomberg.

the BOJ has accumulated an ETF stash that accounted for 52 percent of the entire market at the end of September, figures from Tokyo’s stock exchange show.


There is much to consider here as we see more and more central banks make the journey to what a Martian observer might have trouble distinguishing from a hedge fund. The elephant in the room is making investments which can make losses. Also here is a conceptual question for you. Is something a profit if it results from your subsequent purchases? The Bank of Japan which is both a template and the extreme case should be mulling this today in response to this.

JAPAN’S 30-YEAR YIELD FALLS TO RECORD 0.335% (h/t @moved_average )

In this situation it may already be beyond the point of no return which poses its own questions as it chomps on Japanese financial assets “like a powered up Pac-Man” as The Kaiser Chiefs put it.

Most other central banks have only taken relative baby steps on this road but we see that in yet another “surprise” even their foreign exchange reserve management is being affected. As I note that the ECB is the central bank mostly likely to dip into equities next let me leave you with a question. How is it that people who are badged as so intelligent and skilled seem to be so regularly surprised by the consequences of their own actions?!

For a minute there, I lost myself, I lost myself
Phew, for a minute there, I lost myself, I lost myself

For a minute there, I lost myself, I lost myself
Phew, for a minute there, I lost myself, I lost myself (Radiohead Karma Police)




The rise and fall of the economic central planners

Yesterday was a day which was not a good one for Bank of England Governor Mark Carney. Even the usually supine and tame press corps have spotted that Forward Guidance has been a dismal failure especially for those who remortgaged on the hints and promises of higher mortgage rates only to find that they have fallen. In fact the situation was so bad we got an official denial that it had failed. Also the man who told us that monetary policy was not “maxxed out” ended up going down a familiar road with hints of lower interest-rates and more QE (Quantitative Easing). That does not go well with his mantra of higher interest-rate soon! Indeed this was the theme of the Open Mouth Operations as inflation and interest-rates were to be “higher…….or lower”.


We can take this theme wider as the attempts at central planning abroad are not going so well either. If we look at the Far East and Japan the policy of the Bank of Japan which is only a week old is already looking to be in dissarray. What I mean by this is that the mechanisms by which it is supposed to work are via a lower exchange-rate and via wealth effects from a higher stock market. If you boil Abenomics down to its basics then you have these two.

If we start with the value of the Yen then the main transmission mechanism is via the US Dollar exchange rate because it is the reserve currency in which most commodities are priced. But it is now at 116.9 which is stronger than it was before Governor Kuroda announced the move to an interest-rate of -0.1%. Yes the Yen shot lower as an initial response but since it has regained the ground and some. If we move to the Nikkei 225 equity index we see a similar theme where it shot higher on the announcement but since has come back to where it started and is now at 16,819 for the weekend.

The other mechanism that economic theory would suggest to be at play involves lower interest-rates stimulating the economy. We certainly have lower interest-rates although there are exceptions to the official -0.1% and bond yields too are now ultra-low with the ten-year JGB (Japanese Government Bond) falling as low as 0.01% this morning. But if lower interest-rates provided much of a stimulus in Japan we would not have the concept of the “lost decade(s)” would we?

The Euro

The situation described above has echoes for Mario Draghi and the ECB (European Central Bank). They have cut interest-rates to -0.3% promised further cuts to around -0.5% and are spending 60 billion Euros a month on QE bond purchases. Yet the Euro has gone boing like Zebedee in The Magic Roundabout and is now around 1.12 to the US Dollar. It has also risen to 1.30 versus the UK Pound £. Bloomberg sums it up thus.

The European Central Bank’s own calculation of the single currency’s effective exchange rate against a trade-weighted basket of 38 other currencies stood at 119.9056 on Thursday. That means that the real-world value of the euro has risen faster than the more commonly tracked exchange rate against the dollar.

Trade-weighted, the euro is at the highest level since Jan. 2, 2015,

The rally in 2016 so far has been approximately equivalent to a 0.6% increase in the ECB interest-rate. So we see that in the currency wars which are the major mover and shaker these days the central planners are seeing that their tanks are in retreat. Awkward. Although the ECB is in a better position than Japan because it is seeing some growth it must be wondering if that will now fade a bit.

US Federal Reserve

This is in disarray too right now. I do not particularly mean the response to the 0.25% interest-rate rise which has its own issues. I mean the Forward Guidance that we would get “3-5” more rises of that size in 2016. That has now disappeared with Federal Reserve members suggesting that financial markets have done much of their work for them. In the complicated world in which we live the US Dollar has fallen leading to partly cause the consequences discussed above and the US economy appears to have slowed.

Not good for our “masters of the universe” and the nearest to a world central bank we have.

Are bond yields signaling a recession?

In old-fashioned terms bond yields where they currently are would be signalling more of a depression than a recession. But of course the situation has been distorted by the trillions of bond purchases in the various QE programmes. However if we look at the yield curve we are seeing a reinforcement of this view. From Reuters.

The U.S. two-year/10-year yield curve, the difference between two-year and 10-year borrowing costs, this week fell to 110 basis points, the flattest in eight years…….A flattening yield curve has in the past been a reasonably accurate portent of slowing growth and an inverted curve, when the long-dated yield falls below the short-dated yield, an even more accurate guide to looming recession.

This has worked as a signal reliably in the past although the danger is of course that bond markets are now so distorted and manipulated that it may have changed. One thing we can say is that it is a failure for Forward Guidance that people are discussing it as confidence and psychology matter.

The Baltic Dry Index

This has been falling for a while now. It became fashionable for the economic commentariat to dismiss it hence the phrase Baltic Dry Index Twitter came to be. However rather awkwardly for them it continued to fall.

I know that a move of a particular percentage should have the same impact everywhere but it is at least more symbolic when you see a change from 3 to 2 as the big figure.

Harpex Shipping Index

There are challenges to the methodology of the BDI so let us also take a look at the Harpex which is based on rates for container ships. It hit a high of 646 last summer and since then it too has been falling and seems to have stabilised in 2016 around 364. As you can see it too is signalling in the words of Taylor Swift “trouble,trouble,trouble”.


There are plenty of signals right now that are flashing yellow alert about economic developments. We will have to see how they unfold but there very existence is a challenge to the central planners who bestride the globe proclaiming success as they overlook the moral hazards and junkie culture their polices and actions have encouraged. Eight years into the credit crunch they are in danger of repeating the lost decade from Japan.

Meanwhile the usually sensible and intelligent Gillian Tett has joined the control freak squad in the Financial Times today and returned us to the subject of banning cash so that negative interest-rates would be more effective.

For better or worse, the nature of money is changing. And who knows? If this revolution helps curtail tax evasion and terrorist finance — and makes our lives more convenient along the way, too — it might turn out to be one of the better developments to have emerged from the finance industry in recent years.

There is a good reply pointing out that terrorists use cars and mobile phones so should we ban them too? But underlying this is the fact that the central planners feel they need “More,More,More”

RIP Maurice White

it has been a bad year for music with one of the founders of Earth Wind & Fire dying overnight. Let me leave you with the opening verse of my favourite song of theirs.

Do you remember the
21st night of September?
Love was changing the minds of pretenders
While chasing the clouds away



How much can a central bank lose before bankruptcy looms?

One of the features of the “new normal” of the credit crunch era is that central banks bestride the economic and financial stages like colossi as they dispense both cash and claimed wisdom. Many are in thrall to our central banking overlords but not here as it was only yesterday I discussed their inconsistencies and fudges when setting interest-rates. This morning has brought news of yet another set back for the theory that central banks are omnipotent and it has come from the often sleepy small country of Switzerland. Indeed Swiss citizens are likely to get something of a shock when they read the news and discover what has been done in their name and with their money.

The Swiss National Bank (SNB)

The latest release from the SNB is not for those of a nervous disposition especially if you happen to be a Swiss taxpayer.

The Swiss National Bank (SNB) is reporting a loss of CHF 50.1 billion for the first half of 2015.

If we convert into UK Pound’s then this is £33.3 billion. So how did this happen?

On 15 January 2015, the SNB decided to discontinue the minimum exchange rate of CHF 1.20 per euro with immediate effect. The subsequent appreciation of the Swiss franc led to exchange rate-related losses on all investment currencies. For the first half of 2015, these amounted to a total of CHF 52.2 billion.

Thus we see that it was not only private investors, currency and spread trading companies (some went bust back then) and hedge funds which were hit as a modern version of King Canute finally submitted to the tide. Added to this were problems with bond markets which if you recall have followed the surge of early 2015 with declines since and remember due to the size of its foreign currency intervention and reserves the SNB is a large holder of Euro area bonds.

A loss of CHF 3.9 billion was recorded on interest-bearing paper and instruments.

The SNB must think that it never rains but it pours as it note that it has been a bad 2015 so far for something which it is famous for holding which is of course gold.

A valuation loss of CHF 3.2 billion was recorded on gold holdings.

So far we have too many losses so let me factor in something which is immediately obvious when you think about it. The SNB makes a profit out of its negative interest-rate of -0.75%.

The profit on Swiss franc positions totalled CHF 571 million. It was essentially made up of CHF 530 million of negative interest charged on sight deposit account balances since 22 January 2015,

Also the SNB received some interest payments on its various bond holdings.

Interest income provided a positive contribution, at CHF 3.5 billion,

Thrown into the mix is something that does not get the publicity it deserves outside of on here anyway as the SNB is an equity market punter, excuse me investor. Like the Bank of Japan which owns nearly 7 trillion Yen of equities the SNB has spread its wings into this area. As the early part of 2015 was good for equities the SNB can breathe a small sigh of relief and publish this.

By contrast, equity securities and instruments benefited from the favourable stock market environment and contributed CHF 4.1 billion to the net result……. as did dividend income, at CHF 1.2 billion.

What about Apple?

Some wry entertainment has been found in this development described by Bloomberg on the 6th of May.

Switzerland’s central bank owned 8.9 million shares in the iPhone maker on March 31, according to a regulatory filing made to the U.S. Securities and Exchange Commission. That’s up from 5.6 million shares at the end of 2014, a 60 percent increase, according to Bloomberg calculations.

We do not know the exact state of play here but we do know as Apple’s share price peaked at around 132 and was 122.35 at last night’s close that it is no longer solely a one way trade. Should it not work out then I imagine that the Swiss watchmaking industry will be particularly underwhelmed by their central bank investing in the maker of the Apple Watch.

Balance Sheet Alert

As of the 30th of June the SNB owned some 529.5 billion Swiss Francs of foreign currency assets and some 36.4 billion Swiss Francs of gold. If we look at the investment percentages then we see  it held some 90 billion Swiss Francs worth of equities with the vast majority of the rest in other countries government bonds.

This is an awkward consequence of the foreign currency intervention undertaken by the SNB and if you have heard people describe central banks as hedge funds these days well here is the prima facie case of it.

Is the SNB bust?

The answer to this is not yet as the capital has shrunk for obvious reasons as we note a fall in capital from 86.3 billion Swiss Francs to 34.3 billion. If it was a listed company then we might be heading to the panic zone but of course it is not. Swiss taxpayers may be getting nervous at this point because they via the Swiss Treasury back the SNB. Also as pointed out a few years back by Willem Buiter central banks do have access to a large source of funds.

As long as central banks don’t have significant foreign exchange-denominated liabilities or index-linked liabilities, it will always be possible for the central bank to ensure its solvency though monetary issuance (seigniorage).

A sort of printing response or in modern language press control and the letter P.

Also it is not that central banks cannot go bust as we review one obvious past problem and one less obvious one.

Two recent examples are the Reserve Bank of Zimbabwe (the current inflation rate in Zimbabwe is over 100,000 percent year-on-year) and the National Bank of Tajikistan.

I have written before about issues concerning the structure of the ECB (European Central Bank) partly because it is backed by 19 different treasuries which may copy their attitude to the Greek crisis and have divergent views. However the Swiss taxpayer may null the fact that 40.02 of their central bank is owned by private shareholders. I know nothing about Theo Siegert of Dusseldorf but according to the 2014 Annual Report he owns some 6.5%.

What about Switzerland?

There is an explicit issue for the shareholders in the SNB.

Last year, the SNB paid dividends to shareholders of 2 billion francs after posting 38.3 billion francs in profit but warned such hefty payouts might not continue.

We have the second half of 2015 to come but the outlook for a dividend this year is none to bright as we stand. Also there is the issue of currency strength finally being a drag on the economy. The BBC has looked at its impact on border towns.

The consequences for borders towns like Kreuzlingen were immediate. While Swiss prices have been somewhat higher than those in Germany for some years, with the franc now so high many products cost twice as much or more in Switzerland.

So why shop in Kreuzlingen when ten minutes walk away the bustling German town of Konstanz awaits?

Also Swiss cheese manufacturers are being affected.

“In May our foreign sales figures, especially for traditional cheeses, really slumped”, says Mr Hausammann. “We had a 14% reduction over the same month last year.”


This week has seen more than a few examples of central banking problems. It was  the Bank of Russia on Wednesday with the value of the Rouble and consequent inflation and yesterday it was the US Federal Reserve and the Riksbank with doppelgänger like views on economic policy. Now we see that there are costs to the “unlimited intervention” policy of the SNB which of course turned out to be very large rather than unlimited. Perhaps the Swiss taxpayer will end up  being very grateful for that!

Meanwhile back in the UK another central bank seems to have hit some choppy water. From Reuters.

New Bank of England rate-setter Gertjan Vlieghe should reassure parliament that his ongoing financial link to one of the world’s biggest hedge funds does not pose a conflict of interest, a senior MP said on Thursday.

What could go wrong?


In a world of negative interest-rates they will try to take cash away from us

A central theme of this website has been to predict and then analyse the trend towards negative interest-rates. It is an adjunct of a world where central bankers feel the need to apply ever stronger doses of monetary stimulus as previous doses disappoint. Another way of putting this is that the junkie style culture they have pursued requires ever larger hits. At the moment the main outbreak of negative interest-rates surrounds the Euro area where the European Central Bank has reduced its main interest-rate to -0.2%. This has forced Switzerland and Denmark into a corner where they have reduced to -0.75% and it was only last Thursday that I analysed the reduction to -0.35% by the Riksbank of Sweden.

The concept of central planning is also on the rise as we see capital controls (more literally deposit controls and a closed stock exchange) in Greece and all sorts of machinations,edicts and threats in China against sellers of equities. In China what goes up is apparently not allowed to go down! Although to be fair it is general central bank policy that equity prices should be pushed higher with the Bank of Japan most explicit on that front under Abenomics. Also central banks like to see house prices rising with the Bank of England at the forefront of a group which again includes Sweden’s Riksbank where policy in recent times has driven house prices higher. So in asset markets the message from central bankers is “come on in the water’s lovely” as they tease us with hints of capital gains. This of course provides us with an alternative to cash savings and whilst it only applies to a section of them it is another attempt to move us away from them.

The Proposal To Scrap Cash

The paragraph above showed pressure on some types of cash holdings via an attempt to make both holding equities and investing in houses more attractive. Of course these have quite different risk profiles and so there are plenty of other types of cash holdings in existence. So it was inevitable that someone would have what they consider to be a brainwave and suggest scapping it entirely! As it happens Willem Buiter (who was my tutor for a year at the LSE) of Citi suggested it back in April so let us examine the rationale.

Central bank policy rates have been constrained by a perceived or actual effective lower bound (ELB) on nominal interest in recent years. The existence of the ELB is due to the existence of cash (bank notes) – a negotiable bearer instrument that pays a zero nominal interest rate.

The essential point here is that 0% is something of a rubicon in interest-rate terms because depositors and savers have an easy alternative once interest-rates fall below it. They can simply hold cash and avoid the negative interest-rates that the central bank is prescribing for the economy’s health at that point. Of course whether the central bank is correct in prescribing such medicine is a moot point but let us indulge that line of thought for a moment.

Following this logic and noting where we are makes central bankers unhappy as to coin a phrase the perception that their policies are “maxxed out” may grow.

We view this constraint as undesirable and relatively easily avoidable from a technical, administrative and economic perspective.

You may note the “relatively easily avoidable” and we get an explanation of how.

We present three practical ways to eliminate the ELB: i) abolish currency, ii) tax currency or iii) remove the fixed exchange rate between zero-interest cash currency and central bank reserves/deposits denominated in a virtual currency.

You may note that as Debbie Harry put it “One way or another” this paper has plans on your cash!

Tucked away in it was a rather damning view of Quantitative Easing (QE) and the emphasis is mine.

The option to lower interest rates significantly below zero would have been valuable in the past as an alternative to large-scale asset purchases (QE) by the Fed and the Bank of England and today in Japan and the euro area. Compared to QE, significantly negative interest rates would create fewer financial stability risks and political legitimacy risks.

Central bankers out of office seem suddenly to have a different view of house and equity market prices rises don’t they? “Wealth effects” suddenly morph into “financial stability risks”.

How long might interest-rate go? The example quoted is that of the Taylor Rule which would have had interest-rates at -5% back in 2009. At such a level you can see that cash would be very attractive and why the official view would head towards abolishing it.

Is it the banks again?

If we move to Bank of England research we see the central banking view of the money supply.

Whenever a bank makes a loan, it
simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money……Most money in the modern economy is in the form of bank deposits, which are created by commercial banks themselves.

You can see that the broader measures of the money supply would head south rapidly if individuals withdrew money from banks to hold cash. This is in many ways what we are seeing play out in Greece right now. Negative interest-rates would create yet another credit crunch.


So far I have put this at 0% for simplicity but as Willem Buiter points out there are costs to holding it.

Storage, safekeeping, insurance, transportation and handling costs of currency imply that the effective lower bound on interest rates is not zero, but somewhat negative (and uncertain).

The ECB has set interest-rates at -0.2% because it thinks the ELB is there. Actually I think that we have a zone between 0% and -2% depending on individual solutions. Also this is in the rational world whereas us humans are prone to Ying and Yang changes and in an irrational one the ELB would be 0% and could if you think about it (fear of deposit haircuts) perhaps even be perceived to be positive.

What do the Danes think?

Denmark cut interest-rates to -0.75% back on February 6th so we have some information on the effects of such a move. Here are the latest thoughts of its central bank. It is happy that wholesale money markets have followed its move but the retail sector is much less clear.

Banks have not introduced negative interest rates for households, probably reflecting that negative interest rates could induce some households to cash in their bank deposits.

So 0% is proving to be a rubicon although not in all areas.

The rate of interest on corporate deposits moved into slightly negative territory for the first time in April 2015.

One area is to my mind outright dangerous.

Insurance companies and pension funds (the I&P sector)…… For the I&P sector, the rate was substantially negative in both March and April.

How will industries that offer long-term contracts many of whom rely in effect on positive interest-rates work in a world of negative interest-rates. I recall a comment pointing out that UK pensions now had illustrations showing negative returns well what if the average expectation becomes that?!

On the other side of the coin some mortgage borrowers will be doing something of a jig.

.Interest rates on adjustable rate loans with fixed interest periods up to and including three years fell into negative territory in January and February.

Before all this happened it was easy to assume that banks would plunge deposit rates into negative territory but it would appear that they are afraid to do for the reason stated below.

If bank customer deposit rates fall into negative territory, customers can convert their deposits to cash.

Banking would then begin to eat itself.


Savers may be mulling the trends above and letting out a sigh of relief about the apparent 0% barrier for retail deposit rates. But should they move to ban or tax cash it would disappear and they should be very afraid of the likely next step! Meanwhile the Willem Buiter view confirms that standing up for savers is very unpopular in both official and banking establishments.

Many of these will refer to negative nominal interest rates disapprovingly as ‘punishing savers’. Most of that is simply people talking their own books and/or a failure to distinguish between nominal and real interest rates.

He even tries a bit of what he presumably considers abuse by labelling such thoughts as “German” and counters by arguing this.

. But it is important to highlight that discouraging saving (and encouraging spending) is not a bug of significantly negative interest rates, but a feature.

I am not sure that savers would think that! Here we get to the nub of the issue which is twofold. Firstly central bankers have shifted the balance between savers and debtors in the credit crunch era to “improve demand”. However this shift has required ever higher doses of measures as we see interest-rates not only be reduced but we face the possibility and maybe probability that on this road we need ever more cuts in interest-rates. We are always on the edge of a cure which turns out to be a mirage and repeat. Or as Taylor Swift put it.

I knew you were trouble when you walked in
Trouble, trouble, trouble
I knew you were trouble when you walked in
Trouble, trouble, trouble

In essence we are back to the central bankers thinking they know better than us, of which the easiest critique is the existence of and record so far of the credit crunch.

So now the argument is that QE works whether it reduces or raises bond yields?!

It was only last Thursday  that I discussed and analysed a rise in Euro area bond yields. In fact it turned into such a plummet that it was something of a “flash crash” followed by a sharp rebound. Did it then settle down? Well yes but if we use the ten-year bond of Germany as an example then new yield level was 0.6% which is rather different to the 0.07% we had seen. Last night saw US Treasury Bond prices fell and yields rallied such that right now the ten-year yield is at 2.3% which is a new high for 2015. This has led to a new twist of the cycle as the ten-year bond yield of Germany has risen to 0.7%. So just as the consensus became “down, down” for bond yields we find that apparently “the only way is up”! Intriguing is it not in an era where central banks are operating asset purchases or Quantitative Easing (QE) to push yields lower?! What has happened to the central planners and is the pot boiling over.

The theory of QE

Regular readers will be aware that as events did not develop as it expected the Bank of England changed its view on QE quite a few times. In fact I stopped counting somewhere in the mid-twenties. This of course was a clear sign that things were not going  to plan and an additional one was the introduction of a long word called “counterfactual” in an attempt  to obscure that fact. However there were clear themes about what was supposed to happen in a QE influenced environment.

This cash injection lowers the cost of borrowing and boosts asset prices to support spending and get inflation back to target.

So we have an implication that bond yields are supposed to fall which is reinforced if we look back to the Bank of England Quarterly Bulletin for the 1st quarter of 2011.

 Central bank asset purchases, through this channel, push up the prices of the assets bought and also the prices of other assets.

So they bought UK Gilts totaling some £375 billion pushing up Gilt prices and thereby reducing Gilt of bond yields. That seems clear and they reinforced the theme.

Higher asset prices mean lower yields, and lower borrowing costs for firms and households, which acts to stimulate spending.

Okay and according to the Bank of England Gilt or bond yields did fall.

Summing over the reactions in gilt yields to each of the QE news events gives an overall average fall of just under 100 basis points.

So at that point they felt that they had reduced Gilt yields by 1% and according  to the theory below this boosted the UK economy.

Through lower borrowing costs and higher wealth, asset prices then raise demand, which acts to push up the consumer price level.

Indeed the Bank of England went so far as to suggest an impact of all these effects on  the economy.

this would suggest that QE may have raised the level of real GDP by 1 1/2% to 2% and increased inflation by between 3/4% to 1 1/2% percentage points.

So there you have it the transmission mechanism was that asset purchases boosted the economy via lower bond yields and that the effect was considerable. The Bank of England also put this into context with Base Rates.

would therefore suggest that the effect of QE was equivalent to a 150 to 300 basis point cut in Bank Rate,

Actually the Bank of England ended up doing more QE than analysed above. If we put aside the troubling issue that why was more needed if it was doing so well? Then we can proceed with the Bank of England view that something of the order of a 3.5% boost to GDP had been provided. Triple gins on the veranda all round!

Of course reality was not quite so convenient as the UK economy flat-lined around then which is odd considering the triumphant boost it had apparently provided! My argument is that the effect on savers and final salary pension funds sucked a lot of the boost out of the system. But if we stick with the official view we did see a shifting of the sands. Firstly we saw the use of the word “counterfactual” which was a retreat from claims of success to claiming that a calamity had been averted. Then we saw an explicit confession of failure which was the Funding for Lending Scheme of July 2012. After all if the outlook for QE was so bright why change course?!

But the official view was lower yields equals economic growth.

Market Liquidity

A side effect was that QE was supposed to boost this too according to the Bank of England.

When financial markets are dysfunctional, central bank asset purchases can improve market functioning by increasing liquidity through actively encouraging trading.

What changed?

Well if I deal with the market liquidity point we hear complaint after complaint that this has reduced. Indeed the bond market “flash crash” of last Thursday was littered with complaints of a lack of liquidity. Indeed I spotted this before as the ECB began to buy up the Greek bond market that volumes collapsed and these days so many bonds are on the balance sheets of the various central banks that perhaps something similar is happening. But this is exactly the reverse of what the ivory-tower theorists promised.

What about bond yields?

Under the previous theory the recent rise in bond yields must be bad after all if lower is good it must follow. So the ECB must be shaking its head as yields are now higher than when it began its 60 billion Euros a month of purchases. Apart from this being a failure for the central planners as some form of bond vigilant operation takes place it must mean that the QE plan is not working. Well get ready for this as we set yet another theoretical somersault. From Duncan Weldon of BBC Newsnight.

Now get ready for commentary saying rising bund yields show ECB QE is failing. It isn’t. QE is policy loosening – if it works, yields rise.

Let us go with the flow for a moment. The ECB QE is therefore working after only 3 months which is something of a record! Unfortunately nobody seems to have told the ECB about this new transmission mechanism and the emphasis is mine.

Furthermore, the ECB’s interventions will reduce yields on government bonds, which will set in motion a more conventional chain of propagation channels that will support the economic recovery and help bring inflation back to levels below, but close to, 2%.

In fact Benoit Coure of the ECB Executive Board was trumpeting the falls in yields and the likely economic effect as recently as the 10th of March.

It is important to stress that some of these mechanisms are already at work. Following the announcement of the expanded asset purchase programme on 22 January, we saw a decline in the forward interest rates across all maturities, as well as a decline in government and corporate debt yields, and a rise in equity prices. For example, 10- and 20-year government debt yields declined overnight by 14 and 19 basis points, respectively, in the case of France, and by 17 and 32 basis points in the case of Spain. [5] Note that a relatively more pronounced effect on longer-term government yields suggests that the duration channel is at work.

Up is the new down again?


This is becoming a common feature in the credit crunch era where logic is abandoned. We saw it in the official view to credit creation where monetary policy told banks to lend whilst financial policy told them to contract their balance sheets. The UK Financial Policy Committee later did an embarassing hand-brake turn on this issue. Now we see that QE apparently worked in the UK and US because bond yields fell and is now apparently working in the Euro area because they are rising. Is it a policy for all seasons and circumstances? Is it something of a Stalinist policy where success is declared regardless of the result? I think that theorists have been listening to Genesis.

This is a land of confusion.

I think that the central planners and their acolytes might do well to consider the following lyrics from the same song.

Ooh Superman where are you now
When everything’s gone wrong somehow
The men of steel, the men of power
Are losing control by the hour.

Yes they seem to have control over short-term bond yields of which so many in the Euro area remain negative. But longer maturities are misbehaving. Perhaps they will let us know which one is a sign of success?.Sadly no  doubt someone will claim both in which case it is time for Stealers Wheel.

Losing control, yeah, I’m all over the place,
Clowns to the left of me, Jokers to the right,
Here I am, stuck in the middle with you.

Meanwhile we can see one clear effect of the QE era in the news I think. From the BBC.

Picasso’s Women of Algiers has become the most expensive painting to sell at auction, going for $160m (£102.6m) at Christie’s in New York. The final price of $179.3m (£115m) includes commission of just over 12%.

The sale also featured Alberto Giacometti’s life-size sculpture Pointing Man, which set its own record. It is now the most expensive sculpture sold at auction, after going for $141.3m (£90.6m).

There are building signs of a global property bubble

It was only yesterday that I discussed and analysed the impact of the 60 billion Euros a month QE (Quantitative Easing) program of the European Central Bank. Later that day ECB President Mario Draghi gave himself and his colleagues a slap on the back by describing it thus.

In addition, there is clear evidence that the monetary policy measures we have put in place are effective.

Whilst confettigate occurred soon afterwards I do not think that the protestor who shouted “end the ECB Dicktatorship” was protesting this point,sadly. After all Mario was fulfilling one of the themes of this blog by shamefully attempting to take the credit for the economic boost to the area provided by the fall in the price. Perhaps with the Brent Crude Oil benchmark surging through the US $60 level he felt he had better be quick before it fades away!

However more quietly there was another impact on the day which was a further fall in bond yields as for example the ten-year yield of Germany has now fallen to 0.1% and in some ways even more extraordinarily the equivalent for France is 0.29%. Yesterday I pointed out that this was likely to be causing asset price inflation. So let us now also factor in the preceding efforts at QE from the Federal Reserve, Bank of Japan, Bank of England and Swiss National Bank (via investing its foreign currency reserves) and look at an impact of this.

Global Property

As bond yields fall in so many places investors looking for an income find it ever harder and they have to look elsewhere. This is symbolised in a way by the fact that the time it has taken me to write a paragraph the German ten-year yield has fallen to 0.09%! In such an environment bricks and mortar are something which investors can turn to as they appear physically at least to be an oasis of stability. But what happens if a tidal wave of cash heads in its direction? MSCI have pointed out some consequences. From the Financial Times.

Globally, property generated total average returns of 9.9 per cent in 2014 thanks to rapid capital value appreciation, MSCI found — the best performance since 2007 and the fifth consecutive year of increasing returns.

Okay so happy days for existing investors as well as hinting at how we got into our current malaise. You will not be surprised to read about the leaders of this particular pack.

UK real estate returned 17.9 per cent in 2014 while the US returned 11.5 per cent…..In London returns topped 20 per cent…… price rises in Dublin drove the total return in its real estate markets to hit a record 44.7 per cent — the best performer of all world cities in MSCI’s analysis.

Celtic Tiger mark two anyone?

But there is more.

MSCI found listed real estate companies had also significantly outperformed the world’s booming equity markets. Globally equities generated a 10.4 per cent return, but property stocks returned 19.5 per cent.

So the equity markets which of course are seeing their own QE boost with new high after new high being reported are being left behind by global property markets right now.

Yield and Rent

In essence this is the driving force as places which used to provide it such as sovereign bonds no longer do. So is it all about the rent? The catch is that whilst it is doing well when compared to a plummeting bond yield the outright position is much less cheery.

This is particularly the case in the US, where investors’ returns from rental income are now lower than before 2008, when a crash in massively overleveraged property triggered an international banking slump.

What could go wrong? Also the US is by no means alone.

Most global markets are at or close to historic low [yield] levels,

Of course faced with such a situation there is an inevitable response.

People are moving up the risk curve into riskier locations and taking on higher levels of debt and more challenging development activity.


To get a proper bubble we need for there to be substantial flows of money into that area from new and sadly usually credulous investors so what signs of that can we see?

the voracious spending — dubbed a “wall of capital” — has now spread out into riskier markets…….European QE was likely to boost real estate prices further, Mr Hobbs warned. “QE is sucking in real estate capital because debt finance is so cheap,” he said.

In the past year investment cash has poured into continental Europe — particularly the periphery — MSCI found.


Just under a year ago a sports shop on the Kings Road in Chelsea closed and it did so due to this. From the Evening Standard.

Michael Conitzer, who runs the shop, said he can no longer afford the rent, which was raised by 50 per cent at the review last year to more than £700,000.

My custom of the occasional T-Shirt and shorts purchase was clearly never going to finance that! But if we travel to a land down under to coin a phrase  we see the same thing according to the comments to the FT article.

In a suburb of Melbourne, in the high street and across the lane from a railway station, there is a shop that was brand-new 5 years ago and that has remained empty ever since. The asking rent was too high. Now, it has two adjoining shops that are also empty. (Alfred Nassim).

It got this reply from across the atlantic.

In a suburb of New York City, many of our favourite local restaurants have closed down over the last several years – the reason given by the owners was invariably:  “rent increases, can’t make ends meet”. (User_7995).

Not Everybody Agrees

The OECD compiles a price to rent database and concludes that whilst there are countries with severe imbalances (New Zealand heads the list) overall the situation is actually undervalued. Mind you it shows Ireland as undervalued as we wonder how  last years surge in prices in Dublin will impact the next set of data.

Also Jonathan Gray of Blackstone disagrees but then you could argue that he has a vested interest here.

Blackstone,the world’s largest private real estate investor,,,,,,Mr Gray just made a $26.5bn bet on the global property market.


There is much to consider here as we observe central bankers pumping up the volume in terms of providing liquidity and wonder where the hammer will fall? Of course consumer inflation measures are invariably neutered in this area as they mostly exclude asset prices. Thus asset price gains are presented as an increase in wealth and expected to increase economic output. For those who own property some of that is true as house price growth in the UK for example, has in the last couple of years has exceeded wider inflation and wages by quite a margin. But what about those who do not own property? Either they are left out or they face even higher prices and so they are not richer but are poorer. This leads to a generational issue as the asset rich are mostly older and the asset poor mostly younger. Accordingly my view is that this is more of an asset and wealth transfer than an increase in it.

But if we return to the QE reducing yields issue then we find ourselves mulling this from Germany. The numbers are for institutional property investment.

 The rental yield, including sunk costs, works out around 3%, with tax breaks if you hold for 12 years.

Or a bond yield fast heading to zero. Again what could go wrong?

Once this plays out and these matters invariably take longer than you think which market will central bankers pump up next? As to a musical accompaniment whilst you are thinking this through let us try Joe Walsh of the Eagles.

So I’m floating on a bubble while the world goes down the drain.
Slipping on the soap, running out of rope,
But all and all I can’t complain,
And that’s the rub according to the rules of the game.
The world’s going down the drain,
When the bubble bursts you might as well drink the cork and pop the champagne.
When the bubble bursts, the world goes down the drain.

If the world economy is doing so well why is everybody cutting interest-rates?

Today is European Central Bank day as we await details of the major part of its new Quantitative Easing Programme. It is also Bank of England day as it reaches the sixth anniversary of its cut to a supposedly temporary emergency Base Rate level of 0.5%. However cries of Happy Birthday to its interest-rate “lower bound” (or at least until Governor Mark Carney had yet another rethink) are likely to be drowned out by news of this.

Following the confirmation by the Serious Fraud Office (SFO) that it is investigating material referred to it by the Bank of England, the Bank can now confirm that it commissioned Lord Grabiner QC to conduct an independent inquiry into liquidity auctions during the financial crisis in 2007 and 2008.


Central Banks are supposed to investigate others not be investigated themselves as we add this to the LIBOR (Arise Sir Paul Tucker) and FOREX debacles. Oh and how about the auctions where it purchased some £375 billion of UK Gilts, I do hope that there was no early wire on those. The whole banking sector just gets ever more tainted doesn’t it? Oh and as to the Special Liquidity Scheme which is being investigated readers may want to look up the meaning of “Phantom Securities”. Let me help out a little from the Bank of England in March 2010.

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


ECB Interest-Rate reduction

Of course the official ECB interest-rate is a lowly -0.2% and apparently also the lower bound. There are a multitude of lower bounds around these days! But my main point here is that recent ECB interest-rate cuts have come in another area which is that of bond yields. When the rumours of a substantial ECB QE operation began in December 2014 the ten-year bond yield in Portugal was around 3% and it is now 1.88% illustrating the change seen here. Remember a default is still a considerable risk in Portugal as markets front-run central bank intervention or in other words create a false market. Something to consider as we mull the Fraud Office investigating the Bank of England.

Also other bond yields have dropped like a stone as this from today’s FT Alphaville section highlights.

Across all European investment grade credit, the proportion of issuance yielding more than 2 per cent has shrunk to just 5 per cent.

In less than a year the proportion yielding less than 0.5 per cent has gone from none to almost 1-bond-in-3

Yesterday all my troubles were so far away

Well apparently not in India and Poland so let us review what took place there. From the Reserve Bank of India.

reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.75 per cent to 7.5 per cent with immediate effect.


Okay why?

it is appropriate for the Reserve Bank to be pre-emptive in its policy action to utilise available space for monetary accommodation.


Preempting the boost from lower oil and commodity prices? Oh hang on a minute…

Now Poland as the NBP makes its move.

The Monetary Policy Council decided to decrease NBP interest rates by 0.50 percentage points: reference rate to 1.50% on an annual basis;

I believe that is an all-time low for interest-rates in Poland and the rationale was/is?

In Poland, the pace of economic growth in 2014 Q4 slowed down slightly, but stayed close to 3%……..The seasonally-adjusted unemployment rate has been declining driven to a large extent by rising employment.

So we find that Poland joins Sweden in cutting interest-rates at a time of strong economic growth. That of course used to be a rationale for raising interest-rates! Indeed you may note that the NBP spoke of an improved economic forecast as well.

At the same time, the annual GDP growth rate – in
line with this projection – will be with a 50-percent probability in the range of 2.7÷4.2% in 2015 (as compared with 2.0÷3.7% in the November 2014 projection), 2.2÷4.4% in 2016 (as compared with 1.9÷4.2%) and 2.4÷4.6% in 2017.

Up is indeed the new down these days!

Central banks are willing to “look through” a good growth performance when inflation is low in the way that they do not do so when inflation is high! Asymmetry again.


The Financial Times has given us an explanation of why China cut interest-rates by 0.25% only last Saturday.

China’s ersatz parliament, the National People’s Congress, kicked off today. The leadership set its GDP growth target to “around 7 per cent”, down from the heady heights of much of the past two decades or so and even last year’s 7.5 per cent as the country enters a “new normal”.

I suppose it is a response to lower expected economic growth although many countries would love to be able to forecast an economic growth rate of 7%. However if we return to circumstances in India last weeks Economic Survey from the Finance Ministry tells a rather different story.

The reality and prospect of high and rising growth, combined with macroeconomic stability, is the promise of India going forward……In the coming year, real GDP growth at market prices is estimated to be about 0.6-1.1 percentage points higher vis-a-vis 2014-15. Using the new estimate for 2014-15 as the base, this implies growth at market prices of 8.1-8.5 percent in 2015-16.

So both falling economic growth and rising economic growth are now reasons for an interest-rate reduction?! Actually there is something even more extraordinary in the Indian situation as the upwards arrow on the chart shows quarterly growth exceeding 10% on an annualised basis. Yes this is a country which has now cut the official interest-rate twice so far in 2015.

Whatever happened to the BRICs?

For those unaware this acronym was a produce of a Vampire Squid employee and covered Brazil,Russia,India and China. I have covered the interest-rate cuts in India and China so what about the other two? Well Russia has found itself forced into interest-rate rises by the fall and indeed plummet in the value of the R(o)uble and last week as Brazil raised interest-rates to 12.25% it was in the same position although in the explanatory statement you have to look very hard to find it.

combined with the depreciation of the BRL (Brazilian Real)

Perhaps the latest rise to 12.75% will have it.


This article could have been entitled the rise of the disappearing interest-rate! Of course not everybody has cut this year as Brazil and Ukraine for example have raised interest-rates but they have in effect been forced to by the fall in their exchange-rates. The discretionary or voluntary moves have all been downwards. Even Russia had a 2% trim in early February. If we now move to economies where central banks promise interest-rate increases such as the Bank of England and the Federal Reserve of the United States then they will really be bucking a trend if they do so. I feel that they are promising something that they hope they will find it not necessary to deliver or another form of “open mouth operations”.

As for the US Federal Reserve well it has been here before. From the Wall Street Journal.

Philadelphia Fed President Charles Plosser was already looking ahead to raising interest rates. His forecast for inflation, he said on April 28, “requires that we begin raising the funds rate by the end of this year, certainly by early next year, and then continue to raise it throughout the forecast period. I have it reaching 3½ percent by the fourth quarter of 2011.” In fact, the federal funds rate has remained lodged near zero since December 2008,

I am not so sure that JP Morgan via ZeroHedge are right with this call but I would not be surprised if the ECB did go further into negative territory.

ECB will reduce interest for cash deposits to minus 3% 

As to my view on any such scenario well let me hand you over to the delightful Ms. Taylor Swift.

I knew you were trouble when you walked in
So shame on me now
Flew me to places I’d never been
Now I’m lying on the cold hard ground
Oh, oh, trouble, trouble, trouble
Oh, oh, trouble, trouble, trouble