“All bets are off” as the Bank of England holds a “secret” press conference

Today is the turn of the Bank of England to take centre stage. On a personal level it raises a wry smile as when I was a market maker in UK short sterling options (known as a local) on the LIFFE floor it was the most important day of the month and often make or break. At other times it has been a more implicit big deal. Actually there is no likely change to short-term interest-rates on the cards. Perusing my old stomping ground shows that in fact not much action is expected at all with a pretty flat curve out to March 2024 when maybe a rise to the giddy heights of 0.25% is expected. Personally I think there is a solid chance we will see negative interest-rates first but that is not how the market is set this morning. Also I note that volumes are not great suggesting they are not expecting much today either.

If course some may be “more equal than others” to use that famous phrase as the Monetary Policy Committee voted last night following one of the previous Governor’s ( Mark Carney) “improvements”. He was of the opinion that getting his Minutes and PR prepared was more important than the risk of the vote leaking. Whereas the reality is that central banks are in fact rather leaky vessels.


There will have been consternation at the Bank of England when this news arrived at its hallowed doors. From the BBC.

The UK’s biggest building society has tripled the minimum deposit it will ask for from first-time buyers. The Nationwide will lower its ceiling for mortgage lending to new customers in response to the coronavirus crisis.It said the change, from Thursday, was due to “these unprecedented times and an uncertain mortgage market”.

I do not know if the new Governor Andrew Bailey has the same sharp temper as his predecessor Mark Carney but if he does it would have been in display. After all policy is essentially to get the housing market going once we peer beneath the veneer. Nearly £118 billion of cheap funding ( at the Bank Rate of 0.1%) has been deployed via the Term Funding Scheme(s) to keep the housing market wheels oiled. Also the news looks timed to just precede the MPC meeting.

In terms of detail there it is aimed at first-time buyers which is only likely to anger the Governor more.

First-time buyers are likely to be the most significantly affected because they often have smaller amounts saved to get on the property ladder.

Nationwide has reduced the proportion of a home’s value that is willing to lend from 95% to 85%.

So for example, if a property costs £100,000, a new buyer would now need a £15,000 deposit rather than a £5,000 deposit.

If we look back in time this is a familiar feature of house price falls. As mortgage borrowing becomes more restrained that by its very nature tends to pull house prices lower. For larger falls then it usually requites surveyors to join the party by down valuing some properties which as they are pack animals can spread like wildfire. The quote below shows that the situation is complex.

Some lenders, such as HSBC, still have mortgages with a 90% loan-to-value ratio. However, there is more demand for that type of mortgage than many banks have the capacity to deal with at the moment, he said.


We have already seen an extraordinary set of moves here. We have a record low interest-rate of 0.1% which is quite something from a body which had previously assured us that the “lower-bound” was 0.5%. There is a link to today’s news from this because it was building societies like the Nationwide and their creaking IT systems which got the blame for this, although ironically I think they did us a favour.

Next comes a whole barrage of Quantitative Easing and Credit Easing policies. The headliner here is the purchases of UK bonds ( Gilts) which by my maths passed the £600 billion mark just before 2 pm yesterday as it progresses at a weekly rate of £13.5 billion. This means that they are implicitly financing the UK public-sector right now, something I pointed out when the Ways and Means issue arose. We see that as I note that the UK Debt Management Office has issued some £14.4 billion of new UK bonds or Gilts this week. Whilst the Bank of England did not buy any of these it did oil the wheels with its purchases which means that the net issuance figure is £900 million which is rather different to £14.4 billion. On that road we see how both the two-year yield ( -0.07%) and the five-year yield ( -0,02%) are negative as I type this. Even the fifty-year yield is a mere 0.38%.

There has also been some £15 billion of Corporate Bond buying so far. This policy has not gone well as so desperate are they to find bonds to buy that they have bought some of Apple’s bonds. Yes the company with the enormous cash pile. Also I sure the Danes are grateful we are supporting their shipping company Maersk as it appears to need it, but they are probably somewhat bemused.

As to credit easing I have already noted the Term Funding Scheme and there is also the Covid Financing Facility where it buys Commercial Paper. Some £16.3 billion has been bought so far. Those who like a hot sausage roll may be pleased Greggs have been supported to the tune of £30 million, although North London is likely to be split on tribal lines by the £175 million for Spurs.


These days central banks and governments are hand in glove. Operationally that is required because the QE and credit easing measures require the backing of the taxpayer via HM Treasury. More prosaically the Chancellor Rishi Sunak can borrow at ultra low levels due to Bank of England policies and will do doubt raise a glass of champagne to them. Amazingly some put on such powerful sunglasses that they call this independence. Perhaps they were the ones who disallowed Sheffield United’s goal last night.

However the ability to help the economy is more problematical and was once described as like “pushing on a string”. This is not helped by the issues with our official statistics as we not inflation has been under recorded as I explained yesterday as has unemployment ( it was 5% + not the 3.9% reported) and the monthly drop of 20.4% in GDP has a large error range too. Because of that I have some sympathy for the MPC but I have no sympathy for the “secret” press conference it is holding at 1 pm. Then its “friends” will be able to release the details at 2:30 pm with no official confirmation until tomorrow.

So there are two issues. That is a form of corruption and debases what is left of free markets even more. Next it is supposed to be a publicly accountable institution with transparent policy. Along the way it means that the chances of a more aggressive policy announcement have just risen or as the bookie says in the film Snatch.

All bets are off

The Tokyo Whale is hungry again!

A new week has started with something which we will find awfully familiar although not everyone will as I will explain. But first let me give you something of a counterpoint and indeed irony to the news.

SINGAPORE (Reuters) – Oil prices fell on Monday on signs that worldwide oil storage is filling rapidly, raising concerns that production cuts will not come fast enough to fully offset the collapse in demand from the coronavirus pandemic.

U.S. oil futures led losses, falling by more than $2 a barrel on fears that storage at Cushing, Oklahoma, could reach full capacity soon. U.S. crude inventories rose to 518.6 million barrels in the week to April 17, near an all-time record of 535 million barrels set in 2017. [EIA/S]

In ordinary times this would be a case of let’s get this party started in Japan. This is because it is a large energy importer and thus it would be getting both and balance of payments and manufacturing boost. In itself it would have been extremely welcome because you may recall that its economy had seen a reverse before the present pandemic.

The contraction of Japan’s 4Q 2019 GDP was worse than expected, coming in at -1.8% q/q (- 7.1% annualized rate) versus the first estimate of -1.6% q/q (-6.3% annualized rate) as the contraction in business spending was deeper than what was first reported in February, ( FXStreet )

So the land of the rising sun or Nihon was already in what Taylor Swift would call “trouble, trouble,trouble”, The raising of the Consumption Tax ( what we call VAT) had in an unfortunate coincidence combined with the 2019 trade war. The former was rather like 2014 as we mull all the promises it would not be. Also let me give you a real undercut, Japan acted to improve its fiscal position just in time for it to be considered much less important.

The Tokyo Whale

Let me open with something which for newer readers may come as a shock.

The Bank will actively purchase ETFs and J-REITs for the time being so that their amounts outstanding will increase at annual paces with the upper limit of about 12 trillion
yen and about 180 billion yen, respectively.

Yes the Bank of Japan is buying equities and has just suggested it will double its annual purchases of them. Those who follow me will be aware it has been buying more as for example it is now buying around 120 billion Yen on the days it buys ( nine so far in April) as opposed to the previous 70 billion or so having bought over 200 billion when equity markets were hit hard. The detail is that it buys via Exchange Traded Funds ( ETFs) to avoid the embarrassment of having to vote at AGMs and the like.

Oh and in another familiar theme upper limits are not always upper limits.

With a view to lowering risk premia of asset prices in an appropriate manner, the Bank may increase or decrease the amount of purchases depending on market conditions.

Also the ,you may note that the limit for commercial property purchases has been doubled too. I do sometimes wonder why they bother with the commercial property buys although now we have an extra factor which is that in so many places around the world commercial property looks under a lot of pressure. For example if there is more working from home as seems likely.

The Precious! The Precious!

Japan has an official interest-rate of -0.1% but not for quite everybody.

(3) apply a positive interest rate of 0.1 percent to the outstanding balances of current accounts held by financial institutions at the Bank that correspond to the amounts outstanding of loans provided through this

For whom?

Twice as much as the amounts outstanding of the loans will continue to be included in the Macro Add-on Balances in current accounts held by financial institutions at the Bank.

Yes the banks and as you can see they will be a “double-bubble” gain from lending under the new Bank of Japan scheme. I wonder if the Japanese taxpayer has noted that extension of operations to the private debt sphere as well?

expand the range of eligible collateral to private debt in general, including household debt (from about 8
trillion yen to about 23 trillion yen as of end-March 2020),

Corporate Bonds and Commercial Paper

I have highlighted another risk being taken on behalf of the Japanese taxpayer.

The Bank decided, by a unanimous vote, to significantly increase the maximum amount
of additional purchases of CP and corporate bonds and conduct purchases with the upper
limit of the amount outstanding of about 20 trillion yen in total. In addition, the maximum amounts outstanding of a single issuer’s CP and corporate bonds to be purchased will be raised substantially.

Should there be a default there might be trouble.

The Bank will increase the maximum share of the Bank’s holdings of CP and corporate
bonds within the total amount outstanding of issuance by a single issuer from the current
25 percent to 50 percent and 30 percent, respectively.

Surely at any sign of trouble everyone will simply sell to the Bank of Japan which will then be a buyer of more like first than last resort.

Who will provide the grand design?
What is yours and what is mine?
‘Cause there is no more new frontier
We have got to make it here ( The Eagles )

Japanese Government Bonds

This is something we have been expecting and just as a reminder the previous target was between 70 and 80 trillion Yen a year.

The Bank will purchase a necessary amount of JGBs without setting an upper limit so that 10-year JGB yields will remain at around zero percent.

It is hard to get too worked up about that as we have been expecting it to be along. In theory the plan remains the same, although there is a slight shuffle as in the past they have indicated a range between 0% and -0.1%.


The first issue is that the Japanese economy is doing extremely badly. It already had problems and the PMI business survey suggested a GDP decline of the order of 10%. With its “face” culture that is likely to be an underestimate. In response there has been this.

The Japanese government has outlined details of its plan to hand out 100,000 yen, or more than 900 dollars, in cash to all residents as part of its economic response to the coronavirus outbreak.

The cash handouts will go to every person listed on Japan’s Basic Resident Register, regardless of nationality. ( NHK)

They tried something like this back in the 90s and I remember calculating it as £142 as compared to £752 this time. As to adjusting for inflation well in the Lost Decade era Japan has seen so little of that.

So we see that the Bank of Japan is underwriting the spending plans of the Japanese government which of course is the same Japanese government which underwrites the bond buying of the Bank of Japan! It seems set to make sure that the Japanese government can borrow for free in terms of yield as I note this.

In case of a rapid increase in the yields, the Bank will purchase JGBs promptly and appropriately.

In fact just like a parent speaking to a child you can indulge in the JGB market but only if you play nicely.

While doing so, the yields may move upward and downward to some extent mainly depending on developments in economic activity and prices.

You will find many cheering “Yield Curve Control” although more than a few of those will be hoping that there claims that the Bank of Japan will need to intervene less have been forgotten. Actually there have been phases where it has kept yields up rather than down.

In the future will the Bank of Japan own everything?

The Express

I have done some interviews for it recently and here is one on the benefits of lower oil prices


Podcast on central bank equity purchases


My report card for the Bank of England in the Covid-19 crisis

The advent of the Corona Virus pandemic has seen the Bank of England expand its activity beyond what we already considered to be extraordinary levels. There has been very little criticism I think for two reasons. Many of the new moves are not understood especially by the mainstream media and also they like to copy and paste official communiques of which there have been plenty! So let us work our way through the new policies to see the state of play.

Financing the UK government’s borrowing

Last week we looked at two factors here. The first is the QE ( Quantitative Easing) purchases which are presently running at a weekly rate of £13.5 billion and have so far totalled £35 billion in this phase. This meant that last week the UK did this.

 if we allow for the Bank of England purchases we remain net buyers of the order of £1.3 billion.

So issued debt in gross terms but via the Bank of England bought more. That looks to be a similar situation for this week as it buys the same amount and the UK Debt Management Office plans to issue some £10 billion of UK Gilts in nominal terms. The amount raised will be more than that ( the surge in the Gilt market means the majority of Gilts trade over 100) but as you can see we look to be heading for a similar result.

So we can switch now to the result. On a basic level we see that the UK government can finance itself and at quite a rate as we are issuing debt at a rate of £12 billion or so a week. This is quite a rate! Also we are able to do so very cheaply as the fifty-year yield is 0.48% and the benchmark ten-year is 0.31% as I type this.

On a more minor level let me add in the Ways and Means account which some got so excited about at the end of last week. This is because it is likely to be smaller than the amounts above. I have just asked them for this week’s update.

Corporate Bonds

This is a much more awkward area for the Bank of England. That may be why in spite of Corporate Bond purchases being ongoing its data only goes up to April 1st! Actually the use of April Fools Day is appropriate in some ways and let me explain why. Regular readers will recall that last time the Bank of England struggled to find corporate bonds to buy and ended up buying the Danish shipping company Maersk. No doubt it and the Danish government were grateful.

Well on today’s list are that well know UK technology company Apple as well as IBM. Whilst you could make a case for buying BMW via the Mini operations here will the Bank of England be racing the ECB to buy its bonds? Anyway the operation will provide us with plenty of amusement over time if history is any guide.

Covid Corporate Financing Facility

Let me open with the scale of the operation so far.

Total amount of CP purchased since 02 April
£3.626bn (data as at close 8 April 2020).

It seems worthy enough but as we look at the details I start to get troubled.

The facility is designed to support liquidity among larger firms, helping them to bridge coronavirus disruption to their cash flows through the purchase of short-term debt in the form of commercial paper.

Term Funding Scheme

This has a new incarnation as after all we must keep supporting The Precious.

Following today’s special meeting of the MPC the Initial Borrowing Allowance for the TFSME will be increased from 5% to 10% of participants’ stock of real economy lending, based on the Base Stock of Applicable Loans.

I wonder how they would define fake economy lending? We may yet find out. Anyway as is typical the help for smaller businesses is not yet in play so this is something of a fail and may yet be a grand fail as there are signs that more than a few businesses have folded already.

One thing that finally swung my partners into throwing up their hands and decide retiring was preferable was the hoops we’d have had to jump through to raise money at short notice. ( @MattBrookes3)

There are other reports of problems in funding getting to smaller businesses.

Gary Crosbie wants to keep his staff on, but like other small firms, his profitable business now faces running out of cash owing to the coronavirus shutdown.

Mr Crosbie runs Inter-Refurb, which refurbishes pubs, hotels and restaurants.

He says he can demonstrate three years of profits, with £50,000 cash in the bank.

Yet because his bank decided it didn’t wish to support the construction industry, he failed the test that required banks only to lend according to their pre-shutdown criteria. He was rejected for a government-backed loan last week. ( Andy Verity of the BBC)

There is quite a contrast here between smaller businesses who need money now but are not getting it and The Precious who still have some £107 billion from the previous Term Funding Scheme in their coffers.


There are mortgage holidays in play so let us look as those as after all it is the area about which the Bank of England is most concerned if its track record is any guide.

Lenders have provided over 1.2 million mortgage payment holidays to households whose finances have been impacted by Covid-19, UK Finance has revealed today.

On 17 March, just under a month ago, mortgage lenders announced they would support customers facing financial difficulties due to the Covid-19 crisis. Three weeks later, by Wednesday 8 April, over 1.2 million mortgage borrowers had been offered a payment holiday by their lender.

The action taken by lenders means that one in nine mortgages in the UK are now subject to a payment holiday, helping households across the country through this difficult time. For the average mortgage holder, the payment holiday amounts to £260 per month of suspended interest payments, with many benefitting from the option of extending the scheme for up to three months. ( UK Finance)

However that starts to look like PR spinning when we note this.

And once credit card or mortgage payment holidays end (1 in 9 of us have the latter), we’ll have more debt to pay off – because what isn’t talked about enough is that interest charges will still being calculated – and then added to the amount owed. ( @GCGodfrey)

Here is a song for the banks from Hot Chocolate.

So you win again, you win again
Here I stand again, the loser.

US Dollar Liquidity Swaps

These are proving to be a success on two fronts. Firstly US Dollars are available and secondly the amounts required have been falling. At the peak some US $37.7 billion required but as of yesterday that had fallen to US $21.9 billion.


As you can see there are various layers here. If we start with what has become the modus operandi for QE which is facilitating and financing government spending then it is a success. The UK can borrow both in size and extremely cheaply right now. That is a good idea for the crisis but of course we know that such things have a habit of becoming permanent and then the issue changes.

Next we see that larger companies will be pleased with the Bank of England action including some foreign ones. This creates problems because whilst I do not want companies to fail because of cash flow issues created by the pandemic we arrive yet again at the Zombie businesses issue. One of the reasons we spent so much time in the credit crunch was that the march of the Zombies just carried on and on and on. In this category we can class the banks because in spite of the “resilient” rhetoric and all the support we see that we are invested in Royal Bank of Scotland at around a fiver compared to a share price of £1.10.

Smaller companies will be wondering when the help will start? Let me take you back to March 26th.

Hopefully my late father is no longer spinning quite so fast in his Memorial Vault ( these things have grand names).  That is assuming ashes can spin! We seem to be taking a familiar path where out of touch central bankers claim to be boosting business but we find that the cheap liquidity is indeed poured into the banks.

As to mortgage lending we see that the banks will be getting liquidity at 0.1%, but they are piling debt excuse me help on borrowers at a lot higher rate.

So it is a patchy report card where there are successes but they are not reaching the ordinary person or business. Reality contrasts starkly with the words of Governor Carney from the 11th of March.

I’ll just reiterate that, by providing much more flexibility, an ability to-, the banking system has been put in
a position today where they could make loans to the hardest hit businesses, in fact the entire corporate
sector, not just the hardest hit businesses and Small and Medium Sized enterprises, thirteen times of
what they lent last year in good times.



What has been the economic impact of Bank of England QE?

Whilst the casual observer might think that the QE era is over in fact it is alive and kicking with the Bank of England in action again this afternoon.

Date of operation 26/03/18
Total size of operation Stg 1,220mn
Stocks offered for purchase

This is part of what has become called an Operation Twist style manouevre where maturing bonds held by the Bank of England are reinvested in the market. It is in fact an expansion of the policy not so much today as relatively short-term Gilts are purchased but tomorrow it will stretch out to 2065 as longer maturities join the party. Also if you look at the third Gilt on the list there is a reminder of when the August 2016 Sledgehammer QE launched a kamikaze style assault on the Gilt market and the ten-year yield fell to 0.5%. Of course it was not a ten-year itself but it was a child of those times as I mull whether we will see its like again?

The answer to that question is not without another surge of buying from the Bank of England which brings us to an economic benefit from the current QE. It is that it allows the UK government to borrow more cheaply. This of course has been true of all phases and poses the question of whether this was the real point all along? Initially probably not as the Bank of England struggled to deal with the credit crunch but as time passed as governments got used to borrowing cheaply I am sure there will have been pressure for that to continue. You will have your own thoughts on this. From my perspective I think it is a combination of the Bank of England being nervous on the subject as I discussed on Friday and pressure from the establishment. After all how often does this get a mention outside of on here?

Without QE the UK government would not be able to borrow at 1.47% for ten years as it can this morning. Quantifying the exact impact is near impossible though as we are impacted by foreign QE purchases as for example Japanese and European buyers would be along if our yield rose. But buying £435 billion out of £1,547 must have had an impact especially as the latter number includes index-linked Gilts which have not be bought.

Corporate Bonds

This is another area which tends to get forgotten. On Friday a Bank of England working paper entered the fray.

As part of its August 2016 policy package, the Bank of England announced a scheme to purchase up to
£10 billion of corporate bonds. Only sterling investment-grade bonds issued by firms making a ‘material’
contribution to the UK economy were eligible to be purchased.

I put in the last bit as there were a lot of questions about some of the companies on the list as this from the Guardian from the 13th of September 2016 highlights.

When the list of eligible companies was published on Monday, one major bond dealer said he was astonished at the names included.

Verizon, a US cell phone network, is on the list, as is another big US telecoms company, AT&T, despite both firms arguably having minimal operations in the UK.

I have pointed out in the past the purchases of the corporate bonds of Maersk the Danish shipping company for which the Danes were no doubt grateful. Indeed Especially grateful as Maersk found stormy waters.

But what about the gains?

These purchases were aimed at stimulating investment activity by lowering corporate bond yields which reduces firms’ borrowing costs and stimulates
new issuance………We find that compared to sterling investment-grade corporate bonds that are
not eligible for the CBPS, the spreads of eligible bonds decreased by about 2-5bps after the announcement of the scheme.

Not much so they had another go.

Compared to corporate bonds denominated in USD, spreads of sterling assets fell by 13.8bps, and compared to
EUR bonds by 13bps after the policy was announced.

We are told that this is the lower bound for the impact ( where have we heard that before?) but unfortunately for the authors the answer is rather similar to the initial foray into private-sector assets by the European Central Bank.

: Beirne et al. (2011) who estimate the effect of the
ECB’s covered bond purchase program (CBPP) that took place between 2009 and 2010. They find that the CBPP lowered euro area covered bond yields by about 12bps.

So the conclusion is that there is not much of an impact at all. Although whilst the Bank of England may think this I am not sure anyone else does.

Because the announcement of the CBPS caught the market by surprise,

After it had promised a “Sledgehammer” I am not sure that anything of that sort could be a surprise. However let us move on with the conclusion that the Bank of England was right in 2012/13 when it made some purchases but then gave up as the impact seems minimal.

What about QE overall?

If we go back to a sort of mainlining QE we have been told this by the Bank of England.

According to the reported estimates of the peak
impact, the £200 billion of QE between March 2009 and
January 2010 is likely to have raised the level of real GDP by 1½% to 2% relative to what might otherwise have happened, and increased annual CPI inflation by ¾ to 1½ percentage points.

As you can see central banking research implicitly assumes that higher inflation is a good thing although oddly post the EU leave vote not so much. But if we look at the level of QE we have now then the economic impact is a bit over double that. Keen to make people individually better off the Bank of England also calculated this.

£500–£800 per person in aggregate

Updating that brings us to £650 – £1070

Or to put the effect another way.

For comparison, a simple ready-reckoner from the primary forecasting model used by the Bank of England suggests that a cut in Bank Rate of between 250 and 500 basis points would have been required to achieve the same effect.

Personally I think that this is far from the best example as whilst my theory is untested a Bank Rate between -2% and -4.5% would in fact lead to the collapse of the  pension system and torpedo the banks.


There is a fair bit to consider here. Firstly there is the moral hazard of the research being carried out by the body implementing the policy.. For supporters there must be nagging worry which goes as follows. If it was so good why do we still need it? We continue to make purchases to maintain the stock at £435 billion. In my view the main gainer from that is the government as it can borrow more cheaply. Also the research clearly implies that higher inflation is a good thing when one of the main impacts of the credit crunch both collectively and at the individual level is lower real wages where  inflation is a factor.

Then there is the issue of where the gains from QE went.

By pushing up a range of asset prices, asset purchases have
boosted the value of households’ financial wealth held
outside pension funds, but holdings are heavily skewed with
the top 5% of households holding 40% of these assets.

By definition wealth effects are unlikely to help those hardest hit by the credit crunch. Also Bank of England rhetoric that pensions ( mostly meaning defined benefit ones) were unaffected by this was undermined by its own actions.

It has emerged that employees, led by the Bank’s governor, Mark Carney, received the equivalent of a 50%-plus salary contribution into their pensions last year, underwritten by the taxpayer. ( the Guardian February 2016).

Next is the issue of propping up zombie companies and banks after all wasn’t RBS supposed to be surging into the future some years back?

Will we one day conclude that whilst QE may have had some impacts over time the side-effects build up and eventually would make it a negative.


The problem that Steinhoff poses for both QE and the ECB

Yesterday ECB President Mario Draghi was in bullish mood and in some ways why not as the economy of the Euro area has had a good 2017. He was also able to spread some Christmas cheer by raising the economic growth forecasts.

Draghi: GDP projections: 2.4% in 2017 [2.2% in Sept], 2.3% in 2018 [1.8%], 1.9 in 2019 [1.7%] and 1.7% in 2020

However there was an issue which gave a sour note to proceedings and it came from a topic I looked at on the 7th of this month which is the saga of Steinhoff holdings.

The initial response was one of deflection.

Your second point about the bonds, well, first of all let me say that this programme is one of our policy tools that we consider important – very important – for the attainment of our mandate.

Sadly this remained unchallenged because if you reduce corporate bond yields there is a long and winding road at best to you achieving an inflation target of 2% per annum. This from the ECB August Economic Bulletin is derisory in some respects.

 In pursuing its objective of maintaining price stability, the ECB is mandated to act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources.

How is favouring larger companies by allowing them to fund more cheaply and perhaps for bigger amounts “free competition”? Smaller companies would not consider it to be like that. If you look at the data the issue of an “open market economy” is called into question as well.

CSPP holdings stood at €92 billion as at 7 June 2017, corresponding to around 11% of the CSPP-eligible bond universe.

As the holdings are now 130.2 billion Euros then presumably it owns over 15% now. At what point are markets not open? Also and something that is relevant to the current problem is that the biggest gainers have been companies who are at the riskiest end of the investment grade spectrum. If we allow for an anticipation effect then five-year yields for BBB- companies have fallen from over 3% to more like 1%.  Thus a side -effect is that nearly all the “yield for risk” if I may put it like that has been removed from the “open market” here. Here is a crux of the matter which is that the ECB is subsidising such companies which opens quite a few dangers.

If we return to Mario Draghi we were told this.

 The scope of the programme is not to maximise profits or to avoid losses, so let’s keep this in mind. Having said that, running such big corporate programmes, it’s not unusual that losses may be happening.

Indeed it is going well.

Certainly we have a risk framework which has served us very, very well since the beginning of the existence of the ECB.

Or maybe not.

Certainly if we need to draw lessons we’ll do – we’ll certainly draw lessons from this experience. We are always open to improve, but as I said it’s been very, very good. Also as soon as we got news, we stopped buying.

I should think they did stop buying! “As soon as we got news” is quite a confession if you think about it. Also institutions regularly claim to draw lessons whereas in fact it is a type of kicking it into the long grass tactic as the media hounds move on and the perceived crisis passes.

Next in the deflection playbook is to rubbish existing reports.

Also let me add that the losses that had been reported are by and large exaggerated by a factor of 10 with respect to the actual measure of the losses.

You may note that no actual figure was mentioned in spite of this claim.

 we are different because we are much, much more transparent about our programme.

Anyway the losses are really not very important.

But having said that, having said all this, the losses are there. They are not realised and so the issue is, who’s going to pay for these losses? The answer is that these losses really represent a small digit factor number of our €1.6 billion net interest income we produced last year.

Number Crunching

It looks as though someone has leaked something as the Financial Times is reporting this.

The ECB this year bought parts of a €800m bond issued by Steinhoff and is thought to hold about €130m. The bond is due to mature in early 2025 and has a coupon of 1.875 per cent. The bond was acquired by Finland’s central bank as part of the ECB’s bond-buying programme.

So no Chianti special reserve for the Governor of the Bank of Finland at the ECB Governing Council Christmas party just tap water.

Let me correct a mistake I have made which is that losses and profits in this programme are fully shared by the national central banks as it is part of the 20% below.

The ECB is committed to the principle of risk-sharing, and that’s why 20% of the purchases fall under the regime of full risk-sharing.


The news here goes from bad to worse.  From the FT.

Steinhoff on Wednesday night announced that the accounting irregularities are not only confined to the most recent fiscal year, which ended on September 30, but reached back into the previous one. “The 2016 consolidated financial statements will need to be restated and can no longer be relied upon,” the company said. On Thursday, Mr Wiese tendered his resignation from the board.

As I type this the share price is 8.4 Rand in Johannesburg a far cry from the 45.65 Rand on the 5th of December and nearly 6% lower today alone.

Ratings Agencies

Who could possibly have expected this?

Bankers said that they were caught off-guard because Steinhoff had enjoyed an investment grade rating from Moody’s. ( FT)

The lesson of the credit crunch era that ratings agencies were if not obsolete holed below the waterline seems to have bypassed not only the ECB but the banks.

Wall Street banks including Bank of America and Citigroup are facing potential losses of more than €1bn on loans made to the billionaire backer of Steinhoff International, the South Africa-based home retailer whose shares collapsed last week after disclosing accounting irregularities.  The banks lent €1.6bn to then Steinhoff chairman Christo Wiese in September 2016, which was secured against €3.2bn worth of Mr Wiese’s shares in the company, according to public documents issued by Steinhoff.

As you can see the highly paid banking analysts have been wrong-footed again, will they bear the sort of responsibility those lower in the pecking order would face? It seems unlikely as after all with a central bank having made a mistake too they may step away from the area. Also banks will make mistakes with their lending but the stand out issue here has been summarised well by a reply to the FT.

Another “wizzkid shop owner” has put all their money in his wife’s name in a unfathomable legal system of a third world country.

There was another warning which is  that my late father regularly used to warn me that whilst some companies genuinely go on buying sprees others do so to cover up existing problems.


There is a lot to consider here as we mull the official ECB line.

Since the financial crisis of 2008, the ECB has adopted a number of unconventional policies that prompted critics to warn that it was about to incur huge losses. The fact is that, ever since its inception, the ECB has continued to make profits

The problem with that is the fact that it has in general been able to enforce this. For example Greece was forced to repay its bonds at par (100) when some form of default would have been far better for it. So the ECB made profits but Greece got more debt. This got so bad that the ECB in fact returned “profits” to Greece. In terms of other purchases it is still buying so newer buys make sure older buys make paper profits. When it comes to sell these bonds there may be a different story.

A four-stage process may apply.

  1. There is nothing to worry about we are making profits.
  2. Something may be happening and we will look into it and learn the lessons..
  3. Maybe we should do something but that is both difficult and dangerous to financial stability.
  4. Perhaps we should have done something but it’s too late now.

Meanwhile there is the issue of subsidising what may be zombie companies and worse. Also markets become ever more controlled and there is a clear bias away from  smaller companies to larger ones ossifying the economic system.

This issue will pop up with other central banks as for example the equity holdings of the Bank of Japan look good partly because it keeps buying. We will learn more when it stops. Also the Bank of England holds bonds on the troubled Maersk which may yet hit trouble although its new “improved” website may hide this.

Update 12.20 pm

Sometimes you really couldn’t make it up.


The murky world of central banks and private-sector QE

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

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

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

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

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

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

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

The ECB and Steinhoff

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

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

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

According to Reuters today has seen the same drum beat.

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

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

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

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

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

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

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

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

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

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

How much?

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

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


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

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

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

Me on Core Finance




What evidence is there for a bond market bubble?

There is a saying that even a blind squirrel occasionally finds a nut. I am left wondering about this as I note that the former Chair of the US Federal Reserve Alan Greenspan has posted a warning about bond markets. From Bloomberg.

Equity bears hunting for excess in the stock market might be better off worrying about bond prices, Alan Greenspan says. That’s where the actual bubble is, and when it pops, it’ll be bad for everyone.

Actually that is troubling on two counts. The simplest is the existence of extraordinarily high bond prices and low and in some cases negative yields. The next is that fact that his successors in charge of the various central banks may start pumping more monetary easing into this bubble to stop it deflating and it being “bad for everyone”. Indeed maybe this mornings ECB monthly bulletin is already on the case.

Looking ahead, the Governing Council confirmed that a very substantial degree of monetary accommodation is needed for euro area inflation pressures to gradually build up and support headline inflation developments in the medium term.

Let us look at what he actually said.

“By any measure, real long-term interest rates are much too low and therefore unsustainable,” the former Federal Reserve chairman, 91, said in an interview. “When they move higher they are likely to move reasonably fast. We are experiencing a bubble, not in stock prices but in bond prices. This is not discounted in the marketplace.”

I find it intriguing that he argues that there is no bubble in stock prices which are far higher than when he thought they were the result of “irrational exuberance” . After all low bond yields must be supporting the share prices of pretty much any stock with a solid dividend in a world where investors are so yield hungry that even index-linked Gilts have been used as such.

What is a bubble?

This is hard to define but involves extreme price rises which are then hard to justify with past metrics or measurement techniques. With convenient timing we have seen a clear demonstration of one only this week as something extraordinary develops. From Sky Sports News.

Sky sources: Neymar agrees 5-year-deal at PSG worth £450m, earning £515,000-a-week after tax. More on SSN.

One sign that we are in the “bubbilicious” zone is that no-one is sure of the exact price as I note others suggesting the deal is £576 million. You could drive the whole London bus fleet through the difference. The next sign is that people immediately assure you that everything is just fine as it is normal. From the BBC.

Mourinho said: “Expensive are the ones who get into a certain level without a certain quality. For £200m, I don’t think [Neymar] is expensive.

To be fair he pointed out that there would however be consequences.

“I think he’s expensive in the fact that now you are going to have more players at £100m, you are going have more players at £80m and more players at £60m. And I think that’s the problem.”

Of course Jose will be relieved that what was previously perceived as a large sum spent on Paul Pogba now looks relatively cheap. Oh and did I say that the numbers get confused?

PSG’s total outlay across the initial five-year deal will come to £400m.

If Sky are correct the high property prices we look at will be no problem as he will earn in a mere 8 months enough to buy the highest price flat they could find in Paris ( £18 million). The rub if there is one is that the price could easily rise if they know he is the buyer!

The comparison with the previous record does give us another clue because if we look at the Paul Pogba transfer it has taken only one year for the previous record to be doubled. That speed and indeed acceleration was seen in both the South Sea Bubble and the Tulip Mania.

Perhaps there was a prescient sign some years ago when the team who has fans who are especially keen on blowing bubbles was on the case. From SkyKaveh.

West Ham were close to signing Neymar from Santos in 2010. Offered £25m but move collapsed when Santos asked for more money

Back to bonds

If we look at market levels then the warning lights flash especially in places where investors are paying to get bonds. If we look at the Euro area then a brief check saw me note that for 2 years yields are negative in Germany, France, Belgium, Italy and Spain. For Germany especially investors can go further out in terms of maturity and get a negative yield. Does that define a bubble on its own as they are paying for something which is supposed to pay you?! There are two additional factors to throw in which is that the real yield situation is even worse as over the next two years inflation looks set to be positive at somewhere between 1% and 2%. Also if we look at Spain with economic growth having been ~3% or so a year for a bit why would you buy a bond at anything like these levels?

Another sign of a bubble that has worked pretty well over time is that you find the Japanese buying it. So I noted this earlier from @liukzilla.

“Japanese Almost Triple Foreign Bond Buying in July” exe: buy or + buy => like a double chocolate pie

Here we do get something of a catch as the issue of foreign investors buying involves the currency as well. Whether that is a sign of the Euro peaking I do not know but in a way it shows another form of looking for yield if you can call a profit a yield. Also there is an issue here of Japanese investors buying foreign bonds not only because there is little or no yield to be found at home but also because the Bank of Japan is soaking up the supply of what there is.


If we survey the situation we see that prices and yields especially in what we consider to be the first world do show “bubbilicious” signs. If we look at my home country of the UK it seemed extraordinary when the ten-year Gilt yield went below 2% and yet it is now around 1.2%. Of course the Bank of England with its “Sledgehammer” QE a year ago blew so much that it fell briefly to 0.5% in an effort which was a type of financial vandalism as we set yet again assets prioritised over the real economy. What we are not seeing is an acceleration unless perhaps we move to real yields which have dropped as inflation has picked up.

So far I have looked at sovereign bonds but this has also spilled over into corporate bonds especially with central banks buying them. We have seen them issued at negative yields as well which makes us wonder how that all works if one of the companies should ever go bust. Yet we also need to remind ourselves that there are geographical issues as we look around as Africa has double-digit yields in many places and according to Bloomberg buying short dated bonds in the Venezuelan state oil company yields 152% although the ride would not be good for your heart rate.



The Corporate Bond problem at the Bank of England

It is time to once again lift the lid on the engine of Quantitative Easing especially in the UK. As a I pointed out several weeks ago the ordinary version where sovereign bonds are purchased has reached its target of £435 billion ( to be precise £39 million below). However corporate bond purchases are continuing under this from the August 2016 MPC (Monetary Policy Committee ) Minutes.

the purchase of up to £10 billion of UK corporate bonds

This was to achieve the objectives shown below and the emphasis is mine.

Purchases of corporate bonds could provide somewhat more stimulus than the same amount of gilt purchases. In particular, given that corporate bonds are higher-yielding instruments than government bonds, investors selling corporate debt to the Bank could be more likely to invest the money received in other corporate assets than those selling gilts. In addition, by increasing demand in secondary markets, purchases by the Bank could reduce liquidity premia; and such purchases could stimulate issuance in sterling corporate bond markets.

Okay let me open with the generic issue of whether this is a better version of QE? This starts well if we look at the US Federal Reserve.

The FOMC directed the Desk to purchase $1.25 trillion of agency MBS ( Mortgage Backed Securities)……..The goal of the program was to provide support to mortgage and housing markets and to foster improved conditions in financial markets more generally.

Later it bought some more but here we see a case of a central bank buying assets from the market which was in distress which was a combination of housing and banking. We can see how this had a more direct impact than ordinary QE but applying that to the UK in 2016 has the problem of being years too late unless of course the Bank of England wanted to argue the UK economy was in distress whilst growing solidly in August 2016!

This is a clear change of course from Mark Carney as the previous Governor Baron King of Lothbury was not a fan and whilst the Bank of England had a plan for corporate bond QE in theory in practice it just kicked the ball around for a while and gave up. Why? Well as I have pointed out before the market is small because UK businesses are often international and issue in Euros and US Dollars so that the UK Pound market is reduced. This leads to the Bank of England finding itself having to purchase bonds from foreign companies and this week it is back offering to buy the bonds of the Danish shipping company Maersk.  No doubt it and Danish taxpayers are happy about this but I do hope one day we will get a Working Paper explaining how this boosts the UK economy more than ordinary QE.

The technical view

There are some suggested examples in the Financial Times today from Zoso Davies of Barclays.

Initially, this seemed to work. August and September 2016 witnessed a flurry of new deals in the sterling corporate markets despite the uncertainty created by the UK’s vote to leave the EU. Since then, however, companies’ interest in borrowing in sterling has fallen to levels similar to those seen in 2013 and 2014.

As you can see once the “new toy” effect wore off things seem to have returned to something of a status quo. The “new toy” effect was exacerbated because the borrowing was so cheap.

Borrowers have also benefited from somewhat better terms on their bonds. After the initial announcement, sterling credit spreads (the additional yield risk borrowers must pay relative to the UK government to borrow in sterling) came down sharply.

If we look back we see that not only did the UK ten-year Gilt yield drop towards 0.5% but the spread above it corporate bond issuers had to pay fell, so there was a clear incentive to borrow. The catch is that if we recall the “lost decade(s)” experience of Japan the link between that and productivity activity tends to fail. One rather revealing fact is that the article does not mention real economy benefits at all instead we get this.

Our analysis, based on the limited data available for corporate bond markets, suggests that trading activity has not picked up across the sterling market as a whole, implying that the Bank of England has been crowding out other market participants. That said, the evidence is far from convincing in either direction.

The price effect did not last either.

Since then, however, the sterling market has hardly moved, indicating that most of the market impact came from the announcement rather than their execution. And that lack of movement has been a marked underperformance versus dollar and euro credit markets, to the extent that sterling has returned to being a relatively expensive bond market in which to raise financing.

Of course we have a tangled web here because one of the factors at play is the the 208 billion Euro corporate bond purchases of the ECB have allowed some companies to be paid to borrow, or if you prefer issue at negative yields. This is from Bloomberg in January.

Henkel AG’s two-year note issued at a negative yield

Also its activities make us again wonder who benefits? From Credit Market Daily.

A big theme in 2015-16 was the amount US domiciled corporates funded in the euro-denominated debt markets. As shown in the chart above, it was a record 26% of the total volume in 2015 and 22% in 2016. Low rates everywhere, but lower in Europe along with low spreads made it attractive for US corporates to borrow in euros (even when swapped back to dollars)

So the Bank of England is supporting European corporates and the ECB US ones? Time for Kylie.

I’m spinning around
Move out of my way

The article ends with some points that pose all sorts of moral hazards.

If sterling corporate bond issuance collapses and secondary market volumes plummet, it will be clear that the Bank’s newest tool has been propping up this small corner of the fixed-income universe over the past six months. Conversely, the more graceful the exit from corporate bond buying, the less clear it will be that the CBPS has been much more than a placebo for markets.

So if borrowers want to borrow cheaply just go on an issuers strike? Also what if the lower yields have sent other buyers away and crowded them out? That would have created quite a mess.


There are a lot of issues here. Lets us look at the real economy where are the arguments that it has benefited? Whereas on the other side of the coin we can see that subsidising larger companies both ossifies the economy and would help stop what is called “creative destruction”. Whilst the productivity problem began before this program started is it yet another brick in the wall for it via the routes just described? As the Bank Underground blog puts it.

Since 2008, aggregate productivity performance in the UK has been substantially worse than in the preceding eight years.

Also whilst the Federal Reserve purchases of MBSs seems to have been a relatively successful version of QE we have to add “so far”. This is in the gap between the word “stop” and “end” as whilst it stopped new purchases it maintains its holdings at US $1.75 trillion. How can it sell these and what if there are losses which could easily be large? Will the Bank of England end up in the same quicksand? Frankly I think it is already in it.

Yes equity markets are higher but the one area in the UK that has surged in response to this extra monetary easing has been unsecured rather than business credit.




The Bank of England continues to extend its policy actions

Yesterday the Bank of England gave its latest policy statement and announcement. The headline announcements were policy was unchanged with Bank Rate remaining at 0.25%, that the £60 billion of government bond would continue and the £10 billion of Corporate Bond QE would begin on the 27th of this month as previously announced. There was an announcement however about another significant policy change.

As set out in the August Report, the Term Funding Scheme (TFS), which had been introduced as part of the policy package in August, would have an initial drawdown period of 18 months.

There will not be votes on this as of course banks need a certainty not available to anyone else! There is in fact also a clear change in the Monetary Policy Committee making this decision.

The MPC only expected to adjust the terms and length of the Scheme should macroeconomic conditions warrant it,

You see this is a type of replacement/addition to the Funding for (Mortgage) Lending Scheme or FLS  which was always announced in this form.

The Bank and HM Treasury launched the Funding for Lending Scheme (FLS) on 13 July 2012.

There has been a widening of the Bank of England’s remit here with little debate or actual announcement. A sort of financial equivalent of what the military call mission creep. Also the FLS has got forgotten by many but it still rolls on with some £60.6 billion of cheap finance provided to various banks of which some £33.1 billion went to Lloyds Banking Group.

Term Funding Scheme

I think that this is an extremely significant move and as it begins on Monday it is time to dig deeper. Here is the main definition.

The Term Funding Scheme (TFS or the Scheme) is designed to reinforce the transmission of Bank Rate cuts to those interest rates actually faced by households and businesses by providing term funding to banks at rates close to Bank Rate.

So cheap funding for banks which of course will put downwards pressure on bank deposit savings rates and presumably mortgage-rates too. Actually the money may be at Bank Rate.

For TFS Groups whose Net Lending over the Reference Period as a whole is positive, the fee will be 0bp per annum.

They can borrow up to this.

The Borrowing Allowance for each TFS Group will be set at 5% of its Base Stock plus an amount equal to its most recent Net Lending amount.

This is badged as being a boost to the economy although I note that the Financial Times spotted another familiar impact.

UK banks have a new funding scheme, as this week’s Bank of England interest rate cut increases pressure on the profitability of financial institutions.

Okay so how much will it boost bank lending to the economy? From the Inflation Report.

The MPC does not expect the TFS to lead to significantly faster aggregate loan growth.

So in essence it is a plan to boost the profits of the banking sector although I would not be surprised if like the FLS there is an impact on mortgage-rates. However even there we saw from the evidence of Switzerland yesterday that there appears to be something of a base for them even if official interest-rates go negative.

I shall watch this space for Monday.

Corporate Bond QE

There have been stirrings on this front and I would just like to remind readers of my analysis of this subject from the 23rd of August.

In essence this is yet another central banking program which helps larger businesses and in particular ones large enough to issue corporate bonds. Smaller and medium-sized businesses may reasonably feel that they have been left out again. If you think about it there will be an effect to ossify the financial system and the economy as larger companies which do not do well may simply issue corporate bonds and carry on regardless.

The news on this subject has gone down that line as this from the Financial Times indicates. From a reply by northshore.

Amgen, Maersk, Apple, AT&T, BASF, BMW, Bouygues, Cargill, Saint-Gobain, Daimler AG, Deutsche Bahn, Deutsche Telekom, Dong Energy, E.ON, Eastern Power Networks (Cheung Kong), EDF, Electricty North West (Colonial First State & JPMorgan), Engie, Eversholt, General Electric, Hutchison Whampoa, IBM, Linde, London power Networks (Cheung Kong), LVMH, McDonald’s, Mondelez, Nestle, Northern Gas Networks (Cheung Kong), Northern Powergrid (Berkshire Hathaway), Northumbrian Water (Cheung Kong), Paccar, Pepsico, Pfizer, Procter & Gamble, Roche, Scottish Power (Iberdrola), Siemens, South East power Networks (Cheung Kong), Suez, Thames Water (Macquarie), Total, Toyota, UPS, Vattenfall, Veolia, Verizon, Wales & West Utilities (Cheung Kong), Wal-Mart, Wessex Water (YTL Corp), Western Power Distribution (PPL).

We find that along the lines of my analysis big businesses are potentially benefiting here as we mull this supposed aim of the scheme.

firms making a material contribution to the UK economy,

There are a lot of issues here so let me run through them. The first is that as I pointed out above not only does the concept support big business but so does the definition. We now have an idea of how this will play out and smaller businesses may wonder what is going on especially if they have to compete with subsidised  larger businesses.

The Bank of England is already cheerleading for the results.

The inclusion of a Corporate Bond Purchase Scheme in the package had been less anticipated by market participants. Consistent with this, corporate bond spreads had narrowed and sterling issuance by UK-domiciled firms had been strong.

The use of the word domiciled will raise a wry smile from those who have ever looked at the economic situation in Ireland and the chasm between GDP and GNP there.

Also the next bit makes you wonder about the next step planned?

Equity prices had also risen.


There are obvious issues with both these schemes which lead to the danger of what the Cranberries called “Zombie, Zombie,Zombie”. There are a lot of similarities with the mistakes that Japan made where the schemes that were supposed to provide stimulus in fact just channeled cheap cash to big business and led to the “lost decade” concept.

Meanwhile yesterday’s minutes gave us another clue to how Forward Guidance mark 24 is going.

since the August Inflation Report, a number of indicators of near-term economic activity have been somewhat stronger than expected. The Committee now expect less of a slowing in UK GDP growth in the second half of 2016.

So this is good in that the UK economy does not seem to have had a sharp slow down but for the Bank of England there is the issue of it looking like it panicked last month. Is a “sledgehammer” appropriate for a growth slow down?

Overall, these data were consistent with somewhat less of a slowing in near-term UK GDP growth than envisaged in the August Inflation Report.

In essence economic growth of 0.3% is now expected this quarter rather than the 0.1% previously. Yet in spite of the fact that Forward Guidance was wrong again we are promised yet more micro management of the UK economy.

a majority of members expect to support a further cut in Bank Rate to its effective lower bound at one of the MPC’s forthcoming meetings during the course of this year. The MPC currently judges this bound to be close to, but a little above, zero.

The same lower bound that Governor Mark Carney had previously told us was 0.5%.

BBC Radio 4

Tomorrow I will be on the Money Box program debating Bank of England policy with Professor Tony Yates who used to work at the Bank of England. The program starts just after Midday and is repeated at 9 pm on Sunday.

The economics of and problems created by corporate bond QE

One of the features of 2016 so far has been the appearance of QE or Quantitative Easing for corporate bonds with the ECB announcing a start in March and the Bank of England announcing a start earlier this month. This was a particular volte-face for the Bank of England which has had both the ability and the authority to purchase Corporate Bonds for some years now but had previously fiddled around in the market as if it was a market maker before abandoning the whole thing. Oh and at least one member of the Riksbank of Sweden is on the case according to Danske Bank Research.

Jochnick getting hot: is she suggesting a end to Govvie QE going into CB’s instead?

What is the rationale behind this?

There are two main routes where this could help the economy. These are via a price mechanism and a quantity one. The price mechanism is via lower corporate bond yields making it cheaper for companies to borrow which in theory will make investments cheaper. The quantity mechanism is that they should be able to issue more corporate bonds ( at lower yields) and that this extra borrowing will allow them to expand and help the economy. So in essence more corporate bonds at cheaper yields will in theory give an economic boost.

The next influence is more prosaic. Other central banks have noticed that the US Federal Reserve bought a lot of private-sector debt and still holds US $1.75 trillion of it and feel that they missed out. Perhaps it achieved a type of holy grail. Copying that is a little awkward as for example the ECB is on its third go at buying the Euro area equivalent ( covered bonds) and would be open to the accusation of being years behind even a johnny come lately. So we have corporate bond purchases which are badged as helping the private sector.

The ECB slaps itself on the back

The ECB has reviewed its own program and declared it to be a success on the two economic grounds I pointed out. First yields.

over the identified period from 10 to 24 March, 11 basis points of the total decline of 16 basis points in the spreads of euro area investment-grade corporate bonds was related to the monetary policy measures announced in March, more specifically the launch of the CSPP.

Then issuance volumes.

While issuance was subdued at the beginning of the year amid elevated financial market uncertainty, it rebounded significantly after the CSPP announcement. Preliminary data  suggest that issuance in the second quarter of 2016 was well above the average seen in previous years.

As of the end of last week the ECB had purchased some 17.8 billion Euros of corporate bonds which compares to a total program size of 1207 billion Euros.


What economic effects does lower corporate bond yields have?

The first comes as the theory that lower corporate bond yields leads to more investment collides with reality. On the 11th of this month I pointed out that the US Federal Reserve has its doubts.

Yet, a large body of empirical research offer mixed evidence, at best, for a substantial interest-rate effect on investment………Among the more than 500 responses to the special questions, we find that most firms claim to be quite insensitive to decreases in interest rates, and only mildly more responsive to interest rate increases.

At this point a few Ivory Towers will be resembling the Dark Tower of Barad-dûr as the Ring of Power goes into Mount Doom. Also if we stay with the issue of lower yields then Euro area taxpayers may be wondering why they are giving subsidies to big businesses in this way?

Yields of the purchased bonds have ranged from around -0.3% to above 3%, with just above 20% of the purchases being made at negative yields above the ECB’s deposit facility rate of -0.4%.

The incentive to make good investments fades if the money to fund it is in effect free or even more so if you are paid to borrow. On this road more debt could lead to a more sclerotic economy with increasing ossification.

What about “phantom securities”?

This is an issue faced by a previous Bank of England program (Special Liquidity Scheme) where is suddenly discovered that some of what it was buying was not what it thought it was. Awkward! Imagine going back to taxpayers and having to explain that you had been made a fool of. I believe that this was the reason the SLS was wound up early. Can history repeat itself? From the Wall Street Journal.

The European Central Bank’s corporate-bond-buying program has stirred so much action in credit markets that some investment banks and companies are creating new debt especially for the central bank to buy.

Apparently there have been two private placements but like when it was giving private briefings to hedge funds the ECB appears not to have a grip on moral hazard.

“Typically there won’t be a prospectus, there won’t be any transparency, there won’t be a press release. It’s all done discreetly,”

What could go wrong?

I wish to be clear that the ECB is unworried by this and has implicitly asked for it to happen so that it can buy more bonds. The catch is that as described in both Goodhart’s Law and the Lucas Critique changing things like this can have bad consequences and destroy the intended economic effect.

There is an example of the Turning Japanese theme here. Back in one of the earlier versions of QE the Bank of Japan decided to offer cheap loans to smaller companies. The money did not reach them but it did reach the subsidiaries of Nissan, Toyota, Sony et al which suddenly sprang up. But these were pure economic and financial transactions divorced from the real economy as those companies were busy making the Bank of Japan look good not looking for investment finance.

Big Business

In essence this is yet another central banking program which helps larger businesses and in particular ones large enough to issue corporate bonds. Smaller and medium-sized businesses may reasonably feel that they have been left out again. If you think about it there will be an effect to ossify the financial system and the economy as larger companies which do not do well may simply issue corporate bonds and carry on regardless. As the Cranberries put it.

In your head
In your head
Zombie zombie zombie
What’s in your head
In your head.
Zombie, zombie, zombie

Bank of England problems

The FT published some thoughts from HSBC on the 4th of this month which pointed out this problem.

For the 29 per cent of finance that UK companies obtain from the bond market, more is issued in dollars than in euros, and more in euros than in sterling. Should the Bank choose corporate bond QE, it is not obvious that sterling corporate bonds would be the most effective choice.

So as we stand corporate bond issuance in sterling is a relatively minor deal as shown below.

There are £285bn sterling investment-grade bonds compared with £1.3tn denominated in euros and £4tn denominated in dollars, according to Dealogic.

That could of course grow although that ignores the issue of the fact that UK companies are often international and may choose to issue bonds in Dollars and Euros to match their risks and use bank lending for sterling risks. Ooops! Oh and are you thinking what I am thinking? Well it would appear that the ECB is.

Foreign companies with headquarters located outside
the euro area have not thus far increased their bond issuance in euro.

I wonder who they mean? But UK companies borrowing in Euros and being subsidised to do so by the ECB seems on the face of it to be a bigger opportunity than going to the Bank of England. (Update 9pm The comment from Noo2 below points out that this is in fact would be more difficult than I have said). Now the exchange rate is much lower even that seems to favour Euro borrowing. Perhaps the clearest sign of a sustained turn for the UK Pound will be UK corporates issuing Euro corporate bonds. Quite a potential can of worms……


So on the face of it central bankers will be able to point to lower bond yields and more issuance in response to corporate bond QE. However the latter is not going as well as claimed according to the FT.

While the ECB’s own corporate QE initially lured companies to the bond market — €50bn was sold in March, the month after the policy was announced, supply has since waned.

Also if the problem is demand in the economy as opposed to demand for finance then encouraging businesses to follow the “debt is good” mantra is yet another spider’s web for us to be caught in. Yet another boom for the financial economy that fails to reach the real economy.

I have left pension funds to last. They will be hurt by this as yields go lower again and ironically may buy longer-dated bonds if they are issued. So Bank of England QE will have had the effect of switching them from state backed UK Gilts to private-sector corporate bonds. What could go wrong?

Where is the sledgehammer for the real economy? On this road it is Hall and Oates singing to central bankers.

You’re out of touch