What is happening to the economy of Germany?

As both the largest economy and indeed the bellweather for the Euro area Germany is of obvious importance. This morning has brought us more up to date in the state of play. Firstly the statistics office has continued to update its data on the quarter just gone.

WIESBADEN – The gross domestic product (GDP) rose by 8.5% in the third quarter of 2020 compared with the second quarter of 2020 after adjustment for price, seasonal and calendar variations. Thus, the German economy could offset a large part of the massive decline in the gross domestic product recorded in the second quarter of 2020 due to the coronavirus pandemic. However, the price-, seasonally and calendar-adjusted GDP was still 4.0% lower in the third quarter of 2020 thanin the fourth quarter of 2019, that is the quarter before the global coronavirus crisis.

That is an improvement of the order of 0.3% on what was previously thought. This does in fact give us a partial V-Shape as you can see below.

In the circumstances that is a reasonably good performance and the statistics office puts it like this.

For the whole EU, Eurostat released a preliminary result of -4.3% for the third quarter of 2020. The United States also recorded a strong decline of their gross domestic product (-2.9%, converted figure) compared with the third quarter of 2019. In contrast, year-on-year GDP growth as published by the People’s Republic of China amounted to 4.9% in the third quarter.

There is another context which is that the German economy had previously been struggling. This began with the 0.2% decline at the opening of 2018 which was claimed to be part of the “Euro Boom”. Economic growth was a mere 1.3% in 2018 which then slowed to 0.6% in 2019 so we can see that there were pre pandemic issues.

The Breakdown

I thought that I would switch to the labour market for this and an ongoing consequence for other areas.

The labour volume of the overall economy, which is the total number of hours worked by all persons in employment, declined even more sharply by 4.0% over the same period.

I am using a measure of underemployment as the international definition of unemployment has simply not worked. Next we can switch to wages.

According to first provisional calculations, the compensation of employees was down by just 0.7% year on year, while property and entrepreneurial income fell sharply by 7.8%. On average, gross wages and salaries per employee fell by 0.4%, while net wages and salaries rose slightly by 0.5%.

So we see a familiar situation of income being supported by the furlough scheme although outside it there has been quite a hit. But as there have been restrictions on spending we see a surge in saving.

According to provisional calculations, the savings ratio was 13.5% in the third quarter of 2020.

We wait to see what will be the full economic impact of a surge in involuntary saving but here is the flip side.

Household final consumption expenditure at current prices, however, showed a decrease of 4.0%.

What about now?

This morning has brought the latest update from the Ifo Institute.

Munich, November 24, 2020 – Sentiment among German managers has deteriorated. The ifo Business Climate
Index fell from 92.5 points in October to 90.7 points in November. The drop was due above all to companies’
considerably more pessimistic expectations. Their assessments of the current situation were also a little worse.
Business uncertainty has risen. The second wave of coronavirus has interrupted Germany’s economic recovery.

It is the services sector which has taken the brunt of this.

In the service sector, the Business Climate Index dropped noticeably. For the first time since June, it is back in
negative territory. Assessments of the current situation are much less positive than they were. Moreover,
substantially more companies are pessimistic about the coming months. The indicators for hotels and
hospitality absolutely nosedived.

The one area which has managed some growth is manufacturing.

This month’s bright spot is manufacturing. The business climate improved here, with companies assessing their
current situation as markedly better. Incoming orders rose, albeit more slowly than last month. However,
expectations for the coming months turned notably less optimistic.

Although as you can see the new restrictions due to Covid-19 have affected expectations. But the picture for the overall economy was that things continued to improve in October but have now reversed. So the vaccine news has not impacted expectations there yet and the V-Shape above will see at least a kink. The general view is similar to that given yesterday by the Matkit business survey.

New lockdown measures to curb the spread of
coronavirus disease 2019 (COVID-19) led to an
accelerated decline in services activity across
Germany in November, latest ‘flash’ PMI®
from IHS Markit showed. However, the country’s
manufacturing sector continued to exhibit strong
growth, helping to support overall economic activity.

They did however hint that the Far East is helping German manufacturing.

which the survey shows is
benefitting for growing sales to Asia in particular.

Financial Conditions

These remain extraordinarily easy. There is the -0.5% deposit rate of the ECB with the -1% interest-rate for the banks. Then there is the enormous amount of bond buying which under the original programme ( PSPP) totaled some 562 billion Euros at the end of October. It is a sign of the times that there is another buying programme as well as the ECB tries to muddy the waters and as of the end of September it had bought another 125 billion.

Today Germany issues a two-year bond and it will be paid to do so as the yield is -0.75% as I type this. Furthermore this yield has been negative for over 5 years now as that state of play looks ever more permanent. Indeed with the thirty-year at -0.16% the whole yield curve is negative.

Switching to the Euro exchange-rate things are not so bright. If we take a long-term context Germany joined to get a weaker exchange-rate. However in recent times it has been rising and the effective index is at 121.5 or 21% higher than when the Euro began. Whilst November has seen a dip the index started 2020 at 115.

Comment

The context is that at the end of the third quarter the German economy had grown by 2.7% compared to the 2015 benchmark. But the news restrictions mean that it has “And it’s gone” to quote South Park. There are vaccine hopes for 2021 now but 2020 looks like being a year to forget.

This brings us to the role of the ECB which is already heavily deployed. Can it respond to the latest dip? Not in any timely way as we note the lags in the system. Also for Germany there is not a lot more that can be done in terms of interest-rates or bond yields as all are heavily negative. The wheels of fiscal policy are being oiled by this as well. Looking at it like that only leaves us with the Euro exchange-rate. Can ECB President Lagarde fire a “bazooka” at that? As I pointed out yesterday looking at the UK with all central banks easing that is easier to say than do.

Meanwhile returning to the world of finance there is this.

FRANKFURT (Reuters) – Germany’s blue-chip DAX index will expand to 40 from the current 30 companies with tougher membership criteria, exchange operator Deutsche Boerse said on Tuesday.

In general a good idea as it is too narrow an index for an economy the size of Germany, especially in the light of this.

The most recent departure was payments company Wirecard, which in a blow to Germany’s capital markets, filed for insolvency just two years after its promotion to the index. The payments company owed creditors billions in what auditor EY described as a sophisticated global fraud.

The perils of indexation?

 

 

Will the rally in the Turkish Lira last?

This week has brought a pretty much text book example of what can happen when a currency is in distress as well as a reminder of perspective. Let me start with the trigger for some changes which came last weekend.

The shock departure of finance minister Berat Albayrak, who is President Tayyip Erdogan’s son-in-law, and central bank chief Murat Uysal over the weekend gave the lira its best day in over two years on Monday.

Investors hope their successors will deliver another of the country’s pirouettes, where long-suppressed interest rates are lifted dramatically, providing the currency with some much-needed relief. ( Reuters)

There is a lot going on there. But let’s start with a possible end or at least reduction in cronyism. There we have an unusual mention of a Lira rally followed by a curious mention of “long-suppressed interest-rates”. That depends on your perspective because in these times the rate below is rather extraordinary as it is.

keep the policy rate (one-week repo auction rate) constant at 10.25 percent,

Back on October 12th we noted a change in swap rates to 11.75% to try and support the Lira but in what may seem extraordinary a 1.5% move in these circumstances is not much. The real issue when an interest-rate is trying to support a currency is the gap between it and others. This week we have looked at an interest-rate maybe reaching 1% in the US ( ten-year bond yield) and Japan where we are around 0% so there is quite a gap. Even those are high relative to the -0.5% of the Euro and the around -0.5% of the German ten-year yield and of course there is a lot of trade between the Euro area and Turkey.

The textbook

Put mostly simply a currency is helped by an interest-rate advantage as investors include it in their calculations of expected capital gains. The problem in practice is that in times of real distress the expected currency falls are much larger than any likely interest-rate increase. I provided an example of this back on the 12th of October.

Because of the economic links the exchange-rate with the Euro is significant. Indeed some Euro area banks must be mulling their lending to Turkish borrowers as well as Euro area exporters struggling with an exchange-rate of 9.32. That is some 43% lower than a year ago.

So even with a pick-up of the order of 11% you have lost 32% over the past 12 months.

However this can change rapidly because the moment there is any sort of stability the carry is suddenly rather attractive. After all you can get more in the Turkish Lira in a month than most places in a year and in some cases you can do that in a week. This leads to the situation suddenly reversing and giving us this.

ISTANBUL (Reuters) – Turkey’s lira firmed on Friday to its strongest level in seven weeks, notching a weekly gain of some 12%, after President Tayyip Erdogan’s pledge to adopt a new economic model raised expectations of a sharp rate hike from the central bank.

So we have seen a jump higher in the Lira with expectations now of this.

The central bank is seen raising its policy rate next week to 15% from 10.25%, a Reuters poll showed. Erdogan’s speech was viewed as implying he would condone such a hike.

So the expected carry is even higher and for once there is a capital gain. Some will like this although I have to confess if I had been long the Lira this week I would be considering the advice of the Steve Miller Band.

Hoo-hoo-hoo, go on, take the money and run
Go on, take the money and run
Hoo-hoo-hoo, go on, take the money and run
Go on, take the money and run

As whilst there may be changes there are icebergs waiting for this particular Titanic.

In contrast to previous episodes of lira turmoil, the central bank is estimated to have burnt through more than $100 billion of reserves this year, leaving it effectively around $36 billion overdrawn on those reserves, according to UBS.

The central bank has not commented on analysis suggesting its reserves are ‘net’ negative, though it has said its buffers fluctuate naturally in times of stress. ( Reuters)

So “buffers fluctuate in times of stress” can be added to my financial lexicon for these times.

The economy

There has been some better economic news this morning especially from consumption.

There was better news for retail sales in the country on Friday. The volume of goods purchased by consumers increased by an annual 7.8 percent in September after 6 percent growth in August, the statistics institute said. The monthly increase was 2.8 percent, more than three times the August figure of 0.9 percent. ( Ahval)

Also industrial production rose although Ahval is rather downbeat about it.

Industrial output in the country expanded at the slowest pace on a monthly basis since the outbreak of the coronavirus in March, official data published on Friday showed. Production increased by 1.7 percent month-on-month in September compared with 3.4 percent in August and 8.4 percent in July……..Manufacturing of non-durable goods in the country grew by just 0.6 percent month-on-month in September, the Turkish Statistical Institute said. Production of intermediate goods expanded by 0.7 percent.

There is a catch though in that the better retail sales news rather collides with one of the ongoing economic problems which is the trade deficit.On Wednesday the central bank ( CBRT) updated us about this.

The current account posted USD 2,364 million deficit compared to USD 2,828 million surplus observed in the same month of 2019, bringing the 12-month rolling deficit to USD 27,539 million.

So the passing twelve months have brought a switch from a monthly surplus to deficit and we see that the annual picture is the same. The driving forces of this are below.

This development is mainly driven by the net outflow of USD 3,709 million in the goods item increasing by USD 3,044 million, as well as the net inflow of USD 1,692 million in services item decreasing by USD 2,869 million compared to the same month of the previous year.

One of the issues of economic theory is applying theory to practice. But the expected J-Curve improvement in the trade balance has collided with another currency plunge starting the clock all over again. It has created quite a mess as one clear impact of the Covid-19 pandemic has been on a strength for Turkey which is tourism. Back on October the 12th I noted the numbers for this.

 If we look at the year so far we see this is confirmed by a surplus of US $4.15 billion as opposed to one of US $19.17 billion in the same period in 2019. Another way of looking at this is that 3,225,033 visitors are recorded as opposed to 13,349,256 last year.

Next at a time of currency crisis comes inflation as imports become more expensive.

A rise in general index was realized in CPI (2003=100) on the previous month by 2.13%, on December of the previous year by 10.64%, on same month of the previous year by 11.89% and on the twelve months moving averages basis by 11.74% in October 2020. ( Turkey Statistics)

That may look bad enough but there are two additional kickers. The first is that this is on the back of previous inflation and the second is that far from responding wages have gone the other way putting quite a squeeze on living-standards.

Gross wages-salaries index including industry, construction, trade-services sectors decreased by 8.4% in the second quarter of 2020 compared with the same quarter of the previous year. When sub-sectors are examined; industrial sector decreased by 5.2%, construction sector decreased by 8.6% and trade-services sector decreased by 10.5%. ( Turkey Statistics)

Comment

I promised at the beginning to give some perspective and we get some from looking at the exchange-rate on October 12th which was 7.87 versus the US Dollar and considered a crisis then and the 7.67 as I type this. So better but not by a lot as the rally memes are compared to the 8.58 of last Friday. Thus we have a move for financial markets but for the real economy not so much. It can be looked at in terms of what used to be described as the Misery Index where you add inflation to the unemployment rate which gives you a number around 25% or very bad.

The CBRT looks to have rather boxed itself in on an increase in interest-rates to 15% next week. But whilst it may provide some currency support for a time these are Catch-22 style moves. Because such an interest-rate will provide yet another brake to the domestic economy just at a time it can least afford it. After all whilst a vaccine provides hope for the return of mass tourism in the summer of 2021 that is a while away and is still just a hope, albeit a welcome one. Then there is the vaccine hopium of this week as we mull how much of this week’s Lira rise was due to it?

 

 

The ECB would do well to leave the Euro exchange-rate alone.

Over the past 24 hours we have seen something of a currency wars vibe return. This has other links as we mull whether for example negative interest-rates can boost currencies via the impact of the Carry Trade? In which case economics 101 is like poor old HAL 9000 in the film 2001. As so often is the case the Euro is at the heart of much of it and the Financial Times has taken a break from being the house paper of the Bank of England to take up the role for the ECB.

The euro’s rise is worrying top policymakers at the European Central Bank, who warn that if the currency keeps appreciating it will weigh on exports, drag down prices and intensify pressure for more monetary stimulus. Several members of the ECB’s governing council told the Financial Times that the euro’s rise against the US dollar and many other currencies risks holding back the eurozone’s economic recovery. The council meets next week to discuss monetary policy.

There are a range of issues here. The first is that we are seeing an example of what have become called ECB “sauces” rather then sources leak suggestions to the press to see the impact. Next we are left mulling if the ECB actually has any “top policymakers” as the FT indulges in some flattery. Especially as we then head to a perversion of monetary policy as shown below where lower prices are presented as a bad thing.

drag down prices

So they wish to make workers and consumers worse off ( denying them lower prices) whilst that the economy will be boosted bu some version of a wish fairy. Actually the sentence covers a fair bit of economic theory and modern reality so let us examine it.

The Draghi Rule

Back in 2014 ECB President Draghi gave us his view of the impact of the Euro on inflation.

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

There is a problem with the use of the word “permanent” as exchange-rate moves are usually anything but, However since the nadir in February when the Euro fell to 95.6 it has risen to 101.9 or 6.3 points. Thus we have a disinflationary impact of a bit under 0.3%. That is really fine-tuning things and feels that the ECB has been spooked by this.

In August 2020, a month in which COVID-19 containment measures continued to be lifted, Euro area annual
inflation is expected to be -0.2%, down from 0.4% in July……..

Perhaps nobody has told them they are supposed to be looking a couple of year ahead! This is reinforced by the detail as the inflation fall has been mostly driven by the same energy prices which Mario Draghi argued should be ignored as they are outside the ECB’s control.

Looking at the main components of euro area inflation, food, alcohol & tobacco is expected to have the highest
annual rate in August (1.7%, compared with 2.0% in July), followed by services (0.7%, compared with 0.9% in
July), non-energy industrial goods (-0.1%, compared with 1.6% in July) and energy (-7.8%, compared with -8.4% in
July).

The Carry Trade

This is the next problem for the “top policymakers” who appear to have missed it. Perhaps economics 101 is the only analysis allowed in the Frankfurt Ivory Tower, which misses the reality that interest-rate cuts can strengthen a currency. Newer readers may like to look up my articles on why the Swiss Franc surged as well as the Japanese Yen. But in simple terms investors borrow a currency because it terms of interest-rate (carry) it is cheaper. With an official deposit rate of -0.5% and many negative bond yields Euro borrowing is cheap. So some will borrow in it and cutting interest-rates just makes it cheaper and thereby even more attractive.

As an aside you may have spotted that a potential fix is for others to cut their interest-rates which has happened in many places. But with margins thin these days I suspect investors are playing with smaller numbers. You may note that this is both dangerous and a consequence of the QE era so you can expect some official denials to be floating around.

The Euro as a reserve currency

This is a case of be careful what you wish for! I doubt the current ECB President Christine Lagarde know what she was really saying when she put her name to this back in June.

On the one hand, the euro’s share in outstanding international loans increased significantly.

Carry Trade anyone? In fact you did not need to look a lot deeper to see a confession.

Low interest rates in the euro area continued to support the use of the euro as a funding currency – even after adjusting for the cost of swapping euro proceeds into other currencies, such as the US dollar.

The ECB has wanted the Euro to be more of a reserve currency so it is hard for it then to complain about the consequences of that which will be more demand and a higher price. Perhaps they did not think it through and they are now singing along with John Lennon.

Nobody told me there’d be days like these
Nobody told me there’d be days like these
Nobody told me there’d be days like these
Strange days indeed — strange days indeed

Economic Output

Mario Draghi was more reticent about the impact of a higher Euro on economic output which is revealing about the ECB inflation obsession. But back in 2014 when there were concerns about the Euro CaixaBank noted some 2008 research.

Since January 2013, the euro’s nominal effective exchange rate has appreciated by approximately 5.0%. Based on a study by the ECB,an increase of this size reduces exports by 0.6 p.p. in the first year and by close to 1.0 p.p. cumulative in the long term.

With trade being weaker I would expect the impact right now to be weaker as well. Indeed the Reserve Bank of Australia has pretty much implied that recently with the way it has looked at a higher Aussie Dollar which can’t impact tourism as much as usual for example, because there is less of it right now.

Comment

One context of this is that a decade after the “currency wars” speech from the Brazilian Finance Minister we see that we are still there. This is a particular issue for the Euro area because as a net exporter with its trade and balance of payments surplus you could argue it should have a higher currency as a type of correction mechanism. After all it was such sustained imbalances that contributed to the credit crunch and if you apply purchasing power parity to the situation then according to the OECD the exchange rate to the US Dollar should be 1.42 so a fair bit higher. There are always issues with the precision of such calculations but much higher is the answer. Thus reducing the value of the Euro from here would be seeking a competitive advantage and punishing others.

Next comes the way that this illustrates the control freakery of central bankers these days who in spite of intervening on an extraordinary scale want to intervene more. It never seems to occur to them that the problems are increasingly caused by their past actions.

The irony of course is that the elephant in the room which is the US Dollar mat have seen a nadir with the US Federal Reserve averaging inflation announcement. If so we learn two things of which the first is that the ECB may work as an (inadvertent) market indicator. The second is that central banks may do well to leave this topic alone as it is a sea bed with plenty of minefields in it. After all with a trade-weighted value of 101.53 you can argue it is pretty much where it started.

 

 

 

 

The 2020 Currency War and the role of the US Dollar

As we step into June we have an opportunity to reflect on what has been on the media under card but only because so much has been happening elsewhere. Also we can note yet another fail for economics 101 because the advent of large-scale asset purchases or QE was supposed to cause a currency decline and maybe a large one. A higher supply of money leading to a fall in the price. The Ivory Towers of the central banks were keen on that one as they originally justified QE on the basis of being able to hit their inflation target partly via that route. Of course that has not gone well either as we noted with the ECB that has been on average some 0.7% below its holy grail of just below 2% per annum.

The US Dollar

So on that reading the world’s reserve currency the greenback should be in trouble as we observe this.

The Federal Reserve added $60 billion to its balance sheet last week, now totaling $7.097 trillion. Much of the increase this time (over $41 billion) was in corporate credit and commercial paper facilities. ( @LynAldenContact )

There is a sort of irony in US $60 billion in a week not seeming very much! Anyway the heat has been on.

The Federal Reserve’s balance sheet has expanded a staggering $1.9 trillion since February 26, just days after the S&P 500 peaked. ( @USGlobalETFs )

So plenty of new US Dollar liquidity and as part of that we recall what we might call the external supply which are the liquidity swaps for foreign central banks or US $449 billion.

To that can add an official interest-rate just above 0% ( roughly 0.1%)

Added to those factors the Financial Time has decided to put on its bovver boots and give the Dollar a written kicking.

That begs a question that has been seen as controversial — are we entering a post-dollar world? It might seem a straw-man question, given that more than 60 per cent of the world’s currency reserves are in dollars, which are also used for the vast majority of global commerce. The US Federal Reserve’s recent bolstering of dollar markets outside of the US, as a response to the coronavirus crisis, has given a further boost to global dollar dominance.

The FT writer has rather fumbled the ball there and later again emphasises a US Dollar strength.

Among the many reasons for central banks and global investors to hold US dollars, a key one is that oil is priced in dollars.

Indeed and we have looked at efforts to make ch-ch-changes from the supply side ( Russia) and the demand side ( China) but it remains dominant. There are of course plenty of other commodity markets which have a US Dollar price.

Next is something which intrigues me because if it is true in the US how do you even start with Japan and then of course you get a really rather long list of other countries doing exactly the same.

Finally, there are questions about the way in which the Fed’s unofficial backstopping of US government spending in the wake of the pandemic has politicised the money supply.

Oh and for those of you with inflation concerns ( me too) then this is close to an official denial.

The issue here isn’t really a risk of Weimar Republic-style inflation, at least not any time soon.

Actually the main inflation risk is in asset markets with the S&P 500 above 3k, the Nikkei 225 above 22,000 and the FTSE 100 above 6100 I think we can see clear evidence tight now. But of course the economics editorial line under Chris Giles is that asset prices are not part of inflation and should be ignored as part of his campaign to mislead on this subject.

Emerging Markets

If they were hoping for a US Dollar decline then such hopes have been dashed. One country which has been under the cosh is Brazil where an exchange to the US Dollar of 4 as we began the year has been replaced by one of 5.35 and even that is a fair bit better than the 5.96 at the nadir. Things have been less dramatic for the Argentine Peso but it had a bad 2019 to a move from 60 to the US Dollar to above 68 is further pain and of course an interest-rate of an eye-watering for these times of 38% has been required to restrict it to even that.

India

We have a sub-category all to itself as we note the currency of over a billion people. Let me start with something being debated in so many places, and here is the Economic Times of India from last Tuesday.

The government stimulus package of Rs 20 lakh crore seems to be inadequate to revive the economy, as a large part of it accounts for liquidity-boosting measures by RBI. It is clear that the weak fiscal position forced the government to restrict the stimulus. It is in this scenario, that the need for monetisation of deficit has been widely debated.

In layman’s language, monetisation of deficit means printing more money. In other words, monetisation of deficit happens when RBI buys government securities directly from the primary market to fund government’s expenses.

The Rupee has been a case of slip-sliding away as we note it nearly made 77 and is now 75.3 and that is in spite of the impact of the lower oil price ( and for a while much lower) on India.

Euro

This has not done much at all as I note an annual change of all of -0.38%! We did see some moves as it went to 1.14 at the height of the pandemic panic as the Euro’s “safe haven”  role was stronger than the Dollar’s one. But we then had a dip and now a bounce. So loads of column inches about the world’s main currency pair have led to a net not very much as we stand here today.

Yen

This is really rather similar to the above as we note an annual change of -.0,52% this time after a safe haven spell. Actually 107 or so for the Yen feels strong for it as we remind ourselves that the QE, negative interest-rates and equity purchases of Abenomics were supposed to keep it falling.

UK Pound

The annual picture ( -2%) is a little more misleading here as we have seen swings. The UK Pound £ has been following equity markets so went below US $1.15 at the nadir but has hit US $1.24 as we have bounced. Troubling if you are like me wondering about the equity market bounce. Still we could be the UK media that once again declared this at the bottom.

It’s the end of the world as we know it
It’s the end of the world as we know it
It’s the end of the world as we know it and I feel fine.

Places like the FT and BBC have proved very useful as when they have a “panic party” about the £ and claim it is looking over a cliff is invariably the time to buy it.

Comment

So we see that the situation is in fact one of where the various QE and interest-rate moves have offset more often than been different. In some ways the central banking “More! More! More!” culture means that differences in pace or size get ignored because they are all rocking a “To Infinity! And Beyond!” vibe as shown by the official denial below.

‘Comfortable’ Now, But On B/Sheet ‘Cannot Go To Infinity ( Jerome Powell via @LiveSquawk )

Let me conclude with another perspective which is the world of precious metals and another form of precious. One way of judging a currency is in this vein and as someone who recalls studying mercantilism which essentially revolved around country’s holdings of silver this provided some food for thought.

Those of us with longer memories have no faith in US paper dollars.  Prior to 1964, US coinage was made of 90% silver.  Today, a roll of 40 quarter dollar coins made of 90% silver, worth $10 in 1964, will cost you about $165.  The real purchasing power of the US dollar has plunged. ( h/t ahimsaka in the FT comments )

Podcast

Which Euro area bank needed Dollars from the US Federal Reserve?

Today it is the turn of Europe to be in focus and let me briefly break my rule of looking at the real economy first because there is something going on which if it continues could easily hit it. As I seem to be not far off alone in noting this here is one of my own tweets from this morning.

There are two main things going on here. Firstly as I have pointed out before there is a shortage of US Dollars which tends to get worse as we approach year end. The tighter the situation is expected to be then the earlier people get ready and thus those considered more risky find it harder to get some.

Next comes the issue of the mechanics. This is an example of what have been called central bank FX swaps or liquidity swaps. Here is the ECB ( European Central Bank ) explainer.

Under normal circumstances, if a bank in the euro area needs US dollars, for example because it needs to provide a US dollar loan to a client, the bank turns to the market. But if US dollar funding costs are too high or if the market is disrupted, the bank can go to its national central bank. In this particular case, the ECB can get dollars thanks to the currency agreement with the Federal Reserve.

The next bit is both true and a maybe misleading.

Many of these currency agreements act mainly as a safety net and have never been activated.

According to the ECB website it can borrow up to US $80 billion from the US Federal Reserve. Actually I am not sure that is up to date but I would not worry about that too much as on a crisis the size would quickly be increased.

These are in existence in other areas for example there was a time that there were fears about the Irish banks and a need for UK Pounds back in the day.

The agreement allows pounds sterling to be made available to the Central Bank of Ireland as a precautionary measure, for the purpose of meeting any temporary liquidity needs of the banking system in that currency.

Such a line could be used post Brexit for example should UK banks need Euros or Euro area ones need pounds. But in essence and indeed the experience so far these swaps are for supply of the US Dollar as Aloe Blacc pointed out.

I need a dollar dollar, a dollar is what I need
Hey hey
Well I need a dollar dollar, a dollar is what I need
Hey hey
And I said I need dollar dollar, a dollar is what I need
And if I share with you my story would you share your dollar with me

Actually our Aloe made a decent fist of explaining why a swap line might be used,

Bad times are comin’ and I reap what I don’t sow
Hey hey
Well let me tell you somethin’ all that glitters ain’t gold
Hey hey
It’s been a long old trouble long old troublesome road
And I’m looking for somebody come and help me carry this load

 

The Economy

Whilst the banking sector seems to be rumbling on with the same signs of indigestion we have been observing over time there have been some better hints from the real economy. For example let me hand you over to the Italian statistics office.

In July 2019, estimates for both value and volume of retail sales saw a slight fall when compared with a
month earlier, as the value was down 0.5% and the volume decreased by 0.7%.

As you can see it starts badly but stay with me.

In the three months to July 2019 the retail trade index increased both in value and in volume terms,
growing by 0.5% when compared to the previous three months (Feb – Apr 2019).  Year-on-year both measures of retail trade showed growth for the second consecutive month: the value rose by 2.6%, while the quantity sold was up 2.8%.

The reason why I have noted this is because this area has been a struggle for Italy and because in Italy an annual rate of growth of 2.8% stands out like a sore thumb. Unfortunately Italy’s statisticians have posted the wrong chart ( value not volume) something which no-one else seems to have noted. But even so this looks like a better phase for retail sales than even in the Euro boom.

Maybe it was always there even in the GDP figures.

This result synthetizes inventories negative contribution and domestic demand positive one (-0.3 pp. and +0.3 pp. respectively).

Should inventories simply do nothing Italy will have some economic growth from its domestic impetus. Not a lot and there is manufacturing to consider but for Italy anything is a bonus. Oh and you may have spotted that there is another tick in the box for my argument that low inflation boosts economies via retail sales and real wages. Because with the volume and value figures so close there is very little or no inflation here.

Someone has not noticed this however.

ECB presidential nominee Christine Lagarde pledges to act with “agility” against what she describes as inflation that is persistently too low ( Bloomberg )

Another possible route comes from Germany where things are at least not getting that much worse.

In July 2019, production in industry was down by 0.6% on the previous month on a price, seasonally and calendar adjusted basis according to provisional data of the Federal Statistical Office (Destatis). In June 2019, the corrected figure shows an decrease of 1.1% (primary -1.5%) from May 2019………4.2% on the same month a year earlier (price and calendar adjusted).

Comment

If we start with the Euro area economy then as I pointed out last week things are not as grim as some are saying, The money supply numbers have improved in 2019 and there are one or two flickers of action. However this morning has also brought a signal of trouble as China is not doing this for fun.

CHINA CUTS BANKS’ RESERVE REQUIREMENT RATIO CHINA CUTS RESERVE RATIO BY 0.5 PPT ( @PriapusIQ)

You may note that by acting to increase the money supply they are helping the banks first or behaving like us western capitalist imperialists.

Meanwhile I could type a fair bit about Euro area banks but instead let me show you the tweet of their share prices which speaks volumes. Share prices are far from always right as otherwise they would rarely move but look how long this has been going on.

 

Is this the real reason the ECB will act next week?

What has the Yen flash rally of 2019 taught us?

Yesterday we took a look at the low-level of bond yields for this stage in the cycle and the US Treasury Note yield has fallen further since to 2.63%. Also I note that the 0.17% ten-year German bond yield is being described as being in interest-rate cut territory for Mario Draghi and the ECB. That raises a wry smile after all the media analysis of a rise. But it is a sign of something not being quite right in the financial system and it was joined last night by something else. It started relatively simply as people used “Holla Dolla” to describe US Dollar strength ( the opposite of how we entered 2018 if you recall) and I replied that there also seemed to be a “yen for Yen” too. So much so that I got ahead of the game.

What I was reflecting on at this point was the way that the Yen had strengthened since mid December from just under 114 to the US Dollar to the levels referred to in the tweet. For newer readers that matters on two counts. Firstly Japanese economic policy called Abenomics is geared towards driving the value of the Yen lower and an enormous amount of effort has been put into this, so a rally is domestically awkward. In a wider sweep it is also a sign of people looking for a safe haven – or more realistically foreign exchange traders front-running any perceived need for Mrs.Watanabe to repatriate her enormous investments/savings abroad  –  and usually accompanies falling equity markets.

The Flash Rally

I was much more on the ball than I realised as late last night this happened. From Reuters.

The Japanese yen soared in early Asian trading on Thursday as the break of key technical levels triggered massive stop-loss sales of the U.S. and Australian dollars in very thin markets. The dollar collapsed to as low as 105.25 yen on Reuters dealing JPY=D3, a drop of 3.2 percent from the opening 108.76 and the lowest reading since March 2018. It was last trading around 107.50 yen………..With risk aversion high, the safe-haven yen was propelled through major technical levels and triggered massive stop-loss flows from investors who have been short of the yen for months.

As you can see there was quite a surge in the Yen, or if you prefer a flash rally. If a big trade was happening which I will discuss later it was a clear case of bad timing as markets are thin at that time of day especially when Japan is in the middle of several bank holidays. But as it is in so many respects a control freak where was the Bank of Japan? I have reported many times on what it and the Japanese Ministry of Finance call “bold action” in this area but they appeared to be asleep at the wheel in this instance. Such a move was a clear case for the use of foreign exchange reserves due to the size and speed of the move,

There were also large moves against other currencies.

The Australian dollar tumbled to as low as 72.26 yen AUDJPY=D3 on Reuters dealing, a level not seen since late 2011, having started around 75.21. It was last changing hands at 73.72 yen.

The Aussie in turn sank against the U.S. dollar to as far as $0.6715 AUD=D3, the lowest since March 2009, having started around $0.6984. It was last trading at $0.6888.

Other currencies smashed against the yen included the euro, sterling and the Turkish lira.

There had been pressure on the Aussie Dollar and it broke lower against various currencies and we can bring in two routes to the likely cause. Yesterday we noted the latest manufacturing survey from China signalling more slowing and hence less demand for Australian resources which was followed by this. From CNBC.

 Apple lowered its Q1 guidance in a letter to investors from CEO Tim Cook Wednesday.

Apple stock was halted in after-hours trading just prior to the announcement, and shares were down about 7 percent when trading resumed 20 minutes later.

This particular letter from America was not as welcome as the message Tim Cook sent only a day before.

Wishing you a New Year full of moments that enrich your life and lift up those around you. “What counts is not the mere fact that we have lived. It is what difference we have made to the lives of others that will determine the significance of the life we lead.” — Nelson Mandela

So the economic slow down took a bite out of the Apple and eyes turned to resources demand and if the following is true we have another problem for the Bank of Japan.

“One theory is that may be Japanese retail FX players are forcing out of AUDJPY which is creating a liquidity vacuum,” he added. “This is a market dislocation rather than a fundamental event.”

Sorry but it is a fundamental event as Japanese retail investors are in Australian investments because they can get at least some yield after years and indeed decades on no yield in Japan. This is a direct consequence of Bank of Japan policy as was the move in the Turkish Lira which is explained by Yoshiko Matsuzaki.

This China news hit the EM ccys including Turkish lira where Mrs Watanabe are heavily long against Yen. I bet their stops were triggered in the thin market. Imagine to have TRYyen stops in this market.

So there you have it a development we have seen before or a reversal of a carry trade leading the Japanese Yen to soar. Even worse one caused by the policy response to the last carry trade blow-up! Or fixing this particular hole was delegated to the Beatles.

And it really doesn’t matter if I’m wrong
I’m right

Bank of England

It too had a poor night as whilst it is not a carry trade currency with Bank Rate a mere 0.75% the UK Pound £ took quite a knock against the Yen to around 132. Having done this we might reasonably wonder under what grounds the Bank of England would use the currency reserves it has gone to so much trouble to boost? From December 11th.

Actually the Bank of England has been building up its foreign exchange reserves in the credit crunch era and as of the end of October they amounted to US $115.8 billion as opposed as opposed to dips towards US $35 billion in 2009. So as the UK Pound £ has fallen we see that our own central bank has been on the other side of the ledger with a particular acceleration in 2015. I will leave readers to their own thoughts as to whether that has been sensible management or has weighed on the UK Pound £ or of course both?!

To my mind last nights move was certainly an undue fluctuation.

The EEA was established in 1932 to provide a fund which could be used for “checking undue fluctuations in the exchange value of sterling”.

It is an off world where extraordinary purchases of government bonds ( £435 billion) are accompanied by an apparent terror of foreign exchange intervention.

Comment

I have gone through this in detail because these sort of short-term explosive moves have a habit of being described as something to brush off when often they signal something significant. So let is go through some lessons.

  1. A consequence of negative interest-rates is that the Japanese investors have undertaken their own carry trade.
  2. The financial system is creaking partly because of point 1 and the ongoing economic slow down is not helping.
  3. Contrary to some reports the Euro was relatively stable and something of a safe haven as it behaved to some extent like a German currency might have. There is a lesson for economic theory about negative interest-rates especially when driven by a strong currency. Poor old economics 101 never seems to catch a break.
  4. All the “improvements” to the financial system seem if anything to have made things worse rather than better.
  5. Fast moves seem to send central banks into a panic meaning that they do not apply their own rules.

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

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

Me on The Investing Channel

 

 

Turkey sees currency driven inflation beginning to fade as the Lira rallies

A feature of the modern era is the way that we are presented crises but they then fall off the radar screen. An example of this has been Turkey which hit the media heights but has now faded away. Let us update ourselves via the view of Commerzbank on last months central bank meeting.

The Turkish central bank (CBT) left its benchmark interest rate unchanged at today’s meeting. In our view, this was a major policy mistake. CBT commented that it maintains a tight policy stance. But, when the benchmark rate is 24% and inflation is also 24%, how is this stance “tight”? The decision shows that CBT has not morphed into an active inflation-targeting central bank as some government officials have claimed. Rather CBT is simply taking the path of least resistance – since the market is forgiving at the moment, why ruffle political feathers by continuing to hike rates? Given this CB attitude, prepare for more lira volatility down the line.”  ( via FXStreet )

There is a large amount to cover here and let us start with the idea that a major mistake was made. Also that this from the CBRT is wrong.

The tight stance in monetary policy will be maintained decisively until the inflation outlook displays a significant improvement…….Accordingly, the Committee has decided to maintain the tight monetary policy stance and keep the policy rate (one week repo auction rate) constant at 24 percent.

There are many ways of measuring such a concept but an interest-rate of 24% on its own in these times makes you think, especially if we recall that it had been raised by 6.25% at the previous meeting. How many countries even have interest-rates of 6.25% right now? The real issue here to my mind is that Commerzbank  lost perspective with this by looking at inflation at the moment rather than looking ahead. If we take the view of the CBRT from back then the outlook was this.

In this respect, inflation is projected to be 23.5 percent at end-2018, and then fall to 15.2 percent at end-2019 and 9.3 percent at end-2020 before stabilizing around 5 percent in the medium term. Forecasts are based on a monetary policy framework that envisages that the tight monetary policy stance will be maintained for an extended period.

On this basis if we look ahead to when we might expect the interest-rate rise to be fully effective we should start with the end-2019 figure of 15.2%. Against that outlook then a real interest-rate of 9% is for these times eye-wateringly tight. Of course caution is required as central banks are hardly the best forecasters, But I am reminded of the template I set out on the third of May for such a situation.

However some of the moves can make things worse as for example knee-jerk interest-rate rises. Imagine you had a variable-rate mortgage in Buenos Aires! You crunch your domestic economy when the target is the overseas one.

My warning was given when interest-rates in Argentina were 30.25%, by the end of that day they were 3% higher and now the LELIQ rate is 68.1%. Sadly they are living out my warning.

Inflation now

Let us bring this up to date from the Hurriyet Daily News.

Turkish annual inflation surged to 25 percent in October, official data showed on Nov. 5, hitting its highest in 15 years……..Month-on-month, consumer prices jumped 2.67 percent, the Turkish Statistical Institute (TÜİK) data showed, higher than the 2 percent forecast in a Reuters poll. Core inflation surged 24.34 annually. October  inflation was driven by a 12.74 percent month-on-month surge in clothing and shoe prices and a 4.15 percent rise in housing prices, the data showed.

On a yearly basis, the biggest price hike was in furnishing and household equipment in October with 37.92 percent.

Initially Commerzbank may think it was right but this is only a small nudge higher in annual terms as the monthly increase more than halves. We also get a reminder that this is inflation which is essentially exchange-rate driven by the way that the core inflation rate is so similar to the headline. This is joined by which sectors are influenced by imports showing it is a bad time to overhaul your wardrobe or redecorate your home. Speaking of homes there will be central bankers reading this thinking that the rise in house prices is a triumph. The wealth effects! The wealth effects! Back in your box please.

The Turkish Lira

There have been changes here as we look to see what influence it will have on inflation trends. Here is @UmarFarooq_

Turkish is regaining some of its loses, looks set to return to pre-sanction days of August. Went from 6.3 to 5.3 versus dollar in one month. Still a ways to go compared to one year ago, when it was 3.8

Some of the move has been in relation to political changes but from our point of view that only matters if they intervene again. The fact is that a lot of inflationary pressure has faded in the move from the peak of 7.21 against the US Dollar at the height of the crisis to 5.34 as I type this.

So whilst there is still inflationary pressure in the system it has faded quite a lot and if you believe World Economics things are still out of line.

The Turkish Lira has an FX rate of 5.7 but a PPP value of 2.72 against the USD. ( PPP is Purchasing Power Parity)

Of course with inflation so high PPP may need a bit of an update.

Comment

The exchange-rate is the (F)X-Factor here but the inflation trend is now turning although due to base effects the headline may not respond for a couple of months or so. In some ways like so many things these days events have sped up and it has been like a crisis on speed. Here is the latest official trade data via Google Translate.

Our foreign trade deficit decreased by 92.8% to 529 million dollars in October compared to the same period of the previous year……..October, our exports increased by 13.1% compared to the same month of the previous year and reached 15 billion 732 million  dollars. Our exports increased to the highest level of all time and 
broke the record of the Republican history. 
In October, our imports decreased by 23.5 percent to 16 billion 261 million dollars.

There is an intriguing hint that the Ottoman export performance may have been quite something but we learn several things. Turkey seems to have a very price competitive economy as we see both exports and imports responding in size and in short order. We also have a large slow down and indeed recessionary hint from the size of the fall in imports. Next we admire their ability to have the October figures available on the 1st of November. Also if we look at the year so far you might be surprised at one of the names below.

In January-October period, exports to Germany increased 8.7% to $ 13.5 billion, while exports to the UK increased 17.5% to $ 9.3 billion.

Also Turkey seems to have avoided the automotive slow down which today has spread to Ford suppliers in Valencia.

Thus looking ahead the inflationary episode is now fading as ironically another consequence of the lower exchange-rate which is trade looks to be moving into surplus. For once the real economy is moving as quickly as the financial one. However one aspect that we do not know yet is the size of the slow down or recession partly because a sign of it – lower imports – flatters GDP via trade and often more quickly than the other numbers we receive show the actual cause of it. If you want a Commerzbank style Turkish economy imagine all of the above with another interest-rate increase……

 

 

The Dollar shortage of 2018 and maybe 19

Today we return to a topic which has been regularly in the headlines in 2018. We started the year with the US administration that looking like it was talking the US Dollar lower in line with its America First policy. Back on the 23rd of January we were mulling this.

“Obviously a weaker dollar is good for us as it relates to trade and opportunities,” Mnuchin told reporters in Davos. The currency’s short term value is “not a concern of ours at all,” he said.

However as the year has gone by we have found ourselves mulling what the US Treasury Secretary said next.

“Longer term, the strength of the dollar is a reflection of the strength of the U.S. economy and the fact that it is and will continue to be the primary currency in terms of the reserve currency,” he said.

If we look at matters from the perspective of the Euro then the 1.20 of the opening of 2018 was fairly quickly replaced by 1.25. But since then the US Dollar has rallied and has moved to 1.15. Some of that has been in the past few days as it has moved from 1.18 to 1.15. That recent pattern has been repeated across most currencies and at 114 the US Dollar us now up on the year against the Yen as well. The UK Pound has suffered this year from a combination of the Brexit process and the machinations of the unreliable boyfriend but it too has been falling recently against the US Dollar to below US $1.30 whilst holding station with other currencies.

Year end problems

The currency moves above are being at least partly driven by this from Reuters.

As the Fed raises interest rates and reduces its balance sheet, and the dollar and U.S. bond yields move up, overseas investors are finding it increasingly difficult and costly to access dollars. That much is obvious. What’s perhaps more surprising – and potentially worrying – is just how expensive and scarce those dollars are becoming.

So with US Dollar scarce it seems that some have been dipping their toes into the spot currency markets as a hedge. This is because other avenues have become more expensive.

Until this week the cross-currency basis market, one of the most closely-watched measures of broad dollar demand, liquidity and funding, had showed no sign of stress. Demand for offshore dollars was being met easily and at comfortable prices.But the basis widened sharply on Thursday, the day after the Fed raised rates for the eighth time this cycle and signalled it fully intends to carry on hiking. In euros, it was the biggest one-day widening since the Great Financial Crisis.

So last week there was a type of double whammy of which the first part came from the US Federal Reserve.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 2 to 2-1/4 percent.

So US official interest-rates have risen but something else has been happening.

Three-month dollar funding costs are currently running around 2.50 pct. Not high by historical standards and, on the face of it, surely manageable for most borrowers. But it is heading higher, and the availability of dollars is shrinking.

So as you can see a premium is being paid on official interest-rates. So we have higher interest-rates and a more expensive currency. We know that in spite of the official rhetoric that various countries are moving away from dollar use the trend has been the other way. From Reuters again.

All this at a time when the world’s reliance on the dollar has never been greater. Its dominance as the international funding currency has grown rapidly since the 2008 crisis, especially for emerging market borrowers.

Dollar credit to the non-bank sector outside the United States stood at 14 percent of global GDP at the end of March this year, up from 9.5 pct at the end of 2007, according to the Bank for International Settlements.

Dollar lending to non-bank emerging markets has more than doubled to around $3.7 trillion since the crisis and a similar amount has been borrowed through currency swaps.

Regular readers will recall that back on the 25th of September I took a look at the potential for a US Dollar shortage as we face a new era.

The question to my mind going forwards is will we see a reversal in the QT or Quantitative Tightening era? The supply of US Dollars is now being reduced by it and we wait to see what the consequences are.

Indian problems

The largest country in the sub-continent has been feeling the squeeze in several ways recently. One has been the move away from emerging market economies and currencies. Another has been the impact of the fact that India is a large oil importer and the price of crude oil has been rising making the problem worse. This morning’s move through US $86 for a barrel of Brent Crude Oil may fade away but over the past year we have seen a rise of around 53%. For the Indian Rupee this has been something of what might be called a perfect storm as it has found itself under pressure from different avenues at the same time. Back on the 16th of August I looked at the Indian crude oil dependency and since then the metric have got worse. The price of oil has risen further and partly in response to that the Rupee has weakened from 70 to the US Dollar which was a record low at the time to 74 today.

Accordingly I noted this earlier from Business Standard.

The Reserve Bank of India (RBI) on Wednesday allowed oil-marketing companies (OMCs) to raise dollars directly from overseas markets without a need for hedging.

In a post-market notification, the RBI said the minimum maturity profile of the borrowings should be three years and five years, and the overall cap under the scheme would be $10 billion. The central bank relaxed criteria for this.

It gives us a guide to the scale of the Indian problem.

The oil-swap facility was much anticipated in the market, as that would have taken the pressure away from the market substantially. Annually, the dollar demand on oil count is $120 billion, or about $500 million, on a daily basis for every working day.

And the driving factor was a lack of US Dollar liquidity

The RBI announcements on liquidity are more focused towards providing relief to the NBFCs (non-banking financial companies) and banks, rather than cooling of the rupee in the FX markets,

Let us move on after noting that the Reserve Bank of India may have had a busy day.

Currency dealers say the RBI intervened lightly in the market.

Comment

Overnight we have seen news regarding a possible impact on the US treasury bond market which is for holders a source of US Dollars. From Janus Henderson US.

Euroland, Japanese previous buyers of 10yr Treasuries have been priced out of market due to changes in hedge costs.  For Insurance companies in Germany / Japan for instance, U.S. Treasuries yield only -.10% / -.01%. Lack of foreign buying at these levels likely leading to lower Treasury prices.

This has impacted the US treasury bond market overnight and prices have fallen and yields risen. The ten-year Treasury Note now yields 3.21% instead of 3.15%. That does not make Bill Gross right ( he was famously wrong about UK Gilts being on a bed of nitroglycerine ) as the line of least resistance for markets would be to mark them lower in price terms and see what happens. Try and panic some into selling.

As to the yield issue which may seem odd the problem is that the cost of currency hedging your position is such that you lose the yield. Thus relatively high yielding US Treasuries end up being similar to Japanese Government Bonds and German Bunds.

As ever when there are squeezes on it is not so much the overall position which is a danger but the flows. For example India’s pol problem is good news for oil exporters but if they are not recycling their dollars then there is an imbalance. I guess of the sort which is why this temporary feature became permanent.

In November 2011, the Federal Reserve announced that it had authorized temporary foreign-currency liquidity swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank.

Me on Core Finance TV

 

The Central Bank of Turkey has voted for Christmas

Back on the 3rd of May I pointed out that yet another feature of economics 101 was not working these days. Here was my response to interest-rate rises from the central bank of Argentina or BCRA.

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

Since then the BCRA  has indeed ended up chasing its own tail like a dog, as interest-rates are now an eye watering 60%. But the sequence of rises has been accompanied by further currency falls, as back then an exchange rate to the US Dollar of 21/22 ( it was a volatile day) has been replaced by 39.4. To my mind this has been influenced by the second factor I looked at back in May.

Next comes the way that markets discount this in terms of forward exchange rates which now will factor in the higher interest-rate by lowering the forward price of the Peso. So against the US Dollar it will be of the order of 28% lower in a year’s time so the expected return in each currency is equal. This should not matter but human psychology and nature intervene and it turns out often to matter and helps the currency lower which of course is exactly the wrong result.

Right now the forward price of the Argentine Peso will be heavily discounted by the 60% interest-rate. At least the Argentines got some welcome good news on the rugby front on Saturday when they beat Australia. Although they currently seem unable to avoid bad news for long.

The Argentine peso has lost more than half its value, but U2 frontman Bono is advocating for the economic well-being of the Argentine people  ( Bloomberg ).

Turkey

As you can imagine the announcement below on the 3rd of this month from the Turkish central bank or CBRT made me mull the thoughts above.

monetary stance will be adjusted at the September Monetary Policy Committee Meeting in view of the latest developments.

On the day itself ( last Thursday) the water got very muddy for a while as President Erdogan again made a case for low interest-rates. He apparently has a theory that high interest-rates create high inflation. But the CBRT is not a believer in that.

The Monetary Policy Committee (the Committee) has decided to increase the policy rate (one week repo auction rate) from 17.75 percent to 24 percent.

The consensus was that this was a good idea as highlighted by the economist Timothy Ash.

Turkey – huge move by the CBRT, doing 625bps, taking the base rate to 24%. Respect. Difficult decision set against huge political pressure, but the right should set a floor, and gives the lira and Turkish assets, banks etc a chance.

I have more than a few doubts about that. The simplest is what calculations bring you to a 6.25% rise, or was it plucked out of thin air?  Added to that is the concept of a floor and giving the currency and banks a chance. Really? The words of Newt from the film Aliens comes to mind.

It wont make any difference

Initially the Turkish Lira did respond with a bounce. It rallied to around 6.1 versus the US Dollar on the day and then pushed higher to 6.01 on Friday. In response I tweeted this.

In the case of Argentina the half-life of the currency rally was 24 hours at best….

So as I checked the situation this morning I had a wry smile as I noted the Lira had weakened to 6.26 versus the US Dollar. I also note that the coverage in the Financial Times had someone who agrees with me albeit perhaps by a different route.

But Cristian Maggio, EM strategist at TD Securities, said the central bank did not go far enough, because inflation was likely to rise beyond 20 per cent, and “higher inflation will require even higher rates”.

On the day some speculators will have got their fingers singed as the comments from President Erdogan sent the currency weaker at first, so following that the CBRT move whip sawed them. If that was a tactical plan it succeeded, but that is very different to calling this a strategic success.

Another issue is that the currency may well be even more volatile looking forwards. This is because holding a short position versus the US Dollar has a negative carry of 22% or so and against the Euro has one of 24% or so. Thus there will be a tendency to hold the Turkish Lira for the carry and then to jump out ahead of any possible bad news. The problem with that is not everyone can jump out at once! Any falls will lead to a mass exodus or panic and we know from the experience of past carry trades that the subsequent moves are often large ones.

Foreign Debt

Brad Setser has crunched the numbers on this.

Turkey has about $180 billion external debt coming due, according to the latest central bank data. And most of that is denominated in foreign currency. The Central Bank of Turkey’s foreign exchange reserves are now just over $75 billion, and the banks may have about $25 billion (or a bit less now) in foreign exchange of their own. I left out Turkey’s gold reserves, in part because they are in large part borrowed from the banks and unlikely to be usable.

The total external debt is now a bit over US $450 billion. Very little of that is the government itself although the state banks are responsible for some of it. The problem is thus one for the private-sector and the banks.

How this plays out is very hard to forecast as we do not know how many companies will not be able to pay, and how much of a domino effect that would have on other companies. Also we can be sure that both the government and CBRT will be looking to support such firms, but we can also be sure that they do not have the firepower to support all of them! This is another factor making things very volatile.

The domestic economy

There are a lot of factors at play here but let me open by linking this to the foreign debt. If we look back we would also be adding a current account deficit to the problems above but this is getting much smaller and may soon disappear. From the third of this month.

Turkey’s foreign trade deficit in August fell 58 percent on a yearly basis, according to the trade ministry’s preliminary data on Sept 1.

There should be a boost for exports which will help some but so far the main player has been a fall in imports which were 22.4% lower in the merchandise trade figures above. So a real squeeze is being applied to the economy which the GDP figures will initially record as a boost, as imports are a subtraction from GDP. So they will throw a curve ball as the situation declines.

Added to that is this which was before the latest interest-rate rise.

Switching to a year on year basis the impact so far of this new credit crunch is around three-quarters of the 2008/09 one. The new higher official interest-rate seems set to put this under further pressure as the banks tend to borrow short ( which is now much more expensive) and lend long ( which will remain relatively cheap for a while).

Comment

A major problem in this sort of scenario was explained by Carole King some years ago.

But it’s too late, baby, now it’s too late
Though we really did try to make it
Something inside has died and I can’t hide
And I just can’t fake it, Oh no no no no no

Regular readers will be aware that it is in my opinion as important when you move interest-rates as what you do. Sadly that particular boat sailed some time ago for Turkey ( and Argentina) and macho style responses that are too late may only compound the problem. Or as the CBRT release puts it.

slowdown in domestic demand accelerates

It must be a very grim time for workers and consumers in Turkey so let me end by wishing them all the best in what are hard times as well as a little humour for hard times.

 

 

 

The economic impact of the 2018 currency crises are now being felt

This morning has brought yet more developments in the ongoing currency crises of this summer. An early morning economic salvo was fired by the Turkish central bank the TCMB.

Recent developments regarding the inflation outlook indicate significant risks to price stability.
The Central Bank will take the necessary actions to support price stability.
Accordingly, in line with the previous communication, monetary stance will be adjusted at the
September Monetary Policy Committee Meeting in view of the latest developments.
The Central Bank will continue to use all available instruments in pursuit of the price stability
objective.

The press release was in response to this from the Turkish Statistical Institute.

A rise in general index was realized in CPI (2003=100) on the previous month by 2.30%, on December of the previous year by 12.29%, on same month of the previous year by 17.90% and on the twelve months moving averages basis by 12.61% in August 2018.

What we are seeing here as inflation accelerates is a consequence of the fall in the value of the Turkish Lira as it had been around 10% in the early months of this year. If we look back to last year as well the inflation boost has been ~7%, and if we look at the producer price data also released today we see that there is more to come.

Domestic producer price index (D-PPI) increased by 6.60% on monthly basis, by 25.32% on December of the previous year basis, by 32.13% on same month of the previous year basis and by 18.78% on the twelve months moving averages basis in August 2018.

We get the clearest guide to the driver here when we note what has happened in August alone to goods which are priced across the world in US Dollars.

The highest rates of monthly increase in D-PPI by sub divisions of industry were index for coke and refined petroleum products by 25.11%, for metal ores by 15.33%, for basic metals by 12.07%.

What we are seeing here are the economic consequences of a currency crisis on the real economy, as we see inflation not only considerably up but heading higher as well. This will impact directly on consumers and workers via its impact on real wages. There are other consequences as well.

7 local newspapers in İzmir all cut their Sunday editions this week due to the price of imports like paper ( @06JAnk)

Another is more sinister as there are reports of an investigation into companies which have raised prices. Also the state bank which sold some incredibly cheap US Dollars last week might wish it had not.

But returning to the TCMB it has trouble ahead as we note the last sentence of its press release as of course President Erdogan has publicly stated he is no fan of interest-rate increases. So after a rally the Turkish Lira has been slipped backwards and is at 6.61 versus the US Dollar.

The economic situation

The last few days have given us signals that the economy is not only heading south but it may be doing so at a fair old lick. Here is the Hurriyet Daily News from Saturday.

Turkey’s foreign trade deficit in August fell 58 percent on a yearly basis, according to the trade ministry’s preliminary data on Sept 1.

Trade Minister Ruhsar Pekcan said in a statement that the trade deficit of $2.48 billion last month was the lowest monthly figure in the last nine years…….She added that Turkish exports amounted to $12.4 billion in August, with a yearly fall of 6.5 percent, while the country’s imports declined by 22.4 percent to $14.8 billion.

Care is needed on two counts as there was a longish national holiday in these figures and they are just for merchandise trade. But it is hard not to note the fall in imports which is more of a plummet, and it comes on the back of this reported in the full trade figures for July released last week.

while imports decreased by 9.4% compared with July 2017.

We are seeing a large contraction in purchases of foreign goods and services and this is where initially national accounts let us down. This is because the fall in imports improves the trade balance and via that GDP ( as imports are a subtraction from GDP), so it is a bit like when in the cartoons someone runs straight off the edge of a cliff and hangs in the air before gravity takes over. It takes the national accounts a while to record that people are worse off. On the other side of the coin I think that some help will be provided by export rises and that the August fall was driven by the national holiday.

Looking ahead

The manufacturing survey of the Istanbul Chamber of Industry released this morning was rather pessimistic.

August was a month of challenging business
conditions for manufacturing firms in Istanbul.
Weakness of the Turkish lira led to strong inflationary
pressures, and contributed to slowdowns in both
output and new orders.

They also follow the Markit PMI methodology.

After posting above the 50.0 no-change mark at
51.0 in July, the headline PMI dipped back into
contractionary territory during August. At 46.3, the
PMI signalled an easing of business conditions for
the fourth time in the past five months and the most
marked moderation since July 2015.

The only flicker of good news was from exports.

There was positive news
with regards to new export orders, however, which
increased fractionally and for the second successive
month.

Cots however were reported as rising at a record rate ( since 2006) which after the inflation data should surprise no-one.

Argentina

In Argentina there has been a different response as the central bank has tried to battle a declining Peso with interest-rate increases of which the latest came only on Thursday. Those of a nervous disposition might like to sit down before reading this from the BCRA.

the Monetary Policy Committee (COPOM) of the Central Bank of the Argentine Republic (BCRA) resolved Unanimously after meeting outside the pre-established schedule to increase the monetary policy rate to 60%. Likewise, to guarantee that monetary conditions maintain their contractionary bias, COPOM undertakes not to reduce the new value of its monetary policy rate until at least December.

This is a new form of central bank Forward Guidance in that not only were interest-rate raised by an eye-watering 15%, which is only a couple of percentage or so less than even Turkey, but there was also a promise they would stay there until December. A consequence of such interest-rates was noted this morning by the Financial Times.

One of the bond market’s biggest investors has seen its flagship funds battered by the turmoil in emerging markets unleashed by Argentina’s spiralling financial crisis ………Franklin Templeton funds have lost $1.23bn in the past two weeks on just three of its biggest Argentine positions, according to FT calculations.

Those of you who have a wry sense of humour might like to mull how quickly things can change.

Argentina, which increased interest rates last week by 15 percentage points to 60 per cent, emerged as one of the hottest stories in emerging markets two years ago after the centre-right reformist Mauricio Macri came to power.

Or as David Bowie put it.

Fashion! Turn to the left
Fashion! Turn to the right
Oooh, fashion!
We are the goon squad
And we’re coming to town.

Meanwhile Argentinians will be facing soaring interest-rates for any mortgage or business borrowing rather I would imagine in the manner of their rugby team as it faces up to playing the All Black this weekend.

Comment

There is a certain irony in the war that the “currency wars” described by Brazil’s Finance Minister some 8 years ago have hit its neighbour Argentina. But of course Argentina has long had a troubled path, although we return to the concept of fashion as we recall that it was able to issue a 100 year bond in June of last year. The Vomiting Camel Formation for its likely price that I noted on the third of May performed really rather well.

However as we look at Turkey and Argentina in particular we see that the currency crises are causing inflation which will create a recession. How large and deep depends on where their currencies eventually settle as right now things could hardly be much more volatile. Yet they are far from alone as we note that the Indian Rupee has fallen to 71 versus the US Dollar and impacts on Russia, South Africa, Brazil and Indonesia. It should get more attention than it does as after all that is quite a bit of the world’s population. Also we see the power of the reserve currency the US Dollar.