Rising inflation trends are putting a squeeze on central banks

Sometimes events have their own natural flow and after noting yesterday that the winds of change in UK inflation are reversing we have been reminded twice already today that the heat is on. First from a land down under where inflation expectations have done this according to Trading Economics.

Inflation Expectations in Australia increased to 4.20 percent in June from 3.70 percent in May of 2018.

This is significant in several respects. Firstly the message is expect higher inflation and if we look at the Reserve Bank of Australia this is the highest number in the series ( since March 2013). Next  if we stay with the RBA it poses clear questions as inflation at 1.9% is below target ( 2.5%) but f these expectations are any guide then an interest-rate of 1.5% seems well behind the curve.

Indeed the RBA is between a rock and a hard place as we observe this from Reuters.

Australia’s central bank governor said on Wednesday the current slowdown in the housing market isn’t a cause for concern but flagged the need for policy to remain at record lows for the foreseeable future with wage growth and inflation still weak.

Home prices across Australia’s major cities have fallen for successive months since late last year as tighter lending standards at banks cooled demand in Sydney and Melbourne – the two biggest markets.

You know something is bad when we are told it is not a concern!

If we move to much cooler Sweden I note this from its statistics authority.

The inflation rate according to the CPI with a fixed interest rate (CPIF) was 2.1 percent in May 2018, up from 1.9 percent in April 2018. The CPIF increased by 0.3 percent from April to May.

So Mission Accomplished!

The Riksbank’s target is to hold inflation in terms of the CPIF around 2 per cent a year.

Yet we find that having hit it and via higher oil prices the pressure being upwards it is doing this.

The Executive Board has therefore decided to hold the repo rate unchanged at −0.50 per cent and assesses that the rate will begin to be raised towards the end of the year, which is somewhat later than previously forecast.

Care is needed here as you see the Riksbank has been forecasting an interest-rate rise for some years now but like the Unreliable Boyfriend somehow it keeps forgetting to actually do it.

I keep forgettin’ things will never be the same again
I keep forgettin’ how you made that so clear
I keep forgettin’ ( Michael McDonald )

Anyway it is a case of watch this space as even they have real food for thought right now as they face the situation below with negative interest-rates.

Economic activity in Sweden is still strong and inflation has been close to the target for the past year.

US Inflation

The situation here is part of an increasingly familiar trend.

The all items index rose 2.8 percent for the 12 months ending May, continuing its upward trend since the beginning of the year. The index for all items less food and
energy rose 2.2 percent for the 12 months ending May. The food index increased 1.2 percent, and the energy index rose 11.7 percent.

This was repeated at an earlier stage in the inflation cycle as we found out yesterday.

On an unadjusted basis, the final demand index moved up
3.1 percent for the 12 months ended in May, the largest 12-month increase since climbing 3.1 percent in January 2012.

In May, 60 percent of the rise in the index for final demand is attributable to a 1.0-percent advance in prices for final demand goods.

A little care is needed as the US Federal Reserve targets inflation based on PCE or Personal Consumption Expenditures which you may not be surprised to read is usually lower ( circa 0.4%) than CPI. We do not know what it was for May yet but using my rule of thumb it will be on its way from the 2% in April to maybe 2.4%.

What does the Federal Reserve make of this?

Well this best from yesterday evening is clear.

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 1-3/4 to 2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

If we start with that let me give you a different definition of accommodative which is an interest-rate below the expected inflation rate. Of course that is off the scale in Sweden and perhaps Australia. Next we see a reference to “strong labo(u)r market conditions” which only adds to this. Putting it another way “strong” replaced “moderate” as its view on economic activity.

This is how the New York Times viewed matters.

The Federal Reserve raised interest rates on Wednesday and signaled that two additional increases were on the way this year, as officials expressed confidence that the United States economy was strong enough for borrowing costs to rise without choking off economic growth.

Care is needed about borrowing costs as bond yields ignored the move but of course some may pay more. Also we have seen a sort of lost decade in interest-rate terms.

The last time the rate topped 2 percent was in late summer 2008, when the economy was contracting and the Fed was cutting rates toward zero, where they would remain for years after the financial crisis.

Yet there is a clear gap between rhetoric and reality on one area at least as here is the Fed Chair.

The decision you see today is another sign that the U.S. economy is in great shape,” Mr. Powell said after the Fed’s two-day policy meeting. “Most people who want to find jobs are finding them.”

Yet I note this too.

At a comparable time of low unemployment, in 2000, “wages were growing at near 4 percent year over year and the Fed’s preferred measure of inflation was 2.5 percent,” both above today’s levels, Tara Sinclair, a senior fellow at the Indeed Hiring Lab, said in a research note.

So inflation is either there or near but can anyone realistically say that about wages?

Mr. Powell played down concerns about slow wage growth, acknowledging it is “a bit of a puzzle” but suggesting that it would normalize as the economy continued to strengthen.

What is normal now please Mr.Powell?

Comment

One of my earliest themes was that central banks would struggle when it comes to reducing all the stimulus because they would be terrified if it caused a slow down. A bit like the ECB moved around 2011 then did a U-Turn. What I did not know then was that the scale of their operations would increase dramatically exacerbating the problem. To be fair to the US Federal Reserve it is attempting the move albeit it would be better to take larger earlier steps in my opinion as opposed to this drip-feed of minor ones.

In some ways the US Federal Reserve is the worlds central bank ( via the role of the US Dollar as the reserve currency) and takes the world with it. But there have been changes here as for example the Bank of England used to move in concert with it in terms of trends if not exact amounts. But these days the Unreliable Boyfriend who is Governor of the Bank of England thinks he knows better than that and continues to dangle future rises like a carrot in front of the reality of a 0.5% Bank Rate.

This afternoon will maybe tell us a little more about Euro area monetary policy. Mario Draghi and the ECB have given Forward Guidance about the end of monthly QE via various hints. But that now faces the reality of a Euro area fading of economic growth. So Mario may be yet another central bank Governor who cannot wait for his term of office to end.

 

 

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Italy faces another bond market crisis

The situation in Italy has returned to what we now consider as a bond market danger zone although this time around the mainstream media seems much less interested in a subject which it was all over only a fortnight ago. Before we get to that as ever we will prioritise the real economy and perhaps in a type of cry for help the Italian statistics office has GDP ( Gross Domestic Product) per capita at the top of its page. This shows that the post Second World War surge was replaced by such a decline since the 28,699 Euros of 2007 that the 26,338 of last year took Italy back to 1999. The lack of any growth this century is at the root cause of the current political maelstrom as it is the opposite of what the founders of the Euro promised.

Retail Sales

These attracted my attention on release yesterday and you will quickly see why.

In April 2018, both the value and volume of retail trade show a fall respectively of -4.6% and -5.4%
comparing to April 2017, following strong growth in March 2018.

Imagine if that had been the UK Twitter would have imploded! As we look further we see that there seems to be an Italian spin on the definition of a recession.

In April 2018, the indices of retail trade saw a monthly recession, with value falling by 0.7% and volume
dropping by 0.9%.

Taking a deeper perspective calms the situation somewhat but leaves us noting a quarterly decline.

Notwithstanding the monthly volatility, looking at the underlying pattern, the 3 months to April picture
reports a slight decline as value decreased by 0.5% and volume contracted by 0.2%.

This is significant as this is supposed to be a better period for the Italian economy which has been reporting economic growth for a couple of years now. It does not have the UK problem of inflation impacting on real wages because inflation is quite subdued.

In May 2018, according to preliminary estimates, the Italian harmonised index of consumer prices (HICP) increased by 0.4% compared with April and by 1.1% with respect to May 2017 (it was +0.6% in the previous month).

Actually the rise in inflation there may further impact on retail sales via real wages. Indeed the general picture here sees retail sales in April at 98.6 compared to 2015 being 100. Seeing as that is supposed to have been a better period for the Italian economy I think it speaks for itself.

The economy overall

This is consistent with the general European theme we have been both observing and expecting. From yesterday’s official monthly report.

The downturn in the leading indicator continues, suggesting a deceleration in economic activity for the coming months.

This would continue the decline as in terms of GDP growth we have seen 0.5% twice then 0.4% twice and then 0.3% twice. Ironically that had shifted Italy up the pecking order after the 0.1% for the UK and the 0,2% for France after its downwards revision. But the detail is not optimistic.

Italian growth has been fostered by change in inventories (+0.7 percentage points) and by domestic consumption expenditures (+0.3 percentage points).

The inventory position seems to be a case of “what goes up must come down” from the aptly named Blood Sweat & Tears and we have already seen that retail sales will not be helping consumption.

The trade position is in general a strong one for Italy but the first quarter showed a weakening which seems to have continued in April.

In April, exports toward non-EU countries recorded a contraction (-0.9% compared to the previous month) less marked than in the previous months (- 3.1% over the last three months February-April). In the same quarter, total
imports excluding energy showed a negative change (-0.7%).

So lower exports are not good and lower imports may be a further sign of weakening domestic demand as well. As ever the monthly data is unreliable but as you can see below Italy’s vert strong trade position with non EU countries has weakened so far this year as we mull the stronger Euro.

The trade balance registered a surplus of 7,141 million euro compared to the surplus of 7,547 million euro in the same period of 2017.

An ominous hint of trouble ahead comes if we note the likely impact of a higher oil price on Italy’s energy trade balance deficit of 12.4 billion Euros for the first four months of 2018.

Bond Markets

These are being impacted by two main factors. Via @liukzilla we are able to award today’s prize for stating the obvious to an official at the Bank of Italy.

ROSSI SAYS YIELD SPREAD WIDER DUE TO -EXIT RISK: ANSA || brilliant…

It seems to have been a day where the Bank of Italy is indeed in crisis mode as we have also had a case of never believe anything until it is officially denied.

A GRADUAL RISE IN INTEREST RATES TO PRE-CRISIS LEVELS IS NOT A CAUSE FOR CONCERN FOR ITALY -BANK OF ITALY OFFICIAL ( @DeltaOne )

The other factor is the likelihood that the new Italian government will loosen the fiscal purse strings and spend more. It is already asking the European Union for more funds which of course will come from a budget that will ( May?) lose the net contribution from the UK.

Thus the bond market has been sold off quite substantially again this week. If we look at it in terms of the bond future ( BTP) we see that the 139 and a bit of early May has been replaced by just under 123 as I type this. Whilst there are implications for those holding such instruments such as pension funds the main consequence is that Italy seems to be now facing a future where the ten-year benchmark yields and costs a bit over 3%. This is a slow acting factor especially after a period where the ECB bond purchases under QE have made this cheap for Italy. But there has already been one issue at 3% as the new drumbeat strikes a rhythm.

There has also been considerable action in the two-year maturity. Now this is something that is ordinarily of concern to specialists like me but the sharp movements mean that something is going on and it is not good. It is only a few short week’s ago that this was negative before it then surged over 2% in a dizzying rise before dropping back to sighs of relief from the establishment. But today it is back at 1.68% as I type this. In my opinion something like a big trading position and/or a derivative has blown up here which no doubt will be presented as a surprise at some future date.

Meanwhile here is the Governor of the Bank of Italy describing the scene at the end of last month.

Having widened considerably during the sovereign debt crisis, the spread between the average cost of the debt and GDP growth narrowed to around
1 per cent. It could narrow further over the next few years so long as the economic situation remains positive. If the tensions of the last few days subside, the cost of debt will also fall, if only slightly, when the securities
that were placed at higher rates than newly issued ones come to maturity.

Comment

So to add to the other issues it looks like the Italian economy is now slowing and of course it was not growing very much in the first place. This makes me think of the banks who are of course central to this so let us return to Governor Visco’s speech.

Italian banks strengthened capital in 2017. Common equity increased by €23 billion, of which €4 billion was provided by the Government for the recapitalization of Monte dei Paschi di Siena.

Those who paid up will now be mulling losses yet again as even more good money seems to be turning bad and speaking of bad.

NPLs, net of loan loss provisions, have
diminished by about a third with respect to the end of 2015, to €135 billion. The coverage ratio, i.e. the ratio of the stock of loan loss provisions to gross NPLs, has reached 53 per cent, a much higher level than the average for the
leading European banks.

On and on this particular saga goes which will only really ever be fixed by some economic growth which of course is where we came in. Also whoever has done this has no doubt been suffering from a sleepless night or two recently.

The decrease in the stock of NPLs is partly due to the sharp rise in sales on the secondary market, facilitated by the favourable economic situation
(€35 billion in 2017 against a yearly average of €5 billion in the previous four years). This year sales are expected to reach €65 billion for the banking
system as a whole.

 

 

 

The ongoing problem that is Deutsche Bank

Yesterday saw what might be called an old friend return to the fore. Back in the day I worked at Deutsche Bank or more specifically for Morgan Grenfell which it purchased. Also we have had reason to follow the story of it on here due to several factors. Firstly it is not only intrinsically linked to the German economy it is of course involved all over the Euro area economy as well as being a global bank. But also because it not only was hurt by the impact of the credit crunch and then of course by the Euro area crisis but a decade or so later from the former it has never really shaken off the view that things went very wrong. You could call it a balance sheet problem or a derivatives based one or a combination of both. Perhaps it is better to put it under the label of trust as in lack of.

Or to put it another way we have seen a form of official denial this morning and we know what to do with them! From Reuters.

“At group level, our financial strength is beyond doubt,” new CEO Christian Sewing said in a letter to staff, candidly admitting that the news flow around the bank was “not good”.

We of course know what to think when somebody tells us something is beyond doubt and if we did not this from the Financial Times helps us out.

My dear colleagues, the last few years were tough. Many of you are sick and tired of bad news. That’s exactly how I feel. But there’s no reason for us to be discouraged. Yes, our share price is at a historic low. But we’ll prove that we have earned a better valuation on the financial markets. We’ve achieved a lot we can be proud of. Now we need to look forward.

It would seem that those backing things with their money are not entirely clear about the “beyond doubt” financial strength as a share price at a historic low tends to indicate exactly the reverse. Also share prices are supposed to look forwards.

Number Crunching

This morning the relief around the actual formation of an Italian government plus no doubt some rallying of the fund management troops has seen the share price rise to 9.5 Euros. But this only corrects around half of yesterday’s 7% fall which saw it bottom at 9.06 Euros and close at 9.18. This compares rather badly with the 15.88 Euros at which it closed 2017 especially as we are supposed to be in a Euro boom. Compared to a year ago the share price is some 42% lower and those of a nervous disposition might do well to look away from the over 94 Euros of early 2007.

The price was lower back in the autumn of 2016 as we mull what “historic low” means? But banks are supposed to do well in the good times and yet Deutsche seems back in the mire. Or to put it another way Welt are pointing out that it was once the same size in terms of market capitalisation as JP Morgan whereas it has now fallen to one- sixteenth of it.

Across the pond

The Wall Street Journal has pointed out this.

The Federal Reserve has designated Deutsche Bank AG’s sprawling U.S. business as being in a “troubled condition,” a rare censure for a major financial institution that has contributed to constraints on its operations, according to people familiar with the matter.

It went on to explain what this meant.

The Fed’s downgrade, which took place about a year ago, is secret and hadn’t previously been made public. The “troubled condition” status—one of the lowest designations employed by the Fed—has influenced th bank’s moves to reduce risk-taking in areas including trading and lending to customers.

It also means the bank has had to clear decisions about hiring and firing senior U.S. managers with Fed overseers. Even reassigning job duties and making severance payments for certain employees require Fed approval, the people said.

In one respect this is a welcome move in that it is a regulator acting although we also need to note that the US Fed seems much more enthusiastic about such moves for foreign banks. After all at home it has just announced plans to ease the Volcker Rule.

The issue for Deutsche Bank is that this development calls into question its plans for the US. Is it even in charge of its operations and did it or the US Fed drive the announced changes?

In many ways this is one of the most damning things you can say about a bank.

The Fed also reupped its criticism of Deutsche Bank’s financial documentation. Examiners expressed frustration at what they described as the bank’s inability to calculate, at the end of any given day, its exposures to what banks and other clients it had in specific jurisdictions, and over what duration, some of the people said.

Standard and Poors

We have learnt over time that the ratings agencies are like the cavalry which arrived the day after the battle of Little Big Horn. But sometimes they do add a little value.

June 1, 2018–S&P Global Ratings today lowered its
long-term issuer credit ratings (ICR) on Deutsche Bank AG and its core
subsidiaries to ‘BBB+’ from ‘A-‘. The outlook is stable.

So stable that they are downgrading it? Anyway we get some detail as to why this has happened.

The lowering of our long-term issuer credit rating reflects that Deutsche
Bank’s updated strategy envisages a deeper restructuring of the business model
than we previously expected, with associated non-negligible execution risks……the bank
appears set for a period of sustained underperformance compared with peers,
many of whom have now finished restructuring.

Or to put it more bluntly you are in pretty poor shape if you are behind the sorry crew listed below.

By contrast, key peers such as
Barclays, Commerzbank, Credit Suisse, and the Royal Bank of Scotland (RBS)
have now worked through their restructuring and business model optimization
and are already starting to see improved performance.

Comment

The fundamental problem here in my opinion is the view held by many within it that Germany will always have at least two banks of which Deutsche Bank will be one. Even in the protected world of banking that is an extreme position. Combined with the credit crunch and then the Euro area crisis this means that it is time for the Cranberries.

Zombie, zombie, zombie, ei, ei
What’s in your head?
In your head
Zombie, zombie, zombie

It seems to have little clear purpose other than its own survival as it struggles from one crisis to the next. So far it emerges from each of them weaker than before but the official view mimics the “Tis but a scratch” of the Black Knight.

I note some reporting that the ECB says the turnaround is going well whereas I also note that things seem not so hot in a land down under.

Australia is preparing criminal cartel charges against the country’s third-biggest bank and underwriters Deutsche Bank and Citigroup over a $2.3 billion share issue, in an unprecedented move with potential implications for global capital markets. ( Reuters)

It’s a mistake……

These days even higher house prices do not seem to be enough. From its own research in January.

During the current real-estate cycle, i.e., from 2009 to 2017, house prices have risen 80% in large metropolitan areas (A cities) and c. 60% in B and C cities….The tight market situation has pushed house prices up even more strongly in
2017 than in the preceding years. According to bulwiengesa (which covers 126 cities), house prices rose c. 6 ½% and apartment prices more than 10% on average.

Can Mario Draghi and the ECB help Italy?

Yesterday was quite an extraordinary day especially in Italian markets. However I wish to move on to consider things from the new tower of the European Central Bank. So as we move geographically to the Grossmarkthalle in Frankfurt we would have seen concern and probably not a little panic. The phone lines would have been burning between Frankfurt and the Bank of Italy as they discussed how to respond. At first this would have been on a tactical level about the ongoing QE ( Quantitative Easing) bond buying programme but of course the higher echelons and strategy would pretty quickly have been in play. However you spin it the billion Euros or so a week of buying of Italian bonds might have lasted all of thirty minutes if that if it was spent all in one go! I do not know if the weather was the same as in London but the storms were appropriate.

There was no formal Governing Council Meeting but I am sure that President Draghi and the Executive Board would have been in contact and others would have taken an interest. Some may have had a wry smile as up to this week the main issue would have been the location of the meeting next month in Riga Latvia. There the issues would be corruption, money-laundering and in some respects the ECB trying to put itself outside the legal system. Now the question on everyone’s minds would be Italy and the political crisis triggered there and in particular the impact on debt markets

What could the ECB do?

The obvious first move concerns the QE bond buying. This is something of a new situation as it is the first case of a major bond market facing a price rout with both flow QE as in ongoing purchases and a stock of it as the ECB has bought around 342 billion Euros of Italian government bonds so far. Thus the latter would not be sold and it would have been bought mostly from those who might have done in the situation unfolding. Yet it was not enough and the ECB has tied its own hands.

What I mean by this is that in order to get its 19 constituent nations to agree to the QE plan it buys according to their Capital Key. This is the effective shareholding of each country and reflects factors such as their relative GDP and Italy is approximately 17.5% so that is what it gets. There is scope to vary this but not a lot as Mario Draghi explained in January.

 The ECB doesn’t favour certain countries over others in its PSPP purchase programme implementation. As you know, purchases are guided by the ECB’s capital key, which takes into account GDP and population. Now, focusing excessively on any particular purchase period, for example on 2017 only, could result and yield wrong interpretations. The overall stock of Eurosystem PSPP holdings is the relevant metric for any assessment of the programme and not the recent purchase flows.

Back then too much German debt was held and too little Portuguese.

These flows can differ as the design of the programme is flexible and the distribution of actual purchases often deviates from the ECB capital key.

So whilst there is flexibility there is nowhere near enough especially as the numbers would be released next Monday and everyone would see. Actually I think the flexibility was used up last Wednesday when the ECB in baseball terms stepped up to the plate and then withdrew. No doubt there were discussions about modifying the programme but I doubt they got far and the word nein would not have been needed.

Some have been suggesting the ECB could buy more but at the moment that is a non-starter. Of course we have seen such things change but persuading German and other taxpayers to potentially bankroll a new coalition government in Italy hoping to “spend spend spend” will not be easy.

Securities Markets Programme

This was used in the Euro area crisis.

About e220 billion (bn) of bonds (par
value, excluding redemptions) were acquired from 2010 to early 2012. Greece, Ireland, Portugal, Spain, and
Italy.

As described it does seem to fit the bill.

First, purchases within the SMP occurred during a severe sovereign debt crisis, when sovereign yields in several euro area countries were high, rising, and volatile.

Of course you could argue that in spite of yesterday’s surge in Italian bond yields with the ten-year around 3% as I type this that is not high compared to the 7% of the Euro area crisis. Also the programme is shown as terminated on the ECB website although 84 billion Euros of bonds are still held.

However it is worth noting because the replacement called OMTs or Outright Monetary Transactions have never been used.

Outright Monetary Transactions will be considered for future cases of EFSF/ESM macroeconomic adjustment programmes or precautionary programmes as specified above.

That is an issue because Italy is not in one and you could hardly see Mr. Sissors persuading the Italian parliament of much at all right now let alone this. That is unfortunate from the point of view of the ECB because like the SMP it operates like this.

Transactions will be focused on the shorter part of the yield curve, and in particular on sovereign bonds with a maturity of between one and three years.

This matters because there have been some extraordinary events in short dated Italain government bonds. As recently as the fifteenth of this month the two-year yield was negative reflecting the easy ECB monetary policy and the -0.4% Deposit Rate. Yesterday it rose as high as 2.8% and today it is 2%. So some extraordinary moves with t hose who bought a fortnight ago feeling rather silly I guess.

Wider Moves

The issue here for the ECB is that not only has it been tapering its QE programme but it has been hinting at its end. That makes it awkward to fire it back up. Of course should the current weaker patch for the economy persist then it might provide an excuse/reason but it is just as true that the effect on inflation from the higher oil price is pushing in the opposite direction.

Comment

The ECB finds itself between a rock and a hard place in two respects. The first is that additional bond purchases might turn out to be an own goal if the likely governing coalition returns to its proposal involving the ECB writing off 250 billion Euros of it.Next comes the issue of Greece which does not qualify for QE in spite of enormous efforts and it might reasonably ask how a fiscally expansionary government in Italy qualifies?

There could be specific efforts to help the Italian banks although of course they have received an extraordinary amount of help as it is! Most still seem to be troubled and burdened with bad and sour loans. Mario Draghi was always very keen on buying Asset Backed Securities which I always thought was a way of helping the Italian banks in particular but as we look we see a barrier.

At the time of inclusion in the securitisation, a loan should not be in dispute, default, or unlikely to pay. The borrower associated with the loan should not be deemed credit-impaired (as defined in IAS 36).

Here is my suggestion for the ECB loudspeakers from The Sweet.

Does anyone know the way, did we hear someone say
(We just haven’t got a clue what to do)
Does anyone know the way, there’s got to be a way
To blockbuster

 

Meanwhile the Euro has recovered a bit today and is above 1.16 versus the US Dollar.

 

 

The Italian bond and bank crisis of May 2018

Oh what a difference a couple of days can make, especially in Italy right now. However we can see the cause of this quite easily and have done so more than a few times in the past. Back at the end of the last century when the Euro currency concept was being prepared its supporters argued that it would bring economic convergence to its member countries. The reality for Italy has been this if we look for an individual measure of economic performance.

The convergence issue has been a disaster for Italy. Ironically it seemed to be holding station with Germany before the Euro began but since it the German locomotive has powered ahead leaving the Italian carriage in a siding. If you had set out to diverge the two economies it would have been hard to do better ( worse?) than this. Also my theme that Italy struggles in the relatively good times was at play in the early part of the century. Then it was hit hard by the credit crunch and the Euro area crisis and sadly has still not fully sorted its banking problems.

Poverty

Another way of observing the Italian economic experience has been provided in a paper from the Universities of Modena and Rome which point out another reversal.

The paper explores the changing risk of poverty for older and younger generations of Italians throughout the republican period, 1948 to the present day. We show that
poverty rates have decreased steadily for all age groups, but that youth has been left behind. The risk of poverty for children aged 0-17, relative to adults over 65, has
increased steadily over time: in 1977, children faced a risk of poverty 30 percent lower than the elderly, but by 2016 they are 5 times likelier to be poor than someone in the age
range of their grandparents.

It is easy to always look at the bad side so let us take a moment of cheer as we note that in general poverty has fallen since the second world war and mankind has stepped forwards. However the rub as Shakespeare would put it is that the times may be a-changing and the poverty we see now in Italy is concentrated in younger age groups. This reminds me of another statistic.

Youth unemployment rate (aged 15-24) was 31.7%, -0.9 percentage points over the previous month.

So as the overall unemployment rate is 11% then the youth unemployment rate must be treble that of older age groups. Which means that they have gone back to the future.

As a matter of fact, young Italians today face approximately the same risk of poverty as their equals in age in the 1970s. No economic miracle has happened for them, and none is expected.

This seems to have been a deliberate policy as we note this.

 Our analysis points to the welfare state, which offers better protection for the elderly than it does for
the young and their families………More importantly, the
elderly continued their march towards a poverty-free existence, while the youth did not.

This leads to a rather chilling statement.

Overall, in the last seven decades, Italy has become no country for young people.

Some of this is an international issue as for example the UK had the triple-lock for the basic state pension but some is specifically Italy.

National Debt

This is an issue but not in the ordinary way. This is because what can be described as the third biggest national debt in the world has not be caused by fiscal recklessness. In recent times Italy has been restrained. The problem has been the one described above which is the lack of economic growth. On such a road to nowhere even small fiscal deficits see the national debt rise in relation to economic output or GDP (Gross Domestic Product).

Perhaps the new Prime Minister will live up to his “Mr. Scissors” nickname in this area but it will be hard for a man facing a confidence vote to do much I would think.

Italian bonds

As you can imagine this has felt just like old times for me and in spite of yesterday being a glorious bank holiday at least until the evening thunderstorm I was transfixed for a while by what was happening. Two old rules of mine worked as well.

I like the idea of applying something I was taught at the LSE albeit with a personal spin as so much has found its way into the recycling bin. Nobody seems to pick it up either which means it is set fair for the future. The other is that you buy an intraday fall of more than two points. That worked as well but with the caveat that it was a case of the “quick and the dead” and you would have been stopped out today.

Moving to the state of play as I type this we see what has become a bloodbath. The Italian BTP bond future has fallen 5 points to a low of 124 and this compares to a bit over 139 as recently as the 7th of this month. Putting it another way the ten-year yield has risen from 1.76% to 3.1%. This may not seem large moves so let me explain the issue in the QE ( Quantitative Easing) era.

  1. They are bigger than you think and an example of this is the way the US Treasury Bond market used to have a trading halt after two point moves. Annoying at the time but does give a breather.
  2. In the QE era there is the view that the central bank will bail things out and that to quote Flo “the dogs days are over”
  3. This may have tempted investors to increase position size to make a profit which of course would now be in trouble.
  4. As implied volatilities fall it is tempting not only to put on derivative positions but to increase their size as human nature is particularly vulnerable at such times.

We have two clear examples of such events. One I traded through which was the LTCM crisis of the late 90s which was a case of intellectual arrogance and of course we had the travails of the VIX index earlier this year.

Whatever It Takes

The famous saying from ECB President Draghi from the summer of 2012 of course had to save the Euro as an implication but some translated it as “to save the Italian banks”. We have followed over time the multitude of issues here but as we looked at last week another problem emerged on Thursday. From @YanniKouts.

The minute the markets will realize that Italy will restructure its debt, the Italian banks and eventually the economy will collapse. Corralito.

Since then the share prices of the Italian banks have moved into yet another bear market. Our old friend Monte Paschi the world’s oldest bank is at 2.32 Euros down 5% today or 1 Euro lower than a fortnight ago. Those of a nervous disposition might like to look away now as I point out that compares to a pre credit crunch peak of more like 7700 Euros. In a way the Italian financial crisis can be summed up by Prime Minister Renzi saying it was a good investment. Oh and as Polemic Paine reminds us a past theme is in play right now.

Waiting for second round effects from all the private hands that clamoured to buy the Italian banks’ dodgy debt.

These days the role of the ECB has increased as of course it is also the banking supervisor which I think is a bit like being Liverpool’s goalkeeping coach.

Comment

There is much to consider here and let me throw in something from this morning’s data which will not help. From the ECB.

The annual growth rate of the narrower aggregate M1, which includes currency in circulation
and overnight deposits, decreased to 7.0% in April, from 7.5% in March.

Another hint of an economic slow down albeit broad money was a little better. Moving to the financial crisis this will be felt by individual Italians as they are savers and for example around 64% of Italian debt is held by domestic hands. So they are losing and whilst overseas investors are in a minority that is still some 685 billion Euros due to the size of the market. Thanks to the Bruegel group for the data. This is of course before we get to the stock market and those holding bank debt. Remember when we were told what great deals the bank debt was? Also the “protecting savers” part from President Mattarella not only goes into my financial lexicon for these times but will be part of what historians will call the Mattarella Error.

As a final though this has answered a question we have been asking for a while. What would get the Euro to fall? This has been answered as we note it has dropped to 1.15 and a bit versus the US Dollar and even the UK Pound £ has nudged a little higher to the nearly the same number.

 

 

 

Will Italy get a 250 billion Euro debt write-off from the ECB?

Up until now financial markets have been very sanguine about the coalition talks and arrangements in Italy. I thought it was something of calm before the storm especially as these days something which was a key metric or measure – bond yields – has been given a good dose of morphine by the QE purchases of the European Central Bank. However here is a  tweet from Ferdinando Guigliano  based on information from the Huffington Post which caught everyone’s attention.

1) Five Star and the League expect the to forgive 250 billion euros in Italian bonds bought via quantitative easing, in order to bring down Italy’s debt.

My first thought is that is a bit small as whilst that is a lot of money Italy has a national debt of 2263 billion Euros or 131.8% of its GDP or Gross Domestic Product according to Eurostat. So afterwards it would be some 2213 billion or 117% of GDP which does not seem an enormous difference. Yes it does bring it below the original 120% of GDP target that the Euro area opened its crisis management with but seems hardly likely to be an objective now as frankly that sank without trace. Perhaps they have thoughts for spending that sort of amount and that has driven the number chosen.

Could this happen?

As a matter of mathematics yes because the ECB via the Bank of Italy holds some 368 billion Euros and rising of Italian government bonds and of course rising. However this crosses a monetary policy Rubicon as this would be what is called monetary financing and that is against the rules and as we are regularly told by Mario Draghi the ECB is a “rules based organisation”. Here is Article 123 of the Lisbon Treaty and the emphasis is mine.

Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.

Now we hit what Paul Simon would call “troubled water” as the ECB has of course been very close to the highlighted part. The argument for QE purchases rested on the argument that buying in the secondary market was indirect and not direct or as the ECB puts it.

There will be no primary market purchases under the PSPP, regardless of the type of security, as such purchases are not allowed under Article 123 of the Treaty on the Functioning of the European Union.

It is a bit unclear as to when they become available but if I recall correctly as an example the Bank of England limit is one week.

The reason for this is to stop a national government issuing debt and the central bank immediately buying it would be a clear example of round-tripping. The immediate implication would be a higher money supply raising domestic inflation dangers  although there would be an initial boost to the economy. We did look at an example of this a couple of years ago in the case of Ghana and whilst we never get a test tube example in economics the Cedi then fell a substantial amount and inflation rose . Thus the two worrying implications are inflation and a currency plunge on a scale to cause an economic crisis.

Would this happen in the case of Italy? That depends on how it plays out. Inside the boundaries of the Euro maybe not to a  great extent initially but as it played out there would be an effect as Italy would not doubt be back for “More,More,More” once Pandora’s Box was open and of course others would want to get their fingers in the cookie jar.

Oh and if we go back to the concept of the ECB being a “rules based organisation” that is something that is until it breaks them as we have learnt over time.

Fiscal Policy

You will not be surprised to learn that they wish to take advantage of the windfall. Back to the tweets of Ferdinando Guigliano

5) The draft agreement would see the Italian government spend 17 billion euros a year on a “citizens’ income”. The European Commission would contribute spending 20% of the European Social Fund

That raises a wry smile as we mull the idea of them trying to get the European Commission to pay for at least some of this. Perhaps they are thinking of the example of Donald Trump and his wall although so far that has been more of a case of a “Mexicant” than a “Mexican.”

Next came this.

According to , the 5 Star/League draft document says there would be a “flat tax”… but with several tax rates and deductions

So flat but not flat well this is Italy! Also we see what has become a more popular refrain in this era of austerity.

Italy’s pension reform would be dismantled: workers would be able to retire when the sum of their retirement age and years of contribution is at least 100.

Over time this would be the most damaging factor as we get a drip feed that builds and builds especially at a time of demographic problems such as an aging population.

So a fiscal relaxation which would require some changes in the rules of the European Union.

The two parties want to re-open European Treaties and to “radically reform” the stability and growth pact. The coalition would also want to reconsider Italy’s contribution to the EU budget.

Market Response

That has since reduced partly because the German bond market has rallied. Partly that is luck but there is an odd factor at play here. You might think that as the likely paymaster of all this Germany would see its bonds hit but the reality is that it is seen as something of a safe haven which outplays the former factor. On that road it issued some two-year debt yesterday with investors paying it around 0.5% per annum. Also I think there is such a shock factor here that it takes a while for the human mind to take it in especially after all the QE anaesthetic.

The Euro has pretty much ignored all of this as I use the rate against the Yen as a benchmark and it has basically gone “m’eh” as has most of the others so far.

Comment

There are quite a few factors at play here and no doubt there will be ch-ch-changes along the way. But the rhetoric at least has been raised a notch this morning.

We are in favor of a consultative referendum on the euro. It might be a good idea to have two euros, for two more homogeneous economical regions. One for northern Europe and one for southern Europe. ( Beppe Grillo in Newsweek)

I do not that the BBC and Bloomberg have gone into overdrive with the use of the word “populists” as I mull how you win an election otherwise? If we stick to our economics beat this is plainly a response of sorts to the ongoing economic depression in Italy in the Euro era. Also it was only on Monday when the Italian head of the ECB was asking for supra national fiscal policy. For whom exactly? Now we see Italy pushing for what we might call more fiscal space.

Meanwhile if we look wider we see yet more evidence of an economic slow down in 2018 so far.

Japan GDP suffers first contraction since 2015

Very painful for the Japanese owned Financial Times to print that although just as a reminder Japan is one of the worst at producing preliminary numbers.

An expansion of fiscal policy in the Euro area might help to keep Italy in it

After the action or in many ways inaction at the Bank of England last week there was a shift of attention to the ECB or European Central Bank. Or if you prefer from Governor Mark Carney to President Mario Draghi. This is because tucked away in a rather familiar tale from him in a speech in Florence was what you might call parking your tanks on somebody else’s lawn. It started with this.

One is the ECB’s OMTs, which can be used when there is a threat to euro area price stability and comes with an ESM programme. The other is the ESM itself.

Actually rather contrary to what Mario implies Outright Monetary Transactions or OMTs were never required as the ECB instead expanded its bond puchases via the Quantitative Easing programme which is ongoing currently at a flow of 30 billion Euros a month. One might also argue the European Stability Mechanism has caused anything but in Greece however the fundamental point is that via such mechanisms monetary policy has slipped under and over and around the border into fiscal policy. For example after the progress in the coalition talks in Italy the financial media has moved onto articles about the Italian national debt being un affordable when in fact the factor that has made it affordable is/are the 342 billion Euros of it that the ECB has purchased. The Italy of 7% bond yields at the time of the Euro area crisis would not have reached now in the same form whereas the current Italy of around 2% yields has.

But there is more than tip-toeing onto the fiscal lawn below.

So, we need an additional fiscal instrument to maintain convergence during large shocks, without having to over-burden monetary policy. Its aim would be to provide an extra layer of stabilisation, thereby reinforcing confidence in national policies.

As no doubt you have already recognised that particular lawn has been mined with economic IEDs as Mario then implicitly acknowledges.

And, as we have seen from our longstanding discussions, it is certainly not politically simple, regardless of the shape that such an instrument could take: from the provision of supranational public goods – like security, defence or migration – to a fully-fledged fiscal capacity.

The only one of those that is pretty non contentious these days is the security issue and that of course is because of the grim nature of events in that area. However the movement of ECB tanks onto the fiscal lawn continued.

But the argument whereby risk-sharing may help to greatly reduce risk, or whereby solidarity, in some specific circumstances, contributes to efficient risk-reduction, is compelling in this case as well, and our work on the design and proper timeframe for such an instrument should continue.

All of that is true and just in case people missed it then the ECB broadcasted it from its social media feeds as well.

Why has Mario done this?

One view might be that as he approaches the end of his term he feels that he can do this in a way he could not before. Another ties in with a theme of this website which is to use the words of Governor Carney that monetary policy may not be “maxxed out” but there are clear signs of fatigue and side-effects. Mario may well have had a sleepless night or two as he thinks of his own recent words about the Euro area economy.

When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

Where this fits in with my theme is that this is happening with an official deposit rate of -0.4% and not only an enormously expanded balance sheet but ongoing QE. Thus the sleepless nights will be when Mario wonders what  to do if this also turns out to be ongoing? The two obvious monetary responses have problems as whilst what economists call the “lower bound” has proved to be yet another mirage that is so far and plunging further into the icy cold world of negative interest-rates increases the risk of a dash to cash. The second response which ties in with the issue of policy in Germany is that the ECB is running out of German bunds to buy so firing up the QE operation again is also problematic.

Fiscal Policy

The problem puts Mario on an Odyssey.

And if you’re looking for a way out
I won’t stand here in your way.

In terms of economic theory there is a glittering prize in view here but sadly it only shows an example of what might be called simple minds. This is because at the “lower bound” for interest-rates in a liquidity trap  fiscal policy will be at its most effective according to that theory. So far go good until we note that the “lower bound” has got er lower and lower. There was of course the Governor Carney faux pas of saying it was at 0.5% and then not only cutting to 0.25% but planning to cut to 0.1% before the latter was abandoned but also some argued it was at 0% and of course quite a bit of the world is currently below that.

So Mario is calling for some fiscal policy and as so often all eyes turn to Germany which as I have pointed out before is operating fiscal policy but one heading in the opposite direction as I pointed out on the 20th of November.

Germany’s federal budget  surplus hit a record 18.3 billion euros ($21.6 billion) for the first half of 2017.

This poses various problems as I then pointed out.

With its role in the Euro area should a country with its trade surpluses be aiming at a fiscal surplus too or should it be more expansionary to help reduce both and thus help others?

As you can see Mario is leaving the conceptual issue behind and simply concentrating on his worries for 2018. This of course is standard Euro area policy where changes come in for an emergency and then find themselves becoming permanent. Although to be fair they are far from alone from this as I note that Income Tax in the UK was supposed to be a temporary way of helping to finance the Napoleonic wars.

Comment

This speech may well turn out to be as famous as the “Whatever it takes ( to save the Euro) one. In terms of his own operations Mario has proved to be a steadfast supporter of it but the monetary policy ammunition locker has been emptied. It is also true that it means he has been something of a one-club golfer because the Euro area political class has in essence embraced austerity and left Mario rather lonely. Now his time is running out he is in effect pointing that out and asking for help. Perhaps he is envious of what President Trump has just enacted in the United States.

There are clear problems though. We have been on this road before and it has turned out to be a road to nowhere in spite of many talking heads supporting it. In essence it relies in the backing of Germany and it has been unwilling to allow supranational Eurobonds where for example Italy and Greece could borrow with the German taxpayer potentially on the hook. If anything Germany seems to be heading in the direction of being even more fiscally conservative.

If we look wider we see that at the heart of this is something which has dogged the credit crunch era. If you believe one of the causes of it was imbalances well the German trade surplus has if anything swelled and now it is adding fiscal surpluses to that. Next if we look more narrowly there are the ongoing ch-ch-changes in Mario’s home country Italy. From the Wall Street Journal.

Both parties vowed to scrap or dilute an unpopular pension overhaul from 2011 that steadily raises the retirement age. Economists say the parties’ fiscal promises, if enacted in full, would greatly add to Italy’s budget shortfall, likely breaking EU rules that cap deficits at 3% of gross domestic product. Italy’s public debt, at 132% of GDP, is the EU’s highest after Greece.

So is it to save the Euro or to keep Italy in it?