The murky world of central banks and private-sector QE

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

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

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

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

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

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

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

The ECB and Steinhoff

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

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

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

According to Reuters today has seen the same drum beat.

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

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

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

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

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

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

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

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

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

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

How much?

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

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

Comment

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

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

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

Me on Core Finance

http://www.corelondon.tv/will-bond-yields-ever-go-higher/

 

 

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What and indeed where next for bond markets?

The credit crunch era has brought bond markets towards the centre stage of economics and finance. Before then there were rare expressions of interest in either a crisis or if the media wanted to film a response to an economic data release. You see equities trade rarely but bonds a lot so they filmed us instead and claimed we were equities trades so sorry for my part in any deception! Where things changed was when central banks released that lowering short-term interest-rates ( Bank Rate in the UK) was not the only game in town and that it was not having the effect that they hoped and planned. Also the Ivory Towers style assumption that short-term interest-rates move long-term ones went the way of so many of their assumptions straight to the recycling bin.

QE

It is easy to forget now what a big deal this was as the Federal Reserve and the Bank of England joined the Bank of Japan in buying government bonds or Quantitative Easing ( QE). There is a familiar factor in that what was supposed to be a temporary measure has now become a permanent feature of the economic landscape. As for example the holdings of the Bank of England stretch to 2068 with no current plan to reverse any of it and instead keeping the total at £435 billion by reinvesting maturities. Indeed on Friday it released this on social media.

Should quantitative easing become part of the conventional monetary policy toolkit?

The Author Richard Harrison may be in line for promotion after this.

Though the model does not support the idea that central banks should maintain permanently large balance sheets, it does suggest that we may see more quantitative easing in the future.

So here is a change for bond markets which is that QE will be permanent as so far there has been little or no interest in unwinding it. Even the US Federal Reserve which to be fair is doing some unwinding is doing so with baby steps or the complete opposite of the way it charged in to increase QE.

Along the way other central banks joined in most noticeably the European Central Bank. It had previously indulged in some QE via its purchases of Southern European bonds and covered ( bank mortgage) bonds but of course it then went into the major game. In spite of the fact that the Euro area economy is having a rather good 2017 it is still at it to the order of 60 billion Euros a month albeit that halves next year. So we are a long way away from it stopping let alone reversing. If we look at one of the countries dragged along by the Euro into the QE adventure we see that even annual economic growth of 3.1% does not seem to be enough for a change of course. From Reuters.

Riksbank’s Ohlsson: Too Early To Make MonPol Less Expansionary

If 3.1% economic growth is “too early” then the clear and present danger is that Sweden goes into the next downturn with QE ongoing ( and maybe negative interest-rates too). One consequence that seems likely is that they will run out of bonds to buy as not everyone wants to sell to the central bank.

Whilst we may think that QE is in modern parlance “like so over” in fact on a net basis it is still growing and only last month a new player came with its glass to the punch bowl.

In addition, the Magyar Nemzeti Bank will launch a targeted programme aimed at purchasing mortgage bonds with maturities of three years or more. Both programmes will also contribute to an increase in the share of loans with long periods of interest rate fixation.

Okay so Hungary is in the club albeit via mortgage bond purchases which can be a sort of win double for central banks as it boosts “the precious” ( banks) and via yield substitution implicitly boosts the government bond market too. But we learn something by looking at the economic situation according to the MNB.

The Hungarian economy grew by 3.6 percent in the third quarter of 2017…….The Monetary Council expects annual economic growth of 3.6 percent in 2017 and stable growth of between 3-4 percent over the coming years. The Bank’s and the Government’s stimulating measures contribute substantially to economic growth.

We are now seeing procyclical policy where economies are stimulated by monetary policy in a boom. In particular central banks continue with very large balance sheets full of government and other bonds and in net terms they are still buyers.

The bond vigilantes

They have been beaten back and as we observe the situation above we see why. Many of the scenarios where they are in play and bond yields rise substantially have been taken away for now at least by the central banks. There can be rises in bond yields in individual countries as we see for example in the Turkish crisis or Venezuela but the scale of the crisis needs to be larger and these days countries are picked off individually rather than collectively.

At the moment there are grounds for the bond yield rises to be in play in the Euro area with growth solid but of course the ECB is in play and in fact yesterday brought news of exactly the reverse.

 

A flat yield curve?

The consequence of central banks continuing with what the Bank of Japan calls “yield curve control” has led to comments like this. From the Financial Times yesterday.

Selling of shorter-dated Treasuries pushed the US yield curve to its flattest level since 2007 on Tuesday. The difference between the yields on two-year Treasury notes and 10-year Treasury bonds dropped below 55 basis points in afternoon trading in New York. While the 10-year Treasury was little changed, prices of two-year notes fell for the second consecutive day. The two-year Treasury yield, which moves inversely to the note’s price, has climbed 64 basis points this year to 1.83 per cent.

If we look long the yield curve the numbers are getting more and more similar ironically taking us back to the “one interest-rate” idea the central banks and Ivory Towers came into the credit crunch with. With the US 2 year yield at 1.8% and the 30 year at 2.71% there is not much of a gap.

Why does something which may seem arcane matter? Well the FT explains and the emphasis is mine.

It marks a pronounced “flattening” of the yield curve, with investors receiving decreasing returns for holding longer-dated bonds compared to shorter-dated notes — typically a harbinger of economic recession.

Comment

We have seen phases of falls in bond prices and rises in yield. For example the election of President Trump was one. But once they pass we are left wondering if the around thirty year trend for lower bond yields is still in play and we are heading for 0% ( ZIRP) or the icy cold waters of negativity ( NIRP)? On that road the idea that the current yield curve shape points to a recession gets kicked into touch as Goodhart’s Law or if you prefer the Lucas Critique comes into play. But things are now so mixed up that a recession might actually be on its way after all we are due one.

For yields to rise again on any meaningful scale there will have to be some form of calamity for the central banks. This is because QE is like a drug for so many areas. One clear one is the automotive sector I looked at yesterday but governments are addicted to paying low yields as are those with mortgages. On that road they cannot let go until they are forced to. Thus the low bond yields we see right now are a short-term success which central banks can claim but set us on the road to a type of junkie culture long-term failure. Or in my country this being proclaimed as success.

“Since 1995 the value of land has increased more than fivefold, making it our most valuable asset. At £5 trillion, it accounts for just over half of the total net worth of the UK at end-2016. At over £800 billion, the rise in the nation’s total net worth is the largest annual increase on record.”

Of course this is merely triumphalism for higher house prices in another form. As ever those without are excluded from the party.

 

 

The Italian banks and how they have contributed to a possible end to deposit protection

A regular feature of recent years has been the Italian banking saga where we are continually reassured that banks are fine and then it turns out that they are not. Many of the misrepresentations have come from Finance Minister Padoan who was in fine form in January according to Politico.

Italian Finance Minister Pier Carlo Padoan has defended the way his country dealt with its banking crisis, saying the government had “only spent €3 billion” on bailouts, in an interview with Die Welt published today.

“We are the EU country that has paid the least to save its banks,” Padoan said. Out of 600 banks, only eight “have problems,” he noted, saying the “system as a whole is not in crisis,” having “withstood the financial crisis.”

Apparently this is a mere bagatelle or the Italian equivalent.

Italy’s banking system is groaning under €360 billion in bad loans,

Such is his loose association with the truth he claimed this.

“I assure you, we have no interest in state intervention,” Padoan said

whilst doing this.

The government has set aside a €20-billion fund to save banks, and is expected to provide roughly €6.7 billion of that to prop up ailing Tuscan lender Monte dei Paschi di Siena.

Oh and he had one last go at what in modern parlance is called “misspeaking”.

Everything has been done “according to European guidelines,” the finance minister added, defending the use of bail-ins, whereby creditors and depositors take a loss on their holdings to help rescue a failing bank.

Actually what was about to come drove a Challenger tank through the rules and in my opinion has contributed to potentially ominous developments for bank depositors in the Euro area. At the moment deposits up to 100,000 Euros are covered unequivocally but on the 8th of this month the European Central Bank published an opinion piece including this and the emphasis is mine.

The general exception for covered deposits and claims
under investor compensation schemes should be replaced by limited discretionary exemptions to
be granted by the competent authority in order to retain a degree of flexibility. Under that approach,
the competent authority could, for example, allow depositors to withdraw a limited amount of
deposits on a daily basis consistent with the level of protection established under the Deposit
Guarantee Schemes Directive (DGSD)34,

That has echoes of the demonetisation shambles that took place in India a year or so ago with queues around the corner for the banks. Now let us take care as the deposit protection scheme still exists as I have seen plenty of places on social media claiming it does not but there are questions about it in the future as you can see. One of my themes is in play here as we note that the ECB is much more concerned about “the precious” than the rights and maybe losses of depositors.

The ECB cautions that prolonged periods during which depositors have no access to their deposits undermine confidence in the banking system and might ultimately create risks to financial stability.

You don’t say!

Monte Paschi

Top of the list as ever is the world’s oldest bank and in terms of the terminator it’s back. From Reuters on the 25th of October.

Shares in the bank opened on Wednesday at 4.10 euros, which became the reference price for the session, and then rose to as much as 5.26 euros, up 28 percent.

That price translates to a paper loss of 1.3 billion euros for Italian taxpayers, who are set to hold 68 percent of the Tuscan bank, which was central to public and private finances in Siena and the surrounding region.

Italy’s government paid 6.49 euros a share in August, when it pumped 3.85 billion euros into Monte dei Paschi, and is spending another 1.5 billion euros to shield some of the bank’s junior bondholders, whose debt was converted into equity.

Actually since then shareholders have had a rather familiar sinking feeling as the price as I type this is 3.95 Euros as I type this. Perhaps the former Prime Minister has suggested the shares are a good buy again as of course last time in an unfortunate mistranslation that actually meant good-bye. As I pointed out last week troubles are brewing around this issue. From Reuters.

A group of bondholders challenged Italy’s rescue of ailing bank Monte dei Paschi di Siena (MI:BMPS), suing the lender over the cancellation of their investments and calling for the bonds to be reinstated.

The Italian banking enquiry looked at the state of play yesterday and there are allegations of wrong doing pretty much everywhere as losses were hidden. Indeed Germany’s banking supervisor got dragged in as there are claims it kept back information on the derivatives contracts with Deutsche Bank.

Banca Carige

Next on the list there is this from Reuters this morning.

 Italy’s Banca Carige warned that its working capital is not sufficient to satisfy its own needs for the next 12 months, the lender said in he prospectus for its imminent capital increase.

Carige also said it had not yet received the final SREP assessment by the European Central Bank, adding it could not rule out a request by the authority for additional capital strengthening measures.

The bank secured backing from core shareholders and underwriters for a vital 560 million euro cash call in a last-minute agreement signed on Friday.

Creval

Here is IlSole from Sunday via Google Translate on this subject.

A 70% collapse in less than two weeks had not been taken into account by anyone in Sondrio. Yet that is what is happening in the title of Credito Valtellinese. The Lombard bank has seen its capitalization deflating from 280 million to 95 million in a dozen sessions. And triggering sales was the announcement of the same bank to raise a 700 million capital increase.

There are obvious issues in wanting an extra 700 million Euros when your value is 280 million let alone 95 million! Anyway the share price has seen better days as it has fallen by just under 6% to 1.38 Euros as I type this.

Banca Popolare di Bari.

In a former life I used to deal with quite a few Italian banks on behalf of Deutsche Bank and am straining my memory to recall if my trip to Bari included this one. Anyway times were seemingly much better than now if this letter quoted in i due punti in September is any guide.

An important letter sent by Federconsumatori Italia to the Minister of the Economy, to the Governor of Banca d’Italia and to the President of Consob ….
It reads on the Republic signing of Antonello Cassano ” The bank has ruined our lives, we want to go back our savings. ” It is a climate of anger and despair that one breathes in the headquarters of the Banca Popolare di Bari shareholder protection committee………Investigations by the Bari Public Prosecutor’s Office describe years of irregular management, loss accounts and abnormal loans. Heavy offenses challenged at the top of Bpb, by the association for delinquency and fraud until false statements in the prospectus.

Comment

There is much to consider here as this is happening at the wrong stage in the cycle as the Italian economy has improved ( 0.5% GDP growth in the third quarter) which should be supporting the banks. Some of the non performing loans will be improving. However contrary to the boasting of Finance Minister Padoan the low bailout figure for Italy was a form of denial as problems were hidden and then ignored meaning that they got worse. A factor in this has been Italy’s problem with the size of its national debt and an aversion to adding to it.So now we find ongoing troubles instead of improvement.

Also the ongoing crisis and subversion of Euro area rules has in my view contributed to the way that the ECB is now considering changes to deposit protection. There is an irony here as its President has a past deeply entwined with all this as not only was he Governor of the Bank of Italy but there is a clue in the way that the banking regulations are called the “Draghi Laws”! Here is how he sums up the current state of play.

The other trend is the growing resilience of the financial sector.

Just for clarity in officialese banks are always resilient up to the day they collapse. But Mario is bright enough to cover himself.

Clearly this trend hides some variation among banks, which is largely driven by differences in their business models.

Can anybody think of who he might mean?

 

The ECB has it successes but also plenty of problems

Let is continue the central banking season which allows us to end the week with some good news. As this week has developed there has been good news about economic growth in the Euro area.

The Federal Statistical Office (Destatis) reports that, in the third quarter of 2017, the gross domestic product (GDP) rose 0.8% on the second quarter of 2017 after adjustment for price, seasonal and calendar variations. In the first half of 2017, the GDP had also increased markedly, by 0.6% in the second quarter and 0.9% in the first quarter.

It has been a strong 2017 so far for the German economy but of course whilst analogies about it being the engine of the Euro area economy might be a bitter thinner on the ground due to dieselgate there are still elements of truth about it. But we know that a rising tide does not float all economic boats so ECB President Mario Draghi will have been pleased to see this about a perennial struggler.

In the third quarter of 2017 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) increased by 0.5 per cent with respect to the second quarter of 2017 and by 1.8 per cent in comparison with the third quarter of 2016.

Of course Mario will be especially pleased to see better news from his home country of Italy especially at a time when more issues about the treatment of non-performing loans at its banks are emerging. Also this bank seems to be running its own version of the never-ending story, from the Financial Times.

A group of investors in the world’s oldest bank, Italy’s Monte dei Paschi di Siena, have filed a lawsuit in Luxembourg after it announced bonds would be annulled as part of a state-backed recapitalisation.

But in Mario’s terms he is likely to consider the overall numbers below to be a delivery on his “whatever it takes” speech and promise.

Seasonally adjusted GDP rose by 0.6% in the euro area…….Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.5% in the euro
area.

Inflation

This is a more problematic area for Mario Draghi as this from his speech in this morning indicates.

According to a broad range of measures, underlying inflation has ticked up moderately since the start of this year, but it still lacks clear upward momentum.

This matters because unlike the Bank of England the ECB takes inflation targeting seriously and a past President established a rather precise estimate of it at 1.97% per annum. We seem unlikely now to ever find out how Mario Draghi would deal with above target inflation but he finds himself in what for him maybe a sort of dream. Economic growth has recovered with inflation below target so he can say this.

This recalibration of our asset purchases, supported by the sizeable stock of acquired assets and the forthcoming reinvestments, and by our forward guidance on interest rates, helps to maintain the necessary degree of accommodation and thereby to accompany the economic recovery in an appropriate way.

So we will get negative interest-rates ( -0.4%) for quite a while yet as he has hinted in the past that they may persist past the end of his term. Also of course whilst at a slower rate ( 30 billion Euros a month) the QE ( Quantitative Easing) programme continues. Even that has worked out pretty well for Mario as continuing at the previous pace seemed set to run out of German bonds to buy.

Consequences

However continuing with monetary expansion into a boom is either a new frontier or something which later will have us singing along with Lyndsey Buckingham.

(I think I’m in)(Yes) I think I’m in trouble
(I think I’m in) I think I’m in trouble

Corporate Bonds

When you buy 124 billion Euros of corporate bonds in a year and a few months there are bound to be consequences.

“Tequila Tequila” indeed. What could go wrong with this.?

OK, we are officially in la la land. A BBB rated company just borrowed 500 million EUR for 3 years with a negative yield of -0.026 %. A first..  ( h/t @S_Mikhailovich )

You can take your pick whether you think that Veolia is able to issue debt at a negative interest-rate or at only 0.05% above the swaps rate is worse.

Mario Draghi explained this sort of thing earlier in a way that the Alan Parsons Project would have described as psychobabble.

By accumulating a portfolio of long-duration assets, the central bank can compress term premia by extracting duration risk from private investors. Via this “duration extraction” effect, the central bank frees up risk bearing capacity in markets, spurs a rebalancing of private portfolios toward the remaining securities, and thus lowers term premia and yields across a range of financial assets.

Moral hazard anyone?

The dangers of this sort of thing have been highlighted by what has happened to Carillion this morning.

The wages problem

It is sometimes argued in the UK that weak wage growth is a consequence of high employment and low unemployment. But we see that there are issues too in the Euro area where the latter situations whilst improved are still poorer.

A key issue here is wage growth.Since the trough in mid-2016, growth in compensation per employee has risen, recovering around half of the gap towards its historical average. But overall trends remain subdued and are not broad-based.

Indeed if we look back to late May Mario gave us a rather similar reason to what we often here in the UK as an explanation of weak wages growth.From the Financial Times.

Mr Draghi also acknowledged concerns that sinking unemployment was not leading to a recovery in well-paid permanent jobs………….Mr Draghi said he agreed. “What you say is true,” he said. “Some of this job creation is not of good quality.”

The Italian Job

As I hinted earlier in this piece there are ever more signs of trouble in the Italian banking sector. There have been many cases of can kicking in the credit crunch era but this has been something of a classic with of course a dash of Italian style and finesse. From the FT.

Mid-sized Genoan bank Carige’s future looked uncertain this week after a banking consortium pulled its support for a €560m capital increase demanded by European regulators. Shares in another mid-sized bank Credito Valtellinese fell 8.5 per cent to a market value of €144m after it announced a larger than anticipated €700m capital raising to shore up its balance sheet.

There are issues with banks elsewhere as investors holding bonds which were wiped out insist on their day in court.

Comment

As you can see there is indeed good news for Mario Draghi to celebrate as not only is the Euro area seeing solid economic growth it is expected to continue.

From the ECB’s perspective, we have increasing confidence that the recovery is robust and that this momentum will continue going forward.

The problem though is where does it go from here? Even Mario himself worries about the consequences of monetary policy which has been so easy for so long and is now pro cyclical rather than anti cyclical before of course dismissing them. But unless you believe that growth will continue forever and recessions have been banished there is the issue of how do you deal with the latter when you already have negative interest-rates and ongoing QE?

Also the inflation target problem is covered up by describing it is price stability when of course it is anything but.

Ensuring price stability is a precondition for the economy to be able to grow along a balanced path that can be sustained in the long run.

Wage growth would be improved in real terms if inflation was lower and not higher.

Also Mario has changed his tune on the fiscal situation which he used to regularly compare favourably to elsewhere.

This means actively putting our fiscal houses in order and building up buffers for the future – not just waiting for growth to gradually reduce debt. It means implementing structural reforms that will allow our economies to converge and grow at higher speeds over the long-term.

Number Crunching

This from Bloomberg seemed way too high to me.

Italy’s failure to qualify for the soccer World Cup finals for the first time in 60 years may cost the country about 1 billion euros ($1.2 billion), the former chairman of the national federation said.

Me on Core Finance

http://www.corelondon.tv/2-uk-growth-cap-unreliable-predictive-bodies-bad/

 

 

 

 

 

Why are we told some inflation is good for us?

A major topic in the world of economics is the subject of inflation which has been brought into focus by the events of the past 2/3 years or so. First we had the phase where a fall in the price of crude oil filtered through the system such that official consumer inflation across many countries fell to zero per cent on an annual basis and in some cases below that. If you recall that led to the deflation scare or it you will excuse the capitals what much of the media presented as a DEFLATION scare. We were presented with a four horsemen of the apocalypse style scenario where lower and especially negative inflation would take us to a downwards spiral where wages and economic activity fell as well along the line of this from R.E.M.

It’s the end of the world as we know it.
It’s the end of the world as we know it.

I coined the phrase “deflation nutter” to cover this because as I pointed out, Greece the subject of yesterday suffered from quite a few policy errors pushing it into depression and that on the other side of the coin for all its problems Japan had survived years and indeed decades of 0% inflation. Indeed on the 29th of January 2015 I wrote an article on here explaining how lower consumer inflation was boosting consumption across a range of countries via the positive effect it was having on real wages.

 if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly. If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.

 

Relative prices

The comfortable cosy world of central bankers and theoretical economists told us and indeed continues to tell us that we need positive inflation so that relative prices can change. That leads us to the era of inflation targets which are mostly set at 2% per annum although of course there is a regular cry for inflation targets to be raised. However 2015/16 torpedoed their ship as if we just look at the basic change we saw a large relative price adjustment for crude oil leading to adjustments directly to other energy costs and a lot of other changes. Ooops! Even worse for the theory we saw two large sectors of the economy respond in opposite fashion. A clear example of this was provided by my own country the UK where services inflation barely changed and ironically for a period of deflation paranoia was quite often above the inflation target. But the goods sector saw substantial disinflation as it was it that pulled the overall measure down to around 0%.

We can bring this up to date by looking at the latest data from the Statistics Bureau in Japan.

  The consumer price index for Ku-area of Tokyo in October 2017 (preliminary) was 100.1 (2015=100), down 0.2% over the year before seasonal adjustment, and down 0.1% from the previous month on a seasonally adjusted basis.

So not only is there no inflation here there has not been any for some time. Yet the latest monthly update tells us that food prices fell by 2.4% on an annual basis and the sector including energy fuel and lighting rose by 7.1%. Please remember that the next time the Ivory Towers start to chant their “we need inflation so relative prices can adjust” mantra.

Reality

This is that central banks are in the main failing to reach their inflation targets. For example if we look at the US economy the Federal Reserve targets the PCE ( Personal Consumption Expenditure) inflation measure which was running at an annual rate of 1.6% in September and even that level required an 11.1% increase in energy prices.

So we see central banks and establishments responding to this of which the extreme is often to be found in Japan. From @lemasabachthani yesterday.

JAPAN PM AIDE HONDA: INAPPROPRIATE TO REAPPOINT BOJ GOV KURODA, BOJ NEEDS NEW LEADERSHIP TO ACHIEVE 2 PCT INFLATION TARGET

Poor old Governor Kuroda whose turning of the Bank of Japan into the Tokyo Whale was proving in his terms at least to be quite a success. From the Financial Times.

Trading was at its most eye-catching in Japan. Tokyo’s Topix index touched its highest level since November 1991, only to end down on the day after a volatile session. At its peak, the index reached the fresh high of 1,844.05 with gains across almost all major segments, taking it more than 20 per cent higher for the year to date. But it faded back in late trade to close at 1,817.75.

It makes me wonder what any proposed new Governor would be expected to do?! QE for what else?

Whereas in this morning’s monthly bulletin the ECB ( European Central Bank) has told us this.

Following the decision made on 26 October 2017 the monthly pace will be further reduced to €30 billion from January 2018 and net purchases will be carried out until September 2018. The recalibration of the APP reflects growing confidence in the gradual convergence of inflation rates towards the ECB’s inflation aim, on account of
the increasingly robust and broad-based economic expansion, an uptick in measures of underlying inflation and the continued effective pass-through of the Governing
Council’s policy measures to the financing conditions of the real economy.

So we see proposals for central banking policy lost in  a land of confusion as the US tightens, the Euro area eases a little less and yet again the establishment in Japan cries for more, more, more.

Comment

There is a lot to consider here as we mull a world of easy and in some cases extraordinarily easy monetary policy with what is in general below target inflation. Of course there are exceptions like Venezuela which as far as you can measure it seems to have an inflation rate of the order of 2000% + . But in general such places are importing inflation via a lower currency exchange rate which means that someone else’s is reduced. Also we need to note that 2017 is looking like a good year for economic growth as this morning’s forecasts from the European Commission indicate.

The euro area economy is on track to grow at its fastest pace in a decade this year, with real GDP growth forecast at 2.2%. This is substantially higher than expected in spring (1.7%)……..at 2.1% in 2018 and at 1.9% in 2019.

So then of course you need an excuse for easy monetary policy which is below target inflation! Of course this ignores two technical problems. The first is that at the moment if we get inflation it is mostly from a higher oil price as we mull the likely effects of Brent Crude Oil which has moved into the US $60s. The second is that there is inflation to be found if you look at asset prices as whilst some of the equity market highs we keep seeing is genuine some of it is simply where all the QE has gone. Also there is the issue of house prices where even in the Euro area they are growing at an annual rate of 3.8% so if they were in an inflation index even more questions would be asked about monetary policy.

In a world where wages growth is not only subdued but has clearly shifted onto a lower plane the obsession with raising inflation will simply make the ordinary person worse off via its effect on real wages. Sadly this impact is usually hardest on the poorest.

Me on Core Finance TV

http://www.corelondon.tv/uk-housing-market-house-party-keeps-going/

 

 

 

Let us continue to remember what has been inflicted on Greece

Yesterday the Financial Times revealed the results of an intriguing poll in Greece,

More than half of all Greeks agreed it was a mistake to have joined the euro. Barely a third of Greeks thought the euro wasn’t a mistake. Even among those who wanted to remain in the euro area at the end of 2015, fewer than half would have chosen to join again if given the chance to go back in time and warn their fellow citizens.

That survey took place almost two years ago. Since then, Walter finds that support for the euro has dropped by 10 percentage points.

Frankly I find it a bit of a surprise that even more Greeks do not think that joining the Euro was a mistake! But in life we see so often that some support the status quo again and again almost regardless of what it is. After all so many in the media and in my profession have sung along to Blur about Euro area membership for Greece.

There’s no other way
There’s no other way
All that you can do is watch them play

Regular readers will be aware that I have been arguing there was and indeed is another way since 2011. One of the saddest parts of this sorry saga has been the way that those who have plunged Greece into a severe economic depression accused those suggesting alternatives of heading for economic catastrophe.

If we look at the current state of play we see this.

The available seasonally adjusted data indicate that in the 2nd quarter of 2017 the Gross Domestic Product (GDP) in volume terms increased by 0.5% in comparison with the 1 st quarter of 2017, while in comparison with the 2nd quarter of 2016, it increased by 0.8%.

So economic growth but not very much especially if we note that this is a good year for the Euro area in total. So far not much of that has fed through to Greece although any signs of growth are welcome. To put this in economic terms this is an L-shaped recovery as opposed to the V-shaped one in my scenario. The horizontal part of the L is the fact that growth after the drop has been weak. The vertical drop in the L is illustrated by the fact that twice during its crisis the Greek economy shrank at an annual rate of 10% leaving an economy which had quarterly GDP of 63 billion Euros as 2008 opened now has one of 46.4 billion Euros. By anyone’s standards that is quite an economic depression.

Some good news

Here I would like to switch to what used to be the objective of the International Monetary Fund or IMF which is trade. In essence it helped countries with trade deficits by suggesting programme’s involving reform, austerity and devaluation/depreciation. The French managing directors of the IMF were never going to be keen on devaluation for Greece for obvious reasons and as to reform well you hear Mario Draghi call for that at every single European Central Bank press conference which only left austerity.

This was a shame as you see there was quite a problem. From the Bank of Greece.

In 2010, the current account deficit fell by €1.8 billion or 6.9% in comparison with 2009 and came to €24.0 billion or 10.5% of GDP (2009: 11.0% of GDP).

Even the improvement back then was bad as it was caused by this.

Specifically, the import bill for goods excluding oil and ships fell by €3.9 billion or 12.6%,

The deficit improvement was caused by the economic collapse. Now let us take the TARDIS of Dr. Who and leap forwards in time to the present.

In the January-August 2017 period, the current account improved year-on-year, as the €211 million deficit turned into a €123 million surplus.

This was driven by a welcome rise in tourism to Greece.

In August 2017, the current account showed a surplus of €1.8 billion, up by €163 million year-on-year………The rise in the surplus of the services balance is due to an improvement mostly in the travel balance, since non-residents’ arrivals and the corresponding receipts increased by 14.3% and 16.4%, respectively.

The Bank of Greece is so pleased with the new state of play that it did some in-depth research to discover that it is essentially a European thing.

In January-August 2017, travel receipts increased by 9.1%, relative to the same period of 2016, to €10,524 million. This development is attributed to a 14.5% rise in receipts from within the EU28 to €7,117 million,

I am pleased to note that my country is doing its bit to help Greece which with the weaker Pound £ might not have been expected and that Germans seem both welcome and willing to go.

as did receipts from Germany, by 29.0% to €1,638 million. Receipts from the United Kingdom also increased, by 17.7% to €1,512 million.

So finally we have some better news but there are two catches sadly. The first is that it has taken so long and the second is that Greek should have a solid surplus in terms of scale after such a depression.

Money Money Money

A sign of what Taylor Swift would call “trouble,trouble,trouble” can be found in the monetary system. The media world may have moved onto pastures new but Greece is still suffering from the capital flight of 2015.

On 26 October 2017 the Governing Council of the ECB did not object to an ELA-ceiling for Greek banks of €28.6 billion, up to and including Wednesday, 8 November 2017, following a request by the Bank of Greece.

The amount of Emergency Liquidity Assistance is shrinking but it remains a presence indicating that the banking system still cannot stand on its own two feet. This means that the flow of credit is still not what it should be.

In September 2017, the annual growth rate of total credit extended to the economy stood at -1.5%, unchanged from the previous month and the monthly net flow was negative at €552 million, compared with a negative net flow of €241 million in the previous month.

Also in a country where the central bank has official interest-rates of 0% and -0.4% we see that banks remain afraid to spread the word to ordinary depositors.

The overall weighted average interest rate on all new deposits stood at 0.29%, unchanged from the previous month.

Also we learn that negative official interest-rates are not destructive to bank profits and how banks plan to recover profits in one go.

The spread* between loan and deposit rates stood at 4.26 percentage points from 4.28 points in the previous month.

Comment

There is a lot to consider here but we can see clearly that the “internal devaluation” economic model or if you prefer the suppression of real wages has been a disaster on an epic scale. Economic output collapsed as wages dropped and unemployment soared. Even now the unemployment rate is 21% and the youth unemployment is 42.8%, how many of the latter will never find employment? As for the outlook well in the positive situation that the Euro area sees overall this from Markit on Greek manufacturing prospects is a disappointment.

“The latest PMI data continue to paint a positive
picture of the Greek manufacturing sector, with the
headline PMI signalling an improvement in
business conditions for the fifth month in
succession……….There was, however, a notable slowdown in output growth, which poses a slight cause for concern
going forward.

A bit more than a slight concern I would say.

Meanwhile I note that the media emphasis has moved on as this from Bloomberg Gadfly indicates.

Greece is taking a step closer to get the respect it deserves from Europe.

It is how?

Yields on the country’s government bonds, which have already taken great strides lower this year, hit a new low last week on news the government is preparing a major debt swap.

I have no idea how the latter means the former but let us analyse the state of play. Lower bond yields for Greece are welcome but are currently irrelevant as it is essentially funded by the institutions and mostly by the European Stability Mechanism. There are in fact so few bonds to trade.

So Greece will have an opportunity to issue debt more expensively than it can fund itself via the ESM now? Why would it do that? We come back to the fact that it would get it out of the austerity programme! Not quite the Respect sung about by Aretha Franklin is it?

 

Can the economic renaissance in France fix its unemployment problem?

Today gives us an opportunity to take a closer look at one of the running themes of this website which is the economy of France. It also gives an opportunity to look at the other side of the coin as its performance in 2017 so far has exceeded that of the UK. Indeed if you believe the media it is Usain Bolt to our Eddie the Eagle. So let us go straight to this morning’s economic growth release.

In Q3 2017, gross domestic product (GDP) in volume terms* kept increasing: +0.5%, after +0.6% in Q2……GDP growth estimate for Q2 2017 is slightly revised upward (+0.1 points), in particular with the update of seasonal adjustment coefficients.

There are two clear changes here for France and the first is simply the higher numbers seen. The next is the stability of them as France did produce quarterly growth at this sort of level but then always fell back sometimes substantially in subsequent quarters. This time around France has gone 0.6%,0.5%,0.6% and now 0.5% which is well within any margins of measurement error. This has led to this.

In comparison with Q3 2016, GDP rose by 2.2%; such a growth rate had not been observed since 2011.

This is good news but it does come with perspective as it reminds us how poorly France performed pre 2017 and in particular how its economic growth was knocked back by the Euro area crisis. It did grow but mostly at a crawl.

The detail

The good news is that investment remains strong.

total gross fixed capital formation (GFCF) remained dynamic (+0.8% after +1.0%).

However the economic dream of investment and net trade rising stalled somewhat.

The foreign trade balance contributed negatively to GDP growth (−0.6 points after +0.6 points): imports accelerated sharply (+2.5% after +0.2%) while exports decelerated significantly (+0.7% after +2.3%).

In fact economic growth relied mostly on consumption and rises in inventories.

Household consumption expenditure slightly accelerated (+0.5% after +0.3%) …….changes in inventories contributed positively to GDP growth (+0.5 points after −0.5 points).

The inventory position can be read two ways. The positive view is that it is in anticipation of further economic expansion and the less positive one is that it signals some slowing.

Another factor we may need to watch is the one below as the UK is far from alone in seeing car registrations dip in recent months.

In particular, it (exports) fell back in transport equipment (−0.5% after +6.2%).

I also note that France is also shifting towards a services based economy.

In August 2017, output increased sharply again in services (+1.0% after +1.3% in July).

Prospects

The official survey is still good ( above 100) albeit not quite as good as previously.

In October 2017, the business climate has weakened slightly after a steady improvement for a year. The composite indicator, compiled from the answers of business managers in the main sectors, has lost one point (109) after eight months of rise.

This leads to welcome hopes for a troubled area of the French economy.

In October 2017, the employment climate has risen for the second consecutive month…….The associated composite indicator has gained two points to 109, clearly above its long-term mean.

The PMI ( Purchasing Managers Index) compiled by Markit could hardly be much more bullish.

Flash France Composite Output Index(1) at 57.5 in October (77-month high) ……According to latest flash data, the resurgence in the French private sector showed no sign of abating at the start of the fourth quarter

They were even more bullish on employment prospects.

Buoyed by strong client demand, private sector firms continued to take on additional staff members in October, extending the latest period of job creation to 12 months. Moreover, the rate of  growth was the most marked in just shy of ten-anda-half years (May 2007).

Unemployment

This has been the Achilles heel of the French economy for some time as its sclerotic rate of economic growth has meant there has been little progress in reducing unemployment.

In Q2 2017, the ILO unemployment rate in metropolitan France decreased slightly, by 0.1 percentage points. The employment rate and the activity rate increased by 0.5 percentage points. The unemployment rate in France stood at 9.5% of active population in Q2 2017.

Indeed some countries have unemployment rates similar to the long-term unemployment rate in France.

The long-term unemployment rate stood at 4.0% of active population in Q2 2017

Youth unemployment disappointingly rose to 22.7% in the quarter.

So there is plenty of work for the improved economic situation to do in this area and the survey results indicate that it is ongoing. However we do have a more up to date number from Eurostat this morning showing the unemployment rate rising from 9.6% in June to 9.7% in July, August and September.

Inflation

The good news is that there is not much of this to be found in France.

Over a year, the Consumer Price Index (CPI) should increase by 1.1% in October 2017, after +1.0% in the previous month, according to the provisional estimate made at the end of the month.

One worrying area is this “an acceleration in food prices ” which were 4.5% higher than a year before. How much of that is due to the issue pointed out by Bloomberg below is not specified.

France’s much-loved croissant au beurre has run up against the forces of global markets.

Finding butter for the breakfast staple has become a challenge across France. Soaring global demand and falling supplies have boosted butter prices, and with French supermarkets unwilling to pay more for the dairy product, producers are taking their wares across the border. That has left the French, the world’s biggest per-capita consumers of butter, short of a key ingredient for their sauces and tarts.

We do know that prices have surged at the wholesale level.

Global butter prices have almost tripled to 7,000 euros ($8,144) a ton from 2,500 euros in 2016, according to Agritel, an Paris-based farming consultancy.

Comment

This year has seen a welcome return to form for the French economy. Let us hope that it can continue it as it has seen a weak run. Todays data release shows us that GDP ( base 2010) was at 511.1 billion Euros in the first quarter of 2012 but only rose by 18.4 billion Euros to the third quarter of 2016 before rising by 11.7 billion in the next year. France did not suffer as directly from the Euro area crisis as some countries but it was affected. One impact of that was the way that its national debt to GDP ratio has risen to 99.2% so it will be hoping that the current growth spurt stops it reaching and then moves it away from 100%.

The European Central Bank has put its shoulder to the wheel in terms of monetary policy which has helped France in various ways. The large purchases of French government bonds which total 345.6 billion Euros have helped the public finances by reducing the cost of debt. Also the advent of an official interest-rate which is negative ( deposit rate -0.4%) indicates a very easy monetary policy. The catch here is how and we should add if the ECB can reverse course as we see that a Euro area which is now doing well ( this morning annual GDP growth has been announced at 2.5%) has a negative official interest-rate and ongoing asset purchases which are only slowly being reduced. After all monetary policy has leads and lags meaning that in general it needs to be set for around 18 months time rather than now.

Moving onto comparing with the UK then the quarterly growth rate is only marginally higher but the annual one is much better for France. Prospects for the immediate future look good and maybe there is an area where we are becoming more similar.

Overall, house prices increased by 3.5% yo-y in Q2 2017, after +2.7% in Q1 2017.

Happy Halloween to you.