The Euro area has an inflation problem that the ECB ignores

Yesterday brought us up to date with the thoughts of ECB President Christine Lagarde as she gave evidence to the European Parliament, and grim reading and listening it made.

After a contraction in GDP of 3.8% in the first quarter of the year, our new staff projections see it shrinking by 13% in the second quarter. Despite being expected to bounce back later in the year and recover some of its lost ground, euro area real GDP is now projected to fall by 8.7% over the whole of 2020, followed by growth of 5.2% in 2021 and 3.3% in 2022.

The numbers for 2021 and 22 are pure fantasy of course an area where President Lagarde has quite a track record after her claims about Greece and Argentina. But the fundamental polnt here is of a large and in many ways unprecedented fall in this quarter.

Germany

We have received some hints this morning via the April trade figures for the Euro areas largest economy Germany.

WIESBADEN – Germany exported goods to the value of 75.7 billion euros and imported goods to the value of 72.2 billion euros in April 2020. Based on provisional data, the Federal Statistical Office (Destatis) also reports that exports decreased by 31.1% and imports by 21.6% in April 2020 year on year.

In a pandemic it is no surprise that trade is hit harder than economic output or GDP and the impact was severe.

That was the largest decline of exports in a month compared with the same month a year earlier since the introduction of foreign trade statistics in 1950. The last time German imports went down that much was in July 2009 during the financial crisis (-23.6%).

This meant that the German trade surplus which is essentially the Euro area one faded quite a bit.

The foreign trade balance showed a surplus of 3.5 billion euros in April 2020. That was the lowest export surplus shown for Germany since December 2000 (+1.7 billion euros). In April 2019, the surplus was 17.8 billion euros. In calendar and seasonally adjusted terms, the foreign trade balance recorded a surplus of 3.2 billion euros in April 2020.

In itself that is far from a crisis as both Germany and the Euro area have had plenty of surpluses in this area. But it will be a subtraction to GDP although some will be found elsewhere.

exports to the countries hit particularly hard by the corona virus pandemic dropped sharply from April 2019: France (-48.3%), Italy (-40.1%) and the United States (-35.8%).

So for the first 2 countries the falls will be gains although of course they will have their own losses.

There was a considerable decline in German imports from France (-37.3% to 3.5 billion euros) and Italy (-32.5% to 3.2 billion euros).

So we have a sharp impact on the economy although we need the caveat that these compete with retail sales to be the least reliable numbers we have.

Inflation

If we return to President Lagarde there was also this.

The sharp drop in economic activity is also leaving its mark on euro area inflation. Year-on-year HICP inflation declined further to 0.1% in May, mainly due to falling oil prices. Looking ahead, the inflation outlook has been revised downwards substantially over the entire projection horizon. In the baseline scenario, inflation is projected to average 0.3% in 2020, before rising slightly to 0.8% in 2021, and further to 1.3% in 2022.

There are serious problems with inflation measurement right now and let me explain them.

The HICP sub-indices are aggregated using weights reflecting the household consumption expenditure patterns of the previous year.

This is clearly an issue when expenditure patterns have changed so much. This is illustrated by the area highlighted by President Lagarde oil prices as we note automotive fuel demand was down 46.9% on a year ago. So she is being very misleading. Also I am regularly asked about imputed rent well it has plenty of company right now.

The second principle means that all sub-indices for the full ECOICOP structure will be compiled even when for some categories no products are available on the market. In such cases prices do not exist and they should be replaced with imputed prices.

So if you cannot get a price you make it up. You really could not er make it up…..

Also online quotes are used if necessary. That reflects reality but there is a catch as the prices are likely to be lower than store prices in more than a few cases.

What you might think are minor issues can turn into big ones as we saw last year from a rethink of the state of play concerning package holidays in Germany.

In the following years, the impact of the revision is smaller, between -0.2 and +0.3 p.p. Consequently, the euro area all-items annual rates are revised between 0.0 and +0.3 p.p. in 2015 and between -0.1 and +0.1 p.p. after.

Yes it did change the overall number for the Euro area which is I suppose a case f the mouse scaring and moving the elephant. This really matters when we are told this.

 the deteriorating inflation outlook threatening our medium-term price stability objective.

So we got this in response to a number which is dodgy to say the least.

The Governing Council last Thursday decided to increase the amount of the pandemic emergency purchase programme (PEPP) by an additional €600 billion to a total of €1,350 billion, to extend the net purchase horizon until at least the end of June 2021, and to reinvest maturing assets acquired under the programme until at least the end of 2022.

In context there is also this from Peter Schiff which raises a wry smile.

ECB Pres. Christine Lagarde claims that emergency action is necessary to protect Europeans from a mere 1.3% rise in their cost of living in the year 2022. Lagarde said such a small rise is inconsistent with the ECB’s goal of price stability. Prices must rise more to be stable.

George Orwell must wish he had put that in 1984, although to be fair his themes were spot on. He would have enjoyed how Christine Lagarde sets as her objective making people worse off.

The ECB measures will continue to be crucial in supporting the return of inflation towards our medium-term inflation aim after the worst of the crisis has passed and the euro area economy begins its journey to economic recovery.

Let’s face it even the (wo)man on Mars will probably be aware that these days wages do not necessarily grow faster than prices.

Comment

Let me now spin around to the real game in town for central bankers which is financial markets. Once they had helped the banks by letting them benefit from a -1% interest-rate which of course will in the end be paid by everyone else then boosting asset markets is the next game in town. I have already mentioned the large sums being invested to help governments borrow more cheaply with the 1.35 trillion. As a former finance minister Christine Lagarde can look forwards to being warmly welcomed at meetings with present finance ministers. After all Germany is being paid to borrow and even Italy only has a ten-year yield of 1.42% in spite of having debt metrics which are beginning to spiral.

Next comes equity markets where the Euro Stoxx 50 index was at one point yesterday some 1000 points higher than the 2386 of the 19th of March. The link from all the QE is of portfolio shifts as for example bonds providing less ( and in many cases negative income) make dividends from shares more attractive. As an aside this poses all sorts of risks from pensions investing in wrong areas.

But my main drive is that central banks can push asset prices higher but the problem is that the asset rich benefit but for everyone else there is them inflation. The inflation is conveniently ignored as those responsible for putting housing inflation in the numbers have been on a 20 year holiday. As even the ECB confesses that sector makes up a third of consumer spending you can see again how the numbers are misleading. Or to put it another way how the ordinary person is made worse off whilst the better off gain.

In the future will all central banks buy equities?

As the weather shows a few signs of picking up in London it appears that one central banker at least has overheated listening to Glen Frey on the radio.

The heat is on, on the street
Inside your head, on every beat
And the beat’s so loud, deep inside
The pressure’s high, just to stay alive
‘Cause the heat is on

Yes it is our favourite “loose cannon on the decks” which is the Bank of England Chief Economist Andy Haldane. He has been quiet in recent times after his Grand Tour around the UK to take central banking to the people and get himself appointed as Governor was widely ignored. But he is back.

LONDON (Reuters) – The Bank of England is looking more urgently at options such as negative interest rates and buying riskier assets to prop up the country’s economy as it slides into a deep coronavirus slump, the BoE’s chief economist was quoted as saying.

The Telegraph newspaper said the economist, Andy Haldane, refused to rule out the possibility of taking interest rates below zero and buying lower-quality financial assets under the central bank’s bond-buying programme.

There is a lot going on there and certainly enough for him to be summoned to the Governor’s study to explain why he contradicted what the Governor had said only a few days before. Also as is his wont Andy had also contradicted himself.

“The economy is weaker than a year ago and we are now at the effective lower bound, so in that sense it’s something we’ll need to look at – are looking at – with somewhat greater immediacy,” he said in an interview. “How could we not be?”

So we have a lower bound for interest-rates but we are thinking of cutting below it? So it is not an effective lower bound then. I can help him out with just a couple of letters as calling it an ineffective lower bound would fix it. Of course Andy has experience of numbers slip-sliding away on his watch as the estimate of equilibrium unemployment has gone from 6.5% to around 4.25% ( it has got a bit vague of late) torpedoing his output gap theories. Even worse of course it will now be going back up. Time for him to move from Glen Frey to Kylie Minogue.

I’m spinning around
Move outta my way

Then there is Andy’s hint about buying equities.

buying lower-quality financial assets

He has a problem with those who recall him pointing out he does not understand pensions so he would not be a stock picker more a tracker man. Although of course in the UK in many ways that means the same thing. For example if we look at Astra Zeneca it was worth just under £108 billion at the beginning of this month and Royal Dutch Shell some £95 billion whereas if we those bandying for the number 100 slot we are between £3 and £3.5 billion. Then the FTSE 100 is over 80% of the all-share so by now I think you will have figured that yet again such a policy would benefit big business. Andy may not have done so as his “Sledgehammer QE” of 2016 dashed into such UK stalwarts as er Apple and Maersk. An error being repeated in the current operations.

Chair Powell

Chair Powell of the US Federal Reserve was interviewed on 60 Minutes yesterday which was likely to be more like 40 minutes when you allow for adverts. What did he say? Well after a really odd section on virology we got this burst of hype.

But I would just say this. In the long run, and even in the medium run, you wouldn’t want to bet against the American economy. This economy will recover. And that means people will go back to work. Unemployment will get back down. We’ll get through this. It may take a while. It may take a period of time. It could stretch through the end of next year. We really don’t know. We hope that it will be shorter than that, but no one really knows.

Eyes will have turned to the hint that it might be in 2022 as that begs a lot of questions as to what the Federal Reserve might do in the meantime. What about this for instance?

I continue to think, and my colleagues on the Federal Open Market Committee continue to think that negative interest rates is probably not an appropriate or useful policy for us here in the United States. ( Chair Powell)

“probably not” eh? That is leaving the door open to a change of mind. This is in spite of the fact that in central banking terms this is quite a damning critique ( as it involves an implicit criticism of other central banks).

The evidence on whether it helps is quite mixed.

Also as section which is just plain wrong.

PELLEY: So the banks would pay people to borrow money, essentially?

POWELL: Yes.

Let us now move onto what might be called the money shots.

POWELL: Well, there’s a lot more we can do. We’ve done what we can as we go. But I will say that we’re not out of ammunition by a long shot. No, there’s really no limit to what we can do with these lending programs that we have. So there’s a lot more we can do to support the economy, and we’re committed to doing everything we can as long as we need to.

The track record of central bankers using the phrase “no limit” is not good as the Swiss National Bank most famously found out. But there was more and the emphasis below is mine.

POWELL: Well, to begin, the one thing we can certainly do is we can enlarge our existing lending programs. We can start new lending programs if need be. We can do that. There are things we can do in monetary policy. There are a number of dimensions where we can move to make policy even more accommodative. Through forward guidance, we can change our asset purchase strategy. There are just a lot of things that we can do.

Comment

Central bankers are like gamblers on a losing streak desperately doubling down. You do not need to take my word for it as we can take a look at a country which has been enthusiastically buying equities for a while now, which is Japan. For example the Bank of Japan bought over 100 billion Yen’s worth as recently as Friday on its way to this.

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

As of the last update the Bank of Japan had bought some 31.4 trillion Yen of equity ETFs. How is that going?

Japan fell into a technical recession in the first quarter for the first time since 2015

That is from the Financial Times. If you think that does not do justice to an economy 2% smaller than a year ago and seeing nominal GDP declines with a large national debt, well the FT is Japanese owned these days. Meanwhile back in the real world the lost decade(s) carries on.

Why would you copy that? Yet we seem likely to do so…..

Podcast on the UK Gilt Market

 

Japan sees quite a GDP contraction in spite of the Bank of Japan buying 8% of the equity market

Overnight the agenda for today was set by news out of the land of the rising sun or Nihon. Oh and I do not mean the effort to reproduce the plot line of the film Alien ( Gaijin) for those poor passengers on that quarantined cruise ship. It was this reported by the Asahi Shimbun.

Gross domestic product declined by a seasonally adjusted 1.6 percent in the quarter from the previous three months, or an annualized 6.3 percent, the Cabinet Office figures showed.

The contraction of 6.3 percent was far worse than expectations of many private-sector economists, who predicted a shrinkage of 4 percent or so.

Just to clarify the quarterly fall was 1.6% or using the Japanese style 6.3% in annualised terms. What they do not tell us is that this means that the Japanese economy was 0.4% smaller at the end of 2019 than it was at the end of 2018. So quite a reverse on the previous trend in 2019 which was for the annual rate of growth to pock up.

The Cause

Let me take you back to October 7th last year.

After twice being postponed by the administration of Prime Minister Shinzo Abe, the consumption tax on Tuesday will rise to 10 percent from 8 percent, with the government maintaining that the increased burden on consumers is essential to boost social welfare programs and reduce the swelling national debt. ( The Japan Times )

I pointed out back then that I feared what the impact of this would be.

This is an odd move when we note the current malaise in the world economy which just gets worse as we note the fact that the Pacific region in particular is suffering. We looked at one facet of this last week as Australia cut interest-rates for the third time since the beginning of the summer.

As you can see this was a risky move and it came with something of an official denial of the economic impact.

 about a quarter of the ¥8 trillion cost of the 2014 hike, according to the government and the Bank of Japan.

The 2014 rise in the Consumption Tax ( in rough terms the equivalent of VAT in the UK and Europe) had hit the Japanese economy hard, so the official claim of that the new impact would be a quarter was something I doubted. Now let us return to the Asahi Shimbun this morning.

Japan’s economy shrank in the October-December period for the first time in five quarters, as the sales tax hike and natural disasters pummeled personal consumption, according to preliminary figures released on Feb. 17.

The exact numbers are below.

Personal consumption, which accounts for more than half of Japan’s GDP, grew by 0.5 percent in the July-September period.

But the figure plunged to minus 2.9 percent for the three months from October, when the government raised the consumption tax rate to 10 percent from 8 percent.

We had previously looked at the boost to consumption before the tax rise as electrical appliances in particular were purchased. This will have flattered the economic data for the third quarter of last year and raised the GDP growth rate. But as you can see the party has had quite a hangover. On its own this would have led to a 2.2% decline in quarterly GDP.

The spinning has continued apace.

Yasutoshi Nishimura, minister in charge of economic revitalization, gave a positive outlook for personal consumption in a statement released on Feb. 17.

“The margin of decline in personal consumption is likely to shrink,” he said.

As John Lennon points out in the song Getting Better.

It can’t get no worse

As ever there is a familiar scapegoat which is the weather.

Destructive typhoons that hit eastern Japan and the warmer winter also fueled the slowdown in personal spending, such as purchases of winter clothes.

Although as @Priapus has pointed out there was an impact on the Rugby World Cup and the Japanese Grand Prix.

Investment and Exports

These will be on people’s minds as we try to look forwards. According to the Asahi Shimbun the situation for investment is also poor.

Investment in equipment by businesses, for example, shrank by 3.7 percent, a sharp decline from a rise of 0.5 percent in the preceding quarter, while housing investment tumbled 3.7 percent from an increase of 1.2 percent.

New housing starts have also been waning since the tax hike.

Many companies’ business performances are deteriorating, particularly in the manufacturing sector.

The business investment fall was presumably in response to the trade war and the deteriorating conditions in the Pacific economy we looked at in the latter part of 2019 and of course predates the Corona Virus. By contrast the Bank of Japan like all central banks will be more concerned about the housing market.

Switching to trade itself the position appears brighter.

In contrast, external demand pushed up GDP by 0.5 percentage point.

But in fact this was due to imports falling by 2.6% so a negative and exports fell too albeit by a mere 0.1%. That pattern was repeated for the annual comparison as exports were 2.2% lower than a year before and imports 4.3% lower. It is one of the quirks of the way GDP is calculated that a fall in imports larger than a fall in exports boosts GDP in this instance by 0.4%. Thus the annual comparison would have been -0.8% without it.

Comment

Sometimes the numbers are eloquent in themselves. If we look at the pattern for private consumption in Japan we see that it fell from 306.2 trillion Yen to 291.6 trillion in the first half of 2014 as the first tax rise hit. Well on the same seasonally adjusted basis and 2011 basis it was 294 trillion Yen in the last quarter of 2019. If we allow for the fact that 2014 saw a tax based boost then decline then consumption in 2019 had barely exceeded what it was before the first tax rise before being knocked on the head again. Or if you prefer it has been groundhog day for consumption in Japan since 2013. That is awkward on two counts. Firstly the Japanese trade surplus was one of the economic world’s imbalances pre credit crunch and expanding consumption so that it imported more was the positive way out of it. Instead we are doing the reverse. Also one of the “lost decade” issues for Japan was weak consumption growth which has just got weaker.

This leaves the Japanese establishment in quite a pickle. The government has already announced one stimulus programme and is suggesting it may begin another. The catch is that you are then throwing away the gains to the fiscal position from the Consumption Tax rise. This poses a challenge to the whole Abenomics programme which intended to improve the fiscal position by fiscal stimulus leading to economic growth. I am sure you have spotted the problem here.

Next comes the Bank of Japan which may want to respond but how? For newer readers it has already introduced negative interest-rates ( -0.1%) and bought Japanese Government Bonds like it is a powered up Pac-Man to quote the Kaiser Chiefs, But the extent of its monetary expansionism is best highlighted by this from Etf Stream earlier.

According to the BoJ funds flow report for Q3 2019, the bank now owns some 8% of the entire Japanese equity market, mostly through the current ETF-buying programme.

Hence the nickname of The Tokyo Whale.They think the rate of buying has slowed but I think that’s an illusion because it buys on down days and as The Donald so regularly tweets equity markets are rallying. Just this morning the German Dax index has hit another all-time high. But what do they do next? They cannot buy that many more ETFs because they have bought so many already. As you can see they are already a material player in the equity market and they run the Japanese Government Bond market as that is what Yield Curve Control means. Ironically the latter has seen higher yields at times in an example of how water could run uphill rather than down if the Bank of Japan was in charge of it. It will be wondering how the Japanese Yen has pretty much ignored today’s news.

Also as a final point. More and more countries are finding it hard to raise taxes aren’t they?

Podcast

 

 

 

Are world equity markets front-running expected central bank buying?

Sometimes we get an opportunity to both take some perspective and also to observe what is considered by some to be cutting edge. So let us open with the perspective of the general manager of the Bank for International Settlements.

Growth cannot depend on monetary policy, Agustín Carstens tells CNBC.

I am sure that many of you are thinking that it is a bit late ( like a decade or so) to tell us now.. Interestingly if you watch the video he says in reference to the Euro area that monetary policy “cannot be the only solution for growth”. This reminds me of the statement by ECB President Mario Draghi that it QE was responsible for the better Euro area growth phrase in 2016 to 17. It also brings me to my first official denial of the day.

Some analysts said a tiered rate would make room for the ECB to cut its deposit rate farther — a prospect that one source said was nowhere near being discussed. ( Reuters )

You know what usually happens next….

Asset Markets

This is an area that central banks have increasing moved into with sovereign and corporate bond buying. But in the same Reuters article I spotted something that looked rather familiar.

TLTRO III, a new series of cheap two-year loans aimed at banks, was unveiled in March as a tool to help lenders finance themselves, particularly in countries such as Italy and Portugal. But policymakers now increasingly see it as a stimulus tool for a weakening economy, the sources said.

With the growth outlook fading faster than feared, even hawkish policymakers have given up pricing the loans at the private market rate. Some are even discussing offering the TLTROs at minus 0.4 percent, which is currently the ECB’s deposit rate, the sources said.

That looks rather like the Funding for Lending Scheme which I mentioned yesterday as the way the Bank of England fired up the UK housing market from 2012 onwards. Essentially if you give banks plenty of cheap funding you get a lot of rhetoric about lending to business ( small ones in particular) but the UK experience was that it declined and mortgage lending rose. This was because mortgage rates fell quite quickly by around 1% and according to the Bank of England the total impact rose as high as 2%.

Thus in my opinion the ECB is considering singing along to the “More,more,more” of Andrea True Connection in relation to this.

House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the fourth
quarter of 2018 compared with the same quarter of the previous year.

This is one area where the ECB has managed to create some inflation and may even think that the lack of growth in Italy ( -0.6%) is a sign of its economic malaise. Although you do not have to know much history to mull the 6.7% in Spain and 7.2% in Ireland.

Equities

Regular readers will be aware that the Swiss National Bank and the Bank of Japan started buying equities some time ago now. There are differences in that the SNB is doing so to diversify its foreign exchange reserves which became so large they were influencing the bond markets ( mostly European) they were investing in. So it has bought foreign equities of which the most publicly noted it the holding in Apple because if you invest passively then the larger the company the larger the holding. If we note the Apple Watch this must provide food for thought for the Swiss watchmaking industry.

Japan has taken a different route in two respects in that it buys funds ( Exchange Traded Funds or ETFs) rather than individual equities and that it buys Japanese ones. Also it is still regularly buying as it  bought  70.500,000,000 Yen’s worth on Tuesday, Wednesday and Thursday this week. Whereas buying by the SNB in future will be more ad hoc should it feel the need to intervene to weaken the Swiss Franc again.

Now let us move to Federal Reserve policymaker Neel Kashkari

So an official denial! Also you may note that he has left some weasel room as he has not rejected the Japanese route of indirectly buying them. This is common amongst central bankers as they leave themselves an out and if they fear they might need to introduce a policy that will attract criticism they first deny they intend to do it to give the impression they have been somehow forced.

For a lighter touch @QTRResearch translated it into Trumpese so that the man who many think is really running the US Federal Reserve gets the picture.

Kashkari: We’re not buying stocks, who said anything about buying stocks, we’re definitely not buying stocks, we’d never buy stocks.

It was,of course, only last week that ended with the CIO of BlackRock suggesting that the ECB should purchase equities and no doubt he had a list ready! I suppose it would sort of solve this problem.

ECB will ask Deutsche Bank to raise fresh funds for merger: source ( Reuters)

Although of course that would not open just one can of worms but a whole cupboard full of them. But when faced with a problem the ECB regularly finds itself singing along with Donald Fagen.

Let’s pretend that it’s the real thing
And stay together all night long
And when I really get to know you
We’ll open up the doors and climb into the dawn
Confess your passion your secret fear
Prepare to meet the challenge of the new frontier

Comment

Now let us switch to markets as we remind ourselves that they have developed a habit of front-running or anticipating central bank action. Sometimes by thinking ahead but sometimes sadly via private briefings ( I hope the ECB has stopped them). However you spin it @Sunchartist made me think with this.

*Softbank Group Prices Japan’s Biggest Ever Yen Corporate Bond ¥500 Billion 1.64%

Aramco, Softbank, LYFT, Pinterest, Uber

The gravy train.

Or as Hipster on Twitter put it.

So Uber and Lyft will have a combined market cap of ~$150BN with a combined net loss of ~$3BN

Next there is the issue of something that is really rather uncomfortable.

It’s official: This is an all-time record year for corporate stock buybacks.

Announced buybacks for 2018 are now at $1.1 trillion. And companies are using their authorizations. About $800 billion of stock has already been bought back, leaving about $300 billion yet to be purchased. We’ve seen buyback announcements recently from Lowes’s. Pfizer, and Facebook, but in the last few days, as stocks have moved to new lows, companies are picking up the pace of activity. ( CNBC)

This makes me uncomfortable on several counts. It is the job of a board of directors to run a business not to be punters in its shares. This is especially uncomfortable if their bonuses depend on the share price. Frankly I would look to make that illegal. As to them knowing the future how has that worked out for Boeing? To be fair to CNBC they did highlight a problem.

So the critics of corporate buybacks and dividend raises are correct. It is a form of financial engineering that does not do anything to improve business operations or fundamentals………. obsessing over ways to boost stock prices helps the investing class but not the average American.

Perhaps nothing has been done about this because it suits the establishment after all think of the wealth effects. But that brings inequality and the 0.01% back into focus.

 

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/

 

 

 

Who owns the Swiss National Bank?

A feature of pretty much any discussion about a central bank is that someone invariably pops up and claims that it is privately owned. This comes with the implication that dark forces are at work. Mostly it is simply not true but there are some cases which give food for thought and one of those is the case of the Swiss National Bank. You see it is possible to purchase a share in its equity capital and so far this morning some 14 shares have traded with the current price being 3965 Swiss Francs. If dark forces are at play this morning they have a lot of work to do as we look at the equity capital according to the

The share capital of the National Bank amounts to 25 million Swiss francs. It is divided into 100,000 registered shares with a nominal value of 250 Swiss francs each. The shares are fully paid up.

Also to have any real power you would either need to mislead the regulations or be part of a group as there is a limit to how many voting shares an individual can hold.

A shareholder’s registration is limited to a maximum of 100 shares. This limitation shall not apply to Swiss public-law corporations and institutions or to cantonal banks pursuant to Article 3a of the Federal Act of 8 November 19341 on Banks and Savings Banks.

Mind you as Swissinfo.ch pointed out a year ago not everyone is bothered by this.

The prime suspect is Theo Siegert, a German professor and business expert who sits on the boards of numerous companies. Siegert owned 6.6% of the share capital of the SNB at the end of last year, making him the second-largest shareholder behind the canton of Bern.

If we move to policy we see that we have a curious situation as of course investors are buying shares in what these days is a hedge fund which holds a lot of equities. This particular hedge fund has some 747 billion Swiss Francs in foreign currency investments of which around 20% is in equities.

Swissinfo.ch updated us a year ago on who owned the shares back then.

Cantons own 45% of stock, cantonal banks 15% and private investors (individuals or institutions) the remaining 40%.

What has happened?

The share price has given the impression that as Todd Terry would put it there is “something going on”. Here is the Wall Street Journal from the 21st of September.

Less than a month after its stock smashed through the 3,000-franc-a-share barrier, SNB shares hit an intraday high of 4,324 on Wednesday and were trading as high as 4,600 on Thursday. The stock has tripled in value from a year ago, repeatedly confounding market watchers by regularly hitting records.

So far this year, SNB shares are up about 160%, compared with an 11% gain for the SMI stock-market index of Swiss blue-chip companies. The broader Stoxx Europe 600 is up only 5.7% on the year.

If we look back the share price was in recent years mostly between 1000 and 1100 Swiss Francs so something has changed. The first wave was in August and September last year when the price rose to 1750 Swiss Francs and the next began towards the end of July when the 2000 Swiss Franc barrier was broken. As you can see progress was swift after that. Rather an irony to see a central bank share price surge like well “a boy in a bubble” isn’t it?

Backing

There is a dividend payment as shown below.

 

Subject to the Annual General Meeting’s approval of the proposed profit appropriation, a dividend not exceeding 6% of the share capital is to be paid from net profit (art. 31 para. 1 NBA). The dividend is CHF 15 (gross) and CHF 9.75 (net) per share, after deduction of withholding tax.

Interestingly the SNB itself feels that its shares should be traded like a bond.

Due to the legally stipulated maximum dividend of 6%, the price of the SNB share usually develops along similar lines to a long-term Confederation bond with a 6% coupon.

That gives us grounds for a surge in the price but leaves us with an awkward timing problem. The Swiss ten-year government bond yield went negative at the beginning of 2015 and it is currently 0%. So everybody was asleep at the wheel for quite some time.

The SNB as an equity investor

Here is @stocknewstimes and these tweets are from this morning.

Swiss National Bank boosted its stake in Bright Horizons Family Solutions Inc. (NYSE:BFAM) by 7.8% during the 2nd quarter………..SwissNationalBank Boosts Stake in Bright Horizons Family Solutions Inc. …….SwissNationalBank Boosts Holdings in The Madison Square Garden Company

You get the picture but how is this going? Well here is the Financial Times today.

Japan’s stock market hit a two-year high on Tuesday following fresh records set overnight in New York.

So equity investors are singing along with the band Chic.

Good times, these are the good times
Leave your cares behind, these are the good times
Good times, these are the good times
Our new state of mind, these are the good times

As a very large equity investor the SNB must be cheering from the sidelines and a weaker phase for the Swiss Franc only adds to the party. We do not know how holdings have performed but we are looking at a company with around 150 billion Swiss Francs of overseas equities at a time of all time highs for stock markets. Suddenly we have a potential rationale for buying shares in the Swiss National Bank.

Comment

Let us now move to the public side of the SNB where it sets interest-rates ( currently -0.75%) and monetary policy for Switzerland. This sits rather oddly with the private shareholders. They might be looking for a bond coupon as they are in short supply to say the least in modern-day Switzerland. Much more likely is that eyes are on the profits from the equity investments in particular. It is hard not to think of the phrase “socialisation of losses and privatisation of profits” at this point.

As to getting their hands on it the issue poses formal problems as profit distributions are for the public-sector. From Reuters.

For 2016 it paid 1.7 billion francs to the federal government and cantons. Remaining profit went into SNB reserves.

However according to Reuters some seem to think they have a chance of changing the rules.

A group of private shareholders proposed changing the bank’s rules to allow a higher payment, saying the bank’s foreign currency purchases had diluted the value of the Swiss franc.

“Our proposal aims to demonstrate the dilution of the purchasing power of the Swiss franc following the seven-fold increase in the SNB’s balance sheet since the financial crisis,” said shareholder Blaise Rossellat.

Has nobody told them that rule changes are only for central banks themselves? Or rather the rules get “interpreted” along the lines so memorably described in Yes Prime Minister “they didn’t seem quite appropriate.”

So we have two routes here I think which can be interrelated. Someone may have “high- ticked” the shares to get a reaction. This would most logically be done by an existing investor but may have been someone who was simply bored. The next is that some think they have a solid chance of changing the rules and actually benefitting from the gains of the SNB. Of course they are at this stage almost entirely paper profits but that does not bother people in so many other areas. This simultaneously has everything and nothing to do with monetary policy as we mull yet another series of unintended consequences. The investors must be hoping that the words of Tom Petty do not turn out to be appropriate.

I’m learning to fly, around the clouds
But what goes up must come down.

RIP Tom and thank you for the music.

Is housing a better investment than equities?

As you can imagine articles on long-term real interest-rates attract me perhaps like a moth to a flame. Thank you to FT Alphaville for drawing my attention to an NBER paper called The Rate of Return on Everything,but not for the reason they wrote about as you see on the day we get UK Retail Sales data we get a long-term analysis of one of its drivers. This is of course house prices and let us take a look at what their research from 16 countries tells us.

Notably, housing wealth is on average roughly one half of national wealth in a typical economy, and can fluctuate significantly over time (Piketty, 2014). But there is no previous rate of return database which contains any information on housing returns. Here we build on prior work on housing prices (Knoll, Schularick, and Steger, 2016) and new data on rents (Knoll, 2016) to offer an augmented database which can track returns on this important component of national wealth.

They look at a wide range of countries and end up telling us this.

Over the long run of nearly 150 years, we find that advanced economy risky assets have performed strongly. The average total real rate of return is approximately 7% per year for equities and 8% for housing. The average total real rate of return for safe assets has been much lower, 2.5% for bonds and 1% for bills.

If you look at the bit below there may well be food for thought as to why what we might call the bible of equity investment seems to have overlooked this and the emphasis is mine.

These average rates of return are strikingly consistent over different subsamples, and they hold true whether or not one calculates these averages using GDP-weighted portfolios. Housing returns exceed or match equity returns, but with considerably lower volatility—a challenge to the conventional wisdom of investing in equities for the long-run.

Higher returns and safer? That seems to be something of a win-win double to me. Here is more detail from the research paper.

Although returns on housing and equities are similar, the volatility of housing returns is substantially lower, as Table 3 shows. Returns on the two asset classes are in the same ballpark (7.9% for housing and 7.0% for equities), but the standard deviation of housing returns is substantially smaller than that of equities (10% for housing versus 22% for equities). Predictably, with thinner tails, the compounded return (using the geometric average) is vastly better for housing than for equities—7.5% for housing versus 4.7% for equities. This finding appears to contradict one of the basic assumptions of modern valuation models: higher risks should come with higher rewards.

Also if you think that inflation is on the horizon you should switch from equities to housing.

The top-right panel of Figure 6 shows that equity co-moved negatively with inflation in the 1970s, while housing provided a more robust hedge against rising consumer prices. In fact, apart from the interwar period when the world was gripped by a general deflationary bias, equity returns have co-moved negatively with inflation in almost all eras.

A (Space) Oddity

Let me start with something you might confidently expect. We only get figures for five countries where an analysis of investable assets was done at the end of 2015 but guess who led the list? Yes the UK at 27.5% followed by France ( 23.2%), Germany ( 22.2%) the US ( 13.3%) and then Japan ( 10.9%).

I have written before that the French and UK economies are nearer to each other than the conventional view. Also it would be interesting to see Japan at the end of the 1980s as its surge ended and the lost decades began wouldn’t it? Indeed if we are to coin a phrase “Turning Japanese” then this paper saying housing is a great investment could be at something of a peak as we remind ourselves that it is the future we are interested as looking at the past can hinder as well as help.

The oddity is that in pure returns the UK is one of the countries where equities have out performed housing returns. If we look at since 1950 the returns are 9.02% per year and 7.21% respectively. Whereas Norway and France see housing returns some 4% per annum higher than equities. So the cunning plan was to invest in French housing? Maybe but care is needed as one of the factors here is low equity returns in France.

Adjusted Returns

There is better news for UK housing bulls as our researchers try to adjust returns for the risks involved.

However, although aggregate returns on equities exceed aggregate returns on housing for certain countries and time periods, equities do not outperform housing in simple risk-adjusted terms……… Housing provides a higher return per unit of risk in each of the 16 countries in our sample, and almost double that of equities.

Fixed Exchange Rates

We get a sign of the danger of any correlation style analysis from this below as you see this.

Interestingly, the period of high risk premiums coincided with a remarkably low-frequency of systemic banking crises. In fact, not a single such crisis occurred in our advanced-economy sample between 1946 and 1973.

You see those dates leapt of the page at me as being pretty much the period of fixed(ish) exchange-rates of the Bretton Woods period.

Comment

There is a whole litany of issues here. Whilst we can look back at real interest-rates it is not far off impossible to say what they are going forwards. After all forecasts of inflation as so often wrong especially the official ones. Even worse the advent of low yields has driven investors into index-linked Gilts in the UK as they do offer more income than their conventional peers and thus they now do not really represent what they say on the tin. Added to this we now know that there is no such thing as a safe asset more a range of risks for all assets. We do however know that the risk is invariably higher around the time there are public proclamations of safety.

Moving onto the conclusion that housing is a better investment than equities then there are plenty of caveats around the data and the assumptions used. What may surprise some is the fact that equities did not win clearly as after all we are told this so often. If your grandmother told you to buy property then it seems she was onto something! As to my home country the UK it seems that the Chinese think the prospects for property are bright. From Simon Ting.

From 2017-5-11 90 days, Chinese buyers (incl HK) spent 3.6 bln GBP in London real estate.
Anyway, Chinese is the #1 London property buyer.

Perhaps the Bitcoin ( US $4456 as I type this) London property spread looks good. Oh and as one of the few people who is on the Imputed Rent trail I noted this in the NBER paper.

Measured as a ratio to GDP, rental income has been growing, as Rognlie (2015) argues.

Meanwhile as in a way appropriately INXS remind us here is the view of equity investors on this.

Mystify
Mystify me
Mystify
Mystify me

UK Retail Sales

There is a link between UK house prices and retail sales as we note that both have slowed this year.

The quantity bought increased by 1.3% compared with July 2016; the 51st consecutive year-on-year increase in retail sales since April 2013.

 

 

 

 

In the future will equities be allowed to fall?

The credit crunch era has seen an enormous expansion of monetary policy activity which has manifested itself in two main ways. We have seen interest-rates cut not only to zero but below it into negative territory. Then we saw enormous expansion of central bank balance sheets as well as Quantitative Easing style policies were added to the play book. Indeed this is continuing apace in both the Euro area and Japan and the latter of course has moved into newer areas as well. Japan Macro Advisers have updated us on the current state of play.

At the end of May 31 2017, the Bank of Japan held a total of 500.8 trillion yen in assets, of which Japanese government securities accounted for 427.2 trillion yen.

I think we have a new candidate for the largest number we have used on here! That sends out its own message but also there is the issue that some 14.7% of the total is not purchases of Japanese government bonds or JGBs. So what might be regarded as conventional QE is already out of date as we note that the Bank of Japan calls its operations Quantitative and Qualitative Easing or QQE.

What is it buying?

You might expect this as after all both the Bank of England has recently and the ECB currently, have ventured into this area.

As for CP and corporate bonds, the Bank will maintain their amounts outstanding at about 2.2 trillion yen and about 3.2 trillion yen, respectively. ( CP is Commercial Paper ).

Whether it does much good is of course another matter as it ossifies economic structures but subsidising larger companies who are able to issue such debt whereas smaller ones cannot. But the main game here is shown below.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual
paces of about 6 trillion yen and about 90 billion yen, respectively.

Here we see intervention in a different sphere as both property and equities are being bought here. The property purchases are relatively small, if you can say that about 90 billion! But the main game in town is the equity purchases.

For comparison here is the plan for what is conventional QE.

With regard to the amount of JGBs to be purchased, the Bank will conduct purchases more or less in line with the current pace — an annual pace of increase in the amount outstanding of its JGB holdings at about 80 trillion yen — aiming to achieve the target level of a long-term interest rate specified by the guideline.

The target level of JGB yields is around 0% for the ten-year.

The Tokyo Whale

Just over a year ago on the 25th of April I alerted readers to what was taking place.

They may not realize it yet, but Japan Inc.’s executives are increasingly working for a shareholder unlike any other: the nation’s money-printing central bank……….It’s now a major owner of more Japanese blue-chips than both BlackRock Inc., the world’s largest money manager, and Vanguard Group, which oversees more than $3 trillion.

That begged more than a few questions as for example shareholders are supposed to hold company directors to account and sometimes provide direction to the business. How can a central bank possibly do that? There is of course the issue of potential losses as well before we get to the creation of a false market.

Let us bring this up to date with thanks to the Nikkei Asian Review.

Japan’s central bank nearly doubles ETF holdings in one year.

With the rate of purchases we looked at above I suppose that is no great surprise but there are genuine questions as to where this is taking us?

The Bank of Japan has stepped up purchases of exchange-traded funds as part of its monetary easing policy, with the balance surging to 15.93 trillion yen ($144 billion) as of March 31.

The total marks an 80% rise from a year earlier and more than a sevenfold increase since the central bank kicked off its quantitative and qualitative easing — adding riskier assets to its balance sheet — in April 2013.

Will stock markets be allowed to fall?

I do not mean on a day to day basis as for example the Nikkei 225 equity index dipped below 20,000 earlier today. But I am starting to wonder about this in terms of sustained corrections. Why? Well take a look at this from the Nikkei Asian Review.

The bank apparently buys frequently on days when the stock market dips in the morning, serving to stabilize share prices.

At what point did central bankers become experts in where share prices should be at? If anybody else did this they would be facing accusations of creating a false market. The point gets reinforced later.

“The BOJ’s ETF purchases help provide resistance to selling pressure against Japanese stocks,” says Rieko Otsuka of the Mizuho Research Institute.

This is quite different to central banks responding to a market collapse and panic in terms of timing,size,scale and indeed intention. There is also the danger of a Buzz Lightyear “To Infinity! And Beyond!” reality as we mull the consequences of this.

The bank’s growing market presence has raised concerns about the repercussions when the easing policy eventually winds down. When speculation of a BOJ exit grows, the anticipated cutbacks on ETF purchases would accelerate selling of Japanese stocks. As a precaution against a sharp market decline, “the BOJ many need to set aside provisions,” Otsuka says.

So that poor battered can has been kicked into the future one more time! If we cannot allow equity market falls now how will we be able to in say 5 years time? This leaves the Bank of Japan sounding rather like Elvis Presley.

Don’t you know I’m caught in a trap?
I can’t walk out

As time goes by the situation will go from bad to worse in terms of market manipulation.

Should the current pace of buying continue, the BOJ’s ETF holdings would reach about 30 trillion yen in about two years. The market capitalization of the Tokyo Stock Exchange’s first-section companies comes to 550 trillion yen.

Also all the jokes and humour about a “Plunge Protection Team” stopping equity market falls move from satire to reality.

Comment

There is much for us to consider here. So far the expansion of central bank activity has not been put into reverse. Even the US Federal Reserve which has nudged interest-rates higher has only talked about reducing its balance sheet as opposed to actually doing it. Others are still chomping away like Pac-Men and Women but the scale of their purchases is increasingly posing problems for government bond markets.

Should the next recession or slow down hit before we see any form of exit strategy then there will be much less scope to buy government bonds. Now that the Bank of Japan has broken the moral barrier around buying equities and indeed property such a scenario would see others follow. If we look at the UK then as the current Bank of England Governor is a “dedicated follower of fashion” he would be likely to join the party.

There are a lot of catches here as we look forwards to a potential future. Equities are supposed to provide a form of price discovery as individuals buy and sell and hopefully there is investing in what are good ideas and people. Central banking bureaucrats are unlikely to add any value here.There attempts so far have fallen on stony ground.

Despite the initial excitement among major financial institutions, the Bank of Japan’s push for exchange-traded funds tracking companies that actively raise employee pay or invest in new equipment has run aground. ( Nikkei Asian Review)

But their loudspeakers should have Yazz on repeat in terms of equity indices..

The only way is up, baby
For you and me now
The only way is up, baby
For you and me now

 

How many central banks will turn into hedge funds?

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

The Bank of England

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

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

Foreign Exchange Reserves

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

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

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

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

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

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

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

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

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

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

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

Riskier bonds

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

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

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

Equities and property

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

Swiss National Bank

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

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

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

Bank of Japan

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

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

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

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

Comment

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

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

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

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

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

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