The world wants and needs US Dollars and it wants them now

In the midst if the financial market turmoil there has been a consistent theme which can be missed. Currency markets rarely get too much of a look in on the main stream media unless they can find something dramatic. But CNN Business has given it a mention.

The US dollar is rallying against virtually every other currency and it seems like nothing can stop it.

There are lots of consequences and implications here but let us start with some numbers. My home country has seen an impact as the UK Pound £ has been pushed back to US $1.20 and even the Euro which has benefited from Carry Trade reversals ( people borrowed in Euros to take advantage of negative interest-rates) has been pushed below 1.10. Even the Japanese Yen which is considered a safe haven in such times has been pushed back to 107.50. We can get more thoughts on this from The Straits Times from earlier today.

SYDNEY (REUTERS) – The Australian dollar was ravaged on Wednesday (March 18) after toppling to 17-year lows as fears of a coronavirus-induced global recession sent investors fleeing from risk assets and commodities, with panic selling even spilling over into sovereign bonds.

The New Zealand dollar was also on the ropes at US$0.5954, having shed 1.7 per cent overnight to the lowest since mid-2009.

The Aussie was pinned at US$0.6004 after sliding 2 per cent on Tuesday to US$0.5958, depths not seen since early 2003.

So there are issues ans especially in a land down under as an Aussie Dollar gets closer to the value of a Kiwi one. In fact the Aussie has been hit again today falling to US $0.5935 as I type this. No doubt it is being affected by lower commodity prices signalled in some respects by Dr. Copper falling by over 4% to US $2.20

Sadly the effective or trade-weighted index is not up to date but as of the 13th of this month the official US Federal Reserve version was at 120.7 as opposed to the 115 it began the year.

Demand for Dollars

It was only on Monday we looked at the modifications to the liquidity or FX Swaps between the world’s main central banks. Hot off the wires is this.

BoE Allots $8.210B In 7 Day USD Repo Operation ( @LiveSquawk )

This means that even in the UK we are seeing demands for US Dollars which cannot be easily got in the markets right now. Maybe whoever this is has been pushing the UK Pound £ down but we get a perspective by the fact that this facility had not been used since mid-December when the grand sum of $5 million was requested. There were larger requests back in November 2008.

I was surprised that so little notice was taken when I pointed this out yesterday.

Interesting to see the Bank of Japan supply some US $30.3 billion this morning until June 11th. Was it Japanese banks who were needing dollars?

Completing the set comes the European Central Bank or ECB.

FRANKFURT (Reuters) – The European Central Bank on Wednesday lent euro zone banks $112 billion at two auctions aimed at easing stress in the U.S. dollar funding market, part of the financial fallout of the coronavirus outbreak.

The ECB said it had allotted $75.82 billion in its new 84-day auction, introduced by major central banks last weekend in response to global demand for greenbacks, and $36.27 billion at its regular 7-day tender.

Actually it was good the ECB found the time as it is otherwise busy arguing with itself.

With regards to comments made by Governor Holzmann, the ECB states:

The Governing Council was unanimous in its analysis that in addition to the measures it decided on 12 March 2020, the ECB will continue to monitor closely the consequences for the economy of the spreading coronavirus and that the ECB stands ready to adjust all of its measures, as appropriate, should this be needed to safeguard liquidity conditions in the banking system and to ensure the smooth transmission of its monetary policy in all jurisdictions.

So we see now why the Swap Lines were reinforced and buttressed.

Oh and even the Swiss Banks joined in.

*SNB GETS $315M BIDS FOR 84-DAY DOLLAR REPO ( @GregBeglaryan )

Emerging Markets

This is far worse and let me give you a different perspective on this. During the period of the trade war we looked regularly at the state of play in the Pacific as it was being disproportionately affected.

Let me hand you over to @Trinhnomics or Trinh Nguyen.

Swap lines to EM please (also to Australia – we like Australia in Asia too as it’s APAC). “the supply of liquidity by central banks is beneficial only to those who can access it,

Her concern was over that region and EM is Emerging Markets. I enquired further.

Operationally, the bid for USD in Asia and squeeze in liquidity reflects the massive role of the USD in the global economy & finance. For example, 87% of China merchandise trade is invoiced in US. and the loss of income from export earnings will further push higher the demand of USD. To overcome the global USD squeeze, the Fed must step up its operational support via swap lines with economies such as South Korea.

That was from a piece she wrote for the Financial Times but got cut from it. On twitter she went further with a theme regular readers will find familiar

Guys, the reason why we have a dollar shortage is because we have levered!!!!!!!!!!! So when income collapses, we got major problem because we have leveraged & so debt needs servicing etc. Aniwaize, the stress u see is because we live in a world that’s too leveraged!!!

And again although I would point out that leverage can simply be a gamble rather than a hope for better times.

Don’t forget that low rates only lower interest expense, u still got principal that is high if ur debt stock is high. When u lever, u think the FUTURE IS BETTER THAN TODAY. Obvs very clearly that whoever thought there was growth is in for a surprise given the pandemic situation.

She looks at this from the perspective of the Malaysian Ringgit which has fallen to 4.37 versus the US Dollar and the Singapore Dollar which is at 1.44.

Comment

We are now seeing a phase of King Dollar or Holla Dollar and let me add some more places into the mix. We have previously looked at countries which have borrowed in US Dollars and they will be feeling the strain especially if they are commodity producers as well. This covers quite a few countries in Latin America and of course some of those have their own problems too boot. I also recall Ukraine running the US Dollar as pretty much a parallel currency.

The beat goes on.

In times of stress, capital flees emerging markets to seek safety in $USD . This crisis is no different. ( @IceCapGlobal)

which got this reply.

Investors have yanked at least US$55bn from EMs since January 21, according to the Institute of International Finance, exceeding the withdrawal in 2008. ( @alexharfouche1 )

Let me finish by reminding you that ordinarily we discuss matters around the price of something. But here as well as that we are discussing how much you can get and for some right now that people will not trade with you at all. That is why we are seeing what is effectively the world’s central bank the Federal Reserve offering US Dollars in so many different ways. It is spraying US $500 billion Repo operations around like confetti but I am reminded of the words of Glenn Frey.

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

The Investment Channel

The biggest move by the US Federal Reserve was the one concerning liquidity or FX Swaps

Last night the week started with the arrival of the Kiwi cavalry as the Reserve Bank of New Zealand announced this.

The Official Cash Rate (OCR) is 0.25 percent, reduced from 1.0 percent, and will remain at this level for at least the next 12 months.

With international sporting events being cancelled this was unlikely to have been caused by a defeat for the All Blacks as the statement then confirmed.

The negative economic implications of the COVID-19 virus continue to rise warranting further monetary stimulus.

But soon any muttering in the virtual trading rooms was replaced by quite a roar as this was announced.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The effects of the coronavirus will weigh on economic activity in the near term and pose risks to the economic outlook. In light of these developments, the Committee decided to lower the target range for the federal funds rate to 0 to 1/4 percent. The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals. This action will help support economic activity, strong labor market conditions, and inflation returning to the Committee’s symmetric 2 percent objective. ( US Federal Reserve)

So a 1% interest-rate cut to the previous credit crunch era low for interest-rates and whilst the timing was a surprise it was not a shock. This is because on Saturday evening President Donald Trump had ramped up the pressure by saying that he had the ability to fire the Chair Jeroen Powell. The odd points in the statement were the reference to returning to being “on track” for its objectives which seems like from another world as well as reminding people of Greece which has been “on track” to recovery all the way through its collapse into depression. Also “strong labor market conditions” is simply untrue now. All that is before the reference to inflation returning to target when some will be paying much higher prices for goods due to shortages.

QE5

This came sliding down the slipway last night which will have come as no surprise to regular readers who have followed to my “To Infinity! And Beyond!” theme.

To support the smooth functioning of markets for Treasury securities and agency mortgage-backed securities that are central to the flow of credit to households and businesses, over coming months the Committee will increase its holdings of Treasury securities by at least $500 billion and its holdings of agency mortgage-backed securities by at least $200 billion.

This is quite punchy as we note that the previous peak for its balance sheet was 4.5 trillion Dollars and now it will go above 5 trillion. The Repos may ebb and flow bad as we stand it looks set to head to 5.2 trillion or so. The odd part of the statement was the reference to the “smooth functioning” of the Treasury Bond market when buying such a large amount further reduces liquidity in a market with liquidity problems already. For those unaware off the run bonds ( non benchmarks) have been struggling recently. The situation for mortgage bonds is much clearer as some will no doubt be grateful for any buyers at all. Although whether buying the latter is a good idea for the US taxpayer underwriting all of this is a moot point. At least the money used is effectively free at around 0%.

Liquidity Swaps

This was the most significant announcement of all for two reasons. Firstly it was the only one which was coordinated and secondly because it stares at the heart of one of the main problems right now. Cue Aloe Blacc.

I need a dollar dollar, a dollar is what I need
Hey hey
Well I need a dollar dollar, a dollar is what I need
Hey hey
And I said I need dollar dollar, a dollar is what I need
And if I share with you my story would you share your dollar with me
Bad times are comin’ and I reap what I don’t sow.

I have suggested several times recently that there will be banks and funds in trouble right now as we see simultaneous moves in bond, equity and oil markets. That will only be getting worse as the price of a barrel of Brent Crude Oil approaches US $31. This means that some – and the rumour factory will be at full production – will be finding hard to get US Dollars and some may not be able to get them at all. So the response is that the main central banks will be able to.

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing a coordinated action to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements.

These central banks have agreed to lower the pricing on the standing U.S. dollar liquidity swap arrangements by 25 basis points, so that the new rate will be the U.S. dollar overnight index swap (OIS) rate plus 25 basis points.

So it appears that price matters for some giving us a hint of the scale of the issue here. If I recall correct a 0.5% cut was made as the credit crunch got into gear. Also there was this enhancement to the operations.

 To increase the swap lines’ effectiveness in providing term liquidity, the foreign central banks with regular U.S. dollar liquidity operations have also agreed to begin offering U.S. dollars weekly in each jurisdiction with an 84-day maturity, in addition to the 1-week maturity operations currently offered. These changes will take effect with the next scheduled operations during the week of March 16.

Then we got something actively misleading because the real issue here is for overseas markets.

The new pricing and maturity offerings will remain in place as long as appropriate to support the smooth functioning of U.S. dollar funding markets.

For newer readers wondering who these might be? The main borrowers in recent times have been the European Central Bank and less so the Bank of Japan. This is repeated at the moment as some US $58 million was borrowed by a Euro area bank last week. Very small scale but maybe a toe in the water.

Comment

Some of the things I have feared are taking place right now. We see for example more and more central banks clustering around an interest-rate of 0% or ZIRP ( Zero Interest-Rate Policy). Frankly I expect more as you know my view on official denials.

#BREAKING Fed’s Powell says negative interest rates not likely to be appropriate ( @AFP )

You could also throw in the track record of the Chair of the US Federal Reserve for (bad) luck.

Meanwhile rumours of fund collapses are rife.

Platinum down 18%, silver down 14% Palladium down 12%, Gold down 4% – someone is getting liquidated ( @econhedge )

Some of that may be self-fulfilling but there is a message in that particular bottle.

As to what happens next? I will update more as this week develops but I expect more fiscal policy back stopped by central banks. More central banks to buy equities as I note the Bank of Japan announced earlier it will double its operations this year. Helicopter Money is a little more awkward though as gathering to collect it would spread the Corona Virus. As Bloc Party put it.

Are you hoping for a miracle? (it’s not enough, it’s not enough)
Are you hoping for a miracle? (it’s not enough, it’s not enough)
Are you hoping for a miracle? (it’s not enough, it’s not enough)
Are you hoping for a miracle? (it’s not enough, it’s not enough)

Let me sign off for today by welcoming the new Bank of England Governor Andrew Bailey.

Podcast

I would signpost the second part of it this week as eyes will turn to the problems in the structure of the ECB likely to be exposed in a crisis.

 

 

What and where next for US interest-rates?

Later today the US Federal Reserve will make and announce its latest policy decision on interest-rates and Quantitative Easing. Unless it feels that they can battle the outbreak of the Corona Virus in China it will make no move today but looking ahead it faces quite a few decisions. It was only on Monday that we looked at the impact of the Corona Virus on China and then the world economy and since then events have moved on. For example the last British Airways flights to and from China during the outbreak have now taken off. According to the South China Morning Post there is also this.

The rapid spread of the deadly coronavirus through China could sharply curtail Beijing’s ability to meet the purchasing agreement elements of the trade deal struck with the United States earlier this month, analysts said.As part of the phase one deal signed on January 15, China is obliged to buy US$200 billion in additional US imports over two years on top of pre-trade war purchase levels.

There are two issues here for the US economy. The first is simple which is the reduction in demand for US products and the second is more complex which is the response of US President Donald Trump to this. Also the SCMP gives an example of a company which hit the news with its latest figures only last night.

On Tuesday, Nikkei Asian Review reported that Apple’s suppliers in China had warned that its demands to increase iPhone production by 10 per cent this year may be difficult, since their manufacturing facilities are located in Henan and Guangdong provinces, both of which have been hit by the coronavirus.

So there will be knock-on effects for the US.

What about the US economy now?

The latest nowcast was released by the Atlanta Federal Reserve only yesterday

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2019 is 1.9 percent on January 28, up from 1.8 percent on January 17. After last week’s and this week’s data releases by the National Association of Realtors and the U.S. Census Bureau, the nowcast of fourth-quarter real gross private domestic investment growth increased from -2.3 percent to -2.0 percent..

The durable good release of yesterday did not have a large impact in spite of it generating a lot of column inches. The bit from the Census Bureau that impacts GDP almost spelt out Boeing.

Shipments of manufactured durable goods in December, down six consecutive months, decreased $0.5
billion or 0.2 percent to $250.4 billion. This followed a 0.1 percent November decrease. Transportation
equipment, also down six consecutive months, led the decrease, $0.4 billion or 0.4 percent to $83.2 billion

The 737 Max issue and its consequences continue as you can see.

Switching to the overall picture assuming the same adjustment the New York Fed will now be suggesting 1.3% annualised GDP growth in the final quarter of last year. It’s last reading for this quarter was 1.7%.

Looking Ahead

There was some positive news yesterday in terms of consumer expectations.

The Conference Board Consumer Confidence Index® increased in January, following a moderate increase in December. The Index now stands at 131.6 (1985=100), up from 128.2 (an upward revision) in December.

This led to a rather bold statement in the circumstances.

“Consumer confidence increased in January, following a moderate advance in December, driven primarily by a more positive assessment of the current job market and increased optimism about future job prospects,” said Lynn Franco, Senior Director, Economic Indicators, at The Conference Board. “Optimism about the labor market should continue to support confidence in the short-term and, as a result, consumers will continue driving growth and prevent the economy from slowing in early 2020.”

However if we look further into Conference Board research the situation is not so rosy. From the 23rd of this month.

“The US LEI declined slightly in December, driven by large negative contributions from rising unemployment insurance claims and a drop in housing permits,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “The LEI has now declined in four out of the last five months

The Leading Economic Index has been heading south in recent times leading to this comment from Liz Ann Sonders of Charles Schwab.

Leading Economic Index (LEI) from @Conferenceboard

now below prior 2 mid cycle slowdowns (2013 & 2016) in y/y terms (white); & has been flat in level terms (blue) for over a year.

Money Supply

What we see here is a consequence of the monetary policy easing we saw last year. There were the interest-rate cuts which replaced the promised rises and leaves the official range at 1.5% to 1.75% as well as the end to QT or Quantitative Tightening. Actually we did see some “not QE” as well as the Federal Reserve started to buy some US $60 billion of Treasury Bills each month to try to oil the wheels of the monetary system to help deal with the Repo Crisis. Yesterday’s operations which added a further US $55,75 billion on a daily basis and US $28.95 billion on a fortnightly one show that it has not gone away.

The consequence of this is that money supply growth has strengthened. The narrow money measure or M1 has seen annualised quarterly growth rise to 7.7% replacing the 6.2% of 2019 as a whole. So there has been an economic boost applied from stronger narrow money growth which should be feeding in in the early part of this year.

Looking further ahead broad money growth ( M2 ) has risen as well in response to the monetary stimulus. On the same basis as above it has risen from 6.7% to 7.8%. In terms of economic impact this is more of a slow burner as it takes around 2 years and is split between actual growth and inflation.

The Dollar

Recent events have seen the US Dollar rally again. In terms of specific currencies it has pushed the UK Pound £ back to US $1.30 and the Euro back to 1.10. Switching to a broader perspective the Dollar Index has risen above 98. This does not have the same effect as on other countries because most commodity prices are in dollars so the inflation effect is smaller but over time it is contractionary on economic output.

Comment

As you can see from the above the situation may be quiet on the surface in some respects but there is a lot going on below. For example how will the Fed deal with the ongoing Repo crisis? But as we note the move back towards monetary stimulus we need to also note that as we looked at on the 16th of this month there has been the Trump fiscal boost as well. There are two ways of looking at this. No doubt both will present it as policy responding correctly to an economic slow down ( assuming of course the Donald will admit it has slowed). But there is the deeper issue that growth is lower than it was, and looks like being on an annual basis 2% at best even with the various stimuli. So what happens when they wear off?

In such an environment we may see thoughts turn to what we looked at on the 4th of this month.

The Fed should also consider maintaining constructive ambiguity about the future use of negative short-term rates, both because situations could arise in which negative short-term rates would provide useful policy space; and because entirely ruling out negative short rates, by creating an effective floor for long-term rates as well, could limit the Fed’s future ability to reduce longer-term rates by QE or other means.

This returns us to our main credit crunch theme which is why do we always need more stimulus? Whilst the US has done better than elsewhere in economic growth terms it has deployed a fiscal stimulus as well. So whilst they will deny it members of the US Federal Reserve will be getting nervous just like many of their colleagues as it all goes on and on and on. They need something to change for the better.

Meanwhile whilst we can all make a mistake the claimed omniscience of central bankers as the former Vice-President of the ECB Vitor Constancio confessed he was unaware that Imputed Rents make up 24% of the US CPI.

yes, I just checked and you are right but it is easy to calculate the US CPI excluding the imputed rents and that is what is shown in my second tweet, indicating a small difference in the inflation rate., which was the point I wanted to make. Thanks

Actually the difference looks material to me…..

 

 

 

 

 

 

Will the US deploy negative interest-rates?

On Saturday economists  gathered to listen to the former Chair of the US Federal Reserve Ben Bernanke speak on monetary policy in San Diego. This is because those who used to run the Federal Reserve can say things the present incumbent cannot. So let me get straight to the crux of the matter.

The Fed should also consider maintaining constructive ambiguity about the future use of negative short-term rates, both because situations could arise in which negative short-term rates would provide useful policy space; and because entirely ruling out negative short rates, by creating an effective floor for long-term rates as well, could limit the Fed’s future ability to reduce longer-term rates by QE or other means.

It is no great surprise to see a central banker suggesting that the truth will be withheld. But let us note that he is talking about “policy space” in a situation described by the New York Times like this.

While the economy has recovered and unemployment has fallen to a 50-year low, interest rates have not returned to precrisis levels. Currently, the policy interest rate is set at 1.5 percent to 1.75 percent, leaving far less room to cut in the next crisis.

The apparent need for ever lower interest-rates looks ever more like an addiction of some sort for these central planners. Although as ever they are try to claim that it has in fact been forced upon them.

Since the 1980s, interest rates around the world have trended downward, reflecting lower inflation, demographic and technological forces that have increased desired global saving relative to desired investment, and other factors.

As we so often find the truth is merged with more dubious implications. Yes interest-rates and bond yields did trend lower and let me add something Ben did not say. There were economic gains from this period as for example I remember  mortgage rates in the UK being in double-digits. Also higher rates of inflation caused economic problems and it is easy to forget it caused a lot of problems back then. Younger readers probably find the concept of wage-price spirals as something almost unreal but they were very real back then. Yet Ben seems to want to put a smokescreen over this.

Another way to gain policy space is to increase the Fed’s inflation target, which would eventually raise the nominal neutral interest rate as well.

Curious as they used to tell us interest-rates drove inflation, now they are trying to claim it is the other way around! Are people allowed to get away with this sort of thing in other spheres?

Is there a neutral interest-rate?

Ben seems to think so.

The neutral interest rate is the interest rate consistent with full employment and inflation at target in the long run.  On average, at the neutral interest rate monetary policy is neither expansionary nor contractionary. Most current estimates of the nominal neutral rate for the United States are in the range of 2-3 percent.

The first sentence is ridden with more holes than a Swiss cheese which is quite an achievement considering its brevity. If we ever thought that we were sure what full employment is/was the credit crunch era has hit that for six ( for those who do not follow cricket to get 6 the ball is hit out of the playing area). For example the unemployment rate in Japan is a mere 2.2% so well below “full” but there is essentially no real wage growth rather than it surging as economics 101 text books would suggest. Putting it another way in spite of what is apparently more than full employment real wages may well have ended 2019 exactly where they were in 2015.

This is an important point as it was a foundation of economic theory as the “output gap” concept shifted from output (GDP) to the labour market when they did not get the answers they wanted. Only for the labour market to torpedo the concept and as you can see above it was not just one torpedo as it fired a full spread. Yet so many Ivory Towers persist with things accurately described by Ivan van Dahl.

Please tell me why
Do we build castles in the sky?
Oh tell me why
Are the castles way up high?

Quantitative Easing

Ben is rather keen on this but then as he did so much of it he has little choice in the matter.

Quantitative easing works through two principal channels: by reducing the net supply of longer-term assets, which increases their prices and lower their yields; and by signaling policymakers’ intention to keep short rates low for an extended period. Both channels helped ease financial conditions in the post-crisis era.

Could there be a more biased observer? I also note that there seems to be a titbit thrown in for politicians.

The risk of capital losses on the Fed’s portfolio was never high, but in the event, over the past decade the Fed has remitted more than $800 billion in profits to the Treasury, triple the pre-crisis rate.

A nice gift except and feel free to correct me if I am wrong there is still around US $4 trillion of QE out there. So how can the risk of losses be in the past tense with “was”? It is one of the confidence tricks of out era that establishments have been able to borrow off themselves and then declare a profit on it hasn’t it?

Ben seems to have an issue here though. So by buying trillions of something you increase the supply?

and increases the supply of safe, liquid assets.

Forward Guidance

I do sometimes wonder if this is some form of deep satire Monty Python style.

 Forward guidance helps the public understand how policymakers will respond to changes in the economic outlook and allows policymakers to commit to “lower-for-longer” rate policies. Such policies, by convincing market participants that policymakers will delay rate increases even as the economy strengthens, can help to ease financial conditions and provide economic stimulus today.

Another way of looking at it is that it has been and indeed is an ego trip. The  majority of the population will not know what it is and in the case of my country that is for the best as the Bank of England misled by promising interest-rate rises and then cutting them. Sadly some did seem to listen as more fixed-rate mortgages were incepted just before they got cheaper. So we see that if we return to the real world the track record of Forward Guidance makes people less and not more likely to listen to it. After all who expects and sustained rises in interest-rates anyway?

Comment

These speeches are useful as they give us a guide to what central bankers are really thinking. It does not matter if you consider them to be pack animals or like the large Amoeba that tries to eat the Starship Enterprise in an early episode of Star Trek as the result is the same. This will be what they in general think.

When the nominal neutral rate is in the range of 2-3 percent, then the simulations suggest that this combination of new policy tools can provide the equivalent of 3 percentage points of additional policy space; that is, with the help of QE and forward guidance, policy performs about as well as traditional policies would when the nominal neutral rate is 5-6 percent. In the simulations, the 3 percentage point increase in policy space largely offsets the effects of the zero lower bound on short-term rates.

Actually if we look at the middle-section “traditional policies” did not work but I guess he is hoping no-one will point that out. If they did we would not be where we are! Also you may not that as I have often found myself pointing out why do we always need more of the same!

Still if you believe the research of the Bank of England interest-rates have been falling for centuries. Does this mean that to coin a phrase they have been doing “God’s work” in the credit crunch era?

global real rates have shown a
persistent downward trend over the past five centuries, declining within a corridor of between -0.9 (safe
asset provider basis) and -1.59 basis points (global basis) per annum, with the former displaying a
continuous decline since the deep monetary crises of the late medieval “Bullion Famine”. This downward
trend has persisted throughout the historical gold, silver, mixed bullion, and fiat monetary regimes, is
visible across various asset classes, and long preceded the emergence of modern central banks.

The catch is that if you are saying events have driven things people might start to wonder what your purpose it at all?

Podcast

 

The problems faced by the QE era make me wonder if QT is a mirage

If we were to step back in time to when the new QE era began around a decade ago we would not find any central bankers expecting us to be where we are now. In a way that is summarised by the fact that the original QE pamphlet of the Bank of England from the Charlie Bean tour of the summer of 2009 has a not found at this address description on the website these days. Or if we look back this speech from policymaker David Miles finishes like this.

Concluding, David Miles says that quantitative easing will assist spending but also notes it is hard to decide
what the “.appropriate scale of purchases is when the power of the mechanisms at work are difficult to
gauge.” He also notes that the timing and means of reversing this monetary easing will “.depend on the
economic outlook, which in turn depends on conditions in financial markets in general and with banks in
particular.

As to the reversing we are still waiting as all we have had is “More! More! More!” as we note that despite record highs for equity and bond markets financial market conditions are apparently still not good enough.

Switching to the real economy we see that in fact we are back in something of a trough right now. We discovered yesterday that the UK is flat lining and we know the Euro area is similar and the United States has been slowing down as well.

The New York Fed Staff Nowcast stands at 0.6% for 2019:Q4 and 0.7% for 2020:Q1. ( the numbers are annualised )

To that we can add Japan which faces the impact of the rise in the Consumption Tax to 10% this quarter.

Next and in some ways most revealingly is the way that QE has acquired a new name. In Japan it has morphed into QQE or Quantitative and Qualitative Easing at the time purchases of equities and commercial property began. Since then it has become QQE with Yield Curve Control. We await to see if the review being conducted by President Lagarde leads to changes at the ECB but we do know this about the US Federal Reserve. From CNBC on the 8th of October.

Powell stressed the approach shouldn’t be confused with the quantitative easing done during and after the financial crisis.

“This is not QE. In no sense is this QE,” he said in a question and answer session after the speech.

The reality is that it fulfils the description of David Miles above in the case of the Treasury Bill purchases with the difference that they have a shorter maturity, although of course back then QE was not meant to be long-term.

The Bank of England looks ahead

Last night Andrew Hauser who is the Executive Director looked at the state of play.

Before the financial crisis, our balance sheet was modest, at 4% of GDP. Since then, and in direct response to the
crisis, that figure has risen to around 30%: a more than seven-fold increase.

He then looks ahead and point one covers a lot of ground to say the least.

The first is that, judged by historical standards, big
balance sheets are here to stay. That’s not a prediction that QE will never unwind: it will. But we have a
bigger responsibility than we did to provide liquidity to the system, in good times and bad, and to a wider set
of organisations, to maintain financial stability. And that’s not going away.

It was nice of him to give us a good laugh about it being permanent! At least I hope he was joking. The liquidity mention doffs it cap to some extent to the mess that the US Federal Reserve has got itself into as well as the fact that changes to the structure of the system such as banks being required to have more capital have put increased pressure on this area.

The next point meanders a bit but we eventually get to an estimate of circa £200 billion for a QT target or objective,

Point two is that big doesn’t mean outsized – so the balance sheet will eventually shrink from where it is today. That’s something the Bank has been stressing for some time. But the Discussion Paper has allowed us to put a tighter range on that forecast, and suggests our liabilities probably only need to be half the size they are today to carry out our
mission once QT is underway/

Ah “eventually!” Also some would think the sort of sum he is thinking of is indeed outsized.

Point three contains some welcome honesty.

Neither we nor the firms who use our liquidity really know what their demand will be when conditions normalise.

Finally we have this

The final message, therefore, is that we must have as our ultimate goal an end-state framework that can cope with
that ambiguity without shaking itself, and us, to bits.

How Much?

The Bank of England balance sheet is more than just QE

Three quarters of the Bank’s assets is in the form of a loan to the Asset Purchase Facility backing £435bn of
gilt holdings and £10bn of corporate bonds, while another £127bn has been lent to banks under the
Term Funding Scheme. A further £13bn of liquidity has been extended under the so-called
‘Index Linked Term Repo’ facility, part of the Sterling Monetary Framework (SMF).
Nearly all of that activity has been financed by an increase in central bank reserves.

He does not point it out but this structure led to another consequence which is that the Term Funding Scheme (and some smaller factors) adds to the official definition of the national debt raising it by around 8% of GDP.

Hard Astern Captain

I have long considered the Bank of England course reversal plan to be unwise and perhaps stupid.

First, the MPC does not intend to begin QT until Bank Rate has risen to a level from which it could
be cut materially if required. The MPC currently judges that to be around 1.5%.

– Second, QT will be conducted over a number of years at a gradual and predictable pace, chosen by
the MPC in light of economic and financial market conditions at the time.

– Third, the QT path will take account of the need to maintain the orderly functioning of the gilt and
corporate bond markets including through liaison with the Debt Management Office.

– And, fourth, the QT path can be amended or reversed as required to achieve the inflation target.

 

Comment

Frankly the very concept of the Bank of England raising interest-rates as high as 1.5% is laughable under the present stewardship. I have long thought that the plan as described above demonstrates that there is no real intention to reverse QE. There are former policymakers who explicitly endorse this such as David Blanchflower. But there are also implicit issues such as waiting for yields to rise and prices to fall as well as thinking there can be an “orderly market” when the biggest holder sells. When you intervene in a market on such a large scale there is always going to be trouble exiting. One answer to that is to not get too exposed in the first place and to me selling when others might be selling because of losses as well is classic Ivory Tower thinking.

None of that is Andrew Hausers fault as he is in this regard merely a humble functionary. So we shuld thank him for his thoughts that even if QE somehow was teleported away things would still be different.

Bringing all this together, our conversations with firms suggest the current sterling PMRR is of the
order of £150-250bn.

Meanwhile if Livesquawk are correct Switzerland might be adding more not less extraordinary monetary action. Also the original reason was external ( Swiss Franc) whereas now it seems to have spread.

Oxley said, “There is good reason to take the SNB’s forecasts seriously: it has not tended to change its policy stance in the past unless its inflation forecast foresees deflation at some point over its three-year horizon. If the bank crosses the deflationary Rubicon again, this would lend support to our below-consensus view that the bank will end up cutting the policy rate to -1.00pct in the first half of 2020.”

 

 

 

Why is the US Repo crisis ongoing?

The US Repo crisis is something that seems to turn up every day, or if you prefer as often as we are told there is a solution to trade war between the US and China. On Friday the New York Federal Reserve or Fed provided another US $72.8 billion of overnight liquidity in return for Treasury Bonds ( US $56.1 billion) and Mortgage-Backed Securities ( US $16.7 billion). So something is still going on in spite of the fact that we have two monthly plus Repos ( 42 days) for US $25 billion each in play and 3 fortnightly ones totalling around US $59 billion. So quite a bit of liquidity continues to be deployed and this is before we get to the Treasury Bill purchases.

In accordance with this directive, the Desk plans to purchase Treasury bills at an initial pace of approximately $60 billion per month, starting with the period from mid-October to mid-November.

As an example Friday saw some US $7.525 billion of these bought. So the sums are getting larger.

How did this start?

The Bank for International Settlements or BIS which is the central bankers central bank puts it like this.

On 17 September, the secured overnight funding rate (SOFR) – the new, repo market-based, US dollar overnight reference rate – more than doubled, and the intraday range jumped to about 700 basis points. Intraday volatility in the federal funds rate was also unusually high. The reasons for this dislocation have been extensively debated; explanations include a due date for US corporate taxes and a large settlement of US Treasury securities. Yet none of these temporary factors can fully explain the exceptional jump in repo rates.

Indeed, as for a start the issue has proved to be anything but temporary.

Where the BIS view gets more interesting is via the role of the banks or rather a small group of them.

US repo markets currently rely heavily on four banks as marginal lenders. As the composition of their liquid assets became more skewed towards US Treasuries, their ability to supply funding at short notice in repo markets was diminished.

As the supply of reserves fell in the QT or Quantitative Tightening era they stepped up to the plate on a grand scale.

As repo rates started to increase above the IOER from mid-2018 owing to the large issuance of Treasuries, a remarkable shift took place: the US banking system as a whole, hitherto a net provider of collateral, became a net provider of funds to repo markets. The four largest US banks specifically turned into key players: their net lending position (reverse repo assets minus repo liabilities) increased quickly, reaching about $300 billion at end-June 2019 . At the same time, the next largest 25 banks reduced their demand for repo funding, turning the net repo position of the banking sector positive (centre panel, dashed line).

So things became more vulnerable as we note this.

At the same time, the four largest banks held only about 25% of reserves (ie funding that they could supply at short notice in repo markets).

Then demand for Repo funding was affected by the US Treasury.

After the debt ceiling was suspended in early August 2019, the US Treasury quickly set out to rebuild its dwindling cash balances, draining more than $120 billion of reserves in the 30 days between 14 August and 17 September alone, and half of this amount in the last week of that period. By comparison, while the Federal Reserve runoff removed about five times this amount, it did so over almost two years

As you can see the drain from QT was added to in spite of the fact that the market had become more vulnerable due to the lack of players. There was a clear lack of joined up thinking at play and perhaps a lack of any thinking at all. A factor here was something the BIS identifies for the banks.

For instance, the internal processes and knowledge that banks need to ensure prompt and smooth market operations may start to decay. This could take the form of staff inexperience and fewer market-makers, slowing internal processes

After a decade the experienced hands had in general moved on.

But it was not enough to collapse the house of cards. There were other nudges as well on the horizon.

Market commentary suggests that, in preceding quarters, leveraged players (eg hedge funds) were increasing their demand for Treasury repos to fund arbitrage trades between cash bonds and derivatives. Since 2017, MMFs have been lending to a broader range of repo counterparties, including hedge funds, potentially obtaining higher returns.

So hedge funds were playing in the market but as it happened were not an issue for a while as the US Money Market Funds (MMF) turned up. But then they didn’t.

 During September, however, quantities dropped and rates rose, suggesting a reluctance, also on the part of MMFs, to lend into these markets. Market intelligence suggests MMFs were concerned by potential large redemptions given strong prior inflows. Counterparty exposure limits may have contributed to the drop in quantities, as these repos now account for almost 20% of the total provided by MMFs.

So there is a hint that maybe a hedge fund or two became such large players that they hit counterparty limits. Also redemptions from MMFs would hardly be a surprise as we note the interest-rate cuts we have seen in 2019.

Why should we care?

There is this.

 Repo markets redistribute liquidity between financial institutions: not only banks (as is the case with the federal funds market), but also insurance companies, asset managers, money market funds and other institutional investors. In so doing, they help other financial markets to function smoothly.

So they oil the wheels of financial markets and when they don’t? Well that is one of the causes of the credit crunch.

The freezing-up of repo markets in late 2008 was one of the most damaging aspects of the Great Financial Crisis (GFC).

In case you did not know what they are.

A repo transaction is a short-term (usually overnight) collateralised loan, in which the borrower (of cash) sells a security (typically government bonds as collateral) to the lender, with a commitment to buy it back later at the same price plus interest.

Also it is one of those things which get little publicity ( mostly ironically because they usually work smoothly) but there is a lot of action.

 Thus, any sustained disruption in this market, with daily turnover in the US market of about $1 trillion, could quickly ripple through the financial system.

Comment

Some of the factors in the Repo crisis were unpredictable. But it is also true that the US Fed was at best rather flat-footed. There had been a long-running discussion over the use of Interest On Excess Reserves or IOER to banks on such a scale which was not resolved. Then there was the way that so few banks (4) were able to become such large players creating an obvious risk. Then the role of the MMFs as by their very nature they flow into and out of markets and are likely to flow out when interest-rates are declining.

The BIS analysis adds to what we know but changes in stocks give us broad trends rather than telling what flowed where or rather did not flow on September 17th or since. As David Bowie put it.

Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
Don’t want to be a richer man
Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
There’s gonna have to be a different man
Time may change me
But I can’t trace time

Number Crunching

The BIS has been looking into some other areas.

An analysis of the #TriennialSurvey finds that global notional for #OTCderivatives rose to $640 trn in 2019, dominated by #InterestRateDerivatives

Average daily turnover of OTC interest rate derivatives more than doubled over 2016-19 to $6.5 trillion, taking OTC markets’ share to almost half total trading

30 years, 53 countries, 1,300 reporting dealers, and $6.6 trillion daily FX trades,

Weekly Podcast

 

Where next for US house prices?

Yesterday brought us up to date in the state of play in the US housing market. So without further ado let us take a look.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, covering all nine U.S. census divisions, reported a 3.2% annual gain in September, up from 3.1% in the previous month. The 10-City Composite annual increase came in at 1.5%, no change from the previous month. The 20-City Composite posted a 2.1% year-over-year gain, up from 2.0% in the previous month.

The first impression is that by the standards we have got used to that is a low number providing us with another context for the interest-rate cuts we have seen in 2019 from the US Federal Reserve. Of course it is not only the Fed that likes higher asset prices.

“DOW, NASDAQ, S&P 500 CLOSE AT RECORD HIGHS”

Another new Stock Market Record. Enjoy!

Those are 2 separate tweets from Monday from President Trump who not only loves a stock market rally but enjoys claiming it is all down to him. I do not recall him specifically noting house prices but it seems in the same asset price pumping spirit to me.

In my opinion the crucial part of the analysis provided by S&P comes right at the beginning.

After a long period of decelerating price increases, it’s notable that in September both the national and
20-city composite indices rose at a higher rate than in August, while the 10-city index’s September rise
matched its August performance. It is, of course, too soon to say whether this month marks an end to
the deceleration or is merely a pause in the longer-term trend.

If we look at the situation we see that things are very different from the 10% per annum rate reached in 2014 and indeed the 7% per annum seen in the early part of last year.That will concern the Fed which went to an extreme amount of effort to get house prices rising again. From a peak of 184.62 in July of 2006 the national index fell to 134.62 in February of 2012 and has now rallied to 212.2 or 58% up from the low and 15% up from the previous peak.

As ever there are regional differences.

Phoenix, Charlotte and Tampa reported the highest year-over-year gains among the 20 cities. In
September, Phoenix led the way with a 6.0% year-over-year price increase, followed by Charlotte with
a 4.6% increase and Tampa with a 4.5% increase. Ten of the 20 cities reported greater price increases
in the year ending September 2019 versus the year ending August 2019…….. Of the 20 cities in the composite, only one (San Francisco) saw a year-over-year price
decline in September

Mortgage Rates

If we look for an influence here we see a contributor to the end of the 7% per annum house price rise in 2018 as they rose back then. But since then things have been rather different as those who have followed my updates on the US bond market will be expecting. Indeed Mortgage News Daily put it like this.

2019 has been the best year for mortgage rates since 2011.  Big, long-lasting improvements such as this one are increasingly susceptible to bounces/corrections……Fed policy and the US/China trade war have been key players.

But we see that so far a move that began in bond markets around last November has yet to have a major influence on house prices. If you wish to know what US house buyers are paying for a mortgage here is the state of play.

Today’s Most Prevalent Rates For Top Tier Scenarios

  • 30YR FIXED -3.75%
  • FHA/VA – 3.375%
  • 15 YEAR FIXED – 3.375%
  • 5 YEAR ARMS –  3.25-3.75% depending on the lender

More recently bonds seem to be rallying again so we may see another dip in mortgage rates but we will have to see and with Thanksgiving Day on the horizon things may be well be quiet for the rest of this week.

The economy

This has been less helpful for house prices.There may be a minor revision later but as we stand the third quarter did this.

Real gross domestic product (GDP) increased 1.9 percent in the third quarter of 2019, according to the “advance” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 2.0 percent. ( US BEA ).

Each quarter in 2019 has seen lower growth and that trend seems set to continue.

The New York Fed Staff Nowcast stands at 0.7% for 2019:Q4.

News from this week’s data releases increased the nowcast for 2019:Q4 by 0.3 percentage point.

Positive surprises from housing data drove most of the increase.

Something of a mixture there as the number rallied due to housing data from building permits and housing starts.Mind you more supply into the same demand could push future prices lower! But returning to the wider economy back in late September the NY Fed was expecting economic growth in line with the previous 5 months of around 2% in annualised terms.But now even with a rally it is a mere 0.7%.

Employment and Wages

The situation here has continued to improve.

Total nonfarm payroll employment rose by 128,000 in October, and the unemployment rate was little
changed at 3.6 percent, the U.S. Bureau of Labor Statistics reported today. Notable job gains occurred in
food services and drinking places, social assistance, and financial activities……..In October, average hourly earnings for all employees on private nonfarm payrolls rose by 6 cents to $28.18. Over the past 12 months, average hourly earnings have increased by 3.0 percent.

But the real issue here is the last number. Yes the US has wage gains and they are real wage gains with CPI being as shown below in October.

Over the last 12 months, the all items index increased 1.8 percent before seasonal adjustment.

So this should be helping although it is a slow burner at just over 1% per annum and of course we are reminded that according to the Ivory Towers the employment situation should mean that wage growth is a fair bit higher and certainly over 4% per annum.

Moving back to looking at house prices then wage growth is pretty much the same so houses are not getting more affordable on this criteria.

Comment

As we review the situation it is hard not to laugh at this from Federal Reserve Chair Jerome Powell on Monday.

While events of the year have not much changed the outlook,

You can take this one of two ways.Firstly his interest-rate cuts are not especially relevant or you can wonder why he did them? Looking at the trend for GDP growth does few favours to his statement nor for this bit.

Fortunately, the outlook for further progress is good

Indeed he seemed to keep contradicting himself.

 The preview indicated that job gains over that period were about half a million lower than previously reported. On a monthly basis, job gains were likely about 170,000 per month, rather than 210,000.

But I do note that house prices did get an implicit reference.

But the wealth of middle-income families—savings, home equity, and other assets—has only recently surpassed levels seen before the Great Recession, and the wealth of people with lower incomes, while growing, has yet to fully recover.

As to other signals we get told pretty much every day that the trade war is fixed so there is not a little fatigue and ennui on this subject. Looking at the money supply then it should be supportive but the most recent number for narrow money M1 at 6.8% shows a bit of fading too.

So whilst we may see a boost for the economy from around the spring of next year we seem set for more of the same for house prices.Unless of course the US Federal Reserve has to act again which with the ongoing Repo numbers is a possibility. The background is this though which brings me back to why central bankers are so keen on keeping on keeping house prices out of consumer inflation measures.Can you guess which of the lines below goes into the official CPI?

https://www.bourbonfm.com/blog/house-price-index-vs-owners-equivalent-rent-residences-1990

Whilst it is not sadly up to date it does establish a principle….