Where next for interest-rates and bond yields?

2021 has opened by reminding us that the world has become increasingly bi-polar.Perhaps I should refine that to the human world. Prospects for interest-rates are doing that as well and let me give you an example of one trend.

Government bond #yield keeping higher: 10 year German #Bund yield at -0.48%, 10 year UK Treasury #Gilt yield at 0.32% and 10 year US #Treasury yield at 1.15%. (@CIMBank_News)

The player here is the United States. I noted yesterday the impact of higher US bond yields on the price of Gold and in the meantime the ten-year has nudged higher to 1.15%. Part of this has been caused by the way that the prospects for Yield Curve Control ( essentially more QE bond buying) have collided with this.

WASHINGTON (Reuters) – The Federal Reserve could begin to trim its monthly asset purchases this year if distribution of coronavirus vaccines boosts the economy as expected, Atlanta Fed President Raphael Bostic said on Monday in what amounted to a bullish outlook for the coming months.

As you can see they have been talking bond yields higher just as they were expected to be heading in the opposite direction. So much for Forward Guidance! This is more like a car crash as we wait for the handbrake turn. Just to add to the land of confusion there was also this.

In separate comments, Chicago Fed President Charles Evans also said policymakers were poised to push bond-buying in either direction – adding more if the economy seems to need it but also open to cutting back if the recovery and vaccines gain traction. ( Reuters)

On a technical level this just reminds us how useless Forward Guidance is. We have seen central bankers and their acolytes push it as a policy tool but right now they are pulling in every direction. How can anyone take guidance from this.

Mr and Mrs Market have decided to push bond yields higher and see if they break.Those who remember what was called the Taoer Tantrum and the climb down of the US Federal Reserve in the face of pressure from President Trump will no doubt be thinking when they climb down. Such thoughts are no doubt behind the rise in bond yields because so far QE has been an example of the genius of the song Hotel California.

“Relax”, said the night man
“We are programmed to receive
You can check out any time you like
But you can never leave”

Negative Interest-Rates

On the other side of the coin is the negative interest-rate enthusiast of the Bank of England Silvana Tenreyro. Yesterday she gave a speech setting out her views on them.

Financial-market channels appear to be unimpeded under negative rates, and some may even be
stronger than usual.
 While pass-through to household deposit rates can be constrained near zero, pass-through appears
to be less constrained for corporate deposit rates, which may stimulate spending by firms.
 There is strong evidence of transmission into looser bank lending conditions, even if this is
somewhat constrained relative to ‘normal’.
 There is no clear evidence that negative rates have reduced bank profits overall, and a number of
studies find positive impacts, once you take into account the boost to the economy.
 Taking these points together, the evidence suggests that negative rates can provide significant
stimulus.

Let us examine these in detail. Her view on the financial market channel is really rather extraordinary, so let us take a look in more detail. The emphasis is mine.

For example, estimates from the Bank’s suite of models suggest that financial market channels – operating via the exchange rate, firms’ cost of capital and households’
financial wealth – account for a third to two thirds of the total medium-term impact on output from Bank Rate
changes, and a half to three quarters of the impact on inflation.

Yes we are back to wealth effects again with no addressing of the issuing for younger people of how they will have to buy more expensive assets is inflation for them.We look at this usually in terms of housing. Also if firms cost of capital responded to Bank Rate in the manner hinted at we would not have had the Funding for Lending and Term Funding Schemes. 

Next is the issue of corporate deposit rates which “may” stimulate corporate spending. Well after the years of evidence now about the impact of negative interest-rates in the Euro area then if you can only say “may” it means the answer is no. Although Silvana keeps plugging away at this.

This suggests one aspect of the banking channel of negative rates which could be more powerful than usual.

How bank lending can be both “looser” and “somewhat constrained” speaks for itself so I will leave that there.

Next comes the issue of the banks. The issue her is one of profitability or rather lack of. Her Silvana finds herself trapped between her theories and real world examples where people are backing their views with their money.

Interestingly, a number of studies48 – though not all49 – find that bank equities tend to fall after policy rate
cuts below zero are announced. That seems at odds with the more sanguine results on bank profitability.

Revealingly she decides that she is right and they are wrong.

One interpretation is that financial markets initially focussed on net interest income, but did not initially
account for the indirect boost to profits from negative rates arising from improvements in other sources of
income.

Indeed they have been wrong for quite some time according to her. It would be too cruel to look at the Italian banking sector so let us go to the benchmark for the Euro area banking sector which is Deutsche Bank. Back in 2015 there were two occasions when its share price approached 29 Euros whereas now it is 9.57 Euros. If we take out the Covid-19 pandemic then we see it does not change much as in February last year it was 10.2 Euros. So the share price has plunged over the era of negative interest-rates and bond yields because markets have failed for over five years to spot the “improvements in other sources of income.” Come to think of it the accountants and auditors have missed it as well!

We seem to be entering something of an alternative universe here.

And I have previously highlighted that in the UK interest rates affect inflation more quickly than in the past.

The ECB in fact published some work a few years back suggesting the reverse. I can only think that Silvana has misunderstood what happened in the summer of 2016.

Also we already have negative UK bond yields in the UK at the shorter maturities mostly due to all the QE bond buying she does not think is that important.Meanwhile that influences the increasing number of fixed-rate mortgages. On that road Bank Rate is ever less important which she seems to miss.

Comment

There are several contexts here so let me set out my view. There is a clear asymmetry between how central bankers regard interest-rate rises and cuts. The former are a vague wish and the latter are a clear desire often implemented via panic. Indeed interest-rate rises are often reversed ( the UK is an example of this ) and the new scenario is lower. For example the Bank of England told us the “lower bound” for UK interest-rates was 0.5% whereas Bank Rate is presently 0.1%. In a sane world we would be projecting interest-rate increases but in the insane one we inhabit any further economic weakness will see more cuts.

Next comes the issue of negative interest-rates which so far have been singing along with Muse.

Super massive black hole
Super massive black hole
Super massive black hole
(Super massive black hole)

The main place that has implemented them which is the Euro area is still there. In fact last year it cut again, although contrary to the Tenreyro rhetoric it only cut by 0.1% showing it sees risks. If negative rates had the impact claimed surely things would have got better and interest-rates could have been raised or at least returned to zero? The Riksbank in Sweden has raised back to 0% but that only illustrates the issue. It cut into negative territory in a boom and ended up so unsure about it all that it raised interest-rates in a bust. If they worked surely Sweden would have them now?

 

What is happening to Gold and the Gold price?

It is time for us to check in on Gold and to note that whilst it is up just under 15% over the past year at US $1850 for the February futures contract it has hit a bit of a slump recently. Only a few days ago it was above US $1950 and back in early August last year it went as high as US $2089. One way of looking at things was expressed by Peter Schiff a few days ago.

To the extent that Bitcoin is actually taking any demand away from gold, that’s making Fed governors extremely happy. A rising #gold price is what central bankers fear most. #Bitcoin  is their best friend, which may explain why regulators aren’t in a hurry to help pop the bubble.

Actually central banks which have substantial gold reserves will be pleased and Bitcoin is far from their best friend. But the issue of Gold being replaced as a “safe haven” by Bitcoin is a live one as the tweet below indicates.

Even JPMorgan Chase has acknowledged that Bitcoin is taking market share from gold, the traditional haven asset. On Friday, one Bitcoin was worth more than 22 ounces of gold, which represents a new all-time high. ( @Cointelegraph)

In an article they went further.

According to multiple experts, one possible reason for Bitcoin’s remarkable recent price rise are massive investor outflows from another popular inflation hedge: gold.

Spot gold swooned over the past week, falling 4.62% to $1,857. The asset previously had been surging in unison with Bitcoin, which is up over 40% from $28,000 lows last week.

That narrative has had better Sunday nights and Monday mornings with Bitcoin some US $5800 lower at US $35,000 as I type this. But there is still some food for thought on the piece below.

The moves could be a sign of Bitcoin’s rising status as a legitimate asset class. Gold and Bitcoin have long been linked as both are seen as a way to protect wealth against inflation and macroeconomic uncertainty, but if the price movements over the last week are any indication, however, Bitcoin may be winning the narrative race.

The bull case for Gold

The macroeconomic uncertainty one is so clear we need spend little time with that but the inflation one is quite complex. It opens quite easily and as we recall my subject of Friday and this from Andrew Hauser of the Bank of England.

Since March of last year, G10 central bank balance sheets have risen by over $8 trillion.

In theoretical terms that should lead to inflation and a case for Gold but not so far.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2 percent in November on a seasonally adjusted basis after being unchanged in October,
the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.2 percent before seasonal adjustment. ( US BLS)

That seems likely to rise as we note a Brent Crude Oil price of around US $55 and the general outlook has led to this.

US Inflation Expectations (10-yr breakevens) continue their vertical ascent, now above 2% for the first time since November 2018. ( @charliebilello )

I counsel caution on the issue of inflation breakevens which are unreliable but the broad trend is useful. There is also the additional issue that official inflation measures are designed to avoid the areas where inflation is both most likely and most rampant.

​House prices rose nationwide in October, up 1.5 percent from the previous month, according to the latest Federal Housing Finance Agency House Price Index (FHFA HPI®).  House prices rose 10.2 percent from October 2019 to October 2020. The previously reported 1.7 percent price change for September 2020 remained unchanged.

Here we find that there has been a strong case for Gold with uncertainty extremely high and evidence of asset price inflation all around us. I could go further and look at the rise in the price of some equities such as the FAANGs and of course Tesla. Then there is the issue of the way bond prices have soared.

Also the example of the problems in Zimbabwe raise the issue of the supply of Gold.

HARARE (Reuters) – Gold sales to Zimbabwe’s sole buyer and exporter of bullion Fidelity Printers and Refiners (FPR) fell 31% to 19 tonnes last year after lower deliveries from small-scale miners, official data showed on Monday.

FPR pays U.S. dollars in cash to small-scale gold miners, but a shortage of hard cash caused delays in payments most of last year. That forced many of the miners to sell their gold to illegal buyers, industry officials say.

Deliveries of gold, the top foreign currency earner, have been on the decline since reaching a record 33.2 tonnes 2018, mainly due to delays by FPR in paying miners.

The Bear Case

One factor would be a turn in the trend for the US Dollar and maybe we are seeing that as recently it has regained a little of its losses. But underneath that I think there is a bigger factor in that we have seen something of a shift in US interest-rates. I do not mean the official US Federal Reserve one which remains around 0.1% I mean this.

US 10Y yield is 17bp higher on the week ahead of the Dec jobs report, having done this:

Jan 7 +4.4bp

Jan 6 +8.1bp

Jan 5 +4.2bp ( @business)

The ten-year yield in the US is now 1.11% and whilst that is low in historical terms it is up quite a bit since the 0.5% or so of last March. Also it is taking place in spite of the fact that the US Federal Reserve is buying some US $120 billion of bonds of which 2/3rds are Treasuries each month.

From Gold’s point of view there is no some sort of cost of carry albeit not much as we find ourselves in a bit of a twilight zone. If you look at the inflation trend and expectations then bond yields should go higher, but the counterpoint is whether the US Federal Reserve would then increase its purchasing rate. Indeed it could implement a type of Yield Curve Control and we are at yields where some have expected this to be deployed.

Comment

As you can see from the points above the Gold price is at something of a nexus point and one road is rather familiar.

Hello darkness, my old friend
I’ve come to talk with you again ( Paul Simon)

On it we are back to the central banks being in control again as it would involve even larger purchases of US government debt by the US Federal Reserve. That would certainly be convenient considering the fiscal plans.

Biden has called the current USD 600 round of cash a “down payment,” and early last week he said USD 2,000 checks would go out “immediately” if his party took control of both houses of Congress. ( Financial Express).

So in a type of ultimate irony the US Federal Reserve now has its hand on the tiller of prospects for the Gold price and we are back to Friday’s theme of central banks being our new overlords.

Podcast

Could the US economy contract at the opening of 2021?

The US is in a rather awkward interregnum period between Presidents which is more noticeable at times of change. One way of looking at this is through the plans for another fiscal stimulus. Back on the 5th of November we looked at the plans of the now President elect Biden.

Vice President Biden has proposed a wide
range of changes to the tax code and government spending. In total, he is calling for $4.1 trillion in tax increases and an additional $7.3 trillion in government spending over the next decade.

So a US $3.2 trillion boost was the plan back then and it had the advantage that President Trump has been a fan of fiscal policy and the Federal Reserve was happy to oil the wheels.

Federal Reserve Chairman Jerome Powell called Tuesday for continued aggressive fiscal and monetary stimulus for an economic recovery that he said still has “a long way to go.”

Noting progress made in job creation, goods consumption and business formation, among other areas, Powell said that now would be the wrong time for policymakers to take their foot off the gas. ( CNBC on the 6th of October).

So on the surface everyone was singing along with David Bowie.

Fashion, turn to the left
Fashion, turn to the right
Ooh fashion
We are the goon squad and we’re coming to town
Beep-beep, beep-beep

The Deal

From the New York Times yesterday.

WASHINGTON — Congressional leaders on Sunday reached a hard-fought agreement on a $900 billion stimulus package that would send immediate aid to Americans and businesses to help them cope with the economic devastation of the pandemic and fund the distribution of vaccines.

As you can see that is almost a PR release a theme which continues here.

While the plan is roughly half the size of the $2.2 trillion stimulus law enacted in March, it is one of the largest relief packages in modern history.

The agreement also meant they could stop doing this which was frankly embarrassing. From CNBC on Friday.

JUST IN: House passes two-day funding bill to prevent government shutdown

As to the details here is the New York Times again.

Although text was not immediately available, the agreement was expected to provide $600 stimulus payments to millions of American adults earning up to $75,000. It would revive lapsed supplemental federal unemployment benefits at $300 a week for 11 weeks — setting both at half the amount provided by the original stimulus law.

That makes you wonder what people have been doing in the meantime and I guess the pictures of long queues at US food banks have given us at least a partial answer. There is help for businesses too.

The measure would also provide more than $284 billion for businesses and revive the Paycheck Protection Program, a popular federal loan program for small businesses that lapsed over the summer. …….The agreement is also expected to provide billions of dollars for testing, tracing and vaccine distribution, as well as $82 billion for colleges and schools, $13 billion in increased nutrition assistance, $7 billion for broadband access and $25 billion in rental assistance.

The Precious! The Precious!

Whilst all this was going on the US Federal Reserve was able to focus on its main priority.

In light of the ongoing economic uncertainty and to preserve the strength of the banking sector, the Board is extending the current restrictions on distributions, with modifications. For the first quarter of 2021, both dividends and share repurchases will be limited to an amount based on income over the past year. If a firm does not earn income, it will not be able to pay a dividend or make repurchases.

Sounds as if they are being tough doesn’t it? But then there was this via CNBC.

JPMorgan Chase, the largest U.S. bank by assets, announced in the minutes after the Fed’s test results that its board had approved a new share repurchase program of $30 billion starting in 2021.

Bank share prices joined the new party.

Bank stocks rose across the board in after-hours trading with JPMorgan up 5.3%, Goldman Sachs up 4.4% and Wells Fargo up 3.5%.

House Prices

We are kind of staying with the banks again as we note a consequence of all the Federal Reserve easing. From CNBC.

Mortgage rates set yet another record low last week — the 15th this year and the second record in as many weeks…….

The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($510,400 or less) decreased to 2.85% from 2.90%, with points decreasing to 0.33 from 0.35 (including the origination fee) for loans with a  20% down payment.

Which has led to this.

As prices rise, home equity multiplies. In the past year, homeowners with mortgages, representing about 63% of all properties, have seen their equity increase by 10.8%, according to CoreLogic.

That equates to a collective $1 trillion in gained equity, or an average $17,000 per homeowner, the largest equity gain in more than six years.

Bond Market

There has been quite a change from the 3.15% of the benchmark ten-year yield to the 0.9% as I type this. This has been a road accompanied by a balance sheet expanded to US $7.3 trillion including over US $4.6 trillion of government bonds ( US Treasuries). That seems set to continue for the forseeable future.

In addition, the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.

US Dollar

I though I would add it to the list as maybe we are seeing a change. What I mean by that is the US Federal Reserve has been pursuing a policy of benign neglect towards the US Dollar and it had been weakening. For example the broad index hit 123.6 in April but in November was 114.4.

But driven by the new Covid variant in the UK it has rallied over the weekend by 1% versus the Euro and by 2% versus the UK Pound. Although there is an undercut which is that it seems the UK has detected it in scale first because it tests much more in this way that others. So there may well be a catch up elsewhere…..

Comment

So far I have mostly noted the financial world. So let us now look at what is called main street where we have already noted the food bank issue and can now add in this.

New US unemployment claims for the week that ended Saturday totaled 885,000, the Labor Department said Thursday. It was the highest reading in 14 weeks. ( Business Insider)

So a signal of another downturn heading in the opposite direction to the current consensus as show below.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2020 is 11.1 percent on December 17, up from 11.0 percent on December 16.  ( Atlanta Fed)

I am not sure how they got to that number even when things looked better. But with the Covid pandemic apparently worsening I fear for the first quarter of next year. Could we see another contraction? From @Covid19tracking on Friday.

Our daily update is published. States reported 1.9 million tests, 242k cases, 3,438 deaths, and 114k people currently hospitalized with COVID-19 in the US. Both case and hospitalization counts from today are all-time highs.

Podcast

 

 

 

What are the consequences of bond yields rising further?

This week has brought an unusual development for the credit crunch era. Let me illustrate with an example of the reverse and indeed what we have come to regard as the new normal from last week.

AMSTERDAM, Nov 5 (Reuters) – Italy’s five-year bond yield turned negative for the first time on Thursday as uncertainty from the U.S. election supported government bonds in Europe.

Prima facie that seems insane but of course as I will explain later it is more complicated than that. That is for best when we add in this from Marketwatch on Monday.

Investors now pay Greece for the privilege of owning its debt, an incredible turnaround from its securities being the source of global financial instability a decade ago.

Greece’s three-year debt turned negative on Friday, and then the country received more good news after the surprise decision by Moody’s Investors Service on Friday night to upgrade the nation’s debt. The upgrade, from Ba3 from B1 previously, still leaves Greek debt in junk market territory, and three notches away from becoming investment grade.

The yield on Greek 10-year debt TMBMKGR-10Y, 0.834% fell 4 basis points to 0.77%. In 2012, the yield on Greek 10-year debt surpassed 35%.

Amazing in its own way and well done to investors who got their timing right in these markets. Although a large Grazie is due to Mario Draghi who set things in motion.

US Treasury Bonds

However there has been something of a contrary signal from the US bond market. There was a hint of something going on in what is called the Long Bond which is the thirty-year maturity. Some of you may recall at the height of the pandemic panic in financial markets in March the yield here dipped below 1%. This was driven by two factors.The first was a move to a perceived safe haven in times of trouble and US Treasury Bonds are AAA rated as well as being in the world’s reserve currency. Also there would have been some front-running of the expected bond buying or QE from the US Federal Reserve. It did indeed charge in like the US Cavalry with purchases at the peak of US $75 billion per day.

But around 2 weeks ago the mood music was rather different as the debate was then about whether the yield would break above the 1.6% level that market traders felt was significant. As the election results began to come in it did so and now we find it at 1.75%.

If we switch to the benchmark ten-year ( called the Treasury Note) we see a slightly delayed pattern but also a move higher. In fact it gave us a head fake as the initial response to the election was a rally leading to lower yields and we noted it at 0.72%. But there were ch-ch-changes on the way and now we see it is 0.96%. So perhaps on the cusp of what is called a big figure change should it make 1%.

Why does this matter?

The first reason is for the US economy itself and there is a direct line in from mortgage rates.

Over the course of the past few days, 10yr yields are up roughly 0.2%.  This time around, the mortgage market hasn’t been able to avoid taking its lumps with the average lender now quoting 30yr fixed rates that are 0.125% higher compared to last Thursday.    ( Mortgage Daily News)

The housing market has been juiced by ever lower and indeed record low mortgage rates up until now. The change will feed into other personal and corporate borrowing as well.

Next comes its role as the world’s biggest bond market with some US $21.1 billion and of course rising at play here. I will come back to the domestic issues but there is a worldwide role here.For example back in my days in the UK Gilt ( bond) market the beginning of the day was checking what the US market had done overnight before pricing in any UK changes. That theme will be in play around the world and in fact on spite of the Italian and Greek moves above we have seen it.

For the US there is the domestic issue of debt costs. These have been a pack of dogs that have not barked but with the increases in the size of the bond market and hence higher levels of borrowing and refinancing smaller moves now matter. We know that President Elect Biden wants to spend more and looked at this on the 5th of this month although there remains doubt over how much of it he will be able to get through what looks likely to be a Republican controlled Senate. Even before this here are the projections of the Congressional Budget Office.

Debt. As a result of those deficits, federal debt held by the public is projected to rise sharply, to 98 percent of GDP in 2020, compared with 79 percent at the end of 2019 and 35 percent in 2007, before the start of the previous recession. It would exceed 100 percent in 2021 and increase to 107 percent in 2023, the highest in the nation’s history.

Best I think to take that as a broad sweep as there are a lot of moving parts in the equations used.

Yield Curve Control

This is, as you can see, not going so well! We have looked at the Japanese experience as recently as Monday and in the US it would be a case of recycling a wartime policy.

In early 1942, shortly after the United States declared war, the Fed effectively abdicated its responsibility for monetary policy despite its concern about inflation and focused instead on helping the Treasury finance the conflict. After a series of negotiations with the Treasury, the Fed agreed to peg the Treasury-bill yield at 0.375 percent, to cap the critical long-term government bond yield at 2.5 percent, and to limit all other government securities’ yields in a consistent manner.  ( Cleveland Fed)

The Long Bond yield is still quite some distance from the 2.5% of back then but as I have already explained the situation is I think more exposed now.

Oh and there was a concerning consequence to this.

The Treasury, however, did not wish to relinquish its control over Fed monetary policy and only acquiesced to small increases in short-term interest rates starting in July 1947, after inflation had been hovering around 18 percent for a year. The Treasury believed that it could not possibly finance its unprecedented levels of public debt at reasonable interest rates without the Fed’s continued participation in the government-securities market; in its view, only unrealistically high interest rates could coax enough private-sector savings to finance the debt.

Comment

Let me now switch to what we might expect if we had free markets. The extra borrowing we have looked at would be pushing yields higher. Another influence would be the fact the real ( after inflation) bond yields are heavily negative unless you think US inflation will be less than 1% per year for the next ten years. Even then it is not much of a return, especially compared to the 5% in one day some equity markets have just provided. The reality is that bond markets provide the prospect of capital gains rather than interest right now.

Also the modern era provides something very different from free markets as the US Federal Reserve will be thinking at what point will it intervene? Or to be more precise at what point will it do so on a larger scale as it is already buying some US $80 billion per month of US treasury bonds. It was not so long ago that such amounts were considered to be a lot. The path to Yield Curve Control may be via bond yield rises now followed by its response. So the real question is what level will they think is too much? This quickly becomes an estimate of what they think the US government can afford? As they have become an agent of fiscal policy again.

 

What are the economic policies of Joe Biden?

We find ourselves in unusual but not completely unfamiliar territory as the US election has yet to declare a result.As we stand Joe Biden looks most likely to win although any such win seems set to go straight to the courts. But we need to address what changes he plans for US economic policy? The first step according to Moodys will be more fiscal expansionism.

Vice President Biden has proposed a wide
range of changes to the tax code and government spending. In total, he is calling for $4.1
trillion in tax increases and an additional $7.3
trillion in government spending over the next
decade.

Moodys have taken the current zeitgeist in favour of fiscal policy and projected this impact from it.

The government’s deficits will be
$3.2 trillion larger on a static basis and $2.6
trillion on a dynamic basis, after accounting
for the benefits to the budget of the stronger
economy resulting from his policies.

Of course the “stronger economy” mentioned is an opinion and we have seen in my time here quite a shift in the establishment view on fiscal policy. A decade ago the views was that a contractionary fiscal policy could expand the economy whereas now we are told an expansionary one will. There has been a shift in the cost of borrowing which I will look at in more detail later, but even so there has been more than a little flip-flopping.

Detailed Proposals

Interestingly the fiscal expansionism comes with tax increases for some.

The largest source of new tax revenue in
the vice president’s plan comes from increasing taxes on corporations. Of the $4.1 trillion
in total tax revenue collected under his plan
over the next decade on a static basis, more
than half comes from higher corporate taxes.
The bulk of this results from an increase from
21% to 28% in the top marginal tax rate paid
by corporations.

So he is reversing half of the Trump tax cuts in this area. Next comes a tax on higher earners.

Another large source of new tax revenue in
Biden’s plan is the 12.6% Social Security payroll tax on annual earnings of more than $400,000.
The current earnings cap subject to the payroll tax is almost $138,000………..This change will put
the Social Security trust fund on much sounder
financial footing, and it will raise close to $1
trillion in revenue over the next decade on a
static basis, about one-third of the total tax
revenue raised under Biden’s plan

The theme is of taxing the rich and wealthy and which continues with what might in the past have been called a soak the rich plan.

The vice president would roll back
the tax cuts that those earning more than
$400,000 received under Trump’s TCJA, tax
capital gains and dividend income like ordinary
income for those making more than $1 million
in total income.

Spending

Here we are looking at a Spend! Spend! Spend! plan where the extra revenue above is spent and then some.

His proposal calls for additional spending of $7.9 trillion on a static basis, including on infrastructure, education, the social safety net, and healthcare, with the bulk of the
spending slated to happen during his term as
president in an effort to generate more jobs

Those who bemoan America’s infrastructure should welcome this effort.

Of all of Biden’s spending initiatives, the
most expansive is on infrastructure. On a
static basis, he would increase such spending
by $2.4 trillion for the decade—all of it to
be spent during his term.

Education too will be a beneficiary.

Biden is also calling for a large increase in
an array of educational initiatives. He proposes
to spend $1.9 trillion over 10 years on a static
basis on pre-K, K-12 and higher education (see
Table 3). Attending a public college or university would be tuition-free for children in families with incomes of less than $125,000.

I find the end to tuition fees for some to be intriguing as it is a reversal of the past direction of travel. Also there is this.

The social safety net would meaningfully
expand under Biden (see Table 4). He would
spend an additional $1.5 trillion over 10 years
on a static basis on various social programs,
with the largest outlays going to workers to
receive paid family and medical leave for up
to 12 weeks…….

And healthcare.

The healthcare system would also receive
a significant infusion of funding under a
President Biden primarily via the Affordable
Care Act…….. The 10-year static budget cost of the
proposed changes to the healthcare system
comes to nearly $1.5 trillion.

US Federal Reserve

There are a couple of streams of thought here. The first is that Federal Reserve Chair Jerome Powell has called for more fiscal expansionism.

Federal Reserve Chairman Jerome Powell called Tuesday for continued aggressive fiscal and monetary stimulus for an economic recovery that he said still has “a long way to go.”

Noting progress made in job creation, goods consumption and business formation, among other areas, Powell said that now would be the wrong time for policymakers to take their foot off the gas. ( CNBC on the 6th of October)

Thus he would presumably be happy to run policies to help this. He is already in the game.

At its September meeting, the FOMC directed the Desk to increase SOMA holdings of Treasury securities at the current pace, which is the equivalent of approximately $80 billion per month.

Also he has the ability to respond should he wish without a grand announcement as these days smoothing market operations cover quite a few bases.

The Desk is prepared to increase the size and adjust the composition of its purchase operations as needed to sustain the smooth functioning of the Treasury market.

We can now take that forwards to the next perspective because the market seems to have come to its own conclusion.In the past the bond vigilantes would have driven US bond yields higher but in fact the US bond market has risen and yields fallen.I established a marker on the day of the election and the ten-year Treasury Note yield was 0.87% but as I type this it is 0.73%

Comment

The caveat to today’s post is that is by no means certain that Joe Biden will win and even if he does he seems likely to face a Republican Senate. But we do seem set for a more expansionary fiscal policy which would be oiled and polished by the US Federal Reserve.That does link to the news from the Bank of England earlier when it announced an expansion of £150 billion in its purchases of UK bonds as it too is an agent of fiscal policy these days.

Looking at the economic impact we see from Moodys that the multiplier is back.What I mean by that is fiscal spending is assumed to grow the economy which then helps to pay for it. The catch is always when you do not seem much growth ( think Italy) or if the economy contracts over a long period ( think Greece). We do know that the US economy can grow and that it has been doing better than us in Europe in the credit crunch era but whether it will grow by enough is another matter. With the rise in the Covid-19 cases though it may be a while before it gets the chance to demonstrate that and for such calculations when and how long matter.

 

Central banks are increasingly entering the world of politics

Yesterday brought a barrage of central banking news. So let us start with something rather remarkable from the head of the world’s number one which is the US Federal Reserve. The crucial part of the speech given by Jerome Powell to the National Association for Business Economists is below.

The expansion is still far from complete. At this early stage, I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery, creating unnecessary hardship for households and businesses. Over time, household insolvencies and business bankruptcies would rise, harming the productive capacity of the economy, and holding back wage growth. By contrast, the risks of overdoing it seem, for now, to be smaller. Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.

Some of the economics is really rather dubious. But the main driver is that he is interfering in a political decision which is fiscal policy in the middle of an election campaign. It used to be considered the the Federal Reserve would go into a type of purdah during an election campaign but apparently not now. In the past that would usually mean a period where interest-rates would not be changed.The situation is somewhat different now as interest-rates have already been reduced so close to 0% so the weapon of choice would be more QE bond buying but the principle is the same.

The Economics

The claim that the risk of overdoing policy actions is small is familiar territory for central bankers. But this is really rather extraordinary.

Even if policy actions ultimately prove to be greater than needed, they will not go to waste.

Such a situation would be likely to be one exhibiting inflation. The inflation would be most likely to be in house and other asset prices but none the less would be there, albeit it would be ignored by the main consumer inflation measures.

Also if we look at the opening speech we see some familiar cheerleading for policy.

As the coronavirus spread across the globe, the U.S. economy was in its 128th month of expansion—the longest in our recorded history—and was generally in a strong position.

So strong in fact that “Moderate growth” is considered to be “slightly above-trend”

We travel a similar journey if we look at his view of the recovery which is quite a success.

After rising to 14.7 percent in April, the unemployment rate is back to 7.9 percent, clearly a significant and rapid rebound.

But then there is quite a bit of slip-sliding away.

A broader measure that better captures current labor market conditions—by adjusting for mistaken characterizations of job status, and for the decline in labor force participation since February—is running around 11 percent.

I have pointed out more than a few times how and why the international definition of unemployment has failed us in this pandemic. So it is more than disappointing to see a central banker who should know better using it. In a familiar theme that is the behaviour of a politician.

Meanwhile if we switch to actual politicians the fiscal stimulus call had a bit of trouble with The Donald.

Nancy Pelosi is asking for $2.4 Trillion Dollars to bailout poorly run, high crime, Democrat States, money that is in no way related to COVID-19. We made a very generous offer of $1.6 Trillion Dollars and, as usual, she is not negotiating in good faith. I am rejecting their request, and looking to the future of our Country.

Top of the Class

The ECB decided to issue a career enhancing discussion paper yesterday.

Despite this renewed debate, traditional indices of central bank independence do not suggest a deterioration in central banks’ de jure independence after the GFC. ( GFC = Global Financial Crisis)

Lewis Carroll would be proud. Although there is a brief flash of insight.

The benefits of central bank independence are currently not obvious for many citizens,

Really?! However we return to a place “far,far,away” in the section on the ECB itself.

There have been no visible changes in either the de jure or actual independence of the ECB. The legal frameworks protecting the ECB’s independence have been tested,
and have served to establish its independence more firmly.

Meanwhile back on the ranch the ECB has a President who is a politician and former French Finance Minister and a Vice-President who is the former Economy Minister of Spain. So independence from political control has been established by er, putting politicians in charge! It does at least explain this bit.

Comments by euro area governments on the ECB’s policy decisions are unusual.

Why would then when it is doing their bidding? After all if monetary policy was more overtly under the control of politicians how much more could they have done?

If we switch to the Bank of Russia we get a laugh out loud section. We are assured this.

Central bank independence seems to be observed in Russia, although it was not tested in a controversy with the government in the analysed period.

The idea of independence under Vladimir Putin seems not far off insane which somewhat bizarrely they then confess.

In January 2015, the head of monetary policy was reportedly replaced by a person more acceptable to
bankers, who had called for lower interest rates.

Seems to be a similar model to Roman Abramovich at Chelsea football club albeit no manager there survives for that long.

Interest-Rate Cuts

Just when you though that this game might be over there is an early premonition of Halloween. From the Wall Street Journal.

European Central Bank President Christine Lagarde said the bank is ready to inject fresh monetary stimulus to support the eurozone’s stuttering economic recovery from the Covid-19 pandemic, including by cutting a key interest rate further below zero.

Just as a reminder the Deposit Rate and the Current Account Rate are already -0.5%. Last time this came up for discussion ( about a year ago) it was about a move to -0.6%. Does anybody believe a 0.1% move would make any difference right now?

Insane in the membrane
Insane in the brain!
Insane in the membrane
Insane in the brain! ( Cypress Hill )

There are three issues with this. The first is simply that the evidence is that this does not work as otherwise why so we need ever more doses of it? This leads her to an official denial and we know what to do with them.

ECB hasn’t yet reached the point where a fresh interest-rate cut would do more harm than good, known to economists as the reversal rate. ( WSJ)

Next comes the international impact as another interest-rate cut would affect countries which explicitly ( Denmark) and implicitly (Switzerland) set their interest-rates against the Euro exchange-rate. Thirdly we are pretty much back to trying to devalue the Euro which relates to the point before.

Comment

The problem here is that central banks have found themselves behaving like politicians.The move towards independence did not last long as the various establishments shifted towards appointing people who were and are “one of us”. That is most explicit at the ECB where an actual politician in Christine Lagarde is President. In the United States we have seen a different tack where Jerome Powell was seemingly pressurised by President Trump to do his bidding and cut interest-rates. Neither looks especially independent. As to fiscal policy in the US President Trump may already be switching his tune.

If I am sent a Stand Alone Bill for Stimulus Checks ($1,200), they will go out to our great people IMMEDIATELY. I am ready to sign right now. Are you listening Nancy?

That is the problem with playing politics as it can change daily and indeed hourly but the economy cannot.

Rather ironically a day which started with Jerome Powell calling for more like Oliver Twist and the President saying what? just like The Master in the story had another turn. Until then US bond yields were rising ( 30 year at 1.6%) meaning that we might actually see some of the promised Yield Curve Control. But the Trump Tweet ended that at least for now.

Is the US economy slowing again?

Yesterday brought news that upset something of a sacred cow of these times. And no I do not mean the fact that Lionel Messi not only still has in his possession but actually uses a fax machine. That perhaps trumps even his transfer request. Across the Atlantic came news which challenged the growing consensus about economies soaring up, up and away after the Covid-19 pandemic. So let me hand you over to the Conference Board.

The Conference Board Consumer Confidence Index® decreased in August, after declining in July. The Index now stands at 84.8 (1985=100), down from 91.7 in July. The Present Situation Index – based on consumers’ assessment of current business and labor market conditions – decreased sharply from 95.9 to 84.2. The Expectations Index – based on consumers’ short-term outlook for income, business, and labor market conditions – declined from 88.9 in July to 85.2 this month.

As the consumer is a large part of the US economy a further decline in August poses a question for the recovery we are being promised. Indeed those promising such a recovery forecast it would be 93 so they seem to be inhabiting a different universe. They managed to miss consumers reporting that things had got substantially worse in August. The expectations index decline was more minor but it is on the back of a much lower current reading.

The accompanying explanation put some more meat on the bones.

“Consumer Confidence declined in August for the second consecutive month,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “The Present Situation Index decreased sharply, with consumers stating that both business and employment conditions had deteriorated over the past month. Consumers’ optimism about the short-term outlook, and their financial prospects, also declined and continues on a downward path. Consumer spending has rebounded in recent months but increasing concerns amongst consumers about the economic outlook and their financial well-being will likely cause spending to cool in the months ahead.”

That made me look into the detail for the jobs market which confirmed why consumers think that things have got worse.

Consumers’ appraisal of the job market was also less favorable. The percentage of consumers saying jobs are “plentiful” declined from 22.3 percent to 21.5 percent, while those claiming jobs are “hard to get” increased from 20.1 percent to 25.2 percent.

The change in the “plentiful” number is within the margin of error but the “hard to get” shift is noticeable. There was a similar shift in business conditions where there was what seems a significant increase in the “bad” category.

The percentage of consumers claiming business conditions are “good” declined from 17.5 percent to 16.4 percent, while those claiming business conditions are “bad” increased from 38.9 percent to 43.6 percent.

As you can see below this is a long-running series and so it comes with some credibility.

In 1967, The Conference Board began the Consumer Confidence Survey (CCS) as a mail survey
conducted every two months; in June 1977, the CCS began monthly collection and publication. The CCS
has maintained consistent concepts, definitions, questions, and mail survey operations since its
inception.

The alternative view was provided by MarketWatch.

What they are saying? “I have to admit that I do not take this latest reading at face value,” said chief economist Stephen Stanley of Amherst Pierpont Securities. “If you believe the number, then consumers are feeling worse in August than they were in the depths of the lockdown. I can’t imagine that anyone believes that.”

Perhaps he was one of those who thought it would be 93.

The Housing Market

We can now shift to a look at the market which will have every telescope at the US Federal Reserve pointing at it.

Sales of new single-family houses in July 2020 were at a seasonally adjusted annual rate of 901,000, according to
estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development.
This is 13.9 percent (±20.0 percent)* above the revised June rate of 791,000 and is 36.3 percent (±27.4 percent)
above the July 2019 estimate of 661,000.

There may well have been a cheer at the Fed as the news was released. In absolute terms the main rise was in the south but in percentage terms it was the Mid-West that led with a more than 50% rise on the previous average for this year.

However there is a catch.

For Sale Inventory and Months’ Supply
The seasonally-adjusted estimate of new houses for sale at the end of July was 299,000. This represents a supply of
4.0 months at the current sales rate.

That does not add up until we remind ourselves that like the GDP data the numbers are annualised. If you check the actual data sales rose from 75,000 in June to 78,000 in July compared to a nadir of 52,000 in April.

So we see that for all the hype actual new homes sales rose by around 40,000 in response to this reported by Yahoo Finance.

The weekly average rates for new mortgages as of 20th August were quoted by Freddie Mac to be:

  • 30-year fixed rates increased by 3 basis points to 2.99% in the week. Rates were down from 3.56% from a year ago. The average fee remained unchanged at 0.8 points.
  • 15-year fixed rates rose by 8 basis points to 2.54% in the week. Year-on-year, rates were down from 3.03%. The average fee fell from 0.8 points to 0.7 points.
  • 5-year fixed rates increased from 2.90% to 2.91% in the week. Rates were down by 41 points from last year’s 3.32%. The average fee fell from 0.4 points to 0.3 points.

House Prices

Our central bankers would also be scanning for house price data.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, covering all nine U.S. census divisions, reported a 4.3% annual gain in June, no change from the previous month.

Actually it is a 3 month average so if you prefer it is a second quarter number so apparently as the economy plunged house prices rose. Some detail as to what happened where is below.

“June’s gains were quite broad-based. Prices increased in all 19 cities for which we have data, accelerating in five of them. Phoenix retains the top spot for the 13th consecutive month, with a gain of 9.0% for June. Home prices in Seattle rose by 6.5%, followed by Tampa at 5.9% and Charlotte at 5.7%. As has been the case for the last several months, prices were particularly strong in the Southeast and West, and comparatively weak in the Midwest and (especially) Northeast.

Comment

The consensus view is along the lines of this from the end of last week.

  • The New York Fed Staff Nowcast stands at 14.6% for 2020:Q3.
  • News from this week’s data releases decreased the nowcast for 2020:Q3 by 0.2 percentage point.
  • Negative surprises from the Empire State Manufacturing survey and housing starts data drove most of the decrease.

A strong rebound in the economy is the expectation but the consumer confidence report poses a question about some of that. Then we note that the housing data looks less positive once we allow for the annualisation and indeed seasonal adjustment in a year which is anything but normal.

That provides some food for thought for the US Federal Reserve as it gets ready to host its annual “Jackson Hole” symposium. I have put it in quote because this year the trip is virtual rather than real. Should they announce as they have been hinting that the new policy will be to target average inflation – which will be a loosening as the measure of official inflation is below target – we are left wondering one more time if Newt from the film Aliens will be right again?

It wont make any difference

The Investing Channel

The fraudsters want to raise the US inflation target

Today brings us a new variation on an old theme. This is the issue of what is the right level for an inflation target and sometimes we go as far as to whether there should be one at all? This begins with something of a fluke or happenstance. This is the reality that inflation targets are usually set at 2% per annum following the lead set by New Zealand back in the day. This has become something of a Holy Grail for central banksters in spite of the fact that it had no theoretical backing as this from the Riksbank of Sweden explains.

There was no relevant academic research from which to draw support; instead, the New Zealand authorities had to launch the new regime more or less as an “experiment” and quite simply see how well it worked in practice.

In fact it was as we see so often a case of trying to fit later theory to earlier practice.

This shows that it does not seem to be until the mid-1990s, i.e. about five years after its introduction in practice, that inflation targeting began to attract any significant interest in the academic research.

Basocally it was from a different world where inflation was higher and they wanted something of an anchor and an achievable objective.

Also there is another swerve as other time the central bankster preference for theory over reality has led to claims that it provides price stability when it does not. Let me illustrate from the European Central Bank or ECB.

 The ECB has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.

The truth is in some ways in the “as defined” bit because if we return to the real world it simply isn’t. Also the inflation measure ignores owner-occupied housing an area where we often find inflation. It was relative price stability when inflation was higher but was never updated with the times leaving central bankers aping first world war generals and fighting the previous war.

What about now?

Here is CNBC from earlier this month.

Recent statements from Fed officials and analysis from market veterans and economists point to a move to “average inflation” targeting in which inflation above the central bank’s usual 2% target would be tolerated and even desired.

Actually then CNBC became refreshingly honest.

To achieve that goal, officials would pledge not to raise interest rates until both the inflation and employment targets are hit. With inflation now closer to 1% and the jobless rate higher than it’s been since the Great Depression, the likelihood is that the Fed could need years to hit its targets.

Not fully honest though because we only need to look back to yesterday and the Japanese experience which has gone on for (lost) decades. This theme was added to last week by an Economic Letter from the San Francisco Fed.

Average-inflation targeting is one approach policymakers could use to help address these challenges. Taking into account previous periods of below-target inflation, average-inflation targeting overshoots to bring the average rate back to target over time. If the public perceives it to be credible, average-inflation targeting can help solidify inflation expectations at the 2% inflation target by providing a better inflation anchor and thus maintain space for potential interest rate cuts. It importantly can help lessen the constraint from the effective lower bound in recessions by inducing policymakers to overshoot the inflation target and provide more accommodation in the future.

I have helped out by highlighting the bits which exhibit extreme Ivory Tower style thinking. In general people think inflation is under recorded and would be more sure of this id they knew that housing inflation is either ignored or in the case of the US fantasy rents which are never paid are used to estimate it. It turns into something the Arctic Monkeys dang about.

Fake tales of San Francisco
Echo through the room

Yesterday Bloomberg suggested such a policy was on its way but got itself in something of a mess.

But the Fed’s preferred measure of inflation has consistently fallen short, averaging just 1.4% since the target’s introduction.

The preferred measure PCE ( Personal Consumption Expenditure) was chosen because it gives a lower reading than the more commonly known CPI in the US. This is a familiar tactic by central banksters and if we add in the gap which is often around 0.4% we see things change. Next apparently things move in response to what the Fed is thinking as opposed to the interest-rate cuts, bond buying and credit easing.

“Rising inflation expectations are, in part, indicative of the market beginning to price in the Fed’s shift,” said Bill Merz, senior portfolio strategist and head of fixed-income research at U.S. Bank Wealth Management in Minneapolis.

Rising inflation expectations are presented as a good thing whereas back in the real world the old concept of “sticky wages” is back and in more than a few cases involves wage cuts.

Comment

There is an air of unreality about this which is extreme even for the Ivory Towers of economic theory. After all the last decade has given them everything they could dream of in terms of zero and sometimes negative interest-rates and bond buying on a scale they could not have even dreamt of. If we go back a decade they believed it would work and by that I mean hit the 2% inflation target and rescue the economy. But they have turned out to be the equivalent of snake-oil sales(wo)man where the next bottle will always cure you and even has “Drink Me” written on it in big friendly letters.

But it did not work and even worse like a poor general they left a flank open which is that by having no exit strategy they were exposed to any future downturn. So the Covid pandemic was unlucky in severity but not the event itself as something was always going to come along. To my mind the policy failure has been that central banksters got caught up in the here and now and forgot they had defined a fair bit of inflation away. So they did not realise the  real choice was to lower the target to 1.5% or 1% or to put in a measure of housing inflation that represents inflation reality rather than a non-existent fantasy.

Take a ride in the sky, on our ship fantasii
All your dreams will come true, right away ( Earth Wind & Fire)

Thus they have ended up on a road to nowhere where in their land of confusion they have ended up financing government deficits. This rather than inflation targeting is the new role. Next up they look to support the economy but the truth is that we see another area where they have seen failure. Keynes explained that well I think in that you can shift expectations or trick people for a while but in the end Kelis was right.

Seen it in your one to many times
Said you might trick me once
I won’t let you trick me twice.

So whether they end up targeting average inflation or simply raise the target does not matter in the way it once did. The real issue now is getting politicians weaned off central banks financing their deficits for them. Good luck with that…….

The Investing Channel

More QE will be on the agenda of the US Federal Reserve

Later today the policymakers of what is effectively the world’s central bank meet up to deliberate before making their policy announcement tomorrow evening UK time. Although there is a catch in my description because the US Federal Reserve goes through sustained periods when it effectively ignores the rest of the world and becomes like the US itself can do, rather isolationist. The Financial Times puts it like this.

US coronavirus surge to dominate Federal Reserve meeting…..Central bank policymakers face delicate decision on best way to deliver more monetary support.

As it happens the coronavirus numbers look a little better today. But there are clearly domestic issues at hand which is a switch on the initial situation where on the middle of March the US Federal Reserve intervened to help the rest of the world with foreign exchange liquidity swaps. We were ahead of that game on March 16th. Anyway, that was then and now we see the US $446 billion that they rose to is now US $118 billion and falling.

The US Dollar

There has been a shift of emphasis with Aloe Blacc mulling a dip in royalties from this.

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

This was represented back in the spring not only by a Dollar rally that especially hit the Emerging Market currencies but the Fed response I looked at above. Since then we have gone from slip-sliding away to the Fallin’ of Alicia Keys. Putting that into numbers the peak of 103.6 for September Dollar Index futures on March 19th has been replaced by 93.9 this morning.

If we look at the Euro it fell to 1.06 versus the Dollar and a warning signal flashed as the parity calls began. They had their usual impact as it is now at 1.17. Actually there were some parity calls for the UK Pound $ too so you will not be surprised to see it above US $1.28 as I type this. In terms of economic policy perhaps the most significant is the Japanese Yen at 105.50 because the Bank of Japan has made an enormous effort to weaken it and looks increasingly like King Canute.

There are economic efforts from this as I recall the words of the then Vice-Chair Stanley Fischer from 2015.

Figure 3 uses these results to gauge how a 10 percent dollar appreciation would reduce U.S. gross domestic product (GDP) through the net export channels we have just discussed. The staff’s model indicates that the direct effects on GDP through net exports are large, with GDP falling over 1-1/2 percent below baseline after three years.

We have seen the reverse of that so a rise in GDP of 1.5%. Of course such moves seem smaller right now and they need the move to be sustained but a welcome development none the less.

Whilst the US economy is less affected in terms of inflation than others due to the role of the US Dollar as the reserve currency in which commodities are prices there still is an impact.

This particular model implies that core PCE inflation dips about 0.5 percent in the two quarters following the appreciation before gradually returning to baseline, which is consistent with a four-quarter decline in core PCE inflation of about 0.3 percent in the first year following the shock.

Again this impact is the other way so inflation will rise. For those unaware PCE means Personal Consumption Expenditures and as so familiar for an official choice leads to a lower inflation reading than the more widely known CPI alternative.

Back Home

Interest-Rates

This is a troubled area for the US Federal Reserve which resembles the shambles of General Custer at Little Big Horn. We we being signposted to a “normalisation” where the new interest-rate would be of the order of 3%+ or what was called r*. I am pleased to report I called it out at the time as the reality was that the underpinnings of this particular Ivory Tower crumbled as the eye of Trump turned on it. The pandemic in this sense provided cover for the US Federal Reserve to cut to around 0.1% ( strictly 0% to 0.25%).

Back on March 16th I noted this and you know my view in official denials.

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

I also not this from Reuters yesterday,

With U.S. central bank officials resisting negative interest rates,

How are they resisting them? They could hardly have cut much quicker! This feels like a PR campaign ahead of applying them at some future date.

Yield Curve Control

This is the new way of explaining that the central bank is funding government policy. Although not on the scale some are claiming.

Foreigners have levelled off buying US Debt. Federal Reserve buying has gone parabolic. This tells us all this additional debt the govt is issuing by running HUGE budget deficits is being purchased by directly the Fed. That is what they do in “banana republics”. #monetizethedebt

That was from Ben Rickert on Twitter and is the number one tweet if you look for the US Federal Reserve. Sadly for someone who calls himself The Mentor actual purchases of US government bonds have declined substantially.

the Desk plans to continue to increase SOMA holdings of Treasury securities at that pace, which is the equivalent of approximately $80 billion per month.  ( New York Fed.)

That is less in a month than it was buying some days as I recall a period when it was US £125 billion a day.

If Ben had not ramped up his rhetoric he would be on the scent because Yield Curve Control is where the central bank implicitly rather than explicitly finances the government. Regular readers will have noted my updates on the Bank of Japan doing this and there have been several variations but the sum is that the benchmark ten-year yield has been kept in a range between -0.1% and 0.1%.

There is an obvious issue with the US ten-year yield being around 0.6% and we may see tomorrow the beginning of the process of getting it lower. On the tenth of this month I pointed out that some US bond yields could go negative and if we are to see a Japanese style YCC then the Fed needs to get on with it for the reasons I will note below.

Comment

As the battleground for the US Federal Reserve now seems to be bond yields it has a problem.

INSKEEP: Senator, our time is short. I’ve got a couple of quick questions here. Is there a limit to how much the United States can borrow? Granting the emergency, its another trillion dollars here. ( NPR)

Even in these inflated times that is a lot and the Democrat opposition want treble that. With an election around the corner we are likely to see more grand spending schemes. But returning to the Fed that is a lot to fund and $80 billion a month looks rather thin in response. So somewhere on this yellow brick road I am expecting more QE.

Oh and if you look at Japan if it has done any good it is well hidden. But that seems not to bother policymakers much these days. Also another example of Turning Japanese is provided by giving QE  new name. After all successes do not need one do they?

Still at least the researchers at the Kansas City Fed have kept their sense of humour.

Based on the FOMC’s past use of forward guidance, we argue that date-based forward guidance has the potential to deliver much, though not all, of the accommodation of yield curve control.

Can US house prices bounce?

The US housing market is seeing two tsunami style forces at once but in opposite directions. The first is the economic impact of the Covid-19 virus pandemic on both wages (down) and unemployment (up). Unfortunately the official statistics released only last week are outright misleading as you can see below.

Real average hourly earnings increased 6.5 percent, seasonally adjusted, from May 2019 to May 2020.
The change in real average hourly earnings combined with an increase of 0.9 percent in the average
workweek resulted in 7.4-percent increase in real average weekly earnings over this period.

We got a better idea to the unemployment state of play on Thursday as we note the scale of the issue.

The advance unadjusted number for persons claiming UI benefits in state programs totaled 18,919,804, a decrease of 178,671 (or -0.9 percent) from the preceding week.

The only hopeful bit is the small decline. Anyway let us advance with our own view is that we will be seeing much higher unemployment in 2020 although hopefully falling and falling real wages.

The Policy Response

The other tsunami is the policy response to the pandemic.

FISCAL STIMULUS (FEDERAL) – The U.S. House of Representatives passed a $2.2 trillion aid package – the largest in history – on March 27 including a $500 billion fund to help hard-hit industries and a comparable amount for direct payments of up to $3,000 to millions of U.S. families.

That was the Reuters summary of the policy response which has been added to in the meantime. In essence it is a response to the job losses and an attempt to resist the fall in wages.

Next comes the US Federal Reserve which has charged in like the US Cavalry. Here are their words from the report made to Congress last week.

Specifically, at two meetings in March, the FOMC lowered the target range for the federal funds rate by a total of 1-1/2 percentage points, bringing it to the current range of 0 to 1/4 percent.

That meant that they have now in this area at least nearly fulfilled the wishes of President Trump. They also pumped up their balance sheet.

The Federal Reserve swiftly took a series of policy actions to address these developments. The FOMC announced it would purchase Treasury securities and agency MBS in the amounts needed to ensure smooth market functioning and the effective transmission of monetary policy to broader financial conditions. The Open Market Desk began offering large-scale overnight and term repurchase agreement operations. The Federal Reserve coordinated with other central banks to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements and announced the establishment of temporary U.S. dollar liquidity arrangements (swap lines) with additional central banks.

Their explanation is below.

 Market functioning deteriorated in many markets in late February and much of March, including the critical Treasury and agency MBS markets.

Let me use my updated version of my financial lexicon for these times. Market function deteriorated means prices fell and yields rose and this happening in the area of government and mortgage borrowing made them panic buy in response.

Mortgage Rates

It seems hard to believe now but the US ten-year opened the year at 1.9%, Whereas now after the recent fall driven by the words of Federal Reserve Chair Jerome Powell it is 0.68%. Quite a move and it means that it has been another good year for bond market investors. The thirty-year yield is 1.41% as we note that there has been a large downwards push as we now look at mortgage rates.

Let me hand you over to CNBC from Thursday.

Mortgage rates set new record low, falling below 3%

How many times have I ended up reporting record lows for mortgage rates? Anyway we did get some more detail.

The average rate on the popular 30-year fixed mortgage hit 2.97% Thursday, according to Mortgage News Daily……..For top-tier borrowers, some lenders were quoting as low as 2.75%. Lower-tier borrowers would see higher rates.

Mortgage Amounts

CNBC noted some action here too.

Low rates have fueled a sharp and fast recovery in the housing market, especially for homebuilders. Mortgage applications to purchase a home were up 13% annually last week, according to the Mortgage Bankers Association.

According to Realtor.com the party is just getting started although I have helped out with a little emphasis.

Meanwhile, buyers who still have jobs have been descending on the market en masse, enticed by record-low mortgage interest rates. Rates fell below 3%, to hit an all-time low of 2.94% for 30-year fixed-rate loans on Thursday, according to Mortgage News Daily.

Mortgage demand is back on the rise according to them.

For the past three weeks, the number of buyers applying for purchase mortgages rose year over year, according to the Mortgage Bankers Association. Applications shot up 12.7% annually in the week ending June 5. They were also up 15% from the previous week.

Call me suspicious but I thought it best to check the supply figures as well.

Mortgage credit availability decreased in May according to the Mortgage Credit Availability Index (MCAI)………..The MCAI fell by 3.1 percent to 129.3 in May. A decline in the MCAI indicates that lending standards are tightening, while increases in the index are indicative of loosening credit.

So a decline but still a lot higher than when it was set at 100 in 2012. The recent peak at the end of last year was of the order of 185 and was plainly singing along to the Outhere Brothers.

Boom boom boom let me here you say way-ooh (way-ooh)
Me say boom boom boom now everybody say way-ooh (way-ooh)

What about prices?

As the summer home-buying season gets underway, median home prices are surging. They shot up 4.3% year over year as the number of homes for sale continued to dry up in the week ending June 6, according to a recent realtor.com® report. That’s correct: Prices are going up despite this week’s announcement that the U.S. officially entered a recession in February.

Comment

As Todd Terry sang.

Something’s goin’ on in your soul

The housing market is seeing some surprises although I counsel caution. As I read the pieces about I note that a 4.3% rise is described as “shot up” whereas this gives a better perspective.

While that’s below the typical 5% to 6% annual price appreciation this time of year, it’s nearly back to what it was before the coronavirus pandemic. Median prices were rising 4.5% in the first two weeks of March before the COVID-19 lockdowns began. Nationally, the median home list price was $330,000 in May, according to the most recent realtor.com data.

But as @mikealfred reports there is demand out there.

Did someone forget to tell residential real estate buyers about the recession? I’m helping my in-laws buy a house in Las Vegas right now. Nearly every house in their price range coming to market sees 40+ showings and 5+ offers in the first few days. Crazy demand.

Of course there is the issue as to at what price?

So there we have it. The Federal Reserve will be happy as it has created a demand to buy property. The catch is that it is like crack and if they are to keep house prices rising they will have to intervene on an ever larger scale. For the moment their policy is also being flattered by house supply being low and I doubt that will last. To me this house price rally feels like trying to levitate over the edge of a cliff.

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