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….

 

 

The mad world of negative interest-rates is on the march

Yesterday as is his want the President of the United States Donald Trump focused attention on one of our credit crunch themes.

Just finished a very good & cordial meeting at the White House with Jay Powell of the Federal Reserve. Everything was discussed including interest rates, negative interest, low inflation, easing, Dollar strength & its effect on manufacturing, trade with China, E.U. & others, etc.

I guess he was at the 280 character limit so replaced negative interest-rates with just negative interest. In a way this is quite extraordinary as I recall debates in the earlier part of the credit crunch where people argued that it would be illegal for the US Federal Reserve to impose negative interest-rates. But the Donald does not seem bothered as we see him increasingly warm to a theme he established at the Economic Club of New York late last week.

“Remember we are actively competing with nations that openly cut interest rates so that many are now actually getting paid when they pay off their loan, known as negative interest. Who ever heard of such a thing?” He said. “Give me some of that. Give me some of that money. I want some of that money. Our Federal Reserve doesn’t let us do it.” ( Reuters )

That day the Chair of the US Federal Reserve Jerome Powell rejected the concept according to CNBC.

He also rejected the idea that the Fed might one day consider negative interest rates like those in place across Europe.

The problem is that over the past year the 3 interest-rate cuts look much more driven by Trump than Powell.

Of course, there are contradictions.Why does the “best economy ever” need negative interest-rates for example? Or why a stock market which keeps hitting all-time highs needs them? But the subject keeps returning as we note yesterday’s words from the President of the Cleveland Fed.

Asked her view on negative interest rates, Mester told the audience that Europe’s use of them “is perhaps working better than I might have anticipated” but added she is not supportive of such an approach in the United States should there be a downturn.

Why say “working better” then reject the idea?  We have seen that path before.

The Euro area

As to working better then a deposit-rate of -0.5% and of course many bond yields in negative territory has seen the annual rate of economic growth fall to 1.1%. Also with the last two quarterly growth readings being only 0.2% it looks set to fall further.

So the idea of an economic boost being provided by them is struggling and relying on the counterfactual. But the catch is that such arguments are mostly made by those who think that the last interest-rate cut of 0.1% made any material difference. After all the previous interest-rate cuts that is simply amazing. Actually the moves will have different impacts across the Euro area as this from an ECB working paper points out.

A striking feature of the credit market in the euro area is the very large heterogeneity across countries in the granting of fixed versus adjustable rate mortgages.
FRMs are dominant in Belgium, France, Germany and the Netherlands, while ARMs are prevailing in Austria, Greece, Italy, Portugal and Spain (ECB, 2009; Campbell,
2012)

Actually I would be looking for data from 2019 rather than 2009 but we do get some sort of idea.

Businesses and Savers in Germany are being affected

We have got another signal of the spread of the impact of negative interest-rates .From the Irish Times.

The Bundesbank surveyed 220 lenders at the end of September – two weeks after the ECB’s cut its deposit rate from minus 0.4 to a record low of minus 0.5 per cent. In response 58 per cent of the banks said they were levying negative rates on some corporate deposits, and 23 per cent said they were doing the same for retail depositors.

There was also a strong hint that legality is an issue in this area.

“This is more difficult in the private bank business than in corporate or institutional deposits, and we don’t see an ability to adjust legal terms and conditions of our accounts on a broad-based basis,” said Mr von Moltke, adding that Deutsche was instead approaching retail clients with large deposits on an individual basis.

So perhaps more than a few accounts have legal barriers to the imposition of negative interest-rates. That idea gets some more support here.

Stephan Engels, Commerzbank’s chief financial officer, said this month that Germany’s second largest listed lender had started to approach wealthy retail customers holding deposits of more than €1 million.

Japan

The Bank of Japan has dipped its toe in the water but has always seemed nervous about doing anymore. This has been illustrated overnight.

“There is plenty of scope to deepen negative rates from the current -0.1%,” Kuroda told a semi-annual parliament testimony on monetary policy. “But I’ve never said there are no limits to how much we can deepen negative rates, or that we have unlimited means to ease policy,” he said. ( Reuters )

This is really odd because Japan took its time imposing negative interest-rates as we had seen 2 lost decades by January 2016 but it has then remained at -0.1% or the minimum amount. Mind you there is much that is crazy about Bank of Japan policy as this next bit highlights.

Kuroda also said there was still enough Japanese government bonds (JGB) left in the market for the BOJ to buy, playing down concerns its huge purchases have drained market liquidity.

After years of heavy purchases to flood markets with cash, the BOJ now owns nearly half of the JGB market.

In some ways that fact that a monetary policy activist like Governor Kuroda has not cut below -0.1% is the most revealing thing of all about negative interest-rates.

Switzerland

The Swiss found themselves players in this game when the Swiss Franc soared and they tried to control it. Now they find themselves with a central bank that combines the role of being a hedge fund due to its large overseas equity investments and has a negative interest-rate of -0.75%.

Nearly five years after the fateful day when the SNB stopped capping the Swiss Franc we get ever more deja vu from its assessments.

The situation on the foreign exchange market is still fragile, and the Swiss franc has appreciated in trade-weighted terms. It remains highly valued.

Comment

I have consistently argued that the situation regarding negative interest-rates has two factors. The first is how deep they go? The second is how long they last? I have pointed out that the latter seems to be getting ever longer and may be heading along the lines of “Too Infinity! And Beyond!”. It seems that the Swiss National Bank now agrees with me. The emphasis is mine.

This adjustment to the calculation basis takes account of the fact that the low interest rate environment around the world has recently become more entrenched and could persist for some time yet.

We have seen another signal of that recently because the main priority of the central banks is of course the precious and we see move after move to exempt the banks as far as possible from negative interest-rates. The ECB for example has introduced tiering to bring it into line with the Swiss and the Japanese although the Swiss moved again in September.

The SNB is adjusting the basis for calculating negative interest as follows. Negative interest will continue to be charged on the portion of banks’ sight deposits which exceeds a certain exemption threshold. However, this exemption threshold will now be updated monthly and
thereby reflect developments in banks’ balance sheets over time.

If only the real economy got the same consideration and courtesy. That is the crux of the matter here because so far no-one has actually exited the black hole which is negative interest-rates. The Riksbank of Sweden says that it will next month but this would be a really odd time to raise interest-rates. Also I note that the Danish central bank has its worries about pension funds if interest-rates rise.

A scenario in which interest rates go up
by 1 percentage point over a couple of days is not
implausible. Therefore, pension companies should
be prepared to manage margin requirements at
all times. If the sector is unable to obtain adequate
access to liquidity, it may be necessary to reduce the
use of derivatives.

Personally I am more bothered about the pension funds which have invested in bonds with negative yields.After all, what could go wrong?

 

 

The central banks are losing their grip as well as the plot

The last 24 hours have shown an instance of a central bank losing its grip and another losing the plot. This is significant because central banks have been like our overlords in the credit crunch era as they slashed interest-rates and when that did not work expanded their balance sheets using QE and when that did not work cut interest-rates again and did more QE. This made Limahl look rather prescient.

Neverending story
Ah
Neverending story
Ah
Neverending story
Ah

Also in terms of timing we have today the last policy meeting of ECB President Mario Draghi who has been one of the main central banking overlords especially after his “What ever it takes ( to save the Euro) ” speech. Next month he will be replaced by Christine Lagarde who has given an interview to 60 Minutes in the US.

Christine Lagarde shows John Dickerson how she fakes drinking wine at global gatherings.

US Repo Problems

Regular readers will recall that we looked at the words of US Federal Reserve Chair Jerome Powell on the 9th of this month.

To counter these pressures, we began conducting temporary open market operations. These operations have kept the federal funds rate in the target range and alleviated money market strains more generally.

This involved various moves as the overnight Repos found this added too.

Term repo operations will generally be conducted twice per week, initially in an offering amount of at least $35 billion per operation.

These have been for a fortnight and added to this was a purchase programme for Treasury Bills.

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.

Regular readers will recall that I described this as a new version of QE and it has turned out that the Treasury Bill purchases will be larger than the early estimates by at least double.

This theme of “More! More! More!” continued yesterday with this announcement from the New York Federal Reserve.

Consistent with the most recent FOMC directive, to ensure that the supply of reserves remains ample even during periods of sharp increases in non-reserve liabilities, and to mitigate the risk of money market pressures that could adversely affect policy implementation, the amount offered in overnight repo operations will increase to at least $120 billion starting Thursday, October 24, 2019.  The amount offered for the term repo operations scheduled for Thursday, October 24 and Tuesday, October 29, 2019, which span October month end, will increase to at least $45 billion.

Apologies for their wordy opening sentence but I have put it in because it contradicts the original statement from Jerome Powell. Because the “strains” seem to be requiring ever larger interventions. Or as Brad Huston puts it on Twitter.

9/17: We’re doing repos today and tomorrow.

9/19: We’re extending repos until 10/10. $75B overnight, $30B term

10/4: We’re extending repos until 11/4

10/11:We’re extending repos until Jan 2020

10/23:We’re expanding overnight repo offering to $120B, $45B term

This reinforces the point that I believe is behind this as I pointed out on the 25th of September

The question to my mind going forwards is will we see a reversal in the QT or Quantitative Tightening era? The supply of US Dollars is now being reduced by it and we wait to see what the consequences are.

This added to the US Dollar shortage we have been looking at for the past couple of years or so. It would seem that the US Federal Reserve is worried about a shortage at the end of this month which makes me wonder what they state of play will be at the year end when many books are squared? Also in terms if timing we will get the latest repo announcement at pretty much the same time as Mario Draghi starts his final ECB press conference.

The Riksbank of Sweden

It has made this announcement today.

In line with the forecast from September, the Executive Board has therefore decided to leave the repo rate unchanged at –0.25 per cent. As before, the forecast indicates that the interest rate will most probably be raised in December to zero percent.

I will come to my critique of this in a moment but we only have to progress another sentence or two to find that the Riksbank has provided its own critique.

The forecast for the repo rate has therefore been revised downwards and indicates that the interest rate will be unchanged for a prolonged period after the expected rise in December.

That is really quite a mess because we are supposed to take notice of central bank Forward Guidance which is now for lower interest-rates which will be achieved by raising them! Time for a reminder of their track record on this front.

As you can see their Forward Guidance has had a 100% failure rate. You do well by doing the reverse of what they say. As for now well you really could not make the bit below up!

If the prospects were to change, monetary policy may need to be adjusted going forward. Improved prospects would justify a higher interest rate. If the economy were instead to develop less favourably, the Executive Board could cut the repo rate or make monetary policy more expansionary in some other way.

QE

Well that never seems to go away does it?

In accordance with the decision from April 2019, the Riksbank is purchasing government bonds for a nominal total amount of SEK 45 billion, with effect from July 2019 to December 2020.

The central bank will keep the government sweet by making sure it can borrow very cheaply. The ten-year yield is negative albeit only just ( -0.03%) although in an undercut Sweden is running a fiscal surplus. That becomes really rather odd when we look at the next bit.

The Economy

I have criticised the Riksbank for pro-cyclical monetary policy and it seems set to do so again.

after several years of good growth and
strong economic activity, the Swedish economy is now growing more slowly.

So they have cut interest-rates in the good times and now seem set to raise them in weaker times.

Next comes this.

As economic activity has entered a phase of lower growth in
2019, the labour market has also cooled down. Unemployment is deemed to have increased slightly during the year.

If we switch to last week’s release from Sweden Statistics we see something of a challenge to the “increased slightly” claim.

In September 2019 there were 5 110 000 employed persons. The unemployment rate was 7.1 percent, an increase of 1.1 percentage points compared with September 2018……In September 2019, there were 391 000 unemployed persons aged 15─74, not seasonally adjusted, an increase of 62 000 compared with September 2018.

If we move to manufacturing then the world outlook seemed to hit Sweden in pretty much one go in September according to Swedbank.

The PMI dropped by 5.5 points in September to 46.3 from a downward revision of 51.8 in August. This is the largest monthly decline since autumn 2008 and was part of the reason why the PMI fell in the third quarter to the lowest level since early 2013.

Comment

The US Federal Reserve is the world’s central bank of last resort and currently that is not going especially well. So far it has added around US $200 billion to its balance sheet and seems set to push it back over US $4 trillion. Yet the problem seems to be hanging around rather than going away as it feels like a plaster is being applied to a broken leg. A gear or two is grinding in the banking system.

Moving to Sweden we see a case of a central bank adopting pro-cyclical monetary policy and now finds itself planning to raise interest-rates in a recession. Yet the rise seems to make interest-rates lower in the future! I am afraid the Riksbank has really rather jumped the shark here. It now looks as if it has decided that negative interest-rates are a bad idea which I have a lot of sympathy with but as I have argued many times the boom was the time to end it.

Sweden has economic growth of 4% with an interest-rate of -0.5% ( 28th of July 2017)

The Investing Channel

A new era of US QE starts with it being renamed Reserve Management

Last night saw something of an epoch making event as all eyes turned to Denver Colorado. This time it was not for the famous “hurry up offence” of John Elway in the NFL but instead there was a speech by Jerome Powell the Chair of the US Federal Reserve. In it he confirmed something I have been writing about on here for some time and the emphasis is mine.

Reserve balances are one among several items on the liability side of the Federal Reserve’s balance sheet, and demand for these liabilities—notably, currency in circulation—grows over time. Hence, increasing the supply of reserves or even maintaining a given level over time requires us to increase the size of our balance sheet. As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves. That time is now upon us.

This of course raises my QE ( Quantitative Easing) to infinity theme. I also note Chair Powell raises the issue of the balance sheet so let us look at that. It peaked at around US $4.5 trillion as we moved into 2015 and stayed there until October 2017 when the era of QT ( Quantitative Tightening) or reverse QE began and it began to shrink. Over the last year it shrank from US $4.17 trillion to US $3.76 trillion before the repo crisis struck.

In mid-September, an important channel in the transmission process—wholesale funding markets—exhibited unexpectedly intense volatility. Payments to meet corporate tax obligations and to purchase Treasury securities triggered notable liquidity pressures in money markets. Overnight interest rates spiked, and the effective federal funds rate briefly moved above the FOMC’s target range. To counter these pressures, we began conducting temporary open market operations. These operations have kept the federal funds rate in the target range and alleviated money market strains more generally.

What this misses out is that US Dollar liquidity has been singing along with Queen for some time.

Pressure: pushing down on me,
Pressing down on you, no man ask for.
Under pressure that burns a building down,
Splits a family in two,
Puts people on streets.

Here I am from the 25th of September last year.

The question to my mind going forwards is will we see a reversal in the QT or Quantitative Tightening era? The supply of US Dollars is now being reduced by it and we wait to see what the consequences are.

As you can see the phrase “unexpectedly intense volatility” is not true of anyone who is a follower of my work. One way of looking at this is that forwards pricing of the US Dollar has been in the wrong place for theory. This is one of the reasons why German bond yields have gone so negative ( as I type this the benchmark ten-year yield is -0.58%) because if you try to switch to US Treasury Bonds to gain the 1.54% or 2% higher yield you find that exchange rates take away the gain. To get a higher yield you have to take an exchange rate risk. Returning to the Chair Powell statement we see that it is more realistic to say we were hovering near an edge and then slipped over it.

If we return to the balance sheet we see that it has risen to US $3.95 trillion for a rise of the order of 190 billion in response to the repo crisis. The exact amount varies daily with the individual repo operations and also fortnightly as we now have those too. Just as an example the difference between the operations on Monday and yesterday was some US $9.55 billion lower. I point this out as some places have been claiming you add the repo operations up which is really rather odd when most so far only have the lifespan of a Mayfly.

Those who analyse events via the prism of bank reserves should be happy with this bit.

Indeed, my colleagues and I will soon announce measures to add to the supply of reserves over time. Consistent with a decision we made in January, our goal is to provide an ample supply of reserves to ensure that control of the federal funds rate and other short-term interest rates is exercised primarily by setting our administered rates and not through frequent market interventions.

An official denial

By now you should all know how to treat this.

I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis.

Indeed the next part is simply untrue or if you are less kind a lie.

Neither the recent technical issues nor the purchases of Treasury bills we are contemplating to resolve them should materially affect the stance of monetary policy, to which I now turn.

One of the roles of a central bank is setting interest-rates as part of monetary policy. Those who follow my podcasts will know I defined it as there second role after the existence and provision of a currency, in this case the US Dollar. Briefly monetary policy was affected as overnight interest-rates went outside the official range as described below by the Financial Times.

the pressures that bubbled up in September and sent the cost of borrowing cash overnight via repurchase, or repo, agreements as high as 10 per cent.

That is not as large as you might think as the impact is only for each day but it was way outside the official range. Also there were times when the role of a central bank was in setting the interest-rate for overnight money in terms of its monetary policy. The credit crunch moved events along as that did not have the hoped for impact on the real economy ( and hence we got QE) but the underlying principle remains.

Comment

So we find that the new version of Quantitative Easing or what will no doubt be called QE4 had the champagne bottle smashed on it last night by Jerome Powell as it got ready to go down to the slipway. It remains for it to be fully fitted out as I do not believe it will stop here.

making the case instead for the Fed to buy anywhere from $200bn to more than $300bn of shorter-dated Treasury bills over the next six months. ( Financial Times)

As you can see the lower estimate pretty much coincides with the change in the balance sheet do far with the repo operations. The larger amount perhaps aims for some sort of margin.

The difference between this and the QE we have seen so far is the term of the assets purchased. Treasury Bills last for up to a year whereas Treasury Bonds are for longer periods of time with what is called the long bond being for thirty-years. Also bills do not pay interest as you pay less for them to allow for that.

So there are minor differences with past QE efforts but the direction of travel is the same. Let me put it another way with this from the US Federal Reserve,

Total assets of the Federal Reserve have increased significantly from $870 billion on August 8th, 2007

They have indeed as we wonder how long it will be before we get back to the previous peak of US $4.5 trillion and presumably beyond.

If QE really worked it would not need so many new names would it? Japan now calls it QQE and now the US calls it reserve management. Perhaps Governor Carney will call it climate-related QE.