How much will interest-rates rise?

The issue of interest-rate rises has suddenly become something of a hot topic and let me open with the words of Jamie Dimon of JP Morgan. From the Financial Times.

Jamie Dimon, head of JPMorgan Chase, has warned that the US economy is at risk of overheating, raising the prospect that the Federal Reserve may soon need to slam on the brakes to prevent wages and prices from rising too quickly.

There are more than a few begged questions here but let us park them for now and carry on.

“Many people underestimate the possibility of higher inflation and wages, which means they might be underestimating the chance that the Federal Reserve may have to raise rates faster than we all think,” he wrote. “We have to deal with the possibility that, at one point, the Federal Reserve and other central banks may have to take more drastic action than they currently anticipate.”

Okay let us break this down. Firstly we are back to output gap theory again which of course has been wrong,wrong and wrong again in the credit crunch era. If there are signs of overheating then they are to be found in asset markets where we have seen booming bond prices and house prices and until recently all-time highs for equity markets. Only on Tuesday we looked at US house price growth of 6% or 7% depending which data you use.

Wages

I have picked this out because there has been quite a swerve from Jamie Dimon as for so long nearly everyone has been hoping for higher wages. Now suddenly apparently a rise is a bad thing? The Financial Times article implicitly parrots this line.

The prospect of an overheating economy has spooked the financial markets as recently as February, when stronger-than-expected US wage growth sparked the worst Wall Street sell-off in six years.

In terms of numbers a rise in average earnings growth per hour to 2.9% was hardly groundbreaking and of course it has since faded away showing the unreliable nature of one month’s data. In reality to return to old era trends we would need wages growth of 3.5%+ for a while. But in Jamie’s world that seems to be a bad thing although apparently not always. From Bloomberg.

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon received $29.5 million in total compensation for his work in 2017, an increase of 5.4 percent from a year earlier.

So we are left mulling a view where what was supposed to be good would now be bad! Although those of you who in the comments section have argued we will not see major interest-rate rises until wage rises for the ordinary person picks up are permitted a wry smile at this point.

What is expected?

From the FT article.

Prices of Fed funds futures suggest few expect the Fed to raise rates by more than three times this year, as policymakers have indicated. Longer-term market measures also indicate that investors expect inflation and bond yields to remain subdued for years to come.

I put the second sentence in because it is positively misleading. What those measures are provide a balancing of markets now and usually have very little to do with what will happen. Returning to interest-rates we got a view this week from former Federal Reserve Chair Janet Yellen.

At Monday’s larger forum for Jefferies clients, she expressed the view that three or four rate rises were likely this year, and that recent U.S. tax cuts and a boost in government spending posed at least some risk of running the economy hot, according to the first source, who requested anonymity. ( CNBC)

This is the awkward bit about the Jamie Dimon claim which is that the existing and likely moves in US interest-rates are a response to expected higher inflation anyway as of course as we have looked at many times it is still below the target. Back to Janet.

Later, over dinner at the Manhattan penthouse of Jefferies’ chief executive, Yellen told executives from hedge funds, private equity firms and other companies that she considered inflation to be in check and unlikely to spike, so rates would stay relatively low, according to a second person familiar with the discussion.

Take that as you will as of course we discovered in her time that she does not really understand inflation.

The Bank of England

So how will it respond as traditionally it follows the US Federal Reserve?

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Oh sorry not that one. Let us move onto its favourite publication the Financial Times.

Policymakers at the Bank of England are debating whether to be more forthcoming about their future plans for interest rates, as they gear up for a crunch vote on the cost of borrowing next month.

This is fascinating stuff because it both implies and suggests they know what their forecasts are! Let me give you an example reviewed favourably by Chris Giles the economics editor of the FT.

But last month Gertjan Vlieghe, an external MPC member, broke ranks with his colleagues on the nine-member committee when he said that rates could rise above 2 per cent over the same period.

Actually if we remove the rose-tintin ( sorry but he is Belgian) he seems an excitable chap as this from the Evening Standard in April 2016 reveals.

Vlieghe’s answer is intriguing: “Theoretically, I think interest rates could go a little bit negative.”

The long discussion on negative interest-rates that took place was clearly a hint of expected policy and means that Gertjan was wrong which poses a question over why we should listen this time? Although Chris Giles has a very different view.

Not sure it matters if people believe them.

I think it matters a lot. Oh and as the Swedish Riksbank has found it.

The Riksbank has had some difficulties with its predictions.

But to be fair Chris Giles does have a sense of humour ( I think).

But there remains concern that the BoE could undermine trust in it as an institution running an important public policy if it makes predictions about interest rates that do not come to pass.

Comment

Let me open with a rather good reply to this from GreaterFool.

Any shreds of credibility that the BoE once had disappeared into smoke after the forward guidance experiment. Telling people that you’ll raise rates after unemployment falls below 7% and then dropping them again when unemployment is below 5% will do that.

In fact the hits keep coming as though in this instance from Felix2012

There are quite a few commenters here who still take MPC seriously, unfortunately.

As to clarity well we did get that from Governor Carney back in June 2014.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced….“It could happen sooner than markets currently expect.

That was taken as a clear signal back then and the next day saw a lot of market adjustments which later led to losses as it never happened. Of course the road to a Bank Rate cut after Governor Carney hinted at it was both real and fast as we discovered 3 years later.

So what can we expect? The Bank of England has rather committed itself to a May Bank Rate rise which if you look at falling inflation and some weaker economic news looks out of touch. We have seen signs of slowing in Europe too as German industrial production has shown already today. The US Federal Reserve will no doubt carry on course unless there is a shock stateside although not everyone even thinks we need any tightening. BoI is the Bank of Italy.

 

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What is happening to US house prices?

If you are a believer that the extraordinarily stimulatory monetary policies of the credit crunch era have boosted house prices via their impact on asset prices then the United States currently provides food for thought. This is because of this.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-1/2 to 1-3/4 percent.

For younger readers the US Federal Reserve has raised official interest-rates to extraordinary heights and for older ones it has barely got into the foothills. Either way The Fed-Home as Google now describes us thinks this.

 The stance of monetary policy remains accommodative,

In addition to the series of increases in interest-rates we have seen and continue to expect we are now in what I guess we need to call the QT or Quantitative Tightening era or as Marketwatch described it last month.

Last fall, the Fed announced plans to slowly reduce its balance sheet on auto-pilot, allowing holdings to shrink by $20 billion each month this quarter and moving up to a maximum of $50 billion per month by the end of the year.

From the peak of US $4.5 trillion the balance sheet has shrunk from US $4.5 trillion at its peak to US $.4.4 trillion as of the latest update. So QT has had an impact in terms of a small flow reduction which has led to a small stock reduction. Thus we have gone from small up to small down if we look at it like that although of course in other terms US $100 billion or so was a lot of money.

If we look ahead then Marketwatch point out that we were given a hint of a possible future late last year.

The Fed has not announced how low it wants to shrink its balance sheet. New Fed Chairman Jerome Powell discussed a target range of $2.5 trillion to $2.9 trillion in his confirmation hearing last fall.

Okay what does this impact?

A central bankers heart will gladden when they see these numbers from Money Magnify.

In the second quarter of 2017, real estate values in the United States surpassed their pre- housing crisis levels. The total value of real estate owned by individuals in the United States is $24 trillion, and total mortgages clock in at $9.9 trillion. This means that Americans have $13.9 trillion in homeowners equity.12 This is the highest value of home equity Americans have ever seen.

As they do not let me point out that such value calculations have the flaw of using a marginal price for an average concept which looks great when prices rise but not to great when they fall. If we move on we also see a consequence of the credit crunch era.

Current homeowners have mortgage payments that make up an average of just 16.5% of their annual household income.

That will be changing but not in the way that you think as the US market is mostly one of fixed-rate mortgages. So whilst both the policy changes above may affect it we see that over time QT is likely to have the largest impact. This is because the main player is the 30 year fixed rate mortgage which means that the 30 year Treasury yield is more of a factor that short-term interest-rates. When you look at what it has done you see that in a broad sweep the US Fed helped reduce it by around 1% from 2013 to late 2016 and it then rose by 1% to the current 4.44%. Actually if you look at the chart it is hard not to have a wry smile as for all the rhetoric and talk about QT the main player seems to have been the Donald as most of the rise was around the election of President Trump. Humbling for central bankers and their dreams of ruling the world! If you want to know how this took place I looked at it on the 9th of November 2016.

Before I depart the economic situation let me point out that we may well end up discussing as so often two different markets.

Today, half of all borrowers put down 5% or less. More than 10% of borrowers put 0% down. As a result, the average loan-to-value ratio at origination has climbed to 87%

Manhattan

Is this a case of a perfect storm? We have the effect of the factors above although of course they affect the 0.1% much less than the rest of us. But the winds of change as we have seen in central London have been blowing against capital city ( in which category New York is unofficially if not officially) property prices after many years of plenty. Also there has been this according to the Financial Times.

Some buyers held off buying real estate as they grappled with the impact of President Donald Trump’s changes to the federal tax code, which introduced a cap on the deduction of state and local taxes, including property taxes, from federal tax bills. It also reduced the size of mortgages eligible for interest deductions. The change is expected to hit high earners in high-tax states including New York, particularly in New York City.

This has led to this.

The number of co-op and condominium sales in Manhattan fell nearly 25 per cent during the first quarter compared to the same period last year………..It was the largest annual decline in sales in nine years, according to the report.

Okay so what about prices?

The average sale price across Manhattan fell by 8.1 per cent from the year-earlier quarter, and the average price per square foot also recorded a sharp decline, falling by 18.5 per cent to $1,697.

Perhaps fearing a lack of sympathy amongst even its readers the FT takes its time to point out what this means.

The average sales price of a luxury apartment fell 15.1 per cent, down from $9.36m in the first quarter of 2017 to $7.94m in the first quarter of this year, and the number of sales was down 24.1 per cent. The number of newly built apartments that went into contract fell 54 per cent.

As to lack of sympathy that was at play in the comments.

So now the average luxury apartment in Manhattan costs only $8 million? Not yet a bargain then? ( Genghis)

As was some perspective.

1600 usd per sqf for prime ? Still a bargain compared to London (JP1)……..I know. And positively a steal compared to Hong Kong !! (observer).

Looking wider

You might from the above expect lower prices but in fact at the end of last week we were told this. From Zillow Research.

The continuing inventory pinch helped boost the U.S. national Case Shiller index 6.2 percent in January from a year earlier, down from a 6.3 percent gain in December. Case-Shiller’s 10-City Composite rose 6 percent, while the 20-City Composite climbed 6.4 percent year-over-year.

Some places are in fact red hot.

Home prices in Seattle, Las Vegas, and San Francisco posted the highest annual gains among the 20 cities, rising 12.9 percent, 11.1 percent and 10.2 percent, respectively.

Zillow remain of the view that house prices will continue to rise as I note that rather like us in the UK there is a perception that too few houses have and indeed are being built. For perspective I note that a different piece of research tells us this.

Home values rose 7.6 percent year-over-year to a median of $210,200, with the San Jose, Calif., metro posting astonishing annual home value growth of 26.4 percent, reaching a median of $1.25 million.

Comment

We find ourselves reflecting on the words of Glenn Frey again.

The heat is on

Except not in the way that economics 101 would have predicted as we continue to see house price rises if we ignore the “international effect”. According to the Brookings Institute there may be a deeper factor as human behaviour returns to what it was.

The Census Bureau’s annual county and metropolitan area estimates through 2017 reveal a revival of suburbanization and movement to rural areas along with Snow Belt-to-Sun Belt population shifts. In addition, the data show a new dispersal to large- and moderate-sized metro areas in the middle of the country—especially in the Northeast and Midwest. If these shifts continue, they could call into question the sharp clustering of the nation’s population—in large metropolitan areas and their cities—that characterized the first half of the 2010s.

So the suburbs are back in favour so let me leave you with the thoughts of Arcade Fire on the subject.

And all of the walls that they built in the seventies finally fall
And all of the houses they built in the seventies finally fall

Maybe they got onto the consumer society as well in a different song.

(Everything now!) I need it
(Everything now!) I want it
(Everything now!) I can’t live without
(Everything now!) I can’t live without
(Everything now!) I can’t live
(Everything now!)

The Libor problem is also a US Dollar problem

There is much to consider today as we consider the actions of our lords (ladies) and masters or rather our central bankers. Last night brought something which as we have noted before was in the category of “no surprises” sung about by Radiohead.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-1/2 to 1-3/4 percent. The stance of monetary policy remains accommodative,

That was of course the US Federal Reserve and I added the last bit because in a few words it tells us that they are not finished yet. Regular readers will be aware that I think it would be much better to simply raise rates to 2% and take a break as moving at at snail’s pace gives more time for something to go wrong. This brings me to two consequences of what is happening.

Libor

No not the scandals at least not yet! this time we are looking for the first time in a while at sustained increases. From Bloomberg yesterday.

The three-month London interbank funding rate rose to 2.27 percent Wednesday, the highest since 2008. The concern is that the Libor blowout may have more room to run, a prospect that borrowers and policy makers in various markets are just beginning to grapple with.

One way of looking at this is that as we expect more rises that seems reasonable and if we look at the past rather small fry.

Of course not all of us can remember 1994 and the financial world is of course to coin a phrase “resilient” at least according to the central bankers. This has led people to mull this.

“There has been sort of the perfect storm of factors tightening financial conditions,” said Russ Certo, head of rates at Brean Capital in New York. “Banks do have tremendous liquidity still, but it’s at a higher price.”

You may recall a few years back when worries about bank liquidity in US Dollars were all the rage. This was the era of central banks making agreements for foreign exchange swaps which were mostly ways of making sure they could get US Dollars for their banks from the original source ( the place that can print them at will….) if needed. Here is a refresher on the subject.

In November 2011, the Federal Reserve announced that it had authorized temporary foreign-currency liquidity swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. These arrangements were established to provide the Federal Reserve with the capacity to offer liquidity to U.S. institutions in currencies of the counterparty central banks (that is, in Canadian dollars, sterling, yen, euros, and Swiss francs). The Federal Reserve lines constitute a part of a network of bilateral swap lines among the six central banks, which allow for the provision of liquidity in each jurisdiction in any of the six currencies should central banks judge that market conditions warrant.

These exist for the opposite purpose as whilst the US Fed is describing things from its point of view and it may one day need some £’s Yen or Euros it is vastly more likely that the counterparty central bank will want US Dollars. After all if the world has a reserve currency in spite of some changes it is it and the likely song is from Aloe Blacc.

I need a dollar, dollar
Dollar that’s what I need
Well I need a dollar, dollar
Dollar that’s what I need
Said I said I need dollar, dollar
Dollar that’s what I need
And if I share with you my story would you share your dollar with me?

Oh and you may like to know that the US Federal Reserve eventually fell into line with the definition of temporary to be found in my financial lexicon for these times.

 In October 2013, the Federal Reserve and these central banks announced that their liquidity swap arrangements would be converted to standing arrangements that will remain in place until further notice.

The banks

In the end it all comes down to the “precious” of course and food for thought has been provided by what might be called the central bankers central bank choosing this morning to put this out on social media. From the Bank for International Settlements.

Non-US banks collectively hold $12.6 trillion of dollar-denominated assets – almost as much as US banks…….Dollar funding stress of non-US banks was at the center of the GFC. ( GFC= Global Financial Crisis).

They seem to be pointing the finger in one direction.

We find that Japanese banks pay a premium in their repurchase agreements (“repos”) with US MMFs. We show that the bargaining power of MMFs fund families, together with the particular demand for long term funding of Japanese banks, help explain this premium. ( MMF = Money Market Funds).

This has been a theme of my career which is that in terms of overseas buying ( UK Gilts, Australian property etc…) the Japanese overpay. Care is needed though as the stereotypical response of assuming stupidity ignores the possibility of a longer game being in play. In this instance they have responded.

 We provide evidence for European banks intermediating repos to Japanese banks, with economically significant estimated spreads from maturity transformation.

So any issues with the Japanese banks would also affect European ones? The mind boggles as of course contagion was supposed to be off the menu these days due to all the regulation and reform. As we look back I am reminded that it was European and on a smaller scale Japanese banks which dipped into these lines back in the day.

Would it be considered rude to point out that shares in my old employer Deutsche Bank are down another 2% as I type this? More significantly the 11.8 Euros is a fair bit lower than the 17.1 of mid-December.

Libor-OIS

As a consequence of the factors above this is also taking place. From Bloomberg reporting on some analysis from Citibank.

Strategists at the U.S. lender predict that the gap between the London interbank offered rate for dollars and the overnight indexed swap rate will continue to widen, potentially leading to a sharper tightening of financial conditions than central bankers have been anticipating. The differential between three-month rates has already more than doubled since the end of January to 55 basis points, a level unseen since 2009.

Now 55 basis points sounds much more grand that 0.55% but there is a flicker here as we try to price risk.

Comment

As you can see there are stresses in the financial system right now. Some of this was always going to take place when interest-rates went back up. But for me the real issue comes when we look at another market. This is because whichever way you look at the analysis here you would think that the US Dollar would be rising. You can arrive at that route by observing the apparent demand for US Dollars or by the higher interest-rates being paid in it or both. Yet it has been singing along to Alicia Keys.

Oh baby
I, I, I, I’m fallin’
I, I, I, I’m fallin’
Fall

I keep on
Fallin’

You can represent this by the UK Pound £ being in the US $1.41s or the Japanese Yen being in the 105s take your pick. The latter is off though because if Japanese banks are so keen for US Dollars why is the Yen so strong? To my mind that is much more worrying than Libor on its own as we switch to Carly Simon.

Why?……Don´t know why

Meanwhile returning to the shores of the UK I expect Royal Bank of Scotland to be along. After all it has been in everything else.

Is the US economy at a turning point?

Yesterday brought us some significant news from the US economy. One segment of this was the testimony given by the new Chair of the US Federal Reserve Jerome Powell as everyone combs his words looking for any signs of a change in policy. The sentence from the written testimony that has drawn most attention is below.

In gauging the appropriate path for monetary policy over the next few years, the FOMC will continue to strike a balance between avoiding an overheated economy and bringing PCE price inflation to 2 percent on a sustained basis. ( PCE is Personal Consumption Expenditure )

The reason for that is the use of the word “overheated” which brings with it all sorts of value judgements and implications. This was added to by the phrase he added to this.

My personal outlook for the economy has strengthened since December.

We also got an explanation of what was driving such thoughts.

 In particular, fiscal policy has become more stimulative and foreign demand for U.S. exports is on a firmer trajectory. Despite the recent volatility, financial conditions remain accommodative.

The nod to fiscal policy was a change of emphasis from his predecessor Janet Yellen as I am reminded of the analysis of the US Congress on the subject we looked at on February the 8th.

The Joint Committee staff estimates that this proposal would increase the average level of output (as measured by Gross Domestic Product (“GDP”) by about 0.7 percent relative to average level of output in the present law baseline over the 10-year budget window.

The underlying position

The thoughts above added to the existing situation which Chair Powell described thus.

Turning from the labor market to production, inflation-adjusted gross domestic product rose at an annual rate of about 3 percent in the second half of 2017, 1 percentage point faster than its pace in the first half of the year.

So the fiscal policy will add to an already strengthening situation and the emphasis is mine.

Economic growth in the second half was led by solid gains in consumer spending, supported by rising household incomes and wealth, and upbeat sentiment. In addition, growth in business investment stepped up sharply last year, which should support higher productivity growth in time.

The reason I have highlighted that bit is because Chair Powell had explicitly linked it to wage growth.

Wages have continued to grow moderately, with a modest acceleration in some measures, although the extent of the pickup likely has been damped in part by the weak pace of productivity growth in recent years.

If we switch to the section on employment we see a continuing theme.

Monthly job gains averaged 179,000 from July through December, and payrolls rose an additional 200,000 in January. This pace of job growth was sufficient to push the unemployment rate down to 4.1 percent, about 3/4 percentage point lower than a year earlier and the lowest level since December 2000.

Are we seeing a hint of Phillips Curve style analysis which would predict wage growth acceleration? We did get told he likes policy rules.

Personally, I find these rule prescriptions helpful

Also you may note that he hinted at a pick-up in jobs growth in January which comes when the unemployment rate tells us that according to old policy rules we have what would have been considered to be full employment. It was also interesting that he skirted what we might call the missing eleven million or so via the drop in the participation rate.

the labor force participation rate remained roughly unchanged, on net, as it has for the past several years

I am not sure that it all be blamed on retiring “baby boomers” as we were told.

So we are told that the economy is strong and got a pretty strong hint that higher wage growth is expected and of course that follows the 2.9% growth seen in January in average hourly earnings.

Wages should increase at a faster pace as well.

What about inflation?

That is supposed to pick-up as well as we continue our journey on a type of virtual Phillips Curve.

 we anticipate that inflation on a 12-month basis will move up this year and stabilize around the FOMC’s 2 percent objective over the medium term.

These days it is something of a residual item in speeches by central bankers. This is for two main reasons. The first is that they have really been targeting output and the labour market. The second is that even after an extraordinary amount of QE they failed to generate the ( consumer) inflation they promised and so they are de-emphasising it.

Overheating?

This subject flickered onto some radar screens yesterday as they observed this from the Census Bureau.

The international trade deficit was $74.4 billion in January, up $2.1 billion from $72.3 billion in December.
Exports of goods for January were $133.9 billion, $3.1 billion less than December exports. Imports of goods
for January were $208.3 billion, $0.9 billion less than December imports.

This is something which has been rising as we note this from the Bureau of Economic Analysis or BEA earlier this month.

For 2017, the goods and services deficit increased $61.2 billion, or 12.1 percent, from 2016. Exports
increased $121.2 billion or 5.5 percent. Imports increased $182.5 billion or 6.7 percent.

So we may well be seeing economic growth sucking in imports yet again or a different form of overheating. Thus the words of Chairman Powell above on exports were both true ( they are up) and to some extent misleading as imports have risen faster. This is reinforced with my usual caution about monthly trade data by  the size of the January  goods deficit which is the largest for ten years. If we allow for the fact that the shale oil and gas boom flatters the figures the numbers take a further turn for the worse.

Consumer Confidence

We return to the same theme as we note this.

The Conference Board Consumer Confidence Index® increased in February, following a modest increase in January. The Index now stands at 130.8 (1985=100), up from 124.3 in January. The Present Situation Index increased from 154.7 to 162.4, while the Expectations Index improved from 104.0 last month to 109.7 this month.

So another signal looks strong.

Comment

If we start with the analysis of Chair Powell we see that the US Federal Reserve plans to continue interest-rate rises this year and that it means to do so either 3 or more likely 4 times. This is based on the view that otherwise the economy will overheat as discussed above. Let me add a personal view to this which is the current madness of going along at 0.25%, why not raise by 0.5% in March and then sit back for a while and see what develops? Monetary policy has long lags and if you take ages to act you are at an ever greater risk of being proved wrong.

Another factor in this is the data I have looked at above as I have held something back until now which is troubling. Here is the extra bit from the consumer confidence figures.

Consumer confidence improved to its highest level since 2000 (Nov. 2000, 132.6).

Now if we look at the trade in goods figures the deficit was last higher in January 2008 a time when consumer confidence was high in many places too. What happened next in both instances?

If we continue with that line of thought we find that the oil market may be giving a hint as well.

https://twitter.com/a_coops1/status/968783142717919233

Another reason I think to act more decisively now as after all interest-rates will only be 1.75% to 2% after a 0.5% rise a level I have long argued for and then wait and see. After all we could be seeing a flicker of a road to QE4.

What are the consequences of a weak US Dollar?

So far 2018 has seen an acceleration of a trend we saw last year which is a fall in the value of the US Dollar. The latest push was provided by the US Treasury Secretary only yesterday at Davos. From Bloomberg.

“Obviously a weaker dollar is good for us as it relates to trade and opportunities,” Mnuchin told reporters in Davos. The currency’s short term value is “not a concern of ours at all,” he said.

“Longer term, the strength of the dollar is a reflection of the strength of the U.S. economy and the fact that it is and will continue to be the primary currency in terms of the reserve currency,” he said.

The way it then fell it is probably for best its value is not a concern as the rhetoric was both plain and transparent.

A day before Trump’s scheduled arrival in the Swiss ski resort of Davos for the World Economic Forum’s annual meeting, Treasury Secretary Steven Mnuchin endorsed the dollar’s decline as a benefit to the American economy and Commerce Secretary Wilbur Ross said the U.S. would fight harder to protect its exporters.

The response to the words is a pretty eloquent explanation of why policy makers have a general rule that you do not comment on the level of the exchange rate. Not only might you get something you do not want there is also the issue of being careful what you wish for! Sadly the Rolling Stones were not on the case here.

You can’t always get what you want
But if you try sometime
You’ll find
You get what you need

However you spin it we are in a phase where the US government is encouraging a weaker dollar as part of the America First strategy. It has already produced an echo of the autumn of 2010 if this from the Managing Director of the IMF is any guide.

 “It’s not time to have any kind of currency war,” Lagarde said in an interview with Bloomberg Television.

Criticising someone for rhetoric by upping the rhetoric may not be too bright. Also there are more than a few examples of countries trying to win the race to the bottom around the world.

What does a lower US Dollar do?

Back in November 2015 Stanley Fischer gave us the thoughts of the US Federal Reserve.

To gauge the quantitative effects on exports, the thick blue line in figure 2 shows the response of U.S. real exports to a 10 percent dollar appreciation that is derived from a large econometric model of U.S. trade maintained by the Federal Reserve Board staff. Real exports fall about 3 percent after a year and more than 7 percent after three years.The gradual response of exports reflects that it takes some time for households and firms in foreign countries to substitute away from the now more expensive U.S.-made goods.

Also imports are affected.

The low exchange rate pass-through helps account for the more modest estimated response of U.S. real imports to a 10 percent exchange rate appreciation shown by the thin red line in figure 2, which indicates that real imports rise only about 3-3/4 percent after three years.

This means that the overall economy is affected as shown below.

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. Moreover, the effects materialize quite gradually, with over half of the adverse effects on GDP occurring at a horizon of more than a year.

Okay we need to flip all of that around of course because we are discussing a lower US Dollar this time around. Net exports will be boosted which will raise economic output or GDP over time.

How much?

If we look at the US Dollar Index we see at 89.1 it has already fallen by more than 3% this year. The recent peak was at just over 103 as 2016 ended so we have seen a fall of a bit under 14%. The official US Federal Reserve effective exchange rate has fallen from 128.9 in late December 2016 to 116.8 at the beginning of this week so 116 now say. Conveniently that gives us a fall of the order of 10%.

So if we look up to the preceding analysis we see that via higher exports and reduced imports US GDP will be 1.5% higher in three years time than otherwise.

What about inflation?

There is a lower impact on the US because of the role of the dollar as the reserve currency and in particular as the currency used for pricing the majority of commodities.

While the Board staff uses a range of models to gauge the effect of shocks, the model employed in figure 4–as well as other models used by staff–suggests that the dollar’s large appreciation will probably depress core PCE inflation between 1/4 and 1/2 percentage point this year through this import price channel.

You may note that Stanley Fischer continues the central banking obsession with core inflation measures when major effects will come from food and energy. It would be entertaining when they sit down to luncheon to say that we are having a core day so there isn’t any! Have you ever tried eating an i-pad?

So inflation may be around 0.5% higher.

What about everybody else?

The essential problem with reducing the value of your currency to boost your economy via exports is that overall it is a zero-sum game. As you win somebody else loses.  So the gains are taken from somebody else as no doubt minds in Beijing, Tokyo and Frankfurt are thinking right now. Of course pinning an actual accusation on the United States is not easy because of its persistent trade deficits.

Furthermore the exchange-rate appreciation seen elsewhere will not be welcomed by the ECB ( European Central Bank) and particularly the Bank of Japan. The latter is pursuing an explicit Yen depreciation policy to try to generate some inflation whereas what it has instead seen is a rise towards 109 versus the US Dollar. Of course workers and consumers will have reason to thank the lower dollar as lower inflation will boost their spending power.

Later today we will see how Mario Draghi handles this at the ECB policy meeting press conference. He finds himself pursuing negative interest-rates and still substantial if tapering QE and a stronger currency. It is hard for him to be too critical of the US though when even Christine Lagarde is saying this.

LAGARDE: GERMANY’S 8% CURRENT ACCOUNT SURPLUS IS EXCESSIVE ( @lemasabacthani)

Of course that takes us back to a past competitive depreciation which Germany arranged via its membership of the Euro.

Comment

There is a fair bit to consider here. As it stands it looks as though the US economy will benefit over the next 3 years (convenient for the political timetable) by around 1.5% of GDP at the cost of higher inflation of 0.5%. There are two main problems with this type of analysis of which the first is simply the gap between theory and reality. The smooth mathematical curves of econometrics are replaced in practice by businesses and consumers ignoring moves for as long as they can and then responding but by how much and when? So we see a succession of jump moves. The other issue is that exchange-rates are usually on the move and can change in an instant unlike economies leaving us wondering which exchange-rate they are responding too?

Next we have the awkward issue of a country raising interest-rates and seeing a currency depreciation. Theory predicts the reverse. I have a couple of thoughts on this and the first is about timing. In my opinion exchange-rates these days move on expectations of an event so they have already happened before it does. So the current phase of interest-rate rises was reflected in the US Dollar rise from the summer of 2014 to the spring of 2015. That works because if anything we have seen fewer rate rises than expected back then and the bond market has fallen less. As to the Federal Reserve well with the US Dollar here and inflation with a little upwards pressure it will therefore find a scenario which makes it easy for it to keep nudging interest-rates higher.

Meanwhile there are other factors which are hard to quantify but seem to happen. For example a lower dollar coming with higher commodity prices. Hard to explain and of course there are other factors in play, But it seems to have happened again.

Me on Core Finance TV

http://www.corelondon.tv/will-pound-go-next-vs-us-dollar/

 

 

What is happening to US consumer credit and car loans?

If we take a look at the US economy then we see on the surface something which looks as it is going well. For example the state of play in terms of economic growth is solid according to the official data.

Real gross domestic product (GDP) increased at an annual rate of 3.2 percent in the third quarter of 2017 (table 1), according to the “third” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 3.1 percent.

Looking ahead the outlook is bright as well.

The New York Fed Staff Nowcast stands at 3.9% for 2017:Q4 and 3.1% for 2018:Q1.

That would be a change as the turn of the year has tended to under perform in recent times. Also if we use the income measure for GDP the performance is lower. But if we continue with the data we see that both the unemployment rate ( 4.1% in December) and the underemployment rate ( 8.1% in December) have fallen considerably albeit that the latter nudged higher in December.

Less positive is the rate of wage growth where ( private-sector non farm) hourly earnings are currently growing at 2.5%. This is no doubt related to this issue.

In the 2007-2016 period, annual labor productivity decelerated to 1.2 percent at an annual average rate, as compared to the 2.7 rate in the 2000-2007 period.

So a familiar pattern we have observed in many places although the US is better off than more than a few as it has real wage growth albeit not a lot especially considering the unemployment rate and at least has some productivity growth.

Interest-rates are rising

Whilst wages have not risen much in response to a better economic situation interest-rates are beginning to. The official Federal Reserve rate is now 1.25% to 1.5% and is set to rise further this year. If we move to how such things impact on people then the 30 year (fixed) mortgage rate is now 4.06%. It has had a complicated picture not made any easier by the current government shutdown but in broad terms the downtrend which took it as low as 3.34% is over.

How much debt is there?

As of the end of the third quarter of 2017 the total mortgage debt was 14.75 trillion dollars. This is not a peak which was 14.8 trillion in the spring/summer of 2008 but if we project the recent growth rate we will be above that now. Of course the economy is now much larger than it was then.

If we move to consumer credit then we see the following. It was 3.81 trillion dollars at the end of November and that was up 376 billion dollars on a year before.

In November, consumer credit increased at a seasonally adjusted annual rate of 8-3/4 percent. Revolving credit increased at an annual rate of 13-1/4 percent, while nonrevolving credit increased at an annual rate of 7-1/4 percent.

So quite a surge but care is needed as the numbers are erratic and October gave a much weaker reading. So we wait for the December data. If we look into the detail we see that student loans were 1.48 trillion dollars as of September and the troubled car loans sector was 1.1 trillion dollars. For perspective the former were were 1.05 trillion in 2012 and the latter 809 billion.

In terms of interest-rates new car loans are 5.4% from finance companies and 4.8% from the banks for around a 5 year term. Credit cars debt is a bit over 13% and personal loans are 10.6%.

Credit cards

The Financial Times is reporting possible signs of trouble.

The big four US retail banks sustained a near 20 per cent jump in losses from credit cards in 2017, raising doubts about the ability of consumers to fuel economic expansion……Recently disclosed results showed Citigroup, JPMorgan Chase, Bank of America and Wells Fargo took a combined $12.5bn hit from soured card loans last year, about $2bn more than a year ago.

It suggests that the rise in lending that has been seen is on its way to causing Taylor Swift to sing “trouble,trouble,trouble”

Yet borrower delinquencies are outpacing rising balances. While still less than half crisis-era levels, the consultancy forecasts soured credit card loans will reach almost 4.5 per cent of receivables this year, up from 2.92 per cent in 2015.

The St.Louis Federal Reserve or FRED is much more sanguine as it has the delinquency rate at 2.53% at the end of the third quarter of 2017. So up on the 2.29% of a year before but a fair way short of what the FT is reporting.

Maybe though there have been some ch-ch-changes.

“The driving factor behind the losses is that banks are putting weaker credits on the books,” said Brian Riley, a former credit card executive and now a director at Mercator.

Car Loans

According to CNBC lenders are being more conservative in the automobile arena.

The percentage of subprime auto loans saw a big decline in the third quarter despite growing concerns that auto dealers and banks are writing too many loans to borrowers with checkered credit histories, according to new data.

In fact, Experian says the percentage of loans written for those with subprime and deep subprime credit ratings fell to its lowest point since 2012.

In terms of things going wrong then we did not learn much more.

In the third quarter, there was a slight decrease in the percentage of loans 30 days overdue and slight increase in those that were 60 days delinquent.

Although a development like this is rarely a good sign.

Meanwhile, Experian says the average term for a new vehicle auto loan hit an all-time high of 69 months, thanks in part to a slight increase in the percentage of loans schedule to be repaid over 85 to 94 months.

“We’re starting to see some spillover to loans longer than 85 months,” said Zabritski.

This morning’s Automotive News puts it like this.

Smoke expects higher interest rates and tighter credit this year will drive many consumers to buy a used vehicle instead of a new one. Most of those buying used cars will be millennials, who are often saddled with student loans and remain credit challenged, he said.

It is no fun being a millennial is it? Although I suppose much better than being one in the last century as we have so far avoided a world war.

This piece of detail provides some food or thought.

Last year, the U.S. Federal Reserve raised interest rates three times for a total of 75 basis points, and data show that auto-loan lenders have been tightening credit for six straight quarters, but auto loans for “superprime borrowers” increased by just 20 basis points, Smoke said.

Are lenders afraid of raising sub-prime borrowing rates? Not according to The Associated Press.

Subprime buyers got substantially better rates even a year ago. The average subprime rate of 5.91% last year has jumped to 16.84% today, Smoke says. For a 60-month loan of $20,000, that means a monthly payment hike of more than $100, to $495.

Comment

There is a fair bit to consider here as we mull how normal this is for the mature phase of an economic expansion? Also how abnormal these times have been in terms of whether the benefits of the economic growth have filtered down much to Joe Sixpack? After all wage growth could/should be much better and the unemployment figures obscure the much lower labour participation rate. We will be finding out should interest-rates continue their climb as we mull the significance of this.

Securitisations of US car loans hit a post-financial crisis high in 2017, as investor demand for yield continued to provide favourable borrowing conditions across a range of credit markets. Wall Street sold more than $70bn worth of auto asset backed securities, which bundle up car loans into bond-like products, this year, the highest level since 2007, according to data from S&P Global Ratings. ( Financial Times).

One thing we can be sure of is that we will be told that everything is indeed fine until it can no longer possibly be denied at which point it will be nobody’s ( in authority) fault.

Jimmy Armfield

Not only a giant in the world of football in England but in my opinion the best radio summariser by a country mile. RIP Jimmy and thank you.

 

 

 

What is happening in the US economy?

It is time and in some ways past time for another delve into the state of play in the US economy which some would have you believe has been doing extraordinarily well. I spotted this from @Trickyjabs on Twitter earlier this week.

George Osborne, January 2015:
“Britain could be richer than US by 2030”

2.5 years later:
US GDP +21.5%
UK GDP +4.5%

If we skip the attempt to make a political point this is the sort of thing to cheer Donald Trump especially if he could find a way to argue it had all happened this year! Sadly of course the lesson here is not to use figures you do not understand as the US figures are realised in an annualised version. So still better than the UK but not by much.

Perspective

If we look back we see that the US Bureau of Economic Analysis or BEA tells us that economic output as measured by GDP peaked at 14.99 Trillion US Dollars in the last quarter of 2007 ( 2009 prices). If we jump forwards to the second quarter of this year we see that it had risen to 17.03 Trillion US Dollars. So if we allow for the likely growth in the third quarter an increase of the order of 14%. This tells us that the US has done relatively well on this measure but that growth is lower than what used to be considered normal. Putting it another way we have a type of confirmation that as output did not reach its previous peak until halfway through 2011 the new normal for economic growth may be of the order of 2% per annum.

Also the BEA gives us an insight into the structure of the US economy which goes as follows. 69% is consumption, just under 17% is investment and just over 17% is the government. You may have spotted a mathematical flaw which is solved when we put in net trade which is -3%.So investment has fallen as has the relative size of the government and the gap has partly been filled by services consumption rising from 44% to 47%.

Perhaps the most interesting change is the decline in the trade deficit which peaked at just under 6% of GDP before the credit crunch but is now around 3%. I wonder how much of a role the shale oil industry has played in this.

Looking ahead

One view was expressed by the Donald back in August. From CNBC.

“If we achieve sustained 3 percent growth that means 12 million new jobs and $10 trillion of new economic activity. That’s some number,” Trump said during a speech last month in Missouri promoting tax reform. “I happen to be one that thinks we can go much higher than 3 percent. There’s no reason we shouldn’t.”

If the US Federal Reserve was on board with that then we would have seen more interest-rate increases but its latest forecasts suggest annual economic growth of around 2%. So belatedly they have caught up with us on here!

Interest-Rates

This is an intriguing one as markets expect another rise to circa 1.25% in December and it became more intriguing as we learnt this from the European Central Bank and its President Mario Draghi yesterday.

Real GDP increased by 0.7%, quarter on quarter, in the second quarter of 2017, after 0.6% in the first quarter. The latest data and survey results point to unabated growth momentum in the second half of this year

So better than the US so far in 2017 and the Euro area has seen growth for a while.

Growth is growing and momentum is also growing and labour market and everything is doing – well, I think it’s, I can’t remember how many quarters of consecutive growth, 17 I believe.

But the picture for interest-rates is completely different.

The sequence stays what it is, namely this – the interest rates will stay and they remain at their present – are expected to remain at their present levels for an extended period of time and well past the horizon of our net asset purchases.

So President Draghi is giving us Forward Guidance that the ECB deposit rate will remain at -0.4% for at least the next couple of years and maybe beyond. This is because the cut to the monthly amount of QE to 30 billion Euros a month was accompanied by not only an extension of its term but more hints that it might go “on and on and on ” to coin a phrase.

Whilst 2017 looks like being somewhere between a good year for both the US and Euro area economies sooner or later a recession will come along. Oh except of course in the forecasts of central bankers which seem to actually believe they have ended them! But my point is should it come then we will see a US central bank which has raised interest-rate but an ECB with them starting it in negative territory. The rationale as we look at comparisons is given here.

As such, the US recovery is way more advanced than ours

Quite a compliment for the United States I think.

Inflation

This remains by historical standards relatively mild with this being the latest release from August.

The PCE price index increased
0.2 percent. Excluding food and energy, the PCE price index increased 0.1 percent.

This means that the annual rate for Personal Consumption Expenditure has fallen from 2.2% in February to 1.4% in August. So good news overall and in case you are wondering why CPI is not used the gap between the two measures is variable but tends to see CPI around 0.4% higher.

Wages

From the Bureau of Labour Statistics or BLS.

Real average hourly earnings increased 0.7 percent, seasonally adjusted, from September 2016 to
September 2017. The increase in real average hourly earnings combined with no change in the average
workweek resulted in a 0.6-percent increase in real average weekly earnings over this period.

So there is some growth but hardly stellar.

Comment

In many ways the US economy has done pretty well in the credit crunch era but this does not mean that there are not begged questions. This start in an apparent area of strength because the unemployment has fallen to 4.2% and the underemployment rate to 8.3%. But the catch as was discussed in the comments section yesterday comes from the participation rate which in spite of an improvement in September is some 3% lower than pre credit crunch. So what has happened to nearly 8 million people or ten million if we look further back?

The next issue is one of debt. I am not particularly thinking of the level of it but the way that it seems to have permulated and percolated back down to the sub-prime level again. From Bloomberg in August.

There’s a section of the auto-loan market — known in industry parlance as deep subprime — where delinquency rates have ticked up to levels last seen in 2007, according to data compiled by credit reporting bureau Equifax.

“Performance of recent deep subprime vintages is awful,” Equifax said in a slide show on second-quarter credit trends.

I dread to think what “deep subprime” means don’t you? As to the car market itself this from Automotive News does not seem entirely reassuring.

October is on track to be the second-best month of 2017 for U.S. new-vehicle sales, analysts said, partly due to surging demand in states recovering from hurricane damage, though volume is projected to fall slightly from the same month last year.

When will the next big hurricane come along to boost sales and I note what is happening with prices.

Fleming said incentives have risen to 11 percent of average transaction prices — “an indicator that new-vehicle demand is still contracting, and production cuts could be on the horizon to prevent oversupplies.”
Discounts are all but certain to rise further in the coming months, as automakers roll out year-end promotions that typically start in the next few weeks and stretch into early January.

My financial lexicon for these times of course defines an “incentive” as a price cut.