Central Banks have a big problem with the future

A feature of 2019 so far has been a succession of U-Turns by central banks and by two of the world’s major central banks in particular. This has been most marked at the US Federal Reserve where it was not so long ago that some were suggesting we would see four interest-rate increases ( of 0.25%) this year on the road to what was called normalisation. Regular readers will recall that we were one of the few places that were troubled by the fact that we simply do not know what and where normal is anymore. But for our purposes today the main issue is that the US Federal Reserve looks set to cut later this month and perhaps one more time in 2019. Should that scenario come to pass then the previous concensus will have been wrong by a net 6 interest-rate changes. Seeing as interest-rates are so low these days that is quite an achievement.

This is on my mind because if we take the advice of Kylie Minogue and step back in time just under 7 years central banks were heavily influenced by this from Micheal Woodford and Jackson Hole.

The first of these is forward guidance — explicit statements by a central bank about the outlook for future policy, in addition to its announcements about the immediate policy actions that it is undertaking.

This was always going to be adopted as it flattered central banking egos and provided an alternative at a time when central bankers were afraid of being “maxxed out”. But as my opening paragraph pointed out it has been a complete failure in recent times in the United States where it began.

Europe

This has been something of a two stage failure process for Forward Guidance. The opening part got some intellectual backing last September from Benoit Coeure of the ECB.

Communicating our expectation that the ECB key interest rates would remain at their present levels at least through the summer of 2019 was therefore consistent with the “risk management” approach to monetary policy that the Governing Council has repeatedly applied in recent years,

This had two steps as it was perceived like this.

Yet, on my next slide you can see that, at some point in early 2018, markets expected the ECB to hike its deposit facility rate one month after the expected end of net asset purchases.

So that was a bit of a fail and it continued long after this speech. It was something I found hard to believe but the idea that the ECB would raise interest-rates in 2019 was like these lyrics from Hotel California.

And in the master’s chambers
They gathered for the feast
They stab it with their steely knives
But they just can’t kill the beast.

It seemed to exist in an evidence-free zone but somehow survived. But events recently took a dreadful turn for it and by implication ECB Forward Guidance.

In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required……..This applies to all instruments of our monetary policy stance. Further cuts in policy interest rates and mitigating measures to contain any side effects remain part of our tools.

So the interest-rate rises had not only morphed into unchanged but now we were being forward guided to a cut. Could that be any worse? Apparently it can as the incoming ECB President switches to downplaying the size of the interest-rate cuts on the horizon.

*IMF SAYS THERE MAY ONLY BE LIMITED ROOM FOR ECB RATE CUTS ( @lemasabachthani )

But apparently forward guidance is another beast that our steely knives cannot kill.

We remain able to enhance our forward guidance by adjusting its bias and its conditionality to account for variations in the adjustment path of inflation.

Bank of England

Gertjan Vlieghe has given a speech on this subject and he is in the mood for change and I do not blame him but sadly it does not start well.

In particular, communicating more about the Monetary Policy Committee’s preferred future path of interest rates
would be easier to understand than our current approach.

Preferred? I would prefer England to win the cricket world cup final on Sunday but a balanced reality involves looking at the strengths of New Zealand. Also it is not often central bankers do humour and when they do it is mostly unintentional.

Global central banks have changed their outlook for policy significantly in recent months.

He has a go at placing a smokescreen over events as well.

and the UK outlook for monetary policy continues to be materially affected by Brexit uncertainty.

This is misleading in my view mostly because none of us know what will happen so we cannot allow for it. Even if you think there is an effect right now then it is too late to do anything about it because an interest-rate move takes around 18 months to fully impact.

It feels for a while that we are getting some honesty.

Before diving into the details of the argument I want to stress that a far bigger challenge to monetary policy is
that the future is uncertain, and my suggested communications improvement will not change that. Today’s
preferred path of interest rates will change tomorrow, if the economy turns out differently from what we
expected.

But sadly as so often with Gertjan he drops the ball at the crucial point.

But I am arguing that we can achieve a modest improvement in the understanding that
businesses, households and financial markets have of what our objectives are, and what we think we need
to do to meet those objectives.

Most people only vaguely know who they are at best, so they idea they will be hanging on their every word is laughable. Financial markets do, of course, but how much of the real economy gets missed out?

The next bit reminds me of this from Queen.

Is this the real life?
Is this just fantasy?

Here is Gertjan pedalling hard.

Moreover, the Swedish central bank reported that the quality of its own internal deliberations and discussions
with staff had improved, and that discussion of monetary policy by external observers had become “less
speculative”

Meanwhile if we go back to real life.

The Riksbank has become pretty much a laughing-stock.

Comment

As you can see Forward Guidance has been one of the failures of our times. On an internal level down keeps being the new up but also it is part of a framework where the environment keeps getting worse. What I mean by that is after all the policy accommodation economic growth now has a “speed limit” of 1.5% and 2019 is proving to be a difficult year for the world economy. It flatters central banking egos, gives markets a hare to chase and journalists something to copy and paste, but not so much for the real economy.

The piece de resistance to all this is provided by Gertjan who you may recall has been Forward Guiding us to interest-rate increases for a while now. He has another go.

This would justify further limited and gradual rate increases, such that we might reach 1.00% in a year’s time,
1.25% in two years’ time, and 1.75% in three years’ time, with large uncertainty bands around this central
path.

You may notice the use of the word “might” here. Whereas he seems a lot more sure about this road.

On balance I think it is more likely that I would move to cut Bank Rate towards the effective lower bound of close to 0% in the event of a no deal scenario.

Just for clarity the Bank of England now thinks this is at 0.1% after assuring us for quite a long period ( Governor Carney repeated it more than once) that it was 0.5%.

So if we just look at Gertjan’s career at the Bank of England he looks ro be pointing us towards a situation where he has twice “Forward Guided” us to interest-rate increases and then cut them! I await your thoughts on how useful you think he will have been in such a scenario?

Where next for the US economy?

The end of the week has an American theme as we have just had Independence Day and it will be followed by the labour market and non-farm payrolls data. So a belated happy Independence Day to my American readers. But behind all that is a more troubled picture for the US economy that opened 2019 in fine form.

Real gross domestic product (GDP) increased at an annual rate of 3.1 percent in the first quarter of 2019 (table 1), according to the “third” estimate released by the Bureau of Economic Analysis. In the fourth quarter of 2018, real GDP increased 2.2 percent. ( BEA)

There was a further sub-plot in that not only had economic growth picked up to ~0.8% as we measure it the falling trend of the previous three quarters was broken. But as I pointed out on the 8th of May a warning light had started to flash.

The narrow measure of the money supply or M1 in the United States saw a fall of just over forty billion dollars in March. That catches the eye because it does not fit at all with an economy growing at an annual rate of 3.2%. Indeed we see now that over the three months to March M1 money supply contracted by 2.7%.

What about now?

The money supply picture is not as dark as it looked back then. In fact the contraction of the previous three months of 2.7% has now been replaced by growth of 2.7%. However that is below the annual rate of growth of 3.8% so a gentle brake is still in play as opposed to the previous sharp one. This compares to 8.5% in 2017 as a whole and 4.4% in 2018.

As to the pick-up more recently it may be related to this change in Federal Reserve policy.

The Committee intends to slow the reduction of its holdings of Treasury securities by reducing the cap on monthly redemptions from the current level of $30 billion to $15 billion beginning in May 2019.

So it is no longer acting to reduce the growth rate of the narrow money supply on the same scale. As to how quickly that will impact is not so easy to say because if we look back in time the timescales of similar policies were rather variable. This was the so-called Overfunding phase in the UK when we sold an excess amount of Gilts to reduce the money supply and discovered if we cut to the chase that it was not as simple as it might appear. There is a difference in that we were aiming ( and quite often missing) a broad rather than narrow money measure.

As cash was in the news only yesterday let me point out that at the end of May the M1 money supply comprised some US $1.65 trillion as opposed to US $2.14 trillion of demand and chequeable deposits. There is a blast from the past disappearing as until the end of December the US Fed recorded some £1.7 billion of Travellers Cheques, does anybody still use them?

Other Signals

We get an idea from the New York Fed.

The New York Fed Staff Nowcast stands at 1.3% for 2019:Q2 and 1.2% for 2019:Q3.

News from this week’s data releases decreased the nowcast for both quarters by 0.1 percentage point.

Negative surprises from housing data and the Advance Durable Goods Report accounted for most of the decrease.

As you can see they are rather downbeat for the middle part of 2019 with economic growth being of the order of 0.3% as we would measure it. The Atlanta Fed nowcast is a few days more recent but comes to the same 1.3% answer for the quarter just gone.

A particular driver of that is something that like in the UK has lost much of its ability to shock because it has become part of the economic landscape.

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis announced today that the goods and services deficit was $55.5 billion in May, up $4.3 billion from $51.2 billion in April, revised. ( BEA )

That increase in the deficit is a downwards pull on GDP via net exports and is part of a pretty consistent trend in the year so far.

Year-to-date, the goods and services deficit increased $15.7 billion, or 6.4 percent, from the same period in 2018. Exports increased $5.1 billion or 0.5 percent. Imports increased $20.8 billion or 1.6 percent.

That shows that the trade war does not appear to be going that well as you can see. As to the total effects here is the Bank of England on the subject.

The Bank estimates that these measures will reduce global GDP by only around 0.1%, and the
further US-China tariffs that took effect in May and June will roughly double that effect.

But that may not be the end of the story. The additional tariffs threatened by the US on China and on auto
imports more generally would raise average US tariffs to rates not seen in half a century. If
implemented, they could reduce global GDP by an additional 0.6% through direct trade channels alone.

What will the Federal Reserve Do Next?

If the latest speech from Chair Powell is any guide it seems to be trying to take us for fools.

 The Fed is insulated from short-term political pressures—what is often referred to as our “independence.”

I should note that this came before the appointment of a politician to the ECB Presidency but that really is only part of something which which we have long been aware of. Believing in it these days is a bit like believing in Father Christmas. As to the economic situation we were told this.

Since then, the picture has changed. The crosscurrents have reemerged, with apparent progress on trade turning to greater uncertainty and with incoming data raising renewed concerns about the strength of the global economy……The question my colleagues and I are grappling with is whether these uncertainties will continue to weigh on the outlook and thus call for additional policy accommodation. Many FOMC participants judge that the case for somewhat more accommodative policy has strengthened.

Comment

The next signal for the US economy has been the surge in bond markets. The US ten-year yield was 3.24% in the early part of last November as opposed to 1.97% as I type this. The expectation shifted as we noted back then shifted from interest-rate rises to cuts and on a simple level a two-year yield of 1.78% is expecting three of them which is punchy when we have not had any yet. So they have been accurate in expecting a slowing of the US economy and the prospects for more QE bond buying and have got a slowing of the reduction in QE and a September date for its end.

Moving to the labour market most of the signals do not tell us much at this stage of the cycle. After ten years of expansion for the economy jobs growth should have slowed. But there are two numbers which do tell is something. The first is wages growth because with the rise in employment and fall in unemployment it should have surged but has not. Whilst I welcome wage growth of a bit over 3% it has underperformed compared to the past which is perhaps related to another problem. It gets reported less these days but the change in the labour participation rate is equivalent to around 11 million people.

Both the labor force participation rate, at 62.8 percent, and the employment-population ratio, at 60.6 percent, were unchanged in May.

There is also the issue of leveraged loans which ironically lower interest-rates and bond yields are only likely to make worse. Here is the Bank of France on the subject.

Leveraged loans are loans extended to highly indebted companies. Their strong growth in the US over the last five years and their packaging into securitised financial products bear a number of similarities with the subprime market that triggered the 2008 crisis. While the comparison is debatable, the risks posed by the leveraged loan market to financial stability should not be ignored.

Also in an era of H2O and Woodford there is this.

The presence of Exchange Traded Funds and Mutual Funds means that retail investors have access to these loans in the United States – although they still only account for a minority of investors. Moreover, these structures present a maturity mismatch between their assets and their liabilities. Investors can redeem their fund shares very quickly, whereas underlying assets (leveraged loans) tend to have much longer transaction times.

What could go wrong?

Central banks plan to ride to the rescue of house prices one more time

It is good to be ahead of the pack as I note that this morning the Resolution Foundation has caught up with one of my main themes.

Housing costs have put increasing pressure on living standards for all generations alive today, compared to predecessors at the same age. Housingcost-to-income ratios fell faster (by 1 percentage point) for families headed by
under-30s than for older family units in the year to 2017-18, but this does little to alter the long-term picture. At age 30 housing costs were equivalent to 24 per cent of income for millennials born in the early 1980s, and 21 per cent for
members of generation X born in the early 1970s. That compares to 10 per cent at the same age for members of the silent generation born in the early 1940s.

As you can see this has been a long-running saga where housing in the UK has got more expensive. Yet our inflation numbers have missed much of this. This is for two reasons. The first is that we switched in 2003 to a measure called CPI ( Consumer Price Index) which excludes owner-occupied housing costs and that is what the Bank of England targets. So if we compare the latest situation as we were old yesterday that the official UK House Price Index in April was at 120.1 with for example the 67.8 of April 2003 you can see the danger of ignoring this area as it does.

In some ways more disturbing is that way that our official statisticians claim that such housing costs are now included when in fact they use imputed rental numbers in the CPIH measure. If there is a home owner out there who acts as if they pay themselves rent then you are fine, but the rest of us are not. Actually on a personal basis I fall down on the issue of even knowing how much rent my flat would get.

It gets better in that there are a lot of doubts about the rental series that the numbers are imputed from. These start with concerns that the balance of new to old rents is wrong leading to the number being around 1% too low. Next comes the issue that houses which are bought for ownership may well not be similar to ones which are rented. Finally there is the fact that the Office for National Statistics does not have sight of the actual numbers as it relies on data collected by others.

This is something which the Resolution Foundation returns to.

Younger cohorts are more likely to live in overcrowded homes: between 1994-96 and 2016-18, the share of family units headed by 18-29 year olds in overcrowded
homes increased by almost one-third (from below 8 per cent to above 10 per cent). Younger cohorts spend longer commuting too.

I have highlighted this because it suggests a problem which we have thought is taking place but is hard to get concrete numbers on. This is the issue of a lowering of the quality of housing. We may well be paying more for less meaning that the actual rate of inflation has been higher than we get from just looking at the price indices.

This has consequences.

Our spotlight analysis focuses on the fact that changes in housing costs could be having a more wide-ranging effect on living standards too.

That seems to be the written equivalent of mealy mouthed to me.

Has all the “Help” actually helped?

Maybe a little but as you can see the extraordinary efforts I have documented over the years on here have put only a minor dent in the trend.

While the latest evidence points towards a bottoming out of this decline – family units headed by 18-29 year olds experienced an increase in ownership
rates from 7.9 per cent in 2016 to 9.2 per cent in 2018 – the fundamentals of high house prices and deposit requirements remain a significant barrier to
ownership.

So good work from the Resolution Foundation although as champions of the CPIH inflation measure they have stood on a land mine here in my opinion.

More! More! More!

The issues raised above are on my mind because as the song lyrics above from Andrea True Connection hint the world’s central banks are already riding to the rescue of housing markets and house prices. We have seen rate cuts recently from the Reserve Banks of India and Australia with the latter especially suggesting more is to come. Then yesterday evening there was the US Federal Reserve.

“Overall, our policy discussion focused on the appropriate response to the uncertain environment,” he said. “Many participants believe that some cut to the fed funds rate would be appropriate in the scenario they see as most likely.”……….“Many participants now see the case for somewhat more accommodative policy has strengthened,”  ( Federal Reserve Chair Jerome Powell via CNBC )

This meant that the market for a rate cut in July went straight to 100% with the only debate being whether it would be a quarter or a half point. So those with variable-rate mortgages can expect better news. Added to that we saw further strong rallies in bond markets with for example this morning the US ten-year Treasury Note yield dipping below 2%. Regular readers will be aware I have been writing for a while that I expect the cost of fixed-rate mortgages to fall and the falls just get larger.

If we switch to the Euro area it was only on Monday that we saw ECB President Mario Draghi move the goal posts on monetary policy. This morning a contender for his job post October has joined in. From Reuters.

“We in the Governing Council are ready to act as appropriate unless there is improvement in the economic conditions,” Rehn told a conference in Brussels.

Asked whether the ECB should proceed with rate cuts or resuming asset purchases, Rehn said: “The whole range of instruments is on the table.”

He is not alone as @DeltaOne reports.

ECB’S DE GUINDOS SAYS RISKS ARE TILTED TO DOWNSIDE, IF THEY START TO MATERIALIZE, WE WILL REACT

Apologies for the capitals which are a regular theme of that twitter feed.

If there is going to be a coordinated easing party from the world’s main central banks then the Bank of Japan has its sake ready at body temperature.

BOJ Governor Kuroda: We Will Not Hesitate To Ease Further If Momentum Towards The Price Target Is Lost ( @LiveSquawk )

Although as they are not especially keen on negative interest-rates and are already buying assets like they are powered up pac-men and women their options are not so obvious.

Comment

This week has seen a turbocharger added to the central banking engine. It is also true that one of the drivers of this is asset prices albeit that President Trump concentrates on the stock market. But it increasingly looks that the central banking cavalry will ride to the rescue of house prices yet again. However there is a catch in that as we approach and then pass 0% for official interest-rates the responsiveness of mortgage-rates has fallen. So the cavalry could yet end up like General Custer.

One game changer would be if banks prove willing to pass on negative deposit rates to the retail customer. But even without that we seem set to see more of what took place in Denmark a few weeks ago when mortgage bonds moved into negative yield territory. The central bankers seem to be placing their tanks on this lawn and have added loudspeakers blaring out Whitesnake.

And here I go again on my own
Goin’ down the only road I’ve ever known
Like a drifter, I was born to walk alone
And I’ve made up my mind
I ain’t wasting no more time

Of course in the UK we see that the Bank of England has been wrong-footed by this change as it is still promising interest-rate increases. But I expect it will not take the unreliable boyfriend long to do another 180 degree turn.

The Investing Channel

Will fiscal policy save the US economy or torpedo it?

One of the features of the credit crunch era has been the shift in some places about fiscal policy. For example the International Monetary Fund was rather keen on austerity in places like Greece but then had something of a road to Damascus. Although sadly Greece has been left behind as it ploughs ahead aiming for annual fiscal surpluses like it is in a 2012 time warp. Elsewhere there have been calls for a fiscal boost and we do not need to leave Europe to see them. However as I have pointed out before there is quite a distinct possibility that President Donald Trump has read his economics 101 textbooks and applied fiscal policy into an economic slow down. Of course life these days is rarely simple as his trade policy has helped create the slow down and is no doubt a factor in this from China earlier..

Industrial output grew 5.0 percent in May from a year earlier, data from the National Bureau of Statistics showed on Friday, missing analysts’ expectations of 5.5% and well below April’s 5.4%. It was the weakest reading since early 2002. ( Reuters).

Also there has been another signal of economic worries in the way that the German bond future has risen to another all-time high this morning. Putting that in yield terms holding a benchmark ten-year bond loses you 0.26% a year now. Germany may already be regretting issuing some 3 billion Euros worth at -0.24% on Wednesday although of course they cannot lose.

US Fiscal Policy

Let us take a look at this from the perspective of the South China Morning Post.

The US budget deficit widened to US$738.6 billion in the first eight months of the financial year, a US$206 billion increase from a year earlier, despite a revenue boost from President Donald Trump’s tariffs on imported merchandise.

So we can look at this as a fiscal boost on top of an existing deficit. The latter provides its own food for thought as the US economy has been growing sometimes strongly for some years now yet it still had a deficit. In terms of detail if we look at the US Treasury Statement we seem that expenditure has been very slightly over 3 trillion dollars whereas revenue has been 2.28 trillion. If we look at where the revenue comes from it is income taxes ( 1.16 trillion) and social security and retirement at 829 billion and in comparison corporation taxes at 113 billion seem rather thin to me.

The picture in terms of changes is as shown below.

So far in the financial year that began October 1, a revenue increase of 2.3 per cent has not kept pace with a 9.3 per cent rise in spending.

If we look at the May data we see that the broad trend was exacerbated by monthly expenditure being high at 440 billion dollars as opposed to revenue of 232 billion. Marketwatch has broken this down for us.

Most of the jump can be explained by June 1 occurring on a weekend, which forced some federal payments into May. Excluding those calendar adjustments, the deficit still would have increased by 8%, with spending up by 6% and revenue up by 4%.

In terms of a breakdown it is hard not to think of the oil tankers attacked in the Gulf of Oman yesterday as I note the defence numbers, and I have to confess the phrase “military industrial complex” comes to mind.

What will recur are growing payments for Medicare, Social Security and defense. Medicare spending surged 73% — mostly because of the timing shift, though it would have rose 18% otherwise. Social Security benefits rose by 11% and defense spending rose 23%.

So we have some spending going on here and its impact on the deficit is being added to by this from February 8th last year.

The final conference committee agreement of the Tax Cuts and Jobs Act (TCJA) would cost $1.46 trillion under conventional scoring and over $1 trillion on a dynamic basis over ten years,

Thus policy has been loosened at both ends and the forecast of the Congressional Budget Office that the deficit to GDP ratio would be 4.2% this year looks like it will have to be revised upwards..

National Debt

This was announced as being 22.03 trillion dollars as of the end of May, of which 16.2 trillion is held by the public. Most of the gap is held by the US Federal Reserve. Just for comparison total debt first passed 10 trillion dollars in the 2007/08 fiscal year so it has more than doubled in the credit crunch era.

Moving to this as a share of the economy the Congressional Budget Office puts something of a spin on it.

boosting debt held by the public to $28.5 trillion,
or 92 percent of GDP, by the end of the period—up
from 78 percent now.

The IMF report earlier this month was not quite so kind.

Nonetheless, this has come at the cost of a continued increase in the debt-to-GDP ratio (now at 78 percent of GDP for the federal government and 107 percent of GDP for the general government).

Where are the bond vigilantes?

They have gone missing in action. The financial markets version of economics 101 would have the US government being punished for its perceived financial profligacy by higher bond yields on its debt. Except as I type this the ten-year Treasury Note is yielding a mere 2.06% which is hardly punishing. Indeed it has fallen over the past year as it was around 2.9% a year ago and last November went over 3.2%.

So in our brave new world the situation is one of lower bond yields facing a fiscal expansion. There is an element of worries about the economic situation but the main player here I think is that these days we expect the central bank to step in should bond yields rise. So the US Federal Reserve is increasingly expected to cut interest-rates and to undertake more QE style purchases of US government debt. The water here is a little murky because back at the end of last year there seemed to be a battle between the Federal Reserve and the President over future policy which the latter won. So much for the independence of central banks!

The economy

Let me hand you over to the New York Federal Reserve.

The New York Fed Staff Nowcast stands at 1.0% for 2019:Q2 and 1.3% for 2019:Q3. News from this week’s data releases decreased the nowcast for 2019:Q2 by 0.5 percentage point and decreased the nowcast for 2019:Q3 by 0.7 percentage point.

That compares to 2.2% annualised  for a month ago and 3.1% for the first quarter of the year. So the trend is clear.

Comment

As we track through the ledger we see that the US has entered into a new period of fiscal expansionism. The credit entries are that it has been done so ahead of an economic slow down and at current bond yields is historically cheap to finance. The debits come when we look at the fact that the starting position was of ongoing deficits after a decade long period of economic expansion. These days we worry less about national debt levels and more about the cost of financing them, although as time passes and debts rise that is a slippery slope.

The real issue now is how the economy behaves as a sharp slow down would impact the numbers heavily. We have seen the nowcast from the New York Fed showing a slowing for the summer of 2019. For myself I worry also about the money supply data which as I pointed out on the 8th of May looks weak. So this could yet swing either way although this from February 8th last year is ongoing.

The deep question here is can we even get by these days without another shot of stimulus be it monetary,fiscal or both?

 

Why I now fear a sharp slowing of the US economy later this year

So far the trend towards economic weakness has by passed the United States much to the glee of President Trump. Some of you may have seen the rap to camera by Larry Kudlow who is the President of the National Economic Council which ended with “we are killing it on the economy.” Hubris is of course a dangerous thing and as I shall explain looks like it has not had the best of timing. It was based on the 0.8% (as we measure it) economic growth for the first quarter and took us through the latest employment numbers. He did not specify actual numbers but on Friday the Bureau for Labor Statistics told us this.

Total nonfarm payroll employment increased by 263,000 in April, and the unemployment rate declined to 3.6 percent, the U.S. Bureau of Labor Statistics reported today.

They were good numbers for this stage of the cycle although these days the numbers continue to have this problem.

The labor force participation rate declined by 0.2 percentage point to 62.8 percent in April but was unchanged from a year earlier.

For those who have not followed this saga the US economy pre credit crunch had a participation rate of 66/67% and thus there are a lot of missing people from the ratios above. Moving back to positives this from Thursday was really something to shout about.

Nonfarm business sector labor productivity increased 3.6 percent in the first quarter of 2019, the U.S. Bureau of Labor Statistics reported today, as output increased 4.1 percent and hours worked increased 0.5 percent.

As ever for US data that is annualised but at a time of the “productivity puzzle” a 0.9% growth in one quarter after annual increases of 1.7% in 2017 and 2.1% in 2018 suggests the US has entered a better phase.

Credit

Last night there was a flicker of a warning from Consumer Credit flows. From the Federal Reserve

Consumer credit increased at a seasonally adjusted annual rate of 4-1/4 percent during the first quarter. Revolving credit increased at an annual rate of 1-1/2 percent, while nonrevolving credit increased 5-1/4 percent. In March, consumer credit increased at an annual rate of 3 percent.

To UK eyes used to surges in this area nearly all numbers look low! But as we look at the numbers we see a reduction in quarterly growth from the 5.5% of both the last two quarters of 2018 to 4.25%. Indeed in monthly terms the annual growth rate has gone 5.1%, 4.6% and now a sharper drop to 3.1% in March establishing a pretty clear trend.

If we look further into the March data we see that revolving credit actually fell by US $26 billion or 2.5% and it was this which dragged down the numbers. So let us check what it is.

Revolving credit plans may be unsecured or secured by collateral and allow a consumer to borrow up to a prearranged limit and repay the debt in one or more installments. Credit card loans comprise most of revolving consumer credit measured in the G.19, but other types, such as prearranged overdraft plans, are also included.

Okay so it is  credit cards and overdrafts which on a net basis were repaid in March. At 1.06 trillion dollars they are around a quarter of consumer credit. There was a slight dip in what is called nonrevolving credit but there was no sign of the sharp drop that we saw in UK car loans within it.

Money Supply

This has worked as a reliable leading indicator over the past couple of years or so and this caught my eye. The narrow measure of the money supply or M1 in the United States saw a fall of just over forty billion dollars in March. That catches the eye because it does not fit at all with an economy growing at an annual rate of 3.2%. Indeed we see now that over the three months to March M1 money supply contracted by 2.7%. That means that the annual rate of growth has been reduced to 1.9%. Thus we see that it has fallen below the rate of economic growth recorded which is a clear warning sign. Indeed a warning sign which has worked very well elsewhere.

It may well be something that has been driven by Qualitative Tightening as described by James Bullard of the St.Louis Fed on March 7th.

The Fed has been able to reduce reserve balances (deposits by depository institutions) by about 40 percent from the peak of $2.8 trillion, which occurred in July 2014. (The overall size of the balance sheet has declined by a lower percentage from its peak of $4.5 trillion due to currency growth.)

Actually Mr.Bullard seemed pretty desperate with this bit.

This provides one rationale for why balance sheet policy may be less important today than it was during the period when QE was most effective.

So you claim all the gains but the reverse is nothing to do with you. He might get some support today from the manager of Barcelona football club but I doubt many would allow you to laud a 3-0 win but ignore a 4-0 loss!

More seriously the speech from Mr.Bullard is starting to look like an official denial and we know what to do with those. Perhaps he is a fan of the group Electronic.

I hate that mirror, it makes me feel so worthless
I’m an original sinner but when I’m with you I couldn’t care less
I’ve been getting away with it all my life
Getting away with it … all my life

Interest-Rates

Going through the numbers a by now familiar problem emerged. Let me remind you that in the United States official and market interest-rates are of the order of 2.5%. The ten-year yield is just below it and the official interest-rate is 2.25% to 2.5%.

Now let us look at the interest-rates faced by many people. If you want a car loan you pay around 5.5% to a bank and 6.7% to a finance company, if you want a personal loan you pay 10.4% and on a credit card you pay 15.1%. Those affected by this may take some persuading that this is an era of very low interest-rates.

Comment

This is the clearest warning shot we have seen for the US economy. Outright falls in narrow money supply of this magnitude are rare on a monthly basis. Maybe there is an issue with the seasonal adjustment but if we switch to the unadjusted series we see that March was 37 billion dollars lower than in December which is a very different pattern to the year before. Thus as we move through the autumn I now fear a US slow down and another month or so like this would make me fear a sharp slow down.

Moving to the wider measure called M2 also shows a slowing as the rate of growth over the past twelve months of 3.8% has been replaced by one of 2.8% in the latest three months. It tends to impact further ahead ( 2 years or so) and represents a combination of growth and inflation so as you can see it is not optimistic either. However it is not as reliable as the narrow money signal has been.

Thus in something that raises a wry smile we are facing the possibility that President Trump has been right in calling for an interest-rate cut.

 

 

 

Central bankers are warming us up for more inflation again

A feature of the credit crunch era is the repetition of various suggestions from governments and central banks. One example of this has been the issue of Eurobonds which invariably has a lifespan until the nearest German official spots it. Another has been the concept of central banks overshooting their inflation target for a while. It is something that is usually supported by those especially keen on ( even more) interest-rate cuts and monetary easing so let us take a look.

Last Wednesday European Central Bank President Mario Draghi appeared to join the fray and the emphasis is mine.

Well, on your second question I will answer saying exactly the same thing. We don’t tolerate too low inflation; we remain fully committed to using all necessary instruments to return inflation to 2% without undue delay. Likewise, our inflation aim doesn’t imply a ceiling of 2%. Inflation can deviate from our objective in both directions, so long as the path of inflation converges towards our medium-term objective. I believe I must have said something close to this, or something to this extent a few other times in the past few years.

Nice try Mario but not all pf us had our senses completely dulled by what was otherwise a going through the motions press conference. As what he said at the press conference last September was really rather different.

In relation to that: shouldn’t the ECB be aiming for an overshoot on inflation rather than an undershoot given that it’s been below target for so long?

Second point: our objective is an inflation rate which is below, but close to 2% over the medium term; we stay with that, that’s our objective.

As you can see back then he was clearly sign posting an inflation targeting system aiming for inflation below 2%. That was in line with the valedictory speech given by his predecessor Jean-Claude Trichet which gave us a pretty exact definition by the way he was so pleased with it averaging 1.97% per annum in his term. So we have seen a shift which leads to the question, why?

The actual situation

What makes the switch look rather odd is the actual inflation situation in the Euro area. Back to Mario at the ECB press conference on Wednesday.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.4% in March 2019, after 1.5% in February, reflecting mainly a decline in food, services and non-energy industrial goods price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline over the coming months.

So we find that inflation is below target and expected to fall further in 2019. This was a subject which was probed by one of the questions.

 It’s quite clear that the sliding of the five-year-to-five-year inflation expectations corresponds to a deterioration of the economic outlook. It’s also quite clear that as the economic outlook, especially the economic activity slows down, also markets expect less pressure in the labour market, but we haven’t seen that yet.

The issue of markets for inflation expectations is often misunderstood as the truth is we know so little about what inflation will be then. But such as it is again  the trend may well be lower so why have we been guided towards higher inflation being permitted.

It might have been a slip of the tongue but Mario Draghi is usually quite careful with his language. This leaves us with another thought, which is that if he is warming us up for an attitude change he is doing soon behalf of his successor as he departs to his retirement villa at the end of October.

The US

Minneapolis Fed President Neel Kashkari suggested this in his #AskNeel exercise on Twitter.

Well we officially have a symmetric target and actual inflation has averaged around 1.7%, below our 2% target, for the past several years. So if we were at 2.3% for several years that shouldn’t be concerning.

Also he reminded those observing the debate on Twitter that the US inflation target is symmetric and thus unlike the ECB.

Yes, i think we should really live the symmetric target and not tap the brakes prematurely. This is why I’ve been arguing for more accommodative monetary policy. But we are undertaking a year long review of various approaches so I am keeping an open mind.

As you can see with views like that the Donald is likely to be describing Neel Kashkari as “one of the best people”.  If we move to the detail there are various issues and my initial one is that inflation tends to feed on itself and be self-fulfilling so the idea that we can be just over the target at say 2.3% is far from telling the full picture. Usually iy would then go higher. Also if your wages were not growing or only growing at 1% you would be concerned about even that seemingly low-level of inflation.

If we consider the review the US Fed is undertaken we see from last week’s speech by Vice Chair Clarida a denial that it has any plans to change its 2% per annum target and we know what to do with those! Especially as he later points out this.

In part because of that concern, some economists have advocated “makeup” strategies under which policymakers seek to undo, in part or in whole, past inflation deviations from target. Such strategies include targeting average inflation over a multiyear period and price-level targeting, in which policymakers seek to stabilize the price level around a constant growth path.

As the credit crunch era has seen inflation generally be below target this would be quite a shift as it would allow for quite a catch-up. Which of course is exactly the point!

Comment

Central bankers fear that they are approaching something of a nexus point. They have deployed monetary policy on a scale that would not have been believed before the credit crunch hit us. Yet in spite of the negative interest-rates, QE style bond purchases and in some cases equity and property buys we see that there has been an economic slow down and inflation is generally below target. Also the country that has deployed monetary policy the most in terms of scale Japan has virtually no inflation at all ( 0.2% in February).

At each point in the crisis where central bankers face such issues they have found a way to ease policy again. We have seen various attempts at this and below is an example from Charles Evans the President of the Chicago Fed from back in March 2012.

My preferred inflation threshold is a forecast of 3 percent over the medium term.

We have seen others look for 4% per annum. What we are seeing now is another way of trying to get the same effect but this time looking backwards rather than forwards.

There are plenty of problems with this. Whilst a higher inflation target might make life easier for central bankers the ordinary worker and consumer faces what economists call “sticky” wages. Or in simple terms prices go up but wages may not and if the credit crunch is any guide will not. My country the UK suffered from that in 2010/11 when the Bank of England “looked through” consumer inflation which went above 5% with the consequence of real wages taking a sharp hit from which they have still to recover.

Next comes the issue that in the modern era 2% per annum may be too high as a target anyway. In spite of all the effort it has been mostly undershot and as 2% in itself has no reason for existence why not cut it? Then we might make progress in real wage terms or more realistically reduce the falls. That is before we get to the issue of inflation measures lacking credibility in the real world as things get more expensive but inflation is officially recorded as low.

Meanwhile central bankers sing along to Marvin Gaye.

‘Cause baby there ain’t no mountain high enough

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What is happening with US house prices and its economy?

Sometimes it helps to look back so let us dip into Yahoo Finance from the 17th of December last year.

Home price growth has slowed for six consecutive months since April, according to the S&P CoreLogic Case-Shiller national home price index. And for the first time in a year, annual price growth fell below 6%, dropping to 5.7% and 5.5%, in August and September, respectively. October home price results will be released later this month.

So we see what has in many places become a familiar pattern as housing markets lose some of their growth. There was and indeed is a consequence of this.

“A couple of years of home prices running twice the rate of home income growth leads to affordability challenges,” said Mortgage Bankers Association Chief Economist Mike Fratantoni. “If you’re a buyer in 2019, you won’t see home price running away from you at the same speed in 2018.”

I think he means wages when he says “home income growth” but he is making a point which we have seen in many places where house price growth has soared and decoupled from wage growth. This has been oil by the way that central banks slashed official interest-rates which reduced mortgage-rates and then also indulged in large-scale bond buying which in the US included Mortgage-Backed Securities to further reduce mortgage-rates. This meant that affordability improved as long as you were willing to look away from higher debt burdens and the implication that should interest-rates rise the song “the heat is on” would start playing very quickly.

Or if you wish to consider that in chart form Yahoo Finance helped us out.

That is a chart to gladden a central bankers heart as it shows that the policy measures enacted turned house prices around and led to strong growth in them. The double-digit growth of late 2013 and early 2014 will have then scrambling up into their Ivory Towers to calculate the wealth effects. But the problem is that compared to wage growth they moved away at 8% per annum back then and the minimum since has been 2% per annum. That means that a supposed solution to house prices being too high and contributing to an economic crash has been to make them higher again especially relative to wages.

What about house price growth now?

Yesterday provided us with an update.

CoreLogic® (NYSE: CLGX), a leading global property information, analytics and data-enabled solutions provider, today released the CoreLogic Home Price Index (HPI) and HPI Forecast for February 2019, which shows home prices rose both year over year and month over month. Home prices increased nationally by 4 percent year over year from February 2018. On a month-over-month basis, prices increased by 0.7 percent in February 2019.

So there has been a slowing in the rate of growth which is reflected here.

“During the first two months of the year, home-price growth continued to decelerate,” said Dr. Frank Nothaft, chief economist for CoreLogic. “This is the opposite of what we saw the last two years when price growth accelerated early.

Looking ahead they do however expect something of a pick-up.

“With the Federal Reserve’s announcement to keep short-term interest rates where they are for the rest of the year, we expect mortgage rates to remain low and be a boost for the spring buying season. A strong buying season could lead to a pickup in home-price growth later this year.”

That gives us another perspective on the change of policy from the US Federal Reserve. So far its U-Turn has mostly been locked at through the prism of equity prices partly due to the way that President Trump focuses on them. But another way of looking at it is in response to slower house price growth which was being influenced by higher mortgage rates as the Federal Reserve raised interest-rates and reduced its bond holdings. This saw the 30-year mortgage-rate rise from just under 4% to a bit over 4.9% in November, no doubt providing its own brake on proceedings.

What about now?

If we look at monetary policy we see that perhaps something of a Powell Put Option is in place as at the end of last week the 30-year mortgage rate was 4.06%. Now bond yields have picked up this week so lets round it back up to say 4.15%. Even so that is quite a drop from the peak last year.

There is also some real wage growth according to the Bureau of Labor Statistics.

Real average hourly earnings for all employees increased 1.9 percent, seasonally adjusted, from February 2018 to February 2019. The change in real average hourly earnings, combined with a 0.3-percent decrease in the average workweek, resulted in a 1.6-percent increase in real average weekly earnings over this 12-month period.

In terms of hourly earnings the situation has been improving since last summer whereas the weekly figures were made more complex by the drop in hours worked meaning we particularly await Friday’s update for them.

Moving to the economy then recent figures have been a little more upbeat than when we looked at the US back on the 22nd of February but not by much.

The New York Fed Staff Nowcast stands at 1.3% for 2019:Q1 and 1.6% for 2019:Q2..News from this week’s data releases left the nowcast for 2019:Q1 unchanged and decreased the nowcast for 2019:Q2 by 0.1 percentage point.

Of the main data so far this week we did not learn an enormous amount from the retail sales numbers from the Census Bureau.

Advance estimates of U.S. retail and food services sales for February 2019, adjusted for seasonal variation
and holiday and trading-day differences, but not for price changes, were $506.0 billion, a decrease of 0.2
percent (±0.5 percent)* from the previous month, but 2.2 percent (±0.7 percent) above February 2018.

As these are effectively turnover rather than real growth figures a monthly fall is especially troubling but January had been revised higher.

Comment

We are observing concurrent contradictory waves at the moment. The effect from 2018 was of a slowing economy combined with monetary tightening in terms of higher mortgage-rates. More recently after the policy shift we have seen mortgage-rates fall pretty sharply and since last summer a pick-up in wage growth. So we can expect some growth and maybe we might even see a phase where wage growth exceeds house price growth. But it would appear that the US Federal Reserve has shifted policy to keep asset (house and equity) prices as high as it can so it may move again,

As to the overall picture this from Corelogic troubles me.

According to the CoreLogic Market Condition Indicators (MCI), an analysis of housing values in the country’s 100 largest metropolitan areas based on housing stock, 35 percent of metropolitan areas have an overvalued housing market as of February 2019. The MCI analysis categorizes home prices in individual markets as undervalued, at value or overvalued, by comparing home prices to their long-run, sustainable levels, which are supported by local market fundamentals (such as disposable income).

Only 35% overvalued? Look again at the gap between house price rises and wage rises in the Yahoo chart above. So if we look backwards very few places must have been overvalued just before the crash. Also times are hard for younger people.

Frank Martell, president and CEO of CoreLogic. “Our research tells us that about 74 percent of millennials, the single largest cohort of homebuyers, now report having to cut back on other categories of spending to afford their housing costs.”

I am not sure that goes with the previous research. Also if the stereotype has any validity times for millennials in the US are grim or should that be toast?

The price for Hass avocados from Michoacán, Mexico’s main avocado producing region, increased 34 percent on Tuesday amid President Trump’s calls to shut down the U.S.-Mexico border ( The Hill).

Let me end with a reminder from CoreLogic that averages do not tell us the full story.

Annual change by state ranged from a 10.2 percent high in Idaho to a -1.7 percent low in North Dakota