Just when Turkey had hopes of improvement the Lira has plunged again

The weekend just gone was a long one in the UK as for those unaware the UK has a proliferation of bank holidays at this time of year and then none at all until the end of summer. During that time we saw President Trump try to dominate the news with has new trade tariffs only for him to discover that a Royal Baby trumps everything. The latter news would be welcome in Turkey although sadly for this particular perspective the Ottomans are long gone. Thus they cannot help with this development. from yesterday.

The Turkish lira is tanking after the countries highest electoral body overturned the municipal election results in Istanbul. Far and away the worst performing major currency today. ( @TheStalwart )

So far today the situation continues to deteriorate according to @IGSquawk.

Turkish LIra once again getting hammered this morning: -1.61% against other currencies

6.17027 +1.46%

6.92511 +1.61%

8.10287 +1.66%

17.918 -1.55%

Somebody has tweeted that  at one foreign exchange bureau at Gatwick Airport if you wish to switch from Turkish Lira to Sterling you have to pay 10.09 which is a version of usury really.

How did we get here?

The situation was exacerbated by the election or perhaps I should say second election news but there were issues on the horizon as it was. Let me illustrate from Reuters.

 Turkey is ready to provide its full support to international investors, President Tayyip Erdogan said on Saturday, adding that while attacks on the economy via its currency continued, the government was in control of the situation………“While efforts to collapse our economy through the foreign exchange rate continue, we have control now,” Erdogan told Turkish businesspeople in Istanbul.

This is a familiar feature of a foreign exchange crisis as it is a cheap hit for a politician to blame foreigners and with the emphasis on them being for some reason speculating against the country in question. Maybe one or two do but in general currencies are sold because of other events and there have been some. For example President Erdogan might like to look at his own words according to Reuters from last Thursday.

“Together, we will win this battle against those trying to trap Turkey in the exchange rate, interest rate and inflation plot,” he said in a speech to business people in Ankara. “We are certainly determined to lower exchange rates, interest rates and inflation to targeted levels,” he added.

For those unaware Erdogan has also advanced the theory that lowering interest-rates will reduce inflation. So he had been digging under the foundations of the Turkish Lira which added to the debate over what was going on with the foreign exchange reserves.

The Financial Times reports that Turkey’s currency reserves may not equal the $28.1 billion touted by the central bank. Instead, they could be inflated by short-term borrowing via swaps. Strip those out and reserves total only $16 billion. ( forexlive in Mid-April).

It is not that unusual for a central bank to borrow to boost its reserves but the crucial phrase here is “short-term” which raises the issue of what happens if the borrowing matures before any crisis ends? So as you can see the currency was on yellow alert and a combination of the tariff and re-election news switched the yellow to red.

The defenders

There are two main defences here which are interest-rates and the reserves we have just looked at.

The Central Bank of Turkey increased its benchmark interest rate on Thursday to 24 percent, a hike of 625 basis points from the previous rate of 17.75 percent. ( CNBC last September)

They are still there and Turkey has been using its reserves also to support the currency. Also there have been examples of state banks buying too. The operation seemed to be trying to hold the Lira below 6 versus the US Dollar which is another reason for the sharp rise now as the defenders got beaten, a bit like in football where a team resists the first goal for ages but after it they let in several more.

The economy

Back on the 13th of July last year I pointed out this.

A sharp brake has been applied to the economy via the higher cost of imports and via higher interest-rates.

Actually interest-rates had only risen to 17.75% back then so more was to come. Also I highlighted problems in the energy industry in particular because it had borrowed in US Dollars and the current issue with the reserves reminds me of this.

This is also familiar as countries which are in danger of trouble make it worse by borrowing in a foreign currency because it is cheaper in interest-rate terms. After all what could go wrong?

As to the economy let us switch to the central bank or TCMB inflation report from the end of last month.

In the final quarter of 2018, GDP decreased by 3.0% on an annual basis and by 2.4% on a quarterly basis.

So the sharp brake is being applied and also there is this.

While the contraction in economic activity in the final quarter of 2018 was driven by domestic demand conditions, net exports continued to underpin growth and the rebalancing trend in the Turkish economy became more apparent.

What Talking Heads would call the “Slippery People” bit is the use of “net exports” which can easily be confused and read as exports. You see the contraction in domestic demand boosts GDP via net exports and flatters the numbers which is really very different to an export boom. It is a version of what is called the J-Curve and indeed the reverse J-Curve in economic theory.

The Ankara Times has kindly highlighted this.

Turkey’s foreign trade deficit in the first quarter of this year fell 67.4% year-on-year, the country’s statistical authority announced on Tuesday.

The figure totaled some $6.8 billion from January to March, improving from a $20.7 billion deficit in same period last year, according to TurkStat.

Turkish exports rose to $42.2 billion — up 2.7% on a yearly basis — while imports slipped to $49 billion, down 20.8%.

So the GDP boost on last year is US $13.9 billion which is welcome. But the vast majority of the gain is lower imports which means that the GDP numbers are flattered when people are worse off which is another flaw to add to our list of issues with it. Putting it another way there are similarities with what happened to Greece where reality was flattered before a later “surprise”, which if you look more deeply is no surprise at all.

As to inflation the objective of single figures remains far away.

In March, consumer prices were up by 1.03% and annual inflation rose by 0.04 points to 19.71%. In this period, annual inflation increased in food and energy groups while it decreased in the core goods group. The rise in annual food inflation was driven by the significant hike in prices of fresh fruits and vegetables.

The ordinary worker and consumer will not welcome the rise in food and energy prices in particular. If you are fortunate to be able to spend in a foreign currency over there then some good are cheap as for example I have been told a litre of petrol at the pump is 90 pence. That will help with tourism income.

Comment

Just over a year ago on the third of May I published my view on how to deal with a foreign exchange crisis.

So a central bank can fight a currency decline but the truth is that it can only do so on a temporary basis…….However some of the moves can make things worse as for example knee-jerk interest-rate rises. Imagine you had a variable-rate mortgage in Buenos Aires! You crunch your domestic economy when the target is the overseas one. As to building up foreign exchange reserves by borrowing.

Whilst my emphasis was on Argentina we see that Turkey has raised interest-rates to 24% and continues to apply them thus crunching the domestic economy with not only no sign of a let up but rather perhaps the reverse. I was also way ahead on the issue of borrowing to support your currency reserves.

Moving to the specific I did get to Turkey.

Good market spot: Turks are buying gold to hedge against booming inflation and a falling currency ( Lionel Barber)……Anecdotally central London agents tell me they are seeing an increase in Turkish buyers this year ( Henry Pryor)

How have they done? As the US Dollar is up 44% and the UK Pound 40% pretty well although as individual markets both gold and London property have had better years. Actually when you look at the performance of the Turkish Lira which was ~1.3 to the US Dollar at the beginning it is hard to lose by investing abroad and that of course is part of the problem.

But returning to a pure economics mandate just when some factors are beginning to help Turkey has returned to the same set of problems.

Podcast

Has the Bank of England forgotten about its currency reserves?

We are in the season for a raft of UK economic data although at the moment markets are being driven by Brexit developments, or rather the apparent lack of them. One consequence of this was a nearly 2 cent fall versus the US Dollar to below US $1.26 and around a 1 cent fall versus the Euro to below 1.11. I await the exact numbers on the change in the trade weighted or effective exchange rate index but the move was such that we saw something that under the old rule of thumb was equivalent to a 0.25% Bank Rate cut. That reminded me of this from early April ( no not the 1st…) 2016 in City AM.

Britain’s foreign currency reserves reached a new record high last month, passing $100bn (£70.5bn) for the first time, as the UK looks to be building a buffer to defend the pound against the prospect of a currency crisis ahead of the EU referendum.

 

Another $4.5bn in reserves was acquired in March, taking the total amount held to $104.2bn and fuelling speculation that the Treasury and Threadneedle Street are getting their ducks in a row to deal with wild swings in the value of sterling around the time of the referendum.

Actually the Bank of England has been building up its foreign exchange reserves in the credit crunch era and as of the end of October they amounted to US $115.8 billion as opposed as opposed to dips towards US $35 billion in 2009. So as the UK Pound £ has fallen we see that our own central bank has been on the other side of the ledger with a particular acceleration in 2015. I will leave readers to their own thoughts as to whether that has been sensible management or has weighed on the UK Pound £ or of course both?!

But my fundamental point is to enquire as to under what circumstances would the Bank of England intervene to support the currency? This is what it is officially for.

The EEA was established in 1932 to provide a fund which could be used for “checking undue fluctuations in the exchange value of sterling”.

This, in my opinion could not contrast much more with the UK Gilt market which has surged due to expectations, or fears if you prefer of more QE bond buying from the Bank of England. It does not get reported much but the UK ten-year Gilt now yields a mere 1.24%.

Labour Market

Productivity

Yesterday our official statistician’s produced some research which backed up a long-running theme of my work.

Productivity gap narrows

As a reminder I wrote this back on January 18th on the subject.

I have regularly argued that it is very likely we have miss measured productivity and therefore the crisis will to some extent fade away……..If we go back to the peak headlines where for example the Bank of England argued we were some 19% below where we would have been projecting pre crisis trends we are left wondering how much is due to miss measurement?

Or in musical terms we need some Imagination

Could it be that it’s just an illusion
Putting me back in all this confusion
Could it be that it’s just an illusion now?

That was partly in response to some new work by Diane Coyle suggesting that the telecoms sector had in fact seen more growth than the official statistics recorded. Regular readers will not be surprised to learn that the official response was a somewhat woeful tweaking of the numbers to give basically the same answer as before,

But now there has been a new development.

Historically each country has used the best data available to it, but the OECD’s working paper shows that, when using a more consistent method to compare total hours worked, the UK’s labour productivity improves significantly relative to other countries. For example, the UK’s productivity gap with the US would reduce by about 8 percentage points from 24% to 16% when adopting the simple component method approach.

I do not know about you but when I compare numbers I always look to do them on as “like for like” basis as possible and find it not a little breathtaking that this has not been done before. But the good news is that it has now.

Not everyone’s numbers improve as for example Greece sadly gains little. Oh and if I was looking at these numbers I would be thinking of words like “offshoring” and phrases like “Gross National Product” about the stellar performances of Luxembourg and Ireland.

A clear signal was of course given earlier this year by the Office of Budget Responsibility going bearish on productivity trends.

Good news on wages

Here we go.

Latest estimates show that average weekly earnings for employees in Great Britain in nominal terms (that is, not adjusted for price inflation) increased by 3.3%, both excluding and including bonuses, compared with a year earlier.

As we welcome this let us take the rare opportunity to congratulate the Bank of England on beginning to look correct. After all this has come after many years of pain for it. The official view tells us this about real wages.

Latest estimates show that average weekly earnings for employees in Great Britain in real terms (that is, adjusted for price inflation) increased by 1.0% excluding bonuses, and by 1.1% including bonuses, compared with a year earlier.

The catch is that the number above relies on an inflation number called CPIH which is dragged lower by the use of Imputed Rents. If we switch to the previous measure CPI real wage growth falls to 0.7% or so as the depressing influence of Imputed Rents falls out of the data. If we use RPI then rather than real wage growth we find that it is at least no longer falling. Can anybody think why the establishment does not like the RPI measure? Apart from when it is used in their own defined benefit pensions I mean.

The numbers for October on its own provided some further cheer as at 3.9% it even exceeded RPI by 0.6% as the numbers were pulled higher by the service sector (4.2%).

Employment continues to grow as well.

There were an estimated 32.48 million people in work, 79,000 more than for May to July 2018 and 396,000 more than for a year earlier.

Not so good was the rise in unemployment for men of 27,000 and I am putting it like that as female unemployment fell by 7,000. It was due to a shift out of the inactivity sector so we will have to wait to see what it really means.

Comment

There is a lot to consider right now but let us remind ourselves that producers of official statistics need to consume a slice of humble pie every now and then. Yesterday saw two clear examples of this with the large revision to UK trade especially ( surprise,suprise ) for the services sector and then a solid chunk of the productivity gap faded away. Or rather the perceived productivity gap. The latter had been on my mind Sunday evening because as I went for a run around Battersea Park after 8 pm and noted the shop selling Christmas trees was still open. Great for consumers but bad for one way at least of measuring productivity.

But left me leave you with the question of the day. When would Mark Carney and the Bank of England actually use our currency reserves?

 

 

 

India is counting the cost of its crude oil dependency

Tucked away in the news stream of the past few days has been a developing situation in India. Whilst the headlines have been made by Turkey there have been currency issues in the largest part of the sub-continent as well. Here is DNA India on the subject.

Indian Rupee on Thursday had hit a fresh record low, the Rupee opened at 70.22 versus the US dollar. In wake of the Turkey crisis, the Indian currency started off the session on a weak note. Earlier on Tuesday, after opening at a marginal high of 69.85 against the US Dollar, the Indian rupee touched an all-time low of 70 per US dollar.

The Indian currency touched an all-time low of 70.08 against the US dollar, while marking depreciation of around 10 per cent in 2018.

The fall came majorly due to a drop in Turkish Lira, which helped the US dollar to gained strength on the back of fears that economic crisis in Turkey could spread to other global economies.

In fact it fell to 70.7 this morning versus the US Dollar which is an all time low. Some of the move may have been exacerbated by the issues facing Turkey but over the past couple of days the Turkish Lira has rallied strongly whereas the Rupee has continued to fall. A factor has been the strength of the US Dollar or what is being called King Dollar. This reminds me that themes and memes can change rather quickly in the currency world if we step back in time to the 25th of January.

“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.

If pressed now I guess the US Treasury Secretary would emphasise this bit.

“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.

Returning to the Rupee we see that it had started to fall before the turn in the US Dollar as conveniently it began at the turn of the year when it was at 63.3 versus it.

What are the consequences?

The first is simply inflation or as DNA India puts it.

Continuous downfall in Indian Rupee is worrisome for imported goods as the cost of imports will go up.  Currently, India imports around 80 per cent of its crude requirement. The rupee downfall will expand India’s import bill and will eventually be contributing to the inflation.

This will add to the situation below. From The Times of India.

Inflation based on consumer price index (CPI) for the month of July came at 4.17 per cent, government data ..

That was an improvement and as so often in India the swing factor was food prices.

The food inflation came at 1.37 per cent, driven by cooling of pulses, vegetable and sugar rates.

However a boost is on its way and as inflation is above the 4% target things could get especially awkward should food prices swing the other way.

Interest-Rates

One of the economics 101 assumptions is that higher interest-rates boost a currency but as I warned back on the 3rd of May the situation is more complex than that and Argentina reminded us again by raising to 45% earlier this week. As for India we see this.

increase the policy repo rate under the
liquidity adjustment facility (LAF) by 25
basis points to 6.5 per cent. ( Reserve Bank of India August Bulletin)

That was the second rise this year and these have reversed the previous downwards trend. Of course the problem is that the RBI is perhaps only holding station with the US Federal Reserve.

Intervention

India maintains a sizeable foreign currency reserve which was US $406 billion at the last formal update in March. However it will not be that now if this from Reuters on Tuesday is any guide.

Subhash Chandra Garg, secretary at the department of economic affairs…………said the RBI has spent about $23 billion so far to intervene ..

So we see that the fall has come in spite of intervention which sits rather oddly with the claim from Subhash Chandra Garg that the currency fall does not matter. Also it is usually rather unwise to indicate a currency level as he did (80) as events have a way of making a fool of you.
Anyway using reserves can help for a while but care is needed as quickly markets switch to calculating how much you have left and how long they will last at the current rate of depletion. At that point intervening can make things worse.
Trade
Looking at India’s  domestic economy a clear factor in the currency debate is its trade position. The latest numbers were as highlighted above by DNA India heavily affected by the oil price.

 

Oil imports during July 2018 were valued at US $ 12.35 Billion (Rs. 84,828.57 crore) which was 57.41 percent higher in Dollar terms and 67.76 percent higher in Rupee terms compared to US $7.84 Billion (Rs. 50,565.29 crore) in July 2017.

Such a development feeds into the existing Indian trade problem.

Cumulative value of exports for the period April-July 2018-19 was US $ 108.24 Billion (Rs 7,29,823.08 crore)……….Cumulative value of imports for the period April-July 2018-19 was US $ 171.20 Billion (Rs. 11,54,881.70 crore).

Whilst a little care is needed as petroleum exports grew by 30% overall Indian export growth is on a tear at 14%. Many would love that, but the rub is that not only are imports much larger but due to India’s oil dependency they are rising at an annual rate of 17%. So as we stand things are getting worse and according to Business Standard there is trouble ahead.

India’s crude oil import bill is likely to jump by about $26 billion in 2018-19 as rupee dropping to a record low has made buying of oil from overseas costlier, government officials said today…….. If the rupee is to stay around 70 per dollar for the rest of the ongoing fiscal, the oil import bill will be $114 billion, he said.

Comment

The other side of the coin about the Indian economy was highlighted by the IMF only last week.

India’s economy is picking up and growth prospects look bright—partly thanks to the implementation of recent policies, such as the nationwide goods and services tax. As one of the world’s fastest-growing economies—accounting for about 15 percent of global growth—India’s economy has helped to lift millions out of poverty.

Although developments since the writing of the report may have more than a few wondering about this bit.

India can benefit from improving its integration with global markets.

Perhaps it is a case of Blood,Sweat and Tears.

What goes up must come down
Spinnin’ wheel got to go ’round

There was of course the domestic issue created by the demonetisation debacle not that long ago but the real achilles heel for India is oil. Something of a perfect storm has hit it where the oil price has risen by 40% over the past year and more recently that has been exacerbated by a stronger US Dollar.

So both the economic and Rupee issues seem as much to do with energy policy as conventional economics. Can India find a way of weaning itself off at least some of its oil dependency?

Me on CoreFinance TV

 

How many more central banks will end up buying equities?

One of the features of modern economic life is the way that central banks have expanded their operations. In a way that development is a confession of failure ( as why are new policies requited if they existing ones are working? ) Although of course that would be met with as many official denials as you can shake a stick at. We moved from sharply lower interest-rates to QE (Quantitative Easing) bond purchases to credit easing and in some places to negative interest-rates. The latter brings me to the countries I classified as the “Currency Twins” Japan and Switzerland who both have negative interest-rates and some negative bond yields. In fact this morning the Bank of Japan gave Forward Guidance on this subject.

The Bank intends to maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding
economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019.

So the first feature seems to be negative interest-rates and perhaps ones which persist as both Japan and Switzerland are on that road. Thus you start by funding yourself with money at a negative cost something which ordinary investors can only dream of. But we also have countries with negative interest-rates which have not ( so far) bought equities such as Sweden and the Euro area although the latter does have a sort of hybrid in its ongoing corporate bond programme.

However we find more of a distinguishing factor if we note that both Japan and Switzerland ended up with soaring exchange-rates due to the impact of the large carry-trades that took place before the credit crunch. This was what led me to label them the “Currency Twins”  and the period since then has seen them respond to this which has seen them via different routes end up as equity investors on a larger and larger scale albeit by a different route. An irony comes if we look at an alternative universe where Germany had its own currency too as in that timeline it too would have seen a soaring currency and presumably it too would be an equity investor.

Bank of Japan

Here is this morning’s announcement.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual
paces of about 6 trillion yen and about 90 billion yen, respectively. With a view to lowering risk premia of asset prices in an appropriate manner, the Bank may increase
or decrease the amount of purchases depending on market conditions.

As you can see the Tokyo Whale will continue to gobble up the plankton from the Japanese equity world and at quite a pace. The latter sentence refers to the way it buys more when the market drops which of course looks rather like a type of put option for other equity investors. That is what it means by “lower risk premia” although more than a few would question if this is “appropriate”

Also there are ch-ch-changes ahead. From the Financial Times.

the BoJ also said it would alter the balance of its ¥6tn ($54bn) per year ETF buying programme so that a much greater proportion was focused on ETFs that track the broader, market cap-weighted Topix index. The scale of its Topix-linked ETF purchases would rise from ¥2.7tn to ¥4.2tn per year, the bank said in its statement.

The Japanese owned FT fails however to note the main two significant points of this. The first is that the Tokyo Whale was simply running out of Nikkei index based ETFs to buy as it was up to around 80% of them and of course rising. The next comes from a comparison of the two indices where the Nikkei is described as very underweight this sector and it is much larger in the Topix ( ~9%). Regular readers will no doubt have figured that this is the “precious” or banking sector.

As of this month it has made major purchases on 3 days buying 70.5 billion Yen on each occasion.

Let us move on by noting that Japan has bought equities but so far they have been Japanese ones boosting its own market and keeping the impact on the exchange-rate to an implied one.

Swiss National Bank

The SNB has been a buyer of equities as well but came to it via a different route which is that once it implemented its “unlimited” policy on foreign exchange intervention it then found it had “loadsamoney” and had to find something to do with all the foreign currency it had bought. The conventional route would be to buy short-dated foreign government bonds which it did but because of the scale of the operation it began to impact here and may have been a factor in some Euro area bond yields going negative. The Geneva Whale would have found itself competing with the ECB QE operation if it had carried on so switched to around 20% of its foreign exchange reserves going into equities.

That is a tidy sum when we note it had some 748.8 billion Swiss Francs of foreign exchange reserves at the end of June. How is that going?

. The profit on foreign currency positions amounted to CHF 5.2 billion.

So at that point rather well but of course it is rather strapped in for the ride with its holdings which will have led to some fun and games more recently as it notes its holding in Facebook as the tweet below illustrates.

 

If you ride the tiger on the way up you can end up getting bitten by it in the way down. Also a passive investment strategy means you raise your stake as prices rise whereas an active one means you are an explicit as opposed to an implicit hedge fund. Some like to express this in terms of humour.

SNB OFFERS TO BUY UNLIMITED AMOUNT OF TESLA AT 305 ( @RudyHavenstein )

We do not know if the recent weakness in the so-called FANG tech stocks is just ebb and flow or a sea change, but the latter would have the SNB entering choppy water.

Comment

We see that this particular development can be traced back to the carry trade and a rising currency. Both of the countries hit by this ended up with central banks buying equities although only the Swiss have bought foreign equities. Perhaps the Japanese think that as a nation they own plenty of foreign assets already or there is an inhibition against supporting a gaijin market. That would be both emotional and perhaps logical if we note how many lemons have been passed onto them.

Looking ahead newer entrants may not follow the same path as we note that once a central bank crosses a monetary policy Rubicon it has the effect of emboldening others. The temptation of what so far have been profits will be an incentive although of course any suggestion that such moves are for profit would be meant with the strictest official denial. Should there be losses however we know that they will be nobody’s fault unless they become large in which case it will be entirely the fault of financial terrorists.

Putting this into perspective is the price I am about to describe. Around 1000 until the middle of 2016 but rose to 8380 earlier this year and as of the last trade 6080. One of those volatile coins the central bankers dislike so much? Nope, it is the SNB share price in Swiss Francs.

 

How many central banks will turn into hedge funds?

One of the under appreciated consequences of all the monetary easing and intervention that has gone on in the world since the credit crunch is the impact on central banks themselves. What I mean is that they find themselves holding ever larger sums of assets which in many cases they are compounding by often holding ever riskier ones. They are taking advantage of the fact that they are backed by national treasuries – although being backed by 19 national treasuries as the European Central Bank or ECB  has a different perspective in my opinion  – allowing the view that this is somehow risk-free to proliferate. Well it may not be risk-free for the taxpayers who find themselves backing all this!

The Bank of England

So far it has mostly confined itself to what we might call bog standard QE where it purchases UK Gilts. However it has been lengthening the maturity of its £375 billion of holdings in an Operation Twist style and now for example has some £989 million of our 2068 Gilt. Too Infinity! And Beyond! Indeed…

The main risk to taxpayers is in fact even less understood operations like the house price boosting Funding for Lending Scheme. Some £69 billion of cheap loans to banks have been issue here and should house price ever fall there are risks.

Foreign Exchange Reserves

These seem to be safe but the QE era has led to changes here because you see conventional theory has central banks investing in shorter dated bonds. Some of you will be spotting the problem already! This is how the Financial Times puts it.

European and Japanese (interest) rate cuts are putting pressure on many central banks’ returns — a source of income used to cover running costs and to provide finance ministries with profits on which they have come to rely.

In other words investing at negative yields carries a guaranteed loss if you hold to maturity which is awkward to say the least when you come to explain your stewardship to auditors and indeed taxpayers. The ECB in particular is hoist by its own petard here as I recall it arguing that value on maturity was the way of valuing Greek bonds back in the day and of course that is still convenient there. But not elsewhere. We have just excluded the Euro and the Yen which of course are major markets (even now some 20% and 4% of reserve assets respectively) and logical ones to put some of your reserves. So what are they doing? From the FT.

central bank reserve managers are making or “seriously considering” buying bundles of loans repackaged as asset-backed securities or switching out of currencies affected by negative rates.

There are issues here as we move from theoretically at least safe government bonds to what are less safe assets. There are in fact two issues which the FT does not point out so let me point them out.

The good news for central banks is that a consequence of their own actions is that they have made a profit. Of course they will not put it like that! No doubt the press communiques will concentrate on skilled management and their own abilities. But the QE era has driven the prices of the bonds they hold as foreign exchange reserves higher and hence bingo. Even the own-goal by former UK Chancellor Gordon Brown when he sold gold at what is now cruelly called Brown’s Bottom will look a little better as the replacement strategy of buying bonds does well.

The catch is for future investment as what do you do now with bond prices so high? Indeed these “independent” central bankers will be under pressure from politicians who have no doubt got used to spending the profits created for national treasuries to carry on regardless as the film put it. But where do they go now to do this? The FT gives us a nod and a wink.

But central banks have shed some of their conservatism in recent years, with monetary policies such as quantitative easing forcing them to sell bonds and buy riskier instruments such as equities.

Revealing language there via “forcing them”. Really? Many central banks are not allowed to buy equities for this purpose and so they will be buying longer-dated bonds and dipping into riskier ones. I will discuss the equity buyers in a moment but here is an idea of scale for you.

Total managed reserves were $10.9tn at the end of last year, according to the International Monetary Fund.

Even in these times of ever larger numbers that is quite a lot. By the way how do the numbers keep getting larger when we are supposed to be in deflation? Anyway the UK government has net US $ 38.4 billion which the Bank of England manages. Tucked away here is the issue that gross reserves are around US $97 billion larger as we mull we have liabilities too and the phrase what could go wrong? The bit we do know is that if it should it will not be anybody’s fault.

Riskier bonds

Moving onto a slightly different field which is QE then the ECB gave us an example of this in yesterday’s update.

Asset-backed securities cumulatively purchased and settled as at 15/04/2016 €19,220 mln……..Covered bonds cumulatively purchased and settled as at 15/04/2016 €169,255 mln.

The ABS securities are the riskiest and as an aside you may wonder Mario Draghi made such a big deal of them as in the scheme of things purchases have been relatively small. The US Federal Reserve has been a big buyer in this area and as it still hold some US $1.76 trillion does not seem to have been keen on realising the value stored there.

Equities and property

Here we find what I labelled the “currency twins” back in the day as there were many similarities between the Swiss Franc and the Japanese Yen. The carry trade pushed their currencies lower originally but reversing it post credit crunch saw them shoot higher which the respective central banks resisted. Here are the consequences.

Swiss National Bank

This has the equivalent of some US $600 billion to invest as a result of its past interventions and promises to take on all-comers. Of that some 18% was invested in equities at the end of 2015 and that is why I refer from time to time to it being affected by movements in the share price of Apple for example.

The equity portfolios in the foreign currency investments were comprised of shares from mid-cap and large-cap companies (excluding banks) in advanced economies and, to a lesser extent, shares of small-cap companies. The SNB does not engage in equity selection; it only invests passively.

I wonder what Swiss watchmakers think of their central bank using their money to invest in the creator and manufacturer of the Apple watch? But as we observe this I note that of course we do have what might be considered purist hedge fund behaviour here which is punting, excuse me invested in Apple shares. The equity component had also risen from 15% to 18%.

Bank of Japan

The Bank of Japan also has large foreign exchange reserves amounting to some US $1.26 trillion. All that intervention had to go somewhere or to put it another way we see why the Bank of Japan was reluctant to intervene again as the Yen surged a week or so ago.  The Ministry of Finance is not keen on breaking this down but we do know that in its QQE (Quantiative and Qualitative Easing) policy the Bank of Japan is a keen equity and indeed property investor. From its latest Minutes.

Second, it would purchase ETFs and J-REITs so that their amounts outstanding would increase at annual paces of about 3 trillion yen and about 90 billion yen, respectively.

The Exchnage Traded Funds or ETFs are equity purchases and the J-REITs are property ones. So far just under 7.6 trillion Yen and 300 billion Yen have been purchased respectively. Indeed there are issues building here as regards market stability and structure. From Bloomberg.

the BOJ has accumulated an ETF stash that accounted for 52 percent of the entire market at the end of September, figures from Tokyo’s stock exchange show.

Comment

There is much to consider here as we see more and more central banks make the journey to what a Martian observer might have trouble distinguishing from a hedge fund. The elephant in the room is making investments which can make losses. Also here is a conceptual question for you. Is something a profit if it results from your subsequent purchases? The Bank of Japan which is both a template and the extreme case should be mulling this today in response to this.

JAPAN’S 30-YEAR YIELD FALLS TO RECORD 0.335% (h/t @moved_average )

In this situation it may already be beyond the point of no return which poses its own questions as it chomps on Japanese financial assets “like a powered up Pac-Man” as The Kaiser Chiefs put it.

Most other central banks have only taken relative baby steps on this road but we see that in yet another “surprise” even their foreign exchange reserve management is being affected. As I note that the ECB is the central bank mostly likely to dip into equities next let me leave you with a question. How is it that people who are badged as so intelligent and skilled seem to be so regularly surprised by the consequences of their own actions?!

For a minute there, I lost myself, I lost myself
Phew, for a minute there, I lost myself, I lost myself

For a minute there, I lost myself, I lost myself
Phew, for a minute there, I lost myself, I lost myself (Radiohead Karma Police)