How much difference has the central planning of the Bank of Japan really made?

Sometimes it is hard not to have a wry smile at market developments and how they play out. For example the way that equity markets have returned to falling again has been blamed on the Italian bond market which has rallied since Friday. But this morning has brought a reminder that even central banks have bad days as we note that the Nikkei 225 equity index in Japan has fallen 2.7% or 609 points today. This means that the Bank of Japan will have been busy as it concentrates its buying of equity Exchange Traded Funds or ETFs on down days and if you don’t buy on a day like this when will you? This means it is all very different from the end of September when the Wall Street Journal reported this.

The Nikkei 225 hit 24286.10, the highest intraday level since November 1991—as Japan’s epic 1980s boom was unraveling and giving way to decades of economic stagnation and flat or falling prices. It closed up 1.4% at 24120.04, a fresh eight-month high. The index has more than doubled since Shinzo Abe became prime minister in late 2012, pushing a program of corporate overhaul, economic revitalization, and super-easy monetary policy.

If you are questioning the “corporate overhaul” and “economic revitalization” well so am I. However missing from the WSJ was the role of the Bank of Japan in this as it has reminded us this morning as its balance sheet shows some 21,795,753,836,000 Yen worth of equity ETF holdings. Actually that is not its full holding as there are others tucked away elsewhere. But even the Japanese owned Financial Times thinks this is a problem for corporate overhaul rather than pursuing it.

According to one brokerage calculation, the BoJ has become a top-10 shareholder in about 70 per cent of shares in the Tokyo Stock Exchange first section. Because it does not vote on those shares, nor insists that ETF fund managers do so on its behalf, proponents of better corporate governance see the scheme as diluting shareholder pressure on companies.

Intriguingly the Financial Times article was about the Bank of Japan doing a stealth taper of these purchases but rather oddly pointed out it had in fact over purchased them.Oh Well!

In early July, for example, analysts noted that over the first 124 trading days of the 245-day trading year, the BoJ had bought ETFs that annualised at a pace of ¥7tn — or ¥1tn ahead of target.

That seems to explain a reduction in purchases quite easily. Anyway, moving back to the Bank of Japan’s obsession with manipulating markets goes on as you can see from this earlier.

BoJ Gov Kuroda: Told Japan Gvt Panel He Will Continue TO Monitor Market Moves – RTRS Citing Gvt Official   ( @LiveSquawk )

It was especially revealing that he was discussing the currency which is not far off where it was a year ago. Mind you I guess that is the problem! It is also true that the Yen tends to strengthen in what are called “risk-off” phases as markets adjust in case Japan repatriates any of its large amount of investments placed abroad.

Putting it another way to could say that the Japanese state has built up a large national debt which could be financed by the large foreign currency investments of its private-sector.

Monetary Base

This has been what the Bank of Japan has been expanding in the Abenomics era and it is best expressed I think with the latest number.

504.580.000.000.000 Yen

Inflation

All the buying above was supposed to create consumer inflation which was supposed to reflate the economy and bring the Abenomics miracle. Except it got rather stuck at the create consumer inflation bit. Just for clarity I do not mean asset price inflation of which both Japanese bonds and equities have seen plenty of and has boosted the same corporate Japan that we keep being told this is not for. But in a broad sweep Japan has in fact seen no consumer inflation. If we look at the annual changes beginning in 2011 we see -0.3%,0%,0.4%,2.7%,0.8%,-0.1% and 0.5% in 2017. For those of you thinking I have got you Shaun about 2014 that was the raising of the Consumption Tax which is an issue for consumers in Japan but was not driven by the monetary policy.

In terms of the international comparisons presented by Japan Statistics it is noticeable how much lower inflation has been over this period than in Korea and China or its peers. In fact the country it looks nearest too is Italy which reminds us that there are more similarities between the two countries economies than you might think with the big difference being Italy’s population growth meaning that the performance per capita or per head is therefore very different to Japan.

Bringing it up to date whilst we observe most countries for better or worse ( mostly worse in my opinion) achieving their inflation target Japan is at 1.2% so still below. Considering how much energy it imports and adding the rise in the oil price we have seen that is quite remarkable, but also an Abenomics failure.

The Bank of Japan loves to torture the data and today has published its latest research on inflation without food, without food and energy, Trimmed mean, weighted median, mode and a diffusion index. These essentially tell us that food prices ebb and flow and that the inflation rate of ~0% is er ~0% however you try to spin it.

Trade

Here Japan looks as though it is doing well. According to research released earlier Japan saw real exports rise by 2.5% in 2016 and by 6.4% in 2017 although more recently there has been a dip. A big driver has been exports to China which rose by 14.1% last year and intriguingly there was a warning about the emerging economies as exports to there had struggled overall and have now turned lower quite sharply.

Comment

As you can see from the numbers above the Bank of Japan has taken central planning to new heights. Even it has to admit that such a policy has side-effects.

Risk-taking in Japan’s financial sector hit a near three-decade high in the April-September, a central bank gauge showed, in a sign years of ultra-easy monetary policy may be overheating some parts of the industry…………The index measuring excess risk-taking showed such financial activity was at its highest level since 1990, when Japan experienced the burst of an asset-inflated bubble.

One of the extraordinary consequences of all this is that in many ways Japanese economic life has continued pretty much as before. The population ages and shrinks and the per head performance is better than the aggregate one. If things go wrong the Japanese via their concept of face simply ignore the issue and carry on as the World Economic Forum has inadvertently shown us today.

What a flooded Japanese airport tells us about rising sea levels

You see Kansai airport in Osaka was supposed to be a triumph of Japan’s ability to build an airport in the sea. To some extent this defied the reality that it is both a typhoon and an earthquake zone. But even worse due to a problem with the surveys the airport began to sink of its own accord, and by much more than expected/hoped. I recall worries that it might be insoluble as giving it a bigger base would add to the weight meaning it would then sink faster! Also some were calculating how much each Jumbo Jet landing would make it sink further. So in some respects it is good news that they have fudged their way such that it still exists at all.

Here is another feature of Japanese life from a foreign or gaijin journalist writing in The Japan Times.

If you’re a conspicuous non-Japanese living here who rides the trains or buses, or goes to cafes or anywhere in public where Japanese people have the choice of sitting beside you or sitting elsewhere, then you’ve likely experienced the empty-seat phenomenon with varying frequency and intensity.

Just as a reminder Japanese public travel is very crowded and commutes of more than 2 hours are more frequent than you might think. How often has someone sat next to him?

It’s such a rare occurrence (as in this is the second, maybe third time in 15 years) that my mind started trying to solve the puzzle.

 

 

 

 

 

 

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Inflation reality is increasingly different to the “preferred” measure of the UK

Today brings us a raft of UK data on inflation as we get the consumer, producer and house price numbers. After dipping my toe a little into the energy issue yesterday it is clear that plenty of inflation is on its way from that sector over time. I have a particular fear for still days in winter should the establishment succeed in persuading everyone to have a Smart Meter. Let us face it – and in a refreshing change even the official adverts now do – the only real benefit they offer is for power companies who wish to charge more at certain times. The “something wonderful” from the film 2001 would be an ability to store energy on a large scale or a green consistent source of it. The confirmation that it will be more expensive came here. From the BBC quoting Scottish Power.

We are leaving carbon generation behind for a renewable future powered by cheaper green energy.

We will likely find that it is only cheaper if you use Hinkley B as your benchmark.

Inflation Trends

We find that of our two indicators one has gone rather quiet and the other has been active. The quiet one has been the level of the UK Pound £ against the US Dollar as this influences the price we pay for oil and commodities. It has changed by a mere 0.5% (lower) over the past year after spells where we have seen much larger moves. This has been followed by another development which is that UK inflation has largely converged with inflation trends elsewhere. For example Euro area inflation is expected to be announced at 2.1% later and using a slightly different measure the US declared this around a week ago.

The all items index rose 2.3 percent for the 12 months ending September, a smaller increase than the 2.7-percent increase for the 12 months ending August.

There has been a familiar consequence of this as the Congressional Budget Office explains.

To account for inflation, the Treasury Department
adjusts the principal of its inflation-protected securities each month by using the change in the consumer price index for all urban consumers that was recorded two months earlier. That adjustment was $33 billion in fiscal year 2017 but $60 billion in the current fiscal
year.

The UK was hit by this last year and if there is much more of this worldwide perhaps we can expect central banks to indulge in QE for inflation linked bonds. Also in terms of inflation measurement whilst I still have reservations about the use of imputed rents the US handles it better than the UK.

The shelter index continued to rise and accounted for over half of the seasonally adjusted monthly increase in the all items index.

As you can see it does to some extent work by sometimes adding to inflation whereas in the UK it is a pretty consistent brake on it, even in housing booms.

Crude Oil

The pattern here is rather different as the price of a barrel of Brent Crude Oil has risen by 41% over the past year meaning it has been a major factor in pushing inflation higher. Some this is recent as a push higher started in the middle of August which as we stand added about ten dollars. Although in a startling development OPEC will now be avoiding mentioning it. From Reuters.

OPEC has urged its members not to mention oil prices when discussing policy in a break from the past, as the oil producing group seeks to avoid the risk of U.S. legal action for manipulating the market, sources close to OPEC said.

Seeing as the whole purpose of OPEC is to manipulate the oil price I wonder what they will discuss?

Today’s data

After the copy and pasting of the establishment line yesterday on the subject of wages let us open with the official preferred measure.

The Consumer Prices Index including owner occupiers’ housing costs (CPIH) 12-month inflation rate was 2.2% in September 2018, down from 2.4% in August 2018.

For newer readers the reason why it is the preferred measure can be expressed in a short version or a ore complete one. The short version is that it gives a lower number the longer version is because it includes Imputed Rents where homeowners are assumed to pay rent to themselves which of course they do not.

The OOH component annual rate is 1.0%, unchanged from last month.

As you can see these fantasy rents which comprise around 17% of the index pull it lower and we can see the impact by looking at our previous preferred measure.

The Consumer Prices Index (CPI) 12-month rate was 2.4% in September 2018, down from 2.7% in August 2018.

This trend seems likely to continue as Generation Rent explains.

The experience of the past 14 years suggests rents are most closely linked to wages – i.e. what renters can afford to pay.

With wage growth weak in historical terms then rent growth is likely to be so also and thus from an establishment point of view this is perfect for an inflation measure. This certainly proved to be the case after the credit crunch hit as Generation Rent explains.

As the credit crunch hit in 2008, mortgage lenders tightened lending criteria and the number of first-time buyers halved, boosting demand for private renting – the sector grew by an extra 135,000 per year between 2007 and 2010 compared with 2005-07.  According to the property industry’s logic, the sharp increase in demand should have caused rents to rise – yet inflation-adjusted (real) rent fell by 6.7% in the three years to January 2011.

Meanwhile if we switch to house prices which just as a reminder are actually paid by home owners we see this.

UK average house prices increased by 3.2% in the year to August 2018, with strong growth in the East Midlands and West Midlands.

As you can see 3.2% which is actually paid finds itself replaced with 1% which is not paid by home owners and the recorded inflation rate drops. This is one of the reasons why such a campaign has been launched against the RPI which includes house prices via the use of depreciation.

The all items RPI annual rate is 3.3%, down from 3.5% last month.

There you have it as we go 3.3% as a measure which was replaced by a measure showing 2.4% which was replaced by one showing 2.2%. Thus at the current rate of “improvements” the inflation rate right now will be recorded as 0% somewhere around 2050.

The Trend

This is pretty much a reflection of the oil price we looked at above as its bounce has led to this.

The headline rate of output inflation for goods leaving the factory gate was 3.1% on the year to September 2018, up from 2.9% in August 2018….The growth rate of prices for materials and fuels used in the manufacturing process rose to 10.3% on the year to September 2018, up from 9.4% in August 2018.

So we have an upwards shift in the trend but it is back to energy and oil again.

The largest contribution to both the annual and monthly rate for output inflation came from petroleum products.

Comment

It is indeed welcome to see an inflation dip across all of our measures. It was driven by these factors.

The largest downward contribution came from food and non-alcoholic beverages where prices fell between August and September 2018 but rose between the same two months a year ago…..Other large downward contributions came from transport, recreation and culture, and clothing.

Although on the other side of the coin came a familiar factor.

Partially offsetting upward contributions came from increases to electricity and gas prices.

Are those the cheaper prices promised? I also note that the numbers are swinging around a bit ( bad last month, better this) which has as at least a partial driver, transport costs.

Returning to the issue of inflation measurement I am sorry to see places like the Resolution Foundation using the government’s preferred measures on inflation and wages as it otherwise does some good work. At the moment it is the difference between claiming real wages are rising and the much more likely reality that they are at best flatlining and perhaps still falling. Mind you even officialdom may not be keeping the faith as I note this announcement from the government just now.

Yes that is the same HM Treasury which via exerting its influence on the Office for National Statistics have driven the use of imputed rents in CPIH has apparently got cold feet and is tweeting CPI.

What is happening to the economy of Germany?

This morning has brought news which will bring a smile of satisfaction to the central bankers at the ECB (European Central Bank). From the German statistics office.

The harmonised index of consumer prices (HICP) for Germany, which is calculated for European purposes, rose by 2.2% in September 2018 on September 2017. Compared with August 2018, the HICP increased by 0.4% in September 2018.

All the ECB’s efforts have got German inflation pretty much to where they want it to be. It has been quite an effort as the official deposit rate is still -0.4% and there are still around US $1.5 trillion of bonds with a negative yield in the Euro area. But we are near to the target and the extra 0.2% can be responded to by pointing out that the amount of monthly QE is on its way to zero.

The ordinary German consumer and worker may not be quite so keen as items downgraded to non-core by central bankers are important to them.

 Energy prices rose 7.7% in September 2018 on September 2017. The rate of energy price increase thus increased again (August 2018: +6.9%). ………Food prices rose above average (+2.8%) from September 2017 to September 2018. The year-on-year price increase thus accelerated slightly in September 2018 ( August 2018: +2.5%).  ( From the German CPI detail)

Indeed they may be wondering how to translate ” I cannot eat an I-Pad” into German?

Consumers benefited, among other things, of lower prices of telephones (-5.3%) and consumer electronics (-4.6%).

Those who think that rents are related to real wage growth will get a little food for thought from this.

 A major factor contributing to the increase in service prices was the development of net rents exclusive of heating expenses (+1.5%), as households spend a large part of their consumption expenditure on this item.

Travelling through the detail shows us that whilst the aggregate looks good in fact the inflation numbers have only moved to around the target level because of energy costs. All that monetary easing had little effect on consumer inflation but of course saw large wealth gains for those holding assets and subsidised government borrowing costs.

Asset Prices

This has been an area of satisfaction for the central banker play book as we note that in the first two quarters of 2018 house prices rose at an annual rate of 5.5% and 4.7%. The index set at 100 in 2015 has reached 115.1. So a win double for the establishment as it can claim wealth effects of between 4% and 5% whilst as we have observed above tell the ordinary person that via the use of fantasy imputed rents inflation in this area is only 1.5%.

Although as DW pointed out in May last year not even every central banker is a believer.

Bundesbank warns of German real estate bubble

Why might this be?

Due to mortgage interest rates of well below two percent, Germany has been experiencing a rapid transition towards home ownership in recent years, now creating fears familiar in many other property markets. Housing prices, which were relatively cheap compared with other European countries in the past, have risen sharply.

Real estate prices in cities like Berlin, Hamburg, Munich and Frankfurt have increased by more than 60 percent since 2010, according to recent estimates by the German central bank, the Bundesbank.

We look from time to time for examples of mortgage rates and DW provided us with one.

Commerzbank, the country’s second-largest lender, offers a mortgage with an ultra-cheap fixed rate of just 0.94 percent for a 10-year loan.

It is hard to over emphasise how extraordinary that is! Also should it carry on it may lead to quite a change in the structure of German life.

For many well-off Germans with permanent jobs renting no longer makes sense.

Since then house prices have continued to rise.

Economic growth

As recently as the middle of June the German Bundesbank was very upbeat.

Germany’s economic boom will continue. The already high level of capacity utilisation in the economy will increase up until 2020,

Although hang on.

although growth is unlikely to be quite as strong as in 2017. Growth in exports and business investment will be less strong. In addition, the rising shortage of skilled workers will increasingly dampen employment growth.

Indeed as we look at the specifics frankly it does not look much of a boom to me.

Against this backdrop, the Bundesbank‘s economists expect calendar-adjusted economic growth of 2.0% this year and 1.9% next year. In 2020, real gross domestic product (GDP) could increase by 1.6% in calendar-adjusted terms.

If we apply the rule that has been suggested in the comments on here that official economic growth needs to be 2% per annum for people to feel it then Germany may even be slipping backwards. This week as MarketWatch points out below has seen others fall in line with this growth but perhaps not as we know it scenario.

Germany’s economic growth is now expected to come in at 1.8% this year, rather than the 2.3% forecast previously, the government said Thursday in its autumn report. Next year’s expansion is now seen at 1.8% instead of 2.1%……..Earlier this week, the International Monetary Fund cut its growth forecasts for Germany to 1.9% for both this year and the next, decreases of 0.3 and 0.2 percentage points respectively.

We can bring this up to date by noting the industrial production figures released today by Eurostat. These show a flatlining in August meaning that the annual figure had declined by 0.5%.

Comment

After a good spell for the German economy ( which expanded by 2.2% in 2017) we are starting to wonder if that was as good as it gets? Regular readers will be aware of the way that money supply growth has been fading in the Euro area over the past year or so, and thus will not be surprised to see official forecasts of a boom if not fading to dust being more sanguine. As the money supply changes have as a major factor the fading of ECB QE we return to the theme of Euro area economies being monetary junkies which perhaps Mario Draghi has confirmed this morning.

*DRAGHI: SIGNIFICANT MONETARY POLICY STIMULUS IS STILL NEEDED

After all we are in official parlance still in a broad-based expansion. Moving back to Germany it is starting a little bit to feel like what happened to high streets when they lost individuality and became clones. Some economic growth accompanied by asset price rises whilst official inflation rises by less than you might have thought.Or the equivalent of finding Starbucks and various estate agents on every high street,or putting it another way look at this from the Bundesbank.

German economic growth will therefore consistently outstrip potential output growth,

Yes even the sub 2% economic growth is apparently too much just like most of us in Europe. One can go too far of course as there are the surpluses to consider in trade and government finances. The former was supposed to be something that was going to be dealt with post credit crunch but by now you know the familiar and some might think never-ending story. Sometimes life feels a bit like this experience for a City-AM journalist.

Hey . How am I meant to log into my account to report my lost phone when the login process requires sending a text to my phone?

As has been pointed out the concept of Catch-22 has reached Milennials. Let me leave you with something for the weekend which believe it or not is to promote Frankfurt.

 

 

What is the economic impact of a US $100 price for crude oil?

The last few days have seen something of an explosion in mentions of a one hundred-dollar price for crude oil. Usually they mean the price for Brent Crude Oil which went above US $86 per barrel last week and is now around US $84. This means that we have seen a 50% rally over the past year for it. Some care  is needed as the other main benchmark called West Texas Intermediate is around ten dollars lower at around US $74 per barrel. The last time we saw the spread between these two indices widening then it looked like the bank trading desks and especially the Vampire Squid were to blame and it went as wide as twenty dollars. For those wondering what the Russians get then the Urals benchmark is around 4 or 5 dollars lower than Brent but what always amazes me is the price that Canada get. The price of Western Canada Select is US $25.20 although it was as high as US $58 in the summer. Whatever the cause it is a very odd price for a type of oil that is relatively expensive to produce.

Economic effects

The Far East

The Financial Times took a look at some research on the impact here.

According to Citi’s Johanna Chua, Asian countries suffer the most when oil prices rise because, aside from Malaysia, most are net oil importers. Singapore runs a sizable 6.5 per cent oil and gas deficit, followed closely by Pakistan, Thailand, Sri Lanka and Taiwan. Indonesia and Vietnam manage slightly smaller deficits of roughly 1 per cent.

Given this exposure, many of these economies see the largest inflation swings when oil prices rise…….Sri Lanka, the Philippines and Vietnam lead the pack, with Thailand, India and Taiwan rounding out the top six:

They do not say it but we are of course aware that especially these days inflation rises can have a strong economic impact via their impact on real wages. Of course if an economy is vulnerable higher oil prices can push it over the edge and it has hit Pakistan.From the International Monetary Fund or IMF.

The fast rise in international oil prices, normalization of US monetary policy, and tightening financial conditions for emerging markets are adding to this difficult picture. In this environment, economic growth will likely slow significantly, and inflation will rise.

Some of the impact of the IMF arriving again in Lahore feels eye-watering.

The team welcomes the policy measures implemented since last December. These include 18 percent cumulative depreciation of the rupee, interest rate increases of cumulatively 275 bps, fiscal consolidation through the budget supplement proposed by the minister of finance, a large increase in gas tariffs closer to cost recovery levels, and the proposed increase in electricity tariffs. These measures are necessary steps that go in the right direction.

Whether the population in what is a poor country think this is in the right direction is a moot point but as a cricket fan let me wish the administration of Imran Khan well. Sadly just as I type this the price of oil has just risen another 8.5% via this morning’s devaluation.

What the research above seems to have skipped over to my mind is the impact on China as according to WTEx it was 18.6% of the world’s oil imports totaling US $162 billion last year. Its own production is in decline according to OilPrice.com.

Crude oil production alone fell by an annual 4 percent to 191.51 million tons — or about 3.85 million bpd in 2017 — to the lowest in nine years, due to maturing fields and few viable new discoveries at home.

So we are left wondering how strong a factor the higher oil price was in the monetary easing in China last weekend?

First World

The FT gives us a familiar list of those it expects to be impacted.

For Bank of America Merrill Lynch’s Ethan Harris, Japan, Europe and the UK are “clear losers,” with growth there coming under pressure by 0.2 to 0.5 percentage points next year. Not only do all three import their oil, but also, households in Europe and the UK save little, leaving them with smaller nest eggs to buffer price increases.

I am not sure about the latter point but much of this is familiar with Japan being a big energy importer and Europe not a lot different.The UK became a net importer a while back although there have been some changes recently. What I mean by that is that according to the official data we are importing less and producing slightly more. Firstly that is not quite the picture on North Sea Oil we are sometimes told which did fall but seems currently stable whereas we are using less (-7.4% in the latest quarter). Perhaps it is the impact of a growing share of renewables in electricity production which is 20% or just under 7 Gigawatts as I type this.

Inflation

The IMF researched the impact of a higher oil price last year.

A 10 percent increase in global oil inflation increases, on average, domestic inflation by about 0.4 percentage at impact. The effect is short-lasting—vanishing two years after the shock—, similar between advanced and developing economies and tends to be larger for positive oil price shocks than for negative ones.

I am sure that nobody is surprised that there is more enthusiasm for raising than there is for cutting prices! If we translate that into what we have seen over the past 12 months then the IMF would expect to see a rise in inflation of 2% due to this. More accurately we should say up to as not all prices have risen as much as Brent Crude.

The Winners

There are obvious winners here such as Saudi Arabia and several other Gulf States, Russia, Canada, Brazil and Mexico. Some African countries such as Ghana and Nigeria will benefit and the Norwegian sovereign wealth fund will have to invest even more money. But as it is American foreign policy which has driven the reduction in supply mostly via pressure and embargoes on Iran it is rude to point this out?

Crude oil production in the U.S. shale patch will hit 7.59 million bpd next month, the Energy Information Administration said in its latest Drilling Productivity Report. This is 79,000 bpd more than this month’s estimated production. ( OilPrice.com )

I have written before that due to their high debts this industry is driven by cash flows which currently are pouring in.Is it a coincidence that US foreign policy is so beneficial for them? Or if we go deeper the role of QE and low interest-rates in the shale oil business model.

Comment

Some mathematical economists may be sure there is no impact as overall this is a zero sum game. Also for central bankers the oil price is non-core but in reality it does have an impact as oil producers spend less than oil importers on average.

 If oil prices head above US$100 a barrel, it could shave 0.2 percentage points from global economic growth next year – but this hinges crucially on the US dollar, according to Bank of America Merrill Lynch. ( Straits Times)

I think it might be more than that but the issue is never simple. Also they are right to point out that the US Dollar has strengthened when the convention is for it to fall with an oil price rise. Continuing my theme above is it rude to point out that the US military industrial complex is likely to be a major beneficiary from the extra cash flowing into the Gulf?

There is a catch here which is that so far we have seen “experts” promise us US $200 oil and US $20 oil and we have seen neither? So perhaps we should be looking at the economic effect of an oil price fall.Meanwhile one likely winner from the oil price rises has managed via extreme incompetence to be a loser.

VENEZUELA INFLATION TO REACH 10 MILLION PERCENT IN 2019: IMF ( @lemasabachthani )

 

 

 

 

 

 

 

Higher bond yields and higher inflation mean higher national debt costs

The last week or so has brought a theme of this blog back to life and reminds me of the many years I spent working in bond markets. They have spent much of the credit crunch era being an economic version of the dog that did not bark. Much of that has been due to the enormous scale of the QE ( Quantitative Easing) sovereign bond buying policies of many of the major central banks. The politicians who came up with the idea of making central banks independent and then staffing them with people who were anything but should be warmly toasted by their successors. The successors would never have got away with a policy which has benefited them enormously in terms of ability to spend because of lower debt costs.

Italy

However the times are now a-changing and this morning has brought more bad news on this front from Italy. The BTP bond future for December has fallen to 120 which means it has lost a bit over 7 points over the last ten or eleven days. Putting that into yield terms it means that the ten-year yield has reached 3.5% which has a degree of symbolism. A factor in this is described by the Financial Times.

The commission issued its warning to the Five Star and League governing coalition after Rome deviated from the EU’s fiscal rules by proposing a budget deficit equivalent to 2.4 per cent of gross domestic product instead of the 1.6 per cent previously mooted by the finance minister Giovanni Tria. Although the new plans keep Italy under the EU’s 3 per cent deficit threshold, the country’s high debt levels — the highest in the eurozone after Greece — means Rome is required to cut spending to bring debt levels gradually lower.

However the chart below tells us that in fact you can look at it from another point of view entirely.

Actually I think that the situation is more pronounced than that as the ECB has bought 356 billion Euros worth. But you get the idea. It is hard not to think that a major factor in the recent falls is the halving of ECB QE purchases since the beginning of this month and to worry about their end in the New Year. In case you were wondering why the share prices of Italian banks have been tumbling again recently? The fact they have been buying in size in 2018 when one of the trades of 2018 has been to sell Italian bonds gives quite a clue.

If we switch to the consequences for debt costs then a rough rule of thumb is to multiply the 3.5% by the national debt to GDP ratio of 1.33 which gives us 4.65%. In practice this takes time as there is a large stock of debt and the impact from new debt takes time. For example Italy issued 2 billion Euros of its ten-year on the 28th of last month at 2.9%. So a fair bit less than now although much more expensive that it had got used too. This below from the Italian Treasury forecasts gives an idea of how the higher yields impact over time.

The redemptions in 2018 are approximately €184 billion (excluding BOTs) including approximately
€3 billion in relation to the international programme……..the average life of the stock of
government securities, which was 6.9 years at the end of 2017.

Oh and the tipping point below has been reached. From the Wall Street Journal.

Harvinder Sian, a bond strategist at Citigroup, thinks a 10-year yield of 3.5%-4% is now the tipping point, after which yields jump toward the 7% reached at the height of the last euro crisis

Personally I am not so sure about tipping point as the “gentlemen of the spread” ( with apologies to female bond traders) have been selling it at quite a rate anyway.

 

The United States

Here bond yields have been rising recently and let us take the advice of President Trump and look at what has happened during his term of office. Whilst back then Newsweek was busy congratulating Madame President Hilary Clinton my attention was elsewhere.

There has been a clear market adjustment to this which is that the 30 year ( long bond) yield has risen by 0.12% to 2.75%.

We see that it has risen in the Trump era to 3.4% although maybe not by as much as might have been expected. However if we look to shorter maturities we see a much stronger impact.For example the two-year now yields some 2.9% and the five-year some 3.07%. So if you read about flat yield curves this is what is meant although it is not (yet) literally true as there is a 0.5% difference. Thus the US now faces a yield of circa 3% or so looking ahead. This does have an impact as the New York Times has pointed out.

The federal government could soon pay more in interest on its debt than it spends on the military, Medicaid or children’s programs.

In terms of numbers this is what they think.

Within a decade, more than $900 billion in interest payments will be due annually, easily outpacing spending on myriad other programs. Already the fastest-growing major government expense, the cost of interest is on track to hit $390 billion next year, nearly 50 percent more than in 2017, according to the Congressional Budget Office.

If we switch to the Congressional Budget Office it breaks down some of the influences at play here.From its September report.

Outlays for net interest on the public debt increased by $62 billion (or 20 percent), partly because of a higher rate of inflation.

The CBO points out a factor the New York Times missed which is that countries with index-linked debt are also hit by higher inflation. As the US has some US $1.38 trillion of these it is a considerable factor.

Also the US is borrowing more.

The federal budget deficit was $782 billion in fiscal year 2018, the Congressional Budget Office estimates,
$116 billion more than the shortfall recorded in fiscal year 2017………The 2018 deficit equaled an estimated 3.9 percent of gross domestic product (GDP), up from 3.5 percent in
2017. (If not for the timing shifts, the 2018 deficit would have equaled 4.1 percent of GDP.)

Higher bond yields combined with higher fiscal deficits mean more worries about this factor.

At 78 percent of gross domestic product (GDP), federal
debt held by the public is now at its highest level since
shortly after World War II. If current laws generally
remained unchanged, the Congressional Budget Office
projects, growing budget deficits would boost that
debt sharply over the next 30 years; it would approach
100 percent of GDP by the end of the next decade and
152 percent by 2048 . That amount would
be the highest in the nation’s history by far.

I counsel a lot of caution with this as 2048 will have all sorts of things we cannot think of right now. But the debt is heading higher in the period we can reasonably project and I note the CBO is omitting the debt held by the US Federal Reserve so that QE would make the figures look better but the current QT makes it look worse.

Comment

Debt costs and the associated concept of the mythical bond vigilantes have been in a QE driven hibernation but they seem to be showing signs of waking up. If we look at today’s two examples we see different roads to the destination. If we look at the road to Rome we see that the longer-term factor has been the lost decades involving a lack of economic growth. This has made it vulnerable to rising bond yields and which means that the straw currently breaking the camel’s back has been what is a very small fiscal shift. It is also a case of bad timing as it has taken place as the ECB departs the bond purchases scene.

The US is different in that it has a much better economic growth trajectory but has a President who has also primed the fiscal pumps. Should it grow strongly then the Donald will win “bigly” as he will no doubt let us know. However should economic growth weaken or the long overdue recession appear then the debt metrics will slip away quite quickly. That is a road to QE4.

Returning back home I note that UK Gilt yields are higher with the ten-year passing 1.7% last week for the first time for a few years.So the collar is a little tighter.The main impact on the UK came from the rise in inflation in 2017 leading to higher index-linked debt costs. This was the main factor in our annual debt costs rising by around £10 billion between 2015/16 and 2017/18.

 

 

 

 

For many in the UK there is nothing going on but the rent

The words of Gwen Guthrie’s song are echoing this morning as the BBC seems to have discovered that renting in the UK has become very expensive. In particular it focuses on the impact on your people.

People in their 20s who want to rent a place for themselves face having to pay out an “unaffordable” amount in two-thirds of Britain, BBC research shows.

They face financial strain as average rents for a one-bedroom home eat up more than 30% of their typical salary in 65% of British postcode areas.

Many housing organisations regard spending more than a third of income on rent as unaffordable.

A salary of £51,200 is needed to “afford” to rent a one-bed London home.

How have we got here? There have been two main themes in the credit crunch era driving this of which the first has been the struggles of real wages. If we use the official data we see that setting the index at 100 in 2015 took them back to where they were in the summer of 2005 or a type of lost decade. In spite of the economy growing since then and employment numbers doing well we find that the latest number is a mere 101.7 showing so little growth. Even worse in an irony some of the growth is caused by the fact that our official statisticians use an inflation measure called CPIH which has consistently told us there is no inflation in rents.Oh Dear!

Added to this problem was a further impact on younger people from the credit crunch. We could do with an update but this from a paper by David Blanchflower and Stephen Manchin tells us what was true a few years ago.

The real wages of the typical (median) worker have fallen by around 8–10% – or around 2% a year behind inflation – since 2008. Such falls have occurred across the wage distribution, generating falls in living standards for most people, with the exception of those at the very top.

Some groups have been particularly hard hit, notably the young. Those aged 25 to 29 have seen real wage falls on the order of 12%; for those aged 18 to 24, there have been falls of over 15% (Gregg et al. 2014).

So younger people took a harder hit in real wage terms which will have made the rent squeeze worse. Hopefully recent rises in the minimum wage and looking ahead the planned rise from Amazon will help but overall we have gained little ground back since then.

Rents

Here is at least some of the state of play.

In London, a 20-something with a typical average income would spend 55% of their monthly earnings on a mid-range one-bedroom flat. Housing charity Shelter considers any more than 50% as “extremely unaffordable”.

That rises to 156%, so one-and-a-half times a typical salary, in one part of Westminster – the most expensive part of London – where an average one-bedroom home costs £3,500 a month to rent.

In contrast, a tenant aged 22-29 looking for a typical property of this kind in the Scottish district of Argyll and Bute would only have to spend 15% of their income.

Even to a Battersea boy like me that all seems rather London centric. Wasn’t the BBC supposed to have shifted on mass to Manchester? Perhaps it was only the sports section which has quite an obsession with United as otherwise no doubt we would have got an update on Manchester and its surrounds. Still Westminster is eye-watering and no doubt influenced by all MPs wanting somewhere close to Parliament. By contrast renting in Argyll and Bute is very cheap although the number of people there is not that great.

Mind you there is at least an oasis below for those who want a Manchester link.

This all comes at a time when young adults might look back in anger at previous generations

Still I guess they will have to roll with it or try to anesthetise any pain with cigarettes and alcohol.

Relativities

This provided some food for thought.

The BBC research shows that a private tenant in the UK typically spends more than 30% of their income on rent.

In 1980, UK private renters spent an average of 10% of their income on rent, or 14% in London.

So the amount spent has risen across the board and especially so in London. This however begs a question of our inflation measure which accentuates the use of rents by assuming and fantasising that owner-occupiers pay them. This is around 17% of that index. But contrary to the fact that rents are more expensive they seem to have got there without there being much inflation! As the fantasies are recent we sadly do not have a full data set but the response to a freedom of information enquiry tells us that the index has risen from 89.3 at the beginning of 2005 to 103.8 in early 2017. However they have apparently revised all this in the year or so since and now we are at 103.3 but 2005 is at 77.1. So measuring rents can go firmly in our “You don’t know what you’re doing” category and should be nowhere near any official inflation measure. What could go wrong with fantasies based on something you are unable to measure with any accuracy?

Size issues

This caught my eye as it goes against an assumption we have looked at on here which is that properties have been getting smaller ( as we get larger).

 In the last 10 years, when families have been increasingly likely to rent, owners have seen the average floor space of their homes increase by 7% compared with a 2% rise for tenants. That leaves owners with an average of 30 sq m extra floor space than tenants, which the charity suggests is the equivalent of a master bedroom and a kitchen.

I am not sure how they calculate this issue for renters as back in the day when I was saving up I rented in a shared house. This was pretty much the same house as all the others in what is called Little India in Battersea (because of the names of the streets).

It wasn’t me

This is the response of landlords who presumably need some fast PR. After all longer-term landlords have made extraordinary capital gains on their investments and now seem to have done pretty well out of the income via rent.

Landlords say they face costs, including their mortgages, insurance, maintenance and licensing, that need to be covered from rents.

“These costs are increasing as the government introduces new measures to discourage investment in property, such as the removal of mortgage interest relief and the changes to stamp duty,” said Chris Norris, director of policy at the National Landlords Association.

 

Comment

The underlying theme here is the march of the rentier society. This seems set to affect the younger generations disproportionately especially if the current trend and trajectory of real wages remains as it has been for the last/lost decade. This gives us a “back to the future” style theme as that was the life of my grandparents who owned little but rented a lot. My parents managed to escape that and started by buying a house in Dulwich in the 1970s for £9000 which seems hard to believe now. But were they and I a blip on the long-term chart? It is starting to feel like that and this line of thought is feed by this from the BBC.

The charity estimated that private tenants in England are spending £140 more in housing costs than people with a mortgage.

That has been driven by the extraordinary effort to reduce mortgage rates starting with the cutting of interest-rates to as low as 0.25%, £445 billion of QE and to top it off the credit easing via the Funding for Lending Scheme. No such help was given to renters who of course have not benefited from “Help To Buy” either. Thus renters have a genuine gripe with the Bank of England.

Let me finish on a more hopeful development which is the Amazon news.

1) This is a significant increase. Around 20% above the national living wage and 10% above the real living wage. It amounts to hundreds of £ per worker, and also raises the prospect of other warehouse operators following suit ( Benedict Dellot of the RSA )

Whilst their working conditions may still be a modern version of the dark satanic mills of William Blake at least the wages are a fair bit better.

 

 

 

 

Slowing money supply growth puts the ECB between a rock and a hard place

Sometimes life is awkward and this morning is an example of that for the central bankers of the Euro area at the European Central Bank or ECB. Let me open with the hard place which is a development we have been following closely in 2018 and comes direct from the ECB Towers.

The annual growth rate of the broad monetary aggregate M3 decreased to 3.5% in August 2018 from 4.0% in July, averaging 4.0% in the three months up to August.

This matters because if we look forwards the rule of thumb is that it represents the sum of economic growth and inflation. So we initially see that something of a squeeze is on. In fact it has been one of the guiding variables for ECB policy. Let me give you an example of this from the January press conference where Mario Draghi told us this.

Turning to the monetary analysis, broad money (M3) continues to expand at a robust pace, with an annual rate of growth of 4.9% in November 2017, after 5.0% in October, reflecting the impact of the ECB’s monetary policy measures and the low opportunity cost of holding the most liquid deposits.

Back then the garden looked rosy with the Euroboom apparently still continuing. But in the April press conference Mario Draghi had gone from bullish to nervous.

 It’s quite clear that since our last meeting, broadly all countries experienced, to different extents of course, some moderation in growth or some loss of momentum. When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

He did not specifically refer to the money supply data but we now know that in March the rate of M3 growth had fallen to 3.7% and that whilst he may not have had all the data warning signs would be there. In such circumstances always look for what they do not tell you about!

Since then the numbers have fluctuated somewhat as it their want but the trend is clear as they sing along to “Fallin'” by Alicia Keys. The big picture is that the 5.3% of March 2018 has been replaced by 3.5% now.

The Rock

This for the ECB is its inflation target as it is one of the central banks who really do try very hard to achieve it as opposed to the lip-service of say the Bank of England. I still recall Jean-Claude Trichet defining it as 1.97% in his valedictory speech, and whilst that contains some spurious accuracy you get the idea. So in a sense what we now have are happy days.

The euro area annual inflation rate was 2.0% in August 2018, down from 2.1% in July 2018. A year earlier, the rate
was 1.5%.

Except if you take my rule of thumb above and in a broad sweep the amount left over for economic growth has gone from ~3.5% to more like 1.5%. This morning has brought news which suggests the inflation collar may be getting a little tighter. We do not get the overall number for Germany until later today but the individual lander have been reporting higher numbers with Bavaria leading the charge at 0.5% monthly and 2.5% annually for its CPI. However we do now have what appears to be a leaked number as @fwred explains.

Yep, German CPI apparently leaked early once again . 0.4% MoM consistent with strong regional data, would push inflation rate to 2.3-2.4% YoY, way above expectations.

As the largest economy in the Euro area that will pull inflation higher directly and of course there is also the implicit influence that many inflation trends will be international within the shared currency. Returning to my rule of thumb there is even less scope for economic growth if this is an accurate picture of the inflation trend.

Narrow Money

If broad money growth gives us the general direction of travel then narrow money gives us the impulse for the next few months or so. How is that going?

The annual growth rate of the narrower aggregate M1, which comprises currency in circulation and overnight deposits, decreased to 6.4% in August from 6.9% in July.

This compares to the 9.9% of September last year which is the recent peak. So the short-term impulse has weakened considerably since then and in terms of quarterly GDP growth we have seen a drop from around 0.7% to 0.4% or so. Of course we are now left wondering if more is to come?

A significant part of this has been the actions of the ECB itself as the 9.9% growth of last September was a consequence of monthly QE purchases being ramped up 80 billion Euros per month in the year from April 2016. Now of course we are in a different situation with them about to drop from 30 billion to 15 billion. This suggests that the fall in M1 growth has further to go.

What about credit?

These have been in a better phase so we can expect the ECB and its area of influence to give them emphasis.

However in my view there are two issues with this. The opening one is that they are  backwards as well as forwards looking as they represent a response to the better growth phase the Euro area was in. The next is that they are in the M3 numbers and in fact represent basically its growth right now ( 3.4%) as the other components net out.

Comment

Today’s news continues a theme of 2018 which is that money supply growth has been fading. In the Euro area this has been exacerbated by the winding down of the expansionary monetary policy of the ECB. Some of it is still there as it used to tell us that a deposit rate of -0.4% was a powerful influence here but much of the QE flow has gone. Thus in the period ahead we will find out if the Euro area economy was like a junkie sipping the sweet syrup of combined QE and NIRP. This morning’s economic sentiment data showing a drop of 0.7 to 110.9 might be another example of people and businesses getting the message.

Looking at the international environment we see that the ECB is increasingly out of phase. Not only did the US Federal Reserve raise interest-rates but so did a central bank nearer to home.

At its meeting today, the CNB Bank Board increased the two-week repo rate (2W repo rate) by 25 basis points to 1.50% ( C = Czech )

The situation is complex as we wait to see if they depress the international economy or we shake it off. But the ECB remains with negative interest-rates when economic growth looks set to slow. What could go wrong?

Me on Core Finance TV