How is the Swedish experiment going?

These days the headline above no doubt has you thinking about an alternative approach to the Coronavirus pandemic. However, I would also like to remind you that Sweden was at the fore front of applying negative interest-rates to a country and in addition applied them into something of an economic boom. Or if you prefer they applied exactly the reverse of the old saying that the job of a central banker is to take away the punch bowl as the party gets going. Instead they decided to give it a refill.

The first perspective is that for all the past talk of a different approach they now seem to be in the same boat as the rest of us.

During the summer, a recovery was initiated, but in recent months the spread of infection has increased again and restrictions have been tightened in many countries. This setback shows the great uncertainty that the global economic recovery is still facing. The economic prospects for Sweden and abroad have been revised down, and the economy is expected to weaken again in the near term ( Riksbank)

Where do we stand?

This morning Sweden Statistics has updated us.

GDP increased by 4.9 percent in the third quarter, seasonally adjusted and compared with the second quarter. The recovery was mainly driven by increased exports of goods and household consumption following the historic decline in the second quarter. Calendar adjusted and compared with the third quarter of 2019, GDP decreased by 2.5 percent.

This is a relatively good performance compared to what we have become used to and as the paragraph above notes has been driven by this.

Household final consumption increased by 6.3 percent. Consumption of transports, as well as hotel and restaurant services contributed most to this increase……..Exports increased by 11.2 percent and imports increased by 9.2 percent. Overall, net exports contributed upwards to GDP growth by 1.1 percentage points.

The return of the hospitality sector boosted many economies in the third quarter and I note Sweden benefited from trade. Although if we look at the trade detail the numbers were heavily affected by the oil price.

Exports of mineral fuels and electric current decreased by 40 percent in value and by 10 percent in volume. The large difference between the value and volume trends is due to lower prices on petroleum products……….Imports of crude petroleum oils decreased by 45 percent in value and by 17 percent in volume.

The story shifts a little if we take a look at Sweden’s Nordic peers. This morning we have also learnt some more about Finland.

According to Statistics Finland’s preliminary data, the volume 1) of Finland’s gross domestic product increased in July to September by 3.3 per cent from the previous quarter. Compared with the third quarter of 2019, GDP adjusted for working days contracted by 2.7 per cent.

So for all the talk of differences of approach in fact the annual economic change in Finland and Sweden is well within the margin of error. Maybe the real difference here is that they have populations which are spread out.

Looking Ahead

We see that the retail sector saw some growth in October.

In October, the retail trade sales volume increased by 0.5 percent, compared with September 2020. Retail sales in durables increased by 0.9 percent and retail sales in consumables (excluding Systembolaget, the state-owned chain of liquor stores) increased by 0.1 percent.

This meant that the annual picture looked healthy.

In October, the year-on-year growth rate in the volume of retail sales was 3.6 percent in working-day adjusted figures. Retail sales in durables increased by 4.8 percent and retail sales in consumables (excluding Systembolaget) increased by 0.7 percent.

However that was then and this is now according to the Riksbank.

The growth forecasts for the coming six months
have therefore been revised down…. However, high-frequency data show signs that demand is now slowing down again…….GDP is expected to decline again during the fourth quarter and the situation on the labour market to deteriorate further. The forecast assumes that GDP growth will decline also for the first quarter of next year before it
picks up again both abroad and in Sweden during the second quarter.

The Swedes seem yo be preparing for a rough start to next year which does differentiate them as most have yet to get past a contraction in this quarter.

The Riksbank Response

You might think as an enthusiast for negative interest-rates the Riksbank would have rushed to deploy them in 2020. But we have got something rather different.

The repo rate is held unchanged at zero per cent and is expected to remain at this level in the coming years.

So they have cast aside a past central banking orthodoxy but joined in with a new one.The latter is the plan to apply ZIRP ( in this instance literally at 0%) and to say interest-rates will stay there for some years. So not quite as explicit as the US Federal Reserve which has guided towards a period of 3 years but essentially the same tune. The abandoned orthodoxy is the enthusiasm for negative interest-rates which leaves the Riksbank with quite a lot of egg on its face. After all they have applied negative interest-rates in a boom. Then raised them in a period of economic weakness ( unemployment was rising pre pandemic). Now they do not use them in a clear example of a depression.

By contrast they are more than happy to support any borrowing by the Swedish government.

To improve the conditions for a recovery, the Executive Board has decided to expand the envelope for the asset purchases by SEK 200 billion, to a total nominal amount of up to SEK 700 billion, and to extend the asset purchase programme to 31 December 2021. The Executive Board has also decided to increase the pace in the asset purchases during the first quarter of 2021, in relation to the fourth quarter of 2020.

They have also decided to interfere in the private-sector as well.

The Executive Board has moreover decided that the Riksbank will only offer to buy corporate bonds issued by companies deemed to comply with international standards and norms for sustainability.

So another central bank sings along with The Kinks.

And when he does his little rounds
‘Round the boutiques of London Town
Eagerly pursuing all the latest fads and trends
‘Cause he’s a dedicated follower of fashion

If they were an army this would be called mission creep.

Comment

As you can see the Riksbank seems to have pretty much abandoned the interest-rate weapon it previously waved with such abandon. There is an additional nuance to this if we shift from the domestic to the external situation. The Krona has been rising against the Euro. There have been ebbs and flows but the 11.2 of March 2020 has been replaced by 10.2 now. If we note that the Euro has also been firm then the Krona has had a strong 2020 and it is interesting that the Riksbank is ignoring this. Perhaps it thought more QE would help, but as I pointed out earlier this week pretty much everyone is at that game.

But like elsewhere the Riksbank is keen to make borrowing cheaper for its government in a new twist on the word independent. With Sweden being paid to borrow ( ten-year yield is -0.13%) no doubt the government is suitably grateful.

 

 

Where next for interest-rates and bond yields?

As we find ourselves in a phase where possible solutions to the Covid-19 pandemic are in the news, the economic consequences for 2021 are optimistic. For example, it looks as though it will mean the type of Lockdown the UK is experiencing will get less and less likely. That is a relief as the issue of the Lockdown strategy is that you end up in a repeating loop. The more hopeful reality does have potential consequences for interest-rates and some of this has been highlighted by Reuters.

LONDON (Reuters) – Expectations of interest rate cuts in some of the world’s biggest economies have melted within the space of a month on hopes a successful coronavirus vaccine will fuel a growth bounceback next year.

Why? Well in line with this from Bank of England Chief Economist Andy Haldane yesterday.

LONDON (Reuters) – Bank of England Chief Economist Andy Haldane said the economic outlook for 2021 was “materially brighter” than he had expected just a few weeks ago despite short-term uncertainty from a renewed COVID-19 lockdown in England.

Except as you can see the changes are in fact really rather minor in the broad scheme of things.

Between Nov. 5-9, a period when it became clear Democrat Joe Biden had won the U.S. election and Pfizer announced its vaccine news, eurodollar futures, which track short-term U.S. rate expectations, flipped to reflect expectations of 10 bps in rate hikes by Sept 2022.

Just the previous week, markets were predicting no changes. Futures now expect U.S. rates at 0.50% by September 2023, from 0.25% forecast a month previously.

At the ECB where rates are already minus 0.5%, a nine bps cut was expected by September 2021 but that is now slashed to only five bps.

After all the interest-rate cuts we see that the US is expected to increase interest-rates by a mere 0.25% over the next 3 years. That is a bit thin if you note the promises of economic recovery. But it is in line with one of my main themes which are that interest-rate cuts are for the now and are large whereas interest-rate rises are for some future date and are much smaller if they happen at all. For example Bank of England Governor Mark Carney provided Forward Guidance for interest-rate increases in the summer of 2013. It is hard not to laugh as I type that his next move was to cut them! There was a rise some 5 years or so later to above the original “emergency” level of 0.5% which rather contrasts with the cuts seen in March.

As to the ECB which hasn’t has any increases at all since 2011 there has been this today by its President Christine Lagarde.

While all options are on the table, the pandemic emergency purchase programme (PEPP) and our targeted longer-term refinancing operations (TLTROs) have proven their effectiveness in the current environment and can be dynamically adjusted to react to how the pandemic evolves.

So Definitely Maybe, although these days interest-rate cuts may not be widely announced as for example the present TLTROs allow banks access to funds at -1% as opposed to the more general -0.5% of the Deposit Rate.

Meanwhile

I did point out earlier that interest-rate cuts are for the here and now and they seem to be rather en vogue this morning starting early in the Pacific region.

BI Board of Governors Meeting (RDG) in November 2020 decided to lower the BI 7-Day Reverse Repo Rate (BI7DRR) by 25 bps to 3.75%, as well as the Deposit Facility and Lending Facility rates which fell by 25 bps, to 3.00% and 4.50%.

Bank Indonesia did not have to wait long for company as the central bank of the Philippines was in hot pursuit.

At its meeting on monetary policy today, the Monetary Board decided to cut the interest rate on the BSP’s overnight reverse repurchase facility by 25 basis points to 2.0 percent, effective Friday, 20 November 2020. The interest rates on the overnight deposit and lending facilities were likewise reduced to 1.5 percent and 2.5 percent, respectively.

Perhaps the Bank of  Russia fears missing out.

Russian Central Bank: Monetary Policy To Remain Accommodative In 2021…….Russian Central Bank: See Room For Further Rate Cuts But Not That Big.

Probably they are emboldened by the recent rise in the oil price which is a major issue for the Russian economy.

Indonesia

We looked at the Pacific region back in 2019 as an area especially affected by the “trade war” between the US and China. Some of that looks set to fade with the new US President but the Pacific now has another one.

China is digging in its heels as the trade spat between Canberra and Beijing continues, with officials laying responsibility for the tensions solely at Australia’s feet. ( ABC)

As well as the interest-rate cut Bank Indonesia is working to reduce bond yields.

As of 17 November 2020, Bank Indonesia has purchased SBN on the primary market through a market mechanism in accordance with the Joint Decree of the Minister of Finance and the Governor of Bank Indonesia dated April 16, 2020, amounting to IDR 72.49 trillion, including the main auction scheme, the Greenshoe Option (GSO) and Private Placement.

Primary purchases are unusual especially for an emerging market and another 385 trillion IDR have been bought via other forms of QE.

Philippines

The central bank gives us a conventional explanation around inflation as a starter.

Latest baseline forecasts continue to indicate a benign inflation environment over the policy horizon, with inflation expectations remaining firmly anchored within the target range of 2-4 percent. Average inflation is seen to settle within the lower half of the target band for 2020 up to 2022, reflecting slower domestic economic activity, lower global crude oil prices, and the recent appreciation of the peso. The balance of risks to the inflation outlook also remains tilted toward the downside owing largely to potential disruptions to domestic and global economic activity amid the ongoing pandemic.

But we all know that the main course is this.

Meanwhile, uncertainty remains elevated amid the resurgence of COVID-19 cases globally. However, the Monetary Board also observed that global economic prospects have moderated in recent weeks. At the same time, the Monetary Board noted that while domestic output contracted at a slower pace in the third quarter of 2020, muted business and household sentiment and the impact of recent natural calamities could pose strong headwinds to the recovery of the economy in the coming months.

Comment

As you can see the story about the end of interest-rate cuts has already hit trouble. Central bankers seem unable to break their addiction. I will have to do a proper count again but I am pretty sure we have now had around 780 interest-rate cuts in the credit crunch era. So it seems that the muzak played on the central bank loudspeakers will keep this particular status quo for a while yet.

Get down deeper and down
Down down deeper and down
Down down deeper and down
Get down deeper and down.

There are issues as I noted on the 11th of this month as all the fiscal stimuli puts upward pressure on interest-rates. But the threshold for interest-rate cuts is far lower than for rises. Also we get cuts at warp speed whereas rises have Chief Engineer Scott telling us that the engines “cannae take it”

Putting it another way we have another example of a bipolar world where there may be drivers for higher interest-rates but the central banksters much prefer to cut them.This gets more complex as we see so many countries with or near negative interest-rates and bond yields.

The ECB faces problems from the Euro area banks as well as fiscal policy

This morning has brought us up to date on the state of play at the European Central Bank. Vice President De Guindos opened his speech in Frankfurt telling us this about the expected situation.

The pandemic crisis has put great pressure on economic activity, with euro area growth expected to fall by 8% in 2020. ……The tighter containment measures recently adopted across Europe are weighing on current growth. With the future path of the pandemic highly unclear, risks are clearly tilted to the downside.

So he has set out his stall as vaccine hopes get a relatively minor mention. Thus he looks set to vote for more easing at the December meeting. Also he rather curiously confessed that after 20 years or so the convergence promises for the Euro area economy still have a lot of ground to cover.

The severity of the pandemic shock has varied greatly across euro area countries and sectors, which is leading to uneven economic developments and recovery speeds……..And growth forecasts for 2020 also point towards increasing divergence within the euro area.

Looking ahead that is juts about to be fixed, although a solution to it has been just around the corner for a decade or so now.

The recent European initiatives, such as the Next Generation EU package, should help ensure a more broad-based economic recovery across various jurisdictions and avoid the kind of economic and financial fragmentation that we observed during the euro area sovereign debt crisis.

He also points out there has been sectoral fragmentation although he rather skirts around the issue that this has been a policy choice. Not by the ECB but bu governments.

 Consumers have adopted more cautious behaviour, and the recent tightening of restrictions has notably targeted the services sector, including hotels and restaurants, arts and entertainment, and tourism and travel.

Well Done the ECB!

As ever in a central banking speech there is praise for the central bank itself.

Fiscal support has played a key role in mitigating the impact of the pandemic on the economy and preserving productive capacity. This is very welcome, notwithstanding the sizeable budget deficits anticipated for 2020 and 2021 and the rising levels of sovereign debt.

This theme is added to by this from @Schuldensuehner

 Jefferies shows that France is biggest beneficiary of ECB’s bond purchases. Country has saved €28.2bn since 2015 through artificial reduction in financing costs driven by ECB. In 2nd place among ECB profiteers is Italy w/savings of €26.8bn, Germany 3rd w/€23.7bn.

Care is needed as QE has not been the only game in town especially for Greece which is on the list as saving 2,2 billion Euros a year from a QE plan it was not in! It only was included this year. But the large purchases have clearly reduced costs for government and no doubt makes the ECB popular amongst the politicians it regularly claims to be independent from. But there is more.

While policy support will eventually need to be withdrawn, abrupt and premature termination of the ongoing schemes could give rise to cliff-edge effects and cool the already tepid economic recovery.

It is a bit socco voce but we get a reminder that the ECB is willing to effectively finance a very expansionary fiscal policy. That is why it has two QE programmes running at the same time, but for this purpose the game in town is this.

 The Governing Council will continue its purchases under the pandemic emergency purchase programme (PEPP) with a total envelope of €1,350 billion.

There was a time when that would be an almost unimaginable sum of money but not know as if government’s do as they are told it will be increased.

The purchases will continue to be conducted in a flexible manner over time, across asset classes and among jurisdictions.

Oh and there is a bit of a misprint on the sentence below as they really mean fiscal policy.

This allows the Governing Council to effectively stave off risks to the smooth transmission of monetary policy.

The Banks

These are a running sore with even the ECB Vice President unable to avoid this issue.

The pandemic has also weighed on the long-term profitability outlook for banks in the euro area, depressing their valuations. From around 6% in February of this year, the euro area median banks’ return on equity had declined to slightly above 2% by June.

Tucked away in the explanation is an admittal of the ECB’s role here so I have highlighted it.

The decline in profitability is being driven mainly by higher loan loss provisions and weaker income-generation capacity linked to the ongoing compression of interest margins.

The interest-rate cuts we have seen hurt the banks and this issue was exacerbated by the reductions in the Deposit Rate to -0.5% as the banks have been afraid of passing this onto the ordinary saver and depositor. Thus the Zero Lower Bound ( 0%) did effectively exist for some interest-rates.

This is in spite of the fact that banks have benefited from two main sweeteners. This is the -1% interest-rate of the latest liquidity programmes ( TLTROs) and the QE bond purchases which help inflate the value of the banks bond holdings.

Then we get to the real elephant in the room.

Non-performing loans (NPL) are likely to present a further challenge to bank profitability.

We had got used to being told that a corner had been turned on this issue even in Italy and Greece. Speaking of the latter Piraeus Bank hit trouble last week when it was unable to make a bond payment.

The non-payment of the CoCos coupon will lead to the complete conversion of the convertible bond, amounting to 2.040 billion euros, into 394.4 million common shares.

It is noted that the conversion will not involve an adjustment of the share price and simply, to the 437 million shares of the Bank will be added another 394.4 million shares at the price of 0.70 euros (closing of the share at last Friday’s meeting). ( Capital Gr).

There is a lot of dilution going on here for private shareholders as we note that this is pretty much a nationalisation.

The conversion has one month after December 2 to take place and the result will be the percentage of the Financial Stability Fund, which currently controls 26.4% of Piraeus Bank, to increase to 61.3%.

Meanwhile in Italy you have probably guessed which bank has returned to the news.

LONDON/MILAN/ROME (Reuters) – Italy’s Treasury has asked financial and legal advisers to pitch for a role in the privatisation of Monte dei Paschi BMPS.MI as it strives to secure a merger deal for the Tuscan lender, two sources familiar with the matter told Reuters on Friday.

The equivalent of a Hammer House of Horror production as we mull how like a financial vampire it keeps needing more.

Italy is seeking ways to address pending legal claims amounting to 10 billion euros (£9 billion) that sources say are the main hurdle to privatising the bank.

Even Colin Jackson would struggle with all the hurdles around Monte dei Paschi. Anyway we can confidently expect a coach and horses to be driven through Euro area banking rules.

If we look at the proposed solution we wonder again about the bailouts.

Although banks have stepped up cost-cutting efforts in the wake of the pandemic, they need to push even harder for greater cost efficiency.

So job losses and it seems that muddying the waters will also be the order of the day.

The planned domestic mergers in some countries are an encouraging sign in this regard.

A merger does reduce two problems to one albeit we are back on the road to Too Big To Fail or TBTF.

There is of course the ECB Holy Grail.

Finally, we also need to make progress on the banking union, which unfortunately remains unfinished. Renewed efforts are urgently required to improve its crisis management framework.

Just as Italy makes up its own rules….

Comment

We are now arriving at Monetary Policy 3.0 after number one ( interest-rates) and number two ( QE) have failed to work. In effect the role of monetary policy is to facilitate fiscal policy. It also involves a challenge to democracy as the technocrats of the ECB are looking to set policy for the elected politicians in the Euro area. However there are problems with this and somewhat ironically these have been highlighted by the Twitter feed of the Financial Times which starts with an apparent triumph.

Italy’s bond rally forces key measure of risk to lowest since 2018

So on a financial measure we have convergence. But if we switch to the real economy we get this.

‘There is no money left’: the pandemic’s economic impact is ‘a catastrophe’ for people in southern Italy who were already in a precarious situation

Switching to the banks we are facing the consequences of the Zombification of the sector as the same old names always seem to need more money. Although there has been more hopeful news for BBVA of Spain today albeit exiting the country where banks seem to be able to make money.

PNC to buy U.S. operations of Spanish bank BBVA for $11.6 billion ( @CNBC )

Although the price will no doubt if the speech above is any guide will be pressure to give a home to a Zombie or two.

Podcast

 

 

 

Will the rally in the Turkish Lira last?

This week has brought a pretty much text book example of what can happen when a currency is in distress as well as a reminder of perspective. Let me start with the trigger for some changes which came last weekend.

The shock departure of finance minister Berat Albayrak, who is President Tayyip Erdogan’s son-in-law, and central bank chief Murat Uysal over the weekend gave the lira its best day in over two years on Monday.

Investors hope their successors will deliver another of the country’s pirouettes, where long-suppressed interest rates are lifted dramatically, providing the currency with some much-needed relief. ( Reuters)

There is a lot going on there. But let’s start with a possible end or at least reduction in cronyism. There we have an unusual mention of a Lira rally followed by a curious mention of “long-suppressed interest-rates”. That depends on your perspective because in these times the rate below is rather extraordinary as it is.

keep the policy rate (one-week repo auction rate) constant at 10.25 percent,

Back on October 12th we noted a change in swap rates to 11.75% to try and support the Lira but in what may seem extraordinary a 1.5% move in these circumstances is not much. The real issue when an interest-rate is trying to support a currency is the gap between it and others. This week we have looked at an interest-rate maybe reaching 1% in the US ( ten-year bond yield) and Japan where we are around 0% so there is quite a gap. Even those are high relative to the -0.5% of the Euro and the around -0.5% of the German ten-year yield and of course there is a lot of trade between the Euro area and Turkey.

The textbook

Put mostly simply a currency is helped by an interest-rate advantage as investors include it in their calculations of expected capital gains. The problem in practice is that in times of real distress the expected currency falls are much larger than any likely interest-rate increase. I provided an example of this back on the 12th of October.

Because of the economic links the exchange-rate with the Euro is significant. Indeed some Euro area banks must be mulling their lending to Turkish borrowers as well as Euro area exporters struggling with an exchange-rate of 9.32. That is some 43% lower than a year ago.

So even with a pick-up of the order of 11% you have lost 32% over the past 12 months.

However this can change rapidly because the moment there is any sort of stability the carry is suddenly rather attractive. After all you can get more in the Turkish Lira in a month than most places in a year and in some cases you can do that in a week. This leads to the situation suddenly reversing and giving us this.

ISTANBUL (Reuters) – Turkey’s lira firmed on Friday to its strongest level in seven weeks, notching a weekly gain of some 12%, after President Tayyip Erdogan’s pledge to adopt a new economic model raised expectations of a sharp rate hike from the central bank.

So we have seen a jump higher in the Lira with expectations now of this.

The central bank is seen raising its policy rate next week to 15% from 10.25%, a Reuters poll showed. Erdogan’s speech was viewed as implying he would condone such a hike.

So the expected carry is even higher and for once there is a capital gain. Some will like this although I have to confess if I had been long the Lira this week I would be considering the advice of the Steve Miller Band.

Hoo-hoo-hoo, go on, take the money and run
Go on, take the money and run
Hoo-hoo-hoo, go on, take the money and run
Go on, take the money and run

As whilst there may be changes there are icebergs waiting for this particular Titanic.

In contrast to previous episodes of lira turmoil, the central bank is estimated to have burnt through more than $100 billion of reserves this year, leaving it effectively around $36 billion overdrawn on those reserves, according to UBS.

The central bank has not commented on analysis suggesting its reserves are ‘net’ negative, though it has said its buffers fluctuate naturally in times of stress. ( Reuters)

So “buffers fluctuate in times of stress” can be added to my financial lexicon for these times.

The economy

There has been some better economic news this morning especially from consumption.

There was better news for retail sales in the country on Friday. The volume of goods purchased by consumers increased by an annual 7.8 percent in September after 6 percent growth in August, the statistics institute said. The monthly increase was 2.8 percent, more than three times the August figure of 0.9 percent. ( Ahval)

Also industrial production rose although Ahval is rather downbeat about it.

Industrial output in the country expanded at the slowest pace on a monthly basis since the outbreak of the coronavirus in March, official data published on Friday showed. Production increased by 1.7 percent month-on-month in September compared with 3.4 percent in August and 8.4 percent in July……..Manufacturing of non-durable goods in the country grew by just 0.6 percent month-on-month in September, the Turkish Statistical Institute said. Production of intermediate goods expanded by 0.7 percent.

There is a catch though in that the better retail sales news rather collides with one of the ongoing economic problems which is the trade deficit.On Wednesday the central bank ( CBRT) updated us about this.

The current account posted USD 2,364 million deficit compared to USD 2,828 million surplus observed in the same month of 2019, bringing the 12-month rolling deficit to USD 27,539 million.

So the passing twelve months have brought a switch from a monthly surplus to deficit and we see that the annual picture is the same. The driving forces of this are below.

This development is mainly driven by the net outflow of USD 3,709 million in the goods item increasing by USD 3,044 million, as well as the net inflow of USD 1,692 million in services item decreasing by USD 2,869 million compared to the same month of the previous year.

One of the issues of economic theory is applying theory to practice. But the expected J-Curve improvement in the trade balance has collided with another currency plunge starting the clock all over again. It has created quite a mess as one clear impact of the Covid-19 pandemic has been on a strength for Turkey which is tourism. Back on October the 12th I noted the numbers for this.

 If we look at the year so far we see this is confirmed by a surplus of US $4.15 billion as opposed to one of US $19.17 billion in the same period in 2019. Another way of looking at this is that 3,225,033 visitors are recorded as opposed to 13,349,256 last year.

Next at a time of currency crisis comes inflation as imports become more expensive.

A rise in general index was realized in CPI (2003=100) on the previous month by 2.13%, on December of the previous year by 10.64%, on same month of the previous year by 11.89% and on the twelve months moving averages basis by 11.74% in October 2020. ( Turkey Statistics)

That may look bad enough but there are two additional kickers. The first is that this is on the back of previous inflation and the second is that far from responding wages have gone the other way putting quite a squeeze on living-standards.

Gross wages-salaries index including industry, construction, trade-services sectors decreased by 8.4% in the second quarter of 2020 compared with the same quarter of the previous year. When sub-sectors are examined; industrial sector decreased by 5.2%, construction sector decreased by 8.6% and trade-services sector decreased by 10.5%. ( Turkey Statistics)

Comment

I promised at the beginning to give some perspective and we get some from looking at the exchange-rate on October 12th which was 7.87 versus the US Dollar and considered a crisis then and the 7.67 as I type this. So better but not by a lot as the rally memes are compared to the 8.58 of last Friday. Thus we have a move for financial markets but for the real economy not so much. It can be looked at in terms of what used to be described as the Misery Index where you add inflation to the unemployment rate which gives you a number around 25% or very bad.

The CBRT looks to have rather boxed itself in on an increase in interest-rates to 15% next week. But whilst it may provide some currency support for a time these are Catch-22 style moves. Because such an interest-rate will provide yet another brake to the domestic economy just at a time it can least afford it. After all whilst a vaccine provides hope for the return of mass tourism in the summer of 2021 that is a while away and is still just a hope, albeit a welcome one. Then there is the vaccine hopium of this week as we mull how much of this week’s Lira rise was due to it?

 

 

What are the consequences of bond yields rising further?

This week has brought an unusual development for the credit crunch era. Let me illustrate with an example of the reverse and indeed what we have come to regard as the new normal from last week.

AMSTERDAM, Nov 5 (Reuters) – Italy’s five-year bond yield turned negative for the first time on Thursday as uncertainty from the U.S. election supported government bonds in Europe.

Prima facie that seems insane but of course as I will explain later it is more complicated than that. That is for best when we add in this from Marketwatch on Monday.

Investors now pay Greece for the privilege of owning its debt, an incredible turnaround from its securities being the source of global financial instability a decade ago.

Greece’s three-year debt turned negative on Friday, and then the country received more good news after the surprise decision by Moody’s Investors Service on Friday night to upgrade the nation’s debt. The upgrade, from Ba3 from B1 previously, still leaves Greek debt in junk market territory, and three notches away from becoming investment grade.

The yield on Greek 10-year debt TMBMKGR-10Y, 0.834% fell 4 basis points to 0.77%. In 2012, the yield on Greek 10-year debt surpassed 35%.

Amazing in its own way and well done to investors who got their timing right in these markets. Although a large Grazie is due to Mario Draghi who set things in motion.

US Treasury Bonds

However there has been something of a contrary signal from the US bond market. There was a hint of something going on in what is called the Long Bond which is the thirty-year maturity. Some of you may recall at the height of the pandemic panic in financial markets in March the yield here dipped below 1%. This was driven by two factors.The first was a move to a perceived safe haven in times of trouble and US Treasury Bonds are AAA rated as well as being in the world’s reserve currency. Also there would have been some front-running of the expected bond buying or QE from the US Federal Reserve. It did indeed charge in like the US Cavalry with purchases at the peak of US $75 billion per day.

But around 2 weeks ago the mood music was rather different as the debate was then about whether the yield would break above the 1.6% level that market traders felt was significant. As the election results began to come in it did so and now we find it at 1.75%.

If we switch to the benchmark ten-year ( called the Treasury Note) we see a slightly delayed pattern but also a move higher. In fact it gave us a head fake as the initial response to the election was a rally leading to lower yields and we noted it at 0.72%. But there were ch-ch-changes on the way and now we see it is 0.96%. So perhaps on the cusp of what is called a big figure change should it make 1%.

Why does this matter?

The first reason is for the US economy itself and there is a direct line in from mortgage rates.

Over the course of the past few days, 10yr yields are up roughly 0.2%.  This time around, the mortgage market hasn’t been able to avoid taking its lumps with the average lender now quoting 30yr fixed rates that are 0.125% higher compared to last Thursday.    ( Mortgage Daily News)

The housing market has been juiced by ever lower and indeed record low mortgage rates up until now. The change will feed into other personal and corporate borrowing as well.

Next comes its role as the world’s biggest bond market with some US $21.1 billion and of course rising at play here. I will come back to the domestic issues but there is a worldwide role here.For example back in my days in the UK Gilt ( bond) market the beginning of the day was checking what the US market had done overnight before pricing in any UK changes. That theme will be in play around the world and in fact on spite of the Italian and Greek moves above we have seen it.

For the US there is the domestic issue of debt costs. These have been a pack of dogs that have not barked but with the increases in the size of the bond market and hence higher levels of borrowing and refinancing smaller moves now matter. We know that President Elect Biden wants to spend more and looked at this on the 5th of this month although there remains doubt over how much of it he will be able to get through what looks likely to be a Republican controlled Senate. Even before this here are the projections of the Congressional Budget Office.

Debt. As a result of those deficits, federal debt held by the public is projected to rise sharply, to 98 percent of GDP in 2020, compared with 79 percent at the end of 2019 and 35 percent in 2007, before the start of the previous recession. It would exceed 100 percent in 2021 and increase to 107 percent in 2023, the highest in the nation’s history.

Best I think to take that as a broad sweep as there are a lot of moving parts in the equations used.

Yield Curve Control

This is, as you can see, not going so well! We have looked at the Japanese experience as recently as Monday and in the US it would be a case of recycling a wartime policy.

In early 1942, shortly after the United States declared war, the Fed effectively abdicated its responsibility for monetary policy despite its concern about inflation and focused instead on helping the Treasury finance the conflict. After a series of negotiations with the Treasury, the Fed agreed to peg the Treasury-bill yield at 0.375 percent, to cap the critical long-term government bond yield at 2.5 percent, and to limit all other government securities’ yields in a consistent manner.  ( Cleveland Fed)

The Long Bond yield is still quite some distance from the 2.5% of back then but as I have already explained the situation is I think more exposed now.

Oh and there was a concerning consequence to this.

The Treasury, however, did not wish to relinquish its control over Fed monetary policy and only acquiesced to small increases in short-term interest rates starting in July 1947, after inflation had been hovering around 18 percent for a year. The Treasury believed that it could not possibly finance its unprecedented levels of public debt at reasonable interest rates without the Fed’s continued participation in the government-securities market; in its view, only unrealistically high interest rates could coax enough private-sector savings to finance the debt.

Comment

Let me now switch to what we might expect if we had free markets. The extra borrowing we have looked at would be pushing yields higher. Another influence would be the fact the real ( after inflation) bond yields are heavily negative unless you think US inflation will be less than 1% per year for the next ten years. Even then it is not much of a return, especially compared to the 5% in one day some equity markets have just provided. The reality is that bond markets provide the prospect of capital gains rather than interest right now.

Also the modern era provides something very different from free markets as the US Federal Reserve will be thinking at what point will it intervene? Or to be more precise at what point will it do so on a larger scale as it is already buying some US $80 billion per month of US treasury bonds. It was not so long ago that such amounts were considered to be a lot. The path to Yield Curve Control may be via bond yield rises now followed by its response. So the real question is what level will they think is too much? This quickly becomes an estimate of what they think the US government can afford? As they have become an agent of fiscal policy again.

 

Will the Bank of England give us negative interest-rates?

Later today the members of the Monetary Policy Committee ( MPC) of the Bank of England will cast their votes as to what they think monetary policy will be and as I shall explain this is a live meeting. As in I expect changes today. Unfortunately due to a change made by the previous Governor Mark Carney we will not know the result until tomorrow at midday. Remember when all of this began to be called Super Thursday and then invariably turned out to be anything but?! Tomorrow will be one as we also get the Inflation Report to update us on what is expected for the economy. But the crucial point here is that the preference for bureaucratic convenience means that we are at risk of “some animals being more equal than others” as George Orwell put it so aptly. That risk is added to by the way the ship of state is such a leaky vessel these days.

The economy

The Minutes from the September meeting suggested things were better than expected.

UK GDP in July was around 18½% above its trough in April and around 11½% below its 2019 Q4 level. High-frequency payments data suggest that consumption has continued to recover during the summer and is now at around its start-of-year level in aggregate, stronger than expected in the August Report. Investment intentions have remained very weak and uncertainties among businesses are elevated. For 2020 Q3 as a whole, Bank staff expect GDP to be around 7% below its 2019 Q4 level, less weak than had been expected in the August Report.

Since then some of that has remained true as for example UK Retail Sales have continued to be strong. But as time passed we began to see more and more Covid-19 restrictions applied, first regionally and now including as of midnight all of England.

This morning’s Markit PMI business survey tells us this.

October data indicates that the UK service sector was close
to stalling even before the announcement of lockdown 2
in England, with tighter restrictions on hospitality, travel
and leisure leading to a slump in demand for consumer facing businesses. This was only partly offset by sustained expansion in areas related to digital services, business-to business sales and housing market transactions.

So the existing restrictions had clipped the tails of the service sector. So we are left with a pattern of a manufacturing recovery and very slow services growth followed by an expectation of this.

November’s lockdown in England and a worsening
COVID-19 situation across the rest of Europe means that the UK economy seems on course for a double-dip recession this winter and a far more challenging path to recovery in 2021.

There are issues with the credibility of the PMIs after some misfires but they are relevant because the Bank of England follows them. Some of you may recall Deputy Governor Ben Broadbent guiding us towards sentiment indices like them in the autumn of 2016. The absent-minded professor seems untroubled by the fact that led him up the garden path. Also I am intrigued by them discussing the risk of a double-dip recession when this is in fact a depression with the only issue being how long it will last?

Impact of Lockdown 2

The National Institute for Economic and Social Research or NIESR thinks this.

The second wave of the virus, and newly announced November lockdown, are likely to further increase the fall in 2020 GDP to around 11-12 per cent. This includes a fall of
around 3 per cent in the fourth quarter of 2020, with additional public borrowing but a slower rise in unemployment due to the extension of the furlough scheme.

Later they refine some of this although we are in the territory of spurious accuracy.

Saturday’s announcement of a further he November lockdown in response to resurgent Covid-19 will push
growth in the fourth quarter negative, to an estimated -3.3 per cent.

So we have a change to what we were expecting because we had our concerns about the end of the furlough scheme and its impact on employment and wages which would have knock-on effects elsewhere in the economy. That now will come in early December (probably as we are not sure when the lockdown will end) but in the meantime the lockdown will push economic output around 3% lower.

Another consideration for the Bank of England will be the labour market explicitly.

Our main case scenario was for unemployment to rise to above 7 per cent in the final quarter of 2020 and 8 per cent in the first half of 2021 as the Coronavirus Job Retention Scheme (CJRS) ends: the extension in November will have reduced this at the end of 2020 but may just have
postponed it. Unemployment is expected to rise above 5 per cent until 2024, with long-term persistent unemployment exacerbated by the prospect of a long and uncertain recovery.

Of course it has been a troubled area for them as back in the early days of Forward Guidance they established an unemployment rate of 6.5% as being significant for interest-rate rises and then ignored it.

Looking ahead which is what the Bank of England should be doing today, this looks rather tenuous on the vaccine front. We do not know when or indeed if one will be ready? Also individuals may be less than keen on being injected with something about which the long-term implications cannot be known.

Comment

The analysis suggests more easing is on its way and the first part is easy. These days the role of monetary policy is primarily to encourage fiscal policy by making it as cheap as possible. Today will see another £1.473 billion spent by the Bank of England buying UK government bonds aiming at that objective. But it is running out of road on its present plan because as of the end of today it will have spent some £697 billion out of the £725 billion it has authourised. That is only about another 6 weeks worth at the current rate. Just for the avoidance of doubt the £745 billion figure often quoted includes  £20 billion of corporate bonds which is now all over bar the shouting.

So the easy bit is a vote in favour of another £100 billion of QE which kicks the can comfortably into 2021. They could do more but that takes away some of the opportunity to act or rather looking like they are acting in the future. Regular readers will know I have been expecting an extra £100 billion for a while now as this is simply implicit funding of the government.

The path for Bank Rate is more complex. I still think a move is unlikely but cannot rule out they might be silly enough to cut Bank Rate to 0%. After all with all the rate cuts we have seen another 0.1% would be pretty much laughable. As to a cut into negative interest-rates that would look rather silly when their enquiry into them is not yet complete. However some of the MPC would vote for them and the way things are looking they could easily panic and give us a negative Bank Rate in 2021. Just as a reminder we already have negative bond yields in the UK out to the 6 year maturity. Due to the way that fixed-rate mortgages have become much more popular they are as significant as Bank Rate these days.

 

 

 

Australia cuts interest-rates again

This morning as the world waits on tenterhooks for news on the US election there was yet another move in one of the longest running themes of my work. For that we need to travel to what is often called a land “down under” or more recently the South China Territories. So let me hand you over to the Reserve Bank of Australia.

The elements of today’s package are as follows:

  • a reduction in the cash rate target to 0.1 per cent
  • a reduction in the target for the yield on the 3-year Australian Government bond to around 0.1 per cent
  • a reduction in the interest rate on new drawings under the Term Funding Facility to 0.1 per cent
  • a reduction in the interest rate on Exchange Settlement balances to zero

So we see yet another interest-rate cut in this instance from 0.25% to 0.1% which means that we have gad around 770 in total now since the credit crunch began. There is something very curious about this action because you see that apparently things are going really rather well.

Encouragingly, the recent economic data have been a bit better than expected and the near-term outlook is better than it was three months ago.

Indeed you might also think that as this rate cutting cycle began in June last year when the rate was cut from 1.5% to 1.25% you might wait for its impact to hit, at least if you believe it will have any. After all there were cuts two months in a row meaning a 0.5% cut which should be impacting now. If they do not work how will one of less than a third of the size?

The theme above has become something of a central banking standard where they tell us things are better than expected but cut interest-rates anyway! But I do not see others calling them out for it. After all if you are the South China Territories then this is rather bullish.

The global economy has been recovering from the initial virus outbreaks, with the recovery most advanced in China.

Quantitative Easing

I am sure you have spotted that the trend to more QE is in force as well. It always goes longer in time in line with my “To Infinity! And Beyond!” theme.

Under the program to purchase longer-dated bonds, the Bank will buy bonds issued by the Australian Government and by the states and territories, with an expected 80/20 split. These bonds will be bought in the secondary market through regular auctions, with the first auction to be held this Thursday for Australian Government securities.

As well as going longer there is always “More! More! More!” as a theme too as the extra 100 billion Australian Dollars is only a starting point.

The Bank remains prepared to purchase bonds in whatever quantity is required to achieve the 3-year yield target. Any bonds purchased to support this target would be in addition to the $100 billion bond purchase program.

Of course if you are going longer and presumably feel that is a good idea then why bother keeping the 3-year yield target? But the central planners never seem to give anything up once they have gained control.

The Aussie Dollar

We do get a bit of a divergence from the central bankers rule book with the bit I have highlighted below.

The combination of the RBA’s bond purchases and lower interest rates across the yield curve will assist the recovery by: lowering financing costs for borrowers; contributing to a lower exchange rate than otherwise; and supporting asset prices and balance sheets.

So we have an actual attempt at devaluation or more strictly exchange-rate depreciation. Of course President Trump may be about to depart but should he stay will he be looking at Australia as looking for an economic advantage via a weaker exchange-rate?

If we look at the Trade Weighted Index it’s recent peak was at 65.7 at the end of January 2018. It then gently declined towards 60 and then plunged to around 50 as the pandemic hit. So there was a substantial depreciation,although with economies plunging any economic gains were likely to be small. The index then bounced to a bit above 62 in August and was 59.5 yesterday.So there was and indeed is no clear case for needing a depreciation especially if you are benefiting from some re-stocking by China.

So far this year, Australian exports of iron ore and liquefied natural gas to China have increased by eight percent and nine percent respectively year on year, according to Wood Mackenzie. China’s coal imports from Australia also far exceeded the levels before the pandemic. ( CGTN from the 28th of July).

Housing Market

I see that the Australian Broadcasting Corporation has been on the case already.

Adelaide homeowners Mark and Verity Riessen are eagerly waiting to see how much of the rate cut will be passed on to them by their lender.

“The last rate cut the RBA passed through, was not passed on to us by our lender,” Mr Reissen said.

So the banks have behaved like well banks in not passing on the previous interest-rate cut and that is a theme. What do I mean by that? As interest-rates have approached and then in some places gone below zero the responsiveness or delta of the mortgage-rate changes has clearly declined. It always was important to check the terms of your mortgage but the ones saying linked to Cash Rate ( of the RBA) will be in prime position today.Also you need to check for exemptions as some around the world have (sneakily) imposed a minimum interest-rate.

According to the RBA the Reissen’s are at 3.2% paying what is pretty much the average rate with new mortgages being at 2.69% on average.

House Prices

We only have numbers up until the end of June but here is Australia Statistics.

Weighted average of the eight capital cities Residential Property Price Index:

  • fell 1.8% this quarter.
  • rose 6.2% over the last twelve months.

The total value of residential dwellings in Australia fell $98.2b to $7,138.2b this quarter.

The idea that the number above is any sort of value is pretty much laughable as has there been a bid for the lot? But we see that the RBA may have been triggered by house price falls which central bankers hate.

The index is at 143.2 as opposed to the 100 of 2012.

Comment

Let us look at the reality of the situation. Starting with interest-rates if you are wondering what is the point of a 0.15% cut after so many you are on the right track and the psychobabble continues with this.

Given the outlook, the Board is not expecting to increase the cash rate for at least three years.

So more meaningless Forward Guidance although some seem fooled by it. From ABC.

Dr Hunter said the bank outlining it did not expect to raise the cash rate over the next three years would “provide households and businesses with some certainty over their individual borrowing rates in the near term”.

Perhaps someone should tell Dr.Hunter about the existence of fixed interest-rates! Also as the last interest-rate rise was a decade ago today who exactly expects any sort of interest-rate rise? The fact it was to 4.75% provides plenty of food for thought.

The reality is that central banks have two aims now and that is why we are seeing so much QE and credit easing. Aim one is to help government fiscal policy by keeping the rate at which it can borrow very low and also pumping house prices by reducing mortgage rates.

Meanwhile I know Halloween was a few days ago but this still chills the spine.

Dr Lowe also said the cash rate was very unlikely to drop below zero.

 

 

 

 

The Bank of England has become an agent of fiscal policy

It is time to take a look at the strategy of the Bank of England as there were 2 speeches by policymakers yesterday and 2 more are due today including one from the Governor. But before we get to them let us first note where we are. Bank Rate is at 0.1% which is still considered by the Bank of England to be its lower bound, however it did say that about 0.5% and look what happened next! We are at what might now be called cruising speed for QE bond purchases of just over £4.4 billion per week. Previously this would have been considered fast but compared to the initial surge in late March it is not. The Corporate Bond programme has now reached £20 billion and may now be over as the Bank has been vague about the target here. That is probably for best as whilst the Danish shipping company Maersk and Apple were no doubt grateful for the purchases there were issues especially with the latter. It is hard not to laugh at the latter where the richest company in the world apparently needed cheaper funding. Also we have around £117 billion deployed as a subsidy for banks via the Term Funding Scheme and some £16 billion of Commercial Paper has been bought under the Covid Corporate Financing Facility of CCFF.

The Pound’s Exchange Rate

It has been a volatile 2020 for the UK Pound £ as the Brexit merry-go-round has been added to by the Covid-19 pandemic. The initial impact was for the currency to take a dive although fortunately one of the more reliable reverse indicators kicked in as the Financial Times suggested the only was was down at US $1.15. Yesterday saw a rather different pattern as we rallied above US $1.31. However as we widen our perspective we have been in a phase where both the Euro and the Yen have been firm,

If we switch to the trade-weighted or effective index we see that the Pound fell close to 73 in late March but has now rallied to 78. Under the old Bank of England rule of thumb that is equivalent to a 1.25% increase in Bank Rate. Right now the impact is not as strong due to trade issues but even if we say 1% that is a big move relative to interest-rates these days.

Ramsden

Deputy Governor Ransden opened the batting in his speech yesterday by claiming  that lower interest-rates were nothing at all to do with the cuts he and his colleagues have voted for at all.

Over time, these developments reduced the trend interest-rate, big R*, required to bring stocks of capital and wealth into line. And policy rates, including in the UK, followed the trend downwards.

So we no longer have to pay him a large salary and fund an index-linked pension as doe example AI could do the job quite easily? Also it is hard not to note that we would not be told this if the interest-rate cuts had worked.

As a former official at HM Treasury one might expect him to be a fan of QE as it makes the Treasury’s job far easier so this is little surprise.

QE has been an effective tool for stimulating demand through the 11 years of its use in the UK .

Really? If it has been so effective why has it been required for 11 years then? He moves onto a suggestion that there is plenty of “headroom” for more of it. This is followed by an extraordinary enthusiasm for central planning.

But again my starting point is that we have plenty of scope to affect prices. While yields on longer-dated Gilts are at historically low levels, that does not mean they could not still go lower.

There is a problem with his planning though because the QE he is such an enthusiast for has given the UK negative interest-rates via bond yields. At the time of writing maturities out to 6 years or so have negative yields of around -0.06%, Yet he is not a fan of negative interest-rates.

While there might be an appropriate time to use negative interest-rates, that time is not right now, when the economy and the financial system are grappling with the effects of an unprecedented crisis, as well as the myriad uncertainties this crisis has created.

Ah okay, so he is worried about The Precious! The Precious! Curious that because we are told they are so strong.

the banking sector as a whole starts from a position of strength.

Perhaps somebody should show Deputy Governor Dave a chart of the banks share prices. That would soon end any talk of strength. Also if you are Deputy Governor for Markets and Banking it would help if you had some idea about markets.

As a generic I would just like to point out that those who claim the Bank of England is independent need to explain how it has come to be that all the Deputy-Governors have come from HM Treasury?

The Chief Economist

The loose cannon on the decks has been on the wires this morning as he has been speaking at a virtual event. From ForexLive

  • Nothing new to say on negative rates
  • BOE is doing work on negative rates, not the same as being ready to use it
  • Monetary policy can provide more of a cushion to the crisis
  • But more of the heavy lifting has to be done by fiscal policy

Actually he then went on what is a rather odd excursion even for him.

There Is An Open Question Whether Voluntary Or Involuntary Social Distancing Is Holding Back Spending ( @LiveSquawk)

For newer readers he seems to be on something of a journey as previously one would expect him to be an advocate of negative interest-rates whereas now he is against them.

Comment

There is a sub-plot to all of this and let me ask the question is this all now about fiscal policy? The issues over monetary policy are now relatively minor as any future interest-rate cuts will be small in scale to what we have seen and QE bond buying is on the go already. The counterpoint to this is that the Bank of England has seen something of a reverse takeover by HM Treasury as its alumni fill the Deputy Governor roles. Its role is of course fiscal policy.

The speech by Deputy Governor Ramsden can be translated as we will keep fiscal policy cheap for you as he exhibits his enthusiasm for making the job of his former colleagues easier. That allows the Chancellor to make announcements like this.

Chancellor Rishi Sunak is to unveil new support for workers and firms hit by restrictions imposed as coronavirus cases rise across the UK.
He is due to update the Job Support Scheme, which replaces furlough in November, in the Commons on Thursday. ( BBC )

So we have been on quite a journey where we were assured that monetary policy would work but instead had a troubled decade. Whilst the Covid-19 pandemic episode is a type of Black Swan event there is the issue that something would be along sooner or later that we would be vulnerable to. Now central banks are basically faciliatators for fiscal policy. This brings me to my next point, why are we not asking why we always need more stimuli? Surely that means there is an unaddressed problem.

Is this the end of yield?

A feature of my career has been both lower interest-rates and bond yields. There have been many occasions when it did not feel like that! For example I remember asking Legal and General why they were buying the UK Long bond ( Gilt) at a yield of 15%. Apologies if I have shocked millennial and Generation Z readers there. There was also the day in 1992 when the UK fell out of the Exchange Rate Mechanism and interest-rates were not only raised to 12% but another rise to 15% was also announced. The latter by the way was scrapped as that example of Forward Guidance did not even survive into the next day.

These days the numbers for interest-rates and yields have become much lower, For example it seemed something of a threshold when the benchmark UK bond or Gilt yield crossed 2%. That was mostly driven by the concept of it being at least in theory ( we have an inflation target of 2% per annum) the threshold between having a real yield and not having one. The threshold however was soon bypassed as the Gilt market continued to surge in price terms. So much in fact that we moved a decimal point as 2.0% became 0.2%. In fact it is very close to the latter ( 0.22%) as I type this.

What happened to the Bond Vigilantes?

We get something of an insight into this by looking at the case of Italy. In the Euro area crisis we saw its benchmark bond yield rise above 7% and if we compare then to now everything is worse.

In the second quarter of 2020 the Gross Domestic Product (GDP) was revised downwards by 13% to the previous
quarter (from 12.8%)………In Q2, Gross disposable income of consumer households decreased in nominal terms by 5.8% with respect to the previous quarter, while final consumption expenditure decreased by 11.5% in nominal terms. Thus, the saving rate increased to 18.6%, 5.3 percentage points higher than in the previous quarter.

That is from the Italian Statistics Office last week. It has been followed this week by this from the IMF.

The International Monetary Fund on Tuesday raised its Italy GDP forecast for 2020 to -10.6%, from June’s -12.8%.
That is an improvement of 2.2 percentage points.
But the IMF cut its Italian growth forecast for next year.
GDP is now expected to rise 5.2% in 2021, 1.1 percentage points lower than the 6.3% forecast in June. ( ANSA)

So the IMF have made this year look better but taken half of that away next year. Actually it makes a mockery of the forecasting process because if you do better then surely that should continue? But, for our purposes today, the issue is of a large fall in economic output in double-digits. This especially matters for Italy because we know from our long-running “Girlfriend in a Coma” theme that it struggles to grow in the better times. So if it loses ground we have to question not only when it will regain it but also if it will?

Switching to debt dynamics ANSA also reported this.

The IMF also said Italy’s public debt will rise to 161.8% of GDP this year, from 134.8% last year, and will then fall to 158.3% in 2021 and 152.6% in 2025.

Those numbers raise a wry smile as we were told back in the day by the Euro area that 120% on this measure was significant. That was quite an own goal at the time but now it has been left well behind. As to the projected declines I would ignore them as they are a given in official forecasts but the reality is that the numbers keep singing along with Jackie Wilson.

You know your love (your love keeps lifting me)
Keep on lifting (love keeps lifting me)
Higher (lifting me)
Higher and higher (higher)

Actually Italy has over time been relatively successful in terms of its annual deficit but not now.

The IMF sees a budget deficit of 13% this year and 6.2% next, falling to 2.5% by 2025.

In a Bond  Vigilante world we would see a soaring bond yields as we note all metrics being worse. Whereas last week I noted this.

Italian 10-Year Government #Bond #Yield Falls To Lowest In More Than A Year At 0.765% – RTRS

This represents quite a move in the opposite direction from when the infamous “‘We are not here to close spreads. This is not the function or the mission of the ECB.’” quote from ECB President Christine Lagarde saw the yield head for 3%. That was as recent as March.

Monday brought more of the same.

Italy‘s 10-year and 30-year sovereign bond yields have dropped to all time-lows of 0.72% and 1.59%, respectively. ( @fwred)

Actually the bond market rally has continued meaning that at 0.64% the Italian benchmark yield is below the US one at 0.72%. This has led some to conclude that Italy is more creditworthy than the US, but perhaps they just have a sense of humour. John Authers of Bloomberg puts it like this.

Forza Italia! The Italian spread over German bunds is the lowest in three years, while the yield on Italian bonds is the lowest since at least 1320: (h/t Jim Reid, @DeutscheBank

)

Take care with the last bit because if I recall my history correctly Italy began around 1870.

But the fundamental point that Italy illustrates is that the Bond Vigilante theme relating to economic problems is presently defunct. In fact we see the opposite of it in markets as you make the most money from markets which start with the worst prospects as there is more to gain.

What about exchange-rate problems Shaun?

This is a subtext which does still continue. Only on Monday we noted that Turkey had to pay 6.5% for a US Dollar bond. Some of the exchange-rate risk is removed by issuing in US Dollars but not all because at some point Turkish Lira need to be used to repay it. But 6.5% looks stellar right now. There is also Argentina where yields are between 40% and 50%.

These are special cases where the yields mostly reflect an expected fall in the currency.

Comment

I have looked at Italy in detail because it illustrates so many of the points at hand. It should be seeing bond yield rises if we apply past thinking styles but we are seeing its doppelganger. The situation is very similar in Greece where the benchmark bond yield is 0.78%. If we look wider around the world we see this.From Bloomberg.

JPMorgan Chase & Co. says the stockpile of developed sovereign debt with a negative yields adjusted for inflation has doubled over the past two years to $31 trillion.

As the Federal Reserve prepares to let prices run hotter to fix the pandemic-hit labor market, the Wall Street bank has a message for investors: Get used to it.“Despite how logic defying the phenomenon is, negative real yields will likely stay with us for a long period to come,” wrote strategists including Boyang Liu and Eddie Yoon.

Adding in inflation means that the situation gets worse for bond owners. There is a familiar theme here because those who own bonds have had quite a party. But the hangover is on its way for future owners who see a market where the profits have already been taken, so what is left for them?

I have left out until now the major cause of the moves in recent times which has been all the QE bond buying by central banks. An example of this will take place this afternoon in my home country when the Bank of England buys another £1.473 billion. The market price for bonds these days is what the central bank is willing to pay. If you can call it a market price. Next comes the issue that countries are relying on this and here is the Governor of the Bank of Italy in Corriere della Sera

Then there is the average cost of debt. Right now it’s 2.4%. It is a high value.

2.4% high? So we arrive at my point which is that the central bankers will drive yields ever lower and as to any turn it will require quite a change as they sing along with McFadden & Whitehead.

Ain’t No Stoppin Us Now!
We’re on the move!
Ain’t No Stoppin Us Now!
We’ve got the groove!

Turkey is facing the consequences of another currency collapse

Today we have an example of an exception proving the rule. Indeed it is something so rare in these days of negative interest-rates that I hope you are all sitting comfortably.

ISTANBUL (Reuters) – Turkey’s central bank raised the interest rate in its lira swap operation to 11.75% from 10.25% on Friday, continuing additional tightening steps in the face of a weakening lira after unexpectedly hiking its benchmark interest rate last month.

Following the rate hike in its swap transactions, the lira  rebounded to near 7.90 against the U.S. dollar from a record low of 7.9550 earlier in the day. It had eased back to 7.9375 as of 1010 GMT.

Today is full of hints or more interest-rate cuts in China and Europe but Turkey has found itself raising them again, albeit in an official way. But as you can see the initial reaction in terms of the Turkish Lira was along the lines of “meh”.Actually the Turkish Lira did rally later to 7.84, but that was from another perspective only back to where it was on Wednesday and this morning it is back to 7.89.

Turkish Lira Troubles

It has been a hard year as Bloomberg points out.

Turkey’s lira depreciated to a record against U.S. dollar, decoupling from other emerging-currencies amid mounting geopolitical risks in the region.

The lira fell as much as 0.9% to 7.8692 per dollar, extending losses this year to more than 24%, the second-biggest slide in emerging markets after Brazil’s real.

As you can see that level got replaced and in spite of the unofficial interest-rate rise we are below it now. Regular readers may well recall that the Lira was slip-sliding away and hitting new lows back in the summer of 2018 and the move through 6 versus the US Dollar was regarded as significant whereas now we are on the verge of 8 being the big figure.

Because of the economic links the exchange-rate with the Euro is significant. Indeed some Euro area banks must be mulling their lending to Turkish borrowers as well as Euro area exporters struggling with an exchange-rate of 9.32. That is some 43% lower than a year ago.

Whilst we are discussing big figure changes we see that the UK Pound £ now buys more than ten Turkish Lira.

Inflation Surges

This is the obvious initial consequence of an exchange-rate depreciation.

In August, consumer prices rose by 0.86% and annual inflation remained flat at 11.77%. While annual inflation rose in core goods, energy and food groups, it remained unchanged in the services group. Meanwhile, annual inflation in the alcoholic beverages and tobacco group declined significantly due to the high base from tobacco products

That is from the latest Minutes of the Turkish central bank or TCMB and in fact the impact is even larger in essential goods.

Annual inflation in food and non-alcoholic beverages increased by 0.78 points to 13.51% in August. The rise in annual unprocessed food inflation by 1.51 points to 15.36% was the main driver of this increase.

As important is what happens next and here is the TCMB view.

In September, inflation expectations continued to increase. The year-end inflation expectation rose by 64 basis points to 11.46%, and the 12-month-ahead inflation expectation increased by 45 basis points to 10.15%.

With the ongoing fall in the Lira that looks too low to me. On the other hand I think that Ptofessor Steve Hanke is too high.

Today, I measure #Inflation in #Turkey at 35.67%/yr.

I can see how goods inflation might have such influences but other prices will not respond so mechanically.

Trade Problems

You might think that an ever more competitive economy in terms of the exchange-rate would lead to a balance of payments triumph. However this morning’s figures tell a different story.

The current account posted USD 4,631 million deficit compared to USD 3,314 million surplus observed in the same month of 2019, bringing the 12-month rolling deficit to USD 23,203 million. ( August data).

There are two highlights here. It is significant that the release is in US Dollars and not Turkish Lira. But we also note that Turkey has gone from surplus to deficit about which we get more detail here.

This development is mainly driven by the net outflow of USD 5,347 million in the good deficit increasing by USD 3,948 million, as well as the net inflow of USD 1,179 million in services item decreasing by USD 4,602 million compared to the same month of the previous year.

One factor at play in the services sector weakness is tourism. If we look at the year so far we see this is confirmed by a surplus of US $4.15 billion as opposed to one of US $19.17 billion in the same period in 2019. Another way of looking at this is that 3,225,033 visitors are recorded as opposed to 13,349,256 last year.

The problem here is also what is called the reverse J Curve effect where imports have become more expensive but it takes time for volumes to shift as well as it taking time for more orders to come in for the relatively cheaper exports. At the moment that is exacerbated by the pandemic as for example if we stay with tourism international travel has fallen and with further restrictions possible it may not matter how cheap you are.

Staying with theoretical economics we should be seeing the J Curve effect from the 2018 devaluation but right now as we have noted with tourism practicalities are trumping theory.

Foreign Debt

We get some context here if we note this from Bloomberg.

Meanwhile, Turkey paid a premium as it sold $2.5 billion of debt to international investors on Tuesday, it’s first foray into global markets since February. The bonds priced at 6.4%, compared with 4.25% for similar-maturity notes issued in February.

We note the fact that we have another trend reversal here as most countries have seen lower debt costs whereas Turkey is paying more. The theme of borrowing in US Dollars is a Turkish theme though and in terms of the money raised each one has so far been a success as in it would have been more expensive later. The catch is when we get to interest payments and repayments which have got ever more expensive in Turkish Lira. So if your income is in US Dollars or other overseas currencies you are okay but if it is in Lira you are in trouble.

According to the TCMB here is what is coming up from its July data.

Short-term external debt stock on a remaining maturity basis, calculated based on the external debt maturing within 1 year or less regarding of the original maturity, recorded USD 176.5 billion, of which USD 15.9 billion belongs to the resident banks and private sectors to the banks’ branches and affiliates abroad. From the borrowers side, public sector accounted for 23.9 percent, Central Bank accounted for 11.4 percent and private sector accounted 64.7 percent in total stock.

August saw an outflow from the TCMB as well.

Official reserves recorded net outflow of USD 7,602 million.

They started the year at US $81.2 billion and are now US $41.4 billion.

Comment

So far we have noted a financial sector which is in distress with rising interest-rates a falling currency and overseas borrowing in a toxic mix. Let us now switch to the real economy where these will impact via general inflation highlighted by foreign goods and services being much more expensive. So living-standards will be lower. The normal mechanisms where a currency depreciation can help an economy are in many cases being blocked by the Covid-19 pandemic. Only on Friday we observed that the UK has been importing less which is pretty much a 2020 generic. This is added to be the fact that a Turkish economic strength ( tourism) has had an especially rough 2020.

There are other issues here as the continual foreign currency depreciation has led to a surge in demand for safe assets.

A significant part of the deterioration in the current account balance is due to gold imports. This year, gold imports will exceed $ 20 billion. ( Hakan Kara)

Gold of course exacerbates the US Dollar issue as it becomes increasingly important in Turkey. Actually the central bank has joined the game as its Gold reserves have risen by some US $17 billion so far this year and whilst some of that is a higher price it must also have bought some more.

Will more interest-rate increases help? I am not so sure as they are usually much smaller than the expected fall in the currency and they will crunch the economy even further. It would help of course if Turkey was not either actually in a war or acting belligerently on pretty much every border it has. Putting it another way government’s in economic trouble often look for foreign scapegoats.

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