The shift towards lower rather than higher interest-rates is beginning again

Yesterday was another poor day for the Forward Guidance provided by central bankers as we note developments in the US and UK. There was a flurry of media activity around the statement from Bank of England Governor that the Chinese Yuan could challenge the US Dollar as the world’s reserve currency, but really he was saying that it is a very long way away. So let us start with the US Federal Reserve and look back to September for its Forward Guidance. From Reuters.

Fed policymakers did not jack up their expectations for rate hikes in coming years, as some analysts had thought, instead sticking closely to rate hike path forecasts outlined in June that envision short-term rates, now at 2.0 percent to 2.25 percent, to be at 3.1 percent by the end of next year.

This suggested a couple of rate hikes in 2019 and at the beginning of December Bill Conerly stepped up the pace in Forbes Magazine.

My forecast for interest rates remains higher than the Fed’s September 2018 forecast. I expect the Fed Funds rate to end 2019 at 3.9%, and to end 2020 at 4.5%.

Bill seemingly had not got the memo about a slowing word and hence US economy as he reflected views which in my opinion were several months out of date as well as being extreme for even then. But what we were seeing was a reining back of forecasts of interest-rate rises. Putting that in theoretical terms the so-called neutral rate of interest showed all the flexibility of the natural rate of unemployment in that it means whatever the central bankers want it to mean.

Last Night events took another turn with the publication of the US Federal Reserve Minutes from December.

With regard to the post meeting statement, members agreed to modify the phrase “the Committee expects that further gradual increases” to read “the Committee judges that some further gradual increases.” The use of the word “judges” in the revised phrase was intended to better convey the data-dependency of the Committee’s decisions regarding the future stance of policy; the reference to “some” further gradual increases was viewed as helping indicate that, based on current information, the Committee judged that a relatively limited amount of additional tightening likely would be appropriate.

As you can see they have chosen the words “judges” and “some” carefully and the prospect of interest-rate increases this year has gone from a peak of 4 with maybe more in 2020 to perhaps none. Or for fans of Carly Rae Jepson it has gone from ” I really,really,really,really” will increase interest-rates to “Call Me Maybe”

Why? Well some may mull the idea of there being a form of Jerome Powell put option for the stock market.

Against this backdrop, U.S. stock prices were down nearly 8 percent on the period.

Widening that out it also reflected an economic weakening which has mostly got worse since.

Forward Guidance

This is supposed to help the ordinary consumer and business(wo)man but letting them know what the central bank plans to do. But to my mind this is of no use at all if they keep getting it wrong as the US Federal Reserve just has. In fact in terms of fixed-rate mortgages and loans they have been given exactly the wrong advice. Whereas we had reflected the changing outlook as I quote from my opening post for this year.

The problem is their starting point and for that all eyes turn to the central banks who have driven them there. Get ready for the claims that “it could not possibly have been expected” and “Surprise!Surprise!”

I find myself debating this on social media with supporters of central bank policy who mostly but not always are central banking alumni. They manage to simultaneously claim that Forward Guidance is useful but it does not matter if it is wrong, which not even the best contortionist could match.

Bank of England

The memo saying “the times they are a-changing” had not reached Bank of England Governor Mark Carney as he posted on the Future Forum yesterday afternoon.

 That’s why the MPC expect that any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent.

He is still hammering away with his hints at higher interest-rates although he was also trying to claim that movements in interest-rates are nothing to do with him at all.

So in other words, low policy interest rates are not the caprice of central bankers, but rather the consequence of powerful global forces.

Makes you wonder why he and his 8 interest-rate setting colleagues are paid  some much if the main events are nothing to do with them doesn’t it? I somehow doubt that when a Bank of England footman handed a copy of Mark Carney’s Gilt-Edged CV to the World Bank that it was claiming that.

Governor Carney was in typical form in other ways too as he answered this question.

In your opinion, how likely is a large spike in Inflation in the near future?

For example in a lengthy answer he used the word inflation once but the word unemployment five times and did not mention inflation prospects/trends ( the question) at all! Better still the things which were apparently “the consequence of powerful global forces.” suddenly became due to his ilk.

Simulations using the Bank’s main forecasting model suggest that the Bank’s monetary policy measures raised the level of GDP by around 8% relative to trend and lowered unemployment by 4 percentage points at their peak. Without this action, real wages would have been 8% lower, or around £2,000 per worker per year, and 1.5 million more people would have been out of work.

As we note his slapping of his own back whilst blowing his own trumpet I zeroed in on the wage growth claim which appeared in another form much later.

Although it’s true that QE helped support asset prices, it also boosted job creation and wage growth.

There is a lot in that sentence but let us start with the wage growth issue. The reality is that real wage growth has been negative in the UK and worse than our economic peers. By propping up zombie banks and companies for example there are reasons to argue that the QE era has made things worse. But apparently in a stroke of magic it has made everything better! Now whilst correlation does not prove causation it is hard to argue you have made things better in a period where you have had a major impact and things have got worse.  Indeed  the more recent trend as the QE flow has slowed has been for wages to pick up.

Also there was the “helped support asset prices” point. This is welcome in its honesty but there have been times that the Bank of England ( in spite of its own research on the subject) has tried to deny this.

What about debt?

Back in 2016 Governor Carney told us.

This is not a debt-fuelled recovery.

Yesterday he changed his tune slightly.

 Recent growth in aggregate credit in the UK has been modest, growing a little faster than nominal GDP.

Notice the shift from real GDP to the invariably higher nominal GDP. Missing in action was any mention of unsecured credit which surged into double-digit annual growth in response to the Sledgehammer QE action of the Bank of England in the autumn of 2016 and is still growing at over 7%. Nor did the surge in student loans merit a mention unlike in this from Geoff Tily of the TUC last week.

Total unsecured debt has risen to £428 billion. At 30.4 per cent of household income, this is higher than before the financial crisis:

Comment

There is a fair bit to sweep up here but the main point is that we have developed bodies called independent that do the establishments bidding on a scale politicians themselves would never have got away with. Can you imagine politicians being able to buy trillions of their own debt?! Next we are told that they can help us with the future via Forward Guidance but that when it goes wrong it does not matter. The elastic of credibility just snapped.

In my own country the UK this was added to on LBC Radio where we were grandly told yesterday that someone who used to set UK interest-rates would be on air. When Ian McCafferty came on he seemed confused by the statement that the UK economy grew by 0.6% in the third quarter and sounded out of touch with events. For example in the early part of 2018 it was true that Germany and France were growing more quickly than the UK but as this morning has reminded us to say they are doing so now makes you look out of touch at best.

In November 2018, output slipped back sharply in the manufacturing industry (−1.4% after +1.4% in October) as well as in the whole industry (−1.3% after +1.3%). ( France-Insee ).

Perhaps he will offer a retraction like he had to do when he was on LBC last August. Meanwhile you know I often tell you never to believe anything until it is officially denied don’t you? From Governor Carney yesterday.

We have also made clear that we wouldn’t set negative interest rates – the Bank’s Monetary Policy Committee, which is responsible for setting Bank Rate, has said that the effective lower bound on Bank Rate is close to, but a little above, zero.

As a hint the lower bound was 0.5% until they cut to 0.25% ( and promised a cut to 0.1% in another Forward Guidance failure).

 

 

 

 

 

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Did the Riksbank of Sweden just panic?

This morning has brought news of an event that had been promised so many times but turned out to be a false dawn. Indeed on their way to apparently making sense of this world Rosa & Roubini Associates told us this.

Riksbank Likely to Wait Longer Before Lift-Off

I guess you are now all expecting this.

Economic activity is strong and the conditions are good for inflation to remain close to the inflation target in the period ahead. As inflation and inflation expectations have become established at around 2 per cent, the need for a highly expansionary monetary policy has decreased slightly. The Executive Board has therefore decided to raise the repo rate from −0.50 per cent to −0.25 per cent.

Actually there is quite a bit that is odd about this as indeed there has been, in my opinion, about the monetary policy of the world’s oldest central bank for some time. Let me give you two clear reasons to be doubtful. Firstly GDP growth plummeted from the 1% of the second quarter of this year to -0.2% in the third. Or as the Riksbank puts it.

As expected, Swedish GDP growth has slowed down during
the second half of this year. However, the downturn in the third  quarter was greater than expected.

So if we step back we immediately wonder why you raise rates when economic growth is slowing when you could have done so when it was rising? The excuse provided looks weak especially as we note the automobile industry has continued to struggle.

One contributory cause of  this was that household consumption fell by a surprisingly large  degree, but this can partly be explained by temporarily weak car sales.

Also inconvenient numbers are regularly described as temporary even when they are nothing of the sort.

Moving onto inflation the outlook has also changed as we have moved towards the end of 2018.

The inflation rate according to the CPI with a fixed interest rate (CPIF) was 2.1 percent in November 2018 (2.4 percent in October). The CPIF decreased by 0.1 percent from October to November.  ( Sweden Statistics)

Here is FXStreet from last week when these numbers came out.

Nordea Markets 1/2: : CPIF inflation stood at 2.1% in November, below consensus and 0.3% point below the ’s forecast. Core inflation, i.e. CPIF ex energy, came out at 1.4%, as much as 0.3% point below the Riksbank’s call.

To be fair to Nordea they were expecting a hike so perhaps they had received an official nod because there is now another factor at play. That is of course the lower trajectory of the oil price which looks set to depress headline inflation numbers in the weeks and months ahead. If we take a broad sweep the price of a barrel of Brent Crude Oil has fallen some US $30 since the Riksbank balked at raising Swedish interest-rates. I think you can spot the problem here. Apparently the wages fairy will turn up which of course is yet another central banking standard view in spite of reality not being that helpful.

Wage growth has certainly become a little lower than
the Riksbank’s forecast over recent months and the forecast has been revised downwards slightly.

The Riksbank’s own view

Let me know switch to some sections of their monetary report which frankly would fit better with an interest-rate cut.

The global economy, which has grown rapidly in recent years, is now entering a phase of more subdued GDP growth, which is in line with the Riksbank’s earlier forecasts.

So Sweden is swimming against the trend?

Economic activity in Sweden is still strong, although GDP growth and inflation have been weaker than expected.

So definitely maybe. What about inflation prospects?

Even though inflation has been lower than expected, the conditions remain good for inflation to stay close to the inflation target going forward.

Then we get quite a swerve because you might think that with the claimed view of the Riksbank more interest-rate hikes will be on the way. It would be logical assuming there is anyone who believes the growth path remains strong and inflation will be ~2% per annum. But apparently not.

The forecast for the repo rate has therefore been revised downwards to indicate that the next repo rate rise will probably occur during the second half of 2019 . After this, the forecast indicates approximately two rate rises per year by 0.25 percentage points each time.

If we skip the last sentence on the grounds that this has been not far off the promised pattern since the Riksbank last raised back in 2011 we see that what is now called a “dovish hike” has just taken place. What that means is that whilst there has been a rise the future expected path falls. Thus if you follow central banking forward guidance interest-rates as 2019 develops may now be lower than you were expecting.

Operation Twist and QE

The other factors in Sweden’s monetary policy are described below.

At the end of November, the Riksbank’s government bond
holdings amounted to just under SEK 350 billion, expressed as a nominal amount.

But they are giving Operation Twist an extra squeeze.

In December 2017, the Executive Board also decided that reinvestments of the large principal payments due in the first six months of 2019 should be allocated evenly across the period from January 2018 to June 2019 . This means that the Riksbank’s holdings of government bonds will increase temporarily in 2018 and the beginning of 2019.

If you wished to tighten monetary policy then you could simply let these bonds mature and not replace them.

US Federal Reserve

As we were expecting it did this last night.

Today, we raised our target range for short-term interest
rates by another quarter of a percentage point. ( Chair Powell)

Not everyone was on board however as there was a nearly 800 point swing in the Dow Jones Industrial Average in response to it. This also meant it ignored the advice from President Trump not to do so and to cut the amount of Quantitative Tightening. The issue was summed up by the Wall Street Journal but not in the way the author thought it meant.

The data says the economy is doing great; the markets say it could be headed for a recession.

At turning points the data is always too late by definition which means that some sort of judgement call is required. Central banks have about a 0% success rate in predicting recessions.

Comment

There is a fair bit to consider in the latest central banking moves but the major point is one of timing. Monetary policy is supposed to lead events and not to lag them which is why “data dependency” is not only flawed it is illogical. To be fair to the US Federal Reserve it has at least tried to get ahead of events whereas the Riksbank has not.

Meanwhile there is a country with a central bank meeting today which has just had some strong economic news.

The quantity bought in November 2018 when compared with October 2018 increased by 1.4%, with a strong monthly growth of 5.3% in household goods stores….The strongest growth can be seen in comparison with the same period a year earlier where the amount spent increased by 5.0% and the quantity bought increased by 3.6%.

Is anybody expecting Mark Carney and the Bankof England to have raised interest-rates in response to the strong retail sales data? I am using the past tense as the vote was last night.

Number Crunching

 

 

 

 

The US economy is slowing but how quickly?

A feature of recent times has been the way that economic growth forecasts have been trimmed somewhat. This morning has already seen two examples of that as the Swiss National Bank has suggested it will fall from 2.5% this year to 1.5% next, must be awkward that when your official interest-rate is already -0.75%. Next came the IFO Institute in Germany which did a little pruning to 1.5% this year and more of a short-back and sides to 1.1% in 2019. That provides some food for thought for the European Central Bank today as its largest economy slows.

The situation in the United States has been somewhat different, however, at least according to the official data. From the Bureau for Economic Analysis.

Real gross domestic product (GDP) increased at an annual rate of 3.5 percent in the third quarter of 2018 , according to the “second” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 4.2 percent.

Yes it has slowed but to a rate most first world countries would currently give their right arm for. We can use the Atlanta Fed now cast to see where we stand this quarter.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2018 is 2.4 percent on December 7, down from 2.7 percent on December 6.

They updated it on the basis of this new information.

The nowcast of fourth-quarter real final sales of domestic product growth decreased from 2.9 percent to 2.7 percent after this morning’s employment report from the U.S. Bureau of Labor Statistics. The nowcast of the contribution of inventory investment to fourth-quarter real GDP growth decreased from -0.23 percentage points to -0.33 percentage points after the employment report and this morning’s wholesale trade release from the U.S. Census Bureau.

So we see that whilst the level of economic growth remains relatively good the US has not escaped the cooling winds blowing.

Money Supply

This has proved to be a good guide to economic trends in 2018 and even better it remains widely ignored. Shorter-term trends are usually best encapsulated by narrow money so let us investigate last week’s monetary base data from the Federal Reserve which incorporates this.

The release also provides data on the monetary base, which includes currency in circulation and total balances maintained.

On the 5th of this month it was US $3.444 trillion but we immediately know that as Alicia Keys would say it has been Fallin’ as it was US $3.508 trillion on the 7th of November. We need to switch to the monthly numbers for an annual comparison and when we do so we see that in November it was 11% lower than a year before. If the phrase was not in use elsewhere this would be a credit crunch or to be more specific a type of cash crunch. Not a pure cash crunch as the currency in circulation has risen to US $1.705 trillion but reserve balances at the banks.

The fall has been driven by this.

For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month…….For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

As you can see it is the central bank which is sucking reserve balances out of the system as indeed it was it who pumped them up. In a broad sweep we see that the QE era took the monetary base from a bit under US $0.9 trillion to US $4.1 trillion and now is pulling it back down.

Personally I think the main effect is coming from the reductions in holdings of mortgage-backed securities so if we pro rata that we get a monetary base reduction of say 5% but that is still a crunch.

Interest-Rates

These have been rising in the US another 0.25% still seems likely next week. An intriguing way of putting the international perspective on this has been provided by the Bond Vigilantes website.

 the de facto global discount rate, the 2-year US Treasury bond yield, has risen by almost 100 basis points (bps) over the year, and thus repriced global assets.

Higher US interest-rates effect the world economy and thus have a second order effect on the US economy via trade. Then there are the domestic effects.

the US 30-year mortgage rate hit 4.8% recently, up from 3.3% in 2016. Whilst most existing homeowners, like corporates, will have locked in those cheap rates, new borrowers face costlier loans, and this is already having an impact: US housing and real estate data is surprising to the downside at a rate that exceeds that seen even in 2008 and 2009:

So there has been something of a squeeze on the real economy from this source as well, although it will have weakened recently as US Treasury Bond yields have fallen back from their peaks.

Fiscal Policy

As we mull the developments above it seems that the fiscal stimulus provided by President Trump was not as ill-conceived as some have claimed. Of course views vary about fiscal stimuli as for example they are apparently good for France but bad for Italy. But the Donald has provided one into a slow down which has at least some of the textbook rationale. Where matters get more complex is the fact that the US has so far only really seen its boom slow and other countries such as Germany make a stronger case. But if we skip the absolute level argument the Donald does appear to have spotted the direction of travel.

Comment

We see that the US has not in fact escaped the economic changes in 2018 but it has had an advantage from starting at a higher level of economic growth. But the monetary data is applying a squeeze as are higher interest-rates and as ever we find it impacting in familiar places.

Whenever you saw the supply of unsold homes reach 7 months, a recession followed. It certainly did in 2008, despite the consensus of economic forecasters believing that economic growth would be 2.4% – it was actually negative. Why should we worry now? Well, the supply of unsold new homes is… 7.4 months (blue line).  (BondVigilantes )

That will trouble the US Federal Reserve as will this development.

BKX not far from yesterday’s low. There’s a real problem with the banks. And I don’t think I’m being an alarmist by simply saying something might be going on here that we don’t know about. ( @selling_theta )

Worries about the housing market and the banks? We know how central banks usually respond to those so no wonder the US Fed has cooled on future interest-rate rises. QE4 anyone?

 

 

 

 

The problematic nature of current bond yields

One of the features of the credit crunch era has been the falls in first world interest-rates and bond yields. The first phase saw the slashing of official short-term interest-rates and once that was seen to be inadequate, central banks directly purchased bonds to reduce yields further. It is seldom put like this but there was already an implied failure as according to the models back then the interest-rate cuts should have done the trick. Back then I was already looking ahead to when there would have to be ch-ch-changes and posted the view that central banks would delay what has become called policy normalisation.

For example back on the 24th of February 2011 I pointed out this about a speech from David Miles of the Bank of England.

 My problem with this is that when you act as they have and you have in effect used what weapons the Bank of England has virtually to the maximum by cutting interest-rates by 4.75%% and spending some £200 billion on asset purchases then you have been extraordinarily interventionist. Accordingly it is then hard for you to blame events because some of them are the consequence of your own actions……

What that illustrates is that already the truth was being manipulated and also I am glad I wrote “virtually to the maximum” as of course the amount of asset purchases has more than doubled. In addition we have seen credit easing in the UK via such policies as the Term Funding Scheme and the start of full-scale QE from the European Central Bank as well as negative interest-rates.

But the point about delaying proved to be very accurate as the Euro area is still actively pursuing QE and in net terms the UK has managed to raise interest-rates by a measly 0.25%. The opportunity in 2014/15 was meant with promises via Forward Guidance but no action.

The US

This is the one country which has taken clear action on the path to normalisation. Here is the current state of play.

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

That is currently working out be be around 2.2% and more rises are promised. Also there is some reversing of the QE or Qualitative Tightening.

The Committee directs the Desk to continue
rolling over at auction the amount of principal
payments from the Federal Reserve’s holdings
of Treasury securities maturing during each
calendar month that exceeds $30 billion, and to
continue reinvesting in agency mortgage-backed
securities the amount of principal
payments from the Federal Reserve’s holdings
of agency debt and agency mortgage-backed
securities received during each calendar month
that exceeds $20 billion.

That combined with forecasts of another interest-rate rise in a fortnight and at least a couple next year seemed to put pressure on bond markets. However this sentence in a speech from Federal Reserve Chair Jerome Powell shook things up on the 28th of last month and the emphasis is mine.

We therefore began to raise our policy rate gradually toward levels that are more normal in a healthy economy. Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy‑‑that is, neither speeding up nor slowing down growth.

You may note we seem to have travelled from “policy normalisation” to neutral. But what the neutral interest-rate represents is an attempt to figure out what interest-rate would neither stimulate or contract the economy. Or a sort of measure of what we might aim for as a new normal. When they are trying to put a pseudo scientific gloss on things economist and central bankers call it r-squared.

However the “just below” dropped the expected path for US interest-rates by 0.5%.

Bond Markets

Let me take you to the Wall Street Journal on Tuesday.

This quarter, yields on longer-dated bonds have dropped and those on two-year Treasurys are flat. The gap between two and 10-year Treasury yields is now around 0.11 percentage point, compared with around 0.55 percentage point at the beginning of the year.

This is attracting a lot of attention in the financial media but the change of 0.44% is pretty much my 0.5% suggestion above. Now let us look at the US ten-year yield which is 2.9% as I type this and we see that in basic terms it is predicting a couple more 0.25% interest-rate rises. This will come in the next year or so if true so it is not very different to the two-year yield of 2.76%.

If we look beyond Federal Reserve policy we have seen a fall in the price of oil over the past month or two. If we look at it in Brent Crude terms then just above US $86 of early October has been replaced by below US $59 this morning as oil follows equity markets lower. The exact amount of the change varies but the path for inflation now seems set to be lower as it has been rare in 2018 for the oil price to be below where it was this time last year. That is another reason for lower bond yields.

Is this a signal of a recession? Here is the St.Louis Fed from last week.

Does the recent flattening of the yield curve portend recession? Not necessarily. The flattening of the real yield curve may simply reflect the fact that real consumption growth is not expected to accelerate or decelerate from the present growth rate of about 1 percent year over year. On the other hand, a 1 percent growth rate is substantially lower than the U.S. historical average of 2 percent. Because of this, the risk that a negative shock (of comparable magnitude to past shocks) sends the economy into technical recession is increased.

That is a fascinating way of looking at it and in my experience precisely zero bond market participants will look at it like that. It is also revealing that we seem to just assume growth will now be lower. Didn’t they save us?

Comment

I wanted to look at this subject today because of the clear changes which are happening. Now it looks much less likely that US interest-rates will pass 3% and if they do not by much. So “normalisation” will be at best about two-thirds of what it might have been considered to be pre credit crunch ( 4.5%). Some of you have suggested that we can no longer afford interest-rates and yields above 3% so well done at least if we stay where we are! If Italy folds you may get a second tick in that box.

But as we look wider we see even more extraordinary developments. Let me take a look at my own country the UK which is in political disarray yet the ten-year Gilt yield is below 1.3%. So those predicting a surge in Gilt yields are slipping back into the bushes whilst I note the extraordinary absolute level and the persistence of negative real yields which bust past metrics. Germany has a ten-year yield of 0.26% and a five-year one of -0.3% as we note again more metrics which are busted.

So my view is that we cannot rely on old recession metrics because another cause of all of this is that QE4 from the US Fed has got closer. I have worried all along that interest-rate rises might run into more QE and if they do we will be singing along to Coldplay.

Oh no I see
A spider web and it’s me in the middle
So I twist and turn
Here am I in my little bubble

 

 

Is a reversal of the carry trade behind the rise of the US Dollar?

This morning brings us back to what has been a regular topic in 2018 which has been the US Dollar. Let’s look at it from the perspective of the sub-continent.

The rupee weakened further and dipped by 54 paise to 73.04 against the US dollar Monday, owing to increased demand for the American currency from importers amid increasing global crude oil prices.

International benchmark Brent crude was trading higher by 2.04 per cent at USD 71.61 per barrel.

Forex traders said besides increased demand for the US currency from importers, the dollar’s strength against some currencies overseas weighed on the domestic unit.

From India’s point of view this is not as bad as it has been as twice the Rupee has fallen through 74 versus the US Dollar. However the overall trend has been down as we recall promises it would not go through 70 and the fact it is 11% or so lower than a year ago. The recent dip – until this weekend’s OPEC meeting – did not benefit the Rupee much in comparison.

For Pakistan things have been even worse as it own troubles have led it back into the arms of the International Monetary Fund ( IMF). The Pakistan Rupee is at 134.3 versus the US Dollar or 28% lower than a year ago.

The Euro

This morning the Euro has dipped to 1.125 and Bloomberg is on the case.

The euro fell to its weakest in more than 16 months on Monday as traders fret political risks from Italy to Brexit.

Actually Bloomberg mostly ignores the Euro and concentrates on Brexit which of course is an influence but far from the only one. The weaker phase for the Euro area economy where quarterly economic growth has fallen from 0.7% to 0.2% does not merit a mention. Nor does the expansionary monetary policy of the ECB with its negative interest-rate and ongoing QE which still has a couple of months to run in monthly flow terms. On the other side of the coin is the ongoing trade surplus which supports the Euro but not so much today.

President Macron of France made a suggestion on this front on CNN over the weekend.From Politico.

Macron also talked in the interview about the need to strength the euro’s position as a global reference currency — not as a challenge to the U.S. dollar but as an alternative for purposes of stability.

I guess it and the Chinese Yuan will have to compete but I am not sure how several reference currencies would work? The Euro is of course very widely traded but still a long way behind the US Dollar.

Returning to economic policy this will give both Euro area inflation and the economy a boost. With inflation already around its target the ECB will not welcome the former but will the latter as economic growth has faded. Should it be out of play for a while in terms of monetary policy then the Euro area would have to deal with any further slow down with fiscal policy. That would be awkward after spending so much time telling Italy that it does not work.

The Dollar Index

If we broaden our view and look at an index of which President Macron would approve ( because of the high Euro weighting) we see that the Dollar Index has hit a 2018 high of just above 97.5 this morning. Whilst that is not up an enormous amount on a year ago ( less than 3%) there has been quite a push since it fell below 89 at the opening of the year.

The move has technical analysts in a spin as some see this as the start of a big move higher and others see this as an inflexion point. This proves that it is not only economists who can tell you that a market may go up or down!

US Monetary Policy

Economics 101 will be pleased that at least some of it can be brought out into the sun as the so-called normalisation of US monetary policy leads to a higher dollar. We seem set for another interest-rate increase next month as well as 2/3 more in 2019 meaning US interest-rates look set for the 3 handle.

Also there is a quantity issue as US Dollars are being withdrawn via the advent of Quantitative Tightening or QT. That is happening at the rate of 50 billion dollars a month which is a large sum in spite of the fact that these times have made us somewhat numb about such matters.

Comment

The media seem keen to find reasons for this burst of US Dollar strength which have nothing to do with the US itself. Personally I think the US holiday may be a factor in today’s move but as well as the change in monetary policy stance something else has been at play in 2018. This is the apparent shortage of US Dollars which back on the 18th of May was affecting relative interest-rates.

The problem is a spike in the differential between LIBOR and the Overnight Index Swap, or the premium over the risk-free rate non-US banks pay to borrow dollars outside of the US.

The spread has risen to 42 basis points, the highest since February 2012, and up from 25 basis points at the start of last month and just 10 basis points in November.

While the rise does not pose a systemic risk, it has nevertheless raised the cost, and reduced the availability, of dollar-denominated loans for non-US banks by a considerable margin and in short space of time. ( Bank Pictet).

That improved but has returned to some extent ( 30 earlier this month) and of course in the meantime US interest-rates are higher. On September 25th we looked at the way a new carry trade had developed but apparently stopped.

 The overall amount of dollar credit to the non-bank sector outside the United States has climbed from 9.5% of global GDP at end-2007 to 14% in the first quarter of 2018. Since end-2016, however, the growth in dollar credit has been flat.

What if that reverses? We know from what happened with the Swiss Franc and Japanese Yen that reversals of international carry trades can have powerful effects. At this time of year there is also usually demand for US Dollars for the end of the year. Although frankly if you are thinking of it now you are likely to be too late. For now at least it is time for Aloe Blacc.

I need a dollar dollar, a dollar is what I need
Hey hey
Well I need a dollar dollar, a dollar is what I need
Hey hey

As the US observes Veterans Day let me give a plug to They Shall Not Grow Old which was on BBC 2 last night and was quite something.

 

 

 

 

 

 

What is the economic impact of tighter US monetary policy?

It is time for us to look West again and see what is happening in the new world and this week has brought a curious development. Ordinarily it is central bankers telling us about wealth effects and then trying to bathe in the implications of their own policies but in the US right now there is an alternative.

Stock Market up more than 400 points yesterday. Today looks to be another good one. Companies earnings are great!

That is from the Twitter feed of @realDonaldTrump and continues a theme where this seems if numbers of tweets on the subject are any guide to be his favourite economic indicator. Indeed on Tuesday he was tweeting other people’s research on the matter.

“If the Fed backs off and starts talking a little more Dovish, I think we’re going to be right back to our 2,800 to 2,900 target range that we’ve had for the S&P 500.” Scott Wren, Wells Fargo.

There is a danger in favouring one company over another when you are US President especially with the recent record of Wells Fargo. But the Donald is clearly a fan of higher equity markets, especially on his watch, and was noticeably quiet when we saw falls earlier this month. This does link in a way with the suggestions of a trade deal with China that boosted equity markets late on yesterday, although with the People’s Bank of China hinting at more easing the picture is complex.

The US Federal Reserve

Unless Standard and Poorski is correct below then the Fed is currently out of the wealth effects game.

FEDERAL RESERVE ANNOUNCES IT WILL BEGIN PURCHASES OF APPLE IPHONES AND IWATCHES AT A PACE OF $1 BILLION PER MONTH

One cautionary note is that humour in this area has a habit of becoming reality later as someone in authority might see this as a good idea. Also even the many central banking apologists may struggle with the US Fed buying Apple shares from the Swiss National Bank.

The current reality is rather different because as we stand QE ( Quantitative Easing) has morphed into QT  where the T is for Tightening. For example yesterday’s weekly update told us that its balance sheet  has shrunk by US $299 billion dollars to  US $4.1 trillion and the reduction was mostly due to the sale of US Treasury Bonds ( US $173 billion) followed by US $101 billion of Mortgage-Backed Securities. Over the next year we will expect to see around double the rate of change if it continues at its new raised pace.

 Effective in October, the Committee directs the Desk to roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month that exceeds $30 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month that exceeds $20 billion. ( Federal Reserve ).

Consequences

From the Wall Street Journal on Monday.

After hovering around 2.3% for most of the spring and summer, the three-month London interbank offered rate, or Libor, has been climbing since the middle of September, settling at 2.53% on Monday, its highest level since November 2008.

I am sure most of you are thinking about the rises in US official interest-rates and the shrinking balance sheet as well as the year-end demand for US Dollars I looked at back on the 25th of September . Well your Easter Egg hunt looks likely to be much more fruitful than the one at the WSJ.

Analysts don’t fully know why the spread has moved the way it has in recent months.

If we ignore the why and move onto what happens next? Lisa Abramowich of Bloomberg is on the case.

3-month U.S. Libor rates have surged to a new post-crisis high, of 2.54%, more than double where it was last year. This is important because so much debt, including leveraged loans, are pegged to this rate. Companies will find themselves paying more interest on their debt…

As to how much debt I note Reuters have been estimating it at US $300 trillion which even if we take with a pinch of salt puts the Federal Reserve balance sheet into perspective. Oh and remember the booming leveraged loan market that had gone to about US $1.1 trillion if I recall correctly? Well Lisa has been on the case there too.

Short interest in the biggest leveraged-loan ETF has risen to a record high.

So in areas which bankers would describe as being “innovative” we see that Glenn Frey is back in fashion.

The heat is on, the heat is on, the heat is on
Oh it’s on the street, the heat is on

We can add that to the troubles we have seen in 2018 in emerging markets as the double combination of higher US interest-rates and a stronger Dollar have turned up the heat there too.

The US Dollar

Firstly we need to establish that whilst talk of challenges abounds the US Dollar remains the world’s reserve currency. So a rise impacts on other countries inflation via its role in the pricing of most commodity contracts and more helpfully may make their economies more competitive. But if we are looking for signs of trouble it hits places which have borrowed in US Dollars and that has been on the rise in recent times. I have reported before on the Bank for International Settlements or BIS data on this and here is the September update.

The US dollar has become even more dominant as the prime foreign currency for international borrowing. Dollar credit to the non-bank sector outside the US rose from 9.5% of global GDP at end-2007 to 14% in Q1 2018…….The growth in dollar borrowing by EMEs or  emerging market economies  has been especially strong, but dollar exposures vary substantially both across countries and in terms of sectoral composition.

An example of this has been Argentina which is caught in a trap of its own making as for example a devaluation would make its US Dollar debts more expensive. Or if we look at India it seems its shadow banks have caught something of a cold in this area.

India Is Said to Expect Shadow Banking Default Amid Cash Squeeze- Bloomberg Non-bank financiers and mortgage lenders have 2.7 trillion rupees ($37 billion) of debt maturing in the next five months, immediately ( @SunChartist )

 

Comment

So far we have mostly looked at the international impact of US monetary policy so let us now look more internally. If we look at interest-rates then the 30 year fixed rate mortgage has risen to 4.83% having started the year at 4% and which takes it back to early 2011. This reflects rising Treasury Bond yields which will have to be paid on ever more debt with official suggestions saying US $1.34 trillion will need to be issued in the next year.

Against that the economy continues to be in a boom. We will find out more later as for example will wages growth reach 3%? But economic growth has been above that as the last 6 months suggests around 3.8% in annual terms assuming it continues. So for now it looks fine but then it always does at times like this as for example a slow down and rising bond yields could in my opinion switch things from QT to QE4 quite quickly. After all worries about US stock market falls  started with it still quite near to what are all time highs.

Also if you want some more numbers bingo the BIS provided some more for Halloween.

The notional value of outstanding OTC derivatives increased from $532 trillion at end-2017 to $595 trillion at end-June 2018. This increase in activity was driven largely by US dollar interest rate contracts, especially short-term contracts.

 

 

 

 

The Central Bank of Turkey has voted for Christmas

Back on the 3rd of May I pointed out that yet another feature of economics 101 was not working these days. Here was my response to interest-rate rises from the central bank of Argentina or BCRA.

This is perhaps the most common response and in my view it is the most flawed. The problem is twofold. Firstly you can end up chasing you own tail like a dog. What I mean by this is that markets can expect more interest-rate rises each time the currency falls and usually that is exactly what it does next. Why is this? Well if anticipating a 27,25%% return on your money is not doing the job is 30.25% going to do it?

Since then the BCRA  has indeed ended up chasing its own tail like a dog, as interest-rates are now an eye watering 60%. But the sequence of rises has been accompanied by further currency falls, as back then an exchange rate to the US Dollar of 21/22 ( it was a volatile day) has been replaced by 39.4. To my mind this has been influenced by the second factor I looked at back in May.

Next comes the way that markets discount this in terms of forward exchange rates which now will factor in the higher interest-rate by lowering the forward price of the Peso. So against the US Dollar it will be of the order of 28% lower in a year’s time so the expected return in each currency is equal. This should not matter but human psychology and nature intervene and it turns out often to matter and helps the currency lower which of course is exactly the wrong result.

Right now the forward price of the Argentine Peso will be heavily discounted by the 60% interest-rate. At least the Argentines got some welcome good news on the rugby front on Saturday when they beat Australia. Although they currently seem unable to avoid bad news for long.

The Argentine peso has lost more than half its value, but U2 frontman Bono is advocating for the economic well-being of the Argentine people  ( Bloomberg ).

Turkey

As you can imagine the announcement below on the 3rd of this month from the Turkish central bank or CBRT made me mull the thoughts above.

monetary stance will be adjusted at the September Monetary Policy Committee Meeting in view of the latest developments.

On the day itself ( last Thursday) the water got very muddy for a while as President Erdogan again made a case for low interest-rates. He apparently has a theory that high interest-rates create high inflation. But the CBRT is not a believer in that.

The Monetary Policy Committee (the Committee) has decided to increase the policy rate (one week repo auction rate) from 17.75 percent to 24 percent.

The consensus was that this was a good idea as highlighted by the economist Timothy Ash.

Turkey – huge move by the CBRT, doing 625bps, taking the base rate to 24%. Respect. Difficult decision set against huge political pressure, but the right should set a floor, and gives the lira and Turkish assets, banks etc a chance.

I have more than a few doubts about that. The simplest is what calculations bring you to a 6.25% rise, or was it plucked out of thin air?  Added to that is the concept of a floor and giving the currency and banks a chance. Really? The words of Newt from the film Aliens comes to mind.

It wont make any difference

Initially the Turkish Lira did respond with a bounce. It rallied to around 6.1 versus the US Dollar on the day and then pushed higher to 6.01 on Friday. In response I tweeted this.

In the case of Argentina the half-life of the currency rally was 24 hours at best….

So as I checked the situation this morning I had a wry smile as I noted the Lira had weakened to 6.26 versus the US Dollar. I also note that the coverage in the Financial Times had someone who agrees with me albeit perhaps by a different route.

But Cristian Maggio, EM strategist at TD Securities, said the central bank did not go far enough, because inflation was likely to rise beyond 20 per cent, and “higher inflation will require even higher rates”.

On the day some speculators will have got their fingers singed as the comments from President Erdogan sent the currency weaker at first, so following that the CBRT move whip sawed them. If that was a tactical plan it succeeded, but that is very different to calling this a strategic success.

Another issue is that the currency may well be even more volatile looking forwards. This is because holding a short position versus the US Dollar has a negative carry of 22% or so and against the Euro has one of 24% or so. Thus there will be a tendency to hold the Turkish Lira for the carry and then to jump out ahead of any possible bad news. The problem with that is not everyone can jump out at once! Any falls will lead to a mass exodus or panic and we know from the experience of past carry trades that the subsequent moves are often large ones.

Foreign Debt

Brad Setser has crunched the numbers on this.

Turkey has about $180 billion external debt coming due, according to the latest central bank data. And most of that is denominated in foreign currency. The Central Bank of Turkey’s foreign exchange reserves are now just over $75 billion, and the banks may have about $25 billion (or a bit less now) in foreign exchange of their own. I left out Turkey’s gold reserves, in part because they are in large part borrowed from the banks and unlikely to be usable.

The total external debt is now a bit over US $450 billion. Very little of that is the government itself although the state banks are responsible for some of it. The problem is thus one for the private-sector and the banks.

How this plays out is very hard to forecast as we do not know how many companies will not be able to pay, and how much of a domino effect that would have on other companies. Also we can be sure that both the government and CBRT will be looking to support such firms, but we can also be sure that they do not have the firepower to support all of them! This is another factor making things very volatile.

The domestic economy

There are a lot of factors at play here but let me open by linking this to the foreign debt. If we look back we would also be adding a current account deficit to the problems above but this is getting much smaller and may soon disappear. From the third of this month.

Turkey’s foreign trade deficit in August fell 58 percent on a yearly basis, according to the trade ministry’s preliminary data on Sept 1.

There should be a boost for exports which will help some but so far the main player has been a fall in imports which were 22.4% lower in the merchandise trade figures above. So a real squeeze is being applied to the economy which the GDP figures will initially record as a boost, as imports are a subtraction from GDP. So they will throw a curve ball as the situation declines.

Added to that is this which was before the latest interest-rate rise.

Switching to a year on year basis the impact so far of this new credit crunch is around three-quarters of the 2008/09 one. The new higher official interest-rate seems set to put this under further pressure as the banks tend to borrow short ( which is now much more expensive) and lend long ( which will remain relatively cheap for a while).

Comment

A major problem in this sort of scenario was explained by Carole King some years ago.

But it’s too late, baby, now it’s too late
Though we really did try to make it
Something inside has died and I can’t hide
And I just can’t fake it, Oh no no no no no

Regular readers will be aware that it is in my opinion as important when you move interest-rates as what you do. Sadly that particular boat sailed some time ago for Turkey ( and Argentina) and macho style responses that are too late may only compound the problem. Or as the CBRT release puts it.

slowdown in domestic demand accelerates

It must be a very grim time for workers and consumers in Turkey so let me end by wishing them all the best in what are hard times as well as a little humour for hard times.