Rising inflation trends are putting a squeeze on central banks

Sometimes events have their own natural flow and after noting yesterday that the winds of change in UK inflation are reversing we have been reminded twice already today that the heat is on. First from a land down under where inflation expectations have done this according to Trading Economics.

Inflation Expectations in Australia increased to 4.20 percent in June from 3.70 percent in May of 2018.

This is significant in several respects. Firstly the message is expect higher inflation and if we look at the Reserve Bank of Australia this is the highest number in the series ( since March 2013). Next  if we stay with the RBA it poses clear questions as inflation at 1.9% is below target ( 2.5%) but f these expectations are any guide then an interest-rate of 1.5% seems well behind the curve.

Indeed the RBA is between a rock and a hard place as we observe this from Reuters.

Australia’s central bank governor said on Wednesday the current slowdown in the housing market isn’t a cause for concern but flagged the need for policy to remain at record lows for the foreseeable future with wage growth and inflation still weak.

Home prices across Australia’s major cities have fallen for successive months since late last year as tighter lending standards at banks cooled demand in Sydney and Melbourne – the two biggest markets.

You know something is bad when we are told it is not a concern!

If we move to much cooler Sweden I note this from its statistics authority.

The inflation rate according to the CPI with a fixed interest rate (CPIF) was 2.1 percent in May 2018, up from 1.9 percent in April 2018. The CPIF increased by 0.3 percent from April to May.

So Mission Accomplished!

The Riksbank’s target is to hold inflation in terms of the CPIF around 2 per cent a year.

Yet we find that having hit it and via higher oil prices the pressure being upwards it is doing this.

The Executive Board has therefore decided to hold the repo rate unchanged at −0.50 per cent and assesses that the rate will begin to be raised towards the end of the year, which is somewhat later than previously forecast.

Care is needed here as you see the Riksbank has been forecasting an interest-rate rise for some years now but like the Unreliable Boyfriend somehow it keeps forgetting to actually do it.

I keep forgettin’ things will never be the same again
I keep forgettin’ how you made that so clear
I keep forgettin’ ( Michael McDonald )

Anyway it is a case of watch this space as even they have real food for thought right now as they face the situation below with negative interest-rates.

Economic activity in Sweden is still strong and inflation has been close to the target for the past year.

US Inflation

The situation here is part of an increasingly familiar trend.

The all items index rose 2.8 percent for the 12 months ending May, continuing its upward trend since the beginning of the year. The index for all items less food and
energy rose 2.2 percent for the 12 months ending May. The food index increased 1.2 percent, and the energy index rose 11.7 percent.

This was repeated at an earlier stage in the inflation cycle as we found out yesterday.

On an unadjusted basis, the final demand index moved up
3.1 percent for the 12 months ended in May, the largest 12-month increase since climbing 3.1 percent in January 2012.

In May, 60 percent of the rise in the index for final demand is attributable to a 1.0-percent advance in prices for final demand goods.

A little care is needed as the US Federal Reserve targets inflation based on PCE or Personal Consumption Expenditures which you may not be surprised to read is usually lower ( circa 0.4%) than CPI. We do not know what it was for May yet but using my rule of thumb it will be on its way from the 2% in April to maybe 2.4%.

What does the Federal Reserve make of this?

Well this best from yesterday evening is clear.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-3/4 to 2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

If we start with that let me give you a different definition of accommodative which is an interest-rate below the expected inflation rate. Of course that is off the scale in Sweden and perhaps Australia. Next we see a reference to “strong labo(u)r market conditions” which only adds to this. Putting it another way “strong” replaced “moderate” as its view on economic activity.

This is how the New York Times viewed matters.

The Federal Reserve raised interest rates on Wednesday and signaled that two additional increases were on the way this year, as officials expressed confidence that the United States economy was strong enough for borrowing costs to rise without choking off economic growth.

Care is needed about borrowing costs as bond yields ignored the move but of course some may pay more. Also we have seen a sort of lost decade in interest-rate terms.

The last time the rate topped 2 percent was in late summer 2008, when the economy was contracting and the Fed was cutting rates toward zero, where they would remain for years after the financial crisis.

Yet there is a clear gap between rhetoric and reality on one area at least as here is the Fed Chair.

The decision you see today is another sign that the U.S. economy is in great shape,” Mr. Powell said after the Fed’s two-day policy meeting. “Most people who want to find jobs are finding them.”

Yet I note this too.

At a comparable time of low unemployment, in 2000, “wages were growing at near 4 percent year over year and the Fed’s preferred measure of inflation was 2.5 percent,” both above today’s levels, Tara Sinclair, a senior fellow at the Indeed Hiring Lab, said in a research note.

So inflation is either there or near but can anyone realistically say that about wages?

Mr. Powell played down concerns about slow wage growth, acknowledging it is “a bit of a puzzle” but suggesting that it would normalize as the economy continued to strengthen.

What is normal now please Mr.Powell?

Comment

One of my earliest themes was that central banks would struggle when it comes to reducing all the stimulus because they would be terrified if it caused a slow down. A bit like the ECB moved around 2011 then did a U-Turn. What I did not know then was that the scale of their operations would increase dramatically exacerbating the problem. To be fair to the US Federal Reserve it is attempting the move albeit it would be better to take larger earlier steps in my opinion as opposed to this drip-feed of minor ones.

In some ways the US Federal Reserve is the worlds central bank ( via the role of the US Dollar as the reserve currency) and takes the world with it. But there have been changes here as for example the Bank of England used to move in concert with it in terms of trends if not exact amounts. But these days the Unreliable Boyfriend who is Governor of the Bank of England thinks he knows better than that and continues to dangle future rises like a carrot in front of the reality of a 0.5% Bank Rate.

This afternoon will maybe tell us a little more about Euro area monetary policy. Mario Draghi and the ECB have given Forward Guidance about the end of monthly QE via various hints. But that now faces the reality of a Euro area fading of economic growth. So Mario may be yet another central bank Governor who cannot wait for his term of office to end.

 

 

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Are interest-rates on the rise now?

As we find ourselves heading into the second decade of the credit crunch era we find ourselves observing an interest-rate environment that few expected when it began. At the time the interest-rate cuts ( for example circa 4% in the UK) were considered extraordinary but the Ivory Towers would have been confident. After all they had been busy telling us that the lower bound for interest-rates was 0% and many were nearly there. Sadly for the Ivory Towers the walls then came tumbling down as Denmark, the Euro area , Sweden, Switzerland and Japan all entered the world of negative official interest-rates.

Even that was not enough for some and central banks also entered into sovereign and then other bond purchases to basically reduce the other interest-rates or yields they could find. Such QE ( Quantitative Easing) purchases reduced sovereign bond yields and debt costs which made politicians very happy especially when they like some official interest-rates went negative. When that did not work either we saw what became called credit easing where direct efforts went into reducing specific interest-rates, In the UK this was called the Funding for Lending Scheme which was supposed to reduce the cost of business lending but somehow found that  instead in the manner of the Infinite Improbability Drive in the Hitchhikers Guide to the Galaxy  it reduced mortgage interest-rates initially by around 1% when I checked them and later the Bank of England claimed that some fell by 2%.

What next?

Yesterday brought a reminder that not everywhere is like this so let me hand you over to the Reserve Bank of India.

On the basis of an assessment of the current and evolving macroeconomic situation at its
meeting today, the Monetary Policy Committee (MPC) decided to:
• increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis
points to 6.25 per cent.
Consequently, the reverse repo rate under the LAF stands adjusted to 6.0 per cent, and the
marginal standing facility (MSF) rate and the Bank Rate to 6.50 per cent.

There are two clear differences with life in Europe and the first is a rise in interest-rates with the second being that interest-rates are at or above 6% in India. It feels like another universe rather than being on the sub-continent but it does cover some 1.3 billion people. Sometimes we over emphasise the importance of Europe. As to why it raised interest-rates the RBI feels that the economy is going well and that inflation expectations are rising as domestic inflation ( official rents) has risen as well as the oil price.

The US

This has moved away from zero interest-rates and now we face this.

to maintain the federal funds rate in a target range of
1½ to 1¾ percent

It seems set to raise interest-rates again next week by another 0.25% which has provoked Reuters to tell us this.

With inflation still tame, policymakers are aiming for a “neutral” rate that neither slows nor speeds economic growth. But estimates of neutral are imprecise, and as interest rates top inflation and enter positive “real” territory, analysts feel the Fed is at higher risk of going too far and actually crimping the recovery.

Personally I think that they do not understand real interest-rates which are forwards looking. So rather than last months print you should look forwards and if you do then there are factors which look likely to drive it higher. The most obvious is the price of crude oil which if we look at the West Texas Intermediate benchmark is at US $65 per barrel around 35% higher than a year ago. But last month housing or what the US callers shelter inflation was strong too so there seems to be upwards pressure that might make you use more like 2.5% as your inflation forecast for real interest-rates. So on that basis there is scope for several more 0.25% rises before real interest-rates become positive.

One point to make clear is that the US has two different measures of inflation you might use. I have used the one that has the widest publicity or CPI Urban ( yep if you live in the country you get ignored…) but the US Federal Reserve uses one based on Personal Consumption Expenditures or PCE. The latter does not have a fixed relationship with the former but it usually around 0.4% lower. Please do not shoot the piano player as Elton John reminded us.

If we move to bond yields the picture is a little different. The ten-year seems to have settled around 3% or so ( 2.99% as I type this) giving us an estimated cap for official interest-rates. Of course the picture is made more complex by the advent of Quantitative Tightening albeit it is so far on a relatively minor scale.

The Euro area

Here we are finding that the official line has changed as we await next week’s ECB meeting. From Reuters.

Money market investors are now pricing in a roughly 90 percent chance that the European Central Bank will raise interest rates in July 2019, following hawkish comments from the bank’s chief economist on Wednesday.

In terms of language markets are responding to this from Peter Praet yesterday.

Signals showing the convergence of inflation towards our aim have been improving, and both the underlying strength in the euro area economy and the fact that such strength is increasingly affecting wage formation supports our confidence that inflation will reach a level of below, but close to, 2% over the medium term.

For newer readers he is saying that in ECB terms nirvana is near and so it will then reduce policy accommodation which is taken to mean ending monthly QE and then after a delay raising interest-rates.

So it could be a present from Mario Draghi to his successor or of course if he fails to find the switch a job he could pass on without ever raising interest-rates in his eight years as President.

Comment

Before I give my opinion let me give you a deeper perspective on what has been in some cases all in others some of our lives.

Since 1980, long-term interest rates have declined by about 860 basis points in the United States, 790 basis points in Germany and more than 1,200 basis points in France. ( Peter Praet yesterday)

On this scale even the interest-rate rises likely in the United States seem rather small potatoes. But to answer the question in my title I am expecting them to reach 2% and probably pass it. Once we move to Europe the picture gets more complex as I note this from the speech of Peter Praet.

the underlying strength in the euro area economy

This is not what it was as we observe the 0.4% quarterly growth rate in Euro area GDP confirmed this morning or the monthly and annual fall in manufacturing orders for Germany in April. Looking ahead we know that narrow money growth has also been weakening. Thus the forecasts for an interest-rate rise next June seem to be a bit like the ones for the UK this May to me.

Looking at the UK I expect that whilst Mark Carney is Bank of England Governor we will be always expecting rises which turn out to be a mirage. Unless of course something happens to force his hand.

On a longer perspective I do think the winds of change are blowing in favour of higher interest-rates but it will take time as central bankers have really over committed the other way and are terrified of raising and then seeing an economic slow down. That would run the risk of looking like an Emperor or Empress with no clothes.

 

 

 

 

Is the Bank of England on a road to another Bank Rate cut?

Yesterday was a rather extraordinary day at the Bank of England and in some respects lived up to the Super Thursday moniker although by no means in the way intended. The media dropped that phrase at exactly the wrong moment. The irony was that for once they may have done the right thing in not raising interest-rates but what this exposed was the ineptitude and failures of their past rhetoric promises and hints. The regime of Forward Guidance can not have been much more of a failure as it found itself being adjusted yet again.

the MPC judges that an ongoing, modest tightening of monetary policy over the forecast period will be
appropriate to return inflation sustainably to its target at a conventional horizon.

Let us mark the obvious problem with the use of ongoing when the Bank Rate is still at the emergency level of 0.5% the Term Funding Scheme is at circa £127 billion and we have £435 billion of QE Gilt holdings and look at what they said in February and the emphasis is mine.

The Committee judges that, were the economy to evolve broadly in line with the February Inflation Report projections, monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period than anticipated at the time of the November Report,

So the timing element was wrong and so was the amount which doesn’t really leave much does it?

But things got worse at the press conference because in his attempt to explain this Governor Carney exposed Forward Guidance as an emperor with no clothes. In an exchange with Harry Daniels of LiveSquawk Governor Carney told us that his words were really only for financial markets and implied that they were big enough boys and girls to make their own views. He then contrasted with the ordinary person clearly implying they would not. Seeing as Forward Guidance was supposed to connect with the ordinary person and business Governor Carney torpedoed his own ship there. Also when he later tried to claim people and businesses do listen to him he unwittingly admitted he had misled them,

The people we speak to first and foremost are households and businesses across the country. [They] don’t trade short-sterling. They are not fixated on whether we raise rates on May 10 or at the end of June ( The Times).

They might reasonably have been fixated on his rate rise rhetoric back in June 2014 after all if they could have nearly taken out a couple of 2-year fixed-rate mortgages since then to protect themselves against the interest-rate rises which never happened.

A bizarre element was added on the issue of him talking at 6 pm to the BBC when many UK markets are closed as the Governor tried to claim it was okay because some markets such as the UK Pound £ were traded 24/7. This of course did not address at all the ones that are closed or the lack of liquidity at such times in the ones that are.

Weather or whether?

This got the blame.

The MPC’s central assessment is that it largely reflects the former, and that the underlying pace of growth remains more resilient than the headline data suggest.

The problem here is of course if they really believed that then they should have raised interest-rates! Also it directly contrasted with what our official statisticians had told us a few hours before.

Today’s figures support previous estimates showing the economy was very sluggish in the first quarter of 2018, with little impact overall from the bad weather.

Unreliable Boyfriend

This subject was raised several times and one of them got a rather bizarre response.

Shade from MC: “The only people who throw that term [unreliable boyfriend] at me are in this room” ( @birdyworld )

We do not even need to look beyond the boundaries of this website to know that such a statement is untrue and even the BBC uses the term. The Governor had opened the press conference by shiftily looking around the room before as several people rather amusingly suggested to me talking out of both sides of his mouth. Indeed the man formerly praised for his good looks and for being a rock star central banker seems to have lost the female vote too if this from Blonde Money is any guide.

Carney the ever unreliable boyfriend

There was an alternative view which I doubt the Governor will prefer.

The people outside the room say “who are you” ( @birdyworld )

Especially as it is from someone who thinks he has done a good job.

Wages

There was another odd turn here as Governor Carney went into full Ivory Tower mode and said that the Monetary Policy Committee only looked at regular wages. As it is not that frequent an event let me echo the words of Danny Blanchflower on this subject.

idiotic – workers only care about what is in their pay packet – so you take out the part of pay that varies and then tell us what is left doesn’t vary No other country in the world uses such a dumb measure.

Even worse the Governor tried to say that wages had progressed in line with the forecasts of the Bank of England but this is only if you cherry pick the data. For example the latest month for which we have figures is February and if you take the Governor’s line and look at private-sector regular pay the annual rate of increase was 3%. However if you look at pay across the economy ( and as it happens the private-sector)the annual rate of increase was 2.3%. Will people ignore what was once called “the pound in your pocket” and instead break up the notes and coins into separate piles?

The absent-minded professor

Ben Broadbent is called into play at the press conferences if the going gets tough. His role is twofold being partly to expound widely on minor details to waste time and in a related effort to make the viewers and attendees drowsy if not numb. Sadly I was not that to point out that his rhetoric on Asia ignored Japan where many fear a contraction in the first quarter GDP data due you guessed it to the weather.

He has also been on the Today programme this morning on BBC Radio Four. This seems unwise as people have just got up and do not want to be sent back to sleep but if we move on from that there is this.

BoE’s Broadbent: Message Is That Rate Hikes Will Be Gradual ( @LiveSquawk )

How long can you keep saying that when in net terms there have not been any?

It is entirely the sensible thing to do, to wait to see whether we are right that the economy will bounce back from here, and for me the decision was straightforward

So it was the weather or it wasn’t? Moving on from that is the contrast with August 2016 when Ben appeared somewhat panic-stricken and could not cut rates fast enough where was the waiting for a ” bounce back from here,” then Ben? He also wanted to cut further in November 2016 before of course even he was calmed by the actual data.

On a deeper level I would just like to point out that it was wrong to move Professor Broadbent from being an external member to an internal one. Otherwise external member of the MPC may be influenced by potential sinecures from the Governor which makes their existence pointless.

Comment

The road to a Bank Rate cut and possibly more QE Gilt purchases is simple and it merely involves the current weak patch for the economy persisting. As I have pointed out before the monetary growth numbers have been weakening which suggests the summer and early autumn may not be that good. It is also true that more than a few of our trading partners are seeing a weaker phase too as for example we saw this from France on Wednesday.

Manufacturing output fell sharply over the first
quarter of 2018 (−1.8%)

That leaves it with a similar position to the UK where a better phase seems to have ended at least for now. We know from August 2016 that it will not take much more of this for the Bank of England to look at easing policy in sharp contrast to the nearly four years of unfulfilled Forward Guidance about rises.

I don’t care if you never come home,
I don’t mind if you just keep on
Rowing away on a distant sea,
‘Cause I don’t love you and you don’t love me. ( Eric Clapton)

Meanwhile the consequences continue to build up.

Forty-somethings are now almost twice as likely to be renting from a private landlord than they were 10 years ago.

Rising UK house prices have left many middle-age workers unable to afford a first home,  ( BBC )

 

 

 

 

What are the prospects for the US economy?

As we progress through 2018 we find eyes as ever turning regularly to the US economy. Not only to see what the world’s largest economy is up to but also to note any changes. The economic growth news for the first quarter was pretty solid. From the Bureau of Economic Analysis or BEA.

Real gross domestic product (GDP) increased at an annual rate of 2.3 percent in the first quarter of 2018
according to the “advance” estimate released by the Bureau of Economic Analysis. In the
fourth quarter, real GDP increased 2.9 percent.

So whilst we see a slowing it is exacerbated in feel by the way the numbers are annualised and is much lower than that seen in the UK and much of Europe. Also the US has developed something of a pattern of weak first quarter numbers so we need to remind ourselves that the number is better than that seen in both 2016 and 2017. As to the detail the slowing was fairly general. If we were looking for an estimate of the recovery since the credit crunch hit then we get it from noting that if we use 2009 as out 100 benchmark then the latest quarter was at 120.58.

Let us move on with a reminder of the size of the US economy.

Current-dollar GDP increased 4.3 percent, or $211.2 billion, in the first quarter to a level of $19.97
trillion.

Looking ahead

There was something potentially rather positive tucked away in the Income report that was released with the GDP data.

Disposable personal income increased $222.1 billion, or 6.2 percent, in the first quarter, compared with
an increase of $136.3 billion, or 3.8 percent, in the fourth quarter. Real disposable personal income
increased 3.4 percent, compared with an increase of 1.1 percent.

At a time of weak wages growth considering the economic situation that was a strong reading which may feed forwards into future consumption numbers. I wondered what drove it but in fact it was pretty broad-based across the different sectors with the only fall being in farm income. As an aside the personal income from farming was surprisingly small considering the size of the US farming sector at US $27.9 billion.

Moving onto the Nowcasts of GDP the news has also been good. From the Atlanta Federal Reserve.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2018 is 4.0 percent on May 3, down from 4.1 percent on May 1.

They start the series in optimistic fashion so let us say that around 3% may well be where they end up unless something fundamental changes.

Moving onto the business surveys we saw this yesterday.

April survey data indicated a strong expansion in
business activity across the U.S. service sector.
However, although the rate of growth accelerated, it
remained below the series’ long-run average.
Meanwhile, the upturn in new business quickened
to a sharp rate that was the fastest since March
2015. ( Markit PMI ).

Which added to this from May Day.

April survey data signalled a steep improvement in
operating conditions across the U.S. manufacturing
sector. The latest PMI reading was the highest since
September 2014, supported by stronger expansions
in output and new orders. Moreover, new business
rose at the sharpest pace in over three-and-a-half
years. ( Markit PMI)

Thus the summary for the start of the second quarter is so far so good which again means the US is in better shape than elsewhere at least for now.

Inflation

Earlier this week I note that the US Federal Reserve was for once on target. What I mean by that was that the PCE ( Personal Consumption Expenditure) inflation rate rose by 2% in March compared to a year before. Expectations of this are what caused the addition of the word I have highlighted in Wednesday’s Fed statement.

The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.

There has been a lot of debate over this much of it misinformed. Firstly central bankers virtually never mean it and secondly they are hinting at a possible run higher after a long period when it has been below the 2% target.

Such a likelihood was reinforced by the Markit PMI surveys.

On the price front, input cost inflation picked up in
April. The rate of increase was strong overall and
the second-quickest since June 2015. (services)

Meanwhile, average prices charged rose at the
quickest pace since June 2011, with the rate of
inflation accelerating for the fourth successive
month. Survey respondents commonly noted that
higher charges were due to increased costs being
passed on to clients. (Manufacturing)

Of course having begun the process of raising interest-rates without the most common cause of it these days ( a currency collapse) the US Fed is not in that bad a place at least in its own mind should inflation overshoot the target in the summer. Although of course as I have pointed out before in terms of logic it should have been more decisive rather than dribbling out increases along the lines expected for the rest of 2018 by Reuters.

While the Fed left interest rates unchanged on Wednesday, it is possibly set to raise them by a total of 75 basis points this year.

King Dollar

This was summarised by Reuters thus.

In just two weeks the dollar has surged nearly four percent against a basket of the most traded currencies, erasing all the losses it had suffered since the start of 2018 .DXY.

Against a broader group of currencies, including those from emerging markets, the greenback is now in positive territory against half of them.

This brings us back to the topic of yesterday where the US Dollar rebound has hit the weaker currencies such as the Turkish Lira and the Argentine Peso hard. Following on from the change of heart of the unreliable boyfriend in the UK it has seen the UK Pound £ dip below US $1.36 and the Euro is below US $1.20.

Is this a return to the interest-rate differentials that had up to then been ignored? Maybe a bit but perhaps the reality is more that the modern currency trade seems to be to follow the economic growth and as we have observed above at the moment the US economy looks relatively strong.

Comment

So in terms of conventional economic analysis things look pretty good for the US economy as we stand. The danger might be highlighted this afternoon from the wages data in the non farm payrolls release. This is because rising inflation will chip away at real wages if the rate of wages increase stays at 2.7%. Of course that reminds us of the issue of the fact that wages growth is only at that level with an unemployment rate at 4% leading many economists to scrabble through Google searches trying to redact references to full employment at a higher rate.

Elsewhere there are potential concerns of which one is debt. Should growth continue on its current path then it will help the national debt withstand the pressure placed on it by the Trump tax plan. On the private-sector side though familiar fears are on the scene.

 

Yahoo Finance helpfully updates us with this.

They’re also safer than junk bonds, at least in theory, with lenders getting repaid before creditors when firms get into trouble

What could go wrong?

Finally in spite of the recent dollar strength the Yen has pushed its way back to 109 leaving me with this from Carly Simon.

Why does your love hurt so much?
Don’t know why

 

 

 

How to deal with a foreign-exchange crisis

This week has seen at least a couple of examples of currencies that appear to have gone into free fall. Let us open with the Argentine Peso which was singing along to “Down,Down” by Status Quo yesterday. From the Argentine newspaper Clarin via Google Translate

On Wednesday, the US currency jumped again to reach $ 21.52 in the retail market and $ 21.18 in the wholesaler. It went up 5% in the week.

The abrupt movement of a variable as sensitive as the exchange rate alters the nerves of investors, the general public and -although they deny it- of the Government itself, the last thing it wants is that in the middle of the hard fight to lower the inflation, the price of the dollar occupies large spaces in the media and in public conversation.

What they do not tell us is that this was a new low for the Peso. Actually we get an unusual perspective in that the paper gives a link to exchange rates on the front page  of its website. The situation so far this year is shown later as is a major factor in it.

Is that almost all currencies -especially those of the emerging world- are being devalued against the dollar. And the Argentine peso is the currency that fell the most in the year against the dollar (12.5%) followed by the Russian ruble (9%).

How can a central bank respond?

Interest Rates

From the Argentine central bank or BCRA. You might like to sit down before you read it.

Buenos Aires, April 27, 2018. Given the dynamics acquired by the exchange market, the Monetary Policy Council of the Central Bank of the Argentine Republic met outside of its pre-established schedule and decided to increase its monetary policy rate, the center of the corridor of passes to 7 days, in 300 basis points to 30.25%. He made this decision with the aim of guaranteeing the disinflation process and is ready to act again if necessary.

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? Unlikely in my view as we note that the currency has fallen 5% this week.

On the other side of the coin interest-rates in one place in particular are expected to have an effect. From a speech by BCRA Governor Federico Sturzenegger on the 23rd of April.

This week at the Fund meetings, for example, I saw scenarios with 9 hikes in the FED policy rate over this year and next. But most people did not believe that was the most likely scenario. Yet, whatever form monetary policy normalization takes, certainly such a move will have ample repercussions on the rest of world.

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.

So what should you do? Well respond to inflation changes are per your mandate as per this but then hold your nerve.

The Central Bank will continue using all the tools at its disposal and will conduct its monetary policy to reach its intermediate target of 15% in 2018.

Otherwise each currency fall you will be raising interest-rates and again a downwards spiral can result.

Foreign Exchange Reserves

This is often the first line of defence or can be combined with an interest-rate rise. From Clarin again.

plus the almost 5,000 million dollars of the reserves that sold in the last week of April and the start of May,

The catch is that it is not working although until the interest-rate rise last week it was not helped by the last move being a cut in interest-rates. Also if we return to the speech by the BCRA Governor Argentina was in a really bad place only a couple of years ago.

As we took over from the previous government, our international reserves were reaching very low levels. In fact, what we called net reserves, that is, our reserves net of our obligation in foreign currency, were negative.

In fact it was a real mess.

To make things worse, the previous government had sold USD futures for about the equivalent of a third of the monetary base at off market prices.

In fact it bought its new reserves from the Argentine government.

The combination of the need to accumulate reserves, plus the fact that the government had an excess supply of dollars, as it was financing abroad its gradual fiscal convergence, implied a natural agreement by which the Central Bank would buy these excess dollars to the Treasury, sterilizing afterwards the pesos issued by issuing short-term Central Bank debt.

Okay so now it has some reserves but there is a catch which is that whilst they are getting more valuable in Peso terms of course that is only for the amount left as they are being used up. This is the problem here as people focus on the amounts used and the rate of attrition. Even Russia suffered from this if you recall and it had and has ready sources of foreign exchange from its oil and commodity exports. The IMF estimated at the end of last year that Argentina would have US $50.7 billion of foreign exchange reserves this year and that they would grow in subsequent years. Mind you they also forecast a rising Peso so it was far from their finest hour.

Capital Controls

Argentina did have these but scrapped them. From the Governor’s speech.

The third change occurred at the beginning of 2017, when the government released the remaining capital controls

They can help but problems do arise of which the worst is the development of an official and unofficial exchange-rate. I am sure you can figure out which will be higher than the other. Or the US Dollar becomes the currency most used.

Comment

So a central bank can fight a currency decline but the truth is that it can only do so on a temporary basis. The Swiss Franc has taught us that this is true in the case of currency strength where the central bank in theory at least is in a much stronger position. Oh and by temporary I mean the definition used by the ordinary person not the perversion used by central bankers.

However some of the moves can make things worse as for example knee-jerk interest-rate rises. Imagine you had a variable-rate mortgage in Buenos Aires! You crunch your domestic economy when the target is the overseas one. As to building up foreign exchange reserves by borrowing it is hard not to think of this. From City-AM last June.

About a year after emerging from default, Argentina has surprised investors by offering a 100-year bond.

The US-dollar-denominated bond is offered with a potential 8.25 per cent yield.

Actually it feels like everyone lost there which cannot be true. Argentina has to pay the interest with increasingly devalued Pesos and the price of the bond has to give you a clue been described like this.

Of course Argentina did gain on the initial transaction.

Moving onto Turkey which this morning has joined the club with a new low for the Lira I note this from the editor of the Financial Times Lionel Barber.

Good market spot: Turks are buying gold to hedge against booming inflation and a falling currency

Which got this reply from Henry Pryor.

Anecdotally central London agents tell me they are seeing an increase in Turkish buyers this year…

Which gives me another question. Is London property considered to be the worlds safe asset and please note I typed considered to be?

Oh and helping with this sort of thing was the original role of the IMF as opposed to the way it intervened in the fiscal crisis in part of southern Europe.

This article came to late for the BCRA it would appear as just before 5 pm UK time they raised interest-rates to 33.25%. I would place a link bit nobody seems to have told the English version of their website yet.

 

How much will interest-rates rise?

The issue of interest-rate rises has suddenly become something of a hot topic and let me open with the words of Jamie Dimon of JP Morgan. From the Financial Times.

Jamie Dimon, head of JPMorgan Chase, has warned that the US economy is at risk of overheating, raising the prospect that the Federal Reserve may soon need to slam on the brakes to prevent wages and prices from rising too quickly.

There are more than a few begged questions here but let us park them for now and carry on.

“Many people underestimate the possibility of higher inflation and wages, which means they might be underestimating the chance that the Federal Reserve may have to raise rates faster than we all think,” he wrote. “We have to deal with the possibility that, at one point, the Federal Reserve and other central banks may have to take more drastic action than they currently anticipate.”

Okay let us break this down. Firstly we are back to output gap theory again which of course has been wrong,wrong and wrong again in the credit crunch era. If there are signs of overheating then they are to be found in asset markets where we have seen booming bond prices and house prices and until recently all-time highs for equity markets. Only on Tuesday we looked at US house price growth of 6% or 7% depending which data you use.

Wages

I have picked this out because there has been quite a swerve from Jamie Dimon as for so long nearly everyone has been hoping for higher wages. Now suddenly apparently a rise is a bad thing? The Financial Times article implicitly parrots this line.

The prospect of an overheating economy has spooked the financial markets as recently as February, when stronger-than-expected US wage growth sparked the worst Wall Street sell-off in six years.

In terms of numbers a rise in average earnings growth per hour to 2.9% was hardly groundbreaking and of course it has since faded away showing the unreliable nature of one month’s data. In reality to return to old era trends we would need wages growth of 3.5%+ for a while. But in Jamie’s world that seems to be a bad thing although apparently not always. From Bloomberg.

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon received $29.5 million in total compensation for his work in 2017, an increase of 5.4 percent from a year earlier.

So we are left mulling a view where what was supposed to be good would now be bad! Although those of you who in the comments section have argued we will not see major interest-rate rises until wage rises for the ordinary person picks up are permitted a wry smile at this point.

What is expected?

From the FT article.

Prices of Fed funds futures suggest few expect the Fed to raise rates by more than three times this year, as policymakers have indicated. Longer-term market measures also indicate that investors expect inflation and bond yields to remain subdued for years to come.

I put the second sentence in because it is positively misleading. What those measures are provide a balancing of markets now and usually have very little to do with what will happen. Returning to interest-rates we got a view this week from former Federal Reserve Chair Janet Yellen.

At Monday’s larger forum for Jefferies clients, she expressed the view that three or four rate rises were likely this year, and that recent U.S. tax cuts and a boost in government spending posed at least some risk of running the economy hot, according to the first source, who requested anonymity. ( CNBC)

This is the awkward bit about the Jamie Dimon claim which is that the existing and likely moves in US interest-rates are a response to expected higher inflation anyway as of course as we have looked at many times it is still below the target. Back to Janet.

Later, over dinner at the Manhattan penthouse of Jefferies’ chief executive, Yellen told executives from hedge funds, private equity firms and other companies that she considered inflation to be in check and unlikely to spike, so rates would stay relatively low, according to a second person familiar with the discussion.

Take that as you will as of course we discovered in her time that she does not really understand inflation.

The Bank of England

So how will it respond as traditionally it follows the US Federal Reserve?

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Oh sorry not that one. Let us move onto its favourite publication the Financial Times.

Policymakers at the Bank of England are debating whether to be more forthcoming about their future plans for interest rates, as they gear up for a crunch vote on the cost of borrowing next month.

This is fascinating stuff because it both implies and suggests they know what their forecasts are! Let me give you an example reviewed favourably by Chris Giles the economics editor of the FT.

But last month Gertjan Vlieghe, an external MPC member, broke ranks with his colleagues on the nine-member committee when he said that rates could rise above 2 per cent over the same period.

Actually if we remove the rose-tintin ( sorry but he is Belgian) he seems an excitable chap as this from the Evening Standard in April 2016 reveals.

Vlieghe’s answer is intriguing: “Theoretically, I think interest rates could go a little bit negative.”

The long discussion on negative interest-rates that took place was clearly a hint of expected policy and means that Gertjan was wrong which poses a question over why we should listen this time? Although Chris Giles has a very different view.

Not sure it matters if people believe them.

I think it matters a lot. Oh and as the Swedish Riksbank has found it.

The Riksbank has had some difficulties with its predictions.

But to be fair Chris Giles does have a sense of humour ( I think).

But there remains concern that the BoE could undermine trust in it as an institution running an important public policy if it makes predictions about interest rates that do not come to pass.

Comment

Let me open with a rather good reply to this from GreaterFool.

Any shreds of credibility that the BoE once had disappeared into smoke after the forward guidance experiment. Telling people that you’ll raise rates after unemployment falls below 7% and then dropping them again when unemployment is below 5% will do that.

In fact the hits keep coming as though in this instance from Felix2012

There are quite a few commenters here who still take MPC seriously, unfortunately.

As to clarity well we did get that from Governor Carney back in June 2014.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced….“It could happen sooner than markets currently expect.

That was taken as a clear signal back then and the next day saw a lot of market adjustments which later led to losses as it never happened. Of course the road to a Bank Rate cut after Governor Carney hinted at it was both real and fast as we discovered 3 years later.

So what can we expect? The Bank of England has rather committed itself to a May Bank Rate rise which if you look at falling inflation and some weaker economic news looks out of touch. We have seen signs of slowing in Europe too as German industrial production has shown already today. The US Federal Reserve will no doubt carry on course unless there is a shock stateside although not everyone even thinks we need any tightening. BoI is the Bank of Italy.

 

What is happening to US house prices?

If you are a believer that the extraordinarily stimulatory monetary policies of the credit crunch era have boosted house prices via their impact on asset prices then the United States currently provides food for thought. This is because of this.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-1/2 to 1-3/4 percent.

For younger readers the US Federal Reserve has raised official interest-rates to extraordinary heights and for older ones it has barely got into the foothills. Either way The Fed-Home as Google now describes us thinks this.

 The stance of monetary policy remains accommodative,

In addition to the series of increases in interest-rates we have seen and continue to expect we are now in what I guess we need to call the QT or Quantitative Tightening era or as Marketwatch described it last month.

Last fall, the Fed announced plans to slowly reduce its balance sheet on auto-pilot, allowing holdings to shrink by $20 billion each month this quarter and moving up to a maximum of $50 billion per month by the end of the year.

From the peak of US $4.5 trillion the balance sheet has shrunk from US $4.5 trillion at its peak to US $.4.4 trillion as of the latest update. So QT has had an impact in terms of a small flow reduction which has led to a small stock reduction. Thus we have gone from small up to small down if we look at it like that although of course in other terms US $100 billion or so was a lot of money.

If we look ahead then Marketwatch point out that we were given a hint of a possible future late last year.

The Fed has not announced how low it wants to shrink its balance sheet. New Fed Chairman Jerome Powell discussed a target range of $2.5 trillion to $2.9 trillion in his confirmation hearing last fall.

Okay what does this impact?

A central bankers heart will gladden when they see these numbers from Money Magnify.

In the second quarter of 2017, real estate values in the United States surpassed their pre- housing crisis levels. The total value of real estate owned by individuals in the United States is $24 trillion, and total mortgages clock in at $9.9 trillion. This means that Americans have $13.9 trillion in homeowners equity.12 This is the highest value of home equity Americans have ever seen.

As they do not let me point out that such value calculations have the flaw of using a marginal price for an average concept which looks great when prices rise but not to great when they fall. If we move on we also see a consequence of the credit crunch era.

Current homeowners have mortgage payments that make up an average of just 16.5% of their annual household income.

That will be changing but not in the way that you think as the US market is mostly one of fixed-rate mortgages. So whilst both the policy changes above may affect it we see that over time QT is likely to have the largest impact. This is because the main player is the 30 year fixed rate mortgage which means that the 30 year Treasury yield is more of a factor that short-term interest-rates. When you look at what it has done you see that in a broad sweep the US Fed helped reduce it by around 1% from 2013 to late 2016 and it then rose by 1% to the current 4.44%. Actually if you look at the chart it is hard not to have a wry smile as for all the rhetoric and talk about QT the main player seems to have been the Donald as most of the rise was around the election of President Trump. Humbling for central bankers and their dreams of ruling the world! If you want to know how this took place I looked at it on the 9th of November 2016.

Before I depart the economic situation let me point out that we may well end up discussing as so often two different markets.

Today, half of all borrowers put down 5% or less. More than 10% of borrowers put 0% down. As a result, the average loan-to-value ratio at origination has climbed to 87%

Manhattan

Is this a case of a perfect storm? We have the effect of the factors above although of course they affect the 0.1% much less than the rest of us. But the winds of change as we have seen in central London have been blowing against capital city ( in which category New York is unofficially if not officially) property prices after many years of plenty. Also there has been this according to the Financial Times.

Some buyers held off buying real estate as they grappled with the impact of President Donald Trump’s changes to the federal tax code, which introduced a cap on the deduction of state and local taxes, including property taxes, from federal tax bills. It also reduced the size of mortgages eligible for interest deductions. The change is expected to hit high earners in high-tax states including New York, particularly in New York City.

This has led to this.

The number of co-op and condominium sales in Manhattan fell nearly 25 per cent during the first quarter compared to the same period last year………..It was the largest annual decline in sales in nine years, according to the report.

Okay so what about prices?

The average sale price across Manhattan fell by 8.1 per cent from the year-earlier quarter, and the average price per square foot also recorded a sharp decline, falling by 18.5 per cent to $1,697.

Perhaps fearing a lack of sympathy amongst even its readers the FT takes its time to point out what this means.

The average sales price of a luxury apartment fell 15.1 per cent, down from $9.36m in the first quarter of 2017 to $7.94m in the first quarter of this year, and the number of sales was down 24.1 per cent. The number of newly built apartments that went into contract fell 54 per cent.

As to lack of sympathy that was at play in the comments.

So now the average luxury apartment in Manhattan costs only $8 million? Not yet a bargain then? ( Genghis)

As was some perspective.

1600 usd per sqf for prime ? Still a bargain compared to London (JP1)……..I know. And positively a steal compared to Hong Kong !! (observer).

Looking wider

You might from the above expect lower prices but in fact at the end of last week we were told this. From Zillow Research.

The continuing inventory pinch helped boost the U.S. national Case Shiller index 6.2 percent in January from a year earlier, down from a 6.3 percent gain in December. Case-Shiller’s 10-City Composite rose 6 percent, while the 20-City Composite climbed 6.4 percent year-over-year.

Some places are in fact red hot.

Home prices in Seattle, Las Vegas, and San Francisco posted the highest annual gains among the 20 cities, rising 12.9 percent, 11.1 percent and 10.2 percent, respectively.

Zillow remain of the view that house prices will continue to rise as I note that rather like us in the UK there is a perception that too few houses have and indeed are being built. For perspective I note that a different piece of research tells us this.

Home values rose 7.6 percent year-over-year to a median of $210,200, with the San Jose, Calif., metro posting astonishing annual home value growth of 26.4 percent, reaching a median of $1.25 million.

Comment

We find ourselves reflecting on the words of Glenn Frey again.

The heat is on

Except not in the way that economics 101 would have predicted as we continue to see house price rises if we ignore the “international effect”. According to the Brookings Institute there may be a deeper factor as human behaviour returns to what it was.

The Census Bureau’s annual county and metropolitan area estimates through 2017 reveal a revival of suburbanization and movement to rural areas along with Snow Belt-to-Sun Belt population shifts. In addition, the data show a new dispersal to large- and moderate-sized metro areas in the middle of the country—especially in the Northeast and Midwest. If these shifts continue, they could call into question the sharp clustering of the nation’s population—in large metropolitan areas and their cities—that characterized the first half of the 2010s.

So the suburbs are back in favour so let me leave you with the thoughts of Arcade Fire on the subject.

And all of the walls that they built in the seventies finally fall
And all of the houses they built in the seventies finally fall

Maybe they got onto the consumer society as well in a different song.

(Everything now!) I need it
(Everything now!) I want it
(Everything now!) I can’t live without
(Everything now!) I can’t live without
(Everything now!) I can’t live
(Everything now!)