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.

 

 

 

 

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The Libor problem is also a US Dollar problem

There is much to consider today as we consider the actions of our lords (ladies) and masters or rather our central bankers. Last night brought something which as we have noted before was in the category of “no surprises” sung about by Radiohead.

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. The stance of monetary policy remains accommodative,

That was of course the US Federal Reserve and I added the last bit because in a few words it tells us that they are not finished yet. Regular readers will be aware that I think it would be much better to simply raise rates to 2% and take a break as moving at at snail’s pace gives more time for something to go wrong. This brings me to two consequences of what is happening.

Libor

No not the scandals at least not yet! this time we are looking for the first time in a while at sustained increases. From Bloomberg yesterday.

The three-month London interbank funding rate rose to 2.27 percent Wednesday, the highest since 2008. The concern is that the Libor blowout may have more room to run, a prospect that borrowers and policy makers in various markets are just beginning to grapple with.

One way of looking at this is that as we expect more rises that seems reasonable and if we look at the past rather small fry.

Of course not all of us can remember 1994 and the financial world is of course to coin a phrase “resilient” at least according to the central bankers. This has led people to mull this.

“There has been sort of the perfect storm of factors tightening financial conditions,” said Russ Certo, head of rates at Brean Capital in New York. “Banks do have tremendous liquidity still, but it’s at a higher price.”

You may recall a few years back when worries about bank liquidity in US Dollars were all the rage. This was the era of central banks making agreements for foreign exchange swaps which were mostly ways of making sure they could get US Dollars for their banks from the original source ( the place that can print them at will….) if needed. Here is a refresher on the subject.

In November 2011, the Federal Reserve announced that it had authorized temporary foreign-currency liquidity swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. These arrangements were established to provide the Federal Reserve with the capacity to offer liquidity to U.S. institutions in currencies of the counterparty central banks (that is, in Canadian dollars, sterling, yen, euros, and Swiss francs). The Federal Reserve lines constitute a part of a network of bilateral swap lines among the six central banks, which allow for the provision of liquidity in each jurisdiction in any of the six currencies should central banks judge that market conditions warrant.

These exist for the opposite purpose as whilst the US Fed is describing things from its point of view and it may one day need some £’s Yen or Euros it is vastly more likely that the counterparty central bank will want US Dollars. After all if the world has a reserve currency in spite of some changes it is it and the likely song is from Aloe Blacc.

I need a dollar, dollar
Dollar that’s what I need
Well I need a dollar, dollar
Dollar that’s what I need
Said I said I need dollar, dollar
Dollar that’s what I need
And if I share with you my story would you share your dollar with me?

Oh and you may like to know that the US Federal Reserve eventually fell into line with the definition of temporary to be found in my financial lexicon for these times.

 In October 2013, the Federal Reserve and these central banks announced that their liquidity swap arrangements would be converted to standing arrangements that will remain in place until further notice.

The banks

In the end it all comes down to the “precious” of course and food for thought has been provided by what might be called the central bankers central bank choosing this morning to put this out on social media. From the Bank for International Settlements.

Non-US banks collectively hold $12.6 trillion of dollar-denominated assets – almost as much as US banks…….Dollar funding stress of non-US banks was at the center of the GFC. ( GFC= Global Financial Crisis).

They seem to be pointing the finger in one direction.

We find that Japanese banks pay a premium in their repurchase agreements (“repos”) with US MMFs. We show that the bargaining power of MMFs fund families, together with the particular demand for long term funding of Japanese banks, help explain this premium. ( MMF = Money Market Funds).

This has been a theme of my career which is that in terms of overseas buying ( UK Gilts, Australian property etc…) the Japanese overpay. Care is needed though as the stereotypical response of assuming stupidity ignores the possibility of a longer game being in play. In this instance they have responded.

 We provide evidence for European banks intermediating repos to Japanese banks, with economically significant estimated spreads from maturity transformation.

So any issues with the Japanese banks would also affect European ones? The mind boggles as of course contagion was supposed to be off the menu these days due to all the regulation and reform. As we look back I am reminded that it was European and on a smaller scale Japanese banks which dipped into these lines back in the day.

Would it be considered rude to point out that shares in my old employer Deutsche Bank are down another 2% as I type this? More significantly the 11.8 Euros is a fair bit lower than the 17.1 of mid-December.

Libor-OIS

As a consequence of the factors above this is also taking place. From Bloomberg reporting on some analysis from Citibank.

Strategists at the U.S. lender predict that the gap between the London interbank offered rate for dollars and the overnight indexed swap rate will continue to widen, potentially leading to a sharper tightening of financial conditions than central bankers have been anticipating. The differential between three-month rates has already more than doubled since the end of January to 55 basis points, a level unseen since 2009.

Now 55 basis points sounds much more grand that 0.55% but there is a flicker here as we try to price risk.

Comment

As you can see there are stresses in the financial system right now. Some of this was always going to take place when interest-rates went back up. But for me the real issue comes when we look at another market. This is because whichever way you look at the analysis here you would think that the US Dollar would be rising. You can arrive at that route by observing the apparent demand for US Dollars or by the higher interest-rates being paid in it or both. Yet it has been singing along to Alicia Keys.

Oh baby
I, I, I, I’m fallin’
I, I, I, I’m fallin’
Fall

I keep on
Fallin’

You can represent this by the UK Pound £ being in the US $1.41s or the Japanese Yen being in the 105s take your pick. The latter is off though because if Japanese banks are so keen for US Dollars why is the Yen so strong? To my mind that is much more worrying than Libor on its own as we switch to Carly Simon.

Why?……Don´t know why

Meanwhile returning to the shores of the UK I expect Royal Bank of Scotland to be along. After all it has been in everything else.

The ethical problems of UK banking continue to pile up

On Friday Bank of England Governor Mark Carney was in full flow at Thomson Reuters headquarters in London. In particular he wanted to lecture us about the improvements in ethical standards at the Bank of England and in banking more generally.

The high road to a responsible, open financial system

Okay so what does that mean?

The financial system is fairer because of reforms that are ending the era of “too big to fail” banks and
addressing the root causes of a torrent of misconduct.

I am sure that many of you will be wondering about how he defines the word “fairer” or how the many mergers that were a feature of the UK response to the credit crunch helped end “too big to fail”? The creation of a mega bank by merger Lloyds with Halifax Bank of Scotland for example surely only made the situation more acute. As to addressing the root cause of misconduct we still actually await this happening in practice.

There was plenty of high-flying rhetoric to be found.

On one path, we can build a more effective,
resilient system on the new pillars of responsible financial globalisation.

The new buzz phrase is “efficient resilence” which if the previous buzz words and phrases are any guide ( temporary…… vigilant etc.) will mean anything but! Here is how Mark describes it.

Finally, efficient resilience is why the Bank of England, working with the Financial Conduct Authority, has
been at the forefront of efforts to increase individual accountability in financial services. While the UK’s
action plan to improve conduct includes stronger deterrents and reduced opportunities for bad behaviour, we
recognise that ex post penalties are only part of the solution.

Events other the weekend have brought the claims and boasts of the section below into focus.

To put greater emphasis on individual accountability, the UK has introduced new compensation rules that go
much further than other jurisdictions in aligning risk and reward. And we have put greater stress on the
importance of better governance and firm culture. …
Since codes are of little use if no one reads, follows or enforces them, the UK has instituted a unique Senior
Managers Regime to embed cultures of risk awareness, openness and ethical behaviour. Based on its early
successes, international authorities are now considering following the UK’s lead.

Barclays

Let us see if this is one of the early successes? It too has the rhetoric with its values of  Respect,  Integrity,  Service,  Excellence,  Stewardship or RISES program. ( https://www.home.barclays/about-barclays/barclays-values.html )

Barclays PLC and Barclays Bank PLC (Barclays) announce that the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) have commenced investigations into:

·    Jes Staley, Group Chief Executive Officer of Barclays, as to his individual conduct and senior manager responsibilities relating to Barclays whistleblowing programme and an attempt by Mr Staley in 2016 to identify the author of a letter that was treated by Barclays Bank PLC as a whistleblow; and  

We are expected to believe apparently it was all just a misunderstanding.

The Board has concluded that Jes Staley, Group Chief Executive Officer, honestly, but mistakenly, believed that it was permissible to identify the author of the letter and has accepted his explanation that he was trying to protect a colleague who had experienced personal difficulties in the past from what he believed to be an unfair attack, and has accepted his apology

I would imagine that pretty much everyone reading this is aware of modern whistleblowing procedures so it seems strange that the CEO of Barclays was not. Actually even when he was told he had another go a month later.

There is a clear example of “back to the future” when we note that rather than being sacked we move into Yes Prime Minister land as he will receive one of the “strongly worded letters” so beloved of the apochryphal civil servant Sir Humphrey Appleby! We are told there will be this too “a very significant compensation adjustment will be made to Mr Staley’s variable compensation award.” But as it is “variable” how will we know?

The Bank of England

There is bad news in the offing tonight for the Bank of England as the BBC’s Panorama has looked again at its role in Libor ( London Interbank Offered Rate ) rigging.

A secret recording that implicates the Bank of England in Libor rigging has been uncovered by BBC Panorama.

The 2008 recording adds to evidence the central bank repeatedly pressured commercial banks during the financial crisis to push their Libor rates down.

Well done to Andy Verity for continuing to pursue this issue and along the way we meet some old “friends”

The recording calls into question evidence given in 2012 to the Treasury select committee by former Barclays boss Bob Diamond and Paul Tucker, the man who went on to become the deputy governor of the Bank of England.

It is like a television series with a regular cast isn’t it? Also the BBC does not do Paul Tucker full justice as there was this from 2013.

Paul Tucker, who served as a deputy governor at the Bank of England, has been given a knighthood for services to central banking.

Some might think that a substantial salary and a pension which would current cost around £7 million to buy were rewards enough in themselves. Unless of course you believe that Paul Tucker got his “K” for covering things up.

Comment

There is much to consider here and in the individual case of Governor Carney the Libor or as it became named the Liebor issue predated his arrival. However he has his own problems. The most recent was the resignation of Charlotte Hogg who seemed as uninformed about monetary policy as she was about the consequences of her bother’s job. It was put well by Deborah Orr in the Guardian.

Clearly, people run the risk of feeling over-entitled. They believe strongly in rules, but develop a belief that they are the people who make the rules, not the people who follow them……..….Finally, of course, privileged people assume, often rightly, that no one is going to hold them to account.

Only on Thursday we looked at Gertjan Vlieghe and his problems understanding that once he was at the Bank of England he had to break his financial links with the hedge fund Brevan Howard. Hardly a brave new dawn is it?

Meanwhile if we look back to the effective bailout by the Qataris of Barclays back in the day we wonder how the court case into this will play out? It is all quite a mess is we throw in PPI miss selling and the way that small businesses were miss sold interest-rate swaps as well as those who became “mortgage prisoners”.

Meanwhile though in Mark Carney’s world it is all going rather well.

Being at the heart of the global financial system reinforces the ability of the rest of the UK economy, from
manufacturing to the creative industries, to compete globally. And it broadens the investment opportunities
for UK savers, giving them the potential to earn better risk-adjusted returns.

Do UK savers realise how good they apparently have it? Oh and was the Barclays story released today to help take the pressure off the Bank of England Liebor news?

 

 

Will our banks ever recover and reform?

The last week or two has seen a by now familiar Christmas present from the banking sector to some of its employees. From the Financial Times.

The most recent came last week, as workers at Dutch lender Rabobank learnt of 9,000 cuts across their bank the day after Morgan Stanley announced 1,200 lay-offs, including at its ailing fixed income division.

These Christmas presents in the style of Scrooge followed the pattern of 2015 so far.

The 2015 cuts — which exclude the impact of major asset sales — amount to more than 10 per cent of the total workforce across the 11 large European and US banks that announced fresh lay-offs, according to analysis by the Financial Times.

If we look at the economic situation in 2015 it has been one where the theme has been one of growth and recovery overall even in the Euro area! Thus there is something to consider in the fact that not only are the banks still retrenching and deleveraging but apparently plan to do so next year as well.

Big banks in Europe and the US announced almost 100,000 new job cuts this year, and thousands more are expected from BNP Paribas and Barclays early next year, as the wave of lay-offs that began in 2007 shows no sign of abating.

Although to be fair there has been one public piece of recruitment. From Morgan Stanley.

Morgan Stanley (NYSE: MS) today announced that Alistair Darling has been elected to the Company’s Board of Directors.  His appointment is effective January 1, 2016.

There are obvious issues here as he was the man who was responsible for the UK’s biggest ever bank bailout taking a job at a bank. Also the accompanying statement does him few favours declaring him to have inside knowledge which the bank can benefit from.

We will all benefit from his financial, risk management and regulatory insights.

It has been a long time now

Lehman Brothers collapsed on the 15th of September 2008 so we could set the clock from there. Although in the UK the clock can be set from a year earlier when Northern Rock called for Bank of England help and saw queues around the block outside its branches. So over 7 years or over 8 years take your pick.

The UK like so many others decided on the Too Big To Fail or TBTF strategy and announced bank bailouts totaling some £1.162 trillion according to the National Audit Office (NAO). Of this some £133 billion was present and the rest was in the form of guarantees. This has now reduced to £115 billion according to the NAO and as there have been some share sales in Lloyds Banking Group recently is in fact slightly lower now. Along the way UK net public-sector debt rose to over £2.2 trillion although this number was at the bottom of the monthly data report and therefore missed by most.

Also we have the implicit costs of the bailouts which are more difficult to quantify and these come in two forms. Firstly is the way that even banks which did not get a bailout such as Barclays Bank benefited from the knowledge that they would be bailed out of required. The value of this is impossible to measure but the UK taxpayer was probably gamed to some extent by the Abu Dhabi Investment Authority which invested in Barclays knowing that there was in effect a put option in the offing should matters deteriorate.

Secondly there was economic policy which has been bent and twisted to benefit the banking sector. The opening salvo of interest-rates slash to and of course still at an “emergency” rate of 0.5% did not lack company. We had £375 billion of QE which is also still there and in the summer of 2012 we saw the Funding for Lending Scheme provide cheap funding for the banking sector. There have also been a litany of Help To Buy efforts from the government as I detailed on the 30th of November.

What has all this achieved?

Back in 2010 the National Audit Office highlighted a theme which has continued to this day.

While both banks (RBS and Lloyds Banking Group) met targets for mortgage lending, there was a shortfall of £30 billion against targets for lending to business.

That could pretty much be written right now. From November’s data.

Lending secured on dwellings increased by £3.6 billion in October, compared to the average monthly increase of £2.8 billion over the previous six months…… loans to small and medium-sized enterprises (SMEs) increased by £0.4 billion, compared to an average monthly increase of £0.1 billion over the previous six months.

So mortgage lending continues the boom kicked-off by FLS whereas business lending after a sustained period of falls seems to have stabilised and let us hope is now going to grow. Of course the UK economy has recently put on a strong performance on the aggregate level but per person one might have expected more with all the post 2008 effort.

GDP per head is now 0.9% above its pre-downturn peak in Quarter 1 2008, having surpassed it in Quarter 1 2015.

Even this very thing gain is dependent on our population statistics being accurate as without getting into the migration debate if they are wrong they are likely to be too low.

Another feature of the UK economy which benefits the banks is the push to create inflation especially in house prices.

What about reform?

We get told things like this as if the represent a real change. From the Bank of England.

The aggregate Tier 1 capital position of major UK banks was 13% of risk-weighted assets in September 2015.

Whilst it is good that the banks are running more appropriate capital levels the issue is really that behaviour has to change. In a real crisis the stock of capital is not enough and it is a change in banking behaviour which is needed to be a proper phrophylatic. If we have reformed our financial sector then by now we should be punishing and fining only rarely right. From the Financial Conduct Authority.

This table contains information about fines published during 2015. The total amount of fines is £899,160,574.

It is better than last year but much worse than 2013 as we look for a pattern.

Meanwhile we review the PPI scandal on loans to individuals, the scandal over swap transactions sold to small businesses, the Li(e)bor and foreign exchange fixing scandals much of which happened in the supposedly new era. Still perhaps the Bank of England has developed a sense of humour.

In addition, the FPC places weight on the role of
pre-emptive, judgement-led prudential supervision
conducted by the Prudential Regulation Authority.

If it is fully implemented the Vickers Report will take more than a lost decade before it is in play in 2019. But you see it has only taken two years for other plans to start to fade, remember bank directors being made individually responsible? From the Guardian on the 15 th of October.

Senior managers now subject to a ‘duty of responsibility’ rather having to prove they had done the right thing.

Comment

The world banking sector has plenty of questions to answer even now. This is a particular issue for the UK because we are a large player in this industry in both absolute and relative terms. Indeed Bank of England Governor Mark Carney has proven to be a cheerleader for more,more,more.

By 2050, UK banks’ assets could exceed nine times GDP, and that is to say nothing of the potentially rapid growth of foreign banking and shadow banking based in London.

The catch is that unless the banks have genuinely changed we will become ever more exposed to banking crises. They however still seem to be singing along to J-Lo

Don’t be fooled by the rocks that I got
I’m still, I’m still Jenny from the block
Used to have a little, now I have a lot
No matter where I go, I know where I came from (South-Side Bronx!)
Don’t be fooled by the rocks that I got
I’m still, I’m still Jenny from the block

Putting it another way you know that something is afoot when the language changes just like the leaky Windscale nuclear reprocessing plant became the leak-free Sellafield. Well the TBTF banks are of course now Systemically Important Financial Institutions or SIFIs.