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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Both money supply growth and house prices look weak in Australia

The morning brought us news from what has been called a land down under. It has also been described as the South China Territories due to the symbiotic relationship between its commodity resources and its largest customer. So let us go straight to the Reserve Bank of Australia or RBA.

At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.

At a time of low and negative interest-rates that feels high for what is considered a first world country but in fact the RBA is at a record low. The only difference between it and the general pattern was that due to the commodity price boom that followed the initial impact of the credit crunch it raised interest-rates to 4.75%, but then rejoined the trend. That brought us to August 2016 since when it has indulged in what Sir Humphrey Appleby would call masterly inaction.

Mortgage Rates

However central bankers are not always masters of all they survey as there are market factors at play. Here is Your Mortage Dot Com of Australia from yesterday.

The race to raise interest rates is on as two more major lenders announced interest rate hikes of up to 40 basis points across mortgage products.

According to an Australian Financial Review report, Suncorp and Adelaide Bank have raised variable rates of investor and owner-occupied mortgage products to compensate for increasing capital costs.

Adelaide Bank is hiking rates for eight of its products covering principal and interest and interest-only owner-occupied and investor loans.

Starting 07 September, the rate for principal and interest mortgage products will increase by 12 basis points. On the other hand, interest-only mortgage products will bear 35-40 basis points higher interest rates.

 

This follows Westpac who announced this last week.

The bank announced that its variable standard home-loan rate for owner occupiers will increase 14 basis points to 5.38% after “a sustained increase in wholesale funding costs.”

A rate of 5.38% may make Aussie borrowers feel a bit cheated by the phrase zero interest-rate policy or ZIRP. However a fair bit of that is the familiar tendency for standard variable rate mortgages to be expensive or if you prefer a rip-off to catch those unable to remortgage. Your Mortgage suggests that the best mortgage rates are in fact 3.6% to 3.7%.

Returning to the mortgage rate increases I note that they are driven by bank funding costs.

This means the gap between the cash rate and the BBSW (bank bill swap rate) is likely to remain elevated.

That raises a wry smile as when this happened in my home country the Bank of England responded with the Funding for Lending Scheme to bring them down. So should this situation persist we will see if the RBA is a diligent student. Also I note that one of the banks is raising mortgage rates by more for those with interest-only mortgages.

Interest Only Mortgages

Back in February Michele Bullock of the RBA told us this.

Furthermore, the increasing popularity of interest-only loans over recent years meant that by early 2017, 40 per cent of the debt did not require principal repayments . A particularly large share of property investors has chosen interest-only loans because of the tax incentives, although some owner-occupiers have also not been paying down principal.

So Australia ignored the view that non-repayment mortgages were to be consigned to the past and in fact headed in the other direction until recently. Should this lead to trouble then there will be clear economic impacts as we note this.

As investors purchase more new dwellings than owner-occupiers, they might also exacerbate the housing construction cycle, making it prone to periods of oversupply and having a knock on effect to developers.

In central banking terms that “oversupply” of course is code for house price falls which is like kryptonite to them. Indeed the quote below is classic central banker speak.

 For example, since it is not their home, investors might be more inclined to sell investment properties in an environment of falling house prices in order to minimise capital losses. This might exacerbate the fall in prices, impacting the housing wealth of all home owners.

What does the RBA think about the housing market?

Let us break down the references in this morning’s statement.

Conditions in the Sydney and Melbourne housing markets have continued to ease and nationwide measures of rent inflation remain low. Housing credit growth has declined to an annual rate of 5½ per cent. This is largely due to reduced demand by investors as the dynamics of the housing market have changed. Lending standards are also tighter than they were a few years ago, partly reflecting APRA’s earlier supervisory measures to help contain the build-up of risk in household balance sheets. There is competition for borrowers of high credit quality.

Sadly we only have official data for the first quarter of the year but it makes me wonder why Sydney and Melbourne were picked out.

The capital city residential property price indexes fell in Sydney (-1.2%), Melbourne (-0.6%), Perth (-0.9%), Brisbane (-0.6%) and Darwin (-1.1%) and rose in Hobart (+4.3%), Adelaide (+0.5%) and Canberra (+0.9%).

You could pick out Sydney on its own as it saw an annual fall, albeit one of only 0.5%. Perhaps the wealth effects are already on the RBA’s mind.

The total value of residential dwellings in Australia was $6,913,636.6m at the end of the March quarter 2018, falling $22,498.3m over the quarter. ( usual disclaimer about using marginal prices for a total value)

As to housing credit growth if 5 1/2% is low then there has plainly been a bit of a party. One way of measuring this was looked at by Business Insider back in January.

The ABS and RBA now estimate total Household Debt to Disposable Income at 199.7%, up 3% on previous estimates,

The confirmation that there has been something of a party in mortgage lending, with all the familiar consequences, comes from the section explaining the punch bowl has been taken away! Lastly telling us there is competition for higher credit quality mortgages tells us that there is not anymore for lower quality credit.

Comment

If we look for unofficial data, yesterday brought us some house price news from Business Insider.

Australian home prices fell for an eleventh consecutive month in August, led by declines in a majority of capital cities.

According to CoreLogic’s Hedonic Home Value Index, Australia’s median home price fell 0.3%, adding to a 0.6% drop recorded previously in July.

That took the decline over the past three months to 1.1%, leaving the decline over the past year at 2%.

That is not actually a lot especially if we factor in the price rises which shows how sensitive this subject is especially to central bankers. If we look at the median values we perhaps see why the RBA singled out Sydney ( $855,000) and Melbourne ($703,000) or maybe they were influenced by dinner parties with their contacts.

This trend towards weaker premium housing market conditions is largely attributable to larger falls across Sydney and Melbourne’s most expensive quarter of properties where values are down 8.1% and 5.2% over the past twelve months.

Another issue to throw into the equation is the money supply because for four years broad money growth averaged over 6% and was fairly regularly over 7%. That ended last December when it fell to 4.6% and for the last two months it has been 1.9%. So there has been a clear credit crunch down under which of course is related to the housing market changes. This is further reinforced by the narrower measure M1 which has stagnated so far in 2018.

Much more of that and the RBA could either cut interest-rates further or introduce some credit easing of the Funding for Lending Scheme style. Would that mean one more rally for the housing market against the consensus? Well it did in the UK as we move into watch this space territory.

Also this slow down in broad money growth we have been observing is getting ever more wide-spread,

 

 

Welcome to the Netherlands house price boom 2018 version

As many of the worlds central bankers enjoy the delights of the Jackson Hole conference it is time for us to look what might be regarded as a measuring stick of their interventions. To do so we travel across the channel and take a look at the housing market in the Netherlands which was described like this on Tuesday.

In July 2018, prices of owner-occupied houses (excluding new constructions) were on average 9.0 percent higher than in the same month last year. The price increase was slightly higher than in the preceding months. House prices were at an all-time high in July 2018, according to the price index of owner-occupied houses, a joint publication by Statistics Netherlands (CBS) and the Land Registry Office (Kadaster).

So we see an acceleration as well as an all-time high in price terms and it is hard not to have a wry smile at this being the nation must famous for Tulips. Anyway for those who have not followed this particular saga it has been far from a story of up,up and away.

House prices reached a record high in August 2008 and subsequently started to decline, reaching a low in June 2013. The trend has been upward since then.

The timing of the change is a familiar one as that coincides pretty much with the turn in the UK. Although the exact policy moves were different his provokes the thought that central bankers were thinking along not only the same lines but at the same time. Of course there were differences as for example the Bank of England introducing the house price friendly Funding for Lending Scheme and Mario Draghi announcing “Whatever it takes ( to save the Euro) in the summer of 2012, followed by a cut in the deposit rate to 0% at the July meeting. As to synchronicity it was raised at the ECB press conference.

And my second question is: China also cut rates today and we had further stimulus from the Bank of England. We were just kind of wondering about, you know, how much coordination was involved. Was there any sort of contact between you and the People’s Bank of China and the Bank of England?

Actually the ECB move was more similar to the Bank of England’s actions than in may have first appeared as it too was subsiding the “precious”

 One is the immediate effect on the pricing of the €1 trillion already allotted in LTROs.

That sort of thing tends to lead to lower mortgage interest-rates so let us move onto the research arm of the Dutch central bank the DNB.

Average mortgage interest rates charged by Dutch banks have been declining for some time. Between January 2012 and May 2018, average rates fell by around two percentage points.

Actually the fall was pretty much complete by the autumn of 2016 and since then Dutch mortgage rates have been ~2.4%. That pattern was repeated in general across the Euro area so we see like in the UK mortgage rates were affected much more by what we would call credit easing ( LTROs etc in the Euro area) than by QE which inverts the emphasis placed on the two by the media. Also slightly surprisingly Dutch mortgage rates are higher than the Euro area average which according to the DNB are topped and tailed like this.

Rates vary widely across the euro area, however, with the lowest average rates currently being charged in Finland (0.87%) and the highest in Ireland (3.11%).

In case you are wondering why we also get an explanation which will set off at least some chuntering amongst Irish readers.

Households in Finland tend to opt for mortgages with a short fixed interest period, in which the rates are linked to Euribor. Irish banks charge relatively high margins when setting mortgage interest rates.

 

Saving the Dutch banks?

You may wonder at the mimicking of Mario Draghi’s words but if we step back in time there were plenty of concerns as house prices fell from 120.9 for the official index in August 2008 to 95 in June 2013. Consider the impact on the asset base of the Dutch banking sector is we add in this from the DNB.

Almost 55% of the aggregate Dutch mortgage debt consists of interest-only and investment-based mortgage loans, which do not involve any contractual repayments during the loan term. They must still be repaid when they expire, however.  ( October 2017).

Actually it was worse back then.

. Since 2013, the aggregate interest-only debt has decreased by over EUR 30 billion, and it currently stands at some
EUR 340 billion………. Between 1995 and 2012, virtually none of the mortgage loans taken out involved any contractual repayments during the loan term.

Also back then it was permitted to have loans of more than 100% of the value of the property so the banks faced lower house prices with an interest-only mortgage book some of which had loans larger than the purchase price. What could go wrong?

Several years ago, the economic
slowdown and the housing market correction were mutually reinforcing.

As to the level of debt well that is high for the Dutch private sector according to the DNB.

 In the third quarter of 2017, household and corporate debt came to 106% and 120% of GDP respectively, which is high from an international perspective.

Comment

The “Whatever it takes” saga is usually represented as a move to bail and indeed bale out places like Greece,Ireland, Portugal and Spain and that was true. But it is not the full story because some northern European countries had previously behaved in what they would call a southern European manner and the Netherlands was on that list. We have seen already how the central bank described the housing markets troubles as being in a downwards spiral with the overall economy so let us see if that is true on the other side of the coin. Now house prices are booming what is going on in the economy?

According to the first estimate conducted by Statistics Netherlands (CBS) based on currently available data, gross domestic product (GDP) expanded by 0.7 percent in Q2 2018 relative to the previous quarter…….According to the first estimate, GDP was 2.9 percent up on the same quarter in 2017.  ( Statistics Netherlands )

How very British one might say. If you were thinking of areas in the economy affected by the housing market well……

Output by construction companies showed the strongest growth in Q2 2018………Investments in residential property, commercial buildings, infrastructure and machinery increased in particular.

Also higher house prices and possible wealth effects?

In Q2, consumers spent well over 2 percent more than in Q2 one year previously. For 17 quarters in a row, consumer spending has shown a year-on-year increase.

So the housing market turned and then consumption rose. Of course correlation does not prove causation and other factors will be at play but should Mario Draghi read such numbers his refreshing glass of Chianti will taste even better.

Is this an economic miracle? The other side of the coin is represented by Dutch first time buyers who will be increasingly squeezed out especially in the major cities. There we see something familiar as international investors snap up property ahead of indigenous buyers just like London and so many other cities have seen. The official story is familiar too as they are told because of lower mortgage rates affordability is fine but of course the capital burden relative to income rises and that matters more in a country where interest-rate only mortgages are still 40% of new borrowing. At least most borrowing seems to be fixed-rate now but more fundamentally as we look at this we see a familiar refrain which is can any meaningful rise in interest-rates be afforded now? On that road we see why Mario Draghi has kicked any such discussion into the lap of his successor.

 

 

 

Some in the UK have experienced higher and not lower interest-rates

Today has brought more news on a long running theme of this website. This is the way that ever easier monetary policy has made home ownership increasingly unaffordable for the young. Here is the Institute for Fiscal Studies on the subject and the emphasis is theirs.

Today’s young adults are significantly less likely to own a home at a given age than those born only five or ten years earlier. At the age of 27, those born in the late 1980s had a homeownership rate of 25%, compared with 33% for those born five years earlier (in the early 1980s) and 43% for those born ten years earlier (in the late 1970s).

So in generational terms this has gone 43%, 33% and now 25% with about as clear a trend as you could see. The driving force of this will be very familiar to regular readers but it seems that more than a few elsewhere need to be reminded of it.

The key reason for the decline is the sharp rise in house prices relative to incomes. Mean house prices were 152% higher in 2015–16 than in 1995–96 after adjusting for inflation. By contrast, the real net family incomes of those aged 25–34 grew by only 22% over the same twenty years. As a result, the average (median) ratio between the average house price in the region where a young adult lives and their annual net family income doubled from 4 to 8, with all of the increase occurring by 2007–08.

That is an odd ending to the paragraph because we know house price growth began again in the UK in 2013 and yet real wage growth has been to say the least thin on the ground. But we can at least agree with the broad sweep that compared to income the affordability of houses has halved.  It is also interesting to note that over the twenty year period looked at real family income growth was only 1% per annum. The IFS then goes on to give us more of a breakdown of its analysis.

This increase in house prices relative to family incomes fully explains the fall in homeownership for young adults. The likelihood of a young adult owning their own home given how their income compares with house prices in their region is little changed from twenty years ago. But in 2015–16 almost 90% of 25- to 34-year-olds faced average regional house prices of at least four times their income , compared with less than half twenty years earlier. At the same time, 38% faced a house-price-to-income ratio of over 10, compared with just 9% twenty years ago.

If we step back for a moment this is merely the other side of the coin from the “wealth effects”  otherwise known as higher house prices that the Bank of England has been so keen on. We have had Bank Rate cut to 0.5% and even 0.25% for a while, some £435 billion of Quantitative Easing and of course the Funding for Lending Scheme which the Bank of England felt cut mortgage rates by around 2%. So if we take away the spin the problems with house price affordability were a deliberate policy move by the Bank of England and I do sometimes wonder why millennials are not picketing Threadneedle Street.

Debt

I have some thoughts for you on the report by the Resolution Foundation on the scale of the problem here.

Standing at nearly £1.9 trillion, UK household debt remains a big issue.

We get quite a bit of analysis that tells us much of this is fine but a lot of care is needed here as you see that is a line straight out of the Bank of England which has an enormous vested interest here. This phrase gets us ready for another “surprise” at a later date.

appears to have been associated with borrowing by higher income households,

Also does anyone really believe this line?

And many of the credit market fundamentals look much improved relative to the pre-crisis period, with tighter lending criteria and closer monitoring of potentially unwelcome developments.

We are always told it is better until they can tell us that no more. But even such analysis cannot avoid this.

 Increases in the base rate will inevitably increase costs for many indebted households and have the potential to further increase the debt ‘distress’ faced by some.

We then get much more Bank of England inspired spin.

The base rate is expected to rise only gradually, and to remain well below past norms.

It has been telling us that such 2014 whereas Bank Rate is still 0.5% as they of course cut it after promising increases and then put it back. But you see the position is more complex than that as whilst some borrowing got cheaper for example the mortgage rates I was looking at above and some personal loans other bits of borrowing got more expensive. These days we have a proliferation of payday lenders and the like who are on our television screens plugging loans with annual interest rates of 50% or 60% at best and in some cases far higher. What difference would a Bank Rate of say 1.5% make here?

I noted some analysis on the United States which pointed out that for consumer debt Americans were paying higher interest-rates for a given official one which raised a wry smile as that was one of my earliest themes and may even be the first one albeit I was referring mostly to the UK. Let me explain what I mean as the UK average credit card interest rate was 15.67% on the first of January 2017 pre credit crunch ( Bank of England data). So after all the Bank Rate cuts and QE it has fallen to 17.95%. Oh! The overdraft rate has responded to all the official easing by going from 17.16% to 19.71%. Oh times two!

Putting it another way for the around 4% cut in official interest-rates up is yet again the new down as the borrowers above see a rise of around 2% in what they are paying. Is this yet another bank subsidy?

Also the Bank Rate cut and £60 billion QE about which Governor Carney frequently likes to boast reduced the credit card interest-rate by 0.03% briefly and raised the overdraft rate by 0.03%. I doubt anyone noticed.

Comment

One of the features of the credit crunch era is the way that we have been broken down into different groups. For example those with a mortgage have in general seen lower interest-rates as have personal loans but those with overdrafts or ongoing credit card debt have not and even worse have seen rises. Of course some with credit card debt have been able to take advantage of 0% deals but I notice that these seem to come with fees these days. So lots of different impacts on different groups which brings me to the impact of Bank of England policy. This is yet another example of where it has benefited some groups at the expense of others as some gain but others lose. There is also a more general point that is true everywhere I look is that “the precious” otherwise know as the banks have been able to raise their margins whilst the authorities look away.

If we shift to the asset side of the equation the Bank of England has benefitted those with them by the way it has boosted house prices. But the other side of the coin is seen by the falling levels of home ownership amongst the young as they ( and others) face inflation as they see higher house prices. Next in the equation comes that some will be helped by the “bank of mum and dad” be that by cash or inheritance. How much more of a mixed soup could this be? Yet the central planners continue to meddle and these days are so confused themselves that they come out with rubbish like there will be more interest rate rises than the ones we have promised but not delivered for the last four years.

 

What are the consequences of rising bond yields?

So far in 2018 we have seen a move towards higher bond yields across the financial world. This poses more than a few questions not least for the central banks who went to unparalleled efforts in terms of scale to try to reduce them. This as I pointed out on the 6th of December led to some changes.

The credit crunch era has brought bond markets towards the centre stage of economics and finance. Before then there were rare expressions of interest in either a crisis or if the media wanted to film a response to an economic data release. You see equities trade rarely but bonds a lot so they filmed us instead and claimed we were equities trades so sorry for my part in any deception!

At the moment they are back in the news and this morning the Bank of Japan responded. From the Wall Street Journal.

The Bank of Japan took on the market and won—for now.

As Japanese 10-year bond yields threatened to break through the 0.1% mark early Friday, the bank threw down the gantlet and offered to buy out every player in the market.

If we step back for a moment it is hard not to have a wry smile at the Bank of Japan defending a yield on a mere 0.1%!  Not much of a yield or a bear market is it? It poses the question of how strong the economic recovery might be if that is all we can take. Overall it is a consequence of this.

“Today’s action was aimed at firmly implementing the bank’s policy target of guiding the 10-year yield around zero, taking into consideration recent large increases in long-term yields,” a senior BOJ official said. For the BOJ, “around zero” essentially means up to but not including 0.1%.

I am not so sure about the “large increases in long-term yields” story as in fact the thirty and forty-year yields have been dropping. But the response was as follows.

The bank offered to buy an unlimited amount of JGBs with remaining maturities of five to 10 years at a fixed rate of 0.11%, the same level it used on two previous occasions. Yields slipped to 0.85% from 0.95%.

This poses a couple of questions. Firstly for the argument that the Bank of Japan is tapering its bond buying or QE ( which is called QQE in Japan) as offering to buy an “unlimited amount” is hardly tapering. The issue here you may note is rather like that of the Swiss National Bank defending the Swiss Franc at 1.20 which suddenly found it was intervening on an enormous scale. So what looks like tapering could morph into expansion quite easily. How very Japanese!

Also I guess if you own 40% or so of a market as the Bank of Japan does you too would be touchy and nervous about any rise in yield and fall in prices. Time for En Vogue on its tannoy loudspeakers.

Hold me tight and don’t let go
Don’t let go
You have the right to lose control
Don’t let go

Maybe our songstresses even had a view for us on how likely it is that the central banking control freaks will reverse course.

I know you think that if we move too soon it would all end

The UK

This is an intriguing one as you see the ten-year Gilt yield has risen to 1.58% this morning  Here is how Bloomberg reflects on this.

Ten-year gilt yields climbed five basis points to 1.58 percent as of 9:29 a.m. London time, after touching 1.59 percent, their highest level since May 2016. The yield has surged about 40 basis points this year.

This is considered a bear market which as someone who has definitely seen such moves in a day and maybe when we were ejected from the ERM in 1992 maybe an hour is hard to take. So let us settle on a QE era bear market. Also the QE link comes back in as the high for UK Gilts was driven by the panic buys of late summer 2016 when the Bank of England dove into the market like a kamikaze pushing the yield down to 0.5%. From time to time apologists for such moves claim that QE does not make losses but if you pay 120 for something and get back 100 at maturity what is that please?

Intriguingly at least one player may have been wondering about a real bear market. From James Mackintosh in the WSJ.

The trade goes like this: borrow £750 million ($1 billion) for 100 years at a time when money is basically free. Invest it in shares. Pocket the difference.

Okay perhaps not a real bear market as that would affect shares too and as you see below the money is cheap in historical terms but not free.

 The scale of that demand was shown Wednesday when Wellcome’s 100-year bond was more than four times oversubscribed with a coupon of just 2.517%, the lowest ever paid on a corporate century bond.

That is not likely to be much in real yield terms and I would much rather be Welcome that those who bought the bonds. They think along the lines I pointed out in my post on Monday on pensions and the distorted world there.

Wellcome Chief Investment Officer Nick Moakes says ultralong bonds are distorted by rules forcing insurance companies and pension funds to buy them at any price, creating an uneconomic demand he is happy to satisfy with a bond issue

Of course buying equities at what is something of a top after a succession of all-time highs might be a case of not the best timing.

The US

This is the leader of the pack on such matters on two counts. It is the world’s largest economy and it currently has a central bank which is in the process of raising interest-rates. It’s central bank is even reducing its stock of bonds albeit at a snail’s pace. If we stick with the domestic impact then it is led by the thirty-year yield which has nudged over 3%. This means that the thirty-year fixed mortgage rate is now 4.23% as we look for the clearest link between the financial world and the real economy.

If we look at the shorter end of the scale we see that the rate rises so far combined with the expectations of more have seen the two-year yield rise to 2.16% as opposed to the 1.2% of this time last year. So there has been a tightening of monetary conditions all round from this route.

Comment

There is a lot to consider here and let us start with the economics. A rise in bond yields tightens monetary conditions and in that sense is a logical response to the better economic environment. However it is awkward for central banks who have paid more than the 100 they will get from their treasury on maturity as politicians have got used to spending the explicit and implicit profits. If they sell their holdings then they will exacerbate the price falls and weaken their remaining stock.

Moving to the foreign exchanges we have seen something rather odd. If you buy the US Dollar you get 2.8% right now if you put the money in a ten-year US Treasury Note whereas if you buy the Japanese Yen you only get 0.9%. So the US Dollar is rising right? Eh no, as I have covered many times. Of course some may be buying now thinking that an US Dollar in the 109s is attractive combined with picking up a 2.7% relative yield. Similar arguments can be made for the Euro and UK Pound £ albeit with smaller yield differentials.

Here is another thought for you. Imagine a Swiss or German version of Wellcome if there is one and how cheaply they could borrow for 100 years. Actually with its international position it could presumably have borrowed in Euros. Perhaps it is bullish of the UK Pound £……..brave if you look back 100 years.

Meanwhile if the bond bear market and its consequences are all too much there is apparently something which can take the pain away.

 

 

What is happening to US consumer credit and car loans?

If we take a look at the US economy then we see on the surface something which looks as it is going well. For example the state of play in terms of economic growth is solid according to the official data.

Real gross domestic product (GDP) increased at an annual rate of 3.2 percent in the third quarter of 2017 (table 1), according to the “third” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 3.1 percent.

Looking ahead the outlook is bright as well.

The New York Fed Staff Nowcast stands at 3.9% for 2017:Q4 and 3.1% for 2018:Q1.

That would be a change as the turn of the year has tended to under perform in recent times. Also if we use the income measure for GDP the performance is lower. But if we continue with the data we see that both the unemployment rate ( 4.1% in December) and the underemployment rate ( 8.1% in December) have fallen considerably albeit that the latter nudged higher in December.

Less positive is the rate of wage growth where ( private-sector non farm) hourly earnings are currently growing at 2.5%. This is no doubt related to this issue.

In the 2007-2016 period, annual labor productivity decelerated to 1.2 percent at an annual average rate, as compared to the 2.7 rate in the 2000-2007 period.

So a familiar pattern we have observed in many places although the US is better off than more than a few as it has real wage growth albeit not a lot especially considering the unemployment rate and at least has some productivity growth.

Interest-rates are rising

Whilst wages have not risen much in response to a better economic situation interest-rates are beginning to. The official Federal Reserve rate is now 1.25% to 1.5% and is set to rise further this year. If we move to how such things impact on people then the 30 year (fixed) mortgage rate is now 4.06%. It has had a complicated picture not made any easier by the current government shutdown but in broad terms the downtrend which took it as low as 3.34% is over.

How much debt is there?

As of the end of the third quarter of 2017 the total mortgage debt was 14.75 trillion dollars. This is not a peak which was 14.8 trillion in the spring/summer of 2008 but if we project the recent growth rate we will be above that now. Of course the economy is now much larger than it was then.

If we move to consumer credit then we see the following. It was 3.81 trillion dollars at the end of November and that was up 376 billion dollars on a year before.

In November, consumer credit increased at a seasonally adjusted annual rate of 8-3/4 percent. Revolving credit increased at an annual rate of 13-1/4 percent, while nonrevolving credit increased at an annual rate of 7-1/4 percent.

So quite a surge but care is needed as the numbers are erratic and October gave a much weaker reading. So we wait for the December data. If we look into the detail we see that student loans were 1.48 trillion dollars as of September and the troubled car loans sector was 1.1 trillion dollars. For perspective the former were were 1.05 trillion in 2012 and the latter 809 billion.

In terms of interest-rates new car loans are 5.4% from finance companies and 4.8% from the banks for around a 5 year term. Credit cars debt is a bit over 13% and personal loans are 10.6%.

Credit cards

The Financial Times is reporting possible signs of trouble.

The big four US retail banks sustained a near 20 per cent jump in losses from credit cards in 2017, raising doubts about the ability of consumers to fuel economic expansion……Recently disclosed results showed Citigroup, JPMorgan Chase, Bank of America and Wells Fargo took a combined $12.5bn hit from soured card loans last year, about $2bn more than a year ago.

It suggests that the rise in lending that has been seen is on its way to causing Taylor Swift to sing “trouble,trouble,trouble”

Yet borrower delinquencies are outpacing rising balances. While still less than half crisis-era levels, the consultancy forecasts soured credit card loans will reach almost 4.5 per cent of receivables this year, up from 2.92 per cent in 2015.

The St.Louis Federal Reserve or FRED is much more sanguine as it has the delinquency rate at 2.53% at the end of the third quarter of 2017. So up on the 2.29% of a year before but a fair way short of what the FT is reporting.

Maybe though there have been some ch-ch-changes.

“The driving factor behind the losses is that banks are putting weaker credits on the books,” said Brian Riley, a former credit card executive and now a director at Mercator.

Car Loans

According to CNBC lenders are being more conservative in the automobile arena.

The percentage of subprime auto loans saw a big decline in the third quarter despite growing concerns that auto dealers and banks are writing too many loans to borrowers with checkered credit histories, according to new data.

In fact, Experian says the percentage of loans written for those with subprime and deep subprime credit ratings fell to its lowest point since 2012.

In terms of things going wrong then we did not learn much more.

In the third quarter, there was a slight decrease in the percentage of loans 30 days overdue and slight increase in those that were 60 days delinquent.

Although a development like this is rarely a good sign.

Meanwhile, Experian says the average term for a new vehicle auto loan hit an all-time high of 69 months, thanks in part to a slight increase in the percentage of loans schedule to be repaid over 85 to 94 months.

“We’re starting to see some spillover to loans longer than 85 months,” said Zabritski.

This morning’s Automotive News puts it like this.

Smoke expects higher interest rates and tighter credit this year will drive many consumers to buy a used vehicle instead of a new one. Most of those buying used cars will be millennials, who are often saddled with student loans and remain credit challenged, he said.

It is no fun being a millennial is it? Although I suppose much better than being one in the last century as we have so far avoided a world war.

This piece of detail provides some food or thought.

Last year, the U.S. Federal Reserve raised interest rates three times for a total of 75 basis points, and data show that auto-loan lenders have been tightening credit for six straight quarters, but auto loans for “superprime borrowers” increased by just 20 basis points, Smoke said.

Are lenders afraid of raising sub-prime borrowing rates? Not according to The Associated Press.

Subprime buyers got substantially better rates even a year ago. The average subprime rate of 5.91% last year has jumped to 16.84% today, Smoke says. For a 60-month loan of $20,000, that means a monthly payment hike of more than $100, to $495.

Comment

There is a fair bit to consider here as we mull how normal this is for the mature phase of an economic expansion? Also how abnormal these times have been in terms of whether the benefits of the economic growth have filtered down much to Joe Sixpack? After all wage growth could/should be much better and the unemployment figures obscure the much lower labour participation rate. We will be finding out should interest-rates continue their climb as we mull the significance of this.

Securitisations of US car loans hit a post-financial crisis high in 2017, as investor demand for yield continued to provide favourable borrowing conditions across a range of credit markets. Wall Street sold more than $70bn worth of auto asset backed securities, which bundle up car loans into bond-like products, this year, the highest level since 2007, according to data from S&P Global Ratings. ( Financial Times).

One thing we can be sure of is that we will be told that everything is indeed fine until it can no longer possibly be denied at which point it will be nobody’s ( in authority) fault.

Jimmy Armfield

Not only a giant in the world of football in England but in my opinion the best radio summariser by a country mile. RIP Jimmy and thank you.

 

 

 

What and indeed where next for bond markets?

The credit crunch era has brought bond markets towards the centre stage of economics and finance. Before then there were rare expressions of interest in either a crisis or if the media wanted to film a response to an economic data release. You see equities trade rarely but bonds a lot so they filmed us instead and claimed we were equities trades so sorry for my part in any deception! Where things changed was when central banks released that lowering short-term interest-rates ( Bank Rate in the UK) was not the only game in town and that it was not having the effect that they hoped and planned. Also the Ivory Towers style assumption that short-term interest-rates move long-term ones went the way of so many of their assumptions straight to the recycling bin.

QE

It is easy to forget now what a big deal this was as the Federal Reserve and the Bank of England joined the Bank of Japan in buying government bonds or Quantitative Easing ( QE). There is a familiar factor in that what was supposed to be a temporary measure has now become a permanent feature of the economic landscape. As for example the holdings of the Bank of England stretch to 2068 with no current plan to reverse any of it and instead keeping the total at £435 billion by reinvesting maturities. Indeed on Friday it released this on social media.

Should quantitative easing become part of the conventional monetary policy toolkit?

The Author Richard Harrison may be in line for promotion after this.

Though the model does not support the idea that central banks should maintain permanently large balance sheets, it does suggest that we may see more quantitative easing in the future.

So here is a change for bond markets which is that QE will be permanent as so far there has been little or no interest in unwinding it. Even the US Federal Reserve which to be fair is doing some unwinding is doing so with baby steps or the complete opposite of the way it charged in to increase QE.

Along the way other central banks joined in most noticeably the European Central Bank. It had previously indulged in some QE via its purchases of Southern European bonds and covered ( bank mortgage) bonds but of course it then went into the major game. In spite of the fact that the Euro area economy is having a rather good 2017 it is still at it to the order of 60 billion Euros a month albeit that halves next year. So we are a long way away from it stopping let alone reversing. If we look at one of the countries dragged along by the Euro into the QE adventure we see that even annual economic growth of 3.1% does not seem to be enough for a change of course. From Reuters.

Riksbank’s Ohlsson: Too Early To Make MonPol Less Expansionary

If 3.1% economic growth is “too early” then the clear and present danger is that Sweden goes into the next downturn with QE ongoing ( and maybe negative interest-rates too). One consequence that seems likely is that they will run out of bonds to buy as not everyone wants to sell to the central bank.

Whilst we may think that QE is in modern parlance “like so over” in fact on a net basis it is still growing and only last month a new player came with its glass to the punch bowl.

In addition, the Magyar Nemzeti Bank will launch a targeted programme aimed at purchasing mortgage bonds with maturities of three years or more. Both programmes will also contribute to an increase in the share of loans with long periods of interest rate fixation.

Okay so Hungary is in the club albeit via mortgage bond purchases which can be a sort of win double for central banks as it boosts “the precious” ( banks) and via yield substitution implicitly boosts the government bond market too. But we learn something by looking at the economic situation according to the MNB.

The Hungarian economy grew by 3.6 percent in the third quarter of 2017…….The Monetary Council expects annual economic growth of 3.6 percent in 2017 and stable growth of between 3-4 percent over the coming years. The Bank’s and the Government’s stimulating measures contribute substantially to economic growth.

We are now seeing procyclical policy where economies are stimulated by monetary policy in a boom. In particular central banks continue with very large balance sheets full of government and other bonds and in net terms they are still buyers.

The bond vigilantes

They have been beaten back and as we observe the situation above we see why. Many of the scenarios where they are in play and bond yields rise substantially have been taken away for now at least by the central banks. There can be rises in bond yields in individual countries as we see for example in the Turkish crisis or Venezuela but the scale of the crisis needs to be larger and these days countries are picked off individually rather than collectively.

At the moment there are grounds for the bond yield rises to be in play in the Euro area with growth solid but of course the ECB is in play and in fact yesterday brought news of exactly the reverse.

 

A flat yield curve?

The consequence of central banks continuing with what the Bank of Japan calls “yield curve control” has led to comments like this. From the Financial Times yesterday.

Selling of shorter-dated Treasuries pushed the US yield curve to its flattest level since 2007 on Tuesday. The difference between the yields on two-year Treasury notes and 10-year Treasury bonds dropped below 55 basis points in afternoon trading in New York. While the 10-year Treasury was little changed, prices of two-year notes fell for the second consecutive day. The two-year Treasury yield, which moves inversely to the note’s price, has climbed 64 basis points this year to 1.83 per cent.

If we look long the yield curve the numbers are getting more and more similar ironically taking us back to the “one interest-rate” idea the central banks and Ivory Towers came into the credit crunch with. With the US 2 year yield at 1.8% and the 30 year at 2.71% there is not much of a gap.

Why does something which may seem arcane matter? Well the FT explains and the emphasis is mine.

It marks a pronounced “flattening” of the yield curve, with investors receiving decreasing returns for holding longer-dated bonds compared to shorter-dated notes — typically a harbinger of economic recession.

Comment

We have seen phases of falls in bond prices and rises in yield. For example the election of President Trump was one. But once they pass we are left wondering if the around thirty year trend for lower bond yields is still in play and we are heading for 0% ( ZIRP) or the icy cold waters of negativity ( NIRP)? On that road the idea that the current yield curve shape points to a recession gets kicked into touch as Goodhart’s Law or if you prefer the Lucas Critique comes into play. But things are now so mixed up that a recession might actually be on its way after all we are due one.

For yields to rise again on any meaningful scale there will have to be some form of calamity for the central banks. This is because QE is like a drug for so many areas. One clear one is the automotive sector I looked at yesterday but governments are addicted to paying low yields as are those with mortgages. On that road they cannot let go until they are forced to. Thus the low bond yields we see right now are a short-term success which central banks can claim but set us on the road to a type of junkie culture long-term failure. Or in my country this being proclaimed as success.

“Since 1995 the value of land has increased more than fivefold, making it our most valuable asset. At £5 trillion, it accounts for just over half of the total net worth of the UK at end-2016. At over £800 billion, the rise in the nation’s total net worth is the largest annual increase on record.”

Of course this is merely triumphalism for higher house prices in another form. As ever those without are excluded from the party.