The soaring price of shares in the Swiss National Bank poses many questions

We find ourselves today looking at a country which exhibits many of the economic themes of these times and one of them is brought to mind by this from the fastFT twitter feed.

US 10-year bond yields creep further towards 3% milestone

The fact that the 10-year Treasury Note yield is 2.99% is part of what is called “normalisation” of interest-rates and bond yields, although care is needed as we have been here before. But my subject of today can say the equivalent of “bah humbug” to this as it has a 10-year yield of a mere 0.13%. If we look back and take a broad sweep it has had this yield averaging around 0% for the past five years with a low of -0.6%. In fact Switzerland can still borrow out to the 8 year maturity and be paid for doing so as its yields are negative out to their. So the old normal remains a distant dream ( or nightmare depending on your perspective) and let me throw in a thought. There are arguments you should use such times to borrow and invest but the Swiss have pretty much set their face against this.

The Confederation wants to ensure room for manoeuvre for future generations by means of a sustainable fiscal policy. It has been pursuing a strategy of a balanced budget in the medium-term and a low level of debt since the start of 2000…………Thanks to the debt brake, it has been possible to considerably reduce federal debt ( Department of Finance February 2nd 2018).

According to the OECD it has a national debt of just under 43% of annual GDP. Of course there is a virtuous circle between bond yields and fiscal surpluses but for these times Switzerland is rather abnormal to say the least.

Negative Interest-Rates

The Swiss National Bank has contributed to the above via this.

Interest on sight deposits at the SNB is to remain at –0.75% and the target range for the three-month Libor is
unchanged at between –1.25% and –0.25%.

Money rates are at -0.73% if you want precision and as Swiss Banks have some 573 billion Swiss France deposited at the SNB there will be an icy chill felt although of course the SNB did take measures to protect the “precious”. Nonetheless there is a cost. From Reuters.

Swiss banks paid 970 million Swiss francs ($1 billion) in negative interest rate charges in the first six months of 2017, according to central bank data, up 40 percent year-on-year as clients continue to hoard cash.

Interesting isn’t it that so far ( and we have over 3 years now) there has been little impact on cash holdings? We learn a little more about negative interest-rates from this as there does not seem to be much of an adjustment so far.

Boom!

Last week saw what was quite an event. From Reuters.

The Swiss franc fell to a three-year low of 1.20 against the euro on Thursday as a revival in risk appetite encouraged investors to use it to buy higher yielding assets elsewhere, betting on loose monetary policy keeping the currency weak.

This took us back to January 15th 2015 when this happened.

The Swiss National Bank (SNB) has decided to discontinue the minimum exchange rate of CHF 1.20 per euro with immediate effect and to cease foreign currency purchases associated with enforcing it.

This was how interest-rates were reduced to -0.75% as the previous policy of “unlimited intervention” fell to earth. It was not that the SNB was running out of reserves as when you intervene against a strong currency you are selling something you do have an unlimited supply of at least in theoretical terms. But it was a combination of the scale of interventions  required and the side-effects and consequences which in this instance broke the bank policy.

As ever a move in interest-rates of 0.5% was in currency terms like putting a Band-Aid on a broken leg and the Swiss Franc surged.

; in midMarch 2015 it was at CHF 1.06 per euro, constituting a 12% appreciation against the minimum exchange rate of CHF 1.20 per euro in place until mid-January. ( SNB)

For newer readers wondering why the Swiss Franc was so strong it had been kicked-off by the reversal of the Carry Trade. If you look back in time on here you will see analysis of what I called the Currency Twins of the Swissy and the Japanese Yen who were affected by enormous levels of foreign borrowing pre credit crunch. This strengthened those two currencies after the credit crunch as some rushed to get out and of course the currency markets noted that at least some were desperate to get out.

This had a substantial human cost as many mortgage and business borrowers in Eastern Europe had taken advantage of low interest-rates in the Swiss Franc. They then faced surging monthly repayments when they were converted into the currency in which they had an income and quite a crisis was started. Of course doing such a thing was stupid but care is needed as whilst you should be responsible for your own actions it is also true that the banking sector did its best to miss lead on this issue and hide the risks faced.

Hedge Fund

On the road to the 15th of January 2015 the Swiss National Bank built up an extraordinary amount of foreign exchange reserves. In fact since there it has also intervened from time to time but on a much more minor scale.

The SNB will remain active in the foreign
exchange market as necessary, while taking the overall currency situation into consideration.

Which according to the 2017 annual report has led to this.

The level of currency reserves has risen by more than
CHF 700 billion to almost CHF 800 billion since the onset of the financial and debt crisis in 2008. The increase is largely due to foreign currency purchases aimed at curbing the appreciation of the Swiss franc.

Which has led to this as I pointed out on the 15th of March.

The majority of the SNB’s foreign currency investments are in government bonds, bonds issued by foreign local authorities (e.g. provinces and municipalities) and supranational organisations, as well as corporate bonds, or are placed at other central banks. The proportion of equities is one-fifth. Two-fifths of the foreign currency investments are denominated in euros, and more than one-third in US dollars. Other important investment currencies are the pound sterling, yen and Canadian dollar.

It has become rather a large hedge fund as we note the diversification into equities. Also we get a hint of why Euro area bonds have done so well as not only has the ECB been buying via its QE program so has the Swiss National Bank. A rally driven by competing central banks?

Comment

There is a lot to consider here as for example if we start with an international perspective what will happen to equities if the Swiss National Bank should stop buying and start selling? The bellweather of this is Apple where according to NASDAQ it owned some 19.1 million shares at the end of 2017. Care is needed as we are just below the 1.20 level and the SNB intervened at considerably worse levels but it could decide to reverse course soon at least in part unless of course it is singing along to the ladies of En Vogue.

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

Don’t let go
Don’t let go

Meanwhile staying with the theme of equities there is the ongoing issue of shares in the Swiss National Bank itself.

This has led to quite a lot of speculation that one day the private shareholders might get a share so to speak. This is how it looked back in October.

Less than a month after its stock smashed through the 3,000-franc-a-share barrier, SNB shares hit an intraday high of 4,324 on Wednesday and were trading as high as 4,600 on Thursday. The stock has tripled in value from a year ago, repeatedly confounding market watchers by regularly hitting records.

It is now 8380 Swiss Francs according to Bloomberg. Should shares in a central bank be doing this? The answer is clearly no as we mull a central bank which is partly privately owned.

Moving back to Switzerland I note many are calling this a success for the SNB. Odd isn’t it that this way round the counterfactuals that many are so keen on when things go wrong for central banks seem to get lost in a fog of amnesia? The truth is we do not know as currency trends ebb and flow but there is of course another factor. Any economic slow down would start currently with interest-rates at -0.75% posing the question of what would happen next? Perhaps they will run into Korean Won. From February.

The swap agreement enables Korean won and Swiss francs to be purchased and repurchased between the two central banks, up to a limit of KRW 11.2 trillion, or CHF 10 billion.

 

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The IMF debt arrow warning misses the real target

Yesterday brought the latest forecasts from the IMF ( International Monetary Fund). Don’t worry I am not concerned with them as after all Greece would be now have recovered if they were right. But there is a link to the Greece issue and the way that it has found itself trying to push an enormous deadweight of debt which meant that Euro area policy had to change to make the interest-rates on it much cheaper. Here is the ESM or European Stability Mechanism on that subject.

1% Average interest rate on ESM loans to Greece (as of 28/04/2017)

That is a far cry from the “punishment” 4.5% that regular readers will recall that Germany was calling for in the early days and the implementation of which added to the trouble. Also if we continue with the debt theme there is another familiar consequence.

That is because the two institutions can borrow cash much more cheaply than Greece itself, and offer a long period for repayment. Greece will not have to start repaying its loans to the ESM before 2034, for instance.

So in the words of the payday lenders Greece now has one affordable monthly payment or something like that. As we note the IMF research below I think it is important to keep the consequences in mind.

The IMF Fiscal Monitor

Here is the opening salvo.

Global debt hit a new record high of $164 trillion in 2016, the equivalent of 225 percent of global GDP. Both private and public debt have surged over the past decade.

Later we get a breakdown of this.

Of the $164 trillion, 63 percent is non financial private sector debt, and 37 percent is public sector debt.

That is a fascinating breakdown so the banks have eliminated all their own debt have they? Perhaps it is the new hybrid debt being counted as equity. Also the IMF quickly drops its interest in the 63% which is a shame as there are all sorts of begged questions here. For example who is it borrowed from and is there any asset backing? In the UK for example it would include the fast rising unsecured or consumer credit sector as well as the mortgaged sector but of course even that relies on the house price boom for an asset value. Then we could get onto student debt which whilst I have my doubts about some of the degrees offered in return I have much more confidence in young people as an asset if I may put it like that. So sadly the IMF has missed the really interesting questions and of course is stepping on something of a land mine in discussing government debt after its debacle in Greece.

Government Debt

Here is the IMF hammering out its beat.

Debt in advanced economies is at 105 percent of
GDP on average—levels not seen since World War II.
In emerging market and middle-income economies,
debt is close to 50 percent of GDP on average—levels
last seen during the 1980s debt crisis. For low-income
developing countries, average debt-to-GDP ratios have
been climbing at a rapid pace and exceed 40 percent
as of 2017.

If we invert the order I notice that there are issues with the poorer countries again.

Moreover, nearly half of this debt is on
nonconcessional terms, which has resulted in a doubling
of the interest burden as a share of tax revenues
in the past 10 year.

This gives us food for though as you see one of the charts shows that such countries have received two phases of what is called relief, once in the 90s and once on the noughties. Is it relief or as Elvis Presley put it?

We’re caught in a trap
I can’t walk out
Because I love you too much baby

Next time I see Ann Pettifor who was involved in the Jubilee debt effort I will ask about this. Does such debt relief in a way validate policies which lead such countries straight back into debt trouble?

Advanced Countries

Here the choice of 2016 by the IMF is revealing. I have a little sympathy in that the data is often much slower to arrive than you might think but the government debt world has changed since them. Any example of this came from the UK only this week.

General government deficit (or net borrowing) was £39.4 billion in 2017, a decrease of £19.0 billion compared with 2016; this is equivalent to 1.9% of GDP, 1.1 percentage points below the reference value of 3.0% set out in the Protocol on the Excessive Deficit Procedure.

It is hard not to have a wry smile at the UK passing one of the Maastricht criteria! But the point is that the deficit situation is much better albeit far slower than promised meaning that whilst the debt soared back then now prospects are different.

In truth I fear that the IMF has taken a trip to what we might call Trumpton.

In the United States—where
a fiscal stimulus is happening when the economy is
close to full employment, keeping overall deficits above
$1 trillion (5 percent of GDP) over the next three
years—fiscal policy should be recalibrated to ensure
that the government debt-to-GDP ratio declines over
the medium term.

I have quite a bit of sympathy with questioning why the US has added a fiscal stimulus to all the monetary stimulus? I know it has been raising interest-rates but the truth is that it has less monetary stimulus now rather than a contraction. Those of us who fear that modern economies can only claim growth if they continue to be stimulated or a type of economic junkie culture will think along these lines. But also they lose ground with waffle like “full employment” in a world where the Japanese unemployment rate is 2.5% as to the 4.1% in the US. Oh and whilst we are at it there is of course the fact that Japan has been running such fiscal deficits for years now.

What about interest-rates and yields?

There was this from Lisa Abramowicz of Bloomberg yesterday.

While U.S. yields may still be rising, the world is still awash in central-bank stimulus. The amount of negative-yielding debt has actually grown by nearly $1.4 trillion since February, to about $8.3 trillion: Bloomberg Barclays Global Aggregate Negative Yielding Debt index

My point is that for all the talk and analysis of higher interest-rates and yields we get this.

Comment

There is a fair bit to consider here and let me open with a bit of tidying up. Comparing a debt stock to an income/output flow ( GDP) requires also some idea of the cost of the debt. Moving on an opportunity has been missed to look at private-debt as we note that US consumer credit has passed the pre credit crunch peak. Of course the economy is larger but there are areas of troubled water such as car loans. This matters because the last surge in government debt was driven by the socialisation of private debt previously owned by the banks.

If we note the debt we have generically then there are real questions now as to high interest-rates can go? Some of you have suggested around 3% but in the end that also depends on economic growth which is apposite because the slowing of some monetary indicators suggests we may be about to get less of it. Should that turn further south then more than a few places will see an economic slow down that starts with both negative interest-rates and yields. These are the real issues as opposed to old era thinking.

• First, high government debt can make countries
vulnerable to rollover risk because of large gross
financing needs, particularly when maturities are
short

In reality that will be QE’d away if I may put it like that and the real question is where will the side-effects and consequences of the QE response appear? For example the distributional effects in favour of those with assets. Perhaps the real issue is the continuing prevalence of negative yields in a (claimed) recovery………From the Fab Four.

You never give me your money
You only give me your funny paper
And in the middle of negotiations
You break down

Me on Core Finance TV

What evidence is there for a bond market bubble?

There is a saying that even a blind squirrel occasionally finds a nut. I am left wondering about this as I note that the former Chair of the US Federal Reserve Alan Greenspan has posted a warning about bond markets. From Bloomberg.

Equity bears hunting for excess in the stock market might be better off worrying about bond prices, Alan Greenspan says. That’s where the actual bubble is, and when it pops, it’ll be bad for everyone.

Actually that is troubling on two counts. The simplest is the existence of extraordinarily high bond prices and low and in some cases negative yields. The next is that fact that his successors in charge of the various central banks may start pumping more monetary easing into this bubble to stop it deflating and it being “bad for everyone”. Indeed maybe this mornings ECB monthly bulletin is already on the case.

Looking ahead, the Governing Council confirmed that a very substantial degree of monetary accommodation is needed for euro area inflation pressures to gradually build up and support headline inflation developments in the medium term.

Let us look at what he actually said.

“By any measure, real long-term interest rates are much too low and therefore unsustainable,” the former Federal Reserve chairman, 91, said in an interview. “When they move higher they are likely to move reasonably fast. We are experiencing a bubble, not in stock prices but in bond prices. This is not discounted in the marketplace.”

I find it intriguing that he argues that there is no bubble in stock prices which are far higher than when he thought they were the result of “irrational exuberance” . After all low bond yields must be supporting the share prices of pretty much any stock with a solid dividend in a world where investors are so yield hungry that even index-linked Gilts have been used as such.

What is a bubble?

This is hard to define but involves extreme price rises which are then hard to justify with past metrics or measurement techniques. With convenient timing we have seen a clear demonstration of one only this week as something extraordinary develops. From Sky Sports News.

Sky sources: Neymar agrees 5-year-deal at PSG worth £450m, earning £515,000-a-week after tax. More on SSN.

One sign that we are in the “bubbilicious” zone is that no-one is sure of the exact price as I note others suggesting the deal is £576 million. You could drive the whole London bus fleet through the difference. The next sign is that people immediately assure you that everything is just fine as it is normal. From the BBC.

Mourinho said: “Expensive are the ones who get into a certain level without a certain quality. For £200m, I don’t think [Neymar] is expensive.

To be fair he pointed out that there would however be consequences.

“I think he’s expensive in the fact that now you are going to have more players at £100m, you are going have more players at £80m and more players at £60m. And I think that’s the problem.”

Of course Jose will be relieved that what was previously perceived as a large sum spent on Paul Pogba now looks relatively cheap. Oh and did I say that the numbers get confused?

PSG’s total outlay across the initial five-year deal will come to £400m.

If Sky are correct the high property prices we look at will be no problem as he will earn in a mere 8 months enough to buy the highest price flat they could find in Paris ( £18 million). The rub if there is one is that the price could easily rise if they know he is the buyer!

The comparison with the previous record does give us another clue because if we look at the Paul Pogba transfer it has taken only one year for the previous record to be doubled. That speed and indeed acceleration was seen in both the South Sea Bubble and the Tulip Mania.

Perhaps there was a prescient sign some years ago when the team who has fans who are especially keen on blowing bubbles was on the case. From SkyKaveh.

West Ham were close to signing Neymar from Santos in 2010. Offered £25m but move collapsed when Santos asked for more money

Back to bonds

If we look at market levels then the warning lights flash especially in places where investors are paying to get bonds. If we look at the Euro area then a brief check saw me note that for 2 years yields are negative in Germany, France, Belgium, Italy and Spain. For Germany especially investors can go further out in terms of maturity and get a negative yield. Does that define a bubble on its own as they are paying for something which is supposed to pay you?! There are two additional factors to throw in which is that the real yield situation is even worse as over the next two years inflation looks set to be positive at somewhere between 1% and 2%. Also if we look at Spain with economic growth having been ~3% or so a year for a bit why would you buy a bond at anything like these levels?

Another sign of a bubble that has worked pretty well over time is that you find the Japanese buying it. So I noted this earlier from @liukzilla.

“Japanese Almost Triple Foreign Bond Buying in July” exe: buy or + buy => like a double chocolate pie

Here we do get something of a catch as the issue of foreign investors buying involves the currency as well. Whether that is a sign of the Euro peaking I do not know but in a way it shows another form of looking for yield if you can call a profit a yield. Also there is an issue here of Japanese investors buying foreign bonds not only because there is little or no yield to be found at home but also because the Bank of Japan is soaking up the supply of what there is.

Comment

If we survey the situation we see that prices and yields especially in what we consider to be the first world do show “bubbilicious” signs. If we look at my home country of the UK it seemed extraordinary when the ten-year Gilt yield went below 2% and yet it is now around 1.2%. Of course the Bank of England with its “Sledgehammer” QE a year ago blew so much that it fell briefly to 0.5% in an effort which was a type of financial vandalism as we set yet again assets prioritised over the real economy. What we are not seeing is an acceleration unless perhaps we move to real yields which have dropped as inflation has picked up.

So far I have looked at sovereign bonds but this has also spilled over into corporate bonds especially with central banks buying them. We have seen them issued at negative yields as well which makes us wonder how that all works if one of the companies should ever go bust. Yet we also need to remind ourselves that there are geographical issues as we look around as Africa has double-digit yields in many places and according to Bloomberg buying short dated bonds in the Venezuelan state oil company yields 152% although the ride would not be good for your heart rate.

 

 

What next for the world of negative interest-rates?

There were supposed to be two main general economic issues for 2017. The first was the return of inflation as the price of crude oil stopped being a strong disinflationary force. The second was that we would see a rise in interest-rates and bond yields as we saw an economic recovery combined with the aforementioned inflation. This was described as the “reflation” scenario and the financial trade based on it was to be short bonds. However we have seen a rise in inflation to above target in the UK and US and to just below it in the Euro area but the bond market and interest-rate move has been really rather different.

Negative Official Interest-Rates

Euro area

These are still around particularly in Europe where the main player is the European Central Bank. This plays out in three main areas as it has an official deposit rate of -0.4%, it also has its long-term refinancing operations where banks have been able to borrow out to the early 2020s at an interest-rate that can also be as low as -0.4% plus of course purchasing sovereign bonds at negative yields. So whilst the rate of monthly bond purchases has fallen to 60 billion Euros a month the envelope of negative interest-rates is still large in spite of the economic recovery described earlier this week by ECB President Draghi.

As a result, the euro area is now witnessing an increasingly solid recovery driven largely by a virtuous circle of employment and consumption, although underlying inflation pressures remain subdued. The convergence of credit conditions across countries has also contributed to the upswing becoming more broad-based across sectors and countries. Euro area GDP growth is currently 1.7%, and surveys point to continued resilience in the coming quarters.

Indeed the economic optimism was turned up another notch by the Markit PMI business surveys on Tuesday.

The PMI data indicate that eurozone growth remained impressively strong in May. Business activity is expanding at its fastest rate for six years so far in the second quarter, consistent with 0.6- 0.7% GDP growth. The consensus forecast of 0.4% second quarter growth could well prove overly pessimistic………

That is better than “resilience” I think.

Sweden

This is one of the high fortresses of negative interest-rates as you can see from the latest announcement.

The Executive Board decided to extend the purchases of government bonds by SEK 15 billion during the second half of 2017 and to hold the repo rate unchanged at −0.50 per cent. The repo rate is now not expected to be raised until mid-2018, which is slightly later than in the previous forecast.

As you can see a move away from the world of negative interest-rates seems to have moved further into the distance rather than get nearer. If you look at the economic situation then you may quite reasonably wonder what is going on here?

Swedish economic activity is good and is expected to strengthen further over the next few years. Confidence indicators show that households and companies are optimistic and demand for exports is strong. The economic upturn means that the demand for labour is still strong.

We do not have the numbers for the first quarter but we do know that GDP ( Gross Domestic Product) increased by 1% in the last quarter of 2016. If you read the statement below then it gets ever harder to justify the current official interest-rate.

Rising mortgage debt is a serious threat to Sweden’s economy while regulators need to introduce tougher measures to strengthen banks against future shocks, the central bank said in its semi-annual stability report, published on Wednesday………Swedish house prices have doubled over the last decade. Apartment prices have tripled. Household debt levels – in relation to disposable income – are among the highest in Europe.

Switzerland

The Swiss National Bank feels trapped by the pressure on the Swiss Franc.

The Swiss franc is still significantly overvalued. The negative interest rate and the SNB’s willingness to intervene in the foreign exchange market are necessary and appropriate to ease pressure on the Swiss franc. Negative interest has at least partially restored the traditional interest rate differential against other countries.

You may note that they are pointing the blame pretty much at the ECB and the Euro for the need to have an interest-rate of -0.75% ( strictly a range between -0.25% and -1.25%).

Denmark

As you can see Denmark’s Nationalbank has not moved this year either.

Effective from 8 January 2016, Danmarks Nationalbank’s interest rate on certificates of deposit is increased by 0.10 percentage point to -0.65 per cent.

The 2016 move left it a little exposed when the ECB cut again later than year but it remains firmly in negative interest-rate territory.

Japan

Until now we have been looking at issues surrounding the Euro both geographically and economically but we need to go a lot further east to see the -0.1% interest-rate of the Bank of Japan. Added to that is its policy of bond purchases where it aims to keep the ten-year yield at approximately 0%. So there is no great sign of a change here either.

 

The United States

Here of course we have seen an effort to move interest-rates to a move positive level but so far we have not seen that much and it has not been followed by any of the other major central banks. Indeed one central bank which is normally synchronised with it is the Bank of England but it cut interest-rates and expanded its balance sheet last August so it has headed in the opposite direction this time around.

This theme has been reflected in the US bond market where we saw a rise in yields when President Trump was elected but I note now that not much has happened since. The ten-year Treasury Note now yields around 2.25% which is pretty much where it was back then. We did see a rise to above 2.6% but that faded away as events moved on. Even the prospect of a beginning of an unwinding of all of the bond holdings of the Federal Reserve does not seem to have had much impact. That seems extraordinarily sanguine to me but there are two further factors which are at play. One is that investors do not believe this will happen on any great scale and also that there is no rule book or indeed much experience of how bond markets behave when a central bank looks for the exit.

How much?

There was a time when we were regularly updated on the size of the negative yielding bond universe whereas that has faded but there is this from Fitch Ratings in early March.

Rising long-term sovereign bond yields across the eurozone contributed to a decline in outstanding negative yielding sovereign debt to $8.6 trillion as of March 1 from $9.1 trillion near year-end 2016.

The fall such as it was seemed to be in longer dated maturities.

The total of negative-yielding sovereign debt with remaining maturities of greater than seven years fell significantly to $0.5 trillion as of Mar. 1 from over $2.6 trillion on June 27 2016.

Since then German bond yields have moved only a little so the general picture looks not to be much different.

Comment

I wanted to point out today the fact that whilst it feels like the economic world has moved on in 2017 in fact the negative interest-rate and yield story has changed a lot less than we might have thought. It has fallen out of the media spotlight and perceptions but it has remained as a large iceberg floating around.

One of my themes has been that we will find out more about the economic effects of negative interest-rates as more time passes. Accordingly I noted this from VoxEU yesterday.

Banks throughout the Eurozone are reluctant to cut retail deposit rates below zero, wary of possible client reactions

That has remained true as time has passed and it seems ever clearer that the banking sector is afraid of a type of deposit flight should they offer less than 0% on ordinary retail savings. That distinguishes it from institutional or pension markets where as we have discussed before there have been lots of negative yields and interest-rates. Also if we look at average deposit rates there remain quite large differences in the circumstances.

For example, the average rate on Belgian deposits has dropped to 0.03%. If Belgians took their money across the border, they could get almost ten times that in the Netherlands (0.28%). In France even, rates average 0.43%.

If we move to household borrowing rates we see that there are much wider discrepancies as we wonder if at this level we can in fact call this one monetary policy?

The Finns borrow against 1.8%, the Irish pay 3.6%

Some of the differences are down to different preferences but as the Irish borrowing is more likely to be secured ( mortgages) you might reasonably expect them to be paying less. Oh and as a final point as we move to borrowing we note that rates are a fair distance from the official ones meaning that the banks yet again have a pretty solid margin in their favour, which is somewhat contrary to what we keep being told.

The ECB faces a growing policy dilemma

Today I want to look at what was one of the earliest themes of this blog which is that central banks will dither and delay before they reduce their policy easing and accommodation. Or to put it another way they will be too late because they are afraid of moving too soon and being given the blame should the economy hic-cup or turn downwards. Back in the day I did not realise how far central banks would go with the Bank of Japan seemingly only limited by how many assets there are in existence in Japan as it chomps on government bonds and acts as a Tokyo whale in equity markets. Actually it has made yet more announcements today including this from Governor Kuroda according to Marketwatch.

“There is not much likelihood that we will further lower the negative rate” from the current minus 0.1%, Kuroda said in parliament, citing Japan’s accelerating growth.

Last time he said something like that he cut them 8 days later if I recall correctly!

However the focus right now is on Europe and in particular on the ECB ( European Central Bank). as it faces the policy exit question I posed on the 19th of January.

If we look at the overall picture we see that 2017 poses quite a few issues for central banks as they approach the stage which the brightest always feared. If you come off it will the economy go “cold turkey” or merely have some withdrawal systems? What if the future they have borrowed from emerges and is worse than otherwise?

What has changed?

Yesterday brought news on economic prospects which will have simultaneously cheered and worried Mario Draghi and the ECB. It started with France.

The Markit Flash France Composite Output Index, based on around 85% of normal monthly survey replies, registered 56.2, compared to January’s reading of 54.1. The latest figure pointed to the sharpest rate of growth since May 2011.

Welcome news indeed and considering the ongoing unemployment issue that I looked it only a few days ago this was a welcome feature of the service sector boom.

Staffing numbers rose for the fourth consecutive month during February. The increase was underpinned by a solid rate of growth in the service sector,

Unusually for Markit it did not provide any forecast for expected GDP (Gross Domestic Product) growth from this which is likely to have been caused by its clashes with the French establishment in the past. It has regularly reported private-sector growth slower than the official numbers so this is quite a change.

Next up was Germany and the good news theme continued.

The Markit Flash Germany Composite Output Index rose from January’s fourmonth low of 54.8 to 56.1, the highest since April 2014 and signalling strong growth in the eurozone’s largest economy. Output has risen continuously since May 2013.

The situation is different here because of course Germany has performed better than France in recent times illustrated by its very different unemployment rate. I note that manufacturing is doing well as it benefits from the much lower exchange rate the Euro provides compared to where any prospective German mark would be priced. Markit is much more willing to project forwards from this.

The latest PMI adds to our expectations that economic growth will strengthen in the first quarter to around 0.6% q-o-q, marking a strong start to 2017.

Whilst these are the two largest Eurozone economies there are others so let us add them into the mix.

“The eurozone economy moved up a gear in February. The rise in the flash PMI to its highest since April 2011 means that GDP growth of 0.6% could be seen in the first quarter if this pace of expansion is sustained into March.

There are actually two cautionary notes here. The first is that these indices rely on sentiment as well as numbers and as they point out March is yet to come. But the surveys indicate potential for a very good start to 2017 for the Eurozone.

As the objectives of central banks have moved towards economic growth there is an obvious issue when they look good and it is to coin a phrase “pumping up the volume”.

Also there was a hopeful sign for a chronic Euro area problem which is persistent unemployment in many countries.

February saw the largest monthly rise in employment since August 2007. Service sector jobs were created at a rate not seen for nine years and factory headcounts showed the second-largest rise in almost six years.

What about inflation?

Just like it fell more quickly and further than the ECB expected it has rather caught it on the hop with its rise. The move from 1.1% in December to 1.8% in January means it is just below 2% or where the “rules based” ECB wants it. There is an update later but even if it nudges the number slightly the song has the same drum and bass lines. Indeed yesterday’s surveys pointed to concerns that more inflation is coming over the horizon.

Inflationary pressures meanwhile continued to intensify. Firms’ average input costs rose at the steepest rate since May 2011, with rates accelerating in both services and manufacturing. The latter once again recorded the steeper rise, linked to higher global commodity prices, the weak euro and suppliers regaining some pricing power amid stronger demand.

In the past such news would have the ECB rushing to raise interest-rates which leaves it in an awkward position. The only leg it has left to stand on in this area is weak wage growth.

Asset prices

Mario Draghi’s espresso will taste better this morning as he notes this.

GERMANY’S DAX RISES ABOVE 12,000 FIRST TIME SINCE APRIL 2015 ( h/t Darlington_Dick)

Although even the espresso may provide food for thought.

Oh I don’t know…Robusta coffee futures creeping back towards 5-1/2 year highs

That pesky inflation again. Oh sorry I mean the temporary or transient phase!

As to house prices there is a wide variation but central bankers always want more don’t they?

House prices, as measured by the House Price Index, rose by 3.4% in the euro area and by 4.3% in the EU in the third quarter of 2016 compared with the same quarter of the previous year.

Of course should any boom turn to bust then the rhetoric switches to it was not possible to forecast this and therefore it was a “surprise” and nobody’s fault. The Bank of England was plugging that particular line for all it’s worth only yesterday.

The Euro

Much is going on here and it has been singing along to “Down, Down” by Status Quo again. For example it has moved very near to crossing 1.05 versus the US Dollar this morning which makes us wonder if economists might be right and it will reach parity. Such forecasts are rarely right so it would be its own type of Black Swan but more seriously we are seeing a weaker phase for the Euro as it has fallen from just over 96 in early November 2016 to 93.4 now. Here economists return to their usual form as this has seen the UK Pound £ nudge 1.19 this morning or further away from the parity so enthusiastically forecast by some.

A factor in this brings us back to QE and ECB action. A problem I have reported on has got worse and as ever it involves Germany. The two-year Schatz yield has fallen as low as -0.87% as investors continue to demand German paper even if they have to pay to get it. This is creating quite a differential ( for these times anyway) with US Dollar rates and thereby pushing the Euro lower.

Comment

There are obvious issues here for the ECB as it faces a period where economic growth could pick-up which is of course good but inflation will be doing the same which is not only far from good it is against its official mandate. It does plan to trim its monthly rate of bond buying to 60 billion Euros a month from 80 billion but of course it still has a deposit rate of -0.4%. Thus the accelerator is still being pressed hard. But as we note that the lags of monetary policy are around 18 months then it may well find itself doing that as both growth and inflation rise. Should that lead to trouble then a so-called stimulus will end up having exactly the reverse effect. Yet the consensus remains along the lines of this from Markit yesterday.

No change in policy
therefore looks likely until at least after the German
elections in September.

 

 

The impact of Bitcoin and negative bond yields

As we approach the end of 2016 the natural tendency is to look ahead to 2017. We will soon find ourselves afflicted by a litany of forecasts for the year ahead. I say afflicted because this has been an “annus horribilis” for establishment forecasters but those that I am in touch with seem to have learned little if anything at all. Accordingly the theme “same as it ever was” seems set to turn into a “road to nowhere” for them. However we will take a different tack as the holiday break has thrown up a couple of disturbing signals in the world monetary system.

Bitcoin surges

When I signed off before Christmas I ended with this.

The average price of Bitcoin across all exchanges is 910.16 USD

As you can take the boy out of the city but it is much harder to take the city out of the boy I had noted that it had been further on the move this week and now I note this.

Bid: $972.27 Ask: $972.28

So there has been a push higher and of course we are reminded of two things. The first is simply a factor of the way that we count in base ten meaning that the threshold of US $1000 is on the near horizon and the second is the Bitcoin surge of a bit more than a couple of years ago.

Actually for some I note that threshold city has already arrived. From BTC Manager.

Bitcoin has surpassed its all-time high in two major currencies, the Euro and the British Pound……With the largest weekly volume in almost 12 months, bitcoin looks to continue to soar against the Euro. With a break of the all-time high at €872.90, there are no previous fractal levels to gauge where the market will take us next. However, the best bet is through the use of simple psychology. Buyers will look to cash out once the price has hit a psychological resistance, a big, round number where profits will be locked in and buying interest starts to fade.

So it is interesting to note first that standard analysis ” it might go up or it might go down” applies as much to newer markets as it does to older ones! As ever the possibility it might stay the same is ignored though. But those of you who use the Euro as a currency have seen a considerable devaluation against Bitcoin in recent times which means those of us who use the UK Pound £ have had a particularly poor 2016 against it.

On the Coinfloor exchange, BTC-GBP was at £479.00 week ending June 26, 2016, following our open letter to Britons. Fast forward to the close of 2016, BTC-GBP is looking to break above the £800 mark and is taking aim at the psychological £1000 level. With a break above the all-time high, there is no precedent and £1000 could be a conservative estimate for the long-term, but we will see some exhaustion from bulls at this level.

Looking at the chart a past colleague of mine would be very upset if I did not point out that it looks very much like what he called a “bowl” formation. This means that it needs to continue to accelerate or otherwise it will then be like one of those cartoon characters which run over a cliff edge by mistake. Or to bring things up to date like the Toshiba share price this week as it has now eroded nearly all the gains of 2016.

There is another perspective we can find and StockTwits helps us out with this.

 Some care is needed with the word never as Botcoin was invented on the 31st of October 2008 and is thus a child of the credit crunch era. But the current situation does give us food for thought as the immediate knee-jerk response that it is replacing gold in some fashion does have issues. Let me point out the one which occurs to me which is that discoveries on other planets and moons apart the supply of gold is fixed whereas Bitcoin and especially cryptocurrencies in general is not. ( Just to add that the latter remains true but @BambouClub has pointed out that Bitcoin is limited to 21 million units).

Also those of you who like me watched the BBC 4 documentary on Fleetwood Mac last night which of course featured the “Gold Dust Woman” Stevie Nicks will wonder about any impact on music and this is before the backing vocals she did for John Stewart?

There’s people out there turning music into gold

Somehow I don’t see “Bitcoin Dust Woman” quite cutting it do you?

Why is this happening?

If you follow the advice of go west young (wo)man then you have a long journey as the real pressure is to be found in the East. Let us first take a stop over in India where the Demonetisation debacle continues.  From LiveMint.

Mumbai: Demonetisation has boosted the digital platforms for payment, which has helped the National Payments Corporation’s (NPC) RuPay card usage at merchant terminals soar seven times since 8 November, taking the daily volumes to over 2.1 million.

As we look at the ongoing issue it is not hard to see the motivation for people wanting to escape the Indian monetary system entirely and thus moving towards currencies like Bitcoin. As I pointed out on November 11th.

We can expect the traditional Indian love of gold to be boosted by this and maybe also non-government electronic money like Bitcoin.

Although of course many were left out.

It has made it harder to buy vegetables and rice, and hire rickshaws. And, for hundreds of millions of Indians who work in the informal economy, it has brought commerce to a halt. If there is a well-laid plan to mitigate the impact of this surprise crackdown on “black money”, it has yet to reach rural parts, where few Indians have bank accounts or credit cards.

Here is a link to the details of Demonetisation.

https://notayesmanseconomics.wordpress.com/2016/11/11/the-war-on-cash-continues/

China

There have been signs of creaking from the Chinese monetary system as estimates of the actual outflow of funds from China seem to be around double the official one. Oops! If we move to this morning there are other signals to be found. From the Wall Street Journal.

The yuan dropped 7% against the dollar this year…….

Unlike other emerging markets that have mostly free-floating currencies such as Russia and Brazil, China hasn’t had a chance to find its bottom. Chinese investors, therefore, act as if more depreciation is coming, sending money overseas.

The People’s Bank of China is increasingly replacing deposits and indeed finance in the banking system in a move that has not gone so well for us western capitalist imperialists. But the fundamental point here is that with such a large flow of funds ongoing we see two clear effects. The first is the rise in the Bitcoin price as it would take only a minor proportion of the move to put it in a boom and the second is that the world financial system looks unstable one more time.

Negative Interest-Rates in the UK

One of the forecasts for 2017 will no doubt be for higher bond yields. After all it has to be right one year! But more seriously if we just look at the UK something else is in play and it covers a few areas. It started with this before Christmas. From Bloomberg on December 16th.

The U.K. Treasury sold one-month bills at an average negative yield for the first time ever on Friday, with investors bidding for more than seven times the amount on offer,

That got worse just before Christmas and today a former respondent on here Shireblogger who now contacts me on Twitter pointed out this.

UK gilts just hit a record low 2 year yield at 3.3 bps. ( @bondvigilantes )

What we find ourselves observing is a safe haven problem of sorts as @NelderMead points out.

a year end desperation for collateral. QE creates the priv deposits & takes away the collateral to back ’em

Another “side effect” of the “Sledgehammer” of Andy Haldane and Mark Carney. Are they available for comment and I do not mean a diversion onto green issues?

Comment

So there you have it. After all the central planning and “reform” what we see are yet more signs of stress in the financial system. So much for certainty about 2017 as we expect inflation yet again in the use of the words “unexpected” and “surprise”.

Share Radio

I will be on after the 1 o’clock news today with quite a bit to discuss I think.

The ECB drives Euro area short-dated yields even more negative

The recent trend for world bond yields has been for them to rise. This has been particularly evident at the longer maturities. The clearest example of this comes from the US Long Bond or thirty-year yield which spent late summer around 2.3% and is now 3%. There was a rise before the advent of President-Elect Trump which accelerated quickly afterwards. We will never know now what effect a President- Elect Clinton would have had but I suspect it would have been similar. As to the pre-Trump rise in US bond yields this was mostly driven by hints and promises or what is called Forward Guidance from the US Federal Reserve about a second interest-rate rise. Although of course it has been hinting that for all of 2016 so far without delivering it yet.

The international context

This new trend has had effects in places like Portugal where the ten-year yield is 3.6% and Italy where it is 2.1%. This is of course nothing like the levels seen at the peak of the Euro area crisis but there are two points to note. Firstly government’s tend to spend the gains from lower bond yields ( as the gains are not widely understood politicians can take the credit for their largesse) meaning any reversal can create fiscal issues. Secondly the ECB is of course buying considerable numbers of these bonds as it purchases around a billion Euros of Portuguese government bonds and 13 billion Euros of Italian government bonds each month. So we see a rise in spite of all this buying.

A similar situation has arisen in the UK where the “sledgehammer” QE bond buying of Chief Economist Andy Haldane has been swept aside in yield terms by the recent moves. So far an extra £38 billion of Gilts purchases have been made but whilst the ten-year yield is now at 1.37% below the level at which this started it is not be much and this particular phase is underwater overall. Some of the purchases are well underwater in price terms. Perhaps this is why Bank of England Governor seems to be finding the time to do this according to the Financial Times.

Mark Carney has urged the government to seek transitional arrangements with the 27 remaining members of the EU as it negotiates Brexit in an attempt to smooth the path of leaving the EU for companies and for financial stability.

I guess anything is better than discussing why he eased monetary policy into a currency decline and economic growth which one of his colleagues ( Kristin Forbes) admitted is faster than last year’s! I guess some will also be mulling how Mark Carney rejects politicians interfering in his work yet seems happy to interfere in theirs. I wonder how he would define independence. Still if monetary policy gets any worse I guess we can expect more speeches on climate change.

This higher yield trend has also seen some bond yields depart the negative zone. For example the ten-year bund yield of Germany has risen to the not so giddy heights of 0.22% pulling other Euro area yields out of negative territory as well. Even Japan has seen its ten-year yield nudge above zero albeit marginally and ended at 0.016% today. This is a bit awkward for the Bank of Japan as yields have risen in spite of its rhetoric about “unlimited purchases” as I discussed only last Monday.

A problem for the ECB

This arises at the shorter maturities and is especially evident in Germany. As you review the chart below please remind yourselves that under its rules the ECB QE bond buying cannot buy at yields below its own deposit rate which is currently -0.4%.

This is what are called Schatz bonds in Germany and they have pulled prices on other Euro area bonds higher and yields lower as well. For example the two-years in both Belgium and France yield -0.68%. Perhaps the Italian two-year is a clearer example because in spite of the risks around the upcoming referendum the yield is a mere 0.22%. There was a time yields shot higher in response to such risks!

A Technical Issue

The essential problem here comes from something I have pointed out before which is that central bank bond buying tends to freeze up bond markets. Of course it also destroys the price discovery mechanism but volumes and liquidity dry up. This was quite noticeable in the early days of the Greek crisis where buying by the Securities Markets Programme saw volumes drop to a tenth of what they were. That remains an issue which has recurred in Japan but the current phase is being driven by the repo market. Reuters looked at this last Wednesday.

The European Central Bank is looking for ways to lend out more of its huge pile of government debt to avert a freeze in the 5.5 trillion-euro short-term funding market that underpins the financial system, central bank sources told Reuters.

Why should it care about this?

it has taken away the key ingredient for repurchase agreements, or repos, whereby financial firms lend to each other against collateral, typically high-rated government bonds such as Germany’s.

So it has inadvertently damaged the “precious” which is the banking system. Also it has shot itself in the foot as regards its own objectives.

Repo is used by investment funds to finance trading and is regarded by the ECB as a key avenue to transmit its own monetary stimulus to the economy.

A freeze in repo activity risks undoing some of the ECB’s stimulus by hampering lending between financial companies and leaving bond markets vulnerable to sharp sell offs.

The situation was so bad we even got an official denial that anything was wrong!

“The ECB’s securities lending is proving valuable for smooth market functioning, and it is being reviewed on an ongoing basis,” an ECB spokesman said.

The situation is driven by the way that derivative portfolios now need more collateral to be held against them whilst there is less top-notch collateral to be had.

With the ECB now owning more than a quarter of all outstanding German bonds, funds pay up to 1.5 percent to borrow a 10-year Bund, up from some 0.40 percent a year ago, according to Icap data.

Another problem on the list for pension funds and hence in time pensioners.

Comment

As you can see the side-effects from the ever-growing amounts of central bank QE are growing. This was met with an official denial which sat oddly with the recent changes made by both the Bundesbank and the ECB to try to ameliorate things. It sat even more oddly with the market reversal on the 23rd in response to hopes/hints of a change of policy as shown in the chart about . Since then those hopes have been extinguished, until the next set of rumours anyway. So we get a bond market where the battle between central banks ( price highs) and inflation trends leading to price falls continues.

Meanwhile thank you to @sallycopper C for highlighting an issue which I think may lead to problems for the game of paper, scissors,stone. From Bloomberg.

Paper made from rock tempts Japan’s biggest printer to invest.

Meanwhile I pointed out earlier to the Financial Times that for an article telling us this “the cost of Christmas dinners is almost unchanged from a year ago ” the headline on Twitter from its commodities editor gave a rather different impression.

Christmas pudding pricier after Brexit hits pound

As a Christmas pudding fan I in fact have already bought two rather nice ones for £3 but  one has already gone, after all I had to find out how good it was!