Germany sees quite a plunge in economic output or GDP

After last night’s rather damp squib from the US Federal Reserve ( they can expand QE within meetings) the Euro area takes center stage today. This is because the leader of its economic pack has brought us up to date on its economy.

WIESBADEN – The gross domestic product (GDP) in the 2nd quarter 2020 compared to the 1st quarter 2020 – adjusted by price, season and calendar – by 10.1%. This was the sharpest decline since the beginning of quarterly GDP calculations for Germany in 1970. It was even more pronounced than during the financial market and economic crisis (-4.7% in the first quarter of 2009).

So in broad terms we have seen a move double that of the credit crunch which was considered to be severe at the time.  The economy had also contracted in the first quarter of this year which we can pick up via the annual comparison.

Economic output also fell year-on-year: GDP in the second quarter of 2020 was 11.7% lower than in the previous year after adjustment for prices (including calendar adjusted). Here, too, there had not been such a sharp decline even in the years of the financial market and economic crisis of 2008/2009: the strongest decline to date was recorded in the second quarter of 2009 at -7.9% compared to the same quarter of the previous year.

So the worst annual comparison of the modern era although by not as large an amount.

We do not get an enormous amount of detail at this preliminary stage but there is some.

As the Federal Statistical Office (Destatis) further reports, both exports and imports of goods and services collapsed massively in the second quarter of 2020, as did private consumer spending and investments in equipment. The state, however, increased its consumer spending during the crisis.

Just like in the film Airplane they chose a bad time to do this…

Beginning with the second quarter of 2020, the Federal Statistical Office published GDP for the first time 30 days after the end of the quarter, around two weeks earlier than before. The fact that the results are more up-to-date requires more estimates than was the case after 45 days.

Although not a complete disaster as they would have been mostly guessing anyway. One matter of note is that 2015 was better than previously though and 2017 worse both by 0.3%. That is not good news for the ECB and the “Euro Boom” in response to its policies.

Unemployment

There has been bad but not unexpected news from the Federal Employment Agency as well this morning.

Unemployment rose by 2.0% compared to the previous month and by 27.9% year-on-year to 2.9 million. Underemployment without short-time work increased by 1.3% compared to the previous month and by 14.6% compared to the previous month. It is 3.7 million The unemployment rate is 6.3%, the underemployment rate is 7.9%.

Now things get a little more awkward as the statistics office has reported this also.

According to the results of the labor force survey, the number of unemployed was 1.97 million in June 2020. That was 39,000 people or 2.1% more than in the previous month of May. Compared to June 2019, the number of unemployed rose by 653,000 (+ 49.2%). The unemployment rate was 4.5% in June 2020.

What we are comparing is registered unemployment or if you prefer those receiving unemployment benefits with those officially counted as unemployed. Whilst we have a difference in timing ( July and then June) the gap is far wider than the change. The International Labour Organisation has some work to do I think…..

Being Paid To Borrow

Regular readers will be aware that this has essentially been the state of play in Germany for some time now. In terms of the benchmark ten-year yield this started in the spring of last year, but the five-year has been negative for nearly the last five years. That trend has recently been picking up again with the ten-year going below -0.5% this week. With the thirty-year at -0.12% then at whatever maturity Germany is paid to borrow,

This represents yet another defeat for the bond vigilantes because even Germany’s fiscal position will take a pounding from the economic decline combined with much higher public spending. But these days a weaker economy tends to lead to even lower bond yields due to expectations of more central bank buying of them.

ECB Monthly Bulletin

After the German numbers above we can only say yes to this.

While incoming economic data, particularly survey results, show initial signs of a recovery, they still point to a historic contraction in euro area output in the second quarter of 2020.

The problem is getting any sort of idea of how quickly things are picking back up. The ECB seems to be looking for clues.

Both the Economic Sentiment Indicator and the PMI display a broad-based rebound across both countries and economic sectors. This pick-up in economic activity is also confirmed by high-frequency indicators such as electricity consumption.

Meanwhile it continues to pump it all up.

The Governing Council will continue its purchases under the pandemic emergency purchase programme (PEPP) with a total envelope of €1,350 billion…………Net purchases under the asset purchase programme (APP) will continue at a monthly pace of €20 billion, together with the purchases under the additional €120 billion temporary envelope until the end of the year……..The Governing Council will also continue to provide ample liquidity through its
refinancing operations. In particular, the latest operation in the third series of targeted
longer-term refinancing operations (TLTRO III) has registered a very high take-up of
funds, supporting bank lending to firms and households.

As to the last bit I can only say indeed! After all who would not want money given to you at -1%?

Comment

We now begin to have more of an idea about how much the economy of Germany has shrunk. Also this is not as some are presenting it because the economy changed gear in 2018 and the trade war of last year applied the brakes. Of course neither were on anything like the scale we have noted today. Whilst the numbers are only a broad brush they are a similar decline to Austria ( -10.7%) which gives things a little more credibility. Markets were a little caught out with both the Euro and the Dax falling as well as bond yields.

Looking ahead we can expect a bounce back in July but how much? The Markit PMI surveys seem to have lost their way as what does this mean?

The recovery in the German economy remained on
track in July, according to the latest ‘flash’ PMI® data
from IHS Markit

Which track?

“July’s PMI registered firmly in growth territory and
well above expectations, in a clear sign that
business conditions are improving across Germany
as activity and demand recover. Furthermore, for
an economy that is steered so much by exports, it
was encouraging to see manufacturers reporting a
notable upturn in sales abroad.”

I am not sure that anyone backing their views with actual trades are convinced by this. Of course things will have picked up as the lockdown ended but there will now be worries about this,

Germany records the highest number of new coronavirus cases in about six weeks ( Bloomberg)

So the recovery seems set to have ebbs and flows. Accordingly I have no idea how places can predict such strong bounce backs in economic activity in 2021 as we still are very unsure about 2020. I wish anyone ill with this virus a speedy recovery but I suspect that economies will take quite some time.

Today’s surveys show that any economic recovery in France remains distant

Today out focus shifts to the second largest economy in the Euro area as La Belle France takes centre stage. Let us open with the thoughts of the finance minister on the economic state of play.

PARIS (Reuters) – Recent economic indicators for France are satisfactory but too fragile to change the forecast for an 11% economic contraction this year, Bruno Le Maire said Thursday.

The Minister of the Economy, speaking to the National Assembly for the debate on the orientation of public finances for 2021, said he expected economic growth of 8% for France next year and expressed the will that the in 2022, activity returns to its levels preceding the crisis linked to the new coronavirus.

Only a politician could use the words “satisfactory” and “too fragile” in the same sentence and it is a grim one of a 11% decline in GDP ( Gross Domestic Product) for this year. This means that the expectations for France are worse than those for the Euro area as a whole.

The expectations of SPF respondents for euro area real GDP growth averaged -8.3%, 5.7% and 2.4% for 2020, 2021 and 2022, respectively. ( ECB 16th July)

So around 3% worse which is interesting and I note that there is a similar pattern of predicting most but far from all of it returning in 2021. That is what you call making a forecast that is like an each-way bet where if you do recover no-one will care and if you do worse than that you highlight you did not expect a full recovery. The truth is that none of us know how 2020 will finish let alone what will happen next year. Maybe the quote below suffers from translation from French but “expressed the will?”

expressed the will that the in 2022, activity returns to its levels preceding the crisis

What does that mean? So let us move on knowing 2020 will be bad with a likely double-digit fall in economic output.

Right Here, Right Now

This morning has brought the latest in the long-running official survey on the economy.

In July 2020, the business climate has continued its recovery started in May. The indicator that synthesizes it, calculated from the responses of business managers from the main market sectors, has gained 7 points. At 85, the business climate is however still significantly below its long-term average (100), and a fortiori below its relatively high pre-lockdown level (105).

The ending of the lockdown has seen a welcome rally of 7 points but sadly only to 85% of the long-term average. If we look back though I note it was recording a relatively high 105 which makes me mull this.

In Q1 2020, real gross domestic product (GDP)* fell sharply: -5.3% after -0.1% in Q4 2019, thus a revision of +0.5% compared with the first estimate published in April.

I think the relevant number is the contraction in the last quarter of 2019 and how does that relate to a relatively high reading. As the fall is only 0.1% we could argue the economy was flat lining but we still have a measure recording growth when there wasn’t any.

Going back to the survey we see a similar pattern but weaker number for employment.

In July 2020, the employment climate has continued to recover sharply from the April low. At 77, it has gained 10 points compared to June, but it still remains far below its pre-lockdown level.

Manufacturing

The position here is particularly bad.

According to the business managers surveyed in July 2020, the business climate in industry has continued to improve. The composite indicator has gained 4 points compared to June, after losing 30 points in April due to the health crisis. However, at 82, it remains far below its long term average (100).

Looking ahead the order book does not look exactly auspicious either.

In July 2020, slightly fewer industrialists than in June have declared their order books to be below normal. The balances of opinion on total and foreign order books have very slightly recovered. Both stand at very low levels although slightly higher than in 2009.

If we look back this measure had a recent peak around 112 as 2018 began. This represented quite a rally compared to the dips below 90 seen at times in 2012 and 13. But after that peak it began slip-sliding away to around 100 and now well you can see above.

Saving

Whilst debt hits the headlines the breakdown of the GDP data shows that it is not the only thing going on.

At the same time, household consumption fell (-5.6% after +0.3%), resulting in a sharp rise of the saving rate to 19.6% after 15.1% in Q4 2019.

The pandemic has seen higher levels of saving which has two drivers I think. Firstly many simply could not spend their money as so many outlets closed. Next those who can look like they have been indulging in some precautionary saving which is something of a disaster for supporters of negative interest-rates.

National Debt

Having just looked at ying here is part of the yang.

In Q1 2020 the public deficit increased by 1.1 points: 4.8% of GDP after 3.7% in Q4 2019.

So we see that pandemic France was borrowing more and regular readers will have noted this from past articles. For the year as a whole France had its nose pressed against the Growth and Stability Pact threshold of 3% of GDP. I know some of you measure an economy by tax receipts so they were 1.275 trillion in 2019.

Moving to the national debt we see this.

At the end of Q1 2020, Maastricht’s debt reached €2,438.5 billion, a €58.4 billion increase in comparison to Q4 2019. It accounted for 101.2% of gross domestic product (GDP), 3.1 points higher than last quarter, the highest increase since Q2 2019.

Looking ahead this is the view of the Bank of France.

As a result of the wider deficit and the fall in GDP, government debt should rise substantially to 119% of GDP in 2020, from 98.1% in 2019, and should scarcely decline over the rest of the projection horizon. The average debt-to-GDP ratio for the euro area should also increase in parallel, but to a more limited extent (to 101% of GDP in 2022, easing to 100% by end-2022).

Comment

There are some familiar patterns of a sharp drop in economic output followed by plenty of rhetoric about a sharp recovery next year. However the surveys we have looked at show a very partial recovery so far so that the “V-shaped” hopium users find themselves singing along with Bonnie Tyler.

I was lost in France
In the fields the birds were singing
I was lost in France
And the day was just beginning

Switching to the mounting debt burden it is a clear issue in terms of capital and if you like the weight of the debt. Also estimates of economies at around 120% of GDP went spectacularly wrong in the Euro area crisis. But in terms of debt costs then with a ten-year yield of -0.19% France is often being paid to issue debt. Although care is needed because the ECB does not buy ultra long bonds ( 30 years is its limit) meaning that France has a fifty-year bond yield of 0,58%. We should not forget that even the latter is very cheap, especially in these circumstances.

Also there is this from the head of the ECB Christine Lagarde.

In my interview with @IgnatiusPost

, I explained that price stability and climate change are closely related. Consequently, we must take climate-related risks into account in our central banking activities.

 

 

 

What is the case for Gold?

It is time to look again at a subject which pops up every now and then and this morning has done exactly that. From The Guardian

The price of gold hit $1,865 per ounce for the first time since September 2011 this morning.

Gold has surged by 20% since the depths of the pandemic, and some analysts reckon it could hit $2,000 for the first time ever.

A weak dollar is good for gold, given its reputation as a safe-haven from inflation and money-printing.

Let us start with the price noting that this is a futures price ( August) as we remind ourselves that there is often quite a gap between futures prices and spot gold these days. That leads to a whole raft of conspiracy theories, but I will confine myself to pointing out that in a world where interest-rates are pretty much zero one reason for the difference is gone. Strictly we should use the US Dollar rate which is of the order of 0.1% or not much.

Actually a rally had been in play before the Covid-19 pandemic as we ended 2019 at US $1535 and the rallied. However like pretty much all financial markets there was a pandemic sell-off peaking on March 19th a date we keep coming back to. My chart notes a low of US $1482. Since then it has not always been up,up and away but for the last 6 weeks or so the only way has indeed been up. Of course there is a danger in looking at a peak highlighted by this from The Stone Roses.

I’m standing alone
I’m watching you all
I’m seeing you sinking
I’m standing alone
You’re weighing the gold
I’m watching you sinking
Fool’s gold

What is driving this?

Weak Dollar

The Guardian highlights this and indeed goes further.

Marketwatch says the the US dollar is getting “punched in the mouth” – having dropped 5.1% in the last quarter.

It’s lost 2.3% just in July so far, partly due to a revival in the euro. And there could be wore to come:

There is some more detail.

The US dollar is taking a pummelling, sending commodity prices rattling higher.

The dollar has sunk to its lowest level since early March, when the coronavirus crisis was sweeping global markets. The selloff has driven the euro to its highest level in 18 months, at $1.1547 this morning.

Sterling has also benefited, hitting $1.276 last night for the first time in six weeks.

Here we do have a bit of a problem as whilst the US Dollar is lower it is not really weak. Of course it is against Gold by definition but it was not long ago we were considering it to be strong and it certainly was earlier this year especially against the emerging market currencies. At the beginning of 2018 US Dollar index futures fell to 89 as opposed to the 95.4 of this morning but the Gold price was US $1340. So whilst monthly charts are a broad brush our man or woman from Mars might conclude that a higher Dollar has led to a higher Gold price.

If we stay with currencies those from my country the UK have done much better out of Gold. Looking at a Sterling or UK Pound £ price we see £1465 this morning compared to a previous peak of less than US $1200 and before this surge a price of around US $1000. Another perspective is provided by India a nation with many Gold fans and those fans should they have owned Gold will according to GoldPrice.org have made 996% over the past 20 years.

Negative Interest-Rates

Whilst there has been a general trend towards this super massive black hole there are particular features. For example a nation renowned for being Gold investors cut its official interest-rate to -0.75% in January 2015 and it is still there. That is Switzerland and the Swissy has remained strong overall, so the weak currency argument fades here. We have a small pack of “Carry Trade” nations who end up with strong currencies and negative interest-rates including Japan and more recently the Euro.

The generic situation is that we have seen substantial interest-rate cuts. The UK cut from 0.75% to 0.1% for example reducing the price of holding Gold. But I think that there is more than that. You see official interest-rates are increasingly irrelevant these days as we note cutting them has not worked and the way that people have adapted for example the increased number of fixed-rate mortgages. If we look a my indicator for that I note that we have seen a new record low of -0.11% for the UK five-year bond yield this morning. So now all of the countries I have noted have negative interest-rates or if you prefer the 0% provided by Gold is a gain and not a loss.

As I pointed out in my article of July 10th the US does not have negative bond yields but is exhibiting so familiar trends. The five-year yield has nudged a little nearer at 0.26% this morning. That contrasts sharply with the (just under) 3% of October 2018. So a 2.7% per annum push since then in Gold’s favour.

Inflation

The arrival of the pandemic was accompanied by a wave of experts predicting zero and negative inflation. As I pointed out back then I hope I have taught you all what that means and this highlighted by @chigrl earlier links in with the Gold theme.

India can expect inflation to surge to more than double the central bank’s target and the currency could lose a quarter of its value if the Reserve Bank of India begins printing money to fund the government’s spending…….Rabobank estimates that inflation could surge to an average of 12% in 2021 if the RBI was to finance a second stimulus package of $270 billion, a similar amount to what was announced in the first spending plan earlier this year. The rupee could plunge 16% against the dollar from 2020 levels and almost 25% from 2019 under that scenario.

They are essentially making a case for Indians being long Gold although they have not put it like that.

In the UK last night saw the latest in an increasingly desperate series of attempts by the UK Office for National Statistics to justify its attempt to reduce the UK RPI by around 1% per annum. That would affect around 10 million pensioners according to the actuary who spoke. Indeed the economics editor of the Financial Times Chris Giles was reduced to quoting a couple of anonymous replies to one of his own articles as evidence.How weak is that? Still I guess that when you are impersonating King Canute any piece of wood looks like a branch.

But inflation is on the horizon which of course is why the UK keeps looking for measures which produce lower numbers.

Comment

As you can see there are factors in play supporting the Gold price. The only issue is when they feed in because having established an annual gain of 2.7% from lower US bond yields only an Ivory Tower would expect that to apply each year. In fact I think I can hear one typing that right now. In reality once we come down to altitudes with more oxygen we know that such a thing creates a more favourable environment but exactly when it applies is much less predictable. I have used negative interest-rates rather than the “money printing” of The Guardian because it is a more direct influence.

I have posted my views on the problems of using Gold ( the fixed supply is both a strenght and a weakness) before as a monetary anchor. It was also covered in my opinion by Arthur C. Clarke in 2061. So let move onto something that used to be used as the money supply and some famous British seafarers made their name by stealing.

Silver rallied Tuesday to finish at its highest level since 2014, up by more than 80% from the year’s low, benefiting as both a precious and industrial metal as it looks to catch up with gold’s impressive year-to-date performance…..In Tuesday trading, September silver contract SIU20, 3.26% rose $1.37, or 6.8%, to settle at $21.557 an ounce on Comex. Prices based on the most-active contracts marked their highest settlement since March 2014, according to Dow Jones Market Data. They trade 83% above the year-to-date low of $11.772 seen on March 18, which was the lowest since January 2009. ( MarketWatch)

So I will leave you with those who famously advised us that we may not get what we want but we may get what we need.

Oh babe, you got my soul
You got the silver you got the gold
If that’s your love, it just made me blind

Christine Lagarde and the ECB have switched from monetary to fiscal policy

The Corona Virus pandemic has really rather caught the European Central Bank (ECB) on the hop. You see it was not supposed to be like this on several counts. Firstly the “Euro Boom” was supposed to continue but we now know via various revisions that things had turned down in Germany in early 2018 and then the Trumpian trade war hit as well. So the claims of former ECB President Mario Draghi that a combination of negative interest-rates and QE bond buying had boosted both Gross Domestic Product ( GDP) and inflation by around 1.5% morphed into this.

First, as regards the key ECB interest rates, we decided to lower the interest rate on the deposit facility by 10 basis points to -0.50%……..Second, the Governing Council decided to restart net purchases under its asset purchase programme (APP) at a monthly pace of €20 billion as from 1 November. We expect them to run for as long as necessary to reinforce the accommodative impact of our policy rates, and to end shortly before we start raising the key ECB interest rates.

As you can see the situation was quite problematic. For all the rhetoric who really believed that a cut in interest-rates of 0.1% would make a difference when much larger ones had not? Next comes the issue of having to restart sovereign bond purchases and QE only 9 months or so after stopping it. As a collective then there is the issue of what all the monetary easing has achieved? That leads to my critique that it is always a case of “More! More! More” or if you prefer QE to Infinity.

Next comes the issue of personnel. For all the talk about the ECB being independent the reclaiming of it by the political class was in process via the appointment of the former French Finance Minister Christine Lagarde as President. This of course added to the fact that the Vice President Luis de Guindos had been the Spanish Finance Minister. Combined with this comes the issue of competence as I recall Mario Draghi pointing out he would give Luis de Guindos a specific job when he found one he could do, thereby clearly implying he lacked the required knowledge and skill set. It is hard to know where to start with Christine Lagarde on this subject after her failures involving Greece and Argentina ( which sadly is in the mire again) and her conviction for negligence. Of course she has added to that more recently with her statement about “bond spreads” which saw the ten-year yield in Italy impersonate a Space-X rocket until somebody persuaded her to issue a correction. Although as the last press conference highlighted you never really escape a faux pas like that.

Do you now believe that it is the ECB’s role to control the spreads on government debt?

The Present Situation

This was supposed to be one where monetary policy had been set for the next year or so and President Lagarde could get her Hermes slippers under the table before having to do anything. Life sometimes comes at you quite fast though as this morning has already highlighted. From Eurostat.

In April 2020, the COVID-19 containment measures widely introduced by Member States again had a significant
impact on retail trade, as the seasonally adjusted volume of retail trade decreased by 11.7% in the euro area and
by 11.1% in the EU, compared with March 2020, according to estimates from Eurostat, the statistical office of
the European Union. In March 2020, the retail trade volume decreased by 11.1% in the euro area and by 10.1%
in the EU.
In April 2020 compared with April 2019, the calendar adjusted retail sales index decreased by 19.6% in the euro
area and by 18.0% in the EU.

As you can see Retail Sales have fallen by a fifth as far as we can tell ( normal measuring will be impossible right now and the numbers are erratic in normal times). Also there were large structural shifts with clothing and footwear down 63.5% on a year ago and online up 20.9%. Much of this is due to shops being closed and will be reversed but there is a loss for taxes and GDP which is an issue for ECB policy. Other news points out that May has its troubles as well.

Germany May New Car Registrations Total 168,148 -49.5% Y/Y – KBA ( @LiveSquawk)

Policy Response

For all the claims and rhetoric is that the ECB has prioritised the banks and government’s. So let us start with The Precious! The Precious!

Accordingly, the Governing Council decided today to further ease the conditions on our targeted longer-term refinancing operations (TLTRO III)……. Moreover, for counterparties whose eligible net lending reaches the lending performance threshold, the interest rate over the period from June 2020 to June 2021 will now be 50 basis points below the average deposit facility rate prevailing over the same period.

For newer readers this means that the banks will be facing what is both the lowest interest-rate seen so far anywhere at -1% and also a fix for the problems they have dealing with a -0.5% interest-rate more generally. It also means that whilst the bit below is not an outright lie it is also not true.

In addition, we decided to keep the key ECB interest rates unchanged.

In fact for those who regard the interest-rate for banks as key it is an untruth. Estimates for the gains to the banking sector from this are of the order of 3 billion Euros. Yet another subsidy or if you prefer we are getting the Vapors.

I’m turning Japanese, I think I’m turning Japanese, I really think so
Turning Japanese, I think I’m turning Japanese, I really think so

Fiscal Policy

This is what monetary policy has now morphed into. There is an irony here because one of the reasons the ECB has pursued such expansionary policy is the nature of fiscal policy in the Euro area. That has been highlighted in three main ways. the surpluses of Germany, the Stability and Growth Pact and the depressive policy applied to Greece. But that was then and this is now.

Chancellor Angela Merkel said Wednesday that Germany was set to plow 130 billion euros ($146 billion) into rebooting an economy severely hit by the coronavirus pandemic.

The measures include temporarily cutting value-added tax form 19% to 16%, providing families with an additional €300 per child and doubling a government-supported rebate on electric car purchases.

The package also establishes a €50 billion fund for addressing climate change, innovation and digitization within the German economy. ( dw.com )

Even Italy is being allowed to spend.

Fiat To Use State-Backed Loan To Pay Italy Staff, Suppliers ( @LiveSquawk)

This is the real reason for the QE and is highlighted below.

FRANKFURT (Reuters) – The European Central Bank scooped up all of Italy’s new debt in April and May but merely managed to keep borrowing costs for the indebted, virus-stricken country from rising, data showed on Tuesday.

The ECB bought 51.1 billion euros worth of Italian government bonds in the last two months compared with a net supply, as calculated by analysts at UniCredit, of 49 billion euros.

Comment

Thus President Lagarde will be mulling the words of Boz Scaggs.

(What can I do?)
Ooh, show me that I care
(What can I say?)
Hmmm, got to have your number baby
(What can I do?)

Plainly the ECB needs the flexibility of being able to expand its QE bond buying so that Euro area governments can borrow cheaply as highlighted by Italy or be paid to borrow like Germany. We could see the PEPP plan which is the latest emergency one expanded as it will run out in late September on present trends, also the German Constitutional Court has conveniently given it a bye. But she could do that next time. So finally we have a decision appropriate for a politician!

As to interest-rates we see that the banks have as usual been taken care of. That only leaves the rest of us so it is unlikely. We will only see another cut if they decide that like a First World War general that a futile gesture is needed.

Negative GDP growth and negative interest-rates arrive in the UK

Sometimes things are inevitable although what we are seeing now is a subplot of that. What I mean is that with the people in charge some trends have been established that I have warned about for most if not all of the credit crunch era. Let us start with something announced this morning which is more of a symptom than a cause.

UK gross domestic product (GDP) in volume terms was estimated to have fallen by 2.0% in Quarter 1 (Jan to Mar) 2020, the largest fall since Quarter 4 (Oct to Dec) 2008.

When compared with the same quarter a year ago, UK GDP decreased by 1.6% in Quarter 1 2020; the biggest fall since Quarter 4 2009, when it also fell by 1.6%.

This was in fact a story essentially about the Ides of March.

The decline in the first quarter largely reflects the 5.8% fall in output in March 2020, with widespread monthly declines in output across the services, production and construction industries.

Let us look deeper into that month starting with what usually is a UK economic strength.

There was a drop of 6.2% in the Index of Services (IoS) between February 2020 and March 2020. The biggest negative driver to monthly growth, wholesale and retail trade; repair of motor vehicles and motorcycles, contributed negative 1.27 percentage points; public administration and defence was the largest positive driver, contributing 0.01 percentage points.

Well there you have it as the biggest upwards move was 0.01%! There were other factors which should be under the category that Radiohead would describe as No Surprises.

In services, travel and tourism fell the most, decreasing by 50.1%, while accommodation fell by 45.7% and air transport by 44%.

By the entirely unscientific method of looking up in the air in Battersea and noting the lack of planes it will be worse in April. Next up was this.

Construction output fell by 5.9% in the month-on-month all work series in March 2020; this was driven by a 6.2% decrease in new work and a 5.1% decrease in repair and maintenance; all of these decreases were the largest monthly falls on record since the monthly records began in January 2010.

Then this.

Production output fell by 4.2% between February 2020 and March 2020, with manufacturing providing the largest downward contribution, falling by 4.6%……….The monthly decrease of 4.6% in manufacturing output was led by transport equipment, which fell by 20.5%, with the motor vehicles, trailers and semi-trailers industry falling by a record 34.3%

So the vehicle sector which was already seeing hard times got a punch to the solar plexus.

The Problems Here

There are a whole multitude of issues with this. I regularly highlight the problems with the monthly GDP data and this time we see it is that month ( March) which is material. So we have a drop based on numbers which are unreliable even in ordinary times and let me give you a couple of clear examples of what Taylor Swift would call “Trouble,Trouble,Trouble”.

However, non-market output has long been recognised as a measurement challenge and is one that is likely to be impacted considerably by the coronavirus (COVID-19) pandemic.

What do they mean? Let me look at what right now is the crucial sector.

The volume of healthcare output in the UK is estimated using available information on the number of different kinds of activities and procedures that are carried out in a period and weighting these by the cost of each activity.

In other words they do not really know. Regular readers will recall I covered this when I looked at a book I had helped a bit with which was when Pete Comley wrote a book on inflation. This pointed out that the measurement in the government sector was a combination of sometimes not very educated guesses. Some areas have surged.

The rise in the number of critical care cases is likely to increase healthcare output, as this is among some of the most high-cost care provided by the health service.

Some have not far off collapsed.

For example, the suspension of dental and ophthalmic activities (almost 6% of healthcare output), the cancellation and postponement of outpatient activities (13% of healthcare output), and elective procedures (19% of healthcare output) will likely weigh heavily on our activity figures.

So the numbers will be not far off hopeless. I mean what could go wrong?

 Further, our estimates may be affected by the suspension of some data collections by the NHS in England, which include patient volumes in critical care in England.

Inadvertently our official statisticians show what a shambles the measurement of education is at the best of times.

The volume of education output is produced by weighting the number of full-time equivalent students in different educational settings by the costs of educating the students in that setting.

They miss out another factor which is people doing stuff for themselves. For example my neighbour who fixed his washing machine. I have joined that club but more incompetently as I have a machine that now works but with a leak. Another example is parents now doing their own childcare rather than using nurseries or nanny’s which make be better but reduces GDP.

Oh and it would not be me if I did not point out that the inflation estimates used may be of the Comical Ali variety.

Comment

Now let me switch to the trends which the pandemic has given a shove to but were already on play. Let me return to my subject of yesterday and apologies for quoting my own twitter feed but it is thin pickings for mentions.

Negative Interest-Rates in the UK Klaxon! The two-year UK Gilt yield has fallen to -0.04% this morning

Not entirely bereft though as this from Moyeen Islam notes.

GBP 50yr OIS swap now negative for the first time

This matters if you are a newer reader because once this starts it spreads and sometimes like wildfire. A factor in this was the fact that one of the Bank of England’s loose cannons was on the airwaves yesterday.

“The committee are certainly prepared to do what is necessary to meet our remit with risks still to the downside,” Broadbent told CNBC on Tuesday.

“Yes, it is quite possible that more monetary easing will be needed over time.”

The absent-minded professor needs a minder or two as he can do a lot of damage.

“That is not to say that we stop thinking about this question, but that for the time being is where rates have gone,” he added.

So we have a level of layers here. How did he ever get promoted for example? In some ways even worse how he was switched from being an external member to being a Deputy Governor which opens a Pandora’s Box of moral hazard straight out of the television series Yes Prime Minister. The one clear example of him standing out from the crowd was in the late summer of 2016 when he got things completely wrong.

Moving on “My Precious! My Precious!” is rarely far away.

Broadbent said the potential to stimulate demand would have to be weighed against the impact on banks’ ability to lend, adding that “this is a question that has been thought about on and off since the financial crisis.”

Today we see action on that front.

Britain’s housing market set for comeback ( Financial Times)

I hardly know where to start with that but if we clear the room from the champagne corks fired by the FT I have two thoughts for you. I did warn that all the promised small business lending would end up in the mortgage market just like last time and indeed the time before ( please feel free to add a few more examples). Next whilst some prices may look the same for a while the champagne corks will be replaced by a sense of panic as prices sing along to Tom Perry and his ( Bank of England ) Heartbreakers.

And all the bad boys are standing in the shadows
And the good girls are home with broken hearts
And I’m free
Free fallin’, fallin’
Now I’m free
Free fallin’, fallin’

The Investing Channel

 

 

What can the ECB and European Commission do to help the Euro area economy?

Today our focus switches to the Euro area and the European Central Bank as we await a big set piece event from the ECB. However as is his wont The Donald has rather grabbed the initiative overnight. From the Department of Homeland Security.

(WASHINGTON) Today President Donald J. Trump signed a Presidential Proclamation, which suspends the entry of most foreign nationals who have been in certain European countries at any point during the 14 days prior to their scheduled arrival to the United States. These countries, known as the Schengen Area, include: Austria, Belgium, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Iceland, Italy, Latvia, Liechtenstein, Lithuania, Luxembourg, Malta, Netherlands, Norway, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, and Switzerland.

I have pointed it out in this manner as sadly the mainstream media is misreporting it with Beth Rigby of Sky News for example tweeting it as Europe. Much of it yes but not all of it. Moving on to our regular economics beat this will impact on an area we looked at back on the 27th of February.

Announcing the new findings, ENIT chief Giorgio Palmucci said tourism accounted for 13 percent of Italy’s gross domestic product…… tourism-related spending by both French residents and non-residents, represents around 7.5% of GDP (5% for residents, 2.5% for non-residents)…..This figure represented 11.7% of GDP, 0.4% more than in 2016.  ( Spain)

Numbers must have been hit already in what is as you can see an important economic area. One sector of this is illustrated by the German airline Lufthansa which has a share price dipping below 9 Euros or down 11% today as opposed to over 15 Euros as recently as the 19th of February. There are the beginnings of an official response as you can see from @LiveSquawk below.

Spanish Foreign Minister Gonzalez: Spain To Special Steps To Support Tourism

I presume the minister means the tourism sector here as there is nothing that can be done about current tourism as quarantines and the like move in exactly the opposite direction.

There is also the specific case of Italy where it is easier now I think to say what is open rather than closed. As the economic numbers will be out of date we can try and get a measure from the stock market. We see that the FTSE MIB index is at 17,000 as I type this as opposed to 25,477 on the 19th of last month. It is of course far from a perfect measure but it is at least timely and we get another hint from the bond market. Here we see for all the talk of yield falls elsewhere the ten-year yield has risen to 1.3% as opposed to the 0.9% it had fallen to. That is a signal that there are fears for how much the economy will shrink and how this will affect debt dynamics albeit we also get a sign of the times that an economic contraction that looks large like this only raises bond yields by a small amount.

Meanwhile actual economic data as just realised was better.

In January 2020 compared with December 2019, seasonally adjusted industrial production rose by 2.3% in the euro area (EA19) and by 2.0% in the EU27, according to estimates from Eurostat, the statistical office of the
European Union. In December 2019, industrial production fell by 1.8% in the euro area and by 1.6% in the EU27.

The accompanying chart shows a pick-up in spite of this also being true.

In January 2020 compared with January 2019, industrial production decreased by 1.9% in the euro area and by
1.5% in the EU27.

The problem is that such numbers now feel like they are from a different economic age.

The Euro

This has been strengthening through this phase as we note that the ECB effective or trade weighted index was 94.9 on the 19th of February and was 98.14 yesterday. So if there is a currency war it is losing.

As to causes I think there is a bit of a Germany effect an the interrelated trade surplus. But the main player seems to be the return of the carry trade as Reuters noted this time last year.

On the other hand, the Japanese yen, Swiss franc and euro tend to be carry traders’ funding currencies of choice, as their low yields make them attractive to sell.

Yields in Switzerland on the benchmark bond return -0.35 percent; in Germany barely 0.07 percent. But the euro has been particularly popular this year as the struggling economy has further delayed policy tightening plans in the bloc.

Of course both Euro interest-rates and yields went lower later in the year as the ECB eased policy yet again. But can you spot the current catch as Reuters continues?

Should U.S. growth deteriorate, international trade conflicts escalate or the end of the decade-long bull run crystallise, the resulting volatility spike can send “safe” currencies such as the yen, euro and Swiss franc shooting higher, while inflicting losses on riskier emerging markets.

Comment

There is quite an economic shock being applied to the Euro area right now and it is currently being headlined by Italy. In terms of a response the Euro area has been quiet so far in terms of action although ECB President Christine Lagarde has undertaken some open-mouth operations.

Lagarde, speaking on a conference call late on Tuesday, warned that without concerted action, Europe risks seeing “a scenario that will remind many of us of the 2008 Great Financial Crisis,” according to a person familiar with her comments. With the right response, the shock will likely prove temporary, she added. ( Bloomberg).

 

I have no idea how she thinks monetary action will help much with a virus pandemic but of course in places she goes ( Greece, Argentina) things often get worse and indeed much worse. She has also rather contradicted herself referring to the great financial crisis because she chose not to coordinate her moves with the US Federal Reserve as happened back then. Also all her hot air contrasts rather with her new status as a committed climate change warrior.

A real problem is the limited room for manoeuvre she has which was deliberate. In my opinion she was given the job and was supposed to have a long honeymoon period because her predecessor Mario Draghi had set policy for the early part of her term. But as so often in life  we are reminded of the Harold MacMillan statement “events, dear boy, events” and now Christine Lagarde has quite a few important decisions to make. Even worse she has limited room. It used to be the case that the two-year yield of Germany was a guide but -1% seems unlikely and instead we may get a frankly ridiculous 0.1% reduction to -0.6% in the Deposit Rate.

The ECB may follow the Bank of England path and go for some credit easing to rev up the housing market, so expect plenty of rhetoric that it will boost smaller businesses. We may see the credit easing TLTRO with a lower interest-rate than the headline to boost the banks ( presented as good for business borrowers).

However the main moves now especially in the Euro area are fiscal even more than elsewhere as the monetary ones have been heavily used. So the ECB could increase its QE purchases to oil that wheel. Eyes may switch to European Commission President Von der Leyen’s statement yesterday.

These will concern in particular how to apply flexibility in the context of the Stability and Growth Pact and on the provision of State Aid.

I expect some action here although it is awkward as again President Von der Leyen had a pretty disastrous term as German Defence Minister. Although not for her, I mean for the German armed forces. So buckle up and let’s cross our fingers.

Also do not forget there may be a knock on effect for interest-rates in Denmark and Switzerland in particular as well as Sweden.

The Investing Channel

Can QE defeat the economic impact of the Corona Virus?

The weekend just passed has seen more than a few bits of evidence of the spread of the Corona Virus especially in Japan, South Korea, Italy and Iran. It has been a curious phase in Japan where on that quarantined cruise ship they have seemed determined to follow as closely as they can to the plot of the film Alien. Even China has been forced to admit things are not going well. This is President Xi Jinping in Xinhua News.

The epidemic situation remains grim and complex and it is now a most crucial moment to curb the spread, he noted.

Yet later in the same speech we are told this.

Stressing orderly resumption of work and production, Xi made specific requirements to that end.

Back on February 3rd we looked at the potential impact on the economy of China but today we can look wider. Let us open by seeing the consequences of some of the rhetoric being deployed.

Bond Markets

UST 30-Year yield falls to an all-time low 1.83 ( @fullcarry )

So we see an all-time low for the long bond in the worlds largest sovereign bond market. Rallies in bond markets are a knee-jerk response to signs of financial turmoil except it is supposed to be for the certainty of yield or if you prefer  interest. The catch is that there is not much to be found even in the US now and if we look wider afield we see that in one of the extreme cases of these times there is none to be found at all. This is because even the thirty-year yield in Germany is now -0.04% so in fact it is being paid to borrow all along its maturity spectrum.

It was only on Friday that I pointed out some were suggesting that the “bond vigilantes” might return to the UK whereas the UK Gilt market has surged also today with the 50 year Gilt at a mere 0.76%.

These are extraordinary numbers which come on the back of all the interest-rate cuts and all the central bank QE bond buying. Of course the latter is ongoing in the Euro area and in Japan. So let us look at them in particular.

The ECB has already hinted in the past that a reduction in its deposit rate to -0.6% could be deployed but frankly their situation is highlighted by talking about a 0.1% move. After all if full percentage points have not helped then how will 0.1%? Even they are tilling the ground on this front as they join the central banking rush to claim lower interest-rates are nothing to do with them at all.

Interest rates in advanced economies have been on a broad downward path for more than three decades
and remain close to historical lows.[5]
As has been highlighted in many studies, the drivers of this long-term pattern largely boil down to
demographics, productivity and the elevated net demand for safe assets. ( ECB Chief Economist Lane on Friday )

Next comes the issue that an extension of QE is limited by that fact that there are not so many bonds to buy on Germany and the Netherlands. But the reality is that under pressure this “rules based organisation” has a habit of changing the rules.

Switching to Japan we see that Governor Kuroda has been speaking too.

RIYADH (Reuters) – The Bank of Japan will be fully prepared to take necessary action to mitigate the impact of the coronavirus on the world’s third-largest economy, its Governor Haruhiko Kuroda said.

Okay what?

He also repeated the view that, while the central bank stands ready to ease monetary policy further “without hesitation”, it saw no immediate need to act.

That reminds me of the time he denied any plans to move to negative interest-rates and a mere eight days later he did. The next bit seems to be from a place far,far,away.

Kuroda said there was no major change to the BOJ’s projection that Japan’s economy would keep recovering moderately thanks to an expected rebound in global growth around mid-year.

Perhaps he was hoping that people would forget that GDP fell by 1.6% in the last quarter of 2018 meaning that the economy was 0.4% smaller than a year before.Or that Japanese plans for this year involved an Olympics in Tokyo that is now in doubt, after all the Tokyo Marathon has been dramatically downsized. I write that sadly as there are a couple of people who train at Battersea Park running track with hopes of competing in the Olympics.

But the grand master of expectations here was this from the G 20 conference over the weekend.

“I’m not going to comment on monetary policy, but obviously central bankers will look at various different options as this has an impact on the economy,” Mnuchin said.

Gold

There have been various false dawns for the price of gold and of course enough conspiracy theories about this for anyone. But gold bugs will be singing along with Spandau Ballet as they note a price of US $1688 is up over 23% on a year ago.

Gold
(Gold)
Always believe in your soul
You’ve got the power to know
You’re indestructible, always believe in, ‘cos you are ( Spandau Ballet )

Equity Markets

This have faced something of a conundrum as fears of a slowing world economy have been been by the hopium of even more central bank easing. Last week the Dax 30 of Germany hit an all-time high and today it is down 3.6% at 13,070 as I type this. So for all the media panic today it remains close to its highest ever.

Currencies

There are two main trends here I want to mark. The first is that we seem to be again in a period of what might be called King Dollar. Also there is this.

SNB propping up 1.0600 in $EURCHF ( @RANSquawk )

Trying that at 1.20 imploded rather spectacularly in January 2015. For newer readers the Swiss Franc (CHF) has been strong as the reversal of the pre credit crunch carry trade has been added to by the perceived strength of Switzerland. This was exacerbated as its neighbour the Euro area kept cutting interest-rates and went negative. So the Swiss National Bank are presently intervening against a safe haven flow towards the Swissy.

I have suggested for a while now I could see the Swiss National Bank cutting interest-rates to -1% and expect not to be “so lonely” as The Police put it. Also I would remind you that 20% of the intervention will be reinvested in the US equity market.

Comment

Who knew that interest-rate cuts and QE could be effective cures for the Corona Virus? Especially as they have not worked for much else. Although there are also whispers that it can cure climate change too. This highlights the moral and intellectual bankruptcy at play as central bankers try to offer more central planning to fix the problems of past central planning. The Corona Virus is of course not their fault but anything unexpected was always going to be a problem for a group determined not to allow a recession and thus any reform under creative destruction.

Meanwhile the rest of us wait to see the full economic impact as we mull the flickers of knowledge we get. For example Jaguar Land Rover saying it only has 2 weeks supply of some parts or reports that for some US pharmaceuticals 80% of the basic ingredients come from China. So the latter could see large demand they cannot supply and higher prices just as we see lower demand and inflation elsewhere. More conventionally there is this for France which must send a chill down the spine of Italy to its boot.

The drop off in tourist numbers is an “important impact” on France’s economy, Bruno Le Maire, the country’s finance minister, said…….France is one of the most visited countries in the world, and tourism accounts for nearly 8% of its GDP.

Podcast

 

 

 

 

Will the US deploy negative interest-rates?

On Saturday economists  gathered to listen to the former Chair of the US Federal Reserve Ben Bernanke speak on monetary policy in San Diego. This is because those who used to run the Federal Reserve can say things the present incumbent cannot. So let me get straight to the crux of the matter.

The Fed should also consider maintaining constructive ambiguity about the future use of negative short-term rates, both because situations could arise in which negative short-term rates would provide useful policy space; and because entirely ruling out negative short rates, by creating an effective floor for long-term rates as well, could limit the Fed’s future ability to reduce longer-term rates by QE or other means.

It is no great surprise to see a central banker suggesting that the truth will be withheld. But let us note that he is talking about “policy space” in a situation described by the New York Times like this.

While the economy has recovered and unemployment has fallen to a 50-year low, interest rates have not returned to precrisis levels. Currently, the policy interest rate is set at 1.5 percent to 1.75 percent, leaving far less room to cut in the next crisis.

The apparent need for ever lower interest-rates looks ever more like an addiction of some sort for these central planners. Although as ever they are try to claim that it has in fact been forced upon them.

Since the 1980s, interest rates around the world have trended downward, reflecting lower inflation, demographic and technological forces that have increased desired global saving relative to desired investment, and other factors.

As we so often find the truth is merged with more dubious implications. Yes interest-rates and bond yields did trend lower and let me add something Ben did not say. There were economic gains from this period as for example I remember  mortgage rates in the UK being in double-digits. Also higher rates of inflation caused economic problems and it is easy to forget it caused a lot of problems back then. Younger readers probably find the concept of wage-price spirals as something almost unreal but they were very real back then. Yet Ben seems to want to put a smokescreen over this.

Another way to gain policy space is to increase the Fed’s inflation target, which would eventually raise the nominal neutral interest rate as well.

Curious as they used to tell us interest-rates drove inflation, now they are trying to claim it is the other way around! Are people allowed to get away with this sort of thing in other spheres?

Is there a neutral interest-rate?

Ben seems to think so.

The neutral interest rate is the interest rate consistent with full employment and inflation at target in the long run.  On average, at the neutral interest rate monetary policy is neither expansionary nor contractionary. Most current estimates of the nominal neutral rate for the United States are in the range of 2-3 percent.

The first sentence is ridden with more holes than a Swiss cheese which is quite an achievement considering its brevity. If we ever thought that we were sure what full employment is/was the credit crunch era has hit that for six ( for those who do not follow cricket to get 6 the ball is hit out of the playing area). For example the unemployment rate in Japan is a mere 2.2% so well below “full” but there is essentially no real wage growth rather than it surging as economics 101 text books would suggest. Putting it another way in spite of what is apparently more than full employment real wages may well have ended 2019 exactly where they were in 2015.

This is an important point as it was a foundation of economic theory as the “output gap” concept shifted from output (GDP) to the labour market when they did not get the answers they wanted. Only for the labour market to torpedo the concept and as you can see above it was not just one torpedo as it fired a full spread. Yet so many Ivory Towers persist with things accurately described by Ivan van Dahl.

Please tell me why
Do we build castles in the sky?
Oh tell me why
Are the castles way up high?

Quantitative Easing

Ben is rather keen on this but then as he did so much of it he has little choice in the matter.

Quantitative easing works through two principal channels: by reducing the net supply of longer-term assets, which increases their prices and lower their yields; and by signaling policymakers’ intention to keep short rates low for an extended period. Both channels helped ease financial conditions in the post-crisis era.

Could there be a more biased observer? I also note that there seems to be a titbit thrown in for politicians.

The risk of capital losses on the Fed’s portfolio was never high, but in the event, over the past decade the Fed has remitted more than $800 billion in profits to the Treasury, triple the pre-crisis rate.

A nice gift except and feel free to correct me if I am wrong there is still around US $4 trillion of QE out there. So how can the risk of losses be in the past tense with “was”? It is one of the confidence tricks of out era that establishments have been able to borrow off themselves and then declare a profit on it hasn’t it?

Ben seems to have an issue here though. So by buying trillions of something you increase the supply?

and increases the supply of safe, liquid assets.

Forward Guidance

I do sometimes wonder if this is some form of deep satire Monty Python style.

 Forward guidance helps the public understand how policymakers will respond to changes in the economic outlook and allows policymakers to commit to “lower-for-longer” rate policies. Such policies, by convincing market participants that policymakers will delay rate increases even as the economy strengthens, can help to ease financial conditions and provide economic stimulus today.

Another way of looking at it is that it has been and indeed is an ego trip. The  majority of the population will not know what it is and in the case of my country that is for the best as the Bank of England misled by promising interest-rate rises and then cutting them. Sadly some did seem to listen as more fixed-rate mortgages were incepted just before they got cheaper. So we see that if we return to the real world the track record of Forward Guidance makes people less and not more likely to listen to it. After all who expects and sustained rises in interest-rates anyway?

Comment

These speeches are useful as they give us a guide to what central bankers are really thinking. It does not matter if you consider them to be pack animals or like the large Amoeba that tries to eat the Starship Enterprise in an early episode of Star Trek as the result is the same. This will be what they in general think.

When the nominal neutral rate is in the range of 2-3 percent, then the simulations suggest that this combination of new policy tools can provide the equivalent of 3 percentage points of additional policy space; that is, with the help of QE and forward guidance, policy performs about as well as traditional policies would when the nominal neutral rate is 5-6 percent. In the simulations, the 3 percentage point increase in policy space largely offsets the effects of the zero lower bound on short-term rates.

Actually if we look at the middle-section “traditional policies” did not work but I guess he is hoping no-one will point that out. If they did we would not be where we are! Also you may not that as I have often found myself pointing out why do we always need more of the same!

Still if you believe the research of the Bank of England interest-rates have been falling for centuries. Does this mean that to coin a phrase they have been doing “God’s work” in the credit crunch era?

global real rates have shown a
persistent downward trend over the past five centuries, declining within a corridor of between -0.9 (safe
asset provider basis) and -1.59 basis points (global basis) per annum, with the former displaying a
continuous decline since the deep monetary crises of the late medieval “Bullion Famine”. This downward
trend has persisted throughout the historical gold, silver, mixed bullion, and fiat monetary regimes, is
visible across various asset classes, and long preceded the emergence of modern central banks.

The catch is that if you are saying events have driven things people might start to wonder what your purpose it at all?

Podcast

 

The ECB starts to face up to some of the problems of the Euro area banks

Today has brought the Euro area financial sector and banks in particular into focus as the ECB ( European Central Bank ) issues its latest financial stability report. More than a decade after the credit crunch hit one might reasonably think that this should be a story of success but it is not like that. Because the ECB is rather unlikely to put it like this a major problem is that the medicine to fix the banks ( lower interest-rates) turned out to be harmful to them if you not only continued but increased the dose. Or as Britney Spears would put it, the impact of negative interest-rates on banks is.

I’m addicted to you
Don’t you know that you’re toxic?
And I love what you do
Don’t you know that you’re toxic?

Actually the FSR starts with another confession of trouble as it reviews the Euro area economy.

The euro area economic outlook has deteriorated, with growth expected to remain subdued for longer. Mirroring global growth patterns, information since the previous FSR indicates a more protracted weakness of the euro area economy, leading to a downward revision of real GDP growth forecasts for 2020-21.

There is the by traditional element of blaming Johnny Foreigner which has some credibility with the trade war issue. However if we look deeper we were reminded only yesterday about the told of the Euro area in its genesis.

In September 2019 the current account of the euro area recorded a surplus of €28 billion, compared with a surplus of €29 billion in August 2019. In the 12-month period to September 2019, the current account recorded a surplus of €321 billion (2.7% of euro area GDP), compared with a surplus of €378 billion (3.3% of euro area GDP) in the 12 months to September 2018.

It sometimes gets forgotten now that one of the factors in the build-up to the credit crunch was the Euro area ( essentially German ) trade surplus.

However the essential message here is that lower economic growth is providing a challenge to the Euro area financial sector and banks and tucked away at the bottom of this section is one of the reasons why.

At the same time, inflationary pressures in the euro area are forecast to remain muted over the next two years, translating into overall weaker nominal growth prospects.

Paying down debt can be achieved via inflation as well as real economic growth and is one of the reasons why the ECB keeps implementing policies to get inflation up towards its 2% per annum target. A sort of stealth tax.

Bond Markets

There is a warning here.

Asset valuations, reliant on low interest rates, could face future corrections.

If we start with sovereign bonds then there is am implied danger for Germany as it has the largest sector with negative yields. But if we switch to banking exposure then eyes turn to Italy because not only does it have a large relative national debt but its banks hold a relatively large proportion of it at 20%. They will have done rather well out of the ten-year yield falling by over 2% to 1.3% over the past year but is that the only way Italian banks make money these days? There is a reflection of this sort of thing below.

Very low interest rates, coupled with the large number of investors which have gradually increased the duration of their fixed income portfolios, could exacerbate potential losses if an abrupt repricing were to materialise in the medium-to-long run.

Tucked away is an arrow fired at Germany.

there is a strong case for governments with fiscal space to act in an effective and timely manner.

What about the banks?

Here we go.

Bank profitability concerns remain prominent. Bank profitability prospects have weakened against the backdrop of the deteriorating growth outlook  and the low interest rate environment, especially for banks also facing structural cost and income challenges (see Special Feature A).

Nobody seems to want to back them with their money.

Reflecting these concerns, euro area banks’ market valuations remain depressed with an average price-to-book ratio of around 0.6.

Although the ECB would not put it like this if this was a rock concert the headliner would be my old employer Deutsche Bank. It has a share price of 6.5 Euros which certainly must depress long-term shareholders who have consistently lost money. There have been rallies in this example of a bear market and well played if you have taken advantage but each time they have been followed by Alicia Keys on the stereo.

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

This bit is both true and simply breathtaking!

Banks have made slow progress in addressing structural challenges to profitability.

If you have policies which are fertiliser for zombie banks then complaining about a march of the zombies is a bit much. In this area it is Halloween every day.

If you are wondering about Special Feature A so was I.

These banks all stand out in terms of elevated cost-to-income ratios. But there also appear to be three distinct groups: (i) banks struggling with legacy asset problems; (ii) banks with weak income-generation capacity; and (iii) banks suffering from a combination of cost and revenue-side problems.

We are told this is only for a “sub set” but point (iii) is plainly a generic issue in the Euro area banking sector. The proposed solution looks not a little desperate.

But in systems with many weak-performing small banks, consolidation within their domestic system could improve performance. Finally, a combination of bank-level restructuring and cross-border M&A activity could help reduce the costs and diversify the revenues of large banks that are performing poorly.

Consolidating the cajas in Spain and some of the smaller banks in Italy did reduce the number of banks in trouble but did not change the problem.There is a bit of shuffling deckchairs on the Titanic about this which turns to laughter as I consider “cross-border M&A activity”. Like RBS in the UK? That was one of the ways we got into this mess. One of the problems with banking right now is what do they diversify into?

On aggregate, euro area banks’ return on equity is expected to remain low, limiting the sector’s ability to increase resilience through retained earnings

Er well yes.

Should this all go wrong we will be told we were warned.

A banking system operating with significant overcapacity is also vulnerable to weak competitors driving down lending standards and an underpricing of risk.

Shadow Banking?

Some of the role of banks has moved elsewhere and of course there are plenty of issues for long-term savings in a negative interest-rate world.

After a slight decline in the last quarter of 2018, the total assets of investment funds (IFs), money market funds (MMFs), financial vehicle corporations, insurance corporations (ICs), pension funds (PFs) and other financial institutions gradually increased to almost €46 trillion in June 2019, and represented 56% of total financial sector assets.

Also what do you expect if you drive some corporate bond yields negative by buying so many of them?

But more recently, the low cost of market-based debt has supported a further increase in NFCs’ debt issuance – particularly of investment-grade bonds.

Can anybody remember a time when relying on bond ratings went wrong?

Negative interest-rates again.

As yields have fallen, non-bank financial intermediaries hold a growing share of low-yielding bonds, which decreases their investment income in the medium term and encourages risk-taking.

Comment

The press release is if we read between the lines quite damning.

Low interest rates support economic activity, but there can be side effects

Signs of excessive risk-taking in some sectors require monitoring and targeted macroprudential action in some countries

Banks have further increased resilience, but have made limited progress in improving profitability.

It is welcome that we are seeing some confession of central banking sins but it comes with something else I have noticed recently which is that ECB related accounts are taking the battle to social media.

Dear fellow German economists, if you are wondering what you can do for Europe: Please help to dispel the harmful & wrong narratives about the @ecb  ‘s monetary policy, floating around in political and media circles. These threaten the euro more than many other things.

That is from Isabel Schnabel who is the German government and Eurogroup approved candidate to be a new member on the ECB board. From the replies it is not going down too well but we can see clearly why she was appointed at least.

Me on The Investing Channel

The mad world of negative interest-rates is on the march

Yesterday as is his want the President of the United States Donald Trump focused attention on one of our credit crunch themes.

Just finished a very good & cordial meeting at the White House with Jay Powell of the Federal Reserve. Everything was discussed including interest rates, negative interest, low inflation, easing, Dollar strength & its effect on manufacturing, trade with China, E.U. & others, etc.

I guess he was at the 280 character limit so replaced negative interest-rates with just negative interest. In a way this is quite extraordinary as I recall debates in the earlier part of the credit crunch where people argued that it would be illegal for the US Federal Reserve to impose negative interest-rates. But the Donald does not seem bothered as we see him increasingly warm to a theme he established at the Economic Club of New York late last week.

“Remember we are actively competing with nations that openly cut interest rates so that many are now actually getting paid when they pay off their loan, known as negative interest. Who ever heard of such a thing?” He said. “Give me some of that. Give me some of that money. I want some of that money. Our Federal Reserve doesn’t let us do it.” ( Reuters )

That day the Chair of the US Federal Reserve Jerome Powell rejected the concept according to CNBC.

He also rejected the idea that the Fed might one day consider negative interest rates like those in place across Europe.

The problem is that over the past year the 3 interest-rate cuts look much more driven by Trump than Powell.

Of course, there are contradictions.Why does the “best economy ever” need negative interest-rates for example? Or why a stock market which keeps hitting all-time highs needs them? But the subject keeps returning as we note yesterday’s words from the President of the Cleveland Fed.

Asked her view on negative interest rates, Mester told the audience that Europe’s use of them “is perhaps working better than I might have anticipated” but added she is not supportive of such an approach in the United States should there be a downturn.

Why say “working better” then reject the idea?  We have seen that path before.

The Euro area

As to working better then a deposit-rate of -0.5% and of course many bond yields in negative territory has seen the annual rate of economic growth fall to 1.1%. Also with the last two quarterly growth readings being only 0.2% it looks set to fall further.

So the idea of an economic boost being provided by them is struggling and relying on the counterfactual. But the catch is that such arguments are mostly made by those who think that the last interest-rate cut of 0.1% made any material difference. After all the previous interest-rate cuts that is simply amazing. Actually the moves will have different impacts across the Euro area as this from an ECB working paper points out.

A striking feature of the credit market in the euro area is the very large heterogeneity across countries in the granting of fixed versus adjustable rate mortgages.
FRMs are dominant in Belgium, France, Germany and the Netherlands, while ARMs are prevailing in Austria, Greece, Italy, Portugal and Spain (ECB, 2009; Campbell,
2012)

Actually I would be looking for data from 2019 rather than 2009 but we do get some sort of idea.

Businesses and Savers in Germany are being affected

We have got another signal of the spread of the impact of negative interest-rates .From the Irish Times.

The Bundesbank surveyed 220 lenders at the end of September – two weeks after the ECB’s cut its deposit rate from minus 0.4 to a record low of minus 0.5 per cent. In response 58 per cent of the banks said they were levying negative rates on some corporate deposits, and 23 per cent said they were doing the same for retail depositors.

There was also a strong hint that legality is an issue in this area.

“This is more difficult in the private bank business than in corporate or institutional deposits, and we don’t see an ability to adjust legal terms and conditions of our accounts on a broad-based basis,” said Mr von Moltke, adding that Deutsche was instead approaching retail clients with large deposits on an individual basis.

So perhaps more than a few accounts have legal barriers to the imposition of negative interest-rates. That idea gets some more support here.

Stephan Engels, Commerzbank’s chief financial officer, said this month that Germany’s second largest listed lender had started to approach wealthy retail customers holding deposits of more than €1 million.

Japan

The Bank of Japan has dipped its toe in the water but has always seemed nervous about doing anymore. This has been illustrated overnight.

“There is plenty of scope to deepen negative rates from the current -0.1%,” Kuroda told a semi-annual parliament testimony on monetary policy. “But I’ve never said there are no limits to how much we can deepen negative rates, or that we have unlimited means to ease policy,” he said. ( Reuters )

This is really odd because Japan took its time imposing negative interest-rates as we had seen 2 lost decades by January 2016 but it has then remained at -0.1% or the minimum amount. Mind you there is much that is crazy about Bank of Japan policy as this next bit highlights.

Kuroda also said there was still enough Japanese government bonds (JGB) left in the market for the BOJ to buy, playing down concerns its huge purchases have drained market liquidity.

After years of heavy purchases to flood markets with cash, the BOJ now owns nearly half of the JGB market.

In some ways that fact that a monetary policy activist like Governor Kuroda has not cut below -0.1% is the most revealing thing of all about negative interest-rates.

Switzerland

The Swiss found themselves players in this game when the Swiss Franc soared and they tried to control it. Now they find themselves with a central bank that combines the role of being a hedge fund due to its large overseas equity investments and has a negative interest-rate of -0.75%.

Nearly five years after the fateful day when the SNB stopped capping the Swiss Franc we get ever more deja vu from its assessments.

The situation on the foreign exchange market is still fragile, and the Swiss franc has appreciated in trade-weighted terms. It remains highly valued.

Comment

I have consistently argued that the situation regarding negative interest-rates has two factors. The first is how deep they go? The second is how long they last? I have pointed out that the latter seems to be getting ever longer and may be heading along the lines of “Too Infinity! And Beyond!”. It seems that the Swiss National Bank now agrees with me. The emphasis is mine.

This adjustment to the calculation basis takes account of the fact that the low interest rate environment around the world has recently become more entrenched and could persist for some time yet.

We have seen another signal of that recently because the main priority of the central banks is of course the precious and we see move after move to exempt the banks as far as possible from negative interest-rates. The ECB for example has introduced tiering to bring it into line with the Swiss and the Japanese although the Swiss moved again in September.

The SNB is adjusting the basis for calculating negative interest as follows. Negative interest will continue to be charged on the portion of banks’ sight deposits which exceeds a certain exemption threshold. However, this exemption threshold will now be updated monthly and
thereby reflect developments in banks’ balance sheets over time.

If only the real economy got the same consideration and courtesy. That is the crux of the matter here because so far no-one has actually exited the black hole which is negative interest-rates. The Riksbank of Sweden says that it will next month but this would be a really odd time to raise interest-rates. Also I note that the Danish central bank has its worries about pension funds if interest-rates rise.

A scenario in which interest rates go up
by 1 percentage point over a couple of days is not
implausible. Therefore, pension companies should
be prepared to manage margin requirements at
all times. If the sector is unable to obtain adequate
access to liquidity, it may be necessary to reduce the
use of derivatives.

Personally I am more bothered about the pension funds which have invested in bonds with negative yields.After all, what could go wrong?