What can we expect next from the ECB?

Today the European Central Bank starts its latest policy meeting and tomorrow lunchtime we will be told the outcome. To my mind there are three certainties. The first is that ECB President Mario Draghi will call for more economic reforms in his introductory statement. The next is that he will wish everyone a happy holiday season at the end. The third is that he will find a way to point out that in its own terms the ECB has had a Eureka moment.From Eurostat.

Euro area annual inflation rate was 2.0% in June 2018, up from 1.9% in May 2018. A year earlier, the rate was
1.3%

So the 2% target has been hit and if you take the average of those 2 months you end up pretty near to the 1.97% specified back in the day in the valedictory speech of Mario’s predecessor Jean-Claude Trichet. Next comes this.

Seasonally adjusted GDP rose by 0.4% in the euro area (EA19) (and the EU28 during the first quarter of 2018),
compared with the previous quarter……..Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 2.5% in the euro area.

So economic growth and inflation on target as Mario readies us for the last leg of his triple play.

The number of persons employed increased by 0.4% in both the euro area (EA19) and the EU28 in the first
quarter of 2018 compared with the previous quarter…….Compared with the same quarter of the previous year, employment increased by 1.4% in both the euro area and the EU28 in the first quarter of 2018……Eurostat estimates that, in the first quarter of 2018, 237.9 million men and women were employed in the EU28, of which 157.2 million were in the euro area. These are the highest levels ever recorded in both areas.

So as you can see even the perennial bugbear which is the employment situation in the Euro area has improved. This brings me to another certainty these days which is that Mario will run rings around the journalists at the press conference. The only danger to that is overconfidence as he sings along to Flo and her Machine.

The dog days are over
The dog days are done

A nagging problem

The catch to the scenario above is that the punch bowl at this particular party is still pretty full. No longer right up to the brim but there is still a -0.4% deposit rate and this.

would reduce the monthly pace of net asset purchases to €15 billion until the end of December 2018 and then end net asset purchases.

Lest we forget it will be twisting by the pool this summer and beyond.

Third, it intended to maintain its policy of reinvesting the principal payments from maturing securities purchased under the APP for an extended period of time after ending net purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

One of the biggest beneficiaries does not seem to merit a mention so let me help out. The various Euro area governments will be grateful for the help to fiscal policy via lower borrowing costs especially Mario’s home country because after the election result the bond market there has looked more vulnerable ( 10 year yield 2.65%). Some may think that the new Vice President the ex Spanish Finance Minister was appointed to keep the ECB reminded about this but whatever it does pose questions about the claimed independence. After all it was only at the last press conference that we were told the ECB was struggling to find him a specific role implying he lacked the skills required.

But looking ahead the sovereign bond book will head towards 2.1 trillion Euros and then stay there. So we move on with the nagging worry that people are still drinking from the punch bowl with the band at full volume.

What happens next?

This morning’s monetary data provided some food for thought.

The annual growth rate of the broad monetary aggregate M3 increased to 4.4% in June 2018 from 4.0% in
May, averaging 4.1% in the three months up to June. The components of M3 showed the following
developments. The annual growth rate of the narrower aggregate M1, which comprises currency in
circulation and overnight deposits, stood at 7.4% in June, compared with 7.5% in May

In terms of economic outlook we see that the narrow money supply has stabilised overall at a lower level confirming a weaker economic trajectory. Looking further ahead broad money growth has improved but against that inflation has risen.

The ECB will be pleased to see an improvement in credit provided to businesses but I think that is more of a lagging ( from the period of growth seen last year) than a leading indicator.

A Space Oddity

Strangely perhaps the biggest challenge to the shiny happy people economic view in the Euro area has come from the ECB itself.

The view was also reiterated that the observed slowdown could, to some extent, be seen as a natural development in a maturing expansion after many years of growth above potential.  ( ECB July Minutes )

Er haven’t we just seen many years of growth below potential? I know recently things improved but have the credit crunch and the Euro area crisis just been redacted? Also as so often for central bankers we see such thoughts are driven by a rather downbeat outlook.

An increasing number of countries and sectors were starting to run into capacity constraints and labour shortages, implying a “structural” levelling-off of growth,

If true that is a bit grim.

Banks

Problems here never really go away and claiming “many years of growth above potential” trims the list of possible excuses quite drastically. There is the ongoing issue of money laundering and corruption in the Baltic nations and of course there is the Italian version.

The ECB appears to have lost patience with Carige, which although worth a mere 500 million euros is one of Italy’s top 10 biggest lenders by assets. It has rejected the Genoa-based bank’s current capital plan, and given it until year end to raise its total capital ratio to 13.1 percent, almost 90 basis points above the current level.  ( Reuters )

Comment

As you can see the picture on the surface looks good for the ECB and it is true there have been improvements. I expect Mario to defend the ongoing QE and negative interest-rates by pointing out that what he considers to be core inflation is at 1.2% below target. But the old punch bowl argument does pose questions especially as the man who made the original case could not have been aware of how large a modern punch bowl actually is. The vulnerability is to any combination of a further slowing in the economy and pick up in inflation. That will be there for a while as the ECB intends to maintain the size of its stock of QE  as well as having no plans to raise interest-rates.

This entailed the expectation that policy rates would remain at their present levels at least through the summer of 2019 and in any case for as long as necessary to ensure that the evolution of inflation remained aligned with the Governing Council’s current expectations of a sustained adjustment path. ( ECB July Minutes)

Putting this another way I note that the Taylor Rule would according to the Wall Street Journal have interest-rates at 2.5%. I am no great fan of automatic rules but that is quite a gap and widens if you note the -0.4% deposit rate rather than the 0% rate some like to emphasise. Which returns to the question of why if things are so good we remain enmeshed in zero and indeed negative interest-rates?

 

 

 

 

 

 

 

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Can negative interest-rates prevent a recession in Denmark?

One of the features of the response to the credit crunch was a general reduction in interest-rates. This was followed later by Quantitative Easing and around the Euro area in particular by further reductions in interest-rates. This was evidenced by Denmark where its Nationalbanken cut its current account rate to 0% in June 2012 where it remains. Even more so by its certificate of deposit or CD rate which moved into negative territory in July 2012 at -0.2% and is now -0.65% having been as low as -0.75%. So after raising interest-rates almost unbelievably as the credit crunch hit the Nationalbanken became an enthusiastic cutter of them and before we get to the impact on the Danish economy we need to remind ourselves that there is an external or foreign restraint at play here.

Denmark maintains a fixed-exchange-rate policy vis-à-vis the euro area and participates in the European Exchange Rate Mechanism, ERM 2, at a central rate of 746.038 kroner per 100 euro with a fluctuation band of +/- 2.25 per cent.

So it is no great surprise to note that Danish interest-rates were in effect sucked lower by the impact of Mario Draghi’s “Whatever it takes ( to save the Euro) speech and policies. Of course all interest-rate policies have external and internal economic implications but when you have such an explicit one the external takes over at times of stress. For choice I would call it a pegged currency rather than fixed as whilst it is unlikely it could more easily change the rate than it could leave the “irreversible” Euro if it had joined it. Anyway here is how the Nationalbanken  reviewed events back in the summer of 2012.

For the first time in its nearly 200-year history, one of Danmarks Nationalbank’s interest rates is negative. Negative monetary-policy interest rates are also unique in an international perspective.

They were not lonely for long!

The economic situation

At the end of last month the Nationalbanken told us this.

The Danish economy is in a boom where the
growth outlook is slightly better than the potential……. There is consensus that labour market
pressures will intensify.

We get the picture although the discussion with the Danish Economic Council did have something from the left field.

In addition, the calculation assumes an increase in the retirement age by 12 years relative to today.

Really? It seems for best that they think that the public finances are in good shape. Although I note that the enthusiasm for easy monetary policy does not spread to fiscal policy.

This should not be perceived as scope for fiscal policy accommodation within a foreseeable time horizon. The cyclical position must be taken into account.

Returning to the economic situation we were told this back in March.

The upswing continued in the 2nd half of 2017 and the Danish economy has now entered a boom phase. Labour market pressures have increased, but so far the upswing has been balanced.

That is Danmarks Nationalbank’s conclusion in a new projection of the Danish economy, in which growth in the gross domestic product, GDP, is expected to be 1.9 per cent this year, 1.8 per cent next year and 1.7 per cent in 2020.

We need a caveat for those who think that these days we need recorded growth of 2%  per annum just to stand still but Nationalbanken Governor Lars Rhode is not one of them.

The Danish economy is booming

In fact the outlook is so good that the brakes may need to be applied although it is revealing that Governor Rhode seems to have forgotten that the task below is usually considered to be the role of monetary policy because it is more flexible.

So the government should be prepared to introduce preventive fiscal tightening at short notice if there are signs that the economy is overheating.

The boom

We get a new perspective on the concept of boom if we note that at current prices the GDP of Denmark was 537.9 billion Danish Krone in the first quarter of 2017 and 537.3 billion in the first quarter of this year. This was driven by this.

Gross domestic product fell 0.6 percent in the third quarter from the previous three-month period, Statistics Denmark said on Thursday ( Bloomberg).

In fact we know that on the measure looked at above it fell by 0.8% and unknown to Bloomberg back then it had also fallen by over 1% in the second quarter so there had in fact been a recession in the boom. How can this be? Well there was an element of the Irish problem.

The reason is primarily a large payment of a Danish owned patent which is temporarily accounted for as service exports in Q1 2017. That leaves Q1 GDP at a massive 2.3% q/q growth and Q2 at -1.2%. Q3 turned out even worse than previously suggested at -0.8% but it is largely attributed to negative stock building and the above mentioned sudden stop in car sales. ( Danske Bank ).

This meant that if you looked at 2017 as a calendar year things looked like a boom. From the Financial Times.

Gross domestic product increased 2.1 per cent for the year overall, the country’s best performance since 2006. Jan Størup Nielsen, chief analyst at Nordea, said the country is now “running at full capacity” for the first time in 10 years, and said the solid performance “will likely continue in 2018”.

Yet if you look from the latest data then the economy is smaller than a year before! If we move to the cause here is the likely factor.

However, most of Denmark’s most valuable patents are held by pharmaceuticals companies and several economists pointed to a payment made to Danish group Forward Pharma last January. Nasdaq-listed Forward received a $1.25bn payment from US biotech Biogen as part of a dispute over patents for multiple sclerosis treatments. Forward chief executive Claus Bo Svendsen said the data showed “a nice time-wise correlation with our deal with Biogen”.

House Prices

From the Nationalbanken.

As a result of the gradual shift from bank loans to
mortgage loans in recent years, mortgage lending
continues to drive lending growth.

They will need to drive it a bit faster as at the end of 2017 there was a dip in house prices after a spell of rises which in the light of the negative interest-rates era you may not be surprised to learn began in 2012.  The 85.7 of the index was replaced by 111 in the autumn of last year but it ended the year at 109.1 . Like many capital cities Copenhagen is now under much cooler pressures than were seen before.

Comment

Let me open with this from Bloomberg yesterday.

In the world-record holder of negative rates, there’s been another eye-catching development.

Danes are richer than ever before, according to central bank data on savings and home equity. But they’re spending less, in relative terms. The gap between private consumption and household wealth is the biggest it’s been in three decades.

Those familiar with my analysis will not be surprised unlike those Bloomberg go on to quote. This is because there is a large group of losers as those who do not own property face inflation which does not show up in the Consumer Price Index which is at 102.2 compared to 100 in 2015. Whereas the winners are really only those who have sold and made a profit or more implicitly those who have used higher prices to borrow more.

So wealth is not what is used to be as we get another reminder that GDP isn’t either.

Though private consumption did inch up 0.9 percent in the first quarter, it wasn’t enough to prevent the economy from shrinking on an annual basis.  Danske says GDP growth this year probably won’t exceed 2 percent.

Furthermore will Denmark be influenced by the slowing in the UK and Euro area and with interest-rates already negative how would it respond in such a scenario?

 

 

An expansion of fiscal policy in the Euro area might help to keep Italy in it

After the action or in many ways inaction at the Bank of England last week there was a shift of attention to the ECB or European Central Bank. Or if you prefer from Governor Mark Carney to President Mario Draghi. This is because tucked away in a rather familiar tale from him in a speech in Florence was what you might call parking your tanks on somebody else’s lawn. It started with this.

One is the ECB’s OMTs, which can be used when there is a threat to euro area price stability and comes with an ESM programme. The other is the ESM itself.

Actually rather contrary to what Mario implies Outright Monetary Transactions or OMTs were never required as the ECB instead expanded its bond puchases via the Quantitative Easing programme which is ongoing currently at a flow of 30 billion Euros a month. One might also argue the European Stability Mechanism has caused anything but in Greece however the fundamental point is that via such mechanisms monetary policy has slipped under and over and around the border into fiscal policy. For example after the progress in the coalition talks in Italy the financial media has moved onto articles about the Italian national debt being un affordable when in fact the factor that has made it affordable is/are the 342 billion Euros of it that the ECB has purchased. The Italy of 7% bond yields at the time of the Euro area crisis would not have reached now in the same form whereas the current Italy of around 2% yields has.

But there is more than tip-toeing onto the fiscal lawn below.

So, we need an additional fiscal instrument to maintain convergence during large shocks, without having to over-burden monetary policy. Its aim would be to provide an extra layer of stabilisation, thereby reinforcing confidence in national policies.

As no doubt you have already recognised that particular lawn has been mined with economic IEDs as Mario then implicitly acknowledges.

And, as we have seen from our longstanding discussions, it is certainly not politically simple, regardless of the shape that such an instrument could take: from the provision of supranational public goods – like security, defence or migration – to a fully-fledged fiscal capacity.

The only one of those that is pretty non contentious these days is the security issue and that of course is because of the grim nature of events in that area. However the movement of ECB tanks onto the fiscal lawn continued.

But the argument whereby risk-sharing may help to greatly reduce risk, or whereby solidarity, in some specific circumstances, contributes to efficient risk-reduction, is compelling in this case as well, and our work on the design and proper timeframe for such an instrument should continue.

All of that is true and just in case people missed it then the ECB broadcasted it from its social media feeds as well.

Why has Mario done this?

One view might be that as he approaches the end of his term he feels that he can do this in a way he could not before. Another ties in with a theme of this website which is to use the words of Governor Carney that monetary policy may not be “maxxed out” but there are clear signs of fatigue and side-effects. Mario may well have had a sleepless night or two as he thinks of his own recent words about the Euro area economy.

When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

Where this fits in with my theme is that this is happening with an official deposit rate of -0.4% and not only an enormously expanded balance sheet but ongoing QE. Thus the sleepless nights will be when Mario wonders what  to do if this also turns out to be ongoing? The two obvious monetary responses have problems as whilst what economists call the “lower bound” has proved to be yet another mirage that is so far and plunging further into the icy cold world of negative interest-rates increases the risk of a dash to cash. The second response which ties in with the issue of policy in Germany is that the ECB is running out of German bunds to buy so firing up the QE operation again is also problematic.

Fiscal Policy

The problem puts Mario on an Odyssey.

And if you’re looking for a way out
I won’t stand here in your way.

In terms of economic theory there is a glittering prize in view here but sadly it only shows an example of what might be called simple minds. This is because at the “lower bound” for interest-rates in a liquidity trap  fiscal policy will be at its most effective according to that theory. So far go good until we note that the “lower bound” has got er lower and lower. There was of course the Governor Carney faux pas of saying it was at 0.5% and then not only cutting to 0.25% but planning to cut to 0.1% before the latter was abandoned but also some argued it was at 0% and of course quite a bit of the world is currently below that.

So Mario is calling for some fiscal policy and as so often all eyes turn to Germany which as I have pointed out before is operating fiscal policy but one heading in the opposite direction as I pointed out on the 20th of November.

Germany’s federal budget  surplus hit a record 18.3 billion euros ($21.6 billion) for the first half of 2017.

This poses various problems as I then pointed out.

With its role in the Euro area should a country with its trade surpluses be aiming at a fiscal surplus too or should it be more expansionary to help reduce both and thus help others?

As you can see Mario is leaving the conceptual issue behind and simply concentrating on his worries for 2018. This of course is standard Euro area policy where changes come in for an emergency and then find themselves becoming permanent. Although to be fair they are far from alone from this as I note that Income Tax in the UK was supposed to be a temporary way of helping to finance the Napoleonic wars.

Comment

This speech may well turn out to be as famous as the “Whatever it takes ( to save the Euro) one. In terms of his own operations Mario has proved to be a steadfast supporter of it but the monetary policy ammunition locker has been emptied. It is also true that it means he has been something of a one-club golfer because the Euro area political class has in essence embraced austerity and left Mario rather lonely. Now his time is running out he is in effect pointing that out and asking for help. Perhaps he is envious of what President Trump has just enacted in the United States.

There are clear problems though. We have been on this road before and it has turned out to be a road to nowhere in spite of many talking heads supporting it. In essence it relies in the backing of Germany and it has been unwilling to allow supranational Eurobonds where for example Italy and Greece could borrow with the German taxpayer potentially on the hook. If anything Germany seems to be heading in the direction of being even more fiscally conservative.

If we look wider we see that at the heart of this is something which has dogged the credit crunch era. If you believe one of the causes of it was imbalances well the German trade surplus has if anything swelled and now it is adding fiscal surpluses to that. Next if we look more narrowly there are the ongoing ch-ch-changes in Mario’s home country Italy. From the Wall Street Journal.

Both parties vowed to scrap or dilute an unpopular pension overhaul from 2011 that steadily raises the retirement age. Economists say the parties’ fiscal promises, if enacted in full, would greatly add to Italy’s budget shortfall, likely breaking EU rules that cap deficits at 3% of gross domestic product. Italy’s public debt, at 132% of GDP, is the EU’s highest after Greece.

So is it to save the Euro or to keep Italy in it?

Where next for the Euro exchange-rate?

As we start a new week the focus will be shifting to the Euro area and its economy and exchange-rate. The reason for this comes from my article of last Wednesday which concluded with this.

The ECB finds itself in something of a dilemma. This is because it has continued with a highly stimulatory policy in a boom and now faces the issue of deciding if the current slow down is temporary or not? Even worse for presentational purposes it has suggested it will end QE in September just in time for the economic winds to reverse course.

Such thoughts were strongly reinforced in the Thursday press conference when we started with an Introductory Statement mentioning moderation.

Following several quarters of higher than expected growth, incoming information since our meeting in early March points towards some moderation, while remaining consistent with a solid and broad-based expansion of the euro area economy

At this point we merely have the ECB Governing Council covering itself either way as if they economy picks-up they will emphasis the latter bit and if it slows down they will tell us they warned about moderation. But then in his replies to questions President Draghi took things a step or two further.

 It’s quite clear that since our last meeting, broadly all countries experienced, to different extents of course, some moderation in growth or some loss of momentum. When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

As I pointed out on Friday if we translate from the language of central bankers the use of “significant sharp declines” is of importance as these days they consider it their job to stop that! If you had negative interest-rates and a balance sheet of over 4.5 trillion Euros it would give you food for thought. If we look at the next bit we can see that it did as it occupied so much time they did not discuss monetary policy at all.

 First of all, the interesting thing is that we didn’t discuss monetary policy per se. All Governing Council members reported on the situation of their own countries.

So they decided that as there is nothing they can do in the short-term and policy is already expansionary there was nothing to do. Also they were again caught on the hop.

And these declines were sharp and in some cases, the extent of these declines was unexpected.

Today’s monetary data

This will have attracted the attention of Mario Draghi and the Governing Council so let us start with the headline.

The annual growth rate of the broad monetary aggregate M3 decreased to 3.7% in March 2018,
from 4.2% in February.

Now let us compare it with the press conference Introductory Statement.

Turning to the monetary analysis, broad money (M3) continues to expand at a robust pace, with an annual growth rate of 4.2% in February 2018, slightly below the narrow range observed since mid-2015.

If we look through the rhetoric we see that it was already below the range that had led to the recent stronger economic growth. If we use the rule of thumb that broad money growth can be divided between economic growth and inflation we see that one of them will be squeezed. With the price of a barrel of Brent Crude Oil remaining around US $74 per barrel it seems that there will be upwards pressure on inflation from this source which may further squeeze output.

In terms of the immediate future then it is narrow money which gives us the best guide and it too was a disappointment.

The annual growth rate of the narrower aggregate M1, which includes currency in circulation and overnight deposits, decreased to 7.5% in March, from 8.4% in February.

This series peaked at just under 10% last autumn so we can see that from it we will be expecting something of a slow down over the next 6 months or so.

Is this the impact of QE?

The impact on March may well be the consequence of the reduction in monthly QE purchases from 60 billion Euros a month to 30 billion which began in January. The monthly numbers for M1 growth have gone 51 billion, 31 billion and now 20 billion so whilst it is not that simple as the numbers are erratic I think it added to an existing trend.

This leaves the ECB mulling the irony that it chose to do less as the economy weakened. Or that the expansion needs a continuous dose of the economic pick me up and cannot thrive otherwise.

What about credit?

When you consider that the taps are supposed to be fully open it was not that special.

The annual growth rate of total credit to euro area residents decreased to 2.9% in March 2018, compared
with 3.4% in the previous month.

Whilst it may not look like it from the number above but March was better than February if you look into the detail such as this one.

In particular, the annual growth rate of adjusted loans to households increased to 3.0% in March, from 2.9% in February, and the annual growth rate of adjusted loans to non-financial corporations increased to 3.3% in March, from 3.2% in February.

But such numbers are more of a lagging indicator than a leading one so we are left with a downbeat view.

Comment

In terms of first quarter data the score is 2-1. On the downside we have seen GDP ( Gross Domestic Product) growth in Belgium dip to 0.4% and more of a fall in France to 0.3%. On the other side Spain shrugged it off and grew by 0.7%. As even the German Bundesbank is expecting a slow down there it seems set to be a weaker quarter for Euro area growth and that will not have been helped by the weakness in the UK.

This means that two of the supports for the level of the Euro are weakening. The first is the fading and perhaps end of the Euroboom as the better economic growth data supported the currency. The second is a potential consequence which is the planned reduction in QE in September where eyes will soon turn to this bit from the ECB.

are intended to run until the end of September 2018, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.

Actually the inflation issue is also on the cards today after this from Italy.

In April 2018, according to preliminary estimates, the Italian consumer price index for the whole nation (NIC) increased by 0.1% on monthly basis and by 0.5% compared with April 2017.

So a long way from the just below 2% objective and Portugal at 0.3% was similar. Whilst I expect the new higher oil price to change things we could see a shake-up in the plans for QE in 2018. Whilst we know it is nor as simple as more QE or more negative interest-rates equals a weaker currency a shift like that seems likely to have an effect.

Meanwhile as ever life is complex as according to the oil trader @chigrl a higher oil price boosts the value of the Euro.

Thus the foreign currency reserve balances of these oil exporting countries, in a sense, is broadly reflected by the price of oil. ……However, data also shows that they invest part of their reserves in EUR, as they sell a large share of their production to the Eurozone.

Which leads to this.

Thus, when the price of oil falls, this means that a smaller portion of USD is transferred to EUR, thus contributing to a depreciation of the currency. Inversely, when the price of oil increases, a larger portion is transferred to EUR, contributing to the appreciation of the currency.

This gets exacerbated when some try to game this.

For this reason, many funds lock their positions in EUR/USD with those in crude oil.

 

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.

 

The Swiss mixture of negative interest-rates, currency intervention and equity investing

Today brings an opportunity to look at a consequence of several economic themes. The opening one is related to the way that in both economic and currency terms the Euro is something of a super massive black hole. This accompanies and has exacerbated issues caused by what was called the carry trade in the years that preceded the credit crunch. Back then borrowers both individual and corporate decided to take advantage of cheaper interest-rates abroad and in particular used the Swiss Franc and the Japanese Yen. This meant that both currencies soared and in the early days on here I christened them the currency twins for that reason. Both currencies were bounced around by this as at first as the trade was put on they were depressed but later as the credit crunch hit and nerves replaced greed both currencies soared. This showed how even national economies were to this extent the playthings of international currency flows and meant that Switzerland had elements of the Japanese experience.

Thus it should be no great surprise to see a country with elements of the Euro and the Yen experience finding itself in the cold icy world of negative interest-rates, From the Swiss National Bank earlier.

The Swiss National Bank (SNB) is maintaining its expansionary monetary policy, with the
aim of stabilising price developments and supporting economic activity. 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%.

This goes through to some extent on the nod these days but if we look at the economic situation we see something that is increasingly familiar.

In Switzerland, GDP grew in the fourth quarter at an annualised 2.4%. This growth was again primarily driven by manufacturing, but most other industries also made a positive contribution. In the wake of this development, capacity utilisation in the economy as a whole
improved further. The unemployment rate declined again slightly through to February. The SNB continues to expect GDP growth of around 2% for 2018 and a further gradual decrease in unemployment.

We set yet again that expansionary monetary policy coincides with economic expansion and there is a contradiction. We are told by the SNB that manufacturing is leading the charge whilst it also tells us that the Swiss Franc is at too high an exchange-rate.

The Swiss franc remains highly valued. The situation in the foreign exchange market is still fragile and monetary conditions may change rapidly. The negative interest rate and the SNB’s willingness to intervene in the foreign exchange market as necessary therefore remain essential. This keeps the attractiveness of Swiss franc investments low and eases pressure on the currency.

In other words perhaps the currency is not as big a deal for an area you might think would be price competitive and no doubt the situation below is a factor in this.

The international economic environment is currently favourable. In the fourth quarter of 2017,
the global economy continued to exhibit solid, broad-based growth. International trade
remained dynamic. Employment registered a further increase in the advanced economies,
which is also bolstering domestic demand.
The SNB expects global economic growth to remain above potential in the coming quarters.

So is the Swiss Franc too high as the SNB keeps telling us? If you think of foreign exchange markets as being “fragile” in one of the better periods for the world economy when can you ever leave the party?As you can see below the rhetoric is still the same.

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

The Swiss Franc

Actually the indices of the SNB also pose a question about its policy as it has various real exchange rate indices and they are between 104 and 110 now if we set 2000 as 100. This is different to the nominal measure which is at 153. So the situation is complex as the carry trade pushed it down and then sucked it back up. Of course the SNB would say its policies have helped ameliorate the situation.

Hedge Fund alert

The enthusiasm of the SNB for currency intervention especially in the period running up to the 20th of January 2015 has led to it becoming one of the world’s largest investors. This is because in an unusual situation – from the Uk’s perspective anyway – it has intervened to keep its currency down rather than up so it has bought foreign currencies. this meant that it needed some sort of investment strategy.

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.

As there were some 790 billion Swiss Francs of reserves as of the end of last year this is a big operation. With equity markets rising it has been profitable and of course over time so has the bond investing even allowing for recent tougher times. This has led to this.

Another important project was the renewal of the profit distribution agreement  between the Federal Department of Finance (FDF) and the SNB, which defines the amount of the annual profit distribution to the Confederation and
the cantons.

Yet as I pointed out on the 3rd of October last year there are also private shareholders.

Cantons own 45% of stock, cantonal banks 15% and private investors (individuals or institutions) the remaining 40%.

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.

The price is now as of the last trade 5640 Swiss Francs so the rumours continue. We get many stories about central banks being privately owned which are usually not true whereas here there is some truth  to it.

Comment

There is a lot to consider about the present Swiss situation where we again see negative interest-rates and a different type of balance sheet expansion combined with recorded economic growth that is solid. We also see some familiar risks.

Imbalances on the mortgage and real estate markets persist. While growth in mortgage lending remained relatively low in 2017, prices for single-family houses and owner-occupied apartments began to rise more rapidly again. Residential investment property prices also rose,
albeit at a somewhat slower pace. Owing to the strong growth in recent years, this segment in particular is subject to the risk of a price correction over the medium term.

Things take a further step forwards when we note their line of thinking.

The SNB will
continue to monitor developments on the mortgage and real estate markets closely, and will
regularly reassess the need for an adjustment of the countercyclical capital buffer.

It seems as though rather than stepping back they might intervene even more reminding me of the words of Joe Walsh.

I go to parties sometimes until 4
It’s hard to leave when you can’t find the door

Me on Core Finance TV

Euro area monetary policy heads for a new frontier

The issue of monetary policy in the Euro area is of significance on several levels. Obviously it affects the Euro area itself but also it affects many countries around it as in a nod to the sad departure of Stephen Hawking overnight it is time to sing along with Muse.

Into the supermassive
Supermassive black hole
Supermassive black hole
Supermassive black hole
Supermassive black hole

This has been demonstrated by the way that zero and then negative interest-rates ( a deposit rate of -0.4%) in the Euro has forced others in the locale to follow suit. It was and is a factor in the -0.5% of Sweden the -0.65% certificate of deposit rate in Denmark and the -0.75% of Switzerland amongst others. It is also a factor in the UK still remaining with a Bank Rate of 0.5% after so many years have passed and not following the more traditional route of aping the moves of the US Federal Reserve.

What next?

This is the question on many lips both inside for obvious reasons but also outside the Euro area for the reasons above. Why? Well the President of the European Central Bank Mario Draghi explained this earlier today in Frankfurt.

The economy has been growing consistently above current estimates of potential growth, by more than a percentage point last year. All euro area confidence indicators are close to their highest levels since the start of monetary union, even if the latest readings came in slightly below expectations.

This as I regularly point out means that monetary policy is facing a new frontier. This is because it is procyclical where it is expansionary in an existing expansion. Mario has in fact gone further than me in one area as in his view it is even more procyclical leading to output being more than 1% above potential. If that sounds a little mad I will return to it in a moment.  But another factor in this new frontier is the way that both negative interest-rates and QE have been deployed.

We’ll open up the doors and climb into the dawn
Confess your passion your secret fear
Prepare to meet the challenge of the new frontier ( Donald Fagen)

Potential Output?

Looking at what output has been allows us to figure it out.

Over the whole year 2017, GDP rose by 2.3% in the euro area ( Eurostat)

That would mean that potential output is only 1% per annum but I suspect Mario really means the 2.7% if you compare the last quarter of 2017 with a year before so 1.5%. That is rather downbeat which is very common amongst central bankers these days as for example Governor Carney and the Bank of England used different language “speed limit” for the UK but also came to 1.5%. Due to demographic pressures the Bank of Japan is even more downbeat for Nihon at 1%.

We will see how the media treat that as they make a big deal of the UK situation but let is move onto what causes them to think this? We come to something which is genuinely troubling.

Second, the degree of slack itself is uncertain. Even if slack is now receding, estimates of the size of the output gap have to be made with caution. Strong growth may be leading to higher potential output, as crisis-induced hysteresis may be reversed in conditions of stronger demand. And the effects of past structural reforms, especially in the labour market, may now be showing up in potential output.

As you can see the certainty of earlier has gone as this clearly points out they do not know. We are back to imposing theory on reality again and even worse a failed theory as later we get this.

Phillips curve decompositions find that past low inflation dragged down wage growth from its long-term average by around 0.2 percentage points each year between 2014 and 2017.

If we step back we see that according to the Phillips Curve wages should be soaring as we are above potential output whereas in fact they are doing this.

 The unexplained residuals in the model – which in the past were sizeable – are diminishing, suggesting the link between unemployment and wages should improve.

As in there is no link visible yet but if you inhale enough hopium it will be along at some point! Also I hope you enjoyed the reference to labour market reforms from Mario as we mull the contrast between that and his policy press conferences which every time without fail have a section calling for economic reform.

More! More! More!

It is somewhat awkward when you are telling people the economy is running hot and implying it is overheating if you also say it may be about to run faster.

Non-essential purchases – which make up around 50% of household spending in the euro area – tend to be postponed during recessions and then to catch up as the business cycle advances. Such purchases are currently only 2% above their pre-crisis level, compared with 9% for essential ones. This implies that discretionary household spending still has scope to support the expansion.

So it is below potential Mario? Also an area central bankers love to see boom also seems to be below potential.

Moreover, housing investment is still 17% below its pre-crisis level and is only now starting to pick up, which will likely add an extra impulse to the recovery dynamic.

What about inflation?

This if you look at a Phillips Curve world should be on the march in both senses as wages and prices should be heading upwards and yet.

Wage growth has been trending upwards for the euro area as a whole, rising by 0.5 percentage points from the trough in mid-2016.

Not much is it? As to be fair Mario points out.

But consistent with the weakening of the relationship between slack and inflation, the adjustment of wages during the recovery has so far been atypically slow.

The trouble is the analysis seems to be based on pure hopium.

That said, our analysis suggests that, as the cycle advances, the standard wage Phillips curve should hold better for the euro area on average. The unexplained residuals in the model – which in the past were sizeable – are diminishing, suggesting the link between unemployment and wages should improve.

So when you really want it to work ( in a crisis) it fails and in calmer times it does not seem to work either. But they will continue with it anyway like someone who s stuck in the mud.

Comment

Actually I think that Mario Draghi is more intelligent than this as we see several themes come together. Back in the dim and distant days when I began Notayesmanseconomics I offered the opinion that central bankers would dither when it became time to reverse course on their stimuli. This became a bigger factor as the stimuli grew. Now we see a central banker telling us.

But we still need to see further evidence that inflation dynamics are moving in the right direction. So monetary policy will remain patient, persistent and prudent.

This works nicely for Mario as the inflation forecasts remain below the 1.97% inflation target defined by a predecessor of his ( Monsieur JC Trichet).

The latest ECB projections foresee a pickup in headline inflation from an average rate of 1.4% this year to 1.7% in 2020.

Thus as he has hinted at in past speeches which more than a few seem to have forgotten Mario Draghi may depart as ECB President without ever raising interest-rates. In fact it seems to be his plan and it is something he will leave as a “present” for whoever follows him. Another form of stimulus may have slowed but is still around as well.

The cumulative redemptions under the asset purchase programme between March 2018 and February 2019 are expected to be around EUR 167 billion. And reinvestment amounts will remain sizeable thereafter.

So now we see that policy has been decided and a theory ( Phillips Curve ) has been chosen which is convenient. Mario may not believe it either but it suits his purpose as does claiming their has been labour market reform. This is the same way that we have switched from the economic growth of the “Whatever it takes” speech to inflation now both suggest the same policy which allows Mario to give himself a round of applause.

 Considering all of the monetary measures taken between mid-2014 and October 2017, the overall impact on euro area growth and inflation is estimated, in both cases, to be around 1.9 percentage points cumulatively for the period between 2016 and 2019.

So another masterly performance from Mario Draghi but it should not cover up the many risks from advancing onto a new frontier of procyclical monetary policy.