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?

 

 

Trouble is brewing at the ECB

Sometimes what are presented as events in the news cycle that are unrelated are in fact significant. So let me draw to your attention some tweets from Bloomberg yesterday evening.

BREAKING: Sabine Lautenschlaeger resigned from the ECB Executive Board more than 2 years before the official end of her term.

This is a significant event in several ways. Firstly why leave such a prestigious job? Also in the structure of the ECB an executive board member is more powerful than a central bank governor. This is because they vote at every policy meeting whereas central bank governors now rotate For example I quoted from a speech yesterday from the Governor of the Bank of France Francois Villeroy where he declared his views on the recent policy change at the ECB. But whilst he was present at the meeting he did not have a vote. One of the quirks of the 2019 calendar is that the President of the Bundesbank will not be voting at three meetings but the Governor of the Bank of Malta will vote at all but one.

If you think about it the power of the President of the ECB was raised by the rotation of voting rights of central bank Governors as he or as it will soon be she can choose when to bring a vote.

Moving back to Sabine Bloomberg carried on.

MORE: The shock move that comes amid the biggest dissent over monetary policy in Mario Draghi’s tenure. The German policymaker is stepping down on Oct. 31 and the ECB gave no reason for her decision.

Then they tried to put some more meat on that particular bone.

Latest: Sabine Lautenschlaeger’s surprise exit from the ECB follows a trend of early exits by German policy makers. Her move echos the frustrations of the savings-oriented nation with loose policies by the central bank.

Missing from that description is the fact that Sabine will be resigning just as Christine Lagarde starts. I do not know about you but that seems rather significant. Whilst it seems likely that Sabine has not agreed with some and maybe many of the policies of Mario Draghi it is noticeable that she is serving his full term and departing before the arrival of Lagarde. Something that those who have been accusing her of flouncing out of the ECB might do well to consider.

A German Issue

There is of course a long-running one which bond vigilantes on Twitter have highlighted this morning.

Headlines in Munich this morning: German savings banks (Sparkassen) are closing client accounts as they can’t afford to pay interest on them with negative @ecb  rates.

 

Money Supply

These numbers should be welcomed at the Frankfurt towers of the ECB but I suspect it may well follow the phrase used on BBC TV of “look away now”.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, increased to 8.4% in August from 7.8% in July.

So my signal for short-term monetary trends is looking stronger which continues the pattern we have seen this year so far. For newer readers narrow money changes tend to impact the economy some 3-6 months ahead. Putting it another way we have gone back to February 2018 as that is when annual growth was last at this level.

If we look back to the “Euro boom” we see that M1 growth peaked at 11.7% in July 2015 as the impacts of large-scale QE and negative interest-rates arrived and then faded away to single digits of 8% and 9%. So we are at the bottom of that range. This of course poses a real question for the change of ECB policy and makes me wonder again about the resignation above.

Broad Money

We saw a similar drumbeat from these numbers earlier.

Annual growth rate of broad monetary aggregate M3, increased to 5.7% in August 2019 from 5.1% in July (revised from 5.2%).

There is a similar pattern here of improving numbers in 2019 and we are quite some distance away from the recent low which was 3.5% in August 2018. But there is a further twist as we note that the number is now higher than at any phase in the “Euro boom” phase.

As to the detail it is M1 dominated as you might expect.

The annual growth rate of the broad monetary aggregate M3 increased to 5.7% in August 2019 from 5.1% in July, averaging 5.1% in the three months up to August. 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, increased to 8.4% in August from 7.8% in July. The annual growth rate of short-term deposits other than overnight deposits (M2-M1) increased to 1.0% in August from 0.1% in July. The annual growth rate of marketable instruments (M3-M2) was -2.9% in August, compared with -1.6% in July.

We have some growth as we move broader but not much and we see that the widest part fell. So there is a fly in the ointment but it is also true that there was a large wadge of ointment this month.

There is another way of looking at the numbers and let me first state that using such analysis in the UK went dreadfully wrong a couple of decades or so ago.

 the annual growth rate of M3 in August 2019 can be broken down as follows: credit to the private sector contributed 3.4 percentage points (up from 3.2 percentage points in July), net external assets contributed 3.0 percentage points (up from 2.9 percentage points), credit to general government contributed -0.2 percentage point (as in the previous month), longer-term financial liabilities contributed -1.0 percentage point (up from -1.1 percentage points), and the remaining counterparts of M3 contributed 0.5 percentage point (up from 0.3 percentage point).

The concern in this area is the contribution of money flows from abroad to the growth seen.

The Euro

This is drifting lower at the moment and is 1.093 versus the US Dollar as I type this. Much of this is a phase of “Holla Dolla(r)” because it has been rising generally but that suits the ECB, Putting it another way there has been very little movement this week versus the UK Pound as I set a benchmark at 1.131 before the Supreme Court decision in the UK as opposed to the 1.126 as I type this.

Comment

When I see the monetary numbers today and think of the recent move by the ECB I am reminded of this from Cypress Hill.

Insane in the membrane
Insane in the brain!
Insane in the membrane
Insane in the brain!

There is a perfectly valid question which goes as follows. Why with money supply growth like this do prospects look so weak? The first part of the answer is that narrow money looks around 6 months ahead and broad 18/24 months ahead so ot is yet to come. The next is that no measure tells us everything and good monetary prospects tell us about domestic inputs and impetus in the Euro area but very little about exports of cars to China for example.Then there is another catch. It is a choice how much notice you take of money supply data but to my mind a central bank must follow it and if it things it is misleading explain why it thinks so? Because we have just seen policies to improve money supply growth when in the case of broad money it is in fact stronger than in the “Euro boom”. The August numbers may be a one month fluke but the trend is not. But as we stand the polices just implemented are pretty much irrelevant for a trade war driven slow down signalled by this from Markit earlier this week.

Flash Eurozone Manufacturing PMI Output
Index(4) at 46.0 (47.9 in August). 81-month low.

So a manufacturer can maybe borrow a bit cheaper which is good in itself but if they still cannot export to China then it is of not much use.

Me on The Investing Channel

How has the Riksbank misjudged the economy of Sweden so badly?

Today is the day that central bankers gather for the annual symposium at Jackson Hole in Wyoming. This has produced quite a few changes in central banking policy in recent times such as the introduction of Forward Guidance for interest-rates. Of course that has been a complete failure as the hosting US Federal Reserve is now cutting interest-rates after “guiding” people towards rises.But the title of this year’s symposium does lead into my subject to today. So here is the Kansas City Fed.

Challenges for Monetary Policy

Actually somewhat typically they then lose the plot.

Different rates of recovery have led central banks to chart different courses for the normalization of monetary policy following a period in which most central banks used both conventional and unconventional monetary policy tools in response to the Great Recession. Whereas some central banks are approaching a neutral policy setting, others have yet to begin the process of removing policy accommodation.

Meanwhile back in the real world the one central bank (itself) which had tried to engage neutral has in fact engaged reverse. I suppose they get to some by the central banks which follow the Fed. But rather than thinking about “removing policy accommodation” other central banks such as the ECB are now looking for a gear box with more reverse gears.

Let me now move to a specific example which in a way is symbolised by a symposium starting later for which we do not have a schedule yet! The only thing we do know is that Fed Chair Jerome Powell speaks tomorrow afternoon.

Riksbank

This whole procedure reminds me of the Riksbank which decided it would be amongst the shock troops of the monetary accommodation era. It cut interest-rates into negative territory ( -0.5%) and engaged in some QE bond buying. Then after years of promising a change it did this last December.

The Executive Board has therefore decided to raise the repo rate from −0.50 per cent to −0.25 per cent. The forecast for the repo rate indicates that the next rate rise will probably occur during the second half of 2019. With a repo rate of −0.25 per cent, monetary policy is still expansionary and will thereby continue to support economic activity.

This was one of the challenges for monetary policy or today;s theme as I pointed out at the time. From the 20th of December.

Actually there is quite a bit that is odd about this as indeed there has been, in my opinion, about the monetary policy of the world’s oldest central bank for some time. Let me give you two clear reasons to be doubtful. Firstly GDP growth plummeted from the 1% of the second quarter of this year to -0.2% in the third…….Moving onto inflation the outlook has also changed as we have moved towards the end of 2018.

Actually there was another problem as how did this work out for the Riksbank?

this can partly be explained by temporarily weak car sales.

So as you can see I was pointing out at the time that this was odd as the Riksbank had ignored the good times for the Swedish economy and then as I put it panicked fearing it would approach the next slow down with interest-rates already negative.

Ch-ch-changes

If we move forwards to the July policy meeting the minutes tell us this.

Similarly for Sweden, expectations of further monetary policy stimulation have increased. Pricing on the
financial markets now indicates a higher probability of a rate cut than of a rate rise while bank economists in general expect a postponement of the repo rate increases.

As you can see they were facing up to a situation where even they must have realised they had lost credibility on the subject of interest-rate rises. If we now move forwards to the end of July Sweden Statistics produced more bad news.

Sweden’s GDP decreased 0,1 percent in the second quarter of 2019, seasonally adjusted and compared to the first quarter of 2019. GDP increased by 1,4 percent, working-day adjusted and compared to the second quarter of 2018.

I am less concerned by the contraction than the annual rate. There had been a good first quarter so the best perspective was shown by an annual rate of 1.4%. You see in recent years Sweden has seen annual economic growth peak at 4.5% and at the opening of 2018 it was 3.6%. So it is quite clear that the timing of the interest-rate rise was something of a shocker or in football parlance an own goal.

Today

Sweden Statistics has produced some concerning news.

In July 2019 there were 5 239 000 employed persons. The unemployment rate was 6.9 percent, a decrease of 0.9 percentage points compared with July 2018.

What’s concerning about that? Well they have confused the concepts of up and down as the rate increased rather than decreased.

In July 2019, there were 390 000 unemployed persons aged 15─74, not seasonally adjusted, an increase of 50 000 compared with July 2018. The number of unemployed men increased by 29 000 to 202 000. There were 188 000 unemployed women. The unemployment rate was 6.9 percent, an increase of 0.9 percentage points compared with July 2018.

This poses a real problem for the Riksbank because if we look at the accompanying chart they have raised interest-rates into a downwards turn in the unemployment situation. We know that employment can be a leading indicator so let us look at that.

In July 2019, there were 5 239 000 employed persons aged 15─74, not seasonally adjusted. The number of employed men was 2 739 000, a decrease of 39 000 compared with July 2018. The number of employed women was 2 500 000. This was the third consecutive month in which the employment rate did not increase compared with the same month a year earlier. Prior to that, the number of employed persons had increased every month since September 2016. The employment rate was 69.8 percent, a decrease of 1.0 percentage point compared with the same month a year earlier.

As you can see the picture is not pretty there either. As an aside the labour market switch is sexist as it is mostly men, I guess it must be traditional male jobs being affected.

But the picture here is not only troubling for the Riksbank as we see another statistics agency with troubles.

Last time my model said recession, as it also does now, was ahead of 2012. But the statistics agency all through 2012 posted GDP at +1.5-2% y/y – happy times! Now when all revisions are done GDP was actually below 0% y/y most of 2012. ( Mikael Sarwe of Nordea )

There is more here from Michael Grahn of Danske Bank

Adding July LFS data to our GDP tracker model a very preliminary take on Q3 GDP say growth slowed to 0.9 % yoy.

Comment

The Governor of the Riksbank will have been a relieved man as he boarded his flight from Sweden to the Mid-West. He will escape the economic bad news by being elsewhere and may even find some suggestions from his central banking colleagues about what to do. But the reality is a cruel one in that he and his colleagues are in a pickle of their own making as their timing was so bad they have endulged in some pro-cyclical monetary policy in a downturn. Even worse their previous dithering means they start it with negative interest-rates (-0.25%).

Perhaps that is something they could discuss at Jackson Hole. How the Riksbank got things so wrong?

Let me open the discussion with a talking point.

The annual growth rate of the narrow monetary aggregate, M1, amounted to 6.8 percent in June, a decrease of 0.5 percentage point compared with May. M1 amounted to SEK 3 053 billion in June.

Me on The Investing Channel

 

 

 

Inside the world of negative interest-rates

A feature of modern economic life is that interest-rates were first cut as close to zero as central banks thought they could and then in more than few cases they went below zero giving us the acronym NIRP for Negative Interest-Rate Policy. There was the implication that such a state of affairs would be temporary in that the medicine would work and that interest-rates would then be raised. For example I have put on here before the charts that show that the Riksbank of Sweden has been forecasting interest-rate increases for years whereas the reality was that it either cut or did nothing. Ironically it changed tack a little last December just in time for the world economy to turn down!

As to all this being temporary let me hand you over to ECB President Mario Draghi on the day he cut the Deposit Rate to -0.1% back in June 2014.

Draghi: On the first question, I would say that for all the practical purposes, we have reached the lower bound. However, this doesn’t exclude some little technical adjustments and which could lead to some lower interest rates in one or the other or both parts of the corridor. But from all practical purposes, I would consider having reached the lower bound today.

This has been a feature of central banker speak where they discuss a “lower bound” as if this type of economics is a science. The reality is that the nearest the “lower bound” has got to being a status quo has been this.

Get down
Get down deeper and down
Down down deeper and down
Down down deeper and down

If we let him have the move to -0.2% as a technical adjustment we have to face up to the fact that it is now -0.4% and about to go to -0.5/6%. This has consequences as for example over the past month or so the amount deposited at the ECB at such a rate is 1.86 trillion Euros. So this is a drain on the banking system and therefore wider economic life as well as being a nice little earner for the ECB.

The “lower bound” theme has been the same in the UK as Bank of England Governor Carney asserted it was 0.5% but later decided it was 0.1%. Or you could look at the US Federal Reserve defined “normal” interest-rates as being somewhere above 3% then changed its mind and started cutting them. The truth is that the new normal is that when a central bank raises interest-rates it soon turns tail and starts cutting them.

Switzerland

The Swiss are at the cutting edge of negative interest-rates and it was ECB policy which was the supermassive black hole that sucked them into it. In terms of timing the June 2014 move by the ECB was followed by this in January 2015.

The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%.

For those who have not followed this saga there was an enormous amount of borrowing in Swiss Francs pre credit crunch because interest-rates were there. When the credit crunch hit institutional investors raced to reverse such positions which made the Swiss Franc soar which had the side-effect of crippling those who in eastern Europe who had taken out such mortgages. The SNB found itself like General Custer at Little Big Horn as the ECB version of Indians arrived and gave events another push.

Again there was an implication that this would be temporary until matters calmed down but the reality has been very different. Or to put it another way in central banker speak the word temporary now means permanent.

The signal we now have has been provided by two developments this morning. Let me start with the Swiss one.

Domestic sight deposits CHF 475.3 bn vs CHF 469.0 bn prior…………. Once again, a notable rise in the sight deposits data and that continues to suggest that the SNB is stepping in to smooth the appreciation in the franc over the past few weeks.

In case you are wondering why those numbers are looked at the SNB only occassionally declares it has intervened in foreign exchange markets and does so via other central banks and the BIS. So to find out we have to look at other numbers and thank you to Bank Pictet for this estimate.

In total, sight deposits have increased by CHF 9.8bn in the last 4 weeks, and CHF 10.3bn in the last 5 weeks.

So like The Terminator the SNB is back. Why? The Swiss Franc has been strengthening again and went through 1.09 versus the Euro. Whereas on the 23rd of April last year I noted that Reuters were reporting this.

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.

There were still problems though as I pointed out to a background elsewhere of something of a chorus saying the SNB had triumphed..

Any economic slow down would start currently with interest-rates at -0.75% posing the question of what would happen next?

Well we have an economic slow down and we expect the ECB to cut again which according to Bank Pictet will have this consequence.

SNB officials have emphasized the importance of the interest rate differential (mainly versus the euro area) for the exchange rate and thus the policy outlook. The SNB’s policy rate differential with the ECB’s deposit facility rate now stands at 35bp, below the 50bp in 2015 when the SNB lowered its interest rates to -0.75%.

To be fair to Bank Pictet that was from the end of July and so could not factor in the statements from Bank of Finland Governor Ollie Rehn on Friday about “overshooting” market expectations about the ECB move. So the statement below has got more likely.

In that event, should the CHF come under
excessive upward pressure, our best guess is that the SNB would cut the interest rate on sight deposits by 25 bps, bringing it down to -1.0%.

Comment

Thus we are facing a new frontier should the Swiss find they have to cut to -1% interest-rates or as the SNB might put it.

Yes we’re gonna have a wingding
A summer smoker underground
It’s just a dugout that my dad built
In case the reds decide to push the button down
We’ve got provisions and lots of beer
The key word is survival on the new frontier. ( Donald Fagen )

This will mean that the pressure for more of this will build.

UBS, the world’s largest wealth manager, told its ultra-wealthy clients on Tuesday that it would introduce an annual 0.6% charge on cash savings of more than €500,000 (£461,000). The fee, to be introduced in November, rises to 0.75% on savings of more than 2m Swiss francs (£1.7m). ( The Guardian ).

In some ways the economic situation has already adjusted to this as the Swiss ten-year bond yield is -1.1% and the thirty-year is -0.6%. Imagine the impact of this on long-term contracts such as pensions. Give me 100.000 Swiss Francs and I will give you 84,000 back in thirty-years, who would do that?

Meanwhile here is something to make UK readers very nervous.

BoE Gov Carney: At This Stage We Do Not See Negative Rates As An Option In The UK ( @LiveSquawk )

Podcast

Where next for the Euro, the ECB and the Euro area economy?

In our new financial world where pretty much everything depends on the whims and moods of central bankers one of the main leaders is the ECB or European Central Bank. Yesterday we got one version of its future from the Governor of the Bank of Finland Ollie Rehn. So let me hand you over to his interview with the Wall Street Journal.

“It’s important that we come up with a significant and impactful policy package in September,” said Mr. Rehn, who sits on the ECB’s rate-setting committee as governor of Finland’s central bank.

“When you’re working with financial markets, it’s often better to overshoot than undershoot, and better to have a very strong package of policy measures than to tinker,” Mr. Rehn said.

That is pretty cleat although there is are two self-fulfilling problems in trying to overshoot financial markets. The first is that you are devolving monetary policy to financial markets. The second is that markets will now adjust ( they did so yesterday as I will discuss later) so do you overshoot that as well?

According to the WSJ these are the expectations Ollie was trying to overshoot.

Analysts expect the ECB will announce next month a 0.1 percentage-point cut to its key interest rate, currently set at minus 0.4%, as well as around €50 billion ($56 billion) a month of fresh bond purchases under its quantitative easing program. The program had previously been phased out at the end of last year.

There is already an example of the “slip-sliding away” as Paul Simon would put it that I mentioned earlier as the monthly bond purchases were expected to be 30 billion Euros a month. So which one would Ollie be overshooting?

Even worse for hapless Ollie others seem to have a different set of expectations.

Investors currently expect the ECB to cut its key interest rate to minus 0.7% and to hold rates below their current level through 2024, according to futures markets. Mr. Rehn said those market expectations showed that investors had understood the ECB’s guidance.

So will he now be overshooting -0.5% or -0.7%? Actually it gets better as -0.6% is in there now as well.

The comments suggest the ECB might cut interest rates by more than expected in September, perhaps by 0.2 percentage points, and could start to purchase new types of assets, Mr. Ducrozet said.

So roll up! Roll up! Place your bets on what Ollie will be trying to overshoot. Also as no doubt you have spotted whilst he may be in Finland he wants to start turning Japanese.

Mr. Rehn said he didn’t rule out a move to purchase equities under the QE program, but that would depend on the assessment of ECB staff.

That is a pretty shocking as the ECB staff assessment will be exactly what the Governing Council wants in the manner explained by The Jam.

You want more money – of course, I don’t mind
To buy nuclear textbooks for atomic crimes
And the public gets what the public wants

As I have acquired quite a few extra followers in the last week or two let me explain the Japan reference which is that the Bank of Japan has for a while now been purchasing Japanese equities. According to its latest accounts it now holds 26.6 trillion Yen of them.

The Problem

It is highlighted by this.

To provide space for fresh bond purchases, the ECB could adjust the rules of its bond-buying program, which currently prohibit the bank from buying more than 33% of the debt of any individual eurozone government, he added.

This is an example of what ECB President Mario Draghi calls it being a “rules-based organisation”. It is until they are inconvenient and then it changes them! One of the ways it got support for the previous QE programme was the limit above bit now it will be redacted from history. How high can it go? Well one example is from my own country the UK where the Bank of England does not have country limits ( for obvious reasons) but it does have a limit of 70% for each individual Gilt-Edged bond.

The Euro

Part of the plan behind Ollie’s interview was to talk down the Euro. After all the new “currency war” style consensus is to try a grab a comparative advantage in a zero-sum game. In a small way he succeeded as the Euro fell against most currencies. But there is a catch as highlighted by this release from Eurostat today.

As a result, the euro area recorded a €20.6 bn surplus in trade in goods with the rest of the world in June 2019…….In January to June 2019, euro area exports of goods to the rest of the world rose to €1 163.3 bn (an increase of
3.2% compared with January-June 2018), and imports rose to €1 061.2 bn (an increase of 3.7% compared with
January-June 2018). As a result the euro area recorded a surplus of €102.2 bn, compared with +€103.6 bn in
January-June 2018.

As you can see in the first half of the year trade created a demand for the Euro of around 102 billion Euros which is a barrier against any sustained fall. Actually this is a German thing because if you look at the national breakdown it accounts for 112 billion of this. Other nations such as the Netherlands run large surpluses assuming we look away from the “Rotterdam Effect” but as a collective in a broad sweep they contribute very little. So we get something very awkward which is that the main exchange rate fall came when Germany switched the Dm to the Euro. Since then there has been a lot of hot air on the subject but in terms of the effective exchange rate the Euro is at 98.3 or a mere 1.7% from where it started.

In a purist form I should look at the full current account but hopefully you have the idea from the trade figures. Partly I am doing that because I have very little faith in the other numbers.

Even more awkward for the ECB would be a situation where President Trump actually goes forward with his plan to buy Greenland. He would pay Denmark in its Kroner but as it is pegged to the Euro this would raise the Euro versus the US Dollar which is presumably part of the plan.

Comment

There is a lot to consider here but let me open with looking at the real economy. It is struggling with some but not much growth. So far in 2019 economic growth has gone 0.4% and then 0.2% on a quarterly basis. The fear is that it will slow further based on what was a strength above ( Germany’s trade surplus) which right now looks a weakness or as Frances Coppola out it.

Thread. Germany has been importing demand from China for a long time.

I am not saying it is the only perspective but it is one. On this road we have found little economic growth because even if we take the view of Mario Draghi this created a mere 1.5% of extra GDP growth. On the other side of the ledger is the destruction wreaked on all long-term contracts such as pensions and bond markets by the world of negative interest-rates. Oh and the fact if it had worked we would not be here.

As to the real economy well if we return to Ollie we see that in fact his main concern is “The Precious! The Precious!”

To offset the impact on eurozone banks of a longer period of negative interest rates, the ECB could introduce a tiered-deposit system, under which only a portion of bank deposits might be subject to negative rates, Mr. Rehn said.

The ECB could also alleviate the stress on banks by sweetening the terms of new long-term loans, known as targeted longer-term refinancing operations, he said.

If the real economy merits a mention I will let you know….

As a final point this version of economic management combining “open mouth operations” with reading a Bloomberg or Reuters screen to see where markets are often involves what have become called “sauces” saying something different, so be on your guard.

Meanwhile liuk on twitter has a suggestion which we can file under QE for millennials.

#ECB STAFF WILL INCLUDE AVOCADO FOR NEW ASSET BUYING PROGRAM

It would be a bit dangerous putting them in the Helicopter Money drop though…..

 

Problems are mounting again for the Riksbank of Sweden

Today is one which will concentrate the minds of the Riksbank of Sweden. One way or another they will find themselves affected by what action the European Central Bank takes. Conceptually this is really rather awkward for them as they took this action just before Christmas.

The Executive Board has therefore decided to raise the repo rate from −0.50 per cent to −0.25 per cent.

Even worse they gave Forward Guidance like this.

The forecast for the repo rate indicates that the next rate rise will probably occur during the second half of 2019.

Many central banks have a poor record with their Forward Guidance but the Riksbank competes with the Bank of England for the worst effort. Of course they could decide to support the Krona by raising interest-rates as the ECB eases but that would be a road to Damascus style change. But that does give us the opening influence on their policy which is the large influence of the Euro/Krona exchange rate on Swedish economic policy.

As to the Krona the Riksbank has produced a report suggesting this.

The overall conclusion is that the krona is unexpectedly weak and that a certain appreciation is to be
expected, but that there is considerable uncertainty as to both when and by how much the krona
will strengthen.

Perhaps the appreciation will be due to a new hard Krona policy or perhaps I am jesting. But how can they say their currency is “unexpectedly weak” after applying negative interest-rates and QE bond buying? Of course they do expect people to believe the new version of Forward Guidance.

More precisely, the rate path means that an initial rate rise may occur in October, December or February. After that, the repo rate will be raised by just under 0.5 percentage points a year.

So we can note that the Riksbank is playing the same old song ignoring the fact that over the past 5/6 years it has been full of bum notes. Also as I regularly point out timing is nearly as important as what you do or as Bananarama put it.

It ain’t what you do it’s the way that you do it
It ain’t what you do it’s the way that you do it
It ain’t what you do it’s the way that you do it
And that’s what gets results

On that score the Riksbank took so long to try to get interest-rates out of negative territory that it has done so into a world downturn.

Labour Market

Riksbank policymakers will have been spluttering into their morning espresso as they read this earlier.

In June 2019, there were 427 000 unemployed persons aged 15–74, not seasonally adjusted. This corresponds to an unemployment rate of 7.6 percent. ( Sweden Statistics )

This caught expectations of 6.5% out and yes I did type that correctly. Firstly we should be clear that the monthly unadjusted number is an erratic series But last October and November it was 5.5% and ( with fluctuations) has been rising since. Or if we look at the latest 3 readings we see 6.2%,6.8% and now 7.6%.

If we move to the adjusted series we see this.

Smoothed and seasonally adjusted data indicates a decrease in the employment rate and an increase of the unemployment rate. The unemployment rate was 6.3 percent.

The problem here is use of the word “Smoothed” or if you prefer averaging because it reduces the use of the number as an economic indicator as you will only learn of changes after a delay. The more the numbers are smoothed the more the delay. Danske Bank calculate their own seasonally adjusted series and put the number at 6.6% compared to a couple of occasions where it has dipped below 6%.

If we switch to employment which has worked as a leading indicator at times in the credit crunch era we see another hint of trouble.

 It was the second month in a row that employment did not increase, compared with the same month previous year. Before that, the number of employed persons has increased every month since September 2016……..Smoothed and seasonally adjusted data indicates a minor change in the number of employed persons and a decrease in the employment rate compared with recent months.

Money Supply

We have learnt over the past year or two that narrow measures of the money supply are the best economic leading indicator we have and here is this morning’s release.

The annual growth rate of the narrow monetary aggregate, M1, amounted to 6.8 percent in June, a decrease of 0.5 percentage point compared with May. M1 amounted to SEK 3 053 billion in June.

If we look back we see that the number has been falling since 13.8% was recorded in 2015. That followed the introduction of a negative official interest-rate ( repo rate) and the commencement of QE bond buying. Last year the growth rate had fallen to 7.3% and the latest data raises concerns about further falls as 2019 develops.

Another interesting development is that the stock of note and coins in Sweden rose last year. I note this because Sweden is famous for switching towards electronic forms of payment and cash and has previously seen some ten years of falls in the amount of physical cash. But whilst last year’s rise was small at 1.9% there was one.

Another possible guide is that credit to business seems to be slowing.

In June, the annual growth rate on loans to non-financial corporations was 5.2 percent, which is a decrease of 0.9 percentage points compared with May.

Household credit

This can be viewed through two windows of the Riksbank. A bit like in the BBC childrens TV series Blue Peter. Through the round window the number below is good because Sweden’s households are over indebted. Through the square window it is bad because they may consequently consume less and weaken GDP growth.

In June 2019, the annual growth rate of households’ loans from monetary financial institutions (MFIs) was 4.9 percent, which means that the growth rate decreased by 0.1 percentage point compared with May.

As to interest-rates you may be wondering what a mortgage typically costs in Sweden.

Households’ average housing loan rate for new agreements was 1.52 percent in June, unchanged compared with May. The floating housing loan rate amounted to 1.54 percent in June, which is unchanged compared with May.

That is a bit over a half a percent lower than the UK so the delta from reducing interest-rates seems to be around 0.5 at these levels or mortgage rates fall by around half off the official rate change.

Comment

We have looked at the domestic situation in Sweden and now let us widen our scope. We started the week by looking at signs of economic weakness in the Pacific and that has continued this morning with the news that Nissan is looking to shed around 9% of its workforce. These days Nissan also has strong links to Europe and the mood here will not be helped by this.

German business morale plunged in July to its lowest level in more than six years, a survey showed on Thursday, in a further sign that a manufacturing crisis is pulling Europe’s largest economy toward recession……..The Ifo institute said its business climate index fell to 95.7 from an upwardly revised 97.5 in June. The July reading undershot a consensus forecast for 97.1. It was the fourth monthly decline in a row and the lowest level since April 2013. ( Reuters)

For Sweden this means that the outlook for its major trading partner is poor. Thus the reality is that the Riksbank looks more likely to cut interest-rates again than raise them.

Meanwhile we get yet more evidence that banks take the “Be afraid, Be very afraid” strap line from the film The Fly about inflicting negative interest-rates on the ordinary depositor.

The average interest rate for new deposits by households in bank accounts was 0.07 percent in June, a decrease of 0.01 percentage points compared with May. The interest rate on accounts with fixed periods or a limited number of free withdrawals amounted to 0.17 percent in June, an increase of 0.01 percentage point compared with May.

The Investing Channel

 

How negative can interest-rates go?

A consequence of the credit crunch era that has continued to flow is the trend towards negative interest-rates and yields. For example it was only the week before last I was looking at a speech from Bank of England Governor Carney that referred to there being some US $13 Trillion of negative yielding bonds. Then last week I noticed that some developments are somewhat mindboggling. From The International Financing Review.

The distortion of the credit markets by central banks has produced the ultimate oxymoron: negatively yielding high-yield bonds.

About 2% of the euro high-yield universe is now negative yielding, according to Bank of America Merrill Lynch.

That percentage would rise to 10% if average yields fall by a further 35bp, said Barnaby Martin, European credit strategist at the bank.

So we now need a new name for what we used to call high-yield bonds. I guess junk bonds still cuts it although even it feels a bit awkward. We even got some examples.

Irish paper packaging company Smurfit Kappa (BB+/BB+), for example, has a €500m 3.25% June 2021 bid at -0.012%, according to Tradeweb data.

 

American metal packaging Ball Corporation (BB+ from S&P) also has bullet bonds in negative territory. Its €400m 3.5% December 2020s are quoted at -0.003%.

As you can see the negative yields are marginal but we have learnt that these things have developed a habit of starting and then spreading. Especially as we note what is driving it.

He said the first signs of negative yielding high-yield bonds emerged about two weeks ago in the wake of Mario Draghi’s speech in Sintra where the ECB president hinted at a further dose of bond buying via the central bank’s corporate sector purchase programme. There are now more than 10 high-yield bonds in negative territory.

Personal Injury Claims

This morning my own country the UK has shown how negativity if I may put it like that is spreading into other areas. From Reuters.

Britain’s Ministry of Justice said it plans to change the discount rate applied to personal injury lump sum compensation payments to minus 0.25% from minus 0.75%, it said on Monday.

The decision follows a review started by the Lord Chancellor earlier this year and follows lobbying from auto insurers, whose profits were hit by the decision to cut the so-called ‘Ogden Rate’ from 2.5% in 2017.

As you can see the Lord Chancellor was apparently having the mental equivalent of a nap in the period from 2009 to 2017 as interest-rates and yields plunged. So the legal profession I suppose lives up to its reputation for being out of touch. But the serious point is one we have looked at regularly which is how do you make provision for the future when you are facing negative returns which are increasingly permanent. I doubt their Lordships look at it like this but this is another consequence of the UK Index-Linked bond or Gilt market being eye-wateringly expensive. Why? Well in an era where conventional bonds are so expensive investors drove the price of linkers up as well because otherwise they offered more yield.

So the natural place to invest much of a compensation payment is seeing its own outburst of negativity as real yields have been negative for a while. The issue is complex as Stewarts Law who were one of the few to think this rate would stay negative seem to have a rose-tinted view on wage growth.

This makes it impossible to ignore the long-standing economic phenomenon of earnings-related inflation rising faster than prices inflation.

 

How low can things go?

I am reminded of a research paper by the Bank of Japan which I looked at on the 24th of last month. Let us look at it from a different perspective.

In the second economy, the marginal shock occurs on top of an innovation to the Taylor rule that, on its own, would depress the policy rate to about -1% on impact. The
reversal in loan rates has been crossed at this stage.

The refer to an interest-rate of -1% more than a few time suggesting they think that it is as low as you can realistically go. This is as ever not about you and I but about fears for what more negative interest-rates would do to the banks.

with the evidence documented in Ampudia and Heuvel (2018), who document that the response of banks’ stock valuations to monetary policy shocks changes sign as the
level of interest rates decreases.

Also and this gets increasingly relevant as the credit crunch drags on things get worse as time passes.

However, these assets mature, making net worth
more sensitive in subsequent periods. Second, the impaired deposit rate pass-through as policy rates decrease substantially lowers bank profitability, especially as rates enter negative territory.

This leads them to this.

We have shown the conditions for the existence of a reversal interest rate, the rate at which monetary policy stimulus reverses its intended effect and becomes contractionary.

This should not be a complete surprise as the Bank of Japan has never really been much of a fan of negative interest-rates. It cut to what we would call ZIRP territory (0.5%) in late 1995 and did not go negative until January 2016. Even that was to a mere -0.1% as the bank’s natural caution collided with the zeal of the political appointee Governor Kuroda. Indeed it has stuck to the -0.1% level for what it calls “yield-curve control” which means that in the recent plunge in bond yields it has been holding Japanese ones up rather than down. This means that if we do end up living the lyrics of the Vapors. life may not be what many assume.

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

Comment

This brings us back to the issue of the long-term and the future. That is really rather different in a world of persistent negative interest-rates and yields. Think of a pension which is by definition a form of saving for the long-term. How does that work if you receive an illustration telling you that if you put £1 in you will get £0.9 back? Losses were always possible especially in real or inflation adjusted terms but the concept of expecting to lose is very different. On this road to nowhere fewer people will bother to save for the future? I recall in the early part of this century pension illustrations which suggested 5%,7% and 9% so let me throw this out there what do readers think they should say now?

We know the trend and yet the sporting world reminded only yesterday that life is complex and far from simple. New Zealand were the better cricket team but fate conspired against them as an overthrow went for six, Bottas found that a safety car turned up just in time for  Lewis Hamilton and Federer somehow lost in spite of playing so well. As an England cricket fan I was delighted with the result but could not help wondering if the Black Caps had run over a black cat on the way to Lords.

Still at least we can rely on the banking sector.

A Dutch social housing co-operative a decade ago bought €3bn derivatives from Deutsche Bank & went almost bust when they turned toxic. It later emerged that co-operative’s treasurer was systematically bribed. Deutsche now settled lawsuit for €175m ( @OlafStorbeck ).

As the the reversionary interest-rate I think we went into it as the credit crunch began and have never come out. That is why to coin a phrase it goes on and on and on.

Podcast