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?

 

 

Where will Christine Lagarde lead the ECB?

We find ourselves in a new era for monetary policy in the Euro area and it comes in two forms. The first is the way that the pause in adding to expansionary monetary policy which lasted for all of ten months is now over. It has been replaced by an extra 20 billion Euros a month of QE bond purchases and tiering of interest-rates for the banking sector. The next is the way that technocrats have been replaced by politicians as we note that not only is the President Christine Lagarde the former Finance Minister of France the Vice-President Luis de Guindos is the former Economy Minister of Spain. So much for the much vaunted independence!

Monetary Policy

In addition to the new deposit rate of -0.5% Mario Draghi’s last policy move was this.

The Governing Council decided to restart net purchases under each constituent programme of the asset purchase programme (APP), i.e. the public sector purchase programme (PSPP), the asset-backed securities purchase programme (ABSPP), the third covered bond purchase programme (CBPP3) and the corporate sector purchase programme (CSPP), at a monthly pace of €20 billion as from 1 November 2019.

It is the online equivalent of a bit of a mouthful and has had a by now familiar effect in financial markets. Regular readers will recall mt pointing out that the main impact comes before it happens and we have seen that again. If we use the German ten-year yield as our measure we saw it fall below -0.7% in August and September as hopes/expectations of QE rose but the reality of it now sees the yield at -0.3%. So bond markets have retreated after the pre-announcement hype.

As to reducing the deposit rate from -0.4% to -0.5% was hardly going to have much impact so let us move into the tiering which is a way of helping the banks as described by @fwred of Bank Pictet.

reduces the cost of negative rates from €8.7bn to €5.0bn (though it will increase in 2020) – creates €35bn in arbitrage opportunities for Italian banks – no signs of major disruption in repo, so far.

Oh and there will be another liquidity effort or TLTRO-III but that will be in December.

There is of course ebb and flow in financial markets but as we stand things have gone backwards except for the banks.

The Euro

If we switch to that we need to note first that the economics 101 theory that QE leads to currency depreciation has had at best a patchy credit crunch era. But over this phase we see that the Euro has weakened as its trade weighted index was 98.7 in mid-August compared to the 96.9 of yesterday. As ever the issue is complex because for example my home country the UK has seen a better phase for the UK Pound £ moving from 0.93 in early August to 0.86 now if we quote it the financial market way.

The Economy

The economic growth situation has been this.

Seasonally adjusted GDP rose by 0.2% in the euro area (EA19…….Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 1.1% in the euro area in the third quarter of 2019 ( Eurostat)

As you can see annual economic growth has weakened and if we update to this morning we were told this by the Markit PMI business survey.

The IHS Markit Eurozone PMI® Composite
Output Index improved during October, but
remained close to the crucial 50.0 no-change mark.
The index recorded 50.6, up from 50.1 in
September and slightly better than the earlier flash
reading of 50.2, but still signalling a rate of growth
that was amongst the weakest seen in the past six and-a-half years.

As you can see there was a small improvement but that relies on you believing that the measure is accurate to 0.5 in reality. The Markit conclusion was this.

The euro area remained close to stagnation in
October, with falling order books suggesting that
risks are currently tilted towards contraction in the
fourth quarter. While the October PMI is consistent
with quarterly GDP rising by 0.1%, the forward looking data points to a possible decline in economic output in the fourth quarter.

As you can see this is not entirely hopeful because the possible 0.1% GDP growth looks set to disappear raising the risk of a contraction.

I doubt anyone will be surprised to see the sectoral breakdown.

There remained a divergence between the
manufacturing and service sectors during October.
Whereas manufacturing firms recorded a ninth
successive month of declining production, service
sector companies indicated further growth, albeit at
the second-weakest rate since January.

Retail Sales

According to Eurostat there was some good news here.

In September 2019 compared with August 2019, the seasonally adjusted volume of retail trade increased by 0.1% in the euro area (EA19). In September 2019 compared with September 2018, the calendar adjusted retail sales index increased by 3.1% in the euro area .

The geographical position is rather widespread from the 5.2% annual growth of Ireland to the -2.7% of Slovakia. This is an area which has been influenced by the better money supply growth figures of 2019. This has been an awkward area as they have often been a really good indicator but have been swamped this year by the trade and motor industry problems which are outside their orbit. Also the better picture may now be fading.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, decreased to 7.9% in September from 8.5% in August.

In theory it should rally due to the monthly QE but in reality it is far from that simple as M1 growth picked up after the last phase of QE stopped.

Comment

As you can see there are a lot of challenges on the horizon for the ECB just at the time its leadership is most ill-equipped to deal with them. A sign of that was this from President Lagarde back in September.

“The ECB is supporting the development of such a taxonomy,” Lagarde said. “Once it is agreed, in my view it will facilitate the incorporation of environmental considerations in central bank portfolios.” ( Politico EU)

Fans of climate change policies should be upset if they look at the success record of central banks and indeed Madame Lagarde. More prosaically the ECB would be like a bull in a China shop assuming it can define them in the first place.

More recently President Lagarde made what even for her was an extraordinary speech.

There are few who have done so much for Europe, over so long a period, as you, Wolfgang.

This was for the former German Finance Minister Wolfgang Schauble. Was it the ongoing German current account surplus she was cheering or the heading towards a fiscal one as well? Perhaps the punishment regime for Greece?

As to the banks there were some odd rumours circulating yesterday about Deutsche Bank. We know it has a long list of problems but as far as I can tell it was no more bankrupt yesterday than a month ago. Yet there was this.

Mind you perhaps this is why Germany seems to be warming towards a European banking union…..

Helicopter Money is not the answer to our economic problems

One of the features of the credit crunch era is the way that policies which seem extraordinary have a way of coming to fruition. We have seen many examples of this in the world of monetary policy. The two headliners would be negative interest-rates and Quantitative Easing or QE bond buying. The latter had previously only been a feature of the response to the “lost decade” in Japan but is now widespread. If it had worked we would not be discussing the “lost decades” but that seems to bother only me. Also these moves are invariably badged as temporary but so far none of them have gone away. Indeed in my home country the Bank of England is currently making QE look about as permanent as it can be.

As set out in the minutes of the MPC meeting ending on 31 July 2019, the MPC has agreed to make £15.2bn of gilt purchases, financed by central bank reserves, to reinvest the cash flows associated with the maturity on 7 September 2019 of a gilt owned by the Asset Purchase Facility (APF).

It will reinvest another £1.27 billion today but it is tomorrow that will be the real example of “To Infinity! And Beyond!” when it buys long and ultra-long dated Gilts.

These themes were on my mind when I noted this in the Daily Telegraph.

A radical world of “helicopter money” – where central banks fund government spending – is “inevitable” as policymakers run out of ammunition ahead of the next recession, top economists have warned.

Central banks are likely to “explore more unconventional policies” in the next downturn and blur the lines between fiscal and monetary policy with radical new tools, such as monetary financing, Deutsche Bank argued.

Let us just mark the issue that Deutsche Bank are top economists and move on. As to the details here is the original suggestion from Milton Friedman.

Let us suppose now that one day a helicopter flies over this community and drops an additional $1,000 in bills from the sky, which is, of course, hastily collected by members of the community. Let us suppose further that everyone is convinced that this is a unique event which will never be repeated.

Those of you who follow me on social media will know that I note the daily RAF Chinook flights over Battersea as they could carry a lot of notes. Perhaps they could name them “Carney’s Cash” and “Broadbent’s Bonanza” for the occasion.

The one time this sort of thing was tried it was in fact via a tax rebate in Japan and amounted to £142 if my memory serves me correctly. However being Japanese they mostly saved it so it was not repeated. So any UK repetition of this would be different as if you look at out habits we would be likely to spend it which starts well but then of course would be likely to make our current account deficit worse. Here from this morning is a reminder of it.

The UK current account deficit narrowed by £7.9 billion to £25.2 billion in Quarter 2 (Apr to June) 2019, or 4.6% of gross domestic product (GDP).

Whilst it is welcome we did better the overall picture is this.

The UK has run a current account deficit in each quarter since Quarter 3 (July to Sept) 1998 or, when considering annual totals, 1983.

So there is an issue although I have many doubts about the accuracy of the numbers especially when we get to investment flows. Let me give an example from the savings numbers released this morning.

The most notable recent revision was in 2017, when the previously published lowest annual saving ratio on record was revised upwards from 3.9% to 5.3%, meaning that the lowest annual saving ratio on record is now observed in 1971 where it stood at 4.8%.

If you remember the media furore at the time that is quite a big deal. Also it gets worse.

The annual households’ saving ratio in 2018 was revised upwards 1.9 percentage points to 6.1%.

Let’s us move on by noting how an emergency measure is being presented as almost normal which of course is more than familiar. We will know when they intend to begin it because we will see a phase of official denials as they get their PR spinning in first.

GDP Growth

This morning’s UK release was rather inconvenient for the monetary expansion apologists as we saw this.

UK gross domestic product (GDP) contracted by an unrevised 0.2% in Quarter 2 (Apr to June) 2019, having grown by an upwardly revised 0.6% in the first quarter of the year.

This meant that the annual rate of growth rose to 1.3% which is better than the Euro area’s 1.2%. I point this out because Michael Saunders of the Bank of England was telling us on Friday that we were in a weaker position. Also there was this.

Annual GDP growth in 2017 is now estimated at 1.9%, revised up from 1.8%,

So we move on knowing that the past was better than we thought. or if you prefer that economic growth has slowed by less than we thought.

Money Supply

There has been an improvement in recent months and here is this morning’s release from the Bank of England.

Broad money (M4ex) is a measure of the total amount of money held by households, non-financial businesses (PNFCs) and NIOFCs. In August, money holdings rose by £10.4 billion, with positive contributions from all sectors.

 

The total amount of money held by households rose by £4.6 billion in August. This was primarily due to a large increase in non-interest bearing deposits. The total amount of money held by NIOFCs rose by £3.3 billion, while the amount held by PNFCs rose by £2.5 billion.

Sorry for their love of acronyms and NIOFCs are non intermediating financial companies.

This means that the annual rate of growth for broad money is 3.3% as opposed to the 1.8% registered in May. The main changes have come in July and now August.

If we switch to M4 lending which is sometimes a useful guide then things have improved considerably as the rate of annual growth has pushed up to 5.5%. As mortgage lending remained pretty similar it has been driven by this.

Borrowing by financial companies that do not act as intermediaries, such as pension funds or insurance companies (NIOFCs), rose to £16.6 billion in August, the largest amount since monthly figures were first collected in 2009. Fund managers were the largest contributor to this strength.

Thus as so often with this sort of data ( bank lending) we are left wondering what the economic impact will be?

Consumer Credit

This continues on its merry way.

The extra amount borrowed by consumers in order to buy goods and services fell to £0.9 billion in August, slightly below the £1.0 billion average since July 2018.

The Bank of England are keen to point out this.

The annual growth rate of consumer credit continued to slow in August, falling to 5.4%. This remains considerably lower than its peak of 10.9% in November 2016, and is the lowest level since February 2014.

There are several elements of context to this. Firstly the rate of growth has been so fast it has raised the total to £218.6 billion so percentages would naturally fall. Also the weakening of the car market has contributed. Next the numbers are still much higher than anything else in the economy.

Small Business Loans

Remember when the monetary easing was supposedly for smaller businesses? Well there is a reason why that went quiet.

In contrast, the growth rate of borrowing by SMEs weakened slightly to 0.7%.

Comment

If we consider the overall situation we find several problems with helicopter money. The first is that it is supposed to be an emergency response when we keep being told we are not in an emergency but rather a recovery. It is a bit like putting an electric shock on a heart which is still beating. The next is that it would be an extraordinary move and yet again a big change would be made by unelected technocrats. This reminds me that some years ago I made the case for Bank of England policymakers to be elected. Finally it is just another way of the establishment making things easier for itself at the expense of the wider population.

This is because the wider population would be at risk of inflation and maybe much more inflation. This need not be consumer inflation as so far in the credit crunch era we have seen moves in asset prices such as bonds, equities and house prices. The latter of course allows the establishment to claim people are better off when first-time buyers are clearly worse off. Putting it another way this is why they are so resistant to putting house prices in the inflation indices and the new push to use fantasy rents suggests they fear helicopter money and negative interest-rates are on the horizon.

Podcast

 

 

 

 

 

 

What to do with a problem like Japan?

Next week on Thursday we will get the latest policy announcement from the Bank of Japan and it may well be a live meeting. With other central banks acting – and by this I mean easing policy again – there will be pressure on the Bank of Japan to maintain its relative position. But yesterday provided a catch which at the time of writing is in fact a version of Catch-22. This is because financial markets did the opposite of what Mario Draghi and the ECB wanted. At first markets went the right way and let me highlight bond markets as they digested these words from Mario Draghi at the press conference.

First of all let me start from one thing about which there was unanimous consensus, unanimity, namely that fiscal policy should become the main instrument.

This curious statement which is way beyond any central banking mandate even came with an official denial of its purpose.

they are packages not meant to finance Government deficits,

But my point is that the market move then U-Turned and bond yields rose. So for example the German bond market future fell by over 2 points from its peak. The ten-year yield rose and is now -0.51%. Next the Euro fell but then rose strongly and is now 1.108 versus the US Dollar.

Such developments will be watched closely in Tokyo with the concept of more easing leading to a stronger currency being something that would make Governor Kuroda want something a bit stronger than his morning espresso. Actually even something which is good news may have him chuntering as it reminds him of the demographics issue that Japan faces. From NHK news this morning.

Japan now has more than 70,000 centenarians, according to the health ministry. A new high has been reached every year for 49 years in a row.

The ministry says 71,238 people will be 100 or older as of September 15. That’s 1,453 more than last year………

There were only 153 centenarians when the ministry conducted its first survey in 1963. The figure surpassed 10,000 in 1998 and 50,000 in 2012.

Officials attribute the rapid rise to medical advances and campaigns to stay fit.

The ministry says it will provide support to enable elderly people to maintain their well being.

In this area economics lives up or rather down to its reputation as the dismal science as the good news above reminds us of Japan’s shrinking and ageing population.

The Banks

We rarely here these mentioned as of course the Japanese banks passed into the zombie zone some years and indeed decades ago. But The Japan Times is on the case today.

Since negative rates were introduced in 2016, Japanese bank shares have languished as their lending profitability dwindles. Nishihara estimates another rate reduction could wipe out as much as ¥500 billion ($4.6 billion) of bank profits, though lenders could make up ¥300 billion if they charge ¥1,000 per account annually.

They do not specify but they seem to be assuming Japan will match the ECB ( and its last move) and cut interest-rates from -0.1% to -0.2%. As to the making money from fees this would be especially awkward in Japan for this reason.

Such levies could help to address Japan’s unusually high number of accounts, easing costs for banks, then-central bank Deputy Gov. Hiroshi Nakaso said in 2017. There are about seven accounts per adult in Japan, the most in the world, according to International Monetary Fund figures.

I mean who cares about the people when The Precious is a factor?

Smaller Banks

These are a case of “trouble,trouble,trouble” as Taylor Swift would say.

Troubled regional banks are plunging into riskier corners of the credit markets, in a battle to survive ultralow interest rates and an industry shakeout.

A clear backfire from the QE or as we are in Japan QQE era. If you are wondering why QE became QQE in Japan think of how the leaky Windscale nuclear reprocessing plant became the leak-free Sellafield. I am just trying to remember if it was 13 or 19 versions of QE before the name change but I imagine you get the idea either way.

As to the smaller banks.

The latest case came last week. Local lenders were among the buyers of samurai bonds — those denominated in yen and issued by non-Japanese companies — sold by Export-Import Bank of India with a BBB+ rating, just three steps away from junk, that may have dissuaded the financial firms in the past. In another unconventional move last month, a few regional banks also put their money in the first negative-yielding note issued by a Japanese agency.

The title of “samurai bonds” is worrying enough in itself. Then moving into negative yielding bonds, what could go wrong?

I do enjoy the description of Japan’s face culture as “taking a more lenient view”.

Even Japan’s two major rating firms, which have tended to take a more lenient view, are sounding alarms. Downgrades and outlook cuts of regional lenders have increased to 13 so far this year at Japan Credit Rating Agency and Rating & Investment Information, the most for similar periods in data compiled by Bloomberg going back to 2010.

Oh and please remember when you read the quote below that the third arrow of Abenomics was supposed to be economic reform.

The government also said earlier this year that legislation will be submitted to the Diet in 2020 that will exempt regional banks from the anti-monopoly law for 10 years to facilitate mergers.

Banks are banks

It would seem that banking behaviour is the same wherever we look.

Japan Post Bank improperly sold investment trust products to elderly customers in violation of its rules in a total of some 20,000 cases, according to informed sources.

An investigation by the Japan Post Holdings Co. unit newly discovered some 2,000 cases of improper investment trust sales at 200 post offices, the sources said. Most contracts were conducted in fiscal 2018, which ended March 31.

Bank of Japan

There is often a lot of hot air about private ownership of central banks but as today’s Bank of Japan Annual Review points out, well you can see for yourself.

The Bank is capitalized at 100 million yen in accordance
with Article 8, paragraph 1 of the Act. As of the end of
March 2019, 55,008,000 yen is subscribed by the
government, and the rest by the private sector.

Some food for thought is provided by the word gearing. Why? Well the Bank of Japan has 486,523,186,968,000 Yen of Japanese Government Securities alone on its books.

Life Insurers

A problem for Japan’s life insurers is that they cannot get any interest or yield in Japan without rocketing up the risk scale. So according to Brad Setser they have been doing this.

But that changes when insurers cannot get the returns they want (or need) at home, and they start investing abroad in a quest for yield. Japanese life insurers (and for that matter Post Bank and Nochu) have looked abroad because yields at home are zero, and Japanese firms (in aggregate) don’t need to borrow.

Ah Post Bank again. How much?

For Japan, the data above shows a broader set of institutions—but the life insurers hold around $1.6 trillion, a sum that is around a third of GDP.

Comment

As you can see there are lots of questions about the financial system in Japan. That may move the Bank of Japan to copy the ECB as it notes that shares in The Precious have risen ( Deutsche Bank if up 0.25 Euros at 7.59).

Moving to the real economy it has not had such a bad 2019 so far. Whilst economic growth was revised down from 1.8% to 1.3% in annualised terms in the second quarter that is still better than I though it would be. For Japan these days an annual GDP growth rate of 1% is about par for the course and is better in individual terms due to the shrinking population. But as we look ahead we see a Pacific Region which is in trouble economically and of course a Consumption Tax rise ( which impacted so heavily in 2014) is due soon. So over to you Governor Kuroda.

Oh and something I have not mentioned so far which is that the Yen is at 108.

 

 

 

The madness of central bankers

Today will depending on what time you read this either have seen yet more monetary policy accommodation by the European Central Bank or be about to get it. It;s President Mario Draghi is too smooth an operator to so strongly hint at it for nothing to happen, especially as in my opinion he feels the need to set policy for the new incoming ECB President Christine Lagarde who he knows well. That is quite a damning critique of her abilities if you think about it which is in line with her track record. But as to the action further confirmation has been provided by the way that markets have been toyed with by leaks from what are known as official “sauces”.

For those unaware the “sauces” strategy is to suggest lots of action as I pointed out on the 16th of August.

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.

Actually even this position had its own contradictions.

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

Later we get told that much less will happen as we saw earlier this week as the last thing central bankers want to see on their big day is the word “disappointment”. So we get this.

Oh, the grand old Duke of York
He had ten thousand men
He marched them up to the top of the hill
And he marched them down again
And when they were up, they were up
And when they were down, they were down
And when they were only half-way up
They were neither up nor down

The whole plan here is under the category of “open mouth operations” which might serve the purposes of the ECB but anyone in the real economy is being actively misled. The only saving grace is that most people will be unaware but there have been real world effects on mortgage rates and the rates at which companies and countries can borrow.

Where are we now?

Joumanna Bercetche of CNBC has summarised the expected position.

Here’s what analysts are expecting:
1) Majority expect 10bps rate cut to -50bps (minority 20bps cut)
2) Tiering
3) Restart of Asset Purchases : sov +corp bonds of EUR 30bn x 12 months (risk of LESS given recent hawkish commentary)
4) Enhanced Fwd Guidance

Interest-Rates

Let us address this as it clearly fails Einstein’s definition of madness. As to doing the same thing and expecting a different result well how about cutting interest-rates by 0.1% four times as has happened to the Deposit Rate and then adding a fifth! Or adding another 0.1% ( or even 0.2%) to a sequence of cuts amounting to 3.65% so far and expecting a different result.

Oh and I see more than a few saying the ECB interest-rate is 0% as indeed one of its interest-rates is. However I use the Deposit Rate because the amount of money deposited with the ECB at this rate is some 1.9 trillion Euros.

Next there was a stage where the madness went even further and we were told that shifting the differences between the various ECB interest-rates was a big deal. For example the minimum lending rate has fallen by 4% so 0.35% more than the Deposit Rate. This has an influence for financial markets but little or no impact on the real economy.

It all seems rather small fry compared to this from President Trump.

The Federal Reserve should get our interest rates down to ZERO, or less, and we should then start to refinance our debt. INTEREST COST COULD BE BROUGHT WAY DOWN, while at the same time substantially lengthening the term. We have the great currency, power, and balance sheet………The USA should always be paying the the lowest rate. No Inflation! It is only the naïveté of Jay Powell and the Federal Reserve that doesn’t allow us to do what other countries are already doing. A once in a lifetime opportunity that we are missing because of “Boneheads.”

The problem for the Donald is that if negative interest-rates were any sort of magic elixir we would not be where we are.Sadly the ECB proves this as it ends up having to keep cutting to keep up what I have previously described as a type of junkie culture.

On the upside the “once in a lifetime” reference may mean he is also a Talking Heads fan.

Tiering

This is another sign of central banking madness where their policies are essentially always aimed at the banks. The interest-rate cuts and QE were to help bail them out but went so far that they now hurt the banks. For newer readers this is because the banks are afraid to pass on the negative interest-rates to ordinary depositors in case they withdraw their money.

So we seem likely to see an effort to shield the banks by some of their deposits at the ECB not having the full negative rate applied. The real economy gets no such sweetners.

Again if the policy of protecting “The Precious” worked these new policies would not be necessary would they?

QE

Exactly the same critique applies here. Up until now some 2.6 trillion Euros of bonds has been bought for monetary policy purposes or Quantitative Easing. So what difference will another 360 billion Euros make? Especially if we remind ourselves that the original programme only ended last December so even fans of it have to admit the sugar high went pretty fast.

There is a subtler argument here which is that the ECB is really oiling the wheels of fiscal policy by making debt cheap to issue for Euro area nations. But what difference has this made? Some maybe at the margins but the basic case of Germany is a fail. In spite of its ability to be paid to issue debt Germany still plans to run a fiscal surplus.

Enhanced Forward Guidance

in 2019 this led many ECB watchers to expect an interest-rate rise and instead we are getting a cut. I am not sure how you could enhance this unless they expect to do even worse!

Comment

My critique has so far looked mostly at the ECB but whilst in some areas it is the leader of the pack there are plenty of other signs of madness. After two “lost decades” the Bank of Japan cut interest-rates by 0.1% to -0.1%. Then it introduced Yield Curve Control which in recent times has been raising bond yields rather than cutting them in a complete misfire. In my home country the UK we saw the Bank of England plan to cut interest-rates by 0.15% in November 2016 before fortunately realising that it had misjudged the economy and abandoning the plan. They end up singing along with Genesis.

You know I want to, but I’m in too deep…

As to the situation the immediate one is grim as this from Eurostat today reminds us.

In July 2019 compared with July 2018, industrial production decreased by 2.0% in the euro area.

But this is a “trade war” issue which has very little to do with monetary policy. As to the domestic impulse the money supply figures have picked up in 2019 so the ECB may be easing at exactly the wrong moment just as it turned out it ended easing at the wrong moment. So let me end with the nutty boys.

Madness, madness, they call it madness
Madness, madness, they call it madness
It’s plain to see
That is what they mean to me
Madness, madness, they call it gladness, ha-ha

Number Crunching

This tweet has gained popularity.

“£4,563,350,000 of aggregate short positions on a ‘no deal’ Brexit have been taken out by hedge funds that directly or indirectly bankrolled Boris Johnson’s leadership campaign” ( Carole Cadwalladr)

I took a look at the article referred to in the Byline Times and if you read it then it conflates being short the UK Pound £ with being short individual shares which is bizarre. Next it has no mention at all of any long positions these companies may have.

Some welcome good news for the Euro area and ECB

A feature of the credit crunch era has been its ability to surprise. Mostly on the downside but not always. This week opened with concerns about the trade war situation and then saw a couple of bad news episodes about Germany.  From dw.com.

German business confidence fell more than expected during August, the Munich-based Ifo institute said on Monday. Ifo said its business confidence index — based on a survey of 9,000 firms — fell to 94.3 points this month from 95.7 points in July.

A deterioration was seen both in managers’ views of the current situation and in their predictions for the next six months.

The main driver of this was not a surprise.

Manufacturing: Satisfaction with the current situation declined to new lows, Ifo said, saying: “Not a ray of light was to be seen in any of Germany’s key industries.”

Then we got confirmation of past bad news.

In the second quarter of 2019, the real (price-adjusted) gross domestic product (GDP) was down 0.1% from the preceding quarter, after adjustment for seasonal and calendar variations…….Real GDP stagnated year on year. After calendar adjustment, GDP was up by 0.4% because the second quarter of 2019 had one working day less than the same quarter a year earlier.

There was also some further detail.

After seasonal and calendar adjustment,price-adjusted exports were down 1.3% from the preceding quarter, markedly more than imports (-0.3%).

Money Supply

However the downbeat news was reversed somewhat this morning as the ECB released this.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, increased to 7.8% in July from 7.2% in June.

That changed the theme a bit as it was the best annual growth number since February last year. Not only that but it means that the growth rate has been picking up since the beginning of this year. This is the opposite of the mood music of 2019 where we have seen an economic slowing. It suggests that the outlook is not as grim as many now seem to be suggesting. Ironically they were often the same ones who forecast interest-rate increases in the Euro area this year.

There was good news from the broader measure as well.

Annual growth rate of broad monetary aggregate M3 increased to 5.2% in July 2019 from 4.5% in June.

Here too there has been an improving trend.

The annual growth rate of the broad monetary aggregate M3 increased to 5.2% in July 2019 from 4.5% in June, averaging 4.8% in the three months up to July.

We do get a breakdown of this.

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 7.8% in July from 7.2% in June. The annual growth rate of short-term deposits other than overnight deposits (M2-M1) increased to 0.1% in July from -0.1% in June. The annual growth rate of marketable instruments (M3-M2) was -1.2% in July, compared with -4.7% in June.

It is not surprising that much of the growth came straight from the M1 number but we see that the M2 component grew as well albeit not by much. The wider money supply is still struggling but even it is reducing more slowly. Indeed it turns out that this is really the M1 growth.

Looking at the components’ contributions to the annual growth rate of M3, the narrower aggregate M1 contributed 5.2 percentage points (up from 4.8 percentage points in June), short-term deposits other than overnight deposits (M2-M1) contributed 0.0 percentage point (as in the previous month) and marketable instruments (M3-M2) contributed -0.1 percentage point (up from -0.3 percentage point).

We can look at these numbers another way.

As a reflection of changes in the items on the monetary financial institution (MFI) consolidated balance sheet other than M3 (counterparts of M3), the annual growth rate of M3 in July 2019 can be broken down as follows: credit to the private sector contributed 3.2 percentage points (down from 3.3 percentage points in June), net external assets contributed 2.9 percentage points (up from 2.4 percentage points), credit to general government contributed -0.2 percentage point (down from -0.1 percentage point), longer-term financial liabilities contributed -1.1 percentage points (up from -1.2 percentage points), and the remaining counterparts of M3 contributed 0.3 percentage point (up from 0.0 percentage point).

This type of breakdown can be unreliable ( it went very wrong in the UK in the past) but the amount of growth from abroad worries some.

A change of tack

Vice President de Guidos spoke yesterday and perhaps tried to calm expectations down.

The echo chamber effect and the inherent noisiness of market signals are reasons why we need to take the expectations that are priced in financial markets with a pinch of salt. This means that we need to also rely on other sources of information to ensure that we conduct a robust monetary policy. The incoming macroeconomic data are one such source. As we keep stressing, our monetary policy is data dependent, not market dependent: indications from market expectations cannot replace our policy judgement.

Although I found this a little disturbing as there is a confession they have not done this before tucked away in it.

At the ECB, we are enhancing our toolkit for the communication with the general public in two ways – both by collecting more information about consumers, and by targeting some of our communication efforts more directly at the general public.

Comment

There are two lessons today I think. Firstly the domestic economic outlook in the Euro area is better than many may think. Not great but left to its own devices it would have some growth I think roughly at the rate we have seen so far this year. Also if the trade war calms down and the ECB eases it may end up with pro cyclical monetary policy. Ooops.

 

Is Germany the new sick man of Europe?

The last twelve months have seen quite a turn around in not only perceptions about the performance of the German economy but also the actual data. With the benefit of hindsight we see that there was a clear peak at the end of 2017 when after a year of strong economic growth ( 0.6% to 1.2% quarterly) the annual rate of Gross Domestic Product or GDP growth reached 3.4%. Then things changed and quarterly growth plunged to 0.1% as 2018 opened as quarterly growth fell to 0.1%.

Actually there was a warning sign back then because looking at my post from the 3rd of January 2018 I reported on the good news as it was then but also noted this.

Although there was an ominous tone to the latter part don’t you think?! We have also learnt to be nervous about economic all-time highs.

This was in response to this from the Markit PMI.

2017 was a record-breaking year for the German
manufacturing sector: the PMI posted an all-time
high in December, and the current 37-month
sequence of improving business conditions
surpassed the previous record set in the run up to
the financial crisis.

Actually back then we did not know how bad things were because the GDP numbers were wrong as the Bundesbank announced yesterday.

In the first quarter, growth consequently totalled 0.1% (down from 0.4%), while it amounted to 0.4% in the second quarter (after 0.5%).

So as you can see we have something else to add to the issues with GDP as in this instance it completely missed the turn in the German economy. The GDP data in fact misled us.

If we move forwards to April 25th last year we see the Bundesbank had seen something but blamed the poor old weather.

The Bundesbank expects the German economy’s boom to continue, although the Bank’s economists predict that the growth rate of gross domestic product might be distinctly lower in the first quarter of 2018 than in the preceding quarters.

The “boom to continue” then went in annual economic growth terms 2.3%, 2.1%, 1.1%, 0.6%,0.9% and most recently 0.4%.If we switch to the actual level it is not much of a boom to see GDP rise from 106.04 at the end of 2017 to 107.03 at the end of the second half of 2019.

Looking Ahead

The Bundesbank has changed its tone these days or if you prefer has been forced to change its tone so let us dip into yesterday’s monthly report.

“The domestic economy is still doing well; the weaknesses have so far been concentrated in industry and exports. International trade disputes and Brexit are important reasons behind this,” Mr Weidmann said.

As you can see its President has a good go at blaming Johnny Foreigner and in particular the UK. Actually the latter is somewhat contradicted by the report itself as it points out Germany has also benefited from the UK in 2019.

In particular, exports to the United Kingdom were weak in the second quarter. A contributing factor to this, according to the Bundesbank’s economists, was the original Brexit date scheduled for the end of March. This resulted in substantial stockpiling in the United Kingdom over the winter months. This led to a countermovement in the second quarter.

Actually the report itself does not seem entirely keen on the idea that it is all Johnny Foreigner’s fault either.

“Sales in construction and in the hotel and restaurant sector declined. Wholesale trade slid into the downturn afflicting industry”, the Bank’s economists write. Only retail trade as well as some other services sectors are likely to have provided positive momentum.

So it is more widespread than just trade.In fact if we look at the details below we see that it was the 0.4% growth in the first quarter which looks like the exception to the present trend.

Construction output declined steeply after posting a sharp increase during the first quarter due to favourable weather conditions. Meanwhile, the demand for cars, pent up by delivery bottlenecks last year, had largely been met at the start of 2019 and did not increase further in the second quarter.

Ominous in a way as we wonder if it might get the same treatment as the first quarter of 2018. But if we take the figures as we presently have them then GDP growth in the first half of this year has been a mere 0.3%. But they are not expecting much better and maybe worse.

Economic activity could decline slightly again in the current quarter, the economists suggest. There are, they write, no signs yet of an end to the downturn in industry, adding: “This could also gradually start to weigh on a number of services sectors.”

They also touch on an area which concerns others.

Leading labour market indicators painted a mixed picture. Industry further scaled back its hiring plans. By contrast, in the services sectors, except the wholesale and retail trade, and in construction, positive employment plans dominated.

Is the labour market turning? This morning’s numbers only really tell us what we already knew.

The year-on-year growth rate was slightly lower in the second quarter than in the first quarter of 2019 (+1.1%) and in the fourth quarter of 2018 (+1.3%).

Maybe we learn a little more here.

After seasonal adjustment, that is, after the elimination of the usual seasonal fluctuations, the number of persons in employment increased by 50,000, or 0.1%, in the second quarter of 2019 compared with the previous quarter.

That number looks a fair bit weaker.

Markit PMI

This has not had a good run and let me illustrate this with the latest update from the 5th of this month.

The combination of a deepening downturn in manufacturing output and slower service sector business activity growth saw the Composite Output Index register 50.9 in July, down from 52.6 in June and its lowest reading in just over six years.

Yes it shows a fall but it has continued to suggest growth for Germany and sometimes strong growth when in fact there was not much and then actual declines.

Comment

The situation here is revealing on quite a few levels. Let me start with one perspective which is ironically provided by ECB President Mario Draghi when he suggested his policies  ( negative interest-rates and QE) added 1.5% to GDP. That was for the Euro area overall but if we apply it to Germany we see that the boom fades a bit and more crucially the German economy started “slip-sliding away” as soon as the stimulus began to fade. That is rather a different story to the consensus that it is the southern European countries that have depended most on stimulus policies.

Next is the German economic model which relies on exports or if you prefer demand from abroad. We have seen a phase where this has been reduced at least partly due to the “trade war” but also I think that the issues with diesel engines which damaged the reputation of its car manufacturers hit too. Whatever the reason there is not a lot behind it in terms of domestic consumption.

The issue with domestic consumption gets deeper as we note that economic policy is sucking demand out of the economy. At the beginning of the year the finance ministry thought that the surplus would be 1.75% of GDP. That seems much less likely now as economic growth has faded but it is one of the reasons why we keep getting reports that Germany will provide a fiscal stimulus which reached 50 billion Euros yesterday. With all of its bond maturities showing negative yields it could easily do so and in fact would be paid to do it, but it still looks unlikely as I note the mention of a “deep recession” being required.

As to my question in some ways the answer is yes. But we need to take care as the domestic consumption problem was always there and once export growth comes back we return to something of a status quo. I also expect the ECB to act in September but on the other side who would expect Germany to be the economic version of a junkie desperate for a hit?