Central banks are increasingly entering the world of politics

Yesterday brought a barrage of central banking news. So let us start with something rather remarkable from the head of the world’s number one which is the US Federal Reserve. The crucial part of the speech given by Jerome Powell to the National Association for Business Economists is below.

The expansion is still far from complete. At this early stage, I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery, creating unnecessary hardship for households and businesses. Over time, household insolvencies and business bankruptcies would rise, harming the productive capacity of the economy, and holding back wage growth. By contrast, the risks of overdoing it seem, for now, to be smaller. Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.

Some of the economics is really rather dubious. But the main driver is that he is interfering in a political decision which is fiscal policy in the middle of an election campaign. It used to be considered the the Federal Reserve would go into a type of purdah during an election campaign but apparently not now. In the past that would usually mean a period where interest-rates would not be changed.The situation is somewhat different now as interest-rates have already been reduced so close to 0% so the weapon of choice would be more QE bond buying but the principle is the same.

The Economics

The claim that the risk of overdoing policy actions is small is familiar territory for central bankers. But this is really rather extraordinary.

Even if policy actions ultimately prove to be greater than needed, they will not go to waste.

Such a situation would be likely to be one exhibiting inflation. The inflation would be most likely to be in house and other asset prices but none the less would be there, albeit it would be ignored by the main consumer inflation measures.

Also if we look at the opening speech we see some familiar cheerleading for policy.

As the coronavirus spread across the globe, the U.S. economy was in its 128th month of expansion—the longest in our recorded history—and was generally in a strong position.

So strong in fact that “Moderate growth” is considered to be “slightly above-trend”

We travel a similar journey if we look at his view of the recovery which is quite a success.

After rising to 14.7 percent in April, the unemployment rate is back to 7.9 percent, clearly a significant and rapid rebound.

But then there is quite a bit of slip-sliding away.

A broader measure that better captures current labor market conditions—by adjusting for mistaken characterizations of job status, and for the decline in labor force participation since February—is running around 11 percent.

I have pointed out more than a few times how and why the international definition of unemployment has failed us in this pandemic. So it is more than disappointing to see a central banker who should know better using it. In a familiar theme that is the behaviour of a politician.

Meanwhile if we switch to actual politicians the fiscal stimulus call had a bit of trouble with The Donald.

Nancy Pelosi is asking for $2.4 Trillion Dollars to bailout poorly run, high crime, Democrat States, money that is in no way related to COVID-19. We made a very generous offer of $1.6 Trillion Dollars and, as usual, she is not negotiating in good faith. I am rejecting their request, and looking to the future of our Country.

Top of the Class

The ECB decided to issue a career enhancing discussion paper yesterday.

Despite this renewed debate, traditional indices of central bank independence do not suggest a deterioration in central banks’ de jure independence after the GFC. ( GFC = Global Financial Crisis)

Lewis Carroll would be proud. Although there is a brief flash of insight.

The benefits of central bank independence are currently not obvious for many citizens,

Really?! However we return to a place “far,far,away” in the section on the ECB itself.

There have been no visible changes in either the de jure or actual independence of the ECB. The legal frameworks protecting the ECB’s independence have been tested,
and have served to establish its independence more firmly.

Meanwhile back on the ranch the ECB has a President who is a politician and former French Finance Minister and a Vice-President who is the former Economy Minister of Spain. So independence from political control has been established by er, putting politicians in charge! It does at least explain this bit.

Comments by euro area governments on the ECB’s policy decisions are unusual.

Why would then when it is doing their bidding? After all if monetary policy was more overtly under the control of politicians how much more could they have done?

If we switch to the Bank of Russia we get a laugh out loud section. We are assured this.

Central bank independence seems to be observed in Russia, although it was not tested in a controversy with the government in the analysed period.

The idea of independence under Vladimir Putin seems not far off insane which somewhat bizarrely they then confess.

In January 2015, the head of monetary policy was reportedly replaced by a person more acceptable to
bankers, who had called for lower interest rates.

Seems to be a similar model to Roman Abramovich at Chelsea football club albeit no manager there survives for that long.

Interest-Rate Cuts

Just when you though that this game might be over there is an early premonition of Halloween. From the Wall Street Journal.

European Central Bank President Christine Lagarde said the bank is ready to inject fresh monetary stimulus to support the eurozone’s stuttering economic recovery from the Covid-19 pandemic, including by cutting a key interest rate further below zero.

Just as a reminder the Deposit Rate and the Current Account Rate are already -0.5%. Last time this came up for discussion ( about a year ago) it was about a move to -0.6%. Does anybody believe a 0.1% move would make any difference right now?

Insane in the membrane
Insane in the brain!
Insane in the membrane
Insane in the brain! ( Cypress Hill )

There are three issues with this. The first is simply that the evidence is that this does not work as otherwise why so we need ever more doses of it? This leads her to an official denial and we know what to do with them.

ECB hasn’t yet reached the point where a fresh interest-rate cut would do more harm than good, known to economists as the reversal rate. ( WSJ)

Next comes the international impact as another interest-rate cut would affect countries which explicitly ( Denmark) and implicitly (Switzerland) set their interest-rates against the Euro exchange-rate. Thirdly we are pretty much back to trying to devalue the Euro which relates to the point before.

Comment

The problem here is that central banks have found themselves behaving like politicians.The move towards independence did not last long as the various establishments shifted towards appointing people who were and are “one of us”. That is most explicit at the ECB where an actual politician in Christine Lagarde is President. In the United States we have seen a different tack where Jerome Powell was seemingly pressurised by President Trump to do his bidding and cut interest-rates. Neither looks especially independent. As to fiscal policy in the US President Trump may already be switching his tune.

If I am sent a Stand Alone Bill for Stimulus Checks ($1,200), they will go out to our great people IMMEDIATELY. I am ready to sign right now. Are you listening Nancy?

That is the problem with playing politics as it can change daily and indeed hourly but the economy cannot.

Rather ironically a day which started with Jerome Powell calling for more like Oliver Twist and the President saying what? just like The Master in the story had another turn. Until then US bond yields were rising ( 30 year at 1.6%) meaning that we might actually see some of the promised Yield Curve Control. But the Trump Tweet ended that at least for now.

Meet the new Inflation era same as the old inflation era….

Yesterday brought news about inflation targeting but before we get to what you might think is the headline act, it has been trumped by Prime Minister Abe of Japan. Before I get to that let me wish him well with his health issues. But he also said this in his resignation speech.

JAPAN PM ABE ON ECONOMIC POLICY: WE HAVE SUCCEEDED IN BOOSTING JOBS, ENDING 20 YEARS OF DEFLATION WITH THREE ARROWS OF ABENOMICS. ( @FinancialJuice)

You might think that this is almost at a comical Ali level of denial at this point. For those unaware this was the Iraqi information minister who denied Amercan soldiers were in Baghdad when well I think you have figured the rest. Even the BBC is providing an opposite view to that of Abe san.

The Japanese economy has shrunk at its fastest rate on record as it battles the coronavirus pandemic.

The world’s third largest economy saw gross domestic product fall 7.8% in April-June from the previous quarter, or 27.8% on an annualised basis.

Japan was already struggling with low economic growth before the crisis.

The current situation is bad enough but even if we give him a pass on that there is that rather damning last sentence. Let me give you some context on that. You could argue the 0.6% contraction in the Japanese economy was also Covid related but you cannot argue that the 1.8% contraction at the end of last year was. Indeed the quarter before that was 0%.

So Japan had not escaped deflation and in fact the problems at the end of last year were created by an Abenomics arrow missing the target. People forget now but the economic growth that Abenomics was supposedly going to create was badged as a cure for the chronic fiscal problem faced by Japan. In fact the lack of growth and hence revenue was a factor in the Consumption Tax being raised to 10%. Which of course gave growth another knock.

Inflation

Another arrow was supposed to lead to inflation magically rising to 2% per annum. How is that going? From the Statistics Bureau this morning.

 The consumer price index for Ku-area of Tokyo in August 2020 (preliminary) was 102.1 (2015=100), up 0.3% over the year before seasonal adjustment, and down 0.4% from the previous month on a seasonally adjusted basis.

So it has taken five years and not one to hit 2%. For newer readers that was also the pre pandemic picture in Japan and it has mostly been possible to argue that there is effectively no inflation because the low levels are within any margin for error.

Also as a point of detail there is even more bad news for inflationistas which is that something which they clain cannot happen with zero inflation has. If you look in the detail food prices have risen by 7% and the cost of education has fallen by 7%, so you can have relative price changes. Looking at the national numbers it has been a rough run for fans of Salmon and carrots as prices have risen by more than 50% over the past 5 years.

The US Federal Reserve

The speech by Chair Powell opened with what may turn out to be an unfortunate historical reference.

Forty years ago, the biggest problem our economy faced was high and rising inflation. The Great Inflation demanded a clear focus on restoring the credibility of the FOMC’s commitment to price stability.

It is hard to know where to start with this bit.

Many find it counterintuitive that the Fed would want to push up inflation. After all, low and stable inflation is essential for a well-functioning economy. And we are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes.

I will simply point out that I am pleased to see a recognition that what are usually described by central bankers as “non-core” such as food and energy are suddenly essential. Perhaps the threats ( from The Donald) about him losing his job have focused his mind, although he would remain an extremely wealthy man.

He then got himself into quite a mess.

 Our statement emphasizes that our actions to achieve both sides of our dual mandate will be most effective if longer-term inflation expectations remain well anchored at 2 percent. However, if inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent. Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down.

This really does come from the highest of Ivory Towers where the air is thinnest. Many households and businesses will not even know who he and his colleagues are! Let alone plan ahead on the basis of what they might do especially after the flip-flopping of the last couple of years. Even worse the 2% per annum target which was pretty much pulled out of thin air has become a Holy Grail.

This next bit was frankly not a little embarrassing.

In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting.

So it is an average but without the average bit?

Canada

This week the Bank of Canada inadvertently highlighted a major problem. It starts with this.

Deputy Governor Lawrence Schembri discusses the difference between how Canadians perceive inflation and the actual measured rate.

You see we are back to you ( and I mean us by this) do not know what you are paying and we ( central bankers know better). Except it all went wrong in a predictable area.

Over the last two decades, the price of houses has risen on average more than twice as fast as the price of housing, at a rate of 6 percent versus 2.5 percent.

There is the issue in a nutshell. Your average Canadian has to shell out an extra 6% each year for a house but according to Lawrence and his calculations it is only 2.5%. Someone should give him a pot of money based on his calculations and tell him to go and buy one.

The Euro area

We looked at variations in the price of Nutella recently well according to The Economist there are other issues.

 Three enormous boxes of Pampers come to €168 ($198) on Amazon’s Spanish website. By contrast, the same order from Amazon’s British website costs only €74. (Even after an exorbitant delivery fee is added, the saving is still €42.)

This happens even inside the Euro area.

The swankiest Nespresso model will set them back €460 on Amazon’s French website, but can be snapped up for €301 on the German version. They could then boast about their canny shopping on Samsung’s newest phone, which varies in price by up to €300 depending on which domain is used.

I point this out because official inflation measurement relies on “substitution” where if the price rises you switch to something similar which is cheaper. But if people do not do this for the same thing inn the real world we are back in our Ivory Towers again.

Comment

Firstly we can award ourselves a small slap on the back as we were expecting this. From the movements in the Gold price ( down) and bond yields (up) far from everybody was. If we note the latter there are two serious problems for Chair Powell. The first is that if there is a body of people on this earth who follow his every word it is bond traders and they were to some extent off the pace. Thus all exposition about expectations above is exposed as this.

Every man has a place, in his heart there’s a space,
And the world can’t erase his fantasies
Take a ride in the sky, on our ship fantasii
All your dreams will come true, right away ( Earth,Wind & Fire )

Next is that if you take the policy at face value bond yields should have risen by far more than the 0.1% the long bond did. They did not rise by the 0.5% to 1% you might expect for two possible reasons.

  1. Nobody expected the Fed to raise interest-rates for years anyway so what is the difference?
  2. If there is a policy change it is mostly likely to be more QE treasury bond purchases which will depress bond yields.

So back to the expectations we see that the Fed is responding to expectations it has created. What could go wrong? Putting it another way it is living a combination of Goodhart’s Law and the Lucas Critique.

I brought in the Japanese experience because it has made an extraordinary effort in monetary policy terms but the economy was shrinking before Covid-19 and there was essentially no inflation.

However the stock market ( Nikkei 225) has nearly trebled since Abenomics was seen as likely. Oh and the Bank of Japan has essentially financed the government borrowing.

Podcast

 

Where will all the extra US Money Supply end up?

Today brings both the US economy and monetary policy centre stage. The OECD has already weighed in on the subject this morning.

The COVID-19 outbreak has brought the longest economic expansion on record to a juddering halt. GDP
contracted by 5% in the first quarter at an annualised rate, and the unemployment rate has risen
precipitously. If there is another virus outbreak later in the year, GDP is expected to fall by over 8% in 2020
(the double-hit scenario). If, on the other hand, the virus outbreak subsides by the summer and further
lockdowns are avoided (the single-hit scenario), the impact on annual growth is estimated to be a percentage
point less.

Actually that is less than its view of many other countries. But of course we need to remind ourselves that the OECD is not a particularly good forecaster. Also we find that the official data has its quirks.

Total nonfarm payroll employment rose by 2.5 million in May, and the unemployment rate
declined to 13.3 percent, the U.S. Bureau of Labor Statistics reported today……In May, employment rose sharply in leisure and hospitality, construction, education and health services, and retail trade. By contrast, employment
in government continued to decline sharply……….The unemployment rate declined by 1.4 percentage points to 13.3 percent in May, and the number of unemployed persons fell by 2.1 million to 21.0 million.

Those figures not only completely wrong footed the forecasters they nutmegged them as well in one of the most spectacular examples of this genre I have seen. I forget now if they were expecting a rise in unemployment of eight or nine million but either way you get the gist. We do not know where we are let alone where we are going although the Bureau of Labor Statistics did try to add some clarity.

If the workers who were recorded as employed but absent from work due to “other  reasons” (over and above the number absent for other reasons in a typical May) had
been classified as unemployed on temporary layoff, the overall unemployment rate  would have been about 3 percentage points higher than reported (on a not seasonally  adjusted basis).

We learn more about the state of play from the New York Federal Reserve.

The New York Fed Staff Nowcast stands at -25.5% for 2020:Q2 and -12.0% for 2020:Q3. News from this week’s data releases increased the nowcast for 2020:Q2 by 10 percentage points and increased the nowcast for 2020:Q3 by 24.5 percentage points. Positive surprises from labor, survey, and international trade data drove most of the increase.

As you can see the labo(u)r market data blew their forecasts like a gale and leave us essentially with the view that there has been a large contraction but also a wide possible and indeed probable error range.

The Inflation Problem

We get the latest inflation data later after I publish this piece. But there is a problem with the mantra we are being told which is that there is no inflation. Something similar to the April reading of 0.3% is expected. So if we switch to the measure used by the US Federal Reserve which is based on Personal Consumption Expenditures the annual rate if we use our rule of thumb would in fact be slightly negative right now. On this basis Chair Powell and much of the media can say that all the monetary easing is justified.

But there are more than a few catches which change the picture. Let me start with the issues I raised concerning the Euro area yesterday where the numbers will be pushed downwards by a combination of the weights being (very) wrong, many prices being unavailable and the switch to online prices. It would seem that the ordinary person has been figuring this out for themselves.

The May 2020 Survey of Consumer Expectations shows small signs of improvement in households’ expectations compared to April. Median inflation expectations increased by 0.4 percentage point at the one-year horizon to 3.0 percent, and were unchanged at the three-year horizon at 2.6 percent. ( NY Fed Research from Monday)

It is revealing that they describe an increase in inflation that is already above target as an “improvement” is it not? But we see a complete shift as we leave the Ivory Towers and media palaces as the ordinary person surveyed expects a very different picture. Still the Ivory Towers can take some solace from the fact that inflation is in what they consider to be non-core areas.

Expected year-ahead changes in both food and gasoline prices displayed sharp increases for the second consecutive month and recorded series’ highs in May at 8.7% and 7.8%, respectively, in May.

Just for the avoidance of doubt I have turned my Irony meter beyond even the “turn up to 11” of the film Spinal Tap.

Central bankers will derive some cheer from the apparent improvement in perceptions about the housing market.

Median home price change expectations recovered slightly from its series’ low of 0% reached in April to 0.6% in May. The slight increase was driven by respondents who live in the West and Northeast Census regions.

Credit

More food for thought is provided in this area. If we switch to US Federal Reserve policy Chair Jerome Powell will tell us later that the taps are open and credit is flowing. But those surveyed have different ideas it would seem.

Perceptions of credit access compared to a year ago deteriorated for the third consecutive month, with 49.6% of respondents reporting credit to be harder to get today than a year ago (versus 32.1% in March and 48.0% in April). Expectations for year-ahead credit availability also worsened, with fewer respondents expecting credit will become easier to obtain.

Comment

I now want to shift to a subject which is not getting the attention it deserves. This is the growth in the money supply where the three monthly average for the narrow measure M1 has increased in annualised terms by 67.2% in the three months to the 25th of May. Putting that another way it has gone from a bit over US $4 trillion to over US $5 trillion over the past 3 months. That gives the monetary system quite a short-term shove the size of which we can put into context with this.

In April 2008, M1 was approximately $1.4 trillion, more than half of which consisted of currency.  ( NY Fed)

Contrary to what we keep being told about the decline of cash it has grown quite a bit over this period as there is presently a bit over US $1.8 trillion in circulation.

Moving to the wider measure M2 we see a similar picture where the most recent three months measured grew by 40.6% compared to its predecessor in annualised terms. Or if you prefer it has risen from US $15.6 billion to US $18.1 billion. Again here is the historical perspective from April 2008.

 M2 was approximately $7.7 trillion and largely consisted of savings deposits.

So here is a question for readers, where do you think all this money will go? Whilst you do so you might like to note this from the 2008 report I have quoted.

While as much as two-thirds of U.S. currency in circulation may be held outside the United States….

The Investing Channel

 

What are the prospects for the US economy?

We find ourselves in a curious situation as we wait for ( or for readers over the weekend) mull the speech of Fed Chair Jerome Powell at Jackson Hole. There are several reasons for this and let me start with the pressure being applied by President Trump.

Germany sells 30 year bonds offering negative yields. Germany competes with the USA. Our Federal Reserve does not allow us to do what we must do. They put us at a disadvantage against our competition. Strong Dollar, No Inflation! They move like quicksand. Fight or go home!…….The Economy is doing really well. The Federal Reserve can easily make it Record Setting! The question is being asked, why are we paying much more in interest than Germany and certain other countries? Be early (for a change), not late. Let America win big, rather than just win!

We can see that The Donald has spotted that the US Dollar is strong with reports that the broad trade-weighted index is at an all time high. Care is needed with that as it starts in 1995 and the Dolllar peak was a decade before it, but the basic premise holds. But the real issue here is of course calling for interest-rate cuts when you are saying that the economy is strong! Is it?

Nowcasting

Let me hand you over to the Atlanta Fed.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2019 is 2.2 percent on August 16, unchanged from August 15 after rounding. After this morning’s new residential construction report from the U.S. Census Bureau, the nowcast of third-quarter real residential investment growth increased from -1.2 percent to 0.7 percent.

That is not appreciably different to the New York Fed which has estimated 1.8%. So let us go forwards with 2% as an average. In terms of past definitions from President Trump ( 3%-4%) that is not doing really well but is hardly a call for an interest-rate cut.

Business Surveys

Something caught the eye yesterday in the Markit PMI survey.

The seasonally adjusted IHS Markit Flash U.S.
Manufacturing Purchasing Managers’ Index™
(PMI™) registered 49.9 in August, down from 50.4
in July and below the neutral 50.0 threshold for the
first time since September 2009.

The eye-catching elements were it going below the neutral threshold and the fact this is the lowest reading for nearly a decade. Some of this is symbolism as the PMI is not accurate to anything like 0.1 but there is also the downwards direction of travel. Also it had a consequence as we look wider.

August’s survey data provides a clear signal that
economic growth has continued to soften in the third
quarter. The PMIs for manufacturing and services
remain much weaker than at the beginning of 2019
and collectively point to annualized GDP growth of
around 1.5%

So we started with ~2% and now are at 1.5%.Prospects look none too bright either.

The past isn’t what we thought it was

Earlier this week we saw quite a revision affecting employment trends.

For national CES employment series, the annual benchmark revisions over the last 10 years have averaged plus or minus two-tenths of one percent of total nonfarm employment. The preliminary estimate of the benchmark revision indicates a downward adjustment to March 2019 total nonfarm employment of -501,000 (-0.3 percent).

This begs several questions as it means the monthly non-farm payroll numbers were too high in the year to March by more than 40,000 a month. The worst problem areas were retailing,,professional and business services and leisure and hospitality.

The change in the picture is covered by MarketWatch.

“This makes some sense, as the 223,000 average monthly increase in 2018 seemed too good to be true in light of how tight the labor market has become and how much trouble firms are said to be having finding qualified workers,” said chief economist Stephen Stanley of Amherst Pierpont Securities

In a sense that is both good and bad as he implies the economy might be at a literal version of full employment, at least in some areas. The bad is that growth was weaker than thought.

Money Supply

Back on the eighth of May I posted this warning.

The narrow measure of the money supply or M1 in the United States saw a fall of just over forty billion dollars in March. That catches the eye because it does not fit at all with an economy growing at an annual rate of 3.2%. Indeed we see now that over the three months to March M1 money supply contracted by 2.7%. That means that the annual rate of growth has been reduced to 1.9%. Thus we see that it has fallen below the rate of economic growth recorded which is a clear warning sign. Indeed a warning sign which has worked very well elsewhere.

That has played out and whilst it is a coincidence that the annual rate of economic growth seems now to be what narrow money supply growth was the broad sweep has worked. However that was then and this is now because M1 has been on something of a tear and the last three months have seen annualised growth of 8% pulling the actual annual rate of growth to 4.8%.

Will it be “Boom!Boom! Boom!” a la the Black-Eyed Peas? Well thank you to @RV3003 on twitter who drew my attention to this from Hosington.

First, Treasury deposits at the Fed, which
are not included in M2, fell dramatically as a
result of special measures taken to avoid hitting
the debt ceiling, thus giving M2 a large boost as
Treasury deposits moved to the private sector.
Once the debt ceiling is raised, Treasury deposits
will rebound, reversing the process and slowing
M2 growth.

Did this affect M1? Well maybe as demand deposits have risen by US $75 billion since the March and since the debt ceiling was raised they have fallen back by US $14 billion.

As you can imagine I will be tapping my foot waiting for the next monthly update. Fake money supply growth?

Comment

We can see that the US economy has slowed but if the money supply data is any guide is simply slowing for a bit and may then pick up. That scenario does not fit with the way that bond markets have surged expecting more interest-rate cuts. In fact bond market analysts are arguing that the Federal Reserve needs to cut interest-rates to keep up and avoid losing control, although they are not entirely clear what it would be losing control of.

So I have a lot of sympathy with Jerome Powell who has a very difficult speech to give today. The picture is murky and I would wait for more money supply data before giving any hints of what I would do next. In short I would be willing to be sacked rather than bowing to Presidential pressure.

 

 

Where next for the US economy?

The end of the week has an American theme as we have just had Independence Day and it will be followed by the labour market and non-farm payrolls data. So a belated happy Independence Day to my American readers. But behind all that is a more troubled picture for the US economy that opened 2019 in fine form.

Real gross domestic product (GDP) increased at an annual rate of 3.1 percent in the first quarter of 2019 (table 1), according to the “third” estimate released by the Bureau of Economic Analysis. In the fourth quarter of 2018, real GDP increased 2.2 percent. ( BEA)

There was a further sub-plot in that not only had economic growth picked up to ~0.8% as we measure it the falling trend of the previous three quarters was broken. But as I pointed out on the 8th of May a warning light had started to flash.

The narrow measure of the money supply or M1 in the United States saw a fall of just over forty billion dollars in March. That catches the eye because it does not fit at all with an economy growing at an annual rate of 3.2%. Indeed we see now that over the three months to March M1 money supply contracted by 2.7%.

What about now?

The money supply picture is not as dark as it looked back then. In fact the contraction of the previous three months of 2.7% has now been replaced by growth of 2.7%. However that is below the annual rate of growth of 3.8% so a gentle brake is still in play as opposed to the previous sharp one. This compares to 8.5% in 2017 as a whole and 4.4% in 2018.

As to the pick-up more recently it may be related to this change in Federal Reserve policy.

The Committee intends to slow the reduction of its holdings of Treasury securities by reducing the cap on monthly redemptions from the current level of $30 billion to $15 billion beginning in May 2019.

So it is no longer acting to reduce the growth rate of the narrow money supply on the same scale. As to how quickly that will impact is not so easy to say because if we look back in time the timescales of similar policies were rather variable. This was the so-called Overfunding phase in the UK when we sold an excess amount of Gilts to reduce the money supply and discovered if we cut to the chase that it was not as simple as it might appear. There is a difference in that we were aiming ( and quite often missing) a broad rather than narrow money measure.

As cash was in the news only yesterday let me point out that at the end of May the M1 money supply comprised some US $1.65 trillion as opposed to US $2.14 trillion of demand and chequeable deposits. There is a blast from the past disappearing as until the end of December the US Fed recorded some £1.7 billion of Travellers Cheques, does anybody still use them?

Other Signals

We get an idea from the New York Fed.

The New York Fed Staff Nowcast stands at 1.3% for 2019:Q2 and 1.2% for 2019:Q3.

News from this week’s data releases decreased the nowcast for both quarters by 0.1 percentage point.

Negative surprises from housing data and the Advance Durable Goods Report accounted for most of the decrease.

As you can see they are rather downbeat for the middle part of 2019 with economic growth being of the order of 0.3% as we would measure it. The Atlanta Fed nowcast is a few days more recent but comes to the same 1.3% answer for the quarter just gone.

A particular driver of that is something that like in the UK has lost much of its ability to shock because it has become part of the economic landscape.

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis announced today that the goods and services deficit was $55.5 billion in May, up $4.3 billion from $51.2 billion in April, revised. ( BEA )

That increase in the deficit is a downwards pull on GDP via net exports and is part of a pretty consistent trend in the year so far.

Year-to-date, the goods and services deficit increased $15.7 billion, or 6.4 percent, from the same period in 2018. Exports increased $5.1 billion or 0.5 percent. Imports increased $20.8 billion or 1.6 percent.

That shows that the trade war does not appear to be going that well as you can see. As to the total effects here is the Bank of England on the subject.

The Bank estimates that these measures will reduce global GDP by only around 0.1%, and the
further US-China tariffs that took effect in May and June will roughly double that effect.

But that may not be the end of the story. The additional tariffs threatened by the US on China and on auto
imports more generally would raise average US tariffs to rates not seen in half a century. If
implemented, they could reduce global GDP by an additional 0.6% through direct trade channels alone.

What will the Federal Reserve Do Next?

If the latest speech from Chair Powell is any guide it seems to be trying to take us for fools.

 The Fed is insulated from short-term political pressures—what is often referred to as our “independence.”

I should note that this came before the appointment of a politician to the ECB Presidency but that really is only part of something which which we have long been aware of. Believing in it these days is a bit like believing in Father Christmas. As to the economic situation we were told this.

Since then, the picture has changed. The crosscurrents have reemerged, with apparent progress on trade turning to greater uncertainty and with incoming data raising renewed concerns about the strength of the global economy……The question my colleagues and I are grappling with is whether these uncertainties will continue to weigh on the outlook and thus call for additional policy accommodation. Many FOMC participants judge that the case for somewhat more accommodative policy has strengthened.

Comment

The next signal for the US economy has been the surge in bond markets. The US ten-year yield was 3.24% in the early part of last November as opposed to 1.97% as I type this. The expectation shifted as we noted back then shifted from interest-rate rises to cuts and on a simple level a two-year yield of 1.78% is expecting three of them which is punchy when we have not had any yet. So they have been accurate in expecting a slowing of the US economy and the prospects for more QE bond buying and have got a slowing of the reduction in QE and a September date for its end.

Moving to the labour market most of the signals do not tell us much at this stage of the cycle. After ten years of expansion for the economy jobs growth should have slowed. But there are two numbers which do tell is something. The first is wages growth because with the rise in employment and fall in unemployment it should have surged but has not. Whilst I welcome wage growth of a bit over 3% it has underperformed compared to the past which is perhaps related to another problem. It gets reported less these days but the change in the labour participation rate is equivalent to around 11 million people.

Both the labor force participation rate, at 62.8 percent, and the employment-population ratio, at 60.6 percent, were unchanged in May.

There is also the issue of leveraged loans which ironically lower interest-rates and bond yields are only likely to make worse. Here is the Bank of France on the subject.

Leveraged loans are loans extended to highly indebted companies. Their strong growth in the US over the last five years and their packaging into securitised financial products bear a number of similarities with the subprime market that triggered the 2008 crisis. While the comparison is debatable, the risks posed by the leveraged loan market to financial stability should not be ignored.

Also in an era of H2O and Woodford there is this.

The presence of Exchange Traded Funds and Mutual Funds means that retail investors have access to these loans in the United States – although they still only account for a minority of investors. Moreover, these structures present a maturity mismatch between their assets and their liabilities. Investors can redeem their fund shares very quickly, whereas underlying assets (leveraged loans) tend to have much longer transaction times.

What could go wrong?