The Libor problem is also a US Dollar problem

There is much to consider today as we consider the actions of our lords (ladies) and masters or rather our central bankers. Last night brought something which as we have noted before was in the category of “no surprises” sung about by Radiohead.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-1/2 to 1-3/4 percent. The stance of monetary policy remains accommodative,

That was of course the US Federal Reserve and I added the last bit because in a few words it tells us that they are not finished yet. Regular readers will be aware that I think it would be much better to simply raise rates to 2% and take a break as moving at at snail’s pace gives more time for something to go wrong. This brings me to two consequences of what is happening.


No not the scandals at least not yet! this time we are looking for the first time in a while at sustained increases. From Bloomberg yesterday.

The three-month London interbank funding rate rose to 2.27 percent Wednesday, the highest since 2008. The concern is that the Libor blowout may have more room to run, a prospect that borrowers and policy makers in various markets are just beginning to grapple with.

One way of looking at this is that as we expect more rises that seems reasonable and if we look at the past rather small fry.

Of course not all of us can remember 1994 and the financial world is of course to coin a phrase “resilient” at least according to the central bankers. This has led people to mull this.

“There has been sort of the perfect storm of factors tightening financial conditions,” said Russ Certo, head of rates at Brean Capital in New York. “Banks do have tremendous liquidity still, but it’s at a higher price.”

You may recall a few years back when worries about bank liquidity in US Dollars were all the rage. This was the era of central banks making agreements for foreign exchange swaps which were mostly ways of making sure they could get US Dollars for their banks from the original source ( the place that can print them at will….) if needed. Here is a refresher on the subject.

In November 2011, the Federal Reserve announced that it had authorized temporary foreign-currency liquidity swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. These arrangements were established to provide the Federal Reserve with the capacity to offer liquidity to U.S. institutions in currencies of the counterparty central banks (that is, in Canadian dollars, sterling, yen, euros, and Swiss francs). The Federal Reserve lines constitute a part of a network of bilateral swap lines among the six central banks, which allow for the provision of liquidity in each jurisdiction in any of the six currencies should central banks judge that market conditions warrant.

These exist for the opposite purpose as whilst the US Fed is describing things from its point of view and it may one day need some £’s Yen or Euros it is vastly more likely that the counterparty central bank will want US Dollars. After all if the world has a reserve currency in spite of some changes it is it and the likely song is from Aloe Blacc.

I need a dollar, dollar
Dollar that’s what I need
Well I need a dollar, dollar
Dollar that’s what I need
Said I said I need dollar, dollar
Dollar that’s what I need
And if I share with you my story would you share your dollar with me?

Oh and you may like to know that the US Federal Reserve eventually fell into line with the definition of temporary to be found in my financial lexicon for these times.

 In October 2013, the Federal Reserve and these central banks announced that their liquidity swap arrangements would be converted to standing arrangements that will remain in place until further notice.

The banks

In the end it all comes down to the “precious” of course and food for thought has been provided by what might be called the central bankers central bank choosing this morning to put this out on social media. From the Bank for International Settlements.

Non-US banks collectively hold $12.6 trillion of dollar-denominated assets – almost as much as US banks…….Dollar funding stress of non-US banks was at the center of the GFC. ( GFC= Global Financial Crisis).

They seem to be pointing the finger in one direction.

We find that Japanese banks pay a premium in their repurchase agreements (“repos”) with US MMFs. We show that the bargaining power of MMFs fund families, together with the particular demand for long term funding of Japanese banks, help explain this premium. ( MMF = Money Market Funds).

This has been a theme of my career which is that in terms of overseas buying ( UK Gilts, Australian property etc…) the Japanese overpay. Care is needed though as the stereotypical response of assuming stupidity ignores the possibility of a longer game being in play. In this instance they have responded.

 We provide evidence for European banks intermediating repos to Japanese banks, with economically significant estimated spreads from maturity transformation.

So any issues with the Japanese banks would also affect European ones? The mind boggles as of course contagion was supposed to be off the menu these days due to all the regulation and reform. As we look back I am reminded that it was European and on a smaller scale Japanese banks which dipped into these lines back in the day.

Would it be considered rude to point out that shares in my old employer Deutsche Bank are down another 2% as I type this? More significantly the 11.8 Euros is a fair bit lower than the 17.1 of mid-December.


As a consequence of the factors above this is also taking place. From Bloomberg reporting on some analysis from Citibank.

Strategists at the U.S. lender predict that the gap between the London interbank offered rate for dollars and the overnight indexed swap rate will continue to widen, potentially leading to a sharper tightening of financial conditions than central bankers have been anticipating. The differential between three-month rates has already more than doubled since the end of January to 55 basis points, a level unseen since 2009.

Now 55 basis points sounds much more grand that 0.55% but there is a flicker here as we try to price risk.


As you can see there are stresses in the financial system right now. Some of this was always going to take place when interest-rates went back up. But for me the real issue comes when we look at another market. This is because whichever way you look at the analysis here you would think that the US Dollar would be rising. You can arrive at that route by observing the apparent demand for US Dollars or by the higher interest-rates being paid in it or both. Yet it has been singing along to Alicia Keys.

Oh baby
I, I, I, I’m fallin’
I, I, I, I’m fallin’

I keep on

You can represent this by the UK Pound £ being in the US $1.41s or the Japanese Yen being in the 105s take your pick. The latter is off though because if Japanese banks are so keen for US Dollars why is the Yen so strong? To my mind that is much more worrying than Libor on its own as we switch to Carly Simon.

Why?……Don´t know why

Meanwhile returning to the shores of the UK I expect Royal Bank of Scotland to be along. After all it has been in everything else.


However much the Tokyo Whale buys wages and consumption seem to struggle

On Wednesday evening the US Federal Reserve will announce its latest policy decision and it will be a surprise if it does not give US interest-rates another 0.25% nudge higher. Yet we see in an example of clear policy divergence other countries ploughing on with monetary easing. For example the European Central Bank continues with monthly QE of 30 billion Euros a month and still has a deposit rate of -0.4%. However the leader of this particular pack is the Bank of Japan especially if we look at other signals of what are known as side-effects. From Bloomberg last week.

That’s the backdrop to Tuesday’s session, when not a single benchmark 10-year note was traded on exchange, according to Japan Trading C0. data. Barclays Securities Japan rates strategist Naoya Oshikubo, summed it up, with perhaps an understatement: “the JGB market was generally thin.”

The latter part is simply part of the Japanese concept of face. One reason for this is the size of the holdings of the Bank of Japan.

The Bank of Japan has vacuumed up so much of the government bond market — in excess of 40 percent — that it’s left fewer securities for others to buy and sell. Some other buyers, such as pension funds and life insurers, also tend to follow buy-and-hold strategies.

The latter sentence there is weak as pension funds and life insurers enact such strategies all over the world and have done so for decades so it is hardly their fault. Indeed quite the reverse s many national bond markets have relied on such purchases.

Whilst we keep being told the Bank of Japan is cutting back the amount of buying remains enormous.

Governor Haruhiko Kuroda noted to lawmakers Wednesday that the central bank has bought 75 percent of the government bonds issued in the fiscal year ending this month.

The next bit contradicts itself as it seems to be claiming that if you buy everything you do not need to intervene. Oops!

The upside for the BOJ is that with such little going on in the market, it makes it easier to control the yield curve, with less need for intervention

The Bank of Japan is the yield curve it would seem which is we step back for a moment begs all sorts of questions. For example you might compare currencies as I have certainly done in the past by comparing bond yields yet in such a calculation there is the implicit assumption that you have a “market” rate. But no, we clearly do not in Japan and that is before we get to the moral hazard of it being set by a body trying to depreciate/devalue the Yen. Oh and if you are a Japanese bond trader you might want to send your CV to the Bank of Japan.

Some jobs might be threatened by automation. But when it comes to government bond trading in Japan, the biggest threat might be the country’s central bank.

The Tokyo Whale

This for newer readers refers to the way that the Bank of Japan has piled into the equity market as well. The numbers are opaque as they are in several accounts but Bloomberg has been doing some number-crunching.

The BOJ started buying ETFs in 2010, with Governor Haruhiko Kuroda later accelerating purchases as part of an unprecedented stimulus package aimed at revitalizing the economy. The central bank had spent $150 billion on Japanese ETFs as of Dec. 8. It owned 74 percent of the market at the end of October, up from 65 percent a year earlier, according to Investment Trusts Association figures, BOJ disclosures and data compiled by Bloomberg. ( ETFs are Exchange Traded Funds)

As the Nikkei-225 equity index fell by 195 points today we know that the Tokyo Whale would have been buying again.

The BOJ stepped up purchases in November after equities retreated, buying 598 billion yen of ETFs.

With there being a buy the dip strategy we can be sure that the Bank of Japan has been buying this year as there have been dips. If we were not sure then this morning’s release of “opinions” from the latest policy meeting reinforce the message.

If the current trends of the appreciation of the yen and the decline in stock prices become prolonged, business fixed investment and consumption will be restrained due to negative wealth effects and a deterioration of households’ and firms’ balance sheets,

Just for clarity the BOJ is breaking new ground here is it really believes that. Not by arguing for “wealth effects” as central bankers the world over are true believers in them. What I mean is the implication that they are larger than other factors at play whereas the evidence I have seen over time is that they are minor and thus often hard to find at all. Looking deeper we see that the BOJ seems to have little intention of changing course although a boundary is on the horizon as some holders must want to keep their ETFs meaning it cannot be long before it has to look for greener pastures.

Perhaps this are suggested last November, from Reuters.

The Bank of Japan should consider using derivatives, rather than buying Japanese stock funds directly as it does now, to affect risk premium on stocks, because that would be a better tool, said the chief investment officer of Japan Post Bank………By selling put options of Japanese stocks, the BOJ should be able to not only help bring down the stock market’s volatility but also to make it easier to wean the markets off its stimulus, said Katsunori Sago, a former Goldman Sachs (GS.N) executive.

Alumni of the Vampire Squid get everywhere don’t they? So the fact that the Bank of Japan’s policies have in effect been a put option for Japanese equities should be added to by writing actual put options. Who would be silly enough to buy these options from the Bank of Japan? It is hard to know where to begin with the moral hazard here.

If the BOJ sells out-of-the-money puts, for example, put option with strike price below the current market levels, it can reduce the market’s volatility, Sago said.

Er simply no. You can reduce perceived or implied volatility but should the market move there is actual volatility. Unless of course Sago san is suggesting that the Bank of Japan should intervene in equity markets on the same scale as it has in bond markets and I think there we have it. Whilst there would presumably be profits for equity holders as much of the Japanese markets are Japanese owned we are in many cases simply shifting from one balance sheet to another.


This is something that fits the famous Churchillian phrase.

 It is a riddlewrapped in a mystery, inside an enigma;

Why? Well it is something which all the buying above should according to economics 101 be on its way down and yet there it is at 106 to the US Dollar. You can argue the US Dollar has been weak but I note that the UK Pound £ has been pushed back to 148 Yen as well. We get a clue from this from the Nikkei Asian Review.

Foreign assets held by Japanese institutional and individual investors appear to have topped 1,000 trillion yen ($8.79 trillion) for the first time, according to Nikkei estimates. The amount has increased roughly 50% during the past five years and now is more than twice as much as the country’s gross domestic product.

The market has been responding to fears of a repatriation much more than any new flows. Also as the BOJ has to some extent driven investors overseas it has undermined its own weak Yen policy. We are back to timing effects where something may be true but for a limited time period, Keynes understood it but modern central bankers lack such humility.


We have looked at the financial economy today but lets us via the “opinions” of the Bank of Japan switch to the real economy.

For instance, although the structural unemployment rate was formerly said to be around 3.5 percent, the actual
unemployment rate has continued to decline and registered 2.4 percent recently.

I imagine each Board Member sipping from their celebratory glass of sake as they type that. But there is a problem as we see below.

Although wage increases by firms have been at around 2 percent for the past few years, real wages registered negative growth in 2017 on a year-on-year basis.

That claim about wage rises is news to me and also the ministry of labor but let us pass that as we note the fall in real wages admitted as we reach the nexus of all of this.

The weak recovery in household consumption since last summer is of concern.

You see one way of looking at the Japanese economy is of deficient domestic demand. So when we are in an official world of wealth effects, plunging unemployment and surging wages ( 2% is a surge in Japanese terms or at least it would be) it should be on the up whereas with a little poetic licence it seems still to be rather Japanese.

The more we are told UK household debt is not a problem the more worried we should be

We have reached a stage where the UK establishment is paying more and more attention to household debt issues. This reminds me of the explanation of the bureaucratic response to such issues explained by Yes Prime Minister. All we have to do is switch from foreign to economic policy. From

Sir Humphrey Appleby: Then we follow the four-stage strategy.

Bernard Woolley: What’s that?

Sir Richard Wharton: Standard Foreign Office response in a time of crisis.

Sir Richard Wharton: In stage one we say nothing is going to happen.

Sir Humphrey Appleby: Stage two, we say something may be about to happen, but we should do nothing about it.

Sir Richard Wharton: In stage three, we say that maybe we should do something about it, but there’s nothing we *can* do.

Sir Humphrey Appleby: Stage four, we say maybe there was something we could have done, but it’s too late now.

The other part of the strategy or game is to make it appear that you are on the case which these days in monetary or economic policy is summed up by the use of the word vigilant which seems set to become a metaphor for anything but in the way that Forward Guidance has become.

The Financial Conduct Authority

The Director of Supervision at the FCA Jonathan Davidson told us this yesterday,

The consumer credit sector is by far and away our largest sector in terms of number of firms with almost 40,000 firms registered with the FCA. And as a sector you have been growing – according to the Bank of England, consumer credit grew 9.3% over the last year.

Regular readers will of course be aware of this and we have looked at the issues below too.

After all, none of us can forget the context in which we are operating. Total credit lending to individuals is currently very close to its September 2008 peak. The circumstances are different now than 10 years ago, but there are still worrying numbers of householders who may still be in too deep. For example, 1 in 5 mortgages today are interest only mortgages, many of which were made at the height of the credit boom to borrowers with little equity in their homes and not a lot of disposable income. And they won’t mature until about 2032.

Indeed the circumstances are different as for example real wages are lower but I am not entirely sure that is what he means! The reminder about the scale of interest-only mortgages does make me think that an establishment solution for that would be to push house prices higher, oh hang on! If we look around we see that such a policy has worked in the south-east and other areas but would be struggling for example in Northern Ireland. As to affordability I guess Mr, Davdson would point us to this from the Office for National Statistics.

The median equivalised household disposable income in the UK was £27,300 in the financial year ending (FYE) 2017. After taking account of inflation and changes in household structures over time, the median disposable income has increased by £600 (or 2.3%) since FYE 2016 and is £1,600 higher than the pre-economic downturn level observed in FYE 2008.

Of course the aggregate numbers can hide trouble.

The Bank of England’s Financial Stability Report last year noted that consumer credit has grown rapidly and that, relative to incomes, household debt is high. And there are a significant number of households that are in so deep that the slightest sign of rough weather could see them in over their heads.

If we go back to the press conference back then Governor Carney told us this.

So there are pockets of risk, consumer credit is a pocket of risk, it’s been growing quite rapidly.

That made him sound a little like the “pocketses” of Gollum in the Lord of the Rings, Unfortunately this was not followed up as the press corps was only really interested in Brexit but here are the numbers from the report.

The total stock of UK household debt in 2017 Q2 was
£1.6 trillion, comprising mortgage debt (£1.3 trillion),
consumer credit (£0.2 trillion) and student loans (£0.1 trillion). It is equal to 134% of household incomes , high by historical standards but below its 2008 peak of 147%. Excluding student debt, the aggregate household debt to income ratio is 18 percentage points below its 2008 peak.

Fascinating isn’t it that they continue the campaign to exclude student debt from the numbers. Maybe it is because it is growing so fast or maybe like me they feel most of it will never be repaid. But in my view you cannot ignore it because it is having effects and implications right now. Also there is the false implication that just because the numbers are not quite as bad as 2008 we can sing along with Free.

All right now, baby, it’s a-all right now.
All right now, baby, it’s a-all right now

Interest-Only Mortgages

Oh and if these are an issue then  genuinely vigilant regulators might be on the case here.

However, since reaching a low-point in 2016, the interest-only market is starting to show signs of life again as lenders re-enter the market………However more recently, there are signs that lenders are starting to expand interest-only lending again, which rose to £5.4bn in Q3 2017, a 45% increase on the previous year. ( Bank Underground).

Everything is fine

Back in January research from the Bank of England via Bank Underground told us everything is fine.

Insight 1: Credit growth has not been driven by subprime borrowers

Insight 2: People without mortgages have mainly driven credit growth

Insight 3: Consumers remain indebted for longer than product-level data implies

I have to confess I am always somewhere between cautious and dubious about such detailed analysis I have seen it go wrong and more often than not spectacularly wrong so often. After all the “liar loans” pre credit crunch would have officially looked good. Also the authors seem keen to cover all the bases.

But vulnerabilities remain. Consumers remain indebted for longer than previously thought. And renters with squeezed finances may be an increasingly important (and vulnerable) driver of growth in consumer credit.

Motor Finance

Mr.Davidson offered some reassuring words on this subject.

The growth of PCP contracts in the motor finance market is a good example of an innovation that has had a significant impact………

So financing of car ownership has become more affordable, allowing more consumers to have more expensive cars. Indeed, the number of point-of-sale consumer motor finance agreements for new and used cars has nearly doubled from around 1.2m in 2008 to around 2.3m in 2017.

This type of innovation, and business model diversity, paints a really attractive picture of your industry.

Is it a miracle? Well please now re-read the quote using the definition of innovation from my financial lexicon for these times which was taught us by the Irish banks which is claimed triumph followed by disaster. I guess such thoughts will be reinforced by this bit.

It is important to me that we continue this innovation in the sector,

Also although he does not say it I am for some reason reminded of Royal Bank of Scotland by this.

A key observation and concern for us is that there are some business models for which customers who can’t afford to repay the principal are profitable, sometimes very profitable


There is much to consider here and let me give you a clear theme. Individual speeches are welcome and well done to Mr.Davidson but a succession of them means that the establishment is not  preparing us for moonlight and music and love and romance but rather

There may be trouble ahead……..

There may be teardrops to shed

Whilst they will be mulling this line.

Before the fiddlers have fled,

If we consider the overall position the reverse argument to mine is that collectively the debt is affordable and in theory and up in the clouds with the Ivory Towers it is. But when we return to earth reality is invariably far less convenient as this from Mr,Davidson’s speech suggests.

We are also seeing younger people borrowing a lot more relative to their incomes than my, baby boomer, generation. Why is this? It’s because of:More student borrowing. Our financial lives survey showed that 30% of 25-34 year olds have a Student Loan Company loan. The higher cost of getting onto the housing ladder. Shifting patterns of savings, borrowing and consumption. You don’t need to wait, you can have it now.


Among 25-34 year olds, 19% have no savings whatsoever, and a further 30% have less than a £1000 saved to use on a rainy day. Indeed, 36% had been overdrawn in the last 12 months.

At the same time, the number of self-employed people in the UK has risen by more than 1.5m since the turn of the century (a 45% increase), and more than 900 thousand people currently are on zero-hours contracts. The gig economy is growing strongly.

When bubbles blow up or pockets develop holes in them it is invariably something relatively small that is the trigger. The consequences however are usually widespread.

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

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

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

The Swiss National Bank (SNB) is maintaining its expansionary monetary policy, with the
aim of stabilising price developments and supporting economic activity. Interest on sight deposits at the SNB is to remain at –0.75% and the target range for the three-month Libor is unchanged at between –1.25% and –0.25%.

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

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

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

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

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

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

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

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

The Swiss Franc

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

Hedge Fund alert

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

The majority of the SNB’s foreign currency investments are in government bonds, bonds issued by foreign local authorities (e.g. provinces and municipalities) and supranational organisations, as well as corporate bonds, or are placed at other central banks. The proportion of equities is one-fifth. Two-fifths of the foreign currency investments are denominated in euros, and more than one-third in US dollars. Other important investment currencies are the pound sterling, yen and Canadian dollar.

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

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

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

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

This has led to quite a lot of speculation that one day the private shareholders might get a share so to speak. This is how it looked back in October.

Less than a month after its stock smashed through the 3,000-franc-a-share barrier, SNB shares hit an intraday high of 4,324 on Wednesday and were trading as high as 4,600 on Thursday. The stock has tripled in value from a year ago, repeatedly confounding market watchers by regularly hitting records.

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


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

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

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

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

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

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

Me on Core Finance TV

Euro area monetary policy heads for a new frontier

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

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

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

What next?

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

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

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

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

Potential Output?

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

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

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

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

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

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

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

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

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

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

More! More! More!

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

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

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

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

What about inflation?

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

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

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

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

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

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

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


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

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

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

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

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

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

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

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

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





Are London house prices set for more falls?

This morning has brought news on the state of play concerning UK house prices although I think the Guardian has tripped over its own feet a little in an attempt to slay several dragons at once.

House prices in parts of London that were once at the epicentre of the UK property boom have fallen as much as 15% over the past year in fresh evidence of the impact of the EU referendum.

Actually if you then read the article no evidence of it being caused by the EU referendum is given but in the article linked to by it from December we are pointed towards one rather likely cause as Russell Galley of the Halifax tells us this.

“As a result of the rapid price growth in the capital, house prices in relation to average earnings are still very high in London; at 8.8 times annual average earnings they are close to the historical high of 9.”

I do like the “additionally” in the sentence below, what could it be about the house price to earnings ratio that causes this?

Additionally, mortgage affordability in London is worse than its long-run average, the only region in the UK where this is so.

As we progress on we discover that the peak or nadir of the falls depending on your perspective is rather close to home for me.

Figures from Your Move, one of the UK’s biggest estate agency chains, reveal that the average home in Wandsworth – which includes much of Clapham, Balham and Putney – fell by more than £100,000 in value over the last 12 months………..Homes in the London borough of Wandsworth were fetching an average of £805,000 in January 2017 but this has now fallen to £685,000.

There have been falls elsewhere too.

Other London boroughs are also showing steep price falls. In Southwark, south London, the average price has dropped from £666,000 to £585,000 in 12 months, while prices have pegged back in Islington, north London, from £750,000 to £684,000.

At this point with Wandsworth and Southwark on the list I am starting to feel a little surrounded although a common denominator is beginning to appear.

Wandsworth and Southwark are home to huge speculative property developments facing on to the River Thames – including the Battersea Power Station development – but the market for £1m-plus one-bed properties has shrivelled in recent years.

The scale of this was explained in the Times just under a fortnight ago.

The new neighbourhood — Europe’s biggest regeneration zone, with 39 development sites across 561 acres — will contain 20,000 homes as well as cultural, retail and business facilities. It is set to be completed by 2022. A £1.2 billion Northern Line Tube extension will create two new stations, Nine Elms and Battersea Power Station, to open in 2020.

Or if you prefer in in picture form, here is a part of it which is yet to come.

If you cycle through it as you now can you get an idea of the scale that somehow cycling past does not quite give, If we return to the economic consequences of this we see that the existing lack of affordability in central London combined with the surge in supply is something that can explain the recent price falls. It was always going to require quite an influx of wealthy people to populate the area and of course that would be in addition to the many who have arrived in recent times. A sort of “overshooting” I think in assuming that a trend would not end. If we wish to help the Guardian out we could suggest that the EU Referendum has probably deterred some although it does not actually make that case and curiously I have seen one or two bits of evidence that more in fact have arrived ahead of possible changes. So something along the lines of what happened with Hong Kong a couple of decades ago.

Looking wider

If we do we get something much more sober. Here is LSL Acadata which produced the report.

Prices in London fell again in January, down £4,662 or 0.8%, leaving average prices in the capital at £593,396. That’s down 2.6% annually, the biggest decline since August 2009.

So we have gone from the 15% click bait to a reality more like 2.6%, However as we have often discussed this is significant as the UK establishment pretty much lifted heaven and earth to stop a significant house price fall post credit crunch. I remember prices falling in my locale and wondering of those selling were making a wise decision and that buyers would regret it? Instead of course we got the UK establishment house price put option as interest-rates were cut to 0.5% where they remain, QE and when they were not enough more QE the Funding for Lending Scheme and then more QE as well as the Term Funding Scheme. The latter has now finished albeit a stock of £127 billion remains as we await the next move.

Before we move on there was another hint in the data that affordability is the main player here.

The cheaper boroughs have fared better. More than half have seen price rises over the year, led by 4.5% growth in Bexley, which, with an average price of £363,082, still has the cheapest property in the capital outside Barking and Dagenham (£300,627).

Up up and away

We get reminded that the UK is in fact a collection of different house markets which are connected but sometimes weakly.

That’s now led by 4.6% annual growth in the North West, one of four regions to see new peak prices in January (along with the East Midlands, the South West and Wales).
Just eight months ago, the region was trailing every other region bar one. Now, it’s seeing strong growth in every part of the market: at the bottom, Blackburn with Darwen has seen the biggest increase in prices in the country, up 16.4% annually. At the top, Warrington is also seeing double digit growth, with prices up 10.3%.


We find on today’s journey that the trends for UK house prices remain in place as we see substantial falls in the new developments in central London and helping make the average price fall there too. This means that the UK picture is according to LSL Acadata as shown below.

Including this February, we are now in the ninth month where the annual rate of house price growth has continued to slow. It now stands at 0.6% when including London and the South East, or at 2.5% when excluding these two regions.

This represents quite a change from the 9% of February 2016 and the change has mostly been seen in London. This particular series makes a lot of effort to be comprehensive but like all efforts has its challenges and estimations.

We have subsequently recalculated all our various house price series on the basis of the new weightings, which has had the effect of decreasing the average house price in December 2017 by £6,340.

So did the average house price from this series go above £300,000 or not? I will let you decide.

One consequence of the new weightings is that the average price of a home in England & Wales has fallen below the £300,000 threshold, which we reported as having been breached during 2017.

As we mull what is or is not Fake News there was this in the Evening Standard?

Millennials, criticised by baby boomers for buying avocado on toast instead of houses….

Meanwhile eyes turn to the Bank of England as we wonder how it will respond as house prices in London fall? Perhaps its Governor Mark Carney is already thinking that June 2019 cannot come fast enough.






The UK has a construction problem

Today brings us a whole raft of new data on the UK economy but before we get to that there has been some new analysis and indeed something of a confession. Let us start with @NobleFrancis who has crunched some numbers on the impact of the recent cold snap and snow in the UK.

In terms of construction work lost due to the bad weather between Wednesday and Friday last week, we estimate UK construction output has lost £1.6 billion (annual construction output in 2017 was £156.3 billion)……with the majority of new construction work postponed. External repair & maintenance (r&m) construction work was also postponed. r&m on internals of building could still be done but getting to site meant this was also hindered..

He is unconvinced that there will be a catch-up.

…theoretically it’s possible to ‘catch-up’ on work once the weather improves but in construction this rarely happens in practice.

This of course affects a sector which has been in recession since early summer last year and of course with the factor below might be an example of it never rains but it pours.

will also be adversely affected in 2018 Q1 by the liquidation of the UK’s second largest construction firm, Carillion, in January 2018.

The Markit PMI was showing something of a flat lining but it will have predated the worst of the cold weather. Also it seems to have missed this which is from this morning’s official release.

Construction output also decreased in the month-on-month series following growth in the final two months of 2017, contracting by 3.4% in January 2018.

As you can see Carillion had a big impact and added to what seems to have been weak construction output across much of Europe in January. This is the position compared to a year ago.

Compared with January 2017, construction output decreased by 3.9%, representing the biggest month-on-year decline since March 2013.

If this sector was a bank the UK establishment would be piling in like it was the US cavalry wouldn’t it?

On the other side of the coin we will have had a boost to GDP from the energy supply industry as the heating was turned up and it will be a quarter with the main Forties pipeline at full flow assuming there are no problems this month.

A confession of sorts

This came from the Bank of England in a working paper towards the end of last month. Remember the case I have made plenty of times on here that its QE bond buying inflated pension deficits which weakened the UK corporate sector and therefore was not the triumph it was claimed to be? Anyway after more than a few official denials we now have this.

Nor is this just a problem in the UK as low-interest rates have raised the value of pension liabilities around the world.

A sort of confession and attempted deflection all at once! We do however get some interesting detail on the scale of the issue which in spite of the way the sector has contracted is still substantial.

The 6000 DB pension schemes in the UK private sector are a significant source of retirement income, with around 11 million members and assets of around £1.5 trillion. The aggregate funding deficit that these schemes faced (on a Technical Provisions basis ) is estimated to have reached around £300 billion by 2015 , equivalent to more than 15% of annual GDP.

So how did things play out?

while firms with larger pension deficits had an incentive but not an obligation to act in
response to these deficits they paid lower dividends on average, but they did not invest less.

Okay so the first subtraction from the UK economy was lower dividend payments. Of course one of today’s themes Carillion and its economic impact was the opposite of this as it paid dividends rather than fixing its pension scheme. Moving on we get something which is even more damaging for QE supporters.

We show that obligations under recovery plans agreed with TPR prompted firms to adopt a different pattern of behaviour compared to their more voluntary
responses to deficits. Firms making contributions to close those deficits did reduce investment and
dividend payments on average. These effects were greater for firms that were financially constrained, reflecting the more limited options available to them to use external or other internal  funds to smooth out their expenditures. ( TPR = The Pensions Regulator ).

This had quite a big impact.

The scale of these effects was large for many FTSE 350
companies with DB deficits, and responses to them can explain some of the weakness in aggregate
dividends and investment observed since 2007.

This reinforces work first done by Toby Nangle and it is to his credit he was several years at least ahead in time. Oh and as the writers of the working paper have families to feed and one day might hope that the Bank of England tea and cake trolley might arrive again in the rather damp dungeon they have been posted to for further research there is this.

while the effects for some firms were large, by contrast the effects at the aggregate level
have been small in macroeconomic terms, and are dwarfed by the estimated positive impact of QE.
QE is estimated to have boosted the level of GDP by in the region of 1½-3% (Kapetanios et al,
2012; and Weale and Wieladek, 2016), while the negative effects of deficits are only estimated to
have reduced GDP by around 0.1% GDP since 2007.

I do like the way that one of the authors of the work about the GDP boost is the same Martin Weale who voted for it. We can imagine a paper from say Alan Pardew to the West Bromwich board stating that whilst they might be in a relegation crisis he has boosted their points haul by using counterfactual analysis. How do you think Baggies fans would treat the obvious moral hazard?

Production and Manufacturing

There was some expected good news here.

In January 2018, total production was estimated to have increased by 1.3% compared with December 2017; mining and quarrying provided the largest upward contribution, increasing by 23.5% due mainly to the re-opening of the Forties oil pipeline,

In it there was continued good news for manufacturing.

Since records began in February 1968, this sector has never recorded nine consecutive monthly growths……… ( Quarterly output was) manufacturing provided the largest upward contribution with an increase of 2.6% ( on a year ago).

Yet it was also true the monthly increase was only 0.1% and in something of a contradiction was driven by ( sorry).

Growth this month within manufacturing was due mainly to a rise of 1.9% in transport equipment. Within this sub-sector motor vehicles, trailers and semi-trailers rose by 3.2%

That is not as mad as it may seem as UK engine production has been very healthy. Also the erratic pharmaceuticals sector had a bad quarter (-7.8%) so on its past record it should rebound.


Tucked away in the numbers there was a hint of some better news. This of course has to be taken in the context of years and sadly decades of deficits but there was this.

Comparing the three months to January 2018 with the same period in 2017, the UK total trade (goods and services) deficit widened by £0.4 billion.

Which if we allow for the £2.2 billion increase in oil imports and fall in oil exports should show an improvement. Exports have also had a good year.

Although total (goods and services) exports increased by 5.6% (£8.4 billion)

We of course need a lot more of that.


If we step back and look at the overall position the UK economy continues to bumble its way forwards.We have seen a good run of manufacturing production which means that output is now only 0.3% below its pre credit crunch peak. However the fact it is still below after so much time shows the scale of the damage inflicted. Industrial production is also in a better phase.

On the trade issue there are flickers of improvement but we have a long journey to travel to end the stream of deficits. As to construction it seems to have hit something of a nuclear winter and as government policy has been involved in the creation of this via the impact of Carillion you might think it would be paying more attention, especially as other companies have not dissimilar weaknesses. If this was the banking sector the money would be pouring in. Also are we not supposed to be in the middle of a house building surge?