The history of the credit crunch continues to be rewritten

Today is a day for central bankers as both the Bank of England and European Central Bank declare the results of their latest policy decisions. However it will be a Super Thursday only in name as  the main news concerning the Bank of England this week has been the extension of Governor Carney;s term by seven months to January 2020. A really rather extraordinary move on both sides, as we mull not only the possibility of future monthly or even weekly future extensions,, and on the other side what happened to the personal circumstances that supposedly stopped him staying for longer in the first place?

Moving to the ECB the rumour yesterday was that its economic forecasts will be revised down slightly which is likely to reduce the rhetoric about the Euro area economy being resilient. But apart from that there is little for it to do apart from play down the recent news about money laundering via banks being rife in some of the smaller ( Malta and Estonia) Euro area countries. President Draghi may also repeat the hints he keeps providing that he has no intention of raising interest-rates n his term of office. This may have a market impact as more than a few have convinced themselves that a 0.2% rise is due this time next year. Apart from the fact that the ECB changes interest-rates by 0.25% and not 0.2% the apparent slowing of the Euro area economy makes that increasingly unlikely.

Rewriting History

This week has seen a lot of reviews of the crash of a decade ago but the most significant comes from the man at the centre of the response which was Ben Bernanke of the US Federal Reserve. He has written a paper for Brookings which to my mind illustrates why central banks have put so much effort into raising asset and in particular house prices.

Recent work, including by Atif Mian and Amir Sufi, proposes that the accumulation of debt during the housing boom of the early 2000s made households particularly vulnerable to changes in their net worth. When house prices began to decline, homeowners’ main source of collateral (home equity) contracted, reducing their access to new credit even as their wealth and incomes declined.  These credit constraints exacerbated the declines in consumer spending.

Or if you want the point really rammed home here it is.

Mian and Sufi and others attribute the economic downturn in 2008 and 2009 primarily to the boom and subsequent bust in housing wealth,

Thus central bankers including Ben decided that the response to the bust in housing wealth was to create another boom. Many of them including Ben himself did so well before the paper he quotes was written. For example the US Federal Reserve bought mortgage-backed securities as follows.

From early 2009 through October 2014, the Federal Reserve added on net approximately $1.8 trillion of longer-term agency MBS and agency debt securities to the SOMA portfolio through its large-scale asset purchase programs. ( New York Fed).

Thus we see than Ben Bernanke is being somewhat disingenuous in pointing us to a paper written in 2014 when he made his response in 2009! Anyway there is a statistic you may like in the paper.

that the total amount of debt for American households doubled between 2000 and 2007 to $14 trillion?

The banks

They would have been helped in a variety of ways by the response to the credit crunch. Firstly by the large interest-rate cuts and next by the advent of QE ( Quantitative Easing) which helped them both implicitly by raising the value of their bond holdings and explicitly via the purchase of mortgage debt. Some were also bailed out and that mentality seems to be ongoing.

 We need to make sure that future generations of financial firefighters have the emergency powers they need to prevent the next fire from becoming a conflagration. We must also resist calls to eliminate safeguards as the memory of the crisis fades. For those working to keep our financial system resilient, the enemy is forgetting.

That is from an opinion piece in the New York Times from not only Ben Bernanke but the two US Treasury Secretaries which were Hank Paulson and Timothy Geithner. What powers do they want?

Among these changes, the FDIC can no longer issue blanket guarantees of bank debt as it did in the crisis, the Fed’s emergency lending powers have been constrained, and the Treasury would not be able to repeat its guarantee of the money market funds. These powers were critical in stopping the 2008 panic.

In other words they want to be able to bailout and back stop the banks again. Or if you prefer take us back to the world of privatising profits and socialising losses. For the establishment in the US that worked well as the government made a profit and the banks were eventually able to carry on regardless. Indeed the next stage of fining banks also was something of an establishment merry go round as you can argue that it was just another way of the banks repaying the establishment for the bailouts.

On the other side of the coin ordinary people did lose money. Some had their homes foreclosed on them and others lost their savings. The unfairness of this arrives when we look at bank shareholders who had losses. In itself that is not a crime as by being shareholders they take a clear risk. But the rub is that the losses were driven by a combination of fraud and malpractice for which so few have been punished. If we move onto the bank fines we see that yet again punishment hit bank shareholders whereas bank executives might see a lower bonus but otherwise remained extremely well rewarded. We are back to the theme of the 0.01% being protected whilst the 99.99% bear any pain.

Putting it another way here is former Barclays boss Bob Diamond from the BBC website earlier.

Former Barclays boss Bob Diamond has said he fears banks have become too cautious about taking risks.

Mr Diamond told me the risk-averse culture means they can’t support the economy and generate jobs and growth.

Support the economy or bankers pay?

Inequality

Here is perhaps the biggest rewriting of history as we return to the thoughts of Ben Bernanke at Brookings.

“There’s some folks who don’t like QE, and as each argument fails, they move down the ladder. And so now you have hedge fund managers writing in the Wall Street Journal how QE is creating inequality as if they cared.”

You may note that there is no actual denial that QE creates inequality. Frankly if you boost asset prices which is its main effect you have to benefit the asset rich relative to the poor. However back in March the Bank of England assured us this.

Monetary policy had very little effect on overall inequality

How? Well let me show you their example of inequality being unaffected.

 But it is worth noting that existing differences in net wealth mean that a 10% increase for all would equate to £200 for the bottom decile and £195,000 for the richest.

Apart from anything else this was awkward for the previous research from the Bank of England which assured us QE had boosted wealth for those with pensions and shareholders. I guess they were hoping we had forgotten that.

Comment

The last few days have seen quite a bit of rewriting history about the credit crunch as the establishment wants us to forget three things.

  1. It was asleep at the wheel
  2. Those who caused it got off scot free in the main and were sometimes handsomely rewarded whereas many relative innocents suffered financial hardship.
  3. The response not only boosted the already wealthy but contributed to an economic world of struggling real wage growth

The first problem will recur we know that in spite of all of the official claims to the contrary. As to the response one issue is that those in charge are invariably unsuited to the role. They are picked out of academia and/or the establishment and suddenly find that they go from a cosy slow-moving world to one that is exactly the reverse, so we should not be surprised if they act like rabbits caught in a car’s headlights. So on that score I think we should cut Ben Bernanke some slack but that does not eliminate points two and three which are critiques of the economic regime he implemented.

Also if we stay with central banks it could all have been worse as imagine you are at Turkeys central bank the CBRT deciding how much to raise interest-rates and you read this!

Erdogan says must lower interest rates ( @ForexLive )

 

 

 

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The Italian economy looks to be heading south again

Today has opened with what is more disappointing economic news for the land of la dolce vita. From the Italian Statistics Office or Istat.

In July 2018 the seasonally adjusted industrial production index decreased by 1.8% compared with the previous month. The percentage change of the average of the last three months with respect to the previous three months was -0.2.
The calendar adjusted industrial production index decreased by 1.3% compared with July 2017 (calendar working days being 22 versus 21 days in July 2017);

As you can see output was down both on the preceding month and on a year ago. This is especially disappointing as the year had started with some decent momentum as shown by the year to date numbers.

 in the period January-July 2018 the percentage change was +2.0 compared with the same period of 2017.

However if we look back we see that the push higher in output came in the last three months of 2017 and this year has seen more monthly declines on a seasonally adjusted basis ( 4) than rises (3). Looking ahead we see that things may even get worse as the Markit PMI business survey for manufacturing tells us this.

Italy’s manufacturing sector eased towards
stagnation during August. Both output and new
orders were lower, undermined by weak domestic
demand, whilst employment increased to the
weakest degree since September 2016……..Expectations were at their lowest for over five years.

This seems set to impact on the wider economic position.

At current levels, the PMI data suggest industry
may well provide a net negative contribution to
wider GDP levels in the third quarter of the year.

With Italy’s ongoing struggle concerning economic growth that is yet another problem to face. But it is something with which it has become increasingly familiar as the industrial production sector is still in a severe depression. What I mean by that is the peak for this series was 133.3 in August of 2007 and the benchmarking at 100 for eight years later (2015) shows what Taylor Swift would call “trouble,trouble,trouble” . The initial fall was sharp and peaked at an annual rate of 26% but there was a recovery however, in that lies the rub. In 2011 Italy saw a bounce back in production to 111.9 at the peak but then the Euro area crisis saw it plunge the depths again. It did respond to the “Euroboom” in 2016 and 17 but looks like it is falling again and an index of 105.2 in July tells its own story.

So all these years later it is still 21% lower than the previous peak. We worry in the UK about a production number which is 6.1% lower but as you can see we at least have some hope of regaining it unlike Italy.

The wider outlook

Italy’s economy is heavily influenced by its Euro area colleagues and they seem to be noting a slow down as well. From @stewhampton

The ECB committee that oversees the compilation of the forecasts now sees the risks to economic growth as tilted to the downside.

Perhaps they have suddenly noted their own money supply data! At which point they are some time behind us.  Also in the language of central bankers this is significant as they do not switch from “broadly balanced” to “tilted to the downside” lightly, and especially not when they are winding down a stimulus program.

So we see that the Italian economy will not be getting much of a boost from its neighbours and colleagues into the end of 2018.

Employment

Yet again this morning’s official release poses a question about the economic situation in July?

In the most recent monthly data (July 2018), net of seasonality, the number of employees showed a slight decrease compared to June 2018 (-0.1%) and the employment rate remained stable.

This modifies the previous picture which had been good.

The year-on-year trend showed a growth of 387 thousand employees (+1.7% in one year), concentrated among temporary employees against the decline of those permanent (+390 thousand and -33 thousand, respectively) and the growth of the self-employed (+30 thousand).

So more people were in work which is very welcome in a country where a high level of unemployment has persisted. We keep being told that the unemployment rate in Italy has fallen below 11% ( in this instance to 10.7%) but then later it gets revised back up again. Of course even 10.7% is high. I would imagine many of you have already spotted that the employment growth is entirely one of temporary jobs which does not augur well if things continue to slow down.

Some better news

Italy is a delightful country so let us note what some might regard as a triumph for the “internal competitivesness” policies of the Euro area.

Italy’s current account position is one of the country’s most improved economic fundamentals since the financial crisis. As the above chart shows, it improved by 6.2 percentage points to a sizable surplus of 2.8% of gross domestic product (GDP) last year—the highest level since 1997—from a deficit of 3.4% of GDP in 2010.

That is from DBRS research who in this section will have the champagne glasses clinking at the European Commission/

external cost competitiveness gains related to relatively slower domestic wage growth.

The Italian worker who has been forced to shoulder this will not be anything like as pleased as we note that some of the gain comes directly from this.

In response to the recession, nominal imports of goods declined significantly by around 5% a year between 2012 and
2013.

Also Italy has benefited from lower oil prices.

Since then, lower energy prices further contributed to the improvement in the current account, and Italy’s imported energy bill bottomed out at 1.6% of GDP in 2016, down from a peak of 3.9% of GDP in 2012.

Not quite the export-led growth of the economics textbooks is it? Still maybe there will be a boost from tourism.

Why everyone is suddenly going to Milan on vacation ( Wall Street Journal)

According to the WSJ Milan has  “been hiding in plain sight for decades ” which must be news to all of those who have been there which include yours truly.

Comment

The downbeat economic news has arrived just as things seemed to have got calmer regarding the new coalition government. Or as DBRS research puts it.

More recently, the leaders have reaffirmed their commitment to adhere to the European Union (EU) framework. In DBRS’s view, this is a positive development.

This has meant that the ten-year bond yield which had risen above 3.2% is now 2.75%. So congratulations to anyone who has been long Italian bonds over the past ten days or so and should you choose you will be able to afford to join the WSJ in Milan as a reward. However bond yields have shifted higher if we return to the bigger picture so this will continue to be a factor.

In DBRS’s view, total interest expenditure as a share of gross domestic product (GDP) may slightly narrow this year compared with the 3.8% of GDP recorded in
2017.

As new issuance has got more expensive than in 2017 I am not sure about the narrowing point.

Also there is the ongoing sage about the Italian banks which has become something of a never-ending story. Officially Unicredit has been the success story here and yet if it is such a success why were rumours like these circulating yesterday?

The other rumour was a merger with Societe Generale of France. Anyway the current share price of around 13 Euros is a long way short of the previous peak of 370 or so. This reminds us of the news stories surrounding the fall of Lehman Bros. a decade ago as it has been a dreadful decade for both Unicredit and Italy as we note the economy is still 5% smaller than the previous peak.

 

 

 

 

 

 

 

 

Sweden is a curious mixture of monetary expansionism and fiscal contraction

This morning has brought us a new adventure in the world of central bank Forward Guidance.

The Executive Board has therefore decided to hold the repo rate unchanged at −0.50 per cent. If the economy develops as expected, there will soon be scope to slowly reduce the support from monetary policy. The forecast for the repo rate indicates that it will also be held unchanged at the monetary policy meeting in October and then raised by 0.25 percentage points either in December or February.

You may already have realised that this is from the Riksbank of Sweden and that there is something awfully familiar about this as Martin Enlund highlights below.

There are a multitude of issues here. Let us start with the fact that the Riksbank was ahead of the game in offering Forward Guidance before the concept was formally devised. I guess that sits well with being the world’s oldest central bank. But the catch so typical of the way that Forward Guidance has developed is that it has proven spectacularly wrong! Indeed I cannot think of any central bank that has such a malfunctioning crystal ball. Ever since 2012 an interest-rate rise and indeed succession of rises has been just around the corner on a road that has been so straight even the Roman Empire would be proud of it.

One of the features of Forward Guidance is that it is supposed to allow businesses and households to plan with certainty. The reality here is that they have been consistently pointed in the wrong direction. Indeed their promises of interest-rate rises morphed into interest-rate cuts in the period from 2012 to 2016. Such that their forecasts if we try to average them, suggested the repo rate now would be of the order of 3-4%, rather than the actual -0.5%. If we look at the period when the repo rate has been negative they have consistently suggested it is temporary but it has been permanent so far, or if you prefer has been temporary as defined in my financial lexicon for these times.I think that there are two major possibilities here. The first is that they are collectively incapable of seeing beyond the end of their noses. The other is that it has been a deliberate policy to maintain negative interest-rates whilst promising to end them.

A more subtle suggestion might be that this is all for the foreign exchanges who do take a least some notice rather than the average Swede. After all if he or she did take notice of the Forward Guidance they have probably long since given up.

The Krona

We get the picture here from this from Bloomberg.

Sweden’s elections this weekend could spell more pain for an already floundering currency.

As ever I will skip past the politics and look at the currency. One cannot do so without first noting the role of the Euro here which is like a big brother or sister to its neighbouring nations. When it cut interest-rates it put pressure on them to cut as well. So let us look at the Krona versus the Euro.

What we see is a clear pattern. Essentially the monetary easing of the Riksbank has taken the Krona from 8.4 versus the Euro in the late summer of 2012 to 10.57 as I type this. So a gentle depreciation to add to the negative interest-rates in terms of monetary policy as we rack up the stimulus count.

We can take that wider by looking at the trade-weighted or Kix Index. If we do so we get a similar result as the 102 of late summer 2012 has been replaced by 121 now. Just for clarity this index operates in the reverse direction to the usual method as a higher number indicates a weaker currency.

If we switch to inflation prospects then some should be coming through as the Wall Street Journal reported yesterday.

Down 10% against the dollar, the krona has fallen more than any other developed-market currency. Among the 10 most heavily traded currencies in the world, it has undershot even China’s Yuan—itself under pressure from the trade conflict with the U.S.—and the U.K.’s Brexit-bruised pound.

So commodity prices will have risen in Krona terms from this effect.

QE

This has been another feature of the expansionary toolkit of the Riksbank

At the end of August, the Riksbank’s government bond
holdings amounted to just over SEK 330 billion, expressed as a  nominal amount .Net purchases of government
bonds will be concluded at the turn of the year, but principal  payments and coupon payments will be reinvested in the government bond portfolio until further notice.

So what has become regarded as a pretty regular QE programme which politicians love as it reduces borrowing costs for them. One generic point I would note is that these Operation Twist style reinvestments are only happening because QE has proven rather permanent rather than the extraordinary and temporary originally claimed. So far only the US Federal Reserve is attempting any unwind. Many argue this does not matter, but when you have redistributed both wealth and income towards the already wealthy I think that it does.

Money Supply

This has been an issue across more than a few countries recently, as we have been observing slow downs. This is also true of Sweden because if we look at the narrow measure or M1 we see that an annual rate of growth of 10.5% in July 2017 was replaced with 6.3% this July. If we look back we see that a major player in this has been the QE purchases because when the Riksbank charged into the bond market in 2015 the annual rate of growth in M1 went over 15% in the latter part of that year. Now we see as QE slows down so has M1 growth.

A similar but less volatile pattern can be seen from the broad money measure M3. That was growing at an annual rate of 8.3% in July 2015 as opposed to the 5.1% of this July. So we see clearly looking at these why the Riksbank has just balked on a promise to raise interest-rates at today’s meeting. Taken in isolation that is sensible and in fact much more sensible than the Bank of England for example which has just raised Bank Rate into monetary weakness.

House Prices

I would like to present this in a new way. We have a conventional opening as according to Sweden Statistics house prices fell by 1.2% in 2012 ( they measure one or two dwelling buildings) which explains the about turn in monetary policy seen then. But if we switch to narrow money growth we see that it looks like there is a link. It peaked in 2015 as did house price growth (10.8%). It remained strong in 2016 and 17 as did house price growth ( 8.4% and 8.3% respectively). Okay so with money supply growth fading what has happened to house prices more recently?

In the last three-month period, from June to August 2018, prices rose by almost 1 percent on an annual basis compared with the same period last year.

Boom to bust? As ever we need to be careful about exact links as for example the latest couple of months have been stronger. But what if monetary growth continues to slow?

Comment

Readers will be pleased to discover that the Riksbank has investigated its own policies and given itself a clean bill of health.

The Riksbank’s overall assessment is that the side‐effects
of a negative policy rate and government bond purchases
have so far been manageable.

Where there is a clear question is a policy involving negative interest-rates, QE and a currency depreciation when the economy is doing this.

Activity in the Swedish economy remains high. GDP growth in the second quarter was surprisingly rapid and together with strong indicators, this suggests that economic activity is still not slowing down.

Inflation is also on target. So why is policy so expansionary? Perhaps Fleetwood Mac are correct.

I never change
I never will
I’m so afraid the way I feel

Should they reverse course and find the economy and house prices heading south thoughts will be a lot harsher than the “Oh Well” of Fleetwood Mac.

Oddly we find that fiscal policy is operating in the opposite direction as this from the Swedish Debt Office shows.

For the twelve-month period up to the end of July 2018, central government payments resulted in a surplus of SEK 109.6 billion. Central government debt amounted to SEK 1,196 billion at the end of July. This corresponds to 2.3 and 25.3 percent, respectively, of GDP.

We are in a rare situation where they could genuinely argue they have a plan to pay it all off. The catch comes with the fact that with a ten-year bond yield of 0.54% and a low national debt they have no real need to. So a joined up policy would involve ending negative interest-rates and some fiscal expansionism wouldn’t it?

 

 

The ongoing saga that is Deutsche Bank rumbles on

As the credit crunch unfolded the story so often found its way to the banking sector and the banks. But as we approach a decade from the collapse of Lehman Brothers I doubt anyone realised the story would still so often be about them. A headliner in this particular category has been my former employer Deutsche Bank. It has turned out to be like the Black Knight in the Monty Python sketch where all troubles are “tis but a scratch” and returns to the fray. If we look back it was not explicitly bailed out by Germany although of course there were a range of measures which implicitly helped it. For example the government programme to help interbank lending and the interest-rate cuts and liquidity supply programmes of the European Central Bank ( ECB). Come to think of it we would not have expected the ECB to still be pursuing monetary easing a decade later either. Both sagas are entertwined and indeed incestuous.

As in so many cases Deutsche Bank was able to avail itself of the US bank support structure as Wall Street Parade points out.

According to the Government Accountability Office (GAO), Deutsche Bank received cumulative loans totaling $77 billion under the Federal Reserve’s Primary Dealer Credit Facility (PDCF) and $277 billion in cumulative loans under the Term Securities Lending Facility (TSLF) for a total of $354 billion.

That now seems even more significant as we have had several periods where European and Japanese banks have been singing along with Aloe Blacc.

I need a dollar, dollar, a dollar that’s what I need (Hey Hey),
Well I need a dollar, dollar, a dollar that’s what I need (Hey Hey),
Said I need a dollar, dollar, a dollar that’s what I need,
And if I share with you my story, Will you share your dollar with me?

This is in addition to the gains at the time which were liquidity and US $354 billion is quite a lot of it even in these inflated times and a type of bailout from a below market interest-rate.

On the other side of the ledger Deutsche Bank has provided support to various taxpayers around the world via the fines it has paid as a type of compensation for its many miss-selling scandals. The initial claims that these were a few rotten apples turned out to be an organisation that was rotten to the core. According to FN London it has paid around US $8 billion in fines and agreed to compensate US consumers with US $4.1 billion. So has in a sense made some recompense for the liquidity received in the US although some of the Li(e)bor fines were received by the UK.

Share Price

This is a signal of trouble again as we see that this week it has spent some time below 10 Euros again.This is significant on several levels. It was considered a sign of trouble in the autumn of 2016 when Deutsche Bank was hitting the headlines for all the wrong reasons. It also pales considerably when we look back as I note this from back in February 2009 from The Guardian.

Deutsche cut the dividend from €4.50

Back at the peak the share price was more like 94 Euros according to my monthly chart. From a shareholder point of view there has also been the pain of various rights issues to bolster the financial position. These tell their own story as the sale of 359.8 million shares raised 8.5 billion Euros  in 2014 whereas three years later the sale of 687.5 million was required to raise 8 billion Euros. The price was in the former 22.5 Euros and in the latter 11.65 Euros.

Putting it another way shareholders stumped up 16.5 billion Euros in these two issues more than doubling the number of shares to 2.066.8 million for the company to now be valued at around 21 billion Euros at the current share price. As ever a marginal price may not be a good guide but in this instance I suspect the total price would be less and not more as after all if you wanted to buy the bank it should be relatively easy.

To my mind this is made an even bigger factor by the way that the current situation is so bank friendly. Monetary policy in the Euro area remains very expansionary and we have just seen a phase described as a Euroboom. If we return to Germany’s home base we see an economy that since 2014 has grown by around 2% per annum and according to the German Bundesbank house price index (127 cities) prices rose by 9% in 2016 and 9.1% in 2017, meaning the asset base of the mortgage book has strengthened considerably. Yet in spite of all this good news the share price not only fails to recover it has headed back to the doldrums.

Fixing a hole?

The Financial Times reported this on Tuesday.

To many observers in Frankfurt a tie-up between Deutsche Bank and Commerzbank is not seen as a question of if, but when.  The prevailing view among the banking cognoscenti in Germany’s financial capital is that the country’s two largest listed lenders are very likely to merge eventually.

Eventually?

There are two scenarios that could accelerate the potential merger. One is that Deutsche realises that it is unable to turn itself round under its own steam; the other is that a foreign peer tables a bid for Commerzbank, forcing Deutsche’s chief executive Christian Sewing to make a counter offer.

Forcing? I did enjoy the reference to Deutsche turning itself around under its own steam! How’s that going after a decade? As to the second sentence below it is hard not to laugh.

Assuming a 35 per cent premium on Commerzbank’s current market capitalisation, Deutsche would have to pay €14bn for its smaller rival. “There are different ways to structure this deal but it surely would not be in cash,” said a Frankfurt-based investment banker.

If Deutsche had access to €14 billion in cash it wouldn’t need to buy Commerbank.

Comment

There is quite a bit to consider here as we see that in spite of an economic environment that is very bank friendly Deutsche Bank never seems to actually recover. More money has been taken from shareholders who must be worried about the next downturn especially as the issue below has continued to fester. From Reuters in June 2016.

“Among the G-SIBs, Deutsche Bank appears to be the most important net contributor to systemic risks, followed by HSBC  and Credit Suisse ,” the fund said…….“The relative importance of Deutsche Bank underscores the importance of risk management, intense supervision of G-SIBs and the close monitoring of their cross-border exposures,” the IMF said, adding it was also important to quickly put in place measures for winding down troubled banks.

This is a reminder of the worries about its derivatives book and its global links. It was hard not to think of that yesterday as rumours spread about Germany offering financial aid to Turkey.

As to the proposed merger with Commerzbank has everybody suddenly forgotten the problems of Too Big To Fail or TBTF banks?

With €1900bn in total assets, a merged Deutsche-Commerzbank would be the third-largest European bank after HSBC and BNP Paribas.  ( FT)

Oh and as to the question posed by etfmaven in the comments the experience in the credit crunch era is a pretty resounding no.

Do two lousy banks make one good one?

Shareholders of Commerzbank may also acquire a liking for the Pet Shop Boys.

What have I, what have I, what have I done to deserve this?
What have I, what have I, what have I done to deserve this?

 

Euro area money supply data looks worrying again

One of the features of the credit crunch era is that conventional economics not only clings at times desperately to theories that do not work but also looks the other way from ones which do. I have been reminded of that this morning as I look at the money supply data for the Euro area and note that there is not many of us who publicise it on social media. That is a shame as it has been working pretty well as a signal for economic trends in recent times. The experiments of the 1980s especially in the UK where money supply data was taken very literally taught us to use it for broad trends rather than exact specifics. But the broad trends have sent accurate signals which brings us to this mornings clues as to what will happen next in the Euro area?

Broad Money

From the European Central Bank or ECB.

The annual growth rate of the broad monetary aggregate M3 decreased to 4.0% in July 2018 from 4.5% in
June, averaging 4.1% in the three months up to July.

So the opening salvo returns us to thoughts of an economic slow down. If we look back for a general trend we see that the monetary stimulus lifted M3 growth to around 5% and it rumbled on around that sort of growth in 2016 and 17 with several peaks at 5.2% the most recent being last September. But December 2017 gave a warning as growth fell to 4.6% and this year has seen a clear dip especially when growth fell below 4% in March and April. June gave a hint of a recovery and ironically has been revised up to 4.5% but July has sunk back to 4%.

The rule of thumb is that looking ahead this is the trend for nominal GDP growth which provokes an awkward thought. If 4% is the new trend and the ECB hits its 2% inflation target as it is roughly doing now then annual GDP growth should also be 2%. So the “Euroboom” will continue to fade. Also of note is the fact that in 2016/17 the ECB achieved a level of broad money growth which would be consistent with nominal GDP growth of 5% which we have seen several Ivory Towers make a case for. That may well have been the signal used for deciding the amount of QE bond purchases and other credit easing.

The overall growth can be broken down as follows.

 the annual growth rate of M3 in July 2018 can be broken down as follows: credit to the private sector contributed 3.3 percentage points (up from 3.2 percentage points in
June), credit to general government contributed 1.4 percentage points (down from 1.5 percentage points),
longer-term financial liabilities contributed 0.7 percentage point (down from 0.8 percentage point), net
external assets contributed -0.7 percentage point (down from -0.4 percentage point), and the remaining
counterparts of M3 contributed -0.8 percentage point (down from -0.6 percentage point).

I would counsel taking care with such numbers as this sort of mathematical economics is always advanced confidently by its proponents who in my experience become somewhat elusive when as happens so often it ends in tears.

Narrow Money

This is usually a much more direct line of impact on the economy of say a few months ahead as opposed to the a year plus of broad money. Accordingly this month’s release is not optimistic.

The annual growth rate of the narrower aggregate M1, which comprises currency in circulation and overnight deposits, decreased to 6.9% in July from 7.5% in June.

This is the lowest number for the series so far in this phase eclipsing the 7% of April. Overall the annual rate of growth has been falling for a while now. The double-digit growth of late 2015 and early 2016 drifted into single digits but it has been this year where a clear move lower has been seen. The 8.8% of January was followed by 8.4% and 7.5% and now we seem to be circa 7%.

The difference?

People ask for breakdowns and definitions of the above so here we go.

  • M1 is the sum of currency in circulation and overnight deposits;
  • M2 is the sum of M1, deposits with an agreed maturity of up to two years and deposits redeemable at notice of up to three months; and
  • M3 is the sum of M2, repurchase agreements, money market fund shares/units and debt securities with a maturity of up to two years. (ECB)

Putting that into numbers at the end of July M1 was 8050 billion Euros of which 1136 billion was cash/currency and the rest was overnight deposits. Moving to M2 brings us up to 11,486 billion Euros as we add in time deposits and more technical additions brings us to 12,130 billion Euros.

Negative Interest-Rates

The financial media often points us to the 0% current account rate of the ECB and looks away from the -0.4% deposit rate but some find it applying to them. From Handelsblatt.

Frankfurt Starting in September, Hamburger Sparkasse (Haspa) intends to charge private customers a fine of 0.4 percent for deposits of more than € 500,000. This applies to checking and overnight money accounts. The second largest German savings bank after Berlin reacts to the European Central Bank (ECB) , which in turn charges the banks negative interest-rates , which park money at short notice.

Handelsblatt goes on to tell us that around a dozen savings institutions are now applying negative interest-rates. There has been a slow spread of this since the first one to break ranks did so in the summer of 2016. This reinforces our theme that banks are in fact very nervous about what would happen to deposits if they fully applied negative interest-rates which has mean that relatively few have applied them. Also the way that they are usually applied to larger deposits means they are particularly afraid of applying them to the European equivalent of Joe Sixpack. In addition a lesson from the mortgage rates we looked at on Friday is that banks soon adjust margins to keep them out and usually well out of the negative zone as well.

Thus the fears about the profitability of “the precious” have proved mostly unfounded and in my opinion negative interest-rates would need to go deeper to change this. Past say -1% towards -2%.

Comment

The monetary data suggests not only that the “Euroboom” is over but that the trajectory looks downwards. As it happens that seems to coincide with monetary data for elsewhere in the world for July so a general trend may be in play as we wait a day or two for the UK data. For the ECB and its President Mario Draghi this has a couple of elements. The elephant in the room today has been the reduction in the QE ( Quantitative Easing) bond purchases which have fallen to 15 billion Euros a month from a peak of 60 billion. That has been a factor in the monetary slowing although how much puts us in a chicken and egg situation as it should be crystal clear but rarely is.

In a technical sense that may suit the ECB as it can slap itself on the back for its role in the better economic growth phase for the Euro area. But also it revives my argument that there has been an element of junkie culture here because if growth fades away as the sugar supply is reduced then all the talk of reform fades away too. With Germany running a fiscal surplus it will be less easy to fire up the QE engine looking forwards as there will be fewer bunds to buy and many are have remained at negative yields. There may well of course be plenty of Italian bonds to buy but that is a potential road to nowhere for the ECB.

Looking ahead the battle has begun to be the next ECB President but as the Bank of England may be about to show the earth can move in mysterious ways.

Carney reportedly asked to remain governor of BOE until 2020 ( @RANsquawk )

Although the ECB itself seems keen to emphasise other matters.

Welcome to the Netherlands house price boom 2018 version

As many of the worlds central bankers enjoy the delights of the Jackson Hole conference it is time for us to look what might be regarded as a measuring stick of their interventions. To do so we travel across the channel and take a look at the housing market in the Netherlands which was described like this on Tuesday.

In July 2018, prices of owner-occupied houses (excluding new constructions) were on average 9.0 percent higher than in the same month last year. The price increase was slightly higher than in the preceding months. House prices were at an all-time high in July 2018, according to the price index of owner-occupied houses, a joint publication by Statistics Netherlands (CBS) and the Land Registry Office (Kadaster).

So we see an acceleration as well as an all-time high in price terms and it is hard not to have a wry smile at this being the nation must famous for Tulips. Anyway for those who have not followed this particular saga it has been far from a story of up,up and away.

House prices reached a record high in August 2008 and subsequently started to decline, reaching a low in June 2013. The trend has been upward since then.

The timing of the change is a familiar one as that coincides pretty much with the turn in the UK. Although the exact policy moves were different his provokes the thought that central bankers were thinking along not only the same lines but at the same time. Of course there were differences as for example the Bank of England introducing the house price friendly Funding for Lending Scheme and Mario Draghi announcing “Whatever it takes ( to save the Euro) in the summer of 2012, followed by a cut in the deposit rate to 0% at the July meeting. As to synchronicity it was raised at the ECB press conference.

And my second question is: China also cut rates today and we had further stimulus from the Bank of England. We were just kind of wondering about, you know, how much coordination was involved. Was there any sort of contact between you and the People’s Bank of China and the Bank of England?

Actually the ECB move was more similar to the Bank of England’s actions than in may have first appeared as it too was subsiding the “precious”

 One is the immediate effect on the pricing of the €1 trillion already allotted in LTROs.

That sort of thing tends to lead to lower mortgage interest-rates so let us move onto the research arm of the Dutch central bank the DNB.

Average mortgage interest rates charged by Dutch banks have been declining for some time. Between January 2012 and May 2018, average rates fell by around two percentage points.

Actually the fall was pretty much complete by the autumn of 2016 and since then Dutch mortgage rates have been ~2.4%. That pattern was repeated in general across the Euro area so we see like in the UK mortgage rates were affected much more by what we would call credit easing ( LTROs etc in the Euro area) than by QE which inverts the emphasis placed on the two by the media. Also slightly surprisingly Dutch mortgage rates are higher than the Euro area average which according to the DNB are topped and tailed like this.

Rates vary widely across the euro area, however, with the lowest average rates currently being charged in Finland (0.87%) and the highest in Ireland (3.11%).

In case you are wondering why we also get an explanation which will set off at least some chuntering amongst Irish readers.

Households in Finland tend to opt for mortgages with a short fixed interest period, in which the rates are linked to Euribor. Irish banks charge relatively high margins when setting mortgage interest rates.

 

Saving the Dutch banks?

You may wonder at the mimicking of Mario Draghi’s words but if we step back in time there were plenty of concerns as house prices fell from 120.9 for the official index in August 2008 to 95 in June 2013. Consider the impact on the asset base of the Dutch banking sector is we add in this from the DNB.

Almost 55% of the aggregate Dutch mortgage debt consists of interest-only and investment-based mortgage loans, which do not involve any contractual repayments during the loan term. They must still be repaid when they expire, however.  ( October 2017).

Actually it was worse back then.

. Since 2013, the aggregate interest-only debt has decreased by over EUR 30 billion, and it currently stands at some
EUR 340 billion………. Between 1995 and 2012, virtually none of the mortgage loans taken out involved any contractual repayments during the loan term.

Also back then it was permitted to have loans of more than 100% of the value of the property so the banks faced lower house prices with an interest-only mortgage book some of which had loans larger than the purchase price. What could go wrong?

Several years ago, the economic
slowdown and the housing market correction were mutually reinforcing.

As to the level of debt well that is high for the Dutch private sector according to the DNB.

 In the third quarter of 2017, household and corporate debt came to 106% and 120% of GDP respectively, which is high from an international perspective.

Comment

The “Whatever it takes” saga is usually represented as a move to bail and indeed bale out places like Greece,Ireland, Portugal and Spain and that was true. But it is not the full story because some northern European countries had previously behaved in what they would call a southern European manner and the Netherlands was on that list. We have seen already how the central bank described the housing markets troubles as being in a downwards spiral with the overall economy so let us see if that is true on the other side of the coin. Now house prices are booming what is going on in the economy?

According to the first estimate conducted by Statistics Netherlands (CBS) based on currently available data, gross domestic product (GDP) expanded by 0.7 percent in Q2 2018 relative to the previous quarter…….According to the first estimate, GDP was 2.9 percent up on the same quarter in 2017.  ( Statistics Netherlands )

How very British one might say. If you were thinking of areas in the economy affected by the housing market well……

Output by construction companies showed the strongest growth in Q2 2018………Investments in residential property, commercial buildings, infrastructure and machinery increased in particular.

Also higher house prices and possible wealth effects?

In Q2, consumers spent well over 2 percent more than in Q2 one year previously. For 17 quarters in a row, consumer spending has shown a year-on-year increase.

So the housing market turned and then consumption rose. Of course correlation does not prove causation and other factors will be at play but should Mario Draghi read such numbers his refreshing glass of Chianti will taste even better.

Is this an economic miracle? The other side of the coin is represented by Dutch first time buyers who will be increasingly squeezed out especially in the major cities. There we see something familiar as international investors snap up property ahead of indigenous buyers just like London and so many other cities have seen. The official story is familiar too as they are told because of lower mortgage rates affordability is fine but of course the capital burden relative to income rises and that matters more in a country where interest-rate only mortgages are still 40% of new borrowing. At least most borrowing seems to be fixed-rate now but more fundamentally as we look at this we see a familiar refrain which is can any meaningful rise in interest-rates be afforded now? On that road we see why Mario Draghi has kicked any such discussion into the lap of his successor.

 

 

 

Where next for US monetary policy?

So much of the economic news in 2018 has related to developments in the US economy. In particular monetary policy as the world has found itself adjusting to what is called these days a “normalisation” of policy in the United States. To my mind that poses the immediate question of what is normal now? I am sure we can all agree that monetary policy has been abnormal over the past decade or so but along that path it has also begun to feel normal. People up to the age of ten will know no different and if we allow some time to be a child maybe even those at university regard what we have now as normal. After all they will have grown up in a world of low and then negative interest-rates. The media mostly copy and paste the official pronouncements that tell us it has been good for us and “saved” the economy.

I am thinking this because the US Federal Reserve last night gave a hint that it thinks something else may be the new normal.

The staff provided a briefing that summarized its analysis
of the extent to which some of the Committee’s monetary
policy tools could provide adequate policy accommodation
if, in future economic downturns, the policy
rate were again to become constrained by the effective
lower bound (ELB)

This begs various questions of which the first is simply as we have just been through the biggest trial ever of such policies surely they know them as well as they ever will? Next comes another troubling thought which is the rather odd theory that you need to raise interest-rates now so that you have room to cut them later. This is something which is not far off bizarre but seems to be believed by some. Personally I think you should raise interest-rates when you think there are good reasons for doing so as otherwise you are emulating the Grand Old Duke of York. Also there are costs to moving interest-rates so if you put them up to bring them down you have made things worse not better.

You may also note that the Zero Lower Bound or ZLB  has become the ELB with Effective replacing zero. Is there a hint here that the US would be prepared to move to negative interest-rates next time around? After all we exist in a world where in spite of the recorded recovery we still have negative interest-rates in parts of Europe and in Japan. Indeed the -0.4% deposit rate at the ECB has survived what the media have called the “Euroboom”.

Effective Lower Bound

There are some odd statements to note about all of this. For example.

Accordingly,in their view, spells at the ELB could become
more frequent and protracted than in the past, consistent
with the staff’s analysis.

Seeing as we have been there precisely once what does “more frequent” actually mean? Also considering how long we were there the concept of it being even more protracted is not a little chilling if we consider what that implies. Also this next bit is not a little breathtaking when we consider the scale of the application of the policy “toolkit”

They also emphasized that there was considerable uncertainty about the economic effects of these tools. Consistent with that view, a few participants noted that economic researchers had not yet reached a consensus about the effectiveness of unconventional policies.

I do not know about you but perhaps they might have given that a bit more thought before they expanded the Federal Reserve balance sheet to above 4 trillion dollars! As to possible consequences let me link two different parts of their analysis which would give me sleepless nights if I had implemented such policies.

A number of participants indicated that there might be significant costs associated with the use of unconventional policies……….. That decline was viewed as likely driven by various factors, including slower trend growth of the labor force and productivity as well as increased demand for safe assets.

Policy Now

This is the state of play for interest-rates.

The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity,

How far? Well Robert Kaplan of the Dallas Fed gave a road map on Tuesday.

With the current fed funds rate at 1.75 to 2 percent, it would take approximately three or four more federal funds rate increases of a quarter of a percent to get into the range of this estimated neutral level.

At this stage, I believe the Federal Reserve should be gradually raising the fed funds rate until we reach this neutral level.

So circa 2.5% is the target and that seems to have been accepted by the bond market as we see the ten-year Treasury Note yield at 2.82% and the thirty-year Treasury Bond yield at 2.98%. When you read about the “yield curve” and in particular reports of it being flattish this is what they mean as we have a difference of a bit over 1% between the official interest-rate and the thirty-year bond.

There has been a lot of discussion about what this means but to my mind it simply means that the bond market has figured out where the US Federal Reserve intends to send interest-rates and has set prices in response. It will have noted the problems abroad that the interest-rate rises have contributed too and the discussions about possible future cuts and adjusted yields downwards. Whether that turns out to be right or wrong is a matter of opinion but to my mind whilst we have QT now ( the Federal Reserve balance sheet is being shrunk albeit relatively slowly) regular readers will be aware I think there are scenarios where interest-rates go up and the QE purchases begin again. Some such thoughts were perhaps on the mind of Robert Kaplan on Tuesday.

Despite the fact that the current economic expansion is the second longest in the postwar period, U.S. government debt held by the public now stands at 75.8 percent of GDP, and the present value of unfunded entitlements is estimated at approximately $54 trillion. The recent tax legislation and bipartisan budget compromise legislation are likely to exacerbate these issues. As a consequence of this level of debt, the U.S. is much less likely to have the fiscal capacity to fight the next recession.

Notice the reference to US debt held by the public which of course omits the holdings by the Fed itself.

Comment

There is a fair bit to consider here and so far I have left out two factors. The first is the Donald who has expressed a dislike for interest-rate rises but so far on a much more minor scale than say President Erdogan in Turkey. Next is the issue of the Dollar which is two-fold as in its exchange-rate and how many of them there are to go around. As to the dollar exchange rate then stormy times for the US President seem to have capped it for the short-term. But as to quantity the era of QT seems unsurprisingly to have reduced the supply around the world and therefore contributed to troubles in places which relied on there being plenty of them.

This brings us to the Jackson Hole symposium which starts today where central bankers gather to discuss what to do next. For example back in 2012 Micheal Woodford gave a speech about Forward Guidance which has now become an accepted part of the “toolkit”. Central bankers seem to inhabit a world where it is not a laughing-stock and instead is avidly received and listened to by an expectant population. This time around the official story is of “normalisation” as even the unreliable boyfriend has raised interest-rates albeit only a nervous once. Also the Swedes are again promising to reduce their negativity although that has become something of a hardy perennial.

But in the backrooms I suspect the conversation will shift to “what do we do next time?” when the next recession hits and for the market aware that may be added to by the recent price behaviour of Dr,Copper. On such a road the normalisation debate may suddenly become an Outkast.

I’m sorry, Ms. Jackson, I am for real
Never meant to make your daughter cry
I apologize a trillion times