How is the Swedish experiment going?

These days the headline above no doubt has you thinking about an alternative approach to the Coronavirus pandemic. However, I would also like to remind you that Sweden was at the fore front of applying negative interest-rates to a country and in addition applied them into something of an economic boom. Or if you prefer they applied exactly the reverse of the old saying that the job of a central banker is to take away the punch bowl as the party gets going. Instead they decided to give it a refill.

The first perspective is that for all the past talk of a different approach they now seem to be in the same boat as the rest of us.

During the summer, a recovery was initiated, but in recent months the spread of infection has increased again and restrictions have been tightened in many countries. This setback shows the great uncertainty that the global economic recovery is still facing. The economic prospects for Sweden and abroad have been revised down, and the economy is expected to weaken again in the near term ( Riksbank)

Where do we stand?

This morning Sweden Statistics has updated us.

GDP increased by 4.9 percent in the third quarter, seasonally adjusted and compared with the second quarter. The recovery was mainly driven by increased exports of goods and household consumption following the historic decline in the second quarter. Calendar adjusted and compared with the third quarter of 2019, GDP decreased by 2.5 percent.

This is a relatively good performance compared to what we have become used to and as the paragraph above notes has been driven by this.

Household final consumption increased by 6.3 percent. Consumption of transports, as well as hotel and restaurant services contributed most to this increase……..Exports increased by 11.2 percent and imports increased by 9.2 percent. Overall, net exports contributed upwards to GDP growth by 1.1 percentage points.

The return of the hospitality sector boosted many economies in the third quarter and I note Sweden benefited from trade. Although if we look at the trade detail the numbers were heavily affected by the oil price.

Exports of mineral fuels and electric current decreased by 40 percent in value and by 10 percent in volume. The large difference between the value and volume trends is due to lower prices on petroleum products……….Imports of crude petroleum oils decreased by 45 percent in value and by 17 percent in volume.

The story shifts a little if we take a look at Sweden’s Nordic peers. This morning we have also learnt some more about Finland.

According to Statistics Finland’s preliminary data, the volume 1) of Finland’s gross domestic product increased in July to September by 3.3 per cent from the previous quarter. Compared with the third quarter of 2019, GDP adjusted for working days contracted by 2.7 per cent.

So for all the talk of differences of approach in fact the annual economic change in Finland and Sweden is well within the margin of error. Maybe the real difference here is that they have populations which are spread out.

Looking Ahead

We see that the retail sector saw some growth in October.

In October, the retail trade sales volume increased by 0.5 percent, compared with September 2020. Retail sales in durables increased by 0.9 percent and retail sales in consumables (excluding Systembolaget, the state-owned chain of liquor stores) increased by 0.1 percent.

This meant that the annual picture looked healthy.

In October, the year-on-year growth rate in the volume of retail sales was 3.6 percent in working-day adjusted figures. Retail sales in durables increased by 4.8 percent and retail sales in consumables (excluding Systembolaget) increased by 0.7 percent.

However that was then and this is now according to the Riksbank.

The growth forecasts for the coming six months
have therefore been revised down…. However, high-frequency data show signs that demand is now slowing down again…….GDP is expected to decline again during the fourth quarter and the situation on the labour market to deteriorate further. The forecast assumes that GDP growth will decline also for the first quarter of next year before it
picks up again both abroad and in Sweden during the second quarter.

The Swedes seem yo be preparing for a rough start to next year which does differentiate them as most have yet to get past a contraction in this quarter.

The Riksbank Response

You might think as an enthusiast for negative interest-rates the Riksbank would have rushed to deploy them in 2020. But we have got something rather different.

The repo rate is held unchanged at zero per cent and is expected to remain at this level in the coming years.

So they have cast aside a past central banking orthodoxy but joined in with a new one.The latter is the plan to apply ZIRP ( in this instance literally at 0%) and to say interest-rates will stay there for some years. So not quite as explicit as the US Federal Reserve which has guided towards a period of 3 years but essentially the same tune. The abandoned orthodoxy is the enthusiasm for negative interest-rates which leaves the Riksbank with quite a lot of egg on its face. After all they have applied negative interest-rates in a boom. Then raised them in a period of economic weakness ( unemployment was rising pre pandemic). Now they do not use them in a clear example of a depression.

By contrast they are more than happy to support any borrowing by the Swedish government.

To improve the conditions for a recovery, the Executive Board has decided to expand the envelope for the asset purchases by SEK 200 billion, to a total nominal amount of up to SEK 700 billion, and to extend the asset purchase programme to 31 December 2021. The Executive Board has also decided to increase the pace in the asset purchases during the first quarter of 2021, in relation to the fourth quarter of 2020.

They have also decided to interfere in the private-sector as well.

The Executive Board has moreover decided that the Riksbank will only offer to buy corporate bonds issued by companies deemed to comply with international standards and norms for sustainability.

So another central bank sings along with The Kinks.

And when he does his little rounds
‘Round the boutiques of London Town
Eagerly pursuing all the latest fads and trends
‘Cause he’s a dedicated follower of fashion

If they were an army this would be called mission creep.

Comment

As you can see the Riksbank seems to have pretty much abandoned the interest-rate weapon it previously waved with such abandon. There is an additional nuance to this if we shift from the domestic to the external situation. The Krona has been rising against the Euro. There have been ebbs and flows but the 11.2 of March 2020 has been replaced by 10.2 now. If we note that the Euro has also been firm then the Krona has had a strong 2020 and it is interesting that the Riksbank is ignoring this. Perhaps it thought more QE would help, but as I pointed out earlier this week pretty much everyone is at that game.

But like elsewhere the Riksbank is keen to make borrowing cheaper for its government in a new twist on the word independent. With Sweden being paid to borrow ( ten-year yield is -0.13%) no doubt the government is suitably grateful.

 

 

Does money supply growth feed straight into house prices?

I thought that I would look at things today from a slightly different perspective or to quote the French man in The Matrix series we shall investigate some cause and effect. Let me give you the latest news on the effect.

In Q3 2020, the rise in prices of second-hand dwellings in France (excluding Mayotte) weakened: +0.5% compared to Q2 2020 (provisional seasonally adjusted results), after +1.4% in Q2 and +1.9% in Q1 2019.

Over a year, the rise in prices continued: +5.2%, after +5.6% and +4.9%. As observed since the end of 2016, this increase was more important for flats (+6.5% over the year) than for houses (+4.2%). ( Insee)

The reality of the situation arrives when you look at the overall pattern. We saw negative interest-rates introduced by the ECB in June 2014 and large-scale QE begin in March 2015. After several years of falling house prices we then saw French annual house price growth move into positive territory towards the end of 2015. Since then the rate of growth has tended to rise and is now above 5%. The ECB and Bank of France will of course be noting this down as Wealth Effects a plan which is aided and abetted by the Euro area measure of inflation which conveniently omits owner-occupied housing completely. Apparently the twenty odd years they have had to do something about this is not long enough or something like that.

If we bring this right up to date I am nit especially bothered by the decline in quarterly growth in house prices. After all the background environment is for house price falls and the monetary easing we are about to look at has prevented them so far. Or in an amusing irony we can quote the word “counterfactual” back at the central bankers.

Money Supply

The growth here remains stellar as we look at the measure most affected by all the easing.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, stood at 13.8% in October, unchanged from previous month.

This is a consequence of buying some 25.5 billion Euros of bonds under the original QE programme ( PSPP) and some 62 billion under the new emergency pandemic one or PEPP. Just to mark you cards looking ahead the latter seems to have accelerated recently from around 15 billion per week to around 20 billion in a possible harbinger of the ECB December decision.

This is a game the ECB has been playing since 2015 when it got M1 growth as high as 11.7% which was part of the push on house prices we looked at above. Annual growth had fallen to around 7% before the last act of Mario Draghi last autumn pushed it back above 8% and now the pandemic response pushed it into double-figures. There is another issue here which was described by Kate Bush.

Be running up that road
Be running up that hill
Be running up that building

The 13.8% growth in October is on a much larger amount. Indeed M1 passed 10 trillion Euros in size in October.

Broad Money

If we go wider in monetary terms we see a similar picture.

Annual growth rate of broad monetary aggregate M3 stood at 10.5% in October 2020, after 10.4% in September 2020

The pattern here is different as the previous moves had struggled to get annual growth much above 5% and now well you can see for yourself.Something of a wall of broad money going somewhere but not into the real economy. As you might expect some of this is the tsunami of narrow money.

Looking at the components’ contributions to the annual growth rate of M3, the narrower aggregate M1 contributed 9.4 percentage points (as in the previous month), short-term deposits other than overnight deposits (M2-M1) contributed 0.4 percentage point (as in the previous month) and marketable instruments (M3-M2) contributed 0.7 percentage point (up from 0.6 percentage point).

The ECB will be pleased with the last component of marketable instruments on two counts. Firstly it can point to it as a response to its actions. Secondly growth in such markets will no doubt lead to a growth in sinecures for past central bankers.

Things then get more awkward because it was only the day before yesterday we noted a  savings ratio of 13.5% in Germany on the third quarter. Well from the numbers below it looks as though businesses are saving too and doing it via their bank accounts.

From the perspective of the holding sectors of deposits in M3, the annual growth rate of deposits placed by households increased to 7.9% in October from 7.7% in September, while the annual growth rate of deposits placed by non-financial corporations decreased to 20.5% in October from 21.1% in September. Finally, the annual growth rate of deposits placed by non-monetary financial corporations (excluding insurance corporations and pension funds) decreased to 7.3% in October from 8.2% in September.

It might be more accurate to say they have received money they cannot spend yet as we see a shift in monetary transmission. This is one of the clearest examples of what in economics is called excess money balances I have ever seen. Except right now neither supposed consequence of growth and inflation can happen much.

Credit

With the various support schemes in place it is hard to know what these numbers are really telling us. We do get a pointer to something we know is happening.

The annual growth rate of credit to general government increased to 20.3% in October from 18.9% in September, while the annual growth rate of credit to the private sector stood at 4.9% in October, unchanged from the previous month.

Credit is flowing to governments and some of it is being passed on.

Comment

We can now look more internationally and see examples of monetary policy affecting asset prices. The United States has given us two examples this week alone.

US home prices climbed the most on record in the third quarter as historically low mortgage rates drove outsized demand, the Federal Housing Finance Agency said in a Tuesday report.

Prices gained 3.1% from their prior-quarter levels, according to the report. The jump also places prices 7.8% higher than their year-ago levels. A seasonally adjusted monthly index of prices gained 1.7% in September. ( Business Insider)

And this.

The Dow Jones Industrial Average hit 30000 for the first time on Tuesday, after a rally of more than 60% from its March lows. ( WSJ)

We can also look to Japan where this morning’s Nikkei 225 close at 26,537 compares with more like 8,000 when the Abenomics experiment began.

The catch is that in terms of money supply there are lots of leads and lags in the system. So we can see some things clearly such as the rise in French house price growth but in other areas the rain has not yet gone. For example the CAC-40 has surged in response to the monetary easing but like the UK FTSE 100 is well below past peaks. Of course another asset market which is French sovereign bonds has gone through the roof such that France is being paid to borrow ( ten-year yield -0.34%) in an example of a direct impact.

Switching to the real economy there will be greater lags right now as the Covid-19 restrictions and lockdowns crunch economies regardless of monetary growth. But if you think about it that only raises the inflationary risks and it is not only the Euro area that puts a Nelsonian blind eye to likely developments.

“The government’s plan to replace RPI with CPIH is a clear case of using the wrong tool for the job…” Our CEO @stianwestlake on the news that the RPI will be aligned to the CPIH in 2030 ( Royal Statistical Society)

Happy Thanksgiving.

What is happening to the economy of Germany?

As both the largest economy and indeed the bellweather for the Euro area Germany is of obvious importance. This morning has brought us more up to date in the state of play. Firstly the statistics office has continued to update its data on the quarter just gone.

WIESBADEN – The gross domestic product (GDP) rose by 8.5% in the third quarter of 2020 compared with the second quarter of 2020 after adjustment for price, seasonal and calendar variations. Thus, the German economy could offset a large part of the massive decline in the gross domestic product recorded in the second quarter of 2020 due to the coronavirus pandemic. However, the price-, seasonally and calendar-adjusted GDP was still 4.0% lower in the third quarter of 2020 thanin the fourth quarter of 2019, that is the quarter before the global coronavirus crisis.

That is an improvement of the order of 0.3% on what was previously thought. This does in fact give us a partial V-Shape as you can see below.

In the circumstances that is a reasonably good performance and the statistics office puts it like this.

For the whole EU, Eurostat released a preliminary result of -4.3% for the third quarter of 2020. The United States also recorded a strong decline of their gross domestic product (-2.9%, converted figure) compared with the third quarter of 2019. In contrast, year-on-year GDP growth as published by the People’s Republic of China amounted to 4.9% in the third quarter.

There is another context which is that the German economy had previously been struggling. This began with the 0.2% decline at the opening of 2018 which was claimed to be part of the “Euro Boom”. Economic growth was a mere 1.3% in 2018 which then slowed to 0.6% in 2019 so we can see that there were pre pandemic issues.

The Breakdown

I thought that I would switch to the labour market for this and an ongoing consequence for other areas.

The labour volume of the overall economy, which is the total number of hours worked by all persons in employment, declined even more sharply by 4.0% over the same period.

I am using a measure of underemployment as the international definition of unemployment has simply not worked. Next we can switch to wages.

According to first provisional calculations, the compensation of employees was down by just 0.7% year on year, while property and entrepreneurial income fell sharply by 7.8%. On average, gross wages and salaries per employee fell by 0.4%, while net wages and salaries rose slightly by 0.5%.

So we see a familiar situation of income being supported by the furlough scheme although outside it there has been quite a hit. But as there have been restrictions on spending we see a surge in saving.

According to provisional calculations, the savings ratio was 13.5% in the third quarter of 2020.

We wait to see what will be the full economic impact of a surge in involuntary saving but here is the flip side.

Household final consumption expenditure at current prices, however, showed a decrease of 4.0%.

What about now?

This morning has brought the latest update from the Ifo Institute.

Munich, November 24, 2020 – Sentiment among German managers has deteriorated. The ifo Business Climate
Index fell from 92.5 points in October to 90.7 points in November. The drop was due above all to companies’
considerably more pessimistic expectations. Their assessments of the current situation were also a little worse.
Business uncertainty has risen. The second wave of coronavirus has interrupted Germany’s economic recovery.

It is the services sector which has taken the brunt of this.

In the service sector, the Business Climate Index dropped noticeably. For the first time since June, it is back in
negative territory. Assessments of the current situation are much less positive than they were. Moreover,
substantially more companies are pessimistic about the coming months. The indicators for hotels and
hospitality absolutely nosedived.

The one area which has managed some growth is manufacturing.

This month’s bright spot is manufacturing. The business climate improved here, with companies assessing their
current situation as markedly better. Incoming orders rose, albeit more slowly than last month. However,
expectations for the coming months turned notably less optimistic.

Although as you can see the new restrictions due to Covid-19 have affected expectations. But the picture for the overall economy was that things continued to improve in October but have now reversed. So the vaccine news has not impacted expectations there yet and the V-Shape above will see at least a kink. The general view is similar to that given yesterday by the Matkit business survey.

New lockdown measures to curb the spread of
coronavirus disease 2019 (COVID-19) led to an
accelerated decline in services activity across
Germany in November, latest ‘flash’ PMI®
from IHS Markit showed. However, the country’s
manufacturing sector continued to exhibit strong
growth, helping to support overall economic activity.

They did however hint that the Far East is helping German manufacturing.

which the survey shows is
benefitting for growing sales to Asia in particular.

Financial Conditions

These remain extraordinarily easy. There is the -0.5% deposit rate of the ECB with the -1% interest-rate for the banks. Then there is the enormous amount of bond buying which under the original programme ( PSPP) totaled some 562 billion Euros at the end of October. It is a sign of the times that there is another buying programme as well as the ECB tries to muddy the waters and as of the end of September it had bought another 125 billion.

Today Germany issues a two-year bond and it will be paid to do so as the yield is -0.75% as I type this. Furthermore this yield has been negative for over 5 years now as that state of play looks ever more permanent. Indeed with the thirty-year at -0.16% the whole yield curve is negative.

Switching to the Euro exchange-rate things are not so bright. If we take a long-term context Germany joined to get a weaker exchange-rate. However in recent times it has been rising and the effective index is at 121.5 or 21% higher than when the Euro began. Whilst November has seen a dip the index started 2020 at 115.

Comment

The context is that at the end of the third quarter the German economy had grown by 2.7% compared to the 2015 benchmark. But the news restrictions mean that it has “And it’s gone” to quote South Park. There are vaccine hopes for 2021 now but 2020 looks like being a year to forget.

This brings us to the role of the ECB which is already heavily deployed. Can it respond to the latest dip? Not in any timely way as we note the lags in the system. Also for Germany there is not a lot more that can be done in terms of interest-rates or bond yields as all are heavily negative. The wheels of fiscal policy are being oiled by this as well. Looking at it like that only leaves us with the Euro exchange-rate. Can ECB President Lagarde fire a “bazooka” at that? As I pointed out yesterday looking at the UK with all central banks easing that is easier to say than do.

Meanwhile returning to the world of finance there is this.

FRANKFURT (Reuters) – Germany’s blue-chip DAX index will expand to 40 from the current 30 companies with tougher membership criteria, exchange operator Deutsche Boerse said on Tuesday.

In general a good idea as it is too narrow an index for an economy the size of Germany, especially in the light of this.

The most recent departure was payments company Wirecard, which in a blow to Germany’s capital markets, filed for insolvency just two years after its promotion to the index. The payments company owed creditors billions in what auditor EY described as a sophisticated global fraud.

The perils of indexation?

 

 

Can the UK afford all the extra debt?

I thought that it was time to take stick and consider the overall position in terms of the build up of debt. This has come with a type of economic perfect storm where the UK has begun borrowing on a grand scale whilst the economy has substantially shrunk.So an stand alone rise in debt has also got relatively much larger due to the smaller economy. Hopes that the latter would be short and sharp rather faded as we went into Lockdown 2.0. Although as we look to 2021 and beyond there is increasing hope that the pace of vaccine development will give us an economic shot in the arm.

In terms of scale we got some idea of the flow with Friday’s figures.

Public sector net borrowing (PSNB ex) in the first seven months of this financial year (April to October 2020) is estimated to have been £214.9 billion, £169.1 billion more than in the same period last year and the highest public sector borrowing in any April to October period since records began in 1993.

The pattern of our borrowing has changed completely and it is hard not to have a wry smile at the promises of a budget balance and then a surplus. Wasn’t that supposed to start in 2016? Oh Well! As Fleetwood Mac would say. Now we face a year where if we borrow at the rate above then the total will be of the order of £370 billion.

If we switch to debt and use the official net definition we see that we opened the financial year in April with a net debt of 1.8 trillion Pounds if you will indulge me for £500 million and since then this has happened.

Public sector net debt excluding public sector banks (PSND ex) rose by £276.3 billion in the first seven months of the financial year to reach £2,076.8 billion at the end of October 2020, or around 100.8% of gross domestic product (GDP); debt to GDP ratios in recent months have reached levels last seen in the early 1960s.

You nay note that the rise in debt is quite a bit higher than the borrowing and looking back this essentially took place in the numbers for April and May when the pandemic struck. Anyway if we assume they are now in control of the numbers we are looking at around £2.2 trillion at the end of the financial year if we cross our fingers for a surplus in the self assessment collection month of January.

The Bank of England

How does this get involved? Mostly by bad design of its attempts to keep helping the banks. But also via a curious form of accountancy where marked to market profits as its bond holdings are counted as debt.

If we were to remove the temporary debt impact of these schemes along with the other transactions relating to the normal operations of the BoE, public sector net debt excluding public sector banks (PSND ex) at the end of October 2020 would reduce by £232.9 billion (or 11.3 percentage points of GDP) to £1,843.9 billion (or 89.5% of GDP).

So on this road we look set to end the fiscal year with a net debt of the order of £2 trillion.

Quantitative Easing

This is another factor in the equation but requires some care as I note this from the twitter feed of Richard Murphy.

Outside Japan QE was unknown until 2009. Since then the UK has done £845 billion of it. This is a big deal as a consequence. But as about half of that has happened this year it’s appropriate to suggest that there have been two stage of QE, so far. And I suggest we need a third.

Actually so far we have done £707 billion if you just count UK bond or Gilt purchases. That is quite a numerical mistake.As we look ahead the Bank of England plans to continue in this manner.

The Committee voted unanimously for the Bank of England to continue with the existing programme of £100 billion of UK government bond purchases, financed by the issuance of central bank reserves, and also for the Bank of England to increase the target stock of purchased UK government bonds by an additional £150 billion, financed by the issuance of central bank reserves, to take the total stock of government bond purchases to £875 billion.

We see that this changes the numbers quite a lot. There are a lot of consequences here so let me this time agree with Richard Murphy as he makes a point you on here have been reading for years.

The first shenanigan is that the so-called independence of the Bank of England from the Treasury is blown apart by the fact that the Treasury completely controls the APF and the whole QE process. QE is a Treasury operation in practice, not a Bank of England one. ( APF = Asset Protection Fund)

Actual Debt Costs

These are extraordinarily low right now. Indeed in some areas we are even being paid to borrow. As I type this the UK two-year yield is -0.03% and the five-year yield is 0%. Even if we go to what are called the ultra longs we see that the present yield of the fifty-year is a mere 0.76%. To that we can add the pandemic effect on the official rate of inflation.

Interest payments on the government’s outstanding debt were £2.0 billion in October 2020, £4.4 billion less than in October 2019. Changes in debt interest are largely a result of movements in the Retail Prices Index to which index-linked bonds are pegged.

As an aside this also explains the official effort to neuter the RPI measure of inflation and make it a copy of the CPIH measure so beloved of the UK establishment via the way they use Imputed Rents to get much lower numbers. I covered this issue in detail on the 18th of this month.

So far this financial year we have paid £24.1 billion in debt costs as opposed to the £33.9 billion we paid in the same April to October period last year.

Comment

The elephant in the room here is QE and by using it on such a scale the Bank of England has changed the metrics in two respects. Firstly the impact on the bond market of such a large amount of purchases has been to raise the price which makes yields lower. That flow continues as it will buy another £1.473 billion this afternoon. Having reduced debt costs via that mechanism it does so in another way as the coupons ( interest) on the debt it has bought are returned to HM Treasury. Thus the effect is that we are not paying interest on some £707 billion and rising of the debt that we owe.

Thus for now we can continue to borrow on a grand scale. One of the ways the textbooks said this would go wrong is via a currency devaluation but that is being neutered by the fact that pretty much everyone is at the same game. There are risks ahead with the money supply as it has been increased by this so looking ahead inflation is a clear danger which is presumably why the establishment are so keen on defining it away.

I have left until the end the economy because that is so unpredictable. We should see some strength in 2021 as the vaccines kick in.But we have a long way to go to get back to where we were in 2008. On a collective level we may need to face up to the fact that in broad terms economic growth seems to have at best faded and at worst gone away.

Podcast

 

 

The UK shopper strikes yet again!

This morning has brought an example of something which is both remarkable and familiar. You might argue that you cannot use those two words together but 2020 is a year that continues to defy convention. What I am referring too is more good news for the UK economy from this sector.

In October 2020, retail sales volumes increased by 1.2% when compared with September; the sixth consecutive month of growth in the industry.

This means that the annual picture looks really rather rosy too.

In October, the year-on-year growth rate in the volume of retail sales saw a strong increase of 5.8%, with feedback from a range of businesses suggesting that consumers had started Christmas shopping earlier this year, further helped by early discounting from a range of stores.

In recent times the pattern has changed with for example Black Friday being in a week’s time and there is also Cyber Monday. Some Black Friday offers seem to have already started, if the advertising I see is any guide. So the structure underlying seasonal adjustment has been changing and maybe there has been another shift this year. Thus there may be a hangover from these numbers but we simply do not know how much it will be?

If we try to compare we the period pre the pandemic we see another strong recovery and then boom.

Looking at October’s total retail sales values (excluding fuel), which is a comparable measure to our online series, sales increased by 7.9% when compared with February; driven by a strong increase in sales online at 52.8% in comparison to reduced store sales at negative 3.3%.

From all the deliveries I see happening the online numbers are hardly a surprise, but with Lockdown 2.0 now adding to the problems I fear for quite a bit of the high street.

So we do have a V-shaped recovery for one part of our economy and I guess the orders for the economics text books are already on their way to the printers.

What this has done is out the switch to the online world on speed with food sales seeing a particular boom. That will be fed by the stories that Covid-19 is being spread by supermarket visits.

In October, we can see that online sales for all sectors increased when compared with February. Online food sales nearly doubled, with an increase of 99.2% in comparison with food store sales, which saw a fall of 2.1%. Overall, total food sales increased by 3.4% when compared with February.

Clothing stores, with an overall decline of 14.0% in value sales, increased their online sales by 17.1% but saw the biggest fall in store sales at negative 22.1%.

The area which has most struggled does not really have an option for online sales.

In October, fuel sales still remained 8.8% below February’s pre-lockdown level, while car road traffic reduced by an average 14.2%.

Looking at the overall picture it is also a case of Shaun 1 Bank of England 0 because my case that lower prices lead to growth has got another piece of evidence in its favour.

This was the sixth consecutive month of growth resulting in value and volume sales 5.2% and 6.7% higher respectively than in February 2020, before coronavirus (COVID-19) lockdown restrictions were applied in the UK.

With value growth or if you prefer expenditure in Pounds lower than volume growth there has been disinflation or price falls combined with volume growth. For newer readers I first made the point formally on here on the 29th of January 2015.

Looking ahead that boost may now fade as October gave a hint of a change of trend.

All measures in the total retail sales industry saw an increase in October 2020. The monthly growth rate for value sales was 1.4% and for volume sales 1.2%.

It may take a while to note anything like that as Lockdown 2.0 will affect the December and particularly the November numbers.

Public Finances

These too were numbers that the forecasters got wrong by quite a bit. So today was yet another failure as Retail Sales were supposed to flat line and borrowing be much higher.

Public sector net borrowing (excluding public sector banks, PSNB ex) is estimated to have been £22.3 billion in October 2020, £10.8 billion more than in October 2019, which is both the highest October borrowing and the sixth-highest borrowing in any month since monthly records began in 1993.

Of course, we are borrowing extraordinary amounts so this is relatively good news rather than being outright good. As you can see below a more than half of the rise is extra central government spending.

Central government bodies are estimated to have spent £71.3 billion on day-to-day activities (current expenditure) in October 2020, £6.4 billion more than in October 2019; this growth includes £1.3 billion in Coronavirus Job Retention Scheme (CJRS) and £0.3 billion in Self Employment Income Support Scheme (SEISS) payments.

Also revenues have fallen and some of that is deliberate with the VAT and Stamp Duty cuts.

Central government tax receipts are estimated to have been £39.7 billion in October 2020 (on a national accounts basis), £2.7 billion less than in October 2019, with falls in Value Added Tax (VAT), Business Rates and Pay As You Earn (PAYE) income tax.

You might think that the balancing amount was local councils especially after the blow up in Croydon, which for those unaware is below.

Cash-strapped Labour-run Croydon Council has imposed emergency spending restrictions with “immediate effect”, the BBC has learned.

The Section 114 notice bans all new expenditure at Croydon Council, with the exception of statutory services for protecting vulnerable people.

A document seen by the BBC said “Croydon’s financial pressures are not all related to the pandemic”.

It is under a government review amid claims of “irresponsible spending”.

Section 114 notices are issued when a council cannot achieve a balanced budget. ( BBC News)

However the main other recorded component was the Bank of England at £2.8 billion. This is really rather awkward as it has not actually borrowed anything at all! But a Monty Python style method records it as such and it is the first time I can recall an issue I have regularly flagged about the national debt so explicitly affecting the deficit as well.

National Debt

So without further ado here is the misleading headline that much of the media has gone with today.

Public sector net debt (excluding public sector banks) rose by £276.3 billion in the first seven months of the financial year to reach £2,076.8 billion at the end of October 2020, £283.8 billion more than in October 2019.

This is misleading because it includes the activities of the Bank of England which are not debt. I am no great fan of the Term Funding Scheme but recording its £120 billion as all being debt is quite extraordinary and is a major factor leading to this.

If we were to remove the temporary debt impact of these schemes along with the other transactions relating to the normal operations of the BoE, public sector net debt excluding public sector banks (PSND ex) at the end of October 2020 would reduce by £232.9 billion (or 11.3 percentage points of GDP) to £1,843.9 billion (or 89.5% of GDP).

It makes quite a difference especially for fans of debt to GDP ratios as we go from 89.5% to “around 100.8% of gross domestic product” on this really rather odd road.

Comment

The continued growth of UK retail sales is good news as we see an area that has recovered strongly. This comes with two caveats. The first is that with out enthusiasm for imports it poses a danger for the trade figures. The second is that in a tear with so many changes I doubt any survey is completely reliable so we are more uncertain that usual.

Switching to the public finances and taking a deeper perspective we are posting some extraordinary numbers.

Public sector net borrowing (PSNB ex) in the first seven months of this financial year (April to October 2020) is estimated to have been £214.9 billion, £169.1 billion more than in the same period last year and the highest public sector borrowing in any April to October period since records began in 1993.

We seem set to keep spending more in some areas ( defence) but want to cut back in others ( public-sector pay) so all we can do at the moment is be grateful we can borrow so cheaply. Even the fifty-year Gilt yield is a mere 0.77% and as I have written before at these levels I would issue some one hundred year ones as the burdens are not going away anytime soon.

My theme that low inflation helps economies also gets support from the public finances.

Interest payments on the government’s outstanding debt were £2.0 billion in October 2020, £4.4 billion less than in October 2019. Changes in debt interest are largely a result of movements in the Retail Prices Index to which index-linked bonds are pegged.

The Bank of England never gets challenged as to why it keeps trying to raise our debt costs in this area. Also you see another reason why the establishment wants to neuter the Retail Prices Index ( RPI)

 

 

 

 

 

Where next for interest-rates and bond yields?

As we find ourselves in a phase where possible solutions to the Covid-19 pandemic are in the news, the economic consequences for 2021 are optimistic. For example, it looks as though it will mean the type of Lockdown the UK is experiencing will get less and less likely. That is a relief as the issue of the Lockdown strategy is that you end up in a repeating loop. The more hopeful reality does have potential consequences for interest-rates and some of this has been highlighted by Reuters.

LONDON (Reuters) – Expectations of interest rate cuts in some of the world’s biggest economies have melted within the space of a month on hopes a successful coronavirus vaccine will fuel a growth bounceback next year.

Why? Well in line with this from Bank of England Chief Economist Andy Haldane yesterday.

LONDON (Reuters) – Bank of England Chief Economist Andy Haldane said the economic outlook for 2021 was “materially brighter” than he had expected just a few weeks ago despite short-term uncertainty from a renewed COVID-19 lockdown in England.

Except as you can see the changes are in fact really rather minor in the broad scheme of things.

Between Nov. 5-9, a period when it became clear Democrat Joe Biden had won the U.S. election and Pfizer announced its vaccine news, eurodollar futures, which track short-term U.S. rate expectations, flipped to reflect expectations of 10 bps in rate hikes by Sept 2022.

Just the previous week, markets were predicting no changes. Futures now expect U.S. rates at 0.50% by September 2023, from 0.25% forecast a month previously.

At the ECB where rates are already minus 0.5%, a nine bps cut was expected by September 2021 but that is now slashed to only five bps.

After all the interest-rate cuts we see that the US is expected to increase interest-rates by a mere 0.25% over the next 3 years. That is a bit thin if you note the promises of economic recovery. But it is in line with one of my main themes which are that interest-rate cuts are for the now and are large whereas interest-rate rises are for some future date and are much smaller if they happen at all. For example Bank of England Governor Mark Carney provided Forward Guidance for interest-rate increases in the summer of 2013. It is hard not to laugh as I type that his next move was to cut them! There was a rise some 5 years or so later to above the original “emergency” level of 0.5% which rather contrasts with the cuts seen in March.

As to the ECB which hasn’t has any increases at all since 2011 there has been this today by its President Christine Lagarde.

While all options are on the table, the pandemic emergency purchase programme (PEPP) and our targeted longer-term refinancing operations (TLTROs) have proven their effectiveness in the current environment and can be dynamically adjusted to react to how the pandemic evolves.

So Definitely Maybe, although these days interest-rate cuts may not be widely announced as for example the present TLTROs allow banks access to funds at -1% as opposed to the more general -0.5% of the Deposit Rate.

Meanwhile

I did point out earlier that interest-rate cuts are for the here and now and they seem to be rather en vogue this morning starting early in the Pacific region.

BI Board of Governors Meeting (RDG) in November 2020 decided to lower the BI 7-Day Reverse Repo Rate (BI7DRR) by 25 bps to 3.75%, as well as the Deposit Facility and Lending Facility rates which fell by 25 bps, to 3.00% and 4.50%.

Bank Indonesia did not have to wait long for company as the central bank of the Philippines was in hot pursuit.

At its meeting on monetary policy today, the Monetary Board decided to cut the interest rate on the BSP’s overnight reverse repurchase facility by 25 basis points to 2.0 percent, effective Friday, 20 November 2020. The interest rates on the overnight deposit and lending facilities were likewise reduced to 1.5 percent and 2.5 percent, respectively.

Perhaps the Bank of  Russia fears missing out.

Russian Central Bank: Monetary Policy To Remain Accommodative In 2021…….Russian Central Bank: See Room For Further Rate Cuts But Not That Big.

Probably they are emboldened by the recent rise in the oil price which is a major issue for the Russian economy.

Indonesia

We looked at the Pacific region back in 2019 as an area especially affected by the “trade war” between the US and China. Some of that looks set to fade with the new US President but the Pacific now has another one.

China is digging in its heels as the trade spat between Canberra and Beijing continues, with officials laying responsibility for the tensions solely at Australia’s feet. ( ABC)

As well as the interest-rate cut Bank Indonesia is working to reduce bond yields.

As of 17 November 2020, Bank Indonesia has purchased SBN on the primary market through a market mechanism in accordance with the Joint Decree of the Minister of Finance and the Governor of Bank Indonesia dated April 16, 2020, amounting to IDR 72.49 trillion, including the main auction scheme, the Greenshoe Option (GSO) and Private Placement.

Primary purchases are unusual especially for an emerging market and another 385 trillion IDR have been bought via other forms of QE.

Philippines

The central bank gives us a conventional explanation around inflation as a starter.

Latest baseline forecasts continue to indicate a benign inflation environment over the policy horizon, with inflation expectations remaining firmly anchored within the target range of 2-4 percent. Average inflation is seen to settle within the lower half of the target band for 2020 up to 2022, reflecting slower domestic economic activity, lower global crude oil prices, and the recent appreciation of the peso. The balance of risks to the inflation outlook also remains tilted toward the downside owing largely to potential disruptions to domestic and global economic activity amid the ongoing pandemic.

But we all know that the main course is this.

Meanwhile, uncertainty remains elevated amid the resurgence of COVID-19 cases globally. However, the Monetary Board also observed that global economic prospects have moderated in recent weeks. At the same time, the Monetary Board noted that while domestic output contracted at a slower pace in the third quarter of 2020, muted business and household sentiment and the impact of recent natural calamities could pose strong headwinds to the recovery of the economy in the coming months.

Comment

As you can see the story about the end of interest-rate cuts has already hit trouble. Central bankers seem unable to break their addiction. I will have to do a proper count again but I am pretty sure we have now had around 780 interest-rate cuts in the credit crunch era. So it seems that the muzak played on the central bank loudspeakers will keep this particular status quo for a while yet.

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

There are issues as I noted on the 11th of this month as all the fiscal stimuli puts upward pressure on interest-rates. But the threshold for interest-rate cuts is far lower than for rises. Also we get cuts at warp speed whereas rises have Chief Engineer Scott telling us that the engines “cannae take it”

Putting it another way we have another example of a bipolar world where there may be drivers for higher interest-rates but the central banksters much prefer to cut them.This gets more complex as we see so many countries with or near negative interest-rates and bond yields.

It is a sign of the times that Bitcoin is doing so well

The past week or two has seen quite a rally in the price of Bitcoin and as I type this it is US $16.700. This gives various perspectives and let me open with a bit of hype, or at least what I think is hype.

An independent report from Citi Bank’s Managing Director argues that Bitcoin is the digital gold of the 21st century. The devaluation of the worlds’ reserve currency—the U.S. dollar—formed the basis of the commentary. ( Crypto.Com)

As a starter Citibank have suggested that the US Dollar will fall or depreciate by 20% which has created something of a stir in itself. There are bears around for plenty of currencies tight now as others suggested that the expected December move by the ECB might put the skids under the Euro. Both roads would look bullish for Bitcoin as it is an alternative. The Citibank view starts with a comparison with Gold post Bretton Woods.

With a relatively free currency market, gold’s price grew enormously for the next 50 years.

The monetary inflation and devaluation of the greenback are the basis of Fitzpatricks’ comparison of Bitcoin with gold. ( Crypto.Com)

This is then linked to what we have seen with Bitcoin.

Bitcoin move happened in the aftermath of the Great Financial crisis (of 2008) which saw a new change in the monetary regime as we went to ZERO percent interest rates.

The next step is this.

Fitzpatrick pointed out that the first bull cycle in Bitcoin from 2011 to 2013 when it increased by 555 times resulted from this.
Currently, the COVID-19 crisis and the government’s associated monetary and fiscal response are creating a similar market environment as gold in the 1970s. Governments have made it clear that they will not shy away from unprecedented money printing until the GDP and employment numbers are back up.  ( Crypto.Com)

He then applies his technical analysis.

“You look at price action being much more symmetrical or so over the past seven years forming what looks like a very well defined channel giving us an up move of similar time frame to the last rally (in 2017).”

Which leads to this.

Fitzpatrick did not stop there; his price prediction chart sees Bitcoin price at $318,000 by December 2021.  ( Crypto.Com)

That in itself will no doubt be contributing to the present rise as it puts us in what is called FOMO or Fear Of Missing Out territory.

The Economics

The issue of the money supply and its growth is an issue of these times whereas the situation for Bitcoin is different.

Bitcoin’s total supply is limited by its software and will never exceed 21,000,000 coins. New coins are created during the process known as “mining”: as transactions are relayed across the network, they get picked up by miners and packaged into blocks, which are in turn protected by complex cryptographic calculations. ( coinmarketcap.com)

So there are two differences. Firstly there is a cap and with the present number in circulation being 18.5 million it is not that far away. Secondly whilst there is growth the process of creation is likely to be slower rather than fiat money which as I am about to discuss has been rather up,up and away.

If we start with the world’s reserve currency which is the US Dollar I note a reference to money printing in the Citibank report which we could argue is QE.

Consistent with this directive, the Desk plans to continue to increase SOMA holdings of Treasury securities by approximately $80 billion per month……Similarly, the Desk plans to continue to increase SOMA holdings of agency MBS by approximately $40 billion per month. ( New York Fed)

So we have US $120 billion a month from the main two efforts where bonds are swapped for electronically produced money.

My preferred way of looking at this is the money supply and if we do that we see that in the year to the 2nd of this month the narrow measure of the US money supply has risen by 41% over the past year. This sort of measure used to be called high powered money although right now due to the plunge in velocity it is anything but. However it has been created and I also note that having gone through US $2 trillion in August the amount of cash in circulation is also rising and was US $2.04 trillion in October. So mud in the eye for those predicting its death,especially as we note the switches to using electronic money in retail. As the Belle Stars put it.

This is the sign of the times
Piece of more to come

If we go to the wider money supply measure called M2 we see that it has grown by 23.9% in the year to November 2nd. That is quite something for a number that is now just shy of 19 trillion. So there is a money supply argument in the background. We can add to it by noting fast rises in other types of fiat money. Japan has been at the game for some time and we have seen notable expansions in Euros and UK Pounds as well.

Interest-rates

There was a time that the lack of an interest-rate from Bitcoin was a weakness. The 0% compared unfavourably to what you could get in fiat currencies. After all pre credit crunch many of the major currencies provided interest-rates of 4 to 5%. But now life is very different as we have seen the US Federal Reserve cut interest-rates to just above 0%. Indeed in some cases now Bitcoin has a relative advantage because the spread of not only negative official interest-rates but of negative bond yields ( which total around US $17 trillion now) makes it look much more attractive than before.

Who would have thought that a 0% interest-rate would be attractive? But increasingly that is true.

Comment

When we look at something like this we see that it requires a combination of reality and psychology/belief. The former gets reinforced because as I have pointed out over the past decade the direction of travel has been both clear and consistent. This morning has seen an example of part of this journey.

Italy’s Ruling 5-Star: ECB Should Cancel Covid-Related Debt It Owns – Party Blog Doing So Would Be “Not Only Fair But Easily Achievable” ( @LiveSquawk )

These sort of proposals appear and will no doubt be denied and rejected. But in a year or two’s time past history suggests it may well be on the agenda and then get implemented. It is quite a cynical game but we see it played regularly and feeds into our “To Infinity! And Beyond” theme.

Also there will be demand from those looking to park what are considered to be ill gotten gains. The official response will be around crime but it is probably more likely to be another version of this.

Many Turkish companies and individuals bought foreign currency last week even as the lira registered its biggest weekly gain in almost two decades, Bloomberg reported, citing currency traders it did not identify. ( Ahval )

Turks are using the Lira rally as a chance to buy more US Dollars in a clear safe haven trade. People will disagree about how safe that is but there will be similar flows into Bitcoin. It has its own risks as we note the issues around security and the wide swings in price. The latter are something of an irony because they are exacerbated by a strength which is the supply restrictions and limit. But this is a time of risk in so many areas.

Another way of looking at the change in perception of Bitcoin is the way that central banks are now looking at Digital Coins in a type of spoiler move as it poses a potential challenge to their monopoly over money.

I will be particularly interested in reader’s thoughts on this topic

 

 

The ECB faces problems from the Euro area banks as well as fiscal policy

This morning has brought us up to date on the state of play at the European Central Bank. Vice President De Guindos opened his speech in Frankfurt telling us this about the expected situation.

The pandemic crisis has put great pressure on economic activity, with euro area growth expected to fall by 8% in 2020. ……The tighter containment measures recently adopted across Europe are weighing on current growth. With the future path of the pandemic highly unclear, risks are clearly tilted to the downside.

So he has set out his stall as vaccine hopes get a relatively minor mention. Thus he looks set to vote for more easing at the December meeting. Also he rather curiously confessed that after 20 years or so the convergence promises for the Euro area economy still have a lot of ground to cover.

The severity of the pandemic shock has varied greatly across euro area countries and sectors, which is leading to uneven economic developments and recovery speeds……..And growth forecasts for 2020 also point towards increasing divergence within the euro area.

Looking ahead that is juts about to be fixed, although a solution to it has been just around the corner for a decade or so now.

The recent European initiatives, such as the Next Generation EU package, should help ensure a more broad-based economic recovery across various jurisdictions and avoid the kind of economic and financial fragmentation that we observed during the euro area sovereign debt crisis.

He also points out there has been sectoral fragmentation although he rather skirts around the issue that this has been a policy choice. Not by the ECB but bu governments.

 Consumers have adopted more cautious behaviour, and the recent tightening of restrictions has notably targeted the services sector, including hotels and restaurants, arts and entertainment, and tourism and travel.

Well Done the ECB!

As ever in a central banking speech there is praise for the central bank itself.

Fiscal support has played a key role in mitigating the impact of the pandemic on the economy and preserving productive capacity. This is very welcome, notwithstanding the sizeable budget deficits anticipated for 2020 and 2021 and the rising levels of sovereign debt.

This theme is added to by this from @Schuldensuehner

 Jefferies shows that France is biggest beneficiary of ECB’s bond purchases. Country has saved €28.2bn since 2015 through artificial reduction in financing costs driven by ECB. In 2nd place among ECB profiteers is Italy w/savings of €26.8bn, Germany 3rd w/€23.7bn.

Care is needed as QE has not been the only game in town especially for Greece which is on the list as saving 2,2 billion Euros a year from a QE plan it was not in! It only was included this year. But the large purchases have clearly reduced costs for government and no doubt makes the ECB popular amongst the politicians it regularly claims to be independent from. But there is more.

While policy support will eventually need to be withdrawn, abrupt and premature termination of the ongoing schemes could give rise to cliff-edge effects and cool the already tepid economic recovery.

It is a bit socco voce but we get a reminder that the ECB is willing to effectively finance a very expansionary fiscal policy. That is why it has two QE programmes running at the same time, but for this purpose the game in town is this.

 The Governing Council will continue its purchases under the pandemic emergency purchase programme (PEPP) with a total envelope of €1,350 billion.

There was a time when that would be an almost unimaginable sum of money but not know as if government’s do as they are told it will be increased.

The purchases will continue to be conducted in a flexible manner over time, across asset classes and among jurisdictions.

Oh and there is a bit of a misprint on the sentence below as they really mean fiscal policy.

This allows the Governing Council to effectively stave off risks to the smooth transmission of monetary policy.

The Banks

These are a running sore with even the ECB Vice President unable to avoid this issue.

The pandemic has also weighed on the long-term profitability outlook for banks in the euro area, depressing their valuations. From around 6% in February of this year, the euro area median banks’ return on equity had declined to slightly above 2% by June.

Tucked away in the explanation is an admittal of the ECB’s role here so I have highlighted it.

The decline in profitability is being driven mainly by higher loan loss provisions and weaker income-generation capacity linked to the ongoing compression of interest margins.

The interest-rate cuts we have seen hurt the banks and this issue was exacerbated by the reductions in the Deposit Rate to -0.5% as the banks have been afraid of passing this onto the ordinary saver and depositor. Thus the Zero Lower Bound ( 0%) did effectively exist for some interest-rates.

This is in spite of the fact that banks have benefited from two main sweeteners. This is the -1% interest-rate of the latest liquidity programmes ( TLTROs) and the QE bond purchases which help inflate the value of the banks bond holdings.

Then we get to the real elephant in the room.

Non-performing loans (NPL) are likely to present a further challenge to bank profitability.

We had got used to being told that a corner had been turned on this issue even in Italy and Greece. Speaking of the latter Piraeus Bank hit trouble last week when it was unable to make a bond payment.

The non-payment of the CoCos coupon will lead to the complete conversion of the convertible bond, amounting to 2.040 billion euros, into 394.4 million common shares.

It is noted that the conversion will not involve an adjustment of the share price and simply, to the 437 million shares of the Bank will be added another 394.4 million shares at the price of 0.70 euros (closing of the share at last Friday’s meeting). ( Capital Gr).

There is a lot of dilution going on here for private shareholders as we note that this is pretty much a nationalisation.

The conversion has one month after December 2 to take place and the result will be the percentage of the Financial Stability Fund, which currently controls 26.4% of Piraeus Bank, to increase to 61.3%.

Meanwhile in Italy you have probably guessed which bank has returned to the news.

LONDON/MILAN/ROME (Reuters) – Italy’s Treasury has asked financial and legal advisers to pitch for a role in the privatisation of Monte dei Paschi BMPS.MI as it strives to secure a merger deal for the Tuscan lender, two sources familiar with the matter told Reuters on Friday.

The equivalent of a Hammer House of Horror production as we mull how like a financial vampire it keeps needing more.

Italy is seeking ways to address pending legal claims amounting to 10 billion euros (£9 billion) that sources say are the main hurdle to privatising the bank.

Even Colin Jackson would struggle with all the hurdles around Monte dei Paschi. Anyway we can confidently expect a coach and horses to be driven through Euro area banking rules.

If we look at the proposed solution we wonder again about the bailouts.

Although banks have stepped up cost-cutting efforts in the wake of the pandemic, they need to push even harder for greater cost efficiency.

So job losses and it seems that muddying the waters will also be the order of the day.

The planned domestic mergers in some countries are an encouraging sign in this regard.

A merger does reduce two problems to one albeit we are back on the road to Too Big To Fail or TBTF.

There is of course the ECB Holy Grail.

Finally, we also need to make progress on the banking union, which unfortunately remains unfinished. Renewed efforts are urgently required to improve its crisis management framework.

Just as Italy makes up its own rules….

Comment

We are now arriving at Monetary Policy 3.0 after number one ( interest-rates) and number two ( QE) have failed to work. In effect the role of monetary policy is to facilitate fiscal policy. It also involves a challenge to democracy as the technocrats of the ECB are looking to set policy for the elected politicians in the Euro area. However there are problems with this and somewhat ironically these have been highlighted by the Twitter feed of the Financial Times which starts with an apparent triumph.

Italy’s bond rally forces key measure of risk to lowest since 2018

So on a financial measure we have convergence. But if we switch to the real economy we get this.

‘There is no money left’: the pandemic’s economic impact is ‘a catastrophe’ for people in southern Italy who were already in a precarious situation

Switching to the banks we are facing the consequences of the Zombification of the sector as the same old names always seem to need more money. Although there has been more hopeful news for BBVA of Spain today albeit exiting the country where banks seem to be able to make money.

PNC to buy U.S. operations of Spanish bank BBVA for $11.6 billion ( @CNBC )

Although the price will no doubt if the speech above is any guide will be pressure to give a home to a Zombie or two.

Podcast

 

 

 

What are the consequences of bond yields rising further?

This week has brought an unusual development for the credit crunch era. Let me illustrate with an example of the reverse and indeed what we have come to regard as the new normal from last week.

AMSTERDAM, Nov 5 (Reuters) – Italy’s five-year bond yield turned negative for the first time on Thursday as uncertainty from the U.S. election supported government bonds in Europe.

Prima facie that seems insane but of course as I will explain later it is more complicated than that. That is for best when we add in this from Marketwatch on Monday.

Investors now pay Greece for the privilege of owning its debt, an incredible turnaround from its securities being the source of global financial instability a decade ago.

Greece’s three-year debt turned negative on Friday, and then the country received more good news after the surprise decision by Moody’s Investors Service on Friday night to upgrade the nation’s debt. The upgrade, from Ba3 from B1 previously, still leaves Greek debt in junk market territory, and three notches away from becoming investment grade.

The yield on Greek 10-year debt TMBMKGR-10Y, 0.834% fell 4 basis points to 0.77%. In 2012, the yield on Greek 10-year debt surpassed 35%.

Amazing in its own way and well done to investors who got their timing right in these markets. Although a large Grazie is due to Mario Draghi who set things in motion.

US Treasury Bonds

However there has been something of a contrary signal from the US bond market. There was a hint of something going on in what is called the Long Bond which is the thirty-year maturity. Some of you may recall at the height of the pandemic panic in financial markets in March the yield here dipped below 1%. This was driven by two factors.The first was a move to a perceived safe haven in times of trouble and US Treasury Bonds are AAA rated as well as being in the world’s reserve currency. Also there would have been some front-running of the expected bond buying or QE from the US Federal Reserve. It did indeed charge in like the US Cavalry with purchases at the peak of US $75 billion per day.

But around 2 weeks ago the mood music was rather different as the debate was then about whether the yield would break above the 1.6% level that market traders felt was significant. As the election results began to come in it did so and now we find it at 1.75%.

If we switch to the benchmark ten-year ( called the Treasury Note) we see a slightly delayed pattern but also a move higher. In fact it gave us a head fake as the initial response to the election was a rally leading to lower yields and we noted it at 0.72%. But there were ch-ch-changes on the way and now we see it is 0.96%. So perhaps on the cusp of what is called a big figure change should it make 1%.

Why does this matter?

The first reason is for the US economy itself and there is a direct line in from mortgage rates.

Over the course of the past few days, 10yr yields are up roughly 0.2%.  This time around, the mortgage market hasn’t been able to avoid taking its lumps with the average lender now quoting 30yr fixed rates that are 0.125% higher compared to last Thursday.    ( Mortgage Daily News)

The housing market has been juiced by ever lower and indeed record low mortgage rates up until now. The change will feed into other personal and corporate borrowing as well.

Next comes its role as the world’s biggest bond market with some US $21.1 billion and of course rising at play here. I will come back to the domestic issues but there is a worldwide role here.For example back in my days in the UK Gilt ( bond) market the beginning of the day was checking what the US market had done overnight before pricing in any UK changes. That theme will be in play around the world and in fact on spite of the Italian and Greek moves above we have seen it.

For the US there is the domestic issue of debt costs. These have been a pack of dogs that have not barked but with the increases in the size of the bond market and hence higher levels of borrowing and refinancing smaller moves now matter. We know that President Elect Biden wants to spend more and looked at this on the 5th of this month although there remains doubt over how much of it he will be able to get through what looks likely to be a Republican controlled Senate. Even before this here are the projections of the Congressional Budget Office.

Debt. As a result of those deficits, federal debt held by the public is projected to rise sharply, to 98 percent of GDP in 2020, compared with 79 percent at the end of 2019 and 35 percent in 2007, before the start of the previous recession. It would exceed 100 percent in 2021 and increase to 107 percent in 2023, the highest in the nation’s history.

Best I think to take that as a broad sweep as there are a lot of moving parts in the equations used.

Yield Curve Control

This is, as you can see, not going so well! We have looked at the Japanese experience as recently as Monday and in the US it would be a case of recycling a wartime policy.

In early 1942, shortly after the United States declared war, the Fed effectively abdicated its responsibility for monetary policy despite its concern about inflation and focused instead on helping the Treasury finance the conflict. After a series of negotiations with the Treasury, the Fed agreed to peg the Treasury-bill yield at 0.375 percent, to cap the critical long-term government bond yield at 2.5 percent, and to limit all other government securities’ yields in a consistent manner.  ( Cleveland Fed)

The Long Bond yield is still quite some distance from the 2.5% of back then but as I have already explained the situation is I think more exposed now.

Oh and there was a concerning consequence to this.

The Treasury, however, did not wish to relinquish its control over Fed monetary policy and only acquiesced to small increases in short-term interest rates starting in July 1947, after inflation had been hovering around 18 percent for a year. The Treasury believed that it could not possibly finance its unprecedented levels of public debt at reasonable interest rates without the Fed’s continued participation in the government-securities market; in its view, only unrealistically high interest rates could coax enough private-sector savings to finance the debt.

Comment

Let me now switch to what we might expect if we had free markets. The extra borrowing we have looked at would be pushing yields higher. Another influence would be the fact the real ( after inflation) bond yields are heavily negative unless you think US inflation will be less than 1% per year for the next ten years. Even then it is not much of a return, especially compared to the 5% in one day some equity markets have just provided. The reality is that bond markets provide the prospect of capital gains rather than interest right now.

Also the modern era provides something very different from free markets as the US Federal Reserve will be thinking at what point will it intervene? Or to be more precise at what point will it do so on a larger scale as it is already buying some US $80 billion per month of US treasury bonds. It was not so long ago that such amounts were considered to be a lot. The path to Yield Curve Control may be via bond yield rises now followed by its response. So the real question is what level will they think is too much? This quickly becomes an estimate of what they think the US government can afford? As they have become an agent of fiscal policy again.

 

It is party time at The Tokyo Whale as the Japanese stock market surges

Sometimes you have to wait for things and be patient and this morning has seen an example of that. If we look east to the and of the rising sun we see that it has been a while since it was at the level below.

Japan’s Nikkei 225 stock index closed on Friday at its highest level since November 1991 as individual investors bought up the shares of blue-chip companies at the expense of smaller, more speculative groups. The benchmark, which has been described by some analysts as a “barbarous relic” but remains the favourite yardstick of Japanese retail investors, was propelled to its 29-year high by resurgent stocks like Sony, SoftBank and Uniqlo parent Fast Retailing.

That is from the Financial Times over the weekend and its Japanese owners will no doubt be pointing out that it should be covering this morning’s further rally.

Investing.com – Japan stocks were higher after the close on Monday, as gains in the Paper & PulpRailway & Bus and Real Estate sectors led shares higher.

At the close in Tokyo, the Nikkei 225 rose 2.12% to hit a new 5-year high.

Curiously Investing.com does not seem to have spotted that we have not been here for much longer than 5 years. The market even challenged 25,000 but did not quite make it.

There was something familiar about this but also something new as the FT explained.

Mizuho Securities chief equity strategist Masatoshi Kikuchi said that the Nikkei’s move was driven by individual investors using leverage to magnify their potential returns and losses — a much larger and more active group since the Covid-19 pandemic restricted millions to their homes and prompted many to open online trading accounts.

The Japanese are savers and investors hence the Mrs. Watanabe stereotype but the gearing here reminds us of the Robinhood style investors in the US as well.

The Tokyo Whale

As ever if we look below the surface there has been much more going on and we can start at the Bank of Japan which regular readers will be aware has been buying equities for a while now.Also it increased its purchases in response to the Covid-19 pandemic in two ways. It did not just buy on down days and it also increased its clip size.

For the time being, it would actively purchase ETFs and J-REITs so that their amounts outstanding would increase
at annual paces with the upper limit of about 12 trillion yen and about 180 billion yen, respectively. ( Bank of Japan Minutes)

In October it bought 70 billion Yen’s worth on six occasions and on three days in a row from the 28th. If we recall that world stock markets were falling back then we find ourselves noting the most extreme version of a central bank put option for equity markets we have seen so far. Indeed this is confirmed in the Minutes.

With a view to lowering risk premia of asset prices in an appropriate manner, the Bank might increase or
decrease the amount of purchases, depending on market conditions.

What is appropriate and how do they decide? This morning’s summary of opinions release suggests that some at the Bank of Japan are troubled by all of this. The emphasis is mine.

It is necessary to continue with active purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) for the time being. However, given that monetary easing is expected to be prolonged, the Bank should further look for ways to enhance sustainability of the policy measure so that it will not face difficulty in conducting such purchases when a lowering of risk premia of asset prices is absolutely necessary.

As “monetary easing” has been going on for around 3 decades now it has already been very prolonged. I wonder on what grounds they would regard it as “absolutely necessary” to reduce the value of its large equity holdings. As of the end of October it had bought some 34,771,759,339,000 Yen of it.

Rather curiously the Bank of Japan share price has not responded to the rise in value of its equity holdings. Yes it was up 1.9% today to 26,780 but that is a long way short of the 220,000 or so of November 1991.

The Bank is a juridical person established based on the Bank of Japan Act. Its stated capital is 100 million yen. The issued share capital is owned by the government (55 percent) and the private sector (45 percent).

Abenomics

There is something of an irony in this landmark being reached after Prime Minister Abe has left office. Because as well as the explicit equity buying effort above there were a lot of implicit boosts for the equity market from what became called Abenomics. Back in November 2012 I put it like this.

Also the Japanese stock market has had a good couple of days in response to this and has got back above the 9000 level on the Nikkei 225 at a time when other stock markets have fallen.

As you can see the market has been singing along to Chic in the Abenomics era.

Good times, these are the good times
Leave your cares behind, these are the good times
Good times, these are the good times
Our new state of mind, these are the good times
Happy days are here again
The time is right for makin’ friends.

We have seen interest-rates reduced into negative territory and the Bank of Japan gorge itself on Japanese Government Bonds both of which make any equity dividends more attractive. Also there was the Abenomics “arrow” designed to reduce the value of the Japanese Yen and make Japan’s exporters more competitive. Often the Japanese stock market is the reverse of that day’s move in the Yen but in reverse so Yen down means stick market up.

The latter gave things quite a push at first as the exchange-rate to the US Dollar went from 78 into the mid 120s for a while. However in more recent times the Yen has been mimicking The Terminator by saying “I’ll be back” and is at 103.60 as I type this. There is a lot of food for thought here on the impact of QE on a currency but for our purposes today we see that the currency is weaker but by much less than one might have thought.

Comment

The Japanese stock market has recently received boost from other influences. For example what is becoming called the “Biden Bounce” has seen the Nikkei 225 rally by around 8% in a week. Also this morning’s data with the leading indicator for September rising to 92.9 will have helped. But also we have seen an extraordinary effort by the Japanese state to get the market up over the past 8 years. In itself it has been a success but it does raise problems.

The first is that Japan’s economic problems have not gone away as a result of this. Even if we out the Covid pandemic to one side the economy was struggling in response to the Consumption Tax rise of last autumn. The official objective of raising the inflation rate has got no nearer and the “lost decade” rumbles on. The 0.1% have got a lot wealthier though.

Then there is the issue of an exit strategy, because if The Tokyo Whale stops buying and the market drops there are two problems. First for the value of the Bank of Japan’s holdings and next for the economy itself. So as so often we find ourselves singing along with Elvis Presley.

We’re caught in a trap
I can’t walk out
Because I love you too much, baby

Meanwhile on a personal level I recall these days as I worked for Barings pre collapse.

Baring Nikkei options in the money now! ( @WildboyMarkets)

Indeed I had an indirect role as there were 4 of us on the futures and options desk and we feared trouble and left. So they promoted Nick Leeson from the back office and what happened next became famous even leading to a film.

Podcast