We are now facing a reality of QE to infinity

Today has according to CNBC brought us to a birthday anniversary.

Happy birthday to the BOJ it’s the twentieth anniversary of them starting QE ( @purpleline)

As ever the picture is complicated as the Bank of Japan started buying commercial paper ( which we consider part of QE now) in 1997 and started purchases of Japanese Government Bonds in March 2001. But the underlying principle is that it has been around for much of the “lost decade” period and those claiming success have an obvious problem with the “lost decade” theme. Also they have a problem with then explaining why the name was changed in Japan from QE to QQE as name changes are a sure sign of something that has gone wrong. After all if you have a great brand you don’t change the name. In case you were wondering it is now Qualitative and Quantitative Easing.

It was not consider a triumph as even early on (2006) the San Francisco Fed was worried about this.

While these outcomes appear to be consistent with the intentions of the program, the magnitudes of these impacts are still very uncertain. Moreover, in strengthening the performance of the weakest Japanese banks, quantitative easing may have had the undesired impact of delaying structural reform.

That second sentence has echoed around all subsequent attempts at QE leading to the zombie banks theme of which at the moment Deutsche Bank and Royal Bank of Scotland come to mind but there are plenty of others. The gain was a small drop in JGB yields which is why government’s love the policy as it makes it cheaper for them to borrow.

In 2012 the IMF conducted its own review but with similar results.

Using different measures for economic activity, ranging from growth to unemployment, the VAR
regressions pick up some impact on economic activity. While the evidence is still weak, these results are still an improvement over earlier findings looking at previous QE periods

Looked at like that it makes you wonder why some many countries copied this course of action? The band Sweet gave us a clue I think.

Does anyone know the way, did we hear someone say
We just haven’t got a clue what to do
Does anyone know the way, there’s got to be a way
To Block Buster

Central banks cut interest-rates to what they considered the lower bound saw it was not working and were desperate to find something else. On that subject a theme of mine was confirmed yesterday when David Blanchflower who was a Bank of England policymaker tweeting this.

at mpc in 2008 we were told zlb was .5% for tech reasons relating to building societies. ( ZLB = Zero Lower Bound)

In response to my enquiry that I had heard it was the banks he replied he thought it was due to a regulation but cannot remember exactly. It certainly was a line repeated by Governor Carney although he of course then contradicted it by cutting to 0.25%!

To Infinity! And Beyond!

Regular readers who have followed by argument that interest-rate increases in the United States could be accompanied by more QE in what would no doubt be called QE4 will not be surprised that I spotted this.

U.S. central bankers are currently debating whether it should confine its controversial tool of bond buying to purely emergency situations or if it should turn to that tool more regularly, San Francisco Federal Reserve Bank President Mary Daly said on Friday.

This is intriguing not least because the actual policy right now is an unwinding of QE that we call Qualitative Tightening or QT. We actually have not had much QT and already there seems to be an element of cold feet about it. Let us look at her exact words.

In the financial crisis, in the aftermath of that when we were trying to help the economy, we engaged in these quantitative easing policies, and an important question is, should those always be in the tool kit — should you always have those at your ready — or should you think about those are only tools you use when you really hit the zero lower bound and you have no other things you can do,” Daly told reporters after a talk at the Bay Area Council Economic Institute.

“You could imagine executing policy with your interest rate as your primary tool and the balance sheet as a secondary tool, but one that you would use more readily,” she added. “That’s not decided yet, but it’s part of what we are discussing now.”

These sort of “open mouth operations” are often a way of preparing us for decisions which if not already been taken are serious proposals. So there is an element of kite flying about this to see the response. The bit that sticks out for me is that Mary Daly is willing to use more readily something she is not even sure worked as this below is far from a claim of success for QE.

when we were trying to help the economy,

That is rather different to it did help.

If we move on to looking at the economic outlook then if the US Federal Reserve is debating this the European Central Bank must be desperate to restart QE. Maybe there was a hint this morning from Jens Weidmann of the German Bundesbank when he spoke in South Africa.

Central banks all over the world were forced to climb great hills over the last decade. And there are more hills on the horizon.


Let us step back for a moment and consider what QE is and what it has achieved. Is it money printing? Well in electronic terms yes as the money supply grows but it is also a liquidity swap in that the money is exchanged usually for government bonds which then leads to other liquidity swaps via purchases of other assets. Then the trail gets colder….

So the economic effects are

  1. Money flowing into other assets leading to equity and house prices being at least higher than otherwise and usually higher.
  2. It supports companies that would otherwise have folded leading to the zombie banks and businesses theme.
  3. Lower interest-rates and bond yields meaning that it has indirectly helped both politicians and fiscal policy. This does not get much of an airing in the media because it is not well understood.
  4. Higher narrow money supply which has not led to the surge in inflation expected by economics 101 although that is at least partly due to consumer inflation measures being directed to ignore asset prices.

These may improve economic growth at the margin but there are no grand effects here although Mario Draghi only recently claimed that it was responsible for the Euro improvement in 2016/17. But this ignores the problems created as for example many central bankers are now telling us economic growth has a “speed limit” of 1.5% and the place with QE longest ( Japan) guides us to below 1%. Also there are the problems with productivity which have popped up. Finally there is the issue of helping the already wealthy and boosting inequality that is so bad they have to keep making official denials.

Quantitative easing has also helped to reduce net wealth inequality slightly through its positive impact on house prices. ( ECB January 2019)


This looks like the end of the interest-rates rising cycle

This feels like one of those days where there has been an epoch shift or to be more specific the morning after the night before. It is not as if we have been caught by surprise, as unlike so many have been ahead of the curve about the world economic slow down, and hence the implications for interest-rates and monetary policy. But there will be much wider implications from this as we go forwards and let us start from the fact that the biggest economic decision of 2019 may have just been made by a technocrat.

What happened?

The US Federal Reserve is significant on several counts. There is the ordinary significance of it being responsible for monetary policy in the world’s largest economy and for its reserve currency. There has recently been an additional one as it has been the standard-bearer for voluntarily raising interest-rates. Yet last night we got a combination of this.

 the Committee decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent……… In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.

No great surprise in the lack of a move last night but the promises that peaked at 3-4 interest-rate increases in 2019 have morphed into “will be patient” or perhaps 0. Then there was an additional statement which copied a part of what has become the European Central Bank model.

The Committee is prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.

So what has been called Quantitative Tightening or QT where some of the bonds bought previously are allowed to run off has run out of steam or “economic and financial developments”. The use of the word financial is significant as frankly it only reinforces the view that past falls in equity markets have driven this and we do get a flicker of democratic involvement ( I will leave readers to decide if that is good or bad) as of course they upset President Trump.

Next comes something which regular readers will know is something I have long suspected which is that in any slow down QE4 will come down the slipway. Or to be more specific the Federal Reserve balance sheet will no longer be contracting but will be expanded again. A particular significance of this will be that it could start with the balance sheet already being over US $4 Trillion in size.

There are various consequences of all of this. Two of them are major themes of my work with one of them being the earliest. As central banks went “all in” in terms of monetary policy I feared they would delay any exit policy and thus end up in the wrong cycle. The Fed deserves some credit for at least trying ( unlike so many others) but if not too little it was too late. Next is the issue of “junkie culture” where I feared we would be unable to wean ourselves off cheap credit and yields well that looks like where we are at right now. Some of you deserve credit for pointing out that the “new normal” would mean interest-rates would not go above 3% as that is looking rather en vogue today. That is in spite of the annualised economic growth rate being reported as 3.4% and the unemployment rate being reported as 3.9%.

Along this road the concept of independence of the US Federal Reserve and Chair Jerome Powell has folded like a deck chair, although some ( often ex-central bankers) retain a touching faith in the concept.

The Consequences

Equity Markets

The issue here is summarised to some extent by this tweet from James Mackintosh of the Wall Street Journal.

The FTSE 100 dividend yield ended 2018 3.5 percentage points above the 10-year Gilt yield, the most ever. One possibility: Market pricing risk of dividends being slashed after Brexit. Another: UK stocks are cheap. Or Gilt yields far too low.

After last nights Powell U-Turn whilst Gilt yields are in my opinion too low the reality is that going forwards they look more likely to stay there than before. Therefore on that measure the equity market looks cheap. Or to express it in another form the Yellen put for equity markets which replaced the Bernanke put has not been replaced by the Powell put option. This does not mean that they cannot fall but it does mean that monetary policy will do its best to stop them falling.

This brings us to the concept of the Plunge Protection Team a phrase I do use and sometimes I am joking. But this monetary policy  U-Turn following the way that Treasury Secretary Mnuchin spoke to the largest banks just before Christmas looks like a concerted effort.

Fiscal Policy

That to my mind has just seen a shift too and it comes from bond yields. Pressure for them to rise has just ended at least from one source. If you take the view that bond yields are the sum of expected future interest-rates then the latter has been shifting lower. If we stay with the US forecasts of 4% bond yields now face a reality of a ten-year Treasury Note yield of 2.67% and a thirty-year yield of 3.02%.

Thus fiscal policy just got cheaper and in some places it is currently very cheap if we look at a 1.24% ten-year Gilt yield in my country the UK and ultra-cheap if we look at Germany with its ten-year Bund yield of 0.18%. Let me offer you some thoughts on this.

  1. I know people like to laugh at the Donald but his fiscal plan of tax cuts has coincided with an economic slow down and now has got less expensive via lower bond yields.
  2. The concept of us all turning at least partly Japanese gets another tick in the box as they have never fully escaped the easing cycle either.
  3. Was the original plan of central bank “independence” to allow policies the politicians could never get away with?
  4. Ironically the countries that can most afford a fiscal boost such as Germany are those most set against it. Of course an element of its lower yields is due to its fiscal surplus but to my mind only a small bit.
  5. Politicians seem to be more in favour of fiscal policy when it is more expensive (higher bond yields) rather than cheaper. I cannot fully explain that but it often happens, perhaps they are just slow on the uptake.


There is a lot to consider here and the truth is some of this we have been observing over the last month or two as markets have adjusted to a newer reality. I have developed a new theory in the credit crunch era which is that conventional thought once it believes something takes quite some time to change after the evidence has shifted or the complete opposite of the famous quote attributed to JM Keynes.

When the facts change, I change my mind. What do you do sir?

In reality many have continued on with thoughts about interest-rate rises in 2019 perhaps most bizarrely in the case of the ECB. Whereas for now central bankers seem to have Taylor Swift on repeat to sooth away any such thoughts.

We are never ever ever getting back together,
We are never ever ever getting back together,
You go talk to your friends, talk to my friends, talk to me
But we are never ever ever ever getting back together




Did the Riksbank of Sweden just panic?

This morning has brought news of an event that had been promised so many times but turned out to be a false dawn. Indeed on their way to apparently making sense of this world Rosa & Roubini Associates told us this.

Riksbank Likely to Wait Longer Before Lift-Off

I guess you are now all expecting this.

Economic activity is strong and the conditions are good for inflation to remain close to the inflation target in the period ahead. As inflation and inflation expectations have become established at around 2 per cent, the need for a highly expansionary monetary policy has decreased slightly. The Executive Board has therefore decided to raise the repo rate from −0.50 per cent to −0.25 per cent.

Actually there is quite a bit that is odd about this as indeed there has been, in my opinion, about the monetary policy of the world’s oldest central bank for some time. Let me give you two clear reasons to be doubtful. Firstly GDP growth plummeted from the 1% of the second quarter of this year to -0.2% in the third. Or as the Riksbank puts it.

As expected, Swedish GDP growth has slowed down during
the second half of this year. However, the downturn in the third  quarter was greater than expected.

So if we step back we immediately wonder why you raise rates when economic growth is slowing when you could have done so when it was rising? The excuse provided looks weak especially as we note the automobile industry has continued to struggle.

One contributory cause of  this was that household consumption fell by a surprisingly large  degree, but this can partly be explained by temporarily weak car sales.

Also inconvenient numbers are regularly described as temporary even when they are nothing of the sort.

Moving onto inflation the outlook has also changed as we have moved towards the end of 2018.

The inflation rate according to the CPI with a fixed interest rate (CPIF) was 2.1 percent in November 2018 (2.4 percent in October). The CPIF decreased by 0.1 percent from October to November.  ( Sweden Statistics)

Here is FXStreet from last week when these numbers came out.

Nordea Markets 1/2: : CPIF inflation stood at 2.1% in November, below consensus and 0.3% point below the ’s forecast. Core inflation, i.e. CPIF ex energy, came out at 1.4%, as much as 0.3% point below the Riksbank’s call.

To be fair to Nordea they were expecting a hike so perhaps they had received an official nod because there is now another factor at play. That is of course the lower trajectory of the oil price which looks set to depress headline inflation numbers in the weeks and months ahead. If we take a broad sweep the price of a barrel of Brent Crude Oil has fallen some US $30 since the Riksbank balked at raising Swedish interest-rates. I think you can spot the problem here. Apparently the wages fairy will turn up which of course is yet another central banking standard view in spite of reality not being that helpful.

Wage growth has certainly become a little lower than
the Riksbank’s forecast over recent months and the forecast has been revised downwards slightly.

The Riksbank’s own view

Let me know switch to some sections of their monetary report which frankly would fit better with an interest-rate cut.

The global economy, which has grown rapidly in recent years, is now entering a phase of more subdued GDP growth, which is in line with the Riksbank’s earlier forecasts.

So Sweden is swimming against the trend?

Economic activity in Sweden is still strong, although GDP growth and inflation have been weaker than expected.

So definitely maybe. What about inflation prospects?

Even though inflation has been lower than expected, the conditions remain good for inflation to stay close to the inflation target going forward.

Then we get quite a swerve because you might think that with the claimed view of the Riksbank more interest-rate hikes will be on the way. It would be logical assuming there is anyone who believes the growth path remains strong and inflation will be ~2% per annum. But apparently not.

The forecast for the repo rate has therefore been revised downwards to indicate that the next repo rate rise will probably occur during the second half of 2019 . After this, the forecast indicates approximately two rate rises per year by 0.25 percentage points each time.

If we skip the last sentence on the grounds that this has been not far off the promised pattern since the Riksbank last raised back in 2011 we see that what is now called a “dovish hike” has just taken place. What that means is that whilst there has been a rise the future expected path falls. Thus if you follow central banking forward guidance interest-rates as 2019 develops may now be lower than you were expecting.

Operation Twist and QE

The other factors in Sweden’s monetary policy are described below.

At the end of November, the Riksbank’s government bond
holdings amounted to just under SEK 350 billion, expressed as a nominal amount.

But they are giving Operation Twist an extra squeeze.

In December 2017, the Executive Board also decided that reinvestments of the large principal payments due in the first six months of 2019 should be allocated evenly across the period from January 2018 to June 2019 . This means that the Riksbank’s holdings of government bonds will increase temporarily in 2018 and the beginning of 2019.

If you wished to tighten monetary policy then you could simply let these bonds mature and not replace them.

US Federal Reserve

As we were expecting it did this last night.

Today, we raised our target range for short-term interest
rates by another quarter of a percentage point. ( Chair Powell)

Not everyone was on board however as there was a nearly 800 point swing in the Dow Jones Industrial Average in response to it. This also meant it ignored the advice from President Trump not to do so and to cut the amount of Quantitative Tightening. The issue was summed up by the Wall Street Journal but not in the way the author thought it meant.

The data says the economy is doing great; the markets say it could be headed for a recession.

At turning points the data is always too late by definition which means that some sort of judgement call is required. Central banks have about a 0% success rate in predicting recessions.


There is a fair bit to consider in the latest central banking moves but the major point is one of timing. Monetary policy is supposed to lead events and not to lag them which is why “data dependency” is not only flawed it is illogical. To be fair to the US Federal Reserve it has at least tried to get ahead of events whereas the Riksbank has not.

Meanwhile there is a country with a central bank meeting today which has just had some strong economic news.

The quantity bought in November 2018 when compared with October 2018 increased by 1.4%, with a strong monthly growth of 5.3% in household goods stores….The strongest growth can be seen in comparison with the same period a year earlier where the amount spent increased by 5.0% and the quantity bought increased by 3.6%.

Is anybody expecting Mark Carney and the Bankof England to have raised interest-rates in response to the strong retail sales data? I am using the past tense as the vote was last night.

Number Crunching





The problematic nature of current bond yields

One of the features of the credit crunch era has been the falls in first world interest-rates and bond yields. The first phase saw the slashing of official short-term interest-rates and once that was seen to be inadequate, central banks directly purchased bonds to reduce yields further. It is seldom put like this but there was already an implied failure as according to the models back then the interest-rate cuts should have done the trick. Back then I was already looking ahead to when there would have to be ch-ch-changes and posted the view that central banks would delay what has become called policy normalisation.

For example back on the 24th of February 2011 I pointed out this about a speech from David Miles of the Bank of England.

 My problem with this is that when you act as they have and you have in effect used what weapons the Bank of England has virtually to the maximum by cutting interest-rates by 4.75%% and spending some £200 billion on asset purchases then you have been extraordinarily interventionist. Accordingly it is then hard for you to blame events because some of them are the consequence of your own actions……

What that illustrates is that already the truth was being manipulated and also I am glad I wrote “virtually to the maximum” as of course the amount of asset purchases has more than doubled. In addition we have seen credit easing in the UK via such policies as the Term Funding Scheme and the start of full-scale QE from the European Central Bank as well as negative interest-rates.

But the point about delaying proved to be very accurate as the Euro area is still actively pursuing QE and in net terms the UK has managed to raise interest-rates by a measly 0.25%. The opportunity in 2014/15 was meant with promises via Forward Guidance but no action.

The US

This is the one country which has taken clear action on the path to normalisation. Here is the current state of play.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 2 to 2-1/4 percent.

That is currently working out be be around 2.2% and more rises are promised. Also there is some reversing of the QE or Qualitative Tightening.

The Committee directs the Desk to continue
rolling over at auction the amount of principal
payments from the Federal Reserve’s holdings
of Treasury securities maturing during each
calendar month that exceeds $30 billion, and to
continue reinvesting in agency mortgage-backed
securities the amount of principal
payments from the Federal Reserve’s holdings
of agency debt and agency mortgage-backed
securities received during each calendar month
that exceeds $20 billion.

That combined with forecasts of another interest-rate rise in a fortnight and at least a couple next year seemed to put pressure on bond markets. However this sentence in a speech from Federal Reserve Chair Jerome Powell shook things up on the 28th of last month and the emphasis is mine.

We therefore began to raise our policy rate gradually toward levels that are more normal in a healthy economy. Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy‑‑that is, neither speeding up nor slowing down growth.

You may note we seem to have travelled from “policy normalisation” to neutral. But what the neutral interest-rate represents is an attempt to figure out what interest-rate would neither stimulate or contract the economy. Or a sort of measure of what we might aim for as a new normal. When they are trying to put a pseudo scientific gloss on things economist and central bankers call it r-squared.

However the “just below” dropped the expected path for US interest-rates by 0.5%.

Bond Markets

Let me take you to the Wall Street Journal on Tuesday.

This quarter, yields on longer-dated bonds have dropped and those on two-year Treasurys are flat. The gap between two and 10-year Treasury yields is now around 0.11 percentage point, compared with around 0.55 percentage point at the beginning of the year.

This is attracting a lot of attention in the financial media but the change of 0.44% is pretty much my 0.5% suggestion above. Now let us look at the US ten-year yield which is 2.9% as I type this and we see that in basic terms it is predicting a couple more 0.25% interest-rate rises. This will come in the next year or so if true so it is not very different to the two-year yield of 2.76%.

If we look beyond Federal Reserve policy we have seen a fall in the price of oil over the past month or two. If we look at it in Brent Crude terms then just above US $86 of early October has been replaced by below US $59 this morning as oil follows equity markets lower. The exact amount of the change varies but the path for inflation now seems set to be lower as it has been rare in 2018 for the oil price to be below where it was this time last year. That is another reason for lower bond yields.

Is this a signal of a recession? Here is the St.Louis Fed from last week.

Does the recent flattening of the yield curve portend recession? Not necessarily. The flattening of the real yield curve may simply reflect the fact that real consumption growth is not expected to accelerate or decelerate from the present growth rate of about 1 percent year over year. On the other hand, a 1 percent growth rate is substantially lower than the U.S. historical average of 2 percent. Because of this, the risk that a negative shock (of comparable magnitude to past shocks) sends the economy into technical recession is increased.

That is a fascinating way of looking at it and in my experience precisely zero bond market participants will look at it like that. It is also revealing that we seem to just assume growth will now be lower. Didn’t they save us?


I wanted to look at this subject today because of the clear changes which are happening. Now it looks much less likely that US interest-rates will pass 3% and if they do not by much. So “normalisation” will be at best about two-thirds of what it might have been considered to be pre credit crunch ( 4.5%). Some of you have suggested that we can no longer afford interest-rates and yields above 3% so well done at least if we stay where we are! If Italy folds you may get a second tick in that box.

But as we look wider we see even more extraordinary developments. Let me take a look at my own country the UK which is in political disarray yet the ten-year Gilt yield is below 1.3%. So those predicting a surge in Gilt yields are slipping back into the bushes whilst I note the extraordinary absolute level and the persistence of negative real yields which bust past metrics. Germany has a ten-year yield of 0.26% and a five-year one of -0.3% as we note again more metrics which are busted.

So my view is that we cannot rely on old recession metrics because another cause of all of this is that QE4 from the US Fed has got closer. I have worried all along that interest-rate rises might run into more QE and if they do we will be singing along to Coldplay.

Oh no I see
A spider web and it’s me in the middle
So I twist and turn
Here am I in my little bubble



Is a reversal of the carry trade behind the rise of the US Dollar?

This morning brings us back to what has been a regular topic in 2018 which has been the US Dollar. Let’s look at it from the perspective of the sub-continent.

The rupee weakened further and dipped by 54 paise to 73.04 against the US dollar Monday, owing to increased demand for the American currency from importers amid increasing global crude oil prices.

International benchmark Brent crude was trading higher by 2.04 per cent at USD 71.61 per barrel.

Forex traders said besides increased demand for the US currency from importers, the dollar’s strength against some currencies overseas weighed on the domestic unit.

From India’s point of view this is not as bad as it has been as twice the Rupee has fallen through 74 versus the US Dollar. However the overall trend has been down as we recall promises it would not go through 70 and the fact it is 11% or so lower than a year ago. The recent dip – until this weekend’s OPEC meeting – did not benefit the Rupee much in comparison.

For Pakistan things have been even worse as it own troubles have led it back into the arms of the International Monetary Fund ( IMF). The Pakistan Rupee is at 134.3 versus the US Dollar or 28% lower than a year ago.

The Euro

This morning the Euro has dipped to 1.125 and Bloomberg is on the case.

The euro fell to its weakest in more than 16 months on Monday as traders fret political risks from Italy to Brexit.

Actually Bloomberg mostly ignores the Euro and concentrates on Brexit which of course is an influence but far from the only one. The weaker phase for the Euro area economy where quarterly economic growth has fallen from 0.7% to 0.2% does not merit a mention. Nor does the expansionary monetary policy of the ECB with its negative interest-rate and ongoing QE which still has a couple of months to run in monthly flow terms. On the other side of the coin is the ongoing trade surplus which supports the Euro but not so much today.

President Macron of France made a suggestion on this front on CNN over the weekend.From Politico.

Macron also talked in the interview about the need to strength the euro’s position as a global reference currency — not as a challenge to the U.S. dollar but as an alternative for purposes of stability.

I guess it and the Chinese Yuan will have to compete but I am not sure how several reference currencies would work? The Euro is of course very widely traded but still a long way behind the US Dollar.

Returning to economic policy this will give both Euro area inflation and the economy a boost. With inflation already around its target the ECB will not welcome the former but will the latter as economic growth has faded. Should it be out of play for a while in terms of monetary policy then the Euro area would have to deal with any further slow down with fiscal policy. That would be awkward after spending so much time telling Italy that it does not work.

The Dollar Index

If we broaden our view and look at an index of which President Macron would approve ( because of the high Euro weighting) we see that the Dollar Index has hit a 2018 high of just above 97.5 this morning. Whilst that is not up an enormous amount on a year ago ( less than 3%) there has been quite a push since it fell below 89 at the opening of the year.

The move has technical analysts in a spin as some see this as the start of a big move higher and others see this as an inflexion point. This proves that it is not only economists who can tell you that a market may go up or down!

US Monetary Policy

Economics 101 will be pleased that at least some of it can be brought out into the sun as the so-called normalisation of US monetary policy leads to a higher dollar. We seem set for another interest-rate increase next month as well as 2/3 more in 2019 meaning US interest-rates look set for the 3 handle.

Also there is a quantity issue as US Dollars are being withdrawn via the advent of Quantitative Tightening or QT. That is happening at the rate of 50 billion dollars a month which is a large sum in spite of the fact that these times have made us somewhat numb about such matters.


The media seem keen to find reasons for this burst of US Dollar strength which have nothing to do with the US itself. Personally I think the US holiday may be a factor in today’s move but as well as the change in monetary policy stance something else has been at play in 2018. This is the apparent shortage of US Dollars which back on the 18th of May was affecting relative interest-rates.

The problem is a spike in the differential between LIBOR and the Overnight Index Swap, or the premium over the risk-free rate non-US banks pay to borrow dollars outside of the US.

The spread has risen to 42 basis points, the highest since February 2012, and up from 25 basis points at the start of last month and just 10 basis points in November.

While the rise does not pose a systemic risk, it has nevertheless raised the cost, and reduced the availability, of dollar-denominated loans for non-US banks by a considerable margin and in short space of time. ( Bank Pictet).

That improved but has returned to some extent ( 30 earlier this month) and of course in the meantime US interest-rates are higher. On September 25th we looked at the way a new carry trade had developed but apparently stopped.

 The overall amount of dollar credit to the non-bank sector outside the United States has climbed from 9.5% of global GDP at end-2007 to 14% in the first quarter of 2018. Since end-2016, however, the growth in dollar credit has been flat.

What if that reverses? We know from what happened with the Swiss Franc and Japanese Yen that reversals of international carry trades can have powerful effects. At this time of year there is also usually demand for US Dollars for the end of the year. Although frankly if you are thinking of it now you are likely to be too late. For now at least it is time for Aloe Blacc.

I need a dollar dollar, a dollar is what I need
Hey hey
Well I need a dollar dollar, a dollar is what I need
Hey hey

As the US observes Veterans Day let me give a plug to They Shall Not Grow Old which was on BBC 2 last night and was quite something.







What is the economic impact of tighter US monetary policy?

It is time for us to look West again and see what is happening in the new world and this week has brought a curious development. Ordinarily it is central bankers telling us about wealth effects and then trying to bathe in the implications of their own policies but in the US right now there is an alternative.

Stock Market up more than 400 points yesterday. Today looks to be another good one. Companies earnings are great!

That is from the Twitter feed of @realDonaldTrump and continues a theme where this seems if numbers of tweets on the subject are any guide to be his favourite economic indicator. Indeed on Tuesday he was tweeting other people’s research on the matter.

“If the Fed backs off and starts talking a little more Dovish, I think we’re going to be right back to our 2,800 to 2,900 target range that we’ve had for the S&P 500.” Scott Wren, Wells Fargo.

There is a danger in favouring one company over another when you are US President especially with the recent record of Wells Fargo. But the Donald is clearly a fan of higher equity markets, especially on his watch, and was noticeably quiet when we saw falls earlier this month. This does link in a way with the suggestions of a trade deal with China that boosted equity markets late on yesterday, although with the People’s Bank of China hinting at more easing the picture is complex.

The US Federal Reserve

Unless Standard and Poorski is correct below then the Fed is currently out of the wealth effects game.


One cautionary note is that humour in this area has a habit of becoming reality later as someone in authority might see this as a good idea. Also even the many central banking apologists may struggle with the US Fed buying Apple shares from the Swiss National Bank.

The current reality is rather different because as we stand QE ( Quantitative Easing) has morphed into QT  where the T is for Tightening. For example yesterday’s weekly update told us that its balance sheet  has shrunk by US $299 billion dollars to  US $4.1 trillion and the reduction was mostly due to the sale of US Treasury Bonds ( US $173 billion) followed by US $101 billion of Mortgage-Backed Securities. Over the next year we will expect to see around double the rate of change if it continues at its new raised pace.

 Effective in October, the Committee directs the Desk to roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month that exceeds $30 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month that exceeds $20 billion. ( Federal Reserve ).


From the Wall Street Journal on Monday.

After hovering around 2.3% for most of the spring and summer, the three-month London interbank offered rate, or Libor, has been climbing since the middle of September, settling at 2.53% on Monday, its highest level since November 2008.

I am sure most of you are thinking about the rises in US official interest-rates and the shrinking balance sheet as well as the year-end demand for US Dollars I looked at back on the 25th of September . Well your Easter Egg hunt looks likely to be much more fruitful than the one at the WSJ.

Analysts don’t fully know why the spread has moved the way it has in recent months.

If we ignore the why and move onto what happens next? Lisa Abramowich of Bloomberg is on the case.

3-month U.S. Libor rates have surged to a new post-crisis high, of 2.54%, more than double where it was last year. This is important because so much debt, including leveraged loans, are pegged to this rate. Companies will find themselves paying more interest on their debt…

As to how much debt I note Reuters have been estimating it at US $300 trillion which even if we take with a pinch of salt puts the Federal Reserve balance sheet into perspective. Oh and remember the booming leveraged loan market that had gone to about US $1.1 trillion if I recall correctly? Well Lisa has been on the case there too.

Short interest in the biggest leveraged-loan ETF has risen to a record high.

So in areas which bankers would describe as being “innovative” we see that Glenn Frey is back in fashion.

The heat is on, the heat is on, the heat is on
Oh it’s on the street, the heat is on

We can add that to the troubles we have seen in 2018 in emerging markets as the double combination of higher US interest-rates and a stronger Dollar have turned up the heat there too.

The US Dollar

Firstly we need to establish that whilst talk of challenges abounds the US Dollar remains the world’s reserve currency. So a rise impacts on other countries inflation via its role in the pricing of most commodity contracts and more helpfully may make their economies more competitive. But if we are looking for signs of trouble it hits places which have borrowed in US Dollars and that has been on the rise in recent times. I have reported before on the Bank for International Settlements or BIS data on this and here is the September update.

The US dollar has become even more dominant as the prime foreign currency for international borrowing. Dollar credit to the non-bank sector outside the US rose from 9.5% of global GDP at end-2007 to 14% in Q1 2018…….The growth in dollar borrowing by EMEs or  emerging market economies  has been especially strong, but dollar exposures vary substantially both across countries and in terms of sectoral composition.

An example of this has been Argentina which is caught in a trap of its own making as for example a devaluation would make its US Dollar debts more expensive. Or if we look at India it seems its shadow banks have caught something of a cold in this area.

India Is Said to Expect Shadow Banking Default Amid Cash Squeeze- Bloomberg Non-bank financiers and mortgage lenders have 2.7 trillion rupees ($37 billion) of debt maturing in the next five months, immediately ( @SunChartist )



So far we have mostly looked at the international impact of US monetary policy so let us now look more internally. If we look at interest-rates then the 30 year fixed rate mortgage has risen to 4.83% having started the year at 4% and which takes it back to early 2011. This reflects rising Treasury Bond yields which will have to be paid on ever more debt with official suggestions saying US $1.34 trillion will need to be issued in the next year.

Against that the economy continues to be in a boom. We will find out more later as for example will wages growth reach 3%? But economic growth has been above that as the last 6 months suggests around 3.8% in annual terms assuming it continues. So for now it looks fine but then it always does at times like this as for example a slow down and rising bond yields could in my opinion switch things from QT to QE4 quite quickly. After all worries about US stock market falls  started with it still quite near to what are all time highs.

Also if you want some more numbers bingo the BIS provided some more for Halloween.

The notional value of outstanding OTC derivatives increased from $532 trillion at end-2017 to $595 trillion at end-June 2018. This increase in activity was driven largely by US dollar interest rate contracts, especially short-term contracts.





Higher bond yields and higher inflation mean higher national debt costs

The last week or so has brought a theme of this blog back to life and reminds me of the many years I spent working in bond markets. They have spent much of the credit crunch era being an economic version of the dog that did not bark. Much of that has been due to the enormous scale of the QE ( Quantitative Easing) sovereign bond buying policies of many of the major central banks. The politicians who came up with the idea of making central banks independent and then staffing them with people who were anything but should be warmly toasted by their successors. The successors would never have got away with a policy which has benefited them enormously in terms of ability to spend because of lower debt costs.


However the times are now a-changing and this morning has brought more bad news on this front from Italy. The BTP bond future for December has fallen to 120 which means it has lost a bit over 7 points over the last ten or eleven days. Putting that into yield terms it means that the ten-year yield has reached 3.5% which has a degree of symbolism. A factor in this is described by the Financial Times.

The commission issued its warning to the Five Star and League governing coalition after Rome deviated from the EU’s fiscal rules by proposing a budget deficit equivalent to 2.4 per cent of gross domestic product instead of the 1.6 per cent previously mooted by the finance minister Giovanni Tria. Although the new plans keep Italy under the EU’s 3 per cent deficit threshold, the country’s high debt levels — the highest in the eurozone after Greece — means Rome is required to cut spending to bring debt levels gradually lower.

However the chart below tells us that in fact you can look at it from another point of view entirely.

Actually I think that the situation is more pronounced than that as the ECB has bought 356 billion Euros worth. But you get the idea. It is hard not to think that a major factor in the recent falls is the halving of ECB QE purchases since the beginning of this month and to worry about their end in the New Year. In case you were wondering why the share prices of Italian banks have been tumbling again recently? The fact they have been buying in size in 2018 when one of the trades of 2018 has been to sell Italian bonds gives quite a clue.

If we switch to the consequences for debt costs then a rough rule of thumb is to multiply the 3.5% by the national debt to GDP ratio of 1.33 which gives us 4.65%. In practice this takes time as there is a large stock of debt and the impact from new debt takes time. For example Italy issued 2 billion Euros of its ten-year on the 28th of last month at 2.9%. So a fair bit less than now although much more expensive that it had got used too. This below from the Italian Treasury forecasts gives an idea of how the higher yields impact over time.

The redemptions in 2018 are approximately €184 billion (excluding BOTs) including approximately
€3 billion in relation to the international programme……..the average life of the stock of
government securities, which was 6.9 years at the end of 2017.

Oh and the tipping point below has been reached. From the Wall Street Journal.

Harvinder Sian, a bond strategist at Citigroup, thinks a 10-year yield of 3.5%-4% is now the tipping point, after which yields jump toward the 7% reached at the height of the last euro crisis

Personally I am not so sure about tipping point as the “gentlemen of the spread” ( with apologies to female bond traders) have been selling it at quite a rate anyway.


The United States

Here bond yields have been rising recently and let us take the advice of President Trump and look at what has happened during his term of office. Whilst back then Newsweek was busy congratulating Madame President Hilary Clinton my attention was elsewhere.

There has been a clear market adjustment to this which is that the 30 year ( long bond) yield has risen by 0.12% to 2.75%.

We see that it has risen in the Trump era to 3.4% although maybe not by as much as might have been expected. However if we look to shorter maturities we see a much stronger impact.For example the two-year now yields some 2.9% and the five-year some 3.07%. So if you read about flat yield curves this is what is meant although it is not (yet) literally true as there is a 0.5% difference. Thus the US now faces a yield of circa 3% or so looking ahead. This does have an impact as the New York Times has pointed out.

The federal government could soon pay more in interest on its debt than it spends on the military, Medicaid or children’s programs.

In terms of numbers this is what they think.

Within a decade, more than $900 billion in interest payments will be due annually, easily outpacing spending on myriad other programs. Already the fastest-growing major government expense, the cost of interest is on track to hit $390 billion next year, nearly 50 percent more than in 2017, according to the Congressional Budget Office.

If we switch to the Congressional Budget Office it breaks down some of the influences at play here.From its September report.

Outlays for net interest on the public debt increased by $62 billion (or 20 percent), partly because of a higher rate of inflation.

The CBO points out a factor the New York Times missed which is that countries with index-linked debt are also hit by higher inflation. As the US has some US $1.38 trillion of these it is a considerable factor.

Also the US is borrowing more.

The federal budget deficit was $782 billion in fiscal year 2018, the Congressional Budget Office estimates,
$116 billion more than the shortfall recorded in fiscal year 2017………The 2018 deficit equaled an estimated 3.9 percent of gross domestic product (GDP), up from 3.5 percent in
2017. (If not for the timing shifts, the 2018 deficit would have equaled 4.1 percent of GDP.)

Higher bond yields combined with higher fiscal deficits mean more worries about this factor.

At 78 percent of gross domestic product (GDP), federal
debt held by the public is now at its highest level since
shortly after World War II. If current laws generally
remained unchanged, the Congressional Budget Office
projects, growing budget deficits would boost that
debt sharply over the next 30 years; it would approach
100 percent of GDP by the end of the next decade and
152 percent by 2048 . That amount would
be the highest in the nation’s history by far.

I counsel a lot of caution with this as 2048 will have all sorts of things we cannot think of right now. But the debt is heading higher in the period we can reasonably project and I note the CBO is omitting the debt held by the US Federal Reserve so that QE would make the figures look better but the current QT makes it look worse.


Debt costs and the associated concept of the mythical bond vigilantes have been in a QE driven hibernation but they seem to be showing signs of waking up. If we look at today’s two examples we see different roads to the destination. If we look at the road to Rome we see that the longer-term factor has been the lost decades involving a lack of economic growth. This has made it vulnerable to rising bond yields and which means that the straw currently breaking the camel’s back has been what is a very small fiscal shift. It is also a case of bad timing as it has taken place as the ECB departs the bond purchases scene.

The US is different in that it has a much better economic growth trajectory but has a President who has also primed the fiscal pumps. Should it grow strongly then the Donald will win “bigly” as he will no doubt let us know. However should economic growth weaken or the long overdue recession appear then the debt metrics will slip away quite quickly. That is a road to QE4.

Returning back home I note that UK Gilt yields are higher with the ten-year passing 1.7% last week for the first time for a few years.So the collar is a little tighter.The main impact on the UK came from the rise in inflation in 2017 leading to higher index-linked debt costs. This was the main factor in our annual debt costs rising by around £10 billion between 2015/16 and 2017/18.