The inflation problem is only in the minds of central bankers

Yesterday we looked at the trend towards negative interest-rates and today we can link this into the issue of inflation. So let me open with this morning’s release from Swiss Statistics.

The consumer price index (CPI) remained stable in December 2019 compared with the previous month, remaining at 101.7 points (December 2015 = 100). Inflation was +0.2% compared with the same month of the previous year. The average annual inflation reached +0.4% in 2019.These are the results of the Federal Statistical Office (FSO).

The basic situation is not only that there is little or no inflation but that there has been very little since 2015. Actually if we switch to the Euro area measure called CPI in the UK we see that it picks up even less.

In December 2019, the Swiss Harmonised Index of Consumer Prices (HICP) stood at 101.17 points
(base 2015=100). This corresponds to a rate of change of +0.2% compared with the previous month
and of –0.1% compared with the same month of the previous year.

Negative Interest-Rates

There is a nice bit of timing here in that the situation changed back in 2015 on the 15th to be precise and I am sure many of you still recall it.

The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%.

If we look at this in inflation terms then the implied mantra suggested by Ben Bernanke yesterday would be that Switzerland would have seen some whereas it has not. In fact the (nearly) 5 years since then have been remarkable for their lack of inflation.

There is a secondary issue here related to the exchange rate which is that the negative interest-rate was supposed to weaken it. That is a main route as to how it is supposed to raise inflation but we find that we are nearly back where we began. What I mean by that is the exchange-rate referred to above is 1.084 compared to the Euro. So the Swiss tried to import inflation but have not succeeded and awkwardly for fans of negative interest-rates part of the issue is that the ECB ( European Central Bank) joined the party reminding me of a point I made just under 2 years ago on the 9th of January 2018.

For all the fire and fury ( sorry) there remains a simple underlying point which is that if one currency declines falls or devalues then others have to rise. That is especially awkward for central banks as they attempt to explain how trying to manipulate a zero-sum game brings overall benefits.

The Low Inflation Issue

Let me now switch to another Swiss based organisation the Bank for International Settlements  or BIS. This is often known as the central bankers central bank and I think we learn a lot from just the first sentence.

Inflation in advanced economies (AEs) continues to be subdued, remaining below central banks’ target
in spite of aggressive and persistent monetary policy accommodation over a prolonged period.

As we find so often this begs more than a few questions. For a start why is nobody wondering why all this effort is not wprking as intended? The related issue is then why they are persisting with something that is not working? The Eagles had a view on this.

They stab it with their steely knives
But they just can’t kill the beast

We then get quite a swerve.

To escape the low inflation trap, we argue that, as suggested by Jean-Claude Trichet, governments
and social partners put in place “consensus packages” that include a fiscal policy that supports demand
and a series of ad hoc nominal wage increases over several years.

Actually there are two large swerves here. The first is the switch away from the monetary policies which have been applied on an ever larger scale each time with the promise that this time they will work. Next is a pretty breathtaking switch to advocacy of fiscal policy by the very same Jean-Claude Trichet who was involved in the application of exactly the reverse in places like Greece during his tenure at the ECB.

Their plan is to simply add to the control freakery.

As political economy conditions evolve, this role should be progressively substituted by rebalancing the macro
policy mix with a more expansionary fiscal policy. More importantly, social partners and governments
control an extremely powerful lever, ie the setting of wages at least in the public sector and potentially
in the private sector, to re-anchor inflation expectations near 2%.

The theory was that technocratic central bankers would aim for inflation targets set by elected politicians. Now they want to tell the politicians what to so all just to hit an inflation target that was chosen merely because it seemed right at the time. Next they want wages to rise at this arbitrary rate too! The ordinary worker will get a wage rise of 2% in this environment so that prices can rise by 2% as well. It is the economics equivalent of the Orwellian statements of the novel 1984

Indeed they even think that they can tell employers what to do.

Finally, in a full employment context,
employers have an incentive to implement wage increases to keep their best performing employees
and, given that nominal labour costs of all employers would increase in parallel, they would able to raise
prices in line with the increase of their wage bills with limited risk of losing clients

Ah “full employment” the concept which is in practical terms meaningless as we discussed only yesterday.

Also as someone who studied the “social contracts” or what revealingly were called “wage and price spirals” in the UK the BIS presents in its paper a rose tinted version of the past. Some might say misleading. In the meantime as the economy has changed I would say that they would be even less likely to work.

Putting this another way the Euro area inflation numbers from earlier showed something the ordinary person will dislike but central bankers will cheer.

Looking at the main components of euro area inflation, food, alcohol & tobacco is expected to have the highest
annual rate in December (2.0%, compared with 1.9% in November),

I would send the central bankers out to explain to food shoppers how this is in fact the nirvana of “price stability” as for new readers that is what they call inflation of 2% per annum. We would likely get another ” I cannot eat an I-Pad” moment.

Comment

Let me now bring in some issues which change things substantially and let me open with something that has got FT Alphaville spinning itself into quicksand.

As far as most people are concerned, there is more than enough inflation. Cœuré noted in his speech that most households think the average rate in the eurozone between 2004 and last year has been 9 per cent (in fact it was 1.6 per cent). That’s partly down to higher housing costs (which are not wholly included in central banks’ measurement of inflation).

That last sentence is really rather desperate as it nods to the official FT view of inflation which is in quite a mess on the issue of housing inflation. Actually the things which tend to go up ( house prices) are excluded from the Euro area measure of inflation. There was a plan to include them but that turned out to be an attempt simply to waste time ( about 3 years as it happened). Why? Well they would rather tell you that this is a wealth effect.

House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the
second quarter of 2019 compared with the same quarter of the previous year.

Looking at the situation we see that a sort of Holy Grail has developed – the 2% per annum inflation target – with little or no backing. After all its use was then followed by the credit crunch which non central bankers will consider to be a rather devastating critique. One road out of this is to raise the inflation target even higher to 3%, 4% or more, or so we are told.

There are two main issues with this of which the first is that if you cannot hit the 2% target then 3% or 4% seems pointless. But to my mind the bigger one is that in an era of lower numbers why be King Canute when instead one can learn and adapt. I would either lower the inflation target and/or put house prices in it so that they better reflect the ordinary experience. The reason they do not go down this road is explained by a four letter word, debt. Or as the Eagles put it.

Mirrors on the ceiling
The pink champagne on ice
And she said: “We are all just prisoners here
Of our own device”

The mad world of negative interest-rates is on the march

Yesterday as is his want the President of the United States Donald Trump focused attention on one of our credit crunch themes.

Just finished a very good & cordial meeting at the White House with Jay Powell of the Federal Reserve. Everything was discussed including interest rates, negative interest, low inflation, easing, Dollar strength & its effect on manufacturing, trade with China, E.U. & others, etc.

I guess he was at the 280 character limit so replaced negative interest-rates with just negative interest. In a way this is quite extraordinary as I recall debates in the earlier part of the credit crunch where people argued that it would be illegal for the US Federal Reserve to impose negative interest-rates. But the Donald does not seem bothered as we see him increasingly warm to a theme he established at the Economic Club of New York late last week.

“Remember we are actively competing with nations that openly cut interest rates so that many are now actually getting paid when they pay off their loan, known as negative interest. Who ever heard of such a thing?” He said. “Give me some of that. Give me some of that money. I want some of that money. Our Federal Reserve doesn’t let us do it.” ( Reuters )

That day the Chair of the US Federal Reserve Jerome Powell rejected the concept according to CNBC.

He also rejected the idea that the Fed might one day consider negative interest rates like those in place across Europe.

The problem is that over the past year the 3 interest-rate cuts look much more driven by Trump than Powell.

Of course, there are contradictions.Why does the “best economy ever” need negative interest-rates for example? Or why a stock market which keeps hitting all-time highs needs them? But the subject keeps returning as we note yesterday’s words from the President of the Cleveland Fed.

Asked her view on negative interest rates, Mester told the audience that Europe’s use of them “is perhaps working better than I might have anticipated” but added she is not supportive of such an approach in the United States should there be a downturn.

Why say “working better” then reject the idea?  We have seen that path before.

The Euro area

As to working better then a deposit-rate of -0.5% and of course many bond yields in negative territory has seen the annual rate of economic growth fall to 1.1%. Also with the last two quarterly growth readings being only 0.2% it looks set to fall further.

So the idea of an economic boost being provided by them is struggling and relying on the counterfactual. But the catch is that such arguments are mostly made by those who think that the last interest-rate cut of 0.1% made any material difference. After all the previous interest-rate cuts that is simply amazing. Actually the moves will have different impacts across the Euro area as this from an ECB working paper points out.

A striking feature of the credit market in the euro area is the very large heterogeneity across countries in the granting of fixed versus adjustable rate mortgages.
FRMs are dominant in Belgium, France, Germany and the Netherlands, while ARMs are prevailing in Austria, Greece, Italy, Portugal and Spain (ECB, 2009; Campbell,
2012)

Actually I would be looking for data from 2019 rather than 2009 but we do get some sort of idea.

Businesses and Savers in Germany are being affected

We have got another signal of the spread of the impact of negative interest-rates .From the Irish Times.

The Bundesbank surveyed 220 lenders at the end of September – two weeks after the ECB’s cut its deposit rate from minus 0.4 to a record low of minus 0.5 per cent. In response 58 per cent of the banks said they were levying negative rates on some corporate deposits, and 23 per cent said they were doing the same for retail depositors.

There was also a strong hint that legality is an issue in this area.

“This is more difficult in the private bank business than in corporate or institutional deposits, and we don’t see an ability to adjust legal terms and conditions of our accounts on a broad-based basis,” said Mr von Moltke, adding that Deutsche was instead approaching retail clients with large deposits on an individual basis.

So perhaps more than a few accounts have legal barriers to the imposition of negative interest-rates. That idea gets some more support here.

Stephan Engels, Commerzbank’s chief financial officer, said this month that Germany’s second largest listed lender had started to approach wealthy retail customers holding deposits of more than €1 million.

Japan

The Bank of Japan has dipped its toe in the water but has always seemed nervous about doing anymore. This has been illustrated overnight.

“There is plenty of scope to deepen negative rates from the current -0.1%,” Kuroda told a semi-annual parliament testimony on monetary policy. “But I’ve never said there are no limits to how much we can deepen negative rates, or that we have unlimited means to ease policy,” he said. ( Reuters )

This is really odd because Japan took its time imposing negative interest-rates as we had seen 2 lost decades by January 2016 but it has then remained at -0.1% or the minimum amount. Mind you there is much that is crazy about Bank of Japan policy as this next bit highlights.

Kuroda also said there was still enough Japanese government bonds (JGB) left in the market for the BOJ to buy, playing down concerns its huge purchases have drained market liquidity.

After years of heavy purchases to flood markets with cash, the BOJ now owns nearly half of the JGB market.

In some ways that fact that a monetary policy activist like Governor Kuroda has not cut below -0.1% is the most revealing thing of all about negative interest-rates.

Switzerland

The Swiss found themselves players in this game when the Swiss Franc soared and they tried to control it. Now they find themselves with a central bank that combines the role of being a hedge fund due to its large overseas equity investments and has a negative interest-rate of -0.75%.

Nearly five years after the fateful day when the SNB stopped capping the Swiss Franc we get ever more deja vu from its assessments.

The situation on the foreign exchange market is still fragile, and the Swiss franc has appreciated in trade-weighted terms. It remains highly valued.

Comment

I have consistently argued that the situation regarding negative interest-rates has two factors. The first is how deep they go? The second is how long they last? I have pointed out that the latter seems to be getting ever longer and may be heading along the lines of “Too Infinity! And Beyond!”. It seems that the Swiss National Bank now agrees with me. The emphasis is mine.

This adjustment to the calculation basis takes account of the fact that the low interest rate environment around the world has recently become more entrenched and could persist for some time yet.

We have seen another signal of that recently because the main priority of the central banks is of course the precious and we see move after move to exempt the banks as far as possible from negative interest-rates. The ECB for example has introduced tiering to bring it into line with the Swiss and the Japanese although the Swiss moved again in September.

The SNB is adjusting the basis for calculating negative interest as follows. Negative interest will continue to be charged on the portion of banks’ sight deposits which exceeds a certain exemption threshold. However, this exemption threshold will now be updated monthly and
thereby reflect developments in banks’ balance sheets over time.

If only the real economy got the same consideration and courtesy. That is the crux of the matter here because so far no-one has actually exited the black hole which is negative interest-rates. The Riksbank of Sweden says that it will next month but this would be a really odd time to raise interest-rates. Also I note that the Danish central bank has its worries about pension funds if interest-rates rise.

A scenario in which interest rates go up
by 1 percentage point over a couple of days is not
implausible. Therefore, pension companies should
be prepared to manage margin requirements at
all times. If the sector is unable to obtain adequate
access to liquidity, it may be necessary to reduce the
use of derivatives.

Personally I am more bothered about the pension funds which have invested in bonds with negative yields.After all, what could go wrong?

 

 

Inside the world of negative interest-rates

A feature of modern economic life is that interest-rates were first cut as close to zero as central banks thought they could and then in more than few cases they went below zero giving us the acronym NIRP for Negative Interest-Rate Policy. There was the implication that such a state of affairs would be temporary in that the medicine would work and that interest-rates would then be raised. For example I have put on here before the charts that show that the Riksbank of Sweden has been forecasting interest-rate increases for years whereas the reality was that it either cut or did nothing. Ironically it changed tack a little last December just in time for the world economy to turn down!

As to all this being temporary let me hand you over to ECB President Mario Draghi on the day he cut the Deposit Rate to -0.1% back in June 2014.

Draghi: On the first question, I would say that for all the practical purposes, we have reached the lower bound. However, this doesn’t exclude some little technical adjustments and which could lead to some lower interest rates in one or the other or both parts of the corridor. But from all practical purposes, I would consider having reached the lower bound today.

This has been a feature of central banker speak where they discuss a “lower bound” as if this type of economics is a science. The reality is that the nearest the “lower bound” has got to being a status quo has been this.

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

If we let him have the move to -0.2% as a technical adjustment we have to face up to the fact that it is now -0.4% and about to go to -0.5/6%. This has consequences as for example over the past month or so the amount deposited at the ECB at such a rate is 1.86 trillion Euros. So this is a drain on the banking system and therefore wider economic life as well as being a nice little earner for the ECB.

The “lower bound” theme has been the same in the UK as Bank of England Governor Carney asserted it was 0.5% but later decided it was 0.1%. Or you could look at the US Federal Reserve defined “normal” interest-rates as being somewhere above 3% then changed its mind and started cutting them. The truth is that the new normal is that when a central bank raises interest-rates it soon turns tail and starts cutting them.

Switzerland

The Swiss are at the cutting edge of negative interest-rates and it was ECB policy which was the supermassive black hole that sucked them into it. In terms of timing the June 2014 move by the ECB was followed by this in January 2015.

The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%.

For those who have not followed this saga there was an enormous amount of borrowing in Swiss Francs pre credit crunch because interest-rates were there. When the credit crunch hit institutional investors raced to reverse such positions which made the Swiss Franc soar which had the side-effect of crippling those who in eastern Europe who had taken out such mortgages. The SNB found itself like General Custer at Little Big Horn as the ECB version of Indians arrived and gave events another push.

Again there was an implication that this would be temporary until matters calmed down but the reality has been very different. Or to put it another way in central banker speak the word temporary now means permanent.

The signal we now have has been provided by two developments this morning. Let me start with the Swiss one.

Domestic sight deposits CHF 475.3 bn vs CHF 469.0 bn prior…………. Once again, a notable rise in the sight deposits data and that continues to suggest that the SNB is stepping in to smooth the appreciation in the franc over the past few weeks.

In case you are wondering why those numbers are looked at the SNB only occassionally declares it has intervened in foreign exchange markets and does so via other central banks and the BIS. So to find out we have to look at other numbers and thank you to Bank Pictet for this estimate.

In total, sight deposits have increased by CHF 9.8bn in the last 4 weeks, and CHF 10.3bn in the last 5 weeks.

So like The Terminator the SNB is back. Why? The Swiss Franc has been strengthening again and went through 1.09 versus the Euro. Whereas on the 23rd of April last year I noted that Reuters were reporting this.

The Swiss franc fell to a three-year low of 1.20 against the euro on Thursday as a revival in risk appetite encouraged investors to use it to buy higher yielding assets elsewhere, betting on loose monetary policy keeping the currency weak.

There were still problems though as I pointed out to a background elsewhere of something of a chorus saying the SNB had triumphed..

Any economic slow down would start currently with interest-rates at -0.75% posing the question of what would happen next?

Well we have an economic slow down and we expect the ECB to cut again which according to Bank Pictet will have this consequence.

SNB officials have emphasized the importance of the interest rate differential (mainly versus the euro area) for the exchange rate and thus the policy outlook. The SNB’s policy rate differential with the ECB’s deposit facility rate now stands at 35bp, below the 50bp in 2015 when the SNB lowered its interest rates to -0.75%.

To be fair to Bank Pictet that was from the end of July and so could not factor in the statements from Bank of Finland Governor Ollie Rehn on Friday about “overshooting” market expectations about the ECB move. So the statement below has got more likely.

In that event, should the CHF come under
excessive upward pressure, our best guess is that the SNB would cut the interest rate on sight deposits by 25 bps, bringing it down to -1.0%.

Comment

Thus we are facing a new frontier should the Swiss find they have to cut to -1% interest-rates or as the SNB might put it.

Yes we’re gonna have a wingding
A summer smoker underground
It’s just a dugout that my dad built
In case the reds decide to push the button down
We’ve got provisions and lots of beer
The key word is survival on the new frontier. ( Donald Fagen )

This will mean that the pressure for more of this will build.

UBS, the world’s largest wealth manager, told its ultra-wealthy clients on Tuesday that it would introduce an annual 0.6% charge on cash savings of more than €500,000 (£461,000). The fee, to be introduced in November, rises to 0.75% on savings of more than 2m Swiss francs (£1.7m). ( The Guardian ).

In some ways the economic situation has already adjusted to this as the Swiss ten-year bond yield is -1.1% and the thirty-year is -0.6%. Imagine the impact of this on long-term contracts such as pensions. Give me 100.000 Swiss Francs and I will give you 84,000 back in thirty-years, who would do that?

Meanwhile here is something to make UK readers very nervous.

BoE Gov Carney: At This Stage We Do Not See Negative Rates As An Option In The UK ( @LiveSquawk )

Podcast

Are negative interest-rates becoming a never ending saga?

Today brings this subject to mind and let me open with the state of play in Switzerland.

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

As you can see negative interest-rates are as Simple Minds would put it alive and kicking in Switzerland. They were introduced as part of the response to a surging Swiss Franc but as we observe so often what are introduced as emergency measures do not go away and then become something of a new normal. It was back on the 18th of December 2014 that a new negative interest-rate era began in Switzerland.

The introduction of negative interest rates makes it less attractive to hold Swiss franc investments, and thereby supports the minimum exchange rate.

Actually the -0.25% official rate lasted less than a month as on the 15th of January 2015 the minimum exchange rate of CHF 1.20 per euro was abandoned and the official interest-rate was cut to -0.75% where it remains.

Added to that many longer-term interest-rates in Switzerland are negative too. For example the Swiss National Bank calculates a generic bond yield which as of yesterday was -0.26%. This particular phase of Switzerland as a nation being paid to borrow began in late November last year.

The recovery

The latest monthly bulletin tells us this.

Jobless figures fell further, and in February the
unemployment rate stood at 2.4%.

There was a time when this was considered to be below even “full employment” a perspective which has been added to this morning and the tweet below is I think very revealing.

If we look at the Swiss economy through that microscope we see that in this phase the unemployment rate has fallen by 1%. Furthermore we see that not only is it the lowest rate of the credit crunch era but also for much of the preceding period as it was back around the middle of 2002.

So if we look at the Swiss internal economy it is increasingly hard to see what would lead to interest-rates rising let alone going positive again. This is added to by the present position as described by the SNB monthly bulletin.

According to an initial estimate, GDP in Switzerland grew
by 0.7% in the fourth quarter. Overall, GDP thus stagnated
in the second half of 2018, having grown strongly to
mid-year.
Leading indicators and surveys for Switzerland point to
moderately positive momentum at the beginning of 2019.

The general forecasting view seems to be for around 1.1% GDP growth this year. So having not raised interest-rates in a labour market boom it seems unlikely unless they have a moment like the Swedish Riksbank had last December that we will see one this year,

Exchange Rate

There is little sign of relief here either. There was a brief moment round about a year ago that the Swiss Franc looked like it would get back to its past 1.20 floor versus the Euro. But since then it has strengthened and is now at 1.126 versus the Euro. Frankly if you are looking for a perceived safe-haven then does a charge of 0.75% a year deter you? That seems a weak threshold and reminds me of my article on interest-rates and exchange rates from the 3rd of May last year.

However some of the moves can make things worse as for example knee-jerk interest-rate rises. Imagine you had a variable-rate mortgage in Buenos Aires! You crunch your domestic economy when the target is the overseas one.

Well events have proven me right about Argentina but whilst the scale here is much lower we have a familiar drum beat. The domestic economy has been affected but the exchange-rate policy has had over four years and is ongoing.

The Euro

Let me hand you over to the President of the ECB Mario Draghi at the last formal press conference.

First, we decided to keep the key ECB interest rates unchanged. We now expect them to remain at their present levels at least through the end of 2019……….These are decisions that have been taken following a significant downward revision of the forecasts by our staff.

For reasons only known to themselves part of the financial media persisted in suggesting that an ECB interest-rate rise was in the offing and it would be due round about now. The reality is that any prospect has been pushed further away if we note the present malaise and read this from the same presser.

negative rates have been quite successful in our monetary policy.

Although we can never rule out an attempt to continue to impose negative rates on us but exclude the precious in some form.

Sweden

Last December the Riksbank did start to move away from negative interest-rates. The problem is that they now find themselves wearing something of a central banking dunces cap. Having failed to raise rates in a boom they decided to do so in advance of events like this.

Total orders in industry decreased by 2.0 percent in February 2019 compared with January, in seasonally adjusted figures………..Among the industrial subsectors, the largest decrease was in the industry for motor vehicles, down 12.7 percent compared with January. ( Sweden Statistics yesterday)

Like elsewhere the diesel debacle is taking its toll.

The new registrations of passenger cars during 2019 decreased by 15.2 percent compared with last year. There were 27 710 diesel cars in total registered this year, a decrease of 26 percent compared with last year.

Anyway this is the official view.

As in December, the forecast for the repo rate indicates that the next increase will be during the second half of 2019, provided that the economic outlook and inflation prospects are as expected.

Japan

This is the country that has dipped its toe into the icy cold world of negative rates by the least but the -0.1% has been going for a while now.

introduced “QQE with a Negative Interest Rate” in January 2016 ( Bank of Japan)

If the speech from Bank of Japan Board Member Harida on March 6th is any guide it is going to remain with us.

I mentioned earlier that the economy currently may be weak, and the same can be said about prices.

Also he gives an alternative view on the situation.

Following the introduction of QQE, the nominal GDP growth rate, which had been negative since the global financial crisis, has turned positive………Barring the implementation of both QE and QQE, Japan’s nominal GDP growth would have remained in negative territory this whole time since 1998.

Is it all about the nominal debt of the Japanese state then? Also he seems unlikely to want an interest-rate increase.

Rather, premature policy tightening in the past caused economic deterioration, a decline in both prices and production, and lowered interest rates in the long run.

Comment

We find that there are two routes to negative interest-rates. The first is to weaken the exchange-rate such as we have seen in Switzerland and the second is to boost the economy like in the Euro area. So external in the former and internal in the latter. It can be combined as if you wish to boost your economy a lower exchange-rate is usually welcome and this pretty much defines Abenomics in Japan.

As we stand neither route seems to have worked much. Maybe a negative interest-rate helped the Euro area and Japan for a while but the current slow down suggests not for that long. So we face something of an economic oxymoron which is that it is the very fact that negative interest-rates have not worked which explains their longevity and while they seem set to be with us for a while yet.

 

The world of negative interest-rates now has negative economic growth too

It was not that long ago that many of us “experts” in the interest-rate market felt that negative interest-rates could not be sustained. Back then the past Swiss example could be considered a tax – which remains a way of considering negative interest-rates – and the flicker in Japan was covered by it being Japan. Yesterday brought some fascinating news from the front line which has been in danger of being ignored in the current news flow.

Sweden’s GDP decreased by 0.2 percent in the third quarter of 2018, seasonally adjusted, compared with the second quarter of 2018. GDP increased by 1.6 percent, working-day adjusted, compared with the third quarter of 2017. ( Sweden Statistics).

Firstly let me reassure you that Sweden has no Brexit style plans. What it does have is negative interest-rates as this from the Riksbank shows.

Consequently, in line with the previous forecast, the Executive Board has decided to hold the repo rate unchanged at -0.50 per cent.

I bet they now regret opening their latest forward guidance report like this.

Since the Monetary Policy Report in September, economic developments have been largely as expected, both in Sweden and abroad.

In fact the Riksbank was expecting this.

The most recently published National Accounts paint a picture of  slightly weaker GDP growth in recent years. Nevertheless, the Riksbank deems that economic activity in Sweden has been and continues to be strong.

In fact it has been so nonplussed that it has already reached for the central banking playbook and wondered what is Swedish for Johnny Foreigner?

Riksbank Floden: Sees Increased Uncertainty In World Economy ( @LiveSquawk )

Those who have followed my analysis that central banks will delay moving out of extraordinary monetary policy and negative interest-rates and thus are in danger of being trapped, will have a wry smile at this.

The forecast for the repo rate is unchanged since
the monetary policy meeting in September and indicates that the repo rate will be raised by 0.25
percentage points either in December or in February. As with the first raise, monetary policy will also
subsequently be adjusted according to the prospects for inflation.

That’s the spirit! You keep interest-rates negative through a strong phase of economic growth then you raise them when you have a quarterly decline. Oh hang on. I am not being clever after the event here because a month or so before the Riksbank report on the 6th of September I pointed out this.

This is also true of Sweden because if we look at the narrow measure or M1 we see that an annual rate of growth of 10.5% in July 2017 was replaced with 6.3% this July. …..A similar but less volatile pattern can be seen from the broad money measure M3. That was growing at an annual rate of 8.3% in July 2015 as opposed to the 5.1% of this July.

Since then M1 has stabilised but M3 has fallen further and was 4.5% in October. In fact if you were looking for an area it might effect then it would be domestic consumption so lets take a look.

Household consumption expenditures decreased by 1.0 percent and government consumption expenditures remained unchanged, seasonally adjusted, compared with the previous quarter ( Sweden Statistics).

Time for page 2 of the central banking play book.

Riksbank’s Floden: Recent Data Since Latest Policy Meeting Have Been Disappointing -But There Were Some Temporary Effects In 3Q GDP Data,

Something else caught my eye and it was this.

 Exports grew by 0.3 percent and imports declined by 0.6 percent.

So foreign demand flattered the numbers in a rebuttal to the central banking play book. But if we look at the overall pattern then economics 101 has yet more to think about.

J curve R.I.P. (?) – In Sweden, 2018 is heading for the worst trade year ever. The Oct deficit was SEK8.4bn. One observation: J curve effect does not work and thus the exchange rate channel (on real economy) is partially broken.   ( Stefan Mullin)

So let’s see you have negative interest-rates to boost domestic demand which is falling and you look to drive the currency lower which does not seem to be helping trade. Oh and you plan to raise interest-rates into a monetary decline. What could go wrong?

As it is the end of the week let us have some humour albeit of the gallows variety from Forex Crunch yesterday.

Analysts at TD Securities suggest that their nowcast models point to a 0.6% q/q gain to Sweden’s GDP (mkt: 0.2% q/q on a wide range of estimates), which if materialised would leave TD (and likely the Riksbank) comfortable with a December rate hike

Switzerland

Let us start with a response from Nikolay Markov of Pictet Asset Management.

GDP growth plunged to its lowest pace since the introduction of negative rates in Q1 2015. There is no reason to panic as this is a temporary drop:

There are few things more likely to cause a panic than being told there is no reason for it. I also note he was not so kind to the Swedes. Let us investigate using Swiss Statistics.

Switzerland’s GDP fell by 0.2% in the 3rd quarter of 2018, after climbing by 0.7% in the previous quarter. The strong, continuous growth phase enjoyed by the Swiss economy for one and a half years was suddenly interrupted.

The change has seen annual growth dip from 3.5% to 2.4% so different to Sweden although there has been a fall in the growth of domestic consumption. Quite what a central bank with an interest-rate of -0.75% can do about falling domestic consumption is a moot point. A driver of the decline is a familiar one.

Value added in manufacturing dipped slightly (−0.6%);  Total exports of goods (−4.2%) also contracted substantially.

The official view is that is just a blip but it does require watching as I note this area still seems to be troubled as this from earlier shows.

How cold is ‘s auto market? Passenger car sales down 28% in first 3 weeks of Nov. Whole year drop “inevitable”. Car dealers’ inventory climbing and many of them making losses. Authority said bringing back purchase tax cut will not help much. ( @YuanTalks )

Just as a reminder the Swiss National Bank holds some 778.05 billion Swiss Francs of foreign currency investments as a result of its interventions to reduce the exchange-rate of the Swissy.

Comment

These developments add to those at some other members of the negative interest-rates club or what is called NIRP.

German economic growth has stalled. As the Federal Statistical Office (Destatis) already reported in its first release of 14 November 2018, the gross domestic product (GDP) in the third quarter of 2018 was by 0.2% lower – upon price, seasonal and calendar adjustment – than in the second quarter of 2018.

And another part of discovering Japan.

Japan’s economy shrank in the third quarter as natural disasters hit spending and disrupted exports.

The economy contracted by an annualised 1.2% between July and September, preliminary figures showed. ( BBC )

As you can see we go to part three of the play book as the poor old weather takes another pounding. Quite what this has done to IMF News I am not sure as imagine how it would report such numbers for the UK?

has had an extended period of strong economic growth—GDP expected to rise by 1.1% in 2018.

 

Perhaps it has been discombobulated by a period when expansionary monetary policy has not only crunched to a halt but gone into reverse at least for a bit. But imagine you are a central banker right now wondering of this may go on and you will be starting it with interest-rates already negative. Or to use the old City phrase, how are you left?

Oh and hot off this morning’s press there is also this.

In the third quarter of 2018 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) decreased by 0.1 per cent to the previous quarter and increased by 0.7 per cent in comparison with the third quarter of 2017. ( Italy Statistics)

Japan

There as been a development in something predicted by us on here quite some time ago. So without further ado let me hand you over to The Japan Times.

Japan is considering transforming a helicopter destroyer into an aircraft carrier that can accommodate fighter jets, a government source said Tuesday,

 

 

 

 

The soaring price of shares in the Swiss National Bank poses many questions

We find ourselves today looking at a country which exhibits many of the economic themes of these times and one of them is brought to mind by this from the fastFT twitter feed.

US 10-year bond yields creep further towards 3% milestone

The fact that the 10-year Treasury Note yield is 2.99% is part of what is called “normalisation” of interest-rates and bond yields, although care is needed as we have been here before. But my subject of today can say the equivalent of “bah humbug” to this as it has a 10-year yield of a mere 0.13%. If we look back and take a broad sweep it has had this yield averaging around 0% for the past five years with a low of -0.6%. In fact Switzerland can still borrow out to the 8 year maturity and be paid for doing so as its yields are negative out to their. So the old normal remains a distant dream ( or nightmare depending on your perspective) and let me throw in a thought. There are arguments you should use such times to borrow and invest but the Swiss have pretty much set their face against this.

The Confederation wants to ensure room for manoeuvre for future generations by means of a sustainable fiscal policy. It has been pursuing a strategy of a balanced budget in the medium-term and a low level of debt since the start of 2000…………Thanks to the debt brake, it has been possible to considerably reduce federal debt ( Department of Finance February 2nd 2018).

According to the OECD it has a national debt of just under 43% of annual GDP. Of course there is a virtuous circle between bond yields and fiscal surpluses but for these times Switzerland is rather abnormal to say the least.

Negative Interest-Rates

The Swiss National Bank has contributed to the above via this.

Interest on sight deposits at the SNB is to remain at –0.75% and the target range for the three-month Libor is
unchanged at between –1.25% and –0.25%.

Money rates are at -0.73% if you want precision and as Swiss Banks have some 573 billion Swiss France deposited at the SNB there will be an icy chill felt although of course the SNB did take measures to protect the “precious”. Nonetheless there is a cost. From Reuters.

Swiss banks paid 970 million Swiss francs ($1 billion) in negative interest rate charges in the first six months of 2017, according to central bank data, up 40 percent year-on-year as clients continue to hoard cash.

Interesting isn’t it that so far ( and we have over 3 years now) there has been little impact on cash holdings? We learn a little more about negative interest-rates from this as there does not seem to be much of an adjustment so far.

Boom!

Last week saw what was quite an event. From Reuters.

The Swiss franc fell to a three-year low of 1.20 against the euro on Thursday as a revival in risk appetite encouraged investors to use it to buy higher yielding assets elsewhere, betting on loose monetary policy keeping the currency weak.

This took us back to January 15th 2015 when this happened.

The Swiss National Bank (SNB) has decided to discontinue the minimum exchange rate of CHF 1.20 per euro with immediate effect and to cease foreign currency purchases associated with enforcing it.

This was how interest-rates were reduced to -0.75% as the previous policy of “unlimited intervention” fell to earth. It was not that the SNB was running out of reserves as when you intervene against a strong currency you are selling something you do have an unlimited supply of at least in theoretical terms. But it was a combination of the scale of interventions  required and the side-effects and consequences which in this instance broke the bank policy.

As ever a move in interest-rates of 0.5% was in currency terms like putting a Band-Aid on a broken leg and the Swiss Franc surged.

; in midMarch 2015 it was at CHF 1.06 per euro, constituting a 12% appreciation against the minimum exchange rate of CHF 1.20 per euro in place until mid-January. ( SNB)

For newer readers wondering why the Swiss Franc was so strong it had been kicked-off by the reversal of the Carry Trade. If you look back in time on here you will see analysis of what I called the Currency Twins of the Swissy and the Japanese Yen who were affected by enormous levels of foreign borrowing pre credit crunch. This strengthened those two currencies after the credit crunch as some rushed to get out and of course the currency markets noted that at least some were desperate to get out.

This had a substantial human cost as many mortgage and business borrowers in Eastern Europe had taken advantage of low interest-rates in the Swiss Franc. They then faced surging monthly repayments when they were converted into the currency in which they had an income and quite a crisis was started. Of course doing such a thing was stupid but care is needed as whilst you should be responsible for your own actions it is also true that the banking sector did its best to miss lead on this issue and hide the risks faced.

Hedge Fund

On the road to the 15th of January 2015 the Swiss National Bank built up an extraordinary amount of foreign exchange reserves. In fact since there it has also intervened from time to time but on a much more minor scale.

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

Which according to the 2017 annual report has led to this.

The level of currency reserves has risen by more than
CHF 700 billion to almost CHF 800 billion since the onset of the financial and debt crisis in 2008. The increase is largely due to foreign currency purchases aimed at curbing the appreciation of the Swiss franc.

Which has led to this as I pointed out on the 15th of March.

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

It has become rather a large hedge fund as we note the diversification into equities. Also we get a hint of why Euro area bonds have done so well as not only has the ECB been buying via its QE program so has the Swiss National Bank. A rally driven by competing central banks?

Comment

There is a lot to consider here as for example if we start with an international perspective what will happen to equities if the Swiss National Bank should stop buying and start selling? The bellweather of this is Apple where according to NASDAQ it owned some 19.1 million shares at the end of 2017. Care is needed as we are just below the 1.20 level and the SNB intervened at considerably worse levels but it could decide to reverse course soon at least in part unless of course it is singing along to the ladies of En Vogue.

Hold me tight and don’t let go
Don’t let go
You have the right to lose control
Don’t let go

Don’t let go
Don’t let go

Meanwhile staying with the theme of equities there is the ongoing issue of shares in the Swiss National Bank itself.

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

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

It is now 8380 Swiss Francs according to Bloomberg. Should shares in a central bank be doing this? The answer is clearly no as we mull a central bank which is partly privately owned.

Moving back to Switzerland I note many are calling this a success for the SNB. Odd isn’t it that this way round the counterfactuals that many are so keen on when things go wrong for central banks seem to get lost in a fog of amnesia? The truth is we do not know as currency trends ebb and flow but there is of course another factor. Any economic slow down would start currently with interest-rates at -0.75% posing the question of what would happen next? Perhaps they will run into Korean Won. From February.

The swap agreement enables Korean won and Swiss francs to be purchased and repurchased between the two central banks, up to a limit of KRW 11.2 trillion, or CHF 10 billion.

 

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

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

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

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

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

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

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

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

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

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

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

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

The Swiss Franc

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

Hedge Fund alert

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

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

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

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

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

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

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

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

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

Comment

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

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

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

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

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

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

Me on Core Finance TV