Was the Fed a case of Much Ado About Nothing?

We have become used to central banking being a bit dull, certainly compared to March last year. They essentially opened the monetary taps and have spent the intervening period not doing much. We have had some fiddling at the edges and a lot of open mouth operations, but last night the stakes were higher because of the pace of the recovery in the US economy. If we move to the effect we can see that markets made an immediate response.

After FED meetings, gold fell down significantly in the last Newyork session, from $1860/oz to $1800/oz, then went up back to $1820/oz ( @fxstreet)

So Gold was hit immediately and the futures contract is at US $1810 this morning meaning that $50 was knocked off its price. So it has been a bad 24 hours for Gold bugs and places were it is held such as India. This gives us our first hint of some news about interest-rates.

Hollar Dollar

Investing.com gives us the picture.

At 3:15 AM ET (0755 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, was traded 0.2% higher at 91.418, after surging nearly 1% overnight, its biggest rise since March of last year.

The rally meant that we have seen some big figure changes with the Euro pushed below 1.20 and the UK Pound £ pushed below $1.40. They should not matter but often do. Also there was some relief for the Bank of Japan as the Yen weakened to 110.60 as it continued a weaker run for the Yen since the days it ended up being pinned around 104.

Bond Markets

Having established a theme of financial markets responding to something about interest-rates we now move to one which gives a qualified response. What I mean by that is yes we get some confirmation from a 0.07% rise to 1.56% for the US ten-year yield but it is not a large move. Also bond yields had been falling for the last couple of weeks so net we are still lower.

The Federal Reserve

The initial statement only gave is a couple of hints.

 Amid this progress and strong policy support, indicators of economic activity and employment have strengthened.

So some confirmation of an improvement and we also got the beginnings of covering their backside on inflation via the use of “largely”

Inflation has risen, largely reflecting transitory factors

But neither of those explain the market response. Nor does the interest-rate change which was announced.

The Board of Governors of the Federal Reserve System voted unanimously to set the interest rate paid on required and excess reserve balances at 0.15 percent, effective June 17, 2021.

The 0.05% move was also applied to the troubled reverse repo market which went from 0% to 0.05% and we see why from this.

53 COUNTERPARTIES TAKE $520.9 BLN AT FED’S FIXED-RATE REVERSE REPO. ( @FinancialJuice)

We have looked at this several times before where the monetary push from the Federal Reserve has been added to by the fiscal stimulus and the cheques in particular leaving the banking system awash with cash. The pressure has been such there has been a danger of negative interest-rates spreading ( we have seen some in US Treasury Bills). I know it is an irony but the Fed is now acting to stop further falls in interest-rates. Or as Stevie V put it.

Money talks, mmm, mmm, money talks
Dirty cash I want you, dirty cash I need you, ooh

The US Treasury has been asleep here as it could have helped by issuing some more bonds, it is not as if it will not have deficits to finance.

Projections

More meat came here.

However, the jolt came when new projections saw 11 of 18 central bank policy makers plan for two interest rate increases of 25 basis points in 2023, a year earlier than expected, and a sharp change from the previous meeting when none of these officials were looking for hikes during that year.  ( Investing.com)

Such was the shift that the projection had a 0.6% expectation for interest-rates in 2023 or two 0.25% hikes from the present 0.1%. This led to this perception.

“With the world’s so-called ‘smartest market’ expecting a quicker and more aggressive liftoff in interest rates, the fallout from this Fed meeting could continue to drive all markets in the days and weeks to come,” said Matthew Weller, Global Head of Market Research at GAIN Capital. ( Investing.com)

I have no idea how he could consider that to be aggressive but each to their own. As to the meaning of the shift well I well leave that to Chair Powell.

FED Chair Powell: Not Appropriate To Lay Out Numbers That Mean Substantial Further Progress

Dots Are Not A Great Forecaster Of Future Rate Moves

– Didn’t Discuss If Liftoff Appropriate In Particular Year  (@LiveSquawk )

This is a bit awkward because having sent a signal about higher interest-rates you then say that it does not mean much. Ironically he is of course correct with the statement that central bankers are not great forecasters of future rate moves, and he has thus just torpedoed the “Forward Guidance” claims that have been pressed over the past few years. It gets more awkward as we note they have predicted a “Liftoff” in 2023 but didn’t discuss it. What did they discuss then?

If we return to the dot plot then we see this from Chair Powell back in March 2019.

Each participant’s dots reflect that participant’s view of the policy that would be appropriate in the scenario that he or she sees as most likely.

That could be from Sir Humphrey Appleby in Yes Minister.

Taper Talk 

Essentially it remains that because there is no change.

 In addition, the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.

Comment

In some ways this echoes the much ado about nothing line from William Shakespeare. The Fed has sent a signal with its forecasts but it is hard not to smile at reports it is being hawkish, especially when CPI inflation is at 5%. Also raising interest-rates in 2023 is an inversion of monetary policy leads and lags with inflation higher now. If it is transitory then why bother? Indeed I could go further because in its forecasts is the assumption that the “normal” level of interest-rates is now 2.5%, does anyone actually believe that? None of this deals with house price rises in double-digits.

The Tapering of QE is an issue where some will keep talking about it and claim to be right should it happen forgetting the failed lottery tickets they previously bought. But my view is that the central banks are all hoping someone else will move first. I know that the Bank of Canada has acted but having bought around 40% of the market in short order it soon would have been out of road anyway.

So we are left with markets and if they have pushed the US Dollar upwards and it persists then they may have achieved something. Although did they intend to? Also we have the nuance which is do we have a clear cause and effect or were markets waiting for a trigger and without the Fed something else would have come along?

Also we saw a bit of insurance taken out against the future.

The Federal Reserve on Wednesday announced the extension of its temporary U.S. dollar liquidity swap lines with nine central banks through December 31, 2021

So they can use the word temporary…….

 

 

 

What are the consequences of a stronger UK Pound?

A recent feature of the economic landscape has been a rally in the value of the UK Pound £. For newer readers I am a fan of a stronger currency and felt it was time to not only explain why but to look at the consequences in more detail. Anyway I seem to have hit something of a raw nerve on Twitter earlier.

Well by the replies it has hit something anyway. As to the demands for some examples that leads to something of a first for me as I will now quote from The Sun in September 2017.

Experts had predicted the pound and euro would hit parity by next year, with US bank Morgan Stanley revealing it would be the first time the currencies would be at equal value in the single currency’s 18-year history.

Also

Sterling “could possibly” end up on par with the euro due to the uncertainty over Brexit, according to analyst Fawad Razaqzada at the trading firm Forex.com.

Also poundsterlinglive last March.

The risk of Pound Sterling falling to parity against the Euro is considered to be high by foreign exchange analysts at Nordea Markets, one of Europe’s major lenders and investment banks.

There have been plenty of others around social media but let us move on. There is a serious point around the banter and there is a nuance that I am often alone in making the case for the UK Pound £. Bad days see something of a media party and better days see silence.

What has happened?

The most obvious sign has been the rally against the US Dollar which has taken us towards US $1.42 this morning. That represents quite an improvement on the dip below US $1.15 when the Covid-19 pandemic hit financial markets last March. The Pound was hit hard then because the UK has a large financial sector and because we are a nation which does a lot of trade.

The counter-argument is that the Dollar has been weak which is true but that is far from all of it. If we look at the Japanese Yen we have improved to over 149 Yen this morning from a low around 125. As the Yen has been pretty stable that gives a signal. More recently we have been improving against the Euro as well which is another factor here as in spite of the efforts of the European Central Bank it has been a strong currency through this phase. Just over a year ago it was below 113 on a trade weighted basis but now it is just under 122 which is why the ECB has been trying to weaken it.. So strength against it in noticeable.

If we look at our own effective or trade-weighted position we have rallied from just below 73 as the pandemic hit to just below 82 at these levels.

Why?

If we ask the question posed by Carly Simon we can identify several factors.

  1. The financial system crisis passed and thus the UK saw its large financial sector revalued
  2. The Bank of England has moved away from applying negative interest-rates explicitly. I put it like that for two reasons. One is that we had some negative bond yields for a while and that phase has ended at least for now. The second is that whilst the debate is ongoing within the Bank of England it looks to have shifted away from it.
  3. The relative success of the UK vaccine scheme. I mean that in several contexts. Firstly literally in terms of numbers and also the way the delay in the second dose turned out to be a potential improvement. But also it reminded us we have a strong pharmaceutical sector which is a response to the negative claims that we produce little or nothing these days.
  4. The UK arranged a post Brexit deal with the EU
  5. The potential for something of an exodus from Hong Kong to the UK

The dog that has not barked in this respect is QE. Economics 101 predicted that bond buying and expansion of the money supply would lead to a lower currency. The Bank of England has been doing plenty of that and as an example will by this afternoon have bought another £4.4 billion of UK bonds ( Gilts) this week alone. But everyone else is at the same game as highlighted by Christine Lagarde of the ECB hinting at more yesterday ( awkwardly for her against her promises of less) but the general principle in a nutshell is that they are all at it.

What is the impact?

There is an old Bank of England rule of thumb which tells us that a 1% appreciation of the Pound is equivalent to a 0.25% interest-rate rise. If we apply that we see that the swings in the UK Pound will have been equivalent to a 2% rise in interest-rates now after a 2% cut for a while. I suggest you take that as a broad brush rather than exact figure and I would add a cautionary note. The present Bank of England is, in my opinion, incapable of raising interest-rates by 2%.

The next factor is inflation and a higher UK pound especially against the US Dollar ( due to its role as the world’s reserve currency meaning commodities are priced in it) is anti-inflationary. For example we have been seeing a rise in the price of crude oil from the brief negative period last year to around US $62 as I type this. So the inflationary impact has been partly offset by the stronger Pound. We get few ways of specifying this although we do get one from the Office for National Statistics.

Input producer price inflation is made up of roughly 78% domestic inputs and 22% imported inputs, which are sensitive to exchange rate movements.

Sadly ( and yes I have told them) they make a mistake in using the effective exchange-rate for this because in this instance it understates the position of the US Dollar for the reason I explained above. So we are left making our own adjustment noting that manufacturing uses at least 22% imported inputs.

As to how much a higher Pound affects exports we then get plunged into what Genesis called a “land of confusion”. Why? Well the simple answer that a higher exchange-rate leads to less trade and lower more is much weaker than economic text books tell you. There are various factors in this I think. Big decisions like a car plant are based on much more than the exchange-rate over a period of months. Other contracts are on that basis. I am sure some lose business from a higher exchange-rate but the number of price competitive exports is/are lower than predicted. Putting it the other way unlike in the posy 1992 period we have benefited from a lower Pound less than economics 101 would predict. Just to add another factor the trade figures are rather inaccurate and we know less than many try to claim.

Comment

Let me now switch to my opinion and one of the central tenets of my work as Notayesman is a rejection of the view that inflation is good for us. To be more specific the idea that inflation at 2% per annum makes us better off is not true. I do realise that central bankers and the media pump this message out all the time. But think about it. These days even in the good times wages grow slowly so they are unlikely even then to match higher inflation. In the world of central bank models they do but in the UK that has not worked for over a decade. I prefer reality to their fantasies.

Also the UK is predisposed to inflation. For a given inflationary push we tend to be affected more than Germany and much more than Japan. So in my opinion we should set policy to avoid it if we can and a factor in that is a higher Pound. Care is needed here as I do not mean this.

You took me, oh higher and higher, baby
It’s a livin’ thing ( ELO)

But I do mean that the past policy of many Bank of England Governors which involves talking down the level of the Pound has superficial attractions but has in fact made things worse. Indeed one of them showed his grasp of prices yesterday and the problem here will be clear to anyone looking at their water bill.

Water, which is essential for life, is virtually free ( Mark Carney)

Perhaps we paid his……

The market move of 2021 has been the rise in Bond Yields

So far 2021 has been a rather unsettling one for central bankers. There have been two main drivers of this. One is the rise and rise of Bitcoin which I note saw new highs over the weekend. But today’s subject is something that sends a deeper chill down their spine. Whilst we get a fair bit of talk from them about higher interest-rates in truth they give them sleepless nights.

Yields on 10-year Treasury notes have already reached 1.38%, breaking the psychological 1.30% level and bringing the rise for the year so far to a steep 43 basis points.

Analysts at BofA noted 30-year bonds had returned -9.4% in the year to date, the worst start since 2013. ( Reuters )

Just for clarity we are looking at the United States here and as they missed it out the thirty-year yield is now 2.16%. In terms of a comparison the ten-year began the year around 0.9% and the thirty-year 1.65%

The same rise of around 0.5% can have two different contexts. The historical one would be that it is not much but in my opinion that was then and this is now. So much of financial life is anchored around ZIRP ( Zero Interest-Rate Policy) and in some cases NIRP which suggests that more minor moves will have an economic impact. As an example of this let me bring you a consequence of all the easy monetary policy.

The average yield on US corporate junk bonds has dropped below 4% for the first time on record as investors hunt for stronger returns in an environment of low interest rates, according to a Bloomberg report.

The Bloomberg Barclays U.S. Corporate High-Yield index dropped to 3.96% late Monday, marking a sixth consecutive decline. Bond yields fall as prices rise.

Investors have been scooping up debt that carries low credit ratings as they offer higher yields than bonds in less-risky markets. A major factor driving investors to search for higher returns is the near-zero interest rate policy set by the Federal Reserve. (Business Insider)

That was from the 9th of this month. One way of putting it is that High-Yield is now something of an oxymoron and in spite of the rhetoric about “less-risky matkets” above the risk is well er higher.

The riskiest borrowers in corporate America are making up their largest share of junk-bond sales since 2007 as yield-starved investors hunt for returns and bet on an economic recovery. ( Financial Times )

As you can see what is considered a risk-free yield has risen as much riskier ones have fallen. What could go wrong?

US Federal Reserve

It is still buying bonds on a grand scale.

 In addition, the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.

There is an irony in that what it is buying is currently falling in price and what it is not buying has been rising in price. Oh Well! As Fleetwood Mac would put it.

The US Federal Reserve did announce a junk bond buying programme to quite a fan fare, but in the general scheme of things it tuned out to be minor.

Includes the market value of exchange-traded fund holdings under the SMCCF in the amount of $8,701,747,203 and the amortized cost of corporate bonds purchased under the SMCCF in the amount of $5,490,221,413,

So the Federal Reserve is in rather an awkward corner having put feints in both directions. On the 12th of January we looked at Atlanta Fed President Bostic who suggested bond purchases could slow ( a Taper) layer this year and markets seem to think he and others will stick to that view. On the other hand there was the Yield Curve Control issue where the Fed debated last autumn whether it would try to fix bond yields at a particular level. Some of those suggested have now come and gone.

The UK

The UK bond or Gilt market is quite strongly influenced by the US so it is no surprise that it has responded to. Regular readers will have got used to me mentioning that we do have some negative interest-rates as at the peak bond yields up to the seven-year yield were negative. That has been fading and as of this morning has gone.

The ten-year yield is now 0.7% and the fifty-year is 1.08% so has been moving on from when I pointed out the other day it was now over 1%. Again these are small moves but in such a highly stressed financial system they are significant.

All this has taken place in spite of the Bank of England weekly purchases of £4.4 billion of UK Gilts. They will buy another £1.48 billion this afternoon.

The Euro Area

The generic here is the bonds of its largest economy Germany and I write in that form as people read my articles over the years and should that continue by then there are roads that the largest Euro bond market will be Italy. Anyway the point is that there have been periods where every single German bond yield has been negative and many still are. The benchmark ten-year yield which plunged into a safe-haven party of -0.8% lasy March is now 0.32% and the thirty-year is now 0.2%. So not much in the latter case but a yield to be pad none the less.

Again we have seen this happen in spite of the large-scale bond purchases of the ECB. Only a bureaucrat would consider it a good idea to be running two programmes for the same thing at once, but anyway in the latest week they totaled 26 billion Euros.

We have a similarity and also a difference to the US. Something rather risky has been rallying recently ( the Italian bond market) but the difference with the US is that the ECB has been buying it as well.

Comment

There are various elements to today’s story and let me start with the good news bit which is that it is in response to a better economic outlook. The bad news is that it is also in response to higher inflation expectations which contrary to the official spinning will make us poorer.

But the subplot id for the central banks who have got used to being masters of the bond universe and now find what they would call a tantrum. It is happening in spite of what not so long ago we would consider to be very large purchases. Should it continue we will be finding out what areas cannot cope with it and it may be ones that surprise newer readers. But how would a pension fund invested in negative yielding bonds explain that when there is an actual yield? Some of the junk bonds are that because prospects for that company are well junk. Putting it another way we are observing what are both false markets as even the sovereign markets are nowhere near where they would be without all the QE.

One area which has not seen the benefit you might expect from this is the US Dollar but after rallying a bit seems to be doing this again.

Slip slidin’ away
Slip slidin’ away
You know the nearer your destination
The more you’re slip slidin’ away ( Paul Simon )

Podcast

 

What is happening to Gold and the Gold price?

It is time for us to check in on Gold and to note that whilst it is up just under 15% over the past year at US $1850 for the February futures contract it has hit a bit of a slump recently. Only a few days ago it was above US $1950 and back in early August last year it went as high as US $2089. One way of looking at things was expressed by Peter Schiff a few days ago.

To the extent that Bitcoin is actually taking any demand away from gold, that’s making Fed governors extremely happy. A rising #gold price is what central bankers fear most. #Bitcoin  is their best friend, which may explain why regulators aren’t in a hurry to help pop the bubble.

Actually central banks which have substantial gold reserves will be pleased and Bitcoin is far from their best friend. But the issue of Gold being replaced as a “safe haven” by Bitcoin is a live one as the tweet below indicates.

Even JPMorgan Chase has acknowledged that Bitcoin is taking market share from gold, the traditional haven asset. On Friday, one Bitcoin was worth more than 22 ounces of gold, which represents a new all-time high. ( @Cointelegraph)

In an article they went further.

According to multiple experts, one possible reason for Bitcoin’s remarkable recent price rise are massive investor outflows from another popular inflation hedge: gold.

Spot gold swooned over the past week, falling 4.62% to $1,857. The asset previously had been surging in unison with Bitcoin, which is up over 40% from $28,000 lows last week.

That narrative has had better Sunday nights and Monday mornings with Bitcoin some US $5800 lower at US $35,000 as I type this. But there is still some food for thought on the piece below.

The moves could be a sign of Bitcoin’s rising status as a legitimate asset class. Gold and Bitcoin have long been linked as both are seen as a way to protect wealth against inflation and macroeconomic uncertainty, but if the price movements over the last week are any indication, however, Bitcoin may be winning the narrative race.

The bull case for Gold

The macroeconomic uncertainty one is so clear we need spend little time with that but the inflation one is quite complex. It opens quite easily and as we recall my subject of Friday and this from Andrew Hauser of the Bank of England.

Since March of last year, G10 central bank balance sheets have risen by over $8 trillion.

In theoretical terms that should lead to inflation and a case for Gold but not so far.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.2 percent in November on a seasonally adjusted basis after being unchanged in October,
the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 1.2 percent before seasonal adjustment. ( US BLS)

That seems likely to rise as we note a Brent Crude Oil price of around US $55 and the general outlook has led to this.

US Inflation Expectations (10-yr breakevens) continue their vertical ascent, now above 2% for the first time since November 2018. ( @charliebilello )

I counsel caution on the issue of inflation breakevens which are unreliable but the broad trend is useful. There is also the additional issue that official inflation measures are designed to avoid the areas where inflation is both most likely and most rampant.

​House prices rose nationwide in October, up 1.5 percent from the previous month, according to the latest Federal Housing Finance Agency House Price Index (FHFA HPI®).  House prices rose 10.2 percent from October 2019 to October 2020. The previously reported 1.7 percent price change for September 2020 remained unchanged.

Here we find that there has been a strong case for Gold with uncertainty extremely high and evidence of asset price inflation all around us. I could go further and look at the rise in the price of some equities such as the FAANGs and of course Tesla. Then there is the issue of the way bond prices have soared.

Also the example of the problems in Zimbabwe raise the issue of the supply of Gold.

HARARE (Reuters) – Gold sales to Zimbabwe’s sole buyer and exporter of bullion Fidelity Printers and Refiners (FPR) fell 31% to 19 tonnes last year after lower deliveries from small-scale miners, official data showed on Monday.

FPR pays U.S. dollars in cash to small-scale gold miners, but a shortage of hard cash caused delays in payments most of last year. That forced many of the miners to sell their gold to illegal buyers, industry officials say.

Deliveries of gold, the top foreign currency earner, have been on the decline since reaching a record 33.2 tonnes 2018, mainly due to delays by FPR in paying miners.

The Bear Case

One factor would be a turn in the trend for the US Dollar and maybe we are seeing that as recently it has regained a little of its losses. But underneath that I think there is a bigger factor in that we have seen something of a shift in US interest-rates. I do not mean the official US Federal Reserve one which remains around 0.1% I mean this.

US 10Y yield is 17bp higher on the week ahead of the Dec jobs report, having done this:

Jan 7 +4.4bp

Jan 6 +8.1bp

Jan 5 +4.2bp ( @business)

The ten-year yield in the US is now 1.11% and whilst that is low in historical terms it is up quite a bit since the 0.5% or so of last March. Also it is taking place in spite of the fact that the US Federal Reserve is buying some US $120 billion of bonds of which 2/3rds are Treasuries each month.

From Gold’s point of view there is no some sort of cost of carry albeit not much as we find ourselves in a bit of a twilight zone. If you look at the inflation trend and expectations then bond yields should go higher, but the counterpoint is whether the US Federal Reserve would then increase its purchasing rate. Indeed it could implement a type of Yield Curve Control and we are at yields where some have expected this to be deployed.

Comment

As you can see from the points above the Gold price is at something of a nexus point and one road is rather familiar.

Hello darkness, my old friend
I’ve come to talk with you again ( Paul Simon)

On it we are back to the central banks being in control again as it would involve even larger purchases of US government debt by the US Federal Reserve. That would certainly be convenient considering the fiscal plans.

Biden has called the current USD 600 round of cash a “down payment,” and early last week he said USD 2,000 checks would go out “immediately” if his party took control of both houses of Congress. ( Financial Express).

So in a type of ultimate irony the US Federal Reserve now has its hand on the tiller of prospects for the Gold price and we are back to Friday’s theme of central banks being our new overlords.

Podcast

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

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

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

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

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

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

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

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

The next step is this.

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

He then applies his technical analysis.

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

Which leads to this.

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

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

The Economics

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

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

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

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

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

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

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

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

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

Interest-rates

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

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

Comment

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

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

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

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

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

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

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

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

 

 

More QE will be on the agenda of the US Federal Reserve

Later today the policymakers of what is effectively the world’s central bank meet up to deliberate before making their policy announcement tomorrow evening UK time. Although there is a catch in my description because the US Federal Reserve goes through sustained periods when it effectively ignores the rest of the world and becomes like the US itself can do, rather isolationist. The Financial Times puts it like this.

US coronavirus surge to dominate Federal Reserve meeting…..Central bank policymakers face delicate decision on best way to deliver more monetary support.

As it happens the coronavirus numbers look a little better today. But there are clearly domestic issues at hand which is a switch on the initial situation where on the middle of March the US Federal Reserve intervened to help the rest of the world with foreign exchange liquidity swaps. We were ahead of that game on March 16th. Anyway, that was then and now we see the US $446 billion that they rose to is now US $118 billion and falling.

The US Dollar

There has been a shift of emphasis with Aloe Blacc mulling a dip in royalties from this.

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
And I said I need dollar dollar, a dollar is what I need
And if I share with you my story would you share your dollar with me

This was represented back in the spring not only by a Dollar rally that especially hit the Emerging Market currencies but the Fed response I looked at above. Since then we have gone from slip-sliding away to the Fallin’ of Alicia Keys. Putting that into numbers the peak of 103.6 for September Dollar Index futures on March 19th has been replaced by 93.9 this morning.

If we look at the Euro it fell to 1.06 versus the Dollar and a warning signal flashed as the parity calls began. They had their usual impact as it is now at 1.17. Actually there were some parity calls for the UK Pound $ too so you will not be surprised to see it above US $1.28 as I type this. In terms of economic policy perhaps the most significant is the Japanese Yen at 105.50 because the Bank of Japan has made an enormous effort to weaken it and looks increasingly like King Canute.

There are economic efforts from this as I recall the words of the then Vice-Chair Stanley Fischer from 2015.

Figure 3 uses these results to gauge how a 10 percent dollar appreciation would reduce U.S. gross domestic product (GDP) through the net export channels we have just discussed. The staff’s model indicates that the direct effects on GDP through net exports are large, with GDP falling over 1-1/2 percent below baseline after three years.

We have seen the reverse of that so a rise in GDP of 1.5%. Of course such moves seem smaller right now and they need the move to be sustained but a welcome development none the less.

Whilst the US economy is less affected in terms of inflation than others due to the role of the US Dollar as the reserve currency in which commodities are prices there still is an impact.

This particular model implies that core PCE inflation dips about 0.5 percent in the two quarters following the appreciation before gradually returning to baseline, which is consistent with a four-quarter decline in core PCE inflation of about 0.3 percent in the first year following the shock.

Again this impact is the other way so inflation will rise. For those unaware PCE means Personal Consumption Expenditures and as so familiar for an official choice leads to a lower inflation reading than the more widely known CPI alternative.

Back Home

Interest-Rates

This is a troubled area for the US Federal Reserve which resembles the shambles of General Custer at Little Big Horn. We we being signposted to a “normalisation” where the new interest-rate would be of the order of 3%+ or what was called r*. I am pleased to report I called it out at the time as the reality was that the underpinnings of this particular Ivory Tower crumbled as the eye of Trump turned on it. The pandemic in this sense provided cover for the US Federal Reserve to cut to around 0.1% ( strictly 0% to 0.25%).

Back on March 16th I noted this and you know my view in official denials.

#BREAKING Fed’s Powell says negative interest rates not likely to be appropriate ( @AFP )

I also not this from Reuters yesterday,

With U.S. central bank officials resisting negative interest rates,

How are they resisting them? They could hardly have cut much quicker! This feels like a PR campaign ahead of applying them at some future date.

Yield Curve Control

This is the new way of explaining that the central bank is funding government policy. Although not on the scale some are claiming.

Foreigners have levelled off buying US Debt. Federal Reserve buying has gone parabolic. This tells us all this additional debt the govt is issuing by running HUGE budget deficits is being purchased by directly the Fed. That is what they do in “banana republics”. #monetizethedebt

That was from Ben Rickert on Twitter and is the number one tweet if you look for the US Federal Reserve. Sadly for someone who calls himself The Mentor actual purchases of US government bonds have declined substantially.

the Desk plans to continue to increase SOMA holdings of Treasury securities at that pace, which is the equivalent of approximately $80 billion per month.  ( New York Fed.)

That is less in a month than it was buying some days as I recall a period when it was US £125 billion a day.

If Ben had not ramped up his rhetoric he would be on the scent because Yield Curve Control is where the central bank implicitly rather than explicitly finances the government. Regular readers will have noted my updates on the Bank of Japan doing this and there have been several variations but the sum is that the benchmark ten-year yield has been kept in a range between -0.1% and 0.1%.

There is an obvious issue with the US ten-year yield being around 0.6% and we may see tomorrow the beginning of the process of getting it lower. On the tenth of this month I pointed out that some US bond yields could go negative and if we are to see a Japanese style YCC then the Fed needs to get on with it for the reasons I will note below.

Comment

As the battleground for the US Federal Reserve now seems to be bond yields it has a problem.

INSKEEP: Senator, our time is short. I’ve got a couple of quick questions here. Is there a limit to how much the United States can borrow? Granting the emergency, its another trillion dollars here. ( NPR)

Even in these inflated times that is a lot and the Democrat opposition want treble that. With an election around the corner we are likely to see more grand spending schemes. But returning to the Fed that is a lot to fund and $80 billion a month looks rather thin in response. So somewhere on this yellow brick road I am expecting more QE.

Oh and if you look at Japan if it has done any good it is well hidden. But that seems not to bother policymakers much these days. Also another example of Turning Japanese is provided by giving QE  new name. After all successes do not need one do they?

Still at least the researchers at the Kansas City Fed have kept their sense of humour.

Based on the FOMC’s past use of forward guidance, we argue that date-based forward guidance has the potential to deliver much, though not all, of the accommodation of yield curve control.

The Lebanon poses a problem for central banks and the belief they cannot fail

There is a lot going on in the Lebanon to say the least so let me open by offering my sympathy to those suffering there. My beat is economics where there is an enormous amount happening too and it links into the role of the new overlords of our time which is,of course, the central banking fraternity. They have intervened on an enormous scale and we are regularly told nothing can go wrong rather like in the way that The Titanic was supposed to be indestructible. If you like me watched Thunderbirds as a child you will know that there were few worse portents than being told nothing can go wrong.

The State of Play

The central bank summed things up in its 2019 review like this.

The Lebanese economy has moved into a state of recession in 2019 with GDP growth touching the negative territory. The International Monetary Fund projected Lebanon’s real GDP to shrink by 12% in 2020, a new double-digit contraction not seen in more than 30 years. In comparison, the IMF forecasted real GDP to contract by 3.3% in the MENA region and by 3% globally in 2020. Inflation in Lebanon recorded 2.9% in 2019, and it is expected to reach 17% in 2020, according to the IMF.

As you can see we have two double-digit measures as output falls by that as we note that the ordinary person will be hurt by double-digit inflation. This poses yet another question for output gap theory. I have to confess I am a little surprised to note that the IMF has not updated the forecasts unlike the government. From the Financial Times.

The government says the economy shrank by 6.9 per cent of GDP last year and expects a further contraction this year of 13.8 per cent — a full-blown depression with an estimated 48 per cent of people already below the poverty line.

The next feature is a currency peg to the US Dollar as we return to the Banque Du Liban.

At the monetary level, the year was marked by noticeable net conversions in favor of foreign currencies, a decline in deposit inflows, a shortage of US dollars and a lack of local currency liquidity. As a result, BDL’s assets in foreign currencies witnessed a contraction of 6% to reach $37.3 billion at end December 2019.

Troubling and a signal that if you control the price via a currency peg the risk is that you have a quantity problem which is always likely to be a shortage of US Dollars.

Well I need a dollar dollar, a dollar is what I need
Hey hey
And I said I need dollar dollar, a dollar is what I need
And if I share with you my story would you share your dollar with me ( Aloe Blacc)

This led to what Taylor Swift would call “trouble,trouble,trouble”

It is worth mentioning that in the last quarter of 2019, the Lebanese pound has plunged on a parallel market by nearly 50% versus an official rate of 1507.5 pounds to the dollar. The Central Bank is still maintaining the official peg in bank transactions and for critical imports such as medicine, fuel and wheat.

This leads to the sort of dual currency environment we have looked at elsewhere with Ukraine coming to mind particularly.

The present position is that the official peg is “Under Pressure” as Queen and David Bowie would say as it has been above 1500 for the whole of the last year. There was particular pressure on the 4th of May when it went to 1522. Switching to the unofficial exchange rate then Lira Rate have it at 3890/3940. I think that speaks for itself.

The official Repo rate is 10% and rise as we move away from overnight to 13.46% for three-year paper. Just as a reminder the United States has near zero interest-rates so this is another way of looking at pressure on the currency peg and invites all sorts of problems.For example the forward rate for the official Lebanese Pound will be around 10% lower for a year ahead due to the interest-rate gap. So more pressure on a rate which is from an alternative universe.

It looks like there has been some currency intervention as in the fortnight to the end of May foreign currency assets fell from 51.6 trillion Lebanese Pounds to 50.5 trillion.

Corruption

We start with the Financial Times bigging up the banking sector but even it cannot avoid the consequences of what has happened.

The banks, long the jewel in Lebanon’s economic crown, and the central bank, the Banque du Liban, are at the heart of this crisis. The banks long offered high interest rates to attract dollar deposits, especially from the far-flung Lebanese diaspora. But Riad Salameh, BdL governor since 1993, began from 2016 offering unsustainable interest returns to the banks to lend on these dollars to the government, through the central bank.

That has led to a type of economic dependency.

In sum, 70 per cent of total assets in the banking system were lent to an insolvent state. The recovery programme estimates bank losses at $83bn and “embedded losses” at the BdL at $44bn (subject to audit). Together that is well over twice the size of the shrinking economy.

One of the worst forms of corruption is where government and the banks get together. For them it is symbiotic and both have lived high on the hog but they have a parasitical relationship with the ordinary Lebanese who now find the price is inflation and an economic depression.

Bankers are protesting at government plans to force mergers and recapitalisation, through a mix of wiping out existing shareholdings; fresh capital investment for banks that wish to stay in business, especially by repatriating dividends and interest earnings; recovered illicit assets; and “haircuts” on wealthy depositors.

Or as Reuters put it.

But the banks were not responsible for the devastating waste, pillage and payroll padding in the public sector – about which this plan has little detailed to say.

Comment

We find that this sort of situation involves both war and corruption. Big business, the banks and government getting to close is another warning sign and one we see all around us. But as we review a parallel currency, an economic depression and upcoming high inflation there is also this.

The sources say the plan focuses overwhelmingly on the banks and the central bank, which together lent more than 70% of total deposits in the banking system to an insolvent state at increasingly inflated interest rates put in place by central bank governor Riad Salameh. ( Reuters)

Ordinarily we assume that a central bank cannot fold as the stereotype is of one backed by the national treasury to deal with losses. There is a nuance with the Euro area where the fact there are 19 national treasuries adds not only nuance but risk for the ECB. But in general if you control the currency you can just supply more to settle any debts.the catch is its overseas value or exchange rate as we note that Mr and Mrs Market have already voted on the Lebanese Pound. But there is more as I noted on Twitter last week.

Auditors are asking banks to take a provision of ~40% against exposure to its central bank. This has to be a first in history. ( @dan_azzi)

We have become used to that being the other way around. The next bit is rather mind boggling as we mull the moral hazard at play here.

Even funnier is that BDL is about to send a circular asking banks to take a 30% provision on their exposure to BDL.

Frankly both look too low which means for the ordinary person that there is a risk of bail ins.

Podcast

 

The 2020 Currency War and the role of the US Dollar

As we step into June we have an opportunity to reflect on what has been on the media under card but only because so much has been happening elsewhere. Also we can note yet another fail for economics 101 because the advent of large-scale asset purchases or QE was supposed to cause a currency decline and maybe a large one. A higher supply of money leading to a fall in the price. The Ivory Towers of the central banks were keen on that one as they originally justified QE on the basis of being able to hit their inflation target partly via that route. Of course that has not gone well either as we noted with the ECB that has been on average some 0.7% below its holy grail of just below 2% per annum.

The US Dollar

So on that reading the world’s reserve currency the greenback should be in trouble as we observe this.

The Federal Reserve added $60 billion to its balance sheet last week, now totaling $7.097 trillion. Much of the increase this time (over $41 billion) was in corporate credit and commercial paper facilities. ( @LynAldenContact )

There is a sort of irony in US $60 billion in a week not seeming very much! Anyway the heat has been on.

The Federal Reserve’s balance sheet has expanded a staggering $1.9 trillion since February 26, just days after the S&P 500 peaked. ( @USGlobalETFs )

So plenty of new US Dollar liquidity and as part of that we recall what we might call the external supply which are the liquidity swaps for foreign central banks or US $449 billion.

To that can add an official interest-rate just above 0% ( roughly 0.1%)

Added to those factors the Financial Time has decided to put on its bovver boots and give the Dollar a written kicking.

That begs a question that has been seen as controversial — are we entering a post-dollar world? It might seem a straw-man question, given that more than 60 per cent of the world’s currency reserves are in dollars, which are also used for the vast majority of global commerce. The US Federal Reserve’s recent bolstering of dollar markets outside of the US, as a response to the coronavirus crisis, has given a further boost to global dollar dominance.

The FT writer has rather fumbled the ball there and later again emphasises a US Dollar strength.

Among the many reasons for central banks and global investors to hold US dollars, a key one is that oil is priced in dollars.

Indeed and we have looked at efforts to make ch-ch-changes from the supply side ( Russia) and the demand side ( China) but it remains dominant. There are of course plenty of other commodity markets which have a US Dollar price.

Next is something which intrigues me because if it is true in the US how do you even start with Japan and then of course you get a really rather long list of other countries doing exactly the same.

Finally, there are questions about the way in which the Fed’s unofficial backstopping of US government spending in the wake of the pandemic has politicised the money supply.

Oh and for those of you with inflation concerns ( me too) then this is close to an official denial.

The issue here isn’t really a risk of Weimar Republic-style inflation, at least not any time soon.

Actually the main inflation risk is in asset markets with the S&P 500 above 3k, the Nikkei 225 above 22,000 and the FTSE 100 above 6100 I think we can see clear evidence tight now. But of course the economics editorial line under Chris Giles is that asset prices are not part of inflation and should be ignored as part of his campaign to mislead on this subject.

Emerging Markets

If they were hoping for a US Dollar decline then such hopes have been dashed. One country which has been under the cosh is Brazil where an exchange to the US Dollar of 4 as we began the year has been replaced by one of 5.35 and even that is a fair bit better than the 5.96 at the nadir. Things have been less dramatic for the Argentine Peso but it had a bad 2019 to a move from 60 to the US Dollar to above 68 is further pain and of course an interest-rate of an eye-watering for these times of 38% has been required to restrict it to even that.

India

We have a sub-category all to itself as we note the currency of over a billion people. Let me start with something being debated in so many places, and here is the Economic Times of India from last Tuesday.

The government stimulus package of Rs 20 lakh crore seems to be inadequate to revive the economy, as a large part of it accounts for liquidity-boosting measures by RBI. It is clear that the weak fiscal position forced the government to restrict the stimulus. It is in this scenario, that the need for monetisation of deficit has been widely debated.

In layman’s language, monetisation of deficit means printing more money. In other words, monetisation of deficit happens when RBI buys government securities directly from the primary market to fund government’s expenses.

The Rupee has been a case of slip-sliding away as we note it nearly made 77 and is now 75.3 and that is in spite of the impact of the lower oil price ( and for a while much lower) on India.

Euro

This has not done much at all as I note an annual change of all of -0.38%! We did see some moves as it went to 1.14 at the height of the pandemic panic as the Euro’s “safe haven”  role was stronger than the Dollar’s one. But we then had a dip and now a bounce. So loads of column inches about the world’s main currency pair have led to a net not very much as we stand here today.

Yen

This is really rather similar to the above as we note an annual change of -.0,52% this time after a safe haven spell. Actually 107 or so for the Yen feels strong for it as we remind ourselves that the QE, negative interest-rates and equity purchases of Abenomics were supposed to keep it falling.

UK Pound

The annual picture ( -2%) is a little more misleading here as we have seen swings. The UK Pound £ has been following equity markets so went below US $1.15 at the nadir but has hit US $1.24 as we have bounced. Troubling if you are like me wondering about the equity market bounce. Still we could be the UK media that once again declared this at the bottom.

It’s the end of the world as we know it
It’s the end of the world as we know it
It’s the end of the world as we know it and I feel fine.

Places like the FT and BBC have proved very useful as when they have a “panic party” about the £ and claim it is looking over a cliff is invariably the time to buy it.

Comment

So we see that the situation is in fact one of where the various QE and interest-rate moves have offset more often than been different. In some ways the central banking “More! More! More!” culture means that differences in pace or size get ignored because they are all rocking a “To Infinity! And Beyond!” vibe as shown by the official denial below.

‘Comfortable’ Now, But On B/Sheet ‘Cannot Go To Infinity ( Jerome Powell via @LiveSquawk )

Let me conclude with another perspective which is the world of precious metals and another form of precious. One way of judging a currency is in this vein and as someone who recalls studying mercantilism which essentially revolved around country’s holdings of silver this provided some food for thought.

Those of us with longer memories have no faith in US paper dollars.  Prior to 1964, US coinage was made of 90% silver.  Today, a roll of 40 quarter dollar coins made of 90% silver, worth $10 in 1964, will cost you about $165.  The real purchasing power of the US dollar has plunged. ( h/t ahimsaka in the FT comments )

Podcast

Is Hong Kong really over as a financial centre?

Today I thought I would take a slightly different tack and look at a potential shift in world financial markets. It concerns a place that for many years has had an economic party based on “location, location, location” as Hong Kong has been a sort of add-on to China. We have previously looked at the economic consequences of the unrest there and now the ante is being upped by China. This poses the question can it survive as one of the world’s major financial centres?

BEIJING (Reuters) – China’s parliament on Thursday overwhelmingly approved directly imposing national security legislation on Hong Kong to tackle secession, subversion, terrorism and foreign interference in a city roiled last year by months of anti-government protests.

Also I do not know about you but the 6 were brave and the 1 was courageous.

The National People’s Congress voted 2,878 to 1 in favour of the decision to empower its standing committee to draft the legislation, with six abstentions. The legislators gathered in the Great Hall of the People burst into sustained applause when the vote tally was projected onto screens.

If we switch to Hong Kong itself there is plainly trouble ahead.

Earlier on Thursday, angry exchanges in the city’s assembly, the Legislative Council, during debate on the anthem bill saw some lawmakers removed in chaotic scenes and the session adjourned.

If we look wider there is of course The Donald to consider.

WASHINGTON (Reuters) – U.S. President Donald Trump said on Tuesday the United States was working on a strong response to China’s planned national security legislation for Hong Kong and it would be announced before the end of the week.

So quite a bit of realpolitik and this adds to the Trade Wars issue. Not exactly what you want when you are a hub for financial trade.

Rich Chinese are expected to park fewer funds in Hong Kong on worries that the security law could allow mainland authorities to seize their wealth, bankers and other industry sources said.

That is quite damning for Hong Kong’s future on its own. So many things have rolled out of this and I remember Rolex watches being bought as collateral and then sold as well as if course the Bitcoin purchases. So there are more questions than answers before we even leave China.

The Equity Market

There is of course a Trump Tweet for this now the market is rallying.

Stock Market up BIG, DOW crosses 25,000. S&P 500 over 3000. States should open up ASAP. The Transition to Greatness has started, ahead of schedule. There will be ups and downs, but next year will be one of the best ever!

They are of course a bit thinner on the ground in declines but there is an issue here if we switch to the Hang Seng Index. This is from rthk on the 22nd of this month.

Hong Kong stocks dropped 5 percent in the noon session after Beijing said it plans to push through a national security law for the city, adding to tensions with the US and fuelling fears of fresh civil unrest.

The Hang Seng Index sank 5 percent, or 1,204 points, to 23,075, midway into the second session.

Although it slipped a little today it has not done much overall since then as it closed at 23,132. That is a relative loss at a time other markets have rallied. If we move on from the cheerleading of The Donald I note that the Nikkei 225 has over the past week gone from below the Hang Seng at circa 20500 to above it at this morning’s 21,916.

Exchange-Rates

Let me briefly hand you over to the Hong Kong Monetary Authority.

The Linked Exchange Rate System (LERS) has been implemented in Hong Kong since 17 October 1983. Through a rigorous, robust and transparent Currency Board system, the LERS ensures that the Hong Kong dollar exchange rate remains stable within a band of HK$7.75-7.85 to one US dollar.

The LERS is the cornerstone of Hong Kong’s monetary and financial stability.  It has weathered many economic cycles and has proved highly resilient in the face of regional and global financial crises over the years.

Oh dear “resilient” looks like being as applicable as it is to the banks! Anyway we have a currency peg in action which seems to be news to some. That means they follow US interest-rates too athough you can pick-up a bit more than 0.5% a year.

The Federal Open Market Committee of the US Fed announced last night to adjust downward the target range for the US federal funds rate by 100 basis points to 0-0.25%. In light of the Fed’s decision, the Hong Kong Monetary Authority (HKMA) also adjusted downward the Base Rate today. The Base Rate is set at 0.86% today according to a pre-set formula ( 16th of March)

Actually it has been edging higher and is now 1.11% so maybe a little heat is on.

In terms of any response to pressure the HKMA would intervene first and at 3.6 trillion Hong Kong Dollars worth it has quite a war chest. Trouble is reserves never seem to be quite enough however large and in a panic interest-rate rises do not achieve much either. Well apart from applying a brake in the economy.

It could use the liquidity swaps system of the US Federal Reserve to get US Dollars and sell them but the lifespan of that would presumably be until The Donald spotted it.

Moving onto the Yuan and its offshore variant there has been a lot of talk about it but it has been remarkably stable considering the times ( that is a translation of the Chinese ave obviously been intervening) and is at 7.15 versus the US Dollar.

The Economy

This was in a bad way and things have got worse.

Hong Kong’s coronavirus-ravaged economy has suffered its worst decline on record, shrinking 8.9 per cent year on year in the first quarter and sparking an appeal from the city’s finance chief for unity to face the grim months ahead…….Hong Kong’s coronavirus-ravaged economy has suffered its worst decline on record, shrinking 8.9 per cent year on year in the first quarter and sparking an appeal from the city’s finance chief for unity to face the grim months ahead. ( South China Morning Post )

In case any central bankers are reading here is their priority.

Hong Kong SAR (China)’s Real Residential Property Price Index was reported at 189.610 2010=100 in Sep 2019. This records a decrease from the previous number of 194.800 2010=100 for Jun 2019 ( CEIC)

It will be lower now as I note this from the HKMA.

The Hong Kong Mortgage Corporation Limited (HKMC) announces that, the pilot scheme for fixed-rate mortgages will start receiving applications from 7 May (Thursday). In response to the change in market interest rates, mortgage interest rates under the pilot scheme are lowered, as compared to the levels previously announced in the 2020-21 Budget (Budget). The interest rates per annum for 10, 15 and 20 years of the Fixed-Rate Mortgage Pilot Scheme are as follows:

2.55%, 2.65% and 2.75% respectively in case you were wondering.

Comment

The situation is a bit like a dam which invariably looks perfectly secure until it bursts. Indeed there are some bouncing bombs in play.

TRUMP ADMN TO EXPEL CHINESE STUDENTS WITH TIES TO MILITARY SCHOOLS: NYT ( @FirstSquawk )

Financial markets are more likely to be troubled by this from Secretary Pompeo.

Today, I reported to Congress that Hong Kong is no longer autonomous from China, given facts on the ground. The United States stands with the people of Hong Kong.

This is the real question will they be able to operate freely? Next comes the issue of where will the business go? This begs lots of question as I have a friend who works there.

Looking at Hong Kong itself the currency peg looks vulnerable in spite of the large foreign exchange reserves. It so often turns out that Newt from the film Aliens was right.

It wont make any difference

The real ray of hope is that the Chinese may adapt their bill which lacks detail.

Harmful elements in the air
Symbols clashing everywhere
Reaps the fields of rice and reeds
While the population feeds
Junk floats on polluted water
An old custom to sell your daughter
Would you like number twenty three?
Leave your yens on the counter please
Ho-oh, ho-oh-oh-oh
Hong Kong Garden
Ho-oh, ho-oh-oh-oh
Hong Kong Garden ( Siouxsie and the Banshees )

As to the housing market is this how Nine Elms ( confession my part of London) finds some new buyers?

How many US Dollars are enough?

The issue of what you might call King Dollar is not one which gets the coverage it deserves. Instead the media coverage tends to highlight claims that its period of rule is on the way out with China demanding more use of the Yuan or Russia the rouble and so on. Or we get the various proclamations that we need some sort of world currency which to my mind are more like pie in the sky thinking than blue sky thinking. When we looked at the IMF on the I noted the suggestions that its SDRs ( Special Drawing Rights) could become the world currency but there are all sorts of flaws there.

So far SDR 204.2 billion (equivalent to about US$281 billion) have been allocated to members, including SDR 182.6 billion allocated in 2009 in the wake of the global financial crisis. The value of the SDR is based on a basket of five currencies—the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.

If we look at the issues of the Euro can anybody even imagine trying to apply a fixed exchange-rate to the whole world? We would have all sorts of individual booms and busts before we even get to the idea of a joint interest-rate. That is before we get to the track record of the IMF after all can you imagine trying to get its currency accepted in Argentina and Greece.

Supply of US Dollars

It is not as if the taps have been turned off.

The numbers: The Federal Reserve’s balance sheet expanded to a record $6.6 trillion in the week ended April 22, an increase of $205 billion from the prior week, the central bank said Thursday.

What happened: Holdings of U.S. Treasurys rose by $120.5 billion to $3.9 trillion. The central bank has been purchasing Treasurys at a rapid pace in a bid to restore functioning to this key U.S. financial market. The central bank’s holdings of mortgage-backed securities rose $54 billion to $1.6 trillion. ( MarketWatch)

As you can see the balance sheet is expanding at a rapid rate and let me just add that if you really think the US Federal Reserve is buying US Treasury Bonds to “restore functioning to this key U.S. financial market.” I have a London bridge to sell you. The truth is that it is implicitly financing the US Budget Deficit as we note that the ten-year yield is a mere 0.58% and the long bond is a mere 1.17% in spite of surging expenditure.

We can now switch to the money supply for further insight because we have noted in the past that QE does not go straight into the numbers as one might assume. Looking at the ECB data has shown that what should be clear cut narrow money creation seems to sometimes go missing in action. However we are seeing quite a surge in the money supply as we note that the narrow money measure ( M1) only went through US $4 trillion as March began but by the 13th of April was already US $4.73 trillion.

I’ll be back in the high life again
All the doors I closed one time will open up again
I’ll be back in the high life again
All the eyes that watched me once will smile and take me in ( Steve Winwood )

Putting that another way the annual rate of increase is 11.6% the annualised six-monthly one is 15.7% and the quarterly one is 23.4%. You can see which way that is going and I would point out that only a month or so ago 11.6% would be considered very high.

Peering into the detail we see that the surge in narrow money is mostly deposits, There has been a rise in cold hard cash, dirty money as Stevie V would say but deposits have risen by around US $700 billion over the past couple of months.

Sending Dollars To Friends Abroad

This a subject I have covered throughout the credit crunch and NPR seem to have caught up with.

As the global economy shuts down, the U.S. Federal Reserve has begun sending billions of dollars to central banks all over the world. Last month, it opened up 14 “swap lines” to nations such as Australia, Japan, Mexico, and Norway. A “swap line” is like an emergency pipeline of dollars to countries that need them. The dollars are “swapped,” i.e., traded for the other country’s currency.

The numbers here have ballooned and are the missing link so to speak in the balance sheet data above. As of last night some US $432.3 billion have been supplied to foreign central banks. I will let that sink in and then point out that it means banks in those countries or regions either cannot get US Dollars at all or can only get them at an interest-rate which challenges their solvency.

As to the demand then we always expected it to be mainly from the following too although not always in this order. Bank of Japan US $215 billion and the ECB $142 billion. Particularly troubling from the Japanese point of view is that as well as being the leader of the pack they are needing ever more. When we note that the Bank of England has only asked for US $27.3 billion which is low when you look at the size of the UK’s banks we see the Bank of Japan needed another US $19 billion overnight.

One factor of note is that the Norges Bank requested some US $3.6 billion for 84 days yesterday. So the heat is on for at least one Norwegian bank.

Also the extension of the swaps to Emerging Markets as requested by @trinhonomics has been used. The Bank of Korea has taken US $16.6 billion, the Bank of Mexico some US $6.6 billion and the Monetary Authority of Singapore some US $5.9 billion.

Exchange Rate

In spite of the balance sheet rises and the effort to become in effect the world’s central bank by supplying US Dollars the exchange rate remains firm. We can look at it in terms of the broad index being 123.2 as opposed to the 114.7 it ended 2019 or simply that it was set at 100 in 2006.

Comment

There are plenty of influences here but one thing we can be sure of is that the US Dollar is in demand. Let me give you some examples.

Kenya shilling hits a new all-time low of 107.6500 against the US dollar according to data from @business

 

Rupee falls to all-time low of 76.87 against US dollar in early trade ( Press Trust of India from Wednesday)

 

At the start of the year, $1 bought you 4.00 Brazilian reals. It now buys you 5.53 reais. That’s a 38% rise for the dollar (27% fall for the real) in less than four months. ( @ReutersJamie )

We have looked at India before and back then going through 70 seemed significant. As to Kenya an interest-rate of 7.25% is not helping much is it? Then we have Brazil showing how the Dollar has impacted South America.

So economics 101 is having another bad phase because a massively increased supply is not pushing the price down. In come respects it may even be creating more demand because if you know there is a ready supply then you may then use it more. Ouch! After all the much lower oil price should be reducing the demand for US Dollars and indeed the negative price such as it applied should be depth-charging it.

Once I built a tower up to the sun
Brick and rivet and lime
Once I built a tower, now it’s done
Brother, can you spare a dime? ( Bing Crosby )