There are consequences from US interest-rates remaining at 5.5% for the fiscal deficit and the Japanese Yen

Today is Federal Reserve day when just after 7pm (they are usually late) we learn the interest-rate decision of Jerome Powell and his colleagues. On the surface not much is expected which is highlighted by the front page of the Financial Times not mentioning it at all as I type this.Yet underneath the surface it is being very powerful via what the apocryphal civil servant Sir Humphrey Appleby would call “masterly inaction.” We can start with the financial market event of the week.

LONDON (Reuters) – Japan’s yen saw a sudden jump on Monday, suggesting the country’s authorities may have finally followed through on the FX market intervention warnings they have be making for months.

Monday’s moves follow a near-11% drop in the yen’s value against the dollar this year and a 35% slump over the last three decades that has pushed it to a 34-year low.

The around 5% pick-up in yield terms between the US Dollar and the Japanese Yen left it vulnerable,especially with Japan continuing the Abenomics style policies for a weaker Yen. On Monday with Japan quiet due to Golden Week the Yen found itself pushed to 160 as what the Japanese authorities were hoping would happen in several months took instead several hours. It looks as though they spent around US $30 billion in a barrage of intervention to get it back to 155, although they are being tight-lipped on the matter.

This has affected the Yen against other currencies as it was only recently it seemed a big deal that the Yen passed 160 versus the Euro. I remember people on Twitter scoffing at my view that the UK Pound £ would be strong versus it and I guess they were rather quiet when it nearly made 200 on Monday morning. A factor that has driven this on can be looked at via this from the 14th of December last year.

Most Federal Reserve officials have forecasted that the US central bank could cut rates by about 0.75 percentage points next year, as they held interest rates at a 22-year high…Officials expect rates to fall even lower in 2025, with most officials forecasting they would end up between 3.5 per cent and 3.75 per cent.

That lit the blue touch paper for bond markets and interest-rate cut expectations and on that road tonight could even have been the second cut. Except not only have there not been any so far the first one keeps getting further away.I pointed out at the time that the US two-year yield had fallen to 4.3% that day and in fact it later fell towards 4.1% whereas I recently noted it climbing back to 5% and it is now 5.03%. In itself it may not seem enormous but the change in expectations has been and along the way the central planners at the Bank of Japan have been wrong-footed. On the 30th June last year I pointed out they wanted a lower Yen and along the way Japan Inc will have welcomed that and the consequent all-time highs in the Nikkei 225 equity index as one of the signposts of the Lost Decade was taken down. But on Monday morning it became a bit of a rout, as these things have a habit of doing. This morning the Yen at just under 158 will be singing along with Queen and David Bowie.

Pressure pushin’ down on me
Pressin’ down on you, no man ask for
Under pressure that brings a building down
Splits a family in two, puts people on streets

US Fiscal Problems

The situation here begins will the Bidenomics policy which in old language would be called a dash for growth.

The IMF’s fiscal monitor estimates that the U.S. deficit for 2024 will reach 6.67% of GDP, rising to 7.06% in 2025 – double the 3.5% in 2015. ( Reuters)

In itself that is fine as long as the economy grows which so far it has. Whilst GDP growth in the first quarter of this year slowed to 0.4% it was some 3.1% higher than a year before which oils many fiscal wheels. But last night brought rather a change of emphasis from the US government.

US TREASURY SECRETARY YELLEN: I AM CONCERNED ABOUT WHERE WE’RE GOING WITH THE US DEFICIT. ( @financialjuice )

If we ignore the rather obvious elephant in the room about it being her policies which have sent in there we can see other issues. Back on the 26th of March I pointed out that she was also running the debt in a very risky way.

The US has shifted its deficit funding to short-term debt issuance, something most people in markets link to the fall in long-term Treasury yields since Oct. 2023. No one in the G10 remotely comes close to this shift. Canada is most similar, but debt issuance is much smaller… ( Robin Brooks )

The problem with doing that is you become ever more vulnerable to a fiscal crisis because you end up with quite a schedule of rollovers of your debt.

Now that was in theory going to be sorted by the Federal Reserve beginning a series of interest-rate cuts with US bond yields falling. Clever Janet! Except they have not happened and things in terms of the schedule always began a bit of a crunch next month due to the short-dated nature of her debt policy. Stupid Janet! With bond yields now high again refinancings will be expensive as we mull another case of theory clashing with reality. It also means that something else I noted on the 26th of March becomes more of an influence.

The interest on the debt alone exceeds $1 trillion per year, constituting around 20% of the government’s annual revenue. ( @BigBreakingWire)

As I frequently point out debt interest is a slow burner, but the issue for the US has changed. First there was all the Covid spending ( which officially does not count as most of it is on the books of the Fed). Then we have seen a continuation of loose fiscal policy added to by a very loose style of debt management by the US Treasury. Now US bond yields look set if I may use one of Jerome Powell’s phrases “higher for longer”

Comment

The Bank of Japan will be on alert later in case the policy announcement leads to another phase of Yen selling. It will no doubt be sending hints to Jerome Powell although there is the issue that the Federal Reserve is notoriously insular and rarely takes any notice at all of international implications of its policy. That means if we do get something there is a admission that the problem is very serious.

Next up is the issue of the fiscal deficit and Jerome Powell has mentioned this before as a worry. However he does not want to create a crisis and there are worries here. For example economic growth has been good and in the past many would have called the numbers below full employment.

Total nonfarm payroll employment rose by 303,000 in March, and the unemployment rate changed
little at 3.8 percent, the U.S. Bureau of Labor Statistics reported today.

Yet we see a fiscal deficit heading for 7% of GDP in what are officially good times.So we can expect something which Treasury Secretary Yellen has tried to forestall. These things can escalate quickly. One way of taking the pressure off would be an announcement to reduce QT……

US fiscal policy has juiced bond yields, interest-rates and economic growth

The economic story of 2024 is again being driven by the US economy. Back on the 4th of this month we were ahead of the game.

The Bond market sold off in response to the above and the thirty-year yield has moved above 4.5%. Or if you prefer the bond market was not buying what Jerome Powell was selling. Money markets moved as well.

In fact the US thirty-year yield is 4.7% as I type this so the heat has been on in the meantime. Along the way it has been above 4.75%. There are quite a few consequences from this and let us start with the ones domestic to the US economy.

The IMF has warned the US that its massive fiscal deficits have stoked inflation and pose “significant risks” for the global economy.
The fund said in its benchmark Fiscal Monitor that it expected the US to record a fiscal deficit of 7.1 per cent next year — more than three times the 2 per cent average for other advanced economies. ( Financial Times)

I have pointed out before the dangers of using higher bond yields as a permanent signal as opposed to a potentially temporary one.But it is also true that the US economy has been juiced by quite a bit of fiscal stimulus under President Biden.

But the IMF said the US had exhibited “remarkably large fiscal slippages”, with the fiscal deficit hitting 8.8 per cent of GDP last year — more than double the 4.1 per cent deficit figure recorded for 2022.

This is a change for the IMF because when I recently looked at their database they were suggesting deficits more like 6% of GDP for the US. Interestingly they added an estimate of the inflationary impact of all of this.

The IMF said the country’s fiscal deficit had contributed 0.5 percentage points to core inflation — a measure of underlying price pressures that excludes energy and food.

Being the Financial Times there is an attempt to blame The Donald.

The presumptive Republican presidential nominee Donald Trump has pledged to make his 2017 tax cuts permanent, a move the Committee for a Responsible Federal Budget think-tank expects to cost $5tn over the next decade.

Whilst The Donald is a man of extensive debt experience he is not the President responsible for the surge in US borrowing. Also as I pointed out on the 4th of this month the Biden administration has been issuing debt in a risky way.

Back on the 26th of March I pointed out that the US is borrowing short by the issuance of lots of Treasury Bills thus making things more unstable.

So with bond yields higher things are both riskier and more expensive in the long-term. Also those looking for a mortgage will be facing higher interest-rates.

The bad times keep rolling for mortgage rates with the average conventional 30yr fixed rate back up to 7.5% according to our daily index.  ( Mortgage Daily News on Tuesday)

In the end this all depends on economic growth as along the way decent growth fixes pretty much everything.

IMF FORECASTS US 2024 GROWTH AT 2.7% VS 2.1% IN JANUARY FORECAST; 2025 GROWTH AT 1.9% VS 1.7% IN JANUARY ( @FirstSquawk)

Problems will arise pretty quickly should growth stop though.

Problems for Jerome Powell

The Chair of the US Federal Reserve was at the IMF meeting and used it to give his view.

Powell on Tuesday signaled the Fed will wait longer than previously anticipated to cut borrowing costs following a series of surprisingly high inflation readings — marking a notable shift from his December pivot toward easing. ( Bloomberg)

That was rather awkward for him personally. But we have been guided towards interest-rate cuts in March and then June and now we will get neither. As we seem to be progressing quarterly that now brings September into the frame. Except then we will be in the election campaign I am sure The Donald will be all over the implications of any interest-rate cuts for that.

Looking at the economics what makes me uncomfortable is that central bankers are again looking backwards to past inflation prints when the real issue is what will happen in 2025/26. They are what it can influence but they keep doing this.

I keep forgettin’ we’re not in love anymore
I keep forgettin’ things will never be the same again
I keep forgettin’ how you made that so clear
I keep forgettin’ ( Michael McDonald)

The US Dollar

The factors above mean we have returned to the phase of King Dollar

The US dollar is on track for its best 5-day run since February 2023. The Bloomberg Dollar Spot Index has risen by ~2% over the last 5 trading days, the most in 14 months. Meanwhile, the US dollar index is up ~5% year to date. ( KobeissiLetter)

This has tightened the noose on everyone else just as 2024 was supposed to be the year of lower interest-rates and a weaker US Dollar. Yet we have instead seen this.

• The Japanese Yen has continued to show weakness against the U.S. Dollar following last week’s USD/JPY breakout to fresh 34-year highs. ( forex.com)

In Japanese terms this is awkward on several levels. Their change to a positive interest-rate was supposed to calm things. Then Finance Minister Suzuki indulged in some open mouth foreign exchange interventions. As we stand at 154.25 he has only succeeded in putting his foot in it.

Whilst the situation is not as acute in Europe many central banks there are in the process of having itchy shirt collars due to the strength of the US Dollar. The ECB has guided people as directly as it can towards an interest-rate cut in June where it expected to be accompanying the Federal Reserve. The Swedish Riksbank guided towards May or June. Both will now fear further currency weakness and in an irony might even welcome this.

Purposely devaluing the U.S. dollar by pressing other countries to alter their own currency values would represent the most aggressive proposal yet in Trump’s attempts to reshape global trade……… A weaker dollar would make U.S. exports cheaper on the world market and potentially reduce the U.S.’ yawning trade deficit. ( Politico)

I mean the policies as in an extraordinary statement for a central banker President Lagarde has expressed her hatred of The Donald more than once. The problem with this is that any Dollar decline is likely to come quite some time after the ECB wants ( and indeed needs) to cit Euro area interest-rates.

Comment

There are clear elements of groundhog day here as in some ways we have gone back to last autumn. Higher bond yields leading to fears about the US deficit. Stronger US growth giving us a higher Dollar and so on. Actually also for the Federal Reserve where “higher for longer” which was only a PR phrase has returned.

Some of the implications are welcome, for example US economic growth. But there are risks as we wonder about those who borrow in US Dollars? Plus there are the issues with US regional banks and commercial property. Other countries need interest-rate cuts due to weak economic growth but now also have currency risks. Plus there is the US itself as its numbers will deteriorate fast in the next recession. Which makes fiscal stimulus even more likely as it strives ever harder to avoid it.

“It takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!” (The Mad Hatter)

US interest-rate cuts look to be moving further away

Whilst many of us were enjoying an Easter break the US Bureau of Economic Analysis carried on working and produced this.

From the preceding month, the PCE price index for February increased 0.3 percent. Prices for goods increased 0.5 percent and prices for services increased 0.3 percent. Food prices increased 0.1 percent and energy prices increased 2.3 percent. Excluding food and energy, the PCE price index increased 0.3 percent.

For those unaware it is the PCE or Personal Consumption Expenditure price index that the US Federal Reserve targets. After a period of apparent stability at the end of 2023 when it rose by only 0.1% in the last three months it has now risen by 0.7% in the first two months of 2024 showing a clear acceleration. That is not only off message but would if repeated put the PCE measure above 4%. Next up is that the Federal Reserve also looks at the core measure which has gone 0.5% and now 0.3% so it looks to be heading towards 5%.

The annual numbers have been declining but the headline one rose slightly this time around.

From the same month one year ago, the PCE price index for February increased 2.5 percent. Prices for services increased 3.8 percent and prices for goods decreased 0.2 percent. Food prices increased 1.3 percent and energy prices decreased 2.3 percent. Excluding food and energy, the PCE price index increased 2.8 percent from one year ago.

This unsettled things and the Federal Reserve’s favourite “mouth” had a go at calming things.

The core PCE index rose 0.26% in February. January’s reading (initially 0.42%) was revised up to a 0.45% gain. The 12-month core PCE rate was 2.8% in February, the lowest in three years. ( @NickTimiraos )

But even he found himself having to add this.

The 6-month annualized rate was 2.9% in February. It was 1.9% in December and 2.6% in Jan.

Also using another decimal place reveals that you are looking for something rather than finding it. Paul Krugman of the New York Times joined in but mostly only demonstrated that you can build an Ivory Tower so high that you miss what the word Transitory has come to mean.

The NY Fed measure of underlying inflation has the advantage of being an algorithm, with no judgement calls and hence no motivated reasoning. Still looks pretty transitory.

Then we heard from the main man himself.

WASHINGTON, March 29 (Reuters) – The latest U.S. inflation data is “along the lines of what we would like to see,” Federal Reserve Chair Jerome Powell said on Friday in comments that appeared to keep the central bank’s baseline for interest rate cuts this year intact.

Things quickly went into what I consider to be a bit of a Twilight Zone.

The personal consumption expenditures (PCE) price index data for February, which was released on Friday, “is what we were expecting,” Powell said, and even though the numbers showed less of a slowdown than last year, “you won’t see us overreacting.”

As they are holding rates right now in restrictive territory at 5.25% to 5.5% it in fact makes any action less likely. The next part gets really rather awkward as of all the places he did not want to be in effectively saying this is transitory is likely to upset more than it calms.

Economic Growth

There is an irony in this section in that I am about to describe something that many other countries would love right now,. Especially the Euro area after another round of grim manufacturing PMI numbers yesterday. You see Jerome Powell talked about US economic growth fading from 3% last year to 2% in 2024. This reinforces his argument that inflation is on its way to 2%.

But this from the S&P Purchasing Manager’s Index tells a different story.

“A key development in recent months has been
the broadening-out of the upturn from services to
manufacturing, with reviving demand for goods driving
the fastest increase in factory production since May
2022.”

As you can see this is heading in the opposite direction to what Chair Powell claimed. Even more was the optimism in the outlook.

Stronger demand was also evident in data for new orders,
which showed an increase for the third month running.

Plus we see strength in an area we have been told by the Federal Reserve is important.

Jobs growth has also picked up as firms boost
capacity to meet demand.

All this would ordinarily be very welcome but not for the narrative of interest-rate cuts soon. Finally we had a factor which backed up the pattern for the PCE numbers for 2024.

“The upturn is, however, being accompanied by some
strengthening of pricing power. Average selling prices
charged by producers rose at the fastest rate for 11
months in March as factories passed higher costs on
to customers, with the rate of inflation running well
above the average recorded prior to the pandemic.”

Next up is the Atlanta Fed.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2024 is 2.8 percent on April 1, up from 2.3 percent on March 29. After this morning’s releases from the US Census Bureau and the Institute for Supply Management, the nowcasts of first-quarter real personal consumption expenditures growth and first-quarter real gross private domestic growth increased from 2.6 percent and 3.1 percent, respectively, to 3.2 percent and 3.9 percent.

As you can see just as Jerome Powell was assuring us that the US economy was slowing the Atlanta Fed recorded a strengthening. Indeed quite an improvement in the two numbers it was updating.

Interest Rates

The Bond market sold off in response to the above and the thirty-year yield has moved above 4.5%. Or if you prefer the bond market was not buying what Jerome Powell was selling. Money markets moved as well.

Investors are betting US interest rates will remain significantly higher than the Federal Reserve’s own estimates by the end of a looming rate-cutting cycle, as markets increasingly focus on where borrowing costs will settle. The market-implied probability of the Fed’s benchmark interest rate is about 3.6 per cent from 2027, making traders’ predictions for the so-called terminal rate far higher than the central bank’s median estimate of 2.6 per cent in its “longer run” projection. ( Financial Times)

If we return to the real world any forecasts for interest-rates in 2027 will only be right by fluke. But there has been a clear change in expectations over the past few days.

Comment

In ordinary times much of this would be welcome for the Federal Reserve.After all most countries have been short on economic growth. But the inflation kicker gives it a problem as well as if the new meme about economic growth is correct will interest-rates make a difference?

“The key thing that the market is trying to reprice is the outlook for long-term economic growth in the context of the new productivity story we are hearing about — driven by artificial intelligence and the potential for more fiscal spending.” ( Financial Times)

We pivoted quickly from a fiscal crisis to “more fiscal spending” did we not? Advocates of that are doing so in the face of higher bond yields as well. Back on the 26th of March I pointed out that the US is borrowing short by the issuance of lots of Treasury Bills thus making things more unstable. Plus we should not forget the impact on commercial property and the regional banks.

But the real problem from all of this comes abroad and particularly in the Euro area. Today’s inflation release combined with the weak economic situation suggests in the words of Carly Rae Jepson it “really, really, really, really, really, really” needs some interest-rate cuts. Except the ECB will be worried about the consequences for the Euro if it acts before the Federal Reserve.

There are warning signs about the US fiscal position and the national debt

Today a story which was all the rage around 6 months ago has come back to the surface as the Financial Times has led with this.

The US faces a Liz Truss-style market shock if the government ignores the country’s ballooning federal debt, the head of Congress’s independent fiscal watchdog has warned.

To be fair to the head of the Congressional Budget Office he knew how to trigger the Financial Times via mentioning Liz Truss and that of course gives us an echo of the autumn of 2022. I am not so sure that the Financial Times has thought through the implications of suggesting that President Biden has been as reckless as it considers Liz Truss to have been,

Phillip Swagel, director of the Congressional Budget Office, said the mounting US fiscal burden was on an “unprecedented” trajectory, risking a crisis of the kind that sparked a run on the pound and the collapse of Truss’s government in the UK in 2022.

Actually there are a couple of problems with that analogy. First last week we saw another phase of US Dollar strength and whilst it can fall as the reserve currency with commodities priced in it the situation is different to any other currency. Presidents serve a term and whilst they can lose Congress they do not get replaced until then.

Debt Costs

We get to the meat of the issue with this bit.

The US was “not there yet”, he said, but as higher interest rates raise the cost of paying its creditors to $1tn in 2026, bond markets could “snap back”.

There are all sorts of issues with stating a debt cost for the future like that as the CBO behaves like the UK Office for Budget Responsibility. You do not know what bond yields will be? Inflation? Fiscal Policy (especially post election)? But the trigger here is the big figure change in the use of $1 trillion which is a lot even in these inflated times.

However some think we are already there.

US national debt stands at $34.6 trillion, with an annual budget deficit of approximately $3 trillion. Congress recently approved an additional $1.2 trillion in spending, laden with pork and earmarks. The interest on the debt alone exceeds $1 trillion per year, constituting around 20% of the government’s annual revenue. ( @BigBreakingWire)

According to them we are already there and I think I have spotted the difference which the Financial Times has rather tripped over.

According to the CBO, the US’s federal debt pile amounted to $26.2tn, or 97 per cent of gross domestic product, at the end of last year.

The US $8 trillion plus difference in the two measures of the Federal debt pile is because the CBO does not count the holdings of the US Federal Reserve. That has all sorts of implications for how you treat both QE and the large losses made by the Fed. But let us return to the debt costs situation.

If US government debt averages 4% across the weighted duration spectrum, that would be about $1.4 trillion in annual interest expense. At $50 trillion in debt (which this will get us there quickly), it’ll be $2 trillion in annual interest expense. ( @LynAldenContact)

We went from US $1 trillion to 2 trillion rather fast. But what that illustrates is my analogy in the past of debt costs being like a snowball rolling down a hill.Nothing much happens then it gets quite a bit larger or in musical terms Paul Simon was on the case.

Slip slidin’ away
Slip slidin’ away
You know the nearer your destination
The more you’re slip slidin’ away.

This brings me back to my opening point about us being here around 6 months ago as it was in mid to late October that the US ten-year yield nudged above 5%. That meant that things were slip-sliding away rather faster than the present 4.24%.

At the risk of frightening younger readers I can recall a time early in my career when the UK had a Long Gilt yield of 15% and things slipped away at quite a rate in debt cost terms.

Fiscal Policy

This has clearly been a player in recent times although the Financial Times tries to find a past scapegoat.

It shot up after sweeping tax cuts by Donald Trump in 2017 and huge stimulus spending during the pandemic. Trump has pledged to renew the tax cuts, due to expire next year, if he defeats Joe Biden in this year’s presidential election.

Of course The Donald has all sorts of debt problems but that rather turns a blind eye to the policies of Treasury Secretary Yellen and President Biden.

The CBO’s forecasts show deficits hovering at about 6 per cent over the next 10 years — and are based on the planned expiry of the Trump tax cuts in 2025.

That is not very different from the deficits of the Biden era as according to the IMF they have been in the mid to high 5 per cents. But the Financial Times chooses to ignore present policies and instead focus on definitely maybes.

The Committee for a Responsible Federal Budget, a think-tank, said that if Trump renewed the tax cuts it would add another $5tn to the federal debt between 2026 and 2035.

Issuance

Sometimes a chart is more eloquent than words.

Wow! Back to COVID levels pic.twitter.com/AVUSo6YYTn

— Lawrence Lepard, "fix the money, fix the world" (@LawrenceLepard) March 25, 2024

There are technical factors in the swings around Repos and Reverse Repos. But there is a simple message in issuance being back at the peaks and if we look at the detail there is more.

The US has shifted its deficit funding to short-term debt issuance, something most people in markets link to the fall in long-term Treasury yields since Oct. 2023. No one in the G10 remotely comes close to this shift. Canada is most similar, but debt issuance is much smaller… ( Robin Brooks )

So there is a technical reason why there is so much issuance in that some of it is rolling over maturing (short-term) debt. Regular readers will be aware that should you have a fiscal crisis that is exactly the sort of thing that will exacerbate it.

The US has always been an outlier when it comes to the maturity profile of its debt. The Treasury's recent shift to short-dated debt issuance is making that difference more acute. Most other countries have been using the past couple of years to issue at longer maturities… pic.twitter.com/JRDSYDFNgL

— Robin Brooks (@robin_j_brooks) March 25, 2024

This would not help in a crisis either.

According to the Federal Reserve and U.S. Department of the Treasury, foreign countries held a total of 7.4 trillion U.S. dollars in U.S. treasury securities as of April 2023. ( Statista.com)

Comment

As you can see there are various warning signals about US fiscal policy and national debt. But missing from the analysis above is another important factor which is economic growth. I have regularly pointed out in the past that UK Budget projections used to assume 3% annual GDP growth because pretty much anything looks affordable at that rate of economic growth. So in a sense the US played a form of economic debt Joker in 2023 as it achieved that. That,however, begs the question of what happens if growth slows or even worse the feared recession turns up? Suddenly all your variables get worse at once.

Let me also address the CBO which has its uses but has many of the problems of the UK Office for Budget Responsibility. It is also consistently wrong and we can file this in our recycling bins.

Swagel’s remarks to the FT came a day after the independent watchdog issued new longer-term economic projections, which showed debt levels rising to 166 per cent of GDP in 2054.

It will be a result if it is right in 2024 let alone 2054!

But there is more.Because this is the pre election period and one way of making this look better is to have some interest-rate cuts to flatter the numbers. Or is that too cynical?

What are the consequences of US bond yields rising above 4.5%?

This morning the heat is on and it comes from a source that you might nor expect as investor’s minds turn towards when the central banks will start easing policy. Actually in a way it is a reversal of the response to the credit crunch. Back then we saw interest-rate cuts which were followed by QE bond buying to lower yields. Now we have seen interest-rate rises and maybe the balance sheet reductions ( for example the Bank of England sold another £650 million yesterday) have led us to this.

10-Year Treasury Yield moved up to 4.55% today, highest since Oct 2007. ( @charliebilello )

Others put it in more clickbait fashion.

BREAKING: Bond tracking ETF, $TLT, falls below $90 for the first time since April 2011. The 10-year note yield is now trading above 4.50% for the first time since 2007. The 2-year note yield is now up a massive 500 basis points since September 2021. Treasury yields are hitting 15+ year highs daily now as Fed pause expectations go well the second half of 2024. ( The Kobeissi Letter )

There is quite a bit going on as this applies pressure in a lot of areas. We can start with the US itself where borrowing for the US government is getting more expensive and it is not the only one.

For the average lender, a top tier 30yr fixed rate is now over 7.5% for the first time in at least 22 years.  The average borrower (not “top tier”) is seeing rates that are even higher.  ( Mortgage Daily News)

With yesterday’s push higher in bond yields maybe more is to come. Although care is needed as we have two different situations here. New buyers and those refinancing are being hit but due to the existence of 15 and 30 year mortgages the effective rate for the overall market is between 3.5% and 4% due to some many (wisely) being taken out at cheaper yields.

King Dollar

It could not be much clearer here.

LONDON/SINGAPORE, Sept 26 (Reuters) – The dollar rose to a new 10-month peak on Tuesday as U.S. bond yields surged to their highest level since October 2007, while the Japanese yen resumed its slide, putting traders on alert for signs of government intervention.

The Japanese Yen has gone through 149 and the Euro has gone to a 6 month low.

The euro was last roughly flat against the dollar at $1.0588, after hitting its lowest since March at $1.057.

So the international consequence is another phase of US Dollar strength which makes everyone else’s inflation problem worse. Another issue is that the interest-rate rise from the ECB a week or so ago has not helped here.

What is causing this?

One potential factor is the Higher for Longer theme of the US Federal Reserve.

Sept 25 (Reuters) – Minneapolis Federal Reserve Bank President Neel Kashkari said on Monday that given the surprising resilience of the U.S. economy, the Fed probably needs to raise borrowing rates further and keep them high for some time to bring inflation back down to 2%.

Although if you listened to the words of central bankers you would be long US bonds at the top and now selling at the bottom!

Next up is the borrowing of the US government but that has not really changed although there are again shutdown fears.

“A shutdown would be credit negative” for the U.S. debt, while “A shutdown “would underscore the weakness of U.S. institutional and governance strength relative to other Aaa-rated sovereigns that we have highlighted in recent years,”  Moody’s analysts wrote.

The credit rating firm added, “In particular, it would demonstrate the significant constraints that intensifying political polarization put on fiscal policymaking at a time of declining fiscal strength, driven by widening fiscal deficits and deteriorating debt affordability.” ( CBS News)

This is one of those spiraling issues as higher yields cause wider deficits and weaker debt affordability.

Hedge Funds

There seems to be another factor in this scenario as the Financial Times explains.

Over the past month, the Bank for International Settlements, a convening body for the world’s central banks, and the US Federal Reserve have both pointed to a rapid build-up in hedge fund bets in the Treasury market.

The so-called basis trade involves playing two very similar debt prices against each other — selling futures and buying bonds — and extracting gains from the small gap between the two using borrowed money.

On a tactical level there is no risk here because your futures position should be the mirror image of your cash bond position. It is also nothing new as I recall watching traders do such trades in BTPs on the LIFFE floor in the 1990s. That was very old era technology as they were on landlines connected mostly to Milan to trade cash Italian bonds against the futures in London. It is always Italy isn’t it? Actually it is the higher interest-rates which bring this into play again in the US  which was true of Italy back then with the addition that the frenetic nature of the Italian bond market added to the risk but also potential profits.

The problem is not this per se as someone getting the wrong way on a particular deal may not be significant. But if we switch from tactical to strategic we see that the size of the trades might be an issue.

By taking advantage of the ability to borrow on both sides of the trade, hedge funds can deploy huge leverage. The head of one fund that has engaged in this trade says traders have in the past been able to lever up to 500 times.

Ah leverage of 500 times! What could go wrong?

For them now we have another bit of central banking influence they think very little as thy have a backstop.

In such a situation, it would be highly unlikely for the US central bank to simply stand back and watch. The executive at the large US bank says: “The assumption is that the Fed will step in to save the repo market, which they have in the past, so my view is that they will step in again if anything happens.” ( FT)

Actually what you are creating is the possibility of an enormous whipsaw as this happens first.

Regulators say this all adds up to a situation where just a few large firms getting out of their bets could potentially encourage or force others to do the same, quickly leading to a doom loop of distressed selling in the world’s most important asset market. ( FT)

Comment

In a way a lot of this comes from the consequences of the largest financial punt in history. That was when the central banks surged like headless chickens into the world’s bond markets and not only pushed them to all-time highs but bought at the top. That helped create the inflation that forced them to raise interest-rates and reduce their balance sheets and so  effectively sell bonds at the bottom.

In that scenario we see how bond yields have risen. But there is another factor at play which further raises the risk of the basis game. QE has reduced bond market liquidity as so many players were punished. Think of what the ZIRP equivalent for bond yields did to pension funds and insurance companies?! All the 2020 and 2021 purchases now look awful. In a sense we are back to this again.

Does anyone know the way?
Did we hear someone say
“We just haven’t got a clue what to do!”
Does anyone know the way?
There’s got to be a way
To Block Buster! ( Sweet)

Now as we are seeing a bit of a panic let me give you the other side. Buyers of US Treasuries are getting 4.5% which is 4% or so better than 2020. Next up is those wondering that the central banks have little alternative but to buy it all again, however much they might deny it.

Where next for interest-rates?

We find ourselves in the middle of a bit of a barrage from central banks on the subject of interest-rates. Yesterday evening the present round of rises was kicked off by the worlds main central bank.

At today’s meeting the Committee raised the target range for the federal funds rate by 1/4 percentage point, bringing the target range to 4-3/4 to 5 percent. And we are continuing the process of significantly reducing our securities holdings.

So as we expected and as normal it was followed by those who have a currency pegged to the US Dollar.

Saudi UAE Qatar Oman Bahrain .. all lifted interest rates by the same size ( @ZiadMDoud )

The Hong Kong Monetary Authority also raised by 0.25% to 5.25%. But as importantly everyone was looking for clues as to what will happen next?

We believe, however, that events in the banking system over the past two weeks are likely to result in tighter
credit conditions for households and businesses, which would in turn affect economic outcomes. ( Federal Reserve)

Which means this.

As a result, we no longer state that we anticipate that ongoing rate increases will be appropriate to quell inflation; instead, we now anticipate that some additional
policy firming may be appropriate.

So will has become “may be”. Also in the press conference we were told  this.

Powell on a pause at today’s meeting: “We did consider that.” ( @NickTimiraos )

If we stay with Nick Timiraos in his role as the press mouthpiece for the Fed we can note this.

Takeaways from the Powell presser/FOMC today:

• Much less conviction about further hikes given what may happening with bank credit. Pay attention to “may” and “some” in the FOMC statement

• A significant minority of FOMC officials (7 of 18) now see inflation risks as balanced

Deposit Insurance

There seems to be some confusion amongst the US authorities. Let us start with the US Federal Reserve.

That is why, in response to these events, the Federal Reserve, working with the Treasury Department and the FDIC, took decisive actions to protect the U.S.
economy and to strengthen public confidence in our banking system. These actions demonstrate
that all depositors’ savings and the banking system are safe.

With the recent words from Treasury Secretary Yellen you might infer that all deposits were now at least implicitly protected. But as the press conference continued we were told this from a different interview.

“I have not considered or discussed anything to do with blanket insurance or guarantees of deposits,” Yellen said. ( Financial Times)

It all rather looked as if the US authorities are making it up as they go along.

Yellen said uninsured deposits above $250,000 could be protected only if a failed bank was deemed to pose a systemic risk to the financial system, as occurred earlier this month with Silicon Valley Bank and Signature Bank. She said that determination would occur only on a case-by-case basis. ( FT )

I was not the only person who felt she had previously given a different impression.

The KBW Bank index, which tracks shares in 24 large and midsized banks, dropped almost 5 per cent, reversing all the gains it made after Yellen’s comments at the bankers’ association on Tuesday. ( FT )

This sort of  confusion only makes a pause and then perhaps even interest-rate cuts more likely. That sort of viiew is confirmed by a metric Chair Powell highlighted a year ago.

The expected three-month T-bill rate dropped to 134 basis points under the current rate. That’s below the previous record nadir it hit in January 2001 — about two months before the US economy fell into recession. ( Bloomberg )

The Swiss

By contrast the Swiss have not been deterred by their own banking crisis.

I come now to our monetary policy decision. We have decided to tighten our monetary policy
further and to raise the SNB policy rate by 0.5 percentage points to 1.5%. In doing so, we are
countering the renewed increase in inflationary pressure.

Actually before this there had been another change.Remember the days when the SNB built up all those  foreign currency assets in an attempt to weaken the Swissy? Well no more.

For some quarters now, we have indicated that in order to ensure appropriate monetary conditions, we would consider selling foreign currency in addition to policy rate increases. In the fourth quarter of 2022, we sold foreign currency worth around CHF 27 billion.

Oh and the crisis at Credit Suisse was all the Americans fault.

The global crisis of confidence rapidly intensified last week due to the turmoil in the US banking industry. From Wednesday onwards, this had a direct impact on Credit Suisse’s liquidity situation as a result of strong outflows of customer deposits and cuts in counterparty
limits.

Actually if you look at the chart the share price has been in a clear decline since it was around 13 Swiss Francs in February of 2021.

Norway

Next up this morning was the Norges Bank.

Norges Bank’s Monetary Policy and Financial Stability Committee has unanimously decided to raise the policy rate from 2.75 percent to 3 percent.

Whilst central banks try to emphasise differences there is much about the next bit that is generic.

The Committee assesses that a higher policy rate is needed to curb inflation. Inflation is markedly above target. Growth in the Norwegian economy is slowing, but economic activity remains high. The labour market is tight, and wage growth is on the rise.

As is common they omit to point out that real wages have been falling. Less than in many other places as it looks to be at an annual rate of 1.5 to 2% but it is a counterpoint to the claim of a tight labour market.

Also at a time when infllation is well above target surely if you think 3.5% is necessary then you should do it now.

The policy rate forecast has been revised up from the December Report and indicates a rise in the policy rate to around 3.5% in summer.

Comment

As you can see there is a fair bit of variation in the response here and it is on several levels. Whilst the US did have higher inflation than Norway it is not so different now but whilst the moves over the past 24 hours are the same there is a 2% difference in interest-rates. That perhaps explains why Norway is keen to emphasise it plans to raise more.

The Swiss seem to be determined to ignore the banking crisis that has arrived upon them. That is pretty extraordinary when you consider the relative size of Credit Suisse and the Swiss economy. It feels like a type of denial although it is true that their inflation trajectory so far has been quite a bit lower than elsewhere.

For my own country the UK then the line of least resistance today for the Bank of England is to match the Federal Reserve and raise by 0.25% to 4.25%. Although I am expecting two dissenters in Dhingra and Tenreyro.

Meanwhile if we lift our eyes from the West things are very different elsewhere as this from Tuesday shows.

In order to continue to influence the stability of prices in the economy and ensure an inflation course in line with the medium-term objectives, we decided in today’s session of the Monetary Policy Committee of the National Bank of Angola (CPM), to reduce:

• A Juro Basic Tax (BNA Tax) from 18% to 17%;

It did not take the central banks long to return to boosting their balance sheets and the money supply

It has been quite a week with what looked like being the main event ( US CPI inflation) being rather shuffled down the pecking order. In fact right at this very moment we have seen yet another signal and it comes from the East.

the People’s Bank of China decided to reduce the deposits of financial institutions on March 27, 2023. The reserve ratio reduction is 0.25 percentage points (excluding financial institutions that have implemented a 5% deposit reserve ratio). After this reduction, the weighted average deposit reserve ratio of financial institutions is about 7.6%.

So China is acting to raise the supply of broad money as it hopes this will encourage their banks to lend. That is exactly the opposite of what happened in Europe yesterday.

Summing up, inflation is projected to remain too high for too long. Therefore, the Governing Council today decided to increase the three key ECB interest rates by 50 basis points, in line with our determination to ensure the timely return of inflation to our two per cent medium-term target.  ( ECB)

Actually there is a more literal divergence as we note that the ECB is now acting to reduce the money supply by selling some of the bonds it owns.

The decline will amount to €15 billion per month on average until the end of June 2023 and its subsequent pace will be determined over time.

Federal Reserve

Actually it is not only the Chinese who have been expanding the money supply this week.

NEW: Borrowing at the Fed this week

+$148.3 billion – net discount window borrowing

+$11.9 billion – the new Bank Term Funding Program Subtotal: $160.2 billion

+$142.8 billion – borrowing for banks seized by FDIC

Total: $303 billion ( @NickTimiraos )

Indeed some argue that more is on its way.

Market observers are on alert to find out just how much extra funding the Federal Reserve’s new bank backstop program will ultimately add into the system, with analysts at JPMorgan Chase & Co. positing that it could inject anywhere up to $2 trillion in liquidity. ( Bloomberg)

Care is needed as some on social media are already claiming that US $2 trillion has been added when it is much more accurate to say that a potential liability has been added.

The analysts’ prediction based on the amount of uninsured deposits at six US banks that have the highest ratio of uninsured deposits over total deposits is closer to $460 billion.  ( Bloomberg)

What has happened here was the Federal Reserve backstopping uninsured deposits ( above the FDIC limit of US $250,000) at Silicon Valley Bank and the others which have recently failed. So the implication is that they will have to do the same in future at other banks.

In a tough week in many ways it looks like my theme of “The Precious! The Precious!” is back in full force as the banks just got enormous backing from the US taxpayer via the US Treasury for nothing. The analysts seem to have more faith in the biggest US banks than I do. or perhaps they work for them.

While the largest banks are unlikely to tap the program, the maximum usage envisaged for the facility is close to $2 trillion, which is the par amount of bonds held by US banks outside the five biggest, they said. ( Bloomberg)

The UK

I did not think this through thoroughly at the time but the Bank of England has made the same implied guarantee.

The Bank and HMT can confirm that all depositors’ money with SVBUK is safe and secure as a result of this transaction. SVBUK’s business will continue to be operated normally by SVBUK. All services will continue to operate as normal and customers should not notice any changes.

For those unaware of the situation deposits with a bank are formally guaranteed by the FSCS compensation scheme up to a limit of £85,000. I do recall an occasion where that was applied ( to a small building society if I remember correctly) so there was a clear change of policy here and of course it will be demanded next time.

Switzerland

At the moment the Swiss look to be most exposed as a relatively small country with a large bank that is already in trouble. We looked at the current risk only yesterday.

Credit Suisse plans to borrow up to SFr50bn ($54bn) from the Swiss central bank and buy back about $3bn of its debt, in an attempt to boost its liquidity and calm investors a day after the bank’s share price plummeted. ( Financial Times)

We do not know how much of this will be drawn down by Credit Suisse? Although we do know that as it is cheap there is an incentive to do so and that things usually turn out to be worse than claimed. I have pointed out before that bad news from banks is released in penny packets rather than telling the full truth. It seems investors are thinking along the same lines because as I type this the share price has fallen to 1.95 Swiss Francs. Only last week that would have been considered to be a disaster and remember it has a ready supply of cash to tap at the Swiss National Bank.

Although some look at the supply of cash in another way.

Credit Suisse, a bank that lost $7.8 billion last year, is being rescued by a bank that lost $143 billion last year. Gotta love the banking system. ( @GRDecter )

Comment

It has been an extraordinary as we note that central banks are back to singing along with Elvis Costello.

Pump it up) When you don’t really need it
(Pump it up) Until you can feel it

Sometimes the most significant decisions come away from the monetary policy spotlight. Here their financial stability counterparts have caught them in something of a spider’s web. There is an added nuance though that many of them are the same people.

If we retiurn to the Chinese move this morning it comes with some rather grand ambition and rhetoric.

The function is to maintain an appropriate amount of money and credit and a stable pace, maintain a reasonable and sufficient liquidity, keep the growth rate of the money supply and social financing scale basically matching the nominal economic growth rate, better support key areas and weak links, and avoid flooding Flood irrigation, taking into account internal and external balance, and strive to promote high-quality economic development.

By flood they mean not over expand the money supply rather than literally. Also we know that the growth target has been lowered so surely money supply growth is enough? In reality I think we see another of our themes in play that the Chinese property sector continues to need help.

Meanwhile the ECB in a show of bravado or maybe to avoid too much embarrassment for its President has just raised interest-rates by 0.5%. But investors are not convinced as the two-year yield of Germany is only 2.59%.

What is the fallout from the failures of Silicon Valley Bank and Signature Bank?

We began the weekend with the US Federal Reserve on full alert to find out the extent of the current problems for the US banking system. There were elements of a bank run in play as there were some depositor queues and shares related to Silicon Valley Bank told a pounding, after trading in its shares was halted. Indeed we can start with an element of that became this on Friday.

People lining up to pull money out of First Republic Bank in Brentwood, LA this weekend. Wealthy neighbourhood with many uninsured accounts over $250,000. The banks stock is down 33% in the last week. ( @GRDecter )

Yesterday it tried to take action.

March 12 (Reuters) – U.S. private bank First Republic Bank (FRC.N) said on Sunday it had secured additional financing through JPMorgan Chase & Co (JPM.N), giving it access to a total of $70 billion in funds through various sources.

As an aside JP Morgan seems to be involved in a few places here. But as we start the week well you can see for yourself.

Shares in First Republic Bank fall 60% in premarket trading, as another California bank faces concerns about its financial strength ( Bloomberg)

Apparently US $70 billion isn’t what it used to be….

Along the way we have also seen this.

We are also announcing a similar systemic risk exception for Signature Bank, New York, New York, which was closed today by its state chartering authority.  ( US Treasury & Federal Reserve)

So as Queen would say.

Another one bites the dust
Another one bites the dust
And another one gone and another one gone

This brings another factor which is contagion and fear of contagion which will be pressurising banks linked to both SVB and Signature. Banks which otherwise might have got through this will now also be signing along with Queen.

Pressure pushin’ down on me
Pressin’ down on you, no man ask for
Under pressure that brings a building down

We have seen that with First Republic which was US $147 in February as opposed to the US $40 as I type this.

The Federal Reserve

I have quite a bit of sympathy for junior staff being dispatched to troubled banks but none at all for those in charge as they have been asleep at the wheel. Just look at this.

The CEO of Silicon Valley Bank was also on the board of directors at the Federal Reserve Bank of San Francisco. ( @GRDecter )

We will be hearing about ut being necessary for large depositors to do due diligence on a bank when the Federal Reserve was unable to do it on a board member.

As to the action well the deposit limit of US $250,000 has been scrapped for now.

Depositors will have access to all of their money starting Monday, March 13. No losses associated with the resolution of Silicon Valley Bank will be borne by the taxpayer…..

You may be wondering how they are so sure the taxpayer will not lose money? Regular readers may recall my timeline for a banking collapse where such phrases are followed by “unexpected” losses “which could not possibly have been predicted except by a few financial terrorists”.

For now the losses are passed to this.

Any losses to the Deposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law.

The problem is if the weaker banks are put into trouble by acquiring losses from the ones which have already failed.

Also there is a problem with this and I have highlighted the issue here.

The additional funding will be made available through the creation of a new Bank Term Funding Program (BTFP), offering loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. 

If they were worth par then SVB and Signature Bank would still be with us so they are suspending reality for a year.  Even with this they feel the need for the US Treasury to be on hand.

With approval of the Treasury Secretary, the Department of the Treasury will make available up to $25 billion from the Exchange Stabilization Fund as a backstop for the BTFP.

In fact they have asked for it on the grounds they will not need it. Er……

The Federal Reserve does not anticipate that it will be necessary to draw on these backstop funds.

In a year’s time there may well be a quiet announcement after all less than a week ago we were told this by Chair Jerome Powell.

Last week Fed Chair Jerome Powell said he saw no risk to banks from rising interest rates. ( @rektmando)

As he cannot see a few days ahead I would not be worrying too much about promises a year ahead.

Interest Rates

In a nutshell these have been the problem in another version of the borrow short lend long problem. Banks have had to pay higher interest-rates on deposits as Chair Powell and his colleagues raised interest-rates but having invested in Treasury Bonds for example they locked themselves in at or near to the lows. Not only a yield or carry loss but a market one as something you have bought at say 130 trades at 110.

This has really changed views on future interest-rate rises.

What a difference one #bankrun makes! Last week, markets reflected a 0.5% chance the #FederalReserve Target Rate would peak at 6.50%. Now there is less than 8% chance we get to 5.50%. ( @jsblokland)

Putting it another way the US two-year yield which went above 5% last week ( 5.07%) in response to the rhetoric of Chair Powell is now at 4.3% leaving him in a bit of a mess.From last Thursday.

As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated.

Did his words push things over the edge? He has a lot to think about right now.

We have seen similar moves across much of the world. My home country the UK has seen its ten-year yield fall below 3.5% this morning. Germany has seen its fall to below 2.3%. Meanwhile whilst I am discussing people making themselves hostages to fortune there is this.

In view of the underlying inflation pressures, we intend to raise interest rates by another 50 basis points at our next monetary policy meeting in March and we will then evaluate the subsequent path of our monetary policy.  ( ECB President Lagarde)

 

Comment

We are finding out in practice one of the ways that the QE bond buying era and zero interest-rates were so bad. Ironically the central bankers made it worse by dithering over interest-rate rises so that when they acted in a rush a sort of tsunami has hit some banks and toppled them. I warned about this many times as banks and funds were effectively forced to buy bonds at the top of the market. We have seen trouble in the UK for pension funds and now in the US for banks with opposite immediate impact as in the UK yields rose but in the US falls.

Also we see that the regulators have not only been asleep at the wheel again, they seem unable to even select competent staff. How was someone from SVB on the board of the San Francisco Fed? Plus the interest-rate rises from the central bankers has created work down the corridor.

Next up is the denial that this is a bailout. It is true that share and bond holders will be wiped out. Also management removed. But we are also seeing that depositors of any size are being bailed out.Plus should this continue to spread the US taxpayer will be required to help out.

Now we wait to see what happens next?

We’re just waiting
For the Hammer To Fall ( Qyeen)

After all if someone listened to Chair Powell and hedged their Treasury Bond position they now will have large mark to market losses on the hedge.

Podcast

https://soundcloud.com/shaun-richards-53550081/notayesmanspodcast216?si=b211f6267a754dc08478e6002e545499&utm_source=clipboard&utm_medium=text&utm_campaign=social_sharing

 

 

Will the US end 2023 with interest-rates lower rather than higher than now?

Today is interest-rate day in Europe as we wait for the ECB and the Bank of England. But the world background was set last night in New York by the US Federal Reserve,

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 4-1/2 to 4-3/4 percent.

This bit was also significant.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lael Brainard; Lisa D. Cook; Austan D. Goolsbee; Patrick Harker; Philip N. Jefferson; Neel Kashkari; Lorie K. Logan; and Christopher J. Waller.

As everybody voted for a 0.25% increase. That was in line with my expectation and indeed from our Bank of Canada leading indicator last week. Let me give the Federal Reserve credit here for stating the votes explicitly as for example the ECB does not meaning people end up asking President Lagarde and there is no check on her truthfulness.

However even such a big deal is now in the past and we move smoothly o to what happens next? So let us examine the US economy.

The US Economy

The Atlanta Fed GDP nowcast tells us this.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2023 is 0.7 percent, unchanged from January 27 after rounding.

So 0.2% as we would count it which is not much. Indeed in ordinary times if such a state still exists such a growth rate would have the Federal Reserve thinking about interest-rate cuts not rises. Especially if we add this from Chair Powell’s opening statement.

The U.S. economy slowed significantly last year, with real GDP rising at a below-trend pace of 1 percent. Recent indicators point to modest growth of spending and production this quarter.

He then confessed a lot of it was down to his actions.

Consumer spending appears to be expanding at a subdued pace, in part reflecting tighter financial conditions over the past year. Activity in the housing sector continues to weaken, largely reflecting higher mortgage rates. Higher interest rates and slower output growth also appear to be weighing on business fixed investment.

Inflation

This of course has been something of an X-Factor trumping the situation above. Over again to Chair Powell.

Inflation remains well above our longer-run goal of 2 percent. Over the 12 months ending in December, total PCE prices rose 5.0 percent; excluding the volatile food and energy categories, core PCE prices rose 4.4 percent.

As you can see they are still trying to spin the core inflation line in spite of having to start the statement with this.

My colleagues and I understand the hardship that high
inflation is causing, and we are strongly committed to bringing inflation back down to our
2 percent goal.

Inflation in food and energy has affected people the most. But the situation forced their hand and even their brightest PhD students could not come up with an inflation number below 4.4%. Doing it ignores the reality the central bankers have been forced to confess to.

My colleagues and I are acutely aware that high inflation imposes significant hardship as it erodes purchasing power, especially for those least able to meet the higher costs of essentials like food, housing, and transportation.

A sort of new version of “I cannot eat an I-Pad”

However looking ahead the situation is beginning to turn.

The inflation data received over the past three
months show a welcome reduction in the monthly pace of increases

The next bit is not a little curious because if they really believed that then they could have increased interest-rates by 0.5%.

And while recent developments are encouraging, we will need substantially more evidence to be confident that
inflation is on a sustained downward path.

Jobs

The official line continues to be this and the emphasis is mine.

Despite the slowdown in growth, the labor market remains extremely tight, with the unemployment rate at a 50-year low, job vacancies still very high, and wage growth elevated.

I would argue that arguing wage growth is “elevated” must come in the context of it being rather thin when compared to inflation. But the Federal Reserve must also be aware of this from last year.

From March 2022 to June 2022,
The difference between the number of gross job gains and the number of gross job losses yielded a net
employment loss of 287,000 jobs in the private sector during the second quarter of 2022.

That was from the Bureau of Labor Statistics on the 25th of January and is a bombshell. You will realise how much when I point out that they originally claimed there were 1.1 million job gains. So there has been a downwards revision of some 1.4 million. This provides us with several contexts as we remind ourselves that we were assured the US could not be in recession back then due to the labour market being so strong. Also such large revisions provide quite a context for the non-farm payroll numbers which in that context are smaller than the margin of error. Finally the jobs market looks a fair bit weaker now.

Comment

The statement came with by now usual rhetoric.

Even so, we have more work to do. Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy. Without price stability, the
economy does not work for anyone.

That clearly suggests more interest-rate rises are on there way. Or it would if central bankers were ever clear about such things.

“If I seem unduly clear to you, you must have misunderstood what I said.”

That was Alan Greenspan to a Senate Select Committee back in 1987. I think that the real message came in the previous couple of sentences.

Over the past year, we have taken forceful actions to tighten the stance of monetary policy. We have covered a lot of ground, and the full effects of our rapid tightening so
far are yet to be felt.

The first is essentially PR where they are hoping the media will pick up on and use the word “forceful” to influence perceptions. The second is more important as it hints that they think they may have done enough already.

Indeed my Never believe anything until officially denied line may be getting a hearing as this.

FED‘S POWELL: RATE CUTS WILL NOT BE APPROPRIATE THIS YEAR, ACCORDING TO MY FORECAST AND THAT OF MY COLLEAGUES. ( @financialjuice )

Led to this.

Swap contracts tied to this year’s Fed meetings show approximately 50 basis points of rate cuts are now firmly priced between the June policy peak of 4.90% to the 4.40% overnight lending rate tied to the December policy meeting. ( Bloomberg)

Will we get one more rise or was that it?

Today we find out via Jackson Hole what our monetary policy will be…

Today and tomorrow the world’s central bankers will be speaking at the Jackson Hole symposium held by the Kansas City Federal Reserve. This is a big deal because it has been frequently used in the past as a way of signalling changes in monetary policy. For example some years back I recall the issue of “Forward Guidance” being raised in a presentation there and it then spreading like wildfire amongst the central bankers, who were concerned at the time in the words of Mark Carney that monetary policy was “maxxed out”.

Problems from Last Year

Let me illustrate the problem this year via the speech given a year ago by Fed Chair Jay Powell.

The rapid reopening of the economy has brought a sharp run-up in inflation. Over the 12 months through July, measures of headline and core personal consumption expenditures inflation have run at 4.2 percent and 3.6 percent, respectively—well above our 2 percent longer-run objective

Inflation was already on the march but he assured us it would not last.

But that concern is tempered by a number of factors that suggest that these elevated readings are likely to prove temporary.

It also matters why he said this because it relates to a critique of their analysis I have made for many years.

The spike in inflation is so far largely the product of a relatively narrow group of goods and services that have been directly affected by the pandemic and the reopening of the economy.

The problem is that the inflation fires spread and it is hard to know where to start with the claim about energy costs on a day that we have discovered domestic energy in the UK will rise by 80% in October.

Durable goods alone contributed about 1 percentage point to the latest 12‑month measures of headline and core inflation. Energy prices, which rebounded with the strong recovery, added another 0.8 percentage point to headline inflation, and from long experience we expect the inflation effects of these increases to be transitory.

He couldn’t stop himself.

 temporarily elevating reported inflation. These effects, which are adding a few tenths to measured inflation, should wash out over time.

The issue now moves to them claiming  they have expertise in inflation management by constructing different indices.

We consult a range of measures meant to capture whether price increases for particular items are spilling over into broad-based inflation. These include trimmed mean measures and measures excluding durables and computed from just before the pandemic.

Just by chance they gave exactly the answer he wanted.

These measures generally show inflation at or close to our 2 percent longer-run objective.

I guess there are many football managers who which they could fix the scores when they did not like them! But more seriously we have the issue of bodies which go to a lot of mathematical effort to get the answer they want rather than what is realistic and likely.

It is an example of institutional failure, where a body which is charged with doing something does the reverse. Even the Financial Times is on the case.

Viewing inflation through a “transitory” lens — a term Powell officially abandoned in November — laid the basis for a series of policy blunders that led to the Fed expanding its balance sheet long after additional support was no longer necessary. It also waited until March before raising rates.

Returning to my football analogy or soccer as we are looking at the US the manager would have been sacked long ago. But for central bankers responsibility is an issue for others ( wage restraint for example) but not themselves.

This Year

The present problem is simply this.

From the same month one year ago, the PCE price index for June increased 6.8 percent (table 11). Prices for goods increased 10.4 percent and prices for services increased 4.9 percent. Food prices increased 11.2 percent and energy prices increased 43.5 percent. Excluding food and energy, the PCE price index increased 4.8 percent from one year ago.

For those of you unaware the Fed targets the Personal Consumption Expenditures price index which has the virtue of invariably being lower than CPI. In central banking speak lower in this regard means a superior measure. But even it has every possible derivative above target.

So now he will stand up having done this.

Heading into this year’s Jackson Hole conference, economists say the Fed has tried to correct many of its earlier mistakes, having “front-loaded” its interest rate increases and raised the benchmark policy rate from near-zero to a target range of 2.25 per cent to 2.50 per cent in just four months. ( Financial Yimes)

By the way this is how you mislead whether by ignorance or intention as acting way too late is described as “front-loaded”, But we now face a world where the expectation is for a 3.75% interest-rate next spring.

But even a 3.75% interest-rate should it happen is well below the inflation rate and the reality is that the present 2.25% or so is around half of even the “core” inflation rate. So he is under pressure to talk tough.

The economy weakens

This is the next part of the debate and we can go back to last year’s speech.

The pandemic recession—the briefest yet deepest on record—displaced roughly 30 million workers in the space of two months.

Well the US economy has just seen what many think of as a recession.

Real gross domestic product (GDP) decreased at an annual rate of 0.6 percent in the second quarter of 2022, following a decrease of 1.6 percent in the first quarter.  ( Bureau of Economic Analysis)

Of course officially that is not a recession but as this quarter weakens could we see a third decline in a row?

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2022 is 1.4 percent on August 24, down from 1.6 percent on August 17.  ( Atlanta Fed)

Growth is still predicted but seems to be fading and as we know that central bankers follow the PMI numbers there was this earlier this week.

US private sector firms signalled a sharper fall in business
activity during August, according to latest ‘flash’ PMI™ data from S&P Global. The decrease in output was the fastest seen since May 2020 and solid overall.

The next bit rather stood out.

Excluding the period between March and
May 2020, the fall in total output was the steepest seen
since the series began nearly 13 years ago

Also as the Federal Reserve has emphasised the strength of the labour market this will be noted by them.

“Lower new order inflows and continued efforts to rein in
spending led to the slowest uptick in employment for
almost a year”

Comment

So let me say that I think that Chair Powell has to talk tough on inflation but I expect a soft core to emerge. After all if he and his colleagues really prioritised inflation they would have acted long before they did. Much of central banking talk these days is about public relations so he can talk tough on inflation which will allow him to “pivot” later.  Or in the words of Carly Rae Jepson saying this about higher interest-rates.

I really, really, really, really, really, really like you

Will allow him to reverse course later this year or early next.

Where this matters a lot is caused by the impact of the strength of the US Dollar. It has hit the Japanese Yen the most of the major currencies but its impact is everywhere. Because of it other central banks find themselves pretty much forced to match the Federal Reserve in terms of interest-rate increases. I say pretty much because the Bank of Japan is trying to ignore it and is letting the Yen take the strain. It can do so partly because inflation is lower there.

But he is essentially setting policy for much of the world..