The history of the credit crunch continues to be rewritten

Today is a day for central bankers as both the Bank of England and European Central Bank declare the results of their latest policy decisions. However it will be a Super Thursday only in name as  the main news concerning the Bank of England this week has been the extension of Governor Carney;s term by seven months to January 2020. A really rather extraordinary move on both sides, as we mull not only the possibility of future monthly or even weekly future extensions,, and on the other side what happened to the personal circumstances that supposedly stopped him staying for longer in the first place?

Moving to the ECB the rumour yesterday was that its economic forecasts will be revised down slightly which is likely to reduce the rhetoric about the Euro area economy being resilient. But apart from that there is little for it to do apart from play down the recent news about money laundering via banks being rife in some of the smaller ( Malta and Estonia) Euro area countries. President Draghi may also repeat the hints he keeps providing that he has no intention of raising interest-rates n his term of office. This may have a market impact as more than a few have convinced themselves that a 0.2% rise is due this time next year. Apart from the fact that the ECB changes interest-rates by 0.25% and not 0.2% the apparent slowing of the Euro area economy makes that increasingly unlikely.

Rewriting History

This week has seen a lot of reviews of the crash of a decade ago but the most significant comes from the man at the centre of the response which was Ben Bernanke of the US Federal Reserve. He has written a paper for Brookings which to my mind illustrates why central banks have put so much effort into raising asset and in particular house prices.

Recent work, including by Atif Mian and Amir Sufi, proposes that the accumulation of debt during the housing boom of the early 2000s made households particularly vulnerable to changes in their net worth. When house prices began to decline, homeowners’ main source of collateral (home equity) contracted, reducing their access to new credit even as their wealth and incomes declined.  These credit constraints exacerbated the declines in consumer spending.

Or if you want the point really rammed home here it is.

Mian and Sufi and others attribute the economic downturn in 2008 and 2009 primarily to the boom and subsequent bust in housing wealth,

Thus central bankers including Ben decided that the response to the bust in housing wealth was to create another boom. Many of them including Ben himself did so well before the paper he quotes was written. For example the US Federal Reserve bought mortgage-backed securities as follows.

From early 2009 through October 2014, the Federal Reserve added on net approximately $1.8 trillion of longer-term agency MBS and agency debt securities to the SOMA portfolio through its large-scale asset purchase programs. ( New York Fed).

Thus we see than Ben Bernanke is being somewhat disingenuous in pointing us to a paper written in 2014 when he made his response in 2009! Anyway there is a statistic you may like in the paper.

that the total amount of debt for American households doubled between 2000 and 2007 to $14 trillion?

The banks

They would have been helped in a variety of ways by the response to the credit crunch. Firstly by the large interest-rate cuts and next by the advent of QE ( Quantitative Easing) which helped them both implicitly by raising the value of their bond holdings and explicitly via the purchase of mortgage debt. Some were also bailed out and that mentality seems to be ongoing.

 We need to make sure that future generations of financial firefighters have the emergency powers they need to prevent the next fire from becoming a conflagration. We must also resist calls to eliminate safeguards as the memory of the crisis fades. For those working to keep our financial system resilient, the enemy is forgetting.

That is from an opinion piece in the New York Times from not only Ben Bernanke but the two US Treasury Secretaries which were Hank Paulson and Timothy Geithner. What powers do they want?

Among these changes, the FDIC can no longer issue blanket guarantees of bank debt as it did in the crisis, the Fed’s emergency lending powers have been constrained, and the Treasury would not be able to repeat its guarantee of the money market funds. These powers were critical in stopping the 2008 panic.

In other words they want to be able to bailout and back stop the banks again. Or if you prefer take us back to the world of privatising profits and socialising losses. For the establishment in the US that worked well as the government made a profit and the banks were eventually able to carry on regardless. Indeed the next stage of fining banks also was something of an establishment merry go round as you can argue that it was just another way of the banks repaying the establishment for the bailouts.

On the other side of the coin ordinary people did lose money. Some had their homes foreclosed on them and others lost their savings. The unfairness of this arrives when we look at bank shareholders who had losses. In itself that is not a crime as by being shareholders they take a clear risk. But the rub is that the losses were driven by a combination of fraud and malpractice for which so few have been punished. If we move onto the bank fines we see that yet again punishment hit bank shareholders whereas bank executives might see a lower bonus but otherwise remained extremely well rewarded. We are back to the theme of the 0.01% being protected whilst the 99.99% bear any pain.

Putting it another way here is former Barclays boss Bob Diamond from the BBC website earlier.

Former Barclays boss Bob Diamond has said he fears banks have become too cautious about taking risks.

Mr Diamond told me the risk-averse culture means they can’t support the economy and generate jobs and growth.

Support the economy or bankers pay?

Inequality

Here is perhaps the biggest rewriting of history as we return to the thoughts of Ben Bernanke at Brookings.

“There’s some folks who don’t like QE, and as each argument fails, they move down the ladder. And so now you have hedge fund managers writing in the Wall Street Journal how QE is creating inequality as if they cared.”

You may note that there is no actual denial that QE creates inequality. Frankly if you boost asset prices which is its main effect you have to benefit the asset rich relative to the poor. However back in March the Bank of England assured us this.

Monetary policy had very little effect on overall inequality

How? Well let me show you their example of inequality being unaffected.

 But it is worth noting that existing differences in net wealth mean that a 10% increase for all would equate to £200 for the bottom decile and £195,000 for the richest.

Apart from anything else this was awkward for the previous research from the Bank of England which assured us QE had boosted wealth for those with pensions and shareholders. I guess they were hoping we had forgotten that.

Comment

The last few days have seen quite a bit of rewriting history about the credit crunch as the establishment wants us to forget three things.

  1. It was asleep at the wheel
  2. Those who caused it got off scot free in the main and were sometimes handsomely rewarded whereas many relative innocents suffered financial hardship.
  3. The response not only boosted the already wealthy but contributed to an economic world of struggling real wage growth

The first problem will recur we know that in spite of all of the official claims to the contrary. As to the response one issue is that those in charge are invariably unsuited to the role. They are picked out of academia and/or the establishment and suddenly find that they go from a cosy slow-moving world to one that is exactly the reverse, so we should not be surprised if they act like rabbits caught in a car’s headlights. So on that score I think we should cut Ben Bernanke some slack but that does not eliminate points two and three which are critiques of the economic regime he implemented.

Also if we stay with central banks it could all have been worse as imagine you are at Turkeys central bank the CBRT deciding how much to raise interest-rates and you read this!

Erdogan says must lower interest rates ( @ForexLive )

 

 

 

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What can we expect from the Bank of England in 2018?

Today we find out the results of the latest Bank of England policy meeting which seems set to be along the lines of Merry Christmas and see you in the new year. One area of possible change is to its status as the Old Lady  of Threadneedle Street a 200 year plus tradition. From City AM.

The Bank will use further consultations to remove “all gendered language” from rulebooks and forms used throughout the finance sector, a spokesperson said.

Perhaps it will divert attention from the problems keeping women in senior positions at the Bank as we have seen several cases of “woman overboard” in recent times some for incompetence ( a criteria that could be spread to my sex) but not so in the case of Kristin Forbes. There does seem to be an aversion to appointing British female economists as opposed to what might be called “internationalists” in the style of Governor Carney.

Moving onto interest-rates there is an area where the heat is indeed on at least in relative terms. From the US Federal Reserve last night.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-1/4 to 1‑1/2 percent. The stance of monetary policy remains accommodative

The crucial part is the last bit with its clear hint of more to come which was reinforced by Janet Yellen at the press conference. From the Wall Street Journal.

Even with today’s rate increase, she said the federal-funds rate remains somewhat below its neutral level. That neutral level is low but expected to rise and so more gradual rate hikes are likely going forward, she said.

The WSJ put the expectation like this.

At the same time, they expect inflation to hold steady, and they maintained their expectation of three interest-rate increases in 2018.

Actually if financial markets are any guide that may be it as the US Treasury Bond market looks as though it is looking for US short-term interest-rates rising to around 2%. For example the yield on the five-year Treasury Note is 2.14% and the ten-year is 2.38%.

But the underlying theme here is that the US is leaving the UK behind and if we look back in time we see that such a situation is unusual as we generally move if not in unison along the same path. What was particularly unusual was the August 2016 UK Bank Rate cut.

Inflation Targeting

What is especially unusual is that the Fed and the Bank of England are taking completely different views on inflation trends and indeed targeting. From the Fed.

 Inflation on a 12‑month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

In spite of the fact that consumer inflation is below target they are raising interest-rates based on an expectation ( incorrect so far) that it will rise to their target and in truth because of the improved employment and economic growth situation. A bit of old fashioned taking away the punch bowl monetary policy if you like.

The Bank of England faces a different inflation scenario as we learnt on Tuesday. From Bloomberg.

The latest data mean Carney has to write to Chancellor of the Exchequer Philip Hammond explaining why inflation is more than 1 percentage point away from the official 2 percent target. The letter will be published alongside the BOE’s policy decision in February, rather than this week, as the Monetary Policy Committee has already started its meetings for its Dec. 14 announcement.

If you were a Martian who found a text book on monetary policy floating around you might reasonably expect the Bank of England to be in the middle of a series of interest-rates. Our gender neutral Martian would therefore be confused to note that as inflation expectations rose in the summer of 2016 it cut rather than raised Bank Rate. This was based on a different strategy highlighted by a Twitter exchange I had with former Bank of England policymaker David ( Danny) Blanchflower who assured me there was a “collapse in confidence”. To my point that in reality the economy carried on as before ( in fact the second part of 2016 was better than the first) he seemed to be claiming that the Bank Rate cut was both the fastest acting and most effective 0.25% interest-rate reduction in history. If only the previous 4% +  of Bank Rate cuts had been like that…….

 

Even Norway gets in on the act

For Norges bank earlier today.

On the whole, the changes in the outlook and the balance of risks imply a somewhat earlier increase in the key policy rate than projected in the September Report.

China is on the move as well as this from its central bank indicates.

On December 14, the People’s Bank of China launched the reverse repo and MLF operation rates slightly up 5 basis points.

I am slightly bemused that anyone thinks that a 0.05% change in official interest-rates will have any effect apart from imposing costs and signalling. Supposedly it is a response to the move from the US but it is some 0.2% short.

The UK economic situation

This continues to what we might call bumble along. In fact if the NIESR is any guide ( and it has been in good form) then we may see a nudge forwards.

Our monthly estimates of GDP suggest that output expanded by 0.5 per cent in the three months to November, similar to our estimate from last month.

The international outlook looks solid which should help too. This morning’s retail sales data suggested that the many reports of the demise of the UK consumer continue to be premature,

When compared with October 2017, the quantity bought in November 2017 increased by 1.1%, with household goods stores showing strong growth at 2.9%……..The year-on-year growth rate shows the quantity bought increased by 1.6%.

As ever care is needed especially as Black Friday was included in the November series but Cyber Monday was not. Although I note that there was yet another signal of the Bank of England’s inflation problem.

Total average store prices increased by 3.1% in November 2017 when compared with the same period last year, with price increases across all store types, in particular food stores had the largest price increase of 3.6% since September 2013.

Comment

The Bank of England finds itself in a similar position to the US Federal Reserve in one respect which is that it had two dissenters to its last interest-rate increase. The clear difference is that the Fed is in the middle of a series of rises whereas the Bank of England has so far not convinced on this front in spite of saying things like this. From the Daily Telegraph.

“We’ve said, given all the things we assume in our forecast, many of which will be misses – there are always unknown things and unpredictable things happening – but given our outlook currently, we anticipate we will need maybe a couple more rate rises, to get inflation back on track, while at the same time supporting the economy,” Ben Broadbent told the BBC’s Today programme.

I wonder if he even convinced himself. Also it is disappointing that we will not get the formal letter explaining the rise in inflation until February as it is not as if Governor Carney has been short of time.

So it seems we will only see action from the Bank of England next year if its hand is forced and on that basis I am pleased to see that Governor Carney plans to get about.

Me on Core Finance

http://www.corelondon.tv/inflation-employment-uk/

What and indeed where next for bond markets?

The credit crunch era has brought bond markets towards the centre stage of economics and finance. Before then there were rare expressions of interest in either a crisis or if the media wanted to film a response to an economic data release. You see equities trade rarely but bonds a lot so they filmed us instead and claimed we were equities trades so sorry for my part in any deception! Where things changed was when central banks released that lowering short-term interest-rates ( Bank Rate in the UK) was not the only game in town and that it was not having the effect that they hoped and planned. Also the Ivory Towers style assumption that short-term interest-rates move long-term ones went the way of so many of their assumptions straight to the recycling bin.

QE

It is easy to forget now what a big deal this was as the Federal Reserve and the Bank of England joined the Bank of Japan in buying government bonds or Quantitative Easing ( QE). There is a familiar factor in that what was supposed to be a temporary measure has now become a permanent feature of the economic landscape. As for example the holdings of the Bank of England stretch to 2068 with no current plan to reverse any of it and instead keeping the total at £435 billion by reinvesting maturities. Indeed on Friday it released this on social media.

Should quantitative easing become part of the conventional monetary policy toolkit?

The Author Richard Harrison may be in line for promotion after this.

Though the model does not support the idea that central banks should maintain permanently large balance sheets, it does suggest that we may see more quantitative easing in the future.

So here is a change for bond markets which is that QE will be permanent as so far there has been little or no interest in unwinding it. Even the US Federal Reserve which to be fair is doing some unwinding is doing so with baby steps or the complete opposite of the way it charged in to increase QE.

Along the way other central banks joined in most noticeably the European Central Bank. It had previously indulged in some QE via its purchases of Southern European bonds and covered ( bank mortgage) bonds but of course it then went into the major game. In spite of the fact that the Euro area economy is having a rather good 2017 it is still at it to the order of 60 billion Euros a month albeit that halves next year. So we are a long way away from it stopping let alone reversing. If we look at one of the countries dragged along by the Euro into the QE adventure we see that even annual economic growth of 3.1% does not seem to be enough for a change of course. From Reuters.

Riksbank’s Ohlsson: Too Early To Make MonPol Less Expansionary

If 3.1% economic growth is “too early” then the clear and present danger is that Sweden goes into the next downturn with QE ongoing ( and maybe negative interest-rates too). One consequence that seems likely is that they will run out of bonds to buy as not everyone wants to sell to the central bank.

Whilst we may think that QE is in modern parlance “like so over” in fact on a net basis it is still growing and only last month a new player came with its glass to the punch bowl.

In addition, the Magyar Nemzeti Bank will launch a targeted programme aimed at purchasing mortgage bonds with maturities of three years or more. Both programmes will also contribute to an increase in the share of loans with long periods of interest rate fixation.

Okay so Hungary is in the club albeit via mortgage bond purchases which can be a sort of win double for central banks as it boosts “the precious” ( banks) and via yield substitution implicitly boosts the government bond market too. But we learn something by looking at the economic situation according to the MNB.

The Hungarian economy grew by 3.6 percent in the third quarter of 2017…….The Monetary Council expects annual economic growth of 3.6 percent in 2017 and stable growth of between 3-4 percent over the coming years. The Bank’s and the Government’s stimulating measures contribute substantially to economic growth.

We are now seeing procyclical policy where economies are stimulated by monetary policy in a boom. In particular central banks continue with very large balance sheets full of government and other bonds and in net terms they are still buyers.

The bond vigilantes

They have been beaten back and as we observe the situation above we see why. Many of the scenarios where they are in play and bond yields rise substantially have been taken away for now at least by the central banks. There can be rises in bond yields in individual countries as we see for example in the Turkish crisis or Venezuela but the scale of the crisis needs to be larger and these days countries are picked off individually rather than collectively.

At the moment there are grounds for the bond yield rises to be in play in the Euro area with growth solid but of course the ECB is in play and in fact yesterday brought news of exactly the reverse.

 

A flat yield curve?

The consequence of central banks continuing with what the Bank of Japan calls “yield curve control” has led to comments like this. From the Financial Times yesterday.

Selling of shorter-dated Treasuries pushed the US yield curve to its flattest level since 2007 on Tuesday. The difference between the yields on two-year Treasury notes and 10-year Treasury bonds dropped below 55 basis points in afternoon trading in New York. While the 10-year Treasury was little changed, prices of two-year notes fell for the second consecutive day. The two-year Treasury yield, which moves inversely to the note’s price, has climbed 64 basis points this year to 1.83 per cent.

If we look long the yield curve the numbers are getting more and more similar ironically taking us back to the “one interest-rate” idea the central banks and Ivory Towers came into the credit crunch with. With the US 2 year yield at 1.8% and the 30 year at 2.71% there is not much of a gap.

Why does something which may seem arcane matter? Well the FT explains and the emphasis is mine.

It marks a pronounced “flattening” of the yield curve, with investors receiving decreasing returns for holding longer-dated bonds compared to shorter-dated notes — typically a harbinger of economic recession.

Comment

We have seen phases of falls in bond prices and rises in yield. For example the election of President Trump was one. But once they pass we are left wondering if the around thirty year trend for lower bond yields is still in play and we are heading for 0% ( ZIRP) or the icy cold waters of negativity ( NIRP)? On that road the idea that the current yield curve shape points to a recession gets kicked into touch as Goodhart’s Law or if you prefer the Lucas Critique comes into play. But things are now so mixed up that a recession might actually be on its way after all we are due one.

For yields to rise again on any meaningful scale there will have to be some form of calamity for the central banks. This is because QE is like a drug for so many areas. One clear one is the automotive sector I looked at yesterday but governments are addicted to paying low yields as are those with mortgages. On that road they cannot let go until they are forced to. Thus the low bond yields we see right now are a short-term success which central banks can claim but set us on the road to a type of junkie culture long-term failure. Or in my country this being proclaimed as success.

“Since 1995 the value of land has increased more than fivefold, making it our most valuable asset. At £5 trillion, it accounts for just over half of the total net worth of the UK at end-2016. At over £800 billion, the rise in the nation’s total net worth is the largest annual increase on record.”

Of course this is merely triumphalism for higher house prices in another form. As ever those without are excluded from the party.

 

 

Why are we told some inflation is good for us?

A major topic in the world of economics is the subject of inflation which has been brought into focus by the events of the past 2/3 years or so. First we had the phase where a fall in the price of crude oil filtered through the system such that official consumer inflation across many countries fell to zero per cent on an annual basis and in some cases below that. If you recall that led to the deflation scare or it you will excuse the capitals what much of the media presented as a DEFLATION scare. We were presented with a four horsemen of the apocalypse style scenario where lower and especially negative inflation would take us to a downwards spiral where wages and economic activity fell as well along the line of this from R.E.M.

It’s the end of the world as we know it.
It’s the end of the world as we know it.

I coined the phrase “deflation nutter” to cover this because as I pointed out, Greece the subject of yesterday suffered from quite a few policy errors pushing it into depression and that on the other side of the coin for all its problems Japan had survived years and indeed decades of 0% inflation. Indeed on the 29th of January 2015 I wrote an article on here explaining how lower consumer inflation was boosting consumption across a range of countries via the positive effect it was having on real wages.

 if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly. If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.

 

Relative prices

The comfortable cosy world of central bankers and theoretical economists told us and indeed continues to tell us that we need positive inflation so that relative prices can change. That leads us to the era of inflation targets which are mostly set at 2% per annum although of course there is a regular cry for inflation targets to be raised. However 2015/16 torpedoed their ship as if we just look at the basic change we saw a large relative price adjustment for crude oil leading to adjustments directly to other energy costs and a lot of other changes. Ooops! Even worse for the theory we saw two large sectors of the economy respond in opposite fashion. A clear example of this was provided by my own country the UK where services inflation barely changed and ironically for a period of deflation paranoia was quite often above the inflation target. But the goods sector saw substantial disinflation as it was it that pulled the overall measure down to around 0%.

We can bring this up to date by looking at the latest data from the Statistics Bureau in Japan.

  The consumer price index for Ku-area of Tokyo in October 2017 (preliminary) was 100.1 (2015=100), down 0.2% over the year before seasonal adjustment, and down 0.1% from the previous month on a seasonally adjusted basis.

So not only is there no inflation here there has not been any for some time. Yet the latest monthly update tells us that food prices fell by 2.4% on an annual basis and the sector including energy fuel and lighting rose by 7.1%. Please remember that the next time the Ivory Towers start to chant their “we need inflation so relative prices can adjust” mantra.

Reality

This is that central banks are in the main failing to reach their inflation targets. For example if we look at the US economy the Federal Reserve targets the PCE ( Personal Consumption Expenditure) inflation measure which was running at an annual rate of 1.6% in September and even that level required an 11.1% increase in energy prices.

So we see central banks and establishments responding to this of which the extreme is often to be found in Japan. From @lemasabachthani yesterday.

JAPAN PM AIDE HONDA: INAPPROPRIATE TO REAPPOINT BOJ GOV KURODA, BOJ NEEDS NEW LEADERSHIP TO ACHIEVE 2 PCT INFLATION TARGET

Poor old Governor Kuroda whose turning of the Bank of Japan into the Tokyo Whale was proving in his terms at least to be quite a success. From the Financial Times.

Trading was at its most eye-catching in Japan. Tokyo’s Topix index touched its highest level since November 1991, only to end down on the day after a volatile session. At its peak, the index reached the fresh high of 1,844.05 with gains across almost all major segments, taking it more than 20 per cent higher for the year to date. But it faded back in late trade to close at 1,817.75.

It makes me wonder what any proposed new Governor would be expected to do?! QE for what else?

Whereas in this morning’s monthly bulletin the ECB ( European Central Bank) has told us this.

Following the decision made on 26 October 2017 the monthly pace will be further reduced to €30 billion from January 2018 and net purchases will be carried out until September 2018. The recalibration of the APP reflects growing confidence in the gradual convergence of inflation rates towards the ECB’s inflation aim, on account of
the increasingly robust and broad-based economic expansion, an uptick in measures of underlying inflation and the continued effective pass-through of the Governing
Council’s policy measures to the financing conditions of the real economy.

So we see proposals for central banking policy lost in  a land of confusion as the US tightens, the Euro area eases a little less and yet again the establishment in Japan cries for more, more, more.

Comment

There is a lot to consider here as we mull a world of easy and in some cases extraordinarily easy monetary policy with what is in general below target inflation. Of course there are exceptions like Venezuela which as far as you can measure it seems to have an inflation rate of the order of 2000% + . But in general such places are importing inflation via a lower currency exchange rate which means that someone else’s is reduced. Also we need to note that 2017 is looking like a good year for economic growth as this morning’s forecasts from the European Commission indicate.

The euro area economy is on track to grow at its fastest pace in a decade this year, with real GDP growth forecast at 2.2%. This is substantially higher than expected in spring (1.7%)……..at 2.1% in 2018 and at 1.9% in 2019.

So then of course you need an excuse for easy monetary policy which is below target inflation! Of course this ignores two technical problems. The first is that at the moment if we get inflation it is mostly from a higher oil price as we mull the likely effects of Brent Crude Oil which has moved into the US $60s. The second is that there is inflation to be found if you look at asset prices as whilst some of the equity market highs we keep seeing is genuine some of it is simply where all the QE has gone. Also there is the issue of house prices where even in the Euro area they are growing at an annual rate of 3.8% so if they were in an inflation index even more questions would be asked about monetary policy.

In a world where wages growth is not only subdued but has clearly shifted onto a lower plane the obsession with raising inflation will simply make the ordinary person worse off via its effect on real wages. Sadly this impact is usually hardest on the poorest.

Me on Core Finance TV

http://www.corelondon.tv/uk-housing-market-house-party-keeps-going/

 

 

 

Can QE reductions co-exist with the “To Infinity! And Beyond! Critique?

Today looks set to take us a step nearer a change from the world’s major central bank. Later we will here from the US Federal Reserve on its plans for a reduction in its balance sheet. If we look back to September 2014 there was a basis for a plan announced.

The Committee intends to reduce the Federal Reserve’s securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal on securities held in the SOMA.  ( System Open Market Account).

Okay so what will this mean?

The Committee expects to cease or commence phasing out reinvestments after it begins increasing the target range for the federal funds rate; the timing will depend on how economic and financial conditions and the economic outlook evolve.

So we learnt that it planned to reduce its balance sheet by not reinvesting bonds as they mature. A sensible plan and indeed one I had suggested for the UK a year before in City AM. Of course back then they were talking about doing it rather than actually doing it. Also there was a warning of what it would not entail.

.The Committee currently does not anticipate selling agency mortgage-backed securities as part of the normalization process, although limited sales might be warranted in the longer run to reduce or eliminate residual holdings. The timing and pace of any sales would be communicated to the public in advance

Thus we were already getting the idea that any such process was likely to take a very long time. This was added to by the fact that there is no clear end destination.

The Committee intends that the Federal Reserve will, in the longer run, hold no more securities than necessary to implement monetary policy efficiently and effectively, and that it will hold primarily Treasury securities.

This was brought more up to date this June when we were told that any moves would be in what are baby steps compared to the US $4.5 trillion size of the balance sheet.

For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month.

They will do the same for mortgage-backed securities except US $ 4 billion and US $20 billion are the relevant amounts. But as you can see it will take a year to reach an annual amount of US $0.6 trillion. Thus we reach a situation where balance sheet reduction can in fact be combined with another chorus of “To Infinity! And Beyond!” Why? Well unless they have ended recessions then the reduction seems extremely unlikely to be complete until it is presumably being expanded again. Indeed for some members of the Federal Reserve this seems to be the plan. From the Financial Times.

 

Mr Dudley has said he expects the balance sheet to shrink by roughly $1tn to $2tn over the period, from its current $4.5tn. This compares with an increase of about $3.7tn during the era of quantitative easing.

The ECB

There was a reduction in monthly QE purchases from the European Central Bank from 80 billion Euros to 60 billion which started earlier this year. But so far there has been no announcement of more reductions and of course these are so far only reductions in the rate of increase of its balance sheet. Then yesterday there was a flurry of what are called “sauces”.

FRANKFURT (Reuters) – European Central Bank policymakers disagree on whether to set a definitive end-date for their money-printing programme when they meet in October, raising the chance that they will keep open at least the option of prolonging it again, six sources told Reuters.

Of course talk and leaks are cheap but from time to time they are genuine kite flying. Also there is some potential logic behind this as the higher level of the Euro has reduced the likely path of inflation and the ECB is an institution which takes its target seriously. Now the subject gets complicated so let me show you the “Draghi Rule” from March 2014,

Now, as a rule of thumb, each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points.

So the Euro rally will have trimmed say 0.3% off future inflation. However some are claiming much more with HSBC saying it is 0.75% and if so no wonder the ECB is considering a change of tack. Mind you if I was HSBC I would be quiet right now after the embarrassment of how they changed their forecasts for the UK Pound £ ( when it was low they said US $1.20 and after it rallied to US $1.35 they forecast US $1.35!).

This is something of a moveable feast as on the 9th of this month Reuters sources were telling us a monthly reduction was a done deal. But there is some backing from markets with for example the Euro rising above 1.20 versus the US Dollar today and it hitting a post cap removal high ( remember January 2015?) against the Swiss Franc yesterday.

As we stand the ECB QE programme amounts to 2.2 trillion Euros and of course rising.

The Bank of England

We see something of a different tack from the Bank of England as it increased its QE programme last August and that is over. But it is working to maintain its holdings of UK Gilts at £435 billion as highlighted below.

As set out in the MPC’s statement of 3 August 2017, the MPC has agreed to make £10.1bn of gilt purchases, financed by central bank reserves, to reinvest the cash flows associated with the maturities on 25 August and 7 September 2017 of gilts owned by the Asset Purchase Facility (APF).

Today it will purchase some £1.125 billion of medium-dated Gilts as part of that which may not be that easy as only 3 Gilts are now eligible in that maturity range.

However tucked away in the recent purchases are an intriguing detail. You see over the past 2 weeks the Bank of England has purchased some £1.36 billion of our longest dated conventional Gilt which runs to July 2068. So if Gilts only ever “run off” then QE will be with us in the UK for a very long time.

The current Bank of England plan such as it is involves only looking to reduce its stock of bond holdings after it has raised Bank Rate an unspecified number of times. I fear that such a policy will involve losses as whilst the rises in the US have not particularly affected its position there have been more than a few special factors ( inflation, North Korea, Trumpenomics…), also we would be late comers to the party.

The MPC intends to maintain the stock of purchased assets at least until the first rise in Bank Rate.

Will that be like the 7% unemployment rate? Because also rise from what level?

at least until Bank Rate has been raised from its current level of 0.5%.

Comment

As you can see there is a fair bit to consider and that is without looking at the Bank of Japan or the Swiss National Bank which of course has if its share price is any guide has suddenly become very valuable. We find that any reduction moves are usually small and much smaller than the increases we saw! Some of that is related to the so-called Taper Tantrum but it is also true that central banks ploughed ahead with expansions of their balance sheets without thinking through how they would ever exit from them and some no doubt do not intend to exit.

The future is uncertain but not quite as uncertain as central banks efforts at Forward Guidance might indicate. So if we address my initial question there must be real fears that the next recession will strike before the tapering in the case of the ECB or the reductions of the US Federal Reserve have got that far. As to my own country the Bank of England just simply seems lost in its own land of confusion.

 

 

 

 

 

The Jackson Hole symposium should embace lower inflation

Later this week the world’s central banks will gather at the economics symposium of the US Kansas Federal Reserve at Jackson Hole in Wyoming. The description can be found below.

The 2017 Economic Symposium, “Fostering a Dynamic Global Economy,” will take place Aug. 24-26, 2017.  (The program will be available at 6 p.m., MT, Aug. 24, 2017).

It is appropriate that they do not yet know the program as the world’s central bankers find themselves at a variety of crossroads which they are approaching from different directions. It is also true that after all their expansionary monetary policy and “masters ( and mistresses) of the universe” activities over the last decade or so they now approach one of the most difficult decisions which is how to exit these programs. For some this will simply mean a slowing of the expansion. This all looks very different to when a speech on Forward Guidance was eagerly lapped up by a receptive audience and quickly became policy in many countries. After all Open Mouth Operations make a central banker feel both loved and important as we all hang on every word. Oh and there is a clear irony in the title of “Fostering a Dynamic Global Economy” for a group of people whose propping up of many zombie banks has led to anything but. That is of course assuming anyone knows what the phrase means in practice!

The inflation issue

The issue here is highlighted by this from Bloomberg today.

The world’s top central bankers head to Jackson Hole amid growing unease about low inflation.

Of course central bankers and those in the media subject to their brainwashing program may think this but the ordinary worker and consumer will be relieved. Should any of the central bankers suffer from stomach problems no doubt they will be delighted to discover this from CNBC.

Hikma Pharmaceuticals Plc’s U.S. subsidiary has raised the price of a common diarrhea drug by more than 400 percent and is charging more for five other medicines as well, the Financial Times reported on Sunday……The average wholesale price of a 60 ml bottle of liquid Atropine-Diphenoxylate, a common diarrhea drug also known as Lomotil, went from about $16 a bottle to $84, the FT reported.

Central banker heaven apparently and what needs looking into in my opinion is the clear examples of price gouging we see from time to time. Also more mundane products are seeing price rises. From Mining.com last week.

The iron ore price is now trading up a whopping 43% from its 2017 lows struck just two months ago.

According to Yuan Talks the Dalian futures contract rose 6.6% today before price limits kicked in. It is not alone as the Nikkei Asian Review points out.

Three-month zinc futures were at their highest level in 10 years, at about $3,100 per ton, rising 26% over the same period.
Aluminum also rose 10% over the same period.

So as well as raising a smile on the face of the heads of the central banks of Canada and Australia there are hints of some commodity inflation about. This provides a counterpoint to the concerns about low inflation which in the Euro area and the US is not that far below especially when we allow for the margin of error.

Does QE lead to inflation?

Some care is needed here as of course we have seen waves of asset price inflation across a wide range of countries. But of course the statistical policy across most of the world is to avoid measuring that in consumer inflation. Then it can be presented as growth which for some it is but not for example for first time buyers. However one of the building blocks of economics 101 is that QE ( Quantitative Easing) leads to inflation. Yet the enormous programs in the US and the ongoing one in the Euro area have not got consumer inflation back to target and the leader of the pack in this regard Japan has 0% inflation. After all the money involved has it simply led to price shifts? That is especially awkward for Ivory Tower theorists as they are not supposed to be able to happen with ~0% inflation so I guess they sent their spouse out to fill up the car as the petrol/diesel price fell.

More deeply whilst the initial effect of QE should have some inflationary implications is there something in it such as the support of a zombie business culture that means inflation the fades. It could of course be something outside of the monetary environment such as changing demographics involving ageing populations. Perhaps it was those two factors which broke the Phillips Curve.

As to future prospects there are two issues at play. The US Federal Reserve will start next month on an exit road which I remember suggesting for the Bank of England in City-AM some 4 years ago. If you do not want QE to become a permanent feature of the economic landscape you have to start somewhere. The issue for the ECB is getting more complex mostly driven by the fiscal conservatism of Germany which means that a supply crunch is looming as it faces the prospect of running out of German bonds to buy.

Currency Wars

There are two specific dangers here which relate to timing ( during thin summer markets) and the fact that markets hang on every central banking word. Eyes will be on the Euro because it has been strong in 2017 and in particular since mid April when it did not quite touch 93 on its effective ( trade-weighted) index as opposed to the 98.7 the ECB calculated it at on Friday. It has put another squeeze on the poor battered UK Pound £ but of more international seriousness is yet another example of a problem for economics 101 as interest-rate rises should have the US Dollar rising. Of course there is a timing issue as the US Dollar previously rose anticipating this and maybe more, but from the point of Mario Draghi and the ECB there is the fear that cutting the rate of QE further might make the Euro rally even more. Although one might note that in spite of the swings and roundabouts along the way the Euro at 98.7 is not far away from where it all began.

The Bank of Japan is also facing a yen rallying against the US Dollar and this morning it briefly rose into the 108s versus the US Dollar. Whilst it is lower than this time last year the trend seemed to change a few months back and the Yen has been stronger again.

Comment

It is hard not to have a wry smile at a group of people who via Forward Guidance and Open Mouth Operations have encouraged markets to hang on their every word now trying to downplay this. If you create junkies then you face the choice between cold turkey or a gradual wind down. Even worse you face the prospect of still feeding addiction number one when a need for number two arises as sooner or later an economic slow down will be along. Or creating fears about low inflation when the “lost decades” of Japan has shown that the world does not in fact end.

If we move onto the concept of a total eclipse then I am jealous of those in the United States today. From Scientific American.

Someone said that it is like suddenly being in some sort of CGI of another world or maybe like a drug-induced hallucination that feels (and is) totally real.

No they have not switched to central banking analysis but if the excellent BBC 4 documentary ”  do we really need the moon?” is any guide we should enjoy solar eclipses whilst we still have them. Meanwhile of course there is Bonnie Tyler.

I don’t know what to do and I’m always in the dark
We’re living in a powder keg and giving off sparks.

 

 

 

 

Problems mount for Mark Carney at Mansion House

The UK’s central bank announces its policy decision today and it faces challenges on several fronts. The first was highlighted yesterday evening by the US Federal Reserve.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

UK monetary policy is normally similar to that in the US as our economies often follow the same cycles. This time around however the Bank of England has cut to 0.25% whilst the Federal Reserve has been raising interest-rates creating a gap of 0.75% to 1% now. In terms of the past maybe not a large gap but of course these days the gap is large in a world of zero and indeed negative interest-rates. Also we can expect the gap to grow in the future.

The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate;

There was also more as the Federal Reserve made another change which headed in the opposite direction to Bank of England policy.

The Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.

So the Federal Reserve is planning to start the long journey to what used to be regarded as normal for a central bank balance sheet. Of course only last August the Bank of England set out on expanding its balance sheet by another £70 billion if we include the Corporate Bond purchases in what its Chief Economist Andy Haldane called a “Sledgehammer”. So again the two central banks have been heading in opposite directions. Also on that subject Mr.Haldane was reappointed for another three years this week. Does anybody know on what grounds? After all the wages data from yesterday suggested yet another fail on the forecasting front in an ever-growing series.

Andrew Haldane, Executive Director, Monetary Analysis and Statistics, and Chief Economist at the
Bank of England, has been reappointed for a further three-year term as a member of the Monetary Policy
Committee with effect from 12 June 2017.

For those interested in what Andy would presumably call an anti-Sledgehammer here it is.

( For Treasury Bonds) the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month…… ( for Mortgage Securities) the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

Whilst these really are baby steps compared to a balance sheet of US $4.46 trillion they do at least represent a welcome move in the right direction.

The Inflation Conundrum

This has several facets for the Bank of England. The most obvious is that it eased policy last August as inflation was expected to rise and this month we see that the inflation measure it is supposed to keep around 2% per annum ( CPI ) has risen to 2.9% with more rises expected. It of course badged the “Sledgehammer” move as being expansionary for the economy but I have argued all along that it is more complex than that and may even be contractionary.

Today’s Retail Sales numbers give an example of my thinking so let me use them to explain. Here they are.

In May 2017, the quantity bought in the retail industry was estimated to have increased by 0.9% compared with May 2016; the annual growth rate was last lower in April 2013…..Month-on-month, the quantity bought was estimated to have fallen by 1.2% following strong growth in April 2017.

So after a strong 2016 UK retail sales have weakened in 2017 but my argument is that the main driver here has been this.

Average store prices (excluding fuel) increased by 2.8% on the year; the largest growth since March 2012.

It has been the rise in prices or higher inflation which has been the main driver of the weakness in retail sales. A factor in this has been the lower value of the Pound which if you use the US inflation numbers as a control has so far raised UK inflation by around 1%. This weakness in the currency was added to by expectations of Bank of England monetary easing which of course were fulfilled. You may note I say expectations because as some of us have been discussing in the comments section the main impact of QE on a currency happens in the expectations/anticipation phase.

On the other side of the coin you have to believe that a 0.25% cut in interest-rates has a material impact after cuts of over 4% did not! Also that increasing the Bank of England’s balance sheet will do more than adding to house prices and easing the fiscal deficit. A ten-year Gilt yield of 0.96% does not go well with inflation at 2.9% ( CPI) and of course even worse with RPI ( 3.7%).

House Prices

I spotted this earlier in the Financial Times which poses a serious question to Bank of England policy.

Since 1980, the compounded inflation-adjusted gain for a UK homeowner has been 212 per cent. Before 1980 house price gains were much tamer over the various cycles either side of the second world war. Indeed, in aggregate, prices were largely unchanged over the previous 100 years, once inflation is accounted for.

A change in policy? Of course much of that was before Mark Carney’s time but we know from his time in Canada and here that house price surges and bubbles do happen on his watch. The article then looks at debt availability.

The one factor that did change, though, and marked the start of that step change in 1980, is the supply of mortgage debt……….has resulted in a sevenfold increase in inflation-adjusted mortgage debt levels since then.

This leads to something that I would like Mark Carney to address in his Mansion House speech tonight.

Second an inflation-targeting central bank, which has delivered a more aggressive monetary response to each of the recent downturns, because of that high debt burden.

On that road we in the UK will see negative interest-rates in the next downturn which of course may be on the horizon.

Comment

There is much to consider for the Governor of the Bank of England tonight. If he continues on the current path of cutting interest-rates and adding to QE on any prospect of an economic slow down then neither he nor his 8 fellow policy setting colleagues are required. We could replace them with an AI ( Artificially Intelligent ) Robot although I guess the danger is that it becomes sentient Skynet style ( from The Terminator films ) and starts to question what it is doing?

However moving on from knee-jerk junkie culture monetary policy has plenty of problems. It first requires both acknowledgement and admittal that monetary policy can do some things but cannot do others. Also that international influences are often at play which includes foreign monetary policy. I have looked at the Federal Reserve today well via the Far East other monetary policy applies. Let me hand you over to some research from Neal Hudson of Residential Analysts on buyers of property in London from the Far East.

However, anecdotal evidence suggests that many of these buyers have been using local mortgages to fund their purchases.  The limited evidence I have suggests that around half of Hong Kong and Singaporean buyers use a local mortgage while the majority of mainland Chinese buyers use one.

Okay on what terms?

The main difference is that the mortgage rate tends to be slightly higher (London Home Loan comparison) and local lenders allow borrowers to have far higher debt multiples.

These people are not as rich as might previously have been assumed and we need to throw in changes in the value of the UK Pound £ which are good for new buyers but bad for existing ones. Complicated now isn’t it?

On a personal level I was intrigued by this.

Last year I visited a development in Nine Elms and the lobby felt more like a hotel than a residential block. There were significant numbers of people appearing to pick up and drop off keys with suitcases in tow.

You see I live in another part of Battersea ( the other side of the park) and where i live feels like that as well.