Was that the bond market tantrum of 2019?

Sometimes economics and financial markets provoke a wry smile. This morning has already provided an example of that as Germany’s statistics office tells us Germany exported 4.6% more in September than a year ago, so booming. Yes the same statistics office that told us yesterday that production was down by 4.3% in September so busting if there is such a word. The last couple of months have given us another example of this do let me start by looking at one side of what has taken place.

QE expansion

We have seen two of the world’s major central banks take steps to expand their QE bond buying one explicitly and the other more implicitly. We looked at the European Central Bank or ECB only on Wednesday.

The Governing Council decided to restart net purchases under each constituent programme of the asset purchase programme (APP)……….. at a monthly pace of €20 billion as from 1 November 2019.

More implicitly have been the actions of the US Federal Reserve as it continues to struggle with the Repo crisis.

Based on these considerations, last Friday the FOMC announced that the Fed will be purchasing U.S. Treasury bills at least into the second quarter of next year.7 Specifically, the Desk announced an initial monthly pace of purchases of $60 billion.

That was John Williams of the New York Fed who added this interesting bit.

These permanent purchases

Also there is this.

In concert with these purchases, the FOMC announced that the Desk will continue temporary overnight and term open market operations at least through January of next year.

Maybe a hint that they think dome of this is year end US Dollar demand. But we find that the daily operations continue and at US $80.14 billion as of yesterday they continue on a grand scale. So the Treasury Bill purchases and fortnightly Repo’s have achieved what exactly?

If we move from the official denials that this is QE to looking at the balance sheet we see that it is back above 4 trillions dollars and rising. In fact it was US $4.02 trillion at the end of last month or around US $250 billion higher in this phase.

Bond Markets

You might think and indeed economics 101 would predict that bond markets would be surging and yields falling right now. But we have learnt that things are much more complex than that. Let me illustrate with the US ten-year Treasury Note. You might expect some sort of boost from the expansion of the balance sheet and the purchases of Treasury Bills. But no, the futures contact which nearly made 132 early last month is at 128 and a half now. At one point yesterday the yield looked like it might make 2% as there was quite a rout but some calm returned and it is 1.91% as I type this.

As an aside this is another reminder of the relative impotence of interest-rate cuts these days as if anything a trigger for yields rising was the US interest-rate cut last week. The Ivory Towers will be lost in the clouds yest again.

The situation is even more pronounced in the Euro area where actual purchases have been ongoing for a week now. However in line with our buy the rumour and sell the fact theme we see that the German bond market has fallen a fair bit. In mid-August the benchmark ten-year yield went below -0.7% whereas now it is -0.26%. So Germany is still being paid to borrow at that maturity but considerably less. Indeed at the thirty-year maturity they do have to pay something albeit not very much ( 0.24%).

The UK

There have been a couple of consequences in the UK. The first I spotted in yesterday’s output from the Bank of England.

Mortgage rates and personal loan rates remain near
historical lows, with the rates on some fixed-rate mortgages continuing to fall over the past few months (Table 2.B).
Interest rates on credit cards have increased, although the effective rate paid by the average borrower has remained
stable, in part because of the past lengthening of interest-free periods.

Whilst this is true, if you are going to parade the knowledge of the absent-minded professor Ben Broadbent about foreign exchange options then you should be aware that as Todd Terry put it.

Something’s goin’ on

The five-year Gilt yield has risen from a nadir of 0.22% to 0.52% so the ultra-low period of mortgage rates is on its way out should we stay here.

If we move to the fiscal policy space in the UK then we see that the message that we can borrow cheaply has arrived in the general election campaign.

Although debt stocks are high in many developed countries, debt service ratios are very low. The UK gross debt stock has doubled from 42 per cent of GDP in 1985 to 84 per cent of GDP today, yet debt interest service has halved, from 4 per cent of GDP to below 2 per cent over the same period. It has rarely been lower. A rule using the debt stock would argue for fiscal consolidation, whereas a debt service metric suggests there is ample room for fiscal expansion. Especially as market interest rates are extraordinarily low. (  FT Alphaville)

https://ftalphaville.ft.com/2019/11/06/1573068343000/Is-it-time-for-a-shift-in-fiscal-rules–/

I have avoided the political promises which peak I think with the Greens suggestion of an extra £100 billion a year. But the Toby Nangle and Neville Hill proposal above has strengths and has similarities to what I have suggested here for some time. But I think it needs to come with some way of locking the debt costs in, so if you borrow more because it is cheap you borrow for fifty years and not five. It reinforces my suggestion of the 27th of June that the UK should issue some 100 year Gilts.

Comment

There is a fair bit to consider here and let me start with the borrow whilst it is still cheap theme. There are issues as highlighted by this from Francine Lacqua of Bloomberg.

London’s Elizabeth line has been delayed by a year, and will require extra funding, according to TfL

For those unaware this was called Crossrail ( renaming is often a warning sign) which will be a welcome addition to the London transport infrastructure combing elements of The Tube with the railways. But it gets ever later and more expensive.

There was also some irony as regards the Bank of England as in response to the sole decent question at its presser yesterday (from Joumanna Bercetche of CNBC) Governor Carney effectively suggested the next rate move would be down not up. Yet Gilt yields rose.

Next comes the issue of whether this is a sea-change or just part of the normal ebb and flow of financial markets? We will find out more this afternoon as we wait to see if there were more than just singed fingers in the German bond market for example or whether some were stopped out? After all reporting you had taken negative yield and a capital loss poses more than a few questions about your competence. Even the most credulous will now know it is not a one-way bet but on the other hand if you are expecting QE4 to come down the New York slipway then you can place your bets at much better levels than before.

Which Euro area bank needed Dollars from the US Federal Reserve?

Today it is the turn of Europe to be in focus and let me briefly break my rule of looking at the real economy first because there is something going on which if it continues could easily hit it. As I seem to be not far off alone in noting this here is one of my own tweets from this morning.

There are two main things going on here. Firstly as I have pointed out before there is a shortage of US Dollars which tends to get worse as we approach year end. The tighter the situation is expected to be then the earlier people get ready and thus those considered more risky find it harder to get some.

Next comes the issue of the mechanics. This is an example of what have been called central bank FX swaps or liquidity swaps. Here is the ECB ( European Central Bank ) explainer.

Under normal circumstances, if a bank in the euro area needs US dollars, for example because it needs to provide a US dollar loan to a client, the bank turns to the market. But if US dollar funding costs are too high or if the market is disrupted, the bank can go to its national central bank. In this particular case, the ECB can get dollars thanks to the currency agreement with the Federal Reserve.

The next bit is both true and a maybe misleading.

Many of these currency agreements act mainly as a safety net and have never been activated.

According to the ECB website it can borrow up to US $80 billion from the US Federal Reserve. Actually I am not sure that is up to date but I would not worry about that too much as on a crisis the size would quickly be increased.

These are in existence in other areas for example there was a time that there were fears about the Irish banks and a need for UK Pounds back in the day.

The agreement allows pounds sterling to be made available to the Central Bank of Ireland as a precautionary measure, for the purpose of meeting any temporary liquidity needs of the banking system in that currency.

Such a line could be used post Brexit for example should UK banks need Euros or Euro area ones need pounds. But in essence and indeed the experience so far these swaps are for supply of the US Dollar as Aloe Blacc pointed out.

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

Actually our Aloe made a decent fist of explaining why a swap line might be used,

Bad times are comin’ and I reap what I don’t sow
Hey hey
Well let me tell you somethin’ all that glitters ain’t gold
Hey hey
It’s been a long old trouble long old troublesome road
And I’m looking for somebody come and help me carry this load

 

The Economy

Whilst the banking sector seems to be rumbling on with the same signs of indigestion we have been observing over time there have been some better hints from the real economy. For example let me hand you over to the Italian statistics office.

In July 2019, estimates for both value and volume of retail sales saw a slight fall when compared with a
month earlier, as the value was down 0.5% and the volume decreased by 0.7%.

As you can see it starts badly but stay with me.

In the three months to July 2019 the retail trade index increased both in value and in volume terms,
growing by 0.5% when compared to the previous three months (Feb – Apr 2019).  Year-on-year both measures of retail trade showed growth for the second consecutive month: the value rose by 2.6%, while the quantity sold was up 2.8%.

The reason why I have noted this is because this area has been a struggle for Italy and because in Italy an annual rate of growth of 2.8% stands out like a sore thumb. Unfortunately Italy’s statisticians have posted the wrong chart ( value not volume) something which no-one else seems to have noted. But even so this looks like a better phase for retail sales than even in the Euro boom.

Maybe it was always there even in the GDP figures.

This result synthetizes inventories negative contribution and domestic demand positive one (-0.3 pp. and +0.3 pp. respectively).

Should inventories simply do nothing Italy will have some economic growth from its domestic impetus. Not a lot and there is manufacturing to consider but for Italy anything is a bonus. Oh and you may have spotted that there is another tick in the box for my argument that low inflation boosts economies via retail sales and real wages. Because with the volume and value figures so close there is very little or no inflation here.

Someone has not noticed this however.

ECB presidential nominee Christine Lagarde pledges to act with “agility” against what she describes as inflation that is persistently too low ( Bloomberg )

Another possible route comes from Germany where things are at least not getting that much worse.

In July 2019, production in industry was down by 0.6% on the previous month on a price, seasonally and calendar adjusted basis according to provisional data of the Federal Statistical Office (Destatis). In June 2019, the corrected figure shows an decrease of 1.1% (primary -1.5%) from May 2019………4.2% on the same month a year earlier (price and calendar adjusted).

Comment

If we start with the Euro area economy then as I pointed out last week things are not as grim as some are saying, The money supply numbers have improved in 2019 and there are one or two flickers of action. However this morning has also brought a signal of trouble as China is not doing this for fun.

CHINA CUTS BANKS’ RESERVE REQUIREMENT RATIO CHINA CUTS RESERVE RATIO BY 0.5 PPT ( @PriapusIQ)

You may note that by acting to increase the money supply they are helping the banks first or behaving like us western capitalist imperialists.

Meanwhile I could type a fair bit about Euro area banks but instead let me show you the tweet of their share prices which speaks volumes. Share prices are far from always right as otherwise they would rarely move but look how long this has been going on.

 

Is this the real reason the ECB will act next week?

The Times They Are A-Changing For Inflation Targeting

The concept of inflation targeting had its roots in the abandonment of the gold standard in 1971. The world of fiat money requires some sort of anchor and we have seen various ways of providing this such as fixed exchange-rates and controlling the money supply. None of those were entirely satisfactory and some were complete failures so in the 1990’s we saw the concept of inflation targeting begin and a combination of Canada and New Zealand saw us end up with one of 2 per cent per annum. It is important to note that 2% per annum was chosen because it seemed right not that there was any particular logical thought process. Also it is important to note that the definition of inflation varies much more than you might think and in some cases quite widely. So for example 2% per annum in the United States is very different to 2% per annum in the Euro area as the former has owner-occupied housing costs ( albeit via the Imputed Rent route) and the latter does not.

Price Stability

Central bankers have tried to push the line that 2% per annum is price stability. For example Mario Draghi of the ECB told us this only yesterday at the ECB press conference.

Our mandate is price stability

This is quite an Orwellian style abuse of language and let me illustrate this with Mario’s own words.

On the inflation side, we basically saw inflation which is below our aim and we see projected inflation that says that convergence is further out in time, though as I’ve said on another occasion, the informational content of market-based inflation expectations has to be assessed, taking into account certain technical conditions of these markets. However also in the SPF, the Survey of Professional Forecasters, inflation expectations have gone down so that’s what led the Governing Council to these proposals, to the various proposals.

As you can see “inflation which is below our aim” would give Euro area workers and consumers more price stability but Mario and the ECB do not want it. This is why he was hinting so strongly at policy action in September although there is a catch in that. After all he only stopped QE in December and we still have negative interest-rates in the Euro area yet inflation is doing this.

Euro area annual HICP inflation increased to 1.3% in June 2019, from 1.2 % in May…….Looking through the recent volatility due to temporary factors, measures of underlying inflation remain generally muted. Indicators of inflation expectations have declined.

So here are a couple of thoughts for you. We are being told price stability is the objective when they are doing the opposite and they are using methods which in spite of extraordinary sums ( 2.6 trillion Euros of QE) have not had much impact. Care is needed with the latter conclusion because we know so many asset prices have surged but the Euro area in particular has gone to a lot of effort to keep them out of the consumer inflation numbers. They spent the last 2/3 years promising to put house prices in the numbers and then in December did a handbrake turn, which was so transparent as being what they planned all along. Or if you prefer another version of kicking that poor battered can into the future.

As an aside I have regularly warned about these over time and am pleased that the ECB is finally admitting this.

the informational content of market-based inflation expectations has to be assessed,

It is somewhere between slim and none which is very different to the impression the ECB has previously created.

The Times They Are A-Changing

The ECB interest-rate announcement told us this and the emphasis is mine.

Accordingly, if the medium-term inflation outlook continues to fall short of its aim, the Governing Council is determined to act, in line with its commitment to symmetry in the inflation aim.

That was brand new off the blocks so to speak and as you can imagine led to speculation about what the ECB planned next. For example, as it has been below its 2% per annum target for some time would it plan some “catch-up” in the manner suggested in the past by some members of the US Federal Reserve? So a type of average inflation targeting.

Yet a bit more than 45 minutes later ( Mario was late) there has been some ch-ch-changes.

the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

As one cannot be symmetrically below there is a problem here. Unusually for Mario Draghi he got into quite a mess explaining this.

On the other point: no, there isn’t any change really.

Yet he then confessed there was one.

In fact, it’s true it’s not there in the first page; it’s in the fourth page, it’s just what it is.

The idea that the change just appeared there is laughable and we then found out more about the state of play.

But we had a discussion about symmetry and there is a sense in the Governing Council that there should be a reflection on the objective: namely is it is close to but below 2%, or, should we move to another objective?

There you have it as they had for a while created the impression they had changed it. For clarity the ECB target is unusual in that it sets it for itself. The more common procedure is that the relevant government sets it for the central bank in the way that the Chancellor of the Exchequer does for the Bank of England. The present ECB target has been in place since 2003 and perhaps the advent of Christine Lagarde has Mario wanting to restrict how much damage she can do. After all it was apparent that the gushing praise she received, somehow in an inexplicable oversight omitted her competence for the role,

Whatever the rationale Mario was somewhat discombobulated.

 In the meantime, however, the main thing in this introductory statement is that the Governing Council – I think I have said this many times, but now it’s in the introductory statement – reaffirmed its commitment to symmetry around the inflation aim, which in a sense is 1.9 – it’s close to, but below, 2%.

So he was trying somewhat unconvincingly to sing along with Maxine Nightingale.

Ooh, and it’s alright and it’s coming along
We gotta get right back to where we started from

 

Comment

So we see that the ECB is joining an increasingly global trend to change its inflation target and typically for Ivory Tower thinkers they are missing the main point. After all the advent of the credit crunch which is still causing economic after-effects posed serious questions for the whole concept. Yet the main driver we are seeing is heading towards even easier monetary policy as opposed to a revision of the concepts involved. The same monetary policy that has failed to create much consumer inflation at all and may even have weakened it, although this comes with the caveat that much of this comes from the way inflation is measured.

The establishment remains determined to ram this home. Let me hand you over to the Wall Street Journal.

A higher Federal Reserve inflation target ahead of the 2007-09 recession likely would have given the central bank more room to lower interest rates and resulted in a “substantially” faster economic recovery, a group of economists has found.

If the Fed had set its inflation target above its current 2% level, that would have led to higher inflation over time, which would have caused interest rates to climb higher than they did before the recession, according to a paper by economists Janice Eberly, James Stock and Jonathan Wright.

Missing is anybody pointing out that the higher inflation would have made us all poorer. No doubt in the Ivory Tower scenario the wages fairy would have rescued us but we know in the real world that he or she is always hard and sometimes impossible to find these days.

That is before we get to the point I started with which never quite seems to be received in the thin air at the top of the Ivory Towers that the inflation measures used are at best an approximation and at worst simply wrong.

 

 

 

 

The Bank of Japan fears no longer being the “leader of the pack”

The next two weeks look set to bring a situation you might not expect. After all Japan has built a reputation as the “leader of the pack” as the Shangri-Las would put it in terms of monetary policy easing. Except that it is now facing a situation where it looks set to be left behind. On Thursday the European Central Bank will announce its latest moves and its President Mario Draghi has been warming us up for some action. Either he will announce an interest-rate cut or he will signal one for September. So there are two perspectives here for Japan. The first is that the Euro area looks set to cut by the total amount that Japan has below zero as 0.1% is the minimum and of course 0.2% would be double it. Next is the issue that the new rate of -0.5% or -0.6% would be a considerable amount lower than in Japan.

If we now shift to the United States the US Federal Reserve looks set to cut interest-rates as well when it meets at the end of the month. There was a spell last week when financial markets switched to expecting a 0.5% cut which would put the new rate at 1.75% to 2%. Personally I am far from convinced by that and a 0.25% cut seems much more likely but nonetheless it puts the Bank of Japan under pressure.

The Yen

The factors we have looked at above will be putting some upwards pressure on the Yen as interest-rate expectations shift against it. This has been reinforced by an unintended consequence of the policy applied by the central planners at the Bank of Japan.

The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain more or less at the current level (around zero percent). With regard
to the amount of JGBs to be purchased, the Bank will conduct purchases more or less in line with the current pace — an annual pace of increase in the amount outstanding
of its JGB holdings at about 80 trillion yen — aiming to achieve the target level of a long-term interest rate specified by the guideline. JGBs with a wide range of maturities will continue to be eligible for purchase, while the guideline for average remaining maturity of the Bank’s JGB purchases will be abolished.

The problem here as I have pointed out before is that something which was supposed to have kept Japanese Government Bond ( JGB) yields down has ended up keeping them up. Ooops! As world bond markets have surged Japan has been left behind because its bond market is essentially run by the Bank of Japan ( 80 trillion yen a year buys you that) and it has been wrong footed completely. The recent surge began in early March and the German ten-year yield has fallen as much as by 0.6% and the US by 0.8% but Japan by only 0.16%.

So as you can see relative interest-rates and yields have moved to support the Yen since the early spring of this year. The policy of “yield curve control” aiming for bond yields of 0% to -0.1% no doubt seemed a good way of continuing the Abenomics policy of weakening the Yen at the time. However over the period that bond markets have surged the Yen has strengthened from 112 versus the US Dollar to 108 now. That is before we see any shift in the rhetoric of President Trump who as the tweet from the early part of this month below points out, wants a weaker US Dollar.

China and Europe playing big currency manipulation game and pumping money into their system in order to compete with USA. We should MATCH, or continue being the dummies who sit back and politely watch as other countries continue to play their games – as they have for many years!

That will have been viewed with horror in Tokyo because whilst The Donald is not currently putting Japan in his cross hairs they have looking to weaken the Yen since Abenomics began back in 2013. This would be quite a reverse for Japan as it would not want to get into a currency war with the United States.

Moving to other currencies we see that the Yen has been strengthening against the Euro and the UK Pound as well. Indeed we get another perspective I think from looking at Switzerland which regular readers will know I labelled as a “Currency Twin” with Japan due to the way both currencies were borrowed heavily in the pre credit crunch period. There are increasing rumours that the Swiss National Bank has been getting the equivalent of an itchy collar over the strength of the Swiss Franc and has been checking the markets as a hint that it may intervene again. It may well find itself having to match any ECB interest-rate cut and that will echo in Tokyo as well as giving us a new low for negative interest-rates.

The Pacific Trade Crisis

The stereotype of this area is of fast growing economies with the image of many of them being Pacific Tigers compared to the more sclerotic Western nations. Yet troubles are there too now so let us go to Seoul on Thursday.

The Monetary Policy Board of the Bank of Korea decided today to lower the Base Rate by 25 basis points, from 1.75% to 1.50%.

Okay why?

With respect to future domestic economic growth, the Board expects that the adjustment in construction investment will continue and exports and facilities investment will recover later than originally expected,
although consumption will continue to grow. GDP is forecast to grow at the lower-2% level this year, below the April forecast (2.5%).

This morning has brought more news on that front. From Bloomberg.

South Korea’s exports, a bellwether for global trade, appear set for an eighth straight monthly decline as trade disputes take a toll on global demand. Exports during the first 20 days of July fell 14 percent from a year earlier, data from the Korea Customs Service showed Monday. Semiconductor sales plunged 30 percent, while shipments to China, the biggest buyer of South Korean goods, fell 19 percent.

Korea is a bellwether as these numbers are released very promptly and many of its companies are integrated into global supply chains, so it gives a signal for world trade. Currently it is not good and there is a direct link to Japan.

Imports from the U.S. rose 3.7 percent, while those from Japan dropped 15 percent.

Also on Thursday Bank Indonesia decided to join the party.

The BI Board of Governors agreed on 17th and 18th July 2019 to lower the BI 7-day Reverse Repo Rate by 25 bps to 5,75%,

A day earlier say troubling news for the economy of Singapore.

SINGAPORE’S exports, already in double-digit decline for three straight months, fell again in June, according to Enterprise Singapore data released on Wednesday morning.

Non-oil domestic exports (NODX) were down by 17.3 per cent on the year before – a six-year low  ( Business Times )

Comment

The Bank of Japan finds itself between a rock and a hard place on quite a few fronts. The Yen has been strengthening and other central banks are on their way to matching its policies. That is before we get to the issue of the clear trade slow down in the Pacific region. This will add to the problem hidden in what looked on the surface as solid economic growth in the first part of the year.

In the three-month period, exports dropped 2.4 percent and imports sank 4.6 percent, as in the initial reading. As a result, net exports — exports minus imports — pushed up GDP by 0.4 percentage point. ( Japan Times).

In all other circumstances the Bank of Japan would cut interest-rates in a week. But they do not like negative interest-rates much and they are buying pretty much everything ( bonds, equities and commercial property) as it is! In October another Consumption Tax rise is due as well. Perhaps Bryan Ferry was right.

Say, when you’ve been around, what’s left to do?
Don’t know? Ask Tokyo Joe
So inscrutable her reply
“Ask no question and tell me no lie”

Podcast

 

 

Are world equity markets front-running expected central bank buying?

Sometimes we get an opportunity to both take some perspective and also to observe what is considered by some to be cutting edge. So let us open with the perspective of the general manager of the Bank for International Settlements.

Growth cannot depend on monetary policy, Agustín Carstens tells CNBC.

I am sure that many of you are thinking that it is a bit late ( like a decade or so) to tell us now.. Interestingly if you watch the video he says in reference to the Euro area that monetary policy “cannot be the only solution for growth”. This reminds me of the statement by ECB President Mario Draghi that it QE was responsible for the better Euro area growth phrase in 2016 to 17. It also brings me to my first official denial of the day.

Some analysts said a tiered rate would make room for the ECB to cut its deposit rate farther — a prospect that one source said was nowhere near being discussed. ( Reuters )

You know what usually happens next….

Asset Markets

This is an area that central banks have increasing moved into with sovereign and corporate bond buying. But in the same Reuters article I spotted something that looked rather familiar.

TLTRO III, a new series of cheap two-year loans aimed at banks, was unveiled in March as a tool to help lenders finance themselves, particularly in countries such as Italy and Portugal. But policymakers now increasingly see it as a stimulus tool for a weakening economy, the sources said.

With the growth outlook fading faster than feared, even hawkish policymakers have given up pricing the loans at the private market rate. Some are even discussing offering the TLTROs at minus 0.4 percent, which is currently the ECB’s deposit rate, the sources said.

That looks rather like the Funding for Lending Scheme which I mentioned yesterday as the way the Bank of England fired up the UK housing market from 2012 onwards. Essentially if you give banks plenty of cheap funding you get a lot of rhetoric about lending to business ( small ones in particular) but the UK experience was that it declined and mortgage lending rose. This was because mortgage rates fell quite quickly by around 1% and according to the Bank of England the total impact rose as high as 2%.

Thus in my opinion the ECB is considering singing along to the “More,more,more” of Andrea True Connection in relation to this.

House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the fourth
quarter of 2018 compared with the same quarter of the previous year.

This is one area where the ECB has managed to create some inflation and may even think that the lack of growth in Italy ( -0.6%) is a sign of its economic malaise. Although you do not have to know much history to mull the 6.7% in Spain and 7.2% in Ireland.

Equities

Regular readers will be aware that the Swiss National Bank and the Bank of Japan started buying equities some time ago now. There are differences in that the SNB is doing so to diversify its foreign exchange reserves which became so large they were influencing the bond markets ( mostly European) they were investing in. So it has bought foreign equities of which the most publicly noted it the holding in Apple because if you invest passively then the larger the company the larger the holding. If we note the Apple Watch this must provide food for thought for the Swiss watchmaking industry.

Japan has taken a different route in two respects in that it buys funds ( Exchange Traded Funds or ETFs) rather than individual equities and that it buys Japanese ones. Also it is still regularly buying as it  bought  70.500,000,000 Yen’s worth on Tuesday, Wednesday and Thursday this week. Whereas buying by the SNB in future will be more ad hoc should it feel the need to intervene to weaken the Swiss Franc again.

Now let us move to Federal Reserve policymaker Neel Kashkari

So an official denial! Also you may note that he has left some weasel room as he has not rejected the Japanese route of indirectly buying them. This is common amongst central bankers as they leave themselves an out and if they fear they might need to introduce a policy that will attract criticism they first deny they intend to do it to give the impression they have been somehow forced.

For a lighter touch @QTRResearch translated it into Trumpese so that the man who many think is really running the US Federal Reserve gets the picture.

Kashkari: We’re not buying stocks, who said anything about buying stocks, we’re definitely not buying stocks, we’d never buy stocks.

It was,of course, only last week that ended with the CIO of BlackRock suggesting that the ECB should purchase equities and no doubt he had a list ready! I suppose it would sort of solve this problem.

ECB will ask Deutsche Bank to raise fresh funds for merger: source ( Reuters)

Although of course that would not open just one can of worms but a whole cupboard full of them. But when faced with a problem the ECB regularly finds itself singing along with Donald Fagen.

Let’s pretend that it’s the real thing
And stay together all night long
And when I really get to know you
We’ll open up the doors and climb into the dawn
Confess your passion your secret fear
Prepare to meet the challenge of the new frontier

Comment

Now let us switch to markets as we remind ourselves that they have developed a habit of front-running or anticipating central bank action. Sometimes by thinking ahead but sometimes sadly via private briefings ( I hope the ECB has stopped them). However you spin it @Sunchartist made me think with this.

*Softbank Group Prices Japan’s Biggest Ever Yen Corporate Bond ¥500 Billion 1.64%

Aramco, Softbank, LYFT, Pinterest, Uber

The gravy train.

Or as Hipster on Twitter put it.

So Uber and Lyft will have a combined market cap of ~$150BN with a combined net loss of ~$3BN

Next there is the issue of something that is really rather uncomfortable.

It’s official: This is an all-time record year for corporate stock buybacks.

Announced buybacks for 2018 are now at $1.1 trillion. And companies are using their authorizations. About $800 billion of stock has already been bought back, leaving about $300 billion yet to be purchased. We’ve seen buyback announcements recently from Lowes’s. Pfizer, and Facebook, but in the last few days, as stocks have moved to new lows, companies are picking up the pace of activity. ( CNBC)

This makes me uncomfortable on several counts. It is the job of a board of directors to run a business not to be punters in its shares. This is especially uncomfortable if their bonuses depend on the share price. Frankly I would look to make that illegal. As to them knowing the future how has that worked out for Boeing? To be fair to CNBC they did highlight a problem.

So the critics of corporate buybacks and dividend raises are correct. It is a form of financial engineering that does not do anything to improve business operations or fundamentals………. obsessing over ways to boost stock prices helps the investing class but not the average American.

Perhaps nothing has been done about this because it suits the establishment after all think of the wealth effects. But that brings inequality and the 0.01% back into focus.

 

In the future will everybody be paid to issue debt?

This morning has brought a couple of developments on a road I have both expected and feared for some time. This road to nowhere became a theme as I questioned how central banks would respond to the next slow down? We have two examples of that this morning as we see industrial profits in China fall 14% year on year after quality adjustment or 27% without ( h/t @Trinhnomics). Also we have some clear hints – much more useful than so-called Forward Guidance – from ECB President Mario Draghi. So let me jump to a clear consequence of this.

The stockpile of global bonds with below-zero yields just hit $10 trillion — intensifying the conundrum for investors hungry for returns while fretting the brewing economic slowdown.

A Bloomberg index tracking negative-yielding debt has reached the highest level since September 2017………

This latest move if you look at their chart has taken the amount of negative yielding debt from less than US $6 trillion last September to US $10 trillion now as we observe what a tear it has been on. So if you buy and hold to maturity of these bonds you guarantee you will make a loss. So why might you do it?

While negative yields on paper suggest that investors lose money just by holding the obligations, bond buyers could also be looking at price gains if growth stalls and inflation stays low. But along the way, risk assets may be entering the danger zone.

So one argument is the “greater fool” one. In the hope of price gains someone else may be willing to risk a negative yield and an ultimate loss should they hold the bond to maturity.

However there always ways a nuance to that which was that of a foreign investor. He or she may not be too bothered by the risk of a bond market loss if they expect to make more in the currency. This has played out in the German and Swiss bond markets and never went away in the latter and is back in the former. Also investors pile into those two markets in times of fear where a small loss seems acceptable. This has its dangers as those who invested in negative yielding bonds in Italy have discovered over the past year or two.

The more modern nuance is that you buy a bond at a negative yield expecting the central bank to buy it off you at a higher price and therefore more negative yield. Let me give you an example from my country the UK yesterday afternoon. The Bank of England paid 144 for a UK Gilt maturing in 2034 which will mature at 100. This does not in this instance create a negative yield but it does bring a much lower one as a Gilt issue with a 4.5% coupon finds its yield reduced to 1.32%. There was a time the thought that a UK Gilt would be priced at 144 would only raise loud laughs. I also recall that the Sledgehammer QE of the summer of 2016 did create negative yields in the UK albeit only briefly. Of course in real terms ( allowing for inflation) that made the yield heavily negative.

The Euro area

The activities of the European Central Bank under Mario Draghi and in particular the QE based bond buyer have added to the negative yielding bond total. This morning he is clearly pointing us to the danger of larger negative interest-rates and yields as he focuses on what to him is “the precious”.

We will continue monitoring how banks can maintain healthy earning conditions while net interest margins are compressed. And, if necessary, we need to reflect on possible measures that can preserve the favourable implications of negative rates for the economy, while mitigating the side effects, if any. That said, low bank profitability is not an inevitable consequence of negative rates.

This matters because so far banks have found it difficult to offer depositors less than 0%. There have been some examples of it but in general not so . Thus should the ECB offer a deposit rate even lower than the current -0.4% the banks would be hit and for a central banker this is very concerning. This is made worse in the Euro area by the parlous state of some of the banks. Mario is also pointing us towards the ” favourable implications of negative rates for the economy” which has led Daniel Lacalle to suggest this.

Spain: Mortgage lending rises 16% in the middle of a slowdown with 80% of leading indicators in negative territory.

There is an attempt by Mario to blame Johnny Foreigner for the Euro area slow down.

The last year has seen a loss of growth momentum in the euro area, which has extended into 2019. This has been predominantly driven by pervasive uncertainty in the global economy that has spilled over into the external sector. So far, the domestic economy has remained relatively resilient and the drivers of the current expansion remain in place. However, the risks to the outlook remain tilted to the downside.

Those involved in the domestic economy might be worried by the use of the word “resilient” as that is usually reserved for banks in danger of collapse and we know what invariably happens next. But no doubt you have noted that in spite of the rhetoric we are pointed towards the economy heading south.

Then we get the central banking mic-drop as we wonder if this is the new “Whatever it takes ( to save the Euro)”.

We are not short of instruments to deliver on our mandate.

That also qualifies as an official denial especially as the actual detail shows that things from Mario’s point of view are not going well.

The weakening growth picture has naturally affected the inflation outlook as well. Our projections for headline inflation this year have been revised downwards and we now see inflation at 1.6% in 2021. Slower growth will also lead to a more muted recovery in underlying inflation than we had previously expected.

Comment

We have seen today that not only are there more people finding that debt pays in a literal sense but we have arrived in a zone where more of this is in prospect. I have explained above how this morning has brought a suggestion that there will be more of it in the Euro area and by implication around Europe as it again acts as a supermassive black hole. But let me now introduce the possibility of a new front.

Back in the 1980s the superb BBC television series Yes Prime Minister had an episode where Sir Humphrey Appleby suggests to Prime Minister Jim Hacker.

Why don’t you announce a cut in interest-rates?

Hacker responds by saying the Bank of England will not do it to which Sir Humphrey replies by suggesting a Governor who would ( and then does…). Now in a modern era of independent central banks that cannot possibly happen can it?

 He said the Fed should immediately reverse course and cut rates by half a percentage point.

Those are the words of the likely US Federal Reserve nominee Stephen Moore as spoken to the New York Times. Just in case you think that this is why he is on his way to being appointed I would for reasons of balance like to put the official denial on record.

And he promised he would demonstrate independence from Mr. Trump, whose agenda Mr. Moore has helped shape and frequently praised.

Returning directly to my theme of the day this in itself would not take US yields negative but a drop in the official interest-rate from 2.5% to 2% would bring many other ones towards it. For a start it would make us wonder how many interest-rate cuts might follow? Some of these thoughts are already in play as the US Treasury Note ten-year yield which I pointed out was 2.5% on Friday is 2.39% as I type this, In the UK the ten-year Gilt yield has fallen below 1% following the £2.3 billion of Operation Twist style QE as it refills its coffers on its way back to £435 billion.

 

We are now facing a reality of QE to infinity

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

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

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

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

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

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

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

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

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

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

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

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

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

To Infinity! And Beyond!

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

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

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

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

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

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

when we were trying to help the economy,

That is rather different to it did help.

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

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

Comment

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

So the economic effects are

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

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

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