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.

 

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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)

Can we stop interest-rates falling and going negative?

This week has seen a development I have long-expected and forecast. That is that the establishment will respond to the next economic slow down with negative interest-rates. The rationale for that is in one sense simple as in most places interest-rates never went back up again and if they did by not much, Only yesterday I looked at my own country the UK where in the decade or so since the credit crunch the Bank of England has raised interest-rates by a net 0.25%. Not much is it? Last time around the only reason it did not cut interest-rates even lower it was because it feared that the creaking IT systems of the UK banks could not take it. As it was some mortgages ( mostly with Cheltenham & Gloucester if I recall correctly) went below 0% and were dealt with via capital repayments to stop a HAL 9000 style moment.

Of course more than a few central banks continue to have negative interest-rates as we look at Denmark, the Euro area, Japan, Sweden and Switzerland. The ECB may pause this morning to mull whether it will get its deposit rate ( -0.4%) back even to zero as it note German factory orders some 7% lower than the previous year in December. This brings us to the driver of the current situation which is the economic slow down we have been following and indeed predicting via the decline in money supply growth. That remains as a slow down and has not yet signalled an overall recession but none the less it has produced quite a change.

The San Francisco Fed

It is far from a coincidence that the San Francisco Fed has produced a paper on negative interest-rates this week. After all the overall Federal Reserve has put up the white flag on interest-rate increases as we wait to hear what was discussed when Chair Powell had dinner with President Trump on Monday night.  Anyway the paper seems to open with a statement of regret.

Traditionally, it has been assumed that nominal interest rates cannot fall below zero, known as the “lower bound.” Ever since 2008, researchers have debated how much monetary policy was constrained by this lower bound and how much it affected economic outcomes. To work around this constraint, the Federal Reserve turned to unconventional monetary policy tools such as forward guidance and large-scale asset purchases.

Also an admission that QE was driven by the belief that interest-rates could not go below zero. I cannot be too churlish about that because there was a time when I did not think so either at least on a sustained basis although it was around 20 years ago and before the full impact of the Japanese lost decade! I do not know if one of the drivers of this thought was fear of what negative interest-rates would do to the US banks but history has seen a potential revision.

In this Economic Letter, I consider whether pushing rates below zero would have improved economic outcomes in the United States in the aftermath of the financial crisis.

For a central banker the answer is clearly yes.

Model estimates suggest that reducing the effective lower bound for the federal funds rate to –0.75% would have reduced economic slack by as much as one-half at the trough of the recession and sped up the ensuing recovery. While the boost to the economy would have been negligible after 2014, inflation would have been higher throughout the recovery by about half a percentage point on average.

There are various points here. First the central banker assumption that higher inflation is a good thing whereas in reality the ordinary person is likely to be worse off via lower real wages. Next the interesting observation that it is a temporary gain. Finally there is a later reference to Switzerland which took interest-rates to -0.75% so we are left with the view that this paper might recommend even more negative rates if only someone else had been brave/silly enough to try them. It omits to point out that Switzerland has not escaped from this as it is still at -0.75%.

How does this work?

An old friend appears.

In the model, the output gap falls with the interest rate.

Ah so it works because we assume it will. What could go wrong? Whilst we are at the Outer Limits of fantasy why not throw in the kitchen sink.

However, expectations about the future path of the fed funds rate matter, including any Federal Reserve announcements about its path—known as forward guidance—as well as expectations about being at the zero lower bound.

I am not sure if that is chutzpah, ignorance or just simple Ivory Tower non-thinking. After all we have just had a Forward Guidance U-Turn so are we following the old or new versions and if so what was the cost of the change? Those who have fixed their mortgage expecting higher interest-rates for example. Whereas now Men at Work are being played.

It’s a mistake, it’s a mistake
It’s a mistake, it’s a mistake

Rather oddly the paper says that the output gap is pushed higher when the author must mean lower, But there is a bigger space oddity which is this.

According to these simulations, the negative lower bound would have reached its maximum effect in the first quarter of 2011. Setting the lower bound at –0.25% would have increased the output gap by 1.5 percentage points, while pushing the lower bound down further to –0.75% would have contributed an additional 0.4 percentage point to the output gap. This means that a rate of –0.25% would have done most of the job, and allowing it to drop further would have accomplished fewer additional benefits.

Let us subject that to a sense check because we know that the US Federal Reserve did cut its official interest-rate to 0% ( technically 0% to 0.25%) but that going a mere extra 0.25% would make much of a difference? From the previous peak the US had cut by 5% so would an extra 0.25% make any difference at all?

The IMF goes further

Here we go.

One option to break through the zero lower bound would be to phase out cash.

It wants to go as Madonna would put it, deeper and deeper.

To illustrate, suppose your bank announced a negative 3 percent interest rate on your bank deposit of 100 dollars today.

They need a tax or fine or cash to achieve this.

Suppose also that the central bank announced that cash-dollars would now become a separate currency that would depreciate against e-dollars by 3 percent per year. The conversion rate of cash-dollars into e-dollars would hence change from 1 to 0.97 over the year.

Comment

There is quite a bit to consider here but let me start with the concept of arrogance. This is because monetary policymakers have had the freedom over the past decade to do pretty much what they liked and if it had worked we would not be here would we? Yet like Jose Mourinho in the football transfer market they always want more, more, more. Actually I am being a little unfair on Jose as there was a time his policies brought plenty of success.

Combined with this is an obsessive clinging onto failed past concepts. The output gap has had a dreadful credit crunch yet here it is again. Next the idea that higher inflation is good has ( thank God) had a bad run too but central bankers confuse what is good for the banks with what is good for the rest of us. The reality that no country or economic area has gone into negative interest-rates and then recovered is simply ignored whereas so far they have all sung along with Muse.

Glaciers melting in the dead of night
And the superstars sucked into the super massive
Super massive black hole
Super massive black hole
Super massive black hole
Finally is the idea that those who do not worship at this particular monetary altar need to be punished. Just like in the novel 1984……

Did the Riksbank of Sweden just panic?

This morning has brought news of an event that had been promised so many times but turned out to be a false dawn. Indeed on their way to apparently making sense of this world Rosa & Roubini Associates told us this.

Riksbank Likely to Wait Longer Before Lift-Off

I guess you are now all expecting this.

Economic activity is strong and the conditions are good for inflation to remain close to the inflation target in the period ahead. As inflation and inflation expectations have become established at around 2 per cent, the need for a highly expansionary monetary policy has decreased slightly. The Executive Board has therefore decided to raise the repo rate from −0.50 per cent to −0.25 per cent.

Actually there is quite a bit that is odd about this as indeed there has been, in my opinion, about the monetary policy of the world’s oldest central bank for some time. Let me give you two clear reasons to be doubtful. Firstly GDP growth plummeted from the 1% of the second quarter of this year to -0.2% in the third. Or as the Riksbank puts it.

As expected, Swedish GDP growth has slowed down during
the second half of this year. However, the downturn in the third  quarter was greater than expected.

So if we step back we immediately wonder why you raise rates when economic growth is slowing when you could have done so when it was rising? The excuse provided looks weak especially as we note the automobile industry has continued to struggle.

One contributory cause of  this was that household consumption fell by a surprisingly large  degree, but this can partly be explained by temporarily weak car sales.

Also inconvenient numbers are regularly described as temporary even when they are nothing of the sort.

Moving onto inflation the outlook has also changed as we have moved towards the end of 2018.

The inflation rate according to the CPI with a fixed interest rate (CPIF) was 2.1 percent in November 2018 (2.4 percent in October). The CPIF decreased by 0.1 percent from October to November.  ( Sweden Statistics)

Here is FXStreet from last week when these numbers came out.

Nordea Markets 1/2: : CPIF inflation stood at 2.1% in November, below consensus and 0.3% point below the ’s forecast. Core inflation, i.e. CPIF ex energy, came out at 1.4%, as much as 0.3% point below the Riksbank’s call.

To be fair to Nordea they were expecting a hike so perhaps they had received an official nod because there is now another factor at play. That is of course the lower trajectory of the oil price which looks set to depress headline inflation numbers in the weeks and months ahead. If we take a broad sweep the price of a barrel of Brent Crude Oil has fallen some US $30 since the Riksbank balked at raising Swedish interest-rates. I think you can spot the problem here. Apparently the wages fairy will turn up which of course is yet another central banking standard view in spite of reality not being that helpful.

Wage growth has certainly become a little lower than
the Riksbank’s forecast over recent months and the forecast has been revised downwards slightly.

The Riksbank’s own view

Let me know switch to some sections of their monetary report which frankly would fit better with an interest-rate cut.

The global economy, which has grown rapidly in recent years, is now entering a phase of more subdued GDP growth, which is in line with the Riksbank’s earlier forecasts.

So Sweden is swimming against the trend?

Economic activity in Sweden is still strong, although GDP growth and inflation have been weaker than expected.

So definitely maybe. What about inflation prospects?

Even though inflation has been lower than expected, the conditions remain good for inflation to stay close to the inflation target going forward.

Then we get quite a swerve because you might think that with the claimed view of the Riksbank more interest-rate hikes will be on the way. It would be logical assuming there is anyone who believes the growth path remains strong and inflation will be ~2% per annum. But apparently not.

The forecast for the repo rate has therefore been revised downwards to indicate that the next repo rate rise will probably occur during the second half of 2019 . After this, the forecast indicates approximately two rate rises per year by 0.25 percentage points each time.

If we skip the last sentence on the grounds that this has been not far off the promised pattern since the Riksbank last raised back in 2011 we see that what is now called a “dovish hike” has just taken place. What that means is that whilst there has been a rise the future expected path falls. Thus if you follow central banking forward guidance interest-rates as 2019 develops may now be lower than you were expecting.

Operation Twist and QE

The other factors in Sweden’s monetary policy are described below.

At the end of November, the Riksbank’s government bond
holdings amounted to just under SEK 350 billion, expressed as a nominal amount.

But they are giving Operation Twist an extra squeeze.

In December 2017, the Executive Board also decided that reinvestments of the large principal payments due in the first six months of 2019 should be allocated evenly across the period from January 2018 to June 2019 . This means that the Riksbank’s holdings of government bonds will increase temporarily in 2018 and the beginning of 2019.

If you wished to tighten monetary policy then you could simply let these bonds mature and not replace them.

US Federal Reserve

As we were expecting it did this last night.

Today, we raised our target range for short-term interest
rates by another quarter of a percentage point. ( Chair Powell)

Not everyone was on board however as there was a nearly 800 point swing in the Dow Jones Industrial Average in response to it. This also meant it ignored the advice from President Trump not to do so and to cut the amount of Quantitative Tightening. The issue was summed up by the Wall Street Journal but not in the way the author thought it meant.

The data says the economy is doing great; the markets say it could be headed for a recession.

At turning points the data is always too late by definition which means that some sort of judgement call is required. Central banks have about a 0% success rate in predicting recessions.

Comment

There is a fair bit to consider in the latest central banking moves but the major point is one of timing. Monetary policy is supposed to lead events and not to lag them which is why “data dependency” is not only flawed it is illogical. To be fair to the US Federal Reserve it has at least tried to get ahead of events whereas the Riksbank has not.

Meanwhile there is a country with a central bank meeting today which has just had some strong economic news.

The quantity bought in November 2018 when compared with October 2018 increased by 1.4%, with a strong monthly growth of 5.3% in household goods stores….The strongest growth can be seen in comparison with the same period a year earlier where the amount spent increased by 5.0% and the quantity bought increased by 3.6%.

Is anybody expecting Mark Carney and the Bankof England to have raised interest-rates in response to the strong retail sales data? I am using the past tense as the vote was last night.

Number Crunching

 

 

 

 

The problematic nature of current bond yields

One of the features of the credit crunch era has been the falls in first world interest-rates and bond yields. The first phase saw the slashing of official short-term interest-rates and once that was seen to be inadequate, central banks directly purchased bonds to reduce yields further. It is seldom put like this but there was already an implied failure as according to the models back then the interest-rate cuts should have done the trick. Back then I was already looking ahead to when there would have to be ch-ch-changes and posted the view that central banks would delay what has become called policy normalisation.

For example back on the 24th of February 2011 I pointed out this about a speech from David Miles of the Bank of England.

 My problem with this is that when you act as they have and you have in effect used what weapons the Bank of England has virtually to the maximum by cutting interest-rates by 4.75%% and spending some £200 billion on asset purchases then you have been extraordinarily interventionist. Accordingly it is then hard for you to blame events because some of them are the consequence of your own actions……

What that illustrates is that already the truth was being manipulated and also I am glad I wrote “virtually to the maximum” as of course the amount of asset purchases has more than doubled. In addition we have seen credit easing in the UK via such policies as the Term Funding Scheme and the start of full-scale QE from the European Central Bank as well as negative interest-rates.

But the point about delaying proved to be very accurate as the Euro area is still actively pursuing QE and in net terms the UK has managed to raise interest-rates by a measly 0.25%. The opportunity in 2014/15 was meant with promises via Forward Guidance but no action.

The US

This is the one country which has taken clear action on the path to normalisation. Here is the current state of play.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 2 to 2-1/4 percent.

That is currently working out be be around 2.2% and more rises are promised. Also there is some reversing of the QE or Qualitative Tightening.

The Committee directs the Desk to continue
rolling over at auction the amount of principal
payments from the Federal Reserve’s holdings
of Treasury securities maturing during each
calendar month that exceeds $30 billion, and to
continue reinvesting in agency mortgage-backed
securities the amount of principal
payments from the Federal Reserve’s holdings
of agency debt and agency mortgage-backed
securities received during each calendar month
that exceeds $20 billion.

That combined with forecasts of another interest-rate rise in a fortnight and at least a couple next year seemed to put pressure on bond markets. However this sentence in a speech from Federal Reserve Chair Jerome Powell shook things up on the 28th of last month and the emphasis is mine.

We therefore began to raise our policy rate gradually toward levels that are more normal in a healthy economy. Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy‑‑that is, neither speeding up nor slowing down growth.

You may note we seem to have travelled from “policy normalisation” to neutral. But what the neutral interest-rate represents is an attempt to figure out what interest-rate would neither stimulate or contract the economy. Or a sort of measure of what we might aim for as a new normal. When they are trying to put a pseudo scientific gloss on things economist and central bankers call it r-squared.

However the “just below” dropped the expected path for US interest-rates by 0.5%.

Bond Markets

Let me take you to the Wall Street Journal on Tuesday.

This quarter, yields on longer-dated bonds have dropped and those on two-year Treasurys are flat. The gap between two and 10-year Treasury yields is now around 0.11 percentage point, compared with around 0.55 percentage point at the beginning of the year.

This is attracting a lot of attention in the financial media but the change of 0.44% is pretty much my 0.5% suggestion above. Now let us look at the US ten-year yield which is 2.9% as I type this and we see that in basic terms it is predicting a couple more 0.25% interest-rate rises. This will come in the next year or so if true so it is not very different to the two-year yield of 2.76%.

If we look beyond Federal Reserve policy we have seen a fall in the price of oil over the past month or two. If we look at it in Brent Crude terms then just above US $86 of early October has been replaced by below US $59 this morning as oil follows equity markets lower. The exact amount of the change varies but the path for inflation now seems set to be lower as it has been rare in 2018 for the oil price to be below where it was this time last year. That is another reason for lower bond yields.

Is this a signal of a recession? Here is the St.Louis Fed from last week.

Does the recent flattening of the yield curve portend recession? Not necessarily. The flattening of the real yield curve may simply reflect the fact that real consumption growth is not expected to accelerate or decelerate from the present growth rate of about 1 percent year over year. On the other hand, a 1 percent growth rate is substantially lower than the U.S. historical average of 2 percent. Because of this, the risk that a negative shock (of comparable magnitude to past shocks) sends the economy into technical recession is increased.

That is a fascinating way of looking at it and in my experience precisely zero bond market participants will look at it like that. It is also revealing that we seem to just assume growth will now be lower. Didn’t they save us?

Comment

I wanted to look at this subject today because of the clear changes which are happening. Now it looks much less likely that US interest-rates will pass 3% and if they do not by much. So “normalisation” will be at best about two-thirds of what it might have been considered to be pre credit crunch ( 4.5%). Some of you have suggested that we can no longer afford interest-rates and yields above 3% so well done at least if we stay where we are! If Italy folds you may get a second tick in that box.

But as we look wider we see even more extraordinary developments. Let me take a look at my own country the UK which is in political disarray yet the ten-year Gilt yield is below 1.3%. So those predicting a surge in Gilt yields are slipping back into the bushes whilst I note the extraordinary absolute level and the persistence of negative real yields which bust past metrics. Germany has a ten-year yield of 0.26% and a five-year one of -0.3% as we note again more metrics which are busted.

So my view is that we cannot rely on old recession metrics because another cause of all of this is that QE4 from the US Fed has got closer. I have worried all along that interest-rate rises might run into more QE and if they do we will be singing along to Coldplay.

Oh no I see
A spider web and it’s me in the middle
So I twist and turn
Here am I in my little bubble

 

 

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 )