Why have the bond markets lost their bark and their vigilantes?

The credit crunch era took us on quite a journey in terms of interest-rates. At first central banks reduced official short-term interest-rates in the hope that they would fix the problem. Then they embarked on Quantitative Easing policies which were designed to reduce long-term interest-rates or bond yields. This was because quite a few important interest-rates are not especially dependent on official interest-rates and may from time to time even move in the opposite direction. An example is fixed-rate mortgages. However if they are a “cure” then one day all the downwards manipulation of interest-rates and yields needs to stop. Of course the fact that it is still going on all these years later poses its own issues.

The United States looked as though it was heading on that road last year on two counts. Firstly the Federal Reserve was in a program to raise interest-rates and secondly both Presidential candidates indicated plans for a fiscal stimulus. When Donald Trump was elected as President he reinforced this by telling us this as I reported back on November 9th.

We are going to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals. We’re going to rebuild our infrastructure, which will become, by the way, second to none, and we will put millions of our people to work as we rebuild it.

This was somewhat reminiscent of the “New Deal” of President F.D. Roosevelt although I counselled caution at the time and of course any fiscal expansion would be added to by the plan for tax cuts. The two impacted on bond markets as shown below.

There has been a clear market adjustment to this which is that the 30 year ( long bond) yield has risen by 0.12% to 2.75%.

In the US this tends to have a direct impact on fixed mortgage-rates as many places quote a 30 year one.

What happened next?

US bond yields did rise and in mid March the 10 year Treasury Note yield rose to 2.63% meaning that it was approaching the long bond yield quoted above. Meanwhile the long bond yield rose to 3.21%. However as we look back now those were twin peaks and have been replaced by 2.07% and 2.69% respectively.

Why might this be?

Whilst there does seem to be some sort of concrete plan for tax cuts there is little sign of much concrete around any infrastructure spending. So that has drifted away and there has been an element of this with official interest-rate rises. The US Federal Reserve has raised them to a range between 1% and 1.25% but seems to be in no hurry to raise them further. It does plan to reduce its balance sheet but the plan is very small compared to its size.

The Recovery

The US economy has continued to grow in 2017 as shown below.

Real gross domestic product (GDP) increased at an annual rate of 3.0 percent in the second quarter of 2017 (table 1), according to the “second” estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 1.2 percent. ( These are annualised figures )

This has not been enough to unsettle bond markets especially if we add in that so far in 2017 inflation has if anything faded. Here are the latest numbers from NASDAQ.

Excluding food prices and fuel, core PCE measure – the Fed’s preferred measure of inflation – increased 1.4% in July year over year compared with 1.5% in June. However, it edged up 0.1% in July on a monthly basis. Therefore, it is still far from the Fed’s target of 2%.

For once it does not matter if you use a core inflation measure as it comes to the same answer as the headline! Although the annual rate has only fallen by 0.2% for the core measure since March as opposed to 0.4% for the headline. But we are left with okay growth and fading inflation which gives us a reason why bond markets have rallied and yields fallen.

What about wages?

The various output gap style theories that falling and indeed low unemployment rates would push wage and in particular real wage growth higher have not come to fruition. From the Bureau of Labor Statistics.

From July 2016 to July 2017, real average hourly earnings increased 0.8 percent, seasonally adjusted. The increase in real average hourly earnings combined with no change in the average workweek resulted in a 0.7-percent increase in real average weekly earnings over this period.

Japan

If we stay with the subject of wages here is today’s data from Japan. From the Financial Times.

 

Unadjusted labour cash earnings fell 0.3 per cent year on year in July, down from a 0.4 per cent increase a month earlier, according to a preliminary estimate by the Ministry of Health, Labour and Welfare…….Special cash earnings, which includes bonuses, were down 2.2 per cent on the same month a year ago.

If we widen our discussion geographically and look at the US where there is some wage growth we see that in other places there is not as real wages in Japan fell by 0.8%. If we stay with Japan for a moment then we see that in spite of the media proclamations over the past 4 years that wages are about to turn upwards we are still waiting. Bonuses were supposed to surge this summer. So the “output gap” continues to fail and there is little pressure on bond yields from wage growth in Japan.

QE

This of course continues in quite a few places. In terms of the headline players we have the 60 billion Euros a month of the European Central Bank and the yield curve control of the Bank of Japan which it expects to be around 80 trillion Yen a year. I raise these points as a bond yield rally in these areas would require these to be substantially reduced or stopped. We expect little substantive change from the ECB until the election season is over but some were expecting a reduction from it as the Euro area economy improved. As time passes it will have to make some changes as its rules suggest it will run out of German bonds to buy next spring and the more it shuffles to avoid that the more likely it will run out of bonds to buy in France, Spain and even Italy.

Added to this are the sovereign wealth funds as for example Norway which seems to be rebalancing in favour of US Euro and UK bonds. There are also the investment plans of the Swiss National Bank.

Comment

So we see a dog that has little bark and has not bitten. Some of this is really good news as unlike the central banker cartel I am pleased that so far inflation has for them disappointed. Although as we look ahead there may be issues from some commodity prices. From Mining.com

December copper futures trading on the Comex market in New York made fresh highs on Tuesday after the world’s number one producer of the metal reported a sharp drop in production.
Copper touched $3.1785 a pound ($7,007 per tonne) in morning trade, the highest since September 2014. Copper is now up by more than 50% compared to this time last year.

So Dr,Copper may be giving us a hint although I also note that hedge funds are getting involved so this may be a “financialisation” move as opposed to a real one.

Another factor which would change things would be some real wage growth. Perhaps along the lines of this released by the German statistics office last week.

The collectively agreed earnings, as measured by the index of agreed monthly earnings including extra payments, increased by an average 3.8% in the second quarter of 2017 compared with the same quarter of the previous year. This is the highest rise since the beginning of the time series in 2011. The Federal Statistical Office (Destatis) also reports that, excluding extra payments, the year-on-year increase in the second quarter of 2017 was 3.4%.

If we move to my home country then it remains hard to believe with our penchant for inflation we have a ten-year Gilt yield of 1.01% as I type this. Even worse a five-year Gilt yield of 0.43% as you will lose the total yield in inflation this year alone. I can see how a “punter” might buy at times front-running events or the Bank of England but how can it be an investment unless you expect quite an economic depression?

 

 

 

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Whatever happened to savers and the savings ratio?

A feature of the credit crunch era has been the fall and some would say plummet in quite a range of interest-rates and bond yields. This opened with central banks cutting official short-term interest-rates heavily in response to the initial impact with the Bank of England for example trimming around 4% off its Bank Rate to reduce it to 0.5%. If we go to market rates the drop was even larger because it is often forgotten now that one-year interest-rates in the UK rose to 7% for around a year or so as the credit crunch built up in what was a last hurrah of sorts for savers. Next central banks moved to reduce bond yields via purchases of sovereign bonds via QE ( Quantitative Easing) programmes. In the UK this was followed by some Bank of England rhetoric heading towards the First World War pictures of Lord Kitchener saying your country needs you.

Here is Bank of England Deputy Governor Charlie Bean from September 2010.

“What we’re trying to do by our policy is encourage more spending. Ideally we’d like to see that in the form of more business spending, but part of the mechanism … is having more household spending, so in the short-term we want to see households not saving more but spending more’.

Our Charlie was keen to point out that this was a temporary situation.

“It’s very much swings and roundabouts. At the current juncture, savers might be suffering as a result of bank rate being at low levels, but there will be times in the future — as there have been times in the past — when they will be doing very well.

Mr.Bean was displaying his usual forecasting accuracy here as of course savers have seen only swings and no roundabouts as the Bank Rate got cut even further to 0.25% and the £79.6 billion of the Term Funding Scheme means that banks rarely have to compete for their deposits. This next bit may put savers teeth on edge.

“Savers shouldn’t see themselves as being uniquely hit by this. A lot of people are suffering during this downturn … Savers shouldn’t necessarily expect to be able to live just off their income in times when interest rates are low. It may make sense for them to eat into their capital a bit.”

In May 2014 Charlie was at the same game according to the Financial Times.

BoE’s Charlie Bean expects 3% interest rate within 5 years

There is little sign of that so far although of course Sir Charlie is unlikely to be bothered much with his index-linked pension worth around £4 million if I recall correctly plus his role at the Office for Budget Responsibility.

House prices

I add this in because the UK saw an establishment move to get them back into buying houses. This involved subsidies such as the Bank of England starting the Funding for Lending Scheme in the summer of 2013 to reduce mortgage rates ( by around 1% initially then up to 2%) which continues with the Term Funding Scheme. Also there was the Help to Buy Scheme of the government. I raise these because why would you save when all you have to do is buy a house and the price accelerates into the stratosphere?

The picture on saving gets complex here. Some may save for a deposit but of course the official pressure for larger deposits soon faded. Also the net worth gains are the equivalent of saving in theoretical terms at least but only apply to some and make first time buyers poorer. Also care is needed with net worth gains as people can hardly withdraw them en masse and what goes up can come down. Furthermore there are regional differences here as for example the gains are by far the largest in London which leads to a clear irony as official regional policy is supposed to be spreading wealth, funds and money out of London.

There is also the issue of rents as those affected here have no house price gains to give them theoretical wealth. However the impact of the fact that real wages are still below the credit crunch peak has meant that rents have increasingly become reported as a burden. So the chance to save may be treated with a wry smile by those in Generation rent especially if they are repaying Student Loans.

Share Prices

This is a by now familiar situation. If we skip for a moment the issue of whether it involves an investment or saving as it is mostly both we find yet another side effect of central bank action. In spite of the recent impact of the North Korea situation stock markets are mostly at or near all time highs. The UK FTSE 100 is still around 7300 which is good for existing shareholders but perhaps not so good for those planning to save.

Number Crunching

There are various ways of looking at the state of play or rather as to what the state of play was as we are at best usually a few months behind events. From the Financial Times at the end of June.

UK households have responded to a tight squeeze on incomes from rising inflation, taxes and falling wages by saving less than at any time in at least 50 years. According to new figures from the Office for National Statistics, 1.7 per cent of income was left unspent in the first quarter of 2017, the lowest savings ratio since comparable records began in 1963.

This compares to what?

The savings ratio has averaged 9.2 per cent of disposable income over the past 54 years,

Some of the move was supposed to be temporary which poses its own question but if we move onto July was added to by this.

In Quarter 1 2017, the households and NPISH saving ratio on a cash basis fell to negative 4.8%, which implies that households and NPISH spent more than they earned in income during the quarter.

The above number is a new one which excludes “imputed” numbers a trend I hope will spread further across our official statistics. It also came with a troubling reminder.

This is the lowest quarterly saving ratio on a cash basis since Quarter 1 2008, when it was negative 6.7%.

As they say on the BBC’s Question of Sport television programme, what happened next?

The United States

We in the UK are not entirely alone as this from the Financial Times Alphaville section a week ago points out.

Newly revised data from the Bureau of Economic Analysis show that American consumers have spent the past two years embracing option 2. The average American now saves about 35 per cent less than in 2015……….Not since the beginning of 2008 have Americans saved so little — and that’s before accounting for inflation.

Comment

One of the features of the credit crunch was that central banks changed balance between savers and debtors massively in the latter’s favour. Measure after measure has been applied and along this road the claims of “temporary” have looked ever more permanent. Therefore it is hardly a surprise that savings seem to be out of favour just as it is really no surprise that unsecured credit has been booming. It is after all official policy albeit one which is only confessed to in back corridors and in the shadows. After all look at the central bank panic when inflation fell to ~0% and gave savers some relief relative to inflation. If we consider inflation there has been another campaign going on as measures exclude the asset prices that central banks try to push higher. Fears of bank deposits being confiscated will only add to all of this.

Meanwhile as we find so often the numbers are unreliable. In addition to the revisions above from the US I note that yesterday Ireland revised its savings ratio lower and the UK reshuffled its definitions a couple of years or so ago. I do not know whether to laugh or cry at the view that the changed would boost the numbers?! I doubt the ch-ch-changes are entirely a statistical illusion but the scale may be, aren’t you glad that is clear? We are left mulling what is saving? What is investment?

But we travel a road where many cheerleaders for central bank actions now want us to panic over an entirely predictable consequence. Or to put it another way that poor battered can that was kicked into the future trips us up every now and then.

 

 

 

What is happening in the US economy?

It has been a while since we have taken a good look at the US economy so it is overdue. This morning it has been analysed by the International Monetary Fund which has grabbed some headlines with this.

U.S. growth projections are lower than in April, primarily reflecting the assumption that fiscal policy will be less expansionary going forward than previously anticipated.

As you can see the IMF has had something of a road to Damascus change since the days it argued that Greece could expand its economy in the face of harsh austerity! Also it is hard not to have a wry smile at the thought that anyone can really predict accurately what will emerge from the Trump administration next. Of course it and the IMF are on various collision courses included this one which was mentioned in the IMF’s Friday press conference.

Since the Trump administration has been promoting its “America first” polices, Managing Director Lagarde has talked more about promoting free and fair trade policies

Returning to the forecast here are the specific numbers.

The growth forecast in the United States has been revised down from 2.3 percent to 2.1 percent in 2017 and from 2.5 percent to 2.1 percent in 2018.

In addition to  the view on fiscal policy there were concerns about this.

the markdown in the 2017 forecast reflects in part the weak growth outturn in the first quarter of the year.

That is slightly odd because as regular readers will be aware US economic growth tends to underperform in the first quarter these days. Also it is reassuring to know that the number could be either too high or too low.

Risks to the U.S. forecast are two sided: the implementation of a fiscal stimulus (such as revenue-reducing tax reform) could drive U.S. demand and output growth above the baseline forecast, while implementation of the expenditure-based consolidation proposed in the Administration’s budget would drive them lower.

So let us move on with two thoughts. The first is that if we look at the IMF’s track record it is completely incapable of forecasting economic growth to that level of accuracy. Secondly I note that the forecast for the next two years is the average of the last two.

The Nowcast

Several of the US Federal Reserves do what are called nowcasts of economic forecasts so let us head down to the good old boys and girls in Atlanta.

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2017 is 2.5 percent on July 19, up from 2.4 percent on July 14. The forecast of second-quarter real residential investment growth increased from -1.6 percent to -0.6 percent after this morning’s new residential construction report from the U.S. Census Bureau.

This represents an overall decline on the initial estimate of 4.3% in early May. There have been notable falls in both export expectations and investment of all types including housing combined with a dip in consumption. Perhaps the fall in exports is a response to the stronger dollar that we saw a year or so ago.

The Labour Market

This remains very strong as the latest report indicates.

Total nonfarm payroll employment increased by 222,000 in June, and the unemployment rate was little changed at 4.4 percent, the U.S. Bureau of Labor Statistics reported today.  Since January, the unemployment rate and the number of unemployed are down by 0.4 percentage point and 658,000, respectively.

As you can see in spite of the fact that we are in fact above what some would call full employment jobs are still being generated. If we move to the measure of underemployment there continue to be improvements in it as well. The U-6 measure of this has seen the rate fall from 9.6% in June 2016 to 8.6% in June ( seasonally adjusted) this although a rise in this June needs to be watched.

However as we observe so often to the sound of Ivory Towers crumbling to the ground this has not generated much wage growth.

In June, average hourly earnings for all employees on private nonfarm payrolls rose by 4 cents to $26.25. Over the year, average hourly earnings have risen by 63 cents, or 2.5 percent.

If we move to median wage growth to exclude the impact of very high earners then we see something that is becoming ever more familiar across many different countries.

We see that the good news is that the US has some real wage growth but the bad news is that it is not that great. The numbers if we return to averages are below.

Real average hourly earnings for all private nonfarm employees increased 0.8 percent from June 2016 to June 2017. The increase in real average hourly earnings combined with a 0.3-percent increase in the average workweek resulted in a 1.1-percent increase in real average weekly earnings over the year.

Not much is it? If we look back on the chart above we see higher levels that it looked briefly we might regain but in spite of further employment improvements we are now left mulling wage growth fading and wondering how much it and inflation will dip. At this point it is hard not to wonder also about the impact of the “lost workers” from the around 4% fall in the labour force participation rate.

Monetary policy

This is of course being “normalised” which at a time when nobody really has any idea of what normal is anymore is therefore easy to claim. An interest rate of between 1% and 1.25% certainly does not feel normal nor does a central bank balance sheet approaching US $4.5 trillion. There are now plans to trim a minor amount off the balance sheet.

Of course this leaves everyone wondering what happened when the next recession strikes? Well everyone apart from those who believe that the central bankers have ended recessions. It looks as though bond markets have switched to wondering about that as the 30 year which had pushed above 3% is now at 2.8%. Also even the IMF has spotted that the US Dollar is in a weaker phase now.

As of end-June, the U.S. dollar has depreciated by around 3½ percent in real effective terms since March.

These moves will take a little off the edge of what tightening we have seen as I note that US consumer credit flows are in the middle of the post credit crunch range,

In May, consumer credit increased at a seasonally adjusted annual rate of 5-3/4 percent. Revolving credit increased at an annual rate of 8-3/4 percent, while nonrevolving credit increased at an annual rate of 4-3/4 percent.

Comment

A couple of years or so we discussed the likelihood that US economic growth would be around 2% going forwards and we now note that such thoughts have come true. Is that as good as it gets? The US has had one of the better recoveries from the impact of the credit crunch in terms of GDP and unemployment. We should be grateful for that. But we are again left wondering what happens should things slow or head towards a recession?

Still some will not be too bothered, from the Financial Times

Jamie Dimon and Lloyd Blankfein each enjoyed $150m-plus rises in the value of their stock and options.

Does the continuing enormous gains of the banksters go into the wages numbers?

What is the problem with wage growth?

The problem with wages growth has been a long running theme of this website, also if we look back it is something which even preceded the credit crunch. Although of course the credit crunch has made it worse. The world of economics has been wrong-footed by this as the Ivory Towers as usual projected that it would be “the same old song” as the Four Tops told us. For example the UK Office for Budget Responsibility projected that wages growth in the UK would be 4.5% now, and if they had known how far that unemployment would fall would presumably have projected it even higher.

A contributor to this has been the concept of full employment. From Investopeadia.

Full employment is an economic situation in which all available labor resources are being used in the most efficient way possible. Full employment embodies the highest amount of skilled and unskilled labor that can be employed within an economy at any given time. Any remaining unemployment is considered to be frictional, structural or voluntary.

There were and amazingly still are concepts such as the “natural rate of unemployment” below which inflation was supposed to rise. The catch has been that as we have seen unemployment rates fall post credit crunch we have seen wages either rise weakly or stagnate. At best wage growth has been lower than expected and at worst we have seen it actually fall. Something has changed.

One factor in this is clearly that the old Ivory Tower way of looking at the labour market through the lens of official unemployment rates is flawed. The concept of “underemployment” has been developed whereby people work fewer hours than they would like or take a lower skilled job. This has become entwined with quite a few issues around the concept of self-employment which is often counted as a type of “full” employment when it is not. Indeed being fully employed is in fact in the UK something you think you are rather than being something properly defined. On this road we start to understand that the clouds have yet again gathered between the elevated heights of the Ivory Towers and the ground zero where the rest of us live and work.

Japan’s problem

Weak wages growth has been one of the features of the “lost decade(s)” for the Japanese economy and accordingly it was one of the objectives of the policies of Prime Minister Shinzo Abe to reverse this. So let us examine today’s data as reported by Reuters.

Japan’s March real wages fell at the fastest pace in almost two years, pressured by meagre nominal pay hikes and a slight rise in consumer prices,

The detail is not good.

Inflation-adjusted real wages dropped 0.8 per cent in March from a year earlier to mark their biggest rate of decline since June 2015, labour ministry data showed on Tuesday (May 9)….In nominal terms, wage earners’ cash earnings fell 0.4 per cent year-on-year in March, also notching the biggest rate of decrease since June 2015.

If we continue the themes expressed above then if we imagined that we were inhabitants of an Ivory Tower we would be projecting fast wage growth. From Japan Macro Advisers.

The demand/supply balance in the Japanese labor market continues to remain tight. The unemployment rate remained steady at 2.8% in March 2017, matching the lowest rate since June 1994. Japan is likely to be at its full employment status, with only frictional unemployment remaining in the labor market.

Full employment with no wage growth and maybe even falls in real wages? Actually this is perhaps even worse for the concept of a natural rate of unemployment.

NAIRU, the Non-Accelerating-Inflation-Rate of Unemployment rate, was considered to lie between 3.5% and 4.5% in Japan.

So wages should be rising and doing so quite quickly whereas in reality they are not rising at all. Indeed contrary to the hype and media reporting they have been falling in the period of Abenomics  as the 103.9 of 2013 has been replaced by the 100.7 of 2016 where 2015 =100. The slight nudge up in 2016 has been replaced by falls so far in 2017.

This from Morgan Stanly only last month already seems like it is from a parallel universe.

Record low unemployment rates are pushing up salaries,

The Bank of Japan regularly tells us that wages will rise next year and Governor Kuroda stated this again only on Friday, but so far next year has never arrived.

Is Japan are forerunner for us and should we be singing along with The Vapors one more time?

I’m turning Japanese, I think I’m turning Japanese, I really think so
Turning Japanese, I think I’m turning Japanese, I really think so

The United States

A month ago US News reported this from US Federal Reserve Chair Janet Yellen.

“With an unemployment rate that stands at 4.5 percent, that’s even a little bit below what most of my colleagues and I would take as a marker of where full employment is,” Yellen said. “I’d say we’re doing pretty well.”

Yet on Friday the Bureau of Labor Statistics told us this.

In April, average hourly earnings for all employees on private nonfarm payrolls rose by 7 cents to $26.19. Over the year, average hourly earnings have risen by 65 cents,
or 2.5 percent.

So we are at what we are told is pretty much full employment and we are below the natural rate of employment ( 5.6% according to the Congressional Budget Office) and yet pay growth is still rather weak. It has been so for a while.

http://www.epi.org?p=117112&view=embed&embed_template=charts_v2013_08_21&embed_date=20170509&onp=75850&utm_source=epi_press&utm_medium=chart_embed&utm_campaign=charts_v2

The other issue is that in spite of us apparently being at full employment the level of wage growth is not a lot above inflation with the US CPI being at 2.4% and the Personal Consumption Expenditure being at 1.8%. Something is not right here and we do perhaps get some more perspective by looking at both the underemployment rate in the US ( 8.6%) and the way that the participation rate has fallen.

The UK

The situation here as I have been pointing out pretty much each time the data is released is very good in terms of the quantity measures as we see falling unemployment and rising employment but poor on the price or wages measure. This has been illustrated somewhat ironically by one of the failures of the Bank of England. Remember when it made an issue of the unemployment rate falling below 7%?

In particular, the MPC intends not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%,

There was a clear implication there that it expected economic changes as we moved below that threshold such as higher wage growth. Of course this was abandoned very quickly as unemployment fell sharply leaving the Bank of England’s spinners and PR people with plenty of work. But with the unemployment rate now well below 7% and indeed being 4.7% then wages should be rising quickly as we are well below the rate at which it was expected by our central banking overlords and masters. Er no, as you see wage growth for total pay was 2.3% back then and is 2.3% now. In terms of exact numbers that is happenstance but in terms of theme and principle it is yet another sign that the economic world has seen ch-ch-changes.

Comment

We are seeing something of a shift in the economic tectonic plates. Some of this is welcome as we see a strong recovery in levels of employment and falls in unemployment. However the other side of this coin is that wage growth is weak and in my home country the UK real wages have in spite of the economic recovery are still short of where they were a decade ago. It was only yesterday when I noted the German housing market getting like us well today it is our labour market which has mimicked theirs! Weak wage growth with low unemployment is rather Germanic and in fact is something we aimed at, well until we got it anyway.

Until now I have left out productivity which is an important factor in real wage growth as we wonder if the switch to a mainly service based  economy has neutered it? But there have been issued here as this morning’s working paper from the ECB indicates and its analysis applies much wider than just in the Euro area.

Higher labour productivity growth is a key factor in raising living standards in advanced economies……..Recent labour productivity growth in the euro area has, however, been low – by both historical and international standards – albeit against the backdrop of a generalised slowdown in global labour productivity growth…………..Over the period 2008-16, annual growth in euro area labour productivity per person employed slowed to an average of around 0.5% (based on a three-year moving average), from an average of around 1.1% over the course of the decade to 2007

 

What are the latest trends for inflation?

It is time to review one of the themes of 2017 which is that we expected a pick-up in the annual rate of inflation around the world. This has been in play with the US CPI rising at an annual rate of 2.4% in March and the Euro area CPI rising at 1.9% in April for example. If we switch to the factor that has been the main player in this we see that energy prices were 10.9% higher in the US than a year before and that in the Euro area they had gone from an annual rate of -8.7% in April last year to 7.5% this April. If we look at my own country the UK then the new headline inflation measure called CPIH ( where H includes an Imputed Rent effort at housing costs) then inflation has risen from 0.2% in October 2015 to 2.3% in March. So we see that the US Federal Reserve and the Bank of England have inflation above target and the ECB on it which means two things. Firstly those who went on and on about deflation a couple of years ago were about as accurate as central banking Forward Guidance . Secondly that we can expect inflation in the use of the words “temporary” and “transitory”!

Crude Oil

There has been a change in trend here indicated this morning by this from @LiveSquawk.

Saudi OPEC Governor: Based On Today’s Data, There Is Growing Conviction That 6-Month Extension May Be Needed To Re-balance The Market

You may recall that what used to be the world’s most powerful cartel the Organisation of Petroleum Exporting Countries or OPEC met last November to agree some output cuts. These achieved their objective for a time as the price of crude oil rose however this was undermined by a couple of factors. The first was that it was liable to be a victim of its own success as a higher oil price was always likely to encourage the shale oil wildcatters especially in the United States to increase production. This would not only dampen the price increase but also reduce the relative importance of OPEC. As you can see below that has happened.

U.S. crude production rose to 9.29 million barrels last week, the highest level since August 2015, according to the Energy Information Administration. (Bloomberg).

Also doubts rose as to whether OPEC was delivering the output cuts that it promised. For example they seem to be exporting more than implied by their proclaimed cuts. From the Financial Times.

Analysts at Energy Aspects say tanker tracking data suggests Opec’s exports have fallen by as little as 800,000 b/d so far in 2017 as some members have supplanted oil lost to production cutbacks with crude from storage, or have freed up barrels for export as they carry out maintenance at domestic refineries.

On the other side of the coin there is the fact that for a given level of output we need less oil these days and an example of this comes from the Financial Post in Canada today.

Canada substantially boosted its renewable electricity capacity over the past decade, and has now emerged as the second largest producer of hydroelectricty in the world, a new report said Wednesday.

So the trajectory for oil demand looks lower making the “balance” OPEC is looking for harder to achieve.

Other commodities

We get a guide to this if we look to a land down under as the Reserve Bank of Australia has updated us in its monetary policy today.

Beyond the next couple of quarters, prices of bulk commodities are expected to decline………Consistent with previous forecasts, iron ore prices have already fallen significantly in the past few weeks.

The RBA also produces an index of commodity prices.

Preliminary estimates for April indicate that the index decreased by 3.5 per cent (on a monthly average basis) in SDR terms, after decreasing by 1.7 per cent in March (revised). A decline in the iron ore price more than offset an increase in the coking coal price. Both the rural and base metals subindices decreased slightly in the month. In Australian dollar terms, the index decreased by 2.0 per cent in April.

So the rally seems to be over and the index above was inflated by supply problems for coal which drove its price higher. As to Iron Ore the Melbourne Age updates us on what has been going on.

Spot Asian iron ore prices have performed worse than Chinese steel rebar futures in recent weeks, dropping 31 per cent from a peak of US$94.86 a tonne on February 21 to US$65.20 on Thursday.

If we switch to Dr. Copper then the rally seems to be over there too although so far the price drops have been relatively minor.

What about food prices?

The United Nations updated us yesterday on this.

The FAO Food Price Index* (FFPI) averaged 168.0 points in April 2017, down 3.1 points (1.8 percent) from March, but still 15.2 points (10 percent) higher than in April 2016. As in March, all commodity indices used in the calculation of the FFPI subsided in April, with the exception of meat values.

As ever there are different swings here and of course the swings remind us of the film Trading Places. There was a time that these looked like the most rigged markets but of course there is so much more competition for such a title these days including from those who are supposed to provide fair markets ( central banks ).

Comment

There is a fair bit to consider here as we look forwards. There is always a danger in using financial markets too precisely as of course sharp falls like we have seen this week are often followed by a rebound. But it does look as if the commodity price trajectory has shifted lower which is good for inflation trends which is likely to boost economic growth compared to otherwise. Of course there are losers as well as winners here as commodity producers lose and importers win. But overall we seem set to see a bit less inflation than previously predicted and over time a little more economic growth.

As to the impact of a falling crude oil price on inflation the UK calculates it like this and I would imagine that many nations are in a similar position.

A 1 pence change on average in the cost of a litre of motor fuel contributes approximately 0.02 percentage points to the 1-month change in the CPIH.

There are of course also indirect effects on inflation from lower energy prices as well as other direct effects such as on domestic fuel bills. For the UK itself I estimated that inflation would be around 1.5% higher due to the EU leave due to the lower level of the Pound £ and for that to weaken economic growth. So for us in particular any dip in worldwide inflation is welcome as of course is the rise in the UK Pound £ to US $1.29.

A (space) oddity

We are using electronic methods of payment far more something which I can vouch for. However according to the Bank of England we are also demanding more cash.

Despite speculation to the contrary, the number of banknotes in circulation is increasing. During 2016, growth in the value of Bank of England notes was 10%, double its average growth rate over the past decade.

Who is stocking up and why? Pink Floyd of course famously provided some advice.

Money, it’s a gas
Grab that cash with both hands and make a stash
New car, caviar, four star daydream,
Think I’ll buy me a football team

Share Radio

Sadly it comes to an end today and in truth it has been winding down in 2017. As someone who gave up his time to support it let me say that it is a shame and wish all those associated with it the best for the future.

 

What is happening to US auto-loans?

One of the features of expansionary monetary policy has been that it misses some areas and concentrates in others. It reminds me of the word disintermediation which described a similar problem when central banks were trying to restrict the money supply rather than expand it with policies like QE ( Quantitative Easing) ,as the concept was the same albeit in a different direction. I have noted in the past the issue with auto-loans or loans for cars in the United States and am going to look at that in more detail as the situation is showing signs of bubbling under as we worry about it bubbling over.

What is the background?

Last November the Liberty Street Economics blog of the US New York Fed told us this.

The rise in auto loans has been fueled by high levels of originations across the spectrum of creditworthiness, including subprime loans, which are disproportionately originated by auto finance companies.

There was something of a warning tucked in there which was reinforced by this.

Originations of auto loans have continued at a brisk pace over the past few years, with 2016 shaping up to be the strongest of any year in our data, which begin in 1999……..the $1.135 trillion of outstanding auto loans by credit score and lender type, and we see that 75 percent of the outstanding subprime loans were originated by finance companies.

So there are various concerns which are the size of the market and its rate of growth which are highlighted by the way the finance companies seem to have taken over the subprime sector.

The data suggest some notable deterioration in the performance of subprime auto loans. This translates into a large number of households, with roughly six million individuals at least ninety days late on their auto loan payments.

The feeds into the theme of us “forgetting” how we got into the credit crunch or to put it another way the finance sector returning to past behaviours.

Last month it confirmed the 2016 rise.

auto debt (up $93 billion, or 8.7 percent)

Also there were some numbers to cheer any central banker’s heart.

As of December 31, 2016, total household indebtedness was $12.58 trillion, a $226 billion (1.8%) increase from the third quarter of 2016. Overall household debt remains just 0.8% below its 2008Q3 peak of $12.68 trillion, but is now 12.8% above the 2013Q2 trough.

I note that auto-loans began their recent rise in 2013 in terms of number of loans.

Used car prices

These are of course the asset in this market as the loans are backed by the cars. We live in a world where Bank of England Governor Mark Carney calls such loans “secured” and UK radio has adverts for buy-to-let cars. But earlier this month the US National Automobile Dealers Association released this.

NADA Used Car Guide’s seasonally adjusted used vehicle price index fell for the eighth straight month, declining 3.8% from January to 110.1. The drop was by far the worst recorded for any month since November 2008 as the result of a recession-related 5.6% tumble. February’s index figure was also 8% below February 2016’s 119.4 result and marked the index’s lowest level since September 2010.

As you can see prices have been falling for a while and looking at the chart of prices the rate of fall rather resembles that of 2008/09 with a difference which is that we start with prices having been in the low 120s rather than ~108. Last week we saw a warning from one of the companies involved and let me switch to Ed Harrison who has been on this case for a while.

Yesterday, Ally Financial warned that profits would underperform expectations. Now, they did not say that profits would fall or that they were taking credit writedowns. Neverthless, the warning is an important marker and should be of grave concern…………So with Ally, what we are seeing is that these problems have created enough discounting to induce a profit warning at one of the major auto finance companies. Ally is really the former GMAC, the engine of a huge amount of profit for General Motors, as are all of the finance arms of the automakers in the US. So what happens at Ally will definitely pass through to GM and the other carmakers unless the impact is arrested quickly.

There are various issues here but let us start with a clear difference with the housing market where prices have risen and thus boosted the asset value of the lenders books whereas here prices were pushed higher but are now falling. Also if we look we see that in another development familiar from the past the loans were bigger than the car value. Here is an offer I looked up from a company called DCU on what they call second chance auto loans.

Borrow up to 120% of Price – Qualified borrowers can finance up to 120% of NADA retail book value or 120% of the purchase price – whichever is less,

According to the St.Louis Fed yesterday the loans are a lot cheaper than they were.

The interest rate on a 48-month loan from a commercial bank for a new automobile purchase dropped from close to 8 percent prior to the Great Recession to an average of 4.3 percent since the second quarter of 2014.8 Meanwhile, auto finance company rates for new car loans averaged around 5 percent during this same period.

Also it points out this.

Softened underwriting standards have raised concerns regarding the risk associated with the robust growth in auto debt………..lenders have stretched repayment terms and offered higher advance rates, resulting in greater loan-to-value ratios.

In terms of its own region it is seeing this.

Serious delinquency rates among subprime borrowers in Little Rock and Memphis have now markedly increased during two years of an economic expansion.

Asset Backed Securities (ABS)

Yes they are on the scene as we look to see what is happening in a market that Mario Draghi of the ECB is very keen on. Barrons looked into it yesterday.

While delinquencies, liquidation rates and loss severities are higher across subprime ABS deals regardless of the ABS shelf, it appears that certain issuers are seeing larger increases than others. This analysis invites a few questions. Are the capital structures of deeper subprime lenders built to handle larger losses? Which structures, if any, are more likely to take principal losses in their rated debt tranches?

Comment

There are quite a few factors to consider here. Let us start with household debt which will soon pass the pre credit crunch peak. That needs to be compared to GDP ( Gross Domestic Product) which was 12% higher in 2016 than the previous peak of 2007. Regular readers will be aware of my concerns about GDP but for now let us just note that it has grown.

If we move to auto-loans there are a lot of flashing yellow lights. The trend towards subprime lending and the lending going “in-house” for the car lenders only adds to the moral hazards at play. Securitisation of the loans send a chill down the spine and now we see falling used car prices. Even worse the Financial Times has this morning told us not to panic!

Don’t panic about auto loans just yet — tax season isn’t over, after all

This is based on the fact that this year tax refunds have been particularly slow and therefore may well have influenced the February drop but of course not the ones before it. Also there is no panic here but there is a list that is gaining a growing number of ticks on it and this has just popped up under auto loans on Twitter.

Learn How to Get Fast Approved AutoLoans with No Credit Check Requirement in Texas ( @CarLoanBadCred )

Also this.

Gone are the days when you had to wait for getting bad credit auto loans. There are many online auto financing companies who offer competitive interest rates on these loans. Internet is quickly becoming the best place to get a blank check car loans with bad credit history

https://ezautofinance.net/how_to_get_a_blank_check_auto_loan_even_with_bad_credit.html

What could go wrong?

 

 

2017 is seeing the return of the inflation monster

As we nearly reach the third month of 2017 we find ourselves observing a situation where an old friend is back although of course it is more accurate to describe it as an enemy. This is the return of consumer inflation which was dormant for a couple of years as it was pushed lower by falls particularly in the price of crude oil but also by other commodity prices. That windfall for western economies boosted real wages and led to gains in retail sales in the UK, Spain and Ireland in particular. Of course it was a bad period yet again for mainstream economists who listened to the chattering in the  Ivory Towers about “deflation” as they sung along to “the end of the world as we know it” by REM. Thus we found all sorts of downward spirals described for economies which ignored the fact that the oil price would eventually find a bottom and also the fact that it ignored the evidence from Japan which has seen 0% inflation for quite some time.

A quite different song was playing on here as I pointed out that in many places inflation had remained in the service-sector. Not many countries are as inflation prone as my own the UK but it rarely saw service-sector inflation dip below 2% but the Euro area for example had it at 1.2% a year ago in February 2016 when the headline was -0.2%, Looking into the detail there was confirmation of the energy price effect as it pulled the index down by 0.8%. Once the oil price stopped falling the whole picture changed and let us take a moment to mull how negative interest-rates and QE ( Quantitative Easing) bond buying influenced that? They simply did not. Now we were expecting the rise to come but quite what the ordinary person must think after all the deflation paranoia from the “deflation nutters” I do not know.

Spain

January saw quite a rise in consumer inflation in Spain if we look at the annual number and according to this morning’s release it carried on this month. Via Google Translate.

The leading indicator of the CPI puts its annual variation at 3.0% In February, the same as in January
The annual rate of the leading indicator of the HICP is 3.0%.

Just for clarity it is the HICP version which is the European standard which is called CPI in the UK. It can be like alphabetti spaghetti at times as the same letters get rearranged. We do not get a lot of detail but we have been told that the impact of the rise in electricity prices faded which means something else took its place in the annual rate. Also we got some hints as to what is coming over the horizon from last week’s producer price data.

The annual rate of the General Industrial Price Index (IPRI) for the month of January is 7.5%, more than four and a half points higher than in December and the highest since July 2011.

It would appear that the rises in energy prices affected businesses as much as they did domestic consumers.

Energy, whose annual variation stands at 26.6%, more than 18 points above that of December and the highest since July 2008. In this evolution, Prices of Production, transportation and distribution of electrical energy and Oil Refining,
Compared to the declines recorded in January 2016.

In fact the rise seen is mostly a result of rising commodity prices as we see below.

Behavior is a consequence of the rise in prices of Product Manufacturing Basic iron and steel and ferroalloys and the production of basic chemicals, Nitrogen compounds, fertilizers, plastics and synthetic rubber in primary forms.

The Euro will have had a small impact too as it is a little over 3% lower versus the US Dollar than it was a year ago.

Belgium

The land of beer and chocolate has also been seeing something of an inflationary episode.

Belgium’s inflation rate based on the European harmonised index of consumer prices was running at 3.1% in January compared to 2.2% in December.

The drivers were mostly rather familiar.

The sub-indices with the largest upward effect on inflation were domestic heating oil, motor fuels, electricity, telecommunication and tobacco.

These two are the inflation outliers at this stage but the chart below shows a more general trend in the major economies of the Euro area.

The United States

In the middle of this month the US Bureau of Labor Statistics confirmed the trend.

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.6 percent in January on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics
reported today. Over the last 12 months, the all items index rose 2.5 percent before seasonal adjustment.

This poses some questions of its own in the way that it confirmed that the strong US Dollar had not in fact protected the US economy from inflation all that much. The detail was as you might expect.

The January increase was the largest seasonally adjusted all items increase since February 2013. A sharp rise in the gasoline index accounted for nearly half the increase,

Egypt

A currency plummet of the sort seen by the Egyptian Pound has led to this being reported by Arab News.

Inflation reached almost 30 percent in January, up 5 percent over the previous month, driven by the floatation of the Egyptian pound and slashing of fuel subsidies enacted by President Abdel-Fattah El-Sisi in November.

Ouch although of course central bankers will say “move along now……nothing to see here” after observing that the major drivers are what they call non-core.

Food and drinks have seen some of the largest increases, costing nearly 40 percent more since the floatation, figures from the statistics agency show. Some meat prices have leaped nearly 50 percent.

Comment

There is much to consider here and inflation is indeed back in the style of Arnold Schwarzenegger. However some care is needed as it will be driven at first by the oil price and the annual effect of that will fade as 2017 progresses. What I mean by that is that if we look back to 2016 the price of Brent Crude oil fell below US $30 per barrel in mid-January and then rose so if the oil price remains around here then its inflationary impact will fade.

However even a burst of moderate inflation will pose problems as we look at real wages and real returns for savers. If we look at the Euro area with its -0.4% official ECB deposit rate and wide range of negative bond yields there is an obvious crunch coming. It poses a particular problem for those rushing to buy the German 2 year bond as with a yield of 0.94% then they are facing a real loss of around 5/6% if it is held to maturity. You must be pretty desperate and/or afraid to do that don’t you think?

Meanwhile so far Japan seems immune to this, of course there will eventually be an impact but it is a reminder of how different it really is from us.

UK National Statistician John Pullinger

Thank you to John and to the Royal Statistical Society for his speech on Friday on the planned changes to UK inflation measurement next month. Sadly it looks as if he intends to continue with the use of alternative facts in inflation measurement by the use of rents to measure owner-occupied housing costs. These rents have to be imputed because they do not actually  exist as opposed to house prices and mortgage costs which not only exist in the real world but are also widely understood.