What are the consequences of bond yields rising further?

This week has brought an unusual development for the credit crunch era. Let me illustrate with an example of the reverse and indeed what we have come to regard as the new normal from last week.

AMSTERDAM, Nov 5 (Reuters) – Italy’s five-year bond yield turned negative for the first time on Thursday as uncertainty from the U.S. election supported government bonds in Europe.

Prima facie that seems insane but of course as I will explain later it is more complicated than that. That is for best when we add in this from Marketwatch on Monday.

Investors now pay Greece for the privilege of owning its debt, an incredible turnaround from its securities being the source of global financial instability a decade ago.

Greece’s three-year debt turned negative on Friday, and then the country received more good news after the surprise decision by Moody’s Investors Service on Friday night to upgrade the nation’s debt. The upgrade, from Ba3 from B1 previously, still leaves Greek debt in junk market territory, and three notches away from becoming investment grade.

The yield on Greek 10-year debt TMBMKGR-10Y, 0.834% fell 4 basis points to 0.77%. In 2012, the yield on Greek 10-year debt surpassed 35%.

Amazing in its own way and well done to investors who got their timing right in these markets. Although a large Grazie is due to Mario Draghi who set things in motion.

US Treasury Bonds

However there has been something of a contrary signal from the US bond market. There was a hint of something going on in what is called the Long Bond which is the thirty-year maturity. Some of you may recall at the height of the pandemic panic in financial markets in March the yield here dipped below 1%. This was driven by two factors.The first was a move to a perceived safe haven in times of trouble and US Treasury Bonds are AAA rated as well as being in the world’s reserve currency. Also there would have been some front-running of the expected bond buying or QE from the US Federal Reserve. It did indeed charge in like the US Cavalry with purchases at the peak of US $75 billion per day.

But around 2 weeks ago the mood music was rather different as the debate was then about whether the yield would break above the 1.6% level that market traders felt was significant. As the election results began to come in it did so and now we find it at 1.75%.

If we switch to the benchmark ten-year ( called the Treasury Note) we see a slightly delayed pattern but also a move higher. In fact it gave us a head fake as the initial response to the election was a rally leading to lower yields and we noted it at 0.72%. But there were ch-ch-changes on the way and now we see it is 0.96%. So perhaps on the cusp of what is called a big figure change should it make 1%.

Why does this matter?

The first reason is for the US economy itself and there is a direct line in from mortgage rates.

Over the course of the past few days, 10yr yields are up roughly 0.2%.  This time around, the mortgage market hasn’t been able to avoid taking its lumps with the average lender now quoting 30yr fixed rates that are 0.125% higher compared to last Thursday.    ( Mortgage Daily News)

The housing market has been juiced by ever lower and indeed record low mortgage rates up until now. The change will feed into other personal and corporate borrowing as well.

Next comes its role as the world’s biggest bond market with some US $21.1 billion and of course rising at play here. I will come back to the domestic issues but there is a worldwide role here.For example back in my days in the UK Gilt ( bond) market the beginning of the day was checking what the US market had done overnight before pricing in any UK changes. That theme will be in play around the world and in fact on spite of the Italian and Greek moves above we have seen it.

For the US there is the domestic issue of debt costs. These have been a pack of dogs that have not barked but with the increases in the size of the bond market and hence higher levels of borrowing and refinancing smaller moves now matter. We know that President Elect Biden wants to spend more and looked at this on the 5th of this month although there remains doubt over how much of it he will be able to get through what looks likely to be a Republican controlled Senate. Even before this here are the projections of the Congressional Budget Office.

Debt. As a result of those deficits, federal debt held by the public is projected to rise sharply, to 98 percent of GDP in 2020, compared with 79 percent at the end of 2019 and 35 percent in 2007, before the start of the previous recession. It would exceed 100 percent in 2021 and increase to 107 percent in 2023, the highest in the nation’s history.

Best I think to take that as a broad sweep as there are a lot of moving parts in the equations used.

Yield Curve Control

This is, as you can see, not going so well! We have looked at the Japanese experience as recently as Monday and in the US it would be a case of recycling a wartime policy.

In early 1942, shortly after the United States declared war, the Fed effectively abdicated its responsibility for monetary policy despite its concern about inflation and focused instead on helping the Treasury finance the conflict. After a series of negotiations with the Treasury, the Fed agreed to peg the Treasury-bill yield at 0.375 percent, to cap the critical long-term government bond yield at 2.5 percent, and to limit all other government securities’ yields in a consistent manner.  ( Cleveland Fed)

The Long Bond yield is still quite some distance from the 2.5% of back then but as I have already explained the situation is I think more exposed now.

Oh and there was a concerning consequence to this.

The Treasury, however, did not wish to relinquish its control over Fed monetary policy and only acquiesced to small increases in short-term interest rates starting in July 1947, after inflation had been hovering around 18 percent for a year. The Treasury believed that it could not possibly finance its unprecedented levels of public debt at reasonable interest rates without the Fed’s continued participation in the government-securities market; in its view, only unrealistically high interest rates could coax enough private-sector savings to finance the debt.

Comment

Let me now switch to what we might expect if we had free markets. The extra borrowing we have looked at would be pushing yields higher. Another influence would be the fact the real ( after inflation) bond yields are heavily negative unless you think US inflation will be less than 1% per year for the next ten years. Even then it is not much of a return, especially compared to the 5% in one day some equity markets have just provided. The reality is that bond markets provide the prospect of capital gains rather than interest right now.

Also the modern era provides something very different from free markets as the US Federal Reserve will be thinking at what point will it intervene? Or to be more precise at what point will it do so on a larger scale as it is already buying some US $80 billion per month of US treasury bonds. It was not so long ago that such amounts were considered to be a lot. The path to Yield Curve Control may be via bond yield rises now followed by its response. So the real question is what level will they think is too much? This quickly becomes an estimate of what they think the US government can afford? As they have become an agent of fiscal policy again.

 

What are the economic policies of Joe Biden?

We find ourselves in unusual but not completely unfamiliar territory as the US election has yet to declare a result.As we stand Joe Biden looks most likely to win although any such win seems set to go straight to the courts. But we need to address what changes he plans for US economic policy? The first step according to Moodys will be more fiscal expansionism.

Vice President Biden has proposed a wide
range of changes to the tax code and government spending. In total, he is calling for $4.1
trillion in tax increases and an additional $7.3
trillion in government spending over the next
decade.

Moodys have taken the current zeitgeist in favour of fiscal policy and projected this impact from it.

The government’s deficits will be
$3.2 trillion larger on a static basis and $2.6
trillion on a dynamic basis, after accounting
for the benefits to the budget of the stronger
economy resulting from his policies.

Of course the “stronger economy” mentioned is an opinion and we have seen in my time here quite a shift in the establishment view on fiscal policy. A decade ago the views was that a contractionary fiscal policy could expand the economy whereas now we are told an expansionary one will. There has been a shift in the cost of borrowing which I will look at in more detail later, but even so there has been more than a little flip-flopping.

Detailed Proposals

Interestingly the fiscal expansionism comes with tax increases for some.

The largest source of new tax revenue in
the vice president’s plan comes from increasing taxes on corporations. Of the $4.1 trillion
in total tax revenue collected under his plan
over the next decade on a static basis, more
than half comes from higher corporate taxes.
The bulk of this results from an increase from
21% to 28% in the top marginal tax rate paid
by corporations.

So he is reversing half of the Trump tax cuts in this area. Next comes a tax on higher earners.

Another large source of new tax revenue in
Biden’s plan is the 12.6% Social Security payroll tax on annual earnings of more than $400,000.
The current earnings cap subject to the payroll tax is almost $138,000………..This change will put
the Social Security trust fund on much sounder
financial footing, and it will raise close to $1
trillion in revenue over the next decade on a
static basis, about one-third of the total tax
revenue raised under Biden’s plan

The theme is of taxing the rich and wealthy and which continues with what might in the past have been called a soak the rich plan.

The vice president would roll back
the tax cuts that those earning more than
$400,000 received under Trump’s TCJA, tax
capital gains and dividend income like ordinary
income for those making more than $1 million
in total income.

Spending

Here we are looking at a Spend! Spend! Spend! plan where the extra revenue above is spent and then some.

His proposal calls for additional spending of $7.9 trillion on a static basis, including on infrastructure, education, the social safety net, and healthcare, with the bulk of the
spending slated to happen during his term as
president in an effort to generate more jobs

Those who bemoan America’s infrastructure should welcome this effort.

Of all of Biden’s spending initiatives, the
most expansive is on infrastructure. On a
static basis, he would increase such spending
by $2.4 trillion for the decade—all of it to
be spent during his term.

Education too will be a beneficiary.

Biden is also calling for a large increase in
an array of educational initiatives. He proposes
to spend $1.9 trillion over 10 years on a static
basis on pre-K, K-12 and higher education (see
Table 3). Attending a public college or university would be tuition-free for children in families with incomes of less than $125,000.

I find the end to tuition fees for some to be intriguing as it is a reversal of the past direction of travel. Also there is this.

The social safety net would meaningfully
expand under Biden (see Table 4). He would
spend an additional $1.5 trillion over 10 years
on a static basis on various social programs,
with the largest outlays going to workers to
receive paid family and medical leave for up
to 12 weeks…….

And healthcare.

The healthcare system would also receive
a significant infusion of funding under a
President Biden primarily via the Affordable
Care Act…….. The 10-year static budget cost of the
proposed changes to the healthcare system
comes to nearly $1.5 trillion.

US Federal Reserve

There are a couple of streams of thought here. The first is that Federal Reserve Chair Jerome Powell has called for more fiscal expansionism.

Federal Reserve Chairman Jerome Powell called Tuesday for continued aggressive fiscal and monetary stimulus for an economic recovery that he said still has “a long way to go.”

Noting progress made in job creation, goods consumption and business formation, among other areas, Powell said that now would be the wrong time for policymakers to take their foot off the gas. ( CNBC on the 6th of October)

Thus he would presumably be happy to run policies to help this. He is already in the game.

At its September meeting, the FOMC directed the Desk to increase SOMA holdings of Treasury securities at the current pace, which is the equivalent of approximately $80 billion per month.

Also he has the ability to respond should he wish without a grand announcement as these days smoothing market operations cover quite a few bases.

The Desk is prepared to increase the size and adjust the composition of its purchase operations as needed to sustain the smooth functioning of the Treasury market.

We can now take that forwards to the next perspective because the market seems to have come to its own conclusion.In the past the bond vigilantes would have driven US bond yields higher but in fact the US bond market has risen and yields fallen.I established a marker on the day of the election and the ten-year Treasury Note yield was 0.87% but as I type this it is 0.73%

Comment

The caveat to today’s post is that is by no means certain that Joe Biden will win and even if he does he seems likely to face a Republican Senate. But we do seem set for a more expansionary fiscal policy which would be oiled and polished by the US Federal Reserve.That does link to the news from the Bank of England earlier when it announced an expansion of £150 billion in its purchases of UK bonds as it too is an agent of fiscal policy these days.

Looking at the economic impact we see from Moodys that the multiplier is back.What I mean by that is fiscal spending is assumed to grow the economy which then helps to pay for it. The catch is always when you do not seem much growth ( think Italy) or if the economy contracts over a long period ( think Greece). We do know that the US economy can grow and that it has been doing better than us in Europe in the credit crunch era but whether it will grow by enough is another matter. With the rise in the Covid-19 cases though it may be a while before it gets the chance to demonstrate that and for such calculations when and how long matter.

 

Central banks are increasingly entering the world of politics

Yesterday brought a barrage of central banking news. So let us start with something rather remarkable from the head of the world’s number one which is the US Federal Reserve. The crucial part of the speech given by Jerome Powell to the National Association for Business Economists is below.

The expansion is still far from complete. At this early stage, I would argue that the risks of policy intervention are still asymmetric. Too little support would lead to a weak recovery, creating unnecessary hardship for households and businesses. Over time, household insolvencies and business bankruptcies would rise, harming the productive capacity of the economy, and holding back wage growth. By contrast, the risks of overdoing it seem, for now, to be smaller. Even if policy actions ultimately prove to be greater than needed, they will not go to waste. The recovery will be stronger and move faster if monetary policy and fiscal policy continue to work side by side to provide support to the economy until it is clearly out of the woods.

Some of the economics is really rather dubious. But the main driver is that he is interfering in a political decision which is fiscal policy in the middle of an election campaign. It used to be considered the the Federal Reserve would go into a type of purdah during an election campaign but apparently not now. In the past that would usually mean a period where interest-rates would not be changed.The situation is somewhat different now as interest-rates have already been reduced so close to 0% so the weapon of choice would be more QE bond buying but the principle is the same.

The Economics

The claim that the risk of overdoing policy actions is small is familiar territory for central bankers. But this is really rather extraordinary.

Even if policy actions ultimately prove to be greater than needed, they will not go to waste.

Such a situation would be likely to be one exhibiting inflation. The inflation would be most likely to be in house and other asset prices but none the less would be there, albeit it would be ignored by the main consumer inflation measures.

Also if we look at the opening speech we see some familiar cheerleading for policy.

As the coronavirus spread across the globe, the U.S. economy was in its 128th month of expansion—the longest in our recorded history—and was generally in a strong position.

So strong in fact that “Moderate growth” is considered to be “slightly above-trend”

We travel a similar journey if we look at his view of the recovery which is quite a success.

After rising to 14.7 percent in April, the unemployment rate is back to 7.9 percent, clearly a significant and rapid rebound.

But then there is quite a bit of slip-sliding away.

A broader measure that better captures current labor market conditions—by adjusting for mistaken characterizations of job status, and for the decline in labor force participation since February—is running around 11 percent.

I have pointed out more than a few times how and why the international definition of unemployment has failed us in this pandemic. So it is more than disappointing to see a central banker who should know better using it. In a familiar theme that is the behaviour of a politician.

Meanwhile if we switch to actual politicians the fiscal stimulus call had a bit of trouble with The Donald.

Nancy Pelosi is asking for $2.4 Trillion Dollars to bailout poorly run, high crime, Democrat States, money that is in no way related to COVID-19. We made a very generous offer of $1.6 Trillion Dollars and, as usual, she is not negotiating in good faith. I am rejecting their request, and looking to the future of our Country.

Top of the Class

The ECB decided to issue a career enhancing discussion paper yesterday.

Despite this renewed debate, traditional indices of central bank independence do not suggest a deterioration in central banks’ de jure independence after the GFC. ( GFC = Global Financial Crisis)

Lewis Carroll would be proud. Although there is a brief flash of insight.

The benefits of central bank independence are currently not obvious for many citizens,

Really?! However we return to a place “far,far,away” in the section on the ECB itself.

There have been no visible changes in either the de jure or actual independence of the ECB. The legal frameworks protecting the ECB’s independence have been tested,
and have served to establish its independence more firmly.

Meanwhile back on the ranch the ECB has a President who is a politician and former French Finance Minister and a Vice-President who is the former Economy Minister of Spain. So independence from political control has been established by er, putting politicians in charge! It does at least explain this bit.

Comments by euro area governments on the ECB’s policy decisions are unusual.

Why would then when it is doing their bidding? After all if monetary policy was more overtly under the control of politicians how much more could they have done?

If we switch to the Bank of Russia we get a laugh out loud section. We are assured this.

Central bank independence seems to be observed in Russia, although it was not tested in a controversy with the government in the analysed period.

The idea of independence under Vladimir Putin seems not far off insane which somewhat bizarrely they then confess.

In January 2015, the head of monetary policy was reportedly replaced by a person more acceptable to
bankers, who had called for lower interest rates.

Seems to be a similar model to Roman Abramovich at Chelsea football club albeit no manager there survives for that long.

Interest-Rate Cuts

Just when you though that this game might be over there is an early premonition of Halloween. From the Wall Street Journal.

European Central Bank President Christine Lagarde said the bank is ready to inject fresh monetary stimulus to support the eurozone’s stuttering economic recovery from the Covid-19 pandemic, including by cutting a key interest rate further below zero.

Just as a reminder the Deposit Rate and the Current Account Rate are already -0.5%. Last time this came up for discussion ( about a year ago) it was about a move to -0.6%. Does anybody believe a 0.1% move would make any difference right now?

Insane in the membrane
Insane in the brain!
Insane in the membrane
Insane in the brain! ( Cypress Hill )

There are three issues with this. The first is simply that the evidence is that this does not work as otherwise why so we need ever more doses of it? This leads her to an official denial and we know what to do with them.

ECB hasn’t yet reached the point where a fresh interest-rate cut would do more harm than good, known to economists as the reversal rate. ( WSJ)

Next comes the international impact as another interest-rate cut would affect countries which explicitly ( Denmark) and implicitly (Switzerland) set their interest-rates against the Euro exchange-rate. Thirdly we are pretty much back to trying to devalue the Euro which relates to the point before.

Comment

The problem here is that central banks have found themselves behaving like politicians.The move towards independence did not last long as the various establishments shifted towards appointing people who were and are “one of us”. That is most explicit at the ECB where an actual politician in Christine Lagarde is President. In the United States we have seen a different tack where Jerome Powell was seemingly pressurised by President Trump to do his bidding and cut interest-rates. Neither looks especially independent. As to fiscal policy in the US President Trump may already be switching his tune.

If I am sent a Stand Alone Bill for Stimulus Checks ($1,200), they will go out to our great people IMMEDIATELY. I am ready to sign right now. Are you listening Nancy?

That is the problem with playing politics as it can change daily and indeed hourly but the economy cannot.

Rather ironically a day which started with Jerome Powell calling for more like Oliver Twist and the President saying what? just like The Master in the story had another turn. Until then US bond yields were rising ( 30 year at 1.6%) meaning that we might actually see some of the promised Yield Curve Control. But the Trump Tweet ended that at least for now.

Wages growth looks an increasing problem

Today gives us an opportunity to take a look at an issue which has dogged the credit crunch era. It is the (lack of) growth in wages and in particular real wages which has meant that even before the Covid-19 pandemic they had not regained the previous peak. That is one of the definitions of an economic depression which may well be taking a further turn for the worse. It has been a feature also of the lost decade(s) in Japan so we have another Turning Japanese flavour to this.

Japan

The Ministry of Labor released the July data earlier and here is how NHK News reported it.

New figures from the Japanese government show that both wages and household spending fell in July from a year earlier amid a resurgence in the coronavirus pandemic.

Labor ministry data show that average total wages were down 1.3 percent in yen terms from a year ago, to 3,480 dollars. It was the fourth straight monthly drop.

Overtime and other non-regular pay dropped nearly 17 percent, as workers put in shorter hours.

A ministry official says that despite some improvements, the situation remains serious because of the pandemic.

I find it curious that NHK switches from Yen to US Dollars but I suppose it has not been that volatile in broad terns in recent times. That is awkward for the Abenomics policy of Prime Minister Abe which of course may be on the way out. It was supposed to produce a falling Yen. Also it was supposed to produce higher wages which as you can see are falling.

The issue here is summarised by Japan Macro Advisers.

Wages in Japan have been decreasing relatively steadily since 1998. Between 1997-2019, wages have declined by 10.9%, or by 0.5% per year on average (based on the data before the revision).

The Abenomics push was another disappointment as summarised by this from The Japan Times in May 2019.

Japan’s labor market has achieved full employment over the past two years. Unemployment has declined over the past two years to below 3 percent—close to the levels of the 1980s and early 1990s—after peaking at 5.4 percent in 2012…………..The puzzling thing is why wage growth has been so sluggish despite the apparent labor shortage. It is true that average wages turned positive in 2014 and increased 1.4 percent in 2018. Nonetheless, regular pay, or permanent income, rose a paltry 0.8 percent in 2018. In real terms, average wage growth has failed to take off and recorded just 0.2 percent in 2018.

That is in fact a rather optimistic view of it all because if we switch to real wages we see that the index set at 100 in 2015 was 99.9 last year. So rather than the triumph which many financial news services have regularly anticipated it has turned out to be something of a road to nowhere. Any believers in “output gap” theories have to ignore the real world one more time.

The Japanese owned Financial Times has put its own spin on it.

“Buy my Abenomics!” urged Japanese prime minister Shinzo Abe in 2013. And we did.

No we did not. Anyway their story of triumph which unsurprisingly has quite a list of failures also notes this about wages.

Nor was this the only way Abenomics undermined its own credibility. For example, the government never raised public sector wages in line with the 2 per cent inflation target. Why, then, should the private sector have heeded Mr Abe’s demand for wage increases?

If only places like the FT had reported that along the way. But the real issue here for our purposes is that even in what were supposed to be good times real wages went nowhere. So now we are in much rougher times we see a year where they fall and we note that this adds to a fall last year. Indeed partly by fluke the fall for July is very similar to last year, but we look ahead nervously because if wages had already turned down we seem set for falls again.

Detail

In terms of numbers average pay was 369.551 Yen in July and a fair bit or 106.608 Yen is bonuses ( special cash earnings). The highest paid is the professional and technical one at 542,571 and the lowest is hotels and restaurants at 124,707 Yen. Sadly for the latter not only do they get relatively little it is also falling ( 7.3%)

Somewhat chilling is that not only is the real estare sector well paid at 481.373 Yen it is up 12.3% driven by bonuses some 30% higher. So maybe they are turning British. Also any improvement in the numbers relies on real estate bonuses.

The UK

The latest real wage numbers pose a question.

For June 2020, average regular pay, before tax and other deductions, for employees in Great Britain was estimated at £504 per week in nominal terms. The figure in real terms (constant 2015 prices) fell to £465 per week in June, after reaching £473 per week in December 2019, with pay in real terms back at the same level as it was in December 2018.

The real pay number started this century at £403 per week but the pattern is revealing as we made £473 per week on occasion in 2007 and 2008. So we were doing well and that ended.

Actually if we switch from the Office for National Statistics presentation we have lost ground since 2008. This is because the have flattered the numbers in two respects. One if the choice of regular pay rather than total pay and the other is the choice of the imputed rent driven CPIH inflation measure that is so widely ignored.

The US

There was something of a curiosity here on Friday.

In August, average hourly earnings for all employees on private nonfarm payrolls rose by 11
cents to $29.47. Average hourly earnings of private-sector production and nonsupervisory
employees increased by 18 cents to $24.81, following a decrease of 10 cents in the prior month.

If you do not believe tat then you are in good company as neither does the Bureau of Labor Statistics.

The large employment fluctuations over the past several months–especially in industries with
lower-paid workers–complicate the analysis of recent trends in average hourly earnings.

If we look back this from the World Economic Forum speaks for itself.

today’s wages in the United States are at a historically high level with average hourly earnings in March 2019 amounting to $23.24 in 2019 dollars. Coincidentally that matches the longtime peak of March 1974, when hourly wages adjusted to 2019 dollars amounted to exactly the same sum.

Comment

There has been an issue with real wages for a while as the US, UK and Japanese data illustrate.The US data aims right at the end of the Gold Standard and Bretton Woods doesn’t it? That begs more than a few questions. But with economies lurching lower as we see Japanese GDP growth being confirmed at around 8% in the second quarter and the Euro area at around 12%. Also forecasts of pick-ups are colliding with new Covid-19 issues such as travel bans and quarantines. So real wages look set to decline again.

The next issue is how we measure this? The numbers have been shown to be flawed as they do not provide context. What I mean by this is that we need numbers for if you stay in the same job and ones for those switching. If we look at the US we see recorded wage growth because those already having the disadvantage of lower wages not have none at all as they have lost their job. That is worse and not better. This opens out a wider issue where switches to lower paid jobs and lower real wages are like a double-edged sword. People have a job giving us pre pandemic low unemployment rates and high employment rates. But I would want a breakdown as many have done well but new entrants have not.

There has been a contrary move which has not been well measured which are services in the modern era which get heavy use but do not get counted in this because they are free. Some money may get picked up by advertising spend but to add to the problem we have we are also guilty of measuring it badly

Meet the new Inflation era same as the old inflation era….

Yesterday brought news about inflation targeting but before we get to what you might think is the headline act, it has been trumped by Prime Minister Abe of Japan. Before I get to that let me wish him well with his health issues. But he also said this in his resignation speech.

JAPAN PM ABE ON ECONOMIC POLICY: WE HAVE SUCCEEDED IN BOOSTING JOBS, ENDING 20 YEARS OF DEFLATION WITH THREE ARROWS OF ABENOMICS. ( @FinancialJuice)

You might think that this is almost at a comical Ali level of denial at this point. For those unaware this was the Iraqi information minister who denied Amercan soldiers were in Baghdad when well I think you have figured the rest. Even the BBC is providing an opposite view to that of Abe san.

The Japanese economy has shrunk at its fastest rate on record as it battles the coronavirus pandemic.

The world’s third largest economy saw gross domestic product fall 7.8% in April-June from the previous quarter, or 27.8% on an annualised basis.

Japan was already struggling with low economic growth before the crisis.

The current situation is bad enough but even if we give him a pass on that there is that rather damning last sentence. Let me give you some context on that. You could argue the 0.6% contraction in the Japanese economy was also Covid related but you cannot argue that the 1.8% contraction at the end of last year was. Indeed the quarter before that was 0%.

So Japan had not escaped deflation and in fact the problems at the end of last year were created by an Abenomics arrow missing the target. People forget now but the economic growth that Abenomics was supposedly going to create was badged as a cure for the chronic fiscal problem faced by Japan. In fact the lack of growth and hence revenue was a factor in the Consumption Tax being raised to 10%. Which of course gave growth another knock.

Inflation

Another arrow was supposed to lead to inflation magically rising to 2% per annum. How is that going? From the Statistics Bureau this morning.

 The consumer price index for Ku-area of Tokyo in August 2020 (preliminary) was 102.1 (2015=100), up 0.3% over the year before seasonal adjustment, and down 0.4% from the previous month on a seasonally adjusted basis.

So it has taken five years and not one to hit 2%. For newer readers that was also the pre pandemic picture in Japan and it has mostly been possible to argue that there is effectively no inflation because the low levels are within any margin for error.

Also as a point of detail there is even more bad news for inflationistas which is that something which they clain cannot happen with zero inflation has. If you look in the detail food prices have risen by 7% and the cost of education has fallen by 7%, so you can have relative price changes. Looking at the national numbers it has been a rough run for fans of Salmon and carrots as prices have risen by more than 50% over the past 5 years.

The US Federal Reserve

The speech by Chair Powell opened with what may turn out to be an unfortunate historical reference.

Forty years ago, the biggest problem our economy faced was high and rising inflation. The Great Inflation demanded a clear focus on restoring the credibility of the FOMC’s commitment to price stability.

It is hard to know where to start with this bit.

Many find it counterintuitive that the Fed would want to push up inflation. After all, low and stable inflation is essential for a well-functioning economy. And we are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes.

I will simply point out that I am pleased to see a recognition that what are usually described by central bankers as “non-core” such as food and energy are suddenly essential. Perhaps the threats ( from The Donald) about him losing his job have focused his mind, although he would remain an extremely wealthy man.

He then got himself into quite a mess.

 Our statement emphasizes that our actions to achieve both sides of our dual mandate will be most effective if longer-term inflation expectations remain well anchored at 2 percent. However, if inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent. Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down.

This really does come from the highest of Ivory Towers where the air is thinnest. Many households and businesses will not even know who he and his colleagues are! Let alone plan ahead on the basis of what they might do especially after the flip-flopping of the last couple of years. Even worse the 2% per annum target which was pretty much pulled out of thin air has become a Holy Grail.

This next bit was frankly not a little embarrassing.

In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting.

So it is an average but without the average bit?

Canada

This week the Bank of Canada inadvertently highlighted a major problem. It starts with this.

Deputy Governor Lawrence Schembri discusses the difference between how Canadians perceive inflation and the actual measured rate.

You see we are back to you ( and I mean us by this) do not know what you are paying and we ( central bankers know better). Except it all went wrong in a predictable area.

Over the last two decades, the price of houses has risen on average more than twice as fast as the price of housing, at a rate of 6 percent versus 2.5 percent.

There is the issue in a nutshell. Your average Canadian has to shell out an extra 6% each year for a house but according to Lawrence and his calculations it is only 2.5%. Someone should give him a pot of money based on his calculations and tell him to go and buy one.

The Euro area

We looked at variations in the price of Nutella recently well according to The Economist there are other issues.

 Three enormous boxes of Pampers come to €168 ($198) on Amazon’s Spanish website. By contrast, the same order from Amazon’s British website costs only €74. (Even after an exorbitant delivery fee is added, the saving is still €42.)

This happens even inside the Euro area.

The swankiest Nespresso model will set them back €460 on Amazon’s French website, but can be snapped up for €301 on the German version. They could then boast about their canny shopping on Samsung’s newest phone, which varies in price by up to €300 depending on which domain is used.

I point this out because official inflation measurement relies on “substitution” where if the price rises you switch to something similar which is cheaper. But if people do not do this for the same thing inn the real world we are back in our Ivory Towers again.

Comment

Firstly we can award ourselves a small slap on the back as we were expecting this. From the movements in the Gold price ( down) and bond yields (up) far from everybody was. If we note the latter there are two serious problems for Chair Powell. The first is that if there is a body of people on this earth who follow his every word it is bond traders and they were to some extent off the pace. Thus all exposition about expectations above is exposed as this.

Every man has a place, in his heart there’s a space,
And the world can’t erase his fantasies
Take a ride in the sky, on our ship fantasii
All your dreams will come true, right away ( Earth,Wind & Fire )

Next is that if you take the policy at face value bond yields should have risen by far more than the 0.1% the long bond did. They did not rise by the 0.5% to 1% you might expect for two possible reasons.

  1. Nobody expected the Fed to raise interest-rates for years anyway so what is the difference?
  2. If there is a policy change it is mostly likely to be more QE treasury bond purchases which will depress bond yields.

So back to the expectations we see that the Fed is responding to expectations it has created. What could go wrong? Putting it another way it is living a combination of Goodhart’s Law and the Lucas Critique.

I brought in the Japanese experience because it has made an extraordinary effort in monetary policy terms but the economy was shrinking before Covid-19 and there was essentially no inflation.

However the stock market ( Nikkei 225) has nearly trebled since Abenomics was seen as likely. Oh and the Bank of Japan has essentially financed the government borrowing.

Podcast

 

Is the US economy slowing again?

Yesterday brought news that upset something of a sacred cow of these times. And no I do not mean the fact that Lionel Messi not only still has in his possession but actually uses a fax machine. That perhaps trumps even his transfer request. Across the Atlantic came news which challenged the growing consensus about economies soaring up, up and away after the Covid-19 pandemic. So let me hand you over to the Conference Board.

The Conference Board Consumer Confidence Index® decreased in August, after declining in July. The Index now stands at 84.8 (1985=100), down from 91.7 in July. The Present Situation Index – based on consumers’ assessment of current business and labor market conditions – decreased sharply from 95.9 to 84.2. The Expectations Index – based on consumers’ short-term outlook for income, business, and labor market conditions – declined from 88.9 in July to 85.2 this month.

As the consumer is a large part of the US economy a further decline in August poses a question for the recovery we are being promised. Indeed those promising such a recovery forecast it would be 93 so they seem to be inhabiting a different universe. They managed to miss consumers reporting that things had got substantially worse in August. The expectations index decline was more minor but it is on the back of a much lower current reading.

The accompanying explanation put some more meat on the bones.

“Consumer Confidence declined in August for the second consecutive month,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “The Present Situation Index decreased sharply, with consumers stating that both business and employment conditions had deteriorated over the past month. Consumers’ optimism about the short-term outlook, and their financial prospects, also declined and continues on a downward path. Consumer spending has rebounded in recent months but increasing concerns amongst consumers about the economic outlook and their financial well-being will likely cause spending to cool in the months ahead.”

That made me look into the detail for the jobs market which confirmed why consumers think that things have got worse.

Consumers’ appraisal of the job market was also less favorable. The percentage of consumers saying jobs are “plentiful” declined from 22.3 percent to 21.5 percent, while those claiming jobs are “hard to get” increased from 20.1 percent to 25.2 percent.

The change in the “plentiful” number is within the margin of error but the “hard to get” shift is noticeable. There was a similar shift in business conditions where there was what seems a significant increase in the “bad” category.

The percentage of consumers claiming business conditions are “good” declined from 17.5 percent to 16.4 percent, while those claiming business conditions are “bad” increased from 38.9 percent to 43.6 percent.

As you can see below this is a long-running series and so it comes with some credibility.

In 1967, The Conference Board began the Consumer Confidence Survey (CCS) as a mail survey
conducted every two months; in June 1977, the CCS began monthly collection and publication. The CCS
has maintained consistent concepts, definitions, questions, and mail survey operations since its
inception.

The alternative view was provided by MarketWatch.

What they are saying? “I have to admit that I do not take this latest reading at face value,” said chief economist Stephen Stanley of Amherst Pierpont Securities. “If you believe the number, then consumers are feeling worse in August than they were in the depths of the lockdown. I can’t imagine that anyone believes that.”

Perhaps he was one of those who thought it would be 93.

The Housing Market

We can now shift to a look at the market which will have every telescope at the US Federal Reserve pointing at it.

Sales of new single-family houses in July 2020 were at a seasonally adjusted annual rate of 901,000, according to
estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development.
This is 13.9 percent (±20.0 percent)* above the revised June rate of 791,000 and is 36.3 percent (±27.4 percent)
above the July 2019 estimate of 661,000.

There may well have been a cheer at the Fed as the news was released. In absolute terms the main rise was in the south but in percentage terms it was the Mid-West that led with a more than 50% rise on the previous average for this year.

However there is a catch.

For Sale Inventory and Months’ Supply
The seasonally-adjusted estimate of new houses for sale at the end of July was 299,000. This represents a supply of
4.0 months at the current sales rate.

That does not add up until we remind ourselves that like the GDP data the numbers are annualised. If you check the actual data sales rose from 75,000 in June to 78,000 in July compared to a nadir of 52,000 in April.

So we see that for all the hype actual new homes sales rose by around 40,000 in response to this reported by Yahoo Finance.

The weekly average rates for new mortgages as of 20th August were quoted by Freddie Mac to be:

  • 30-year fixed rates increased by 3 basis points to 2.99% in the week. Rates were down from 3.56% from a year ago. The average fee remained unchanged at 0.8 points.
  • 15-year fixed rates rose by 8 basis points to 2.54% in the week. Year-on-year, rates were down from 3.03%. The average fee fell from 0.8 points to 0.7 points.
  • 5-year fixed rates increased from 2.90% to 2.91% in the week. Rates were down by 41 points from last year’s 3.32%. The average fee fell from 0.4 points to 0.3 points.

House Prices

Our central bankers would also be scanning for house price data.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, covering all nine U.S. census divisions, reported a 4.3% annual gain in June, no change from the previous month.

Actually it is a 3 month average so if you prefer it is a second quarter number so apparently as the economy plunged house prices rose. Some detail as to what happened where is below.

“June’s gains were quite broad-based. Prices increased in all 19 cities for which we have data, accelerating in five of them. Phoenix retains the top spot for the 13th consecutive month, with a gain of 9.0% for June. Home prices in Seattle rose by 6.5%, followed by Tampa at 5.9% and Charlotte at 5.7%. As has been the case for the last several months, prices were particularly strong in the Southeast and West, and comparatively weak in the Midwest and (especially) Northeast.

Comment

The consensus view is along the lines of this from the end of last week.

  • The New York Fed Staff Nowcast stands at 14.6% for 2020:Q3.
  • News from this week’s data releases decreased the nowcast for 2020:Q3 by 0.2 percentage point.
  • Negative surprises from the Empire State Manufacturing survey and housing starts data drove most of the decrease.

A strong rebound in the economy is the expectation but the consumer confidence report poses a question about some of that. Then we note that the housing data looks less positive once we allow for the annualisation and indeed seasonal adjustment in a year which is anything but normal.

That provides some food for thought for the US Federal Reserve as it gets ready to host its annual “Jackson Hole” symposium. I have put it in quote because this year the trip is virtual rather than real. Should they announce as they have been hinting that the new policy will be to target average inflation – which will be a loosening as the measure of official inflation is below target – we are left wondering one more time if Newt from the film Aliens will be right again?

It wont make any difference

The Investing Channel

The fraudsters want to raise the US inflation target

Today brings us a new variation on an old theme. This is the issue of what is the right level for an inflation target and sometimes we go as far as to whether there should be one at all? This begins with something of a fluke or happenstance. This is the reality that inflation targets are usually set at 2% per annum following the lead set by New Zealand back in the day. This has become something of a Holy Grail for central banksters in spite of the fact that it had no theoretical backing as this from the Riksbank of Sweden explains.

There was no relevant academic research from which to draw support; instead, the New Zealand authorities had to launch the new regime more or less as an “experiment” and quite simply see how well it worked in practice.

In fact it was as we see so often a case of trying to fit later theory to earlier practice.

This shows that it does not seem to be until the mid-1990s, i.e. about five years after its introduction in practice, that inflation targeting began to attract any significant interest in the academic research.

Basocally it was from a different world where inflation was higher and they wanted something of an anchor and an achievable objective.

Also there is another swerve as other time the central bankster preference for theory over reality has led to claims that it provides price stability when it does not. Let me illustrate from the European Central Bank or ECB.

 The ECB has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.

The truth is in some ways in the “as defined” bit because if we return to the real world it simply isn’t. Also the inflation measure ignores owner-occupied housing an area where we often find inflation. It was relative price stability when inflation was higher but was never updated with the times leaving central bankers aping first world war generals and fighting the previous war.

What about now?

Here is CNBC from earlier this month.

Recent statements from Fed officials and analysis from market veterans and economists point to a move to “average inflation” targeting in which inflation above the central bank’s usual 2% target would be tolerated and even desired.

Actually then CNBC became refreshingly honest.

To achieve that goal, officials would pledge not to raise interest rates until both the inflation and employment targets are hit. With inflation now closer to 1% and the jobless rate higher than it’s been since the Great Depression, the likelihood is that the Fed could need years to hit its targets.

Not fully honest though because we only need to look back to yesterday and the Japanese experience which has gone on for (lost) decades. This theme was added to last week by an Economic Letter from the San Francisco Fed.

Average-inflation targeting is one approach policymakers could use to help address these challenges. Taking into account previous periods of below-target inflation, average-inflation targeting overshoots to bring the average rate back to target over time. If the public perceives it to be credible, average-inflation targeting can help solidify inflation expectations at the 2% inflation target by providing a better inflation anchor and thus maintain space for potential interest rate cuts. It importantly can help lessen the constraint from the effective lower bound in recessions by inducing policymakers to overshoot the inflation target and provide more accommodation in the future.

I have helped out by highlighting the bits which exhibit extreme Ivory Tower style thinking. In general people think inflation is under recorded and would be more sure of this id they knew that housing inflation is either ignored or in the case of the US fantasy rents which are never paid are used to estimate it. It turns into something the Arctic Monkeys dang about.

Fake tales of San Francisco
Echo through the room

Yesterday Bloomberg suggested such a policy was on its way but got itself in something of a mess.

But the Fed’s preferred measure of inflation has consistently fallen short, averaging just 1.4% since the target’s introduction.

The preferred measure PCE ( Personal Consumption Expenditure) was chosen because it gives a lower reading than the more commonly known CPI in the US. This is a familiar tactic by central banksters and if we add in the gap which is often around 0.4% we see things change. Next apparently things move in response to what the Fed is thinking as opposed to the interest-rate cuts, bond buying and credit easing.

“Rising inflation expectations are, in part, indicative of the market beginning to price in the Fed’s shift,” said Bill Merz, senior portfolio strategist and head of fixed-income research at U.S. Bank Wealth Management in Minneapolis.

Rising inflation expectations are presented as a good thing whereas back in the real world the old concept of “sticky wages” is back and in more than a few cases involves wage cuts.

Comment

There is an air of unreality about this which is extreme even for the Ivory Towers of economic theory. After all the last decade has given them everything they could dream of in terms of zero and sometimes negative interest-rates and bond buying on a scale they could not have even dreamt of. If we go back a decade they believed it would work and by that I mean hit the 2% inflation target and rescue the economy. But they have turned out to be the equivalent of snake-oil sales(wo)man where the next bottle will always cure you and even has “Drink Me” written on it in big friendly letters.

But it did not work and even worse like a poor general they left a flank open which is that by having no exit strategy they were exposed to any future downturn. So the Covid pandemic was unlucky in severity but not the event itself as something was always going to come along. To my mind the policy failure has been that central banksters got caught up in the here and now and forgot they had defined a fair bit of inflation away. So they did not realise the  real choice was to lower the target to 1.5% or 1% or to put in a measure of housing inflation that represents inflation reality rather than a non-existent fantasy.

Take a ride in the sky, on our ship fantasii
All your dreams will come true, right away ( Earth Wind & Fire)

Thus they have ended up on a road to nowhere where in their land of confusion they have ended up financing government deficits. This rather than inflation targeting is the new role. Next up they look to support the economy but the truth is that we see another area where they have seen failure. Keynes explained that well I think in that you can shift expectations or trick people for a while but in the end Kelis was right.

Seen it in your one to many times
Said you might trick me once
I won’t let you trick me twice.

So whether they end up targeting average inflation or simply raise the target does not matter in the way it once did. The real issue now is getting politicians weaned off central banks financing their deficits for them. Good luck with that…….

The Investing Channel

More QE will be on the agenda of the US Federal Reserve

Later today the policymakers of what is effectively the world’s central bank meet up to deliberate before making their policy announcement tomorrow evening UK time. Although there is a catch in my description because the US Federal Reserve goes through sustained periods when it effectively ignores the rest of the world and becomes like the US itself can do, rather isolationist. The Financial Times puts it like this.

US coronavirus surge to dominate Federal Reserve meeting…..Central bank policymakers face delicate decision on best way to deliver more monetary support.

As it happens the coronavirus numbers look a little better today. But there are clearly domestic issues at hand which is a switch on the initial situation where on the middle of March the US Federal Reserve intervened to help the rest of the world with foreign exchange liquidity swaps. We were ahead of that game on March 16th. Anyway, that was then and now we see the US $446 billion that they rose to is now US $118 billion and falling.

The US Dollar

There has been a shift of emphasis with Aloe Blacc mulling a dip in royalties from this.

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

This was represented back in the spring not only by a Dollar rally that especially hit the Emerging Market currencies but the Fed response I looked at above. Since then we have gone from slip-sliding away to the Fallin’ of Alicia Keys. Putting that into numbers the peak of 103.6 for September Dollar Index futures on March 19th has been replaced by 93.9 this morning.

If we look at the Euro it fell to 1.06 versus the Dollar and a warning signal flashed as the parity calls began. They had their usual impact as it is now at 1.17. Actually there were some parity calls for the UK Pound $ too so you will not be surprised to see it above US $1.28 as I type this. In terms of economic policy perhaps the most significant is the Japanese Yen at 105.50 because the Bank of Japan has made an enormous effort to weaken it and looks increasingly like King Canute.

There are economic efforts from this as I recall the words of the then Vice-Chair Stanley Fischer from 2015.

Figure 3 uses these results to gauge how a 10 percent dollar appreciation would reduce U.S. gross domestic product (GDP) through the net export channels we have just discussed. The staff’s model indicates that the direct effects on GDP through net exports are large, with GDP falling over 1-1/2 percent below baseline after three years.

We have seen the reverse of that so a rise in GDP of 1.5%. Of course such moves seem smaller right now and they need the move to be sustained but a welcome development none the less.

Whilst the US economy is less affected in terms of inflation than others due to the role of the US Dollar as the reserve currency in which commodities are prices there still is an impact.

This particular model implies that core PCE inflation dips about 0.5 percent in the two quarters following the appreciation before gradually returning to baseline, which is consistent with a four-quarter decline in core PCE inflation of about 0.3 percent in the first year following the shock.

Again this impact is the other way so inflation will rise. For those unaware PCE means Personal Consumption Expenditures and as so familiar for an official choice leads to a lower inflation reading than the more widely known CPI alternative.

Back Home

Interest-Rates

This is a troubled area for the US Federal Reserve which resembles the shambles of General Custer at Little Big Horn. We we being signposted to a “normalisation” where the new interest-rate would be of the order of 3%+ or what was called r*. I am pleased to report I called it out at the time as the reality was that the underpinnings of this particular Ivory Tower crumbled as the eye of Trump turned on it. The pandemic in this sense provided cover for the US Federal Reserve to cut to around 0.1% ( strictly 0% to 0.25%).

Back on March 16th I noted this and you know my view in official denials.

#BREAKING Fed’s Powell says negative interest rates not likely to be appropriate ( @AFP )

I also not this from Reuters yesterday,

With U.S. central bank officials resisting negative interest rates,

How are they resisting them? They could hardly have cut much quicker! This feels like a PR campaign ahead of applying them at some future date.

Yield Curve Control

This is the new way of explaining that the central bank is funding government policy. Although not on the scale some are claiming.

Foreigners have levelled off buying US Debt. Federal Reserve buying has gone parabolic. This tells us all this additional debt the govt is issuing by running HUGE budget deficits is being purchased by directly the Fed. That is what they do in “banana republics”. #monetizethedebt

That was from Ben Rickert on Twitter and is the number one tweet if you look for the US Federal Reserve. Sadly for someone who calls himself The Mentor actual purchases of US government bonds have declined substantially.

the Desk plans to continue to increase SOMA holdings of Treasury securities at that pace, which is the equivalent of approximately $80 billion per month.  ( New York Fed.)

That is less in a month than it was buying some days as I recall a period when it was US £125 billion a day.

If Ben had not ramped up his rhetoric he would be on the scent because Yield Curve Control is where the central bank implicitly rather than explicitly finances the government. Regular readers will have noted my updates on the Bank of Japan doing this and there have been several variations but the sum is that the benchmark ten-year yield has been kept in a range between -0.1% and 0.1%.

There is an obvious issue with the US ten-year yield being around 0.6% and we may see tomorrow the beginning of the process of getting it lower. On the tenth of this month I pointed out that some US bond yields could go negative and if we are to see a Japanese style YCC then the Fed needs to get on with it for the reasons I will note below.

Comment

As the battleground for the US Federal Reserve now seems to be bond yields it has a problem.

INSKEEP: Senator, our time is short. I’ve got a couple of quick questions here. Is there a limit to how much the United States can borrow? Granting the emergency, its another trillion dollars here. ( NPR)

Even in these inflated times that is a lot and the Democrat opposition want treble that. With an election around the corner we are likely to see more grand spending schemes. But returning to the Fed that is a lot to fund and $80 billion a month looks rather thin in response. So somewhere on this yellow brick road I am expecting more QE.

Oh and if you look at Japan if it has done any good it is well hidden. But that seems not to bother policymakers much these days. Also another example of Turning Japanese is provided by giving QE  new name. After all successes do not need one do they?

Still at least the researchers at the Kansas City Fed have kept their sense of humour.

Based on the FOMC’s past use of forward guidance, we argue that date-based forward guidance has the potential to deliver much, though not all, of the accommodation of yield curve control.

Is Japan the future for all of us?

A regular feature of these times is to compare our economic performance with that of Japan. That has propped up pretty regularly in this crisis mostly about the Euro area but with sub-plots for the US and UK. One group that will be happy about this with be The Vapors and I wonder how much they have made out of it?

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 two basic concepts here are interrelated and are of Deflation and what was called The Lost Decade but now are The Lost Decades. These matters are more nuanced that usually presented so let me start with Deflation which is a fall in aggregate demand in an economy. According to the latest Bank of Japan Minutes this is happening again.

This is because aggregate demand is
highly likely to be pushed down by deterioration in the labor market and the utilization rate of conventional types of services could decline given a new lifestyle that takes into
consideration the risk of COVID-19.

The latter point echoes a discussion from the comments section yesterday about an extension to the railway to the Scottish Borders. Before COVID-19 anything like that would come with a round of applause but now there are genuine questions about public transport for the future. There is an irony close to me as I have lived in Battersea for nearly 3 decades and a tube line there has been promised for most of that. Now it is on its way will it get much use?

This is a difficult conceptual issue because if we build “White Elephants” they will be counted in GDP ( it is both output and income), but if they are not used the money is to some extent wasted. I differ to that extent from the view of John Maynard Keynes that you can dig and hole and fill it in. If that worked we would not be where we are now. In the credit crunch we saw facets of this with the empty hotels in Ireland, the unused airport in Spain and roads to nowhere in Portugal. That was before China built empty cities.

Inflation Deflation

There is something of a double swerve applied here which I will illustrate from the Bank of Japan Minutes again.

Next, the three arrows of Abenomics should continue to be carried out to the fullest extent until the economy returns to a growth path in which the annual inflation
rate is maintained sustainably at around 2 percent.

A 2% inflation target has nothing at all to do with deflation and this should be challenged more, especially when it has this Orwellian element.

It is assumed that achievement of the price stability target will be delayed due to COVID-19
and that monetary easing will be prolonged further

It is not a price stability target it is an inflation rate target. This is of particular relevance in Japan as it has had stable prices pretty much throughout the lost decade period. It is up by 0.1% in the past year and at 101.8 if we take 2015 as 100, so marginal at most. The undercut to this is that you need inflation for relative price changes. But this is also untrue as the essentially inflation-free Japan has a food price index at 105.8 and an education one of 92.7.

Policy Failure

The issue here is that as you can see above there has been a complete failure but that has not stopped other central banks from speeding down the failure road. It is what is missing from the statement below that is revealing.

: the Special Program to Support Financing in Response to the Novel Coronavirus (COVID-19); an ample provision of
yen and foreign currency funds without setting upper limits; and active purchases of assets such as exchange-traded funds (ETFs).

No mention of negative interest-rates? Also the large-scale purchases of Japanese Government Bonds only get an implicit mention. Whereas by contrast the purchase of equities as in this coded language that is what “active purchases of assets such as exchange-traded funds (ETFs)” means gets highlighted. The 0.1% will be happy but as any asset price rise is omitted from the inflation indices it is entirely pointless according to their stated objective. No wonder they keep failing…

This matters because pretty much every central bank has put on their running shoes and set off in pursuit of the Bank of Japan. Ever more interest-rate cuts and ever more QE bond buying. Perhaps the most extreme case is the ECB (European Central Bank) with its -0.5% Deposit Rate and large-scale QE. On the latter subject it seems to be actively mirroring Japan.

The ECB may not need to use the full size of its recently expanded pandemic purchase program, Executive Board member Isabel Schnabel says ( Bloomberg)

This is a regular tactic of hinting at reductions whereas the reality invariably ends up on the Andrea True Connection road.

More! More! More!

Staying with the Euro area the ECB has unveiled all sorts of policies and has a balance sheet of 6.2 trillion Euros but keeps missing its stated target. We noted recently that over the past decade or so they have been around 0.7% per year below it and that is not getting any better.

In June 2020, a month in which many COVID-19 containment measures have been gradually lifted, Euro area annual inflation is expected to be 0.3%, up from 0.1% in May ( Eurostat )

Real Wage Deflation

This to my mind is the bigger issue. It used to be the case ( in what was called the NICE era by former Bank of England Governor Mervyn King) that wages grew faster than wages by 1-2% per annum. That was fading out before the credit crunch and since there have been real problems. The state of play for the leader of the pack here has been highlighted by Nippon.com.

Wage growth in Japan is also slow compared with other major economies. According to statistics published by the Organization for Economic Cooperation and Development, the average Japanese annual wage in 2018 was the equivalent of $46,000—a mere 0.2% increase on the figure for 2000 ($45,000).

They mean 2% and everyone else seems to be heading that way.

This increase is significantly smaller than those recorded in the same period in the United States ($53,900 to 63,100), Germany ($43,300 to 49,800), and France ($37,100 to 44,500).

The UK has gone from around $39,000 to the same as France at $44.500.

There is an obvious issue in using another currency but we have the general picture and right now it is getting worse everywhere.

Comment

The answers to the question in my title unfold as follows. In terms of central bank action we have an unequivocal yes. They have copied Japan as much as they can showing they have learnt nothing. We could replace them with an AI version ( with the hope that the I of Intelligence might apply). Related to this is the inflation issue where all the evidence is that they will continue to fail. We have here an example of failure squared where they pursue policies that do not work in pursuit of an objective which would make people worse rather than better off.

That last point feeds into the wages issue which in my opinion is the key one of our times. The Ivory Towers of the central banks still pursue policies where wages growth exceeds inflation and their models assume it. Perhaps because for them it is true. But for the rest of us it is not as real wages have struggled at best and fallen at worst. This is in spite of the increasingly desperate manipulation of inflation numbers that has been going on.

So we see different elements in different places. The Euro area is heading down the same road as Japan in terms of inflation and apart from Germany wages too. The UK is an inflation nation so that part we are if not immune a step or two away from, but that means our real wage performance is looking rather Japanese.

There is also another sub-plot.

30y gilt yield < 30y JGB yield ( Divyang Shah )

The Investing Channel

 

Can US house prices bounce?

The US housing market is seeing two tsunami style forces at once but in opposite directions. The first is the economic impact of the Covid-19 virus pandemic on both wages (down) and unemployment (up). Unfortunately the official statistics released only last week are outright misleading as you can see below.

Real average hourly earnings increased 6.5 percent, seasonally adjusted, from May 2019 to May 2020.
The change in real average hourly earnings combined with an increase of 0.9 percent in the average
workweek resulted in 7.4-percent increase in real average weekly earnings over this period.

We got a better idea to the unemployment state of play on Thursday as we note the scale of the issue.

The advance unadjusted number for persons claiming UI benefits in state programs totaled 18,919,804, a decrease of 178,671 (or -0.9 percent) from the preceding week.

The only hopeful bit is the small decline. Anyway let us advance with our own view is that we will be seeing much higher unemployment in 2020 although hopefully falling and falling real wages.

The Policy Response

The other tsunami is the policy response to the pandemic.

FISCAL STIMULUS (FEDERAL) – The U.S. House of Representatives passed a $2.2 trillion aid package – the largest in history – on March 27 including a $500 billion fund to help hard-hit industries and a comparable amount for direct payments of up to $3,000 to millions of U.S. families.

That was the Reuters summary of the policy response which has been added to in the meantime. In essence it is a response to the job losses and an attempt to resist the fall in wages.

Next comes the US Federal Reserve which has charged in like the US Cavalry. Here are their words from the report made to Congress last week.

Specifically, at two meetings in March, the FOMC lowered the target range for the federal funds rate by a total of 1-1/2 percentage points, bringing it to the current range of 0 to 1/4 percent.

That meant that they have now in this area at least nearly fulfilled the wishes of President Trump. They also pumped up their balance sheet.

The Federal Reserve swiftly took a series of policy actions to address these developments. The FOMC announced it would purchase Treasury securities and agency MBS in the amounts needed to ensure smooth market functioning and the effective transmission of monetary policy to broader financial conditions. The Open Market Desk began offering large-scale overnight and term repurchase agreement operations. The Federal Reserve coordinated with other central banks to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements and announced the establishment of temporary U.S. dollar liquidity arrangements (swap lines) with additional central banks.

Their explanation is below.

 Market functioning deteriorated in many markets in late February and much of March, including the critical Treasury and agency MBS markets.

Let me use my updated version of my financial lexicon for these times. Market function deteriorated means prices fell and yields rose and this happening in the area of government and mortgage borrowing made them panic buy in response.

Mortgage Rates

It seems hard to believe now but the US ten-year opened the year at 1.9%, Whereas now after the recent fall driven by the words of Federal Reserve Chair Jerome Powell it is 0.68%. Quite a move and it means that it has been another good year for bond market investors. The thirty-year yield is 1.41% as we note that there has been a large downwards push as we now look at mortgage rates.

Let me hand you over to CNBC from Thursday.

Mortgage rates set new record low, falling below 3%

How many times have I ended up reporting record lows for mortgage rates? Anyway we did get some more detail.

The average rate on the popular 30-year fixed mortgage hit 2.97% Thursday, according to Mortgage News Daily……..For top-tier borrowers, some lenders were quoting as low as 2.75%. Lower-tier borrowers would see higher rates.

Mortgage Amounts

CNBC noted some action here too.

Low rates have fueled a sharp and fast recovery in the housing market, especially for homebuilders. Mortgage applications to purchase a home were up 13% annually last week, according to the Mortgage Bankers Association.

According to Realtor.com the party is just getting started although I have helped out with a little emphasis.

Meanwhile, buyers who still have jobs have been descending on the market en masse, enticed by record-low mortgage interest rates. Rates fell below 3%, to hit an all-time low of 2.94% for 30-year fixed-rate loans on Thursday, according to Mortgage News Daily.

Mortgage demand is back on the rise according to them.

For the past three weeks, the number of buyers applying for purchase mortgages rose year over year, according to the Mortgage Bankers Association. Applications shot up 12.7% annually in the week ending June 5. They were also up 15% from the previous week.

Call me suspicious but I thought it best to check the supply figures as well.

Mortgage credit availability decreased in May according to the Mortgage Credit Availability Index (MCAI)………..The MCAI fell by 3.1 percent to 129.3 in May. A decline in the MCAI indicates that lending standards are tightening, while increases in the index are indicative of loosening credit.

So a decline but still a lot higher than when it was set at 100 in 2012. The recent peak at the end of last year was of the order of 185 and was plainly singing along to the Outhere Brothers.

Boom boom boom let me here you say way-ooh (way-ooh)
Me say boom boom boom now everybody say way-ooh (way-ooh)

What about prices?

As the summer home-buying season gets underway, median home prices are surging. They shot up 4.3% year over year as the number of homes for sale continued to dry up in the week ending June 6, according to a recent realtor.com® report. That’s correct: Prices are going up despite this week’s announcement that the U.S. officially entered a recession in February.

Comment

As Todd Terry sang.

Something’s goin’ on in your soul

The housing market is seeing some surprises although I counsel caution. As I read the pieces about I note that a 4.3% rise is described as “shot up” whereas this gives a better perspective.

While that’s below the typical 5% to 6% annual price appreciation this time of year, it’s nearly back to what it was before the coronavirus pandemic. Median prices were rising 4.5% in the first two weeks of March before the COVID-19 lockdowns began. Nationally, the median home list price was $330,000 in May, according to the most recent realtor.com data.

But as @mikealfred reports there is demand out there.

Did someone forget to tell residential real estate buyers about the recession? I’m helping my in-laws buy a house in Las Vegas right now. Nearly every house in their price range coming to market sees 40+ showings and 5+ offers in the first few days. Crazy demand.

Of course there is the issue as to at what price?

So there we have it. The Federal Reserve will be happy as it has created a demand to buy property. The catch is that it is like crack and if they are to keep house prices rising they will have to intervene on an ever larger scale. For the moment their policy is also being flattered by house supply being low and I doubt that will last. To me this house price rally feels like trying to levitate over the edge of a cliff.

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