This looks like the end of the interest-rates rising cycle

This feels like one of those days where there has been an epoch shift or to be more specific the morning after the night before. It is not as if we have been caught by surprise, as unlike so many have been ahead of the curve about the world economic slow down, and hence the implications for interest-rates and monetary policy. But there will be much wider implications from this as we go forwards and let us start from the fact that the biggest economic decision of 2019 may have just been made by a technocrat.

What happened?

The US Federal Reserve is significant on several counts. There is the ordinary significance of it being responsible for monetary policy in the world’s largest economy and for its reserve currency. There has recently been an additional one as it has been the standard-bearer for voluntarily raising interest-rates. Yet last night we got a combination of this.

 the Committee decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent……… In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.

No great surprise in the lack of a move last night but the promises that peaked at 3-4 interest-rate increases in 2019 have morphed into “will be patient” or perhaps 0. Then there was an additional statement which copied a part of what has become the European Central Bank model.

The Committee is prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.

So what has been called Quantitative Tightening or QT where some of the bonds bought previously are allowed to run off has run out of steam or “economic and financial developments”. The use of the word financial is significant as frankly it only reinforces the view that past falls in equity markets have driven this and we do get a flicker of democratic involvement ( I will leave readers to decide if that is good or bad) as of course they upset President Trump.

Next comes something which regular readers will know is something I have long suspected which is that in any slow down QE4 will come down the slipway. Or to be more specific the Federal Reserve balance sheet will no longer be contracting but will be expanded again. A particular significance of this will be that it could start with the balance sheet already being over US $4 Trillion in size.

There are various consequences of all of this. Two of them are major themes of my work with one of them being the earliest. As central banks went “all in” in terms of monetary policy I feared they would delay any exit policy and thus end up in the wrong cycle. The Fed deserves some credit for at least trying ( unlike so many others) but if not too little it was too late. Next is the issue of “junkie culture” where I feared we would be unable to wean ourselves off cheap credit and yields well that looks like where we are at right now. Some of you deserve credit for pointing out that the “new normal” would mean interest-rates would not go above 3% as that is looking rather en vogue today. That is in spite of the annualised economic growth rate being reported as 3.4% and the unemployment rate being reported as 3.9%.

Along this road the concept of independence of the US Federal Reserve and Chair Jerome Powell has folded like a deck chair, although some ( often ex-central bankers) retain a touching faith in the concept.

The Consequences

Equity Markets

The issue here is summarised to some extent by this tweet from James Mackintosh of the Wall Street Journal.

The FTSE 100 dividend yield ended 2018 3.5 percentage points above the 10-year Gilt yield, the most ever. One possibility: Market pricing risk of dividends being slashed after Brexit. Another: UK stocks are cheap. Or Gilt yields far too low.

After last nights Powell U-Turn whilst Gilt yields are in my opinion too low the reality is that going forwards they look more likely to stay there than before. Therefore on that measure the equity market looks cheap. Or to express it in another form the Yellen put for equity markets which replaced the Bernanke put has not been replaced by the Powell put option. This does not mean that they cannot fall but it does mean that monetary policy will do its best to stop them falling.

This brings us to the concept of the Plunge Protection Team a phrase I do use and sometimes I am joking. But this monetary policy  U-Turn following the way that Treasury Secretary Mnuchin spoke to the largest banks just before Christmas looks like a concerted effort.

Fiscal Policy

That to my mind has just seen a shift too and it comes from bond yields. Pressure for them to rise has just ended at least from one source. If you take the view that bond yields are the sum of expected future interest-rates then the latter has been shifting lower. If we stay with the US forecasts of 4% bond yields now face a reality of a ten-year Treasury Note yield of 2.67% and a thirty-year yield of 3.02%.

Thus fiscal policy just got cheaper and in some places it is currently very cheap if we look at a 1.24% ten-year Gilt yield in my country the UK and ultra-cheap if we look at Germany with its ten-year Bund yield of 0.18%. Let me offer you some thoughts on this.

  1. I know people like to laugh at the Donald but his fiscal plan of tax cuts has coincided with an economic slow down and now has got less expensive via lower bond yields.
  2. The concept of us all turning at least partly Japanese gets another tick in the box as they have never fully escaped the easing cycle either.
  3. Was the original plan of central bank “independence” to allow policies the politicians could never get away with?
  4. Ironically the countries that can most afford a fiscal boost such as Germany are those most set against it. Of course an element of its lower yields is due to its fiscal surplus but to my mind only a small bit.
  5. Politicians seem to be more in favour of fiscal policy when it is more expensive (higher bond yields) rather than cheaper. I cannot fully explain that but it often happens, perhaps they are just slow on the uptake.


There is a lot to consider here and the truth is some of this we have been observing over the last month or two as markets have adjusted to a newer reality. I have developed a new theory in the credit crunch era which is that conventional thought once it believes something takes quite some time to change after the evidence has shifted or the complete opposite of the famous quote attributed to JM Keynes.

When the facts change, I change my mind. What do you do sir?

In reality many have continued on with thoughts about interest-rate rises in 2019 perhaps most bizarrely in the case of the ECB. Whereas for now central bankers seem to have Taylor Swift on repeat to sooth away any such thoughts.

We are never ever ever getting back together,
We are never ever ever getting back together,
You go talk to your friends, talk to my friends, talk to me
But we are never ever ever ever getting back together





The shift towards lower rather than higher interest-rates is beginning again

Yesterday was another poor day for the Forward Guidance provided by central bankers as we note developments in the US and UK. There was a flurry of media activity around the statement from Bank of England Governor that the Chinese Yuan could challenge the US Dollar as the world’s reserve currency, but really he was saying that it is a very long way away. So let us start with the US Federal Reserve and look back to September for its Forward Guidance. From Reuters.

Fed policymakers did not jack up their expectations for rate hikes in coming years, as some analysts had thought, instead sticking closely to rate hike path forecasts outlined in June that envision short-term rates, now at 2.0 percent to 2.25 percent, to be at 3.1 percent by the end of next year.

This suggested a couple of rate hikes in 2019 and at the beginning of December Bill Conerly stepped up the pace in Forbes Magazine.

My forecast for interest rates remains higher than the Fed’s September 2018 forecast. I expect the Fed Funds rate to end 2019 at 3.9%, and to end 2020 at 4.5%.

Bill seemingly had not got the memo about a slowing word and hence US economy as he reflected views which in my opinion were several months out of date as well as being extreme for even then. But what we were seeing was a reining back of forecasts of interest-rate rises. Putting that in theoretical terms the so-called neutral rate of interest showed all the flexibility of the natural rate of unemployment in that it means whatever the central bankers want it to mean.

Last Night events took another turn with the publication of the US Federal Reserve Minutes from December.

With regard to the post meeting statement, members agreed to modify the phrase “the Committee expects that further gradual increases” to read “the Committee judges that some further gradual increases.” The use of the word “judges” in the revised phrase was intended to better convey the data-dependency of the Committee’s decisions regarding the future stance of policy; the reference to “some” further gradual increases was viewed as helping indicate that, based on current information, the Committee judged that a relatively limited amount of additional tightening likely would be appropriate.

As you can see they have chosen the words “judges” and “some” carefully and the prospect of interest-rate increases this year has gone from a peak of 4 with maybe more in 2020 to perhaps none. Or for fans of Carly Rae Jepson it has gone from ” I really,really,really,really” will increase interest-rates to “Call Me Maybe”

Why? Well some may mull the idea of there being a form of Jerome Powell put option for the stock market.

Against this backdrop, U.S. stock prices were down nearly 8 percent on the period.

Widening that out it also reflected an economic weakening which has mostly got worse since.

Forward Guidance

This is supposed to help the ordinary consumer and business(wo)man but letting them know what the central bank plans to do. But to my mind this is of no use at all if they keep getting it wrong as the US Federal Reserve just has. In fact in terms of fixed-rate mortgages and loans they have been given exactly the wrong advice. Whereas we had reflected the changing outlook as I quote from my opening post for this year.

The problem is their starting point and for that all eyes turn to the central banks who have driven them there. Get ready for the claims that “it could not possibly have been expected” and “Surprise!Surprise!”

I find myself debating this on social media with supporters of central bank policy who mostly but not always are central banking alumni. They manage to simultaneously claim that Forward Guidance is useful but it does not matter if it is wrong, which not even the best contortionist could match.

Bank of England

The memo saying “the times they are a-changing” had not reached Bank of England Governor Mark Carney as he posted on the Future Forum yesterday afternoon.

 That’s why the MPC expect that any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent.

He is still hammering away with his hints at higher interest-rates although he was also trying to claim that movements in interest-rates are nothing to do with him at all.

So in other words, low policy interest rates are not the caprice of central bankers, but rather the consequence of powerful global forces.

Makes you wonder why he and his 8 interest-rate setting colleagues are paid  some much if the main events are nothing to do with them doesn’t it? I somehow doubt that when a Bank of England footman handed a copy of Mark Carney’s Gilt-Edged CV to the World Bank that it was claiming that.

Governor Carney was in typical form in other ways too as he answered this question.

In your opinion, how likely is a large spike in Inflation in the near future?

For example in a lengthy answer he used the word inflation once but the word unemployment five times and did not mention inflation prospects/trends ( the question) at all! Better still the things which were apparently “the consequence of powerful global forces.” suddenly became due to his ilk.

Simulations using the Bank’s main forecasting model suggest that the Bank’s monetary policy measures raised the level of GDP by around 8% relative to trend and lowered unemployment by 4 percentage points at their peak. Without this action, real wages would have been 8% lower, or around £2,000 per worker per year, and 1.5 million more people would have been out of work.

As we note his slapping of his own back whilst blowing his own trumpet I zeroed in on the wage growth claim which appeared in another form much later.

Although it’s true that QE helped support asset prices, it also boosted job creation and wage growth.

There is a lot in that sentence but let us start with the wage growth issue. The reality is that real wage growth has been negative in the UK and worse than our economic peers. By propping up zombie banks and companies for example there are reasons to argue that the QE era has made things worse. But apparently in a stroke of magic it has made everything better! Now whilst correlation does not prove causation it is hard to argue you have made things better in a period where you have had a major impact and things have got worse.  Indeed  the more recent trend as the QE flow has slowed has been for wages to pick up.

Also there was the “helped support asset prices” point. This is welcome in its honesty but there have been times that the Bank of England ( in spite of its own research on the subject) has tried to deny this.

What about debt?

Back in 2016 Governor Carney told us.

This is not a debt-fuelled recovery.

Yesterday he changed his tune slightly.

 Recent growth in aggregate credit in the UK has been modest, growing a little faster than nominal GDP.

Notice the shift from real GDP to the invariably higher nominal GDP. Missing in action was any mention of unsecured credit which surged into double-digit annual growth in response to the Sledgehammer QE action of the Bank of England in the autumn of 2016 and is still growing at over 7%. Nor did the surge in student loans merit a mention unlike in this from Geoff Tily of the TUC last week.

Total unsecured debt has risen to £428 billion. At 30.4 per cent of household income, this is higher than before the financial crisis:


There is a fair bit to sweep up here but the main point is that we have developed bodies called independent that do the establishments bidding on a scale politicians themselves would never have got away with. Can you imagine politicians being able to buy trillions of their own debt?! Next we are told that they can help us with the future via Forward Guidance but that when it goes wrong it does not matter. The elastic of credibility just snapped.

In my own country the UK this was added to on LBC Radio where we were grandly told yesterday that someone who used to set UK interest-rates would be on air. When Ian McCafferty came on he seemed confused by the statement that the UK economy grew by 0.6% in the third quarter and sounded out of touch with events. For example in the early part of 2018 it was true that Germany and France were growing more quickly than the UK but as this morning has reminded us to say they are doing so now makes you look out of touch at best.

In November 2018, output slipped back sharply in the manufacturing industry (−1.4% after +1.4% in October) as well as in the whole industry (−1.3% after +1.3%). ( France-Insee ).

Perhaps he will offer a retraction like he had to do when he was on LBC last August. Meanwhile you know I often tell you never to believe anything until it is officially denied don’t you? From Governor Carney yesterday.

We have also made clear that we wouldn’t set negative interest rates – the Bank’s Monetary Policy Committee, which is responsible for setting Bank Rate, has said that the effective lower bound on Bank Rate is close to, but a little above, zero.

As a hint the lower bound was 0.5% until they cut to 0.25% ( and promised a cut to 0.1% in another Forward Guidance failure).






The US economy is slowing but how quickly?

A feature of recent times has been the way that economic growth forecasts have been trimmed somewhat. This morning has already seen two examples of that as the Swiss National Bank has suggested it will fall from 2.5% this year to 1.5% next, must be awkward that when your official interest-rate is already -0.75%. Next came the IFO Institute in Germany which did a little pruning to 1.5% this year and more of a short-back and sides to 1.1% in 2019. That provides some food for thought for the European Central Bank today as its largest economy slows.

The situation in the United States has been somewhat different, however, at least according to the official data. From the Bureau for Economic Analysis.

Real gross domestic product (GDP) increased at an annual rate of 3.5 percent in the third quarter of 2018 , according to the “second” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 4.2 percent.

Yes it has slowed but to a rate most first world countries would currently give their right arm for. We can use the Atlanta Fed now cast to see where we stand this quarter.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2018 is 2.4 percent on December 7, down from 2.7 percent on December 6.

They updated it on the basis of this new information.

The nowcast of fourth-quarter real final sales of domestic product growth decreased from 2.9 percent to 2.7 percent after this morning’s employment report from the U.S. Bureau of Labor Statistics. The nowcast of the contribution of inventory investment to fourth-quarter real GDP growth decreased from -0.23 percentage points to -0.33 percentage points after the employment report and this morning’s wholesale trade release from the U.S. Census Bureau.

So we see that whilst the level of economic growth remains relatively good the US has not escaped the cooling winds blowing.

Money Supply

This has proved to be a good guide to economic trends in 2018 and even better it remains widely ignored. Shorter-term trends are usually best encapsulated by narrow money so let us investigate last week’s monetary base data from the Federal Reserve which incorporates this.

The release also provides data on the monetary base, which includes currency in circulation and total balances maintained.

On the 5th of this month it was US $3.444 trillion but we immediately know that as Alicia Keys would say it has been Fallin’ as it was US $3.508 trillion on the 7th of November. We need to switch to the monthly numbers for an annual comparison and when we do so we see that in November it was 11% lower than a year before. If the phrase was not in use elsewhere this would be a credit crunch or to be more specific a type of cash crunch. Not a pure cash crunch as the currency in circulation has risen to US $1.705 trillion but reserve balances at the banks.

The fall has been driven by this.

For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month…….For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

As you can see it is the central bank which is sucking reserve balances out of the system as indeed it was it who pumped them up. In a broad sweep we see that the QE era took the monetary base from a bit under US $0.9 trillion to US $4.1 trillion and now is pulling it back down.

Personally I think the main effect is coming from the reductions in holdings of mortgage-backed securities so if we pro rata that we get a monetary base reduction of say 5% but that is still a crunch.


These have been rising in the US another 0.25% still seems likely next week. An intriguing way of putting the international perspective on this has been provided by the Bond Vigilantes website.

 the de facto global discount rate, the 2-year US Treasury bond yield, has risen by almost 100 basis points (bps) over the year, and thus repriced global assets.

Higher US interest-rates effect the world economy and thus have a second order effect on the US economy via trade. Then there are the domestic effects.

the US 30-year mortgage rate hit 4.8% recently, up from 3.3% in 2016. Whilst most existing homeowners, like corporates, will have locked in those cheap rates, new borrowers face costlier loans, and this is already having an impact: US housing and real estate data is surprising to the downside at a rate that exceeds that seen even in 2008 and 2009:

So there has been something of a squeeze on the real economy from this source as well, although it will have weakened recently as US Treasury Bond yields have fallen back from their peaks.

Fiscal Policy

As we mull the developments above it seems that the fiscal stimulus provided by President Trump was not as ill-conceived as some have claimed. Of course views vary about fiscal stimuli as for example they are apparently good for France but bad for Italy. But the Donald has provided one into a slow down which has at least some of the textbook rationale. Where matters get more complex is the fact that the US has so far only really seen its boom slow and other countries such as Germany make a stronger case. But if we skip the absolute level argument the Donald does appear to have spotted the direction of travel.


We see that the US has not in fact escaped the economic changes in 2018 but it has had an advantage from starting at a higher level of economic growth. But the monetary data is applying a squeeze as are higher interest-rates and as ever we find it impacting in familiar places.

Whenever you saw the supply of unsold homes reach 7 months, a recession followed. It certainly did in 2008, despite the consensus of economic forecasters believing that economic growth would be 2.4% – it was actually negative. Why should we worry now? Well, the supply of unsold new homes is… 7.4 months (blue line).  (BondVigilantes )

That will trouble the US Federal Reserve as will this development.

BKX not far from yesterday’s low. There’s a real problem with the banks. And I don’t think I’m being an alarmist by simply saying something might be going on here that we don’t know about. ( @selling_theta )

Worries about the housing market and the banks? We know how central banks usually respond to those so no wonder the US Fed has cooled on future interest-rate rises. QE4 anyone?





The problematic nature of current bond yields

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

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

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

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

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

The US

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

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

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

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

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

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

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

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

Bond Markets

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

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

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

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

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

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

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


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

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

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

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



Central banking forward guidance ignores the rules of probability

Today we can continue our journey into the world of central bankers which is a cosy international club. It was hard as the New York Federal Reserve Bank reported in glowing terms the visit of its President John Williams to the Bronx not to recall a previous effort from his predecessor William Dudley. From Reuters in 2011.

He then stretched for a real world example. The only problem was he chose the Apple’s latest tablet computer that hit stores on Friday, which may be more popular at the New York Fed’s headquarters near Wall Street than it is on the gritty streets of Queens.

“Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful,” he said.”You have to look at the prices of all things.”

This prompted guffaws and widespread murmuring from the audience, with one audience member calling the comment “tone deaf.”

“I can’t eat an iPad,” another said.

That of course echoed around the world. This event by the Tweet storm looks more controlled in terms of audience so he may have avoided questions like this.

“When was the last time, sir, that you went grocery shopping?” one audience member asked.

Equilibrium Unemployment

Last night Michael Saunders of the Bank of England gave a speech to the CBI and as early as the fourth sentence he was pontificating about the theory that just will not die and about a number he cannot possibly know.

In the last 10-15 years, these effects from population ageing have been fairly benign, reducing the equilibrium jobless rate and neutral interest rate.

Let me now take you back just over five years when David “I can see for” Miles was giving us forward guidance on the equilibrium unemployment rate.

we will not tighten monetary policy until a recovery is strong enough and sustained enough that it has made a meaningful dent in unemployment so that it at least falls to 7 per cent…….. that linking the horizon over which an exceptionally expansionary monetary policy continues to support demand to the rate of unemployment has merit.

It is easy to forget now that we were being steered away from using GDP for monetary policy and towards the unemployment rate along these lines. Poor old David must wish he had never uttered the words below.

I suspect this is largely because the weight of money is behind a view that the significant positive news on the economic outlook means that the 7% unemployment level might be reached within around eighteen months………

Actually the unemployment rate plunged such that by the New Year these words were even more embarrassing.

If that is so unemployment is likely to fall rather more
slowly than would be usual.

Putting it another way the equilibrium unemployment rate is now 4.25% according to the Bank of England via 4.5%,5%, 5.5% and 6,5%. They may have guided to 6% as well but I do not recall it and these things tend to get redacted. Imagine you went to an engineer who guided you towards 7000 revs in your car then a few years later decided it was 4250! This sort of thing can only happen because central banking is a closed shop where the establishment appoint the same old “independent” crew.

Returning to Michael Saunders and yesterday he loses the plot more here.

Over the last 25 years, the share of the 25-64 age population with tertiary level (ie university or
similar) education has risen from 19% to 43%, a bigger rise than in most advanced economies (see figure
4).ix The tertiary education share among people aged 25-40 years is now around 50%, and the rise in this
measure has slowed in recent years.

A triumph according to Michael except he ignores the fact that this accompanies a really poor period for real wages. Indeed if the workforce is indeed more qualified, then real wages are even lower on a like for like basis. Are qualifications now required for lower skilled jobs and frankly what value are they? These are the real questions central bankers ignore as they pose the question how did we get here? That of course has been driven by their policies.

The attempt to use demographics as a smokescreen clears quickly as we compare the number below with the 2.75% error.

 This shift in workforce composition away from age groups that tend to have high jobless rates has cut the equilibrium jobless rate by about 0.3 percentage point since 2007.


Neutral Interest-Rate

We now move on to one of the central banking obsessions of our times. The so-called neutral interest-rate is examined below.

However, the MPC judges that, in practice, population ageing currently is lifting the stock of household assets, both in the UK and globally – and hence is pushing the equilibrium level of global real interest rates lower, and will continue to do so for some time.

Interesting ( sorry). If we look at the UK real interest-rate are low because the Bank of England put them there! It then thought bond yields were too high so QE was used to help lower them. Even this was not enough so it used credit easing to reduce mortgage rates. On the other side of the coin it has had two main phases of what it calls “looking through” rises in inflation. The first in 2010/11 when both main consumer inflation measures peaked above 5% per annum and then more recently after the EU leave vote.

The fundamental issue here is something that I learnt during my days as an option trader. On the quiet days we spent many hours discussing how to measure low probability events or what we would call  far out of the money options. One company called CRT built quite a empire based on the view that low probability events were undervalued and therefore bought them and counted the profits. Those of you who have followed the collapse of the company called OptionsSellers last weekend might note that it appears ( it has been vague on the details) to have done the reverse and accordingly according to the CRT theory has lost money. In this instance all of it.

Bringing this back to central bankers lets us note that Bank Rate is presently 0.75% and the estimate of the neutral rate is say in the range 2.5% to 3%. Because that is far away and also because interest-rate changes have been so rare that is an extraordinarily low probability event. An intelligent man or woman would therefore conclude that they are likely to know little or nothing about it until there is more evidence ( like some actual interest-rate rises). By contrast central bankers regularly opine about it and attempt to present it as a fact when in fact the rest of us are singing along to Ivan Van Dahl.

Oh tell me why
Do we build castles in the sky?
Oh tell me why
Are the castles way up high?


I would like to look at something I think we can all agree with.

For most of the last 10 years, the economy has generally had significant amounts of spare capacity.

But look where it then goes.

Now, with the economy having grown above its modest potential pace for six or seven years that spare
capacity has been used up, with supply and demand in the economy broadly in balance.

Really? A more intelligent statement would be to say that the quantity measure (employment) has been strong but wage growth has been disappointingly weak. The failures around the “output gap” have led to claims wage growth is on the turn for many years from this crew. The reality is that the two main real wage falls have come when they have “looked through” inflation.

Anyway he saved the best to nearly last. If so how come we are where we are then?

BoE research suggests that this is not the case for the UK so far, and that the total impact of interest rate changes on growth and inflation is similar to the pre-crisis period.xlv The easing in mid-2016 seemed to provide the expected boost to the economy.

There are a couple of escape clauses in the second sentence such as “seemed to” and “expected” ( by who?) but we seem to be in “the operation was a success but the patient died” territory to me.






What is the economic impact of tighter US monetary policy?

It is time for us to look West again and see what is happening in the new world and this week has brought a curious development. Ordinarily it is central bankers telling us about wealth effects and then trying to bathe in the implications of their own policies but in the US right now there is an alternative.

Stock Market up more than 400 points yesterday. Today looks to be another good one. Companies earnings are great!

That is from the Twitter feed of @realDonaldTrump and continues a theme where this seems if numbers of tweets on the subject are any guide to be his favourite economic indicator. Indeed on Tuesday he was tweeting other people’s research on the matter.

“If the Fed backs off and starts talking a little more Dovish, I think we’re going to be right back to our 2,800 to 2,900 target range that we’ve had for the S&P 500.” Scott Wren, Wells Fargo.

There is a danger in favouring one company over another when you are US President especially with the recent record of Wells Fargo. But the Donald is clearly a fan of higher equity markets, especially on his watch, and was noticeably quiet when we saw falls earlier this month. This does link in a way with the suggestions of a trade deal with China that boosted equity markets late on yesterday, although with the People’s Bank of China hinting at more easing the picture is complex.

The US Federal Reserve

Unless Standard and Poorski is correct below then the Fed is currently out of the wealth effects game.


One cautionary note is that humour in this area has a habit of becoming reality later as someone in authority might see this as a good idea. Also even the many central banking apologists may struggle with the US Fed buying Apple shares from the Swiss National Bank.

The current reality is rather different because as we stand QE ( Quantitative Easing) has morphed into QT  where the T is for Tightening. For example yesterday’s weekly update told us that its balance sheet  has shrunk by US $299 billion dollars to  US $4.1 trillion and the reduction was mostly due to the sale of US Treasury Bonds ( US $173 billion) followed by US $101 billion of Mortgage-Backed Securities. Over the next year we will expect to see around double the rate of change if it continues at its new raised pace.

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


From the Wall Street Journal on Monday.

After hovering around 2.3% for most of the spring and summer, the three-month London interbank offered rate, or Libor, has been climbing since the middle of September, settling at 2.53% on Monday, its highest level since November 2008.

I am sure most of you are thinking about the rises in US official interest-rates and the shrinking balance sheet as well as the year-end demand for US Dollars I looked at back on the 25th of September . Well your Easter Egg hunt looks likely to be much more fruitful than the one at the WSJ.

Analysts don’t fully know why the spread has moved the way it has in recent months.

If we ignore the why and move onto what happens next? Lisa Abramowich of Bloomberg is on the case.

3-month U.S. Libor rates have surged to a new post-crisis high, of 2.54%, more than double where it was last year. This is important because so much debt, including leveraged loans, are pegged to this rate. Companies will find themselves paying more interest on their debt…

As to how much debt I note Reuters have been estimating it at US $300 trillion which even if we take with a pinch of salt puts the Federal Reserve balance sheet into perspective. Oh and remember the booming leveraged loan market that had gone to about US $1.1 trillion if I recall correctly? Well Lisa has been on the case there too.

Short interest in the biggest leveraged-loan ETF has risen to a record high.

So in areas which bankers would describe as being “innovative” we see that Glenn Frey is back in fashion.

The heat is on, the heat is on, the heat is on
Oh it’s on the street, the heat is on

We can add that to the troubles we have seen in 2018 in emerging markets as the double combination of higher US interest-rates and a stronger Dollar have turned up the heat there too.

The US Dollar

Firstly we need to establish that whilst talk of challenges abounds the US Dollar remains the world’s reserve currency. So a rise impacts on other countries inflation via its role in the pricing of most commodity contracts and more helpfully may make their economies more competitive. But if we are looking for signs of trouble it hits places which have borrowed in US Dollars and that has been on the rise in recent times. I have reported before on the Bank for International Settlements or BIS data on this and here is the September update.

The US dollar has become even more dominant as the prime foreign currency for international borrowing. Dollar credit to the non-bank sector outside the US rose from 9.5% of global GDP at end-2007 to 14% in Q1 2018…….The growth in dollar borrowing by EMEs or  emerging market economies  has been especially strong, but dollar exposures vary substantially both across countries and in terms of sectoral composition.

An example of this has been Argentina which is caught in a trap of its own making as for example a devaluation would make its US Dollar debts more expensive. Or if we look at India it seems its shadow banks have caught something of a cold in this area.

India Is Said to Expect Shadow Banking Default Amid Cash Squeeze- Bloomberg Non-bank financiers and mortgage lenders have 2.7 trillion rupees ($37 billion) of debt maturing in the next five months, immediately ( @SunChartist )



So far we have mostly looked at the international impact of US monetary policy so let us now look more internally. If we look at interest-rates then the 30 year fixed rate mortgage has risen to 4.83% having started the year at 4% and which takes it back to early 2011. This reflects rising Treasury Bond yields which will have to be paid on ever more debt with official suggestions saying US $1.34 trillion will need to be issued in the next year.

Against that the economy continues to be in a boom. We will find out more later as for example will wages growth reach 3%? But economic growth has been above that as the last 6 months suggests around 3.8% in annual terms assuming it continues. So for now it looks fine but then it always does at times like this as for example a slow down and rising bond yields could in my opinion switch things from QT to QE4 quite quickly. After all worries about US stock market falls  started with it still quite near to what are all time highs.

Also if you want some more numbers bingo the BIS provided some more for Halloween.

The notional value of outstanding OTC derivatives increased from $532 trillion at end-2017 to $595 trillion at end-June 2018. This increase in activity was driven largely by US dollar interest rate contracts, especially short-term contracts.





What next for the War on Cash?

Yesterday we took a look at a country which seems to be happy heading for a post cash era. Sweden has seen nearly a halving of cash use in the past decade and the size of the change would be even larger if we factored in inflation and did the calculation in real terms. This is particularly significant as we remind ourselves that Sweden already has negative interest-rates, and as I pointed out yesterday there are roads ahead where it would cut them further from the current -0.5%. The reason why cash is an issue for negative interest-rates is that it offers 0%, and so there must be a “tipping point” where interest-rates go so negative that bank deposits switch to cash in enough size to create a bank run. Such a prospect has created terror in central banking halls and boardrooms and has been the main barrier to interest-rates being cut even lower than they have. In my own country the Bank of England was so terrified of the impact of lower interest-rates on the “precious” that it claimed 0.5% was a “lower bound”, even when other countries were below it. That had a different reason ( their creaking antiquated IT systems could not cope with 0%) but told us of their primary response function.

Cash in the USA

The Financial Times has taken a look at this and seems upset at the result.

Americans can’t quit cash

If we switch to the actual research which was undertaken by  the Federal Reserve Banks of Atlanta, Boston, Richmond, and San Francisco we see the following.

In October 2017, U.S. consumers each made on average 41.0 payments for the month . Thus, on average, an adult consumer made 1.3 payments per day. Notably, an average
of 40.2 percent of consumers per day reported making zero payments. Also in October 2017, U.S. consumers each made on average $3,418 worth of payments for
the month.

So after finding out how much as well as how often? We get to see via what method.

In October 2017, consumers paid mostly with cash (30.3 percent of payments), debit cards (26.2 percent), and credit cards (21.0 percent). These instruments accounted for three-quarters of the number of payments, but only about 40 percent of the total value of payments, because they tend to be used more for smaller-value payments. In contrast,
electronic payments accounted for 30.3 percent of the value of total payments but only 8.9 percent of the number
of payments. Checks, at 17.7 percent, continued to account for a relatively high percentage of the value of

As you can see cash remains king (queen) in volume terms but has faded in value terms. The bit that sticks out to me is the amount still accounted for by Checks ( cheques) as I am struggling to think of the last time that I used one. Also the comments section provides a reason as to why cash remains in use for small payments on such a large-scale in the US.

Americans carry cash for smaller transactions partly because their unstinting devotion to the $1 bill means it is much lighter.  I can carry round a bunch of 1s and 5s for coffee in the day at a fraction of the weight of the euros or pounds that would do the similar job in Europe. ( Saughton)

For those unaware UK coins are fairly heavy and the £1 and £2 coins get more use than you might expect as the Bank of England has had its struggles with getting £5 notes into general circulation. So suit and trouser pockets can take a bit of a pasting. If we continue in the same vein even the convenience of digital payments faces an apparent challenge.

Those of us still paying cash are standing in lines behind phonsters fumbling with their payment app. When it looks faster and easier I’ll switch. ( Proclone )

That may be because it does not work well.

The other main reason the US lags on electronic purchases is because the cashless infrastructure is atrocious. ( Saughton)

Also that it may be businesses rather than consumers which prefer cash.

Mom and pop stores and restaurants may require cash for any transaction, and almost all do for purchases under $10. Cheques for larger payments are also due to vendor requirement. That dynamic would be worth comparing to other markets instead of implying consumer preference. ( Pharmacy )

What about the Euro area?

I noted that the replies pointed out the way that cash remains prevalent in Germany (historical), Belgium ( tax-avoidance) and Austria ( see Germany) so let us take a look. From the European Central Bank or ECB.

The survey results show that in 2016 cash was the dominant payment instrument at POS. In terms of number, 79% of all transactions were carried out using cash,
amounting to 54% of the total value of all payments. Cards were the second most frequently used payment instrument at POS; 19% of all transactions were settled using a payment card. In terms of value, this amounts to 39% of the total value paid at POS. ( POS = Point Of Sale )

I doubt using geography as a method of analysis will surprise you much.

In terms of number of transactions, cash was most used in the southern euro area countries, as well as in Germany, Austria and Slovenia, where 80% or more of POS transactions were conducted with cash……… In
terms of value, the share of cash was highest in Greece, Cyprus and Malta (above 70%), while it was lowest in the Benelux countries, Estonia, France and Finland (at,
or below, 33%).

The ECB thinks it tells us this.

This seems to challenge the perception that
cash is rapidly being replaced by cashless means of payment.

It then goes further.

The study confirms that cash is not only used as a means of payment, but also as a store of value, with almost a quarter of consumers keeping some cash at home as a
precautionary reserve. It also shows that more people than often thought use high denomination banknotes; almost 20% of respondents reported having a €200 or
€500 banknote in their possession in the year before the survey was carried out.

This means that the ECB will find itself in opposition to more than a few of its population soon.

 It has decided to permanently stop producing the €500 banknote and to exclude it from the Europa series, taking into account concerns that this banknote could facilitate illicit activities. The issuance of the €500 will be stopped around the end of 2018, when the €100 and €200 banknotes of the Europa series are planned to be introduced,



Let us consider the relationship between the use of cash and financial crime. You may note that the ECB statement uses the word “could”. That as I pointed out back on the 5th of May 2016 is because the German Bundesbank thinks this.

There is scant concrete information on the extent to which cash is being used to facilitate illicit activity……… the volume of notes devoted to such transactions is unknown and would be extremely difficult, if not impossible, to estimate.

So the ECB seems to be basing its policy on the rhetoric of Kenneth Rogoff who in a not entirely unrelated coincidence thinks that central banks will have to go even further into negative interest-rates next time around. Our Ken has been rather quite recently on the subject of cash equals crime. This may be because if we look above we see that Estonia has moved away from cash both relatively and absolutely and yet you will have had to have spent 2018 under a stone to have missed this.

Danske Bank Estonia has been revealed as the hub of a $234bn money laundering scheme involving Russian and Eastern European customers. ( Frances Coppola)

Perhaps the authorities were too busy checking on the 500 Euro notes and missed a crime that would have taken four of out five of the total Euro area circulation. Priorities eh?

There are levels I think where this will be come more urgent. I have suggested before that I think that around -2% would be the level where people might move away from banks on a larger scale. So far in terms of headline official rates the lowest is the -0.75% of Switzerland. Of course another problem area would be created if we saw bank bailins on any scale which may be a reason why so many bank share prices have struggled.

Me on Core Finance TV