Why is the US Repo crisis ongoing?

The US Repo crisis is something that seems to turn up every day, or if you prefer as often as we are told there is a solution to trade war between the US and China. On Friday the New York Federal Reserve or Fed provided another US $72.8 billion of overnight liquidity in return for Treasury Bonds ( US $56.1 billion) and Mortgage-Backed Securities ( US $16.7 billion). So something is still going on in spite of the fact that we have two monthly plus Repos ( 42 days) for US $25 billion each in play and 3 fortnightly ones totalling around US $59 billion. So quite a bit of liquidity continues to be deployed and this is before we get to the Treasury Bill purchases.

In accordance with this directive, the Desk plans to purchase Treasury bills at an initial pace of approximately $60 billion per month, starting with the period from mid-October to mid-November.

As an example Friday saw some US $7.525 billion of these bought. So the sums are getting larger.

How did this start?

The Bank for International Settlements or BIS which is the central bankers central bank puts it like this.

On 17 September, the secured overnight funding rate (SOFR) – the new, repo market-based, US dollar overnight reference rate – more than doubled, and the intraday range jumped to about 700 basis points. Intraday volatility in the federal funds rate was also unusually high. The reasons for this dislocation have been extensively debated; explanations include a due date for US corporate taxes and a large settlement of US Treasury securities. Yet none of these temporary factors can fully explain the exceptional jump in repo rates.

Indeed, as for a start the issue has proved to be anything but temporary.

Where the BIS view gets more interesting is via the role of the banks or rather a small group of them.

US repo markets currently rely heavily on four banks as marginal lenders. As the composition of their liquid assets became more skewed towards US Treasuries, their ability to supply funding at short notice in repo markets was diminished.

As the supply of reserves fell in the QT or Quantitative Tightening era they stepped up to the plate on a grand scale.

As repo rates started to increase above the IOER from mid-2018 owing to the large issuance of Treasuries, a remarkable shift took place: the US banking system as a whole, hitherto a net provider of collateral, became a net provider of funds to repo markets. The four largest US banks specifically turned into key players: their net lending position (reverse repo assets minus repo liabilities) increased quickly, reaching about $300 billion at end-June 2019 . At the same time, the next largest 25 banks reduced their demand for repo funding, turning the net repo position of the banking sector positive (centre panel, dashed line).

So things became more vulnerable as we note this.

At the same time, the four largest banks held only about 25% of reserves (ie funding that they could supply at short notice in repo markets).

Then demand for Repo funding was affected by the US Treasury.

After the debt ceiling was suspended in early August 2019, the US Treasury quickly set out to rebuild its dwindling cash balances, draining more than $120 billion of reserves in the 30 days between 14 August and 17 September alone, and half of this amount in the last week of that period. By comparison, while the Federal Reserve runoff removed about five times this amount, it did so over almost two years

As you can see the drain from QT was added to in spite of the fact that the market had become more vulnerable due to the lack of players. There was a clear lack of joined up thinking at play and perhaps a lack of any thinking at all. A factor here was something the BIS identifies for the banks.

For instance, the internal processes and knowledge that banks need to ensure prompt and smooth market operations may start to decay. This could take the form of staff inexperience and fewer market-makers, slowing internal processes

After a decade the experienced hands had in general moved on.

But it was not enough to collapse the house of cards. There were other nudges as well on the horizon.

Market commentary suggests that, in preceding quarters, leveraged players (eg hedge funds) were increasing their demand for Treasury repos to fund arbitrage trades between cash bonds and derivatives. Since 2017, MMFs have been lending to a broader range of repo counterparties, including hedge funds, potentially obtaining higher returns.

So hedge funds were playing in the market but as it happened were not an issue for a while as the US Money Market Funds (MMF) turned up. But then they didn’t.

 During September, however, quantities dropped and rates rose, suggesting a reluctance, also on the part of MMFs, to lend into these markets. Market intelligence suggests MMFs were concerned by potential large redemptions given strong prior inflows. Counterparty exposure limits may have contributed to the drop in quantities, as these repos now account for almost 20% of the total provided by MMFs.

So there is a hint that maybe a hedge fund or two became such large players that they hit counterparty limits. Also redemptions from MMFs would hardly be a surprise as we note the interest-rate cuts we have seen in 2019.

Why should we care?

There is this.

 Repo markets redistribute liquidity between financial institutions: not only banks (as is the case with the federal funds market), but also insurance companies, asset managers, money market funds and other institutional investors. In so doing, they help other financial markets to function smoothly.

So they oil the wheels of financial markets and when they don’t? Well that is one of the causes of the credit crunch.

The freezing-up of repo markets in late 2008 was one of the most damaging aspects of the Great Financial Crisis (GFC).

In case you did not know what they are.

A repo transaction is a short-term (usually overnight) collateralised loan, in which the borrower (of cash) sells a security (typically government bonds as collateral) to the lender, with a commitment to buy it back later at the same price plus interest.

Also it is one of those things which get little publicity ( mostly ironically because they usually work smoothly) but there is a lot of action.

 Thus, any sustained disruption in this market, with daily turnover in the US market of about $1 trillion, could quickly ripple through the financial system.

Comment

Some of the factors in the Repo crisis were unpredictable. But it is also true that the US Fed was at best rather flat-footed. There had been a long-running discussion over the use of Interest On Excess Reserves or IOER to banks on such a scale which was not resolved. Then there was the way that so few banks (4) were able to become such large players creating an obvious risk. Then the role of the MMFs as by their very nature they flow into and out of markets and are likely to flow out when interest-rates are declining.

The BIS analysis adds to what we know but changes in stocks give us broad trends rather than telling what flowed where or rather did not flow on September 17th or since. As David Bowie put it.

Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
Don’t want to be a richer man
Ch-ch-ch-ch-changes
Turn and face the strange
Ch-ch-changes
There’s gonna have to be a different man
Time may change me
But I can’t trace time

Number Crunching

The BIS has been looking into some other areas.

An analysis of the #TriennialSurvey finds that global notional for #OTCderivatives rose to $640 trn in 2019, dominated by #InterestRateDerivatives

Average daily turnover of OTC interest rate derivatives more than doubled over 2016-19 to $6.5 trillion, taking OTC markets’ share to almost half total trading

30 years, 53 countries, 1,300 reporting dealers, and $6.6 trillion daily FX trades,

Weekly Podcast

 

Where next for US house prices?

Yesterday brought us up to date in the state of play in the US housing market. So without further ado let us take a look.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index, covering all nine U.S. census divisions, reported a 3.2% annual gain in September, up from 3.1% in the previous month. The 10-City Composite annual increase came in at 1.5%, no change from the previous month. The 20-City Composite posted a 2.1% year-over-year gain, up from 2.0% in the previous month.

The first impression is that by the standards we have got used to that is a low number providing us with another context for the interest-rate cuts we have seen in 2019 from the US Federal Reserve. Of course it is not only the Fed that likes higher asset prices.

“DOW, NASDAQ, S&P 500 CLOSE AT RECORD HIGHS”

Another new Stock Market Record. Enjoy!

Those are 2 separate tweets from Monday from President Trump who not only loves a stock market rally but enjoys claiming it is all down to him. I do not recall him specifically noting house prices but it seems in the same asset price pumping spirit to me.

In my opinion the crucial part of the analysis provided by S&P comes right at the beginning.

After a long period of decelerating price increases, it’s notable that in September both the national and
20-city composite indices rose at a higher rate than in August, while the 10-city index’s September rise
matched its August performance. It is, of course, too soon to say whether this month marks an end to
the deceleration or is merely a pause in the longer-term trend.

If we look at the situation we see that things are very different from the 10% per annum rate reached in 2014 and indeed the 7% per annum seen in the early part of last year.That will concern the Fed which went to an extreme amount of effort to get house prices rising again. From a peak of 184.62 in July of 2006 the national index fell to 134.62 in February of 2012 and has now rallied to 212.2 or 58% up from the low and 15% up from the previous peak.

As ever there are regional differences.

Phoenix, Charlotte and Tampa reported the highest year-over-year gains among the 20 cities. In
September, Phoenix led the way with a 6.0% year-over-year price increase, followed by Charlotte with
a 4.6% increase and Tampa with a 4.5% increase. Ten of the 20 cities reported greater price increases
in the year ending September 2019 versus the year ending August 2019…….. Of the 20 cities in the composite, only one (San Francisco) saw a year-over-year price
decline in September

Mortgage Rates

If we look for an influence here we see a contributor to the end of the 7% per annum house price rise in 2018 as they rose back then. But since then things have been rather different as those who have followed my updates on the US bond market will be expecting. Indeed Mortgage News Daily put it like this.

2019 has been the best year for mortgage rates since 2011.  Big, long-lasting improvements such as this one are increasingly susceptible to bounces/corrections……Fed policy and the US/China trade war have been key players.

But we see that so far a move that began in bond markets around last November has yet to have a major influence on house prices. If you wish to know what US house buyers are paying for a mortgage here is the state of play.

Today’s Most Prevalent Rates For Top Tier Scenarios

  • 30YR FIXED -3.75%
  • FHA/VA – 3.375%
  • 15 YEAR FIXED – 3.375%
  • 5 YEAR ARMS –  3.25-3.75% depending on the lender

More recently bonds seem to be rallying again so we may see another dip in mortgage rates but we will have to see and with Thanksgiving Day on the horizon things may be well be quiet for the rest of this week.

The economy

This has been less helpful for house prices.There may be a minor revision later but as we stand the third quarter did this.

Real gross domestic product (GDP) increased 1.9 percent in the third quarter of 2019, according to the “advance” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 2.0 percent. ( US BEA ).

Each quarter in 2019 has seen lower growth and that trend seems set to continue.

The New York Fed Staff Nowcast stands at 0.7% for 2019:Q4.

News from this week’s data releases increased the nowcast for 2019:Q4 by 0.3 percentage point.

Positive surprises from housing data drove most of the increase.

Something of a mixture there as the number rallied due to housing data from building permits and housing starts.Mind you more supply into the same demand could push future prices lower! But returning to the wider economy back in late September the NY Fed was expecting economic growth in line with the previous 5 months of around 2% in annualised terms.But now even with a rally it is a mere 0.7%.

Employment and Wages

The situation here has continued to improve.

Total nonfarm payroll employment rose by 128,000 in October, and the unemployment rate was little
changed at 3.6 percent, the U.S. Bureau of Labor Statistics reported today. Notable job gains occurred in
food services and drinking places, social assistance, and financial activities……..In October, average hourly earnings for all employees on private nonfarm payrolls rose by 6 cents to $28.18. Over the past 12 months, average hourly earnings have increased by 3.0 percent.

But the real issue here is the last number. Yes the US has wage gains and they are real wage gains with CPI being as shown below in October.

Over the last 12 months, the all items index increased 1.8 percent before seasonal adjustment.

So this should be helping although it is a slow burner at just over 1% per annum and of course we are reminded that according to the Ivory Towers the employment situation should mean that wage growth is a fair bit higher and certainly over 4% per annum.

Moving back to looking at house prices then wage growth is pretty much the same so houses are not getting more affordable on this criteria.

Comment

As we review the situation it is hard not to laugh at this from Federal Reserve Chair Jerome Powell on Monday.

While events of the year have not much changed the outlook,

You can take this one of two ways.Firstly his interest-rate cuts are not especially relevant or you can wonder why he did them? Looking at the trend for GDP growth does few favours to his statement nor for this bit.

Fortunately, the outlook for further progress is good

Indeed he seemed to keep contradicting himself.

 The preview indicated that job gains over that period were about half a million lower than previously reported. On a monthly basis, job gains were likely about 170,000 per month, rather than 210,000.

But I do note that house prices did get an implicit reference.

But the wealth of middle-income families—savings, home equity, and other assets—has only recently surpassed levels seen before the Great Recession, and the wealth of people with lower incomes, while growing, has yet to fully recover.

As to other signals we get told pretty much every day that the trade war is fixed so there is not a little fatigue and ennui on this subject. Looking at the money supply then it should be supportive but the most recent number for narrow money M1 at 6.8% shows a bit of fading too.

So whilst we may see a boost for the economy from around the spring of next year we seem set for more of the same for house prices.Unless of course the US Federal Reserve has to act again which with the ongoing Repo numbers is a possibility. The background is this though which brings me back to why central bankers are so keen on keeping on keeping house prices out of consumer inflation measures.Can you guess which of the lines below goes into the official CPI?

https://www.bourbonfm.com/blog/house-price-index-vs-owners-equivalent-rent-residences-1990

Whilst it is not sadly up to date it does establish a principle….

 

 

The mad world of negative interest-rates is on the march

Yesterday as is his want the President of the United States Donald Trump focused attention on one of our credit crunch themes.

Just finished a very good & cordial meeting at the White House with Jay Powell of the Federal Reserve. Everything was discussed including interest rates, negative interest, low inflation, easing, Dollar strength & its effect on manufacturing, trade with China, E.U. & others, etc.

I guess he was at the 280 character limit so replaced negative interest-rates with just negative interest. In a way this is quite extraordinary as I recall debates in the earlier part of the credit crunch where people argued that it would be illegal for the US Federal Reserve to impose negative interest-rates. But the Donald does not seem bothered as we see him increasingly warm to a theme he established at the Economic Club of New York late last week.

“Remember we are actively competing with nations that openly cut interest rates so that many are now actually getting paid when they pay off their loan, known as negative interest. Who ever heard of such a thing?” He said. “Give me some of that. Give me some of that money. I want some of that money. Our Federal Reserve doesn’t let us do it.” ( Reuters )

That day the Chair of the US Federal Reserve Jerome Powell rejected the concept according to CNBC.

He also rejected the idea that the Fed might one day consider negative interest rates like those in place across Europe.

The problem is that over the past year the 3 interest-rate cuts look much more driven by Trump than Powell.

Of course, there are contradictions.Why does the “best economy ever” need negative interest-rates for example? Or why a stock market which keeps hitting all-time highs needs them? But the subject keeps returning as we note yesterday’s words from the President of the Cleveland Fed.

Asked her view on negative interest rates, Mester told the audience that Europe’s use of them “is perhaps working better than I might have anticipated” but added she is not supportive of such an approach in the United States should there be a downturn.

Why say “working better” then reject the idea?  We have seen that path before.

The Euro area

As to working better then a deposit-rate of -0.5% and of course many bond yields in negative territory has seen the annual rate of economic growth fall to 1.1%. Also with the last two quarterly growth readings being only 0.2% it looks set to fall further.

So the idea of an economic boost being provided by them is struggling and relying on the counterfactual. But the catch is that such arguments are mostly made by those who think that the last interest-rate cut of 0.1% made any material difference. After all the previous interest-rate cuts that is simply amazing. Actually the moves will have different impacts across the Euro area as this from an ECB working paper points out.

A striking feature of the credit market in the euro area is the very large heterogeneity across countries in the granting of fixed versus adjustable rate mortgages.
FRMs are dominant in Belgium, France, Germany and the Netherlands, while ARMs are prevailing in Austria, Greece, Italy, Portugal and Spain (ECB, 2009; Campbell,
2012)

Actually I would be looking for data from 2019 rather than 2009 but we do get some sort of idea.

Businesses and Savers in Germany are being affected

We have got another signal of the spread of the impact of negative interest-rates .From the Irish Times.

The Bundesbank surveyed 220 lenders at the end of September – two weeks after the ECB’s cut its deposit rate from minus 0.4 to a record low of minus 0.5 per cent. In response 58 per cent of the banks said they were levying negative rates on some corporate deposits, and 23 per cent said they were doing the same for retail depositors.

There was also a strong hint that legality is an issue in this area.

“This is more difficult in the private bank business than in corporate or institutional deposits, and we don’t see an ability to adjust legal terms and conditions of our accounts on a broad-based basis,” said Mr von Moltke, adding that Deutsche was instead approaching retail clients with large deposits on an individual basis.

So perhaps more than a few accounts have legal barriers to the imposition of negative interest-rates. That idea gets some more support here.

Stephan Engels, Commerzbank’s chief financial officer, said this month that Germany’s second largest listed lender had started to approach wealthy retail customers holding deposits of more than €1 million.

Japan

The Bank of Japan has dipped its toe in the water but has always seemed nervous about doing anymore. This has been illustrated overnight.

“There is plenty of scope to deepen negative rates from the current -0.1%,” Kuroda told a semi-annual parliament testimony on monetary policy. “But I’ve never said there are no limits to how much we can deepen negative rates, or that we have unlimited means to ease policy,” he said. ( Reuters )

This is really odd because Japan took its time imposing negative interest-rates as we had seen 2 lost decades by January 2016 but it has then remained at -0.1% or the minimum amount. Mind you there is much that is crazy about Bank of Japan policy as this next bit highlights.

Kuroda also said there was still enough Japanese government bonds (JGB) left in the market for the BOJ to buy, playing down concerns its huge purchases have drained market liquidity.

After years of heavy purchases to flood markets with cash, the BOJ now owns nearly half of the JGB market.

In some ways that fact that a monetary policy activist like Governor Kuroda has not cut below -0.1% is the most revealing thing of all about negative interest-rates.

Switzerland

The Swiss found themselves players in this game when the Swiss Franc soared and they tried to control it. Now they find themselves with a central bank that combines the role of being a hedge fund due to its large overseas equity investments and has a negative interest-rate of -0.75%.

Nearly five years after the fateful day when the SNB stopped capping the Swiss Franc we get ever more deja vu from its assessments.

The situation on the foreign exchange market is still fragile, and the Swiss franc has appreciated in trade-weighted terms. It remains highly valued.

Comment

I have consistently argued that the situation regarding negative interest-rates has two factors. The first is how deep they go? The second is how long they last? I have pointed out that the latter seems to be getting ever longer and may be heading along the lines of “Too Infinity! And Beyond!”. It seems that the Swiss National Bank now agrees with me. The emphasis is mine.

This adjustment to the calculation basis takes account of the fact that the low interest rate environment around the world has recently become more entrenched and could persist for some time yet.

We have seen another signal of that recently because the main priority of the central banks is of course the precious and we see move after move to exempt the banks as far as possible from negative interest-rates. The ECB for example has introduced tiering to bring it into line with the Swiss and the Japanese although the Swiss moved again in September.

The SNB is adjusting the basis for calculating negative interest as follows. Negative interest will continue to be charged on the portion of banks’ sight deposits which exceeds a certain exemption threshold. However, this exemption threshold will now be updated monthly and
thereby reflect developments in banks’ balance sheets over time.

If only the real economy got the same consideration and courtesy. That is the crux of the matter here because so far no-one has actually exited the black hole which is negative interest-rates. The Riksbank of Sweden says that it will next month but this would be a really odd time to raise interest-rates. Also I note that the Danish central bank has its worries about pension funds if interest-rates rise.

A scenario in which interest rates go up
by 1 percentage point over a couple of days is not
implausible. Therefore, pension companies should
be prepared to manage margin requirements at
all times. If the sector is unable to obtain adequate
access to liquidity, it may be necessary to reduce the
use of derivatives.

Personally I am more bothered about the pension funds which have invested in bonds with negative yields.After all, what could go wrong?

 

 

What is the outlook for the US economy?

We see plenty of rhetoric about challenges and changes but the two biggest players in the world economy are the United States and the US Dollar. So it is time for us to peer under the bonnet again and let me open with the result from the third quarter.

Real gross domestic product (GDP) increased at an annual rate of 1.9 percent in the third quarter of 2019 , according to the “advance” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 2.0 percent. ( BEA )

There are several implications here of which the first is simply that this is better than we are seeing in most places with Germany and Japan reporting growth rates much lower in the last 24 hours. In general this is , however, weaker than last year although the last quarter of 2018 was particularly weak.

A supporting element for the US has been a strong labour market.

 Real disposable personal income increased 2.9 percent, compared with an increase of 2.4 percent.

Has the easier fiscal policy of President Trump been a factor? Yes but we simply get told this.

federal government spending,

If we shift to a potential consequence which is rising debt well actually the ability of the US to repay it looks strong too.

Current dollar GDP increased 3.5 percent, or $185.6 billion, in the third quarter to a level of $21.53 trillion. In the second quarter, GDP increased 4.7 percent, or $241.4 billion.

As you can see there has been an element of inflating away the debt in there.

What happens next?

The now cast system uses the latest official data to look ahead and just like last year it looks like being a weak end to the year.

The New York Fed Staff Nowcast stands at 0.7% for 2019:Q4.

News from this week’s data releases decreased the nowcast for 2019:Q4 by 0.1 percentage point.

Negative surprises from lower than expected exports and imports data accounted for most of the decrease.

Another factor in play is that the labour market is not providing the push it was.

Earnings growth is still below late 2018 levels……Payroll growth was moderate in October, but remained solid year-to-date.

Money Supply

Back on the 22nd February I posted my concerns about the prospects for 2019.

So we can expect a slowing economic effect from it as we note that some of the decline will be due to the QT programme…….So we move on with noting that a monetary brake for say the first half of 2019 has been applied to the economy.

Of course that was then and this is now as the reference to the now ended QT programme. For example this happened at the end of last month.

the Committee decided to lower the target range for the federal funds rate to 1-1/2 to 1-3/4 percent.

Yesterday saw Repo operations from the New York Fed which provided some US $73.6 billion of overnight liquidity and US $30.7 billion of 13 day liquidity. Thus the cash is flowing rather than being reduced and like so many things what was presented as temporary seems to keep going.

In accordance with the most recent FOMC directive, the Desk will continue to offer at least $35 billion in two-week term repo operations twice per week and at least $120 billion in daily overnight repo operations.

The Desk will also offer three additional term repo operations during this calendar period with longer maturities that extend past the end of 2019.  ( NY Fed )

That is for the next month and there will be more to come as they catch up with something we have been looking at for a couple of years now which is the year end demand for US Dollars.

These additional operations are intended to help offset the reserve effects of sharp increases in non-reserve liabilities later this year and ensure that the supply of reserves remains ample during the period through year end.

Returning to the money supply data you will not be surprised to read that the numbers have improved considerably. The outright fall of US $42 billion in the narrow money measure in March has been replaced by growth and indeed strong growth as both the last 3 months and 6 months have seen growth at an annual rate of the order of 8%. Back in February I noted that cash growth was strong and it was demand deposits which were weak and it is really the latter which have turned around. Demand deposits totalled US $1.45 trillion in March but had risen to US $1.57 trillion at the end of October.

Talk of the demise of what Stevie V called

Dirty cash I want you, dirty cash I need you, woh-oh
Money talks, money talks
Dirty cash I want you, dirty cash I need you, woh-oh

continues which is rather the opposite of official rhetoric.

Thus a monetary stimulus has been applied and for those of you who like to look at this in real terms might now that the inflation measures in GDP have faded making the impetus stronger for say the opening and spring of 2020.

Have the Repo operations influenced this? If you look at the September data I think that they have. But this comes with a cautionary note as QE operations do not flow into the monetary data as obviously as you might think and at times in the Euro area for example have perhaps taken quite a while.

Credit

By contrast a bit of a brake was applied in September.

Consumer credit increased at a seasonally adjusted annual rate of 5 percent during the third quarter. Revolving credit increased at an annual rate of 2-1/4 percent, while nonrevolving credit increased at an annual rate of 6 percent. In September, consumer credit increased at an annual rate of 2-3/4 percent.

Those sort of levels would have the Bank of England at panic stations. It makes me wonder if fears over the financial intermediation of the banks was a factor in the starting of Repo operations?

If you are wondering if car loans are a factor here we only get quarterly data and as of the end of the third quarter the annual rate of growth was 4.3% so definitely, maybe.

The US Dollar

The official view is expressed like this.

NEW YORK (Reuters) – President Donald Trump on Tuesday renewed his criticism of the Federal Reserve’s raising and then cutting of interest rates, saying the central bank had put the United States at a competitive disadvantage with other countries and calling for negative interest rates.

He wants lower interest-rates and a lower US Dollar. What we have seen is a trade-weighted index which has risen from 116 in February of last year to above 129 as I type this. So not much luck for the Donald

Comment

As you can see things are better than some doom mongers would have us believe. The monetary situation has picked up albeit with weaker consumer credit and there is the fiscal stimulus. But that is too late for this quarter and there are ongoing issues highlighted by the weak data we have seen out of China this week which the New York Fed summarises like this.

China’s monthly economic activity data is steady at a lower level.

Then there is the ongoing sequence of interest-rate cuts around the world which rose by 2 yesterday as Mexico and Egypt got on the bandwagon. That makes 770 for the credit crunch era now.

Meanwhile for those who have equities the Donald thinks that life is good.

Hit New Stock Market record again yesterday, the 20th time this year, with GREAT potential for the future. USA is where the action is. Companies and jobs are coming back like never before!

 

 

 

 

 

 

The central banks are losing their grip as well as the plot

The last 24 hours have shown an instance of a central bank losing its grip and another losing the plot. This is significant because central banks have been like our overlords in the credit crunch era as they slashed interest-rates and when that did not work expanded their balance sheets using QE and when that did not work cut interest-rates again and did more QE. This made Limahl look rather prescient.

Neverending story
Ah
Neverending story
Ah
Neverending story
Ah

Also in terms of timing we have today the last policy meeting of ECB President Mario Draghi who has been one of the main central banking overlords especially after his “What ever it takes ( to save the Euro) ” speech. Next month he will be replaced by Christine Lagarde who has given an interview to 60 Minutes in the US.

Christine Lagarde shows John Dickerson how she fakes drinking wine at global gatherings.

US Repo Problems

Regular readers will recall that we looked at the words of US Federal Reserve Chair Jerome Powell on the 9th of this month.

To counter these pressures, we began conducting temporary open market operations. These operations have kept the federal funds rate in the target range and alleviated money market strains more generally.

This involved various moves as the overnight Repos found this added too.

Term repo operations will generally be conducted twice per week, initially in an offering amount of at least $35 billion per operation.

These have been for a fortnight and added to this was a purchase programme for Treasury Bills.

In accordance with this directive, the Desk plans to purchase Treasury bills at an initial pace of approximately $60 billion per month, starting with the period from mid-October to mid-November.

Regular readers will recall that I described this as a new version of QE and it has turned out that the Treasury Bill purchases will be larger than the early estimates by at least double.

This theme of “More! More! More!” continued yesterday with this announcement from the New York Federal Reserve.

Consistent with the most recent FOMC directive, to ensure that the supply of reserves remains ample even during periods of sharp increases in non-reserve liabilities, and to mitigate the risk of money market pressures that could adversely affect policy implementation, the amount offered in overnight repo operations will increase to at least $120 billion starting Thursday, October 24, 2019.  The amount offered for the term repo operations scheduled for Thursday, October 24 and Tuesday, October 29, 2019, which span October month end, will increase to at least $45 billion.

Apologies for their wordy opening sentence but I have put it in because it contradicts the original statement from Jerome Powell. Because the “strains” seem to be requiring ever larger interventions. Or as Brad Huston puts it on Twitter.

9/17: We’re doing repos today and tomorrow.

9/19: We’re extending repos until 10/10. $75B overnight, $30B term

10/4: We’re extending repos until 11/4

10/11:We’re extending repos until Jan 2020

10/23:We’re expanding overnight repo offering to $120B, $45B term

This reinforces the point that I believe is behind this as I pointed out on the 25th of September

The question to my mind going forwards is will we see a reversal in the QT or Quantitative Tightening era? The supply of US Dollars is now being reduced by it and we wait to see what the consequences are.

This added to the US Dollar shortage we have been looking at for the past couple of years or so. It would seem that the US Federal Reserve is worried about a shortage at the end of this month which makes me wonder what they state of play will be at the year end when many books are squared? Also in terms if timing we will get the latest repo announcement at pretty much the same time as Mario Draghi starts his final ECB press conference.

The Riksbank of Sweden

It has made this announcement today.

In line with the forecast from September, the Executive Board has therefore decided to leave the repo rate unchanged at –0.25 per cent. As before, the forecast indicates that the interest rate will most probably be raised in December to zero percent.

I will come to my critique of this in a moment but we only have to progress another sentence or two to find that the Riksbank has provided its own critique.

The forecast for the repo rate has therefore been revised downwards and indicates that the interest rate will be unchanged for a prolonged period after the expected rise in December.

That is really quite a mess because we are supposed to take notice of central bank Forward Guidance which is now for lower interest-rates which will be achieved by raising them! Time for a reminder of their track record on this front.

As you can see their Forward Guidance has had a 100% failure rate. You do well by doing the reverse of what they say. As for now well you really could not make the bit below up!

If the prospects were to change, monetary policy may need to be adjusted going forward. Improved prospects would justify a higher interest rate. If the economy were instead to develop less favourably, the Executive Board could cut the repo rate or make monetary policy more expansionary in some other way.

QE

Well that never seems to go away does it?

In accordance with the decision from April 2019, the Riksbank is purchasing government bonds for a nominal total amount of SEK 45 billion, with effect from July 2019 to December 2020.

The central bank will keep the government sweet by making sure it can borrow very cheaply. The ten-year yield is negative albeit only just ( -0.03%) although in an undercut Sweden is running a fiscal surplus. That becomes really rather odd when we look at the next bit.

The Economy

I have criticised the Riksbank for pro-cyclical monetary policy and it seems set to do so again.

after several years of good growth and
strong economic activity, the Swedish economy is now growing more slowly.

So they have cut interest-rates in the good times and now seem set to raise them in weaker times.

Next comes this.

As economic activity has entered a phase of lower growth in
2019, the labour market has also cooled down. Unemployment is deemed to have increased slightly during the year.

If we switch to last week’s release from Sweden Statistics we see something of a challenge to the “increased slightly” claim.

In September 2019 there were 5 110 000 employed persons. The unemployment rate was 7.1 percent, an increase of 1.1 percentage points compared with September 2018……In September 2019, there were 391 000 unemployed persons aged 15─74, not seasonally adjusted, an increase of 62 000 compared with September 2018.

If we move to manufacturing then the world outlook seemed to hit Sweden in pretty much one go in September according to Swedbank.

The PMI dropped by 5.5 points in September to 46.3 from a downward revision of 51.8 in August. This is the largest monthly decline since autumn 2008 and was part of the reason why the PMI fell in the third quarter to the lowest level since early 2013.

Comment

The US Federal Reserve is the world’s central bank of last resort and currently that is not going especially well. So far it has added around US $200 billion to its balance sheet and seems set to push it back over US $4 trillion. Yet the problem seems to be hanging around rather than going away as it feels like a plaster is being applied to a broken leg. A gear or two is grinding in the banking system.

Moving to Sweden we see a case of a central bank adopting pro-cyclical monetary policy and now finds itself planning to raise interest-rates in a recession. Yet the rise seems to make interest-rates lower in the future! I am afraid the Riksbank has really rather jumped the shark here. It now looks as if it has decided that negative interest-rates are a bad idea which I have a lot of sympathy with but as I have argued many times the boom was the time to end it.

Sweden has economic growth of 4% with an interest-rate of -0.5% ( 28th of July 2017)

The Investing Channel

Why inflation is bad for so many people

Today I wish to address what is one of the major economic swizzles of our time. That is the drip drip feed by the establishment and a largely supine media that inflation is good for us, and in particular an inflation rate of 2% per annum is a type of nirvana. This ignores the fact that that particular number was chosen by the Reserve Bank of New Zealand because it “seemed right” back in the day. There was no analysis of the benefits and costs.

On the other side of the coin there has been a major campaign against low or no inflation claiming it is the road to deflation which is presented as a bogey(wo)man. There are several major problems with this. The first is that many periods of human economic advancement are exhibited this such as the Industrial Revolution in the UK. Or more recently the enormous advances in technology, computing and the link in more modern times. On the other side of the coin we see inflation involved in economies suffering deflation. For example Greece saw consumer inflation rising at an annual rate of over 5% in the early stages of its economic depression. That was partly due to the rise in consumer taxes or VAT but the ordinary Greek will simply feel it as paying more. Right now we see extraordinary economic dislocation in Argentina where a monthly inflation rate of 4% in August comes with this from Reuters.

The country’s economy shrank 2.5% last year and 5.8% in the first quarter of 2019. The government expects a 2.6% contraction this year.

Argentina’s unemployment rate also rose to 10.6% in the second quarter from 9.6% in the same period last year, the official INDEC statistics agency said on Thursday.

The Euro Area

The situation here is highlighted by this release from the German statistics office this morning.

Harmonised index of consumer prices, September 2019
+0.9% on the same month a year earlier (provisional result confirmed)
-0.1% on the previous month (provisional result confirmed)

This is around half of the European Central Bank or ECB inflation target so let us switch to its view on the subject.

Today’s decisions were taken in response to the continued shortfall of inflation with respect to our aim. In fact, incoming information since the last Governing Council meeting indicates a more protracted weakness of the euro area economy, the persistence of prominent downside risks and muted inflationary pressures. This is reflected in the new staff projections, which show a further downgrade of the inflation outlook.

That is from the introductory statement to the September press conference. As you can see it is a type of central banking standard. But later Mario Draghi went further and to the more intelligent listener gave the game away.

The reference to levels sufficiently close to but below 2% signals that we want to see projected inflation to significantly increase from the current realised and projected inflation figures which are well below the levels that we consider to be in line with our aim.

My contention is that this objective makes the ordinary worker and consumer worse off.

Real Wages

The behaviour of real wages has changed a lot in the credit crunch era. If we look at my home country the UK we see that nominal wage growth has only recently pushed above an annual rate of 4%. But if we look at the Ivory Tower style projections of the OBR it should have pushed above 5% years ago based on Phillips Curve style analysis like this from their report on the 2010 Budget.

Wages and salaries growth rises gradually throughout the forecast, reaching 5½ percent in 2014…………Thereafter, the more rapid increase in employment is sufficient to lower unemployment, so that the ILO unemployment rate falls to
6 per cent in 2015.

As you can see wages growth was supposed to be far higher than now when unemployment was far higher. If they knew the number below was associated with a UK unemployment rate of below 4% their computers would have had a moment like HAL-9000 in the film 2001 A Space Odyssey.

The equivalent figures for total pay in real terms are £502 per week in July 2019 and £525 in February 2008, a 4.3% difference.

Real pay still has some distance to go to reach the previous peak even using a measure of inflation ( CPIH) that is systematically too low via its use of Imputed Rents to measure owner-occupied housing inflation.

It is the change here which means that old fashioned theories about inflation rates are now broken but the Ivory Tower establishment has turned a Nelsonian style blind eye to it. Let me illustrate by returning to the ECB press conference.

While labour cost pressures strengthened and broadened amid high levels of capacity utilisation and tightening labour markets, their pass-through to inflation is taking longer than previously anticipated. Over the medium term underlying inflation is expected to increase, supported by our monetary policy measures, the ongoing economic expansion and robust wage growth.

This is the old assumption that higher inflation means higher wage growth and comes with an implicit assumption that there will be real wage growth. But we have learnt in the credit crunch era that not only are things more complex than that at times things move in the opposite direction. There is no former rejection of Phillips Curve style thinking than the credit crunch history of my country the UK. Indeed this from the Czech National Bank last year is pretty damning of the whole concept.

Wage dynamics in the euro area remain subdued even ten years after the financial crisis. Nominal wage growth1 has seldom exceeded 2% since 2013 (see Chart 1). Wages have not accelerated significantly even since 2014, when the euro area began to enjoy rising economic growth and falling unemployment. Following tentative signs of increasing wage growth in the first half of 2017, wages slowed in the second half of the year.

Comment

It is the breakdown of the relationship between wages and inflation that mean that the 2% inflation target is now bad for us. The central bankers pursue it because one part of the theory works in that gentle consumer inflation helps with the burden of debt. The catch is that as we switch to the ordinary worker and consumer they are not seeing the wage increases that would come with that in the Ivory Tower theory. In the UK it used to be assumed that real wage growth would be towards 2% per annum whereas in net terms the credit crunch era has shown a contraction.

If we look at the United States then last week’s unemployment report gave us another signal as we saw these two factors combine.

The unemployment rate declined to 3.5 percent in September, and total nonfarm
payroll employment rose by 136,000, the U.S. Bureau of Labor Statistics reported
today………In September, average hourly earnings for all employees on private nonfarm payrolls,
at $28.09, were little changed (-1 cent), after rising by 11 cents in August. Over the
past 12 months, average hourly earnings have increased by 2.9 percent.

It is only one example but an extraordinary unemployment performance saw wage growth fall. There have been hundreds of these butt any individual example the other way is presented as a triumph for the Phillips Curve. Yet the US performance has been better than elsewhere.

Oh did I say the US has done better, Here is the Pew Research Center from last year.

After adjusting for inflation, however, today’s average hourly wage has just about the same purchasing power it did in 1978, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms average hourly earnings peaked more than 45 years ago: The $4.03-an-hour rate recorded in January 1973 had the same purchasing power that $23.68 would today.

All of this is added to by the way that rises in the cost of housing are kept out of the consumer inflation numbers so they can be presented as beneficial wealth effects instead.

A new era of US QE starts with it being renamed Reserve Management

Last night saw something of an epoch making event as all eyes turned to Denver Colorado. This time it was not for the famous “hurry up offence” of John Elway in the NFL but instead there was a speech by Jerome Powell the Chair of the US Federal Reserve. In it he confirmed something I have been writing about on here for some time and the emphasis is mine.

Reserve balances are one among several items on the liability side of the Federal Reserve’s balance sheet, and demand for these liabilities—notably, currency in circulation—grows over time. Hence, increasing the supply of reserves or even maintaining a given level over time requires us to increase the size of our balance sheet. As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves. That time is now upon us.

This of course raises my QE ( Quantitative Easing) to infinity theme. I also note Chair Powell raises the issue of the balance sheet so let us look at that. It peaked at around US $4.5 trillion as we moved into 2015 and stayed there until October 2017 when the era of QT ( Quantitative Tightening) or reverse QE began and it began to shrink. Over the last year it shrank from US $4.17 trillion to US $3.76 trillion before the repo crisis struck.

In mid-September, an important channel in the transmission process—wholesale funding markets—exhibited unexpectedly intense volatility. Payments to meet corporate tax obligations and to purchase Treasury securities triggered notable liquidity pressures in money markets. Overnight interest rates spiked, and the effective federal funds rate briefly moved above the FOMC’s target range. To counter these pressures, we began conducting temporary open market operations. These operations have kept the federal funds rate in the target range and alleviated money market strains more generally.

What this misses out is that US Dollar liquidity has been singing along with Queen for some time.

Pressure: pushing down on me,
Pressing down on you, no man ask for.
Under pressure that burns a building down,
Splits a family in two,
Puts people on streets.

Here I am from the 25th of September last year.

The question to my mind going forwards is will we see a reversal in the QT or Quantitative Tightening era? The supply of US Dollars is now being reduced by it and we wait to see what the consequences are.

As you can see the phrase “unexpectedly intense volatility” is not true of anyone who is a follower of my work. One way of looking at this is that forwards pricing of the US Dollar has been in the wrong place for theory. This is one of the reasons why German bond yields have gone so negative ( as I type this the benchmark ten-year yield is -0.58%) because if you try to switch to US Treasury Bonds to gain the 1.54% or 2% higher yield you find that exchange rates take away the gain. To get a higher yield you have to take an exchange rate risk. Returning to the Chair Powell statement we see that it is more realistic to say we were hovering near an edge and then slipped over it.

If we return to the balance sheet we see that it has risen to US $3.95 trillion for a rise of the order of 190 billion in response to the repo crisis. The exact amount varies daily with the individual repo operations and also fortnightly as we now have those too. Just as an example the difference between the operations on Monday and yesterday was some US $9.55 billion lower. I point this out as some places have been claiming you add the repo operations up which is really rather odd when most so far only have the lifespan of a Mayfly.

Those who analyse events via the prism of bank reserves should be happy with this bit.

Indeed, my colleagues and I will soon announce measures to add to the supply of reserves over time. Consistent with a decision we made in January, our goal is to provide an ample supply of reserves to ensure that control of the federal funds rate and other short-term interest rates is exercised primarily by setting our administered rates and not through frequent market interventions.

An official denial

By now you should all know how to treat this.

I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis.

Indeed the next part is simply untrue or if you are less kind a lie.

Neither the recent technical issues nor the purchases of Treasury bills we are contemplating to resolve them should materially affect the stance of monetary policy, to which I now turn.

One of the roles of a central bank is setting interest-rates as part of monetary policy. Those who follow my podcasts will know I defined it as there second role after the existence and provision of a currency, in this case the US Dollar. Briefly monetary policy was affected as overnight interest-rates went outside the official range as described below by the Financial Times.

the pressures that bubbled up in September and sent the cost of borrowing cash overnight via repurchase, or repo, agreements as high as 10 per cent.

That is not as large as you might think as the impact is only for each day but it was way outside the official range. Also there were times when the role of a central bank was in setting the interest-rate for overnight money in terms of its monetary policy. The credit crunch moved events along as that did not have the hoped for impact on the real economy ( and hence we got QE) but the underlying principle remains.

Comment

So we find that the new version of Quantitative Easing or what will no doubt be called QE4 had the champagne bottle smashed on it last night by Jerome Powell as it got ready to go down to the slipway. It remains for it to be fully fitted out as I do not believe it will stop here.

making the case instead for the Fed to buy anywhere from $200bn to more than $300bn of shorter-dated Treasury bills over the next six months. ( Financial Times)

As you can see the lower estimate pretty much coincides with the change in the balance sheet do far with the repo operations. The larger amount perhaps aims for some sort of margin.

The difference between this and the QE we have seen so far is the term of the assets purchased. Treasury Bills last for up to a year whereas Treasury Bonds are for longer periods of time with what is called the long bond being for thirty-years. Also bills do not pay interest as you pay less for them to allow for that.

So there are minor differences with past QE efforts but the direction of travel is the same. Let me put it another way with this from the US Federal Reserve,

Total assets of the Federal Reserve have increased significantly from $870 billion on August 8th, 2007

They have indeed as we wonder how long it will be before we get back to the previous peak of US $4.5 trillion and presumably beyond.

If QE really worked it would not need so many new names would it? Japan now calls it QQE and now the US calls it reserve management. Perhaps Governor Carney will call it climate-related QE.