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.

 

 

 

Is this the manufacturing recession of 2019?

The year so far has seen increasing focus on a sector of the economy that has been shrinking in relative terms for quite some time. Actually in the credit crunch era it has in some places shrunk in absolute terms as this from my home country illustrates.

Production and manufacturing output have risen since then but remain 7.1% and 3.1% lower, respectively, for July 2019 than the pre-downturn peak in February 2008.

This means that it is now a little over 10% of total UK GDP and so it is completely dwarfed by the services sector which is marching on its way to 80%.Thus we have a context that the current concern about a recession is odd in the sense that we have in fact been in a depression as output more than a decade later is below the previous peak.Yet there is much less concern over that.

We learn more from the detail of the breakdown from the official analysis of the period 2008-18.

The recovery of the manufacturing sector from the 2008 recession has been heavily dependent upon four out of the 24 industries; manufacture of food, motor vehicles, other transport equipment and repair of machinery………..Without the positive impact of these four industries, the Index of Manufacturing in Quarter 4 (Oct to Dec) 2018 would still be below its lowest value during the 2008 recession.

There is always a danger in any analysis that excludes the things that went up but we do learn that there has been quite a shift. Also a lot of the sector has been in an even worse depression than the average. Then we have the situation where two of the fantastic four currently have problems to say the least.

However caution is required as I so often observe and today it is highlighted by this.

The pharmaceutical industry was a strong performer during the recession; at the industry’s highest point in April 2009 the industry had grown by 22% since Quarter 1 (Jan to Mar) 2008. However, the industry would steadily decline from this point over the decade and would finish in Quarter 4 (Oct to Dec) 2018 23% below its Quarter 1 2008 value, though some of this decline is due to business restructuring.

Something looks wrong with that and if I was in charge I would be looking further as to whether this is/was really like for like. For newer readers I looked because in recent times the pharmaceutical sector has been a strength in the data albeit with erratic swings.

The United States

If we now switch from an underlying issue of depression in some countries to the more recent one of recession well this from the Institute of Supply Management or ISM yesterday upped the ante.

Manufacturing contracted in September, as the PMI® registered 47.8 percent, a decrease of 1.3 percentage points from the August reading of 49.1 percent. This is the lowest reading since June 2009, the last month of the Great Recession, when the index registered 46.3 percent.

This seemed to catch out quite a few people and led to some extraordinary responses like this on CNBC.

“There is no end in sight to this slowdown, the recession risk is real,” Torsten Slok, chief economist at Deutsche Bank said in a note Tuesday after the report.

I agree on the recession risk but “no end in sight”? That applies more to the problems Deutsche Bank itself faces. If we switch to the detail there are some clear things to note which is that is showed a more severe contraction and that the “Great Recession” klaxon was triggered. Furthermore the trade war influence was impossible to avoid.

ISM®’s New Export Orders Index registered 41 percent in September, 2.3 percentage points lower compared to the August reading of 43.3 percent, indicating that new export orders contracted for the third month in a row. “The index had its lowest reading since March 2009 (39.4 percent).

The news reached the Donald and his response was to sing along with “It wasn’t me ” by Shaggy.

As I predicted, Jay Powell and the Federal Reserve have allowed the Dollar to get so strong, especially relative to ALL other currencies, that our manufacturers are being negatively affected. Fed Rate too high. They are their own worst enemies, they don’t have a clue. Pathetic!

So far this has not reached the official output numbers. Here is the August announcement from the Federal Reserve.

Manufacturing production increased 0.5 percent, more than reversing its decrease in July. Factory output has increased 0.2 percent per month over the past four months after having decreased 0.5 percent per month during the first four months of the year.

Putting it another way the output level in August was 105.2 which was the same as March. So according to the official data the only impact it has picked up is an end to growth if we try to look through the monthly ebbs and flows.

The World

There is a survey conducted on behalf of JP Morgan which yesterday told us this.

National PMI data signalled deteriorations in overall business conditions in 15 of the countries covered. Among the larger industrial regions, growth was registered in both the US and China. In contrast, Japan saw further contraction while the downturn in the euro area deepened. The rate of decline in the eurozone was the fastest in almost seven years, mainly due to a sharp deterioration in the performance of Germany.

They showed a slight improvement to 49.7 but there is the issue of the US where JP Morgan thinks there has been growth whereas the ISM as we have just observed does not. Here is the Markit PMI view on a possible reason.

Divergence is possibly related to ISM membership skewed towards large multinationals. IHS Markit panel is representative mix of small, medium and large (and asks only about US operations, so excludes overseas facilities)

Financial markets hit the ISM road and were probably also influenced by this from Bloomberg.

Results were disastrous for leading Asian automakers such as Toyota Motor Corp. and Honda Motor Co., which each suffered double-digit declines that were worse than analysts expected. While a fuller picture will emerge Wednesday when General Motors Co (NYSE: GM). and Ford Motor (NYSE:F) Co. are due to report, the poor performance suggests that overall deliveries of cars and light trucks could come in worse than the 12% drop anticipated by analysts, based on six estimates.

Comment

There are various strands to this of which the first is the motor industry. In the credit crunch era it has seen a lot of support ranging from “cash for clunkers” style operations to much cheaper credit. In the UK it is often cheaper to buy via credit that to pay up front which is part of the theme that has seen this according to the Finance and Leasing Association.

 Over 91% of all private new car registrations in the UK were financed by FLA members.

That seems to be wearing off so we were due something of a dip and that has been exacerbated by the diesel crisis where buyers have understandably lost faith after the dieselgate scandal and the ongoing emissions issue.

Politicans are regularly on the case which was highlighted in the UK by the “march of the makers” claim of former Chancellor George Osbourne. Whilst there was some growth it was hardly a march and now we have President Trump pushing manufacturing as part of MAGA but more latterly giving it a downwards tug with his trade war.

Then there is the issue of green policies which have to lead to less manufacturing but get deflected onto talk of more solar panels and windmills and the like. On that road the depression theme returns.

 

What are the prospects for the US economy?

We find ourselves in a curious situation as we wait for ( or for readers over the weekend) mull the speech of Fed Chair Jerome Powell at Jackson Hole. There are several reasons for this and let me start with the pressure being applied by President Trump.

Germany sells 30 year bonds offering negative yields. Germany competes with the USA. Our Federal Reserve does not allow us to do what we must do. They put us at a disadvantage against our competition. Strong Dollar, No Inflation! They move like quicksand. Fight or go home!…….The Economy is doing really well. The Federal Reserve can easily make it Record Setting! The question is being asked, why are we paying much more in interest than Germany and certain other countries? Be early (for a change), not late. Let America win big, rather than just win!

We can see that The Donald has spotted that the US Dollar is strong with reports that the broad trade-weighted index is at an all time high. Care is needed with that as it starts in 1995 and the Dolllar peak was a decade before it, but the basic premise holds. But the real issue here is of course calling for interest-rate cuts when you are saying that the economy is strong! Is it?

Nowcasting

Let me hand you over to the Atlanta Fed.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2019 is 2.2 percent on August 16, unchanged from August 15 after rounding. After this morning’s new residential construction report from the U.S. Census Bureau, the nowcast of third-quarter real residential investment growth increased from -1.2 percent to 0.7 percent.

That is not appreciably different to the New York Fed which has estimated 1.8%. So let us go forwards with 2% as an average. In terms of past definitions from President Trump ( 3%-4%) that is not doing really well but is hardly a call for an interest-rate cut.

Business Surveys

Something caught the eye yesterday in the Markit PMI survey.

The seasonally adjusted IHS Markit Flash U.S.
Manufacturing Purchasing Managers’ Index™
(PMI™) registered 49.9 in August, down from 50.4
in July and below the neutral 50.0 threshold for the
first time since September 2009.

The eye-catching elements were it going below the neutral threshold and the fact this is the lowest reading for nearly a decade. Some of this is symbolism as the PMI is not accurate to anything like 0.1 but there is also the downwards direction of travel. Also it had a consequence as we look wider.

August’s survey data provides a clear signal that
economic growth has continued to soften in the third
quarter. The PMIs for manufacturing and services
remain much weaker than at the beginning of 2019
and collectively point to annualized GDP growth of
around 1.5%

So we started with ~2% and now are at 1.5%.Prospects look none too bright either.

The past isn’t what we thought it was

Earlier this week we saw quite a revision affecting employment trends.

For national CES employment series, the annual benchmark revisions over the last 10 years have averaged plus or minus two-tenths of one percent of total nonfarm employment. The preliminary estimate of the benchmark revision indicates a downward adjustment to March 2019 total nonfarm employment of -501,000 (-0.3 percent).

This begs several questions as it means the monthly non-farm payroll numbers were too high in the year to March by more than 40,000 a month. The worst problem areas were retailing,,professional and business services and leisure and hospitality.

The change in the picture is covered by MarketWatch.

“This makes some sense, as the 223,000 average monthly increase in 2018 seemed too good to be true in light of how tight the labor market has become and how much trouble firms are said to be having finding qualified workers,” said chief economist Stephen Stanley of Amherst Pierpont Securities

In a sense that is both good and bad as he implies the economy might be at a literal version of full employment, at least in some areas. The bad is that growth was weaker than thought.

Money Supply

Back on the eighth of May I posted this warning.

The narrow measure of the money supply or M1 in the United States saw a fall of just over forty billion dollars in March. That catches the eye because it does not fit at all with an economy growing at an annual rate of 3.2%. Indeed we see now that over the three months to March M1 money supply contracted by 2.7%. That means that the annual rate of growth has been reduced to 1.9%. Thus we see that it has fallen below the rate of economic growth recorded which is a clear warning sign. Indeed a warning sign which has worked very well elsewhere.

That has played out and whilst it is a coincidence that the annual rate of economic growth seems now to be what narrow money supply growth was the broad sweep has worked. However that was then and this is now because M1 has been on something of a tear and the last three months have seen annualised growth of 8% pulling the actual annual rate of growth to 4.8%.

Will it be “Boom!Boom! Boom!” a la the Black-Eyed Peas? Well thank you to @RV3003 on twitter who drew my attention to this from Hosington.

First, Treasury deposits at the Fed, which
are not included in M2, fell dramatically as a
result of special measures taken to avoid hitting
the debt ceiling, thus giving M2 a large boost as
Treasury deposits moved to the private sector.
Once the debt ceiling is raised, Treasury deposits
will rebound, reversing the process and slowing
M2 growth.

Did this affect M1? Well maybe as demand deposits have risen by US $75 billion since the March and since the debt ceiling was raised they have fallen back by US $14 billion.

As you can imagine I will be tapping my foot waiting for the next monthly update. Fake money supply growth?

Comment

We can see that the US economy has slowed but if the money supply data is any guide is simply slowing for a bit and may then pick up. That scenario does not fit with the way that bond markets have surged expecting more interest-rate cuts. In fact bond market analysts are arguing that the Federal Reserve needs to cut interest-rates to keep up and avoid losing control, although they are not entirely clear what it would be losing control of.

So I have a lot of sympathy with Jerome Powell who has a very difficult speech to give today. The picture is murky and I would wait for more money supply data before giving any hints of what I would do next. In short I would be willing to be sacked rather than bowing to Presidential pressure.

 

 

In the future will all mortgage rates be negative?

Today I thought that I would look at some real world implications of the surge in bond markets which has led to lower and in more than a few cases ( Germany and Switzerland especially) negative bond yields. The first is that government’s can borrow very cheaply and in the case of the two countries I have mention are in fact being paid to borrow at any maturity you care to choose. This gets little publicity because government’s prefer to take the credit themselves. My country the UK is an extreme case of this as the various “think tanks” do all sorts of analysis of spending plans whilst completely ignoring this basic fact as if a media D-Notice has been issued. I would say that “think tank” is an oxymoron except in this instance I think you can take out the oxy bit.

Negative Mortgage Rates

Denmark

Back on the 29th of May we were already on the case.

Interest rates on Danish mortgage loans have fallen since 2008. From an average interest rate including administration fee of close to 6 per cent in 2008 to under 2.2 per cent in August 2018. This is the lowest level since the beginning of the statistics in 2003.

Back then we also observed this.

For one-year adjustable-rate mortgage bonds, Nykredit’s refinancing auctions resulted in a negative rate of 0.23%. The three-year rate was minus 0.28%, while the five-year rate was minus 0.04%.

As you can see at the wholesale or institutional level interest-rates had gone negative and the central bank the Nationalbanken had seen reductions in the fees added to these as well.

That was then but let us pick up the pace and move forwards to the 2nd of this month. Here is The Local in Denmark.

Mortgage provider Realkredit Danmark will next week start offering Denmark’s cheapest ever 30-year mortgage, with an interest rate of just 0.5 percent per year. The fixed-rate 30-year loan is the lowest interest mortgage ever seen in Denmark, and is likely to be matched by Realkredit competitor Nordea Kredit.

That implied negative mortgage rates at shorter maturities although we already knew that but this week things have taken a further step forwards or perhaps I should write backwards. From Bloomberg.

In the world’s biggest covered-bond market, a Danish bank says it’s now ready to sell 10-year mortgage-backed notes at a negative coupon for the first time.

It’s the latest record to be set in a world that’s being dragged down by ever lower interest rates. In Denmark, where Jyske Bank will offer 10-year mortgage bonds at a fixed rate of minus 0.5 per cent, average Danes will borrow at rates far lower than those at which the US government can sell its debt.

Since then things have taken a further step as Nordea has started offering some mortgage bonds for twenty years at 0%, So we have nice even 0.5% changes every ten years.

If we look at Finance Denmark it tells us that variable rate mortgage bonds are at -0.67% in Danish Kroner and -0.83% in Euro in the 31st week of this year with a noticeable 0.2% drop in Euro rates.

This is impacting on business as we see that the latest three months have seen over 30,000 mortgages a month taken out peaking at 39,668 in June. This compares to 16/17k over the same 3 months last year so quite a surge. If we switch to lending volumes then the Danish mortgage banks lent more than double ( 212 billion Kroner) in the second quarter of this year.

Also as the Copenhagen Post points out whilst it may seem that negative mortgages are easy to get banks will behave like banks.

Banks are set to make money from the mortgage loan restructuring.

“We are in the process of a huge conversion wave, and the banks are of course also very interested in talking about that. Because they make good money every time a new loan is taken up,” explained Morten Bruun Pedersen, a senior economist at the Consumer Council, to TV2.

These days banks make money from fees and charges as there is no net interest income and on that subject we have a curiousity. On the one hand Danes are behaving rationally by switching to cheaper mortgages on the other the data from the Nationalbanken is from earlier this year but they have around 900 billion Kroner on deposit at 0% which is less rational and will have central banking Ivory Towers blowing out plenty of steam.

So whilst there are some negative mortgage rates the fees added are doing their best to get them into positive territory. The Nationalbanken highlights this here.

In 2018, Danish households paid an average interest rate of 1.20 per cent on their mortgage debt along with 0.96 per cent in administration fees.

I guess someone has to pay the banks money laundering fines

Just for research purposes I looked at borrowing 2 million Kroner on the Danske bank website and after 30 years I would have repaid 2.2 million so not much extra but it was positive.

Portugal

It has not been reported on much but there was an outbreak of negative mortgage rates in Portugal as this from Portugal on the move highlights.

The new law forces banks to reflect Euribor negative interest in home loan contracts. It was supported by all political parties in the country except the centre-right PSD which abstained.

The bill, which the banks and the Bank of Portugal tried to block, applies to all mortgages index-linked to Euribor rates.

Above all the law will benefit those with Euribor mortgages with very low spreads (commercial margins of banks), at around 0.30%.

The law allows for Euribor rates, currently in the negative across all terms, should be reflected in contracts, even after the cancelled spread, which implies a capital payout.

Typical that the banks would try to evade their obligations and notable that the Bank of Portugal could not look beyond “The Precious”

UK

When the credit crunch hit the UK saw a brief burst of negative mortgage rates. This was caused by the market being very competitive and mortgages being offered below Bank Rate and so much so that when it plunged to 0.5% some went negative. The most famous was Cheltenham and Gloucester and I forget now if it went to -0.02% or -0.04%.

This had wider consequences than you might think as banking systems were unable to cope and repaid capital rather than recording a negative monthly repayment. That was echoed more recently in the saga in Portugal above. A consequence of this was that the Bank of England went white faced with terror muttering “The Precious! The Precious!” and did not cut below an interest-rate of 0.5%. This was the rationale behind Governor Carney;s later statements that the “lower bound” was 0.5% in the UK.

If you are wondering how he later cut to 0.25% please do not forget that the banks received an around £126 billion sweetener called the Term Funding Scheme.

Comment

So we have seen that there are negative mortgage rates to be found and that we can as a strategy expect more of them. After all it was only yesterday we saw 3 central banks cut interest-rates and I expect plenty of others to follow. A reduction in the ECB Deposit Rate (-0.4%) will put pressure on the Danish CD rate ( -0.65%) and the band will strike up again.

In terms of tactics though maybe things will ebb away for a bit as this from Pimco highlights.

It is no longer absurd to think that the nominal yield on U.S. Treasury securities could go negative……..What was once viewed as a short-term aberration – that creditors are paying debtors for taking their money – has already become commonplace in developed markets outside of the U.S. Whenever the world economy next goes into hibernation, U.S. Treasuries – which many investors view as the ultimate “safe haven” apart from gold – may be no exception to the negative yield phenomenon. And if trade tensions keep escalating, bond markets may move in that direction faster than many investors think.

The first thought is, what took you so long? After all we have been there for years now. But you see Pimco has developed quite a track record. It described UK Gilts as being “on a bed of nitro-glycerine” which was followed by one of the strongest bull markets in history. Also what happened to US bond yields surging to 4%?

Maybe they are operating the “Muppet” strategy so beloved of Goldman Sachs which is to say such things so they can trade in the opposite direction with those who listen.

As to the question posed in my headline it is indeed one version of our future and the one we are currently on course for.

 

 

 

Where next for the US economy?

The end of the week has an American theme as we have just had Independence Day and it will be followed by the labour market and non-farm payrolls data. So a belated happy Independence Day to my American readers. But behind all that is a more troubled picture for the US economy that opened 2019 in fine form.

Real gross domestic product (GDP) increased at an annual rate of 3.1 percent in the first quarter of 2019 (table 1), according to the “third” estimate released by the Bureau of Economic Analysis. In the fourth quarter of 2018, real GDP increased 2.2 percent. ( BEA)

There was a further sub-plot in that not only had economic growth picked up to ~0.8% as we measure it the falling trend of the previous three quarters was broken. But as I pointed out on the 8th of May a warning light had started to flash.

The narrow measure of the money supply or M1 in the United States saw a fall of just over forty billion dollars in March. That catches the eye because it does not fit at all with an economy growing at an annual rate of 3.2%. Indeed we see now that over the three months to March M1 money supply contracted by 2.7%.

What about now?

The money supply picture is not as dark as it looked back then. In fact the contraction of the previous three months of 2.7% has now been replaced by growth of 2.7%. However that is below the annual rate of growth of 3.8% so a gentle brake is still in play as opposed to the previous sharp one. This compares to 8.5% in 2017 as a whole and 4.4% in 2018.

As to the pick-up more recently it may be related to this change in Federal Reserve policy.

The Committee intends to slow the reduction of its holdings of Treasury securities by reducing the cap on monthly redemptions from the current level of $30 billion to $15 billion beginning in May 2019.

So it is no longer acting to reduce the growth rate of the narrow money supply on the same scale. As to how quickly that will impact is not so easy to say because if we look back in time the timescales of similar policies were rather variable. This was the so-called Overfunding phase in the UK when we sold an excess amount of Gilts to reduce the money supply and discovered if we cut to the chase that it was not as simple as it might appear. There is a difference in that we were aiming ( and quite often missing) a broad rather than narrow money measure.

As cash was in the news only yesterday let me point out that at the end of May the M1 money supply comprised some US $1.65 trillion as opposed to US $2.14 trillion of demand and chequeable deposits. There is a blast from the past disappearing as until the end of December the US Fed recorded some £1.7 billion of Travellers Cheques, does anybody still use them?

Other Signals

We get an idea from the New York Fed.

The New York Fed Staff Nowcast stands at 1.3% for 2019:Q2 and 1.2% for 2019:Q3.

News from this week’s data releases decreased the nowcast for both quarters by 0.1 percentage point.

Negative surprises from housing data and the Advance Durable Goods Report accounted for most of the decrease.

As you can see they are rather downbeat for the middle part of 2019 with economic growth being of the order of 0.3% as we would measure it. The Atlanta Fed nowcast is a few days more recent but comes to the same 1.3% answer for the quarter just gone.

A particular driver of that is something that like in the UK has lost much of its ability to shock because it has become part of the economic landscape.

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis announced today that the goods and services deficit was $55.5 billion in May, up $4.3 billion from $51.2 billion in April, revised. ( BEA )

That increase in the deficit is a downwards pull on GDP via net exports and is part of a pretty consistent trend in the year so far.

Year-to-date, the goods and services deficit increased $15.7 billion, or 6.4 percent, from the same period in 2018. Exports increased $5.1 billion or 0.5 percent. Imports increased $20.8 billion or 1.6 percent.

That shows that the trade war does not appear to be going that well as you can see. As to the total effects here is the Bank of England on the subject.

The Bank estimates that these measures will reduce global GDP by only around 0.1%, and the
further US-China tariffs that took effect in May and June will roughly double that effect.

But that may not be the end of the story. The additional tariffs threatened by the US on China and on auto
imports more generally would raise average US tariffs to rates not seen in half a century. If
implemented, they could reduce global GDP by an additional 0.6% through direct trade channels alone.

What will the Federal Reserve Do Next?

If the latest speech from Chair Powell is any guide it seems to be trying to take us for fools.

 The Fed is insulated from short-term political pressures—what is often referred to as our “independence.”

I should note that this came before the appointment of a politician to the ECB Presidency but that really is only part of something which which we have long been aware of. Believing in it these days is a bit like believing in Father Christmas. As to the economic situation we were told this.

Since then, the picture has changed. The crosscurrents have reemerged, with apparent progress on trade turning to greater uncertainty and with incoming data raising renewed concerns about the strength of the global economy……The question my colleagues and I are grappling with is whether these uncertainties will continue to weigh on the outlook and thus call for additional policy accommodation. Many FOMC participants judge that the case for somewhat more accommodative policy has strengthened.

Comment

The next signal for the US economy has been the surge in bond markets. The US ten-year yield was 3.24% in the early part of last November as opposed to 1.97% as I type this. The expectation shifted as we noted back then shifted from interest-rate rises to cuts and on a simple level a two-year yield of 1.78% is expecting three of them which is punchy when we have not had any yet. So they have been accurate in expecting a slowing of the US economy and the prospects for more QE bond buying and have got a slowing of the reduction in QE and a September date for its end.

Moving to the labour market most of the signals do not tell us much at this stage of the cycle. After ten years of expansion for the economy jobs growth should have slowed. But there are two numbers which do tell is something. The first is wages growth because with the rise in employment and fall in unemployment it should have surged but has not. Whilst I welcome wage growth of a bit over 3% it has underperformed compared to the past which is perhaps related to another problem. It gets reported less these days but the change in the labour participation rate is equivalent to around 11 million people.

Both the labor force participation rate, at 62.8 percent, and the employment-population ratio, at 60.6 percent, were unchanged in May.

There is also the issue of leveraged loans which ironically lower interest-rates and bond yields are only likely to make worse. Here is the Bank of France on the subject.

Leveraged loans are loans extended to highly indebted companies. Their strong growth in the US over the last five years and their packaging into securitised financial products bear a number of similarities with the subprime market that triggered the 2008 crisis. While the comparison is debatable, the risks posed by the leveraged loan market to financial stability should not be ignored.

Also in an era of H2O and Woodford there is this.

The presence of Exchange Traded Funds and Mutual Funds means that retail investors have access to these loans in the United States – although they still only account for a minority of investors. Moreover, these structures present a maturity mismatch between their assets and their liabilities. Investors can redeem their fund shares very quickly, whereas underlying assets (leveraged loans) tend to have much longer transaction times.

What could go wrong?

Will fiscal policy save the US economy or torpedo it?

One of the features of the credit crunch era has been the shift in some places about fiscal policy. For example the International Monetary Fund was rather keen on austerity in places like Greece but then had something of a road to Damascus. Although sadly Greece has been left behind as it ploughs ahead aiming for annual fiscal surpluses like it is in a 2012 time warp. Elsewhere there have been calls for a fiscal boost and we do not need to leave Europe to see them. However as I have pointed out before there is quite a distinct possibility that President Donald Trump has read his economics 101 textbooks and applied fiscal policy into an economic slow down. Of course life these days is rarely simple as his trade policy has helped create the slow down and is no doubt a factor in this from China earlier..

Industrial output grew 5.0 percent in May from a year earlier, data from the National Bureau of Statistics showed on Friday, missing analysts’ expectations of 5.5% and well below April’s 5.4%. It was the weakest reading since early 2002. ( Reuters).

Also there has been another signal of economic worries in the way that the German bond future has risen to another all-time high this morning. Putting that in yield terms holding a benchmark ten-year bond loses you 0.26% a year now. Germany may already be regretting issuing some 3 billion Euros worth at -0.24% on Wednesday although of course they cannot lose.

US Fiscal Policy

Let us take a look at this from the perspective of the South China Morning Post.

The US budget deficit widened to US$738.6 billion in the first eight months of the financial year, a US$206 billion increase from a year earlier, despite a revenue boost from President Donald Trump’s tariffs on imported merchandise.

So we can look at this as a fiscal boost on top of an existing deficit. The latter provides its own food for thought as the US economy has been growing sometimes strongly for some years now yet it still had a deficit. In terms of detail if we look at the US Treasury Statement we seem that expenditure has been very slightly over 3 trillion dollars whereas revenue has been 2.28 trillion. If we look at where the revenue comes from it is income taxes ( 1.16 trillion) and social security and retirement at 829 billion and in comparison corporation taxes at 113 billion seem rather thin to me.

The picture in terms of changes is as shown below.

So far in the financial year that began October 1, a revenue increase of 2.3 per cent has not kept pace with a 9.3 per cent rise in spending.

If we look at the May data we see that the broad trend was exacerbated by monthly expenditure being high at 440 billion dollars as opposed to revenue of 232 billion. Marketwatch has broken this down for us.

Most of the jump can be explained by June 1 occurring on a weekend, which forced some federal payments into May. Excluding those calendar adjustments, the deficit still would have increased by 8%, with spending up by 6% and revenue up by 4%.

In terms of a breakdown it is hard not to think of the oil tankers attacked in the Gulf of Oman yesterday as I note the defence numbers, and I have to confess the phrase “military industrial complex” comes to mind.

What will recur are growing payments for Medicare, Social Security and defense. Medicare spending surged 73% — mostly because of the timing shift, though it would have rose 18% otherwise. Social Security benefits rose by 11% and defense spending rose 23%.

So we have some spending going on here and its impact on the deficit is being added to by this from February 8th last year.

The final conference committee agreement of the Tax Cuts and Jobs Act (TCJA) would cost $1.46 trillion under conventional scoring and over $1 trillion on a dynamic basis over ten years,

Thus policy has been loosened at both ends and the forecast of the Congressional Budget Office that the deficit to GDP ratio would be 4.2% this year looks like it will have to be revised upwards..

National Debt

This was announced as being 22.03 trillion dollars as of the end of May, of which 16.2 trillion is held by the public. Most of the gap is held by the US Federal Reserve. Just for comparison total debt first passed 10 trillion dollars in the 2007/08 fiscal year so it has more than doubled in the credit crunch era.

Moving to this as a share of the economy the Congressional Budget Office puts something of a spin on it.

boosting debt held by the public to $28.5 trillion,
or 92 percent of GDP, by the end of the period—up
from 78 percent now.

The IMF report earlier this month was not quite so kind.

Nonetheless, this has come at the cost of a continued increase in the debt-to-GDP ratio (now at 78 percent of GDP for the federal government and 107 percent of GDP for the general government).

Where are the bond vigilantes?

They have gone missing in action. The financial markets version of economics 101 would have the US government being punished for its perceived financial profligacy by higher bond yields on its debt. Except as I type this the ten-year Treasury Note is yielding a mere 2.06% which is hardly punishing. Indeed it has fallen over the past year as it was around 2.9% a year ago and last November went over 3.2%.

So in our brave new world the situation is one of lower bond yields facing a fiscal expansion. There is an element of worries about the economic situation but the main player here I think is that these days we expect the central bank to step in should bond yields rise. So the US Federal Reserve is increasingly expected to cut interest-rates and to undertake more QE style purchases of US government debt. The water here is a little murky because back at the end of last year there seemed to be a battle between the Federal Reserve and the President over future policy which the latter won. So much for the independence of central banks!

The economy

Let me hand you over to the New York Federal Reserve.

The New York Fed Staff Nowcast stands at 1.0% for 2019:Q2 and 1.3% for 2019:Q3. News from this week’s data releases decreased the nowcast for 2019:Q2 by 0.5 percentage point and decreased the nowcast for 2019:Q3 by 0.7 percentage point.

That compares to 2.2% annualised  for a month ago and 3.1% for the first quarter of the year. So the trend is clear.

Comment

As we track through the ledger we see that the US has entered into a new period of fiscal expansionism. The credit entries are that it has been done so ahead of an economic slow down and at current bond yields is historically cheap to finance. The debits come when we look at the fact that the starting position was of ongoing deficits after a decade long period of economic expansion. These days we worry less about national debt levels and more about the cost of financing them, although as time passes and debts rise that is a slippery slope.

The real issue now is how the economy behaves as a sharp slow down would impact the numbers heavily. We have seen the nowcast from the New York Fed showing a slowing for the summer of 2019. For myself I worry also about the money supply data which as I pointed out on the 8th of May looks weak. So this could yet swing either way although this from February 8th last year is ongoing.

The deep question here is can we even get by these days without another shot of stimulus be it monetary,fiscal or both?