Simon Ward - Money Moves Markets

Chinese interest rates falling

Simon Ward — Fri, 25 May 2012 09:31:13 +0000

China is stepping up policy easing, as warranted by recent weak monetary and economic data – see previous post. The three-month repo rate this week fell to its lowest level since March 2011, almost converging with the officially-set one-year deposit rate, of 3.5% – see first chart.

The easing process should be facilitated by better inflation news. Chinese food prices usually fall into mid-year but the decline in 2012 has been larger than in 2011, judging from weekly statistics – second chart. CPI food inflation may subside from an annual 7.0% in April to below 5%, cutting the headline CPI rate from 3.4% to 2.75% or lower (based on the one-third weighting of food in the basket and assuming non-food inflation remains at the current 1.7%).

Policy-makers are likely to wish to avoid a consumption-sapping rise in real interest rates, so a fall in inflation to well below the 3.5% one-year deposit rate could trigger an early downward adjustment in the spectrum of official rates.

Monetary impact of ECB LTROs much less than UK QE

Simon Ward — Thu, 24 May 2012 13:11:32 +0000

Evidence to date suggests that the ECB’s subsidised loans to banks have been much less effective in delivering monetary stimulus than “conventional” QE as practised by the Bank of England.

A positive impact on the supply of money from such policies depends on the banking system increasing lending to, or buying securities from, non-banks (including governments). Banks “finance” a rise in their assets by crediting the deposit accounts of borrowers or sellers of securities with newly-created money*.

The ECB’s lending to banks via its weekly and longer-term refinancing operations rose by €512 billion between the end of November and the end of March. Bank lending to the non-bank private sector, however, fell by €70 billion over the four months, or €32 billion after seasonal adjustment. The decline, admittedly, might have been even larger without the ECB’s additional loans but it is reasonable to conclude that any positive impact was small.

The ECB’s actions have been much more successful in inducing banks to buy government bonds – purchases totalled €127 billion over December-March following sales of €39 billion in the prior four months. Comparing this buying with the €512 billion increase in ECB lending, however, suggests “pass-through” of only 25%.

Contrast this with the Bank of England’s QE2 operation, involving the central bank buying £125 billion of securities directly rather than relying on banks using officially-lent funds to do so. The monetary impact has been slightly reduced by small-scale bank sales of gilts – £15 billion between October, when QE2 started, and March. This still, however, suggests a monetary boost of £110 billion, implying pass-through of 88%.

The ECB, in other words, would have obtained a much bigger “bang for its buck” – three and half times the impact, based on the above figures – by channeling funds directly into government bonds rather than lending to banks. It could, alternatively, have delivered the same amount of stimulus with a much smaller increase in its balance sheet, thereby preserving ammunition likely to be needed in the event of “Grexit”.

April monetary statistics are released next week but the suspicion is that Eurozone money supply trends remain too weak to promote economic recovery, warranting further policy easing. The view here is that this should take the form of country-neutral QE, i.e. bond purchases spread across markets in proportion to GDP. Such an approach would deliver Eurozone-wide stimulus – helpful for “rebalancing” – while limiting risk to the ECB’s balance sheet and avoiding an inappropriate subsidy to peripheral sovereigns (implied by the operation to date of the “securities markets programme”).

*The “banking system” here refers to the central bank plus commercial banks. To the extent that newly-created money is held by overseas residents or governments, it will not show up in published monetary aggregates, which usually cover only domestic private sector holdings. Subsequent transactions, however, may result in the money being transferred to private residents.

ECB lending to banks up again last week

Simon Ward — Tue, 22 May 2012 15:00:50 +0000

Eurosystem gross lending to banks in euros rose by a further €7.1 billion last week to a record €1,339.5 billion, consistent with speculation that institutions in Greece and other peripheral countries are continuing to suffer an outflow of funding, necessitating increased borrowing from the ECB and national central banks.

The gross figure comprises “lending related to monetary policy operations” and “other claims”, under which the Greek and Irish “emergency liquidity assistance” (ELA) operations are recorded. The latter component rose by €4.1 billion last week, probably reflecting additional Greek ELA. This may have been related to last week’s announcement that some Greek banks had been temporarily shifted from regular lending (i.e. “related to monetary policy operations”) to ELA pending recapitalisation.

The switch, however, did not prevent a further €2.9 billion rise in regular loans last week, i.e. any reduction to the affected Greek banks was more than offset by an increase in lending to other institutions.

The suggestion is that that the ECB’s exposure to the periphery is continuing to mount, with a probable parallel rise in Bundesbank exposure to the ECB via TARGET2.

UK "core" inflation still high

Simon Ward — Tue, 22 May 2012 12:58:05 +0000

The fall in annual CPI inflation from 3.5% in March to 3.0% in April was slightly smaller than projected here – a 2.9% April print had been expected – and reflects a favourable “base effect” (i.e. an unusually large monthly CPI rise in April 2011 dropping from the 12-month calculation). Motor fuel price relief could maintain the headline rate at 3.0% in May, allowing a welcome suspension of the King / Osborne letter-writing charade. Shorter-term “core” price momentum, however, remains stubbornly strong and inconsistent with a return of inflation to target.

The lower headline annual rate conceals a solid 0.3% monthly rise in the core price measure tracked here – the CPI excluding unprocessed food and energy, adjusted for VAT effects and seasonal factors. The six-month rate of change of this measure (smoothed by taking a three-month moving average) remains near the top of its range in recent years, at 2.9% annualised – see chart.

A partial unwinding of the favourable April base effect in May could be offset by a recent reversal in motor fuel costs that promises to shave 0.2 percentage points from annual CPI inflation – the average price of unleaded has fallen back to about 138 pence per litre from 142.5 pence last month. The outcome may depend on rounding but this could allow the Governor to escape letter-writing duties – triggered by a headline print of 3.1% or higher.

The forecast here remains that CPI inflation will finish 2012 at about 2.75%, based on a small easing of core price momentum and broad stability of commodity prices and the exchange rate. Following the recent upward revision, the Bank’s central projection is similar (the May Inflation Report fan chart numbers will be published tomorrow).

US recession still unlikely but risk greater than in 2010-11

Simon Ward — Tue, 22 May 2012 08:48:35 +0000

Previous posts have discussed the US recession-warning properties of real narrow money (i.e. currency in circulation plus demand deposits divided by consumer prices). 10 of the 11 post-WW2 downturns identified by the National Bureau of Economic Research (NBER) were preceded by a contraction in real money. The exception was the 1953-54 recession, apparently caused by severe fiscal tightening as defence spending was slashed after the Korean war.

On the basis of this record, posts in 2010 and 2011 expressed scepticism about forecasts at the time – for example by John Hussman* – that the economy was about to enter another recession. Real narrow money grew robustly during 2010-11.

Real money has slowed since late 2011 but was still up by a solid 4.3% (not annualised) in the six months to April – see first chart. Recent posts, therefore, have suggested that US growth will fall back during 2012 while remaining respectable.

Monetary trends, however, bear close scrutiny. Real narrow money was flat between January and April. The latest nominal figure – for 7 May – was 1.8% below the April average, although the weekly series displays considerable volatility.

Also generating some concern here is a recent fall in the Monster index of online job vacancies – the decline in March and April was the largest since the end of the December 2007-June 2009 recession. The index turned down sharply just before the onset of that recession – second chart. (This weakness, however, is at odds with several other labour market leading indicators.)

At the time of writing, the Intrade prediction market was discounting a 16% probability of a recession in 2012, defined as two consecutive negative US GDP quarters between the fourth quarters of 2011 and 2012. The judgement here is that the probability remains well below 50% but is greater than 16%, especially given the risk of spill-over from an escalating Eurozone crisis.

*In his weekly market comment (link to left) of 28 June 2010 Mr Hussman wrote: “Based on evidence that has always and only been observed during or immediately prior to US recessions, the US economy appears headed into a second leg of an unusually challenging downturn.” The comment of 8 August 2011 stated similarly that “the composite of economic and financial evidence we presently observe has always and only been associated with ongoing or immediately impending recessions”. Mr Hussman now expects the NBER to judge that a recession started in May or June 2012, suggesting that one was not “immediately impending” in August 2011.

Euro woes advance risk sell-off

Simon Ward — Fri, 18 May 2012 09:37:59 +0000

Previous posts suggested switching from a neutral to defensive stance on equities in response to a fall in a global leading indicator derived from the OECD’s country leading indices. The thinking was that such a decline would confirm the monetary forecast of a slowdown in global growth from the spring, implying increased headwinds for risk assets.

The signal was duly delivered last week – see here – and has been followed by a 4.3% decline in global equities, as measured by the MSCI World index in US dollars. Stocks, however, had already fallen by 6.1% from a 19 March peak, probably reflecting a reescalaton of the Eurozone crisis. Euro woes, in other words, may have advanced and exaggerated the expected risk sell-off.

This, needless to say, complicates investment decision-making. Current equity prices may already discount likely economic weakness – global real money is currently still expanding, suggesting a slowdown rather than anything worse. A full meltdown of the euro would warrant further falls but the probability of such a scenario is unknowable, depending on the psychology of Spanish and Italian bank depositors as much as, or more than, any decisions by political leaders.

Stocks look short-term oversold based on the put / call ratio and other indicators, while further monetary easing is in train: Chinese repo rates, for example, this week fell to their lowest for a year – see first and second charts. G7 12-month real narrow money growth has yet to cross beneath industrial output expansion, a development that usually precedes major bear phases. There may be a better opportunity to undertake a further defensive shift.

Footnote: An interesting curiosity is that fluctuations in US stocks so far this year resemble those 25 years ago in 1987. A spring sell-off that year bottomed on 21 May and was followed by summer strength before much greater weakness in the autumn – third chart.

Dovish UK IR suggests QE hold was tactical

Simon Ward — Wed, 16 May 2012 13:21:46 +0000

The May Inflation Report suggests that more QE is in the offing but the Bank of England is reserving its ammunition until the fall-out from the Eurozone crisis becomes clearer. The Bank, however, continues to deny any responsibility for improving credit conditions, despite believing that credit constraints have contributed to supply-side weakness.

The Report downgraded the Bank’s growth forecast while maintaining a projection of below-target inflation in two years’ time. The mean two-year-ahead inflation expectation based on unchanged policy seems to be 1.8%, the same as in February, based on “eye-balling” the relevant fan chart. This raises the question of why more QE was not announced last week, as suggested by the “MPC-ometer” used here to predict the monthly decision.

One possible explanation is that the Bank felt constrained by another forced upward revision to its shorter-term inflation forecast – the mean projection for the second quarter of 2013, for example, has been raised from 1.65% to an estimated 2.3%. This, however, would be at odds with its usual focus on the two-year horizon, while the Report plays down the significance of the change.

The more likely reason for inaction is that the Bank is waiting for the full horror of the Eurozone crisis to be revealed before calibrating its next programme. Delay, moreover, leaves the door open to co-ordinated action with other central banks, for example in the event of a forced Greek exit from EMU – the Bank may believe this would deliver more “bang for the buck”.

Greek bank depositors, not voters, key to EMU future

Simon Ward — Wed, 16 May 2012 09:09:01 +0000

Press reports of faster deposit outflows from Greek banks accord with developments on the ECB’s balance sheet last week.

“Other claims on euro area credit institutions denominated in euro” – a category that includes the Greek and Irish emergency liquidity assistance (ELA) operations – rose by €3.7 billion in the week to Friday. This may reflect Greek banks borrowing more to plug a funding gap created by deposit flight.

Greek banks are unable to increase borrowing under the ECB’s regular programmes (i.e. refinancing operations and the marginal lending facility) because of a lack of higher-quality collateral. Regular lending, however, rose by €7.0 billion last week, possibly indicating capital flight from other peripheral banking systems not currently constrained by a collateral shortage.

The €3.7 billion rise in “other claims” last week compares with a fall of €11.7 billion in Greek deposits during the first quarter. Domestic private sector deposits stood at €170 billion at the end of March, of which €66 billion was in overnight deposits. It is reasonable to expect this instantly-accessible cash to leave the Greek banking system amid current political and economic chaos, implying a heightened risk of deposits being frozen and/or redenominated in the event of EMU expulsion.

Faster capital flight could push Greece out of the euro well before next month’s elections, rendering current political manoeuvring irrelevant. The mechanism would be Greek banks losing access to additional ELA either because they run out of lower-quality collateral or because the Bundesbank and other “core” central banks place a cap on their Target2 exposure – why, after all, should German tax-payers underwrite high-risk lending serving the function of allowing austerity-resistant Greeks to transform deposits in bust domestic banks into Bunds and other “safe” assets?

Sluggish UK trade cautionary for Greek devaluationists

Simon Ward — Tue, 15 May 2012 15:22:08 +0000

Officialdom and the consensus cheered sterling’s 2007-08 collapse on the grounds that it would speed economic recovery. Posts at the time suggested that capacity and credit constraints would prevent a major expansion of tradeables output, implying a bigger boost to inflation and consequent squeeze on real incomes and spending – see, for example, here. The net impact on the economy, therefore, would be negative, at least in the short to medium run.

Three years on, there is little reason to revise this assessment. The trade volume response to the lower exchange rate has been muted – net exports strengthened by 0.9% of GDP between the fourth quarters of 2008 and 2011. Non-oil import prices, meanwhile, surged by 8.8% over the same period, implying a 2.6% direct boost to the domestic price level (based on a 29% share of non-oil imports in domestic demand).

Weak wage trends suggest that workers have been unable to obtain compensation for increased prices. The import cost boost, in other words, may have cut real employment incomes by 2.6%. An equivalent impact on consumer spending would imply a GDP drag of 1.6% (based on a 62% share of consumption in GDP), comfortably exceeding the positive contribution from net exports. (This ignores any effect on corporate spending.)

Trade improvement has stalled since early 2011, partly reflecting Eurozone economic weakness. Goods export volumes rose by only 0.3% in the year to the first quarter of 2012, with a fall of 3.3% in deliveries to other EU countries offsetting 4.4% growth to the rest of the world.

Supply-side weaknesses may constrain trade performance even if foreign demand strengthens. The percentage of CBI manufacturers operating below capacity is close to the historical average, while skilled labour shortages have surged. The percentage citing credit or finance as a constraint on exports remains elevated.

The UK’s experience casts doubt on the view expressed in a Financial Times comment piece today that “Greek growth would probably surge” in response to a mega-devaluation following EMU exit. Rather than an unlikely export boom, the case for leaving rests on Greece gaining the ability to calibrate monetary conditions to the needs of the domestic economy. Monetary autonomy, however, might be severely restricted amid the financial chaos likely to accompany departure.

Wrong-way speculators buy Treasuries

Simon Ward — Mon, 14 May 2012 15:28:31 +0000

Speculators in US Treasury futures have a poor timing record and last week went long, suggesting a rebound in yields.

The chart aggregates the positions of “non-commercial” investors in four Treasury futures contracts using duration-based weights. Examples of recent poor timing include: 1) a large long position in October 2010 – yields subsequently surged; 2) a large short position in early 2011 – yields subsequently collapsed; and 3) another large short position in March this year ahead of the recent yield decline.

The poor record reflects trend-following behaviour – more precisely, a tendency to invest in trends when they are at a late stage. Speculators are occasionally “bailed out” by events that cause an established trend to extend – a long position adopted in the second half of 2007, for example, benefited from the unfolding financial crisis. Such events, however, need to surprise – current Eurozone woes, presumably, are well-discounted.

Another possible contrarian signal is the swelling consensus that the US bond market is “turning Japanese”, i.e. low nominal yields reflect deflationary excess private saving. Current negative real yields, however, have no parallel in recent Japanese experience and are more plausibly the product of “financial repression” – Federal Reserve imposition of zero interest rates and effective deficit monetisation.