Central bank intervention
Imagine someone told you about a country where real output per person is at an all-time high and growing at an increasingly rapid pace, its employment rate is at the highest level in decades, the country’s housing sector is on fire, and its current account surplus is about 6 per cent of GDP. In the absence of other information, would you say this country should be: If you answered yes to the above questions, congratulations! You’ve just described the behaviour of the Sveriges Riksbank. From their policy announcement on Thursday (our emphasis):
Jaime Caruana, the general manager of the Bank for International Settlements, and the former boss of the Bank of Spain, gave an important speech Friday, which, among other things, highlights the radically different frameworks economists use to evaluate what’s going on. In textbook macro models, economies grow at some “trend” rate based on productivity on population growth, except when occasionally buffeted by “shocks” in different directions such as an oil price spike or a tax cut — shocks that fade in importance over time as economies “naturally” return to their “trend”. In these models, policymakers should focus on boosting productivity, which improves the trend path, and establishing institutions that smooth out the impact of the shocks when they occur by temporarily shifting resources to those most affected. Little else matters.
Here begins a tale of how the Bank of England’s settlement system got broken without anyone really noticing… On October 20 2014, the BoE suffered an embarrassing collapse of its real-time gross settlements (RTGS) system, forcing it to revert to manual processing for large payments such as CHAPs for about a day. At the time, Bank personnel, bankers and the market in general passed the incident off as largely a technical issue, like a site falling down or a regular IT fail. Nothing to lose sleep over. But the incident was arguably much graver than that. A long-standing RTGS collapse would have constituted nothing less than a systemic collapse of the sterling monetary market with potentially catastrophic consequences for the UK economy. Think human sacrifice, dogs and cats living together, mass hysteria. That sort of thing. Also never pointed out at the time was how the events of 20 October 2014 linked back to the banking crisis of 2008.
Bank of Russia Governor Elvira Nabiullina is leaving it to the market to imagine when a ruble collapse will pose a threat to financial stability and force policy makers into action. So far it hasn’t, and the currency is close to its “fundamental levels,” Nabiullina said in an interview on Wednesday. Other top officials also took the crisis in their stride, with President Vladimir Putin saying that changes in the exchange rate are actually opening up “additional opportunities” for some businesses. - Bloomberg, Jan 21 - Markets, Jan 21
The man who knows about the size of central bank reserves needed to defend domestic economic stability says this on Thursday at an economic forum in Sri Lanka (via Bloomberg): “China has a major adjustment problem,” Soros said. “I would say it amounts to a crisis. When I look at the financial markets there is a serious challenge which reminds me of the crisis we had in 2008.” Which is apropos because, via Reuters, on Thursday: China FX reserves fall $512.66 bln in 2015, biggest annual drop on record – RTRS BEIJING, Jan 7 (Reuters) – China’s foreign exchange reserves, the world’s largest, fell $107.9 billion in December to $3.33 trillion, the biggest monthly drop on record, central bank data showed on Thursday. The December figure missed market expectations of $3.40 trillion, according to a Reuters poll. China’s foreign exchange reserves fell $512.66 billion in 2015, the biggest annual drop on record. The value of its gold reserves stood at $60.19 billion at the end of December, up from $59.52 billion at the end of November, the People’s Bank of China said on its website. Gold reserves stood at 56.66 million fine troy ounces at the end of December, up from 56.05 million at end-November.
Today’s market priorities in one handy sentence, via SocGen’s Kit Juckes: With the USD/CNY fix up above 6.53 and the USD/CNH rate heading for 6.70, not to mention a reported hydrogen bomb test in North Korea and a weak milk auction yesterday afternoon.. Which is to say that you should all be watching the China devaluation threat building. The USD is up 1.1 per cent against the CNH, the offshore market unit, today.
As has been well reported, the IMF has recommended that China’s renminbi should join the basket of currencies used to value its own de facto currency. There’s been lots of talk, as a consequence, of China now being in a position to properly disrupt the US dollar’s global reserve currency status. Except, SDR inclusion doesn’t imply anything of the sort. Furthermore, we’ve very much been here before*.
The euro may have been pointless, but it might have been a whole lot less pointless if there’d been political union from the onset. So implied Mario Draghi, ECB President, at the BoE Open Forum on Wednesday. For the laissez faire radicals out there, here’s how he went on to define the nature of “truly free” markets in that context (our emphasis): Consider the case of markets that are truly open – by which I mean, as open as the Single Market of the European Union, where internal frontiers have been abolished entirely, where passporting of services across the entire EU is a right, not a privilege. In this situation, national governments, or national courts of law, cannot alone provide full protection to their citizens against abuse of property rights or any form of unfair competition that may arise from abroad. Nor can they alone protect the rights of their citizens to carry out business abroad unimpeded by protectionist restrictions. For the market to be truly free, there needs to exist a judiciary power that can enforce the Rule of Law on all, everywhere. It has to have jurisdiction across the entire market.
When your correspondent visited pawnshops in Macau this week and asked whether they could help him shift 1m yuan ($157,000) out of China—three times what one can legally withdraw in a year—most demurred. - Anon (ish), Economist, Sept 19 Sad really to see them in such decline, even if said correspondent did find a brave few who would help. Nervous times is the headline reason for their nervousness, what with all those police raids and a general chill redescending along China’s capital-borders as flows out of the country continue to make the government nervous — even if some of the headline outflow (a record of over $150bn or so in August according to estimates) is probably just dollars being hoarded by Chinese corporates, it’s very clearly a point of stress for China’s leaders. Which is fair when you consider what it would mean for Chinese reserves if it chooses to absorb the capital outflows and what it means for the CNY if it doesn’t.
Nobody knows China like Michael Pettis, and his latest post on the RMB doesn’t disappoint. Before we get to the crux of his argument we should point out that FT Alphaville has long argued that the RMB was probably over rather than under valued, based on its capital account position. Understandably we were feeling a bit chipper with our analysis following last week’s depreciation, until we read Pettis this morning. The Beijing-based academic argues convincingly that the RMB is still under valued because there’s a big difference between a technical misvaluation and a fundamental one.
The laissez faire school of finance has always orientated towards the notion that capital market funding is preferable to bank financing. Why? Because it’s only by taking your business to the open market that a borrower’s situation can be properly scrutinised and a fair price arrived at. But, of course, some capital markets are more developed, sophisticated and disintermediated than others. In the US, for example, funding by way of the capital market is common practice even for small and medium-sized corporations. Unsecured household borrowers are even heading to P2P market-based lending solutions. In Europe, however, the private sector — especially the SME sector — has always tended to fund through bank loans.
A mangled, half-frozen, market up 6 per cent? With one eye on our now abused ‘rule‘, here’s the Shanghai Comp at pixel (click through the chart for the updated price from Google Finance): And here’s Credit Suisse, with our emphasis: When a central bank says “whatever it takes”, we think the market should listen. The US Federal Reserve did so in 2008 and the European Central Bank did so in 2012. Is it the People’s Bank of China’s turn now?
But, as the foreign press corp does its best to hurry some much needed euro into the Greek economy, we should also look at what Greece is doing to the euro. Here’s Nomura’s head of FX, Jens Nordvig, on what to watch where the single, now more parlous, currency is concerned:
We’ll be slamming up the best of our collective inbox on matters Greece as and when the good stuff pours in. Catching up on the last few hours, here’s JP Morgan’s Greg Fuzesi:
For the latest on the ECB’s liquidity position on Greece, see our post here. Meanwhile, here’s some instant analysis by way of the FT Alphaville collective inbox: UPDATE: Capital controls and a bank holiday now confirmed; full research pack from Buiter, Barr and others available in the usual place.
Might have to pop this at the top, it’s a chart with lots of negative yield stuff on it after all: Now, as we have said before… friends don’t let friends extrapolate too wildly from the IMF’s COFER data.
Why are the great and the good of the banking and financial services world suddenly extolling the virtues of blockchain, the technology that underpins the artificial scarcity of bitcoin? Possibly because they’ve finally figured out that what the technology really facilitates is cartel management for groups that don’t trust each other but which still need to work together if they’re to protect the value and stability of the markets they serve. Cartel enforcement, in that sense, appeals to all sorts of financial players from bankers and commodity producers to general asset creators.
We’ve already had some of the IMF Cofer story spelt out, namely that “foreign currency reserves in emerging markets fell last year for the first time in two decades”. At the least, there’s a hint of a new divergent pattern between EM and DM central banks going on there. But we wonder if we mightn’t squeeze a bit more out of it. Particularly where the euro is concerned. The IMF data showed that the share of euro in global central bank reserve assets kept falling last year — to a new cycle low of 22 per cent. However, as Deutsche’s George Saravelos says, almost all of that drop is down to valuation effects, rather than active selling. Of course, he also says that’s not the full picture. With our emphasis: The IMF data excludes two of the world’s largest holders of FX reserves, holding as many assets as the rest of the world’s central banks combined. It is precisely these holders that have the largest ongoing potential to sell euros:
Regarding how low negative interest rates can go, Paul Krugman wrote a couple of weeks ago that: When central banks push interest rates on government debt below zero, the effective lower bound is the return on cash held by people who would otherwise be holding that government debt — not people looking to expand their checking accounts. So the liquidity advantages of bank deposits over cash in a vault are pretty much irrelevant. It’s all about the cost of storage.
About 20 years ago or so, it started becoming fashionable to conclude that the Japanese government’s borrowing costs were going to go up a lot. Demographic changes were going to dramatically increase the share of retirees dependent on the state for income and healthcare at the same time as the working population — and therefore the tax base — would be shrinking. Add in alleged economic stagnation and the result would be a rapidly widening gap between inflows and outflows. The ratio of government debt to GDP would skyrocket.
It’s been a long time since so many developed central banks were tested by free market forces. And free market forces aren’t finished yet. Hot on the heels of the SNB giving up on its euro ceiling policy, the market is zoning in on the Danish central bank and its ability to maintain its euro-peg. As Dan already pointed out, the Danes have had to cut rates three times in in the last two weeks: January 19, January 22 and January 29. If that looks and feels desperate, perhaps that’s because it is?
Last week’s Swiss surprise was a useful reminder that betting against currency pegs is one of the classic macro hedge fund trades. Think Soros and Druckenmiller versus the Bank of England. It’s attractive because the cost of maintaining the position is usually small while the potential upside can be quite large. Someone who had been continuously buying short-dated puts on EURCHF at 1.2 since the establishment of the Swiss National Bank’s exchange rate floor over the past few years would have paid a pittance for the opportunity to make a lot of money.