Central bank intervention
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.
On Monday Mark Carney, Bank of England governor, injected fear into the hearts of highly paid bankers everywhere by stating… Standards may need to be developed to put non-bonus or fixed pay at risk. That could potentially be achieved through payment in instruments other than cash. Bill Dudley’s recent proposal for certain staff to be paid partly in ‘performance bonds’ is worthy of investigation as a potentially elegant solution. Senior manager accountability and new compensation structures will help to rebuild trust in financial institutions. In a diverse financial system, trust must also be rebuilt in markets. His comments came on the back of growing regulatory concerns that banks avoid bonus caps by boosting fixed salaries and so offer less variable pay, weakening the link between performance and compensation.
Nigeria’s fiscal exposure to falling oil prices is amongst the most acute within the Opec group. But as Standard Bank analysts note on Monday, whilst the country’s central bank has shown it is prepared to defend the currency ahead of all-important national elections in February, its ability to do so diminishes with every dollar that the Brent crude price loses: The CBN is clearly struggling to balance constraining upside USD/NGN pressure with limiting the depletion of FX reserves. At present, the CBN is intervening in the interbank market just below the prevailing rate rather than protecting a line in the sand. The CBN has also recently shifted the RDAS rate higher and we suspect may move it to the upper end of 155 +3% band in coming weeks. Our core scenario remains that there will not be an official shift in the RDAS central rate until after the elections in Feb 15. The ability of the CBN to achieve such an outcome clearly diminishes, the lower the oil price goes.
BearWhale n./bâr-weil/ 1. A large mythical creature known to operate in FX markets with the explicit intention of shattering upstanding and well-managed currencies like bitcoin, the rouble and the naira. If found to display extreme speculative dumping behaviour, defences must be organised by the champions of the superior currency zone so as to scare the wunderbeast away. These defences usually involve feeding the BearWhale large amounts of unwanted inferior dirty currency until it can physically consume no more and withdraws to its BearWhale cave. A successfully slain Bearwhale is usually cause for much jubilation and festivity within the defending community.
According to Goldman, the answer is sooner than the market thinks. A new note argues that the Swiss franc is already overvalued against the euro, which should give the Swiss National Bank cover to raise rates in response to a vibrant domestic economy and an overheating housing market. Thanks to a history of low inflation, institutional stability, and (until recently) a long tradition of banking secrecy, money tends to flow into Switzerland when people are worried, and it flows out when investors are looking to take more risk. Between the 2007 low and the peak in the summer of 2011, the trade-weighted franc appreciated by nearly a third as savers in the euro area worried about the collapse of the single currency.
Osborne to set out plans to curb welfare bill || Balfour Beatty warns on profits for fifth time || Middle-class swell profits at Aldi as it looks to expand ranges || HMRC to take tax debts from pay packets || Apple hit by Brussels finding over illegal Irish tax deals || Markets
Markets: Asia-Pacific equities were in decline for a third straight day, as investors braced for a possible conflict in Ukraine and Australia’s jobless rate jumped to a 12-year high. However, haven assets that were pushed up overnight stabilised in Asia, with the Japanese yen steadying at Y102.2 after rising half a per cent overnight, and the price of gold edging up 0.1 per cent to $1,307.25 per ounce, after climbing 1.3 per cent overnight. Sentiment in Asia was damped by a closely watched Australia jobs report that showed the jobless rate jumped from 6 in June to 6.4 per cent in July – a 12-year high. The unemployment rate is now higher than that of the US for the first time since 2007. (FT’s Global Markets Overview)
A new article by Andrew Haldane, the Bank of England’s chief economist, is a useful reminder that the debate over how (or whether) central bankers should respond to excessive risk-taking continues to heat up as the pain of the recession gradually recedes in the US and UK. Before getting to Haldane’s recent contribution to the discussion, it makes sense to start with a July speech on the subject by Fed chief Janet Yellen, which nicely frames the disagreement. She drew a distinction “between tools that primarily build through-the-cycle resilience against adverse financial developments and those primarily intended to lean against financial excesses”.
This guest post, from Brian Reid, chief economist of the Investment Company Institute, is a response to this speech in April by the Bank of England’s chief economist, Andrew Haldane… ——– As banks learn to live under tighter post-crisis constraints, central bankers around the world are worrying about financial risks that could move from banks to capital markets and perhaps trigger the next great crisis. After the experience of 2007–08, regulators rightly should be on guard for sources of weakness in the financial system. Unfortunately, in their vigour, many regulators are seeing ‘systemic risk’—threats to the stability of the financial system—when the issue at hand is investment risk. Investment risk is a necessary part of a well-functioning economy, attracting investors willing to take known risks in hopes of gaining a reward. Systemic risk occurs when the financial system itself breaks down and is unable to perform its normal functions of matching savings to investment opportunities or facilitating economic activity.
Banco Espirito Santo, the Portugese lender which had a few problems earlier this week to do with its complicated corporate structure and then saw its shares temporarily suspended on Thursday, has become this week’s goat on which all scapes may be laid. Perhaps it is the summer quiet, but a sample of our inbox detects some caprine hitching.
The Federal Reserve’s June minutes are out and as usual offer good insight into the FOMC’s thinking when it comes economic confidence and recovery (more positive) as well as its opinion on rates (still dovish). But they also reveal a new preoccupation with matters related to exit strategy and financial plumbing. Here’s the section we’re referring to (H/T David Beckworth) While generally agreeing that an ON RRP facility could play an important role in the policy normalization process, participants discussed several potential unintended consequences of using such a facility and design features that could help to mitigate these consequences. Most participants expressed concerns that in times of financial stress, the facility’s counterparties could shift investments toward the facility and away from financial and nonfinancial corporations, possibly causing disruptions in funding that could magnify the stress.
Creditors offer Argentina breathing room in debt restructuring dispute: Holdout investors who rejected Argentina’s debt restructurings in the wake of its $95bn default have said they are prepared to give Buenos Aires extra time to settle, but only if the country negotiates in good faith. (FT) ECB under pressure to tackle ‘crazy’ euro: The European Central Bank is being pushed to take action against a persistently strong euro with a leading industrialist calling on Frankfurt to tackle the “crazy” strength of the currency. Fabrice Brégier, chief executive of Airbus’s passenger jet business, said the ECB should intervene to push the value of the euro against the dollar down by 10 per cent from an “excessive” $1.35 to between $1.20 and $1.25. (FT)
Camp Alphaville reminder: Yes, the colour-code used to illustrate the full line-up of Camp AV speakers has relevance. No, I don’t know what it is. (Details here) Markets: Asia-Pacific markets were given a boost as manufacturing readings for the region’s two powerhouses, China and Japan, showed a return to growth this month. SBC’s “flash” purchasing managers’ index for China jumped from 49.4 in May to 50.8 in June, beating forecasts and ending a five-month streak of contraction. Markit’s PMI for Japan rose from 49.9 in May to 51.1 in June, its highest since March. (FT’s Global Markets Overview)
Given the recent proliferation of debate about monetary policy and the fall in volatility — among central bank officials and the economics commentariat both — it might be worth revisiting first principles. Start with the obvious point that the Fed’s monetary policy mandate says nothing about financial stability, which therefore must be a secondary variable. It matters only inasmuch as it affects the Fed’s ability to satisfy its mandates of price stability and full employment. This is mostly undisputed but not often stated plainly.
There’s a good note from Goldman Sachs this week on the implications of negative rates at the ECB. But given that many of the points echo much of the discussion already featured on FT Alphaville for years, we’ll cut straight to the interesting bits. Goldman agree there isn’t anything conceptually special about negative rates because bond math works with negative numbers (as it’s focused on real returns). However, they add, there is a specific reason why negative rates might have qualitatively different macroeconomic implications, unless controls on cash were put in place with them:
We wonder if, after a brief blaze of real scrutiny, people have started to look past the imposition of a negative deposit rate by the ECB in favour of the more seductive and mysterious ECB QE and how it might be constructed. And we wonder if that is something of a mistake. How a move to negative is constructed will, of course, have much to do with what it is intended to achieve — a weaker euro at last check — but we also can’t help but think it would be cool to make sure it won’t cause too much harm either. Herein lies a plan.
Markets: Asia-Pacific bourses were on the rise, led by Japan, but Greater China equity markets pared gains after the world’s second-largest economy reported its slowest quarterly growth since late 2012. The tone across the rest of the region was broadly positive after the S&P 500 swung out of negative territory early in the New York session to close 0.7 per cent higher. Forecast-beating earnings from Coca-Cola and Johnson & Johnson helped the mood. (FT’s Global Market Overview)
Unanimous in its commitment to using also unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation… – Mario Draghi, April ECB press conference Don’t try saying that with a mouthful of peas. More seriously, spot the caveats. A few members of the ECB governing council have since added to the noise around ECB QE — Nowotny, Mersch, Constancio, Coeure and Weidmann — but we feel better no informed than when the presser ended on Thursday.
China’s central bank engineered an abrupt end to the carry trade in the renminbi last month. Could it also be helping to drive up the ever-appreciating euro? Very likely, is the conclusion of currency strategists. Chinese officials have long been determined to lessen a reliance on the dollar as the world’s dominant reserve currency. But they can only act on this resolve at times when foreign exchange reserves are accumulating – giving reserve managers the opportunity to diversify.
China’s central bank has drained Rmb48bn ($7.9bn) from money markets || BoJ maintains expansionary monetary policy || Banks review rules on forex traders betting own money || Barclays bankers face Libor charges || Head of Vitol calls for reform of Brent || Iran’s Bank Mellat sues UK Treasury in $3.9bn lawsuit || BHP Billiton posted a 31 per increase in profits in the first half || Alcoa to cut smelting capacity || Temasek seeks to sell $3.1bn Shin Corp stake ||
Buy equities said man owning equities. Maybe buy loans hinted man at the ECB: We think that a revitalisation of a certain type of ABS, a so-called plain vanilla ABS, capable of packaging together loans, bank loans, capable of being rated, priced and traded, would be a very important instrument for revitalising credit flows and for our own monetary policy…
There is a destabilising force pounding its way through the global economy, generating untold chaos in its wake. You can’t see it, you can’t touch it, and you definitely can’t kill it. At best, you can scare it away (temporarily). Sometimes, if you’re lucky and it serves your interests, you can woo it back as well. What we’re talking about, of course, is idle capital, the sort that greedily seeks out guaranteed returns without any respect for conditionality, commitment or risk. Something also frequently referred to as ‘hot money’. In many ways it’s the equivalent of a bar-shy friend, or one who always somehow knows how to dodge the bill by the end of the night. A ‘friend’ who has no problem in taking from others, and never giving back. Someone who’s around for the good times only. An outright user of others. A flake.
Our broad US outlook for 2014 is that it represents an inversion of the situation from the start of last year: while the conditions for economic growth in the US now seem better than they were then, the prospects for debt and equity markets are much more complicated. It’s easy to understand this flipped dynamic in equities. After a 30 per cent return in the S&P 500 last year, stocks are widely thought to be either fairly priced or perhaps a little overpriced, making it tough to know what happens next.
In our money entanglement posts this week, we presented the view that a nation’s money should not be judged as a neutral and interchangeable stock of identical value units, since it’s actually made up of a web of competing monies, issued by many different entities. These units appear to be identical, however, because system preferences — especially during periods of economic stability — encourage convergence to the most liquid and most money-like of all the units: namely the state currency. In reality, however, not all money units are created equal. It is during financial panics that the market is violently reminded of the inherent inequality of the money that circulates through the system. The panic grows as the market realises the money market is so entangled there is no efficient way of segregating corrupted value units from trusted units, at least not without turning to overt collateralisation.