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Category Archives: Interest Rates
the macro cons
Skipping the pros and focusing on the cons regarding the economy:
1. 0 rates (including QE) continue to be a highly deflationary bias that require deficits to be that much higher.
2. The FICA hike’s a serious setback that reduces growth from 3 or 4% to 1.5 or 2.5% or less.
3. Corporate cash building, foreign dollar accumulation, pension fund rebuilding, etc. are demand leakages
4. Past expansions were fueled by things we won’t do again- sub prime fraud, tech/y2k bubble, S&L expansion leg, emerging market fx debt fueled bubble, etc.- and that Japan has been careful to avoid.
5. Global austerity, where, in general, everyone of consequence thinks the problem is deficits are too large when in fact they are far too small for current credit conditions.
The January ‘bounce back’ from avoiding the cliff, debt ceiling delay, ideologues angry at the election results, etc. and the head fakes from the accelerated dividends and bonuses in Dec, seasonal issues with claims, the strong euro, some relatively modest China strength, and a few other things, is all fading fast.
a word on the euro, US deficit doves, and Japan
As previously discussed, the euro looks to keep going up until the trade surplus reverses. Problem is the strong euro doesn’t necessarily cause the trade surplus to reverse, at least not in the short term. But it does tend to work against earnings and growth. And there’s nothing the ECB can do about it, short of buying dollars via direct intervention, which would be counter to their core ideology, as building dollar reserves would give the appearance of the dollar backing the euro. The solvency issue has now been behind them for quite a while, and still no sign of any ‘official’ recognition that deficits need to be higher to restore output and employment.
And, also as previously discussed, while the future was looking up for the US a few months ago, the caveat of ‘austerity’ has come into play with the year end FICA and other tax hikes, and now the odds are the sequesters are allowed to come into play March 1 as well. Note this has been Japan’s policy as well- fiscal tightening at the first sign of any hope for expansion. Fed policy also looks to remain restrictive as blatantly evidenced by the recent turn over of some $90 billion of ‘profits’ to the Treasury that otherwise would have been earned by the economy.
The headline ‘deficit doves’ pushing for larger deficits with their ‘out of paradigm’ arguments are also serving to continue to support austerity. They have been arguing that the low interest rates are a signal from the markets (as if they know anything about markets) indicating the economy wants the govt to sell more bonds. This is in response to the hawk’s equally out of paradigm argument that financing deficits will eventually drive up interest rates. So now that interest rates have started going higher, the dove’s case is for higher deficits is pretty much gone, removing the resistance to ‘getting our fiscal house in order’ just as the sequester date is approaching. Whether it’s gross ignorance or intellectual dishonesty doesn’t matter all that much at this point- it’s happening. At the same time oil and gasoline prices have been creeping up, taking a few more shekels away from consumers. January and it’s strong equity inflows/allocations and releases of December’s stats ends tomorrow. February’s releases of Jan stats will bring more post FICA hike clarity.
Japan’s weak yen, pro inflation policy seems to have been all talk with only a modest fiscal expansion to do the heavy lifting. Changing targets does nothing, nor does the BOJ have any tools that do the trick as evidenced now by two decades of using all those tools to the max. And while I’ve been saying all the while that 0 rates, QE, and all that are deflationary biases that make the yen stronger, there is no sign of that understanding even being considered by policy makers, so expect more of same. What has been happening to weaken the yen is a quasi govt policy of the large pension funds and insurance companies buying euro and dollar denominated bonds, which shifts their portfolio compositions from yen to euros and dollars, thereby acting to weaken the yen. I have no idea now long this will continue, but if history is any guide, it could go on for a considerable period of time. Yes, it adds substantial fx risk to those institutions, but that kind of thing has never gotten in the way before. And should it all blow up some day, look for the govt to simply write the check and move on.
QE follow up
It’s been about a week, and the initial reactions are already wearing off and markets settling in.
The lasting effects are those of the income lost to the economy as the Fed earns the interest on the securities it buys instead of the economy. This reduces the federal deficit and is a ‘contractionary’ force. At the same time the Fed removes securities/duration/convexity/vol from the economy which tends to lower the term structure of risk free rates some and further reduce volatility as well.
Initially the long end sold off on the presumption that QE works to lower the output gap/restore growth and employment, which means the Fed would, down the road, be hiking rates in response to the improving economy.
However, as the reality that QE doesn’t work to support aggregate demand sinks in, long end yields can come down on the anticipation that future growth prospects are not good, increasing the odds that the Fed will be keeping rates low that much longer.
Likewise, it’s a mixed bag for stocks, though overall modestly supportive. QE doesn’t improve earnings prospects, and serves to keep growth down, but the lower interest rates help valuations, and high unemployment along with productivity increases work to keep unit labor costs down.
Europe has solved the solvency issue, but it’s all conditional on bringing deficits down, and so far it looks like they are all working to keep doing exactly that, and with no prospects for material private sector credit expansion or export growth,
GDP can continue to be negative.
Then there’s the US fiscal cliff. Everyone agrees deficit reduction slows things down, which is why they say we shouldn’t do it now. But they also therefore know it will slow down things whenever they do it in the future. So how hard should it be to come to recognize that slowing things down is actually the point of deficit reduction, and is appropriate only for that reason? Apparently it’s impossible. And the fiscal cliff is already taking its toll as anticipated contracts for next year along with purchases are being delayed.
So without some kind of fiscal paradigm shift I don’t see much good happening, and even the muddle through scenario is now at risk.
Quick update
A few more modest ‘green shoots’ including US personal income up .5, a few more jobs, houses and cars looking reasonable firm, etc. and markets starting to ‘undiscount’ a US recession.
Govt deficits remain plenty high to support income/sales/employment at current (depressed) levels and promote modest growth. Just as in the prior two double dip panics of the last several years, markets and the mainstream tend to give little if any weight to the notion that large deficits support aggregate demand. (Interesting how ideology seems to be adversely influencing their forecasting.)
So right now I see no fundamental reason for a meaningful drop in aggregate demand, apart from a politically driven external shock of some sort from Europe or maybe Iran, where there have been a few too many very recent noises regarding an Israeli attack for comfort.
Swiss Manufacturing Slump Unexpectedly Eases on Output Gain
By Simone Meier and Klaus Wille
August 2 (Bloomberg) — Swiss manufacturing contracted at a slower pace in July than in the previous month as companies stepped up production, suggesting that the economy is weathering Europe’s deepening slump.
The procure.ch Purchasing Managers’ Index rose to 48.6 from 48.1 in June, when adjusted for seasonal swings, Credit Suisse Group AG said in an e-mailed statement today. That’s the highest since March. A reading below 50 indicates contraction.
Marginal rise in construction output, but new orders continue to decline during July
August 2 (Markit) — At 50.9 in July, up from 48.2, the Markit/CIPS Construction PMI rebounded slightly from June’s two-and-a-half year low. However, the latest reading was well below the long-run series average (54.2). Growth was largely confined to the commercial sub-sector in July, as house building and civil engineering activity continued to decline. July data indicated a further reduction in new work received by construction companies. Although the rate of decline eased over the month, it was still the second-fastest since January 2010. Survey respondents widely cited a lack of new opportunities to tender and a general weakness in underlying market demand.
Sweden Krona Jumps as Rate Cut Calls Fade on Accelerating Growth
By Stephen Treloar and Johan Carlstrom
August 1 (Bloomberg) — Sweden’s krona surged, posting the biggest gains of all major currencies, after a report showed manufacturing unexpectedly expanded, damping speculation the Riksbank will cut interest rates at its meeting next month.
The krona rose as much as 0.8 percent to 8.2979 per euro, the highest since Sept. 11, 2000, and was up 0.5 percent at 8.3217 as of 1:15 p.m. in Stockholm. It surged almost 0.9 percent against the dollar to 6.7411, a three-month high. It gained against all 16 major currencies tracked by Bloomberg.
An index based on responses from purchasing managers rose to a seasonally adjusted 50.6 in July from 48.4 the previous month, Stockholm-based Swedbank AB said today. A reading above 50 signals an expansion. It was estimated to drop to 47.7, according to the median estimate in a Bloomberg survey.
“Following the surprisingly strong GDP number Monday this gives further ammunition for unchanged Riksbank rates at the September meeting and lends additional support to krona appreciation,” said Claes Maahlen, head of trading strategy at Svenska Handelsbanken AB in Stockholm, in a note today.
Sweden has been able to avoid a recession this year as companies such as retailer Hennes & Mauritz AB and Sandvik AB have benefitted from demand outside Europe and as the central bank cut interest rates. The economy expanded 1.4 percent in the second quarter as increased exports of services offset a decline in the export of goods. Consumer spending also rose.
The yield on Sweden’s two-year notes increased three basis points to 0.9 percent.
Interest income loss from rate cuts
Word’s getting around, from CS:
The side-effect of the Fed’s near-zero interest medicine – the collapse in personal interest income over the last few years. The decline in interest income actually dwarfs estimates of debt service savings. Exhibit 2 compares the evolution of household debt service costs and personal interest income. Both aggregates peaked around $1.4 trn at roughly the same time – the middle of 2008. According to our analysis of Federal Reserve figures, total debt service – which includes mortgage and consumer servicing costs – is down $206bn from the peak. The contraction in interest income amounts to roughly $407bn from its peak, more than double the windfall from lower debt service.
John’s got it!
Congress, Not the Fed, Needs to ‘Get to Work’
By John Carney
July 17 (CNBC) — The Senate Banking Committee’s grilling of Federal Reserve Chairman Ben Bernanke just got weird.
Senator Charles Schumer, the New York Democrat, proposed a novel theory of political management of the economy shortly before 11 am Tuesday morning.
The gist of the theory: If the elected branches of government cannot agree to act, the responsibility for the economy falls to the Fed.
Schumer’s argument amounted to the idea that that because disagreements between Republican and Democrats (and, of course, the political ambitions of members of both parties in a presidential election year) are blocking any agreement to provide fiscal relief to the economy, the Fed should “get to work.”
It’s tempting to say that this is the drunk’s theory of the bar tab.
The drunk has been drinking so much he can’t work—and therefore can’t afford to pay his tab. So it’s up to the bartender to pour another cocktail and extend the tab a bit longer.
But this would be insulting to drunks everywhere. The drunk actually understands the economics of the bar better than Schumer understands the difference between monetary and fiscal policy.
The economy right now suffers because the private sector is attempting to save more than it spends, mostly by paying down its enormous debt burden. Because everyone’s income comes from someone else’s spending, reduced overall spending results in income reduction. In our economy, that means higher unemployment.
If the economy is going to grow while households and businesses pay down their debts instead of spending, someone else must take the opposite side of the trade by growing spending more than its income.
With the rest of the world heading toward recession, the only plausible source of this added income is the government. In other words, the government must cut taxes relative to spending (or grow spending relative to taxes) to replace the lost income in the private sector.
What the economy certainly isn’t suffering from right now is a shortage of liquidity or a meager money supply. Which is to say, we’ve reached the limits of what the Fed can do to spur growth. (Although perhaps not the limits of what the Fed can do to fend off a sharp turn downward in the economy.)
To hear a member of the shirker branch of our government blame the Fed for not doing enough would be laughable if we weren’t living with the consequences of the shirking.
Sen. Schumer—and his fellow lawmakers—are the ones who should “get to work.”
Banks Face $6 Billion of Libor Litigation, Morgan Stanley estimates
The libor scandal is particularly bad, even though not a lot of actual $ gains/losses involved, in that it happened after the financial crisis when there was at least some hope that the surviving major banks had, in general, cleaned up their act. And also at least some hope that the crisis was a wake up call to bank regulators and supervisors.
It’s not that hard to spot. For example, relatively wide libor basis swaps indicate markets are discounting libor settings being away from actual deposit rates by more than typical bid/offered spreads.
Banks Face $6 Billion of Libor Litigation, Morgan Stanley estimates
July 12 (Bloomberg) — Banks being probed for attempting to rig benchmark interest rates could face $6 billion of related litigation costs, analysts at Morgan Stanley estimated. The 16 banks may also lose 4 percent to 13 percent in 2012 earnings per share from regulatory fines on a base case scenario, Morgan Stanley analysts led by Betsy Graseck wrote in a note to investors today. They may also suffer from tighter scrutiny from regulators in response to the Libor investigations, the analysts said.
Libor Criminal Investigations Will Happen: Diamond
Libor Criminal Investigations Will Happen: Diamond
By Catherine Boyle
July 4 (CNBC) — Bob Diamond, the recently-departed chief executive of Barclays, told U.K. politicians that there would be criminal investigations into the manipulation of the London interbank offered rate (Libor) scandal which led to his resignation.
From my 2009 proposals here:
2. US banks should not be allowed to contract in LIBOR. LIBOR is an interest rate set in a foreign country (the UK) with a large, subjective component that is out of the hands of the US government. Part of the current crisis was the Federal Reserve’s inability to bring down the LIBOR settings to its target interest rate, as it tried to assist millions of US homeowners and other borrowers who had contacted with US banks to pay interest based on LIBOR settings. Desperate to bring $US interest rates down for domestic borrowers, the Federal Reserve resorted to a very high risk policy of advancing unlimited, functionally unsecured, $US lines of credit called ‘swap lines’ to several foreign central banks. These loans were advanced at the Fed’s low target rate, with the hope that the foreign central banks would lend these funds to their member banks at the low rates, and thereby bring down the LIBOR settings and the cost of borrowing $US for US households and businesses. The loans to the foreign central banks peaked at about $600 billion and did eventually work to bring down the LIBOR settings. But the risks were substantial. There is no way for the Fed to collect a loan from a foreign central bank that elects not to pay it back. If, instead of contracting based on LIBOR settings, US banks had been linking their loan rates and lines of credit to the US fed funds rate, this problem would have been avoided. The rates paid by US borrowers, including homeowners and businesses, would have come down as the Fed intended when it cut the fed funds rate.
Brazil Cuts Rates to Record Low as Economy Stalls
Another central bank may have it backwards as lower rates turn out to be deflationary and slow things down via interest income channels?
Brazil Cuts Rates to Record Low as Economy Stalls
May 30 (Bloomberg) — Brazil’s central bank cut interest rates on Wednesday for the seventh straight time to a record low 8.50 percent, moving into uncharted territory in a bid to shield a fragile recovery from a gloomy global outlook.
President Dilma Rousseff has made lower interest rates one of the top priorities of her government which is struggling to steer the economy back to the 4 percent-plus growth rates that made Brazil one of the world’s most attractive emerging markets in the last decade.
The central bank’s monetary policy committee, known as Copom, voted unanimously to lower the benchmark Selic rate 50 basis points from 9 percent, in line with market expectations.
“At this moment, Copom believes that the risks to the inflation outlook remain limited,” the bank said in a statement that accompanied the decision. The statement used the exact same language as the previous statement when the bank cut the Selic rate in April.
With Wednesday’s cut, the central bank has now lopped 400 basis points off the Selic rate since August 2011, when it surprised markets by starting an easing cycle despite widespread concerns at the time about surging consumer prices.
Inflation has eased since then with some help from a sluggish global economy, bringing the annual rate to well below the 6.5 percent ceiling of the central bank’s target range.
That has allowed the central bank to test the boundaries on interest rates, ushering in what some economists predict might be a new era of lower borrowing costs for Brazil.
The size of Wednesday’s rate cut marked a slowdown in the pace of easing after two straight reductions of 75 basis points in March and April. The central bank signaled after its April policy meeting that future rate cuts might be more cautious.
The previous low for the Selic was set in 2009, when the central bank in the administration of former President Luiz Inacio Lula da Silva slashed the rate to 8.75 percent to fend off the global financial crisis.