5/4/21: The Coming Wave of Financial Repression

 

In a recent article for The Currency, I covered the topic of the forthcoming wave of financial repression, as Governments worldwide pursue non-conventional fiscal tightening in years to come: Make no mistake, financial repression is coming in the US: https://thecurrency.news/articles/36547/make-no-mistake-financial-repression-is-coming-in-the-us/. 

3/2/21: Monetary Easing and Stock Market Valuation

There has been quite a puzzling development in recent years in the monetary policy universe. A decade plus of ultra low interest rates has been associated with rising, not falling, risk premium in investment markets. In other words, a dramatically lower cost of new and carried debt induced by lower interest rates - a driver for lower risk, is being offset by something else. What?

Laine, Olli-Matti paper "Monetary Policy and Stock Market Valuation" (September 18, 2020, Bank of Finland Research Discussion Paper No. 16/2020: https://ssrn.com/abstract=3764721) tries to explain. 

To start with, some theory - especially for my students in the Investment and Financial Systems courses. Per author, "the value of a stock is the present value of its expected future dividends... Hence, the changes in stock prices must be explained by 

• either changes in dividend expectations or 
• changes in discount rates. 

The discount rate, or (approximately) expected rate of return, can be thought as a sum of a risk-free rate and a risk premium. Theoretically, monetary policy should have an effect on stock prices through the risk-free rates. In addition, monetary policy should affect dividend expectations, for example, through the output or debt interest payments of firms. The effect on the risk premium (not to mention the term structure of risk premia), however, is less clear."

Looking at Eurostoxx50 index components, Laine shows "...that the average expected premium has increased considerably since the global financial crisis. This change is explained by the change in long-horizon expected premia. ... monetary policy easing has had a positive impact on the expected average premium."

Specifically (emphasis added): "a negative shock to the shadow rate is estimated to increase average expected premium persistently. Instead, the results show that monetary policy easing temporarily decreases short-term expected [risk] premia. This means that expansionary monetary policy steepens the slope of the term structure of risk premia."

This is not exactly new, as Bernanke and Kuttner (2005) observed that "expansionary monetary policy generates an immediate rise in equity prices followed by a period of lower-than-normal excess returns. ...However, Bernanke and Kuttner (2005) do not study the effect on the long-run excess returns. My results show that effect on long-horizon expected premia has a different sign. This effect on long-horizon premia seems to more than offset the effect on short-horizon premia."

Interestingly, "Contractionary monetary policy increases the short-term premia temporarily, but decreases long-horizon premia persistently. The effect on average expected premium is negative. Thus, monetary policy tightening actually makes stocks expensive relative to the expected stream of dividends. The results provide no evidence that expansionary monetary policy causes stock market bubbles..."

Here is (annotated by me) a chart showing evolution of implied and actual risk premia:

From theory perspective, therefore, monetary policy "can affect equity prices through the dividend expectations, expected risk-free rates or expected premia":

• "The effect of expansionary monetary policy on the dividend expectations is probably positive, because expansionary monetary policy can be expected to increase output and firms’ earnings.
• "Expansionary policy probably lowers the risk-free rates, but it is also possible that the effect is totally different. Central bank’s rate cut can increase risk-free rates, if people think that the rate cut eventually increases inflation. 
• "As for the expected premium, the sign of the effect is unclear. ... Gust and López-Salido (2014) show theoretically that expansionary monetary policy lowers the premium ... where asset and goods markets are segmented. When it comes to quantitative easing, ... investors who have sold their assets to the central bank rebalance their portfolios into riskier assets, which lowers their expected returns. ... Theoretically, it is also possible to argue that monetary policy easing actually increases the expected premium. If one assumes that there exists mispricing like Galí (2014) and Galí and Gambetti (2015), then the sign of the response is ambiguous. ... This means that monetary policy easing increases the expected premium implied by dividend discount model (see Galí and Gambetti, 2015, p. 250-252)."

So, onto the empirical results by Laine: 

1. "Interest rates have declined considerably since the global financial crisis, yet the expected average stock market return has remained quite stable at around 9 percent. This implies that expected average stock market premium has increased remarkably. This rise is mainly explained by the premia over a discounting horizon of four years.
2. "These results may seem unintuitive as the prices of stocks have risen, and ratios like price-to-earnings have been historically high. However, high price-to-earnings ratios do not necessarily mean that stocks are expensive, because the value of a stock is the present value of its expected future dividends.
3. "When it comes to the role of monetary policy, the results show that monetary policy easing decreases short-horizon required premia, but increases longer-horizon premia. 
4. "The effect on expected average premium is positive, i.e. expansionary monetary policy lowers the prices of stocks in relation to the expected dividend stream."

11/8/20: Euromoney Seminar on Longer-Term Trends in Economics

 

My seminar from last week for Euromoney is now available online here: https://zoom.us/webinar/register/3015960150760/WN_zHo5R5sNTMyKzm9xhxtIMA. 

We talked less about MMT (currently, monetary policies already replicate some of the key features of the proposition) and more about longer-term problems with economic growth and monetary policies.

18/6/20: Cheap Institutional Money: It's Supply Thingy

In a recent post, I covered the difference between M1 and MZM money supply, which effectively links money available to households and institutional investors for investment purposes, including households deposits that are available for investment by the banks (https://trueeconomics.blogspot.com/2020/06/what-do-money-supply-changes-tell-us.html). Here, consider money instruments issuance to institutional investors alone:

Effectively, over the last 12 years, U.S. Federal reserve has pumped in some USD 2.6 trillion of cash into the financial asset markets in the U.S. These are institutional investors' money over and above direct asset price supports via Fed assets purchasing programs, indirect asset price supports via Fed's interest rates policies and QE measures aimed at suppression of government bond yields (https://trueeconomics.blogspot.com/2020/05/21520-how-pitchforks-see-greatest.html). 

Any wonder we are in a market that is no longer making any sense, set against the economic fundamentals, where free money is available for speculative trading risk-free (https://trueeconomics.blogspot.com/2020/06/8620-30-years-of-financial-markets.html)?

13/6/2020: What Do Money Supply Numbers Tell Us About Social Economics?

What do money supply changes tell us about social economics? A lot. Take two key measures of U.S. money supply:

• M1, which includes funds that are readily accessible for spending, primarily by households and non-financial companies, such as currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; traveler's checks; demand deposits; and other checkable deposits. 

• MZM, which is M2 less small-denomination time deposits plus institutional money funds, or in more simple terms, institutional money and funds available for investment and financial trading.

Here we go, folks:

Does this help explain why Trumpism is not an idiosyncratic phenomena? It does. But it also helps explain why the waves of social unrest and protests are also not idiosyncratic phenomena. More interesting is that this helps to explain why both of these phenomena are tightly linked to each other: one and the other are both co-caused by the same drivers. If you spend a good part of 20 years pumping money into the Wall Street while largely ignoring the Main Street, pitchforks will come out. 

The *will* bit in the sentence above is now here.

12/6/20: Summary of the Eurosystem Response Measures to COVID19

Great and tight summary of the Eurosystem monetary policies deployed in response to COVID19 pandemic: https://blocnotesdeleco.banque-france.fr/en/blog-entry/monetary-policy-measures-taken-eurosystem-response-covid-19.  Cumulative total through the end of May, EUR 1.27 trillion.

26/5/20: Franco-German Eurobonds: A First Step on the Road to Federalism

My recent article on the Franco-German proposal for Euro bonds for The Currency: https://www.thecurrency.news/articles/17392/france-and-germany-have-proposed-a-e500m-fund-to-shield-european-economy-what-does-it-mean-for-ireland.

21/5/20: How Pitchforks See the Greatest Economy in the World

Folks with pitchforks don't care for nuance of financial wizardry. Or for econophysics of data-rich markets. They like simple, somewhat stylized facts. So here is how the world of the last 12 years looks to them:

Nothing to add.

$5.9 trillion and counting: the scale of Monetary Easing

Updating my previous post: https://trueeconomics.blogspot.com/2020/03/20320-46-trillion-and-counting-scale-of.html listing all measures monetary authorities around the world have unleashed in response to the Covid19 crisis:

• 23/3/2020 Federal Reserve Bank of the U.S.: 

1. Commitment to continue asset purchasing program “in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy”. Basically, an open-ended pledge, with no USD amount. This does not move the needle on its prior commitment if USD 700 billion in purchasing, for 2020. But it does expand the program, should the crisis continue unabated, and probably allows for bringing the committed purchases forward
2. The Fed also will be buying corporate bonds, crucially the investment-grade securities in primary and secondary markets and through exchange-traded funds. Again, this has been pre-committed to, but 'primary' markets operations are something that is truly unprecedented.
3. An unspecified lending program for Main Street businesses and the Term Asset-Backed Loan Facility implemented during the financial crisis
4. There will be a program worth $300 billion “supporting the flow of credit” to employers, consumers and businesses 
5. Two facilities set up to provide credit to large employers
6. Issuance of asset-backed securities backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration and certain other assets
7. Expanding Commercial Paper Funding Facility. The program now will include “high-quality, tax-exempt commercial paper” and the pricing will be reduced.
8. Lower the interest rate on its repo operations to 0% from 0.1%.
9. My estimate of the 1H 2020 net impact of new measures is in the region of USD200-400 billion.

• 22/3/2020 Chancellor Angela Merkel’s government plans to increase borrowing up to EUR 150 billion in 2020 and pass a EUR 156 billion supplementary budget. Germany is also planning to set up a bailout fund for critical industries of about EUR 500 billion. While the measures are fiscal in nature, they require monetary policy supports to sustain low borrowing costs and demand for these securities.

These measures moves the needle for global measures from USD4.6 trillion to USD 5.9 trillion.

20/3/20: $4.6 trillion and counting: the scale of Monetary Easing

The monetary largesses to-date: Central Banks across the world have slashed interest rates in the past few weeks, provided additional emergency liquidity supports for the markets, ranging from equity markets to bond markets to municipal debt markets and money markets. They also announced trillions worth of direct asset purchasing and debt monetization programs. Ex-international / multinational lines and direct swaps lines, total amounts of monetary and financial channels supports deployed so far is around USD 4.582 trillion. This number also excludes open-ended (unbounded) measures, such as programs to purchase securities to guarantee specific price/yield ranges.

Here is the summary of these (and direct Government lending) programs to-date:

• 20/03/2020  Banco de México: rate cut bps = -50, base rate = 6.50, overnight interbank rate.
• 20/03/2020  National Bank of Romania: rate cut bps = -50, base rate = 2.00
• 20/03/2020  Bank of Thailand rate cut bps = -25, base rate = 0.75
• 20/03/2020  Norges Bank (Norway) rate cut bps = -75, base rate = 0.25
• 19/03/2020  Central Reserve Bank of Peru rate cut bps = -100, base rate = 1.25
• 19/03/2020  Bank of England rate cut bps = -15, base rate = 0.1, added GBP 200 billion to bond buying programme raising it to GBP 645 billion. On 17/03/2020: the U.K. Government unveiled another, larger stimulus package. It includes, among other things USD 379 billion in business loan guarantees, USD 23 billion in business tax cuts and grant funding to businesses hit worst by the virus, such as retail and hotel businesses
• 19/03/2020  South African Reserve Bank rate cut bps = -100, base rate = 5.25
• 19/03/2020  Taiwan Central Bank rate cut bps = -25, base rate = 1.125
• 19/03/2020  Bank Indonesia rate cut bps = -25, base rate = 4.5
• 19/03/2020  Philippine Central Bank cut bps = -50, base rate = 3.25
• 19/03/2020  Reserve Bank of Australia cut bps = -25, base rate = 0.25, set a target for the yield on 3-year government bonds at ~0.25%, plans to purchases bonds in the secondary market do sustain yield around 25 bps; provided a 3-year funding facility to the banks at a fixed rate of 0.25%
• 18/03/2020  Central Bank of Brazil cut bps = -50, base rate = 3.75
• 18/03/2020  Bank of Ghana cut bps = -150, base rate = 14.50
• 18/03/2020  Central Bank of Iceland cut bps = -50, base rate = 1.75
• 18/03/2020 Federal Reserve Bank of the U.S. announced the Money Market Mutual Fund Liquidity Facility (MMLF), to lend money to banks so they can purchase assets from money market funds. The U.S. Treasury will cover up to USD 10 billion of loan losses from this program, and lending under the program will not effect bank capital requirements. The program is scheduled to run until the end of September. This is similar to the AMLF program launched in 2008 after the collapse of Lehman Brothers.
• 17/03/2020 French Government announced a guarantee on bank loans to businesses up to USD 327 billion
• 17/03/2020  National Bank of Poland cut bps = -50, base rate = 1.00
• 17/03/2020  Central Bank of Armenia cut bps = -25, base rate = 5.25
• 17/03/2020  Bank Al-Maghrib, Marocco cut bps = -25, base rate = 2.00
• 17/03/2020  State Bank of Pakistan cut bps = -75, base rate = 12.50
• 17/03/2020  Central Bank of the Rep. of Turkey cut bps = -100, base repo rate = 9.75
• 17/03/2020  State Bank of Vietnam cut bps = -100, base refinancing rate = 5.00, cut bps = 50, base discount rate 3.50
• 17/03/2020 Federal Reserve Bank of the U.S.: U.S. Treasury Secretary Mnuchin approved the Federal Reserve's "Commercial Paper Funding Facility" (CPFF) which allows the Fed to create a corporation which can purchase commercial paper, short-term, unsecured loans made by businesses for everyday expenses. Mnuchin authorized up to USD 10 billion from the U.S. Treasury to help cover loan losses incurred under this program. The program will end on March 17, 2021 unless it is extended. The program is similar to the one launched after the Global Financial Crisis. On the same day, the Federal Reserve received approval to re-launch another Great Recession-era tool, the Primary Dealer Credit Facility (PDCF). PDCF will offer short-term loans to banks secured by collateral such as municipal bonds or investment-grade corporate debt. The program will run at least six months and can be extended.
• 16/03/2020 Federal Reserve Bank of the U.S. increased reverse repo operations by another $500 billion to USD 2 trillion
• 16/03/2020  Central Bank of Jordan cut bps = -100, base rate = 2.50
• 16/03/2020  Central Bank of Chile cut bps -75, base rate = 1.00
• 16/03/2020  Central Bank of Egypt cut bps -300, base overnight rate = 10.25; cut bps = -300, base overnight deposit rate = 9.25
• 16/03/2020  Czech Central Bank, cut bps = -50, base rate = 1.75
• 16/03/2020  Central Bank of Bahrain, one week deposit rate, cut bps = -75, rate =1.00
• 16/03/2020  Qatar Central Bank, cut bps = 50, base repo rate = 1.00
• 16/03/2020  Saudi Arabian Monetary Authority, cut base repo rate = -75 bps, to rate = 1.00
• 16/03/2020  Central Bank of Sri Lanka, cut base deposit rate to 6.25 and standing lending rate to 7.25
• 16/03/2020  Bank of Korea cut 50 bps to the base rate of 0.75
• 16/03/2020  Bank of Japan: short term rate -0.1%, long term 10-year JGB yield target at 0%; raised purchases of exchange-traded funds (ETFs) x2 from USD 56 billion a year to USD 112 billion for ETFs and for other risky assets, including commercial paper, created new loan program for 1 year at zero rate for financial institution.  
• 16/03/2020  Reserve Bank of New Zealand, cut bps = -75, base rate = 0.25
• 16/03/2020 Bank of Canada: the Office of the Superintendent of Financial Institutions (OSFI), Canada's financial regulatory body, lowered bank reserve requirements, allowing banks to lend an additional USD 214 billion
• 15/03/2020  Federal Reserve of the U.S., cut bps = -100, base rates 0-0.25 range, will purchase at least USD 700 billion of securities, including at least $500 billion of U.S. Treasuries and at least $200 billion of mortgage-backed securities
• 13/03/2020 Germany authorizes state-owned KfW bank, to lend out as much as USD 610 billion to companies to cushion the effects of the coronavirus
• 13/03/2020  Bank of Canada, cut bps = -50, base rate = 0.75
• 13/03/2020  Norges Bank, Norway, cut bps = -50, base rate = 1.00
• 13/03/2020 People's Bank of China: lowered the banks' reserve requirement ratio by 0.5-1 percentage points to free USD79 billion worth of new lending
• 12/03/2020 Federal Reserve Bank of the U.S. massively expanded reverse repo operations, adding USD1.5 trillion of liquidity. Effectively, the Fed extended the amount of short term loans to banks in an attempt to stabilize money markets and increase banks' access to cash.
• 12/03/2020  European Central Bank, deposit rate remains = -0.50%, cut TLTROIII rate by 25 bps to -0.75% (TLTROs are Targeted Long-Term Refinancing Operations providing negative cost loans to banks); later added to its 2019-announced asset purchase programme of EUR 20 billion a month: a one-off EUR 120 billion purchases in 2020 on top of EUR240 billion already planned, plus another EUR 750 billion in a Pandemic Emergency Purchase Programme. Purchases total planned for 2020 is at EUR 1.1 trillion.
• 11/03/2020  Bank of England, cut bps = -50, base rate = 0.25, also introduced a new programme for cheap lending and reduced a capital buffer requirements for the banks. Lowered capital requirements for U.K. banks, allowing them to use a "counter-cyclical capital buffer". Facilitating nearly USD 390 billion in new loans.
• 11/03/2020  National Bank of Serbia, cut bps = -50, base rate = 1.75
• 11/03/2020  Central Bank of Iceland, cut bps = -50, base rate = 2.25
• 05/03/2020  Central Bank of Jordan, cut bps = -50, base rate = 3.50
• 04/03/2020  Bank of Canada, cut bps = -50, base rate = 1.25
• 04/03/2020  Hong Kong Monetary Authority, cut bps = -50, base rate = 1.50
• 04/03/2020 and 03/03/2020: People's Bank of China expanded its reverse repo operations by USD 71 billion and USD 174 billion, respectively.
• 03/03/2020  Federal of the U.S., cut bps = -50, base rates range = 1.00-1.25. Largest cut since 2008
• 03/03/2020  Central Bank of Malaysia, cut bps = -25, base rate = 2.50
• 03/03/2020  Reserve Bank of Australia, cut bps = -25, base rate = 0.50
• 20/02/2020  Bank of Indonesia, cut bps = -25, base rate = 4.75
• 20/02/2020  People's Bank of China, cut bps = -10, base rate = 4.05 for 1 year loan prime rate and 5-year rate from 4.80% to 4.75%.
• 06/02/2020  Philippine Central Bank, cut bps = -25, base rate = 3.75
• 05/02/2020  Bank of Thailand, cut bps = -25, base rate = 1.00

Multinational efforts:
 

• The Fed, along with the ECB, Bank of Canada, Bank of England, Bank of Japan and the Swiss National Bank also agreed to offer three-month credit in U.S. dollars on a regular basis and at a rate cheaper than usual.
• 04/03/2020 the International Monetary Fund made USD 50 billion in loans available to deal with the coronavirus, including USD10 billion of zero-interest loans to the poorest IMF member countries. 16/03/2020 the IMF said it, "stands ready to mobilize its USD 1 trillion lending capacity to help our membership." In the same statement, the IMF said it has $200 billion in current lines of credit, some of which could be used for the COVID crisis, and that they have "received interest from about 20 countries and will be following up with them in the coming days." The IMF also is aiming to boost its debt relief fund to $1 billion from its current level of $400 million.
• 03/03/2020 the World Bank announced an initial package of up to USD 12 billion in loans for countries to help cope with the effects of the COVID19. USD 8 billion of the funding is new loans and the remaining USD 4 billion is redirected from current lines of credit.

 

20/3/20: Central Banks are Failing to Reinflate the Deflating Bubble

In the last 5 days, central banks around the world have announced 2020 monetary stimuli to the tune of USD 4 trillion (inclusive of measures continuing from those announced back in late 2019). This is what this bought them in the markets:

The problem with 'doing more of the same and expecting different results' is that the measures being deployed by the monetary authorities are predominantly skewed on simply increasing the total quantum of debt in the global economy already croaking under a mountain of debt. The markets see this. The markets know this. And, at long last, the markets are not buying any more of this.

On what timeline will the central bankers and their masters in the governments recognize the same?..

18/3/20: Banks, The Fed and Money Markets Woes

My article for the International Banker on pre-Covid monetary policy bottlenecks in the US markets is out and available here: https://internationalbanker.com/finance/banks-the-fed-and-money-markets-woes/

10/1/20: Eight centuries of global real interest rates

There is a smashingly good paper out from the Bank of England, titled "Eight centuries of global real interest rates, R-G, and the ‘suprasecular’ decline, 1311–2018", Staff Working Paper No. 845, by Paul Schmelzing.

Using "archival, printed primary, and secondary sources, this paper reconstructs global real interest rates on an annual basis going back to the 14th century, covering 78% of advanced economy GDP over time."

Key findings:

• "... across successive monetary and fiscal regimes, and a variety of asset classes, real interest rates have not been ‘stable’, and...
• "... since the major monetary upheavals of the late middle ages, a trend decline between 0.6–1.6 basis points per annum has prevailed."
• "A gradual increase in real negative‑yielding rates in advanced economies over the same horizon is identified, despite important temporary reversals such as the 17th Century Crisis."

The present 'abnormality' in declining interest rates is not, in fact 'abnormal'. Instead, as the author points out: "Against their long‑term context, currently depressed sovereign real rates are in fact converging ‘back to historical trend’ — a trend that makes narratives about a ‘secular stagnation’ environment entirely misleading, and suggests that — irrespective of particular monetary and fiscal responses — real rates could soon enter permanently negative territory."

Two things worth commenting on:

1. Secular stagnation: in my opinion, interest rates trend is not in itself a unique identifier of the secular stagnation. While interest rates did decline on a super-long trend, as the paper correctly shows, the broader drivers of this decline can be distinct from the 'secular stagnation'-linked declines in productivity and growth. In other words, at different periods of time, different factors could have been driving the interest rates declines, including higher (not lower) productivity of the financial system, e.g. development of modern markets and banking, broadening of capital funding sources (such as increase in merchant classes wealth, emergence of the middle class, etc), and decoupling of capital supply from the gold standard (which did not happen in 1973 abandonment of formal gold standard, but predates this development by a good part of 60-70 years).
2. "Permanently negative territory" for interest rates forward: this is a major hypothesis from the perspective of the future markets. And it is consistent with the secular stagnation, as availability of capital is now being linked to the monetary expansion, not to supply of 'organic' - economy-generated - capital.

More hypotheses from the author worth looking at: "I also posit that the return data here reflects a substantial share of ‘non‑human wealth’ over time: the resulting R-G series derived from this data show a downward trend over the same timeframe: suggestions about the ‘virtual stability’ of capital returns, and the policy implications advanced by Piketty (2014) are in consequence equally unsubstantiated by the historical record."

There is a lot in the paper that is worth pondering. One key question is whether, as measured by the 'safe' (aka Government) cost of capital, the real interest rates even matter in terms of the productive economy capital? Does R vs G debate reflect the productivity growth or economic growth and do the two types of growth actually align as closely as we theoretically postulate to the financial assets returns?

The macroeconomics folks will call my musings on the topic a heresy. But... when one watches endlessly massive skews in financial returns to the upside, amidst relatively slow economic growth and even slower real increases in the economic well-being experienced in the last few decades, one starts to wonder: do G (GDP growth) and R (real interest rates determined by the Government cost of funding) matter? Heresy has its way of signaling unacknowledged reality.

10/12/19: Irish Banks: Part 2

Continuing with the coverage of the Irish banks, in the second article for The Currency, available here: https://www.thecurrency.news/articles/4810/a-catalyst-for-underperformance-how-systemic-risk-and-strategic-failures-are-eroding-the-performance-of-the-irish-banks, I cover the assets side of the banks' balancesheets.

The article argues that "The banks are failing to provide sufficient support for the demand for investment funding, and are effectively removed from financing corporate investment. In this case, what does not make sense to investors does not make sense to society at large." In other words, strategic errors that have been forced onto the banks by deleveraging post-crisis have resulted in the Irish banks becoming a de facto peripheral play within the Euro area financial system, making them unattractive - from growth potential - to international markets.

The key conclusions are: "From investors’ perspective, neither of these parts of the Irish lenders’ story makes much sense as a long term investment proposition. From the Irish economy’s point of view, the banks are failing to provide sufficient support for the demand for investment funding, and are effectively removed from financing corporate investment. In this case, what doesn’t make sense to investors doesn’t make sense to the society at large."

10/12/19: Irish Banks: Part 1

Returning back to the blog after a break, some updates on recent published work.

In the first article on Irish banking for The Currency, titled "Culture wars and poor financial performance: examining Ireland’s dysfunctional, beleaguered banking system", I argued that "The financial performance of the Irish banks has been abysmal. Not for the lack of profit margins, but due to strategic decisions to withdraw from lending in the potential growth segments of the domestic and European economies." The article shows the funding side of the Irish banks and the explicit subsidy they receive from the ECB through monetary easing policies - a subsidy not passed to the end credit users.

In simple terms, high profit margins are underpinned - in Irish banks case - by low cost of funding.

Conclusions: "The implications of the lower cost of banks equity, interbank loans, as well as deposits for the Irish banking sector are clear cut: since the start of the economic recovery, Irish banks have enjoyed an effectively free ride through the funding markets courtesy of the ECB and the blind eye of the Irish consumer protection regulators. Yet, despite sky-high profit margins extracted by the banks from the households and businesses, the Irish banking sector remains the weakest link in the entire Eurozone’s financial services sector, save for Greece and Cyprus. If the funding side of the equation is not the culprit for this woeful record of recovery, the other two sides of the banking business, namely assets and regulatory costs, must be."

Read the full article here: https://www.thecurrency.news/articles/3833/culture-wars-and-poor-financial-performance-just-what-is-going-on-within-irelands-beleaguered-banks. 

29/9/19: Divided ECB

Divided they stand...

Source: https://www.bloomberg.com/news/articles/2019-09-29/lagarde-inherits-ecb-tinged-by-bitterness-of-draghi-stimulus

The ECB is more divided than ever on the 'new' direction of QE policies announced earlier this month, as its severely restricted 'political mandate' comes hard against the reality of VUCA environment the euro area is facing, with:

1.  Reduced forward growth forecasts (net positive uncertainty factor for QE)
2. Anaemic inflation expectations (net positive risk factor for QE), but reduced expectations as to the effectiveness of the QE measures in their ability to lift these expectations (net negative uncertainty factor)
3. Low unemployment and long duration of the current recovery period (net negative uncertainty factor for QE)
4. Relative strength of the euro, as per chart below, going into QE (net positive risk factor for QE)
5. Related to (5), deteriorating global growth and trade outlooks, with the euro area being a beneficiary of the Trump Trade Wars so far (ambiguous support for QE)
6. Expectations concerning the Fed, Bank of Japan, Bank of England etc policy directions (a complexity factor in favour of QE), and
7. Expectations concerning the potential impact of Brexit on euro area economy (another complexity factor supporting QE).

Here is a chart showing exchange rate evolution for the euro area, and key QE programs timings (higher values denote stronger euro):

Meanwhile, for the measures of monetary policy effectiveness (lack thereof) see upcoming analysis of the forward forecasts for euro area growth on this blog in relation to Eurocoin data.

1/9/19: Priming the Bubble Pump: Extreme Credit Accommodation in the U.S.

Using Chicago Fed National Financial Conditions Credit Subindex (weekly, not seasonally adjusted data), I have plotted credit conditions measurements for expansionary cycles from 1971 through late August 2019. Positive values of the index indicate tightening of credit conditions in the economy, while negative values denote loosening of credit conditions.

Since the start of the 1982 expansionary cycle, every consecutive cycle was associated with sustained, long term loosening of credit conditions, which means the Fed and the regulatory authorities have effectively pumped up credit in the economy during economic expansions - a mark of a pro-cyclical approach to financial policies. This trend became extreme in the last three expansionary cycles, including the current one. In simple terms, credit conditions from the end of the 1990s recession, through today, have been exceptionally accommodating. Not surprisingly, all three expansionary cycles in question have been associated with massive increases in leverage and financialization of the economy, as well as resulting asset bubbles (dot.com bubble in the 1990s, property bubble in the 2000s, and financial assets bubbles in the 2010s).

The current cycle, however, takes this broader trend toward pro-cyclical financial policies to a new level in terms of the duration of accommodation and the fact that it lacks any significant indication of moderation.

31/7/19: Fed rate cut won't move the needle on 'Losing Globally' Trade Wars impacts

Dear investors, welcome to the Trump Trade Wars, where 'winning bigly' is really about 'losing globally':

As the chart above, via FactSet, indicates, companies in the S&P500 with global trading exposures are carrying the hefty cost of the Trump wars. In 2Q 2019, expected earnings for those S&P500 firms with more than 50% revenues exposure to global (ex-US markets) are expected to fall a massive 13.6 percent. Revenue declines for these companies are forecast at 2.4%.

This is hardly surprising. U.S. companies trading abroad are facing the following headwinds:

1. Trump tariffs on inputs into production are resulting in slower deflation in imports costs by the U.S. producers than for other economies (as indicated by this evidence: https://trueeconomics.blogspot.com/2019/07/22719-what-import-price-indices-do-not.html).
2. At the same time, countries' retaliatory measures against the U.S. exporters are hurting U.S. exports (U.S. exports are down 2.7 percent in June).
3. U.S. dollar is up against major currencies, further reducing exporters' room for price adjustments.

Three sectors are driving S&P500 earnings and revenues divergence for globally-trading companies:

• Industrials,
• Information Technology,
• Materials, and 
• Energy.

What is harder to price in, yet is probably material to these trends, is the adverse reputational / demand effects of the Trump Administration policies on the ability of American companies to market their goods and services abroad. The Fed rate cut today is a bit of plaster on the gaping wound inflicted onto U.S. internationally exporting companies by the Trump Trade Wars. If the likes of ECB, BoJ and PBOC counter this move with their own easing of monetary conditions, the trend toward continued concentration of the U.S. corporate earnings and revenues in the U.S. domestic markets will persist. 

16/7/19: Monetary Policy Paradigm: To Cut or To Cut, and Not to Not Cut

QE is back... almost. After a decade plus of failing to deliver on its core objectives, and having primed the massive bubble in risky assets, while pumping sky high wealth inequality through massive monetary transfers to the established Wall Street elites... all while denying that we are in an ongoing secular stagnation. So, courtesy of the unpredictable, erratic and highly uneven economic parameters performance of the last 12 months, we now have this:

Because, for all the obvious reasons, doing more of the same and expecting a different result is the wisdom of the policymaking in the 21st century.

24/6/19: Markets Expect the Next QE Soon...

Adding to the previous post on the negative yielding debt, here is a recent post from @TracyAlloway showing Goldman Sachs' chart on implied probability of the U.S. Fed rate cuts over the next 12 months:

Source of chart: https://twitter.com/tracyalloway/status/1141895516801732608/photo/1.

The rate of increases in the probability of at least 1 rate cut is staggering (as annotated by me in the chart). These dynamics directly relate to falling sovereign debt yields (and associated declines in corporate debt yields) covered here: https://trueeconomics.blogspot.com/2019/06/24619-negative-yielding-debt-monetary.html.

Notably, as the markets are now 90% convinced a new QE is coming, their conviction about the scale of the new QE (expectations as to > 3 cuts) is off the chart and rising faster in 2Q 2019 than in the previous quarters.