13/4/15: Bonds Traders: Give Us a Shake, Cause We So Sleepy...

Recently, I have been highlighting some of the problems relating to the Central Bank's driving up the valuations of government bonds across the advanced economies. In the negative-yield environment, the victims of Central Banks' activism are numerous - from banks to long-hold investors, to corporates, to capex, to savers, to... well... the fabled bonds trades(wo)men... the poor chaps (and chapettes) aren't even showing up for work nowadays: http://www.bloomberg.com/news/articles/2015-04-10/take-off-friday-and-monday-because-most-bond-traders-already-are because Sig. Mario is making their lives sheer misery with his euro bonds acrobatics.

Apparently, there is just not that big of a demand out there for the idea of giving money to the Governments on top of paying taxes and trading volumes are now where the rates are - in the zero corner. So the 'industry' solution is, predictably, for the Fed to raise rates. When was the last time you heard the car manufacturers begging regulators for a safety recall of their vehicles 'to jolt the complacent consumers a bit'?

12/4/15: Economic Divergence: U.S. v Europe

Recently, I have highlighted couple of signs of emerging weaknesses in the U.S. economy relative to the positive news momentum in the euro area. You can see Manufacturing Sector evidence here and Business Activity evidence here. Meanwhile, economic surprise indices have also been pointing to the same: here.

An interesting chart from Pictet summarising the trend by plotting Economic Surprise Indices for euro area and the U.S. side by side:

Source: Pictet

The above shows divergence in the two series from Q4 2014 on.

And the overall markets valuations heat map showing stronger over-valuation (lighter colouring) in Q1 2015 in the euro area core compared to the US:

Source: BBVA Research

In cyclical terms, the above reinforces the view that the U.S. economy is settling into the growth range around 3.1% of GDP, while the euro area economy is moving closer to 1.1-1.4% growth. The divergence in two economies' core signals of future activity is in part driven by the differences in the monetary policies expectations, with ECB driving deeper into its QE programme, while the Fed is now shifting toward tighter stance.

In particular, recent statements from the Fed are fuelling uncertainty about the dollar and the U.S. interest rates environment. Median analysts outlook suggests a 50bps hike by the end of 2015 on the Fed side, with my own view that the Fed is most likely to hike around September. This outlook is highly uncertain, due to divergent signals coming from the Fed. Another point of uncertainty is what will follow the initial hike in U.S. rates. My view is that we can see a relatively long period of time over which the Fed will do nothing, before hiking the rates for the second time. The reason for this is that the Fed is fully aware of the risk of making a policy error on its first hike size and timing, and it will leave a wide enough period to collect evidence on the effects of its first intervention before moving again.

Meanwhile, the ECB has delivered twin push on its expansionary monetary policy in March, completing EUR60 billion in purchases of bonds and also deploying EUR97.8 billion TLTRO lending. The balancesheet of the ECB is growing, finally, and with it, Frankfurt has delivered a big stimulus to the euro area financial markets. This pushed bond yields to record lows: German yields are negative out to 6 year maturity, with 10 year Bunds trading at around 0.2% yields, and UST-Bund 10 year spread widening to 180 bps. It also shifted liquidity into risk assets, such as stocks and corporate bonds. Stock markets rallied: Germany up 25% in 2015 so far, France up 22%, Portugal up 31%, Spain up 14% and so on. Virtually none of these gains can be attributed to improved corporate balancesheets or companies' performance.

Here is a neat summary by Pictet of markets moves over Q1 2015:

Source: Pictet

The above highlights two things:

1. European equities outperformance over Q1 2015 is massive and is completely unjustified by the macroeconomic fundamentals and companies' performance; and
2. European equities outperformance accelerated in March

As Pictet notes, virtually all of the above outperformance is down to monetary policy-induced revaluation of the exchange rates: "Shares, in local currency terms and with dividends reinvested, are up by 16.8% in Europe, well ahead of the S&P 500’s 1.0% gain. However, European investors who

had invested in US equities will have benefited from a 13.7% rise in the S&P 500 when translated into euros, considerably reducing Wall Street’s underperformance in the year to date. Japanese shares have been the top performers though, advancing by 10.5%. If we add in the euro’s fall in value against the yen, that translates into a rise of just over 24.5%." 

Excluding energy sectors, corporate earnings growth forecasts currently put expected earnings uplift of 9.0% in the U.S. against 15.8% in the euro area over 2015, again predominantly on the back of currency valuations changes.

All in, the worrying trend of economic performance fully dependent on unorthodox monetary policies and relatively unanchored in the real economy remains. Rising divergence between the U.S. - euro area signals shows inherent weaknesses and risks present in such  environment.

11/4/15: 2014 European Labour Costs Comparatives

Ireland's manufacturing is booming, services exploding, unemployment falling, and wages... well, wages...

Here is the latest data for full year 2014 from Eurostat providing some comparatives:

Ireland ranks on par with Italy and below all high income euro area states (ahead of just 'Southern' or 'peripheral' Europe) in terms of hourly labour costs. For the 'most productive' (if measured by returns on FDI booked via Ireland) country, we are amazingly labour cost-competitive. Which, of course, only highlights the questionable nature of our labour productivity, plus lower non-wage costs of labour (such as employer taxation).

Now, recall - Ireland has been aggressively rebuilding its 'competitiveness' by reducing costs of labour. The internal devaluation meme and so on.... Right? Almost:

Over 2008-2014 our labour costs actually rose. Of course, our favourite 'competitiveness' metric - the unit labour costs (cost of labour required to produce a unit of output) fell. But that decline has nothing to do with our gained labour cost 'competitiveness'. Instead, it has to do with increased output 'units' booked per hour of work. Which is, primarily, down to two factors:

• MNCs pushing more and more tax optimising 'activities' via Ireland (superficially increasing units of output per hour of work); and
• Destroying hundreds of thousands jobs in less productive sectors (the unemployment effect).

Hence a paradox: Irish labour costs rose last time in 2012 - not a great year for our economic performance. They stayed static since then, through the stagnation of 2013 and the roaring GDP & GNP growth in 2014. 

And another paradox, the one yet to come: once construction industry and retail sector employment and activity pick up, the unit labour costs in the economy will rise solely due to output in less productive sectors picking up. If wages inflation returns, they will rise even faster, proving again that all this competitiveness story is largely a figment of tax-optimisation-induced imagination.

11/4/15: One Number Busts Greek 'Internal Devaluation Can Work' Myth

An interesting note from the Fitch on the likelihood of success for Greek 'bad bank' set up here.

Neat summary of the problem: "NPLs have reached staggeringly high levels. Fitch estimates that domestic NPLs at National Bank of Greece, Piraeus Bank, Eurobank Ergasias and Alpha Bank (which together account for around 95% of sector assets) reached EUR72bn at end-2014, equivalent to 35% of combined domestic loans. Net of reserves, Greek NPLs reached a high EUR30bn and still exceeded the banks' combined equity."

NPLs at 35% of all domestic loans... and someone still believes Greece can just do that external devaluation thingy?..

11/4/15: Inflation, Wages Controls and Ruble: Welcome to Q2 Start in Russia

Russian inflation reached 16.9% in March, year-on-year, highest since 2002, despite slowing month-on-month inflation. March inflation came in at 1.2% m/m, lower than 2.2% m/m in February.

Slower m/m trend is down to Ruble re-valuation, so assuming no renewed speculative attacks on the currency, annual rate of inflation should be down at year end, around 10-12 percent range, or broadly in line with 11.4% annual inflation registered in 2014.

One key policy instrument to contain inflation (and also to correct for the adverse effect of ruble strengthening on budget balance - see below) is the decision by President Putin to suspend the legal requirement for automatic cost-of-living (COLI) adjustments to public sector wages. The decision, signed on April 6th will allow the Government to avoid hiking wages for 9 months through December 2015. President Putin's amendment also covers some of the COLI requirements on social payments adjustments. Overall, public wages and social benefits will increase in 2015 only to reflect the Budget 2015 assumed medium-term inflation target - 5.5%, well short of the actual inflation that is projected to range between 11 and 13 percent this year.

On the subject of Ruble valuations and budgetary pressures: Russian Federal Budget is set in Rubles. As Ruble strengthens against the USD and EUR, exports revenues-related taxes fall, imports declines are moderated and external surplus on trade account declines. This means potential pressure on Government deficits. Last year dramatic devaluation of the Ruble, while causing hysterical reactions abroad, actually helped the Government to achieve near balanced budget (with a deficit of just around 1 percent of GDP). This time around, the pressure is reversing.

11/4/15: BOFIT on Ruble Rise Debate

Yesterday I posted some thoughts on Ruble appreciation over recent months http://trueeconomics.blogspot.ie/2015/04/10415rubles-mysterious-rise-some.html. Here is last night's BOFIT note on the same, highlighting CBR repo arrangements as the policy tool also contributing to changes in the trend:

10/4/15: Comments on the EU Comm Paper “Building a Capital Markets Union”

I have recently been asked to present my views on the European Capital Markets Union proposals from the European Commission to the Oireachtas Joint Committee on Finance, Public Expenditure and Reform. Here is the briefing paper to accompany my presentation:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2592918

10/4/15:Ruble's Mysterious Rise: Some Thoughts

There is an interesting debate starting up around the Ruble: in recent weeks, Ruble appreciation against the USD has pushed it out of its traditional long term alignment with oil prices, as noted in the chart below:

Source: @Schuldensuehner 

There are several possible factor that can account for this.

1. Oil price expectations - if the markets expect oil prices to rise further, Ruble buyers can bid the currency up ahead of the oil price changes. This is unlikely in my view, as we are not seeing oil price firming significantly in both spot and futures markets.
2. Oil price revelation - if the markets priced in severe forecasts uncertainty linked to oil price dynamics to the Russian economy back in October-December 2014, then the new information about Russian economy's performance in Q1 2015 should lead to re-pricing of risks. In my opinion, Ruble was heavily oversold in December (not in october-November) and there is some upside potential, given that the Q1 2015 data coming out of the Russian economy is not as apocalyptic as some currency markets analysts expected. Notably, there has been a significant cut in USD long positions vis-a-vis Ruble in recent days, which signals speculative re-alignment toward long-Ruble.
3. Demand Factor 1 - March is the end of Q1, so it is the month of rising demand for Ruble to cover corporate tax liabilities (Russian corporates pay taxes in Rubles). VAT receipts are also coming due. And estimated forward taxes and charges. In my opinion, this helps to temporarily boost Ruble valuations.
4. Demand Factor 2 - March is the last month before major companies in Russia are due to reverse their forex holdings to October 2014 levels (per December agreement hammered out by President Putin). This means increased supply of USD and other currencies, and increased demand for Rubles. Again, a temporary factor, in my opinion.
5. Supply Factor - March and April are also large months for corporates to book in energy-related exports earnings. Note that Russian Central Bank is recording a small rise in reserves in late March, followed by a decline in April.
6. Demand Factor 3 - March also was the month of largest (for 2015) external debt redemptions by Russian banks and corporates. Repayment of these debts involves buying dollars and selling Rubles, but timing-wise, companies have been pre-building their forex reserves for some time, so it is most likely that in recent 3 weeks there has been less demand for dollars (and other forex) than in previous 2 months. Note, I covered this here: http://trueeconomics.blogspot.ie/2015/04/8415-rubles-gains-are-convincing-but.html
7. Demand factor 4 - since the start of 2014, Russia actively pursued reduction of the degree of dollarisation in its economy. The first stage of this process involved increasing trade settlements in other currencies (most recent one - announced this week - with Indonesia). This, alongside with imports collapse, reduced external trade-linked demand for dollars. The second phase of de-dollarisation started in February, when Russian retail deposits started exiting dollars and shifting back into Ruble on improved confidence in the banks and high deposit rates. Again - a temporary support for the Ruble.
8. Demand factor 5 - as Russian CDS show, probability of default declines for Russia sustained in recent weeks implies improved demand for Russian Government (and local) bonds, issued in Ruble markets. The result is improved demand for OFZs and, thus, for Ruble. 
9. Real vs Nominal exchange Rates - inflation dynamics in Russia are most likely drawing a gap between real and nominal exchange rates, so nominal rate firming up is not imposing equivalent increase in the real rates. 

In other words, we have many, many moving parts to one equation. One can't tell the dominant one, or which are likely to last longer, but my sense is that majority of these forces are temporary and the long-run link between Ruble and oil price will be regained.

Now, assuming oil price dynamics remain where they are today (weak upside), Ruble is likely to devalue again, back to USD/RUB 55-57 range. If inflation does not fall toward 10% in Q2 2015 (and I do not think it will), we are likely to see Ruble move into USD/RUB 60-65 range over this quarter. On the other hand, improved outlook for the economy (signalling, say annual contraction closer to 3.5-4 percent) can see Ruble staying within the USD/RUB 50-53 range.

One thing is for sure: so far, the Central Bank of Russia has managed damn well its dance in a very tight monetary policy corner between runaway inflation, prohibitively high interest rates and a massive squeeze on forex valuations. How long this 'smart game' in multidimensional and highly dynamic chess can go on is everyone's guess.

10/4/15: Irish Construction Sector Performance: a European Perspective

Irish Construction Sector has been a positive contributor to GDP over the second half of 2014, prompting some - in fact many - media outlets to herald the return of the Men in Hard Hats. You can be excused for wondering, as to how many men (and women) in hard hats are out there working today, given there is little visible activity on the ground, but the numbers do not lie. Or so they say.

Here is the latest data from the Eurostat giving construction sector activity in terms comparable across the EU states.

Actual activity for all building and construction sectors in Ireland over Q4 2014 was running some 53.2% below the average activity levels recorded in 2000-2002. Over the course of 2014, average activity in the sector in Ireland was 53.2% below the same activity over 2000-2002. Both metrics ranked Ireland as the third worst-performing construction sector in the group of euro area 15 economies.

Having risen to 111.20 in Q4 2010, the index of overall construction activity in Ireland was at the highest level since Q4 2009, but below any quarter for the period of Q1 2000-Q4 2009.

Things are even worse in the case of building activity (ex-civil engineering), where Ireland ranks second worst, on par with Portugal in the EU28. Here, Q4 2014 reading is 63.5% below 2000-2002 average and full year 2014 average reading is 69% lower than 2000-2002 average. Once again, the index is currently reading at the highest level since Q4 2009, but as above, this reading is well below any quarterly reading between Q1 2000 and Q4 2009.

Here is a chart showing relative performance to EU and EA:

Two things to note in the above:

1. EU and EA uplift in Q4 2014 has been more pronounced than that for Ireland. 
2. The trends are now not exactly converging, with EU and EA both pushing up, while Ireland's upward momentum appearing to be weakening once again from H1 2014 on.

One aside question is: with the above evidence at hand, can anyone explain a huge rise in the reported 'investment' in commercial property in 2014? Other than buy-to-flip strategies of the vulture funds, where is all this 'investment' going?

10/4/15: Shared Economy of the Future: It's All About the Bandwidth Access

A very interesting chart plotting evolution of the auto markets in the current technological environment from the Morgan Stanley:

The point of convergence is the 'Shared Economy'. But the real insight here is not about the auto market. Instead it is about technologically-enabled breakdown of the barriers between:

• Producers and consumers: as technology allows for greater and greater customisation, product offer becomes consumer/user driven in services and increasingly in physical goods;
• Owners and users: one model of 'own-to-use' is now increasingly being replaced by a dual option: 'own-to-use' or 'contract-to-use'. Goods conversion to services (e.g. ability to extract service from the physical goods without the need for ownership) adds another dimension to this.

This is happening in auto industry, but it also happens increasingly in smaller ticket goods and services markets. And it is going to change dramatically the retail sector. Here is an interesting article on Amazon vision of the present (not even the future) in terms of purchasing (note: the issue here is to what extent can brand standardisation consolidate product offers): 

http://qz.com/378310/amazons-vision-of-the-future-is-less-than-dashing/.

All of this, ultimately, is about the ability to create a 'shared bandwidth' around a quasi-commoditised service with some heterogeneity and customisation around it, and efficiently allocate consumer access to it. Which really means that the 'shared economy' is like a shared pipeline: someone will, in the end, have to arbitrage access to it, just as today someone has to arbitrage access to shared services (tolls, grids, etc). For now, we do so very inefficiently even crudely (very little demand-linked variability in toll pricing, long-term contracts nature of access to grids etc), but as the number of users-producers rises and their share in the overall economy grows, this arbitraging will have to become more refined, more dynamic, real time responsive.

I will be speaking about these and other longer-term trends in retail sector at an international retail sector conference in June so stay tuned.

9/4/15: Irish Bilateral Trade with the UK

With the UK heading in for the elections, someone asked me recently for the stats on Ireland' bilateral trade with the UK. Here are the numbers:

9/4/15: Expresso on IMF's WEO Update: Secular Stagnation is Here

Portugal's Expresso on IMF's 'secular stagnation' evidence via April 2015 WEO Update (Chapter 3): http://expresso.sapo.pt/a-receita-do-fmi-mais-infraestruturas-mais-inovacao-mais-produtividade=f918917. With my comments...

My view in full:

IMF findings on potential and long-term growth trends in the advanced economies published as a part of the April 2015 WEO update confirm what we have already known for some time: the ongoing economic growth slowdown is not only structural in natural, but is permanent, in economic terms.

More importantly, however, the IMF study shows that the structural slowdown in growth has started prior to the onset of the Global Financial Crisis and has been concentrated, in terms of drivers, in demographics of ageing, leading to decline in investment, and a fall off in the growth of the total factor productivity as advanced economies continued to exhaust growth along the technological frontier.

In simple terms, this confirms the thesis of the secular stagnation, especially as formulated by Robert J. Gordon (see http://trueeconomics.blogspot.ie/2012/08/2882012-challenging-constant-growth.html).

From my point of view, the study documents one key trend: the trend of increasingly lower contribution of the human capital to growth over the period of 2001-2007 in the presence of slower, but still, relatively sustained growth contribution from employment.

This shows that during the pre-crisis boom, much of economic growth was derived not from intensive margin (technological progress and linking of technology to greater labour productivity) but from extensive margin (increased supply of physical capital and asset bubbles).

In the future, this imbalance in growth will require significant policy corrections in order to restore human capital growth to 2001-2003 levels. Absent these highly disruptive policy reforms (covering taxation systems, provision and distribution of key public services, restructuring of enterprise management systems etc), the world will find itself at the tail end of technological growth frontier, with low rates of return to technology and innovation and, as the result, permanently lower growth in the advanced economies.