30/12/15: Slon.ru: Эпоха несправедливости

My new column for Slon.ru is now live and available here: Эпоха несправедливости. Почему России нужно разделять политику и бизнес.

29/12/15: There Are Two Ways 2016 Can Play Out for Euro Area Bonds

With the pause in ECB QE over the holidays season, bond markets have been largely looking forward to 2016 and counting the blessings of the year past. The blessings are pretty impressive: ECB’s purchases of government bonds have driven prices up and yields down so much so that at the end of this month, yields on some USD1.68 trillion worth of Government bonds across 10 euro area countries have been pushed below zero.

Per Bloomberg chart:

Value of bonds with yields below ECB’s -0.3% deposit rate, which makes them ineligible for purchases by the ECB, is $616 billion, just shy of 10 percent of the $6.35 trillion of bonds covered by the Bloomberg Eurozone Sovereign Bond Index. As the share of the total pool of marketable European bonds, negative yield bonds amounted to more than 40% of the total across Europe at the start of December (see here: http://www.marketwatch.com/story/40-of-european-government-bonds-sport-negative-yields-and-more-may-follow-2015-12-02).

Two questions weigh on the bond markets right now:
1) Will the ECB expand the current programme? Market consensus is that it will and that the programme will run well beyond 1Q 2016 and spread to a broader range of securities; and
2) Will low inflation environment remain supportive of monetary easing? Market consensus is that it will and that inflation is unlikely to rise much above 1% in 2016.

In my view, both consensus positions are highly risky. On ECB expectations. Setting aside inflationary dynamics, ECB has continuously failed to ‘surprise’ the markets on the dovish side. Nonetheless, the markets continued to price in such a surprise throughout 2015. In other words, current pricing is probably already reflecting high probability of the QE extension/amplification. There is not much room between priced-in expectations and what ECB might/can do forward.

Beyond that, my sense is that ECB is growing weary of the QE. The hope - at the end of 2014 - was that QE will give sovereigns a chance to reform their finances and that the economies will boom on foot of cheaper funding costs. Neither has happened and, if anything, public finances are remaining weak across the Euro area. The ECB has been getting a signal: QE ≠ support for reforms. And this is bound to weigh heavily on Frankfurt.

On inflationary side, when we strip out energy prices, inflation was running at around 1.0% in November and 1.2% in October. On Services side, inflation is at 1.2% and on Food, alcohol & tobacco it is at 1.5%. This is hardly consistent with expectations for further aggressive QE deployment and were ECB to engage in more stimulus, any reversion of energy prices toward the mean will trigger much sharper tightening cycle on monetary side.

The dangers of such tightening are material. Per Bloomberg estimate, a 1% rise in the U.S. Fed rates spells estimated USD3 trillion wipe-out from the about USD45 trillion valuation in investment-grade bonds issued in major currencies, including government, corporate, mortgage and other asset-backed securities tracked by BAML index:

Source here.

European bonds are more sensitive to the ECB rate hikes than the global bonds are to the Fed hike, primarily because they are already trading at much lower yields.

Overall, thus, there is a serious risk build up in the Euro area bond markets. And this risk can go only two ways in 2016: up (and toward a much worse blowout in the future) or down (and into a serious pain in 2016). There, really, is no third way…

28/12/15: Russia: Unsurprisingly Surprising November GDP Print

Per latest report from the Economy Ministry, Russian GDP contracted 0.3% m/m in November in real terms and is down 3.7% y/y over 11 months through November 2015. Compared to 12 months ago, November GDP was down 4%.

This implies that, the economy will likely be down 3.8 percent (by my estimates: 3.8-3.9 percent) in 2015 as a whole. More significantly, with November GDP being down on foot of weaker oil prices and with crude prices continuing to contract through December, we are now less likely to see stabilisation in the economy (zero growth or return to positive growth) in 1Q 2016.

Meanwhile, in November, real wages were down 10% y/y while retail sales were down 13% for eleventh month in a row, according to Rosstat.

Rosstat data shows that over the last 12 months through November, food sales were down more than 11% and non-food goods sales fell nearly 15%. The figures for November 2015 show sharper contraction, in part because in November 2014 retail sales in Russia actually rose on foot of rapid devaluation of the Ruble. But overall, private consumption in Russia continues to run at a level consistent with where it was back in 2011. As noted recently by BOFIT, private consumption in Russia is still some 10 percent above where it was pre-crisis in 2008. Which is no mean feat, as for example, in the case of Ireland private consumption currently remains below its pre crisis levels despite the fact that Irish economy has been recovering very robustly from the crisis in recent years.

Rosstat data shows that seasonally adjusted industrial output fell again in November. Activity in extractive industries in November was unchanged from a year earlier, having supported the output to the upside in previous months. Manufacturing production, however, fell for the third month in a row, down ca 5% y/y in November. BOFIT noted that this suggests that “the impact of increased defence spending that supported manufacturing industries earlier this year is likely fading. First-half defence spending grew on-year by over a third, but since autumn defence spending has fallen.”

All of this supports negative view of the Russian economy going into 2016, summarised in my earlier post here: http://trueeconomics.blogspot.ie/2015/12/281215-bofit-summary-of-2016-outlook.html

The outrun so far has been quite disappointing for the forecasting hawks, including for example Danske Bank analysts who at the end of May 2015 predicted Russian economy will shrink 7.9% y/y in 2015 ( forecast they revised to -6.2% at the end of August 2015).

Or for that matter for seasoned hawks, like Andres Aslund who in January prediction put the matters thus: “Russia’s GDP is likely to plunge in 2015. Indeed, it would be prudent to expect a slump on the order of 10 percent. In many ways, Russia’s financial situation is eerily similar to the fall of 2008, when then-Prime Minister Vladimir Putin called his country a safe haven in the global financial crisis. In 2009, Russia’s GDP dropped by 7.8 percent. In other ways, the situation seems even worse.” (H/T to @27khv for the link: http://www.the-american-interest.com/2015/01/15/russias-output-will-slump-sharply-in-2015/).

But the outrun is also a bit on a reality check to some Russian political and Government figures (including President Putin and Prime Minister Medvedev) who bought into the fragile and dynamically uncertain improvements over Summer 2015 to announce the bottoming out of the economic crisis.

Truth is, Russian economy is a very hard nut to crack for any forecaster, as it is currently subject to a series of coincident shocks that themselves are hard to price and predict: oil prices and gas prices slump, contracting demand for energy globally, including on foot of both geopolitical changes and warm weather; broader commodities prices collapse, including on foot of global demand weaknesses and regional (e.g. China) weaknesses; geopolitical risks and sanctions (including financial sanctions); ongoing deleveraging of the Russian banking sector (including outside Russia, especially in Ukraine and the rest of the Former USSR and in parts of Central and Eastern Europe); domestic structural weaknesses (including those that started manifesting themselves in late 2011 and continue to play weak economic hand to-date); and so on. Thus, we shall be kind to forecasters and politicians making bets on Russian economy’s direction.

I wrote about most of the above already, including the banking sector woes (http://trueeconomics.blogspot.ie/2015/12/231215-vnesheconombank-where-things.html). And the trends in both manufacturing and services sectors were pretty clear in the PMIs (see http://trueeconomics.blogspot.ie/2015/12/41215-bric-composite-pmis-november.html).

But translating these indicators into actual growth performance is a perilous task... as the November figures showed.

28/12/15: BOFIT summary of 2016 outlook for Russian Economy

Per recent BOFIT summary:

“Forecasters see the Russian economy contracting slightly in 2016. Recent economic forecasts, with the exception of the brighter projection of Russia’s economy ministry, see GDP contracting about a half per cent. A couple of forecasts expect a drop of about 1 %. The average price of oil next year is assumed to average $50–55 a barrel.

Most forecasts also see imports declining a bit further. Almost all forecasts see private consumption shrinking next year, most by about 1 %.

The CBR’s forecast update this month, however, reduced its earlier projection and now expects private consumption to contract by nearly 4 %. The consumption projections reflect the anticipation that household income growth will not keep up with inflation, especially as increases of public sector wages and pensions have been set very low due to the frail condition of government budgets.

The forecasts also see fixed investment slipping further by roughly 1 %. Estimates of the volume of Russian exports vary more widely, but forecasters generally expect exports to rise slightly in 2016.”

My view on Russian economic growth prospects for 2016 were reflected in my column for Slon.ru: http://trueeconomics.blogspot.ie/2015/12/151215-russian-outlook-for-2016-slon.html.

26/12/15: Depositors Insurance or Depositors Rip-off?

What's wrong with this picture?

In simple terms, nothing. The Central Bank has embarked on building up reserves to fund any future pay-outs on deposits guarantee.

In real terms, a lot.

Central Bank deposits guarantee will be funded from bank levies. However, in current market environment of low competition between the banks in the Irish market, these payments will be passed onto depositors and customers. Hence, depositors and customers will be funding the insurance fund.

Which sounds just fine, except when one considers a pesky little problem: under the laws, and contrary to all the claims as per reforms of the EU banking systems, depositors remain treated pari passu (on equal footing) with bondholders (see note here on EU's problems with doing away with pari passu clause even in a very limited setting: http://trueeconomics.blogspot.ie/2015/11/271115-more-tiers-lower-risks-but.html). Now, let's consider the following case: bank A goes into liquidation. Depositors are paid 100 cents on the euro using the new scheme and bondholders are paid 100 cents on the euro using the old pari passu clause.

Consider two balancesheets: one for depositor holding EUR100 in a deposit account in an average Irish bank over 5 years, and one for the bondholder lending the same average bank EUR100 for 5 years.

Note: updated version

Yes, the numbers are approximate, but you get the point: under insurance scheme the Central Bank is embarking on, the depositor and the bondholder assume same risks (via pari passu clause), but:

• Depositor is liable for tax, fees and insurance contributions, whilst facing low interest rates on their deposits; while
• Bondholder is liable for none of the above costs, whilst collecting higher returns on their bonds.

So, same risk, different (vastly different) returns. Still think that insurance fund we are about to pay for a fair deal?..

26/12/15: A Trendless World of 'Recovery'?

Anyone watching financial markets and economics in 2015 would know that this year was marked by a huge rise in volatility. Not the continuous volatility along the established trend, but a 'surprise' volatility concentrated on the tails of distributions of returns and growth numbers. In other words, the worst kind of volatility - the loss and regret aversion type.

Here are two charts confirming the said pattern.

Starting with asset classes:

Source: BAML

In the 'repaired' world of predictable monetary policy with well-signalled forward guidance, 2015 should have been much calmer, as policy surprises were nowhere to be seen (Bank of Japan continued unabated flooding of money, while ECB embarked on its well-in-advance-flagged QE and the Fed 'cautious rates normalisation' switched was anticipated for months, amidst BOE staying put, as predicted by everyone every time London committee met). Alas, that was not the case and 2015 ended up being a year of more extreme shifts into stress than any other year on record.

Likewise, the U.S. economic growth - the most watched and most forecasted series in the global economy - produced more surprises for forecasters:

Source: Goldman Sachs

Per above, 2015 has been a second consecutive year with U.S. GDP growth surprising forecasters to the downside. Worse, yet, since 2001, U.S. GDP growth produced downside surprises compared to consensus forecasts in 12 out of 15 years.

In the past cycles, the early 1990s recession produced an exit from the downside cycle that resulted in 2 consecutive years of upside surprises in growth; for the exit from the 1980s recession, there were five consecutive periods of upside growth relative to the forecasts. Even in the horrific 1970s, the average forecast over-optimism relative to outrun was closer to zero, against the current post-recessionary period average surprise to the forecast being around -0.5 percentage points.

In other words, if you need a confirmation that four years after the 'recovery' onset, the world of finance and growth remains effectively 'trendless', have another look at the charts above...

25/12/15: WLASZE: Weekend Links on Arts, Sciences and Zero Economics

Merry Christmas to all! And in spirit of the holiday, time to revive my WLASZE: Weekend Links on Arts, Sciences and Zero Economics postings that wilted away under the snowstorm of work and minutiae, but deserve to be reinstated in 2016.

[Fortunately for WLASZE and unfortunately for die harder economics readers of the blog, I suspect my work commitments in 2016 will be a little more balanced to allow for this...]


Let's start with Artificial Intelligence - folks at ArsTechnica are running an excellent essay, debunking some of the AI myths. Read it here. The list is pretty much on the money:

• Is AI about machines that can think (in human intelligence sense)? Answer: predictably No.  
• Is AI capable of outstripping human ethics? Answer: not necessarily.
• Will AI be a threat to humanity? Answer: not any time soon.
• Can the AI system acquire sudden singularity? Answer: sort of too far away and doubtful even then.

The topic is hugely important, extremely exciting and virtually open-ended. Perhaps of interest, I wrote back in 2005 about the non-linearity and discontinuity of our intelligence as a 'unique' identifier of humanity. The working paper on this (I have not revisited it since 2005) is still available here.

And to top the topic up, here is a link on advances in robotics over the grand year of 2015: http://qz.com/569285/2015-was-a-year-of-dumb-robots/. The title says it all... "dumb robots"... or does it?..

Update: another thought-provoking essay - via QZ - on the topic of AI and its perceived dangers. A quote summarising the story:
"Elon Musk and Stephen Hawking are right: AI is dangerous. But they are dangerously wrong about why. I see two fairly likely futures:

• Future one: AI destroys itself, humanity, and most or all life on earth, probably a lot sooner than within 1000 years.
• Future two: Humanity radically restructures its institutions to empower individuals, probably via trans-humanist modification that effectively merges us with AI. We go to the stars."

Personally, I am not sure which future will emerge, but I am sure that there is only one future in which we - humans - can have a stable, liberty-based society. And it is the second one. Hence my concerns - expressed in public speeches and blog posts - with the effects of technological innovation and the emergence of the Gig-Economy on the fabric of our socio-economic interactions.

At any rate... that is a cool dystopian pic from QZ

Dangers of AI or not, I do hope we sort out architecture before robots either consume or empower us...

On the lighter side, or may be on a brighter side - for the art cannot really be considered a lighter side - Saatchi Art are running their Best of 2015 online show here: http://www.saatchiart.com/shows/best-of-2015 that is worth running through. It is loaded with some younger and excitingly fresher works than make traditional art shows. 

Like Jonas Fisch's vibrantly rough, Gears of Power 

All the way to the hyper-expressionist realism of Tom Pazderka, here is an example of his Elegies to Failed Revolutions, Right Wing Rock'n'Roll 

And for that Christmas spirit in us, by Joseph Brodsky, translated by Derek Walcott (for a double-Nobel take):

The air—fierce frost and pine-boughs.


We’ll cram ourselves in thick clothes,


stumbling in drifts till we’re weary—


better a reindeer than a dromedary.

In the North if faith does not fail


God appears as the warden of a jail


where the kicks in our ribs were rough


but what you hear is “They didn’t get enough.”

In the South the white stuff’s a rare sight,


they love Christ who was also in flight,


desert-born, sand and straw his welcome,


he died, so they say, far from home.

So today, commemorate with wine and bread,


a life with just the sky’s roof overhead


because up there a man escapes


the arresting earth—plus there’s more space.

Merry Christmas to all!

25/12/15: Comment for Expresso on U.S. Fed hike

My comment for Portugal's Expresso (December 19) on U.S. Fed rate hike:

23/12/15: Corporate Leverage: "I miss you since the place got wrecked"

Remember all the deleveraging the U.S. economy has gone through during the crisis? Why, sure, we've learned a lesson about too much debt, did we not?

Except when you look at the Deutsche Bank data in the following chart:

Source: @SoberLook 

By which the investment grade corporates' net leverage is at all time high 3 quarters running and rising; and gross leverage is at all time high 4 quarters running and rising. Or as Leonard Cohen's lyrics go:

"Ah we're drinking and we're dancing 

and the band is really happening 

and the Johnny Walker wisdom running high..."

23/12/15: Vnesheconombank: where things stay ugly

As reported by BOFIT, Russia’s 4th largest and state-owned Vnesheconombank  (VEB Group which technically is not a bank, but a development bank and an owner of a number of banks, so as such VEB is not subject to CBR supervision) requires estimated funding supports at EUR15–20 billion “to cover at least the next few years”.  Per Bloomberg, VEB has been seeking USD23 billion “to support long-term growth and pay off the upcoming loan” (data as of November 23). VEB total assets in Russia amount to ca EUR45 billion, which, per BOFIT, “would make VEB Russia’s fourth largest bank with holdings that correspond to about 4 % of the banking sector’s total assets”. Overall, VEB holds 2.8 trillion Rubles in loans assets and around 1 trillion Rubles in other assets.

To-date, VEB received EUR8 billion in deposits from the National Welfare Fund and about EUR500 million in other monies (most of which came from the Central Bank’s 2014 profits).

Per both, Bloomberg and BOFIT: VEB has been a major lender behind Sochi Winter Olympics 2014. New lending increased total loans held by the bank by some 25% in Ruble terms in 2013 before doubling loans in 2014. VEB started aggressive loans expansion in 2007 since when its assets base grew almost 10-fold. Over 2015, bank-held loans posted some serious deterioration in quality forcing bank to set aside significant reserves to cover potential losses. Per Reuters report, “S&P estimates some 500 billion roubles of VEB's loans were directed by the government and are therefore regarded as relatively risky. While the huge investments made in Sochi have generated public discussion in Russia, far less attention has been given to no less massive investments VEB made in Ukraine. "That's still on their books and they keep rolling those loans over. Of course it's only a question of time before they accept losses on those assets," said S&P's Vartapetov. In an interview in December 2013, VEB Chairman Vladimir Dmitriev said the bank had via Russian investors ploughed $8 billion into Ukrainian steel plants, mainly in the Donbass region, since ravaged in a separatist conflict. He said the investment had supported 40,000 Ukrainian workers, but did not say how the Russian economy had benefited.” Overall, Russian banks’ continued presence and even growth in Ukraine - while puzzling to some external observers - can be explained by the significant role these banks play in the Ukrainian economy.

In 2014, VEB posted full year loss of USD4.5 billion / RUB250 billion and in 1H 2015 losses totalled USD1.5 billion. VEB’s Ukrainian subsidiary was one of the big drivers for these. Based on the figures, VEB posted the largest loss of any Russian company in 2014.  The top three largest loss making companies in 2014 were: Vnesheconombank, followed by the steelmaking giant Mechel (loss of 167 billion rubles) and the monopoly Russian Railways (losses of 99 billion rubles).

In addition, VEB holds some USD19.3 billion of debt maturing through 2025 (see chart from Bloomberg) with EUR9 billion of this in eurobonds:

VEB is subject to both EU and US sanctions which effectively shut VEB access to funding markets and the bank will require between EUR2.5 and 3 billion for debt servicing in 2016 alone. This week, VEB secured a five-year loan of 10 billion yuan or EUR1.4 billion from China Development Bank.

Recently, Finance Minister Anton Siluanov stated that VEB requires as much as USD20 billion in funding (ca 1.7% of Russian GDP), and that VEB is expected to sell some of its assets to fund part of the gap.


Per Bloomberg, “the finance ministry’s proposals include exchanging the lender’s Eurobonds for Russian government securities, Vedomosti reported Nov. 24. Other options on the table include a local government bond offering for 1.5 trillion rubles to recapitalize the bank, and transferring bad assets from VEB’s balance sheet to the state, according to newspaper Kommersant.”

22/12/15: Baltic Dry Index: not much of a post-Fed bounce

With the optimism of Christmas week forecast (traditionally keen on stressing the upside to the global economic conditions), let's not forget the Baltic Dry Index:

As the chart above shows, global trade ain't doing too well in this *finally repaired* and *full employment-bound* world economy. In fact, the index has been ploughing the depths that put to shame even the abysmal December 2008 crisis lows. Not surprisingly, the post-Fed bounce was pretty much a fizzle...

Ho-ho-ho... 

20/12/15: Of those Russian GDP 2016 forecasts

In my recent column for Slon.ru (see: http://trueeconomics.blogspot.ie/2015/12/151215-russian-outlook-for-2016-slon.html) I quipped that in the case of the Russian economy, forecasts for 2016 growth rates might just as well be taken from the fortune tellers, as there are too many moving factors driving the economy, all of which are virtually impossible to forecast.

Now, h/t to @JoMichell, we have a picture of 'predictability' of one key driver of the Russian economy - oil prices. Please, keep in mind: these are Brent prices (Urals grade predictability is even lower, as Urals-Brent spread is subject to further uncertainty, including geopolitical risks and substitution risks, as discussed in my Slon.ru column).

So here is a chart showing IMF forecasts for Brent prices issued back in June 2015:

 Note that in the above, least probable downside scenario is for oil above USD40 per barrel through 2015. Alas, the least probable forecast is not exactly the lower bound for reality:

So here we have it: less than 6 months forecast out, and the least probable worst case scenario has been breached already. Good luck pinning Russian GDP forecasts down...