Sunday, 6 April 2014

Short update post US jobs

A short Sunday update after a week in the US.The US jobs report deserves two charts, but not more. The top one shows real GDP growth, and employment growth from the non-farm payroll data. Year over year employment growth on this measure picked up a bit to 1.66% in March. It's over three years since annual employment growth was outside a 1.5-1.9% range. The first Friday of the month isn't as thrilling as it used to be!

Since 1990 (the period covered by this chart), employment growth has averaged 1%, and real GDP growth 2.5%. The period of tediously boring employment data since Q4 2011, has seen employment growth average 1.7%, and real GDP average 2.3%, so more jobs are created than has been the norm since 1990 but productivity has lagged pretty badly. Why? the wrong kind of jobs (too many self-employed, or part-time jobs), perhaps?
The second chart shows the annual growth of average hourly wages for non-supervisory workers, and the unemployment rate (inverted). The slowdown in wage growth (on this measure, from 2.4% per annum to 2.2%), was the most significant piece of information in the jobs report because without a pick-up in wage growth there is virtually no chance that the Federal Reserve will deviate from its dovish policy stance. And indeed, very few investors, traders or financial market participants in general will be worried about inflationary pressures unless or until wage growth picks up a god bit further. Mind you, the current modest acceleration in wage growth is enough for the traditional correlation between lower unemployment and f aster wage growth to be re-asserting itself. So we may not worry now but as the unemployment rate falls, it seems wage growth is indeed responding. Now, I live in a country where wage growth is still well below inflation and I see this re-coupling in the US as good news for Americans, and a reason to be just a teeny-weeny bit jealous!
So there you have it  - an OK pace of jobs creation, a pause in the acceleration in wage growth, and nothing much for financial markets to get het up about. There's still lots and lots and lots of cash looking for a place to be invested.

Sunday, 23 March 2014

Janet's Jackhammer

It's Sunday in Abu Dhabi and there's lots of noise coming from the construction site outside my hotel window (as there was for much of the night). I'm inclined to blame this on the Federal Reserve. This may same harsh but the UAE has pegged its exchange rate to the dollar (hence my tall latte this morning cost a mere £2.32, a mere 3% more than I paid last week in London). The other side of the competitive exchange rate however, is that monetary policy is too easy, asset prices rising and the Middle Eastern property boom is back  - hence the over-enthusiastic workers outside. Still, there's more chance that the hotel will change my room for one the other side of the building, than there is of the Fed tightening policy this year.

This tendency to see everything as being a result of Fed policy does have a serious side. In a world where the world's biggest economy has set the cost of money at a level that is utterly inconsistent with her own growth rate, let alone anyone else's (except perhaps the Eurozone's), asset prices rise to daft levels, irrespective of the 'fundamentals' of individual companies, or countries. Market analysis (particularly sell-side investment bank research) is reduced to guessing whether a particular share price is a 'dangerous bubble' or a 'justifiable boom', over-intrepreting every single utterance we get from the FOMC, and watching for random market-affecting events anywhere else in the world. Of course the 'exogenous shocks' from global political events then require London or New-York based analysts to sound like 'experts' in everything from Russian regional politics to Chinese currency policy.

Anyway, what we learnt about the world last week:

1) The Fed is not discouraged by winter weather-distorted data and will continue to pump money into the bond market at a slower and slower rate. Then, something like six months after they have finished buying bonds (which is an illustrative, not a literal six months) the Fed will start to raise rates, and the best guess of the committee is that they could be at about 1% rates by the end of 2015, maybe up close to 2 1/2% by the end of 2016, and perhaps just a little under 4% at some point in the dim and distant future, subject as usual to their changing their minds between now and then.

I am SO glad that's cleared up any uncertainty.

2) The Crimea became part of Russia, a bunch of names were put on a list, some more sanctions may or may not be imposed and in a wider sense, financial markets have not reacted very much. Europe is hurrying to wean itself off Russian gas according to the press, the leaders of several countries that used to be part of the USSR are very worried about what Mr Putin might do next, and, well, that's about it.

3) The Chinese renminbi has continued to weaken at a snail's pace and the subject is gradually attracting fewer headlines, though the publication later today of the first of the Chinese 'flash' PMIs will doubtless bring the issue top again. A tall latte in Beijing, I remind you, costs £2.63 and yet the consensus view amongst eco-people is that the currency will continue to appreciate in nominal as well as real terms from here. hey ho.

4) The UK had a 'Budget' and having spent years removing tax incentives to save for a private pension, the government has decided that in the future, pensioners won't have to buy annuities whose prices have been as distorted by Bank of England and Fed policy as any other asset. This has helped narrow the gap between Conservative and Labour parties in the polls, though it hasn't stopped the gap between 'yes' and  'no' closing in Scotland too.

We can now all move to on to analyse expertly the French local elections, before we get into the monthly PMI-fest tomorrow. Along with any random events about which people will have to become immediate experts. For myself I am gong to go on relying on Twitter to seek out and find me experts to explain the (very long) list of subjects about which I know almost nothing, while I try and work out whether the Fed's painfully slow pace of policy normalisation will strike fear into the hearts of the world's investors (somehow, I doubt it, but we'll see….). In the mean-time, I just need to get away from the noise of this Yellen-propelled jackhammer….

Sunday, 16 March 2014

Wandering around Asia - it's all about Chinese currency policy

I have spent a week in Asia, 40 hours flying to four countries in five days and have returned to find out that someone turned Winter off and Spring on instead. B&Q are likely to see barbecue sales go through the roof….

Singapore's economy is in full boom. As usual. There aren't enough workers in the country to fill the jobs available in bars, coffee shops or driving taxis. Reclaiming land from the sea just continues. The last time I was there, the Marina Bay Sands hotel ($3.5bn with a gigantic surf board on the top, a vast pool and a casino) was surrounded by building work. Now, it's surrounded by the Marina Bay Shoppes (sic). And a light show in the evening. A thriving economy has diversified into tourism and casinos, at pretty much exactly the same time as a newly-affluent Asian middle class took to the airways and started going on holiday. The post-2008 collapse in trade was followed a bounce pretty quickly,  Singapore's banks escaped relatively unscathed from the crisis and now it's all go.

The investor community in Singapore listen politely to views about Europe, the US and financial markets in general, but the conversation pretty quickly turned to the Renminbi.  Singapore is the private banking hub for Southern Asia, and benefiting from the combination of an ever-appreciating RMB and higher yields than are on offer in either US or Singapore dollars, is one the most popular investment strategies for their high net worth clients. The general view or hope of these investors is that the current PBoC-induced volatility in the USD/CNY rate is just a blip, which will not stand in the way of their investment strategy.

From Singapore to Seoul, a 5 1/2 hour overnight flight followed by a day of meetings. Really, I remember less of them than I should - I just wanted to sleep! I found a spa in the airport to shower, shave and try to calm my cold down in a sauna, then took the train into the city rather than a cab because it is so much cheaper. I've been visiting Seoul for over 20 years and it has transformed from 'developing' to 'developed' more impressively perhaps than any other city I visit. In the early 1990s it was full of identical black saloon cars and utilitarian-looking buildings. Not any more.  

Beijing, by contrast, has become a hard place to visit. I was lucky to have a day of clear skies and breathable air but the traffic is awful, cars nose to tail where not that many years ago bicycles outnumbered cars. Here, the conversations were about investment in Europe, with a fascination for Australia and Canada too, but when the talk turned to the domestic currency, I sensed nervousness and uncertainty. That is unusual in Beijing, a place where there is usually certainty about the authorities' goals and little doubt that they will be successfully achieved.

Hong Kong is an astonishing city. The drive in from the airport is a reminder that this is a major trade hub, as you pass container ship after container ship. More the  one person though, tells me that the luxury shopping brands and stores are doing less well now. The Chinese slowdown is being felt here. As for the clients, we were back to talking about China. I was asked how far I think the USD/CNY rate may rise and retorted that if the idea was to reduce the appeal of the 'carry trade', then what I learnt in Singapore is that those buying the Renminbi are not feeling dissuaded yet. The glib remark that from the current 6.15, we are more likely to see the rate at 7 than 5 in the coming years caused real concern until I qualified it by saying that neither of these levels is likely. What did I learn is that a 2 1/2% depreciation is causing more anguish than a fall that magnitude should. And by association that there is more leverage in the trade than I had realised. That increase in leverage makes me concerned, particularly in the wake of the announcement this weekend that the daily trading band for USD/CNY is being widened.

A note at the end. I've ben jotting down the price of a tall latte at Starbucks stores around the world for many years. This week, I paid SGD 5.60 (£ 2.66) , KRW 4400 (£2.47) , CNY 27(£ 2.64) and HKD 31 (£2.40), all of them more expensive that the £2.25  I get charged in london, the steady widening of the price differential between Beijing and Hong Kong perhaps the most striking feature.

Sunday, 9 February 2014

The Grand Old Duke of Rio

The emerging market sell-off paused for much of last week but the debate about what it all 'means' rages on.  So to carry on from last weekend's themes here are a few points and a picture:

Firstly, a re-cap: really low rates (and QE) in the US (and Europe) caused a huge flow of money into almost any asset with any yield both in 2004-2008 and 2009-2002. Secondly, many (not all) central bankers allowed the effects of this to be felt in 2009-2012 through currency appreciation, a major difference with the 1990s. Some of them ended up with very expensive currencies. The US ended up with a very cheap one. Thirdly, many (but definitely not all) EM countries were consequently able to avoid the explosion of debt, notably foreign currency debt, that they suffered from in the 1990s. In aggregate, foreign currency debt is a smaller share of EM exports today that it was a decade ago and the interest that is paid on it totals something like 2 1/2% of export earnings. Fourthly, it isn't the US' 'fault' that the Fed sets a domestic level of interest rates that works for the US but doesn't work for the rest of the world. And finally, I think it would be very useful if we stopped talking EM and DM, and at the very least took China out of EM and started calling it the world's second biggest economy with the world's biggest domestic credit problem. It makes a mess of 'EM-wide' data if it isn't considered separately and if China's debt bubble does burst, I for one won't describe the outcome as an 'EM crisis'  

Anyway, here's a chart of real effective exchange rates, some EM and some DM, back to 2005. I drew it to keep my mind occupied for the last hour of a truly awful game of football yesterday and I'll do some 'work' on this theme in the next few days.  The data are from the BIS, and I've updated them as best as I could in the time I had. With any index-based look at FX, the starting point is arbitrary and therefore prone to skewing conclusions if you're not careful, but I chose 10 years ago because that was far enough after the 1990s EM crisis for recovery to be underway, and far enough after the Euro's launch for EUR/USD to have both collapsed and recovered. So for better or for worse, this chart shows how real exchange rates have moved since the global economy was in a relatively balanced state, in the early stages of the great financial bubble.

A few things are interesting. The first is that towards the end of 2012, the three cheapest currencies on this arbitrary list and relative to my arbitrary starting point, are the dollar, euro and pound. The second is that three currencies saw truly staggering real appreciation in 2004-2008 and then again after 2009:  The Chinese Yuan has appreciated by 40% in real terms over a decade. The Brazilian real had at one point almost doubled in value in real terms and even now is still 50% more expensive than it was in 2004. Go to the World Cup, and experience what that means for yourself. The Rouble too, is 40% more expensive in real terms than it was. If you are in Sochi, you probably realise what that means. But at the other end of the spectrum, whatever else is going wrong in South Africa, the rand has replaced the pound as the biggest FX faller in this list over the last decade, the Turkish Lira is correcting fast and the whole EMFX boom, in real terms anyway, rather passed the Mexico Peso by.

Perhaps it isn't surprising given the trend above, that the current account balance of the developed economies as a whole, should have improved by over USD 400bn per annum over this period. The developed economies now have a combined current account surplus. And by contrast, the surplus of the emerging and developing economies has, of course, shrunk. Indeed, in all probability some time this year the current account balance of 'EM' will be in deficit if we exclude China.

The shift in the balance of payments reflects in part the real appreciation of EM currencies and the real depreciation of the two most important developed economy currencies. But that still doesn't automatically mean that EM disaster in upon us. In 2007, just before everything went wrong, the EM world had a $600bn current account surplus, but an even bigger inflow of private capital, almost USD 700bn. The other side of that coin was a USD 1.2trn increase in EM central banks' currency reserves. Madness! We all thought everything would change after 2008 but in 2010-2012, the total private sector inflow into EM was $1.5trn, and FX reserves grew by another $2trn to mop as much of that up as possible.

So much investor capital has flowed into EM overall that the global financial system is inherently unstable and prone to the kind of volatility we are seeing. Really, am I supposed to be shocked by weekly flow data that show money still coming out of EM funds?

More facts: External debt of EM economies has risen from around $3trn in 2005 to about $7trn now but as  a share of exports, that total is actually down slightly from 80% to something a little above 75% today. It's above 100% GDP in Latin America and the CIS while in Central and Eastern Europe it's north of 150% of exports. It's around 50% of exports in Asia.

Finally, the big hornet's next is the growth of domestic debt, and this is a global rather than an EM problem. There is much debate about whether deflation is here, whether it's bad and whether there are good and bad kinds of deflation. The kind of deflation that will cause us all trouble will be the kind that results in nominal growth rates being too low to prevent debt/GDP ratios heading inexorably upwards. That's the biggest challenge facing Japan, Europe and as Chinese growth slows while debt grows very quickly, it will be more than a headache for the world's second biggest economy.

Saturday, 1 February 2014

Unravelling the global effects of mad money

Since some of my 'work' observations on currencies have been doing the rounds in the press over the last few days, I thought I'd lay out some broad thoughts on recent weakness in emerging market (and other) currencies. There's a danger in broad generalisation in a quick sweep through thirty years of the after-effects of very low US interest rates, but this is a blog not a research paper so here goes....

In 1993, when the Federal Reserve maintained interest rates at what was then perceived to be an astonishingly low level of 3% as the US economy recovered from the aftermath of the S&L crisis and the recession two years earlier, the seeds were sown for the 1990s Asian crisis.

When the central bank of the world's biggest economy decides that its domestic interests are best served by extraordinary monetary policy settings, policy-makers all over the world have to decide how to react. In 1993, by and large, Asian policy-makers' response was to continue to gradually liberalise the flow of money into and out of their economies, to maintain formal or informal pegs between their currencies and the US dollar and to let the good times roll. In countries like Thailand, the decision not to allow currencies to appreciate pretty much automatically resulted in US interest rates being imported into economies which were growing far too fast for 3% rates. What followed was a surge in both domestic credit growth and in foreign currency borrowing - if your central bank sets rates at 6%, the Fed is at 3% and you have a fixed exchange rate between your currency and the US dollar, why not just borrow cheap dollars?

The result through the early part of the 1990s was that a lot of Asian countries maintained competitive exchange rates and saw very rapid growth in credit. That was fine for a while but as US interest rates rose, it became problematic. It became clear to everyone that what looked like a credit 'boom' was a bubble and that too many golf courses, casinos and beach resorts had been built without regard for whether there was income enough to service the debts to pay for them - debts whose services costs were going up.

As growth slowed, bad debts ballooned and capital left their countries, Asian central banks found that they did not have enough currency reserves to stop the pressure on their (pegged) exchange rates, and were forced to choose between letting them fall (making the foreign currency debt problem worse), raising interest rates (causing an even greater economic downturn) or imposing capital controls. Different countries chose different paths but the Asian crisis followed and the next few years were spent trying to learn the lessons from the disaster.

The lessons which were learnt served Asia well in 2001-2012. As the Federal Reserve once again embarked on a policy of exceptionally easy monetary policy after 2000, Asian central banks were much more alert to the danger of poor lending practises and to the danger of foreign currency borrowing. They set about building vast war-chests of currency reserves to help defend themselves against future runs on their currencies. And they started to allow their currencies to float somewhat more freely, which mostly meant that they allowed them to appreciate against a US dollar anchored by low interest rates.

Because they avoided the worst excesses of credit growth in this period, Asian economies weathered the 2008 crisis much better than Europe and the US. But what came out of that period was even lower interest rates (3% Fed Funds in the 1990s become 1% Fed Funds in the 2000s and then zero Fed Funds in the 2010s) with the added twist of Quantitative Easing.

The challenge remained the same and was no longer in any way an 'Asian' problem or even one just for 'emerging' economies. The central bank of the world's biggest economy set interest rates at zero when the emerging market economies as a whole were enjoying real GDP growth of 7 1/2% in 2010. They faced the choice of allowing their currencies to appreciate sharply, of allowing domestic asset prices to rise and credit to grow because rates were too low, or of imposing capital controls. No wonder many complained they were in a currency war.

Different countries faced different domestic issues and reacted to the global environment in different ways. But if there is a common thread it is that most allowed their currencies, in nominal and even more in real terms, to appreciate more than they had in the early 1990s.  In 1993, a young backpacker wandering the world would generally have found that 'emerging economies' were cheap places to visit. By 2011, that was no longer the case. Again, it was not just an 'emerging market' story. In 1995, British people could go and enjoy cheap prices for winter sun in Australia, while young Australians came to London to earn better pay than they could get at home and see the world at the same time. Now, Australia's youth stays at home to serve beer to locals who enjoy watching their cricket team thrash England's.

When the notion of the Federal Reserve 'tapering' its bond purchases was first mooted last May, there was a temptation to ask whether that was important. Buying bonds more slowly is only a marginal shift and interest rates are still at zero, after all. However, a turn in the monetary policy cycle was signalled and was enough to trigger a violent response in asset markets. US bond yields rose and the currencies which had been allowed to appreciate in reponse to super-easy US monetary policy, started to fall back, chaotically in many cases.

The most positive way to look at the events of the last 9 months is that most of the central banks whose currencies are falling, probably welcome at least part of the adjustment. They didn't choose to have overvalued exchange rates, after all. What they chose was to allow the currency to take the strain of offsetting US monetary policy, which in turn allowed them to maintain some degree of control over domestic credit conditions. If I compare the modest sell-off we have seen in emerging market bonds, for example, with the larger moves we have seen in currencies, the conclusion is that the currency is doing its job of acting as a shock-absorber and this is a currency adjustment (so far) and not a crisis. In Australia, whose currency is now 20% cheaper than it was at its peak, there is no sense of crisis at all. In Argentina whose currency has fallen almost 20% in January, it's definitely a crisis.

Whether it is right to conclude that there is 'no crisis' is a matter of judgement. But I would draw three very broad conclusions:

Firstly, the willingness to allow currencies to act as a shock-absorber helps prevent the extremes of domestic credit imbalances which plagued Asia in the 1990s. That is a very good thing indeed in those countries which did allow their currencies to float more freely and did manage their domestic financial system more closely.

Secondly, given that we are still in the very early stages of the US policy nomalisation and since there are still an awful lot of countries whose currencies are far more expensive in real terms today than they were 10 years ago, it would be rash to assume that the adjustment is mostly complete.

And thirdly, since Fed policy was even more accommodative in this cycle than in the early 2000s or the 1990s, it isn't surprising that the scale of the capital flight from G3 economies into the rest of the world was much bigger this time and the accompanying asset inflation was also much greater. And so, the turmoil that can be caused by those flows being reversed, can also be greater than it was in the second half of the 1990s. Which is to say that even while I don't think this IS a crisis at this point, the risk of it becoming one is clear. Particularly in those countries where control of domestic asset inflation and credit creation was weakest.

Saturday, 11 January 2014

A short Saturday morning US jobs post

A quick run down of the US employment data and where it leaves this particular fool...

There are three charts to consider. The first shows falling unemployment rate, which is a function of the on-going decline in the labour force. That's been written about to death. At some point people will stop just leaving the labour force, but it hasn't happened yet. When they do, the pace of decline in the unemployment rate will slow, but the best estimate I have seen of the long-term trend growth rate of the US labour force is around 80,000 per month, which suggests that even yesterday's 74k increase in jobs is enough to keep the unemployment rate steady.

I've plotted it against the hourly earnings series, which has slowed to 1.8% y/y, and to 2% on a 3-month smoothed basis. Unemployment has fallen sharply but there's nothing pointing to any significant pick-up in wage growth yet. That will be yet another factor keeping consumer price inflation at bay.

The second chart shows the two measures of employment, the non-farm payroll series, plotted against the growth rate in employment from the household survey (the one that is used to measure the unemployment rate). Employment growth in the NFP series has slowed to 1.62% from 1.73%, and you'll excuse me I hope if I fail to get over-excited. The December payroll data were bad, albeit possibly excused by the weather, but the underlying trend in employment growth is close to long-term averages and still very consistent with a 'new-normal' economic recovery. Little has changed as a result of yesterday's soft headline and won't unless it is repeated for a couple more months. But the household survey shows employment growth of 0.8%, which is much worse. Even if I smooth it out, the gap is bigger than it has been since the late 1990s. Just looking at the two lines you can see that the (smaller) household survey is more volatile, but even so, the divergence is big enough that I for one will be watching it in the months ahead.

The last chart shows the NFP data, plotted against a 36-month standard deviation, i.e. a measure of the volatility of the series. Relative to recent norms, yesterday's number was a genuine outlier. If you glance across a the last period of low NFP volatility in the late 1990s, you can see that there were spikes, but they were followed by corrections. The lack of volatility in the US employment data is a source of optimism about this year's growth, because weather aside there isn't much which 'ought;' to cause a negative shock. In the 1995-1998 period, low employment volatility was accompanied by equity price gains, a strong dollar, and strengthening growth until the Fed 'blew it' by cutting rates and keeping them too low for too long after LTCM went bust -  re-fuelling the housing and dotcom booms. I take heart from both solid employment gains and the lack of volatility in the series, so a pick-up in vol would alarm me...

The jobs report poses questions about whether this was a one-month weather-induced outlier or something more meaningful. Most people will guess that it's the former, at least for a couple more months,. But the slowdown in wage growth either puts NAIRU even lower or says the wage/unemployment relationship is broken. Either way, the only inflation we should worry about is asset price inflation and the Fed seems happy to ignore that. The household survey meanwhile, needs to show employment growing faster or I'll start to really worry about that, too. And as a final aside, since no-one knows what to make of the jobs data, the big news was the fall in the US trade deficit as energy independence raises the attractive prospect of an economic recovery that is NOT accompanied by a widening deficit. In short, a recovery with much better balance between output and demand growth than we've been used to in the US. Oh, that we in the UK could dream of such balance in our recovery....

Sunday, 5 January 2014

UK and US monetary policy - designed in Monaco

The Sunday Times shadow MPC is voting for a rate hike in the UK. It won't make a blind bit of difference, what we will get instead is a bit of tinkering with the forward guidance the MPC use, to lower the rate unemployment needs to fall below before they will contemplate rate hikes.

The UK rate debate is echoed in the US, though it seems more vociferous here, and centres around the question of whether it is interest rate changes that matter, or the level of interest rates.  If you ever play with monetary policy rules, like the Taylor Rule, they will suggest appropriate rate levels, rather than moves and will definitely suggest that rates should be raised even when inflation is low. Their starting point is that there is a 'neutral interest rate' from which actual rates should differ as a function of how much slack there is in the economy and how far inflation is from target.

A standard Taylor rule estimate would put UK interest rates around 2% at the moment, on the basis of a 6 1/2% NAIRU and a 2% inflation rate target. Core CPI inflation is just below target and unemployment is not that far above target, so a real interest rate a little above zero would seem to make sense. You need to get NAIRU under 4% to justify current policy rates. That's even lower than the US (NAIRU at 4.3%) and of course far lower than the level of NAIRU which justifies current rates in Europe (around10%).

The Taylor rule isn't the holy grail of policy making, and it's certainly being ignored by central banks at the moment; but should rates to be kept at current (extraordinarily low) levels just because there is slack in the economy? On that basis, rates would be far below 'neutral' until there was no slack in the economy, or until growth was consistently above trend, and then they would have to rise very fast. It's the equivalent of keeping your foot hard down on the accelerator of a car until it's time to brake equally hard - more like how you might drive an F1 car round Monaco than a Ford Fiesta round Islington.

Setting rates too far from 'neutral', however that's measured, causes mis-allocation of capital. By keeping rates too low for too long a decade ago, the Fed provided the fertiliser that allowed the credit bubble to blossom so disastrously.  There are times when extraordinary monetary policy makes sense, but I'd like to see a return to rate levels that are higher, but still very low relative measures of 'neutral', as soon as it is safe to do so. So the question now, is whether it's 'safe' to take baby steps in the direction of nomalising policy, not whether it's time for policy to be 'tightened'?

For now,  the debate (in the UK and the US) is about whether rates should be raised or not, rather than whether they are at appropriate levels for economies with falling unemployment and above-trend growth rates. That's a  mindset which is friendly for asset prices and even if there is little risk that we see any significant upward pressure on either wage growth or inflation, it will continue to cause capital to be misallocated.