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Introduction
Over the last several decades, governments have collectively pledged to slow global warming. But despite intensified diplomacy, the world is already facing the consequences of climate…
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Steel Productivity has Plummeted Since Trump’s 2018 Tariffs
Studies have shown that tariffs depress productivity in protected industries. U.S. steel is a case in point.
Carney’s Forward Garble
The Bank of England’s dramatic new “forward guidance” policy, announced on August 7 with great fanfare, struck the markets like a soggy noodle – the FTSE fell, gilts fell, and sterling rose, none of which could the Bank have wanted to see.
Why the disappointment? Others have pointed to the multiple caveats and exit clauses, but we would highlight something much more tangible: the pledge to keep interest rates super-low at least until unemployment fell to 7% was meaningless, as 7% is nearly two full percentage points over what the Bank considers to be the long-term equilibrium rate of UK unemployment. This is like a football coach pledging to keep throwing the football until his team is down by less than 50 points; it tells the defense nothing it didn’t already know.
Compare the BoE’s rate pledge to the Fed’s rate pledge, which has the latter committing to a near-zero policy rate until unemployment falls to less than a percentage point above what the Fed considers to be the long-term equilibrium rate of US unemployment. While hardly shocking, the Fed’s commitment was newsworthy.
If a 7% unemployment target was the best that new BoE Governor Mark Carney could deliver through his Monetary Policy Committee, he would have been better advised to skip the forward guidance and simply let the market judge his actions going forward.
Bank of England: August Inflation Report
The Guardian: MPC Member Failed to Back Carney Over Forward Guidance
The Economist: Guidance on Forward Guidance
Financial Times: Carney Ties UK Rates to Jobs Data
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Will Portugal Bring Down the Spanish Banking Sector?
In its recent evaluation of the Greek bailout program, the IMF revealed that the euro area leadership sought to delay a Greek sovereign debt restructuring back in 2010 because of contagion fears; that is, Greece’s creditors might get sucked into the bailout vortex. Among eurozone national banking systems, France had the largest exposure. At its peak in the second quarter of 2008, France’s exposure to Greece totaled $86 billion. That exposure has since plummeted, partly because French banks took advantage of the ECB’s Securities Market Programme (SMP) during 2010-11 to fob off Greek bonds, effectively forcing a eurozone mutualization of the debt. SMP was terminated in September 2012.
What is much less widely known is that Spanish bank exposure to Portugal today, as shown in our Geo-Graphic, is higher than French bank exposure to Greece in early 2010, despite the fact that the Spanish banking sector is only 40% the size of the French. Spanish bank stress tests in 2012 suggested that the capital hole was more manageable than widely feared, but those tests looked only at the domestic lending books; foreign assets were excluded.
A restructuring of Portuguese sovereign debt similar to the one completed by Greece, which involved haircuts of over 50%, could wreak havoc on Spain’s banking system. Yet delaying restructuring, as Greece is showing, may simply drag down Portugal—whose debt-to-GDP ratio is expected to approach 125% next year—faster and further, worsening creditor losses.
Without an SMP to mutualize Spanish bank exposure to Portugal, the way it mutualized French bank exposure to Greece, delaying a Portuguese restructuring will also do nothing to help Spain weather the shock. The euro area has already lent Spain €41.3 billion to recapitalize its banks, but finding a politically palatable way to convert that debt into mutualized eurozone equity may be a necessary cost of sustaining the European single currency.
Oliver Wyman: Spain Stress Test
Financial Times: Portugal’s Political Turmoil Risks Debt Restructure
IMF: Ex Post Evaluation of Exceptional Access Under the 2010 Stand-By Arrangement on Greece
Ecofin: Financial Stability Support Package for Spain
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Fed Taper Talk Jolts Rate Expectations for 2015
From September 2012 to March of this year, the Fed had been remarkably successful at guiding the market’s expectations for future interest rates through publication of its unemployment projections. As today’s Geo-Graphic shows, when the Fed lowered its unemployment projection for a given future date the market raised its projection for interest rates around that date proportionately. It was a tightly correlated dance.
Then came Bernanke’s taper talk.
As we showed in our last post on mortgages and monetary policy, the rate reaction to the Fed chairman’s May 22 and June 19 comments, suggesting an imminent slowdown in asset purchases, was sudden and sharp. As today’s figure shows, the comments also triggered a jump in the market’s rate expectations for second-half 2015 to a level well beyond what would earlier have been expected, given the Fed’s updated unemployment projection.
The market now seems to believe that the Fed will raise rates more quickly and substantially after the unemployment rate crosses the Fed’s 6.5% threshold, an observation consistent with a hawkish interpretation of Bernanke’s taper talk.
Many pundits have suggested that the chairman’s comments were misconstrued, and that he had no intention of signaling higher future rates than the market had previously inferred. If so, the Fed will have to walk the market back with some clarity on how it will steer rates once unemployment falls below 6.5%.
FOMC: Economic Projections from June 2013
Bernanke: May 22 Economic Outlook Congressional Testimony
Wonkblog: The Fed's Tricky Messaging
Wall Street Journal: Up for Debate at the Fed Is a Sharper Easy-Money Message
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Mortgages and Monetary Policy Don’t Mix
From the beginning of 2009 through this past May 21st, the Fed amassed a portfolio of mortgage-backed securities (MBS) valued at $1.2 trillion. Over this period, the average 30-year fixed mortgage rate fell from 5.33% to 3.65%, and the spread between that rate and the 10-year government borrowing rate fell from 2.8 percentage points to 1.7 percentage points.
Then came talk of “calibration” and “tapering” . . .
"Calibrating" asset purchases to volatile data while pledging to ignore data on rates, as we argued recently in Dow Jones’ Financial News, is a tough line for the Fed to walk. On May 22, and then again on June 19, Chairman Ben Bernanke suggested that the Fed might soon begin reducing the pace of MBS purchases, dependent on developments in the labor market. Mortgage rates soared. The average 30-year rate is now hovering around 4.5%; about half the decline in mortgage rates that the Fed had engineered through its multi-year MBS purchase scheme has evaporated. In consequence, the monthly mortgage payment on a $200,000 home purchased with a 10% down payment has risen by a whopping 10% since calibration talk began. Housing starts also plummeted 10% from May to June, hitting their lowest level since last August, just before the Fed’s latest round of MBS purchases.
This confirms our view, expressed recently in the Wall Street Journal, that the Fed should never have gotten involved in sectoral credit allocation in the first place: it should have limited its interventions to the Treasury market, and let the Treasury take politically charged decisions on whether and how to intervene in specific areas of the economy, such as the mortgage and housing markets. The Fed has only set itself up, as well as the market, for ongoing exit strategy headaches. Mortgages and monetary policy just don’t mix.
Financial Times: U.S. Housing Construction Slides to Ten-Month Low
Bernanke: May 22 Congressional Testimony
Bernanke: June 19 FOMC Press Conference
Wall Street Journal: Thirty-Year Mortgage Rate Posts Largest Weekly Increase Since 1987
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The New Geo-Graphics iPad Mini Index Should Calm Talk of Currency Wars
The “law of one price” holds that identical goods should trade for the same price in an efficient market. To what extent does it hold internationally?
The Economist magazine’s famous Big Mac Index uses the price of McDonalds’ burgers around the world, expressed in a common currency (U.S. dollars), to estimate the extent to which various currencies are over- or under-valued. The Big Mac is a global product, identical across borders, which makes it an interesting one for this purpose. Yet it travels badly – cross-border flows of burgers won’t align their prices internationally.
We’ve created our own index which better meets the condition that the product can flow quickly and cheaply across borders: meet the new Geo-Graphics iPad mini Index.
The iPad mini is a global product that travels by plane in a coat pocket, unlike a burger, and its manufacturer, Apple, is highly attuned to shifting currency values. “We made some pricing adjustments due to changes in foreign exchange rates,” Apple spokesman Takashi Tabayashi told Bloomberg News after Apple raised Japanese iPad prices 15% in May, offsetting the early effect of Abenomics on the yen.
As this week’s Geo-Graphic shows, there are no major violations of the law of one price in the global market for iPad minis – unlike the market for Big Macs. This is particularly the case after stripping out Value-Added Tax distortions. (Sales tax in many countries, like the United States, is not included in the sales price Apple advertises, but VAT is included in such prices for VAT-levying countries. VAT is also at least partly refundable for foreigners exporting the product.)
The Geo-Graphics iPad mini Index confirms that the Swiss franc is a bit overvalued, and the Malaysian ringgit undervalued, but the scale of the misvaluation is much less than the Big Mac index suggests.
In China, an iPad mini now sells for 5.6% more, ex-VAT, in dollar terms than it does in the U.S.. This suggests that the RMB may be closer to its “correct” level than Big Macs, and numerous pundits, suggest.
Currency warriors, take heed – the new Geo-Graphics iPad mini Index, at least, says that you can’t win.
We thank Andrew Henderson for his contribution to this post.
The Economist: Big Mac Index
Pakko and Pollard: Burgernomics
Financial Times: Apple Raises Prices As Abenomics Bites Japanese Consumers
Geo-Graphics: Beware Friendly Fire in the Currency Wars
Follow Benn on Twitter: @BennSteil
