Jan 31, 2016. Central bank desperation
“And then, depression set in” -Bill Murray as John Winger in Stripes
Last week’s title was “Central Banking Confidence Game”. This week it smells more like desperation. Consider the recent chain of events: two weeks ago Draghi signals further easing in March (bullet spent), and then Kuroda suggests China implement capital controls. Last week the Fed back-pedaled from the idea of a hiking campaign (bullet spent). Friday the BoJ went negative (bullet spent). Take a step back and what does it mean? It means that central banks are desperate to force consumer spending, the last game in town. And they are running out of ammo. Consider the chart below (from dshort.com):
“As for the role of Personal Consumption Expenditures (PCE) in GDP and how it has increased over time, here is a snapshot of the PCE-to-GDP ratio since the inception of quarterly GDP in 1947. To one decimal place, latest ratio of 68.9%. From a theoretical perspective, there is a point at which personal consumption as a percent of GDP can’t really go any higher. We may be approaching that upper range.”
http://www.advisorperspectives.com/dshort/updates/GDP-Components
This chart is only for the US. As I have mentioned previously, household balance sheets aren’t in bad shape. There are some positive notes from labor markets (aside from the obvious drop in the unemployment rate). For example, the WSJ says “Income for Recent Graduates the Highest in Over a Decade”… stereotype of college graduates working in coffee shops is fading. However, there’s only so much that can be squeezed from consumer spending.
So if this chart is just for the US, doesn’t it mean that other consumers in other parts of the world can pick up the slack? For example, we’ve all heard that China is trying to transition more to a consumer led economy. Perhaps true, but then why is every bloc trying to depreciate their currency vs the dollar? It’s so the US consumer can ride to the rescue.
In terms of the business sector, there’s this note from Bloomberg (Jan 28): “Credit-rating downgrades account for the biggest chunk of ratings actions since 2009; corporate leverage is at a 12-year high; and perhaps most worrisome, growing numbers of companies — one third globally — are failing to generate high enough returns on investments to cover their cost of funding.” FAILING TO COVER THE COST OF FUNDING. That’s the sort of problem that gets a central banker’s notice. The corporate borrowing binge has made this sector the largest source of fragility.
I’m all for government deficit spending on infrastructure as a means to spur immediate growth and set the framework for future growth. And I’m not talking about painting bike lanes on Chicago’s pot-holed streets. But the political will doesn’t seem to be there for an infrastructure investment initiative.
What are markets saying?
There was huge short positioning in December ’16 eurodollars prior to the Fed. Someone obviously believed Fed officials in terms of hiking plans and the perceived strength of the economy. [Jobs report this Friday]. However, this contract closed at its highest level since the October spike, at 9918.5. At the end of December it was 9875, so we’ve seen a 43.5 bp drop in yield in one month! The market continues to tell a different internal story than the Fed, warning of bankruptcies and a lack of growth and inflation. Sure, stocks had a spirited rally Friday. The same “wealth managers” that were saying ‘stocks don’t reflect what is going on with the health of the economy’ when near the lows, are going to come out this week and say ‘See? The stock market now “gets it” and is back to pricing in our glorious fundamentals.’ Interest rate markets across the globe whisper a different narrative. German 2 year notes made an all-time low at -49 bps. Same for Japanese twos and tens, record lows at -8 bps and +9.5 bps. There is no way to escape the twin overhanging problems of aging populations that demand expensive medical care and extreme global debt levels. Reuters had this headline: “US economy hits a soft patch in Q4.” As you know, Q4 GDP was released Friday at 0.7%. Perhaps it IS just a “soft patch.” But since the beginning of this year, the US five year treasury yield has also fallen 43 bps. Calendar spreads on the Eurodollar curve have imploded. EDH’16/EDH’17 (March/March) closed at just 27 bps, down 8.5 on the week and barely holding above ¼% for a full year. 2/10 treasury spread remains pinned to the lows just above 115 (ended last year at 122). However, 5/30 ended the week at a new high, just over 142. The bond yield this week only fell 7 bps to 275.
In terms of negative rates spurring bank lending, there are constant stories about European bank problems. Regarding Kuroda’s move to negative, Bloomberg had this to say: “When it comes to bank lending, however, the central bank’s announcement will probably have more of a dampening effect than a stimulative one. Shares of Mitsubishi UFJ Financial Group and Mizuho fell in the wake of Kuroda’s announcement.”
Pushing on a string.
