FED TRIES DAMMAGE CONTROL
Fed Toils in Vain to Calm Markets The financial markets’ violent movements this week underscore the immense challenge the Fed faces as it eyes an eventual end to its $85 billion-a-month bond-buying program.
The market reaction presents the Fed with new questions that will only be answered in the months ahead: Are the economy and markets really healthy enough now to stand on their own? Might the prospect of withdrawing stimulus undermine the recovery the Fed has been struggling for years to engineer? Are its efforts to clarify its thinking helping or hurting? (…)
Mr. Bernanke likens the two levers to driving a car: When it reduces its bond purchases, that will be like lightening the pressure on the accelerator; when it starts raising rates, it will be akin to tapping the brake.
Many investors appear to have missed Mr. Bernanke’s signals that the Fed might wait longer than expected before raising short-term rates. He said on Wednesday that the 6.5% unemployment rate threshold might be too high and that the Fed might decide to keep rates low for long after the rate drops below that level, especially if inflation remains low.
But it is the Fed’s bond purchases that have driven mid and long term rates 200-300 bps below normal. The Fed may well keep short term rates low, but it does not set longer term rates, including mortgage rates, simply by diktat. This is what QE3 was all about. Bernanke won his bet. He himself closed the debate on flows vs stock.
(…) However, a close look at Mr. Bernanke’s press conference comments and Fed official’s interest-rate projections released after the meeting show the Fed took several steps aimed at sending the opposite signal.
–Mr. Bernanke emphasized that even though the Fed might pull back on bond-buying later this year — which is akin to easing your foot off the gas pedal of a car — it would be a long time before it took the more aggressive step of raising short-term interest rates — which is akin to pressing the brake. He also emphasized in his prepared statement that when rate increases come, they “are likely to be gradual,” a hint of future caution about rate increases he hasn’t given before.
–Mr. Bernanke suggested the Fed could keep short-term interest rates near zero even longer than previously planned. Since December, the Fed has said it would keep short-term rates near zero at least as long as the jobless rate is above 6.5%. In his prepared statement, Mr. Bernanke emphasized that rates could stay low for a while even after unemployment falls below 6.5%, particularly if inflation stays low. “The more subdued the outlook for inflation,” he said, “the more patient the [Fed] would likely be,” he said. In the question-and-answer session he went even further and said for the first time that the Fed might even lower that 6.5% threshold.
–Fifteen Fed officials expect the central bank won’t need to raise short-term interest rates until 2015 or 2016 and just four said it would need to do so before then. That was a slight move away from early tightening: Previously five anticipated tightening before 2015. The average short-term benchmark rate expected at the end of 2015 among Fed officials didn’t change much – it was 1.34%, compared to 1.30% in March. The median expected rate – meaning half saw one higher and half saw one lower – remained unchanged at 1%.
–Mr. Bernanke said “a strong majority” of Fed officials had concluded the Fed won’t ever sell its growing portfolio of mortgage-backed securities, and instead will let it shrink as mortgages are paid off. In the past the Fed had said it might someday sell these bonds, a threat to any investor who held the bonds. He was more emphatic than ever Wednesday about not selling.
–A hawk became a very vocal dove. St. Louis Fed president James Bullard dissented from the Fed’s policy statement, saying he thought the central bank should be leaning toward even easier money policies. In the past, Mr. Bullard has tended to side with Fed “hawks” opposed to easy money policies. In a statement his office released Friday morning, he argued that the Fed’s decision to lay out a plan for pulling back easy money was “inappropriately timed” because inflation and economic output have been soft.
–Mr. Bernanke emphasized the conditional nature of the Fed’s plan to withdraw bond-buying. “If you draw the conclusion that I’ve said that our policies, that our purchases, will end in the middle of next year, you’ve drawn the wrong conclusion, because our purchases are tied to what happens in the economy … we have no deterministic or fixed plan.”
Maybe Bernanke should do the “read my lips” trick. Still, he should at least remember what the FOMC wrote just the month before as Barron’s Randall Forsyth points out:
NOW, HOWEVER, THE FED sees things sunny side-up. The FOMC last week declared “downside risks to the outlook for the economy and the labor market as having diminished since the fall,” a darned sight better than the assessment in May, when the panel “continued to see downside risks to the economic outlook.” (…)
What positives the FOMC saw during the last 4 weeks seem to have been totally missed by investors! For his part,
David P. Goldman, the head of the Macrostrategy advisory and the former head of bond research at Bank of America, writes in a note to clients, the conventional wisdom of a pickup in the second half of 2013 is contradicted by the lack of sources for growth: Real incomes are falling; exports are stagnant and are likely to be hampered by a higher dollar; corporate profits began to slide in the first quarter, and guidance from S&P 500 companies is negative; government spending is constrained, and there is “not a flicker of improvement” in corporate investment. Housing is the sole bright spot, and that will be restrained by the jump in mortgage rates.
Speaking of the sole bright spot, has anybody at the Fed noticed that housing starts have actually declined since last December and building permits have increased a mere 3%?
And despite all the bullish talk from house builders, they are not hiring any more workers:
And now, by the Fed’s own making:
Bond selling hits US homebuyer costs Yields on US Treasuries reach highest level in two years
The average rate on a new 30-year fixed rate mortgage has jumped to 4.24 per cent, according to bankrate.com. The average 30-year fixed rate was 3.40 per cent as recently as early May. Wholesale mortgage rates rose by 15 basis points on Friday, an indicator that new loans could rise still further.
The WSJ did the real numbers for us:
Economists say there would not be much impact until rates reach 6%. How many people who can only afford a $208k house have $200 or $250 of spare cash per month, let alone having the $40k cash down? By the way, the median sales price is now $270k, 30% higher!
But don’t worry, economists and banks have solutions to everything:
While rising costs make purchasing real estate more expensive, the upshot for homebuyers is that banks will need to respond by improving credit availability that has been holding back the market for the past five years.
“If people believe house prices are going up, credit availability will evolve,” said Paul Willen, a senior economist at the Federal Reserve Bank of Boston. “There is too much money to be made lending to homebuyers. Lenders will find a way.” (…)
Bank of America Corp. is doing more lower-down-payment originations because mortgage insurers are getting more comfortable with them as home prices rise, he said. The company is considering lowering its down-payment requirement for jumbo loans to 15 percent from 20 percent, he said.
“We would never change credit conditions due to market pressures,” he said. “Any changes would be based on economic factors.” (…)
Zillow Mortgage Marketplace, an online comparison shopping site for home loans, saw a 570 percent increase in the number of lenders offering conforming loan quotes with down payments of 3.5 percent to 5 percent in March 2013 compared with two years earlier, said Erin Lantz, director of the site, which received 15 million loan requests during the past 12 months.
“More lenders are willing to lend to borrowers with lower down payments — it’s an indication that they are able to extend credit more broadly,” Lantz said.
HIGHER RATES COULD ALSO HIT CAR SALES
(…) the auto industry accounts for about 4% of U.S. gross domestic product, and directly employs 2.5 million people. In the first quarter, vehicle production accounted for about half of the U.S. economy’s growth, according to data from the Bureau of Economic Analysis.
(…) In recent months, auto sales have continued to rise but at more moderate rates than the 13% growth the industry saw in 2012. And those lower growth rates have required increased efforts by auto makers. The percentage of loans and leases going to subprime customers are increasing. Subsidized interest rates of 0% or close to 0% are widely available, even on new models. If the Federal Reserve begins to taper off its bond-buying efforts later this year, as it said it might, offering such rates would likely become more costly for auto makers.
And, by the way,
Increased housing activity also spurs contractors, plumbers and electricians to go out and buy new pickup trucks—which are big profit-makers for Detroit.
Benchmark government yields face upward pressure
Dealers will underwrite $99bn of new Treasury debt spread across the two, five and seven-year sectors in what shapes as a test of investor appetite for government paper.
HIGHER RATES ALSO HAVE A WEALTH EFFECT:
MEANWHILE, CHINA CONTINUES TO WORRY PEOPLE
The funding squeeze, which sent overnight funds soaring as high as 30% in intraday trade last week, began in late May, but only Monday did the People’s Bank of China make its position clear: “All financial institutions must…continue to strengthen their liquidity management to promote stability in the monetary environment,” it said in a statement on its website.
“Commercial banks need to closely follow the liquidity conditions and boost their ability to analyze and make predictions on the factors that influence liquidity,” it said. (…)
China’s benchmark Shanghai Composite index fell 5.3% to its lowest point in nearly seven months, and China Development Bank, one of the country’s three policy banks, canceled a planned Tuesday sale of 20 billion yuan ($3.26 billion) in floating-rate bonds. (…)
On Monday, concerns over the funding problems led to a wave of selling in shares of midsize banks, many of them heavily reliant on the interbank market for their funds. China Minsheng Banking, Industrial Bank and Ping An Bank all fell by the market limit of 10%.
The People’s Bank of China also said Monday that banks need to maintain “stable and appropriate” credit growth and adhere to its prudent monetary policy, adding that liquidity in the banking system overall was reasonable. (…)
(…) It’s hard to know exactly what degree of control the PBoC has over the events unfolding in China’s interbank markets.
On the one hand, making the smaller banks and shadow finance entities sweat fits with the central bank’s new high-priority goal, introduced late last year, of containing ‘financial risks’, and also with a broader government theme of clamping down on excess.
On the other hand, Chinese liquidity is also being affected by external forces (shrinking capital inflows) and the shadow financing calendar (WMP end-of-quarter maturities). Michael Pettis says he suspects the PBoC was “caught flat-footed” by this combination of events, and it certainly isn’t hard to imagine. He also points out that this is a central bank which has almost no experience of any market conditions other than credit creation and expansion.
First a chart from Fitch’s China shadow banking guru, Charlene Chu:
That shows the issuance of Wealth Management Products by Chinese banks slowing down in 2013, driven says Chu by a tightening in regulation and a strong pick-up in credit growth that has propelled a rebound in deposits. But she also estimates that more than Y1.5tn in WMPs – substitutes for time deposits – will mature in the last 10 days of June.
All of which provides a pretty sturdy clue as to why this squeeze by the PBoC might be happening now.
As Chu says, “issuance of new products, and borrowing from the interbank market, are among the most common sources of repayment for maturing WMPs, and the recent interbank liquidity shortage complicates both. China’s mid-tier banks, also known as joint-stock, are likely to face the most difficulty, with an average of 20%-30% of total deposits in WMPs. This compares with 10%-20% for state-owned and city/rural banks.” (…)
Increasing economic and financial stresses are testing Beijing’s resolve to ride out a slowdown without resorting to its usual interventions.
(…) With funding pressures threatening to spread to other parts of the economy, the costs of the central bank’s decision to stand pat are becoming increasingly evident.
“Because of the PBOC’s refusal to inject liquidity, interbank funding costs will likely continue to rise in the short run,” said Li Zhiqiang, chief economist at China Minsheng Banking Corp. (…)
Those surging rates are also causing problems for companies, with one senior executive at a copper cable maker saying his borrowing costs set by the banks had risen to as high as 8%, from about 4% normally, adding that “if it keeps going up, we’ll be in big trouble.”
Excerpts from a good Barron’s piece: Where Will It End? China’s credit growth to back lavish construction and infrastructure projects is similar to that of the U.S. and Japan before they faced financial calamities.
(…) THE PRIMARY FAULT LINE in the Chinese economy that worries many has been the explosion in the credit-to-GDP ratio since the onset of the 2008 global financial crisis and economic slowdown, as China sought to stimulate its economy in the face of a lag in its longtime growth engine, exports. This total societal debt load has followed a similar growth trajectory to that of the U.S. and British economies in the six years leading up to the 2008 crisis; Japan’s credit orgy from 1985 to 1990, a prelude to two decades of stagnant growth punctuated by bouts of deflation, or Korea prior to the Asian financial crisis (see charts below).
According to a report from analysts at Fitch, China’s recent credit bubble has topped them all with total debt (a broad measure which includes business, household and local government debt but not central government debt) rising from 130% of GDP in 2007 to 210% in the first quarter of this year. In Japan, by comparison, during the fateful six-year credit bubble, the jump in the ratio was just 45 percentage points, from about 150% to just over 195%. (…)
The Chinese credit explosion, however, has sluiced funds into sectors that hold much peril. For example, money has been lavished on giant state-owned enterprises that dominate such key basic industries as steel, cement, electrolytic aluminum, plate glass, coking coal, solar panels, and wind-turbine production. This has created severe overcapacity in these industries that, ominously, has sent China’s producer price index into negative territory in the last 12 months, slipping another 2.9% in May, and sharply curtailed corporate profitability.
There has also been a huge surge in infrastructure spending since 2008, primarily on the part of local-government financial vehicles, which are special investment platforms. Many of the projects — roads, bridges, international ports, and airports — don’t seem to have a good economic rationale.
(…) many recent, debt-financed projects won’t generate cash flow for years, if ever. They were merely big, splashy projects that temporarily boosted employment and economic growth during their construction phase before sinking into a moribund state. The New South China Mall, twice the size of the U.S.’s Mall of America in Minnesota, has been 99% vacant since its 2005 opening.
In fact, a recent working paper by the International Monetary Fund concluded after a cross-country survey that excessive investment on infrastructure and industrial projects, amounting to about 10% of GDP, or about CNY5 trillion, would have “little impact on future growth” or long-term “favorable spillover into household income or consumer spending.”
BUT NO CHINA CREDIT STORY would be complete without mention of the real-estate construction boom that has pumped up perhaps the biggest bubble of all. For example, nine times the commercial space sold last year is under construction now. Residential construction has been in a white heat for some time and has attracted much notice in the financial press and elsewhere. Stories about the “ghost city” of Ordos in Inner Mongolia have become a staple, showing the eerie empty streets and deserted modern, high-rise apartment buildings, stores, and public buildings of a megapolis expected to attract more than one million people. It has been empty for the six years since its construction.
Stories abound about similar projects in other cities either still under construction or sitting vacant. (…)
A credit crisis would likely begin somewhere in the shadow banking system with a large credit default or the bankruptcy of a major player, observes Charlene Chu, Fitch’s senior banking analyst in Beijing. “In China, trouble starts on the fringes of the system and then moves into the core,” she says. (…)
How much debt will go bad is anybody’s guess, but the total is much higher than the 1% that Beijing officially reports in the Chinese banking system. Some estimate the eventual total, including sources outside the banks, could be as high as 20% of 2012 year-end total debt of about CNY100 trillion. Losses of just CNY6-7 trillion would wipe out the capital of the state banking system. (…)
More on that from the WSJ today:
Companies listed on China’s stock exchanges received 85.68 billion yuan ($13.83 billion) in government subsidies last year, up 23% from a year earlier, while corporate profits rose less than 1%, according to a Chinese data provider. The subsidies were equivalent to more than 4% of the companies’ total profits last year, up from around 3% between 2009 and 2011.
The subsidies—largely from local authorities but also from the national government—took the form of cheap land, tax rebates, support for loan repayments and straight-up cash. There were a range of reasons, including research and development and support for government environment priorities.
(…) But the overall health of China’s corporate sector—and, in particular, the country’s industrial realm—increasingly has relied on subsidies as many industries struggle with overcapacity and weak demand for exports. That is adding to the financial pressures on local governments that provide much of the cash—many of which already carry heavy debt from funding development projects—and to tension with foreign trading partners. (…)
About 90% of the 2,400 companies listed in mainland China received government support last year, according to Hithink’s analysis of earnings reports. More than half the companies listed in China are state-owned. (…)
Copper prices started the week on the same trajectory they’ve been on since the start of the month, slipping to their lowest levels of the year, tracking other industrial metals as well as share markets, which have been rattled by China’s cash crunch.
Three-month copper changed hands as low as $6,640.50 a metric ton Monday, down 2.6% since Friday and 9.1% so far this month.
China demand, accounting for around 40% of global copper consumption, provides essential support for futures on the London Metal Exchange, and signs of a sluggish manufacturing sector in the world’s biggest buyer have contributed to a more than 16% price drop in the benchmark three-month contract since the start of 2013.
BEN IS NOT THE ONLY ONE WITH POOR TIMING:
BIS tells members to get back to inflation focus
The BIS, which counts the world’s leading monetary authorities as members, said cheap and plentiful central bank money had merely bought time, warning that more bond buying would retard the global economy’s return to health. It used its influential annual report to call on members to re-emphasise their focus on inflation and press governments to do more to spearhead a return to growth. (…)
“Alas, central banks cannot do more without compounding the risks they have already created,” the BIS said, adding that delivering more “extraordinary” stimulus was “becoming increasingly perilous”.
“How can central banks encourage those responsible for structural adjustment to implement those reforms? How can they avoid making the economy too dependent on monetary stimulus? When is the right time for them to pull back … [and] how can they avoid sparking a sharp rise in bond yields? It is time for monetary policy to begin answering these questions,” the report said.
Mario Draghi’s rallying cry, uttered last summer at the height of the eurozone turmoil, that the European Central Bank would do “whatever it takes” to preserve the currency bloc was now being misconstrued, it warned.
“Can central banks now really do ‘whatever it takes’?” the BIS asked. “It seems less and less likely. Central banks cannot repair the balance sheets of households and financial institutions.”
Japan’s public debt would swell to 600 percent of gross domestic product by 2050 on a 2 percentage-point increase in funding costs, should its age-related government spending continue unchecked, the Basel-based BIS said in its 83rd annual report. In the U.S., the debt-to-GDP ratio would almost double to 200 percent under the same circumstances, it said.
“Governments in several major economies currently benefit from historically low funding costs,” the BIS said. “At the same time, rising debt levels have increased their exposure to higher interest rates. The consolidation needs of countries experiencing low interest rates would be greater if their growth-adjusted interest rates were to rise.” (…)
Government liabilities related to health care and pensions as a proportion of GDP will rise by 9 percentage points in the U.S. between 2013 and 2040, the biggest increase among developed economies, it estimated. (…)
U.S. debt as a percentage of GDP will be 108.1 percent this year and 109.2 percent next year, the according to an International Monetary Fund forecast in April. Debt will reach 245.4 percent of GDP in Japan and 93.6 percent in the U.K. in 2013, it said.
Of the three, the U.K. would be least affected by an increase in borrowing costs because the average maturity of its debt, at around 14 years, is the longest, the BIS said. U.S. bonds mature in 64.5 months on average, according to data compiled by Bloomberg.
OTHER BRICS HAVE PROBLEMS OF THEIR OWN
Over the last decade, Brazil capitalized on a global commodity boom to lift millions out of poverty and create a new middle class. Politicians from all political stripes now find themselves under siege from the very same group.
(…) Some say much of the explanation for why hundreds of thousands of Brazilians are on the streets right now can be found in (..) a school of thought in development economics about why seemingly better-off middle class populations have taken to the streets across the emerging world from Turkey to Chile.
The idea is that populations begin to demand more of their leaders as their own economic conditions improve. Citizens who are better off have the luxury to focus on social grievances that seem less pressing to impoverished people whose biggest concern are earning enough to feed themselves. (…)
Much of the ire is directed at a political system that critics say affords broad impunity to engage in corruption while mostly ignoring the demands of ordinary Brazilians. (…)
The FT adds:
(…) So fast and unexpected has been the emergence of the biggest street protest movement in Brazil since the impeachment of President Fernando Collor in 1992, and so diffuse are its demands, that it has caught the nation’s politicians flat-footed. (…)
On Monday, hundreds of thousands of people appeared on the streets of São Paulo, Rio de Janeiro and other cities to protest. They were not only students but also architects, businessmen, trade unionists, workers and families. The protests continued through the week. On Thursday night, an estimated 1m people staged mostly peaceful protests across the country, from the capital cities to interior towns. (…)
As Ms Rousseff said on Tuesday, Brazil – from its students to its workers to its football stars – has “awakened”. So too now must its politicians.
No doubt that China’s leaders are watching with interest.
“A sustained depreciation of the Australian dollar in those circumstances would be a very good thing, to stimulate further growth in the non-mining sector — while the firms that have adjusted to the historically high dollar stand to benefit from its fall,” Gillard said in a speech in Canberra today.
SOME THINGS WILL JUST NEVER CHANGE
Euro-area bonds slumped, led by Spain and Italy, after negotiations among the 27-member bloc’s finance ministers stalled over the weekend in Luxembourg. They failed to agree on assigning losses at failing banks as part of proposed rules on bank resolution and recovery. (…)
The banking-union talks collapsed early Saturday after 19 hours of negotiations on the question of which creditors face writedowns when banks fail, compounded by differences between euro-area countries and EU states outside the euro.
“There are still core issues outstanding,” Irish Finance Minister Michael Noonan told reporters as he left the meeting. “We have another meeting next week, and there’s no guarantee it’ll reach a conclusion.”