tag:blogger.com,1999:blog-67456234590548604972024-02-08T01:07:06.586-05:00Sober LookUnknownnoreply@blogger.comBlogger2534125tag:blogger.com,1999:blog-6745623459054860497.post-69055370290655804352020-12-23T16:54:00.002-05:002020-12-23T16:54:14.936-05:00Join us at The Daily Shot<blockquote> </blockquote><span style="font-size: medium;">Please join us at <b><a href="https://thedailyshot.com/">The Daily Shot</a>.</b></span><div><br /></div><div><div>The Daily Shot® (TheDailyShot.com) is a niche graphical newsletter (<a href="https://thedailyshot.com/the-daily-shot-sample-newsletter/" target="_blank">see sample</a>) that is not meant for broad distribution. Our objective is to work with a small group of professionals who are interested in a brief unbiased daily overview of global macro currents. We do not offer investment advice or trading recommendations, and nothing in The Daily Shot® should be interpreted as such.</div><div><br /></div><div>The Daily Shot® began as an internal daily memo at a multi-strategy hedge fund. The goal was to provide traders and analysts with a quick visual overview of key global macro trends. This daily memo was later made available to the fund’s clients, most of whom were institutional investors.</div><div><br /></div><div>In 2014 we started distributing the Daily Shot® to a broader group of financial services professionals in areas such as wealth management, trading, risk/portfolio management, research, and regulation. In August of 2016, we joined forces with Dow Jones to offer The Daily Shot® to subscribers of the Wall Street Journal.</div><div><br /></div><div>In 2020 The Daily Shot® became an independent, ad-free publication supported entirely by membership fees. Our subscribers include top hedge fund managers, institutional investors, wealth advisors, economists, and central bankers.</div><div><br /></div><div>The Daily Shot® is edited by <a href="https://www.linkedin.com/in/levborodovsky/">Lev Borodovsky, Ph.D</a>., who has an extensive background in financial risk management, covering a broad array of markets and asset classes.</div>
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</div><div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-28456816744231771822016-09-17T17:50:00.001-04:002016-09-18T12:05:45.240-04:00Why Won't the Fed Raise Rates?<blockquote>
Guest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_146446973266811&key=8a69ede45b8445f6b533712ba9899ffb&libId=iornfyqs0100r7tw000DA2r2a7rqw&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&title=Sober%20Look&txt=Norman%20Mogil&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646" target="_blank"><span style="font-family: "arial" , "sans-serif";"><span style="color: blue; font-size: small;">Norman Mogil</span></span></a>
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<span style="font-family: "arial" , "sans-serif";">When the Federal Reserve's Open Market Committee (FOMC) meets in the coming week, there will be pressure from various quarters to raise the federal funds rate. Jamie Dimon, chairman of JP Morgan, has stated blankly “Let’s just raise rates." <span style="mso-spacerun: yes;"> </span>Furthermore, he has said a quarter point is just a “drop in the bucket." </span><span style="font-family: "arial" , "sans-serif";"><span style="font-family: "arial" , "sans-serif";">We know where the big money banks stand on the issue. They need higher rates to achieve better profit margins. But even from other financial quarters, there are calls for the Fed to stop speaking and start acting. Many point to that fact that the labour markets have recovered very well from the 2008 crash and that the economy is hovering around full employment. Although the Fed's inflation target has not yet been reached, there are many who warn that the real risk now lies in getting behind the curve. Once the inflation genie is out of the bottle, they argue, it will be too hard or, at least painful, to put back.</span><br />
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<span style="font-family: "arial" , "sans-serif";"> So, why is that the Fed so reticent to start a real move towards ‘normalizing’ credit conditions? </span><br />
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<i style="mso-bidi-font-style: normal;"><span style="font-family: "arial" , "sans-serif";">The Level of Interest Rates</span></i><br />
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<span style="font-family: "arial" , "sans-serif";">In a speech last week, Fed Governor Lael Brainard offered an insight into this question <span style="color: #3d85c6; font-size: xx-small;">(1).</span> The clue to her thinking lies in the analysis of the "<i style="mso-bidi-font-style: normal;">neutral rate of interest."</i> This rate is defined as the '' level that is consistent with output growing close to its potential and with full employment and stable inflation". In other words, it is an ideal condition when the economy is using all its resources to the fullest and inflation remains constant. If the fed funds rate is below the neutral rate, then monetary policy is promoting expansion; a fed funds rate above the neutral rate implies a tightening of monetary conditions. </span></span><br />
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<span style="font-family: "arial" , "sans-serif";">But here is the rub. The “neutral rate” cannot be observed. We have to back out the number by observing the behaviour of the major components of the economy; we need to look at output and employment as it is and then judge whether what we observe are, in fact, the conditions that give rise to the neutral rate. It is a judgment call, and with all such calls, one can be second-guessed.</span><br />
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<span style="font-family: "arial" , "sans-serif";">Governor Brainard argues, on two related grounds, for waiting longer before raising the federal funds rate: 1) that the <i style="mso-bidi-font-style: normal;">current</i> fed funds rate is consistent with the <i style="mso-bidi-font-style: normal;">current</i> neutral rate, and 2) the neutral rate today is <i style="mso-bidi-font-style: normal;">much lower</i> than the rate in previous decades. In other words, this time, it is different.( see accompanying chart).</span><br />
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<span style="font-family: "arial" , "sans-serif";">It is this second point that bears scrutiny. There has been a downward shift in the neutral rate. Hence, we are in what is now referred to as the “ new normal”.<span style="mso-spacerun: yes;"> </span></span><span style="font-family: "arial" , "sans-serif";">There is a lot to be said in support of this view. During the Great Recession, starting in 2008, nominal interest rates have been zero in the US (and negative in the EU and Japan). All the while, growth has been subdued (less than 2 per cent) and inflation very stable (about 1.5 per cent). Put differently; the US economy continues to expand modestly with the nominal rate at zero </span></span>and<span style="font-family: "arial" , sans-serif;"> the real rate negative. </span>This has<span style="font-family: "arial" , sans-serif;"> not happened anytime in the post-war era. </span><br />
<span style="font-family: "arial" , "sans-serif";"> <span style="font-family: "times new roman";"> </span><br />
<i style="mso-bidi-font-style: normal;"><span style="font-family: "arial" , "sans-serif";">The Pace of Future Rate Increases.</span></i><span style="font-family: "arial" , "sans-serif";"></span><br />
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<span style="font-family: "arial" , "sans-serif";"><span style="font-family: "arial" , "sans-serif";">Turning to the future, Brainard points out that the Blue Chip consensus anticipates that the longer-run federal funds rate will be 1.1 per cent over the next decade. This is about 1 per cent lower than the pre-crisis average. It now appears that the FOMC has adopted a similar outlook. In January 2012, the Fed projected a long run average federal funds rate of 2.25 per cent. Now, its most recent projection is for a rate of 1.5 per cent -- a significant 75 basis points (bps) downward revision. The Fed is recognizing that the “new normal“ features a much lower funds rate, a much lower neutral rate and hence there is no urgency to raise rates. </span></span><br />
<span style="font-family: "arial" , "sans-serif";"><span style="font-family: "arial" , "sans-serif";"></span></span><br />
<span style="font-family: "arial" , "sans-serif";"><span style="font-family: "arial" , "sans-serif";">Given this outlook, what can be inferred about the pace of future rate increases? After all, if the new normal features a lower neutral rate and accompanying slower growth and subdued inflation, then what will be the path for future rate changes in pursuit of ‘normalization’? </span></span></div>
<span style="font-family: "arial" , "sans-serif";"><span style="font-family: "arial" , "sans-serif";">Brainard lays out a case for a very slow pace, arguing that,</span></span><br />
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<span style="font-family: "arial" , "sans-serif";"><i style="mso-bidi-font-style: normal;"><span style="color: black; font-family: "arial" , "sans-serif";">But seven years into the expansion and with little sign of a significant acceleration in activity, the low neutral rate looks likely to persist. Indeed, developments over the past year confirm that the underlying causes will be with us for some time.<a href="https://www.blogger.com/null" name="f12"> </a>Foreign consumption and investment are weak, while foreign demand for savings is high, along with an elevated demand for safe assets. Productivity growth, which increased at an average annual rate of nearly 2-1/2 percent from 1950 to 2000, has increased only 1/2 percent on average over the past five years, and demographics also suggest a persistent slowing of the labor force.</span></i></span></div>
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<span style="font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "arial" , "sans-serif";">This is a long list of what ails economies everywhere. Simply put, all the weak conditions that are present today are expected to continue in the future. If the current conditions justify near zero-bound interest rates, then we can expect near zero-bound rates for a considerable time. At best, those who want the Fed to move faster will have to be content with ‘baby steps’.</span><span style="font-family: "arial" , "sans-serif";"></span></span></div>
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<span style="font-family: "arial" , "sans-serif";"> <span style="font-family: "times new roman";"> </span><span style="font-size: x-small;"><sup>(1)</sup></span> <a href="https://www.thechicagocouncil.org/event/economic-outlook-and-monetary-policy-implications">https://www.thechicagocouncil.org/event/economic-outlook-and-monetary-policy-implications</a><br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-29129663656796831162016-08-29T13:04:00.000-04:002016-08-29T13:04:00.861-04:00The ECB’s corporate bond purchase programme takes shape<blockquote>
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Guest post by Marcello Minenna<br />
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With the awaited decision of August 4, even the Bank of England has put aside any delay and has steered towards an aggressive expansionary monetary policy to contrast the recessionary pressures due to the Brexit shock on market expectations. Apart from the expected interest rate cut of 25 basis points, different unconventional measures stand out: a 6-months resumption of the government bonds (Gilts) buying programme for a monthly amount of $ 60 billion, to be combined in synergy with the purchase of £ 10 billion of corporate bonds in 18 months.<br />
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The intervention in the corporate debt markets remains one of the most incisive tools in the hands of the central banks in order to induce a reduction in the funding costs of the non-financial sector and bypass the credit crunch due to a distressed banking system. At the state of the art, corporate bonds purchase programs are active in Japan, UK and in the Eurozone. On many occasions the Bank of japan has accelerated the pace of the purchases, even if now it appears it has reached its limits of intervention: the size of the market is not ample enough to support further expansions of the program, while the big Japanese industrial corporations are able to finance themselves at near zero interest rates (recently Toyota succeeded in placing a 3-years bond by offering a yield of 0.001%).<br />
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In Europe the program is instead in its infancy; at the present state, the room to maneuver is ample. The ECB has started the purchase operations of corporate bonds in June 2016 and only now the first stream of official data has begun to be released; few numbers that however are enough to verify if the first estimates made when the program was launched in March 2016, were at least realistic. According to the numbers published by the ECB, the 93% of the overall € 13.2 billion of purchases has been made on the secondary market, while only the 7% (that corresponds to € 1.16 billion) during the placement of new issues. This is not a negligible amount if we consider the traditional reluctance of the ECB to intervene in primary markets (the Quantitative Easing on government bonds is focused exclusively on the secondary market). From our point of view, this behavior signals a relative scarcity of eligible securities on the secondary market to sustain the planned pace of the ECB purchases.<br />
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On the basis of the experience of the Quantitative Easing, we estimated an overall pool of corporate eligible assets of € 550 billion and a monthly purchase ranging from a minimum of € 3 billion to a maximum of € 6 billion, without however taking in account the possible response of the market. In fact, in the hopes of the ECB, the non-financial sector should have increased the issues of debt to take advantage of the launch of the program. In this perspective, the historical records were not so favorable, since they showed a downward trend of the market issues (both gross and net of reimbursements), with a decline that was accelerating in the last months of 2015. In August 2016, we have to acknowledge that the real data of monthly purchases (€ 6.6 billion) lie outside the estimated range, but only for a small amount. Therefore it’s interesting to check if an “announcement effect” of the CBPP program has effectively pushed the non-financial sector to issue more debt. To this purpose, let’s observe carefully the following bar charts that represent the historical trend of gross and net issues of Euro-denominated bonds of Euro-Area non-financial corporations.<br />
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Figure 1.</div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhubji_nrtSShkpgqdX0pU8V0nvci_tA4afa3-v_ETNMYBW5uidozDwvxCbiY7PjJYKImeeRxecF4LAMarVE1O-5USEjqpPDg4THX0QO05S8XT_bmDo3OtnLOMkOncSog1jQ7YWiRhWC_o/s1600/1.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="504" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhubji_nrtSShkpgqdX0pU8V0nvci_tA4afa3-v_ETNMYBW5uidozDwvxCbiY7PjJYKImeeRxecF4LAMarVE1O-5USEjqpPDg4THX0QO05S8XT_bmDo3OtnLOMkOncSog1jQ7YWiRhWC_o/s640/1.png" width="565" /></a></div>
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Figure 2.</div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBPwLlbtoBf939vl2G21QTMNV7q8fus3h0P6pMFQoT2bA7XMGaZMNK7Mr1rXg8e5sIwdVSrAnEevm-Y59skRd3qEm2FDj3-FGT3pDhwcCe2F3_WMTW9ymvyjC0OlREEJ3KaZ4jL45VAXk/s1600/2.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="504" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiBPwLlbtoBf939vl2G21QTMNV7q8fus3h0P6pMFQoT2bA7XMGaZMNK7Mr1rXg8e5sIwdVSrAnEevm-Y59skRd3qEm2FDj3-FGT3pDhwcCe2F3_WMTW9ymvyjC0OlREEJ3KaZ4jL45VAXk/s640/2.png" width="565" /></a></div>
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One can easily notice that starting with the month of March 2016, the big European corporations have increased considerably the issues (from € 30 billion to € 70 billion for what regards the monthly gross issues, from 0 to 20 in net terms). Hence, the good response of the market in the last four months and the consequently augmented availability of eligible assets could reasonably explain the dynamics above expectations of the ECB purchases.<br />
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The ECB is clearly aiming at having a positive, durable impact on the financing costs of the non-financial sector, to be achieved through a compression of bonds yields. In fact, the presence of the ECB as a buyer of last resort should provide to the corporations a stable, implied guarantee of a successful placement, a necessary condition to obtain lower yields. Even in this case, we have been able to retrieve useful empirical data to clarify the impact of the “announcement-effect” first and then of the purchases on the yields' dynamics (see Figure 3).<br />
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Figure 3.</div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh21PtQdrGlgU0fLishIhiUOBJpetl0MTliWhxVsWFYlHjf3YKs2EtOjhREluScDWIrnXsRf2rC1l1pDoLv4H1ev-L8Adjr_wBh8RkZ-ueSSwlB3GFwUswP0_hMPKbRuKzKRCs64EspMak/s1600/3.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="530" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh21PtQdrGlgU0fLishIhiUOBJpetl0MTliWhxVsWFYlHjf3YKs2EtOjhREluScDWIrnXsRf2rC1l1pDoLv4H1ev-L8Adjr_wBh8RkZ-ueSSwlB3GFwUswP0_hMPKbRuKzKRCs64EspMak/s640/3.png" width="565" /></a></div>
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In Figure 3, the historical trend of the Bank of America Nonfinancial Index from January to August 2016 is analyzed. The index is representative of the average yields non-financial Euro denominated investment grade corporate debt publicly issued in the Euro member domestic market. The observed pattern of the index shows a marked decline after the launch of the program by President Draghi in March 2016, a subsequent stasis and a relapse in the downward trend in conjunction with the start of the ECB purchases on the primary and secondary markets.<br />
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Overall it could be observed a reduction in the BofA index (that as said before should roughly correspond to a weighted average of yields of Euro-denominated corporate bonds) up to 90 basis points from the relative maximum registered at the beginning of 2016.<br />
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In summary, the first empirical evidence seems to confirm the potentiality of the ECB corporate bonds purchase programme in contrast to the credit crunch, at least in average at a European level. The data seem to highlight a significant responsivity of the new debt issues and of the average yields to the ECB monetary stimulus, which intensity appears to exceed the prudential expectations of the market. However, in the future months, it should be observed if the central bank will be able to continue the purchases at this sustained pace without impacting the market liquidity that remains very thin. Moreover, it’s not granted that lower funding cost for the non-financial sector will stimulate new investments.<br />
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On the issue, numerous doubts are still in place: in Japan, the big corporations have used the new liquidity trickling from the monetary authorities to the banking and corporate sector to benefit the existing shareholders, both directly by boosting the dividends and indirectly via buybacks. The buybacks have exploded from ¥ 1000 billion in 2012 to over ¥ 4000 billion in 2015, but visible effects have been appreciated only on the stock markets, where the ETF and corporate bonds purchases have been determinant in sustaining the Nikkei index to high levels. The dynamics of corporate investment have been largely unaffected by the BoJ unconventional measures. Paradoxically, the market rewarded these strategies since a reduction of the floating stocks increases by definition the earning per share. Time will tell. Surely, the small businesses, cut off by Draghi’s CBPP, will continue to endure a persistent credit crunch due to the difficulties of the Eurozone banking system, especially in peripheral countries. This is not exactly encouraging from the perspective of growth in countries where the small-medium enterprises are the core of the manufacturing sector, like Italy.<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-31308519295450330292016-08-29T07:50:00.000-04:002016-08-29T07:50:34.674-04:00What is Behind the Surge in the Corporate DebtGuest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_146446973266811&key=8a69ede45b8445f6b533712ba9899ffb&libId=iornfyqs0100r7tw000DA2r2a7rqw&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&title=Sober%20Look&txt=Norman%20Mogil&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646" target="_blank">Norman Mogil</a><br />
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Just as governments are cutting back on issuing new debt, the corporate sector has taken up the role of being the largest source of new debt in the United States. This shift in debt issuance is readily apparent in Chart 1. Since the crisis of 2008, the growth in government debt has dramatically decreased from nearly 20 per cent annually to less than 5 per cent, more in line with the nominal growth in the economy. Consumers continue to remain wary of increasing their debt load . On the other hand, the corporate bond market has been on a bit of a tear in recent years .That segment of the debt market now outpaces all other debt issuers. The U.S. corporate bond market is valued at nearly US $9 trillion; by comparison, it is larger than the GDP of Germany, France and the U.K. combined. No longer are governments the leaders in generating new debt, it has ceded that title to corporate America.<br />
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<b>Chart 1: Growth Rates in Debt of U.S. Non-financial Sector 2010-2015 </b></div>
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As investors search for yield, corporate bonds are viewed as the darlings of the debt market, principally due to higher yields offered. As the demand for corporates grows, the spread in yields between corporates and U.S. Treasuries has narrowed, a further sign of the strength of the corporate bond market, thus encouraging more companies to issue debt. The rise in corporate debt is supplied mainly by investment-grade corporations i.e. from corporations with excellent credit ratings. High yielding debt (so-called junk bonds) is not as responsible for the burst in corporate debt as is often portrayed in the media . Well-heeled corporations have turned to corporate debt, rather than issuing additional equity, to meet their business needs.What lies behind the surge in new corporate debt?<br />
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<b>Chart 2: U.S. Corporate Bonds--Annual Issuance and O/S Amounts ($mill)</b></div>
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<em>Profits are inadequate to fund capital expenditures</em>. Notwithstanding the fact that the stock market is reaching historic highs, corporate profits have steadily declined. The S&P 500 companies have experienced six straight quarters of declining profits. Table 1 connects profit growth with capital expenditures. To begin with, capital expenditures are, initially, funded from internal resources------- profits less dividends, less income taxes, plus accumulated capital cost allowances. From 2010 to 2013, U.S. non-financial corporations were able to fund business capital expenditures from internal resources. Since 2013 the sector has turned to the debt market to make up the shortfall, currently at approximately $200 billion. In and of itself, there is nothing inherently wrong with this approach, since it is vital to a company's long-term viability to increase and improve its capital investment. Raising debt to fund business investment, rather than raising equity, is an acceptable strategy to take, especially in this low interest rate environment.<br />
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<b>Table 1: US Non-financial Corporate Business, ( $ billions)</b></div>
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<em>Pressure to Increase Dividends</em>. Shareholders are pressuring corporations to increase dividends in the wake of falling yields on bonds. Now, investors are piling into dividend stocks to meet their long-term goals. Today, approximately 60 per cent of S&P companies generate a dividend yield--- the annual payout as a share of the market price---- that exceeds the yield on a 10 year Treasury bond. Historically, the relationship was just the opposite as investors looked to stocks to provide capital gains, not dividends, and to bonds to provide yields above the dividend rate.<br />
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<em>Rising Operating Costs</em>. Debt issuance has soared while cash from operations has weakened, suggesting that many firms have turned to the debt market to help cover operating expenses. Chart 3 measures the rise in corporate debt against cash flow for the S&P 500 companies. The steeply sloped ratio of debt-to-free cash flow strongly suggests that corporate debt is being used to support daily operations.<br />
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<b>Chart 3: Comparison of Debt Relative to Cash Flow</b> </div>
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<em>Corporate Stock Buybacks are all the Rage</em>. U.S. corporations have conducted many experiments involving financial engineering. In response to the pressures to increase shareholder value, hundreds of U.S. corporations conduct continuous programs to buy their own shares in the open market. In some cases it is done to offset stock dilution created by employee stock options; in other cases firms consider buybacks as the highest and best use of corporate cash; and, in other instances, the maintenance of high stock prices leads to granting greater bonuses to top management. Whatever the reasons, the rise in corporate buybacks is quite dramatic (Chart 4). The extent of these programs can be measured in terms of both the total amounts--- $1.6 trillion ---and the breadth of companies conducting such programs---nearly 400-- so far in 2016. Both measures rival that experienced prior to 2008 and every indication is that this trend will continue.<br />
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<b>Chart 4: U.S. Corporate Repurchasing Shares, 2005-2016 (Q1)</b></div>
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No matter how low interest rates get, it is hard to justify the raising of corporate debt to purchase outstanding stock. Longer term debt should be used for longer term needs, e.g. capital expenditures. But from a macroeconomic view, raising stock price does not figure in promoting economic growth or general well-being--- it is simply financial engineering serving the interest of only shareholders and management. No new jobs are created and no new capital investment is undertaken in a world of corporate buybacks. Investors are simply bribed with their own money.<br />
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<b>Chart 5: Use of Corporate Cash</b></div>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJ1mLSb95VD3iyK8Z8cmrjRkYSvazb_Q0bgWR18pKChiwhI5Cq17DKQxXH2qRAbljiUVwt7UnlrHnKx3cvvxeODZyeVOx1ksYYgKNHbdYVycV3DxD-KksSm_p8KbcKkhBHp6CmMwAdXUs/s1600/5.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgJ1mLSb95VD3iyK8Z8cmrjRkYSvazb_Q0bgWR18pKChiwhI5Cq17DKQxXH2qRAbljiUVwt7UnlrHnKx3cvvxeODZyeVOx1ksYYgKNHbdYVycV3DxD-KksSm_p8KbcKkhBHp6CmMwAdXUs/s1600/5.png" /></a></div>
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The Carlyle Group summarizes the use of corporate cash in Chart 5. Since 2009, share buybacks have increased at enormous rate of 194% ; dividends have grown by 67%; and, business investment expanded a modest 43%. Rewarding shareholders with higher dividends and propping up share prices at the expense of investment in new plant, equipment and technology is a serious misallocation of resources at a time when the economy is experiencing slow growth and very poor productivity performance. It also represents serious short-sightedness on the part of management who feel so beholden to shareholders that they risk the longer term health of their companies.<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-8013931643999981662016-07-25T07:37:00.005-04:002016-07-30T18:47:27.151-04:00The Big Disconnect in the Pension IndustryGuest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_146446973266811&key=8a69ede45b8445f6b533712ba9899ffb&libId=iornfyqs0100r7tw000DA2r2a7rqw&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&title=Sober%20Look&txt=Norman%20Mogil&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646">Norman Mogil</a><br />
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When two of the biggest US pension funds reported very disappointing financial results this month, it became apparent that the pension industry needs a reality check. For the past fiscal year the California Public Employees’ Retirement System earned a merger return of 0.6 percent on its investments; the California State Teachers' Retirement<span class="vm-hook-outer vm-hook-default"><span class="vm-hook-icon" style="display: inline-block;"></span></span> System did only marginal better, clocking an investment return of 1.4 percent. Both funds had a target rate of return 7.5 percent . To be fair, one year`s result does not make a trend, but the results were so far below target as to warrant an examination of the new world confronting pension fund managers.</blockquote>
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<em>Underfunding of Public and Private Funds </em></blockquote>
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We begin by taking the measure of how far public pension funds (Chart 1) and corporate pension funds (Chart 2) are underfunded. Underfunding is a moving target over time and is reflective of several moving parts, such as : shifts in demographics (an aging population); estimates of longevity of retirees; economic performance (slow growth means lower contributions); and rates of return on various asset classes. In the US, both public and private pensions have experienced a steady erosion in funding status over the past decade and a half. The large public pension plans and large corporations only support 75-80 percent of liabilities today. The underfunding exists despite a very good rate of growth in total assets under management; however, liabilities have increased faster and one reason for this can be traced to the dramatic fall in long term interest, especially, post 2008.<br />
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The decline in interest rates affects both sides of the ledger. On the asset side, lower interest rates imply lower overall returns; on the liability side, the book value of pension obligations move up due to the lower discount rate used to calculation the liabilities. In fact, these two changes in value --- assets and liabilities-- do not offset one another, rather they move in the same direction. The net affect is that the underfunding situation is exacerbated, increasing the gap between assets and liabilities. More worrisome is that pension funds will have to replace higher-yielding bonds with lower-yielding bonds over time. This concern is especially acute in the UK ,Germany and other EU countries as bonds yield sink into negative territory , thereby reducing the size of bond market in which pensions can particpate . The tightening of the supply of positive-yielding bonds is becoming a very real problem today, let alone in the coming years. (<a href="http://soberlook.com/2016/07/the-looming-shortage-in-government-bonds.html">http://soberlook.com/2016/07/the-looming-shortage-in-government-bonds.html</a>)</blockquote>
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Overall rates of return earned in the pension industry throughout the developed world have steadily fallen, resulting in a relative weak performance in asset accumulation .A recent OECD study measured the rates of return over 5- year and a 10 -year periods. (Chart 3). Nominally, the US (3 percent) has underperformed its peer group in the UK (9 percent) and Canada (6 percent); all countries have experienced weak results over a 10- year period. These relatively low rates of return are at the heart of the issue facing the industry: namely, are the targets set too high?</blockquote>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhq5dWQepOHdKD5uDEmG_vUk1OmSns7bDPWF2kyhHdrlO3pxk02gqgKG-uQZo9aOVgU91p7fApfpEnkWixP6guKejPkx4Vj8yqaMHZYsz3-XYls2K1uo7xiydHdthbHfihK2Nd92p4B2Ew/s1600/c3.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhq5dWQepOHdKD5uDEmG_vUk1OmSns7bDPWF2kyhHdrlO3pxk02gqgKG-uQZo9aOVgU91p7fApfpEnkWixP6guKejPkx4Vj8yqaMHZYsz3-XYls2K1uo7xiydHdthbHfihK2Nd92p4B2Ew/s1600/c3.png" /></a></div>
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<span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";"><em><span style="font-family: "arial";">What does it take to earn 7.5% ? </span></em></span></span></blockquote>
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<span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";">The vast majority of the US pension industry clings to investment targets of 7-8 percent annually. True, this is an expectation over an average of 5 years as the industry must live in a world of high volatility. Yet, how realistic is this target? Lets look it at from a macroeconomic perspective. A nominal return of 7.5 percent implies that national income --- wages, profits-- should, on average, grow at 7.5 percent. That is, the national income growth should be about 5 percent real growth plus 2.5 percent inflation. Neither that real growth rate or that inflation rate has been achieved on a sustained basis over the past decade. Moreover, mainstream economists do not anticipate that the US economy will achieve real growth rates of 5 percent in the coming years; continued moderate real growth of 2-3 percent is anticipated ; and inflation expectations remain very subdued, as evidenced by the low long term interest rates. So, from a macro perspective, the 7.5 percent target is hard to justify. The industry needs to generate rates of return well in excess of the economy`s capacity to create income growth.</span></span></blockquote>
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<span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";">Considering the target from a microeconomic perspective, the target seems even more illusive. Table 1A presents the findings of the OECD study on the composition of assets in the majority of large pension funds. The funds continue to rely on the "traditional" assets of government and high quality corporate bonds (50-55 percent) and publicly traded equities (20-25 percent) of all pension fund assets. In recent years, the funds sought to enhance yields--- the so-called 'search for yield'-- by investing in commodities, private equity funds, hedge funds. commercial real estate and large infrastructure projects. These " alternative " assets account for about 12-15 percent of total assets under management. However, these alternative investments can and have been very volatile, e.g. commodities, and some of the large funds have dropped that category from their investment basket.</span></span></blockquote>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNnH8RqfaGlJ59qTrth9yuZcILs0METxBaTwAvaj8kBITmKjhx5m4gnz8UN2XCWegqjNtTgkOD-63YTY4WWEZlmwpM2UVT6vkwTWXFNIHOZlEAylufdy0Q8t1fXuXwLFD5_9SXn441ARU/s1600/T1a.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjNnH8RqfaGlJ59qTrth9yuZcILs0METxBaTwAvaj8kBITmKjhx5m4gnz8UN2XCWegqjNtTgkOD-63YTY4WWEZlmwpM2UVT6vkwTWXFNIHOZlEAylufdy0Q8t1fXuXwLFD5_9SXn441ARU/s1600/T1a.png" /></a></div>
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<span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";">Table 1B considers what the growth rates of the various asset classes needs to be in order to generate an overall growth rate of 7.5 percent. Clearly, all asset classes must grow at quite high rates in order to reach the overall target. Equities need to average a growth rate of 15 percent annually, bonds need to return 4 percent a year, and more importantly alternative asset classes have to clock in at rates of 12 percent a year to help achieve the overall investment target.</span></span></blockquote>
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEis38p1r4BHqyov44bb-x5kDylV2V7c4jnwucs5mvYoFS5NZT9Pzx001kJ0HE_DQ9F0PWiHX9OH0VLxmJ0oeugNZu5gYBBGXRzPuXaJbBssMOFksscX2Up9_bqDspwjiCvfcY6IjVNB6z0/s1600/T1B.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEis38p1r4BHqyov44bb-x5kDylV2V7c4jnwucs5mvYoFS5NZT9Pzx001kJ0HE_DQ9F0PWiHX9OH0VLxmJ0oeugNZu5gYBBGXRzPuXaJbBssMOFksscX2Up9_bqDspwjiCvfcY6IjVNB6z0/s1600/T1B.png" /></a></div>
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<span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";">The most important asset class--- US Treasuries-- has suffered the most as illustrated in Chart 4. As yields in Treasury yields continue to fall since 2011, the spread between Treasuries and target returns has widen. This puts additional pressure on fund managers to seek higher yields in the non-traditional asset groups, especially in commodities and hedge fund activities-- both of which are very volatile and risky. All the while, the funds cannot run afoul of the regulatory authorities who have to safeguard current and future retirees` income.</span></span></blockquote>
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<span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";">Pension fund managers are caught between a rock and hard place . Many US state plans are forced to meet the underfunding issue by increasingly relying on tax receipts to top up funds at the expense of other basic state obligations such as public education. With each passing year, the shortfalls increase, yet the state needs for other obligations continue to climb. Thus the short falls come at a considerable cost to the nation.</span></span></blockquote>
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<span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";">Some public funds, such as the Canadian Pension Plan, have invested in long term infrastructure projects at home and abroad as a means of boosting returns. Such opportunities are far and few between. In the US, many pension plans have invested in hedge funds and a variety of financial derivatives as a way to overcome low yields from traditional assets. Nonetheless, this search for yield does not move the needle sufficiently to allow the pension funds to meet their targets. </span></span> </blockquote>
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<span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";">By no means is this situation confined to the US. The British pension industry has been underfunded for sometime, and the situation became a whole lot worse following the Brexit vote. UK interest rates fell significantly since the June vote, applying more pressure on managers to correct underfunding. Finally, the wave of negative interest rates in Germany and other EU countries have made pension managers` lives a lot more difficult in their search for positive- returning assets.</span></span></blockquote>
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<span style="color: #676767; font-family: "arial" , "sans-serif";"><br />
<span style="color: black; font-family: "times new roman";"><em>What does the Future Have in Store</em> <em>for Pension Funds</em></span></span></blockquote>
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<span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";">
The OECD study does not mince words. It states `` </span></span><span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";"><em>to reduce insolvency risks, insurers may need to offer lower guaranteed
returns on new contracts to reduce liabilities and, in extreme cases,
renegotiate current terms. Pension plan sponsors could adjust or terminate
existing plans and offer less attractive terms to new employees. Defined
benefit pension plan sponsors could increase contributions to funds. Regulators
and policy makers will need to remain vigilant to prevent excessive “search for
yield”,</em> (1) </span></span></blockquote>
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<span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";"> </span></span><span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";">Implicit in this report is the recognition that slow global income growth and low interest rates will dominate the international community and historic investment targets are <em>not</em> expected to be repeated. Thus, we can anticipate a number of changes in the industry, including: </span></span><span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";">the demise of the defined benefit program</span></span>; <span style="color: #676767; font-family: "arial" , "sans-serif";"><span style="color: black; font-family: "times new roman";">younger members having to pony up more in pension contributions; taxpayers topping up state plans; a continual re-assessment of longevity risks; and an downward adjustment to overall investment targets. These changes amount to a significant adjustment to the parameters that guide pension funds going forward.</span></span></blockquote>
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(1) OECD, Pension Market in Focus, 2015<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-2828267896500590462016-07-16T10:51:00.000-04:002016-07-16T10:51:37.507-04:00The Looming Shortage in Government BondsGuest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_146446973266811&key=8a69ede45b8445f6b533712ba9899ffb&libId=iornfyqs0100r7tw000DA2r2a7rqw&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&title=Sober%20Look&txt=Norman%20Mogil&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646" target="_blank">Norman Mogil</a><br />
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<blockquote>
Ever since the 2008 financial crisis, there has been a persistent shortage of high-quality government debt. More than just a safe haven in times of financial stress--- the so-called 'flight to quality' -- the supply of high- quality sovereign debt has been steadily shrinking. This shortage became acutely apparent with the results of the Brexit referendum as investors worldwide bid up bond prices to the point where most long term bond yields reached historic lows in the US, UK , Germany and Japan. Brexit only exacerbated a shortage problem that bond investors have had to contend with for nearly a decade. The current squeeze in supply is just the latest manifestation of this wider issue in today's financial markets. </blockquote>
<blockquote>
To claim that there is a shortage of government debt must seem counter-intuitive to many readers. After all, there is no end of studies demonstrating that major economies have record high government debt-to- GDP ratios, signifying that there is too much debt, not too little. Many critics call for governments everywhere to issue less debt, arguing that such high levels of debt ratios contribute to sluggish growth, if not, outright stagnation. European governments continue to exercise spending restraints and, in general, austerity is the byword throughout the industrialized world. Governments have been very reluctant to open up their coffers by issuing more debt to fund expenditures.</blockquote>
<blockquote>
However, a case can be made for more government debt. In a recent article, <u><span style="color: #0066cc;">The World Needs More U.S. Government Debt</span></u> former FOMC member, Narayana Kocherlakota argued this case, succinctly, when he wrote:</blockquote>
<blockquote>
<em>But scarcity is not about supply alone. In the wake of the financial crisis, households and businesses are demanding more safe assets to protect themselves against sudden downturns. Similarly, regulators are requiring banks to hold more safe assets. Market prices tell us that the government needs to produce more safety in order to meet this increased demand</em>. ........ <em>The inadequate provision of safe assets also has profound implications for financial stability</em>. <em>Without enough Treasury bonds to go around, investors “reach for yield” by buying apparently safe securities from the private sector ...if such behavior becomes widespread, it can create systemic risks that tip the financial system into crisis. </em> </blockquote>
<blockquote>
To better understand how bonds became scarcer, we begin by looking at who is buying government debt and why.</blockquote>
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<blockquote>
<em>The Expanding Role of Central Banks</em></blockquote>
<blockquote>
As the Federal Reserve sought ways to stimulate the economy, it became the first major central bank to start a bond-purchase program-- Quantitative Easing (QE) Soon after the Bank of England (BoE) , the Bank of Japan (BoJ) and most recently the European Central Bank (ECB) developed their own versions of QE. ( Chart 1). The US Fed holds nearly 20 percent of all Federal government debt; the BoJ owns over 30 percent ; the BoE, 25 percent; and, the ECB has so far bought about 15 percent of German debt. The Fed is no longer purchasing debt, while the other central banks continue with their QE programs. </blockquote>
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<blockquote>
The Fed increased its balance sheet dramatically from about $800 billion to over $2.4 trillion under three QE programs . Although the Fed no longer actively purchases government bonds, it appears in no hurry to release those bonds into the marketplace, instead allowing the bonds to mature fully over time. </blockquote>
<blockquote>
Over 40 percent of outstanding US Treasuries are held by foreign central banks , sovereign wealth funds and other institutions. China and Japan together account for about 12 percent. As the US runs current account deficits with its major trading partners, the excess in US dollars are re-cycled into purchases of US Treasuries. More importantly, many central banks , especially, those in emerging countries have purchased Treasuries in increasing amounts and holding them to shore up their balance sheets and to provide needed foreign exchange reserves. In sum, Treasuries are been soaked up by US domestic and foreign entities as part of a worldwide push to strengthen balances in the private and public sectors in the wake of the 2008 financial crisis. </blockquote>
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<blockquote>
The ECB and the BoJ both continue with very aggressive bond purchasing programs. The BoE may be forced to expand its current program in response to the fallout from UK voters opting to leave the EU. The ECB came late to the game of bond purchases, starting in 2015, some six years after the US first implemented QE. Initially, the ECB embarked on a program of purchasing government debt at a rate of 50 billion euros per month. But as the supply of qualified government debt diminished the ECB increased its bond purchasing program to included corporates . Overall, the ECB program now soaks up about 80 billion euros a month of high quality debt . Speculation is ripe that the ECB will do more bond purchasing in the wake of the Brexit vote. Turning to Japan, the BoJ has long been a huge purchaser of domestic government bonds( JGBs) .Over the next four years, the BoJ is expected to own over 60 percent of all outstanding JGBs, the highest of any country.</blockquote>
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<blockquote>
<em>Growing Domestic Needs for Treasuries</em></blockquote>
<blockquote>
Domestically, major holders of Treasuries include Federal government and state / local pension plans ( Table 1). These plans will require additional risk-free Treasuries to meet longer term obligations. US charted banks have significantly increased their holdings of Treasuries and Agency debt as a means of strengthening their balance sheets. From 2013 to the present , commercial banks increased holdings of Treasuries by 30 percent .Finally, private pension funds and the life insurance companies hold approximately 6 percent of their assets in Treasuries. Industry analysts argue that proportion is inadequate to meet future liabilities and it is expected that these institutions need to double their holdings to satisfy future income requirements. In short, government bonds will be a strong asset class from here on out as these institutions re-balance their portfolios to meet long run requirements. </blockquote>
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<blockquote>
<em>The Phenomenon of Negative Interest Rates</em></blockquote>
<blockquote>
One does not have to look any further than the exploding market for negative interest rate bonds to find convincing proof of a bond shortage . Today negative interest rate bonds total over $US12 trillion in Europe and Japan ( Chart 2). More importantly, the average duration of these bonds has increased remarkably just within the past year. Negative yields extend out to 10+ years in Germany, 15 years in Japan and even as far as 30 years in Switzerland . ( <a href="http://soberlook.com/2016/04/understanding-negative-interest-rates.html">http://soberlook.com/2016/04/understanding-negative-interest-rates.html</a>) </blockquote>
<blockquote>
Not surprisingly, central banks themselves are having trouble finding all the bonds they need. For example ,the ECB is not permitted to buy bonds with a yield lower than its deposit rate of minus 0.4 percent, thus excluding many billions of euro-dominated bonds issued by Switzerland, Germany, France , Netherlands and Sweden. In other words, there is a real squeeze on positive-yielding safe haven bonds. </blockquote>
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<blockquote>
<em> Vanishing Credit Quality and Liquidity </em></blockquote>
<blockquote>
Since the emergence of the debt crisis in Europe starting in 2012, there has been a wave of national debt downgrades .The Bank of America Merrill Lynch estimates that the share of bonds with the three highest credit ratings has dropped to 51percent of all debt tracked by the bank’s world sovereign bond index from 84 percent in 2011. With so many institutions restricted from purchasing anything less than high quality bonds, managers are facing a smaller and smaller market in which to participate. Credit worthiness comes into play in the very large repo loan market where high quality debt is used as short term collateral by hedge funds, money markets, private equity and other lending groups. It is estimated that the volume of repo loans using Treasury debt has nearly halved since the financial crisis of 2008. </blockquote>
<blockquote>
On the issue of liquidity, there have been system wide reductions, even in the case of the US Treasury market, considered to the most liquid of all bond markets. Regulatory changes post-2008 have made bond dealers less willing to hold inventory and facilitate trades. Bond trading desks have slashed inventories in response to regulations such as Basel III and the Volcker Rule. Hence, primary dealers have reduced their U.S. debt holdings by as much as 80 percent according to Bloomberg. com estimates. </blockquote>
<blockquote>
These liquidity developments have prompted Barry Eichengreen of UC Berkeley to argue that ``international liquidity has plummeted from nearly 60 percent of global GDP in 2009 to barely 30 percent today.`. Recent auctions for US Treasuries feature large oversubscriptions, and this has driven yields lower. There is more than just a temporary flight to safety to quality debt; there appears to be a major shift in asset preference in favour of high-quality debt issued by the US and other major countries at a time when the supply of that debt is not keeping with demand.</blockquote>
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<blockquote>
<em>Outlook for Supply </em> </blockquote>
<blockquote>
In a recent report , Bank of America Merrill Lynch said that "the world is running out of positive-yielding safe-haven bonds’’. The looming shortage has implications in many segments of the fixed income market. Every indication points to a worsening of the supply shortage of high quality bonds. In the US, the 2016 Federal deficit is expected to be lower than the previous year by some 25 percent. To finance this lower deficit, the Treasury has opted to issue more bills instead of bonds as a means of lowering interest costs .This combination will exacerbate the shortage situation and will most likely keep long rates down at these current levels. </blockquote>
<blockquote>
In Europe, the ECB is running out of qualified government bonds to purchase in the wake of a growing segment of the market having gone deep into negative territory. It has had to resort to buying corporate bonds to satisfy its purchasing objectives. There is no sign that Euroland will ease up on its austerity program and we can expect a tight supply of new government issuance in 2016-17. Japan continues to wallow in deflation and the BoJ is continues to be under pressure to step up its bond purchasing program, driving longer dated yields ever lower. From a supply perspective alone, we can expect that long term rates will be kept at these historic low levels. </blockquote>
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<a href="http://dailyshotletter.com/" target="_blank">Sign up for our daily newsletter called <b>the Daily Shot</b></a>. It's a quick graphical summary of topics covered here and on Twitter (<a href="http://soberlook.com/p/the-daily-shot.html">see overview</a>). Emails are NEVER sold or otherwise shared with anyone.<br />
_________________________________________________________________________<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-10507201201545321022016-06-19T16:56:00.000-04:002016-06-19T16:56:22.578-04:00What the Bond Market is Telling InvestorsGuest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_146446973266811&key=8a69ede45b8445f6b533712ba9899ffb&libId=iornfyqs0100r7tw000DA2r2a7rqw&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&title=Sober%20Look&txt=Norman%20Mogil&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646" target="_blank">Norman Mogil</a><br />
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Over the past month, the global bond markets have been sending out signals that all is not well with the global economies. Initially, the surge in negative nominal rates in Europe and Japan rattled many investors in both the fixed income and equities markets. This historic development suggests that large-scale investors are anticipating low growth and disinflation for many more years. Simultaneously, the yield curve, especially in the US, has been flattening, again signalling that growth is slowing, giving the policy makers considerable pause in their deliberations on the course of future interest rates. This blog examines both these developments to help the reader understand the signals coming out of the bond markets around the world.<br />
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<i>Nominal and Real Rates of Interest</i><br />
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For more than a year, short to medium term rates of interest in many countries have landed in negative territory. The ECB instituted negative overnight lending rates in an effort to discourage commercial banks from depositing excess reserves with the ECB; instead, these such funds should be made available to their borrowers in the hope of stimulating loan demand throughout the region. More recently, the ECB started to buy, initially, longer dated sovereign debt from member countries in the expectation that long-term rates would fall to stimulate investment growth. Now, the ECB has expanded this quantitative easing program to include investment grade corporate bonds. Purchases of both types of debt exceed 80 billion euros a month, as the ECB pulls out all stops in pursuing its goal of re-inflating the EU economies. The result of this combined effort is shown in Table 1 which reveals that major European countries and Japan now live under a regime of negative long-term rates.<br />
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Of more significance is the measure of real rates of interest--- nominal rates minus the rate of inflation. In some countries, real rates have turned negative ( e.g. Japan, Switzerland, and Canada) and in other countries, the real rates are barely in positive territory ( e.g. Germany and France). The key takeaway from Table 1 is that the industrialized nations now offer 10-year bonds at real rates that are less than 1 percent, well below the long term historic rate of 2 percent.<br />
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<i>Flattening Yield Curve </i><br />
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The yield curve represents what investors are willing to accept by holding debt over short, intermediate and long-term periods. A typical yield curve is sloping upwards since longer term investors normally require a greater return to compensate for the risks of holding debt over many years. The extra return - referred to as the term premium - reflects the investor's view of future economic growth and inflation among other considerations. A rising term premium reflects concerns over excess supply of debt, credit quality, and higher inflation in the future; a falling term premium has these factors moving in the other direction. Over the past year or more, the term premium has fallen significantly, hence the fall in long-term rates. <br />
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Changes in the slope of the yield curve signify changes in the economic outlook. Over the past few months, the yields on long-dated US Treasuries, 10 years and up, have fallen and, at the same time short term rates have moved up. ( see Chart 1) These two developments are related. Short rates have moved up in anticipation of the Fed increasing its overnight interest rate. Fed Chairperson, Janet Yellen, has spoken of the need to increase the policy rate in " the coming months" and other members of her committee have voiced similar views. In its most recent policy meeting, the FOMC continues to hold out the possibility for at least one or more rate increases before year's end. At the same time, investors in the long end of the bond market are saying that any short rate increases will have a detrimental effect on economic growth and that any policy shift must weigh that consideration. In effect, the long end of the curve is saying: increase short rates at your ( Fed`s) peril.<br />
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Chart 2 maps out the change in the spread between 2- 10-year yield. It has narrowed from 170 bps to 90 bps over the past year. In part, the 2-year rate moved up sharply in response to the Fed signalling that it wants the bank rate to move up this year as part of its objective to “ normalize” rates. But it is the falling long-term yields which are most disconcerting. It signifies that the investors expect future growth to be weaker and that they also expect future inflation to be lower than was previously forecasted a year earlier ( Chart 1). It is the change in<em> expectations</em> that we need to focus upon.<br />
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<i><br /></i> <i>Changing Expectations </i><br />
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There has been a dramatic shift in the way consumers' view future inflation. The University of Michigan surveys reveal that there has been a persistent decline in the expected rate of inflation over the next 5- 10 years (Chart 3). In the 1990s, consumers expect annual inflation to exceed 4 percent; by 2010-15, consumers' expectations have dropped down to well under 3 percent. In its most recent survey, U of M discovered that consumers expect inflation to average just 2.3 percent for the next 5 years<br />
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Investors have also adjusted their inflation expectations. One measure of inflation expectation is the 5-year breakeven inflation rate. This is the difference between the 5-Year Treasury bond rate and the yield on an inflation-protected security with 5-years remaining to maturity ( so-called TIPS). Chart 4 shows how these expectations have dropped considerably from around 2.8 percent in 2012 to 1.6 percent today. In fact, investors have adopted a greater downward revision to their expectations than in the case of consumer groups. It is the investors who are driving the bus on the yield curve road.<br />
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<i><br /></i> <i>Other Factors Affecting Long-term Bond Yields.</i><br />
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Ben Bernanke has maintained for some time that the global savings rate is too high and that excess savings is fuelling the demand for debt instruments, especially quality sovereign debt. There is a lot of merit in this argument when one looks at the high savings rates in the emerging markets - often in excess of 25 percent of GDP. Even in the industrialized countries savings are relatively high. Or, alternatively, consumption is too low. Either way, excess loanable funds have to be channeled into investment, and this generates a growing demand for credit instruments worldwide.<br />
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Another explanation for the fall in long-term rates is related to liquidity in the international bond markets. Barry Eichengreen argues that ``international liquidity has plummeted from nearly 60 percent of global GDP in 2009 to barely 30 percent today.` The most important form of bond liquidity is the US government bonds which are held by banks, large institutions, and foreign central governments. Recent auctions for US Treasuries feature large oversubscriptions, and this has driven yields lower. There is more than just a temporary flight to safety to quality debt; there appears to be a major shift in asset preference in favour of high-quality debt issued by the US, Germany, Japan, and UK governments . To the extent that new government debt issued is immediately taken up by these institutions and are essentially held to maturity rather than traded, means that there is less liquidity in the marketplace. Scarcity will drive up bond prices.<br />
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<i><br /></i> <i>What can we learn from the recent behaviour of the yield curve? </i><br />
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<em>Low yields are a symptom of economic malaise</em><strong> </strong>. Although there have been many criticisms of central bankers for introducing negative short interest rates, the central bankers are not responsible for the decline in long-term interest rates. Negative interest rates are not the problem. Slow growth and disinflation are driving longer rates to historic low levels. These bond yields are not the problem but are the symptom of widespread economic weakness that is not expected to improve over the next decade. <br />
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<em>Low inflationary expectations are well-entrenched</em>. Clearly, the negative nominal and real rates of interest are sending a powerful signal that those economies are going to experience very low growth without inflation for the next 5 to 10 years. There is a well-entrenched view that inflation and growth will remain very subdued over the next decade.<br />
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<em>Shortage of quality debt</em>.There is growing evidence that quality debt remains in strong demand and highly sought-after. The decline in the term premium on long-dated government bonds demanded by institutional and central bank investors supports this assertion.<br />
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<em>Long term rates to remain low</em>. The combination of strong demand and supply restraints will keep long bond yields at these levels or even lower for many years. Any change in the current direction of bond yields will not come from within the market itself. Rather yields will rise only if governments resort to aggressive fiscal policies that promote growth and higher inflation. As yet, there is no sign of any policy shift in that direction, especially in the US and the EU.<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-15176252146106874852016-06-19T00:43:00.001-04:002016-06-19T00:46:08.418-04:00Unconventional Policies and Their Effects on Financial Markets<blockquote>
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Guest post by <a href="https://twitter.com/sobata416" target="_blank">$hane Obata</a><br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-70841442467851464352016-06-07T22:54:00.000-04:002016-06-07T22:54:45.096-04:00The fall in commodity prices hits the Canadian banks<blockquote>
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Guest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_146446973266811&key=8a69ede45b8445f6b533712ba9899ffb&libId=iornfyqs0100r7tw000DA2r2a7rqw&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&title=Sober%20Look&txt=Norman%20Mogil&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646" target="_blank">Norman Mogil</a><br />
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With the release of Canadian banks’ second-quarter results, investors are beginning to measure the impact of the oil price collapse on the domestic financial industry. Widespread are the write-downs and other provisions the banks are taking in response to the weakened credit quality of many clients in the oil patch. This blog looks at this issue and its implications for future bank stock performance.<br />
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On the whole, the Canadian banks turned in a profitable second quarter, although in some instances profits declined ( e.g. Scotiabank and BMO Montreal). The banking sector continues to show respectable results in its retail and consumer loan divisions. Also, their mortgage portfolio remains healthy, supported, to a great measure, by good loan-to-value measures and mortgage insurance. Finally, the banks’ capital ratios meet international standards as the they continue to improve in this area. Where the banks face the biggest challenge is with their loans to the energy and commodity sectors in Canada and the United States.<br />
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<i>Provisions for Loan Losses </i>(PCL). Chart 1 measures the loan losses for the major Canadian banks in terms of a percentage of the average loans outstanding. PCLs represent loans that have been written down for non-performance. There has been a dramatic increase since 2015 Q4 results as the slump in the oil prices take its toll.<br />
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<i>Gross Impairment of Loans</i> (GILs). Another way to look at the impact of the oil sector is to examine the increase in GILs. GILs are loans that are non-performing loans that a bank will have to either write off or sell at a discount to a debt collector who will likely seize the collateral. Either way, bank profits will be negatively impacted. Chart 2 graphs the substantial increase over the past 12 months in GILs, especially Canada’s largest domestic bank, RBC.<br />
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Chart 3 demonstrates the combined effects of both PCLs and GILs. RBC attributes the increases in both ratios to the sustained low oil price environment. Furthermore, these ratios could well deteriorate further the longer oil prices remain around these levels.<br />
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The banking industry is most exposed to the highest risk segment of the energy sector. Fully 82 percent of RBCs energy sector loans go to exploration, production and drilling activities; loans to the integrated and refining segments remains relatively small. And, geographically, the bank’s exposure is roughly split evenly between Canada and the United States.<br />
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<i>Capital Market Revenues</i>(CMRs). CMRs are closely related to the commodity sector performance. The banks generate a significant proportion of total revenues from such activities as M&A, trading in equity and fixed incomes, IPOs, and advisory services, all of which have suffered declines over the past few years.( Chart 5). Moreover, this segment of the industry has come under heavy regulatory scrutiny, adding to the cost of operations at a time when revenues are declining. Where CMRs used to generate between 15- 20 percent of total bank revenues, this activity now generates about between 11-16 percent, more importantly, the trend has been steadily declining as the industry grapples with a weak investment environment and rising costs.<br />
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<i>The Outlook</i>. The Canadian banks continue to perform reasonably well as their core segments--- retail and mortgage markets--- hold up well. Nevertheless, they face considerable headwinds as Canada contends with weak oil and commodity prices and declining business investment. (<a href="http://soberlook.com/2016/06/the-decline-in-canadian-business_5.html">http://soberlook.com/2016/06/the-decline-in-canadian-business_5.html</a>). Recent surveys by Statistics Canada point to continued declines in additions to capital stock. The Bank of Canada anticipates that this erosion in business investment will contribute to a lower potential GDP growth and that , in turn, will impact future wage and profit growth--- both of which will be felt by the banks going forward.<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-8666733695472438752016-06-06T00:00:00.001-04:002016-06-06T00:03:17.458-04:00US labor markets take a turn for the worse<blockquote>
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Friday's US payrolls report, which to a large extent represents a latent effect of the US dollar rally over the past couple of years, was dismal. On a relative basis, hiring Americans has become more expensive for global firms. An elevated level of uncertainty, driven in part by risks associated with the US monetary policy as well as the presidential elections, has not helped.<br />
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Let's look at some trends in the labor markets.<br />
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1. The job market's weakness has now spread to the services sector.<br />
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://gallery.mailchimp.com/451473e81730c5a3ae680c489/images/e3951e9a-2d12-490f-b1e4-c957ad3818d9.jpg" style="margin-left: auto; margin-right: auto;"><img border="0" height="480" src="https://gallery.mailchimp.com/451473e81730c5a3ae680c489/images/e3951e9a-2d12-490f-b1e4-c957ad3818d9.jpg" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: BofAML</td></tr>
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2. After a strong showing over a previous couple of months, US labor force participation has turned lower.<br />
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3. Even as the headline unemployment rate (U-3) declined to lows not seen since 2007, a broader measure of unemployment, which includes marginally attached workers plus those employed part-time for economic reasons (U-6), has stalled.<br />
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Below is the ratio of the headline jobless rate to the broad (U-6) unemployment over the past couple of decades. While fewer people are filing for unemployment benefits, the health of the broader labor market has significant room for improvement.<br />
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4. Related to the above, here is part-time employment for "economic reasons".<br />
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5. US manufacturing jobs growth has worsened again on a year-over-year basis.<br />
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6. Wage growth is back below 2.5% (YoY). Unless the non-demographic component of labor force participation begins to climb again, it's difficult to see a significant jump in hourly earnings growth. It is worth pointing out, however, that given slow inflation, real wage growth in the US is reasonable relative to a number of other developed economies.<br />
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7. The next chart shows the average weekly hours worked by US employees on a year-over-year basis. Even with a positive hourly wage growth (above), declining hours could mean less cash in households' pockets.<br />
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8. For what it's worth, the headline unemployment rate is now below the 'Natural Rate of Unemployment". According to classical economic theory, inflation should begin to rise at this point. But given some of the labor market challenges shown above, price increases - outside the recent increase in energy and agricultural commodities - should remain benign.<br />
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Separately, the ISM Services PMI weakened in May. This provides more evidence that the soft patch in the US economy is not limited to manufacturing and energy.<br />
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The ISM Non-manufacturing Employment Index is consistent with Friday's poor payrolls report (above). The ISM services sector new orders index is also shown. Is this consistent with the projected 2.5%-3.0% US GDP growth in Q2?<br />
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In response to the weak jobs report (and to some extent the ISM Non-manufacturing PMI) the June rate hike is off the table according to the futures market. The July contract rose above the pre-Fed-minutes levels (it was the Fed minutes that temporarily resurrected the chances of the Fed doing something in June.)<br />
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Here is what Friday's economic reports did to the implied rate hike expectations in 2016. Another weak jobs report will send the probability of "no hikes" to 100%.<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-91388739615661988372016-06-05T22:38:00.000-04:002016-06-05T22:39:59.686-04:00The Decline in Canadian Business Investment<blockquote>
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Guest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_146446973266811&key=8a69ede45b8445f6b533712ba9899ffb&libId=iornfyqs0100r7tw000DA2r2a7rqw&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646&ref=http%3A%2F%2Fsoberlook.com%2F&title=Sober%20Look%3A%20Housing%20in%20Canada%3A%20A%20Tale%20of%20Two%20Markets&txt=Norman%20Mogil">Norman Mogil</a><br />
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Business Investment “<i>depends on the prospective yield of capital, and not merely on its current yield</i>” , John Maynard Keynes<br />
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One of the many puzzles of the recovery since the 2008 crisis has been the corporate sector’s reluctance to add to a nation’s capital stock. Investment in new plant and equipment along with the construction of new productive facilities has lagged behind the experience of previous recoveries. Throughout the industrialized world, the rate of growth in fixed capital investment has been dismal, resulting in below average rates of growth in national income. The decline in business investment has been quite dramatic. In North America business fixed capital investment is running 20 percent lower that recorded in 2007. (See Chart 1)<br />
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg3OSbbpeBsPYQolDkatmp1jsJdOnURRdzYBJRpZqvA4EBkEsVfLdqTfobkWuRYyAwoBU0wmwGWk1Q4agkFO1cTNGpIYn33fpiLrWvBMbykz4STuu73vS5sphVkVja-NpvIVvx3RlMJtDs/s1600/1.png" style="margin-left: auto; margin-right: auto;"><img border="0" height="352" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg3OSbbpeBsPYQolDkatmp1jsJdOnURRdzYBJRpZqvA4EBkEsVfLdqTfobkWuRYyAwoBU0wmwGWk1Q4agkFO1cTNGpIYn33fpiLrWvBMbykz4STuu73vS5sphVkVja-NpvIVvx3RlMJtDs/s640/1.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: BIS</td></tr>
</tbody></table>
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This dramatic weakness in capital formation is worrisome given all the factors that one would expect would generate a flourish in capital expenditures. Central banks have implemented unprecedented monetary stimuli in the form of zero interest rate and quantitative easing, contributing to the dramatic fall in long-term interest rates. Corporate profit margins are at historic high, and retained earnings continue to grow. And, equity prices remain quite elevated--- all these developments should provide the corporate sector with the enthusiasm to undertake capital investments. Yet, that sector continues to display weakness, contributing to what the IMF characterizes as the`` new mediocre`` growth performance. What lies behind the failure of business investment to expand?<br />
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<i>The Decline in Corporate Profits </i><br />
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The first clue to this answer lies with the slump in corporate profits and corporate profitability. Chart 2.1 and 2.2 shows the significant fall-off in the level of corporate profits in the United States and Canada over the past two years. The principal reason for this decline is the failure for the revenue to grow. Profits would have been even weaker had wage growth not been contained.<br />
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<i>The Canadian Experience</i><br />
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The Canadian experience exemplifies what lies behind this profit weakness. If we look at the rates of return on equity and on capital employed, we see that there has been a steady decline in returns to investment for all industries and in particular for non-financial industries. (See Chart 3). Whereas the Canadian non-financial companies return on total capital employed registered 6.7 percent in 2104, by the first quarter of 2016 these returns fell a full 100 bps. Clearly, the capital employed was not churning out profits as before, casting doubt on the effectiveness of the investment already in place, let alone what could be expected on new ventures.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSTsFbdDsSmaqqJ4wWgEAn4fV6lXyxHiRb3wkBZyNTHGBINQnSNp7FDZNZQMCBG9v_lQv5cmYED6bBanqmbuM4J4k0QH6SfpYNFY6rMjXilqCWMypM49fPygGUTCegcwlY8B9VX7OYU2k/s1600/4.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="470" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhSTsFbdDsSmaqqJ4wWgEAn4fV6lXyxHiRb3wkBZyNTHGBINQnSNp7FDZNZQMCBG9v_lQv5cmYED6bBanqmbuM4J4k0QH6SfpYNFY6rMjXilqCWMypM49fPygGUTCegcwlY8B9VX7OYU2k/s640/4.png" width="565" /></a></div>
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A recent survey by Statistics Canada on capital spending paints a very disquieting situation. Total spending intentions are expected to fall by 4.4 percent led by a decline of 9.3 percent in the private sector which accounts for about two-thirds of total capital investment. Moreover, expenditures in manufacturing are poised to drop by 11 percent. It is no wonder that the forecasts for the Canadian economy remain tepid. The real engine of growth is badly misfiring.<br />
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In addition, there is considerable excess capacity in all sectors. Capacity utilization ratios are currently running at 75 percent compared to the longer-run average of 80 per cent. (See Table 1). With excess capacity and falling rates of return, Canadian corporations have no real incentive to undertake capital investment.<br />
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<i>The Longer Term Impacts</i><br />
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The Bank of Canada, in its most recent monthly report ( April, 2016) concluded that Canada's potential GDP growth has weakened over the past year.Potential GDP is comprised of the growth in the labour force plus the growth in labour productivity. The Bank downgraded Canada's potential GDP growth from 1.8 percent to 1.5 percent.( see Table 2). Labour productivity growth will exhibit a marked decline over the next three years, according to the report. The Bank argues that since<br />
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" the trend in labour productivity influences the outlook for potential output, the current weakness in trend labour productivity reflects the decline in business investment." <br />
Thus, we come full circle: the lack of new business investment leads to poor productivity performance which, ultimately, leads to a lowering of the country's potential growth rate. The slowdown in business investment and its implications are now well- embedded in the economy for the next three years at least.<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-70372435519894067002016-05-09T14:42:00.000-04:002016-05-09T14:42:52.280-04:00Disentangling the nature of Italy’s capital flights<blockquote>
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<span style="font-size: large;">The ECB T-LTROs and the QE efforts are fueling significant outflows toward the core countries, driven by the non-banking sector. </span><br />
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Guest post by Marcello Minenna<br />
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Net balances in the Eurozone continue to widen as capital flows from the periphery to Germany and other core countries. Much of the convergence in net balances that took place between 2012 and 2014 has reversed. As for the underlying reasons, we’ll show that empirical evidence points mainly to the combined effects of the new ECB programs of monetary expansion (T-LTROs and Quantitative Easing). As of March of this year, Italy reported its largest Target 2 net deficit 2012 (€ -263 billion), followed closely by Spain (€ -262 billion) and Greece (€ -95 billion). Germany’s Bundesbank saw its surplus grow to over € +600 billion once again (see Figure 1).<br />
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<i>Figure 1.</i></div>
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The ECB itself has seen its deficit widen to € -90 billion due to quantitative easing purchases (see Figure 3). Around 10% of QE assets are risk-shared between Eurozone countries and thus are accounted as an ECB “debt” towards National Central Banks (NCBs).<br />
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<i>Figure 2.</i></div>
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This unusual accounting confirms that, also because of complex technicalities involved, a clear explanation of the driving components of this central banks' accounting method continues to prove elusive. Even the same ECB is explicitly warning not to infer bold assumptions from analysis of these data since simplistic explanations could lead to wrong conclusions.<br />
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Some academic research on the importance of Target2 balances has progressed considerably from the seminal but disputed work of Sinn (2012). The Sinn research has the merit in attracting attention on the relationship between the current accounts and the Target2 balances of Eurozone countries. A surplus in the current account should lead to a positive Target2 net balance, and vice versa. In this perspective, the Sinn research considers the Target2 balances in terms of a “stealth bail-out” of peripheral countries by the creditor central banks. According to Sinn, in the case a “debtor” central bank would leave the Eurosystem, the Target2 net balance would become immediately payable. A subsequent default of the debtor central bank would turn into a net loss for the Eurosystem to be absorbed jointly by all the remaining members (risk mutualisation or risk-sharing). Whelan (2012 and 2014) contested this view in many papers, pointing out that any central bank can always operate with “negative equity” (in other terms it could offset losses "printing money", without fiscal transfers from the taxpayers). Now it seems understood (Szécsényi, 2015) that Target2 assets and liabilities could eventually lead to losses in case of a Euro break-up, but these should be a lot less than the raw net imbalances suggest.<br />
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At the present, a large part of the financial community seems to acknowledge that diverging net balances in the last two years are driven by purely financial transactions. The current accounts of Eurozone countries are mainly in surplus (see Figure 2) due to the depreciating Euro and the compression of the level of prices and wages in the periphery (i.e. a phenomenon also known as internal devaluation). Hence, it could be inferred that the intra-European trade between Germany and the periphery (the Sinn hypothesis) is not the leading factor in explaining Target2 net balances.<br />
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<i>Figure 3.</i></div>
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Digging deeper, it’s interesting to highlight also the strong correlation between the size of the ECB balance sheet and NCBs Target2 numbers. When the ECB inflates its accounts via expansionary measures, newly created money flows towards Eurozone banks that use it to regulate different kinds of transactions. When they are settled and accounted, these operations produce variations in the Target2 net balances. Let’s investigate the Italy’s case. As Figure 4 clearly depicts, Italy’s Target2 net balance and central bank balance sheet show a 96% correlation between 2011 and 2016.<br />
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<i>Figure 4.</i></div>
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In the pursuit to understand movements in Italy's Target2 net balance, a detailed decomposition has been calculated by exploiting financial account data from the balance of payments (see Figure 5). The reconstruction has a good degree of precision, with little unexplained residual flows (the orange bars).<br />
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<i>Figure 5.</i></div>
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In 2011 and 2012, core Eurozone banks sold significant amounts of Italian government bonds on the secondary markets because of an augmented perception of Italy’s credit risk (the green bars grew quickly). Those bonds were then purchased by Italian banks, which increased their exposure to national public debt. At the same time, German banks were deleveraging from long-term commercial credit exposure to Southern Europe. Net borrowing by the Italian banks on the Euro area interbank market also decreased markedly, due to the substantial reduction of deposits abroad and the missed renewals of existing loans. These phenomena (together with a progressively higher cost of financing) were signaling stress on the Italian banking sector’s funding practices (the yellow bars). Together, this led to large capital outflow from Italy to the Eurozone core (denoted with a positive sign in core Target2 accounts; vice versa for Italy). The ECB’s LTROs and other unconventional measures have supplied over € 1 trillion to the Eurozone banks (€ 270 billion to Italy alone) that have been employed to finance the capital flight and transfer risk from the German banking system to the ECB.<br />
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When LTROs repayments began in 2013, the ECB balance sheets gradually deflated along with the Target2 net balances. Foreign investment in the Italian public sector resumed, though it did not reach previous levels. The missing amounts were partially compensated by a positive influx of foreign money in the private sector (sky blue bars). The divergence returned in June 2014 when Mr. Draghi launched the new T-LTROs in an effort to revive the sluggish Eurozone credit growth. In March 2015, PSPP’s launch accelerated the growth of ECB assets and had widened the spread between Target2 net balances.<br />
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New money flows (TLTROs loans and revenues from the selling of government bonds) reached Eurozone banks but only partially were employed to increase the exposure on national government bonds. A new source of capital flows has emerged and become the primary driver of Italy Target2 negative net balance: a shift in Italy’s private non-banking sector from government and banking bonds to foreign shares and mutual funds. Looking closer at Figure 6, one can infer that the Target2 net balance (blue line) was only affected by the sell-off and the subsequent repurchase of Italian government bonds (green line) until June 2014. Afterward, foreign investment by the non-banking sector (red line) played a larger role in dragging down the Target2 balance. Moreover, the last few months of decline could be attributed to a renewed – albeit moderate – flight from government bonds.<br />
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<i>Figure 6.</i></div>
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As of the beginning of 2016, over € 180 billion has shifted from Italy towards mutual funds located in Luxembourg, Netherlands and Germany. Only 20% of them can be traced back to Italian entities (i.e. round trip funds). The hunt for yield in a unprecedently low-interest-rate environment can only explain part of this sustained capital flight towards Northern Europe. Subtle but persistent redenomination risk (the risk that a euro asset will be redenominated into a devalued legacy currency after a partial or total Euro break-up) affecting Italian assets. Moreover, the fear of adverse effects of the bail-in regulation that came into effect in January 2016 may have had a meaningful role in explaining this massive portfolio readjustment by the private non-banking sector.<br />
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References and Further Readings:<br />
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Publication of TARGET balances (2015) <a href="https://www.ecb.europa.eu/pub/pdf/other/eb201506_focus04.en.pdf" target="_blank">https://www.ecb.europa.eu/pub/pdf/other/eb201506_focus04.en.pdf</a>.<br />
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Minenna et al. (2016 - forthcoming) “The Incomplete Currency: The Future of the Euro and Solutions for the Eurozone”, Wiley.<br />
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Sinn H.-W., Wollmershäuser T. (2012b), “Target balances and the German financial account in light of the European balance-of-Payments crisis”, CESifo Working Paper No. 4051, December.<br />
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Szécsényi P. (2015), “Nature of TARGET2 Imbalances”, <a href="https://www.asz.hu/storage/files/files/public-finance-quarterly-articles/2015/a_szecsenyip_2015_3.pdf" target="_blank">https://www.asz.hu/storage/files/files/public-finance-quarterly-articles/2015/a_szecsenyip_2015_3.pdf</a><br />
<br />
Whelan (2012) “TARGET2: Not why Germans should fear a euro breakup”, <a href="http://voxeu.org/article/target2-germany-has-bigger-things-worry-about" target="_blank">http://voxeu.org/article/target2-germany-has-bigger-things-worry-about</a><br />
<br />
Whelan K. (2014), TARGET2 and central bank balance sheets, Economic Policy January 2014<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-26406040873398092392016-05-08T20:40:00.000-04:002016-05-08T20:40:07.745-04:00Fiscal Policy to the Rescue?<blockquote>
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When appearing before their political masters, central bankers, invariably, urge them to adopt an expansionary fiscal policy. Ben Bernanke, and now his successor, Janet Yellen have pleaded with Congress to adopt a more simulative fiscal policy. Mario Draghi continuously stresses the need for fiscal policy in support of the ECB's easy money policy. Most recently, the head of the IMF, Christine Lagarde, stated that some countries “may have room for fiscal expansion", citing Canada as one country that has "made the most of this space." Indeed, the Governor of the Bank of Canada (BoC) has made it a selling point that they believe that Canada's latest fiscal stimulus measures will have a positive effect on the real GDP. In part, the fiscal policy shift has allowed the BoC to refrain from cutting its lending bank rate.<br />
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Monetary policy is reaching its limits in terms of stimulating economic activity and has carried that burden well beyond what was envisioned immediately after the 2008 crisis. This blog looks at the issue of fiscal policy, especially the fiscal multipliers that are considered to be the drivers behind the movement towards fiscal expansion.<br />
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<em><b>The Multipliers</b></em><br />
<em><br /></em>
The Keynesian multiplier is at the centre of the analytical debate regarding the impact of a central government's budget on promoting growth. Simply put, the multipliers measure the bang one gets for the fiscal buck .That is, the amount of short-run economic expansion one gets from a dollar of government spending, or, from changes in tax policy. Multipliers can be calculated to measure any kind of expenditure change on GDP. Thus, for example, if government spending were to increase by $100, leading to an expansion of $150 in GDP, then the spending multiplier is 1.5. Other types of multipliers can measure the impact of government transfers or of specific tax changes affecting profits and wages.<br />
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Using historical data, a recent IMF study calculated the average multiplier impact for major industrialized countries (see Chart 1). What is striking is the relatively wide-ranging implications of stimuli for these countries. The US and China have experienced a multiplier effect of 1.5 and 1.7, respectively; Canada, Australia and the Eurozone have experienced less effective results. We will return to this point later.<br />
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Not all fiscal stimuli act with the same degree of potency. Chart 2 separates the type of stimulus between " investment" and "tax" measures. The governments obtain the greatest bang for the buck when undertaking infrastructure projects, both for their immediate impact on jobs and income as well as for their longer term benefits in adding to productive capacity (e.g. urban transportation systems). Next in importance are stimulus programs generated by increasing government consumption of goods and services (i.e. day-to-day expenses associated with government operations).<br />
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Tax measures, on the other hand, have not proven to be anywhere nearly as effective in promoting growth. The impact of reductions in personal or corporate tax cuts are de minimis. Since some portion of a tax cut is usually saved rather than entering the spending stream, tax multipliers are lower than government spending multipliers.<br />
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Thus, economists have long urged governments to look to stepping up their capital investment activities as the primary driver of fiscal stimulus policy.<br />
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<em><b>Conditions Affecting the Multiplier</b></em><br />
<br />
How effective fiscal policy can be depends largely on the following conditions:<br />
<ul>
<li><em>the stage of the business cycle. </em>If the economy is fully utilizing all its resources, then a stimulus program would have no effect and might even worsen conditions as the government would tend to "crowd out" the private sector in the competition for workers and for physical and financial capital. This is <em>not</em> the situation today. Government expenditures simply will augment aggregate demand and contribute to overall growth without any inflationary results. In fact, recent research has shown the multipliers are likely be higher those of the past--- there is that much slack in the economy. Furthermore, some researchers even go further and argue that these expenditures will, in time, ease, not exacerbate the government’s long run budget constraint <span style="font-size: xx-small;"><sup>(1)</sup>.</span></li>
</ul>
<ul>
<li><span style="font-size: x-small;"><span style="font-size: small;"><em>reliance</em></span></span><span style="font-size: x-small;"><em><span style="font-size: small;"> on international trade</span>. </em><span style="font-size: small;">For countries such as such as Canada, Australia and those in the Eurozone, international trade accounts for as much as</span> <span style="font-size: small;">25 percent or more </span></span>of national income. In these cases, there will be some leakage as consumers and businesses purchase products made overseas resulting a net reduction to national income. This may account for why the multipliers for those countries are lower than for the US and Japan which are more closed economies.</li>
</ul>
<ul>
<li><em>the level of interest rates</em>. As long as interest rates are less than growth in nominal income, the amortization of the additional liabilities will negative. This is a very cost-efficient means to finance long term infrastructure projects.</li>
</ul>
<ul>
<li><em>on the fiscal policy mix. </em>As we pointed out earlier, it is important to emphasize government " investment" expenditures over "tax" expenditures as a means of stimulating growth. The mix often depends on the political forces at work at the time that budgets are being drawn up.</li>
</ul>
We did mention that economists debate the value of fiscal stimulus. Some point to the experience of the US stimulus bill of 2008 had very little impact. However, that program was dominated by tax cuts which have the smallest impact of any stimulus measure. Also, the size of the program, roughly $750 billion was less than 1 percent of the economy and would not likely have produced the desired impact. The program was designed to kick start only, rather than to provide for sustained increase in economic activity.<br />
<i><b><br /></b></i>
<i><b>Summing Up </b></i><br />
<br />
As the monetary policy options are exhausted, the industrialized countries are going to look to fiscal policy to boost growth. In the recent the G-20 meeting, the IMF recommended the G-20 stand ready to implement <em>coordinated</em> stimulus equal to 1 percent to 1.5 percent of GDP. More importantly, should this be a coordinated action the multipliers cumulative affects would be even greater than each country going it alone. Hence, the urging by the IMF to have the major players work together. A tall order, indeed.<br />
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<span style="font-size: xx-small;">(1) "Fiscal Policy in a Depressed Economy", J. Bradford DeLong U.C. Berkeley and NBER Lawrence H. Summers Harvard University and NBER,2012</span> </div>
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-4148372157543069902016-04-11T16:14:00.000-04:002016-04-24T23:16:23.787-04:00 Understanding Negative Interest Rates<blockquote>
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Guest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_145600242818110&key=8a69ede45b8445f6b533712ba9899ffb&libId=ikvm82qu0100r7tw000DAn8hgum24&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&title=Sober%20Look&txt=Norman%20Mogil&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646" target="_blank">Norman Mogil</a><br />
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When the central banks of three European countries and the European Central Bank (ECB) itself introduced negative interest rates (NIR) in mid -2014, many considered it be a temporary measure, a new experiment in monetary policy. But when the Bank of Japan did the same in January 2016 and when the ECB pushed rates further into negative territory in March 2016, the international investment world stood up and took notice. Policy makers are now prepared to test this unconventional technique in an effort to stimulate growth and tackle deflation.<br />
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The financial press is full of articles on the dangers of this policy. These unconventional moves have provoked a lot of criticism, especially from the banking community who fear a strangulation of normal banking activities. A lot has been written about the dangers that NIR pose to the stability of banks and to the possible harm to savers and investors alike. This article is an attempt to put the whole question of NIR into a more balanced perspective. To begin with, it is important to have some background to why and how NIRs have come to characterize so much of government debt.<br />
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<em>How Pervasive are NIRs?</em><br />
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According to the JP Morgan international bond index, approximately 25% of its government bond index is in negative territory ( see Chart1). More importantly, the size of that market has grown rapidly and dramatically from zero in mid- 2014 to more than US$6 trillion today.<br />
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgJLyLr6Q6w2qVLUU3jzTYRFZc1xP18ufZmWHVmvg0tfQfZSrC3WuMm_5TOEyJ0FjM9vaCRoctEAEq_JNWyk_Yfue87sC96_d8L4YrRzOnSqL-mnms0_yi-E5POdQ2JkjJI3l10x7ezhc/s1600/Chart1.jpg" style="margin-left: auto; margin-right: auto;"><img border="0" height="480" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhgJLyLr6Q6w2qVLUU3jzTYRFZc1xP18ufZmWHVmvg0tfQfZSrC3WuMm_5TOEyJ0FjM9vaCRoctEAEq_JNWyk_Yfue87sC96_d8L4YrRzOnSqL-mnms0_yi-E5POdQ2JkjJI3l10x7ezhc/s640/Chart1.jpg" width="575" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: FT</td></tr>
</tbody></table>
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Table l lists the countries whose official central policy calls for NIRs and whose interbank lending rates are negative. The interbank lending rates are a measure of how willing commercial banks are prepared to lend to each other on a very short term basis. In Europe, alone, nine countries' interbank lending rates are in negative territory.<br />
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<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKwO9imvFNIpxi-mnKh2DOgKkJi2p7z1LcuJqzUp_y4qo5h_5UGKd9a6av-hqSqqHOWbxatX036RdHCpF0E91dhqvJ0Kye90rKKb6Ur0ldsnl9ppKk1DfAQXH9nqfEQf9XtiewsqPsWmI/s1600/Table1.jpg" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKwO9imvFNIpxi-mnKh2DOgKkJi2p7z1LcuJqzUp_y4qo5h_5UGKd9a6av-hqSqqHOWbxatX036RdHCpF0E91dhqvJ0Kye90rKKb6Ur0ldsnl9ppKk1DfAQXH9nqfEQf9XtiewsqPsWmI/s1600/Table1.jpg" /></a></div>
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Initially, the sub-zero debt instruments were confined to the very short end of the yield curve. However, as Chart 2 reveals, NIRs have been extended to the middle and longer ends of the yield curve. In Germany, sub-zero rates extend up to five years and, in Japan negative rates extend out to 10 years - the Japanese 30-year bond trades at a mere 0.50 percent. It should be emphasized that, although the central banks set only bank policy rate, the market place determines all rates along the yield curve from 2 years to 30 years. Clearly, the goal of lowering long-term interest rates has been achieved in Europe and Japan. It will take an extraordinary shift inflationary expectations to eliminate negative rates this far out on the yield curve.<br />
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHJIjrILHf4NK_MQ1vEOPxn9HmMdeFUHLjz2Lq6bdOCDeQGnGjSAbef_171wPwTKztLyxIPQhg5ailQ0xd7IeYJNHWc1GH6mCOiFvTZVSP15P_QESp2v9o5n3YRx6x4pbILVBrXw_jnwA/s1600/Chart2.jpg" style="margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgHJIjrILHf4NK_MQ1vEOPxn9HmMdeFUHLjz2Lq6bdOCDeQGnGjSAbef_171wPwTKztLyxIPQhg5ailQ0xd7IeYJNHWc1GH6mCOiFvTZVSP15P_QESp2v9o5n3YRx6x4pbILVBrXw_jnwA/s1600/Chart2.jpg" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: <a href="http://www.bloombergview.com/quicktake/negative-interest-rates">http://www.bloombergview.com/quicktake/negative-interest-rates</a>, March 18,2016</td></tr>
</tbody></table>
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In the case of non-Euro countries like Sweden, Denmark and Switzerland, these countries adopted a policy of NIR to hold down the external value of their domestic currencies. Money was flowing into these nations' coffers from the Euro countries, putting undue upward pressure on their domestic currencies to the detriment of their trade and capital balances. Despite the fact that the Federal Reserve has signaled that it wants to raise the short-term rates as part of its efforts to `` normalize`` monetary policy , Janet Yellen said last November that certain economic conditions could put negative rates "on the table". Never say never.<br />
<br />
NIR bonds are not solely confined to the government sector. Recently, such blue chip European corporations as Nestle, the energy corporation EDF,Royal Dutch Shell and drug makers, Sanofi and Novartis, have been trading at sub-zero rates for more than a year .Chart 3 sets the dramatic drop in investment grade corporate bond yields since the announcement of NIRs by the ECB in 2014.<br />
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEixCmwxkVOtVao3a127COgCu2Rtl61am9VZfxPLQk8-XvXY4mY_cav8MFkYNbu-TQPmQuBlegTggv1fCFoMB1MrS9GgfxQo3UiK-vxf_YLSPoHGbrqw8doKDA_L0SCXs1gbONvoJJMj3O0/s1600/Chart3.jpg" style="margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEixCmwxkVOtVao3a127COgCu2Rtl61am9VZfxPLQk8-XvXY4mY_cav8MFkYNbu-TQPmQuBlegTggv1fCFoMB1MrS9GgfxQo3UiK-vxf_YLSPoHGbrqw8doKDA_L0SCXs1gbONvoJJMj3O0/s1600/Chart3.jpg" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: FT</td></tr>
</tbody></table>
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<div class="MsoNormal" style="line-height: 19.2pt; margin: 0cm 0cm 10.9pt;">
<em>What Gives Rise to Negative Rates?</em></div>
One way to approach this question is to consider the nature of a " liquidity trap'. In describing monetary conditions in the 1930s, John Maynard Keynes coined the term "liquidity trap" in which declining interest rates fail to promote greater consumer borrowing and spending. The demand for money from consumers and business owners are no longer sensitive to the drop in interest rates.<br />
<br />
Another way to look at this phenomenon is to consider that money is essentially <em>trapped</em> in the financial system--- even at zero rates of interest, the economy fails to show any signs of meaningful economic growth. We have not seen this situation since the 1930s when Keynes first labelled it. So, it is quite a shock to the policy makers that even a zero rate of interest did not stimulate borrowing and spending . Now, some central banks have resorted to introducing unconventional means such as NIRs,<br />
<br />
Economists have cited various reasons for a liquidity trap and some are featured in today's environment:<br />
<ul>
<li><em>expectation of deflation. </em>In Japan an entire generation since the 1989 financial and property market crash has experienced deflation; consumers feel no urgency to go out and spend now, since they expect prices to fall further in the near future. In the EU, the debt crisis of 2012 has ushered in a period of austerity, accompanied by expectations of stagnation and further deflation.</li>
</ul>
<ul>
<li><em>credit tightening</em>. Following the 2008 banking crisis, banks worldwide have had to raise capital in order to improve their balance sheets ; they are reluctant to lend, regardless of the creditworthiness of the borrowers.</li>
</ul>
<ul>
<li><em>savings rate increases. </em>A pessimistic outlook will lead to consumers increasing their savings as a precaution; the debt crisis in Europe has prompted consumers and government to hold back on expenditures as part of an overall austerity policy. Savings as share of GDP is relatively high in countries featuring NIRs.</li>
</ul>
<br />
<em>Who Buys Negative Interest Bonds?</em><br />
<br />
So, who would buy a NIR bond?<br />
One category include <em>institutional investors</em> who have to own government bonds, regardless of their returns . Central banks own bonds as part of their foreign exchange reserve positions. Insurance companies and pension funds need to hold bonds as part of their reserve requirements and to match long-term liabilities.And, commercial banks need bonds to meet liquidity requirements.<br />
<br />
A second group include <em>speculative investors</em> who expect bond yields to fall further in response to other monetary policy shifts, eg. the ECB announcing an extension of its bond buying programme ( QE) , Or, these investors anticipate a currency appreciation that more than offsets the loss due to negative yields. Many foreign investors buy Japanese bonds with expectation that the yen will appreciate beyond the loss in yield. In fact, the yen has been strengthening against the US dollar over the last couple months, since the BoJ introduced its NIR policy.<br />
<br />
A third group of <em>investors have no alternatives </em>. The security and transactional cost of holding very large cash balances can be very expensive compared to a small loss from an NIR bond. Finally, government bonds ,even if yielding negative returns, are considered as a relatively cheap and safe haven in the time of market volatility.<br />
<br />
<br />
<em>How do NIRs Work?</em><br />
<em></em><br />
Let's clear up a few misconceptions.<br />
<br />
<em>First</em>, the negative rates are really aimed at the institutional investor, eg. pension funds, large corporations, The retail investor is not the target and has not been directly impacted; rates may be low, but there are positive for the retail saver.<br />
<br />
<em>Second</em>, no government is forcing an investor to accept negative rates. After all, the investor can seek higher returns in more risky assets. In fact, that is precisely the desired goal of the policy makers. However, given what happened in the 2008 financial crisis, it is entirely rational for a risk-averse investor to buy a highly liquid and safe investment to protect against a future financial crash. For example, foreign banks have approximately 17 billion Swiss francs on deposit in the Swiss central bank at negative rates as a way of protecting capital and having access to liquidity; both are prudent corporate policies.<br />
<br />
<em>Third</em>, Japan, for example, cut its deposit rate on cash held at the BoJ by the commercial banks that exceeded<em> </em>the legally required reserves; banks often find themselves with cash reserves in excess of their banking requirements and those excess reserves are normally lent to the central bank. The BoJ wants to encourage the commercial banks to make these excess reserves available for lending to consumers and businesses. The BoJ made it clear that the aim is to make more money available at lower costs to stimulate growth and inflation.<br />
<br />
The Bank for International Settlements (BIS) recently examined the how NIRs are implemented within Europe, the area with the most experience to date. The BIS concluded that:<br />
<ul>
<li> NIRs work through the money markets and other interest rates in the same way that positive rates do; no disruptions were identified.</li>
</ul>
<ul>
<li>the one major exception is that banks have been reluctant to pass negative rates to their retail customers; the fear was that negative rates would lead to major deposit withdrawals.</li>
</ul>
<ul>
<li>the drop in longer-term interest rates has taken place at the same time as ECB adopted a programme of purchasing government debt ( QE ); so, it is difficult to isolate the impact of negative rates from that of its bond buying programme.</li>
</ul>
The BIS concludes that `` looking ahead, there is great uncertainty about the behaviour of individuals and institutions if rates were to decline further into negative territory or remain for a prolonged period`` . Nevertheless, the policy, to date, has not harmed the banking system nor has it disrupted savings patterns (1).<br />
<br />
<br />
<em>Are NIRs necessary?</em><br />
<em></em><br />
<em>NIRs </em>are part of a long list of unconventional monetary policy moves which include purchases of government bonds, purchases of mortgages and other asset-backed securities,forward guidance and currency devaluations. To date, these efforts have failed to stimulate growth. Had these governments adopted expansionary fiscal policies, there would not be the need for so many unconventional policy moves, of which the latest is NIRs. In a sense, governments have been struggling to shake off slow growth and deflation with one hand tied behind their backs.<br />
<br />
Summing up, NIRs have permeated the banking world, especially in Europe and Japan and by all accounts this is not just a temporary condition. Subzero rates now extend into the longer end of the yield curve as the demand for government debt continues to remain strong. Reasons vary by investor groups as to why they participant in what is , on the surface, a counter-intuitive investment strategy. The strategy may <em>not</em> have been necessary had governments adopted more expansionary fiscal policies. Nevertheless, the jury remains out regarding the longer term effectiveness of NIRs.<br />
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(1) BIS `How have central banks implemented negative policy rates? ", M. Linnermann and A. Malkhozov, March 2016<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-51525396248668201502016-03-24T18:36:00.003-04:002016-03-24T18:36:34.059-04:00Canada`s Fiscal Policy Shift<blockquote>
Guest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_145600242818110&key=8a69ede45b8445f6b533712ba9899ffb&libId=ikvm82qu0100r7tw000DAn8hgum24&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&title=Sober%20Look&txt=Norman%20Mogil&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646" target="_blank">Norman Mogil</a></blockquote>
After nearly a decade of fiscal policy taking a back seat to monetary policy, the newly elected Liberal Government moved public spending into the driver`s seat with its first budget since the election last October. Canada will now use fiscal deficits to re-invigorate its limping economy. It has launched a policy of fiscal stimulus, lead by large infrastructure investment for at least the next five years. While the political analysts argue as to which election promises were kept and which were broken, the principle issue in the budget concerns the role of deficits in generating economic well-being.<br />
<br />
Deficit financing has been used in Canada several times over the past four decades, as successive governments contended with economic downturns (Chart 1). Recovery from the severe recession of 1980-82 and again in 1991-93, Canada ran very large deficits - in excess of 4% of GDP. From 1997 to 2008 government finances returned to the black, only to be hit hard with the 2008 global crisis, necessitating a return to deficits in the order of 3% of GDP . That deficit position was ultimately eliminated by 2014-15.<br />
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Once again, Canada faces a very difficult economic environment and now turns to deficit financing to clear a path towards higher economic growth.<br />
<br />
When the election was called in the summer of 2015, the Liberal Party advocated deficit spending and proposed a deficit of C$10 billion in the first year. By the time the budget was delivered on March 22, 2016, the forecasted deficit was increased to C$29 billion and the Government planned to run up a total C$100 billion in deficits over the next five years. What happened in the interim between the election call and the budget delivery?<br />
<br />
According to Finance Canada documents, surveys of private sector economists taken in June 2014, indicated a relatively robust growth path. ( Chart 2). However, the collapse in the commodity markets changed everything . Forecasts were significantly lowered for nominal growth GDP, by as much as 7% for 2017. The original deficit projections could no longer be justified.<br />
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The principal culprit was the severe drop in investment plans in the energy sector and its knock-on effects for the rest of the economy. Industrial sectors, outside of the energy-producing provinces, were suffering a decline in nominal incomes. Overall, capital investment in Canada has been on a decline for several years, and the collapse of commodity prices has only served to accentuate that decline. No longer can we count on the commodity sector to sustain economic growth.<br />
<br />
Canadian governments at all levels have made considerable strides in reducing debt ratios over the past 25 years. Chart 3 traces the debt-to-GDP ratio for all governments over that period. The ratio has declined from nearly 90% in the mid -1990s to under 50% today. As the deficit ratio fell, the bond rating agencies raised Canada's ratings and today the country enjoys one of the highest ratings in the G-7 countries. Within the Federal sphere, the debt-to- GDP ratio has fallen from nearly 70% in the 1990s to just over 30% today. The 2016 budget projections expect that ratio to continue over the planning time horizon.<br />
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Starting in 2016-17, the deficit will be financed by a record issuance of C$133 billion of which C$92 billion is rolling over old debt from the previous borrowings and the balance represents the deficit to be financed this coming fiscal year. Interestingly, Finance Canada recommends issuing bonds in the two-, three-, and five-year borrowing periods, rather than locking into low rates for 10 - and 30-year bonds. One could argue that, given that much of the deficit arises from infrastructure investment, they should be financing with long term rates which are at historic lows. However, if the goal is to return to a balanced budget at the end of five years, then using short-term rates seems appropriate. This was the strategy of the Harper government as it sought to return to a balanced budget by 2015. Either way, today's borrowing costs affords an opportunity to expand the budget without measurably adding to the burden of interest costs.<br />
<br />
Turning to Table 1, the outstanding Federal debt will be increased by C$113 billion over the period. Nonetheless, the debt as a percent of GDP remains static at approximately 30% throughout the period. And, more importantly, interest costs as a percent of total revenues marginally increase from 8.8% in 2016-17 to 10.3% in 2021. Both measures suggest that the Federal debt position is sustainable and does not impinge on the expansion of programs designed to stimulate the economy.<br />
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In the past, Canada has relied on foreign capital inflows to help finance it public sector deficits. Given the Federal Government's sound bond rating and also that Canada's offers competitive interest rates - certainly higher than those in Europe or Japan - there is every reason to expect that the international investing community will look favourably upon future bond issuances.<br />
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<span style="color: #262626; font-family: TiemposTextWeb-Regular; mso-bidi-font-family: Arial;"> </span> <strong></strong><br />
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The budget has prompted many forecasters to reassess their earlier growth projections.TD Canada and BAML both bumped up their forecasts for 2016 and 2017 on the strength of the proposed budget. It is no secret that the Bank of Canada has had its hand stayed, awaiting Federal budget .This level of deficit spending will be welcomed by the Bank as a tool to augment its accommodating monetary policy. The central bank estimates growth of 1.4 percent in 2016 and 2.4 percent in 2017, in the absence of fiscal stimulus. At least, the Bank now finds it has a partner in promoting economic growth.<br />
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A final word. With the EU countries under austerity regimes and the US operating with a relatively non-expansionary Federal budget, Canada now embarks upon a program of deficit financing to counter its problems of slow growth. It will be of interest to many other nations to see if this strategy is what is needed to pull out of the current weak economic environment.<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-68991593113624051282016-03-13T20:04:00.000-04:002016-03-13T22:19:09.331-04:00Canada`s Changing Financial Landscape, Part 3: Lifecos and Real Estate<blockquote>
Guest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_145600242818110&key=8a69ede45b8445f6b533712ba9899ffb&libId=ikvm82qu0100r7tw000DAn8hgum24&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&title=Sober%20Look%3A%20Canada%27s%20Changing%20Financial%20Landscape%3A%20Part%202%2C%20Banking&txt=Norman%20Mogil&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646&ref=http%3A%2F%2Fsoberlook.com%2F">Norman Mogil</a></blockquote>
<strong><br /></strong> <strong>Lifecos</strong><br />
<br />
Although innocent bystanders in the 2008 financial crisis, the life insurance companies were most impacted by the knock-on effects of the fall in equity prices, declines in long-term interest rates, poor credit quality of debt and a general decline in economic activity.<br />
<br />
As Table 1 demonstrates, the industry remains permanently ( i.e. long lastingly) impaired. Share prices of the major lifecos are, largely, below pre-2008 levels and/or have not participated in the upswing of equity prices enjoyed by other financial institutions. Major lifecos, such as Manulife and Sunlife, remain well below levels of a decade ago. More importantly, prior to the 2008 crisis, the industry commanded price-to-book values of 2.5 times, only to see that metric drop down to 1.5 times today. The industry continues to face a challenge of repairing balance sheets and of tailoring their products to reflect the changes in today`s economic environment.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsh5aRaNS4-fWORswoZBrc0ChC9MJjOb4dOREkdJAqy1lmZgNPdz2ClMut7vHQA7vEA4x_N4xSnEFH1rqcbefN2gPKir2P4jvZTZd49jjgWjt_TDXoCYcEML2QVL71-ZdHUYvRgKLuDP0/s1600/table1.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsh5aRaNS4-fWORswoZBrc0ChC9MJjOb4dOREkdJAqy1lmZgNPdz2ClMut7vHQA7vEA4x_N4xSnEFH1rqcbefN2gPKir2P4jvZTZd49jjgWjt_TDXoCYcEML2QVL71-ZdHUYvRgKLuDP0/s1600/table1.png" /></a></div>
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Above all else, the lifecos have suffered at the hands of today's low-interest rate world. They are in a constant struggle to match the return on assets to the requirements of future liabilities. Re-investing fixed income assets at successively lower rates, in effect, increases the risk of long-term liabilities. In particular, the liabilities most at risk are annuities and guaranteed income products. Low rates also affect reserves and capital margins, necessitating capital infusions to meet industry regulations.<br />
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Although the bulk of the industry`s assets are in fixed income, the industry was compelled to seek greater returns from equities and other asset classes-- the familiar "stretch for yield". Many of these other assets groups failed to provide the needed additional returns to offset the declining returns from bonds. For example, Manulife assumed a higher risk profile from the purchase of equities, specifically in the oil and gas sector; the slump in energy prices has hurt profitability. Any mismatch between assets and liabilities leads to profit volatility, a state of affairs that continues to exist.<br />
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Persistent low-interest rates are changing the product mix that lifecos offers, for example:<br />
<ul>
<li>certain long-term guarantee products will likely disappear ( e.g. permanent life insurance);</li>
<li>some risks will be shared with customers; and,</li>
<li>premiums will rise, at the risk of losing potential customers.</li>
</ul>
One bright spot is that the aging population allows the industry to expand its<br />
wealth management business. The industry is increasing its ``investment type``<br />
products, such as mutual funds, universal life policies and managed accounts. The growth of this segment is reflecting the maturity of the baby boomers and their needs for retirement income. Finally, given that the domestic market is quite mature, if not saturated, the majors are looking at markets internationally, especially in Asia.<br />
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<strong>The Canadian Housing Market</strong><br />
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If you live in Toronto or Vancouver, you cannot help but be confronted constantly by conversations about the hot housing market. Continuing a trend started more than a decade ago, home prices in these two cities registered double-digit increases in 2015. The accompanying Table 2 shows that Vancouver's home prices increased by over 20% and Toronto's by more than 10% in the past year; whereas, the rest of the country exhibited quite modest increases. The reasons behind this two-city housing market were examined previously. (<a href="http://soberlook.com/2015/08/housing-in-canada-tale-of-two-markets_2.html">http://soberlook.com/2015/08/housing-in-canada-tale-of-two-markets_2.html</a>)<br />
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<strong></strong> There has been no end of warnings by domestic and international organizations that the Canadian housing market is primed for a major fall, a correction that many consider long overdue. The Canadian Mortgage and Housing Corporation ( a crown corporation) cites the " problematic overvaluation conditions in local markets". The OECD claims that the Canadian market is anywhere from 30-50% overvalued. It is not our intention to get into this debate directly. Rather, we want to point out a number of mitigating conditions that will operate to cushion, if not actually prevent, any major decline in house prices.<br />
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<em>From the borrowers' perspective</em>, one of the most often cited metrics is that which measures the level of household debt to household incomes. There is no magic ratio that will automatically trigger a significant market decline. No one can answer the question: how high is too high? What is more relevant is the nature of the household sector's balance sheet.<br />
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Table 3 sets out some basic parameters by which to judge the vulnerability of the housing market from the perspective of household wealth. In the past 12 months, households' net worth to disposable income has increased by more than 2%. At the same time, debt-to-assets remain constant at a very low level of 17%. And, most importantly, owner's equity in their homes remains constant at 73%, indicating that homeowners have amassed a considerable amount of equity. Hence, there is an adequate buffer within the household sector, providing stability in the housing market.<br />
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<em>From the mortgage lender's perspective, </em>over the past 5 years, the Federal government has tightened up lending practices by:<br />
<ul>
<li>reducing amortization periods from 40 years to 25 years;</li>
<li>reducing the loan-to-value( LTV) lending percentage from 95% to 80%;</li>
<li>reducing the cap on gross debt services levels, and</li>
<li>upping the insurance premiums on mortgages with less than 10% down payment.</li>
</ul>
The commercial banks dominate the mortgage market, capturing over 80% of all mortgages issued. These lenders' have been relatively conservative in their management of their mortgage portfolio. On average, the major banks have issued mortgages with an LTV between 65-70%, and , in addition, 50-60% of all mortgages are insured (Chart 1). For the industry as a whole, 3% of its total loan portfolio is in uninsured real estate in Alberta. In sum, there is a considerable buffer created by the banks and the insurers in the event of a sharp decline in housing prices. Both borrowers and lenders are reasonably able to maintain stability in the Canadian market.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7Jqtb7gvbScAVV2Ztj9uhWH-znoPqAj8IgXdhO3_yt8iuyUt5bk1KawIGmtVj1RU0uT01GNjSQZRLtvVEYq1FhTpMxoRg-B5YK_TwtfZvLWCUjrQiwPPDCh622ZH48dRvNvwY52TGSZY/s1600/Chart1.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7Jqtb7gvbScAVV2Ztj9uhWH-znoPqAj8IgXdhO3_yt8iuyUt5bk1KawIGmtVj1RU0uT01GNjSQZRLtvVEYq1FhTpMxoRg-B5YK_TwtfZvLWCUjrQiwPPDCh622ZH48dRvNvwY52TGSZY/s1600/Chart1.png" /></a></div>
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<strong>Summing Up</strong><br />
<strong><br /></strong> The Canadian financial institutions have weathered the storm of the 2008 crisis, yet many challenges lie ahead. Investment dealers are struggling with changes due to technological innovation, government regulations, and a seriously weakened natural resource sector. The commercial banks are challenged by persistently low interest rates and the current weakness in the energy sector and its spillover into the national economy. The lifecos are looking at new strategies to ease the task of matching assets and long-term liabilities in an effort to stabilize profits.<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-15160535898867307032016-03-06T19:51:00.001-05:002016-03-12T19:52:20.855-05:00China's Wealth Management Products, a Q&A<blockquote>
</blockquote>
We've had a number of questions regarding the growth and the risks surrounding China's Wealth Management Products (WMPs). Here is an overview in a Q&A format.<br />
<br />
<b>Q: What are the reasons for the continuing demand and proliferation of WMPs in China?</b><br />
<br />
1. China's bank deposit rates have been extremely low over the past decade and until recently have been artificially capped by the nation's central bank, the PBoC. The reason for these low rates is Beijing's effort to make sure that the banking system has access to cheap financing in order to stimulate credit growth.<br />
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjzS0VIiCtyydJo_xmZruhxHgrbSuxJnbABAakE3sE1OUp4cvXbi_Sdqj_f-zF9_ZwFjZ7XQhi8OXWh_TfHcE6l5uJZ6Z4sbVnJ72VL4oSZuuV6iBi8PZbE1eXhZj3n3aN0TIuHLKRsOts/s1600/deposits+chi.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="317" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjzS0VIiCtyydJo_xmZruhxHgrbSuxJnbABAakE3sE1OUp4cvXbi_Sdqj_f-zF9_ZwFjZ7XQhi8OXWh_TfHcE6l5uJZ6Z4sbVnJ72VL4oSZuuV6iBi8PZbE1eXhZj3n3aN0TIuHLKRsOts/s640/deposits+chi.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: Tradingeconomics, PBoC</td></tr>
</tbody></table>
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These days, awash with deposits, many banks pay even less than the <a href="http://www.pbc.gov.cn/english/130721/2941752/index.html" target="_blank">latest rate set by the PBoC</a>. Here is one example showing why China's depositors have been desperate for yield.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7bcGdc9OrxJdCQ3XIhAj4aGLptwndfaidydSx3BiG2JEOVz5ybdjUoQJ3B8jTK8Wk1Wdri1i1Pge4jCwScjpJPSIZ7-Y0A2sktWwHMMZ6Zh9JWUY61VGJ-Cfwb-C__GpdTyzuHB036OE/s1600/cny+bank+of+china.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="640" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi7bcGdc9OrxJdCQ3XIhAj4aGLptwndfaidydSx3BiG2JEOVz5ybdjUoQJ3B8jTK8Wk1Wdri1i1Pge4jCwScjpJPSIZ7-Y0A2sktWwHMMZ6Zh9JWUY61VGJ-Cfwb-C__GpdTyzuHB036OE/s640/cny+bank+of+china.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: Bank of China (one of the 5 biggest state-owned commercial banks in China)</td></tr>
</tbody></table>
<br />
2. Another reason for the explosion in WMPs in China is the rapid growth in money supply, with limited options to deploy all the new cash. The chart below shows China's broad money supply (M2), now 15 times the size it was at the end of 1999. That's a great deal of liquidity sloshing around.<br />
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<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGkbxyOo7NwniYSorZRTdmAuRCp8ZEbm2PQAYDKPmaFmV-mMh7qupl97D5lXG8cnD0PjuLLrqtF82AXpwTkeZA7hoqTBAQYGJggg0YnKa3Um-RQMW76_3-x4K9NUxj5cxcLinzEggWvE8/s1600/Relative+growth+of+M2.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="558" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiGkbxyOo7NwniYSorZRTdmAuRCp8ZEbm2PQAYDKPmaFmV-mMh7qupl97D5lXG8cnD0PjuLLrqtF82AXpwTkeZA7hoqTBAQYGJggg0YnKa3Um-RQMW76_3-x4K9NUxj5cxcLinzEggWvE8/s640/Relative+growth+of+M2.png" width="565" /></a></div>
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3. More money poured into WMOs last year after the massive "correction" in China's stock market, as investors looked for other sources of yield.<br />
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<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjupFsP2NgD7i_2JyqoB_n4cpKuQvxWyVDyCH98laR8GXc5MLOP-sd2Be20Lc43wpXIRuzqOl9093fh0zfcjHvdSDWUP7GYGwdCKVGJtpysY9kGUlC9ImhK_4Q0vh9BO2I-f1xhIeoBgPQ/s1600/shang.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="491" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjupFsP2NgD7i_2JyqoB_n4cpKuQvxWyVDyCH98laR8GXc5MLOP-sd2Be20Lc43wpXIRuzqOl9093fh0zfcjHvdSDWUP7GYGwdCKVGJtpysY9kGUlC9ImhK_4Q0vh9BO2I-f1xhIeoBgPQ/s640/shang.png" width="565" /></a></div>
<br />
<br />
<b>Q. What rates do banks offer to their WMP customers?</b><br />
A. In 2015 the typical WMP product yield ranged between 4.5% and 5%.<br />
<br />
<b>Q. What is the typical WMP term?</b><br />
A. According to HSBC, "more than 90% of China’s fixed duration WMPs are shorter than a year".<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi6qaSNAlJYna1WEn1ZB_NwdYkIWq9xFCEO51nQ7FvhviLm1o6ipIoZU4xsR7zTBUaj40Zn1ndN344V6eImx1m_Z99jnpuPErNe9NEZ4tQ0UI18xuQlpW5ub9oGYj1gRjNae4OI_zjTtSc/s1600/Duration+of+WMP.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi6qaSNAlJYna1WEn1ZB_NwdYkIWq9xFCEO51nQ7FvhviLm1o6ipIoZU4xsR7zTBUaj40Zn1ndN344V6eImx1m_Z99jnpuPErNe9NEZ4tQ0UI18xuQlpW5ub9oGYj1gRjNae4OI_zjTtSc/s1600/Duration+of+WMP.png" /></a></td></tr>
<tr><td class="tr-caption" style="font-size: 12.8px;">Source: HSBC</td></tr>
</tbody></table>
<b><br /></b>
<b>Q. How do WMPs generate returns?</b><br />
A. These days most are invested in corporate bonds although some also invest in private loans. The most popular type of bond in WMPs' asset portfolios is a AA corporate (domestic agency ratings of course) with a 4-5 year maturity.<br />
<br />
<b>Q. What is the yield on such bonds currently and is it sufficient to pay the WMP rates?</b><br />
A. Here is the RMB AA corporate yield curve. With a little help from leverage (usually via the repo market) and/or a big duration mismatch, WMPs generate the necessary yield.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj06qIn4r5A-8v0dq8YFTYAnECQ58m-lvFcCnNJQ7ziLNYqtfQxoyEhH53ZCYeNKDtEM7S4C9nemq7WjogJoyGV2NYdGp4E6G03oeBd0DJjgXl10oJKQ2AJ0SgXhyADXSifnprtygrIv8o/s1600/AA.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj06qIn4r5A-8v0dq8YFTYAnECQ58m-lvFcCnNJQ7ziLNYqtfQxoyEhH53ZCYeNKDtEM7S4C9nemq7WjogJoyGV2NYdGp4E6G03oeBd0DJjgXl10oJKQ2AJ0SgXhyADXSifnprtygrIv8o/s1600/AA.png" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: HSBC</td></tr>
</tbody></table>
<br />
<b>Q. Has the WMP growth impacted corporate bond yields in China?</b><br />
A. Yes. Since early 2014, China's corporate bond yields have been steadily declining. A great deal of this is the result of China's WMP demand.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8k7VqQXyooe5XNTHNkW7g6RdyLo9Rt33MTBvuFz2MVEa2uRlee9MBBbFyJv587oCP38vr90jj2ablpHbMFJb7PHloRA8KpGEatxV8TTQyqJQyC1lnwt13LPga6Szln0e_jIK741RHbdQ/s1600/SP+Chi+corp+bond+yld.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh8k7VqQXyooe5XNTHNkW7g6RdyLo9Rt33MTBvuFz2MVEa2uRlee9MBBbFyJv587oCP38vr90jj2ablpHbMFJb7PHloRA8KpGEatxV8TTQyqJQyC1lnwt13LPga6Szln0e_jIK741RHbdQ/s1600/SP+Chi+corp+bond+yld.png" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: S&P</td></tr>
</tbody></table>
<b><br /></b>
<b>Q. Who manages WMPs?</b><br />
A. While banks actively market these products, these days the management is outsourced to brokers (and other non-bank entities) with asset management/trading desks. Banks used to manage WMPs but due to regulatory and resource constraints have shifted the process to third parties.<br />
<br />
<b>Q. What sort of arrangements do banks have with WMP managers?</b><br />
A. WMP managers operate like hedge funds, retaining 20-30% of the upside above the "guaranteed" contractual return of 4.5% - 5% (this is on top of the management fees).<br />
<br />
<b>Q. What type of risks are inherent in this market?</b><br />
A. Given the hedge-fund style upside, this can be an extremely profitable business, encouraging higher leverage as rates decline. Since this activity is concentrated outside of the banking system, it is not yet regulated, resulting in rapid growth in China's "shadow banking". In fact this is one of the key reasons the PBoC has been so reluctant to lower the target interest rate, focusing on the reserve ratio (RRR) instead. Lower rates will encourage further "reach for yield" and increase leverage in the system.<br />
<br />
An even greater systemic risk in the WMP market is the asset-liability mismatch - one of the key problems that precipitated the financial crisis in the United States (funding illiquid mortgage bonds with asset-backed commercial paper or repo). The chart below shows the amount of WMP placed vs. what is actually reported at year-end by banks. Many WMPs are timed to mature before the bank reporting date ("window dressing"). Most WMPs of course mature several times a year and the industry relies on the WMP customers to roll (on a net basis) their maturing WMPs. Moreover the market's tremendous growth has banks and managers believing that rolling would not be an issue. If some investors pull their money out, there will always be plenty of new ones wanting to come in. Sounds familiar?<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiXUT3TMd1ycRV_ehlgi_NSJck37Ft3MhKVk6oKyhMQ2k1xmguipxWqW_YAuYlDBotHo_CmbvQjYTYx_XaHW0JJ-EQvc3M_dAS5Z6ynHctSnIqELkmMAi35DHMXfdHrE-U33YNwQ8aTg5Y/s1600/Size+WMP.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiXUT3TMd1ycRV_ehlgi_NSJck37Ft3MhKVk6oKyhMQ2k1xmguipxWqW_YAuYlDBotHo_CmbvQjYTYx_XaHW0JJ-EQvc3M_dAS5Z6ynHctSnIqELkmMAi35DHMXfdHrE-U33YNwQ8aTg5Y/s1600/Size+WMP.png" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: HSBC</td></tr>
</tbody></table>
<br />
<b>Q. Why isn't Beijing addressing this rising systemic risk?</b><br />
A. The PBoC has to tread carefully in order to avoid disrupting its growing domestic bond markets. The situation is quite fragile and any hint of a serious regulation could send the corporate and other bond markets tumbling (starting a deleveraging cycle). As the regulators try to figure out how to contain these risks (including endless discussions with the major banks), the WMP market continues to grow.<br />
<br />
<br />
<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-47780834775408560522016-03-06T09:06:00.000-05:002016-03-06T12:43:10.523-05:00Canada's Changing Financial Landscape: Part 2, BankingGuest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_145600242818110&key=8a69ede45b8445f6b533712ba9899ffb&libId=ikvm82qu0100r7tw000DAn8hgum24&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&title=Sober%20Look&txt=Norman%20Mogil&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646" target="_blank">Norman Mogil</a><br />
<br />
Canadians generally take pride that their banks have been able to weather the 2008 storm well and continue to exhibit solid performance . Recent financial results point to growing profits, increases in dividends and improvements in reserve requirements. Yet, the industry is aware of serious challenges from the collapse of oil prices as well as the challenges that all banks worldwide face from a low or negative interest rate environment. In this blog we will look at what will influence the performance of the Canadian banks in the near term.<br />
<br />
For the benefit of our American readers, we should point out there are significant differences between the Canadian and US banking systems. The industry in Canada is dominated by six large banks ( Big Six) which are national in scope, each having as many as one thousand branches throughout the country and each providing a full range of commercial and personal banking services ( much like the money centre banks in the US) . There are dozens of much smaller banks that operate only regionally or in specific market segments In the US, even after a consolidation ,post-2008, there are about 7000 commercial banks and savings institutions , the majority of which operate independently only in local communities and have no national presence.<br />
<br />
Canadian banks feature a high percentage of assets in personal loans, especially mortgages; whereas, the US banks sell their loans through the securitization market. The Canadian banks carry very little risk of loss since higher loan-to-value mortgages must carry mortgage insurance. <br />
<br />
Finally, the Canadian financial regulatory environment has remained basically untouched even after the 2008 crisis; the US industry underwent dramatic changes that are still being implemented to this day. With a more stable regulatory environment, the Canadian industry is able to operate with little disruption, compared to what we see happening in the US and in the European market<sup>(1)</sup>. <br />
<br />
Lets turn our attention to challenges facing the Canadian industry. To begin, we note the structure of banks assets and revenues. Chart 1 sets out the asset classes and their relative importance.<br />
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<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEivg749zyaBPTvwWEqZOSZmcNiYEyukvmCylj2QW4T_gTgXSPSEyeoF5kvQz800_Vu7MV6xpMjq1Un4qPdq37bWBZTNR46rqoDHY07fNoABeGlJUggY4tYRE6H8OvCTSCYtRzuNdHHcpK4/s1600/Ch1.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEivg749zyaBPTvwWEqZOSZmcNiYEyukvmCylj2QW4T_gTgXSPSEyeoF5kvQz800_Vu7MV6xpMjq1Un4qPdq37bWBZTNR46rqoDHY07fNoABeGlJUggY4tYRE6H8OvCTSCYtRzuNdHHcpK4/s1600/Ch1.png" /></a></div>
<br />
Personal lending occupies more than half of all bank assets; personal accounts make up 16% and mortgages for an additional 36%. Business loans make up 31% of all assets. These proportions have remained relatively static over the years.<br />
<br />
Regarding revenues, Table 1 reveals that the prime source of revenue ( 47%) is net interest income (NII), the basis of all banking operations. Ever since the banks purchased securities dealers in the 1990s, the industry has grown to rely increasing on capital market returns which ,on average, account for about 21% of all revenues. Finally, the Canadian banks have steadily increased the importance of fee-based income which now generates about 1/3 of its total revenues. The question we need to explore are : what factors will impact bank revenues and, hence , profits going forward?<br />
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<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqHwePF1Da55byRYGOr5upQGIwgvBVQXSdglNFrC66IHWLoKynvYilht0-0Vtoc9635Rd5V-rts8P3i2S2sB7oJYPAxLS3iotVU0MA6Y7IItPU56dVQASQovF6KfWKaWFNvJQB7QBTreg/s1600/Ta+1.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjqHwePF1Da55byRYGOr5upQGIwgvBVQXSdglNFrC66IHWLoKynvYilht0-0Vtoc9635Rd5V-rts8P3i2S2sB7oJYPAxLS3iotVU0MA6Y7IItPU56dVQASQovF6KfWKaWFNvJQB7QBTreg/s1600/Ta+1.png" /></a></div>
<br />
There are four developments that need to be watched carefully as the industry copes with a changing environment.<br />
<br />
1) A<em>sset growth slowing</em>. Domestic personal lending, especially mortgages has slowed . The banks are concerned with their exposure to that segment of their portfolio in view of weak economic growth and, especially, the impact of a hard-hit energy sector. Caution has taken hold<span style="font-family: "calibri" , "sans-serif"; font-size: 11pt; line-height: 115%;">.</span><br />
<br />
2) E<em>xposure to the energy sector</em>. Canada's depressed energy sector is now hitting the banking community. The banks have steadily increased provisions for loan losses with each new quarterly reporting. However many analysts are arguing that these provisions are insufficient. The banks are conducting various stress tests to counter these arguments. Only six months ago, the price of oil was around $60 bbl and now trades at $30-35 bbl; the full impact of this dramatic decline has not yet been felt by lenders. The longer oil prices remain at this level, the more we can anticipate corporate and personal loan losses will climb .Time is not on the side of the banks in this regard. <br />
<br />
Industry analysts have been trying to get a handle on just what is the exposure of the Big Six to the oil patch. Exposure takes two forms: 1) direct outstanding loans and 2) untapped credit lines. In the accompanying Chart 2, according to Bloomberg.com, the total outstanding exposure is C$107 billion, not the C$ 50 billion highlighted by the banks in their recent quarterly reports. The difference lies principally in how much of untapped credit lines exist and other commitments the banks have undertaken to support clients. To be fair, these commitments in total will overstate the banks' actual risks, since not all lenders will draw down all these lines, even in times of greater difficulties; nevertheless, as the energy sector continues to operate in this tough environment , the banks' exposure needs to be watched closely.<br />
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj9VBwfAk_RB2Wgp0u6IghwooJzFje6Spgx0jK492tkWF3S07B2NPaxe_Pi3xGXDnsilKn0-tLgro-W-XgePfi8UB0BuZvIRCI3aUJVAbch4t0GhWjQKF6kkOW1R57yiYpbV5VTF-cQsH4/s1600/Ch+2.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj9VBwfAk_RB2Wgp0u6IghwooJzFje6Spgx0jK492tkWF3S07B2NPaxe_Pi3xGXDnsilKn0-tLgro-W-XgePfi8UB0BuZvIRCI3aUJVAbch4t0GhWjQKF6kkOW1R57yiYpbV5VTF-cQsH4/s1600/Ch+2.png" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: <a href="https://twitter.com/business" target="_blank">@business</a></td></tr>
</tbody></table>
<br />
3)<em> </em>N<em>arrowing of net interest margins (NII). </em>The biggest single determinant of bank profits is the shape of the yield curve. Particularly ominous for the banks is the spread between short- and long-term rates, between the 2 and 10 year rates. Banks do well by borrowing short and lending long; the steeper the yield curve, the greater the opportunity for profits. However, as Table 2 clearly points out, the trend has been moving in the opposite direction. This spread has narrowed considerably, from 100bps in 2014 to just 54bps in 2016. In an era of super low interest rates, this narrowing of the spread is putting tremendous pressure on the banks to generate profit growth quarter after quarter. Worse yet, the decline in long term rates herald a weakening economy and deflationary developments, further pressuring profitability. The spectre of negative interests, as is the case in Europe and Japan, is also of great concern to the Canadian banking community.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgrCPVIHzKwThyphenhypheny1NxtNTYB81yg1-et_-Y7b6JCYYt3wXuFgB8LgiVWPwYwXnXYWvV1HtqOoexrZPSDg3MpRHCG1MrRpJwbO1lee7ZU9hcHxXehMHO2TMbLlhjIQiL0-Xaf1St5KTiDPcc/s1600/Ta+2.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgrCPVIHzKwThyphenhypheny1NxtNTYB81yg1-et_-Y7b6JCYYt3wXuFgB8LgiVWPwYwXnXYWvV1HtqOoexrZPSDg3MpRHCG1MrRpJwbO1lee7ZU9hcHxXehMHO2TMbLlhjIQiL0-Xaf1St5KTiDPcc/s1600/Ta+2.png" /></a></div>
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<strong></strong>
4)<strong> </strong>C<em>apital market volatility.</em>
Capital market revenues have to be earned afresh each day. That is, the revenues are a combination of trading profits, underwriting and advisory services, and as such exhibit a lot of volatility. As such, these revenues cannot be relied upon as a consistent and recurring source of income in comparison to mortgages or business loans. Moreover, as we explained in Part 1 of this series, this segment of the industry is undergoing major structural adjustments and profitability is becoming illusive. (<a href="http://soberlook.com/2016/02/canadas-changing-financial-landscape.html">http://soberlook.com/2016/02/canadas-changing-financial-landscape.html</a> ).<br />
<br />
5) H<em>ousing market</em> .Canada's housing market poses an additional challenge to improving NII. There are many different opinions as to when and to what degree a slowdown in housing prices will take place. It is clear, however, that mortgage originations are not going to continue at the recent rapid rates of growth. The banks have signaled that are they concerned regarding the connection between household debt and home prices. Given that mortgages represent about half of all loans outstanding, this possible slowdown combined with a flattening yield curve will impinge on NII.<br />
<br />
We will look at this housing and mortgage topic in Part 3 of this series.<br />
<br />
<blockquote>
</blockquote>
<sup>(1)</sup> See the CIBC Bank Primer - 2015<br />
<br />
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<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-51065653690316901992016-02-28T00:24:00.002-05:002016-02-28T01:03:45.880-05:00The Fed could be back in play in 2016<blockquote>
</blockquote>
One or more rate hikes by the Federal Reserve in 2016 remains a real possibility. Why would the Fed consider such a policy action given the recent collapse in inflation expectations?<br />
<br />
Over the past couple of months many analysts and the futures markets have assigned a rather high probability to the so-called "one and done" - no change in policy in 2016. Indeed, here is what we've heard recently from St. Louis Fed President James Bullard:<br />
<blockquote>
<a href="http://www.reuters.com/article/us-usa-fed-bullard-policy-idUSKCN0VY04D" target="_blank">Reuters</a>: - The Federal Reserve must act to stop inflation expectations from getting too low, St. Louis Fed President James Bullard said on Wednesday, reiterating his concerns about continuing to raise interest rates.<br />
<br />
The U.S. central bank cannot let low inflation expectations "get out of hand," he told a dinner of bond traders here, adding he "can't stomach" currently low readings. "It's just that they've fallen so far that it's got to be a concern."</blockquote>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh92ZCekVdyNbmPWOzQAHwHJrAkZSuW9ZKeBWx_zLhvqMB4VZ1a74mNFksTlGe84A1NgF73BLxHgK5n6ueDtDT-Q_3JEi4TLhQ5Y9-PkyDvCYNlrMaQ2oxaKK7JRaeSY4AYrXom2Wz8Jwc/s1600/319ae43b-73ea-46a2-ae70-0bd60e9fb715.jpg" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="406" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh92ZCekVdyNbmPWOzQAHwHJrAkZSuW9ZKeBWx_zLhvqMB4VZ1a74mNFksTlGe84A1NgF73BLxHgK5n6ueDtDT-Q_3JEi4TLhQ5Y9-PkyDvCYNlrMaQ2oxaKK7JRaeSY4AYrXom2Wz8Jwc/s640/319ae43b-73ea-46a2-ae70-0bd60e9fb715.jpg" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;"><a href="http://dailyshotletter.us10.list-manage1.com/track/click?u=451473e81730c5a3ae680c489&id=c96436dc3c&e=ad3f47a592" target="_blank">Source: @auaurelija</a></td></tr>
</tbody></table>
<br />
However a number of researches have suggested that with a relatively stable core inflation in the United States, oil prices would need to collapse to levels that are neither consistent with today's forward curve nor sustainable. Therefore, these studies argue, the current market-based inflation expectations are simply irrational.<br />
<br />
1. Here is the latest analysis from Goldman Sachs.<br />
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<div class="separator" style="clear: both; text-align: center;">
</div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhvk4Jn0VZo4voWml95xKZH-tsHKAr8A9_zsp0ww5XSekbN8wcvzgEqfeVFYIe19Jnh1FzJDQsTt5fakz0RTwZryl1F1PavHh3PTXboeALgeYbUxpzY698VaKOvbsDi-Xh2B9TSR6WEYB4/s1600/inf+expe+gildm.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="588" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhvk4Jn0VZo4voWml95xKZH-tsHKAr8A9_zsp0ww5XSekbN8wcvzgEqfeVFYIe19Jnh1FzJDQsTt5fakz0RTwZryl1F1PavHh3PTXboeALgeYbUxpzY698VaKOvbsDi-Xh2B9TSR6WEYB4/s640/inf+expe+gildm.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: Goldman Sachs</td></tr>
</tbody></table>
<br />
2. Also, a study from the St. Louis Fed shows a similar result.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKxh5gfo3jqE1xhriIV9WcWGmD8692xANFWhLAbSOhFrtACbMEYuyjgbN6qANWS_9SmEMSNhyphenhyphenz3yowHufRdifWOUnKE18bXK2ho4mnR4voaWVrqFCYiNrhNFJ5jpkO1Y4j04dp8ALrQGs/s1600/inflation+expectations+bad.jpg" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="464" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKxh5gfo3jqE1xhriIV9WcWGmD8692xANFWhLAbSOhFrtACbMEYuyjgbN6qANWS_9SmEMSNhyphenhyphenz3yowHufRdifWOUnKE18bXK2ho4mnR4voaWVrqFCYiNrhNFJ5jpkO1Y4j04dp8ALrQGs/s640/inflation+expectations+bad.jpg" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;"><a href="https://t.co/amJYGGwz8W" target="_blank">Source: St. Louis Fed</a></td></tr>
</tbody></table>
<br />
Moreover, US inflation measures are starting to stir - especially in the services sector. This is something the FOMC is not going to ignore. Below we have some of the recent reports.<br />
<br />
1. The core PCE inflation, the Fed's primary inflation measure, exceeded consensus on Friday.<br />
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<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhNAt6ITZ0QL0f62GsKw5LsMhA0oppVDRWk5nPHjKCZKzJdu_0J3HohlTQYGFLpaF5OoYURWP9WAMJQTJTBqsxSjA-karVxsyJYm99zc65l31pHLP9TJp083-7hb_iQooSWd0rMSwzDK_E/s1600/CcKLOFgXIAAmetN.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="315" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhNAt6ITZ0QL0f62GsKw5LsMhA0oppVDRWk5nPHjKCZKzJdu_0J3HohlTQYGFLpaF5OoYURWP9WAMJQTJTBqsxSjA-karVxsyJYm99zc65l31pHLP9TJp083-7hb_iQooSWd0rMSwzDK_E/s640/CcKLOFgXIAAmetN.jpg" width="565" /></a></div>
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<br />
2. US CPI measures, both the headline and the core, also came in above expectations.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkec4oY0kqDrDQboeprQ_37-eJB6mq9ZaPciuRuSbpoR4xgd0D_XvnVESWhFUebie1Gq7xKaFosMqdHQ2OXp54Obyn01_y8hs273UVbbAi2bKGSDfI3py4hPdENOnduZCv86174y0UxiY/s1600/Cbmog-BXIAAqjR9.png" imageanchor="1"><img border="0" height="316" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkec4oY0kqDrDQboeprQ_37-eJB6mq9ZaPciuRuSbpoR4xgd0D_XvnVESWhFUebie1Gq7xKaFosMqdHQ2OXp54Obyn01_y8hs273UVbbAi2bKGSDfI3py4hPdENOnduZCv86174y0UxiY/s640/Cbmog-BXIAAqjR9.png" width="565" /></a></div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiG4u572QeLazbf432n66CQbXepEEUxGIkJ5iQ6yYramS2BT4mfBU6yLIpEmdbSVzqZ3FdDVR2DLt2eIYI7mI5bF1rcDPmlde_4GCqX5Vg0q2CXlmQl4W5dRtCupBtL8kgEk7PM1Tm8dGo/s1600/Cbmog94WwAQ079_.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="308" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiG4u572QeLazbf432n66CQbXepEEUxGIkJ5iQ6yYramS2BT4mfBU6yLIpEmdbSVzqZ3FdDVR2DLt2eIYI7mI5bF1rcDPmlde_4GCqX5Vg0q2CXlmQl4W5dRtCupBtL8kgEk7PM1Tm8dGo/s640/Cbmog94WwAQ079_.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: <a href="http://investing.com/" target="_blank">Investing.com</a></td></tr>
</tbody></table>
<br />
3. As an example of where some of this inflation is coming from, shown below is the medical care CPI. It has been subdued last year but is now is waking up again.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEid3jQV6hDgdj7Xmvrpm2k5vFjvXgh6ZvqoE6nGaXEJpZjaDwMOqAJjnIsJU-yCY0lFv22igUZvYKScLTdV8Nc6sBh7LfYYlMk6ntcY19O2hG5vwFu4mTryHo9b8fO-231kCEeOHV6Gbb0/s1600/medical+cpi.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="272" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEid3jQV6hDgdj7Xmvrpm2k5vFjvXgh6ZvqoE6nGaXEJpZjaDwMOqAJjnIsJU-yCY0lFv22igUZvYKScLTdV8Nc6sBh7LfYYlMk6ntcY19O2hG5vwFu4mTryHo9b8fO-231kCEeOHV6Gbb0/s640/medical+cpi.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: St. Louis Fed</td></tr>
</tbody></table>
<br />
Additionally, the cost of shelter in the US is now rising at over 3% per year, with the rate continuing to increase. Sadly, this is materially higher than the national wage growth rate, putting pressure on Americans with low-paying jobs.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0ICUY1E19io0UdlHGiyDVzgTmaOmE0TDI5wHHT15qmEA2LQCFKATMw8pYx4nSNJNk-AYpJWVSodNLTBOKDX0rf7qGjkr0VDpnmXsEHQUPLnmvcMxQOBWo2jKGk6-O0IYti9V_fRkJpjw/s1600/Shelter+cpi.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="284" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0ICUY1E19io0UdlHGiyDVzgTmaOmE0TDI5wHHT15qmEA2LQCFKATMw8pYx4nSNJNk-AYpJWVSodNLTBOKDX0rf7qGjkr0VDpnmXsEHQUPLnmvcMxQOBWo2jKGk6-O0IYti9V_fRkJpjw/s640/Shelter+cpi.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: St. Louis Fed</td></tr>
</tbody></table>
<br />
4. We also see the so-called "sticky" CPI (the less volatile components of the CPI) reaching 2.5% - the highest since 2009.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhf4V36rDLx_XGZ7fuayoj0Q-xpOqFHIPgX_seEoFWoNnrmHLWADbAhyphenhyphenDu8F5Ul0n_ZM-F8Z2SDi0VHEff1Jt67s1Bv7Ji_aEdOpVfckYbZOda9Ir_sBUeWfGZzMVVyeXd5e5l3TDQK2Zs/s1600/sticky+cpi.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="282" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhf4V36rDLx_XGZ7fuayoj0Q-xpOqFHIPgX_seEoFWoNnrmHLWADbAhyphenhyphenDu8F5Ul0n_ZM-F8Z2SDi0VHEff1Jt67s1Bv7Ji_aEdOpVfckYbZOda9Ir_sBUeWfGZzMVVyeXd5e5l3TDQK2Zs/s640/sticky+cpi.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: St. Louis Fed</td></tr>
</tbody></table>
<br />
Some analysts (RBS for example) have been suggesting that deflation is about to sweep the global economy, pulling in the US along the way. For now however there is simply no evidence of deflationary pressures in the world's largest economy.<br />
<br />
Other indicators released last week could add to the ammunition of the more hawkish FOMC members.<br />
<br />
1. US consumer spending was stronger than expected last month. Alas, some of this increase was driven by higher spending on healthcare, but it's an important data point nevertheless.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhwC7zVuDBzbGuFkoleX5wSW1wIn-MkaTToQuJ-pOM0UgdG_Ch1jBLk7YUVuK2kjLA8ZYO1D0Kn2dT71cL9ia_XK-iClUtHXTycZqBwtd2eJRp7H7u_vRhPpw640qkXR1_MniFaLPw2Gzo/s1600/US+consumer+spenidng.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="280" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhwC7zVuDBzbGuFkoleX5wSW1wIn-MkaTToQuJ-pOM0UgdG_Ch1jBLk7YUVuK2kjLA8ZYO1D0Kn2dT71cL9ia_XK-iClUtHXTycZqBwtd2eJRp7H7u_vRhPpw640qkXR1_MniFaLPw2Gzo/s640/US+consumer+spenidng.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: St. Louis Fed</td></tr>
</tbody></table>
<br />
2. While this next item is more symbolic in nature, it's an important milestone nevertheless. US house prices (at least according to the government's index) are finally above the pre-recession peak.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEir8Yl_efEOiVx28c5GJaLRFYDqbzJgcDUbYTYB02WvqeXrsHWlD4d1_Tg52FgMLUo634GKT0mbD59NnbZTmvxx25N9tlbBvjNj0057ugk-B1JGtpWwpvg7xvy5gK2haT6wOr6eUh-Wt_w/s1600/housing+price.jpg" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="280" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEir8Yl_efEOiVx28c5GJaLRFYDqbzJgcDUbYTYB02WvqeXrsHWlD4d1_Tg52FgMLUo634GKT0mbD59NnbZTmvxx25N9tlbBvjNj0057ugk-B1JGtpWwpvg7xvy5gK2haT6wOr6eUh-Wt_w/s640/housing+price.jpg" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: St. Louis Fed</td></tr>
</tbody></table>
<br />
The futures markets are starting to react to all these reports, with the Fed Funds futures falling on Friday (lower futures prices imply higher rates).<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsjwW96WaU7w2tIZ7pw0t4WX3LJKrTYWr0HmawiQ84hWv5_DoRZ3v-go2uiPQ8UJyapgtfuTaYlKFdyEdmsK7phENmJAsnSAj8i8tqblZ8tFZ4MiUiOKlWycTNTAuXVdnxkUTH-5opXr4/s1600/fed+fumds.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="338" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhsjwW96WaU7w2tIZ7pw0t4WX3LJKrTYWr0HmawiQ84hWv5_DoRZ3v-go2uiPQ8UJyapgtfuTaYlKFdyEdmsK7phENmJAsnSAj8i8tqblZ8tFZ4MiUiOKlWycTNTAuXVdnxkUTH-5opXr4/s640/fed+fumds.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: barchart</td></tr>
</tbody></table>
<br />
In the coming months the Fed will be closely watching two key economic measures as the Committee contemplates further rate hikes.<br />
<br />
1. Any indications of acceleration in wage growth will get the Fed going again. The high-frequency Gallup jobs indicator suggests that US labor markets remain stable, but material improvements in wage growth have been elusive.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgT_g-1zR7jXOfuKT2u2NYE8ODnXgWx3ZacLmZa7vUTWTEY1fuxciWOTPtyluHEHyl1mr3hOndgOOTevgs8-eTyesN8NbnnmetwUwwkauRoxb7nT9GJ7TLRAyx3RuzClgkVlWKF9wbqiQU/s1600/Gallup.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="285" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgT_g-1zR7jXOfuKT2u2NYE8ODnXgWx3ZacLmZa7vUTWTEY1fuxciWOTPtyluHEHyl1mr3hOndgOOTevgs8-eTyesN8NbnnmetwUwwkauRoxb7nT9GJ7TLRAyx3RuzClgkVlWKF9wbqiQU/s640/Gallup.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;"><a href="http://www.gallup.com/" target="_blank">Source: Gallup</a></td></tr>
</tbody></table>
<br />
2. The recent market turmoil has ignited concerns about tight credit conditions. The Fed's surveys suggest stricter underwriting standards in business lending while other indicators point to weakness in credit availability for middle-market and smaller businesses. And of course credit spreads have risen sharply, especially for the more leveraged firms. However the overall corporate loan growth remains close to 11% per year - for now.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhLMOimqpI8-xPL6lxBNW7lygurbVOejDeiQrJDUK7NDoobPErCTab0y70k100GUrQhjlj7H3_9keU8JMBRk83ayY17Ow19vIIhhKA2kh4KpCBtj-xfTk6hc5Hjz_VNPyPR1J32vL022fk/s1600/commercial+loans.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="278" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhLMOimqpI8-xPL6lxBNW7lygurbVOejDeiQrJDUK7NDoobPErCTab0y70k100GUrQhjlj7H3_9keU8JMBRk83ayY17Ow19vIIhhKA2kh4KpCBtj-xfTk6hc5Hjz_VNPyPR1J32vL022fk/s640/commercial+loans.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: St. Louis Fed</td></tr>
</tbody></table>
<br />
Some suggest that raising rates in the current environment is nothing short of insanity. Given the monetary easing by the ECB, the BOJ, etc. (as rates move deeper into negative territory) or the dovish stance by the BOC, the BOE, and others, the US dollar is bound to resume its rally, causing further damage to the US economy. In fact the latest PMI measures, (from Markit as well as ISM) suggest that the US economic activity has already slowed sharply in the first quarter. Nevertheless, given the Fed's focus on some of the indicators discussed above, rate hikes in 2016 are now back on the table.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXPwhuayx7xQtyNl7HxmVUOOm1F2lEb8Ttq5eB7ggyeIwMfxcE-EaAxqqqlFqYKfDgLxWM-G3nAAamY3DkidWwKuLTldqHfvLddZnF59xwNrY09TjBz52BoKRoTXC3PhKOe1a8yQEzMPI/s1600/CcAVasrW8AEx5fa.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="516" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXPwhuayx7xQtyNl7HxmVUOOm1F2lEb8Ttq5eB7ggyeIwMfxcE-EaAxqqqlFqYKfDgLxWM-G3nAAamY3DkidWwKuLTldqHfvLddZnF59xwNrY09TjBz52BoKRoTXC3PhKOe1a8yQEzMPI/s640/CcAVasrW8AEx5fa.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: Markit</td></tr>
</tbody></table>
<br />
<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-38334661572917085592016-02-20T19:00:00.000-05:002016-02-20T19:00:02.979-05:00Canada`s Changing Financial Landscape, Part 1: the Securities Industry<blockquote>
Guest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_145600242818110&key=8a69ede45b8445f6b533712ba9899ffb&libId=ikvm82qu0100r7tw000DAn8hgum24&loc=http%3A%2F%2Fsoberlook.com%2F2015%2F08%2Fhousing-in-canada-tale-of-two-markets_2.html&v=1&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646&ref=http%3A%2F%2Fsoberlook.com%2F2016%2F02%2Fthe-case-for-global-quantitative.html&title=Sober%20Look%3A%20Housing%20in%20Canada%3A%20A%20Tale%20of%20Two%20Markets&txt=Norman%20Mogil" target="_blank">Norman Mogil</a></blockquote>
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The worldwide collapse in commodity prices is now working its way through the financial markets in Canada. Canada is just now experiencing fundamental changes in the financial community, the sector better known as F.I.RE ( Finance, Insurance and Real Estate ) . This sector accounts for approximately 20% of national income and employs more than one million workers, providing a broad spectrum of services to all parts of the economy. One subsector, in particular, the investment or securities industry has been hardest hit of late.. This blog examines the adjustments in the securities industry; future blogs will look at the banks, life insurance and real estate markets.<br />
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To appreciate just how much the F.I.R.E. industry has suffered , we turn to the TSX and its major components as listed in Table 1. In the period 2007 to 2014, the Canadian stock market as a whole fell by 4%. However, the financial sector as a whole performed relatively well increasing by some 21%, largely on the back of the commercial banks, supported by good loan growth and capital market activities. However, within the investment community, independent investment houses have taken quite a beating. The two publicly traded companies, GMP and Canaccord, have seen their corporate value been truly been decimated ( a price drop of 80%) . Finally, the lifecos have yet to recover from the 2008 crisis and continue to see their stocks trade well below pre-crisis levels ( as much as 60% lower).<br />
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These trials and tribulations continued over the past 12 months as all segments of the FIRE industry have seen values drop further. Along with the decline of the TSX60 , the finance sector is off a further 19% , partly in concert with the decline in world stock markets, but more reflective in the fall in oil and other commodity prices. Even the much vaulted Canadian banks are feeling the impact of losses in the energy sector. REITs which have been a haven for investors are now in decline( off by 18%). And, of course, the investment dealers continue their slide as they suffer under the weight of several factors unique to the industry. We now turn our attention to those issues.<br />
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<strong> Investment Industry Under Pressure</strong><br />
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The securities industry, and in particular, the independent dealers are crucial to a well-functioning capital market. The big six banks have swallowed up major investment dealers in the 1990s; they use these investment firms to continue to fund large publicly traded companies . Independents, on the other hand, supply funds to small and medium size industries, especially in the resource and tech sectors. Often these companies are deemed too risky to qualify for conventional bank lending . Thus, they have filled an important gap in the capital markets and their current weakened position will have an adverse impact on the effectiveness of the Canada's capital markets to promote economic growth. <br />
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These are not happy days for the investment dealers. Revenues are weak, costs are escalating and the nature of their business is undergoing structural changes.<br />
The number of firms have declined as part of a wider consolidation as profitability is squeezed throughout the industry. Chart 1 illustrates the change in revenue sources between 2007 and 2015.<br />
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With the exception of fixed income trading, all categories of revenues have declined, especially equity trading commissions and investment banking fees - two stalwarts of the past. Table 2 summarizes the main financial operating results of the past 12 months. The two notable impacts have been the reduction in revenues and the rise in the cost of operations. Overall, profitability is dismal compared to prior years--- 4.6% rate of return in an industry accustomed to rates of 20% or more. As a result, shareholders' equity has taken a beating, forcing weak companies out of business and others to shore up capital to meet regulatory requirements. What is behind this poor performance?<br />
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A series of radical changes has hit the industry simultaneously :<br />
<ul>
<li> <em>the collapse of the commodity markets. </em>Many of the independent firms specialize in financing medium size resource/extraction enterprises; the collapse resulted in very few investment banking opportunities, shrinking that revenue segment of the industry significantly,</li>
</ul>
<ul>
<li><em>technological driven price wars</em>. There has been a relentless move towards lower commission prices and electronic trading, contributing to the fall off in revenues.</li>
</ul>
<ul>
<li><em>compliance and regulatory changes. </em> Ian Russell the President of the Investment Industry Association of Canada (IIAC), estimates these costs have risen by 7% in 2015, on top of a 6% rise in 2014. He believes " the relentless rise in operating costs will squeeze profitably" in 2016.</li>
</ul>
<em> </em>The industry features many small independent, boutique -size firms that no longer can compete for capital; the bulk of the firms are capitalized at $10 million or less, precluding them from participating in larger financing deals. Russell expects a further consolidation as firms either merge and/or shut down. <br />
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The IIAC recently conducted a survey of its members on the outlook for the industry.<br />
The majority of members remain pessimistic , citing the following:<br />
<ul>
<li><em>Rising costs</em> owing to higher compliance and new technology requirements; both add to staff and to total operating costs;</li>
</ul>
<ul>
<li><em>Weak economic conditions</em> as Canada adjusts to the new realty in commodity prices and the slowdown in world trade;</li>
</ul>
<ul>
<li><em>Consolidation and restructuring.</em> Over the past 4 years, 25% of the industry has left the business through mergers and amalgamations , closing operations entirely or transferring business out to competitors.</li>
</ul>
It is no wonder that the majority of the industry leaders expect further contraction in the coming years as part of shake out in the industry . It may turn out, in the longer run, that the Canadian capital market will benefit from this re-structuring and may be stronger as a result. However, at present, the principal concern is that this consolidation will negatively affect the viability of the industry to participate in the financing of future economic growth.<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-49910027633020314752016-02-14T14:34:00.000-05:002016-02-14T14:34:13.099-05:00The case for “global quantitative tightening”<blockquote>
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Guest post by Marcello Minenna<br />
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In January 2016, global foreign reserves (FX) continued their decline after an absolute peak in June 2014, declining significantly in distressed emerging countries and some notable oil-producing economies (see Figure 1).<br />
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Figure 1.
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China and Saudi Arabia, the leading owners of foreign reserves outside the OECD circle, both experienced an outflow greater than 5% of their outstanding reserves in less than 6 months (see Figure 2). A common factor explains these drawdowns: both the countries are struggling to defend their currency peg to the Dollar. The pressures on the exchange rates can be traced back to three intertwined drivers: the (still to come) interest rate hike cycle in the US, the low oil price and the China slow growth. While the “US rate hike tantrum” can be considered as a symmetrical shock for all the worlds currency different from the Dollar, the other factors have hit the distressed countries in differentiated ways.
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From the Chinese side, the worsening growth’s prospects and strong capital outflows are forcing the People bank of China (PBOC) to employ its FX reserves with the aim to manage a controlled, but unavoidable, devaluation. Meanwhile, the persistent slump oil price (that depends a lot from China’s slowdown) have decimated the revenues of the Saudis. Since these money flows count for over 80% of the State budget, the government is now tapping the debt market at the astronomical pace of 16% of GDP at year to compensate for the loss. This dramatic reversal in the health of public finances obviously put pressure on the fixed peg with the dollar.
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<div style="text-align: center;">
Figure 2.</div>
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Indeed, as it emerges from the comparative analysis of Figures 1,2, both the declines for China and Saudi Arabia took off and reinforced during the prolonged crash of the oil price. The same phenomenon can be appreciated on a global scale (Figure 3): world FX reserves peaked and declined in sync with the oil price. Net of “value effects” that depend from the changing composition of the reserves, falling oil revenues and GDP slowdown in major exporting countries remain significant explaining factors.<br />
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<div style="text-align: center;">
Figure 3.
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4c6BHMfZkMTw9eWI-2Bt7_5g-DEzuF8NKoybF6uo29ZRNVpbxhWOMhQhTQdRy1uCnqYCibcp9IG-Q6rV2wYHPYNdWvCv9oeJYy5CntrjZiA1JgxW0kQW_GDCwJok_RgvEgzQxKOfwx14/s1600/3.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="462" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4c6BHMfZkMTw9eWI-2Bt7_5g-DEzuF8NKoybF6uo29ZRNVpbxhWOMhQhTQdRy1uCnqYCibcp9IG-Q6rV2wYHPYNdWvCv9oeJYy5CntrjZiA1JgxW0kQW_GDCwJok_RgvEgzQxKOfwx14/s640/3.png" width="565" /></a></div>
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A central bank’s monetary policy stance is often captured better by changes in their overall balance sheet that comprehend both FX reserve movements than other conventional monetary policy actions, e.g. reserve rates cuts or repo operations. Broad-based indicators such as monthly variation in central bank total assets are more informative of the aggregate global value of central bank liquidity.<br />
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Figure 4 illustrates the historical movements of central bank assets in the past 6 six years: Fed QE 2 and 3 are clearly identified by the navy bars, and Shinzo Abe’s QQE (Qualitative and Quantitative Easing) is captured by the red bars. The first expansion in ECB balance sheet of 2011-2012 (light blue bars) is attributable to the two big LTROs, and the subsequent contraction is due to LTROs repayment by European banks. In 2015 the Draghi QE (the Public Sector Purchase Programme or PSPP) has taken off and has pushed the ECB net liquidity flows in positive territory. It’s interesting also to notice the expansionary pulses of the Swiss National Bank (SNB) monetary policy, aimed at maintaining the peg of the Swiss Franc with the Euro in 2012-2014. The last frantic efforts ended suddenly in January 2015, when the ballooning the of SNB balance sheet and the accelerating expansion of the monetary base forced the SNB to readjust the CHF /EUR exchange rate.<br />
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<div style="text-align: center;">
Figure 4.
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Declining FX reserves caused concern in global markets following the decision of the PBOC to abandon the Renminbi fixed exchange rate with the Dollar. Struggling against mounting pressures on the Renminbi / Dollar exchange rate, the People Bank of China flooded the market with US Treasuries, causing a spike in yields and turmoil in global equities. Since selling foreign assets acts as a counterbalance to Quantitative Easing, some market participants applied the phrase Global Quantitative Tightening (QT). In other terms, by liquidating US Treasuries and other OECD government and private bonds, the central banks of emerging countries resupply the market of securities, balancing the purchase made by their OECD counterparts. This QT action by emerging and oil-exporting countries would therefore drain liquidity from the market, neutralizing expansionary policies of Eurozone and Japan. In this perspective the $ 130 billion of fresh money injected monthly via asset purchases by the OECD central banks would be offset by their emerging counterparts.<br />
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Our indicator of central banks' global liquidity seems to support this reconstruction. In 2015, EM central bank sales of foreign assets reduced central banks’ liquidity flows (Figure 5). The effect began in July and peaked in September during the Renminbi crisis.<br />
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Figure 5.</div>
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The concept of global QT gained traction in September 2015 as the negative correlation between global equities and foreign reserves increased. The Fed’s decision to maintain interest rates relieved the downward pressures on Renminbi and the interest in QT quickly waned. <br />
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There have been reasoned opinions on the economic theory behind global QT. More than one analyst correctly observed that a USD asset sales by foreign central banks will not drain liquidity and counteract Fed monetary policy because these assets simply change hands and do not disappear. Changing ownership does not preclude reinvestment in the US banking system, which limits the sale’s tightening effect. Moreover, as already pointed out, changes in foreign reserves may not reflect a central bank’s attitude towards monetary policy since they do not account that other conventional monetary policy actions on banks’ reserves or interest rates can dominate changes of foreign reserves. <br />
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In the last quarter of 2015, the correlation between global stock indices and central banks net liquidity is again up (see Figure 6).<br />
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<div style="text-align: center;">
Figure 6.</div>
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Remarkably, temporary positive net flows of central banks liquidity are associated with the markets rebound of October 2015.<br />
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We are obviously aware that correlation does not necessarily mean causation. From a broader perspective, it's more than reasonable that the same three cyclical drivers that explain drawdowns in foreign reserves (China’s slowdown, the US rate hike cycle, and collapsing oil prices) are also affecting equity markets.<br />
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We should acknowledge these changes in foreign reserves as a reaction by emerging countries central banks to these three primary factors. Nevertheless, their impact on net liquidity, which may mitigate monetary expansion by the ECB and BoJ should be worthy of further investigation.<br />
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<b>Further Reading:</b><br />
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Winkler, Robin, “The Great Accumulation” Is Over: FX Reserves Have Peaked, Beware QT”, Deutsche Bank Market Research (September 2015).<br />
<br />
Asymmetric Wager Blog, September 11, 2015 Economics: The Myth of "Quantitative Tightening" <a href="http://prodiptag.blogspot.in/2015/09/economics-myth-of-quantitative.html" target="_blank">http://prodiptag.blogspot.in/2015/09/economics-myth-of-quantitative.html</a><br />
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Discussion on FT Alphaville, September 14, 2015 "Debunking quantitative tightening in one paragraph?" <a href="http://ftalphaville.ft.com/2015/09/14/2140021/debunking-quantitative-tightening-in-one-paragraph/" target="_blank">http://ftalphaville.ft.com/2015/09/14/2140021/debunking-quantitative-tightening-in-one-paragraph/</a><br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-14341640447165666352016-02-07T19:56:00.000-05:002016-02-07T19:56:00.253-05:00The Golden Age<blockquote>
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Guest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_145488435220212&key=8a69ede45b8445f6b533712ba9899ffb&libId=ikd4jl6g0100r7tw000DAc1ywlvwq&loc=http%3A%2F%2Fsoberlook.com%2F2016%2F01%2Fbig-bad-china.html&v=1&out=https%3A%2F%2Ftwitter.com%2Fsobata416&ref=https%3A%2F%2Fwww.google.com%2F&title=Sober%20Look%3A%20Big%20Bad%20China&txt=%24hane%20Obata" target="_blank">$hane Obata</a><br />
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<br />
Some people say that gold is dead. They point to deflationary pressures and a bear market that started back in September of 2011. The bulls have been wrong for years; however, that may be about to change…<br />
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At present, there are multiple reasons to consider gold:<br />
<ul>
<li>Sentiment is very negative and almost everyone is underweight</li>
</ul>
<ul>
<li>Supply & demand fundamentals are positive</li>
</ul>
<ul>
<li>Chinese demand continues to rise</li>
</ul>
<ul>
<li>Gold is a means to portfolio diversification</li>
</ul>
<ul>
<li>The main risks to prices are overblown</li>
</ul>
In the next sections, we will examine the bull case for gold and the risks facing it. In conclusion, we will try to answer the following question: Is this the beginning of a new golden age?<br />
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<b>Sentiment & Positioning</b><br />
<br />
In the latest <a href="https://www.google.ca/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&uact=8&ved=0ahUKEwievafgsM3KAhWDgYMKHU1nAmAQFggcMAA&url=http%3A%2F%2Fwww.barrons.com%2Farticles%2Fbulls-gain-ground-in-barrons-fall-big-money-poll-1445055740&usg=AFQjCNH2KrOh4oQn2FOhtBthYJsXYp57Ng&sig2=_cqtdXIm8jBEIw0eO_Notg" target="_blank">Barron’s Big Money Poll</a>, only 3% of respondents thought that gold was the most attractive asset class. Moreover, 71% were bearish on the yellow metal. Volume traded in $GLD (the SPDR Gold Trust ETF) has come down dramatically, which indicates a lack of interest in gold bullion. Volume traded in $GDX (miners) and $GDXJ (junior miners) has been increasing; however, <a href="https://www.google.com/trends/explore#q=gold%20mining%20stocks" target="_blank">interest in “gold mining stocks”</a> has been falling since mid-2011. This suggests that traders are trying to catch the falling knife, even though investors are not convinced that gold is undervalued.<br />
<br />
In terms of positioning, market participants are heavily underweight materials and commodity stocks. Is this a contrarian buying opportunity? It could be. Especially because the current bear market is getting old. The following table shows the 5 most recent bull and bear markets:<br />
<div>
<br /></div>
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<br />
Gold prices fell by 44% over the 52 months from September of 2011 to January 7th of 2016. Those numbers match the median length and average cumulative return of the previous 4 bear markets. Gold may continue to fall from here; however, we are probably closer to the end of the bear market than to the beginning…<br />
<br />
<b>Supply & Demand</b><br />
<br />
~46% of gold production is FCF negative at current prices. In other words, $1100 is not the equilibrium price. If we stay at these levels then supply will likely decline. Analysts at Credit Suisse ($CS) are projecting a deficit to begin in 2016. They expect that mine supply will fall by 11.5% from 2015 to 2018:<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKpToa-EwWV9ILu7xpkKyvStdOsEf1CIIxYuu9CX8wlIko6JhBg_yT2LzOAXUy5ub_RfC1n35CPCtFVqwsGtdCR68Ez-tFXyFTMJvnIFn6dQtsgwhyphenhyphenUXNJ3QTKLbpN_6Dpq82MD3Roufw/s1600/f2.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="280" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiKpToa-EwWV9ILu7xpkKyvStdOsEf1CIIxYuu9CX8wlIko6JhBg_yT2LzOAXUy5ub_RfC1n35CPCtFVqwsGtdCR68Ez-tFXyFTMJvnIFn6dQtsgwhyphenhyphenUXNJ3QTKLbpN_6Dpq82MD3Roufw/s640/f2.png" width="565" /></a></div>
<br />
Even at higher prices, gold miners will be unable to replace all of their depleting reserves. Also, it will be very expensive for them to bring new projects online. Lastly, it is important to note that<a href="https://twitter.com/sobata416/status/692416314057564160/photo/1" target="_blank"> major gold discoveries have become scarce</a>. These trends are negative for supply and positive for prices.<br />
<br />
On the demand side, Asia and Europe should continue to support the market. Total bar and coin demand (in tonnes) increased 33% YoY from Q3’14 to Q3’15. Furthermore, consumer demand was up across the board, with exceptionally big numbers in the US. According to the World Gold Council (WGC), “coin sales by the US mint during the quarter were on par with that of Q4 2008.” Another key source of demand is central banks. They have continued to buy <b>as they look to diversify their reserve assets</b>. This speaks to gold’s utility as a portfolio diversifier. Total demand has been falling; however, the quarterly numbers suggest it could be stabilizing. Going forward, consumer demand is likely to offset ETF outflows.<br />
<br />
India & China are the main drivers of demand for gold. In 2014, they accounted for ~1710 tonnes of demand. To put that in perspective, <b>1700 tonnes = 53% of total consumer demand</b>:<br />
<br />
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<br />
<br />
Gold is a big part of both India’s and China’s culture. As such, it is likely that demand will remain strong.<br />
<br />
<b> China’s Gold Market</b><br />
<br />
There is an interesting divergence taking place in the physical gold market. China’s demand numbers, as measured by withdrawals from the Shanghai Gold Exchange (SGE) are much higher than those reported by the World Gold Council (WGC). SGE withdrawals exceeded the WGC’s demand estimates by <b>3,193 tonnes</b> from 2007 to 2014.<br />
<br />
The following passage is from Bullion Star’s Koos Jansen helps to explain the discrepancy. “The difference was labeled as net investment (in the CGA Gold Yearbook 2013 at 1,022.44 tonnes), which is calculated by the China Gold Association (CGA) as a residual between what is withdrawn from the SGE vaults and gold sold at retail level (jewelry shops and banks). <b>The WGC doesn’t count net investment on its demand balance, but only measures what is being sold at retail level</b>. Net investment, which roughly equals the difference, can only be caused by direct purchases from individual and institutional customers at the SGE that withdraw their metal.”<br />
<br />
In China, gold imports must pass through the SGE before entering the market place. In addition, bullion exports are prohibited. It follows that <b>Imports + Mine Supply + Scrap = Total Supply = SGE Withdrawals</b>. Said another way, SGE withdrawals are equivalent to domestic wholesale demand. The preceding formula is supported by reports from the CGA and the SGE. For example, the SGE reported that 2197 tonnes were withdrawn its vaults in 2013. That is the same number that the CGA reported for total demand in 2013. More evidence comes from the SGE’s chairman, Xu Luode, who said the following in 2014:<br />
<br />
The main conclusion is that the SGE’s measure of Chinese gold demand is much higher than the WGC’s. If the SGE’s number are correct then China is absorbing most of the world’s mine supply. Gold withdrawals from the SGE for 2015 amounted to <b>2596 tonnes, or 91% of world gold production:</b><br />
<div>
<br /></div>
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<br />
<br />
<b>Diversification & Protection</b><br />
<br />
Gold has a negative correlation with US stocks during expansions. More importantly, <b>its correlation with both global and US stocks is more negative during contractions:</b><br />
<br />
<div class="separator" style="clear: both; text-align: center;">
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<br />
<br />
As a result, gold tends to rise when stocks fall, which is good for portfolio diversification.<br />
<br />
Gold is also an FX hedge for foreign investors. In 2015, <a href="https://twitter.com/sobata416/status/686638601602334720/photo/1" target="_blank">it performed relatively well in non-dollar currencies</a> such as the Brazilian Real, the Russian Ruble, the Chinese Yuan and the Canadian dollar. This is important because non-US countries are the main consumers of gold.<br />
<br />
Loose monetary policy is here to stay. This cycle, <a href="https://twitter.com/sobata416/status/692444850663350276/photo/1" target="_blank">every central bank that tried to raise rates has had to reverse course</a>. That is bad for currencies and good for gold, since no one controls its supply.<br />
<br />
Gold can also protect us against a rising cost of living because it tends to hold its value over time. If you look at the CPI then inflation seems relatively low. That said, the CPI is a utility index, not a measure of the cost of living. Most people would agree that cost of living is rising. For example, <a href="https://twitter.com/TenYearNote/status/690184900477980672/photo/1" target="_blank">education and medical care costs have been outpacing the CPI for years</a>.<br />
<div>
<br /></div>
<b>Risks</b><br />
<br />
Gold’s main threats are…<br />
<br />
1) A stronger USD<br />
<div>
<br /></div>
Typically, the US dollar index and gold are negatively correlated. Said differently, when the dollar index does up, gold goes down. Even so, last year, the US dollar (USD) influenced gold prices more than it usually does. In 2015, the correlation between the two was -0.50 in 2015, much higher than -0.36, which is the 30-year average. Going forward, it’s likely that the correlation between gold and the USD will revert back to normal.<br />
<br />
An additional concern is rising rates. One may assume that higher interest rates are good for the dollar. Actually, that is not the case. Historically, <a href="https://twitter.com/sobata416/status/692445270336999424/photo/1" target="_blank">the dollar has stopped appreciating when the US raised rates</a>. If the USD index has peaked then that would be good for gold prices.<br />
<br />
2) Rising rates<br />
<br />
Despite the fed’s intentions, <b><a href="https://twitter.com/ConnectedWealth/status/692735312490029056/photo/1" target="_blank">the yield curve (2s10s) has flattened to its lowest levels of the expansion.</a></b> The short end has increased but the long end, which is driven by growth expectations, has not. Basically, the market is not convinced that the era of low rates is over.<br />
<br />
Even if rates do increase, gold may perform well. According to Sundial Capital Research, <a href="https://twitter.com/sobata416/status/625513811429191680/photo/1" target="_blank">gold actually does quite well in rising rate environments</a>. Gold prices increased by an average of 25.2% in each of the rising rate environments from Dec31’76 to Dec27’13. The median gain was 5.2%, which is much less impressive but still positive. Low rates are probably better for gold than high ones. That said, it may show good returns either way.<br />
<br />
3) Leverage<br />
<br />
In the US, the paper gold market is much bigger than the physical one is. In other words, many contracts are traded but not much gold changes hands. The level of gold dilution has reached unprecedented levels. <a href="http://www.zerohedge.com/news/2016-01-26/comex-snaps-gold-dilution-hits-record-542-oz-gold-claims-every-ounce-physical" target="_blank">In a recent blog post</a>, zerohedge showed that there are 40 million ounces worth of open interest but only 74 thousand ounces of registered gold at the Comex. <b>This works out to a gold cover ratio (open interest/registered gold) of 542!</b> The takeaway point is that the amount of gold that is traded is much greater than the amount that actually exists.<br />
<br />
The downside risk is that supply in the futures market overshadows demand in the physical market, thereby weighing on prices. Still, there is an upside risk. If demand for physical gold remains strong and inventories continue to fall then then the Comex may run out of supply. If that happens then gold prices will rise as market participants start to question the divergence between the paper and physical markets.<br />
<div>
<br /></div>
<div>
<b>Conclusion</b></div>
<br />
Gold should be considered as a contra buy…<br />
<br />
<ul>
<li>It is hated</li>
<li>Its fundamentals are improving</li>
<li>Demand from the east is robust</li>
<li>It is negatively correlated with stocks</li>
<li>The benefits outweigh the risks</li>
</ul>
<br />
Gold is massively under owned. <b>If sentiment improves then it could easily outperform other asset classes in 2016…</b><br />
<br />
<br />
<br />
<br />
<a href="https://twitter.com/sobata416" target="_blank">$hane Obata</a> & <a href="http://dir.richardsongmp.com/web/RGMP-Asset-Management/home" target="_blank">Richardson GMP AM</a><br />
<div>
<br /></div>
Edited by <a href="https://twitter.com/MattGarrett3" target="_blank">Matt Garrett</a>.<br />
_________________________________________________________________________<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-21016708944753650242016-02-07T08:33:00.000-05:002016-02-07T17:06:57.817-05:00Canada Adjusts to the Oil Price Shock<blockquote>
Guest post by <a href="http://lwlink3.linkwithin.com/api/click?format=go&jsonp=vglnk_145470251834610&key=8a69ede45b8445f6b533712ba9899ffb&libId=ika4a1570100r7tw000DA1fy83tlaxy3py&loc=http%3A%2F%2Fsoberlook.com%2F&v=1&out=https%3A%2F%2Fca.linkedin.com%2Fpub%2Fnorman-mogil%2F84%2F591%2F646&title=Sober%20Look&txt=Norman%20Mogil" target="_blank">Norman Mogil</a></blockquote>
What does the oil price collapse mean for Canada? A simple question with an the answer that is anything but simple. As the Governor of the Bank of Canada (BoC), stated the "<em>oil price shock is complex because it sets in motion several forces</em> " that will alter the path of Canada's economic future. The Governor goes on to argue that "it may take up to <span lang="EN-US" style="mso-ansi-language: EN-US;">three years for the full
economic impact to be felt, and even longer for all of the structural
adjustments to take place.” Just what are the <em>structura</em>l and <em>time</em> factors that we need to understand as we adjust to the new environment of lower commodity prices? </span><br />
<br />
We start out by considering the structure of the Canadian economy. This will help identify how the various sectors of the economy will be impacted in the future. Broadly speaking, Canada is a service-based economy (70% of output) and only selectively a goods-producing country (30%). The largest component of services is the finance, insurance and real estate (FIRE) which now comprises about 20% of national income. These industries surpass the contribution of mining, oil/gas and energy distribution (17%) and manufacturing (10%). The strength of the services sector blunts much of the pain of falling oil prices.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
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<br />
<strong>Immediate Impacts of the Oil Price Collapse</strong><br />
<br />
Taking a snapshot of what has happened in the past 12 months, we note in Table 2 that:<br />
<br />
<ul>
<li>Oil prices declined by 40% in 2015, the Canadian dollar sank another 20%, on top of a 20% drop in 2014. The currency bore the greatest adjustment ;</li>
</ul>
<ul>
<li>The currency devaluation did not , however, affect trade picture. The current account balance remained deep in negative territory;</li>
</ul>
<ul>
<li>National output clocked in at a dismal rate of less than 1%;</li>
</ul>
<ul>
<li>The rate of inflation accelerated due to the falling currency and its impact on basic imports, especially food products; and,</li>
</ul>
<ul>
<li>Unemployment remained steady at around 7% for the year 2015.</li>
</ul>
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiVNOqsJfyZWQKPQzlDcrCqBw8xMNftn6ondW7eZAmePKBUg1pOgFhoAMPwUkmv_yuEatILqXmcnGZFL5qMXBd_Y2XiMnfRwYMfXWwER0oqMLJ_19X84GQpHaYOe3_Q7o98jlUGt9NvVfw/s1600/Table+2.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiVNOqsJfyZWQKPQzlDcrCqBw8xMNftn6ondW7eZAmePKBUg1pOgFhoAMPwUkmv_yuEatILqXmcnGZFL5qMXBd_Y2XiMnfRwYMfXWwER0oqMLJ_19X84GQpHaYOe3_Q7o98jlUGt9NvVfw/s1600/Table+2.png" /></a></div>
<br />
Viewed from a national perspective, the oil price collapse has had a marginal impact on the economy during 2015. The burden of adjustment has fallen almost exclusively on the exchange rate; most other indicators have not change appreciably . However, below the surface, we are seeing evidence of the deteriorating conditions. <br />
<br />
Within the resource sector, employment declined by 9-12% and incomes have fallen as much as 15-16% ( Table 3). More importantly for the future, the cumulative decline in business investment in this period was 8% and ,in the case of engineering structures, (related to resource development) the decline was 13%.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
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<br />
The dominance of the service sector and other non-energy goods producing industries allows for national income and jobs to remain in positive territory. In other words, the impact of falling oil prices has, temporarily, been confined to the resource sector and to its geographic centre. The emphasis is on <em>temporarily</em> since there are longer term consequences facing the country as it comes to terms with the worldwide deflation in commodity prices. <br />
<br />
<strong>Longer Run Adjustments</strong><br />
<br />
Research staff at the Bank assessed the path of economic growth over the next 3-5 years<em> assuming that commodity prices remain at current levels</em>.(1) Theirs is an attempt to map out the path the economy would likely take ,given the new reality of low commodity prices..<br />
<br />
The analysis sets a control" scenario in which commodity prices remain at mid-2014 level. Results are then measured against the "control" scenario. Thus, an outcome that is “lower” implies it is lower than in the "control "case, not that it is lower in absolute terms. By the end of 2020 we can expect that:<br />
<div style="text-align: left;">
<br />
<ul>
<li>capital investment in the commodities sector to be lower , reducing the economy's buildup of productive capacity; this results in a lower potential GDP growth rate;</li>
</ul>
<ul>
<li>the share of commodities in the economy will decline toward the pre-boom levels of 2002;</li>
</ul>
<ul>
<li>exports as a share of national income will be lower due to the decrease in the terms of trade; </li>
</ul>
<ul>
<li>domestically, households will gradually adjust to lower wealth and incomes; and</li>
</ul>
<ul>
<li>personal consumption will be lower, reflecting the reduction in incomes.</li>
<li></li>
</ul>
</div>
These outcomes strongly indicate that it will take much longer to absorb the current excess capacity. Investment, consumption and overall growth will be lower than had the oil prices not collapsed . Simply put, the road to recovery has now become longer and steeper.<br />
<span lang="EN-US" style="mso-ansi-language: EN-US;"><o:p></o:p></span><br />
<br />
------------------------<br />
(1) <a href="http://www.bankofcanada.ca/wp-content/uploads/2016/01/san2016-1.pdf">http://www.bankofcanada.ca/wp-content/uploads/2016/01/san2016-1.pdf</a><br />
<br />
<strong></strong><br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-33869916727906782542016-01-30T17:48:00.003-05:002016-01-31T14:41:33.053-05:00US consumer is the last defense against strong dollar drag on the economy<blockquote>
</blockquote>
We continue to receive questions about the impact of the recent dollar strengthening on the US economy. The most immediate impact of course is on trade, which has created an immediate drag on the GDP growth.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsCK1ziEMGrnakURDu4fc2_ZdhRdVCUD_yVrWTO7Sdk_XE9G9i7M5X-CALXxt_F9HSvpmwO8eAXvKgl3uefTRFLfTtOTTSqvfm99pesXmJKSaNCdTxTJMHNJGjhvTe0JyQQNVkQ6xsZ_g/s1600/dollar+gdp.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="565" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgsCK1ziEMGrnakURDu4fc2_ZdhRdVCUD_yVrWTO7Sdk_XE9G9i7M5X-CALXxt_F9HSvpmwO8eAXvKgl3uefTRFLfTtOTTSqvfm99pesXmJKSaNCdTxTJMHNJGjhvTe0JyQQNVkQ6xsZ_g/s640/dollar+gdp.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: St Louis Fed, Goldman Sachs</td></tr>
</tbody></table>
<br />
We know that the impact on US industrial production in particular has been terrible.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiJLYZdcIfCsucofLIqZdL4pBAj35mX2CVyMhflZzlcS_kxkWk6Hl0NvM0Hm5jPY20r0D5Js3AxNmZKByS8vrYL-KRXjIjoMdS3yJjHZ93LHvf8vl2kjNsHSAc60GH4rXzsAPPaTCmrKhk/s1600/Indus.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="277" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiJLYZdcIfCsucofLIqZdL4pBAj35mX2CVyMhflZzlcS_kxkWk6Hl0NvM0Hm5jPY20r0D5Js3AxNmZKByS8vrYL-KRXjIjoMdS3yJjHZ93LHvf8vl2kjNsHSAc60GH4rXzsAPPaTCmrKhk/s640/Indus.png" width="565" /></a></div>
<br />
On the other hand this currency appreciation, combined with weaker energy prices, is supposed to improve consumption as imports become cheaper.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhyYH7dbIrQycbOIJwvkP_viFvzKW2eEeutQRvxIIBpdArSCrE4DiMMZ8NLq_U_CIL32sXuy9zhnsoar_QX7OXMt3p3dBb2hG2IbopQ3bwADRq3atPj_CWKwD7SMJuM6hC08OA7gVy18nk/s1600/Import+price+index.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="283" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhyYH7dbIrQycbOIJwvkP_viFvzKW2eEeutQRvxIIBpdArSCrE4DiMMZ8NLq_U_CIL32sXuy9zhnsoar_QX7OXMt3p3dBb2hG2IbopQ3bwADRq3atPj_CWKwD7SMJuM6hC08OA7gVy18nk/s640/Import+price+index.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">The chart shows US import price index</td></tr>
</tbody></table>
<br />
And of course all the cheap fuel (combined with a warmer winter) should be providing material support to US households.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYMqug4Q_236wgb5i1p-SXBLbntsHsxyFJ7YNDdDsxX651yfiXGXn4qmcANC099FR5ZS8s9_gM1VvWeXL4eabGhItD79TKYUYPxVPwi9hQBJV7cpZkJeguWlU_W0Jjl1CmdI62WNsquZ4/s1600/gasoline.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="320" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYMqug4Q_236wgb5i1p-SXBLbntsHsxyFJ7YNDdDsxX651yfiXGXn4qmcANC099FR5ZS8s9_gM1VvWeXL4eabGhItD79TKYUYPxVPwi9hQBJV7cpZkJeguWlU_W0Jjl1CmdI62WNsquZ4/s640/gasoline.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">US average gasoline price</td></tr>
</tbody></table>
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi6ZN3KMqp3EJYZHPqKmr2w59xCl1HFfntEN_9NE2OTKBF_KwLCrlrtH4Xik6BzSpgJWX4C8ujM-b3uNVqnwIx-0hgID2zZpw_LNmv-h6TjCkb0rQm215VUAKnkqKUmvvQZ8NdU0VN4NAk/s1600/cheap+fuel.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi6ZN3KMqp3EJYZHPqKmr2w59xCl1HFfntEN_9NE2OTKBF_KwLCrlrtH4Xik6BzSpgJWX4C8ujM-b3uNVqnwIx-0hgID2zZpw_LNmv-h6TjCkb0rQm215VUAKnkqKUmvvQZ8NdU0VN4NAk/s1600/cheap+fuel.png" /></a></div>
<br />
Will that be enough to give US consumer spending a boost? Goldman outlines two potential scenarios, the second one of which leads to a contraction in US gross output.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiyxoUEOzzp9WMw_XvMqfVUekpEyRnf-jsTJd9wW9i9nhRfH3H2fjfkaJQtV1NPwHYCXWF2aTitlWi7lstBOrw1N3Kz3WaUiZ9Cwl_WjHBlpepjl3ERsVm4ZcB8XNVVyJ_UMOP7UUQY9cc/s1600/Consumer.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="565" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiyxoUEOzzp9WMw_XvMqfVUekpEyRnf-jsTJd9wW9i9nhRfH3H2fjfkaJQtV1NPwHYCXWF2aTitlWi7lstBOrw1N3Kz3WaUiZ9Cwl_WjHBlpepjl3ERsVm4ZcB8XNVVyJ_UMOP7UUQY9cc/s640/Consumer.png" width="505" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: Goldman Sachs</td></tr>
</tbody></table>
<br />
The full impact of the US dollar rally thus depends very much on the behavior of the consumer in the months to come. From a balance sheet perspective US households certainly don't seem to be "stressed", as the Financial Obligations Ratio remains near multi-decade lows.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4LbsmZ4rqFcsPdBU84IMTmZEci_XfKB3Sb3qvKNJfJN5SDzH90sguW29xHb3WE-GwBaojbinqhJ6ULGeJG1Hu6wbHHY7tojTOWaYdIVTRIu0D28xSac_YQOnRyJUg0pztQ25lELTP4Jk/s1600/FOR.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi4LbsmZ4rqFcsPdBU84IMTmZEci_XfKB3Sb3qvKNJfJN5SDzH90sguW29xHb3WE-GwBaojbinqhJ6ULGeJG1Hu6wbHHY7tojTOWaYdIVTRIu0D28xSac_YQOnRyJUg0pztQ25lELTP4Jk/s1600/FOR.png" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: @SoberLook, FRB</td></tr>
</tbody></table>
<br />
Moreover, high-frequency economic sentiment data, while showing some stock-market induced jitters, remains robust. <br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYInfYZhoUWpLpa7e8JI6saqrU9eyfEEdsJyjl_cdIyGOY2P7LVPzBQs9KwfhyrE0xivMVPwcBtf4yktkF7ncel9jJnx9GMhEzEX1U6OgWsvcMmHdUPW9gO6In7thQsJQKwIROALhWcas/s1600/consumer+sentiment.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="291" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgYInfYZhoUWpLpa7e8JI6saqrU9eyfEEdsJyjl_cdIyGOY2P7LVPzBQs9KwfhyrE0xivMVPwcBtf4yktkF7ncel9jJnx9GMhEzEX1U6OgWsvcMmHdUPW9gO6In7thQsJQKwIROALhWcas/s640/consumer+sentiment.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: Gallup</td></tr>
</tbody></table>
<br />
Whether this will translate into stable spending patterns remains a question. According to Gallup, at least through December, US consumer spending has been solid.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhhOPIeyLyUQhYd4vaV7XHNsBkHfJDu8FhQ9hXB3IzpxR7s31UVWUuj9NgVS6z2I2w5xiNd-18kBhqiIoXfw2CkbD2EYbpEkzmOsDXxrcYz__jMLsuJg9vTJbsCpYXMXUZgBoDDGaF8zp4/s1600/Consumer+spending.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="270" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhhOPIeyLyUQhYd4vaV7XHNsBkHfJDu8FhQ9hXB3IzpxR7s31UVWUuj9NgVS6z2I2w5xiNd-18kBhqiIoXfw2CkbD2EYbpEkzmOsDXxrcYz__jMLsuJg9vTJbsCpYXMXUZgBoDDGaF8zp4/s640/Consumer+spending.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: Gallup</td></tr>
</tbody></table>
<br />
The equity markets however are now pricing in a much weaker discretionary spending pattern, while companies focused on staples seem to be doing much better. Note that much of the divergence has taken place this year. Is the market concerned about consumer retrenchment?<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2g00JwcQW99L2fEb7TFUwnAwwR5qwF3vzcCgFpcX6v26DQHkehYw-es0P2QR3IbJw0XBGKR9n1fPtX7G1LYi0yy5tMwAQiWB10rUL4BICfT_Z_qtkrHmuWWBhmO5iP2tVd1fzqNepVMU/s1600/consumer+staples+discretionary.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="304" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj2g00JwcQW99L2fEb7TFUwnAwwR5qwF3vzcCgFpcX6v26DQHkehYw-es0P2QR3IbJw0XBGKR9n1fPtX7G1LYi0yy5tMwAQiWB10rUL4BICfT_Z_qtkrHmuWWBhmO5iP2tVd1fzqNepVMU/s640/consumer+staples+discretionary.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: Ycharts</td></tr>
</tbody></table>
<br />
The December GDP report (0.7% growth) showed that growth has already slowed as financial conditions tightened. A great deal of this tightening has been driven by the US currency appreciation.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhfTyv0kg4SrZVN6t5Orc_tjxq5dbeYy4EVcCGlhhVcRezNoOTLLKHKlKncmJNgxsHEoK7mWK8aKvUvjN8N1En1s_v_L5s0G9QsbPB5aUdvbFJ2JWF-AvmqsuPwIFOh67jQ5pMXVBTvsUI/s1600/Financial+conditions+index.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="402" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhfTyv0kg4SrZVN6t5Orc_tjxq5dbeYy4EVcCGlhhVcRezNoOTLLKHKlKncmJNgxsHEoK7mWK8aKvUvjN8N1En1s_v_L5s0G9QsbPB5aUdvbFJ2JWF-AvmqsuPwIFOh67jQ5pMXVBTvsUI/s640/Financial+conditions+index.png" width="565" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;"> Source: @jbjakobsen </td></tr>
</tbody></table>
<br />
Consumer spending stability in the next few months is therefore critical. Strong US dollar has created a significant drag on economic activity but economists are betting that the consumer tailwinds should support growth,. If however the consumer (spooked by the recemt sharp correction in the equity markets) retrenches, US growth could stall.<br />
<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Unknownnoreply@blogger.comtag:blogger.com,1999:blog-6745623459054860497.post-34302281457514914322016-01-24T11:13:00.002-05:002016-01-24T11:13:47.140-05:00Currency Realignment and Export Growth Guest post by <a href="https://ca.linkedin.com/pub/norman-mogil/84/591/646" target="_blank">Norman Mogil</a><br />
<br />
<br />
The realignment of currencies in the past 18 months has been the most dramatic in decades. A perfect storm is occurring: Federal Reserve tightening; Eurozone and Asian monetary easing; and a collapse of major commodities, all conspire to drive just about every currency in the world to lower values against the USD. Governments are anticipating that this re-alignment will revive economic growth, lead by the external sector. How likely is to happen?<br />
<br />
Two recent studies, from the IMF and OECD, draw attention to the question of<br />
how effective are devaluations in changing the fortunes of "open" economies. The term "open" refers to those economies which generate a significant portion of national income from exports, such as Germany, Canada, and several Asian economies. Before reporting on the studies, it is helpful to get a sense of the reasons behind devaluations, the extent of currency adjustments and the importance of exports to major trading nations.<br />
<br />
Table 1 groups these devaluations by size and by importance as measured by the contribution of exports to national income.<br />
<br />
* <em>Depreciation in excess of 25% </em>The greatest depreciations has happened in those countries that are highly dependent on commodity exports, --- Russia, Canada, Australia and South Africa. The worldwide collapse of major commodities resulted in significant declines in their respective trade accounts and national income. Commodity markets are over-supplied and these currencies are not expected to recover anytime soon .The big concern is when will commodity cycle reach bottom and for how long will they remain there.<br />
<br />
*<em>Depreciations of 20-25%</em> . This group includes both manufacturing exporters<br />
( eg Germany) and natural resource exporters ( eg Sweden). The European currencies have adjusted downwardly in part a reflection of the EU debt crisis and domestic deflation.<br />
<br />
* <em>Depreciations of 10-20% </em> This group includes highly industrialized countries such as Japan and the UK , countries that have benefited from lower commodity prices, and <br />
<br />
* <em>Depreciations of less than 10%.</em> The final group features emerging economies,<br />
( eg China, India) that convert imported raw materials into intermediate and final goods for export.<br />
<br />
No major trading country escaped the surge in the USD last year, a condition that is carried forward into 2016, especially in the wake of further declines in oil and other major commodities.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi680soaaJYv4_ObatwDyn8GxFvGhqWEgbnc5O-ggpN6IBmy0N6pK1e_AKgJM2wz3-rNsl7t9PW_wLYJs949jHqnHE1ajd6o3skSvdONTKjFJIvsbW9GmmjJy7qq3iIqCXJD_RCet2Vi5w/s1600/t1.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi680soaaJYv4_ObatwDyn8GxFvGhqWEgbnc5O-ggpN6IBmy0N6pK1e_AKgJM2wz3-rNsl7t9PW_wLYJs949jHqnHE1ajd6o3skSvdONTKjFJIvsbW9GmmjJy7qq3iIqCXJD_RCet2Vi5w/s1600/t1.png" /></a></div>
<br />
<br />
<br />
<strong>The IMF Study</strong><br />
<br />
The IMF study starts with two basic questions: how responsive are exports to changes in the exchange rate; and has that responsiveness changed over time?(1) The agency estimates the "elasticity of demand"; this measures how price changes affect demand. A number equal to or greater than 1 indicates that demand for exports is very sensitive to exchange rate changes ( ``elastic``) a number less than 1, demand is less sensitive to exchange rate adjustments (``inelastic``). (2). <br />
<br />
The IMF examined dozens of countries and several sectors over a 15-year period . Their findings are summarized in Table 2. Exports are less sensitive to exchange rate movements over time; half as much in the case of all exports and nearly half as much in the case of manufactured exports. That elasticity has lessened over time and across sectors casts doubt on the effectiveness of the recent currency realignments in promoting growth of exports.<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiaGgs8EBdrGZXxecK7aNamgs518Nn4BDncExc6L5ul3nS_EWnn0B0I8YTAYY5eeXMrlvecrywTn2z1OjRgz2BoP9Bq6jBsKVCkBa9MZg1KlRVgT9idfw4NvDs30V2VqMnX1cDu6muMIic/s1600/t2.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiaGgs8EBdrGZXxecK7aNamgs518Nn4BDncExc6L5ul3nS_EWnn0B0I8YTAYY5eeXMrlvecrywTn2z1OjRgz2BoP9Bq6jBsKVCkBa9MZg1KlRVgT9idfw4NvDs30V2VqMnX1cDu6muMIic/s1600/t2.png" /></a></div>
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<br />
The IMF researchers offer some explanation for why demand for exports are less responsive to exchange rate depreciation compared to previous decades. First, worldwide trade has slowed, especially since the 2008 crisis, although the IMF points out that the change in elasticity pre-dates that financial crisis year.
Secondly, a more important reason is offered. The IMF states "intuitively, as countries are more integrated in global production processes, a currency depreciation only improves <em>competitiveness of a fraction of the value of final good exports" (</em>1)
. This explanation leads us to the OECD study on importance of the foreign value added in determining the effectiveness of depreciating one's currency.<br />
<br />
<strong>The OECD Study</strong><br />
<strong></strong><br />
The OECD examined one aspect of globalization that relates to devaluation and export performance. It recognized that a country`s exports are increasingly reliant on intermediate goods imported from foreign suppliers. The agency measures<br />
"trade in value added" in which it traces the value added in each country and in each industry as part of the production chain leading to final exports. Often overlooked is that devaluation raises the cost of imported inputs. The more a country is integrated within the worldwide supply chain, the less it can expect a currency depreciation to drive export growth--- the high cost of imports mitigates much of the advantages of a lower currency. <br />
<br />
Take the case of Canada .(Chart 1). Canadian exports contain 25% foreign value added, more than that of the US , its largest export market and competitor. The comparison is even more pronounced in the case of transportation equipment. Canadian transportation exports contain more than 50% foreign content ; the US contains only 29% imported value added . Transportation exports comprise the second largest export sector in Canada after oil. This degree of reliance on foreign content suggest that the devaluation of the Canadian dollar will have limited effectiveness in improving the trade imbalances .<br />
<br />
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<a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh6f9RoZ9ttoHve05_s0Nr0hyphenhyphenjqU5tdKdh5ZteoCsiug1NJKEDMOPuKZPKd1VjXpC2sXzT1rl5fJXBkTLk_LWEqqOnxaVEMZqyOfcqUxWycoRv8PrCBfqj42A4pCcTeUdOyQgsstgvNE40/s1600/T3.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh6f9RoZ9ttoHve05_s0Nr0hyphenhyphenjqU5tdKdh5ZteoCsiug1NJKEDMOPuKZPKd1VjXpC2sXzT1rl5fJXBkTLk_LWEqqOnxaVEMZqyOfcqUxWycoRv8PrCBfqj42A4pCcTeUdOyQgsstgvNE40/s1600/T3.png" /></a></div>
<br />
<br />
So,will devaluation work as a means to stimulate export growth and trade in general? Canada is a good case in point.<br />
<br />
At the global level, trade is expected to expand at less than 3% this year, one of the slowest paces since 2000. The forces that lead up to the currency re-alignments, namely a collapse in commodity prices and a slowdown in world manufacturing continue to plague the world. Canadian non-energy exports have to contend in this difficult environment.<br />
<br />
As long as commodity prices remain down for long count, Canada will not see any marked improvement in its trade balances . Many observers are pinning their hopes that fall in the Loonie will promote the expansion of non-energy exports. However, it is more likely that Canadians will undergo a fall in their standard of living as long as oil prices remain at these current levels. Simply, the slack is too great to be picked up by non energy exports alone.<br />
<br />
Canada relies heavily on the worldwide supply chains for production of exports, more than its US competitors .This integration works against the perceived advantage of a lower Canadian dollar.<br />
<br />
No longer can we expect devaluation to be a panacea.<br />
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1) IMF, "Depreciations without Exports ?" (2015)</div>
2) The negative sign indicates that the exchange rate and quantity demand are inversely related.<br />
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<div class="blogger-post-footer">www.SoberLook.com</div>Anonymoushttp://www.blogger.com/profile/03313767737385682926noreply@blogger.com