Fed Mountaineering

The US Federal Reserve has stopped so-called quantitative easing, namely the buying of US Treasuries and mortgage bonds. But it has not yet allowed the maturing assets to run off its balance sheet. Instead it has reinvested funds to keep the outstanding sum of assets pretty stable since 2014, at around $4.2 trillion. As recently as the end of March 2017, the Fed still had $2,464bn of Treasury notes and bonds plus $1,769bn of mortgage-backed securities on its books, totalling $4,233bn. In 2017, the Fed is likely to begin reducing this mountain, while trying to avoid an avalanche.

The following chart shows how the mountain grew after the 2007-08 crisis struck:

A Fed study in 2012 estimated that for every $300bn of Treasury bond purchases, yields fell by some 30 basis points. This was believed to be due to a 'stock effect' that lowered the supply of bonds in the market, raised their price and so reduced yields. This is only one influence on the market, but it is evident that there will be upward pressure on yields once the Fed starts selling off its accumulated stock.

The potential impact is widespread. It will run from higher US government borrowing costs and higher mortgage rates to higher corporate bond yields (since these have the government yield as a baseline). Interest rates in international markets will also be influenced by the level of US rates. This is especially so for the more vulnerable 'emerging market' economies. All of these have huge levels of debt that are likely to become more expensive to service.* Much of the latter's debt is also US dollar-denominated, which puts them at further risk if their currency values fall.

Tony Norfield, 6 April 2017

Note: * See the reviews of debt trends in a range of countries in the September 2016 articles on this blog.

Pictures of Trouble

Two charts from the Bank of England sum up interesting aspects of capitalism's problems today.

First, the decline in long-term government bond yields. These have been on a steady downward trend since 1990 (actually, for even longer, since the mid-late 1980s), as shown in the following chart which gives GDP-weighted average 10-year yields for the top 20 countries. It is not only that nominal yields have fallen alongside lower inflation, but 'real yields' have also fallen and are now negative. The estimate of real yields is only approximate, but the picture is clear enough.

Chart 1: 10-year government bond yields, 1990-2016

The drop in yields has been accentuated by central bank asset purchases under 'quantitative easing' (QE) policies, but not fully explained by them. Outside Japan, QE only got going from 2008. Lower yields are a problem for pension funds and other bond investors, while making the huge debts accumulated by borrowers (see earlier articles on the blog) somewhat easier to service and pay back. This delicate, unstable balance results from the difficulties the capitalist economy has had producing enough profit, or growing enough to produce anything extra at all.

Chart 2: Central bank balance sheets, 2006-2018

The second chart shows the shows the rise in central bank balance sheets as a percentage of GDP. This has come about as a result of QE policies, and the Bank of Japan (note that only Japan is measured on the left hand axis), the Bank of England and the European Central will add to their accumulated assets in the next few years. Only in the US has the share of GDP not gone up recently, and is not projected to under current policies. Even for the US, the absolute holdings of Treasuries and mortgage-backed securities are not likely to fall by much.


Tony Norfield, 2 October 2016

Europe Gets Even More QuEasy

Today the European Central Bank did what financial markets had expected, after lots of leaking of the policy moves. They announced they would buy securities in the asset markets, at a rate a little higher than had been expected of €60 billion per month, from March 2015. The policy will continue until inflation looks like getting closer to 2%, which, with the slump in energy prices, will be a while yet. In all likelihood, this extra asset buying (there has been some before) will amount to a bit over €1 trillion and last until September 2016, maybe longer. For comparison's sake, the new policy is around 10% of euro area GDP, compared to the US and UK policies of 'quantitative easing' that have amounted to more than 20% of GDP.

This policy move is the latest in a series that indicate there is no way out of the crisis. How can anyone believe that this policy, essentially making government bonds have even lower yields, can do anything for the economy when 10-year government borrowing costs were already less than 1% in Germany and France and less than 2% in Italy and Spain, the euro area's biggest economies?

The central bank's notion is that this will feed into private sector borrowing costs being lower, but there are some difficulties here. One is that there is very little demand to borrow to invest, given the dire economic outlook; the other is that banks would not to lend at anything like the sub-1% or 2% numbers to private investors, and the level of interest rates is not the problem. The problem is that there is no profitable avenue for large-scale capital investment, or any investment that does not depend upon government subsidy, tax dodging or some form of financial trickery. Even the countries that claim they have done better than the euro average - especially the US, but also the UK and Switzerland - are now faced with higher currency values against the ones that are under the market's cosh. Last week, the Swiss National Bank's made a dramatic move to abandon its 3-year attempt to stabilise its currency against the euro. This was done largely in anticipation of this week's action by the ECB and so far the euro's value has fallen 18% against the Swiss franc. Unsurprisingly, the euro fell another 1-2% today.

The ECB made a concession to German worries about the new policy. They said that 80% of the risk of the new purchases would be borne by national central banks, because central banks in the euro area might buy rubbish and face a loss. In its press releases today, they did not explain who would buy what, or how much. Because the scale of the buying, if it is not directed, would evidently be concentrated on the better risks - Germany, especially - a proviso was included: only up to one-third of a country's outstanding debt could be bought in this way, and the debt had to have a maturity of 2-30 years. Germany has around €1.1 trillion of debt outstanding, with less than this in the 2-30 maturity range. So these, the 'safest assets', will not be able to use up more than about a third of the new programme. German government securities out to a maturity of 5 years also have a yield that is zero or negative. So, presumably, this is good news for the government securities of France, Italy and Spain, the other countries with large bond markets.

The ECB's hope is that the lower yields will force investors to take on more economy-boosting risks. Instead, the likelihood is that there will be a continued reliance by capitalists on 'making money' through financial investment, something that further stretches the gap between value creation and financial accounting. On occasion, that gap is narrowed by a slump of financial market prices for bonds and/or equities, but the ECB has signalled that it will gamble for a while longer on trying to push the gap still wider.

Tony Norfield, 22 January 2015

Operation Twist

If somebody took money out of one pocket and then put it back into another, it would be hard to think that there had been any significant change. That is what the US Federal Reserve has just done, and it is meant to be a major policy initiative! I would not normally want to discuss in this forum the details of yields available on US government securities, but the latest policy move from the US Fed demands that these be given some attention.

Today, the Fed announced a new anti-crisis policy that has been dubbed ‘Operation Twist’, and the more closely one examines what is going on the worse is the conclusion one must draw about the prospects for US (and global) capitalism. Faced with official interest rates that are already zero, and having a balance sheet that holds nearly a trillion dollars of toxic bank securities from previous rounds of its ‘quantitative easing’, the Fed has basically run out of room to implement further expansionary monetary policies. This is no small problem, since the previous policies have had no lasting effect on the economy. So, its latest trick is to alter the mix of assets it holds, leaving the total size of its balance sheet unchanged. The basic idea is to sell one portion of its US government securities and to use the funds to buy some more.

One may sensibly ask: ‘What possible good can this do?’ The official rationale is that the Fed thinks that short-term yields are already low enough – since it has promised to keep interest rates at zero until mid-2013 – but that long-term yields are still too high. It believes that the high long-term yields are a constraint on investment and on spending in the economy. By selling $400bn of government securities on its books that have maturities up to three years, it can buy $400bn in the market with maturities from six up to 30 years. One-third of the $400bn is to be spent on US Treasuries with 20-30 years to maturity. The effect will be to push shorter-term yields up and longer-term yields down.

Following the Fed announcement, two-year yields did rise from 0.l6% to 0.20%, and yields beyond six years fell. But the problem comes to light when one looks at the level of yields that is supposed to be holding US capitalism back. The 10-year US Treasury yields fell to 1.86% today, the lowest for more than 60 years. But before this drop the yield was only 1.94%. The 30-year yield fell from 3.20% to 3.00%. These yields are lower than CPI inflation, currently running at 3.8% year-on-year.

The low level of yields reflects stagnant investment and a crisis of capital accumulation. The Fed trying to make long-term interest rates even lower will do little to change this, and its own lack of confidence is revealed in its assessment that “there are significant downside risks to the economic outlook, including strains in global financial markets”.

Another dimension of the Fed’s new policy was that it would use any early repayments from its holdings of mortgage securities to reinvest back into debt issued by mortgage agencies such as Fannie Mae. So, rather than looking forward to getting rid of toxic assets, it is committing to keep the same volume of junk on its books!

The Fed’s policies are not exceptional. Similar stunts are under way from the Bank of England, the European Central Bank and others as they grapple with the intractable crisis. However, the latest trick must rank high in the annals of moribund capitalism!