There has been an interesting juxtaposition of stock markets overnight which has gone in the opposite direction to the old economic world/new economic world debate. Yesterday evening the US Dow Jones Industrial Average rose by 217 points or 1.7% to 13,177 whereas this morning the Shanghai All Ordinaries Index has fallen by 64 points or 2.6% to 2391. For twenty-four hour period that is quite a shift and we see an economy that is still growing strongly being outperformed by one where the performance looks to have improved but the jury is still out. The problem with using stock markets as a guide is the question this poses or which price is right? Yesterday’s or today’s (or neither)? In other words the television programme “The Price is Right” missed out not always in the title.
The US Central Bank or FOMC Meeting
There was little real news here as the FOMC confirmed that it thought that the US economy had improved since its last meeting. For example its statement that the US economy was “expanding moderately” dropped this bit “notwithstanding some slowing in global growth”. We also got these.
Labor market conditions have improved further……. Household spending and business fixed investment have continued to advance……the unemployment rate will decline gradually toward levels that the Committee judges to be consistent with its dual mandate.
Nothing especially ground shaking is there? There was something further down the report however which could have been written by the Bank of England.
The recent increase in oil and gasoline prices will push up inflation temporarily, but the Committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate.
So an admittal of inflationary pressure and confirmation that the central bank mantra where inflation is always tempoary still applies. For newer readers my financial lexicon defines “temporary” for central bankers and politicians as any period between now and the end of time!
Operation Twist “Untwisted”
Last September the FOMC announced the above mentioned programme to reduce longer-term interest rates. It has spent a considerable sum of money on this but they are now higher than when it started. I established some benchmarks at the time.
In terms of government bond yields then the five-year yields 0.84% the ten-year yields 1.94% and the thirty-year yields some 3.21%. Moving onto currencies then the trade-weighted US dollar index stands at 77.15.
The two main tests are the ten-year yield which has now risen to 2.18% and the thirty-year yield which has risen to 3.33%. So as we stand that is a fail for Operation Twist and the implied aim of reducing the value of the US Dollar is not going well either as the trade weighted dollar index has risen to 80.37. The economic effect of this was supposed to be a boost for the housing market which has remained mostly in the doldrums.
Another implication of this feeds into a more recent theme the weakening of the Japanese Yen which has now fallen to 83.40 versus the US dollar. No wonder the Nikkei 225 equity index has broken the 10,000 barrier.
There is plenty of food for thought here for those who support more widespread central bank action. A problem I have labelled under “exit strategies” will now be arising for the FOMC. The bonds it has bought under Operation Twist are making a loss on a mark to market basis and any further economic strengthening will lead to higher yields and more losses. We have become used to very low levels of bond yields in some countries but in a recovery we are likely to see considerable rises. Adding to this the objective of Operation Twist was to buy longer -term bonds so the problem will remain for a long time. It is not only the European Central Bank which has issues with its balance sheet.
For me this is one of the problems of Quantitative Easing type policies which is that for what have been limited and debatable gains (even supporters have taken to using the owrd counterfactual which is applicable to anything…) balance sheet losses are potentially wrapped around the can which is kicked into the future. In the UK the Bank of England purchased some £691 million of out 2060 maturity bond yesterday and in spite of this the price fell heavily (1.8 points).
The UK considers issuing a 100 year Gilt (government bond)
This idea was first floated before Christmas and has gained ground overnight. As ever the mainstream media has handled it badly with phrases like “debt for generations”. As it does not change the amount of debt we have or the time period we intend to have it for this is utter rubbish as we would have been borrowing in one form or another anyway.
The actual position requires a little more nuance. For the UK taxpayer it is an excellent idea as it locks in low borrowing costs. As someone who has worked through periods where we have had to pay 15% on our longer-dated debt then current 3% and a bit seems very low and for the issuer that is good. Also it helps to avoid crunches in difficult economic times where debt needs rolling over and we have seen this affect Greece this month with the deadline for her March 20th bond approaching with little cash to pay it without another bailout. Debt management is a UK strength and this would improve it.
The other side of the coin is buyers and here is the problem, who would buy it? To buy at such levels for such a long time you either have a very pessimistic view of the UK economic outlook probably combined with a very optimistic outlook on UK inflation, or you do not know what you are doing! Oh and the problem with an economic view that pessimistic is will there be any money to pay you in 100 years time? The current economic outlook which I discussed only on Monday looks rather stagflationary and that is a long way from the best outlook for a fixed coupon bond holder.
Will the Bank of England buy it?
Under its current strategy of buying longer dated gilts such as our 2060 stock the answer is yes I think. There are thresholds to cover off such as it will not buy for a week after issue and it only buys Gilts with more than £4 billion in issue. If you want the day it will probably be Tuesdays as it tends to buy the longest dated stock then. Mind you perhaps we should be looking at the Bank of England’s balance sheet too as UK Gilt yields are following American ones upwards with our ten-year yield now at 2.27%. Losses on a 2112 maturity bond will take a lot of hiding for a very long time, does Mervyn King have a son or daughter ready to step into the fold? Oh and do they have any kids as well?
A Musical link
As purchasers of such a Gilt (including possibly UK taxpayers and their children and granchildren should the Bank of England buy it…) are likely to have as troubled a time as those who have held our previous long-term Gilts like War Loan I thought they might like something to sing. From the Welsh songstress Duffy.
I don’t know what you do
but you do it well
I’m under your spell.
You got me beggin’ you for Mercy (yeah yeah yeah)
Why won’t you release me (yeah yeah yeah)
You got me beggin’ you for mercy (yeah yeah yeah)
Why won’t you release me (yeah yeah yeah)
I said release me (yeah yeah yeah)
Oh and as a final thought for you if the government had any faith in its inflation forecasts should we not also have a one hundred year index-linked Gilt?