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Thursday, January 29, 2015

North American Bond Market Fireworks

Chart: U.S. 10-Year Treasury Bond Yield

There is very little going the Treasury bond bears' way this year. They could not even be saved by a hawkish FOMC statement yesterday. Looking North, the Bank of Canada decision may be better explained by the downward revisions to job creation in 2014.


Wednesday, January 28, 2015

You Cannot Judge A Fiscal Stance By The Deficit

One of the difficulties with analysing fiscal policy is that the policy stance is relatively hard to measure (at least compared to monetary policy, where we can try to judge the effect of policy by looking at the policy rate*). We cannot look at the fiscal deficit, as it is driven by economic activity, and it is not under direct control of policymakers. (That is, it is endogenous, not exogenous.) For example, we cannot say that austerity policies were not implemented in the euro periphery just because fiscal deficits continue. This has also come up in the argument by Scott Sumner that "Keynesians" were wrong in their predictions about a recession in the United States in 2013.


Saturday, January 24, 2015

What Are Government Promises Worth - Gold, The SNB, And Sovereign Debt (Part 2)

The Swiss National Bank (SNB) decision to dismantle its financially sustainable currency target against the euro, raises questions about the values of other government promises. I explain herein why I believe that inflation target commitments are fairly credible, while nominal GDP level targets less so. This is the second part of a three-part article; the third part will discuss why commitments to repay debt are strongly credible. (The first part discussed currency pegs, and is found here.)

Wednesday, January 21, 2015

Bank Of Canada - Policy Error

The Bank of Canada surprised markets (and me) and cut the overnight rate to 0.75% from 1% today. Even though I have been saying that the Canadian economy is doomed for a long time, I think this was a policy error. Interest rates 25 basis points lower will have no measurable effect upon the economy, but it will most likely be interpreted as the beginning of a (very short) rate cut cycle. Since rate cut cycles are almost invariably associated with recessions, the correct question to ask: what does the Bank know? The biggest risk facing the economy is a loss of confidence in the ability of Canadian households to service their debts; increasing uncertainty is the last thing Canada needs. The weaker Canadian dollar will take quarters or even years to help growth (as a result of the J-curve), but confidence within the housing market could be lost within weeks.

What Are Government Promises Worth - Gold, The SNB, And Sovereign Debt (Part 1)

The shock decision by the Swiss National Bank (SNB) to drop its policy of capping the strength of the Swiss franc came as a shock to most, and proved to be financially painful for some. Certain policies, such as gold or currency pegs, are inherently unsustainable, and the only question is the timing of the end of the policy. But in the case of the SNB's policy, it appeared financially sustainable, as they have unlimited capacity to create francs. This creates an uncomfortable parallel with government bonds - they are typically viewed as default risk-free since the government can create money at no cost.

Saturday, January 17, 2015

Book Review: The Shifts And The Shocks


The book The Shifts and the Shocks: What We've Learned - And Have Still To Learn - from the Financial Crisis, by Martin Wolf (a prominent writer for the Financial Times)  offers a comprehensive explanation of the malaise in the economies of the developed world, as well as suggested reforms. One thing that stands out is how he has given up on mainstream economics, and looks for guidance from heterodox economists. Although not his intention, his book underlines my suspicion that reforming increasingly sclerotic developed countries will not be easy.

Thursday, January 15, 2015

Hawks Ambushed By The SNB. Sigh.

I assume that the Treasury bears would like to take a Mulligan for 2015. Annual outlooks published just a month ago were almost uniformly bearish, But in just two weeks of trading the 30-year bond has rallied more than 30 basis points. To add insult to injury, the latest rally has been fuelled by the normally innocuous Swiss National Bank (SNB). Closer to home, my fairly hawkish "base case scenarios" look like they are morphing into what I saw as the lower probability "crisis and panic" scenario.


Wednesday, January 14, 2015

Canada: Still Debalancing

Chart: Canadian Job Growth

The Canadian Labour Force Survey for December 2014 was released last week, and it dipped lower. The survey - the equivalent of the Household Survey in the United States - is noisy, but the overall picture remains of relatively weak job growth. Unfortunately, construction dominates the private sector contribution; other sectors have not been able to take over as a "job machine" during this expansion. This means that Canada has not been able to take advantage of avoiding the real estate collapse that hit south of the border and rebalance towards other drivers of growth. Instead, Canada has continued to "debalance", with construction remaining dominant. (Please see this article I wrote just over a year go to get further background on debalancing.)

[UPDATE 2015-01-15. There has been a wave of high profile layoffs and closures in Canada that have hit the news after this was written (link to the latest). It would take time for this to show up in the official data, but it could lead to recessionary psychology now being in place. An assumption behind this article was that the probability of a Canadian recession in 2015 was below 100%; I do not know whether the latest information puts that assumption in doubt. I prefer not to revise my text in order to account for new information.]