A policy change by the Swiss National Bank has addled markets and governments worldwide. How to explain that your lower mortgage rate is courtesy of the Gnomes of Zurich?
The 10-year T-note has bottomed at 1.72%, down more than a half-percent since Christmas, but has decoupled from mortgages which stopped falling near 3.75%, jumbos rising a hair. Panicked global cash runs more to Treasurys than mortgage backed securities (MBS).
Before the Swiss discussion, other data: December retail sales fell .9%, even ex-gasoline off .3%. December CPI fell .4% because of oil, but core CPI ex-oil and food in December was unchanged and worrisome.
What will the Fed do if inflation continues down?
The Fed continues to thump the rate-hike tub, but if US core inflation continues to fall from target the Fed will have some explaining to do. The threat of a US rate hike is adding to instability everywhere else.
The Swiss. 8 million hard-working and disciplined budget-balancers, 72% of GDP last year from exports. Their reward for model behavior? We will ruin them unless they drop this class-grind behavior and become irresponsible like the rest of us.
In 1972, as a 23-year-old manager of a US importer of Swiss watches, every day I punched $0.2604 as the value of the Swiss franc (SFr), where it had been since WW II. Our business and the Swiss exportersā to us were based on $0.2604. Late in 1972 the dollar suddenly crashed from its unsustainable post-war height, inflation rising here, and the SFr jumped over $0.40 — which made Swiss watches too expensive to buy.
Long since… the euro failed years ago, member economies sinking. Nevertheless the euro remained strong, $1.40 or more, held up by German hard-money history and ever-lower inflation.
In the perverse world of deflation, your economy is in trouble but others want to hold your money. But the SFr rose even faster, and so in 2011 to protect Swiss exports to Europe the Swiss National Bank (SNB) promised to hold its currency no stronger than 1.2 SFr per euro. Then, six months ago the European Central Bank (ECB) entered its last ditch by trying to cut the value of the euro to help euro-zone exports.
To weaken a currency intentionally requires printing it and spending the new SFr to buy other currencies. In three years the SNB had printed and spent SFrs almost equal to its GDP. Unsustainable. (BTW: Russia is the opposite, defending its currency by spending its hoard of foreign currencies to buy rubles.) Thursday morning the SNB announced it would stop trying to hold the SFr down versus the crashing euro: on Tuesday one SFr bought .85 euro; today, one for one.
On Tuesday the SFr traded $0.98, four times its post-war dollar value. Discipline will do that. Fridayt: $1.19. A Swiss vacationing in Paris feels rich, but goes home to a failing business. Excessive discipline, ultimate safe-haven status, and repeatedly the Swiss have waked up as King Midas, rich beyond avarice but starving.
Switzerland is 1% of global GDP. So, whatās the big deal? A very big deal indeed: the world depends on continuing rescue by central banks. The US is the only major one which can dream of coming up from zero percent, but still very stimulative. If the SNBās word is not good, subject to change without notice, what is the word of the others worth? THATās what hit markets Thursday.
Next up, the ECB on the 22nd is supposed to embrace quantitative easing (QE). Markets are trading as though any cash eruption from the ECB will wash right through Europe to safe places, pushing sovereign yields lower, lower, then below zero. The SNB also cut its overnight rate minimum to negative 1.25%. The Swiss 10-year yield is 0.033%, all shorter maturities negative. The German 5-year is now negative 0.053%.
In deflation, my return despite negative interest is payback of principal worth more than I invested to buy the bond in the first place. On the other side, loans appear cheap to borrowers, rates ridiculous, but principal must be paid back in money more expensive than borrowed. Central bank rate cuts can no longer stimulate borrowing. So try to cut your currency to help your exports, but that forces others to do the same.
See related story by CBS analyst, “Is the U.S. the next deflation nation?
Be damned glad we are here in the US, our economy flexible enough to avoid deflation but our rates the beneficiary of panic by others.
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The euro. A fall so precipitous has unpredictable consequences. In the lead: ācompetitive devaluationsā elsewhere. A weakened euro will help Club Med exports, and German ones which donāt need help, but will do nothing for internal euro contradictions:
US 10-year T-note. This has to stop, right? Not necessarily:
Oil. Everyone knows about this one, except nobody knows for sure how much of the drop is due to oversupply versus weakening demand in a weakening global economy:
Copper is a better proxy for global growth, especially including the appetite of China for raw materials. Oil is off by 50%, but copper is off a full 25%:
Now a tale of confidence indices. The NFIB showed protracted tough conditions for small business, but in the last 90 days suddenly says all is back to normal:
The overall optimism index joined by steadily improving plans to hire:
BUT… See the immense gap between hopeful intentions and actual hiring. Maybe they canāt find qualified workers. Maybe theyāre just happy about Republicans winning Congress (NFIB respondents are notoriously right-side), or along with everyone else happy about gasoline. I am sure I donāt know. Canāt dismiss the survey, but canāt quite believe the strength.
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