Daily Note – The easiest way to rob a bank is to run it

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Summary

Ukraine: Russia turns the screw on Ukraine and by extension the EU and the US

United States: Fed’s regulation head has obviously learnt nothing as he favours using rates against bubbles

United Kingdom: The Brits are doing what they always do, betting on bricks and mortar

Eurozone: What don’t the ECB understand about debt deflation?

Good morning.

We all know that the easiest way to rob a bank is to run one.  I am always terrified when I hear central bankers talking about using interest rates to control bubbles as it’s a bit like using remote legislation, rather than cops on the ground, to control criminals.

Yet this is what we heard from the Fed last night. More on that in a bit.

Russia turning the screw

As I said yesterday and have been maintaining since our first note and our outlook for 2014, Russia will not be beaten in its own back yard.

Deputy Finance Minister Storchak maintained that Ukraine will default. He omitted to add the “if Russia has anything to do with it” bit. There’s also news that Ukraine is cutting gas imports from Russia. So where else is it going to get gas? From Baku behind the Caucasus? Let’s get real. We remain cautious on the situation in Ukraine. Russia has yet to show its full hand.

United States: Fed’s Tarullo shows he has learnt nothing

Last night we had the terrifying vista of the guy who heads supervision at the Fed taking about using interest rates to prick bubbles!

We have long talked about new Federal Reserve Chair Janet Yellen’s change in emphasis. I see her as being less concerned about Wall Street (thus QE will be wound down) and more concerned about Main Street (unemployment). But a bigger concern for me is the fact that the head of regulation at the Fed still seems to believe in the efficient markets hypothesis. This contends that banks don’t need too much regulation just more capital. But we all know that capital is only an accounting residual, something that goes up and down when assets are greater than liabilities!

So this guy tells us that monetary policy is a tool to deal with broad sustained systemic risk and that the current financial risks does not warrant any change to policy

What Tarullo is saying here is that if push comes to shove, the Fed will use interest rates to prick bubbles.  Yesterday US stocks  didn’t like this idea and finished weakly. I don’t like it, not because the market doesn’t like it, but because it is rubbish. The greatest danger to a bank is its CEO. That we know and the only way to prevent bubbles is via on-site regulation of credit. Have we learned nothing from 2008?

United States: House prices continue higher while consumer confidence remains stable at high levels

Table 1 26 feb

The 20-city S&P/Case-Shiller home price index rose a solid 0.8% in December (vs. consensus +0.6%). This was only a small downtick from November’s 0.9% increase.

The Conference Board consumer confidence declined to 78.1 in February (vs. consensus 80.0), from 80.7 in January. Consumers’ assessment of the present situation rose (4.4 pt to 81.7), although expectations for the future declined (-5.1pt to 75.7). The labour differential―the net percent of respondents reporting jobs plentiful versus hard to get―continued to improve, rising 1.6pt to -18.6.

This is a good indicator of future job prospects in the US and tends to lead the official employment data by 3 months.

A key driver for US consumer confidence is the price of Gasoline at the pump as you can see form the chart below.

Figure 1: US Consumer Conf vs Gasoline Prices

Chart 1 26 feb

United Kingdom: Strong Housing Loan growth and CBI Sales

Table 2 26 feb

The UK housing market is still very strong, with “Loans for House Purchases” now back to pre-2008 levels. The chart below shows how abnormal the current Bank of England base rate is given the lending in the economy and it screams a massive move upwards in UK long term interest rates in time – when the housing boom gets frothy.

Figure 2: UK home loans vs BoE base rate

Chart 2 26 feb

The level of bank lending needs the base rate to be closer to 2% not 50bps. While the BoE seems determined to hold the base rate until well into 2015, we see this as being increasingly lacking in credibility. My core view is we will see a 25bps rise towards the end of 2014.

Eurozone: Banks won’t change their behaviour over negative rates says Nowotny

Austria’s financial newspaper Wirtschaftsblatt had an interesting interview with influential ECB board member Nowotny who says “banks that deposit money short term at the ECB, are already getting zero percent on it. With a negative interest rate, which can’t be very high, maybe 10bp, they are not going to change their behaviour. The negative rate would be, in that case, a kind of insurance premium”.

Ahead of the key inflation data on Friday and the ECB board meeting next Thursday, the battle lines are being drawn. This may end up being one of the toughest meetings that Draghi has had to chair.

As you can see from the chart below, the ECB balance sheet continues to shrink (the banks are repaying LTRO because they have nothing else to do with the money). The ECB balance sheet has been shrinking over the last 12 months and this has been one of the key drivers of the recent Euro strength. This is because European money supply is shrinking.

Figure 3: ECB Balance Sheet & the Euro FX

Chart 3 26 feb

This Euro strength is driving down inflation for the EZ, but as most countries are heavily indebted, deflation and chronic debts means the debt to income ratio, rises.

I see this Friday’s inflation number and next week’s ECB meeting as being key events for the outlook for the Eurozone in 2014.

Portfolio: Chinese stocks weigh on performance, but I remain patient

Table 4 26 feb

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