Daily Note – The Return of NIARU


UK: Better than expected employment data puts the BOE in a tough spot

China: No US style crunch for China says former PBOC advisor

Japan: BOJ’s Kuroda says risks to BOJ’s price forecast have not materialized

Eurozone: France will honour pledge to bring deficit back below 3% of GDP in 2015

Portfolio: Continued move higher in US 5 Year Yields


Good morning,

I have just finished my first ever spinning class and I can hardly walk. But apparently it gets easier and, eventually, you get to the sweet spot where you actually like going to the class. I will keep you posted but right now I have about as much conviction as an Old Trafford season ticket holder.

Speaking of “sweet spots”, the UK’s latest data indicated, tentatively, that our neighbours across the sea might just have hit that sweet spot which economists call NIARU – the non accelerating inflation rate of unemployment. I realize that’s a bit of a mouthful and few economists will be front runners for the Hemmingway prize for succinct prose, but bear with me.

The NIARU is the elixir of independent central banking because it is the rate of unemployment where wage inflation doesn’t build. Remember a few weeks back I reacquainted you with the Phillips Curve? Have a look here. The Phillips Curve is in the top drawer of all decent central bankers and it postulated that there is a relationship between the rate of unemployment and the rate of inflation. If you have low unemployment you have more people working, this means more wages in the economy and as these wages are spent, prices will go up because demand goes up. As prices go up, workers will say, “Hold on! My wages should be going up too,” so they will demand higher wages. Also when there are fewer unemployed workers around, wages should go up of their own accord as employers compete with each other for the remaining workers to respond to the demand which has just been created by the fact that unemployment is down and spending is up.

Implicitly, Mark Carney, believed that the NIARU in the UK was an unemployment rate of 7%. Anything under that would begin to push up wages and he would have to respond by ultimately raising interest rates to keep within his inflation targets. The logic of the whole exercise is  that if unemployment falls below 7%, inflation will rise.  7% is the NIARU. It is that rate of unemployment where inflation doesn’t rise. It is just right, not too hot and not too cold.

But what if he is wrong?

Yesterday, the UK registered much lower unemployment that expected and much lower wage inflation than expected. There are loads of jobs around and wages aren’t going up. This implies that the NIARU isn’t 7% and unemployment below 7% does not necessarily presage a hike in interest rates.

What if the NIARU is 6% or 5% or even 4%? This has massive implications for the rate of interest. If the NIARU is 5%, then UK rates don’t have to go up for a long, long time.

But why would the NIARU change?

Well there are numerous reasons. The first could be that workers are so petrified of losing what little they have, that they will work for any money. This would be because they know that if they don’t take the job, the next lad will. This is a reflection of the amount of lads and lassies looking for work. If there are loads and loads of people willing to work for nothing, the NIARU will be lower than people expected.

If the NIARU is lower than previously thought, the UK could be in for a long period of low rates. This has massive implications for the already overheating Home Counties’ property market, as well as for sterling, social equality, gilts and the political cycle. It is a witches’ brew of answered Tory prayers. I am sure Cameron can’t believe his luck.

What did Napoleon say about lucky generals? Indeed, what did he say about the nation of shopkeepers?

United Kingdom: Much better than expected employment data puts the Bank of England in a tough spot

Table 1 23 Jan

From Narnia to Nairu

Lewis Carroll– a Belfast religious fundamentalist from a city that produces these lads far too regularly– famously wrote about the children who walked through a wardrobe into a fantasy world. I’d bet George Osborne thinks he has also walked through such a wardrobe this morning.

The LFS unemployment rate in Britain fell from 7.4% to 7.1% (Cons 7.3%) in the three months to November. Employment growth continues to be very strong and normally this should increase the pressure on the Bank of England to raise rates. But hold on. Why raise rates if there is no inflation?

Threadneedle Street could also move down its 7% threshold.. In separate releases, the Minutes of the January meeting were mixed, while public sector finances data were better than expected which argues also for holding off rate increases.

The headline unemployment rate fell from 7.35% to 7.15%. Behind the headline rate, employment growth was very strong. The Brits created  250,000 more new jobs in the three months to November, compared with the previous three months.

This rise in employment was accounted for by a 110,000 rise in participation – more new punters coming into the market, and a 170,000 decline in unemployment – old punters who were on the dole, finding jobs.

The UK doesn’t have the same demographic (structural) problems surrounding its participation rate as in the US. In the States, the baby boomers are retiring, in the UK they was never such a significant 1950s baby boom in the first place.

Despite the continued decline in unemployment, earnings growth remains weak. The annual growth rate of Average Weekly Earnings (exc. bonuses) averaged 0.9% in the three months to November, edging up from 0.8% in the three months to October. It remains close to its lowest growth rate since records began in 2001. Meanwhile jobs are being created at a rate not seen for over a decade.

We also got the minutes of the last BOE meeting from earlier this month. In line with its forward guidance, the MPC voted unanimously to maintain official rates at 0.5% and keep the QE total at £375bn. The committee continued to sound positive on growth, stating that “the recovery was becoming more firmly entrenched”.

Some parts of the Minutes sounded quite hawkish, such as their acknowledgement that “the strong growth in employment was consistent with the degree of slack remaining within the economy being somewhat less than previously thought”. But this is how central bankers sound. I am a recovering central banker after all. I have written these minutes in the past!.

Most importantly, the committee saw “no immediate need to raise Bank Rate even if the 7% unemployment threshold were to be reached in the near future”.

The market is now pricing in 75% chance that the BoE will increase rates by 25bps point in December of this year. There has been a considerable re-pricing of interest rate expectations in the last six months as the strong economy confounded everyone.

In a sense, the BoE are now boxed in. If the unemployment rate falls below target and inflation remains low, there is no need for any policy response.

If they decide that indeed they are in Narnia and the NIARU is lower, then they should move the “threshold” lower but the property bubble in London would love that. And the last thing they want is an uncontrolled property bubble in the South and low growth in wages and employment in the North.

Late yesterday afternoon we had comments from BOE’s board member McCafferty to the effect that the MPC sees no immediate need to raise interest rates even if unemployment hits 7% in the near future. He highlighted the UK economy is:

  • In the very early stages of investment recovery. He suspects that some 2013 data will be revised higher
  • He says that conditions are underway for a rebound in business investment and this could continue into 2015
  • He maintains that it is appropriate to reduce stimulus only gradually.

The Newry Trade

GBP made a new high against the Euro, trading down to 0.8171. This remains our biggest mistake of 2014 so far. This is what I term the Newry trade because as Newry is the first town in the only land border between the Euro and sterling, the views of local traders of Euro/sterling there are much more instructive than any economist in the City of London.

We have liked GBP in recent months but as we talked about in earlier Daily Notes, we were looking for an entry level above O.8400. Unfortunately, unlike with our Euro position, the market didn’t give us our level. We need now to take our time and see how the BoE decides to play this strong data. Will it be a threshold move or interest rate hike?

Are we in economic Narnia where the NIARU is falling or are we right back in 1988? Back then we had the UK, under a Europe-obsessed Tory government, that inflated a property bubble in the South which exacerbated regional and social inequality between workers on low incomes and property owners with high house prices, allowed sterling to get too strong and ultimately came crashing down.

Are we there again? Let’s keep an eye on this one.

China: No US style crunch for China says former PBOC advisor

Bashing the China financial system has become as fashionable as a social conscience at Davos, the fight back from China officialdom is gaining momentum. Ex PBOC advisor Yu Yongding was quoted on Bloomberg:

  • He says China is well capitalised to face liquidity issues
  • But interestingly he maintained that ICBC shouldn’t be responsible to repay troubled trust. This suggests they will allow the market to dictate how the bankrupted trusts are dealt with.

We continue to think the China financial system has the potential to cause volatility. But isn’t it fascinating? In the US in 2008 we had the free market capitalist George Bush acting like a Communist and bailing out bankrupt banks and here we have the Communist, Yu Yongding, acting like a capitalist, allowing the market to sort things out!

Japan: BOJ’s Kuroda: risks to BOJ’s price forecast have not materialized

While the there was no change in policy at the end of their two day meeting, there were some interesting comments by the Bank of Japan, regarding further stimulus during the press conference.

  • They said that monetary policy is aimed at achieving domestic price stability, not the  level of the Yen.
  • They have nothing to say on the Yen
  • The BOJ stated that markets may move one way or the other, but it wants to guide policy by carefully and gradually watching the economy and prices.
  • It maintains that the sales tax hike will not hurt the positive cycle building up in the Japanese economy
  • It expects Japan to see 2% inflation around the end of fiscal year 2014 and through fiscal year 2015
  • The downside risks to overseas economies have receded
  • An economic recovery is becoming more clear in US and Europe
  • In contrast to the IMF’s loudspeaker diplomacy from Davos. The Japanese are not worried that Europe will lead the global economy into disinflation or deflation

In plain English, all this means is that the likelihood of further policy action in H1 of this year is remote. With USYEN close to the top of the recent range at 104.30, we think there are downside risks to this cross. It is the most over-crowded consensus trade in the world right now. We are also moving towards a non-consensus view that Japan is not half as bad as people make it out to be and indeed the Japanese are playing a long trade game not a short market one. In short the market plays monopoly, the Japanese play chess.

Eurozone: ECB’s Coeure says 10 years too long to set up single resolution fund

The ECB are planking about the stress tests. Every time one of their suits gets up to speak you can hear the panic in their voices. The latest is the ECB’s Coeure who continues to bang the drum on the dangers surrounding a delay in the single resolution fund for dodgy banks.

  • He says it should be shortened to 5 years
  • He contends that the EZ needs common backstop arrangements for the transition period and beyond to enhance the resolution fund’s credibility
  • An EU wide supervisor should solely determine whether a bank is failing or is likely to fail

As we speculated last week, the ECB already has sight of some of the Bank Stress Test data; are they getting nervous? And why would they?

Eurozone: France will honour pledge to bring deficit back below 3% of GDP in 2015

French finance Minister Pierre Moscovici was quoted in local press and not a Moped in sight. The target budget deficit deadline was 3% by end of 2013 but as is customary when missing the mark, it got booted out to 2015. “If you can’t meet a target, move it” is the French mantra which as a general rule in life is eminently sensible. But we would consider little prospect of the 2015 target being met either!

However, France will not be penalised for missing targets as long as Draghi keeps open the possibility of buying short-dated government debt in Frankfurt.

Portfolio: Continued move higher in US 5 Year Yields

US 5 Year yields continued higher yesterday on an expectation that the Federal Reserve will “taper” again next week. If we can close about 1.70% on a weekly basis, it opens up a test of the recent high.

Portfolio 23 Jan

Download a PDF version of the note here:

Global Macro 360 -Daily Note – The Return of NIARU



The statements, opinions and analyses presented in the articles, newsletters, and other materials appearing on this website are provided as general information and for educational purposes. Opinions, estimates and probabilities expressed herein constitute the judgment of the author as of the date indicated and are subject to change without notice. Nothing contained in this website is intended to be, nor shall it be construed as, investment advice, nor is it to be relied upon in making any investment or other decision. Prior to making any investment decision, you are advised to consult with your broker, investment advisor or other appropriate tax or financial professional to determine the suitability of any investment. David McWilliams shall not be responsible or have any liability for investment decisions based upon, or the results obtained from, the information provided.

Categories: Daily Note