Wage-obsessed rate hikes are badly-timed

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assets, Athens, austerity, bailout, Bank of England, banks, bonds, borrowing, crisis, Cyprus, debt, debt crisis, default, ECB, economy, EU, euro, Europe, European Union, eurozone, Federal Reserve, FOMC, George Osborne, greece, HSBC, inflation, interest rates, investors, Labour, politics, recession, steven major, UK, US, wealth

UK and US interest rates sit at historic lows, where they have been snug for years. So does inflation. Yet now the hawks are beginning to win the argument for raising the price of credit. The problem is, that the reasoning behind such moves is flawed by its emphasis only on some of the factors that matter. Namely wages growth.

You would think that with Greece still teetering on the edge of collapse – the next bailout has not yet been agreed – and China pumping liquidity into its markets to stave off bourse collapse, and a general worry about whether Greece’s crisis can be contained or will spread to other parts of Europe, this really isn’t the right time to be talking up rates. Even talking them up, getting money markets all excited, let alone actually hiking rates!

Nevertheless, UK interest rates could rise by February 2016, all because of an obsession with rising labour costs.

According to the hawks, and even some of the neutral voters on the Bank of England’s Monetary Policy Committee, a pip higher in wages, growing at their fastest rate since 2007 when the financial crisis began, is justification to talk up rates.

Meanwhile, there is talk of a US rate hike as soon as September – late July at the FOMC’s next meeting is rather unlikely – which only helps to fuel speculation.

Markets, however, aren’t in a hurry to price in a rate hike. Neither in the US nor UK, so some sanity still prevails.

In fact, two-year US Treasuries have not repeated the actions of previous tightening cycles. In 1994, 1999 and again in 2004 yields jumped as prices fell at the front end of US government debt’s yield curve. Rather, at 0.7% the two-year US T-Note yield is at the same level it was anchored at during late 2008 at the height of the banking leg of the crisis with the Lehman Brothers collapse. In other words, yields are pretty much as low as they have been during the crisis nestled next to historically low interest rates at a range of zero to 0.25%. Markets still price in crisis rather than recovery and inflation.

It would appear US Treasuries and UK gilts are calling the bluff of their respective central banks. That’s also helping contain a re-pricing of mortgage and other interest rate-sensitive products.

And so they might. At present the notion of rising wages is fraught with problems. For one thing, most workers have had at very best flat real wage growth since 2007. But for many in the public sector and beyond, pay gains have reversed, leading to a real income drop if you take into account a modest inflation rate, which only recently dropped to zero. Even a rise in tax allowances is pegged to inflation, so hardly a generous pay rise has been enjoyed by most workers.

Perhaps ironically, the only pay rise that UK labour will record is Chancellor of the Exchequer George Osborne’s planned introduction of the national Living Wage, which comes in higher than the current national minimum wage.

At present, the UK’s national minimum wage for over 18 year olds among the 10 Organisation for Economic Co-operation & Development nations who enforce them stands at a paltry USD8/hour. Only the United States at USD7.30 and Canada at USD7.80 stand lower. Low-tax-put-the-burden-on-employers haven Luxembourg offers the highest, at USD10.80.

Given that Eurozone borrowing has jus hit a fresh record high of 92.9 per cent in the first quarter of 2015 from 92% in Q4 2014, according to figures from Eurostat, the EU’s statistical agency, this is alarming when the UK and US are talking up rates.

Why? Well, as Steven Major, head of fixed income research at HSBC, has elegantly explained, the debt increase among eurozone nations is “opportunistic borrowing”. These nations are keen to capture and lock-in debt at the current historically low interest rates in the eurozone, UK and US.

But as we all know, that is not necessarily fiscally-responsible. When the debt comes to be rolled over, a few years down the road, when rates begin to rise across the spectrum. Those same governments will be gambling that economic growth and tax receipts prevailing then will offset the fact they need to pay more back to hold onto debt or to redeem the debt. Risky.

Europe’s unholy alliance

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Alexis Tsipras, Angela Merkel, Athens, austerity, bailout, Bank of England, banks, bonds, Britain, Bunds, creditors, crisis, Cyprus, debt, debt crisis, ECB, economy, EFSF, election, EU, EUR, euro, euro zone, Europe, eurozone, GBP, greece, housing, maastricht, NKK, Norway

A deal struck between debt-ridden Greece and its international creditors could safely be called an “unholy alliance”. Cobbled together under pressure and doomed to failure.

Europe has been host to many over the centuries. In 1855, the term Unholy Alliance was coined for Western European alliances with the Ottoman Empire against the interests of the orthodox Catholics of Russia, Greece, and most of the Balkans.

Before World War II, the term was used for the Molotov-Ribbentrop Pact between Nazi Germany and the Soviet Union which partitioned Poland in 1939.

Perhaps not militarily, but economically surely, the deal struck for Athens has caused humiliation to Greece. Even the Greek premier Alexis Tsipras, who appears to judge a snap election this year may help him – or perhaps ensure he doesn’t actually need to implement the pledges he made to Europe and the International Monetary Fund – recalls the brokered deal was made with “a knife to my throat”.

With that kind of language, and deep resentment between Germany’s Angela Merkel and Tsipras, is this the way Europe should be governed? Is this a credible way to win influence and win a debate? Is this really going to help Greece and Europe in the long-run or upset everyone now and later?

Europe is supposed to be a force for good. Many of us who believed in the European goal did so because we felt it would help unite and end hostilities. Although violence has been contained to the streets of Athens, there is no doubt that we have witnessed a war.

So the European Union does feel rather hollow. It is not just about whether we can trust the Greeks this time to deliver, to reform, to pay back their debts. But whether Europe can still work together.

Since the eurozone debt crisis began in 2009, some rather unsettling things have happened, which point to the Greece showdown being the beginning of the end for this European experiment.

Like Germany’s response to depositor protection in Ireland in 2010 when the crisis built up steam, to arguing over a bank levy which penalises a non-eurozone member, the City of London, to enforcing Greek compliance, there has been nothing but delays, prevarications, failed summits, and rule fudges.

When the euro was being talked about in the late 1990s I was working at Dow Jones Newswires. I was asked to write about how European fund managers were gearing up for the single common European currency which would kick off in January 1999, with Greece delayed to join until January 2001.

European fund managers were on balance keen on the currency. To them it meant doing away with 20-odd currencies and just having one to deal with. No more transactional costs or forex risks. It also meant that fund managers were beginning to think of Europe as one portfolio. Gone were the country-specific funds and in came the regional. Easier to manage with all of the then eleven eurozone member states plus Greece soon after. Well, if only all the countries had complied.

We now know that a hollow promise was sold and the Maastricht Treaty of 1992 had failed to draft law around “what if” happens scenarios. It was all about the positives and never about the negatives.

No one much cared to ask what would happen if any member state was not delivering. No one built in contingency plans, so that when the crisis started a decade later, the EU top decision-makers were bereft of making decisions and debated and procrastinated. They applied pointless compliance rules to a situation which had shifted and had no buffers in place to take the blow safely and without mess.

Now investors are starting to feel like they have been undermined by politicians. Having bought into a political pact, they now realise this may have been a mistake. Central banks are much the same.

The euro remains a major currency today, but seems to be in decline. Major central bank reserves of euros have fallen by a third since 2009 to around 20% from around 30%. That is not a vote of confidence in the currency or the policy.

Meanwhile, with the procrastination that has followed since 2009, not only have the cash sizes of bailout of places like Greece become ever more expensive, but the over-arching policy of quantitative easing by the European Central Bank has begun having peculiar consequences both inside and outside the eurozone.

The QE programme risks fuelling house price bubbles as investors seeking higher returns pour cash into real estate. Germany, Norway and the UK with ultra-low interest rates and bond yields are sending investors into real estate, according to a Moody’s Analytics report. Since 2010, average house prices in Norway have risen more than 30 per cent, in Germany by nearly 25 per cent and in the UK by nearly 15 per cent, the research found. Both sterling and the Norwegian crown are seen as safe haven currencies too.

So not only has the eurozone mismanaged itself. It has caused problems for others too.