French inflation unexpectedly slowed to 5.9% (for the last twelve months) in December 2022. Inflation stood at 5.6% in September and 6.2% for both October and November.
Source: INSEE
The slowdown in the French inflation rate is mostly due to a decline in energy prices, and to a lesser extent, in services. The drop in energy prices resulted from a decline in the price of oil. Food prices increased at the same pace as in November while prices manufactured goods showed a slight acceleration. Food prices increased by 12.1% while services only went up by 2.9%.
Over the month of December alone, prices for goods and services declined by 0.1% following a +0.3% in November.
INSEE – the French Institute for Statistics – expects inflation to accelerate in France in early 2023. Energy prices – which are regulated in France – are due to increase by 15% as previously announced by the Government. Gas prices are set to increased in January and electricity prices will follow in February.
Note that this a flash reading and INSEE may revised upwards or downwards its estimate of inflation for December 2022.
Following Spain’s report that inflation slowed down, Germany just announced something similar.
German inflation slowed more than expected in December (EU Harmonized -1.2% MoM vs -0.8% exp). This would be the biggest MoM drop since January 2015.
Source: Bloomberg
Bloomberg noted that the decline in the main rate masked an increase in food costs across Germany at the end of 2022. An increase in good costs would tend to make worse the cost of living crisis that many European countries are facing this winter.
It is worth noting that the annual pace of the country’s energy inflation slowed to 24.4% in December from 38.7% in November, helped by the German government measures.
The German central bank – the Bundesbank – predicts that inflation will remain above 7% in 2023, which is way above that the permissible 2% under the ECB’s mandate. The central bank has cautioned against misinterpreting single data reports as a shift in trend, citing a “great deal of uncertainty.”
Germany’s labor market remained strong in December. Unemployment unexpectedly dropped in December, supporting the ECB’s hawkish stance. The data would suggest that a mild winter recession will not push the economy off a cliff.
Germany’s inflation rate of 8.7% last year was already by far the strongest on record since the country’s reunification.
Most economists still expect the ECB to raise the benchmark rate by 50 basis points in February.
ECB rate rises are about to get real. Says the ECB.
The Governing Council of the ECB decided on December 15, 2022, to raise the three key ECB interest rates by 50 basis points and expect to raise such rates further based on a substantial upward revision of the inflation outlook.
Following its decision, the ECB increased the interest rate on the main refinancing operations, the interest rates on the marginal lending facility and the deposit facility to 2.50%, 2.75% and 2.00% respectively, effective from December 21, 2022.
The hawkish press release issued by the ECB stressed that the following:
In particular, the Governing Council judges that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-target.
Klaas Knot, Dutch central bank governor and one of the hawks on the Governing Council, recently stated that the central bank was only just beginning the “second half” of its rate-increasing cycle. Based on this, the interest rate on the marginal lending facility could reach a whooping 5%…
Most economists are not buying it. Four-fifths of the 37 economists polled by the FT in December forecast the ECB would stop raising rates in the first six months of 2023 and two-thirds predicted it would start cutting them in 2024 in response to weaker growth.
Source: Financial Times poll of economists
The ECB expects to begin reducing its balance sheet in 2023
The ECB was hawkish on rates but also set forth its plan on normalizing its balance sheet.
The ECB intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP until the end of February 2023. After February, the APP portfolio will decline “at a measured and predictable pace” as not all principal payments from maturing securities will be reinvested. The ECB stated that the decline will amount to EUR 15 billion per month on average until the end of the of the second quarter of 2023. From March 2023 to June 2023, that would amount to EUR 60 billion of maturing securities that are not reinvested. The situation is to be reevaluated for the period after June 2023.
As for the PEPP, the ECB does not intend to change anything until at least the end of 2024. Principal payments from maturing securities purchased under the PEPP are to be reinvested. The ECB left itself some wiggle room by stating the following:
In any case, the future roll-off of the PEPP portfolio will be managed to avoid interference with the appropriate monetary policy stance.
If you have any idea what this means, please let me know…
As you know the APP is not one program. I know, it’s confusing because people and institutions, including the ECB in its December 15, 2022 press release, tend to say “the Asset Purchase Program”. The APP is actually the combination of the four asset purchase programs, which are:
The details surrounding each purchase program are beyond the scope of this post. However, you can find further information on the ECB’s website, here.
All you need to know at this stage is that the CSPP and the PSPP are the two big ones within the APP. The ECB did not say whether the EUR 15 billion of maturing securities that are not reinvested are to be split proportionally across the four programs. If the weightings are different, this could have a significant impact on European corporate bonds.
With such a press release and Lagarde’s hawkish press conference, no wonder why Italian Prime Minister Giorgia Meloni is fretting about the ECB’s monetary policy. Rome’s borrowing costs have risen sharply since the ECB started to hike rates last summer. The 10-year bond yield climbed above 4.6% last week, four times the level twelve months ago and 2.1% above the equivalent German bond yield. Meloni said:
It would be useful if the ECB handled its communication well… otherwise it risks generating not panic but fluctuations on the market that nullify the efforts that governments are making.”
Source: Reuters
Italian public debt remains one of the highest in Europe at just over 145% of GDP…
Do not underestimate inflation
Like the Fed, the ECB raised its inflation forecasts for the euro zone and stated that price growth would remain above its 2% target throughout the projection horizon, which now extends to 2025.
Source: ECB
Bear in mind that the ECB has persistently underestimated inflation over the past two years (like the Fed and other central banks to be fair). The ECB’s main worry is that food and services costs are now becoming increasing apparent, making price growth relatively broad.
However, there are signs that inflation is beginning to subside. Spain’s 12-month inflation slowed down again in December to 5.8%. This was the slowest annual pace for the year, due to lower electricity prices compared to a year ago.
Germany will released its inflation figures today. I expect a slowdown too.
Markets might be tempted to price a dovish pivot from the ECB. I would urge caution. Even if inflation is slowing, a rate of 5.8% remains completely unacceptable and is almost three times the ECB’s 2% medium-term target. It’s far from over…
Happy new year 2023! Without you readers, there would be no blog and I wish you the best. If there are any specific topics you are interested in, please let me know and leave a comment!
Let’s not pretend otherwise. The blog has been awfully quiet for over a year and a half. Way too quiet.
It’s entirely my fault. I had to deal with some personal issues and I only had so much bandwidth at a time. First, I had to deal with the fallout of my personal life. Then, some health issues that started appearing at the worst possible time. And yes, all of this was before Covid-19. More recently, there was the stock market meltdown and the incredible bounce back. I will discuss this last topic in a subsequent in-depth post.
So just like when you are debugging a program to fix the issues, I had to suspend non-core aspects of my life to focus on the very essential stuff. Unfortunately, this blog was one of those non-core items. I’m sad I couldn’t keep up with it. Nonetheless, pausing operations seemed better compared to publishing crap content. Posting for the sake of posting is never a good idea.
I am writing this post with some apprehension. Obviously, it is on the more personal side, which is most likely why I feel more vulnerable. It is a lot more difficult to expose personal failures and feelings compared to discussing graphs and stamp duty. In addition, it has also been a while. Have I lost my touch or the ability to write? I guess we will find out.
Robinhood and the Hertz debacle
I missed the blog, hence why I am back. I also decided to get of hibernation for another reason. We have just witnessed the largest synchronized drop in economic activity since WWII. Yet, I see a lot of people – including politicians and “analysts” – pretending that we will soon be back to normal. While the stock market crashed at the end of February and in March – hopefully you followed some of those tips before – the Nasdaq is reaching new highs and the S&P500 is now more or less flat for the year. On top of this, an army of Robinhood traders in the United States are piling on some of the riskiest shares. This leads to some disastrous consequences.
None of this makes sense and I fear that a lot of people will suffer losses.
The Hertz bankruptcy is a disaster in the making. In a bankruptcy, common shareholders are the first stakeholders to be wiped out. Secured creditors such as lenders or bondholders have a “higher” (i.e. first-priority for instance) claim against the assets of the company. As a result, this begs the question: why would retail traders purchase shares that are worthless given that the equity is underwater? Either they are geniuses or the speculative bubble has reached new levels. If Carl Icahn – one of the most successful investors of our time – dumped his shares, maybe there was a reason.
And rest assured, companies will take advantage of this speculative bubble. Propped up by an unfathomable amount of FED liquidity, investors have both become desperate to find a decent yield and greedy as they have been led to believe that the FED put will backstop every single risky asset. Hertz tried to pull an equity offering (a bankrupt company offering worthless shares!) when traders pushed the stock price to new and unexpected levels. The Securities and Exchange Commission – for once – did something about it and put a stop to the masquerade.
An elusive V-shaped recovery
Don’t get me wrong – not all companies are worthless. However, I posit that stock prices have reached unsustainable levels in the United States, which will in turn impact other markets. The U.S. economy must grapple with new Covid-19 cases which is already forcing some states to roll back reopening plans. If the economy is not experiencing a V-shaped recovery, those high price levels can only be maintained with a combination of (i) looser monetary policy and (ii) looser fiscal policy. In other words, Jerome Powell and Donald Trump will need to continue spending. I do not believe that the U.S. economy will experience a V-shaped recovery. I could be wrong.
To summarize, in my view, the U.S. stock market is out of control due to the ultra-accommodative policies of the Fed and the Trump Administration. To some extent, European stock markets have been more subdued in their recovery.
A final word on the United Kingdom. Compared to other European countries such as France, Germany or Switzerland, it is clear that the UK economy is not recovering as quickly as anticipated. With a meager 1.8% increase in GDP from the previous month, the Office for National Statistics stated that the economy is “in the doldrums.” It is clear that the irrational exuberance witness in stock markets is not being matched by the same degree of enthusiasm in the high streets.
In short, we have a lot to discuss. I also want to hear from you: do not hesitate to leave a comment and tell me which topics you would like to discuss. I’m not an expert on everything but a healthy discussion can only be a positive.
I recently moved out of my old apartment located in the City of London. I am now based in Westminster. As a result, I now have to pay my council tax to Westminster City Council.
Virtually all councils will offer various means and methods of payments to settle your council tax bill. Monthly direct debit tends to be a very popular option.
I thought I would be “responsible” and pay my 2019/2020 council tax bill upfront, in full, this year. Therefore, when I received the bill in April, I promptly paid the full amount, which amounted to a hefty £1,215.82. Note this included the 25% discount for a single occupier. The original bill was £1,621.10.
Moving out: a quick overview of the basics
As most people may already know, council tax is managed by the relevant council, which depends on where you reside. Council tax is not collected on a national level by HMRC.
As a result, when you move out from one council to another, you need to close your existing council tax account and open a new one with the council where you moved to.
If you paid your council tax in full at the beginning of the tax year, you will need to claim a refund from your existing council (i.e. the local authority where you existing home is located). You would hope that they could make the process easy. It’s a pretty common thing for people to regularly move in and move out from one council to another. Think again…
Filling out the moving out form (also known as the “Vacating Occupier Form”)
First, you need to fill out the form notifying the authority that you are moving out of their perimeter. For some councils, you may be able to do so online. For others – such as the City of London – they are more old school and you need to email them a form. Below is an example:
Most of the form is fairly self-explanatory although a bit tedious to fill out. There are two sections that I found confusing: (3) State the exact date you stopped residing at the property and State the exact date for the expiry of your tenancy.
In many cases, those two dates will probably be the same. You will move out right at the end of the tenancy (to avoid paying rent twice for instance).
However, I did not have that option for multiple reasons, one of which was that my new landlord was keen to have me moving in as soon as possible. Therefore, I moved out on 11 July but my tenancy technically expired on 4 August.
I filled out the form without overthinking this any further.
Time to claim the refund
A few days later, I received an email from a council tax officer telling me that I owed money. I was stunned and told them that I had already paid the council tax bill in full. I indicated the date of the wire transfer. It turns out he had made a mistake and promised to revert promptly.
Ok, fine, mistakes happen I guess.
He emailed me again and told me that I had to fill out another form to claim the refund. So here is the first trick. You need to claim the refund, which requires you to take action. Do not sit around thinking that the council authority will refund you automatically.
Yes I know. They probably already have you account details and can calculate the refund. Still, you need to make the claim. Below is the form.
I promptly filled out the form and sent it to the officer by email.
The officer had mentioned in the email the refund that I should receive. It wasn’t exactly the amount I had calculated. The discrepancy was huge (approximately £40) but I wanted to understand his calculations. I know, I’m a geek.
So I emailed him. And then I waited, waited and waited again…
Three weeks later, I received a detailed response. As a matter of transparency, below is the response (which I have anonymized for everyone’s privacy!).
Council tax response with the relevant calculations
The pro rata calculations are pretty standard. But one thing did shock me.
Notice how the officer removed the benefit of the 25% single person discount from 11 July 2019 to 4 August 2019. The status of the property changes. The property is now deemed to be a Second Home Class B (!) for which no discount is available. This is what was causing the discrepancy with my calculations.
Am I the only one thinking this is unfair?
Here are a few observations on this.
First, it’s now very clear why they ask for the expiry date of your tenancy and the date on which you vacated the property. Essentially, in most cases, you will be liable for the council tax until the end of your tenancy (and not just the day on which you vacated the property). However, you will lose the single occupier discount from the date you stopped residing at the property.
Second, this strikes me as particularly unfair for two reasons. Nowhere is this explained or advertised in advance so it is hard to plan in accordance with rules no one knows about. Also, if you had to move out early, that’s probably because you didn’t have a choice. After all, who likes paying for an empty apartment? Losing that one benefit may not be the end of the world for most people, but it’s another hit to your wallet at a time where many expenses are incurred in connection with the move. When you have to pay for movers, a new deposit, and settle utility bills, the last thing you need is for your council tax refund to be reduced out of nowhere.
Third, this rule incentivizes dishonest behaviors. There is no reason to be truthful and state that you moved out of the property early if that will lead you to losing a key benefit. You might as well ensure that the date on which you stopped residing at the property always matches the date of the end of your tenancy. Even if it’s not true.
Conclusion
Council tax bills are already increasing across the country, and especially in London. I understand that some of those increases are meant to fund social care and other necessary services provided by councils.
However, I don’t think that councils should try to screw residents also. I thought I was doing them a favor by paying the council tax upfront in one payment (which is ideal in terms of cash collection for councils). I don’t think it was necessary to take away the single occupier discount in this precise instance. Now, I pay council tax on a monthly basis by direct debit. What’s the point of paying everything in advance if you have to overcome multiple obstacles to get a refund?
In the end, it took a solid two months from the moment I sent the form to the day I received the refund in my bank account. That delay also seems quite unnecessary. Surely councils can do a better job at handling what is a fairly routine task.
As some of you know, I’m a high-yield bond lawyer. What this means is that I take care of the legal documentation in the context of offerings of sub-investment grade debt (i.e. “junk bonds”).
This does not mean I’m an expert at timing bond investments. However, I’m definitely closer to this particular market and I can see broad trends: is the market busy? Are companies issuing bonds for opportunistic refinancings or acquire other companies? Or are corporates turning to loans because the pricing offered by banks is more attractive?
When the Fed appeared to raise rates on “auto-pilot”, markets panicked. Equities tanked and new bond offerings vanished. Market conditions were too volatile. More importantly, why would you invest in a risky “high-yield” bond at 4% when you could get 3% guaranteed from the U.S. government?
Bond investors were asking for a higher coupons, and companies were essentially waiting out to see if this was a temporary pushback for investors or the new normal.
For a while, it seemed that normalization was firmly underway after an era of quantitative easing and cheap money. Call it a reversion to the mean.
And then the U.S. yield curve inverted and everybody panicked.
The yield curve in a “normal” environment
The yield curve is a dotted line on a graph that indicates the yield of fixed-income securities against the length of time left until maturity. When the economy functions properly, the yield curve trends upward. Why?
Due to inflation, the value of a dollar or a pound is less tomorrow than it is today. Therefore, investors will ask for a higher yield to at least offset the inflation that will dent their returns over time.
There are also other factors at play. Holding a security for a longer period means that you cannot reinvest your money in the meantime. That’s an opportunity cost. Additionally, there are increased risks and uncertainty in holding a security for a longer period of time (i.e. predicting events in three months tends to be slightly easier than predicting the next 30 years).
If you want to learn more about the basics, Sam at Financial Samurai wrote a nice post a couple of months ago. I encourage you to read it here.
The inversion of the yield curve: why it matters
As explained by Investopedia, “an inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality.”
To the avid reader, this should make no sense. Why would investors agree to lend money with a longer term maturity and for a lower coupon? Why not just take the money for the three-month bond?
Answer: if you expect things to get worse and taking the lower coupon is still the best way to protect your money for the foreseeable future. In other words, an inverted yield curve is considered to be an indicator for a future economic recession.
One could reasonably argue that an inverted yield curve is simply an indicator. Economic theory is one thing but reality is a very different one.
The issue is that an inverted yield curve proves to be a very accurate indicator in light of the past decades.
How accurate you wanted to ask? Historically, inversions of the U.S. yield curve have preceded many – if not all – US recessions. For instance, the last inversion occurred right before the 2007/2008 subprime crisis. With maybe one false-positive in the last 60 years and no recessions ever having a false negative, investors value an inverted yield curve as a prime indicator for investors across the globe.
The self-fulfilling prophecy argument
There might be an element of self-fulfilling prophecy here, which cannot be ruled out. If someone argues that the yield-curve is not a reliable indicator because it is the result of a self-fulfilling prophecy, that person might be right. More importantly, however, the outcome remains the same. If corporates and individuals believe a recession is coming, investments and spending will be curtailed, and growth will nose-dive.
To quote a friend, “a self-fulfilling prophecy is still a valid prophecy and there is no point in fighting market psychology since none of us can stop the stampede.“
Which yield curve recently inverted?
Following reports showing weaknesses in France and Germany, along with a slowdown in a key U.S. manufacturing index, the gap between the 3-month and 10-year rates turned negative. In the context of U.S. Treasuries, this means that the yield for lending money for debt with a ten-year maturity is now lower than the one available for a three money maturity.
According to Bloomberg, this portion of the curve flipped to inverted in early 2006. This was right in the lead-up to the economic downturn that started in 2007.
I also believe that the dovish announcement from the Fed that it would continue with its “wait and see” approach amid a slew of mixed economic data contributed to the inversion. As a result, market participants cut their expectations in seeing another interest rate increase before the end of the year. This is consistent with money-market traders betting that the Fed might even cut rates by the end of the year if the underlying data fail to improve significantly. This impacted the upward trajectory of the curve.
The San Francisco Fed called the 3-month-to-10-year spread the most useful for purposes of forecasting recessions. However, it is not the only key spread to look for.
There are multiple “yield curves” waiting for their inversion. Theoretically, you could look at the 5-years-to-10-year spread. But, to be a useful indicator, it is more appropriate to compare reasonably short term maturity to longer-term maturity.
The 2-year-to-10-year spread is also considered to be a very valuable indicator. Investors already responded strongly to the first inversion in over a decade with the Nasdaq down 2.5% on Friday and the Footsie 100 down 2.01%. An inversion between the 2-year and 10-year rates is likely to cause further market jitters.
And we are getting very close now. The spread only stands at 0.13%.
Source: charts.com
But this is a new world…
Some have argued that the yield curve’s importance is overstated in light of the flow of liquidity. The argument is the following: quantitative easing has distorted our markets and the liquidity environment. This is true from low-interest rate mortgages to negative interests in Europe. Economies are flushed with liquidity and therefore, the normal signal sent by an inversion of the yield curve is distorted and could simply be a false positive.
Only time will tell if this is true. However, there are two observations to be made. First, rates are lower, that’s true. Maybe it’s only a matter of moving the range where the yield curve sits. Instead of comparing 4% in the short term and 7% in the long term, we now have 3% and 5%. The point of origin may change but the trend remains: an inversion should not occur. Second, again, this does not alter the outcome of a self-fulfilling prophecy.
It usually takes 36 months to assess if an inversion is a false positive. Inevitably, there is a lag in the receiving the data, especially with the fairly recent U.S. shutdown. If no recession occurs in the next three years, then the skeptics may be right.
Readjusting your portfolio allocation BEFORE the imminent stock market crash tends to yield better results.
If you believe that the inversion of the yield curve is a reliable indicator in predicting a recession or a selloff in the stock market, then it’s time to take corrective actions.
In a recession, stocks and bonds move in opposite directions. If you believe that stocks are overvalued and that the equity market has not yet fully internalized a recession, then buying (i) government bonds, (ii) high-value corporate bonds (so not high-yield bonds, think of Apple instead) or (iii) mortgage-backed securities (the quality of the mortgage pool has improved since 2007) are reasonable options.
As always, you should do your own research. And yes, investing always carries a degree of risk. Personally, I am having a hard time getting comfortable with the fundamentals here, whether in the United States or in Europe especially. Any trade deal between China and the U.S. will only result in a temporary boost. There is no further room for tax cuts. House prices in key cities such as London and New-York are slowing. And manufacturing data continue to disappoint. As of today, it is difficult to see the next catalyst that would boost corporate earnings.
