Macro Wrap-Up

Sweden's Noll Hypothesis

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Sweden's Noll Hypothesis

Macroeconomics is the study of large groups of people over the course of many years. As such, it does not lend itself well to experimentation. No researcher can get the millions of people who make up an economy into a study, even if he offers each of them a nice gift card. In the real world, there may only be a few examples of each event that an economist studies. There are a hundred approaches to measuring growth but perhaps only one business cycle in each decade to measure. This lack of observations may discourage a few folks from drawing conclusions, instead choosing to live in constant uncertainty. 1 1 Close The paradox is that there is a wealth of data available, but not necessarily enough unique instances of what you’re studying. There may be a thousand data points and only one instance to measure. This can fool you into thinking you have statistically significant results. You can study thousands of price points in early 2009, but your conclusion will be biased toward selling stocks, which may not have been a good strategy in other years. More commonly, economists and investors place undue weight on individual events, such as the financial crisis or an oil shock, and this can move markets. While we may disagree with the merits of such extrapolation, we should be aware when such “experiments” are happening.

In the past decade or so, there has been no better economic laboratory than Sweden. It has had growth and recession; external and internal shocks; and some unorthodox monetary policy. In response to the financial crisis in 2009 the Swedish Central Bank, the famed Riksbank, took its deposit rate to negative levels, well before its neighbors in Denmark, Switzerland or the euro area dared to break the zero lower bound. 2 2 Close The repo rate which is their primary target remained above zero during that time.  That experiment didn’t last long because Sweden recovered from the crisis quickly. The Riksbank again led the way as one of the first central banks to raise rates. By mid-2011 its repo rate was up to 2%. The economy stalled, and Swedish GDP went negative again. 3 3 Close Statistics Sweden.  Many economists and some Swedish citizens blame what they see as premature normalization of rates for this double-dip. As with any single event, there is no way to isolate the causes, but it seems fairly intuitive that higher rates so soon after a deep recession might hurt growth. However, some of the Riksbank members deny the connection. They can point out that Sweden has an export-oriented industrial economy, which made it vulnerable to external shocks such as the European sovereign debt crisis.  

The Riksbank reversed course and cut rates back to noll. 4 4 Close Noll means zero in Swedish. I made sure I learned at least one word in Swedish during my research this week. I also learned the Swedish chef from The Muppet Show has a Norwegian accent at least according to one person from Sweden. I may have already known that. The economy recovered: in 2014 Sweden grew at 3.4% by one measure. 5 5 Close Real GDP growth adjusted for changes in working days.  An uneducated Riksbank-watcher might have expected another hiking cycle, but he would have been disappointed. In fact, those industrious Swedes cut rates 50 bps below zero and added an asset purchase program for good measure. This surprising turn of events could be attributed to some form of central bank post-traumatic stress after the previous hiking cycle. Perhaps it was the result of political pressure or a reaction to a sick burn by one of the winners of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. 6 6 Close Paul Krugman referred to Riksbank policy as sado-monetarism. That is only a sick burn by Central Bank standards. Note that I didn’t call him an economist. New York Times: “Sweden Turns Japanese,” 4/20/14.  It seems unusual for a country growing at a brisk pace to engage in such aggressive monetary policy stimulus.  

But maybe it isn’t. The Riksbank does not share the Fed’s dual mandate. The Sveriges Riksbank Act states that the Riksbank shall “maintain price stability,” which the Riksbank interprets to mean that “inflation should be low and stable.”  7 7 Close Riksbank.  Their inflation target is 2%. Supporting other economic objectives is expressly secondary. In 2014, despite strong growth, inflation was near zero. It only got up to target in the middle of 2017, where it’s mostly been since. 8 8 Close It dipped in the middle of the year which further muddied the case for rate hikes. The latest reading is 1.8% year on year for headline inflation. The Swedish experiment with negative rates can be viewed as a strict adherence to the principles of inflation targeting. And by some accounts a successful one.

In late 2018, growth started to slow in Sweden. Data was on balance disappointing as it was for much of the rest of Europe. The weakness in global manufacturing took its toll on the Swedish economy. But with inflation somewhere near target, the Riksbank hiked rates, bringing the target rate from -50bps all the way back to zero at the end of 2019. From an inflation perspective the move made some sense, but it seemed unusual to hike rates with growth slowing. Economists can argue about the best way to conduct monetary policy, but none have proposed adopting an inverse growth target.  

This has led to speculation that the Governors were keen to end the negative rate experiment, regardless of the economic data. Negative rates remain very controversial. Economists had warned of cash hoarding, but that has not been a serious problem. The concern has moved to the economic effects. Some critics claim that once rates fall below a so-called “reversal rate,” negative rates become a drag on growth rather than providing stimulus. The Riksbank may be hiking rates to get them above this reversal rate or to escape any potential side-effects of the experimental policy.

Riksbank members do not have a unified view on this issue. Deputy Governor and resident dove Per Jansson said on Monday that “there is no intrinsic value in moving out of negative territory.”  9 9 Close Bloomberg: “Riksbank’s Jansson: Need to Be Realistic in Coming Rate Calls,” 1/13/20.  Governor Stefan Ingves provided more nuanced and complex views that probably better reflect the official policy. He said that negative rates “worked well on the whole” but that he was “comfortable” that rates did not stay low for so long that they had become “natural, the way things are supposed to be.”  10 10 Close Bloomberg: “Riksbank Ends Negative Rates But Remains Expansionary: Ingves (Video)” 12/19/19. As transcribed by AQR. 

To much of the investing world, the Riksbank is embarking on a new experiment: positive (or zero) rates.  Investors will be looking at every Swedish data point with increased scrutiny to see how this experiment goes. They will be trying to determine whether negative rates have in fact been a drag on growth. We know there are so many factors that go into the economy, that one instance can’t prove the success or failure of the policy, but that knowledge may not matter. It won’t stop investors from drawing sweeping conclusions. This is particularly important because there is a big central bank which is rethinking its monetary policy and possibly its experiment with negative rates. The ECB may take its cues from the Riksbank. If Swedish growth stalls again, rates may stay negative for quite a while in Europe. You can bet that ECB governors will be looking for economic releases from their friends in the north, whether they’d like to admit it or not.  

What We Are Watching 

Bank of Canada Meeting (Wednesday)
Canadian economic data has been volatile lately. In early December, the country reported the largest increase in the unemployment rate since the Global Financial Crisis only to reverse most of this increase in the January report. Despite weak data on manufacturing output and retail sales for November, the Bank of Canada’s business and consumer surveys for the same month report quite upbeat sentiment on both groups and rising capacity pressures. The volatility in the data have not affected the Bank of Canada’s policy bias so far. The central bank maintains a neutral stance with the current level of rates seen as being “about right.”  11 11 Close Dow Jones Newswires: “Bank of Canada Governor Says Monetary Conditions Are About Right,” 11/21/19 Any departure from the BoC’s neutral stance would surprise markets and could lead to notable re-pricing in rates and currency markets.  

ECB Meeting (Thursday)
Last month, Christine Lagarde’s first meeting as President of the ECB came with no surprises, reflecting an uneventful transition between largely likeminded policymakers. Following the announcement of additional stimulus in September, including a 0.1% deposit rate cut and a resumption of asset purchases, the guidance from President Lagarde was one of cautious vigilance and optimism, emphasizing somewhat less intense downward momentum in the European economy toward the end of the year. Next week’s meeting should maintain a similar “wait-and-see” message with the potential for additional optimism following agreement between the U.S. and China on a Phase One trade deal. Without much expected from the ECB, any meaningful change in either a hawkish or dovish direction could produce a significant market reaction.

U.K. PMIs (Friday)
U.K. growth slowed significantly in 2019, weighed down by a softer global economy and elevated domestic uncertainty as politicians struggled to approve a plan for Brexit. 12 12 Close Estimates of monthly GDP from the UK Office of National Statistics show near-zero growth from February to November.  Nonetheless, the Bank of England refrained from easing policy, waiting for clarity on whether the country would be able to orchestrate an orderly exit from the EU. The December General Election paved the way for approval of Prime Minister Johnson’s Brexit plan, reducing the risk of a disruptive “No Deal” Brexit and fueling hopes that confidence and growth could improve significantly in 2020. However, recent data releases have pointed to even lower-than-expected growth and inflation towards the end of 2019 and BoE Governor Carney noted in a recent speech that “there is a debate at the MPC over the relative merits of near term stimulus,” as “much hinges on the speed with which domestic confidence returns.”  Carney went on to note that “in the coming weeks, the MPC will watch closely surveys of business and consumer confidence.” The Manufacturing and Service sector PMIs scheduled to be published this week are the highest-profile surveys that will be published ahead of the BoE’s next monetary policy meeting. Both PMIs have recently been at subdued levels, and any failure to improve this month could convince the BoE to move forward with a rate cut. As a result, lower-than-expected readings would likely trigger weakness in the British pound and a rally in domestic fixed income. 

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