Housing Market Braces For Interest Rate Hikes?

Per square meter prices for condos in the central Stockholm region has decreased recently, according to statistics from brokers, diagram above (SEK/m^2). A temporary effect or the impact of signals from the Riksbank, the Swedish Central Bank, that interest rates are soon going to be hiked from today's record low level of 1.5% p.a. As most households here fund their house or condo at short variable rates that are closely related to the Rikbanks' repo-rate, the Bank's decision has a direct impact on households finances. Conspiratory speculation: the bank cut rates this summer even as most Riksbank Deputy Governors during the spring told they were in favor of hikes. There is a general election this year so one could ask about the extent of political influences in the Riksbank. Or perhaps the other way round, will they hike in January just to show off their independence?

Money Talks Again

I don't know if it is because of the headline of the latest post, or if it is the lack of policing (my bad), but comment spam relating to money-making has apparently flourished here. Furthermore, a commercial enterprise in the finance-sector has asked to place a banner on this blog, paid for on a monthly basis. I'm most fluttered. Still it's not yet clear to me about what to post on a blog, and when to write it. Ideally, as I see it, inspiration and ideas gained from blogging should be a valuable input to your daytime job. Risks are of course that time gets wasted on interesting and exciting thoughts that eventually turn out to be unfruitful from a commercial perspective. My daytime tasks right now relates to the implimentation of the EU occupational pensions dircective (IORP) into Swedish law and pension managers' long term investment plans. Who on earth wants to read, where on blogosphere could I get some input? Anyway, I'll surf around and see what I can find, when I get some spare time.

(I swear this is wholly unintentional on my part, but the blogger spell check just suggested me to change the occurence above of "blog" to "bloc", and "blogging" to "flogging"!!?)

Money Talks

This blogger evidently took a long and unannounced vacation. It was not really vacation from writing; it was more the case that the texts I write for a living - about news with an impact on the Swedish bondmarket - got increasingly demanded and spare time hence increasingly scarce. Because of almost everyday practice from blogging in English? Maybe - anyway here is a text in Swedish by Liza Marklund, a successful writer of detective stories. It is about labor taxes, gender and everyday economics, all of which are favorite issues of mine (published as a column in the leading Swedish tabloid Aftonbladet; Social Democratic). With impressing clarity of thought she efficiently reveals how an important, but underestimated, sector of the economy and its taxation is built on old-fashioned and obsolete attitudes towards gender. I would have loved to summarize it for you together with a short background. Some other time maybe.

"Employment Lags GDP" - Really?

Amid faltering job-growth pressures have risen on the Riksbank to cut rates. There is hence a fierce debate focused on these two issues going on here in Sweden right now; the job-market and the central-bank policy (here is the latest contribution, in Swedish). Rather than adding anything to this, which seems more than fully covered by mainstream media, I would just like to comment on a very common but partially unclear use of language in this context. It is often said things like that "the labour market lags the business cycle". But plotting annual changes in GDP against annual changes in employment as measured by non-farm payrolls, the two appears to have developed synchronous from 1970 up to today. Hence it is actually perfectly safe to say that:

the labour market does not lag the business cycle!

Still the above sounds highly controversial - why? To me it seems that when it comes to employment, we are not satisfied with seeing the annual change of it rising - we do not feel that things are going in the right direction before the employment itself is acutally rising. With GDP however, the story is different, as soon as the annual change of GDP - or "growth" - is rising, we cheer the event that the business cycle has bottomed out and brighter times lies ahead. That the GDP change is still negative does not seem to matter in this respect as long as it is rising. So when we say that

"Employment Lags GDP"

we simply mean that the number of employed lags the rate of change of annual GDP growth. Given that employment and production is neither significantly lagging or leading each other, this is the same as saying

"GDP Level Lags Annual Changes in GDP"

which is trivial. Yet it might have given many of us the false impression that much faster job creation lies ahead. But in the US, job creation is conditional upon GDP growth, which has recently stagnated. The best thing we can hope for in Sweden is for job creation starting off with the much awaited expansion in the service-sector. But so far we are still waiting.

Why Are Asian Savings This High?

As I was writing about the bond-yield conundrum from the perspective of household savings in countries that are rising or recently have risen from poverty, Institutional Economics have apparently done the same thing. There, John Quiggin is quoted as writing "there is no convincing micro story as to why people in poor countries should want to save massive amounts", in direct opposition to my thoughts below. I was writing that a poor household optimally saves as much it can to lower the risk of facing starvation. This need not amount to much, or even to any net savings at all over time, as these households may now and then have to liquidate funds to survive. But, if these households, or households in the next generation apply the same method of saving when its possible, they might well end up with to massive if household income steadily grows in a prospering economy.

The general view, which is represented by Instituinal Economics, is however not that oversaving is caused by households, but by Governments:
I agree with John that it is perverse that we should see developing countries saving to fund investment in rich countries, but this is due to forced saving via managed exchange rate regimes. It is indeed ridiculous that China is issuing domestic debt to fund purchases of US debt instruments, as Deepak Lal has noted, but symptomatic of its mercantilist development strategy. I agree that this will not be sustained because fixed exchange rate regimes always come unstuck, but I see this as being more of an issue for China than for the US or Australia.
But to me, the claim that [the government of]China is "issuing domestic debt to fund purchases of US debt" seems a very good support of my household story. As domestic investors could find it more difficult to invest in US than domestically, the government here sees a natural business opportunity to channel the domestic Chinese demand for savings into US assets. Furthermore, I would like to question the currency-peg explanation. It is true that an undervalued currency stimulates export industry at the cost of domestic services, hence stimulating savings. But with arguments similar to those in the Balassa-Samuelson framework, the real exchange rate will anyway be adjusted by inflation, eventually neutralizing the nominal peg.

Why Are Interest Rates This Low?

Interest rates for long-term gov't guaranteed loans (yields on T-Bonds in the US) having fallen back to where they were when Greenspan in February called the low rates a "conundrum". Hence an opportunity to get back to the discussion on why most countries today have such an unusually low interest rate levels, at odds with economists repeated predictions of higher rates. For us in Sweden, this discussion is important for our central bank, the Riksbank's, whose board sees their interest rate levels as "basically very low", and looks for arguments to hike them in. This is troublesome, as politicians and some leading economists are calling for cuts amid a faltering recovery in the labor market and low inflation rates. Nevertheless, one board-member, perhaps by the market considered as the most hawkish, recently managed to discuss the subject in a speech called Unusual market rate developments, much influenced by that of Greenspan mentioned above with my comments here.

Several different reasons for low rates have been put forth, and it is easy to agree that factors like low expected inflation, central bank inflation targeting in increasingly productive economies, and decreased need for investments in an industry that manages to increase output while slimming production are important. Asian central bank buying and currency pegging is also to some extent helpful in explaining the low first world rates, but do these factors really have a bearing on the world interest rates, or are they merely increasing the spread between the effective interest-rates in e.g. China and the USA? But one factor, the hedge fund buying, long-standing member of the usual suspects, should be off the list since bond-yields now probably is seen as too risky, with all its variation (in the 4.0 - 5.0 % range for the 10-year treasury) for the return, especially in the view of decreased carry (aprox. bond-yield minus repo-rate). A new explanation has however materialized: pension reforms in Europe, and possibly elsewhere, that requires life insurers to match their liabilities, i.e. buy long and even ultra-long bonds.

But on the other hand are factors that acts in the other direction, interest rates are buoyed by consumers, most notably in the USA, that are rapidly expanding their debt, and by most of the largest world-economies' governments that are borrowing at a pace corresponding to several percent of total production, GDP.

All in all, the old rule of thumb that the rate net of inflation, the real rate, should correspond to the expected economic growth rate, does simply not work that well these days, as was mentioned in the Riksbank speech. Even though it is a rule with quite some support in economic theory, one should find good reason to examine, and perhaps overhaul it, today. Before, I have done so from several perspectives concerning households investment in their own human capital, skills and education. Today it should be enough to concentrate at the households financial savings, as the production perspective has, at least when it comes to the companies, been discussed in e.g. the Riksbank speech mentioned above. According to the rule of thumb, we save when we see worse times ahead, and borrow when the future looks brighter, to smooth out variations in lifetime consumption. Theoretically, we are assumed to optimize derived utility, which is supposed to be a smooth function of consumption with declining steepness.

In everyday life, at least in a place that has industrialized rapidly, consumption smoothing seems not to be on all household's agendas. The rule is rather that you should save while you can if you can, at least if you talk with people in older generations. And this rule was probably rational in the old days when saved money could save your life in times of economic hardship. Furthermore as we know that - or at least assume in policy-making regarding pensions - life-time saving decisions by individuals are not rational (a claim that is made probable by the lack of learning - you only retire once), the save-if-you-can rule might be inherited by younger generations. Theoretically, if your utility function displays a sharp knee between a steep line at poverty-level consumption and a flat one above, it might be rational to save, even at low or zero rates, until your risk of dropping back into poverty becomes low. Let us hence revise the rule of thumb:

A. If the representative household faces little risk of poverty and has distanced itself from traditional views on savings, real rates correspond to expected growth.

B. If the representative household still holds the traditional views on savings, real rates are much lower than you should expect in A.

And if we take the representative household to be one that belongs to a group that is responsible for a large part of world consumption, we should be much closer to the low-rate regime in B. than the old regime where the world outside USA, Japan and Europe really didn't count.

Free Lunch for Writers!

Some of us that are writing about the economy, especially with applications to finance, are sometimes getting away with earning almost free lunches. At least we sometimes get good paid by stating the bleeding obvious. If demand rises relative to supply, prises increase! Regions where this rise is the strongest will be net importers of the good in question!

From the Wall Street Journal via Institutional Economics:
in a world of excess saving relative to investment, not only will real interest rates be driven down, but some country or group of countries must run current-account deficits to absorb the excess saving

Update: Broken link fixed, thanks to Frans for pointing it out for me, and for the link from his post on a nearby issue. It seem that things like the changing distribution of world growth, directions of investment flows, and the new level of international interest rates are things that we still could discuss some more.

Job Vacancies Down

The number of new job vacancies were down for yet another week, according to the latest weekly report from the Labour Market Administration. Now the picture is beginning to look less optimistic than it did in the beginning of this year and in the end of last. The Riksbank wrote in its latest Inflation Report under the headline "Signs of improvement in the labour market" that "the number of new job vacancies reported to employment offices has risen". As is clear from the diagram is that this rise has slowed and reversed during the last couple of months. (Being more careful with seasonal adjustment makes the situation look brighter for the recent months, but worse for the beginning of the year. At any rate, the situation seems worse than it did according to the Riksbank's description)

Jobless Growth Comes to Sweden?

Despite GPD growth above trend, the Swedish labour market has so far failed to recover. The debate on this gained new strength as business confidence weakend and household's inflation expectations plunged, according to a report released last week by the economic research institute NIER. The Central Bank, the Riksbank, was by NIER's head critizised for running a too hakish policy, a critique that the Social Democratic PM soon followed up upon. The PM was in his turn attacked by a prominent bank economist during the weekend, who blamed the PM's policy for hidering rather than stiumulating job-growth. Much the same ideas were echoed in the business daily DI's editorial this morning. Proposed measures by the goverment seem rather directed towards making the labour market statistics look better than actually making the labour market work better.

Interestingly, the critique sees based upon the ideas about changes in the business cycle presented in the paper by Grosher and Potter called "Has Structural Change Contributed to a Jobless Recovery?". Old sectors are shut down or offshored, and the job growth is created in new and developing sectors, Grosher and Potter shows. Updated statistics from Cleveland FED could be found here (thanks to the Big Picture for the link). The Swedish government does not at all try to enhance labour market efficiency to facilitate growth in new sectors; even worse, they are actively stopping private initiatives in the domestic service sector.

According to figures from Statistics Sweden, it is now make or break for jobless growth in Sweden. In their quarterly economic review, employment should pick up this quarter if its traditional link to GPD still holds. There is however scant evidence of this so far.

A First World Debt Crisis!?

It's not only the USA, most large first world economies' governments are running deficits amounting to several percentage of GDP. From a bondmarket perspective, it's a conundrum why economists think that long term interest rates are 'artificially' pushed too low. Why, first world governments are holding rates up by flooding the markets with bonds. According to the Financial Times,
Standard & Poor's says if fiscal trends prevail, the cost of ageing populations will fuel downgrades of France, the US, Germany and the UK from investment grade to speculative, or junk, category France by the early 2020s, the US and Germany before 2030 and the UK before 2035.
Even though the buyers of these bonds might look irrational from this perspective, the first world governments sure do not. As long as they can bring large volumes of debt that is still top rated (AAA) to the market at high prices, they should. And they do. At least as long as they could find good use for the money raised. Let's hope they will...

Unemployment - Everyones Argument

Despite the rapid growth of Swedish GDP, the employment situation fails to improve. Day before yesterday, Statistics Sweden released figures pointing to a shrinking labour-market during the last quarter of 2004, while production was lifted (although at a slightly slower pace) by a strong productivity development. Yesterday, the Labour Market Admin. reported disappointing news for the February unemployment, up 0.7% to 8.5% in total (forget about the headline figure of 5.5%, that's just cosmetics). Now the unemployment is everyones argument. Head of the nat'l union wants more fiscal stimulus and a more dowish central bank, pundits and politicians on the right want to reform the structure of the labour market. At any rate, it's good to see that they all seem to be troubled over the severe problem that the Swedish unemployment represents.

Economist Bias

Economists have to an increasing extent tended to over-estimate the monthly inflation-rate in Sweden. Are they using an old map that lacks e.g. the recent trend towards inexpensiveness, "billighetstrenden" in retail? Here is what one analyst wrote yesterday a propos the soon to be announced Swedish February CPI:
The February CPI figure, due Friday, is expected to print 0.1% according to economists polled by Bloomberg, 0,2% says Sweden-based pollster SME-Direkt. ... For a quantitative perspective, economists have on average overestimated inflation by 0.05% since Oct 02. During last year, they overestimated inflation in most months, on average the figure came out 0.1% below expectations. The very last number, the Jan CPI came out -0.5% and was estimated -0.2% in Bloomberg’s poll


Retail Sales Above Expectations But Prices Decline - SCB, HUI
Swedish retail sales for February increased 6.9% YoY, faster than the consensus forecast 5.2% (Bloomberg). Retail prices on mostly food fell 0.7% during the month, and on mostly durables they fell 3.6%. According to the Swedish Research Institute of Trade, HUI, whome publishes the figure together with Statistics Sweden, SCB, the fall in prices was due to "Many reasons", among them a "relatively strong Krona, technical development and a trend towards inexpensiveness (billighetstrend)".

Economists, Noise-Traders and Journalists Happy Together

One of the large public Swedish pension funds, AP3, indicated last week that they had sold out their entire holdings of (Swedish) bonds, among those the inflation-protected. Considering the long-term nature of the funds' cash-flows, which the bonds probably to some extent matched, this must be seen as is a huge bet on an (faster than implied by the yield curve) increase in long-term interest rates. I've personally seen how such a bet have been made: the trader needs risk in his or her portfolio. He or she also need a good arguments behind that risk-taking, arguments that should point to in what direction the risk should be taken (black/red manque/pair). The (macro-) economist, who has been shouting for a long while about a bond-bubble and unsustainably low levels on bond yields in particular and interest-rates in general, is happy to eventually find someone who listens. If the bet fails, as it has before, they blame each other and others have to pay.

The most annoying part in the current story is that the journalists at Svenska Dagbladet (Swedish leading daily conservative) happily have refrained from doing their job, uncritically referring to the huge short-position on bonds by writing that AP3 has "reduced the risk in their interest-rate bearing portfolio". Technically true, but in its context a lie.

Do Low Long Term Interest Rates Really Confuse Greenspan?

In Greenspan's testimony yesterday, he seemed to embraced the view most economists share today: that the world's long term interest rates are unexplicably low. Good for economist then; not even the guru can explain this, how could we? For instance, DeLong is happy to quote: "The Fed chief said it was hard to explain why long-term interest rates have declined in the face of the U.S. central bank's short-term rate increases." However, looking closer, Greenspan actually explains quite a lot of the world economies newly opened sources for capital which eases the need for funding over the capital market and lessens upward pressure on yields:
"There is little doubt that, with the breakup of the Soviet Union and the integration of China and India into the global trading market, more of the world's productive capacity is being tapped to satisfy global demands for goods and services. Concurrently, greater integration of financial markets has meant that a larger share of the world's pool of savings is being deployed in cross-border financing of investment."
he says. He hence seems more puzzled over the very last rally in bonds, not the since several year established low long term rates. He continues, sayint that:
"none of this is new and hence it is difficult to attribute the long-term interest rate declines of the last nine months to glacially increasing globalization."
Now the time has come to express a different opinion. Hasn't the continuing unbroken pace of the globalization surprised markets. Abolishing of textile quotas? China's growing demand for oil? Long term contracts for oil, the very same ones that Greenspan is referring to have become more than 50% more expensive in these "last nine months". Consider then that the increased need for crude oil comes from new industrial plants that China have built without net external funding. The case is actually that they simultaneously have build up new crude guzzling industries while simultanousely beeing increasingly larger net-exporters of capital! This nine month development clearly have surprised at least the oil market, and from that perspective it would be most appropriate to talk abot it as brand new, at least in a quantitative sense.

Greenspan concluded his speech talking about human capital, or "skill":
"workers will need to acquire the skills required to compete effectively for the new jobs that our economy will create. ...We need to reduce the relative excess of lesser-skilled workers and enhance the number of skilled workers by expediting the acquisition of skills by all students, both through formal education and on-the-job training."
This is of course most important, and also helps explain the low level of interest rate. While processes in Asia is adding human capital to the world market (at least implicitly so via their export markets), interest rates are as already mentioned pushed down through lower overall demand for capital. But as Greenspan points out, the return of human capital decreases, and the US worforce needs to add skills to keep its share of returns, to keep up its wages. Now, if workers leave factories for schools, they would need funding to cover for lost wages, putting upward pressure on interest-rates. However, in "on-the-job training", they may well be able to simulateously produce (and hence save), and invest in their own increased skill. Much the same way as China have managed to be net-exporters while rapidly builing up their own industry. I can only speak for myself, but I clearly didn't learn in school the digital communications tools and software package I'm using in everyday work!

War Really Sucks (Dresden Edition)

Sixty years after the allied air raid that probably killed more than 35 000 people in Dresden, mostly civilans, the terror-bombing is still a crime against humanity that is not forgotten. And with the inevitable and tragic logic of violence, it has now become a propaganda tool for Nazis.

CO2 Allowances on Nordic Electricity Exch.

Allowances to emitt carbon di-oxide, the bulk bi-product from burning fossil fuels, are now trading at the nordic electricity exchange Nord Pool: CO2 Allowances The allowance are given under the EU Emission Trading Scheme, and the purpose is to "counter the threat of greenhouse gases". Currently trading slightly above 7Eur per (metric) tonne, it would cout about 3Eur to buy allowances to burn a barrel of oil (using the formula for heating oil here). Burning the barrel gives about 1.7 MWh of thermal energy, from which one could perhaps produce 0.5 MWh of electricity. Each MWh produced this way would hence cost an extra 6 Eur if one would have to buy emission allowance. The MWh is now trading around 20 Eur. Analysts have estimated the price impact from new CO2 rules to be about 4 Eur/MWh. It might be useful to keep an eye on these figures for us Scandinaves. One tend to think that electricity is produced by nukes and hydropower facilities, but the Danish coal-powered plants should not be forgotten in this.


As I've got some readers to this post sent to me from the Swedish blog "Sänd mina rötter regn", I just thought it should be worth to update the post. According to people referred to as trustworhty sources from within the industry, their estimates for the price-increase on Nordic electricity is 25-50 Norweigian Krona per MWh, less than 2.5-5 Eur/MWh.

A Technical Note on Volatility Feedback

A note for those interested in the relationship between expected risk and expected return. This relationship makes itself felt for instance in the negative correlation between moves in index-option volatility and the index-value itself, and is sometimes referred to as volatility feedback. Simply put: the reward for risk should be proportional to return variance.

Motivation: consider a two-year period during which the index-return has had an annual volatility of let's say 10%, which corresponds to an annual variance of 1%. Suppose the risk-premia has been 1% annually. In total, a risk-premia of 2% should be required for a total index-return variance of 2% and a standard deviation of 14%. Now look at another two-year period with the same risk and return, only that the first year has a known return of 0%. The second year should hence have a variance of 2%, a standard deviation of 14% and a required risk-premium of 2% to make the two-year characteristics equal the first example.

In all risky periods, the ratio risk-premia to variance is constant (=1) in the example. Note that the Sharpe ratio, risk-premia to standard deviation, is higher in the period with the highest risk.


The decrease of short-term implied volatility as indicated by the "VIX"-index from 40ish to slightly about 10% from the Enron-crisis up to today may look like risk having decreased to a 4:th. However, with index risk-premia proportional to variance, they should rather be viewd as having decreased to a 16:th. In other words, the stock market has already collected most of the gains from risk-reduction since Enron fell. Don't expect any good stock-index returns before risk expectations have found reason to rise again.

Bomb Supply => Bond Supply

The costs for the war in Iraq are increasing, reports the Washington Post:
"The latest war request would push the total cost of military operations in Iraq and Afghanistan and other efforts since the Sept. 11, 2001, attacks to $277 billion, according to the CBO. That figure well exceeds the inflation-adjusted $200 billion cost of World War I and is approaching the $350 billion cost of the Korean War, according to Commerce Department figures. "
With the current and projected future U.S. central government deficits, supplying bombs to the military is tightly linked to supplying bonds to the treasury market. Lots of them.

Topically Swedish - The Central Bank Target

Is the Swedish Central Bank, the Riksbank, sliding from its inflation-rate targeting? Or will it have to cut the repo-rate in the face of the currently low inflation despite the central bank governor's strong and pronounced bias towards hiking rates? This is the topical discussion after recent decreases in market expectations in the future repo-rate in the wake of the Governor's speech last week.

Sveriges Riksbank - Low inflation, but outlook remains largely the same: "The fact that I did not advocate further or larger interest rate cuts was not merely due to the expectation that inflation would be in line with the target two years ahead; it was also due to the strong growth in demand. The Riksbank has explained on previous occasions that it is reasonable to take some account of developments in the real economy, both because these say something about inflation in the longer term and because a stable real economic development is important in itself. "

Klein Bottles

The Swedish paper Ny Teknik, published by the Engineer's Organization, recommended these Klein Bottles as christmas gifts for those who "already had everything" and an interest in mathematics too. I didn't notice it in time for christmas, maybe next year?

Klein Bottles

Here is a short background from the vendor's site:
In 1882, Felix Klein imagined sewing two Möbius Loops together to create a single sided bottle with no boundary. Its inside is its outside. It contains itself.

Take a rectangle and join one pair of opposite sides -- you'll now have a cylinder. Now join the other pair of sides with a half-twist. That last step isn't possible in our universe, sad to say. A true Klein Bottle requires 4-dimensions because the surface has to pass through itself without a hole.

It's closed and non-orientable, so a symbol on its surface can be slid around on it and reappear backwards at the same place.You can't do this trick on a sphere, doughnut, or pet ferret -- they're orientable.

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