Aurelia Butler

The writer is a visiting professor of economics at Columbia Business SchoolThe European Central Bank’s transmission protection instrument has been created with the best intentions. As ECB president Christine Lagarde explained, the TPI “can be activated to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro”.There is clearly value in an instrument that backstops the euro without limit. However, to be beneficial to the EU such an instrument must not undermine sound fiscal and economic policies. In this case, the absence of effective conditionality leads to atrocious incentives for countries, politicians and, crucially right now, voters. The ECB listed four criteria for a country to be eligible: compliance with the EU fiscal framework; absence of severe macroeconomic imbalances; sustainable debt, according to the analysis of several institutions; and compliance with other EU recommendations. In practice, the first is suspended given the fiscal rules. The second and fourth do not seem effective since they offer large discretion for judgment by the European Commission. On the last, the commission has been giving free rides to all countries in their recovery plans (except Hungary and Poland, because of disputes about the rule of law). Whether it does this for supposedly good, Keynesian reasons or for bad, political economy reasons, is irrelevant. And, based on sufficiently optimistic assumptions, a declaration by the institutions that debt is sustainable is no real hurdle. Moreover, the ECB must merely “consider” these criteria as “an input”. The ECB has put itself in an impossible position. It has dulled all desirable market signals and incentives, without replacing them with any credible conditionality. The TPI is not accompanied by a fiscal backstop from eurozone countries. So, if the ECB stops intervening “based on an assessment that persistent tensions are due to country fundamentals”, the state supported will face a fiscal crisis. But the ECB will want to avoid sovereign debt restructuring, so it will be trapped into continuing support.

It is no wonder that rightwing parties in Italy brought down Mario Draghi’s government at exactly the moment they knew the ECB was about to announce the backstop for bondholders. The incentives for a new far right, Eurosceptic government to choose a responsible course are low. More likely, it will cut taxes, increase pensions and offer untargeted energy support, betting that the ECB will have no choice but to activate the TPI and continue buying Italian debt. With the ECB providing such full insurance, the incentives to complete the architecture of the euro have evaporated as well. In a stunning development, the member states have quietly announced the abandonment of efforts to conclude the EU’s banking union by putting in place a European deposit insurance. Most importantly, the TPI creates a dangerous lack of transparency for voters. If a coalition that is leading the polls is likely to govern badly and put a country at risk, voters have a right to know the pitfalls and see them reflected in the markets.The creation of such a largely unconditional instrument is a mistake, and one that Draghi avoided while at the helm of the ECB. The instrument he devised at the height of the euro crisis, the Outright Monetary Transactions programme, provided all the right incentives as it could only be activated with the backing of the European Stability Mechanism, and an approved reform programme. The coming winter will test this weak institutional set-up. As long as the eurozone does not move towards a true fiscal and banking union, it is likely to reveal the unsustainable nature of the current construction of the euro. More

BEIJING (Reuters) -The stock of new homes in small Chinese cities hit its highest since 2019 as of the end of August, according to a report from an independent consultancy, amid fragile demand in the country’s downtrodden property market.The number of unsold new homes in tier-three and tier-four cities jumped 5% as of the end of August from a year ago, according to China Real Estate Information Corp (CRIC) which monitors 100 Chinese cities.It was currently taking developers about 20 months to sell a new home nationwide and over 50 months in some small cities, CRIC said in a report published on Wednesday.Small cities generally account for about half of all unsold new homes in China. CRIC declined to comment when asked by Reuters to give more details.China’s property market has repeatedly grappled with crises since 2020 and problems worsened in August as a mortgage boycott and developers’ financial strains further hurt confidence in the sector, data showed earlier this month.Prices were dragged down by weak demand in smaller cities amid persistently slow deliveries by heavily-indebted developers, the data showed.Developers in tier-two cities including some provincial capitals, were also struggling to find buyers, the CRIC report showed, and it was taking them around 18 months to sell houses.The eastern city of Qingdao and the central city of Wuhan both reported more than 20 million square meters of unsold new home stock each, topping the cities monitored by CRIC.While the number of unsold new homes increased by 13% year on-year in August in tier-one cities, where developers tend to launch new projects, it took nearly 13 months for new homes to be sold in cities such as Beijing, Shanghai, Guangzhou and Shenzhen, said CRIC.Nationwide, housing stock rose 3% to 587.2 million square metres, according to CRIC. That’s the equivalent of about 6.5 million typical Chinese homes measuring 90 square metres each.Housing stock has been rising at least since mid-2020 when policymakers started to step in to cut excessive debt held by developers.As of August, there were 6.1 billion square metres of housing projects under construction, according to data from China’s statistics bureau.The market will continue to find its bottom, with home sales likely to fall in the traditional peak buying season of September, said the CRIC.”Overall inventories are likely to maintain a rising trend,” it said. More

Britain’s public finances have given new chancellor Kwasi Kwarteng a difficult backdrop for his mini Budget on Friday, with government borrowing rising to twice the level the independent fiscal watchdog had expected for August.The figures and overnight indications from Prime Minister Liz Truss’s government that it wants to cut taxes further than expected this week raised fears that the package would prove unsustainable and require significantly higher interest rates. Markets are concerned that a borrow and spend package when unemployment is at a 50-year low and inflationary pressure is already high will leave the UK living beyond its means and require the Bank of England to slam on the brakes. The prospect of even higher interest rates did not bolster sterling against a very strong US dollar in early trading on Wednesday, with the pound slipping to another 37-year low of $1.132.In August, the public sector borrowed £11.8bn, higher than City forecasts of £8.8bn and almost twice the amount estimated by the Office for Budget Responsibility earlier in the year. The fiscal watchdog thought the figure would be only £6bn.With the chancellor set to unveil the costs of the government’s energy support package on Friday, financed by additional borrowing and large permanent tax cuts, the level of borrowing is expected to rise sharply above these estimates later in the year. Kwarteng was unapologetic about the government’s new strategy. In a statement he said that strong growth and sustainable public finances went hand in hand. “As chancellor, I have pledged to get debt down in the medium term. However, in the face of a major economic shock, it is absolutely right that the government takes action now to help families and businesses, just as we did during the pandemic,” he said. Jens Larsen, a director at Eurasia Group, the consultancy, said that the government’s new strategy was likely to result in a decline in the popularity of UK assets in financial markets. “The combination of a potentially expensive and relatively inefficient fiscal package, a central bank intent on demonstrating its independence and a very large net supply of gilts will probably lead to continued upward pressure on UK risk premia,” Larsen said. Loosening fiscal policy will put the Bank of England on the spot on Thursday when officials meet to decide how quickly to raise interest rates from the current 1.75 per cent. Financial markets expect rates to rise above 4 per cent by the summer of next year. On the public finances, economists were certain that borrowing would rise significantly. Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said that even excluding the energy package, “the new government’s fiscal activism” would leave public borrowing much higher than expected this year, with a deficit of £125bn compared with the OBR’s March forecast of £99.1bn.Including the energy package, which is to be financed by borrowing and could amount to £150bn over two years, Capital Economics said the deficit was likely to be £165bn this year — representing 6.5 per cent of national income. The data did not show that a slowdown in economic growth had increased borrowing, with central government tax receipts of £69.6bn only a little below the OBR’s expectation of £70.5bn.

Instead, public spending was higher than expected. Debt interest payments, linked to higher inflation, were £8.2bn, much higher than the £4.9bn expected, and other public spending also exceeded forecasts. The one bright spot in the figures was that borrowing for the first four months of the financial year was revised down by £8.6bn, leaving the starting point close to original OBR estimates. During her visit to the US on Tuesday, Truss said she wanted to cut taxes further to boost growth, and aides have not denied reports that the government is considering stamp duty reductions on top of cuts to national insurance and a reversal of plans to increase corporate tax rates. More

The Bank of Korea has denied that it will announce a currency swap arrangement with the US Federal Reserve this week, as the Korean won continues its slide against the dollar to the lowest levels since March 2009.The won has fallen 15 per cent against the dollar since the beginning of the year, more than any other major currency in Asia apart from the yen. On Wednesday, the Korean currency was at Won1,394.9 to the dollar.The east Asian country is struggling to defend its currency as the Fed sharply raises interest rates to curb inflation. Despite the denial, expectations for a currency swap deal have grown after Choi Sang-mok, senior presidential secretary for economic affairs, said last week that both sides had taken an interest in reopening a currency swap line.The Bank of Korea and the US Fed signed a $60bn currency swap pact in March 2020 as an emergency measure to stabilise foreign exchange markets, but the deal expired at the end of last year.Analysts see such a deal, which would allow South Korea to borrow US dollars at a preset rate in exchange for won, as a last resort to stabilise the volatile market.Calls for a currency swap deal have intensified in recent weeks as analysts expect the dollar’s rally — near its highest level in more than two decades against major currencies — to continue at least until the end of the year. “Authorities in South Korea and other Asian markets could be preparing for worst-case scenarios as the dollar is likely to continue to rise with the Fed’s rate hikes, but there is not much they can do to reverse the trend other than gradually raising their own interest rates to slow the pace,” said Hwang Se-woon, a researcher at Korea Capital Market Institute. Export-dependent countries such as South Korea are under increasing pressure, with the country’s growing trade deficit and higher oil prices dimming the won’s outlook. South Korea reported a record trade deficit of $9.47bn in August.Korean authorities have stepped up oversight of currency markets, with the Bank of Korea asking currency dealers to provide hourly reports on dollar demand after a series of verbal warnings failed to halt the won’s descent.

A South Korean panel that oversees the country’s massive National Pension Service, the world’s third-largest pension fund, plans to discuss improving its forex management rules on Friday.“The government is trying hard to defend the psychologically important Won1,400 threshold, drawing a red line against it,” said Kim Seung-hyuk, a researcher at NH Futures. “Authorities are not just ramping up their rhetoric but also are actually intervening in the market, to slow the pace.”The won is not the only victim of a surging dollar in Asia. The renminbi has breached the psychological level of Rmb7 against the dollar despite Beijing’s verbal warnings and other attempts to shore up the currency. More

European companies are being forced to “reduce, localise and silo” operations in China as the country loses its attractiveness as an investment destination, executives said in a bleak report on operating conditions in the world’s second-largest economy.The assessment from the European Union Chamber of Commerce in China is by far its most pessimistic since its founding in 2000, executives said, citing President Xi Jinping’s regulatory crackdowns on previously booming industries and his administration’s enforcement of draconian lockdowns and travel restrictions to crush Covid-19 outbreaks.“Ideology trumps the economy,” said Jörg Wuttke, chamber president. “Predictability has been challenged by frequent and erratic policy shifts, particularly when it comes to Covid. [Zero-Covid] is a real burden for the economy.”In what Wuttke described as the chamber’s “most dark [position] paper ever”, the organisation warned that “European firms’ engagement [in China] can no longer be taken for granted”. It added that China was quickly losing “its allure as an investment destination” and that China and the EU were “drifting further and further apart”.The warning was issued as the EU reassesses its economic and political relationship with China. Brussels and Beijing have hit an impasse on a proposed trade agreement after exchanging sanctions over China’s mass detention of Uyghur Muslims in Xinjiang. EU representative Josep Borrell described the sides’ annual summit in April as a “dialogue of the deaf”. Brussels is preparing to adopt a series of tools to retaliate against trade partners that block market access to European companies. These measures are expected to be applied to China.“Discussions once centred primarily on investment opportunities . . . are now focused on building supply-chain resilience, the challenges of doing business, managing the risk of reputational damage and the importance of global compliance,” the European chamber said.Xi’s zero-Covid policy has made it all but impossible to visit the country, halting travel by executives based at headquarters and leading to an exodus of foreign staff frustrated with conditions in China. Since the beginning of the coronavirus pandemic, no new EU businesses have moved into the Chinese market, according to the chamber.Wuttke noted that his last trip out of China was in February 2020, but said he hoped to visit his native Germany at the end of the year. “It is high time,” he said. “I haven’t seen my [older] kids in Germany in two and a half years.”Rapidly changing protocols over importing goods — including the disinfection and sometimes confiscation of parcels — have also disrupted companies’ supply chains, while severe lockdowns imposed across the country have weakened consumer demand.“China is not the stable sourcing destination that it used to be,” Wuttke said. “It was a rock, [but] the Shanghai lockdown [in April and May] was a shock for our companies and for the global economy.”Beyond pandemic-related challenges, the chamber described a growing political gap, with companies coming under “increasing scrutiny” at home for their practices in China.

The Uyghur Forced Labor Prevention Act, passed this year in the US, as well as two forthcoming EU regulations on forced labour and corporate due diligence, “pose a compliance challenge for European businesses operating in China . . . due to the inability to carry out independent third-party audits of supply chains in Xinjiang”, the chamber said.Fears over further Covid supply chain disruptions, and to a lesser extent the prospect of a Chinese invasion of Taiwan, have led companies to diversify their suppliers and redirect investments.Businesses are evaluating “reshoring, nearshoring or ‘friendshoring’”, the chamber said, referring to the practices of bringing production home, closer to consumers or to allied countries.The Russian invasion of Ukraine and subsequent sanctions have also made EU companies in China worry about their investments in the event of a Chinese invasion of Taiwan. In a survey by the European chamber in April, a third of respondents said that the war in Ukraine made China a less attractive investment destination. More

If you’ve recently packed a child off to university, you’ll be hoping you’ve done all you can to prepare them — financially as well as emotionally. The university experience in England comes with a hefty bill. The average undergraduate degree now costs £27,750, and that number can easily double when factoring in the cost of living. However, a comprehensive student loan system means that most decide to go ahead and pay for the pleasure over the course of their professional lives.The loan carries a significant long-term cost. It accrues interest from the day funds are received in the account, and graduates will repay 9 per cent of everything they earn over £27,295. The interest rate used is based on the retail prices index on September 1 each year. There have been interventions to ease this burden, including an announcement in August that the interest rate on student loans will be capped at 6.3 per cent, instead of the 12 per cent figure implied by RPI inflation.However, if parents are fortunate enough to have the funds available, they may want to avoid these added charges by paying the university tuition fees themselves. Only a few currently do: of more than 1mn students eligible for tuition fee loans in 2019-20, only 5 per cent did not take one up, according to government data. As well as reducing the extra interest accumulated over the years of repaying a student loan, paying university fees directly through regular gifting out of surplus income would help reduce the value of a family’s estate, which may be effective for inheritance tax (IHT) purposes.Paying the fee directly also beefs up the take-home income for a graduate once they start earning, which could be used for investment purposes. Graduates could also direct the money that otherwise would have gone to paying off a student loan into a personal pension, further solidifying their long-term financial future and allowing them to benefit from a generous tax uplift equal to their marginal income tax rate, at 20, 40 or 45 per cent in other words. Avoiding the student loan system will benefit graduates when it comes to buying property. Mortgage affordability calculators factor in any student loans, so if a student still has a large amount to repay when they are ready to buy a home this may marginally reduce the amount they are able to borrow. Families with the means and the interest to look at an investment-oriented alternative may look to a third option: take out the student loan to fund the costs, and invest the money parents would have spent on university fees to try and get the best returns. However, this is a high-risk strategy and not an approach I would recommend. In a high-inflation environment, cash held on deposit rapidly loses its value in real terms. Normally this would present an investment opportunity, as investing the money provides the potential to generate above-inflation returns over the medium to longer term. However, in this case, the time horizon on investments is very short, since you will need to use the funds to generate a better return before any repayment is due.

Student loans become repayable as soon as the graduate starts earning an income, so potentially three years after they are received. The best current fixed term Isa account on the market over a three-year period is offering an interest rate of around 3.2 per cent. Comparing this with a student loan that potentially gathers interest at 6.3 per cent, the funds are therefore being eroded by 3.1 per cent a year in real terms. To beat the current interest rate being charged, families would need to look at higher-risk investments, but I would counsel against this. In another climate the picture might be different, but in 2022 the investment options to support children through university are more limited and parents need to consider whether they are willing to gamble with their children’s future in an already volatile macroeconomic environment. This brings us back to the student loan. It is well known and well understood, with many benefits in the short term. But the long-term interest and tax could add to the financial burdens on a young adult as they look to strike their own path through life. If parents have the capital available, paying the fees directly can save significant costs in the long term. For those without it — and if you expect your child to become a middling-to-high earner — the best option is likely to be the student loan, with parents providing regular help after graduation to pay it off. This method will allow families to reap potential IHT benefits and maximise the children’s future disposable income in a way that puts them firmly on the road to financial independence. James Hymers is a wealth manager at Raymond James, Spinningfields More

US real yields, the returns investors can expect to earn from long-term government bonds after accounting for inflation, have soared to the highest level since 2011, further eroding the appeal of stocks on Wall Street. The yield on 10-year Treasury inflation-protected securities (Tips) hit 1.2 per cent on Tuesday, up from roughly minus 1 per cent at the start of the year, as traders bet the Federal Reserve will aggressively raise interest rates and keep them elevated for years to come as it attempts to cool inflation. The sharply higher returns safe-haven government debt now offer have weighed heavily on the $42tn US stock market, given investors can find enticing investment opportunities with far less risk. Strategists with Goldman Sachs on Tuesday said that “after a long stretch”, investors buying Treasuries or holding cash would soon earn returns that have been “impossible” to come by for the past 15 years.Real yields are closely followed on Wall Street and by policymakers at the Fed, offering a gauge of borrowing costs for companies and households as well as a scale to judge the relative value of any number of investments.Those real yields fell deeply into negative territory at the height of the coronavirus pandemic as the Fed cut interest rates to stimulate the economy, sending investors racing into stocks and other risky assets in search of returns. That has reversed as the US central bank has rapidly tightened policy.“What you see in the higher real rates is the clear expectation that the Fed is going to drain a tremendous amount of cash and liquidity out of the market,” said Steven Abrahams, head of investment strategy at Amherst Pierpont. The Fed has already lifted its main interest rate from near zero at the start of the year to a range of 2.25 to 2.5 per cent. It is expected to boost it by another 0.75 percentage points later on Wednesday, with further increases bringing the federal funds rate to around 4.5 per cent by early 2023. The Fed’s quantitative tightening programme, in which it is reducing its $9tn balance sheet, is putting additional upward pressure on yields.The jump in so-called real yields has been driven in part by expectations that the Fed will be able to bring inflation closer to its long-term target of 2 per cent in the years to come.A measure of inflation expectations known as the 10-year break-even rate, which is based on the difference in yield on traditional Treasuries and Tips, has eased from a high of 3 per cent in April to 2.4 per cent this week. That would mark a dramatic decline from the August inflation rate of 8.3 per cent. “What is important for growth equities is not whether the peak has happened in interest rates, but the fact that the discounting rate will remain higher for a longer time,” said Gargi Chaudhuri, head of iShares investment strategy for the Americas at BlackRock. “For the next 18 to 24 months, all of these companies’ valuations will continue to get discounted at that higher level.” Fast-growing companies that led the rally on Wall Street from the depths of the coronavirus crisis in 2020 are under the most pressure from rising real yields. That is because higher real yields reduce — or “discount” — the value of the earning these companies are expected to generate years from now in models investors use to gauge how expensive stocks look. Since the start of the year, the tech-heavy Nasdaq Composite has tumbled 27 per cent. A recovery in the latter half of the summer has been all but obliterated as expectations of further aggressive Fed action have been cemented. The fall in unprofitable tech stocks, which had posted spectacular gains as investors chased high yields, has been particularly notable — with a Goldman Sachs index tracking such companies losing half its value in 2022.“Very expensive and very unprofitable technology companies have been accustomed to discounting their cash flows at a negative rate and now have to readjust to positive rates,” Chaudhuri said. “Because your discounting rate is higher, the valuations of those companies will look less attractive, because they’re discounting at a higher level.”Rising real yields may also put greater pressure on companies that took out leveraged loans, which are made to borrowers that already have significant debt loads. Interest rates on these loans are usually floating, meaning they adjust in line with the broader market as opposed to being fixed at a particular level.

“This is particularly bad news for leveraged borrowers,” said Abrahams.Ian Lyngen, head of US rates strategy at BMO Capital Markets, added that “sentiment across the economy, in terms of risk asset performance and the perception of the impact on consumers, is closer to real yields than it has been to nominal yields”. He said: “The logic there being that when adjusted for inflation, real yields represents the clear impact of effective borrowing costs on end users.” More

The Federal Reserve is set to raise its benchmark policy rate by 0.75 percentage points for the third time in a row on Wednesday as it looks to hit the brakes on the overheating US economy.The Federal Open Market Committee is expected to lift the federal funds rate to a new target range of 3 per cent to 3.25 per cent following its two-day policy meeting, advancing its most aggressive monetary tightening campaign since the early 1980s.Some economists have speculated the Fed will opt for a full percentage point rate rise, but the odds overwhelmingly favour a move of 0.75 percentage points.Alongside the rate decision, which is due at 2pm Eastern time, the US central bank will also publish a compilation of Fed officials’ interest rate projections — the so-called “dot plot” — for the period through to the end of 2025.This is expected to show officials committing to a “higher for longer” policy approach, involving additional large rate rises this year that will bring the fed funds rate to roughly 4 per cent, as they look to back up their recent hawkishness on fighting inflation.Economists expect further rate rises to be projected into 2023, pushing the peak of the fed funds rate closer to 4.5 per cent. Officials are unlikely to project cutting the policy rate before 2024, Fed watchers say.In June, the last time the projections were updated, officials predicted the fed funds rate would reach just 3.4 per cent by the end of the year and 3.8 per cent in 2023, before declining in 2024. At that time, the median estimate for the unemployment rate was 3.9 per cent in 2023 and 4.1 per cent in 2024.On Wednesday, that unemployment figure is expected to rise higher and faster, as officials more directly acknowledge the impact of their efforts to tackle inflation. The median estimate for the unemployment rate is now likely to top 4 per cent in 2023.Fed chair Jay Powell has also indicated the US central bank needs to see a “sustained period of below-trend growth” if it is to be successful in containing price pressures, suggesting officials’ gross domestic product forecasts will also be revised lower.In June, policymakers projected inflation would moderate closer to the Fed’s target of 2 per cent, with growth falling only to 1.7 per cent. Most economists now expect the US economy to tip into a recession next year, although they do not expect officials to yet forecast that.

The September meeting marks an important juncture for the central bank, which faced questions this summer over its resolve to restore price stability after Powell suggested the Fed was discussing easing up on its aggressive monetary tightening and beginning to worry about overtightening.At the annual symposium of central bankers in Jackson Hole, Wyoming, last month, the chair sought to counter that narrative by declaring that the Fed “must keep at it until the job is done”.Financial markets have repriced to the Fed’s new path forward, and US government bond yields have surged as rate expectations have risen.The two-year Treasury, which is most sensitive to changes in the policy outlook, is trading around 4 per cent, having hovered at roughly 3 per cent at the start of August. The yield on the benchmark 10-year note also recently rose above 3.5 per cent for the first time since 2011.US stocks, meanwhile, recorded their biggest weekly loss in months last week. More