Central banks face up to Super Wednesday

One of the features of the times is the way that financial markets spend so much of their time front-running central banks. This creates quite an atmosphere today as they wait for the Bank of Japan early tomorrow UK time and then later in the day the US Federal Reserve. We have seen already an example of skittish trading as the Euro pushed above 1.12 versus the US Dollar for no apparent reason. Also it will be a nervous day in bond markets where the “tantrum” I wrote about on the 12th if this month is ongoing and of course has pushed markets in the opposite direction to all the central banking bond buying. The ten-year bond yield in Germany has nervous poked its head into positive territory albeit only at 0.02% as I type this and yet the ECB QE (Quantitative Easing) bond buying continues and across all the eligible Euro area nations (not Greece) it had reached some 1.034 trillion Euros as of the end of last week.

Bank of Japan

This faces quite a list of problems which adds to its conundrum as in many ways it is the central bank which has gone furthest. If you do a check list you go negative interest-rates, QE albeit called QQE, corporate bond purchases, commercial paper ( where it is as far as I recall alone)  as well as equities and commercial property via exchange traded funds.

Those wondering about the equity purchases might like to look back to my article on the Tokyo Whale as the Bank of Japan must own two-thirds of that market by now. Here is an update on this subject from Bloomberg last week.

The central bank is on course to become the No. 1 shareholder of 55 companies in Japan’s Nikkei 225 Stock Average by the end of 2017, according to estimates compiled by Bloomberg last month.

The Yen

This will be on the mind of the members of the Bank of Japan because it is not behaving as they would have hoped and expected. In the early days of Abenomics the Yen fell and against the US Dollar reached a nadir of just below 124 in early May 2015. The rally in the Yen began at the start of 2016 and has seen it move by 20 points from just below 122 to just below 102. Even worse for the Bank of Japan a fair bit of the strengthening followed this announcement in January,

The Bank will apply a negative interest rate of minus 0.1 percent to current accounts that financial institutions hold at the Bank. It will cut the interest rate further into negative territory if judged as necessary.

We saw that the application of negative interest-rates with the hint of more worked for 24 hours in Yen terms. It went on a wild ride where it weakened for about a day but then surged and has with the occasional halt and back track continued in the same direction until now.

So another Ivory Tower has come crashing down as more QE ( called QQE in Japan as QE has become discredited) and negative interest-rates have led to a stronger and not weaker Yen in 2016.

Inflation

This is a clear area where things are made awkward for Abenomics as the stronger Yen means that there will be downwards pressure on inflation as commodities and oil get cheaper. That makes it harder for the Bank of Japan to hit its target of consumer inflation rising at 2% per annum. Here is the latest data on the subject.

The consumer price index for Japan in July 2016 was 99.6 (2015=100), down 0.2% from the previous month, and down 0.4% over the year….  The consumer price index for Ku-area of Tokyo in August 2016 (preliminary) was 99.6 (2015=100), up 0.1% from the previous month, and down 0.5% over the year.

As you can see prices are falling again which collapses another row of Ivory Towers as expanding the monetary base on this scale should lead to inflation in their models.

Now we get to something awkward which is that the lower rather than higher inflation is achieving an Abenomics objective. It has given Japan some real wage growth but by a completely different route to the one envisaged. Under Abenomics higher inflation was supposed to be accompanied by some sort of wages fairy which would sprinkle magic dust on the numbers.

So by an unexpected route Japan is getting an economic boost. Accordingly I can only completely disagree by this from Gavyn Davies in the Financial Times.

As a result, the inflation credibility of the BoJ has sunk to a new low, and the policy board badly needs to restore confidence in the 2 per cent inflation target.

The economy

This is not going so well as Bank of Japan policymaker Funo told us last week.

Looking ahead, sluggishness is expected to remain in exports and production for some time, and the pace of economic recovery is likely to remain slow.

He was more specific later on the numbers.

the medians of the Policy Board members’ forecasts for the economic growth rate are 1.0 percent for fiscal 2016, 1.3 percent for fiscal 2017, and 0.9 percent for fiscal 2018, and the economy is expected to continue growing at a pace above its potential through the projection period.

Is he really saying that growth at such a low-level is above potential?Yes he is.

Japan’s potential growth rate, as estimated by the Bank, has declined to the range of 0.0-0.5 percent,

 

On a collective level we got news today on the population and ageing problem that Japan has. According to its Statistics Bureau the population fell by another 300,000 in the 6 months to the beginning of this month making it 126.6 million now. There are now 10.5 million people over 80 which only the “dismal science” would conclude is a bad thing.

Deposit Rates

Have raised the issue of people saving more when interest-rates get very low let me give you the Bank of Japan data on deposit rates. The ordinary depositor gets 0.002% and if you do a time deposit for a year you get 0.016% and for ten years between 0.2% and 0.3% per annum.

The Federal Reserve

It has been a dreadful year for Forward Guidance from the US central bank. The “three to five” interest-rate increases promised at the start of 2016 by John Williams of the San Francisco Fed have morphed into zero so far. As we approach the election changes will be less likely but not impossible. So it is now or after the election you would think. Except now relies on someone as cautious as Janet Yellen taking a risk. So I think we can expect yet more Open Mouth Operations and promises of future rises just like we have seen all year.

Comment

My job as an options trader in UK interest-rate markets used to involve predicting what central banks will do and whilst I had quite a few successes it is also true that sometimes it teaches you some humility. Let me remind you of another view of Japan which I have been pointing out on here in 2016. On an individual or per capita basis its performance is in fact okay and might point at us in the UK. So in my view it does not need all the monetary splashing around. Where the catch comes is the level of the national debt compared to output which in gross terms is very high (250% or so of GDP according to the IMF) and rising due to the fiscal deficit which does not fit well with a shrinking and aging population. Is it all about the debt then? Pretty much I think the idea that it will boost the economy is all Imagination.

It’s just an illusion, illusion, illusion

Illusion, illusion, illusion, illusion

 

 

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9 thoughts on “Central banks face up to Super Wednesday

  1. Yet again, Shaun, you are pointing out things that, in my opinion, the mainstream media just do not cover any more.
    Just a few things from above:
    1. Japan debt 250% of GDP
    2. GDP growth expected to be zero
    3. The BoJ will be the number one shareholder in 55 of the top 225 companies next year
    4. Incredible ageing and shrinking demographics
    5. Zero interest rates, which must mean low pension returns
    How can this be sustainable?
    As you say, what could go wrong?

  2. Great blog as always, Shaun.
    Like you, I have no idea why Gavyn Davies would set so much store by a two percent inflation target for Japan. On September 13, there was an FT post titled “Former Bank of Japan board member urges lower inflation targets”. Sayurai Shirai, who only left the board in March, thought the target should be one percent, an inflation rate that Japan has never achieved in the last twenty years. When it was achieved in a stable manner, she said the BoJ could look at moving to two percent, but she doesn’t seem to be committed to two percent in the long term. It would seem to me that potentially a one percent target rate could be quite viable in most developing countries. It is at or above the upward bias in inflation measurement in most target inflation indicators, and even further above what the bias could be if the proper measurement reforms were made.

    • Hi Andrew and thank you

      The obsession with a 2% annual inflation target goes on does it not? After being pulled out of the air it is now treated as not far off a holy grail. In the specific case of Japan I agree that lowering the target would be sensible.

  3. Will be amazed if the Fed raises rates even a measly 0.25%, if rates were to go up to where they should be the debt bomb would explode,so they just talk but never act and never will.
    Meanwhile I note Deutsche Bank’s share price is down to € 11.26 on May 17th 2007 it was €117.96 …..there may be trouble ahead the derivative ship might go down,which will make the interest rate will they or won’t they game irrelevant.

    • Hi Private Fraser

      Yes I noted that it was yet another bad day for Deutsche Bank with the share price down over 3% and it got near to its all time low. I gather that some of its bonds were hit hard as well. Rough times for my old employer to say the least!

      • I have now looked into the share price of Deutsche and, if you have a weak heart, look away now. It has $42 trillion (yes, trillion) of gross derivatives outstanding. EU GDP is $14.6 trillion.
        What could possibly go wrong?

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