Are world equity markets front-running expected central bank buying?

Sometimes we get an opportunity to both take some perspective and also to observe what is considered by some to be cutting edge. So let us open with the perspective of the general manager of the Bank for International Settlements.

Growth cannot depend on monetary policy, Agustín Carstens tells CNBC.

I am sure that many of you are thinking that it is a bit late ( like a decade or so) to tell us now.. Interestingly if you watch the video he says in reference to the Euro area that monetary policy “cannot be the only solution for growth”. This reminds me of the statement by ECB President Mario Draghi that it QE was responsible for the better Euro area growth phrase in 2016 to 17. It also brings me to my first official denial of the day.

Some analysts said a tiered rate would make room for the ECB to cut its deposit rate farther — a prospect that one source said was nowhere near being discussed. ( Reuters )

You know what usually happens next….

Asset Markets

This is an area that central banks have increasing moved into with sovereign and corporate bond buying. But in the same Reuters article I spotted something that looked rather familiar.

TLTRO III, a new series of cheap two-year loans aimed at banks, was unveiled in March as a tool to help lenders finance themselves, particularly in countries such as Italy and Portugal. But policymakers now increasingly see it as a stimulus tool for a weakening economy, the sources said.

With the growth outlook fading faster than feared, even hawkish policymakers have given up pricing the loans at the private market rate. Some are even discussing offering the TLTROs at minus 0.4 percent, which is currently the ECB’s deposit rate, the sources said.

That looks rather like the Funding for Lending Scheme which I mentioned yesterday as the way the Bank of England fired up the UK housing market from 2012 onwards. Essentially if you give banks plenty of cheap funding you get a lot of rhetoric about lending to business ( small ones in particular) but the UK experience was that it declined and mortgage lending rose. This was because mortgage rates fell quite quickly by around 1% and according to the Bank of England the total impact rose as high as 2%.

Thus in my opinion the ECB is considering singing along to the “More,more,more” of Andrea True Connection in relation to this.

House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the fourth
quarter of 2018 compared with the same quarter of the previous year.

This is one area where the ECB has managed to create some inflation and may even think that the lack of growth in Italy ( -0.6%) is a sign of its economic malaise. Although you do not have to know much history to mull the 6.7% in Spain and 7.2% in Ireland.

Equities

Regular readers will be aware that the Swiss National Bank and the Bank of Japan started buying equities some time ago now. There are differences in that the SNB is doing so to diversify its foreign exchange reserves which became so large they were influencing the bond markets ( mostly European) they were investing in. So it has bought foreign equities of which the most publicly noted it the holding in Apple because if you invest passively then the larger the company the larger the holding. If we note the Apple Watch this must provide food for thought for the Swiss watchmaking industry.

Japan has taken a different route in two respects in that it buys funds ( Exchange Traded Funds or ETFs) rather than individual equities and that it buys Japanese ones. Also it is still regularly buying as it  bought  70.500,000,000 Yen’s worth on Tuesday, Wednesday and Thursday this week. Whereas buying by the SNB in future will be more ad hoc should it feel the need to intervene to weaken the Swiss Franc again.

Now let us move to Federal Reserve policymaker Neel Kashkari

So an official denial! Also you may note that he has left some weasel room as he has not rejected the Japanese route of indirectly buying them. This is common amongst central bankers as they leave themselves an out and if they fear they might need to introduce a policy that will attract criticism they first deny they intend to do it to give the impression they have been somehow forced.

For a lighter touch @QTRResearch translated it into Trumpese so that the man who many think is really running the US Federal Reserve gets the picture.

Kashkari: We’re not buying stocks, who said anything about buying stocks, we’re definitely not buying stocks, we’d never buy stocks.

It was,of course, only last week that ended with the CIO of BlackRock suggesting that the ECB should purchase equities and no doubt he had a list ready! I suppose it would sort of solve this problem.

ECB will ask Deutsche Bank to raise fresh funds for merger: source ( Reuters)

Although of course that would not open just one can of worms but a whole cupboard full of them. But when faced with a problem the ECB regularly finds itself singing along with Donald Fagen.

Let’s pretend that it’s the real thing
And stay together all night long
And when I really get to know you
We’ll open up the doors and climb into the dawn
Confess your passion your secret fear
Prepare to meet the challenge of the new frontier

Comment

Now let us switch to markets as we remind ourselves that they have developed a habit of front-running or anticipating central bank action. Sometimes by thinking ahead but sometimes sadly via private briefings ( I hope the ECB has stopped them). However you spin it @Sunchartist made me think with this.

*Softbank Group Prices Japan’s Biggest Ever Yen Corporate Bond ¥500 Billion 1.64%

Aramco, Softbank, LYFT, Pinterest, Uber

The gravy train.

Or as Hipster on Twitter put it.

So Uber and Lyft will have a combined market cap of ~$150BN with a combined net loss of ~$3BN

Next there is the issue of something that is really rather uncomfortable.

It’s official: This is an all-time record year for corporate stock buybacks.

Announced buybacks for 2018 are now at $1.1 trillion. And companies are using their authorizations. About $800 billion of stock has already been bought back, leaving about $300 billion yet to be purchased. We’ve seen buyback announcements recently from Lowes’s. Pfizer, and Facebook, but in the last few days, as stocks have moved to new lows, companies are picking up the pace of activity. ( CNBC)

This makes me uncomfortable on several counts. It is the job of a board of directors to run a business not to be punters in its shares. This is especially uncomfortable if their bonuses depend on the share price. Frankly I would look to make that illegal. As to them knowing the future how has that worked out for Boeing? To be fair to CNBC they did highlight a problem.

So the critics of corporate buybacks and dividend raises are correct. It is a form of financial engineering that does not do anything to improve business operations or fundamentals………. obsessing over ways to boost stock prices helps the investing class but not the average American.

Perhaps nothing has been done about this because it suits the establishment after all think of the wealth effects. But that brings inequality and the 0.01% back into focus.

 

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The Bank of Japan is exploring the outer limits of monetary policy

Today I wish to invert my usual rule and open with a look at financial markets because in this instance they help to give us an insight into the real economy.

The Nikkei 225 average tumbled 650.23 points, or 3.01 percent, to end at 20,977.11, its first closing below 21,000 since Feb. 15. On Friday, the key market gauge rose 18.42 points.

The Topix, which covers all first-section issues on the Tokyo Stock Exchange, finished 39.70 points, or 2.45 percent, lower at 1,577.41 after gaining 2.72 points Friday. ( The Japan Times)

We have a crossover here as Japan catches up with what western markets did on Friday. But if we return to Friday’s subject of expected central bank activity, well in Japan it is already happening. In other markets discussions of the existence of a Plunge Protection Team for stock markets are more implicit than explicit but Japan actually has one. The Bank of Japan or as it has become known the Tokyo Whales does so and according to its accounts bought some 70,200,000.000 Yen’s worth this morning in its attempt to resist the fall. That amount has become a habit in more ways than one as on days of solid falls that is the amount it buys as for example it bought the same amount on the 13th, 8th and 7th of this month. It’s total holdings are now at least 24,595,566,159,000 Yen and I write at least because whilst it declares most of them explicitly in its accounts some other holdings are tucked away elsewhere.

Monetary Policy

To finance these purchases the Bank of Japan creates money and expands the monetary base. It adds to its other attempts to do so as for example it also buys commercial property ( in a similar route to the equity market it buys exchange-traded funds or ETFs) as well as commercial paper and corporate bonds. But the main effort is here.

The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain at around zero percent. While doing so, the yields may move upward
and downward to some extent mainly depending on developments in economic activity and prices.
7 With regard to the amount of JGBs to be purchased, the Bank will conduct purchases in a flexible manner so that their amount outstanding will increase at an annual
pace of about 80 trillion yen.

As you can see it is buying pretty much everything with the only variable left being how much. If we stay with that theme we have seen regular media reports that it is tapering it s buying of which the latest was Bloomberg on the 14th, Those reports have varied from being outright wrong ( about equity purchases) to nuanced as for example circumstances can limit the size of JGB buys.

Meanwhile, the government would continue to undertake expenditure reforms and reduce the
amount of newly issued government bonds for fiscal 2019 by about 1 trillion yen compared to that for fiscal 2018. ( Bank of Japan)

But also market developments play a role as I note this from @DavidInglesTV this morning.

Japan 10Y yields collapse further into negative territory

There is a bit of hype in the use of the word collapse to represent the benchmark yield falling to -0.06% but there are relevant factors in play. For example yet another benchmark bond yield is moving further into negative yield territory as Japan accompanies Germany. Next we have an issue for Bank of Japan policy as it is left sitting on its hands if Mr(s) Market takes JGBs to where its “guidance” is anyway meaning it does not have to buy more. So its bond buyers are left singing along with the Young Disciples.

Apparently nothing
Nothing apparently
Apparently nothing
Nothing apparently

The Yen

This is another area where the Bank of Japan is active. These days it is not that often in the news promising “bold action” and much less actually explicitly intervening. But according to economics 101 all the money printing ( more technically expansion of the monetary base) should lead to a lower Yen. For a while it did but these days the position is more nuanced as The Japan Times reminds us.

The stronger yen battered export-oriented issues. Industrial equipment manufacturers Fanuc sagged 3.84 percent and Yaskawa Electric 5.35 percent, and electronic parts supplier Murata Manufacturing lost 3.14 percent.

In a way here the Tokyo Whale is spoilt for choice as it could act to weaken the Yen and/or buy ETFs with those equities in them. But the reality is that lower equity markets create a double-whammy for it as hoped for wealth effects fade and a flight to perceived safety strengthens the Yen. Thus we find the Yen at around 110 to the US Dollar as I type this.

One of the central tenets of Abenomics was supposed to be the delivery of a 2% annual inflation target which would “rescue” Japan from deflation. Yet mostly through the way the Yen has resisted the downwards pressure leaves us observing this.

As for prices, members concurred that the year-on-year rate of change in the CPI for all items less fresh food was in the range of 0.5-1.0 percent, and the rate of increase in
the CPI for all items less fresh food and energy remained in the range of 0.0-0.5 percent, due partly to firms’ cautious wage- and price-setting stance.

The all items inflation rate was 0.2% in February. The situation is a clear failure leading one Board Member to spread the blame.

households’ tolerance of price rises had not shown clear improvement and services prices in such sectors as dining-out had not risen as much as expected.

Comment

We can now bring in a strand from recent articles which has been illustrated earlier by the former chair of the US Federal Reserve Janet Yellen.

*YELLEN: GLOBAL CENTRAL BANKS DON’T HAVE ADEQUATE CRISIS TOOLS ( @lemasabachthani )

Also something which we figured out some months back.

*YELLEN: FED TO OPERATE WITH LARGE BALANCE SHEET FOR LONG TIME

Also let me throw in something which shows an even deeper lack of understanding.

Former U.S. Federal Reserve Chair Janet Yellen said Monday that the U.S. Treasury yield curve[s:TMUBMUSD10Y], which inverted on Friday for the first time since 2007, may signal the need to cut interest rates at some point, but it does not signal a recession. ( @bankinformer )

Firstly central bankers have pretty much a 100% failure rate when it comes to forecasting recessions. Next we have an issue where they help create an inverted yield curve then worry about it! That may turn out to be something with very different effects to one achieved more naturally.

But the real issue here is that Janet like her ilk is guiding us towards more monetary easing but we have been observing for some years that in terms of the Shangri-Las the Bank of Japan is the Leader of the Pack. But once we switch to how is that going we hit trouble. From Friday.

The flash Nikkei Manufacturing PMI for March remained unchanged at 48.9 in March, registering below the 50.0 no change level for a second successive month to indicate an ongoing downturn in the goods-producing sector. The latest readings are the lowest recorded since June 2016.

Among the various survey sub-indices, the output index signalled a third consecutive monthly fall in manufacturing production, with the rate of decline accelerating to the fastest since May 2016. The drop in production was the third largest seen since 2012.

Now today.

Japan’s new vehicle sales in fiscal 2019 are projected to fall 2.0 percent from the current fiscal year to 5.22 million units amid growing economic uncertainty, an industry body said Monday. ( The Mainichi )

That adds to the slow down in the real growth rate such that GDP rose in the final quarter of 2018 by a mere 0.3% on a year before. Not exactly an advert for all the monetary easing is it?

Weekly Podcast

 

 

 

 

 

 

What happens when the Bank of Japan has bought everything?

It is time for another chapter of our Discovering Japan ( h/t Graham Parker and the Rumour) series and let us open by dipping into Japanese culture.

As spring approaches, the country’s weather forecasters face one of their biggest missions of the year: predicting exactly when the famed cherry blossoms will bloom.

The nation’s sakura (cherry blossom) season is feverishly anticipated by locals and visitors alike. Many tourists plan their entire trips around the blooms, and Japanese flock to parks in droves to enjoy the seasonal spectacle. ( Japan Times).

This is something which can be shared to some extent by users of Battersea Park as the Japanese Embassy financed an avenue of cherry blossom trees there in a nice touch of what is called cherry blossom diplomacy.

If we switch to financial news that will be considered good by the Bank of Japan, then we can see three factors at the moment. We can start with the equity market where the Nikkei 225 index has risen 126 points to 21,431 this morning. This means that the dip of the end of December is now only a bad dream for it as we recall that central banks love higher equity markets especially when in this case they have been buying it. Japan is a country that literally has a Plunge Protection Team as what has become called the Tokyo Whale makes equity purchases on down days.

If we switch to the currency then the Bank of Japan will be a lot happier than it was in mid-January. At that point markets had what we might call a yen for Yen and in a “flash rally” it went below 105 versus the US Dollar which rather suspiciously broke more than a few Japanese exporters currency hedges and to 132.5 versus the UK Pound £. As a central bank with an objective to weaken the yen under the Abenomics strategy this will have upset the Bank of Japan and it will be much happier with the 110.87 to the US Dollar as I type this. It would of course prefer an exchange rate over 120 as it managed for a while but with a summit due with President Trump that can be overlooked for now.

Next we can look at what is a strong candidate for the most rigged market on earth which is the Japanese Government Bond market. So far the Bank of Japan has purchased some 473,087,792.358,000 Yen’s worth of Japanese government securities in as near to monetary financing as a first world country has actually got. Whilst the pure definition of the treasury issuing debt to the central bank does not take place over time it starts to rather look like that in effect. Here is the current description.

yield curve control, in which the Bank seeks a decline in real interest rates by controlling short-term and long-term interest rates, has been placed at the core of the new policy framework.

This means that Japan can borrow effectively for nothing as its ten-year yield is -0.04% as I type this and therefore a lot of its debt is adding to the world total of negative yielding debt. Not all of it as the thirty-year yield is 0.58% but even that is very low and means that should it so choose Japan can borrow incredibly cheaply.

So Governor Kuroda can sleep soundly at night on these three grounds.

The economy

This is much less satisfactory as it shrank in the second half of last year as quarterly growth of 0.3% followed -0.7%. This meant that at the end of 2018 the annual rate of growth was zero or as their official statisticians put it. -0.0%. This is quite a slowing on the 2.4% recorded at the end of 2017 but if we take a broad sweep we see that all this monetary action of negative interest-rates and QQE doesn’t seem to be doing that much good. This theme will hardly be helped by this morning’s news.

The nation’s trade deficit for January grew from a year earlier with exports to China tumbling in their worst decline in three years, government data showed Wednesday.

Japan logged a trade deficit for the month of ¥1.41 trillion ($12.8 billion), 49.2 percent larger than a year before, the Finance Ministry said. ( Japan Times)

The January data is generally a weaker month due to the timing of the Chinese New Year but as you can see there has been a sharper impact this year as we get another perspective on the Chinese economic slow down.

But last month, “exports of products such as microchip-making devices that are not related to China’s New Year celebration fell, showing that Chinese companies’ spending on equipment and plants is falling,” Minami said.

Overall Japanese exports in January were 8.4% lower in January than in 2018 and this will be a further deduction from an already weak economic outlook. This adds to this from Reuters.

Data released on Monday showed core machinery orders, considered a leading indicator of capital expenditure, fell 0.1 percent month-on-month in December……

Highlighting bigger concerns about the external environment, however, was a 21.9 percent month-on-month slump in orders from overseas, the biggest fall since November 2007.

This had previously been a strong series but whilst domestic demand has continued foreign demand has not.

Demographics

We have looked at the consequences of an ageing and indeed shrinking population many times and here is a new perspective from the World Economic Foundation.

In 2018, there were 921,000 births and 1.37 million deaths, meaning Japan’s population fell by 448.000 people. That was its largest ever annual natural population decline.

The number of male workers in 2040 will fall by 7.11 million from 2017, while the number of working women will decrease by 5.75 million.

Or to add it all up.

As many as 12 million Japanese people may disappear from the country’s workforce by 2040, according to official estimates. That’s a fall of around 20%.

Comment

Let me open by advancing my theme that it would be better if Japan simply accepted reality rather than undertaking what are King Canute style actions. On this road it would accept that a shrinking and ageing population will have periods of economic decline in GDP terms.  In many ways Japan deals with its ageing population better than we do and it could also be a leader in terms of a shrinking one. This could be a route forwards for our planet too as fewer humans would place less of a strain on Japan’s limited natural resources. Also it does have a very large national debt but it is mostly domestically owned and would benefit from a national debate of how to deal with it rather than snake-oil efforts. Instead we get ever more financial action pushing for growth accompanied by threats and sanctions based on a green response to the growth.

Meanwhile the chorus is tuning up for “more,more,more” as this illustrates.

“If (currency moves) are having an impact on the economy and prices, and if we consider it necessary to achieve our price target, we’ll consider easing policy,” ( Governor Kuroda yesterday according to Reuters).

Mind you even past supporters of the extraordinary monetary policies are giving up or rather switching to fiscal policy.

Japan must ramp up fiscal spending with debt bank-rolled by the central bank, the Bank of Japan’s former deputy governor Kikuo Iwata said, a controversial proposal that highlights the BOJ’s challenge as it tries to reignite an economy after years of sub-par growth. ( Reuters)

It is not that he would not like to expand monetary policy more but he is unable to look beyond his “precious”

He said there are few tools left to ease monetary policy further as cutting already ultra-low interest rates could push some financial institutions into bankruptcy.

Where these people never get challenged is that they promise success each time but in a burst of collective amnesia their past failures seem to give them credibility rather than demotion. I guess that is what happens when you do what the establishment wants….

Also the financial media that pushed the story of last autumn that the Bank of Japan was reducing equity purchases should be red faced now. For the rest of us we need to be thinking if the Vapors were prescient all those years ago.

I’m turning Japanese
I think I’m turning Japanese
I really think so
Turning Japanese
I think I’m turning Japanese
I really think so

 

 

We are now facing a reality of QE to infinity

Today has according to CNBC brought us to a birthday anniversary.

Happy birthday to the BOJ it’s the twentieth anniversary of them starting QE ( @purpleline)

As ever the picture is complicated as the Bank of Japan started buying commercial paper ( which we consider part of QE now) in 1997 and started purchases of Japanese Government Bonds in March 2001. But the underlying principle is that it has been around for much of the “lost decade” period and those claiming success have an obvious problem with the “lost decade” theme. Also they have a problem with then explaining why the name was changed in Japan from QE to QQE as name changes are a sure sign of something that has gone wrong. After all if you have a great brand you don’t change the name. In case you were wondering it is now Qualitative and Quantitative Easing.

It was not consider a triumph as even early on (2006) the San Francisco Fed was worried about this.

While these outcomes appear to be consistent with the intentions of the program, the magnitudes of these impacts are still very uncertain. Moreover, in strengthening the performance of the weakest Japanese banks, quantitative easing may have had the undesired impact of delaying structural reform.

That second sentence has echoed around all subsequent attempts at QE leading to the zombie banks theme of which at the moment Deutsche Bank and Royal Bank of Scotland come to mind but there are plenty of others. The gain was a small drop in JGB yields which is why government’s love the policy as it makes it cheaper for them to borrow.

In 2012 the IMF conducted its own review but with similar results.

Using different measures for economic activity, ranging from growth to unemployment, the VAR
regressions pick up some impact on economic activity. While the evidence is still weak, these results are still an improvement over earlier findings looking at previous QE periods

Looked at like that it makes you wonder why some many countries copied this course of action? The band Sweet gave us a clue I think.

Does anyone know the way, did we hear someone say
We just haven’t got a clue what to do
Does anyone know the way, there’s got to be a way
To Block Buster

Central banks cut interest-rates to what they considered the lower bound saw it was not working and were desperate to find something else. On that subject a theme of mine was confirmed yesterday when David Blanchflower who was a Bank of England policymaker tweeting this.

at mpc in 2008 we were told zlb was .5% for tech reasons relating to building societies. ( ZLB = Zero Lower Bound)

In response to my enquiry that I had heard it was the banks he replied he thought it was due to a regulation but cannot remember exactly. It certainly was a line repeated by Governor Carney although he of course then contradicted it by cutting to 0.25%!

To Infinity! And Beyond!

Regular readers who have followed by argument that interest-rate increases in the United States could be accompanied by more QE in what would no doubt be called QE4 will not be surprised that I spotted this.

U.S. central bankers are currently debating whether it should confine its controversial tool of bond buying to purely emergency situations or if it should turn to that tool more regularly, San Francisco Federal Reserve Bank President Mary Daly said on Friday.

This is intriguing not least because the actual policy right now is an unwinding of QE that we call Qualitative Tightening or QT. We actually have not had much QT and already there seems to be an element of cold feet about it. Let us look at her exact words.

In the financial crisis, in the aftermath of that when we were trying to help the economy, we engaged in these quantitative easing policies, and an important question is, should those always be in the tool kit — should you always have those at your ready — or should you think about those are only tools you use when you really hit the zero lower bound and you have no other things you can do,” Daly told reporters after a talk at the Bay Area Council Economic Institute.

“You could imagine executing policy with your interest rate as your primary tool and the balance sheet as a secondary tool, but one that you would use more readily,” she added. “That’s not decided yet, but it’s part of what we are discussing now.”

These sort of “open mouth operations” are often a way of preparing us for decisions which if not already been taken are serious proposals. So there is an element of kite flying about this to see the response. The bit that sticks out for me is that Mary Daly is willing to use more readily something she is not even sure worked as this below is far from a claim of success for QE.

when we were trying to help the economy,

That is rather different to it did help.

If we move on to looking at the economic outlook then if the US Federal Reserve is debating this the European Central Bank must be desperate to restart QE. Maybe there was a hint this morning from Jens Weidmann of the German Bundesbank when he spoke in South Africa.

Central banks all over the world were forced to climb great hills over the last decade. And there are more hills on the horizon.

Comment

Let us step back for a moment and consider what QE is and what it has achieved. Is it money printing? Well in electronic terms yes as the money supply grows but it is also a liquidity swap in that the money is exchanged usually for government bonds which then leads to other liquidity swaps via purchases of other assets. Then the trail gets colder….

So the economic effects are

  1. Money flowing into other assets leading to equity and house prices being at least higher than otherwise and usually higher.
  2. It supports companies that would otherwise have folded leading to the zombie banks and businesses theme.
  3. Lower interest-rates and bond yields meaning that it has indirectly helped both politicians and fiscal policy. This does not get much of an airing in the media because it is not well understood.
  4. Higher narrow money supply which has not led to the surge in inflation expected by economics 101 although that is at least partly due to consumer inflation measures being directed to ignore asset prices.

These may improve economic growth at the margin but there are no grand effects here although Mario Draghi only recently claimed that it was responsible for the Euro improvement in 2016/17. But this ignores the problems created as for example many central bankers are now telling us economic growth has a “speed limit” of 1.5% and the place with QE longest ( Japan) guides us to below 1%. Also there are the problems with productivity which have popped up. Finally there is the issue of helping the already wealthy and boosting inequality that is so bad they have to keep making official denials.

Quantitative easing has also helped to reduce net wealth inequality slightly through its positive impact on house prices. ( ECB January 2019)

Can we stop interest-rates falling and going negative?

This week has seen a development I have long-expected and forecast. That is that the establishment will respond to the next economic slow down with negative interest-rates. The rationale for that is in one sense simple as in most places interest-rates never went back up again and if they did by not much, Only yesterday I looked at my own country the UK where in the decade or so since the credit crunch the Bank of England has raised interest-rates by a net 0.25%. Not much is it? Last time around the only reason it did not cut interest-rates even lower it was because it feared that the creaking IT systems of the UK banks could not take it. As it was some mortgages ( mostly with Cheltenham & Gloucester if I recall correctly) went below 0% and were dealt with via capital repayments to stop a HAL 9000 style moment.

Of course more than a few central banks continue to have negative interest-rates as we look at Denmark, the Euro area, Japan, Sweden and Switzerland. The ECB may pause this morning to mull whether it will get its deposit rate ( -0.4%) back even to zero as it note German factory orders some 7% lower than the previous year in December. This brings us to the driver of the current situation which is the economic slow down we have been following and indeed predicting via the decline in money supply growth. That remains as a slow down and has not yet signalled an overall recession but none the less it has produced quite a change.

The San Francisco Fed

It is far from a coincidence that the San Francisco Fed has produced a paper on negative interest-rates this week. After all the overall Federal Reserve has put up the white flag on interest-rate increases as we wait to hear what was discussed when Chair Powell had dinner with President Trump on Monday night.  Anyway the paper seems to open with a statement of regret.

Traditionally, it has been assumed that nominal interest rates cannot fall below zero, known as the “lower bound.” Ever since 2008, researchers have debated how much monetary policy was constrained by this lower bound and how much it affected economic outcomes. To work around this constraint, the Federal Reserve turned to unconventional monetary policy tools such as forward guidance and large-scale asset purchases.

Also an admission that QE was driven by the belief that interest-rates could not go below zero. I cannot be too churlish about that because there was a time when I did not think so either at least on a sustained basis although it was around 20 years ago and before the full impact of the Japanese lost decade! I do not know if one of the drivers of this thought was fear of what negative interest-rates would do to the US banks but history has seen a potential revision.

In this Economic Letter, I consider whether pushing rates below zero would have improved economic outcomes in the United States in the aftermath of the financial crisis.

For a central banker the answer is clearly yes.

Model estimates suggest that reducing the effective lower bound for the federal funds rate to –0.75% would have reduced economic slack by as much as one-half at the trough of the recession and sped up the ensuing recovery. While the boost to the economy would have been negligible after 2014, inflation would have been higher throughout the recovery by about half a percentage point on average.

There are various points here. First the central banker assumption that higher inflation is a good thing whereas in reality the ordinary person is likely to be worse off via lower real wages. Next the interesting observation that it is a temporary gain. Finally there is a later reference to Switzerland which took interest-rates to -0.75% so we are left with the view that this paper might recommend even more negative rates if only someone else had been brave/silly enough to try them. It omits to point out that Switzerland has not escaped from this as it is still at -0.75%.

How does this work?

An old friend appears.

In the model, the output gap falls with the interest rate.

Ah so it works because we assume it will. What could go wrong? Whilst we are at the Outer Limits of fantasy why not throw in the kitchen sink.

However, expectations about the future path of the fed funds rate matter, including any Federal Reserve announcements about its path—known as forward guidance—as well as expectations about being at the zero lower bound.

I am not sure if that is chutzpah, ignorance or just simple Ivory Tower non-thinking. After all we have just had a Forward Guidance U-Turn so are we following the old or new versions and if so what was the cost of the change? Those who have fixed their mortgage expecting higher interest-rates for example. Whereas now Men at Work are being played.

It’s a mistake, it’s a mistake
It’s a mistake, it’s a mistake

Rather oddly the paper says that the output gap is pushed higher when the author must mean lower, But there is a bigger space oddity which is this.

According to these simulations, the negative lower bound would have reached its maximum effect in the first quarter of 2011. Setting the lower bound at –0.25% would have increased the output gap by 1.5 percentage points, while pushing the lower bound down further to –0.75% would have contributed an additional 0.4 percentage point to the output gap. This means that a rate of –0.25% would have done most of the job, and allowing it to drop further would have accomplished fewer additional benefits.

Let us subject that to a sense check because we know that the US Federal Reserve did cut its official interest-rate to 0% ( technically 0% to 0.25%) but that going a mere extra 0.25% would make much of a difference? From the previous peak the US had cut by 5% so would an extra 0.25% make any difference at all?

The IMF goes further

Here we go.

One option to break through the zero lower bound would be to phase out cash.

It wants to go as Madonna would put it, deeper and deeper.

To illustrate, suppose your bank announced a negative 3 percent interest rate on your bank deposit of 100 dollars today.

They need a tax or fine or cash to achieve this.

Suppose also that the central bank announced that cash-dollars would now become a separate currency that would depreciate against e-dollars by 3 percent per year. The conversion rate of cash-dollars into e-dollars would hence change from 1 to 0.97 over the year.

Comment

There is quite a bit to consider here but let me start with the concept of arrogance. This is because monetary policymakers have had the freedom over the past decade to do pretty much what they liked and if it had worked we would not be here would we? Yet like Jose Mourinho in the football transfer market they always want more, more, more. Actually I am being a little unfair on Jose as there was a time his policies brought plenty of success.

Combined with this is an obsessive clinging onto failed past concepts. The output gap has had a dreadful credit crunch yet here it is again. Next the idea that higher inflation is good has ( thank God) had a bad run too but central bankers confuse what is good for the banks with what is good for the rest of us. The reality that no country or economic area has gone into negative interest-rates and then recovered is simply ignored whereas so far they have all sung along with Muse.

Glaciers melting in the dead of night
And the superstars sucked into the super massive
Super massive black hole
Super massive black hole
Super massive black hole
Finally is the idea that those who do not worship at this particular monetary altar need to be punished. Just like in the novel 1984……

The Tokyo Whale will need to get its buying boots on again

Let us begin the week with some good news for the central bank from the land of the rising sun or Nihon. That is that the Nikkei 225 equity index rallied strongly this morning and its 2.44% surge saw it regain the 20,000 level and close at 20,038. The Bank of Japan will be pleased on two counts, of which the first is the wealth effects it will expect from a higher equity market. The second is that it will improve its own position as what we have labelled the Tokyo Whale.

The Bank of Japan’s purchases of exchange-traded funds since the start of 2018 exceeded 6 trillion yen ($53 billion) on Tuesday, reaching a record high on a yearly basis and signaling the central bank has been increasingly exposed to riskier assets. ( The Mainichi).

For newer readers the Bank of Japan has been buying Japanese equities for around 5 years and has been doing so on an increasing scale.

Under Governor Haruhiko Kuroda, the BOJ announced aggressive monetary stimulus in 2013 aimed at breaking Japan’s economy out of its deflationary malaise.

The measures included increasing the central bank’s holdings of ETFs by an annual 1 trillion yen, which it expanded to 3 trillion yen in 2014 and again to 6 trillion yen in 2016.

The name “Tokyo Whale” came about because as you can see it found the need to keep increasing the size of the purchases as the expect results did not materialise. This meant that it cannot keep this going for much longer as it will run out of equity ETFs to buy. Why does it buy them? Well the bit below hints at it.

ETFs allow investors to buy and sell exposure to a basket of equities or an index without owning the underlying shares.

So the Bank of Japan can avoid claims it is explicitly investing in the companies concerned or if you like is a passive fund manager. Those of you who recall the media claims last autumn that the Bank of Japan was in the process of conducting a “tapering” of its purchases will find the bit below familiar.

The purchases have been criticized by some as artificially buoying stock prices, leading the BOJ in July this year to give itself more flexibility by saying it “may increase or decrease the amount of purchases depending on market conditions.”

The Tokyo Whale bought more and not less as the 24,000 or so of late summer was replaced by the current level.

Purchases of the investment funds swelled as the BOJ stepped in to underpin the stock market, which in October suffered huge losses amid concerns over heightened trade tensions between the United States and China.

If we step back and wonder what influence this has been then this from the Tokyo Whale itself hardly provides much support.

a challenge lies in the household sector in that the mechanism of the virtuous cycle from
income to consumption expenditure has been operating weakly.

Money Supply

We have been observing for some months now that many countries have had lower money supply growth which has then led to lower economic growth. So as you can imagine I was waiting for the monetary base data released today. What we see is that the monetary base in Japan grew by 17% in 2017 but by a much lower 7.3% in 2018 and the annual rate in the month of December was only 4.8%. Quite remarkably there were spells in December when the monetary base actually fell. That begs a question about this.

The Bank of Japan will conduct money market operations so that the monetary base will increase at an annual pace of about 80 trillion yen.

As ever in Japan picking one’s way through this is complex as we arrive at what I think is the largest number we have noted on here. You see the Japanese monetary base which is some 504.2 trillion Ten has been pumped up so much by the Bank of Japan the annual rate of growth could not be kept up. For a start there was the issue of how many bonds and the like have already been bought.

The BOJ’s balance sheet, after all, reached a dubious milestone in 2018, when it topped Japan’s $4.87 trillion of annual gross domestic product. ( Nikkei Asian Review)

Rather oddly the NAR then tells us this.

The BOJ could easily buy more government debt and ETFs.

Actually there are not many ETFs left to buy and the Bank of Japan itself is seeing dissent against the current level of purchases. That is not to say that the Bank of Japan could not use other methods as it has shown itself willing to buy pretty much anything.

If we move to the wider liquidity measure of the Bank of Japan we see that the rate of growth was 3.5% in November 2017 but only 1.8% this November. Thus both the bass line and the drumbeat from the monetary system are not only the same but they are a 2018 theme. Because of the different nature of the Japanese system it is hard to be precise about any likely effect because all the expansion seemed to have only a minor upwards effect but one would expect that to now disappear.

Oh and my largest number did not last long as Japanese liquidity is 1788.5 trillion Yen.

The Yen

It was only last week that we were mulling the “flash rally” in the Yen as yet another weak period for equity markets saw a yen for Yen. A combination of thin markets and a Japanese bank holiday saw the Yen strengthen into the high 104s versus the US Dollar. I am told that exited some of the hedges placed by Japanese exporters but there was no sign of the “bold action” often promised by the Bank of Japan. Things are now calmer and the Yen is at 108 but even that is higher over time and that has been against a relatively strong US Dollar.

As the NAR points out this will not be welcomed by the Japanese authorities.

The central problem is that Japan’s economic growth relies largely a weak yen and its capacity to boost exports. Though Prime Minister Shinzo Abe talked grandly about structural reform, the yen’s 30% drop beginning in late 2012 was the fuel behind the 12-quarter run of growth Japan experienced until its July-September stumble.

Comment

The Tokyo Whale faces quite a few problems right now. For example the third quarter of 2018 showed something it has claimed was temporary.

Quarter-on-quarter, GDP shrank a real 0.6 percent, downgraded from the earlier reading of a 0.3 percent contraction. ( The Japan Times)

According to the Markit business survey there was a bounce back. From earlier today.

“Positive survey data from the manufacturing sector
were not mirrored by Japan’s dominant service providing industry in December, where business
activity increased at the weakest pace since May if
the natural-disaster-hit September is discounted.
The survey also pointed to abating demand
pressures, as private sector sales increased only
mildly on the month.”

But then we will expect to see the impact of slowing money supply growth. So 2019 may see the Tokyo Whale do this as we wait to see how those who have presented Abenomics as a triumph deal with Elvis Costello being number one again.

She’s been a bad girl, she’s like a chemical
Though you try to stop it, she’s like a narcotic
You want to torture her, you want to talk to her
All the things you bought for her, putting up your temperature
Pump it up, until you can feel it
Pump it up, when you don’t really need it

Meanwhile here is my podcast from last week with covers my thoughts on how Japan has survived the “lost decade(s)”.

 

 

 

 

 

The Bank of Japan reminds us it is all about the banks

It is time for another part of our discovering Japan theme as we travel to Nagoya, where Governor Kuroda of the Bank of Japan was talking earlier today. Let us open with some good news.

The real GDP has been on an increasing trend, albeit with fluctuations, and the output gap — which shows the utilization of capital and labor — widened within positive territory from late 2016, for seven consecutive quarters through the April-June quarter of 2018 . Under such circumstances, the duration of the current
economic recovery phase, which began in December 2012, is likely to have reached 69 consecutive months this August. If this recovery continues, its duration in January next year will exceed the longest post-war recovery phase of 73 months.

So reasons to be cheerful part one, and below we get part two, but as you can see part three is a disappointment.

In the Outlook Report released last week, the real GDP growth rate for fiscal 2018 is projected to be 1.4 percent, and this is clearly above Japan’s potential growth rate, which is estimated to be in the range of 0.5-1.0 percent. As for fiscal 2019 and 2020, the real GDP growth rates are both projected to be 0.8 percent.

Economics gets called the dismal science but at the moment central bankers are trying to under perform that with the UK having a growth “speed limit” of 1.5% and the ECB saying something similar. The Bank of Japan is even more downbeat which is partly related to the demographics of both an ageing and declining population. This is partly because the previous foundation of their Ivory Towers called the output gap has failed so badly in the credit crunch era but the more eagle-eyed amongst you will have noted a reference to it above. How is that going?

The Output Gap

It is “boom,boom,boom” according to the Black-Eyed Peas and the emphasis is mine.

In the labor market, the active job openings-to-applicants ratio has been at a high level that exceeds the peak of the bubble period, and the unemployment rate has declined to around 2.5 percent. The number of employees has registered a year-on-year rate of increase of around 2 percent, and total cash earnings per employee have risen moderately but steadily.

As you can see the Japanese output gap is already struggling as we are apparently beyond bubbilicious in terms of demand but wage growth is only moderate. What about inflation?

The year-on-year rate of change in the consumer price index (CPI) has continued to show relatively weak developments compared to the economic expansion and the labor market tightening, and that excluding fresh food
and energy prices has been at around 0.5 percent.

In fact after deploying so much effort Governor Kuroda abandons his favourite measure for a higher one.

The year-on-year rate of increase in the CPI (all items less fresh food) has continued to accelerate, albeit with fluctuations. Although there is still a long way to go to achieve the price stability target of 2 percent, the year-on-year rate of change recently has risen to around 1 percent, which is about half the target .

Actually the state of play here is as  strong of a critique of the original claims about QE as we have as according to the central bankers it would raise inflation. Whilst it has created asset price inflation there has been a lack of consumer inflation except in places where currencies have fallen, and in Japan not even much of that. Indeed whilst I would welcome the development below Governor Kuroda will be crying into his glass of sake.

What lies behind this likely is that people’s tolerance of price rises has decreased.

 

Monetary Policy

We have found something which has given the Bank of Japan food for thought. Output gap failure? Rigging so many markets? Impact on individual Japanese? Of course not! It is worries about the banks.

The Bank fully recognizes that, by continuing such monetary easing, financial institutions’
strength will be cumulatively affected by low profitability, mainly through a decrease in
their lending margins, and that it could have an impact on financial system stability as well
as the functioning of financial intermediation.

This is a little mind-boggling as we note that policies which were instituted to help the banks are now being described as hurting them. This is because the banks did not have to change and pretty much carried on as before knowing that they are too big to be allowed to fail. Also I though central banks and regulators were on the case these days but apparently not.

That is, if financial institutions become more active in risk taking to secure profits amid the low interest rate environment and severe competition continuing, the financial system could destabilize should large negative shocks actually occur in the future.

This if we think about it is quite a confession of failure. We have already looked at how economic policy has been directed to suit the banks and in Japan’ case that has continued for nearly thirty years now. Next we seem to have a loss of faith in the new regulations which were supposed to fix this. Finally we have something of a confession that it could all happen again!

If we looked wider we do see some context for example in the way that the European bank stress tests were widely ignored over the weekend. I think that those interested have already voted via bank share prices in 2018, but we do see something rather familiar via @jeuasommenulle.

While everybody is having fun bashing EU banks and pointing out that market volatility on Italian govies will hurt bank capital… the US quietly removes rules that make market volatility impact capital in the 1st place 🤪

Yep back to mark to model rather than mark to market. Just like last time in fact, what could go wrong?

You and I get told what to do but the banks get a different message.

encourage them to take concrete actions as necessary.

The Tokyo Whale

The Bank of Japan has been living up to its reputation and moniker.

The Bank of Japan bought a monthly record of 870 billion yen ($7.68 billion) in exchange-traded funds in October, apparently aiming to support equities as investors turned bearish amid sell-offs in U.S. shares. ( Nikkei Asian Review)

Back on the 23rd of October I pointed about I was bemused by the Japanese owned Financial Times report on a “stealth taper”.

The central bank has become more flexible on its annual ETF purchase quota of around 6 trillion yen — a mark it will likely exceed by year-end at the current pace. ( NAR)

Another Japanese style development comes from this.

 But its large-scale purchases under Gov. Haruhiko Kuroda’s massive monetary easing program were criticized for propping up share prices for a limited range of companies and distorting the market.

To which the classically Japanese response is of course to rig even more of them.

This prompted the BOJ to decide this July to spread out buying more widely.

 

Comment

The comments about an interest-rate hike from Japan are mostly driven by this from today’s speech.

Japan’s economic activity and prices are no longer in a situation where decisively implementing a large-scale policy to overcome deflation was judged as the most appropriate policy conduct, as was the case before.

The problem with such rhetoric comes from the section about as we note that Bank of Japan bought a record amount of equities via ETFs in October. Also this summer it give a specific pronouncement on this subject which was repeated today.

Specifically, the Bank publicly made clear to “maintain the current extremely low levels of short- and long-term interest rates for an extended period of time, taking into account uncertainties regarding economic activity and prices including the effects of the consumption tax hike scheduled to take place in October 2019.”

Indeed he even hints at my “To Infinity! And Beyond!” theme.

it has become necessary to persistently continue with powerful monetary easing while considering both the positive effects and side effects if monetary policy in a balanced manner.

So they will continue the side effects but carry on regardless unless of course the side effects become an even bigger problem for the banks. The status quo continues to play out.

Whatever you want
Whatever you like
Whatever you say
You pay your money
You take your choice
Whatever you need
Whatever you use
Whatever you win
Whatever you lose.

Podcasts

I plan to begin a new series of weekly podcasts this Friday.If anyone has any thoughts or suggestions please let me know.