The murky world of central banks and private-sector QE

The last 24 hours has seen something of a development in the world of central bank monetary easing which has highlighted an issue I have often warned about. Along the way it has provoked a few jokes along the lines of Poundland should now be 50 pence land or in old money ten shillings. Actually the new issue is related to one that the Bank of England experienced back in 2009 when it was operating what was called the SLS or Special Liquidity Scheme. If you have forgotten what it was I am sure the words “Special” and “Liquidity” have pointed you towards the banking sector and you would be right. The banks got liquidity/cash and in return had to provide collateral which is where the link as because on that road the Bank of England suddenly had to value lots of private-sector assets. Indeed it faced a choice between not giving the banks what they wanted or changing ( loosening) its collateral rules which of course was an easy decision for it. But valuing the new pieces of paper it got proved awkward. From FT Alphaville back then.

Accepting raw loans would also ensure that securities taken in the Bank’s operations have a genuine private sector demand rather than comprising ‘phantom’ securities created only for use in central bank operations.

In other words the Bank of England was concerned it was being done up like a kipper which is rather different from the way it tried to portray things.

Under the terms of the SLS, banks and building societies (hereafter ‘banks’) could, for a fee, swap high-quality mortgage-backed and other securities that had temporarily become illiquid for UK Treasury bills, for a period of up to three years.

Some how “high-quality” securities which to the logically minded was always problematic if you thought about the mortgage situation back then had morphed into a much more worrying “phantom” security.  Indeed as the June 2010 Quarterly Bulletin indicated there was rather a lot of them.

But a large proportion of the securities taken have been created specifically for use as collateral with the Bank by the originator of the underlying assets, and have therefore not been traded in the market. Such ‘own-name’ securities accounted for around 76% of the Bank’s extended collateral (around the peak of usage in January 2009), and form the overwhelming majority of collateral taken in the SLS.

Although you would not believe it from its pronouncements now the Bank of England was very worried about the consequences of this and in my opinion this is why it ended the SLS early. Which was a shame as the scheme had strengths and it ended up with other schemes ( FLS, TFS) as we mull the words “one-off” and “temporarily”. But the fundamental theme here is a central bank having trouble with private-sector assets which in the instance above was always likely to happen with instruments that have “not been traded in the market.”

The ECB and Steinhoff

Central banks can also get into trouble with assets that have been traded in the market. After all if market prices were always correct they would move much less than they do. In particular minds have been focused in the last 24 hours on this development.

The news that Steinhoff’s long-serving CEO Markus Jooste had quit sent the company’s share price into freefall on Wednesday morning. Steinhoff opened more than 60% lower, falling from its overnight close of R45.65 to as low as R17.57.

Overall, Steinhoff’s share price has dropped more than 80% over the past 18 months. The stock peaked at over R90 in June last year.  ( Moneyweb).

According to Reuters today has seen the same drum beat.

By 0748 GMT, the stock had slid 37 percent to 11.05 rand in Johannesburg, adding to a more than 60 percent plunge in the previous session. It was down about 34 percent in Frankfurt where it had had its primary listing since 2015.

You may be wondering how a story which might ( in fact is…) a big deal and scandal arrives at the twin towers of the ECB or European Central Bank. The first is a geographical move as Steinhoff has operations in Europe and two years ago today listed on the Frankfurt stock exchange. I am not sure that Happy Birthday is quite appropriate for investors who have seen the 5 Euros of then fall to 0.77 Euros now.

Next enter a central bank looking to buy private-sector assets and in this instance corporate bonds.

Corporate bonds cumulatively purchased and settled as at 01/12/2017 €129,087 (24/11/2017: €127,690) million.

One of the ( over 1000) holdings is as you have probably already guessed a Steinhoff corporate bond and in particular one which theoretically matures in 2025. I say theoretically because the news flow is so grim that it may in practice be sooner. From FT Alphaville.

German prosecutors say they are investigating whether Steinhoff International inflated its revenue and book value, one day after the global home retailer announced that its longtime chief executive had quit…The investigators are probing whether Steinhoff flattered its numbers by selling intangible assets and partnership shares without disclosing that it had close connections to the buyers. The suspicious sales were in “three-digit million” euros territory each, according to the prosecutors.

In terms of scale then the losses will not be relatively large as the bond size is 800 million Euros which would mean that the ECB would not buy more than 560 million under its 70% limit but it does pose questions.

they have a minimum first-best credit assessment of at least credit quality step 3 (rating of BBB- or equivalent) obtained from an external credit assessment institution

This leaves us mulling what investment grade actually means these days with egg on the face of the ratings agencies yet again. As time has passed I notice that the “high-quality” of the Bank of England has become the investment grade of the ECB.

The next question is simply to wonder what the ECB is doing here? Its claim that buying these bonds helps it achieve its inflation target of 2% per annum is hard to substantiate. What it has created is a bull market in corporate bonds which may help economic activity as for example we have seen negative yields even in some cases at issue. But there are side-effects such as moral hazard where the ECB has driven the price higher helping what appears to be fraudulent activity.

How much?

For those of you wondering about the size of the losses there are some factors we do not know such as the size of the holding. We do know that the ECB bought at a price over 90 which compares to the 58.2 as I type this. Some amelioration comes from the yield but not much as the coupon is 1.875% and of course that assumes it gets paid.

My understanding of how this is split is that 20% is collective and the other 80% is at the risk of the national central bank. So there may well be some fun and games when the Bank of Finland ( h/t Robert Pearson) finally reports on this.

Comment

There is much to consider here. Whilst this is only one corporate bond it does highlight the moral hazard issue of a central bank buying private-sector assets. There is another one to my mind which is that overall the ECB will have a (paper) profit but that is pretty much driven by its own ongoing purchases. This begs the question of what happens when it stops? Should it then fear a sharp reversal of prices it is in the situation described by Coldplay.

Oh no what’s this
A spider web and I’m caught in the middle
So I turn to run
And thought of all the stupid things I’d done.

The same is true of the corporate bond buying of the Bank of England which was on a smaller scale but even so ended up buying bonds from companies with ever weaker links ( Maersk) to the UK economy. Even worse in some ways is the issue of how the Bank of Japan is ploughing into the private-sector via its ever-growing purchases of Japanese shares vis equity ETFs. At the same time we are seeing a rising tide of scandals in Japan mostly around data faking.

Me on Core Finance

http://www.corelondon.tv/will-bond-yields-ever-go-higher/

 

 

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What and indeed where next for bond markets?

The credit crunch era has brought bond markets towards the centre stage of economics and finance. Before then there were rare expressions of interest in either a crisis or if the media wanted to film a response to an economic data release. You see equities trade rarely but bonds a lot so they filmed us instead and claimed we were equities trades so sorry for my part in any deception! Where things changed was when central banks released that lowering short-term interest-rates ( Bank Rate in the UK) was not the only game in town and that it was not having the effect that they hoped and planned. Also the Ivory Towers style assumption that short-term interest-rates move long-term ones went the way of so many of their assumptions straight to the recycling bin.

QE

It is easy to forget now what a big deal this was as the Federal Reserve and the Bank of England joined the Bank of Japan in buying government bonds or Quantitative Easing ( QE). There is a familiar factor in that what was supposed to be a temporary measure has now become a permanent feature of the economic landscape. As for example the holdings of the Bank of England stretch to 2068 with no current plan to reverse any of it and instead keeping the total at £435 billion by reinvesting maturities. Indeed on Friday it released this on social media.

Should quantitative easing become part of the conventional monetary policy toolkit?

The Author Richard Harrison may be in line for promotion after this.

Though the model does not support the idea that central banks should maintain permanently large balance sheets, it does suggest that we may see more quantitative easing in the future.

So here is a change for bond markets which is that QE will be permanent as so far there has been little or no interest in unwinding it. Even the US Federal Reserve which to be fair is doing some unwinding is doing so with baby steps or the complete opposite of the way it charged in to increase QE.

Along the way other central banks joined in most noticeably the European Central Bank. It had previously indulged in some QE via its purchases of Southern European bonds and covered ( bank mortgage) bonds but of course it then went into the major game. In spite of the fact that the Euro area economy is having a rather good 2017 it is still at it to the order of 60 billion Euros a month albeit that halves next year. So we are a long way away from it stopping let alone reversing. If we look at one of the countries dragged along by the Euro into the QE adventure we see that even annual economic growth of 3.1% does not seem to be enough for a change of course. From Reuters.

Riksbank’s Ohlsson: Too Early To Make MonPol Less Expansionary

If 3.1% economic growth is “too early” then the clear and present danger is that Sweden goes into the next downturn with QE ongoing ( and maybe negative interest-rates too). One consequence that seems likely is that they will run out of bonds to buy as not everyone wants to sell to the central bank.

Whilst we may think that QE is in modern parlance “like so over” in fact on a net basis it is still growing and only last month a new player came with its glass to the punch bowl.

In addition, the Magyar Nemzeti Bank will launch a targeted programme aimed at purchasing mortgage bonds with maturities of three years or more. Both programmes will also contribute to an increase in the share of loans with long periods of interest rate fixation.

Okay so Hungary is in the club albeit via mortgage bond purchases which can be a sort of win double for central banks as it boosts “the precious” ( banks) and via yield substitution implicitly boosts the government bond market too. But we learn something by looking at the economic situation according to the MNB.

The Hungarian economy grew by 3.6 percent in the third quarter of 2017…….The Monetary Council expects annual economic growth of 3.6 percent in 2017 and stable growth of between 3-4 percent over the coming years. The Bank’s and the Government’s stimulating measures contribute substantially to economic growth.

We are now seeing procyclical policy where economies are stimulated by monetary policy in a boom. In particular central banks continue with very large balance sheets full of government and other bonds and in net terms they are still buyers.

The bond vigilantes

They have been beaten back and as we observe the situation above we see why. Many of the scenarios where they are in play and bond yields rise substantially have been taken away for now at least by the central banks. There can be rises in bond yields in individual countries as we see for example in the Turkish crisis or Venezuela but the scale of the crisis needs to be larger and these days countries are picked off individually rather than collectively.

At the moment there are grounds for the bond yield rises to be in play in the Euro area with growth solid but of course the ECB is in play and in fact yesterday brought news of exactly the reverse.

 

A flat yield curve?

The consequence of central banks continuing with what the Bank of Japan calls “yield curve control” has led to comments like this. From the Financial Times yesterday.

Selling of shorter-dated Treasuries pushed the US yield curve to its flattest level since 2007 on Tuesday. The difference between the yields on two-year Treasury notes and 10-year Treasury bonds dropped below 55 basis points in afternoon trading in New York. While the 10-year Treasury was little changed, prices of two-year notes fell for the second consecutive day. The two-year Treasury yield, which moves inversely to the note’s price, has climbed 64 basis points this year to 1.83 per cent.

If we look long the yield curve the numbers are getting more and more similar ironically taking us back to the “one interest-rate” idea the central banks and Ivory Towers came into the credit crunch with. With the US 2 year yield at 1.8% and the 30 year at 2.71% there is not much of a gap.

Why does something which may seem arcane matter? Well the FT explains and the emphasis is mine.

It marks a pronounced “flattening” of the yield curve, with investors receiving decreasing returns for holding longer-dated bonds compared to shorter-dated notes — typically a harbinger of economic recession.

Comment

We have seen phases of falls in bond prices and rises in yield. For example the election of President Trump was one. But once they pass we are left wondering if the around thirty year trend for lower bond yields is still in play and we are heading for 0% ( ZIRP) or the icy cold waters of negativity ( NIRP)? On that road the idea that the current yield curve shape points to a recession gets kicked into touch as Goodhart’s Law or if you prefer the Lucas Critique comes into play. But things are now so mixed up that a recession might actually be on its way after all we are due one.

For yields to rise again on any meaningful scale there will have to be some form of calamity for the central banks. This is because QE is like a drug for so many areas. One clear one is the automotive sector I looked at yesterday but governments are addicted to paying low yields as are those with mortgages. On that road they cannot let go until they are forced to. Thus the low bond yields we see right now are a short-term success which central banks can claim but set us on the road to a type of junkie culture long-term failure. Or in my country this being proclaimed as success.

“Since 1995 the value of land has increased more than fivefold, making it our most valuable asset. At £5 trillion, it accounts for just over half of the total net worth of the UK at end-2016. At over £800 billion, the rise in the nation’s total net worth is the largest annual increase on record.”

Of course this is merely triumphalism for higher house prices in another form. As ever those without are excluded from the party.

 

 

Why are we told some inflation is good for us?

A major topic in the world of economics is the subject of inflation which has been brought into focus by the events of the past 2/3 years or so. First we had the phase where a fall in the price of crude oil filtered through the system such that official consumer inflation across many countries fell to zero per cent on an annual basis and in some cases below that. If you recall that led to the deflation scare or it you will excuse the capitals what much of the media presented as a DEFLATION scare. We were presented with a four horsemen of the apocalypse style scenario where lower and especially negative inflation would take us to a downwards spiral where wages and economic activity fell as well along the line of this from R.E.M.

It’s the end of the world as we know it.
It’s the end of the world as we know it.

I coined the phrase “deflation nutter” to cover this because as I pointed out, Greece the subject of yesterday suffered from quite a few policy errors pushing it into depression and that on the other side of the coin for all its problems Japan had survived years and indeed decades of 0% inflation. Indeed on the 29th of January 2015 I wrote an article on here explaining how lower consumer inflation was boosting consumption across a range of countries via the positive effect it was having on real wages.

 if we look at the retail-sectors in the UK,Spain and Ireland we see that price falls are so far being accompanied by volume gains and as it happens by strong volume gains. This could not contradict conventional economic theory much more clearly. If the history of the credit crunch is any guide many will try to ignore reality and instead cling to their prized and pet theories but I prefer reality ever time.

 

Relative prices

The comfortable cosy world of central bankers and theoretical economists told us and indeed continues to tell us that we need positive inflation so that relative prices can change. That leads us to the era of inflation targets which are mostly set at 2% per annum although of course there is a regular cry for inflation targets to be raised. However 2015/16 torpedoed their ship as if we just look at the basic change we saw a large relative price adjustment for crude oil leading to adjustments directly to other energy costs and a lot of other changes. Ooops! Even worse for the theory we saw two large sectors of the economy respond in opposite fashion. A clear example of this was provided by my own country the UK where services inflation barely changed and ironically for a period of deflation paranoia was quite often above the inflation target. But the goods sector saw substantial disinflation as it was it that pulled the overall measure down to around 0%.

We can bring this up to date by looking at the latest data from the Statistics Bureau in Japan.

  The consumer price index for Ku-area of Tokyo in October 2017 (preliminary) was 100.1 (2015=100), down 0.2% over the year before seasonal adjustment, and down 0.1% from the previous month on a seasonally adjusted basis.

So not only is there no inflation here there has not been any for some time. Yet the latest monthly update tells us that food prices fell by 2.4% on an annual basis and the sector including energy fuel and lighting rose by 7.1%. Please remember that the next time the Ivory Towers start to chant their “we need inflation so relative prices can adjust” mantra.

Reality

This is that central banks are in the main failing to reach their inflation targets. For example if we look at the US economy the Federal Reserve targets the PCE ( Personal Consumption Expenditure) inflation measure which was running at an annual rate of 1.6% in September and even that level required an 11.1% increase in energy prices.

So we see central banks and establishments responding to this of which the extreme is often to be found in Japan. From @lemasabachthani yesterday.

JAPAN PM AIDE HONDA: INAPPROPRIATE TO REAPPOINT BOJ GOV KURODA, BOJ NEEDS NEW LEADERSHIP TO ACHIEVE 2 PCT INFLATION TARGET

Poor old Governor Kuroda whose turning of the Bank of Japan into the Tokyo Whale was proving in his terms at least to be quite a success. From the Financial Times.

Trading was at its most eye-catching in Japan. Tokyo’s Topix index touched its highest level since November 1991, only to end down on the day after a volatile session. At its peak, the index reached the fresh high of 1,844.05 with gains across almost all major segments, taking it more than 20 per cent higher for the year to date. But it faded back in late trade to close at 1,817.75.

It makes me wonder what any proposed new Governor would be expected to do?! QE for what else?

Whereas in this morning’s monthly bulletin the ECB ( European Central Bank) has told us this.

Following the decision made on 26 October 2017 the monthly pace will be further reduced to €30 billion from January 2018 and net purchases will be carried out until September 2018. The recalibration of the APP reflects growing confidence in the gradual convergence of inflation rates towards the ECB’s inflation aim, on account of
the increasingly robust and broad-based economic expansion, an uptick in measures of underlying inflation and the continued effective pass-through of the Governing
Council’s policy measures to the financing conditions of the real economy.

So we see proposals for central banking policy lost in  a land of confusion as the US tightens, the Euro area eases a little less and yet again the establishment in Japan cries for more, more, more.

Comment

There is a lot to consider here as we mull a world of easy and in some cases extraordinarily easy monetary policy with what is in general below target inflation. Of course there are exceptions like Venezuela which as far as you can measure it seems to have an inflation rate of the order of 2000% + . But in general such places are importing inflation via a lower currency exchange rate which means that someone else’s is reduced. Also we need to note that 2017 is looking like a good year for economic growth as this morning’s forecasts from the European Commission indicate.

The euro area economy is on track to grow at its fastest pace in a decade this year, with real GDP growth forecast at 2.2%. This is substantially higher than expected in spring (1.7%)……..at 2.1% in 2018 and at 1.9% in 2019.

So then of course you need an excuse for easy monetary policy which is below target inflation! Of course this ignores two technical problems. The first is that at the moment if we get inflation it is mostly from a higher oil price as we mull the likely effects of Brent Crude Oil which has moved into the US $60s. The second is that there is inflation to be found if you look at asset prices as whilst some of the equity market highs we keep seeing is genuine some of it is simply where all the QE has gone. Also there is the issue of house prices where even in the Euro area they are growing at an annual rate of 3.8% so if they were in an inflation index even more questions would be asked about monetary policy.

In a world where wages growth is not only subdued but has clearly shifted onto a lower plane the obsession with raising inflation will simply make the ordinary person worse off via its effect on real wages. Sadly this impact is usually hardest on the poorest.

Me on Core Finance TV

http://www.corelondon.tv/uk-housing-market-house-party-keeps-going/

 

 

 

What does the lack of wage growth in Japan tell us about our future?

As the credit crunch era has developed we have seen many countries discover that past relationships between the level of unemployment and the rate of wage growth no longer exists. Actually if we look back we see that there had been changes before the credit crunch but it has both exacerbated them and brought them into focus. This issue is particularly pronounced in Japan where the unemployment and employment numbers are very strong. From Japan Macro Advisers.

The Japanese economy keeps adding jobs. 200K new jobs were added in August 2017. The unemployment rate was unchanged at 2.8% in August, remaining at the lowest rate in 23 years.

The stand out number is an unemployment rate of a mere 2.8% which is rather extraordinary especially if we recall estimates of full employment from the past as it is below them! How can this be? Well as even economic concepts do not mean what they say as for example central bankers talk of “price stability” when they mean inflation stability usually at 2% per annum. The concept of full employment was and indeed is like that as it does not mean everyone has a job. It always assumed some frictional unemployment or people temporarily out of work and that implied a higher unemployment rate than Japan now has. If we look at other measures the numbers are also strong.

Japan’s job offers to applicant ratio also remained constant in August at 1.52, the highest ratio since February 1974. The new job offers to applicant ratio slightly declined to 2.21 from 2.27 in July, but it is still close to its historical high and continues to show there are more than two vacant jobs to one applicant.

However we also need to note that there is a particularly Japanese feature to this which is on its way to other countries with demographics issues.

The work age population in Japan, defined as the population of the age between 15 and 64, has been shrinking rapidly. In 2016, it fell by 0.7 million people. In 2017, it is projected to shrink further by 0.8 million in 2017. While the Japanese economy is making ends meet by higher labor participation from its senior citizens, the labor resource limitation is an issue Japan needs to address soon.

Work till you drop is perhaps the new theme here.

What about wages?

The story of my time online covering Japan is that since the Abe government came to power there has been prediction after prediction that wage growth will pick up. Regular readers will be aware that some news organisations such as Bloomberg have regularly reported that wage growth has picked up but the truth is that so far there has been no real sign. If we move from the past hype to reality we see that according to the official data real wages fell by 0.9% in 2013, 2.8% in 2014 and 0.9% in 2015 before rising by 0.7% in 2016. Putting it another way the real wage index which was 103.9 in 2013 was 100.7 in 2016.

If we return to Japan Macro Advisers we see this.

The wage report for August was encouraging. Total wages rose by 0.9% year on year (YoY), the highest increase in the last 12 months. Basic and overtime wages rose by 0.6% YoY, the highest rise since April 2016.

We learn a lot there as growth of a mere 0.9% is “encouraging”?! If we switch to real wages the picture is not because they were 0.1% lower than a year before. They are optimistic because of what is essentially a challenge to the unemployment data as they hint at a change in underemployment.

The report shows that 30.5% of workers covered in the survey were part-time workers, a decline of 0.2% point from a year ago. The government does not publish a seasonally adjusted series, but in our own estimation, we see a clear sign that the part-time ratio is starting to decline.

This matters because.

Part-time workers receive one-third of wages that regular workers receive. There are other important benefits such as social security, and the job security is far stronger for regular workers.

Why might wages growth remain weak?

An interesting facet of the issue was highlighted yesterday by the Wall Street Journal.

Facing the tightest labor market in Japan in 43 years, Gatten Sushi recently hired two Chinese kitchen workers and a Filipino waitress who calls out “Welcome” to customers, each for about $10 an hour.

For a country which in many respects prides itself on being homogenous the situation below represents quite a change.

Japan added 400,000 foreign workers in the four years through 2016, surpassing one million for the first time, or nearly 2% of the workforce, labor ministry data show. That is still low compared with the U.S.’s 17% of foreign-born workers but enough to sway the labor market in urban centers like Tokyo.

This is something familiar these days where countries in effect import immigrants to help cope with poor demographics such as an ageing population but there is a catch.

RDC’s Mr. Fukui said foreign workers help the company keep prices flat, especially at budget places like a conveyer-belt sushi restaurant where Vietnamese workers in masks and plastic gloves place fish atop small rice balls formed by a robot. They are useful in other ways too: Sometimes they help out by serving foreign tourists in their own languages, and Mr. Fukui hopes they will continue working with the company even when they go back home to help it expand overseas.

There is a clear implication here that foreign workers are being used as a way of keeper wages lower. This can work because whilst the wages are low for Japan they are high for elsewhere.

Minimum wage in Japan, too low to attract many native-born workers, is still generous for many other Asians. In 2015, Japan’s minimum wage was 21 times higher than that of Vietnam, 12 times higher than in Nepal, and triple that of China, data from Dai-Ichi Research Institute show.

As to this being a permanent situation well maybe not.

Most foreign workers cannot stay permanently owing to immigration rules. Mr. Abe has repeatedly said he doesn’t want large numbers of immigrants in low-paying jobs coming to Japan for the long term.

Government policy

This has been announced since last weekend’s election according to Reuters.

Japan’s government is considering expanding tax incentives for companies to encourage them to raise wages, three people involved in discussions told Reuters, as many firms remain hesitant to spend their cash reserves on salary increases.

As the existing tax breaks are not working this sounds rather like the approach to QE ( QQE in Japan) where like Agent Smith in The Matrix series of films the cry always goes up for “More”

Comment

There are lessons here because Japan has for some time run a policy of declaring pretty much full employment. What I mean by that is that when I worked in Tokyo some 20 years ago people were employed to count you walking across bridges and lifts in the Ghinza shopping district had operators to save you from the arduous task of pressing a lift button! Of course many other countries are now facing up to the issue of what low levels of unemployment really mean.

The next issue is demographics where Japan is the leader of a pack you would rather not be in. Yes it is welcome people are living longer but it has a shrinking population too. Even it has accepted some immigration but as you have seen earlier on its own terms. As the Abe administration is nationalistic that could easily change, But the immigration that has taken place looks like it has affected wages in some occupations. If we look at the restaurant sector it seems clear that to attract Japanese labour wages would have had to have risen if viable.

That conclusion is not far off dynamite as we are so often told that immigration does not depress wages as this from Noah Smith of Bloomberg reminds us.

Normally immigrants don’t depress native wages, but in Japan, given investment constraints, they actually might. Still…skeptical.

If you have workers coming in from much poorer countries to work in particular sectors then surely it must depress wages in them or make them rise more slowly. I can see that there are areas it is unlikely to affect as for example Eastern European construction workers in the UK or Vietnamese/Chinese restaurant workers in Japan may have no impact at all on many other skills but to say they have no impact in their areas seems strange. Also what happens in their home country?

But if we return to the pattern of Japan upon which immigration has been only a recent thin screen then we see that for all the media and Ivory Tower hype the road on what it has been on for 2 “lost decades” now poses a question for our future.

Wages in Japan has been steadily falling in Japan since 1998. Between 1997 and 2012, wages have fallen by 12.5%, or by 0.9% per year on average. ( Japan Macro Advisers).

But we cannot just simply assume we will be “Turning Japanese” in every respect as this from the UK Office for National Statistics has reminded us today.

UK population projected to grow from 65.6 million in 2016 to 72.9 million in 2041

 

Me on Core Finance TV

http://www.corelondon.tv/uk-gdp-0-4-pleasant-number/

 

It is party and sake time at The Tokyo Whale as the Nikkei 225 hits highs

This week has brought a succession of news which will be welcomed by supporters of what has become called Abenomics and the Bank of Japan in particular. In fact the Bank of Japan will be pleased in two ways, one as an ordinary central bank and the other in its hedge fund style role as the Tokyo Whale. From The Japan Times.

The benchmark Nikkei average rose further and marked another 21-year closing high on the Tokyo Stock Exchange on Thursday, boosted by Wall Street’s overnight advance. The Nikkei 225 average gained 73.45 points, or 0.35 percent, to end at 20,954.72 — the best finish since Nov. 29, 1996.

Today this has gone one step further or for Madness fans one step beyond,

Let us start with the most recent period from when Abenomics was first likely to be applied to now. In that time the Nikkei 225 equity index has risen from around 8000 to 21000. As this was one of the policy objectives as according to the mantra it leads to positive wealth effects for the economy it will be regarded as a success. It may also help oil the wheels in the ongoing Japanese election. But you see there is another reason for the Bank of Japan to be happy about this because since a trial effort back in 2010 it has been buying Japanese shares via Exchange Traded Funds. A more regular programme started in 2012 and this was boosted in size and scale over time and here is the current position from the September monetary policy statement.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively.

So the Bank of Japan will have some considerable paper profits right now especially in the light of a clear behavioural pattern which I looked at on the 6th of June.

The bank apparently buys frequently on days when the stock market dips in the morning, serving to stabilize share prices.

The Nikkei Asian Review analysed this development like this.

“The BOJ’s ETF purchases help provide resistance to selling pressure against Japanese stocks,” says Rieko Otsuka of the Mizuho Research Institute.

There have been various rumours over the years about central banks providing something of a “put option” for equity markets leading to talk of a “plunge protection team”, well here is one literally in action. The Japanese taxpayer may reasonably wonder why it is supporting equity investors in yet another example of a policy which the 0.01% will welcome in particular. But for now let is move on with the Governor of the Bank of Japan enjoying a celebratory glass of sake as he looks at the wealth effects of the equity market high and the paper profits in the Bank’s coffers.

The “Put Option” in practice

A paper had been written by Toby Nangle and Tony Yates on this. You may well recall Tony Yates as the person I had a debate with on BBC Radio 4’s Moneybox programme and that events since have not been kind to his views. Anyway they tell us this.

 the cumulative purchases by the Bank of Japanese equities are becoming substantial. We estimate the market value to have been just below ¥20 trillion at the end of July 2017, or around 3.2% of the total Japanese stock market, making the central bank the second largest owner of Japanese stocks after the Government Pension Investment Fund.

Indeed they find themselves producing analysis along the lines of my “To Infinity! And Beyond!” theme.

Without further adjusting the pace of ETF purchases, we project that the central bank will own 10% of the market sometime between 2022-2026, depending on the interim market performance.

First they look for an announcement effect.

We control for this by examining the excess returns of Japanese stocks versus global stocks two business days post-announcement in common currency (last column in Table 1). The relationship between the scale of purchases and the price change is positive in each episode, although the confidence we have in the relationship is not strong given such few data points.

Personally I would also be looking at the days ahead of the announcement as many of these type of events are anticipated and if you like “front-run” these days. Next we see they look for an execution effect and they struggle to find one as the Japanese market underperformed in the period they looked at compared to other equity markets. However we do get a confirmation of the put option in operation.

 we find that the Bank of Japan has timed the execution of its ETF purchase programme to coincide with episodes of market weakness, potentially with the aim of dampening price volatility.

Oh and “dampening price volatility” is the new reduce and/or stop market falls as otherwise it would also sell on days of market strength.

Will it spread?

This is slightly dubious depending on how you regard the actions of the Swiss National Bank which of course buys equities abroad which I presume they regard as the difference.

Japan has been alone in purchasing equities as part of its monetary easing programme, and the question of whether the purchase of equity securities is the next step along this path is of wider interest.

But I agree with the conclusion.

 Even if central banks in the US/Eurozone/UK achieve a lasting lift-off from the zero bound, and are able to shed asset purchases from their balance sheet, low central bank rates are discounted by markets to be a fact of life for the next decade or two, and the chance of needing to have recourse to unconventional measures appears very large.

Comment

Thank you to Tony and Toby for their paper but they use very neutral language and avoid any opinion on whether this is a good idea which tends to suggest a form of approval. Yet there are a myriad of problems.

The ordinary Japanese taxpayer is very unlikely to be aware of this and what is being done both in their name and with their backing. This is especially important if we consider the exit door as in how does this end?

There is a moral hazard problem in both backing and financing a market which disproportionately benefits the already well off. This gets added to by the latest scandal in Japan as the company below has been ( indirectly) backed by the Bank of Japan.

DJ KOBE STEEL SAYS FOUND MORE INSTANCES OF SHIPPED PRODUCTS WITH QUALITY PROBLEMS ( h/t @DeltaOne )

There are real problems here and is one of the arguments against central banks buying risky assets of this form and the clue of course is in the use of the word risky.

Next we have the issue of what good does it do? Yes some get an increase in their paper wealth and some will take profits. In a sense good luck to them, but as we note that this will be disproportionately in favour of the wealthy this is in my opinion a perversion of the role of a central bank.

On the other side of the coin is the current media cheerleading for equity markets of which this from Bloomberg this morning is an especially disturbing example.

To put this year’s gains in perspective, the value of global equities is now 3 1/2 times that at the financial crisis bottom in March 2009. Aided by an 8 percent drop in the U.S. currency, the dollar-denominated capitalization of worldwide shares appreciated in 2017 by an amount — $20 trillion — that is comparable to the total value of all equities nine years ago……… And yet skeptics still abound, pointing to stretched valuations or policy uncertainty from Washington to Brussels. Those concerns are nothing new, but heeding to them is proving an especially costly mistake.

You see congratulating people on doing well out of equity investments is very different to saying you should buy now at what are higher prices. Unless of course Bloomberg thinks they are more attractive at higher prices in which case perhaps it should be buying Bitcoin. Let me leave you with this which feels like something out of a dystopian science fiction piece.

Big companies are becoming huge, from Apple Inc. to Alibaba Group Holding Ltd.

The land of the rising sun sees rising GDP too

Today starts with good news from the land of the rising sun or Nihon. I do not mean the sporting sphere although there was success as a bronze medal in the men’s 4 by 100m relay was followed by silver and bronze in the men’s 50 km walk at the world athletics championships. There was also a near miss as Hideki Matsuyama faded at the US PGA  and did not become the first Japanese man to win a golf major. But the major good news came from the Cabinet Office as this from The Mainichi tells us.

Japan’s economy grew an annualized real 4.0 percent in the April-June period for a sixth straight quarter of expansion, marking the longest growth run since 2006, as private consumption and corporate spending showed signs of vigor, government data showed Monday.

If we convert to the terms we use there was 1% economic growth from the previous quarter which was quite a surge. Actually that is way beyond what the Bank of Japan thinks is the potential growth rate for Japan but let us park that for now and move on to the detail.  Reuters points out that consumption was strong.

Private consumption, which accounts for about two-thirds of GDP, rose 0.9 percent from the previous quarter, more than the median estimate of 0.5 percent growth.

That marked the fastest expansion in more than three years as shoppers splashed out on durable goods, an encouraging sign that consumer spending is no longer the weak spot in Japan’s economic outlook.

In fact so was investment.

Capital expenditure jumped by 2.4 percent in April-June from the previous quarter, versus the median estimate for a 1.2 percent increase. That was the fastest growth in business investment since January-March 2014.

The combination is interesting as this is something that Japan has wanted for a long time as its “lost decade(s)” of economic malaise have seen domestic demand and consumption in particular struggle. Some countries would be especially troubled by the trade figures below but of course Japan has seen many years of surpluses as this from the Nikkei Asian Review indicates.

 Japan’s current account surplus expanded in the January-June period to the highest level since 2007 as earnings from foreign investments moved further into the black, despite rising energy prices pushing up the overall value of the country’s imports, government data showed Tuesday.

 

Thus it is likely to see this as another welcome sign of strong domestic demand.

External demand subtracted 0.3 percentage point from GDP growth in April-June in part due to an increase in imports.

Those who look at the world economy will be pleased to see a “surplus” economy importing more.

Where does this leave Abenomics?

There are various ways of looking at this and the Japanese owned Financial Times leads the cheers.

‘Not a fluke’: Japan on course to record best GDP growth streak since 2000

“Not a fluke” is an odd thing to write because if you look at the GDP chart they provide we see several spikes like this one which imply it may well be er not only a fluke but another one. They are less keen to credit another form of Abenomics which is the way that the latest stimulus programme impacted with a 5.1% (21.9% annualised) rise in public investment causing a 0.2% rise in GDP on its own. Perhaps this is because of the dichotomy in this part of Abenomics where on the one hand fiscal expansionism is proclaimed and on the other so is a lower deficit! Also there are memories of past stimulus projects where pork barrel politics led to both bridges and roads to nowhere.

Actually the FT does then give us a bit of perspective.

 

Japan’s economy, as measured by real GDP, is now 7 per cent larger than when prime minister Shinzo Abe took office in late 2012, notes Emily Nicol at Daiwa Capital Markets.

That is a long way short of the original promises which is one of the reasons why the Japanese government page on the subject introduces Abenomics 2.0.  If we look at the longer-term chart below is there a clear change.

On such a basis one might think it was the US or UK that had seen Abenomics as opposed to Japan. Of course the figures are muddied by the recession created by the consumption tax rise in 2014 but the performance otherwise even with this quarter’s boost is far from relatively stellar.

Bank of Japan

It will of course be pleased to see the economic news although it also provides plenty of food for thought as details like this provide backing for my analysis that ~0% inflation is far from the demon it is presented as and can provide economic benefits. From Bloomberg.

The GDP deflator, a broad measure of price changes, fell 0.4 percent from a year earlier.

Board Member Funo confirmed this in a speech earlier this month.

The rate of increase for all items less fresh food and energy had remained on a decelerating trend, following the peak of 1.2 percent in winter 2015; recently, the rate of change has been at around 0 percent.

He of course followed this with the usual rhetoric.

The rate will likely reach around 2 percent in around fiscal 2019.

It is always just around the corner in not entirely dissimilar fashion to a fiscal surplus in the UK. As to the official view it is going rather well apparently.

Taking this into consideration, the Bank decided to adopt a commitment that allows inflation to overshoot the price stability target so as to strengthen the forward-looking mechanism in the formation of inflation expectations, enhance the credibility of achieving the price stability target among the public, and raise inflation expectations in a more forceful manner.

Make of that what you will. The reality is that the QQE programme did weaken the Yen but that effect wore off and inflation is now ~0% as is wage growth.

Comment

This growth figures are good news and let me add something that appears to have been missed in the reports I have read. Back to Board Member Funo.

In an economy with a declining population.

Thus the per capita or per person GDP numbers are likely to be even better than the headline. I would say that this would benefit the ordinary Japanese worker and consumer but we know that real wage growth has dipped into negative territory again. This provides a problem for Prime Minister Abe as when he came to power the criticisms were based around his past history of being part of the Japanese establishment. What we see nearly 5 years down the road is a lack of real wage growth combined with good times for Japanese corporate profitability. As to the reform programme there is not a lot to be seen and maybe this is why Board Member Funo was so downbeat.

In an economy with a declining population, as is the case in Japan, demand is expected to decrease for many goods and services; therefore, it will be important to adequately adjust supply capacity; that is, employees and production capacity to meet such a decreasing trend.

I do not know about you but trying to raise prices when you expect both demand and supply to fall seems extremely reckless to me.

As to the GDP numbers themselves we need a cautionary note as Japan has had particular problems with them and they are revised more and by larger amounts than elsewhere.

 

Could the Japanese Government cope with an end to QE in Japan?

It is time for us to look east again to the land of the rising sun or Nihon. It remains in the grip of an extraordinary economic experiment as its central bank continues to offer freshly printed Yen ( albeit electronic rather than paper ones) on a grand scale in return for bonds, commercial paper , corporate bonds, equities and property so just about everything!

With regard to the amount of JGBs to be purchased, the Bank will conduct purchases at more or less the current pace — an annual pace of increase in the amount outstanding of its JGB holdings of about 80 trillion yen — aiming to achieve the target level of the long-term interest rate specified by the guideline. …… The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively.

Perhaps it was the scale of all of this that led much of the media to start writing articles that the Bank of Japan would reduce its operations or as it is now called “taper” them. Only on Friday I quoted this from the Wall Street Journal.

Japan shows Europe how to dial back stimulus without spooking investors

The Bank of Japan responds

Sadly for the media the word taper required the word reverse in front of it. From the Nikkei Asian Review only a few short hours later.

At 10:10 a.m. Japan time, the BOJ unleashed what a market manager for a leading brokerage called a “devastating” combination, announcing both a fixed-rate operation, in which the central bank agrees to buy unlimited bonds at a fixed yield, and an increase in the size of regular bond-buying operations. It was the first time the bank had executed such policies simultaneously.

So more is apparently less as we note that this bit could only have come from Japan.

When yields on 10-year Japanese government bonds hit 0.1% on Thursday evening, the central bank was forced to ring up Japan’s leading securities firms for advice.

What would they have done in places like Greece Italy or Portugal in the Euro area crisis or in the early days of my career when longer UK Gilt yields passed 15%?!

By Friday morning, 10-year JGB yields had reached 0.105% — the last straw

We will have to see what happens next but should the Bank of Japan feel the need to keep intervening this could be the state of play.

If the central bank keeps buying up 10-year JGBs as quickly as it did Friday, annual purchases could exceed new issuance, according to Takenobu Nakashima of Nomura Securities, burning through fuel for measures to combat a future yield surge.

Actually if it bought them all that would of itself tend to stop any yield surge. Although of course that is just the flow so there would still be an existing stock albeit one which the Bank of Japan owes a fair bit of.

Massive bond purchases have swollen the BOJ’s balance sheet to roughly the size of Japan’s gross domestic product

Around 90% I think. There are various issues here one of which has been conveniently pointed out by the European Central Bank this morning.

Worsened liquidity in domestic government bond market

They mean in the Euro area but imagine how much worse the state of play will be in Japan. We do know that trading volumes have dropped a lot so should the day come that the Bank of Japan decides to withdraw a lot of Japanese fingers will be crossed that past traders and buyers will return. The truth is we simply do not know.

Oh and I see some looking at the equity capital of the Bank of Japan implying it could go broke. But that misses the fact that not only is it backed by the Japanese Treasury but it is pursuing Abenomics a government policy.

Number Crunching

Currently Japan owes this according to Japan Macro Advisers.

At the end of March 2017, the Japanese general government owed a total of 1270.5 trillion yen in liability, equivalent to 236.4% of GDP. The liability includes 863 trillion yen of JGBs, 115.2 trillion yen of T-bills and 157.5 trillion yen of loans.

The Bank of Japan owns over 400 Trillion Yen of these so in round numbers if it wrote these off it would reduce the debt burden to ~160% of GDP. I am by no means suggesting this but if such a situation led to a lower value for the Japanese Yen well that is government policy isn’t it? Of course the danger of debt monetisation of that form is that the currency falls heavily or plummets in a destabilising fashion like Ghana saw for those who recall when I looked at its woes.

The Yen

This has been drifting lower recently and Friday’s news added to that with it now taking more than 114 Yen to buy one US Dollar. This continues a trend which began in the middle of last month.  A sign of the Yen weakness is that the poor battered UK Pound £ is near its post EU Leave vote highs at 147 Yen.

But none of this is anything like enough to spark off the amount of inflation required by Abenomics.

The Inflation Target

More than 3 years down the road after the Bank of Japan kicked off its QQE ( Qualitative and Quantitative Easing) effort we find ourselves noting this. From Japan’s Statistics Bureau.

The consumer price index for Japan in May 2017 was 100.4 (2015=100), up 0.4% over the year before seasonal adjustment, and the same level as the previous month on a seasonally adjusted basis……  The consumer price index for Ku-area of Tokyo in June 2017 (preliminary) was 99.8 (2015=100), the same level as the previous year before seasonal adjustment, and the same level as the previous month on a seasonally adjusted basis.

This represents not far off complete failure in spite of the rhetoric about defeating deflation as if Tokyo is any guide 0% is the new 2%. Although of course we have seen asset price inflation leaving us mulling how much of the rise in the Nikkei 225 equity index from around 8000 to the current 20000 is growth and how much inflation?

Often policies to raise inflation really mean wages growth so let us look at that. From The Japan Times.

Japan’s real wages in May gained 0.1 percent from a year earlier for the first rise in five months, the government said Friday.
Total cash earnings per worker, including base and overtime pay, increased 0.7 percent to an average ¥270,241 (around $2,300), the second consecutive monthly rise, the Health and Welfare Ministry also said in a preliminary report.

You can look at this in two ways. The first is that it is not much and the second is that it is about as good as it has got over the past decade or so. One area that is different to the West where we are worrying about workers in the gig economy is that wage growth in Japan is centred on part-time work. It appears to be the one area where conventional economics can breathe a sigh of relief.

Comment

The situation continues to see some gains but also some retreats as these two quotes from The Japan Times today indicates.

Japan ‘economy watchers’ sentiment rises in June for third straight month……..Core private-sector machinery orders defied expectations and fell in May, the second consecutive month of decline, due to weakness in the service sector, the government said Monday.

Of course the UK data on Friday reminded us of the problems that sentiment indicators can have as optimism emerged as a fall!

I would like to return to my central theme that Japan has done okay in many ways with 0% inflation especially as we note its demographic problem. So why all the bond buying? Well a debt burden does of course often require some inflation to ease the burden for debtors of which the largest debtor is the government. The biggest beneficiary has been the Japanese government which has been able to do a lot of its borrowing for pretty much nothing for a while. Could it afford a return to normality? At what bond yield would it find things difficult and would it have to apply austerity? A sort of road to nowhere……