Where next for the Japanese Yen and the Bank of Japan?

As the third most traded currency the Japanese Yen is one of the bedrocks of the world economy. In spite of the size and strength of the Japanese economy the currency tail can wag the economy dog as we saw on the period of the “Carry Trade” and its consequences. For newer readers I looked at the initial impact back on the 19th of September 2016.

 Ironically if done on a large-scale as happened back in the day with the Swiss Franc and the Japanese Yen it lowers the currency and so not only is the interest cheaper but you have a capital gain. What could go wrong? Well we will come to that. But this same effect turned out to make things uncomfortable for both Japan and Switzerland as their currencies were pushed lower and lower.

At that point borrowers were having a party as the got a cheaper borrowing rate and a currency gain but the Japanese ( and Swiss) saw their currency being depressed. However the credit crunch ended that party as currency traders saw the risk and that people might buy Yen to cover the risk. Thus there was a combination of speculative and actual buying which saw the Yen strengthen from over 120 Yen to the US Dollar to below 80.

There were various impacts from this and starting in Japan life became difficult for its exporters and some sent production abroad as the mulled an exchange rate of around 78 to the US Dollar. For example some shifted production to Thailand. Looking wider the investors who remained in the carry trade shifted from profit to loss. On this road in generic terms the typical Japanese investor often described as Mrs. Watanabe was having a rough patch as in Yen terms their investments went being hit. Actually that is something of a generic over my career for Mrs Watanabe as timing of investments in say UK Gilts or Australian property has often been poor. Of course as it turns out property in Oz did work but you would have needed plenty of patience.

Enter the Bank of Japan

The next phase was a type of enter the dragon as the Bank of Japan in 2013 embarked on an extraordinary monetary stimulus programme. Under the banner of Abenomics that was designed to weaken the Yen although it was not officially one of the 3 arrows it was supposed to fire. For a while this worked as the Yen fell towards 125 to the US Dollar. But just as economics 101 felt it could celebrate a rare triumph the Yen then strengthened again and actually rallied to 101 in spite of negative interest-rates being deployed  leading to yet another new effort called QQE and Yield Curve Control in September 2016.

So we see that Japan had some success in weakening the Yen but that then ended and even with negative interest-rates and the purchases by the Bank of Japan below there was a fizzling out of any impact.

The Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 80 trillion yen.

But you see these things have unintended consequences as Brad Setser points out below.

Japanese investors have been big buyers of foreign bonds—and U.S. bonds in particular. The lifers, the Japanese government through the government pension fund (GPIF), the Japanese government through Post Bank (which takes in deposits and cannot make loans so it buys foreign bonds since it cannot make money buying JGBs), and Norinchukin*

So a policy to weaken the Yen has a side-effect of strengthening it and even worse makes the global financial system more risky. Back to Brad.

In broad terms, a number of Japanese financial institutions have become, in part, dollar based intermediaries. They borrow dollars from U.S. money market funds, U.S. banks, and increasingly the world’s large reserve managers (all of whom want to hold short-term dollar claims for liquidity reasons) and invest in longer dated U.S. bonds.

What about now?

Things are rather different to this time last year when we were trying to figure out what had caused this?

The Japanese yen soared in early Asian trading on Thursday as the break of key technical levels triggered massive stop-loss sales of the U.S. and Australian dollars in very thin markets. The dollar collapsed to as low as 105.25 yen on Reuters dealing JPY=D3, a drop of 3.2 percent from the opening 108.76 and the lowest reading since March 2018. It was last trading around 107.50 yen………. ( Reuters )

That was from January 3rd whereas overnight we see this.

The major was trading 0.1 percent up at 110.09, having hit a high of 110.21 earlier, its highest since May 23.  ( EconoTimes )

On its own this may seen the Governor of the Bank of Japan have a quiet smile and a celebratory glass of sake. But falls in the Yen are associated with something else which will please the head of The Tokyo Whale.

TOKYO (Kyodo) — Tokyo stocks rose Tuesday, with the benchmark Nikkei index ending above 24,000 for the first time since mid-December, as investor sentiment improved on expectations for further easing of U.S.-China trade tensions. ( The Mainichi)

The Mainichi seems to have missed the currency connection with this but no doubt Governor Kuroda   will be pointing out both thresholds to Prime Minister Shinzo Abe.

Has something changed?

On Monday JP Morgan thought so. Via Forex Flow.

But because in recent years the yen is no longer being sold off in the first place, it is not acting as much like a safe-haven currency as in the past.

Okay so why?

if interest rates increase in other countries (opening a wider gap with rates in Japan)

Well good luck with that one! Maybe some day but the credit crunch era has seen 733 interest-rate cuts. However the Financial Times has joined in.

First, Japan is running trade deficits, which would imply a weaker currency. Second, domestic asset managers are busy buying higher-yielding foreign assets. Third, Japanese companies, confronting a chronic shortage of decent ways to deploy their capital at home, are increasingly spending it on deals overseas.

The last point is a really rather devastating critique of the six years of Abenomics as one of the stated Arrows was for exactly the opposite. Also there us more trouble for economics 101 as a lower Yen has seen a trade surplus switch to a deficit. Actually I think that responses to exchange rate moves can be very slow and measured in years so with all the ch-ch-changes it is hard to know what move is in play.

Comment

There is much to reflect on here. For example today may be one to raise a smile at the Bank of Japan as it calculates the value of its large equity holdings and sees the Yen weaken across a threshold. But it is also true that exactly the same policies saw the “flash rally” of over a year ago. In addition we see that the enormous effort in play to weaken the Yen has seen compensating side-effects which raise the risk level in the international finance system. Really rather like the Carry Trade did.

A warning is required because in the short-term crossing a threshold like 110 Yen sees a reversal but we could see the Yen weaken for a while. This is problematic with so many others wanting to devalue their currency as well with the Bank of England currently in the van. From a Japanese perspective this will be see as a gain against a nation they have all sorts of issues with.

“China has made enforceable commitments to refrain from competitive devaluation, while promoting transparency and accountability,” US Treasury Secretary, Steven Mnuchin, said.

President Donald Trump has repeatedly accused China of allowing the value of the yuan to fall, making Chinese goods cheaper.

But, on Monday, the US said that the value of the yuan had appreciated since August, at the height of the trade war. ( BBC )

How will that play out?

 

 

 

2019 and all that….

As we arrive at Christmas and reach the end of the blogging year there is a lot to consider and review. Markets have thinned out to such an extent I noted a news service mentioning a rally in Japan earlier. Well I suppose 9 points up to 23,830 is indeed a rally but you get the idea. It also gives us a opening perspective as that level means it has been a successful year for The Tokyo Whale. As it progresses on its journey to buy all the ETFs listed in Japan the buying on down days strategy has been a winner on two counts. Firstly it provides a type of put option for an equity market already bolstered by a negative interest-rate and other forms of QE or rather QQE as the former name got rather debased in Japan by all the failures. Secondly it can declare a marked to market profit although of course there is the issue of how you would ever take it?

Below from this morning’s Bank of Japan balance sheet update are its holding so far.

28,199,294,050,000 Yen

The Plunge Protection Team indeed.

As Governor Kuroda enjoys his glass of celebratory sake there is the issue of the economy though which this was supposed to boost. This morning’s release of the minutes of the October meeting suggest little real progress has been made here.

A different member pointed out that, taking into account the current situation in which downside risks to economic activity and prices were significant, the Bank should continue to examine whether additional monetary easing would be necessary.

Then there was this,

In response to this, some members pointed out that, while it was appropriate for the Bank to maintain the current monetary easing policy at this meeting, it was necessary for the Bank not to hesitate to take additional easing measures if there was a greater possibility that the momentum toward achieving the price stability target would be lost.

This really is fantasy stuff as the inflation rate below indicates.

  The consumer price index for Japan in Novbember 2019 was 102.3 (2015=100), up 0.5% over the year before seasonal adjustment, and up 0.2% from the previous month on a seasonally adjusted basis.

More significant is the index level showing a total of 2.3% inflation since 2015 or in spite of the Abenomics effort there pretty much isn’t any. The Consumption Tax rise will bump it up for a bit and then it will presumably go back down just like last time.

Tesla

As you can see there was quite an event yesterday,

New York (CNN Business)Tesla CEO Elon Musk once said he had a buyer that would take Tesla private at $420 a share. That never happened — but the stock just got there on its own.

Musk tweeted in August last year that he is “considering taking Tesla private at $420. Funding secured.” At the time, the share price was $379.57 — nowhere near $420. Speculation about the identity of the mystery buyer was rife, and many investors thought Musk might be making a joke: 420 has become synonymous with cannabis culture.

This provokes all sorts of thoughts starting with Elon Musk should in my opinion have been punished much harder for that tweet. Next comes the fact that the share price fell to US $180 in June when there were lots of doubts about the company. One of the amazing parts of the rally has been that they have not gone away. In fact in some ways they are reinforced by this sort of thing,

BEIJING/SHANGHAI (Reuters) – U.S. electric vehicle maker Tesla Inc (TSLA.O) and a group of China banks have agreed a new 10 billion yuan ($1.4 billion), five-year loan facility for the automaker’s Shanghai car plant, three sources familiar with the matter said, part of which will be used to roll over an existing loan.

Also I guess it has benefited to some extent by the stock market ramping of President Trump. A development which we noted late last year carried on where he is essence got at least some of the policy moves from the US Federal Reserve he wanted and the equity market has flown.

The S&P 500 climbed 0.09, hitting another all-time high of 3,224.01. The Nasdaq Composite advanced 0.23% to 8,945.65. The S&P 500 is up more than 28% for 2019 through Friday, about 1 percentage point away from 2013′s gain of 29.6%. ( CNBC)

Merry Christmas Mr.President….

Bond Markets

This is a slightly different story from the one above. Yes we saw some extraordinary highs for bond markets this year and out of them the most extraordinary was seen In Germany.  A ten-year yield that went below -0.7% for a while in late summer which begged all sorts of questions. In compound terms you would be expecting to lose more than 7% if you bought and held to maturity which poses the question why would you buy at all? Beyond that there is the issue of the impact on pensions and other forms of long-term saving as who would invest 100 Euros to get around 92 back?

That to my mind is one of the reasons why QE has not worked. The impact on what Keynes called “animal spirits” of the fact that we always seemed to need more monetary “help” and easing unsettled things as well as, ironically in the circumstances, torpedoing the banking business model.

But back to bond markets we saw the futures contract in Germany head near to 180 which to any does not mean much but these things were designed to be between say 80 and 120. The QE era put a light under that.

Now though things have quietened down with some longer-date German bonds in positive yield territory and the ten-year now -0.25%. Still negative in the latter case but less so. It has turned out to be a case of buy the rumour and sell the fact as bond prices have fallen and yields risen since the ECB restarted its QE bond purchases in November. Some were obviously punting on the amount being higher than 20 billion a month which is curious as for some countries ( Germany and the Netherlands for example) there are not so many left to buy.

Meanwhile back home in the UK the ten-year Gilt yield has for now anchored itself around the Bank Rate of 0.75%. There is a tug of war going on between chances of an interest-rate cut and more fiscal expansionism. But there are two themes as the fiscal policy chance to have really low borrowing yields has to some extant passed and as a final point real yields are still strongly negative.

Comment

I intend to take a break until the New Year. So let me wish you all a Merry Christmas and a Happy New Year and I will return in the next decade.

Japan and Korea have chosen a bad time to fire up their own trade war

This is a story influenced by a brewing trade war but not the one that you might think. It is between Japan and Korea and the latest phase started in July when Japan imposed restrictions on trade with Korea for 3 chemicals. This gets more significant when you realise that they are crucial for smartphones ( displays on particular) and that according to CNBC Japan is responsible for 90% of the world’s supply of them. This affects quite of bit of Korean industry with Samsung being the headliner. Them Japan dropped Korea from its whitelist of trusted trading partners making trade more difficult before Korea did the same.

According to Bloomberg Citigroup have tried to downplay this today but I note these bits of it.

Meanwhile, boycotts in South Korea have led to a plunge in sales of Japanese consumer goods and a decrease in tourists to Japan, who may have decided to travel domestically instead, according to Citi………Last month, South Korean exports to Japan fell 14 percent, while imports from Japan slid 23 percent. South Korea’s trade ministry attributed the declines to industrial factors rather than trade actions.

Ah an official denial! We know what that means.

The issue has deep roots in the past and the Japanese occupation of the Korean peninsula a century ago as well as its later use of Korean “comfort women.” That explains the Korean issue with Japan and on the other side the Japanese consider themselves superior to Koreans and in my time there were quite open about it. Whilst he initially made moves to calm the situation there was always going to be an issue with a nationalistic politician like  Shinzo Abe running Japan.But let us move on noting that both countries will be experiencing an economic brake.

Japan Economic Growth

Let me hand you over to The Japan Times which gives us the position and some perspective.

In the third quarter the world’s third-largest economy grew an annualized 0.2 percent, slowing sharply from a revised 1.8 percent expansion in April to June, according to preliminary gross domestic product data released by the government Thursday.

It fell well short of a median market forecast for a 0.8 percent gain, and marked the weakest growth since a 2.0 percent contraction in the July-September period last year.

So over the past six months Japan has grown by 0.5% and we also get an idea of the erratic nature of economic growth there.This is partly due to the way that Japan does not conform to stereotype as it has struggled more than elsewhere to measure GDP. Partly due to last year’s third quarter drop. annual growth has picked up to 1.3% but that looks like being the peak.

Why? Well the 0.2% growth was driven by a 0.9% rise in domestic demand ( both numbers are annualised) just in time for the consumption tax to be raised. Actually private consumption was up 1.4% in the quarter suggesting that purchases were being made ahead of the rise.

At the end of last month this was reinforced by this.

The Consumer Confidence Index (seasonally adjusted series) in October 2019 was 36.2, up 0.6 points from the previous month.

Yes it was up but you see the number had fallen from around 44 at the opening of 2018 and these are the lowest readings since 2011.

Korea Economic Growth

Real gross domestic product (chained volume measure of GDP) grew by 0.4 percent in the third quarter of 2019 compared to the previous quarter……Real GDP (chained volume measure of GDP) increased by 2.0 percent year on
year in the third quarter of 2019.

In a broad sweep this means that economic growth has been slowing as it was 3.2% in 2017 and 2.7% in 2018. Rather unusually Korea saw strong export growth especially of we look at what was exported.

Exports increased by 4.1 percent, as exports of goods such as motor vehicles and semiconductors expanded. Imports were up by 0.9 percent, owing to increased imports of transportation equipment.

Also manufacturing grew.

Manufacturing rose by 2.1 percent, mainly due to an increase in computer, electronic and optical products.

However the economy has been slowing and if either of those reverse will slow even more quickly. Back on the 18th of October we noted this response.

The Monetary Policy Board of the Bank of Korea decided today to lower the Base Rate by 25 basis points, from 1.50% to 1.25%.

This was more of an external rather than an internal move as last week we learnt this.

During September 2019 Narrow Money (M1, seasonally adjusted, period-average) increased by 0.6% compared to the previous month.

So whilst it had been weak as annual growth was 3.3% in June it has risen since to 5% which is slightly above the average for 2018.

However they could cut on inflation grounds as this from Korea Statistics shows.

The Consumer Price Index was 105.46(2015=100) in October 2019. The index increased 0.2 percent from the preceding  month and was unchanged from the same month of the previous year.

According to the Bank of Korea the outlook is for more of the same.

 The Producer Price Index increased by 0.1% month-on-month in September 2019 – in year-on-year terms it decreased by 0.7%.

Exchange Rate

This is at 10.68 Won to the Yen as I type this and is up over 7% over the past year. So an additional factor in the situation will be that the Korean’s have been winning the currency war. This of course, will be annoying for Shinzo Abe who’s Abenomics programme set out to weaker the Japanese Yen. As we stand Korea has an official interest-rate some 1.35% higher so there is not a lot the Bank of Japan can do about this.

Comment

As we stand it initially looks as if Korea will be the relative winner here.

“Domestic demand had made up for some of the weakness in external demand, but we can’t count on this to continue,” said Taro Saito, executive research fellow at NLI Research Institute.

“A contraction in October-December GDP is a done deal. The economy may rebound early next year, but will lack momentum.” ( Japan Times)

But the argument it is in a stronger position weakens somewhat if we switch to its Gross National Income.

Real gross domestic income (GDI) increased by 0.1 percent compared to the previous quarter.

Over the past year it has gone on a quarterly basis -0.3%,0.2%,-0.7% and now 0.1%.

Korea is looking to use fiscal policy to stimulate its economy which sets it in the opposite direction to the consumption tax rise in Japan. But as they use a time of trouble to posture and scrap let us look at something that they share.

Korea’s potential output growth is expected to fall further in the long term, as the productive population declines in line with population aging and the low fertility rate……In addition, it is necessary to slow down the decline in labor supply resulting from population aging and the low birth rate, through policy efforts including encouraging women and young people to participate in economic activities and coping actively with the low birth rate. ( Bank of Korea Working Paper )

I wonder what the latter bit really means?

Meanwhile this is the last thing Japan needs right now.

(Reuters) – Japan’s Nissan Motor Co Ltd (7201.T) has said it is recalling 394,025 cars in the United States over a braking system defect, causing concerns that a brake fluid leak could potentially lead to a fire.

Podcast

 

 

The madness of central bankers

Today will depending on what time you read this either have seen yet more monetary policy accommodation by the European Central Bank or be about to get it. It;s President Mario Draghi is too smooth an operator to so strongly hint at it for nothing to happen, especially as in my opinion he feels the need to set policy for the new incoming ECB President Christine Lagarde who he knows well. That is quite a damning critique of her abilities if you think about it which is in line with her track record. But as to the action further confirmation has been provided by the way that markets have been toyed with by leaks from what are known as official “sauces”.

For those unaware the “sauces” strategy is to suggest lots of action as I pointed out on the 16th of August.

Investors currently expect the ECB to cut its key interest rate to minus 0.7% and to hold rates below their current level through 2024, according to futures markets. Mr. Rehn said those market expectations showed that investors had understood the ECB’s guidance.

Actually even this position had its own contradictions.

So will he now be overshooting -0.5% or -0.7%? Actually it gets better as -0.6% is in there now as well.

Later we get told that much less will happen as we saw earlier this week as the last thing central bankers want to see on their big day is the word “disappointment”. So we get this.

Oh, the grand old Duke of York
He had ten thousand men
He marched them up to the top of the hill
And he marched them down again
And when they were up, they were up
And when they were down, they were down
And when they were only half-way up
They were neither up nor down

The whole plan here is under the category of “open mouth operations” which might serve the purposes of the ECB but anyone in the real economy is being actively misled. The only saving grace is that most people will be unaware but there have been real world effects on mortgage rates and the rates at which companies and countries can borrow.

Where are we now?

Joumanna Bercetche of CNBC has summarised the expected position.

Here’s what analysts are expecting:
1) Majority expect 10bps rate cut to -50bps (minority 20bps cut)
2) Tiering
3) Restart of Asset Purchases : sov +corp bonds of EUR 30bn x 12 months (risk of LESS given recent hawkish commentary)
4) Enhanced Fwd Guidance

Interest-Rates

Let us address this as it clearly fails Einstein’s definition of madness. As to doing the same thing and expecting a different result well how about cutting interest-rates by 0.1% four times as has happened to the Deposit Rate and then adding a fifth! Or adding another 0.1% ( or even 0.2%) to a sequence of cuts amounting to 3.65% so far and expecting a different result.

Oh and I see more than a few saying the ECB interest-rate is 0% as indeed one of its interest-rates is. However I use the Deposit Rate because the amount of money deposited with the ECB at this rate is some 1.9 trillion Euros.

Next there was a stage where the madness went even further and we were told that shifting the differences between the various ECB interest-rates was a big deal. For example the minimum lending rate has fallen by 4% so 0.35% more than the Deposit Rate. This has an influence for financial markets but little or no impact on the real economy.

It all seems rather small fry compared to this from President Trump.

The Federal Reserve should get our interest rates down to ZERO, or less, and we should then start to refinance our debt. INTEREST COST COULD BE BROUGHT WAY DOWN, while at the same time substantially lengthening the term. We have the great currency, power, and balance sheet………The USA should always be paying the the lowest rate. No Inflation! It is only the naïveté of Jay Powell and the Federal Reserve that doesn’t allow us to do what other countries are already doing. A once in a lifetime opportunity that we are missing because of “Boneheads.”

The problem for the Donald is that if negative interest-rates were any sort of magic elixir we would not be where we are.Sadly the ECB proves this as it ends up having to keep cutting to keep up what I have previously described as a type of junkie culture.

On the upside the “once in a lifetime” reference may mean he is also a Talking Heads fan.

Tiering

This is another sign of central banking madness where their policies are essentially always aimed at the banks. The interest-rate cuts and QE were to help bail them out but went so far that they now hurt the banks. For newer readers this is because the banks are afraid to pass on the negative interest-rates to ordinary depositors in case they withdraw their money.

So we seem likely to see an effort to shield the banks by some of their deposits at the ECB not having the full negative rate applied. The real economy gets no such sweetners.

Again if the policy of protecting “The Precious” worked these new policies would not be necessary would they?

QE

Exactly the same critique applies here. Up until now some 2.6 trillion Euros of bonds has been bought for monetary policy purposes or Quantitative Easing. So what difference will another 360 billion Euros make? Especially if we remind ourselves that the original programme only ended last December so even fans of it have to admit the sugar high went pretty fast.

There is a subtler argument here which is that the ECB is really oiling the wheels of fiscal policy by making debt cheap to issue for Euro area nations. But what difference has this made? Some maybe at the margins but the basic case of Germany is a fail. In spite of its ability to be paid to issue debt Germany still plans to run a fiscal surplus.

Enhanced Forward Guidance

in 2019 this led many ECB watchers to expect an interest-rate rise and instead we are getting a cut. I am not sure how you could enhance this unless they expect to do even worse!

Comment

My critique has so far looked mostly at the ECB but whilst in some areas it is the leader of the pack there are plenty of other signs of madness. After two “lost decades” the Bank of Japan cut interest-rates by 0.1% to -0.1%. Then it introduced Yield Curve Control which in recent times has been raising bond yields rather than cutting them in a complete misfire. In my home country the UK we saw the Bank of England plan to cut interest-rates by 0.15% in November 2016 before fortunately realising that it had misjudged the economy and abandoning the plan. They end up singing along with Genesis.

You know I want to, but I’m in too deep…

As to the situation the immediate one is grim as this from Eurostat today reminds us.

In July 2019 compared with July 2018, industrial production decreased by 2.0% in the euro area.

But this is a “trade war” issue which has very little to do with monetary policy. As to the domestic impulse the money supply figures have picked up in 2019 so the ECB may be easing at exactly the wrong moment just as it turned out it ended easing at the wrong moment. So let me end with the nutty boys.

Madness, madness, they call it madness
Madness, madness, they call it madness
It’s plain to see
That is what they mean to me
Madness, madness, they call it gladness, ha-ha

Number Crunching

This tweet has gained popularity.

“£4,563,350,000 of aggregate short positions on a ‘no deal’ Brexit have been taken out by hedge funds that directly or indirectly bankrolled Boris Johnson’s leadership campaign” ( Carole Cadwalladr)

I took a look at the article referred to in the Byline Times and if you read it then it conflates being short the UK Pound £ with being short individual shares which is bizarre. Next it has no mention at all of any long positions these companies may have.

The Bank of Japan fears no longer being the “leader of the pack”

The next two weeks look set to bring a situation you might not expect. After all Japan has built a reputation as the “leader of the pack” as the Shangri-Las would put it in terms of monetary policy easing. Except that it is now facing a situation where it looks set to be left behind. On Thursday the European Central Bank will announce its latest moves and its President Mario Draghi has been warming us up for some action. Either he will announce an interest-rate cut or he will signal one for September. So there are two perspectives here for Japan. The first is that the Euro area looks set to cut by the total amount that Japan has below zero as 0.1% is the minimum and of course 0.2% would be double it. Next is the issue that the new rate of -0.5% or -0.6% would be a considerable amount lower than in Japan.

If we now shift to the United States the US Federal Reserve looks set to cut interest-rates as well when it meets at the end of the month. There was a spell last week when financial markets switched to expecting a 0.5% cut which would put the new rate at 1.75% to 2%. Personally I am far from convinced by that and a 0.25% cut seems much more likely but nonetheless it puts the Bank of Japan under pressure.

The Yen

The factors we have looked at above will be putting some upwards pressure on the Yen as interest-rate expectations shift against it. This has been reinforced by an unintended consequence of the policy applied by the central planners at the Bank of Japan.

The Bank will purchase Japanese government bonds (JGBs) so that 10-year JGB yields will remain more or less at the current level (around zero percent). With regard
to the amount of JGBs to be purchased, the Bank will conduct purchases more or less in line with the current pace — an annual pace of increase in the amount outstanding
of its JGB holdings at about 80 trillion yen — aiming to achieve the target level of a long-term interest rate specified by the guideline. JGBs with a wide range of maturities will continue to be eligible for purchase, while the guideline for average remaining maturity of the Bank’s JGB purchases will be abolished.

The problem here as I have pointed out before is that something which was supposed to have kept Japanese Government Bond ( JGB) yields down has ended up keeping them up. Ooops! As world bond markets have surged Japan has been left behind because its bond market is essentially run by the Bank of Japan ( 80 trillion yen a year buys you that) and it has been wrong footed completely. The recent surge began in early March and the German ten-year yield has fallen as much as by 0.6% and the US by 0.8% but Japan by only 0.16%.

So as you can see relative interest-rates and yields have moved to support the Yen since the early spring of this year. The policy of “yield curve control” aiming for bond yields of 0% to -0.1% no doubt seemed a good way of continuing the Abenomics policy of weakening the Yen at the time. However over the period that bond markets have surged the Yen has strengthened from 112 versus the US Dollar to 108 now. That is before we see any shift in the rhetoric of President Trump who as the tweet from the early part of this month below points out, wants a weaker US Dollar.

China and Europe playing big currency manipulation game and pumping money into their system in order to compete with USA. We should MATCH, or continue being the dummies who sit back and politely watch as other countries continue to play their games – as they have for many years!

That will have been viewed with horror in Tokyo because whilst The Donald is not currently putting Japan in his cross hairs they have looking to weaken the Yen since Abenomics began back in 2013. This would be quite a reverse for Japan as it would not want to get into a currency war with the United States.

Moving to other currencies we see that the Yen has been strengthening against the Euro and the UK Pound as well. Indeed we get another perspective I think from looking at Switzerland which regular readers will know I labelled as a “Currency Twin” with Japan due to the way both currencies were borrowed heavily in the pre credit crunch period. There are increasing rumours that the Swiss National Bank has been getting the equivalent of an itchy collar over the strength of the Swiss Franc and has been checking the markets as a hint that it may intervene again. It may well find itself having to match any ECB interest-rate cut and that will echo in Tokyo as well as giving us a new low for negative interest-rates.

The Pacific Trade Crisis

The stereotype of this area is of fast growing economies with the image of many of them being Pacific Tigers compared to the more sclerotic Western nations. Yet troubles are there too now so let us go to Seoul on Thursday.

The Monetary Policy Board of the Bank of Korea decided today to lower the Base Rate by 25 basis points, from 1.75% to 1.50%.

Okay why?

With respect to future domestic economic growth, the Board expects that the adjustment in construction investment will continue and exports and facilities investment will recover later than originally expected,
although consumption will continue to grow. GDP is forecast to grow at the lower-2% level this year, below the April forecast (2.5%).

This morning has brought more news on that front. From Bloomberg.

South Korea’s exports, a bellwether for global trade, appear set for an eighth straight monthly decline as trade disputes take a toll on global demand. Exports during the first 20 days of July fell 14 percent from a year earlier, data from the Korea Customs Service showed Monday. Semiconductor sales plunged 30 percent, while shipments to China, the biggest buyer of South Korean goods, fell 19 percent.

Korea is a bellwether as these numbers are released very promptly and many of its companies are integrated into global supply chains, so it gives a signal for world trade. Currently it is not good and there is a direct link to Japan.

Imports from the U.S. rose 3.7 percent, while those from Japan dropped 15 percent.

Also on Thursday Bank Indonesia decided to join the party.

The BI Board of Governors agreed on 17th and 18th July 2019 to lower the BI 7-day Reverse Repo Rate by 25 bps to 5,75%,

A day earlier say troubling news for the economy of Singapore.

SINGAPORE’S exports, already in double-digit decline for three straight months, fell again in June, according to Enterprise Singapore data released on Wednesday morning.

Non-oil domestic exports (NODX) were down by 17.3 per cent on the year before – a six-year low  ( Business Times )

Comment

The Bank of Japan finds itself between a rock and a hard place on quite a few fronts. The Yen has been strengthening and other central banks are on their way to matching its policies. That is before we get to the issue of the clear trade slow down in the Pacific region. This will add to the problem hidden in what looked on the surface as solid economic growth in the first part of the year.

In the three-month period, exports dropped 2.4 percent and imports sank 4.6 percent, as in the initial reading. As a result, net exports — exports minus imports — pushed up GDP by 0.4 percentage point. ( Japan Times).

In all other circumstances the Bank of Japan would cut interest-rates in a week. But they do not like negative interest-rates much and they are buying pretty much everything ( bonds, equities and commercial property) as it is! In October another Consumption Tax rise is due as well. Perhaps Bryan Ferry was right.

Say, when you’ve been around, what’s left to do?
Don’t know? Ask Tokyo Joe
So inscrutable her reply
“Ask no question and tell me no lie”

Podcast

 

 

How negative can interest-rates go?

A consequence of the credit crunch era that has continued to flow is the trend towards negative interest-rates and yields. For example it was only the week before last I was looking at a speech from Bank of England Governor Carney that referred to there being some US $13 Trillion of negative yielding bonds. Then last week I noticed that some developments are somewhat mindboggling. From The International Financing Review.

The distortion of the credit markets by central banks has produced the ultimate oxymoron: negatively yielding high-yield bonds.

About 2% of the euro high-yield universe is now negative yielding, according to Bank of America Merrill Lynch.

That percentage would rise to 10% if average yields fall by a further 35bp, said Barnaby Martin, European credit strategist at the bank.

So we now need a new name for what we used to call high-yield bonds. I guess junk bonds still cuts it although even it feels a bit awkward. We even got some examples.

Irish paper packaging company Smurfit Kappa (BB+/BB+), for example, has a €500m 3.25% June 2021 bid at -0.012%, according to Tradeweb data.

 

American metal packaging Ball Corporation (BB+ from S&P) also has bullet bonds in negative territory. Its €400m 3.5% December 2020s are quoted at -0.003%.

As you can see the negative yields are marginal but we have learnt that these things have developed a habit of starting and then spreading. Especially as we note what is driving it.

He said the first signs of negative yielding high-yield bonds emerged about two weeks ago in the wake of Mario Draghi’s speech in Sintra where the ECB president hinted at a further dose of bond buying via the central bank’s corporate sector purchase programme. There are now more than 10 high-yield bonds in negative territory.

Personal Injury Claims

This morning my own country the UK has shown how negativity if I may put it like that is spreading into other areas. From Reuters.

Britain’s Ministry of Justice said it plans to change the discount rate applied to personal injury lump sum compensation payments to minus 0.25% from minus 0.75%, it said on Monday.

The decision follows a review started by the Lord Chancellor earlier this year and follows lobbying from auto insurers, whose profits were hit by the decision to cut the so-called ‘Ogden Rate’ from 2.5% in 2017.

As you can see the Lord Chancellor was apparently having the mental equivalent of a nap in the period from 2009 to 2017 as interest-rates and yields plunged. So the legal profession I suppose lives up to its reputation for being out of touch. But the serious point is one we have looked at regularly which is how do you make provision for the future when you are facing negative returns which are increasingly permanent. I doubt their Lordships look at it like this but this is another consequence of the UK Index-Linked bond or Gilt market being eye-wateringly expensive. Why? Well in an era where conventional bonds are so expensive investors drove the price of linkers up as well because otherwise they offered more yield.

So the natural place to invest much of a compensation payment is seeing its own outburst of negativity as real yields have been negative for a while. The issue is complex as Stewarts Law who were one of the few to think this rate would stay negative seem to have a rose-tinted view on wage growth.

This makes it impossible to ignore the long-standing economic phenomenon of earnings-related inflation rising faster than prices inflation.

 

How low can things go?

I am reminded of a research paper by the Bank of Japan which I looked at on the 24th of last month. Let us look at it from a different perspective.

In the second economy, the marginal shock occurs on top of an innovation to the Taylor rule that, on its own, would depress the policy rate to about -1% on impact. The
reversal in loan rates has been crossed at this stage.

The refer to an interest-rate of -1% more than a few time suggesting they think that it is as low as you can realistically go. This is as ever not about you and I but about fears for what more negative interest-rates would do to the banks.

with the evidence documented in Ampudia and Heuvel (2018), who document that the response of banks’ stock valuations to monetary policy shocks changes sign as the
level of interest rates decreases.

Also and this gets increasingly relevant as the credit crunch drags on things get worse as time passes.

However, these assets mature, making net worth
more sensitive in subsequent periods. Second, the impaired deposit rate pass-through as policy rates decrease substantially lowers bank profitability, especially as rates enter negative territory.

This leads them to this.

We have shown the conditions for the existence of a reversal interest rate, the rate at which monetary policy stimulus reverses its intended effect and becomes contractionary.

This should not be a complete surprise as the Bank of Japan has never really been much of a fan of negative interest-rates. It cut to what we would call ZIRP territory (0.5%) in late 1995 and did not go negative until January 2016. Even that was to a mere -0.1% as the bank’s natural caution collided with the zeal of the political appointee Governor Kuroda. Indeed it has stuck to the -0.1% level for what it calls “yield-curve control” which means that in the recent plunge in bond yields it has been holding Japanese ones up rather than down. This means that if we do end up living the lyrics of the Vapors. life may not be what many assume.

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

Comment

This brings us back to the issue of the long-term and the future. That is really rather different in a world of persistent negative interest-rates and yields. Think of a pension which is by definition a form of saving for the long-term. How does that work if you receive an illustration telling you that if you put £1 in you will get £0.9 back? Losses were always possible especially in real or inflation adjusted terms but the concept of expecting to lose is very different. On this road to nowhere fewer people will bother to save for the future? I recall in the early part of this century pension illustrations which suggested 5%,7% and 9% so let me throw this out there what do readers think they should say now?

We know the trend and yet the sporting world reminded only yesterday that life is complex and far from simple. New Zealand were the better cricket team but fate conspired against them as an overthrow went for six, Bottas found that a safety car turned up just in time for  Lewis Hamilton and Federer somehow lost in spite of playing so well. As an England cricket fan I was delighted with the result but could not help wondering if the Black Caps had run over a black cat on the way to Lords.

Still at least we can rely on the banking sector.

A Dutch social housing co-operative a decade ago bought €3bn derivatives from Deutsche Bank & went almost bust when they turned toxic. It later emerged that co-operative’s treasurer was systematically bribed. Deutsche now settled lawsuit for €175m ( @OlafStorbeck ).

As the the reversionary interest-rate I think we went into it as the credit crunch began and have never come out. That is why to coin a phrase it goes on and on and on.

Podcast

 

 

The Bank of Japan begins to face its failures

The last couple of weeks have seen two of the world’s main central banks strongly hint that the path for interest-rates is now lower, or perhaps I should say even lower. So as we open this week my thoughts turn eastwards to what the Shangri-Las would call the leader of the pack in this respect, Nihon or Japan. If we look at the Nikkei newspaper we see that Governor Kuroda of the Bank of Japan has also been conducting some open mouth operations.

TOKYO — Bank of Japan Governor Haruko Kuroda said extra stimulus would be an option if prices refuse to keep rising toward the central bank’s 2% inflation target.

The BOJ “will consider extra easing measures without hesitation” if the economy runs into a situation where momentum toward reaching stable inflation is lost, Kuroda said at a news conference on Thursday in Tokyo after keeping monetary policy unchanged.

There are various problems with this which start with the issue of inflation which has simply not responded to all the stimulus that the Bank of Japan has provided.

  The consumer price index for Japan in May 2019 was 101.8 (2015=100), up 0.7% over the year before seasonal adjustment,   and the same level as the previous month on a seasonally adjusted basis. ( Statistics Bureau).

This has been pretty much a constant in his term ( the only real change was caused by the rise in the Consumption Tax rate in 2014) and as I have pointed out many times over the years challenges Abenomics at its most basic point. If we stick to the monthly report above the situation is even worse than the overall number implies. This is because utility bills are rising at an annual rate of 3.2% but this is offset by other lower influences such as housing where the annual rate of (rental) inflation is a mere 0.1%. Also the services sector basically has virtually no inflation as the annual rate of change is 0.3%. Even the Bank of Japan does not think there is much going on here.

On the price front, the year-on-year rate of change in the
consumer price index (CPI, all items less fresh food) is in the range of 0.5-1.0 percent. Inflation expectations have been more or less unchanged.

Wages

On Friday we got the latest wages data which showed that real wages fell at an annual rate of 1.4% in April, This meant that so far every month in Japan has seen real wages lower than the year before. If we look back we see that an index set at 100 in 2015 was at 100.8 in 2018 so now may well be back where it started.

This matters because this was the index that Abenomics was aimed at. Back in 2012/13 it was assumed by its advocates that pushing inflation higher would push wages even faster. Whereas that relationship was struggling before the credit crunch and it made it worse. Indeed so strong was the assumed relationship here that much of financial media has regularly reported this it has been happening in a version of fake news for economics. The truth is that there has been an occassional rally such as last summer’s bonus payments but no clear upwards trend and the numbers have trod water especially after Japan’s statisticians discovered mistakes in their calculations.

Problems for economics

Back when QE style policies began there was an assumption that they would automatically lead to inflation whereas the situation has turned out to be much more nuanced. As well as an interest-rate of -0.1% the Bank of Japan is doing this.

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……….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…….As for CP and corporate bonds, the Bank will maintain their amounts outstanding at
about 2.2 trillion yen and about 3.2 trillion yen, respectively.

Yet we have neither price nor wage inflation. If we look for a sign of inflation then it comes from the equity market where the Nikkei 225 equity index was around 8000 when Abenomics was proposed as opposed to the 21,286 of this morning. Maybe it is also true of Japanese Government Bonds but you see selling those has been something of a financial widow maker since around 1990.

Misfire on bond yields

2019 has seen yet another phase of the bond bull market which if we look back has been in play since before the turn of the century. But Japan has not participated as much as you might think due to something of a central planning failure.

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.

That was designed to keep JGB yields down but is currently keeping them up. Ooops! We see that bond yields in Germany and Switzerland have gone deeper into negative territory than in Japan. If we compared benchmark yields they go -0.31% and -0.51% respectively whereas in Japan the ten-year yield is -0.15%.

Economic Growth

On the face of it the first quarter of this year showed an improvement as it raised the annual rate of economic or GDP growth to 0.9%. That in itself showed an ongoing problem if 0.9% is better and that is before we get to the fact that the main feature was ominous. You see the quarterly growth rate of 0.6% was mostly ( two-thirds) driven by imports falling faster then exports, which is rather unauspicious for a trading nation.

If we look ahead Friday’s manufacturing PMI report from Markit posted a warning.

June survey data reveals a further loss of momentum
across the manufacturing sector, as signalled by the
headline PMI dropping to a three-month low. Softer
demand in both domestic and international markets
contributed to the sharpest fall in total new orders for
three years. A soft patch for automotive demand…..

The last few words are of course no great surprise but the main point here is the weaker order book. So Japan will be relying on its services sector for any growth. Also there is the issue of the proposed October Consumption Tax hike from 8% to 10% which would weaken the economy further. So we have to suspect it will be delayed yet again.

Comment

To my mind the Abenomics experiment never really addressed the main issue for Japan which is one of demographics. The population is both ageing and shrinking as this from the Yomiuri Shimbun earlier this month highlights.

The government on Friday released a rough calculation of vital statistics for 2018, revealing that the number of deaths minus births totaled 444,085, exceeding 400,000 for the first time.

The latest numbers on Thursday showed yet another fall in children (0-15) to 12.1% of the population and yet another rise in those over 85 to 4.7%. In many ways the latter is a good thing which is why economics gets called the dismal science. The demographics are weakening as Japan continues to borrow more with a national debt of 238% of GDP.

The size of the national debt is affordable at the moment for two reasons. The first is the low and at times negative level of bond yields. Next Japan has a large amount of private savings to offset the debt. The rub is that those savings are a buffer against the demographic issue and there is another problem with Abenomics which I have feared all along. Let me hand you over to a new research paper from the Bank of Japan.

The reversal interest rate is the rate at which accommodative monetary policy
reverses and becomes contractionary for lending. Its determinants are 1) banks’
fixed-income holdings, 2) the strictness of capital constraints, 3) the degree of passthrough to deposit rates, and 4) the initial capitalization of banks.

So it looks like they are beginning to agree with me that so-called stimulus can turn out to be contractionary and there is more.

The reversal interest rate creeps up over time, making steep but short rate cuts preferable to “low for long” interest rate environments.

Exactly the reverse of what Japan has employed and we seem set to copy.

Podcast