Central bankers are warming us up for more inflation again

A feature of the credit crunch era is the repetition of various suggestions from governments and central banks. One example of this has been the issue of Eurobonds which invariably has a lifespan until the nearest German official spots it. Another has been the concept of central banks overshooting their inflation target for a while. It is something that is usually supported by those especially keen on ( even more) interest-rate cuts and monetary easing so let us take a look.

Last Wednesday European Central Bank President Mario Draghi appeared to join the fray and the emphasis is mine.

Well, on your second question I will answer saying exactly the same thing. We don’t tolerate too low inflation; we remain fully committed to using all necessary instruments to return inflation to 2% without undue delay. Likewise, our inflation aim doesn’t imply a ceiling of 2%. Inflation can deviate from our objective in both directions, so long as the path of inflation converges towards our medium-term objective. I believe I must have said something close to this, or something to this extent a few other times in the past few years.

Nice try Mario but not all pf us had our senses completely dulled by what was otherwise a going through the motions press conference. As what he said at the press conference last September was really rather different.

In relation to that: shouldn’t the ECB be aiming for an overshoot on inflation rather than an undershoot given that it’s been below target for so long?

Second point: our objective is an inflation rate which is below, but close to 2% over the medium term; we stay with that, that’s our objective.

As you can see back then he was clearly sign posting an inflation targeting system aiming for inflation below 2%. That was in line with the valedictory speech given by his predecessor Jean-Claude Trichet which gave us a pretty exact definition by the way he was so pleased with it averaging 1.97% per annum in his term. So we have seen a shift which leads to the question, why?

The actual situation

What makes the switch look rather odd is the actual inflation situation in the Euro area. Back to Mario at the ECB press conference on Wednesday.

According to Eurostat’s flash estimate, euro area annual HICP inflation was 1.4% in March 2019, after 1.5% in February, reflecting mainly a decline in food, services and non-energy industrial goods price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline over the coming months.

So we find that inflation is below target and expected to fall further in 2019. This was a subject which was probed by one of the questions.

 It’s quite clear that the sliding of the five-year-to-five-year inflation expectations corresponds to a deterioration of the economic outlook. It’s also quite clear that as the economic outlook, especially the economic activity slows down, also markets expect less pressure in the labour market, but we haven’t seen that yet.

The issue of markets for inflation expectations is often misunderstood as the truth is we know so little about what inflation will be then. But such as it is again  the trend may well be lower so why have we been guided towards higher inflation being permitted.

It might have been a slip of the tongue but Mario Draghi is usually quite careful with his language. This leaves us with another thought, which is that if he is warming us up for an attitude change he is doing soon behalf of his successor as he departs to his retirement villa at the end of October.

The US

Minneapolis Fed President Neel Kashkari suggested this in his #AskNeel exercise on Twitter.

Well we officially have a symmetric target and actual inflation has averaged around 1.7%, below our 2% target, for the past several years. So if we were at 2.3% for several years that shouldn’t be concerning.

Also he reminded those observing the debate on Twitter that the US inflation target is symmetric and thus unlike the ECB.

Yes, i think we should really live the symmetric target and not tap the brakes prematurely. This is why I’ve been arguing for more accommodative monetary policy. But we are undertaking a year long review of various approaches so I am keeping an open mind.

As you can see with views like that the Donald is likely to be describing Neel Kashkari as “one of the best people”.  If we move to the detail there are various issues and my initial one is that inflation tends to feed on itself and be self-fulfilling so the idea that we can be just over the target at say 2.3% is far from telling the full picture. Usually iy would then go higher. Also if your wages were not growing or only growing at 1% you would be concerned about even that seemingly low-level of inflation.

If we consider the review the US Fed is undertaken we see from last week’s speech by Vice Chair Clarida a denial that it has any plans to change its 2% per annum target and we know what to do with those! Especially as he later points out this.

In part because of that concern, some economists have advocated “makeup” strategies under which policymakers seek to undo, in part or in whole, past inflation deviations from target. Such strategies include targeting average inflation over a multiyear period and price-level targeting, in which policymakers seek to stabilize the price level around a constant growth path.

As the credit crunch era has seen inflation generally be below target this would be quite a shift as it would allow for quite a catch-up. Which of course is exactly the point!

Comment

Central bankers fear that they are approaching something of a nexus point. They have deployed monetary policy on a scale that would not have been believed before the credit crunch hit us. Yet in spite of the negative interest-rates, QE style bond purchases and in some cases equity and property buys we see that there has been an economic slow down and inflation is generally below target. Also the country that has deployed monetary policy the most in terms of scale Japan has virtually no inflation at all ( 0.2% in February).

At each point in the crisis where central bankers face such issues they have found a way to ease policy again. We have seen various attempts at this and below is an example from Charles Evans the President of the Chicago Fed from back in March 2012.

My preferred inflation threshold is a forecast of 3 percent over the medium term.

We have seen others look for 4% per annum. What we are seeing now is another way of trying to get the same effect but this time looking backwards rather than forwards.

There are plenty of problems with this. Whilst a higher inflation target might make life easier for central bankers the ordinary worker and consumer faces what economists call “sticky” wages. Or in simple terms prices go up but wages may not and if the credit crunch is any guide will not. My country the UK suffered from that in 2010/11 when the Bank of England “looked through” consumer inflation which went above 5% with the consequence of real wages taking a sharp hit from which they have still to recover.

Next comes the issue that in the modern era 2% per annum may be too high as a target anyway. In spite of all the effort it has been mostly undershot and as 2% in itself has no reason for existence why not cut it? Then we might make progress in real wage terms or more realistically reduce the falls. That is before we get to the issue of inflation measures lacking credibility in the real world as things get more expensive but inflation is officially recorded as low.

Meanwhile central bankers sing along to Marvin Gaye.

‘Cause baby there ain’t no mountain high enough

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Are negative interest-rates becoming a never ending saga?

Today brings this subject to mind and let me open with the state of play in Switzerland.

The Swiss National Bank is maintaining its expansionary
monetary policy, thereby stabilising price developments
and supporting economic activity. Interest on sight
deposits at the SNB remains at – 0.75% and the target
range for the three-month Libor is unchanged at between
– 1.25% and – 0.25%.

As you can see negative interest-rates are as Simple Minds would put it alive and kicking in Switzerland. They were introduced as part of the response to a surging Swiss Franc but as we observe so often what are introduced as emergency measures do not go away and then become something of a new normal. It was back on the 18th of December 2014 that a new negative interest-rate era began in Switzerland.

The introduction of negative interest rates makes it less attractive to hold Swiss franc investments, and thereby supports the minimum exchange rate.

Actually the -0.25% official rate lasted less than a month as on the 15th of January 2015 the minimum exchange rate of CHF 1.20 per euro was abandoned and the official interest-rate was cut to -0.75% where it remains.

Added to that many longer-term interest-rates in Switzerland are negative too. For example the Swiss National Bank calculates a generic bond yield which as of yesterday was -0.26%. This particular phase of Switzerland as a nation being paid to borrow began in late November last year.

The recovery

The latest monthly bulletin tells us this.

Jobless figures fell further, and in February the
unemployment rate stood at 2.4%.

There was a time when this was considered to be below even “full employment” a perspective which has been added to this morning and the tweet below is I think very revealing.

If we look at the Swiss economy through that microscope we see that in this phase the unemployment rate has fallen by 1%. Furthermore we see that not only is it the lowest rate of the credit crunch era but also for much of the preceding period as it was back around the middle of 2002.

So if we look at the Swiss internal economy it is increasingly hard to see what would lead to interest-rates rising let alone going positive again. This is added to by the present position as described by the SNB monthly bulletin.

According to an initial estimate, GDP in Switzerland grew
by 0.7% in the fourth quarter. Overall, GDP thus stagnated
in the second half of 2018, having grown strongly to
mid-year.
Leading indicators and surveys for Switzerland point to
moderately positive momentum at the beginning of 2019.

The general forecasting view seems to be for around 1.1% GDP growth this year. So having not raised interest-rates in a labour market boom it seems unlikely unless they have a moment like the Swedish Riksbank had last December that we will see one this year,

Exchange Rate

There is little sign of relief here either. There was a brief moment round about a year ago that the Swiss Franc looked like it would get back to its past 1.20 floor versus the Euro. But since then it has strengthened and is now at 1.126 versus the Euro. Frankly if you are looking for a perceived safe-haven then does a charge of 0.75% a year deter you? That seems a weak threshold and reminds me of my article on interest-rates and exchange rates from the 3rd of May last year.

However some of the moves can make things worse as for example knee-jerk interest-rate rises. Imagine you had a variable-rate mortgage in Buenos Aires! You crunch your domestic economy when the target is the overseas one.

Well events have proven me right about Argentina but whilst the scale here is much lower we have a familiar drum beat. The domestic economy has been affected but the exchange-rate policy has had over four years and is ongoing.

The Euro

Let me hand you over to the President of the ECB Mario Draghi at the last formal press conference.

First, we decided to keep the key ECB interest rates unchanged. We now expect them to remain at their present levels at least through the end of 2019……….These are decisions that have been taken following a significant downward revision of the forecasts by our staff.

For reasons only known to themselves part of the financial media persisted in suggesting that an ECB interest-rate rise was in the offing and it would be due round about now. The reality is that any prospect has been pushed further away if we note the present malaise and read this from the same presser.

negative rates have been quite successful in our monetary policy.

Although we can never rule out an attempt to continue to impose negative rates on us but exclude the precious in some form.

Sweden

Last December the Riksbank did start to move away from negative interest-rates. The problem is that they now find themselves wearing something of a central banking dunces cap. Having failed to raise rates in a boom they decided to do so in advance of events like this.

Total orders in industry decreased by 2.0 percent in February 2019 compared with January, in seasonally adjusted figures………..Among the industrial subsectors, the largest decrease was in the industry for motor vehicles, down 12.7 percent compared with January. ( Sweden Statistics yesterday)

Like elsewhere the diesel debacle is taking its toll.

The new registrations of passenger cars during 2019 decreased by 15.2 percent compared with last year. There were 27 710 diesel cars in total registered this year, a decrease of 26 percent compared with last year.

Anyway this is the official view.

As in December, the forecast for the repo rate indicates that the next increase will be during the second half of 2019, provided that the economic outlook and inflation prospects are as expected.

Japan

This is the country that has dipped its toe into the icy cold world of negative rates by the least but the -0.1% has been going for a while now.

introduced “QQE with a Negative Interest Rate” in January 2016 ( Bank of Japan)

If the speech from Bank of Japan Board Member Harida on March 6th is any guide it is going to remain with us.

I mentioned earlier that the economy currently may be weak, and the same can be said about prices.

Also he gives an alternative view on the situation.

Following the introduction of QQE, the nominal GDP growth rate, which had been negative since the global financial crisis, has turned positive………Barring the implementation of both QE and QQE, Japan’s nominal GDP growth would have remained in negative territory this whole time since 1998.

Is it all about the nominal debt of the Japanese state then? Also he seems unlikely to want an interest-rate increase.

Rather, premature policy tightening in the past caused economic deterioration, a decline in both prices and production, and lowered interest rates in the long run.

Comment

We find that there are two routes to negative interest-rates. The first is to weaken the exchange-rate such as we have seen in Switzerland and the second is to boost the economy like in the Euro area. So external in the former and internal in the latter. It can be combined as if you wish to boost your economy a lower exchange-rate is usually welcome and this pretty much defines Abenomics in Japan.

As we stand neither route seems to have worked much. Maybe a negative interest-rate helped the Euro area and Japan for a while but the current slow down suggests not for that long. So we face something of an economic oxymoron which is that it is the very fact that negative interest-rates have not worked which explains their longevity and while they seem set to be with us for a while yet.

 

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

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

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

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

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

Monetary Policy

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

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

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

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

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

Japan 10Y yields collapse further into negative territory

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

Apparently nothing
Nothing apparently
Apparently nothing
Nothing apparently

The Yen

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

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

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

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

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

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

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

Comment

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

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

Also something which we figured out some months back.

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

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

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

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

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

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

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

Now today.

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

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

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What happens when the Bank of Japan has bought everything?

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

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

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

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

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

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

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

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

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

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

The economy

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

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

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

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

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

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

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

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

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

Demographics

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

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

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

Or to add it all up.

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

Comment

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

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

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

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

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

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

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

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

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

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

 

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Money Supply

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

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

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

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

Rather oddly the NAR then tells us this.

The BOJ could easily buy more government debt and ETFs.

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

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

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

The Yen

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

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

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

Comment

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

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

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

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

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

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

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

 

 

 

 

 

The world of negative interest-rates now has negative economic growth too

It was not that long ago that many of us “experts” in the interest-rate market felt that negative interest-rates could not be sustained. Back then the past Swiss example could be considered a tax – which remains a way of considering negative interest-rates – and the flicker in Japan was covered by it being Japan. Yesterday brought some fascinating news from the front line which has been in danger of being ignored in the current news flow.

Sweden’s GDP decreased by 0.2 percent in the third quarter of 2018, seasonally adjusted, compared with the second quarter of 2018. GDP increased by 1.6 percent, working-day adjusted, compared with the third quarter of 2017. ( Sweden Statistics).

Firstly let me reassure you that Sweden has no Brexit style plans. What it does have is negative interest-rates as this from the Riksbank shows.

Consequently, in line with the previous forecast, the Executive Board has decided to hold the repo rate unchanged at -0.50 per cent.

I bet they now regret opening their latest forward guidance report like this.

Since the Monetary Policy Report in September, economic developments have been largely as expected, both in Sweden and abroad.

In fact the Riksbank was expecting this.

The most recently published National Accounts paint a picture of  slightly weaker GDP growth in recent years. Nevertheless, the Riksbank deems that economic activity in Sweden has been and continues to be strong.

In fact it has been so nonplussed that it has already reached for the central banking playbook and wondered what is Swedish for Johnny Foreigner?

Riksbank Floden: Sees Increased Uncertainty In World Economy ( @LiveSquawk )

Those who have followed my analysis that central banks will delay moving out of extraordinary monetary policy and negative interest-rates and thus are in danger of being trapped, will have a wry smile at this.

The forecast for the repo rate is unchanged since
the monetary policy meeting in September and indicates that the repo rate will be raised by 0.25
percentage points either in December or in February. As with the first raise, monetary policy will also
subsequently be adjusted according to the prospects for inflation.

That’s the spirit! You keep interest-rates negative through a strong phase of economic growth then you raise them when you have a quarterly decline. Oh hang on. I am not being clever after the event here because a month or so before the Riksbank report on the 6th of September I pointed out this.

This is also true of Sweden because if we look at the narrow measure or M1 we see that an annual rate of growth of 10.5% in July 2017 was replaced with 6.3% this July. …..A similar but less volatile pattern can be seen from the broad money measure M3. That was growing at an annual rate of 8.3% in July 2015 as opposed to the 5.1% of this July.

Since then M1 has stabilised but M3 has fallen further and was 4.5% in October. In fact if you were looking for an area it might effect then it would be domestic consumption so lets take a look.

Household consumption expenditures decreased by 1.0 percent and government consumption expenditures remained unchanged, seasonally adjusted, compared with the previous quarter ( Sweden Statistics).

Time for page 2 of the central banking play book.

Riksbank’s Floden: Recent Data Since Latest Policy Meeting Have Been Disappointing -But There Were Some Temporary Effects In 3Q GDP Data,

Something else caught my eye and it was this.

 Exports grew by 0.3 percent and imports declined by 0.6 percent.

So foreign demand flattered the numbers in a rebuttal to the central banking play book. But if we look at the overall pattern then economics 101 has yet more to think about.

J curve R.I.P. (?) – In Sweden, 2018 is heading for the worst trade year ever. The Oct deficit was SEK8.4bn. One observation: J curve effect does not work and thus the exchange rate channel (on real economy) is partially broken.   ( Stefan Mullin)

So let’s see you have negative interest-rates to boost domestic demand which is falling and you look to drive the currency lower which does not seem to be helping trade. Oh and you plan to raise interest-rates into a monetary decline. What could go wrong?

As it is the end of the week let us have some humour albeit of the gallows variety from Forex Crunch yesterday.

Analysts at TD Securities suggest that their nowcast models point to a 0.6% q/q gain to Sweden’s GDP (mkt: 0.2% q/q on a wide range of estimates), which if materialised would leave TD (and likely the Riksbank) comfortable with a December rate hike

Switzerland

Let us start with a response from Nikolay Markov of Pictet Asset Management.

GDP growth plunged to its lowest pace since the introduction of negative rates in Q1 2015. There is no reason to panic as this is a temporary drop:

There are few things more likely to cause a panic than being told there is no reason for it. I also note he was not so kind to the Swedes. Let us investigate using Swiss Statistics.

Switzerland’s GDP fell by 0.2% in the 3rd quarter of 2018, after climbing by 0.7% in the previous quarter. The strong, continuous growth phase enjoyed by the Swiss economy for one and a half years was suddenly interrupted.

The change has seen annual growth dip from 3.5% to 2.4% so different to Sweden although there has been a fall in the growth of domestic consumption. Quite what a central bank with an interest-rate of -0.75% can do about falling domestic consumption is a moot point. A driver of the decline is a familiar one.

Value added in manufacturing dipped slightly (−0.6%);  Total exports of goods (−4.2%) also contracted substantially.

The official view is that is just a blip but it does require watching as I note this area still seems to be troubled as this from earlier shows.

How cold is ‘s auto market? Passenger car sales down 28% in first 3 weeks of Nov. Whole year drop “inevitable”. Car dealers’ inventory climbing and many of them making losses. Authority said bringing back purchase tax cut will not help much. ( @YuanTalks )

Just as a reminder the Swiss National Bank holds some 778.05 billion Swiss Francs of foreign currency investments as a result of its interventions to reduce the exchange-rate of the Swissy.

Comment

These developments add to those at some other members of the negative interest-rates club or what is called NIRP.

German economic growth has stalled. As the Federal Statistical Office (Destatis) already reported in its first release of 14 November 2018, the gross domestic product (GDP) in the third quarter of 2018 was by 0.2% lower – upon price, seasonal and calendar adjustment – than in the second quarter of 2018.

And another part of discovering Japan.

Japan’s economy shrank in the third quarter as natural disasters hit spending and disrupted exports.

The economy contracted by an annualised 1.2% between July and September, preliminary figures showed. ( BBC )

As you can see we go to part three of the play book as the poor old weather takes another pounding. Quite what this has done to IMF News I am not sure as imagine how it would report such numbers for the UK?

has had an extended period of strong economic growth—GDP expected to rise by 1.1% in 2018.

 

Perhaps it has been discombobulated by a period when expansionary monetary policy has not only crunched to a halt but gone into reverse at least for a bit. But imagine you are a central banker right now wondering of this may go on and you will be starting it with interest-rates already negative. Or to use the old City phrase, how are you left?

Oh and hot off this morning’s press there is also this.

In the third quarter of 2018 the seasonally and calendar adjusted, chained volume measure of Gross Domestic Product (GDP) decreased by 0.1 per cent to the previous quarter and increased by 0.7 per cent in comparison with the third quarter of 2017. ( Italy Statistics)

Japan

There as been a development in something predicted by us on here quite some time ago. So without further ado let me hand you over to The Japan Times.

Japan is considering transforming a helicopter destroyer into an aircraft carrier that can accommodate fighter jets, a government source said Tuesday,

 

 

 

 

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

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

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

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

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

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

The Output Gap

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

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

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

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

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

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

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

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

 

Monetary Policy

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

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

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

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

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

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

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

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

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

encourage them to take concrete actions as necessary.

The Tokyo Whale

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

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

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

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

Another Japanese style development comes from this.

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

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

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

 

Comment

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

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

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

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

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

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

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

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

Podcasts

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