More QE will be on the agenda of the US Federal Reserve

Later today the policymakers of what is effectively the world’s central bank meet up to deliberate before making their policy announcement tomorrow evening UK time. Although there is a catch in my description because the US Federal Reserve goes through sustained periods when it effectively ignores the rest of the world and becomes like the US itself can do, rather isolationist. The Financial Times puts it like this.

US coronavirus surge to dominate Federal Reserve meeting…..Central bank policymakers face delicate decision on best way to deliver more monetary support.

As it happens the coronavirus numbers look a little better today. But there are clearly domestic issues at hand which is a switch on the initial situation where on the middle of March the US Federal Reserve intervened to help the rest of the world with foreign exchange liquidity swaps. We were ahead of that game on March 16th. Anyway, that was then and now we see the US $446 billion that they rose to is now US $118 billion and falling.

The US Dollar

There has been a shift of emphasis with Aloe Blacc mulling a dip in royalties from this.

I need a dollar dollar, a dollar is what I need
Hey hey
Well I need a dollar dollar, a dollar is what I need
Hey hey
And I said I need dollar dollar, a dollar is what I need
And if I share with you my story would you share your dollar with me

This was represented back in the spring not only by a Dollar rally that especially hit the Emerging Market currencies but the Fed response I looked at above. Since then we have gone from slip-sliding away to the Fallin’ of Alicia Keys. Putting that into numbers the peak of 103.6 for September Dollar Index futures on March 19th has been replaced by 93.9 this morning.

If we look at the Euro it fell to 1.06 versus the Dollar and a warning signal flashed as the parity calls began. They had their usual impact as it is now at 1.17. Actually there were some parity calls for the UK Pound $ too so you will not be surprised to see it above US $1.28 as I type this. In terms of economic policy perhaps the most significant is the Japanese Yen at 105.50 because the Bank of Japan has made an enormous effort to weaken it and looks increasingly like King Canute.

There are economic efforts from this as I recall the words of the then Vice-Chair Stanley Fischer from 2015.

Figure 3 uses these results to gauge how a 10 percent dollar appreciation would reduce U.S. gross domestic product (GDP) through the net export channels we have just discussed. The staff’s model indicates that the direct effects on GDP through net exports are large, with GDP falling over 1-1/2 percent below baseline after three years.

We have seen the reverse of that so a rise in GDP of 1.5%. Of course such moves seem smaller right now and they need the move to be sustained but a welcome development none the less.

Whilst the US economy is less affected in terms of inflation than others due to the role of the US Dollar as the reserve currency in which commodities are prices there still is an impact.

This particular model implies that core PCE inflation dips about 0.5 percent in the two quarters following the appreciation before gradually returning to baseline, which is consistent with a four-quarter decline in core PCE inflation of about 0.3 percent in the first year following the shock.

Again this impact is the other way so inflation will rise. For those unaware PCE means Personal Consumption Expenditures and as so familiar for an official choice leads to a lower inflation reading than the more widely known CPI alternative.

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Interest-Rates

This is a troubled area for the US Federal Reserve which resembles the shambles of General Custer at Little Big Horn. We we being signposted to a “normalisation” where the new interest-rate would be of the order of 3%+ or what was called r*. I am pleased to report I called it out at the time as the reality was that the underpinnings of this particular Ivory Tower crumbled as the eye of Trump turned on it. The pandemic in this sense provided cover for the US Federal Reserve to cut to around 0.1% ( strictly 0% to 0.25%).

Back on March 16th I noted this and you know my view in official denials.

#BREAKING Fed’s Powell says negative interest rates not likely to be appropriate ( @AFP )

I also not this from Reuters yesterday,

With U.S. central bank officials resisting negative interest rates,

How are they resisting them? They could hardly have cut much quicker! This feels like a PR campaign ahead of applying them at some future date.

Yield Curve Control

This is the new way of explaining that the central bank is funding government policy. Although not on the scale some are claiming.

Foreigners have levelled off buying US Debt. Federal Reserve buying has gone parabolic. This tells us all this additional debt the govt is issuing by running HUGE budget deficits is being purchased by directly the Fed. That is what they do in “banana republics”. #monetizethedebt

That was from Ben Rickert on Twitter and is the number one tweet if you look for the US Federal Reserve. Sadly for someone who calls himself The Mentor actual purchases of US government bonds have declined substantially.

the Desk plans to continue to increase SOMA holdings of Treasury securities at that pace, which is the equivalent of approximately $80 billion per month.  ( New York Fed.)

That is less in a month than it was buying some days as I recall a period when it was US £125 billion a day.

If Ben had not ramped up his rhetoric he would be on the scent because Yield Curve Control is where the central bank implicitly rather than explicitly finances the government. Regular readers will have noted my updates on the Bank of Japan doing this and there have been several variations but the sum is that the benchmark ten-year yield has been kept in a range between -0.1% and 0.1%.

There is an obvious issue with the US ten-year yield being around 0.6% and we may see tomorrow the beginning of the process of getting it lower. On the tenth of this month I pointed out that some US bond yields could go negative and if we are to see a Japanese style YCC then the Fed needs to get on with it for the reasons I will note below.

Comment

As the battleground for the US Federal Reserve now seems to be bond yields it has a problem.

INSKEEP: Senator, our time is short. I’ve got a couple of quick questions here. Is there a limit to how much the United States can borrow? Granting the emergency, its another trillion dollars here. ( NPR)

Even in these inflated times that is a lot and the Democrat opposition want treble that. With an election around the corner we are likely to see more grand spending schemes. But returning to the Fed that is a lot to fund and $80 billion a month looks rather thin in response. So somewhere on this yellow brick road I am expecting more QE.

Oh and if you look at Japan if it has done any good it is well hidden. But that seems not to bother policymakers much these days. Also another example of Turning Japanese is provided by giving QE  new name. After all successes do not need one do they?

Still at least the researchers at the Kansas City Fed have kept their sense of humour.

Based on the FOMC’s past use of forward guidance, we argue that date-based forward guidance has the potential to deliver much, though not all, of the accommodation of yield curve control.

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.

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Japan is the land with no inflation

The concept of the “lost decade” in Japan which of course now encompasses at least two of them has many features but one of them is the lack of inflation. This has continued in spite of the enormous effort to create some driven by the Abenomics economic policy of the current government and the Bank of Japan. Or as James Mackintosh put it yesterday.

Japanese consumer prices are now at the same level as in October 1998. Not inflation, but the *level* of CPI.

So not quite two lost decades although care is needed because as regular readers will be aware my view is that the inflation obsession of the world’s central banks is misguided. After all the 2% annual target was something that seemed right rather than being a considered thought out plan.

If we move to more recent developments we see a familiar tale of not much going on as the annual inflation rate was 0.7% in June. The index based at 2015 levels is at 100.9. Even in an area where you would expect inflation which is medical services ( for an aging population) there is not much as it is 2% and 103.3 respectively. This is a world where the 100 Yen machine still exists and you get the same drink or chocolate bar you got years ago. The feature that sticks in my mind from when I worked in Tokyo was the gloriously named “Pocari Sweat” which tasted better than in sounds. Another feature that is different to the UK in particular is the housing sector where there is little or no inflation either as it registers a 0.1% fall in the last year and the index is at 99.6. That’s where it was in 1996!

The Bank of Japan

There have been developments here this week as it once again faces the prospect of failing with regards to it inflation target. This is analagous to Mario Draghi calling for reform in the Euro area which is also in every policy statement. This morning saw the release of its latest research into underlying inflation which of course central bankers love when the headline isn’t behaving. But if anything it makes things worse as we plough through the trimmed mean, the weighted median and the mode. If I was Governor I would be rather pleased to see the weighted median at 0% but Governor Kuroda of course is not.

Here is yesterday’s response described by NHK News.

The Bank of Japan has made a move to curb the recent rise in long-term interest rates.

BOJ officials said on Monday that they are offering to buy an unlimited amount of Japanese government bonds at a fixed rate.

There is a bit of hype in the use of “unlimited amount” as whilst Japan issues plenty of bonds the Tokyo Whale has gobbled quite a few up already. Also the yield movements are very Japanese.

On Monday morning, the yield on the benchmark 10-year government bond briefly hit 0.090 percent on speculation the central bank may review its bond-buying program at next week’s meeting. The BOJ’s target for the yield is around zero percent.

After the officials made the suggestion, the yield fell to 0.065 percent.

Firstly let us note the small difference here before we look at the  Reuters perspective

The country’s government bond yields rose sharply on Monday, the first chance Asian traders had to react to a Reuters report that the central bank was debating whether to scale back monetary stimulus………Yields on the benchmark 10-year Japanese government bonds, or JGBs, shot up nearly six basis points on Monday before the central bank offered to buy unlimited amounts at a yield of 0.11 percent.

So returning to the yield issue it is not much but is better in real terms than in many places especially if you take a broad sweep of Japanese inflation. You may also note that the Bank of Japan more threatened to buy rather than actually buying. This is the new yield curve control programme which has seen its purchases slow. The hint it might step back has the problem that for so long it has pretty much centrally planned the Japanese Government Bond market which otherwise has withered on the vine.

 

The economy

There have been problems here too as we remind ourselves of what happened in the first quarter.

The economy shrank by an annual rate of 0.6 percent in the first quarter of 2018 as consumers kept their purse strings tight despite signs that paychecks are finally beginning to rise after decades of flat wages. ( Japan Times).

This morning’s PMI business survey for manufacturing has done little to improve the mood.

Japan Flash Manufacturing PMI falls to 20-month
low of 51.6 in July, from 53.0 in June…….New business grew at a much weaker rate and was broadly flat,
while export demand, despite further yen depreciation,
deteriorated for a second month running ( Markit ).

Actually these developments bring things more into line with the Bank of Japan in the sense that it felt the Japanese economy had outperformed in the previous 2 years.

However the labour market remains strong.

The unemployment rate fell to the lowest level in more than 25 years in May as companies ramped up hiring amid solidifying economic conditions, government data showed Friday……..The rate fell to 2.2 percent, against an estimated 2.5 percent, the lowest since 1992, the Internal Affairs and Communications Ministry said. Separate data released the same day by the labor ministry showed the job-to-applicant ratio was 1.6, the highest since 1974.

There was also a flicker from wage growth in May as bonuses boosted the numbers meaning that real wages were 1.3% higher than a year before. It has led t the usual flurry of excitement from the media desperate to justify all their past pro Abenomics headlines who presumably follow the advice of “look away now” at the previous months as 3 out of 4 showed negative annual growth. Still for fans of “output gap” style analysis it is an improvement from complete disaster to mere failure assuming it lasts. They would be expecting the equivalent of the 41 degrees celsius recorded near to Tokyo yesterday.

Comment

Actually the twenty years of being an inflation free zone has not gone that badly for Japan. Collectively the economic growth rate has been weak but individually it has done better as we see a positive spin on the falling population level. Personally I think that pumping up inflation to 2% per annum would be likely to inflict economic danger on Japan because if we look across to the west we see that the Ivory Tower assumption that wages would automatically rise in response is another error.

But as so often the cry for “More! More! More!” goes up as I note this from Gavyn Davies in the Financial Times.

Even with very careful communication and forward guidance, monetary policy may not be sufficient, on its own, to reach the inflation target. Eventually, unconventional fiscal easing may also be needed, though this is not remotely on the horizon at present.

So the monetary policy which apparently could not fail has so lets pump up fiscal policy. That starts from an interesting level of the national debt and from a curious view of where inflation has been.

Bank of Japan faces the return of very low inflation

How can you return if you never went away?