Hands Up if You’re Not Easing, Part Infinity

This is the thread that just keeps on giving. Eight years on from emergency levels of interest rates, unprecedented QE from the G4 central banks, and unlimited intervention in a G10 currency like the Swiss Franc, the central banks are still at the same game. This time it was the Bank of Japan, who finally broke their own shibboleth, and cut their interest rates into negative territory. Only marginally, to be fair, with -0.10% on new balances held with the BOJ (they created a three-tier system to prevent distortions in the banking system). However the symbolic impact is huge. Make no mistake, even though it was a 5-4 vote, the doves on the BOJ are clearly in command.

You might say…. well it’s bad for Japan because it screws up their banking system; that it risks passing on negative rates to a consumer that’s already been dead for years; that it stunts their own purchase programme in JGBs; that it means they have reached the limits of their easing policy.

Well, lucky for you, the BOJ have produced their own handy guide which answers all of these questions and more: BOJeases

Here’s a little chart that they included to show how the tiering will work:

BOJ tier system

Read the full document. Not because you want to know the technicalities of the system but much more importantly for its tone and language. This is one of the clearest central bank communications Blondemoney has ever seen. There are only 4 pages, and it ends with 7 Questions. These are the questions of the nay-sayers and the doom-mongers. Their response? Absolutely emphatic. Look at this response to Q1:

Q1. Will the Bank continue to purchase Japanese government bonds (JGBs) after the introduction of a negative interest rate?

A. Under “QQE with a Negative Interest Rate,” the Bank will pursue monetary easing by making full use of possible measures in terms of three dimensions, combining quantity, quality, and interest rate. It will lower the short end of the yield curve by slashing its deposit rate on current accounts into negative territory and will exert further downward pressure on interest rates across the entire yield curve, in combination with large-scale purchases of JGBs.

This is no messing around with hints. They don’t say, we aim to flatten the yield curve, or suggest their actions might move it in that direction. No. “It WILL lower the short end…. and WILL exert further pressure across the entire yield curve”. Making such a public commitment shows that they are absolutely determined to deliver it. So if they don’t achieve it yet, they will the next time. They have crossed the rubicon into negative rates and as we already know from the ECB, Riksbank, Swiss National Bank et al, this is the thin end of the wedge.

Of course it is a surprise that they took this route rather than expanding QQE. After all, Kuroda said explicitly just 8 days ago that he was not even considering negative interest rates:

‘”There are pros and cons of adopting negative interest rates … The Federal Reserve didn’t adopt negative interest rates and yet, its policy succeeded in stimulating the U.S. economy,” he told parliament on Thursday.’

So he evidently wanted to achieve bang for his buck by surprising the market.

The question now is, what kind of surprise? Is this positive for risk sentiment because it’s yet more cheap money to fuel the asset bubble train? Or negative once the shock subsides, as central bank credibility is on the line, given they have thrown the stimulus kitchen sink out the window and inflation is still heading lower?

The answer, unfortunately, is probably both. But we will need to work through the first scenario, and see risky assets head higher, before reality digestion takes us to the latter. The problem we have is that easy money policies are running into the wall of a decline in global trade. Blondemoney has shifted stance on deflation, expecting that it would be counteracted by a rebound to the consumer who loved the windfall from low oil prices. Instead, commodities are in the opposite of a SuperCycle [a prize for the first reader to coin a phrase for that], and will be as long as China is rebalancing its economy. Meanwhile the US recovery is running out of steam and the consumer is still severely wounded by the ghost of Lehman past, preferring to save rather than spend. On top of all of this, we remain in the midst of a massive technological revolution that has chewed up and spat out the classic Phillips Curve relationship between unemployment and inflation. Add all of this together, and inflation isn’t going up any time soon.

The reason that right now we have another post in the “Hands Up” chain, is that oil didn’t bottom out at the end of last year and there were no helpful base effects. Inflation-targeting central banks cannot just sit back and hope that it turns around, particularly if they are losing the impulse from their currency.

It’s the currency that is the crux. The ECB and the BOJ have been motivated to act now because their currencies have stopped falling. Here is the trade weighted Dollar, Euro and Japanese Yen, normalised from November 2014 when the oil price began to drop, and with a vertical line from a year after that:

The US dollar has been pretty stable since then, but the Yen (yellow line) and Euro (white line) have appreciated. With inflation remaining low, these central banks know they have to shock this back into reverse.

So the Fed are now in a bind. By doing nothing, their interest rates remain relatively more attractive, potentially strengthening the US Dollar, which will have a deflationary impact on the US. So even if the Fed wanted to tighten more, they already are doing, even by doing nothing, because of the actions of the other central banks. Today’s US GDP number might show just how much the US economy started to slow into the end of Q4, which will raise even more questions about how the Fed can keep their heads above the parapet. Just as equity markets have recently undergone a big correction from the rally of the past 2 years, so the US Dollar might be next.



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