Blain's Morning Porridge
Blain’s Morning Porridge September 21st 2016
“Well, as you know, I always felt we tried to go a bridge too far.”
After a “comprehensive” review of monetary policy, The Bank of Japan has introduced a new package, including QQE – which boils down to managing the steepness of the yield curve.
My Japan Guru, Martin Malone, describes this morning’s news from Tokyo as an all-round WIN – promising inflation by expanding the monetary base to bring down currency, and with the option of lower rates if required. Keeping the curve steep will help banks’ margins as they borrow short and lend long.. BUT! Is it just me thinking that’s a recipe for banking disaster.. “Danger, Danger Will Robinson, Danger”!
It’s a fairly dramatic deep-dive focus from the BoJ – digging even deeper into what I always thought was the function of markets. The BoJ seeks to impose its vision on the Yield curve – which I mistakenly believed was a factor of inflationary expectations and market confidence.. rather than government/central banking fiat. Sure, you can set prices through demand (the BoJ now looking to own over 50% of the JGB market), but is monetary distortion now going too far?
I read a quote about how the BoJ is the most “daring” central bank. I was thinking the most “desperate” myself. I’m not in the least convinced you change the function of an economy by randomly yanking the monetary levers! You invigorate it by fueling demand, innovation, growth and, in Japan’s case, structural reform across the board. I’m afraid that’s hardly been touched.
It strikes me the decision to start playing the yield curve and carry on regardless is more about the absence of any other real policy options. Call me a cynic.. but I suspect the BoJ is fearful that doing nothing is no longer an option.
My concern is how the market reacts – will they see the BoJ action as “extraordinary” or “underwhelming”. I suspect the latter – frankly we’re losing confidence in monetary tinkering for the very simple reason it’s not working. It’s a bit like trying to push a boulder up a hill with a length of wet wool! (Fiscal policy, by contrast is very different – it’s pulling the same boulder up same hill with the same soggy wool… again of limited efficacy.)
The back lash is coming – which might explain why governments are discovering that even with QE Infinity, their control of markets is more limited than they think.
Keep a close eye on JGB yields and Yen in coming days to watch how this develops. And buy the Topic – the BoJ is by expanding their ETF buy programme.
Meanwhile, the consensus remains for Janet Yellen to do diddley-squat tonight in terms of US rates – all of which is going to make what the media are breathlessly describing as “Super Wednesday” look a bit pedestrian. I rather wish they’d bite the bullet and get on with normalisation – by hiking rates.
I rather suspect the horrible truth will soon be out. The last 7 years of extreme monetary experimentation has created a mutant economy.. where the only beneficiaries have been holders of financial assets. Investors have been loath to invest in real plant, infrastructure or jobs because the returns look so limited by artificially low rates. Instead they invest in financial assets because these returns are being inflated by monetary policy. Doh..
QE and ZIRP has the effect of sucking all the financial momentum out of economies – corporates borrow billions; not to invest in creating jobs and wealth, but to buy back their stock – further fuelling financial asset-inflation. Eventually the economy sinks into an entropy-minus state where the only game is financial assets fuelled by increasingly pointless further monetary injections…
Markets are utterly addicted to repeated hits of govt stimulus in the form of artificially low rates and asset purchase programmes – creating a massive moral hazard risk.
It might be time to encourage real investment in the real economy by spanking financial assets into touch – forcing money to back the real world instead. Higher rates will trigger massive correction in bonds and stocks – but that may well be a very very good thing!
My second theme for this morning is Deutsche Bank. It would be nice to able to say something positive.. such as this is a massive buy opportunity, or the crashing stock price is a massive over-reaction for what is fundamentally a great name, but... There seem to be just too many threats – the potential capital damage from the $14 bln mortgage settlement fine hanging over them, to the persistent rumours of valuation problems in the derivative books. I don’t want to do them down.. but there are definitely shades of Lehman in the story as it unfolds.
But equally, Deutsche is not Lehman – it may well be better to see it in terms of RBS. Its critical to the German economy and its inconceivable to think it would go down.. but it seems equally likely the cost of such aid would include triggering the CoCo/AT1s. That’s the difference between then and now – then bank debt investors (Tier 1 to covered) were feather-bedded.. today they are on the front-line!
On that happy thought.. back to the day job..
Bill Blain
Strategist - Mint Partners