Notes From Underground

The central banks were in play today and while the Bank of England held to its present course, the Bank of Japan declared that they were now in full battle gear and announced a very aggressive monetary policy agenda. I was surprised by the tenacity of the announced program and certainly by its timing. The recent movements in the YEN, and,especially the EUR/YEN crossrate meant that the BOJ and the Japanese Finance Ministry had some breathing space to allow some of the ill effects of the Cypriot crisis to calm. No such by the BOJ as they “damned the torpedoes and announced full speed ahead.” If other central banks wish to muddle about that is their business but the Japanese are determined to end the deflation that has plagued their economy. The steps that the BOJ announced, which had the greatest impact on the YEN and the Nikkei were:

1. Doubling the size of monthly bond purchases and doubling the monetary base. The monthly amount of bond purchases will be 7.5 trillion YEN, or roughly $78 billion. Remember, the FED purchases $85 billion but the U.S. GDP is almost three times the size of Japan’s so the bond purchasing program is huge;
2. It announced intentions of a two-year horizon for meeting the 2% level inflation target. This is an enormous task for a country that has been in deflation for 15 years;
3. Increasing the duration of the bonds that the BOJ will purchase thus being a repository for the huge JGB holdings of Japanese insurance companies, banks and small investors. The BOJ will be purchasing about seven years out compared with the previous average of three years;
4. The BOJ will also be buying ETFs and real-estate investment trusts (REITs), an area that the FED doesn’t go. The impact was to rally the NIKKEI EQUITIES and to drive the Japanese 10-year note to a record low yield of 0.425%. The result will be that the BOJ will further distort the bond rates as an indicator of economic growth; and
5. Governor Kuroda also suspended the banknote rule, which stipulated that the BOJ would keep the value of its bond holdings below the amount of cash in circulation.

The BOJ, under the guidance of Haruhiko Kuroda, has shown it understands the words of Chairman Bernanke about the global financial system being healthier by creating growth through monetary stimulation. The G-7 is dead, slayed by the race to monetary stimulus. Governor Kuroda has well paraphrased Patrick Henry: I know not course what others may take  bus as for the BOJ give us inflation or death trying.

The course that others may take is that of the European Central Bank. President Draghi was clear in maintaining the present policy  of pursuing the mandate of the ECB: price stability. The ECB held its lending rate at 0.75% and is very comfortable that inflation is firmly anchored. The post-meeting press conference did reveal some concerns that President Draghi has but nothing of a concern that would get the ECB to involve itself in the global quest for growth.

1. Draghi threw the responsibility for Cyprus to the Eurocrats in Brussels and stressed the need for a single European bank supervisor and thus the establishment of a banking union. He maintained that the decision to levy a tax on insured deposits was NOT SMART but was happy that it was immediately corrected. He maintained that Mr. Dijsselbloem had been misunderstood (stop laughing);
2. The ECB is very concerned about loan fragmentation and the impact it is having on business borrowers in the peripheral nations. The EU is much more dependent on its banks for financial intermediation and thus the failure of banks to lend based on the ECB‘s directed lending rate is a big problem. In Europe the capital markets (corporate bonds and other finance providers) are not as significant as in the U.S. and other nations so bank activity has a far greater impact. The ECB is greatly concerned about the continued problem of FRAGMENTATION so we will look for a huge change in the collateralization requirements when the ECB finally goes into ease mode;
3. Governor Draghi did note his concern that growth was slowing in countries where fragmentation is not an issue. This comment was a problem for me following the overnight action of the BOJ. Do you think Germany and Holland are going to benefit from a rising EUR/YEN cross? The recently released European auto numbers showed a huge decline in auto production and its Japanese carmakers regaining market share. And yet again the ECB maintained its present policy;
4. A journalist whose name I did not catch, asked President Draghi about the BOJ policy announced last night and whether it concerned him. It was a deft performance by Draghi to avoid answering the question. Draghi said that the ECB does not target exchange rates as a policy and he didn’t believe that it was a race to the bottom. The euro currency followed the Draghi press conference with a strong rally as markets for the moments believed the ECB will not succumb to the GLOBAL CURRENCY WAR and thus will maintain a hard currency policy. The course for austerity is set: Let large bank depositors beware. As a result, the European equity markets closed down on the day. The European bond markets rallied strongly with the French and Spanish 10-years outperforming the rest of the markets due to a very successful bond auction that was well oversubscribed at lower rates than anticipated.

***Tomorrow’s unemployment report has been rendered less meaningful because of the BOJ‘s declaration of financial war. But the markets will react so let’s look at the market guesstimates and what impact it may have. The consensus is for U.S. nonfarm payrolls to increase by 190,000; average hourly earnings to increase 0.2%; and for the work week to remain steady at 34.5 hours. The key will be average  hourly earnings which need to grow to keep consumer demand healthy. Phillipe Dunne of the Liscio Report has raised the issue of the importance of manufacturing and construction job growth. If the housing story has real traction, job growth in the construction sector should reflect it and continue its steady increase and if the export numbers continue to improve, manufacturing should be the beneficiary. The Bloomberg  consensus for manufacturing is for an increase of 10,000 jobs. The U.S. jobless rate is expected to remain at 7.7%.

The significance from tomorrow’s U.S. unemployment numbers will be from a trader’s view: IF THE NFP IS BIGGER THAN 250,000 I would watch the U.S. Treasury market. The initial reaction should be a selloff on strong data but a bond market recoil rally would indicate that the recent strong correction in commodity prices and precious metals is something to be alert to as an indicator of a global slowing. The BOJ action is a problem because the huge bond buying program set into action by Governor Kuroda will force Japanese investors to look for yield elsewhere, indicating a further bid to all bond markets, so a strong close after robust data will be very revealing.

The inverse, of course, will be the action of the U.S. equity markets (SPOOs) on a softer employment report. A number on the nonfarm payrolls of less than 110,000 should make the SPOOS  sell off but the test will be where the S&Ps close in the event there’s weak data. Some analysts are shorting stocks because the underlying fundamentals fail to support a market floating on FED liquidity. The BOJ’s firing a new round of liquidity may be the overwhelming fundamental in the arsenal of global central banks. Be patient and let the fog of war clear so as to see the battlefield.

As usual, the Canadian jobs data will also be released. The market is expecting an increase of 7,000 jobs and an increase in the rate to 7.1%. Last month, Canada had a huge job gain of 51,000, well above expectations.

Tags: BOJ, ECB, Eur/Yen, Fed, Kuroda, Mario Draghi, nonfarm payrolls, QE, SPS, Yen

This entry was posted on April 4, 2013 at 8:19 pm and is filed under BoJ, ECB, Fed, unemployment. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.