After the newest moves by the wily fox Mario Draghi last Thursday, NOTES raised the issue of what the Swiss National Bank would do in response to the negative vibes emanating from the guardians of the EURO currency. The SNB has supported the EUR/CHF cross at a floor of 1.20 to “prevent” the Swiss economy from slipping into a deflationary spiral. The SNB has accumulated a massive foreign exchange portfolio as it has bought hundreds of billions of euros to ensure the floor holds on the. The massive buying of euros has been somewhat successful as 1.20 holds but the market still puts pressure on the Swiss as the cross is trading between 1.2050 and 1.2100. All that buying and the CROSS is a mere 0.8% off the floor.
The SNB made it known that it is willing to take its interest rates on deposits to a more NEGATIVE level in order to punish foreign depositors and investors who would like to stash money in Swiss financial entities. The SWISS RATES ARE ALREADY NEGATIVE as the one-year deposit rate is NEGATIVE 12 basis points. After the Swiss announcement the Swiss did drop on all the major crosses but the damage was slight and it will take REAL ACTION to dramatically effect the Swiss franc. The market will continue to test the resolve of the SWISS. Watch the Swiss cross rates for any potential trades for I doubt the Swiss will just keep printing money to buy euros when there are so many better choices with higher yields to boot. The end result is that CENTRAL BANK ACTIONS CAUSE MANY RIPPLE EFFECTS WITH UNINTENDED CONSEQUENCES.
***Following the SNB and its unintended consequences from a flawed policy, comes a peek at the Bank of Japan and some of the negatives of the massive QE program of the BOJ. On a September 1 post on the blog Sober Look titled, “Japan Moves From Paul Krugman’s Liquidity Trap to Haruhiko Kuroda’s ‘Indefinite QE’ Trap,” the author notes that the massive JGB purchases have distorted the market. The article cites the Economist, noting that the BOJ is buying 7 TRILLION YEN worth of bonds a month ($67 billion) and owns 20% of the outstanding government debt. Some days there has been no trading in 10-year bonds as the BOJ has become the market.
“Last year’s QE acceleration started to take more securities out of the private market than are being issued by the government.” When the central bank buys more bonds on a monthly basis than the government is issuing it appears as if we have entered a phase of DEBT MONETIZATION. As long as inflation remains subdued the BOJ can keep this going. However, if inflation finally begins to take hold, financial institutions will begin unloading JGBs with a negative real yield. The reason banks haven’t unloaded more JGBs is that private sector loans remain at very low levels as borrowers remain leery about taking on debt. Japan corporates are flush with cash after the spending the last decade repairing their balance sheets.
Going forward the dilemma for the BOJ is that if it’s successful and drives inflation higher through QE it will be forced into sustaining the monetary stimulus to try and keep JGB interest rates from rising. Japanese bond yields at 0.52% make financing the government’s deficit easy. If yields were to rise to 2% it would make the 225% debt/GDP level very difficult to sustain–a negative feedback loop of rising yields and rising debt burden.
The Japanese are certainly not alone in this trap. The YEN has been making six-year lows this month in the face of euro and British pound weakness but the YEN is toiling under terrible fundamentals. The policy employed during the last two years to weaken the yen has not had the typical beneficial effects on Japanese manufacturing. Previous years of YEN strength resulted in Japanese corporations “hollowing out” its industrial base by moving factories overseas. Japanese corporate balance sheets have improved as repatriated earnings buy more yen. Two years ago the dollar bought 80 yen while today it buys 105 yen, thus every repatriated dollar has had a big effect on earnings.
A bigger problem has been the results from the Fukushima nuclear disaster, which forced Japan to turn off its nuclear reactors. The Japanese now have to meet its power needs with imported fuel, which costs ever more as it takes more yen to buy the needed dollars for energy imports. Japan is in a terrible negative feedback loop and the most positive news for the YEN would be a return to nuclear energy, but that may be politically impossible as the electorate is opposed to any more Fukushimas. If the YEN were to get a boost from a sudden change in energy policy it would be short-lived. The game of unintended consequences lives on. Volatility, wherefore art thou?