Notes From Underground

On Monday, the yield curves tried to confuse us and the result was that the 2/10 provided the impetus for flattening across the board. The yield differentials are rangebound, creating a grind trade as the market looks for some clarification for longer term direction. The Wisconsin Primary will probably add more confusion to the Republican Presidential race. The situation in Europe is confused as the refugee issue has now become a negotiating chip for debt relief and Mario Draghi prays every night for an economic slowdown in Germany so as to get some support for some fiscal stimulus. ECB Chief Economist Peter Praet is quoted in a story from MNI Group, saying, “The need for a superior policy mix is no excuse for central banks to be passive when their mandates are under threat. The ECB has demonstrated through its actions  that it does not wait for others to move first.”

Italian economist Luigi Guiso is also cited for calling for enhanced fiscal stimulus but notes a significant problem for the European Union. He said, “The ECB is doing all it can both with conventional tools like rate cuts and unconventional ones including bond-buying programmes, but in order to be really effective these must be accompanied by parallel European fiscal measures. The TROUBLE IS THAT EUROPE DOES NOT YET HAVE A REAL GOVERNMENT THAT CAN ADOPT A COMMON BUDGET AND DEFINE A SINGLE TAXATION SCHEME” (emphasis mine). The politics to resolve the fiscal harmonization in the EU is difficult because the ECB is loading its balance sheet with sovereign debt and it is again, A BACKDOOR ATTEMPT TO FORCE GERMANY TO BE THE PAYMASTER OF ALL PRIOR DEBT COMMITMENTS. The EU wants to believe that it is the U.S. in the 1780s and has reached an agreement to consolidate all outstanding sovereign debt in a federal government, but there is no Alexander Hamilton to solidify all parties.

The larger problem is that the EU citizens, especially the major creditor, Germany, has never asked its voters if it desires to be the financial backstop of the EU. The phrase, NO TAXATION WITHOUT REPRESENTATION. President Draghi has successfully pushed European sovereign bond yields to preposterous low levels by aggregating debt onto the ECB balance sheet. But why this is only a trade and not position? EVERY BUYER OF EU SOVEREIGN DEBT HAD BETTER ASK THE QUESTION: WHO OR WHAT GUARANTEES THE ECB? If you can’t answer the question  then trade it but not own it.

Confusing the landscape is the renewed weakness in the NIKKEI. The main Japanese equity index is DOWN 17% on the year and this is in the face of very aggressive easing by the BOJ in an effort to stimulate the very slow-growing economy. But the BOJ’s efforts have failed to weaken the YEN as it is higher by almost 9% on the year. Will the weakness in the Nikkei lead to problems for Prime Minister Abe’s three arrows policy. One of the prime elements of the BOJ’s monetary easing has been a PORTFOLIO BALANCE effect as investors are forced to EQUITIES from BONDS. The Government Pension Investment Fund, began reweighting its massive portfolio away from JGBs to equities. The shift began in November 2014, leaving the GPIF on the losing end.

My key consultation of Japanese politics, Tobias Harris of TENEO, suggests that Abe may not mind a weakening in the NIKKEI and its potential problems because it would enable the prime minister to defang the budget hawks and allow the government to pursue a fiscal stimulus policy and also be able to delay the scheduled increase in the consumption tax. It is an interesting outlook and may help explain why the recent dramatic drop in the Japanese equity markets has been met with silence. ABE is politically strong because of a weakened opposition so playing for time may be an acceptable strategy. It is too early to know how large of a negative impact the rising YEN will have on corporate profits. As in the U.S. and Europe, the credibility of the central banks is being measured.

I went down Virginia,seeking shelter from the storm,

Caught up in the fable, I watched the tower grow

Five year plans and new deal, Wrapped in golden chains,

And I wonder still I wonder, Who’ll stop the rain.

Tags: Abe, BOJ, ECB, EU. Nikkei, Mario Draghi, Yen

This entry was posted on April 6, 2016 at 5:11 pm and is filed under BoJ, ECB, Europe, Japan. 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.