The Wizard of Oz provides so many appropriate metaphors for dealing with global central bank policy. The failure of the wisdom of those who meet behind the “curtain” enthrall the members of the elite media who genuflect on the altar of access. Provide the necessary backdrop of equations and the media believes everything. It reinforces the sentiment of the Greenspan era: “If you think you understood what I said, I must have misspoken.” The idea of an “all-knowing Fed” is beginning to lose its luster as markets begin to understand that FED policy is not rocket science. There is no predictable outcome for the global experiment of negative interest rates or zero interest rates. Even the growth of supersized central bank sheets is causing doubts among the blind followers of free money forever.
The global bond markets have suffered a massive two-day sell-off, which is raising questions among those central bankers as they ascribe to the rationale that sovereign bonds are impervious to a sustained correction. Regardless of President Draghi’s failure to bring more tinder to the pile, the ECB and the BOJ will still be purchasing around $200 billion of assets in September, October, November and on through at least March 2017. There is talk that the BOJ has decided to cut the amount of JGBs it will purchase in an effort to steepen the Japanese yield curve and placate the pension funds, insurance companies and banks. Teneo analyst Tobias Harris reported Governor Kuroda and Prime Minister Abe held a meeting on Friday, September 9. We don’t know what was discussed but it was conjectured that it may be an effort to give the BOJ political cover to cut interest rates further into negative territory in an effort to steepen the curve.
Message to Governor Kuroda from Yra Harris: If the BOJ wishes to steepen the curve then get the Ministry of Finance to issue all new debt in a period of TWO YEARS OR LESS. Then, stop buying any sovereign debt beyond two years and I GUARANTEE THE CURVE WILL STEEPEN DRAMATICALLY.
But for global concerns the idea of the BOJ cutting its longer term asset purchases may have put pressure on all bonds as it would shrink the monthly purchase amount from the current global total of $200 billion. This repricing would provide juice to the Santelli Theorem about low yields on U.S. 10-YEAR debt the result of global relative values. The massive selloff in BUNDS, OATS and Italian debt on Thursday and Friday may have more to do with the BOJ rather than President Draghi failing to deliver any increase in ECB purchases or extending the QE period.
Some analysts think it was Boston Fed President Eric Rosengren shifting to a hawkish stance–in sympathy with other Fed presidents–that exacerbated the selloff. I am skeptical because FED Governor Tarullo also spoke on Friday and he continued with a dovish mantra. So the LION of the ECB and the Tiger of the BOJ have hinted that previous policy has not delivered the desired economic outcomes. Any suggestion of central bank failure will UNLEASH THE BOND AND EQUITY BEARS BECAUSE IT WILL FORCE A REWEIGHTING OF RISK PREMIUMS.
The continuous aggressive liquidity policies of the world’s central banks have resulted in investor complacency. The rise of fear will result in a reassessment of the amount of risk in investors portfolios. Remember, the ECB has an enormous amount of purchases to place into the market as does the BOJ. Tomorrow, GOOD WITCH Lael Brainard will have a discussion with former Chicago Fed President Mike Moscow. If Governor Brainard is the FOMC confidant of Chair Yellen then her words carry more wight than others. Brainard has been very vocal in her view of lower for longer and as an international economist she has been concerned about the “too strong” DOLLAR.
In a June 2 CNBC interview, Governor Brainard was forceful in saying, “The dollar’s rise reduces net exports, and that drag can last for some time.” (That day the Euro was 111.50 and the U.S. dollar index was 95.55. On Friday, the Euro closed at 112.50 and the $ index at 95.34.) Pay attention to Brainard dovish rhetoric based on the dollar and potential headwinds.
***I will be on vacation as I need a break to recharge for what sets up to be a tumultuous fourth quarter. I’ll be back to the grind in nine days for the FED and BOJ meetings September 20 and 21. Stay focused and disciplined to trade and invest in with the lowest risk profile possible.