Notes From Underground

Coming on the heels of my first Kenny Chesney concert I am viewing the synchronicity of central banks as a reflection of the rhythms of global financial repression. Last Thursday, the ECB issued its last statement before the summer recess, while this week we have the Bank of Japan tonight, the FED on Wednesday and the Bank of England on Thursday.

The ECB meeting was so inconsequential that the usual hour-long Mario Draghi press conference was limited to 35 minutes as the European press was bored to silence. The most controversial question was on the issue of Target2 funds and whether or not their was an issue of ECB/Bundesbank liability as funds flowed from Italy to Germany and the Netherlands as the German financial institutions were deemed a safer venue for euro deposits. Draghi asserted that Target2 is a payments system so no “need for concern.”

The ECB president maintained that much of these capital flows emanated from foreign holders of European debt so it was too early to understand the full implications for the ECB and other creditors. My response is that this is typical Draghi obfuscation. Italian savers have grown weary of the risk to their savings and have opted for placing EUROS into the protective custody of German institutions. There will be no relief until the European Union creates some type of EU-wide insurance program. The French and Italians are trying to create such a system but the Germans and Dutch are opposed because they don’t want to inherit the legacy liabilities of the Global Financial Crisis as still reverberating through the system via Italy’s high percentage of non-performing loans. Regardless of Draghi’s perfidy the ECB held policy steady.

Tonight the BOJ is announcing its monetary policy. Some in the market believe that Governor Kuroda will announce a “tweak” to its current Japanese government bonds (JGB) purchases in an effort to maintain its yield curve control. Markets have been spooked and pushing the Japanese bond yields below the long-held 200-day moving average. If the BOJ does scale back its bond purchases it may not mean as much as the FED‘s quantitative tightening.

The Japanese have used QQE, which implied a steady buying of BONDS as well as equities. The problem for the BOJ is that they have purchased so many bonds that the MARKET is dysfunctional and fails to trade on many days. Imagine that the world’s second largest debt market barely trades on many days as it is by appointment only. Therefore, the BOJ utilizes the Japanese equity markets as the mechanism to inject liquidity. Any adjustment to BOND purchases will result in a YEN rally but I would be cautious until there is full disclosure about the entire QQE program. I advise patience. Watch the NIKKEI index as it will be the KEY indicator.

Over the past few weeks the Japanese Banks have actually had a bid. The Japanese financial institutions have been the worst investment for many years as they have been left for dead while the system suffered under the burden of zero interest rates. I parked money in the banks in 2010 as a way to weather the global financial crisis. It was a small investment that has YIELDED small results, even with dividends. The recent move has attracted my attention but these institutions have disappointed many times but it is something to watch if there is a genuine change in BOJ policy. If the YEN fails to rally look to the Japanese equity market for a sense of market sentiment about BOJ policy.

On Wednesday, the FED will release its FOMC statement. Market consensus is for NO CHANGE and I will not disagree with that assessment. If I was Jerome Powell and felt that last week’s 4.1% second-quarter GDP was sustainable, I push the FOMC to raise rates in an effort to get to a positive real yield.

It is the issue of real yields that will drive many asset classes. If Powell believes there is genuine financial risk due to overvalued assets it would be better to raise now, but consensus believes that if there is no press conference then NO FED ACTION. The FED will probably raise some concern about the uncertainty of growth due to Trump tariffs giving cover to waiting for the September meeting. The DOLLAR has been steady over the last few months allowing the FED another reason to hold rates at the current 1.75%-2% target range.

I will not argue with consensus. The ongoing CURVE FLATTENING will get another push on Wednesday morning when the Treasury releases its refunding announcement and the size of future debt auctions. The rapid growth in government deficits stands to be a political problem as debt servicing costs rise with FED interest rate increases. The front-loading of Treasury debt has PROBABLY impacted the yield curve as buyers step back from rushing to purchase bills in the face of FOMC policy. The rising debt servicing costs will be a far bigger political problem than the economic costs of the rate increases. If Chairman Powell wishes to get out ahead of the Presidential tweets then he OUGHT to raise rates tomorrow.

Closing out the central bank fest is the Bank of England on Thursday morning. Market consensus is for a 25 basis point increase to 0.75%. The BOE has been VERY WRONG in analyzing the economic impact from Brexit so it is time that the BOE finally raises rates, even though it won’t begin its shrinking of the balance sheet. The uncertainty of Brexit will be cited as a potential economic headwind so the BOE will remain cautious. Will the British pound receive a strong bid on the rate rise?

Probably NOT because the uncertainty over the political life of the Prime Minister May’s Government continues to be a drag on British assets. A fear over the collapse of the present Conservative Government keeps financial markets spooked over the possibility of a Corbyn Labor Party victory. A 25 basis point increase will not assuage investor fears. For the Brits it will be back to the beach. So much for central bank palooza and the symphony of loose monetary policy.

Tags: BOE, BOJ, British pound, Draghi, ECB, Euro, Fed, FOMC, Japanese yen, Kuroda, Powell, U.S. Treasuries

This entry was posted on July 30, 2018 at 7:42 pm and is filed under Central Banks. 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.