This week we got a clear example of how central bankers will continue to beat us until the morale (inflation) improves.
In a previous post I applauded the governor of the BOJ Kuroda for his actions taken towards the end of last year by not increasing his QQE (quantitative & qualitative easing programmer) but actually promising incentives for management of companies who invest in their people and innovation. In this author’s opinion a far better use of time and effort, as it actually touches on blending monetary policy with fiscal policy.
“What I did like recently was Kuroda attempt to throw a twist into his QQE (quantitative and qualitative) programme by saying that he will invest roughly $3bln into companies who invest in human capital. This is important, it is a signaling mechanism to say that the BOJ is behind companies who not only hire more but invest in their people to incentivize them to work more or more importantly innovate more. Once this message filters down appropriately to the top/middle management in Japanese companies who are probably invested in the company they are going to push for more hiring, better wages and hopefully empowering their employees to be more innovative.”
This week saw a far more direct and tried and tested approach. However we must remember just because it is tried and tested does not mean it will work.
Kuroda has now moved the BOJ to negative interest rates or NIRP. Not content with a near ZIRP for approx. 16 years, Kuroda now feels that had that just been a tiny bit lower inflation would have achieved the magic 2% mark that central bankers seem to repeat like a religious mantra so oft. The best quote I read from a money manager in japan was that the carrot has been abandoned and now we are working with the stick.
Japan is renowned in the macro world for being the “widow maker”- i.e. plenty of macro fund managers have gone broke over the years betting on a return to form of inflation and growth not seen since the magic 80’s in Japan when they arguably dominated the scene for consumer electronics in a fast changing world. The below shows the inflation rate in japan over time and what’s more striking is that around the time they adopted the ZIRP policy while there may have been periods of above zero inflation there were also plenty of periods of deflation.
So Kuroda has now resorted back to usual tricks by central bankers. Instead of trying to foster a culture change of risk taking and “animal spirits” he is just going to try and force money to float around the system by charging institutions for extra reserves held at the BOJ. I am not sure why Kuroda thinks that this move will have any effect greater than the already very loose monetary policy that has been shown not only in Japan but also around the world.
But let’s look at what potentially triggered such a decision and whether Kuroda has shot an intentional arrow or merely just reacted aggressively to current events.
What where big headlines in Japan less than a week ago was the resignation of the minster for Economy Akiri Amari for alleged dubious practices regarding brown envelopes. This, he has of course not admitted too but doing the honorable thing and not allowing suspicion to fall on the party. The very next day Mr. Kuroda who up until a week ago had denied contemplating lowering interest rates through the zero barrier suddenly had a change of heart. This would certainly seem like a strategy to divert headlines away from the scandal and allow us all too simply forget about Mr. Amari’s alleged transgressions. It seems a little too coincidental to me but would also caveat by saying I doubt Mr Kuroda would make such a rash decision. So this has been a tool (or arrow) in his arsenal for some time and he has just been waiting for the right time to do it must be the only explanation.
Why then, is now the right time outside of the reason above? Again the obvious answers don’t cover Kuroda in glory either.
Recent movements in markets have seen what is known as “RISK OFF” this is a general term that I have discussed before (here). As most of the market was unwinding their foolish “ carry trades” which is when you borrow a low yielding currency and invest in a high yielding currency the Yen found itself being in an awkward position for the BOJ. In a regime when you are desperately trying to devalue your currency and the rest of the market cannot see beyond their red flashing PNL on their screens. The best evidence of this is the AUDJPY cross or if you want to be super sexy (risky) you could have borrowed Yen and invested in equities just because leverage is fun right?
USDJPY was fast approaching a level of ¥115/6. i.e ¥115-¥116 Yen to the USD. I work as a trader and can spot areas of price levels that if broken can cause enormous amounts of volatility and pain (in the financial sense), If little old me can spot these obvious areas you can be dam sure the BOJ and all its army of advisors etc can also and put ¥115/6 as a line in the sand. An implicit put if you will. And by the way it’s not rocket science, look at chart attached below and tell me that ¥115/6 level is not important. It may not look like much to you know but imagine how many people, traders, highly levered options traders, structured products,fund managers, algos, quant finance models, businesses etc etc draw these “lines in the sand”. When a line in sand breaks, there are reactions, just ask the FX traders back in the day who used to make a great living (some still do) “running the stops”
Kuroda has come out and defended the ¥115/6 level with the only thing he could use to ensure it would hold- negative deposit rates. A move so bold that it forces everyone in the market to respect (for a while). Why do I think this is such a poor strategy? It reduces the BOJ to nothing more than a technical analyst, developing monetary policy according to charting techniques. Don’t get me wrong I’m a firm believer in TA just not so sure I would like my monetary policy to be dictated by it.
Also, now the market knows it weakness. It knows how to force a decision out of Kuroda. The Master –servant relationship is a complicated one in macro finance. Sometimes the market is beholden to the Central bank and sometimes the central bank is beholden to the market. Kuroda I believe now is firmly in the hands of the market, it may appear the other way but not so. When the market wants something it knows how to get it- fundamentals be dammed.
Where have we seen this type of behavior before? I.E negative rates for a currency. Well one that is close to my experience is of course Switzerland. The Swiss currency has had negative rates for some time now (Dec/Jan 2015).
Now you would assume that if this was an effective tool of monetary policy that inflation should be around the magic 2% mark in Switzerland, right? Wrong? The official Swiss inflation rate is even worse than the Japanese rate, and what you may note is that the below chart shows negative inflation or deflation throughout a period where oil prices were trading around the $100 mark so, don’t just say the very lazy and defeatist comment of…… “ Yes, but oil …………….”
In a race to devalue currencies all around the world the Swiss central bank (SNB ) commonly known as the world’s biggest hedge fund did the only thing they could do to devalue their currency. Pegging it to a level didn’t work EURCHF ( 1.20) to hold back the tide of those who rush into buying CHF in times of strife, so they famously abandoned it and all hell broke loose as the leverage in the system in that particular pair unwound itself. Now the USDCHF is back to the very level it was before that move, EURCHF is not owing to the ECB’s concerted campaign to drive the Euro lower, but USDCHF has found its way back and is looking to go lower higher ( implying a weaker CHF ). Why is this? Negative rates are such a drag man. Is inflation any higher in Switzerland? No, arguably its lower.
So Kuroda had me last year with some policies and now he has lost me. His negative rates may succeed in devaluing the currency and (therefore assisting in debt reduction strategy which is a whole other blog post) but he will not succeed in achieving anything close to a 2% inflation level.
And while this goes on it seeks to develop the idea that central banks are indeed out of carrots (arguably they had never had any in the first place) so the stick will be used in Japan and every other major economy around the globe ( US & EU ) until morale improves.