Bank Of Japan
Monday, August 13th, 2012
by Don Vialoux, EquityClock.com
Upcoming US Events for Today:
- No Significant Events Scheduled
Upcoming International Events for Today:
- The Bank of Japan releases the Minutes from its July meeting at 7:50pm EST.
Markets in the US ended positive on Friday, despite concerning signs of economic contraction with China posting a disappointingly low trade surplus number for the month of July. Investors were expecting a surplus of $33.0B, up from the $31.7B reported previous, but the actual was a mere $25.2B. A shockingly low increase in exports at only 1.0%, off from the 8.8% analyst expectation, was the predominant factor behind the weak headline number, which is being pinched primarily by slowing demand from Europe. According to Econoday.com, “this was their worst performance for a non-holiday month since November 2009.” The impact of slowing exports from China is being picked up in the Baltic Dry Index (BDI), which tracks the price to ship freight over the world’s oceans. The BDI is once again pushing towards the lows of the year, signaling that economic fundamentals remain severely depressed. This is typically a leading indicator to equity market weakness.
The Baltic Dry Index is not the only shipping gauge that is under pressure. The Dow Transportation Index has been significantly underperforming the market for almost a month, hinting of weak demand for goods. The Dow Transports typically confirm broad market equity moves, leading markets higher when economic fundamentals are strong, and leading the markets lower when fundamentals are weak. The fact that this cyclical industry, Transportation, is not showing the same upside momentum as what the broad market showing is a significant concern. Higher oil prices are also pressuring transportation stocks, a situation which is seasonally typical into September and October.
Turning to the equity markets, last week saw the lowest equity market volumes for a non-Christmas holiday week in years. The S&P 500 ETF (SPY) was shown on Friday with a 4-day volume moving average. The fifth day, Friday, only weakened the average further. The Dow Jones Industrial Average is also showing a similar volume profile to SPY. Now take a look at the NYSE Primary Exchange Index, which showed the lowest 5-day volume average since the 1990’s. Low volume implies low conviction, often a precursor to market declines. Volumes are typically lower than average during the summer months, albeit not as low as present levels, picking up once again in September as traders return to their desks from summer vacation. As a result, September and October are known to be the most volatile months on the calendar as regular trading resumes.
Concerning activity remains evident in the price of Copper, often referred to as “Doctor Copper” due to its ability to predict broad market moves. Copper has maintained a long-term declining path over the past year, underperforming the market in the process. With expectations of further monetary stimulus overriding economic fundamentals, it would be expected that copper would react positively as well, producing positive results and outperforming the market before central bank officials confirm activity, similar to what occurred prior to the last two QE programs. Investors in the cyclical metal are showing signs of skepticism toward the prominent stimulus expectations, perhaps warning that fundamental concerns are still too serious to ignore. Copper seasonally declines between August and October due to economic factors, such as weak manufacturing demand.
Despite a number of warning signals that remain intact, bullish characteristics are prevailing within the price action of equity markets. The S&P 500 continues to maintain a trend of higher-highs and higher-lows following a June low. Significant moving averages (20, 50, and 200-day) are curling positive. Even bond prices are showing signs of coming under pressure, a positive for equity markets. Sell signals for broad market indices have yet to be confirmed, so although risks are increasing, maintaining appropriate allocations to equities appears prudent until technical indicators roll over. Seasonal tendencies for Presidential election years turn negative into September, so equities are within a window where a peak could be realized at any time. Be prepare to react accordingly.
Sentiment on Friday, as gauged by the put-call ratio, ended neutral at 0.99. The ratio broke out of a falling wedge pattern, which could be the precursor to elevated levels of volatility. The VIX has fallen back to levels where the market has been known to correct as complacency reaches extremes. Volatility remains seasonally positive through to October.
Chart Courtesy of StockCharts.com
Chart Courtesy of StockCharts.com
- Closing Market Value: $12.37 (unchanged)
- Closing NAV/Unit: $12.39 (unchanged)
|2012 Year-to-Date||Since Inception (Nov 19, 2009)|
* performance calculated on Closing NAV/Unit as provided by custodian
Click Here to learn more about the proprietary, seasonal rotation investment strategy developed by research analysts Don Vialoux, Brooke Thackray, and Jon Vialoux.
Tags: Baltic Dry Index, Baltic Dry Index Bdi, Bank Of Japan, Broad Market, Christmas Holiday, Don Vialoux, Economic Contraction, Economic Fundamentals, ETF, ETFs, Exports From China, Headline Number, Leading Indicator, Lows, Market Equity, Market Weakness, Oil Prices, Predominant Factor, Seasonal Weakness, Significant Events, Trade Surplus, Transportation Index, Transportation Stocks
Posted in Markets | Comments Off
Monday, July 30th, 2012
Goldman’s ex-employee Mario Draghi is in a box: he knows he has to do something, but he also knows his options are very limited politically and financially. Yet he has no choice but to escalate and must surprise markets with a forceful intervention as per his words last week or else. What does that leave him? Well, according to Goldman’s Huw Pill, nothing short of pulling a BOJ and announcing on Thursday that he will proceed with monetization of private assets, an event which so far only the Bank of Japan has publicly engaged in, and one which will confirm the world’s relentless Japanization. From Pill: “Given the (to us) surprisingly bold tone of Mr. Draghi’s comments last week, we nevertheless think a new initiative may well be in the offing. We have argued in the past that the next step in the escalation of the ECB response would be outright purchases of private assets. Acting in this direction on Thursday would represent a significant event. We forecast the announcement of measures to permit NCBs to purchase private-sector assets under their own risk to implement ‘credit easing’, within a general framework approved by the Governing Council. This would allow purchases of unsecured bank debt and corporate debt, enabling NCBs to ease private-sector financial conditions where such support is most needed.” Why would the ECB do this: “A natural objection to outright purchases of assets issued by the private sector is that they involve the assumption of too much credit risk by the ECB. But substantial risk is already assumed via credit operations.” In other words, the only thing better than a little global central banker put is a whole lot global central banker put, and when every central planner is now all in, there is no longer any downside to putting in even more taxpayer risk on the table. Or so the thinking goes.
Of course, a rational person may wonder: why would the ECB, which a week ago was arguing for impairing senior debt, suddenly go ahead and monetize not only senior but subordinated debt. And one step further, one may also wonder if this is merely the latest iteration of a Goldman call that should be faded. Because if so, the market is in for a rude awakening. Alternatively, if Draghi does go the full Shirakawa, expect merely a brief LTRO-type response higher, to be followed by yet another major swoon lower as the drug addict demands more, more, more, only that more no longer exists with each succeesive asset dilution iteration.
We forecast that the ECB will permit NCB purchases of private sector assets
ECB President Draghi’s comments in London last week have raised market expectations that important new measures will be announced by the Governing Council on Thursday (August 2).
Were the Spanish government to request support from the EFSF ahead of Thursday’s meeting and accept the implied conditionality, we would expect the ECB to offer significant support to sovereigns, including through outright ECB purchases of government debt via the SMP. This would mark a significant acceleration and intensification of what we have previously forecast. However, our base case is that events will not move so quickly: the Spanish government is pre-funded through October and, according to the latest reports, an immediate Spanish request to the EFSF is unlikely. We do not expect the ECB to move unilaterally: we view explicit and concrete political support for its actions via EFSF conditionality as a prerequisite for an extension of support to the sovereign markets.
The ECB therefore risks disappointing heightened expectations. Bringing forward measures to ease private-sector financing conditions in the periphery is a likely response. Well-flagged possibilities in this regard include a further easing of collateral eligibility standards and new longer-tenor refinancing operations. But precisely because these measures have been anticipated, they are unlikely to satisfy the market expectations raised by Mr. Draghi’s comments. And we would in any case view the effectiveness of such measures as questionable, given the segmentation of financial markets and dysfunctionality of financial systems in the periphery.
Given the (to us) surprisingly bold tone of Mr. Draghi’s comments last week, we nevertheless think a new initiative may well be in the offing. We have argued in the past that the next step in the escalation of the ECB response would be outright purchases of private assets. Acting in this direction on Thursday would represent a significant event. We forecast the announcement of measures to permit NCBs to purchase private-sector assets under their own risk to implement ‘credit easing’, within a general framework approved by the Governing Council. This would allow purchases of unsecured bank debt and corporate debt, enabling NCBs to ease private-sector financial conditions where such support is most needed. Progress in centralising banking supervision at the ECB would facilitate such support for the banking sector.
1.Market tensions continue to mount in the Euro area, in an environment of ongoing macroeconomic weakness.
2.Thursday’s comments by ECB President Draghi in London have raised expectations that the ECB will resume purchases of peripheral sovereign debt via its Securities Markets Programme (SMP). Peripheral markets have rallied as a result.
3.Anything short of an announcement of such a resumption at next week’s ECB Governing Council meeting risks disappointing markets. Indeed, expectations have been raised further on reports that a package of additional measures (interest rate cuts, new liquidity operations) is being prepared in parallel for the August 2 ECB monetary policy meeting.
4.Thus far, we have assumed that the European Financial Stability Facility (EFSF) would be the authorities’ first line of defence in addressing sovereign market tensions. We continue to hold this view. Moreover, we anticipated that the ECB would act in a supportive manner towards sovereign markets should the EFSF take up its responsibility in this regard, for example by offering another longer tenor LTRO operation on a fixed rate / full allotment basis (thereby supporting Euro area banks’ purchase of peripheral sovereign debt). We also continue to hold this view. And recognising the limited capacity of the EFSF / ESM, we have assumed that ultimately the ECB’s balance sheet will need to be mobilised to fund financial support for vulnerable Euro area sovereigns. Our view here is also unchanged.
5.How then to interpret the (to us) surprising boldness of Mr. Draghi’s remarks in London last week? We see them as reflective of an accelerated pace of events, rather than a fundamental change of character. We organise our further analysis around two possible explanations for this acceleration: (a) that Mr. Draghi expects an imminent Spanish request for EFSF support, and therefore foreshadows ECB action as part of a more comprehensive policy response; and (b) that Mr. Draghi’s concerns about contagion and spillovers from sovereign funding tensions in Spain have become more acute.
The Spanish are coming
6.We had been working on the assumption that – with the Spanish sovereign pre-funded for several months yet – we would not see Spanish recourse to the EFSF until the early autumn, as the usual political prevarication prevailed.
7.Mr. Draghi was clearly aware of the market expectations he was creating last week; hence, his comments might suggest he is confident that the Spanish government will turn to the EFSF sooner than that, opening the way for new ECB actions in the coming weeks. Comments from the German and French governments in the aftermath of Mr. Draghi’s remarks, which point to the EFSF as the vehicle for addressing market tensions, would support this view.
8.We continue to doubt the ECB will act ahead of a Spanish request for EFSF support. A unilateral reactivation of SMP purchases of sovereign debt by the ECB in the form seen on past occasions risks being not only ineffective, but even counterproductive – for all the usual reasons:
- As Friday’s statement from the Bundesbank demonstrates, its resistance to central bank purchases of peripheral sovereign debt remains strong. The Bundesbank is not alone. Reigniting discord within the ECB’s decision-making bodies by restarting the SMP threatens to disrupt once again the ECB’s capacity to act on this and other dimensions of policy. And such discord inevitably implies commitment to such interventions is somewhat ambiguous, thereby undermining their effectiveness;
- Given how ECB holdings were treated in the Greek debt restructuring, subordination concerns understandably persist among market participants. Declarations of a willingness to take losses on SMP holdings ring hollow: actions speak louder than words in this context. While the ECB may have the opportunity to demonstrate such willingness sooner rather than later in the Greek context, the effectiveness of unilateral SMP purchases is questionable: they need to encourage rather than deter the natural longer-term holders of peripheral sovereign debt from re-entering this market;
- Above all, were the ECB to restart SMP purchases unilaterally, the incentive for the Spanish government to seek EFSF support – and accept the implied conditionality – would be reduced. An opportunity to hardwire the necessary consolidation, reform and adjustment into the institutional system would be lost. Broadly speaking, we take a positive view of the Spanish government’s policy programme. While we see scope for accelerating and deepening structural reform, if anything we view their envisaged fiscal adjustment as possibly too aggressive. But these measures have not arisen spontaneously: they have come in response to market pressure. For market pressure to be relieved by external financial support, we view the introduction of greater conditionality as crucial to maintain the momentum of adjustment.
- More generally, it has been a long-held ambition of the ECB to ensure governments have explicit financial involvement with regard to peripheral sovereign debt purchases via the EFSF, rather than leaving the ECB to take sole responsibility. And involving the EFSF introduces the necessary formal conditionality and political accountability to the process, which – as last year’s experience in Italy demonstrates – the ECB acting alone lacks.
9.As we have argued in the past, such concerns make us even more sceptical of proposals to cap peripheral sovereign yields or target spreads through an ECB commitment to potentially unlimited SMP purchases of peripheral government debt. Market participants seek the certainty offered by such an unconditional commitment to stabilise yields. Given the multiplicity of uncertainties they face at present, that desire is understandable. But such an unconditional commitment by the ECB renders public budget constraints very soft. Irrespective of their behaviour, governments are able to borrow at the rates pegged by the ECB, serving to create moral hazard and scope for ‘free-riding’ on others’ disciplined behaviour.
10.For the ECB in the current environment, this tension between satisfying markets and constraining government is inescapable. It lies at the heart of the difficult course the ECB has charted throughout the financial crisis. Managing the trade-off entails offering external financial support to governments in return for their acceptance of conditionality. Hence, involvement of the EFSF to provide political legitimacy to that conditionality appears crucial.
11.All this leaves the initiative for triggering the next steps in the hands of the Spanish government. Should a request for EFSF support be forthcoming ahead of or in parallel with the ECB Governing Council meeting next Thursday, it would open the door for the ECB to announce supportive measures on that occasion.
12.As we have said in the past, in parallel with EFSF purchases of Spanish sovereign debt subject to adherence to the conditionality expressed in the required Memorandum of Understanding (MoU), we would expect the ECB to support sovereign markets through a repeat of the longer-tenor LTROs that served this purpose earlier in the year. These fund banks to buy domestic sovereign debt in the primary market (where the ECB is prohibited by the Treaty from operating directly). The latest data reveal greater reluctance on the part of Spanish banks to increase their holdings of sovereign debt, while Italian banks continue to show a willingness to do so. In the former case, some ‘arm twisting’ may be required to ensure demand at sovereign auctions, but with public ownership of the Spanish banking sector on the increase, this should be possible.
13.Moreover, recognising the inadequate capacity of the EFSF in the face of sovereign tensions in Spain and / or Italy, we have argued that ultimately – and probably sooner rather than later –the ECB will be drawn into funding that vehicle. With considerations in the German Constitutional Court delaying the introduction of the EFSF’s permanent (and slightly larger) successor (the European Stability Mechanism, ESM) until at least mid-September, this concern will be particularly acute in the coming weeks.
14.We have always argued that the typical characterisation of how this funding would be provided – giving the EFSF / ESM a banking licence – was an unnecessarily clumsy and provocative route in the face of the well-known institutional and political sensitivities. Admittedly, having the ECB make outright government debt purchases via the SMP in parallel with EFSF / ESM interventions (as envisaged above) is not much (if any) better in this regard, but nevertheless has returned to the discussion. A less controversial scheme, perhaps involving the publicly-owned development banks of the larger Euro area countries, could be found. But these institutional and legal niceties should not detract from the underlying economic reality: one way or another, the ECB’s balance sheet has been and will be mobilised to support sovereign funding. As reflected in the preceding discussion, the crucial question concerns the terms on which this funding is provided.
Addressing contagion (1): Cross-country sovereign spillovers
15.All this assumes that Spain will request EFSF support. Yet German Finance Minister Schaeuble is reported on Saturday as saying a Spanish request for EFSF support is not imminent, as Spain does not face immediate funding problems. And in this Mr. Schaeuble is correct. Having taking advantage of the post-LTRO euphoria in the first quarter, the Spanish government has pre-funded itself, probably through early October. On Spain’s part, there is no urgency to seek external financial support.
16.But Spanish tensions have implications elsewhere. One rationale for immediate ECB action is to contain potential contagion across countries. After all, the introduction of the SMP back in May 2010 stemmed from the concerns that disorder in Greek sovereign markets was dragging down ‘innocent bystanders’ with more modest fundamental problems, simply because of adverse market dynamics. In his London remarks, Mr. Draghi appeared to endorse this line by reviving discussion of the need to re-establish an effective transmission of monetary policy throughout the Euro area.
17.Italy is the most pressing case in this regard. With a primary fiscal surplus, even from its initial high level of sovereign debt the Italian fiscal situation is sustainable – provided that outstanding debt can be rolled over at reasonable rates. But this crucial condition is not met in the current challenging environment. Political pressure is therefore building in Italy: despite accepting the pain of fiscal austerity (and suffering a deep and prolonged recession as a result), Italy has not been rewarded by the markets or by their European partners.
18.In his London comments, Mr. Draghi referred to the impact of ‘convertibility risk’ on interest rates, yields and financial conditions. These remarks are consistent with our own interpretation of recent developments: as the risk of Euro exit has mounted through the crisis, a redenomination risk has become embedded in some asset prices. Uncertain as to what a paper Euro-denominated asset originating from the periphery really represents, foreign investors have been unwilling to hold, still less buy, such assets – and peripheral financial conditions have tightened significantly as a result. Viewing the emergence of this redenomination risk as a systemic problem of which Spanish funding tensions are simply a symptom, one can argue that a systemic solution is required. However well Spain and Italy behave, they are victims of a systemic problem over which they have limited influence.
19.The impact of such systemic considerations could justify ECB actions to contain sovereign spreads. But unfortunately for ECB policy makers, spreads do not come with labels. As we have argued in the past with respect to the distinction between liquidity and solvency risks, a grey area exists between spreads arising from systemic risks and those coming from country-specific economic fundamentals. Attempts to cap sovereign spreads run foul of the dangers expressed above: while they can offset the impact of systemic risks beyond the country’s control, they can also induce free-riding and moral hazard.
20.Conditionality is therefore required. And that leads us back to the role of the EFSF/ ESM in providing the political legitimacy for such conditionality. In the end, the elimination of redenomination risk requires fundamental changes that prompt long-term private holders of sovereign debt back into peripheral markets. Introducing incentive problems makes achievement of that goal harder rather than easier.
Addressing contagion (2): Spillovers from public- to private-sector financing
21.Concerns about spillovers from Spanish sovereign funding tensions not only extend to other countries, but also to the Spanish private sector. Mr. Draghi’s remarks about the impairment of the monetary policy transmission mechanism reflect the extremely difficult financing conditions facing Spanish companies and households, and weak pass-through of official ECB rate cuts to the Spanish real economy. Our own recent analysis of the relationships among official interest rates, bank lending rates and sovereign yields support these concerns. And we have demonstrated that these concerns are not unique to Spain: similar issues arise in Italy and the rest of the periphery.
22.One approach to addressing this problem is to reduce the sovereign spreads that are associated with higher bank funding costs and financial market dislocations. SMP purchases of sovereign debt are a natural vehicle for the ECB to use in that context. But such an approach immediately runs into the problems identified above: the effectiveness of such interventions will be greater the less conditional they are, but the risk of free-riding by the fiscal authorities will be greater.
23.An alternative approach would be to bypass the sovereign spreads and support private-sector financing directly. With its broad and widening definition of collateral eligibility, purchases of bank covered bonds and 3-year LTROs, the ECB has already engaged in variants of this approach, a path now being mimicked by some other central banks. But scope exists to go further.
24.Collateral eligibility could be relaxed again and the haircuts imposed on collateral values reduced. Indeed, the ECB is already engaged in a review of its collateral framework: we anticipate that this will look to remove sovereign credit ratings from the system, in an attempt to eliminate the ‘cliff risk’ inherent in the current system. While the rationale for such a measure may be systemic, it is undoubtedly convenient in the specific circumstances faced by Spain now. And a review of the collateral system offers scope to make more aggressive easing measures elsewhere. Further longer-tenor LTRO operations could be envisaged, out to 5 or 10 years.
25.But, particularly in Spain, the efficacy of such measures is open to question. With the replacement of private unsecured financing with funding from the ECB’s 3-year LTROs against eligible collateral, assets on Spanish bank balance sheets have become encumbered. While bank funding at ECB operations is now cheap and readily available, insufficient free collateral is available to exploit this. Buying covered bonds – as the ECB has done in the past – does not help in this respect (as it also, by nature, involves encumbering bank assets), while changes in collateral eligibility and haircuts have a marginal impact.
26.Outright central bank purchases of unsecured bank debt – something that we have discussed previously – would address this issue. They would support banks’ balance sheet flexibility and facilitate the flow of credit to bank-dependent (and thus credit-starved) small and medium-sized enterprises (SMEs), particularly if marginal incentives were introduced to expand new credit and direct it towards SMEs. Of course, despite the recapitalisation scheme being put in place in Spain, other constraints (notably capital problems) weigh on banks’ ability to lend. And credit demand is weak. So such measures are not a panacea. But in a bank-dependent economy where the traditional interest rate channel of monetary policy transmission is impaired by market segmentation, they may be the most effective tools available. And the prospect of assuming responsibility for banking supervision across the Euro area may make the ECB more willing to act aggressively through the banks.
27.Extending the chain of logic developed above, this would point to the desirability of bypassing not only the sovereign space, but also the banking system by buying corporate debt. Admittedly corporate debt markets in the periphery are underdeveloped. But were the ECB to initiate purchases, issuance would no doubt quickly follow. And financing the larger corporates that are able to issue would improve their working capital position and thereby indirectly ease financing pressures on their SME suppliers as payment periods normalise.
28.A natural objection to outright purchases of assets issued by the private sector is that they involve the assumption of too much credit risk by the ECB. But substantial risk is already assumed via credit operations. And, by their nature, credit easing measures involve the assumption of credit risk. The more aggressive the measure, the greater risk assumed. If – as the macro data suggest – Spain and Italy need substantial stimulus, then imparting that via credit easing means that a lot of risk will need to be taken. And given the present segmented state of Euro area financial markets, for a given willingness to accept risk, it may be preferable to make targeted interventions in the countries and sectors where tensions are most acute – even if this means the risks inherent in any single position is greater.
29.The risk assumed can also be distributed across countries in a politically acceptable manner. As with the risk associated with the national schemes for bringing unrated corporate loans as collateral introduced last December, one could envisage the ECB approving a set of voluntary national private asset programmes proposed by NCBs to reflect their particular circumstances, where the credit risk in those operations remained on the NCB balance sheet. Of course, this would not eliminate the risk faced by Germany and the Bundesbank: to the extent that such purchases create TARGET 2 balances (which is likely to be significant), the Bundesbank would still suffer losses in the event of Euro break-up or a peripheral country exit. But the idiosyncratic risks associated with an individual purchase (or indeed any cyclical or sectoral risk that does not lead to exit) would fall on the peripheral country alone, and not on Germany or other Euro area countries. (Of course, in some respects this is a disadvantage: only the ‘catastrophe risk’ is mutualised, but other forms of risk are concentrated at the national level. Thus the risk sharing benefits of a more integrated financial sector are forgone.)
30.Such a scheme allows NCBs to undertake quasi-fiscal action (since credit easing is a form of public subsidy) and monetise the fiscal consequences (by expanding their balance sheets). NCB purchases of private-sector assets (within a framework overseen by the ECB that leaves the credit risk inherent in such operations lying on the NCB balance sheet) offer scope for surgical interventions targeted to address the most impaired elements of monetary policy transmission, while limiting the potential adverse consequences for incentives (especially of governments). Cosmetically, such measures will add to the impression of a renewed Balkanisation of monetary policy in the Euro area. But, with Euro financial markets deeply segmented, such targeted measures offer a way of managing the consequences of that segmentation for the private sector and real economy while maintaining the pressure for governments to act on fundamentals in a manner that reduces and ultimately eliminates the segmentation over time.
Tags: Bank Debt, Bank Of Japan, Central Planner, Corporate Debt, Credit Operations, Credit Risk, Downside, ECB, Escalation, Goldman, Governing Council, Huw, Japanization, Mario Draghi, Monetization, Private Assets, Rational Person, Substantial Risk, Taxpayer Risk, Whole Lot
Posted in Markets | Comments Off
Monday, May 7th, 2012
One can call the BOJ inefficient, slow and for the most part utterly worthless, but one can certainly not accuse them of lying, and beating around the bush. Because unlike all other central banks, with the BOJ at least it has been fully public knowledge that this particular central bank unlike all others (wink wink), is actively engaged in buying equity products, among them REITs and broad equity ETFs (which provide much explicit tail-wags-dog leverage and explains why the FRBNY’s red phone hotline goes directly to Citadel’s ETF trading desk).
And buy stocks on full tilt and in record quantities is precisely what the BOJ just did, only as one can expect, with absolutely no impact on the broader stock market. Because once even the central bank is exposed as participating in the market, the element of surprise is gone, and the central bank becomes just one mark (if one with a largish balance sheet).
As MarketWatch reports, “The Bank of Japan stepped back into the stock market Monday, making its largest single-day purchase of exchange-traded funds to date… The Japanese central bank said it spent 39.7 billion yen (about $500 million) buying up stock ETFs as part of its ongoing asset-purchase program, breaking a previous record of ¥28.5 billion, set on April 16. In addition to the ETF buys, the Bank of Japan also acquired ¥2.3 billion in real-estate investment trusts Monday.”
Too bad that this latest outright bull in a Japan store (sic) intervention had zero impact: “the move failed to prevent a sharp fall for the Tokyo equity market.” But at least they are honest. Imagine the shock and horror (and complete lack of apologies to all those who have predicted just that) when the world finally gets a trade confirm-based proof that Brian Sack was indeed buying (never selling) SPYs and ES. Why everyone would be truly shocked, SHOCKED, that the Fed is nothing but another two-bit gambler in a rigged and broken casino.
For those who are unaware of Japan’s explicit but at least forthright approach to asset price manipulation, read on:
Japan’s monetary authority is almost unique among its peers in the major developed economies, in its high-profile purchases of ETFs, which it began in December 2010 as part of aggressive easing measures.
Since then, the Bank of Japan has bought almost ¥1 trillion worth of ETFs — along with another ¥78.9 billion in REITs — and has an additional ¥642 billion to spend on the stock funds after raising the program’s size at it last policy meeting in April.
The central bank emphasizes that the program has only broad goals such as supporting interest rates and reducing risk premiums, rather than supporting financial markets.
Jefferies Japan’s head of Japanese strategy Naomi Fink says that while the ETF purchases are really part of the broad push to reflate asset prices in the deflation-plagued country, they do “provide a bit of a backstop, when they think they can curb the downside” for the market.
“Still, it’s a very small amount,” Fink said of the ETF purchases. “It’s more designed to bolster sentiment … [and] it works best when sentiment is fragile.”
As a tangent here, do these “strategists” even listen to what they sound like? “Very small amount”… “designed to bolster sentiment.” Oh ok. That makes everything so much better. It is just too bad that a Martingale strategy where one has an infinite balance sheet is not all that available to everyone in the world, except to 5 or 6 market participants of course, all of whom are incentivized to destroy their currencies and ramp their “inflation-sensitive” assets ever higher. Surely that according to Jefferies is perfectly acceptable.
Sentiment was certainly fragile Monday, as investors returned from a four-day holiday weekend to find the yen considerably stronger — a negative factor for Japan’s export-focused corporations — U.S. employment growth weaker than expected, and European election results raising more uncertainty for the euro zone.
And while investors don’t find out about the Bank of Japan’s market operations until after the close of trading, “there’s a market assumption that when the Topix falls more than 1%, that triggers ETFs,” according to Fink.
Still, Fink advised against trying to front-run the central bank by jumping into the market whenever the Topix — Japan’s key broad-market index — drops 1%.
And whatever you do kids, remember: frontrunning central banks is not to be tried at home…
“I wouldn’t exactly call that my favorite strategy,” she said, adding that since the ETF-buying program isn’t meant to be a “price-keeping operation,” it offers little in the way of trading opportunities.
… After all that’s what Primary Dealers are for: and since they make sure that no bond auctions can ever fail (courtesy of the $30 trillion custodial asset cloud, which desperate economists have pegged fancy post-modernist theories to explain how infinite supply can generate infinite+1 demand without having the faintest clue of how the shadow banking system works) there naturally has to be some kickback in it for them. Because otherwise one of them might even speak up and tell the rest of the world just how much of a fraud the system truly is.
And yes, the BOJ IS completely open about what they buy and how much:
Tags: Asset Purchase, Bank Of Japan, Beating Around The Bush, Buy Stocks, Central Banks, Element Of Surprise, Equity Products, ETFs, Exchange Traded Funds, Frbny, Full Tilt, Japan Store, Japanese Central Bank, Phone Hotline, Public Knowledge, Real Estate Investment, Real Estate Investment Trusts, Spys, Tail Wags, Wink Wink
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Wednesday, April 18th, 2012
Nothing dramatic here, but the Chairman of the fermentation committee [Cashin] just has that unique flair for explaining things so simply, even an economics Ph.D., a caveman, or the other kind of ‘Chairman’, would understand…
The Not So Clandestine War Among The Central Banks - Back in Philosophy class in the 5th grade, the instructor in Epistemology used to have an interesting parable on problems of perception.
The thesis went something like this: Suppose you are an alien and have been told about the game of chess. Due to a technicality, however, your equipment would only allow you to see one square on the board. Over the course of the game any, or all, the pieces might arrive on your square.
You might see a Knight or a Bishop; a Rook or a Queen or a Pawn, but you would never know where it had come from nor where it had gone when it disappeared. You never got quite enough information to envision the entire board or the concept of the game.
I was reminded of the parable as I have watched the actions of some key central banks over the last few years.
According to the financial media, each central bank is easing aggressively to serve a need of the area it serves.
The Fed is easing to help employment and the housing market in the U.S. The ECB is easing to help it banks, sinking under sovereign debt problems. The People’s Bank of China is easing to avoid a hard landing. The Bank of Japan is easing to restart an economy that has been dormant for two decades.
Those may be the official lines but cynics think there may be more to the game than is seen through this telescope. Cynics think it’s all about the currencies.
The thinking is that each bank would like to see its currency weaken to make its exports more attractive. It doesn’t stop there. With Europe being China’s biggest trade partner, some believe the PBOC is the bid under the Euro at 1:30, keeping the Euro strong enough to make Chinese goods attractive.
The currency influences of the other central banks may be a bit more subtle but no less effective or intense. No trade war yet but lots of drilling and marching.
Actually that is not true. from Mercopress: “US and EU considering WTO actions against Argentine ‘protectionist practices”
The US and forty countries which formalized a joint statement before the World Trade Organization complaining about Argentina’s trade restrictions are considering moving a step further and begin a “disputes settlement” process which could lead to an open condemnation if the administration of President Cristina Kirchner does not lift the protectionist network.
According to Buenos Aires daily Clarin quoting WTO sources in Geneva, “expectations are that it will be the US that presents the “disputes settlement” process since the White House was the main sponsor of the joint statement. The process could end with a formal condemnation of Argentina opening the way for commercial reprisals”.
In the March joint statement presented by the US and forty other leading countries the main complaints against Argentina included the non automatic licences system; the previous sworn statement registry to obtain the approval of an imports operation and the policy forcing companies to apply the ‘dollar-to-dollar’ mechanism which means they have to export a dollar for each dollar import.
Once the disputes settlement begins there is a period of consultations in which in this case Argentina must prove it has not infringed WTO rules, and if no agreement is reached a three member panel is named, chosen by the litigants or WTO Director General Pascal Lamy.
Time for some blogger-cum-budding author (which is about 99% of all) to write a currency wars sequel: Trade Wars: The Final Frontier.
Tags: Art Cashin, Bank Of China, Bank Of Japan, Caveman, Central Banks, Chinese Goods, Clandestine War, Cynics, Debt Problems, ECB, Epistemology, Game Of Chess, Parable, Pboc, Philosophy Class, Problems Of Perception, Rook, Sovereign Debt, Technicality, Trade Partner
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Monday, April 9th, 2012
Tomorrow will bring the end of a two-day policy meeting at the Bank of Japan which SocGen expects will result in the announcement of additional easing measures. Whether medium-term macro-economic issues or short-term risk tolerance fading weighs heavier on their minds as their efforts from the previous easing announced on Feb 14 are rapidly losing their effectiveness – especially evident in their recent inability to restrain JPY appreciation (which notably JPM believes will continue on the back of a disconnect between Commitment of Traders positioning and the JPY carry divergence – via Bloomberg’s chart-of-the-day). Critically the exchange rate is a cornerstone of BoJ policy and while risk-off will drive JPY appreciation via carry unwinds (in a purely technical world) the political, currency, and economic factors that SocGen lays out suggests strongly that the BoJ (under increasing attack from politicians for its failure to reflate the economy) will bring out yet another bazooka to show its worth – and prove this time is different even as we noted here with inflationary concerns rising. Lastly, will JPY lose its carry-trade attractiveness and implicitly its impact on US equities even if they do ease dramatically or when will the market/politicians lose patience with a drip-drip-drip approach and side with China’s view of a rising devaluation risk as we noted here recently.
Societe Generale: Further Easing Likely
We have previously predicted that the BoJ would maintain a wait-and-see stance for the time being. However, we now expect the Monetary Policy Meeting scheduled for April 9-10 to result in additional easing measures. There are three reasons why Japan’s central bank will opt to implement monetary easing measures next week.
1) Political factors:
The BoJ reform proposal revealed by the Liberal Democratic Party (LDP), Japan’s leading opposition party, will push Prime Minister Noda into a difficult position. Under the proposed reform, the BoJ will be required to end deflation with a specific time limit, and the government may dismiss BoJ executives when the central bank fail to meet its objective. This would naturally be unacceptable for the BoJ. But unless the BoJ adopts a clear stance as a deflation fighter, Mr. Noda will find it difficult to oppose the LDP’s reform bill. Many Diet members within the Democratic Party of Japan (DPJ) also appear to support the aims of the reform bill, and Mr. Noda will want to avoid any proliferation of issues that could divide the party. In this sense, both the BoJ and the Noda cabinet would benefit considerably if the central bank decides to implement monetary easing measures at this time and to maintain its deflation fighter stance.
2) Currency factors:
Since 2009, the BoJ has focused on the exchange rate as its channel for influencing the real economy through monetary policies. All of the key shifts in the BoJ’s monetary policy over the past few years, including the introduction of 3-month fixed-rate operations with a price stability goal centering on 1% in December 2009, the establishment of the Asset Purchase Program in October 2010, and more recently the adoption of an inflation goal in February 2012, have been targeted toward the reversal of expectations of a higher yen. The easing of monetary policy in February 2012 triggered a shift in the trend toward a higher yen, but the effects appear to have waned in recent weeks. The BoJ can stave off the emergence of high yen expectations by indicating that it cannot rule out additional easing measures.
3) Economic factors:
In 2012, the Japanese economy is expected to achieve high growth thanks to the stimulatory effect of reconstruction demand. We are predicting 2.4% growth in this calendar year and 2.6% in the fiscal year ending March 2013. However, reconstruction demand will start to fade in 2013 and beyond, and the economy will also come under considerable downward pressure from the consumption tax increase in 2014. Japan needs to ensure that the baton is passed smoothly from reconstruction demand to other sources of demand, especially capital investment and consumer spending. BoJ could help ensure such transition through holding down the expected real interest rate with the combination of keeping its virtually zero nominal interest rate and higher inflation expectation. Since it takes between six months and year for the effects of monetary easing to permeate through to the real economy, it is appropriate to implement easing measures now in anticipation of an economic slowdown in 2013.
Specific easing measures
What measures would be appropriate if the BoJ decides to implement monetary easing measures on April 10?
Raising the inflation goal to 2%?…
As indicated in the minutes for February 14, the BoJ appears to be considering an increase in the inflation goal from 1% to “a positive range of 2% or lower.” Lifting the inflation goal posts to 2% would certainly strengthen the effectiveness of the policy interest rate along the time axis. We believe that the inflation goal should be moved to 2% in the medium/long-term perspective. However, Japan’s CPI remained at the low end of the 1% range even during the bubble era of the early 1990s, while the average for the period since 1980 is just 0.5%. It would be necessary to think carefully about whether a CPI rate of increase in the high end of the 1% range would be appropriate for Japan. Furthermore, trends in the OIS market already suggest that the rate is unlikely to rise for about five years, which means that there would be little benefit in terms of strengthening the time axis.
An increase in the Purchase Program…
An increase in the Purchase Program, especially for government bonds, seems an appropriate way for the BoJ of ease monetary policy at this stage. If purchases are increased by around ¥5 trillion, it would be necessary to expand the scope of purchasing, which is currently limited to bonds up to two years, to include bonds up to five years. However, we do not believe that the BoJ needs to specify this next week. The announcement of an increase in the Purchase Program would be sufficiently effective in its own right. The prices of risk assets, such as stocks, purchases of which have not increased recently, are now higher than previously. It would not be inappropriate to include a certain amount of these assets in the scope of purchasing as a way of emphasizing the BoJ’s stance as an inflation fighter.
Tags: Attractiveness, Bank Of Japan, Bazooka, Boj, Carry Trade, Commitment Of Traders, Devaluation Risk, Drip Drip Drip, Economic Factors, Economic Issues, Ldp Japan, Liberal Democratic Party, Noda, Opposition Party, Political Factors, Reform Proposal, Risk Tolerance, S Central, Societe Generale, Term Macro
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Wednesday, March 21st, 2012
In today’s Globe and Mail, Martin Middlestaedt says the Japanese yen’s 40-year bull market is at a turning point. He also writes about betting against (shorting) the yen and in favour of risky assets. The recent decline (Dennis Gartman believes this is a trend to hitch hike on) of the yen is not only a welcome break for Japanese exporters, and currency speculators wishing to capitalize on its falling valuation; it is a welcome development (risk-on) for hedge funds, as it provides a basis for a resurgence in short-yen carry trades.
Here are some snippets:
- Dennis Gartman, is convinced that the long advance of the yen is finally over. He’s urging investors to sell the currency short, a trade he thinks will work for years as Japan’s economic problems continue to grow and the currency takes a drubbing.
- “I think it’s the trade of the next 10 years,” says Mr. Gartman of the Gartman Letter, a market advisory service. “The yen is doomed fundamentally. Japan just has so many problems, none of which are going to go away anytime soon.”
- Its government debt is twice the size of its GDP, the scariest ratio in the developed world. To make matters worse, its lofty currency is an obstacle for its exporters, it has been fighting persistent deflation, and its population is aging rapidly.
- “This is one of the slowest moving train wrecks in the history of finance, but we’re just not quite sure when it clicks over,” says Andrew Busch, global currency strategist at Bank of Montreal’s investment arm.
- Camilla Sutton, chief currency strategist at Scotia Capital, says sentiment “used to be quite bullish for yen for a very long time,” but the market view has “turned wildly negative just over the last few weeks.”
- Much of the yen weakness occurred after the Bank of Japan said in February that it would buy ¥10-trillion worth of government bonds – in effect printing money to finance the government’s debt.
- Another approach advocated by Mr. Gartman has been to buy futures contracts on gold and other commodities and simultaneously sell Japanese yen futures. If he buys contracts representing $1 million in gold, he then sells futures contracts on yen worth $1 million. “You create your own synthetic derivative” that allows purchases of assets in yen terms, he says of the strategy. “Generally I think you should buy assets in yen terms across the board.”
- These somewhat complicated trades will have supersized payouts if the yen falls and the various commodities rise, but will suffer large losses if the yen strengthens and commodity prices weaken.
- Mr. Gartman says there is an additional reason the yen will likely continue to be weak: Japanese companies want a cheaper currency to make exports more competitive. “Clearly, the Japanese corporate structure wants a weaker yen. They’re obviously cheering this on.”
Source: Globe and Mail
Tags: Andrew Busch, Bank Of Japan, Bank Of Montreal, Currency Speculators, Currency Strategist, Dennis Gartman, Development Risk, Directional Flow, Equilibrium Equation, Gartman Letter, Global Currency, Globe And Mail, Globe Mail, Government Bonds, Hitch Hike, Investment Arm, Japanese Exporters, Japanese Yen, Moving Train, Printing Money, Risky Assets, Scotia Capital, Train Wrecks, Welcome Development
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Sunday, March 11th, 2012
Appreciating China to its Fullest
By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors
Wine expert and social media guru Gary Vaynerchuk attributes his ability to detect subtleties in wine that others might not recognize because of his unique taste-testing as a teen. Because drinking wine was illegal, he says he tasted the flavors associated with wine instead. He not only ate fruits and vegetables, but also chewed on chunks of grass, dirt, tobacco and wood so he could learn to recognize the complex flavors that wine has to offer.
For investors, an appreciation of China requires a similar comprehensive analysis.
One significant subtlety that seems to be overlooked by investors today is China’s macro policy strategy. Professor Stephen Roach in the Financial Times thinks the country has been “doing a far better job in managing its economy than most give it credit.” Its actions have been deliberate and purposeful, and, most important, successful. He points to measures that China enacted to lower food inflation, along with the numerous times the country raised required reserve ratios and policy interest rates as illustrations of China’s increasing “prowess” in stabilizing its economy.
The positive results of the government’s actions have a delayed effect, only to be detected a few months later. For example, the chart below shows how the food and non-food consumer price index (CPI) have declined on a year-over-year basis over the past several months. CPI is now at its lowest level since July 2010, says CLSA.
With inflation now under control, China is stocked with other possible monetary policy actions to help growth in 2012, as opposed to the central banks of the U.S., Europe and England, which have run empty. “They have followed the Bank of Japan and taken their short-term policy rates down to the zero bound,” Roach says.
Perhaps the sommeliers have become the students: Rather than the developed countries’ central banks providing directives to China on ways to grow its economy, maybe it should be the other way around. Roach says that China “offers some lessons in macro policy strategy that the rest of the world should heed.”
Roach concludes that “long focused on stability, [China] is more than willing to accept the short-term costs of a growth sacrifice to keep its development strategy on track.”
Jim Rogers has also identified many attractive nuances of China, which he believes China Bears are missing. When the legendary international investor was interviewed this week by Business Insider, he pointed to the country’s long history of “entrepreneurship [and] capitalism, they have the brains, they have the know-how” as reasons to be bullish.
Its likely China will experience setbacks as it grows, says Rogers. After centuries of decline, the country just recently experienced a rebirth when Deng Xiaoping led China toward a market economy in 1978. Growth is still in its early stages. However, each time China data appears slightly off, bears are quick to doubt Beijing’s ability to successfully navigate its economic terrain.
When Premier Wen Jiabao announced this week that the government’s targeted GDP growth was expected to be 7.5 percent, it wasn’t a surprise to seasoned China followers. Andy Rothman of CLSA says it was consistent with his expectations. Premier Wen’s message came as “neither a surprise nor a signal that the Communist Party believes growth is decelerating beyond what we had expected.” Rothman also doesn’t think Wen’s speech signaled additional stimulus either.
Sometimes a target is just a target: China’s GDP has always grown more than what was projected. Take a look at the chart below. The yellow line shows how China has conservatively set its target GDP growth for the past decade. Every year, actual GDP growth has been higher and much higher in some cases. For example, in 2007, while the government projected GDP to grow 8 percent, actual GDP growth came in much higher at 14 percent.
While most analysts don’t expect another moon shot rise in GDP this year, a 7.5 percent growth rate still exceeds most emerging economies and all developed nations. Advanced economy growth is expected to be meager, slowing from 1.6 percent to 1.3 percent in 2012, according to The Conference Board.
Since the new year, the MSCI China Index has risen about 11 percent. This increase comes after a 2011 decline of nearly 20 percent. However, last year’s sell off continues to provide bargain basement prices for some Chinese stocks, as the index is trading at an attractive price-to-earnings level, says Deutsche Bank. While the 10-year P/E has averaged 12.5 times, the 12-month forward price-to-earnings for the MSCI China index is currently at 9.1 times.
Deutsche Bank strategists say with “very healthy” GDP growth and moderate inflation, the “macro fundamentals should easily justify a further rerating of the forward P/E to 10.5 times” by the end of 2012. This valuation suggests that the MSCI China could increase 15 percent from its March 8 level, says Deutsche Bank.
For long-term investors learning to appreciate the finer points of the country, we believe China is somewhat like fine wine; it only gets better with age.
Tags: Bank Of Japan, Central Banks, Chart Below Shows, Chief Investment Officer, Consumer Price Index, Drinking Wine, Flavors, Frank Holmes, Fruits And Vegetables, Guru Gary, Index Cpi, Macro Policy, Media Guru, Monetary Policy Actions, Policy Interest, Reserve Ratios, Stephen Roach, Taste Testing, U S Global Investors, Wine Expert
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Albert Edwards: JPY Devaluation Exacerbates Risk of China Hard Landing, Drags them into Currency war
Thursday, March 8th, 2012
“What do people think will happen if another recession strides into sight any time soon? We are a hair’s breadth or, more exactly, one recession away from a market panic on outright deflation — a panic that will send the central banks into a printing frenzy that will make their balance sheet expansion so far seem like a warm-up act for the main show.” Albert Edwards in his latest note, taking a look at wage inflation (or lack thereof) in the United States:
Edwards calls the current environment the “Ice Age reality of ever lower nominal quantities” and references Lakshman Achuthan of ECRI’s recent interview in which he reaffirmed his call for a recession in the U.S. as well as John Hussman’s latest comment, which discusses the same.
Albert Edwards’ Soc Gen colleague Dylan Grice in his most recent note described the decision behind the Bank of Japan’s latest move to ease further, weakening the yen. Further, current inflation expectations remain below target in many DM economies, providing central banks further justification to continue printing.
Edwards notes that Asian currencies like the Korean won haven’t been taken down by the BoJ move yet due to the risk rally that’s played out so far this year, but sees that changing if markets reverse. Then, Edwards points out that “if the yen’s decline takes other Asian currencies lower, it would leave the renminbi as the anomalously strong currency in the region – much to the annoyance of the Chinese authorities,” like so:
This, of course, will not sit well with Chinese authorities, who are currently dealing with a renminbi at all-time highs in real terms, which is necessarily foreboding for the Chinese export situation:
Edwards on the inevitable consequences:
We have long stated that if the Chinese economy looks to be hard landing, as we believe it will, the authorities there will actively consider renminbi devaluation, despite the political consequences of such action. The renminbi devaluation option is widely ignored by the markets in the same way they ignore the likelihood that the Chinese economy is hard landing. The devaluation option should be seen as “in play” however unthinkable it is believed to be at present.
And a China-U.S. trade imbalance also residing at all-time highs on a seasonally adjusted basis, one can imagine the effect China’s forceful entry into the race to the bottom might have on the United States. Edwards concludes:
The BoJ-inspired slide in the yen could accelerate now that a major chart point has been breached — foreign exchange trading being the asset class most dominated by chartists. And to the extent that this spills over into other regional currencies, clearly this can only exacerbate the risk of a China hard landing. Investors seem reassured by the recovery in some of the Chinese PMI data recently. Yet looking at things like M1 growth and sliding house prices both nationally and in some of the key provinces does not reassure. For many mid-1990s Asian commentators, the weak yen between 1995 and 1997 helped trigger the Asian currency crisis. We may have just come full circle!
Tags: All Time Highs, Asian Currencies, Bank Of Japan, Central Banks, Chinese Authorities, Chinese Economy, Chinese Export, Colateral, Currency War, Devaluation, Ecri, Grice, Inevitable Consequences, Inflation Expectations, John Hussman, Lakshman, Market Panic, Renminbi, Target, Wage Inflation
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Wednesday, February 29th, 2012
by Bob Doll, Chief Equity Strategist, BlackRock
Markets Climb to 12-Month Highs
Stock prices rose again last week, although at a more labored pace than has been the case for most of 2012. For the week, the Dow Jones Industrial Average rose 0.3% to 12,982 (and did move above the psychologically important 13,000 level a few times), the S&P 500 Index advanced 0.3% to 1,365 and the Nasdaq Composite climbed 0.4% to 2,963. With these gains, markets have reached new 12-month highs and have rallied close to 25% from their low point of October 2011.
A Quiet Week for the Economy, But Good News Nonetheless
It was a relatively subdued week in terms of economic data, with the highlight perhaps being the weekly initial unemployment claims, which were unchanged (a stronger-than-expected result). This data helps confirm that improvements in the labor market have been gaining traction. This Friday we will see the February employment report and most economists are calling for a new jobs number of 200,000 or higher with a flat or perhaps slightly lower unemployment rate.
One area of the economy that has long been troubled is the residential housing sector, but this area of the economy is beginning to show some limited signs of improvement. New home sales, mortgage applications and home building levels are all showing some gains and the large inventory of unsold homes is beginning to clear. We believe that the housing market remains in the midst of a multi-year bottoming process that began in 2009 and we expect that residential construction will be a modest positive contributor to growth in 2012, as it was last year.
From a global perspective, the world economy has experienced a decent start to 2012, but the ongoing recovery does have some risks and question marks. Fiscal policy remains tight in some quarters of the globe and there is still room for easing (as we saw with the Bank of Japan’s recent decision to enact some new quantitative easing measures). Additionally, ongoing debt deleveraging remains a concern, as does the recent move higher in oil prices. Of course, we would also add the ongoing European debt crisis to the list of issues that could potentially disrupt the global economy’s positive momentum.
Climbing Oil Prices Spark Concerns
Several of the risks that we have been discussing for some time now have ebbed over the last several months, such as the removal of the uncertainty over the US payroll tax cut extension, some additional clarity over the Greek debt restructuring and China’s policy easing and likely economic soft landing. An additional risk, however, has surfaced in the form of higher oil prices. The oil price spike from early 2011 is fresh in investors’ minds and the recent advance in oil prices has some wondering whether history will repeat itself. Last year’s price spike came as a result of social and political unrest throughout the Middle East and in North Africa and this year escalating geopolitical tensions with Iran has been the primary culprit.
While higher oil prices are unambiguously a negative for global economic growth and have the potential to act as a drag on equity markets, the scale of the recent increase has still been relatively modest. To put it in context, oil prices have advanced by around 20% over the last few months. In contrast, oil jumped 50% between September 2010 and March 2011. While higher oil prices bear watching, we would not consider oil a significant risk unless the price increase grows more severe.
Further Gains for Stocks?
The impressive advance we have seen in stock prices over the past several months has largely come about from a string of positive economic news and the absence of the emergence of additional downside risk. In other words, a few months ago, stocks were priced for a weaker macro environment than the one that has come to pass. So what will it take for stocks to continue to move higher? We believe we would need to see some broader improvements in economic data and/or further political progress in terms of reducing macro uncertainty.
Regarding that second point, last week’s announced Greek debt restructuring deal should help reduce some uncertainty, assuming the measures are successfully implemented. There was little market response to the announced deal as it generally met investors’ expectations and there is still more work to be done on this front. We expect the situation in Greece to worsen from both a fiscal and social perspective, but we also believe that the debt restructuring will move forward.
Equity risk premiums have fallen in recent months as markets have rallied and we do believe that there is room for further advances. At the same time, however, we expect the pace of price appreciation to become slower and more uneven. As we have been saying for the last couple of weeks, we would not be surprised to see some sort of pullback or correction in the near term, but we also believe that stock prices will end the year higher than where they are today.
About Bob Doll
Bob Doll is Chief Equity Strategist for Fundamental Equities at BlackRock® a premier provider of global investment management, risk management and advisory services. Mr. Doll is also Lead Portfolio Manager of BlackRock’s Large Cap Series Funds. Prior to joining the firm, Mr. Doll was President and Chief Investment Officer at Merrill Lynch Investment Managers.
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Sources: BlackRock, Bank Credit Analyst. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 27, 2012, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.
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Tags: Bank Of Japan, Bob Doll, Dow Jones, Dow Jones Industrial, Dow Jones Industrial Average, Economic Data, Employment Report, Fiscal Policy, Global Perspective, Housing Market, Initial Unemployment Claims, Mortgage Applications, Nasdaq Composite, New Jobs, Question Marks, Residential Construction, Stock Prices, Strategist, Unemployment Rate, World Economy
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Sunday, February 26th, 2012
By Eric Sprott & David Baker
2012 is proving to be the ‘Year of the Central Bank’. It is an exciting celebration of all the wonderful maneuvers central banks can employ to keep the system from falling apart. Western central banks have gone into complete overdrive since last November, convening, colluding and printing their way out of the mess that is the Eurozone. The scale and frequency of their maneuvering seems to increase with every passing week, and speaks to the desperate fragility that continues to define much of the financial system today.
The first major maneuver took place on November 30, 2011, when the world’s G6 central banks (the Federal Reserve, the Bank of England, the Bank of Japan, the European Central Bank [ECB], the Swiss National Bank, and the Bank of Canada) announced “coordinated actions to enhance their capacity to provide liquidity support to the global financial system”.1 Long story short, in an effort to avert a total collapse in the European banking system, the US Fed agreed to offer unlimitedUS dollar swap agreements with the other central banks. These US dollar swaps allow the other central banks, most notably the ECB, to borrow US dollars from the Federal Reserve and lend them to their respective national banks to meet withdrawals and make debt payments. The best part about these swaps is that they are limitless in scope – meaning that until February 1, 2013, the Federal Reserve is, and will be, prepared to lend as many US dollars as it takes to keep the financial system from imploding. It sounds absolutely great, and the Europeans should be nothing but thankful, except for the tiny little fact that to supply these unlimited US dollars, the Federal Reserve will have to print them out of thin air.
Don’t worry, it gets better. Since unlimited US swap lines weren’t enough to solve the problem, roughly three weeks later, on December 21, 2011, the European Central Bank launched the first tranche of its lauded Long Term Refinancing Operation (LTRO). This is the program where the ECB flooded 523 separate European banks with 489 billion euros worth of 3-year loans to keep them going through Christmas. A second tranche of LTRO loans is planned to launch at the end of February, with expectations for size ranging from 300 billion to more than 1 trillion euros of uptake.2 The good news is that Italian, Portuguese and Spanish bond yields have dropped since the first LTRO went through, which suggests that at least some of the initial LTRO funds have been reinvested back into sovereign debt auctions. The bad news is that the Eurozone banks may now be hooked on what is clearly a back-door quantitative easing (QE) program, and as the warning goes for addictive drugs – once you start, it can be very hard to stop.
Britain is definitely hooked. On February 9, 2012, the Bank of England announced another QE extension for 50 billion pounds, raising their total QE print to £325 billion since March 2009.3 Japan’s hooked as well. On February 14, 2012, the Bank of Japan announced a ¥10 trillion ($129 billion) expansion to its own QE program, raising its total QE program to ¥65 trillion ($825 billion).4 Not to be outdone, in the most recent Fed news conference, US Fed Chairman Bernanke signaled that the Fed will keep interest rates near zero until late 2014, which is 18 months later than he had promised in Fed meetings last year. If Bernanke keeps his word, by the end of 2014 the US government will have enjoyed near zero interest rates for six years in a row. Granted, extended zero percent interest rates is not nearly as satisfying as a proper QE program, but who needs traditional QE when the Fed already buys 91 percent of all 20-30 year maturity US Treasury bonds?5 Perhaps they’re saving traditional QE for the upcoming election.
All of this pervasive intervention most likely explains more than 90 percent of the market’s positive performance this past January. Had the G6 NOT convened on swaps, had the ECB NOT launched the LTRO programs, and had Bernanke NOT expressed a continuation of zero interest rates, one wonders where the equity indices would trade today. One also wonders if the European banking system would have made it through December. Thank goodness for “coordinated action”. It does work in the short-term.
But what about the long-term? What are the unintended consequences of repeatedly juicing the system? What are the repercussions of all this money printing? We can think of a few.
First and foremost, without continued central bank support, interbank liquidity may cease to function entirely in the coming year. Consider the implications of the ECB’s LTRO program: when you create a loan program to save the EU banks and make its participation voluntary, every one of those 523 banks that participates is essentially admitting that they have a problem. How will they ever lend money to each other again? If you’re a bank that participated in the LTRO program because you were on the verge of bankruptcy, how can you possibly trust other banks that took advantage of the same program? The ECB’s LTRO program has the potential to be very dangerous, because if the EU banks start to rely on the loans too heavily, the ECB may find itself inadvertently attached to the broken EU banking system forever.
The second unintended consequence is the impact that interventions have had on the non-G6 countries’ perception of western solvency. If you’re a foreign lender to the United States, Britain, Europe or Japan today, how comfortable can you possibly be in lending them money? How do you lend to countries whose sole basis as a going concern rests in their ability to wrangle cash injections printed by their respective central banks? Going further, what happens when the rest of the world, the non-G6 world, starts to question the G6 Central Banks themselves? What entity exists to bailout the financial system if the market moves against the Fed or the ECB?
The fact remains that there are few rungs left in the financial confidence chain in 2012, and central banks may end up pushing their printing schemes too far. In 2008-2009, it was the banks that lost credibility and required massive bailouts by their respective sovereign states. In 2010-2011, it was the sovereigns, most notably those in Europe, that lost credibility and required massive bailouts by their respective central banks. But there is no lender of last resort for the central banks themselves. That the IMF is now trying to raise another $600 billion as a security buffer doesn’t go unnoticed, but do they honestly think that’s going to make any difference?6
When reviewing today’s macro environment, we keep coming back to the same conclusion. The non-G6 world isn’t blind to the efforts of the Fed and the ECB. When the Fed openly targets a 2 percent inflation rate, foreign lenders know that means they will lose, at a minimum, at least 2 percent of purchasing power on their US loans in 2012. It therefore shouldn’t surprise anyone to see those lenders piling into alternative assets that have a better chance at protecting their wealth, long-term.
Tags: Bank Of Canada, Bank Of England, Bank Of Japan, Central Banks, David Baker, Debt Payments, Eric Sprott, European Banking System, Eurozone, Firs, Fragility, Global Financial System, Investment Outlook, Last November, Liquidity Support, Maneuvers, National Banks, Swiss National Bank, Thin Air, Unintended Consequences
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