Negative Interest Rates
It’s almost BoJ comprehensive assessment time with Kuroda’s massive JGB purchases and NIRP policy standing naked beneath the spotlights awaiting judgement from their own creators. Part of that judgment involves the pain that a NIRP and QQE induced flattening of the yield curve has wrought on financials. Thus, as we’ve talked about already, part of the recommended remedy might involve some sort of Japanese Operation Twist to steepen said yield curve and help out said financials. Of course, the range of things the BoJ can actually do is large and the subject of predicable disagreement. So before we get to the yield curve question, here’s some summary for those who want it. Those who don’t can skip down to below the breaks.
The short answer: Both bondholders and issuers could be in an awkward spot. Many corporate bonds have “floors” in place, which means their coupon payments can’t go below zero. But in a recent note, S&P Global Market Intelligence calls attention to a host of floating-rate securities that don’t have coupon floors.
Janet Yellen opened the festivities at this year’s Jackson Hole economic symposium by musing on what central bankers had learned since the crisis and how they can deal with future recessions in a world where interest rates are far lower than in the past. Unsurprisingly, bond-buying and “forward guidance” featured prominently in Yellen’s narrative of successful new tools. (On the other hand, scholars have estimated the combined impact of these measures was an unemployment rate a mere 0.13 percentage points below where it would have been using purely conventional instruments.)
For most of human history, financiers believed in the sanctity of the Lower Bound, imagining that if we crossed from the world of positive interest rates into the Hades of negative numbers all manner of disasters would befall society. In the real world, it took six years of fallout from a global financial crisis to push us boldly below zero; in the FT Alphaville Fantasy Football League world, it took barely a fortnight.
Fine, the Japanese stock market maybe isn’t paying attention to the Bank of Japan the way it used to. But did things have to get this mean? From CLSA’s Benthos: Faced with the problem of when to fire its last bullet, the Bank of Japan decided to fire half a bullet at half-cock. Now, speculators will be free to take liberties, fortified by the knowledge that the BoJ has only enough powder left to miss the mark one more time. The yen surged derisively. Governor Haruhiko Kuroda warned he has ample room to extend bankkiller Nirp. Three years after saying he’d achieve 2% inflation in two years, he said he would achieve 2% inflation in two years. It seems the BoJ has entered the Age of Impotence.
Or moved into riskier assets by the ECB’s corporate bond buying machine (CSPP to its friends). Resistance may be futile but we’ll have to wait to make sure. To move into those riskier assets you’d like to think that eventually the search for yield will become a real, worthwhile thing in Europe again. And not everyone buys that – Credit Suisse for example point out that over the last 2.5yrs in particular government bonds (bunds) have outperformed both high and low yielding credit assets. Their point is that “the time to hunt for yield as a dominant strategy (rather than as a short-term trade) might actually be when yields start to rise.” But BofAML’s European credit team think it’ll maybe happen a bit sooner:
This is a guest post from Richard Koo, chief economist of the Nomura Research Institute and, amongst many other things, author of “The Holy Grail of Macroeconomics, Lessons from Japan’s Great Recession”, which lays out his balance sheet recession thesis in detail. The post is an updated extract from his most recent note for Nomura and reproduced here, with his permission, for your arguing pleasure… The US, the UK, Japan, and Europe all implemented quantitative easing (QE) policies, but the understanding of how those policies work apparently differs greatly from country to country, leading to very different outcomes. With the US economy doing better than the rest, there has been some debate in Europe as to why that is the case.
Despite popular belief, we take no comfort in the decline in interest rates and argue that it should be viewed as a bad sign. So says Shyam Rajan of BoAML’s liquidity insight report team, and in so doing echoes the thoughts and sentiments of probably the entire banking industry. We’ve noted before – channeling Paul Krugman, no less — that zero rates (even more so negative rates) are not a banker’s cup of tea. Indeed, with little capacity to pass negative rates onto customers, the lower for longer scenario compromises hallowed net interest margins, the key source of predictable and sustained revenue for banks. All other services from origination to advisory collect one-off based fees. As great and balance-sheet light as they may be, they’re variable and thus unpredictable, hence inconsistent with the historical reason for buying bank stock.
From Citi’s global head of G10 strategy, Steven Englander, who wonders if markets have begun pricing another round in: US economic data have been soggy, other than labor market data, which means that we get one positive data release a month followed by a series of disappointments. This is reflected in the Citi’s economic surprise index (Figure 1), which has been dropping since mid‐April and where a 0 level would be considered strong outperformance. My conjecture is that investors have begun to price out June/July hiking risk they are beginning to reject the view that there is a high‐probability fed funds path that is as shallow as the market is pricing in. If you really think that a full hike is not likely until May 2017 (as is now priced in), you have to think there is a non‐negligible probability that the economy is so bad that you would want to cut.
Jefferies: Japan has a fever and the only prescription is NGDP targeting and zero coupon perpetual bonds
We’re paraphrasing a bit in the headline but Jefferies do think the Japanese authorities are in a corner, painted in by a strengthening yen, tighter monetary conditions and a drop in inflation expectations.
The first question is whether there was a lovely new, but secret, currency accord agreed at the G20 in Shanghai in February. The answer is: Probably not.
This post will be made up of two pieces. The first will try to explain why JPY continues to defy Japan’s negative rate-led demand for currency weakness. The second will add words to this picture from HSBC which proclaims a break in the (so-called, he adds hastily) currency wars, predicated mostly on said JPY strength: At last sighting JPY was hovering at about Y108. That’s not good if you are the BoJ’s Kuroda or the overarching Abe, particularly because FX strength can beget more FX strength. The question is why did the yen start this slide:
A qualified defense of negative rates effects on banks’ net interest margins, you say? Go on then. From Andrew Garthwaite and team at Credit Suisse…
By Nomura first, who are worried that Japan’s economy has taken a dangerous turn — what with GDP dropping at an annualised rate of 1.4 per cent in the fourth quarter and Abenomics being felt for a pulse:
It seemed so plausible. Break through the zero lower bound and ta dah! A new scale of economic stimulus can be engineered. And yet, as the likes of us, Frances Coppola and even Downfall Hitler have been warning for a number of years, this was always a silly presumption because negative carry creates an entirely different incentive structure to that of a positive carry world. Notably, it encourages predation, monopolisation, hoarding and in some cases, even contraction as opposed to growth.
It’s all a bit messy at the moment — European banks, Japanese banks post the BoJ’s move negative, er other stuff — but it’s not really clear what’s actually going on. This seems like a decent list of possibilities, from Citi’s Steven Englander: We think the following concerns are weighing on the market. 1. US economic fragility means there is no one to depreciate against 2. Too many simultaneous issues and policy coordination unlikely. 3. QE/negative rates have lost their financial market impact, 4. QE/negative rates have lost their economic impact 5. QE/negative rates are constrained by bank profits But his colleague Matt King has a somewhat more involved, if not entirely separate, explanation for what he says is, at the surface, an orderly sell-off but which hides a number of indicators under “extreme stress”. Basically, it’s all about bank balance sheets coming under pressure. Less basically, he suggests these dislocations “raise awkward questions about the entire narrative which led to the wave of post-crisis bank regulation.”
Imagine someone told you about a country where real output per person is at an all-time high and growing at an increasingly rapid pace, its employment rate is at the highest level in decades, the country’s housing sector is on fire, and its current account surplus is about 6 per cent of GDP. In the absence of other information, would you say this country should be: If you answered yes to the above questions, congratulations! You’ve just described the behaviour of the Sveriges Riksbank. From their policy announcement on Thursday (our emphasis):
From Reuters: LONDON, May 3 (Reuters) 13.04 – The euro pared gains while German Bund futures edged up on Friday after European Central Bank policymaker Ewald Nowotny said the central bank was open-minded about taking deposit rates into negative territory. Nowotny said he was “astonished” by the market’s reaction to his comments earlier in the day, when he said negative deposit rates were not relevant in the near term.