We have two big central bank meetings this week–BOJ and the Fed. With that, as we head into the week, let’s look at a key chart.
This chart is from a St. Louis Fed blog post last year. The inflation data, however, is all up-to-date. The Fed says “the chart above shows eight series that receive a lot of attention in the context of policy.”
So according to this chart, last year, as the Fed was building into its first rate hike to move away from emergency level rates and policies, the inflation data was looking soft. The Fed was telegraphing, clearly, a September hike, though six of the eight inflation measures in the chart above were running south of their target of 2% in the middle of last year. The headline inflation number for September, their preferred date of a hike, was zero!
Of course, after markets went haywire following China’s currency devaluation in August of last year, the Fed balked and stood pat. When things calmed, in December, they made their move. And at the same meeting, they projected to hike FOUR times this year. So far it hasn’t happened. It’s been a one and done.
Moreover, as of March of this year, they took two of those projected hikes off the table, and guided lower on growth, lower on inflation and a lower rate trajectory into the future. I would argue removing two hikes from guidance was effectively easing.
But if we look at the chart above, where inflation stands now relative to the middle of last year, when they were all “bulled-up” on rates, the story doesn’t jive. By all of the inflation measures, the economy is clearly running hotter (a relative term). Five of the eight inflation measures are running ABOVE the Fed’s 2% target (the horizontal black line in the chart). Yet, aside from a few Fed hawks that have been out trying to build expectations for a rate move soon, on balance, the messaging from the Fed has been mixed at best, if not dovish.
The Bernanke-led Fed relied heavily on communication (i.e. massaging sentiment and perception) to orchestrate the recovery, but the Fed, under Yellen, has been a communications disaster.
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Global markets continue to swing around today. Remember, the past couple of days we’ve looked at the three most important markets in the world right now: U.S., German and Japanese 10-year government bonds.
In recent days, German and Japanese debt have swung back into positive territory. That’s a huge signal for markets, and it’s sustaining today – with German 10-year yields now at +8 basis points, and Japanese yields hanging around the zero line, after six months in negative territory.
Stocks are on the slide again, though. And the volatility index for stocks is surging again. Those two observations alone would have you thinking risk is elevated and perhaps a “calling uncle” stage is upon us and/or coming down the pike, especially if it’s a bubbly bond market. If that’s the case, gold should be screaming. It’s not. Gold is down today, steadily falling over the past five days.
So if you have a penchant for understanding and diagnosing every tick in the markets, as the media does, you will likely be a little confused by the inter-market relationships of the past few days.
That’s been the prevailing message from the Delivering Alpha conference today in New York: Confusion. Delivering Alpha is another high profile, big investor/best ideas conference. There are several conferences throughout the year now that the media covers heavily. And it’s been a platform for big investors to talk their books and, sometimes, get some meaningful follow on support for their positions.
Interestingly, one of the panelist today, Bill Miller, thinks we’ll see continued higher stocks, but lower bonds (i.e. higher yields/rates). Miller is a legendary fund manager. He beat the market 15 consecutive years, from the 90s into the early 2000s.
Miller’s view fits nicely with the themes we talk about here in my daily notes. Still, people are having a hard time understanding the disconnect between this theme and the historical relationship between stocks and bonds.
Let’s talk about why …
Historically, when rates go up, stocks go down — and vice versa. There is an inverse correlation.
This see-saw of capital flow from stocks to bonds tends to happen, in normal times, when stocks are hot and the economy is hot and the Fed responds with a rate hiking cycle. The rate path cools the economy, which puts pressure on stocks. That’s a signal to sell. And rising rates creates a more attractive risk-adjusted return for investors, so money moves out of stocks and into bonds.
But in this world, when the Fed is moving off of the zero line for rates, with the hope of being able to escape emergency policies and slowly normalize rates, they aren’t doing it with the intent of cooling off a hot economy (as would be the motive in normal times). They’re doing it and praying that they don’t cool off or destabilize a sluggishly growing economy. They’re hoping that a slow “normalization” in rates can actually provide some positive influence on the economy, by 1) sending a message to consumers and businesses that the economy is strong enough and robust enough to end emergency level policy. And by 2) restoring some degree of proper function in the financial system via a risk-free yield. Better economic outlook is good for stocks. And historically, when rates are lower than normal (under the long term average of 3% on the Fed Funds rate), P/E multiples run north of 20 – which gives plenty of room for multiple expansion on expected earnings (i.e. supports the bullish stocks case).
That’s why I think stocks go higher and rates go higher in the U.S. I assume that’s why Bill Miller (the legendary fund manager) thinks so too. It all assumes the ECB and the BOJ do their part – carrying the QE torch, which translates to, standing ready to act against any shocks that could derail the global economy.
But even if the Fed is able to carry on with a higher rate path, they continue to walk that fine line, as we discussed yesterday, of managing a slow crawl higher in key benchmark market rates (like the 10-year yield). An abrupt move higher in market rates would undo a lot of economic progress by killing the housing market recovery and resetting consumer loans higher (killing consumer spending and activity).
After the past two weeks, that included a Fed decision, more BOJ action, the approval of Japanese fiscal stimulus, a rate cut and the return to QE for the Bank of England, and a strong jobs report, this week is a relative snoozer.
With that, every headline this week seems to contain the word Trump. Clearly the media thought a post by the former Fed Chairman, the architect of the global economic recovery and interventionist strategies that continue to dictate the stability of the global economy (and world, in general) today, wasn’t quite as important as Trump watching.
On Monday, Ben Bernanke wrote a blog post that laid out what appears to be his interpretation of a shift in gears for the Fed – an important message. Don’t forget, this is also the guy that may have the most intimate knowledge of where the world has been over the past decade, what it’s vulnerable to, and what the probable outcomes look like for the global economy. And he’s advising one of the biggest hedge funds in the world, the biggest bond fund in the world and one of the most important central banks in the world (at the moment), the Bank of Japan. And it’s safe to assume he still has influence plenty of influence at the Fed.
My takeaway from his post: The Fed’s forward guidance of the past two years has led to a tightening in financial conditions, which has led to weaker growth, lower market interest rates and lower inflation.
Why? Because people have responded to the Fed’s many, many promises of a higher interest rate environment, by pulling in the reins somewhat.
To step back a bit, while still in the midst of its third round of QE, the Fed determined in 2012, under Bernanke’s watch, that words (i.e. perception manipulation) had been as effective, if not more, than actual QE. In Europe, the ECB had proven that idea by warding off a bond market attack and looming defaults in Spain and Italy, and a collapse of the euro, by simply making promises and threats. With that in mind, and with the successful record of Bernanke’s verbal intervention along the way, the Fed ultimately abandoned QE in favor of “forward guidance.” That was the overtly stated gameplan by the Fed. Underpin confidence by telling people we are here, ready to act to ensure the recovery won’t run off of the rails — no more shock events.
The “forward guidance” game was working well until the Fed, under Yellen, started moving the goal posts. They gave a target on unemployment as a signal that the Fed would keep rates ultra low for quite some time. But the unemployment rate hit a lot sooner than they expected. They didn’t hike and they removed the target. Then they telegraphed their first rate hike for September of last year. Global markets then stirred on fears about China’s currency moves, and the Fed balked on its first rate move.
By the time they finally moved in December of last year, the market was already questioning the Fed’s confidence in the robustness of the U.S. economy, and with the first rate hike, the yield curve was flattening. The flattening of the yield curve (money moving out of short term Treasuries and into longer term Treasuries, instead of riskier assets) is a predictor of recession and an indicator that the market is betting the Fed made/is making a mistake.
And then consider the Fed’s economic projections that include the committee’s forecasts on interest rates. By showing the market/the world an expectation that rates will be dramatically higher in the coming months, quarters and years, Bernanke argued in his post that this “guidance” has had the opposite of the desired effect — it’s softened the economy.
So in recent months, starting back in March, the Fed began dramatically dialing back on the levels and speed they had been projecting for rates. It’s all beginning to look like the Fed should show the world they are positioned to well underestimate the outlook, rather than overestimate it, as it’s implied by Bernanke. The thought? Perhaps that can lead to the desired effect of better growth, hotter inflation.
This post by Bernanke is reversing some of the expectations that had been set in the market for a September or December rate hike by the Fed. And the U.S. 10-year yield has, again, fallen back — from 1.62% on Monday to a low of 1.50% today. Still, the Fed showed us in June they expect one to two hikes this year. Given where market rates are, they may still be overly hawkish.
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Yesterday we walked through some charts from key global stock markets. As we know, the S&P 500 has been leading the way, printing new highs this week.
U.S. stocks serve as a proxy on global economic stability confidence, so when stocks go up in the U.S., in this environment, there becomes a feedback loop of stability and confidence (higher stocks = better perception on stability and confidence = higher stocks …)
That said, as they begin to capitulate on the bear stories for stocks, the media is turning attention to opportunities in emerging markets. But as we observed yesterday in the charts, you don’t have to depart from the developed world to find very interesting investment opportunities. The broad stock market indicies in Germany and Japan look like a bullish technical breakout is coming (if not upon us) and should outpace gains in U.S. stocks in second half of the year.
Now, over the past few weeks, we’ve talked about the slide in oil and the potential risks that could re-emerge for the global economy and markets.
On Wednesday of last week, we said this divergence (in the chart below) between oil and stocks has hit an extreme — and said, “the oil ‘sharp bounce’ scenario is the safer bet to close the gap.”
Sources: Billionaire’s Portfolio, Reuters
Given this divergence, a continued slide in oil would unquestionably destabilize the fundamentals again for the nascent recovery in energy companies.
With that, and given the rescue measures that global central banks extended in response to the oil bust earlier this year, it was good bet that the divergence in the chart above would be closed by a bounce back in oil.
That’s been the case as you can see in the updated chart below (the purple line rising).
Sources: Billionaire’s Portfolio, Reuters
At the peak today, oil had bounced 11% in just five trading days. Oil sustaining above the $40 is key for the stability of the energy industry (and thus the quelling the potential knock-on effects through banks and oil producing sovereigns). Below $40 is the danger zone.
In a fairly quiet week for markets (relative to last week), there was a very interesting piece written by former Fed Chairman Ben Bernanke yesterday.
Tomorrow we’ll dig a little deeper into his message, but it appears that the Fed’s recent downgrade on what they have been projecting for the U.S. economy (and the path of policy moves) is an attempt to stimulate economic activity, switching for optimistic forward guidance (which he argues stifled activity) to more pessimistic/dovish guidance (which might produce to opposite).
Remember, we’ve talked in recent months about the effect of positive surprises on markets and the economy. We’ve said that, given the ratcheting down of earnings expectations and expectations on economic data, that we were/are set up for positive surprises. Like it or not, that’s good for sentiment. And it’s good for markets. And it can translate into good things for the economy (more hiring, more investment, more spending).
The positive surprises have been clear in earnings. It’s happening in economic data. It looks like the Fed is consciously playing the game too.
This is the perfect time to join us in our Billionaire’s Portfolio, where we follow the lead of the best billionaire investors in the world. You can join us here.
Today we want to look at some key charts as we head into the week.
First, to step back a bit, as we started last week, we had some big market events ahead of us. Japan was due to approve a big fiscal stimulus plan. The Bank of England was meeting on rates and the U.S. jobs report was on the docket to wrap up the first week of August.
As we discussed Thursday, the BOE announced they’ve returned to the QE game. Japan doubled the size of its stock buying plan. And the jobs report came in Friday with another solid report. As we thought, despite the volatility in the monthly numbers the media likes to overanalyze, the longer term trend continues to clearly argue the health of the job market is in good shape, and not a legitimate concern for the Fed’s rate path.
All together, the events of the week only solidified reasons to be long stocks.
Most importantly, stocks have been, and continue to be, a key tool for central bankers in this global economic recovery. They want and need stocks higher. A higher stock market provides fuel for economic activity by underpinning confidence and wealth creation, which encourages hiring, spending and more investment.
With that, as we’ve said, this is the sweet spot for stocks, where good news is good news for stocks (better outlook triggers capital flows out of cash and bonds, and into stocks), and bad news is good news for stocks (it triggers more stimulus).
When it comes to stocks, back on May 25th, we said “everyone could benefit by having a healthy dose of ‘fear of missing out.’ Stock returns tend to be lumpy over the long run. When we you wait to buy strength, you miss out on A LOT of the punch that contributes to the long run return for stocks.”
Fast forward to today, and the S&P 500 has printed yet another new record high.
But the horse is not already out of the barn on global stocks (including U.S. stocks).
Let’s take a look at the chart on the S&P 500…
Sources: Billionaire’s Portfolio, Reuters
You can see, we’ve broken out in U.S. stocks (very bullish).
Next, in the UK, the place people were most afraid of, just a little more than a month ago, traded near 14-month highs today and is nearing a breakout to record highs, with support of fresh central bank easing from the Bank of England.
Sources: Billionaire’s Portfolio, Reuters
In the next two charts, we can see the opportunities to buy the laggards, in areas that have been beaten down on broader global economic concerns, but also benefiting directly from domestic central bank easing.
In the chart below, you can see German stocks have fallen hard from the highs of last year, but have technically broken the corrective downtrend. A return to the April highs of last year would be a 19% return for current levels.
Sources: Billionaire’s Portfolio, Reuters
In the next chart, Japanese stocks also look like a break of this corrective downtrend is upon us. A return to the highs of last year would be a 25% run for the Nikkei. As we discussed last week, the sharp ascent in the chart below from the lower left corner of the chart can be attributed to the BOJ’s QE program, which first included a 1 trillion yen stock buying program and was later tripled to three trillion (a driver of the run from around 15k to 21k in the index). Last week, that stock buying program was doubled to six trillion yen.
Sources: Billionaire’s Portfolio, Reuters
Given the trajectory of the charts above (global stocks), which both promote and reflect global confidence, and the given lack of consequence that QE has had on meaningful inflation, the world’s inflation-fear hedge, gold, looks like its run into brick wall up here.
Sources: Billionaire’s Portfolio, Reuters
Remember, we have a convergence of fresh monetary policy in the world this year, with fiscal policy in Japan, and the growing appetite for fiscal policy in other key economies. That’s powerful fuel for global economic growth, risk appetite and stocks.
This is the perfect time to join us in our Billionaire’s Portfolio, where we follow the lead of the best billionaire investors in the world. You can join us here.
As we’ve said, oil has been quietly sliding over the past three weeks. It closed yesterday more than 20% off of the highs of the year.
And we looked at this chart and said, this divergence has hit an extreme, something has to give.
Source: Billionaire’s Portfolio, Reuters
Yesterday it was stocks. Today it was a sharp bounce in crude – up 4%. The oil “sharp bounce” scenario is the safer bet to close the gap on the chart above.
Alternatively, oil under $40 puts it in the danger zone for the global economy and broad financial market stability. With that, we had a close in the danger zone, under $40, yesterday. But it may turn out to be just a brief visit.
If we look at the longer term chart, the 200 day moving average comes in right in this $40 area ($40.67). Again, we had a close below yesterday, but a close back above the 200 day moving average today.
Sources: Billionaire’s Portfolio, TradingView
For technicians, two consecutive closes below the 200 day moving average would create some concern for this post-oil price bust recovery.
In that case, many companies in the struggling energy sector would be back on bankruptcy watch. But the global economic recovery can’t afford another bout with weaker oil prices, and the ugly baggage that comes with it (oil company defaults, which would lead to financial system instability and sovereign defaults). If two of the best billionaire oil traders in the world are right about oil, and we see $80 in the next year, this dip is a great buying opportunity (for the underlying commodity and energy stocks).
Tomorrow, we hear from the Bank of England. The expectations are that the BOE will cut rates to support economic activity in the face of Brexit uncertainty. But there’s also a decent bet being wagered that the BOE will return to QE (a second post-global financial crisis bond buying program). History tells us that, in this environment, central banks like to save bullets for the moments when crisis and fear is peaking. With that, the BOE may disappoint tomorrow. If so, it could pour some gas on the nascent rise in market rates that started yesterday in Japanese, German and American 10-year yields.
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Yesterday we pointed to the renewed risk that oil represented for stocks.
The persistent bleed in the price of oil for the past three weeks has been with little attention. Even the energy stocks, which have had huge runs since oil bottomed in February, were largely ignoring the slide in the most significant input for those businesses.
As we said yesterday, oil continued to leak lower, even as stocks printed a fresh record high yesterday. As oil went out at the key $40 level, the divergence between oil and stocks had reached an extreme. We said something has to give.
Today, it’s been stocks. Stocks have fallen back, following the lead of further declines in crude — which settles BELOW $40 today.
Why is oil important for stocks?
As we’ve said in a world where stability is king, central bankers have been very sensitive to swings in key financial markets, with the idea that confidence and the perception of stability can quickly become unhinged by market moves. When that happens, it becomes a big, viable threat to the global economic recovery and outlook.
Now, we’ve talked a lot about the divergence between yields and stocks too. In this post-global financial crisis world, when people feel better about the global outlook, they take risk. That means they buy stocks and they move money OUT of the “safe-haven” treasury market. That means yields should move higher, while stock move higher.
That hasn’t been the case. Yields have continued to trade toward the record lows in recent weeks, even as stocks have traded to new record highs. Why? It’s being driven by capital flows and speculation related to central bank action in Japan and Europe. U.S. Treasuries are offering both a relative safe haven, and a positive yield in a world of negative yields. That keeps freshly printed global money flowing into U.S. Treasuries, which drives up price, and drives down the yield.
With that, logic has again been tossed on its head today. Stocks are falling, along with oil. This is typically a trigger for some elevated risk aversion. One would think Treasuries would be rallying today, pushing yields lower. It has been the opposite.
It may have a lot to do with the fiscal stimulus package that was approved today (overnight) in Japan. The central banks have had the pedal pinned to the floor on monetary policy for the better part of the past seven years, and they’ve gotten no help from governments on fiscal stimulus. Today’s move in Japan may represent a changing of the stimulus guard. With that, the bet on lower yields is being reversed, not just in the U.S., but in Europe and Japan.
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In our Billionaire’s Portfolio we followed the number one performing hedge fund on the planet into a stock that has the potential to triple on an upcoming event.
This fund returned an incredible 52% last year, while the S&P 500 was flat. And since 1999, they’ve done 40% a year. And they’ve done it without one losing year. For perspective, that takes every $100,000 to $30 million.
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We make investing easy. We follow the guys with the power and the influence to control their own destiny – and a record of unmatchable success. And you come along for the ride.
Stocks printed another fresh record high in the S&P 500 today before falling back. As we discussed Friday, the BOJ undershot expectations last week, because many thought anything short of full blown debt monetization (to coincide with fresh fiscal stimulus to be approved this week) was a disappointment.
But doubling the size of ETF purchases was kind of a big deal, especially if you consider where their stock buying program has come from (1 trillion yen), where it is now (6 trillion yen), and what it has meant for the performance of Japanese stocks (and global stocks).
Still, just as the Fed opened the door last week to a September rate hike, the BOJ opened the door to a revamp of its current QE program in September.
Remember, the last time the BOJ came in with a doubling down on their QE program (a QE2 for the BOJ) was in October of 2014. That same month, the Fed ended its QE program. As we’ve said, the Fed has only had the confidence to end emergency policies (that includes the beginning of a tightening cycle) because they know the BOJ is there to take the QE torch.
Now, with earnings season nearing an end, we’ve now heard from a majority of the companies in the S&P 500, and the positive earnings surprises continue to provide fuel for stocks.
When earnings reports were kicking off in the middle of last month, we said: “Among the reasons we’ve thought stocks look well underpinned and the economy could be in the early stages of a boom, is that the bar has been set so low, in terms of expectations, that we’re set up for positive surprises — both in earnings and economic data. Surprises create changes in outlooks. And ‘change’ is the primary catalyst that moves/reprices markets.
Last earnings seasons 72% of the companies in the S&P 500 beat expectations. Still, companies dialed down expectations coming into the second quarter. Wall Street then lowers its bar. And they beat.
Like it or not, that’s how Wall Street works and has always worked. FACTSET says on average (the five-year average) 67% of companies in the S&P 500 beat their analyst expectations. And they beat by an average of 4%….As we know, better than expected earnings are fuel for stocks.”
So now 71% of the companies that have reported have beaten expectations on earnings for the past quarter. And 57% have beaten on revenues. The media will continue to point to the lower decline in earnings compared to last year and wonder why stocks are going higher. But, again, that information was priced in, and stocks reprice on change. And earnings beats represent change/ new information.
This week we have another jobs report. Non farm payrolls/job creation is the data point that market participants and the media have been trained for decades to over analyze/over-emphasize. We’ve had and will have undershoots and overshoots on the number. But for the Fed, an unemployment rate around 5% and non farm payroll number averaging 200k a month, the jobs data is in pretty good shape.
The biggest risk to stocks in the very near term is oil. We talked about keeping a close eye on the slide in oil, a market that was, at one point earlier this year, THE most important market in the world.
On that note, we said, “in a world where stability is king, central bankers have been very sensitive to swings in key financial markets, with the idea that confidence and the perception of stability can quickly become unhinged by market moves. When that happens, it becomes a big, viable threat to the global economic recovery and outlook.”
At $26 oil was threatening another global financial crisis. It bounced aggressively after the BOJ stepped in and intervened in USDJPY back in early February. Oil bottomed that day, so did stocks. Soon thereafter, oil doubled and stocks have printed fresh record highs.
But oil has been moving lower in recent weeks. As we said, this will grow in importance, and send negative signals, if it were to continue lower.
It has indeed continued to slide, closing today just above $40. We’ve looked at this chart of oil and the S&P 500.
Sources: Billionaire’s Portfolio, Reuters
When the oil price bust was threatening economic stability, stocks were moving almost tick for tick with the slide in oil. But we’ve had some significant divergence in the past few weeks, with oil going lower and stocks going higher. And oil trades $40 today, which is a huge level. Expect this gap to close, with either a slide in stocks, or a nice bounce on the retracement in oil. We bet on the latter.
Don’t Miss Out On This Stock
In our Billionaire’s Portfolio we followed the number one performing hedge fund on the planet into a stock that has the potential to triple on an upcoming event.
This fund returned an incredible 52% last year, while the S&P 500 was flat. And since 1999, they’ve done 40% a year. And they’ve done it without one losing year. For perspective, that takes every $100,000 to $30 million.
We want you on board. To find out the name of this hedge fund, the stock we followed them into, and the catalyst that could cause the stock to triple by the end of the month, click here and join us in our Billionaire’s Portfolio.
We make investing easy. We follow the guys with the power and the influence to control their own destiny – and a record of unmatchable success. And you come along for the ride.
The Bank of Japan acted last night, but it wasn’t the bazooka-type response markets were hoping for. But it may be the response stock investors were hoping for. The yen denominated Nikkei actually finished UP on the day. And German and U.S. stocks have fared well too.
As we’ve said, in this environment, what’s good for stocks has a powerful effect on global economic stability, because it positively influences confidence. And confidence can lead to a lot of good economic fuel (spending, hiring, credit creation, investment, etc). And the BOJ action last night may end up being very good for stocks.
To step back a bit, the Bank of Japan launched their big monetary stimulus program back in April of 2013, promising to pump about 112 trillion yen (that’s about 1.4 trillion dollars, with a T) into the economy. As part of that plan, they announced they would buy 1 trillion yen worth of ETFs in Japan (i.e. they would outright buy stocks).
Stocks lifted off. The Nikkei ran from 9k to as high as 16k, nearly doubling over the next SIX months. By October of 2014, the economy was still flat, inflation was still dead. And the BOJ surprised by announcing a big expansion of what was already a huge undertaking. As part of that expansion, they announced they would TRIPLE the annual ETF purchases — going to 3 trillion yen a year.
Stocks lifted off again, climbing from the mid 15k level in the Nikkei 225 to as high as 21k in just eight months.
All the while, stocks in the U.S. (and other leading economies) tracked the path of Japanese stocks.
Here’s a chart of the Japanese stocks and U.S. stocks from 2012 (when Japan first telegraphed its big new plan) to the end of last year. You can see the clear influence of Japanese monetary policy.
Sources: Billionaire’s Portfolio, Reuters
Early this year, Bloomberg estimated that the BOJ owned more than half of the ETF assets in Japan, and is a top 10 holder in 90% of the stocks in the Nikkei 225. And with that, the Japanese stock market, as of mid last year, had tripled from the 2012 pre-BOJ QE levels. U.S. stocks have gone up 55% since.
Now the BOJ is doubling down.
So, the BOJ launched with a trillion yen ETF buying program – Japanese stocks rose almost 80%. They added another 2 trillion to that number in 2014 — Japanese stocks rose 35%. And last night, they just announced they will double that number — adding another 3 trillion yen for a total of 6 trillion yen in ETF purchases a year.
Japan will approve a huge spending plan next week, and with more fuel for stocks from the BOJ (and likely a resumption of a falling yen — another place the BOJ has been clearly engaged), perhaps the response last night was not as disappointing as most have thought.
As we’ve discussed, the big event of the week is the Bank of Japan decision on monetary policy tonight. Today the speculation is that Abe presented his big government spending plan earlier than expected, and bigger than expected, to put pressure on the Bank of Japan to act now, rather than later.
But as we discuss in today’s note, the Bank of Japan is run by a governor hand selected by Abe. It’s fair to think they are on the same page.
Today we want to revisit some of our past analysis on why this event is so meaningful to global markets and the global economy. The stakes are high.
As we know, where the Fed left off on its global economic stimulus, the Bank of Japan has picked up. QE hasn’t had the punch to growth that central bankers initially thought it might, but it has indirectly driven the global economic recovery, by restoring confidence, which has ultimately incentivized people to invest again, hire again, and spend again.
Nobody knows the fragile state of the world like the biggest central banks. They’ve committed trillions of dollars over the past seven years to pull the world from the edge of apocalypse, to manufacture a recovery and to keep it all together along the way. With that, the Fed began reversing its emergency policies only because they knew the torch would be picked up by Europe and Japan. But it’s Japan that has the perfect ingredients to meaningfully change the path of the global economic recovery, and cement its certainty.
Japan, unlike many other major central banks (including the Fed), has all of the right ingredients to achieve its inflation goal via the printing press – it has the biggest debt load in the world (which can be inflated away by yen printing), it has persistent deflation (which can be reversed by printing), and it has decades of economic stagnation (which can be reversed with hyper easy money and improvements in the global economy).
In short, they can do all of the things that other powerful central banks/economies can’t do – and it can result in a huge benefit not just in Japan but for fueling a recovery in the global economy (as capital pours out of Japan). In a world with few antidotes to the structural economic problems, this is a potential solution for everyone. So perhaps the most important ingredient for a successful campaign in Japan – they have the full support/hope/wishes of the major global economic powers (U.S., Europe, U.K.).
The Japanese Prime Minister Abe was elected on the promise of ending the economic malaise and deflationary vortex that’s troubled Japan for more than two decades. And he hand appointed a governor of the Bank of Japan (Kuroda) to execute an all out war on deflation.
The Bank of Japan has promised to run their aggressive QE program at full tilt until they can produce a target of 2% inflation in their economy. But inflation is still dead in Japan. Both Kuroda and Abe have said in the past year that they’ve committed to do whatever it takes, and for as long as it takes. Importantly, a huge part of their success is (and will be) dependent upon higher Japanese stocks, and a weaker yen. They have explicitly said so. It’s part of their gameplan.
With that in mind, Japan surprised markets on January 29 by cutting rates to negative. Prior to that move, we made the case that they needed to act. The market was ripe for it. They did. They surprised many. But they haven’t gotten the desired effect.
Since they cut their deposit rates below zero, the yield on the 10 year Japanese government bond has gone negative. And the 20, 30 and 40 year bond yield has collapsed too — indicating the market doesn’t believe Japan will ever emerge for the deflationary vortex. On that note, the move to negative rates hasn’t worked thus far.
And when it comes to stocks and the yen, they’ve gotten the opposite of what they need and want.
Japanese stocks and the yen have returned back to the 2014 levels, when the BOJ surprised markets with a big second round of QE. So there’s been an undoing of significant policy action.
You can see in the chart below, the BOJ action on October 13, 2014 (“BOJ Surprise QQE2″), and the effect it had on stocks.
Source: Reuters, Billionaire’s Portfolio
Japanese stocks took off and rose 33% over the following eight months. And virtually all global stocks followed, including U.S. stocks. Now it has all reversed for Japanese stocks and the yen.
As we’ve said, before it’s all over, we think the BOJ will ultimately destroy the value of the yen, returning USDJPY to 250+ versus the dollar (last seen in the 1980s). USDJPY goes into the meeting around 105.
We know Bernanke met with the BOJ governor late last month to discuss the concept of “helicopter money” in Japan. So while the expectations have been set for more action, the magnitude of response could easily surprise. A negative surprise, where they do nothing tonight, would almost certainly put Japan in an even more difficult hole to fight out of.
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After the past two weeks, that included a Fed decision, more BOJ action, the approval of Japanese fiscal stimulus, a rate cut and the return to QE for the Bank of England, and a strong jobs report, this week is a relative snoozer.
