September was a reasonably volatile month as the markets had to digest key meetings from the ECB, BOJ & Fed and deal with a renewed focus on the viability of Deutsche Bank, after the US Department of Justice (DOJ) put forward their opening bid on the mortgage-securities cases fines. The ECB was the first key central bank meeting and they disappointed markets as they chose not to extend the QE program another six months. The Fed managed to out-dove the markets yet again and now view interest rates as only ‘moderately accommodating’. Given how quickly their estimates of the neutral rate are falling they may well have completed the tightening cycle after only 1 hike. While the markets are now keenly awaiting a fiscal response we fear this may only be forthcoming materially in the next recession, which increasingly looks not that far away.
It seems everyone in power is doing their best to perpetuate this state of denial. World debt-to-GDP has reached new highs again, with governments driving the borrowing via directly running fiscal deficits or by promoting growth in debt elsewhere through policy. Global central banks are also doing their bit to avoid the admission of a lower level of trend growth and inflation by essentially ‘fixing’ prices in bond, credit, and equity markets. Previously we had a set amount of buying conducted by central banks under the banner of “quantitative easing,” which started with the buying of government bonds. This could arguably be seen as a more ‘normal’ type of monetary easing as it attempted to get yields down without actually intentionally controlling them. This is only true of course if it doesn’t impede market liquidity, but this is pretty hard to avoid when you’ve been forced into a situation where you are essentially indefinitely tied to the program. The argument gets far weaker as they began buying credit and equities, as these markets far exceed their remit except in cases of extreme market stress. Maybe they know more than we do and the market is in a state of extreme stress? Either way, the Bank of Japan meeting at the end of September was a key turning point and a monumental shift in actions of central banks, which now explicitly have no interest in allowing markets to clear.
The BOJ’s latest volley: QQEWYCC
The Bank of Japan (BOJ) meeting was eagerly awaited as it had already announced a comprehensive review of monetary policy, so a radical change was the only option for the bank given the build in expectations. The Yen has appreciated roughly 25% since they announced negative interest rates, resulting in material disappointments in both growth and inflation. The new policy is called “Quantitative and Qualitative Monetary Easing (QQE) with Yield Curve Control” and it is as confusing as it is difficult to say. The BOJ explains:
“The new policy framework consists of two major components: the first is "yield curve control" in which the Bank will control short-term and long-term interest rates; and the second is an "inflation-overshooting commitment" in which the Bank commits itself to expanding the monetary base until the year-on-year rate of increase in the observed consumer price index (CPI) exceeds the price stability target of 2 percent and stays above the target in a stable manner.”
Who’s in control? And of what?
It is, however, the first part of this paragraph that has the keyword in it which is a substantial shift away from current extraordinary monetary policy, that word is ‘control.' “The Bank will control short-term and long-term interest rates” is a far step from what any other central bank is currently doing right now. That they are looking to control the shape and level of the yield curve highlights the arguments we have made in previous newsletters; that market manipulation is accepted and that ‘the man’ really doesn’t care what the market thinks and has decided to fix levels without considering supply and demand dynamics.
Extract contributed by BT Investment Management & written by Vimal Gor. Read his full Income & Fixed Interest Newsletter here: (VIEW LINK)