Friday, October 31, 2014

BoJ's Halloween Surprise?

 Leika Kihara and Tetsushi Kajimoto of Reuters report, Japan's central bank shocks markets with more easing as inflation slows:
The Bank of Japan shocked global financial markets on Friday by expanding its massive stimulus spending in a stark admission that economic growth and inflation have not picked up as much as expected after a sales tax hike in April.

BOJ Governor Haruhiko Kuroda portrayed the board's tightly-split decision to buy more assets as a preemptive strike to keep policy on track, rather than an admission that his plan to reflate the long moribund-economy had derailed.

But some economists wondered if pushing even more money into the financial system would be effective as long as consumer confidence continues to worsen and demand remains weak.

"It's clearly a big surprise given Kuroda's repeated insistence that policy was on track and assorted politicians have been warning about the negative side of a weak yen currency," said Sean Callow, a currency strategist at Westpac.

"We salute the BoJ for admitting that they weren't going to reach their goals on inflation or GDP, though we do note that the new policy equates to about $60 billion of quantitative easing per month. This perspective does raise the question of just how much impact monetary policy is having."

The jolt from the BOJ, which had been expected to maintain its level of asset purchases, came as the government signaled its readiness to ramp up spending to boost the economy and as the government pension fund, the world's largest, was set to increase purchases of domestic and foreign stocks.

"We decided to expand the quantitative and qualitative easing to ensure the early achievement of our price target," Kuroda told a news conference, reaffirming the BOJ's goal of pushing consumer price inflation to 2 percent next year.

"Now is a critical moment for Japan to emerge from deflation. Today's step shows our unwavering determination to end deflation."

Kuroda said the BOJ's easing was unrelated to major portfolio changes by the Government Pension Investment Fund (GPIF) also announced on Friday, but the effect of the day's two major decisions means that the central bank will step up its buying of Japanese government bonds, offsetting the giant pension fund's increased sales of them.

The BOJ's move stands in marked contrast with the Federal Reserve, which on Wednesday ended its own "quantitative easing," judging that the U.S. economy had recovered enough to dispense with the emergency flood of cash into its financial system.

In a rare split decision, the BOJ's board voted 5-4 to accelerate purchases of Japanese government bonds so that its holdings increase at an annual pace of 80 trillion yen ($723.4 billion), up by 30 trillion yen.

The central bank also said it would triple its purchases of exchange-traded funds (ETFs) and real-estate investment trusts (REITs) and buy longer-dated debt, sending Tokyo shares soaring and prompting a sharp sell-off in the yen.

Kuroda said that while the economy continues to recover, plunging oil prices, slowing global growth and weak household spending after the tax hike were weighing on price growth.

"There was a risk that despite having made steady progress, we could face a delay in eradicating the public's deflation mindset," he said.

Before Friday's shock decision, Kuroda had been relentlessly optimistic that the unprecedented monetary stimulus he unleashed 18 months ago would succeed in bolstering an economic recovery and ending 15 years of falling prices.

But the world's third-largest economy has sputtered despite the BOJ's asset purchases and earlier government spending.

Most economists polled by Reuters last week had expected the central bank to ease policy again but not so soon. A majority had expected it to move early next year.

The bank's previous failed effort to defeat deflation via quantitative easing (QE) in the five years to 2006 failed.


Still, Economy Minister Akira Amari called the BOJ's easing a timely move, saying the decision was related to but separate from Prime Minister Shinzo Abe's looming decision on whether to raise the sales tax again next October, which would help rein in hefty government debt but risk a further economic blow.

In a semiannual report, the BOJ halved its growth forecast for the fiscal year to March to 0.5 percent. It trimmed its CPI forecast for fiscal 2014 and 2015, but still expects to meet its inflation target within the two years it originally set out.

"This is very significant because it reasserts Kuroda's leadership over the policy board, which was beginning to show open dissent," said Jesper Koll, director of research at JPMorgan Securities.

"It recognizes what we have known, that the real economy has been weaker than expected, weaker than forecast, and reasserts that Kuroda thinks they can do something about this."

The benchmark Nikkei stock index .N225 spiked to a 7-year high on the BOJ bombshell and closed up 4.8 percent. The yen tumbled, with the dollar climbing to 110.91 yen, its highest since 2008, from 109.34 before the announcement.

"It’s easy money, so financials, banks and securities, and real estate stocks stand to benefit further," said Masayuki Doshida, senior market analyst at Rakuten Securities.

In a reminder of the challenges the central bank faces, data earlier on Friday showed annual core consumer inflation was 1 percent when stripping out the effect of April's tax hike, half the BOJ's target.

Household spending fell for a six straight month in September from a year earlier, while the job-availability rate eased from its 22-year high in August.

Also on Friday, a Japanese government panel overseeing the GPIF approved plans for the fund to raise its holding of domestic stocks to 25 percent of its portfolio from the current 12 percent.

The $1.2-trillion GPIF is under pressure from Abe to shift funds towards riskier, higher-yielding investments to support the fast-ageing population, and away from low-yielding JGBs.

With Abe set to decide in December whether to raise the sales tax next year to 10 percent from 8 percent, voices are growing for him to delay the planned fiscal tightening, given the economy's weakness.

Isamu Ueda, a senior official in Komeito, the junior party in Abe's coalition, said on Friday it would be difficult to press ahead with plans to raise the tax next year.

"I think conditions are severe for (raising the tax) next October," Ueda told reporters after a meeting of Komeito's economic revival council, which he heads.
The surprise decision by the Bank of Japan to engage in more quantitative easing prompted a huge rally in global equities and at this writing, U.S. stock futures are up sharply.

So what is going on? Despite unprecedented monetary and fiscal stimulus, Japan is still trying to slay its deflation dragon and Europe and the United States better be paying attention because this could very well be their future.

Interestingly, the Fed ended its quantitative easing program a couple of days ago and if you read the FOMC statement, it was somewhat hawkish, which makes me wonder if the Fed is on track for making a huge policy blunder.

Importantly, I think the Bank of Japan is right to be worried and the Fed is too complacent about contagion risks emanating from the euro deflation crisis, taking away the punch bowl too soon. The doves on the Fed, like James Bullard, understand the dangers of deflation spreading to the U.S. and why it's important to leave the door open for more QE down the road, but he's not a voting member. Charles Plosser and Richard Fisher, two of the hawkish presidents on the FOMC, voted to end QE but they will be replaced early next year and this could change the tenor of debate within the U.S. central bank's policy-setting committee.

I wrote my thoughts on Fed policy last Friday, emphasizing this:
...the biggest policy mistake the hawks on the FOMC are making is ignoring global weakness, especially eurozone's weakness, thinking the U.S. domestic economy can withstand any price shock out of Europe. If eurozone and U.S. inflation expectations keep dropping, the Fed will have no choice but to engage in more QE. And if it doesn't, and deflation settles in and markets perceive the Fed as being behind the deflation curve, then there is a real risk of a crisis in confidence which Michael Gayed is warning about. Perhaps this is the real reason why big U.S. banks are loading up on bonds (not just regulatory reasons).
It's also interesting to read how Japan's giant pension fund, the GPIF, is unloading JGBs to buy domestic equities but the BoJ is snapping them up to keep rates low (central banks are more powerful than giant pension funds). 

What does all this mean for the markets? Global risk assets will continue to rally and we will await the news from the European Central Bank to see if it finally starts engaging in massive QE. Morgan Stanley and Goldman Sachs are warning that European QE, while fully priced in, is neither imminent nor likely. If that's the case, then expect the Fed to stand ready to engage in more QE down the road, especially if inflation expectations keep dropping despite massive global monetary stimulus. 

Former Federal Reserve Chairman Alan Greenspan is right to warn of market turmoil as QE unwinds, but I don't think he understands the real danger in the global economy, namely, a protracted period of debt deflation. BoJ Governor Kuroda is way ahead of his global counterparts but he's fighting a losing battle. No matter what monetary authorities do, deflation and deleveraging are coming, and that will scare everyone next Halloween. 

Below, Marc Lasry, Avenue Capital chairman & CEO, explains how his hedge fund was able to profit from banks and Europe's "structural issues." Lasry also explains why he likes energy plays now, but he prefers playing the credit side than investing in energy stocks (I wouldn't touch energy or commodity stocks until you get a better sense of where inflation expectations are heading).

One thing Lasry said that I really liked (not in clips below) was when the risk-free rate was at 4%, distressed debt investing was expected to deliver 20% annually (5x the risk-free rate) but with rates at 0.25%, investors are happy with low to mid-teen returns, recognizing the "risk parameters have changed" and you have to take on a lot more leverage to obtain these returns. Smart guy which is why he's one of the best distressed debt investors in the world. Happy Halloween!

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