This week will could bring more clarity or volatility into the end of March with the data on tap for the week. The week will be driven a lot by inflation expectations in the US starting with PCE due out later today, Fed Reserve members speaking Tuesday and Thursday, ADP employment and Non-Farm payrolls are also due out Thursday and Friday respectively. These data points and metrics will be important to look at whether the Fed believes the US market can buck the trend of other major countries or if they have room to pare back their expectations of future rates.
Source: Yahoo Finance
Longer term the Central bank needs to keep the cost of borrowing lower than the growth rate in order to spur investment by companies and spending by consumers. When this occurs you can have a positive growth with declining debt. This worked for the US in the past and Europe and Japan have struggled for not taking this approach sooner, now as these two central banks are starting to take stimulus more seriously, the US is looking to tighten. This break from the rest of the major central banks will create misalignments in the flow of money and spending within regions. The carry trade will become popular again as invest see the higher rates in the US more attractive than the risk of the Eurozone or Japan.
How the US will manage this and the expectations the market has vs the Fed will be a very important part of this, so the numbers coming out over the week should not be overlooked as many will be gearing up for earnings season.
With the government in Japan weakening its assessment of the economy and talks with Nobel Prize winning economists, many are thinking that Abe will look to delay the increase in consumption tax due a year from now. The government is hoping this will boost confidence in the private sector, increasing spending by consumers and wages by companies. This is concerning in the long run because it will shake the foundation of the confidence in the bond market. As discussed in an earlier post the inflationary expectations will be the biggest factor to get people and companies to spend savings.
Japan is facing issues with the amount of debt that they are buying back in an effort to spur inflation, not from the lack of inflation being spurred but from the very outcome they are looking to achieve: inflation.
Once Japan reaches its goal of spurring inflation (in all fairness they have a long way to go with that) and inflation expectations start to creep into the economy and businesses more money will be spend on consumption and business expansion. This will take a portion of the buyers of JGBs out of the market at the same time that the Bank of Japan is looking to cut back on the asset purchasing. The question to ask then is who will be the buyer of JGBs?
When this comes there will be a need to build confidence with international investors that the government is serious about its debt load and offer a higher rate to attract investors from higher rates in the US or EM if volatility resides. If this cannot be achieved the BOJ will have to continue to be the buyer of most of the bonds issued in order to fill the budget gaps and rolling of debt. This could effectively get Japan stuck into a scenario where they will have to monetize their debt as well as large portions of their budget. It will be at this time that Abe and others in Japan will look back on what confidence they should have been trying to restore.
The Bank of Japan has left things unchanged at the meeting early today in Asia. They have acknowledged the risks to slowing economies in the rest of Asia they seemed too upbeat about the prospects of a turnaround.
In the statement the BoJ said that a virtuous cycle in will come from domestic spending and a rebound in exports from other Asian economies coming out of their downturns. This seems a bit optimistic and many economists that were surveyed by Bloomberg still believe there will be more stimulus added by the summer.
One of the biggest problems that I am glad to see in the statement is that the confidence of businesses will have to change in terms of inflation. The inflationary mindset will be the biggest hurdle to the success of Abenomics and this can be monitored by looking at the cash on the sidelines (and still in JGBs). With a proper inflationary mindset there will be more cash used in investments into companies and people to grow and outpace the expected inflation rate. With the Yen in a stronger position over the year and the economy of Japan still not confident in growth after the latest GPD numbers, the Central Bank will have to do more to change confidence.
Policy seems to be setting the standard in the markets as of late. Oil is going up on talks of coordinated cuts across OPEC and Russia. Iron Ore and other china related commodities spiked because of the People’s Congress meeting and the hope of stimulus as a result. Japan’s economy is confirmed to have shrunk in the 4th quarter of 2015, which will have many speculating more simulative measures from that government there as well. With the ECB meeting on Thursday expecting more stimulus and the only question is the method(s) taken this week will be shaped by the events of the ECB (or lack of them) that will set the mood in terms of rates, bank stocks, and commodities. The current speculation of negative rates not having the same effect as asset purchases did when first introduced has caused some concerns among investors that the ECB will have to try and quell. Whether this means taking more asset purchases on, or extending the existing scheme, or both, will he weighed.
In Japan however the markets have given a clear sign that they are not pleased with the negative rate decision, seeing the Yen spike off the announcement should be looked at by the BoJ as a sign that investors will want a more comprehensive form of stimulus as opposed to negative rates on selective deposits. This measure did more to hurt bank shares and instill panic into the market (causing a flight to safety) than convince the markets that inflation will pick up.
Remember the end goal of all of these simulative measures is to boost inflation expectations, which is changing how market participants think. The difficulty lies in implementing unconventional measures and expecting a rational result in the wake of irrational market volatility. A tall order.
Today’s Jobs numbers are all about wage inflation. Should there be more pressure on the costs of hiring the Fed will tend to look more hawkish at its next meeting. This would help confirm the assumption that the US can be an outlier and raise rates as other central banks lower theirs. It would be interesting to see the effect on the dollar, which has been creeping back from its lows in February against a basket of currencies.
In March the ECB is expected to come out with more stimulus measures, possibly taking the lending rate deeper into negative territory. Increasing concerns in Japan have many thinking measures will have to be stepped up with the BoJ this year as well. If these measures hold true and the US does remain the outlier in the disinflationary pressures plaguing the global economy, the dollar index is sure to surge. But at what level is the stronger dollar going to slow growth?
Oil has been quiet in recent days, with volatility down and the price rising steadily. A lot of this has been attested to the talks between Saudi Arabia and Russia in their pledge to freeze production increases. This could have given reluctant buyers the conviction to take speculative positions forcing up oil and oil related stocks. The stability of oil prices will have longer term effects on oil price directions as companies start to look at the reality of a lower price band and move their cap-ex towards projects that will align with the new reality of oil prices.
A good example of these shifts is the series of discussions in Canadian politics about the need for the oil industry to transport their goods to global buyers and not rely on transportation to the US and the sole selling point for oil. The oversupply in US oil has caused the majority of the pain in Canada because they couldn’t tap the global markets after the denial of the Keystone XL permit. Looking at companies that are making a shift in exploration and cap-ex to meet the new economic realities of the energy market will be good long term plays which, in hindsight, are priced very attractively.