7/26/2016 0 Comments
Japan falls short again
News that Japan will fall short on stimulus has strengthened the Yen back below 105 to the dollar. Market expectations are looking for more to be done in terms of Fiscal stimulus. While the BoJ is expected to ease policy further at the end of its meetings, there isn’t too much that can be done without the fiscal side stepping in.
This issue is not unique to Japan (though more urgent). European countries are in need of direct stimulus to their economies and banking sector but are prevented from doing so by Euro regulations. The UK post referendum will most likely see a slowdown and depending on the severity, may have to see more than rates cuts to spur growth again. Japan is beyond the point where it will need government spending to pick up. Shocks to the currency after the introduction of negative interest rates was unexpected and there could be more uncertainty with a deeper cut into negative territory. Therefore it will be a better bet to have a coordinated effort, greater than expectations, which show investors and retailors you are serious about starting the economy back up.
Until these issues get fixed in Japan you can use the country’s economy as a sign of things to come for the EU. Doing too little too late diminishes the shock value of the moves and will put businesses and investors into wait and see mode before taking action after stimulus does occur.
The BoE governor Weale came out saying that bank officials need more evidence before a rate cut and the August cut many expect is not a given. This is one of a latest string of trends where officials are seeing resiliency in the markets after Brexit. What this will do to expectations and the markets has yet to be seen.
In the near term the talk of things not being as bad as many feared can be a good thing. An overreaction by officials could bring about even more uncertainty and become self-fulfilling to the greater economies. Many central banks are now in a ‘wait and see’ mode in order to assess what the real toll of the Brexit to employment, spending, and inflation. In some countries in Europe this has exacerbated some issues that were already present and has no doubt put business investment on a slower path. But overall there is some hope that the new UK government, dialogue between the UK and EU, and central banks monitoring the situation will keep the economy moving along.
In the longer term the language out of the BoE and elsewhere could again raise the question of whether the markets are expecting too much accommodation from central banks as a result of the market shocks. Not taking into account the mandates that central banks have to look at could expose a disconnect between market interest rates and even equity prices. Equities have seen a rise from the post Brexit lows from the classic self-reinforcing assumption that market turmoil will lower rates as investors run to safety, then lower rates or more stimulus will keep rates lower, boosting the attraction of equities.
As rates go into negative territories in Europe and Japan, the desire for central banks to stay at these levels will wear thin. Any outlook to the contrary of the doomsday scenarios that the markets priced in could be dashed by the data coming out in the coming months as well as central bank speeches.
The Bank of England did not look to increase stimulus or cut rates at this meeting, which many were anticipating. The reaction was a drop in the UK 10yr price, moving yields higher. Across the world we are seeing yields continue to hit record lows and the BoE’s decision to stand pat was the first of expectations of easing not being satisfied. Should the Fed talk alter today be less dovish and Data points for the US and UK are better than the expectations, you could see interest rates start to move Treasuries and even Gilts back towards safe havens.
This could have a negative implication on Gold and Silver, where the rise in these metals can be correlated with the dampening expectations of inflation and interest rates over the coming years. To an extent the rise in the precious metal prices are justified, growth across the globe is being revised lower and inflation expectations are going with it. Central banks seem to need to start increasing asset purchases in Japan, the Eurozone, and the UK (depending on data according to the minutes). As discussed in an earlier post, expectations of longer term interest rates and the price of precious metals will have a higher correlation and any mis-match in expectations could take the wind out of the precious metal rally.
Revisions to Japan’s growth forecasts and inflation prospects have helped give the Yen a much needed decline. Many investors believed that the successful election results and an upcoming meeting with Former Fed chair Ben Bernanke means that more stimulus is on the horizon. This would be a welcome addition for the economy, which has been suffering from the strength of the Yen and would experience more pain from the post Brexit highs reached recently.
One point that holds some promise if the ability for the central bank and the newly elected parliament to coordinate fiscal and monetary stimulus. This will be needed to turn around the falling growth and inflation forecasts. With many in Japan becoming more skeptical of Abenomics and its ability to succeed, the timing of stimulus should be sooner. Many businesses and consumers are paring back their spending because of the recent turmoil brought on By Brexit and the rest of Europe.
Jobs numbers will be the big new event of the week with analysts thinking a rebound is in order after May’s poor numbers. I would agree that moves in the dollar and interest rate prospects in the US will be linked to this report more than usual. Market participants are looking for a safe haven that has a positive return with no prospects of capital loss. The rise in gold prices seem to show how little there is of these other assets to go around.
On the other end of the spectrum a jobs report that comes out better than many expect; sharp upward revisions, higher wage growth, higher participation rate, you could see the looming prospects of rate increases coming back into the picture. In either of these scenarios you will see the Dollar and yields in treasuries re price as the last bastion for safety or the next country moving towards lower for longer.
Markets have taken prices of gold and silver to new highs and there is talk of the rally being over, and the rally just beginning. With precious metals it is difficult to place a finger on the factors that make move in either direction. With no major industrial uses the metals are thought of as currencies, commodities, or alternative asset.
Whatever the reason for people to get into precious metals the universal reason to get out is the lack on income from holding longer term, especially in the face of higher rates. Now in the current settings we have no real loss of income from holding gold, in fact in some countries it would be better to hold gold as the yields on other safe haven alternatives (I struggle to call them that with a guaranteed loss) are negative.
Before the Brexit there was a sense of safety in Gilts and US Treasuries because of the higher interest rates and the prospects of higher yields in the future. Post Brexit the markets seem to be pushing the Fed’s next rate increase further into the future. The UK is now expected to ease policy and lower rates as a result of the referendum. This combination of lower for longer and the possibility of cuts is creating an opportunity for gold and silver to be a safe haven for Europeans. To measure the interest in precious metals going forward I would look to the European and UK yields as a guide. Excluding the periphery countries, most of Europe is going deeper into negative rates (Japan included) and the Pound has collapsed in value and continues to stay volatile. This makes Gold and Silver the perfect place to park gold in the interim. Factors to watch would be good economic data from the US, giving investors some hope that the US will not turn around and resort to easing anytime soon.
Markets look to open to the downside after US holidays with risk off plays back in focus. Brexit news is still causing the markets hold on to safe haven assets and add to them in the form of Silver and German Bunds. There is little reason to expect this trend to stop without some decisions made by the UK in terms of leaving the EU officially. It seems that all party members will wait until the autumn elections to make a decision, and possibly the end of the year before starting article 50 proceedings. This will cause uncertainty as businesses will no doubt delay investments into the country’s economy and possibly start moving parts of their business out. There are some hoping that a turn of events will change the minds of the British people to elect someone who will have another referendum on the subject of leaving and make this all a bad dream. While this could be the case for the UK the mindset of the European Union and the Eurozone as a viable entity will still be in question. This will not be as easily reversible.
The Brexit has already brought Italian Banks and the far left parties into focus as major threats to the Euro. Not to mention Greece. As spreads in the Eurozone widen across countries you will be able to see if the European experiment is starting to look shaky in the eyes of the markets. As long as German Bunds stay at negative yields out to the 10yr mark while Italian and Spanish yields continue to rise, it is safe to assume the markets are pricing in the two speed Europe or worse.
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