Tag Archives: #PEPP

Infinite Buying

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Is infinite buying
Kuroda-san’s new mantra
If so, will it help?

An interesting lesson was learned, for those paying attention, yesterday after a headline hit the tape about the BOJ. The headline, BOJ Considering Unlimited JGB Purchases, had an immediate impact on the yen’s value, driving it lower by 0.7% in minutes. After all, logic dictates that a central bank that will buy all the government debt available will drive rates, no matter where they are, even lower, and that the currency would suffer on the back of the news. But, as is often the case, upon further reflection, the market realized that there was much less here than met the eye, and the yen recouped all those losses by early afternoon. In fact, over the past two sessions, the yen is essentially unchanged overall.

But why, you may ask, would that headline have been misleading. The key is to recognize that the BOJ’s current policy describes their QQE (Qualitative and Quantitative Easing) as targeting ¥80 trillion per year, equivalent in today’s market to approximately $740 billion. But they haven’t come close to achieving that target since 2017, actually only purchasing about ¥15 trillion last year. That’s a pretty big miss, but a year after they created that target, they began Yield-Curve Control (YCC), which states that 10-year JGB’s will be kept at around a 0.0% yield, +/-0.2%. Now, given that the BOJ already owns nearly 50% of all JGB’s outstanding, there is very little actual trading ongoing in the JGB market, so it doesn’t really move very much. The point is, the BOJ doesn’t need to buy many JGB’s to keep yields around 0.0%. However, they have been concerned over the optics of reducing that ¥80 trillion target, as reducing it might seem a signal that the BOJ was tightening policy. But now, in the wake of the Fed’s announcement that they will be executing unlimited QE, the BOJ has the perfect answer. They can get rid of a target that no longer means anything, while seeming to expand their program. At the same time, when pressed, they will point to their successful YCC and claim they are purchasing everything necessary to keep rates low. And in fairness, they will be right.

Next week it’s the central bank three
Who meet and they’ll try to agree
On proper next steps
(Increasing the PEPP?)
And printing cash like it was free

This was merely a prelude to what the next several days are going to hold, anticipation of the next central bank actions as the three major central banks, BOJ, Fed and ECB, all meet next week. At this point, we have already seen all the excitement regarding the BOJ, and as to the Fed, while they may well announce more details on their efforts to get funds flowing to SME’s, they are already at unlimited QE (and they are active, buying $75 billion/day) and so it seems unlikely that there will be anything else new to be learned.

The ECB, however, is the place where all the action is going to be. Remember, Madame Lagarde was a little slow off the mark, when back in March she stated that the ECB’s job was not to worry about spreads in the government bond market. Granted, within two weeks, after the market crushed Italian BTP’s and called into question Italy’s ability to fund its Covid-19 response, she realized that was, in fact, her only role. And so subsequently we got a €750 billion PEPP program that included Greek debt for the first time. But clearly, based on the recent PMI data, as well as things like this morning’s Ifo Expectations Survey (69.4 vs. exp 75.0), more is needed. So, speculation is now rampant that PEPP will be increased by €250 billion, and that the Capital Key will be explicitly scrapped. The latter is important because that is the driver of which nation’s debt they purchase and is based on the relative size of each economy. But the main problem is Italy, and so you can be sure that the ECB is going to wind up with a lot more Italian debt than would be allowed under the old rules.

Turning back to this week, though, we still have a whole day to traverse before the weekend arrives. Overall, markets are beginning to quiet down, with actual volatility a bit softer than we had seen recently. For example, though equity markets in Europe are lower, the declines are between 0.7% (FTSE 100) and 1.1% (Spain’s IBEX), with the CAC and DAX in between. If you recall, we were seeing daily movement on the order of 2%-5% not that long ago. The same was true overnight, with the Nikkei (-0.9%), Hang Seng (-0.6%) and Shanghai (-1.1%) all softer but by less dramatic amounts. As to US futures, while they were negative earlier, they are actually currently higher by about 0.5%, although we have a long way to go before the opening.

Bond markets are uninspiring, with Treasuries basically unchanged. European markets are a bit firmer (yields lower) across the board as investors try to anticipate the mooted increase in PEPP. And JGB’s are yielding -0.026%, right where the BOJ wants them.

The dollar this morning is now ever so slightly softer, with CAD actually the leading gainer up 0.2%, while the rest of the G10 is +/-0.1%. The Ifo data was the only release of note, although we have seen oil prices rebound slightly, currently higher by about 1.0% helping both CAD and NOK. In the EMG bloc, the story is a bit more mixed, although gainers have had a better day than losers. By that I mean, CZK (+1.35%), HUF (+1.1%) and RUB (+1.0%) have seen stronger gains than the worst performers (INR and KRW both -0.5%). As always, there are idiosyncratic drivers, with CZK seeming to benefit from word that lockdowns are about to ease, while HUF is gaining on the imminent beginning of QE purchases by the central bank. As to RUB, the combination of oil’s continuing rally off its worst levels earlier this week, and the Bank of Russia’s 50bp rate cut, to 5.50%, has investors looking for better times ahead. Ironically, that stronger oil seems to be weighing on the rupee, while the won fell as foreign equity selling dominated the market narrative.

Yesterday’s Claims data was pretty much as expected, granted that was 4.4M, still horrific, but the market absorbed the news easily. This morning brings Durable Goods (exp -12.0%, -6.5% ex transport) and then at 10:00 Michigan Sentiment (68.0). Not surprisingly, expectations are for some of the worst readings in history, but the way the market has been behaving, I think the risk is actually for a less negative data print and a sharp risk rally. Eventually, unless there really is a V-shaped recovery, I do see risk being shed, but it doesn’t seem like today is the day to get started.

Good luck, good weekend and stay safe
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A Huge Threat

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In Europe officials now fret
‘bout dealing with Italy’s debt
If it gets downgraded
It could be blockaded
From PEPP, which would be a huge threat

At home, both the Senate and House
Agreed that it’s time to espouse
More spending is needed
And so, they proceeded
To spend half a trill, thereabouts

While oil prices are still getting press (and still under pressure), the return to positive prices has quickly turned that story into one about supply and demand, and the knock-on economic impacts of lower oil prices, rather than the extraordinary commentary on the meaning of negative prices for a commodity. In other words, it’s just not so exciting any more. Instead, today has seen markets turn their collective attention back toward government and central bank activities with investors trying to determine the next place to take advantage of all the ongoing financial largesse.

Starting in Europe, this evening the ECB will be having a video conference to discuss its next steps. Topic number one is what to do about Italian, and to a lesser extent, the rest of Southern Europe’s debt. Remember, the ECB is precluded from financing government spending by its charter, and the Teutonic trio watch that issue like hawks. So, news from Rome this morning that highlighted PM Conte’s promise to double the stimulus spending to €55 billion in order to better support the economy is at odds with that promise.

The problem is, that much spending will take the budget deficit above 10% of GDP and drive the debt/GDP ratio above 155%. While the latter will still simply be the third highest ratio in the world (Japan and Greece have nothing to fear yet), both the budget and debt numbers are far higher than currently allowed under the Stability and Growth Pact as defined by the EU. (For good order’s sake, the EU demands its members to maintain budget deficits below 3% of GDP and a debt/GDP ratio of 60% or lower).

A potentially larger problem is that Italy’s sovereign debt is currently rated at BBB with a negative outlook, just two notches above junk. Italian interest rates have been rising as BTP’s are no longer seen as a haven, but rather a pure risk trade. Combining all this together puts the ECB in a very tough position. If Italian debt is downgraded to junk, the ECB charter would preclude it from purchasing Italian debt. But if that were the case, you could pretty much bank on a collapse in the Italian bond market, followed by a collapse in the Italian economy, and a very real risk that Italy exits the euro, likely collapsing that as well. Clearly, the ECB wants to prevent that sequence of events. Thus, to successfully sail between the Scylla of financing government spending and the Charybdis of a euro collapse, the ECB is very likely to revise their collateral rules such that sub-investment grade debt is acceptable to purchase. And they will be buying the long-dated bonds which they will hold to maturity, thus effectively funding Italy but being able to technically tell the Germans they are not. It is an unenviable position for Madame Lagarde, but the alternatives are worse. Once again, if you wonder about the euro’s long-term viability, these are the questions that need to be answered.

However, despite the latest drama on the rates side, the market seems to be focusing on the positive stories today, namely the decisions by a number of European governments to gradually reduce the ongoing covid-inspired restrictions on their citizens. Throughout Europe, small shops are gradually being allowed to reopen and there have been discussions of schools reopening as well. The infection data appears to have stabilized overall, with many countries reporting a downtick in the number of new infections. Governments worldwide have the unenviable task of balancing the risk of further damage to their economies vs. the risk of another increase in the spread of the disease. At this time, it seems clear that there is a broad-based move toward getting on with life. And that’s a good thing!

In the meantime, this morning, the House is set to approve the Senate bill to extend further stimulus in the US, this time with a $480 billion price tag. The bulk of this will go to extending the Paycheck Protection Program, but there are various other goodies to support farms and hospitals. As well, the discussion about reopening the US economy continues apace, with the latest updates seeming to show that about half the states, mostly in the Midwest and mountain states, are going to be returning to a more normal footing, as they have been the least impacted. Even parts of western New York are now being considered for a removal of restrictions, given the demographic there is far closer to Wyoming than Manhattan.

Put it all together, and the bulls get to define the narrative today, with a better future ahead and more government spending to support things. It should be no surprise that equity markets are modestly higher this morning, with European bourses up by 1% or so, and US futures higher by a similar amount. Treasuries have seen some supply, with the yield on the 10-year rising 2bps, and the dollar is softer vs. almost all other currencies.

In the G10 bloc, only NOK is weaker today, and by just 0.1% as oil prices continue to slide, but even CAD, also closely linked to oil, is higher today, up 0.5%. Aussie is the biggest winner today, higher by 1.0% after a short-covering spree emerged in the wake of better than expected Retail Sales data. But the dollar’s weakness is broad-based today.

EMG currencies are also faring well today with ZAR (+1.15%) leading the way on the back of a $26 billion stimulus package, and RUB (+0.75%) following up as traders begin to believe the currency markets have oversold the ruble. MXN (+0.55%) is gaining on the same thesis, and, in fact, most of the space is higher due to this more positive feeling in the markets. The one outlier here is KRW (-0.2%) which is coming under pressure as a second wave of Covid infections makes its way through the country.

On the data front this morning, there is nothing of note to be released in the US. Yesterday saw Existing Home Sales fall slightly less than expected, to 5.27M, but just slightly. All eyes are on tomorrow’s claims data, as well as the PMI’s. The only data from Europe showed that UK inflation remains quiescent (and is likely to fall further) while Italian industry continues to shrink with Industrial Orders -2.6% in February, ahead of the worst of the outbreak.

Risk has a better tone this morning, but I fear it has the ability to be a fleeting break. Markets have shown they still like new stimulus, but at some point, questioning the ability to pay for it all is going to overwhelm the short-term benefits of receiving it. Today doesn’t seem like that day, but I assure you it is getting closer.

Good luck and stay safe
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